Producers' Fuel Co. v. Commissioner

1 B.T.A. 202, 1924 BTA LEXIS 216

• Court: United States Board of Tax Appeals
• Decided: December 18, 1924
• Docket: Docket No. 159.
• Status: Published

Opinion

OPINION.

Trussell:

This appeal presents for consideration two questions relating to the application of the Revenue Act of 1918 in determining the total income and profits tax liability of this taxpayer for the calendar years 1919 and 1920. The first question is the amount of net taxable income for the year 1920 and the second the application of the taxpayer for special assessment under the provisions of sections 327 and 328 of said Act for both the years 1919 and 1920.

This taxpayer, during the periods under review, was engaged in the business of a coal broker. In carrying on this business it was its practice to make contracts with coal mining companies for the delivery to it or upon its order of stipulated quantities of coal at agreed prices and for fixed' periods of time. The taxpayer itself was not the owner or operator of any coal mines or mining operations. It carried on its business by entering into contracts for the purchase and delivery of coal and thereafter securing buyers for such coal as it was under contract to purchase. In this manner it carried on a large but variable business, its gross sales in the year 1920 exceeding $10,000,000.

In the course of its operations it did on or about May 11, 1920, enter into a contract with the Monongahela Powder Co., hereinafter called the Monongahela contract, by. the terms of which the Monongahe’a Powder Co. agreed to sell, and this taxpayer agreed to buy, 15,100 net tons of coal at the fixed price of $4.15 per net ton of 2,000 pounds f. o. b. at the seller’s mines; said amount of coal to be delivered upon the order of this taxpayer at the rate of approximately 1,500 tons per month and the contract to be completely performed between the dates of May 15, 1920, and March 31, 1921. On or about the 27111 day of May, 1920, the taxpayer entered into a contract with Campbell, Peacock & Kinzer, Inc., a mining corporation, hereinafter referred to as the Campbell contract, by which the Campbell company agreed to sell, and this taxpayer agreed to buy 24,000 net tons of coal at a rate of delivery of approximately 2,000 tons per month and the contract to be completely performed between the dates May 27, 1920, and May 31, 1921, and the contract price of the coal under this contract was fixed at $4.75 per net ton according to railroad weights. While these two contracts appear to affect only a small part of the total business of this company for the year 1920, the operations under them present the only issue with respect to the amount of net taxable income raised in this appeal.

Immediately upon the execution of these contracts all the parties thereto entered upon and performed all their respective duties and obligations until on or about December 1, 1920, when it appears that due to an abnormal and unexpected slump in the selling prices of coal in the general market this taxpayer found that it could no longer sell the quantities of coal agreed to be purchased from month to month under these contracts without sustaining heavy losses and it appears that thereupon the taxpayer chose deliberately to breach these contracts and to default its obligations thereunder.

Having committed this breach of contract and defaulted in its obligations the taxpayer, of course, at once realized that it was in a position to be called upon to respond in damages in such an amount as the sellers in the contracts would be able to recover on account of the taxpayer’s failure to carry out its obligations, and with little delay the taxpayer began negotiations with a view to 'a compromise and settlement of such claims for damages as the selling companies could be found to have the right to recover and in this effort to compromise these liabilities it made definite offers of settlement, both to the Campbell company and the Monongahela company, offering to pay to the former as liquidated damages the sum of $15,000 and to the latter the sum of $4,500, in compromise 'and settlement of the taxpayer’s liability to said companies under their contracts. These negotiations began in the month of December, 1920. The proposed offers of settlement, however, were not promptly accepted and negotiations were still pending when the taxpayer closed its accounting period on December 31, 1920, at which time the taxpayer, realizing its liability growing out of its default upon these contracts, made an estimate of the probable amount of such liabilities upon each of said contracts and estimated the liability under the Campbell contract to be $30,000, and under the Monongahela contract to be $7,500, and set these respective sums upon its books as an accrued liability of its business for the calendar year 1920, and claimed each of said sums 'as a deduction from gross income when it made its income and profits tax returns for said year.

Thereafter it continued its efforts to compromise and settle these liabilities and ultimately succeeded in affecting such settlements. Liability under the Monongahela contract was settled on or about January 24, 1921, by the payment of the sum of $5,500. On or about January 29, 1921, a plan of settlement was agreed to with the Campbell company, under which this taxpayer, between that date and November 1, 1921, paid damages in the total sum of $29,792.40.

In support of its contention that it was and is entitled to claim the amount set up on its books 'as herein stated as deductions from gross income for the year 1920, the taxpayer relies, among other things, upon the following authorities:

Eevenue Act of 1918, section 234(a)—

That in computing the net income of a corporation * * * there shall be allowed as deductions:

***** * *

(4) Losses sustained during the taxable year and not compensated for by insurance or otherwise.

Regulations 45, article 111, where the following language occurs:

* * * A person making returns on an accrual basis has the right to deduct all authorized allowances, whether paid in cash or set up as a liability. * * *

In addition to the foregoing, the taxpayer’s brief quotes a number of other pronouncements of the Internal Revenue Bureau, all in line with the foregoing quotations.

We are thus led to what appears to be the vital question in this case: Whether the losses or damages to which this taxpayer became subject on account of the breach of the contracts and for which reserves were set up were liabilities actually incurred during the year 1920.

These contracts were entered into during the month of May, 1920, and from the date of their execution until approximately December 1, 1920, all of the parties to these contracts fulfilled their obligations thereunder and any profits or losses growing out of these business transactions were no doubt reflected on the taxpayer’s books in its regular method of accounting. On or about December 1, 1920, the taxpayer found that if it continued to operate under these contracts it faced the certainty of heavy losses on account of the slump in the selling price of coal. Thereupon, with the view, no doubt, of _ minimizing such losses to the greatest possible extent, it broke off its contractual relations, became in default in its obligations, and the other parties to the contracts, in pursuance to the terms thereof, terminated the contracts.’ All the parties thereto then entered upon negotiations looking to 'a compromise of the liabilities of this taxpayer.

The taxpayer’s computation of its liability for the breach of these contracts, may, in the absence of other evidence, be accepted, when its return is made, as a reasonable calculation of the amount that it could be called upon to pay in damages.

The taxpayer’s liability for damages on account of the breach of these contracts was a liability actually incurred at the date of the breach. In Donovan v. Sheridan, 24 New York Supplement, 116, the court says:

The law is settled that an action for breach of contract will lie at once upon a positive refusal to perform, although the time specified for performance has not arrived (citing Burtis v. Thompson, 42 N. Y. 246, and other eases).

Corpus Juris, vol. 13, 651, states the general rule of law as follows:

Where a party bound by an executory contract repudiates his obligation before time for performance, the promisee has, according to the great weight of authority, an option to treat the contract as ended so far as further performance is concerned, and to maintain an action at once for the damages occasioned by such anticipatory breach. The rule is the same whether the contract is wholly executory or has been partially executed.

Further support of the general rule of law above quoted and of the taxpayer’s contention in this case is found in United States v. Purcell Envelope Co., 249 U. S. 313, where the court says:

The Court of Claims decided that the measure of damages was the difference between the cost to the envelope company of materials and the manufacture and delivery of the envelopes and wrappers in accordance with the terms of its contract and what it would have made if it had been allowed to perform the contract. For this the court cited and relied upon Roehm v. Horst, 178 U. S. 1, 44 L. ed. 953, 20 Supreme Court Reporter 780. It is there decided that the positive refusal to perform a contract is a breach of it, though the time for performance has not arrived, and that liability for the breach at once occurs. And it is further decided that the measure of damages is the difference between the contract price and the cost of performance. The ease was replete in its review of prior cases. We may refer, however, to United States v. Speed, 8 Wall. 77, 85, 19 L. ed. 449; United States v. Behan, 110 U. S. 338, 28 L. ed. 168, 4 Supreme Court Reporter 81; Hinckley v. Pittsburgh Bessemer Steel Co., 121 U. S. 264, 30 L. ed. 967, 7 Supreme Court Reporter 875.

Under these contracts as originally made operations were expected to continue in the one case from May, 1920, to March, 1921, and in the other from May, 1920, to May, 1921, but owing to the breach and default which occurred in December, 1920, contractual relations were terminated and operations under such contracts ceased, and all opportunity for the production of either profits or losses passed, and there was nothing further to be done under these contracts except to arrive at a settlement of the taxpayer’s liability. We therefore arrive at the conclusion that the taxpayer’s liability to damages and losses under these breached contracts was incurred in the month of December, 1920, and at that time became a fixed liability for which it was entitled to claim a deduction from gross income for the year 1920.

While it appears that at the end of the year 1920 this taxpayer estimated its liability under the breached contracts with approximate accuracy and set the sum up on its books of account and then made its income and profits tax return in accordance with such books, we have now before us a review of that income and profits tax return and in making such review it is our duty to consiaer not only the facts known and recorded at the close of December, 1920, but also those same facts as modified by subsequent events. These subsequent events have developed the fact that the damages and losses sustained by the taxpayer on account of the breach of the Monongahela contract were settled for the sum of $5,500, and that the damages and losses sustained by the taxpayer on account of the breach of the Campbell contract were finally determined and settled for the sum of $29,742.40. With these facts before us, and for the purpose of determining the final net taxable income of the taxpayer for the year 1920, the amounts of damages and losses as finally determined must now be substituted for the estimate originally made, and in place of the deductions claimed by the taxpayer in his return and disallowed by the Commissioner the losses and damages as finally settled must be allowed as the deduction contemplated by the law.

TRammell, Marquette, and Smith dissent.