
    POND’S EXTRACT COMPANY v. THE UNITED STATES
    [No. 50029.
    Decided October 4, 1955]
    
      
      Mr. Edmund. W. Pavenstedt for the plaintiff. Messrs. White <& Oase and Mr. Josiah Willard were on the briefs.
    
      Mr. Harlan Pomeroy, with whom was Mr. Assistant Attorney General H. Brian Holland, for the defendant. Mr. Andrew^ D. Sharpe was on the brief.
   Laramore, Judge,

delivered the opinion of the court:

The plaintiff, sues to recover excess profits taxes, for the year 1944 in the amount of $118,301.24 with interest thereon on the ground that section 734 of the Internal Eevenue Code, as amended, 26 U. S. C. (Supp. IV) § 734 (1940 Ed.) was improperly applied by the Commissioner of Internal Eevenue, or in the alternative, for an equitable recoupment of income taxes overpaid for 1940, for which a timely claim for refund was not filed, against such excess profits taxes paid for 1944.

The facts, which have been stipulated, may be summarized as follows: The plaintiff filed its income and excess profits tax returns on the calendar year accrual basis. For the years 1932 to 1939, inclusive, the defendant claimed that plaintiff owed additional excise taxes of $1,346,469 plus interest. The plaintiff contested this claim and it was compromised in 1940 for $615,975.58, plus interest of $134,024.42.' Pursuant to this settlement plaintiff, in 1940, paid $750,000 to the defendant.

This $615,975.58 excise tax paid was allocated for income tax purposes to the years 1932 through 1939 in proportion to the total additional excise tax liabilities originally asserted by the Commissioner for each of these years. The amounts paid in settlement were claimed and allowed as deductions for income tax purposes for the years here in question, the base period years employed in determining the excess profits credit, as follows: 1936, $97,489.67;T937, $104,919.06; 1938, $112,711.98; 1939, $61,452.58. The entire amount of interest paid by.plaintiff under the settlement was claimed and allowed as a deduction in 1940.

In January 1944, the Supreme Court decided in Dixie Pine Products Co. v. Commissioner, 320 U. S. 516, that a contested tax liability could not be deducted until the taxable year in which the liability for the tax was finally adjudicated. This decision clearly indicated that in the instant case the amount of $615,975.58 was erroneously allocated over the years 1932 through 1939 and should have been déducted in 1940, the year, in which the contested tax liability was compromised.

If the amount of $615,975.58 had not been allocated and claimed and allowed as deductions for the years 1932 through 1939, and had been deducted in 1940, no part of plaintiff’s 1940 tax of $123,027.77 would have been payable and there would have been a net operating loss carryover and an unused excess profits credit carryover to the year 1941, which would have resulted in a tax savings to plaintiff on account of its 1941 tax liability of $12,576.18 in income tax and $54,-793.89 in excess profits tax.

In computing its excess profits tax credit for the years 1940 through 1943, plaintiff erroneously included the deduction of the allocated amounts in the base period years, thus incorrectly reducing its excess profits credit for the years 1940 through 1943. For 1944, plaintiff excluded the deduction of the erroneously allocated amounts from the base period years and correctly computed its excess profits credit for that year. If plaintiff had correctly computed its excess profits credit, its excess profits tax liability would have been the same for 1940, reduced for 1941 in the amount of $34,061.77, the same for 1942, and reduced for 1943 in the amount of $17,173.63.

Upon audit of plaintiff’s excess profits tax return for 1944, the Commissioner determined, in January 1947, that plaintiff had correctly computed its base period income for excess profits credit purposes for 1944 by eliminating as deductions the previously erroneously allowed excise tax deductions for the years 1936 through 1939, but made an adjustment in plaintiff’s excess profits tax liability for 1944 under section 734 of the Code because of plaintiff’s inconsistent position caused by its taking the erroneous deductions in the base period years. The section 734 adjustment was made by adding to plaintiff’s excess profits tax liability for 1944, as excess profits tax liability, an amount of excess profits tax measured by the income tax which plaintiff would have paid for the years 1936 through 1939 if the deductions on account of the excise tax settlements allocated to those years had not been allowed, plus interest. This adjustment was $84,182.39 plus $34,118.85 interest, or a total of $118,301.24. This section 734 adjustment less offsetting adjustments resulted in a deficiency in plaintiff’s excess profits tax for 1944 in the amount of $99, 318.48. The deficiency was assessed on June 27, 1947, and on July 28,1947, payments and credits in the total amount of $113,610.80 were made in satisfaction of the $99,318.48 and the interest in the amount of $14,292.32.

The plaintiff was allowed $34,118.85 deduction for the interest included in the section 734 adjustment, in the computation of its 1945 income and excess profits tax liability. As a result of this deduction and the consequent unused excess profits credit carryback to 1944, plaintiff’s income and excess profits tax liabilities for 1944 and 1945 were reduced by $25,907.53.

On July 26, 1949, plaintiff filed a claim for refund of its 1940 income taxes in the amount of $123,027.77 and a claim for refund of $123,027.77 of its 1944 excess profits taxes. The claim for 1944 was timely, at least to the extent of $113,-610.80, but the claim for 1940 was not timely. Both claims were rejected and suit was duly filed in this court.. The .amount of excess profits taxes, including interest, paid by or ■credited to plaintiff for 1944 on and after July 25,1947, does not exceed $113,610.80. See 26 U. S. C. § 322 (b) (2) (B).

The pertinent part of section 734 of the Code provides:

(b) Circumstances of Adjustment.—
1) If—
(A) in determining at any time the tax of a taxpayer under this subchapter an item affecting the determination of the excess profits credit is- treated in a manner Inconsistent with the treatment accorded such item in the determination of the income-tax liability of such taxpayer or a predecessor for a prior taxable year or years, and
(B) the treatment of such item in the prior taxable year or years consistently with the determination under this subchapter would effect an increase or decrease in the amount of the income taxes previously determined for such taxable year or years, and
(C) on the date of such determination of the tax under this subchapter correction of the effect of the inconsistent treatment in any one or more of the prior taxable years is prevented (except for the provisions of section 3801) by the operation of any law or rule of law (other than section 3761, relating to compromises), ■then the correction shall be made by an adjustment under this section. If in a subsequent determination of the tax under this subchapter for such taxable year such inconsistent treatment is not adopted, then the correction shall not be made in connection with such subsequent determination.
(2) Such adjustment shall be made only if there is adopted in the determination a position maintained by the Commissioner (in case the net effect of the adjustment would be a decrease in the income taxes previously determined for such year or years) or by the taxpayer with respect to whom the determination is •made (in case the net effect of the adjustment would be an increase in the income taxes previously determined for such year or years) which position is inconsistent with the treatment accorded such item in the prior taxable year or years which was not correct under the law applicable to such year. ■

The facts establish and the plaintiff concedes that the -technical requirements for the application of section 734 Ihave been met in this case. The plaintiff contends, however, that this section was designed as a relief provision to prevent overreaching on the part of a taxpayer or the Government in order to achieve a just result. The plaintiff then points out that the Government needs no relief, it already has more money than it is justly entitled to keep. The defendant’s position is that the application of section 734 is mandatory once its conditions have been met and that it was designed to discourage inconsistent positions and further that it would be inequitable not to apply section 734.

The purpose of section 734 and section 3801 was to correct errors made in prior years which were closed by the statute of limitations without allowing a double benefit to either the taxpayer or the Government. The person taking the inconsistent position is not required to take such a position, but if it is deemed advisable for present or future tax purposes to correct the error made in prior years these sections allow the correction. The allowance of such a correction with the recomputation of the tax for the prior year reflecting the change is inherently just and equitable, since it results in the payment of the correct tax. If the party taking the inconsistent positions persists in that position, the correction of the tax for the prior years is mandatory. Section 734 provides that “the correction shall be made by an adjustment under this section.”

We conclude that regardless of the equities, section 734 is mandatory if its conditions are met and since the conditions were satisfied in this case that section was properly applied.

We turn now to plaintiff’s contention of equitable recoupment of its income taxes overpaid for 1940, for which a timely claim for refund was not filed, against its excess profits taxes paid for 1944. The plaintiff relies primarily on Bull v. United States, 295 U. S. 247, and Stone v. White, 301 U. S. 532, which set up a case law exception to the statute of limitations where the application of the statute worked a palpable injustice. In the Bull case, where equitable recoupment was applied in favor of the plaintiff, the Commissioner was collecting an estate tax on money received after the plaintiff’s death and also collecting an income tax on the same amount. In the Stone case, where equitable recoupment was applied in favor of the Government, the Commissioner was allowed to retain the income tax erroneously collected from a trustee where the beneficiary, against whom the statute of limitations had run, was to ultimately receive the benefits of the refund. The basic facts of the Bull and Stone cases are essentially indistinguishable from those of the present case and the principle of equitable recoupment as enunciated in those cases would be applicable to the present case.

The Supreme Court, however, restricted and limited the Bull and Stone cases in Rothensies v. Electric Storage Battery Co., 329 U. S. 296. In the Rothensies case the taxpayer had overpaid its excise taxes for the years 1919 and 1926. In 1926 it sued for a refund for the open years, 1922 to 1926. The Commissioner settled by refund of $1,395,-515.35. The Commissioner included this refund as income for the year 1935 and the taxpayer sought recovery on the ground that the refund was either not income or that it was entitled to recoup the excise taxes overpaid for 1919 to 1922. In holding for the Government and severely limiting the application of recoupment in tax cases, the Supreme Court stated at pages 299 and 300:

* * * The essence of the doctrine of recoupment is stated in the Bull case: “recoupment is in the nature of a defense arising out of some feature of the transaction upon which the plaintiffs action is grounded.” 295 U. S. 247,262. It has never been thought to allow one transaction to be offset against another, but only to permit a transaction which is made the subject of suit by a plaintiff to be examined in all its aspects, and judgment to be rendered that does justice in view of the one transaction as a whole. * * * In both cases a single transaction constituted the taxable event claimed upon and the one considered in recoupment. In both, the single transaction or taxable event had been subjected to two taxes on inconsistent legal theories, and what was mistakenly paid was recouped against what was correctly due.

The Supreme Court pointed out that the statute of limitations itself was based upon fairness and the necessity to bring an end to claims, and specifically stated that the doctrine of recoupment should not be expanded in tax cases.

The task of distinguishing between factual situations that warrant tbe application of equitable recoupment in tax cases is admittedly a difficult one, and tbe distinction when made in some cases will be a tenuous one. However, we are of tbe opinion that plaintiff falls within the bounds of tbe Bull and Stone doctrine, as restricted by the Bothensies case. In tbe instant case there was only a single transaction or taxable event involved. That transaction was tbe 1940 erroneous allocation of the excise tax compromise. Because of this erroneous allocation made in 1940 and plaintiff’s desire to correct the mistake, and only because of that, the Commissioner was entitled to apply section 134, and in effect exclude the deductions from the base period years. The fact that the plaintiff took the inconsistent position by correcting its 1944 excess profits credit does not negate or devitalize the fact that plaintiff was, in effect, being taxed upon two inconsistent theories. One was that the settlement should not have been deducted from the base period years, thus it was excluded by the application of section 734, and additional tax was collected. The other was that a deduction was not allowed for 1940 when it was undeniably deductible in one or the other, thus the 1940 tax was not reduced. The failure to allow a deduction in one year or the other is equivalent to the same as taxing an item twice or the failure to pay any tax at all on an item. It is true that plaintiff could have filed a timely claim for refund, but that was also true in the Bull and Stone cases.

We think that it would be gross injustice under the facts and circumstances of this case, where the question of whether the settlement should be allocated or deducted in 1940 was much disputed, to allow the defendant to retain the plaintiff’s overpayment and also to collect additional taxes arising out of the same taxable event. The defendant is clearly entitled to the correct additional taxes under section 734, but plaintiff is entitled to recoup against that sum the taxes mistakenly paid; L e., $113,610.80, plus interest.

Judgment will be entered for plaintiff for $113,610.80 with interest as provided by law.

■ MaddeN, Judge; Whitaker, Judge; LittletoN, Judge; and JoNes, Chief Judge, concur.

FINDINGS OF FACT

The court, having considered the stipulation of facts and. ■the briefs and argument of counsel, makes findings of fact .as follows:

1. Plaintiff, Pond’s Extract Company, is and during the years 1932 through 1945 was a corporation of the State of Delaware, engaged in the business of manufacturing and selling cosmetics. It filed its federal income, declared value excess profits, defense and excess profits tax returns on the calendar year accrual basis. During all of this period and until early in 1954 plaintiff had its executive offices at 60 Hudson Street, New York City.

2. For each of the months beginning with June of 1932 .and ending with June of 1939, plaintiff filed a return with the Collector of Internal Eevenue on which it disclosed .manufacturers’ excise tax liability under Section 603 of the Eevenue Act of 1932 (47 Stat. 169) and corresponding provisions of later Eevenue Acts. The Commissioner of In-ternal Eevenue proposed assessments of additional excise ;.taxes and interest for each of these months.

Plaintiff resisted these proposed assessments. The proposed assessments of additional excise taxes for the period ■beginning with June of 1932 and ending with June of 1935 were made. When settlement attempts failed, securities were placed in escrow by plaintiff, the assessments for May and June of 1935, amounting to $47,259.52, were paid, and plaintiff commenced a test suit in which it contested its liability for the additional excise taxes.

Later, in 1940, these additional claims of the United States, for the aggregate amounts of $1,346,469.22 in excise taxes .and $292,965.73 in interest for the months beginning with June of 1932 and ending with June of 1939 and the test suit, were settled by payment by plaintiff of approximately 46% ■of such additional claims.

Pursuant to such settlement taxpayer paid to-the Collector of Internal Eevenue the sum of $750,000 (including the ■previous payment of $47,259.52) representing $615,975.58 in •excise tax liabilities and the balance in interest.

3. The total amount of the additional excise tax liabilities paid pursuant to this settlement was allocated, for income tax purposes, to the years 1932 through 1939 in proportion to the total additional excise tax liabilities originally asserted by the Commissioner for each of these years. Accordingly, the amounts paid in settlement of such liabilities were claimed and allowed as deductions for federal income tax purposes as follows:

а. 1936. $97,489. 67
1937. 104,919.06
1938. 112, 711.98
1939. 61,462.68
б. 1932 (479. 64)
1933. 32,071.78
1934. 107,906.83
1936. 99, 904.32
e. The entire amount of interest paid by plaintiff: under the settlement was claimed and allowed as a deduction in computing plaintiff’s 1940 federal income, declared value excess profits, defense and excess profits taxes. .

4. The periods of time during which the Commissioner of Internal Eevenue could have made assessments against plaintiff of additional income taxes for the years 1932 through 1939 expired on the following dates:

1932_ March 15, 1936
1933_ March 16, 1937
1934_ March 15, 1938
1935_ March 15, 1939
1936- June 30, 1941
1937_ March 15, 1941
1938_ March 15, 1942
1939- March 15, 1943

No assessments of additional taxes were made for the years 1932 through 1939 after the amounts of the settlement of plaintiff’s excise tax liabilities for 1932 through 1939 had been claimed and allowed as deductions for income tax purposes for those years. The allowance of such deductions became final on the dates specified in the first sentence of this paragraph, apart from consideration of Section 734 of the Internal Eevenue Code of 1939. The amounts of the excise tax settlements allocated for income tax deduction purposes to the years 1932 through 1939 and allowed as deductions for such years have not been claimed or allowed as deductions for income tax purposes for any years prior to 1932 or •subsequent to 1939, except that such amounts were claimed as deductions for income tax purposes for 1940 in one of the refund claims on which this suit is based as indicated in finding 16.

5. Plaintiff in its federal income, declared value excess •profits and defense tax return for 1940 reported net income of $512,028.75. On audit this amount was increased by '$714.46. Plaintiff paid total federal income, declared value excess profits, and defense taxes for 1940 in the amount of $123,027.77 to the Collector of Internal Eevenue, Second District of New York. It neither reported nor paid excess profits tax liability for 1940.

6. The period during which plaintiff could have filed a timely claim for credit or refund of income, declared value -excess profits, defense and excess profits taxes for the years 1940 and 1941 expired on March 15,1944' and March 15,1945, respectively. Plaintiff did not file a timely claim for refund -or credit of income, declared value excess profits, and defense taxes for 1940, or of income or excess profits taxes for 1941.

7. If the amount of $376,573.29, representing the aggregate amount of excise tax settlements allocated to and allowed as deductions for income tax purposes for the years 1936 through 1939, had not been so allowed and had been timely claimed and allowed as a deduction in 1940, plaintiff’s tax liability for that year would have been'reduced by $90,346.99 and there would have been an unused excess profits credit carry-over to the year 1941 which, if timely claimed, would have resulted in a tax savings to plaintiff on account of its 1941 tax liability of $54,793.89 in excess profits tax. By deducting the amount of $376,573.29, representing the aggregate amounts of excise tax settlements allocated to and allowed as deductions for the years 1936 through 1939, plaintiff’s income tax liabilities for the years 1936 through 1939 were reduced in the aggregate by $84,689.52. If the amount of $376,573.29 had not been claimed and allowed as deductions for the years 1936 through 1939, plaintiff’s income taxes for such years would have been increased in the aggregate by $84,689.52.

8.Plaintiff filed its federal income, declared value excess-profits, defense and excess profits tax returns for the years 1940 through 1945 on the following dates:

1940_March 14, 1941
1941_March 13, 1942'
1942_March 12, 1943-
1943_March 14, 1944
1944_March 14, 1945'
1945_March 14, 1943-

In these returns plaintiff computed its excess profits tax credit by the income credit method. In its excess profits tax returns for the years 1940 through 1948, in computing its-excess profits tax credit, plaintiff deducted, in computing its income for the base period years 1936 through 1939, the amount of the excise tax settlements previously allocated to and allowed as deductions for each of the base period years 1936 through 1939. This was the same basis upon which it paid its income taxes for the years 1936 through 1939.

9. In January, 1944, the Supreme Court of the United States decided Dixie Pine Products Co. v. Commissioner, 320 U. S. 516. The treatment for income tax purposes accorded the amounts of the excise tax settlements allocated to the years 1932 through 1939 was not correct under the law applicable to such years as announced in Dixie Pine Products Co. v. Commissioner, supra. Under this decision the amount of' $615,975.58, if it had not been allowed as deductions for years--1932 through 1939 and had been timely claimed as a deduction for 1940, would have been allowable as a deduction for federal income tax purposes in 1940, the year in which the contested excise tax liabilities were compromised, and not in the years 1932 through 1939.

10. If the amount of $615,975.58 which represents the entire amount of the excise tax liability settlements allocated and allowed as deductions for income tax purposes for the years 1932 through 1939 had not been claimed and allowed as deductions for such years and' had been timely claimed and allowed as a deduction for the year 1940 instead of for the years 1932 through 1939, no part of the 1940 tax of $123,027.77 set forth in finding 5 would have been payable and there would have been a net operating loss carry-over and an un~ used excess profits credit carry-over to the year 1941 which,, if timely claimed, would have resulted in a tax savings to plaintiff on account of its 1941 tax liability of $12,576.18 in income tax and $54,793.89 in excess profits tax.

11. In its federal excess profits tax return for 1944 in determining income for the base period years 1936 through 1939, for purposes of computing its excess profits tax credit by the income method, plaintiff followed the decision in the Dixie Pine Products Go. case, and did not deduct the amounts of the excise tax settlements which had previously been claimed and allowed as deductions in computing its income taxes for the years 1936 through 1939. Plaintiff’s excess profits credit was thereby increased. No notice under Section 35.734-2 (c) of Regulations 112 was filed by plaintiff.

12. Upon audit of plaintiff’s excess profits tax return for the year 1944, the Commissioner of Internal Revenue determined, in January of 1947, that plaintiff, in accordance with the position which it was asserting and maintaining, was entitled to compute its base period income for excess profits credit purposes by eliminating as deductions the previously allowed excise tax deductions for the years 1936 through 1939, but made an adjustment in plaintiff’s excess profits tax liability for 1944 under Section 734 of the Internal Revenue Code. No subsequent determination of plaintiff’s excess profits tax liability for 1944 has been made. The-Section 734 adjustment was made by adding to plaintiff’s excess profits tax liability for 1944, as excess profits tax liability, an amount of excess profits tax measured by the income tax which plaintiff would have paid for the years 1936 through 1939 if the deductions on account of the excise tax settlements allocated to those years had not been allowed,, plus interest as required under Section 734 as follows:

Year Additional income tax which plaintiff would have paid Interest to s/lB/jS Total: Additional excess profits tax liability for IB it
1936 _ $24,138.04 $11, 586. 26 $35, 724.30'
1937 _ 26,953.08 11, 320. 29 38,273.37
1938 _ 21,415.28 7,709. 50 29,124. 78'
1939 ^_ 11,675.99 3, 502. 80 15,178. 79
Totals_ $84,182.39 $34,118. 85 $118, 301.24:

13. The adjustment under Section 734 to plaintiff’s excess profits tax for 1944 and other offsetting adjustments resulted in a deficiency in plaintiff’s excess profits tax for 1944 in the amount of $99,318.48. This deficiency was assessed on June 27,1947. On and after July 28,1947, payments and credits in the total amount of $113,610.80 were made in satisfaction of said assessment of $99,318.48 plus interest in the amount of $14,292.32.

14. By following the decision of the Dixie Finé case in computing its excess profits credit plaintiff did not affect its income and excess profits tax liability for the year 1940; for the year 1941 such liability would have been reduced by $34,061.77 but no refund claim was filed therefor; for the year 1942 such liability was not affected; for the year 1943 it was reduced by $17,173.63; for the year 1944 it would have been reduced by $107,473.45 but for the adjustment under Section 734, set for in finding 12, which converted this reduction into a net increase of $10,827.79; fo.r the year 1945 the liability was reduced by $20,392.60.

15. Plaintiff was allowed a deduction of $34,118.85, representing interest included in the amount of the Section 734 adjustment, in the computation of its 1945 income and •excess profits tax liability. As a result of such deduction and the consequent unused excess profits credit carry-back to 1944, plaintiff’s income and excess profits tax liabilities for 1944 and 1945 were reduced in the following net amounts:

1945_$13,647. 55
1944_ 12,259.98
Total_$25,907.53

16. Plaintiff, on July 26, 1949, filed with the Collector of Internal Kevenue for the Second District of New York claims for refund as follows:

Character of taw Tear Amount
1940 $123, 027. 77 Income tax-
1944 123,027. 77 Excess profits tax.

17.The amount of excess profits taxes, including interest, paid by or credited to plaintiff for 1944 on and after July 25, 1947, does not exceed $113,610.80.

18. On October 16,1950, plaintiff received a formal notice-of disallowance in full of its claim for refund of $123,027.77 for the year 1944 pursuant to Section 3772 (a) (2) of the-Internal Eevenue Code.

19. On January 18,1951, plaintiff received a formal notice-of disallowance in full of its claim for refund of $123,027.77 for the year 1940 pursuant to Section 3772 (a) (2) of the-Internal Eevenue Code.

20. No refund of the amount of income taxes of $90,348.99' for the year 1940 as set forth in finding 7, has been made to the plaintiff.

21. No refund of the amount of additional excess profits taxes for 1944 due to the adjustment under Section 734 of the Internal Eevenue Code has been made to the plaintiff.

CONCLUSION OF LAW

Upon the foregoing findings of fact, which are made a part of the judgment herein, the court concludes that as a matter of law the plaintiff is entitled to recover, and it is therefore adjudged and ordered that it recover of and from the United States one hundred thirteen thousand six hundred ten dollars- and eighty cents ($113,610.80) with interest as provided by law.  