
    NATIONAL BISCUIT COMPANY v. THE UNITED STATES
    [No. 49752.
    Decided December 4, 1957]
    
      
      Mr. Montgomery B. Angelí for the plaintiff. Messrs. Wallace 8. Jones and Davis Polk WardweTl Sunderland'& Kiendl were on the brief.
    
      Mr. Harlan Pomeroy, with whom was Mr. Assistant Attorney General Charles K. Biee, for the defendant. Mr. James P. Garland was on the brief.
   Jones, Chief Judge,

delivered the opinion of the court:

This is a suit for the refund of excess profits taxes alleged to have been improperly assessed for the years 1941 and 1942 in the amounts of $105,678.47 and $151,891.08, respectively, with interest.

In 1941 and 1942, plaintiff timely filed its excess profits tax returns and in those returns the excess profits tax credit was computed on plaintiff’s average base period net income for the base period years 1936-1939, inclusive. . The problem for tbe court is the correct determination, of the excess profits tax credit which of necessity depends upon a correct statement of the income during the base period. There is some confusion as to just what the proper income for that period is, because of the uncertainty of treatment for the years 1935 and 1936 of certain processing taxes which were due the Government, and paid or accrued by the plaintiff, in 1935, but which were declared unconstitutional by the Supreme Court on January 6,1936. United. States v. Butler, 297 U. S. 1 (1936).

During the year 1935, the plaintiff accrued on its books, as part of the cost of goods sold, processing tax liabilities for wheat processed by it into flour or cereals for the months of June through December 1935, in the amount of $227,640.73. However, the collection of these taxes by the Government was enjoined by order of the District Court for the Southern District of New York in a suit by plaintiff until such time as the United States Supreme Court decided the Butler case, sufra. The order, however, required the plaintiff to give bond to the Government for the amount of the taxes. The bonding company, in return, required the plaintiff to deposit into an escrow account in the joint names of the bonding company and the plaintiff an amount equal to the amount of the taxes due. Of the aforementioned $227,640.73, $29,754.28 was not deposited in the escrow account, since that amount represented the December 1935 taxes which were not due until January 31,1936. By that time the Supreme Court had rendered its decision in the Butler case. Plaintiff accrued that amount on its books as part of its cost of goods sold in 1935.

During 1935, plaintiff also paid $1,121,629.03 in processing taxes to companies from which it had made purchases prior to 1936 of flour and other commodities, the manufacture of which had been subject”to processing taxes. These taxes were passed along to the purchaser as part of the purchase price. The purchaser in this case, of course, was plaintiff. Of that amount $1,078,950.60 represented processing taxes paid to the National Milling Company, a wholly owned subsidiary of the plaintiff, and the balance, $42,678.43, represented the amount paid to vendors other than the National Milling Company.

It was agreed between plaintiff and the National Milling Company and the other vendors that, should the Supreme Court declare the processing taxes unconstitutional, the amounts which represented processing taxes and which were paid the respective companies as part of the increased purchase price would become the property of plaintiff or be credited to it.

During the year 1935, the plaintiff accrued on its books all of the amounts referred to above, a total of $1,349,269.76, as part of its cost of goods sold. On its 1935 income tax return, filed in 1936 after the Butler decision, it reported only $42,678.43 in the cost of goods sold. This was the amount paid as processing taxes to the vendors other than National Milling Company. Plaintiff, on the 1935 return, excluded from the cost of goods sold the balance, $1,306,591.33, which had been previously accrued on its company books. By excluding these amounts, plaintiff’s income and income tax for that year were, of course, increased. On a later examination of plaintiff’s tax return for 1935, the Commissioner added the amount of $42,678.43 to its net income. This had the effect of eliminating from plaintiff’s cost of goods sold the amount paid to the other vendors in processing taxes. None of the amounts referred to above were included as income in plaintiff’s income tax return for 1936.

In 1941, when plaintiff filed its excess profits tax return it computed its excess profits tax credit on the average base period net income method, and the base period years, as hereinbefore noted, were 1936-1939. The income and excess profits taxes of plaintiff for 1941 were computed on that basis, as were the income and excess profits taxes for 1942, also here in question.

On January 19, 1945, plaintiff filed a claim for refund on form 843 with the Collector of Internal Bevenue for the refund of 1941 taxes, and on August 29, 1945, plaintiff filed a claim for the refund of taxes for 1942. These claims were based on the inclusion of the aforementioned $1,349,269.76 as 1936 income for the purpose of determining plaintiff’s excess profits tax credit for 1941 and 1942. The Commissioner denied both of the claims for refund, and on April 20, 1948, assessed deficiencies against plaintiff for the years 1941 and 1942 in the amounts of $57,123.19, plus interest of $21,370.33, and $36,590.43, respectively, which amounts, upon notice and demand, were duly paid by the plaintiff on August 26,1948.

In assessing these deficiencies the defendant allowed plaintiff to include in its 1936 income for the purpose of computing its excess profits tax credit the amount of $1,349,269.76, but in doing so the Commissioner applied the provisions of section 734 of the Internal Revenue Code of 1939.

Section 734 provides for an adjustment in excess profits taxes for the. years in question where an item affecting the determination of the excess profits credit is treated, either by the taxpayer or the Commissioner, in a manner inconsistent with the treatment accorded such item in the determination of the income tax liability “for a prior taxable year or years,” and where the correction for income tax purposes is prevented by the operation of some rule of law, such as the statute of limitations.

The adjustment is computed by first ascertaining the amount of the income taxes previously determined for each of the prior taxable years affected by the inconsistency and for which correction is prevented, such amount being the final amount of tax after all deficiencies, credits, and refunds. There is then ascertained the increase or decrease in the tax previously determined for each such year which results solely from the treatment of the item consistently with the treatment accorded such item in the determination of the excess profits tax liability. The aggregate increase or decrease in taxes for the years affected by the inconsistent treatment is then computed and that aggregate overassessment or deficiency is then added or subtracted from the tax for the excess profits tax years in question. In the case before us those years against which the aggregate would be applied are 1941 and 1942.

In the determination of the adjustment, interest in favor of the Government on increases in tax liability and of interest in favor of the taxpayer on decreases in tax liability are provided for. The interest is computed as though the increase or decrease constituted a deficiency or an overpayment for the earlier year. The section also provides that this interest is treated as income or as a deduction just as if it were receivable or payable on an overassessment or a deficiency.

A basic provision of the section, however, is that if the inconsistent position is maintained by the Commissioner, the net effect of the adjustment must be a decrease in the recomputed income taxes for the prior years, and if the inconsistent position is maintained by the taxpayer, the net effect of the adjustment must be an increase in the recomputed taxes for prior years. This, in effect, means that neither the Commissioner nor the taxpayer may obtain a-tax benefit as a result of the inconsistent treatment of an item of income for excess profits tax purposes. The parties concede that the facts of this case require section 784 treatment, but there is a difference of opinion as to the interpretation and application of that section.

In applying the provisions of section 784 in plaintiff’s case, and in considering plaintiff’s claims for refund for the years 1941 and 1942, the Commissioner permitted plaintiff’s request to include the sum total of the processing taxes which arose as the result of 1935 operations, $1,349,269.76, to be shifted from 1935 income to 1936 income. However, in computing the adjustment in tax liability for the years affected by the inconsistent treatment as required by section 734, he adjusted only for the years 1936 through 1938. No adjustment in the income taxes for 1939 was necessitated and this is conceded by the parties. The Commissioner’s treatment resulted in an aggregate tax deficiency for the years 1936-1938 of $250,809.11, plus interest of $73,362.22, or a total of $324,-171.33, of which amount $184,600.64 was applied against plaintiff’s 1941 tax situation, and the balance of $139,570.69 was applied against plaintiff ’s 1942 tax situation. The interest of $73,362.22 was allowed as a deduction in 1943. Such application of the aggregate tax deficiency for the years 1936-1939 resulted in a tax deficiency for plaintiff for the years 1941 and 1942 in the amounts hereinbefore stated, and which were duly paid to the Commissioner of Internal Revenue.

Plaintiff contends that the adjustment should have taken into consideration the year 1935, since that year was also affected by the inconsistent treatment; the shifting of the item of income from 1935 to 1936. Plaintiff points out that because of the exclusion of the amount from its 1935 cost of goods sold, its 1935 taxes were increased. If that income is to be shifted from 1935 to 1936, plaintiff argues, it is inescapable that its 1935 tax situation would be affected by the inconsistent treatment. An overassessment for 1935 would be reflected by the shift. Plaintiff feels that if it is going to pay taxes on that amount in 1936, it should be credited with the taxes paid thereon in 1935, and argues that section 734 specifically provides for such treatment.

If plaintiff’s position is sustained, a considerable overpayment would be reflected for 1935, which would reduce the net deficiency already determined for the years 1936-1938. The result would be that instead of plaintiff having a net deficiency of $324,171.33 to be applied to its 1941 and 1942 tax situation, it would only have a net deficiency of $80,258.45 (which includes interest on the deficiency of $14,934.42) which would be applied against plaintiff’s 1941 tax situation. Because the plaintiff has already paid deficiencies assessed by the Commissioner as the result of the Commissioner’s method of computing the adjustment under section 734, plaintiff would be entitled to a refund judgment.

Thus, the issue in the case when plaintiff brought suit was the interpretation and application of section 734. Should, under that section, the $1,349,269.76 included in 1936 income for the computation of plaintiff’s base period net income for excess profits tax purposes be excluded from 1935 income and the year 1935 be included in determining the amount of the adjustment which resulted from the inconsistent treatment?

As to this particular point, defendant argues that 1935 cannot be used in computing the adjustment since section 734 required only base period years to be used in that computation.

Before we get to that issue, however, we must first dispose of a contention of defendant raised for the first time on trial, to wit, that the Supreme Court decision in 1936 did not effectuate a return of processing taxes to plaintiff such as would constitute additional income for the base period year of 1936.

Plaintiff protests that raising such a defense at this late date would unduly prejudice it and points out that the contention of defendant is directly contrary to the expressions of the Commissioner of Internal Bevenue contained in a ruling, I. T. 3064, directly contrary to a determination made by the Commissioner of tax due for the years here in question, which determination assessed a deficiency against plaintiff based upon the inclusion of the subject sum in the year 1936; directly contrary to a determination of an Excess Profits Tax Council panel in its determination that, because of the inclusion in 1936 income of the $1,349,269.76, the plaintiff would have to show additional abnormalities to be entitled to the section 722 relief applied for and, therefore, recommended denial of section 722 relief; and directly contrary to a statutory notice by the Excess Profits Tax Council to plaintiff approving the determination of the Council panel and denying section 722 relief. Plaintiff points out that because of the reason given by the Excess Profits Tax Council for denying section 722 relief, it (plaintiff) acted to its detriment by not pursuing the sought for section 722 relief further, that is, by appeal to the Council’s determination to the Tax Court, which has the final say in section 722 matters. Section 722 relief is now closed to plaintiff. Because it so acted in reliance on the reasons given by the Council in denying section 722 relief, it feels that it is inequitable for the defendant to now assert the contention that the subject amount should never have been included in 1936 income at all. If the defendant is successful, were section 722 relief still available to plaintiff, it is possible that it would have received some relief thereunder.

We feel also, as the plaintiff must, that there should be some point at which a taxpayer can rely on determinations of the Commissioner of Internal Bevenue and the Excess Profits Tax Council; a point at which the taxpayer can feel the issues have been struck and proceed thenceforward. That is what plaintiff herein apparently thought it was doing when it came into this court assuming that the only issue which needed to be resolved was the interpretation and application of section 734.

However, we are bound by the law as we find it and can only apply it as found. We feel that a considerable part of the subject sum is includible in 1936 income and deductible from 1935 income; but, we likewise feel, that there is a portion of the total sum which must, if we are to follow the precedents of the Supreme Court, be omitted from 1936 income and not deducted in 1935.

It is well settled that a taxpayer may not accrue as a deduction an expense when he is denying liability and refusing and contesting its payment. Security Flour Mills v. Commissioner, 321 U. S. 281 (1944); Dixie Pine Products v. Commissioner, 320 U. S. 516 (1944); North American Oil Consolidated v. Burnet, 286 U. S. 417 (1932); Consolidated Edison Co. of New York v. United States, 133 C. Cls. 376 (1955) cert. den., 351 U. S. 909 (1956); Chestnut Securities Company v. United States, 104 C. Cls. 489 (1945). The underlying reason for such a rule is that where the taxpayer has not paid the expense and is contesting it, he may never incur it, thus, it should not be deductible until it is incurred. The point of accrual in a contested liability case would be the year in which the court makes its determination.

It has also been held that where an amount is being contested, but has actually been paid, it may be deducted in the year of payment notwithstanding the fact that it is being contested because payment discharges the liability for the year of payment. Chestnut Securities Company v. United States, supra.

We covered this situation in Chestnut Securities Company, supra, at page 494, wherein we stated as follows:

* * * One is not entitled to accrue a debt or other liability which is asserted against him but which he disputes and litigates, until the litigation is concluded. But if a liability is asserted against him and he pays it, though under protest, and though he promptly begins litigation to get the money back, the status of the liability is that it has been discharged by payment. It is hardly conceivable that a liability asserted against him, which he has discharged by payment, has not yet “accrued” within the meaning of the tax laws and the terminology of accounting. Accrual, from the debtor’s standpoint, precedes payment, and does not survive it.

In a case on a parallel with, the issues now before ns, Security Flour Mills v. Commissioner, supra, the taxpayer, in 1985, obtained an injunction against the collection of processing taxes, the court requiring as a condition of the granting of the injunction that the taxpayer pay the amount of the taxes into a depository designated by the court. On its 1935 income tax return, the taxpayer took deductions of the amount paid into the depository as taxes accrued in that year. The Court stated that the plaintiff therein was not entitled to the deductions in 1935. It said, at page 284:

* * * Since it denied liability for, and failed to pay, the tax during the taxable year 1935, it was not in a position in its tax accounting to treat the Government’s claim as an accrued liability.

Thus, the Supreme Court has ruled that amounts paid into escrow do not constitute payment of the tax liability in the sense that the taxpayer should be allowed a deduction for an already paid contested liability.

In applying the above rules to the case at hand, we find that the entire amount of processing taxes accrued by the taxpayer on its books in 1935 which was attributable to its own processing operations, $227,640.73, as distinguished from the taxes it incurred as part of the purchase price of products it bought from its vendors, is excludible from 1936 income and not deductible in 1935. Liability for those taxes was being contested within the meaning of Dixie Pine Products, supra; North American Oil Consolidated, supra; Consolidated Edison Co. of New York, supra; and Chestnut Securities Company, supra, and was not paid within the meaning of the Security Flour Mills case, supra.

It does not follow, however, that the balance of the subject amount of $1,349,269.76, i. e., $1,121,629.03, is not includible in 1936 income and correspondingly deductible in 1935. We hold that it is so includible and deductible.

The $1,121,629.03 referred to above represents that amount of taxes which was paid by plaintiff as part of the purchase price of processed products which plaintiff bought from its vendors, the processors. During 1935 plaintiff was fully liable for the purchase price to those vendors. Being on the accrual basis, it was thus entitled to accrue the entire amount of the purchase price paid for its products as part of its cost of goods sold. As to these particular taxes plaintiff was making no contest. The vendors on their own were, but they aré entities separate from plaintiff. We do not feel that a liability contested by them can relate back to plaintiff with the conclusion that plaintiff was contesting the liability and, hence, not entitled to the deduction in 1935 and the inclusion of a like amount in 1936 income. This is so, notwithstanding the fact that plaintiff had agreements with all of these vendors to the effect that, should the Supreme Court find the processing taxes unconstitutional, the amounts of processing taxes paid to the vendors as part of the purchase price would become the property of plaintiff, or be refunded or credited to it. The separate corporate entities were contesting the liabilities, not plaintiff.

This leads us to the next of defendant’s contentions, also not raised by the Commissioner of Internal Revenue, but brought up by defendant for the first time on trial. Defendant contends that the National Milling Company, to whom the bulk of the money referred to in the immediately preceding two paragraphs was paid, some $1,078,950.60, was part of the plaintiff, not a separate organization, notwithstanding the fact that, in form, it had separate corporate life. This assertion is made because of the alleged close control exercised over National Milling by plaintiff. Defendant feels that because of this close control National Milling has been reduced to the status of a branch, rather than a subsidiary of plaintiff.

While the record does show that National Milling was treated by plaintiff somewhat on a par with its other branches, we find, after considering all the facts and circumstances, that the evidence is not sufficient to support a conclusion that it was a branch of plaintiff. The evidence shows that, while plaintiff exercised very close control over National Milling, it was, during the period in question, engaged in the same type of operations that it was engaged in prior to the time the company came under plaintiff’s control some years prior. There had been no substantial change even though plaintiff had installed its own bookkeeping system and officers. The record also shows that it filed its 1934 and 1935 Federal income tax returns with the Internal Revenue Bureau as a separate corporate entity. Those returns were signed by officers of the National Milling Company and apparently the Commissioner of Internal Revenue did not feel at that time that it was a branch of plaintiff rather than a separate corporation.

Something more than this record contains must be shown before we can nullify the legal separateness of a corporation from its owner. Therefore, we cannot at this late date hold that National Milling Company was not at the time a separate corporate entity. The evidence of record is insufficient to pierce the corporate veil.

That part of our decision above which relates to the processing taxes paid into escrow by the plaintiff itself because of its own processing operations would appear to be in conflict with a ruling of the Commissioner of Internal Revenue designated I. T. 3064,1931-1 cum. bull. 94. That ruling permitted the taxpayer to deduct in 1935 amounts of processing taxes paid into escrow and to add to income in 1936 the amount of the refunds. In so deciding, the Commissioner reasoned that no valid right to the reimbursement in question existed during the year 1935 which was enforceable during that year, but that the taxpayer’s right to the reimbursement was contingent upon the happening of a future event which did not occur until January 6,1936, when the Butler case, sufra, was decided. In so holding, North American Oil Consolidated v. Burnet, supra, was cited.

North American Oil Consolidated does stand for the proposition that a taxpayer does not have to report as income an amount which it may never receive because of the possibility of an adverse decision by a court. However, the principle applies as well to a deduction, that is, a deduction cannot be taken until such time as it has been incurrred. When it is being contested it has not been incurred and may never be if the court enters a decision of no liability. Also, when North American Oil Consolidated is read together with Security Flow Mills v. Commissioner, supra; Dixie Pine Products v. Commissioner, supra; Consolidated Edison Co. of New York v. United States, supra, and Chestnut Securities Company v. United States, supra, I. T. 3064 is apparently in error. YvTiile we do not pretend to say that it was in error , when issued in 1937, we do hold that since the decision of the above-cited cases, I. T. 3064 does not represent a correct application of prevailing law. Hence, plaintiff’s arguments with respect to I. T. 3064 are of no avail.

Having disposed of these contentions of defendant, we now come to what we regard as the main issue in the case, that is, the interpretation and application of section 734 of the 1939 Internal Revenue Code.

As to this phase of the case, the only difference of opinion is whether or not 1935 should be taken into consideration in computing the adjustment to be made pursuant to section 734. The defendant argues that since 1935 is outside the base period it cannot be taken into consideration. However, the court is of a different view, since nowhere does section 734 specify that only base period years should be used in making the adjustment.

The language of section 734 in pertinent part is as follows:

(b) CIRCUMSTANCES OP ADJUSTMENT.-
(!) 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.
* * * * *
( d) ASCERTAINMENT OE AMOUNT OP ADJUSTMENT.-In computing the amount of an adjustment under this section there shall first be ascertained the amount of the income taxes previously determined for each of the prior taxable years for which correction is prevented. The amount of each such tax previously determined for each such taxable year shall be (1) the tax shown by the taxpayer, or by the predecessor, upon the return for such prior taxable year, increased by the amounts previously assessed (or collected without assessment) as deficiencies, and decreased by the amounts previously abated, credited, refunded or otherwise repaid in respect of such tax; or (2) if no amount was shown as the tax by such taxpayer or such predecessor upon the return, or if no return was made by such taxpayer or such predecessor, then the amounts previously assessed (or collected without assessment) as deficiencies, but such amounts previously assessed, or collected without assessment, shall be decreased by the amounts previously abated, credited, refunded, or otherwise repaid in respect of such tax. There shall then be ascertained the increase or decrease in each such tax previously determined for each such year which results solely from the treatment of the item consistently with the treatment accorded such item in the determination of the tax liability under this sub-chapter. * * * [Italic ours.]

If not explicit, it is certainly implicit in the language of these subsections that, where there is an inconsistent treatment of an item of income in order to compute the excess profits credit, then an adjustment shall be made which will take into consideration all the tax years affected by the inconsistent treatment in which correction of the effect of the inconsistent treatment is otherwise prevented by operation of law; 1935 is such a year. A close analysis of the subsections shows that this conclusion is correct.

Subsection (b) (1) provides that if there is, for the purpose of determining the excess profits credit of plaintiff, a treatment given an item of income which is inconsistent with the treatment “accorded such item in the determination of the income-tax liability * * * for a prior taxable year or years,” and if other provisions are met and correction is prevented by operation of law, then a “correction shall be made by adjustment under this section.” Subsection (d) explains how to mate that adjustment. It provides that “there shall first be ascertained the amount of income taxes previously determined for each of the prior taxable years for which correction is prevented” (correction was prevented for 1935), then the section provides there “shall then be ascertained the increase or decrease in each such tax previously determined for each such year which results solely from the treatment of the item consistently with the treatment accorded such item in the determination of the tax liability wader this subchapter.” [Italic ours.1 In the case before us, a treatment was given to the $1,121,629.03 for the computation of the excess profits tax credit which was inconsistent with its treatment in a prior taxable year, 1935. Thus, 1935 is a prior taxable year within the scope of section 734 and must be taken into consideration in computing the section 734 adjustment.

If there is any doubt that such language was intended to include 1935 in the computation of the adjustment, a reference to an example contained in the legislative history of section 734 is all that is needed to clarify that doubt. See House Beport No. 146,77th Cong., 1st Sess., section 11, page 17, and Senate Beport No. 75, 77th Cong., 1st Sess., section 11, page 17. That example is too long to be fully set forth here, but in it the years 1934 and 1935, as well as 1936 and 1937, were taken into consideration in making the section 734 adjustment.

The Commissioner’s regulations are of like effect, and also use an example similar to that used in the legislative history.

Section 35.734-2 (b) of Begulations 112 provides as follows:

The ascertainment of whether correction of the effect of the inconsistent treatment is prevented within the meaning [of section 784] * * * must be made with respect to each income tax for each prior taxable year affected by the erroneous treatment of the item or transaction. * * * [Italic ours.]

It can be seen, therefore, that there is nothing in the statute, the legislative history, or the Commissioner’s regulations that restricts computation of the adjustment to the base period years.

There is little case law on this particular subject. However, the Government relies on Crown Zellerbach Paper Co. v. Commissioner, 8 T. C. 511 (1947) to sustain its contention. This case does not support the Government’s contention as it is distinguishable on the facts, and thus inapposite. That case related to the inconsistent treatment accorded a depreciation item which was incorrectly stated every year for several years, prior to the base period, as well as being erroneously stated during the base period years. The court held that only the base period years would be taken into consideration in computing the adjustment under section 734. Such treatment is not inconsistent with our decision in the instant case because an item of depreciation is a recurring annual item, a different item for each year. A change in the amount of a depreciation deduction for 1936, made to arrive at a correct excess profits credit, would not of itself affect the 1935 depreciation item or those of earlier years. It is not a situation of shifting income; that is, the shifting of an item of income from one year to the next as we have in the case before us. Our case involves a single item of income, not an annually recurring deduction. That item of income was shifted from 1935 to 1936, thus 1935 was directly affected by the inconsistent treatment in the base period year. That was not the situation in the Crown Zellerbach case, where depreciation deduction for 1936 was changed. This of itself did not affect the depreciation deduction taken in 1935. Thus, 1935 was not affected by the inconsistent treatment of an item for the purpose of determining the excess profits tax credit.

We hold, therefore, that in computing the adjustment provided for in section 734, the facts of this particular case require the inclusion of 1935 in the computation. Such inclusion will reflect a refund due plaintiff for the years in question.

The last issue presented by this case involves the doctrine of equitable recoupment and is raised by defendant. This doctrine specifies that a taxpayer should not recover from the Government refunds due it for a particular year to the extent that it has underpaid its taxes relating to the same transaction in a year which is barred by the statute of limitations. Conversely, it also provides that the Government should not be permitted to collect a deficiency for a particular year to the extent that a taxpayer has overpaid its taxes relating to the same transaction in a year which is barred by the statute of limitations. Bull v. United States, 295 U. S. 247 (1935) ; Stone v. White, 301 U. S. 532 (1937) ; as limited by Rothensies v. Electric Storage Battery Co., 329 U. S. 296 (1946). See also Pond's Extract Co. v. United States, 133 C. Cls.43 (1955).

The cited cases show that the doctrine of equitable recoupment is available to both the taxpayer and the Government depending upon the particular fact situation. It was conceived of necessity by the requirement of fairness due to the danger of injustices resulting from the bar of the statute of limitations. It is really a case law exception to the statute of limitations where the application of the statute would work a palpable injustice. Pond's Extract Co. v. United States, supra. The doctrine is restricted, however, to situations in which a single transaction constituted the taxable event claimed upon and the one considered in recoupment. Rothensies v. Electric Storage Battery Co., supra, at page 229. Thus, in order for the Government or the taxpayer in any case to have the doctrine of equitable recoupment applied, the offsetting amount from the year barred by the statute of limitations must result from the same transaction which gave rise to the refund or deficiency in the open year. To provide otherwise, every assessment of deficiency and each claim for refund would invite a search of the taxpayer’s entire tax history for items to recoup. This would in itself be inequitable, since statutes of limitation are, in their conclusive effects, designed to promote justice by preventing surprises through the revival of claims that have been allowed to slumber until evidence has been lost, memories have faded and witnesses have disappeared. Rothensies v. Electric Storage Battery Co., supra, at pages 301 and 302.

With respect to the fairness of statutes of limitation, the Supreme Court in the Bothensies case continues as follows, at page 301:

* * * The theory is that even if one has a just claim it is unjust not to put the adversary on notice to defend within the period of limitation and that the right to be free of stale claims in time comes to prevail over the right to prosecute them.

Based upon the decisions cited above, we are of the opinion that the doctrine of equitable recoupment applies in the instant case. There was only a single transaction or taxable event involved. Plaintiff’s arguments against the applicability of the doctrine have been considered but they are without merit.

In the determination of the plaintiff’s taxes for the years 1941 through 1945, the Commissioner used as an excess profits credit an amount that, on the basis of our decision as herein announced, becomes too great as the result of the erroneous inclusion of $227,640.73 in the base period income. Because the credit was thereby increased, plaintiff, in each of the years 1941 through 1945, received a benefit, by way of decreased taxes, in an amount proportionate to the excessive credit. Plaintiff also received a benefit because of the $73,362.22 allowed in 1943 as an interest deduction. That amount represented interest on the net deficiency computed by the Commissioner of Internal Revenue under section 734 for, the years 1936-1938. Because we have decided that the tax year 1935 must be taken into consideration in computing the section 734 adjustment, the net deficiency, and consequently the interest thereon, will be reduced.

As previously noted, by taking 1935 into consideration in computing the section 734 adjustment, a refund of taxes to plaintiff for the years in question will result. Against that refund, however, since the doctrine of equitable recoupment applies, there must be offset the amount of benefit the plaintiff received because of the overstated excess profits tax credit and because of the above-mentioned excessive interest deduction. It is impossible without the aid of detailed computations to say at this time how the application of the doctrine will affect the amount of recovery; however, it will considerably reduce it.

To recapitulate, we hold that the $227,640.13 accrued on plaintiff’s books in 1935 as the result of its own processing operations is not deductible in 1935 as a cost of goods sold and is not includible in 1936 income for the purpose of computing the excess profits tax credit; that the National Milling Company is a separate corporate entity and that amounts accrued by plaintiff representing processing taxes paid or due National Milling and other vendors in 1935, i. e., $1,121,-629.03, is properly deductible in 1935 as part of the cost of goods sold, and includible as income in 1936 for the purpose of computing plaintiff’s excess profits tax credit; that in computing the adjustment provided for by section 734 of the 1939 Internal Eevenue Code the year 1935 must be included in the computation, such year showing as part of the cost of goods sold the aforementioned $1,121,629.03, but not the $227,640.73; and, finally, that the doctrine of equitable re-coupment is applicable in the instant case. In applying that doctrine, the excess profits tax credit will be adjusted in accordance with this opinion, to wit, the base period income will be decreased by $227,640.73, and the correct excess profits taxes for the years 1941 through 1945 will be determined. The excessive interest deduction taken in the tax year 1943 will also be adjusted pursuant to the corrected section 734 adjustment. Any taxes thereby found not to have been previously paid by plaintiff will be offset against any recovery which would otherwise be due plaintiff because of the inclusion of the tax year 1935 in the section 734 adjustment computations.

The case will be remanded to the commissioner of this court for further proceedings pursuant to Rule 38 (c).

It is so ordered.

Fahy, Circuit Judge, sitting by designation; Madden, Judge; Whitaker, Judge; and LittletoN, Judge, concur.

FINDINGS OF FACT

The court, having considered the evidence, the report of Commissioner Bichard H. Akers, and the briefs and argument of counsel, makes findings of fact as follows:

1. The plaintiff, National Biscuit Company, is a corporation incorporated on February 3,1898, under the laws of the State of New Jersey and since September, 1930, has maintained its principal office and place of business at 449 West 14th Street, New York, New York. In the years here involved, the plaintiff kept its books and filed its corporation income and excess profits tax returns on the calendar year and accrual basis.

2. For the year 1935, the plaintiff accrued on its books as part of the cost of goods sold processing tax liabilities, mostly in respect of purchased wheat processed by the plaintiff into flour or cereals, assessed against it for the months of June through December 1935, in the amount of $227,640.73.

3. Pursuant to an action filed by the plaintiff in July 1935, in the United States District Court for the Southern District of New York against James J. Hoey, individually, and as collector of internal revenue for the Second District of New York, and Francis W. H. Adams, individually, and as United States district attorney for the Southern District of New York, collection of the processing taxes referred to in the preceding finding for the months of June through December 1935, was enjoined. The temporary restraining order dated July 31,1935, was continued in effect in accordance with an order of the court issued pursuant to E. Regensburg & Sons v. Higgins, 79 F. (2d) 516, until the decision by the United States Supreme Court in United States v. Butter, 297 U. S. 1. That restraining order included the following provisions:

Oedbred that pending the determination of the motion for an injunction pendente lite heretofore made in this cause, the defendants and each of them and each of their officers, employees, attorneys and deputies be and hereby are enjoined from demanding payment of, imposing, levying,, assessing or collecting against the complainant, or attempting so to do, any processing taxes under and pursuant to said Agricultural Adjustment Act, or any amendments thereto; from demanding payment of, imposing, assessing or collecting or attempting so to do, upon or from the complainant any interest or penalties on account of its failure to pay said taxes, from levying upon or imposing or creating a lien upon or restraining the manufacturing plants, inventory, cash on hand, or other property of the complainant on account of the nonpayment of said processing taxes, penalties and interest now due or hereafter to become due in accordance with the terms and provisions of said Agricultural Adjustment Act or amendments and it is further
Oedeeed that the complainant furnish forthwith a bond of a duly qualified and solvent surety company in the amount of $35,358.85, being equal to the amount of the processing taxes shown to be due on complainant’s consolidated return for wheat processed by complainant during the month of June 1935, conditioned upon the payment of such costs and damages as may be incurred or suffered by any party who may be found to have been enjoined or and it is further
Ordered that the complainant shall furnish a bond of a duly qualified and solvent surety company in an amount equal to the amount which hereafter becomes due and payable by the complainant to the defendant Hoey as processing taxes, and as interest and penalties that shall accrue because of the nonpayment of such taxes, at such times as such sums shall become due and payable as such processing taxes, interest or penalties in accordance with the provisions of the Act of Congress of May 12, 1933, sec. 25, 48 Stat. 31, entitled “The Agricultural Adjustment Act, as amended,” such additional bond or bonds to be conditioned in a manner similar to the aforesaid bond for the sum of $35,358.85.

4. The processing taxes assessed against the plaintiff for the months of June through November 1935, in the amount of $197,886.45 were not paid to the United States. In compliance with the injunction, bonds were posted by the plaintiff. There were separate bonds so posted covering the processing taxes for each of the months June through November, which bonds were issued by the American Surety Company of New York. Prior to the execution of each bond an agreement was entered into between the American Surety Company, the plaintiff, and the First National Bank of the City of New York, requiring the plaintiff, as a condition of the execution of each bond, to deposit an amount equal to the amount of such, processing taxes which, but for the injunction, would have become due each month, in an escrow account in the First National Bank of the City of New York, the account being entitled “National Biscuit Company and American Surety Company in Escrow.” The records of the First National Bank show deposits by the plaintiff pursuant to the escrow agreements in the escrow account as follows:

August 6, 1935_$35,358. 85
August 26, 1935_ 33,382.56
October 3, 1935_ 31,329.89
October 29, 1935_ 32,934. 92
December 2, 1935_ 37,571.72
December 27, 1935_ 27,308.51
Total_.- 197,886.45

5. The processing taxes assessed against the plaintiff for the month of December 1935, in the amount of $29,754.28 were not paid to the United States. The due date for the processing taxes for each month was the last day of the next month.

6. The National Milling Company was a corporation organized under the laws of the State of Ohio on or about July 7,1905.

7. In January 1926, the plaintiff purchased all of the outstanding common stock of The National Milling Company, consisting of 2,000 shares of a par value of $100 a share, but did not purchase any of the outstanding preferred stock, consisting of 2,340 shares of a par value of $100 a share.

8. On or about October 1, 1926, The National Milling Company retired all of its outstanding preferred stock, and from that date until the dissolution of The National Milling Company in January 1936, The National Milling Company was a wholly owned subsidiary of the plaintiff.

On November 22,1935, at a conference between officials of The National Milling Company and the plaintiff, it was decided that The National Milling Company should be liquidated and dissolved into the plaintiff early in 1936. It was decided that the liquidation should take place in 1936, with the expectation that it be tax-free under section 112 (b) (6) of the revenue act of 1934, as amended by section 110 of the revenue act of 1935, but that it occur early in 1936 so that tax on intercorporate dividends, effective January 1, 1936, would be minimized or avoided and so that The National Milling Company would not have any substantial amount of cash at the time of its liquidation. In preparation for such liquidation, The National Milling Company paid cash dividends to the plaintiff in December, 1935, which divested it of all its cash, with a view to its ensuing liquidation and dissolution early in 1936. Consistent with the foregoing, it was known by the plaintiff in November, 1935, that it had been decided that The National Milling Company would be liquidated into the plaintiff and dissolved early in 1936. The dissolution agreement, effective January 2, 1936, was executed on January 2, 1936, and the certificate of dissolution was filed with the Secretary of State of Ohio on January 7, 1936.

9. During the year 1935, The National Milling Company was engaged in the purchase, sale, storage and milling of wheat, the sale of flour and animal feed, and the unloading, storage and shipment of various grains.

10. During the year 1935, The National Milling Company accrued on its books as part of the cost of goods sold processing taxes assessed against The National Milling Company for the months of May through December, 1935, in the amount of $1,078,950.60.

11. Pursuant to an action filed by The National Milling Company in the United States District Court for the Northern District of Ohio, collection of those processing taxes assessed against The National Milling Company for the months of May through December 1935, was enjoined on August 13, 1935. The order allowing a temporary injunction, entered August 13, 1935, included the following provisions:

It is now ordered that a temporary injunction be granted against Charles H. Graves, Individually and as Collector of Internal Bevenue for the 10th District of Ohio, pending further orders of this court, enjoining and restraining him from :
(1) Attempting to collect from the appellant any so-called processing tax on the milling of wheat, imposed under the authority of the Act of Congress of the United States, known as the Agricultural Adjustment Act, by distraint, levy or other summary, process ;
(2) Imposing or giving notice of intention to impose any lien upon the property of the appellant, whether real or personal, or
(3) In any other manner of collecting or attempting to collect said so-called processing taxes, for or in respect of the months of May and June, 1935, or any other months, during the pendency of this appeal, and so long as this injunction shall be in force.
This injunction is granted only upon condition that The National Milling Company, Complainant-Appellant, shall deposit, as the same shall become due and payable in accordance with the terms of the Agricultural Adjustment Act, in the Toledo Trust Company of Toledo, Ohio, to the joint account of Charles H. Graves, as Collector of Internal Bevenue for the 10th District of Ohio, and The National Milling Company, the appellant herein, such tax as is now due and payable and such tax as may hereafter, from month to month, become due and payable during the pendency of this proceeding or until further order of this court; and such tax so paid into said joint account shall not be subject to change or disposition at any time except in accordance with the order or orders of this court; and provided further that said bank shall give bond to the United States of America, conditioned upon the safekeeping of said deposits and the payment thereof as directed by the further orders of this court.

12. The processing taxes assessed against The National Milling Company for the months of May through November 1935, in the amount of $875,856.65 were not paid to the United States but were, in compliance with the injunction, paid by The National Milling Company into escrow, and the processing taxes assessed against The National Milling Company for the month of December 1935 in the amount of $203,093.95 were not paid into escrow. That amount of $203,093.95 was not paid to the United States. The due date for the processing taxes for each month was the last day of the next month.

The plaintiff from time to time advanced such funds as were needed by The National Milling Company in the operation of its business, including the amounts to cover the processing taxes of $875,856.65 assessed against The National Milling Company for the months of May through November 1935. That amount of $875,856.65 was paid into escrow by the checks of The National Milling Company from the funds advanced by the plaintiff. The amount so advanced was charged by the plaintiff to The National Milling Company in an open intercompany account. Flour purchases by the plaintiff from The National Milling Company were charged against the plaintiff by The National Milling Company in a similar intercompany account.

Prior to the period May through November 1935, referred to above, the plaintiff paid processing taxes on behalf of and for the account of The National Milling Company in the sum of $3,090,522.70, and, after the Agricultural Adjustment Act was declared unconstitutional, the plaintiff on its own behalf and on behalf of The National Milling Company filed petitions with The Tax Court of the United States for the recovery of those processing taxes.

13. During the year 1935 the plaintiff purchased flour from The National Milling Company. On or about July 12,1935, the plaintiff and The National Milling Company reached an agreement with respect to the refunding of processing taxes in the event the Agricultural Adjustment Act was declared unconstitutional. That agreement was in the form of a letter from the plaintiff to The National Milling Company on which The National Milling Company duly noted its acceptance. The letter read as follows:

There seems to be at least a possibility that the processing taxes now levied under the Agricultural Adjustment Act will be declared unconstitutional. While there is legislation pending which will bar suits for recovery of taxes already paid, the validity of such legislation is doubtful. If we are to continue to pay prices which include processing taxes we feel that we must be protected against the invalidity of the law and possible refund of the said taxes. Therefore, in consideration of our continued patronage, we request you to agree that should the processing taxes be finally adjudged invalid, and should you at some future time receive a refund thereof, or should you successfully withhold the payment of any such processing taxes, then such refund or withholding shall be the property of National Biscuit Company.
Please indicate your agreement by executing the acceptance provided below returning one copy to us.

Upon receipt of that letter, The National Milling Company duly noted thereon its acceptance of the terms thereof.

The form used during the year 1935 to confirm purchases of flour made by the plaintiff from The National Milling Company contained the following condition:

The prices named in this contract include all taxes or impositions that are levied or imposed upon grain or grain products, or upon the containers, ingredients or other items used in connection with the manufacturing, Erocessing, blending, sale or distribution thereof on the asis of the tax rates in effect on the date of this contract, and any decrease or increase in such taxes shall he for the account of the Buyer and shall be deducted from or added to the prices named in this contract; also all further taxes not in effect on the date of this contract but thereafter levied or imposed upon the aforesaid, shall be added to the prices named in this contract, and any decrease or increase in such further taxes shall be deducted from or added to the prices named in this contract. It is further understood that should any refunds accrue to the Seller with respect to any taxes included in these prices, by reason of the invalidity of the law under which they are assessed or for any other reason, or should the Seller withhold the payment of any such taxes successfully contesting the validity thereof, such refund or withholding shall likewise be for the account of the Buyer and shall be paid over upon final determination and settlement.

14.During the year 1935 the plaintiff accrued on its books as cost of goods sold the full amount charged by The National Milling Company for flour purchased from The National Milling Company by the plaintiff, including the amounts of processing taxes set forth in paragraphs 1 and 2 of finding 12.

15.On January 6,1936, the United States Supreme Court decided the case of United States v. Butler, 297 U. S. 1, which held unconstitutional processing taxes similar to those referred to in findings 2, 3, 4, 5, 10, 11, 12, and 13.

16.After January 6, 1936, but on or before the due date thereof, the plaintiff filed its Federal income tax: return (form 1120) for 1935 with the collector of internal revenue, Second District of New York, and timely paid the income taxes shown on such return in quarterly installments within the year 1936. In such return, the plaintiff reported as a cost of goods sold an amount which was $1,306,591.33 less than the cost of goods sold as shown on the plaintiff’s books. That amount of $1,306,591.33 comprised the amount of $227,-640.73 set forth in finding 2 and the amount of $1,078,950.60 set forth in finding 10. In Schedule L of that return entitled “Reconciliation of Net Income and Analysis of Changes in Surplus”, under the general heading of “Unal-lowable deductions” and under a further subheading of “(j) Additions to reserves for contingencies, etc.”, the plaintiff showed the amount of processing taxes just referred to as “Processing Tax Refunds $1,306,591.33”.

17. During the year 1936, the plaintiff received refunds aggregating $42,678.43 from various vendors other than The National Milling Company from whom it had made purchases prior to 1936 of flour and other commodities, the manufacture of which had been subject to processing taxes similar to those referred to in finding 15. A form letter dated July 21,1935, from the plaintiff to those vendors and accepted in writing by those vendors contained the following language:

There seems to be at least a possibility that the processing taxes now levied under the Agricultural Adjustment Act will be declared unconstitutional. While there is legislation pending which will bar suits for recovery of taxes already paid, the validity of such legislation is doubtful. If we are to continue to pay prices which include processing taxes we feel that we must be protected against the invalidity of the law and possible refund of the said taxes. Therefore, in consideration of continued patronage, we request you to agree that should the processing taxes be finally adjudged invalid, and should you at some future time receive a refund thereof, or should you successfully withhold the payment of any such processing taxes, then such refund or withholding will be paid or credited to us proportionately to the extent that our purchases from you have included such taxes throughout the effective period of the law.

The form used during the year 1935 to confirm purchases of flour made by the plaintiff from such of the above vendors from whom it purchased flour was the same as that referred to in finding 13 and contained the conditions set forth in that finding.

18. During the year 1985, the plaintiff accrued on its books as a part of the cost of goods sold the full amounts charged by the vendors referred to in finding 17 for products processed by and purchased from such vendors during 1935. In its 1935 income tax return, the plaintiff, in reporting its cost of goods sold, included therein an amount equal to the processing taxes listed in the form referred to in finding 17, that is, $42,678.43, which was the total amount received by the plaintiff during 1936 from vendors other than The National Milling Company on account of the determined invalidity of the processing tax statute in question.

19. On examination of the plaintiff’s Federal income tax return for 1935, the Internal Bevenue Service increased the net income of the plaintiff for that year, inter alia, by an amount of $42,678.43, representing the sum of the amounts received during 1936 from the vendors referred to in finding 17. Upon notice and demand, the plaintiff on April 2,1937, paid the additional taxes attributable to such increase.

20. On or about March 15,1937, the plaintiff filed its Federal income tax return (form 1120) for 1936 with the collector of internal revenue, Second District of New York, and timely paid the income taxes shown on such return in quarterly installments within the year 1937. In such return the plaintiff did not include as income the amount of $1,306,591.33, referred to in finding 16, nor the amount of $42,678.43, referred to in finding 19. On the examination of such return, certain adjustments were made but the Commissioner of Internal Bevenue (hereinafter sometimes referred to as the “Commissioner”) did not add either of the foregoing amounts as income in 1936. The other adjustments made were agreed upon and on or about July 25,1938, the plaintiff paid additional taxes of $38,740.15.

21. The income tax return and the excess profits tax return of the plaintiff for 1941 were timely filed with the collector of internal revenue, Second District of New York. In the plaintiff’s excess profits tax return the excess profits tax credit was computed upon the basis of the plaintiff’s average base period net income for the base period years 1936-1939, inclusive. The excess profits tax net income for the base period year 1936 reported in such excess profits tax return was $16,066,602.10.

22. Upon the basis of the plaintiff’s income tax and excess profits tax returns for 1941, as filed, the plaintiff paid income taxes of $4,425,117.87, and excess profits taxes of $1,662,353.01. Following an examination in 1943 of such returns, the plaintiff, pursuant to a deficiency assessment and notice, paid additional income taxes for 1941 of $24,019.51 and interest thereon of $1,561.27, and additional excess profits taxes for 1941 of $20,558.14 and interest thereon of $1,336.28.

23. The income tax return and the excess profits tax return of the plaintiff for 1942 were timely filed with the collector of internal revenue, Second District of New York. In the plaintiff’s excess profits tax return, the excess, profits tax was computed upon the basis of the plaintiff’s average base period net income for the base period years 1936-1939, inclusive. The excess profits tax net income for the base period year 1936 reported in such excess profits tax return was $16,066,602.10.

24. Upon the basis of the plaintiff’s income tax and excess profits tax returns for 1942, as filed, the plaintiff paid income taxes of $5,390,584.11 and excess profits taxes of $7,020,201.53. Following a deficiency assessment and notice, the plaintiff paid additional income taxes for 1942 of $1,984.35 and interest thereon of $104.11, and additional excess profits taxes for 1942 of $64,130.84 and interest thereon of $3,364.67.

25. If the plaintiff’s net income for the year 1935 had been reduced by $1,349,269.76 (the sum of $42,678.43 referred to in finding 19 and $1,306,591.33 referred to in finding 16), its Federal income tax liability for such year would have been reduced by $185,485.08. If the plaintiff’s net income for the year 1936 had been increased by the amount of $1,349,269.76, its Federal income tax liability for the years 1936,1937, and 1938 would have been increased by $232,626.60, $5,023.07, and $13,159.44, respectively, that is, an aggregate of $250,809.11.

26. On or about January 19, 1945, the plaintiff filed with the collector of internal revenue, Second District of New York, a claim for refund (form 843) of taxes for the year 1941 in the amount of $132,355.36, or such greater amount as is legally refundable, which claim was filed within the statutory period for filing such, a claim. On or about August 29, 1945, the plaintiff filed with the collector of internal revenue, Second District of New York, a claim for refund (form 843) of taxes for 1942 in the amount of $154,833.16, or such greater amount as is legally refundable, which claim was filed within the statutory period for filing such a claim.

27. During the year 1946 a second examination of the income and excess profits tax returns of the plaintiff for the years 1941 and 1942 was made by a revenue agent of the Internal Revenue Service. The reports on such second examination were both dated December 26, 1946, and were transmitted to the plaintiff by letters dated June 12,1947, and June 13, 1947, signed by the Internal Revenue Agent in Charge, Second New York Division.

28. In the revenue agent’s report attached to the letter of June 12,1947 (relating to the year 1941), referred to in finding 27, in schedule No. 13 thereof, the following summary of adjustment under section 734 appeared:

Increase in Aggregate Year Tax Interest Net Increase
. $232,626.60 $69,787.98 $302,414.58 1936.
. 5,023.07 1,205.54 6,228.61 1937.
. 13,159.44 2,368.70 15,528.14 1938.
Total. 250,809.11 73,362.22 324,171.33
Adjustment applied toward 1941 (Tax Only). 184,600.64
Balance applicable to 1942........ 139,570.69
Interest allowable as a deduction in 1943_ $73,362.22

29. Schedule No. 8-A of the same revenue agent’s report attached to the letter of June 12,1947, referred to in findings 27 and 28, included the following language:

Explanation of Items Changed : Tear Ended : 12/31/41 19S6
To increase 1936 income for processing tax adjustments. It was contended by taxpayer that the amount of $1,349,269.76 which was applied as 1935 income had been erroneously treated and belonged to 1936. As a result of same, taxpayer requested (as per Claim Form 843) that the base period income for 1936 be increased by that amount.
The filing of Form 843, for the year 1941, adopting the inconsistent position represents a determination authorizing an adjustment under Section 734 of the Internal Revenue Code.
The circumstances prerequisite to an adjustment appear to be present as follows:
1. An inconsistent position has been adopted and maintained by taxpayer.
2. The inconsistent position has been adopted in connection with a determination of excess profits tax liability.
3. The treatment accorded the item for the prior taxable year had been erroneous under the provisions of the Internal Revenue laws applicable to such prior taxable year.
4. Correction of the effect of the error, under ordinary procedure, is prevented by some provision of law or rule of law.
5. Taxpayer who is adopting the inconsistent position is the party adversely affected.
1939
(a) — Increase in base period earnings for the year 1939 as disclosed by adjustment made in RAR dated June 4, 1943, covering reexamination of 1939 return. Excessive deduction of Federal Capital Stock Tax claimed in 1939 restored to taxable income-$18, 572. 72

30. In the report attached to the letter of June 13, 1947 (relating to the year 1942), referred to in finding 27, schedule No. 10-A and schedule No. 14 adopted the figures and conclusions appearing in the report attached to the letter of June 12,1947, set put in findings 28 and 29, in the computation of the plaintiff’s excess profits tax for the year 1942.

31. On April 20, 1948, the plaintiff was notified by the Commissioner of a deficiency in income tax of the plaintiff for 1941 of $57,123.19, which deficiency, with interest thereon of $21,370.33, the plaintiff, pursuant to notice and demand, duly paid to the collector of internal revenue, Second District of New York, on August 26,1948.

On April 20, 1948, the plaintiff was also notified by the Commissioner of a deficiency in income tax of the plaintiff for 1942 of $122,572.29 and a net overassessment in excess profits taxes for 1942 in the amount of $145,210.21. Such deficiency and net overassessment, after adjustment for interest of $3,364.67 and a postwar refund of $24,091.89, resulted in a net deficiency in taxes for 1942 of $36,590.43, which, upon notice and demand, was duly paid by the plaintiff on August 26,1948, to the collector of internal revenue, Second District of New York.

32. In the deficiency notices of April 20,1948, referred to in the preceding finding, which notices were signed “Geo. J. Schoeneman, Commissioner, By C. B. Krigbaum, Internal Bevenue Agent in Charge,” the following adjustments and explanations thereof appear:

Schedule 4. — Adjustments to Excess Profits Wet Income for Base Period Years
me 1937 1938 1939
As previously determined.. $16,066,602.10 $13,976,036.17 $15,369,131.14 $13,893,089.07 Increases:
(a) Processing tax re-
imbursements.. . 1,349,269.76
(b) Capital stock tax_____ 18,672.72
As adjusted_ 17,416,871.86 13,975,036.17 15,369,131.14 13,911,661.79
Net aggregate_ 60,671,700.96
Average base period net income (12/48 x $60,671,700.96)_ 15.167,925.24
Schedule 4A. — Explanation of Adjustments
(a) Processing tax reimbursements in the amount of $1,349,269.76, erroneously omitted from income in the year 1936, are herein included in the base period not income for such year, to give effect to an inconsistent position asserted and maintained by you for tho determination of your excess profits tax liability for the year 1941. Section 734 adjustment in respect thereof is shown in schedule 6, infra.
(b) Excessive deduction of $18,572.72 claimed for Federal capital stock tax in the year 1939, and previously disallowed, is restored to taxable income for such year for the purpose of computing your average base period net income.
Schedule 5. — Computation of Adjustment Due to Application of Section 784
me 1957 1938
Net income as disclosed by reports of examination to which you have agreed_ $16, Oil, 712.00 $13,982,660.90 Add: Processing tax reimbursements. 1,349,269.76 $15,388,223.04
Net income for income tax computation, as adjusted_ 17,360,981.76 13,982,660.90 15,388,223.04
Correct income tax liability recomputed, the details of which have been furnished you heretofore...... 2,319,687.27 Income tax previously assessed__ 2,087,060.67 1,849,082.34 1,844,059.27 2,358,765.70 2,345,606.26
Increase in income tax.. Interest from due date of filing return to March 15,1942. 232,626.60 69,787.98 5,023.07 1,205.54 13,169.44 2,368.70
Total increase__ 302,414.58 6,228.61 15,528.14
Aggregate increase in income tax and interest-324,171.33
Adjustment under section 734 applied as follows:
Portion applied to the computation of excess profits tax for 1941 (Schedule 6).-.-. $184,600.64
Portion applied to the computation of excess profits tax for 1942 (Schedule 10).;.. 139,570.69
Total adjustment. 324,171.33
Credit for income taxes paid to a foreign country is decreased from $96,664.22, as previously determined, to $86,347.30, the details of which were furnished to you in report of examination dated December 26,1946.

33. The claim for refund for 1941, referred to in finding 26, was disallowed in full by tlie Commissioner on or about July 27,1948, and on or about September 30,1948, the claim for refund for 1942, referred to in finding 26, was disallowed by. the Commissioner to the extent not previously allowed and reflected in the letter of April 20, 1948, referred to in finding 31.

34. The plaintiff in its claims for refund filed on January 19,1945, and August 29,1945, and referred to in finding 26, treated the amount of $1,349,269.76, heretofore referred to, as 1936 income for the purpose of determining the plaintiff’s excess profits tax credit for 1941 and 1942. On the date of determination of the plaintiff’s excess profits taxes for 1941 and 1942, any correction in the income tax liability of the plaintiff for 1935 and any correction in the income tax liability of the plaintiff for 1936 were prevented by the operation of the applicable statute of limitations.

35. The adjustments made by the Internal Kevenue Agent under section 734 and approved by the Commissioner, as set forth above, were based upon the taxable years 1936 through 1938 only and did not include an adjustment on account of 1935.

36. If the adjustment of the plaintiff’s excess profits taxes for 1941 under section 734 were properly to include a decrease of net income for 1935 in the amount of $1,349,269.76, such adjustment would be:

Year Increase or Aggregate {Decrease) Increase or in Tax Interest {Decrease)
1636. $232,626.60 $69,787.98 $302,414.58
1937. 6,228.61
1938. 13,159.44 2,368.70 15,528.14
250,809.11 73,362.22 324,171.33 1935. (185,485.08) (58,427.80) (243,612.88)
Net.
Applicable to 1941... 80,258.45
Interest allowable as a deduction in 1942 pursuant to Section 734 (e)_ 14,934.42

37. The plaintiff timely filed excess profits tax returns with the collector of internal revenue, Second District of New York, for the years 1943, 1944, and 1945. In such returns the excess profits tax credit was computed upon the basis of the plaintiff’s average base period net income for the base period years 1936-1939, inclusive. The excess profits tax net income for the base period year 1936 reported by the plaintiff in such excess profits tax returns was $17,415,871.86, which included the processing taxes in the amount of $1,349,269.76 heretofore referred to. On examination of such excess profits tax returns certain adjustments were made, but the Commissioner made no change in the reported excess profits tax net income for the base period year 1936.

38. As the result of computing its excess profits tax credit for the years 1941-1945 by including the amount of $1,349,269.76 in base period income for 1936, the plaintiff’s excess profits tax liability for the years 1940 through 1945 was reduced by the following gross amounts, before application of the section 734 adjustment:

1940_ 0
1941_ $181,535. 89
1942_ 250,098.63
1943_ 250,043.79
1944_ 986..09
1945_ 273,986.09

and its income, declared value excess-profits, defense and excess profits tax liabilities for these same years were reduced in the following net amounts, before application of the section 734 adjustment:

1940_ o
1941_$125,188.64
1942_ 127,525.37
1943_ 125,384.02
1944_ 145, 805.46
1945_ 145,805.46
Total_1_ 669, 708. 95

39. The plaintiff was allowed a deduction of $73,362.22, representing interest included in the amount of the section 734 adjustment set forth in finding 28 in the computation of its 1943 income and excess profits tax liabilities. As a result of such deduction, the plaintiff’s income and excess profits tax liabilities for 1943 were reduced in the net amount of $59,114.19.

40. If the adjustment had been computed as set forth in finding 36, instead of as set forth in finding 28, the plaintiff would not have been entitled to the deduction described in finding 39, but would have been entitled to a deduction of $14,934.42, representing interest included in the amount of the adjustment set forth in finding 36, in the computation of its 1942 income and excess profits tax liabilities. An additional deduction of $14,934.42 for 1942 would have reduced the plaintiff’s income and excess profits tax liabilities for 1942 in the net amount of $11,820.39.

41. As shown in finding 8, during the year 1935 the plaintiff owned all of the outstanding stock of The National Milling Company. The plaintiff had acquired the common stock of The National Milling Company in 1926 for the purpose of milling its own flour and thereby obtaining uniform quality and reducing its cost of flour. All of the output of flour of The National Milling Company was consumed by the various baking plants of the plaintiff and its wholly owned subsidiary, National Bread Company, with the exception of less than y2% of the flour purchased which was shipped to a blender of doughnut flour for use in the special mix prepared and used by the plaintiff or the National Bread Company.

42. Immediately upon the acquisition of The National Milling Company, the plaintiff installed at the mill of The National Milling Company its regular branch accounting system, using regular branch account books and records and requiring the same weekly and monthly reports on forms similar to the forms used for all its other branches. Shortly after the acquisition, the plaintiff commenced to bring in monthly to its general office books the profits of The National Milling Company in substantially the same manner as it brought in the monthly profits of its branches. While the plaintiff made the foregoing changes in the accounting system of The National Milling Company, The National Milling Company continued to keep separate corporate records and books of account as a separate corporation until its dissolution in 1936.

43. Promptly after the acquisition of The National Milling Company, the plaintiff began to place its own officers and employees in The National Milling Company’s organization so that at all times here material substantially all the individuals who were officers and directors of The National Milling Company were individuals who had been and continued to be officers or employees of the plaintiff. In the management and operation of its branches which were not separately incorporated, the plaintiff at all times here material imposed well defined limitations upon the discretionary authority of its branch managers and executives. Substantially the same limitations were imposed by the plaintiff upon the officers and executives of The National Milling Company.

The National Milling Company carried on certain activities which were independent of or unrelated to activities of the plaintiff, such as the sales of wheat to persons other than the plaintiff and the unloading and storage of grain owned by third parties. The National Milling Company continued its identity as a separate corporation until its dissolution in January 1936, as heretofore shown.

44. The National Milling Company prepared and filed its own separate Federal income tax returns and Ohio franchise tax returns for 1934 and 1935, which returns were signed by officers of The National Milling Company at Toledo, Ohio.

45» The plaintiff filed applications for relief and claims for refund under section 722 of the Internal Revenue Code in connection with its excess profits tax liability for the years 1941-1945 inclusive. In accordance with the practice of the Excess Profits Tax Council, those applications and claims, after consideration by a field committee which recommended disallowance, were referred to a panel of the Council for consideration and recommendation. On October 24, 1951, that panel which at that time consisted of one member of the Council wrote a letter to counsel for the plaintiff setting out not only the determination of the panel that the claims for relief should be denied in full but also the reasons for that action, which reasons included a discussion of the various items set out by the plaintiff in its claims. With respect to the item of processing taxes for 1935, the following statements were made:

Abnormal income from refund of processing taxes:
Refunds of $1,474,993 of processing taxes relating to prior years were received in 1936. This is extraneous income not connected with current year operations and it is therefore considered as abnormal for section 722 purposes. The base period average adjustment is $368,748 ($1,474,993 divided by 4), and has the effect of reducing actual average earnings by that amount.

The figure of $1,474,993, referred to in the above quotation, included the figure of $1,349,269.76 for processing taxes heretofore referred to.

In connection with the discussion of certain items set out in the plaintiff’s claims, the letter continued as follows:

The following schedule summarizes the net effect of the foregoing adjustments:
Constructive decreases from actual average earnings:
Processing tax refunds-$368,748
Casualty losses- 21,376
Total decreases_ $390,124
Constructive increases in actual average earnings:
Foreign dividends_$166,131
New products_ 49,036
Total increases_ 215,167
Net constructive decrease from actual average earnings 174,957
The foregoing summarizes the net effect of all points of claim except those relating to section 722 (b) (4) with respect to alleged changes in the character of the business in the form of increased capacity and differences in operation, as evidenced by the installation of new band ovens at the Cambridge, New York, and Atlanta plants, and new tray ovens at certain bread baking plants. In order for the taxpayer to obtain relief under section 722, in the opinion of the Council panel, it is necessary that the adjustment for these additional factors exceed $174,957. These factors are discussed separately below.
The letter concluded with the following statement:
In the light of the foregoing, the panel has determined that the applications for relief should be disallowed in full. A report to that effect is being prepared for submission to the Executive Committee of the Council, and you will be notified promptly of the action taken by the Committee after its review.

46. On November 9, 1951, the plaintiff was advised that the Excess Profits Tax Council had approved the determination of the Council panel referred to in the preceding finding and that a statutory notice under section 732 would be issued in accordance with established procedure. On September 23, 1953, the Commissioner issued the statutory notice just referred to, which notice read in part as follows:

After careful consideration of your applications for relief under section 722 of the Internal Eevenue Code, filed as indicated below, it has been determined that you have not established your right to the relief requested in such applications.
In accordance with the provisions of section 732 of the Internal Revenue Code notice is hereby given of the dis-allowance of the claims for refund asserted in your applications (Form 991) and in the related claims (Form 843), filed as indicated below.
*****
Within 90 days from the date of the mailing of this letter you may file a petition with The Tax Court of the United States, at its principal address, Washington 4, D. C., for a redetermination of your excess profit tax liabilities under the Internal Revenue Code. * * *

The plaintiff did not file petitions with The Tax Court of the United States seeking relief from the foregoing determination.

47. While this court is without jurisdiction to review a section 722 determination, and it is a matter of conjecture as to whether the plaintiff would have obtained any relief under section 722 if the item of $1,849,269.76 had not been treated as abnormal income for 1986, reasonable conclusions from the evidence are that (1) any relief under section 722 would have been of less tax benefit to the plaintiff than the net benefit it obtained by computing its excess profits credit with the inclusion of $1,349,269.76 of abnormal income in 1936, and that (2) more than $699,828 of abnormal income would have had to be excluded from 1936 before any tax benefit to the plaintiff would arise under section 722.

48. The trial of this case was limited in this proceeding to the issues of law and fact relating to the right of the plaintiff to recover, reserving the determination of the amount of recovery and offsets, if any, for further proceedings.

49. Plaintiff is the sole owner of the claims herewith presented, and has not at any time assigned or transferred such claims or any part thereof or interest therein.

CONCLUSION OP LAW

Upon the foregoing findings of fact, which are made a part of the judgment herein, the court concludes as a matter of law that plaintiff is entitled to recover subject to defendant’s right of equitable recoupment and judgment will be entered to that effect. The amount of recovery will be determined pursuant to Buie 38 (c). •

In accordance with the opinion of the court and on a memorandum report of the commissioner as to the amount due thereunder, it was ordered June 4, 1958, that judgment for the plaintiff be entered for $195,769.67, plus interest on $110,530 from October 7, 1957, as provided by law.  