
    FARREL-BIRMINGHAM COMPANY, INC. v. THE UNITED STATES
    [No. 598-52.
    Decided June 8, 1954.
    Rehearing granted and opinion modified November 2, 1954.]
    
      
      Mr. N. Barr Miller for plaintiff. Mr. J. Marvin, Haynes, Messrs. Haynes At Miller, Julius G. Day, Jr., F. Eberhart Haynes and Osear L. Tyree were on the briefs,
    
      Mr. J. W. Hussey, with whom was Mr. Assistant Attorney General H. Brian Holland, for defendant: Messrs. Andrew D. Sharpe and Lee A. Jackson were on the brief.
   Madden, Judge,

delivered the opinion of the court on plaintiff’s motion for a rehearing:

In our decision of June 8, 1954, we interpreted Section 710 (a) (1) (B) of the Internal Eevenue Code as requiring a corporation taxpayer which made the election permitted by Section 736 (b), to recompute its surtax net income as if its regular method of computation of its income was based upon percentage of completion of its contracts. We did not quote Section 736 (b) in our former opinion. We now quote it, omitting irrelevant parts:

(b) Election on Long-Term Contracts. — In the case of any taxpayer computing income from contracts the performance of which requires more than 12 months * * * it may elect, in its return * * * for the purposes of this subchapter * * *, to compute, in accordance with regulations prescribed by the Commissioner with the approval of the Secretary, such income upon the percentage of completion method of accounting. ¡Such election shall be made in accordance with such regulations * * *.

We said that the language of Section 736 (b) required the taxpayer, which elected to take advantage of the section, to compute, not merely its excess profits income, but its income, upon the percentage of completion method, for the purposes of this subchapter, which subchapter included Section 710 (a) (1) (B). In the presentation of this case before our former decision, the only point argued by the parties was whether the recomputation required by Section 736 (b) applied to the surtax net income, which by Section 710 (a) (1) (B) was made the basic amount upon which the excess profits tax was to be computed. The plaintiff urged that the surtax net income referred to in Section 710 (a) (1) (B) was the surtax net income upon which its surtax had actually been computed, and not a hypothetical surtax net income produced by a recomputation based upon a percentage of completion method of computation. The Government urged the contrary, and we concluded that the Government was right.

The plaintiff, in support of its motion for a rehearing, makes the same contention which it made before. But it also presents an alternative contention. It says that if we persist in our former view, that Section 736 (b) requires a recomputation of the surtax net income, which is a basic factor in the Section 710 (a) (1) (B) computation, by the same logic it requires a recomputation of the “tax imposed for the taxable year under Chapter 1” (the corporation’s noi'mal and surtax), which is also a factor in the computation of the excess profits tax under Section 710 (a) (1) (B).

Our former decision was that it was right for the Commissioner of Internal Revenue to recompute the plaintiff’s surtax net income upon the percentage of completion method of accounting, thereby obtaining a figure $1,419,611.37 higher than the one on which the plaintiff had actually paid its surtax. Since Section 710 (a) (1) (B) imposed an excess profits tax of an amount which, when added to the Chapter 1 taxes (normal and surtax) would constitute 80% of the surtax net income, and since the Chapter 1 taxes actually paid, amounting to $226,981.31, had already been deducted in the plaintiff’s own computation, the Commissioner in fact taxed the $1,419,611.37 which he added to the surtax net income, at 80%. The resulting addition to the tax on this account was $1,135,689.10.

The plaintiff says that the $1,419,611.37 which was added to its income by the percentage of completion computation, and on which it was taxed at 80% in 1943, will appear again in 1944 or some subsequent year in which it has completed the pertinent contracts, as income under its regular method of accounting, the completed contract method. It will then, under Chapter 1, have to pay the normal tax and the surtax on this amount. Those taxes together amount to 40%. It will then have been taxed a total of 120% upon the $1,419,611.37. The plaintiff says that this is an injustice. We think even the most hardened publican would feel constrained to agree.

The plaintiff suggests, in its alternative contention, that a way for us to eliminate the injustice is to be consistent in our interpretation of the application of Section 736 (b) to Section 710 (a) (1) (B). If, as we formerly decided, the surtax net income mentioned in Section 710 (a) (1) (B) is not the actual surtax net income used by the plaintiff in computing its surtax, but a recomputed surtax net income, why is not “the tax imposed for the taxable- year under Chapter 1,” to be similarly recomputed ? We have said that Section 736 (b) requires that for the purposes of the excess profits tax subchapter the taxpayer compute its income on the percentage of completion method. If it had done so, it would have computed normal and surtaxes on the additional $1,419,611.37 at the 40% rate, and would thus have had a large additional amount to deduct from the 80% of its recomputed surtax net income. Then only 60%. of the $1,419,611.37 would be taxed at the 80% rate. When the $1,419,611.37 actually came into the plaintiff’s income, on the basis of its completed contract method of accounting, in some subsequent year, it would be taxed at the 40% normal and surtax rate.

We have only vague ideas as to how this complex law would work out for the plaintiff in the long run. It will be remembered that, once a corporation had made the Section 736 (b) election, the elected method of computation was carried back to the beginning of the excess profits tax years, and had to be adhered to for all subsequent excess profits tax years. The plaintiff made the election, faced with a Treasury Regulation interpreting the statute in a way which the plaintiff now claims to have been to its disadvantage, for the year 1943. It must, when it made its election, have seen advantages which would flow to it from the readjustment of its computations for prior years, and from the application of the elected method of computation in subsequent years. The record before us gives us no idea what those advantages may have been. We have only the text of the statutes, and the demonstrated example of what seems to us to be a hardship as to one application of the statutes, to work with.

The plaintiff’s alternative contention is new, and somewhat striking, but we think it is reasonable. We quote again Section 710 :

Sec. 710. Imposition oe Tax.
tal Imposition.—
(1) General Rule. — There shall be levied, collected, and paid, for each taxable year, upon the adjusted excess-profits net income, as defined in subsection (b), of every corporation (except a corporation exempt under section 727) a tax equal to whichever of the following amounts is the lesser:
(A) 90 per centum of the adjusted excess-profits net income, or
(B) an amount which when added to the tax imposed for the taxable year under Chapter 1 (other than section 102) equals 80 per centum of the corporation surtax net income, computed under section 15 or Supplement G, as the case may be, but without regard to the credit provided in section 26 (e) (relating to income subject to the tax imposed by this subchapter).
*****

A consistent application of the idea that Section 736 (b) requires a computation of a hypothetical surtax net income Avould, in the context, also require a computation of a hypothetical Chapter 1 normal and surtax, “for the purposes of this [the excess profits tax] subchapter.”

In the Excess Profits Tax Act of 1950, Congress, in what is Section 430 (a) (2) (A) of the Internal Revenue Code expressly provided for the hypothetical recomputation of the normal tax and surtax as well as the normal tax and surtax net incomes, in situations such as the one before us. This is evidence of the logic and the equity of our conclusion.

In our former opinion we cited and, to a degree, relied upon Treasury Regulations 112, Section 35.736 (b)-3, as amended by T. D. 5388, 1944 Cum. Bull. 387, applicable to Section 736 (b) of the Internal Revenue Code. We pointed out that the regulation expressly provided for the recomputation, for Section 710 (a) (1) (B) purposes, of the surtax net income on the percentage of completion basis. We did not point out, because the then contentions of the parties made it irrelevant, that the regulation also said:

* * * the normal tax and surtax shall be the actual normal tax and surtax determined under Chapter 1.

By our present decision, we are nullifying that part of the regulation. We think it is inconsistent with the statute, and with the other part of the same regulation, which other paid; we approved in our former decision.

We adopt the plaintiff’s alternative contention. The plaintiff’s motion for a rehearing is granted, and our former decision is modified to accord with this opinion. Our former conclusion of law is vacated. The plaintiff is entitled to recover, with interest as provided by law. Entry of judgment is suspended to await the filing by counsel of a stipulation showing the amount due, pursuant to this opinion.

Whitaker, Judge/ LittletoN, Judge; and JoNes, Chief Judge, concur.

LaramoRe, Judge, took no part in the consideration or decision of this case. .

Madden, Judge,

on June 8, 1954, delivered the opinion of the court as follows:

The plaintiff corporation is in disagreement with the Government as to what is the right way to compute its excess profits tax for the year 1943. It computed its tax by the method which it claims to be right, and found the tax to be $3,489,638.68 which it paid on time. The Commissioner of Internal Eevenue computed the tax by the method which he claimed to be right, and it came to $1,022,120.18 more, which he assessed, together with interest of $168,886.18. The plaintiff paid these additional sums, and filed a timely claim for refund to get them back. The claim for refund was denied, and the plaintiff brought this suit.

The dispute concerns the interpretation of certain sections of the Internal Eevenue Code, and the validity of a Begulation of the Treasury Department which Eegulation places upon the sections of the code the interpretation for which the Government contends.

The plaintiff is a manufacturing corporation, and had work contracted for in 1943 which required more than twelve months for its completion. That fact created an accounting problem with regard to the computation of its profits on those contracts, for its income tax and other accounting purposes. Section 41 of the Internal Eevenue Code provides that a taxpayer shall compute his income, for normal income and surtax purposes, in accordance with the method of accounting regularly employed in keeping his books. The plaintiff, in keeping its books, in relation to its contracts requiring more than 12 months for completion, used the “completed contract” method of accounting, that is, it did not count its profit on such a contract until the contract was completed. It therefore computed its normal income tax and surtax on this same basis of accounting.

Our problem concerns the plaintiff’s excess profits tax. The following section of the Internal Eevenue Code is pertinent :

Seo. 710. Imposition oe tax.
(a) IMPOSITION.—
(1) General Rule. — There shall be levied, collected, and paid, for each taxable year, upon the adjusted excess-profits net income, as defined in subsection (b), of every corporation (except a corporation exempt under section 727) a tax equal to whichever of the following amounts is the lesser:
(A) 90 per centum of the adjusted excess-profits net income, or
(B) an amount which when added to the tax imposed for the taxable year under Chapter 1 (other than section 102) equals 80 per centmn of the corporation surtax net income, computed under section 15 or Supplement G, as the case may be, but without regard to the credit provided in section 26 (e) (relating to income subject to the tax imposed by this subchapter).
* $ $ $ ‡

Section 736 (b) of the Internal Revenue Code provided that a taxpayer, having contracts requiring more than 12 months for their performance, if certain other conditions existed which did exist in the case of this plaintiff, might elect, in its excess profits tax return, to compute its income from such contracts upon the “percentage of completion” method of accounting. That meant that the taxpayer could, if he so elected, apportion his profits or prospective profits on such contracts over the period of performance, thus keeping them from being “bunched” in the year in which he happened to complete the contracts. Section 736 (b) said that this computation should be made “in accordance with regulations prescribed by the Commissioner (of Internal Revenue) with the approval of the Secretary (of the Treasury).”

The plaintiff elected, as it had a right to do under Section 736 (b), to compute its excess profits income on the “percentage of completion” method of accounting. This produced a figure much higher than the figure which would have been produced by its regular “completed contract” method, which method, as we have said, it used for its own internal accounting, and for computing its normal tax and surtax. It then made its computations taking, under Section 710 (a) (1) (A), 90 percent of its excess profits net income, so determined, and taking, under Section 710 (a) (1) (B),80percent of its surtax net income as actually computed for the determination of the amount of its surtax, plus and minus certain items not here in dispute. The 90 percent figure was $4,-979,035.74, while the 80 percent figure, applied, of course, to a different base, was $3,563,929.31. As provided in Section TIO (a) (1) it paid the lesser amount.

The Government nrges that the plaintiff having elected, for the purpose of the (A) computation, to use the “percentage of completion” method, it must do likewise in making the (B) computation. That means that it had to recompute its surtax net income as if its regular method of accounting had been the “percentage of completion” method, thereby, in this instance, getting for this purpose a higher surtax net income than the one on which it had actually computed and paid its surtax. Since Section 710 (a) (1) (B) called for 80 percent of that surtax net income, with certain deductions, the Government’s (B) figure was much higher than the plaintiff’s. It was, nevertheless, not as high as the (A) figure, and therefore set the amount of the tax.

The plaintiff points to the statute, Section 710 (a) (1) (B) which as we have seen, speaks of the “surtax net income, computed under section 15.” Section 15 defines the term “corporation surtax net income” and imposes the surtax.

The Government points to the language of Section 736 (b) which says that the corporation may elect to compute “in accordance with regulations prescribed by the Commissioner with the approval of the Secretary” and in the following sentence says “Such election shall be made in accordance with such regulations * * It then points to Treasury Eegulations 112, Section 35.736(b)-3 as amended by T. D. 5388, 1944 Cum. Bull. 387, applicable to Section 736 (b) of the Code, which Eegulation says:

For such purpose, the corporation surtax net income shall be determined by computing the income from long-term contracts upon the percentage of completion method of accounting.

The Eegulation is directly applicable, and, if it is valid, it settles the question. The plaintiff contends that it is invalid because it contradicts the statute. The plaintiff says that the reference in Section 710 (a) (1) (B) to the “corporation surtax net income, computed under section 15,” so plainly means the surtax net income as actually computed by the taxpayer in his return that that meaning cannot be changed by a Eegulation. That position was taken practically without discussion in Basalt Rock Co., Inc. v. Commissioner, 180 F. 2d 281, C. A. 9 (certiorari denied 339 U. S. 966), reversing 10 T. C. 600.

The Government points out that Section 136 (b) in permitting the taxpayer to use the “percentage of completion” method of accounting, says that the corporation “may elect, in its return for such taxable year for the purposes of this subchapter, * * * to compute, * * * such income upon the percentage of completion method of accounting.” Since both Sections 710 (a) (1) (A) and 710 (a) (1) (B) are in Sub-chapter E of Chapter 2, which subchapter covers the subject of the excess profits tax, the Government says that it would be illogical to suppose that Congress intended that the taxpayer should use the elected method to compute what its excess profits tax would be under (A), then use another method under (B), and pay its tax on the basis of the (B) computation. This was the reasoning of the Court in the case of Sokol Bros. Furniture Co. v. Commissioner, 185 F. 2d 222, C. A. 5 (certiorari denied, 340 U. S. 952), affirming 8 T. C. M. 239.

The statute does not say that the taxpayer may so elect to compute its excess profits net income, which would limit the effect of the election to Section 710 (a) (1) (A). It says that the taxpayer may elect, for the purposes of this (the Excess Profits Tax) subchapter, to compute such mcome upon the percentage of completion method of accounting. The preceding language of Section 736 (b) shows that such income does not mean excess profits net income. It means the taxpayer’s income. If, then, the taxpayer makes the permitted election, it must, for all subchapter E purposes, make its computation according to that election. That means that it must recompute its surtax net income on this method of accounting, since that surtax net income is the basis of the determination of the amount of the tax due under Section 710 (a) (1) (B).

It seems to us that there is a fundamental inconsistency in the method of computation for which the plaintiff contends. Section 710 (a) (1), in setting up alternatives (A) and (B), and fixing the tax as the lower of the two figures, must have contemplated that the figures and the methods of arriving at them should be comparable, should be based upon similar basic data. If not so based, the results are accidental, and have no logical relation to one another.

Regulations, especially when expressly authorized by the applicable statute, carry, of course, a strong presumption of validity. It is easy to imagine that Congress, in legislating upon so complicated a matter as the one before us, saw the need of clarifying Regulations. The statutory ensemble does not show a clear meaning, as is evident from the conflicting decisions referred to above. In that situation, Regulations not plainly inconsistent with the statute should not be held invalid.

The plaintiff points out that the Government’s computation causes the plaintiff to pay more taxes than its net income was for the year, when computed according to the completed contract method, which was its regular method of keeping its books. This asserted hardship is more apparent than real, since neither the completed contract nor the percentage of completion method had any necessary relation to the plaintiff’s real financial or income status. Either method represents an arbitrary choice made for bookkeeping purposes. It is not likely that the plaintiff, in fact, received no payments on its long-term contracts until they were completed.

We think that the Court of Appeals for the Fifth Circuit in the Sokol case, and the Tax Court in that case and the Basalt Bock Company case were right. We therefore dismiss the plaintiff’s petition.

It is so ordered.

LittletoN, Judge; and Jones, Chief Judge, concur.

Whitaker, Judge,

dissenting:

I dissent. I agree with the decision of the Court of Appeals in the Basalt Bock Company case, supra.

Judge Laramore took no part in the consideration or decision of this case.

FINDINGS OF FACT. .

The court made findings of fact, based upon the stipulation of the parties, and the briefs and argument of counsel, as follows:

1. Farrel-Birmingham Company, Inc., is a corporation organized in 1921 under the laws of the State of Connecticut and is engaged primarily in the business of manufacture and sale of heavy machinery. Its principal office is located in Ansonia, Connecticut. Plaintiff sues for recovery of the sum of $1,022,120.18 excess profits tax and $168,886.18 deficiency interest, a total of $1,191,006.36, including interest thereon as provided by statute, which amount represents excess profits tax and interest paid by plaintiff for its taxable year ended December 31,1943.

2. Within the time required by law, plaintiff filed with the Collector of Internal Eevenue at Hartford, Connecticut, its corporation excess profits tax return (Form 1121) for the taxable year ended December 31, 1943, on which a liability for excess profits tax was shown in the amount of $3,489,638.68. This amount was duly paid to the said Collector on or before the statutory installment dates fixed by law. Subsequently, as the result of various adjustments made by the Commissioner of Internal Eevenue, the Commissioner made a final determination that plaintiff’s excess profits tax due for the taxable year 1943 was $4,229,656.66 with deficiency interest of $168,886.18, all of which amounts have been duly paid.

3. Under date of June 27, 1952, and within the time required by law, plaintiff filed with the Collector of Internal Eevenue at Hartford, Connecticut, a claim for refund of excess profits tax for the taxable year 1943 in the amount of $1,022,120.18, or such other amount as was legally refundable. In its claim plaintiff asserted that in computing its excess profits tax for 1943 under the provisions of Section 710 (a) (1) (B) of the Internal Eevenue Code, surtax net income should have been the amount computed in accordance with the completed contract method of accounting instead of the percentage of completion method used by the Commissioner of Internal Revenue. The claim also asserted that tbe Commissioner’s computation of surtax net income had been made in accordance with an invalid regulation which had been issued by the Commissioner.

4. The Commissioner of Internal Revenue by registered letter under date of September 19, 1952, rejected the claim for refund.

5. In rejecting plaintiff’s claim for refund the Commissioner of Internal Revenue determined that plaintiff’s excess profits tax for 1943 was an amount which, when added to the normal and surtax imposed on plaintiff for that year, equaled 80 percent of plaintiff’s surtax net income computed under the percentage of completion method.

6. During the taxable year 1943 plaintiff derived income from contracts, the performance of which required more than twelve months.

7. For the taxable year 1943 plaintiff filed its corporation income and declared value excess profits tax return (Form 1120) reporting income from contracts requiring more than twelve months to perform on a completed contract basis in accordance with its regular method of reporting such income, and it filed its corporation excess profits tax return (Form 1121) for the taxable year 1943 reporting income from such contracts on the percentage of completion method of accounting pursuant to an election made under Section 736 (b) of the Internal Revenue Code.

8. With respects to the computation of the excess profits tax for 1943, Section 710. (a) (1) of the Internal Revenue Code, as amended by Section 202 of the Revenue Act 1942, provided as follows:

Sec. 710. ImpositioN or tax.
(a) imposition.—
(1) General Buie. — There shall be levied, collected, and paid, for each taxable year, upon the adjusted excess-profits net income, as defined in subsection (b), of every corporation (except a corporation exempt under section 727) a tax equal to whichever of the following amounts is the lesser:
(A) 90 per centum of the adjusted excess-profits net income, or
(B) an amount which when added to the tax imposed for the taxable year under Chapter 1 (other than section 102) equals 80 percentum of the corporation surtax net income, computed under section 15 or Supplement G, as the case may be, but without regard to the credit provided in section 26 (e) (relating to income subject to the tax imposed by this subchapter).

9. Supplement G of the Internal Revenue Code, as amended, for the taxable year 1943 did not apply to plaintiff. Plaintiff’s corporation surtax net income, computed under Section 15 of the Internal Revenue Code, but without regard to the credit provided in Section 26 (e), as finally determined by the Commissioner for the taxable year 1943 was $4,738,648.27 as computed on the completed contract basis and the amount of $6,158,259.64 as computed on the percentage of completion basis.

10. In computing plaintiff’s excess profits tax for the year 1943, and in rejecting plaintiff’s claim for refund with respect thereto, the Commissioner of Internal Revenue determined that the surtax net income for purposes of the 80 percent limitation prescribed in Section 710 (a) (1) (B) should be computed under the percentage of completion method of accounting and that the surtax net income was $6,158,259.64, of which 80 percent was $4,926,607.71. The Commissioner determined that plaintiff’s adjusted excess profits net income was $5,532,261.93 and that 90 percent thereof was $4,979,035.74. Having determined that plaintiff’s normal tax and surtax for the year 1943 was the amount of $226,989.31, the Commissioner determined under his regulations that the excess profits tax of plaintiff computed under Section 710 (a) (1) (B) for the year 1943 was the amount of $4,699,618.40, ($4,926,607.71 minus $226,989.31).

11. The computation of plaintiff’s net income on the percentage of completion basis as finally determined by the Commissioner, which he designated as “surtax net income” pursuant to Section 35.736 (b)-3 (a) of Reg. 112, is shown as follows in a revenue agent’s report dated July 2,1951:

Schedule 18-A
subtax net income — percentage of completion basis
Surtax net income:
Completed contract basis, sch. 12_$4, 738,719. 37
Add: Increase in income on % of comp, basis, sch. 17_ 1, 419, 611.37
6,158,330. 74
Less: Dividends received credit- 71.10
Surtax net income_ 6,158,259.64

After arriving at the above surtax net income figure, the Commissioner in his final determination proceeded to compute the excess profits tax under Section 710 (a) (1) (B) in the following manner:

7. Surtax net income (computed without regard to the credit provided by section 26 (e))_$6,158,259.64
8. 80% of Item 7_ 4,926,607.71
9. Income tax (other than section 102)_ 226,989.81
10. Excess of Item 8 over Item 9_ 4,699, 618.40

12.Plaintiff asserts that its excess profits tax for the year 1943 is limited under the provisions of Section 710 (a) (1) (B) of the Internal Bevenue Code, as amended, to an amount which, when added to its normal tax and surtax for the year 1943, equals 80 percent of its surtax net income for said year determined under the provisions of Section 15 of the Internal Bevenue Code on a completed contract basis, as follows:

Surtax net income as determined by the Commissioner under Section 15 on the completed contract basis, without regard to the credit provided in Section
26 (e)-$4,738,648.27
80 percent thereof_ 3,790,918. 62
Less normal and surtax_ 226, 989.31
Excess profits tax under Section 710 (a) (1) (B)__ 3,563,929.31

13. For the year 1943 with respect to income from contracts which required more than twelve months to perform, plaintiff computed its surtax net income under Section 15 of the Internal Bevenue Code in accordance with the completed contract method of accounting.

14. Plaintiff computed its income from contracts requiring more than twelve months to perform on the percentage of completion method of accounting, in accordance with its election under Section 736 (b), only for the purpose of computing its adjusted excess profits net income, which enters into the computation of its excess profits tax computed under the provisions of Section 710 (a) (1) (A).

15. The Commissioner of Internal Revenue, in computing the limitation on plaintiff’s excess profits tax under Section 710(a)(1)(B) by determining plaintiff’s so-called surtax net income on the percentage of completion method of accounting, did so in accordance with the following provisions of Reg. 112, Section 35.736(b)-3(a), which he promulgated:

The excess profits tax may be computed under section 710 (a) (1) (B) as an amount which when added to the normal tax and surtax computed under Chapter 1 for the taxable year equals 80 percent of the corporation surtax net income properly adjusted under the provisions of section 710 (a) (1) (B) applicable to such year. For such purpose, the corporation surtax net income shall be determined by computing the income from long-term contracts upon the percentage of completion method of accounting. The credit for dividends received used in computing corporation surtax net income shall be limited to 85 percent of the net income determined by computing income from long-term contracts upon the percentage of completion method of accounting, and the normal tax and surtax shall be the actual normal tax and surtax determined under Chapter 1.  