Corn Exchange Bank v. Commissioner , 6 B.T.A. 158 ( 1927 )

OPINION.

Littleton:

There is no dispute as to the facts or the figures. Petitioner claims that it is entitled under the provisions of subsection (b) of section 212 of the Revenue Act of 1921 to have its net income computed in accordance with the method of accounting regularly employed in keeping its books and that its income for' any year from bonds held by it must be increased or decreased as the case may be in the amount of the amortization of the discount or premium at which such bonds were purchased; that in allowing the gain or loss from the sale of such bonds the basis to be employed is the cost as increased or decreased by amortization of the discount or 'premium previously entered upon the books.

The Commissioner takes the position that the method employed by the petitioner in determining its income and losses on bonds owned by it does not clearly reflect its income and is not in accordance with the tests of the statute for the determination of income losses.

In New York Life Insurance Co. v. Edwards, 271 U. S. 109, the court said:

The Company owned many bonds, etc., payable at future dates, purchased at prices above their par values, and to amortize these premiums a fund was set up. It claimed that an addition to this fund should be deducted from gross receipts. The District Court thought the claim well founded, tout the Circuit Court of Appeals took another view. Unless the addition amounted to a loss “ actually sustained within the year ” no deduction could be made therefor. Obviously, no actual ascertainable loss had occurred. All of the securities might have been sold thereafter above cost. The result of the venture could not be known until they were either sold or paid off.

The petitioner undertakes to distinguish the decision of the court in New York Life Insurance Co. v. Edwards, supra, from this proceeding upon the ground that returns of income under the Revenue Act of 1913, which was involved in the case cited, were required to be made on the basis of cash received and disbursed, whereas the. petitioner’s return for the year 1921 was made upon the accrual basis. We think, however, that no accrual can be predicated on the • premium or discount at which a bond is purchased before the bond is sold or redeemed. Before sale or redemption of a bond nothing occurs to fix the amount which the holder thereof will actually realize from it (eliminating from consideration the matter of interest which is not in dispute here). The discount on the bond purchased below par is unlike interest, which is a fixed charge and accrues periodically. The right to receive this discount, or difference between the cost of the bond and its par, can not be determined in advance as the bond may be sold for more or less than its cost, or, perhaps, as in the case of many bonds, it may be redeemed prior to its maturity at an amount different from its principal or face amount of the bond. This discount is not earned or accrued in annual installments and can not be income to the holder of the bond, either as additional interest or as a separate item of income. If anything, the annual amortization of this discount represents merely a theoretical appreciation in value unrealized by a sale or other disposition oí the bond. It does not even represént actual appreciation as the current market price for the bond may be above Or below the cost thereof as adjusted for previous amortization of the discount.

The amount by which the petitioner has annually written up its bonds and correspondingly increased income on account of the amortization of discount thereon can not represent income received or accrued to the petitioner under the definition of income as laid down by the courts in many cases.' The converse is true in respect to the amortization of premium on bonds bought above par. The interest received 'from such bonds is not, in fact, diminished by annual charges made for the purpose of amortizing this premium. The fact that the petitioner may consider a part of this interest as set aside annually for the purpose of amortizing the premium does not diminish the actual interest received or accrued on the bonds. Nor does the setting aside of an annual amount for this purpose constitute a realized loss on the bonds as the court has pointed out in New York Life Insurance Co. v. Edwards, supra.

The same consideration governs in determining the proper basis to be employed in computing gain or loss on the sale of the bonds under the 1921 Act as under the 1913 Act. The basis prescribed by the statute for computing gain or loss is cost. (The March 1, 1913, value is not involved in this proceeding.) This basis can not be changed because of any supposed appreciation or diminution in value not previously allowed. Unlike depreciation, the annual amortization of premium or discount on securities of other corporations held for investment is not an allowable adjustment to income, nor an allowable adjustment to the basis for computing gain or loss on sale. See Appeal of Even Realty Co., 1 B. T. A. 355.

The petitioner insists that because it has adhered to a certain method of keeping its accounts over a number of years, its income must be computed solely in accordance with that method of accounting. Bookkeeping entries are significant only as evidence or records of transactions and the legal effect of such transactions and the method employed in keeping the books must be determined from the transactions themselves, and not merely from the book entries affecting them. See Appeal of Chatham & Phenix National Bank, 1 B. T. A. 460. Moreover, section 212 (b) of the Revenue Act of 1921, upon which the petitioner relies in support of this contention, provides that a taxpayer’s method of accounting shall be followed only if such method clearly reflects income. The effect of this section is to permit a taxpayer to adopt any recognized or logical method of accounting, but requires that the method so adopted clearly reflect income. See Appeal of Owen-Ames-Kimball Co., 5 B. T. A. 921. A method of accounting which reflects purely theoretical increases or decreases in income not realized, as we believe tbe method contended for by petitioner does, can not correctly reflect income as contemplated by the statute. Section 212 does not contemplate that such a method of accounting shall itself be conclusive as to the true income of a taxpayer.

It is also contended by the petitioner that the net result of its method of accounting is the same as that used by the Commissioner when considered over a period of years; in other words, that it reports the same gain or loss on bonds, which the Commissioner contends is realized only upon the sale or retirement of the bonds, but that it reports this amount in annual installments. We think it is not enough however that a particular method of accounting be correct only when its effect over a period of years is considered. The income and profits tax is levied with respect to annual periods and each such period stands by itself. The statute requires that the income for each year be correctly determined and the tax imposed thereon. The erroneous computation of income for some prior years or subsequent years does not justify an erroneous computation of income for the year under consideration. Appeal of MacMillan Co., 4 B. T. A. 251.

Judgment will be entered for the respondent.