Lawton Mills Corp. v. Commissioner , 14 B.T.A. 775 ( 1928 )

LAWTON MILLS CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Lawton Mills Corp. v. Commissioner

Docket No. 19480.

United States Board of Tax Appeals

14 B.T.A. 775; 1928 BTA LEXIS 2924;

December 17, 1928, Promulgated

---

A liability to respond in damages for breach of contract is not a proper deduction in the taxable year, where the defects in the goods giving rise to the liability were not, and could not have been, discovered, and no claim was made against petitioner or paid by it until the next year.

W. Sidney Felton, Esq., for the petitioner.

Owen W. Swecker, Esq., for the respondent.

---

ARUNDELL

This is a proceeding for the redetermination of a deficiency of $15,640 in income and excess-profits taxes for the fiscal year ended November 30, 1920. The issue is whether respondent erred in not allowing as a deduction the sum of $34,000 paid in damages during the next year for breaches of contract. The case was submitted on the pleadings and a stipulation of fact.

FINDINGS OF FACT.

The petitioner, a Connecticut corporation with an office in Boston, Massachusetts, on September 26, 1919, and December 8, 1919, entered into contracts with Weiner Bros., New York City, and the Textile Factors Co., respectively, for a certain quantity of cloth goods in the grey.

The goods sold to Weiner Bros. were all cotton and were to be dyed after weaving. In dyeing the goods the color came out shady instead of even, and as a consequence the goods were not first-class. This result of dyeing occurs occasionally and its cause is not understood by dyers. In lieu of availing itself of the right to reject the goods the buyer elected to retain them upon payment of $1,500 damages, which payment petitioner made on February 4, 1921.

The goods sold to the Textile Factors Co. were made up of a warp of cotton threads and a filling of canton silk. Upon completion of the cloth it was ascertained that the silk was defective because of age, and as a result the quality of the goods was not first-class as required by the contract of sale. Because of the defective condition of the goods petitioner became liable to the buyer in damages in the amount of $32,500, which sum the former paid to the latter on February 17, 1921.

The shipment of the goods to independent bleacheries in the taxable year for finishing, pursuant to instructions from and for the account of the buyer, was in accordance with terms of the contracts of sale and constituted delivery of the goods by petitioner to the respective buyers. The goods were paid for by the purchasers during the taxable year.

None of the defects giving rise to the claims paid by petitioner could have been discovered before the goods were finished. In each case the defects were ascertained and the claims for damages were made by the buyers promptly upon the receipt of the finished goods from the bleacheries some time after the taxable year. Petitioner admitted its liability immediately upon the completion of its investigation of the claims filed against it.

In the return filed by petitioner on February 15, 1921, for the fiscal year ended November 30, 1920, the sum of $34,000 paid in settlement of the claims filed for defective goods was not claimed as a deduction from gross income.

OPINION.

ARUNDELL: The petitioner's argument in favor of the deductibility of the items in disputes as losses sustained is based upon the theory that its liability to answer in damages for the breaches of contract arose within the taxable year. Petitioner also contends that since it had no opportunity to acknowledge liability to the buyers for the breaches during the taxable year, because of the latent nature of the defects giving rise to its liability, the case is distinguishable from those heretofore decided by us on similar questions. Whatever distinction may exist in our opinion is not important.

In , a case involving a deduction for breach of contract, we said that "it is well settled that if the liability was not admitted, or an offer in settlement was not made, or the estimated amount of the loss was not entered on the books for the taxable year, a deduction of the loss in the year in which the breach occurred, was unallowable. ; ; ; ."

The evidence clearly proves that no liability had been asserted against the petitioner during the taxable year to pay or to accrue on its books. The defects in the goods giving rise to the claims were of such a nature that they were not discoverable while the goods remained unfinished. The finished goods were not received by the buyers from the bleacheries until after the close of the taxable year, and consequently the purchasers had no opportunity within that period to ascertain whether the goods conformed in quality to the contract, and if not, to assert a claim against petitioner for breach thereof. The claims in fact were not made by the vendees until after the close of the fiscal year November 30, 1920, and the petitioner had no knowledge within the taxable year that the goods were defective, or that the buyers would, upon receipt of the finished goods, call upon it to answer in damages for breach of contract.

The amount sought to be deducted was neither paid nor accrued within the taxable year and the facts in our opinion constitute no basis for the allowance of the claimed loss for the taxable year ended November 30, 1920.

Judgment will be entered for the respondent.