Freudmann v. Commissioner , 10 T.C. 775 ( 1948 )

Max Freudmann, Petitioner, v. Commissioner of Internal Revenue, Respondent. Henri Freudmann, Petitioner, v. Commissioner of Internal Revenue, Respondent

Freudmann v. Commissioner

Docket Nos. 9100, 9101

United States Tax Court

10 T.C. 775; 1948 U.S. Tax Ct. LEXIS 196;

May 10, 1948, Promulgated

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Decisions will be entered under Rule 50.

1. Petitioners are brothers and partners. For many years prior to 1940 they were diamond merchants in Belgium. On April 1, 1939, they opened a branch in New York City. When Germany invaded Belgium in May 1940, they fled from Belgium into France and took their stock of diamonds with them. Before leaving they made a list of all of their diamonds at cost price from the stock sheets. They deposited the diamonds in a bank in France. Henri's son later brought the diamonds to the United States and turned them over to the partnership. The partnership imported other diamonds direct from Brazil and purchased some locally in the United States. The respondent determined that the cost of these diamonds could not be ascertained from the books of the New York partnership and further determined that the cost of these diamonds was an arbitrary 65 per cent of the gross sales. Held, the cost of all the diamonds sold in the fiscal year 1941 is the amount of $ 325,218.16.

2. The New York partnership kept its books on a fiscal year basis and its first taxable year was the fiscal year ended March 31, 1940. Petitioners filed their individual income tax returns upon the basis of fiscal years ended March 31, 1940 and 1941. The respondent determined that petitioners did not keep books and, under section 41, I. R. C., computed their tax liabilities upon the basis of calendar years ended December 31, 1940 and 1941. Held, this was not error because the evidence shows that petitioners failed to keep any individual books in the United States prior to 1943, and petitioners have failed to show that the individual books which they kept in Belgium were kept in accordance with an accounting period ended March 31, 1940, definitely established as such before its close.

3. During the calendar years 1940 and 1941 and for several years prior thereto, petitioners, together with another individual, operated a partnership in Canada. The parties have stipulated the amount of Canadian partnership income that is taxable to each petitioner, providing petitioners are taxable on any of the Canadian income. Held, each petitioner's respective distributive share of the net income from the Canadian partnership is includible in the net income of each petitioner for the calendar years 1940 and 1941, under section 182 (c) of the Internal Revenue Code, notwithstanding the fact that the Canadian Government refused to permit petitioners to remove any part of such net income to the United States during the period of the war. Phanor J. Eder, 47 B. T. A. 235; affd., 138 Fed. (2d) 27, followed.

4. The respondent allowed petitioners deductions under section 23 (c) (1) (C), I. R. C., as amended, for income taxes paid to Canada during the calendar year 1941. Petitioners assigned this as error and alleged they were entitled to credits for income taxes paid to Canada under section 131 (a), (b), and (d), I. R. C., as amended, and under the tax convention and protocol between the United States and Canada proclaimed by the President of the United States on June 17, 1942, effective January 1, 1941. Held, petitioners are not entitled to the credits claimed, but are entitled to deductions for the calendar years 1940 and 1941 for such taxes as were paid to Canada during those calendar years.

Bernard Weiss, Esq., for the petitioners.

Henry C. Clark, Esq., for the respondent.

Black, Judge.

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BLACK

In these proceedings, duly consolidated, the respondent determined deficiencies in income tax for the taxable years ended December 31, 1940 and 1941, as follows:

Docket No.	Petitioner	1940	1941
9100	Max Freudmann	$ 1,063.92	$ 32,816.31
9101	Henri Freudmann	242.06	38,794.24

Petitioners are members of a partnership in New York City called H. & M. Freudmann, which filed partnership returns of income for the fiscal years ended March 31, 1940 and 1941. Petitioners filed their income tax returns on the same fiscal year basis as the partnership. In each statement attached to each notice of deficiency addressed to each petitioner the respondent said:

It is held that you did not keep regular books of account or records during the years 1940 and 1941 and your taxable net income has therefore, been determined on the basis of calendar years as provided in section 41 of the Internal Revenue Code.

Each petitioner, by appropriate assignments of error, contests the above holding.

The respondent, in determining petitioners' net incomes on the basis of calendar years, made certain adjustments to the net incomes as disclosed by the returns filed by petitioners on the fiscal year basis. In Docket No. 9100 the adjustments made by the respondent, together with his explanation thereof, were as follows:

TAXABLE YEAR ENDED DECEMBER 31, 1940
ADJUSTMENTS TO NET INCOME
Net income as disclosed by return			$ 4,208.79
Unallowable deductions and additional income:
	(a) Income from partnership	$ 881.40
	(b) Canadian partnership income	8,823.96	9,705.36
	Total		13,914.15
Non-taxable income and additional deductions:
	(c) New York State Income Tax		42.90
Net income adjusted			13,871.25

Explanation of Adjustments

(a) It is held that your proportionate shares of the net income of H. & M. Freudman (a domestic partnership) as reported by you for the years 1940 and 1941 are understated by $ 881.40 and $ 47,999.36, respectively. The income reported for those years has, therefore, been increased accordingly.

(b) It is held that your proportionate shares of the net income of H. & M. Freudman (a Canadian partnership) for the years 1940 and 1941 are $ 8,366.77 and $ 17,627.67, respectively, and that the amounts of $ 8,823.96 and $ 14,352.19, respectively, constitute taxable income for those years. The taxable net income reported by you for the years 1940 and 1941 has, therefore, been increased accordingly.

(c) Inasmuch as your taxable net income has been determined on the basis of calendar years for 1940 and 1941, you have been allowed deductions of $ 42.90 and $ 612.61 [should be $ 569.71], respectively, representing New York State income taxes actually paid during those years.

TAXABLE YEAR ENDED DECEMBER 31, 1941
ADJUSTMENTS TO NET INCOME
Net income as disclosed by return			$ 12,847.99
Unallowable deductions and additional income:
	(a) Partnership income	$ 47,999.36
	(b) Canadian partnership income	14,352.19
	(c) Interest and dividends	92.27	62,443.82
	Total		75,291.81
Non-taxable income and additional deductions:
	(d) New York State Income Tax	569.71
	(e) Canadian Taxes	2,752.73	3,322.44
Net income adjusted			71,969.37

Explanation of Adjustments

[Note: We omit here the respondent's explanation of adjustments (a), (b) and (d), as they were explained in the previous year.]

(c) The taxable net income reported by you for the year 1941 has been increased by $ 92.27 so as to include dividends and interest actually received during that calendar year.

(e) It is held that you are entitled to a deduction of $ 2,752.73 in determining taxable net income for the calendar year 1941 for Canadian income taxes paid during that year.

Petitioner Max Freudmann, by appropriate assignments of error, contests all of the above mentioned adjustments for both years, except adjustment (a) for 1940, and in a motion for leave to amend petition, duly granted, assigns an additional error as follows:

9. If this honorable Court finds that the petitioner's distributive share of Canadian partnership profits is taxable income for 1940 and 1941, petitioner claims he is entitled to a credit against Federal Income Taxes due for 1940 and 1941 for the Income and Excess Profits Taxes paid to Canada and the Province of Ontario individually and/or through the Canadian partnership.

In Docket No. 9101, the adjustments made by the respondent similar to those made in the case of Max are as follows:

TAXABLE YEAR ENDED DECEMBER 31, 1940
ADJUSTMENTS TO NET INCOME
Net income as disclosed by return			$ 4,208.80
Unallowable deductions and additional income:
	(a) Income from partnership	$ 881.40
	(b) Interest	1,150.00
	(c) Canadian Partnership Income	914.37	2,945.77
Total			7,154.57
Non-taxable income and additional deductions:
	(d) New York State Income Tax		42.90
Net income adjusted			7,111.67

TAXABLE YEAR ENDED DECEMBER 31, 1941
ADJUSTMENTS TO NET INCOME
Net income as disclosed by return			$ 18,106.66
Unallowable deductions and additional income:
	(a) Income from partnership	$ 47,999.35
	(b) Canadian income	16,025.14
	(c) Dividends and interest	1,654.86
	(d) Short term capital gain	147.20
	(e) Long term capital gain	193.79	66,020.34
Total			84,127.00
Non-taxable income and additional deductions:
	(f) Canadian taxes	$ 285.24
	(g) New York State Income Taxes	1,089.44	1,374.68
Net income adjusted			82,752.32

Petitioner Henri Freudmann, by appropriate assignments of error, contests all of the above mentioned adjustments for both years, except adjustment (a) for 1940, and in a motion for leave to amend petition, duly granted, assigns an additional error which is identical with the additional error assigned in Docket No. 9100.

The issues thus raised in both dockets may be summarized as follows:

1. In determining the net income of the New York partnership for the fiscal year ended March 31, 1941, did the respondent err in determining the cost of certain rough diamonds sold by the partnership during the fiscal year to be an arbitrary amount of 65 per cent of the selling price of the said diamonds, and, if so, did the partnership itself err in reducing the cost of these diamonds as shown on its books by an amount of $ 39,979.76 and also in failing to include as a part of such cost an expenditure of $ 21,307.75 incurred in connection with the transportation of certain of the rough diamonds from Biarritz, France, to Lisbon, Portugal? (Embraced under this issue is adjustment (a) for 1941 in both dockets.)

2. Are petitioners entitled to compute their tax liabilities upon the basis of fiscal years ended March 31, 1940 and 1941, or must they compute their tax liabilities upon the basis of calendar years ended December 31, 1940 and 1941? (Embraced under this issue are adjustment (c) for 1940 and adjustments (c) and (d) for 1941 in Docket No. 9100; and adjustments (b) and (d) for 1940 and adjustments (c), (d), (e), and (g) for 1941 in Docket No. 9101.)

3. Is any part of the income of a certain Canadian partnership earned during the calendar years 1940 and 1941, but not distributed, taxable to petitioners? (Embraced under this issue are adjustments (b) for 1940 and 1941 in Docket No. 9100; and adjustment (c) for 1940 and adjustment (b) for 1941 in Docket No. 9101.)

4. Are petitioners entitled to a foreign tax credit for income taxes paid or accrued to Canada? (Embraced under this issue are adjustment (e) for 1941 in Docket No. 9100; adjustment (f) for 1941 in Docket No. 9101; and the additional error assigned by motion for leave to amend petition, duly granted, in both dockets.)

FINDINGS OF FACT.

So much of the facts as were stipulated are found.

Petitioners Max and Henri Freudmann are brothers. For many years prior to World War II they were engaged in the diamond business in Belgium as partners under the name of H. & M. Freudmann. On April 1, 1939, petitioners, as partners, opened a branch under the same name in New York City, which partnership is sometimes referred to as the New York partnership, and employed one Evans to manage it for them prior to their entrance in the United States. Petitioners, together with Selig Gross, operated a partnership in Canada for 15 or more years prior to 1942 under the same name of H. & M. Freudmann, which partnership is sometimes referred to as the Canadian partnership. The returns here in question were all filed with the collector for the third district of New York.

During the entire periods here in question petitioners were citizens or subjects of Belgium. Max became an alien resident of the United States on June 22, 1940, and Henri became an alien resident of the United States on December 12, 1940.

Facts Relating to Issue 1.

The diamond business of petitioners consisted mostly of buying and selling rough diamonds imported from Brazil, although they also dealt to some extent in polished diamonds. The New York partnership of H. & M. Freudmann filed a partnership return of income for the fiscal year ended March 31, 1941, and reported a net income of $ 31,397.21, determined as follows:

		Polished	Rough	Total
		diamonds	diamonds
Net selling price of diamonds		$ 179,458.60	$ 326,520.09	$ 505,978.69
Less cost of diamonds:
	(a) Inventory at beginning of year	90,903.15	None	90,903.15
	(b) Merchandise bought for sale	134,089.49	695,983.80	830,073.29
	(c) Cost of labor, supplies, etc	2,757.67	909.69	3,667.36
	(d) Total of lines (a), (b) and (c)	227,750.31	696,893.49	924,643.80
	(e) Less inventory at end of year	97,493.26	389,680.75	487,174.01
	(f) Cost of diamonds sold	130,257.05	307,212.74	437,469.79
Gross profit (selling price less cost)		49,201.55	19,307.35	68,508.90
Interest received				59.76
Total gross income				68,568.66
Less total deductions				37,171.45
Net income				31,397.21

Max, on his individual return for the fiscal year ended March 31, 1941, reported $ 15,698.60 of the above mentioned partnership net income and Henri reported $ 15,698.61.

Issue 1 involves only the cost of the rough diamonds. ^{*781 above, petitioners, at the time they filed their partnership return for the fiscal year ended March 31, 1941, determined that the rough diamonds bought for sale during that year amounted to $ 695,983.80. Petitioners arrived at this amount as follows:}

Diamonds brought over to the United States from Belgium in the
manner hereafter described and originally set up on the New
York partnership books on October 14, 1940 at a cost of			$ 295,578.63
Other rough diamonds either imported direct from Brazil or
purchased locally in the United States			460,826.26
	Total		756,404.89
Less three adjustments:
	(1) Diamonds included in those brought over from
	Belgium which in fact belonged to another	$ 7,445.71
	(2) Adjustment downward of the cost of the
	diamonds brought over from Belgium in the
	manner hereafter described	39,979.76
	(3) Diamonds transferred to the polished
	department	12,995.62	60,421.09
Rough diamonds bought for sale as determined by
petitioners at the time the partnership return was filed			695,983.80

Both petitioners resided in Antwerp, Belgium, until about May 10, 1940. After World War II commenced on September 1, 1939, there was a great demand for rough diamonds and during the month of September 1939 petitioners sold practically all the diamonds they had on hand in Belgium. On October 19, 1939, petitioners had practically no inventory of diamonds on hand in Belgium. They had received no shipments from Brazil during the months of July, August, or September of 1939. Between October 20, 1939, and May 1, 1940, petitioners imported into Belgium from Brazil 37,642.85 carats of rough diamonds at a total cost of $ 561,586.63. The purchases of these diamonds were financed solely by the Banque Diamantaire Anversoise in Antwerp.

On May 10, 1940, when Germany invaded Belgium, petitioners fled from Antwerp with their stock of diamonds, and on May 12, acting in accordance with instructions received over the radio from both the Belgian and the French Governments, petitioners left Belgium for France, finally meeting each other at Biarritz in southern France near the Spanish border.

Just prior to leaving Antwerp on May 10, petitioners made a list of the diamonds they were taking, together with the number of carats and the cost prices thereof, which were taken from the "stock sheets" of petitioners' records in Antwerp. Max left early in the morning with one package and the list. Henri did not leave until in the evening. He spent most of the day collecting some goods that were outstanding in the hands of their brokers. The French radio announced that Belgian refugees would be permitted to enter France without any customs regulations for diamonds or for gold, but with the restriction that as soon as they had settled in one city they would have to declare such goods in one of the five large banks.

Upon arriving in Biarritz, petitioners each declared his stones to the Credit Lyonnais on May 22, 1940, as follows:

Henri declared	2,017.00 carats
Max declared	16,694.40 carats
Total	18,711.40 carats

Out of the 18,711.40 carats, petitioners turned over between 800 and 900 carats to a broker in Paris for sale in case they would need extra funds. They then took the remaining diamonds in the two packages and made a complete revised list, mostly in French, of all the diamonds they had at that time, using the cost figures that were on the original Antwerp list. Some of these cost figures were stated in Belgian francs. Because of fears for the safety of their families and themselves, petitioners departed from France about the middle of June 1940, leaving their diamonds with the manager of the Credit Lyonnais. Max went to Bordeaux and sailed for the United States, arriving in the United States on June 22, 1940. Henri went to Portugal.

After Henri arrived in Portugal he engaged Antonio de Lago Cerqueira, ex-Minister of Foreign Affairs for Portugal, to bring the diamonds out of France. Henri agreed to pay Cerqueira $ 1,200 for the cost of the trip, plus 7 per cent of the value of the diamonds if he was successful. One reason for engaging Cerqueira was that he was a neutral and there was a rumor that when a refugee reached the other side of Hendaye (a French town on the Spanish border) the Spaniards would take away from him all his valuables, and Henri thought it would be unsafe for anyone else to attempt to transport the diamonds from France to Portugal.

Cerqueira was successful in transporting the diamonds from Biarritz, France, to Lisbon, Portugal, and delivered them to Henri. Cerqueira was then paid for his services a total of $ 530,000 Escudos, which in American money amounted to $ 21,307.75. Of this amount $ 1,200 was paid by Henri with funds he had on hand and $ 20,107.75 was cabled to him from the New York partnership on two different dates, $ 12,063 on September 9, 1940, and $ 8,044.75 on September 17, 1940. The New York partners charged the $ 20,107.75 against the personal accounts of the partners. It did not deduct as a part of its cost of the diamonds any part of the $ 21,307.75 paid to Cerqueira.

After receiving the diamonds from Cerqueira, Henri and his son Felix checked the contents of the package against the revised list made by petitioners at Biarritz. They then took the revised list and, wherever the cost figures were stated in Belgian francs, they converted the francs into United States dollars. The foreign exchange rate used was 30 Belgian francs to the dollar, which was the official rate of exchange used at the time of the purchase of the diamonds. After this conversion the revised list then showed a total of 17,840.45 *215 of petitioners.

Felix then sailed with the diamonds to the United States, arriving in New York on September 27, 1940. Felix gave the diamonds and the revised inventory list to the customs officials and representatives of Overton & Co., customhouse brokers. There was no duty on rough diamonds. The aforementioned revised inventory list was written mostly in French and was subsequently translated into English at the request of Overton & Co. by Max. Max turned over the translated list to the customs officials and he thinks he also turned over to them the original revised list prepared at Biarritz after he had finished translating it into English. In any event, petitioners have not been able to locate the original revised list that they prepared at Biarritz. It took about four weeks for the diamonds to clear the customs officials.

Henri left Lisbon, Portugal, by plane on October 6, 1940. He had a visa to go through the United States to Canada. He remained in Canada until December 12, 1940, at which time he departed from Canada and entered the United States.

At the time the diamonds were delivered from the boat to the customhouse, they were insured for $ 300,000 in a transit insurance policy taken out by Max.

When the diamonds were received at the New York office of H. & M. Freudmann, Max checked the contents of the packages against the translated list and found they were substantially in agreement.

These Brazilian rough diamonds brought over by Felix were entered on the books of the New York partnership on October 14, 1940, as a debit to rough purchases in the amount of $ 295,578.63 and a credit to the capital accounts of petitioners in the same amount. The increase of $ 2,777.54 over the costs on the translated list was due to the fact that the customs officials had in a few instances changed the weight of some of the diamonds. The rough purchases account was later credited with $ 7,445.71 so as to exclude from the cost those diamonds which belonged to Felix instead of petitioners. The difference between $ 7,445.71 and $ 7,350.96 ($ 94.75) was a part of the above mentioned increase of $ 2,777.54.

According to the books of the New York partnership, the first sale of Brazilian rough diamonds brought over from Belgium was made on October 15, 1940. The net selling price of rough diamonds from April 1 to October 10, 1940, the date of the last sale prior to October 15, amounted to $ 154,547.18. The net selling price of rough diamonds from October 15 through December 31, 1940, amounted to $ 110,095.98, of which amount $ 78,898.10 was identified as being from the Brazilian rough diamonds brought over from Belgium, the cost of which is in question. The net selling price of rough diamonds from January 1 to March 31, 1941, was $ 61,876.93, which includes rough diamonds purchased directly from Brazil and other sources, as well as those brought in from Belgium. The net selling price of all rough diamonds from April 1, 1940, to March 31, 1941, was the sum of $ 154,547.18, $ 110,095.98 and $ 61,876.93, or $ 326,520.09.

An analysis of the sales of some of the Brazilian rough diamonds imported by the New York partnership directly from Brazil to New York City from February to June 10, 1940, which period overlaps the period of time when Brazilian rough diamonds were being imported into Belgium, shows that a basic loss of $ 10,853.58 was sustained on sales made between May 16 and November 13, 1940, having a net selling price of $ 59,622.94 and a total cost of $ 70,476.52.

Petitioners bought rough diamonds in Brazil through a representative who would go into the interior, sometimes with assistants, and bid for diamonds. Although a suggested price list was sent to the representative in Brazil, there was no means of contact once he went into the interior.

When the war broke out in Europe in September 1939, market prices in Brazil went up substantially because of the competition for small diamonds to be polished in Holland and Belgium before any possible occupation by the Nazis, as well as the fact that Brazil was the one free market where the Germans and Japanese could buy diamonds for industrial and war purposes. When Belgium and Holland were occupied by the Germans, the manufacture of small diamonds ceased, so that there was practically no market for small diamonds, there being no manufacturers to polish them. In the United States there were a few manufacturers cutting and polishing larger stones, but there were practically no buyers for the smaller rough diamonds. Petitioners, in order to meet the demands for money from their Brazilian representative, often had to sacrifice large quantities of stones in order to keep up business relations with rough diamond sources. There was practically no market in the United States for small rough diamonds in 1940, and the diamonds purchased in Brazil for the New York partnership on which substantial losses were particularly sustained were mostly carbons.

The Brazilian rough diamonds brought over from Belgium consisted of two main classes, namely, rough cuttables and rough industrials. Those appearing on the translated inventory list as rough cuttables, exclusive of those belonging to Felix, consisted of 7,448.10 carats of rough cuttables listed with a cost of $ 194,720.30 or approximately $ 26.14 per carat. Those appearing on the translated inventory list as rough industrials, exclusive of those belonging to Felix, consisted of 8,610.50 carats of rough industrials listed with a cost of $ 90,929.83, or approximately $ 10.54 per carat.

The price of Brazilian rough diamonds in April and May of 1940 was approximately the same as from October to December 1939. The basic cost of 3,932.97 carats of Brazilian rough diamonds imported directly from Brazil to New York in 1940 up to June 10 was approximately $ 17.92 per carat.

The average cost price per carat of the 17,840.45 carats itemized on the translated list was about $ 16.41 per carat. The list contained approximately 258 separate items and ranged in cost for each separate item all the way from a low of 7 cents per carat to a high of $ 140 per carat.

The previously mentioned inventory of rough diamonds on hand at the end of the fiscal year ended March 31, 1941, in the amount of $ 389,680.75 was taken on the basis of cost or market, whichever was lower, and was a physical check of all diamonds on hand at that time, amounting to 27,999.43 carats, or an inventory value of about $ 13.92 per carat. The inventory represented a complete list of all unsold diamonds which had been brought over to the United States from Belgium and also those which had either been imported direct from Brazil or purchased locally in the United States. It contained approximately 317 separate items and ranged in inventory value all the way from a low of 7 cents per carat to a high of $ 155 per carat.

At the time this inventory was taken it was noted that the then market value of about eight items of the diamonds brought over to the United States from Belgium was approximately $ 40,000 less than the cost shown on the translated list. Because of that fact petitioners caused the rough purchases account in the books of the New York partnership to be credited with an amount of $ 39,979.76 and their individual capital accounts to be charged each with one-half of a like amount.

The cost of the rough diamonds which the New York partnership sold during the fiscal year ended March 31, 1941, was the amount of $ 325,218.16, determined as follows:

Diamonds brought over to the United States from Belgium as
per the translated list			$ 292,801.09
Amount paid to Cerqueira for transporting diamonds from
Biarritz to Lisbon [$ 21,307.75 less 7,350.96/252,821.33
($ 292,801.09 minus $ 39,979.76) of $ 21,307.75 or $ 619.54]			$ 20,688.21
Other rough diamonds either imported direct from Brazil or
purchased locally in the United States			460,826.26
	Total		774,315.56
Less three adjustments:
	(1) Diamonds included in the translated list
	which belonged to Felix	$ 7,350.96
	(2) Adjustment of the cost as shown on the
	translated list which petitioners caused to be
	made on the books of the New York partnership	39,979.76
	(3) Diamonds transferred to the polished
	department	12,995.62	60,326.34
Rough diamonds bought for sale			713,989.22
Cost of labor, supplies, etc			909.69
Inventory at beginning of year			None
	Total		714,898.91
Less inventory at end of the year			389,680.75
Cost of rough diamonds sold			325,218.16

Facts Relating to Issue 2.

The New York partnership kept its books and records and filed its returns of income on the basis of fiscal years ended March 31. In its first return filed for the fiscal year ended March 31, 1940, it reported a net income of $ 8,417.59 and in schedule J of the return it reported the partners' shares of such net income as being $ 4,208.79 for Max and $ 4,208.80 for Henri.

When petitioners left Belgium they left behind any books which they may have kept in that country.

After arriving in the United States, petitioners turned over to their then accountants all information pertaining to their personal incomes and instructed them to keep the necessary books and records for filing their income tax returns on the same fiscal year basis as their New York partnership books were kept. Notwithstanding these instructions, no regular set of individual books was kept by petitioners in the United States until about April 1943, when a new firm of accountants wrote up a set of individual books for each petitioner, beginning with the fiscal year ended March 31, 1941.

Max filed a nonresident alien income tax return for the fiscal year ended March 31, 1940, in which he reported a total net income from sources within the United States of $ 4,208.79; and Henri filed a like return for the same fiscal year in which he reported a total net income from sources within the United States of $ 4,208.80. Each petitioner also filed an individual income and defense tax return for the fiscal year ended March 31, 1941.

The respondent determined that petitioners did not keep regular books of account or records during the years 1940 and 1941 and that, therefore, their taxable net incomes should be determined on the basis of calendar years instead of fiscal years ended March 31.

Facts Relating to Issues 3 and 4.

Henri Freudmann (one of the petitioners herein), while in Canada at the end of 1940, arranged with the Canadian Government that petitioners could bring out of Canada into the United States $ 90,725.75 in United States dollars, but that they would not be permitted to bring any further funds from Canada to the United States during the war. The $ 90,725.75 represented either the cost or value of diamonds shipped from Antwerp to Canada during December 1939. Henri, sometimes accompanied by his attorney, one Wilson of Toronto, also made several visits to the Controller of Alien Property in Ottawa in 1941, 1942, and 1943 for the purpose of securing the release of moneys from Canada to the United States. The Canadian Government at all times during these visits refused to allow the export of any Canadian funds, whether from capital or profits.

In Docket No. 9100, the parties stipulated as follows:

(1) During the calendar year 1940 H. & M. Freudman (a Canadian partnership) realized profits in Canada of Canadian $ 56,636.15 after deducting partners' salaries. On these profits the partnership paid an excess profits tax to Canada of Canadian $ 8,915.46 leaving a balance available for distribution of Canadian $ 47,720.69. The petitioner, Max Freudman, reported one-third of the latter amount in his Canadian income tax return as his distributive share, namely Canadian $ 15,906.90, and also reported his salary as a partner in the amount of Canadian $ 2,500.00. On this income of Canadian $ 18,406.90 Max Freudman paid a tax of Canadian $ 5,730.63. Therefore, the petitioner's distributive share of the total profits realized by the Canadian partnership during the calendar year 1940 is Canadian $ 21,378.72, comprised of one-third of Canadian $ 56,636.15 plus Canadian $ 2,500.00. The petitioner's share of Canadian income taxes accrued on such income is Canadian $ 8,702.45, comprised of one-third of Canadian $ 8,915.46 plus Canadian $ 5,730.63. The United States equivalents at a foreign exchange rate of .90909 for the Canadian $ are $ 19,435.18 for the distributive share of income from the Canadian partnership and $ 7,911.31 for Canadian income tax accrued and paid thereon.

(2) The petitioner arrived in the United States on June 22, on which date he became a resident alien and retained that status to December 31, 1940, for a total of 193 days. Applying the fraction 193/366 to the petitioner's share of Canadian partnership income of $ 19,435.18 and Canadian income taxes accrued thereon of $ 7,911.31 gives Canadian income of $ 10,248.60 and tax accrued of $ 4,171.81 for that part of 1940 beginning with June 22, 1940.

(3) If the taxable year of Max Freudman is found by the Court to be the fiscal year ended March 31, 1940, the petitioner has no income from Canada for that year; whereas, if the taxable year is found by the Court to be the calendar year 1940, the petitioner's share of distributive income from the Canadian partnership is $ 10,248.60 and the Canadian income tax accrued thereon is $ 4,171.81.

(4) The distributive share of the income of the petitioner, Max Freudman, from the Canadian partnership for the calendar year 1941 similarly determined as under point (1) is U. S. $ 20,354.00 and the Canadian income tax accrued and paid thereon is U. S. $ 11,239.88. If the Court finds the petitioner's taxable year to be the fiscal year ended March 31, 1941, the petitioner's distributive share of income from the Canadian partnership is $ 10,248.60 and the Canadian income taxes accrued thereon is $ 4,171.81. However, if the Court finds the taxable year to be the calendar year 1941, then the taxpayer's distributive share of income from the Canadian partnership is $ 20,354.00 and the Canadian income taxes accrued thereon is $ 11,239.88.

(5) No part of the earnings of the Canadian partnership above specified were received in the United States up to December 31, 1941.

In Docket No. 9101, the parties stipulated as follows (Note: Paragraph 1 of the stipulation is omitted as it is the same as paragraph 1 of the stipulation in Docket No. 9100 except for the name of the respective petitioner):

(2) The petitioner arrived in the United States on December 12, 1940 on which date he became a resident alien and retained that status to December 31, 1940, for a total of 20 days. Applying the fraction 20/366 to the petitioner's share of Canadian partnership income of $ 19,435.18 and Canadian income taxes accrued thereon of $ 7,911.31 gives Canadian income of $ 1,062.03 and tax accrued of $ 432.31 for that part of 1940 beginning with December 12, 1940.

(3) If the Court finds the taxable year of Henri Freudmann to be the fiscal year ended March 31, 1940, the petitioner has no income from Canada for that year; whereas, if the taxable year is found by the Court to be the calendar year 1940, the petitioner's distributive share of income from the Canadian partnership is $ 1,062.03 and the Canadian income taxes accrued thereon is $ 432.31.

(4) The distributive share of the income of the petitioner, Henri Freudmann, from the Canadian partnership for the calendar year 1941 similarly determined as under point (1) is U. S. $ 22,032.46 and the Canadian income tax accrued and paid thereon is U. S. $ 12,115.87. If the Court finds the petitioner's taxable year to be the fiscal year ended March 31, 1941, the petitioner's distributive share of income from the Canadian partnership is $ 1,062.03 and the Canadian income taxes accrued thereon is $ 432.31. However, if the Court finds the taxable year to be the calendar year 1941, then the taxpayer's distributive share of income from the Canadian partnership is $ 22,032.46 and the Canadian income taxes accrued thereon is $ 12,115.87.

(5) No part of the distributive share of Canadian partnership income above specified was received by the taxpayer in the United States up to December 31, 1941.

Petitioners filed their individual income and defense tax returns for the fiscal year ended March 31, 1941, on Form 1040. Item 33 of the "Computation of Tax" schedule on Form 1040 reads "Income tax paid to a foreign country or U. S. possession (Attach Form 1116)." Max left the space opposite item 33 blank and did not attach Form 1116. A Form 1116 was later filled out by or for Max for the calendar year 1941 in support of a credit for taxes paid or accrued to Canada under the limitation of section 131 (b) (2) of the Internal Revenue Code in the amount of $ 4,047.43. The record does not show whether this form was ever filed with the Commissioner. Henri claimed in the space opposite item 33 a credit for taxes paid to Great Britain under the limitation of section 131 (b) (2) in the amount of $ 158.22, but did not claim any credit for taxes paid to Canada. He attached Form 1116 for the fiscal year ended March 31, 1941, in support of the said credit claimed of $ 158.22. In Form 1116 he did not elect under section 131 (d) to claim credit for taxes accrued. The said form was in part as follows:

Claim for credit is made by the taxpayer named above, who is a citizen or subject of Belgium/(Name of country) and is a resident of United States,/(Name of country) on the attached income tax return, which is based on income Received/(Received or accrued) for the taxable year begun April 1, 1940, and ended March 31, 1941, for taxes Paid/(Paid or accrued) I, as follows:

Footnote 1 of Form 1116 provided:

If attached income return is based on income "accrued," or you elect under Section 131 (d) to claim credit for taxes accrued, write "accrued" in the space provided. (See Section 131 (d) and instructions on page 4.)

The respondent did not allow either petitioner any "credit" under section 131 of the code for taxes paid to Canada; neither did he allow Henri any credit for taxes paid to Great Britain. In redetermining petitioners' Federal tax liabilities on the basis of calendar years, the respondent allowed Max and Henri "deductions" for the calendar year 1941 under section 23 (c) (1) (C) of the code of $ 2,752.73 and $ 285.24, respectively.

The method of accounting used by petitioners was the cash method.

OPINION.

The four issues previously summarized will be considered in their regular order.

Issue 1. -- This issue is described in our opening statement and in footnote 1 of our findings of fact. The material provisions of the Internal Revenue Code are in the margin. *231

Section 19.22 (a)-5 of Regulations 103 provides that "In the case of a manufacturing, merchandising, or mining business, 'gross income' means the total sales, less the cost of goods sold * * *."

During the fiscal year ended March 31, 1941, the New York partnership sold both polished and rough diamonds. It reported a gross profit of $ 49,201.55 on the polished diamonds and a gross profit of $ 19,307.35 on the rough diamonds. The respondent determined that the gross profit on the rough diamonds, instead of $ 19,307.35, was $ 114,282.03, which is an arbitrary 35 per cent of the net sales of rough diamonds of $ 326,520.09. In arriving at this gross profit of $ 114,282.03 the respondent determined that the cost of the rough diamonds sold was $ 212,238.06, which is an arbitrary 65 per cent of the net sales of rough diamonds. This issue involves only the determination of the proper cost of the rough diamonds sold during the fiscal year ended March 31, 1941, and is purely a question of fact. The partnership determined that this cost was $ 307,212.74. As above stated, the respondent determined it to be $ 212,238.06. Petitioners now contend it was $ 365,817.46. We have found as an ultimate fact that the cost of the rough diamonds sold was $ 325,218.16, which is $ 40,599.30 ($ 39,979.76 plus $ 619.54) less than the amount contended for by petitioners. The details of this ultimate determination are set out in our findings of fact relating to this issue.

The entire controversy on this issue is narrowed down to whether the petitioners have sufficiently proved the cost of the diamonds brought over to the United States from Belgium by Felix. The respondent contends that petitioners have failed in their proof, whereas petitioners contend that they have proved this cost to be $ 306,757.88, determined as follows:

Cost as per the translated list	$ 292,801.09
Less diamonds belonging to Felix	7,350.96
Balance of cost per the translated list	285,450.13
Add amount paid to Cerqueira	21,307.75
Cost of diamonds brought from Belgium	306,757.88

We agree with petitioners' contention, except that we do not think petitioners have sufficiently proved that the adjustment which they made on the books of the partnership at the close of the fiscal year, whereby the cost of the diamonds brought over from Belgium as set up on the books of the partnership was adjusted downward by the amount of $ 39,979.76, was improper, and except that we think the amount paid to Cerqueira must be reduced by $ 619.54, the amount allocable to the diamonds belonging to Felix.

The respondent offered no evidence in explanation of how he arrived at the arbitrary determination that 65 per cent of the gross sales equaled the cost of the rough diamonds sold. The basis for his determination was, of course, that, in his opinion, petitioners had not established the cost of the diamonds brought over to the United States from Belgium. But petitioners had gross sales of rough diamonds other than those brought over from Belgium in an amount in excess of $ 185,745.06 ($ 110,095.98 minus $ 78,898.10 plus $ 154,547.18) and the respondent's 65 per cent rule applied to these other rough diamonds as well as those brought over from Belgium, although the partnership maintained complete records as to these other rough diamonds.

We, therefore, hold for reasons already stated that petitioners have sufficiently proved the cost of the diamonds brought over to the United States from Belgium to be $ 245,470.37, exclusive of the amount paid to Cerqueira which we shall now consider.

The respondent contends that no part of the $ 21,307.75 paid to Cerqueira is deductible as a part of the cost of the diamonds brought over to the United States from Belgium on the ground that, as stated in his brief, "The payments to him were for his political influence and ability in this regard and come within the decisions of" Kelley-Dempsey & Co., 31 B. T. A. 351; Easton Tractor & Equipment Co., 35 B. T. A. 189; New Orleans Tractor Co., 35 B. T. A. 218; and T. G. Nicholson, 38 B. T. A. 190. There is no basis for the respondent's assumptions that the amount paid to Cerqueira was paid for political influence and was of such a nature as to be against public policy. Petitioners employed Cerqueira because he was considered the best man to accomplish the task of transporting the diamonds from France to Portugal. The cases relied upon by the respondent are not in point. We hold that the amount paid to Cerqueira represented a part of the cost of the diamonds that were transported. Since $ 7,350.96 worth of the diamonds transported belonged to Felix and $ 245,470.37 belonged to petitioners, we hold that 7,350.96/252,821.33 ($ 245,470.37 plus $ 7,350.96) of the $ 21,307.75 or $ 619.54 should be considered a part of the cost of the diamonds belonging to Felix and the balance of $ 20,688.21 should be considered a part of the cost of the diamonds belonging to petitioners.

For the reasons heretofore given we hold that the cost of all of the rough diamonds sold by the New York partnership during the fiscal year ended March 31, 1941, was the amount of $ 325,218.16, the details of which appear in our findings of fact.

Issue 2. -- This issue is whether petitioners are entitled to compute their tax liabilities upon the basis of fiscal years ended March 31, 1940 and 1941, as petitioners contend, or whether they must compute their tax liabilities upon the basis of calendar years ended December 31, 1940 and 1941, as the respondent has determined. The parties have stipulated what adjustments are to be made "If the Court finds that the petitioners' taxable years are the fiscal years" and what adjustments are to be made "If the Court finds that the petitioners' taxable years are the calendar years * * *." Our sole problem is to determine whether petitioners' taxable years are the fiscal or the calendar years. The material provisions of the Internal Revenue Code and Regulations 103 are set forth in the margin. *237 Section 41 deals with accounting periods and methods of accounting. We are not here concerned with the methods, but are concerned only with whether petitioners have proved that during the periods here in question they kept books on a fiscal year annual accounting period ending March 31. If the evidence shows that during the periods here in question petitioners kept books on a fiscal year annual accounting period ending March 31, then under the plain language of section 41 "The net income shall be computed" upon that basis. The respondent contends that during the periods here in question petitioners had no annual accounting period and did not keep books and that, therefore, under section 41 "the net income shall be computed on the basis of the calendar year."

Prior to 1940 petitioners were nonresident aliens. As such, they were subject to the United States income tax only if they had income from sources within the United States. They had no such income until the New York partnership was formed on April 1, 1939. The partnership established a fiscal year annual accounting period ending on March 31, and the respondent concedes that the net income of the partnership must be computed upon that basis. The books of the partnership, however, are not for income tax purposes the books of the individual taxpayers making up the partnership. Fred R. Drake, 1 B. T. A. 1235; Max H. Stryker, 36 B. T. A. 326. Prior to April 1, 1939, petitioners, being nonresident aliens and not having any income from sources within the United States, were not required to file any United States income tax returns. After the New York partnership was organized on April 1, 1939, petitioners had an election as to whether they would file their first individual nonresident alien income tax returns on the calendar year basis or on the basis of some "fiscal year" as defined in section 48 (b) of the code, provided that if they elected the latter it would be necessary for them, prior to the close of the first fiscal year, to comply definitely with section 41 of the code and section 19.41-4 of Regulations 103. Cf. O. D. 404, 2 C. B. 67, and Estate of Cyrus H. K. Curtis, 36 B. T. A. 899, 906.

Petitioners elected to file their individual income tax returns on the same fiscal year basis as that used by the New York partnership and, as the evidence shows, they did file them on that basis. Petitioners had a right to make this election, provided they fully complied with the code and the regulations thereunder. Under section 41 of the code and section 19.41-4 of Regulations 103 it was necessary for petitioners, before the close of any such elected fiscal year, definitely to establish such an annual accounting period by means of books kept upon such a basis. We are unable to find from the evidence that petitioners, as individuals, kept books, either in Belgium or in the United States, on an annual accounting period of twelve months ending on March 31 until some time in 1943. Petitioners did testify that they kept some books in Belgium, which they left behind at the time they fled from that country. We are, however, unable to find from this testimony or any other evidence of record that any such books as may have been kept in Belgium were kept in accordance with an accounting period ended March 31, 1940, which had been definitely established as such before its close. The evidence is clear that petitioners, as individuals, kept no regular set of books in the United States until April 1943. Section 41 of the code provides that "if the taxpayer has no annual accounting period or does not keep books, the net income shall be computed on the basis of the calendar year." And section 19.41-4 of Regulations 103 provides:

* * * No fiscal year will, however, be recognized unless before its close it was definitely established as an accounting period by the taxpayer and the books of such taxpayer were kept in accordance therewith. A person having no such fiscal year must make his return on the basis of the calendar year.

We, accordingly, hold that petitioners must compute their tax liabilities upon the basis of calendar years ended December 31, 1940 and 1941, as the respondent has determined. Cf. Max H. Stryker, supra; and Louis M. Brooks, 6 T. C. 504. Therefore, the adjustments agreed upon in paragraph 7 of each of the stipulations will be made in a recomputation under Rule 50.

Issue 3. -- Under this issue petitioners contend they are not taxable in the United States on any part of the income from the Canadian partnership which was earned during the calendar years 1940 and 1941. The respondent contends that petitioners are taxable on the above mentioned income from the Canadian partnership under the language of section 182 of the Internal Revenue Code. section 42 of the Internal Revenue Codesection 19.42-2 of Regulations 103. Section 42 of the code was amended by section 114 of the Revenue Act of 1941 by inserting before the first sentence thereof "(a) General Rule. --" and by inserting at the end of such section a new subsection, (b), not here material. Section 118 of the Revenue Act of 1941 provided that "The amendments made by this title * * * shall be applicable only with respect to taxable years beginning after December 31, 1940." Although this amendment is applicable only to the calendar year 1941 and is not applicable with respect to the calendar year 1940, now under consideration, the rule provided by section 42 (prior to the amendment) was nevertheless in substance a general rule as compared with the specific rule stated in section 182, supra, relied upon by the respondent. "It is an old and familiar rule that, 'where there is, in the same statute, a particular enactment, and also a general one, which, in its most comprehensive sense, would include what is embraced in the former, the particular enactment must be operative, and the general enactment must be taken to affect only such cases within its general language as are not within the provisions of the particular enactment.'" Monarch Life Insurance Co., 38 B. T. A. 801, 805-806, citing United States v. Chase, 135 U.S. 255">135 U.S. 255, 260; and Ginsberg & Sons v. Popkin, 285 U.S. 204">285 U.S. 204. Section 182 (c), being a specific provision dealing with the computation of the net income of each partner of a partnership, takes precedence over the general provision of section 42 dealing with the period in which items of gross income are to be included. Ruud Manufacturing Co., 14">10 T. C. 14. Section 182 (c) provides that, in computing the net income of each partner, he shall include his distributive share of the net income of the partnership whether or not distribution is made to him. In so far as the present issue is concerned, it would make no difference whether petitioners reported their income in accordance with the cash or the accrual method of accounting.

Petitioners nevertheless contend that, because the Canadian Government refused to permit petitioners to bring any of the funds of the Canadian partnership to the United States, they are not taxable on any of the net income of such partnership, under the doctrine of International Mortgage & Investment Corporation, 36 B. T. A. 187. The taxpayer in that case was a Maryland corporation. Its taxable year was the calendar year 1931. In years prior to 1931 the taxpayer took dollars into Germany when the rate of exchange was 4.198 marks to the dollar, and used the money to purchase German mortgages at less than face value. In July 1931 there was a banking crisis in Germany and Germany thereafter prohibited the transfer out of Germany of marks received on repayment of capital sums without permission of the German Foreign Exchange Office. During the period July 13 to December 31, 1931, mortgages which had cost the taxpayer 3,352,398.29 reichsmarks when reichsmarks had an exchange value of 4.198 to the dollar, were repaid to the taxpayer's agents in Germany in the amount of 4,208,408.21 reichsmarks. The Commissioner determined that the excess of 856,009.92 reichsmarks was income to the taxpayer at the rate of 4.198 reichsmarks to the dollar. After July 12, 1931, no part of the above 4,208,408.21 reichsmarks could be paid over or credited to the taxpayer in such a way that the taxpayer could obtain or use the money outside of Germany. The United States Board of Tax Appeals (now this Court) found as a fact that "There was no market in 1931 for the restricted marks, and no one could form an opinion as to their value at that time." Based primarily upon that finding, it was held that the taxpayer realized no gain during 1931 from the receipt of the blocked marks.

The International Mortgage case was distinguished in Phanor J. Eder, 47 B. T. A. 235, as having been decided squarely under the doctrine of "constructive receipt" and not premised upon any specific legislation. We have specific legislation in the instant proceedings, namely, section 182 (c), supra. The taxpayer in the Eder case was a shareholder of a foreign personal holding company organized in 1936 under the laws of the Republic of Colombia. The taxable year was 1938. Section 337 (a) of the Revenue Act of 1938 provided that "The undistributed Supplement P net income of a foreign personal holding company shall be included in the gross income of the citizens or residents of the United States * * * who are shareholders in such foreign personal holding company * * *." The Colombian company for 1938 had a Supplement P net income of 167,904.98 pesos. It received permission to and did transmit 58,296.60 of these pesos to its stockholders in the United States, with respect to which it claimed and was allowed by the Commissioner a "dividends paid credit" measured in United States dollars at the exchange rate of 57.06 cents per peso. This left an undistributed Supplement P net income of 109,608.38 pesos. This undistributed net income could not legally be transferred outside the boundaries of Colombia because of prohibitions imposed by the exchange control laws and regulations of that country, but there was no law of Colombia during 1938 forbidding the spending or investment of pesos within the boundary of that republic. The taxpayer contended that because of these restrictions no part of the undistributed Supplement P net income was taxable to him, notwithstanding the specific provisions of section 337 (a) of the Revenue Act of 1938, supra. The Commissioner rejected this contention and determined that the taxpayer was taxable on his share (25 per cent) of the undistributed Supplement P net income of the Colombian company at the current rate of exchange for free pesos of 57.06 cents per peso. We sustained the Commissioner's determination. The Circuit Court of Appeals, Second Circuit, in Eder v. Commissioner, 138 Fed. (2d) 27, remanded the case to us and, among other things in its opinion, said:

We agree with the taxpayers that the Commissioner and the Tax Court were in error in adopting as the value of "blocked" pesos the current rate of exchange for "free" pesos. It does not follow, however, that the taxpayers must win. * * *

There is nothing in the record to show how economic satisfaction in Colombia can be measured in American dollars. * * * We therefore remand the case to the Tax Court for further consideration of the appropriate measure of valuation, with leave, of course, to any of the parties to introduce further evidence hearing on that particular subject.

We do not agree with taxpayers' argument that inability to expend income in the United States, or to use any portion of it in payment of income taxes, necessarily precludes taxability. In a variety of circumstances it has been held that the fact that the distribution of income is prevented by operation of law, or by agreement among private parties, is no bar to its taxability. See, e. g., Heiner v. Mellon, 304 U.S. 271">304 U.S. 271, 281, 58 S. Ct. 926">58 S. Ct. 926, 82 L. Ed. 1337">82 L. Ed. 1337; Helvering v. Enright's Estate, 312 U.S. 636">312 U.S. 636, 641, 61 S. Ct. 777">61 S. Ct. 777, 85 L. Ed. 1093">85 L. Ed. 1093; cf. Helvering v. Bruun, 309 U.S. 461">309 U.S. 461, 60 S. Ct. 631">60 S. Ct. 631, 84 L. Ed. 864">84 L. Ed. 864. * * *

Upon rehearing it was found that the 109,608.38 pesos had a value of 28.53 cents per peso in United States money instead of 57.06 cents and the deficiencies were recomputed in accordance with that finding.

We followed the Eder case, supra, and were affirmed by the Second Circuit in Edmond Weil, Inc. v. Commissioner, 150 Fed. (2d) 950.

In the instant proceedings petitioners offered no proof as to what the laws of Canada were relative to the transmission of funds from that country to the United States. At the time Henri arranged with Canada to bring the $ 90,725.75 representing either the cost or value of the diamonds petitioners had shipped from Antwerp to Canada in 1939, he was told that petitioners would not be permitted to bring any further funds from Canada to the United States during the war. As to the nature of these restrictions we were left uninformed, but we shall assume they were effective to prevent the transmission of any of these funds to the United States. However, there is no evidence to show that petitioners did not at all times have free use of the income in question in the conduct of their partnership business in Canada.

It is our opinion, and we hold, that, under the provisions of section 182 (c) of the code and upon the authority of the Eder and Weil cases, supra, the petitioners are taxable for the calendar years 1940 and 1941 on the respective amounts of income from the Canadian partnership mentioned in the parts of the stipulations of facts set out in our findings. Cf. Heiner v. Mellon, 304 U.S. 271">304 U.S. 271.

Issue 4. -- Are petitioners entitled to a foreign tax credit for income taxes paid or accrued to Canada? The applicable statutory provisions for the calendar year 1940 are sections 23 (c) (2), unamended, and 131 (a), (b), and (d) of the Internal Revenue Code as amended by section 216 of the Revenue Act of 1939, which, so far as they are relevant, are set out in the margin. ^{section 23 (c) (1) (C) of the code, as amended by section 202 (a) of the Revenue Act of 1941 and section 158 (b) of the Revenue Act of 1942, and section 131 (a) of the code as amended by section 158 (a) of the Revenue Act of 1942. In view of our later holding herein on this issue, we do not set out these provisions in the margin, since their differences from the applicable statutory provisions for the calendar year 1940 as set out in footnote 8 are not such as would make any change in our holding for the two calendar years here involved.}

Max did not signify in his return his desire to have the benefit of section 131. Henri did so signify, but did not claim any credit for taxes paid or accrued to Canada. The record does not show that either petitioner claimed any credit for taxes paid or accrued to Canada until they filed their respective motions "for leave to amend petition," as noted in our preliminary statement in which motion claims were made for taxes "paid" to Canada. We need not and do not decide whether these claims for credit are timely, for, assuming that they are, there are other reasons why the claims must be denied.

The respondent contends that petitioners do not meet the condition precedent provided in section 131 (a) (3), supra, which is the same for both years and is as follows:

In the case of an alien resident of the United States, the amount of any such taxes paid or accrued during the taxable year to any foreign country, if the foreign country of which such alien resident is a citizen or subject, in imposing such taxes, allows a similar credit to citizens of the United States residing in such country.

During the taxable years here involved petitioners were citizens or subjects ofBelgium. Section 131 (a) (3) of the Revenue Act of 1928 is identical with the above provision of the code. Article 695 (b) of Regulations 74, promulgated under the 1928 Act, provided in part as follows:

Art. 695. Countries which do or do not satisfy the similar credit requirement. * * *

(b) The following is an incomplete list of the countries which do not satisfy the similar credit requirement of section 131 (a) (3) of the Revenue Act of 1928, either because such countries do not allow any credit to citizens of the United States residing in such countries for the amount of income taxes paid to the United States, or because such countries do not impose any income taxes: * * * Belgium * * *.

As far as we have been able to determine, the status of Belgium as being a country which does or does not satisfy the similar credit requirement has not changed since the promulgation of Regulations 74. If it has changed, the burden would be upon petitioners to prove it and they have offered no evidence to show that Belgium satisfies the similar credit requirement of the code. In their brief petitioners say:

It is the petitioners' contention that the reciprocal credit provision of Section 131 (a) (3) is not material in that it refers to a set of facts entirely different from that which exists in the instant case. * * * The petitioners further contend that their claim for credit for foreign income taxes paid to Canada is governed by the Tax Convention with Canada * * *.

The "Tax Convention" thus relied upon by petitioners is the tax convention and protocol between the United States and Canada which was proclaimed by the President of the United States on June 17, 1942, and made effective as of January 1, 1941. On December 31, 1942, the Commissioner issued comprehensive regulations as T. D. 5206 (1943 C. B. 526) to govern procedure under this tax convention and protocol, which tax convention and protocol is set out in full under section 7.20 of the regulations. The portions of the tax convention and protocol relied upon by petitioners are set forth in the margin. *254 We do not think the portions of the tax convention and protocol relied upon by petitioners are of any help to petitioners. They do not enlarge the statutory provisions of section 131 of the code. Article XV of the convention simply states that the United States agrees to allow as a deduction from taxes imposed by the United States the appropriate amount of such taxes paid to Canada "In accordance with the provisions of section 131 of the United States Internal Revenue Code as in effect on the day of the entry into force of this convention * * *." Section 7.35 of the regulations issued as T. D. 5206, supra, provides:

Sec. 7.35. Credit Against United StatesTax Liability For Income Tax Paid To Canada. -- For the purpose of avoidance of double taxation, Article XV provides that, on the part of the United States, there shall be allowed against the United States income and excess profits tax liability a credit for any such taxes paid to Canada by United States citizens or domestic corporations. Such principle also applies in the case of a citizen of Canada residing in the United States. Such credit, however, is subject to the limitations provided in section 131. Internal Revenue Code (relating to the credit for foreign taxes). See sections 19.131-1 to 19.131-8, Regulations 103. The article is complementary to the provisions of Article XVII, which provides that the United States in ascertaining the income and excess profits tax of its citizens and residents and corporations may take into the basis upon which such taxes are imposed all items of income as though the convention had not come into effect.

In view of the specific provision in article XV of the convention wherein the "appropriate amount" is to be allowed in accordance with "the provisions of section 131" and in view of the regulations issued thereunder, we hold that section 131 (a) (3) of the code is not only material, but is controlling, and, since petitioners have not shown that Belgium satisfies the similar credit requirement of section 131 (a) (3), it follows that petitioners are not entitled to any credit for income taxes either paid or accrued to Canada. As a result of this holding we need not consider the question whether if petitioners were entitled to a credit it should be for taxes "paid" or for taxes "accrued." Petitioners have contended and argued both ways in their brief.

We think, however, that, since petitioners are not entitled to any credit for taxes either paid or accrued to Canada under section 131, supra, they should be allowed as deductions from gross income for the calendar years 1940 and 1941, under section 23 (c) (1) (C) of the code, as amended, the amounts paid to the Canadian Government on the partnership income. The parties have entered into detailed stipulations in each case covering the amounts of Canadian partnership income, the amounts of Canadian income taxes accrued and paid, and the respective shares of this income and these taxes allocable to each partner, depending in each case as to whether we hold petitioners entitled to use the fiscal year basis, as they contend, or whether we sustain the Commissioner in putting them on the calendar year basis. Effect will be given to the facts thus stipulated in determining in each case the deductions which are allowable to each petitioner for Canadian income tax so paid on the partnership income here involved.

Decisions will be entered under Rule 50.

---

Footnotes

• 1. The statements attached to the deficiency notices in both dockets do not show the details of adjustment (a) for 1941. They merely state that petitioners' proportionate share of the net income of the New York partnership as reported for the year 1941 is understated, in the case of Max Freudmann by $ 47,999.36, and in the case of Henri Freudmann by $ 47,999.35. Counsel for petitioners in his opening statement at the hearing (T. 6) stated that the respondent had disregarded the cost of rough diamonds as shown on the books of the partnership and had substituted "an arbitrary 35% gross profit percentage on all sales of such rough diamonds; thereby increasing the distributive share of partnership income for the fiscal year ending March 31, 1941, for each of the petitioners, roughly $ 48,000." Counsel for the respondent in his opening statement at the hearing (T. 8) said "Respondent has determined that the cost of the diamonds sold was $ 212,000." From these opening statements it would appear that the respondent had disregarded the cost of rough diamonds as shown by the partnership books of $ 307,212.74 and had substituted in lieu of that cost an arbitrary cost of 65% of the selling price of rough diamonds, namely, 65% of $ 326,520.09 which is $ 212,238.06. This adjustment alone would increase the partnership net income by $ 94,974.68, which is the difference between the cost of $ 307,212.74 as determined by petitioners and the cost of $ 212,238.06 as determined by the respondent. Since the respondent actually increased the partnership net income by $ 95,998.71 ($ 47,999.36 plus $ 47,999.35) it is evident he also made some minor adjustments in the partnership net income which are not here disclosed and which are not contested. Petitioners contend that the cost of the rough diamonds sold during the fiscal year ended March 31, 1941, is, except for a slight difference which will appear later in our findings, the amount shown on the books of the partnership, plus an amount of $ 39,979.76 and also an amount of $ 21,307.75 the details of which will also appear later in our findings. The respondent contends that his determination should be approved.↩

• 2. The collector's office of the Custom House at New York certified a total of 17,840.45 carats. The list actually adds up to only 17,839.65 carats, but for the purposes of this report will be considered as if the total of 17,840.45 shown on the list was correct.↩

• 3. SEC. 22. GROSS INCOME.

  (a) General Definition. -- "Gross income" includes gains, profits, and income derived from * * * trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. * * *

  * * * *

  (c) Inventories. -- Whenever in the opinion of the Commissioner the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer upon such basis as the Commissioner, with the approval of the Secretary, may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income.↩

• 4. SEC. 41. GENERAL RULE.

  The net income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income. If the taxpayer's annual accounting period is other than a fiscal year as defined in section 48 or if the taxpayer has no annual accounting period or does not keep books, the net income shall be computed on the basis of the calendar year.

  SEC. 46. CHANGE OF ACCOUNTING PERIOD.

  If a taxpayer changes his accounting period from fiscal year to calendar year, from calendar year to fiscal year, or from one fiscal year to another, the net income shall, with the approval of the Commissioner, be computed on the basis of such new accounting period, subject to the provisions of section 47.

  SEC. 48. DEFINITIONS.

  When used in this chapter --

  (a) Taxable Year. -- "Taxable year" means the calendar year, or the fiscal year ending during such calendar year, upon the basis of which the net income is computed under this Part. * * *

  (b) Fiscal Year. -- "Fiscal year" means an accounting period of twelve months ending on the last day of any month other than December.

  Sec. 19.41-4. [Regulations 103.] Accounting Period. -- The return of a taxpayer is made and his income computed for his taxable year, which in general means his fiscal year, or the calendar year if he has not established a fiscal year. (See section 48↩.) The term "fiscal year" means an accounting period of 12 months ending on the last day of any month other than December. No fiscal year will, however, be recognized unless before its close it was definitely established as an accounting period by the taxpayer and the books of such taxpayer were kept in accordance therewith. A person having no such fiscal year must make his return on the basis of the calendar year. Except in the case of a first return for income tax a taxpayer shall make his return on the basis upon which he made his return for the taxable year immediately preceding, unless, with the approval of the Commissioner, he has changed his accounting period. * * *

• 5. SEC. 182. TAX OF PARTNERS.

  In computing the net income of each partner, he shall include, whether or not distribution is made to him --

  * * * *

  (c) His distributive share of the ordinary net income or the ordinary net loss of the partnership, computed * * *. [Note: The parties have stipulated how it is to be "computed".]↩

• 6. SEC. 42. PERIOD IN WHICH ITEMS OF GROSS INCOME INCLUDED.

  The amount of all items of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under methods of accounting permitted under section 41↩, any such amounts are to be properly accounted for as of a different period. * * *

• 7. Sec. 19.42-2. Income not reduced to possession↩. -- Income which is credited to the account of or set apart for a taxpayer and which may be drawn upon by him at any time is subject to tax for the year during which so credited or set apart, although not then actually reduced to possession. To constitute receipt in such a case the income must be credited or set apart to the taxpayer without any substantial limitation or restriction as to the time or manner of payment or condition upon which payment is to be made, and must be made available to him so that it may be drawn at any time, and its receipt brought within his own control and disposition. A book entry, if made, should indicate an absolute transfer from one account to another. If a corporation contingently credits its employees with bonus stock, but the stock is not available to such employees until some future date, the mere crediting on the books of the corporation does not constitute receipt.

• 8. SEC. 23. DEDUCTIONS FROM GROSS INCOME.

  In computing net income there shall be allowed as deductions:

  * * * *

  (c) Taxes Generally. -- Taxes paid or accrued within the taxable year, except --

  * * * *

  (2) income, war-profits, and excess-profits taxes imposed by the authority of any foreign country or possession of the United States; but this deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to have to any extent the benefits of section 131 (relating to credit for taxes of foreign countries and possessions of the United States).

  SEC. 131. TAXES OF FOREIGN COUNTRIES AND POSSESSIONS OF UNITED STATES.

  (a) Allowance of Credit. -- If the taxpayer signifies in his return his desire to have the benefits of this section, the tax imposed by this chapter, except the tax imposed under section 102, shall be credited with:

  * * * *

  (3) Alien resident of United States. -- In the case of an alien resident of the United States, the amount of any such taxes paid or accrued during the taxable year to any foreign country, if the foreign country of which such alien resident is a citizen or subject, in imposing such taxes, allows a similar credit to citizens of the United States residing in such country; and

  (4) Partnerships and Estates. -- In the case of any such individual who is a member of a partnership or a beneficiary of an estate or trust, his proportionate share of such taxes of the partnership or the estate or trust paid or accrued during the taxable year to a foreign country or to any possession of the United States, as the case may be.

  (b) Limit on Credit. -- The amount of the credit taken under this section shall be subject to each of the following limitations:

  (1) The amount of the credit in respect of the tax paid or accrued to any country shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayer's net income from sources within such country bears to his entire net income, in the case of a taxpayer other than a corporation, or to the normal-tax net income, in the case of a corporation, for the same taxable year; and

  (2) The total amount of the credit shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayer's net income from sources without the United States bears to his entire net income, in the case of a taxpayer other than a corporation, or to the normal-tax net income, in the case of a corporation, for the same taxable year.

  * * * *

  (d) Year in Which Credit Taken. -- The credits provided for in this section may, at the option of the taxpayer and irrespective of the method of accounting employed in keeping his books, be taken in the year in which the taxes of the foreign country or the possession of the United States accrued, subject, however, to the conditions prescribed in subsection (c) of this section. If the taxpayer elects to take such credits in the year in which the taxes of the foreign country or the possession of the United States accrued, the credits for all subsequent years shall be taken upon the same basis, and no portion of any such taxes shall be allowed as a deduction in the same or any succeeding year.↩

• 9. Article XV.

  In accordance with the provisions of section 8 of the Income War Tax Act as in effect on the day of the entry into force of this convention, Canada agrees to allow as a deduction from the Dominion income and excess profits taxes on any income which was derived from sources within the United States of America and was there taxed, the appropriate amount of such taxes paid to the United States of America.

  In accordance with the provisions of section 131 of the United States Internal Revenue Code as in effect on the day of the entry into force of this convention, the United States of America agrees to allow as a deduction from the income and excess profits taxes imposed by the United States of America the appropriate amount of such taxes paid to Canada.

  Article XVI.

  Where a taxpayer shows proof that the action of the revenue authorities of the contracting States has resulted in double taxation in his case in respect of any of the taxes to which the present convention relates, he shall be entitled to lodge a claim with the State of which he is a citizen or resident or, if the taxpayer is a corporation or other entity, with the State in which it was created or organized. If the claim should be deemed worthy of consideration, the competent authority of such State may consult with the competent authority of the other State to determine whether the double taxation in question may be avoided in accordance with the terms of this convention.

  * * * *

  Protocol.

  At the moment of signing the convention for the avoidance of double taxation, and the establishment of rules of reciprocal administrative assistance in the case of income taxes, this day concluded between the United States of America and Canada, the undersigned plenipotentiaries have agreed upon the following provisions and definitions:

  1. The taxes referred to in this convention are:

  (a) for the United States of America: the Federal income taxes, including surtaxes, and excess-profits taxes.

  (b) for Canada: the Dominion income taxes, including surtaxes, and excess-profits taxes.

  2. In the event of appreciable changes in the fiscal laws of either of the contracting States, the Government of the two contracting States will consult together.

  3. As used in this convention:

  (a) the terms "person," "individual" and "corporation" shall have the same meanings, respectively, as they have under the revenue laws of the taxing State or the State furnishing the information, as the case may be;

  (b) the term "enterprise" includes every form of undertaking, whether carried on by an individual, partnership, corporation or any other entity;

  (c) the term "enterprise of one of the contracting States" means, as the case may be, "United States enterprise" or "Canadian enterprise";

  (d) the term "United States enterprise" means an enterprise carried on in the United States of America by an individual resident in the United States of America or by a corporation, partnership or other entity created or organized in or under the laws of the United States of America, or of any of the States or Territories of the United States of America;

  (e) the term "Canadian enterprise" is defined in the same manner mutatis mutandis as the term "United States enterprise."↩