Dilks v. Commissioner

LORENZO C. DILKS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Dilks v. Commissioner

Docket No. 12115.

United States Board of Tax Appeals

15 B.T.A. 1294; 1929 BTA LEXIS 2686;

April 9, 1929, Promulgated

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">*2686 1. Payments to petitioner made in 1920 constituted loans or advances and were neither gratuities nor payments of additional compensation under the terms of a contract of employment.

2. Where, in 1921, after completion of work on certain ship construction contracts, the sale of the shipbuilding plant and the ascertainment of the actual profit earned, the company credited petitioner's account with his share of the net profits, such crediting entry converted the loans or advances made in 1920 into payments of additional compensation under the contract of employment and the petitioner, on a cash receipts basis, is taxable thereon.

3. Charge of fraud disapproved.

Benjamin Mahler, Esq., for the petitioner.

Bruce A. Low, Esq., and George S. Herr, Esq., for the respondent.

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VAN FOSSAN

">*1295 In this proceeding petitioner seeks a redetermination of the income taxes for the year 1921 for which the Commissioner has determined a deficiency of $27,473.74.

The petitioner alleges error on the part of the Commissioner (1) in failing to mail the deficiency letter required by law in that the Commissioner sent such deficiency letter to the wrong">*2687 address; (2) in increasing the income of the petitioner for the year 1921 by the sum of $74,703.94.

At the hearing the Commissioner made an affirmative allegation of fraud and requested this Board to impose a penalty as provided by law.

FINDINGS OF FACT.

Petitioner is an individual with his principal office at 160 North LaSalle Street, Chicago, Ill.

Some time in 1918 the Carolina Shipbuilding Corporation, a corporation organized, owned and controlled by the George A. Fuller Co., entered into a contract with the United States Shipping Board Emergency Fleet Corporation to construct 12 steel vessels of approximately 9,600 gross tons capacity each. Work began in May, 1918. The Shipbuilding Corporation constructed a shipyard with four ways and also bought or placed orders for the material necessary for 12 boats.

Shortly after the Armistice the contract between the Carolina Shipbuilding Corporation and the United States Emergency Fleet Corporation was canceled. None of the boats had been completed. The contract was, thereafter, in August, 1919, replaced by a new contract between the George A. Fuller Co. and the United States Shipping Board. Under the terms of the new">*2688 contract the United States Shipping Board was to purchase 8 of the 12 boats at a price of $1,944,000 per boat. The Fuller Company was required to take over from the Shipping Board the shipyard at a cost of $500,000. It also took over at cost all the material and supplies acquired.

Since the organization of the Shipbuilding Corporation, Lorenzo C. Dilks, the petitioner herein, had been in charge of the shipbuilding plant, located at Wilmington, N.C. He remained in the employ of that company until the end of 1919. On January 1, 1920, and after ">*1296 the execution of the contract between the George A. Fuller Co. and the Shipping Board, Dilks entered into the employ of the George A. Fuller Co. under the terms of a written contract dated February, 1920. This contract was as follows:

THIS AGREEMENT, made this eighteenth day of February, 1920, between LORENZO C. DILKS, of Wilmington, North Carolina, party of the first part, and GEORGE A. FULLER COMPANY, a corporation organized under the laws of the State of New Jersey, party of the second part * * * WITNESSETH:

That said Lorenzo C. Dilks agrees to diligently serve said George A. Fuller Company as Vice President of the Company">*2689 at its office in Wilmington, North Carolina, to April 30, 1921. In consideration of such service so to be performed, said George A. Fuller Company agrees to pay said Lorenzo C. Dilks the sum of Twenty Thousand Dollars ($20,000) per annum in equal monthly instalments during said term; and the George A. Fuller Company agrees to set aside a sum equal to twenty per centum (20%) of the net profits earned by the Wilmington office, of which fifty per centum (50%) or one-half (1/2) is to be paid to said Lorenzo C. Dilks as additional compensation. In arriving at the net profits, the value of the plant shall be ascertained by sale or otherwise, and profit or loss on same to be taken into account. It is understood that the word "earned" shall mean the actual net profits taken into account on the books of the Company during that period and under its customary rules. Settlement of the said ten per centum (10%) additional compensation is to be made in May, 1920, as of April 30, 1920, and in May, 1921, as of April 30, 1921. If any of the profits realized ae represented by mortgage bonds or other securities, which the Company has taken on account of contracts in the Wilmington territory, the">*2690 pro rata proportion thereof may, if the Company so elects, be delivered to said Lorenzo C. Dilks in lieu of cash under this agreement.

This agreement may be terminated by either party upon sixty (60) days' notice in writing, and in such event the amount due said Lorenzo C. Dilks is to be determined by taking the actual amount of the net profits earned on the last day of the month prior to the expiration of the said sixty (60) days' notice, and settlement made thereon on or before the 15th day of the following month. In case no such notice is given by either party, and no change in terms is made by mutual agreement, the same arrangement is to be continued for another year, subject to the limitations herein contained.

This agreement takes the place of and cancels all other agreements, whether written or verbal.

IN WITNESS WHEREOF, said parties have hereunto set their hands and seals the day and year first above written.

LORENZO C. DILKS,

GEORGE A. FULLER COMPANY,

BY PAUL STARRETT, President.

During 1920 the George A. Fuller Co. completed the construction of the eight boats known as Hulls 1446 to 1453, inclusive, in accordance with the terms of its contract">*2691 with the Shipping Board. The boats were delivered to the Shipping Board in 1920.

As work progressed on the vessels the petitioner received reports of the cost of construction from the bookkeeper and entered the totals of such costs on separate cost sheets, each one showing the cost of an individual vessel. Upon the completion of the vessel the sheet showed ">*1297 a total figure which was designated "estimated final cost total." These estimated costs of the 8 boats, the dates of delivery of each boat, the sales price, and the estimated profits made on each boat before any charges on account of distributions to Dilks, Starrett, or other employees, were as follows:

Name and number of boat	Date delivered	Sale price	Cost	Profit per boat
Cranford - 1446	Jan. 17, 1920	$1,944,000	$1,726,465	$217,535
City of Omaha - 1447	Mar. 12, 1920	1,944,000	1,692,794	251,206
Winston-Salem - 1449	Apr. 26, 1920	1,944,000	1,588,277	355,723
City of Joliet - 1448	May 25, 1920	1,944,000	1,751,167	193,833
Nemaha - 1450	July 13, 1920	1,944,000	1,542,392	401,068
City of Fort Worth - 1451	Sept. 2, 1920	1,944,000	1,443,278	500,722
Huybert - 1452	Sept. 27, 1920	1,944,000	1,437,622	506,378
Syros - 1453	Nov. 10, 1920	1,944,000	1,462,888	481,112

">*2692 In August, 1920, the George A. Fuller Co. entered into a contract with the Eagle Oil Transport Co. for the construction and sale of two oil tankers at a price of $1,820,000 per boat. The bulk of the material and parts used in the construction of these boats consisted of the supplies and material taken over by the George A. Fuller Co. at the time it made its contract with the Shipping Board. These boats were delivered in February and March of 1921. The cost of these boats was $1,997,652 and $1,827,800, respectively. Losses were sustained on these boats in the amounts of $177,652 and $7,800, or a total of $185,452.

The George A. Fuller Co. is a corporation engaged principally in building construction. Its construction contracts usually cover a long term. It had adopted the practice of entering on its books the proportion of total profit earned each year which the amount of completed work bore to the total. To that end it kept accurate costs of all work, monthly computations being made of the progress of the work.

At December 31, 1920, the George A. Fuller Co. set up on its books and took into its accounts an estimated profit of $700,000 on account of the eight Government">*2693 boats completed and delivered. This was arrived at by taking as a profit $100,000 on each boat with the exception of Hull 1453, on which no profit was taken.

During the latter part of 1921, the shipyard and the unused material remaining was sold for a sum in excess of $300,000. The final payment of $37,641.65 on account of this sale was not made until March 31, 1922.

During the year 1920 the George A. Fuller Co. paid Dilks various sums in addition to his annual compensation of $20,000. These sums, according to the testimony of Dilks, amounted to $74,703.94. According to the testimony of B. M. Fellows, treasurer of George A. ">*1298 Fuller Co., however, the amount shown on the books of the George A. Fuller Co. as having been advanced to the petitioner during the year 1920 was $72,766.88. This sum was carried by the company as an account receivable.

In the personal account of Lorenzo C. Dilks, as kept by the George A. Fuller Co., it is shown that by May, 1921, there was a debit balance to his account of $82,446.02, representing amounts advanced to Dilks. Between December 31, 1920, and May 1, 1921, there was advanced to the petitioner over and above his salary">*2694 an amount of $9,679.14. This sum is included in the amount of $82,446.02 shown on May 1, 1921, as due from Dilks to the company. On December 30, 1921, the company credited to Dilks' account the sum of $87,500.

Dilks kept his books and filed his returns on a cash receipts and disbursements basis. For the year 1920 he did not include in the return any part of the advances received over and above his salary.

In the petitioner's return for the year 1921 the petitioner did not include as income any amounts received from the George A. Fuller Co. in excess of $20,000 salary but attached to the return a statement reading: "During the year 1921 I received from the George A. Fuller Company the sum of $74,703.94 as a gratuity, and I am informed that the company is reporting it as such."

On November 23, 1921, the George A. Fuller Co. filed an amended return for its subsidiary, the United States Realty & Improvement Co., which contains the following statement:

During the years 1919 and 1920 the George A. Fuller Company made certain payments to its officers over and above their regular yearly compensation which payments were treated as expense in the George A. Fuller Company's part">*2695 of the Consolidated Return of the U.S. Realty and Improvement Company. This deduction made by the Company was evidently in error inasmuch as the officers of the George A. Fuller Company understood that the amounts received were not paid as compensation for services rendered during these taxable years and therefore did not include them in their personal income tax returns. The amounts were clearly deducted in error as they were not ordinary and necessary expenses of the taxable years. Upon discovering that this matter had been erroneously treated in the Corporation's Income Tax Returns, the Directors of the George A. Fuller Company held a meeting at which the original intention was set forth in the minutes and it was ordered that amended returns be made and the correct amount of tax due be paid.

Reference to the statements attached to the individual income tax returns of the officers will show that these payments were not considered as having been made for services rendered during these taxable years and it was not the officers' intention that they be deducted in the Corporation's tax return as they were not proper deductions. Amended return is herewith submitted, together with">*2696 check for amount of tax due.

The Commissioner determined that the sum of $74,703.94 was additional income to the petitioner in the year 1921.

">*1299 OPINION.

VAN FOSSAN: No evidence having been introduced as to the first contention of the petitioner, the alleged erroneous mailing of the deficiency letter, it is considered to be abandoned and we go at once to the merits of the case.

In February, 1920, petitioner and the George A. Fuller Co. entered into a contract of employment by the terms of which the company agreed to pay the petitioner $20,000 per year and 10 per cent of the "net profits earned by the Wilmington office." In the computation of the net profit the value of the shipbuilding plant was to be taken into account and the net profit increased or decreased as the plant value showed profit or loss. The 10 per cent so computed was to be paid as "additional compensation" and settlement was to be made in May, 1920, for the year ending April 30, 1920, and in May, 1921, for the year ending April 30, 1921. There was no provision for partial or pro rata payments.

During the year 1920 the company advanced or paid to petitioner various sums, aggregating for the">*2697 year $72,766.88. During 1921 there was similarly advanced or paid the sum of $9,679.14. The company carried these sums on its books as "accounts receivable." Dilks testified that at the time they were received he considered the payments as loans or advances, some of which he might have to pay back. He also testified that in preparing his tax return for 1920 he did not consider it as income for that year and accordingly made no mention of it in his return. In his return for 1921, filed in March, 1922, Dilks stated he had received in 1921 the sum of $74,704.94 "as a gratuity" and accordingly he did not report it as income.

During 1920 and 1921 the company set up periodically estimated profits earned on each ship and in July, 1921, sold the plant for a sum in excess of $300,000. On December 30, 1921, the company credited petitioner's account with $87,500, being approximately $5,000 in excess of the amount theretofore carried as an account receivable due from Dilks to the company. On November 23, 1921, the company, pursuant to a resolution of its board of directors declaring the payments to its officers and employees to be gratuities, filed an amended return on behalf of a subsidiary">*2698 company, setting forth that the amounts of such payments had been improperly claimed as an expense deduction on its original return. Check in payment of the difference in taxes was enclosed.

Confronted by the contract of employment, by his own adverse characterization of the payments made in 1920 as loans, and by the fact that the company treated them as accounts receivable up to December 30, 1921, it is difficult to conceive how petitioner can now contend, as he does, either that the payments were a gratuity or constituted ">*1300 income in 1920. The first alternative may be readily disposed of. The contract is the best evidence of the intention of the parties; it is clear and unambiguous in language. It provided for the payment of 10 per cent of the net profits as "additional compensation." The single fact that the amount was contingent on the success of the plant operations did not alter the character of the payment when earned and ascertained. The payments to Dilks were not gratuities.

Nor do we believe they were income in 1920. By the terms of the contract he payment was to be a sum equal to 10 per cent of the "net profits earned," in the computation of which">*2699 the profit or loss on the plant was to be considered. Obviously the plant value for such a purpose could not be determined until the conclusion of operations. Further, the settlement was to take place in May of each year for the preceding year. By way of definition the contract states that "earned" profits means "actual net profits" taken into account on the company's books and under its customary rules. The additional compensation depended on the net result of all of the company's activities at the Wilmington plant. These provisions all tend to demonstrate that the payments in 1920 were not payments of the additional compensation provided by the contract. At the time they were made the actual net profits could not be determined. Losses suffered on the Eagle Oil Transport Co. contract were yet to be ascertained and the plant value had not been determined. The books showed only estimated profits. There was no provision for partial payments. We believe petitioner's characterization of the payments as loans or advances which might have to be paid back was peculiarly apt. By treating the payments as accounts receivable, i.e., debts of Dilks due to the company, the company">*2700 expressed its concurrence in the view that they were loans or advances and not payments under the contract. We are of the same opinion. This conclusion disposes of petitioner's alternative contention as to 1920. There remains to consider when, if ever, the payments became income to the petitioner.

As pointed out above, when these sums were advanced to Dilks the company charged them against him and carried the amounts as an account receivable. This treatment obtained throughout 1920 and until December 30, 1921, when the ships being completed, the plant sold and net profits ascertainable, the company credited to Dilks' account the sum of $87,500. As $82,446.02 had already been paid into Dilks' hands as loans or advances, this crediting entry completed the transaction of payment of this amount of additional compensation under the contract. (The difference between the sum credited and the sum advanced, approximately $5,000, was not paid to Dilks until January, 1922.) The account receivable was offset by the credit entry and that which had been a loan or advance was ">*1301 converted into a payment for services. Petitioner being on a cash basis, at that moment the payment">*2701 became income for the year 1921.

Petitioner's return for 1921 shows that no return was made of any amount on account of the additional compensation provided by contract. At this time it was explained away as a gratuity. The evidence before us establishes that $82,446.02 was received in that year. Petitioner's income should be increased by this amount.

At the close of the testimony and before the conclusion of the hearing counsel for the respondent requested the Board to find that the return for the year 1921 was fraudulently made and that a penalty for fraud should be imposed. As indicated above, at the time he filed his return for the year 1921 petitioner made a disclosure of the fact that he had received $74,703.94, which he was not returning as income, claiming the same to have been paid him as a gratuity. Though we have held him to be in error in his characterization and treatment of the sum so received, we are of the opinion that the respondent, on whom rested the burden of proof on this issue, has not established fraud. The disclosure, in our judgment, negatives any intention on the part of the petitioner to file a false and fraudulent return with intent to evade">*2702 tax and, on the contrary, evidences an honesty of belief that the sum received was not taxable. The charge of fraud is disapproved.

Judgment will be entered under Rule 50.