Peninsula Shipbuilding Co. v. Commissioner

PENINSULA SHIPBUILDING CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Peninsula Shipbuilding Co. v. Commissioner

Docket No. 5741.

United States Board of Tax Appeals

9 B.T.A. 189; 1927 BTA LEXIS 2640;

November 21, 1927, Promulgated

---

">*2640 During the years 1918, 1919, and 1920 the petitioner was engaged in building wooden ships for the United States Shipping Board Emergency Fleet Corporation on a cost-plus, fixed-fee basis, the contracts under which the work was being done providing that depreciation of plant and equipment was to be considered an element of cost. The contracts further provided that the cost of extensions authorized by the Emergency Fleet Corporation should be considered as a part of the cost of the plant to be depreciated. The petitioner was unable to get authorization to make certain required extensions of plant but nevertheless made such extensions upon its own responsibility. In the determination of the cost of the ships the Emergency Fleet Corporation made payments to the petitioner for the ships, ignoring its claims with respect to the cost of unauthorized extensions. In 1923 the petitioner entered into a compromise settlement with the Emergency Fleet Corporation by which it recovered from the Government a part of the cost of the extensions above referred to. The petitioner's books of account were kept upon the accrual basis and for the years during which ships were being constructed for the">*2641 United States Government it did not accrue as income any part of its claims against the Emergency Fleet Corporation for the cost of unauthorized plant extensions. In the audit of the petitioner's tax returns for the years 1918, 1919, and 1920 the commissioner added to its gross income pro rata portions of the amounts received by the petitioner from the Emergency Fleet Corporation in 1923. Held, that the amounts received in 1923 were income of that year. Decision in Appeal of Peninsula Shipbuilding Co.,5 B.T.A. 739">5 B.T.A. 739, revised.

C. E. McCulloch, Esq., and Stiles W. Burr, Esq., for the petitioner.

Alva C. Baird, Esq., for the respondent.

---

SMITH

">*190 This is a proceeding for the revision and amplification of the findings of fact in Appeal of Peninsula Shipbuilding Co.,5 B.T.A. 739">5 B.T.A. 739, and for a reconsideration of the case upon the basis of the record already made.

FINDINGS OF FACT.

Petitioner is a corporation organized under the laws of Oregon with its office at Portland. It was organized in 1916 for the purpose of building small wooden vessels as a private enterprise and was so operated until May 15, 1917. ">*2642 On that date it entered into the first of three contracts with the United States Shipping Board Emergency Fleet Corporation for the construction of wooden ships for the Government. The shipbuilding facilities of the plant at that time consisted of two "ways"; that is, facilities for the construction of two ships at a time, and represented a capital expenditure of $110,116.04.

The first contract, above referred, to known as Contract 5-W.C., provided for the construction of four wooden vessels, to be completed under specifications approved by the Emergency Fleet Corporation, the first by February 15, 1918, and the remaining three, one every 30 days thereafter. Pertinent portions of this contract read as follows:

[Art.] II.

[Par. 1] The purchase price to be paid by the Owner is Five hundred thousand Dollars per ship to be paid as hereinafter provided. The Owner, however, guaranties the Contractor a profit of Forty thousand dollars on each completed ship. The Contractor agrees that the Owner may withhold from said purchase price of five hundred thousand dollars per ship any amount over the actual cost of the work plus forty thousand dollars (so that the Contractor's rofit">*2643 on each completed ship shall be limited to forty thousand dollars).

[Par. 2] For the purpose of this contract, the actual cost shall be generally as defined in the United States Revenue Bill of September 6th, 1916, Section 302, insofar as the requirements of said Revenue Bill are applicable to and not inconsistent herewith.

">*191 [Par. 3] The actual cost shall include the following and items similar thereto in principle, provided that all items of overhead or indirect cost included in paragraphs (b) to (e) of this article and all items under paragraphs (f) and (g) shall, as far as possible, be submitted to the Owner in advance for its approval, and no item so submitted in advance and disapproved by the Owner shall be payable to the Contractor. (Italics ours.)

(a) The cost of labor and materials machinery equipment and supplies entering into the building or construction of the vessel and other direct charges, such as insurance on vessels.

(b) A proper proportion of running expenses, including ordinary rentals, cost of repairs and maintenance, light, heat, power, insurance (including liability and compensation insurance), management, salaries and other indirect">*2644 charges.

(c) A proper proportion of interest accrued and paid on debts or loans, contracted to meet the needs of the business and the proceeds of which have been actually used to meet such needs.

(d) A proper proportion of taxes of all kinds accrued and paid with respect to the business or property.

(e) A proper proportion of losses actually sustained in connection with the business, including losses from fire, flood, storm, riot, vandalism, any act of God, acts of war, or other casualties, and not compensated for by insurance or otherwise.

(f) A reasonable allowance, according to the conditions, for depreciation of values of plant and property (account being taken of exceptional depreciation of extensions, increases, and additions to plant and property specially acquired for or devoted to the manufacture or erection of the work or the construction of the vessel under this contract provided the same have not been paid for by the Owner under (g)).

(g) The cost of labor materials machinery equipment and supplies (other than real estate) for the establishment of and extensions increases and additions to plant and property of the Contractor authorized by the Owner specially">*2645 acquired for or devoted to the building or construction of the vessels under this contract and rentals actually paid for such establishments extensions increases and additions authorized by the Owner.

* * *

[Par. 5] Physical property represented by items of cost included in paragraph (g) supra paid for by the Owners shall continue to be Owner's property after termination of this contract, but may be purchased by the Contractor at such termination at a value to be agreed upon.

* * *

Determination of cost.

The determination of the actual cost as above defined shall be made by and under the direction of George W. Goethals as General Manager of the Owner or his successors in such office (herein called the General Manager) and his decision shall (except as hereinafter stated) be binding on both parties. Wherever possible, he will lay down in advance the methods to be followed in ascertaining and determining the actual cost, and where this cannot be done, will act on claims submitted by the Contractor. He will determine methods to be followed by the Contractor in preparing bills and by engineers and auditors, in certifying to them, and will determine the items which">*2646 must be referred for his decision. He will so far as possible determine in advance the ratio of amortization referred to in paragraph (f) supra, and allowances to be made for indirect charges. * * *

[Art.] ">*192 III.

* * *

Orders.

The Owner shall have full control of all orders for materials, machinery equipment supplies and other purchases and commitments made under this agreement (including establishment of extensions increases and additions to plant and property) and all contracts and orders placed by the Contractor may be in the name of the Owner by the Contractor as agent, and it is understood that the Contractor shall assume no pecuniary liability under or by reason of such obligations where made with the written approval of the Owner.

The number and class of men engaged on the work (including establishment of extensions increases and additions to plant and property), the hours of labor, methods of work and terms of employment shall be subject to the approval and direction of the General Manager of the Owner. * * *

[Art.] VIII.

Disputes.

If any doubt or dispute arises as to the meaning or effect of this contract, or the drawings or specifications">*2647 which are a part hereof, or if any discrepancy occurs, the matter shall be promptly referred to the General Manager and his decision in the premises shall be conclusive and binding upon both parties. In case after delivery of a completed vessel to the Owner under this contract (but only in that event) the Contractor shall deem that it is aggrieved by any decision of the General Manager either as to actual cost or as to any disputed matter hereunder of any kind and shall give notice to the Owner to that effect within thirty days after delivery or after final payment by the Owner, such matter shall be determined by a Board which shall consist of three naval architects or engineers or experts to be appointed, one by the Owner, one by the Contractor, and one by the American Bureau of Shipping. Such Board shall within thirty days after submission of such matter to it determine what if any further sum shall be due by the Owner to the Contractor hereunder on account of such delivered vessel and its finding (made by a majority of the Board) shall be conclusive on both parties.

The second contract, known as Contract 172-W.C., dated December 15, 1917, carried substantially the same provisions">*2648 as Contract 5-W.C., and called for the delivery of four ships, the first by November 1, 1918, and the remaining three, one every 30 days thereafter. The pertinent provisions of this contract are as follows:

[Art.] I.

* * * Said vessels are to be constructed under the terms of said contract dated May 15, 1917, and payment therefor is to be made under the terms of said contract, which contract is to govern in all respects in the construction of said vessels and is to be binding upon the parties hereto as if fully set out herein, except in the following particulars:

1. The Contractor agrees to deliver said completed vessels to the Owner afloat at the works of the Contractor at Portland, Oregon, on or before the following dates:

One vessel to be delivered on or before November 1, 1918; and the remaining three vessels to be delivered - one every thirty (30) days thereafter. All four (4) vessels, however, to be delivered prior to February 1, 1919.

">*193 2. The 5th paragraph of Article II, relating to the purchase of physical property represented by items of cost included under subdivision (g) of the 3d paragraph of Article II, is eliminated, and in lieu thereof the">*2649 following is substituted:

The Contractor agrees to purchase and pay for, from its own funds, any real estate or other improvements to the plant authorized by the Owner, providing any are necessary for the construction and completion of the vessels herein contracted for. The Owner agrees to allow the Contractor for the use of said improvements and plant, as a part of the cost of constructing the vessels, at the rate of thirty per cent. (30%) per annum depreciation (exclusive of the cost of grading); if any further additions to plant or equipment are necessary for the construction of the vessels under the contract of May 15, 1917, the Contractor is to pay for the same from its own funds, and the Owner is to allow as part of the cost of constructing the vessels at the rate of thirty per cent. (30%) per annum depreciation upon the plant and equipment so purchased by the Contractor.

3. The 11th paragraph of Article II, relating to payment, is amended to read as follows:

No payment shall be made except upon such certificates as the Owner may from time to time require. Final approval of such certificates by the Owner shall be necessary for the payments.

4. The second paragraph">*2650 of Article III entitled "Orders" is amended to read as follows:

The Owner shall have full control over all orders for material, machinery, equipment, supplies, and all other purchases and commitments made under this contract (including the establishment of extensions, increases and additions to plant and property); and all contracts and orders placed by the Contractor shall be first submitted to the Owner for its approval. Any contracts or orders placed by the Contractor, which have not been first approved by the Owner, shall, in no way, be binding upon the Owner, and the Contractor shall be solely liable therefor. * * *

[Art.] IV.

* * * And PROVIDED FURTHER, That the Owner may, without prejudice to the rights of the Contractor, reserve his decision upon any or all claims for extension until the completion of the vessel, the work in the meantime not to be discontinued or delayed on account thereof. In the event that parties shall not agree as to such extension, such extension shall be determined in accordance with Article VIII of the contract of May 15, 1917. * * *

[Art.] VII.

The Contractor agrees immediately to make a complete inventory of its yard and plant and">*2651 to submit a complete list of all purchases made to date. And the Contractor further agrees that no new purchases shall be made without proper authorization of the Owner; that when said inventory is submitted that the Contractor will submit therewith, in writing, a complete list of all improvements for which the Contractor claims depreciation as a part of the cost, together with full details of each and every item upon said list.

The third contract, known as Contract 437-W.C., was similar to the preceding contract and called for the completion and delivery of four more vessels, the first by April 1, 1919, and the remaining three, one every 30 days thereafter.

">*194 The pertinent provisions of this contract are:

[Art.] I.

Shipyard.

1. The Contractor agrees to maintain upon a suitable site, a complete shipbuilding plant, including unobstructed channel to high seas, office building, shops, building slips, plant equipment and appurtenances, including adequate protection against fire, fencing and other necessary arrangements for protection of the yard and the Owner's interest against trespassers; necessary and proper hygienic and sanitary conditions; which site shall">*2652 be served with ample facilities for the transportation of materials and employees and shall be so located as to have available sufficient housing accommodations for Contractor's employees, all to be satisfactory to the Owner and adequate to insure the construction, completion and delivery of the vessels under the terms and at the time herein provided for.

Launching ways, depth of water, etc.

2. The Contractor shall, subject to the approval of the Owner, at its own expense, provide and maintain adequate shipways and ample depth of water for launching the vessels herein contracted for and for navigating said vessels to the high seas. In case any dredging is required for the launching of the vessels herein contracted for or for the navigation of said vessels to the high seas and the Contractor fails to do such dredging within a reasonable time after being so requested by the Owner, the Owner shall have the right to do such dredging as may be required, the total cost thereof to be deducted from any moneys due or to become due the Contractor.

[Art.] II.

Payment.

1. In consideration of the performance of this agreement by the Contractor, the Owner agrees as follows:

">*2653 The Owner agrees to pay the Contractor the actual cost of each vessel, and a fixed fee to the Contractor for its profit, of Forty Thousand Dollars (40,000) on each completed vessel, such fee being payable to the Contractor when such vessel is delivered to and conditionally accepted by the Owner, except as hereinafter provided in Section 11.

Actual Cost.

2. For the purposes of this contract, the actual cost shall be generally as defined in the United States Revenue bill of September 8, 1916, Section 302, insofar as the requirements of said revenue bill are applicable to and not inconsistent herewith.

The actual cost shall include the following and items similar thereto in principle, provided that all items of overhead or indirect cost included in paragraphs (b) to (d) of this article and all items under paragraphs (e) and (f) must be approved by the Owner.

(a) The net cost of labor and materials, machinery equipment and supplies entering into the building, or construction of the vessels and other direct charges (such as insurance on the vessels.)

(b) A proper proportion of running expenses, including ordinary rentals, cost of repairs and maintenance, light, heat, power, ">*2654 insurance (including liability and compensation insurance) management, salaries, if reasonable, and other indirect charges.

">*195 (c) A proper proportion of interest accrued and paid on debts or loans, contracted to meet the needs of the business and the proceeds of which have been actually used to meet such needs.

(d) A proper proportion of losses actually sustained in connection with the business, including losses from fire, flood, storm, riot, vandalism, any act of God, acts of War, or other casualties, and not compensated for by insurance or otherwise.

(e) A reasonable allowance, according to the conditions, for depreciation of values of plant and property (account being taken of exceptional depreciation of extensions, increases and additions to plant and property specifically acquired for or devoted to the manufacture or erection of the work or the construction of the vessels under this contract provided the same have not been paid for by the Owner under (f)).

(f) The cost of labor, materials, machinery, equipment and supplies (other than real estate) for the extensions, increases, and additions to plant and property of the Contractor authorized by the Owner">*2655 and specifically acquired for or devoted to the building or construction of the vessels under this contract and rentals actually paid for such establishments, extensions, increases and additions authorized by the Owner.

Physical property and unexpired leases represented by items of cost included in paragraph (f) paid for by the Owner shall continue to be the Owner's property after the termination of this contract, but may be purchased by the Contractor at such termination at a valuation to be agreed upon.

Salvage.

All the material, tools, equipment, supplies and appliances purchased for the work to be done hereunder and not used, shall be and remain the property of the Owner, and the amount realized from the sale or other disposition thereof, and the salvage value of all tools, belting, hose and similar articles, as well as of all scrap and waste, containers, etc., shall be the Owner's and credited to its account.

[Art.] XV.

Additional Plant Protection.

In addition to the precautions that have heretofore been taken by the Contractor for the guarding and protection of its plant, and of the work being carried on therein, the Contractor shall, at the Owner's cost, ">*2656 provide such additional watchmen, guards, and devices for the protection of its plant and property and of the work in progress for the Owner against fire, espionage and acts of war, and any damage or delay that might result therefrom as may be required by the Owner, and the Contractor further agrees, at its own expense, to promptly comply with all instructions given it by the Owner in regard to the management and conduct of its fire protection, watching and guarding systems. Or the Owner, at its option, may furnish and install such devices. Should the Owner install such devices and fixtures although affixed to the realty they shall be and remain the Owner's property, with the right to remove the same upon the termination of this contract. The Contractor shall have the right to purchase such fixtures and improvements upon the completion of the contract on the basis of cost to the Owner, less a reasonable allowance for depreciation, if any. If the price cannot be agreed upon, if shall be determined by arbitrators appointed in the manner provided for in Article VI. In the event the Owner installs the fixtures or improvements or pays the cost thereof, the Contractor agrees that it">*2657 will execute such chattel mortgage, bill of sale, or other instrument which may be recorded, for the purpose of protecting the Owner's right and title in and to the property so furnished or paid for by it.

">*196 [Art.] XXII.

Payments hereunder shall be made by the Owner by check addressed to the Contractor by mail at Portland, Oregon.

It is understood and agreed that the items of cost, charges and depreciation contained in the letter dated May 28, 1917, addressed to F. C. Knapp (of the Contractor) and signed by George W. Goethals, General Manager of the Owner, shall not enter into or form a part of the actual cost as provided in Article II of this contract for the vessels to be constructed under this contract.

Under each contract the builders were guaranteed a profit of $40,000 per vessel over and above the cost as defined by the respective contracts. Work under the first contract was begun immediately after its execution. It was necessary in the beginning to make extensive additions to the plant. In order to carry on the construction of four vessels simultaneously the plant had to be enlarged to a "four-way" plant. The periods over which these additions were">*2658 made and the costs thereof were billed as follows:

Period	Amount
April 6, 1917, to December 31, 1917	$87,252.55
Jan. 1, 1918, to November 14, 1918	59,228.99
Total additions to November 14, 1918	146,481.54
Nov. 14, 1918, to December 31, 1918	27,227.77
Jan. 1, 1919, to December 31, 1919	11,462.32
Jan. 1, 1920, to June 30, 1920	8,167.58
Total additions to June 30, 1920	193,339.21

One vessel had been completed and delivered and the other 11 were in various stages of construction when the Armistice was signed. Soon thereafter, notice to suspend work on the unfinished vessels was issued and the contracts declared canceled. Later the contracts were extended so as to allow completion of all 12 of the vessels, the specifications for the last two being changed to provide for saving equipment and the price therefor being reduced from a profit of $40,000 to a profit of $20,000 on each. All the work was completed in 1920 and the plant shut down in that year. In 1921 it was sold for $30,000, which was its salvage value. Both the petitioner and the Emergency Fleet Corporation had realized when work on the Government contracts was begun that the shipyards would">*2659 have only a salvage value after the completion of the Government contracts.

Although amounts spent by the petitioner for additions to plant from April 6, 1917, to June 3, 1920, aggregated $193,339.21, only a small portion of these expenditures was ever approved in advance by the Emergency Fleet Corporation. Repeated requests for such approval were made to the district representatives of the Emergency Fleet Corporation and to headquarters in Washington, D.C., but they were for the most part denied. The petitioner made repeated claims for additional depreciation on prewar plant and for depreciation on ">*197 unauthorized additions to plant and continued to make claims therefor until it obtained final settlements under its contracts in 1923.

At no time during 1917, 1918, 1919, 1920, or thereafter did the Emergency Fleet Corporation authorize any plants, establishments, extensions, increases or additions under paragraph 3(g) of Article II of Contract 5-W.C. or under paragraph 2(f) of Article II of Contract 437-W.C., nor did it ever at any time advance funds to petitioner for such plants, establishments, extensions, increases or additions to plant or approve expenditures therefor">*2660 or otherwise at any time proceed under or exercise any rights which it had under said provisions of the contracts.

Under date of May 28, 1917, F. C. Knapp, president of the petitioner, received a letter from George W. Goethals, general manager for the Emergency Fleet Corporation, which provided as follows:

DEAR SIR:

Referring to your contract WC 3, dated May 15th, and to your memorandum of same date of certain charges in connection with the business of the Peninsula Shipbuilding Company which you desire to be taken into account from May 15th, as a part of fixed charges mentioned in the contract, I beg to confirm the oral approval given when you were in Washington for these charges as follows:

Land rent		$9,000
Dock rent		5,000
Administration and Management:
President	$10,000
Secretary	5,000
Assistant Secretary	3,000
Manager	6,000
Buyer	4,000
Superintendent	4,000
		32,000
New York Office		24,000
		70,000

For depreciation 30% of cost of plant.

It is understood, of course, that these charges are not to be billed against the cost of the vessels in question unless they are actually incurred.

As regards the charges for the New">*2661 York Office it is understood that these are based on a contract entered into with your New York Representatives on a percentage basis; that the percentage is one-half or less than the usual commission and that the basis of the $24,000 charges is six vessels per annum at $4,000. As regards the depreciation for the cost of the plant it is understood that this is based on your expression that upon the conclusion of contracts for the Emergency Fleet Corporation there will be no profitable business remaining for your company, and that, therefore, the entire cost of the plant will have to be absorbed within practically three or four years from the time it was purchased. This, of course, is a matter which is subject to adjustment upon the conclusion of the Corporation's contract in case the conditions at that time do not accord with your expectations, as stated herein above.

Very truly yours,

GEO. W. GOETHALS,

General Manager.

">*198 The Emergency Fleet Corporation allowed during the years 1918, 1919, and 1920, as depreciation or obsolescence of plant in computing the cost of the twelve vessels under the terms of the contracts, a total of $50,236.99. The total claimed">*2662 for plant depreciation from the Emergency Fleet Corporation amounted to $249,012.53. This claim was adjudicated by the Claims Commission of the United States Shipping Board on February 3, 1923, and was allowed for a total amount of $200,000, less $50,236.99 theretofore allowed. The additional payment made to the petitioner in 1923 was $149,763.01. Said allowance covered depreciation of both prewar plant and war plant indiscriminately and without segregation.

At the time of payment the petitioner and the United States Shipping Board, acting by the said Emergency Fleet Corporation, executed a settlement agreement which was in words and figures as follows:

SETTLEMENT AGREEMENT AND RELEASE AFFECTING CONTRACTS 5 W.C., 172 W.C. AND 437 W.C. - PENINSULA SHIPBUILDING COMPANY, PORTLAND, OREGON. SERIALS 3165, 3432 AND 3437.

AGREEMENT entered into this 8th day of February, 1923, between PENINSULA SHIPBUILDING COMPANY, a corporation organized and existing under the laws of the State of Oregon, party of the first part, and UNITED STATES SHIPPING BOARD, acting as such and also on behalf of the United States of America, for United States Shipping Board Emergency Fleet Corporation, a corporation">*2663 organized and existing under the laws of the United States of America, for the District of Columbia, hereinafter referred to as the Fleet Corporation, party of the second part, WITNESSETH:

WHEREAS, heretofore the Fleet Corporation entered into three agreements in writing with the party of the first part, known as contracts 5 W.C., dated May 15, 1917, 172 W.C., dated December 15, 1917, and 437 W.C., dated October 8, 1918, for the construction of certain wood cargo carrying vessels of the character and on the terms in said contracts set forth; and

WHEREAS, in the performance of said contracts the party of the first part incurred certain disbursements for war taxes on railroad freight bills and for traveling expenses of the president of the party of the first part, in connection with ship construction, and certain losses by way of depreciation of plant and equipment; and

WHEREAS, the party of the first part has filed with the United States Shipping Board its three claims arising out of the foregoing matters in the sums of $521.65 for war taxes, $2705.02 for traveling expenses and $249,012.53 for plant depreciation, making a total claim on account of the three aforesaid contracts">*2664 of $252,239.20; and

WHEREAS, on February 3, 1923, the Claim Commission of the United States Shipping Board, after due deliberation, recommended allowance of the aforesaid claims in the amounts of $521.65, $2705.02 and $200,000.00, respectively, or a total allowed amount of $203,226.67, less $50,236.99 heretofore paid on account, or a net award of $152,989.68; and on February 7, 1923, the United States Shipping Board duly approved, ratified and confirmed the aforesaid recommendation; and

">*199 WHEREAS, the party of the first part has agreed to accept the said net award in full and final compromise and settlement of its said claims.

Now, THEREFORE, in consideration of the premises and the mutual covenants herein contained and of other good and valuable consideration, it is agreed between the parties hereto as follows:

FIRST

The Fleet Corporation, upon the execution and delivery of this agreement, will pay to the party of the first part the sum of $152,989.68.

SECOND

The party of the first part agrees to accept the said sum in full and final settlement and adjustment of its said three claims above described and does further covenant and agree to release and forever">*2665 discharge and by these presents does release and forever discharge and agree to hold harmless the party of the second part and United States Shipping Board Emergency Fleet Corporation and the United States of America from any and all claims, damages, causes of action, suits and charges of whatsoever kind and nature that it had, or has or may have against them or any of them arising out of the aforesaid contracts, or in any manner therewith connected.

THIRD

This agreement shall be executed in triplicate and the respective originals shall be known as Parts I, II and III. Parts I and III shall be delivered to the party of the second part and Part II to the party of the first part.

IN WITNESS WHEREOF, the parties hereto have caused this agreement to be executed by causing the same to be signed respectively by duly authorized officers of the party of the first part and of the Fleet Corporation, acting for the party of the second part as aforesaid, and by causing the corporate seals of the said party of the first part and of the Fleet Corporation to be hereunto affixed, duly attested, on the day and year first above written.

The petitioner kept its books of account on the accrual">*2666 basis. It reported the $50,236.99, allowed by the auditors as obsolescence of plant from November 14, 1918, to June 30, 1920, as having accrued - $3,100.66 in 1918, $27,998.58 in 1919, and $19,236.75 in 1920. These amounts were included in the gross income shown on the income-tax returns filed for those years. No part of the claim against the Emergency Fleet Corporation for additional depreciation or obsolescence not approved by the district auditors was set up as accrued income on the petitioner's books for the years 1918, 1919, and 1920.

In his computation of tax liability for the years 1918, 1919, and 1920 the Commissioner allowed the deduction of $17,999.53 for depreciation for the period January 1, 1918, to November 14, 1918. He determined that the depreciated cost of plant and facilities as of November 14, 1918, was $218,268.60. To the depreciated cost at that date the Commissioner added the cost, as determined by him, of the additions made to the plant over the period November 14, 1918, to June 30, 1920, amounting to $46,857.67, giving a total of $265,126.27. ">*200 That amount less salvage, $30,000, the Commissioner allowed as obsolescence for 1918, 1919, and">*2667 1920 in the amounts of $16,754.36, $146,625.91 and $71,746, respectively.

In his audit of the petitioner's returns for the years 1918, 1919, and 1920, the Commissioner added to the gross income reported by the petitioner, $8,948.34 for 1918; $83,467.42 for 1919; $57,347.25 for 1920, the sum of these being the additional amount for depreciation received by the petitioner in 1923 from the Emergency Fleet Corporation in compromise of its claim for plant depreciation. This amount was apportioned to the income over the three years in the same ratio that the $50,236.99 depreciation allowed by the Emergency Fleet Corporation was apportioned to the deduction.

OPINION.

SMITH: In the letter addressed to the petitioner under date of May 26, 1925, the respondent determined deficiencies in tax against the petitioner for the years 1918, 1919, and 1920 in the aggregate amount of $117,706.70. In his letter he stated:

It is further held * * * that you are entitled to deductions from income on account of obsolescence actually sustained, since there was a definite determination on your part on or about November 15, 1918, that at a future time reasonably susceptible of definite determination, ">*2668 your plant would have no useful value, and would therefore be abandoned. The latter date in your case was June 3, 1920. This is in accordance with the contention of your representative as stated at the oral hearing on your case.

In view of the foregoing the following adjustments have been made:

(1) Depreciation at 10% on cost of plant and equipment has been allowed for the period January 1, 1918 to November 15, 1918.

(2) The depreciated cost of all plant and equipment on hand as at November 16, 1918, less adjustment for salvage, has been spread ratably over the period November 15, 1918 to June 3, 1920 and allowed as obsolescence.

(3) The cost of plant and equipment acquired subsequent to November 16, 1918, in order to carry out your contracts with the U.S. Shipping Board, less adjustment for salvage, has been spread ratably over the period from date of acquirement to June 3, 1920, and allowed as obsolescence.

(4) The amount of $200,000.00 allowed by the United States Shipping Board, on account of depreciation of plant, has been included in income for the years 1918, 1919, and 1920, apportioned to each year on the basis of the amount of depreciation chargeable to the">*2669 boats completed within the year, at the rates of 30% for the first two contracts and 20% for the third contract.

In its petition to this Board the petitioner alleges as error on the part of the respondent as follows:

(a) The Commissioner of Internal Revenue erred in including in income for the years 1918, 1919 and 1920, the sum of $149,763.01 received by the taxpayer in 1923 from the United States Shipping Board Emergency Fleet Corporation in compromise settlement of a larger amount claimed by the taxpayer to be due, which claim of the taxpayer was disputed and denied in toto by the United States Shipping Board Emergency Fleet Corporation during all of the years ">*201 1918, 1919 and 1920, and was not determined or liquidated until 1923, in which year it was paid to the taxpayer.

(See paragraph (4) on page one of the Statement attached to the deficiency letter of May 26, 1925, where it is said:

"(4) The amount of $200,000 allowed by the United States Shipping Board, on account of depreciation of plant, has been included in income for the years 1918, 1919, and 1920, apportioned to each year * * *.)"

(b) The Commissioner of Internal Revenue erred in determining that">*2670 there is now due from the taxpayer for the years 1918, 1919 and 1920 income and profits taxes in the sum of $117,706.70 or any sum whatsoever in excess of approximately $12,000.

In his answer to the petition the respondent denied that the Commissioner erred in determining the taxpayer's tax liability for the years 1918, 1919, and 1920.

At the hearing of this appeal counsel for the respondent stated as follows:

Mr. LOVELESS: May it please the Board, the question involved in this case is one of the utmost importance. The taxpayer had three contracts with the Government for the erection of ships. These contracts, or copies of them, have been stipulated and will be offered in evidence. Under these contracts it was explicitly provided that the depreciation should constitute a part of the cost of the ships to be borne by the United States Government.

The taxpayer over the years 1918, 1919 and 1920 was allowed by the representatives of the Government in its plant the amount of $50,236.99 as depreciation on the plant. The taxpayer was not satisfied with that allowance and the deposition shows and so will the contract that that allowance was not final.

The taxpayer filed with">*2671 the Shipping Board the claim for depreciation, totaling some $249,000. In 1923 that claim for two hundred and forty-nine odd thousand dollars was allowed by the Government for $200,000; that included the $50,236.99 that was previously allowed, leaving a difference of $149,763.01. Now the taxpayer's attorney in his opening statement raised the question of whether or not that constituted income in the years 1918, 1919 and 1920 or 1923 when it was paid.

Mr. SMITH: Just one point. What constituted income, the $149,000?

Mr. LOVELESS: Yes. Now get this straight. The $149,763.01, not the $200,000, which represents the total, never constituted income at any time. It was simply a repayment by the United States Government of cost which it was obligated under the contract to bear, which had previously been borne by this taxpayer in the years 1918, 1919 and 1920.

The Commissioner is merely throwing back into the cost of the years 1918, 1919 and 1920 these amounts, because the Commissioner said that they were the years in which the costs were incurred in the construction of the ships, and therefore those were the years in which it should be reflected in the accounts of the taxpayer.

">*2672 To put this in the year 1923 would be to say that this constituted income in the year 1923. It never constituted income.

At the time that the petitioner entered into its first contract with the United States Shipping Board Emergency Fleet Corporation on May 15, 1917, it had a shipbuilding plant which represented a capital expenditure of $110,116.04. To carry out its contract with the Emergency ">*202 Fleet Corporation it was necessary for it to enlarge its plant. The total additions made to its plant from April 6, 1917, to June 3, 1920, at which time it completed its contracts with the Government and finished active operations, cost $193,339.21. At the time the contracts were entered into it was the expectation of the petitioner that the Government would bear the cost of necessary additions. This was in accordance with its understanding of the terms of the contract. The auditors of the Emergency Fleet Corporation refused, however, to sanction the extensions deemed to be necessary by the petitioner with the result that the petitioner made such extensions at its own expense. Only a small part of the extensions made by the petitioner was authorized by the Emergency Fleet">*2673 Corporation in advance of the making of such extensions and was paid for during the years 1918, 1919, and 1920. It was contemplated by all parties concerned that any depreciation allowable with respect to the plant should be spread over the period of operations of the petitioner on the war contracts. It was fully appreciated by all that the plant would have only a salvage value upon the completion of such contracts.

The petitioner made claim for greater amounts for depreciation than were allowed by the Emergency Fleet Corporation. This depreciation related not only to the war plant investment items but also to prewar plant investment items. There was also in dispute in certain instances the correct rate to apply to certain items which were added by the Emergency Fleet Corporation. These items were in dispute during the taxable years and were not settled until 1923.

In the determination of the deficiencies herein involved the respondent spread the cost of the prewar plant and of the war plant over the tax years herein involved in a manner satisfactory to the petitioner. He added to the gross income of each of the years, however, prorated portions of the additional allowance">*2674 made by the Emergency Fleet Corporation to the petitioner in 1923 in the amount of $149,763.01, adding to the gross income of 1918, $8,948.34; of 1919, $83,467.42; and of 1920, $57,347.25. These additions to gross income had the effect of increasing the net income in like amounts. The petitioner objects to such additions to gross and net income for the tax years in question and insists that the amount of $149,763.01 in question was income of the year 1923; that the respondent was in error in adding to the gross income of the tax years in question the amounts above stated and that the deductions from gross income allowed for those years by the respondent in his deficiency letter for depreciation and obsolescence were correct.

The applicable provisions of the taxing statutes are as follows:

That in the case of a corporation subject to the tax imposed by section 230 the term "net income" means the gross income as defined in section 233 less ">*203 the deductions allowed by section 234, and the net income shall be computed on the same basis as is provided in subdivision (b) of section 212 or in section 226. (Section 232, Revenue Act of 1918.)

(b) The net income shall be">*2675 computed upon the basis of the taxpayer's annual accounting period * * * 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 upon such basis and in such manner as in the opinion of the Commissioner does clearly reflect the income. * * * (Section 212, Revenue Act of 1918.)

(a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:

* * *

(7) A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence;

(8) In the case of buildings, machinery, equipment, or other facilities, constructed, erected, installed, or acquired, on or after April 6, 1917, for the production of articles contributing to the prosecution of the present war, and in the case of vessels constructed or acquired on or after such date for the transportation of articles or men contributing to the prosecution of the present war, there shall be allowed a reasonable">*2676 deduction for the amortization of such part of the cost of such facilities or vessels as has been borne by the taxpayer, but not again including any amount otherwise allowed under this title or previous Acts of Congress as a deduction in computing net income. * * * (Section 234, Revenue Act of 1918.)

We will consider first the question whether claims made by the petitioner against the Emergency Fleet Corporation for depreciation as an element in determining the cost of the vessels built during the taxable year were accruable items. In numerous appeals the Board has held that disputed and contested claims not set up on the books of account of taxpayers are not accruable items of income or deductions therefrom until the year of actual settlement. In Appeal of Brighton Mills,1 B.T.A. 392">1 B.T.A. 392, we said:

An alleged liability of the taxpayer in 1920 for a failure to fulfill a condition precedent to the other party's performance of a contract must be clearly established and must be then recognized by the parties in order to result in an accrued deductible loss in the year of such alleged breach. The bringing of suit in 1922 and payment in settlement in 1923 do not under">*2677 the circumstances of the record entitle the taxpayer to deduction of loss in 1920.

To the same effect see Citizens Trust Co. of Utica,2 B.T.A. 1239">2 B.T.A. 1239; Coghlin Electric Co.,3 B.T.A. 1071">3 B.T.A. 1071; Russel Wheel & Foundry Co.,3 B.T.A. 1168">3 B.T.A. 1168; New Process Cork Co.,3 B.T.A. 1339">3 B.T.A. 1339; Bump Confectionery Co.,4 B.T.A. 50">4 B.T.A. 50; Lane Construction Corporation,4 B.T.A. 1133">4 B.T.A. 1133; Empire Printing & Box Co.,5 B.T.A. 203">5 B.T.A. 203; Gopher Granite Co.,5 B.T.A. 1216">5 B.T.A. 1216; Frank J. Jewell,6 B.T.A. 1040">6 B.T.A. 1040; Great Northern Ry. Co.,8 B.T.A. 225">8 B.T.A. 225.

From the evidence of record petitioner had no certainty of ever receiving from the Emergency Fleet Corporation any part of the ">*204 claims which it was making against it for depreciation. The auditors working on the case steadfastly refused to grant the claims of the petitioner and the denial of such claims was confirmed by superior officers. We are of the opinion that no portion of the amount of $149,763.01 was income of the taxable years involved in this proceeding.

The question next arises as to whether the Board">*2678 was in error in its former opinion in holding that these were claims for amortization under subdivision (8) of section 234(a) of the Revenue Act of 1918 and as such, subject to adjustment in the light of the settlement of the claims in 1923. (See section 234(a) of the Revenue Act of 1924.) The contracts between the petitioner and the Emergency Fleet Corporation did not provide for any deduction for amortization of war facilities. They simply provided for depreciation. The respondent has not found that the deductions were for amortization. The amounts allowed as deductions for the taxable years were allowed as depreciation and obsolescence and were allowed under subdivision (7) of section 234(a) of the Revenue Act of 1918. The allowances would have been made if there had been no provision in the statute for an allowance for amortization. This is upon the understanding reached by the petitioner and the Emergency Fleet Corporation that the plant would have only a salvage value upon the termination of the war and completion of the contracts.

The allowance for amortization contained in subdivision (8) of section 234(a) of the Revenue Act of 1918 is a special provision giving relief">*2679 in a particular class of cases. The claims made by the petitioner against the Emergency Fleet Corporation were, as stated above, not only for depreciation on the war plant but also upon the prewar plant. The allowance finally made by the Emergency Fleet Corporation was not specifically for depreciation upon the war plant but was in settlement of all claims made by the petitioner for depreciation on both the war plant and the prewar plant. We are therefore of the opinion that the settlement of this case in no wise involves section 234(a)(8) of the Revenue Act of 1918.

We now come to the question as to whether in the determination of a reasonable amount for the allowance of depreciation and obsolescence of plant the amounts determined by the respondent in his deficiency letter to this petitioner should in any wise be reduced by reason of the fact that in 1923 the Emergency Fleet Corporation allowed a larger amount for depreciation than it had been willing to allow during the taxable years. It has been argued by the respondent that the allowance for depreciation and obsolescence should be based upon the cost of the plant to the petitioner and that the cost of the plant should be">*2680 reduced by the reimbursement made to the petitioner in 1923. We are of the opinion, that the allowable deductions ">*205 for depreciation and obsolescence should not be made to depend upon the settlement made with the petitioner by the Emergency Fleet Corporation in 1923. The cost of both the prewar plant and the war plant was borne by the petitioner in the first instance. Title to the plant always remained in the petitioner. This is evidenced by the fact that it was the petitioner which sold the plant in 1921, and that it did not account to the Emergency Fleet Corporation for any part of the proceeds of the sale. We therefore think that the reasonable allowance for depreciation and obsolescence for the tax years involved should not be reduced by the amount paid to it by the Emergency Fleet Corporation in 1923.

The amount of $149,763.01 received by the petitioner from the Emergency Fleet Corporation in 1923 was income of 1923, and did not affect its taxable income for prior years.

The opinion in this case, 5 B.T.A. 739">5 B.T.A. 739, is revised accordingly.

Reviewed by the Board.

Judgment will be entered on 15 days' notice, under Rule 50.

VAN FOSSAN and MILLIKEN">*2681 did not participate.

STERNHAGEN and MURDOCK concur in the result only.

PHILLIPS dissents.