DocketNumber: Docket No. 12678-78.
Citation Numbers: 43 T.C.M. 241, 1981 Tax Ct. Memo LEXIS 7, 1981 T.C. Memo. 742
Filed Date: 12/31/1981
Status: Non-Precedential
Modified Date: 11/20/2020
MEMORANDUM FINDINGS OF FACT AND OPINION
RAUM,
FINDINGS OF FACT
Some of the facts have been stipulated. The stipulation of facts and related exhibits are incorporated herein by this reference.
Petitioner is a Florida corporation with its principal office in Miami, Florida. It maintains its books and records on the accrual basis of accounting. By means of an oral contract, petitioner agreed to construct, and did construct, a combination showroom, warehouse, and office facility for Continental Equities, Inc. (Continental). Continental is "owned" 50 percent by Tom Maxey and 50 percent by William C. Webb, petitioner's sole shareholder.
*9 The building was constructed explicitly for the use and occupancy of Levitz Furniture Co. of Florida (Levitz), which entered into a long-term written lease with Continental. Levitz provided the plans and specifications for construction of the building, as well as the construction financing, and cost overruns were to be borne by Levitz. The terms of the lease disclose that Levitz had significantly greater rights and obligations in respect of the property than those of an ordinary lessee. The initial term of the lease was 30 years, and Levitz was given renewal options by which it could extend its occupancy for an additional 20 years. Included in the lease was a clause for escalation of the rent at five-year intervals in accordance with a formula pegged to the Consumer Price Index. The lease was termed "absolutely net to [Continental]", which apparently meant that the yield to Continental was the stated rent free of any cost of repair, maintenance, or operation of the property. In this regard, Levitz promised to keep the property in good repair and return the property in like condition at the termination of the lease. Any expense incurred for major repairs was to be borne by*10 Levitz. Levitz was required to maintain insurance against damage from fire and other causes, and Continental agreed to pay for repair of any resulting damage only to the extent that it received the proceeds from such insurance.
On May 9, 1973, a portion of the roof and supporting walls of the building collapsed, resulting in substantial damage to the building. The collapse was occasioned by an unusually heavy rainfall and windstorm. Petitioner determined that the collapse was due to latent defects in the welds of the roof joists which gave way under the highly abnormal weather conditions. Petitioner had purchased the roof joists from a jobber, Electric Steel Products, Inc., which in turn had obtained them from Congaree Iron and Steel Co. Petitioner commenced repairs at the request of Levitz, but ceased work when Levitz refused to pay petitioner's initial invoice for the work. The charges for that initial work were some $ 30,000, and are not involved in this case. Levitz then completed the repairs at a total cost to it of $ 563,522.
Petitioner held a special meeting of its board of directors on April 19, 1974. Present at the meeting were Robert A. Shupack, counsel to petitioner; *11 Myles Klein, petitioner's C.P.A.; and the three directors of petitioner, William C. Webb, Tom Maxey, and H. Ted Webb. The minutes describe the proceedings as follows:
The Chairman requested a financial report from Mr. Klein and his pencilled, informal and unaudited opinion as to the Corporation's profit and loss statement for the fiscal year ending April 30, 1974. Mr. Klein orally gave same and pointed out that the profit sharing contribution was due to be reflected on the books of the Corporation no later than the end of its said fiscal year. Mr. Klein further stated that because the Corporation anticipated a loss for said fiscal year it was questionable whether a profit sharing contribution could be made.
The Chairman then requested a report relative to the collapse of the Levitz Warehouse roof which occurred on May 9, 1973.
It was reported that M.R. Harrison had completed repairs to the Levitz building and that the cost thereof was $ 563,522. Since liability insurance is unavailable to cover the repairs to the Levitz building this obligation for payment will have to be undertaken by the Corporation. It was stated that such was the opinion of Reginald L. Williams, Esquire. *12 It was stated that the Corporation's insurance carriers were Maryland Casualty and American Home Insurance Company.
Mr. Shupack then stated that because the aforesaid liability was ascertainable, all events fixing total liability had occurred and that liability was uncontested based upon the doctrine of vicarious liability that
The Chairman then recommended that the Corporation accrue on its books and on its Tax Return the Levitz loss in the amount of $ 563,522.
Thereupon, on a motion duly made, seconded and unanimously carried the following Resolution was adopted:
RESOLVED, that the Corporation accrue on its books and Tax Return on or before the end of the fiscal year the loss emanating from the collapse of the Levitz Warehouse roof in the amount of $ 563,522.
Petitioner accrued a cost of sales deduction in the amount of $ 563,522 on its tax return for the fiscal year ended April 30, 1974, claiming this amount represented petitioner's ascertainable liability for the cost of repairs to the building. This amount was*13 determined by reference to actual amounts expended by Levitz (primarily through M. R. Harrison), and the parties agree that, if otherwise deductible in fiscal 1974, the amount claimed ($ 563,522) is correct.
Petitioner did not accrue this amount as a loss on its books at year end, because the decision was made not to reflect a loss from the collapse on petitioner's financial statements for this period. 1 At no time was an entry made on the books of Continental to reflect either a reduction in the value of the building or a receivable from petitioner with respect to the damage to the building. Continental was a cash basis taxpayer, but this fact was entirely irrelevant in respect of the propriety of including a debt owed to it as an asset on its balance sheet.
On or about May 7, 1975, Levitz sued petitioner, William C. Webb, Continental, and other defendants in Dade County, Florida, Circuit Court.The complaint alleged that Webb Construction expressly*14 warranted to Continental that the work would be of good quality, that Webb breached this warranty, and that Levitz was a third party beneficiary of the warranty. The complaint also alleged that Webb Construction breached its implied warranties with respect to the building, and was negligent in the construction of the building. In its answer, petitioner denied these allegations 2 and stated several affirmative defenses, including the claim that the collapse occurred due to an "act of God". At the time of trial of this case, the Levitz litigation was on appeal from a summary judgment in favor of Continental on a counterclaim for rent withheld by Levitz.
*15 From the date of the collapse to the time of trial in this case, petitioner had not paid any amount to Continental, Levitz, or any other party in respect of the $ 563,522 expended by Levitz for repairs to the building.
The examiner of petitioner's fiscal 1974 tax return apparently proposed an adjustment disallowing the deduction for the accrued liability on the ground that the liability was not fixed at the close of the year. Petitioner protested this adjustment, in a memorandum verified under penalty of perjury by its president, claiming that "the deduction represented an accrual of liability for reimbursement
OPINION
The issue for decision is whether, under the petitioner's method of tax accounting, the liability for loss from the collapse is properly deductible in the taxable year ended April 30, 1974.
[A]n expense is deductible for the taxable year in which all the events have occurred which determine the fact of the liability and the amount thereof can be determined with reasonable accuracy.
This so-called*17 "all-events test" is actually two separate tests: the deduction is permitted only when the existence of the liability is definitely fixed and the amount thereof is reasonably determinable. No issue has been raised as to the latter requirement, for the parties have stipulated that, if properly deductible, the amount shown on the taxpayer's return is correct. Thus, it is only the "fact of the liability" which concerns us.
Petitioner contends that occurrence of the collapse, Levitz's repair of the building, and alleged admission of its own liability to Continental in the amount paid by Levitz, all within the taxable year, should be sufficient to establish deductibility of the loss in the year ended April 30, 1974. The Government disputes petitioner's claim that petitioner's liability
According to petitioner, the basis of its liability to Continental was for breach of its contract for construction of the building. In a series of early cases, the Board of Tax Appeals wrestled with the issue of when a*18 liability for breach of contract is sufficiently established to justify a deduction. In general, the cases seemed to turn on whether the taxpayer had admitted the liability to the injured party and whether the liability was accrued on the taxpayer's books. Compare
[A] loss occasioned by the taxpayer's breach of contract is not deductible in the year of the breach, except under the special circumstances where, within the tax year, there is a
The Court explained further the rationale for requiring the taxpayer*19 to meet this standard, distinguishing between the mere breach and actual realization of the loss: "For, even an unquestionable breach does not result in loss, if the injured party forgives or refrains from prosecuting his claim".
Petitioner argues that in the absence of a previous denial of liability, such as by judicial contest or express repudiation, the requirement of admission i superfluous and unrealistic. We cannot agree. The taxpayer has the burden of proving that the asserted liability was in fact uncontested. The presence of an admission, express or implied, serves as direct proof that the taxpayer was not contesting liability. * * * A taxpayer may resist payment of an asserted claim in more subtle ways than express denial of liability or adoption of a litigious attitude.
Thus, it is incumbent upon petitioner to show that liability to Continental was admitted within the taxable year.
As to accrual of the loss on the books, we have found as a fact*20 that the accrual was made for tax purposes only and not for book purposes. We have no doubt that a conscious decision was made by the accountant responsible for compiling petitioner's financial statements to treat this item in a contradictory fashion, at once accruing the loss for the tax return and postponing recognition of it on the income statement and balance sheet. Whether this inconsistency alone 3 would be sufficient to preclude the deduction, even though liability were admitted, is a question we need not address, for we find that petitioner has failed to carry its burden of proof as to admission of the liability. Since petitioner has therefore failed to satisfy essential requirements for establishing the deduction, we hold for the Government.
The resolution passed at the special*21 meeting of petitioner's board of directors cannot, standing alone, qualify as a "definite admission of liability"
*22 Petitioner contends that, both before and at the special meeting, demand was made by Mr. Maxey (on behalf of Continental) that petitioner pay for the cost of repairs to the building, and that at the meeting Mr. Webb (on behalf of petitioner) did agree to pay. While the testimony of these two directors of petitioner supports such a contention, we do not find the statements of such obviously interested witnesses to be convincing in the context of this case, and they are insufficient to carry petitioner's burden of proof. We heard that testimony and did not find it credible. As noted above, Mr. Shupack, an independent witness, failed to corroborate this assertion of a clear admission of liability being made to continental (via Mr. Maxey, present as a director of petitioner) at the meeting. In addition, the other independent witness, Mr. Klein, indicated that the relevant discussion at the meeting was not in terms of liability solely to Continental, but that liability to Levitz and other parties was discussed as well. Indeed, it was Mr. Klein who prepared the protest letter which spoke, as late as 1977, of liability
*24 A further consideration casting doubt upon the existence in fact of any explicit unconditional admission of liability to Continental is the history of petitioner's pleadings in this very case. In its original verified petition in this Court petitioner sought to accrue the liability in question as a debt owed
Petitioner's position * * * has undergone radical changes during this litigation. * * * Petitioner, of course, was entitled to revise her contentions in her amended petition, but to the extent that they represent a new and inconsistent presentation of basic facts, it is appropriate to examine her present allegations with particular caution.
An appreciation of the unhappy consequences of petitioner's original position undoubtedly led to the filing of the amended petition in which an entirely different version of the transaction is set forth. * * * We do not agree that the new look can successfully change the old result.
The purpose of requiring an admission of liability is to bridge the gap between an "unquestionable breach" and actual loss. 7 Here, despite petitioner's "proof", a chasm remains. If Mr. Webb did*26 express in absolute terms his intention (on behalf of petitioner) to pay Continental, he apparently did not do so in the presence of the other persons at the meeting. We are unconvinced by petitioner's evidence that any such admission was in fact made. It is clear that petitioner was not admitting unconditional liability to anyone in particular; instead, its attention was focused on contesting the Levitz claim 8 with the hope that it would escape the affair unscathed due to Levitz's obligation to repair the building under the terms of the Levitz-Continental lease. Petitioner was actively seeking to prevent its "mere liability to suit" from maturing into a "recognized obligation to pay",
*27
1. We note that the amount was first entered on petitioner's books as a "contingent liability" and then the entry was immediately reversed, an apparent accounting technique used to take the deduction for tax purposes only.↩
2. It is true that the denial was to allegations in the conjunctive with respect to William C. Webb (also a defendant) and the petitioner, thus leaving it open to theoretical conjecture whether the denial was intended to mean only that the allegations were contested merely to the extent that they referred to both. However, we think that a fair interpretation of the pleading reflects a denial as it relates to each of those two defendants, and particularly as it relates to petitioner which filed its own denial to the allegations.↩
3. While there is no evidence that the third factor mentioned in
4. The resolution does speak of "the collapse of the Levitz Warehouse roof", and the matter is left in a fog as to who would be treated as the proper claimant against petitioner. It does appear that Levitz later sued petitioner and others, but petitioner vigorously contested Levitz's right to recover, and there is no credible evidence that Continental ever made a claim against petitioner. ↩
5. No explanation was offered as to why the loss was not accrued on the books for fiscal 1974 despite this resolution of the directors. For our purposes, the significant act is the accrual itself, and a mere resolution directing such accrual does not meet the requirement set out in
6. Petitioner directs our attention to Florida's collateral source rule, see, e.g.,
7. See
With the breach there of course arises a cause of action by the injured party, which it may or may not see fit to pursue. Should it, for reasons of policy, or otherwise, not demand damages, the obligor may escape payment. Conceding that it may be proper to accrue any approximation, it is certainly essential that there be a recognized obligation to pay before one's right to accrue arises, and a mere liability to suit is not sufficient. ↩
8. Petitioner has made no claim that it is entitled to a deduction under