The opinion of the court was delivered by: GIBSON
By its petition plaintiff seeks to recover income and excess profits taxes for the year 1920, with interest, which it claims were erroneously assessed against it.
The basic question involved is whether supplies, not to become a part of the finished product, were properly included by the plaintiff in its inventory at the end of the year 1920 at market, then less than cost. The taxpayer inventoried all the materials on hand at that time which were used by it in the manufacture of its products at cost or market, whichever was less, and based its return upon that inventory. The Commissioner of Internal Revenue conceded the propriety of an inventory and the inclusion therein at cost or market, whichever was the lower, of partly manufactured articles and materials to become physical parts of the products, but held that some articles used in the manufacture, but not becoming components of the products, were includible at cost and should not be written down to market. So holding, he assessed a deficiency tax against the plaintiff, and the amount of this tax the plaintiff seeks to recover.
The foregoing, in a general way, states the issues of the instant case. However, the plaintiff now admits that the Commissioner properly disallowed a write-down of $78,037.32 upon items acquired for construction of fixed assets, and the defendant concedes that $24,984.66 of the $667,423.66 originally disallowed was properly inventoried at less than market, and that $92,215.97 of the original amount found by the Commissioner to have been correctly so inventoried, i.e., $348,210.93, was allowable, but that the balance had been erroneously allowed. The plaintiff's claim is that its income for 1920 was overstated by the Commissioner of Internal Revenue in the amount of $495,114.36, and that it was compelled to overpay its taxes by $138,580.90.
Another phase of the case relates to interest collected from the plaintiff upon the overpayment. Upon trial the parties were in accord as to this item, the claim to be determined largely upon the decision as to other matters involved in suit.
Section 203 of the Revenue Act of 1918, 40 Stat. 1060, in force for 1920, is as follows: "Sec. 203. That 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."
Acting upon the foregoing section the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, adopted the following regulations (Reg. 45, Articles 1581-1584):
"Art. 1581. Need of inventories. -- In order to reflect the net income correctly inventories at the beginning and end of each year are necessary in every case in which the production, purchase or sale of merchandise is an income-producing factor. The inventory should include raw materials and supplies on hand that have been acquired for sale, consumption or use in productive processes, together with all finished or partly finished goods."
"Art. 1582. Valuation of inventories. -- The Act provides two tests to which each inventory must conform -- (1) It must conform as nearly as may be to the best accounting practice in the trade or business, and (2) it must clearly reflect the income. It follows, therefore, that inventory rules can not be uniform but must give effect to trade customs which come within the scope of the best accounting practice in the particular trade or business. In order to clearly reflect income, the inventory practice of a taxpayer should be consistent from year to year, and greater weight is to be given to consistency than to any particular method of inventorying or basis of valuation, so long as the method or basis used is substantially in accord with these regulations. An inventory that can be used under the best accounting practice in a balance sheet showing the financial position of the taxpayer can, as a general rule, be regarded as clearly reflecting his income.
"The basis of valuation most commonly used by business concerns and which meets the requirements of the Revenue Act is (a) cost or (b) cost or market, whichever is lower.
"In respect to normal goods, whichever basis (a) or (b) is adopted must be applied with reasonable consistency to the entire inventory. * * *
"Art. 1583. Inventories at cost. -- Cost means:
"(1) In the case of merchandise on hand at the beginning of the taxable year, the inventory price of such goods.