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October 30, 1944


The opinion of the court was delivered by: KIRKPATRICK

This is a suit to recover income and excess profits taxes and interest in the sum of $229,805.34, assessed for the year 1935 and paid by the plaintiff under protest. The case was tried to the court without a jury, most, if not all, of the material facts being covered by a stipulation.

The taxpayer (keeping its books and making its returns upon the accrual basis) took deductions in its income tax returns for the years 1922 to 1926 inclusive, amounting in the aggregate to $825,151.52, representing manufacturer's excise taxes which had been assessed against it during those years upon the erroneous theory that the storage batteries which it manufactured were parts of automobiles within the meaning of the Revenue Acts. The excise taxes were paid under protest to avoid penalties, upon demand of the then Collectors of Internal Revenue. The deductions were allowed by the Commissioner and resulted in saving the plaintiff a total of $139,668.83 of income tax for the years in question.

 In July 1926 the plaintiff filed a claim for refund of the excise taxes, which was rejected, and the plaintiff then brought suit and finally, on May 1, 1933, after an appeal to the Circuit Court of Appeals, McCaughn v. Electric Storage Battery Co., 63 F.2d 715, obtained a judgment for $1,416,567.81, being the amount of excise taxes, with interest. After lengthy negotiations, the government, on October 15, 1935, paid the plaintiff $1,395,515.35, which sum the plaintiff accepted in full satisfaction of the judgment.

 The Commissioner added the bulk of this sum *fn1" to the income returned by the plaintiff for 1935, and as a result assessed additional income and excess profits taxes amounting, with interest, to $229,805.34. This the plaintiff is seeking to recover in this suit.

 An additional fact is that for the years 1919 to 1922 inclusive the plaintiff paid, under protest, a total of $534,205.04 *fn2" as excise taxes upon the sale of its storage batteries -- an amount not included in the claim for refund filed by it in 1926, because then barred by the statute of limitations.

 The plaintiff bases its case upon alternative theories, first, that the payment to it in 1935 was not income at all, but the restoration of a part of its capital which had been taken when the government, illegally, compelled it to pay the excise taxes in the years 1922 to 1926. Second, that, if income, it was properly accruable not for 1935 but for the years 1922 to 1926, and, consequently, the statute of limitations prevents assessment in 1935 of an additional tax in respect of it. Finally, the plaintiff contends that even if the assessment of the income tax in suit is held proper it is entitled to judgment by way of recoupment for the admittedly illegal excise taxes paid by it under protest between 1919 and 1922.

 First. "The law is pretty well settled that * * * Refunds of taxes erroneously and illegally collected constitute taxable income. * * *" Universal, Inc., v. Commissioner, 7 Cir., 109 F.2d 616, 617. See also Nash v. Commissioner, 7 Cir., 88 F.2d 477 and Bimberg v. Helvering, 2 Cir., 126 F.2d 412. So far as I know, the rule of these cases has not been expressly rejected by any court decision.

 The plaintiff contends that the payment of the excise taxes resulted in an impairment of its capital and that the exaction was in the nature of a trespass. The Board of Tax Appeals in a group of recently decided cases conceded as much but held that the subsequent refund was income, for the reason that "by the prior deduction of the amount of loss from taxable income the taxpayer has already had, for income tax purposes, a recoupment of the capital out of taxable income. Any further recovery is accordingly in the nature of a replacement of taxable income and, being in excess of the reduced cost of the capital asset, is equivalent to gain to the taxpayer." Estate of James N. Collins v. Commissioner, 46 B.T.A. 765, 769; John V. Dobson v. Commissioner, 46 B.T.A. 770. See also Houbigant, Inc., v. Commissioner, 31 B.T.A. 954. These cases held in effect that the money, upon its return, has lost its character as capital. This Court, in Philadelphia National Bank v. Rothensies, 43 F.Supp. 923 (a recovery of a bad debt case), took a somewhat different view and held that, although the money taken by the government remained capital even upon its return, the taxpayer, by claiming and receiving a benefit in respect of the loss in the form of a deduction in its income tax, had voluntarily consented that it be taxed as income in the event of its return, regardless of its nature. It does not matter which theory be accepted; whether the recovery be taxable as income or, by waiver or implied consent as capital, the result is the same.

 Second. The refund being taxable income, the question is as to the year in which it is properly accruable. Judge Hand in Bimberg v. Helvering, supra, called attention to the distinction recognized by a number of decisions between situations in which the statute had run against assessment in the year of the illegal overcharge and those in which it had not. He said [ 126 F.2d 413]: "It has been several times held that the Commissioner may cancel a deduction taken in one year for a tax which the taxpayer has accrued or paid, when the tax has been refunded in a later year because it was unlawfully imposed. Inland Products Co. v. Blair, 4 Cir., 31 F.2d 867; Leach v. Commissioner, 1 Cir., 50 F.2d 371; Bergan v. Commissioner, 2 Cir., 80 F.2d 89.* * * On the other hand, in several cases when the time has passed to assess a deficiency for the earlier year, courts have allowed the Commissioner to surcharge the income for the year of the refund. Houbigant, Inc., v. Commissioner, 2 Cir., 80 F.2d 1012; Nash v. Commissioner, 7 Cir., 88 F.2d 477; Union Trust Co. v. Commissioner, 7 Cir., 111 F.2d 60." In Bohemian Breweries v. U.S., 27 F.Supp. 588, 592, 89 Ct.Cl. 57, the Court of Claims referred to, as established, "the rule that an amount deducted and allowed from income in a certain year must be included in income when collected or recovered in a subsequent year when the correction of the return and the tax liability in a prior year is barred by the statute of limitation." Bimberg v. Helvering, supra, was a case in which, although the statute had not run, the Commissioner's determination that the refund was income for the year in which it was received was sustained, mainly because the taxpayer itself had accrued it for that year by returning part of it, but the opinion goes beyond the facts and expressly approves the rule of the Houbigant case to the effect that if the statute has run the refund may be assessed against the taxpayer in the year in which it was received.

 Although, in this case, the plaintiff's accounting was at all times upon an accrual basis, *fn3" that does not mean that the plaintiff may attribute an item of income to any year it pleases or that its determination of the year is final and conclusive. The question still remains whether the income is properly and legally accruable in the year to which the taxpayer has attributed it.

 In each of the two recent cases of Dixie Pine Products Co. v. Commissioner, 320 U.S. 516, 64 S. Ct. 364, and Security Flour Mills Co. v. Commissioner, 321 U.S. 281, 64 S. Ct. 596, the taxpayer was on an accrual basis. In the Dixie Pine case the taxpayer had been assessed for and had paid a manufacturer's gasoline tax to the state of Mississippi upon a product which it claimed was not gasoline and had brought suit in the state court to recover the payment. It accrued the liability on its books for the year in which it had paid the tax and claimed a corresponding deduction from its income tax for that year. The court said [ 320 U.S. 516, 64 S. Ct. 365]: "Here the taxpayer was strenuously contesting liability in the courts and, at the same time, deducting the amount of the tax, on the theory that the state's exaction constituted a fixed and certain liability. This it could not do. It must, in the circumstances, await the event of the state court litigation and might claim a deduction only for the taxable year in which its liability for the tax was finally adjudicated." In the Security Flour Mills case the taxpayer had not actually paid but had deposited, pendente lite, a processing tax the legality of which it was contesting. Meanwhile it had passed the tax on to its customers thereby assuming an obligation to reimburse them if the tax should be declared invalid. The tax was declared invalid, the impounded money was returned to the taxpayer and thereafter, in subsequent years, refunds were made to the customers. In spite of the fact that the taxpayer accrued the amount deposited as a liability for the year in which it was deposited, the court held that it was not entitled to a deduction for that year but must include in its income the total amount received from its customers in that year and take whatever deductions it was entitled to during the years in which refunds to the customers were made. The court said [ 321 U.S. 281, 64 S. Ct. 598]: "Since it denied liability for, and failed to pay, the tax during the taxable year 1935, it was not in a position in its tax accounting to treat the Government's claim as an accrued liability. As it admittedly received the money in question in 1935 and could not deduct from gross income an accrued liability to offset it, the receipt, it would seem, must constitute income for that year."

 In the Security Flour Mills case the court further said: "The uniform result has been denial both to government and to taxpayer of the privilege of allocating income or outgo to a year other than the year of actual receipt or payment, or, applying the accrual basis, the year in which the right to receive, or the obligation to pay, has become final and definite in amount." The question in the present case therefore is, in what year had the plaintiff's right to receive a refund of the excise tax which it illegally paid, become "final and definite in amount"? Obviously, under the rule of the two cases just cited, not in the years 1922 to 1926, during which the tax was paid.It is also plain from those decisions that the fact that the exaction was subsequently determined to be illegal did not mean that there had been from the moment it was paid an immediate final and definite obligation to return it or a correlative right to receive it, -- at least so far as allocating income or outgo in respect of it is concerned.

 In its suit for the recovery of the excise taxes the plaintiff obtained judgment in 1933, but neither party in this case contends that the amount of the judgment is income for that year. Perhaps under ordinary circumstances it would be, but a special situation existed which, the defendant contends, and I think rightly, postponed the finality and definiteness of the taxpayer's right to receive and the government's obligation to pay the ...

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