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Rockwell International Corp. v. Commissioner of Internal Revenue

November 29, 1982; As Amended December 2, 1982.

ROCKWELL INTERNATIONAL CORPORATION, APPELLANT
v.
COMMISSIONER OF INTERNAL REVENUE



APPEAL FROM THE UNITED STATES TAX COURT

Before: SEITZ, Chief Judge, ROSENN and GARTH, Circuit Judges

Opinion OF THE COURT

Per Curiam.

I.

Rockwell International Corp. (taxpayer) appeals from the Tax Court's denial of its petition to redetermine a tax deficiency and argues that it was an abuse of discretion for the Commissioner of Internal Revenue to disallow a $16,250,000 writedown in inventory held under a fixed-price contract. Taxpayer computed this writedown pursuant to its method of inventory accounting, which it claims is acceptable under I.R.C. ยงยง 446 and 471.

Sections 446 and 471 vest the Commissioner with wide discretion to determine whether a particular method of accounting should be disallowed as not clearly reflective of income. The United States Supreme Court was held that the "Commissioner's disallowance of an inventory accounting method is not to be set aside unless shown to be "plainly arbitrary." Thor Power Tool Co. v. Commissioner, 439 U.S. 522, 532-33, 58 L. Ed. 2d 785, 99 S. Ct. 773 (1979) (quoting Lucas v. Structural Steel Co., 281 U.S. 264, 271, 50 S. Ct. 263, 74 L. Ed. 848 (1930)). The Tax Court held that the Commissioner's disallowance of taxpayer's 1969 inventory writedown was not plainly arbitrary and that the Commissioner did not abuse his discretion. Rockwell International Corp. v. Commissioner of Internal Revenue, 77 T.C. 780 (1981). We affirm.

II.

Section 471 allows taxpayers to calculate taxable income by inventory accounting. Treasury Regulation section 1.471-4 allows taxpayers to value inventory at lower of cost or market.

In 1969, taxpayer estimated that its total loss under an ongoing fixed-price contract would be $16,250,000. Inventory held under that contract could only be sold to the contract buyer. Because taxpayer reasoned that the value of its inventory had thus decreased by the amount of loss it would suffer under the contract, taxpayer used lower of cost or market to write down the value of its 1969 inventory by the estimated $16,250,000 net loss.

The Tax Court addressed two issues in affirming the Commissioner's disallowance of that writedown. First, did the Commissioner abuse his discretion in refusing to recognize taxpayer's entire projected loss in 1969? Second, did the Commissioner abuse his discretion in finding that taxpayer had presented insufficient objective evidence to support a writedown of any portion of that projected loss?

A.

The Tax Court held that it was not an abuse of discretion for the Commissioner to disallow recognition of taxpayer's entire estimated net loss in its 1969 taxable income. At the time of the writedown, taxpayer had incurred less than half of the total costs to complete and the contract was six years from completion. Thus, taxpayer attempted to recognize a loss that was at least partially attributable to costs it had not yet incurred.

The lower of cost or market method of valuation allowed under section 471 is an exception to the principle that there is no recognition of profit or loss under the tax laws until there is a realizable event. However, this does not mean that under lower of cost or market a taxpayer may recognize a loss for costs it has not yet incurred.

Because the Commissioner has wide discretion to reject the use of any accounting method that does not clearly reflect income, we agree with the Tax Court's decision ...


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