MEMORANDUM FINDINGS OF FACT AND OPINION

HARRON:

 

The Commissioner determined a deficiency in the income tax liability of Samuel Caplan for the year 1933 in the amount of $ $1,225.28; and a deficiency in the income tax liability of Charles Dubbs for the year 1933 in the amount of $1,613.85. These proceedings have been consolidated for hearing and opinion. The sole question is what amount constitutes the share of each petitioner in the income of a partnership for the year 1933. The respondent alleges, by an amended answer filed at the hearing, that the adjusted net income of the partnership for 1933 is $66,549.44, and that the share of each petitioner in the net income is $22,183.15, there being three members of the partnership.

 

The partnership filed a return for 1933 in which it reported net income in the amount of $62,227.67. The Commissioner has made adjustments, increasing the net income, which raise several questions, namely, did the partnership sell 100,000 gallons of wine to a New York concern in 1933; did the Commissioner err in disallowing deduction of $587.99 as depreciation on partnership plant and buildings; is the total sum of $11,429.76, fortification or floor taxes on wines, deductible from partnership income in 1933? In computing the net income of the partnership for 1933, it is necessary to deduct from gross sales the cost of goods sold. To arrive at the cost of goods sold in the taxable year it is necessary to arrive at a figure representing cost of inventory as well as the number of gallons of wine to be included in inventory in computing the net income of the partnership. The matter of final computations must be made under Rule 50.

 

Findings of Fact

In 1933 a co-partnership, under the name of Alta Winery and Distillery, was formed by petitioners and a third person, Zina Kolodny. Samuel Caplan and Charles Dubbs were members of the partnership in 1933, each having a one-third interest. The business of the partnership was located at Dinuba, California, and it was the business of manufacturing and selling wines. Caplan and Dubbs each filed individual income tax returns for 1933. Caplan reported his share of partnership income as $20,742.55, and Dubbs reported his share of partnership income in the same amount.

 

The partnership was organized in July, 1933, and conducted business as a partnership until the end of the year. In January, 1934, a corporation was organized under the laws of California, under the name, Alta Winery and Distillery, Inc. The three partners in the partnership became owners of stock in the corporation. All the property of the partnership was transferred to the corporation, subject to all of the debts and liabilities of the partnership, which were assumed by the corporation. Each of the petitioners, Caplan and Dubbs, became officers of the corporation.

 

Dubbs was general sales manager of the partnership. He went to New York City in 1933 to negotiate for the sale of wine to the Virginia Dare Extract Company. The negotiations in New York City were oral. Upon Dubbs' return to California, correspondence ensued between the partnership and the Extract Company, and a sales agent of the partnership in New York City. The Extract Company wrote a letter, under date of December 7, 1933, to the partnership, stating that it was ‘understood‘ that the Extract Company was to purchase 20,000 gallons of sweet wines at 77 1/2 cents a gallon, f.o.b. winery; that the wine was to be taken out before the next pressing season, not later than August 20, 1934; that the Extract Company was to have an option on another 20,000 gallons of wines at the same price and to be taken out during the same period, the option to be exercised by April 1, 1934; that the alcoholic content of the wines should be 20 or 21 per cent; that the quality of the wine was to be in conformity with samples submitted; that if sherry was not in satisfactory grade, the contract could be taken out in other sweet wines including port, muscatel or angelica. The Extract Company stated in the letter that it would appreciate ‘prompt shipment at all times when orders are placed.‘

 

On December 28, 1933, the Extract Company addressed a letter to the partnership's sales agent in New York City, in which it stated:

 

Referring to our conversation over the telephone today you may raise our order with the Alta Winery and Distillery at Dinuba, California to 100,000 gallons of Sweet Wines to be assorted as we may direct as to variety.

 

On January 8, 1934 the partnership addressed a letter to the Extract Company stating, among other things,

 

it is understood that we agree to sell to you and that you agree to purchase from us an additional 60,000 gallons of our sweet wines of Port, Muscatel, Angelica and Sherry at the agreed price of 85¢ per gallon, marked f.o.b. our winery.

 

The letter was signed by the president of the Extract Company, upon receipt by it, under the words ‘Approved and Accepted,‘ except as to terms as to credit, which the Extract Company requested should be modified, by letter dated January 13, 1934.

 

During 1933 the partnership shipped 6,720 gallons of wine to the Extract Company. During 1934 between 60,000 and 70,000 gallons of wine were shipped to the Extract Company. The balance of the 100,000 gallons of wine agreed to be purchased by the Extract Company, i.e., between 33,280 and 23,280 gallons, was never withdrawn by or shipped to the Extract Company.

 

The partnership kept its books on an accrual basis.

 

The closing inventory of the partnership, as of December 31, 1933, included all the wines on hand at that time, including the wine agreed to be purchased by the Extract Company. No wine was segregated to be applied to the contract with the Extract Company. Until that Company sent an order to the partnership designating the quantity and type of wine desired, the partnership did not know what quantity or type of wine to ship to the Extract Company. The partnership's inventory of wines, at the end of 1933, was 289,998 gallons.

 

Opinion

It may be stated at the outset that the record made in these proceedings is very unsatisfactory, making it very difficult to ascertain the facts. As stated in Evergreen Cemetery Association, 25 B.T.A. 544, 551-552, ‘The proper trial of a case before the Board requires thorough preparation, a clear understanding of the issues, and the marshaling of the evidence in such a way as to indicate clearly the effect of the same and the issues to which it appertains. *** One of the duties of counsel is to assist in ascertaining the true facts.‘ What the Board stated, in E. J. Barry, 1 B.T.A. 156, 157, is also appropriate here:

 

When a taxpayer brings his case before the Board he proceeds by trial de novo. The record of the case made in the Internal Revenue Bureau is not before the Board except in so far as it may be properly placed in evidence by the taxpayer or by the Commissioner. The Board must decide each case upon the record made at the hearing before it, *** .

 

Wisconsin Butter & Cheese Co., 10 B.T.A. 852, 854. Rule 6 of the Rules of the Board provides that the ‘petition shall be complete in itself so as fully to state the issues.‘ The petitions filed herein fail to comply with the requirements of this Rule.

 

The petitions of Caplan and of Dubbs are worded identically in paragraphs 4 and 5, which contain the allegation of error. In each petition the error alleged is as follows:

 

4. The petitioner has been assessed a tax upon the same income for each of the taxable periods, 1933 and 1934, that has already been assessed against a partnership, known as the Alta Winery & Distillery, for the year 1933.

 

This is not a proper pleading. The tax year is 1933, only. Counsel for petitioners drafted the petition and signed it. He appears to not know that a partnership is not taxable, but that individuals carrying on a business as a partnership are liable for tax on the partnership income in their individual capacities. See sections 181 and 182 of the Revenue Act of 1932.

 

While the petitions of each petitioner are inadequate, the proceedings are now to be disposed of upon the evidence which has been adduced at the hearing. Counsel for petitioners has at no time moved to amend the petition to make better the pleadings.

 

Attached to each notice of deficiency to each petitioner, is a schedule in which the respondent makes adjustments in various items resulting in adjusted net income to the partnership. Respondent added to the partnership's income the following amounts, which petitioners do not contest: organization expense (not deductible) $250; appraisal fees (not deductible) $165; taxes accrued March 1, 1933 (not deductible) $231.61.

 

Respondent added to the partnership income, $687.99, excessive depreciation not deductible. Subsequently, by amended answer, respondent allowed as a deduction $100 of the above, and left $587.99 added to taxable income as excessive depreciation not deductible. The petition of each petitioner does not allege error, specifically, in the above, original determination as to disallowance of a depreciation deduction. If respondent erred in this adjustment, the burden was upon petitioners to introduce proper evidence as to the life and cost of property for which depreciation deduction was sought. Petitioners' counsel appears to not understand that the burden of proof was upon petitioners to show that a total sum for depreciation should be allowed, inclusive of the $587.99 disallowed. No evidence on this point was introduced by petitioners. Counsel for petitioners makes an argument on page 7 of his brief, but it is not supported by any evidence whatever relating to the property in question for which the depreciation deduction is claimed.

 

Petitioners have failed to prove error in respondent's determination as to the depreciation deduction. It is held that $587.99 of the depreciation deduction claimed is not allowable. Respondent is sustained in his determination.

 

The partnership, in its return for 1933, did not deduct separately, as taxes, any sum for fortification of wine tax. It did, however, include in cost of goods manufactured ‘U. S. Tax on Brandy and Wine,‘ $5,787.19. From the income tax return for 1934 of the succeeding corporation, it appears that fortifying taxes for 1933 in the amount of $11,429.76 were included in cost of goods manufactured in 1934. The record is silent as to any facts relating to fortification tax in the amount of $11,429.76. All that there is before us is contained in schedules attached to the separate returns of the partnership for 1933, and the corporation for 1934, and the schedules fail to disclose explanatory facts.

 

Respondent disallowed a deduction in 1934 to Alta Winery & Distillery, Inc., the corporation, for the above fortification tax, for the reason that it appeared to be a proper deduction in 1933 as a cost of production. A separate opinion in the corporation's case, Docket No. 90628, is entered this day, in which it is held that the item is not deductible in 1934. That holding eliminates any possibility of deduction of this one item in two tax years.

 

Turning then to the question of deductibility of this item in 1933, we are cognizant that the item may not be treated so as to be deducted twice in 1933 by the partnership, in any way. The question is whether allowance of deduction of $11,429.76 in 1933, as taxes accrued in 1933 by the partnership which reported income on an accrual basis, will result in a double deduction.

 

It is pointed out that the Commissioner determined, as of June 16, 1937, that the partnership had accrued liability for $11,429.76 taxes on wines in 1933, and had not included that sum in costs of manufacture for 1933, and, consequently, the partnership was entitled to deduct the above sum in 1933 as a deduction for Federal tax accrued. The Commissioner deducted the above sum in computing the taxable income of the partnership for 1933, and that resulted in decrease of each petitioner's share in the partnership income. In the petition for each petitioner in this proceeding, no allegation of error is made with respect to that determination. Upon the pleadings as they stood before the hearing in this case, it would be held, necessarily, that the fortification tax in question is deductible from partnership income in 1933.

 

At the hearing respondent filed an amended answer in each proceeding, affirmatively alleging, in substance, that the fortification tax in question had been included in costs of manufacture for 1933 of the partnership, and that the item could not be deducted separately, as a tax, because such would result in a double deduction. Respondent attached to his amended answers a new schedule of the computation of the partnership income for 1933. Respondent's new allegations and determinations increased net income of the partnership, and thereby the deficiency in tax liability of each petitioner. The respondent's amended answer raised a new issue, and the burden or proof then shifted to respondent to introduce evidence to prove his allegation. See Rule 32 of the Board's Rules of Practice.

 

However, respondent failed to introduce any evidence on the question. He has not shown that $11,429.76 fortification tax was included in costs of manufacture in 1933 in any manner. His theory appears to be that the item is included in costs which comprise a unit cost of 21 1/2 cents a gallon for making wines in 1933. Counsel for petitioners denied this at the hearing. He has not shown that the sum of $5,787.19, ‘U. S. Tax on Brandy and Wines,‘ which was included in costs of manufacture for 1933, represents any part of the $11,429.76 in question. He asserts in his brief, at page 31, that counsel for petitioners admitted at the hearing that the partnership had received a double deduction for this item. There is an ambiguous statement by counsel for petitioners, at page 79 of the transcript. Taken with other statements on the same page, we cannot view the statement referred to as an admission that double deduction will result, if the deduction is allowed the partnership in 1933, and is not allowed to the corporation in 1934. Further, counsel for petitioners make no such admission in the brief, but rather, he argues that part of the item is deductible in 1933, and part in 1934. Respondent has failed to sustain the burden of proof on him in this question.

 

Upon such state of the pleadings, it is only fair and reasonable to conclude that respondent's original determination that $11,429.76 is deductible from partnership income in 1933 must stand undisturbed. It is held that fortification tax of $11,429.76 is deductible in 1933 from partnership income.

 

There remains the main question whether the partnership made a sale in 1933 of a total of 100,000 gallons of wine to the Virginia Dare Extract Company. Petitioners alleged that sale of the total quantity was made in 1933, although only 6,720 gallons of wine were delivered to the Extract Company in 1933. Respondent contends that, upon the facts, all that was done in 1933 by the parties was to enter into an agreement to sell and to buy a total of 100,000 gallons of wine, and that the agreement remained executory in 1933 with respect to the alleged sale of 93,280 gallons of wine not delivered in 1933. Determination of this question affects the inventory of the partnership at the close of 1933, and thereby affects computation of the net income of the partnership for 1933. The income tax return of the partnership, for 1933, reported net income of the partnership upon a calculation using inventory, and there is no question raised relating to the use of inventory. See also, section 22(c) of the Revenue Act of 1932.

 

In making its income tax return for 1933, the partnership did not include the entire 100,000 gallons in reported 1933 sales. It included therein merely the 6,720 gallons shipped in 1933, and included the unshipped wine of 93,280 gallons in its closing inventory. The accounts receivable as of January 1, 1934 of the corporation, to which the partnership transferred all its assets, totalled only $10,177.90. The selling price of the wine unshipped on December 31, 1933 was about $72,270. Apparently no sale of 100,000 gallons was set up on the partnership's books of account as a sale or charged to the Extract Company in an account receivable. Although it was expressly agreed that the 100,000 gallons of wines were to be withdrawn not later than August 20, 1934, the entire 100,000 gallons have not been withdrawn to date. At the most, only 76,720 gallons have been delivered to date, and between 60,000 and 70,000 gallons were delivered in 1934. There is no evidence that the partnership or corporation ever treated the transaction as a completed sale in 1933 of 100,000 gallons of wines, or made any claim against the Extract Company for the withdrawal and payment of the unshipped wines.

 

It is concluded that the partnership did not sell wine to the Extract Company, in 1933, in excess of the 6,720 gallons delivered in 1933. The correspondence, which constitutes the agreement between the parties, clearly shows that the buyer intended to place orders with the partnership up to August 20, 1934, designating by each order the type of wine and quantity. Prior to receipt of such orders from the buyer, the seller could not possibly know how much of any of several types of sweet wines it would be called upon to deliver. There could not be any identification of goods, or segregation, or earmarking, prior to receipt of orders. Under the loose arrangement, one chief element of a sale was so lacking in 1933, as to 93,280 gallons of wine, namely, identification of the goods, that it cannot be concluded that sale thereof was made in 1933. Giffen v. Selma Fruit Co., 89 Pac. 855. It cannot be said that any condition precedent occurred in 1933 by which title to 93,280 gallons of wine passed in 1933 to the Extract Company. The condition precedent, under the informal agreement between the parties, was the designation by the buyer of both the type and quantity of any sweet wine desired at a time within the buyer's determination. Until the Extract Company placed an order for a quantity of any of several types of wine, the partnership was not obligated to deliver any wine under the contract. See Pearson v. McKinney, 160 Cal. 649; 117 Pac. 919, where the court stated, in part:

 

When the contract is not a general undertaking to sell the goods, which the seller is to have ready at all events when delivery is due, but is a contract to sell a specified article when it grows to a specified size or age, or of a certain number to be selected out of a particular larger lot or to be produced from a specified source, or to be prepared in a manner to be afterwards prescribed by the buyer, a different rule prevails. The sale and delivery are then made to depend upon the happening of the precedent conditions. Until they have occurred, there is no obligation upon the seller to deliver, unless their nonoccurrence was occasioned by his fault. And if they do not occur, or their occurrence becomes impossible without his fault he is excused from performance. (Emphasis supplied.)

 

Further, the terms of sale of the additional 60,000 gallons of wine, referred to in the letter of the Extract Company of December 28, 1933, were not agreed upon by the parties until around January 13, 1934. The letter of the Extract Company, of that date, shows that it was not until after January 8, 1934, that the parties were in agreement that 40,000 gallons were to be sold on the terms of ‘cash on delivery,‘ or ‘sight draft against papers,‘ and 60,000 gallons were to be sold against a letter of credit to be obtained by the Extract Company from a California bank. Since the terms of the contract of sale were not finally agreed upon by the parties, as to the total 100,000 gallons of wine, until in January, 1934, it cannot be said that title to all the wine in question passed to the Extract Company by virtue of the partial agreement reached in 1933, as evidenced by the letters of December 7 and December 28, 1933.

 

We are satisfied from the facts that negotiations with the Extract Company were instituted in December, 1933, but were not concluded until January, 1934; that the informal agreement, as finally concluded in 1934, represented an executory agreement to sell a total of 100,000 gallons of wine subject to specific orders as to type and quantity to be placed in the future by the Extract Company, under an option to purchase the above total quantity on or before August 20, 1934; that the parties did not intend that title to any quantity of wine should pass to the Extract Company until it placed firm orders for quantity and type; that title to the 93,280 gallons of wine in question did not pass to the Extract Company in December 1933.

 

It is held that the partnership did not sell the 93,280 gallons of wine in question in 1933. Respondent is sustained upon this question. See Article 101, Regulations 77, Act of 1932, and Article 22(c) 1, Regulations 86, Act of 1934.

 

In computing inventory values, respondent determined that the cost per gallon of wine to the partnership in 1933 was 21 1/2 cents. He adjusted inventory value of goods at the end of 1933 by reducing the reported cost from 40 cents a gallon. At the hearing, there was much argument from counsel for petitioners that shrinkage of wines from evaporation was not considered by respondent, and it was contended that cost per gallon should be 22.76 cents per gallon. Counsel for petitioners, failing to brief the point, has abandoned it. Petitioners introduced no evidence to overcome the presumptive correctness of respondent's determination that cost was 21 1/2 cents per gallon. Respondent's determination as to cost to the partnership, accordingly, is sustained. It is pointed out that this reduction in the value of inventory of wines at the end of 1933, results in reduction of the partnership income for 1933, so that it is not clear why petitioners should oppose respondent's determination in this respect.

 

For recomputation under Rule 50, it is pointed out that the partnership, on its return, did not include in income from sales, any sum for any alleged sale in 1933 of 93,280 gallons of wine; and that it reported value of inventory on the basis of 40 cents a gallon for 289,998 gallons of wine. It did not exclude from inventory 93,280 gallons allegedly sold in 1933. Respondent, by the argument in his brief that 93,280 gallons of wine were not sold in 1933, must concede error in the computations he has made in which he added to sales $76,792 as the selling price of 93,280 gallons of wine, and reduced inventory for valuation by the same quantity. The holding made herein that there was no sale in 1933 of certain wines, benefits the taxpayers, and must be given effect in the recomputation under Rule 50. It now appears that recomputation will show that the partnership did not have any taxable income for 1933.

 

The income tax liability of each petitioner must be recomputed under Rule 50.

 

Decision will be entered under Rule 50.

 

 

Entered: January 18, 1940.

 

 

B.T.A. 1940.

Caplan v Commissioner

1940 WL 9814 (B.T.A.), B.T.A.M. (P-H) P 40,028

 

END OF DOCUMENT