#### MALLEABLE IRON RANGE COMPANY v. THE UNITED STATES1

[No. D-510.

Decided June 14, 1926]

*On the Proofs*

*Income tax; return on accrual Vasts; deduction for judgment deVf affirmed after return.*— Where plaintiff makes its income-tax returns on an accrual basis for the years 1918 and 1919, it can. *426not deduct therein irom its gross income the amount of a judgment decreed against it by a district court of the United States January 15, 1918, as damages for patent infringement and affirmed and increased by the Circuit Court of Appeals March 15, 1920.

*The Reporter's*statement of the case:

*Mr. J. Gilbert Ha/rdgrove*for the plaintiff. Miller, *Mack & Fairchild*were on the briefs.

*Mr. John R.*Wheeler, with whom was *Mr. Assistant Attorney General Herman J.*Galloway, for the defendant. *Mr. Fred K. Dyarr*was on the brief.

The court made special findings of fact, as follows:

I. At all of the times herein mentioned the plaintiff, Malleable Iron Eange Co., was and now is a corporation or-. ganized and existing under and by virtue of the laws of the State of Wisconsin and a citizen of said State, having its principal office and place of business at the city of Beaver Dam, in the eastern district of Wisconsin.

II. On and at all times since April 26, 1923, one A. H. Wilkinson, hereinafter referred to as the collector, was and now is the duly appointed, qualified, and acting collector of internal revenue for the eastern district of Wisconsin.

III. On April 26, 1923, the said collector • notified the plaintiff that a tax of $83,023.86 had been assessed against the plaintiff in respect to its income for the year 1918, and that a further additional tax of $925.89 had been assessed against the plaintiff in respect to its income for the year 1919, and demanded payment of said taxes, and threatened that if said taxes were not paid, penalties would be imposed upon the plaintiff and that as such collector he would collect said taxes and penalties by distraint of the plaintiff’s property.

IY. Thereafter, and on May 7, 1923, the plaintiff, under protest and compulsion and not voluntarily and only for •the purpose of avoiding the imposition of penalties, seizure, ■or prosecution, paid to the said collector the amount of said taxes, respectively, to wit, the sum of $33,023.86 for the year 1918 and the sum of $925.89 for the year 1919, notifying said ..collector at the time of such payments that it objected to *427said taxes and to each thereof, that the objection to the said taxes upon which said protest was based was “that there has been eliminated from the accrued liabilities of the undersigned a certain judgment entered January 15, 1918, against the undersigned by the District Court of the United States for the Eastern District of Wisconsin, because of the claim of your department that said judgment was a liability in the year 1920 and not in the year 1918; that if the amount of said judgment were allowed as a deductible liability in the year 1918, as heretofore treated by the undersigned in returns and claims heretofore filed, as under the revenue acts it should properly and legally be treated, no additional tax liability would be assessable against the undersigned, and that the payment of said additional tax is exacted under compulsion and illegally and under threat of the imposition of illegal, unjust, and oppressive penalties,” and further notified said collector that the recovery of the amount of ' said taxes, and of each thereof, would be sought by all means available for that purpose.

V. The assessment of said taxes was made by the Deputy Commissioner of Internal Revenue on June 30,1921. Thereafter the plaintiff objected thereto and requested a conference and duly presented its objections and the evidence in support thereof before the income-tax unit of the Internal Revenue Department for the purpose of showing cause why said tax should not have been assessed and should not be paid. Thereafter, and on October 27, 1921, the plaintiff’s objections were overruled by the deputy commissioner. Thereafter, and on November 19, 1921, the plaintiff duly appealed to the committee on appeals and review from said ruling and said appeal was thereafter duly heard. There-' after, and on February 21, 1923, said committee on appeals and review recommended the disallowance of the plaintiff’s claims, which recommendation was thereupon approved by the Commissioner of Internal Revenue. Demand for payment of said taxes having been made by said collector on April 26,1923, requiring the making of such payment within 10 days thereafter, the plaintiff made payment of said taxes under protest, as hereinabove stated, on May 7,1923. Thereafter, and on August 23, 1923, the plaintiff duly filed with *428the collector of internal revenue of the said district in which said assessment had been made a claim for refund of the taxes so illegally collected from it. Thereafter, and on November 8,1923, the said claim was rejected by the Deputy Commissioner of Internal Bevenue.

VI. The said additional taxes of $33,023.86 for the year 1918 and $925.89 for the year 1919 were assessed as hereinafter more particularly shown.

(1) On January 15, 1918, a decree was duly entered in the District Court of the United States for the Eastern District of Wisconsin in a cause there pending in which one Ered E. Lee, as administrator of the estate of one Arthur E. Bechwith, deceased, was plaintiff, and in which the plaintiff herein was defendant, finding and adjudging the plaintiff entitled to recover from the plaintiff herein the sum of $78,816.61 damages for certain patent infringements extending from April, 1905, to April, 1911, together with interest thereon at 6 per cent June 10, 1915, to January 15, * 1918, and as punitive damages 20 per cent of said $78,816.67, or $15,763.33, making a total of $106,862.26, together with costs taxed at $2,803.28, amounting in all to $109,665.54. On February 25, 1918, the plaintiff gave notice of appeal from said decree and an order was made in open court *giving*the defendant 10 days in which to file a petition for appeal, and assignment of errors.

(2) During the year 1918 and the succeeding years the. plaintiff kept its books on the accrual basis and not on the cash basis. It set up on its books in the year 1918 as an accrued liability the said sum of $109,665.56, with interest at the rate of 6 per cent per annum from the date of the ‘entry of said decree to December 31, 1918, to wit, $6,305.77, or a total of $115,971.33.

(3) On March 6, 1918, the plaintiff duly filed its petition for appeal from said decree to the United States Circuit Court of Appeals for the Seventh Circuit.

(4) Thereafter, by proceedings duly had, said appeal was perfected and said cause heard in said circuit court of appeals, and on March 15, 1920, said decree was by said circuit court of appeals modified by adding to the amount fixed *429therein interest on $78,816.67, at 6 per cent from April 18, to June 10, 1915, and as so modified affirmed. Thereafter pursuant to the mandate of said circuit court of appeals said district court modified its decree by providing that the amount of the recovery thereunder be increased by adding thereto the sum of $19,599.09, being the interest on the item of $78,816.67, at 6 per cent from April 18, 1911, to June 10, 1915, making a total of $126,461.17, and by providing for the recovery by the plantiff therein of the interest on the costs theretofore taxed and on the amount of the modified decree from January 15, 1918, making a total to March 15, 1920, the date as of which said modified decree was entered, of $146,049.73.

(5) In making its return of income for the year 1918 the plaintiff deducted the amount of said alleged judgment debt represented by said decree of January 15, 1918, and the interest which had accrued thereon during the year 1918, and in making its return for the year 1919 deducted, among other things, the interest on said alleged judgment debt. In the assessment of the taxes hereinbefore mentioned the deductions so claimed by the plaintiff were disallowed and rejected. The disallowance and rejection of the deductions so claimed resulted in an increase in the plaintiff’s net taxable income as determined by the Internal Revenue Department for the years 1918 and 1919. The said additional taxes so assessed against the plaintiff for said years 1918 and 1919 are the amounts of the additional taxes assessed against said plaintiff for said years 1918 and 1919 by reason of the disallowance and rejection of the deductions aforesaid.

The court decided that plaintiff was not entitled to recover.

1

 Writ of certiorari granted.

Hat, Judge,

delivered the opinion of the court:

This is a suit brought by the plaintiff, the Malleable Iron Range Co. against the United States, to recover corporation and excess-profits taxes for the years 1918 and 1919, which it alleges have been erroneously and unlawfully assessed against it and which have been collected by the United States.

The plaintiff is and was at all the times hereinafter mentioned a duly organized and existing corporation under the *430laws of the State of Wisconsin, and is a resident of that State, with its principal place of business at Beaver Dam therein. Its returns for income and excess-profits taxes were filed within the time required by law.

On January 1, 1918, a decree was entered by the United States District Court for the Eastern District of Wisconsin against the plaintiff in this cause in favor of Fred E. Lee, administrator of the estate of Arthur K. Beckwith, deceased, in the sum of $109,665.54. On February 25, 1918, the plaintiff herein gave notice of appeal of said cause to the United States Circuit Court of Appeals for the Seventh Circuit, and on March 16, 1918, its petition for appeal was filed. Thereafter said appeal was perfected, and the said cause was heard in the Circuit Coiirt of Appeals, and on March 15, 1920, the decree appealed from by the plaintiff herein was modified by the said Circuit Court of Appeals by raising the amount of the judgment of the lower court to the sum of $146,049.73, and as so modified was affirmed.

In the income and. excess-profits tax returns filed by it for the year 1918 the plaintiff deducted the amount of the said judgment and the interest which had accrued thereon during the year 1918 and the year 1919 deducted an additional amount of $29,028.67 to provide for a possible increase in final judgment and also the interest which had accrued on said judgment during the year 1919.

These deductions were not allowed by the Commissioner of Internal Revenue, as the liability of the plaintiff to pay the said judgment was not determined until March 15, 1920. The judgment as modified and affirmed by the Circuit Court of Appeals could not be deducted except for the year 1920, when it was ascertained and determined. By reason of this disallowance of the deduction for the year 1918 the net income of the plaintiff was increased, and additional taxes for the year 1918 in the sum of $33,023.86 and for the year 1919 in the sum of $925.85 were assessed against the plaintiff on June 30, 1921. On May 7, 1923, these additional assessments were paid under protest by the plaintiff. On August 23,1923, the plaintiff filed a claim for refund of the amount so paid, which claim was rejected by the commissioner on November 8, 1923.

*431This case is governed by the provisions of the revenue act of 1918, 40 Stat. 1057.

“ Sec. 232. That in che case of a corporation subject to the tax imposed by section 230 the term *‘*net income ’ means the gross income as defined in section 233, less the deductions allowed by section 234, and the net income shall be computed on the same basis as is provided in subdivision (b) of section 212 or in section 226.

^ # H* ‡ H*

*“*Sec. 212. (b) The net income shall be computed upon the basis of the taxpayer’s annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made upon such basis and in such manner as in the opinion of the commissioner does clearly reflect the income. If the taxpayer’s annual accounting period is other than a .fiscal year as defined in section 200 or if the taxpayer has no annual accounting period or does not keep books, the net income shall be computed on the basis of the calendar year.

“ Sec. 234. (a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:

“(4) Losses sustained during the taxable year and not compensated for by insurance or otherwise;

“ The term ‘ paid,’ for the purpose of the deductions and •credits under this title, means ‘ paid or accrued ’ or ‘ paid or incurred,’ and the terms c paid or incurred ’ and £ paid or accrued,’ shall be construed according to the method of accounting upon the basis of which the net income is computed under section 212.”

The Treasury Regulations., 1920 edition, provide as follows:

“Aet. 111. *When charges deductible.*— Each year’s return, so far as practicable, both as to gross income and deductions therefrom, should be complete in itself, and taxpayers axe expected to make every reasonable effort to ascertain the facts necessary to make a correct return. See articles 21-24 and 52. The expenses, liabilities, or deficit of one year can not be used to reduce the income of a subsequent year. A person making returns on an-accrual basis *432has the right to deduct all authorized allowances, whether paid in cash or set up as a liability, and it follows that if he-does not within any year pay or accrue certain of his expenses, interest, taxes, or other charges, and makes no deduction therefor, he can not deduct from the income of the next or any subsequent year any amounts then paid in liquidation of the previous year’s liabilities. A loss from theft or embezzlement occurring in one year and discovered in another is deductible only for the year of its occurrence. Any amount paid pursuant to a judgment or otherwise on. account of damages for personal injuries, patent infringement, or-otherwise is deductible from gross income when the claim is put in judgment or paid, less any amount of such damages-as may have been compensated for by insurance or otherwise. If subsequently to its occurrence, however, a taxpayer first ascertains the amount of a loss sustained during a prior taxable year which has not been deducted from gross income, he may render an amended return for such preceding taxable year, including such amount of loss in the deductions from gross income, and may file a claim for refund of the excess tax paid by reason of the failure to deduct such loss in the original return. * *

It would seem plain from the foregoing that when there-is a question of whether or not there is any liability, no-amount can accrue until it is determined that a liability exists. When the amount in question is in litigation it can. not be determined until the litigation is ended. If any other rule were adopted it would inevitably result in confusion and there would be no certainty at any given time as to when, the liability should be allowed for. A good example is the-case at bar. In January, 1918, a judgment was rendered against the plaintiff for the sum of $109,665.56. In March,, 1920, that judgment was so modified by the higher court that it then amounted to the sum of $146,049.73.

When the plaintiff appealed the case it denied in effect the-liability, and certainly that liability did not accrue to it on. the date of the judgment in the lower court. The plaintiff' by its action in taking the appeal distinctly denied the liability.

The liability which is being claimed by the plaintiff in this-case is not a fixed liability. It was not determined at the-time when the plaintiff seeks to fix it as an accrual. For the-liability ivas contingent upon the action of the higher court,. *433and until that action was taken there was no fixed liability which could be deducted under the internal revenue act of 1918. Until all the events occurred which fixed the amount to be deducted, and determined the liability of the taxpayer to pay it, there was no method by which the Commissioner of Internal Revenue could assess the amount of the tax.

Under the circumstances of the case we are constrained to deny the relief asked for by the plaintiff, and to dismiss its petition. It is so ordered.

Graham, Judge; Booth, Judge; and Campbell, *OMef*Justice, concur.