Source: https://caselaw.findlaw.com/us-supreme-court/291/193.html
Timestamp: 2019-04-23 19:36:51+00:00

Document:
[291 U.S. 193, 194] Messrs. Arthur B. Dunne and Peter F. Dunne, both of San Francisco, Cal., for petitioner.
The Attorney General, and Mr. J. Crawford Biggs, Sol. Gen., of Washington, D.C., for respondent.
An unincorporated concern known as Edward Brown & Sons, of San Francisco, has since 1896 acted as Pacific [291 U.S. 193, 195] Coast General Agent for fire insurance companies. 1 In 1923, Arthur M. Brown conducted the concern alone. In 1925 and 1926, he and his son Arthur M. Brown, Jr., conducted it as partners. The general agent receives as compensation from its principals, among other things, a so-called 'overriding commission' on the net premiums derived from business written through the local agents. The question for decision is, how the income of the petitioner, Arthur M. Brown, derived from overriding commissions during the years 1923, 1925, and 1926 should be calculated for purposes of the federal income tax. The Commissioner of Internal Revenue held that, in determining income, the gross overriding commissions on business written during the year should not be subjected to any deduction on account of cancellations expected to occur in later years. The taxpayer contends that either the gross overriding commissions should be subjected to such a deduction of that parts of the gross overriding commissions should be allocated as earnings of future years. [291 U.S. 193, 196] The term 'net premium' as used in providing for overriding commissions means the gross premium on the business written less the return premium and the net cost of any reinsurance. Fire insurance policies are written for periods of one, three, or five years, with the right of cancellation by either party at stipulated rates of premium return. Premiums being payable in advance (subject to the 60-day grace period), a return premium is paid to the policyholder in case of cancellation; and the general agent, who receives the premium, pays the return premium. The company writing a policy frequently reinsures in another company a part of its contingent liability; and the general agent, who makes the payments for reinsurance, receives, in case of cancellation, a return of a proportionate part of the cost of the canceled reinsurance. The general agent makes to each principal remittances on monthly balances, crediting itself, among other things, with the overriding commissions on premiums receivable, with the return premiums paid and with the net amount paid for reinsurance; and charging itself, among other things, with a proportionate part of any overriding commissions previously credited in respect of any business which has been canceled during the month. Thus, whenever there is a cancellation and a return or credit of a portion of the premium and of the cost of any reinsurance, the general agent returns to the company or charges itself with a corresponding portion of the overriding commission.
Prior to 1923, overriding commissions on new business were accounted income of the year in which the business was written; and refunds of overriding commission on account of cancellations were accounted expenses of the year of cancellation. The books of the general agent have at all times been kept on the accrual basis. Although no change was made in the method of accounting between the general agent and its principals, there was [291 U.S. 193, 197] set up on the books of the concern at the close of 1923, for the first time, a liability account entitled 'Return Commission.' In it was recorded an estimate of the liability expected to arise out of the general agent's obligations to refund to the companies a proportionate part of the overriding commission received because of cancellations which it was expected would occur in future years. The estimate was based on the experience of the preceding five years. Thus, on the books, the year's income from overriding commissions was reduced by the amount of refunds which, it was estimated, would have to be made in future years. This changed method of accounting has been followed ever since; and the difference in the method of calculating the general agent's income has been reflected in the returns made by Brown of his taxable income.
In making his federal income tax return for the years 1923, 1925, and 1926, Brown claimed as deductions the benefit of the credits so made to the 'Return Commission' account. The Commissioner of Internal Revenue disallowed these deductions; and accordingly assessed to Brown for 1923 a deficiency of $17,923.03; for 1925 a deficiency of $1,520.19; and for 1926 a deficiency of $944.30.3 The Commission's determinations were sustained by the Board of Tax Appeals, 22 B.T.A. 678; and its order was affirmed by the Circuit Court of Appeals. 63 F.(2d) 66. Certiorari was granted by this Court ( 290 U.S. 607 , 54 S.Ct. 61, 78 L.Ed. --) because of alleged conflict with the decision of the Circuit Court of Appeals for the Fourth Circuit in Virginia-Lincoln Furniture Corp. v. Commissioner of Internal Revenue, 56 F.(2d) 1028, and other cases.
First. The Commissioner properly disallowed the deduction on account of the credits to the 'Return Com- [291 U.S. 193, 199] mission' account. Under the Revenue Acts, taxable income is computed for annual periods. If the accounts are kept on the accrual basis, the income is to be accounted for in the year in which it is realized, even if not then actually received; and the deductions are to be taken in the year in which the deductible items are incurred. What is taxable as income is provided by the Revenue Act of 1921, c. 136, 42 Stat. 227, 237, 239.4 Section 212(a) declares: 'That in the case of an individual the term 'net income' means the gross income as defined in section 213, less the deductions allowed by section 214.' Section 214(a) declares: 'That in computing net income there shall be allowed as deductions: 1. All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.' The only relevant deductions allowable by law are those provided for in section 214; and the burden rests upon the taxpayer to show that he was entitled to the deduction claimed. Reinecke v. Spalding, 280 U.S. 227, 232 , 50 S.Ct. 96.
The overriding commissions were gross income of the year in which they were receivable. As to each such commission there arose the obligation-a contingent liability-to return a proportionate part in case of cancellation. But the mere fact that some portion of it might have to be refunded in some future year in the event of cancellation or reinsurance did not affect its quality as income. Compare American National Co. v. United States, 274 U.S. 99 , 47 S.Ct. 520 71 L.Ed. 946. When received, the general agent's right to it was absolute. It was under no restriction, contractual or otherwise, as to its disposition, use, or enjoyment. Compare North American Oil Consolidated v. Burnet, 286 U.S. [291 U.S. 193, 200] 417, 424, 52 S.Ct. 613.5 The refunds during the tax year of those portions of the overriding commissions which represented cancellations during the tax year had, prior to the tax return for 1923, always been claimed as deductions; and they were apparently allowed as 'necessary expenses paid or incurred during the taxable year.' The right to such deductions is not now questioned. Those which the taxpayer claims now are of a very different character. They are obviously not 'expenses paid during the taxable year.' They are bookkeeping changes representing credits to a reserve account.
These charges on account of credits to the 'Return Commission' reserve account are claimed as deductions on the ground that they are expenses 'incurred,' 'during the taxable year.' It is true that, where a liability has 'accrued during the taxable year,' it may be treated as an expense incurred; and hence as the basis for a deduction, although payment is not presently due, United States v. Anderson, 269 U.S. 422, 440 , 441 S., 46 S.Ct. 131; American National Co. v. United States, 274 U.S. 99 , 47 S.Ct. 520; Aluminum Castings Co. v. Routzahn, 282 U.S. 92 , 51 S.Ct. 11, and although the amount of the liability has not been definitely ascertained. United States v. Anderson, supra. 6 Compare Continental Tie & Lumber Co. v. United States, 286 U.S. 290, 296 , 52 S.Ct. 529. But no liability accrues during the taxable year on account of cancellations which it is expected may occur in future years, since the events necessary to create the liability do not occur during the taxable year. Except as otherwise specifically provided by statute, a liability does not accrue as long as it remains contingent. Weiss v. Wiener, 279 U.S. 333, 335 , 49 S.Ct. 337; Lucas v. American Code Co., 280 U.S. 445, 450 , 452 S., 50 S.Ct. 202; compare New York Life Ins. Co. [291 U.S. 193, 201] v. Edwards, 271 U.S. 109, 116 , 46 S.Ct. 436; Ewing Thomas Converting Co. v. McCaughn (C.C.A.) 43 F.(2d) 503; Highland Milk Condensing Co. v. Phillips (C.C.A.) 34 F.(2d) 777.
The accrual method of accounting had been regularly employed by Edward Brown & Sons before 1923, but no 'Return Commission' account had been set up. Moreover, the method employed by the taxpayer is never conclusive. If in the opinion of the Commissioner it does not clearly reflect the income, 'the computation shall be made upon such basis and in such manner' as will, in his opinion, do so. United States v. Anderson, 269 U.S. 422, 439 , 46 S.Ct. 131; Lucas v. American Code Co., 280 U.S. 445, 449 , 50 S.Ct. 202; Lucas v. Ox Fibre Brush Co., 281 U.S. 115, 120 , 50 S.Ct. 273; compare Williamsport Wire Rope Co. v. United States, 277 U.S. 551 , 48 S.Ct. 587; Lucas v. Structural Steel Co., 281 U.S. 264 , 50 S.Ct. 263.11 In assessing the deficiencies, the Commissioner required in effect that the taxpayer continue to follow the method of accounting which had been in use prior to the change made in 1923. To so require was within his administrative discretion. Compare Bent v. Com'r Int. Rev. (C.C.A.) 56 F.( 2d) 99.
Second. The Board of Tax Appeals did not err in refusing to allocate to future years part of the overriding commissions on business written during the taxable year. Brown urges that the overriding commission is compensation for services rendered throughout the life of the policy; that the compensation to be rendered in later years cannot be considered as earned until the required services have been performed; and that the Revenue Acts con- [291 U.S. 193, 204] template that, where books are kept on the accrual basis, the income shall be accounted for as it is earned. He suggests, therefore, as an alternative method of ascertaining the income, that the commissions on each year's writing be prorated over the life of the policies.
Under this alternative proposal, the practice of making deductions prevailing prior to 1923 would remain unchanged; but the method of ascertaining the gross income of the taxable year would be subjected to a farreaching change. The proposal is that all policies be deemed to have been written on July 1; that, of the overriding commission on one-year policies, one-half should be returned as income of the year in which the policy was written, the other half as income of the next year; that, of the commissions on three-year policies, one-sixth should be returned as income of the year in which the policy was written, one-third as the income of each of the next two years, and one-sixth as income of the fourth year; and that, of the commission on five-year policies, one-tenth should be returned as income of the first year, one-fifth as income of each of the next four years, and one-tenth as income of the sixth year.
This proposed alternative method of computing the income from overriding commissions was not employed by Edward Brown & Sons either before or after 1923. Moreover, the Board concluded that there 'is no proof that the overriding commissions contain any element of compensation for services to be rendered in future years.' The whole of the overriding commissions has at all times been treated as income of the year in which the policy was written. The Commissioner was of opinion that the method of accounting consistently applied prior to 1923 accurately reflected the income. He was vested with a wide discretion in deciding whether to permit or to forbid a change. Compare Bent v. Com'r Int. Rev. (C.C.A.) 56 F.(2d) 99. It is not the province of the court to weigh and determine [291 U.S. 193, 205] the relative merits of systems of accounting. Lucas v. American Code Co., 280 U.S. 445, 449 , 50 S.Ct. 202.
The deductions here claimed, not being authorized specifically either by the Revenue Acts, or by any regulation applying them, were properly disallowed. So far as the decision in Virginia-Lincoln Furniture Corporation v. Commissioner of Internal Revenue (C.C.A.) 56 F.(2d) 1028, may be inconsistent with this opinion, it is disapproved.
[ Footnote 1 ] The duties required of and performed by the general agent are described by the Board of Tax Appeals as follows: The firm appointed and removed local agents; accepted service of process; adjusted losses under policies; received and acknowledged service of proof of loss; issued, countersigned, and canceled policies; received and receipted for premiums, surveyed all risks offered, and accepted or rejected the same; represented its principals on the Pacific Board of Underwriters; computed and paid commissions due local agents; ceded or reinsured certain lines of business with treaty or other companies; computed and paid return premiums on canceled policies; secured return of premium on canceled reinsurance; rendered all reports required of its principals by the authorities of political subdivisions in the territory in which it operated; attended to the payment of all license fees and taxes; furnished all necessary printed matter, except policy blanks, to local agents; transferred insurance by indorsement, determined whether its principals should participate in special pools; and generally attended to all the affairs of its principals in the territory in which it operated.
Judge Wilbur concurred specially below, taking the ground, among others, that the result of this method was a claim in 1923 for deductions both of the entire reserve and of actual cancellations during the year.
[ Footnote 3 ] The amount of the deficiency for each year was affected by an additional claim as a deduction of $3,000, which was disallowed. It is not here in question.
[ Footnote 4 ] Sections 212, 213, and 214 of the Revenue Act of 1924, c. 234, 43 Stat. 253 (26 USCA 953-955 and notes), 267-270, and the corresponding sections of the Revenue Act of 1926, c. 27, 44 Stat. 9, 23-27 (26 USCA 953-955) contain provisions identical with those quoted above, except that section 206 of those acts is also referred to as defining deductions.
[ Footnote 5 ] See, also, Vang v. Lewellyn (C.C.A.) 35 F.(2d) 283.
[ Footnote 6 ] See, also, Uncasville Mf'g Co. v. Com'r Int. Rev. (C.C.A.) 55 F.(2d) 893, 895; Ocean Accident & Guarantee Corp. v. Com'r Int. Rev. (C.C.A.) 47 F.(2d) 582. Compare Com'r Int. Rev. v. Old Dominion S.S. Co. (C.C.A.) 47 F.( 2d) 148.
[ Footnote 8 ] Compare Barde Steel Products Corp. v. Com'r Int. Rev. (C.C.A.) 40 F.( 2d) 412, 416; Spring Canyon Coal Co. v. Com'r Int. Rev. (C.C.A.) 43 F.(2d) 78, 76 A.L.R. 1063.
[ Footnote 10 ] United States v. Anderson, 269 U.S. 422 , 46 S.Ct. 131; American National Co. v. United States, 274 U.S. 99, 101 , 47 S.Ct. 520; Niles Bement Pond Co. v. United States, 281 U.S. 357, 359 , 50 S.Ct. 251; Aluminum Castings Co. v. Routzahn, 282 U.S. 92, 98 , 51 S.Ct. 11.
[ Footnote 11 ] See, also, Industrial Lumber Co. v. Com'r Int. Rev. (C.C.A.) 58 F.( 2d) 123; Jennings & Co. v. Com'r Int. Rev. (C.C.A.) 59 F.(2d) 32.

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