Case Name: Sohio Corporation, a Delaware Corporation, and Sohio Petroleum Company, an Ohio Corporation, Petitioners, v. Commissioner of Internal Revenue, Respondent
Court: United States Tax Court
Jurisdiction: United States
Decision Date: 1946-07-31
Citations: 7 T.C. 435
Docket Number: Docket No. 7192
Parties: Sohio Corporation, a Delaware Corporation, and Sohio Petroleum Company, an Ohio Corporation, Petitioners, v. Commissioner of Internal Revenue, Respondent.
Judges: Hill, </., dissents.
Reporter: Reports of the Tax Court of the United States
Volume: 7
Pages: 435–453

Head Matter:
Sohio Corporation, a Delaware Corporation, and Sohio Petroleum Company, an Ohio Corporation, Petitioners, v. Commissioner of Internal Revenue, Respondent.
Docket No. 7192.
Promulgated July 31, 1946.
M. E. Neweow,er, Esq., for the petitioners.
M. W. Kerr, Esq., for the respondent.

Opinion:
opinion.
Black, Judge:
This case involves income tax for the year 194.1 and excess profits tax liability for the year 1942. Deficiencies were determined in the respective amounts of $919.69 and $23,954.40. Several items entering into such deficiencies have been disposed of by stipulation and will be reflected in decision under Rule 50. This leaves for consideration only the question as to whether there should be included in petitioner's gross income in each of the taxable years certain amounts retained by the petitioner as compensation for the collection and payment to the State of Illinois of a tax levied on oil purchased by the petitioner. The petitioner was required by law to retain the compensation out of a tax which it was required to deduct from the purchase price of oil. The petitioner protested the tax and it was later held unconstitutional; after which the petitioner refunded to its vendors of oil the amounts so retained.
The facts are found as stipulated. The following summary of the facts will suffice for the purpose of decision of the only issue presented.
Petitioner Sohio Corporation was a corporation organized and existing under the laws of the State of Delaware, with its principal place of business at Cleveland, Ohio. Petitioner Sohio P'etroleum Co. is the successor by merger of petitioner Sohio Corporation. Such merger became effective as of January 1, 1944. The Sohio Corporation, which was the taxpayer in connection with the transactions involved herein, is referred to as the petitioner. The corporation income and excess profits tax returns for the taxable years were filed with the collector for the eighteenth district of Ohio, at Cleveland, Ohio.
The pertinent facts are that in 1941 and 1942 petitioner was purchasing oil in large quantities from various oil producers in Illinois; that the Assembly of the State of Illinois passed a law, effective on July 1, 1941, requiring the petitioner, among others, to retain from the amounts owing to its vendors of oil a tax of 3 per cent of the value of the oil, and to remit it to the State of Illinois, deducting reasonable compensation, subject to the approval of the state, for such collection and payment of the tax, the expense not to exceed 2 per cent of the amount of the tax so retained from vendors of oil and remitted to the state. The act imposed heavy penalties for failure to comply therewith. The petitioner was required to keep records, make monthly returns, secure a revocable registration certificate in order to receive oil, and retain and remit the tax on oil. Failure to comply with such provision subjected the corporate officers to criminal penalties, and failure to make the monthly return and pay the tax to the Department of Finance of Illinois subjected the petitioner to liability of cancellation of certificate and a penalty of 50 per cent of the tax due, and interest of 1 per cent per month. In addition, injunction could be applied for by the state to prevent the petitioner from purchasing oil in Illinois if the act or the regulations were violated. The petitioner retained such tax from the amounts due its vendors and remitted it, under protest, to the state treasurer, through the taxable years after passage of the act, retaining 2 per cent of the amount collected as its expenses. The 2 per cent amounted to $15,701.95 in 1941 and $23,151.02 in 1942. It was not set aside in any escrow or trust fund, but was commingled with petitioner's common income from all sources.
Shortly after the effective date of the act of the Illinois Assembly, and upon September 17, 1941, petitioner filed action in court, as did others, seeking to have the act of the assembly declared invalid as unconstitutional, and to restrain the state treasurer from transferring the funds collected into the general revenue' fund of the state. The petitioner's complaint alleged, inter alia, that it had become obligated by the act to collect the tax, had done so, had retained 2 per cent thereof to compensate it for the cost of collecting and remitting, and had paid the remainder under protest, to the state, to prevent the imposition of the penalties provided by the act for failure to collect the tax and pay to the state. Reciting the penalties provided by the act, the complaint alleged that petitioner was threatened with loss of its business in Illinois should it have failed to pay the tax as provided, and that it intended to collect the tax and pay it to the state, under protest, so long as it was threatened with the penalties of the act for failure to do so.
Promptly after filing the action to have the law declared invalid, the petitioner gave notice, in writing, of the filing of the action to those from whom it was collecting the oil production tax, stating that the suit was filed to protect their interests as well as petitioner's and that it was petitioner's opinion that the law would be declared unconstitutional and the taxes would be refunded.
On March 21, 1944, the Supreme Court of Illinois, in Ohio Oil Co. v. Wright, 386 Ill. 206; 53 N. E. (2d) 966, declared the whole act invalid for unconstitutionality, and in pursuance of its mandate the Circuit Court of Sangamon County, in which petitioner had filed its case, directed the state treasurer to refund the entire amount of the production taxes collected by petitioner and remitted to him by the petitioner, upon condition that petitioner distribute the full amount thereof to the parties from whom it was collected. Accordingly, the state treasurer refunded the entire amount received by him from petitioner, and the petitioner returned the moneys, together with the 2 per cent it had retained as compensation for collection and remittance, to the parties from whom it had been retained. In accordance with the decree of the Circuit Court, the petitioner on July 7, 1945, filed a report with that court. It reported distribution made by it of all moneys retained from those from whom it purchased oil, including the 2 per cent retained for services.
In the computation of its income and excess profits tax liabilities, the petitioner deducted the actual expenses incurred in connection with the collection of the Illinois oil production tax and remittance thereof to the Finance Department of Illinois, and such deductions were allowed. These deductions are not separately designated. Petitioner included the $15,701.95 and $23,151.02 in its gross income, but upon receipt of the deficiency notice it, by letter, requested the Commissioner to correct and adjust the deficiency to eliminate such amounts from income. This request the Commissioner denied, and he included the amounts in gross income. The petition here alleges that petitioner erred in including the amounts in income and that the Commissioner erred in refusing to reduce the reported income accordingly.
The petitioner's argument is, in effect, that it never had a right to any of the funds involved and never asserted any such right, but at all times denied such right; that in retaining the 2 per cent it acted only under threat of heavy penalties for violation of the Illinois statute; and that later in 1944 it repaid the money, so that its gross income should not be held to include it. The respondent in substance argues that in the computation of petitioner's income and excess profits tax liabilities for the years 1941 and 1942 the petitioner properly included the $15,701.95 and $23,151.02, respectively, as part of its gross income and the actual expenses incurred by the petitioner in connection with the collection of the Illinois production tax and remittance of the same to the treasurer of the State of Illinois were reflected as expense deductions in said returns and said deductions were properly allowed by the respondent in the computation of the deficiencies here involved. "In other words," says respondent, "although the petitioner protested the constitutionality of the tax in question, in all other respects the income was unquestionably treated as though it was received under a claim of right." In support of his contentions respondent cites North American Oil Consolidated v. Burnet, 286 U. S. 417; Burnet v. Sanford & Brooks Co., 282 U. S. 359: Blum v. Helvering, 74 Fed. (2d) 482; D. H. Byrd, 32 B. T. A. 568; S. B. Heininger, 47 B. T. A. 95; and Security Flow Mills Co. v. Commissioner, 321 U. S. 281. We think respondent must be sustained. In the first place, the Illinois statutes did not require petitioner to retain 2 per cent of the amount which it collected to compensate it for the expenses incurred in collecting and remitting to the state the production taxes. The statute permitted the petitioner to deduct for such purposes not more than 2 per cent. The statute itself provides as follows:
Each manager and each receiver who is required to collect the tax from any producer shall determine the actual cost of making such collection and payment to the Department and shall, subject to the approval of the Department, deduct such cost, not to exceed two (2%) per cent of the amount so collected, from the amount of his tax return.
Presumably petitioner, in making its rendition to the State of Illinois, estimated that the cost of collecting and remitting the tax was approximately the 2 per cent allowed by the statute. Whatever the actual cost to petitioner was for doing this service for the State of Illinois it was deducted as expenses for each of the taxable years, and these expenses were allowed by the Commissioner. On this point it has been stipulated:
In the computation of petitioner's income and excess profits tax liabilities for the years 1941 and 1942, the actual expenses incurred by the petitioner in connection with the collection of the Illinois Oil Production Tax and remittance of the same to the Treasurer of the State of Illinois were reflected as expense deductions in said returns, and said deductions were allowed by the respondent in the computation .of the deficiencies in controversy herein for the said years 1941 and 1942.
This being so, it seems to us petitioner was required to return as gross income the $15,701.95 and $28,151.02 which it retained to reimburse it for these expenses. Otherwise, petitioner would have been receiving deductions for expenses for which in the same year it was being reimbursed by another, and that is not permissible under our income tax laws. It is of course true that, if petitioner had known in each of the taxable years that it would have to return later to the oil-producing companies the 2 per cent which it was retaining, then doubtless it could have accrued, as an offset to the amounts in question, liabilities to its customers to make restitution of like amounts in future years. It had no such knowledge in either of the taxable years. While it believed in good faith that the taxing act was unconstitutional, it did not know that to be true. Clearly, it intended to make refund of the 2 per cent retained to the oil producers only if and when the act was declared unconstitutional. If the Supreme Court of Illinois had declared the act to be constitutional, there is no reason to suppose that petitioner would have ever returned the 2 per cent in question to the oil producers. It would have been under no obligation to do so, either legally or morally.
We think that under the facts we have here the case is controlled by the Supreme Court's decision in Security Flour Mills Co. v. Commissioner, supra. The substance of the Court's holding in that case was that the Commissioner and the Tax Court are not authorized to make exceptions to a general rule of accounting by annual periods upon finding that it would be unjust or unfair not to isolate particular transactions and treat them on a basis of long term result. In the Security Flour Mills Co. case the taxpayer set up on its books a suspense account which it termed "Reserve for processing tax, claims, etc." The taxpayer refunded various sums to its customers, totaling over $45,000 in 1936, 1937, and 1938, to reimburse customers for processing tax included in the price of flour sold them in 1935 and not paid to the collector of internal revenue as processing taxes. In its 1935 tax return the taxpayer deducted from gross income, as accrued tax liability, the total of the amounts impounded and accrued but not paid the collector in the year 1935. The Commissioner found a deficiency upon disallowing the petitioner's deduction for taxes accrued but not paid in 1935. In its appeal to the Board the taxpayer assigned as its first allegation of error the failure of the Commissioner to allow as a deduction in 1935 the $45,865.90 which the taxpayer had refunded to its customers in 1936, 1937, and 1938. Petitioner argued that it was necessary to do this in order to correctly reflect its income. We sustained petitioner on authority of Cannon Valley Milling Co., 44 B. T. A. 763. See Security Flour Mills Co., 45 B. T. A. 671. We were reversed by the Tenth Circuit, see Commissioner v. Security Flow Mills Co., 135 Fed. (2d) 165, and the Supreme Court granted certio-rari and affirmed the Tenth Circuit and reversed the Board. In its opinion the Supreme Court, among other things, said:
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 instant case the petitioner in each of the taxable years retained, out of the price due its customers for oil purchased from them, the 3 per cent tax due the State of Illinois. Of the amount thus retained, petitioner paid over to the state treasurer 98 per cent thereof. As to this latter amount there is no controversy. But, as we have already pointed out, petitioner had retained and commingled with its own funds the other 2 per cent, and unless it is entitled to accrue against this amount the refunds which it subsequently made to its customers in 1944, it is taxable on the 2 per cent retained in 1941 and 1942, under the language of the Supreme Court's opinion in the Security Flour Mills Co. case, supra. We think petitioner could not properly accrue on its books in 1941 as an offset against the $15,701.95 which it retained that year an equivalent amount which it actually refunded to its customers in 1944. The same is true of the $23,151.02 collected and retained by petitioner in 1942. The principles of the Security Flour Mills Go. case forbid such an offset accrual. There would be no more reason to allow petitioner such an accrual in the taxable years which we have before us than there was to allow the taxpayer in the Security Flow Mills Co. case the benefit of such a deduction of the $45,865.90 in 1935 for amounts which it refunded to customers in 1936, 1937, and 1938. The Supreme Court, in the Security Flow Mills Go. case, refused to permit such an adjustment.
In Brown v. Helvering, 291 U. S. 193, the Supreme Court laid down the strict rule that a contingent liability which is dependent on the last day of the accounting period upon a future event is not a deductible accrued liability for the taxable year. The Court there stated:
But no liability accrues (luring 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. * » *
As we have already pointed out, there was no fixed and certain liability on petitioner's part in either of the taxable years to make any refunds to its customers of the 2 per cent which it used as reimbursement for collecting and remitting the tax. On this point see the discussion of the Tenth Circuit in Commissioner v. Security Flour Mills Co., supra, in which the court said:
Here the taxpayer received from its vendees amounts equal to the processing tax on flour sold during the period in which the injunction was in force. It made no promise or contractual obligation to repay or refund any or all thereof in the event the act was declared unconstitutional, or otherwise. But it became entitled to the money and actually received it in 1935 under claim of right without legal restriction as to its use and disposition, and it therefore constituted taxable income in that year. [Citing authorities.]
The Commissioner contends that as a matter of fact there was never any liability on petitioner's part to refund any of the 2 per cent which it deducted for expenses. The Commissioner contends that what petitioner was legally bound to refund to its customers in 1944 was the 98 per cent which the treasurer of the State of Illinois refunded to petitioner and that petitioner simply acted as a volunteer when it refunded the other 2 per cent. We do not express any opinion as to the merits of respondent's contention in this respect. We do not have the year 1944 before us. We do hold, however, that petitioner was under no legal obligation in either of the taxable years to make any future refunds to its customers of the amounts in question and we therefore sustain the determination of the Commissioner on this issue.
Reviewed by the Court.
Decision will be entered under Bule 50.
Hill, </., dissents.