Before SWAN, CLARK, and FRIENDLY, Circuit Judges.
These are petitions by both the Commissioner of Internal Revenue and the taxpayer for review of a Tax Court decision, 31 T.C. 1080, sustaining in part only determinations of deficiencies in the taxpayer's income taxes for the years 1943 to 1947 and excess profits tax for the year 1943. The taxable year 1948 is involved only in so far as the earlier years are affected by a net operating loss deduction from 1948 and a carry-back of unused excess profits credits. Taxpayer, an operator of motor coaches in Manhattan, reports its income on a calendar year accrual basis. Both petitions require a determination of the year in which certain deductions, to which taxpayer is concededly entitled, accrued for tax purposes.
I. The Commissioner's Petition for Review.
The Commissioner seeks review of the Tax Court's allowance of a deduction for unpaid interest on certain tax deficiencies. The question arises from earlier litigation in the Tax Court which determined deficiencies for the years 1937 to 1939. Taxpayer's income and excess profits taxes for the years 1940 to 1947 were also affected by the determination, as the major item in dispute was the cost basis of its bus franchise for amortization purposes. See C.I.R. v. Sunnen, 333 U.S. 591, 68 S. Ct. 715, 92 L. Ed. 898. The Tax Court rendered its opinion in the case on November 30, 1948, and the decision was formally entered on December 22, 1948. New York City Omnibus Corp. v. C.I.R., 17 P-H Tax Ct.Mem. 803 (1948). The court found that the cost basis of the franchise was that determined in the deficiency notice, upheld the Commissioner as to the date on which amortization should commence, and upheld the taxpayer as to the longevity of its motor buses, the taxability of net earnings which taxpayer was required by court order to turn over to another company, and the deductibility of a reserve for accident and damage claims. Since neither the Commissioner nor the taxpayer appealed, the Tax Court decision became final on March 22, 1949. See I.R.C.1939, §§ 1140, 1142.
On December 30, 1948, the taxpayer mailed certified checks totaling $1,355,727.97 to the Collector of Internal Revenue. This amount represented deficiencies and interest for the years 1937 to 1942. Taxpayer also accrued on its books and deducted on its 1948 tax return the amount of $109,802.30 as interest on deficiencies for the years 1943 to 1947. It is this accrual which is here in issue. The Tax Court found that, although there was no clear admission of liability by reason of the payments in 1948,*fn1 it was extremely unlikely that the decision would be appealed. From this it concluded that the interest liability resulting from the 1948 decision was substantially fixed and unconditional in that year, so that accrual of the expense was justified. The decision was written by Judge Train and was reviewed and accepted by the full court, but Judge Harron filed a dissenting opinion, 31 T.C. 1080, 1104, with which we find ourselves in accord.
On the issue of likelihood of appeal there was evidence that prior to December 31, 1948, taxpayer's comptroller-vice president, after conferring with tax counsel, advised its president that an appeal should not be prosecuted. The minutes of a meeting of the board of directors on February 25, 1949, disclosed a statement by a board member that an appeal should not be prosecuted unless the Commissioner appealed, in which event a cross-appeal should be filed. This board member, the senior partner of a law firm representing taxpayer in tax matters, although not in the particular litigation, indicated that he had previously recommended this course to taxpayer's officers. The Tax Court also stressed the fact that its 1948 decision respecting the cost basis of the bus franchise "was based on findings of fact established by voluminous conflicting evidence," 31 T.C. 1080, 1102, although it should be noted that the court specifically had refused to include in the cost basis a number of items for which the taxpayer had contended. Upon consideration of the above-mentioned evidence the Tax Court found that, although taxpayer "did not decide not to appeal until sometime in 1949," it "did not contemplate appealing" as of December 31, 1948. 31 T.C. 1080, 1101.
While we agree that as of the end of the year 1948 it was more likely that taxpayer would not appeal than the contrary, it is unnecessary to decide the degree of remoteness of the probability of appeal, since we are of the opinion that the test adopted by the Tax Court was erroneous. The controlling principle is that enunciated by the Supreme Court in Dixie Pine Products Co. v. C.I.R., 320 U.S. 516, 519, 64 S. Ct. 364, 365, 88 L. Ed. 270: "It has long been held that, in order truly to reflect the income of a given year, all the events must occur in that year which fix the amount and the fact of the taxpayer's liability for items of indebtedness deducted though not paid; and this cannot be the case where the liability is contingent and is contested by the taxpayer. * * * [The taxpayer must] await the event of the state court litigation and might claim a deduction only for the taxable year in which its liability for the tax was finally adjudicated."
We think it clear that taxpayer's liability for the tax deficiencies, and thus the interest thereon, was not "finally adjudicated" in 1948. As the Ninth Circuit concluded in H. Liebes & Co. v. C.I.R., 9 Cir., 90 F.2d 932, 938, "If appeal is taken, the right is not fixed until determination of the appeal; and if no appeal is taken, * * * the right becomes fixed on termination of the appeal time." Or as picturesquely stated in United States v. Texas Mexican Ry. Co., 5 Cir., 263 F.2d 31, 34, "the existence of any liability is uncertain until the last bell is rung in the last court."*fn2 See also United States v. Safety Car Heating & Lighting Co., 297 U.S. 88, 56 S. Ct. 353, 80 L. Ed. 500; North American Oil Consolidated v. Burnet, 286 U.S. 417, 52 S. Ct. 613, 76 L. Ed. 1197; Lynch's Estate v. C.I.R., 2 Cir., 150 F.2d 747, 162 A.L.R. 313, certiorari denied 326 U.S. 780, 66 S. Ct. 336, 90 L. Ed. 472. To the extent that accounting principles are persuasive,*fn3 we note that the American Institute of Accountants has voiced its approval of the rule that contested or litigated liabilities such as tax deficiencies are deductible in the year in which the contest is resolved. See Recommendations to Congress by the American Institute of Accountants Regarding Divergencies Between Rules of Tax Accounting and Generally Accepted Accounting Principles, 97 J.Accountancy 93, 96 (1954).
While such a determinate standard might be deemed mechanical, by the same token it offers a clear guide to the taxpayer, promotes ease of administration, and contributes to the certainty of the revenue. Slight difficulty is imposed upon a taxpayer who desires an earlier deduction, since the right to appeal can be relinquished at any time by notifying the Commissioner of acquiescence. We thus see neither theoretical nor practical justification for introducing the complexities involved in determining reasonableness of expectation of appeal. As Judge Harron noted in her dissent, the decision therein would permit a taxpayer to choose the most advantageous year for accruing a deduction. Certainly taxpayer could have deducted the interest payment in 1949 without encountering any opposition from the Commissioner. The opportunity for manipulation is enhanced where, as here, taxpayer relies primarily upon evidence of private conversations among its officers, uncommunicated to any third party. The Supreme Court has continually denied both the Government and the taxpayer "the privilege of allocating income or outgo to a year other than the year * * * in which the right to receive, or the obligation to pay, has become final and definite in amount." Security Flour Mills Co. v. C.I.R., 321 U.S. 281, 286-287, 64 S. Ct. 596, 599, 88 L. Ed. 725. While there might be exceptional situations justifying accrual prior to termination of the right to appeal, a case where the taxpayer has not decided during the taxable year whether or not to appeal is not one of them.
II. The Taxpayer's Petition for Review.
The taxpayer seeks review of the Tax Court's disallowance of an accrual for contested wage claims in the years 1946 and 1948. Taxpayer and the Transport Workers Union of America, which represented its employees, were parties to a collective bargaining agreement which expired on September 30, 1946. Prior to and following this date the parties were unable to reach agreement as to a new wage scale, but in order to continue operations they agreed on October 7, 1946, that any subsequent contract resulting from the negotiations would be retroactive to October 1, 1946. In the interim the employees continued to work at the wage scale provided in the expired contract. Negotiations continued without success until March 7, 1947, when the parties agreed to submit the dispute to arbitration. The union sought a 25-cent-per-hour increase, while the taxpayer insisted that no increase was justified. On June 18, 1947, the arbitrator promulgated his award which, inter alia, granted a wage increase of 6 cents per hour, retroactive to October 1, 1946.
This agreement arrived at by arbitration expired on January 31, 1948.The parties again were unable to agree upon new terms, and on January 26, 1948, they entered into an agreement similar to that of October 7, 1946. Subsequently the taxpayer agreed to a wage increase effective May 1, 1948, on the condition that the city grant a fare increase. This condition was fulfilled and petitioner increased wages by 24 cents per hour.The question of additional compensation for the interim period remained a matter of dispute, however, and the matter was finally submitted to arbitration on March 1, 1949. The union urged that the 24-cent-per-hour increase be applied retroactively, while the taxpayer adopted the position that no back pay award should be granted. On May 30, 1949, the arbitrator determined that the employees were entitled to an additional 10 cents per hour for the period February 1 to April 30, 1948.
These retroactive wage increases of 6 and 10 cents per hour were accurately estimated by taxpayer, which deducted the additional amounts as accrued wage expense in its tax returns for 1946 and 1948.*fn4 The Commissioner refused to allow these deductions on the ground that the taxpayer had been actively contesting the union demands, so that neither liability nor the amount thereof was reasonably established at the end of the taxable years. Taxpayer relied upon the fact that it had contracted to pay any increase that should be determined, contended that it always recognized its obligation to pay just compensation for the services rendered, and maintained that its officers ...