B-25554, JUNE 2, 1942, 21 COMP. GEN. 1082

B-25554, JUNE 2, 1942, 21 COMP. GEN. 1082

CONTRACTS - COST-PLUS - INCLUSION OF CAPITAL STOCK TAX REIMBURSEMENT OF AN AMOUNT REPRESENTING FEDERAL CAPITAL STOCK TAX PAID BY A COST-PLUS-A-FIXED-FEE CONTRACTOR IS NOT AUTHORIZED UNDER A CONTRACT WHICH, BY REFERENCE TO TREASURY DECISION 5000 CONTROLLING AMOUNTS PAYABLE THEREUNDER, SPECIFICALLY DESIGNATES EXCESS PROFITS TAX TO BE AN ITEM OF COST NOT ALLOWABLE AND DOES NOT EXPRESSLY PROVIDE FOR REIMBURSEMENT OF CAPITAL STOCK TAX, WHICH IS SO CLOSELY RELATED TO EXCESS PROFITS TAX THAT A HIGHER VALUATION OF CAPITAL STOCK, RESULTING IN AN INCREASE IN CAPITAL STOCK TAX, ACTS TO DECREASE THE AMOUNT OF ANY EXCESS PROFITS TAX.

COMPTROLLER GENERAL WARREN TO LT. COL. F. E. COYNE, U.S. ARMY, JUNE 2, 1942:

THERE HAS BEEN RECEIVED, BY INDORSEMENT OF APRIL 20, FROM THE DIRECTOR, FISCAL DIVISION, YOUR LETTER OF APRIL 13, 1942, REQUESTING A DECISION AS TO WHETHER YOU ARE AUTHORIZED TO MAKE PAYMENT ON A VOUCHER TRANSMITTED THEREWITH IN FAVOR OF THE NORTH AMERICAN AVIATION, INC., OF KANSAS, IN THE AMOUNT OF $50,000, REPRESENTING CAPITAL STOCK TAX AS AN ITEM OF COST UNDER COST-PLUS-A-FIXED-FEE CONTRACT NO. W-535 AC-19341, DATED JUNE 27, 1941.

THE VOUCHER IS SUPPORTED BY EVIDENCE OF PAYMENT OF THE TAX AND BY A COPY OF A 1941 CAPITAL STOCK TAX RETURN FOR THE YEAR ENDED JUNE 30, 1941, FILED BY THE CONTRACTOR, FROM WHICH IT APPEARS THAT THE CORPORATION WAS INCORPORATED OR ORGANIZED IN THE STATE OF DELAWARE ON JUNE 23, 1941, FOR THE PURPOSE OF DOING BUSINESS AS A MANUFACTURER OF AIRCRAFT AND PARTS; THAT ON JUNE 30, 1941, THE CORPORATION'S OUTSTANDING STOCK CONSISTED OF 6,000 SHARES OF COMMON STOCK OF A PAR VALUE OF $1 PER SHARE; AND THAT ITS PAID-IN SURPLUS AMOUNTED TO $2,994,000. THE VOUCHER HAS BEEN APPROVED FOR PAYMENT BY THE CONTRACTING OFFICER SUBJECT TO AN EXCEPTION THERETO BASED UPON AN OPINION OF JOSEPH C. GLAZER, CONTRACT SECTION, OFFICE OF THE DISTRICT SUPERVISOR, CENTRAL A.C. PROCUREMENT DISTRICT, DETROIT, MICHIGAN, AS FOLLOWS:

1. THE CONTRACTOR, IN MAKING A DECLARATION OF VALUE FOR CAPITAL STOCK TAX RETURN, HAS ARBITRARILY DECLARED A VALUATION OF $40,000,000, ALTHOUGH PAID IN CAPITAL IS LESS THAN $3,000,000.

2. THE SUBJECT CONTRACT FAILS TO MENTION THE ALLOWABILITY OF ANY EXPENSES INVOLVED IN CONNECTION WITH THE CORPORATE CAPITAL STRUCTURE.

3. THE CONTRACTOR IS NOT IN ANY MANNER AIDED IN THE PERFORMANCE OF THIS CONTRACT BY THE PAYMENT OF THIS CAPITAL STOCK TAX AMOUNTING TO $50,000. ON THE OTHER HAND, THE CORPORATION IS ATTEMPTING TO AVOID ITS PROPER RATE OF TAXATION BY THE USE OF AN EXCESSIVE VALUATION IN ITS CAPITAL STOCK TAX RETURN. CAPITAL STOCK TAX IS IN EFFECT JUST ANOTHER FORM OF INCOME OR EXCESS PROFITS TAX. THE DECLARED VALUE EXCESS PROFITS TAX MAY BE AVOIDED ENTIRELY BY A SUFFICIENTLY HIGH DECLARED VALUE FOR THE PURPOSE OF THE CAPITAL STOCK TAX.

4. T.D. 5000 SPECIFICALLY DISALLOWS THE FOLLOWING EXPENSES:

INTEREST ON INVESTED CAPITAL; FEDERAL AND STATE INCOME TAXES; EXCESS PROFIT TAXES AND SURTAXES; EXPENSES OF SECURITIES, AND CAPITAL STOCK ISSUES. ( (G) (4) ( IT CAN CLEARLY BE SEEN THAT ALL EXPENDITURES CONNECTED WITH THE CORPORATE CAPITAL STRUCTURE ARE NOT ALLOWABLE COSTS.

5. T.D. 5000 SPECIFICALLY DISALLOWS PROFIT OR LOSS FROM SALE OR EXCHANGE OF CAPITAL ASSETS. THIS IS ANOTHER INDICATION THAT ALL EXPENSES INVOLVING THE CORPORATE CAPITAL STRUCTURE ARE NOT ALLOWABLE COSTS.

6. THE ONLY TAXES SPECIFICALLY ALLOWED IN T.D. 5000 ARE:

SALES TAXES; COMPENSATION INSURANCE; FEDERAL AND STATE UNEMPLOYMENT, OLD- AGE, AND SOCIAL SECURITY TAXES; AND PROPERTY TAXES. NONE OF THESE TAXES, WHICH ARE ALLOWABLE COSTS, ARE IN ANY WAY CONNECTED WITH THE CAPITAL STRUCTURE OF THE CORPORATION. THEY ALL ARE DIRECTLY CONNECTED WITH THE CORPORATE PROPERTY OR LABOR.

7. DEPRECIATION IS AN ALLOWABLE ITEM OF EXPENSE ONLY AS APPLIED TO PROPERTY ACTUALLY USED AND REASONABLE STAND-BY EQUIPMENT. IN LIKE MANNER, THE EXCESSIVE VALUATION SHOULD NOT BE USED AS A BASIS TO CREATE ADDITIONAL ALLOWABLE EXPENSES.

8. IT MIGHT BE ARGUED THAT THE PAYMENT OF THE CAPITAL STOCK TAX ON A REASONABLE DECLARATION OF VALUE IS AN ORDINARY AND PROPER EXPENSE OF A PRIVATE CORPORATION, ESPECIALLY SINCE IT DOES LAWFULLY REDUCE THE AMOUNT OF ITS OTHER TAX LIABILITY, AND SO SHOULD BE ALLOWED AS ONE OF THE EXPENSES IN THE COST-1PLUS-1A-1FIXED-1FEE CONTRACT. HOWEVER, ON NOVEMBER 12, 1941, COMPTROLLER GENERAL DECISION B-21209 HELD THAT UNDER LIKE CIRCUMSTANCES ( CPFF CONTRACT PROVIDED FOR THE GOVERNMENT BEARING ALL COSTS AND EXPENSES OF EVERY CHARACTER WHEN APPROVED BY THE CONTRACTING OFFICER) THAT AN APPROVED EXPENDITURE FOR MEMBERSHIP IN THE LOCAL CHAMBER OF COMMERCE IS NOT AN ALLOWABLE ITEM OF COST:

"WHILE REFERENCE IS MADE TO CERTAIN INFORMATION WHICH HAS BEEN AND MAY BE OBTAINED BY REASON OF SUCH MEMBERSHIP, IT APPEARS FROM THE FACTS OF RECORD THAT SUCH BENEFITS ARE PURELY INCIDENTAL, THAT IS, THE APPROVAL OF THE CONTRACTING OFFICER'S REPRESENTATIVE OF THE EXPENSE OF THE MEMBERSHIP FEE IN THE CHAMBER OF COMMERCE IS NOT BY REASON OF ITS HAVING BEEN INCURRED IN PURSUANCE OF ANY LEGAL OBLIGATION OR IN THE FURTHERANCE OF ANY DUTY REQUIRED UNDER THE CONTRACT, BUT IS "GRANTED BECAUSE IT IS THE POLICY OF THE ATLAS POWDER CO. TO TAKE MEMBERSHIP IN THE CHAMBER OF COMMERCE IN THE LOCALITY WHERE THEY OPERATE A PLANT OR FACTORY.' WHILE IT MAY BE CONCEDED THAT SUCH IS THE POLICY OF THE CONTRACTOR AND OF PRIVATE FIRMS IN GENERAL WHO, BY PROMOTING THE GENERAL TRADE AND COMMERCE OF THE LOCALITY IN WHICH THEY OPERATE, THUS DIRECTLY OR INDIRECTLY PROMOTE THEIR OWN INTERESTS, SUCH MEMBERSHIP, INSOFAR AS THE OPERATION OF A PLANT ON BEHALF OF THE GOVERNMENT IS CONCERNED, MAY NOT UNDER ANY FAIR AND REASONABLE CONSTRUCTION OF THE CONTRACT TERMS BE VIEWED AS A COST OR EXPENSE PERTINENT TO, OR NECESSARY FOR, THE PROPER PERFORMANCE OF THE WORK THEREUNDER.'

THERE WAS TRANSMITTED WITH YOUR REQUEST FOR DECISION A LETTER DATED APRIL 6, 1942, FROM THE ASSISTANT TREASURER, NORTH AMERICAN AVIATION, INC., OF KANSAS, TO THE RESIDENT AUDITOR OF THAT CORPORATION AT KANSAS CITY, KANS., AS FOLLOWS:

IN ACCORDANCE WITH THE REQUEST OF THE RESIDENT AUDITOR FOR THE CONTRACTOR TO FURNISH STATEMENT AS TO WHY SUCH VOUCHER SHOULD BE PAID AND REIMBURSEMENT RECEIVED UNDER CONTRACT W 535-AC-19341 IS SET FORTH IN THE FOLLOWING PARAGRAPH.

UNDER THE CONTRACT ENTERED INTO BY NORTH AMERICAN AVIATION, INC., OF KANSAS AND THE WAR DEPARTMENT, APPROVED BY THE DIRECTION OF THE SECRETARY OF WAR AND SIGNED BY THE UNDER SECRETARY OF WAR, ROBERT P. PATTERSON, DATED JUNE 28TH, 1941, PARAGRAPH C, ARTICLE 3 OF SAID CONTRACT W 535-AC- 19341 SETS FORTH THAT THE CONTRACTING OFFICER WILL REIMBURSE THE CONTRACTOR FOR COSTS IN PERFORMING THE CONTRACT IN ACCORDANCE WITH SECTION 26.9 OF CHAPTER 1 AS CONTAINED IN T.D. 5000.

THE SECTION REFERRED TO IN T.D. 5000 IS THE LAST PARAGRAPH IN G-4. FEDERAL AND STATE INCOME AND EXCESS PROFITS TAX AND SURTAX ARE NOT ALLOWABLE ITEMS OF COST. IN OTHER PORTIONS OF THE SECTION REFERRED TO VARIOUS TAXES, BUT NOT ALL TAXES, ARE REFERRED TO AS BEING ALLOWABLE ITEMS OF COST. FEDERAL CAPITAL STOCK TAXES ARE NOT SPECIFICALLY MENTIONED, AND SINCE THEY ARE NOT SPECIFICALLY MENTIONED AND EXCLUDED, THE CONTRACTOR IS OF THE OPINION THAT THEY ARE ALLOWABLE ITEMS OF COST, FOR IT IS NOT POSSIBLE TO PERFORM THE CONTRACT WITHOUT PAYING SUCH TAXES.

FURTHERMORE, FEDERAL CAPITAL STOCK TAXES HAVE LONG BEEN INCLUDED AMONG THE TAXES ASSESSED BY THE FEDERAL GOVERNMENT, AND IF IT HAD BEEN THE INTENTION OF THE TREASURY DEPARTMENT TO EXCLUDE SUCH TAXES, THE TAXPAYER BELIEVES THAT IT WOULD HAVE BEEN SPECIFICALLY MENTIONED.

IF THE CONTRACTOR IS TO PROCEED TO SECURE A LEGAL OPINION AT THE REQUEST OF THE GOVERNMENT, PLEASE ADVISE, HOWEVER, THE CONTRACTOR BELIEVES IT IS NOT NECESSARY TO DO THIS, FOR IT IS THE CONTRACTOR'S OPINION THERE SHOULD BE NO DISPUTE AS TO THE ALLOWABILITY OF THIS TAX.

THE CONTRACT PROVIDES FOR THE DELIVERY OF 1,200 BOMBARDMENT AIRPLANES, ENGINEERING INFORMATION AND SERVICE IN CONSIDERATION OF THE REIMBURSEMENT OF THE CONTRACTOR'S COST OF FURNISHING AIRPLANES, AND A FIXED PRICE OF $900,000 FOR THE ENGINEERING INFORMATION AND SERVICE, PLUS A STIPULATED FIXED FEE. WITH RESPECT TO THE DETERMINATION OF THE CONTRACTOR'S COST OF FURNISHING THE AIRPLANES, ARTICLE 3 (C) OF THE CONTRACT PROVIDES:

FOR PURPOSES OF DETERMINING THE AMOUNTS PAYABLE TO THE CONTRACTOR UNDER THIS CONTRACT, ALLOWABLE ITEMS OF COST WILL BE DETERMINED BY THE CONTRACTING OFFICER IN ACCORDANCE WITH THE REGULATIONS FOR THE DETERMINATION OF THE COST OF PERFORMING A CONTRACT AS PROMULGATED BY THE TREASURY DEPARTMENT IN SECTION 26.9 OF CHAPTER 1, OF TITLE 26 OF CODE OF FEDERAL REGULATIONS, AS CONTAINED IN T.D. 5000 AND APPROVED BY THE SECRETARY OF WAR AUGUST 2, 1940, * * *.

SECTION 26.9 OF THE CITED TREASURY DECISION 5000 SETS FORTH IN SOME DETAIL NUMEROUS ITEMS OF ALLOWABLE COSTS BUT DOES NOT INCLUDE AMONG SAME CAPITAL STOCK TAX AS AN ALLOWABLE ITEM. HOWEVER, SAID SECTION 26.9 INCLUDES THE FOLLOWING:

AMONG THE ITEMS WHICH SHALL NOT BE INCLUDED AS A PART OF THE COST OF PERFORMING A CONTRACT OR SUBCONTRACT OR CONSIDERED IN DETERMINING SUCH COST, ARE THE FOLLOWING: ENTERTAINMENT EXPENSES; DUES AND MEMBERSHIPS OTHER THAN OF REGULAR TRADE ASSOCIATIONS; DONATIONS EXCEPT AS OTHERWISE PROVIDED ABOVE; LOSSES ON OTHER CONTRACTS; PROFITS OR LOSSES FROM SALES OR EXCHANGES OF CAPITAL ASSETS; EXTRAORDINARY EXPENSES DUE TO STRIKES OR LOCKOUTS; FINES AND PENALTIES; AMORTIZATION OF UNREALIZED APPRECIATION OF VALUES OF ASSETS; EXPENSES, MAINTENANCE AND DEPRECIATION OF EXCESS FACILITIES (INCLUDING IDLE LAND AND BUILDING, IDLE PARTS OF A BUILDING, AND EXCESS MACHINERY AND EQUIPMENT) VACATED OR ABANDONED, OR NOT ADAPTABLE FOR FUTURE USE IN PERFORMING CONTRACTS OR SUBCONTRACTS; INCREASES IN RESERVE ACCOUNTS FOR CONTINGENCIES, REPAIRS, COMPENSATION INSURANCE (EXCEPT AS ABOVE PROVIDED WITH RESPECT TO SELF-INSURANCE) AND GUARANTEE WORK; FEDERAL AND STATE INCOME AND EXCESS-PROFITS TAXES AND SURTAXES; CASH DISCOUNT EARNED UP TO ONE PERCENT OF THE AMOUNT OF THE PURCHASE, EXCEPT THAT ALL DISCOUNTS ON SUBCONTRACTS SUBJECT TO THE ACT WILL BE CONSIDERED; INTEREST INCURRED OR EARNED; BOND DISCOUNT OR FINANCE CHARGES; PREMIUMS FOR LIFE INSURANCE ON THE LIVES OF OFFICERS; LEGAL AND ACCOUNTING FEES IN CONNECTION WITH REORGANIZATIONS, SECURITY ISSUES, CAPITAL STOCK ISSUES AND THE PROSECUTION OF CLAIMS AGAINST THE UNITED STATES (INCLUDING INCOME TAX MATTERS); TAXES AND EXPENSES ON ISSUES AND TRANSFERS OF CAPITAL STOCK; LOSSES ON INVESTMENTS; BAD DEBTS; AND EXPENSES OF COLLECTION AND EXCHANGE.

WHETHER A PARTICULAR ITEM OF EXPENSE IS REIMBURSABLE TO THE CONTRACTOR AS SUCH UNDER THIS FORM OF CONTRACT OR WHETHER IT IS INCLUDED IN LUMP-SUM- FIXED-FEES OR OTHER PAYMENTS DEPENDS UPON THE TERMS OF THE CONTRACT. TREASURY DECISION 5000, WHICH IS TO SERVE AS THE CONTRACTING OFFICER'S CRITERION IN DETERMINING THE AMOUNTS PAYABLE UNDER THE CONTRACT, PROVIDES THAT FEDERAL AND STATE INCOME AND EXCESS PROFITS TAXES AND SURTAXES AS WELL AS TAXES AND EXPENSES ON ISSUES AND TRANSFERS OF CAPITAL STOCK ARE ITEMS OF COST WHICH MAY NOT BE INCLUDED AS A PART OF THE COST OF PERFORMING A CONTRACT OR SUBCONTRACT OR BE CONSIDERED IN DETERMINING SUCH COST. MOREOVER, NEITHER THE CONTRACT NOR THE TREASURY DECISION EXPRESSLY PROVIDES FOR REIMBURSEMENT OF CAPITAL STOCK TAXES AS ITEMS OF COST AND NONE OF THE ITEMS OF EXPENSES WHICH ARE DEFINED AS ALLOWABLE COSTS COMPREHEND THE ALLOWANCE OF SUCH TAXES. ON THE CONTRARY, SUCH TAXES AS ARE ALLOWABLE RELATE TO PROPERTY OR LABOR AND ARE NOT CONNECTED IN ANY WAY WITH THE CAPITAL STRUCTURE OF THE CORPORATION, WHEREAS THE CAPITAL STOCK TAX IS A TAX ON THE CORPORATE STRUCTURE.

THE CONTRACTOR ADMITS THAT THE CAPITAL STOCK TAX IS NOT SPECIFICALLY MENTIONED IN THE CONTRACT BUT CONTENDS THAT SINCE THE TAX WAS NOT EXCLUDED IT SHOULD BE CONSIDERED AN ALLOWABLE ITEM OF COST BECAUSE "IT IS NOT POSSIBLE TO PERFORM THE CONTRACT WITHOUT PAYING SUCH TAXES.'

UNDER SECTION 26.9 IT IS PROVIDED, INTER ALIA, THAT THE COST OF PERFORMING A CONTRACT OR SUBCONTRACT GENERALLY INCLUDES THE PROPORTION OF ANY INDIRECT COST (INCLUDING THEREIN A REASONABLE PROPORTION OF MANAGEMENT EXPENSES) INCIDENT TO AND NECESSARY FOR THE PERFORMANCE OF THE CONTRACT OR SUBCONTRACT, AND WHILE IT IS FURTHER PROVIDED THAT NO DEFINITION OF THE ELEMENTS OF COST MAY BE STATED WHICH ARE FOR INVARIABLE APPLICATION TO ALL CONTRACTORS AND SUBCONTRACTORS ALIKE, MANIFESTLY, THE CAPITAL STOCK TAX, WHILE ADMITTEDLY AN EXPENSE WHICH THE CONTRACTOR WAS REQUIRED TO PAY, MAY NOT BE REGARDED AS WITHIN ANY REASONABLE CONCEPT OF THE TERM "INCIDENT TO AND NECESSARY FOR THE PERFORMANCE OF THE CONTRACT"--- THAT IS, AN EXPENSE NECESSARY FOR THE COMPLETION OF THE CONTRACT WORK.

MOREOVER, WHILE THE CAPITAL STOCK TAX HAS BEEN HELD TO BE AN EXCISE TAX LEVIED UPON THE PRIVILEGE OF DOING BUSINESS AS A CORPORATION, FLINT V. STONE TRACY COMPANY, 220 U.S. 107, THAT TAX AND THE EXCESS PROFITS TAX ARE CLOSELY INTERRELATED DUE TO THE FACT THAT THE DECLARED VALUE OF THE CAPITAL STOCK IS THE BASIS OF COMPUTATION OF BOTH TAXES. SEE SECTIONS 1200 (A) AND 600 OF THE INTERNAL REVENUE CODE, AS AMENDED, AND HELVERING V. LERNER STORES CORP., 86 S.1CT. 299, WHEREIN THE COURT STATED AT PAGE 301, AS FOLLOWS:

* * * THE TAXPAYER IS FREE TO DECLARE ANY VALUE OF THE CAPITAL STOCK FOR THE FIRST YEAR WHICH IT MAY CHOOSE. WHILE A LOW DECLARATION OF VALUE DECREASES THE AMOUNT OF THE CAPITAL STOCK TAX, IT INCREASES THE RISK OF A HIGH EXCESS PROFITS TAX. ON THE OTHER HAND, A HIGH DECLARATION OF VALUE WHILE DECREASING THE TAX ON EXCESS PROFITS, INCREASES THE CAPITAL STOCK TAX. BY ALLOWING THE TAXPAYER "TO FIX FOR ITSELF THE AMOUNT OF THE TAXABLE BASE" FOR PURPOSES OF COMPUTATION OF THESE TAXES, CONGRESS "AVOIDED THE NECESSITY OF PRESCRIBING A FORMULA FOR ARRIVING AT THE ACTUAL VALUE OF CAPITAL"--- A PROBLEM "WHICH HAD BEEN FOUND PRODUCTIVE OF MUCH LITIGATION UNDER EARLIER TAXING ACTS.' HAGGAR CO. V. HELVERING, SUPRA (308 U.S. P. 394, 84 L.ED. 344, 60 S.1CT. 337). SEE 1 BONBRIGHT, VALUATION OF PROPERTY, PP. 577-594. "AT THE SAME TIME IT GUARDED AGAINST LOSS OF REVENUE TO THE GOVERNMENT THROUGH UNDERSTATEMENTS OF CAPITAL" BY PROVIDING A FORMULA WHICH WOULD IN SUCH CIRCUMSTANCES RESULT IN AN INCREASE IN THE EXCESS PROFITS TAX. HAGGAR CO. V. HELVERING, SUPRA (308 U.S. P. 394, 84 L.ED. 344, 60 S.1CT. 337).

IN THE INSTANT CASE, THE CONTRACTOR PLACED A VALUATION OF $40,000,000 ON ITS ENTIRE CAPITAL STOCK AND ON THE BASIS OF THIS VALUATION IT PAID A CAPITAL STOCK TAX OF $50,000, COMPUTED AT $1.25 FOR EACH FULL THOUSAND DOLLARS, AS PROVIDED BY SECTION 1200 (A) OF THE INTERNAL REVENUE CODE, AS AMENDED. OBVIOUSLY, SUCH A HIGH DECLARED VALUATION RESULTS IN THE PAYMENT OF A HIGHER CAPITAL STOCK TAX AND A LOWER EXCESS PROFITS TAX, IF ANY, AND TO ALLOW THE CONTRACTOR REIMBURSEMENT OF THE AMOUNT OF CAPITAL STOCK TAX AS AN ITEM OF COST UNDER THE CONTRACT WOULD, IN EFFECT, CIRCUMVENT--- TO SOME EXTENT, AT LEAST--- THE PROVISION EXPRESSLY DESIGNATING EXCESS PROFITS TAX AS AN ITEM OF COST NOT ALLOWABLE UNDER THE CONTRACT.

ACCORDINGLY, THE VOUCHER, TOGETHER WITH PERTINENT PAPERS, IS RETURNED HEREWITH, AND YOU ARE ADVISED THAT PAYMENT THEREON IS NOT AUTHORIZED.