Litigation ensued. . . . and in 1922 a final settlement was made by the taxpayers with the purchasers.

The acceptance of a draft is a condition precedent to the passing of title... Accordingly, the merchandise in question should have been carried in the inventory of the taxpayers until 1922, when a closed transaction occurred in connection therewith. (C. B. III-1, 57; I. T. 2001.)

General Basis for Valuation of Inventories

REGULATION. Section 205 provides two tests to which each inventory must conform:

First. It must conform as nearly as may be to the best accounting practice in the trade or business, and

Second. It must clearly reflect the income.

It follows, therefore, that inventory rules can not be uniform but must give effect to trade customs which come within the scope of the best accounting practice in the particular trade or business. In order clearly to reflect income, the inventory practice of a taxpayer should be consistent from year to year, and greater weight is to be given to consistency than to any particular method of inventorying or basis of valuation so long as the method or basis used is substantially in accord with these regulations. An inventory that can be used under the best accounting practice in a balance sheet showing the financial position of the taxpayer can, as a general rule, be regarded as clearly reflecting his income.

The bases of valuation most commonly used by business concerns and which meet the requirements of section 205 are (a) cost and (b) cost or market, whichever is lower. . .

In respect to normal goods, whichever basis is adopted must be applied with reasonable consistency to the entire inventory. Taxpayers were given an option to adopt the basis of either (a) cost or (b) cost or market, whichever is lower, for their 1920 inventories. The basis adopted for that year is controlling, and a change can now be made only after permission is secured from the Commissioner. Application for permission to change the basis of valuing inventories shall be made at least 30 days prior to the close of the taxable year for which the change is to be effective. Goods taken in the inventory which have been so intermingled that they can not be identified with specific invoices will be deemed to be the goods most recently purchased or produced, and the cost thereof will be the actual cost of the goods purchased or produced during the period in which the quantity of goods in the inventory has been acquired. Where the taxpayer maintains book inventories in accordance with a sound accounting system in which the respective inventory accounts are charged with the actual cost of the goods purchased or produced and credited with the value of goods used, transferred, or sold, calculated upon the basis of the actual cost of the goods acquired during the taxable year (including the inventory at the beginning of the year), the net value as shown by such inventory accounts will be deemed to be the cost of the goods on hand. The balances shown by such book inventories should be verified by physical inventories at reasonable intervals and adjusted to conform therewith.

Inventories should be recorded in a legible manner, properly computed and summarized, and should be preserved as a part of the accounting

records of the taxpayer. The inventories of taxpayers on whatever basis taken will be subject to investigation by the Commissioner, and the taxpayer must satisfy the Commissioner of the correctness of the prices adopted.

The following methods, among others, are sometimes used in taking or valuing inventories, but are not in accord with these regulations, viz.: (1) Deducting from the inventory a reserve for price changes, or an estimated depreciation in the value thereof.

(2) Taking work in process, or other parts of the inventory, at a nominal price or at less than its proper value.

(3) Omitting portions of the stock on hand.

(4) Using a constant price or nominal value for a so-called normal quantity of materials or goods in stock."

(5) Including stock in transit, either shipped to or from the taxpayer, the title of which is not vested in the taxpayer. (Art. 1612.)

The foregoing regulation is an admirable exposition of good accounting practice. The five methods which are specifically disapproved are in themselves technical departures from good accounting practice. In practice the necessary writing down of inventory values to meet actual market conditions, adhering strictly to the regulations, will in many cases produce the same net result as if one or more of the methods disapproved had been used.

In Buss Co.'s Appeal [2 B. T. A. 266 (A)] the Board overruled the Commissioner who had disapproved the methods of a taxpayer which had been consistently followed for twelve years, and set up adjustments which produced an absurd result. Article 1612 was

followed by the taxpayer and ignored by the Commissioner.

DECISION. The taxpayer since its organization in 1911 has used the method of inventorying its merchandise set forth in the findings of fact. This method is somewhat faulty in that it does not show with mathematical precision the actual cost or the cost or market values, whichever is lower, of the merchandise, and in that it does not comply strictly with the regulations of the Commissioner. The principal fault is that such inventories are based on estimates. The principal merit of the taxpayer's system is that it has been uniformly and consistently used for twelve years or more. However, we cannot see that the Commissioner has improved the situation. He has used the same estimated values and restored what he considers was the taxpayer's depreciation to obtain market value. At the hearing it developed that the taxpayer had not depreciated the market values but was in fact attempting to reduce market to cost. . . . The result of the Commissioner's computation is obviously to distort the true situation. . . . . However faulty the taxpayer's inventory method was, we believe that greater weight should be given to consistency than to any particular method of inventorying or basis of valuation so long as the method or basis used substantially reflects the income. This For discussion of this method see "Inventories," by H. B. Fernald, Proceedings, American Mining Congress, 1923.

rule has been given great weight both by the Commissioner and the Board in Appeal of The Thomas Shoe Co., 1 B. T. A. 124, and Appeal of George C. Peterson Co., 1 B. T. A. 690.

The Board indicates in its opinion that inventories may be exact. For a number of years, the author has contended that the best inventories are those which are carefully estimated, not those taken by clerks who are concerned only with book cost or quoted market values.

The author's criticisms of Treasury and Tax Board practice in previous editions of this book, are repeated by the Court in Wood & Ewer Co. v. Ham, Collector (U. S. Dist. Ct. N. D. Maine, Sept. 29, 1926). The General Counsel has recommended to the Department of Justice that no appeal be taken from this decision.

The court in discussing the whole field of inventory valuation said:

DECISION. By the Government records it appears that the plaintiff corporation in March, 1920, filed its return for the year ending December 31, 1919, in which it showed an inventory of $81,192.15 as the value of goods and stock. On May 21, 1924, an additional tax was assessed upon it in the sum of $4,599.38 for the year 1919. The assessment was based upon an adjusted value of its inventories, which was increased by 25 per cent of the amount previously returned. In 1920, by its return, it deducted, as its closing inventory the sum of $78,598.82 . On May 21, 1924, the closing inventory was increased from $78,598.82, as shown on the return of the corporation, to $104,798.42. A tax was assessed upon the difference in the two inventories.

For the year 1919 the question at issue arises upon the plaintiff's method of keeping its inventory. . .

Section 203 of the U. S. Revenue Act of 1918, provides as follows:

"Whenever in the opinion of the Commissioner the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer upon such basis as the Commissioner with the approval of the Secretary, may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income."

A regulation, issued in 1920, relating to income taxes under the Revenue Act of 1918, contains the following: "Art. 1582 Valuation of Inventories. Inventories should be valued at (a) cost, or (b) cost or market, whichever is lower. Whichever basis is adopted must be applied to each item and not merely to the total of the inventory; that is, if for instance basis (b) is adopted, the value of each item in the inventory will be measured by market if that is lower than cost, or by cost if that is lower than market. . . ."

The assessment of the taxes by the officials of the United States, charged with the duty of assessment, is prima facie valid. The burden is on the taxpayer to establish by a fair preponderance of evidence, that

the assessment is not correct; and that the tax is not a valid tax. Anderson v. Farmers' Loan & Trust Co., 241 Fed. 322, 329; Germantown Trust Co. v. Lederer, 263 Fed. 672, 676.

1. The first question arises upon the assessment for 1919. The regulation makes it incumbent upon the plaintiff to present an inventory "valued at (a) cost, or (b) cost or market, whichever is lower. Whichever basis is adopted must be applied to each item and not merely to the total of the inventory."

The plaintiff says that it has made its inventory in compliance with the above provision; that it carried out each item in the inventory; that it took its reduction on each item, in some cases article by article, and in some cases by applying a reasonable discount, such discount being shown by affirmative testimony to have arrived at a fair market value; that it applied its basis of valuation to each item, and not to the total; that it was pursuing the method which the Government had allowed the company to pursue for several years; that the result was favorable to the Government, rather than to the corporation; and that it is a fair method of finding market value.

The defendant urges that, upon the evidence, a flat discount of twentyfive per cent was taken from cost to determine the market value, the market being lower than cost, and that such a method was not allowable under the regulations, and did not show such market value as contemplated by the law; that the method followed by the plaintiff, even though it may have produced a result nearly correct, was not allowable under the law; and that the Commissioner properly restored the inventory to cost, such being the only market value on which the tax could be assessed.

The learned counsel for the defendant urges that, while the actual inventory returned by the taxpayer may have been close to the market, it is not a "market inventory" and must be disallowed.

The plaintiff introduces the testimony of the buyers for the company. These ladies testified that they knew the market; that they went to New York frequently and were familiar with the cost prices and sale prices and that the figures in the inventory represented, according to their best judgment, a fair market value of the articles on hand; that they conferred together and placed a fair market value upon the stock, in some instances article by article, and in others department by department, and that the discount which they took upon some of the items was such as, to the best of their ability, represented a fair market value of the goods. It was shown by the testimony of the competitors in business that the figures arrived at as the fair market value for the years 1919 and 1920 were altogether in favor of the Government; that, even in cases where the twenty-five per cent discount was made, the market was lower than the figures arrived at by the plaintiff in its inventory; that fixing a local market value is difficult and at best a matter of judgment; that, while the market value is said by some witnesses to have been arrived at "by guess," it appears that such "guess" represented the fair estimation of the witnesses.

It is shown by evidence that the Government Tax Inspector recognized the difficulty of arriving at market value; that he made a report to the Government holding that percentage mark-downs of inventories were not allowable under the regulations, but saying that "it is impossible to as

certain the exact market value of the goods in this inventory, which consisted of thousands of articles of ladies' wearing apparel varying in quality, style and fabric, particularly at a time when prices were dropping rapidly."

It is not altogether easy to give the proper interpretation to the regulation. Such a regulation must receive a strict construction. Schwab v. Doyle, 258 Ú. S., 529, 536. It cannot mean that the Government expects a market value to be assigned in detail to each item, enumerating each item. The purpose of the regulation is, I think, to provide that each item must be set down separately in the inventory, so as to give the Government the opportunity to examine in detail, and to present testimony upon every item if it chooses, and to contradict any testimony offered by the plaintiff.

The record shows that the plaintiff carried the inventory department by department, each article being identified by stock number; that the cost price of each article was carried out; that the year when each article was purchased was indicated; that, in arriving at the market value of the goods at the end of each year, in some departments the discount was taken on the department as a whole; and, in every case, each box containing the article was removed from the shelf, identified, the number of articles it contained was called off by one person and the number and and the cost price written down by another.

The learned counsel for the defendant cites the case of the Farmers' Hardware Company (2 B. T. A. 90), in which case the Commissioner restored the taxpayer's inventory to cost, under circumstances claimed to be similar to those in the case at bar. He cites also When Clothing Company (1 B. T. A. 973) and the case of Orkin Brothers (2 B. T. A. 65). I am unable to obtain much aid from the cases cited. In each case the decision seems to have been based upon facts in some respects unlike those now before me. In the instant case the witnesses for the plaintiff were subjected to careful and critical cross-examination by the able and experienced counsel for the Government. No witnesses were produced to contradict the testimony offered by the plaintiff or to show that its witnesses were mistaken as to the market value of the articles in the inventory, although each item was set out in the inventory; and a full opportunity was given to question the good faith of the witnesses, and to challenge the result reached by them.

I am constrained to find that the plaintiff made a substantial compliance with the law and with the regulation under which the inventory in question was made; and that the market value arrived at by the plaintiffs represented the fair market value of the articles in question.

Inventory losses.-In Haas Bros.' Appeal (3 B. T. A. 113) the Board sustained the Commissioner who had disallowed losses which had accrued in fact at December 31, 1919 and December 31, 1920, due to a decline in market prices. Certain goods had been purchased for future delivery, were in existence and in one case storage and insurance were being charged. It appeared, however, that the goods sold to the taxpayer had not specifically been set aside. The Board