INVESTIGATION OF THE BUREAU OF INTERNAL REVENUE WEDNESDAY, JANUARY 28, 1925 UNITED STATES SENATE, SELECT COMMITTEE TO INVESTIGATE THE BUREAU OF INTERNAL REVENUE, Washington, D. C. The committee met at 10:30 o'clock a. m., pursuant to adjournment of yesterday. Present: Senators Couzens (presiding), Watson, and Jones of New Mexico. Present also: Mr. L. C. Manson, of counsel for the committee; Mr. L. H. Parker, chief engineer for the committee; and Mr. Raleigh C. Thomas, investigating engineer for the committee. Present on behalf of the Bureau of Internal Revenue: Mr. Nelson T. Hartson, Solicitor Bureau of Internal Revenue; Mr. James M. Williamson, attorney, office of Solicitor, Bureau of Internal Revenue; Mr. S. M. Greenidge, head, engineering division, Bureau of Internal Revenue; and Mr. W. S. Tandrow, appraisal engineer, Bureau of Internal Revenue. Mr. MANSON. This is the matter of the amortization allowance of the Saginaw Shipbuilding Co. It involves the question of contractual amortization. The amortization claimed on the original return was $1,239,757.83. The amortization allowance was $1,078,316.73. The taxpayer then filed a revised claim in the same amount as originally claimed, upon which the Unit allowed $1,234,763.13. The Shipping Board allowed amortization to this taxpayer of $685,171.34. Senator WATSON. What case is this, now? Mr. MANSON. This is the Saginaw Shipbuilding Co. This amortization allowance by the Shipping Board was ignored. I will supply the figures as to the difference in tax later, as I have not secured them yet. I wish to say that we learned last night that after this case left the . engineering division of the income tax unit and went to audit there was a further deduction of about $130,000, which did not involve this contractual amortization, but which, however, was an allowance of cost, as I understand it, rather than an allowance affecting the contractual amortization of $685,000 allowed by the Shipping Board. This taxpayer received several shipbuilding contracts from the Shipping Board. Under those contracts the taxpayer built, as I understand it, 18 ships, and contracts for 6 ships were canceled. The shipbuilding company, the taxpayer, submitted to the Shipping Board a claim in the net sum of $1,140,041.53. This claim, while not specifically mentioning "amortization," included an item for " "Special facilities cost" in the sum of $654,981.89. This item was to reimburse the contractor for plant expenditures. These facilities were purchased and installed by the taxpayer in the performance of the contract, the material portions of which read as follows: The CHAIRMAN. Let me ask at this point, do you contend that this claim for excess or special plant facilities amounts to the same thing as "amortization "? Mr. MANSON. It does. Any amount allowed the contractor to reimburse the contractor for plant expenditure is an amortization of plant expenditures. The CHAIRMAN. I asked that question because you mentioned that amortization was not specifically named in the taxpayer's claim to the Shipping Board. Mr. MANSON. I stated that he did not set it up as amortization. He set it up as the cost of special facilities. Senator WATSON. Is that very often done, Mr. Manson? Mr. MANSON. Yes; it is very frequently done. The word "amortization came in use in connection with some legislation, that is, so far as shipbuilding is concerned. It was not until the shipbuilders sought legislation, particularly with regard to wood ships, that the word "amortization" as coined, if you might use that term, for the purpose of having a term to apply to this particular class of claims. I started to read this contract, but before doing so I would call attention to the fact that this claim was allowed by the Shipping Board for amortization, in the sum of $685,171.34, the total claim being $922,171.34, from which was deducted a residual value of $237,000, leaving the difference that I have mentioned. The plant cost was $1,576,763.13. The entire plant, including inventory, was sold for $500,000. The company set up a claim to the effect that of the $500,000, $158,000 was to cover inventory, leaving $342,000 to cover what it received for its plant. The CHAIRMAN. In other words, the residual value. Mr. MANSON. Yes; the residual value, and that amount of $342,000 was deducted from the actual cost of the plant of $1,576,763.13, leaving a difference of $1,234,763.13. This is the amount which was allowed by the engineers in determining amortization. As I have stated, there has been subsequently deducted from this amount approximately $130,000, but that deduction, as I have also stated, is not made because of the disallowance by the Shipping Board. It will be seen that inasmuch as the amortization allowed is equal to the difference between the amount received by the company for the plant, and the cost of the plant, the $685,000 received from the Shipping Board could not have been considered, and was not considered. Referring now to the contract under which the plant expenditures were made, I desire to quote as follows: In view of the existing emergency, we are desirous of having you increase with the greatest expedition the capacity of your plants by making alterations and providing extra ways, equipments, and facilities, so that your company may deliver to us largely increased tonnages before the close of navigation, 1919. We request that you prepare at your earliest convenience a statement of the manner in which you believe your plants can most advantageously be extended to serve the above purpose, and submit that list to us. We shall be guided very largely by your request and your judgment in this matter, and we shall express our approval as promptly as circumstances will permit. We appreciate that the legitimate business needs of your company do not require these alterations and expansions which probably will be of little or no value to you after the completion of this contract. We understand, therefore, that what ever you do in this respect is done at our instance and for the sole purpose of facilitating the prompt production of the additional ships hereinafter ordered, and constituted a part of the cost to you of the construction of said ships. You are to proceed immediately with the alterations and additions to your plants as soon as the list referred to has been approved by us. Additional lists of alterations and improvements may be furnished hereafter for approval. We shall pay you $815,000 for each of said ships. Price is based on $800,000 as the price of the ship itself and $15,000 as a contribution to plant alterations and equipment. It is also based on a minimum expenditure of $275,000 for plant and equipment additional to that now being provided by you to carry out your other contracts. You are to submit proper proof of these expenditures to us. It will be seen that under that contract the Shipping Board agreed to pay, as part of the cost of each ship $15,000 per ship, and the contractor agreed to spend a minimum of $275,000. When it came to the cancellation of the six ships, the claim was made that they had spent in excess of that amount, and they were entitled to the full amount of their extra expenditures. The sum of $922,171.34, less the residual value of $237,000 was allowed by the Shipping Board. The auditors have not furnished us with the computation of the difference in tax, but we are advised that the difference in tax would be approximately 30 per cent, which would be about $200,000. The CHAIRMAN. Your contention is that the $200,000 excess was allowed, or the whole $685,000? Mr. MANSON. No; my contention is that they allowed $685,171.34 too much amortization, which would make a difference in tax of approximately $200,000. The CHAIRMAN. I see. Mr. MANSON. In other words, I contend that this whole amount allowed by the Shipping Board should have been deducted. What happened was this: The taxpayer sold his plant. In arriving at the amortization of $1,200,000, plus, they deducted from the cost of the plant the amount that the taxpayer received for the plant, and allowed him as his amortization, the difference, or his total loss. Of that total loss $685,171.34 had been borne by the Shipping Board. The CHAIRMAN. Does an examination of the taxpayer's claim for amortization disclose that the Shipping Board claim was considered at all? Mr. MANSON. I do not believe there is anything in the record at all to show it. We secured the information from the Shipping Board. I do not think there is anything in the record to show that the amortization allowed by the Shipping Board was ever investigated. Mr. Parker states that the subject of contractual amortization was not mentioned in the engineer's report. The CHAIRMAN. Is that the entire presentation of your case, Mr. Manson? Mr. MANSON. Yes. Senator WATSON. Let me ask you one question about your method. I have never asked anybody about this, nor have I ever talked to anybody about it. When your men start in to investigate a case do they go in independently or do they work in collaboration with or in connection with the employees of the Treasury Department? Mr. MANSON. We call for the record in the case. I will try to give you the steps of it, and if I do not give them right I wish the engineers would correct me. We call for the record in a case. We go over that record; that is, our engineers go over it. If there is something about the record that we do not understand if there has been apparently a mistake made, or if there is something done that requires explanation, we call on the engineer who examined that case for the unit to explain what he did and why he did it. Does that answer the Senator's question? Senator WATSON. Then, after that, you go on and make your own independent investigation? Mr. MANSON. Yes. Senator WATSON. Do you then call anybody's attention to it before it is presented here? Mr. MANSON. We do this: When it comes to determining the difference in tax, we call on the auditor who handled the case. Mr. THOMAS. If he is there. Mr. MANSON. If he is there, to make that computation. We check that computation. These engineers are not auditors, and we do not rely on our own computations when it comes to a checking of the difference in tax. Senator WATSON. Take this particular case, for instance. Did Mr. Hartson, so far as you know, ever hear of this case? Mr. MANSON. What is that? Senator WATSON. I asked you whether Mr. Hartson ever heard of this case until just now? Mr. MANSON. I do not suppose so. Senator WATSON. That is what I wanted to get at. I wanted to know just your method of operating down there and how you worked. Mr. MANSON. It is not our policy to go to any officer of the unit and criticize anything that they do. Senator WATSON. I understand. method. I was just trying to get your Mr. MANSON. We submit it to the committee and leave it to the committee to determine whether or not the bureau is to be criticized. We do not assume to do that. The CHAIRMAN. I might say for the benefit of the Senators that the question has arisen a number of times as to how we land on specific cases or how we call for specific cases. An examination of last week's reports submitted to me by the engineers covering the progress of the work shows a whole list of cases which are under examination by auditors and some by engineers. In this memorandum nearly every case, or at least a great many of them, indicated the source of information or the source of the suggestion that we examine a specific case. Some of these cases are referred to us by engineers and auditors of the bureau, who have disagreed with the |