Opinion
Docket No. 89719.
1963-02-12
FOSTER FROSTY FOODS, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
James E. Carpenter, Esq., for the petitioner. Jack Morton, Esq., for the respondent.
James E. Carpenter, Esq., for the petitioner. Jack Morton, Esq., for the respondent.
ADDITION TO RESERVE FOR BAD DEBT— SEC. 166(c), I.R.C. 1954.— The petitioner has no right under sec. 166(c) to deduct an addition to bad debt reserve for notes discounted and not then owned by it.
The Commissioner determined deficiencies in income tax of the petitioner for its fiscal years ending with February in 1956, 1957, and 1958 of $8,525.40, and $6,028.58. The only adjustment challenged herein is a part of the amount disallowed in each year representing the deduction of an addition to the reserve for bad debts.
The additions claimed and the portions allowed were as follows:
+--------------------------------+ ¦Fiscal year¦Claimed ¦Allowed ¦ +-----------+----------+---------¦ ¦1956 ¦$16,394.99¦None ¦ +-----------+----------+---------¦ ¦1957 ¦16,139.70 ¦$7,332.74¦ +-----------+----------+---------¦ ¦1958 ¦43,308.40 ¦31,714.99¦ +--------------------------------+
FINDINGS OF FACT.
The petitioner was incorporated early in 1948 and since then has been engaged in business in Denver, selling food freezers, food, and food memberships. It filed its income tax returns with the district director of internal revenue, Denver, Colo. Petitioner used an accrual method of accounting.
Its customers, desiring to buy on credit, were required to execute a promissory note for the balance due on purchases of food, to enter into a food service membership agreement in purchases of food memberships, and to execute a contract note and chattel mortgage in purchases of freezers.
There is no showing of the amount, if any,
of its creditor obligations disposed of by the petitioner prior to its fiscal year ended February 29, 1956, but in that year and thereafter it discounted portions of such notes or contracts at three local banks, with recourse. The amounts of notes and accounts discounted and not discounted for certain years were as follows:
The returns indicate that there were none prior to March 1, 1955.
No showing.
The petitioner received credit to its account for the paper discounted with recourse in the face amount of the note or contract less the agreed upon discount and less the amount which was required to be placed in a loss reserve under the governing contracts.
The taxpayer included in income all amounts credited to a bank's loss reserve at the time said credits were made.
If a purchaser fell behind on payment of a discounted obligation, the bank would notify the petitioner's credit department which would then try to have the account made current. If it failed or if the bank was not satisfied with any delinquent account it would require the petitioner to buy it back.
The actual losses of the petitioner on reacquired obligations are not shown in this record.
The Commissioner in computing a reasonable reserve at the end of each tax year recognized that the petitioner held outstanding installment contracts amounting to $9,018.25 for 1956, $1,939.67 for 1957, and $8,983.48 for 1958. He included 50 percent of those amounts in computing the allowable additions to the reserve. The petitioner reacquired much larger amounts of these obligations during the tax years but the record does not show what became of them.
The petitioner established a bad debt reserve computed with reference to its total sales, cash and credit, including sales involving notes discounted with recourse, by taking $25 per freezer sold (average sale price $630), 5 percent of the price of food sold, and 25 percent of the sale price of food memberships, and adding an amount to the reserve each year on that basis.
The following taken from the returns shows the results of that method while in use through February 28, 1958 (omitting cents):
Indeed, even if the addition were thought not to be ‘reasonable,‘ the method employed by the Commissioner is sound, and a correct result would simply require an upward revision of the 50 percent formula as applied to the outstanding reacquired notes. As indicated, the statute contains no requirement whatever that the addition, in order to be ‘reasonable,‘ must be measured by a fixed percentage of all the notes.
+--------------------------------------+ ¦Fiscal year¦Not discounted¦Discounted ¦ +-----------+--------------+-----------¦ ¦1952 ¦$31,795.24 ¦(1) ¦ +-----------+--------------+-----------¦ ¦1953 ¦55,846.05 ¦(1) ¦ +-----------+--------------+-----------¦ ¦1954 ¦56,676.74 ¦(1) ¦ +-----------+--------------+-----------¦ ¦1955 ¦82,043.52 ¦(1) ¦ +-----------+--------------+-----------¦ ¦1956 ¦191,725.62 ¦$396,010.53¦ +-----------+--------------+-----------¦ ¦1957 ¦62,100.07 ¦644,007.64 ¦ +-----------+--------------+-----------¦ ¦1958 ¦56,495.77 ¦876,494.73 ¦ +--------------------------------------+
Reviewed by the Court.
Decision will be entered under Rule 50.
BRUCE, J., concurs in the result.
RAUM, J., concurring: The issue which the Court decides is, in my judgment, not necessary to the disposition of this case. True, the parties may have attempted to stipulate the Court into deciding whether petitioner is entitled to an addition to the reserve in respect of the discounted notes still in the hands of the bank. However, the parties cannot by stipulation force the Court to pass upon a question that need not be reached.
The only dispositive question is whether the addition to the reserve approved by the Commissioner are ‘reasonable.’ The Commissioner's method was to allow an addition measured in part by 50 percent of the previously discounted items reacquired by petitioner that were still outstanding at the end of the year. In my opinion, such a disproportionately large allowance in respect of the reacquired items is sufficient to cover all of the discounted receivables, whether still in the hands of the bank or reacquired by petitioner. The findings of the Court setting forth petitioner's actual loss experience and the balances in the reserve account show that the allowances approved by the Commissioner are ‘reasonable.’ That is all that the statute requires, and it is not necessary to deal with the troublesome issue which the parties seek to have this Court decide. Certainly, the method approved by the Commissioner is reasonable. There is nothing in the statute requiring the addition to the reserve to be measured by an across-the-board percentage of all debts. The question simply is whether the addition to the reserve, considered in the light of the balance already in that reserve, is reasonably calculated to absorb the anticipated bad debts. The answer to that question should not involve any conceptual inquiry into the theoretical status of the notes still in the hands of the banks. If the addition approved by the Commissioner in the light of the balances in the reserve and petitioner's actual loss experience is ‘reasonable,‘ that should be an end to the matter.
1 In these circumstances there is no need to deal with the question whether Wilkins Pontiac should be followed. It has long been established that the Commissioner's determination will be sustained if it is correct regardless of whether he gave the correct reason for it or indeed even if he gave a wrong reason for it. Blansett v. United States, 283 F.2d 474, 478-479 (C.A. 8); Bernstein v. Commissioner, 267 F.2d 879, 881-882 (C.A. 5); Acer Realty Co. v. Commissioner, 132 F.2d 512, 514-515 (C.A. 8); Alexander Sprunt & Son v. Commissioner, 64 F.2d 424, 427 (C.A. 4); Crowell v. Commissioner, 62 F.2d 51, 53 (C.A. 6); J. & O. Altschul Tobacco Co. v. Commissioner, 42 F.2d 609, 610 (C.A. 5); Hughes v. Commissioner, 38 F.2d 755, 757 (C.A. 10); cf. Helvering v. Rankin, 295 U.S. 123, 132-133.
TIETJENS and WITHEY, JJ., agree with this concurring opinion.
PIERCE, J., dissenting: I think the Court should have followed and applied the recent decision of the Ninth Circuit in Wilkins Pontiac v. Commissioner, 298 F.2d 893, which I believe reached the correct result.
FISHER and MULRONEY, JJ., agree with this dissent.
+-------------------------------------+ ¦Fiscal year¦Additions¦Charges¦Balance¦ +-----------+---------+-------+-------¦ ¦1952 ¦ ¦ ¦$918 ¦ +-----------+---------+-------+-------¦ ¦1953 ¦$11,226 ¦$61 ¦12,083 ¦ +-----------+---------+-------+-------¦ ¦1954 ¦11,547 ¦9,505 ¦14,126 ¦ +-----------+---------+-------+-------¦ ¦1955 ¦17,664 ¦11,563 ¦20,227 ¦ +-----------+---------+-------+-------¦ ¦1956 ¦16,394 ¦7,963 ¦28,658 ¦ +-----------+---------+-------+-------¦ ¦1957 ¦16,139 ¦16,320 ¦30,915 ¦ +-----------+---------+-------+-------¦ ¦1958 ¦43,308 ¦28,859 ¦45,364 ¦ +-------------------------------------+
The Commissioner, in determining the deficiencies, held that the total reasonable reserve for bad debts at the end of each year should be the total of 4 percent of outstanding receivables held by the petitioner (excluding those discounted and held by banks) plus 50 percent of all previously discounted items reacquired by the petitioner and held by it at the end of the year and not charged against the reserve, as shown below:
+-------------------------------------------+ ¦Reserve, Feb. 28, 1955¦ ¦Balance ¦ +----------------------+---------+----------¦ ¦Feb. 29, 1956: ¦ ¦$20,227.14¦ +----------------------+---------+----------¦ ¦Additions allowed ¦None ¦ ¦ +----------------------+---------+----------¦ ¦Charge-offs per return¦$7,963.76¦ ¦ +----------------------+---------+----------¦ ¦Balance in reserve ¦ ¦12,263.38 ¦ +----------------------+---------+----------¦ ¦Feb. 28, 1957: ¦ ¦ ¦ +----------------------+---------+----------¦ ¦Additions allowed ¦7,332.74 ¦ ¦ +----------------------+---------+----------¦ ¦Charge-offs per return¦16,320.01¦ ¦ +----------------------+---------+----------¦ ¦Balance in reserve ¦ ¦3,276.11 ¦ +----------------------+---------+----------¦ ¦Feb. 28, 1958: ¦ ¦ ¦ +----------------------+---------+----------¦ ¦Additions allowed ¦31,714.99¦ ¦ +----------------------+---------+----------¦ ¦Charge-offs per return¦28,859.14¦ ¦ +----------------------+---------+----------¦ ¦Balance in reserve ¦ ¦6,131.96 ¦ +-------------------------------------------+
Paragraph 11 of the stipulation filed is as follows:
Petitioner concedes that for the purposes of this case only, its reserve for bad debts shall be computed in the manner of the schedule representing respondent's computation thereof for statutory notice purposes, hereinabove, paragraph 8, except for the exclusion by respondent of petitioner's notes receivable discounted; accordingly, only the aforesaid exception by respondent as to each adjustment (b) ‘Reserve for bad debts,‘ for each of the taxable years per statutory notice of deficiency, is at issue, that is, whether the statutory notice of deficiency computation of a reasonable bad debt reserve should take into consideration petitioner's total notes and accounts receivable, including those discounted with banks, or just total notes and accounts receivable, excluding notes receivable discounted.
The Commissioner made no concession regarding any narrowing of the issue for decision.
All stipulated facts are incorporated herein by this reference.
OPINION.
MURDOCK, Judge:
Deductions for bad debts are allowed by section 166(a) in the year in which worthlessness occurs, whereas (c), by allowing ‘a deduction for a reasonable addition to a reserve for bad debts,‘ enables the taxpayer to take the deduction in anticipation of the actual worthlessness and to charge the current losses against the reserve thus created. The word ‘reasonable’ brings a relative, as opposed to a definite, amount into the law. No set formula for computing ‘a reasonable addition’ has ever been fixed by law, the regulations, or the courts. The computation depends upon the circumstances of each case and this is wife though sometimes difficult. The provisions of the Code obviously refer to debts owed to the taxpayer. Cf. sec. 1.166-1(a), Income Tax Regs. There are perhaps contingent liabilities of taxpayers for which good accounting might set up a reserve but for which the Internal Revenue Code does not allow deductions of additions to such reserve. Lucas v. American Code Co., 280 U.S. 445, 452. Good accounting, relied upon by the petitioner, is not determinative in this case.
The reserve accounting used by the petitioner up to March 1, 1955, had created a reserve balance which the Commissioner apparently considered excessive and sufficient, without any addition, to take care of fiscal year 1956. The figures in the record do not show error on his part in reaching that conclusion. He devised a new method of determining a reserve for the petitioner to which the latter objects only in part. The record does not contain facts upon which this Court could determine a proper reserve or reasonable additions thereto and the parties, apparently, expect the Court to decide only whether the receivables held by banks must be treated the same as those owned by the petitioner.
The petitioner argues that the discounted notes should be treated just like the ones not discounted, despite the fact that it disposed of those notes, ceased to be the creditor, was a guarantor only, and when it reacquired some of them the Commissioner included 50 percent of the outstanding reacquired debt in the addition to the reserve. The petitioner is supported in this contention by a recent decision of the Court of Appeals for the Ninth Circuit, Wilkins Pontiac v. Commissioner, 298 F.2d 893, reversing the Tax Court decision in that case, 34 T.C. 1065. We cannot in good conscience follow the reversal because we think our opinion in that case was in line with prior decisions, correctly interpreted the law, and reached the correct result. The discounted notes, not being debts due the petitioner, could not be considered in determining a reasonable addition to a reserve for its debts until as guarantor it reacquired them and again became creditor of the debtor (Putnam v. Commissioner, 352 U.S. 82), only then could the notes be the basis for a deductible addition to its reserve for its bad debts.