Opinion
Docket No. 52388.
1956-12-21
TEXAS TRAILERCOACH, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Truxton Shaw, Esq., and Wentworth T. Durant, Esq., for the petitioner. Carswell H. Cobb, Esq., for the respondent.
Truxton Shaw, Esq., and Wentworth T. Durant, Esq., for the petitioner. Carswell H. Cobb, Esq., for the respondent.
Petitioner (hereinafter referred to as Dealer), an accrual basis taxpayer, made installment sales of trailers. Purchaser executed time payment contracts, agreeing to pay the selling price of the trailer, plus a finance or time payment charge. Dealer, being financially unable to hold all of these contracts, assigned most of them to a finance company for 95 per cent of the selling price of the trailer in cash. Also, Finance Co. would credit the Dealer with the remaining 5 per cent of the selling price of the trailer and would, at its discretion, credit the Dealer with a portion of the finance charge as it was earned. These credits were to a dealers' reserve account. No amounts were payable to the Dealer until the balance in the dealers' reserve account exceeded 15 per cent of the balance due on all contracts assigned. Dealer guaranteed all contracts assigned and Finance Co. could charge reserve with any amounts due from Dealer to Finance Co. No amounts were paid or payable from the dealers' reserve account during the year in question. Respondent added the balance in the dealers' reserve account at end of the year to Dealer's income. Held, that the full selling price of the trailers is accruable as income at time of sale; that the portion of finance charge credited to the Dealer is income when it is credited; and that amount credited to Dealer in dealers' reserve account by Finance Co. is not deductible since it is an absolute credit and will be either paid to Dealer in cash or used to discharge its obligation to Finance Co.
The respondent has determined a deficiency in petitioner's income tax of $2,587.68 for the fiscal year ended June 30. 1952. The deficiency is due to adjustments made to the net income reported by petitioner on its return, as follows:
Unallowable deduction and additional income:
+-----------------------------------------------------+ ¦Unallowable deduction and additional income:¦ ¦ +--------------------------------------------+--------¦ ¦(a) Legal and audit ¦$250.00 ¦ +--------------------------------------------+--------¦ ¦(b) Dealers Finance reserve ¦8,375.59¦ +-----------------------------------------------------+
Petitioner does not contest adjustment (a). Petitioner contests adjustment (b) by the following assignments of error:
(a) The Commissioner has increased Petitioner's gross income in the amount of $8,375.59, by including as income in the current year an amount that is only a potential future claim of the Petitioner.
(b) The Commissioner has computed net income for Petitioner by using a method of accounting that is not in accordance with the method regularly employed in keeping the books of said Petitioner.
FINDINGS OF FACT.
A stipulation of facts has been filed and is incorporated herein by reference.
The petitioner, Texas Trailercoach, Inc. (hereinafter sometimes referred to as the Dealer), is a corporation organized under the laws of Texas for the purpose of carrying on trade in new and used trailers. The petitioner was incorporated July 1, 1951. The petitioner reported its taxable income on the accrual basis of accounting on a June 30 fiscal year basis. The year before the Court is the petitioner's first fiscal year ending June 30, 1952, and its first taxable period. Its income tax return for this period was filed with the director of internal revenue at Dallas, Texas.
The petitioner sells most of its trailers on the installment plan. When a trailer is sold on the installment plan, the purchaser makes a trade-in and/or a downpayment and executes a conditional sale contract. The purchaser agrees to pay the contract balance at a fixed rate over a definite period of months. Under the terms of the contract the seller or its assignee may assign the contract. Upon assignment all rights and remedies of the seller are transferred to the assignee.
The petitioner has never been financially able to hold all of these contracts to maturity and on July 10, 1951, entered into an agreement with the Minnehoma Financial Co. (hereinafter referred to as the Finance Co.) of Tulsa, Oklahoma. The agreement was to cover the assignment of any conditional sales contracts that the Dealer desired to assign and the Finance Co. desired to purchase. The Finance Co. was the only party that the Dealer assigned contracts to during the year in question.
The contract between the Dealer and the Finance Co. provided, inter alia, that:
(1) Each contract offered to the Finance Co. for purchase shall be executed on a form provided by the Finance Co.
(2) The purchaser of the trailer (hereinafter referred to as purchaser) shall be required to pay the selling price of the trailer (Selling price means the price at which the trailer would be sold for cash. The purchaser is required to pay the sales tax, recording and filing fees, and insurance and if the Dealer and/or the Finance Co. originally pays for these items they are included in the price that the purchaser must pay. For the purposes of clarity those items will be disregarded since they are not material to the question involved herein.) plus the finance or time payment charge (usually computed at 5 per cent on new trailers and 6 per cent on used trailers per year on selling price less downpayment) less the downpayment made to the Dealer in cash or by trade-in allowance.
(3) The entire amount payable by the purchaser shall be payable in equal monthly installments over a period of not more than 60 months for new trailers and 36 to 60 months for used trailers.
(4) All such payments are payable to the Finance Co. at the Finance Co.‘s office.
(5) Such payments received by the Dealer shall be held in trust for the Finance Co. and forwarded immediately to the Finance Co.
(6) The purchase price of each contract purchased by and assigned to the Finance Co. shall be equal to 95 per cent of the selling price of the trailer less downpayment.
(7) An amount (hereinafter referred to as the discount) to be determined by the Finance Co. equal to not more than 5 per cent of the selling price of the trailer less downpayment will be credited by the Finance Co. to a special reserve account (hereinafter referred to as a dealers' reserve account).
(8) The Finance Co. may credit to such dealers' reserve account, but shall not be obligated to do so, one-tenth on new trailers and one-twelfth on used trailers, or such other portions as the Finance Co. may determine, of the finance charge paid or agreed to be paid by the purchaser in each contract (this amount will hereinafter be referred to as a bonus).
(9) The Finance Co. may charge against the dealers' reserve account any sum that the Dealer may owe to the Finance Co. at any time.
(10) In the event that the dealers' reserve account shall exceed 15 per cent of the aggregate unpaid balances of all contracts purchased by and assigned to the Finance Co. plus all contingent liabilities, which, on the sole determination of the Finance Co. it may have in respect to such contracts, the Finance Co. will pay such excess to the Dealer (usually monthly).
(11) In the event that, and at such time as, all contracts as shall have been purchased and assigned to the Finance Co. by the Dealer shall have been paid in full and no sums shall remain unpaid thereunder and in the opinion of the Finance Co. there shall be no contingent liability on the part of the Finance Co. with relation thereto, the Finance Co. shall pay to the Dealer the balance of the credit in such dealers' reserve account.
(12) The Dealer unconditionally guarantees the payment of all sums required to be paid under each contract purchased by and assigned to the Finance Co.
(13) If the purchaser defaults on the contract the Dealer agrees to repurchase the contract for the amount of the entire unpaid balance.
(14) At the election of the Finance Co. and at its request, the Dealer will at its own risk and expense repossess any trailer concerning which there is a default under the contract.
(15) The Dealer will purchase the repossessed trailer at the request of the Finance Co.
The Dealer was not required to assign any of its contracts to the Finance Co. and it did not assign all of them. The following example represents a typical transaction when the contract was assigned (items involved such as downpayment, insurance, sales tax, recording fees, etc., are left out for simplification purposes since they are not material to the question involved):
Dealer sells a trailer with a selling price of $5,000 to purchaser on an installment plan. The finance chare is $500. The total unpaid balance is therefore $5,500. Purchaser and Dealer execute a contract, the purchaser agreeing to pay the $5,500 in equal monthly installments for 55 months. Dealer assigns the contract to the Finance Co. Finance Co. gives Dealer $4,750 in cash, representing 95 per cent of the $5,000 selling price. Finance Co. credits dealers' reserve account with the discount of $250, representing 5 per cent of $5,000 cash selling price. The Dealer would record such a transaction as follows:
+----------------------------------------------------------------------------+ ¦When the purchaser executes the contract: ¦ ¦ ¦ +--------------------------------------------------------------+------+------¦ ¦Debit, contracts in transit ¦$4,750¦ ¦ +--------------------------------------------------------------+------+------¦ ¦Credit, sales ¦ ¦$4,750¦ +--------------------------------------------------------------+------+------¦ ¦ ¦ ¦ ¦ +--------------------------------------------------------------+------+------¦ ¦When the Finance Co. accepts the contract and remits the cash:¦ ¦ ¦ +--------------------------------------------------------------+------+------¦ ¦Debit: Cash ¦4,750 ¦ ¦ +--------------------------------------------------------------+------+------¦ ¦Repossession reserve ¦250 ¦ ¦ +--------------------------------------------------------------+------+------¦ ¦Credit: Contracts in transit ¦ ¦4,750 ¦ +--------------------------------------------------------------+------+------¦ ¦Deferred income ¦ ¦250 ¦ +----------------------------------------------------------------------------+
The Finance Co. would place the whole finance charge in its unearned income account and transfer it to income over the life of the contract as it was earned. As it was earned the Finance Co. would, at its discretion, credit the dealers' reserve account with the bonus or the portion of the finance charge that it was giving to the Dealer. When the Finance Co. so credited the dealers' reserve account the Dealer would make the following entry (assuming one-tenth of finance charge is credited):
+-----------------------------------+ ¦Debit, repossession reserve¦$50¦ ¦ +---------------------------+---+---¦ ¦Credit, deferred income ¦ ¦$50¦ +-----------------------------------+
If the Dealer did not assign the contract in the above transaction it would accrue on its books the entire sales price without discount.
The sales account was closed to profit and loss at the end of the year and the balance in that account was reflected in income. The repossession reserve account with its debit balance and the deferred income account with its credit balance was not reflected in the computation of net income, but were shown on the balance sheet and actually offset each other. The balance in the latter account and in the dealers' reserve account on the books of the Finance Co. was $8,375.59 on June 30, 1952. That amount did not exceed the balance required to be maintained in that account before the Dealer was entitled to receive any cash payments from it. The petitioner did not receive any cash from the dealers' reserve account in the year involved.
The portion of the $8,375.59 that represented discounts (the various 5 per cent of the selling prices of the trailers) and the portion that represented bonuses (the part of the finance charge that the Finance Co. credited to dealers' reserve account) are not shown in the record.
The Dealer did not incur any bad debts during the year in question. The Dealer did not take any bad debt deductions during that year, either by way of the specific chargeoff method or the reserve method. In subsequent years the specific chargeoff method was used for bad debts arising from contracts that it held itself. In subsequent years if a contract purchased by the Finance Co. became worthless the Dealer repurchased it pursuant to the agreement between the Finance Co. and the Dealer. The Dealer would repossess the trailer and include it in its inventory at the price at which it repurchased the contract. Any loss or bad debt on the transaction would be reflected in the cost of sales when the repossessed trailer was sold. The Dealer, therefore, had no bad debt account, as such, for the contracts that it assigned to the Finance Co.
The amounts withheld on all contracts assigned by the Dealer were recorded in the same dealers' reserve account. There was no segregation on the Finance Co.‘s books of the amount withheld from each contract. The Finance Co. did not segregate any cash to cover the balance in the dealers' reserve account. The Finance Co. did not take the amounts in the dealers' reserve account into income. The Finance Co. was at all times in such financial condition that it was able to pay any amounts which might have been due and payable to the Dealer.
The respondent determined that the amount of $8,375.59 in the dealers' reserve account on the Finance Co.‘s books and in the deferred income account on the Dealer's books on June 30, 1952, should be included in Dealer's income for the fiscal year ended June 30, 1952.
OPINION.
BLACK, Judge:
The respondent has included $8,375.59 in the income of the Dealer (petitioner), an accrual basis taxpayer, for the Dealer's first taxable period, the fiscal year ended June 30, 1952, which had been omitted by the taxpayer from its tax return. This determination is resisted on the ground that the $8,375.59, which is the balance in an account labeled ‘Deferred Income’ on the books of the Dealer and credited to the Dealer in an account labeled ‘Dealer Reserve’ on the books of the Finance Co. which purchased deferred payment contracts from the Dealer, is not accruable as income in the year in question because the $8,375.59 represents only a potential future claim of petitioner.
The question involved requires a review of the manner in which the item involved arose and a determination of the period in which it becomes accrual as income. For purposes of clarity we will use the simplified typical transaction as set out in our Findings of Fact in discussing the essential facts and the applicable law.
The Dealer sells a trailer with a selling price of $5,000. The purchaser does not pay cash; therefore, a finance or time charge of $500 is added. The purchaser executes a contract agreeing to pay the $5,500 in equal monthly installments for 55 months. The sale, which has been consummated, is the identifiable event which fixes the rights of the parties. At this point the selling price of the trailer has been earned; there is an unconditional right to receive the selling price. The finance or time charge has not been earned; it will be earned over the life of the contract. When the contract is assigned the Finance Co. rather than the Dealer earns and is entitled to the finance charge. Under the accrual method of accounting the selling price of $5,000 is gross income; the cost of the trailer is deducted; and the difference is the Dealer's gross profit on the sale and is income in the year of the sale.
Spring City Foundry Co. v. Commissioner, 292 U.S. 182 (1934). This is so even though the Dealer will not receive the selling price until the 55 months have expired, cf. San Francisco Stevedoring Co., 8 T.C. 222, 225 (1947), and if the purchaser defaults it may never receive it. There is always the possibility that the purchaser or debtor will default on his obligation, but that contingency is not sufficient to defer the accruing of income that has been earned, Spring City Foundry Co. v. Commissioner, supra; Vancoh Realty Co., 33 B.T.A. 918, 922-923 (1936).
There is no contention that the taxpayer has elected to return its income on the installment basis as provided for in section 44, Internal Revenue Code of 1939, and regulations thereunder.
The Dealer has recognized the foregoing because in recording installment sales of trailers in instances where it did not assign the contracts, it accrued the full sales price at the time of the sale. This was proper. Its practice of accruing less than the full sales price (95 per cent thereof) on contracts that it assigned was clearly inconsistent with the accrual method of accounting which it admittedly used. We fail to see that there should be any difference in accruing the full sale price of trailers where petitioner intended to handle the paper itself and in instances where petitioner intended to assign the paper to Finance Co. In each instance there was a sale and it seems to us that the full amount of the sales price must be accrued.
The Dealer, being financially unable to hold all of its sales contracts, would sell most of them to the Finance Co. Under the terms of their agreement the Finance Co. would give the Dealer 95 per cent of the selling price of the trailer in cash and credit the Dealer with the remaining 5 per cent. The Finance Co. also would, at its discretion, credit the Dealer with a portion of the finance charge as it was earned by the Finance Co. A balance equal to 15 per cent of the amounts due on all contracts assigned had to be maintained in the dealers' reserve account. Nevertheless, these credits to the dealers' reserve account were absolute. The amounts credited would be paid to the Dealer in cash or used to discharge the Dealer's obligation to the Finance Co. They were not payable at the time they were credited because the Dealer guaranteed the contracts that it sold to the Finance Co. The Finance Co. required this fund to be maintained for its own protection.
Since the full sales price of the trailer is accruable at the time of the sale, the real question involved, we think, is not whether the amount in the dealers' reserve account is includible in income, but whether the amount in the dealers' reserve account is deductible from income.
Generally speaking, only realized losses are deductible. See Lucas v. American Code Co., 280 U.S. 445 (1930). Here there is no realized loss. The amount credited to the dealers' reserve account will be realized. The Dealer will receive that amount in cash or it will be used to discharge its obligation to the Finance Co. If the latter occurs, it will be because a trailer purchaser has defaulted on his obligation. In that sense the dealers' reserve account is analogous to reserve for bad debts. However, the Dealer has neither pleaded nor argued that it is entitled to a bad debt deduction. Likewise, there is no showing that the amount in question is deductible as a reasonable addition to a reserve for bad debts as provided for in section 23(k) of the 1939 Code and Regulation 111, section 29.23(k)-5.
And regardless of whether the sale of the trailer and the sale of the contract are viewed as two separate transactions or as one transaction the result must be the same. In either case the only thing that will prevent the Dealer from receiving the full sales price is the possibility that the purchaser will default. As we said before, that contingency is not sufficient to defer the accruing of income that has been earned. Spring City Foundry Co. v. Commissioner, supra. There is also no justification for deferring the portion of the finance charge that the Finance Co. credited to the Dealer. Although the Finance Co. was not required to so credit the Dealer, when it did so the credit was absolute and was income to the accrual basis taxpayer. Cf. Shoemaker-Nash, Inc., 41 B.T.A. 417 (1940).
Our holding, that the full selling price is accruable at the time of the sale and that the portions of the finance charge that are credited to the Dealer are accruable at the time the credits are made, is in accord with the prior decisions of this Court. Shoemaker-Nash, Inc., supra, involved portions of the finance charges that were credited to the dealers' reserve account by the finance company. It was assumed in that case that the finance company had paid the dealer the full selling price of the automobiles. It was held that the credits are income to the dealer at the time they are credited because, although not immediately payable, there was no showing that they would not be paid when due.
Blaine Johnson, 25 T.C. 123 (1955), as in the instant case, involved credits by the finance company of both the discount on the selling price and the bonus or portion of the finance charge. The taxpayer accrued the full selling price of the trailer and deducted from gross sales the amounts credited to the dealers' reserve by the finance company. In computing the deficiencies the Commissioner restored these amounts to income. See our Findings of Fact, p. 129, Blaine Johnson, supra. We held that the credits to the dealers' reserve are not deductible from gross sales and sustained the Commissioner. Blaine Johnson, supra, was followed in Albert M. Brodsky, 27 T.C. 216 (1956).
Commissioner v. Cleveland Trinidad Paving Co., (C.A. 6, 1932) 62 F.2d 85, is clearly distinguishable. In that case the taxpayer ‘completed pavement construction contracts under which substantial portions of the agreed considerations were retained, by the municipalities for which the work was done, to guarantee maintenance of the pavements for specified periods.’ The question involved was whether the amounts retained were accruable. The court held that there was no need ‘to accrue that which is but contingently earned.’ Here the selling price of the trailer was earned at the time of the sale. There was no guaranty on petitioner's part to maintain the trailer after it was sold. Cf. Schuessler v. Commissioner, (C.A. 5, 1956) 230 F.2d 722.
The Court of Appeals for the Fourth Circuit has reversed Blaine Johnson, supra, in Johnson v. Commissioner, (C.A. 4, 1956) 233 F.2d 952. The petitioner in its reply brief, which was filed after the Fourth Circuit reversed us, calls our attention to this reversal and relies upon it in support of its position. However, after carefully reexamining the question involved and with due respect and deference to that court we feel compelled to follow our own decisions for the reasons set forth above. Accordingly, the determination of the respondent is upheld.
Decision will be entered for the respondent.