Commissioner v. Hansen (1959)
COMMISSIONER OF INTERNAL REVENUE v. HANSEN ET UX.
No. 380
SUPREME COURT OF THE UNITED STATES
360 U.S. 446; 79 S. Ct. 1270; 3 L.
Ed. 2d 1360; 59-2 U.S. Tax Cas. (CCH) P9533; 3 A.F.T.R.2d (RIA) 1690;
1959-2 C.B. 460
April 29-30, 1959, Argued
June 22, 1959, Decided *
* Together with No. 381,
Commissioner of Internal Revenue v. Glover, on certiorari to the United
States Court of Appeals for the Eighth Circuit, argued April 29-30, 1959;
and No.512, Baird et ux. v. Commissioner of Internal Revenue, on
certiorari to the United States
Court of Appeals for the
Seventh Circuit, argued April 30,
1959.
PRIOR HISTORY:
CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR
THE NINTH CIRCUIT.
DISPOSITION: 258 F.2d 585 and 253 F.2d 735, reversed.
256 F.2d 918, affirmed.
CORE TERMS: dealer, finance, reserve, installment,
partnership, credited, purchaser, reserve account, unpaid, accrued,
mortgage, trailer, undersigned, customer, accrual basis, payable,
conditional sale, endorsed, sell, collateral security, withheld, full
recourse, contingent, right to receive, recorded, purchase price,
presently, accrual, accrue, purpose of securing
SUMMARY: Accrual basis taxpayers, retail dealers
in automobiles (in Nos. 380 and 381) and house trailers (in No.
512), engaged in sales of commercial instalment paper, executed
by purchasers in favor of the taxpayers, to finance companies. The
finance companies paid in cash to the taxpayers a portion of the
sales price of the instalment paper and retained a percentage, crediting
it on their books to the taxpayers' reserve accounts for the purpose
of securing performance by the taxpayers of their guarantor, indorser,
and other liabilities to the finance companies. The question presented
was whether the amounts placed by the finance companies in the reserve
accounts were accrued income to the taxpayers in the years of the
sales of the instalment paper. The Commissioner contended that this
question was to be answered in the affirmative and the Tax Court
sustained the Commissioner in each case. On review the Courts of
Appeals for the Ninth Circuit (No. 380; 258 F2d 585) and the Eighth
Circuit (No. 381; 253 F2d 735) reversed, and the Court of Appeals
for the Seventh Circuit (No. 512; 256 F2d 918) affirmed.
On certiorari, the United States Supreme Court
affirmed the judgment of the Court of Appeals for the Seventh Circuit (in
No. 512) and reversed the judgments of the Courts of Appeals for the Ninth
and Eighth Circuits (in Nos. 380 and 381). Whittaker, J., speaking for
seven members of the Court, held that in the year of their sales of
instalment paper to the finance companies the taxpayers acquired a fixed
right to receive the percentage of the purchase money that was retained by
the finance companies and credited to the reserve accounts, and hence,
those amounts constituted accrued income to the taxpayers in that year.
Douglas, J., dissented without opinion.
Black, J., did not participate.
SYLLABUS: The taxpayers here involved are
two retail automobile dealers and a house trailer dealer who keep
their books and make their income tax returns on the accrual basis.
Obligations of purchasers for deferred payments on instalment sales
are discounted or sold by them to finance companies, which pay the
dealers most of the amounts in cash but credit to each dealer in
a "reserve account" a small percentage thereof, which
is retained by the finance company to secure performance of the
dealer's obligations under his guaranties or endorsements. Held:
The amounts thus credited to the dealers in "reserve accounts"
on the books of the finance companies must be reported as income
accrued during the tax years in which they are credited to such
reserve accounts. Pp. 447-469.
(a) The retained percentages of the purchase price of
the instalment paper, from the time they are entered on the books of the
finance companies as liabilities to the respective dealers, were vested in
and belonged to the respective dealers, subject only to their pledges
thereof to the respective finance companies as collateral security for the
payment of their then contingent liabilities to the finance companies. Pp.
460-463.
(b) The percentages of the purchase price of the
instalment paper that were withheld by the finance companies constituted
accrued income to these dealers at the time the withheld amounts were
entered on the books of the finance companies as liabilities to the
dealers, for at that time the dealers acquired a fixed right to receive
the amounts so retained by the finance companies. Pp. 463-466.
(c) That this holding will require taxpayers to pay
taxes upon funds which are not available to them for that purpose is but a
normal result of the accrual basis of accounting. Pp. 466-467.
(d) The respective taxpayers here involved have wholly
failed to sustain the burden of showing that any part of the amounts
credited to them on the books of the finance companies was entitled to
special treatment. Pp. 468-469.
COUNSEL: Meyer Rothwacks argued the causes for the
Commissioner of Internal Revenue. With him on the brief for the
Commissioner were Solicitor General Rankin, Assistant Attorney General
Rice and Joseph F. Goetten.
Lester M. Ponder argued the cause for petitioners in
No. 512. With him on the brief were W. Byron Sorrell, John C. Williamson,
Cullen B. Jones, Jr. and Thomas M. Scanlon.
Emmett E. McInnis, Jr. argued the cause and filed a
brief for respondents in No. 380.
William S. Miller, Jr. argued the cause for respondent
in No. 381. With him on the brief were E. Chas. Eichenbaum and Leonard L.
Scott.
Briefs of amici curiae in support of the taxpayers
were filed by James C. Moore and L. W. Anderson for the National
Automobile Dealers Association, and by William Waller for Vance L. Wiley
et al.
JUDGES: Warren, Frankfurter, Douglas, Clark, Harlan,
Brennan, Whittaker, Stewart; Black took no part in the consideration or
decision of this case.
OPINIONBY: WHITTAKER
OPINION: MR. JUSTICE WHITTAKER delivered the opinion
of the Court.
These federal income tax cases present questions
concerning the proper and timely accrual of gross income deriving from
sales of commercial installment paper by retail dealers to finance
companies. The taxpayers involved in these cases are two retail automobile
dealers and a house trailer dealer. All keep their books on the accrual
basis. Most of their sales are "credit sales." It appears that
they generally negotiate, consummate, and finance such sales in accordance
with a common pattern. The dealer and his customer agree upon a "Cash
Delivered Price" for a particular vehicle owned by the dealer. In
part payment of that price the customer makes a down payment to the dealer
in cash or "trade in," or both. To the remaining balance of that
cash price there is added the cost of insurance on the vehicle and a
"finance charge." The aggregate is sometimes called the
"Deferred Balance." It is evidenced and secured by an assignable
or negotiable instrument retaining defeasible title to or a lien on the
vehicle -- generally on a form supplied by the finance company with which
the dealer may then be doing business -- and the instrument is signed by
the customer, delivered to the dealer, and made payable to him in monthly
installments over an agreed period -- one to three years on automobiles
and three to five years on house trailers. Thereupon, the dealer delivers
the vehicle to his customer, with such memoranda or bill of sale as will
enable him to register, license and use it.
Soon after completion of these procedures, these
dealers sell (discount) those instruments (hereafter called
"installment paper") to finance companies for an agreed or
formula fixed price, and the dealers guarantee payment, in whole or in
part, of the installment paper.
Under contracts between the respective dealers and
finance companies here concerned, the latter, upon receipt and acceptance
of installment paper, are obligated to pay immediately to the dealers a
major percentage of the purchase price, but they are thereby also
authorized to retain the remaining percentage of the price and to credit
it on their books to a "Dealers Reserve Account" in the name of
the particular dealer, for the purpose of securing performance by him of
his guarantor, endorser, and other liabilities to the finance company.
The dealers involved in these cases recorded on their
books in the years the installment paper was sold, and included in their
income tax returns for those years, the cash received from the finance
companies, but they did not accrue on their books or include in their
returns the percentage of the price that was retained by the finance
companies and credited to their reserve accounts.
The Commissioner contends that in the year of their
sales of installment paper to the finance companies, the taxpayers
acquired a fixed right to receive -- even though not until a later year --
the percentage of the purchase money that was retained by the finance
companies and credited on their books to the dealers' reserve accounts in
that year, and, hence, those amounts constituted accrued income to the
taxpayers in that year, and should have been accrued on their books and
included in their returns for that year. The taxpayers, on the other hand,
contend that the amounts so retained and credited were never under or
subject to their control, and were always subject to such contingent
liabilities of the taxpayers to the finance companies that it could not
have been known, in the year of the sales, how much, if any, of the
reserves would actually be received by them in cash, and hence they did
not acquire, in the year of any of the sales, a fixed right to receive --
in a later year or at any time -- the amounts credited to them in the
reserves, and, therefore, the reserves did not constitute accrued income
to them. This presents, in essence, the issue for decision in these cases.
On the grounds stated, the Commissioner proposed
assessment of income tax deficiencies for certain years against the
respective taxpayers here involved. The taxpayers each petitioned the Tax
Court for a redetermination. After hearings, the Tax Court sustained the
Commissioner in each case. The taxpayers petitioned for review. In No.
380, the Hansen case, the Ninth Circuit reversed, 258 F.2d 585; in No.
381, the Glover case, the Eighth Circuit reversed, 253 F.2d 735; and in
No. 512, the Baird case, the Seventh Circuit affirmed, 256 F.2d 918.
Because of an asserted conflict between those circuits in these cases, and
between other circuits on the question involved, n1 and because of the
importance of the question to the proper administration of the revenue
laws, we granted certiorari in all three cases.
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n1 The Sixth Circuit in Schaeffer v. Commissioner, 258
F.2d 861, sustained the Commissioner's position. Also the Tax Court since
Shoemaker-Nash, Inc., v. Commissioner, 41 B. T. A. 417 (1940), has by a
long line of decisions consistently sustained the Commissioner's position.
On the other hand the Fourth Circuit has sustained the
taxpayers' position in Johnson v. Commissioner, 233 F.2d 952. And the
Fifth Circuit has sustained the taxpayers' position in Texas Trailercoach,
Inc., v. Commissioner, 251 F.2d 395, West Pontiac, Inc., v. Commissioner,
257 F.2d 810, and in several judgments (without opinions) entered on
stipulations specifically presenting anew the same issue which that court
had decided in Texas Trailercoach, Inc., v. Commissioner, supra. In
entering those judgments (in United States v. Hines Pontiac, 2 P-H Fed.
Tax Rep. 2d 5694, United States v. Modern Olds, Inc., 2 P-H Fed. Tax Rep.
2d 5713, and Kilborn v. Commissioner, 2 P-H Fed. Tax Rep. 2d 5812), the
Fifth Circuit adhered to its decision in Texas Trailercoach, Inc., v.
Commissioner, supra.
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Inasmuch as these cases turn on the same issue, and
the Hansen and Glover cases were consolidated for argument and argued
together in this Court, and the Baird case was argued immediately
following, it will be convenient to decide the three cases in one opinion.
Although the relevant facts in the three cases are very similar and follow
the pattern just explained, there are variations which we think should be
set forth.
Respondents in No. 380, John R. Hansen and Shirley G.
Hansen, are husband and wife and filed joint federal income tax returns
for the taxable years 1951, 1952 and 1953 here involved. During those
years, John R. Hansen ("taxpayer"), was a motorcar dealer in
Bellevue, Washington, and kept his books on the accrual basis. He
frequently sold automobiles on "time payments." The taxpayer was
not bound by any contract to sell his installment paper, but because of
his needs for operating capital he consistently sold it to General Motors
Acceptance Corporation ("GMAC").
Although before selling installment paper to GMAC the
taxpayer did not have an express contract with that company concerning the
terms and conditions of such sales and purchases, he had received its
manual covering its policies on those subjects and apparently acted under
them. That manual was not put in evidence, but it is intimated in the
evidence and findings and stated in the briefs, without contradiction,
that it contained provisions to the effect that upon receipt and
acceptance of a duly assigned conditional sale contract guaranteed by the
dealer, GMAC would pay to the dealer the major percentage (not specified
in the evidence or findings) of the agreed price therefor, but would
retain the remaining percentage of the price and credit the same on its
books to a "Dealers Reserve Account" in the name of the dealer,
as security for performance of his obligations to GMAC under his guaranty
of payment of the installment paper and for the payment of any other
obligation which he might incur to GMAC. Once in each year GMAC would
remit to the dealer so much of his accumulated reserve as exceeded 5% of
the then aggregate unpaid balances on installment paper which GMAC had
purchased from the dealer.
Upon negotiating a time sale of an automobile and
receiving the down payment and any other sum immediately payable, the
taxpayer prepared, on forms supplied by GMAC, a conditional sale contract
setting forth a compilation of the figures, including insurance and a
finance charge, involved in the time sale and concluding with a statement
of the "Time (Deferred) Balance" which was payable at the office
of GMAC in fixed monthly installments. When the customer signed and
delivered to the taxpayer the conditional sale contract, the automobile
was delivered to the customer and, as recited in that contract, he
acknowledged "delivery and acceptance of [it] in good order." n2
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n2 At the very beginning of the form there is a
recital that "The undersigned seller [the dealer] hereby sells, and
the undersigned purchaser or purchasers, jointly and severally, hereby
purchase(s), subject to the terms and conditions hereinafter set forth,
the following property, delivery and acceptance of which in good order are
hereby acknowledged by purchaser," and then follows a detailed
description of the automobile, and a computation of the amounts which
support the "Time (Deferred) Balance" that is payable by the
purchaser in monthly installments.
The reverse side of the form recites that "for
the purpose of securing payment of the obligation hereunder, seller
reserves title, and shall have a security interest, in said property until
said amount is fully paid in cash." It then goes on to specify the
various conditions to be observed by the purchaser, which are usually
found in conditional sale contracts.
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It was the taxpayer's consistent practice immediately
thereafter to assign the conditional sale contract (and guarantee its
payment) to GMAC by executing the form of assignment printed at the foot
of the form and forwarding it to GMAC for purchase. n3 Upon receipt and
acceptance of the conditional sale contract and assignment, GMAC remitted
to the taxpayer the major percentage of the price it was to pay therefor,
but retained the remaining percentage and credited it on its books to a
"Dealers Reserve Account" in the name of the taxpayer, for the
purpose of securing performance by him of his obligations to GMAC.
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n3 That assignment, so far as pertinent, provides:
"For value received, undersigned [the dealer]
does hereby sell, assign and transfer to the General Motors Acceptance
Corporation his . . . right, title and interest in and to the within
contract, herewith submitted for purchase by it, and the property covered
thereby and authorizes said General Motors Acceptance Corporation to do
every act and thing necessary to collect and discharge the same.
. . . .
"In consideration of your purchase of the within
contract, undersigned [the dealer] guarantees payment of the full amount
remaining unpaid hereon, and covenants if default be made in payment of
any instalment herein to pay the full amount then unpaid to General Motors
Acceptance Corporation upon demand. . . ."
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The taxpayer recorded on his books in the year such
installment paper was sold, and included in his income tax return for that
year, the cash received from GMAC, but he did not accrue on his books, or
include in his return, the percentage of the price that was retained by
GMAC and credited to his reserve account.
The Commissioner proposed the assessment of
deficiencies in income taxes against the taxpayer and his wife for the
years involved upon the grounds earlier stated. The taxpayer sought a
redetermination in the Tax Court which, after hearing, sustained the
Commissioner, but on taxpayer's petition for review the Ninth Circuit
reversed, 258 F.2d 585, and we granted certiorari for the reasons already
stated, 358 U.S. 879.
Respondent in No. 381, Burl P. Glover
("taxpayer"), during the years 1949, 1950 and 1951 here
involved, was a motorcar dealer in Pine Bluff, Arkansas, and kept his
books and filed his income tax returns on a calendar year accrual basis.
He frequently sold automobiles on time payments, the unpaid balance of the
purchase price of each automobile, including insurance and a finance
charge, being evidenced by the customer's promissory note payable to the
dealer, or his order, in monthly installments over a fixed period, and
secured by a chattel mortgage on the automobile.
Before the note and mortgage sales transactions here
involved, the taxpayer signed a letter addressed to Universal C. I. T.
Credit Corporation (obviously written on a form prepared by the addressee)
proposing to sell to Universal C. I. T. Credit Corporation ("C. I.
T.") such of his notes and mortgages as he chose to sell and as were
"acceptable to" C. I. T., and agreeing, among other things, to
endorse with "full recourse" certain of the notes accepted and
purchased by C. I. T., and to purchase from C. I. T. any automobile that
it repossessed or recovered under a note and mortgage bought from him, at
a cash price, payable on demand, equal to the then unpaid balance of the
note and mortgage, or, failing in that obligation, to pay to C. I. T. the
amount of any loss incurred by it in selling such repossessed automobile.
The letter also stated that the provisions for "reserves as outlined
in [C. I. T.'s] reserve arrangement effective at the time paper [was]
purchased by [it]," would apply to such sales, n4 and that 3 times in
each 12-month period, if the dealer was not then indebted to C. I. T., the
latter would pay to the dealer so much of his reserves as exceeded 3% of
the then aggregate unpaid balances on paper purchased from the dealer. n5
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n4 This record does not contain C. I. T.'s
"reserve arrangement."
n5 The pertinent parts of the taxpayer's letter,
referred to in the text, may be more fully summarized as follows: C. I. T.
was to buy from the taxpayer such of his notes and mortgages as he chose
to sell and as were "acceptable to" C. I. T. Some of the notes
and mortgages were to be endorsed by the dealer to C. I. T. without
recourse, but "paper covering commercial cars used for long distance
hauling, commercial cars of more than two tons capacity, busses, cars used
for taxi, jitney, 'drive-yourself' service, or cars sold to relatives or
employees" was to bear the dealer's "full recourse
endorsement."
Provisions for "reserves as outlined in [C. I.
T.'s] reserve arrangement effective at the time paper [was] purchased by
[it]," were to be applicable to such sales, but as earlier observed
this record does not contain C. I. T.'s "reserve arrangement."
Three times in each 12-month period, if the dealer was not then indebted
to C. I. T., the latter would pay to the dealer his "accumulated
reserves in excess of 3% of the then aggregate unpaid balances on paper
purchased from [him]," but if C. I. T. stopped buying installment
paper from the dealer the former was authorized to "hold and apply
all reserves until liquidation of all paper purchased from [the dealer
was] completed."
The taxpayer was to purchase from C. I. T. "each
repossessed or recovered car tendered at [the dealer's] place of business
within 90 days after maturity of the earliest instalment still
unpaid," at a price, payable on demand, equal to "the unpaid
balance due on the car," or, if the dealer failed to do so, he was to
pay to C. I. T. the amount of "any deficiency incurred by [C. I. T.]
in the resale of such repossessed cars. . . ."
If because of prepayment of a note by a maker, C. I.
T. refunded any part of a "service charge," the taxpayer agreed
to pay to C. I. T. the same percentages, if any, of the refund as had
originally been credited to his reserve account.
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Upon consummating a time sale of an automobile with
his customer in the manner stated, the taxpayer delivered the automobile
to his customer, along with a bill of sale, subject to the mortgage, which
enabled the customer to register, license and use it.
Soon afterward the taxpayer, pursuant to his letter to
C. I. T. just referred to, endorsed the note (and assigned the mortgage)
to C. I. T., in some cases without recourse and in others with full
recourse, and forwarded the same to C. I. T. for purchase. Upon receipt
and acceptance of the note and mortgage, C. I. T. remitted to the taxpayer
the major percentage (not specified in the evidence or findings) of the
agreed price therefor, but retained the remaining percentage and credited
it on its books to a "Dealers Reserve Account" in the name of
the taxpayer, for the purpose of securing performance by him of his
obligations to C. I. T.
As in the Hansen case, the taxpayer recorded on his
books in the year the installment paper was sold, and included in his
income tax return for that year, the cash received from C. I. T., but he
did not accrue on his books, or include in his return, the percentage of
the price that was retained by C. I. T. and credited to his reserve
account. And, as in the Hansen case, the Commissioner proposed the
assessment of deficiencies in income taxes against the taxpayer for the
years involved upon the grounds earlier stated. The taxpayer sought a
redetermination in the Tax Court which, after hearing, sustained the
Commissioner, but, on the taxpayer's petition for review, the Eighth
Circuit reversed, 253 F.2d 735, and we granted certiorari for the reasons
already stated, 358 U.S. 879.
Petitioners in No. 512, Clifton E. Baird and Violet L.
Baird ("taxpayers"), are husband and wife and, during the years
1952, 1953 and 1954 here involved, they were also partners in a firm known
as "Baird Trailer Sales" ("the partnership") which was
engaged primarily in selling house trailers at Salem, Indiana. The
partnership kept its books and filed its partnership
(informational) income tax returns on a fiscal year
accrual basis, but the taxpayers kept their personal books, and filed
their returns, on a calendar year cash basis. During the years involved
the partnership sold many of its trailers on "the installment
basis," the unpaid purchase price of each trailer being evidenced and
secured by an assignable or negotiable instrument, retaining in the
partnership defeasible title to or a lien on the trailer, signed by the
customer, delivered to the partnership, and payable to it in monthly
installments over an agreed period.
The partnership was not legally obligated to sell its
installment paper but its limited operating capital made it necessary, as
a practical matter, to do so. Prior to the transactions here involved the
partnership entered into contracts with Minnehoma Financial Company
("Minnehoma"), of Tulsa, Oklahoma, Michigan National Bank, of
Grand Rapids, Michigan, and Midland Discount Corporation
("Midland"), of Cincinnati, Ohio, providing for the sale and
purchase of such of the partnership's installment paper as it offered for
sale and as those companies were willing to buy, and throughout the years
in question the partnership sold installment paper to each of those
companies under those contracts.
It was provided in the Minnehoma contract that the
partnership, among other liabilities assumed by it to Minnehoma, would
unconditionally guarantee payment when due of all sums called for by any
installment paper purchased from it, and that Minnehoma, upon receipt and
acceptance of such installment paper, would remit to the partnership 95%
of the agreed price to be paid therefor, but would retain the remaining 5%
of the price and credit it (and also, if it wished, a portion of the
"finance charge") to a reserve account on its books in the name
of the partnership, as security for performance of all endorser,
guarantor, and other liabilities of the partnership to Minnehoma. n6
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n6 The material parts of the contract between the
partnership and Minnehoma may be summarized as follows: Upon receipt and
acceptance of installment paper from the partnership, Minnehoma would
remit to the partnership 95% of the price to be paid therefor, but would
retain the remaining 5% of the price and credit it (and also, if it
wished, a portion of the "finance charge" paid by the maker) to
a reserve account on its books in the name of the partnership. The
partnership unconditionally guaranteed payment when due of all sums called
for by the installment paper, and guaranteed that the makers would perform
all obligations assumed by them under that paper, and that in the event
the makers failed to pay any installment when due or to keep any
obligation assumed by them under the installment paper, the partnership
would repurchase such installment paper from Minnehoma, upon demand, at a
price equal to the unpaid balance thereon.
Minnehoma was authorized to charge against the
partnership's reserve account any sums for which the partnership might be
or become indebted to Minnehoma; and at such times as -- after the payment
of all contingent liabilities of the partnership to Minnehoma -- the
amount then credited to the partnership's reserve account exceeded 15% of
the aggregate unpaid balances of all outstanding installment paper so sold
and purchased, Minnehoma would pay such excess, once each month, to the
partnership; and when all installment paper purchased by Minnehoma from
the partnership had been paid in full, Minnehoma would pay to the
partnership the balance of its reserve account.
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Under an oral contract with Michigan National Bank,
the bank agreed that, upon receipt and acceptance of installment paper
endorsed by the partnership with full recourse, it would immediately pay
to the partnership a percentage (not specified in the evidence or
findings) of the price to be paid therefor, but that the remaining
percentage of the price would be retained and credited to a "reserve
account" in the bank in the name of the partnership. That reserve
account was contemporaneously assigned to the bank by the partnership
under the "collateral assignment" shown in the margin. n7
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n7 "COLLATERAL ASSIGNMENT.
"For Valuable Consideration, the receipt of which
is hereby acknowledged, the undersigned hereby sells, assigns, transfers,
and conveys unto Michigan National Bank, of Grand Rapids, Michigan, its
successors, and assigns forever, irrevocably, all of his, its, or their
right, title and interest in certain sums of money now on deposit or that
may hereafter be deposited in the Michigan National Bank, of Grand Rapids,
Michigan, and identified and represented by Reserve account in the name of
the undersigned in the Michigan National Bank.
"This Assignment and Transfer is made as
collateral security for the payment of the direct and indirect liability
of the undersigned to the said Michigan National Bank, of Grand Rapids,
Michigan, and to secure the payment of the several notes representing said
direct and indirect liability and any renewal or renewals thereof, or any
installment payment or payments and to secure any obligation . . . which
the undersigned may owe to said Michigan National Bank, of Grand Rapids,
Michigan.
"In the event of default in the payment of said
liability or any installment thereof, or any of the several notes at the
time when same shall fall due or in the payment of the interest thereon or
any part of the principal of said liability then the Michigan National
Bank, of Grand Rapids, Michigan, at their election, notice of said
election being hereby expressly waived, may apply the total of said sums
of money represented by said Reserve account at the date of election or
any part thereof to meet the default in the liability.
"Whenever the indebtedness secured hereby is paid
in full the Michigan National Bank, of Grand Rapids, Michigan, shall
reassign said sums of money represented by said Reserve account along with
all right, title and interest back to the undersigned.
"If in the opinion of the bank the undersigned
dealer's account is in good standing, all sums in this reserve account in
excess of ten per cent (10%) of the gross unpaid balance of all contracts
outstanding on February 28 of each year will promptly be returned to the
undersigned dealer."
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The contract with Midland was evidenced by two
letters. In essence they stated that upon receipt and acceptance of
installment paper, endorsed by the partnership with full recourse, Midland
would "advance" 97% of the price to be paid therefor if on new
trailers and 95% of the price if on used trailers, and that the
"differentials of 3% and 5%" would be retained and credited on
Midland's books to a reserve account in the name of the partnership, for
the purpose of securing performance of its obligations to Midland. n8 They
also stated that, when a particular note has been paid out, the amount
credited to the reserve on account of that note would be immediately paid
to the dealer, and that when the "reserve fund exceeds 10% of [the
partnership's] outstandings, the excess will be paid [to the partnership]
automatically."
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n8 Midland's vice president who handled these
transactions with the partnership testified relative to the purpose of the
reserve as follows:
"A. Well, we buy this paper from all of our
dealers on a straight endorsed basis, in other words, it's fully recoursed.
If a trailer is given to a note-maker and the note-maker can't pay for it,
the dealer has to take it back, [and] if he can't pay us . . . the net
pay-off on the trailer, we would take the reserve money to liquidate the
account."
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Here, as in the Hansen and Glover cases, the
partnership did not accrue on its books, and the taxpayers did not include
in their individual returns, in any of the years here involved, the
amounts that were retained by Minnehoma, Michigan National Bank and
Midland and credited on their respective books to the partnership's
reserve accounts, and, again, as in the Hansen and Glover cases, the
Commissioner proposed assessment against the taxpayers of deficiencies in
income taxes for the years involved upon the grounds previously stated.
Similarly, the taxpayers sought a redetermination in the Tax Court which,
after hearing, sustained the Commissioner. On the taxpayers' petition for
review, the Seventh Circuit affirmed, 256 F.2d 918, and we granted
certiorari for the reasons already stated, 358 U.S. 918.
We turn, first, to the taxpayers' contention that, in
substance, the purchaser, not the dealer, obtains the loan directly from a
finance company, and that the percentage of the loan which is retained by
the finance company -- although credited on its books to a reserve account
in the name of the dealer as collateral security for the payment of his
liabilities to the finance company -- is the property of the purchaser of
the vehicle, not the dealer, and therefore may not be regarded as accrued
income to the dealer.
The basis of the contention (filling in the omitted
but necessarily involved steps) is that each of these transactions is a
single, "three-cornered" one between the dealer, the finance
company and the purchaser; that, in substance, the dealer agrees to sell
the vehicle to the purchaser for "a down payment plus cash" (the
term "cash" as here used must necessarily refer to the unpaid
balance of the purchase price); that the purchaser agrees immediately to
obtain from the finance company, and it agrees to make to the purchaser, a
loan, on the security of the vehicle, in an amount at least equal to the
unpaid balance of the purchase price owing by the purchaser to the dealer
for the vehicle; and that the purchaser agrees immediately to pay, or to
direct the finance company to pay, to the dealer, out of the proceeds of
the loan, an amount equal to 95% (in most instances) of the unpaid balance
of the purchase price owing by the purchaser to the dealer for the
vehicle. Although this leaves an unpaid balance of the purchase price of
the vehicle (5% in most instances) still owing by the purchaser to the
dealer, it also leaves in possession of the finance company, out of the
proceeds of the loan, an amount at least equal to that 5%. Nevertheless
the purchaser, with the consent of the dealer, agrees with the finance
company that the latter shall retain that 5% and credit it on its books to
a reserve account in the name of the dealer, as collateral security for
the payment of his contingent liabilities to the finance company. On these
assumptions of fact the taxpayers contend that the reserves retained by
the finance companies, though credited on their books to the dealers'
reserve accounts, are only contingently so credited and are subject to
cancellation if the purchaser fails to pay out his loan and, at all
events, the reserves belong to the purchasers, and should not be regarded
as accrued income of the dealers.
The Ninth Circuit in the Hansen case, heavily relying
upon the opinion of the Fifth Circuit in Texas Trailercoach, Inc., v.
Commissioner, 251 F.2d 395, adopted this theory and largely rested its
decision upon that ground, 258 F.2d, at 588, and, to a lesser extent, so
did the Eighth Circuit in the Glover case, 253 F.2d, at 737. The taxpayers
contend here that such is the substance, if not the form, of their
transactions and that, inasmuch as taxation depends on substance and not
on form, the Hansen and Glover cases should be affirmed and the Baird case
should be reversed on this ground alone. We agree, of course, that the
incidence of taxation depends upon the substance, not the form, of the
transaction, Commissioner v. Court Holding Co., 324 U.S. 331, 334;
Helvering v. F. & R. Lazarus & Co., 308 U.S. 252, 255; Bowers v.
Kerbaugh-Empire Co., 271 U.S. 170, 174; Weiss v. Stearn, 265 U.S. 242,
254; United States v. Phellis, 257 U.S. 156, 168, but we think that the
taxpayers have assumed facts which are contrary to the records and are
wholly without substance.
These records clearly show that, in every instance,
the installment paper was executed by the purchaser and made payable to
the dealer (though in the Hansen case "at the office of" GMAC,
and in the Baird case "at the office of" Minnehoma), and that
the same was later assigned or endorsed by the dealer and sent to the
finance company for purchase, under and subject to the dealer's
contractually assumed contingent liabilities to the finance company
respecting it, n9 and that, in every instance, the finance company, upon
receipt and acceptance of the installment paper and of the dealer's
obligations respecting it, immediately paid to the dealer a major
percentage of the agreed or formula fixed price for the paper; but,
pursuant to the terms of the dealer's contract with the finance company,
the latter retained the remaining percentage of the price and credited it
on its books to the dealer's reserve account, as collateral security for
the payment of his contingent liabilities to the finance company on such
installment paper.
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n9 The record in the Hansen case shows that the
conditional sale contracts were made between the dealer and the purchaser
of the vehicle, and that the latter acknowledged to the dealer
"delivery and acceptance of [the automobile] in good order" (see
Note 2); that the dealer consistently assigned his conditional sale
contracts to GMAC by executing the form of assignment printed at the foot
of the form and sending the same to GMAC for purchase, guaranteeing
payment of the full amount remaining unpaid thereon and covenanting that
if default be made in the payment of any installment thereof to pay the
full amount then unpaid to GMAC upon demand (see Note 3).
The record in the Glover case shows that the notes and
mortgages were payable to the dealer and that, upon a sale of them, he
endorsed them, in some cases without recourse and in others with
"full recourse," and forwarded them to C. I. T. for purchase,
subject, of course, to the various obligations he had undertaken to C. I.
T. in respect thereto that are shown in Note 5.
The record in the Baird case shows that the
partnership entered into contracts with its customers, taking assignable
or negotiable instruments retaining defeasible title to or a lien on the
trailers evidencing and securing the unpaid purchase price of the
trailers; that it assigned its conditional sale contracts to Minnehoma
with the guaranties and covenants shown in Note 6; that it endorsed with
full recourse, sold and delivered to Michigan National Bank certain of its
notes and mortgages, under the further guaranties contained in the
"collateral assignment" shown in Note 7; and that it also
endorsed with full recourse, sold and delivered other of its notes and
mortgages to Midland, and authorized it to retain a percentage of the
purchase price to secure performance of its endorser liabilities to
Midland. See Note 8.
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It is therefore clear that the retained percentages of
the purchase price of the installment paper, from the time they were
entered on the books of the finance companies as liabilities to the
respective dealers, were vested in and belonged to the respective dealers,
subject only to their several pledges thereof to the respective finance
companies as collateral security for the payment of their then contingent
liabilities to the finance companies.
This brings us to the question whether amounts of
purchase price withheld by finance companies as security to cover possible
losses on installment paper purchased from dealers, who employ the accrual
method of accounting, constitute income to them at the time the withheld
amounts are recorded on the books of the finance companies as liabilities
to the dealers.
The principles governing the accrual and reporting of
income by taxpayers who employ the accrual basis have long been settled by
the opinions of this Court, Security Flour Mills Co. v. Commissioner, 321
U.S. 281; Spring City Foundry Co. v. Commissioner, 292 U.S. 182, 184;
[*464] Brown v. Helvering, 291 U.S. 193, 199. In Spring City Foundry Co.
v. Commissioner, supra, Chief Justice Hughes, speaking for the Court,
said:
"Keeping accounts and making returns on the
accrual basis, as distinguished from the cash basis, import that it is the
right to receive and not the actual receipt that determines the inclusion
of the amount in gross income. When the right to receive an amount becomes
fixed, the right accrues." 292 U.S., at 184-185. Those principles are
not questioned here, but the parties differ respecting their application
to the facts of these cases. The taxpayers contend, first, that they
cannot presently compel the finance companies to pay to them the amounts
of their reserve accounts, and therefore they have not acquired a
presently enforcible right to recover those reserves, and, hence, they
should not be deemed to constitute accrued income to them. Inasmuch as
these records show that the pay-out period for automobiles varies from 12
to 36 months and for house trailers from 36 to 60 months, it is doubtless
true that the taxpayers, having pledged their reserve accounts to the
finance companies as collateral security, cannot presently compel the
finance companies to pay over their reserves. But the question is not
whether the taxpayers can presently recover their reserves, for, as
stated, it is the time of acquisition of the fixed right to receive the
reserves and not the time of their actual receipt that determines whether
or not the reserves have accrued and are taxable.
The taxpayers next contend that the amounts that were
retained by the finance companies and entered on their books as
liabilities to the dealers under their reserve accounts, were subject to
such contingencies that it could not have been known, in the year of such
retentions and credits, what amount of those reserves would actually be
received by them and, hence, they did not acquire, in the year of such
retentions and credits, a fixed right to receive -- in a later year or at
any time -- the amounts so withheld and credited to them, and therefore
those amounts did not constitute accrued income to them.
It is true that the amounts retained by any one of the
finance companies, and entered on its books as a liability to a particular
dealer, are subject to such liabilities as the dealer may have
contractually assumed to the finance company, but only the obligations of
the dealer to the finance company arising from those liabilities may be
offset against a like amount in the dealer's reserve account. Hence, those
liabilities and obligations provide the only conditions that can affect
full cash payment to the dealer of his reserve account. No amount may be
charged by the finance company against the dealer's reserve account which
he has not thus authorized.
It follows that only one or the other of two things
can happen to the dealer's reserve account: (1) the finance company is
bound to pay the full amount to the dealer in cash, or (2) if the dealer
has incurred obligations to the finance company under his guaranty,
endorsement, or contract of sale, of the installment paper, the finance
company may apply so much of the reserve as is necessary to discharge
those obligations, and is bound to pay the remainder to the dealer in
cash.
Does the dealer "receive" funds which are so
taken from his reserve account and applied to the payment of his
obligations to the finance company? The dealer agreed in his contract with
the finance company to receive his reserve in offset payment of his
obligations to the finance company and the balance in cash. It would
therefore seem that funds in the dealer's reserve which are applied to the
payment of his obligations to the finance company are as much
"received" by him as those which the finance company pays to him
in cash. The Seventh Circuit took that view in the Baird case, saying:
"Ultimately only two things could happen to the
funds in the dealer's reserve accounts: either the amounts would be paid
to the partnership in cash or they would be used to satisfy the
partnership's other obligations to the finance companies." 256 F.2d,
at 924.
In any realistic view we think that the dealer has
"received" his reserve account whether it is applied, as he
authorized, to the payment of his obligations to the finance company, or
is paid to him in cash. n10
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n10 Cf. Old Colony Trust Co. v. Commissioner, 279 U.S.
716, 729; Douglas v. Willcuts, 296 U.S. 1, 9; Tressler v. Commissioner,
228 F.2d 356, 359, n. 6 (C. A. 9th Cir.).
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It follows that the amounts (of purchase price of the
installment paper) that were withheld by the finance companies constituted
accrued income to these accrual basis dealers at the time the withheld
amounts were entered on the books of the finance companies as liabilities
to the dealers, for at that time the dealers acquired a fixed right to
receive the amounts so retained by the finance companies. The taxpayers
complain that such a holding will unfairly require them to pay taxes upon
funds which are not available to them for that purpose. Though the funds
are not presently available to the taxpayers for the payment of taxes,
they are nevertheless owned by the taxpayers, and the latter cannot expect
to collateralize their liabilities, for periods running from 1 to 5 years,
by the use of their accrued but untaxed funds. Moreover, it is a normal
result of the accrual basis of accounting and reporting that taxes
frequently must be paid on accrued funds before receipt of the cash with
which to pay them, just as the Ninth Circuit stated in the Hansen case,
258 F.2d, at 587. See Security Flour Mills Co. v. Commissioner, 321 U.S.
281, 284-285. To permit accrual basis taxpayers to escape accrual and
taxation, in a particular year, of such portions of their sales as they
may permit to be retained by buyers, as collateral security, well might
violate @ 42 (a) of the 1939 Internal Revenue Code as amended, n11 and,
moreover, might well afford opportunities to accrual basis taxpayers to
allocate income to years deemed most advantageous.
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n11 Section 42 (a) (as amended by @ 114, Revenue Act
of 1941, c. 412, 55 Stat. 687), 26 U. S. C. (1952 ed.) @ 42, so far as
pertinent, provides:
"(a) General Rule -- The amount of all items of
gross income shall be included in the gross income for the taxable year in
which received by the taxpayer, unless, under methods of accounting
permitted under section 41, any such amounts are to be properly accounted
for as of a different period."
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The Commissioner has broad powers in determining
whether accounting methods used by a taxpayer clearly reflect income,
Lucas v. American Code Co., 280 U.S. 445, 449; Automobile Club of Michigan
v. Commissioner, 353 U.S. 180, 189-190, and under @ 41 of the Internal
Revenue Code of 1939, 26 U. S. C. (1952 ed.) @ 41, the Commissioner,
believing that the accounting method employed by a taxpayer "does not
clearly reflect the income," may require that "computation shall
be made in accordance with such method as in [his] opinion . . . does
clearly reflect the income." Since 1931 the Internal Revenue Service
has consistently maintained that amounts withheld by finance companies to
cover possible losses on notes purchased from dealers constitute income to
dealers, who employ the accrual method of accounting, from the time the
amounts are recorded on the books of the finance companies as liabilities
to the dealers. n12 That position, in general, accords with our view.
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n12 The first publication of its views was inG. C. M.
9571, X-2 Cum. Bull. 153 (1931). Its most recently published views on the
subject are contained inRev. Rul. 57-2, 1957-1 Cum. Bull. 17, which, so
far as pertinent, provides:
"Amounts withheld by banks or finance companies
to cover possible losses on notes purchased from dealers constitute income
to dealers employing the accrual method of accounting, to the extent of
their interest therein at the time the amounts are recorded on the books
of the bank or finance company as a liability to the dealer . . . ."
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The taxpayers have argued that portions of the Dealers
Reserve Accounts consist of percentages of "finance charges" n13
which the finance companies agreed to allow them, and that such
percentages of the "finance charges," not being a part of the
purchase price of the installment paper, should in no event be regarded as
accrued income to the dealers. However, the respective taxpayers, each of
whom had the burden of showing that he did not owe the taxes which the
Commissioner proposed to assess against him, wholly failed to adduce
evidence to support their claims. They failed even to adduce evidence
showing whether any percentages of the "finance charges" that
may have been allowed to them by the respective finance companies were
entered on the books of the finance companies as credits to the respective
"Dealers Reserve Accounts," and if so, whether such percentages
of the "finance charges" so credited had been identified and
separated in character and amount from the percentages of the purchase
price of the installment paper that were retained by the finance companies
and entered on their books as liabilities to the dealers in their
respective Dealers Reserve Accounts. For these reasons the respective
taxpayers have wholly failed to sustain the burden of showing that any
part of the amounts credited on the books of the finance companies to the
respective Dealers Reserve Accounts was entitled to special treatment.
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n13 As to the term "finance charges," the
records and briefs in these cases make one thing clear: it is not a term
of art. Its meaning appears to be both erratic and elastic. Nor have we
been told by any one of these taxpayers what he intends to be included in
his use of the term.
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The judgments in No. 380 and No. 381 are reversed and
the judgment in No. 512 is affirmed.
MR. JUSTICE DOUGLAS dissents.
MR. JUSTICE BLACK took no part in the consideration
or decision of these cases.
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