Commissioner v. Indianapolis Power & Light Co. (1990)
COMMISSIONER OF INTERNAL REVENUE v.
INDIANAPOLIS POWER & LIGHT CO.
No. 88-1319
SUPREME COURT OF THE UNITED STATES
493 U.S. 203; 110 S. Ct. 589;
107 L.Ed. 2d 591; 58 U.S.L.W. 4098;
90-1 U.S. Tax Cas. (CCH) P50,007;
65 A.F.T.R.2d (P-H) 394
October 31, 1989, Argued
January 9, 1990, Decided
PRIOR HISTORY:
CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR
THE SEVENTH CIRCUIT.
DISPOSITION: 857 F. 2d 1162, affirmed.
SYLLABUS: Respondent Indianapolis Power & Light
Co. (IPL), a regulated Indiana utility and an accrual-basis taxpayer,
requires customers having suspect credit to make deposits with it to
assure prompt payment of future electric bills. Prior to termination of
service, customers who satisfy a credit test can obtain a refund of their
deposits or can choose to have the amount applied against future bills.
Although the deposits are at all times subject to the company's unfettered
use and control, IPL does not treat them as income at the time of receipt
but carries them on its books as current liabilities. Upon audit of IPL's
returns for the tax years at issue, petitioner Commissioner of Internal
Revenue asserted deficiencies, claiming that the deposits are advance
payments for electricity and therefore are taxable to IPL in the year of
receipt. The Tax Court ruled in favor of IPL on its petition for
redetermination, holding that the deposits' principal purpose is to serve
as security rather than as prepayment of income. The Court of Appeals
affirmed.
Held: The customer deposits are not advance payments
for electricity and therefore do not constitute taxable income to IPL upon
receipt. Although IPL derives some economic benefit from the deposits, it
does not have the requisite "complete dominion" over them at the
time they are made, the crucial point for determining taxable income. IPL
has an obligation to repay the deposits upon termination of service or
satisfaction of the credit test. Moreover, a customer submitting a deposit
makes no commitment to purchase any electricity at all. Thus, while
deposits eventually may be used to pay for electricity by virtue of
customer default or choice, IPL's right to retain them at the time they
are made is contingent upon events outside its control. This construction
is consistent with the Tax Court's long-standing treatment of sums
deposited to secure a tenant's performance of a lease agreement, perhaps
the closest analogy to the present situation. Pp. 207-214.
COUNSEL: Deputy Solicitor General Wallace, argued the
cause for petitioner. With him on the briefs were Solicitor General Starr,
Acting Assistant Attorney General Knapp, Alan I. Horowitz, Jonathan S.
Cohen, and William A. Whitledge. Larry J. Stroble, argued the cause for
respondent. With him on the brief was Stanley C. Fickle. *
* Briefs of amici curiae urging affirmance were filed
for American Information Technologies Corporation et al. by Jerome B.
Libin, Bradley M. Seltzer, Jim J. Kilpatric, and Lawrence H. Cohen; for El
Paso Electric Company by Stephen R. Nelson; for Oak Industries, Inc., and
Subsidiaries by John P. Warner and Samuel M. Maruca; and for Wisconsin
Electric Power Co. and Affiliated Companies by Joseph E. Tierney, Jr., and
Margaret T. Lund.
JUDGES: BLACKMUN, J., delivered the opinion for a
unanimous Court.
OPINIONBY: BLACKMUN
OPINION: JUSTICE BLACKMUN delivered the opinion of the
Court.
Respondent Indianapolis Power & Light Company (IPL)
requires certain customers to make deposits with it to assure payment of
future bills for electric service. Petitioner Commissioner of Internal
Revenue contends that these deposits are advance payments for electricity
and therefore constitute taxable income to IPL upon receipt. IPL contends
otherwise.
IPL is a regulated Indiana corporation that
generates and sells electricity in Indianapolis and its environs.
It keeps its books on the accrual and calendar year basis. During
the years 1974 through 1977, approximately 5% of IPL's residential
and commercial customers were required to make deposits "to
insure prompt payment," as the customers' receipts stated,
of future utility bills. These customers were selected because their
credit was suspect. Prior to March 10, 1976, the deposit requirement
was imposed on a case-by-case basis. IPL relied on a credit test
but employed no fixed formula. The amount of the required deposit
ordinarily was twice the customer's estimated monthly bill. IPL
paid 3% interest on a deposit held for six months or more. A customer
could obtain a refund of the deposit prior to termination of service
by requesting a review and demonstrating acceptable credit. The
refund usually was made in cash or by check, but the customer could
choose to have the amount applied against future bills.
In March 1976, IPL amended its rules governing the
deposit program. See 170 Ind. Admin. Code @ 4-1-15 (1988). Under the
amended rules, the residential customers from whom deposits were required
were selected on the basis of a fixed formula. The interest rate was
raised to 6% but was payable only on deposits held for 12 months or more.
A deposit was refunded when the customer made timely payments for either 9
consecutive months, or for 10 out of 12 consecutive months so long as the
2 delinquent months were not themselves consecutive. A customer could
obtain a refund prior to that time by satisfying the credit test. As under
the previous rules, the refund would be made in cash or by check, or, at
the customer's option, applied against future bills. Any deposit unclaimed
after seven years was to escheat to the State. See Ind. Code @ 32-9-1-6(a)
(1988). n1
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n1 During the years 1974 through 1977, the total
amount that escheated to the State was less than $ 9,325. Stipulation of
Facts para. 25.
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I
IPL did not treat these deposits as
income at the time of receipt. Rather, as required by state administrative
regulations, the deposits were carried on its books as current liabilities.
Under its accounting system, IPL recognized income when it mailed
a monthly bill. If the deposit was used to offset a customer's bill,
the utility made the necessary accounting adjustments. Customer
deposits were not physically segregated in any way from the company's
general funds. They were commingled with other receipts and at all
times were subject to IPL's unfettered use and control. It is undisputed
that IPL's treatment of the deposits was consistent with accepted
accounting practice and applicable state regulations.
Upon audit of respondent's returns for the calendar
years 1974 through 1977, the Commissioner asserted deficiencies. Although
other items initially were in dispute, the parties were able to reach
agreement on every issue except that of the proper treatment of customer
deposits for the years 1975, 1976, and 1977. The Commissioner took the
position that the deposits were advance payments for electricity and
therefore were taxable to IPL in the year of receipt. He contended that
the increase or decrease in customer deposits outstanding at the end of
each year represented an increase or decrease in IPL's income for the
year. n2 IPL disagreed and filed a petition in the United States Tax Court
for redetermination of the asserted deficiencies.
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n2 The parties' stipulation sets forth the balance in
IPL's customer-deposit account on December 31 of each of the years 1954,
1974, 1975, 1976, and 1977. In his notice of deficiency, the Commissioner
concluded that IPL was required to include in income for 1975 the increase
in the account between December 31, 1954, and December 31, 1975. For 1976
and 1977, IPL was allowed to reflect in income the respective decreases in
the account during those years.
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In a reviewed decision, with one judge not
participating, a unanimous Tax Court ruled in favor of IPL. 88 T. C. 964
(1987). The court followed the approach it had adopted in City Gas Co. of
Florida v. Commissioner, 74 T. C. 386 (1980), rev'd, 689 F.2d 943 (CA11
1982). It found it necessary to "continue to examine all of the facts
and circumstances," 88 T. C., at 976, and relied on several factors
in concluding that the deposits in question were properly excluded from
gross income. It noted, among other things, that only 5% of IPL's
customers were required to make deposits; that the customer rather than
the utility controlled the ultimate disposition of a deposit; and that IPL
consistently treated the deposits as belonging to the customers, both by
listing them as current liabilities for accounting purposes and by paying
interest. Id., at 976-978.
The United States Court of Appeals for the Seventh
Circuit affirmed the Tax Court's decision. 857 F.2d 1162 (1988). The court
stated that "the proper approach to determining the appropriate tax
treatment of a customer deposit is to look at the primary purpose of the
deposit based on all the [*207] facts and circumstances . . . ." Id.,
at 1167. The court appeared to place primary reliance, however, on IPL's
obligation to pay interest on the deposits. It asserted that "as the
interest rate paid on a deposit to secure income begins to approximate the
return that the recipient would be expected to make from 'the use' of the
deposit amount, the deposit begins to serve purposes that comport more
squarely with a security deposit." Id., at 1169. Noting that IPL had
paid interest on the customer deposits throughout the period in question,
the court upheld, as not clearly erroneous, the Tax Court's determination
that the principal purpose of these deposits was to serve as security
rather than as prepayment of income. Id., at 1170.
Because the Seventh Circuit was in specific
disagreement with the Eleventh Circuit's ruling in City Gas Co. of
Florida, supra, we granted certiorari to resolve the conflict. 490 U.S.
1033 (1989).
II
We begin with the common ground. IPL acknowledges that
these customer deposits are taxable as income upon receipt if they
constitute advance payments for electricity to be supplied. n3 The
Commissioner, on his part, concedes that customer deposits that secure the
performance of
non-income-producing covenants -- such as a utility
customer's obligation to ensure that meters will not be damaged -- are not
taxable income. And it is settled that receipt of a loan is not income to
the borrower. See Commissioner v. Tufts, 461 U.S. 300, 307 (1983)
("Because of [the repayment] obligation, the loan proceeds do not
qualify as income to the taxpayer"); James v. United States, 366 U.S.
213, 219 (1961) (accepted definition of gross income "excludes
loans"); Commissioner v. Wilcox, 327 U.S. 404, 408 (1946). IPL,
stressing its obligation to refund the deposits with interest, asserts
that the payments are similar to loans. The Commissioner, however,
contends that a deposit which serves to secure the payment of future
income is properly analogized to an advance payment for goods or services.
SeeRev. Rul. 72-519, 1972-2 Cum. Bull. 32, 33 ("When the purpose of
the deposit is to guarantee the customer's payment of amounts owed to the
creditor, such a deposit is treated as an advance payment, but when the
purpose of the deposit is to secure a property interest of the taxpayer
the deposit is regarded as a true security deposit").
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n3 This Court has held that an accrual-basis taxpayer
is required to treat advance payments as income in the year of receipt.
See Schlude v. Commissioner, 372 U.S. 128 (1963); American Automobile
Assn. v. United States, 367 U.S. 687 (1961); Automobile Club of Michigan
v. Commissioner, 353 U.S. 180 (1957). These cases concerned payments --
nonrefundable fees for services -- that indisputably constituted income;
the issue was when that income was taxable. Here, in contrast, the issue
is whether these deposits, as such, are income at all.
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In economic terms, to be sure, the distinction between
a loan and an advance payment is one of degree rather than of kind. A
commercial loan, like an advance payment, confers an economic benefit on
the recipient: a business presumably does not borrow money unless it
believes that the income it can earn from its use of the borrowed funds
will be greater than its interest obligation. See Illinois Power Co. v.
Commissioner, 792 F.2d 683, 690 (CA7 1986). Even though receipt of the
money is subject to a duty to repay, the borrower must regard itself as
better off after the loan than it was before. The economic benefit of a
loan, however, consists entirely of the opportunity to earn income on the
use of the money prior to the time the loan must be repaid. And in that
context our system is content to tax these earnings as they are realized.
The recipient of an advance payment, in contrast, gains both immediate use
of the money (with the chance to realize earnings thereon) and the
opportunity to make a profit by providing goods or services at a cost
lower than the amount of the payment.
The question, therefore, cannot be resolved simply by
noting that respondent derives some economic benefit from receipt of these
deposits. n4 Rather, the issue turns upon the nature of the rights and
obligations that IPL assumed when the deposits were made. In determining
what sort of economic benefits qualify as income, this Court has invoked
various formulations. It has referred, for example, to "undeniable
accessions to wealth, clearly realized, and over which the taxpayers have
complete dominion." Commissioner v. Glenshaw Glass Co., 348 U.S. 426,
431 (1955). It also has stated: "When a taxpayer acquires earnings,
lawfully or unlawfully, without the consensual recognition, express or
implied, of an obligation to repay and without restriction as to their
disposition, 'he has received income . . . .'" James v. United
States, 366 U.S., at 219, quoting North American Oil Consolidated v.
Burnet, 286 U.S. 417, 424 (1932). IPL hardly enjoyed "complete
dominion" over the customer deposits entrusted to it. Rather, these
deposits were acquired subject to an express "obligation to
repay," either at the time service was terminated or at the time a
customer established good credit. So long as the customer fulfills his
legal obligation to make timely payments, his deposit ultimately is to be
refunded, and both the timing and method of that refund are largely within
the control of the customer.
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n4 See Illinois Power Co. v. Commissioner, 792 F.2d
683, 690 (CA7 1986). See also Burke & Friel, Recent Developments in
the Income Taxation of Individuals, Tax-Free Security: Reflections on
Indianapolis Power & Light, 12 Rev. of Taxation of Individuals 157,
174 (1988) (arguing that economic-benefit approach is superior in theory,
but acknowledging that "an economic-benefit test has not been
adopted, and it is unlikely that such an approach will be pursued by the
Service or the courts").
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The Commissioner stresses the fact that these deposits
were not placed in escrow or segregated from IPL's other funds, and that
IPL therefore enjoyed unrestricted use of the money. That circumstance,
however, cannot be dispositive. After all, the same might be said of a
commercial loan; yet the Commissioner does not suggest that a loan is
taxable upon receipt simply because the borrower is free to use the funds
in whatever fashion he chooses until the time of repayment. In determining
whether a taxpayer enjoys "complete dominion" over a given sum,
the crucial point is not whether his use of the funds is unconstrained
during some interim period. The key is whether the taxpayer has some
guarantee that he will be allowed to keep the money. IPL's receipt of
these deposits was accompanied by no such guarantee.
Nor is it especially significant that these deposits
could be expected to generate income greater than the modest interest IPL
was required to pay. Again, the same could be said of a commercial loan,
since, as has been noted, a business is unlikely to borrow unless it
believes that it can realize benefits that exceed the cost of servicing
the debt. A bank could hardly operate profitably if its earnings on
deposits did not surpass its interest obligations; but the deposits
themselves are not treated as income. n5 Any income that the utility may
earn through use of the deposit money of course is taxable, but the
prospect that income will be generated provides no ground for taxing the
principal.
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n5 Cf.Rev. Rul. 71-189, 1971-1 Cum. Bull. 32 (inactive
deposits are not income until bank asserts dominion over the accounts).
See also
Fidelity-Philadelphia Trust Co. v. Commissioner, 23 T.
C. 527 (1954).
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The Commissioner's advance-payment analogy seems to us
to rest upon a misconception of the value of an advance payment to its
recipient. An advance payment, like the deposits at issue here, concededly
protects the seller against the risk that it would be unable to collect
money owed it after it has furnished goods or services. But an advance
payment does much more: it protects against the risk that the purchaser
will back out of the deal before the seller performs. From the moment an
advance payment is made, the seller is assured that, so long as it
fulfills its contractual obligation, the money is its to keep. Here, in
contrast, a customer submitting a deposit made no commitment to purchase a
specified quantity of electricity, or indeed to purchase any electricity
at all. n6 IPL's right to keep the money depends upon the customer's
purchase of electricity, and upon his later decision to have the deposit
applied to future bills, not merely upon the utility's adherence to its
contractual duties. Under these circumstances, IPL's dominion over the
fund is far less complete than is ordinarily the case in an
advance-payment situation.
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n6 A customer, for example, might terminate service
the day after making the deposit. Also, IPL's dominion over a deposit
remains incomplete even after the customer begins buying electricity. As
has been noted, the deposit typically is set at twice the customer's
estimated monthly bill. So long as the customer pays his bills in a timely
fashion, the money he owes the utility (for electricity used but not yet
paid for) almost always will be less than the amount of the deposit. If
this were not the case, the deposit would provide inadequate protection.
Thus, throughout the period the deposit is held, at least a portion is
likely to be money that IPL has no real assurance of ever retaining.
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The Commissioner emphasizes that these deposits
frequently will be used to pay for electricity, either because the
customer defaults on his obligation or because the customer, having
established credit, chooses to apply the deposit to future bills rather
than to accept a refund. When this occurs, the Commissioner argues, the
transaction, from a cash-flow standpoint, is equivalent to an advance
payment. In his view this economic equivalence mandates identical tax
treatment. n7
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n7 The Commissioner is unwilling, however, to pursue
this line of reasoning to the limit of its logic. He concedes that these
deposits would not be taxable if they were placed in escrow, Tr. of Oral
Arg. 4; but from a cashflow standpoint it does not make much difference
whether the money is placed in escrow or commingled with the utility's
other funds. In either case, the utility receives the money and allocates
it to subsequent purchases of electricity if the customer defaults or
chooses to apply his refund to a future bill.
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Whether these payments constitute income when
received, however, depends upon the parties' rights and obligations at the
time the payments are made. The problem with petitioner's argument perhaps
can best be understood if we imagine a loan between parties involved in an
ongoing commercial relationship. At the time the loan falls due, the
lender may decide to apply the money owed him to the purchase of goods or
services rather than to accept repayment in cash. But this decision does
not mean that the loan, when made, was an advance payment after all. The
lender in effect has taken repayment of his money (as was his contractual
right) and has chosen to use the proceeds for the purchase of goods or
services from the borrower. Although, for the sake of convenience, the
parties may combine the two steps, that decision does not blind us to the
fact that in substance two transactions are involved. n8 It is this
element of choice that distinguishes an advance payment from a loan.
Whether these customer deposits are the economic equivalents of advance
payments, and therefore taxable upon receipt, must be determined by
examining the relationship between the parties at the time of the deposit.
The individual who makes an advance payment retains no right to insist
upon the return of the funds; so long as the recipient fulfills the terms
of the bargain, the money is its to keep. The customer who submits a
deposit to the utility, like the lender in the previous hypothetical,
retains the right to insist upon repayment in cash; he may choose to apply
the money to the purchase of electricity, but he assumes no obligation to
do so, and the utility therefore acquires no unfettered
"dominion" over the money at the time of receipt.
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n8 The Commissioner contends that a customer's
decision to take his refund while making a separate payment for services,
rather than applying the deposit to his bill, would amount to nothing more
than an economically meaningless "exchange of checks." But in
our view the "exchange of checks," while less convenient, more
accurately reflects the economic substance of the transactions.
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When the Commissioner examines privately structured
transactions, the true understanding of the parties, of course, may not be
apparent. It may be that a transfer of funds, though nominally a loan, may
conceal an unstated agreement that the money is to be applied to the
purchase of goods or services. We need not, and do not, attempt to devise
a test for addressing those situations where the nature of the parties'
bargain is legitimately in dispute. This particular respondent, however,
conducts its business in a heavily regulated environment; its rights and
obligations vis-a-vis its customers are largely determined by law and
regulation rather than by private negotiation. That the utility's
customers, when they qualify for refunds of deposits, frequently choose to
apply those refunds to future bills rather than taking repayment in cash
does not mean that any customer has made an unspoken commitment to do so.
Our decision is also consistent with the Tax Court's
long-standing treatment of lease deposits -- perhaps the closest analogy
to the present situation. The Tax Court traditionally has distinguished
between a sum designated as a prepayment of rent -- which is taxable upon
receipt -- and a sum deposited to secure the tenant's performance of a
lease agreement. See, e.g., J. & E. Enterprises, Inc. v. Commissioner,
26 TCM 944 (1967). n9 In fact, the customer deposits at issue here are
less plausibly regarded as income than lease deposits would be. The
typical lease deposit secures the tenant's fulfillment of a contractual
obligation to pay a specified rent throughout the term of the lease. The
utility customer, however, makes no commitment to purchase any services at
all at the time he tenders the deposit.
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n9 In J. & E. Enterprises the Tax Court stated:
"If a sum is received by a lessor at the beginning of a lease, is
subject to his unfettered control, and is to be applied as rent for a
subsequent period during the term of the lease, such sum is income in the
year of receipt even though in certain circumstances a refund thereof may
be required. . . . If, on the other hand, a sum is deposited to secure the
lessee's performance under a lease, and is to be returned at the
expiration thereof, it is not taxable income even though the fund is
deposited with the lessor instead of in escrow and the lessor has
temporary use of the money. . . . In this situation the acknowledged
liability of the lessor to account for the deposited sum on the lessee's
performance of the lease covenants prevents the sum from being taxable in
the year of receipt." 26 TCM, at 945-946.
InRev. Rul. 72-519, 1972-2 Cum. Bull. 32, the
Commissioner relied in part on J. & E. Enterprises as authority for
the proposition that deposits intended to secure income-producing
covenants are advance payments taxable as income upon receipt, while
deposits intended to secure nonincome-producing covenants are not. 1972-2
Cum. Bull., at 33. In our view, neither J. & E. Enterprises nor the
other cases cited in the Revenue Ruling support that distinction. See
Hirsch Improvement Co. v. Commissioner, 143 F.2d 912 (CA2), cert. denied,
323 U.S. 750 (1944); Mantell v. Commissioner, 17 T. C. 1143 (1952); Gilken
Corp. v. Commissioner, 10 T. C. 445 (1948), aff'd, 176 F.2d 141 (CA6
1949). These cases all distinguish between advance payments and security
deposits, not between deposits that do and do not secure income-producing
covenants.
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We recognize that IPL derives an economic benefit from
these deposits. But a taxpayer does not realize taxable income from every
event that improves his economic condition. A customer who makes this
deposit reflects no commitment to purchase services, and IPL's right to
retain the money is contingent upon events outside its control. We hold
that such dominion as IPL has over these customer deposits is insufficient
for the deposits to qualify as taxable income at the time they are made.
The judgment of the Court of Appeals is affirmed.
It is so ordered.
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