General Gas v. Commissioner (1961)

GENERAL GAS CORPORATION, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 18365

UNITED STATES COURT OF APPEALS FIFTH CIRCUIT

293 F.2d 35; 61-2 U.S. Tax Cas. (CCH) P9618; 8 A.F.T.R.2d (P-H) 5298

August 11, 1961

SUBSEQUENT HISTORY: Petition for Writ of Certiorari Denied, Reported at 369

U.S. 816. Petition for Rehearing Denied, October 2, 1961.

COUNSEL:

Paul O. H. Pigman of Stone, Pigman & Benjamin, New Orleans, La., and Charles

W. Wilson, Harvey H. Posner, Watson, Blanche, Wilson, Posner & Thibault, and E.

Leland Richardson, Dale, Richardson & Dale, Baton Rouge, La., of counsel, for

petitioner.

Meyer Rothwacks, Carolyn R. Just, Lee A. Jackson, Dept. of Justice,

Washington, ,D.C., Louis F. Oberdorfer, Asst. Atty. Gen., Dept. of Justice, Hart

H. Spiegel, Chief Counsel, John M. Morawski, Atty., Internal Revenue Service,

Washington D.C., for respondent.

JUDGES: Before JONES and BROWN, Circuit Judges, and DE VANE, District Judge.

OPINIONBY: BROWN

OPINION:

This appeal from the Tax Court involves two questions. The first is whether

this accrual basis Taxpayer, a corporation, must include in its taxable income

amounts held to its credit in a 'Dealer's Reserve Account' by a finance company

which had purchased its customer notes during the year in which the finance

company credits it to the dealer-Taxpayer. If that inquiry is answered

affirmatively, the second issue must be resolved. Should the portions of the

reserve which constitute finance charges imposed by the Taxpayer on its

customers and included in the face of the notes be given any different

treatment? More specifically, the question is whether reserves made up of

finance charges are to be taken into income at the time the credit is entered by

the finance company or pro rata during the life of the installment note as

monthly collections are made. The Tax Court answered both of these questions

favorably to the Commissioner. 33 T.C. 303. Prime reliance was placed on

Commissioner of Internal Revenue v. Hansen, 1959, 360 U.S. 446, 79 S.Ct. 1270, 3

L.Ed.2d 1360, recently decided by the Supreme Court, which was a decision on

three appeals all involving factual situations similar in most respects to the

one now before us. We agree with the Tax Court's determination of both

questions.

The somewhat involved facts, most of which are formally stipulated by the

parties, may be briefly summarized. The Taxpayer, General Gas Corporation, is a

distributor of liquefied petroleum gas and also sells tanks and other equipment

required in the storage and use of gas. Its customers include both industrial

and home users. To increase the home-use market for its gas, the corporation in

1949 expanded its activities to include sales of household gas appliances. The

corporation found that to be competitive in this field it was necessary that

installment credit purchases of these items be readily available to its

potential customers. Consequently, an installment-time-payment plan was

established. A customer desiring to make an installment credit purchase was

required to make a down payment of cash or acceptable trade-in. In addition he

would execute a note in the amount of the unpaid portion of the selling price

plus finance charges which General Gas charged for an installment-time-sale. A

chattel mortgage, conditional sales contract or the like was utilized to secure

the note. The customer obligated himself to pay off the note in installments

over a period of 12 to 36 months.

Originally General Gas did not refinance its credit sales but merely held the

notes until maturity. Shortly, though, a more liquid position was necessary and

several long-term loan arrangements were entered into, as well as a short-term

arrangement whereby customer notes were endorsed with recourse as collateral.

Only a little over a year passed before more cash was needed. It [*37] was

then determined that due to the demands of its long-term loan sources and a

desire to place some of its capital stock on the open market a new note

financing plan would have to be worked out. This precipitated the financing

arrangement here under scrutiny.

Early in 1952, the tax year here in question, General Gas entered into

contracts with three different financing agencies, Bancredit, Guaranty and

ReDisCo, n1 providing for the sale to them of all acceptable customer notes to

be endorsed without recourse. The Bancredit contract, identical to the Guaranty

contract, provided that the notes were to be endorsed to Bancredit in exchange

for payment to General Gas of the 'net cash selling price' n2 of the appliance

less 10%. The agreement also provided that the aggregate of this 10% and the

finance charges (which made up the balance of the face of the note) was to be

set up as a reserve account on Bancredit's books. Customer payments were to be

made directly to General Gas for immediate daily transmission to Bancredit.

While the reserve was maintained to the credit of General Gas and was subject to

specified charges against it arising under the financing agreement payments by

Bancredit from the account to General Gas were to be made only when the reserve

exceeded 30% of the balance of all outstanding notes. n3 On termination of the

arrangement, the entire balance was to be remitted. Unlike many refinancing

arrangements, the profit of Bancredit was not to come from the finance charges

built into the customers' time-purchase notes. Under the 'Reserve' set-up of

this arrangement, finance charges were for General Gas. For credit extended by

it, Bancredit was to receive simple 7% interest on the balance of its investment

in the notes.

The contract with ReDisCo was identical in every respect except that there

was to be no deduction of a 10% discount. On the transfer of the note ReDisCo

was to pay General Gas the entire 'net cash selling price' of the note without

discount. Consequently, under this agreement only the portion of a note

representing finance charges went into the Reserve Account. n4

The primary position advanced by General Gas here and below is that no part

of the Dealer Reserve Account is includible in its taxable income so long as it

stands as a mere credit on the books of the finance company. Rather, it

contends, the amounts are taxable only when actually received in some form.

This position on Dealer Reserve Accounts has, of course, been advanced in

numerous cases and has been based on many varying theories. n5

It facilitates discussion of both questions to reduce this to the

example used in the record of a typical credit sale by General Gas with the

contemporaneous financing. An appliance is sold to a customer on which $ 400

remains due after the down payment. The finance charge is $ 100. Therefore the

customer executes a note for $ 500 payable in 24 monthly fixed installments.

General Gas sells the note to Bancredit and receives a payment of $ 360 (being

the net cash selling price less the 10% discount). This discount of $ 40 and

the $ 100 finance charge are credited to the Reserve, account on Bancredit's

books. n6

The theory most commonly urged has been that the so-called reserves (Items

(d) and (f), note 6, supra) have not presently been received, their immediate

payment may not be demanded, and, of most importance, due to the contingencies

existing in these situations may never be received. Whatever may have been the

conflict among the Circuit Courts on this question, the authoritative word of

the Supreme Court in Commissioner of Internal Revenue v. Hansen has laid to rest

most of the uncertainties. That decision required the taxpayers involved to

include reserves similar at least to Item (d) in their taxable income for the

year in which credits were made on the finance company's books. The basis of

the Court's holding was that 'it is the time of (the) 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.' 360 U.S.

446, at page 464, 79 S.Ct. 1270, at page 1280.

We conclude that the Hansen case is in point and controlling as to the first

issue raised by the Taxpayer. General Gas has attempted to distinguish the

present situation on the facts by pointing out that the notes here involved were

sold 'without recourse,' while those in Hansen were endorsed 'with recourse.'

This distinction is not significant. While it is true that General Gas had no

direct personal liability, the Reserve Account (Items (d) and (f)) was liable

for all customer defaults, losses from repossessions, payment of Bancredit's 7%

interest charge and all other liabilities of General Gas under the financing

contract. Consequently General Gas receives full financial benefit from the

entire amount of these reserve credits. It receives in cash the cumulative

reserve in excess of the 30% limit and, of course, will eventually receive the

entire amount remaining to its credit. To the extent that charges are made

against the reserve for note defaults and the like, they constitute offsets

against, and hence payment of, liabilities of General Gas under the financing

agreement. Therefore the entire amounts contained in the reserves will be

received in full, either by reduction in liabilities or by cash payment. The

fact that the financing agreements in effect put a ceiling on General Gas'

[*39] economic liability did not alter in the slightest the full beneficial

receipt of these sums by General Gas. Moreover, on the Hansen concept this was

certain and known at the moment the credit was entered. Thus the language of

Hansen, quoting from the Seventh Circuit, is equally applicable here.

'Ultimately only two things could happen to the funds in the dealer's reserve

accounts: either the amounts would be paid to the (dealer) in cash or they would

be used to satisfy the (dealer's) other obligations to the finance companies.'

360 U.S. 446, at page 466, 79 S.Ct. 1270, at page 1281, 3 L.Ed.2d 1360.

This brings us to the second problem concerning the inclusion in income of

Item (f) which is the portion of the reserves representing finance charges. As

pointed out these charges are included in the face amount of the notes.

Taxpayer insists that even though it fails on the basic issue finance charges

should be taken into income ratably as collectible, and collected, over the life

of the note.

The basic positions of the parties may be briefly stated. General Gas argues

that the $ 100 finance charge (Item (f)) is imposed by it for the extension of

credit, that is for interest, insurance and administrative expense of handling

the installment-time-sale. The amount is not fully earned at the time the notes

are received from the customer. Nor is the situation altered any by the

inclusion of these amounts in reserve accounts since these finance charges will

be received only when and if payments are actually made by the customer.

Consequently, they should not be included in income until actually earned or

actually received.

The Commissioner takes the position that the entire $ 140 (Items (d) and (f))

is taxable when credited to the Reserve Account. This is true, he argues,

despite the fact that the entire $ 100 finance charge may not have been fully

earned by General Gas at the time of the sale of the note since here, as in

Hansen, General Gas was credited immediately with the full amount of it and, as

in the case of the 10% discount (Item (d)), it acquired a known fixed right to

receive this either in cash or offsets to liabilities or both. He continues

that the finance charge is part of the total consideration for the note sale and

thus the gain on that charge should be accrued when the sale occurs.

The Hansen decision involved three different appeals, each concerning

taxpayers making credit sales to their customers in much the same manner as did

General Gas. Each customer desiring to make a credit purchase was required to

execute a note which was to be paid off in installments. The note equaled the

sum of the unpaid balance of the purchase price (e.g., $ 400, Item (s)) plus

finance charge ($ 100, Item (f)). To finance these purchases, the taxpayer

would sell the note to a finance company for the 'agreed price,' apparently

something less than the face amount of the note. The finance company would

remit a major percentage of this purchase price to the taxpayer crediting the

balance to a Dealer Reserve Account. Provisions were made in each case for

payments to the taxpayer from the Reserve Account when it exceeded a specified

percentage of the unpaid balance of the notes. As pointed out the Court held

these reserves to be includible in income at the time of the credit since there

was then a fixed right to receive them.

The Court then turned to the specific problem of finance charges included in

the face of the notes. To the contention that portions of the Reserve Accounts

'consist of * * * percentages of 'finance charges,' not being a part of the

purchase price of the installment paper,' and that they therefore 'should in no

event be regarded as accrued income to the dealers,' the Court replied that the

taxpayers had 'wholly failed to adduce evidence (in) support (of) their claims.'

360 U.S. 446, at page 468, 79 S.Ct. 1270, at page 1282. Specifically the Court

pointed out that they made no showing that any percentages of the finance

charges were even credited to the Reserve Accounts and, if they were,

that they were identified and separated 'from the percentages of the purchases

price of the installment paper that were retained by the finance companies * *

*.' 360 U.S. 446, at page 468, 79 S.Ct. 1270, at page 1282. The Court then

concluded that '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.' 360 U.S. 446, at page 469, 79 S.Ct. 1270, at page 1282.

We agree with Taxpayer that Hansen did not decide this specific issue as

such. The Court merely concluded that facts were not adequately established to

show any basis for difference in treatment. It did not, however, undertake to

rule out the likelihood of such distinction on a proper showing. Likewise, we

agree with Taxpayer that nothing can be read into the denial of certiorari in

Wiley v. Commissioner, 6 Cir., 1959, 266 F.2d 48, certiorari denied 361 U.S.

831, 80 S.Ct. 80, 4 L.Ed.2d 73, since we are told often that this is of no

significance. n7 But that is far from agreeing with Taxpayer that Hansen does

not control. On the contrary, we think the principles announced there compel a

like result on the facts of this case concerning Item (f).

Once we accept, as we must, the rationale of Hansen, there is nothing to

distinguish the installment charges (Item (f)) from the 10% discount (Item (d)).

Under the Hansen concept the immediate availability of the $ 40 (Item (d))

discount did not depend on either the actual receipt of that sum, or the time of

its receipt, from the customer. No more so does the actual payment of the

finance charges of Item (f) depend on them. Indeed, in the operation of this

so-called reserve plan the failure to collect the notes from which proceeds the

net cash sales price (Item (s)) or the 10% discount (Item (d)) would be paid is

virtually self-executing. As a defaulted item it would be charged against the

reserve. This would, of course, mean that to this extent General Gas would not

in the future recover any cash from that transaction. But at the same time the

charge against the reserve to the extent of the loss from the default (not in

excess of total reserves) would relieve General Gas of its obligation to make

good. n8

We do not think that the contention that these finance charges (Item (f)) are

not 'earned' is of any significance. As a matter of fact, as between the dealer

and the customer, they appear to us to be earned, certainly as far as a legally

enforceable obligation is concerned. At least this record is silent that any

one of the thousands of customer installment purchase notes were ever paid in

advance, or that any discount or rebate was, or would be due in such event.

Availability of a time purchase sale -- a facility which General Gas could

offer -- was what presumably made it possible for the customer to acquire the

appliance. That 'service' was fully performed at the moment a time purchase

sale was effected. Certainly General Gas had no further obligations to the

customer. So far as the relations between the dealer and the finance company

were concerned, these were, as a contract liability, equally earned. While it is

true that the financing contract required General Gas to service the accounts,

make the collections, handle repossessions, etc., this was an obligation

undertaken by General Gas and there is nothing to indicate that it was for these

services so essential to its own economic welfare that the finance companies

agreed to grant the discount reserve of either one or both of Items

(d) and (f). Perhaps one could look upon them as 'unearned' in the sense that

with respect to each monthly payment due from customers, some steps had to be

taken in the way of collection and servicing of the accounts, the remittances to

the finance company, and the like. But if these factors had any significant

bearing on the amount of the so-called reserve whether for Item (f) alone or

both Item (d) and (f) together, the record fails to show it.

We do not consider any more persuasive the argument by General Gas that since

as to customer notes retained by it General Gas was permitted to defer the

portion representing finance charges (the equivalent of Item (f)) over the life

of the note, the same procedure should be allowed as to finance charges reserved

in notes sold to Bancredit. This is based primarily on contentions made by the

Government in the Hansen litigation somewhat to the effect that neither sound

analysis nor consideration of the practical realities justifies the conclusion

that the interposition of a finance company makes a change in the dealer's tax

liability. It is not disputed that General Gas treated these finance charges

under the declining balance method. n9

The simple answer, of course, is that things were not the same. There was a

vital distinction. As to those notes retained by General Gas it was an

unlimited exposure of the corporation's direct credit to their full amount. It

had no such exposure on those sold to the three financing companies. Indeed, it

was the very necessity of escaping this accumulating direct corporate liability

through the repledging of customer notes which led to the making of these

financing arrangements. Where formerly it had unlimited liability, its

liability was now limited to an amount approximating 35%. On the other side of

the ledger, it also had substantial advantages under the financing arrangement.

Where, for notes held by General Gas, it got the benefit of the installment

finance charges only when and as paid, under the financing arrangement at least

two things occurred. first, there was an immediate credit constituting an

unconditional liability upon the part of the financing company to pay the

equivalent of the finance charges either in cash or offsets or both. Second,

depending upon the state of the balance in the reserve fund and the current

business being done, the addition of each new note and the reserves made up of

Items (d) and (f) could produce distributable cash long in advance of the time

the installments of such paper would be collectible or collected. These things

were the direct consequence of a sale, not a mere pledge, of these customer

notes to the financing companies. The note was sold. For it General Gas

obtained cash (Item (c)) and valuable credits (Items (d) and (f)). It is the

sale itself which makes a difference. It makes a difference here even though

with respect to some phases of the Hansen problem the Government may have

contended that the interposition of the finance company would work no change in

a dealer's tax liability.

Hansen compels affirmance. If this is unsatisfactory, relief must now come

from Congress.

Affirmed.

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n1. First Bancredit Corporation of St. Paul, Minnesota; Guaranty Bank & Trust

Company of Lafayette, Louisiana; Refrigeration Discount Corporation of Detroit,

Michigan.

n2. The 'net cash selling price' was defined in the contracts to be the 'cash

selling price of the merchandise financed without the addition of any finance

charge, less any trade-in allowance or discount for cash, and less any down

payment.' In other words it was the unpaid portion of the sales price of the

item purchased not including finance charges.

n3. The Reverse Account was not to be reduced below $ 10,000.

n4. It was stipulated that this more favorable arrangement was made possible

because it related only to the appliances sold by General Gas which were

manufactured by an affiliate of ReDisCo.

n5. Schaeffer v. Commissioner, 6 Cir., 1958, 258 F.2d 861; Baird v.

Commissioner, 7 Cir., 1958, 256 F.2d 918, affirmed Commissioner of Internal

Revenue v. Hansen, 1959, 360 U.S. 446, 79 S.Ct. 1270, 3 L.Ed.2d 1360; Texas

Trailercoach v. Commissioner, 5 Cir., 1958, 251 F.2d 395; West Pontiac v.

Commissioner, 5 Cir., 1958, 257 F.2d 810; Morgan v. Commissioner, 9 Cir., 1960,

277 F.2d 152; Wiley v. Commissioner, 6 Cir., 1959, 266 F.2d 48; United States v.

Hine Pontiac, 58-2 USTC Par. 9841, reversed 360 U.S. 715, 79 S.Ct. 1443, 3

L.Ed.2d 1539; Shapiro v. Commissioner, 1959 P-H, T.C.Memo.Dec., par. 59,151

(July 24, 1959) (pending on appeal to the 9th Circuit); Cadjew v. Commissioner,

1959 P-H, T.C.Memo.Dec., par. 59,148 (July 20, 1959); Shoemaker-Nash v.

Commissioner, 41 B.T.A. 417.

n6. This is plainer in tabular form.

Between Dealer and Customer

Item

(s) Net cash selling price $ 400

(f) Finance charges 100

(n) Face amount of note $ 500

Between Dealer and Bancredit

(p) Amount to be paid to General

Gas (Item (n)) $ 500

Paid by:

Reserves

(d) 10% discount $ 40

(f) Finance charges 100 140 $ 500

n7. Brown v. Allen, 1953, 344 U.S. 443, 73 S.Ct. 397, 97 L.Ed. 469; Atlantic

Coast Line R. Co. v. Powe, 1931, 283 U.S. 401, 51 S.Ct. 498, 75 L.Ed. 1142;

Flowers v. Travelers Ins. Co., 5 Cir., 1958, 258 F.2d 220.

n8. Thus at the very instant one note is declared in default, the full

reserve in a note just transferred is available to extinguish, to that extent,

the liability of General Gas. Its utility in this respect does not depend on

when it is due from, or actually paid by, the customer.

n9. In May 1952 General Gas held a total of $ 1,681,067.87 in customers'

notes which had formerly been pledged with a Chicago bank. In addition, during

that year it acquired new customers' notes in the sum of $ 378,926.64 on sales

which did not qualify under any one of the three financing arrangements. At

December 31, 1952 the total of these company-held notes was $ 1,099,648.07.

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