Resale Mobile Homes
v. Commissioner (1988)
Resale Mobile Homes, Inc.,
Petitioner v. Commissioner of Internal Revenue, Respondent
91 T.C. 1085
91 T.C. No. 69
Docket No. 39593-84
UNITED STATES TAX COURT
91 T.C. 1085; 91 T.C. No. 69
December 21, 1988; As amended
December 21, 1988
December 21, 1988, Filed
Decision will be entered under Rule
155.
SYLLABUS: Petitioner, a Colorado
corporation, was engaged in the business of selling new and used mobile
homes at retail. Purchaser financing was provided by petitioner through arrangements
with two finance companies. Pursuant to such arrangements, petitioner sold the
consumer paper created from the credit sale to either of the finance companies,
receiving in return the principal amount of the consumer paper plus participation
interest based on the excess of the interest rate petitioner charged the
purchaser over the rate the finance company charged petitioner. Prior to the years in
dispute, the participation interest was held by the finance companies in a
dealer reserve account and was paid to petitioner to the extent it was not required
as security for petitioner's obligations under its agreement with the finance
companies. As an accrual basis taxpayer, petitioner reported the amount held
in the reserve account as income in the year of sale. In 1975, Colorado law was
changed with respect to the prepayment of consumer paper. In response to the
change in law, the provisions set forth in petitioner's consumer paper were
changed. As a result, petitioner received the participation interest
following the finance company's receipt of payment from the mobile home
purchaser and reported the participation interest as received. Held, petitioner is
required to report the entire participation interest in the year the consumer
paper is sold to the finance company
COUNSEL: Robert Shaiman and John D.
Moats, for the petitioner. Barbara E. Horan, for the
respondent.
JUDGES: Jacobs, Judge.
OPINIONBY: JACOBS
OPINION: Respondent determined
deficiencies in petitioner's Federal income taxes in the following
amounts:
TYE May 31 -- Deficiency
1978
$ 9,289
1979
194,698
1980
156,858
1981
99,056
By its amended petition, petitioner
claims entitlement to a refund of $ 3,015 as a result of a carryback (from
its 1982 taxable year to its 1979 taxable year)of an investment tax credit. By his
amended answer, respondent claims an increased deficiency in the amount
of $ 9,302 with respect to petitioner's 1980 taxable year based on an allegedly
erroneous refund to petitioner. After concessions, the issues for
decision are: (1) Whether petitioner correctly reported its entitlement
to a portion of interest income to be collected under consumer
installment contracts it sold to finance companies; (2) whether petitioner
is entitled to an investment tax credit carryback from its 1982 taxable
year to its 1979 taxable year; and (3) whether petitioner incurred an operating
loss for its 1981 taxable year entitling it to net operating loss carrybacks to
its 1978 and 1979 taxable years.
FINDINGS OF FACT
Some of the facts have been
stipulated and are so found. The stipulation of facts and related exhibits are
incorporated herein by this reference. Petitioner, a Colorado corporation
having its principal place of business located in Denver, was engaged in
the business of selling new and used mobile homes at retail under the name
Mobile World. Petitioner reports its income using the accrual method of
accounting.
When purchasing a mobile home on
credit, the purchaser was required to sign a document, referred to as consumer
paper, evidencing the purchaser's obligation to pay the balance due in
installments, plus interest. The consumer paper was then immediately sold by petitioner
to either of two finance companies, Midland Federal Savings
& Loan Association of Denver (Midland) or Advance Mortgage Co. (Advance),
which had agreed in advance to purchase the consumer paper and
which thereafter collected the installment payments made by the purchaser of
the home.
Upon the sale of the consumer paper
to one of the finance companies, petitioner was entitled to receive
not only the principal amount of the consumer paper, but also the excess (the
participation interest) of the total amount of interest to be collected from the
mobile home purchaser pursuant to the consumer paper over the total amount of
interest the finance company charged petitioner the buy rate). The interest rate
petitioner charged the purchaser in the consumer paper was dictated by
competition in the mobile home market; such rate was usually higher than the buy
rate, resulting in participation interest being payable to petitioner.
Pursuant to its agreements with the
finance companies, petitioner warranted, among other things, that the
consumer paper sold complied with all Federal, State, and local laws; that it was
free from all defenses, setoffs, and counterclaims; that petitioner had
a valid first lien against the mobile home sold; and that upon the finance
company's purchase of the consumer paper, the finance company would have a valid
first lien against the mobile home. In the event any of these
warranties proved untrue, petitioner was obligated to repurchase the consumer paper with
respect to which there was a breach of warranty.
Prior to the taxable years in
dispute, Midland immediately paid petitioner the principal amount of the
consumer paper purchased. The participation interest was retained by Midland in
a reserve account. This reserve account served as security in the event one
of petitioner's warranties to Midland was breached, which in fact never
occurred.
Prior to the taxable years in
dispute, the consumer paper paper) required the mobile home
purchaser to pay a stated number of equal installment payments. Late payment
did not vary the portion of each installment payment otherwise allocable to
interest and principal. However, in the event the purchaser's installment payment
was late, a delinquency charge was imposed; such charge was
retained by Midland.
The precalculated participation
interest was reduced only if the home purchaser prepaid the old consumer
paper or if repossession in the event of default occurred (such events
collectively referred to as a prepayment). In the event of prepayment, the
unearned finance charge under the old consumer paper was calculated using
the Rule of 78's. n1 Other than in the event of prepayment, the exact
amount of interest to be earned under the old consumer paper could be calculated
at the time the paper was created and sold by petitioner to the finance company.
Also, the exact participation interest, including the amount held back in
the dealer reserve account, could be calculated at the time the consumer
paper was sold to the finance company.
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n1 The Rule of 78's is a method of
allocating interest among time periods during the term of the loan. Under
this method, the amount of interest allocable to each time period is
determined by multiplying the total interest payable over the loan term by a
fraction (a) the numerator of which is the number of periods remaining on the
loan at the time the calculation is made, and (b) the denominator of which is the
sum of all time periods during the loan term.
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The transactions between petitioner
and Advance prior to the years in dispute were similar to those
between petitioner and Midland. However, when Advance purchased the consumer
paper, it paid petitioner the principal amount of the consumer paper plus 50 percent
of the participation interest. The balance of the participation interest was
held in a reserve account which was paid to petitioner to the extent not
required as security for petitioner's obligations. Under its agreements with both
Advance and Midland, petitioner's right to the participation interest was earned,
and its right to receive the participation interest was fixed, at the time the
consumer paper was sold.
Petitioner reported the entire
participation interest received from Midland and Advance as income in the year
in which the consumer paper was sold. In the event the mobile home purchaser
prepaid the consumer paper, petitioner claimed (in the year of prepayment) a
deduction for the participation interest previously reported but not
received due to the prepayment.
Under the terms of the agreements
between petitioner and the finance companies in effect prior to the
taxable years in dispute (the old financing agreements), each of the finance
companies aggregated the balance due under all consumer
paper purchased from petitioner as well as the total participation interest held
back in the reserve account. Petitioner was entitled to monthly payment of that
portion of the amount held in reserve which exceeded a percentage (3 percent
with respect to Midland; 5 percent with respect to Advance) of the balance
due under all consumer paper purchased from petitioner. Thus, since the amount
payable to petitioner depended solely on the balance in the reserve account,
petitioner received payment of the participation interest from the finance company
prior to payment by the mobile home purchaser to the finance company.
On October 28, 1975, the Colorado
statute regarding the calculation of the balance due on consumer paper in
the event of prepayment (Col. Rev. Stat. tit. 5, pt. 2, sec. 210, (1973)) was
amended to prohibit the use of the Rule of 78's in calculating such balance. The
amended statute provided that after May 14, 1976, in the event the consumer
paper was prepaid, the balance due was to be calculated using simple interest.
As a result of the statutory
amendment, the agreements between the finance companies and petitioner were
changed to reflect the fact that if the consumer paper were prepaid, the
amount of interest deemed earned would be substantially reduced. In addition,
the terms of the consumer paper had to be changed (the new consumer paper).
The new consumer paper contained
provisions requiring each payment made by the mobile home purchaser to be
applied first to accrued interest through the date of payment and then to
principal. Accrued interest was computed on a simple interest basis which was
dependent upon the number of days between actual payments, rather than the due dates
of such payments.
Since the amount of interest to be
earned with respect to each payment was based upon the date payments were
actually received rather than the dates they were due, after the change in the
law, neither the total amount of interest to be earned under the new consumer
paper nor the participation interest could exactly be determined in advance.
However, both the amount of interest to be earned on each individual contract
of new consumer paper and the participation interest could be
reasonably estimated by using an amortization schedule which assumed that all
required payments would be made every 30 days.
Under petitioner's agreement with
Midland during the taxable years in dispute (the new Midland agreement),
petitioner no longer received the participation interest in advance of payment by
the mobile home purchaser; rather, it received the participation interest from the
new consumer paper when Midland received the installment payments from the
mobile home purchaser. When a payment under the new consumer paper was received,
Midland would (a) calculate the amount of such payment to be applied to accrued
interest, (b) determine the amount of such interest to be retained by Midland
(based upon the buy rate), and (c) determine the amount of the participation
interest to be paid to petitioner. Midland would then pay petitioner the
amount of participation interest so determined. A dealer reserve account was not
established (although Midland had the option to do so), and there was no percentage
ratio required to determine the extent by which petitioner was to receive
payment with respect to the participation interest.
The agreement between Advance and
petitioner during the taxable years in dispute (the new Advance agreement)
provided that Advance would maintain a reserve account for petitioner. The
participation interest was credited to this account and paid
to petitioner over the life of the consumer paper.
Petitioner prepared a list of
consumer paper sold to the finance companies setting forth the amount of
participation interest it expected to receive if all the mobile home purchasers timely
made all payments to maturity. With respect to the new consumer
paper, petitioner reported the participation interest as income as checks were
received from the finance companies. Respondent determined that
petitioner should have accrued all the participation interest in the year the new
consumer paper was sold (on the theory that petitioner's right to receive such
income was fixed and the amount was reasonably ascertainable). As a
result of such determination, and his review of petitioner's financial statements
n2 and its accountant's (Coopers & Lybrand's) workpapers, respondent
claims petitioner understated its income as follows:
Increase in Petitioner's Petitioner's
petitioner's
Petitioner's gross receipts gross
receipts taxable income
taxable year as determined as
reported as determined
ended May 31 -- by respondent by
petitioner by respondent
1979 $ 4,262,512 $ 3,854,512 n3 $
410,000
1980 4,599,073 4,249,073 350,000
1981 4,016,179 3,701,179 315,000
On its tax return for the taxable
year ended May 31, 1981, petitioner claimed a
$ 56,809 net operating loss, which
it carried back to taxable years ended May
31, 1978, and May 31, 1979.
Respondent disallowed the loss, and in turn the
carrybacks, because of his
determination that petitioner understated its income
for its taxable year ended May 31,
1981.
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n2 In its financial statements,
petitioner reported the finance income as an
asset in an account entitled
"Finance income included in uncollected finance
contracts held by financing
institutions"; there was also a contra liability
account entitled "Unearned
finance income."
n3 The apparent $ 2,000 discrepancy
was not explained.
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On its tax return for the taxable
year ended May 31, 1982, petitioner claimed
entitlement to a $ 3,760 investment
tax credit of which it used $ 745.
Petitioner filed an amended return
for its taxable year ended May 31, 1979,
claiming a carryback of the unused
amount of the investment tax credit, i.e., $
3,015. Respondent's notice of
deficiency disallowed the carryback.
In December 1983, petitioner filed
an amended return for its taxable year
ended December 31, 1980, requesting
a refund in the amount of $ 9,302;
respondent issued a refund in the
amount requested. Subsequently, respondent
determined that the notice of
deficiency did not take into account this refund.
By an amendment to answer,
respondent claims an increased deficiency for the $
9,302 refunded.
At trial, respondent introduced,
through a tax partner of Coopers & Lybrand,
a copy of Coopers & Lybrand's
audit workpaper entitled "Mobile World, finance
income computation carryforward."
The workpaper, dated September 10, 1980, was
prepared by two individuals
formerly employed by Coopers & Lybrand, in
connection with the preparation of
petitioner's financial statements
for its year ended May 31, 1980. No
one explained the computations set forth on
the workpaper, and the auditor's
note set forth thereon is not comprehensible
due to the poor quality of the copy
filed with the Court. Petitioner objects to
the admission of the workpaper on
the grounds of hearsay and relevancy.
Respondent contends that the
workpaper falls within the business records
exception to the hearsay rule and
is relevant. We did not use the
workpaper in reaching our decision,
hence we need not rule on petitioner's
objection.
OPINION
The first issue for determination
is whether petitioner properly reported the
participation interest, during the
taxable years in dispute. Section 446(a) n4
provides the general rule that:
Taxable income shall be computed
under the method of accounting on the basis of
which the taxpayer regularly
computes his income in keeping his books.
Section 446(b) provides that if the
method used by the taxpayer does not clearly
reflect its income, the computation
of such taxable income is to be made under a
method which, in the opinion of the
Secretary, clearly reflects income.
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n4 All section references are to
the Internal Revenue Code of 1954 as amended
and in effect during the years in
dispute.
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Section 451(a) provides the
following:
The amount of any item of gross
income shall be included in the gross income
for the taxable year in which
received by the taxpayer, unless, under
the method of accounting used in
computing taxable income, such amount is to be
properly accounted for as of a
different period.
Under the accrual method of
accounting, income is includable in gross income
when all events have occurred which
fix the right to receive such income and the
amount thereof can be determined
with reasonable accuracy. Secs. 1.451-1(a),
1.446-1(c)(1)(ii), Income Tax Regs.;
Spring City Foundry Co. v. Commissioner,
292 U.S. 182, 184-185 (1934).
Section 446(e) provides "a
taxpayer who changes his method of accounting on
the basis of which he regularly
computes the income in keeping his
books shall, before computing his
income under the new method, secure the
consent of the Secretary." A
change in the method of accounting includes a
change in treatment of any material
item used in the overall plan. Sec.
1.446-1(e)(2)(ii)(a), Income Tax
Regs. Further, the regulations provide that a
change from the accrual method to
the cash receipts and disbursement method is
a change in accounting method. Sec.
1.446-1(e)(2)(ii)(a), Income Tax Regs.
Petitioner is and always has been
an accrual basis taxpayer. Respondent
contends that by reporting the
participation interest as received from
the finance company, rather than
when the new consumer paper was sold,
petitioner changed its method of
reporting the participation interest from the
accrual method to the cash receipts
and disbursements method and that such
change was both unauthorized and
improper. Petitioner argues otherwise,
claiming that until receipt, the
participation interest was not fixed and
determinable. We agree with
respondent.
Under the accrual method of
accounting, the inclusion of an amount in income
is based on the right to receive
the amount, not the actual receipt of the
amount. When the right to receive
the amount is fixed, and the amount can be
determined with reasonable
accuracy, the amount must be accrued into income.
Spring City Foundry Co. v.
Commissioner, supra. Here, petitioner's sale of the
new consumer paper activated its
right to receive the participation interest,
even though payment of such
interest was to be deferred.
We believe the rationale of
Commissioner v. Hansen, 360 U.S. 446 (1959), is
apposite to the instant case. In
Hansen, three accrual basis
taxpayers (two retail automobile
dealers and one trailer dealer) sold
installment paper to finance
companies, receiving a major percentage of the
paper's face value from them. The
finance companies retained an amount equal to
the remaining percentage of the
paper's face value in a dealer reserve account
as security for payment of the
dealer's contingent liabilities. The finance
companies made payments to the
dealers from the reserve account as the
accumulated reserves exceeded a
percentage of the unpaid balances on the
installment paper.
The dealers argued that the
existence of the reserves foreclosed
their having a present and
enforceable right to the payment of the income. The
Supreme Court disagreed, stating
that the right to presently recover the
reserves was not the key to the
accrual of income, but rather, it is the time of
acquisition of the fixed right to
receive the reserves, which the Court held
occurred at the time of sale of the
installment paper.
The dealers also argued that the
reserves were subject to such contingencies
that they could not have reasonably
determined in the year of sale the amount of
reserves they would ultimately
receive. The Court disagreed with this
argument, stating that since the
amounts in the reserve accounts would either be
paid to the dealers or applied to
their obligations under their guarantees, the
dealers in essence would
"receive" the entire amounts in the reserve accounts in
all events. In this regard, it is
to be noted that in the instant case, the
participation interest held in
reserve would either be paid to petitioner in
cash or applied to satisfy
petitioner's obligations to the finance companies.
In the instant case, petitioner
acquired a fixed right to receive the
participation interest when it sold
the consumer paper to the finance companies.
While petitioner could not compel
the finance companies to immediately pay over
the participation interest, such is
not the key to the accrual of income.
Petitioner argues that the instant
case differs from Hansen because, under
the arrangements between petitioner
and the finance companies, there were no
reserve accounts. We do not believe
the creation of a reserve account is
controlling. A reserve account is
simply a bookkeeping entry. The finance
companies intended to share the
interest paid by the mobile home purchasers with
petitioner; however, they obviously
were unwilling to share interest
which they did not receive due to
the purchaser's default or prepayment.
Economically, holding back payment
to petitioner until such time as
participation interest was received
by the finance company served the same
purpose as the creation of a
reserve account.
Petitioner next contends that the
amount of income they were to receive could
not be determined with reasonable
accuracy. While the word
"accuracy" means
exactness or precision, when modified by the word "reasonable"
it implies something less than an
exact or completely accurate amount. George
K. Herman Chevrolet, Inc. v.
Commissioner, 39 T.C. 846, 850 (1963).
An accrual basis taxpayer must
report income in the year the right to such
income accrues, despite the
necessity for mathematical computations or
ministerial acts George K. Herman
Chevrolet, Inc. v. Commissioner, supra at 850.
In addition, where an amount of
income is properly accrued on the basis of a
reasonable estimate and the exact
amount is later determined, any difference may
be included in income or deducted,
as appropriate, in the year in
which the correct amount is
determined. Sec. 1.451-1(a), Income Tax Regs.;
Continental Tie & Lumber Co. v.
United States, 286 U.S. 290 (1932).
In our opinion, the amount of
deferred finance income payable to petitioner
was capable of reasonable
estimation at the time of sale of the new consumer
paper. The amount of such income
could be calculated through amortization
tables, and we find persuasive that
such calculation was in fact reflected in
petitioner's financial statements.
We recognize that there may be some
variation in the final amounts
received by petitioner due to the default of
purchasers or other prepayment of
the paper. However, this factor alone does
not prevent petitioner from
accruing the amount estimated. Commissioner v.
Hansen, supra. We do not believe
that any variance in amount, due to periodic or
late payments, would be of such
significance as to prevent petitioner from
making a reasonable estimate of the
amount to be received or that any errors in
such estimation would stand
incapable of correction in a later year. As such,
we find that respondent properly
computed petitioner's participation
interest for the taxable years in
dispute.
The next issue to be addressed is
whether petitioner is entitled to an
investment tax credit carryback in
the amount of $ 3,015 from its 1982 taxable
year to its 1979 taxable year.
Petitioner bears the burden of proving
entitlement to the investment tax
credit. Munford, Inc. v. Commissioner, 87
T.C. 463, 488 (1986), affd. 849
F.2d 1398 (11th Cir. 1988).
Other than a copy of its amended
return for the fiscal year ended
1979, petitioner failed to produce
any evidence from which it can be determined
whether petitioner is entitled to
the claimed investment tax credit carryback.
Because of such failure, we are
unable to ascertain whether an investment tax
credit arose in 1982, and if so,
whether it was actually of sufficient magnitude
to permit a carryback. Accordingly,
petitioner is not entitled to the claimed
carryback.
The final issue is whether
petitioner is entitled to net operating loss
carrybacks from its 1981 taxable
year to its 1978 and 1979 taxable years. Since
the resolution of this issue is
dependent upon the resolution of the first
issue, i.e., the accrual of the
participation interest issue, and
since we sustained respondent's
determination with respect to that issue, it
follows that petitioner had no net
operating loss for its 1981 taxable year
available for carryback to its 1978
and 1979 taxable years.
Because we have resolved the issues
in favor of respondent, the $ 9,302
refund with respect to petitioner's
1980 taxable year was erroneous.
Accordingly, respondent is entitled
to the asserted $ 9,302 increase in
deficiency for such year.
To reflect concessions made by
respondent,
Decision will be entered under Rule
155. |
