Highland Merchandising Co. v. Commissioner ( 1952 )

Highland Merchandising Company, Petitioner, v. Commissioner of Internal Revenue, Respondent

Highland Merchandising Co. v. Commissioner

Docket No. 23882

United States Tax Court

18 T.C. 737; 1952 U.S. Tax Ct. LEXIS 143;

July 8, 1952, Promulgated

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Decision will be entered for the respondent.

Petitioner, engaged in the business of selling household furnishings on the installment basis, kept its books on the accrual method of accounting and filed its tax returns on the installment basis. Its excess profits credits were computed on the invested capital method. Petitioner's claim for relief under section 722 (b) (5) is based on the theory that its election in 1934 to file its tax returns on the installment basis under section 44 (a) was a factor affecting its business under (b) (5) which resulted in an inadequate standard of normal earnings during the base period and an inadequate excess profits credit and that, therefore, the excess profits taxes for the years 1941 through 1944 were excessive and discriminatory. Held, petitioner has not shown that its method of accounting resulted in an inadequate standard of normal earnings during the base period.

Robert J. Bird, Esq., for the petitioner.

Cyrus A. Newman, Esq., for the respondent.

Rice, Judge.

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RICE

This proceeding arises from the Commissioner's disallowance of petitioner's claims for relief under section 722 (b) (5) of the Internal Revenue Code for the calendar years 1941 through 1944 in the amounts of $ 6,802.12, $ 47,171.74, $ 39,194.51, and $ 29,302.88, respectively. The question presented is whether petitioner's election in 1934 to file its income tax returns on the installment method under section 44 (a) of the Code was a factor affecting its business under section 722 (b) (5) which might reasonably be considered as resulting in an inadequate standard of normal earnings during the base period. Most of the facts were stipulated.

FINDINGS OF FACT.

The stipulated facts are so found and are incorporated herein.

Petitioner is a Delaware corporation with its principal office and place of business in Detroit, Michigan. Petitioner filed its excess profits tax returns on a calendar year basis with the collector of internal revenue for the district of Michigan and paid excess profits taxes as follows:

Year	Tax
1941	$ 6,838.40
1942	47,171.74
1943	39,194.51
1944	29,302.88

Its applications for relief and claims for refund of excess profits taxes for such years were rejected on March 23, 1949.

Petitioner began business in April 1934 and at all times since has been engaged in the sale of household furnishings on the installment basis.

The following table shows petitioner's net sales, collections, and taxable income as determined by respondent for the calendar years 1935 to 1945, inclusive:

Year	Net sales	Collections	Taxable income
1935	$ 296,269.33	$ 214,683.08	$ 3,618.74
1936	430,723.45	360,946.95	7,970.95
1937	557,107.11	472,586.14	9,956.04
1938	424,666.40	408,748,66	1939	572,508.13	531,546.58	10,497.82
1940	676,552.82	585,519.84	3,861.33
1941	864,726.12	762,818.27	42,782.79
1942	843,410.17	905,902.08	67,546.61
1943	996,122.65	930,447.41	59,172.64
1944	992,462.87	988,949.95	55,792.18
1945	1,026,681.26	952,439.77	23,313.34

The sharp increase in collections during the taxable years was due, in part, to the promulgation of Regulation W by the Federal Reserve Board in 1941, which increased the down-payment on installment sales and shortened the period for payment, resulting in a shortening of the terms of petitioner's installment contracts. Petitioner did not change its method of doing business during the years 1940 to 1945, inclusive.

Petitioner could not qualify for relief from excess profits taxes under section 736 of the Code. Petitioner used house-to-house salesmen who were hard to find, and it could not have kept its salesmen on its payroll unless they produced.

Petitioner has always kept its books of account on the accrual method of accounting, and has filed its tax returns on the installment basis under section 44 (a) of the Code. Petitioner's taxable income for the years 1935 to 1945, inclusive, computed on the accrual method of accounting is as follows:

	Taxable income
	or loss * on the
	accrual method
Year	(cents omitted)
1934	$ 68,621(A)
1935	60,075(A)
1936	50,800
1937	51,929
1938	7,414 *
1939	23,358
1940	49,910
1941	97,377
1942	24,220 *
1943	87,354
1944	52,963
1945	15,800

Note (A) -- Profits in 1934 and 1935 were abnormally high due to recoveries on receivables and inventories of a bankrupt company which had been purchased at a substantial discount.

The following table shows the amount of taxes paid by petitioner during the years 1934 to 1945, inclusive, and the amount of taxes which would have been due and payable if its tax returns had been filed on the accrual method:

	Installment	Accrual
Year	method	method
1934	$ 2,335	$ 9,435
1935	498	8,260
1936	817	6,460
1937	1,035	6,629
1938	0	0
1939	1,395	3,262
1940	573	12,805
1941	17,384	22,646
1942	46,441	0
1943	39,393	44,491
1944	35,044	23,368
1945	6,795	4,166
Total	$ 151,710	$ 141,522

The following table shows petitioner's excess profits credit allowed by respondent based on the invested capital method; its excess profits credit based on the average earning method, with the earnings of the base period computed under the installment method of reporting income; and its excess profits credit based on the average earning method, to which petitioner would have been entitled, if it had originally reported its income for the base period years under the accrual method of accounting:

		Excess profits
	Excess profits	credit based on	Excess profits
Year	credit based	average earnings	credit based on
	on invested	of base period	average earnings
	capital	installment	accrual method
		method
1940	$ 8,641.41	$ 5,449.23	$ 26,062.00
1941	9,711.35	6,737.22	29,945.78
1942	10,964.31	8,676.11	37,432.21
1943	11,370.52	8,676.11	37,432.21
1944	12,079.58	8,676.11	37,432.21
1945	12,468.04	8,676.11	37,432.21

Petitioner's excess profits taxes for the years in question, computed without the benefit of section 722, are not excessive and discriminatory and its method of accounting has not been shown to result in an inadequate standard of normal earnings during the base period.

OPINION.

Petitioner argues (1) that its election to use the installment method of reporting its income for tax purposes was a factor affecting petitioner's business during the base period which resulted in an inadequate standard of normal earnings; (2) that the additional taxes paid by petitioner approximating $ 85,000, resulting from its use of the installment method, is proof that the excess profits taxes paid during the taxable years were excessive and discriminatory because such additional amount would not have been payable if petitioner had reported its income on the accrual method; (3) that its income during the base period, as computed on the accrual method, is a fair and just amount representing its normal earnings and should be used as a constructive average base period net income for excess profits credit purposes.

Respondent argues that petitioner is not entitled to relief because (1) the tax computed under subchapter E does not result in excessive and discriminatory tax; (2) it has failed to establish that its actual base period earnings were not normal; (3) it has failed to establish under section 722 (b) (5)^{*741 may reasonably be considered as resulting in an inadequate standard of normal earnings during the base period; (4) it has failed to establish what would constitute a fair and just amount representing normal earnings to be used as a constructive average base period net income.}

The parties stipulated that the petitioner could not qualify for relief from excess profits taxes under section 736 of the Code which is a relief provision permitting certain installment basis taxpayers to file returns for excess profits tax years on the accrual basis. In addition to the above-mentioned arguments of respondent, he also argued that since petitioner could not qualify under section 736 it is automatically precluded from securing relief under section 722 (b) (5) because Congress specifically considered the problems of installment basis taxpayers in section 736 and "the inference is plain that Congress did not intend the general provisions of section 722 (b) (5) to apply to taxpayers whose claim of hardship was based solely on their use of the installment method of reporting income." Petitioner's officers discussed the problem as to how it could qualify under section 736, and came to the conclusion that the only way petitioner could come within the 125 per cent requirement of the section was by a drastic reduction in petitioner's sales force which would, in effect, be a partial liquidation of the business.

Only one question presented by the above arguments need be considered to decide this case. Section 722 (b) (5) relates to "any other factor affecting the taxpayer's business which may reasonably be considered as resulting in an inadequate standard of normal earnings during the base period * * *."

To be entitled to relief under section 722 (b) (5), it is necessary for a taxpayer to show, among other things, that some factor reasonably resulted in an "inadequate standard of normal earnings during the base period." If the earnings during the base period were normal, no relief may be granted. Matheson Co., 16 T. C. 478 (1951); Clinton Carpet Co., 14 T. C. 581 (1950). This record does not disclose that merely because of the method of accounting used by petitioner, which method was adopted by its own election, its earnings during the base period were not normal. On the contrary, the record shows that it was the normal method of accounting in petitioner's business, and that it had not changed such method through the taxable years here in question.

The Bulletin on Section 722, part VI (D), page 129, states:

(D) Accounting Methods.

The taxable net income of a taxpayer is determined in accordance with the method of accounting employed by it in keeping its books and in accordance with statutory provisions supplemented by regulations and court decisions interpreting such provisions. Such taxable net income is the basis for determining excess profits net income for each base period year which in turn forms the basis for the excess profits credit based on income. The method of accounting employed in the determination of taxable net income, such as the cash or accrual method, is not a factor affecting the taxpayer's business which may reasonably be considered as resulting in an inadequate standard of normal earnings. Such accounting methods do not affect the operation of a business. They are merely devices for recording the dollar results of completed transactions in order that periodic statements of the financial condition and progress of the business may be prepared. It is therefore the transactions themselves and not methods of accounting for such transactions which constitute the factors to be considered in determining whether or not an inadequate standard of normal earnings has resulted.

The use of a method of accounting by the taxpayer and its acceptance by the Commissioner may be taken to indicate that it clearly reflects its taxable income for a particular period. The mere fact that under some other method the taxpayer's income during the base period would have been different is not a basis for relief under section 722. * * *

Taxpayers who elect a form of accounting best suited to their particular needs and under which they are entitled to and are granted a tax advantage cannot be heard to complain when the Commissioner refuses to permit them to adopt a different method of accounting in order to achieve a further tax advantage denied to other taxpayers. See Commissioner v. South Texas Lumber Co., 333 U.S. 496">333 U.S. 496 (1948), rehearing denied 334 U.S. 813">334 U.S. 813 (1948).

Petitioner, having elected to report its income on the installment basis during the base period years, cannot, in the excess profits tax years, successfully contend that such method resulted in an inadequate standard of normal earnings when, in fact, this was its normal method of doing business. In view of our holding on this question, it is unnecessary to reach the other arguments made by the parties.

Decision will be entered for the respondent.

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Footnotes

• *. Loss.↩

• 1. SEC. 722. GENERAL RELIEF -- CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME.

  * * * *

  (b) Taxpayers Using Average Earnings Method. -- The tax computed under this subchapter (without the benefit of this section) shall be considered to be excessive and discriminatory in the case of a taxpayer entitled to use the excess profits credit based on income pursuant to section 713, if its average base period net income is an inadequate standard of normal earnings because --

  * * * *

  (5) of any other factor affecting the taxpayer's business which may reasonably be considered as resulting in an inadequate standard of normal earnings during the base period and the application of this section to the taxpayer would not be inconsistent with the principles underlying the provisions of this subsection, and with the conditions and limitations enumerated therein.↩