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JFM, INC. AND SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentJFM, Inc. v. CommissionerDocket No. 2470-92
United States Tax Court T.C. Memo 1994-239; 1994 Tax Ct. Memo LEXIS 234; 67 T.C.M. (CCH) 3020;May 26, 1994, Filed; As Corrected June 6, 1994*234 For petitioner:Harris H. Barnes III .For respondent: J. Craig Young.GERBERGERBERMEMORANDUM FINDINGS OF FACT AND OPINION
GERBER,
Judge : Respondent determined deficiencies in petitioner's 1986 and 1987 consolidated Federal income tax in the amounts of $ 60,558 and $ 30,508, respectively. The issues presented for our consideration are: (1) Whether franchise fees are includable in the year of receipt or in the year the contractual performance is complete; and (2) whether gasoline pump canopies, fixtures, and signs should be classified in a 20-year depreciation class life, as determined by respondent, or in a shorter-year class life as advocated by petitioner.FINDINGS OF FACT General Background
During 1986 JFM received $ 50,000 in fees, which were not reported until 1987. During 1987 JFM received $ 57,500*238 Depreciation Class Life Category
A.
Franchise Fee -- Year of Includability -- JFM realizes fees in the year the agreements are entered into and does not *242 recognize them for income tax purposes until the time all possible obligations under the agreement are complete. Respondent disagreed with JFM's method of reporting the fees and determined that the fees were reportable in the earlier year under the accrual method of accounting. The issue here concerns the concept "clear reflection of income" under section 446. . That determination is entitled to more than the usual presumption of correctness and "'should not be interfered with unless clearly unlawful.'"RLC Industries Co. v. Commissioner , 98 T.C. 457">98 T.C. 457, 491 (1992) 439 U.S. 522">439 U.S. 522, 532 (1979)*243 (quotingThor Power Tool Co. v. Commissioner , , 449 (1930)). JFM bears the heavy burden of showing that respondent's determination is plainly arbitrary.Lucas v. American Code Co. , 280 U.S. 445">280 U.S. 445 ;Thor Power Tool Co. v. Commissioner ,supra , 271 (1930). For JFM to prevail, it must prove that respondent's inclusion of fees in the year received, i.e., prior to the year reported, is arbitrary and capricious and without sound basis in fact or law.Lucas v. Kansas City Structural Steel Co. , 281 U.S. 264">281 U.S. 264 , 90 (1994).Ford Motor Company v. Commissioner , 102 T.C. 87">102 T.C. 87JFM uses the accrual method of accounting for financial and tax reporting purposes. The accrual method does not focus on the time of payment or receipt, but upon the time there is an obligation to pay or a right to receive. See
, 599, 604 (1986);United States v. Hughes Properties, Inc. , 476 U.S. 593">476 U.S. 593 , 184 (1934). The all events test was judicially devised to measure whether and when an item should be accrued or reported. *244 The all events test was formulated in case law more than 50 years ago and has long been embodied inSpring City Foundry Co. v. Commissioner , 292 U.S. 182">292 U.S. 182section 1.461-1(a)(2), Income Tax Regs. , which contains the following two requirements:Under an accrual method of accounting, an expense is deductible for the taxable year in which [1] all the events have occurred which determine the fact of the liability and [2] the amount thereof can be determined with reasonable accuracy. * * *
Here we consider a situation where JFM is paid the full established amount of a fee upon execution of a territorial agreement and is then obligated to perform various services for the franchisee in connection with the startup of a Mart franchise. These services are usually performed over an 18-month period, culminating when the Mart is fully operational. The services to be performed are substantial and occasionally may cost twice the fee amount. On the other hand, occasionally, the service may cost less than half the fee amount.
The services include selecting and procuring the Mart site; constructing the Mart building and leasing it to the franchisee; assistance in recruiting, hiring, and training of employees for up to the first three Marts*245 of a franchisee; assistance in ordering and stocking of merchandise for up to the first three Marts of a franchisee; and consultation and merchandising assistance as reasonably requested by a franchisee. Of about 800 franchise situations, JFM has returned about 4 franchise fees. The refunds occurred only in situations where JFM was unable to locate a suitable site for a Mart within the franchisee's territory. Chronologically, the location of a Mart site is one of the first obligations performed by JFM. Additionally, it is likely that the site will be located during the earliest portion of the 18-month process in establishing an operational Mart. Although it is possible that the fee may be received on the last day of JFM's taxable year and no work may be performed during the year of receipt, JFM has not shown any such pattern with respect to the transactions it has experienced. The pattern is one where the fee is received at the time of execution of the agreement during year one, and the Mart is completely operational about 18 months later during year two, the year in which JFM reports the fee.
JFM relies heavily upon
(7th Cir. 1968),*246 revg. and remandingArtnell Co. v. Commissioner , 400 F.2d 981">400 F.2d 98148 T.C. 411">48 T.C. 411 (1967). In that case a baseball team had sold advance tickets for the season and its stock was acquired by the taxpayer early in the baseball season (prior to May 31, the tax yearend for the baseball team). As games were played, the taxpayer recognized the prepaid tickets in income, but the Commissioner determined that the prepaid tickets were includable by the taxpayer in the return for the prior tax year ended May 31, by which time all of the tickets had been prepaid.This Court, relying upon several Supreme Court opinions and its own opinions, Artnell Co. v. Commissioner, 48 T.C. at 414-415. The Court of Appeals for the Seventh Circuit reversed and remanded for further proceedings in this Court holding that the principle that prepaid income must be reported in the year of receipt at the Commissioner's discretion is not an absolute one. The Court of Appeals' opinion contained the reasoning that it was*247 possible that a particular taxpayer's method could so clearly reflect income that it would be an abuse of discretion for the Commissioner to require recognition in the year of receipt.
On remand, this Court found that the taxpayer's method of accounting more clearly reflected income because it more effectively matched income and expenses in the same accounting period, one of the goals of the accrual method.
.*248 The criteria used by this Court on remand resided in the principle that the "purpose of the accrual method of accounting is to allow the matching in a single fiscal period of revenues and expenses attributable to economic activities carried on within such period.Artnell Co. v. Commissioner , T.C. Memo. 1970-85 269 U.S. 422">269 U.S. 422 (1926)".United States v. Anderson , .Artnell Co. v. Commissioner , T.C. Memo. 1970-85This case is unlike
Artnell in that here the fee is paid at the commencement of the performance by JFM. Performance, including incurring expenses, is not to begin at some future time, as inArtnell . Here, JFM likely began incurring substantial costs in its efforts locating a site, constructing, and leasing the Mart during the year the fee was received. Equally as important here, JFM deducted its costs regarding its efforts under the agreements in the year those costs were incurred and not upon the completion of the entire process of making a franchisee's Mart operational. *249 Finally, JFM has not provided sufficient evidence from which we could find that respondent abused her discretion in determining that JFM's method did not clearly reflect income. Accordingly, we find that JFM has not shown that its method of reporting the fees clearly reflected income and/or that respondent abused her discretion in requiring inclusion of fees in income in the year of receipt.B.
Depreciation Class Life Category -- The parties differ regarding the category in which gasoline pump canopies and related assets should be classified. The use of ACRS and MACRS is mandatory for certain types of tangible depreciable assets which were placed in service after 1980. If property, mandatorily or by election, comes within this depreciation classification concept, the Secretary is authorized to prescribe allowable depreciation and the anticipated useful lives for various categories or classes of property for a particular industry or group of assets. See sec. 167.Rev. Proc. 83-35, 1 C.B. 745">1983-1 C.B. 745 , andRev. Proc. 87-56, 2 C.B. 674">1987-2 C.B. 674 .*250 If depreciable property does not fit within the specific classes designated by respondent, then it comes within the catchall provisions of section 168(c)(2)(B) for 1986 and section 168(e)(3)(C) for 1987 and is depreciable for 5 and 7 years, respectively.The revenue procedures
section 1.48-1(e) of the regulations. . *252 . .*253 First, we cannot agree with JFM's argument that gasoline canopies do not fit within any of the categories of the revenue procedures and therefore must default to the catchall provisions of section 168. The specific definitions and classifications of guidelines 57.0 and 57.1 encompass gasoline pump canopies. Both guidelines include section 1245 and/or 1250 property "used in marketing petroleum products." *254 In order to carry its burden of showing that 57.0 is the correct classification (9-year class life), JFM must show that the canopies are section 1245 property; otherwise the canopies would more aptly come with class 57.1 (20-year class life). Section 1245 property could come within class 57.1 if it is considered a land improvement.
Stated in the vernacular of the investment credit statutes and regulations, we must decide whether the canopies are "buildings or inherently permanent structures." *256 and used in marketing petroleum products. This is a factual pursuit governed by the record in this case. Helpful criteria for resolving this question are contained in
, 672-673 (1975), as follows:Whiteco Industries, Inc. v. Commissioner , 65 T.C. 664">65 T.C. 664(1) Is the property capable of being moved and has it in fact been moved? * * *
(2) Is the property designed or constructed to remain permanently in place? * * *
(5) How much damage will the property sustain upon its removal? * * *
(6) What is the manner of affixation of the property to the land? * * * [Citations omitted.]
*257 To assist in our consideration of the canopies' classification, we will use the
supra, guidelines to focus on the facts of this case. We recognize that no one factor is necessarily decisive, but that each, to some extent, is probative.Whiteco Industries, Inc. ,(1) Is the property capable of being moved and has it in fact been moved? The record here reflects that, although the canopies are large and becoming larger, they are modular, homogeneous, and portable. We are cognizant that the canopies are being placed on the land by lessees with a 15- or shorter-year lease term. Further, at least 2 of 14 had been sold to third parties for reuse, and at least 3 were taken down and either moved to another location or extensively rebuilt and reinstalled at the same location. In addition, the canopies may be expanded, contracted, and readily modified. For example, when the brand of oil changes, the old side panels are replaced with new panels containing the new logo, brand name, and/or color scheme.(2) Is the property designed or constructed to remain permanently in place?, and (3) are there circumstances that tend to show the expected or intended length of affixation; *258i.e., are there circumstances which show that the property may or will have to be moved? We are cognizant that the canopies are being placed on the land by lessees with a 15- or shorter-year lease term. Once the initial 15-year lease ends, renewal leases are generally for 5-year terms. From the point of view of a lessee with a relatively short-term lease (in these instances from one-fourth to three-fourths as long as the 20-year class life of class 57.1), a truly permanent structure would not be cost effective. This is especially so where obsolescence has proven a factor. JFM's experience has been that the size of the gasoline facilities at the Marts has been increasing precipitously in the period preceding the tax years in question. In some instances, they have found it more economical to install new canopies, rather than to expand or modify existing ones. In addition, unpredictable weather conditions periodically require extensive replacement of panels and other components.(4) How substantial a job is removal of the property and how time-consuming is it? Is it "readily removable"?; (5) How much damage will the property sustain upon its removal?; and (6) What is the *259manner of affixation of the property to the land? Although the canopy components are collectively formidable, the whole structure can be erected and/or dismantled and moved in a few days. Moreover, the canopies have been dismantled, modified, and reinstalled and/or sold to third parties. The side panels are occasionally damaged, but most of the components are reusable. The entire canopy structure is bolted together from component beams and parts and attached to posts bolted onto four to six special concrete footings which are generally 3 feet deep and about 2 feet square. When the canopy is unbolted from the footings, the footings are the residual structures remaining on the land.Using the
, guidelines, we find that the canopies in this case are not "inherently permanent structures." We find that the canopies were readily movable and constructed so as not to be permanent. SeeWhiteco Industries, Inc. ,supra .Fox Photo Inc. v. Commissioner , T.C. Memo. 1990-348Respondent, however, makes the further argument that the use of the term "land improvement" in class 57.1 would include any improvement to land even though*260 it may not be considered an "inherently permanent structure". Respondent draws upon class 00.3, which contains a broad definition of "land improvement". We reject respondent's approach for the same reasons we rejected JFM's attempt to classify the canopies in the catchall provisions of section 168. It is clear that classes 57.0 and 57.1 were intended to cover all possible types of real or personal property used in marketing petroleum products, whereas 00.3 is a catchall for otherwise unclassifiable improvements to realty.
Although the actual life expectancy of an asset is not determinative of the asset class for depreciation, we acknowledge JFM's point that the actual life expectancy of the canopies is around 5 years because of wear and/or obsolescence. Even considering that canopies could last 10 or more years, it seems less appropriate that they would be classified as realty with a 20-year class life rather than as personalty with a 9-year class life. In this regard, JFM focused our attention on the conference committee report of the Tax Reform Act of 1986 which contains the following guidance to the executive branch in connection with the formulation of asset guidelines: *261
Any class life prescribed under the Secretary's authority must reflect the anticipated useful life, and the anticipated decline in value over time, of an asset to the industry or other group. Useful life means the economic life span of property over all users combined and not, as under prior law, the typical period over which a taxpayer holds the property. Evidence indicative of the useful life of property which the Secretary is expected to take into account in prescribing a class life includes the depreciation practices followed by taxpayers for book purposes with respect to the property. * * *
H. Conf. Rept. 99-841 (1986), 1986-3 C.B. (Vol. 4) 42.Accordingly, we hold that petitioner's canopies for the tax years 1986 and 1987 should be classified under class 57.0 for purposes of their depreciable class life.
To reflect the foregoing and concessions of the parties,
Decision will be entered under Rule 155. Footnotes
1. The parties have stipulated to facts and exhibits for purposes of trial, and the parties' stipulations are, to the extent relevant, incorporated by this reference.↩
2. The $ 57,500 consists of two $ 25,000 territorial fees and three $ 2,500 initial store fees. It is not entirely clear whether the terms and conditions of the $ 2,500 initial store fees are the same as the $ 25,000 territorial fees, but the parties have treated them the same and we have found no reason to treat them differently.↩
3. Section references are to the Internal Revenue Code in effect for the years in issue, and Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated.↩
4.
(1963);Schlude v. Commissioner , 372 U.S. 128">372 U.S. 128 (1961);American Automobile Association v. United States , 367 U.S. 687">367 U.S. 687 (1957);Automobile Club of Michigan v. Commissioner , 353 U.S. 180">353 U.S. 180 (1966);Hagen Advertising Displays, Inc. v. Commissioner , 47 T.C. 139">47 T.C. 139 (1966);Decision, Inc. v. Commissioner , 47 T.C. 58">47 T.C. 58 .Farrara v. Commissioner , 44 T.C. 189↩ (1965)5. It should be noted that the payments in
(7th Cir. 1968), revg. and remandingArtnell Co. v. Commissioner , 400 F.2d 981">400 F.2d 98148 T.C. 411">48 T.C. 411 (1967), are more easily apportioned and matched to expenses because the payments there were for specific baseball games to be played pursuant to a fixed schedule. See also , 881 n.3 (1982), whereChesapeake Financial Corp. v. Commissioner , 78 T.C. 869">78 T.C. 869Artnell↩ was similarly distinguished.6. Former sec. 167(m)(1) was applicable for 1986 and sec. 167(m) for 1987.↩
7. Fortunately,
Rev. Proc. 83-35, 1 C.B. 747">1983-1 C.B. 747 , 762, andRev. Proc. 87-56, 2 C.B. 677">1987-2 C.B. 677↩ , 686, contain the same definition for the asset guideline classes 57.0 and 57.1.8. Sec. 1245(a)(3) defines "section 1245 property" to include depreciable property which is either personal property or certain enumerated categories of real property. Sec. 1250(c) defines "section 1250 property" as any depreciable real property other than sec. 1245 property. It does not appear that gasoline pump canopies fall within any of the enumerated categories of real property afforded sec. 1245 property treatment.↩
9. We note that
Rev. Rul. 68-345, 2 C.B. 30">1968-2 C.B. 30↩ , 32, specifically reaches the conclusion that "canopies installed over the pump islands of * * * gasoline stations" are "inherently permanent structures" for investment credit purposes. Respondent did not rely upon or reference this ruling in the original or reply briefs, even though petitioner discussed the ruling in its opening simultaneous brief. Because we do not consider a revenue ruling to have the effect of law, but merely to represent the position of respondent, as a party, we must assume that respondent's position in this case is the one presented on brief, which does not include the subject ruling.
Document Info
Docket Number: Docket No. 2470-92
Citation Numbers: 67 T.C.M. 3020, 1994 Tax Ct. Memo LEXIS 234, 1994 T.C. Memo. 239
Judges: GERBER
Filed Date: 5/26/1994
Precedential Status: Non-Precedential
Modified Date: 11/21/2020