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TIME ACCEPTANCE, INC., ET AL., Time Acceptance, Inc. v. CommissionerDocket Nos. 21190-82, 21191-82, 21192-82, 21193-82, 21194-82, 21195-82, 21196-82.
United States Tax Court T.C. Memo 1985-173; 1985 Tax Ct. Memo LEXIS 455; 49 T.C.M. (CCH) 1186; T.C.M. (RIA) 85173;April 8, 1985. *455 Ps were consumer finance corporations. The Commissioner redetermined Ps' allowable additions to their reserves for bad debts by use of the
Black Motor formula.Held, Ps failed to prove that the Commissioner's determination of the allowable additions to their reserves was unreasonable.Robert R. Casey, for the petitioners.Linda K. West ,SIMPSONMEMORANDUM FINDINGS OF FACT AND OPINION
SIMPSON,
Judge: The Commissioner determined the following deficiencies in the petitioners' Federal*456 income taxes:Taxable Year Docket No. Petitioner Ended June 30 Deficiency 21190-82 Time Acceptance, Inc. 1977 $5,382.00 1978 3,540.00 21191-82 Community Acceptance 1977 1,467.00 Corporation of 1978 2,327.00 Donaldsonville 21192-82 Time Acceptance of 1978 4,482.00 Zachary, Inc. 21193-82 Gonzales Acceptance 1977 1,961.00 Corporation 1978 3,228.00 1979 3,528.05 21194-82 Community Acceptance 1977 14,613,00 Corporation 1978 16,891.00 1979 7,568.00 21195-82 Community Acceptance 1977 723.00 Corporation of 1978 4,622.00 Baton Rouge 21196-82 Delta Acceptance 1977 2,142.00 Corporation 1978 4,409.00 Delta Acceptance Corporation has conceded its case. After such concession, the issue for decision is whether the Commissioner abused his discretion in redetermining the allowable additions to the petitioners' bad debt reserves.
FINDINGS OF FACT
Some of the facts have been stipulated, and those facts are so found.
Each of the petitioners is a Louisiana corporation, and each had its principal place of business in Louisiana when its petition in this case was filed. All of the petitioners*457 filed their Federal corporate income tax returns for the years at issue with the Internal Revenue Service Center, Austin, Tex., except that the returns of Gonzales Acceptance Corporation and Community Acceptance Corporation for the taxable year ended June 30, 1979, were, so far as we know, merely filed somewhere with the Internal Revenue Service. We will refer to a taxable year of a petitioner by the calendar year in which such year ended.
Time Acceptance, Inc. (Time Acceptance), was incorporated on September 14, 1970. Community Acceptance Corporation of Donaldsonville (Community of Donaldsonville) was incorporated on March 1, 1965. Time Acceptance of Zachary, Inc. (Time of Zachary), was incorporated on September 14, 1972. Gonzales Acceptance Corporation (Gonzales) was incorporated on February 6, 1973. Community Acceptance Corporation (Community Acceptance) was incorporated on August 18, 1964. Community Acceptance Corporation of Baton Rouge (Community of Baton Rouge) was incorporated on May 16, 1968.
All of the petitioners are in the consumer finance business, and Leo P. Lambert, Jr., was an officer in each of them. The petitioners make loans to individuals either on an*458 unsecured basis or secured by chattel mortgages on household goods, furniture, television sets, and appliances. Generally, their customers are blue-collar workers and are individuals who cannot borrow money from lending institutions, such as banks. Some of the loans made by the petitioners are for up to 5 years. The petitioners finance their operations by borrowing from commercial lenders such as General Electric Credit Corporation. Such indebtedness is secured by pleadges of the petitioners' consumer promissory notes and chattel mortgages.
Each petitioner's reserve for bad debts was established in connection with the annual audit of each petitioner. The reserves for bad debts were established in accordance with the following procedures: The petitioners' independent certified public accountant visited each branch office of each eptitioner in connection with the annual audit. He examined all individual delinquent loan cards and samples of all other loan cards representing loans to customers. He selected various accounts and reviewed their loan files. He mailed confirmation slips to a sample group of customers, including delinquent customers. He also reviewed all delinquency*459 summaries prepared by each office showing the accounts for which no payments had been received within the previous 3-, 60-, and 90-day periods. In order to determine which delinquent accounts were likely to become worthless, the accountant reviewed all actions taken by the branch managers to determine whether all efforts had been made to collect the delinquent accounts. He then reviewed the monthly reports of the commercial lenders from whom the petitioners borrow funds. The petitioners' lenders recompute their lending base on a monthly basis by independently examining the petitioners' finance notes receivable.
After reviewing the delinquency summaries prepared by each branch manager, the collateral for each delinquent loan, and the history of all payments on each delinquent loan, the petitioners' accountant discussed the delinquent accounts with each petitioner's management and with the individual loan office managers and obtained their recommendations as to which accounts should be written off against the reserve for bad debts. Based on such review and discussions, the accountant prepared his workpapers which listed the delinquent accounts for each petitioner and his estimate*460 of what the reserve should be as of the end of each year in order to take into account that portion of the delinquent accounts which he reasonably believed would become wortheless in the future. The petitioners' accountant made recommendations concerning the appropriate bad debt reserves to the petitioners' management. The bad debt reserves were the product of discussions between the petitioners' management and their accountant. The final decision concerning at what levels to set the bad debt reserves was made by the management.
The management of the petitioners generally was reluctant to chargeoff notes receivable as recommended by the accountant. One reason given for such reluctance was that loans which were charged off reduce the base upon which the petitioners' commercial lenders determine how much they were willing to loan the petitioners. Another reason for such reluctance was that if a loan was kept on the books, it was more likely that collection efforts by the petitioners' employees would continue with respect to that loan.
When an account became delinquent for a period of 2 days, a first notice was mailed to the borrower. Thereafter, subsequent notices were mailed*461 every 2 days, and prior to the third notice, the borrower was contacted by telephone. After such notices were sent, a borrower was contacted by telephone several times a week, and occasionally, several times a day. Sometimes a borrower was visited at home or asked to come into one of the petitioners' offices to discuss an overdue account. Occasionally, a customer's loan was renewed. Usually, the customer wanted to borrow more money, or he needed to have the payment schedule adjusted so that the payments were smaller. Renewals of notes receivable were treated as new loans on the petitioners' books in the year of renewal.
Effective January 1, 1973, Louisiana banks were permitted to make loans to individuals at rates of interest comparable to the rates charged by the petitioners. This change caused many of the petitioners' better customers to borrow money from banks rather than from the petitioners, and accordingly, the petitioners were forced to make more loans involving higher risks.
The revenue agent assigned to audit the petitioners first did a pre-audit analysis. He then conducted an initial interview with Mr. Lambert. After the initial interview, the agent examined the*462 books and records of the petitioners, reconciling the figures in the books and records with the figures on the tax returns. In some cases, he adjusted the tax year in which certain debts were charged off. Finally, he determined that the petitioners' additions to bad debt reserves were unreasonable, by use of the
Black Motor formula.The agent who conducted the audit of the petitioners did not inquire as to what portion of the notes receivable outstanding at the end of each year represented renewals of loans originally made in prior years. He did review renewal loans which were part of the chargeoffs on the petitioners' returns. He did not review notes receivable outstanding as of the end of each year on which an installment payment had not been made within the prior 30-, 60-, or 90-day period and which had not as yet been charged off by the petitioners against their reserves as of the close of each year. He also did not review or determine what collection efforts had been made with respect to outstanding loans on which no installment payment had been received within the prior 30-, 60-, or 90-day period as of the end of each year. Nor did he review the collection efforts*463 made by the petitioners with respect to delinquent accounts that were not charged off as of the end of each year. The agent did not review the amount of notes receivable of each petitioner outstanding as of the end of each fiscal year which subsequently were charged off against the reserve of each petitioner as of the date of the audit. The only adjustments made as a result of the audit were reductions in the additions to the petitioners' bad debt reserves.
For each petitioner, the amount listed on its corporate income tax returns as trade notes and accounts receivable outstanding at the end of the year, the amount added to reserve, the amount charged against reserve, and the reserve for bad debts at the end of the year were as follows:
Trade notes and accounts Amount added Amount charged Reserve for Year receivable to reserve against reserve bad debts TIME ACCEPTANCE 1978 $1,295,110 $13,586 $19,995 $64,755 1977 1,423,281 34,945 21,674 71,164 1976 1,447,325 19,400 17,320 57,893 1975 1,395,316 37,170 21,015 55,813 1974 1,321,931 20,896 4,420 39,658 1973 772,720 15,145 11,709 23,182 1972 658,211 16,886 8,352 19,746 COMMUNITY OF DONALDSONVILLE 1978 $ 829,950 $11,638 $ 5,480 $33,198 1977 676,000 12,848 6,699 27,040 1976 522,285 5,331 5,153 20,891 1975 517,836 12,408 4,640 20,713 1974 431,491 4,241 3,636 12,945 1973 415,777 5,692 4,744 12,340 1972 379,728 7,116 6,699 11,392 TIME OF ZACHARY 1978 $522,540 $ 9,479 $11,980 $20,902 1977 585,087 6,497 1,136 23,403 1976 451,040 5,628 6,986 18,042 1975 485,004 10,383 6,554 19,400 1974 519,021 10,059 8,353 15,571 1973 462,163 13,865 13,865 GONZALES 1979 $914,835 $22,876 $20,074 $35,948 1978 828,659 14,482 10,989 33,146 1977 743,657 10,014 4,095 29,653 1976 593,353 6,654 4,194 23,734 1975 531,843 13,090 2,870 21,274 1974 368,451 7,627 11,054 1973 114,205 3,427 3,427 COMMUNITY ACCEPTANCE 1979 $1,642,831 $61,830 $56,212 $82,142 1978 1,530,481 37,656 16,180 76,524 1977 2,028,815 35,507 16,900 81,153 1976 1,563,649 21,486 8,473 62,546 1975 1,228,333 31,239 8,044 49,533 1974 877,926 8,229 8,535 26,338 1973 888,137 14,816 14,814 26,644 1972 888,053 21,580 24,272 26,642 COMMUNITY OF BATON ROUGE 1978 $1,669,635 $31,528 $20,539 $66,785 1977 1,394,902 23,720 924 55,796 1976 825,012 12,948 14,165 33,000 1975 855,422 24,594 10,481 34,217 1974 670,131 18,927 18,245 20,104 1973 647,258 15,520 15,993 19,422 1972 663,170 17,662 17,048 19,895 *464 For each petitioner, the ratio of amount charged against reserve to trade notes and accounts receivable outstanding at the end of the year and the ratio of reserve for bad debts at the end of the year to trade notes and accounts receivable were as follows:
Ratio of amount charged Ratio of reserve for bad against reserve to trade debts at end of year to notes and accounts trade notes and accounts Year receivable receivable TIME ACCEPTANCE 1978 1.54 5.00 1977 1.52 5.00 1976 1.20 4.00 1975 1.51 4.00 1974 .33 3.00 1973 1.52 3.00 1972 1.27 3.00 COMMUNITY OF DONALDSONVILLE 1978 .66 4.00 1977 .99 4.00 1976 .99 4.00 1975 .90 4.00 1974 .84 3.00 1973 1.14 2.97 1972 1.76 3.00 TIME OF ZACHARY 1978 2.29 4.00 1977 .19 4.00 1976 1.55 4.00 1975 1.35 4.00 1974 1.61 3.00 1973 3.00 GONZALES 1979 2.19 3.93 1978 1.33 4.00 1977 .55 3.99 1976 .71 4.00 1975 .54 4.00 1974 3.00 1973 3.00 COMMUNITY ACCEPTANCE 1979 3.42 5.00 1978 1.06 5.00 1977 .83 4.00 1976 .54 4.00 1975 .65 4.03 1974 .97 3.00 1973 1.67 3.00 1972 2.73 3.00 COMMUNITY OF BATON ROUGE 1978 1.23 4.00 1977 .07 4.00 1976 1.72 4.00 1975 1.23 4.00 1974 2.72 3.00 1973 2.47 3.00 1972 2.57 3.00 *465 The following chart contains, for each petitioner, the amounts listed on its accountant's workpapers
1976 1977 1978 1979 1980 Total loans $1,034,552 $1,423,281 $1,295,110 $1,373,460 $1,416,284 Reserve for bad debts 41,382 56,931 64,753 68,673 70,814 Chargeoffs 30 days 0 0 0 0 0 60 days 894 0 0 0 0 90 days 9,149 18,180 26,032 24,037 25,193 Total $ 10,043 $ 18,180 $ 26,032 $ 24,037 $ 25,193 Delinquent accounts 30 days 41,124 79,163 80,943 24,703 60,567 60 days 25,709 20,788 18,202 21,116 22,545 90 days 25,391 83,632 78,521 48,526 58,543 Total $ 92,224 $ 183,583 $ 177,666 $ 94,345 $ 141,655 Accounts out- standing at year end which have been charged off as of 6/30/83 70,777 74,998 27,955 Ratio of re- serve for bad debts to all delinquent accounts 44.87 31.01 36.45 72.79 49.99 Ratio of re- serve for bad debts to accounts delinquent more than 90 days 162.98 68.07 82.47 141.52 120.96 *466 COMMUNITY OF DONALDSONVILLE
1976 1977 1978 1979 1980 Total loans $522,285 $676,000 $829,950 $759,444 $632,252 Reserve for bad debts 20,891 27,040 33,198 30,378 25,290 Chargeoffs 30 days 0 0 0 0 0 60 days 0 0 0 0 0 90 days 6,857 8,913 7,291 8,335 11,086 Total $ 6,857 $ 8,913 $ 7,291 $ 8,335 $ 11,086 Delinquent accounts 30 days 12,773 22,201 43,154 35,525 27,288 60 days 5,884 9,276 15,480 21,435 18,419 90 days 8,038 9,287 33,969 39,342 34,962 Total $ 26,695 $ 40,764 $ 92,603 $ 96,302 $ 80,669 Accounts out- standing at year end which have been charged off as of 6/30/83 26,642 70,540 17,448 Ratio of re- serve for bad debts to all delinquent accounts 78.26 66.33 35.85 31.54 31.35 Ratio of re- serve for bad debts to accounts delinquent more than 90 days 259.90 291.16 97.73 77.22 72.34 TIME OF ZACHARY
1976 1977 1978 1979 1980 Total loans $451,041 $585,087 $522,540 $914,835 $889,999 Reserve for bad debts 18,042 23,403 20,902 36,593 35,600 Chargeoffs 30 days 0 0 0 0 0 60 days 0 0 0 0 0 90 days 9,487 11,821 16,149 10,496 13,451 Total $ 9,487 $ 11,821 $ 16,149 $ 10,496 $ 13,451 Delinquent accounts 30 days 36,744 52,397 27,102 61,357 73,934 60 days 10,514 18,515 10,109 5,342 7,647 90 days 25,108 41,436 44,071 24,957 17,241 Total $ 72,366 $112,348 $ 81,282 $ 91,656 $ 98,822 Accounts out- standing at year end which have been charged off as of 6/30/83 43,606 68,581 44,888 Ratio of re- serve for bad debts to all delinquent accounts 24.93 20.83 25.72 39.92 36.02 Ratio of re- serve for bad debts to accounts delinquent more than 90 days 71.86 56.48 47.43 146.62 206.48 *467 GONZALES
1976 1977 1978 1979 Total loans $593,353 $743,658 $828,659 $914,835 Reserve for bad debts 23,734 29,653 33,146 36,593 Chargeoffs 30 days 0 0 0 0 60 days 0 0 0 0 90 days 5,565 5,434 14,580 10,496 Total $ 5,565 $ 5,434 $ 14,580 $ 10,496 Delinquent accounts 30 days 23,981 25,703 36,131 61,357 60 days 8,252 11,943 8,409 5,342 90 days 15,497 23,245 20,646 24,957 Total $ 47,730 $ 60,891 $ 65,186 $ 91,656 Accounts out- standing at year end which have been charged off as of 6/30/83 30,201 28,246 10,125 Ratio of re- serve for bad debts to all delinquent accounts 49.73 48.70 50.85 39.92 Ratio of re- serve for bad debts to accounts delinquent more than 90 days 153.15 127.57 160.54 146.62 COMMUNITY ACCEPTANCE
1976 1977 1978 1979 1980 Total loans $1,152,073 1,434,950 1,530,481 $1,680,400 $1,751,201 Reserve for bad debts 46,082 57,398 76,524 84,020 87,560 Chargeoffs 30 days 0 0 0 0 0 60 days 0 0 0 0 3,249 90 days 10,080 15,230 18,953 35,534 23,693 Total $ 10,080 $ 15,230 $ 18,953 $ 35,534 $ 26,942 Delinquent accounts 30 days 60,199 69,747 67,047 59,846 127,454 60 days 16,266 20,359 18,421 16,295 21,278 90 days 33,836 28,004 63,423 69,594 76,240 Total $ 110,301 $ 118,110 $ 148,891 $ 145,735 $ 224,972 Accounts out- standing at year end which have been charged off as of 6/30/83 99,709 106,073 $65,855 Ratio of re- serve for bad debts to all delinquent accounts 41.78 48.60 51.40 57.65 38.92 Ratio of re- serve for bad debts to accounts delinquent more than 90 days 136.19 204.96 120.66 120.73 114.85 *468 COMMUNITY OF BATON ROUGE
1976 1977 1978 1979 1980 Total loans $825,012 $1,394,902 $1,669,635 $1,596,829 $1,300,549 Reserve for bad debts 33,000 $55,796 66,785 63,873 104,044 Chargeoffs 30 days 0 789 2,184 0 0 60 days 0 0 0 0 0 90 days 18,848 28,800 24,454 38,185 36,038 Total $ 18,848 $ 29,589 $ 26,638 $ 38,185 $ 36,038 Delinquent accounts 30 days 12,412 117,705 96,873 68,240 145,805 60 days 14,308 57,029 30,259 39,232 43,839 90 days 47,900 34,185 63,876 56,122 149,626 Total $ 74,620 $ 208,919 $ 191,008 $ 163,594 $ 339,270 Accounts out- standing at year end which have been charged off as of 6/30/83 97,779 132,751 165,596 Ratio of re- serve for bad debts to all delinquent accounts 44.22 26.71 34.96 39.04 30.67 Ratio of re- serve for bad debts to accounts delinquent more than 90 days 68.89 163.22 104.55 113.81 69.54 *469 In his notices of deficiency, the Commissioner determined that the petitioners' additions to their reserves for bad debts were not reasonable. The amounts claimed by the petitioners and the amounts allowed by the Commissioner were as follows:
Addition to Addition to reserve claimed reserve allowed Time Acceptance 1977 $34,945 $0 1978 13,586 4,254 Community of Donaldsonville 1977 12,848 0 1978 11,638 0 Time of Zachary 1978 9,479 0 Gonzales 1977 10,014 0 1978 14,482 0 1979 22,876 10,081 Community Acceptance 1977 35,507 0 1978 37,656 0 1979 61,830 0 Community of Baton Rouge 1977 23,720 0 1978 31,528 10,346 OPINION
We must decide whether the Commissioner's determination of the allowable additions to the petitioners' reserves for bad debts was unreasonable.
In connection with the determination of the proper amount of a reserve for bad debts,
section 1.166-4(b)(1), Income Tax Regs. , provides:(b) Reasonableness of addition to reserve--(1) Relevant factors. What constitutes a reasonable addition to a reserve for bad debts shall be determined in the light of the facts existing at the close of the taxable year of the proposed addition. The reasonableness of the addition will vary as between classes of business and with conditions of business prosperity. It will depend primarily upon the total amount of debts outstanding as of the close of the taxable year, including those arising currently as well as those arising in prior taxable years, and the total amount of the existing reserve.
This Court has stated that the past experience of the taxpayer in collecting accounts and notes receivable is a reliable guide for measuring*472 probable future losses.
Roanoke Vending Exchange, Inc. v. Commissioner, 40 T.C. at 741Home Ice Cream & Ice Co. v. Commissioner, 19 B.T.A. 762">19 B.T.A. 762Roanoke Vending Exchange, Inc. v. Commissioner, supra ; Apex Brewing Co. v. Commissioner, 40 B.T.A. 1110">40 B.T.A. 1110Roanoke Vending Exchange, Inc. v. Commissioner, supra ; Carithers-Wallace-Courtenay v. Commissioner, 5 T.C. 942">5 T.C. 942The Commissioner's determination with respect to additions to a reserve for bad debts carries a great deal of weight because of the discretion vested in him under
section 166(c) ; accordingly, the burden of proof on a taxpayer is greater than the usual burden which faces the taxpayer who seeks to disprove the Commissioner's determination.Roth Steel Tube Co. v. Commissioner, 68 T.C. 213">68 T.C. 213620 F.2d 1176">620 F.2d 1176 , 1179 (6th Cir. 1980);Roanoke Vending Exchange, Inc. v. Commissioner, supra ; Krim-Ko Corp. v. Commissioner, 16 T.C. 31">16 T.C. 31Westchester Development Co. v. Commissioner, 63 T.C. at 211Roanoke Vending Exchange, Inc. v. Commissioner, supra ; *474Krim-Ko Corp. v. Commissioner, supra. Westchester Development Co. v. Commissioner, supra ; Roanoke Vending Exchange, Inc. v. Commissioner, supra. In the present case, the Commissioner used the
Black Motor formula to recompute the petitioners' additions to their bad debt reserves. TheBlack Motor formula originated inBlack Motor Co. v. Commissioner, 41 B.T.A. 300">41 B.T.A. 300125 F.2d 977">125 F.2d 977 (6th Cir. 1942), where the reasonableness of an addition to the taxpayer's bad debt reserve was measured by the taxpayer's actual bad debt experience during the current year and the 5 immediately preceding years. Pursuant to the formula, a computation is made to determine the average percentage of debts actually charged off during each of the 6 years in relation to the relevant outstanding year-end receivables in order to determine what percentage of the outstanding year-end debts of the current year can reasonably be expected to become worthless*475 thereafter. The Supreme Court upheld the use of theBlack Motor formula inThor Power Tool Co. v. Commissioner, 439 U.S. 522">439 U.S. 522Common sense suggests that a firm's recent credit experience offers a reasonable index of the credit problems it may suffer currently. And the formula possesses the not inconsiderable advantage of enhancing certainty and predictability in an area peculiarly susceptible of taxpayer abuse. In any event, after its 40 years of nearuniversal acceptance, we are not inclined to disturb the
Black Motor formula now. [439 U.S. at 549 .]The Court also pointed out:
Since it first received the approval of the Tax Court in 1940, the
Black Motor bad-debt formula has enjoyed the favor of all three branches of the Federal Government. The formula has been employed consistently by the Commissioner, approved by the courts, and collaterally recognized by the Congress. * * * [439 U.S. at 548 ; fn. refs. omitted.]However, the Court also recognized that there are situations in which the formula might generate an arbitrary result:
If a taxpayer's most recent bad-debt experience*476 is unrepresentative for some reason, a formula using that experience as data cannot be expected to produce a "reasonable" addition for the current year. * * * [
439 U.S. at 549 ; fn. ref. omitted.]The petitioners in the present case have failed to meet their greater than usual burden of proof; on the record before us, they have not established that the Commissioner's determination was unreasonable. The petitioners make a number of arguments; we will discuss their arguments in turn.
First, the petitioners argue that although the
Black Motor formula may properly be applicable to reserves for bad debts in a business involving trade receivables, which are generally collected within 90 days, it is not an appropriate method to calculate bad debt reserves for consumer finance companies. They attempt to support this contention by stating that consumer finance companies usually make loans having maturities of 5 or more years and, thus, that such loans may not be charged off for up to 5 years or more after the loans are made. There is evidence in the record, and we have found as a fact, that some of the petitioners' loans had maturities in excess of 5 years. However, *477 there is no evidence in the record concerning what portion of the petitioners' loans had maturities of 5 or more years. The petitioners have failed to introduce sufficient evidence to support their argument, and consequently, we are not persuaded by such argument.The petitioners likewise have failed to introduce sufficient evidence to support another of their arguments. They argue that they wait a much longer time before charging off notes receivable against their reserves for bad debts than do other consumer finance companies generally. However, their evidence on this point consisted of one of their employees testifying only that three local companies, that he had previously worked for, charged off notes receivable sooner than the petitioners. Such evidence hardly establishes what is generally the practice of consumer finance companies. Furthermore, the Supreme Court in
Thor Power Tool Co. v. Commissioner, supra , essentially rejected the argument which the petitioners herein attempt to make:Thor faults the
Black Motor formula because of its retrospectivity: By ascertaining current additions to a reserve by reference to past chargeoff experience, *478 the formula assertedly penalizes taxpayers who have delayed in making writeoffs in the past, or whose receivables have just recently begun to deteriorate. Petitioner's objection is not altogether irrational, but it falls short of rendering the formula arbitrary. * * * [439 U.S. at 548-549 .]The present case warrants a similar conclusion.
The petitioners also contend, citing
Industrial Credit Co. v. Commissioner, T.C. Memo 1967-75">T.C. Memo 1967-75Black Motor formula to determine the proper levels of bad debt reserves. This argument is seriously flawed. TheBlack Motor formula has been used to establish appropriate bad debt reserves for consumer finance companies. SeeAtlantic Discount Co. v. United States, 473 F.2d 412">473 F.2d 412S.W. Coe & Co. v. Dallman, 216 F.2d 566">216 F.2d 566Industrial *479Credit Co., we explicitly based our holding that the taxpayer's reserves for bad debts were reasonable on our findings of fact that the taxpayer was engaged in a high risk financing business, that it had not had sufficient time in which to develop a history of actual bad debts, and that comparable lending institutions which had less risk were allowed a larger percentage of bad debts. The record in the present case does not support comparable fact findings.The petitioners do argue that they had not been engaged in business for a sufficient length of time prior to the years at issue to establish a representative history of bad debt chargeoffs. However, four of the petitioners had been in existence for more than 5 years before the years at issue: two for more than 11 years, one for more than 8 years, and the other nearly 6 years. Only two of the petitioners, Time of Zachary and Gonzales, had not been in business for more than 5 years before the years at issue. Time of Zachary had been in business for more than 4-1/2 years prior to the beginning of its 1978 taxable year, and Gonzales had been in business for more than 3 years prior to the beginning of its 1977 taxable year. The*480 petitioners have not confined this argument to these two companies; rather, the petitioners argue that even the three companies that had been in business for more than 8 years had not developed a sufficient loss experience to permit application of the
Black Motor formula. TheBlack Motor formula measures the reasonableness of an addition to a bad debt reserve by using the taxpayer's actual bad debt experience during the current year and the 5 immediately preceding years. Absent some showing that a reserve calculated thereby is inadequate, we must sustain the application of such formula.Thor Power Tool Co. v. Commissioner, supra at 550-551The petitioners also point to the amounts of delinquent loans as evidence that their additions to their bad debt reserves were reasonable. They argue that their ratios of reserves to total delinquent accounts ranged from 26.7 percent to 68.7 percent Norfolk Industrial Loan Association v. United States, an unreported case ( E.D. Va. 1970, 70-2 U.S.T.C. par. 9527,
26 A.F.T.R.2d (RIA) 70">26 A.F.T.R.2d 70 -5296). *481 on the ratios of reserves to total delinquent accounts is misplaced. According to the workpapers of the petitioners' accountant, during the years 1976 through 1980, for all six petitioners, there were only 4 years in which loans delinquent for less than 90 days were charged off: In 1976, Time Acceptance charged off $894, which was 60 days delinquent; in 1980, Community Acceptance charged off $3,249, which was 60 days delinquent; and in 1977, Community of Baton Rouge charged off $789, which was 30 days delinquent, and in 1978, it charged off $2,184, which was 30 days delinquent. Thus, it was comparatively rare for any of the petitioners to chargeoff loans less than 90 days delinquent. When the petitioners' reserves for bad debts, as set forth in the accountant's workpapers, are compared to the accounts over 90 days delinquent, the ratios are significantly higher during the years at issue, ranging from 47.43 percent to 291.16 percent. For from demonstrating the reasonableness of the petitioners' additions to their bad debt reserves, such ratios show the unreasonableness of those reserves.*482 Crucial to this case is the method by which the petitioners' additions to their bad debt reserves were calculated. The petitioners argue that computations of additions to bad debt reserves may be made based upon a review by a taxpayers' certified public accountant of delinquent loans and a determination of what portion of those loans is likely to become worthless in the future. In
Westchester Development Co. v. Commissioner, supra , the taxpayer had been in existence for only a brief time, and its borrowers constituted particularly poor risks. Under the circumstances, we concluded that it was reasonable for the taxpayer to compute its additions to its reserves for bad debts by relying on the advice of its independent accountant. The accountants had investigated individual debtors of the taxpayer to determine a reasonable addition to the taxpayer's bad debt reserve. In the present case, the petitioners argue that the method they employed was substantially identical to that used inWestchester Development. However, the facts simply do not support the petitioners' contention.Although we found as a fact that the petitioners' accountant examined each individual*483 delinquent loan card, as well as other loan cards, that he reviewed certain loan files, delinquency summaries, collection efforts, and commercial lenders' monthly reports, and that he consulted with the petitioners' management and individual loan office managers, we did not find as a fact that the accountant's recommendations were accepted by the petitioners in setting the amounts of their bad debt reserves.Rather, we found that the reserves were the product of discussions between the petitioners' management and the accountant, but that the ultimate decision was made by the petitioners' management. These circumstances, among others, distinguish the present case from
Westchester Development, since in that case the taxpayer had only a brief operational history and since the taxpayer's addition to its bad debt reserve was very close to the amount recommended by its disinterested accountants.Moreover, we have calculated the ratio of reserves for bad debts to total loans outstanding for each of the petitioners during the years 1973 through 1978 or 1979 and for some of the petitioners for the years 1972 through 1978 or 1979. We rounded our calculations to the nearest one-hundredth*484 of a percent. In 38 of the total of 42 years for which ratios were calculated, the ratios were exact percentages, to the hundredth of a percent. In the 4 years where the ratios were not exact percentages, the ratios were within seven one-hundredths of an exact percentage. We cannot ignore the obvious. The fact that the petitioners' bad debt reserves were, for the most part, exact percentages of their total loans outstanding is surely not a mere coincidence. Such relationship strongly suggests that the petitioners' reserves were merely determined as a percentage of the outstanding debts, and that such reserves were not based on a careful analysis of the worthlessness of such outstanding debt.
Finally, the petitioners argue that the reasonableness of their bad debt reserves is evidenced by the fact that each petitioner through 1983 has charged off an amount of loans outstanding as of the close of the years at issue which approximated or far exceeded the balances in its bad debt reserves as of the close of the years at issue. The petitioners contend that the reason that the chargeoffs through 1983 have not in every case equalled or exceeded the amount of the bad debt reserves*485 as of 1979 is that the period from 1979 through 1983 was an insufficient amount of time for the chargeoffs to occur. However, what constitutes a reasonable addition to a reserve for bad debts must be determined in light of the facts existing at the close of the taxable year of the addition. See. 1.166-4(b), Income Tax Regs. Evidence of the uncollectibility of certain accounts subsequent to the taxable year has a limited role in our determination.
Roanoke Vending Exchange, Inc. v. Commissioner, 40 T.C. at 741Carithers-Wallace-Courtenay v. Commissioner, 5 T.C. at 945In summary, the Commissioner has calculated the amounts needed for the petitioners' reserves for bad debts by use of the
Black Motor formula. His determination must be given great weight and must be sustained unless*486 arbitrary.Thor Power Tool Co. v. Commissioner, supra at 547-548Black Motor formula has the advantages that it bases the reserves on past experience and results in predictability. For such reasons, it is generally used, and we will sustain the Commissioner's reliance on it in the absence of a showing that a taxpayer's past history is not representative. The petitioners have made several attempts to demonstrate that their past history was not representative, but those attempts, singularly or in the aggregate, were simply not sufficient to overcome the weight to be given to the Commissioner's determination and theBlack Motor formula. After carefully reviewing all of the petitioners' arguments, we are not convinced that their past history is not representative or that it does not provide the most reliable basis for determining their bad debt reserves. What is more, the petitioners' actual loss experience rarely exceeded 2 percent; yet, for virtually all of the years at issue, they maintained reserves of 4 or more percent. We are certainly not convinced that the Commissioner acted arbitrarily or unreasonably in relying upon theBlack Motor *487 formula in this case.Decisions will be entered for the respondent. Footnotes
1. Cases of the following petitioners have been consolidated herewith: Community Acceptance Corporation of Donaldsonville, docket No. 21191-82; Time Acceptance of Zachary, Inc., docket No. 21192-82; Gonzales Acceptance Corporation, docket No. 21193-82; Community Acceptance Corporation, docket No. 21194-82; Community Acceptance Corporation of Baton Rouge, docket No. 21195-82; Delta Acceptance Corporation, docket No. 21196-82.↩
2. The figures on the petitioners' tax returns and the figures on the petitioners' accountant's workpapers do not always coincide. The workpapers were prepared on the basis of financial accounting principles; the petitioners' tax returns were prepared on the basis of tax accounting principles; and some of the differences in the figures may be due to differences in such principles. The petitioners' accountant prepared his workpapers after consultation with the management.↩
3. All statutory references are to the Internal Revenue Code of 1954 as in effect during the years in issue.↩
4. During the years at issue, the petitioners' ratios of reserves to total delinquent accounts ranged from 25.75 percent to 66.33 percent.↩
5. In
Norfolk Industrial Loan Association v. United States, an unreported case ( E.D. Va. 1970, 70-2 U.S.T.C. par. 9527,26 A.F.T.R.2d (RIA) 70">26 A.F.T.R.2d 70↩ -5296), the taxpayer's bad debt reserve was in fact less than 30 percent of its total delinquent accounts during the first year at issue and less than 30 percent in the second year at issue.
Document Info
Docket Number： Docket Nos. 21190-82, 21191-82, 21192-82, 21193-82, 21194-82, 21195-82, 21196-82.
Citation Numbers： 49 T.C.M. 1186, 1985 Tax Ct. Memo LEXIS 455, 1985 T.C. Memo. 173
Filed Date： 4/8/1985
Precedential Status： Non-Precedential
Modified Date： 11/21/2020