National Bank of South Carolina v. Commissioner

NATIONAL BANK OF SOUTH CAROLINA, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

National Bank of South Carolina v. Commissioner

Docket No. 8628.

United States Board of Tax Appeals

10 B.T.A. 642; 1928 BTA LEXIS 4060;

February 10, 1928, Promulgated

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1. Commissioner's action in including in petitioner's taxable income for the year 1919 the difference between the "reserve for unearned discount" as of December 31, 1918, and as of December 31, 1919, is disapproved.

2. Upon the evidence, held that during the years 1918 and 1919 the petitioner kept its books of account on the cash receipts and disbursements basis.

3. During the year 1918, petitioner accrued bank discount as earned within that year and reported as income for that year the amount accrued, although the amount so accrued and returned was actually paid and received in 1919. Held, that the amount accrued in 1918 was improperly reported as income for that year; Held, further, that the amount paid to and received by petitioner in 1919 constituted income for that year although erroneously reported as income for the prior year.

Adrian C. Humphreys, Esq., for the petitioner.

John W. Fisher, Esq., for the respondent.

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LOVE

The Commissioner determined a deficiency of $3,063.97 for the calendar year 1919 and overassessments for the calendar years 1920 and 1921 of $235.19 and $92.66, respectively, such overassessments not arising from the denial of any claim for abatement of deficiencies for the respective years. The petitioner alleges that with respect to the year 1919, the Commissioner erred in including in taxable income an amount of $15,798.85, representing the difference in the reserve for unearned discount as at December 31, 1918, and as at December 31, 1919. The same error was alleged as to 1920 and 1921, except as to amounts.

FINDINGS OF FACT.

The petitioner is a South Carolina corporation with its place of business at Sumter. It is and was during the years 1918 and 1919 engaged in business as a bank of discount and deposit.

During the year 1918, petitioner kept its books of account on a cash receipts and disbursements basis with two exceptions. The first of those exceptions consisted of petitioner's practice of maintaining an account styled "Reserve Interest Certificates of Deposit" from which the interest on certificates of deposit was paid, and into which from time to time petitioner would place different amounts without reference to the exact requirements thereof; in other words, the account did not constitute a true reserve for interest on certificates of deposit by the accrual of the interest as it was earned. This account, in any event, was maintained only for convenience, as its nature and purpose is otherwise unexplainable.

The second of the exceptions to the cash receipts and disbursements method of accounting as employed by petitioner during 1918 was its method of accounting for discount. Up to about the middle of the year 1918, petitioner had treated discount as income only when it was received, but thereafter during that year it pursued the following practice: When a note was discounted, petitioner computed or estimated the amount of discount that would accrue or be earned in 1918 and the amount so computed and accrued was in 1918 credited to profit and loss. The discount which would be earned in 1919 was credited to an account called "Reserve for Unearned Discount." In other words, for about one-half of the year 1918, petitioner deviated from a cash receipts and disbursements basis and followed an accrual method of accounting for discount only.

Pursuant to the method of accounting for discount, petitioner during the latter part of 1918, accrued and credited to profit and loss earned discount in the amount of $10,473.77 and also credited unearned discount to the "Reserve for Unearned Discount" the amount of $9,297.94, which was its balance on December 31, 1918.

In its return for the year 1918, which petitioner alleges was made on an accrual basis, there was included in income the amount of $10,473.77 as discount accrued and earned in that year.

During the year 1919, petitioner kept its books and accounts on a cash receipts and disbursement basis with no exceptions thereto. For convenience, however, in making reports on its condition, petitioner first carried into an unearned discount account the total discount on any note at the time the note was discounted and upon the payment thereof the unearned discount account was charged and the earned discount account was credited with the amount paid. The unearned discount account, which had a balance on December 31, 1919, of $25,096.79, did not in any manner affect or reflect petitioner's income for the year and, as above stated, was maintained for convenience only.

During the year 1919 petitioner, in addition to other discount received, collected and received the amount of $10,473.77 as discount which had been accrued in and reported for 1918 and also collected and received the amount of $9,297.94, the balance of the "Reserve for Unearned Discount" as of December 31, 1918.

In its return for 1919, petitioner in reporting its income from discount included, in addition to other discount, the amount of $9,297.94 but did not include in income the amount of $10,473.77 collected and received in 1919, but accrued and reported in 1918.

Upon audit of petitioner's return for the year 1919, the Commissioner determined that there should be included in income for that year the amount of $15.798.85, representing the difference in the "Reserve for Unearned Discount" as of December 31, 1918, and as of December 31, 1919, and accordingly, he increased taxable income by that amount.

OPINION.

LOVE: The petitioner contends that the Commissioner erred in including in taxable income for the year 1919 an amount of $15,798.85, representing the difference in the "Reserve for Unearned Discount" as of December 31, 1918, and as of December 31, 1919.

The respondent, on the other hand, apparently concedes that his action with respect to which error is alleged was erroneous, but he contends that the amount of $10,473.77 collected and received by petitioner in 1919 for discount earned and accrued in 1918 should be included in petitioner's income for 1919, although reported in its 1918 return. And, in support of this position, the respondent urges that during the year 1918 petitioner was on a cash receipts and disbursements basis of accounting and that its action in accruing and reporting discounts, although not received, was erroneous, thereby necessitating, under the Board's decision in , the return as income for 1919 the amount of $10,473.77 discount received in that year.

The respondent's contention in respect of the basis of accounting for 1918 is denied by the petitioner and it is urged on its behalf that during 1918 petitioner was on an accrual basis and that the amount of $10,473.77 having been properly accrued and reported as income for that year, petitioner can not be required to report that amount in 1919, although received in that year, during which it was on a strict cash receipts and disbursements basis.

Although it is apparently conceded by the respondent that his action in including in income for 1919 the amount of $15,798.85, representing the difference in the "Reserve for Unearned Discount" as of December 31, 1918, and as of December 31, 1919, was erroneous, it seems advisable to point out that under either basis of accounting the amount included in petitioner's income for 1919 did not and could not constitute income. We stated in , that:

When a bank keeps its books of account on a cash basis, discount is income only when it is received; upon an accrual basis discount becomes income as it is earned.

Clearly, then, unearned discount does not in the case of the petitioner constitute income and obviously it is impossible to make it such by subtracting a smaller from a greater amount thereof. Furthermore, as set forth in the findings of fact, petitioner during 1919 was on a cash basis maintaining a "Reserve for Unearned Discount" only for convenience and during that year discount, except the amount of $10,473.77, was treated as income as received. Consequently, the Commissioner's action in this respect is reversed and, accordingly, petitioner's taxable income as determined by the Commissioner should be reduced by the amount of $15,798.85.

We come, therefore, to a consideration of the respondent's contention that the amount of $10,473.77 should be included in income for the year 1919 although accrued and reported as income for 1918, the reporting of which, it is urged, was erroneous.

The facts disclose that with two exceptions, petitioner was during 1918 on a cash basis. One of the two exceptions, that of maintaining a reserve for interest on certificates of deposit, was clearly not an accrual method of handling that item. It was merely a convenience and closely approximated a cash basis. The other exception was, during the latter part of 1918, the accrual method of handling discount, which method petitioner discontinued at the beginning of 1919. The mere fact that petitioner for the latter part of 1918 undertook to change its method of accounting with respect to the item of discount, does not, in our opinion, warrant a conclusion that the method of accounting regularly employed was not a cash basis. We stated in , that:

The law requires that the method of accounting used shall clearly reflect the income, and it does not contemplate that a taxpayer shall keep its books of account partly on one basis and partly on another, for the very reason that income is not thereby correctly reflected. .

We think, therefore, that the method of accounting employed by petitioner in 1918 was, clearly, a cash basis.

Having been on a cash basis in 1918, it follows that petitioner's action in reporting as income for 1918 any discount other than that received was erroneous. Consequently, the amount of $10,473.77 discount, reported in 1918 but received in 1919, during which year petitioner employed a cash basis of accounting, was income for 1919. Accordingly, petitioner's income for that year should be increased by that amount.

The petitioner alleged error with respect to the years 1920 and 1921, but inasmuch as the Commissioner determined overassessments with respect to each year which overassessments did not result from the denial of any claim in abatement of a deficiency for the respective years, the Board is without jurisdiction in regard thereto. .

The deficiency for the year 1919 should be recomputed in accordance with the foregoing opinion.

Judgment will be entered on 15 days' notice, under Rule 50.