Marshall Bros. Lumber Co. v. Commissioner

MARSHALL BROTHERS LUMBER CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Marshall Bros. Lumber Co. v. Commissioner

Docket Nos. 12987, 16608.

United States Board of Tax Appeals

13 B.T.A. 1111; 1928 BTA LEXIS 3112;

October 17, 1928, Promulgated

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">*3112 1. Installment Sales. - The filing of original returns on accrual basis is no bar to later filing amended returns on installment basis providing books contain sufficient information to so compute the net income.

2. ID. - Petitioner held to be "regularly" selling personal property on the installment plan within the meaning of that term as used in section 212(d) of the Revenue Act of 1926.

3. ID. - Evidence held insufficient to properly compute the income on the installment sales basis.

4. ID. - Section 705 of the Revenue Act of 1928 held not applicable where change of reporting net income from accrual to installment basis was made on amended rather than original returns.

5. Evidence. - Where counsel for petitioner states at the hearing that certain depositions previously taken will not be offered and counsel for respondent does not offer them, they are not a part of the record.

T. B. Benson, Esq., Harry Schwartz, Esq., and E. R. Zane, C.P.A., for the petitioner.

Harold Allen, Esq., and W. R. Lansford, Esq., for the respondent.

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GREEN

">*1112 In these proceedings, which were consolidated, the petitioner">*3113 seeks a redetermination of its income and profits-tax liabilities for the calendar years 1920 and 1921, for which the respondent, as set forth in his deficiency letters dated February 16, 1926, and April 30, 1926, determined deficiencies of $5,315.59 and $4,379.16, respectively.

The only issue is whether the respondent erred in determining the petitioner's income on an accrual basis rather than on the installment basis. A second error relating to bad debts was alleged with respect to the year 1921, but was abandoned at the hearing.

FINDINGS OF FACT.

Petitioner is a Tennessee corporation with its principal office at Johnson City. During the years 1920 and 1921, and for several years prior thereto, it had been engaged in retailing lumber and building materials both for cash and on credit. Its credit sales, which represented from 14 to 17 per cent of its total sales during the years in question, were made upon the installment plan in the following manner. If a prospective purchaser owned a lot and was able to finance the labor, the petitioner would sell him his material on a monthlypayment plan ranging from $10 per month upward. Upon the completion of the building the petitioner">*3114 would take the purchaser's note secured by a deed of trust on the real estate. In case the purchaser defaulted the petitioner would purchase the real estate on foreclosure and credit the purchaser's account with the purchase price and treat he subsequent disposition of the acquired real estate as a new transaction.

Petitioner's books of account, for 1920 and 1921, show income from all sources, cost of goods sold, operating expenses, gross and net income, as follows:

1920
Sales	$421,607.79
Less returns and allowances	17,518.40
Net sales		$404,089.39
Cost of merchandise sold
Inventory Jan. 1, 1920	$30,130.30
Purchases	317,856.23
Total merchandise	347,986.53
Inventory Dec. 31, 1920	42,043.02
Cost of merchandise sold		$305,943.51
Gross profit on sales		98,145.88
Percentage of gross profit to sales		24.28
Cash and current account sales	$333,119.73
Earned profit	24.28	80,914.44
Collections on installment contracts, Exhibit D	5,912.13
Earned profit	24.28	1,435.47
Total profit earned, 1920 sales		82,349.91
Earned profit 1917 installment contracts,
Exhibit A		612.03
Earned profit 1918 installment contracts, Exhibit B		490.63
Earned profit 1919 installment contracts, Exhibit C		1,006.85
Other operating income		11,014.62
Total		95,474.04
Operating expense
Salaries	$24,209.51
Drayage	10,354.92
Mill labor expense	4,062.00
Bank discount	2,848.41
Cash discount	507.82
Insurance	288.69
Advertising	520.48
Stable and motor-truck expense	1,940.16
General expense	2,050.81
Taxes	1,384.47
Rent	4,824.00
Miscellaneous expense	1,432.30
Bad accounts	4,828.04
1918 additional tax	1,839.08
1919 Federal income tax	4,561.52
Donations	478.00
Life-insurance premiums	283.80
Depreciation	1,879.16
Total		68,293.17
Net profit		27,180.87
1921
Sales	$329,726.98
Less returns and allowances	17,136.85
Net sales		$312,590.13
Cost of goods sold
Inventory Jan. 1, 1921	$30,130.30
Purchases	206,581.51
Total merchandise	236,711.81
Inventory Dec. 31, 1921	23,978.05
Cost of sales		$212,733.76
Gross profit on sales		99,856.37
Percentage of gross profit jto sales		31.94
Cash and current acount sales	$266,576.59
Earned profit	31.94	85,159.65
Earned profit 1917 installment contracts, Exhibit A		422.53
Earned profit 1918 installment contracts, Exhibit B		372.41
Earned profit 1919 installment contracts, Exhibit C		795.83
Earned profit 1920 installment contracts, Exhibit D		3,082.52
Collections 1921 installment sales	$5,227.71
Earned profit	31.94	1,669.73
Other operating income		10,901.91
Gross profit earned		102,404.58
Operating expense
Salaries	$12,500.00
Rent	6,000.00
Bank discount	5,704.73
Taxes	1,242.71
Depreciation	1,879.66
Bad accounts	8,326.13
1920 Federal income taxes	8,821.33
Insurance premiums	278.90
Donations	650.00
Other business expenses	28,355.19
1921 expense charged to reserve disallowed by
revenue agent in 1920	3,248.90
Total		$77,007.55
Net income		25,397.03

">*3115 ">*1114 The total installment sales for the years 1917 to 1921 were:

Year	Number of transactions	Amount
1917	23	$20,065.72
1918	11	11,163.78
1919	18	17,338.05
1920	41	70,969.66
1921	42	46,013.54

The percentage of gross profit to sales for the years 1917 to 1919, inclusive, computed in the same manner as the 24.28 per cent and ">*1115 31.94 per cent set out in the above profit and loss statements for 1920 and 1921, respectively, is as follows:

	Per cent
1917	25.502
1918	24.79
1919	23.26

The collections in 1920 and 1921 on sales made during the years 1917 to 1921, inclusive, together with the balance remaining uncollected at the end of 1921, are as follows:

Year in which sale was made	Collected in 1920	Collected in 1921	Uncollected on Dec. 31, 1921
1917	$2,399.92	$1,656.88	$2,520.06
1918	1,979.14	1,502.26	4,728.15
1919	4,328.67	3,421.46	8,259.70
1920	5,912.13	12,695.73	52,361.80
1921	None.	5,227.71	40,785.83

By amended returns filed on May 16, 1923, petitioner attempted to change to the installment basis of reporting income for the years 1917 to 1921, inclusive. Respondent">*3116 refused to accept these returns and to permit the change in reporting income, and has determined the deficiencies here involved by computing income on other than the installment basis.

OPINION.

GREEN: The question here is whether the petitioner is entitled to have its income from installment sales determined on the installment sales basis, and, if so, whether the record is sufficiently complete to enable such a determination to be made. It originally filed its returns on the accrual basis but, as set out in the findings, on May 16, 1923, it filed amended returns on what it believed to be a true and correct installment basis. The respondent rejected the amended returns on the ground that once the petitioner having elected to file on one basis it could not laer elect to file on another basis for the same years. He now contends that the petitioner was not "regularly" engaged in selling personal property on the installment plan as that term is used in section 212(d) of the Revenue Act of 1926 and that at best its deferred payment sales could only be classed as "casual" sales and only those sales could be returned on an installment basis as exceeded $1,000 in amount and in which">*3117 the initial payment did not exceed one-fourth of the purchase price. Section 212(d), supra, provides in part that:

Under regulations prescribed by the Commissioner with the aproval of the Secretary, a person who regularly sells or otherwise disposes of personal property on the installment plan may return as income therefrom in any taxable ">*1116 year that proportion of the installment payments actually received in that year which the total profit realized or to be realized when the payment is completed, bears to the total contract price. In case (1) of a casual sale or other causual disposition of personal property for a price exceeding $1,000, or (2) of a sale or other disposition of real property, if in either case the initial payments do not exceed one-fourth of the purchase price, the income may, under regulations prescribed by the Commissioner with the approval of the Secretary, be returned on the basis and in the manner above prescribed in this subdivision.

The above section was made retroactive by section 1208 of the 1926 act to January 1, 1916.

The fact that the petitioner originally filed its returns on the accrual basis would not deprive it of the right">*3118 to have its income determined on the installment basis, if, in fact, it met the tests provided in section 212(d), supra.We have repeatedly held that for the years subsequent to December 31, 1915, a taxpayer may, even though its books are not kept strictly upon the installment basis, report its income on that basis providing the books contain sufficient information and were so kept that the income could be computed on that basis. ; ; ; and . As a reference to the history of the installment sales method of returning income from the time of its conception in departmental regulations until it finally received legislative sanction by explicit enactment of the Revenue Act of 1926, see , pp. 751-758.

Did the petitioner "regularly" sell lumber and building materials, which are of course "personal property," on the installment plan within the meaning of the term "regularly" ">*3119 as used in section 212(d), supra, or should each sale it made on this plan be classed as "a casual sale" within the meaning of that term as used in the same section? The facts show that 83 such sales were made during the two years here in question. There were some made in every month during the two-year period except February, 1920, and May, 1921. The petitioner's president testified that "for the past eleven or twelve years we have catered to this business (installment plan) as much as our capital would allow us to." Counsel for respondent argues that because the cash sales amounted to five or six times as much as those on the credit or installment basis, it could not be said petitioner was "regularly" selling on the installment plan. We do not believe, however, that the proportion existing between the different classes of sales is controlling. The question is, did the petitioner "regularly" sell on the installment plan basis? The fact that it also sold on the cash basis is only one element to be considered along with other circumstances such as the frequency in which installment sales were made, the number of such sales and the general holding ">*1117 out to the public">*3120 that such arrangements could be made. We think the facts here conclusively show that the petitioner regularly sold personal property on the installment plan and that it should be permitted to report its income on that basis provided the record shows that its books contained sufficient information and were so kept that income could be computed upon that basis.

But when we examine the report referred to in the findings of fact we find that it is deficient in certain elements necessary to a correct computation of income on the installment basis. Reference is made to the items of "Returns and Allowances" of $17,518.40 and $17,136.85, respectively, contained in the profit and loss statements for the years 1920 and 1921. In (page 758 to page 762), we pointed out that the ordinary item of "Returns and Allowances" usually consisted of at least three different situations, each of which should receive different treatment in the determination of the percentage rate of gross profit to be applied against the cash collections. The first situation is where the contract is mutually canceled with both parties being restored to status quo. In that">*3121 situation, we held that in determining the percentage rate of gross profit, the gross sales should first be reduced by the entire amount of such cancellations, and only the amount of the net sales should be used as the divisor with the gross profit realized or to be realized as the dividend. The second situation embraced those cases where sales were made and canceled in the same year but with the purchaser forfeiting the payments already made and the seller repossessing the merchandise usually depreciated somewhat in value by the damage and use while in the hands of the purchaser. The third situation is identical with the second except that the sales canceled consist of those made in a year prior to the current year. In each of the last two situations we held that for the purpose of computing the percentage rate of gross profit the proper procedure was as follows (pages 761-762):

In the case of sales made and canceled in the same year on account of default in payments: Gross sales should be reduced by the total contract price of the canceled sales. All payments made and forfeited by purchasers should be included, in their entirety, in gross income, though not in gross">*3122 or net sales upon which the percentage of gross profit on all other sales of the year will be computed. In order that the petitioner may have advantage of the deduction, in the year of repossession, of the full amount of the loss sustained, if any, through damage and use of merchandise while in the hands of the purchaser, the difference between the value at which such merchandise was included in the opening inventory, or the cost of the merchandise, according to whether it was on hand at the beginning of the year or was purchased during the year, and its value when repossessed, should be deducted from the cost of goods sold and taken as a separate loss deduction from gross income.

In the case of sales canceled, on account of default in payments, in a year subsequent to the year or years in which made: No deduction in the gross sales ">*1118 of the year should be made. All payments made and forfeited by the purchaser, in the year in which the sale is canceled, should be included, in their entirety, in gross income for that year, though not in gross or net sales upon which the percentage of profit on sales for the year will be computed. Payments made in prior years should">*3123 not be taken into account in computing gross income for the year in which the sale was canceled. The repossessed merchandise should be included in purchases at cost, less proper allowance for damage and use, if any, or at cost, less any part thereof previously recovered through payments made bythe purchasers, in prior years, and not returned as income, whichever is lower. The difference, if any, between the cost, less allowance for damage and use, and cost, less any part thereof previously recovered, should be taken as a loss deduction from gross income of the year of repossession.

The cost of repossessed merchandise should be determined by applying to the contract price (selling price to defaulted purchaser) that percentage rate which is complementary to the percentage rate of profit for the year in which the sale was made.

No evidence was offered in the instant case as to what the above items of "Returns and Allowances" consisted. The nearest approach to evidence along this line was the testimony of petitioner's president on redirect examination which was as follows:

Q. Mr. Marshall, will you explain how you handled repossessions in case a purchaser defaulted in the payment? ">*3124 How would you put that on your books?

A. Yes, sir. That is closed under the deed of trust, and the property, where it is necessary for us to repossess it, is purchased by us and the full amount credited in that year, and we carry it then as real estate.

Q. The full amount of what is credited?

A. The full amount of the deferred payment is credited in that particular year that we repossess it.

Q. In the same manner as if it had all been paid in cash? A. Yes; the same as if it had all been paid in cash. Q. Then if you sold that same property a second time -

A. It would then go into our bills receivable, and if sold on the installment plan would be carried over the period of years that it was sold over.

Q. Being a new transaction? A. Yes, sir.

Mr. BENSON. That is all.

The above testimony does not take cognizance of the three different situations discussed in the Blum case, supra, and previously referred to here, which situations must be present in all businesses done on the installment plan. The petitioner's books were not offered in evidence and the accountant who prepared the report referred to in the findings of fact did not testify. ">*3125 With only the accountant's report before us and with no explanation as to what the items of "Returns and Allowances" contained therein represented, we are unable from the record to determine properly the percentage of gross profit to sales for the years 1917 to 1921, inclusive, and since collections on sales made in each of those years were had during the years 1920 and 1921, it follows that we are likewise unable to properly determine the income of this petitioner on the installment basis for the years in question.

">*1119 It should be noted in passing that section 705 of the Revenue Act of 1928, which was made retroactive to "the taxable year 1924 or any prior taxable year" does not apply to the present case for the reason that the provisions of that section are restricted to instances in which an original return was made prior to February 26, 1926, changing the method of reporting net income. In the instant case it was the amended return in which the petitioners sought to make the change.

The respondent in his brief has made several references to certain depositions which had been taken prior to the hearing in these proceedings. Sch depositions, however, were">*3126 not offered in evidence by either party. At the close of the hearing counsel for the petitioner remarked:

Depositions have been taken, but they will not be offered in evidence. That is the petitioner's case. The petitioner rests.

Under such circumstances the depositions are not a part of the record and have not been considered by us in deciding the case.

Reviewed by the Board.

Judgment will be entered for the respondent.

PHILLIPS and ARUNDELL concur in the result.

LANSDON dissents.