Opinion
No. H-308.
April 7, 1930.
Suit by the John M. Brant Company against the United States.
Judgment for defendant.
In this suit plaintiff asked judgment for income and profits tax alleged to have been erroneously and illegally collected in the amount of $34,201.97 for 1918 and of $10,473.66 for 1919, with interest, as provided by law.
Prior to 1918, plaintiff employed the accrual method of accounting in keeping its books and making its tax returns. In 1918 it changed its method and thereafter employed the installment sales method of accounting and in making its tax returns.
The questions are (1) whether there should be included in income for 1918 and 1919 a proper proportion of the installment payments received in those years on account of sales made in 1917 and prior years, notwithstanding the total profits from such sales were returned and taxed under the accrual method of accounting employed for such prior years; and (2) should unrealized profits at January 1 of a given year on installment sales made prior thereto be excluded from the computation of invested capital for such year?
The facts were stipulated.
Special findings of fact:
1. The plaintiff, an Illinois corporation, was organized in 1903. During the years here in question it was engaged in the sale of power machinery; about one third of its business being the sale of repair parts and the balance equally divided between cash and installment sales of power machinery. Its subsidiary records show specific costs and sales and specific collections. From these records the installment sales were allocated to the respective years in which they were made and the gross profits thereon determined.
2. April 30, 1919, plaintiff prepared and filed its corporation income and profits tax return for the calendar year 1918 on the accrual basis showing a total tax of $56,307.72, which was duly assessed and paid. The Commissioner on his 1923 list assessed an additional tax for 1918 of $1,508.16, which was paid in due course. In September, 1928, the Commissioner determined an overassessment of $1,372.88 for 1918, which was refunded. The net tax assessed and paid for 1918 was $56,443.
3. March 13, 1920, plaintiff filed its income and profits tax return for the calendar year 1919 showing a total tax of $43,646.75, which was duly assessed and paid. The accrual method of accounting was employed in making this return. November 13, 1924, the Commissioner determined an overpayment of $174.40 for 1919, and in September, 1928, he determined a further overpayment of $12,130.23, which amounts were duly refunded. The net tax assessed against and collected from plaintiff for 1919 was $31,342.12.
4. March 13, 1924, plaintiff filed a claim for refund of the tax paid for the years 1918 and 1919 and based its claim upon the ground that its income for these years should be determined on the installment sales basis of accounting. By letters of November 13, 1924, October 16, 1926, and August 8, 1927, the Commissioner of Internal Revenue denied plaintiff's application for a computation of its income for 1918 and 1919 on an installment sales basis. April 18, 1928, the Commissioner sent a representative to the plaintiff's place of business to make an examination of its books and records for the purpose of determining whether its income for the years 1918 and 1919 might be accurately computed upon the installment sales basis, and if so, what such income and the resulting tax would be for each year. The commissioner found from this investigation that the income for the years mentioned could be accurately determined upon the installment sales basis, and, as a result, he determined overassessments of $1,372.88 for 1918 and $12,130.23 for 1919, as set forth above. These overassessments were allowed by the Commissioner in schedules of overassessments signed September 17, 1928.
5. A computation of plaintiff's tax liability for 1918 and 1919, computed under section 1208 of the Revenue Act of 1926 (26 USCA § 953a) as interpreted by Treasury Decision 3921, is as follows:
1918
Net Income
Net income as corrected (revenue agent's report 5/15/28) ............................. $103,347 06 Invested Capital Invested capital as adjusted ................... 244,777 04 Excess profits tax credit ...................... 22,582 16 War profits credit ............................. 40,447 41 Total excess and war profits tax ............... 50,319 72
Income Tax
Net income taxable year ........... $103,347 06 Less: Profits Tax .................. 50,319 72 Exemption .................... 2,000 00 Balance taxable at 2% ............. 51,027 34 Income tax ..................................... $ 6,123 28 Total tax assessable ........................... 56,443 00 Previously assessed, original and additional ... 57,815 88 __________ Overassessment (allowed by Commissioner; see finding 2) ................................ $ 1,372 88
1919
Net income as corrected ........................ $101,531 60 Invested capital as adjusted ................... 290,127 41 Excess profits tax credit ...................... 26,210 19
Computation of Tax
Excess profits taxes ........................... $ 23,765 51
Income Tax
Net income taxable year ............ $101,531 60 Less: Excess profits tax ............ 23,765 51 Exemption ..................... 2,000 00 Balance taxable at 10% ............. 75,766 09 Income tax ..................................... 7,576 61 Total tax assessable ........................... 31,342 12 Previously assessed ............................ 43,472 35 _________ Overassessment (allowed by Commissioner; see finding 3) ................................ $ 12,130 23
6. In making the foregoing computation on the installment sales basis under sections 212(d) and 1208 of the Revenue Act of 1926 ( 26 USCA §§ 953(d), 953a), the defendant included in taxable net income for each of the years 1918 and 1919 the following amounts, although such amounts had previously been included by the defendant in taxable net income for the calendar year 1917 and prior taxable years under the accrual method of accounting then employed:
1918
Realized profits on prior years' sales .... $33,302 49 Realization of prior years' interest ...... 2,015 93 Realization of accrued interest ........... 44 80 __________ Total ................................. $35,363 22 ==========
1919
Realized profits on sales prior to 1918 ... $12,117 90 Realization of prior years' interest ...... 335 26 __________ Total .................................. $12,453 16
7. In the computation of tax liability for the calendar year 1917 and prior taxable years, the defendant included in taxable net income for such years the total profit on all sales made prior to and including December 31, 1917, regardless of whether or not payment in full had been received prior to December 31, 1917, and also included in income the aggregate amount of all interest accruing prior to and including December 31, 1917. Plaintiff agreed to this computation, and the tax resulting therefrom for the respective years was duly assessed by the defendant and paid by plaintiff. No change in the tax liability so computed for the calendar year 1917 and prior taxable years has been made by the defendant or is in contemplation.
8. In the computation of tax liability for 1918 and 1919 in accordance with T.D. 3921, interpreting section 1208 of the Revenue Act of 1926, which computation is set forth in finding 5, the defendant excluded from earned surplus in the computation of invested capital for the respective years the following amounts, although such amounts had previously been included in taxable net income for the calendar year 1917 and prior years when the accrual method of accounting was employed, and despite the fact that such amounts were included in earned surplus by the plaintiff on its books at December 31, 1917:
1918
Notes receivable interest adjustment ....... $4,338 16 Unrealized profit at 12/31/17 .............. 54,679 74 Accrued interest ........................... 12,903 32 __________ Total .................................. $71,921 22 ==========
1919
Notes receivable interest adjustment ...... $ 2,322 23 Unrealized profit at 12/31/18 ............. 64,038 57 Accrued interest 12/31/18 ................. 12,858 52 Huntley note adjustment ................... 520 02 __________ Total .................................. $79,729 34 Unrealized profits for 1918 ............... 44,002 85 __________ Net unrealized prior year income .......... $35,726 49
The plaintiff's books were kept and maintained on the accrual basis for the calendar year 1917 and prior years. The earned surplus shown by plaintiffs books at December 31, 1917, included the total amount of all sales made prior to and including that date, and also the aggregate amount of all interest and income accruing prior to and including December 31, 1917, regardless of whether or not payment in full had been received prior to December 31, 1917.
9. A computation of plaintiff's tax liability for the years 1918 and 1919, which adds to invested capital, as determined by the Commissioner, and set forth in finding 5, the amount of all unrealized gross profits at the beginning of each year, would result in an overassessment of $5,062.67 for 1918 and of $4,124.88 for 1919.
10. A computation of plaintiff's tax liability for the years 1918 and 1919 excluding from taxable income determined by the Commissioner, and set forth in finding 5, the profits realized on sales made in years prior to 1918, and from invested capital, as determined by the Commissioner and set forth in finding 5, all unrealized gross profits after January 1, 1918, would result in an overassessment of $34,201.97 for 1918 and of $8,256.39 for 1919.
11. A computation of plaintiffs tax liability for the years 1918 and 1919, which excludes from taxable income determined by the Commissioner, and set forth in finding 5, profits realized on sales made in years prior to 1918, and includes in invested capital, as determined by the Commissioner and set forth in finding 5, all unrealized gross profits at the beginning of each year, would result in an overassessment of $34,201.97 for 1918 and of $10,473.66 for 1919. This computation is the one for which the plaintiff contends.
Ben Jenkins, of Washington, D.C. (Earle W. Wallick and David J. Shorb, both of Washington, D.C., on the brief), for plaintiff.
George H. Foster, of Washington, D.C., and Herman J. Galloway, Asst. Atty. Gen. (Ottamar Hamele, of Washington, D.C., on the brief), for the United States.
Before BOOTH, Chief Justice, and WILLIAMS, GREEN, GRAHAM, and LITTLETON, Judges.
Plaintiff contends that by section 212(d) of the Revenue Act of 1926, 26 USCA § 953(d), Congress did not intend that payments received in years subsequent to a change from the accrual method of accounting to the installment sales method of accounting should be included in taxable net income under the installment sales basis of determining net income; that section 1208 of the Revenue Act of 1926, 26 USCA § 953a, was without significance except to make section 212(d) retroactive in its application, and whether Congress authorized the inclusion in taxable net income, on the installment sales basis for 1918 and 1919 profits realized from installment sales in 1917 and prior years, depends entirely upon the provisions of section 212(d).
We think it is clear from a consideration of these two sections and the legislative history of the Revenue Act of 1926, that the statute expressly requires the inclusion in taxable net income in the years in which the installment sales method of accounting is employed of amounts received in those years from installment sales made in prior years, notwithstanding the profits upon such sales were reported as income by the taxpayer in such prior years in which it employed the straight accrual method of accounting. Blum's, Inc., 7 B.T.A. 737, and Mayer Co., 9 B.T.A. 815.
It is further contended that, if the statute requires the inclusion in income of payments received in years subsequent to the change to the installment sales method of accounting, it imposes a direct tax upon capital without apportionment among the several states in proportion to their population in violation of section 9, art. 1, of the Constitution. There is no merit in this contention. The amounts taxed represent profits on installment sales effected in years prior to 1918, and the tax therefore is necessarily one upon income and not upon capital. Such amounts do not lose their character as income merely because, under a new method of accounting which the taxpayer elected to adopt, it is required to treat them as income in a year other than the one in which they were originally reported under its method of accounting. Profits earned subsequent to the Sixteenth Amendment to the Constitution do not become capital of a nature such as may not be subjected to income tax, although such imposition may result in taxation of such income a second time. The amounts which the defendant included in plaintiff's taxable income for the years involved constituted income under the Sixteenth Amendment, and, such being the case, it is within the power of Congress to prescribe the time, the manner, and the method of accounting for such income for tax purposes. No attempt is made by the statute to define new objects of income. It simply provides that those taxpayers who choose to report their income in accordance with its provisions must report the income as it is reduced to possession in cash, notwithstanding the fact that some part of it had previously been returned and taxed under the accrual method of accounting employed in earlier years, and it is no defense to say that double taxation results. Tennessee v. Whitworth, 117 U.S. 129, 137, 6 S. Ct. 645, 29 L. Ed. 830; Hellmich v. Hellman, 276 U.S. 233, 48 S. Ct. 244, 72 L. Ed. 544, 56 A.L.R. 379.
Plaintiff contended in argument that the total tax exacted by the defendant in the taxable years was in excess of the profit from such sales, and asserted that, to the extent of such excess, it was a tax upon capital. There are no facts to support this contention, and counsel finally admitted that, in this case, this did not occur. We need not, therefore, consider whether in any case of a change from the accrual to the installment sales method of accounting a tax in excess of the profit upon the sale might be exacted.
On the second question, we are of opinion that unrealized profits on installment sales made in 1917 and prior years should be excluded from the computation of invested capital for 1918 and 1919. This question was considered by the United States Board of Tax Appeals in Blum's, Inc., supra, wherein it was said:
"The Commissioner eliminated from invested capital of 1918, 1919, and 1920, the profits included in the outstanding 1917 installment accounts receivable, at the beginning of each of those years, as unrealized and not properly includable in earned surplus. The petitioner opposes this action of the Commissioner on the ground that the entire profits on installment sales of 1917 were returned and taxed as income of that year. We think that the action of the Commissioner * * * is correct. For the years in question, the installment sales method has been used in computing income. By the use of that method all of the profits actually reduced to possession in those years, are to be returned as income of those years. The fact that some of these profits have been returned in prior years is to be ignored, and they are, for the purposes of the tax, to be treated as a part of the earnings of the years in which they are reduced to possession. Obviously, the petitioner may not include in invested capital of any taxable year, as earned surplus, the earnings of that year and subsequent years."
This is in accordance with the practice of the Department in its computation of invested capital when the installment sales method of accounting is employed. In S.M. 632, of November 23, 1918, it was held that the unrealized profit contained in installments unpaid at the beginning of the taxable year must be excluded from surplus and undivided profits in computing invested capital for excess-profits tax purposes.
For similar reasons we are of opinion that unrealized profits on installments sales made in 1918 should be excluded from the computation of invested capital for 1919. J.B. Bradford Piano Co., 15 B.T.A. 1045. In this case the Board of Tax Appeals said:
"The petitioner, however, has chosen to take advantage of the postponement of the payment of income taxes until the installment payments upon its sales have been actually collected. It thus procures the advantage of postponing taxes until cash collections have been made and, having secured such advantages, it should not complain if the accounting system results in some counter disadvantages. * * *
"In Blum's, Inc., * * * the Board has established the rule that unrealized and untaxed gains represented by accounts receivable may not be included in surplus by a taxpayer reporting on the installment sales basis. A like course of reasoning brings us to the conclusion that adjustments of surplus for invested capital purposes may be properly made in accordance with the accounting methods made necessary by the taxpayer reporting upon an installment sales basis. * * *"
Plaintiff is not entitled to recover. The petition must therefore be dismissed, and it is so ordered.