Opinion
No. 23 (1974).
Argued September 2, 1975. —
Decided September 30, 1975.
APPEAL from a judgment of the circuit court for Dane county: WILLIAM C. SACHTJEN, Circuit Judge. Modified and, as modified, affirmed.
For the appellants there were briefs by Quarles Brady, attorneys, and Elwin J. Zarwell, John A. Hazelwood and Peter C. Karegeannes of counsel, all of Milwaukee, and oral argument by Mr. Hazelwood.
For the respondent the cause was argued by Allan P. Hubbard, assistant attorney general, with whom on the brief was Robert W. Warren, attorney general.
Facts.
This is an appeal by the taxpayer from a judgment entered after a review under ch. 227, Stats., by the circuit court for Dane county, affirming a Wisconsin tax appeals commission's denial of taxpayer's request for an abatement of an additional assessment of taxes.
The parties have stipulated the relevant facts. The taxpayer, a Wisconsin corporation, reports its income and files its returns on a calendar year base period. The years involved here are 1964 to 1967, inclusive. The taxpayer filed tentative Wisconsin income tax returns and later filed amended or final returns with the department of revenue for each of the years involved. On July 11, 1969, the department issued a notice of assessment of additional Wisconsin income and franchise taxes of $84,971.58. Interest through March 1, 1970, totaled $23,096.96. On August 8, 1969, the taxpayer filed an application for abatement of this additional assessment. This application for abatement was denied on February 3, 1970.
The taxpayer has admitted that approximately $37,000 in taxes and $7,000 in interest are due and owing to the department. The remainder forms the basis of this appeal, i.e., $47,900 of additional taxes and $16,000 in interest, all involving the account maintained by the company for vacation pay adjustments. The Wisconsin tax appeals commission affirmed the action of the commissioner on May 31, 1973. The circuit court affirmed on January 8, 1974.
Union contracts between the taxpayer corporation and the labor unions representing its employees provide that the basic vacation earning period for an employee is to be from April 1st of one year through March 31st of the succeeding year. Such contracts provide that when vacation time is paid, it is calculated proportionately based on the amount of time worked. The only time, the contracts provide, when this is not done is when the employee quits or is discharged for cause prior to April 1st of the succeeding year. In such case, the contracts provide that the employee ". . . shall forfeit any right to vacation pay."
The taxpayer company has been on the accrual basis of accounting since 1945. Since that time the taxpayer has taken vacation pay deductions in its tax returns which reflect the vacation pay accrued during the last nine months of the calendar year involved. It is stipulated that this method of treating vacation pay in computing net income ". . . was in accordance with generally accepted commercial accounting principles." (The department states that it does not consider this stipulated fact to be determinative for tax purposes.) The difference between the amount of vacation pay accrued and the amount actually paid out in the succeeding year was returned to income in the succeeding year. It was established that "Of the $855,314.38 of vacation pay which was accrued on December 31, 1967, and is at issue in this case, $3,645.98 was so returned to taxable income as the result of employees quitting or being discharged prior to April 1, 1968." In the years involved, nearly all of the amount accrued as vacation pay in the previous year was thus paid out in the succeeding year.
Specifically, the department disallowed the following accruals of vacation pay:
". . . 1964: $1,124,575.79; 1965: $1,439,595.92 offset by $1,124,575.79 (the former year's disallowed accrual) netting to $315,020.13; 1966: $1,661,744.99 offset by $1,439,595.92 (the former year's disallowed accrual) netting to $222,149.07; 1967: $855,314.38 offset by $1,661,744.99 (the former year's disallowed accrual) netting to a decrease in taxable income of $806,430.61."
It is the right of the department to make these disallowances that was challenged before the department, before the tax appeals commission, before the circuit court, and before this court.
With the facts stipulated, the issues raised on this appeal are issues of law as to right of the taxpayer to deduct pay accruals for the last nine months of each calendar year.
Time of accrual
. Both parties apparently agree that if the employees' right to vacation pay has vested in such employees at the end of the calendar year, then the amount of money in the employer's vacation pay account is properly deductible. Read together, the statute governing corporate deductions and the statute defining the terms, "paid" or "actually paid," do compel the conclusion that payments to employees "accrued" during the taxable year are deductible in the tax return for the year in which they "accrued."If the right to vacation pay is held to be "contingent," under the statute, it would be a nondeductible reserve "for contingent losses or liabilities." Generally speaking, liability does not "accrue" as long as the liability remains contingent with the fact of contingency resting for tax purposes not on certainty of payment, but on the certainty of the obligation arising. So, as to time of accrual, the question of whether the employer can deduct as "accrued" the money in the vacation pay account at the end of the taxable year depends upon whether or not the employees' right to such vacation pay has vested, or whether it is then "contingent" upon such employees not quitting or being discharged for cause before March 31st of the next taxable year.
Sec. 71.04(7), Stats., providing in material part: ". . . Reserves for contingent losses or liabilities shall not be deducted."
Levin v. Commissioner of Internal Revenue (3d Cir. 1955), 219 F.2d 588, 589, the court there holding: "It is well settled and taxpayers seem to agree that a liability does not accrue so long as it remains contingent."
Tennessee Consolidated Coal Co. (1950), 15 T.C. 424, 431, the tax court there holding: "`The accruability test of a debt is not certainty of payment, but rather certainty of its liability . . . .' Trans-California Oil Co., Ltd., 37 B.T.A. 119, 127."
In support of its right to deduct as "accrued" during the taxable year the moneys in the vacation pay account the employer corporation relies heavily upon the wording of the contracts between the corporation and unions representing its employees. These contracts, it is submitted, establish the intent of the parties and intent of the parties should control. Such contracts provide that the basic vacation earning period for an employee is from April 1st of one year through March 31st of the succeeding year, with paid vacation time calculated proportionately according to the amount of time worked. When an employee quits or is discharged for cause prior to April 1st of the succeeding year, the employee ". . . shall forfeit any right to vacation pay." While the question is close, we do not see these contract provisions as determining whether for tax purposes the employer's liability on January 1st, not March 31st, was vested or remained contingent upon the employees not quitting or being discharged for cause.
See: W.S. Badcock Corp. v. Commissioner of Internal Revenue (5th Cir. 1974), 491 F.2d 1226, holding that where both parties considered unpaid commissions for the sale of household furnishings to be vested, including the use of them as collateral for loans, what the parties intended and how they treated such unpaid commissions should be controlling.
Additionally, in support of its right to deduct the vacation pay account on January 1st, the employer relies upon the stipulation that the taxpayer's "accrual" of the vacation pay is in accordance with the generally accepted methods of accounting. This is relevant, but not controlling. Normally, this fact does not foreclose or determine the issue of whether it is proper for tax purposes to make a particular deduction. The question, under our statutes, is whether the computation under the method of accounting does or does not "clearly reflect the income." Income taxes "accrue" as the events giving rise to them occur (as income is earned), and it follows that ". . . a deduction `accrues' when those factors giving rise to it occur."
See: State ex rel. Crucible Steel Casting Co. v. Wisconsin Tax Comm. (1925), 185 Wis. 525, 531, 532, 201 N.W. 764, holding that "income" for the purpose of taxation is not necessarily identical with "income" for other purposes. See also: American Automobile Asso. v. United States (1961), 367 U.S. 687, 692, 693, 81 Sup. Ct. 1727, 6 L.Ed.2d 1109.
Sec. 71.11(8)(a), Stats., providing in material part: "The income and profits of corporations for the income year shall be computed in accordance with the method of accounting regularly employed in keeping the books of the taxpayer, but if . . . the method employed does not clearly reflect the income, the computation shall be made upon such basis and in such manner as in the opinion of the department of revenue does clearly reflect the income."
Trepte v. Department of Revenue (1972), 56 Wis.2d 81, 91, 201 N.W.2d 567.
What then is the legal test as to whether, for tax purposes, the vacation pay rights had become vested on January 1st, or remained contingent until March 31st? That test, as we see it, is the "all-events" test requiring that the events which fix the amount of the taxpayer's liability must have come about or occurred before the end of the tax year in which the deduction is made. This test requires that for an expense to be deductible in taxable year, the events must have occurred which determine the fact of liability. It follows that only when an obligation to pay an amount becomes fixed that a deduction of such amount from gross income is allowable to an accrual basis taxpayer for Wisconsin income tax purposes. Under the facts of the instant case, the employer's liability for vacation pay credits on March 31st is contingent upon the individual employee's not quitting or being discharged for cause before March 31st. The event which must occur to ascertain and determine liability for tax purposes is the continued employment of such employee through March 31st, such employment uninterrupted by the employee's quitting or being discharged for cause. Under such test and on these facts, we hold that the employer's liability for payments for vacation pay had not "accrued" on January 1st of the years involved. Statute of limitations
See: United States v. Anderson (1926), 269 U.S. 422, 441, 46 Sup. Ct. 131, 70 L.Ed. 347. (Cited and followed in Trepte v. Department of Revenue, supra, footnote 9, at page 91.)
Aunt Nellie's Foods, Inc. v. Department of Revenue (1971), 8 W.T.A.C. 264, 267 (affirmed by Dane County Circuit Court, August 19, 1971), the tax appeals commission there stating: "Stated shortly, `accrual' requires that at the closing date of an income year, income should include existing rights to receive and deductions should include existing obligations to pay." See also: Belle City Malleable Iron Co. v. Department of Taxation (1947), 3 W.B.T.A. 236, 251, 252, the board of tax appeals holding: "In general, expenses are `accrued' when they are incurred." (Citing H. Liebes Co. v. Commissioner of Internal Revenue (9th Cir. 1937), 90 F.2d 932, 933.)
See: World Airways, Inc. v. Commissioner of Internal Revenue (1974), 62 T.C. 786, 803, appeal pending, the tax court there disallowing the deduction of future overhaul expenses per flight hour in advance of their actually being paid, holding: "Thus in the taxable years for which the accrued expenses were deducted, the operative facts had not occurred and petitioner's liability for the overhaul costs had not become fixed."
"Synopsis of bill
"This bill is based on Section 481(a) of the Internal Revenue Code of 1954 and provides uniformity of treatment for taxpayers changing from the cash to accrual basis of accounting, or vice versa, regardless of whether the change is made voluntarily by the taxpayer or on order of the tax authorities. Uniformity between state and federal tax laws on this point is also achieved by this bill."
While we do not have before us a change from cash to accrual basis of accounting, the reference to intending "uniformity" between state and federal law and the patterning of the language of the state statute after sec. 481(a) of the federal internal revenue code, leads us to accept and adopt the federal court interpretation of the federal code on the issue raised. If there is ambiguity in the Wisconsin statute, as well there may be, we resolve it in favor of "uniformity" of interpretation with the federal statute on which it is based and patterned.
The federal interpretation of the issue present, applying to the almost identical language of sec. 481(a) of the federal internal revenue code, is contained in Treas. Reg. Sec. 1.481-1(a)(1), providing: "A change in method of accounting to which section 481 applies includes a change in the over-all method of accounting for gross income or deductions, or a change in the treatment of a material item." Under this federal interpretation of the federal code provision, which we adopt and apply here, all that the taxpayer must establish is that there has been a change in the treatment of a "material item." In the case before us we see no room for arguing that the item of deduction for vacation pay accrual was not such a material item, and we hold that the treatment of such material item by the state department of revenue was changed. So we conclude that the taxpayer here is not barred from seeking or securing an offset on its tax return for 1964 for the accrual of 1953 vacation pay. While it can be claimed that this constitutes a second deduction for this same item, and we have held that, absent legislative authorization, a double credit for a single exemption cannot be claimed, we hold here, applying the federal construction, that the legislature has authorized such an offset in the 1964 tax return for vacation pay accrued in 1953 because "a change in the treatment of a material item" in the method of accounting occurred by reason of the action of the state revenue department. So holding, we modify the judgment of the circuit court to grant an allowance of the deduction for vacation pay accrued in 1953 in the amount stipulated by the parties on the 1964 tax return of the defendant corporation.
Commissioner of Internal Revenue v. O. Liquidating Corp. (3d Cir. 1961), 292 F.2d 225, 230, certiorari denied (1961), 368 U.S. 898, 82 Sup. Ct. 177, 7 L.Ed.2d 94, the federal appeals court there holding: "On review of the record we agree with the Commissioner's contention that while taxpayer did not change its overall method of accounting it did change its treatment of a significant item — the insurance dividends which amounted to $114,000 — and that its action constituted a change in the method of accounting within the meaning of the Treasury Regulations." See also: Dorr-Oliver, Inc. v. Commissioner of internal Revenue (1963), 40 T.C. 50, holding vacation pay to be a "material item."
The state revenue department does not dispute that if there has been a change in the method of accounting, the taxpayer corporation is entitled to an offset to the disallowed 1964 deduction equal to the amount of the 1953 accrual. (The department sees the change as involving time of accrual, not method of accounting.) The basis for such deduction would derive from the interpretation of sec. 481 of the federal internal revenue code, on which sec. 71.11(8)(b) of our statutes is patterned. The federal treasury regulation, sec. 1.481-3, provides: "If the adjustments required by section 481(a) and sec. 1.481-1 are attributable to a change in method of accounting which was not initiated by the taxpayer, no portion of any adjustments which is attributable to pre-1954 Code years shall be taken into account in computing taxable income. For example, if the total adjustments in the case of a change in method of accounting which is not initiated by the taxpayer amount to $10,000, of which $4,000 is attributable to pre-1954 Code years, only $6,000 of the $10,000 total adjustments is required to be taken into account under section 481 in computing taxable income. The portion of the adjustments which is attributable to pre-1954 Code years is the net amount of the adjustments which would have been required if the taxpayer had changed his method of accounting in his first taxable year which began after December 31, 1953, and ended after August 16, 1954. See section 481(b)(4)(A)."
See: Oberman Mfg. Co. v. Commissioner of Internal Revenue (1967), 47 T.C. 471, 481, stating of a change in the treatment of a marital item in the method of accounting and a consequent tax deduction allowed: "Indeed as a result of the change in method initiated by the respondent, the petitioner will have the benefit of a duplication of deductions on account of vacation pay to the extent of $18,551.85."
By the Court. — Judgment modified and, as modified, affirmed.