Automobile Club of New York, Inc. v. Commissioner

32 T.C. 906, 1959 U.S. Tax Ct. LEXIS 125

• Court: United States Tax Court
• Decided: July 20, 1959
• Docket: Docket No. 61999
• Status: Published

Opinions

OPINION.

Kaum, Judge:

The parties have filed a stipulation of facts which is hereby adopted as our findings. Petitioner, a New York corporation having its principal office in New York City, filed its income and excess profits tax returns here involved with the then collector of internal revenue for the third district of New York. It was incorporated on April 26, 1934, under the Membership Corporation Law of the State of New York; it functions as an “automobile club” which provides emergency road service, travel assistance, personal accident policies, bail bonds, and other similar and related services to its members. For purposes of this litigation, it is conceded that petitioner is not a tax-exempt organization and is subject to tax in the same manner as any other corporation carrying on or engaged in business for profit.

Petitioner maintains its boobs and records on a calendar year basis and has from its inception employed “the accrual method” in beeping its corporate accounts. In 1943, the first year petitioner was required to file a corporation income tax return, and for the years 1944 and 1945, petitioner reported receipts from membership dues as gross income in the year of receipt. However, petitioner subsequently filed amended 1944 and 1945 returns in which it deferred a ratable portion of its receipts from membership dues in accordance with the method of bookkeeping employed in keeping its corporate accounts; returns for 1946 through 1950 reported income according to the same method.

Membership dues constituted the primary source of petitioner’s annual revenues, as indicated below:

Year Membership dues Initiation fees Miscellaneous receipts

1944. $383,700 ¹ $3,705.01

1945. 680,595 7,725.89

1946. 1,477,560 $24,175 24,175.00

1947. 1,996,965 231,875 154,002.10

1948. 2,687,490 289,985 134,594.32

1949. 3,171,270 254,975 182,653.95

1950. 3,761,745 279,880 226,371.11

The column headed “Miscellaneous receipts” represents receipts from the operation of a driving school, proceeds of the sale of maps and publications, travel bureau commissions, and other items.

A person otherwise qualified for membership became a member upon payment of an initiation fee and annual dues of $15; payment might be made on any day of the calendar year. For years subsequent to the first year of membership, annual dues became payable on the last day of the month corresponding to the month in which the member was originally admitted to membership. Initiation fees were reported in full by petitioner as gross income in the year of receipt. Annual dues, on the other hand, were not immediately recorded as receipts of income on petitioner’s books, nor were they reported in full as gross income in the year of receipt. Petitioner instead credited each month’s receipts to a reserve account; during the first month of membership and each of the following 11 months, one-twelfth of the reserve was taken into income. The effect of this accounting was to spread the receipts of any given month ratably over the ensuing 12-month period. Consequently, at the end of each calendar year, the reserve account contained substantial funds which petitioner had received during the year but had not yet credited to income; such funds remained to be taken into income ratably over that part of the 12-month period falling in the next calendar year. The amounts of annual receipts thus deferred are shown by the following table:

Year Dues received Dues reported as income Dues deferred and not reported as income

1944. $383,700 ¹ $351,570.60 ¹ $32,129.40

1945. 680,595 ¹ 479,572.74 ¹201,022.26

1946. 1,477,560 1,005,813.12 471,746.88

1947. 1,996,965 1,722,312.49 274,652.51

1948. 2,687,490 2,348,615.00 338,875.00

1949. 3,171,270 2,911,775.00 259,495.00

1950. 3,761,745 3,464,268.75 297,476.25

* Per amended return.

The annual increase in receipts from membership dues was attributable to the steady increase in petitioner’s membership from 25,580 in 1944 to 250,783 in 1950.

All receipts of membership dues were deposited in petitioner’s bank account, unsegregated from its general funds, and were available and used without restriction for general corporate purposes. Petitioner’s bylaws provided that if a member resigned (or canceled his contract with petitioner), he forfeited all rights in petitioner’s property and assets and was not entitled to a refund of any portion of his advance payments. In the event of liquidation, dissolution, or other discontinuance of petitioner’s business, any surplus remaining after payment of debts and liabilities would be distributed to charities selected by petitioner’s board of directors, and not to petitioner’s members.

Petitioner incurred certain expenses in rendering services to its members. The table below reveals the annual amounts of such expenses and the purposes for which they were incurred:

Year Emergency road service Travel department Personal accident policies and bail bonds

1944. $83,389.23 $33, 566.28 $26,925.34

1945. 161,606.74 55,837.29 46,021.09

1946. 313,325.12 172,794.66 99,364.50

1947. 546,507.37 332,389.16 134,793.40

1948. 899, 512.91 395,756.60 181,864.72

1949. 860,895.87 454,834.62 214,887.43

1950. 1,185,644.63 521,188.21 254,553.93

Petitioner could not estimate in advance the amount of monthly or annual expenses that would be incurred in rendering services to its members since such expenses were dependent upon the membership’s demands and requirements. For example, the largest component of expenses incurred for “Emergency road service” was for “towing.” Pursuant to separate contracts between petitioner and various automobile service stations, the stations agreed to tow a member’s automobile from the point of disablement to the station’s place of business or any other station on the way to the contracting station’s place of business; petitioner agreed to pay for such emergency towing service (and other incidental mechanical service) at a flat rate per call, either $1.50, $2, or $2.50, depending on the terms of the particular contract. No limit was imposed on the number of calls a member could make. In addition, petitioner’s board of directors reserved the discretion to grant monthly and/or quarterly bonuses to contracting stations which rendered satisfactory service to petitioner’s members during the particular month or quarter. The cost of providing travel assistance likewise depended on the demands of the membership. The average annual cost per member of providing emergency road service and travel assistance varied between a low of $4.57 in 1944 and a high of $7.23 in 1948; the variation in the average monthly cost per member for the same services in any given year ranged from 24 per cent to 100 per cent. The range per year of such average monthly costs per member, with their corresponding percentage variations, are as follows:

Range per year Percentage variation per year Year

$0.49-0.67 37 1946.

.64- . 67 24 1947..

. 60-1.00 100 1948..

.47- .65 38 1949..

. 50- . 75 50 1950..

In addition to the above services, petitioner made a purchase discount plan available to its members. Pursuant to contracts, petitioner sold “savings plan coupons” to service stations and automobile accessory stores at face value (100 cents in coupons for $1); the contracting stations and stores then distributed the coupons to petitioner’s members in an amount equal to 10 per cent of each member’s purchases. Members could then redeem their coupons either by applying them to the payment of annual dues or having them refunded in cash by petitioner; the coupons did not have a time limit for redemption. In most years, petitioner’s receipts from the sale of coupons exceeded the amounts paid out in redemptions, as follows:

Year Sales Redemptions Sales in excess of redemptions Redemptions in excess of sales

Nov. to Dec. 1935.. $1,775.00 $20.27 $1,754.73

1936. 18,267.26 6,701.31 11,565.95

1937. 38,844.67 22,924.48 15,920.19

1938. 54,850.81 44,016.79 10,834.02

1939. 80,703.73 57.310.12 23,393.61

1940. 108,910.23 87,960.01 20,950.22

1941. 121, 593.47 94,369.15 27,224.32

1942. 43,242.21 126,302.60 $83,060.39

1943. 4,406.06 13.444.13 9,038.07

1944. 2,738.13 4,428.67 1,690.54

1946. 6,985.76 3,224.95 3,760.81

1946. 97,099.32 26,499.88 70,599.44

1947. 296,738.08 145,087.71 151,650.37

1948. 644,449.50 315,405.78 229,043.72

1949. 963,967.79 654,159.75 309,808.04

1960. 1,193,546.72 1,007,450.48 186,096.24

Coupons offered for redemption by service stations and accessory stores (as opposed to those redeemed by petitioner’s members) were redeemed only upon cancellation of the savings plan contracts between petitioner and the redeeming stations or stores. The amounts of such redemptions never exceeded between $200 and $300 in any given year.

No amounts received from the sale of coupons during the taxable years in question were reported by petitioner as income, nor were any redemptions taken as deductions. Instead petitioner credited all sales proceeds, and debited all redemptions, to a reserve account. The credit balance in the reserve account increased as follows during the taxable years in question:

Year Credit balance

1944_ $67,864.04

1945_ 61, 614.85

1946_ 182,214.29

1947_ 283,864.66

1948_ $512,908.38

1949_ 782,716.42

1950_ 968,812.66

The “Credit balance” shown on the exhibit submitted jointly by the parties has been increased, as agreed to by them, by $40,000 for the years 1944 through 1948 to reflect a debit to the reserve for coupon redemption in 1942, which entry was reversed in 1949.

All receipts from the sale of coupons were deposited in petitioner’s general bank account, unsegregated from its general funds, and were available and used without restriction for general corporate purposes. Those redemptions paid in cash were likewise paid from petitioner’s general and unsegregated funds.

Petitioner, at all times, maintained sufficient cash and liquid securities to redeem all outstanding coupons; but such assets were not segregated from general corporate assets not restricted to any particular use.

1. Deferral of membership dues. — This Court has consistently held that the Commissioner has authority to require that prepaid income be reported no later than the year in which it is received, provided such income is subject to unrestricted use by the taxpayer. This rule applies to taxpayers on an accrual basis as well as to those on the cash basis; it applies even though the income may in a sense be regarded as “earned” in a year subsequent to the year of receipt, and even though some systems of accounting in the business world may recognize deferral in such circumstances. E. B. Elliott Co., 45 B.T.A. 82; South Dade Farms, Inc. v. Commissioner, 138 F. 2d 818 (C.A. 5), affirming a Memorandum Opinion of this Court; Clay Sewer Pipe Association, Inc., 1 T.C. 529, affirmed 139 F. 2d 130 (C.A. 3); South Tacoma Motor Co., 3 T.C. 411; Your Health Club, Inc., 4 T.C. 385; National Airlines, Inc., 9 T.C. 159; Capital Warehouse Co., 9 T.C. 966, affirmed 171 F. 2d 395 (C.A. 8); Krim-Ko Corporation, 16 T.C. 31, 38-40; Curtis R. Andrews, 23 T.C. 1026; Advertisers Exchange, Inc., 25 T.C. 1086, affirmed per curiam 240 F. 2d 958 (C.A. 2); Automobile Club of Michigan, 20 T.C. 1033, affirmed 230 F. 2d 585 (C.A. 6), affirmed 353 U.S. 180; Bressner Radio, Inc., 28 T.C. 378, on appeal (C.A. 2); New Capital Hotel, Inc., 28 T.C. 706, affirmed per curiam 261 F. 2d 437 (C.A. 6). Our decision in Beacon Publishing Co., 21 T.C. 610, was reversed in 218 F. 2d 697 (C.A. 10), but we have previously noted our agreement with the dissenting opinion in that case. Curtis R. Andrews, supra at 1033. Cf. Schuessler v. Commissioner, 230 F. 2d 722 (C.A. 5), reversing 24 T.C. 247. Moreover, the uncertain basis upon which the decisions of the Courts of Appeals in the Beacon and Schuessler cases rest is underscored by the statement of the Supreme Court in Automobile Club v. Commissioner, 353 U.S. 180, 189 fn. 20, to the effect that, “We express no opinion upon the correctness of the decisions in Beacon or Schuessler.”

We are not persuaded that the case at bar warrants modification of the established rule which has been followed in a long line of cases. There is no serious question here that the amounts in controversy are taxable as income. The only issue is when. Ordinarily, under the cash system, items of income are taxable when received and deductions are allowable when payment is made. On an accrual basis of accounting, items of income and deduction may “accrue” even prior to actual receipt or payment; income is treated as received when the right thereto becomes fixed and deductions are allowable when the liability in respect thereof is unqualifiedly determined. As a practical matter, the income tax laws must operate on an annual basis, and there is no assurance under either an accrual or cash basis of accounting that there will be complete correlation between items of income and deductions pertinent thereto in any given taxable year or that income will always be taxed in the year “earned.” As the foregoing cases strikingly demonstrate, income may be taxed in one year, although the events to which it may pertain may occur in a subsequent year. The question simply is: When was the income received under the cash system, or when did it accrue under an accrual system (i.e., when did the taxpayer acquire the unqualified right thereto) ? Thus, in National Airlines, 9 T.C. 159, the taxpayer was required to report as income receipts from ticket sales regardless of whether the transportation represented by the tickets had been furnished by the end of the year, and notwithstanding the direction of the Civil Aeronautics Board to defer receipts from tickets where transportation had not yet been furnished. The other cases cited above have reached the same general conclusion in a wide variety of factual situations.

Under accrual accounting, a taxpayer may be required to accrue an item prior to actual receipt if the right thereto has become unquali-fiedly established. But where there is actual receipt and the funds are at the unrestricted disposal of ithe taxpayer, as is the case here, all the events have already occurred that call for accrual. It has not been the practice in tax accounting to enter upon a further inquiry as to whether the income has been “earned” in order .to defer the reporting of such income to a later year. The practical difficulties in embarking upon such inquiry and the burden of making the necessary allocations of the amounts of income which, though realized in the taxable year, would have to be charged in part to the taxable year and in part to other years, make clear why no such system has ever been part of the general scheme of our tax laws. To be sure, there may be special situations, such as those involving bond premiums, where specific regulations have permitted “amortization” of the premiums over the life of the bonds. But even in those exceptional situations, it has been recognized that the premium income is realised in the year the bonds are issued. Cf. Old Colony R. Co. v. Commissioner, 284 U.S. 552. There are no such special regulations or exceptional statutory provisions ² applicable in the present case, and there is therefore no reason to depart from the general rule. An item of income cannot accrue for tax purposes after it has in fact been received subject to the unrestricted use of the taxpayer. Income may accrue prior to receipt, but not subsequent thereto.

Petitioner earnestly urges upon us a highly elaborate analysis of the Supreme Court’s opinion in the Automobile Club case in support of its position. But that opinion affirmed the decision of the Court of Appeals which in turn approved our decision in that case, and, notwithstanding certain language relied upon by petitioner, we cannot say that there was an intention on the part of the Supreme Court to disapprove the theory on which this long line of cases has been bottomed. To the contrary, we find monitory language about the Beacon and Schuessler cases where the decisions of this Court were reversed.

Whether the Commissioner’s action herein be regarded merely as correcting certain items within petitioner’s system of accounting or whether it be treated as requiring a different system of accounting is not a matter of crucial significance. If the former, he was plainly justified in so doing because the income in question must be taxed no later than when received under either cash or accrual systems of accounting. And if the latter, he is on even stronger ground. For, the latitude allowable to the Commissioner is very broad, and it is not the function of the courts to exercise the discretion which under the statute is committed to him. As the Supreme Court said in Brown v. Helvering, 291 U.S. 193, in sustaining tbe Commissioner in disallowing botb tbe accrual of reserves for future cancellations of insurance policies and the deferral of gross overriding commissions received on such policies (pp. 203-204) :

Moreover, tbe method, employed by the taxpayer is never conclusive. If in the opinion of the Commissioner it does not clearly reflect the income, “the computation shall be made upon such basis and in such manner” as will, in his opinion, do so. United States v. Anderson, 269 U.S. 422, 439 * * *; Lucas v. American Code Co., 280 U.S. 445, 449 * * *

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It is not the province of the court to weigh and determine the relative merits of systems of accounting. * * *

See also Security Flour Mills v. Commissioner, 321 U.S. 281, 286.

Tbe contention that tbe tax is “in violation of tbe Sixteenth Amendment” is without substance. Petitioner completely misconceives tbe purpose and effect of tbe amendment. See Penn Mutual Indemnity Co., 32 T.C. 653. Moreover, tbe amounts received do not cease to be “income” under the statute merely because all tbe expenses allocable to tbe earning of such income have not yet been incurred. Wholly apart from tbe question whether pertinent expenses generally affect tbe quality of receipts as income, the point here is that net income under tbe statute is computed on an annual basis, and, as pointed out above, there is no necessary correlation in any given year between receipts and expenses. Expenses with respect to income not yet earned are deductible when paid or accrued ; and conversely, income is reportable when received or accrued, notwithstanding that some, or even all, expenses allocable thereto have not yet been incurred. Plainly, nothing in tbe Constitution prohibits any such result.

Subsequent to the preparation of this opinion, the Court of Appeals for the Second Circuit, on May 28, 1959, reversed our decision in Bressner Radio, Inc., 28 T.C. 378. However, the Court of Appeals itself undertook to distinguish Automobile Club of Michigan v. Commissioner, 353 U.S. 180, affirming 230 F. 2d 585 (C.A. 6), which, in turn, affirmed our decision, 20 T.C. 1033. Without pausing to comment upon the distinctions, we think that the present case more closely resembles the Automobile Club of Michigan case, and we therefore find no reason to reach a different result here.

2. Proceeds from the sale of savings flan coupons. — Petitioner advances three arguments to support its contention that the excess of annual proceeds from the sale of coupons over annual redemptions does not represent taxable income: (a) That it did not intend to make a profit on the transaction since it was obligated to pay out to members the same amount which it received in the form of sales proceeds; (b) that it did not “own” the proceeds but held them as trustee for its members; and (c) that tbe Commissioner’s determination is arbitrary in tbat, if tbe Commissioner wishes to avert petitioner’s realization of a windfall from tbe failure of petitioner’s members to redeem tbeir coupons, his determination must be limited to such windfaE.

We have bad a number of occasions in tbe past to consider similar contentions, in analogous situations, and have repeatedly held that unrestricted income, subject only to a contingent liability to refund in future years, must be reported in the year of receipt, with tbe consequence tbat deductions for refunds may be taken in the year in which such refunds are in fact made. See, e.g., Beadleston & Woerz, Inc., 5 B.T.A. 165; Plymouth Brewing & Malting Co., 16 B.T.A. 123; Okonite Co., 4 T.C. 618, affirmed on other issues 155 F. 2d 248 (C.A. 3), certiorari denied 329 U.S. 164; Fort Pitt Brewimg Co., 20 T.C. 1, affirmed 210 F. 2d 6 (C.A. 3). The result is required by the system of reporting income on the basis of annual accounting periods.

The fact that petitioner did not intend ultimately to profit from the coupon transactions is not controlling. As was stated by the Court of Appeals in Fort Pitt Brewing Co., supra at 8, “even though no trust is created, such a procedure of deposits and repayments is not designed for gain; yet at times it may yield income. These characteristics are properly reflected in accounting and recognized in taxation.” Similarly, in Plymouth Brewing & Malting Co., supra at 128, it was stated:

Usually at the end of any year, containers are outstanding in the hands of the customers and income for the year includes charges for the outstanding containers; in the end, the charges will be nullified by credits for such of the containers as are returned. Although there is intended ultimately no gain in the transaction, the tide of “income” ebbs and flows over the dividing line between the statutory taxable years. We have decided that a reserve is unallowable by way of excluding from income the charge for containers expected to be returned. Beadleston & Woerz, Inc., 5 B.T.A. 165.

Our opinion in the Fort Pitt case held that the Commissioner did not act arbitrarily in refusing to accept a method of accounting whereby taxpayer credited all deposits, and debited all refunds, to a reserve account for the containers in which it sold its products; we recognized that under the taxpayer’s method the Commissioner might be compeUed to wait an unreasonable time, perhaps indefinitely, for the collection of tax on amounts which in fact would never be refunded. The facts in the case at bar suggest a similar conclusion, witness the increase in the credit balance of the reserve account from $57,854.04 in 1944 to $968,812.66 in 1950, an increase of nearly 17 times during a 6-year period, while membership increased only about 10 times during the same period. Unless petitioner is able to account for coupon transactions in a manner likely to avert the obvious windfall inherent in its present method, it fails to carry the burden of proving the Commissioner’s determination to be arbitrary.

Finally, petitioner’s argument that it did not “own” the proceeds but held them subject to a “trust” for its members has no support in the record, particularly in view of petitioner’s stipulation that the funds might be used for general corporate purposes. Clay Sewer Pipe Ass’n v. Commissioner, 139 F. 2d 130 (C.A. 3), affirming 1 T.C. 529; Krim-Ko Corporation, 16 T.C. 31. Seven-Up Co., 14 T.C. 965, upon which petitioner relies, was distinguished in Krim-Ko Corporation, supra at 40, as involving “a mere conduit in passing funds.” Cf. Broadcast Measurement Bureau, Inc., 16 T.C. 988.

Reviewed by the Court.

Decision will Toe entered under Rule 50.

1 None.

2 A change in the law made by section 452 of the Internal Revenue Code of 1954 permitted the deferral of reporting of “prepaid income” in accordance with specified conditions. However, these provisions were not made retroactive, and, in any event, they were retroactively repealed by the Act of June 15, 1955, ch. 143, 69 Stat. 134.