112 T.C. No. 19

UNITED STATES TAX COURT

GENERAL MOTORS CORPORATION AND SUBSIDIARIES, Petitioner 

v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 27026-96. Filed May 25, 1999.

GM and GMAC are members of a consolidated group. 

GM manufactured motor vehicles. GMAC financed motor

vehicles.

Held: The consolidated return regulations in

issue constituted a method of reporting and not a

method of accounting. Henry C. Beck Co. v.

Commissioner, 52 T.C. 1 (1969), affd. per curiam 433

F.2d 309 (5th Cir. 1970), and Henry C. Beck Builders,

Inc. v. Commissioner, 41 T.C. 616 (1964), followed.

Held, further, GM's rate support deductions are

not subject to deferral pursuant to sec. 1.1502-

13(b)(2), Income Tax Regs.

Raymond P. Wexler, Todd F. Maynes, and William R. Welke, for

petitioner.

Nancy B. Herbert and John A. Guarnieri, for respondent.
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1 Petitioner concedes that for 1985 it is not entitled to

deduct (1) $57,532,843 for retail rate support payments incurred

by GM, (2) $233,071,869 for retail rate support payments GM did

not bill until 1986, and (3) $1,557,226 for fleet rate support

payments GM did not bill until 1986. Respondent concedes that

for 1985 (1) petitioner's income should not be increased by

$119,004,997 on account of estimated refunds of retail rate

support payments, and (2) petitioner is entitled to $13,572,139

in deductions for fleet rate support payments. 

Additionally, the parties agree that petitioner, in

computing its taxable income for 1985, is entitled to claim

foreign tax credits in the amount of $101,000,636 arising from

carrybacks from 1986 and 1987. 

2 Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the year in issue, and

all Rule references are to the Tax Court Rules of Practice and

Procedure.

OPINION

VASQUEZ, Judge: Respondent determined a deficiency of

$339,076,705 in petitioner's 1985 consolidated Federal income

tax. The issues in this case, the rate support and special tools

issues, have been bifurcated for separate resolution. This

opinion addresses the rate support issues.

After concessions by the parties,1 the issues for decision

are: (1) Whether General Motors Corporation (GM) and its

consolidated affiliated subsidiaries (together, the GM group)

changed its method of accounting, and (2) whether section 1.1502-

13(b)(2), Income Tax Regs., requires GM to defer its deduction of

"rate support" payments.2
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Background

Most of the facts have been stipulated and are so found. 

The stipulation of facts, the supplemental stipulation of facts,

the stipulation of partial settlement, the stipulation of settled

issues and the attached exhibits are incorporated herein by this

reference. At the time it filed the petition, GM had its

principal place of business in Detroit, Michigan. 

I. General Background

GM is a corporation duly organized under the laws of the

State of Delaware, doing business directly and through

subsidiaries in the United States and abroad. For 1985 and all

relevant prior and subsequent years, GM filed a consolidated

Federal income tax return, Form 1120, on a calendar year basis on

behalf of GM and its consolidated affiliated subsidiaries within

the meaning of section 1504. In 1985 and all relevant prior and

subsequent years, General Motors Acceptance Corporation (GMAC), a

wholly owned subsidiary of GM, was part of the GM group. GM and

GMAC both maintain their books and records, and report their

income for Federal income tax purposes, using the accrual method

of accounting. 

At all relevant times, GM was a multiplant manufacturing

enterprise primarily engaged in the design, manufacture,

assembly, and sale of motor vehicles (including automobiles,

trucks, and buses) and related parts and accessories. 
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In 1919, GMAC was incorporated under the New York banking

law relating to investment companies. Operating directly and

through subsidiaries and associated companies in which it has

equity investments, GMAC provides a wide variety of financial

services to its customers. 

GMAC and its subsidiaries' principal business is to finance

the acquisition and resale by independent GM dealers of various

new automotive and nonautomotive products manufactured by GM and

to acquire from independent GM dealers, either directly or

indirectly, installment obligations covering retail sales of GM

products as well as used units of any make. Additionally, GMAC

acquired from independent GM dealers installment obligations

covering new products of other (i.e., non-GM) motor vehicle

manufacturers where the independent GM dealers also owned and

operated non-GM motor vehicle dealerships. As a purchaser of

installment obligations, GMAC faces competition from finance

companies and most banks. Banks also finance car loans directly

with customers; however, GMAC does not provide this service. 

GMAC also offered other financial services to independent GM

dealers. These services included providing inventory financing

for both new and used vehicles, insurance, real estate lending,

financing of service machinery and mechanical equipment, and

other related services. 
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3 The term "retail customers" refers to all purchasers who

were not fleet customers.

II. Independent GM Dealers' Relationship With GM and GMAC

A. General Background

GM sells the motor vehicles it manufactures to the public

primarily through a network of independently owned dealerships

(i.e., independent GM dealers). These independent GM dealers

purchase GM motor vehicles from GM for resale to individual

customers, businesses, leasing companies, and other entities. 

Some of these customers (e.g., businesses and leasing companies)

are "fleet customers". Fleet customers purchase large volumes of

motor vehicles in a single transaction. 

When a retail customer3 purchased a vehicle from an

independent GM dealer, the retail customer could (1) pay cash for

the entire purchase price, (2) purchase the vehicle using thirdparty financing, or (3) execute a retail installment sales

contract (RISC) with the independent GM dealer under which the

retail customer agreed to pay for the vehicle over the term of

the contract at a stated interest rate. Under the terms of the

RISC, the independent GM dealer could (1) hold the RISC for its

own account, (2) assign the RISC to a lender unrelated to GM or

GMAC, or (3) assign the RISC to GMAC.

If the independent GM dealer assigned the RISC to GMAC, GMAC

acquired the RISC at a price based on GMAC's "buy rate" (which
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was also known as the "market discount" rate). GMAC's buy rate

reflected a market rate of interest. If the interest rate the

RISC carried equaled the GMAC buy rate, GMAC paid face value for

the RISC. 

Independent GM dealers were not legally required to assign

any RISC to GMAC, and GMAC was not legally required to accept any

RISC offered by an independent GM dealer to GMAC. GMAC, however,

accepted assigned RISC's from independent GM dealers provided the

retail customer and the terms of the RISC met GMAC's credit

standards. 

During 1985, for approximately 41 percent of all GM vehicles

sold by independent GM dealers, the customer executed an RISC

with the independent GM dealer, and the independent GM dealer

then assigned the RISC to GMAC. This represented GMAC's highest

market share since 1931. 

Between 1984 and 1986, GMAC accepted assignment of

approximately 75 percent of the total number of RISC's that

independent GM dealers offered to GMAC. GMAC conditionally

accepted another 10 percent of such RISC's subject to the retail

customer increasing his or her downpayment or adding a cosigner. 

GMAC rejected approximately 15 percent of the RISC's independent

GM dealers offered to GMAC. 
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4 For convenience, we shall hereinafter refer to these

terms as dealer finance income.

5 The opinion, infra pp. 32-38, contains examples

calculating dealer finance income and rate support payments and

explaining GM's and GMAC's accounting for rate support. For an

example of dealer finance income, see infra p. 32.

B. Dealer Finance Income

"Dealer finance income", "dealer allowance credit", and

"dealer participation" are terms used to describe certain amounts

paid or credited by GMAC to independent GM dealers in connection

with the assignment of an RISC by an independent GM dealer to

GMAC.4 Dealer finance income was produced when an independent GM

dealer assigned to GMAC an RISC bearing an interest rate that is

higher than the GMAC buy rate. 

When GMAC acquired an RISC from an independent GM dealer,

GMAC paid or credited the independent GM dealer the fair market

value of the assigned RISC at the time of purchase. The fair

market value was computed using the GMAC buy rate (i.e., the RISC

was discounted to present value based on the GMAC buy rate). 

When a retail customer's RISC carried an interest rate greater

than the GMAC buy rate, the fair market value was higher than the

face amount of the RISC, and the amount GMAC paid in excess of

the face amount of the RISC was dealer finance income.5 If the

retail customer paid off its RISC early, the independent GM
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6 This was because if the RISC carried a below-market

interest rate the independent GM dealer forwent money on the sale

of the car. This money was "lost" because the independent GM

dealer credited the face value of the RISC towards the retail

customer's purchase price of the vehicle even though the RISC

carried a below-market interest rate (i.e., the RISC's fair

market value at the time of purchase was less than its face value

at the time of issuance). Thus, the independent GM dealer

forwent the difference between the face value and fair market

value of the RISC.

dealer credited back to GMAC a portion of the dealer finance

income. 

A retail customer's RISC seldom carried an interest rate

below GMAC's buy rate when the motor vehicle was not covered by a

retail rate support program.6 See infra pp. 10-19 (discussing

retail rate support programs). In that case, the fair market

value of the RISC was lower than the face amount of the RISC. 

GMAC paid or credited the independent GM dealer less than the

face value of the RISC (so that the effective yield to GMAC on

the RISC equaled the GMAC buy rate). This reduced the income the

independent GM dealer received on the sale of the vehicle.

III. Incentive Programs

 A. GM Incentives to Independent GM Dealers to

 Purchase/Sell GM Vehicles

In 1985, there were numerous programs in effect that GM had

established to provide financial incentives to independent GM

dealers to purchase and sell more GM motor vehicles (dealer

incentives). 
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One dealer incentive program involved the payment of "close

out allowances" to independent GM dealers. Under the terms of

the sale from GM to an independent GM dealer, if the independent

GM dealer could not resell a vehicle by a specified date, GM paid

a "close-out allowance" to the independent GM dealer. Close-out

allowances were intended to encourage independent GM dealers to

purchase and stock current model year vehicles. 

Other dealer incentives included cash payments tied to the

volume of vehicles either sold by the independent GM dealer or

purchased from GM by the independent GM dealer. These dealer

incentives might apply to particular vehicle lines or to total

numbers of vehicles sold or purchased. Various sales incentives

were also paid to dealership salespeople.

Independent GM dealers were also given the opportunity to

purchase certain upgrades or option packages for certain vehicle

models at either a reduced or no additional cost. 

B. Retail Customer Incentives

In addition to dealer incentives, GM established programs

involving retail customer incentives to increase sales of GM

motor vehicles. GM retail customer sales incentives included: 

(1) Cash rebates and incentive packages, (2) discount option

packages, (3) reduced financing rates made available through

GMAC, and/or (4) allowing the purchaser to delay the initial
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monthly payment to GMAC due on the retail customer's RISC for a

stated period. 

C. Oversight of Incentive Programs

During the 1980's, GM's "Price Review Group" made the

decision to provide dealer incentives, incentives to dealership

salespeople, and retail sales incentives. 

D. Retail Rate Support Programs

 1. History and Overview

Around 1980, the domestic car market in the United States

was extremely depressed. The United States was coming off the

second oil shock. In 1980, GM incurred only the second year of

losses in its history. It was a traumatic time for GM, and there

was a lot of effort and work going on at GM to try to stimulate

sales of motor vehicles.

At this time, GM was offering direct rebates to customers;

however, the programs were not effective at increasing sales of

GM vehicles to the desired levels. GM executives believed that

sales were depressed due to the very high interest rates that

were present in the U.S. economy at the time. During 1980, the

prime rate of interest hit a high of approximately 21 percent.

GM was considering using sales allowances to try to find

something that was more attractive to customers than rebate

programs, which had lost their luster in the then existing high

interest rate environment. In 1980, GM executives made proposals
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7 The parties referred to the different divisions of GM

(i.e., Chevrolet, Buick, GMC, Pontiac, Oldsmobile, and Cadillac)

as "marketing divisions", "car divisions", and "vehicle

divisions" of GM. For clarity and uniformity, we shall refer to

them as car divisions.

to create a program to address the issue of high interest rates. 

The proposals suggested a program by which retail customers could

finance GM vehicles at a below-market interest rate. 

The car divisions (i.e., Chevrolet, Buick, GMC, Pontiac,

Oldsmobile, and Cadillac)7 initially opposed retail rate support

programs. These proposals were not implemented in 1980 due to

perceived administrative difficulties and a lack of the necessary

internal support. 

In 1981, GM executives again made proposals to address the

issue of high interest rates. This time, GM initiated programs

through GMAC which made below-market interest rate financing

available to retail customers who purchased GM vehicles (the

retail rate support program). The motivation for the program

included stimulating retail demand for cars and increasing market

penetration. 

GMAC's initial reaction to the initial proposed retail rate

support program was negative. GMAC was concerned with the impact

of the retail rate support program on independent GM dealers, who

were GMAC's customers, and the independent GM dealers' ability to

earn dealer finance income. See supra pp. 7-8. GM's initial
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proposals for rate support programs involved GMAC's bearing a

cost of such programs, and GMAC refused to bear such costs. 

GMAC's position was that its margins did not allow it to absorb

these costs. GMAC considered these costs a cost of selling

automobiles that should be borne by GM. GM eventually decided to

pay these costs. 

The first retail rate support program, initiated in July

1981, included all U.S. car divisions. The initial retail rate

support proposal was quite successful. It was more effective

than GM executives hoped, and sales increased more than GM

expected. 

In 1981, when GM first announced retail rate support

programs, GMAC immediately contacted its lenders and credit

rating agencies to inform them that (1) GMAC's margins were not

going to be adversely affected by such programs, (2) GM, and not

GMAC, was bearing the costs of such programs, and (3) GMAC was

earning its normal rate of return on RISC's entered into by

retail customers under a retail rate support program (ratesupported RISC).

 2. Nuts and Bolts of a Retail Rate Support Program

Retail rate support programs involved GM's central

management, GM's car divisions, independent GM dealers, and GMAC. 

The purpose of the retail rate support programs was to spur the
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sale of GM vehicles by independent GM dealers so that GM could

sell more vehicles to the independent GM dealers. 

Vehicles sold under a retail rate support program were

financed at an interest rate below the prevailing market interest

rate. Independent GM dealers who participated in the program

were required to advertise the below-market interest rate to

their retail customers. As discussed earlier, independent GM

dealers were not able to earn dealer finance income from GMAC on

the rate-supported RISC's. In order to encourage independent GM

dealers to participate in retail rate support programs, GM paid

independent GM dealers who had been using GMAC's services a

stated fraction of the average dealer finance income the

independent GM dealer had earned on nonrate-supported RISC's

during a previous base period. Such payments were described as

representing a percentage of the independent GM dealers' normal

dealer financing income. Independent GM dealers who had not been

using GMAC's services were paid a stated fraction of the average

dealer finance income that other independent GM dealers in the

same geographic area earned on nonrate-supported RISC's during a

previous base period. 

Retail rate support programs were structured as follows:

(1) GM sold its vehicles to independent GM dealers. 

(2) GM's car divisions prepared proposals to use a

portion of their sales allowance budget on a retail rate
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support program. The car divisions submitted the proposal

to GM's operating analysis section (OAS), which was part of

the GM comptroller's staff. OAS worked with the car

divisions in preparing the financial analysis and a proposal

for the price review group. The proposal suggested the

vehicles to be covered, the interest rate to be offered, and

the period of time the program would be in effect. 

(3) The price review group reviewed the proposal. In

deciding whether to approve a retail rate support program,

the price review group considered projections of income

impact to the affected GM car divisions and GMAC based on

the cost of the program plus the gain from projected

increased vehicle sales. The price review group's

consideration of projected income impact included projected

increased contract penetration by GMAC.

The price review group also considered the "gross stock

days supply" with proposed vehicle lines chosen to address

"days supply" problems of specific car divisions. "Gross

stock" is the number of vehicles that are in the field

available for sale. The "days supply" is the projected

number of days it would take to sell that gross stock. 

The price review group evaluated some programs and

found that the entire expected sales increase would be "pull

ahead" sales. Pull ahead sales were sales GM reasonably
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8 We assume that this refers to the next financial period.

expected to occur in the ensuing period8 if there were no

retail rate support program in place. Thus, there was no

anticipated increase in the number of sales of GM motor

vehicles, but the sales would occur earlier with a retail

rate support program in place than they would otherwise. 

The price review group also considered the impact of

"plus" sales. Plus sales were additional GM cars projected

to be sold because of the retail rate support program. 

GM's price review group, based on the recommendation of

GM's marketing personnel, set the below-market interest rate

to be offered based on the market for particular vehicles

and competitive conditions. 

(4) After approval by the price review group, the

proposal went to GM's executive committee. The executive

committee either approved or rejected the proposal. If

approved, GM notified the car divisions in writing and the

independent GM dealers through an electronic dealer 

communication system (DCS) of the retail rate support

program. The DCS message identified the car models covered,

the period of time the retail rate support program was in

effect, and the amount of dealer finance income that would

be earned (or lost) by participating in the program. 
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(5) In order to participate in a retail rate support

program, independent GM dealers had to elect to be in the

program. 

(6) The retail rate support program required

participating independent GM dealers to charge the retail

customers an interest rate that was no higher than the

below-market interest rate offered under the retail rate

support program.

(7) GM (through its car divisions), GMAC, and the

independent GM dealers announced the retail rate support

program to the public. 

Interest rates in a retail rate support program often varied

based on the term of the RISC. Generally, an RISC with a term of

49-to-60 months bore a higher interest rate than an RISC with a

term of 48 months or less. 

 3. Sale of a Car

When a participating independent GM dealer sold a qualifying

vehicle to a retail customer under a retail rate support program,

the customer could elect to make a cash downpayment and finance

the balance of the purchase price not paid in cash. The retail

customer satisfied the balance due by entering into an RISC with

the independent GM dealer at the below-market interest rate

established under the rate support program. The independent GM

dealer credited the face value of the RISC towards the retail
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9 GMAC never paid an independent GM dealer more than the

fair market value for an RISC in the absence of a retail rate

support program because GMAC's margin for profit on an individual

RISC was very small. If GMAC paid more than the fair market

value for an RISC without receiving a retail rate support

payment, GMAC would have experienced a loss on the RISC (i.e.,

the expenses would have exceeded the income on the RISC).

10 The retail rate support payment GM made to GMAC

represented the difference between the amount GMAC paid the

independent GM dealer for the RISC under a retail rate support

program and the amount GMAC would have paid the independent GM

dealer for the RISC in the absence of such a program.

customer's purchase price of the vehicle even though the RISC

carried a below-market interest rate (i.e., the RISC's fair

market value at the time of purchase was less than its face value

at the time of issuance). If the participating independent GM

dealer offered to assign the RISC to GMAC and GMAC accepted the

RISC, GMAC paid or credited the independent GM dealer an amount

equal to the face value of the RISC (which was greater than the

RISC's fair market value at the time of purchase).9

 4. The Retail Rate Support Payment

When GMAC acquired a retail customer's RISC carrying a

below-market interest rate (i.e., a rate-supported RISC) from an

independent GM dealer, GM paid (or credited to) GMAC an amount

(the retail rate support payment) equal to the difference between

the face amount of the RISC and the fair market value discounted

at GMAC's buy rate.10 GM paid GMAC the rate support payment to
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11 From 1985 to the present, the retail rate support

(continued...)

reimburse GMAC for the amount GMAC paid the independent dealer in

excess of the RISC's fair market value at the time of purchase. 

For RISC's executed before 1985, if the retail customer

prepaid the RISC held by GMAC, GMAC returned (or credited) to GM

a portion of the retail rate support payment that GM had

previously paid (or credited) to GMAC. 

Beginning in 1985, GM and GMAC began to take anticipated

retail customer prepayments into account in determining the

amount of the retail rate support payments GM paid to GMAC. This

reduction in the amount of the retail rate support payments was

actuarially determined. 

During 1985, GM reduced the retail rate support payments it

made to GMAC by 7 percent to take account of anticipated

prepayments. In 1985, if a retail customer prepaid an RISC, GMAC

was not obligated to return to GM any portion of the retail rate

support payment GMAC received from GM on that RISC because

anticipated payments were taken into account in determining the

amount of the retail rate support payments. 

GM made retail rate support payments to GMAC as an up front,

lump sum payment. This treatment was similar to the treatment of

direct rebate programs--car divisions charged the whole amount to

their sales allowance budget.11 GMAC wanted the retail rate
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11(...continued)

program has been a significant part of the sales allowances of

GM. Additionally, retail rate support payments continue to be

charged against the car divisions' sales allowance budget. 

support payment up front because GMAC incurred the expense up

front by paying the independent GM dealer an amount in excess of

the fair market value of the RISC at the time of its purchase.

 5. 1985 Retail Rate Support Programs

In 1985, GM offered eight retail rate support programs on

selected GM vehicles. These eight programs included the

following:

a. 8.8% financing on Chevrolet and GMC S-10 and

S-15 trucks purchased between February 1, 1985 and

April 30, 1985;

b. 8.8% financing on J and P model passenger cars

purchased between March 20, 1985 and April 30, 1985;

c. 8.8% financing on Chevrolet Cavalier, Pontiac

Sunbird, Cadillac Seville and Eldorado, Chevrolet S-10

Blazer and GMC S-15 Jimmy, Oldsmobile Calais, and Buick

Somerset models purchased between May 1, 1985 and

August 15, 1985;

d. 9.9% financing on Buick Electra and Oldsmobile

Ninety-Eight Regency models purchased between June 21,

1985 and August 15, 1985;

e. 7.7% financing on a wide variety of 1985 model

Chevrolet, Pontiac, Oldsmobile, Buick, Cadillac, and

GMC vehicles purchased between August 15, 1985 and

October 2, 1985;

f. 8.8% financing on a wide variety of 1985 model

Chevrolet, Pontiac, Oldsmobile, Buick, Cadillac, and

GMC vehicles purchased between October 7, 1985 and

November 20, 1985; 
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g. 8.5% financing on "J" passenger cars purchased

between December 4, 1985, and December 31, 1985; and

h. 7.9% financing on a wide variety of Chevrolet,

Pontiac, Oldsmobile, Buick, Cadillac, and GMC vehicles

purchased between December 26, 1985 and February 22,

1986.

 6. Effect of the Rate Support Programs

Retail rate support programs affected the number of units

financed by GMAC and GMAC's market penetration. In 1984, GMAC's

number of units financed and market penetration decreased

primarily to increased competition for automobile financing and

the absence of reduced retail rate programs that had been in

effect during most of 1983. In 1985, GMAC's number of units

financed and market penetration increased reflecting the

favorable results of various reduced rate programs (including the

rate support programs) and other incentives. 

In 1985, GMAC's "average earning assets" rose $9.5 billion

principally due to the effect of several rate support programs

offered throughout the year. 

GMAC's 1985 annual report contained the following statement

regarding the retail rate support programs:

A number of very successful reduced retail rate

programs offered by GMAC in cooperation with General

Motors, combined with improved availability of GM

products, contributed to the rise in the level of

deliveries. The increased volume of units financed by

GMAC under the reduced rate programs resulted in

significant growth in retail receivables and lease

assets in 1985.
- 21 -

GMAC's 1986 Annual Report also contained similar language. The

1986 report stated:

The financial services market continues to be

intensely competitive. GMAC is meeting this challenge

with new and improved programs for consumers, dealers

and investors. Most notable last year were the

factory-supported, special rate financing plans which

contributed to GMAC's record volume and resulted in a

significant number of new and more affluent GMAC

customers. During these rate programs, financing

volume increased more than 40% and placed great demands

on the entire organization.

 7. Non-GM Rate Support Programs

Some independent GM dealers also operated motor vehicle

dealerships for vehicle manufacturers other than GM (e.g., Nissan

Motor Corporation (Nissan)). GMAC purchased RISC's from these

independent GM dealers even if the automobile being financed was

not a GM vehicle. Consistent with this policy, during 1985, GMAC

participated in rate support type programs offered by three nonGM manufacturers of motor vehicles. 

From January 4 through October 2, 1985, GMAC had an

agreement with Nissan to purchase RISC's bearing an 8.8-percent

interest rate from Nissan dealers who sold Nissan trucks to

retail customers. Under this program, Nissan paid GMAC the

difference between the face amount of the RISC and the fair

market value of the RISC (discounted at the rate of 13.5 percent)

at the time of purchase. 
- 22 -

12 For an example, see infra pp. 33-34.

From June 1 through September 15, 1985, GMAC had an

agreement with American Isuzu Motors, Inc. (Isuzu), to purchase

RISC's bearing an 8.6-percent interest rate from Isuzu dealers

who sold Isuzu trucks to retail customers. Under this program,

Isuzu paid GMAC the difference between the face amount of the

RISC and the fair market value of the RISC (discounted at the

rate of 13.5 percent) at the time of purchase. 

From October 9 through November 20, 1985, GMAC had an

agreement with American Motors Corporation (AMC) to purchase

RISC's bearing an 8.8-percent interest rate from AMC dealers who

sold (1) Renault Alliance and Encore vehicles, and (2) Jeep

Cherokee, Wagoneer, and Comanche vehicles to retail customers. 

Under this program, AMC reimbursed GMAC the difference between

the face amount of the RISC and the fair market value of the RISC

(discounted at the rate of 13.25%) at the time of purchase. 

IV. GM's and GMAC's Accounting

A. GMAC's Accounting for Rate-Supported RISC's12

GMAC accounted for the acquisition of a rate-supported RISC

(whether for a GM or non-GM vehicle) as follows: When GMAC

purchased the rate-supported RISC, it recorded as assets on its

books (1) a "retail customer receivable", and (2) a "rate support

receivable". The retail customer receivable was equal to the
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face amount of the RISC plus the below-market interest stated in

the RISC that was to be paid over the term of the RISC (belowmarket stated interest). The rate support receivable was equal

to the retail rate support payment GM would make to GMAC. 

GMAC also recorded two offsetting credit amounts: (1) A

cash reduction in the amount paid to the independent GM dealer to

purchase the rate-supported RISC, and (2) a contra asset called

"unearned income". 

The unearned income account balance equaled the face amount

of the RISC plus the below-market stated interest (i.e., the

total amount the retail customer was to pay GMAC over the term of

the RISC) minus the fair market value of the note, based on

GMAC's buy rate, at its time of purchase. Thus, the unearned

income account included the discount income GMAC earned on a

rate-supported RISC and the below-market stated interest. The

retail rate support payment, however, was not included in the

unearned income account. 

The contra asset account was designed so that the RISC was

reported in GMAC's published financial statements at its fair

market value at the time of its purchase. 

When GMAC received the retail rate support payment, GMAC

increased its cash by the amount of the retail rate support

payment and eliminated the rate support receivable. The unearned

income account remained unchanged. 
- 24 -

13 For an example, see infra pp. 35-36.

When GMAC acquired a rate-supported RISC from an independent

GM dealer, GMAC did not record the rate support payment as

income. GMAC recognized the unearned income as earned income on

a monthly basis as the retail customer made payments over the

term of the RISC. Each month GMAC also reduced the unearned

income account on its balance sheet in an amount equal to the

amount it recognized as earned income on its income statement. 

B. GMAC's Accounting for Nonrate-Supported RISC's13

GMAC accounted for the acquisition of a nonrate-supported

RISC, whether it carried a market rate of interest or a belowmarket rate of interest, as follows: When GMAC purchased the

RISC, it recorded as an asset on its books a retail customer

receivable equal to the face amount of the RISC plus the interest

stated in the RISC that was to be paid over the term of the RISC.

GMAC also recorded two offsetting credit amounts: (1) A

cash reduction in the amount paid to the independent GM dealer to

purchase the RISC, and (2) unearned income equal to the face

amount of the RISC plus the stated market stated interest (i.e.,

the total amount the retail customer paid GMAC over the term of

the RISC) minus the fair market value of the note at the time of

its purchase. Thus, the unearned income account included the
- 25 -

14 For an example, see infra p. 35.

stated interest plus the discount income GMAC earned if the

nonrate-supported RISC bore a below-market rate of interest. 

C. GM's Accounting for Retail Rate Support Payments14

GM accounted for its retail rate support payment liability

as follows: When GM's liability first arose, GM recorded a sales

allowance in the amount of the retail rate support payment and an

accrued liability to GMAC in the amount of the retail rate

support payment. When GMAC actually purchased the RISC from an

independent GM dealer and GM made the retail rate support payment

to GMAC, GM eliminated the accrued liability and recorded a cash

reduction in the amount of the retail rate support payment. The

net effect on GM's balance sheet was a reduction in GM's cash

balance in the amount of the retail rate support payment. There

were no subsequent entries. 

D. Consolidated Accounting

GM was required to eliminate intercompany items between GM

and GMAC in determining GM's consolidated income and balance

sheet. GM's expense for retail rate support payments was never

eliminated in determining the GM group's net book income. 

Similarly, unearned income recognized by GMAC over the term of a

rate-supported RISC was never eliminated in determining the GM

group's net book income. 
- 26 -

15 For an example, see infra p. 35.

16 An independent GM dealer was needed as the seller of

record.

V. GMAC's Basis in Rate-Supported RISC's15

GMAC's reported tax basis in a rate-supported RISC was equal

to the net amount of the RISC reported on GMAC's balance sheet. 

VI. Fleet Rate Support Programs

A. General Background

During 1985, GM regularly negotiated incentive arrangements

for the sale of multiple GM vehicles to fleet customers (fleet

vehicles). The terms of a fleet transaction were set between GM

and the fleet customer. GM sold fleet vehicles to an independent

GM dealer16 who in turn sold the fleet vehicles to the fleet

customer. Depending on the circumstances, delivery of the fleet

vehicles might be coordinated through the independent GM dealer

or, alternatively, might be delivered by GM directly to the fleet

purchaser. The independent GM dealer, however, was responsible

for payment for the fleet vehicles. 

In a fleet transaction, because the independent GM dealer

actually completed the sale of the fleet vehicles to the fleet

customer, the independent GM dealer earned a profit on the fleet

transactions. This profit margin, however, generally was lower

than the independent GM dealer's average profit margin on sales

to retail customers. The amount of the independent GM dealer's
- 27 -

17 GMAC established its lending rate the same way it

(continued...)

profit turned on the fleet customer's buying leverage and the

services the independent GM dealer provided to the fleet

customer. 

In connection with a purchase of fleet vehicles, GM made

incentives available to fleet customers. As an incentive to

these fleet customers, GM offered below-market interest rate

financing through GMAC or offered to assist a fleet customer in

obtaining below-market interest rate financing from an unrelated

lender. Generally, fleet customers opted to use the below-market

financing provided by GMAC, but occasionally fleet customers used

below-market financing provided by an unrelated lender. 

Unlike sales to retail customers, the independent GM dealer

who helped complete a fleet transaction had no role in the

financing of the fleet vehicles purchased. The fleet customer

did not execute an RISC with an independent GM dealer; instead,

GMAC or an unrelated lender lent the money directly to the fleet

customers (fleet loans). In fleet transactions, GMAC used a

chattel mortgage type financing document. GMAC lent the money to

the fleet customers and took a security position in the fleet

vehicles as collateral. Any below-market interest rate offered

to fleet customers on fleet loans was a reduction in GMAC's

otherwise available "lending rate".17 
- 28 -

17(...continued)

determined its buy rate. 

18 For an example, see infra pp. 36-37.

Upon shipment by GM of a fleet purchase, GM received payment

for the fleet vehicles. In most cases, this payment was made

through the independent GM dealer's wholesale financing source.

The fleet customer then borrowed the agreed-upon amount of

funds from GMAC or an unrelated lender. This amount was credited

to the independent GM dealer (or, in most cases, the independent

GM dealer's wholesale financing source) as consideration for the

vehicles. 

If the lender made a below-market interest rate loan, GM

paid GMAC or the unrelated lender a "fleet rate support payment". 

The amount of the fleet rate support payment equaled the

difference between the face amount of the fleet loan and the fair

market value of the fleet loan at GMAC's lending rate.

B. GMAC's Accounting for the Fleet Loans18

GMAC accounted for the fleet loans as follows: When GMAC

made a fleet loan, it recorded as assets on its books (1) a

"fleet purchaser receivable", and (2) a rate support receivable. 

The fleet purchaser receivable was equal to the face amount of

the loan (i.e., the amount the fleet customer actually borrowed

from GMAC). The rate support receivable was equal to the fleet

rate support payment to be made by GM to GMAC. 
- 29 -

19 The unearned income account in the fleet transactions

was a contra asset account that reduced the amount of GMAC's

assets and ensured that the fleet purchaser receivable was

reported at its fair market value on GMAC's balance sheet. 

20 Thus, the unearned income account included the discount

income GMAC earned on a rate supported fleet loan. The fleet

rate support payment was not included in the unearned income

account.

GMAC also recorded two offsetting credit amounts: (1) A

cash reduction in the amount it paid to the independent GM dealer

to purchase the rate supported fleet loan, and (2) unearned

income.19 The unearned income account was credited the face

amount of the note minus the fair market value of the note at the

time of its purchase.20 

Unlike its treatment of retail rate support payments, GMAC

did not record the stated interest in the note as part of the

fleet purchase receivable or as unearned income. 

When GMAC received the fleet rate support payment from GM,

GMAC increased its cash by the amount of the fleet rate support

payment and eliminated the rate support receivable. The unearned

income account remained unchanged. 

GMAC did not include fleet rate support payments in income. 

GMAC recognized the unearned income as earned income on a monthly

basis as the customer made payments over the term of the fleet

loan. 
- 30 -

21 For an example, see infra pp. 37-38.

C. GM's Accounting for the Fleet Rate Support Payments21

GM accounted for its fleet rate support payment liability as

follows: When GM's liability first arose, GM recorded a sales

allowance in the amount of the fleet rate support payment and an

accrued liability to GMAC in the amount of the fleet rate support

payment. When GMAC actually lent the funds to the fleet customer

and GM made the fleet rate support payment to GMAC, GM eliminated

the accrued liability and recorded a cash reduction in the amount

of the fleet rate support payment. The net effect on GM's income

statement was a sales allowance in the amount of the fleet rate

support payment, and the net effect on GM's balance sheet was a

reduction in GM's cash balance in the amount of the fleet rate

support payment. 

VII. Tax Return Treatment of Item Related to Retail and

 Fleet Rate Support Programs

In the relevant taxable years, in computing its separate

taxable income, GM treated the retail rate support payments it

made to GMAC and the fleet rate support payments made to GMAC and

to other unrelated lenders as current deductions by the parent GM

(rate support deductions). For purposes of computing its

separate taxable income, GMAC treated the discount earned on

rate-supported RISC's and rate supported fleet loans (which were

mathematically equal to the retail/fleet rate support payment
- 31 -

associated with that RISC/fleet loan that GMAC received from GM)

as income over the life of the RISC/fleet loan (rate support

discount income). 

For taxable years prior to 1985, the GM group reported GM's

rate support deductions and GMAC's rate support discount income

as intercompany transactions. A consolidation adjustment was

made deferring GM's rate support deductions in the GM group's

consolidated income tax return until GMAC recognized the discount

income. 

For 1985 and subsequent years, the GM group did not report

GM's rate support deductions and GMAC's rate support discount

income as intercompany transactions. GM continued to claim the

retail and fleet rate support payments as current deductions when

paid (or credited) to GMAC. No consolidation adjustment was made

deferring GM's rate support deductions in the GM group's

consolidated income tax return. 

The GM group did not file, in 1985 or any other relevant

year, a Form 3115, Application for Change in Accounting Method,

with the Commissioner. 

VIII. Claims for Refund

GM filed refund claims with the Internal Revenue Service

(IRS) for tax years prior to 1985 on the basis that the deferral

of GM's rate support deductions on the GM group's consolidated

return for those years was incorrect. 
- 32 -

22 For convenience, all figures are rounded to the nearest

dollar.

Discussion

I. Examples

Before reaching our analysis of the applicable law, we set

forth some examples of the accounting, tax, and financial aspects

of the case at bar that will elucidate the facts of the case. 

The parties have stipulated the following examples.

A. Dealer Finance Income 

Suppose that when GMAC's buy rate was 8 percent a retail

customer entered into an RISC with a principal amount of $10,000,

for a term of 48 months, bearing an interest rate of 8.25

percent. GMAC paid or credited $10,04822 (the fair

market/discounted value of the RISC at 8 percent) to the

independent GM dealer for assignment of the RISC to GMAC. Thus,

the independent GM dealer received $48 of dealer finance income

(the fair market value of the RISC--$10,048--less the principal

amount--$10,000).

B. Retail Rate Support Payment Calculations

 1. Pre-1985

Suppose a retail customer purchased a vehicle from an

independent GM dealer for $12,000 and paid $2,000 in cash and

financed the $10,000 balance with a rate-supported RISC with a

48-month term. The retail rate support program offered 7.9
- 33 -

23 The $9,253 figure is arrived at by discounting to

present value the 48 monthly payments of $244 by 12 percent.

percent financing when GMAC's buy rate for a 4-year loan was 12

percent. The monthly payment due on the rate-supported RISC was

$244, and the fair market value of the rate-supported RISC at the

time of purchase was $9,253.23 Even though the rate-supported

RISC was worth only $9,253, GMAC paid the independent GM dealer

$10,000. GM paid GMAC a retail rate support payment in the

amount of $747--the difference between the $10,000 face value of

the rate-supported RISC and the $9,253 fair market value of the

rate-supported RISC at the time of its purchase.

 2. 1985 and Post-1985

In 1985 and thereafter, GM's retail rate support payment was

adjusted (reduced) for the actuarially determined retail customer

prepayments. During 1985, GM reduced the retail rate support

payments it made to GMAC by 7 percent to take account of

anticipated prepayments. Thus, given the same facts as above for

pre-1985, in 1985, the retail rate support payment of $747 would

have been reduced to $695.

C. GM and GMAC Financial Accounting

 1. Rate-Supported RISC

Suppose a retail customer's RISC had a face amount of

$10,000, below-market stated interest of $2,000 to be paid by the

customer over the term of the RISC, and a fair market value of
- 34 -

$9,500, and GM paid GMAC a retail rate support payment of $500

(retail rate support example). 

 a. GMAC

GMAC purchased the RISC from an independent GM dealer for

$10,000, and it recorded the following assets on its books:

Retail customer receivable 1$12,000

Rate support receivable 500

1 This figure included the $10,000 face value of the

RISC and $2,000 below-market interest stated in the

RISC. 

GMAC credited the $10,000 it paid the independent GM dealer

for the RISC to its cash account and $2,500 to its unearned

income account. These items were recorded as follows:

Cash ($10,000)

Unearned income 

1(2,500)

1 This figure equaled the face amount of the RISC plus

the below-market stated interest (i.e., the total

amount the retail customer was to pay GMAC over the

term of the RISC) minus the fair market value of the

RISC at the time of its purchase. Thus, the unearned

income account included the discount income and the

below-market stated interest that GMAC earned on the

RISC. 

When GMAC received the $500 retail rate support payment from

GM, GMAC increased its cash by $500 and eliminated the rate

support receivable. The net effect on GMAC's balance sheet was

as follows: 

Retail customer receivable $12,000

Cash (9,500)

Unearned income (2,500)
- 35 -

 b. GMAC's Basis in a Rate-Supported RISC

In the retail rate support example, GMAC's book and tax

basis in the rate-supported RISC was $9,500.

 c. GM

In the retail rate support example, GM accounted for its

retail rate support payment liability as follows: When GM's

liability first arose, GM recorded a $500 sales allowance and a

$500 accrued liability to GMAC. When GMAC actually purchased the

RISC from an independent GM dealer and GM made the $500 retail

rate support payment to GMAC, GM eliminated the $500 accrued

liability and recorded a cash reduction of $500. The net effect

on GM's balance sheet was a $500 reduction in GM's cash balance.

 2. Nonrate-Supported RISC

 a. RISC Bearing a Market Interest Rate

Suppose a retail customer's RISC had a face amount and fair

market value of $10,000 and stated interest of $2,500 to be paid

by the customer over the term of the RISC. GMAC purchased the

RISC for $10,000, and it recorded the following items on its

books:

Retail customer receivable 1$12,500

Cash (10,000)

Unearned income 

2(2,500)

1 This figure included the $10,000 face value of the

RISC and $2,500 interest stated in the RISC. 

2 This figure equaled the face amount of the RISC plus

the stated interest (i.e., the total amount that the
- 36 -

24 The parties stipulated this example and calculated the

fair market value of the note to be $957,600 and the fleet rate

(continued...)

retail customer paid GMAC over the term of the RISC)

minus the fair market value of the RISC at the time of

its purchase. 

 b. RISC Bearing a Below-Market Interest Rate

Suppose a retail customer's RISC had a face amount of

$10,000, below-market stated interest of $2,000 to be paid by the

customer over the term of the RISC, and a fair market value of

$9,500. GMAC purchased the RISC for $9,500, and it recorded the

following items on its books:

Retail customer receivable 1$12,000

Cash (9,500)

Unearned income 

2(2,500)

1 This figure included the $10,000 face value of the

RISC and $2,000 below-market stated interest. 

2 This figure equaled the face amount of the RISC plus

the stated interest (i.e., the total amount the retail

customer was to pay GMAC over the term of the RISC)

minus the fair market value of the RISC at the time of

its purchase. 

 3. Fleet Loans and Fleet Rate Support 

Suppose a fleet customer acquired fleet vehicles for

$1,100,000 making a $100,000 downpayment in cash and financing

the $1 million balance with a note from GMAC with a term of 48

months at an interest rate of 8 percent when GMAC's lending rate

was 10 percent. The fair market value of the note at the time of

its purchase, therefore, was $957,600.24 GMAC lent $1 million to
- 37 -

24(...continued)

support payment to be $42,400 (the difference between the

$1,000,000 face value of the note and the $957,600 fair market

value of the note). This appears to be a mathematical error--the

fair market value based on a loan with a $1 million principal

balance at 8 percent for 48 months when the market rate of

interest is 10 percent is $962,557, and the fleet rate support

payment therefore is $37,443. For convenience, we shall use the

parties' figures.

the fleet customer who used the $1 million as consideration for

the purchase of the fleet vehicles. GM then paid $42,400 to GMAC

(altogether, the fleet rate support example).

 a. GMAC

In the fleet rate support example, when GMAC made the loan

for $1 million, it recorded the following items on its books:

Fleet purchaser receivable $1,000,000

Rate support receivable 42,400

Cash (1,000,000)

Unearned income (42,400)

When GMAC received the $42,400 fleet rate support payment,

GMAC increased its cash by $42,400 and eliminated the rate

support receivable. The net effect on GMAC's balance sheet was

as follows: 

Fleet purchaser receivable $1,000,000

Cash (957,600) 

Unearned income (42,400)

 b. GM

In the fleet rate support example, GM accounted for its

fleet rate support payment liability as follows: When GM's

liability first arose, GM recorded a $42,400 sales allowance and
- 38 -

25 We use the term "rate support payments" to refer to both

the retail rate support payments and fleet rate support payments.

26 On brief, respondent argues that "GM" changed its method

of accounting. Most of respondent's arguments, however, pertain

to changes made by the GM group on its consolidated returns. 

Therefore, we believe that many of respondent's references to GM

in respondent's discussion of the change in method of accounting

issue are references to the GM group.

a $42,400 accrued liability to GMAC. When GMAC actually lent the

funds to the fleet customer and GM made the $42,400 fleet rate

support payment to GMAC, GM eliminated the $42,400 accrued

liability and recorded a cash reduction of $42,400. The net

effect on GM's income statement was a $42,400 sales allowance;

the net effect on GM's balance sheet was a $42,400 reduction in

GM's cash balance.

II. Change in Method of Accounting

Respondent's primary argument is that the consolidated

return regulations constituted a method of accounting, and the GM

group's consistent deferral of GM's rate support deduction prior

to 1985 established the regular method of accounting for the rate

support payments.25 See sec. 1.446-1(e)(2)(ii)(a), Income Tax

Regs. Respondent contends that in 1985 the GM group26 changed

its method of accounting when (1) the GM group stopped reporting

GM's rate support payments as intercompany transactions under

section 1.1502-13(a)(1), Income Tax Regs., (2) GM continued to

claim the rate support payments as current deductions when paid
- 39 -

(or credited) to GMAC, and (3) the rate support deductions were

no longer deferred in the GM group's consolidated income tax

return (i.e., no consolidation adjustment was made pursuant to

section 1.1502-13(b)(2), Income Tax Regs.). Respondent further

argues that this change in the method of accounting could not be

effected without the Secretary's consent. See sec. 446(e). 

Petitioner counters that the consolidated return regulations

in effect for 1985 were not a method of accounting. Furthermore,

petitioner contends that respondent is attempting to apply

retroactively the 1995 amendments to the consolidated return

regulations (1995 amendments), and that this is improper.

A. The Law

An affiliated group can make a consolidated return with

respect to the income tax imposed by chapter 1 in lieu of filing 

separate returns. See sec. 1501. All members of the affiliated

group must consent to the consolidated return regulations

prescribed under section 1502 prior to the last day prescribed by

law for the filing of a consolidated return. See id. Filing a

consolidated return was considered such consent. See id.

Section 1502 provided:

The Secretary shall prescribe such regulations as

he may deem necessary in order that the tax liability

of any affiliated group of corporations making a

consolidated return and of each corporation in the

group, both during and after the period of affiliation,

may be returned, determined, computed, assessed,

collected, and adjusted, in such manner as clearly to
- 40 -

reflect the income tax liability and the various

factors necessary for the determination of such

liability, and in order to prevent avoidance of such

tax liability.

Furthermore, if a consolidated return was made, the tax was

determined, computed, assessed, collected, and adjusted in

accordance with the regulations under section 1502 prescribed

before the last day prescribed by law for the filing of such

return. See sec. 1503(a).

Section 1.1502-2, Income Tax Regs., explained how a

consolidated group determined its tax liability. It provided, in

relevant part, as follows:

The tax liability of a group for a consolidated

return year shall be determined by adding together--

(a) The tax imposed by section 11 on the

consolidated taxable income for such year (see

[section] 1.1502-11 for the computation of consolidated

taxable income); * * *

Section 1.1502-11, Income Tax Regs., provided, in relevant

part, as follows:

(a) In general. The consolidated taxable income

for a consolidated return year shall be determined by

taking into account--

 (1) The separate taxable income of each

member of the group (see [section] 1.1502-12

for the computation of separate taxable

income); * * * 

Section 1.1502-12, Income Tax Regs., provided, in relevant

part, as follows:
- 41 -

27 Sec. 1.1502-13(a)(1), Income Tax Regs., defined the term

"intercompany transaction" as "a transaction during a

consolidated return year between corporations which are members

of the same group immediately after such transaction".

The separate taxable income of a member (including a

case in which deductions exceed gross income) is

computed in accordance with the provisions of the Code

covering the determination of taxable income of

separate corporations, subject to the following

modifications:

(a) Transactions between members * * * shall be

reflected according to the provisions of [section]

1.1502-13 * * * ;

* * * * * * *

(d) The method of accounting under which such

computation is made and the adjustments to be made

because of any change in method of accounting shall be

determined under [section] 1.1502-17; 

Section 1.1502-13(b)(1), Income Tax Regs., provided that,

generally, gain or loss on intercompany transactions,27 other

than "deferred intercompany transactions", was not deferred or

eliminated. Section 1.1502-13(b)(2), Income Tax Regs., however,

contained an exception to this rule:

(2) Special rule. If, in an intercompany

transaction (other than a deferred intercompany

transaction), one member would otherwise properly

[take] an item of income or a deduction into account

for a consolidated return year earlier than the year

(whether consolidated or separate) for which another

member of the group can properly take into account the

corresponding item of income or deduction, then both

the item of income and the deduction shall be taken

into account for the later year (whether consolidated

or separate). * * *
- 42 -

Section 1.1502-17, Income Tax Regs., entitled "Methods of

accounting", stated that "The method of accounting to be used by

each member of the group shall be determined in accordance with

the provisions of section 446 as if such member filed a separate

return."

Section 446(a) stated that "Taxable income shall be computed

under the method of accounting on the basis of which the taxpayer

regularly computes his income in keeping his books." Section

1.446-1(a)(1), Income Tax Regs., further provided that "The term

'method of accounting' includes not only the over-all method of

accounting of the taxpayer but also the accounting treatment of

any item."

Section 446(c) listed the permissible methods of accounting:

(c) Permissible Methods.--Subject to the

provisions of subsections (a) and (b), a taxpayer may

compute taxable income under any of the following

methods of accounting--

(1) the cash receipts and disbursements

 method;

(2) an accrual method;

(3) any other method permitted by this

 chapter;

(4) any combination of the foregoing methods

 permitted under regulations prescribed by the

 Secretary.

See also sec. 1.446-1(c), Income Tax Regs.
- 43 -

Before a taxpayer could change the taxpayer's method of

accounting, the taxpayer needed to secure the consent of the

Secretary. See sec. 446(e).

(ii)(a) A change in the method of accounting

includes a change in the overall plan of accounting for

gross income or deductions or a change in the treatment

of any material item used in such overall plan. * * * 

A material item is any item which involves the proper

time for the inclusion of the item in income or the

taking of a deduction. * * * [Sec. 1.446-

1(e)(2)(ii)(a), Income Tax Regs.]

An accounting practice that involves the timing of when an

item is included in income or when it is deducted is considered a

method of accounting. See Knight-Ridder Newspapers, Inc. v.

United States, 743 F.2d 781, 797-798 (11th Cir. 1984); Diebold,

Inc. v. United States, 16 Cl. Ct. 193, 198-199 (1989), affd. 891

F.2d 1579 (Fed. Cir. 1989).

B. Analysis

Respondent argues that the matching rule contained in

section 1.1502-13(b)(2), Income Tax Regs., is a method of

accounting because the rule affects the timing (i.e.,

recognition) of corresponding items of income and deduction. 

This Court has previously addressed the issue of whether the

consolidated return regulations are a method of accounting. In

Henry C. Beck Builders, Inc. v. Commissioner, 41 T.C. 616 (1964)

(Henry C. Beck Builders, Inc.), a Court-reviewed opinion, we

refused to accept the IRS's argument that the application of the
- 44 -

consolidated return regulations was a method of accounting. See

id. at 622. This Court subsequently followed Henry C. Beck

Builders, Inc. in Vernon C. Neal, Inc. v. Commissioner, T.C.

Memo. 1964-145, and in United Contractors, Inc. v. Commissioner,

T.C. Memo. 1964-68, affd. per curiam 344 F.2d 123 (4th Cir.

1965).

In another Court-reviewed opinion issued 5 years after Henry

C. Beck Builders, Inc., the Court again rejected the IRS's

argument that the intercompany transaction rules contained in the

consolidated return regulations were a method of accounting. See

Henry C. Beck Co. v. Commissioner, 52 T.C. 1 (1969), affd. per

curiam 433 F.2d 309 (5th Cir. 1970) (Henry C. Beck Co.). Citing

Henry C. Beck Builders, Inc., the Court stated that "Consolidated

returns are not a method of accounting but only a method of

reporting." Id. at 7-8. Later in the opinion, we reemphasized

this point: "As previously pointed out, it is well settled by

decisions of this Court that a consolidated return is merely a

method of reporting taxes, not a method of accounting." Id. at

12.

Respondent correctly points out that Henry C. Beck Builders,

Inc. and Henry C. Beck Co. involved the consolidated return

regulations in effect prior to 1966 (pre-1966 regulations), see

Henry C. Beck Co. v. Commissioner, supra at 11-12, and that the

case at bar involves the consolidated return regulations the
- 45 -

Treasury adopted in 1966 (1966 regulations) which substantially

overhauled the pre-1966 regulations. See T.D. 6894, 1966-2 C.B.

362; 1 Dubroff et al., Federal Income Taxation of Corporations

Filing Consolidated Returns sec. 1.02 (2d ed. 1999).

Respondent argues that our decisions in Henry C. Beck

Builders, Inc. and Henry C. Beck Co. are therefore irrelevant to

the case at bar. Respondent contends that the pre-1966

regulations were an "elimination" system where income, gains,

losses, and deductions were zeroed out (eliminated) between

members of a consolidated group; therefore, timing questions

regarding the reporting of these items could never arise. The

1966 regulations, respondent points out, provided for a

"deferral" system where income, gains, losses, and deductions

were matched between members of a consolidated group. Respondent

argues that timing issues could arise under the 1966 regulations;

therefore the 1966 regulations should be characterized as a

method of accounting. 

Petitioner agrees with respondent that the consolidated

return regulations were substantially amended in 1966 and

acknowledges that Henry C. Beck Builders, Inc. and Henry C. Beck

Co. were decided under the pre-1966 regulations. Petitioner

argues, however, that the 1966 regulations did not affect the

holdings in Henry C. Beck Builders, Inc. and Henry C. Beck Co.
- 46 -

that the consolidated return regulations were not a method of

accounting.

We do not believe that the 1966 regulations undercut the

holdings in Henry C. Beck Builders, Inc. and Henry C. Beck

Co. that the consolidated return regulations are a method of

reporting and not a method of accounting. To the contrary, the

1966 regulations fortify the reasoning contained in Henry C. Beck

Builders, Inc. and Henry C. Beck Co.

Respondent adopted sections 1.1502-12(d) and 1.1502-17,

Income Tax Regs., as part of the 1966 regulations. These

sections provide the rules for determining methods of accounting

and changes in method of accounting under the consolidated return

regulations. 

Section 1.1502-12(d), Income Tax Regs., states that the

method of accounting under which the computation of separate

taxable income of each member of the consolidated group is made

and the adjustments to be made because of any change in method of

accounting shall be determined under section 1.1502-17, Income

Tax Regs. Section 1.1502-17, Income Tax Regs., entitled "Methods

of accounting", states that "The method of accounting to be used

by each member of the group shall be determined in accordance

with the provisions of section 446 as if such member filed a

separate return." Thus, each member (and not the group)

determines its method of accounting on a separate company basis--
- 47 -

there is no method of accounting for the group as a whole. 

Furthermore, section 446 controls the determination of the method

of accounting. 

Section 446 supports the conclusion that the consolidated

return regulations are not a method of accounting. Section

446(c) lists four methods of accounting that are permissible: 

(1) The cash method, (2) an accrual method, (3) any other method

permitted by chapter 1 of the Code, and (4) any permissible

combination of the three aforementioned methods. The

consolidated return regulations are neither the cash method nor

an accrual method. The consolidated return regulations are

authorized under chapter 6 of the Code. Section 446(c) and the

consolidated return regulations simply do not treat the

regulations (or more specifically, the matching rule contained in

section 1.1502-13(b)(2), Income Tax Regs.) as a method of

accounting. See Vernon C. Neal, Inc. v. Commissioner, T.C. Memo.

1964-220.

Additionally, section 446(a) and (e) refer to the method of

accounting on the basis of which the taxpayer regularly computes

his income in keeping his books. Corporations do not keep their

books based on the consolidated return regulations; the

consolidated return regulations make adjustments to each

corporation's income determined under each corporation's separate

method of accounting. The Commissioner's supervisory authority
- 48 -

28 The 1995 amendments are effective as of July 18, 1995,

and apply to transactions occurring in years beginning on or

after July 12, 1995. See T.D. 8597, 1995-2 C.B. 147, 185; sec.

1.1502-13(l)(1), Income Tax Regs., as amended. The 1995

amendments are not before the Court; therefore, we make no

conclusions as to whether these amendments are valid.

over accounting methods simply is not implicated here. See sec.

1.1502-17, Income Tax Regs.

It was not until 1995 that section 1.1502-13, Income Tax

Regs., was amended to state that the timing rules contained in

the consolidated return regulations are a method of accounting.28

See sec. 1.1502-13(a)(3), Income Tax Regs., as amended ("The

timing rules of this section are a method of accounting for

intercompany transactions, to be applied by each member in

addition to the member's other methods of accounting."); T.D.

8597, 1995-2 C.B. 147, 162.

Petitioner also argues that on a separate company basis GM

and GMAC did not change their respective methods of accounting

for the rate support payments or discount income. We agree. GM

always treated rate support payments as current deductions, and

GMAC always recognized discount income over the life of the

RISC/fleet loan. It was only when the GM group filed a

consolidated return that, on this return, the GM group deferred

the rate support deductions that, according to GM's accounting

method, GM was currently deducting.
- 49 -

Furthermore, we do not believe that respondent argues that

on a separate company basis either GM or GMAC changed its methods

of accounting for the rate support payments or discount income.

Based on the foregoing, we conclude that the consolidated

return regulations in effect during the year in issue constituted

a method of reporting and not a method of accounting. Therefore,

the GM group did not have to obtain the Secretary's consent

before changing how it reported the rate support deductions on

its consolidated return.

III. Deferral of the Rate Support Payments

Respondent's secondary argument is: (1) The rate support

payments GM made to GMAC were part of intercompany transactions

subject to the matching rule contained in section 1.1502-

13(b)(2), Income Tax Regs.; (2) the corresponding item of income

to the rate support deductions was the discount income GMAC

earned over the term of the RISC's/fleet loans; and (3) GM should

have deferred its rate support deductions until GMAC took the

corresponding item of income into account. 

Petitioner counters that the rate support deductions were

not subject to the matching rule contained in section 1.1502-

13(b)(2), Income Tax Regs., because: (1) The rate support

payments were not income to GMAC; therefore they could not have

been the corresponding item of income to the rate support

deductions; (2) the discount income that GMAC earned from
- 50 -

29 The 1995 amendments are effective as of July 18, 1995,

and apply to transactions occurring in years beginning on or

after July 12, 1995. See T.D. 8597, 1995-2 C.B. 147, 185; sec.

1.1502-13(l)(1), Income Tax Regs., as amended. The 1995

amendments, therefore, are not before the Court.

retail/fleet customers was not the corresponding item of income

to the rate support deductions; and (3) the discount income was

not earned in intercompany transactions.

A. The Matching Rule

As stated earlier, section 1.1502-13(b)(2), Income Tax

Regs., provided in part:

(2) Special rule. If, in an intercompany

transaction (other than a deferred intercompany

transaction), one member would otherwise properly

[take] an item of income or a deduction into account

for a consolidated return year earlier than the year

(whether consolidated or separate) for which another

member of the group can properly take into account the

corresponding item of income or deduction, then both

the item of income and the deduction shall be taken

into account for the later year (whether consolidated

or separate). * * *

In 1995, section 1.1502-13, Income Tax Regs., was amended to

state the following: "An item is a corresponding item whether it

is directly or indirectly from an intercompany transaction."29

Sec. 1.1502-13(b)(3)(i), Income Tax Regs., as amended; T.D. 8597,

1995-2 C.B. at 164.
- 51 -

30 The rate support payments were not income to GMAC; they

reduced GMAC's basis in the rate-supported RISC's/fleet loans. 

This was because the rate support payments induced GMAC to

purchase RISC's/fleet loans from independent GM dealers at face

value (i.e., GMAC paid independent GM dealers more than fair

market value for a below-market RISC/fleet loan only because GM

made rate support payments to GMAC for the excess amount paid). 

See Brown v. Commissioner, 10 B.T.A. 1036, 1054-1055 (1928)

(amount received by buyer to induce him to purchase property is a

reduction in his cost of the property rather than income to the

buyer); Rev. Rul. 73-559, 1973-2 C.B. 299 (basis in acquired

mortgage is reduced by the amount of the inducement payment); see

also Freedom Newspapers, Inc. v. Commissioner, T.C. Memo. 1977-

429; Rev. Rul. 76-96, 1976-1 C.B. 23 (new car purchaser must

reduce his basis by amount of manufacturer rebate).

B. The Corresponding Item of Income and Intercompany

 Transactions

Respondent agrees that the rate support payments were not

income to GMAC.30 Respondent contends, however, that the

corresponding item of income does not have to be from the very

same payment that creates the deduction. Respondent asserts that

"income or deduction that flows directly or indirectly from an

intercompany transaction constitutes a corresponding item" under

section 1.1502-13(b)(2), Income Tax Regs. 

We must determine what the regulations meant by "the

corresponding item of income". Three examples contained in

section 1.1502-13(h), Income Tax Regs., illustrated what this

term meant:

Example (3). Corporations P and S file

consolidated returns on a calendar year basis and

report income on the cash basis. On July 1, 1966, S

pays P $1,000 interest on a loan made in 1961. The

payment of interest is an intercompany transaction
- 52 -

other than a deferred intercompany transaction; S does

not defer or eliminate the $1,000 deduction for

interest and P does not defer or eliminate the $1,000

item of interest income. Thus, consolidated taxable

income for 1966 reflects interest income of $1,000 and

a corresponding deduction for interest of $1,000.

* * * * * * *

Example (13). Corporations P and S file

consolidated returns on a calendar year basis for 1966

and 1967. S reports income on the accrual method while

P reports income on the cash method. On December 31,

1966, S would properly accrue interest of $1,000 which

is payable to P. On February 1, 1967, S pays P the

$1,000. Both the deduction and the item of income are

taken into account for 1967, the later year. * * * 

Consolidated taxable income for 1967 reflects both

interest income of $1,000 and a corresponding deduction

for interest of $1,000.

* * * * * * *

Example (16). Corporations P and S file

consolidated returns on a calendar year basis. On

January 10, 1968, P sells an issue of its $100 par

value bonds. S purchases a bond from P for $110. S

does not elect under section 171 to amortize the $10

premium. P may not take the $10 premium into account

as income until it redeems the bond since S cannot

properly take a deduction for the $10 premium until the

bond is redeemed.

In each of these examples, there was a direct relationship

between the income and the deduction. The money never left the

consolidated group, and third parties were not involved. A

single item (payment) within the group was an expense (deduction)

for one member of the group and income for another member.

In the case at bar, third parties (the independent GM

dealers and retail/fleet customers) were involved, and a single
- 53 -

item (the rate support payment) was not an expense (deduction)

for one member of the group (GM) and income for another member

(GMAC). The payment GM made to GMAC (which was the deduction)

was not directly related to the payments the retail/fleet

customers made to GMAC (which contained the discount income). 

Additionally, here the money left the consolidated group. 

Compare the examples of rate supported and nonrate-supported

RISC's bearing a below-market rate of interest. See supra pp.

33-36. In the example of a nonrate-supported RISC bearing a

below-market rate of interest, GMAC paid the independent GM

dealer $9,500. Thus, the GM group's total net expense was

$9,500. In the example of a rate-supported RISC, GMAC paid the

independent GM dealer $10,000 and GM paid GMAC $500. Thus, the

GM group's total net expense was $10,000. Five hundred dollars

($500) more left the GM group when a below-market RISC/fleet loan

was rate supported as compared with when there was no rate

support.

As respondent pointed out on brief, the matching rule

ensures clear reflection of income and prevents the creation of

"paper" deductions when the group as a whole has not incurred a

net expense. Here, the group had a net expense.

Furthermore, the GM group's additional $500 expense was a

real loss of $500 to the GM group. In both the example of a

nonrate-supported RISC and a rate-supported RISC bearing a below-
- 54 -

market rate of interest, the RISC's had face values of $10,000

and stated interest of $2,000. See supra pp. 33-36. Thus, if

GMAC held the below-market nonrate-supported RISC to maturity the

GM group made a $2,500 profit ($12,000 minus the $9,500 paid to

the independent GM dealer), or if the customer paid off the RISC

immediately the GM group made a $500 profit (the $10,000 of

stated principal minus the $9,500 paid to the independent GM

dealer). Whereas, if GMAC held the rate-supported RISC to

maturity the GM group made a $2,000 profit ($12,000 minus the

$10,000 paid to the independent GM dealer), or if the customer

paid off the RISC immediately the GM group made no profit (the

$10,000 of stated principal minus the $10,000 paid to the

independent GM dealer).

The purpose of the consolidated return regulations is to

provide rules so that the tax liability of a consolidated group

will be clearly reflected and to prevent the avoidance of such

tax liability. See sec. 1502. GM and GMAC have not fabricated a

transaction where numbers merely are being shuffled on paper

without any real loss to the GM group. The GM group's treatment

of the rate support deductions and the discount income clearly

reflected its tax liability.

Based on the foregoing, we conclude that the discount income

was not the corresponding item of income to the rate support

deductions.
- 55 -

Even if, however, the discount income was the corresponding

item of income, the discount income would have to be part of an

intercompany transaction in order for the consolidated return

regulations to apply. See sec. 1.1502-13(b)(2). Section 1.1502-

13(a)(1), Income Tax Regs., defined the term "intercompany

transaction" as "a transaction during a consolidated return year

between corporations which are members of the same group

immediately after such transaction".

GMAC received the discount income from either a retail

customer or a fleet customer. GMAC acquired the right to receive

the discount income from an independent GM dealer when the

independent GM dealer assigned the RISC/fleet loan to GMAC. 

Neither the retail/fleet customer nor the independent GM dealer

was part of the GM group; therefore the transactions between GMAC

and retail/fleet customers and GMAC and independent GM dealers

were not intercompany transactions.

The intercompany transaction rules of the consolidated

return regulations and the examples therein contemplated a

transaction solely within the consolidated group between members

of the group and not a situation where income comes from outside

the group in a transaction involving third parties. See section

1.1502-13(a)(1), (b)(2), (h) Examples (3), (13), (16), Income Tax

Regs., and the discussion of these examples supra.
- 56 -

Based on the foregoing, we conclude that the discount income

was not earned in an intercompany transaction.

C. Conclusion

We conclude that under the 1966 regulations, the discount

income GMAC earned over the term of RISC's/fleet loans from

retail/fleet customers was not the corresponding item of income

in an intercompany transaction to the rate support deductions. 

Therefore, the GM group was not required to defer the rate

support deductions on its consolidated income tax return.

To reflect the foregoing,

An appropriate order

will be issued.