PUBLISHED

UNITED STATES COURT OF APPEALS

FOR THE FOURTH CIRCUIT

SIGNET BANKING CORPORATION,

Petitioner-Appellant,

v. No. 96-2429

COMMISSIONER OF INTERNAL REVENUE,

Respondent-Appellee.

Appeal from the United States Tax Court.

(Tax Ct. No. 92-7887)

Argued: June 2, 1997

Decided: July 8, 1997

Before WILKINSON, Chief Judge, and WILKINS and

MOTZ, Circuit Judges.

_________________________________________________________________

Affirmed by published opinion. Chief Judge Wilkinson wrote the

opinion, in which Judge Wilkins and Judge Motz joined.

_________________________________________________________________

COUNSEL

ARGUED: William L. Goldman, MCDERMOTT, WILL &

EMERY, Washington, D.C., for Appellant. Teresa Thomas Milton,

Tax Division, UNITED STATES DEPARTMENT OF JUSTICE,

Washington, D.C., for Appellee. ON BRIEF: Christopher Kliefoth,

Dianne Suarez-Lasa, MCDERMOTT, WILL & EMERY, Washington, D.C., for Appellant. Loretta C. Argrett, Assistant Attorney

General, Gilbert S. Rothenberg, Tax Division, UNITED STATES

DEPARTMENT OF JUSTICE, Washington, D.C., for Appellee.

_________________________________________________________________
OPINION

WILKINSON, Chief Judge:

Signet Banking Corporation challenges the Commissioner's determination that the bank failed to properly report annual membership

fee revenue from its credit card operations in the year it was

received.

The Tax Court upheld the Commissioner. Signet Banking Corp. v.

Commissioner, 106 T.C. 117 (1996). Signet now appeals, claiming

that the fee income represented payment for services provided over

the membership year and therefore qualified for partial deferral

pursuant to Revenue Procedure 71-21, 1971-2 C.B. 549. We disagree. The

nature of the fee and the terms of the cardholder agreement drafted

by Signet make clear that the annual fee is paid solely for the

issuing

of a card and the establishment of a credit limit. While the

Internal

Revenue Code permits taxpayers to structure their economic affairs

as they wish, they must then abide by the tax consequences. Accordingly, we affirm the judgment of the Tax Court.

I.

During the tax years at issue in this case, 1983 through 1985, Signet issued MasterCard and VISA credit cards. The bank offered a

number of services to cardholders, including replacement of lost or

stolen cards, payment processing, provision of periodic statements,

and verification of credit to enable cardholders to make specific

purchases. Prior to 1981, ninety percent of Signet's credit card

revenue

came from finance charges assessed when card users failed to pay

off

their monthly balance. Rising interest rates narrowed the gap

between

the bank's cost of funds and the finance charge it could legally

impose to the point where, in 1980, Signet's credit card operation

was

losing money. In 1981, the bank imposed a flat annual membership

fee of fifteen dollars which was charged to cardholders at the

beginning of the twelve-month period covered by the fee.

Signet provided all new cardholders with a copy of the Customer

Agreement, which described many of the various cardmember services. Under "OTHER CHARGES," the agreement stated:

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4. You agree to pay a non-refundable annual membership

fee of $15.00 in consideration of the issuance of your Card

and the establishment of your credit limit. The membership

fee will be charged on your Periodic Statement each year in

the month in which you opened your account.

The agreement also permitted either the bank or the cardholder to

cancel the card at any time.

Signet is an accrual method, calendar year taxpayer. For the tax

years in question, the bank did not report annual fee income in the

year of receipt but rather recognized it ratably over the twelve

months

covered by the fee. Thus, in the case of a cardmember who opened

an account in July, Signet included half of the fee in income that

same

year and half in the succeeding year.

Following an audit, the Commissioner determined that under the

tax accounting rules governing accrual method taxpayers, Signet

should have reported all of the fee revenue in the year it was

received.

The bank challenged this determination in the Tax Court, arguing

that

the annual fee was compensation for cardholder services rendered

throughout the membership year and that the fee income therefore

qualified for partial deferral under an exception created by

Revenue

Procedure 71-21.

The Tax Court held that Signet could not rely on Revenue Procedure 71-21 because the cardholder agreement itself stated that the

fee

was not paid for services to be performed over time, but rather in

consideration of issuing a card and establishing a credit limit.

Signet

Banking, 107 T.C. at 117. The court noted that the bank reserved

the

right to cancel the card at any time and that the bank "had no duty

under the agreement to return any part of the fee even if [Signet]

or

the cardholder closed the account immediately" after it was

activated.

Id. at 127. Signet appeals.

II.

Accrual method taxpayers are generally required to recognize payments for future services as income in the year of receipt. See

Schlude

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v. Commissioner, 372 U.S. 128 (1963); American Automobile Association v. United States, 367 U.S. 687 (1961). Revenue Procedure

71-21 provides an exception to this rule "in certain specified and

limited circumstances." The Procedure permits taxpayers to partially

defer income received in one tax year for services to be performed

over a period ending no later than the conclusion of the next tax

year.

The portion which may be deferred is the portion attributable to

those

services which are to be performed during the following tax year.

Signet argues that its annual membership fee income qualified for

partial deferral under Revenue Procedure 71-21 because the fee

represents payment for card services provided to cardholders over the

membership year. The bank asserts that the credit cards are useless

without payment processing, credit verification, and the other

services

explicitly or implicitly provided for in the cardholder agreement.

It

concludes that "[n]o one would pay a $15.00 annual membership fee

for . . . an inert piece of plastic."

This observation, however, is immediately countered by several

others which are far less favorable to Signet's position. To begin

with,

the fee that Signet charges is a flat one, taking no account of a

particular cardmember's actual use of the card. Such usage varies

dramatically -- some cardholders do very little with their cards, while

others

take advantage of the full spectrum of available benefits. The

record

also suggests that the fee is not even calculated to cover the

aggregate

cost of providing card services. Signet's financial reports provide

no

correlation between the fee income and the expense of providing

such

services. Moreover, we note the coincidence in timing whereby the

annual fee was imposed shortly after Signet's credit card

operations

became unprofitable. Indeed, William Binns, Executive Vice President of Signet's Bank Card Division at the time, testified that the

bank began considering an annual fee precisely because "[i]n 1980,

the bank card business . . . was losing money." Taken together,

these

facts suggest that the annual fee represented a general revenue

raising

measure as opposed to an attempt to charge users for the cost of

ser-
vices rendered.

The terms of the cardholder agreement itself also do not link the

fee to services provided over the membership year. Under "OTHER

CHARGES," Part 4, the agreement clearly states:"You agree to pay

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a non-refundable annual membership fee of $15.00 in consideration

of the issuance of your Card and the establishment of your credit

limit." (emphasis added). This is classic contract language,

drafted by

Signet itself, and it requires the bank to do no more than complete

the

discrete tasks enumerated to earn the fee. Whether services or not,

those tasks are certainly not services to be provided over time and

therefore cannot bring the fee income within the terms of Revenue

Procedure 71-21.

While the distinction between issuance of a card and the provision

of card services may be an artificial one, as Signet contends, it

is a

distinction created by Signet. The Supreme Court"has observed

repeatedly that, while a taxpayer is free to organize his affairs

as he

chooses, nevertheless, once having done so, he must accept the tax

consequences of his choice, whether contemplated or not, and may

not enjoy the benefit of some other route he might have chosen to

follow but did not." Commissioner v. National Alfalfa Dehydrating &

Milling Co., 417 U.S. 134, 149 (1974) (citations omitted).

Signet also objects to the Tax Court's reliance on the fact that

the

fee was non-refundable and the card could be cancelled at any time

by the bank or the cardholder. The Tax Court suggested that these

provisions permitted Signet to cancel the card and keep the fee

without providing any services other than issuing a card and

establishing

a credit limit. Signet Banking, 106 T.C. at 127. Signet argues that

this

reasoning is flawed because the implied covenant of good faith

imposed by Virginia law would prevent the bank from arbitrarily

cancelling an account and retaining the fee.

Signet's argument misses the mark. The implied covenant would

have no impact in the vast majority of cases where either the cardholder cancels the card or the bank has cause to close the account.

Furthermore, the bank simply cannot structure the terms of the

cardholder agreement to its advantage and then rely on an indeterminate

question of Virginia law to evade the federal tax implications

thereof.

None of Signet's arguments change either the nature of the fee or

the terms of the cardholder agreement, and the bank is bound

accordingly under the Internal Revenue Code.
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III.

Signet insists finally that we must take account of the fact that

the

fee is denominated an "annual membership" fee. The bank argues,

"the fee is paid for `membership' in the Signet MasterCard plan.

That

plan entails all of the Cardmember Services contemplated by the

Cardmember Agreement," not just issuance of a card and establishment of a credit limit. In particular, the bank asserts that use of

the

term "annual" indicates that the payment is for services to be

provided

throughout the membership year. Mere labelling, however, cannot

alter the substance of the fee arrangement as established by the

considerations previously noted. For obvious reasons, a taxpayer's

classification of its own transaction cannot determine the appropriate

tax

treatment. See Commissioner v. Court Holding Co., 324 U.S. 331,

334 (1945).

Revenue Procedure 71-21 represents an attempt to balance the

straightforwardness of a report-upon-receipt requirement with some

sense of fairness to taxpayers receiving payment for services

rendered

by the close of the succeeding tax year. The Procedure, however, is

a strictly limited exception. It does not sanction open-ended

efforts to

fine-tune fairness, a step that would threaten to sacrifice the

benefits

of simplicity entirely. The Commissioner is correct to underscore

the

presumption that accrual method taxpayers are to recognize payments

for future services as income when those payments are received.

Revenue Procedure 71-21 represents a limited exception to this rule,

one

for which the annual fee income at issue does not qualify. Accordingly, the judgment of the Tax Court is affirmed.

AFFIRMED

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