Case Name: Budget Credits, Inc., Petitioner v. Commissioner of Internal Revenue, Respondent
Court: United States Tax Court
Jurisdiction: United States
Decision Date: 1968-04-15
Citations: 50 T.C. 52
Docket Number: Docket No. 5697-00
Parties: Budget Credits, Inc., Petitioner v. Commissioner of Internal Revenue, Respondent
Judges: SimpsoN, /., agrees with this dissenting opinion.
Reporter: Reports of the Tax Court of the United States
Volume: 50
Pages: 52–59

Head Matter:
Budget Credits, Inc., Petitioner v. Commissioner of Internal Revenue, Respondent
Docket No. 5697-00.
Filed April 15, 1968.
Miles Jaffe, for the petitioner.
Ohauncey W. Tuttle, Jr., for the respondent.

Opinion:
OPINION
Tannenwald, Judge:
Respondent determined deficiencies in petitioner's Federal income tax for tbe fiscal years ended July 31, 1960, July 81,1961, July 28, 1962, and July 27,1963, of $13,000, $50,468.73, $26,676.25, and $9,880, respectively. In view of petitioner's concessions, the sole issue for determination is whether petitioner is entitled to deduct those additions to its reserve for bad debts for each of the fiscal years in question, which were computed by reference to accounts receivable sold by petitioner to a bank.
All of the facts have been stipulated, and the stipulation of facts, together with the exhibits attached thereto, is incorporated herein by this reference.
Petitioner is a Michigan corporation having its principal offices, at the time the petition herein was filed, in Detroit, Mich. It filed its Federal income tax returns for the taxable years in issue with the district director of internal revenue, Detroit, Mich.
Since 1948, petitioner has been the wholly owned subsidiary of Federal's, Inc., a Michigan corporation, the name of which for the years involved herein was Davidson Bros., Inc. This corporation will hereinafter be referred to as Federal's, Inc.
During the years in question, Federal's, Inc., operated a number of department stores in various cities. It made sales of tangible personal property for cash and extended credit terms, utilizing the forms and conditions of credit sales customarily followed in the retail business.
In each of the years in question, Federal's, Inc., sold, without recourse, to petitioner all of its accounts receivable arising out of sales in Michigan and Ohio together with any security interests retained.
During its fiscal year ended July 31, 1961, Federal's, Inc., acquired a number of stores in the States of New York and Ohio. It thereafter, on February 23, 1961, organized a New York corporation, B.C.I. Credit Corp. (hereinafter referred to as B.C.I.). Starting in May 1961, accounts receivable arising out of sales of tangible personal property by Federal's, Inc., in New York, together with security interests retained, were sold, without recourse, by Federal's, Inc., to B.C.I. and were then transferred by B.C.I. to petitioner. B.C.I. was organized and utilized because petitioner could not be admitted to do business in New York due to a conflict between its name and an unrelated New York corporation.
At all times since 1948, Federal's, Inc., has held all of the outstanding capital stock of petitioner. Since that time, petitioner has engaged in no business other than -the financing of accounts receivable acquired from Federal's, Inc., and B.C.I. and arising out of sales by Federal's, Inc., of tangible personal property, except that petitioner acquired certain accounts receivable from Federal's, Inc., which, had in turn been acquired by it as part of its acquisition of certain stores in Ohio and New York and which arose from sales of tangible personal property by those stores prior to such acquisition.
The purchase and financing of the accounts receivable of Federal's, Inc., has been accomplished through petitioner, rather than directly by Federal's, Inc., for the primary reasons that advertising and goodwill advantages were obtained by avoiding legal actions for collection in the name of Federal's, Inc. Similar advantages were obtained from the ability to attribute refusal of credit to rules imposed by a corporation other than Federal's, Inc.
All of the accounts receivable purchased by petitioner were sold to Manufacturers National Bank of Detroit, Mich, (hereinafter referred to as the bank). The sales to the bank were without recourse, under an agreement whereby the bank retained 10 percent as a reserve and remitted the remaining 90 percent to petitioner. If an account receivable was in default, the bank could retransfer such account to the petitioner and charge the reserve accordingly. The bank received a fee in the nature of an interest charge for financing petitioner's accounts receivable. Federal's, Inc., was a party to the agreement, but bore no losses on accounts receivable sold by petitioner.
Petitioner did the accounting for and collection of the accounts receivable sold to the bank, except that B.C.I. did the accounting for and collection of New York accounts receivable. When no payment was received on an account receivable for 6 months, when the principal debtor went into bankruptcy, or when, for any other reason, it was believed by petitioner that the account receivable would not be paid, petitioner repurchased that account receivable from the bank, except that B.C.I., rather than petitioner, repurchased and bore such losses on New York accounts receivable.
Petitioner included the amounts of outstanding accounts receivable sold to the bank in determining its bad debt reserve. Respondent, in his statutory notice of deficiency, disallowed the increases to the reserve for bad debts claimed by petitioner in the taxable years 1960, 1961, 1962, and 1963 in the respective amounts of $25,000, $83,002.66, $41,997.34, and $20,000. The parties have stipulated that if petitioner is entitled to compute its reserve for bad debts by reference to the accounts receivable then these additions were proper.
The soie question before us, therefore, is whether petitioner may compute its additions to the reserve for bad debts by reference to the accounts receivable sold to the bank and with respect to which respondent has conceded that petitioner was a guarantor, endorser, or indemnitor.
Section 166 of the Internal Revenue Code of 1954, as it existed during the years in question, provided as follows:
(a) General Rule.—
(1) Wholly worthless debts. — There shall he allowed as a deduction any debt which becomes worthless within the taxable year.
(2) Partially worthless debts.' — When satisfied that a debt is recoverable only in part, the Secretary or his delegate may allow such debt, in an amount not in excess o£ the part charged off within the taxable year, as a deduction.
(b) Amount of Deduction. — For purposes of subsection (a), the basis for determining the amount of the deduction for any bad debt shall be the adjusted basis provided in section 1011 for determining the loss from the sale or other disposition of property.
(e) Reserve for Bad Debts. — In lieu of any deduction under subsection (a), there shall be allowed (in the discretion of the Secretary or his delegate) a deduction for a reasonable addition to a reserve for bad debts.
In applying tliese provisions, the courts were in controversy as to the allowance of additions to reserves for bad debts claimed by taxpayers who had sold the debt obligations to others. In a series of cases, we held that where a taxpayer had sold its accounts receivable to a bant or other financing entity, even though the taxpayer remained liable as a guarantor, it was not entitled to take a deduction for an addition to a reserve for bad debts because the debts were not owing to it but to another. We maintained our position despite reversals by the Court of Appeals. See Wilkins Pontiac v. Commissioner, 298 F. 2d 893 (C.A. 9, 1961), reversing 34 T.C. 1065 (1960), Foster Frosty Foods, Inc. v. Commissioner, 332 F. 2d 230 (C.A. 10, 1964), reversing 39 T.C. 172 (1963), and Bolling v. Commissioner, 357 F. 2d 3 (C.A. 8, 1966), affirming in part and reversing in part a Memorandum Opinion of this Court; see Mike Persia Chevrolet, Inc., 41 T.C. 198, 202 (1963).
As the direct result of this controversy, section 166 was amended in 1966 by Pub. L. 89-722, 89th Cong., 2d Sess., which added, inter alia, subsection (g), providing in pertinent part as follows:
(g) Reserve for Certain Guaranteed Debt Obligations.—
(1) Allowance of deduction. — In the case of a taxpayer who is a Healer in property, in lieu of any deduction under subsection (a) there shall be allowed (in the discretion of the Secretary or his delegate) for any taxable year ending-after October 21,1965, a deduction—
(A) for a reasonable addition to a reserve for bad debts which may arise out of his liability as a guarantor, endorser, or indemnitor of debt obligations wising out of the sale by Mm of real property or tangible personal property (including related services) in the ordinary course of his trade or business; and
# # # # *
(2) Deduction disallowed in other cases. — Except as provided in paragraph (1), no deduction shall be allowed to a taxpayer for any addition to a reserve for bad debts which may arise out of his liability as guarantor, endorser, or indemnitor of debt obligations.
[Emphasis supplied.]
The amending legislation made subsection (g), under the circumstances of this case, retroactive to taxable years beginning after December 31, 1953, and ending after August 16, 1954. See sec. 2, Pub. L. 89-722.
Unquestionably, Congress clearly had the constitutional power to provide for such retroactive effect, since "the right to deductions in the computation of Federal income tax is a matter of legislative grace." See Estate of Harris Fahnestock, 2 T.C. 756, 759 (1943); cf. Paul H. Travis, 47 T.C. 502, 516 (1967), on appeal (C.A. 6, June 22, 1967). Under these circumstances, any reconsideration of our position as to the availability of a reserve for bad debts to guarantors, aside from the effect of section 166 (g), is effectively precluded.
We therefore confine ourselves to the applicability of section 166 (g). Paragraph (1) of that section requires that the taxpayer-guarantor be "a dealer in property" and that the obligations be those "arising out of the sale by Him of real property or tangible personal property." (Emphasis supplied.) Clearly, petitioner does not meet the statutory description. Such being the case, petitioner cannot escape the impact of paragraph (2) of section 166 (g), which specifically provides that, except to the extent provided in paragraph (1), no deduction shall be allowed for any addition to a bad debt reserve by a taxpayer-guarantor.
Petitioner seeks to avoid the effect of the statutory provisions by asserting that if Federal's, Inc., had sold its accounts receivable directly to the bank, it would have been entitled to the benefits of section 166 (g); that the indirect method of sale to petitioner and by petitioner to the bank was adopted for valid business purposes; and that, section 166(g) being remedial legislation, petitioner should be entitled to its benefits. Plowever sympathetic we may be with this line of reasoning, we cannot agree. Petitioner and Federal's, Inc., were valid, separate entities and, indeed, petitioner does not contend otherwise. Such being the case, certain tax consequences flow from this separation and the parties must take the bitter with the sweet. Interstate Transit Lines v. Commissioner, 319 U.S. 590 (1943); Moline Properties v. Commissioner, 319 U.S. 436 (1943). Perhaps the Congress should have included the situation involved herein, but the fact remains that it did not do so. By unambiguous affirmative and negative language, it expressly limited the scope of subsection (g) (cf. Paul H. Travis, supra) and we have no alternative but to apply its plain mandate. See, e.g., United States v. Martin, 337 F. 2d 171, 174-175 (C.A. 8, 1964).
Ill view of tb© foregoing, respondent's position must be sustained. Reviewed by the Court.
Decision will be entered wider Bule 50.
Respondent did likewise. Rev. Rul. 62-214, 1962-2 C.B. 72.
The committee reports leave no doubt that the Congress intended sec. 166 (g) to have limited applicability. H. Rept. No. 2157, 89th Cong., 2d Sess. (1966); S. Rept. No. 1710, 89th Cong., 2d Sess. (1966).
Respondent has confined its attack to the additions to petitioner's bad debt reserve and has raised no question regarding the treatment of petitioner's bad debt reserve as it existed on the first day of the first taxable year before us. Similarly, respondent has conceded the reasonableness of the amounts of petitioner's additions without regard to the fact that the bank's right to charge petitioner with defaulted accounts receivable seems to have been limited to the amount in the retained reserve.