Earl Warren: Number 380, Commissioner of Internal Revenue, Petitioner, versus John R. Hansen and Shirley G. Hansen, and Number 381, Commissioner of Internal Revenue, Petitioner, versus Burl P. Glover. Mr. McInnis, you may proceed.
Emmett E. McInnis, Jr.: May it please the Court. There is a general statutory problem presented in the Hansen case, and that is set forth in Section 41 of the Internal Revenue Code of 1939 which applies to the tax years in issue, 1951, 1952 and 1953. That Section is set forth in its entirety at page 11 of the brief for the respondent, and it sets the general ground rule here. The net income shall be computed upon the basis of the taxpayer's annual accounting period and further language in accordance with the method of accounting regularly employed in keeping the books of such taxpayer. That is the rule and the qualification follows. But, if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner, does not clearly reflect the income -- does clearly reflect the income. It is not for the opinion of the Commissioner to determine, in the first place, whether the method employed does clearly reflect the income, but for him, if it does not, to determine which one does. And, the basic argument for this respondent both before the Ninth Circuit where he won the unanimous decision and here is that his method of accounting does clearly reflect his income. He fears no question. There is no mystery in this case, nothing too complex to be analyzed and presented by affirmatively or in response to question.
Charles E. Whittaker: (Inaudible) the amount of the reserve (Inaudible)
Emmett E. McInnis, Jr.: They do, Mr. Justice Whittaker. As a memorandum account, not a -- an account taken into income or expense but only as a memorandum, just as the accounting of the General Motors Acceptance Corporation is a memorandum accounting.
Potter Stewart: Mr. McInnis, you told us these cases arise under the 1939 Code.
Emmett E. McInnis, Jr.: Yes, Your Honor.
Potter Stewart: There was no substantial change in the pertinent part of this language in -- in the 1954 Code, was there?
Emmett E. McInnis, Jr.: No change affecting this case in --
Potter Stewart: Affecting these cases.
Emmett E. McInnis, Jr.: -- in any way, according to my understanding.
Potter Stewart: Thank you.
Emmett E. McInnis, Jr.: The facts in the Hansen case require some clarification, hitting only the high points which are the core of the case. Yesterday, in the presentation of the facts, there was repeated mention of the facts of the Schaeffer case and of the Baird case and of a third case just recently decided, so recently that the opinion has not been printed in airmail services. That was the Wiley case. Now, we submit that the case before the Court, there are two, but the case before the Court in this consolidated action is the Hansen case and, in 30 minutes, Mr. Miller will be arguing the Glover case. And, I must point to the facts in the Hansen case in order to clarify exactly what is at issue now. There is no note -- no promissory note in favor of the dealer. There is no other commercial paper payable to the dealer and no account receivable arising out of this transaction from the retail auto purchaser to the dealer. The only contract in issue is one so easily found that we do not even require the index because it's the only gatefold in the Hansen record, and it is the Joint Exhibit 5E, the conditional sales contract. And, that one sheet of paper mirrors this entire transaction with but one exception. The exception is that there is a pre-existing general contract in this case not specific and in writing, but by course of dealing and by a dealer's manual not in the record because not useful to the record. In other words, there is a pre-existing contract between the dealer and the General Motors Acceptance Corporation which applies to all of his credit sales and did, in fact, apply to every credit sale in the three tax years at issue. But, the contract before the Court is this single contract which, we contend, is a single three-party transaction, and I shall develop that in detail. I want to point out, while referring to Joint Exhibit 5E, that the payments which the retail purchaser is required to make over the life of the contract, usually 18 months, sometimes 24, sometimes 36, in the years in question are to -- are payments to be made at the office of General Motors Acceptance Corporation. The amount of each payment is filled in and the place where it is to be paid is filled in and, while it does not specifically state that the payment is to General Motors Acceptance Corporation, that follows from the entire context and the practice. The payments are not to the dealer. The dealer has no account receivable from the retail purchaser. All he gets, he gets from General Motors Acceptance Corporation from this prior general background contract which, in this case, I have shown in the testimony of record, is a course of dealing. So that, there is no receipt of an account receivable, no promissory note, or other negotiable instrument payable to the dealer in the Hansen case. Accordingly, there is no sale of paper by the dealer to the finance company. It is true that, at the foot, at the base of Joint Exhibit 5E, there is an assignment of all rights in the contract by the dealer to General Motors Acceptance Corporation but, in view of the requirement that the payments be made at General Motors Acceptance Corporation and, in fact -- in practical fact, to GMAC, we view this as a recital inserted by the dominant party to the contract with the stronger bargaining position to make it perfectly clear that there is no retained right from this contract in the dealer accepting any right that may arise on his course of dealing with General Motors Acceptance Corporation.
Speaker: General Motors does consign this contract.
Emmett E. McInnis, Jr.: GMAC does accept the contract, yes. The --
Speaker: It does that?
Emmett E. McInnis, Jr.: Well, the -- their acceptance is in accordance with their contract with the dealer that they will accept all of his contracts --
Speaker: Under the basic contract.
Emmett E. McInnis, Jr.: Yes, their basic contract which is contingent upon their approval of the credit status, and they investigate it before this sale can be made.
Speaker: They're not a formal party in this piece of paper.
Emmett E. McInnis, Jr.: In effect, they are, I submit, formal parties to the paper but not in the sense of signing the piece of paper. They are named and patent parties.
Charles E. Whittaker: Do I understand you to argue that because (Inaudible) to say you made some interest in that?
Emmett E. McInnis, Jr.: Your Honor, only in conjunction with the fact that these payments are actually made to General Motors Acceptance Corporation which receives them month by month, takes custody and control of the entire payment.
Charles E. Whittaker: Are they doing the (Inaudible) the contracts between the dealer and the purchaser of the automobile and (Inaudible) that you can sell the notes as payable to your client?
Emmett E. McInnis, Jr.: That is the -- the practical effect of the entire course of dealing. It is not expressed as it is in several of the other cases before the Court where that contract between dealer and finance company is clearly specified. Here, there is a dealer's manual which is issued and it is partly a sales argument to the dealer to finance for GMAC, and counsel for the Internal Revenue Service has examined that before the Tax Court and we agreed that there was nothing specific enough to make it useful to the record. So, we rely upon the testimony of the accountant for the dealer and the dealer himself, appearing in the record in the pages following 30, as to the nature of the course of dealing and the contract itself. The accrual principle is a crucial importance here, and it is -- it is agreed by both sides to the suit that the -- a key case is the Spring City Foundry case on accrual of income. Income accrues upon fixation of right to receive.And, that has been developed a little further in the North American Oil Consolidated case, also cited in the brief, that there must be a claim of right or an enforceable claim to money in order for it to be income -- to accrue as income to the recipient. He doesn't have to receive it, but he has to have a right or an enforceable claim to receive it. And, we submit that this dealer has no fixation of right to receive the reserve at the time the car is sold and he cannot acquire that right by anything else than the satisfaction of -- over a period of many months of the specific contingencies to which his right to any of that reserve is subject, and there are three of those contingencies. Yesterday, the statement was made that there is only the chance that the debtor, the retail purchaser, will be unable to pay. There is, of course, the chance that he might be unable to pay. There is also the chance that the chattel will be destroyed, and this is a conditional sales contract with, title to the chattel retained in the seller, the dealer. So that, recourse to this chattel, under the conditional sales contract, might prevent a loss otherwise chargeable to the reserve under the contract between the dealer and the finance company. And, that destruction of chattel in the language of the dealers is referred to as “accelerated depreciation or premature depreciation” and it occurs when a purchaser on credit is involved in an accident which demolishes the car. Then, very abruptly, this chattel has depreciated in value below the remaining debt upon the car and recourse to the chattel sold by the conditional sales contract becomes impossible. There is a third contingency, and that is the contingency of pre-payment. In our blessed land, many of the credit purchasers of cars receive Christmas bonuses or, in other ways, are able to pre-pay their conditional sales contracts and, when that is done, this reserve, this memorandum account on the books of General Motors Acceptance Corporation must be -- there must be subtracted from this reserve the amount of unearned interest which is lost by the pre-payment. For by pre-paying, the retail purchaser saves the unearned interest upon his contract, and this results, as the testimony of the dealer shows in the record, in loss to the reserve through prepayment. It is not merely hardship upon the potential inability to pay, but it is ability to pay and to prepay that diminishes the reserve. So, there are specific concrete contingencies which decrease the size of this memorandum account, this unearned interest, upon the books of General Motors Acceptance Corporation. The nature of this dealer's reserve is part of the finance charge. It is unearned income, a memorandum contingent credit. It is due -- it is not even due at the sale of the car. It is due in monthly installment payments of a specified amount in the filled-in blank on Exhibit 5E. It's due month by month and not at the time of sale and it is, in the accounting concept, unearned or deferred income. Like next year's salary or a salary of man, like the patronage refund credit in long poultry -- in the Long Poultry Farms case cited in my brief, like the unearned insurance premium in Leedy-Glover Realty or the oil drilling payments in Commissioner versus Edwards which is one of a number of useful cases cited in the brief amicus filed herein by the National Automobile Dealers Association. There is a line of cases there, starting with page 9 and going through page 14, which is useful but cumulative upon this principle. There are summarily unearned advertising commissions in the Telephone Directory Advertising case. There, too, the concept of unearned income. Now, there is no constructive receipt. This theory has been given, perhaps, undue importance here, in the light of the language of the court below, pointing out that the doctrine of constructive receipt pertains to a cash basis taxpayer and not to an accrual basis taxpayer, that the accrual basis taxpayer is governess to accrual by fixation of the right to receive by enforceable claim of right. But, even if we disregard this accounting distinction, there has been no constructive receipt here anyway under the terms of the Treasury's own Regulation 118 which points out that, in order for there to be constructive receipt, the income must be available to the recipient. It must be within his power and control or subject to be drawn upon by him at any time. And, the testimony of the dealer and of his certified public accountant in the record in the Hansen case makes it clear that he could not draw upon that money and had no access to it. This testimony was unrebutted, was not compromised upon cross-examination. Glancing at the very bottom of page 37 of the Hansen Record, the certified public accountant had this to say. “No, there definitely was not, in my opinion, any constructive receipt of income until he was paid the money. He had no access to it in any way until General Motors decided to pay it. He might have had and did and have -- he might have had many thousands of dollars and did have many thousands of dollars predated to this reserve. But, as far as his ability to even borrow against it or receive it in any form, he had absolutely no privilege or recourse to it at all.” “When did such a right accrue to him?” “When General Motors Acceptance Corporation set him -- sent him a check for the amount that they decided he should have of that reserve.” And, in passing, let me point out that any amount to which he was entitled under his contract with GMAC was excess over the 5% cushion. This was the question suggested -- or this was suggested by the question from Mr. Justice Douglas, yesterday, as to whether he was certain ever to get the 5%. The answer is that General Motors Acceptance Corporation, in its day-to-day accounting experience, cited that 5% was about what those losses would run. 5% of the total contracts outstanding for this dealer's customers and that they required that to be kept there for their own protection and safety. It was a genuine reserve against loss and not a reserve of profit. That 5%, in all likelihood, would never get to the -- or could never be paid to the dealer unless he went out of business and all of the debts were closed out -- all the contracts were closed and then there was something left, but it's the excess over.
Charles E. Whittaker: (Inaudible)
Emmett E. McInnis, Jr.: It is, Your Honor. And, I might mention that it is unilaterally variable by the dominant party. This is not of the record, so, I shall not express it further. But, there is testimony in the record, however, at the very outset in the Tax Court as to the nature of that agreement. “Can you tell us in some detail just what” -- on page 30 of the Hansen record, at the top, testimony of John R. Hansen. “Can you tell us in some detail just what happened when a customer purchased a car upon credit for you -- from you in those years?” “Well, we figured the cash price on the car, deducted his down payment, and then computed what the finance cost would be on the unpaid balance and what the monthly payments would be. And, in any event that the contract was paid up in advance, he would get a rebate on the finance which would be charged both to my dealer reserve and to General Motors Acceptance Corporation.” And, perhaps more effectively, here on the following page 31, “Well, we have more reserve for the more outstanding we have and, as the outstanding goes down, well, they give us anything in excess of 5%.” “Was it 5% of outstanding conditional sales contracts in the three years at issue 1951, 1952 and 1953?” “Yes.” That is the limit of the participation by the dealer and is set forth, actually, in the oral testimony in the record which is briefed.
Charles E. Whittaker: Then, I would like (Inaudible) What is the difficulty in bringing (Inaudible) in the situation where (Inaudible) to sell the note to the finance company for its face amount and, then, under some collateral (Inaudible) by the dealer who is selling (Inaudible) requirements of his undertaking in that collateral (Inaudible) Do you understand what I'm asking you?
Emmett E. McInnis, Jr.: Yes, I do. I believe that --
Charles E. Whittaker: Is there a difference?
Emmett E. McInnis, Jr.: I believe that there is -- that the difference lies merely in the clarity and strength of these facts and that it is a -- that, in both situations, I believe that the dealer is entitled -- is entitled to treat this as unearned income rather than as earned income. And, that takes us squarely into the point of constructive receipt which was argued, “Is there a constructive receipt of income by virtue of the argument that, sooner or later, this reserve must either be paid in cash to the dealer or must satisfy an obligation of the dealer to the finance company?” That is a persuasive and a rather formidable argument, at first conjecture, and here is how it is to be met. Let us take a hypothetical question. If A warrants that B will pay C, whereupon A becomes contingently liable for the payment as secondary liability in case the party primarily liable does not pay. If A warrants that B will pay C and B does pay C, then, has A received taxable income?Our answer is of course not. He had merely avoided a potential liability which never became a liability. He is in the same position as counsel descending the staircase of a building who may stumble. If he falls, he may incur -- he will incur a potential liability for hospital expenses. But, if he catches his balance, he avoids that future or potential liability. Has he received -- has he accrued taxable income merely because he succeeded in not falling? He has avoided a future loss and it is not a present or existing liability that has been avoided, but a possible future one at a later date. Does that satisfy the line of inquiry, Mr. Justice Whittaker?
Charles E. Whittaker: Well, I understand -- I understand your logic, but what if I go into the facts even though there will be $1000 as to that (Inaudible) and I endorse that you agreed to it and I endorse it in blank. (Inaudible) What they say as the condition of agreement, we asked you to pledge with us, under a collateral agreement, some amount of money to secure the requirements of any liability it may have as endorser. Now, then, have I not received the full purchase price of the notes and then taken from that fund or some other funds, money required by the bank and deposited with them your obligations as endorser?
Emmett E. McInnis, Jr.: We distinguish that, Your Honor, as a distinct case for the reason that this is, as held below, a single three-party transaction, as I would like to develop right now. There have to -- there are and there have to be, in realistic absolute practical substance, three parties to this conditional sales contract. The reason why is that the purchaser on credit doesn't have the money to pay for the car. The dealer cannot buy the car and sell it on credit directly. That would be the bank situation where he would have a -- an account receivable. He can't do that because he doesn't have the money and the facts and testimony show that he never made a credit sale in three years that way. So, there has to be someone to supply the money, and that is the finance company, General Motors Acceptance Corporation. The retail purchaser buys two things. He buys a car from the dealer whose job is to secure the car and to sell it, and he buys credit from General Motors Acceptance Corporation by this very contract and the underlying contract. And, the General Motors Acceptance Corporation sells credit for a finance charge and the dealer sells the car for the price of the car. Now, he gets the price of the car in trade-in from the purchaser or down payment, partly, and the rest of the price he gets by return mail from General Motors Acceptance Corporation. The reserve is a contingent added consideration to the dealer for doing business with General Motors Acceptance Corporation rather than with some other source of credit. So, there are three parties to the one contract, and it is a single contract and not a two -- a two-transaction hypothesis or not a two -- a double-transaction of sale of a car and then sale of paper. It is simultaneous. General Motors Acceptance Corporation appears on the face of the contract. In every credit sale through the three years in issue, it was General Motors Acceptance Corporation, and the retail purchaser knows it because his obligation is to go there and pay his money each month for 18 or 36 months. Respondents never acquired an account receivable from the purchaser because this was a single three-party transaction and that is a point just made. Now, the point as for the rather formidable suggestion has been made that this case, as argued and as established in four Circuits already in favor of the taxpayer, would destroy the accrual concept of accounting or would endanger the accrual concept with danger to the Federal Treasury. But, this is not so because this is consistent with the accrual concept. It does not, in the first place, affect the great volume of sales on credit. Let us take a two-party sales on credit where the seller is also the creditor. If a man buys on open account from a department store, he owes the department store and, certainly, the department store must accrue what he owes. But, this is a situation with a third party supplying the credit under distinct and under contracts which make the obligation to the third party. Income will still accrue in the normal debtor-creditor transaction and will still be taxable as it accrues, but not before. The case authority supports the dealer taxpayer strongly, as pointed out in the brief for respondents. The Blaine Johnson case in the Fourth Circuit, with two cases following it, decided upon stipulation without oral argument or briefing, the Texas Trailer-coach case in the Fifth Circuit, with four cases following it, again, on stipulation without oral argument or briefing. West Pontiac, Modern Olds, Kilborn, and Hines-Pontiac, these, I suspect, conform on our side to the Wiley case, so recently decided in the Sixth Circuit following the Schaffer case on the other. It's only conjecture, however, since the printed opinion is not available to counsel as yet. The Glover case in that Eighth Circuit establishes the same rule for the Eighth Circuit as the Hansen case before the Court now in the Ninth Circuit. There are other earlier cases which are closely similar in principle, and are set forth in my brief at page 18 and 19, dealing with asbestos retailers' reserves and, again, a maintenance percentage on paving contracts. The only reason why the facts of these are not drawn before the Court is that there is a limitation of time and attention imposed by the time. I want to make a point of the inconsistent tax treatment of the other parties by the Internal Revenue Service. It's consist -- it is correct tax treatment but it is inconsistent with that which has been imposed upon the dealers. What about the retail purchaser? He is going to be paying interest on this purchase on his borrowing, his credit. He's going to be paying at over 18 or 24 or 36 months in equal installments. What does the Commissioner let him do? He has a choice. He either declares -- he can either deduct his interest expense as he actually incurred, or he can capitalize all of his interest expense as part of the value of the car and then amortize it over the life of the car under ordinary amortization rules. So, he can't deduct all these interests at the date of the sale and the finance company is not required to declare its part of the -- of the finance charges as income at the date of the sale. The finance company is allowed to treat his income a proportionate share of the interest as each payment is made by the purchaser month by month, perhaps, for 36 months on a 30 -- on a three-year contact and for longer in a trailer coach contract. The finance company has as -- accrues his income by the permission of the Commissioner, as shown in the Motor Securities case, only the interest as the interest is earned. And, the purchaser can deduct it only as the interest is incurred and, yet, the dealer is asked to pay income tax on interest which is not earned and which he may never receive because of losses chargeable to it before he has any fixed right to it. There is a -- an inconsistency. My portion of the time is up and I shall submit to the Court. Thank you.
Earl Warren: Mr. Miller.
William S.Miller, Jr.: Mr. Chief Justice, may it please the Court. There are three distinct cases here and, because of that fact, it is necessary to distinguish particular facts in the cases. However, before going to the distinguishing or different facts in the Glover case, I should like to ask the Court's attention to the question of what is the issue here. Yesterday, counsel for the Commissioner has argued and questioned from the Court today indicate that there are some concern over the face amount of the note originally signed by the customer. And, I -- the Government, in brief, has intermitted if not alleged that some portion of that has, by these dealers, been sought to be omitted from income. And, at least in the Glover case, I wish to set clear the fact that the statutory notice in that case which set this proceeding underway refers only to the reserve which is set up under a contract between the finance company and the dealer. That is all that was alleged to have been omitted, a portion of that reserve. That reserve is something completely separate from a part of the price over here.The service charge or finance charge, if you would call it that, or carrying charge or interest charged to the customer is not the same thing as the contract agreed finance withheld -- financing charge withheld or reserve by the finance company. It's not the same thing, although they may be part, and we allege they all are part, of one intrical transaction. They are not identical. And, in its -- in his petition, Mr. Glover referred only to the reserve and alleged that the Commissioner had erred in seeking to tax the entire reserve, the amount he was entitled to collect, as well as the amount which he had no right to collect. So, the only issue involved in the Glover case is this portion of the reserve which is referred to as the amount under 3% of total outstanding notes of this dealer. That part was omitted from the tax return and was deferred. Not only is the amount of the price charged to the customer, the credit price or the total credit prices for the entire calendar year involved, not only are they not in issue, they're not in evidence. And, there is no amount of customer price that can be litigated in the Glover case. The only amount is, and I would refer to the record at page -- the Glover record at page 10 and point out what the Government disallowed in -- that started this case under little a -- under Schedule 1a, explanation of adjustments. In your return for the taxable year, $8026.85 in finance reserve was included in the net profit. It -- and, skipping down, the $8000 somewhat represented a portion of $11,000 credited on the books of the finance company, less the $3885 which is the reserve which, we contend, we're not entitled to. It has been determined that, in as much as you reported income on an accrual basis, the entire amount is now reportable, the additional $3885.71. I submit that has nothing whatever to do with the original credit price on the original notes signed by the customers of Glover in any of these taxable years. So, the issue is really, is Glover to be taxed on the amount of the reserve which is withheld under the contract? Now, turning to the distinguishing facts in the Glover case, there is only one finance contract and it is in evidence. It is with C.I.T. Credit Corporation. And, under that contract, which is printed in full at record page 33 -- 23, I'm sorry, under that contract, Glover assigned his notes without recourse with respect to all, except commercial cars. And, at page 24, you will see that Glover received from the finance company not the entire amount as was stated by Government counsel yesterday. It was stated that he received the entire amount with the exception of the reserve. But, as a matter of fact, the finance company, of course, makes something o these transactions. The face amount of a note is already signed by the customer.The note is assigned without recourse. At paragraph 4, the language appears you're -- that C.I.T. rate charges will include, for our protection, reserves as outline in your reserve arrangement, effective at the time paper is purchased by you. Now, that provides for a variable reserve which is withheld from the dealer at the instance of C.I.T.and solely under its control. And so, that would vary according to the value of money or to whatever charge they wanted to place on the dealer. Probably, it was affected by his bargaining power, his credit rating. But, it was variable. However, the dealer's right to a portion of this reserve remained constant throughout these years and provided that three times in each 12-month period, if we are not then indebted to you, you, C.I.T., will pay us our accumulated reserves in excess of 3% of the then aggregate unpaid balances on paper purchased from us. Now, lets again see what the real issue is. 3% of the aggregate unpaid balances of all notes then payable under this arrangement, the Court should understand that this includes notes from last year and, possibly, the year before, as well as the current year. Once that portion of the reserve is placed in the pot, so to speak, the retained reserve, it becomes -- it loses its identity and it's affected not by a particular customer who's paying his account, but by all customers that pay their accounts and by all new sales which a caused an increase in the outstanding notes of Glover, so that this issue refers to an amount which arises not only in the current year, but from accumulated transactions in prior years. It should be pointed out also that this contract to which I have referred in the record existed prior to any sale in any of these taxable years. The amount charged and placed in the reserve, the rate is not as shown because it is variable. The 3%, you will note and that's -- I am repeating here, refer -- refers to a percentage of unpaid balances and not a percentage of that particular contract. But, the contract with the finance company preceded and antedated any receipt of a note from a customer, and we therefore contend that the contract itself is controlling. And, we cite this simple example. If a dealer discounted -- received a $1000-note from a customer, its face value, and discounted it with the bank, as Justice Whittaker has suggested, and received $950, if that's all that occur, that taxpayer under any rule of accounting would have net taxable income of $950 in that year. He would have gross income of $1000, a business expense of $50, and he'd have net taxable income of $950. In these cases, when you boil them down, you have one additional factor only and it is, in my opinion, the answer to Justice Whittaker's question, and I'll come to that again in a moment. The additional factor is not that the dealer voluntarily antis up something to guarantee the finance company against loss, but that, under the contract, the finance company gets the whole $50 and they say, “However, it's ours. However, if certain things happen in the future, we may give you back part of what is ours.” Now, that, I think, is the answer to the difference between where the dealer voluntarily puts something up to protect someone and where, by contract, the finance company has it all and says, “If certain things happen in the future, I'll get part of it back.” And, that's the contingency which we say, under the ordinary accrual method of accounting, entitles us to defer until the contingency is realized and we have the right to that extra amount.
Charles E. Whittaker: Is it true, Mr. Miller, every bank to allow the agreement to -- that you know anything about or, at least it seems to me, that I know anything about that if I put up money or collaterals under a collateral agreement with a bank to ensure obligations that may accrue against me on notes of conditional sales contracts I have transferred to the bank, then, at the end of the transaction, what has not been properly deducted from this collateral deposit I have made necessarily comes back to me because it's always been mine and it's been simply pledged as collateral to secure my obligation?
William S.Miller, Jr.: I think that the answer to the question is in just what Mr. Justice Whittaker just said that, in a pledge, the chattel, the collateral is mine pledged to the bank for a purpose. In the case that we have here, we contend, in the Glover case, the reserve is the finance company's until certain things happen, and then, they pay us.
Charles E. Whittaker: Now, isn't that the question for decision?
William S.Miller, Jr.: I think it is, Your Honor, and that that is our contention and not that some portion of the original note from the customer has been omitted from income, as counsel for the Government would speak to, as we say, twist the issue. I think that that is the issue and, in line with that, the contingency -- whether or not there is a substantial contingency which prevents us from having present control of that retained reserve is, I think, covered by the Government's own regulations on that point which appear in Government's brief, in the appendix, page 65. It is Treasure Regulation 111 under the Internal Revenue Code of 1939 which first states on page 64 that the time as of which any item of gross income or any deduction is to be accounted for must be determined in the light of the fundamental rule that the computation shall be made in such a manner as clearly reflects the taxpayer's income. And then, on page 65, down approximately 15 lines, a taxpayer is deemed to have received items of gross income which have been credited to or set apart for him without restriction. Now, we contend that the Government's own regulation states that if there are restrictions on the right of the taxpayer to receive an amount set apart for him, then it is not presently accruable. The contract in the Glover case, if you will note again paragraph 4 on page 24 of the Glover brief, in the last part of that paragraph, the question should be asked. At the end of the year, the first year, let's take the first year when the $3885 was omitted by the taxpayer as not being then subject to his control. It represented 3% of outstanding notes. In any court of law, could Glover have then gone in and receive either a judgment for a declaratory, or otherwise, for that amount at that time? Government has argued that this should be done on an annual basis. We agree. At the end this year, under this contract arrangement, Glover could not claim any part of the amount below 3%. That's all he has omitted from his income and excluded. He has deferred it because the contract says, “Three times in each year, if you are not indebted to us, we will give you the amount above 3%.” It's silent about his right to the amount below and, as pointed out by previous counsel, only if he goes out of business sometime in the future can he ultimately, in the absence of losses, collect it. So, we say, not as Government counsel has said, only two things can happen either he will get it in cash or it would be applied against his obligation. We say that completely jumps over the primary contingency that he may never get it at all and he has no present right to it under the specific language of the contract between the parties.
Charles E. Whittaker: But contract between the -- by that statement, you mean, the contract between the dealer and the finance company?
William S.Miller, Jr.: Yes, sir.
Charles E. Whittaker: The one that preceded this -- the sale in question?
William S.Miller, Jr.: If the Court please, the statutory notice, the petition, and the Court's own questions, I believe, and our response have indicated the only thing in issue is a portion of the reserve. Does the customer have any control over that reserve? None whatever. It's solely within the control of the finance company and, ultimately, the dealer under certain contingencies. That's the only issue in the Glover case. That's all that was raised by the Government initially. Nothing else is before this Court is our contingent and that, under that contract, that reserve account is in the control inexorably of the finance company until these contingencies occur, and it did not occur in the taxable year. We only excluded the amount that was subject -- not subject to our withdrawal or use because it cannot even be applied to our obligation unless we got a right to it. That's -- that's primary and elementary. If we had no right to it, they would sue us for it. They wouldn't apply it against the reserve. The Commissioner's argument, if the Court please, really goes to the amount of this reserve account and not to the right. They don't rely, really, on Spring City Foundry case which they cite, but they argue about the amount as ultimately going to be realized. But, that's not the question of immediate taxability under the accruable system of accounting -- accrual system. The question is the right to it, not whether the amount is fixed, but the right to it. And, we contend, of course, that even the amount is indeterminate in the calendar year, but the right to receive it does not exist in the calendar year. The Motors Securities case, cited in the brief, brings out the point that Mr. McInnis mentioned that the finance company doesn't take into -- take into income the finance charge from the customer until they receive it, and that certainly is an inconsistency. In conclusion, I would like to reiterate the legal principle upon which we rely. First, we rely on the -- on the fact that the issue refers only to the finance account, the reserve, and not to something with the -- with the original customer, and the finance company has control of that account. And, the legal principle that the taxpayer had no right to that $3885 in similar amounts in the other years determines this case. Furthermore, we contend that the sales on credit and the financing contract should be viewed as a whole because, before that credit is given, it must be approved. On page 23 of the brief, the first sentence, the second line, “You propose to buy from us on a basis stated in this agreement paper acceptable to you” which indicates that C.I.T. must approve each transaction before the customer signs the note. So, it is an integral three-party transaction. And, in fact, it was most strange to hear, and I'm not arguing that the dealer does not have a legal right to collect that note when it's signed. I don't think that is controlling. I would concede that he does. But, the transaction should be viewed as a whole because, as a practical matter, it is one three-party transaction and, as I was saying, it is strange that the Government would argue that this should be itemize into separate transaction in the view of their long-established and contented position in the Court Holding case and others that we should not take a business transaction and split it up into a group of separate parts and treat them as independent. In fact, it reminds me of what Isaac once said, “The voice is Jacob's voice, but the hands are the hands of Esau.” I think it would not be uncommon that the Government would be back here on the other side of this question of itemizing this transaction and treating it as separable independent steps.
Speaker: Do your basic contract in -- between C.I.T. and Glover, is that in the record?
William S.Miller, Jr.: Yes, sir. That's the contract I've been referring to, Your Honor.
Speaker: I known -- I know you've been referring to it, but I understood Mr. McInnis to say that his was not.
William S.Miller, Jr.: That's correct. But, in the Glover case --
Speaker: Is there any reason why we --
William S.Miller, Jr.: -- the basic contract --
Speaker: -- shouldn't have them in both cases.
William S.Miller, Jr.: Sir?
Speaker: Is there any reason why we shouldn't have them under Mr. McInnis' case?
William S.Miller, Jr.: As I understand it, --
Speaker: That's what I'm going to ask you.
William S.Miller, Jr.: -- his contract is a course of dealing and not a written agreement, Your Honor.
Speaker: I beg your pardon?
William S.Miller, Jr.: I understand that, in the Hansen case, the contract exists under a course of dealing, not a written instrument, the basic contract. In our case, the basic contract between the finance company and the dealer is in evidence because we consider that's the only thing in issue, not the contract with the customer because that's not what the Government raised when they filed the statutory notes. And, finally, on the legal principles, we contend that Section 41, which is cited by the Government in the appendix at page 60, the general statute applies here and that the taxpayer's method is correct unless it fails to collect correctly state income. And, in that connection, I want to refer once more to this argument that, since the amount might sometime in the future be applied to an obligation, it must now be approved. That argument is, it seems to me, fallacious, in that, it would cause a distortion of income. First, in the year in which you -- you were required to take the income into account before you have the right to get it. It distorts income, over states it. And then, in the later year, when your right to the income actually accrues and you apply it against an obligation, then you will -- because you've already been required to take the income into account, you will take into account a deduction and understate your income. The argument of the Government would cause a distortion at two points, the first time and then at the time that the obligation is actually satisfied from a reserve to which you then had the right. And, we submit that this case -- in these cases, the taxpayer's method of accounting has correctly reflected income.
Earl Warren: Mr. Rothwacks.
Meyer Rothwacks: May it please this Court. I should like to say, at the outset, that I am grateful to counsel for calling my attention to an apparent misstatement of mine yesterday. The Government, of course, does not contend that all of the so-called finance charges eventually come into the pocket of the dealer. It's obvious that only a portion of the finance charge does. Now, first I'd like to say that, in effect -- in effect, and not without some reasonable basis from their point of view, in effect, counsel on the other side are asking us to accept, for tax purposes, a view of these situations which their accountants would urge upon them. Now, while the conclusions drawn by my brothers may be reasonable from an accounting point of view, they're not necessarily conclusive from a tax point of view. This Court, of course, had said so at least on two occasions. In Weiss versus Wiener, this Court said that income tax laws do not profess to embody perfect economic theory. They ignore some things that either a theorist or a businessman would take into account in determining the pecuniary condition of the taxpayer. And, in the Baisely case, this Court says that the form of the transaction, as reflected by correct, and I emphasize, as reflected by correct corporate accounting, merely opens questions as to the proper application of a tax statute, it doesn't close them. Now, what, in substance, is involved in these cases? As was mentioned yesterday, long prior to the first litigated case on this question, the Shoemaker-Nash case in 1940, the Commissioner had a simple, clear, understandable, administrative position and practice with respect to this issue. The first, GCM was in 1931. Along came a ruling in 1957 which reaffirmed it but which was, in a sense, clearer than the prior GCM because it set forth, from the industry point of view, from a nationwide point of view, from a trade practice point of view, what is involved in these cases? And, I'd like to read two or three sentences of that ruling because this is what the Commissioner determined was the essence of the transactions in the business situation which with -- with which we are here concerned.
Earl Warren: Is this the 1931 or --
Meyer Rothwacks: This is the 1957.
Earl Warren: -- the 1957?
Meyer Rothwacks: This is the 1957.
Earl Warren: 1957.
Meyer Rothwacks: In explaining what happens in these transactions, the ruling said, “when a car is purchased on credit from a dealer, the purchaser makes a down payment either in the form of cash or by turning in another car in an agreed value, the balance being satisfied by the purchaser's promissory note and a supporting conditional sales contract.” And, now comes the important sentence, and I think this must be true with respect to all of the transactions involved here, as they are with respect to the transactions involved in the thousands of situations of this kind that are entered into annually over the country. “The face amount of the note reflects two elements, not one, two elements. The balance of what would be the purchase price of the car and, the second, a finance charge.” Now, in those situations in which the dealer signed a contract with the purchaser and executed a note, the note was sold to the finance company. In the situation, as in the Hansen case, where we're not dealing with notes but a conditional sale contract, we have, as Mr. Justice Whittaker pointed out, we have a contract and the contract -- the parties in the contract are the dealer and the purchaser. Now, it's, of course, true that the collateral arrangement between the parties may call for the payment of the amounts over the cash purchase price. The deferred amounts may call for payment to the -- at the locale and to the finance company. But, insofar as the contract between the parties are concerned, there are only two parties the dealer and the purchaser. And, the contract in the Hansen case obligates the purchaser to pay what is called in the contract “at designation eight,” a time-deferred balance, and then we have a completely separate document. True, it's on the same sheet of paper, but it involves two other, that is, it involves two parties, and they're not the same parties as were involved in the conditional sales contract, involved a dealer and the finance company. Now, why has this practice grown up? The Government has taken care to set forth, rather voluminously, in some footnotes to its brief found at page 44, articles that are written, three, I think they are, that were written in the Indiana Law Journal which indicate -- make it very clear that the arrangement between the dealer and the finance company was this. You do your business with your purchaser. You get your price set with him. You had a finance charge and, if you will then sell us your purchaser's obligation, we'll rake you in, so to speak, on part of the finance charge which, under other conditions and except for our understanding, would go entirely to us. So that, as even the Hansen opinion conceded, the finance charge was worked into, and this is the language of the Hansen opinion, the finance charge was worked into the sales price. And, part of that sales price was the amount that was reflected in the dealer's reserve account set up in favor of the dealer. Now, as I said yesterday, the uncertainty, if there was any, that the dealer would not receive the full amount in those credits could arise only because there would be either a default on the part of the purchaser, which was an uncertainty no greater than the uncertainty in any commercial transaction of any kind, where it is always possible that the debtor may not be able to perform. And, the second uncertainty was that in those very fortunate circumstances in which the purchaser found himself able to prepay, that if there was a reduction in the finance charge, which would then be owing by the purchaser to the finance company, there would be a corresponding offset in the credit. Now, that doesn't affect the situation, as far as the accrual principle of accounting is concerned. In the first place, one would have to examine these records with a microscope to find any real indication that the incidence of prepayment was so great as to cause any major degree of uncertainty. In the second place, even if it was great, under the accrual system of accounting, if the dealer lost anything by virtue of a depletion of the reserve, then he would be entitled to a deduction for a loss in the year in which that loss occurred. Now, I think I've used practically all my time. I think that is the basic situation before us. The emphasis of the taxpayers is upon what they call the “contingencies” or the probabilities that the purchaser would default and that the dealer would then have to step in to the breach and make the finance company whole. Of course that's true but, from our point of view, we say it's irrelevant to this issue, irrelevant to this issue. We think this case doesn't involve contingencies in the sense in which the taxpayer dealers refer to them. We think this case involves only the question, are there such uncertainties that this dealer will not receive the amounts credited to him which were part of a note payable to him in a prior separate transaction. Are there such uncertainties that this Court cannot say -- or that this Court must say, rather, such uncertainties that -- that there can be no question of accrual? We think the records in no way would support that hypothesis.