Court Opinion

ID: 4478628
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:13:12.197375+00
Date Added: 2024-06-11T15:03:36.455360
License: Public Domain

Pieeoe, /., dissenting: The Court’s opinion on the first issue of the instant case has brought to the forefront again two questions of major importance in the operation of our Federal income tax system, on which the positions taken by this Court appear to be out of harmony with the weight and trend of Courts of Appeals’ authority. These questions are: 1. Whether, under the accrual method of accounting, amounts received in one taxable year which are admittedly the price of services to be performed in future years, must as a matter of law be included in taxable income only in the year when received; or whether such advance payments may, when handled in accordance with sound business accounting principles, be accounted for in the respective years when earned. 2. Whether, if the Court of Appeals for a particular circuit has decided a question of law (such, for example, as the question above mentioned) in such manner and at such time as to leave no doubt as to its present position, the Tax Court should, in deciding the same question of law in a case wherein its decision will (unless otherwise stipulated by the parties) be subject to review by said particular circuit, follow the settled law of such circuit. My dissent from the majority opinion in the instant case is directed to the positions therein taken with respect to each of the above questions. I. (A) As regards the first of said questions, this Court in deciding the first issue of the instant case, relied on a so-called “established rule” which it had developed and consistently applied in numerous other cited cases. It said: “[WJhere there is actual receipt and the funds are at the unrestricted disposal of the taxpayer, as is the case here, all the events have already occurred that call for accrual”; and it further said more specifically: “An item of income cannot accrue for tax purposes after it has in fact been received subject to the unrestricted use of the taxpayer. Income may accrue prior to receipt, but not subsequent thereto.” (Emphasis is the Court’s.) Such “established rule” is, in substance, an application of the so-called “claim of right” doctrine to the accrual method of accounting— although it was not here, as it was in several of the cited cases, so labeled. The following review of several of said cited cases reveals not only that such “established rule” actually is based on the “claim of right” doctrine, but also that this Court’s application of such “rule” is absolute and inflexible — even when such application conflicts with sound business accounting practice. Thus, in Krim-Ko Corporation, 16 T.C. 31 (1951), wherein an accrual basis taxpayer had received advance payments for advertising services to be rendered in subsequent years, this Court said: Having teen received under claim of right and without restriction as to disposition, they constitute income in the year of receipt or accrual notwithstanding that Krim-Ko or its successor might in later years make refunds or expenditures with respect to them. [Emphasis supplied.] Also in Curtis R. Andrews, 23 T.C. 1026 (1955), which is twice cited in the Court’s Opinion herein, the nature and inflexibility of such “established rule” is even more clearly shown. There a dancing school which employed the accrual method of accounting, received advance payments from students as the price for dancing lessons to be given over more than 1 year. This Court said: the partnership’s accounting system may well have “clearly reflected income” according to generally accepted commercial accounting practice. However, accounting practice must bow to established rules of law in the determination of taxable income. The “claim of right” doctrine is firmly established and must govern the result herein. We agree with the dissenting (rather than the majority] opinion in Beacon Publishing Co. v. Commissioner * * * . [Emphasis supplied.] Likewise, in E. W. Schuessler, 24 T.C. 247 (1955), revd. 230 F. 2d 722 (C.A. 5, 1956), wherein advance payments were received for personal services to be rendered over a 5-year period, this Conrt said: We agree that the principle upon which the Andrews case [quoted above] was decided is not in harmony with generally accepted commercial accounting practices; but, on the other hand, a contrary result, such as the one reached in the Beacon Publishing Co. case [C.A. 10] does not appear to us to conform to the firmly established “claim of right" doctrine governing the receipt of income and its taxability in the year in which received. * * * [Emphasis supplied.] (B) Several of the Courts of Appeals have reversed the Tax Court in cases dealing with advance payments for future services. They have indicated that, with proper accounting, portions of advance payments received in one period by an accrual basis taxpayer may be taken into income in subsequent periods; and that sole emphasis should not be placed on the receipt of the money. Bressner Radio, Inc. v. Commissioner, 267 F. 2d 520 (C.A. 2, 1959), reversing 28 T.C. 378; Bayshore Gardens, Inc. v. Commissioner, 267 F. 2d 55 (C.A. 2, 1959), reversing 30 T.C. 1292; Schuessler v. Commissioner, 230 F. 2d 722 (C.A. 5, 1956), reversing 24 T.C. 247; and Pacific Grape Products Co. v. Commissioner, 219 F. 2d 862 (C.A. 9, 1955), reversing 17 T.C. 1097. See also Harrold v. Commissioner, 192 F. 2d 1002 (C.A. 4, 1951), reversing 16 T.C. 134. Some of these cases dealt with a situation where the taxpayer’s regular accounting practice was to defer taking into income, portions of advance payments received for future service; and others dealt with a situation (which in reality is the opposite side of the same coin) where the taxpayer’s regular accounting practice was to set up a reserve in the year of receipt, to meet the estimated costs of rendering the services for which the advance payments admittedly were made. ISTo detailed review of the above Courts of Appeals’ cases is here presented, for their import can best be gathered from reading them in their entirety. It appears sufficient to state here that, while each case deals with different facts and approaches the general problem from a somewhat different viewpoint, all are consistent with one another. Emerging from these cases, when considered collectively, are the following principles: 1. That the “claim of right” doctrine has no proper application to the present problem of determining when advance payments of undisputed income should be subject to tax. 2. That the purpose of Congress, in authorizing the use of the accrual method of accounting, was to bring tax accounting into closer harmony with recognized methods of business accounting;1 and thus to permit a clearer reflection of income than had been possible when sole emphasis had been placed on the time of receipts and the time of disbursements. 3. That sections 42 and 43 of the 1939 Code, which define the periods in which items of gross income shall be included and in which deductions and credits may be taken, are sufficient to provide the flexibility which Congress intended to make possible under the accrual method of accounting.2  4. That permitting deferral of advance payments does not involve interference with the Commissioner’s broad discretion to require that taxpayers’ accounting methods shall clearly reflect income. It represents, rather, judicial correction of the Commissioner’s action in improperly applying a legal principle. 5. That any “rule” which requires advance payments for future services to be accrued in their entirety solely in the year of receipt, places undue emphasis on the receipt of the money; and in effect, it compels use of a hybrid system composed partly of the cash receipts method and partly of the accrual method. Such hybrid system may not clearly reflect the income. 6. That established accounting systems based on sound accounting principles, under which advance payments are deferred, should not be disapproved solely because they do not conform to the Commissioner’s application of the “claim of right” doctrine. It is significant that in the Pacific Grape Products Co. case, supra, several Judges of the Tax Court expressed impatience with the application of inflexible rules, to upset long-established business accounting systems. Judge Opper, in his dissenting opinion in which five other Judges concurred, said (17 T.C. at 1110-1111) : The practice of disapproving consistent accounting systems of long standing seems to me to be exceeding all reasonable bounds. * * * Methods of keeping records do not spring in glittering perfection from some unchangeable natural law but are devised to aid business men in maintaining sometimes intricate accounts. If reasonably adapted to that use they should not be condemned for some abstruse legal reason, but only when they fail to reflect income. There is no persuasive indication that such a condition exists here. On the contrary, a whole industry apparently has adopted the method used by petitioner. It will not do to say that respondent should not have disturbed petitioner’s accounting method, but that since he has done so, we are powerless to do otherwise. As long as we continue to approve the imposition of theoretical criteria in so purely practical a field, respondent will go on attempting to seize on such recurring fortuitous occasions to increase the revenue, even though he may actually accomplish the opposite. * * * I think it evident that petitioner’s generally recognized accounting system did not distort its income and that it should be permitted to continue to use it. * * * The above dissenting opinion was approved and quoted in full by the Ninth Circuit, in its reversal of the majority opinion; and said court further said: Not only do we have here a system of accounting which for years has been adopted and carried into effect by substantially all members of a large industry, but the system is one which appeals to us as so much in line with plain common sense that we are at a loss to understand what could have prompted the Commissioner to disapprove it. * * * This statement of the Ninth Circuit was thereafter quoted with approval by the Fifth Circuit in the Schuessler case, supra. Also, Roswell Magill who is one of the outstanding authorities on Federal income taxation, has indicated disagreement with the accrual in a single year, of amounts which are admittedly the price of services to be performed in future years. In his treatise, entitled “Taxable Income” (rev. ed. 1945) at pages 201-202, he said: The receipt of the money in a given year satisfied only half the statutory requirements; it remains to inquire whether, under accrual accounting, it should properly be accounted for in later years. • * * * * * Thus, an insurance company collects a premium in one year for insurance with a three-year term. The premium can hardly be regarded as earned in the year of collection, so the company reports only one-third of it as income in that year. Nevertheless, the relatively few cases which have involved the point have held the income to have been realized in full in the first year. [Earlier eases cited in footnote.] These decisions put an undue emphasis upon the receipt iof the money, an element which is the basic test of income under a cash receipts method, but which ought not to be under an accrual method. It is evident that such decisions, which would apparently treat a $1,000,000 down payment on a fifty-year lease as income in the year of receipt, lead to a gross and, it seems, quite unnecessary distortion of income. Moreover, they are inconsistent with the decisions denying to the lessee, on these facts, a deduction of $1,000,000 at the time the lease was made, and requiring him to prorate the deduction over the life of the lease. No controlling administrative reason for this bird-in-hand policy has yet been set forth; the inequities of the present decisions seem to overbalance the probable loss of revenue from some future insolvencies of taxpayers who have prorated these cash receipts. (C) The Supreme Court had an opportunity to pass upon the instant problem in Automobile Club of Michigan v. Commissioner, 353 U.S. 180; but it did not do so. There, both the Tax Court (20 T.C. 1033) and the Court of Appeals for the Sixth Circuit (230 F. 2d 585) had based their decisions on an application of the “claim of right” doctrine. But, as the Second Circuit aptly pointed out in Bressner Radio, Inc., supra: “[T]he decision of the Supreme Court was placed on the far narrower ground that the particular method of deferral adopted by the Club was unsatisfactory.” Likewise, Mr. Justice Harlan, in his dissenting opinion in which two other justices concurred, said: “The Court, however, now by-passes the Commissioner’s ‘claim of right’ argument, and rests its decision instead on the ground that the ‘pro-rata allocation of the membership dues in monthly amounts is purely artificial * * *.’ ” Moreover, it seems apparent that if the Supreme Court had believed, as did the Tax Court in the instant case, that under the accrual method advance payments must as a matter of law be included in income solely in the year of receipt, irrespective of the business accounting system employed — then the Supreme Court’s footnote 20, in which the particular accounting system in the Beacon and Bchuessler cases were distinguished, would have been unnecessary. Thus it appears that the present question is an open one, so far as the Supreme Court is concerned. (D) Based on all the foregoing, I believe that this Court in deciding the first issue of the instant case, erred in applying its inflexible “established rule” based on the “claim of right” doctrine; and that the present question of law, which is the threshold to any consideration of the petitioner’s particular method of accounting, should have been decided in favor of the petitioner. Thereafter, if the Court believed that any question regarding the adequacy of petitioner’s particular method of accounting was properly before it, it should have decided such secondary question, and should have developed the facts and reasoning to support its conclusion. See Gilbert v. Commissioner, 248 F. 2d 399 (C.A. 2), reversing a Memorandum Opinion of this Court; MacCrowe's v. Commissioner, 264 F. 2d 621 (C.A. 4), vacating and remanding 30 T.C. 653. II. The second ground for my dissent from the Court’s opinion on the first issue of the instant case, is that this Court failed to follow the settled law of the Court of Appeals for the controlling circuit. On May 28,1959, as hereinbefore pointed out, the Court of Appeals for the Second Circuit decided Bressner Radio, Inc. v. Commissioner, 267 F. 2d 520, reversing 28 T.C. 378. In said case, that court defined the question presented and described the actions thereon of the Commissioner and the Tax Court, as follows: The petition presents the question * * ’* whether or in what circumstances a taxpayer who has long employed the accrual method of accounting may defer the inclusion in income of prepaid revenues on contracts to render future services over a twelve month period subsequent to the date of receipt. The Commissioner asserted a deficiency * * * on tbe ground that “the method employed does not clearly reflect the income” of petitioner, § 41, Internal Revenue Code of 1939, and demanded the inclusion of all revenues in gross income in the year of receipt in place of the taxpayer’s pro-rata monthly deferral. The Tax Court agreed with the Commissioner * * * The Second Circuit tlien reviewed extensively the statutes and authorities bearing on the problem; and it made the following holdings: the petitioner’s “true income” would he distorted by the inclusion of the entire receipt in its year’s revenues [when received]. * * * * * * * with the sole exception of Automobile Club of Michigan v. Commissioner, supra, not one of these cases [pertaining to the “claim of right” doctrine] deals on the merits with the question of the propriety of the deferral of prepaid receipts, held without other restriction as to use than the liability to perform future services on demand. * * * [[Image here]] It is apparent from the decision of the majority [of the Supreme Court in said Automobile Club case] that at least for purposes of the decision of the case it assumed that a realistic deferral would have been permissible, and found only that no realistic deferral was made. It thus did not pass on the issue which concerns us here. * * * [[Image here]] Therefore there is no basis whatever in the cited cases for the Commissioner’s broad assertion that for tax purposes concededly unearned receipts must be regarded as income in the year of receipt, and there is nothing to indicate that in construing §§41 and 42 and their predecessors the Supreme Court has generally departed from the standard of sound accounting practice in determining what methods are authorized under § 41. * * * [[Image here]] In conclusion, petitioner’s regularly employed method of accounting on an accrual basis and its deferral of income so that it most closely matched the corresponding expenses clearly reflected its true income. * * * Tbe opinion was -unanimous; and tbe decision of tbe Tax Court was reversed. On tbe following day, May 29, 1959, tbe same court (composed tbis time of three different judges) decided Bayshore Gardens, Inc. v. Commissioner, 267 F. 2d 55, reversing 30 T.C. 1292. There, the taxpayer bad received payment of a premium on a 32-year mortgage loan, which it sought to amortize over tbe period of tbe loan. The court stated that tbe Commissioner’s argument, was “that because tbe taxpayer received the amount in question under a claim of right and without a restriction as to its disposition, it was income reportable when received.” Tbe court thereupon rejected tbis argument, and sustained the right of tbe taxpayer to spread tbe income. Here again, tbe opinion was unanimous; and the decision of tbe Tax Court was reversed. Notwithstanding the two above-mentioned decisions of the Second Circuit, and notwithstanding that any appeal from the Tax Court’s decision in the instant case lies within the jurisdiction of that circuit, this Court decided the first issue in reliance upon its so-called “established rule” which is based on the “claim of right” doctrine. There can be no doubt that the position taken by this Court in the instant case is in direct conflict with the position of the Second Circuit in the Bressner case, supra. Two Courts of Appeals have recently admonished this Court, in no uncertain terms, that its duty is to follow the settled law of the controlling circuit. Stacey Mfg. Co. v. Commissioner, 237 F. 2d 605 (C.A. 6, 1956); Sullivan v. Commissioner, 241 F. 2d 46 (C.A. 7, 1957). In the Stacey case, the Sixth Circuit said: the Tax Court of the United States is not lawfully privileged to disregard and refuse to follow, as the settled law of the circuit, an opinion of the court of appeals for that circuit. If the tax court is not bound on questions of law by decisions of the appropriate circuit having jurisdiction, why should any jurisdiction be vested in circuit courts of appeals to review decisions of the tax court? The district courts of the several circuits also have statutory jurisdiction in tax eases and they are bound to follow the rules of decision pronounced by the United States Court of Appeals having appellate jurisdiction over the particular district court. The tax court is no less bound to do so. The mere fact that it is a court having jurisdiction in tax cases throughout the United States does not establish the tax court as superior in any aspect to United States District Courts. The desire of the tax court to establish by its decisions a uniform rule does not empower it to disregard the decisions of its several reviewing courts of appeals. It is for the Supreme Court of the United States — and for that tribunal alone — to review and reverse decisions of the courts of appeals of the United States in their respective jurisdictions. Until the Supreme Court reverses p rule by a court of appeals for its circuit, that rule must be followed by the tax court. The statement of the Seventh Circuit, in the Sullivan case, supra, is to the same effect. No contrary statement of any appellate court has been found. The instant case does not present a situation, where the controlling circuit has not expressed its views on the particular question involved, or where a decision of the controlling circuit on such question is so old or so indefinite that the circuit’s current position may be subject to reasonable doubt. Father, the situation here presented is one where the controlling circuit has very recently considered, reviewed, and passed upon the identical question which the Tax Court has now decided in a contrary manner. I believe that this Court, in deciding the first issue of the present case, should have followed the settled law of the Second Circuit. And I further believe that, at least as to situations like the present, the views heretofore expressed in Arthur L. Lawrence, 27 T.C. 713 (1957), reversed on other grounds 258 F. 2d 562 (C.A. 9), should be modified. This is not to say that, if in a particular case this Court’s views are contrary to those of the controlling circuit, it may not properly state that its decision in such case will not be regarded as a precedent. It is my conviction, however, that under our judicial tradition this Court should not substitute its own views for the contrary settled views of the Court of Appeals for a controlling circuit.  H. Rept. No. 922, 64th Cong., 1st Sees., 19S9-1 C.B. (Part 2) 22-24.    Section 42, after providing generally that all items of gross income shall be included for the taxable year in which received, further provides: “[Ulnless, under methods of accounting permitted under section 41 [which includes the accrual methodli any such amounts are to be properly accounted for as of a different period.” Similarly section 43, after providing generally that deductions and credits shaU be taken for the year in which “paid or accrued” or “paid or incurred,” further provides: “[Ulnless in order to clearly reflect the income the deductions or credits should be taken as of a different period.”