Filed: May 25, 1999
Latest Update: Mar. 03, 2020
Summary: 112 T.C. No. 19 UNITED STATES TAX COURT GENERAL MOTORS CORPORATION AND SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 27026-96. Filed May 25, 1999. GM and GMAC are members of a consolidated group. GM manufactured motor vehicles. GMAC financed motor vehicles. Held: The consolidated return regulations in issue constituted a method of reporting and not a method of accounting. Henry C. Beck Co. v. Commissioner, 52 T.C. 1 (1969), affd. per curiam 433 F.2d 309 (5th
Summary: 112 T.C. No. 19 UNITED STATES TAX COURT GENERAL MOTORS CORPORATION AND SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 27026-96. Filed May 25, 1999. GM and GMAC are members of a consolidated group. GM manufactured motor vehicles. GMAC financed motor vehicles. Held: The consolidated return regulations in issue constituted a method of reporting and not a method of accounting. Henry C. Beck Co. v. Commissioner, 52 T.C. 1 (1969), affd. per curiam 433 F.2d 309 (5th ..
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112 T.C. No. 19
UNITED STATES TAX COURT
GENERAL MOTORS CORPORATION AND SUBSIDIARIES, Petitioner
v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 27026-96. Filed May 25, 1999.
GM and GMAC are members of a consolidated group.
GM manufactured motor vehicles. GMAC financed motor
vehicles.
Held: The consolidated return regulations in
issue constituted a method of reporting and not a
method of accounting. Henry C. Beck Co. v.
Commissioner, 52 T.C. 1 (1969), affd. per curiam
433
F.2d 309 (5th Cir. 1970), and Henry C. Beck Builders,
Inc. v. Commissioner, 41 T.C. 616 (1964), followed.
Held, further, GM's rate support deductions are
not subject to deferral pursuant to sec. 1.1502-
13(b)(2), Income Tax Regs.
Raymond P. Wexler, Todd F. Maynes, and William R. Welke, for
petitioner.
Nancy B. Herbert and John A. Guarnieri, for respondent.
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OPINION
VASQUEZ, Judge: Respondent determined a deficiency of
$339,076,705 in petitioner's 1985 consolidated Federal income
tax. The issues in this case, the rate support and special tools
issues, have been bifurcated for separate resolution. This
opinion addresses the rate support issues.
After concessions by the parties,1 the issues for decision
are: (1) Whether General Motors Corporation (GM) and its
consolidated affiliated subsidiaries (together, the GM group)
changed its method of accounting, and (2) whether section 1.1502-
13(b)(2), Income Tax Regs., requires GM to defer its deduction of
"rate support" payments.2
1
Petitioner concedes that for 1985 it is not entitled to
deduct (1) $57,532,843 for retail rate support payments incurred
by GM, (2) $233,071,869 for retail rate support payments GM did
not bill until 1986, and (3) $1,557,226 for fleet rate support
payments GM did not bill until 1986. Respondent concedes that
for 1985 (1) petitioner's income should not be increased by
$119,004,997 on account of estimated refunds of retail rate
support payments, and (2) petitioner is entitled to $13,572,139
in deductions for fleet rate support payments.
Additionally, the parties agree that petitioner, in
computing its taxable income for 1985, is entitled to claim
foreign tax credits in the amount of $101,000,636 arising from
carrybacks from 1986 and 1987.
2
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
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Background
Most of the facts have been stipulated and are so found.
The stipulation of facts, the supplemental stipulation of facts,
the stipulation of partial settlement, the stipulation of settled
issues and the attached exhibits are incorporated herein by this
reference. At the time it filed the petition, GM had its
principal place of business in Detroit, Michigan.
I. General Background
GM is a corporation duly organized under the laws of the
State of Delaware, doing business directly and through
subsidiaries in the United States and abroad. For 1985 and all
relevant prior and subsequent years, GM filed a consolidated
Federal income tax return, Form 1120, on a calendar year basis on
behalf of GM and its consolidated affiliated subsidiaries within
the meaning of section 1504. In 1985 and all relevant prior and
subsequent years, General Motors Acceptance Corporation (GMAC), a
wholly owned subsidiary of GM, was part of the GM group. GM and
GMAC both maintain their books and records, and report their
income for Federal income tax purposes, using the accrual method
of accounting.
At all relevant times, GM was a multiplant manufacturing
enterprise primarily engaged in the design, manufacture,
assembly, and sale of motor vehicles (including automobiles,
trucks, and buses) and related parts and accessories.
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In 1919, GMAC was incorporated under the New York banking
law relating to investment companies. Operating directly and
through subsidiaries and associated companies in which it has
equity investments, GMAC provides a wide variety of financial
services to its customers.
GMAC and its subsidiaries' principal business is to finance
the acquisition and resale by independent GM dealers of various
new automotive and nonautomotive products manufactured by GM and
to acquire from independent GM dealers, either directly or
indirectly, installment obligations covering retail sales of GM
products as well as used units of any make. Additionally, GMAC
acquired from independent GM dealers installment obligations
covering new products of other (i.e., non-GM) motor vehicle
manufacturers where the independent GM dealers also owned and
operated non-GM motor vehicle dealerships. As a purchaser of
installment obligations, GMAC faces competition from finance
companies and most banks. Banks also finance car loans directly
with customers; however, GMAC does not provide this service.
GMAC also offered other financial services to independent GM
dealers. These services included providing inventory financing
for both new and used vehicles, insurance, real estate lending,
financing of service machinery and mechanical equipment, and
other related services.
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II. Independent GM Dealers' Relationship With GM and GMAC
A. General Background
GM sells the motor vehicles it manufactures to the public
primarily through a network of independently owned dealerships
(i.e., independent GM dealers). These independent GM dealers
purchase GM motor vehicles from GM for resale to individual
customers, businesses, leasing companies, and other entities.
Some of these customers (e.g., businesses and leasing companies)
are "fleet customers". Fleet customers purchase large volumes of
motor vehicles in a single transaction.
When a retail customer3 purchased a vehicle from an
independent GM dealer, the retail customer could (1) pay cash for
the entire purchase price, (2) purchase the vehicle using third-
party financing, or (3) execute a retail installment sales
contract (RISC) with the independent GM dealer under which the
retail customer agreed to pay for the vehicle over the term of
the contract at a stated interest rate. Under the terms of the
RISC, the independent GM dealer could (1) hold the RISC for its
own account, (2) assign the RISC to a lender unrelated to GM or
GMAC, or (3) assign the RISC to GMAC.
If the independent GM dealer assigned the RISC to GMAC, GMAC
acquired the RISC at a price based on GMAC's "buy rate" (which
3
The term "retail customers" refers to all purchasers who
were not fleet customers.
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was also known as the "market discount" rate). GMAC's buy rate
reflected a market rate of interest. If the interest rate the
RISC carried equaled the GMAC buy rate, GMAC paid face value for
the RISC.
Independent GM dealers were not legally required to assign
any RISC to GMAC, and GMAC was not legally required to accept any
RISC offered by an independent GM dealer to GMAC. GMAC, however,
accepted assigned RISC's from independent GM dealers provided the
retail customer and the terms of the RISC met GMAC's credit
standards.
During 1985, for approximately 41 percent of all GM vehicles
sold by independent GM dealers, the customer executed an RISC
with the independent GM dealer, and the independent GM dealer
then assigned the RISC to GMAC. This represented GMAC's highest
market share since 1931.
Between 1984 and 1986, GMAC accepted assignment of
approximately 75 percent of the total number of RISC's that
independent GM dealers offered to GMAC. GMAC conditionally
accepted another 10 percent of such RISC's subject to the retail
customer increasing his or her downpayment or adding a cosigner.
GMAC rejected approximately 15 percent of the RISC's independent
GM dealers offered to GMAC.
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B. Dealer Finance Income
"Dealer finance income", "dealer allowance credit", and
"dealer participation" are terms used to describe certain amounts
paid or credited by GMAC to independent GM dealers in connection
with the assignment of an RISC by an independent GM dealer to
GMAC.4 Dealer finance income was produced when an independent GM
dealer assigned to GMAC an RISC bearing an interest rate that is
higher than the GMAC buy rate.
When GMAC acquired an RISC from an independent GM dealer,
GMAC paid or credited the independent GM dealer the fair market
value of the assigned RISC at the time of purchase. The fair
market value was computed using the GMAC buy rate (i.e., the RISC
was discounted to present value based on the GMAC buy rate).
When a retail customer's RISC carried an interest rate greater
than the GMAC buy rate, the fair market value was higher than the
face amount of the RISC, and the amount GMAC paid in excess of
the face amount of the RISC was dealer finance income.5 If the
retail customer paid off its RISC early, the independent GM
4
For convenience, we shall hereinafter refer to these
terms as dealer finance income.
5
The opinion, infra pp. 32-38, contains examples
calculating dealer finance income and rate support payments and
explaining GM's and GMAC's accounting for rate support. For an
example of dealer finance income, see infra p. 32.
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dealer credited back to GMAC a portion of the dealer finance
income.
A retail customer's RISC seldom carried an interest rate
below GMAC's buy rate when the motor vehicle was not covered by a
retail rate support program.6 See infra pp. 10-19 (discussing
retail rate support programs). In that case, the fair market
value of the RISC was lower than the face amount of the RISC.
GMAC paid or credited the independent GM dealer less than the
face value of the RISC (so that the effective yield to GMAC on
the RISC equaled the GMAC buy rate). This reduced the income the
independent GM dealer received on the sale of the vehicle.
III. Incentive Programs
A. GM Incentives to Independent GM Dealers to
Purchase/Sell GM Vehicles
In 1985, there were numerous programs in effect that GM had
established to provide financial incentives to independent GM
dealers to purchase and sell more GM motor vehicles (dealer
incentives).
6
This was because if the RISC carried a below-market
interest rate the independent GM dealer forwent money on the sale
of the car. This money was "lost" because the independent GM
dealer credited the face value of the RISC towards the retail
customer's purchase price of the vehicle even though the RISC
carried a below-market interest rate (i.e., the RISC's fair
market value at the time of purchase was less than its face value
at the time of issuance). Thus, the independent GM dealer
forwent the difference between the face value and fair market
value of the RISC.
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One dealer incentive program involved the payment of "close
out allowances" to independent GM dealers. Under the terms of
the sale from GM to an independent GM dealer, if the independent
GM dealer could not resell a vehicle by a specified date, GM paid
a "close-out allowance" to the independent GM dealer. Close-out
allowances were intended to encourage independent GM dealers to
purchase and stock current model year vehicles.
Other dealer incentives included cash payments tied to the
volume of vehicles either sold by the independent GM dealer or
purchased from GM by the independent GM dealer. These dealer
incentives might apply to particular vehicle lines or to total
numbers of vehicles sold or purchased. Various sales incentives
were also paid to dealership salespeople.
Independent GM dealers were also given the opportunity to
purchase certain upgrades or option packages for certain vehicle
models at either a reduced or no additional cost.
B. Retail Customer Incentives
In addition to dealer incentives, GM established programs
involving retail customer incentives to increase sales of GM
motor vehicles. GM retail customer sales incentives included:
(1) Cash rebates and incentive packages, (2) discount option
packages, (3) reduced financing rates made available through
GMAC, and/or (4) allowing the purchaser to delay the initial
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monthly payment to GMAC due on the retail customer's RISC for a
stated period.
C. Oversight of Incentive Programs
During the 1980's, GM's "Price Review Group" made the
decision to provide dealer incentives, incentives to dealership
salespeople, and retail sales incentives.
D. Retail Rate Support Programs
1. History and Overview
Around 1980, the domestic car market in the United States
was extremely depressed. The United States was coming off the
second oil shock. In 1980, GM incurred only the second year of
losses in its history. It was a traumatic time for GM, and there
was a lot of effort and work going on at GM to try to stimulate
sales of motor vehicles.
At this time, GM was offering direct rebates to customers;
however, the programs were not effective at increasing sales of
GM vehicles to the desired levels. GM executives believed that
sales were depressed due to the very high interest rates that
were present in the U.S. economy at the time. During 1980, the
prime rate of interest hit a high of approximately 21 percent.
GM was considering using sales allowances to try to find
something that was more attractive to customers than rebate
programs, which had lost their luster in the then existing high
interest rate environment. In 1980, GM executives made proposals
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to create a program to address the issue of high interest rates.
The proposals suggested a program by which retail customers could
finance GM vehicles at a below-market interest rate.
The car divisions (i.e., Chevrolet, Buick, GMC, Pontiac,
Oldsmobile, and Cadillac)7 initially opposed retail rate support
programs. These proposals were not implemented in 1980 due to
perceived administrative difficulties and a lack of the necessary
internal support.
In 1981, GM executives again made proposals to address the
issue of high interest rates. This time, GM initiated programs
through GMAC which made below-market interest rate financing
available to retail customers who purchased GM vehicles (the
retail rate support program). The motivation for the program
included stimulating retail demand for cars and increasing market
penetration.
GMAC's initial reaction to the initial proposed retail rate
support program was negative. GMAC was concerned with the impact
of the retail rate support program on independent GM dealers, who
were GMAC's customers, and the independent GM dealers' ability to
earn dealer finance income. See supra pp. 7-8. GM's initial
7
The parties referred to the different divisions of GM
(i.e., Chevrolet, Buick, GMC, Pontiac, Oldsmobile, and Cadillac)
as "marketing divisions", "car divisions", and "vehicle
divisions" of GM. For clarity and uniformity, we shall refer to
them as car divisions.
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proposals for rate support programs involved GMAC's bearing a
cost of such programs, and GMAC refused to bear such costs.
GMAC's position was that its margins did not allow it to absorb
these costs. GMAC considered these costs a cost of selling
automobiles that should be borne by GM. GM eventually decided to
pay these costs.
The first retail rate support program, initiated in July
1981, included all U.S. car divisions. The initial retail rate
support proposal was quite successful. It was more effective
than GM executives hoped, and sales increased more than GM
expected.
In 1981, when GM first announced retail rate support
programs, GMAC immediately contacted its lenders and credit
rating agencies to inform them that (1) GMAC's margins were not
going to be adversely affected by such programs, (2) GM, and not
GMAC, was bearing the costs of such programs, and (3) GMAC was
earning its normal rate of return on RISC's entered into by
retail customers under a retail rate support program (rate-
supported RISC).
2. Nuts and Bolts of a Retail Rate Support Program
Retail rate support programs involved GM's central
management, GM's car divisions, independent GM dealers, and GMAC.
The purpose of the retail rate support programs was to spur the
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sale of GM vehicles by independent GM dealers so that GM could
sell more vehicles to the independent GM dealers.
Vehicles sold under a retail rate support program were
financed at an interest rate below the prevailing market interest
rate. Independent GM dealers who participated in the program
were required to advertise the below-market interest rate to
their retail customers. As discussed earlier, independent GM
dealers were not able to earn dealer finance income from GMAC on
the rate-supported RISC's. In order to encourage independent GM
dealers to participate in retail rate support programs, GM paid
independent GM dealers who had been using GMAC's services a
stated fraction of the average dealer finance income the
independent GM dealer had earned on nonrate-supported RISC's
during a previous base period. Such payments were described as
representing a percentage of the independent GM dealers' normal
dealer financing income. Independent GM dealers who had not been
using GMAC's services were paid a stated fraction of the average
dealer finance income that other independent GM dealers in the
same geographic area earned on nonrate-supported RISC's during a
previous base period.
Retail rate support programs were structured as follows:
(1) GM sold its vehicles to independent GM dealers.
(2) GM's car divisions prepared proposals to use a
portion of their sales allowance budget on a retail rate
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support program. The car divisions submitted the proposal
to GM's operating analysis section (OAS), which was part of
the GM comptroller's staff. OAS worked with the car
divisions in preparing the financial analysis and a proposal
for the price review group. The proposal suggested the
vehicles to be covered, the interest rate to be offered, and
the period of time the program would be in effect.
(3) The price review group reviewed the proposal. In
deciding whether to approve a retail rate support program,
the price review group considered projections of income
impact to the affected GM car divisions and GMAC based on
the cost of the program plus the gain from projected
increased vehicle sales. The price review group's
consideration of projected income impact included projected
increased contract penetration by GMAC.
The price review group also considered the "gross stock
days supply" with proposed vehicle lines chosen to address
"days supply" problems of specific car divisions. "Gross
stock" is the number of vehicles that are in the field
available for sale. The "days supply" is the projected
number of days it would take to sell that gross stock.
The price review group evaluated some programs and
found that the entire expected sales increase would be "pull
ahead" sales. Pull ahead sales were sales GM reasonably
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expected to occur in the ensuing period8 if there were no
retail rate support program in place. Thus, there was no
anticipated increase in the number of sales of GM motor
vehicles, but the sales would occur earlier with a retail
rate support program in place than they would otherwise.
The price review group also considered the impact of
"plus" sales. Plus sales were additional GM cars projected
to be sold because of the retail rate support program.
GM's price review group, based on the recommendation of
GM's marketing personnel, set the below-market interest rate
to be offered based on the market for particular vehicles
and competitive conditions.
(4) After approval by the price review group, the
proposal went to GM's executive committee. The executive
committee either approved or rejected the proposal. If
approved, GM notified the car divisions in writing and the
independent GM dealers through an electronic dealer
communication system (DCS) of the retail rate support
program. The DCS message identified the car models covered,
the period of time the retail rate support program was in
effect, and the amount of dealer finance income that would
be earned (or lost) by participating in the program.
8
We assume that this refers to the next financial period.
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(5) In order to participate in a retail rate support
program, independent GM dealers had to elect to be in the
program.
(6) The retail rate support program required
participating independent GM dealers to charge the retail
customers an interest rate that was no higher than the
below-market interest rate offered under the retail rate
support program.
(7) GM (through its car divisions), GMAC, and the
independent GM dealers announced the retail rate support
program to the public.
Interest rates in a retail rate support program often varied
based on the term of the RISC. Generally, an RISC with a term of
49-to-60 months bore a higher interest rate than an RISC with a
term of 48 months or less.
3. Sale of a Car
When a participating independent GM dealer sold a qualifying
vehicle to a retail customer under a retail rate support program,
the customer could elect to make a cash downpayment and finance
the balance of the purchase price not paid in cash. The retail
customer satisfied the balance due by entering into an RISC with
the independent GM dealer at the below-market interest rate
established under the rate support program. The independent GM
dealer credited the face value of the RISC towards the retail
- 17 -
customer's purchase price of the vehicle even though the RISC
carried a below-market interest rate (i.e., the RISC's fair
market value at the time of purchase was less than its face value
at the time of issuance). If the participating independent GM
dealer offered to assign the RISC to GMAC and GMAC accepted the
RISC, GMAC paid or credited the independent GM dealer an amount
equal to the face value of the RISC (which was greater than the
RISC's fair market value at the time of purchase).9
4. The Retail Rate Support Payment
When GMAC acquired a retail customer's RISC carrying a
below-market interest rate (i.e., a rate-supported RISC) from an
independent GM dealer, GM paid (or credited to) GMAC an amount
(the retail rate support payment) equal to the difference between
the face amount of the RISC and the fair market value discounted
at GMAC's buy rate.10 GM paid GMAC the rate support payment to
9
GMAC never paid an independent GM dealer more than the
fair market value for an RISC in the absence of a retail rate
support program because GMAC's margin for profit on an individual
RISC was very small. If GMAC paid more than the fair market
value for an RISC without receiving a retail rate support
payment, GMAC would have experienced a loss on the RISC (i.e.,
the expenses would have exceeded the income on the RISC).
10
The retail rate support payment GM made to GMAC
represented the difference between the amount GMAC paid the
independent GM dealer for the RISC under a retail rate support
program and the amount GMAC would have paid the independent GM
dealer for the RISC in the absence of such a program.
- 18 -
reimburse GMAC for the amount GMAC paid the independent dealer in
excess of the RISC's fair market value at the time of purchase.
For RISC's executed before 1985, if the retail customer
prepaid the RISC held by GMAC, GMAC returned (or credited) to GM
a portion of the retail rate support payment that GM had
previously paid (or credited) to GMAC.
Beginning in 1985, GM and GMAC began to take anticipated
retail customer prepayments into account in determining the
amount of the retail rate support payments GM paid to GMAC. This
reduction in the amount of the retail rate support payments was
actuarially determined.
During 1985, GM reduced the retail rate support payments it
made to GMAC by 7 percent to take account of anticipated
prepayments. In 1985, if a retail customer prepaid an RISC, GMAC
was not obligated to return to GM any portion of the retail rate
support payment GMAC received from GM on that RISC because
anticipated payments were taken into account in determining the
amount of the retail rate support payments.
GM made retail rate support payments to GMAC as an up front,
lump sum payment. This treatment was similar to the treatment of
direct rebate programs--car divisions charged the whole amount to
their sales allowance budget.11 GMAC wanted the retail rate
11
From 1985 to the present, the retail rate support
(continued...)
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support payment up front because GMAC incurred the expense up
front by paying the independent GM dealer an amount in excess of
the fair market value of the RISC at the time of its purchase.
5. 1985 Retail Rate Support Programs
In 1985, GM offered eight retail rate support programs on
selected GM vehicles. These eight programs included the
following:
a. 8.8% financing on Chevrolet and GMC S-10 and
S-15 trucks purchased between February 1, 1985 and
April 30, 1985;
b. 8.8% financing on J and P model passenger cars
purchased between March 20, 1985 and April 30, 1985;
c. 8.8% financing on Chevrolet Cavalier, Pontiac
Sunbird, Cadillac Seville and Eldorado, Chevrolet S-10
Blazer and GMC S-15 Jimmy, Oldsmobile Calais, and Buick
Somerset models purchased between May 1, 1985 and
August 15, 1985;
d. 9.9% financing on Buick Electra and Oldsmobile
Ninety-Eight Regency models purchased between June 21,
1985 and August 15, 1985;
e. 7.7% financing on a wide variety of 1985 model
Chevrolet, Pontiac, Oldsmobile, Buick, Cadillac, and
GMC vehicles purchased between August 15, 1985 and
October 2, 1985;
f. 8.8% financing on a wide variety of 1985 model
Chevrolet, Pontiac, Oldsmobile, Buick, Cadillac, and
GMC vehicles purchased between October 7, 1985 and
November 20, 1985;
11
(...continued)
program has been a significant part of the sales allowances of
GM. Additionally, retail rate support payments continue to be
charged against the car divisions' sales allowance budget.
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g. 8.5% financing on "J" passenger cars purchased
between December 4, 1985, and December 31, 1985; and
h. 7.9% financing on a wide variety of Chevrolet,
Pontiac, Oldsmobile, Buick, Cadillac, and GMC vehicles
purchased between December 26, 1985 and February 22,
1986.
6. Effect of the Rate Support Programs
Retail rate support programs affected the number of units
financed by GMAC and GMAC's market penetration. In 1984, GMAC's
number of units financed and market penetration decreased
primarily to increased competition for automobile financing and
the absence of reduced retail rate programs that had been in
effect during most of 1983. In 1985, GMAC's number of units
financed and market penetration increased reflecting the
favorable results of various reduced rate programs (including the
rate support programs) and other incentives.
In 1985, GMAC's "average earning assets" rose $9.5 billion
principally due to the effect of several rate support programs
offered throughout the year.
GMAC's 1985 annual report contained the following statement
regarding the retail rate support programs:
A number of very successful reduced retail rate
programs offered by GMAC in cooperation with General
Motors, combined with improved availability of GM
products, contributed to the rise in the level of
deliveries. The increased volume of units financed by
GMAC under the reduced rate programs resulted in
significant growth in retail receivables and lease
assets in 1985.
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GMAC's 1986 Annual Report also contained similar language. The
1986 report stated:
The financial services market continues to be
intensely competitive. GMAC is meeting this challenge
with new and improved programs for consumers, dealers
and investors. Most notable last year were the
factory-supported, special rate financing plans which
contributed to GMAC's record volume and resulted in a
significant number of new and more affluent GMAC
customers. During these rate programs, financing
volume increased more than 40% and placed great demands
on the entire organization.
7. Non-GM Rate Support Programs
Some independent GM dealers also operated motor vehicle
dealerships for vehicle manufacturers other than GM (e.g., Nissan
Motor Corporation (Nissan)). GMAC purchased RISC's from these
independent GM dealers even if the automobile being financed was
not a GM vehicle. Consistent with this policy, during 1985, GMAC
participated in rate support type programs offered by three non-
GM manufacturers of motor vehicles.
From January 4 through October 2, 1985, GMAC had an
agreement with Nissan to purchase RISC's bearing an 8.8-percent
interest rate from Nissan dealers who sold Nissan trucks to
retail customers. Under this program, Nissan paid GMAC the
difference between the face amount of the RISC and the fair
market value of the RISC (discounted at the rate of 13.5 percent)
at the time of purchase.
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From June 1 through September 15, 1985, GMAC had an
agreement with American Isuzu Motors, Inc. (Isuzu), to purchase
RISC's bearing an 8.6-percent interest rate from Isuzu dealers
who sold Isuzu trucks to retail customers. Under this program,
Isuzu paid GMAC the difference between the face amount of the
RISC and the fair market value of the RISC (discounted at the
rate of 13.5 percent) at the time of purchase.
From October 9 through November 20, 1985, GMAC had an
agreement with American Motors Corporation (AMC) to purchase
RISC's bearing an 8.8-percent interest rate from AMC dealers who
sold (1) Renault Alliance and Encore vehicles, and (2) Jeep
Cherokee, Wagoneer, and Comanche vehicles to retail customers.
Under this program, AMC reimbursed GMAC the difference between
the face amount of the RISC and the fair market value of the RISC
(discounted at the rate of 13.25%) at the time of purchase.
IV. GM's and GMAC's Accounting
A. GMAC's Accounting for Rate-Supported RISC's12
GMAC accounted for the acquisition of a rate-supported RISC
(whether for a GM or non-GM vehicle) as follows: When GMAC
purchased the rate-supported RISC, it recorded as assets on its
books (1) a "retail customer receivable", and (2) a "rate support
receivable". The retail customer receivable was equal to the
12
For an example, see infra pp. 33-34.
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face amount of the RISC plus the below-market interest stated in
the RISC that was to be paid over the term of the RISC (below-
market stated interest). The rate support receivable was equal
to the retail rate support payment GM would make to GMAC.
GMAC also recorded two offsetting credit amounts: (1) A
cash reduction in the amount paid to the independent GM dealer to
purchase the rate-supported RISC, and (2) a contra asset called
"unearned income".
The unearned income account balance equaled the face amount
of the RISC plus the below-market stated interest (i.e., the
total amount the retail customer was to pay GMAC over the term of
the RISC) minus the fair market value of the note, based on
GMAC's buy rate, at its time of purchase. Thus, the unearned
income account included the discount income GMAC earned on a
rate-supported RISC and the below-market stated interest. The
retail rate support payment, however, was not included in the
unearned income account.
The contra asset account was designed so that the RISC was
reported in GMAC's published financial statements at its fair
market value at the time of its purchase.
When GMAC received the retail rate support payment, GMAC
increased its cash by the amount of the retail rate support
payment and eliminated the rate support receivable. The unearned
income account remained unchanged.
- 24 -
When GMAC acquired a rate-supported RISC from an independent
GM dealer, GMAC did not record the rate support payment as
income. GMAC recognized the unearned income as earned income on
a monthly basis as the retail customer made payments over the
term of the RISC. Each month GMAC also reduced the unearned
income account on its balance sheet in an amount equal to the
amount it recognized as earned income on its income statement.
B. GMAC's Accounting for Nonrate-Supported RISC's13
GMAC accounted for the acquisition of a nonrate-supported
RISC, whether it carried a market rate of interest or a below-
market rate of interest, as follows: When GMAC purchased the
RISC, it recorded as an asset on its books a retail customer
receivable equal to the face amount of the RISC plus the interest
stated in the RISC that was to be paid over the term of the RISC.
GMAC also recorded two offsetting credit amounts: (1) A
cash reduction in the amount paid to the independent GM dealer to
purchase the RISC, and (2) unearned income equal to the face
amount of the RISC plus the stated market stated interest (i.e.,
the total amount the retail customer paid GMAC over the term of
the RISC) minus the fair market value of the note at the time of
its purchase. Thus, the unearned income account included the
13
For an example, see infra pp. 35-36.
- 25 -
stated interest plus the discount income GMAC earned if the
nonrate-supported RISC bore a below-market rate of interest.
C. GM's Accounting for Retail Rate Support Payments14
GM accounted for its retail rate support payment liability
as follows: When GM's liability first arose, GM recorded a sales
allowance in the amount of the retail rate support payment and an
accrued liability to GMAC in the amount of the retail rate
support payment. When GMAC actually purchased the RISC from an
independent GM dealer and GM made the retail rate support payment
to GMAC, GM eliminated the accrued liability and recorded a cash
reduction in the amount of the retail rate support payment. The
net effect on GM's balance sheet was a reduction in GM's cash
balance in the amount of the retail rate support payment. There
were no subsequent entries.
D. Consolidated Accounting
GM was required to eliminate intercompany items between GM
and GMAC in determining GM's consolidated income and balance
sheet. GM's expense for retail rate support payments was never
eliminated in determining the GM group's net book income.
Similarly, unearned income recognized by GMAC over the term of a
rate-supported RISC was never eliminated in determining the GM
group's net book income.
14
For an example, see infra p. 35.
- 26 -
V. GMAC's Basis in Rate-Supported RISC's15
GMAC's reported tax basis in a rate-supported RISC was equal
to the net amount of the RISC reported on GMAC's balance sheet.
VI. Fleet Rate Support Programs
A. General Background
During 1985, GM regularly negotiated incentive arrangements
for the sale of multiple GM vehicles to fleet customers (fleet
vehicles). The terms of a fleet transaction were set between GM
and the fleet customer. GM sold fleet vehicles to an independent
GM dealer16 who in turn sold the fleet vehicles to the fleet
customer. Depending on the circumstances, delivery of the fleet
vehicles might be coordinated through the independent GM dealer
or, alternatively, might be delivered by GM directly to the fleet
purchaser. The independent GM dealer, however, was responsible
for payment for the fleet vehicles.
In a fleet transaction, because the independent GM dealer
actually completed the sale of the fleet vehicles to the fleet
customer, the independent GM dealer earned a profit on the fleet
transactions. This profit margin, however, generally was lower
than the independent GM dealer's average profit margin on sales
to retail customers. The amount of the independent GM dealer's
15
For an example, see infra p. 35.
16
An independent GM dealer was needed as the seller of
record.
- 27 -
profit turned on the fleet customer's buying leverage and the
services the independent GM dealer provided to the fleet
customer.
In connection with a purchase of fleet vehicles, GM made
incentives available to fleet customers. As an incentive to
these fleet customers, GM offered below-market interest rate
financing through GMAC or offered to assist a fleet customer in
obtaining below-market interest rate financing from an unrelated
lender. Generally, fleet customers opted to use the below-market
financing provided by GMAC, but occasionally fleet customers used
below-market financing provided by an unrelated lender.
Unlike sales to retail customers, the independent GM dealer
who helped complete a fleet transaction had no role in the
financing of the fleet vehicles purchased. The fleet customer
did not execute an RISC with an independent GM dealer; instead,
GMAC or an unrelated lender lent the money directly to the fleet
customers (fleet loans). In fleet transactions, GMAC used a
chattel mortgage type financing document. GMAC lent the money to
the fleet customers and took a security position in the fleet
vehicles as collateral. Any below-market interest rate offered
to fleet customers on fleet loans was a reduction in GMAC's
otherwise available "lending rate".17
17
GMAC established its lending rate the same way it
(continued...)
- 28 -
Upon shipment by GM of a fleet purchase, GM received payment
for the fleet vehicles. In most cases, this payment was made
through the independent GM dealer's wholesale financing source.
The fleet customer then borrowed the agreed-upon amount of
funds from GMAC or an unrelated lender. This amount was credited
to the independent GM dealer (or, in most cases, the independent
GM dealer's wholesale financing source) as consideration for the
vehicles.
If the lender made a below-market interest rate loan, GM
paid GMAC or the unrelated lender a "fleet rate support payment".
The amount of the fleet rate support payment equaled the
difference between the face amount of the fleet loan and the fair
market value of the fleet loan at GMAC's lending rate.
B. GMAC's Accounting for the Fleet Loans18
GMAC accounted for the fleet loans as follows: When GMAC
made a fleet loan, it recorded as assets on its books (1) a
"fleet purchaser receivable", and (2) a rate support receivable.
The fleet purchaser receivable was equal to the face amount of
the loan (i.e., the amount the fleet customer actually borrowed
from GMAC). The rate support receivable was equal to the fleet
rate support payment to be made by GM to GMAC.
17
(...continued)
determined its buy rate.
18
For an example, see infra pp. 36-37.
- 29 -
GMAC also recorded two offsetting credit amounts: (1) A
cash reduction in the amount it paid to the independent GM dealer
to purchase the rate supported fleet loan, and (2) unearned
income.19 The unearned income account was credited the face
amount of the note minus the fair market value of the note at the
time of its purchase.20
Unlike its treatment of retail rate support payments, GMAC
did not record the stated interest in the note as part of the
fleet purchase receivable or as unearned income.
When GMAC received the fleet rate support payment from GM,
GMAC increased its cash by the amount of the fleet rate support
payment and eliminated the rate support receivable. The unearned
income account remained unchanged.
GMAC did not include fleet rate support payments in income.
GMAC recognized the unearned income as earned income on a monthly
basis as the customer made payments over the term of the fleet
loan.
19
The unearned income account in the fleet transactions
was a contra asset account that reduced the amount of GMAC's
assets and ensured that the fleet purchaser receivable was
reported at its fair market value on GMAC's balance sheet.
20
Thus, the unearned income account included the discount
income GMAC earned on a rate supported fleet loan. The fleet
rate support payment was not included in the unearned income
account.
- 30 -
C. GM's Accounting for the Fleet Rate Support Payments21
GM accounted for its fleet rate support payment liability as
follows: When GM's liability first arose, GM recorded a sales
allowance in the amount of the fleet rate support payment and an
accrued liability to GMAC in the amount of the fleet rate support
payment. When GMAC actually lent the funds to the fleet customer
and GM made the fleet rate support payment to GMAC, GM eliminated
the accrued liability and recorded a cash reduction in the amount
of the fleet rate support payment. The net effect on GM's income
statement was a sales allowance in the amount of the fleet rate
support payment, and the net effect on GM's balance sheet was a
reduction in GM's cash balance in the amount of the fleet rate
support payment.
VII. Tax Return Treatment of Item Related to Retail and
Fleet Rate Support Programs
In the relevant taxable years, in computing its separate
taxable income, GM treated the retail rate support payments it
made to GMAC and the fleet rate support payments made to GMAC and
to other unrelated lenders as current deductions by the parent GM
(rate support deductions). For purposes of computing its
separate taxable income, GMAC treated the discount earned on
rate-supported RISC's and rate supported fleet loans (which were
mathematically equal to the retail/fleet rate support payment
21
For an example, see infra pp. 37-38.
- 31 -
associated with that RISC/fleet loan that GMAC received from GM)
as income over the life of the RISC/fleet loan (rate support
discount income).
For taxable years prior to 1985, the GM group reported GM's
rate support deductions and GMAC's rate support discount income
as intercompany transactions. A consolidation adjustment was
made deferring GM's rate support deductions in the GM group's
consolidated income tax return until GMAC recognized the discount
income.
For 1985 and subsequent years, the GM group did not report
GM's rate support deductions and GMAC's rate support discount
income as intercompany transactions. GM continued to claim the
retail and fleet rate support payments as current deductions when
paid (or credited) to GMAC. No consolidation adjustment was made
deferring GM's rate support deductions in the GM group's
consolidated income tax return.
The GM group did not file, in 1985 or any other relevant
year, a Form 3115, Application for Change in Accounting Method,
with the Commissioner.
VIII. Claims for Refund
GM filed refund claims with the Internal Revenue Service
(IRS) for tax years prior to 1985 on the basis that the deferral
of GM's rate support deductions on the GM group's consolidated
return for those years was incorrect.
- 32 -
Discussion
I. Examples
Before reaching our analysis of the applicable law, we set
forth some examples of the accounting, tax, and financial aspects
of the case at bar that will elucidate the facts of the case.
The parties have stipulated the following examples.
A. Dealer Finance Income
Suppose that when GMAC's buy rate was 8 percent a retail
customer entered into an RISC with a principal amount of $10,000,
for a term of 48 months, bearing an interest rate of 8.25
percent. GMAC paid or credited $10,04822 (the fair
market/discounted value of the RISC at 8 percent) to the
independent GM dealer for assignment of the RISC to GMAC. Thus,
the independent GM dealer received $48 of dealer finance income
(the fair market value of the RISC--$10,048--less the principal
amount--$10,000).
B. Retail Rate Support Payment Calculations
1. Pre-1985
Suppose a retail customer purchased a vehicle from an
independent GM dealer for $12,000 and paid $2,000 in cash and
financed the $10,000 balance with a rate-supported RISC with a
48-month term. The retail rate support program offered 7.9
22
For convenience, all figures are rounded to the nearest
dollar.
- 33 -
percent financing when GMAC's buy rate for a 4-year loan was 12
percent. The monthly payment due on the rate-supported RISC was
$244, and the fair market value of the rate-supported RISC at the
time of purchase was $9,253.23 Even though the rate-supported
RISC was worth only $9,253, GMAC paid the independent GM dealer
$10,000. GM paid GMAC a retail rate support payment in the
amount of $747--the difference between the $10,000 face value of
the rate-supported RISC and the $9,253 fair market value of the
rate-supported RISC at the time of its purchase.
2. 1985 and Post-1985
In 1985 and thereafter, GM's retail rate support payment was
adjusted (reduced) for the actuarially determined retail customer
prepayments. During 1985, GM reduced the retail rate support
payments it made to GMAC by 7 percent to take account of
anticipated prepayments. Thus, given the same facts as above for
pre-1985, in 1985, the retail rate support payment of $747 would
have been reduced to $695.
C. GM and GMAC Financial Accounting
1. Rate-Supported RISC
Suppose a retail customer's RISC had a face amount of
$10,000, below-market stated interest of $2,000 to be paid by the
customer over the term of the RISC, and a fair market value of
23
The $9,253 figure is arrived at by discounting to
present value the 48 monthly payments of $244 by 12 percent.
- 34 -
$9,500, and GM paid GMAC a retail rate support payment of $500
(retail rate support example).
a. GMAC
GMAC purchased the RISC from an independent GM dealer for
$10,000, and it recorded the following assets on its books:
1
Retail customer receivable $12,000
Rate support receivable 500
1
This figure included the $10,000 face value of the
RISC and $2,000 below-market interest stated in the
RISC.
GMAC credited the $10,000 it paid the independent GM dealer
for the RISC to its cash account and $2,500 to its unearned
income account. These items were recorded as follows:
Cash ($10,000)
1
Unearned income (2,500)
1
This figure equaled the face amount of the RISC plus
the below-market stated interest (i.e., the total
amount the retail customer was to pay GMAC over the
term of the RISC) minus the fair market value of the
RISC at the time of its purchase. Thus, the unearned
income account included the discount income and the
below-market stated interest that GMAC earned on the
RISC.
When GMAC received the $500 retail rate support payment from
GM, GMAC increased its cash by $500 and eliminated the rate
support receivable. The net effect on GMAC's balance sheet was
as follows:
Retail customer receivable $12,000
Cash (9,500)
Unearned income (2,500)
- 35 -
b. GMAC's Basis in a Rate-Supported RISC
In the retail rate support example, GMAC's book and tax
basis in the rate-supported RISC was $9,500.
c. GM
In the retail rate support example, GM accounted for its
retail rate support payment liability as follows: When GM's
liability first arose, GM recorded a $500 sales allowance and a
$500 accrued liability to GMAC. When GMAC actually purchased the
RISC from an independent GM dealer and GM made the $500 retail
rate support payment to GMAC, GM eliminated the $500 accrued
liability and recorded a cash reduction of $500. The net effect
on GM's balance sheet was a $500 reduction in GM's cash balance.
2. Nonrate-Supported RISC
a. RISC Bearing a Market Interest Rate
Suppose a retail customer's RISC had a face amount and fair
market value of $10,000 and stated interest of $2,500 to be paid
by the customer over the term of the RISC. GMAC purchased the
RISC for $10,000, and it recorded the following items on its
books:
1
Retail customer receivable $12,500
Cash (10,000)
2
Unearned income (2,500)
1
This figure included the $10,000 face value of the
RISC and $2,500 interest stated in the RISC.
2
This figure equaled the face amount of the RISC plus
the stated interest (i.e., the total amount that the
- 36 -
retail customer paid GMAC over the term of the RISC)
minus the fair market value of the RISC at the time of
its purchase.
b. RISC Bearing a Below-Market Interest Rate
Suppose a retail customer's RISC had a face amount of
$10,000, below-market stated interest of $2,000 to be paid by the
customer over the term of the RISC, and a fair market value of
$9,500. GMAC purchased the RISC for $9,500, and it recorded the
following items on its books:
1
Retail customer receivable $12,000
Cash (9,500)
2
Unearned income (2,500)
1
This figure included the $10,000 face value of the
RISC and $2,000 below-market stated interest.
2
This figure equaled the face amount of the RISC plus
the stated interest (i.e., the total amount the retail
customer was to pay GMAC over the term of the RISC)
minus the fair market value of the RISC at the time of
its purchase.
3. Fleet Loans and Fleet Rate Support
Suppose a fleet customer acquired fleet vehicles for
$1,100,000 making a $100,000 downpayment in cash and financing
the $1 million balance with a note from GMAC with a term of 48
months at an interest rate of 8 percent when GMAC's lending rate
was 10 percent. The fair market value of the note at the time of
its purchase, therefore, was $957,600.24 GMAC lent $1 million to
24
The parties stipulated this example and calculated the
fair market value of the note to be $957,600 and the fleet rate
(continued...)
- 37 -
the fleet customer who used the $1 million as consideration for
the purchase of the fleet vehicles. GM then paid $42,400 to GMAC
(altogether, the fleet rate support example).
a. GMAC
In the fleet rate support example, when GMAC made the loan
for $1 million, it recorded the following items on its books:
Fleet purchaser receivable $1,000,000
Rate support receivable 42,400
Cash (1,000,000)
Unearned income (42,400)
When GMAC received the $42,400 fleet rate support payment,
GMAC increased its cash by $42,400 and eliminated the rate
support receivable. The net effect on GMAC's balance sheet was
as follows:
Fleet purchaser receivable $1,000,000
Cash (957,600)
Unearned income (42,400)
b. GM
In the fleet rate support example, GM accounted for its
fleet rate support payment liability as follows: When GM's
liability first arose, GM recorded a $42,400 sales allowance and
24
(...continued)
support payment to be $42,400 (the difference between the
$1,000,000 face value of the note and the $957,600 fair market
value of the note). This appears to be a mathematical error--the
fair market value based on a loan with a $1 million principal
balance at 8 percent for 48 months when the market rate of
interest is 10 percent is $962,557, and the fleet rate support
payment therefore is $37,443. For convenience, we shall use the
parties' figures.
- 38 -
a $42,400 accrued liability to GMAC. When GMAC actually lent the
funds to the fleet customer and GM made the $42,400 fleet rate
support payment to GMAC, GM eliminated the $42,400 accrued
liability and recorded a cash reduction of $42,400. The net
effect on GM's income statement was a $42,400 sales allowance;
the net effect on GM's balance sheet was a $42,400 reduction in
GM's cash balance.
II. Change in Method of Accounting
Respondent's primary argument is that the consolidated
return regulations constituted a method of accounting, and the GM
group's consistent deferral of GM's rate support deduction prior
to 1985 established the regular method of accounting for the rate
support payments.25 See sec. 1.446-1(e)(2)(ii)(a), Income Tax
Regs. Respondent contends that in 1985 the GM group26 changed
its method of accounting when (1) the GM group stopped reporting
GM's rate support payments as intercompany transactions under
section 1.1502-13(a)(1), Income Tax Regs., (2) GM continued to
claim the rate support payments as current deductions when paid
25
We use the term "rate support payments" to refer to both
the retail rate support payments and fleet rate support payments.
26
On brief, respondent argues that "GM" changed its method
of accounting. Most of respondent's arguments, however, pertain
to changes made by the GM group on its consolidated returns.
Therefore, we believe that many of respondent's references to GM
in respondent's discussion of the change in method of accounting
issue are references to the GM group.
- 39 -
(or credited) to GMAC, and (3) the rate support deductions were
no longer deferred in the GM group's consolidated income tax
return (i.e., no consolidation adjustment was made pursuant to
section 1.1502-13(b)(2), Income Tax Regs.). Respondent further
argues that this change in the method of accounting could not be
effected without the Secretary's consent. See sec. 446(e).
Petitioner counters that the consolidated return regulations
in effect for 1985 were not a method of accounting. Furthermore,
petitioner contends that respondent is attempting to apply
retroactively the 1995 amendments to the consolidated return
regulations (1995 amendments), and that this is improper.
A. The Law
An affiliated group can make a consolidated return with
respect to the income tax imposed by chapter 1 in lieu of filing
separate returns. See sec. 1501. All members of the affiliated
group must consent to the consolidated return regulations
prescribed under section 1502 prior to the last day prescribed by
law for the filing of a consolidated return. See id. Filing a
consolidated return was considered such consent. See
id.
Section 1502 provided:
The Secretary shall prescribe such regulations as
he may deem necessary in order that the tax liability
of any affiliated group of corporations making a
consolidated return and of each corporation in the
group, both during and after the period of affiliation,
may be returned, determined, computed, assessed,
collected, and adjusted, in such manner as clearly to
- 40 -
reflect the income tax liability and the various
factors necessary for the determination of such
liability, and in order to prevent avoidance of such
tax liability.
Furthermore, if a consolidated return was made, the tax was
determined, computed, assessed, collected, and adjusted in
accordance with the regulations under section 1502 prescribed
before the last day prescribed by law for the filing of such
return. See sec. 1503(a).
Section 1.1502-2, Income Tax Regs., explained how a
consolidated group determined its tax liability. It provided, in
relevant part, as follows:
The tax liability of a group for a consolidated
return year shall be determined by adding together--
(a) The tax imposed by section 11 on the
consolidated taxable income for such year (see
[section] 1.1502-11 for the computation of consolidated
taxable income); * * *
Section 1.1502-11, Income Tax Regs., provided, in relevant
part, as follows:
(a) In general. The consolidated taxable income
for a consolidated return year shall be determined by
taking into account--
(1) The separate taxable income of each
member of the group (see [section] 1.1502-12
for the computation of separate taxable
income); * * *
Section 1.1502-12, Income Tax Regs., provided, in relevant
part, as follows:
- 41 -
The separate taxable income of a member (including a
case in which deductions exceed gross income) is
computed in accordance with the provisions of the Code
covering the determination of taxable income of
separate corporations, subject to the following
modifications:
(a) Transactions between members * * * shall be
reflected according to the provisions of [section]
1.1502-13 * * * ;
* * * * * * *
(d) The method of accounting under which such
computation is made and the adjustments to be made
because of any change in method of accounting shall be
determined under [section] 1.1502-17;
Section 1.1502-13(b)(1), Income Tax Regs., provided that,
generally, gain or loss on intercompany transactions,27 other
than "deferred intercompany transactions", was not deferred or
eliminated. Section 1.1502-13(b)(2), Income Tax Regs., however,
contained an exception to this rule:
(2) Special rule. If, in an intercompany
transaction (other than a deferred intercompany
transaction), one member would otherwise properly
[take] an item of income or a deduction into account
for a consolidated return year earlier than the year
(whether consolidated or separate) for which another
member of the group can properly take into account the
corresponding item of income or deduction, then both
the item of income and the deduction shall be taken
into account for the later year (whether consolidated
or separate). * * *
27
Sec. 1.1502-13(a)(1), Income Tax Regs., defined the term
"intercompany transaction" as "a transaction during a
consolidated return year between corporations which are members
of the same group immediately after such transaction".
- 42 -
Section 1.1502-17, Income Tax Regs., entitled "Methods of
accounting", stated that "The method of accounting to be used by
each member of the group shall be determined in accordance with
the provisions of section 446 as if such member filed a separate
return."
Section 446(a) stated that "Taxable income shall be computed
under the method of accounting on the basis of which the taxpayer
regularly computes his income in keeping his books." Section
1.446-1(a)(1), Income Tax Regs., further provided that "The term
'method of accounting' includes not only the over-all method of
accounting of the taxpayer but also the accounting treatment of
any item."
Section 446(c) listed the permissible methods of accounting:
(c) Permissible Methods.--Subject to the
provisions of subsections (a) and (b), a taxpayer may
compute taxable income under any of the following
methods of accounting--
(1) the cash receipts and disbursements
method;
(2) an accrual method;
(3) any other method permitted by this
chapter;
(4) any combination of the foregoing methods
permitted under regulations prescribed by the
Secretary.
See also sec. 1.446-1(c), Income Tax Regs.
- 43 -
Before a taxpayer could change the taxpayer's method of
accounting, the taxpayer needed to secure the consent of the
Secretary. See sec. 446(e).
(ii)(a) A change in the method of accounting
includes a change in the overall plan of accounting for
gross income or deductions or a change in the treatment
of any material item used in such overall plan. * * *
A material item is any item which involves the proper
time for the inclusion of the item in income or the
taking of a deduction. * * * [Sec. 1.446-
1(e)(2)(ii)(a), Income Tax Regs.]
An accounting practice that involves the timing of when an
item is included in income or when it is deducted is considered a
method of accounting. See Knight-Ridder Newspapers, Inc. v.
United States, 743 F.2d 781, 797-798 (11th Cir. 1984); Diebold,
Inc. v. United States,
16 Cl. Ct. 193, 198-199 (1989), affd.
891
F.2d 1579 (Fed. Cir. 1989).
B. Analysis
Respondent argues that the matching rule contained in
section 1.1502-13(b)(2), Income Tax Regs., is a method of
accounting because the rule affects the timing (i.e.,
recognition) of corresponding items of income and deduction.
This Court has previously addressed the issue of whether the
consolidated return regulations are a method of accounting. In
Henry C. Beck Builders, Inc. v. Commissioner, 41 T.C. 616 (1964)
(Henry C. Beck Builders, Inc.), a Court-reviewed opinion, we
refused to accept the IRS's argument that the application of the
- 44 -
consolidated return regulations was a method of accounting. See
id. at 622. This Court subsequently followed Henry C. Beck
Builders, Inc. in Vernon C. Neal, Inc. v. Commissioner, T.C.
Memo. 1964-145, and in United Contractors, Inc. v. Commissioner,
T.C. Memo. 1964-68, affd. per curiam
344 F.2d 123 (4th Cir.
1965).
In another Court-reviewed opinion issued 5 years after Henry
C. Beck Builders, Inc., the Court again rejected the IRS's
argument that the intercompany transaction rules contained in the
consolidated return regulations were a method of accounting. See
Henry C. Beck Co. v. Commissioner, 52 T.C. 1 (1969), affd. per
curiam
433 F.2d 309 (5th Cir. 1970) (Henry C. Beck Co.). Citing
Henry C. Beck Builders, Inc., the Court stated that "Consolidated
returns are not a method of accounting but only a method of
reporting."
Id. at 7-8. Later in the opinion, we reemphasized
this point: "As previously pointed out, it is well settled by
decisions of this Court that a consolidated return is merely a
method of reporting taxes, not a method of accounting."
Id. at
12.
Respondent correctly points out that Henry C. Beck Builders,
Inc. and Henry C. Beck Co. involved the consolidated return
regulations in effect prior to 1966 (pre-1966 regulations), see
Henry C. Beck Co. v. Commissioner, supra at 11-12, and that the
case at bar involves the consolidated return regulations the
- 45 -
Treasury adopted in 1966 (1966 regulations) which substantially
overhauled the pre-1966 regulations. See T.D. 6894, 1966-2 C.B.
362; 1 Dubroff et al., Federal Income Taxation of Corporations
Filing Consolidated Returns sec. 1.02 (2d ed. 1999).
Respondent argues that our decisions in Henry C. Beck
Builders, Inc. and Henry C. Beck Co. are therefore irrelevant to
the case at bar. Respondent contends that the pre-1966
regulations were an "elimination" system where income, gains,
losses, and deductions were zeroed out (eliminated) between
members of a consolidated group; therefore, timing questions
regarding the reporting of these items could never arise. The
1966 regulations, respondent points out, provided for a
"deferral" system where income, gains, losses, and deductions
were matched between members of a consolidated group. Respondent
argues that timing issues could arise under the 1966 regulations;
therefore the 1966 regulations should be characterized as a
method of accounting.
Petitioner agrees with respondent that the consolidated
return regulations were substantially amended in 1966 and
acknowledges that Henry C. Beck Builders, Inc. and Henry C. Beck
Co. were decided under the pre-1966 regulations. Petitioner
argues, however, that the 1966 regulations did not affect the
holdings in Henry C. Beck Builders, Inc. and Henry C. Beck Co.
- 46 -
that the consolidated return regulations were not a method of
accounting.
We do not believe that the 1966 regulations undercut the
holdings in Henry C. Beck Builders, Inc. and Henry C. Beck
Co. that the consolidated return regulations are a method of
reporting and not a method of accounting. To the contrary, the
1966 regulations fortify the reasoning contained in Henry C. Beck
Builders, Inc. and Henry C. Beck Co.
Respondent adopted sections 1.1502-12(d) and 1.1502-17,
Income Tax Regs., as part of the 1966 regulations. These
sections provide the rules for determining methods of accounting
and changes in method of accounting under the consolidated return
regulations.
Section 1.1502-12(d), Income Tax Regs., states that the
method of accounting under which the computation of separate
taxable income of each member of the consolidated group is made
and the adjustments to be made because of any change in method of
accounting shall be determined under section 1.1502-17, Income
Tax Regs. Section 1.1502-17, Income Tax Regs., entitled "Methods
of accounting", states that "The method of accounting to be used
by each member of the group shall be determined in accordance
with the provisions of section 446 as if such member filed a
separate return." Thus, each member (and not the group)
determines its method of accounting on a separate company basis--
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there is no method of accounting for the group as a whole.
Furthermore, section 446 controls the determination of the method
of accounting.
Section 446 supports the conclusion that the consolidated
return regulations are not a method of accounting. Section
446(c) lists four methods of accounting that are permissible:
(1) The cash method, (2) an accrual method, (3) any other method
permitted by chapter 1 of the Code, and (4) any permissible
combination of the three aforementioned methods. The
consolidated return regulations are neither the cash method nor
an accrual method. The consolidated return regulations are
authorized under chapter 6 of the Code. Section 446(c) and the
consolidated return regulations simply do not treat the
regulations (or more specifically, the matching rule contained in
section 1.1502-13(b)(2), Income Tax Regs.) as a method of
accounting. See Vernon C. Neal, Inc. v. Commissioner, T.C. Memo.
1964-220.
Additionally, section 446(a) and (e) refer to the method of
accounting on the basis of which the taxpayer regularly computes
his income in keeping his books. Corporations do not keep their
books based on the consolidated return regulations; the
consolidated return regulations make adjustments to each
corporation's income determined under each corporation's separate
method of accounting. The Commissioner's supervisory authority
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over accounting methods simply is not implicated here. See sec.
1.1502-17, Income Tax Regs.
It was not until 1995 that section 1.1502-13, Income Tax
Regs., was amended to state that the timing rules contained in
the consolidated return regulations are a method of accounting.28
See sec. 1.1502-13(a)(3), Income Tax Regs., as amended ("The
timing rules of this section are a method of accounting for
intercompany transactions, to be applied by each member in
addition to the member's other methods of accounting."); T.D.
8597, 1995-2 C.B. 147, 162.
Petitioner also argues that on a separate company basis GM
and GMAC did not change their respective methods of accounting
for the rate support payments or discount income. We agree. GM
always treated rate support payments as current deductions, and
GMAC always recognized discount income over the life of the
RISC/fleet loan. It was only when the GM group filed a
consolidated return that, on this return, the GM group deferred
the rate support deductions that, according to GM's accounting
method, GM was currently deducting.
28
The 1995 amendments are effective as of July 18, 1995,
and apply to transactions occurring in years beginning on or
after July 12, 1995. See T.D. 8597, 1995-2 C.B. 147, 185; sec.
1.1502-13(l)(1), Income Tax Regs., as amended. The 1995
amendments are not before the Court; therefore, we make no
conclusions as to whether these amendments are valid.
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Furthermore, we do not believe that respondent argues that
on a separate company basis either GM or GMAC changed its methods
of accounting for the rate support payments or discount income.
Based on the foregoing, we conclude that the consolidated
return regulations in effect during the year in issue constituted
a method of reporting and not a method of accounting. Therefore,
the GM group did not have to obtain the Secretary's consent
before changing how it reported the rate support deductions on
its consolidated return.
III. Deferral of the Rate Support Payments
Respondent's secondary argument is: (1) The rate support
payments GM made to GMAC were part of intercompany transactions
subject to the matching rule contained in section 1.1502-
13(b)(2), Income Tax Regs.; (2) the corresponding item of income
to the rate support deductions was the discount income GMAC
earned over the term of the RISC's/fleet loans; and (3) GM should
have deferred its rate support deductions until GMAC took the
corresponding item of income into account.
Petitioner counters that the rate support deductions were
not subject to the matching rule contained in section 1.1502-
13(b)(2), Income Tax Regs., because: (1) The rate support
payments were not income to GMAC; therefore they could not have
been the corresponding item of income to the rate support
deductions; (2) the discount income that GMAC earned from
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retail/fleet customers was not the corresponding item of income
to the rate support deductions; and (3) the discount income was
not earned in intercompany transactions.
A. The Matching Rule
As stated earlier, section 1.1502-13(b)(2), Income Tax
Regs., provided in part:
(2) Special rule. If, in an intercompany
transaction (other than a deferred intercompany
transaction), one member would otherwise properly
[take] an item of income or a deduction into account
for a consolidated return year earlier than the year
(whether consolidated or separate) for which another
member of the group can properly take into account the
corresponding item of income or deduction, then both
the item of income and the deduction shall be taken
into account for the later year (whether consolidated
or separate). * * *
In 1995, section 1.1502-13, Income Tax Regs., was amended to
state the following: "An item is a corresponding item whether it
is directly or indirectly from an intercompany transaction."29
Sec. 1.1502-13(b)(3)(i), Income Tax Regs., as amended; T.D. 8597,
1995-2 C.B. at 164.
29
The 1995 amendments are effective as of July 18, 1995,
and apply to transactions occurring in years beginning on or
after July 12, 1995. See T.D. 8597, 1995-2 C.B. 147, 185; sec.
1.1502-13(l)(1), Income Tax Regs., as amended. The 1995
amendments, therefore, are not before the Court.
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B. The Corresponding Item of Income and Intercompany
Transactions
Respondent agrees that the rate support payments were not
income to GMAC.30 Respondent contends, however, that the
corresponding item of income does not have to be from the very
same payment that creates the deduction. Respondent asserts that
"income or deduction that flows directly or indirectly from an
intercompany transaction constitutes a corresponding item" under
section 1.1502-13(b)(2), Income Tax Regs.
We must determine what the regulations meant by "the
corresponding item of income". Three examples contained in
section 1.1502-13(h), Income Tax Regs., illustrated what this
term meant:
Example (3). Corporations P and S file
consolidated returns on a calendar year basis and
report income on the cash basis. On July 1, 1966, S
pays P $1,000 interest on a loan made in 1961. The
payment of interest is an intercompany transaction
30
The rate support payments were not income to GMAC; they
reduced GMAC's basis in the rate-supported RISC's/fleet loans.
This was because the rate support payments induced GMAC to
purchase RISC's/fleet loans from independent GM dealers at face
value (i.e., GMAC paid independent GM dealers more than fair
market value for a below-market RISC/fleet loan only because GM
made rate support payments to GMAC for the excess amount paid).
See Brown v. Commissioner, 10 B.T.A. 1036, 1054-1055 (1928)
(amount received by buyer to induce him to purchase property is a
reduction in his cost of the property rather than income to the
buyer); Rev. Rul. 73-559, 1973-2 C.B. 299 (basis in acquired
mortgage is reduced by the amount of the inducement payment); see
also Freedom Newspapers, Inc. v. Commissioner, T.C. Memo. 1977-
429; Rev. Rul. 76-96, 1976-1 C.B. 23 (new car purchaser must
reduce his basis by amount of manufacturer rebate).
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other than a deferred intercompany transaction; S does
not defer or eliminate the $1,000 deduction for
interest and P does not defer or eliminate the $1,000
item of interest income. Thus, consolidated taxable
income for 1966 reflects interest income of $1,000 and
a corresponding deduction for interest of $1,000.
* * * * * * *
Example (13). Corporations P and S file
consolidated returns on a calendar year basis for 1966
and 1967. S reports income on the accrual method while
P reports income on the cash method. On December 31,
1966, S would properly accrue interest of $1,000 which
is payable to P. On February 1, 1967, S pays P the
$1,000. Both the deduction and the item of income are
taken into account for 1967, the later year. * * *
Consolidated taxable income for 1967 reflects both
interest income of $1,000 and a corresponding deduction
for interest of $1,000.
* * * * * * *
Example (16). Corporations P and S file
consolidated returns on a calendar year basis. On
January 10, 1968, P sells an issue of its $100 par
value bonds. S purchases a bond from P for $110. S
does not elect under section 171 to amortize the $10
premium. P may not take the $10 premium into account
as income until it redeems the bond since S cannot
properly take a deduction for the $10 premium until the
bond is redeemed.
In each of these examples, there was a direct relationship
between the income and the deduction. The money never left the
consolidated group, and third parties were not involved. A
single item (payment) within the group was an expense (deduction)
for one member of the group and income for another member.
In the case at bar, third parties (the independent GM
dealers and retail/fleet customers) were involved, and a single
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item (the rate support payment) was not an expense (deduction)
for one member of the group (GM) and income for another member
(GMAC). The payment GM made to GMAC (which was the deduction)
was not directly related to the payments the retail/fleet
customers made to GMAC (which contained the discount income).
Additionally, here the money left the consolidated group.
Compare the examples of rate supported and nonrate-supported
RISC's bearing a below-market rate of interest. See supra pp.
33-36. In the example of a nonrate-supported RISC bearing a
below-market rate of interest, GMAC paid the independent GM
dealer $9,500. Thus, the GM group's total net expense was
$9,500. In the example of a rate-supported RISC, GMAC paid the
independent GM dealer $10,000 and GM paid GMAC $500. Thus, the
GM group's total net expense was $10,000. Five hundred dollars
($500) more left the GM group when a below-market RISC/fleet loan
was rate supported as compared with when there was no rate
support.
As respondent pointed out on brief, the matching rule
ensures clear reflection of income and prevents the creation of
"paper" deductions when the group as a whole has not incurred a
net expense. Here, the group had a net expense.
Furthermore, the GM group's additional $500 expense was a
real loss of $500 to the GM group. In both the example of a
nonrate-supported RISC and a rate-supported RISC bearing a below-
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market rate of interest, the RISC's had face values of $10,000
and stated interest of $2,000. See supra pp. 33-36. Thus, if
GMAC held the below-market nonrate-supported RISC to maturity the
GM group made a $2,500 profit ($12,000 minus the $9,500 paid to
the independent GM dealer), or if the customer paid off the RISC
immediately the GM group made a $500 profit (the $10,000 of
stated principal minus the $9,500 paid to the independent GM
dealer). Whereas, if GMAC held the rate-supported RISC to
maturity the GM group made a $2,000 profit ($12,000 minus the
$10,000 paid to the independent GM dealer), or if the customer
paid off the RISC immediately the GM group made no profit (the
$10,000 of stated principal minus the $10,000 paid to the
independent GM dealer).
The purpose of the consolidated return regulations is to
provide rules so that the tax liability of a consolidated group
will be clearly reflected and to prevent the avoidance of such
tax liability. See sec. 1502. GM and GMAC have not fabricated a
transaction where numbers merely are being shuffled on paper
without any real loss to the GM group. The GM group's treatment
of the rate support deductions and the discount income clearly
reflected its tax liability.
Based on the foregoing, we conclude that the discount income
was not the corresponding item of income to the rate support
deductions.
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Even if, however, the discount income was the corresponding
item of income, the discount income would have to be part of an
intercompany transaction in order for the consolidated return
regulations to apply. See sec. 1.1502-13(b)(2). Section 1.1502-
13(a)(1), Income Tax Regs., defined the term "intercompany
transaction" as "a transaction during a consolidated return year
between corporations which are members of the same group
immediately after such transaction".
GMAC received the discount income from either a retail
customer or a fleet customer. GMAC acquired the right to receive
the discount income from an independent GM dealer when the
independent GM dealer assigned the RISC/fleet loan to GMAC.
Neither the retail/fleet customer nor the independent GM dealer
was part of the GM group; therefore the transactions between GMAC
and retail/fleet customers and GMAC and independent GM dealers
were not intercompany transactions.
The intercompany transaction rules of the consolidated
return regulations and the examples therein contemplated a
transaction solely within the consolidated group between members
of the group and not a situation where income comes from outside
the group in a transaction involving third parties. See section
1.1502-13(a)(1), (b)(2), (h) Examples (3), (13), (16), Income Tax
Regs., and the discussion of these examples supra.
- 56 -
Based on the foregoing, we conclude that the discount income
was not earned in an intercompany transaction.
C. Conclusion
We conclude that under the 1966 regulations, the discount
income GMAC earned over the term of RISC's/fleet loans from
retail/fleet customers was not the corresponding item of income
in an intercompany transaction to the rate support deductions.
Therefore, the GM group was not required to defer the rate
support deductions on its consolidated income tax return.
To reflect the foregoing,
An appropriate order
will be issued.
