1946 U.S. Tax Ct. LEXIS 94">*94
Petitioner, a regular dealer in personal property on the installment plan, became qualified at the close of 1942 to elect, and did elect, under
7 T.C. 648">*648 These consolidated proceedings involve excess profits tax deficiencies for the calendar years 1940 and 1941, in the respective amounts of $ 3,411.19 and $ 1,384.90. The sole issue is whether petitioner, an installment basis taxpayer, having elected under
The facts have1946 U.S. Tax Ct. LEXIS 94">*97 been stipulated and are accordingly adopted.
7 T.C. 648">*649 FINDINGS OF FACT.
Petitioner is a corporation organized under the laws of Maine in 1929, with principal offices at Portland, in that state. Its original and amended income and excess profits tax returns for the years in issue were filed with the collector for the district of Maine.
Since its organization petitioner has been engaged in the business of selling clothing and jewelry at retail on the installment plan. For each of the years 1938 to 1942, inclusive, petitioner reported its income on the installment method of accounting under section 44 of the code and the applicable revenue acts. Its original excess profits tax returns for 1940 and 1941 were filed on the same basis.
After the close of the year 1942 petitioner established that its average of outstanding installment accounts receivable at the end of each of the years 1938 to 1941, inclusive, was more than 125 per cent of its outstanding installment accounts receivable at the end of 1942. Pursuant to
Debts owing to petitioner in the aggregate amount of $ 26,468.10 became worthless during 1940. The amount of $ 13,607.67 of those worthless debts represented debts arising out of installment sales made prior to January 1, 1940. Unrealized profits reflected in such pre-1940 debts amounted to $ 7,924.36. The balance of $ 5,683.31 represented petitioner's unrecovered cost of the sales.
In 1941 petitioner had bad debts amounting to $ 29,303.20, of which $ 3,462.22 represented debts arising out of installment sales made prior to January 1, 1940. Unrealized profits reflected in such pre-1940 debts amounted to $ 2,065.77, and the balance of $ 1,396.45 represented unrecovered cost of the sales.
Respondent refused to allow petitioner any bad debt deduction for excess profits tax purposes in either 1940 or 1941 on account of pre-1940 sales. For income tax purposes, however, the amounts of $ 5,683.31 and $ 1,396.45, representing unrecovered cost, were allowed as bad debt deductions for 1940 and 1941, respectively.
OPINION.
1946 U.S. Tax Ct. LEXIS 94">*100 Respondent's action in refusing to allow petitioner any deduction for bad debts with respect to installment sales made prior to January 1, 1940, is based on section 30.736 (a)-3 of Regulations 109, as amended by
Sec. 30.736 (a)-3. Computation of Income on Straight Accrual Basis. -- If the taxpayer has elected under
1946 U.S. Tax Ct. LEXIS 94">*101 The last sentence of the above quoted portion of the regulation is predicated, according to respondent, upon that part of
Furthermore, the effect of the existing situation in respect of an installment basis taxpayer was to subject to excess profits tax income arising from sales made in years when there was no such tax -- that is, income which in reality accrued before the adoption of the excess profits tax legislation. The excess profits tax, being1946 U.S. Tax Ct. LEXIS 94">*103 an emergency or war measure aimed at profits attributable to war years in excess of normal or average profits during prior base period years, fell with undue impact upon certain installment basis taxpayers whose method of accounting, in view of the business conditions and credit restrictions above referred to, did not afford an accurate measure of their true "excess" profits attributable to war years. Recognizing the hardship which thus befell installment basis taxpayers as compared with other taxpayers, Congress gave relief in
If
Section 44 (a) of the code, providing for the installment basis of reporting income, is concerned with the computation of the amounts of gross profits on installment sales to be returned as income in a given year. It provides that regular dealers in personal property on the installment plan "may return as income therefrom in any taxable year that proportion of the installment payments actually received in that year which the
* * * the statute goes no farther than to prescribe a method by the use of which a dealer in personal property on the installment plan may return income from installment sales. Nothing is contained in the statute which can possibly be construed to deny to this class of taxpayers the deductions provided for under sections 214 and 234 [predecessors of section 23 of the Code], and the petitioner having employed the accrual method of accounting in keeping1946 U.S. Tax Ct. LEXIS 94">*106 its books of account [though reporting its income from installment sales on the installment basis], we think it is entitled to deduct all of the expenses, allowances, and losses enumerated in those sections, which were paid or incurred, or paid or accrued within the taxable years, with the single reservation that it may not deduct as bad debts such portion of its installment accounts receivable not previously returned as income.
In support of his regulation respondent advances an equitable argument to the effect that, since no income from pre-1940 sales is subjected to excess profits tax, it is only fair that no deductions relating to such sales should be allowed, and that if deductions are allowed a qualified electing installment basis taxpayer gains an unfair advantage over other taxpayers consistently reporting on an accrual basis. At first blush there might appear to be some merit in the argument, but we think it proceeds upon a fundamental fallacy. In the case of accrual basis taxpayers generally, the profits attributable to pre-1940 sales are no more subject to excess profits tax than those of installment basis taxpayers1946 U.S. Tax Ct. LEXIS 94">*108 electing under
For present purposes, therefore, the only difference we perceive between the two types of taxpayers is that in the single case of the deduction for bad debts, the amount of the electing installment basis taxpayer's deductible loss1946 U.S. Tax Ct. LEXIS 94">*109 is less than that of the accrual basis taxpayer to the extent of the unrealized profits in the particular installment contracts which the latter has taken into income and paid income tax thereon, but which the former has not. In other words, where an accrual basis taxpayer has accrued and paid tax on the uncollected profits in an 7 T.C. 648">*654 installment contract which later becomes worthless, thereby capitalizing such profits, his loss of capital -- and the measure of his bad debt deduction -- upon default of the contract is the uncollectible balance of the contract. On the other hand, the installment basis taxpayer's loss of capital -- and the measure of his bad debt deduction -- is the unrecovered cost of the goods sold. Cf.
All the petitioner is here claiming is the allowance of deductions for the unrecovered cost of goods represented in the installment accounts receivable charged off as worthless in the taxable years. To these we think petitioner is clearly entitled. There is no warrant for the respondent's regulation precluding the allowance of such deductions to qualified1946 U.S. Tax Ct. LEXIS 94">*110 electing taxpayers.
1.
(a) Election to Accrue Income. -- In the case of any taxpayer computing income from installment sales under the method provided by section 44 (a), if such taxpayer establishes, in accordance with regulations prescribed by the Commissioner with the approval of the Secretary, that the average volume of credit extended to purchasers on the installment plan in the four taxable years preceding the first taxable year beginning after December 31, 1941, was more than 125 per centum of the volume of such credit extended to such purchasers in the taxable year, or the average outstanding installment accounts receivable at the end of each of the four taxable years preceding the first taxable year beginning after December 31, 1941, was more than 125 per centum of the amount of such accounts receivable at the end of the taxable year, or if the taxpayer was not in existence for four previous taxable years, the taxable years during which the taxpayer was in existence, in either case including only such years for which the income was computed under the method provided in section 44 (a), it may elect, in its return for the taxable year, for the purposes of the tax imposed by this subchapter, to compute, in accordance with regulations prescribed by the Commissioner with the approval of the Secretary, its income from installment sales on the basis of the taxable period for which such income is accrued, in lieu of the basis provided by section 44 (a). Except as hereinafter provided, such election shall be irrevocable when once made and shall apply also to all subsequent taxable years, and the income from installment sales for each taxable year before the first year with respect to which the election is made but beginning after December 31, 1939, shall be adjusted for the purposes of this subchapter to conform to such election. In making such adjustments, no amount shall be included in computing excess profits net income for any excess profits tax taxable year on account of installment sales made in taxable years beginning before January 1, 1940. * * *↩
2. H. Rept. No. 2333, 77th Cong., 1st sess.,