54 T.C. 1215">*1215 The respondent determined deficiencies in petitioner's income taxes as follows:

The issues for decision are:

(1) Whether with respect to the years1970 U.S. Tax Ct. LEXIS 121">*125 ended November 30, 1962, 1963, and 1964, the petitioner is entitled to compute a reserve for bad debts pursuant to section 166(g)¹ with respect to guaranteed debt obligations.

(2) Whether petitioner "disposed of" installment obligations during its taxable years ended November 30, 1965 and 1966, so as to preclude its reporting income on the installment method under section 453.

54 T.C. 1215">*1216 (3) The determination of the loss ratio to be used in computing allowable additions to the petitioner's reserve for bad debts for those years in which the petitioner properly maintained such a reserve.

FINDINGS OF FACT

Some of the facts have been stipulated. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.

The petitioner, United Surgical Steel Co., Inc., is an Alabama corporation. Its principal office, both now and at the time the petition was filed in this case, is located 1970 U.S. Tax Ct. LEXIS 121">*126 in Montgomery, Ala.

The petitioner filed its corporate income tax returns for its taxable years ended November 30, 1962, through November 30, 1966, with the district director of internal revenue, Birmingham, Ala.

The petitioner was incorporated on April 1, 1962. At all times from that date until November 30, 1966, Mr. John O. Hope owned over 96 percent of petitioner's outstanding common stock.

During the taxable years involved in this case, petitioner was engaged in the business of selling cookware, china, and related items to consumers. Most of petitioner's sales were made on conditional sales contracts with installment notes where a 10-percent downpayment was made by the customer and the balance of the contract was secured by a note payable in monthly installments over a period of 12, 15, 18, or 24 months.

On April 1, 1962, petitioner entered into an agreement with United Discount Co., Inc., an Alabama corporation in which Mr. John O. Hope also had a controlling interest, whereby the latter company agreed to purchase the conditional sales contracts entered into by petitioner. The agreement provided that all conditional1970 U.S. Tax Ct. LEXIS 121">*127 sales contracts purchased by United Discount Co., Inc., were "with recourse" against the petitioner and that the petitioner would, on demand, repurchase all contracts that became "delinquent in payment by a period in excess of ninety (90) days."

During its taxable years ended November 30, 1962, November 30, 1963, and November 30, 1964, nearly all conditional sales contracts petitioner entered into upon the sale of cookware and related items were sold to United Discount Co., Inc. The total amount owing on December 1, 1964, on the conditional sales contracts that the petitioner had sold to United Discount Co., Inc., was $ 721,777.32. On May 31, 1965, the petitioner repurchased all the conditional sales contracts it had previously sold to United Discount Co., Inc.

54 T.C. 1215">*1217 After entering into the agreement with United Discount Co., Inc., on April 1, 1962, the petitioner set up an account entitled "Provision for Repurchase of Notes Discounted" and added $ 59,887.27 to this account by the end of its taxable year ended November 30, 1962.

During its taxable year ended November 30, 1962, the petitioner provided $ 730.83 for bad debts arising from accounts receivable other than those where1970 U.S. Tax Ct. LEXIS 121">*128 conditional sales contracts were sold to United Discount Co., Inc.

During its taxable year ended November 30, 1962, the petitioner repurchased conditional sales contracts with installment notes from United Discount Co., Inc., in the total amount of $ 1,040.30 which had become worthless by November 30, 1962.

In its income tax return filed for its taxable period from April 1, 1962, to November 30, 1962, inclusive, the petitioner elected to use the reserve method for deducting its bad debts and deducted $ 61,526.16 as bad debts, consisting of $ 59,887.27 as a provision for repurchase of notes discounted, $ 1,040.30 for repurchased notes, and $ 598.86 as a provision for bad accounts.

During its taxable year ended November 30, 1963, the petitioner added $ 15,054.31 to its account entitled "Provision for Repurchase of Notes Discounted."

During its taxable year ended November 30, 1963, the petitioner repurchased conditional sales contracts with installment notes from United Discount Co., Inc., in the total amount of $ 10,774.26 which had become worthless by November 30, 1963.

During its taxable year ended November 30, 1964, the petitioner reduced its account entitled "Provision for Repurchase1970 U.S. Tax Ct. LEXIS 121">*129 of Notes Discounted" by $ 14,578.41 as it actually had bad debts totaling $ 49,504.96 during that taxable year.

The petitioner's returns for its taxable years ended November 30, 1962, 1963, and 1964, were received by the respondent on February 18, 1963, on February 17, 1964, and on February 16, 1965, respectively. On December 17, 1965, the petitioner signed a Form 872, Consent Fixing Period of Limitations upon Assessment of Income and Profits Tax, for its taxable year ended November 30, 1962, extending the period for assessment for that year to February 15, 1967.

As a result of an examination by the respondent of the petitioner's tax returns for its taxable years ended November 30, 1962, November 30, 1963, and November 30, 1964, which examination was completed on or about February 1, 1966, the respondent made certain 54 T.C. 1215">*1218 adjustments to the deductions claimed by the petitioner on those tax returns including the following:

1970 U.S. Tax Ct. LEXIS 121">*130 The respondent also made other adjustments that are not in dispute.

The petitioner's taxable income as adjusted by the respondent and the resulting adjustments in the petitioner's tax liability were as follows:

The petitioner agreed to the adjustments made by the respondent and executed a Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment, which was received in respondent's office in Montgomery, Ala., on February 1, 1966. The deficiencies resulting from those adjustments in the net amount of $ 39,598.14 were assessed on April 1, 1966.

On February 16, 1966, the petitioner filed Form 1139, Application for Tentative Carryback Adjustment, for its taxable year ended November 30, 1965, which stated that the petitioner had a net operating loss of $ 170,489.18. The petitioner requested that this loss be applied to reduce taxable income1970 U.S. Tax Ct. LEXIS 121">*131 for prior years, as follows:

54 T.C. 1215">*1219 On April 11, 1966, a tentative allowance of the requested net operating loss carryback was made pursuant to section 6411(b) whereby the respondent redetermined the petitioner's total income tax liability for its taxable years ended November 30, 1962 through 1964, as follows:

On February 13, 1967, the petitioner filed Form 1139 for its taxable year ended November 30, 1966, setting forth a net operating loss of $ 133,879.81 for that taxable year. The petitioner requested that $ 35,268.33 of this loss be applied to reduce its remaining taxable income of $ 35,268.33 for its taxable year ended November 30, 1964, to zero.

On March 17, 1967, a tentative allowance of the requested net operating loss carryback was made1970 U.S. Tax Ct. LEXIS 121">*132 pursuant to section 6411(b) whereby the petitioner's income tax liability for its taxable year ended November 30, 1964, was reduced from $ 11,377.84 to zero.

On an examination of the petitioner's returns, the respondent determined that the petitioner had realized income for its taxable year ended November 30, 1965, in the amount of $ 57,613.99, and for its taxable year ended November 30, 1966, in the amount of $ 62,080.46. The respondent's determination was based mainly on his contention that the petitioner had disposed of its conditional sales contracts during its taxable years ended November 30, 1965 and 1966, when it assigned those contracts to a bank pursuant to a loan agreement.

The respondent further determined that the amounts applied and refunded under section 6411(b) with respect to the petitioner's applications for tentative carryback adjustments should not have been so applied and refunded. Therefore, on January 18, 1968, the respondent issued a notice of deficiency in which he redetermined the petitioner's tax liability and assessed deficiencies for the petitioner's taxable years ended November 30, 1962, 1963, and 1964, as follows:

1970 U.S. Tax Ct. LEXIS 121">*133 On January 25, 1968, the petitioner filed claims (Form 843) for the refund of taxes for its taxable years ended November 30, 1962, 1963, and 1964. In a statement attached to these claims, the petitioner 54 T.C. 1215">*1220 stated, in substance, that it was claiming its rights under section 166(g) to maintain its account entitled "Provision for Repurchase of Notes Discounted" for those years.

On May 31, 1965, a loan agreement was entered into by and between petitioner as the borrower, Modern China & Table Institute, Inc., and United Discount Co., Inc., as the guarantors, and the First National Bank of Montgomery, Montgomery, Ala. (the bank). The agreement provided, in part, that:

1. Subject to all the terms of this agreement and concurrently with assignment to the Bank by the Borrower of collateral acceptable to the Bank and during the life of this agreement, Bank shall lend to the Borrower from time to time, such amounts as the Borrower may request, provided, (a) That Borrower is not insolvent; (b) That the debit balance of the Borrower's loan account calculated upon promissory notes secured by conditional sales contracts or chattel mortgages1970 U.S. Tax Ct. LEXIS 121">*134 assigned to the Bank, after reflecting such requested loan, shall not exceed 88% of the outstanding balance of such notes so secured, and (c) that at the time of the requested loan the Borrower and Guarantors are not in default in any respect hereunder.

* * * *

5. This loan agreement and the financing arrangement contemplated hereunder is based on the following method of operation:

a. Notes and conditional sales contracts or chattel mortgages securing said notes will be transferred, assigned and delivered to the Bank. Said transfers and assignment shall be in form and substance satisfactory to bank and shall be with full recourse.

b. There will be attached to each contract evidence showing delivery of merchandise, and a credit statement on the individual buyer.

c. The Bank will advance 88% of the unpaid balance on the note and assigned collateral and place 12% of the unpaid balance in a dealer reserve account. The advance of 88% of the unpaid balance shall be considered "money in use" as mentioned herein;

d. The dealer reserve account will be built up to and then shall be maintained at 35% of aggregate unpaid balance of assigned collateral; any excess shall be paid to Borrower.

1970 U.S. Tax Ct. LEXIS 121">*135 * * * *

f. Collections on assigned collateral shall be deposited daily in kind to a collection account subject to withdrawal by Bank only, which account shall be the property of the Bank. Borrower shall maintain an impounded balance of $ 1,000.00 in said account. On Monday of each week borrower will send bank a recapitulation of payments deposited to the Collection Account the previous week. From this recapitulation, bank will withdraw the collected funds and apply as a credit to borrower's loan account. Returned checks shall be charged back to this account.

g. Any account represented by collateral which is three payments past due is to be bought back in cash by Borrower for the full unpaid balance. This repurchase is to take place no later than five days before the fourth payment falls due.

The loan agreement further provided that the petitioner was to keep its records in a manner satisfactory to the bank; the bank was 54 T.C. 1215">*1221 to have the right to audit the books of petitioner; the petitioner was to furnish the bank periodically with financial statements of its operations; the petitioner was to pay all its taxes as such taxes came due; the petitioner was to keep its property1970 U.S. Tax Ct. LEXIS 121">*136 insured; the petitioner was not to purchase any additional fixed assets other than automobiles and individual purchases of less than $ 1,000 without prior approval of the bank; the petitioner was not to change the compensation of certain employees and officers, or pay dividends, without prior approval of the bank; and, the petitioner was not to allow its property to become subject to liens.

The bank initially extended a line of credit up to a maximum of $ 650,000. On October 8, 1965, the line of credit was increased to a maximum of $ 850,000.

On October 8, 1965, petitioner executed its demand promissory note in the amount of $ 850,000 to the bank. The demand promissory note was described as a "draw" note. That is, petitioner did not owe the full amount of the note, but it was permitted to draw a percentage of the collateral assignments made by the petitioner to the bank. As a matter of practice, the petitioner did not borrow up to the maximum amount allowable.

Petitioner handled all collections of the assigned conditional sales contracts, without coordination with or approval of the bank. None of petitioner's customers were ever notified of the fact of the assignment of their1970 U.S. Tax Ct. LEXIS 121">*137 respective conditional sales contracts to the bank, and all communications with petitioner's customers concerning their accounts were made by petitioner. The bank did not maintain individual records on the assigned conditional sales contracts but accounted for such assigned contracts only in the total amount thereof.

After the loan agreement was entered into on May 31, 1965, petitioner assigned nearly all the consumer cookware contracts to the bank. It continued to so assign those contracts through November 30, 1966.

In its return for its taxable year ended November 30, 1965, the petitioner elected to report the income from cookware sold on the installment plan on the installment method of accounting. Based on this method of accounting, the petitioner reported $ 560,891.54 as gross profits on the collection of conditional sales contracts in its taxable year ended November 30, 1965, and $ 562,939.65 as gross profits on the collection of such contracts in its taxable year ended November 30, 1966.

On an examination by the respondent of the petitioner's returns, the respondent increased the petitioner's gross income for its taxable years ended November 30, 1965 and 1966, in the amounts1970 U.S. Tax Ct. LEXIS 121">*138 of $ 224,889.65 and $ 169,726.32, respectively. The respondent's adjustments were based 54 T.C. 1215">*1222 on his determination that the petitioner disposed of its conditional sales contracts when it assigned those contracts to the bank under the loan agreement of May 31, 1965.

The petitioner used the reserve method for deducting its bad debts in its taxable years ended November 30, 1965 and 1966.

The petitioner computed its additions to its reserve for bad debts for its taxable years ended November 30, 1965 and 1966, using as a basis the unrecovered cost of goods sold rather than the face amount of the installment notes subject to the loan agreement with the bank.

The petitioner deducted $ 90,363.60 in its return for its taxable year ended November 30, 1965, as an addition to its reserve for bad debts based on a loss ratio of 10.39 percent. The petitioner deducted $ 85,175.11 in its return for its taxable year ended November 30, 1966, as an addition to its reserve for bad debts based on a loss ratio of 8.12 percent.

The respondent redetermined the petitioner's deductions for additions to its reserve for bad debts and allowed deductions for such additions for the1970 U.S. Tax Ct. LEXIS 121">*139 petitioner's taxable years ended November 30, 1965 and 1966, in the amounts of $ 84,615.08 and $ 55,018.87, respectively, using as a basis for his computation the face amount of the installment notes subject to the loan agreement with the bank and loss ratio of 8.13 percent. The loss ratio of 8.13 percent was furnished to the respondent by the petitioner during the respondent's examination of the petitioner's returns.

For the purposes of resolving their dispute as to reasonable additions to the reserve for bad debts, the parties have stipulated that the petitioner held notes receivable and had incurred bad debts on the last day of its taxable year, as follows:

Petitioner's loss ratios for its taxable years ended November 30, 1964, 1965, and 1966, computed1970 U.S. Tax Ct. LEXIS 121">*140 on the basis of the average of the net bad debts (bad debts less subsequent recoveries thereof) to the average amounts of the petitioner's installment notes receivables for the 54 T.C. 1215">*1223 periods between November 30, 1963, and November 30, 1964, November 30, 1963, and November 30, 1965, and November 30, 1963, and November 30, 1966, respectively, were as follows:

OPINION

In its returns for the taxable years ended November 30, 1962, 1963, and 1964, the petitioner deducted additions to its reserve for bad debts on account of conditional sales contracts sold to United Discount Co., Inc., payment of which was guaranteed by the petitioner. In the examination of those returns, the deductions of the additions to the reserve were disallowed by the respondent and the resulting deficiencies were assessed on April 1, 1966.

In the meanwhile, on February 16, 1966, the petitioner filed an Application for Tentative Carryback Adjustment (Form 1139) for the taxable year ended November 30, 1965, showing a net operating loss carryback in an amount sufficient to offset1970 U.S. Tax Ct. LEXIS 121">*141 its taxable income, as determined by the respondent, for the taxable years ended November 30, 1962 and 1963, and to reduce substantially its taxable income for the year ended November 30, 1964. Thereafter, on February 13, 1967, the petitioner filed an Application for Tentative Carryback Adjustment (Form 1139) for the taxable year ended November 30, 1966, showing a net operating loss carryback sufficient in amount to offset the balance of its taxable income, as determined by the respondent, for the taxable year ended November 30, 1964.

Upon later examination of the petitioner's returns for the taxable years ended November 30, 1965 and 1966, the respondent determined that the petitioner had realized taxable income for such years.

In a notice of deficiency dated January 18, 1968, the respondent asserted deficiencies for the taxable years ended November 30, 1962, 1963, and 1964. ² The respondent also asserted deficiencies for the taxable years ended November 30, 1965 and 1966, resulting from the recomputation of the income (loss) for such years. The petitioner has sought a redetermination of those deficiencies.

1970 U.S. Tax Ct. LEXIS 121">*142 The notice of deficiency set forth a recomputation of the tax liability for the taxable years ended November 30, 1962 to 1966, inclusive, 54 T.C. 1215">*1224 commencing with the tax liability shown in the return for each of those years and setting forth all prior adjustments, credits and/or refunds.

In its petition, the petitioner put in issue not only respondent's determination with respect to the taxable years ended November 30, 1965 and 1966, but also the prior adjustments with respect to the years ended November 30, 1962, 1963, and 1964, whereby the respondent disallowed the deduction of the additions to the reserve for bad debts on account of the guaranteed obligations discounted with United Discount Co., Inc. The petition states:

The disallowance of bad debts for the fiscal years ended November 30, 1962, November 30, 1963, and November 30, 1964 as a result of a prior examination (February 11, 1966) was prior to the enactment of Section 166 (9) [sic], U.S.I.R.C., and, consequently, the disallowance of such amounts by the Commissioner is erroneous. The deduction for addition to Reserve for Bad Debts for the fiscal years ended November 30, 1965 and November 30, 1966 as shown by Petitioner's1970 U.S. Tax Ct. LEXIS 121">*143 returns for such respective years is correct.

Tax settlements previously agreed upon between Petitioner and the Commissioner for the fiscal years ended November 30, 1962, November 30, 1963, and November 30, 1964 were affected by the addition of Section 166(g)(4)(c) to the U.S.I.R.C. as to Bad Debt Reserves carried on Petitioner's books for any taxable year ending before October 22, 1965. Petitioner did have a Reserve for Bad Debts on their [sic] books as of the end of the fiscal year 1964, November 30, 1964. The subject addition to the Internal Revenue Code affects all the periods here involved.

The respondent contends that the petitioner's claim to the allowance of a reserve for bad debts under section 166(g) is barred by the statute of limitations and, in any event, is not before the Court for decision.

With respect to this issue there is thus presented for decision (1) whether the petitioner qualifies for the adjustment under section 166(g) and (2) whether the petitioner's claim for the adjustment is timely and before this Court.

Section 1 of Pub. L. 89-722 (Nov. 2, 1966), 80 Stat. 1151, amended section 166 by adding section 166(g) to allow deductions for additions to reserves1970 U.S. Tax Ct. LEXIS 121">*144 for guaranteed debt obligations. ³ With respect to taxable 54 T.C. 1215">*1225 years ending before October 22, 1965, section 2 of Pub. L. 89-722 provides as follows:

Sec. 2. (a) Except as provided in subsections (b) and (c), the amendments made by the first section of this Act shall apply to taxable years ending after October 21, 1965.

(b) If --

(1) the taxpayer before October 22, 1965, claimed a deduction, for a taxable year ending before such date, under section 166(c) of the Internal Revenue Code of 1954 for an addition to a reserve for bad debts on account of debt obligations described in section 166(g)(1)(A) of such Code (as amended by the first section of this Act), and

(2) the assessment of a deficiency of the tax imposed by chapter 1 of such Code for such taxable year and each subsequent taxable year ending before October 22, 1965, is not prevented on December 31, 1966, by the operation of any law or rule of law,