Hachette USA, Inc. v. Comm'r of Internal Revenue

Citation105 T.C. No. 17,105 T.C. 234
Decision Date25 September 1995
Docket NumberDocket Nos. 11693–94,11694–94.
PartiesHACHETTE USA, INC., as Successor to Hachette Publications, Inc., and Curtis Circulation Co., Subsidiary, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent.HACHETTE USA, INC. as Successor to Hachette Distribution, Inc., and Curtis Circulation Co., Subsidiary, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
CourtUnited States Tax Court

OPINION TEXT STARTS HERE

Daniel M. Davidson and John Wester, for petitioners.

John A. Guarnieri and Douglas A. Fendrick, for respondent.

OPINION

LARO, Judge:

These cases were consolidated for trial, briefing, and opinion, and submitted to the Court without trial pursuant to Rule 122(a).1 Hachette USA, Inc. (Hachette USA), and its subsidiary Curtis Circulation Co. (Curtis) petitioned the Court for redetermination of the following Federal income tax deficiencies determined by respondent:

+-----------------------------+
                ¦¦Docket No. 11693–94:       ¦¦
                ++---------------------------+¦
                ¦¦                           ¦¦
                ++---------------------------+¦
                ¦¦Taxable Year   ¦¦Deficiency¦¦
                ++---------------++----------+¦
                ¦¦1987           ¦¦$665,225  ¦¦
                ++---------------++----------+¦
                ¦¦               ¦¦          ¦¦
                ++---------------------------+¦
                ¦¦Docket No. 11694–94:       ¦¦
                ++---------------------------+¦
                ¦¦                           ¦¦
                ++---------------------------+¦
                ¦¦Taxable Year   ¦¦Deficiency¦¦
                ++---------------++----------+¦
                ¦¦1987           ¦¦$139,502  ¦¦
                ++---------------++----------+¦
                ¦¦               ¦¦          ¦¦
                ++---------------++----------+¦
                ¦¦Tax Year Ended ¦¦Deficiency¦¦
                ++---------------++----------+¦
                ¦¦Nov. 30, 1988  ¦¦$2,535,928¦¦
                +-----------------------------+
                

After concessions, the issues for decision are: (1) Whether section 1.458–1(g), Income Tax Regs., which requires a taxpayer to reduce cost of goods sold when it elects to exclude sales income under section 458, is invalid; and (2) even if it is invalid, whether a taxpayer must obtain the Secretary's consent under section 446(e) before recomputing its taxable income without the erroneous cost of goods sold adjustments. Because we hold that the regulation is valid, we find it unnecessary to reach the second issue.

Stipulations by the Parties

The facts have been fully stipulated and are so found. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference.2 Petitioner Hachette USA is a Delaware corporation whose principal place of business on the date the petitions in this case were filed was in New York, New York. Petitioner Curtis was organized under Delaware law on May 28, 1986. From that time until June 30, 1987, it was a member of an affiliated group of corporations whose parent was Hachette Publications, Inc., a New York corporation (HPI). Curtis' income and deductions from May 28 through December 31, 1986, were included in the consolidated Federal income tax return, Form 1120, U.S. Corporation Income Tax Return (Form 1120), filed by HPI for HPI's 1986 taxable year. Curtis' income and deductions for the 6–month period ended June 30, 1987, were included on Form 1120 filed by HPI for HPI's 1987 taxable year.

On June 30, 1987, HPI transferred all of its stock in Curtis to Hachette Distribution, Inc., a Delaware corporation (HDI). Curtis' income and deductions for the 6–month period ended December 31, 1987, and for the 11–month period ended November 30, 1988, were included on Forms 1120 filed by HDI for HDI's 1987 and 1988 taxable years, respectively. In a merger consummated on November 30, 1988, Hachette USA, succeeded to all the assets, claims, debts, and liabilities of HPI and HDI.

At all times relevant to these cases, Curtis was a national wholesale distributor of magazines. Its customers were local or regional distributors who sold the magazines acquired from Curtis to retail merchants. In accordance with established industry practice Curtis billed its customers for the full number of copies that it shipped to them, but granted them the legal right to receive full credit for copies of magazines that they were unable to sell. Curtis, in turn, was entitled to receive full credit from the magazine publishers for these unsold copies. Thus, the financial risk associated with returned merchandise was ultimately and solely borne by Curtis, suppliers.

In computing its income for the taxable years in issue Curtis properly elected under section 458 to exclude from gross income the full amount of the sale price of copies returned by its customers within the first 2– 1/2 months of the following taxable year. On Forms 1120 filed for HPI's 1986 and 1987 taxable years and HDI's 1987 taxable year, Curtis also reduced its cost of goods sold by the amount of the credits that it was entitled to receive and in due course did receive from the magazine publishers with respect to the returned magazines. These correlative cost adjustments were in accordance with section 1.458–1(g), Proposed Income Tax Regs., 49 Fed.Reg. 34523 (Aug. 31, 1984) (the Regulation). In early 1989 Curtis learned that the Government had conceded a refund action involving another taxpayer's attempt to make the section 458 election without offsetting cost adjustments. In reliance upon this concession, Curtis filed a Federal income tax return, Form 1120X, Amended U.S. Corporation Income Tax Return (Form 1120X), for HPI's 1986 and 1987 taxable years and HDI's 1987 taxable year covered by its section 458 election, on which it recomputed the amount of the gross income exclusion without regard to the requirements of the Regulation and claimed refunds for overpayment of tax and interest. With respect to HPI's 1987 taxable year, respondent refunded the full amount claimed, but she has not allowed the claim with respect to the HDI 1987 taxable year.

On Form 1120 for HDI's 1988 taxable year Curtis computed the exclusion for returned merchandise without offsetting adjustments for the credits it was entitled to receive from its suppliers. On April 13, 1994, respondent timely mailed notices of deficiency to HPI and HDI. In the notice sent to HDI respondent disallowed the claim for refund with respect to the HDI 1987 taxable year. On July 5, 1994, Hachette USA, as successor to HPI and HDI, and Curtis timely filed petitions with the Court.

All of the deficiencies and overpayments in dispute turn on the application of the Regulation to the computation of gross income under the section 458 election. The parties agree that if Curtis was required to follow the Regulation, there are deficiencies of $665,225 for HPI's 1987 taxable year, $135,804 for HDI's 1987 taxable year, and $2,535,928 for HDI's 1988 taxable year. If the Regulation is invalid, and Curtis was not required to secure the Secretary's consent to recompute its taxable income on the Forms 1120X, there are no deficiencies, and there is an overpayment for HDI's 1987 taxable year in the amount of $1,165,475.

Legislative Background

Section 458 was added to the Code by section 372(a) of the Revenue Act of 1978, Pub.L. 95–600, 92 Stat. 2763, 2860. The specific problems to which it was addressed are explained in the legislative history. Under general tax principles accrual basis taxpayers must include sales revenues in income for the taxable year when all events have occurred which fix the right to receive the income and. the amount of the income can be determined with reasonable accuracy. See sec. 451(a); sec. 1.451–1(a), Income Tax Regs. The seller has some flexibility in determining when to account for sales, such as, for example, at the time of shipment or title passage or acceptance, but the expectation that some of the merchandise may be returned after the date of sale for credit or refund does not warrant the postponement of accrual. The way that the accrual method of accounting corrects the overstatement of income resulting from the return of merchandise is by allowing the seller a deduction in the year of return for the amount of the credit or refund given to the purchaser. In periods of generally rising sales and fairly constant rates of merchandise returns this method of accounting leads to persistent overstatement of income. In the print and sound recording industries, where merchandise returns regularly constitute a substantial percentage of total sales, the general accrual principles were perceived to be inconsistent with economic realities and unfair.

The Senate Finance Committee report accompanying the Revenue Act of 1978 gave its assessment of the problem as follows:

Reasons for change

Publishers and distributors of magazines, paperbacks, and records often sell more copies of their merchandise than it is anticipated will be sold to consumers. This “overstocking” is part of a mass-marketing promotion technique, which relies in part on conspicuous display of the merchandise and ability of the retailer promptly to satisfy consumer demand. Publishers usually bear the cost of such mass-marketing promotion by agreeing to repurchase unsold copies of merchandise from distributors, who in turn agree to repurchase unsold copies from retailers. These unsold items are commonly called “returns”.

The generally accepted method of accounting for returns in the publishing industry is to record sales at the time merchandise is shipped and to establish an offsetting reserve for estimated returns. The effect of this accounting treatment is to report sales net of estimated returns. Tax accounting rules, however, do not permit gross income to be reduced for returns until the returned items are received, which may not occur until a taxable year subsequent to that in which the sale was recorded.

The committee believes that the present method of tax accounting for returns of magazines, paperbacks, and records does not accurately measure income for Federal income tax purposes and. that it adversely affects publishers and distributors of these items. [S. Rept. 95–1278, at 4 (1978).]

The basic formula of ...

To continue reading

Request your trial
4 cases
  • Greenberg Bros. P'ship # 4 v. Comm'r of Internal Revenue, 19575–91
    • United States
    • United States Tax Court
    • August 24, 1998
    ...a statute is a necessary and proper part of the Secretary's role in the administration of our tax laws.” Hachette USA, Inc. v. Commissioner, 105 T.C. 234, 251, 1995 WL 563984 (1995), affd. per curiam 87 F.3d 43 (2d Cir.1996). “ ‘The power of an administrative agency to administer a congress......
  • Wal-Mart Stores, Inc. v. Commissioner, Docket No. 27022-93.
    • United States
    • United States Tax Court
    • January 2, 1997
    ...is synonymous with GAAP. Thor Power Tool Co. v. Commissioner [79-1 USTC ¶ 9139], 439 U.S. at 531; see also Hachette USA, Inc. v. Commissioner [Dec. 50,902], 105 T.C. 234, 247 (1995), affd. [96-2 USTC ¶ 50,333] 87 F.3d 43 (2d Cir. 1996). Thus, petitioners' method of accounting for their inve......
  • Ohio Periodical Distributors, Inc. v. C.I.R., 96-1136
    • United States
    • United States Courts of Appeals. United States Court of Appeals (6th Circuit)
    • January 29, 1997
    ...1995). The court noted that petitioners' counsel had represented another petitioner on this same issue in Hachette USA, Inc. v. Commissioner, 105 T.C. 234, 1995 WL 563984 (1995), aff'd, 87 F.3d 43 (2d Cir.1996), presenting a substantially verbatim argument. 68 T.C.M. (RIA) at 95-3117. Conse......
  • Kraus v. Commissioner
    • United States
    • United States Tax Court
    • January 9, 2003
    ...for 1997 and 1998, respectively, as "cost of goods sold". Petitioner relies on section 458 and the case of Hachette USA, Inc. v. Commissioner [Dec. 50,902], 105 T.C. 234 (1995), as support for his claimed reductions to gross Section 458 is an elective provision that permits the exclusion fr......

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT