Knight-Ridder Newspapers, Inc. v. U.S.
| Decision Date | 03 October 1984 |
| Docket Number | No. 82-6157,KNIGHT-RIDDER,82-6157 |
| Citation | 743 F.2d 781 |
| Parties | 84-2 USTC P 9827 NEWSPAPERS, INC., Plaintiff-Appellee, v. UNITED STATES of America, Defendant-Appellant. |
| Court | U.S. Court of Appeals — Eleventh Circuit |
Glenn L. Archer, Jr., Asst. Atty., Gen., Michael L. Paup, Chief, Robert S. Pomerance, William A. Whitledge, Gayle P. Miller, Tax. Div., Dept. of Justice, Washington, D.C., for defendant-appellant.
Murai, Wald & Biondo, Gerald B. Wald, Miami, Fla., Hughes, Hubbard & Reed, George A. Davidson, New York City, for Knight-Ridder.
Appeal from the United States District Court for the Southern District of Florida.
Before TJOFLAT and CLARK, Circuit Judges, and GOLDBERG *, Senior Circuit Judge.
The United States appeals from a decision of the District Court, holding that Knight-Ridder Newspapers ("Taxpayer" or "Knight-Ridder") is entitled to recover certain federal income tax payments with respect to its 1972, 1973, and 1974 taxable years. The payments represent various deficiencies assessed by the Internal Revenue Service and involve three separate legal issues. Taking them in order, we hold first that the Commissioner of Internal Revenue ("Commissioner") did not abuse his discretion under I.R.C. Sec. 446 when he determined that the cash method of accounting did not clearly reflect the income of two of Taxpayer's subsidiaries. The Commissioner acted well within his authority in requiring those subsidiaries to adopt the accrual method.
Second, we hold that Taxpayer did not properly elect to use the "Guideline Class Life System" for depreciating the press equipment of several of its subsidiaries. Taxpayer failed to substantially comply with the regulatory requirements because its tax returns contained nothing to alert the Commissioner that an election had been made.
Finally, we hold that the use of an advertising rebate reserve is a "method of accounting," such that the abandonment of the method triggers compensatory adjustments pursuant to I.R.C. Sec. 481.
Taxpayer runs a large newspaper chain. It was formed on November 30, 1974, as a result of the merger of Knight Newspapers, Inc. ("Knight Newspapers") and Ridder Publications, Inc. Knight Newspapers in turn was the sole owner of a number of subsidiaries whose main business involved the publication of newspapers. For the taxable years 1972 and 1973, Knight Newspapers filed consolidated tax returns, reporting the income of the following subsidiaries: Beacon Journal Publishing Company, Tallahassee Democrat, Inc., Macon Telegraph Publishing Company, Boca Raton News, Inc., Philadelphia Newspapers, Inc., Detroit Free Press, Inc. ("Detroit Free Press") and Knight Publishing Company. The Lexington Herald Leader Company was a party to the consolidated return for 1973.
In addition, Knight Newspapers acquired the R.W. Page Corporation ("Page") on October 1, 1973. Page had been actively engaged since 1927 in the business of publishing newspapers in Columbus, Ga. Page had also operated as a separate business the Bradenton Herald, Inc. ("Bradenton"), which published a newspaper in Bradenton, Florida. On November 1, 1973, Knight Finally, Knight-Ridder filed a consolidated return in 1974, covering among other things, the operations of the same subsidiaries whose operations had been covered by the 1973 return filed by Knight Newspapers.
Newspapers organized Bradenton as a subsidiary of Page. Thus, Page and Bradenton were parties to the 1973 consolidated return of Knight Newspapers. Page was a party to the return for the period from October 1 through December 31, 1973; Bradenton was a party for the period November 1 through December 31.
One of the disputes in this case concerns whether Page and Bradenton should use the cash and disbursements method of accounting or the accrual method. To simplify the distinction: under the cash method, expenditures are deducted when made and payments included in income when received. Under the accrual method, by contrast, income and deductions are generally recognized when an obligation becomes fixed, rather than when cash payments are actually made. Thus, accounts payable and accounts receivable are taken into account when the debts are fixed, even though no money has changed hands. 1
Throughout their history, Page and Bradenton have reported their income for tax purposes using the cash method. They have used the accrual method in preparing financial statements. During an audit of Page's tax returns for the years 1964 through 1966, Page proposed to the I.R.S. examining agent that the company change its method of accounting to the accrual method. The agent considered the proposal but did not require 2 a change of method for those years. The Service later audited Page's returns for 1969 and 1970 and again did not object to the use of the cash method. During that period, the cash and accrual methods reached substantially the same results in measuring the before-tax income of Page and Bradenton.
After Knight Newspapers bought Page and Bradenton in late 1973, however, a substantial discrepancy appeared between the two methods. In the tax year ending December 31, 1974, the cash method netted approximately $1,400,000 in taxable income for Page and Bradenton, while the accrual method would have yielded approximately $1,900,000, a difference of $500,000 (according to the calculations of Mr. William Pruitt, an accounting expert who testified for Taxpayer). See Plaintiff's Exhibit 13, at 4; Plaintiff's Exhibit 20, at 4; Plaintiff's Chart # 1. 3
This distortion was the result of Knight-Ridder's investment of capital in the business of Page and Bradenton, building up accounts receivable and inventories of raw materials (newsprint and ink). The inventories in particular increased by about $240,000 in 1974, from $210,000 to $450,000. The cash and accrual methods did not show such gross discrepancies again during the years 1975 to 1979.
In an audit of the 1973 and 1974 tax returns of Knight-Ridder and its subsidiaries, the Commissioner determined that the cash method did not clearly reflect income for Page and Bradenton in those years. He found that a timing distortion resulted because of the accounts receivable and inventory fluctuations. Therefore, he required Page and Bradenton to switch to the accrual method for the short tax period ending December 31, 1973 (i.e., the months after the take-over by Knight-Ridder), and the full tax year ending December 31, 1974.
In line with that decision, the Commissioner required Taxpayer to include in its income for those years the adjustments prescribed by section 481 of the Internal Revenue Code, 26 U.S.C. Sec. 481. Section 481 adjustments are designed to compensate for the duplication or omission of items of income or expense that occurs when a taxpayer changes its method of accounting. Taxpayer paid the tax resulting from these adjustments and, after satisfying the requisite administrative claim procedure, filed this suit for a refund.
The case was tried to the bench in the Southern District of Florida. The trial court held that the Commissioner had consented to Page's and Bradenton's use of the cash method and that, in any event, the method clearly reflected their income. Therefore, the Commissioner had abused his discretion in requiring Page and Bradenton to use the accrual method for 1973 and 1974.
The Internal Revenue Code has always permitted depreciation to be taken on the "facts and circumstances" method. That method requires a taxpayer to assign a separate useful life to each capital item based on a judgment as to how long it is expected to last. In recent years the Code and regulations have permitted taxpayers to elect various "class life" systems under which whole classes of assets may be assigned the same specified, and artificially short, useful life. The "Guideline Class Life System" applies to assets put into service before 1971. Since at least 1970, Taxpayer's policy has been to take the most rapid depreciation allowed on the press equipment of its subsidiaries. It advised its tax accountant of the policy; and its subsidiaries accurately computed depreciation on their own books in accordance with the Guideline Class Life System.
A number of the subsidiaries, however, did not indicate on their tax forms for 1972 and 1973 that they were electing to use the system. Knight-Ridder's consolidated returns were prepared by a national independent accounting firm. A local office of the firm prepared the returns for the local subsidiary of Knight-Ridder. Then, the local office sent the returns to the Miami office where all of the forms were collected A number of the forms as prepared did not comply with Treasury Regulations governing the election of the Guideline Class Life System, Treas.Reg. Sec. 1.167(a)-12, 26 C.F.R. Sec. 1.167(a)-12 (1983). The Regulations require the taxpayer to "check" a box provided in Schedule G of its Corporate Tax Return and file a completed Form 5006 with the return. For their 1972 and 1973 taxable years, two of the subsidiaries--the Detroit Free Press and the Knight Publishing Company--checked the appropriate box and filed Form 5006. However, for the same years, neither Knight Newspapers nor any of its other seven subsidiaries 4 checked that box or filed Form 5006. Nor did the information required by the Treasury appear anywhere else in their returns. Most of them did, however, check a similar box electing to use the "Class Life ADR System," which applies only to assets put into service after 1971. 5
and attached to Knight-Ridder's consolidated return.
The Commissioner concluded that Knight Newspapers and the seven subsidiaries had not elected the Guideline Class Life System for pre-1971 assets. He recomputed their depreciation according to the "facts and circumstances" test, determining that the proper useful life for the...
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