Doubleday & Co., Inc. v. US

• Decision Date: 12 September 1989
• Docket Number: No. 86 CV 307.,86 CV 307.
• Citation: 721 F. Supp. 436
• Parties: DOUBLEDAY & COMPANY, INC., Plaintiff, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — Eastern District of New York

721 F. Supp. 436

DOUBLEDAY & COMPANY, INC., Plaintiff, v. UNITED STATES of America, Defendant.

No. 86 CV 307.

United States District Court, E.D. New York.

September 12, 1989.

Satterlee Stephens Burke & Burke, Jeremy Nowak, New York City, for plaintiff.

U.S. Dept. of Justice, Peter Sklarew, Washington, D.C., for defendant.

COSTANTINO, District Judge.

Plaintiff, Doubleday & Co., Inc., commenced this action seeking a refund of corporate income tax in the sum of $1,423,328 plus interest arising from its 1977 tax year return.

The parties have submitted a detailed stipulation of facts as to all issues and both sides have filed cross-motions for summary judgment. For the reasons to follow defendant's motion for summary judgment is granted in all respects.

BACKGROUND

As stated above the parties have entered into a 45 page stipulation of facts which clearly sets forth the history of this litigation. For the sake of clarity, the Court will summarize a few of the important facts.

Plaintiff has been in the publishing business since 1897, and has since expanded into various related businesses. In mid 1976, plaintiff acquired the assets of Dell Publishing Co., Inc. and its subsidiaries. Largely replicating the corporate structure of Dell, plaintiff formed a group of new corporations among which were; a new Dell Publishing Co. Inc., Dell Distributing, Inc., and Dell International, Inc. (referred to herein collectively as "Dell"). The issues involved in this suit concern plaintiff's tax liabilities for its fiscal year ended April 30, 1977, stemming from its Dell subsidiaries with which plaintiff filed a consolidated income tax return.

In this consolidated return, plaintiff reported income on an accrual basis rather than a cash basis. The accrual method for tax purposes essentially requires taxpayers to report items of income and expense in the year in which the right or obligation becomes fixed and definite in amount. However, Dell sells most of its paperbacks on an installment payment basis and reported incomes from such sales is reported under the installment method. Essentially, the installment method allows a taxpayer to report gross receipts from installment sales over more than one year in accordance with the payment schedule, even though an accrual method taxpayer would otherwise be required to report the entire contract price in the year of the sale.

Plaintiff's original refund claim was $1,423,328 and premised on a particular issue concerning the computation of deferred gross profit on installment sales ("deferred gross profit issue"). The deferred gross profit issue first arose in an audit of plaintiff's fiscal 1977 tax return wherein the IRS determined that deferred gross profit on installment sales was incorrectly computed. (Plaintiff initially indicated that it would not contest the adjustment made in connection with this issue, although no binding agreement was entered, and plaintiff later determined to contest the adjustment and file its refund claim. As further noted below, the IRS eventually accepted plaintiff's position with respect to the deferred gross profit issue when processing plaintiff's amended refund claim, but again no binding agreement was reached.)

Plaintiff's amended refund claim restated the deferred gross profit issue and further claimed additional amounts of overpaid tax based on additional issues. All of the other issues raised in the amended refund claim were settled between plaintiff and the IRS.

Subsequently the IRS tentatively determined to allow plaintiff's refund claim with respect to the deferred gross profit issue which would have resulted in a reduction in plaintiff's taxable income in the amount of $2,965,266 and would have warranted the conclusion that plaintiff overpaid income taxes for its 1977 fiscal year in the amount of $1,423,328. This figure is identical to the amount of the overpayment claimed by plaintiff in its original unamended claim.

Notwithstanding the facts set forth above, the IRS denied plaintiff's claim for refund because, in considering the same, it raised a new issue by disallowing the deduction of certain royalty expenses claimed by plaintiff, referred to herein as "royalties reconciliation deduction." This disallowance increased plaintiff's taxable income by $3,139,617. The "royalties reconciliation deduction" issue first arose in connection with an IRS audit of plaintiff's fiscal 1978 and 1979 tax returns (and also after plaintiff's amended claim for refund with respect to fiscal 1977 had already been filed). At such time, the IRS was barred by the statute of limitations (I.R.C. § 6501) from making a further assessment with respect to fiscal 1977 but was able to rely upon the disallowance of the royalties reconciliation deduction to deny plaintiff's refund claim.

The IRS further determined that its disallowance of the royalties reconciliation deduction required a concomitant elimination of the reported accrual of certain commission income on plaintiff's fiscal 1977 tax return, referred to herein as "commissions reconciliation income". This decreased plaintiff's taxable income by $286,000, partially offsetting the increase from the disallowance of the royalties reconciliation deduction.

Together, the disallowance of the royalties reconciliation deduction described above (+$3,139,617) and the concomitant elimination of the commissions reconciliation income also described above (-$286,000) result in a net increase in taxable income of $2,853.617. This increase does not fully offset the $2,965,266 decrease in taxable income which the IRS was tentatively accepting with respect to the deferred gross profit issue as described above. Rather, plaintiff's taxable income would still have been $111,649 lower, which would have entitled plaintiff to a refund of $53,590 in tax, plus interest.

For the reasons set forth in the preceding paragraph, the IRS posted a credit to plaintiff's fiscal 1977 tax account in the amount of $53,590. The credit was frozen or suspended pending the full and final resolution of all issues pertaining to plaintiff's original and amended refund claim. However, on August 18, 1986, the IRS mistakenly removed the freeze code on its computer and a refund was issued to plaintiff in the amount of $53,590 in tax, plus interest, with respect to fiscal 1977.

In connection with the foregoing facts, the United States had a right, pursuant to I.R.C. § 7405(b) and 28 U.S.C. § 1346(c), to bring a counterclaim in this suit, alleging that the refund of $53,590 in tax plus interest was erroneous and, therefore, plaintiff and defendant executed an agreed order for entry by the Court, granting defendant leave to file its supplemental counterclaim for such purpose. Plaintiff further agrees that the United States will be entitled to recover said refund of $53,590 plus interest, with interest thereon as provided by law, in the event the Court rules in the United States' favor with respect to the "deferred gross profit" issue even if the Court rules in plaintiff's favor with respect to the "royalties reconciliation deduction" issue (or on the "sales reconciliation income" issue raised as an offset to the IRS's "royalties reconciliation deduction" defense). Plaintiff's argument as stated in the preceding sentence is limited to a determination of the issues on cross-motions for summary judgment and does not address the issue of which party has the burden of proof in the event that a trial of any factual matters is determined to be necessary.

Based upon the stipulation of facts submitted, it is now incumbent for the Court to decide the following issues:

"DEFERRED GROSS PROFIT" ISSUE

Whether a paperback book publisher's royalty payments to authors or hardcover publishers and certain other publishing costs may be immediately deducted in full or must instead be treated as part of the "cost of goods sold" on an installment plan, within the meaning of Regs. § 1.453-1(b), and therefore written off over the years by decreasing the percentage of the full sale price that is considered "gross profit" reportable over the years in proportion to installment payments?

"CAPITALIZATION" ISSUE

Whether royalty expenses, including advance-paid minimum guaranteed royalties, plus expenses for plate processing, typesetting, editing, and paperback book cover design, may be fully deducted in the year in which the particular title to which they are attributable is first published, or instead must be capitalized and then depreciated over the useful life of the publishing rights granted under the applicable contract.

"ROYALTIES RECONCILIATION DEDUCTION" ISSUE

Whether the terms of taxpayer's standardized publishing contract — providing for royalty payments in accordance with periodic statements to authors or hardcover publishers showing the number of paperbacks sold to distributors less "a reasonable estimated reserve against returns" require, as a matter of law, that taxpayer's deduction for royalties accrued during the year be limited to royalties attributable to gross sales less estimated total eventual returns therefrom (i.e. estimated retail sales from shipments to distributors during the year)?

"SALES RECONCILIATION INCOME" ISSUE

Whether a determination in favor of the United States on the "royalties reconciliation deduction" issue (i.e. that royalties should be based on the year's sales net of estimated total eventual returns from those sales) would also require an offsetting determination that taxpayer should have reported its net sales for tax purposes on the basis of gross sales less estimated total eventual returns from such year's sales (instead of gross sales less only the year's returns as reported by the taxpayer on its fiscal 1977 income tax return)?

"COMMISSIONS RECONCILIATION INCOME"

Whether the wording of the taxpayer's distribution agreements with magazine publishers — tying periodic credits earned by the taxpayer as commissions on magazine...