Beneficial Corp. and Subsidiaries v. U.S.
| Decision Date | 26 March 1987 |
| Docket Number | No. 86-778,86-778 |
| Citation | 814 F.2d 1570 |
| Parties | -830, 87-1 USTC P 9240 BENEFICIAL CORPORATION AND SUBSIDIARIES, Appellant, v. The UNITED STATES, Appellee. Appeal |
| Court | U.S. Court of Appeals — Federal Circuit |
Jose E. Trias, Paul, Weiss, Rifkind, Wharton & Garrison, Washington, D.C., argued for appellant. With him on brief were Jerome Kurtz, Peter Buscemi and Victoria P. Rostow.
Joan Oppenheimer, Tax Div., Dept. of Justice, Washington, D.C., argued for appellee. With her on brief were Roger M. Olsen, Asst. Atty. Gen., Michael L. Paup and Jonathan S. Cohen.
Before MARKEY, Chief Judge, RICH, Circuit Judge, and BALDWIN, Senior Circuit Judge. *
Appeal by Beneficial Corporation and Subsidiaries (Beneficial) from a judgment of the United States Claims Court 9 Cl.Ct. 119, (Claims Court) in a tax refund case under Sec. 166(c) of the Internal Revenue Code of 1954 (IRC). Though that section was repealed by Sec. 805(a) of the Tax Reform Act of 1986, Pub.L. No. 99-514, 100 Stat. 2085, the repeal was effective as of December 31, 1986 and, hence, is inapplicable to the facts of this case. 1 The Claims Court granted summary judgment for the government and denied partial summary judgment for Beneficial. We reverse the judgment and remand for further proceedings consistent herewith.
Beneficial is an accrual basis taxpayer in the consumer finance business and keeps its books on a calendar year basis. In the course of its business, Beneficial makes long term loans that are not always paid back. Section 166(c) of the IRC allowed a deduction for such losses:
Sec. 166. Bad debts
(a) General rule
There shall be allowed as a deduction any debt which becomes worthless within the taxable year.
When satisfied that a debt is recoverable only in part, the Secretary may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction.
* * *
* * *
(c) Reserve for bad debts
In lieu of any deduction under subsection (a), there shall be allowed (in the discretion of the Secretary) a deduction for a reasonable addition to a reserve for bad debts.
Section 166(a) prescribed a specific charge-off method for bad debts that actually became worthless, and were charged off on the taxpayer's books, in the taxable year. Under that section, the amount of deduction reflected the actual charge-off experience during the taxable year.
In lieu of a deduction for specific bad debts incurred during the taxable year, Sec. 166(c) allowed an accrual basis taxpayer to establish a reserve for bad debts and to deduct reasonable additions thereto. The reserve approximated loan amounts presently outstanding but expected to be uncollectable in the future. Each year, the proper amount of reserve was redetermined, and a reasonable addition to the reserve balance necessary to bring it up to the proper level was deductible, subject to the Secretary's discretion. 2
Beneficial utilized the reserve method of Sec. 166(c). On audit of Beneficial's tax returns for 1976 and 1977, the Internal Revenue Service ("IRS") found that Beneficial's reserve level reflected an amount exceeding those bad debts reasonably expected to be written off in the next succeeding year.
As a result, the IRS disallowed Beneficial's additions to its bad debt reserve. Instead, it applied the "Black Motor formula," which is based on the methodology used in Black Motor Co. v. Commissioner, 41 B.T.A. 300 (1940), aff'd on other grounds, 125 F.2d 977 (6th Cir.1942). 3
The Commissioner's application of the Black Motor formula resulted in Beneficial having deficient tax obligations of $16,037,089 and $4,641,296 for 1976 and 1977, respectively. The difference stems basically from Beneficial including in its reserve all outstanding debts presently expected to become worthless in the next and succeeding years. In contrast, Black Motor focuses on outstanding debts expected to become worthless in the next succeeding year only. Beneficial paid the resulting deficiencies and filed timely claims for refund pursuant to Sec. 6511 of the IRC. After its claims for refund were disallowed by the IRS, Beneficial filed this action for refund in the Claims Court.
The Claims Court, in granting the government's summary judgment motion and denying Beneficial's partial summary judgment motion, weighed heavily the discretion expressly granted the Commissioner in Sec. 166(c). Stating that Beneficial has a "heavy burden" of proof, the Claims Court held that the Commissioner did not abuse his discretion in using the Black Motor formula to calculate reasonable addition to bad debt reserve. That formula, reasoned the Claims Court, has been in existence for many years and approved in numerous cases.
Beneficial argues that, where the outstanding receivables have an average maturity substantially in excess of one year, the current reserve should be large enough to cover those receivables expected to be charged off in later years as well as those receivables expected to be written off in the next succeeding year. Beneficial maintains that the Commissioner's discretion in Sec. 166(c) pertained to choosing those who should be eligible for that section or approving the accuracy of figures used, but that it did not allow the Commissioner to change the concept of "reserve for bad debts" so that it would reflect projected losses only in the next year. Beneficial urges that a bad debt reserve by its nature accounts for an "impairment to capital," and if it is reasonably certain that some portion of the outstanding loans will never be recovered--whether in the next or succeeding years--that amount of taxpayer's capital has been presently impaired because it is for all practical purposes forever lost. 4
The government does not challenge the accuracy of Beneficial's projected losses beyond the next year. Instead, it contends that the statute expressly gave the Commissioner discretion to allow a deduction for a reasonable addition to a bad debt reserve and that the Commissioner did not abuse that discretion in focusing only on next year's losses.
Whether the Commissioner's discretion under Sec. 166(c) allowed him, when assessing "reasonable addition to a reserve for bad debts," to focus only on that portion of outstanding debts expected to become worthless in the next taxable year.
OPINIONNormally, the Commissioner had great discretion under Sec. 166(c) in determining a "reasonable" addition to a reserve for bad debts. The Commissioner's determination of a reasonable addition had to be sustained unless the taxpayer proved that the Commissioner abused that discretion. Thor Power Tool Co. v. Commissioner, 439 U.S. 522, 99 S.Ct. 773, 58 L.Ed.2d 785 (1979); Paramount Finance Co. v. United States, 157 Ct.Cl. 824, 304 F.2d 460 (1962). As stated by the Claims Court in this case:
It is clear from the language of the statute that a taxpayer has an absolute right to choose to deduct his worthless debts when they are ascertained to be worthless [Section 166(a) ], but if, instead, he chooses to deduct additions to a reserve, he subjects himself to a reasonable and discretionary review of the additions to the reserve [Section 166(c) ].
We agree with the Claims Court that deductions based on reserves are rarely permitted under the IRC and that, when Congress makes an exception to that rule but explicitly conditions the exception upon the Commissioner's discretion, the condition (i.e., the Commissioner's discretion) "is as important as the permission." Krim-Ko Corp. v. Commissioner, 16 T.C. 31, 37 (1951). However, undue expansion of that condition beyond its legitimate scope would improperly circumvent congressional intent.
Section 166 itself did not define "reserve for bad debts."
Beneficial introduced expert testimony supporting an established, commonly accepted definition of that phrase in the accounting world in 1921, the time of enactment of Sec. 166(c). That definition is inconsistent with the "next-year only" focus of the government. The government's focus, Beneficial argues, is inconsistent with the concept of a reserve, which is to reduce the amount of accounts or lower receivables to what will ultimately be collected. Indeed, Beneficial argues, not only is the 1921 accounting concept still with us today but the government's focus on "next-year only" is unknown in accounting theory and practice.
The government does not dispute that there was a well established, commonly accepted meaning of "reserve for bad debts" in the accounting field at the time of enactment of Sec. 166(c). Indeed, the government does not even contend that a competing meaning of "reserve for bad debts" existed at that time. Instead, the government argues that the meaning of "reserve," as established for purposes of business accounting, is inconsistent with the notion of annual accounting in tax law, that Congress did not intend to adopt the accountant's meaning of "reserve for bad debts," and that the Commissioner's discretion expressly conferred by statute, as well as a demonstrated legislative concern for the fisc, overrides that meaning.
We take as uncontested this fact: at the time of enactment of Sec. 166(c), the only acceptable meaning of "reserve for bad debts" was the accounting concept urged by Beneficial. The Claims Court opinion does not reveal a genuine dispute on that fact; nor does the government contest it on appeal. Indeed, both parties filed summary judgment motions below, each urging no genuine disputes on material facts, and the government's summary judgment motion was granted by the Claims Court. 5
Given the accounting concept of "reserve for bad debts" as the only approach in 1921, we find compelling Beneficial's argument that Congress intended to incorporate that concept into the statute. Though the government persuasively argues that...
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