City Gas Co. of Florida v. C. I. R.

• Decision Date: 21 October 1982
• Docket Number: No. 80-5882,80-5882
• Citation: 689 F.2d 943
• Parties: 82-2 USTC P 9643 CITY GAS COMPANY OF FLORIDA, et al., Petitioners-Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.
• Court: U.S. Court of Appeals — Eleventh Circuit

Page 943

689 F.2d 943

82-2 USTC P 9643

CITY GAS COMPANY OF FLORIDA, et al., Petitioners-Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.

No. 80-5882.

United States Court of Appeals, Eleventh Circuit.

Oct. 21, 1982.

John F. Murray, Acting Asst. Atty. Gen., Michael L. Paup, Chief, Appellate Section, Ann Belanger Durney, Karl P. Fryzel, Daniel F. Ross, Tax Div., Dept. of Justice, Washington, D. C., for respondent-appellant.

Miller & Chevalier, David W. Richmond, Charles J. Monahan, Frederick Brook Voght, Washington, D. C., for petitioners-appellees.

Appeal from the Tax Court of the United States.

Before TJOFLAT, HILL and ANDERSON, Circuit Judges.

R. LANIER ANDERSON, III, Circuit Judge:

The Commissioner of Internal Revenue brings this appeal from adverse judgments entered by the Tax Court of the United States. The sole issue on appeal is whether certain deposits paid by customers upon the opening of new accounts are includable in appellees' gross income. The Tax Court held that these deposits were not income. City Gas Co. of Florida v. Commissioner, 74 T.C. 386 (1980). After reviewing the applicable case law, however, we conclude that deposits of this nature are income if the primary purpose of the deposit is to act as a prepayment of income items. Because the Tax Court applied a different legal standard, the judgments below must be reversed and the case remanded for further proceedings.

I. FACTS

At issue in this case is the federal income tax treatment of certain customer deposits received by appellees City Gas Company of Florida ("City Gas"), Dri-Gas Corporation ("Dri-Gas"), and Dade Gas Company ("Dade Gas"). City Gas is a public utility engaged in the business of selling natural gas to both private and commercial customers. City Gas is a Florida corporation and is under the regulatory jurisdiction of the Florida Public Service Commission ("FPSC"). Dri-Gas and Dade Gas are wholly owned subsidiaries of City Gas. They are unregulated utility companies that sell liquid propane gas to residential and commercial customers. Each of these companies follow the accrual method of accounting for federal income tax purposes.

In the normal course of business, all three companies required new customers to deposit a sum of money in order to open an account. The companies required new residential customers to make a $15 deposit during fiscal years 1966, 1967, and 1968. Commercial customers were required to deposit the equivalent of twice their expected monthly bill. When a customer paid the deposit, he was given a receipt which read as follows:

To be held as a deposit to secure payment of all bills for service rendered above customer. Upon discontinuance of service, or at the election of the company prior thereto, the amount of this deposit will be returned to the depositor after deducting any amounts owed to the company.

The companies had the benefit of the use of those funds while holding them and mingled those funds with general corporate funds.

With respect to its accounts for natural gas service, City Gas was required to comply with the requirements of the FPSC. The FPSC promulgated the following rules relating to customer deposits:

Rule 310-7.54 Customer Deposits

(1) Each utility may require from any customer or prospective customer a cash deposit intended to guarantee payment of bills, such deposit not to exceed ten dollars ($10.00) or an amount necessary to cover charges for service for two billing periods, whichever is greater.

(2) A non-transferable certificate of deposit shall be issued to the customer and means provided so that the customer may claim deposit if certificate is lost.

(3) Each utility having on hand deposits from customers shall keep records to show: (a) the name of each customer making such deposit; (b) the premises occupied by the customer when the deposit was made; (c) the amount and date of making such deposit; and (d) a record of each transaction concerning such deposit.

(4) the utility may provide for the return of the deposit after a reasonable period.

(5) Upon termination of service the deposit may be credited against the final account and the balance, if any, shall be returned to the customer.

The FPSC also required City Gas to pay interest on customer deposits at a rate of 4% or higher in March, 1966, July, 1967, and July, 1968, at which time the interest was credited against the customer's bill. Dri-Gas and Dade Gas were not subject to the jurisdiction of the FPSC and therefore paid no interest on deposits, and City Gas paid no interest on deposits on propane accounts that were not under the FPSC's jurisdiction.

Upon the termination of service, which the customer was entitled to effect at any time, the companies billed the customer for the balance of the gas used by the customer, any outstanding service charge, including turn-on and turn-off charges and repairs to the customer's appliances and pipes, any taxes due, and charges for any damage to meters.

The deposit was generally applied to this final bill. If any amount due remained, the customer was billed for this amount. If a credit resulted, the companies would refund this amount to the customer. Where customers paid their final bill in full without regard to their deposit, they were entitled to a full refund of the deposit. Deposits that went unclaimed escheated to the State of Florida after a period of time. ¹

Between 1962 and 1968, the FPSC required utilities under its jurisdiction to follow the National Association of Regulatory Utility Commissioners ("NARUC") Uniform System of Accounts for financial accounting purposes. The NARUC System treated customer deposits as current liabilities. During this period, appellees likewise treated the deposits as current liabilities rather than income for federal income tax purposes.

The Commissioner filed notices of deficiency with respect to each company on September 14, 1973. The deficiencies related to tax returns filed for appellees' fiscal years ending in 1963 through 1968. The Commissioner took the position that the deposits constituted advance payments for gas, and as such were includable in income. ²

Appellees petitioned the Tax Court of the United States for a redetermination of the deficiencies noted above, arguing that the customer deposits were nontaxable security deposits. After holding an evidentiary hearing, the Tax Court concluded that these deposits did not constitute income. The Commissioner appeals.

II. ADVANCE PAYMENT OR SECURITY DEPOSIT-THE PRIMARY PURPOSE TEST

This case requires us to examine the taxability of customer payments to utility companies that are labeled "deposits." More specifically, we must determine whether these amounts are includable in gross income under § 61 of the Internal Revenue Code of 1954 and the applicable case law. ³

It is well settled that where a taxpayer receives an advance payment for goods or services or other income items over which the taxpayer has a present right and complete and unrestricted control, the advance payment constitutes income. Van Wagoner v. United States, 368 F.2d 95, 98 (5th Cir. 1966); Hirsch Improvement Co. v. Commissioner, 143 F.2d 912, 915 (2d Cir. 1944), cert. denied, 323 U.S. 750, 65 S.Ct. 84, 89 L.Ed 601 (1945); Astor Holding Co. v. Commissioner, 135 F.2d 47, 48 (5th Cir. 1943); Clinton Hotel Realty Corp. v. Commissioner, 128 F.2d 968, 969 (5th Cir. 1942). Such payments are taxable even though a refund may be required under certain circumstances. J. and E. Enterprises, Inc. v. Commissioner, T.C.M. (P-H) P 67-191 (1967). Mantell v. Commissioner, 17 T.C. 1143, 1148 (1952); Hirsch Improvement Co. v. Commissioner, 143 F.2d at 915. An example of such an advance payment would be a sum paid to a lessor at the beginning of a lease which is to be applied to the rent for a subsequent period, such as the final month or year of the leasehold. See J. and E. Enterprises, Inc. v. Commissioner, supra.

On the other hand, where the amount paid is intended to secure property of the taxpayer against damages or loss, or to secure the performance of conditions or other nonincome-producing covenants of a contract, and the sum is to be returned to the payor, the payment is a nontaxable security deposit, notwithstanding the fact that the taxpayer had temporary use of the money. Mantell v. Commissioner, 17 T.C. at 1148; Clinton Hotel Realty Corp. v. Commissioner, 128 F.2d at 969; Growers Credit Corp. v. Commissioner, 33 T.C. 981, 996-97 (1960). An example of such a case would be where a lessor requires a lessee to deposit a sum to secure against damage to the rented premises and agrees to refund the deposit in full if no such damage occurs.

In the instant case, there is little doubt but that taxpayers here have a present right to income, ⁴ and it is undisputed that taxpayers have unrestricted control over the sums deposited. The issue is whether the sums were intended to be applied to discharge payment for income items (e.g., the final month's bill for gas, or for turn-on and turn-off charges or other charges for services), or on the other hand were intended to secure performance of nonincome-producing covenants (e.g., damage to meters).

Of course, it is unrealistic to expect that all cases will fit neatly into one of two categories mentioned above. Often the purpose of an advance payment or deposit is mixed; it may serve both as security for property or performance of nonincome-producing covenants and also as a prepayment of bills, rent, or other charges for goods or services. As we understand it, the taxpayers here do not, nor could they, argue that the payments at issue were intended solely as collateral to secure performance of nonincome covenants; taxpayers argue only that the purpose was mixed. In such cases, the taxation of such payments must turn on the circumstances of the transaction and the intent of the parties: if the primary purpose of the payment is to act as a prepayment for...