Guarantee Title and Trust Co. v. CIR

• Citation: 313 F.2d 225
• Decision Date: 18 February 1963
• Docket Number: No. 14838.,14838.
• Parties: The GUARANTEE TITLE AND TRUST CO., Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Sixth Circuit

313 F.2d 225 (1963)

The GUARANTEE TITLE AND TRUST CO., Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 14838.

United States Court of Appeals Sixth Circuit.

February 18, 1963.

Roger K. Powell, Columbus, Ohio, for petitioner.

H. Gilmer Wells, New York City (Cadwalader, Wickersham & Taft, New York City, on the brief; Arnold J. Zurcher, Jr., Laurence Vogel, New York City, of counsel), for Bowery Savings Bank, amicus curiae.

Giora Ben-Horin, Atty., Dept. of Justice, Washington, D. C. (Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson, Harry Baum, Attys., Dept. of Justice, Washington, D. C., on the brief), for respondent.

Before CECIL, Chief Judge, O'SULLIVAN, Circuit Judge, and WILLIAM E. MILLER, District Judge.

WILLIAM E. MILLER, District Judge.

This case comes before us on the petition of the Taxpayer, The Guarantee Title & Trust Company, an Ohio corporation, to review the decision of the Tax Court that the Taxpayer was required to accrue as income for federal income tax purposes, as of the end of its taxable years 1955 and 1956, certain amounts reflected on its books in excess of the compensation actually paid to it in those years by The Bowery Savings Bank pursuant to a mortgage servicing contract.

The Bowery, a mutual savings institution located in New York City, invests in mortgage loans on real estate. Its practice is to enter into a mortgage servicing contract with a mortgage company, such as the Taxpayer, under which the mortgage company agrees to perform the usual services in connection with the servicing of the mortgages. These services consist of the collection of payments due from the mortgagor, seeing that taxes are paid and insurance coverage maintained, the remission of funds collected to The Bowery, and general supervision of the mortgagor's performance under the mortgage. The mortgage company for its services is compensated on the basis of monthly servicing fees at rates agreed upon in the servicing contract. The Bowery in its amicus curiae brief suggests two methods used in the industry for fixing the amount of these monthly fees. One method is to compensate the mortgage company by a fee based upon a fixed percentage of the principal amount of the mortgages being serviced and outstanding from month to month. Referred to as "basic rate compensation," this formula would obviously result in a constantly diminishing amount being paid to the mortgage company over the life of the mortgages, since the fee represents a percentage of the monthly outstanding principal balances of the mortgages being serviced. In consequence, as pointed out by The Bowery, in the later years of the mortgages monthly compensation received by the mortgage servicing contractors would necessarily become relatively small, although it would be safe to assume that the expenses to the mortgage company in performing the necessary services would remain fairly constant throughout the entire life of the mortgages notwithstanding the amortization of the outstanding principal balances. Another method is the "level payment" plan of compensation under which the servicing contractor is compensated at a "level payment" rate of so many cents per one thousand dollars of effective principal amount of the mortgages being serviced. The mortgage company would receive a uniform monthly fee over the entire life of the mortgage loan rather than a constantly diminishing amount.

A servicing contract was entered into between the Taxpayer and The Bowery on February 18, 1954. Under this contract, the Taxpayer agreed to service all mortgages purchased by The Bowery from it or referred to it for servicing, and to perform the specific services described in the contract. The actual mortgages serviced under the contract were purchased by The Bowery from the Taxpayer pursuant to so-called "commitment letters," the chief purpose of which was to serve as a contract by Bowery to purchase the mortgages set forth therein for an agreed price. The commitment letters provided that the mortgages so purchased should be serviced by the mortgage contractor under and subject to the existing servicing contract.

During the years 1955 and 1956, the Taxpayer serviced several mortgages for The Bowery under its contract of February, 18, 1954, for which the Taxpayer received total compensation in 1955 of $5,681.98, and in 1956 of $17,254.67. On its books the Taxpayer established an asset account described as "Accounts Receivable — Bowery Savings Bank," and a liability account described as "Deferred Credit — Mortgage Servicing — Bowery." Equal amounts were debited to one and credited to the other; and to these accounts the Taxpayer debited and credited the excess of servicing fees which would have been payable at the basic rate over the amount of level payment compensation actually received. These accounts disclosed increases of $2,965.32 and $10,389.88, respectively, for the years 1955 and 1956. The Taxpayer filed its federal income tax returns and kept its books of account upon the accrual method of accounting during 1955 and 1956. It reported as income only those amounts of level payment compensation received by it in 1955 and 1956. The Commissioner of Internal Revenue added to the Taxpayer's income the increases for these years reflected on the books of the Taxpayer, determining that such amounts were properly accrued by it in the taxable years.

In approving this ruling of the Commissioner the Tax Court, in our opinion, misconstrued the contract of February 18, 1954. Pertinent provisions of the servicing contract dealing with compensation are contained in paragraphs 3 and 4 which are set forth in the appendix.

As we construe these provisions, the contract is one which essentially provides for the level payment plan of compensation. Under its terms the only absolute and unconditional right which vested in the Taxpayer during the taxable years with respect to compensation, was the right to be compensated at the level payment rate based upon the effective principal amount of each mortgage. During those years the right to receive any amount of compensation in excess of the level payments actually made was subject to the occurrence of certain conditions precedent, including prepayment in full of the loan, foreclosure, assignment by the mortgagee, or any other event giving rise to termination without cause. If the loan being serviced should run its normal course to maturity, or if the contract should be terminated for cause as a result of the occurrence of one of the events specified in paragraph 4 of the contract, the Taxpayer is entitled only to the level payments theretofore received by it. Additional compensation in excess of the level payment rate is provided for in paragraph 3(d) (i) of the contract. If servicing of a particular mortgage should be terminated by one of the events specified therein, the Taxpayer would become entitled at that time to "additional compensation" in an amount equal to the excess of compensation which would have been payable to that date under the basic rate over the level payment compensation already received. The Taxpayer would be required, on the other hand, to repay the excess to The Bowery in such event if the level payment compensation exceeded compensation at the basic rate. We are unable to escape the conclusion that the Taxpayer's right to any amount in addition to the level payments received was at all times contingent upon the occurrence of the specified conditions precedent.

It may be conceded, as pointed out by the Tax Court and by the Commissioner, that if a particular mortgage runs its full term, the basic rate compensation and the level payment rate would produce the same total amount. But the test is not the amount received by the Taxpayer upon completion of the servicing of the mortgage, but the nature and character of its right during the taxable years. We find that its only fixed and accrued right during those years was to receive compensation at the level payment rate.

It is well settled under such circumstances that there can be no accrual. As stated by the Supreme Court in the leading case of Spring City Foundry Co. v. Commissioner, 292 U.S. 182 at pp. 184-185, 54 S.Ct. 644, at p. 645, 78 L.Ed. 1200:

"Keeping accounts and making returns on the accrual basis, as distinguished from the cash basis, import that it is the right to receive and not the actual receipt that determines the inclusion of the amount in gross income. When the right to receive an amount becomes fixed, the right accrues." (Emphasis supplied by the Court.)

If the right to receive income is contingent upon the happening of a future event, the right cannot be said to arise or exist in the taxable year to be accounted for as income under the accrual method of accounting. Bauer Bros. Co. v. Commissioner of Internal Revenue, 46 F.2d 874 (C.A.6, 1931), cert. denied 283 U.S. 850, 51 S.Ct. 560, 75 L.Ed. 1458; Commissioner of Internal Revenue v. R. J. Darnell, Inc., 60 F.2d 82 (C.A.6, 1932); Franklin County Distilling Co. v. Commissioner of Internal Revenue, 125 F.2d 800 (C.A.6, 1942); Cappel House Furnishing Company v. United States, 244 F.2d 525 (C.A.6, 1957); Schaeffer v. Commissioner of Internal Revenue, 258 F.2d 861 (C.A.6, 1958), cert. denied ...