Gunderson Bros. Eng'g Corp. v. Comm'r of Internal Revenue, Docket No. 4360-62.

• Decision Date: 21 May 1964
• Docket Number: Docket No. 4360-62.
• Citation: 42 T.C. 419
• Parties: GUNDERSON BROS. ENGINEERING CORP., PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

42 T.C. 419

GUNDERSON BROS. ENGINEERING CORP., PETITIONER

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 4360-62.

Tax Court of the United States.

Filed May 21, 1964.

Frank E. Nash and Maurice O. Georges, for the petitioner.

John D. Picco and Richard H. M. Hickok, for the respondent.

Petitioner, who kept its books and records on an accrual basis, sold trucks and trailers on a deferred payment basis. A finance charge was added to the cash sales price. The purchaser, under State law and under the terms of the installment contract, was entitled to a refund credit of a portion of the finance charge upon early payment of the balance of the contract. Prior to November 1958, petitioner sold most of the customers' obligations to financial institutions. In November 1958 petitioner established its own finance division and thereafter retained all customers' obligations. In addition, it purchased all outstanding customers' obligations originally sold. Held, petitioner's method of reporting a portion of the finance charge as income as each installment became due and payable clearly reflected its income and was proper. Held, further, petitioner is not entitled to the benefits of the Dealer Reserve Income Adjustment Act of 1960.

FAY, Judge:

The Commissioner determined deficiencies in petitioner's income tax for the fiscal years ending May 31, 1958,¹ and May 31, 1959, in the respective amounts of $17,152.07 and $33,322.21. The parties have agreed to certain adjustments with respect to the deficiencies.

The remaining issues for decision are (1) whether the petitioner, an accrual basis taxpayer, must include as income in the year of sale, finance charges attributable to sales on a deferred payment basis where the petitioner retains the customers' obligations and where under State law and by terms of the contract the purchaser has the right to receive a refund of a portion of the finance charge by early payment, and (2) whether the petitioner is entitled to the benefits of the Dealer Reserve Income Adjustment Act of 1960.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

Petitioner is an Oregon corporation organized on June 1, 1942, with its principal office located in Portland, Oreg. Petitioner maintained its books on the accrual method of accounting, using a fiscal year ending May 31. It filed Federal corporate income tax returns for the fiscal years here involved with the district director of internal revenue at Portland, Oreg.

During the: period here involved and for many years prior thereto, petitioner was engaged in the business of manufacturing and selling industrial products and engaged in the business of selling trucks, trailers, and similar equipment for use in the logging industry. Starting in 1945, trailers purchased the same on a deferred payment basis. Many trucks and trailers were so sold during the period involved herein. Purchasers were required to pay a finance charge in addition to the cash selling price of the equipment. The practice of making a finance charge in connection with deferred payment sales is customary in the truck and trailer sales business.

A sales price was first negotiated with the customer. After agreement was reached as to the sales price, the finance charge was then discussed. Petitioner did not compute finance charges at the same rate for each customer but based the amount of such charge on a credit report prepared for each particular customer. Among the factors considered in determining the rate of finance charges were the customer's net worth, his reputation for maintaining equipment, any rate which he may have been able to establish with a bank or other financial institution, and the general condition of the lumber market.

Prior to the petitioner's establishing its own finance division in November 1958, most of the deferred payment sales made by the petitioner were financed by selling the obligations of the customers to a financial institution on a full recourse basis. Although not expressly provided for in the sales contracts prior to January 1, 1958, it was the consistent practice of petitioner and the financial institutions to which petitioner sold deferred payment obligations of its customers to refund a portion of the finance charge in the event of early payment.

Where petitioner sold its customers' obligations to financial institutions, the latter would credit petitioner's reserve account with the finance charge, less the institution's service charge. Petitioner would defer its portion of the finance charge due it from the financial institution and accrue it in equal monthly installments.

Starting in November 1958, when petitioner established its own finance division, the practice of selling the customers' installment obligations to financial institutions was discontinued.

In 1957 the Oregon Legislative Assembly enacted Oregon Laws, chapter 625, which is now Ore. Rev. Stat. ch. 83, relating to the installment sale and financing of motor vehicles, with an effective date of January 1, 1958. Ore. Rev. Stat. ch. 83 requires a reduction in the finance charge in the event of early payment. Ore. Rev. Stat. ch. 83 provides that the following items by expressly set out in any retail installment contract for motor vehicles: (1) Cash sales price; (2) downpayment; (3) difference between items 1 and 2; (4) insurance; (5) filing fees; (6) principal balance (items 3, 4 and 5); (7) finance charge; (8) time balance (items 6 and 7); and (9) time-sales price. Petitioner would accrue all of item 1 (cash sales price) and all of items 4 and 5 (insurance and filing fees) in the year in which the sale took place and would defer all of item 7 (finance charge) in a manner to be discussed subsequently. In addition, the Oregon statute required the following notice to appear on every retail installment contract involving the sale of a motor vehicle:

NOTICE TO THE BUYER

Do not sign this contract before you read it or if it contains any blank space, except that if delivery of the vehicle is to be made to you after this contract is signed, the serial number or other identifying information and the due date of the first installment may be filled in at the time of delivery.

You are entitled to a copy of this contract.

You have the right to pay off in advance the full amount due and to obtain a partial refund of the finance charge.

The Oregon statute further provided the maximum limitation on the amount of finance charges. The amount varied from $8 per year per $100 of the principal balance to $12 per $100. No other charges were permitted by the statute for the extension of credit.

The retail installment contract used by petitioner complied fully with the requirements as to form and contents as set forth in Ore. Rev. Stat. ch. 83. The refund (reduction) required to be made in the event of early payment was computed by petitioner in accordance with Ore. Rev. Stat. ch. 83 for those early payments made after January 1, 1958.

The typical contract provided that the purchaser agreed to pay the contract ‘time balance’ which included the cash sales price of the motor vehicle (less the downpayment), insurance, filing fees, and finance charge. Each retail installment contract was accompanied by a non-interest-bearing note given as a part of the same transactions. Each deferred-payment buyer signed both the contract and the note. The note was made out for the full amount of the time balance, which included the finance charge. The note, a copy of which is set forth in the margin,² provided for installment payments which divided the time balance into the number of payments called for in the contract.

As a general rule, in all instances where petitioner retained the customers' obligations, it would accrue the finance charges as installment payments when collected. Some of the contracts allowed the customer to ‘skip’ one or more payments without increasing the finance charge. In those cases in which payments were so skipped, the petitioner accrued the portion of the finance charge allocable to it, even though the payment was not then due. Where payments were missed by the customer in violation of the terms of the contract, the portion of the finance charge allocable to the installment period was not accrued until the payment was actually made. The finance charge accrued each month was a portion computed on the sum-of-the-digits method.

The fair market value of the promissory notes at no time exceeded the ‘principal balance’ as that term is used in the retain installment contract.

The petitioner did not elect to report income by use of the installment method as provided by section 453 of the Internal Revenue Code of 1954.

In those cases where the customers' obligations were retained by petitioner at the time of sale, the entire amount of the finance charges was credited to a deferred income account on the books of the petitioner. At the close of each fiscal period, debits measuring the accruals during the period were made to that account and the debits were reported as earned income on the petitioner's tax return for that period.

As of May 31, 1959, the balance in petitioner's deferred income account was $108,482.20, of which $61,525.18³ represented unearned finance fees attributable to credit extended to purchasers of merchandise sold on a deferred payment basis, the customers' obligations being retained by petitioner.

Respondent determined that petitioner's practice of accruing less than the entire finance charge at the time of sale was inconsistent with the accrual method of accounting. Accordingly, respondent included the amount of $108,416.55 in the gross income of the petitioner for the fiscal year ended May 31, 1959.⁴ This amount has been reduced by agreement of the parties ⁵ to $61,525.18, representing the unearned finance fees attributable to customers' obligations retained by petitioner.

Any net operating loss sustained by petitioner in its fiscal year ended May...