Husnik v. Commissioner, Docket No. 2398-67

• Decision Date: 19 February 1969
• Docket Number: 2399-67.,Docket No. 2398-67
• Citation: 1969 TC Memo 34,28 TCM (CCH) 163
• Parties: Bernard J. Husnik, Jr. and Joyce Husnik v. Commissioner. Donald Husnik and Beatrice Husnik v. Commissioner.
• Court: U.S. Tax Court

28 T.C.M. (CCH) 163 (1969)

T.C. Memo. 1969-34.

Bernard J. Husnik, Jr. and Joyce Husnik v. Commissioner.

Donald Husnik and Beatrice Husnik v. Commissioner.

Docket Nos. 2398-67, 2399-67.

United States Tax Court.

Filed February 19, 1969.

Stanley J. Mosio, 303 Degree of Honor Bldg., St. Paul, Minn., for the petitioners. Charles L. Riter, for the respondent.

Memorandum Findings of Fact and Opinion

TANNENWALD, Judge:

Respondent determined deficiencies in petitioners' income taxes as follows:

                  Taxable         Bernard J.       Donald Husnik
                   year        Husnik, Jr. and         and
                                 Joyce Husnik     Beatrice Husnik
                   1962 .......   $  387.58          $  275.58
                   1963 .......       63.02              72.56
                   1964 .......    2,651.55           2,556.61
                

The sole issue is whether the method of accounting with respect to a food savings plan used by the partnership, doing business as Husnik Food Center, clearly reflected its income in 1963 and 1964. The year 1962 is involved only because of a claimed net operating loss carryback from the taxable year 1964 and certain matters conceded by petitioners Donald Husnik and Beatrice Husnik.

Findings of Fact

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

Petitioners Bernard J. Husnik, Jr., and Joyce Husnik are husband and wife and had their legal residence in St. Paul, Minnesota, at the time of the filing of their petition herein. Petitioners Donald Husnik and Beatrice Husnik are husband and wife and also had their legal residence in St. Paul, Minnesota, at the time their petition herein was filed. Petitioners Joyce Husnik and Beatrice Husnik are parties herein solely by reason of having filed joint returns with their husbands during the years in question. Subsequent references to petitioners shall be deemed to refer to petitioners Bernard J. Husnik, Jr. and Donald Husnik.

During 1963 and 1964, petitioners were equal partners in a retail grocery business then known as the Husnik Food Center (and hereinafter referred to as the partnership). The partnership used an accrual method of accounting and filed Federal income tax returns on a calendar year, accrual basis.

During 1963, in order to meet competition, petitioners decided to sell a plan that entitled subscribers to buy food at discount prices. Subscribers in return committed themselves to pay $12 a month for 30 months and to buy at least $150 worth of food every six months. After purchasing $3,000 worth of food, the subscriber was entitled to receive a refund, either $300 worth of food or $200 in cash, as he chose. The qualifying amount was later raised to $4,000 and then $5,000. Each plan was embodied in a document entitled "Warranty Bond."¹ These warranty bonds were assignable, but were not negotiable instruments.

In 1963, the partnership sold 4 such plans; in 1964, 115 plans; in 1965, 184 plans; in 1966, 182 plans; and in 1967, 338 plans. There were no defaults in 1963, 5 defaults in 1964, 26 in 1965, 42 in 1966, and 53 in 1967. By the end of 1967, only three subscribers had qualified for a refund, two of whom chose to take their refund in cash rather than in food.

The partnership paid commissions and, in some cases, referral fees on the sale of the plans. The commissions and the referral fees averaged approximately $110 for each plan. All expenses attributable to the plans were deducted currently.

The partnership customarily and promptly discounted the warranty bonds for $300 each after their execution. Most of the warranty bonds were discounted with Murphy Plan, Inc., which held back $25 for each plan as a reserve against subscribers failing to pay. The warranty bonds not discounted by Murphy Plan, Inc., were discounted by the West St. Paul Bank. The warranty bonds were endorsed with recourse to the discounting institution, which collected the monthly payments directly from the subscribers.

The partnership, under its method of accounting, recognized its liability to make refunds to its subscribers when the warranty bonds were executed. When a warranty bond was executed, $300 would be debited to an account entitled "Purchases of Contract Agreement," and $300 would be credited to an account entitled "Membership Pay Off," which was treated as a long-term liability account. On the partnership return of income, these debits were charged to purchases and thus entered into the determination of cost of goods sold.

At the time the notes were discounted, "Cash in Bank" was debited $300, and "Sales" was credited $300. On the partnership return of income, these credits were taken into income as an element of gross sales.

The discount proceeds were deposited in the partnership's general bank account. Some of these proceeds were used to pay expenses petitioners considered allocable to the plans; any funds left over were periodically deposited in a savings account. This savings account was not subject to any trust in favor of the subscribers or to any other restrictions and constituted a segregation merely for the partnership's convenience.

Opinion

Petitioners' partnership, a retail grocery business, sold plans to certain of its customers which entitled them to buy food at discount prices. In return, subscribers to the plans obligated themselves to pay $12 a month for 30 months and to purchase at least $150 worth of food every six months. After a subscriber had purchased $3,000 worth of food ($4,000 or $5,000 in later plans), he was entitled to a refund, which he could take either in the form of $300 worth of food or $200 in cash. The plans were embodied in documents entitled "warranty bonds."

Although not negotiable instruments, the warranty bonds were customarily and promptly assigned to and discounted with a financial institution for $300, of which $25 was withheld in most cases as a reserve against failure of the subscriber to make payment of installments when due. The partnership endorsed the bonds to the financial institution with recourse.

For both accounting and tax purposes, the partnership took the full $300 received from the financial institution into income as the proceeds of sales. It offset this amount by a corresponding deduction via a charge to purchases in computing costs of goods sold, on the assumption that it would eventually refund this amount to the subscriber when the latter had purchased the required designated quantity of food. Petitioners contend that the treatment was entirely proper and advance a variety of theories to support their contention. Respondent argues that the $300 was properly accounted for as income and that the partnership is not entitled to any deduction for its potential liability to refund this amount to the subscriber. We agree with respondent.²

At the outset, we will deal with the general assertion of petitioners that the taxability of the proceeds of the warranty bonds should be postponed until and unless the subscriber defaulted on his obligation. The foundation for this assertion is that the petitioners were only interested in selling food and keeping their customers, not in keeping the money derived from the warranty bonds. Since the plan envisaged an ultimate refund to the subscriber of the amount received, the claim is made that, irrespective of the receipt of the proceeds of discounting, the entire transaction reflects an investment or loan.

Whether or not a receipt is a loan depends upon all the facts and circumstances. See New England Tank Industries, Inc. Dec. 29,104, 50 T. C. 771, 777 (1968), on appeal (C. A. 1, Dec. 26, 1968). The sole aspect of the plan suggesting that the monthly payments constituted a loan is the fact that under certain circumstances the partnership would be obligated to make a refund. But the obligation to make a refund was highly contingent. It arose only if the subscriber purchased at least $150 worth of food every six months, made his monthly payments when due, and purchased a minimum amount of food during the 10-year life of the plan. And even if a subscriber qualified for a refund, he would receive back, not the $360 which he would have paid, but only $300 in the form of food³ or a cash refund limited to $200. Finally, the obligation to make a refund was geared to the purchase of several thousand dollars worth of food, not to the passage of time, as in an ordinary loan. The dominant characteristics of the refund thus suggest that it was a type of patronage refund rather than the repayment of a loan or an investment.

In other respects, the monthly payments have the characteristics of an item of income. The subscribers only participated in the plan to get the benefit of low food prices. They could get those prices only if they made the monthly payments. Accordingly, the payments seem clearly to have been payments for the privilege of buying food at discount prices. Such receipts are income within the meaning of section 61.⁴ Accord, United Grocers, Ltd. v. United States 62-2 USTC ¶ 9763, 308 F. 2d 634 (C. A. 9, 1962); Affiliated Government Employees' Distributing Co. Dec. 25,351, 37 T. C. 909 (1962), affd. 63-2 USTC ¶ 9707 322 F. 2d 872 (C. A. 9, 1963); cf. James Hotel Co. Dec. 25,709, 39 T. C. 135 (1962), affd. 64-1 USTC ¶ 9102 325 F. 2d 280 (C. A. 10, 1963). Petitioners argue that they did not intend to make a profit on the sale of the plans. But they can hardly deny that they hoped to make a profit from the purchases of food by their subscribers. And, in any event, a profit motive is not a necessary condition for the characterization of a receipt as taxable income. Automobile Club of New York, Inc. Dec. 23,689, 32 T. C. 906, 915 (1959), affd. 62-2 USTC ¶ 9567 304 F. 2d 781 (C. A. 2, 1962). We hold that petitioners may not defer the proceeds of the warranty bonds on any general loan or investment theory. Cf. Creasey Corporation v. Helburn 1932 CCH ¶ 9175, 57 F. 2d 204 (W. D. Ky. 1932); Wallace A. Moritz Dec. 20,129, 21 T. C. 622 (1954); S. B. Heininger Dec. 12,554, 47 B. T. A. 95 (1942),...