Kimbrell's Home Furnishings, Inc. v. Comm'r of Internal Revenue
| Decision Date | 11 June 1946 |
| Docket Number | Docket No. 8154. |
| Citation | 7 T.C. 339 |
| Parties | KIMBRELL'S HOME FURNISHINGS, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Petitioner, a corporation engaged in the sale of furniture at retail, computed its normal tax net income on the installment basis. It computed its excess profits income on the accrual basis, pursuant to section 736(a) of the Internal Revenue Code. Held, that petitioner's reserve for unrealized profits on installment sales as of the beginning of the taxable year is not includible in equity invested capital as accumulated earnings and profits within section 718(a)(4) of the Internal Revenue Code. W. H. Holderness, Esq., for the petitioner.
E. M. Woolf, Esq., for the respondent.
The Commissioner determined a deficiency in petitioner's excess profits tax for the fiscal year ended August 31, 1943, in the amount of $329.38. By this proceeding the petitioner challenges that determination and claims an overpayment in the amount of $862.56. The question presented is whether in computing its excess profits tax credit petitioner, which filed its income tax returns on the installment basis as provided in section 44(a) of the Internal Revenue Code and which elected under section 736(a) to compute its excess profits net income on the accrual basis, may include its reserve for unrealized profits on installment sales in its equity invested capital as ‘accumulated earnings and profits‘ within the meaning of section 718(a)(4) of the code.
The facts are stipulated and are so found; those pertinent are set forth in our findings of fact.
Petitioner is a corporation which was organized under the laws of the State of North Carolina on September 13, 1940. Its income and excess profits tax returns for the fiscal year ended August 31, 1943, were filed with the collector of internal revenue for the district of North Carolina.
Petitioner is engaged in the retail sale of home furnishings and a substantial portion of its sales is made on the installment basis. For income tax purposes the petitioner computes net income on the installment basis as provided by section 44(a) of the Internal Revenue Code.
In its excess profits tax return filed for the fiscal year ended August 31, 1943, the petitioner elected to have the provisions of section 736(a) of the code apply and computed its excess profits net income for that year on the accrual basis. Upon examination of the returns the revenue agent adjusted the excess profits net income for the years ended August 31, 1941, and August 31, 1942, to conform to such election, as provided by section 736(a) and the regulations promulgated thereunder. The excess profits net income prior to the application of this section, the addition or reduction under section 736(a), and the excess profits net income under section 736(a), are as follows:
+-------------------------------------------------------+
¦ ¦Excess profits¦ ¦ ¦
+-------------+--------------+-----------+--------------¦
¦ ¦net income ¦Addition or¦Excess profits¦
+-------------+--------------+-----------+--------------¦
¦Year ended- ¦prior to ¦(reduction)¦net income ¦
+-------------+--------------+-----------+--------------¦
¦ ¦application of¦under sec. ¦under sec. ¦
+-------------+--------------+-----------+--------------¦
¦ ¦sec. 736 (a). ¦736 (a). ¦376 (a). ¦
+-------------+--------------+-----------+--------------¦
¦Aug. 31, 1941¦$10,469.17 ¦$21,850.09 ¦$32,319.26 ¦
+-------------+--------------+-----------+--------------¦
¦Aug. 31, 1942¦12,028.92 ¦(3,456.05) ¦8,572.87 ¦
+-------------+--------------+-----------+--------------¦
¦Aug. 31, 1943¦15,837.52 ¦(4,623.90) ¦11,213.62 ¦
+-------------------------------------------------------+
Petitioner's reserve for unrealized profits on installment sales at the beginning of each year was as follows:
Reserve for unrealized profits on installment sales at the beginning of each year was as follows:
+------------------------------------+
¦ ¦Reserve for unrealized¦
+-------------+----------------------¦
¦ ¦profits on installment¦
+-------------+----------------------¦
¦Year ended- ¦sales ¦
+-------------+----------------------¦
¦Aug. 31, 1941¦ ¦
+-------------+----------------------¦
¦Aug. 31, 1942¦$21,850.09 ¦
+-------------+----------------------¦
¦Aug. 31, 1943¦18,394.04 ¦
+------------------------------------+
Under the installment method of accounting used by the petitioner for income tax purposes, the reserve for unrealized profits on installment sales, as shown above, has not been included, and is not includible, in net income under chapter 1 of the Internal Revenue Code.
For the year ended August 31, 1943, the petitioner included the reserve for unrealized profits on installment sales at the beginning of the year in equity invested capital. In his recomputation the respondent has excluded the reserve from equity invested capital on the ground that it does not represent accumulated earnings and profits as contemplated by section 718(a)(4) of the Internal Revenue Code.
As computed by the petitioner, its excess profits tax for the taxable year 1943 was paid by it within two years prior to the mailing of the notice of deficiency by the Commissioner.
Having come into existence after January 1, 1940, petitioner was required, in determining its excess profits tax liability for the fiscal year ended August 31, 1943, to compute its excess profits credit under section 714 of the Internal Revenue Code. This computation required an ascertainment of its equity invested capital, which, by section 718(a), is defined as including the ‘accumulated earnings and profits as of the beginning of such taxable year. 1 Petitioner contends on two separate grounds that such accumulated earnings and profits include its reserve as of August 31, 1942, for unrealized profits on installment sales, in the amount of $18,394.04.
‘Accumulated earnings and profits‘ is not defined in either chapter 1 or chapter 2 of the Internal Revenue Code, but in Federal Union Insurance Co., 5 T.C. 374, we considered and approved the portion of section 35.718-2 of Regulations 112 which provides that ‘In general, the concept of 'accumulated earnings and profits' for the purpose of the excess profits tax is the same as for the purpose of the income tax.‘ Section 115 of the code, dealing with corporate distributions and their income tax consequences, makes frequent reference to ‘earnings and profits‘ and prescribes the effect of certain corporate transactions thereon. Relative thereto the respondent has promulgated regulations which, in part, are as follows:
SEC. 29.115-3 (Regulations 111). EARNINGS OR PROFITS. In determining the amount of earnings or profits * * * due consideration must be given to the facts, and, while mere bookkeeping entries increasing or decreasing surplus will not be conclusive, the amount of the earnings or profits in any case will be dependent upon the method of accounting properly employed in computing net income. For instance, a corporation keeping its books and filing its income tax returns under sections 41, 42 and 43 on the cash receipts and disbursements basis may not use the accrual basis in determining earnings and profits; a corporation computing income on the installment basis as provided in section 44 shall, with respect to the installment transactions, compute earnings and profits on such basis; and an insurance company subject to taxation under section 204 shall exclude from earnings and profits that portion of any premium which is unearned under the provisions of section 204(b)(5) and which is segregated accordingly in the unearned premium reserve.
Among the items entering into the computation of corporate earnings or profits for a particular period are all income exempted by statute, income not taxable by the Federal Government under the Constitution, as well as all items includible in gross income under section 22(a) or corresponding provisions of prior Revenue Acts. Gains and losses within the purview of section 112 or corresponding provisions of prior Revenue Acts are brought into the earnings and profits at the time and to the extent such gains and losses are recognized under that section (see section 29.115-12). * * *
The scope of ‘earnings and profits‘ has been defined as sufficiently broad to encompass, in the absence of statutory exclusion, all economic gain realized by the corporation, and it has been held repeatedly that corporate profits are not necessarily limited to accumulations of surplus which prior thereto have been included in taxable income. It does not necessarily follow, however, that the respondent's regulation is incorrect in its general provision that the ‘amount of the earnings or profits in any case will be dependent upon the method of accounting properly employed in computing net income.‘ Immediately following this general rule, three purported examples thereof are stated in the regulation. In Federal Union Insurance Co., supra, we expressly approved the last of the three examples. We held there that reserves for unearned premiums are not includible in an insurance company's earnings or profits for excess profits tax purposes because ‘an item may not become a part of the accumulated earnings or profits for income tax purposes except by going through the income account.‘
Petitioner's position is directly in conflict with the second illustration, however, for this illustration provides that ‘a corporation computing income on the installment basis as provided in section 44 shall, with respect to the installment transactions, compute earnings and profits on such basis * * * . ‘ Petitioner's first argument is that under the established principles of...
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