Telephone Directory Advertising Co. v. United States

• Decision Date: 12 July 1956
• Docket Number: No. 560-53.,560-53.
• Citation: 142 F. Supp. 884
• Parties: TELEPHONE DIRECTORY ADVERTISING COMPANY and C. Harry Chisholm, Charles F. Welsh, and Rose J. Mertz, as Directors and Liquidating Trustees of Telephone Directory Advertising Company v. The UNITED STATES.
• Court: U.S. Claims Court

142 F. Supp. 884

TELEPHONE DIRECTORY ADVERTISING COMPANY and C. Harry Chisholm, Charles F. Welsh, and Rose J. Mertz, as Directors and Liquidating Trustees of Telephone Directory Advertising Company v. The UNITED STATES.

No. 560-53.

United States Court of Claims.

July 12, 1956.

Joseph H. Sheppard, Washington, D. C., for the plaintiffs. J. Marvin Haynes, Haynes & Miller, N. Barr Miller, F. Eberhart Haynes, and Oscar L. Tyree, Washington, D. C., were on the briefs.

J. W. Hussey, Washington, D. C., with whom was Asst. Atty. Gen. Charles K. Rice for defendant. Andrew D. Sharpe, Washington, D. C., was on the brief.

Before JONES, Chief Judge, and LITTLETON, WHITAKER, MADDEN and LARAMORE, Judges.

LITTLETON, Judge.

The plaintiffs sue to recover $493,378.41, with interest, as an overpayment of corporation income and excess profits taxes and interest for the period from August 1, 1950, to October 31, 1950. There are two issues. The first issue is whether the Commissioner of Internal Revenue properly included certain future commissions in the income of the Telephone Directory Advertising Company, a corporation, for its final taxable period. The second issue is whether the Commissioner properly included the proceeds from the sale of certain assets in the income of the Telephone Directory Advertising Company.

The facts relating to the first issue may be summarized as follows: The Telephone Directory Advertising Company (hereinafter referred to as plaintiff) kept its books and filed its tax returns on an accrual method of accounting. The plaintiff filed its corporation tax returns on the basis of fiscal years ending July 31, and filed its final corporation tax return for the taxable period beginning August 1, 1950, and ending October 31, 1950.

The plaintiff, from its inception in 1913 until its liquidation on October 31, 1950, was engaged in the business of selling and scheduling advertising for publication in telephone directories to be issued by the Michigan Bell Telephone Company (hereinafter referred to as Telephone Company) in Detroit and other areas of the State of Michigan. Substantially all its income was derived from that source. The plaintiff was the sole advertising solicitation agent for the Telephone Company.

The advertisers were required by their contract to pay when billed by the Telephone Company a certain amount per month during the life of a directory. Under the contract, dated May 26, 1947, the Telephone Company was required to pay plaintiff specified commissions monthly, limited to the amounts collected from the advertisers. The amounts paid plaintiff monthly were subject to adjustments every six months. This contract was amended on November 5, 1949, to eliminate the six months' adjustment provision and to provide that the commissions should be payable monthly on a gross sales basis. Commissions under both arrangements are involved in this case.

When a directory was issued by the Telephone Company it was assigned a projected or estimated life, but frequently the projected life was cut back or extended because of the exigencies of the telephone business. The average projected life for directories was from ten to twelve months, but the Telephone Company had complete control of the length of time a directory would be outstanding and frequently issues were extended or curtailed by one or two months and in some instances for periods of as long as three, four, seven, or nine months. If the projected life of a directory was cut back, an advertising subscriber was not liable for advertising charges beyond the last month the directory was outstanding, and conversely, when the life of a directory was extended under his contract a subscriber was liable for advertising charges for the number of additional months added to the original projected life. Subscribers were thus bound by their contracts to pay advertising charges to the Telephone Company only so long as the directory in which their advertising appeared remained in use and the plaintiff was only entitled to commissions on such advertising under the same conditions and circumstances.

When a directory was issued plaintiff would compute the amount of one month's commission thereon and multiply that amount by the number of months in the projected life of the directory. This amount was then reflected in plaintiff's books as deferred revenue, but no portion of that sum was taken into income through this entry. At the end of the first month in which a new directory was outstanding and at the end of each following month while such directory was outstanding, plaintiff accrued on its books the monthly portion of the commission it was entitled to receive from the Telephone Company and treated this amount as income accruing at the end of the month for which the entry was made. If the projected life of the directory was changed appropriate entries were made.

The plaintiff paid its individual salesmen each month on the basis of the gross value of sales of advertising made by them. At that time it charged the amounts to a deferred expense account. When a directory was issued and the plaintiff became entitled to receive commissions from the Telephone Company for the advertising sold, plaintiff charged against such commissions each month a pro rata part of the salesmen's commissions which had been set up as deferred expense at the time the advertising was sold.

The plaintiff treated the commissions as accruing as income for tax purposes at the end of each month for which an applicable directory was outstanding and charged a pro rata part of the applicable salesmen's commissions against such income. The plaintiff consistently followed this method of reporting its income and expenses from 1931 to the date of its liquidation. This method of accounting clearly reflected plaintiff's income. Except for the three months' period ended October 31, 1950, these returns have always been accepted by the Commissioner insofar as the method of accounting was concerned.

Dissension concerning the terms of the contract arose between the plaintiff and the Telephone Company sometime in 1948. Numerous conferences were held and correspondence was exchanged in an effort to effect a satisfactory renewal contract. The negotiations failed and plaintiff's contract with the Telephone Company expired on October 31, 1950. Termination of the contract resulted in the collapse of plaintiff's business. For this reason the plaintiff completely liquidated and dissoslved on October 31, 1950, and distributed all its assets to its stockholders through duly appointed agents as a liquidating dividend in kind.

On the date of dissolution of plaintiff there remained in its deferred revenue account the sum of $277,565.05 which had not yet accrued as income. This sum represented anticipated commissions on outstanding directories of the Telephone Company to which the plaintiff would have been entitled monthly in the future had it remained in business and had the directories to which such commissions related remained outstanding through their full projected lives. Prior to its dissolution plaintiff had solicited advertising for inclusion in directories which had not yet been issued by the Telephone Company at the date of dissolution. No amount was reflected on its books with respect to commissions on these directories because under its regular method of accounting a book entry was not made until directories were issued. The monthly payments for the directories outstanding on dissolution and those issued by the Telephone Company after dissolution were made to the agents for the stockholders over a period of approximately 18 months.

The Commissioner included in plaintiff's income for the short period August 1 to October 31, 1950, the entire amount of $277,565.05 reflected in its deferred revenue account representing anticipated commissions from the directories then outstanding, and in addition included the amount of $635,929.51 representing anticipated commissions from directories to be issued in the future. In accordance with plaintiff's regular method of accounting these sums would not have been accrued as income in less than 18 months had it remained in existence. Deduction for expenses paid in connection with these directories were allowed for the short period.

Deficiencies in income and excess profits taxes were assessed, with interest, by the Commissioner, and paid by plaintiffs. Claims for refund were duly filed, rejected, and this suit was timely instituted.

The plaintiffs contend that the Telephone Directory Advertising Company did not realize the commission income in dispute in this case because such income had not accrued at October 31, 1950; that its accrual method of accounting properly reflected its income for the short period; that in the circumstances the Commissioner lacked authority under the law to change its accounting method, and therefore the taxes were improperly collected.

The defendant contends that this income was properly taxed to the plaintiff because plaintiff earned the income and should not be allowed to escape tax by dissolving and distributing the right to receive that income to the stockholders. The applicable sections of the Code are set forth below.¹

At the outset the defendant asserts that plaintiff employed a hybrid system of accounting in keeping its books and reporting its income for tax purposes. The plaintiff was on an accrual method of accounting. The plaintiff's method of accounting more accurately reflects income than does the pure tax accrual method because the income is matched with the expenses incurred in earning it. The only difference between plaintiff's method of accounting and the pure accrual method as recognized for tax purposes is that plaintiff did not deduct its expenses when "incurred," but rather deferred them until the income earned from the sales accrued. Insofar as the accrual of the income was concerned, which is the question in dispute...