Iowa Guarantee Mortg. Corp. v. Commissioner

IOWA GUARANTEE MORTGAGE CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Iowa Guarantee Mortg. Corp. v. Commissioner Docket No. 43247. United States Board of Tax Appeals 28 B.T.A. 213; 1933 BTA LEXIS 1158; May 31, 1933, Promulgated *1158 In the circumstances herein it is held that the petitioner is not a dealer in personal property on the installment plan and, therefore, is not entitled to the benefit of the relief provision of section 705 of the Revenue Act of 1928. Clyde B. Charlton, Esq., for the petitioner. William E. Davis, Esq., for the respondent. LANSDON *214 The respondent has determined deficiencies in income taxes for the years 1924, 1925 and 1926 in the respective amounts of $7,157.39, $2,035.24 and $1,124.30. In the petition it is alleged that the respondent erred (1) by including the amount of $64,679.96 in the petitioner's income for 1924 representing income realized on loans made in prior years; (2) by disallowing a net loss in 1924 and in failing to allow such amount as a deduction from income for the year 1925; and (3) by disallowing as deductions from income certain additions to reserve for bad debts in the years 1924, 1925 and 1926 in the respective amounts of $2,155.81, $2,312.70 and $8,328.13. The parties have filed a stipulation which is incorporated herein by reference and from which we have made the following findings of fact. FINDINGS OF FACT. *1159 The petitioner is a South Dakota corporation, duly authorized to operate in the State of Iowa. Its principal office is at Des Moines, Iowa, where it is engaged in what is commonly known as the automobile financing business. Dealers in new and used automobiles accomplish sales on the installment basis approximately as follows: The dealer tentatively negotiates a sale and enters into an arrangement with a buyer, who agrees to make an initial payment in some amount and to pay the remainder of the purchase price in twelve equal monthly installments. Upon agreement between the dealer and the purchase a written contract embodying the terms upon which the deferred payments are to be made is executed and sold to the petitioner, who pays the dealer the cash selling price, less the initial payment, and takes title to the contract by assignment without recourse from the dealer. The automobile is then delivered to the purchaser, who thereafter makes all payments to the petitioner. If the purchaser defaults in any of his installments the whole of the remaining balance of the purchase price becomes payable and the petitioner may repossess and resell the automobile in satisfaction of its*1160 lien thereon. The contract provides expressly that all installments thereon shall be paid at the office of the petitioner in conformity with a "certain negotiable promissory note of even date payable to the order of the purchaser and signed, endorsed and delivered by said purchaser to the dealer. The dates and amounts of payments being as follows * * *." It also provides that "The purchaser * * * take notice that the dealer for value received, hereby sells and assigns the contract and all the right, title and interest of the dealer in said property to the Iowa Guarantee Mortgage Corporation." *215 The petitioner's gross income, except from minor sources, is made up of its collections under contracts as above set out and its net income from such collections is the difference between the cash and deferred payment price of the automobile, less the amount that it pays for insurance thereon. It is always possible, therefore, to determine the net profit resulting from any single transaction as well as the net profit from all such transactions in any year, with due allowances for defaults in payments. Prior to January 1, 1924, the petitioner kept all its accounts on the accrual*1161 basis. In its income tax return for 1923 it included in its gross income the amount of $64,877.11 which represented unrealized profits on installment contracts it had acquired in that year. As of January 1, 1924, the petitioner changed its method of accounting for the profit involved in installment contracts and thereafter took into income the realizations therefrom as and when received in cash. In its income tax return for 1924 and all succeeding years, it reported as income only the amounts realized from collections in each of such years. The effects of this change in accounting for and reporting income were that no part of the $64,877.11 collected in 1924 on contracts acquired in 1923 was reported as income in 1924; that no part of the unrealized profits involved in the contracts acquired in 1924 was reported as income in that year; and that the books of the petitioner showed a net operating loss in 1924 in the amount of $10,929.66. Upon audit of petitioner's return for 1924 the respondent added to the income therein reported the amount of $64,679.96, made other minor adjustments, and determined the deficiency for such year that is now in controversy. From the inception*1162 of its operations the petitioner maintained a reserve for bad and doubtful accounts and annual charges thereto were based on its experience in the collection of installments. In his audit of petitioner's return for the years 1924, 1925 and 1926, the respondent disallowed additions to such reserve in the respective amounts of $2,155.81, $2,312.70 and $8,328.13. The parties have stipulated that one half of one percent of the face amounts of purchase notes acquired is approximately the collection loss sustained by the petitioner in the years 1920 to 1924, inclusive. OPINION. LANSDON: The petitioner's major contention is that, in the circumstances as set out in our findings of fact, it properly changed its method of accounting for and reporting income from receipts on deferred payment contracts at January 1, 1924, and that thereafter *216 it was entitled to report such income on the installment basis. If this contention is sound it follows that if it then comes within the provisions of section 705(a)(2) of the Revenue Act of 1928 1 no deficiency can be determined against it in respect of the amount of $64,679.96 which was reported as taxable income in a prior year and*1163 income tax paid thereon. The respondent has determined that the petitioner is a money lender and is not a dealer in personal property and so is not entitled to the benefit of any of the statutory provisions relating to sales on the installment basis. The Board has heretofore held in many cases that where the owner of installment contracts realizes his profits therein by sale to another party he loss his right to report income on the installment basis. *1164 ; ; ; . This principle was specifically applied to automobile dealers who sell their installment contracts to finance companies in ; and . It is clear, therefore, that under these cited decisions, an automobile dealer in the circumstances herein loses his right to report his income on the installment basis when he sells such contracts to a finance company. Whether the purchaser acquires an interest in the contract and the automobile that makes him a seller of personal property on the installment plan remains to be considered. Prior to the effective date of the Revenue Act of 1926, there was no express statutory authority for reporting income from installment sales as and when realized. Early in the history of the present system of income taxation profits from such transactions were returned on the accrual basis, but as early as 1919 in Regulations 45, article 42, the Commissioner authorized*1165 returns on the installment basis and later incorporated practically identical language in Regulations 45, 62 and 69 interpreting the Revenue Acts of 1921, 1924 and 1926. In 1926 the Congress for the first time included in the Revenue Act of that year a provision expressly authorizing the report of income from installment sales as and when realized in the following language: *217 SEC. 212. (d) Under regulations prescribed by the Commissioner with the approval of the Secretary, a person who regularly sells or otherwise disposes of personal property on the installment plan may return as income therefrom in any taxable year that proportion of the installment payments actually received in that year which the total profit realized or to be realized when payment is completed bears to the total contract price. * * * Section 1208 of the Revenue Act of 1926 provides as follows: The provisions of subdivision (d) of section 212 shall be retroactively applied in computing income under the provisions of the Revenue Act of 1916, the Revenue Act of 1917, the Revenue Act of 1918, the Revenue Act of 1921, or the Revenue Act of 1924, or any of such Acts as amended. A change of accounting*1166 from the accrual to either the cash or the installment basis necessarily results in an overlapping period in which accruals theretofore made in one period become cash receipts in another. To relieve this situation in so far as it applies to dealers in personal property and real estate, Congress included section 705, heretofore set out in the margin of this report, in the Revenue Act of 1928. Certainly it was within the legislative power to make this provision broad enough to cover the situation of all taxpayers changing from the accrual to the cash basis, but Congress saw fit to limit the relief to a change from the accrual to the installment basis, probably because installment merchants and real estate dealers through their own organized efforts asked for such legislation in their own interests. The petitioner is entitled to the relief sought in this proceeding if it is the seller of personal property on the installment plan. In our opinion it is not a merchant but is a money lender. It sells no automobiles except in the very few instances in which it is compelled to take over those upon which purchasers have defaulted in their payments. The record does not disclose the plan*1167 upon which such cars are disposed of, which is immaterial since the sale thereof is merely the disposition of property pledged as security for the loans made by the petitioner and therefore is only a minor incident of its business. It may be true, as argued by counsel, that petitioner acquires some sort of legal title to the automobiles covered by the contracts, but that title is similar to the rights acquired by a money lender in a mortgage or deed of trust made to secure payment of loans on real estate. The petitioner is not entitled to relief under the provisions of section 705 of the Revenue Act of 1928. On this issue the determination of the respondent is affirmed. The inclusion of $64,679.96 in the petitioner's income for 1924 results in a net profit instead of a loss for that year. Accordingly, the claim for a net loss must be denied. *218 The parties have stipulated that "One-half of one per cent of the face amount of the purchasers' notes acquired is approximately the collection loss experienced by petitioner during the years 1920 to 1924, inclusive." Petitioner therefore contends that it should be allowed to include in a reserve for bad debts one half of*1168 one percent of the face value of the contracts purchased in the taxable year. Under the method of accounting which it adopted as of January 1, 1924, no income results from the purchase of contracts until the profit therefrom is realized in cash. Since there is no proof that collections were made in 1924 on any of the contracts acquired in that year, it is obvious that there is no income from which the amount claimed on account of bad debts can be deducted. Reviewed by the Board. Decision will be entered under Rule 50. Footnotes 1. SEC. 705. (a) If any taxpayer by an original return made prior to February 26, 1926, changed the method of reporting his net income for the taxable year 1924 or any prior taxable year to the installment basis, then, if his income for such year is properly to be computed on the installment basis - * * * (2) No deficiency shall be determined or found in respect of any such taxes unless the taxpayer has underpaid his taxes for such year, computed by excluding, in computing income, amounts received during such year on account of sales or other dispositions of property made in any year prior to the year in respect of which the change was made. ↩