Swain & Myers, Inc. v. Commissioner

SWAIN AND MYERS, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Swain & Myers, Inc. v. Commissioner Docket No. 94477. United States Board of Tax Appeals 42 B.T.A. 306; 1940 BTA LEXIS 1024; June 28, 1940, Promulgated *1024 RESERVE FOR CONTINGENT LIABILITY - NOT DEDUCTIBLE. - During the taxable year 1935 petitioner was engaged in the business of selling merchandise at retail, and was subject to the tax imposed on gross receipts from sales by the Illinois Retailers' Occupation Tax Act. Held, a reserve set up by petitioner on its books to cover the state tax in respect of accounts receivable, uncollected at the close of the taxable year, may not be accrued and deducted from gross income for Federal income tax purposes, although included in the gross sales price accrued as income. Reuben H. Donnelley Corporation,22 B.T.A. 175 followed. David Altman, Esq., for the respondent. HILL *307 Respondent determined deficiencies in petitioner's income tax and excess profits tax liabilities for the year ended September 30, 1935, in the respective amounts of $208.67 and $11.44. The issue submitted for decision is whether or not respondent erred in disallowing a deduction claimed by petitioner as a reserve for tax accrued under the Retailers' Occupation Tax Act of Illinois in respect of outstanding uncollected accounts receivable. The facts were stipulated*1025 by the parties. FINDINGS OF FACT. Petitioner is a corporation, organized under the laws of the State of Illinois. During the taxable year ended September 30, 1935, it was engaged in the business of selling at retail store fixtures and equipment, with its principal office at 544 North Main Street, Decatur, Illinois. The petitioner is subject to tax on its intrastate sales imposed by the State of Illinois under an act known as the Retailers' Occupation Tax Act, Illinois Revised Statutes (1937) chapter 120, sections 440 et seq. The tax rate for the taxable year here involved was 2 percent on receipts from sales made on and after July 1, 1933, and prior to July 1, 1935, and 3 percent on receipts from sales on and after July 1, 1935. The retailers' occupation tax is due and payable 30 days after the retailer has received proceeds from a sale. However, under article 10 of the rules and regulations issued by the Department of Finance of the State of Illinois relating to the Illinois Retailers' Occupation Tax Act in force during the taxable year here involved, permission may be secured upon written request to pay the tax on the basis of the gross amount of sales instead of*1026 the gross receipts from sales. The petitioner neither applied for nor secured such permission at any time. The petitioner keeps its books and reports its income on an annual accounting period or fiscal year ending September 30. Upon all sales made during the fiscal year ended September 30, 1935, the petitioner added to the normal selling price of its merchandise an amount equal to 2 percent or 3 percent of the sale price (depending on whether the sale was made before or after July 1, 1935) and charged its customers with the resulting total amount. The additions of such amounts to cash sales are not in dispute. The question arises only with regard to the additions made to sales on credit. In each of the credit sales made, the petitioner debited the customer's account with the normal selling price of the merchandise plus the 2 percent or 3 percent addition. However, the sales account was credited with only the selling price, excluding the 2 percent or 3 *308 percent addition. The 2 percent or 3 percent addition was credited to a reserve account captioned "Sales Expense Collected." (It should be noted that since the retailers' occupation tax is levied on the vendor*1027 and not on the vendee and is measured by 2 percent or 3 percent of the actual receipts by the vendor, it is necessary for the petitioner in making payment of the tax to the state to pay, in addition to the 2 percent or 3 percent amount added to sales, 2 percent or 3 percent of the amount credited to the "Sales Expense Collected" account. In other words, the petitioner pays the state the requisite 2 percent or 3 percent on the full amount charged to the customer, not merely on the amount credited to its sales account.) As the petitioner receives payments from its credit customers, it credits their accounts with the full amount of such payments. Within approximately 30 days after the close of each month, the petitioner pays its retailers' occupation tax to the State of Illinois on collections received during the month from both cash and credit sales. At the time of such payment to the State of Illinois, the petitioner debits the "Sales Expense Collected" account with an amount equal to 2 percent or 3 percent of the receipts from credit customers in the preceding month, so that the balance remaining in the account represents that part of the 2 percent or 3 percent added at the time*1028 of the original sale which may be said to be "allocable" to the outstanding uncollected amounts. During the taxable year ended September 30, 1935, there was credited to petitioner's "Sales Expense Collected" account $2,301.73, of which there remained the sum of $1,497.61 at the close of the year. In reporting its income for the taxable year ended September 30, 1935, the petitioner did not include in sales the sum of $1,497.61. The petitioner keeps its books and accounts on the accrual basis, although respondent does not concede that the amount of $1,497.61 represented items properly accruable as liabilities. Upon audit of the petitioner's return for the taxable year ended September 30, 1935, and examination of the petitioner's books and records, the Commissioner issued the notice of deficiency herein and determined that the amount of $1,497.61 should be included in the petitioner's income for the taxable year as an addition to sales. The Commissioner also refused to allow an offsetting deduction in an equivalent amount ($1,497.61) as sales tax expense as claimed by the petitioner and stated as his reasons for such refusal that the petitioner's liability to the State of*1029 Illinois for this amount did not become fixed and did not accrue until such time as collections were made on the credit accounts, inasmuch as the tax was not imposed until installment payments or collections were actually received by the petitioner as seller. *309 In issuing the notice of deficiency the Commissioner also disallowed deductions claimed for donations in the amount of $20. It is conceded that this disallowance is a proper adjustment to the petitioner's income. OPINION. HILL: The question for decision here is whether or not petitioner is entitled to accrue and deduct from its gross income for the taxable year ended September 30, 1935, in computing its Federal income tax, an amount representing the tax imposed by the Illinois Retailers' Occupation Tax Act (Jones Illinois Stat. Ann., sec. 119.450 et seq. ) in respect of the uncollected portion of the sales price of merchandise sold in the taxable year. The pertinent provisions of the Illinois statute are quoted in the margin. 1 *1030 Petitioner was engaged in the business of selling at retail store fixtures and equipment, and kept its books of account on an accrual basis. In determining the deficiencies respondent has allowed deduction of the full amount of the state tax accrued on petitioner's gross receipts in the taxable year, without regard to whether the tax was paid in such year, but petitioner contends that, since it included in the sales price an amount equivalent to the tax imposed on the gross receipts when collected and accrued such gross amount as income, it is entitled also to accrue and deduct as business expense the amount of the Illinois tax in order to reflect its true income. This contention can not be sustained. The fallacy of petitioner's argument lies in the fact that the full gross amount of each sale made by it, which included an amount equal to the tax here in controversy, became a definitely fixed obligation of the vendee at the time of sale, and hence such amount was properly accrued by petitioner as gross income. But petitioner did not become liable to pay the state tax until it made collection from its customers. *1031 The Illinois statute clearly imposed the tax only upon gross receipts from sales, and petitioner does not contend otherwise. Hence, prior to collection, petitioner's liability to pay the tax in respect of credit sales was wholly contingent, and the fact that it set up on its books a reserve to cover such contingent liability does not change the legal effect of the situation. "Contingent liabilities are not accruable for income tax purposes." , and authorities cited. We have repeatedly *310 held that a reserve set up on a taxpayer's books to take care of a contingent liability is not deductible in computing Federal income tax. See , and authorities cited at page 180. The facts in the Donnelley case are, in all material respects, similar to those involved here. There the taxpayer was engaged in the business of publishing classified business telephone directories, and derived its income from sales, through agents, of advertising space. The commissions to be paid to the salesmen for procuring advertising contracts were not due until the*1032 amounts of the contracts were paid. The amounts due on the contracts were immediately charged by the taxpayer to its customers' accounts and accrued as income. We held that such amounts constituted gross income, but that the salesmen's commissions on the unpaid accounts were not accruable or deductible. In that connection we said: It may be inquired why such items should be accrued as income and the amounts due salesmen as commissions on these advertising contracts should not be accrued as expense. We think the answer lies in the fact that the accounts for advertising were unconditionally due when the directories were published, whereas the amounts due salesmen for commissions were contingent upon the customers paying their accounts. Petitioner in the instant case strenuously insists that since it accrued the Illinois tax as gross income, the true net income will not be reflected unless it is permitted to accrue and deduct the amount of the State tax, citing in support of this contention, . It is obvious, we think, that to permit the deduction claimed in respect of petitioner's accounts receivable would result in*1033 a distortion of income if and to the extent that such accounts were not thereafter collected. Furthermore, in no event would petitioner have to bear the burden of double taxation in respect of uncollected accounts, since it would be entitled to deduct in a subsequent year any worthless debts, which would include pro tanto the accrued State tax. Not only is it unnecessary to accrue a contingent liability in order clearly to reflect income, but any system of bookkeeping which accrues such item distorts income. ;; . Nor do we think that , lends support to petitioner's argument. That case involved a reserve for taxes on profits from sales of munitions in 1916, which taxes were not due and payable until 1917. The taxpayer sought to take a deduction in 1917. The Supreme Court held that the amount was properly accruable and deductible in 1916 for the reason that in the economic and bookkeeping sense the taxes had accrued in that year, saying: *311 In a*1034 technical sense it may be argued that a tax does not accrue until it has been assessed and becomes due; but it is also true that in advance of the assessment of a tax all the events may occur which fix the amount of the tax and determine the liability of the taxpayer to pay it. The present case differs from the facts in the Anderson case in that here, prior to the close of the taxable year, all events which fixed the amount of the tax and determined the liability of petitioner to pay it had not occurred. Both the amount of the tax and petitioner's liability to pay were dependent upon collection. The Anderson case involved an unconditional liability; the case at bar involves a contingent liability. The deficiencies determined by respondent are approved. Decision will be entered for respondent. Footnotes 1. 119.451. A tax is imposed upon persons engaged in the business of selling tangible personal property at retail in this State at the rate of two per cent (2%) of the gross receipts from such sales in this State of tangible personal property made in the course of such business upon and after the taking effect of this Act and prior to July 1, 1935, and at the rate of three per cent (3%) of the gross receipts from such sales on and after July 1, 1935 * * *. ↩