COMMISSIONER v. HANSEN
Legal provision: Internal Revenue Code
Argument of Lester M. Ponder
Chief Justice Earl Warren: Number 512, Clifton E. Baird and Violet L. Baird, Petitioners, versus Commissioner of Internal Revenue.
Mr. Ponder, you may proceed.
Mr. Lester M. Ponder: Mr. Chief Justice, may it please the Court.
I'd like to refer at this time to two statements that were made -- have been made by the counsel for the Government which are on my mind.
One is that it has been a long established administrative practice to treat the accruals as the Government contends in this case.
I'd like to point out that first on that point, the administrative ruling to which counsel refers was not issued until 1957 long after this question was deeply in litigation in the lower courts.
Secondly, I'd like to point out that the Commissioner has never seen fit to embody this position in regulations either under the 1939 Code or more lately under the 1954 Code.
And we submit that if the Commissioner felt strongly as to the correctness of this administrative position, he would have embodied it in a regulation carrying the weight of a regulation and not of a ruling, which, of course, it does not have the standing on regulation, secondly, on the point just made as to the accrual point of the later deduction.
I believe it is safe to say that a search of all the cases decided by this Court involving the proper year of accrual of items, of income or deductions in the lower courts without exception and that includes two cases, I think the most recent cases of this Court on the accrual question which have not been referred to, those are the Dixie Pine Products and the Security Flour Mills cases which are cited, of course, in the brief in 1944.
And in none of those cases, I submit, has this Court eluded to or ever referred to any later offset or credit as having any possible effect on the year of accrual but the test being as annunciated in the Spring City case and as reiterated in all the later cases that is the right to income which becomes fixed in the year which was determined to question.
The offset to --
Chief Justice Earl Warren: What --
Mr. Lester M. Ponder: Excuse me.
Chief Justice Earl Warren: -- what was the practice between 1931, as counsel referred to the ruling of the Department, and 1957.
Did the 1957 regulation changed the practice or did it merely codify it in -- in the regulations?
Mr. Lester M. Ponder: Let me say this, Your Honor, in the first place, it was never put in the regulations in 1957 and has --
Chief Justice Earl Warren: Well, whatever --
Mr. Lester M. Ponder: The ruling, a revenue ruling.
Chief Justice Earl Warren: Ruling.
Mr. Lester M. Ponder: As I understand it, Your Honor, there was no change in the treatment accorded by the Commissioner when the question arose as to how taxpayers treated it in that interim period, I cannot say.
In other words, the 1931 ruling was -- what is known as a GCM, which is the General Counsel's Memorandum so-called at that time.
Frequently, as you know, taxpayers do not see fit to follow inferior administrative rulings but preferring to litigate those rulings if they feel they are incorrect.
Now, as -- answering your question, as far as I know, there was no change in this general view of the Commissioner during that period.
But as I say, he failed to give this position the dignity and standing of a regulation even though from the year, I say, 1948 to the present, this question has been litigated time and time again but no changes -- but, as I say, no regulation was issued on the point.
I called the Court's attention briefly to an error in printing on page 9 of the brief.
I do not think it is material.
But in the line on that page in a tabulation entitled Financing Charge Paid to Finance Company $420, that amount should be $1265.80 as it appears on page 18 of the record which is given as the reference there, that is there is no confusion if the record is checked but it's simply in the printing there was a transposition because that figure had appeared earlier in the tabulation.
I simply call that to the Court's attention.
Now, I will endeavor not to repeat the basic accrual points which have already been, I think, very amply covered by preceding counsel.
I would like to point out to the Court, however, that it is the position of the petitioners in the Baird case that their rights to income where even more contingent during the taxable years than those of the automobile dealers.
Why do I say that?
First place, automobile sales, of course, have been financed by finance companies organized especially for that purpose over a period of many years, 30 or 35 years or longer, whereas the Baird case involves mobile homes which are sometimes referred to as house trailers rather than automobiles as in the Hansen and Glover cases just argued.
House trailers were of comparatively small use prior to World War II but with the wartime housing shortage, the need for itinerant workers and other such causes, the house trailer industry began to increase greatly about 1945.
As a matter of fact, it's now estimated that about 3,500,000 persons live in about 1,200,000 house trailers at this time.
And in 1948 -- excuse me, 1958 last year for every 100 houses started, 14 new house trailers were manufactured to show the growth, the growth of the industry.
Now, what significance does that have on our case?
We think it has this significance that the trailer dealers, like the automobile dealers before them, were unable to finance their sales and had to turn to outside financial institutions for this service.
But the established automobile finance companies apparently had no interest in this business.
Consequently, the few institutions which would agree to furnish financing were in a bargaining position which permitted them to incorporate very stringent terms governing the retail dealers such as the Baird's and their rights to the amounts credited.
Now, why did they have this difference between the trailers and automobiles?
Several facts quickly show it.
One is that there was a very long credit period for trailers as compared to automobiles.
It would run from three to seven years as compared to an average of perhaps two and one half years for automobiles.
Secondly, trailers cost more than automobiles in the nature of the product.
They will average from $5000 to $8000 in price compared to automobile prices during our period, and I quickly say this was several years ago before prices are as high as now when the automobiles would be between, say, $2500 and $4000 for the average car.
The third factor that made the house trailer dealers in a very poor position to arrange financing was the transient and impermanent nature of the majority of trailer purchasers compared to automobile owners.
Now, only two Circuit Courts of Appeal have had occasion to consider the identical question that is involved in the Baird case on these facts.
They are the Blaine Johnson case in the Fourth Circuit and the Texas Trailer-coach case in the Fifth Circuit.
I submit that the facts in all three cases are identical and I do not believe that the Government contends to the contrary.
During this period, we have an additional complication in our case that is not present in the Hansen and Glover case, that is complication on the facts.
Mr. Baird and Mrs.Baird, as partners, did business during this period with three separate finance companies.
Well, of course, each one drove a separate bargain.
They are all in the record.
Most of those agreements were in writing.
There were some oral bases which are in the record in two of the three agreements.
But the basic agreement and the one to which I want to refer chiefly was with Minnehoma Financial Company of Tulsa, Oklahoma and that was entirely in writing and, of course, is in the record.
I believe it's at page -- starting at page 27.
Now, during this taxable period, the Baird's, as I say, assigned their contracts and I want to point this out to that contrary to a statement yesterday which I'm sure was simply a slip on the part of counsel for the respondent, in Minnehoma, there was no note but in the other two Midland and Michigan, the other two companies, did have notes.
We do not think that is material.
I simply call that to the Court's attention so the Court will understand that in the Minnehoma, there was no note.
There was simply the conditional sales contract.
Now, I will, for purposes of the gravity of time allotted me, refer solely to the details of the Minnehoma agreement for this reason.
The Minnehoma agreement, of the three agreements involved in the Baird case, is the only one that is common to the three cases involving trailer dealers, that is Blaine Johnson in the Fourth Circuit, Texas Trailer-coach in the Fifth and the Baird case.
Therefore, since it's as a common contract, and I'd like -- like to just simply stress that one contract.
And, of course, as I have said that's at record 27 in toto and another reason for referring to that one is that it was entirely in writing.
Now, under that contract, what were, what were the limitations on the Baird's that made their rights to these credited amounts so contingent that we contend they were not accruable in the years of the sales of the trailers?
First, the trailer purchaser must complete a credit form supplied by Minnehoma.
Minnehoma supplied the credit form.
The dealer had to forward this in two copies of either at Dun & Bradstreet or a retail merchant's credit report to Minnehoma.
And Minnehoma had to approve the purchaser's credit before there could be any sale.
Secondly, each trailer contract had to be on a printed form provided by Minnehoma, in which the name, of course, Minnehoma is inserted therein at the appropriate places as will be shown in the record.
Thirdly, the balance owed by the purchaser is payable only at the Minnehoma office in Tulsa and if, by any chance, it should be paid to the dealer, he has to immediately forward these under very stringent conditions on that.
Next, Minnehoma designated the amount of the down payment.
Fifthly, the dealer unconditionally guaranteed Minnehoma against any losses including loss of prospective profits.
That's the wording of the agreement, “prospective profits”.
This guarantee, therefore, covers much more than the 5% holdback.
It covers insurance premiums for the full-term.
If the -- if the purchaser would prepay, still Baird was liable only full-term insurance premium, same way with finance charges.
They guaranteed full-term finance charges, prospective profits.
So you can see that Baird's reserve was subject to being reduced by much more than the 5%, not only that involved but these other factors.
And that, of course, is pointed out in detail at page 19 of the brief.
Now, what does Baird get back?
The contract says this, “An amount to be determined, to be determined by Minnehoma from time to time in its absolute discretion, equal to not more than 5%”.
Not just 5%, equal to not more than 5%.
But the total purchase price would be credited by Minnehoma.
Payments, when do they be made?
They are to be made only from time to time as determined by Minnehoma.
Then in addition to this holdback reserve credit, Minnehoma may, but it doesn't have to, credit the partnership with a portion of the finance charge of matter solely within the discretion of Minnehoma.
And then, of course, if that is done, that credit, of course, becomes subject to the same contingencies governing the hold -- the holdback, as I've already outlined.
I call the Court's attention to a -- to another provision this contract, we think, makes Baird's rights extremely contingent.
Minnehoma's determination as to the possibility of the contingent liability shall be filed and not subject to question by the dealer.
And how could that be written any stronger, I submit?
Thirdly or I should say further, Minnehoma could reassign any contract upon such terms as -- and conditions as Minnehoma should determine and even if they did that without Baird having anything to say about it, they didn't waive their rights against Baird, expressly in the contract and then such as her niece would succeed to all of Minnehoma's rights against Baird.
Now, as I say, these identical facts were before the Fourth Circuit in the Johnson case and they were before the Fifth Circuit in the Texas Trailer-coach case.
In Johnson, there were other contracts also which, as we say, just as we had other contracts, we think that fundamentally, they were of the same general nature but, of course, differed in their precise wording.
In the Seventh Circuit opinion in this case, we feel that the Court made an error in failing to perceive the identical factual situation between the two cases because there is a reference in the opinion of that Court to a possible deviation between the facts where the Court states in the last paragraph of its opinion, “Ignoring some of the factual differences,” the Court said, “we decline to follow if -- all the same rather, “we decline to follow Johnson and Texas Trailer-coach”.
I submit there are no factual differences and that that error caused the opinion of the Seventh Circuit to be contrary to these petitioners.
The reason, as I say, that I say the facts are the same, it was stipulated in the tax court trial of the Baird case that the entire Blaine Johnson record was received in evidence in the Baird case.
How could the facts be different on that stipulation?
Secondly, in the -- in the Texas Trailer-coach case, the only finance company involved was Minnehoma.
The contract was in evidence, the agreements were in evidence and, of course, they were identical with the agreements in the Baird case because Minnehoma had drawn up a set of agreements and contracts which it used uniformly with trailer dealers.
And in any event, they are identical and our comparison shows that.
Now, the basic accrual principles coming to those points, as I say I will not dwell at length because I think they have been covered.
But I would like to point out to the Court that it has been held on several occasions that a strained construction in administrative efforts to accrue income should be avoided.
And we submit that the position here of the respondent is an extremely strained effort to accrue income regardless of what else may be said.
I also like to point out that in the Dixie Pine Products case and the Security Flour Mills case of this Court in 1944, Mr. Justice Black said that the right to income -- excuse me, when the right to income has become final and definite in amount, then the income is to be accrued.
And I think that in some of the discussions on this point, those cases have been overlooked.
And I call the Court's attention to those cases which, of course, cited in the brief.
We feel that we have shown that substantial contingencies govern the petitioner's rights to the amounts credited.
They were, of course, clearly unavailable to the petitioner's in any sense during the tax years involved whether they would ever be available was uncertain during the taxable years because of this wide control of the finance companies over the credited amounts.
And as I have already pointed out, the respondent has never challenged the similarity in effect of the three finance companies that we have involved in this case.
So, of course, as time won't permit, I won't go into the others except to say that they are substantially similar.
Now, with respect to this one or two transactions hypothesis, of course, we say under the decided cases of that there simply was one transaction here.
The -- that was so held expressly in those words in Johnson and expressly in Texas Trailer-coach, and our facts are identical.
And we say that only that result can obtain here.
We say that further in its brief, the respondent states on pages 40 and 41 that regardless of whether this Court holds a one or two transaction hypothesis, the tax result must be the same.
So curiously enough, we find respondent arguing in this Court that there are two transactions and it's saying the brief that it makes no difference.
Now, quickly as to the finance company being a party, we think in treat and in fact it was a party.
From Texas Trailer-coach, we find this language.
A trailer dealer has little hope of opinion financing unless he agrees to the establishment of a reserve account.
Its existence means life or death to the trailer business.
And again, from Blaine Johnson in the Fourth Circuit, those few financial institutions which would finance this paper were able to dictate to the trailer dealers the terms on which they would do so.
In view of these facts, we feel that our position should be sustained.
And I would like to say again that curiously here, the respondent also has departed from his historic position and the historic position of this Court as exemplified by the Clifford case, the horse case and many others in arguing what we feel is a hyper technical argument which glorifies form instead of the substance of the transaction which, of course, is well established to be the guiding tax principle.
If I have any further time, Your Honor, I will reserve it.
Chief Justice Earl Warren: Mr. Rothwacks.
Argument of Meyer Rothwacks
Mr. Meyer Rothwacks: May it please the Court.
The question on whether or not the Commissioner's position in these cases glorifies form over substance was the subject was the subject of some comment in article in 43 Cornell Law Quarterly.
There, the editorial comment looked to the decision of the Texas Trailer-coach case which involved the sale of trailers as it does in the Baird case.
The note editor concludes and we think that this is a correct conclusion calling attention to Judge Wisdom's estimation in the Texas Trailer case that the Commissioner was fascinated by the form and overlooked the substance of the transaction as my Brother says, he said that it was submitted that this criticism applies equally well to his own analysis which stretch -- stress so heavily the unitary nature of the transaction.
And that this stress of form over substance by the taxpayer in emphasizing the unitary nature of the transaction was demonstrated by a consideration of the situation in which a dealer disposes of some notes by subsequent independent sales while retaining others.
In such a case, the editor says, it would seem to be clearly necessary to accrue the full value of the notes which are discounted as well as those which are retained.
What it want to admit is this, as it seems the Court must, is it not a surrender to form to say that different tax consequences for discounted note should follow merely because the two sales have been simplified and integrated into a single transaction.
Justice Charles E. Whittaker: (Inaudible) would you state the citation --
Mr. Meyer Rothwacks: 43 Cornell Law Quarterly.
Justice Charles E. Whittaker: 43?
Mr. Meyer Rothwacks: 43 Cornell Law Quarterly.
Justice Charles E. Whittaker: Thank -- thank you.
Mr. Meyer Rothwacks: At --
Justice Charles E. Whittaker: Thank you.
Mr. Meyer Rothwacks: -- at 719 dealing with a decision in the Texas Trailer-coach case.
Justice Charles E. Whittaker: Thank you.
Mr. Meyer Rothwacks: I shall not burden the Court in this rebuttal with a restatement of the Government's position.
I'd like merely to point out in response to the Chief Justice's inquiry as to the Government's administrative position in these cases that it has been a perfectly consistent administrative policy ever since 1931, some nine years before the first litigated case in this area.
I -- I merely adverted to the 1957 ruling because the 1957 ruling spells out, and it was very helpful indeed, spells out the nature of the transactions in these cases.
The -- the GCM merely stated the policy and it stated it in this unequivocal fashion.
It observed that in the event the purchaser fails to meet his obligation, that is a man who buys the car or buys the trailer, the dealer is given the benefit of the reserved credit through a corresponding reduction in his liability to the finance company.
The ruling said that in as much as the taxpayer has adopted the accrual method of accounting, he must be consistent in the treatment of all of his items of income.
Such treatment under the accrual method demands that each item of income shall be accrued when earned rather than when received.
This is the basis upon which the theory of accrual is founded and the possibility of an item of earned income not being received due to some unforeseen circumstances is immaterial.
It is true, the Commissioner said, that where an entry on the books of account is based on a remote contingency which may never happen such item could not reasonably be accrued for income tax purposes.
The contingency must, however, be something more, something more than the mere possibility of the debtor not satisfying his indebtedness.
The facts show -- the Commissioner said, the facts show that the reserved credit is not a contingent credit but is paid to the dealer either at the time the note is liquidated by the purchaser or in case the purchaser fails to meet his obligation, the dealer is given the benefit of the reserved credit through a corresponding reducion in his liability to the finance company.
Now, in that connection, it is far clearer in the Baird case than in Glover and Hansen because of the contractual obligations running from the dealer to the finance company on the separate contract entered into between those two entities, that the reserve could be charged when there was a loss on repossession, that the reserved to be charged when there was a prepayment, that the reserved could be charged on account of any indebtedness whether or not related to defense, action and question between any indebtedness between the dealer and the finance company.
Now, in that circumstance, in that circumstance, it becomes all the more evident in Baird than it was in Glover and Hansen, that the dealer will either get the amount in that dealer's reserved in cash or he will get it by something that from a tax point of view is the equivalent of cash and that is the discharge of his obligations.
Rebuttal of Lester M. Ponder
Mr. Lester M. Ponder: If the Court please.
Just two comments, I believe, here.
One is again, on the two-transaction hypothesis, it is my belief that the Seventh Circuit Court of Appeals decision on the two transaction point was based primarily on taking certain testimony of Mr. Baird out of context and attributing to it a meaning which did not exist, that is to say in testimony on cross-examination, he was asked if when the trailer purchaser came to his place of business, the purchaser knew what finance company was going to handle the transaction.
Well, of course, he said no.
But the other evidence shows that before the sale was completed, the purchaser knew the identity of the finance company.
As I say if, for no other reasons, than that in the contract itself, the finance company name was set forth, the payment place to be at that location and many other such points.
But the Court apparently, as I say, I think in error, seized on that one statement out of context that when he walked in his place of business and picked out the trailer, of course, he didn't know at that time, he wanted a model, a certain model at a certain price, only later when they discussed terms and his credit was approved by the finance company.
Of course, before the sale was completed, then, of course, the purchaser did know.
So as I say, I think that was the crux of the erroneous holding on the two-transaction point if that is important in this case.
Secondly, again referring quickly --
Justice Potter Stewart: (Voice Overlap) the --
Mr. Lester M. Ponder: Yes.
Justice Potter Stewart: Excuse me, the -- the Seventh Circuit did reason to its conclusion upon the basis that this was two transactions and (Voice Overlap) --
Mr. Lester M. Ponder: That's correct, Your Honor.
Justice Potter Stewart: -- so that the Sixth Circuit in the Schaeffer case.
Mr. Lester M. Ponder: That's correct, Your Honor.
Justice Potter Stewart: But it's the Government's position here, an alternative position, if you will, that even if this be assumed to be one transaction, still, for the reasons they developed in their brief, the Commissioner should prevail.
Mr. Lester M. Ponder: That's correct, Your Honor.
And I don't feel I should spend more time on the point because of their position in -- in that regard.
Justice Potter Stewart: I just want to be (Voice Overlap) --
Mr. Lester M. Ponder: Yes, that's my understanding.
Justice Potter Stewart: It didn't feel that that was necessarily dispositive whether or not this was one or two transactions.
Mr. Lester M. Ponder: That's correct.
I'm simply trying to explain why I think the Seventh Circuit did go off on a tangent if that should be important.
That's my only point on that.
Secondly, I want to point out again that this administrative ruling in 1957, again, does not have the standing, in our opinion, to which respondent attributes because it simply is a restatement of their argument before this Court and before all the Courts of Appeal and before the tax court.
It's just nothing more than a restatement in a more elaborate form on certain points.
But the point is it is not of the standing, of course, of a regulation.
Now, we'd like to point out here, as I've already done, I'd like to say that there is much more here than the debtor not satisfying his indebtedness, as I pointed out.
Baird was liable for loss of prospective profits, for example, which had nothing to do with the debtor not satisfying his indebtedness.
It's -- it's just the opposite.
If he has satisfied it early, that caused Baird to be liable under that provision.
Then in conclusion, I would say, Your Honors, that as I understand respondent's argument, he is asking this Court to establish a new rule of accrual something that might be called the possible later offsetting tax benefit theory.
This Court has never adopted such a view.
And we submit that the established accrual principles governed this case and require decision for the petitioners.
I thank you.
Argument of Meyer Rothwacks
Chief Justice Earl Warren: Number 380, Commissioner of Internal Revenue, Petitioner, versus John R. Hansen and Shirley G. Hansen, and Number 381, Commissioner of Internal Revenue, Petitioner, versus Burl P. Glover.
Mr. Rothwacks, you may proceed.
Mr. Meyer Rothwacks: May it please this Court.
Numbers 380, 381 and 512, the Baird case, are all income tax cases.
They involve the so-called Dealers Reserve issue.
They are three cases in a long line of litigation extending, since 1940, on this important issue.
And they have all been litigated against a background of a consistent administrative practice since 1931, which supports the position which the Commissioner takes before this Court.
Since 1931, of course, there had been two enactments of the Internal Revenue Code.
Congress has not seen fit to enact any provisions in support of the position which the taxpayer dealers advocate before this Court.
Now these cases, all of them, involved dealers who are on an accrual basis of accounting.
They sell goods on credit.
They receive, from their customers, contracts and other retail paper which embodies the customer's obligation, an obligation to pay a full-time deferred balance.
Now, this contract is entered into between the dealer and the purchaser.
The finance company is not a part or party to that contract.
The dealer may retain the contract, he may retain the notes, or he may sell them.
And in all of these cases, he did indeed sell them to one or more finance companies.
Having sold the obligations of his purchasers to finance companies, the dealer was then paid a certain amount of approximately the face value of the paper in cash by the finance company, and the remaining portion was paid in the form of a credit that was entered on the finance companies' books as a liability of the finance company.
And eventually, as we shall make more clear in the development of our argument, eventually, the amounts of those credits were paid to the dealers either in cash or in the discharge of the dealer's obligations to the finance companies.
Now, the question that is raised here in all of these cases is an important one.
It's important, not only from the purpose from the viewpoint of maintaining the integrity of the accrual basis of accounting, it's also important from a practical point of view.
Now, the taxpayers' representatives will, no doubt, urge upon this Court why is the Government seeking to report -- to have the dealers report the amounts that were credited in the dealer's reserve accounts when they were credited, when, eventually, they will report them when they get paid or when their obligations to the finance company are discharged?
As I said before, the question is not only of great academic importance in connection with the integrity of the -- maintaining the integrity of the accrual principle, but if this Court were to accept the position advocated by the taxpayers, the effect of it would be, not only with respect to the thousands of automobile and trailer dealers throughout the country, to take them off the pay as you go basis and unto a, more or less, rollback basis, but it would also give the green light to hundreds, if not thousands, of other credit businesses all over the country to do precisely the same thing.
Now, there are two simple controlling principles in these cases.
The first is -- and this Court has stated it many times, the first is that, while a cash basis taxpayer reports income on an actual or constructive receipt of the cash, there is a difference in the accrual basis of accounting.
An accrual basis taxpayer must report his income and pay the tax on it upon the fixation of his right to receive the income and not upon actual or constructive receipt of income.
And the fact that the payment may be deferred, the fact that the agreement between the parties may contemplate that, while the amount is fixed, while the obligation is presently fixed, payment may be made in the future is irrelevant and immaterial to the accrual basis of accounting.
And in --
Justice William O. Douglas: Is that an exemption in the body of regulation and --
Mr. Meyer Rothwacks: Yes, it is, Your Honor.
It -- it arises, I believe, under the regulations that were promulgated pursuant to Sections 41, 42 and possibly 43 of the Internal Revenue Code.
Justice William O. Douglas: But they -- they are not printed here, are they?
Mr. Meyer Rothwacks: They -- they are not.
They are not.
But they have been so clearly and so often enunciated by this Court and by other courts that we didn't feel it necessary to print that.
We'll be very glad to do it.
This Court said, for example, in the Spring City case.
In that case, this Court will remember that the taxpayer was on the accrual basis.He sold goods on an open account in 1920.
His customer went into bankruptcy in that year.
In 1923 and 1924, he received dividends from the receiver in bankruptcy.
The taxpayer reported his income, in -- in 1923 and 1924, the amounts which he received from the receiver.
This Court said “No.”
This Court said he was required to report the amounts as income in 1920 because keeping accounts and making returns on the accrual basis, this Court said, as distinguished from the cash basis, important that it is the right to receive and not the actual receipt that determines the inclusion of the amount in gross income, and when the right becomes fixed, then the right accrues.
And the second controlling principle in these cases, related somewhat to the accrual accounting principle, is that every taxpayer under our revenue system, regardless of the accounting method that he uses, is required to compute his income and to report his income on the basis of an annual, as distinguished from a transactional, basis.
In other words, the fact that an income producing transaction such as the sale of an automobile or trailer on credit, as in these cases, extends over a period of more than one year, as they did in these cases.
It does not affect the requirement but under our tax system, the computation of the income for tax purposes must show the net result of all of the taxpayer's transactions in a given year rather than the net result of any particular transaction which may extend beyond that period.
Now, the facts in each of the cases in 380, 381 and 512 are of course somewhat different.
But while there are factual differences, we maintain that in their broad significant aspects, they do present a workable common picture which we may use to determine the application of the controlling principles which I have just enunciated.
Now, generally speaking, in these cases, the taxpayers were dealers who sold automobiles or trailers on credit.
They entered into negotiations with their customers.
They arrived at a time before balance with their customers.
They took the contract or the note of the customer which reflected the full-time balance less the amount that was paid in cash or the trade-in value of the car that was offered.
And that was the obligation of the customer, the purchaser, to pay to the dealer.
There's no indication in this record at all, in any of the records in these cases, except to the extent that the finance company may have supplied forms for the convenience of the taxpayers that the finance company participated in any way in the negotiations between the dealer, on the one hand and his customer, on the other, nor was the dealer under any obligation at all to sell his contract or notes either to the finance company to which he actually did sell or to any other finance company.
Now, the fact is, of course, that he did sell the contract.
He did sell the notes under agreements which were either oral or written.
In some instances, the notes were transferred with recourse, in some instances, without.
The contracts vary --
Justice Charles E. Whittaker: Excuse me.
Mr. Meyer Rothwacks: Yes?
Justice Charles E. Whittaker: Did I understand you to say, in some instances, they will be transferred without recourse?
Mr. Meyer Rothwacks: Yes, that is true, Your Honor.
Justice Charles E. Whittaker: But under the contract (Inaudible) obligations?
Mr. Meyer Rothwacks: Well, the -- the notes, in some instances, were transferred without -- without recourse but the contracts, the contracts would provide guarantees running from the -- after the sale of the note to the -- to the finance company.
The contracts between the -- between the dealer and the finance company would provide guarantee, certain guarantees running from the dealer to the finance companies.
Justice Charles E. Whittaker: In other words, they're separate collateral agreements?
Mr. Meyer Rothwacks: Well, they were -- they were separate agreements.
lf Your Honor is referring to -- now to the transaction between the dealer and the finance company, yes, they were separate agreements, separate transactions, and the Courts of Appeals in the Seventh Circuit in the Baird case, in the Sixth Circuit in the Schaeffer case and last week, in the Wiley case have so held.
Now, on the sale of the notes --
Justice Potter Stewart: The sale of what?
I didn't hear you.
Mr. Meyer Rothwacks: That the transactions were separable transactions.
That the one transaction was that between the dealer and his customer in which the customer gave the dealer the contract and the note which embodied the full-time deferred balance.
Then, there was a separate transaction between the dealer and the finance company in which in a contract which was either written or oral, the dealer sold the note or sold the contract to the finance company and there were certain obligations under the contract running from the finance company to the dealer and from the dealer to the finance company.
We'll come to those later.
Justice Potter Stewart: In view of the Seventh Circuit (Inaudible)
Mr. Meyer Rothwacks: Yes, Seventh and --
Justice Potter Stewart: (Inaudible)
Mr. Meyer Rothwacks: That's right.
Justice Potter Stewart: You mention at the outset there were, obviously, must be minor factual differences among the cases that we have here.
Are there any important differences between these cases and the cases decided by the Seventh Circuit and the Sixth Circuit?
Mr. Meyer Rothwacks: We don't think so.
We don't think that there are any important differences that -- on our rationale and the rationale of the Wiley case last week in the Sixth Circuit, there are no important differences among these cases.
I may, at this point, interpolate by saying that one of the amicus briefs in these cases, filed by counsel in the Wiley case, does suggest that there may be an important difference in a situation where the dealer sells the obligation of his customer to the finance company and the finance company credits what is referred to as a holdback which, I take it, is part of the -- what would normally be the purchase price, if there were no service charge or finance charge added on to the original note between the dealer and his customer.
The position of counsel in the Wiley case was that where -- where the credit, which was entered by the finance company on its books in favor of the dealer, reflected something other than this so-called holdback, namely, a finance charge, then another principle obtained.
And in the Wiley case, which was handed down on April 24 and which was argued just 10 days ago, I believe, or two weeks ago, the Wiley case, in effect, held that the factual differences that were pointed out by counsel are not sufficient to distinguish this case in principle from the ruling in the Schaeffer case which it had previously decided.
Now, what I have given so far is, admittedly, a generalized picture of what transpired in these cases.
And while this Court will, of course, look to the records, it may be helpful on this opening presentation to at least give the highlights of the pertinent facts with respect to the records in each of these cases.
Now, in Hansen, Number 380, we find practically everything that we're looking for at Record 39, joint Exhibit 5E, and that's -- contract, at the top of the page, a conditional sales contract between a dealer and his customer.
And the dealer sells and the customer buys a car for a total time price which, among other things, includes a finance charge and which results in an obligation called the “Time Deferred Balance” which is the amount reflected as the customer's obligation to the dealer in the conditional sale contract.
But then, at the --
Unknown Speaker: Where -- where in the record you'll find it?
Mr. Meyer Rothwacks: At Record 39, Number 380.
Now, at the bottom of the page on this form which was provided by GMAC, the dealer then sells and -- and as I said before, he was not obliged to sell.
As a matter of fact, the testimony of the taxpayer makes this seemingly clear.
He was asked, Record 33, “You are free either to hold these conditional sales contracts or sign them, depending upon what you wanted to do.”
The answer was “What do you mean hold them?”
Question, “Hold them personally, assuming you had sufficient cash.
I'm not saying that you did.”
The answer was “Yes, I could have held them if I -- if I had my own contracts made up.”
He was asked whether he could have signed them to any other finance company and the answer to that was yes.
So, nothing of any consequence turns in taxpayer's favor on the mere fact that the conditional sale contract from the dealer to the finance company happens to be on the same sheet of paper as the completely separate contract between the dealer and the customer.
Now, in the contract between the dealer and the finance company, the dealer sells to GMAC its right, title and interest to the -- within contract and the dealer, in turn, guarantees full payment of the amount remaining unpaid hereon and covenants that if default be made in the payment of any installment, then to pay the full amount unpaid to GMAC.
The purpose of this reserve, as the Tax Court found and as indeed, Mr. Hansen himself testified, was to protect GMAC against any loss that might arise from the repossession of any automobile in case of default in payment.
Justice Charles E. Whittaker: (Inaudible)
Mr. Meyer Rothwacks: I think the agreement simply spells out what the parties sold to each other and the purpose of the -- the purpose of the contract, it seems -- would seem to us, could be ascertained from the testimony of the party entering into the contract.
Justice Charles E. Whittaker: Is this a way to make clear what I had in mind that they found at least two points of the contract, one is the contract between the seller and the buyer of the car, and the other part of it is a form for constable use in the event of the sale of securities evidenced in deferred payment.
And in some instances, you have occurred document to render notes or maybe a chattel mortgage or something he could use.
Isn't that what -- is that not right?
Mr. Meyer Rothwacks: Well, that's -- that's another way of stating, I think, the same thing, Your Honor.
The important point from the Commissioner's point of view is, as we will develop the argument later on, that these are separate transactions, that they are not telescoped into a single transaction.
And this is the point of view that was adopted in the Baird, Schaeffer and Wiley cases.
Now, in the Glover case, we have a very short record and practically everything that is of use to us in this case is found in the stipulation at Record 20.
In that case, the taxpayer sold new and used cars on credit.
He received notes from his purchasers.
The record doesn't show the composition of the notes.
However, the record does show an agreement between C.I.T., which was the finance company and the dealer, and that agreement provided that the paper executed by the dealer -- by the customer to the dealer was to be sold to the finance company without recourse except as to commercial cars, that the finance company would pay the dealer 97% of the face value of the notes and would credit -- would set up credit on its books to the extent of the remaining 3% that C.I.T. would pay to the taxpayer out of the reserve everything in excess of 3% of the total outstanding balance on the notes, three times in every 12-month period if the taxpayer was not then indebted to it.
And that in the event C.I.T. stopped buying paper from Glover, then C.I.T. could hold and apply the credits until all the paper was liquidated.
The dealer's obligations under this contract with C.I.T. was to purchase -- to repurchase the -- the repossessed cars and if it failed to do so, to make good to C.I.T. for any loss that it was -- was incurred by C.I.T. and to pay a proportionate amount of the amount that was credited to the reserve in the event any purchaser prepaid on his obligation.
C.I.T. would refund the part of the service charge.
The obligation of the dealer was to pay a proportionate part of that refund out of the amounts in the credits.
In the Baird case, we have a dealer who, in the main, sold trailers.
Justice William O. Douglas: Is that the Seventh Circuit case?
Mr. Meyer Rothwacks: This is the Seventh Circuit case, also, other commodities.
He sold on -- this was a partnership which sold on conditional sales contracts and received notes from its customers.
It sold its notes to three finance companies.
One of them was a bank.
And in every instance, the paper was either endorsed with recourse or the partnership independently guaranteed payment to the finance companies.
The finance companies paid over 95% to 97% of the amount of the customer's obligation and credited the remainder to the dealer's reserve account in favor of the partnership.
Now, it's important to noted that here, as in the other cases, the finance companies carried the accounts as liabilities and that the annual balances in the reserves -- in the credit in reserves which they carried were not at all reflected in their income.
It was provided, as between the partnership and the finance companies that, in any event, the credits would be paid to the partnership after all of the customer's obligations had been fulfilled, in other words, after all the notes have been paid.
There were also other provisions for accelerated payment.
For example, in the first -- one of two contracts with one of the finance companies, Midland it was provided that when the reserve fund exceeded 10% of the balance of the total outstanding obligations of customers, the excess would be paid over by the finance company to the dealer automatically.
Furthermore, it was agreed between the dealer and the finance companies that the credits entered on the finance companies' books in favor of the dealer could be charged with any unpaid balance owing by the customer, could be charged with repossession losses suffered by the finance companies, could be charged with any default by the partnership on its independent guarantees to the finance company and also, could be charged with a matured financial obligation of any nature, running from the partnership to the finance companies of any nature not necessarily related to the sale of the automobile or trailer by the dealer to his customer.
Now, we think that this brief review of what we consider to be the salient facts in this case demonstrates that, basically, there was a common mode of dealing in these cases.
First, a sale of a commodity between dealer and customer, the signing of a contract, the issuance of paper.
Secondly, the sale of a contract or paper to a finance company not under any legal obligation to do so whatsoever.
Thirdly, the finance company would pay part of the value of the contract or note that it bought and would set up the balance as a credit to the dealer.
And the credit -- the balance was to be paid in due course pursuant to arrangements that were made between the dealers and the finance companies.
Now, on this common analysis of the facts, the courts have said that there are two ways of looking at the transactions, two ways of looking at what happened in these cases.
In the Baird case, which is the Seventh Circuit case, and in Schaeffer and by necessary implication, the Wiley opinion which was handed down on April 24, the courts have said that we're dealing here with two separate and distinct transactions, first, the sale of the commodity to the purchaser at a time-deferred balance, second, the sale of a paper to the finance company.
On the other hand, the Hansen case spells out another theory.
This was announced, I think, in the Texas Trailercoach, that what is involved here is a single three-party transaction.
Now, the two transaction hypothesis was used by the courts to support taxability of the amounts that were credited to the reserves when the credits were made.
The one transaction, three-party hypothesis has been used by the courts to support the contrary conclusion.
Now, while we think that the better reason theory is the reasoning of the Sixth and Seventh Circuits, we, nevertheless, believe, and we'll attempt to demonstrate, that it doesn't make any difference what theory is used.
The tax incidence remains the same.
Now, what is there to support the two transaction theory in these cases?
First, it was the dealer, not the finance company that actually sold a car or trailer.
The purchaser's contract was with the dealer, not with the finance company.
The note executed for the contract obligation was payable to the dealer, not to the finance company.
The dealer was under no legal obligation whatsoever to sell the contract or any note.
He could have financed any deal himself if he had had the ability.
As the Seventh Circuit said in the Baird case, in a typical case, the dealer completed the transaction of the sale of a trailer at the time the down payment was made and the purchaser executed and delivered to it notes and a chattel mortgage or a conditional sales contract.
The dealer, thus, acquired a complete and forceable right to receive the remainder of the purchase price at the times specified in the -- in the retail paper.
In the Schaeffer case, which is the Sixth Circuit case, the Court was even more emphatic.
It said that the first transaction, the transaction between the dealer and the customer, was the controlling factor in the case.
And the Sixth Circuit said that in taking the purchaser's note and conditional sale contract, the dealer acquired an asset in the nature of an account receivable with respect to which there was no contingency whatsoever.
As between the dealer and the purchaser, the entire amount of the contract obligation approved to the dealer.
If such account receivable became uncollectible in the future in whole or in part, the question then was one of taking a deduction under an applicable statute.
But the income accrued to the dealer before the transfer was made to the finance company, and the subsequent transfer did not change the legal effect of the prior completed transaction.
Justice William O. Douglas: There might be circumstances where buying would never get the 5%, might it not?
Mr. Meyer Rothwacks: I don't think so, Your Honor, for this reason.
Was Your Honor thinking in terms --
Justice William O. Douglas: Of the reserve.
Mr. Meyer Rothwacks: -- of the prepayments?
Justice William O. Douglas: Of the reserve of the 5%.
Mr. Meyer Rothwacks: Well, we think not for this reason, that the dealer would either get the amount in cash or it would get it in discharge of its obligations to the finance company by virtue of its own contractual setup with the -- with the finance company.
Justice William O. Douglas: The endorsement of the paper, you mean?
Mr. Meyer Rothwacks: The endorsement of the paper for one thing but -- and -- and more, the agreements to -- to guarantee the payment of the -- of the full amount of -- of the note or the contract by the purchaser and to say the -- the finance company harmless in the event of a repossession.
And in -- in the Baird case, in the Baird case, went into further.
In the Baird case, the contract called for the credits to be applied against any indebtedness of any kind of the -- of the partnership dealer to the -- to the finance company, whether or not it arose in connection with the sale of a trailer or --
Justice John M. Harlan: What would happen, actually, if he didn't get paid the full amount of the reserve in such a way that it did?
Did he deduct it later on?
Mr. Meyer Rothwacks: Yes.
Justice John M. Harlan: The loss?
Mr. Meyer Rothwacks: We -- we assumed that he would be entitled to a deduction.
This is in the very nature of the accrual system of accounting.
In other words, if there was a fixed right to the income and we say, for example, when the -- when the dealer -- when the customer rather, executed his note to the purchaser as the courts in the Baird and Schaeffer cases have said.
The dealer had then an enforceable right to the full amount of that -- of that note.
Now, any -- any dealer who sells commodities on -- on credits and -- and includes in the -- in the amount of the price to be paid by -- by the customer, a -- a finance charge, accrues the -- accrues the amount.
The -- the accrual isn't -- isn't defeated, isn't negated, isn't -- isn't undermined in any way if, after he has dealt with his customer, he decides to go to a bank and -- and discount the paper, discount the note.
It's interesting -- it's interesting, Mr. Justice Harlan, in connection with your question that in a case in which the Government's position was not sustained, the Court of Appeals opinion on the Hansen case, the -- the Hansen opinion says, at least, it doesn't seriously question the correctness of the conclusion that the full amount, which is credited to the reserve but which was reflected at a prior time in the contract or obligation, is income when the sale is made and when the credits are made because this is practically simultaneously.
The Hansen opinion said that we have no quarrel with the theory of the Tax Court's position.
Had the dealer financed the sales himself or elected to sell the contract as a separate transaction, the result reached below would be correct.
Now, if we look to the conclusion of the dealer-purchaser transaction as giving rise to the taxable event, which is what the Sixth and Seventh Circuits have said, it seems fairly clear that insofar as the dealer is concerned, there are no uncertainties with respect to the ultimate payment of the obligation which would bar accrual because the only uncertainty, the only uncertainty is the one that is inherent in every debtor-creditor relationship, namely, that it may turn out that the debtor may not be able to pay.
But it's, of course, fundamental, fundamental under our accrual basis of accounting that an accrual basis taxpayer who receives payment in the form of a promissory note or any other shows of an action, which appears to be collectible, cannot refuse to accrue the amount of the obligation simply because it might not prove to be collectible when due.
If such a concept were adopted, it would indeed undermine the entire theory of accrual accounting in regard to commercial transactions.
Now, returning for a moment to the hypothesis espoused by the Hansen opinion, in effect, what the Hansen opinion does is to telescope, to telescope everything that transpired and to say “We look not to the amount of the note, not to the amount of the contract as between dealer and purchaser, but we look only to the credits that were entered by the finance company after sale of the obligation or the note.”
And in effect, the Hansen opinion says, although not in these words, that looking to the transaction in this way, we find that there are such grave uncertainties that the dealers will receive any payment at all, that the credits are really contingent credits and not accrued income.
Now, let us ask ourselves, what is the nature of the uncertainties as to the payments out of the reserves?
In the first place, whatever they were, whatever they were, they certainly were no greater than the uncertainty of payment would have been if the dealer had retained the purchaser's contract or had retained the notes himself.
The real uncertainty in both situations, and I stressed this, the real uncertainty in both situations was that the purchaser would fail to make payment on the notes.
And as far as the dealer is concerned, he has added nothing to his risk by disposing of the retail paper instead of holding it himself.
The same risk is there, and it's no more than the normal risk of any commercial seller who has sold on credit rather than for cash.
In the second place, the records in these cases show no basis at all for concern on the part of the dealers that the credits would not, in due course, be paid over to them.
If we look to the Hansen record, we find that Mr. Hansen testified at Record 31 that there were only some prepayments, that there were some loses from abnormal depreciation before repossession, and that the bad debts charged on his books had nothing to do with the credit sales of automobiles.
In the Glover record, which is sparse indeed, nothing is shown as to purchaser's defaults or prepayments.
But on the other hand it is shown that the taxpayer had total bad debt expenses of only some $13,000 out of more than $3 million of gross retail sales.
In the Baird case, at Record 19, is the conclusion that most of the trailer purchasers were paying their notes when due.
Furthermore, there's nothing in these cases, nothing in the -- in the records in any of these cases to show that the finance companies would not be in any position to pay over the credits at the appropriate times.
In the Hansen and Glover cases, there isn't a slightest indication in the record that there was any possibility that GMAC and C.I.T. could not perform when it came time to perform and in the Baird case, indeed, it was stipulated that during the years here involved, the finance companies were in such good financial condition that they were able to pay any accounts which might have been due and payable to the partnership out of the dealer reserve.
And finally, even if the dealers were not paid in cash out of the reserves, we submit that they would have had their obligations to the finance companies discharged by offsets against the credits and so, would have realized income in that fashion.
As the Baird opinion says, ultimately, only two things could happen to the funds in the dealer's reserve accounts.
Either the amounts would be paid in cash or they would be used to satisfy the dealer's other obligations to the finance companies.
And the Sixth Circuit said in the Schaeffer case, looking to the hypothesis upon which the Hansen case is predicated, there was nothing contingent about the dealer's legal right to the amounts credited in the reserve account.The only contingency that existed was how much of the -- the amounts would be paid in cash and how much would not be paid in cash but would be applied by the finance company to the payment of the dealer's legal obligations to it under the contracts between the dealer and the finance companies.
Now, we think that when properly analyzed, the taxpayer's real grievance in these cases is that a tax must be paid without the funds upon which the tax is levied being available for the payment of the tax.
But as the Hansen opinion itself pointed out in this case, this may often be the result, it said, of the accrual accounting just as it may be the result of the operation of the doctrine of realization and of the doctrine of constructive receipt.
And secondly, taxpayer's real grievance may be in these cases that they are entitled to some relief because, as stated in the Baird case, they find themselves at the mercy of the finance companies.
We think that the Circuit Court of Appeals for the Seventh Circuit has given the correct answer to this plea.
Congress has the power to lay and collect income taxes.
If the application of the income tax law to persons situated, as taxpayers say they were, require a special consideration, then it's for Congress to say so, not the courts.
Our duty is to ascertain what the law is and apply it to this case.
And to that conclusion, the Commissioner says “Amen.”
Argument of Emmett E. Mcinnis, Jr.
Chief Justice Earl Warren: Number 380, Commissioner of Internal Revenue, Petitioner, versus John R. Hansen and Shirley G. Hansen, and Number 381, Commissioner of Internal Revenue, Petitioner, versus Burl P. Glover.
Mr. McInnis, you may proceed.
Mr. Emmett E. Mcinnis, Jr.: May it please the Court.
There is a general statutory problem presented in the Hansen case, and that is set forth in Section 41 of the Internal Revenue Code of 1939 which applies to the tax years in issue, 1951, 1952 and 1953.
That Section is set forth in its entirety at page 11 of the brief for the respondent, and it sets the general ground rule here.
The net income shall be computed upon the basis of the taxpayer's annual accounting period and further language in accordance with the method of accounting regularly employed in keeping the books of such taxpayer.
That is the rule and the qualification follows.
But, if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner, does not clearly reflect the income -- does clearly reflect the income.
It is not for the opinion of the Commissioner to determine, in the first place, whether the method employed does clearly reflect the income, but for him, if it does not, to determine which one does.
And, the basic argument for this respondent both before the Ninth Circuit where he won the unanimous decision and here is that his method of accounting does clearly reflect his income.
He fears no question.
There is no mystery in this case, nothing too complex to be analyzed and presented by affirmatively or in response to question.
Justice Charles E. Whittaker: (Inaudible) the amount of the reserve (Inaudible)
Mr. Emmett E. Mcinnis, Jr.: They do, Mr. Justice Whittaker.
As a memorandum account, not a -- an account taken into income or expense but only as a memorandum, just as the accounting of the General Motors Acceptance Corporation is a memorandum accounting.
Justice Potter Stewart: Mr. McInnis, you told us these cases arise under the 1939 Code.
Mr. Emmett E. Mcinnis, Jr.: Yes, Your Honor.
Justice Potter Stewart: There was no substantial change in the pertinent part of this language in -- in the 1954 Code, was there?
Mr. Emmett E. Mcinnis, Jr.: No change affecting this case in --
Justice Potter Stewart: Affecting these cases.
Mr. Emmett E. Mcinnis, Jr.: -- in any way, according to my understanding.
Justice Potter Stewart: Thank you.
Mr. Emmett E. Mcinnis, Jr.: The facts in the Hansen case require some clarification, hitting only the high points which are the core of the case.
Yesterday, in the presentation of the facts, there was repeated mention of the facts of the Schaeffer case and of the Baird case and of a third case just recently decided, so recently that the opinion has not been printed in airmail services.
That was the Wiley case.
Now, we submit that the case before the Court, there are two, but the case before the Court in this consolidated action is the Hansen case and, in 30 minutes, Mr. Miller will be arguing the Glover case.
And, I must point to the facts in the Hansen case in order to clarify exactly what is at issue now.
There is no note -- no promissory note in favor of the dealer.
There is no other commercial paper payable to the dealer and no account receivable arising out of this transaction from the retail auto purchaser to the dealer.
The only contract in issue is one so easily found that we do not even require the index because it's the only gatefold in the Hansen record, and it is the Joint Exhibit 5E, the conditional sales contract.
And, that one sheet of paper mirrors this entire transaction with but one exception.
The exception is that there is a pre-existing general contract in this case not specific and in writing, but by course of dealing and by a dealer's manual not in the record because not useful to the record.
In other words, there is a pre-existing contract between the dealer and the General Motors Acceptance Corporation which applies to all of his credit sales and did, in fact, apply to every credit sale in the three tax years at issue.
But, the contract before the Court is this single contract which, we contend, is a single three-party transaction, and I shall develop that in detail.
I want to point out, while referring to Joint Exhibit 5E, that the payments which the retail purchaser is required to make over the life of the contract, usually 18 months, sometimes 24, sometimes 36, in the years in question are to -- are payments to be made at the office of General Motors Acceptance Corporation.
The amount of each payment is filled in and the place where it is to be paid is filled in and, while it does not specifically state that the payment is to General Motors Acceptance Corporation, that follows from the entire context and the practice.
The payments are not to the dealer.
The dealer has no account receivable from the retail purchaser.
All he gets, he gets from General Motors Acceptance Corporation from this prior general background contract which, in this case, I have shown in the testimony of record, is a course of dealing.
So that, there is no receipt of an account receivable, no promissory note, or other negotiable instrument payable to the dealer in the Hansen case.
Accordingly, there is no sale of paper by the dealer to the finance company.
It is true that, at the foot, at the base of Joint Exhibit 5E, there is an assignment of all rights in the contract by the dealer to General Motors Acceptance Corporation but, in view of the requirement that the payments be made at General Motors Acceptance Corporation and, in fact -- in practical fact, to GMAC, we view this as a recital inserted by the dominant party to the contract with the stronger bargaining position to make it perfectly clear that there is no retained right from this contract in the dealer accepting any right that may arise on his course of dealing with General Motors Acceptance Corporation.
Justice John M. Harlan: General Motors does consign this contract.
Mr. Emmett E. Mcinnis, Jr.: GMAC does accept the contract, yes.
Justice John M. Harlan: It does that?
Mr. Emmett E. Mcinnis, Jr.: Well, the -- their acceptance is in accordance with their contract with the dealer that they will accept all of his contracts --
Justice John M. Harlan: Under the basic contract.
Mr. Emmett E. Mcinnis, Jr.: Yes, their basic contract which is contingent upon their approval of the credit status, and they investigate it before this sale can be made.
Justice John M. Harlan: They're not a formal party in this piece of paper.
Mr. Emmett E. Mcinnis, Jr.: In effect, they are, I submit, formal parties to the paper but not in the sense of signing the piece of paper.
They are named and patent parties.
Justice Charles E. Whittaker: Do I understand you to argue that because (Inaudible) to say you made some interest in that?
Mr. Emmett E. Mcinnis, Jr.: Your Honor, only in conjunction with the fact that these payments are actually made to General Motors Acceptance Corporation which receives them month by month, takes custody and control of the entire payment.
Justice Charles E. Whittaker: Are they doing the (Inaudible) the contracts between the dealer and the purchaser of the automobile and (Inaudible) that you can sell the notes as payable to your client?
Mr. Emmett E. Mcinnis, Jr.: That is the -- the practical effect of the entire course of dealing.
It is not expressed as it is in several of the other cases before the Court where that contract between dealer and finance company is clearly specified.
Here, there is a dealer's manual which is issued and it is partly a sales argument to the dealer to finance for GMAC, and counsel for the Internal Revenue Service has examined that before the Tax Court and we agreed that there was nothing specific enough to make it useful to the record.
So, we rely upon the testimony of the accountant for the dealer and the dealer himself, appearing in the record in the pages following 30, as to the nature of the course of dealing and the contract itself.
The accrual principle is a crucial importance here, and it is -- it is agreed by both sides to the suit that the -- a key case is the Spring City Foundry case on accrual of income.
Income accrues upon fixation of right to receive.And, that has been developed a little further in the North American Oil Consolidated case, also cited in the brief, that there must be a claim of right or an enforceable claim to money in order for it to be income -- to accrue as income to the recipient.
He doesn't have to receive it, but he has to have a right or an enforceable claim to receive it.
And, we submit that this dealer has no fixation of right to receive the reserve at the time the car is sold and he cannot acquire that right by anything else than the satisfaction of -- over a period of many months of the specific contingencies to which his right to any of that reserve is subject, and there are three of those contingencies.
Yesterday, the statement was made that there is only the chance that the debtor, the retail purchaser, will be unable to pay.
There is, of course, the chance that he might be unable to pay.
There is also the chance that the chattel will be destroyed, and this is a conditional sales contract with, title to the chattel retained in the seller, the dealer.
So that, recourse to this chattel, under the conditional sales contract, might prevent a loss otherwise chargeable to the reserve under the contract between the dealer and the finance company.
And, that destruction of chattel in the language of the dealers is referred to as “accelerated depreciation or premature depreciation” and it occurs when a purchaser on credit is involved in an accident which demolishes the car.
Then, very abruptly, this chattel has depreciated in value below the remaining debt upon the car and recourse to the chattel sold by the conditional sales contract becomes impossible.
There is a third contingency, and that is the contingency of pre-payment.
In our blessed land, many of the credit purchasers of cars receive Christmas bonuses or, in other ways, are able to pre-pay their conditional sales contracts and, when that is done, this reserve, this memorandum account on the books of General Motors Acceptance Corporation must be -- there must be subtracted from this reserve the amount of unearned interest which is lost by the pre-payment.
For by pre-paying, the retail purchaser saves the unearned interest upon his contract, and this results, as the testimony of the dealer shows in the record, in loss to the reserve through prepayment.
It is not merely hardship upon the potential inability to pay, but it is ability to pay and to prepay that diminishes the reserve.
So, there are specific concrete contingencies which decrease the size of this memorandum account, this unearned interest, upon the books of General Motors Acceptance Corporation.
The nature of this dealer's reserve is part of the finance charge.
It is unearned income, a memorandum contingent credit.
It is due -- it is not even due at the sale of the car.
It is due in monthly installment payments of a specified amount in the filled-in blank on Exhibit 5E.
It's due month by month and not at the time of sale and it is, in the accounting concept, unearned or deferred income.
Like next year's salary or a salary of man, like the patronage refund credit in long poultry -- in the Long Poultry Farms case cited in my brief, like the unearned insurance premium in Leedy-Glover Realty or the oil drilling payments in Commissioner versus Edwards which is one of a number of useful cases cited in the brief amicus filed herein by the National Automobile Dealers Association.
There is a line of cases there, starting with page 9 and going through page 14, which is useful but cumulative upon this principle.
There are summarily unearned advertising commissions in the Telephone Directory Advertising case.
There, too, the concept of unearned income.
Now, there is no constructive receipt.
This theory has been given, perhaps, undue importance here, in the light of the language of the court below, pointing out that the doctrine of constructive receipt pertains to a cash basis taxpayer and not to an accrual basis taxpayer, that the accrual basis taxpayer is governess to accrual by fixation of the right to receive by enforceable claim of right.
But, even if we disregard this accounting distinction, there has been no constructive receipt here anyway under the terms of the Treasury's own Regulation 118 which points out that, in order for there to be constructive receipt, the income must be available to the recipient.
It must be within his power and control or subject to be drawn upon by him at any time.
And, the testimony of the dealer and of his certified public accountant in the record in the Hansen case makes it clear that he could not draw upon that money and had no access to it.
This testimony was unrebutted, was not compromised upon cross-examination.
Glancing at the very bottom of page 37 of the Hansen Record, the certified public accountant had this to say.
“No, there definitely was not, in my opinion, any constructive receipt of income until he was paid the money.
He had no access to it in any way until General Motors decided to pay it.
He might have had and did and have -- he might have had many thousands of dollars and did have many thousands of dollars predated to this reserve.
But, as far as his ability to even borrow against it or receive it in any form, he had absolutely no privilege or recourse to it at all.”
“When did such a right accrue to him?”
“When General Motors Acceptance Corporation set him -- sent him a check for the amount that they decided he should have of that reserve.”
And, in passing, let me point out that any amount to which he was entitled under his contract with GMAC was excess over the 5% cushion.
This was the question suggested -- or this was suggested by the question from Mr. Justice Douglas, yesterday, as to whether he was certain ever to get the 5%.
The answer is that General Motors Acceptance Corporation, in its day-to-day accounting experience, cited that 5% was about what those losses would run.
5% of the total contracts outstanding for this dealer's customers and that they required that to be kept there for their own protection and safety.
It was a genuine reserve against loss and not a reserve of profit.
That 5%, in all likelihood, would never get to the -- or could never be paid to the dealer unless he went out of business and all of the debts were closed out -- all the contracts were closed and then there was something left, but it's the excess over.
Justice Charles E. Whittaker: (Inaudible)
Mr. Emmett E. Mcinnis, Jr.: It is, Your Honor.
And, I might mention that it is unilaterally variable by the dominant party.
This is not of the record, so, I shall not express it further.
But, there is testimony in the record, however, at the very outset in the Tax Court as to the nature of that agreement.
“Can you tell us in some detail just what” -- on page 30 of the Hansen record, at the top, testimony of John R. Hansen.
“Can you tell us in some detail just what happened when a customer purchased a car upon credit for you -- from you in those years?”
“Well, we figured the cash price on the car, deducted his down payment, and then computed what the finance cost would be on the unpaid balance and what the monthly payments would be.
And, in any event that the contract was paid up in advance, he would get a rebate on the finance which would be charged both to my dealer reserve and to General Motors Acceptance Corporation.”
And, perhaps more effectively, here on the following page 31, “Well, we have more reserve for the more outstanding we have and, as the outstanding goes down, well, they give us anything in excess of 5%.”
“Was it 5% of outstanding conditional sales contracts in the three years at issue 1951, 1952 and 1953?”
That is the limit of the participation by the dealer and is set forth, actually, in the oral testimony in the record which is briefed.
Justice Charles E. Whittaker: Then, I would like (Inaudible) What is the difficulty in bringing (Inaudible) in the situation where (Inaudible) to sell the note to the finance company for its face amount and, then, under some collateral (Inaudible) by the dealer who is selling (Inaudible) requirements of his undertaking in that collateral (Inaudible) Do you understand what I'm asking you?
Mr. Emmett E. Mcinnis, Jr.: Yes, I do.
I believe that --
Justice Charles E. Whittaker: Is there a difference?
Mr. Emmett E. Mcinnis, Jr.: I believe that there is -- that the difference lies merely in the clarity and strength of these facts and that it is a -- that, in both situations, I believe that the dealer is entitled -- is entitled to treat this as unearned income rather than as earned income.
And, that takes us squarely into the point of constructive receipt which was argued, “Is there a constructive receipt of income by virtue of the argument that, sooner or later, this reserve must either be paid in cash to the dealer or must satisfy an obligation of the dealer to the finance company?”
That is a persuasive and a rather formidable argument, at first conjecture, and here is how it is to be met.
Let us take a hypothetical question.
If A warrants that B will pay C, whereupon A becomes contingently liable for the payment as secondary liability in case the party primarily liable does not pay.
If A warrants that B will pay C and B does pay C, then, has A received taxable income?Our answer is of course not.
He had merely avoided a potential liability which never became a liability.
He is in the same position as counsel descending the staircase of a building who may stumble.
If he falls, he may incur -- he will incur a potential liability for hospital expenses.
But, if he catches his balance, he avoids that future or potential liability.
Has he received -- has he accrued taxable income merely because he succeeded in not falling?
He has avoided a future loss and it is not a present or existing liability that has been avoided, but a possible future one at a later date.
Does that satisfy the line of inquiry, Mr. Justice Whittaker?
Justice Charles E. Whittaker: Well, I understand -- I understand your logic, but what if I go into the facts even though there will be $1000 as to that (Inaudible) and I endorse that you agreed to it and I endorse it in blank.
(Inaudible) What they say as the condition of agreement, we asked you to pledge with us, under a collateral agreement, some amount of money to secure the requirements of any liability it may have as endorser.
Now, then, have I not received the full purchase price of the notes and then taken from that fund or some other funds, money required by the bank and deposited with them your obligations as endorser?
Mr. Emmett E. Mcinnis, Jr.: We distinguish that, Your Honor, as a distinct case for the reason that this is, as held below, a single three-party transaction, as I would like to develop right now.
There have to -- there are and there have to be, in realistic absolute practical substance, three parties to this conditional sales contract.
The reason why is that the purchaser on credit doesn't have the money to pay for the car.
The dealer cannot buy the car and sell it on credit directly.
That would be the bank situation where he would have a -- an account receivable.
He can't do that because he doesn't have the money and the facts and testimony show that he never made a credit sale in three years that way.
So, there has to be someone to supply the money, and that is the finance company, General Motors Acceptance Corporation.
The retail purchaser buys two things.
He buys a car from the dealer whose job is to secure the car and to sell it, and he buys credit from General Motors Acceptance Corporation by this very contract and the underlying contract.
And, the General Motors Acceptance Corporation sells credit for a finance charge and the dealer sells the car for the price of the car.
Now, he gets the price of the car in trade-in from the purchaser or down payment, partly, and the rest of the price he gets by return mail from General Motors Acceptance Corporation.
The reserve is a contingent added consideration to the dealer for doing business with General Motors Acceptance Corporation rather than with some other source of credit.
So, there are three parties to the one contract, and it is a single contract and not a two -- a two-transaction hypothesis or not a two -- a double-transaction of sale of a car and then sale of paper.
It is simultaneous.
General Motors Acceptance Corporation appears on the face of the contract.
In every credit sale through the three years in issue, it was General Motors Acceptance Corporation, and the retail purchaser knows it because his obligation is to go there and pay his money each month for 18 or 36 months.
Respondents never acquired an account receivable from the purchaser because this was a single three-party transaction and that is a point just made.
Now, the point as for the rather formidable suggestion has been made that this case, as argued and as established in four Circuits already in favor of the taxpayer, would destroy the accrual concept of accounting or would endanger the accrual concept with danger to the Federal Treasury.
But, this is not so because this is consistent with the accrual concept.
It does not, in the first place, affect the great volume of sales on credit.
Let us take a two-party sales on credit where the seller is also the creditor.
If a man buys on open account from a department store, he owes the department store and, certainly, the department store must accrue what he owes.
But, this is a situation with a third party supplying the credit under distinct and under contracts which make the obligation to the third party.
Income will still accrue in the normal debtor-creditor transaction and will still be taxable as it accrues, but not before.
The case authority supports the dealer taxpayer strongly, as pointed out in the brief for respondents.
The Blaine Johnson case in the Fourth Circuit, with two cases following it, decided upon stipulation without oral argument or briefing, the Texas Trailer-coach case in the Fifth Circuit, with four cases following it, again, on stipulation without oral argument or briefing.
West Pontiac, Modern Olds, Kilborn, and Hines-Pontiac, these, I suspect, conform on our side to the Wiley case, so recently decided in the Sixth Circuit following the Schaffer case on the other.
It's only conjecture, however, since the printed opinion is not available to counsel as yet.
The Glover case in that Eighth Circuit establishes the same rule for the Eighth Circuit as the Hansen case before the Court now in the Ninth Circuit.
There are other earlier cases which are closely similar in principle, and are set forth in my brief at page 18 and 19, dealing with asbestos retailers' reserves and, again, a maintenance percentage on paving contracts.
The only reason why the facts of these are not drawn before the Court is that there is a limitation of time and attention imposed by the time.
I want to make a point of the inconsistent tax treatment of the other parties by the Internal Revenue Service.
It's consist -- it is correct tax treatment but it is inconsistent with that which has been imposed upon the dealers.
What about the retail purchaser?
He is going to be paying interest on this purchase on his borrowing, his credit.
He's going to be paying at over 18 or 24 or 36 months in equal installments.
What does the Commissioner let him do?
He has a choice.
He either declares -- he can either deduct his interest expense as he actually incurred, or he can capitalize all of his interest expense as part of the value of the car and then amortize it over the life of the car under ordinary amortization rules.
So, he can't deduct all these interests at the date of the sale and the finance company is not required to declare its part of the -- of the finance charges as income at the date of the sale.
The finance company is allowed to treat his income a proportionate share of the interest as each payment is made by the purchaser month by month, perhaps, for 36 months on a 30 -- on a three-year contact and for longer in a trailer coach contract.
The finance company has as -- accrues his income by the permission of the Commissioner, as shown in the Motor Securities case, only the interest as the interest is earned.
And, the purchaser can deduct it only as the interest is incurred and, yet, the dealer is asked to pay income tax on interest which is not earned and which he may never receive because of losses chargeable to it before he has any fixed right to it.
There is a -- an inconsistency.
My portion of the time is up and I shall submit to the Court.
Chief Justice Earl Warren: Mr. Miller.
Argument of William S.miller, Jr.
Mr. William S.miller, Jr.: Mr. Chief Justice, may it please the Court.
There are three distinct cases here and, because of that fact, it is necessary to distinguish particular facts in the cases.
However, before going to the distinguishing or different facts in the Glover case, I should like to ask the Court's attention to the question of what is the issue here.
Yesterday, counsel for the Commissioner has argued and questioned from the Court today indicate that there are some concern over the face amount of the note originally signed by the customer.
And, I -- the Government, in brief, has intermitted if not alleged that some portion of that has, by these dealers, been sought to be omitted from income.
And, at least in the Glover case, I wish to set clear the fact that the statutory notice in that case which set this proceeding underway refers only to the reserve which is set up under a contract between the finance company and the dealer.
That is all that was alleged to have been omitted, a portion of that reserve.
That reserve is something completely separate from a part of the price over here.The service charge or finance charge, if you would call it that, or carrying charge or interest charged to the customer is not the same thing as the contract agreed finance withheld -- financing charge withheld or reserve by the finance company.
It's not the same thing, although they may be part, and we allege they all are part, of one intrical transaction.
They are not identical.
And, in its -- in his petition, Mr. Glover referred only to the reserve and alleged that the Commissioner had erred in seeking to tax the entire reserve, the amount he was entitled to collect, as well as the amount which he had no right to collect.
So, the only issue involved in the Glover case is this portion of the reserve which is referred to as the amount under 3% of total outstanding notes of this dealer.
That part was omitted from the tax return and was deferred.
Not only is the amount of the price charged to the customer, the credit price or the total credit prices for the entire calendar year involved, not only are they not in issue, they're not in evidence.
And, there is no amount of customer price that can be litigated in the Glover case.
The only amount is, and I would refer to the record at page -- the Glover record at page 10 and point out what the Government disallowed in -- that started this case under little a -- under Schedule 1a, explanation of adjustments.
In your return for the taxable year, $8026.85 in finance reserve was included in the net profit.
It -- and, skipping down, the $8000 somewhat represented a portion of $11,000 credited on the books of the finance company, less the $3885 which is the reserve which, we contend, we're not entitled to.
It has been determined that, in as much as you reported income on an accrual basis, the entire amount is now reportable, the additional $3885.71.
I submit that has nothing whatever to do with the original credit price on the original notes signed by the customers of Glover in any of these taxable years.
So, the issue is really, is Glover to be taxed on the amount of the reserve which is withheld under the contract?
Now, turning to the distinguishing facts in the Glover case, there is only one finance contract and it is in evidence.
It is with C.I.T. Credit Corporation.
And, under that contract, which is printed in full at record page 33 -- 23, I'm sorry, under that contract, Glover assigned his notes without recourse with respect to all, except commercial cars.
And, at page 24, you will see that Glover received from the finance company not the entire amount as was stated by Government counsel yesterday.
It was stated that he received the entire amount with the exception of the reserve.
But, as a matter of fact, the finance company, of course, makes something o these transactions.
The face amount of a note is already signed by the customer.The note is assigned without recourse.
At paragraph 4, the language appears you're -- that C.I.T. rate charges will include, for our protection, reserves as outline in your reserve arrangement, effective at the time paper is purchased by you.
Now, that provides for a variable reserve which is withheld from the dealer at the instance of C.I.T.and solely under its control.
And so, that would vary according to the value of money or to whatever charge they wanted to place on the dealer.
Probably, it was affected by his bargaining power, his credit rating.
But, it was variable.
However, the dealer's right to a portion of this reserve remained constant throughout these years and provided that three times in each 12-month period, if we are not then indebted to you, you, C.I.T., will pay us our accumulated reserves in excess of 3% of the then aggregate unpaid balances on paper purchased from us.
Now, lets again see what the real issue is.
3% of the aggregate unpaid balances of all notes then payable under this arrangement, the Court should understand that this includes notes from last year and, possibly, the year before, as well as the current year.
Once that portion of the reserve is placed in the pot, so to speak, the retained reserve, it becomes -- it loses its identity and it's affected not by a particular customer who's paying his account, but by all customers that pay their accounts and by all new sales which a caused an increase in the outstanding notes of Glover, so that this issue refers to an amount which arises not only in the current year, but from accumulated transactions in prior years.
It should be pointed out also that this contract to which I have referred in the record existed prior to any sale in any of these taxable years.
The amount charged and placed in the reserve, the rate is not as shown because it is variable.
The 3%, you will note and that's -- I am repeating here, refer -- refers to a percentage of unpaid balances and not a percentage of that particular contract.
But, the contract with the finance company preceded and antedated any receipt of a note from a customer, and we therefore contend that the contract itself is controlling.
And, we cite this simple example.
If a dealer discounted -- received a $1000-note from a customer, its face value, and discounted it with the bank, as Justice Whittaker has suggested, and received $950, if that's all that occur, that taxpayer under any rule of accounting would have net taxable income of $950 in that year.
He would have gross income of $1000, a business expense of $50, and he'd have net taxable income of $950.
In these cases, when you boil them down, you have one additional factor only and it is, in my opinion, the answer to Justice Whittaker's question, and I'll come to that again in a moment.
The additional factor is not that the dealer voluntarily antis up something to guarantee the finance company against loss, but that, under the contract, the finance company gets the whole $50 and they say, “However, it's ours.
However, if certain things happen in the future, we may give you back part of what is ours.”
Now, that, I think, is the answer to the difference between where the dealer voluntarily puts something up to protect someone and where, by contract, the finance company has it all and says, “If certain things happen in the future, I'll get part of it back.”
And, that's the contingency which we say, under the ordinary accrual method of accounting, entitles us to defer until the contingency is realized and we have the right to that extra amount.
Justice Charles E. Whittaker: Is it true, Mr. Miller, every bank to allow the agreement to -- that you know anything about or, at least it seems to me, that I know anything about that if I put up money or collaterals under a collateral agreement with a bank to ensure obligations that may accrue against me on notes of conditional sales contracts I have transferred to the bank, then, at the end of the transaction, what has not been properly deducted from this collateral deposit I have made necessarily comes back to me because it's always been mine and it's been simply pledged as collateral to secure my obligation?
Mr. William S.miller, Jr.: I think that the answer to the question is in just what Mr. Justice Whittaker just said that, in a pledge, the chattel, the collateral is mine pledged to the bank for a purpose.
In the case that we have here, we contend, in the Glover case, the reserve is the finance company's until certain things happen, and then, they pay us.
Justice Charles E. Whittaker: Now, isn't that the question for decision?
Mr. William S.miller, Jr.: I think it is, Your Honor, and that that is our contention and not that some portion of the original note from the customer has been omitted from income, as counsel for the Government would speak to, as we say, twist the issue.
I think that that is the issue and, in line with that, the contingency -- whether or not there is a substantial contingency which prevents us from having present control of that retained reserve is, I think, covered by the Government's own regulations on that point which appear in Government's brief, in the appendix, page 65.
It is Treasure Regulation 111 under the Internal Revenue Code of 1939 which first states on page 64 that the time as of which any item of gross income or any deduction is to be accounted for must be determined in the light of the fundamental rule that the computation shall be made in such a manner as clearly reflects the taxpayer's income.
And then, on page 65, down approximately 15 lines, a taxpayer is deemed to have received items of gross income which have been credited to or set apart for him without restriction.
Now, we contend that the Government's own regulation states that if there are restrictions on the right of the taxpayer to receive an amount set apart for him, then it is not presently accruable.
The contract in the Glover case, if you will note again paragraph 4 on page 24 of the Glover brief, in the last part of that paragraph, the question should be asked.
At the end of the year, the first year, let's take the first year when the $3885 was omitted by the taxpayer as not being then subject to his control.
It represented 3% of outstanding notes.
In any court of law, could Glover have then gone in and receive either a judgment for a declaratory, or otherwise, for that amount at that time?
Government has argued that this should be done on an annual basis.
At the end this year, under this contract arrangement, Glover could not claim any part of the amount below 3%.
That's all he has omitted from his income and excluded.
He has deferred it because the contract says, “Three times in each year, if you are not indebted to us, we will give you the amount above 3%.”
It's silent about his right to the amount below and, as pointed out by previous counsel, only if he goes out of business sometime in the future can he ultimately, in the absence of losses, collect it.
So, we say, not as Government counsel has said, only two things can happen either he will get it in cash or it would be applied against his obligation.
We say that completely jumps over the primary contingency that he may never get it at all and he has no present right to it under the specific language of the contract between the parties.
Justice Charles E. Whittaker: But contract between the -- by that statement, you mean, the contract between the dealer and the finance company?
Mr. William S.miller, Jr.: Yes, sir.
Justice Charles E. Whittaker: The one that preceded this -- the sale in question?
Mr. William S.miller, Jr.: If the Court please, the statutory notice, the petition, and the Court's own questions, I believe, and our response have indicated the only thing in issue is a portion of the reserve.
Does the customer have any control over that reserve?
It's solely within the control of the finance company and, ultimately, the dealer under certain contingencies.
That's the only issue in the Glover case.
That's all that was raised by the Government initially.
Nothing else is before this Court is our contingent and that, under that contract, that reserve account is in the control inexorably of the finance company until these contingencies occur, and it did not occur in the taxable year.
We only excluded the amount that was subject -- not subject to our withdrawal or use because it cannot even be applied to our obligation unless we got a right to it.
That's -- that's primary and elementary.
If we had no right to it, they would sue us for it.
They wouldn't apply it against the reserve.
The Commissioner's argument, if the Court please, really goes to the amount of this reserve account and not to the right.
They don't rely, really, on Spring City Foundry case which they cite, but they argue about the amount as ultimately going to be realized.
But, that's not the question of immediate taxability under the accruable system of accounting -- accrual system.
The question is the right to it, not whether the amount is fixed, but the right to it.
And, we contend, of course, that even the amount is indeterminate in the calendar year, but the right to receive it does not exist in the calendar year.
The Motors Securities case, cited in the brief, brings out the point that Mr. McInnis mentioned that the finance company doesn't take into -- take into income the finance charge from the customer until they receive it, and that certainly is an inconsistency.
In conclusion, I would like to reiterate the legal principle upon which we rely.
First, we rely on the -- on the fact that the issue refers only to the finance account, the reserve, and not to something with the -- with the original customer, and the finance company has control of that account.
And, the legal principle that the taxpayer had no right to that $3885 in similar amounts in the other years determines this case.
Furthermore, we contend that the sales on credit and the financing contract should be viewed as a whole because, before that credit is given, it must be approved.
On page 23 of the brief, the first sentence, the second line, “You propose to buy from us on a basis stated in this agreement paper acceptable to you” which indicates that C.I.T. must approve each transaction before the customer signs the note.
So, it is an integral three-party transaction.
And, in fact, it was most strange to hear, and I'm not arguing that the dealer does not have a legal right to collect that note when it's signed.
I don't think that is controlling.
I would concede that he does.
But, the transaction should be viewed as a whole because, as a practical matter, it is one three-party transaction and, as I was saying, it is strange that the Government would argue that this should be itemize into separate transaction in the view of their long-established and contented position in the Court Holding case and others that we should not take a business transaction and split it up into a group of separate parts and treat them as independent.
In fact, it reminds me of what Isaac once said, “The voice is Jacob's voice, but the hands are the hands of Esau.”
I think it would not be uncommon that the Government would be back here on the other side of this question of itemizing this transaction and treating it as separable independent steps.
Justice John M. Harlan: Do your basic contract in -- between C.I.T. and Glover, is that in the record?
Mr. William S.miller, Jr.: Yes, sir.
That's the contract I've been referring to, Your Honor.
Justice John M. Harlan: I known -- I know you've been referring to it, but I understood Mr. McInnis to say that his was not.
Mr. William S.miller, Jr.: That's correct.
But, in the Glover case --
Justice John M. Harlan: Is there any reason why we --
Mr. William S.miller, Jr.: -- the basic contract --
Justice John M. Harlan: -- shouldn't have them in both cases.
Mr. William S.miller, Jr.: Sir?
Justice John M. Harlan: Is there any reason why we shouldn't have them under Mr. McInnis' case?
Mr. William S.miller, Jr.: As I understand it, --
Justice John M. Harlan: That's what I'm going to ask you.
Mr. William S.miller, Jr.: -- his contract is a course of dealing and not a written agreement, Your Honor.
Justice John M. Harlan: I beg your pardon?
Mr. William S.miller, Jr.: I understand that, in the Hansen case, the contract exists under a course of dealing, not a written instrument, the basic contract.
In our case, the basic contract between the finance company and the dealer is in evidence because we consider that's the only thing in issue, not the contract with the customer because that's not what the Government raised when they filed the statutory notes.
And, finally, on the legal principles, we contend that Section 41, which is cited by the Government in the appendix at page 60, the general statute applies here and that the taxpayer's method is correct unless it fails to collect correctly state income.
And, in that connection, I want to refer once more to this argument that, since the amount might sometime in the future be applied to an obligation, it must now be approved.
That argument is, it seems to me, fallacious, in that, it would cause a distortion of income.
First, in the year in which you -- you were required to take the income into account before you have the right to get it.
It distorts income, over states it.
And then, in the later year, when your right to the income actually accrues and you apply it against an obligation, then you will -- because you've already been required to take the income into account, you will take into account a deduction and understate your income.
The argument of the Government would cause a distortion at two points, the first time and then at the time that the obligation is actually satisfied from a reserve to which you then had the right.
And, we submit that this case -- in these cases, the taxpayer's method of accounting has correctly reflected income.
Chief Justice Earl Warren: Mr. Rothwacks.
Argument of Meyer Rothwacks
Mr. Meyer Rothwacks: May it please this Court.
I should like to say, at the outset, that I am grateful to counsel for calling my attention to an apparent misstatement of mine yesterday.
The Government, of course, does not contend that all of the so-called finance charges eventually come into the pocket of the dealer.
It's obvious that only a portion of the finance charge does.
Now, first I'd like to say that, in effect -- in effect, and not without some reasonable basis from their point of view, in effect, counsel on the other side are asking us to accept, for tax purposes, a view of these situations which their accountants would urge upon them.
Now, while the conclusions drawn by my brothers may be reasonable from an accounting point of view, they're not necessarily conclusive from a tax point of view.
This Court, of course, had said so at least on two occasions.
In Weiss versus Wiener, this Court said that income tax laws do not profess to embody perfect economic theory.
They ignore some things that either a theorist or a businessman would take into account in determining the pecuniary condition of the taxpayer.
And, in the Baisely case, this Court says that the form of the transaction, as reflected by correct, and I emphasize, as reflected by correct corporate accounting, merely opens questions as to the proper application of a tax statute, it doesn't close them.
Now, what, in substance, is involved in these cases?
As was mentioned yesterday, long prior to the first litigated case on this question, the Shoemaker-Nash case in 1940, the Commissioner had a simple, clear, understandable, administrative position and practice with respect to this issue.
The first, GCM was in 1931.
Along came a ruling in 1957 which reaffirmed it but which was, in a sense, clearer than the prior GCM because it set forth, from the industry point of view, from a nationwide point of view, from a trade practice point of view, what is involved in these cases?
And, I'd like to read two or three sentences of that ruling because this is what the Commissioner determined was the essence of the transactions in the business situation which with -- with which we are here concerned.
Chief Justice Earl Warren: Is this the 1931 or --
Mr. Meyer Rothwacks: This is the 1957.
Chief Justice Earl Warren: -- the 1957?
Mr. Meyer Rothwacks: This is the 1957.
Chief Justice Earl Warren: 1957.
Mr. Meyer Rothwacks: In explaining what happens in these transactions, the ruling said, “when a car is purchased on credit from a dealer, the purchaser makes a down payment either in the form of cash or by turning in another car in an agreed value, the balance being satisfied by the purchaser's promissory note and a supporting conditional sales contract.”
And, now comes the important sentence, and I think this must be true with respect to all of the transactions involved here, as they are with respect to the transactions involved in the thousands of situations of this kind that are entered into annually over the country.
“The face amount of the note reflects two elements, not one, two elements.
The balance of what would be the purchase price of the car and, the second, a finance charge.”
Now, in those situations in which the dealer signed a contract with the purchaser and executed a note, the note was sold to the finance company.
In the situation, as in the Hansen case, where we're not dealing with notes but a conditional sale contract, we have, as Mr. Justice Whittaker pointed out, we have a contract and the contract -- the parties in the contract are the dealer and the purchaser.
Now, it's, of course, true that the collateral arrangement between the parties may call for the payment of the amounts over the cash purchase price.
The deferred amounts may call for payment to the -- at the locale and to the finance company.
But, insofar as the contract between the parties are concerned, there are only two parties the dealer and the purchaser.
And, the contract in the Hansen case obligates the purchaser to pay what is called in the contract “at designation eight,” a time-deferred balance, and then we have a completely separate document.
True, it's on the same sheet of paper, but it involves two other, that is, it involves two parties, and they're not the same parties as were involved in the conditional sales contract, involved a dealer and the finance company.
Now, why has this practice grown up?
The Government has taken care to set forth, rather voluminously, in some footnotes to its brief found at page 44, articles that are written, three, I think they are, that were written in the Indiana Law Journal which indicate -- make it very clear that the arrangement between the dealer and the finance company was this.
You do your business with your purchaser.
You get your price set with him.
You had a finance charge and, if you will then sell us your purchaser's obligation, we'll rake you in, so to speak, on part of the finance charge which, under other conditions and except for our understanding, would go entirely to us.
So that, as even the Hansen opinion conceded, the finance charge was worked into, and this is the language of the Hansen opinion, the finance charge was worked into the sales price.
And, part of that sales price was the amount that was reflected in the dealer's reserve account set up in favor of the dealer.
Now, as I said yesterday, the uncertainty, if there was any, that the dealer would not receive the full amount in those credits could arise only because there would be either a default on the part of the purchaser, which was an uncertainty no greater than the uncertainty in any commercial transaction of any kind, where it is always possible that the debtor may not be able to perform.
And, the second uncertainty was that in those very fortunate circumstances in which the purchaser found himself able to prepay, that if there was a reduction in the finance charge, which would then be owing by the purchaser to the finance company, there would be a corresponding offset in the credit.
Now, that doesn't affect the situation, as far as the accrual principle of accounting is concerned.
In the first place, one would have to examine these records with a microscope to find any real indication that the incidence of prepayment was so great as to cause any major degree of uncertainty.
In the second place, even if it was great, under the accrual system of accounting, if the dealer lost anything by virtue of a depletion of the reserve, then he would be entitled to a deduction for a loss in the year in which that loss occurred.
Now, I think I've used practically all my time.
I think that is the basic situation before us.
The emphasis of the taxpayers is upon what they call the “contingencies” or the probabilities that the purchaser would default and that the dealer would then have to step in to the breach and make the finance company whole.
Of course that's true but, from our point of view, we say it's irrelevant to this issue, irrelevant to this issue.
We think this case doesn't involve contingencies in the sense in which the taxpayer dealers refer to them.
We think this case involves only the question, are there such uncertainties that this dealer will not receive the amounts credited to him which were part of a note payable to him in a prior separate transaction.
Are there such uncertainties that this Court cannot say -- or that this Court must say, rather, such uncertainties that -- that there can be no question of accrual?
We think the records in no way would support that hypothesis.