concurring: There can be no doubt that the majority reaches the proper result. I think it is time, however, that we expressly discarded whatever shreds of life may remain in the idea that prepaid interest stands on any different footing than prepaid rent. Rather than engage in an essentially illusory examination for “material distortion of income,” I would simply hold that prepaid interest, like prepaid rent, creates an asset of value, the cost of which may be deducted, if at all, only during its useful life.
Prepaid interest is indistinguishable in logic or legislative history from prepaid rent. Prepaid rent purchases the use of property; prepaid interest the use of money. No doubt, as the majority observes, money differs from other property, but the relevance of that difference to the question of deductibility is not apparent. In Security Flour Mills Co. v. Commissioner, 321 U.S. 281, 285 (1944), the Supreme Court stated that “a tenant would not be compelled to accrue, in the first year of a lease, the rental liability covering the entire term nor would he be permitted, if he saw fit to pay all the rent in advance, to deduct the whole payment as an expense of the current year.” And in University Properties, Inc., 45 T.C. 416 (1966), affd. 378 F. 2d 83 (9th Cir. 1967), we held, without inquiry into the degree of materiality of distortion of income involved, that a cash method taxpayer may not deduct prepaid rent. As we pointed out in Andrew A. Sandor, 62 T.C. 469, 478-479 (1974), on appeal to the Ninth Circuit, the legislative history of section 200(d) of the Revenue Act of 1924 made no distinction between the possible distortion of income resulting from prepaid rent and prepaid interest. We there said “We think that the parallel between prepaid rent and prepaid interest is inescapable.” 62 T.C. at 480.
I have no objection to respondent’s use of the “material distortion” test as an administrative matter, to put taxpayers on notice of the circumstances under which he will on audit disallow a deduction claimed for prepaid interest. However, I find no adequate statutory sanction for the proposition that as a matter of law prepaid interest, unlike prepaid rent, can be deducted by a cash method taxpayer absent “material distortion.” Therefore, I would make no inquiry into the materiality of distortion, but would simply disallow the challenged deduction. The majority relies on “more than one-third of a century” of history in distinguishing prepaid rent from prepaid interest. However, in Sandor we cut ourselves adrift from that history, and therefore should not be appealing to it here.
My concern with the majority’s approach is not, however, limited to the view that we should not keep flickering for cash method taxpayers some largely illusory flame of hope that they might be successful in deducting prepaid interest under certain circumstances. I am also concerned by the large inroads which the majority’s opinion inferentially makes upon taxpayer’s right to use the cash method of accounting. The use of the cash method has not heretofore been held conditional upon its results being reasonably similar to those of accrual accounting. Yet if prepaid interest is, as a general rule, a legitimate deduction for a cash method taxpayer, what else are we to make of the proposition that such a deduction can be disallowed where it materially distorts income? The “income” so distorted cannot be that resulting from application of the cash method — for on that method the amounts were indeed paid, and the majority does not hold an asset was created. Rather, “income” as measured by cash method accounting is compared with the results of some inferentially superior method of measuring “income.” But since “income” is not a self-defining term, where do we find the superior source? Evidently, in accrual accounting.
I do not believe that respondent has, nor has he claimed, the generalized power to take what he likes of cash method accounting and reject what he dislikes merely because it varies from the results of accrual accounting. Here respondent accepts the results of forward bunching of petitioners’ income, but rejects as distortion the attempt to achieve offsetting results through an interest prepayment. Neither the statute, however, nor any of the cases cited, except possibly Sandor, so qualify the taxpayer’s right, where he has properly adopted the cash method. Where a variance from the result of accrual accounting exists solely as a result of taxpayer’s application of the cash method, no taxpayer has heretofore been denied such a result solely because of the extent of such variance. In Peoples Bank & Trust Co., 50 T.C. 750 (1968), affd. 415 F. 2d 1341 (7th Cir. 1969), an accrual basis taxpayer was properly precluded from deducting interest payable before the events establishing the liability had become fixed. In Commissioner v. Hansen, 360 U.S. 446 (1959), accrual method taxpayers were required to include in income certain “Dealers’ Reserve Accounts” to which they were held to have had fixed rights. In Fort Howard Paper Co., 49 T.C. 275 (1967), we refused to disturb the accrual basis taxpayer’s long-standing inventory costing method. In Photo-Sonics, Inc., 42 T.C. 926 (1964), affd. 357 F. 2d 656 (9th Cir. 1966), the accrual basis taxpayer was required to change an erroneous method of inventory costing. In American Automobile Association v. United States, 367 U.S. 687 (1961), an accrual basis taxpayer was required to include in its income amounts it earned and held under claim of right. In none of these cases was a cash method taxpayer precluded from the results of proper use of the authorized cash method. So to construe respondent’s powers under section 446 is effectively to emasculate the well-recognized right of taxpayers to the use of that method, with whatever favorable or adverse tax consequences follow.
Not only, however, are there no prior cases permitting such encroachment on the cash method, but the Supreme Court has already rejected the majority’s permissive interpretation of respondent’s powers. Security Flour Mills Co. v. Commissioner, 321 U.S. 281 (1944). In Security Flour Mills Co. the Court construed the clause in section 43 of the Revenue Act of 1934, “unless in order to clearly reflect the income the deductions or credits should be taken as of a definite period.” The Court said of that clause:
But we think it was not intended to upset the well-understood and consistently applied doctrine that cash receipts or matured accounts due on the one hand, and cash payments or accrued definite obligations on the other, should not be taken out of the annual accounting system and, for the benefit of the Government or the taxpayer, treated on a basis which is neither a cash basis nor an accrual basis, because so to do would, in a given instance, work a supposedly more equitable result to the Government or to the taxpayer. [321 U.S. at 285-286.]
The Court also said:
The rationale of the system is this: “It is the essence of any system of taxation that it should produce revenue ascertainable, and payable to the government, at regular intervals. Only by such a system is it practicable to produce a regular flow of income and apply methods of accounting, assessment, and collection capable of practical operation.”
This legal principle has often been stated and applied. The uniform result has been denial both to Government and to taxpayer of the privilege of allocating income or outgo to a year other than the year of actual receipt or payment, or, applying the accrual basis, the year in which the right to receive, or the obligation to pay, has become final and definite in amount.
But the petitioner urges that §43 has altered the rule so that a hybrid system, partly, annual and partly transactional, may, within administrative discretion, be substituted for that of annual accounting periods. It urges that the change was due to the desire of Congress to prevent distortion of true income. This must mean distortion of true income, not of a given year, but, in the light of ultimate gain, from a series of transactions over a period of years, growing out of, or in some way related to, an initial transaction in the taxable year. The very section on which petitioner relies, however, reiterates the adherence of Congress to the system of annual periods of computation.
As we said in Dixie Pine Products Co. v. Commissioner, supra, referring to a section identical with § 43 now under consideration, “The provisions of the Revenue Act of 1936 worked no significant change over earlier Acts respecting the permissible basis of calculating annual taxable income.”
We are of opinion that the purpose of the language which Congress used was not to substitute, whenever in the discretion of an administrative officer or tribunal such a course would seem proper, a divided and inconsistent method of accounting not properly to be denominated either a cash or an accrual system. [Fn. refs, omitted; 321 U.S. at 286-287.] [1]
I see no material difference between the former section 43 and present Code section 446(b) which would justify us in allowing respondent to do what he was so clearly prohibited from doing in Security Flour Mills Co.
We, too, have heretofore rejected the notion of enforced use of hybrid cash-accrual accounting methods to “clearly reflect” the income of a cash method taxpayer. In Sol C. Siegel Productions; Inc., 46 T.C. 15 (1966), we said:
Finally, the Commissioner seeks to support his position by reliance upon section 446(b) of the 1954 Code. His theory is that the $300,000 must be included in petitioner’s income for the fiscal year ending May 31,1961, in order to “clearly reflect income.” In effect the Commissioner has attempted to place petitioner on an accrual basis of accounting in respect of the $300,000 item, without otherwise disturbing petitioner’s cash basis. Of course, the Commissioner has broad discretion under section 446(b), and the burden is upon the taxpayer to show that there has been an abuse of that discretion. Idaho First National Bank v. United States, 265 F. 2d 6, 9 (C.A. 9). We think the record herein clearly establishes that there is no ground whatever for reliance upon section 446(b) and that resort thereto would amount to an abuse of discretion. [Fn. ref. omitted; 46 T.C. at 24-25.]
The only legitimate question here is not whether claiming a deduction for prepaid interest creates an undue disparity in a particular case between the results of cash method and accrual method accounting. If the cash method is properly used, the disparity is not a distortion of income but merely the consequences of proper use of a permissible method of measuring income. The legitimate question is whether prepaid interest is a proper deduction at all for a cash method taxpayer. I would hold that in the light of Sandor it is not. But the majority’s rationale herein for reaching its result is not only precluded by authority, but would potentially trench deeply upon the tax law’s predictability. It would render largely illusory the right to security in the use of cash method accounting generally.
Scott, J., agrees with this concurring opinion.It might be contended that the Security Flour Mills Co. language is made obsolete by subsequent congressional adoption of what is now sec. 446(c)(4), authorizing the Secretary to prescribe regulations permitting hybrid methods. However, the taxpayer’s right, under such circumstances, initially to adopt a hybrid method does not entitle the Commissioner to place a cash method taxpayer on a hybrid method. Taxpayers have at all times had the right to adopt an accrual method, but it has never been held that respondent has the arbitrary power to place any cash method taxpayer on the accrual basis merely because the respondent determines that accrual rather than cash method accounting more clearly reflects his income. The addition of the hybrid method to the permissible range of choices does not by itself empower the respondent to require a taxpayer properly applying the cash method to shift to the hybrid method.