*1192 The petitioner, an automobile dealer, kept its books of account and reported its income on the accrual method. It sold deferred payment notes received in payment for automobiles to two finance companies. The finance companies did not immediately pay over the full amount of the purchase price of the notes byt retained a portion thereof as agreed upon with petitioner, the amount so retained being released and paid over to petitioner as the unpaid balance on all the notes so acquired plus the amount of any indebtedness of petitioner to the particular finance company should be reduced. Held, that in determining petitioner's taxable income the entire amount of the selling price of such notes is to be accrued at the time the notes were sold.
*417 This proceeding involves a deficiency in income tax of $302.69 for the fiscal year ended June 30, 1937. The only issue presented is the correctness of the respondent's action in including in petitioner's gross income the amount of $2,252.25 which represented the portions of the prices at which two finance*1193 companies purchased from petitioner certain notes of its customers, such portions being withheld by the finance companies at the time the notes were purchased, to be released and paid over to petitioner under circumstances hereinafter described. The amounts so withheld were credited to the account of petitioner on the books of the finance companies and the petitioner was so advised. The proceeding was submitted upon the pleadings, a stipulation of facts and certain documentary evidence.
FINDINGS OF FACT.
The petitioner is an Arkansas corporation having its principal place of business at Little Rock. It filed its income tax return for the fiscal year ended June 30, 1937, with the collector of internal revenue for the district of Arkansas.
During the taxable year the petitioner was engaged in business as a dealer in new and used automobiles. As part payment of the purchase price of certain automobiles sold by it the petitioner received notes of the purchasers payable monthly over periods of from 12 to 24 months. In some if not all cases the petitioner then sold the notes of the automobile purchasers to two finance companies, the C. I. T. Corporation and the General Contract*1194 Purchase Corporation. These sales were made pursuant to special agreements between the petitioner and the respective companies. Under the respective agreements each *418 company, at the time of purchasing the notes, withheld payment of a portion of the purchase price of said notes, the withheld portion, designated a "reserve", being credited to the petitioner on the books of the finance company at the time the notes were purchased.
Under the agreement with the General Contract Purchase Corporation, sometimes referred to as the General Corporation, the percentage of the purchase price of a note which was to be withheld with respect to the notes of any automobile purchaser appears to have been a matter for determination at the time the General Corporation purchased the notes and not a fixed percentage for notes of any particular period of payment. The agreement with the General Corporation, in which the petitioner was designated "Dealer" and the General Corporation as "Company", provided as follows respecting the purpose for which the reserve was withheld and the circumstances under which it would be paid to or could be withdrawn by the petitioner:
NOW, THEREFORE, it is*1195 agreed by Dealer and Company that said reserve and every part thereof shall be held by Company as security for all the obligations of Dealer incurred by contract or otherwise on or in respect to each or all of said Accounts [notes, contracts, mortgages, and other choses in action] or any conditional sale contracts, mortgages, or other instruments securing them, or in respect to any property or merchandise out of the sale of which any of said accounts may have arusen or which may be covered by any of said accounts or by any conditional sale contract, mortgage, or other instrument securing them, or arising out of any agreement in writhing heretofore or hereafter existing between Dealer and Company.
At any time when said reserve is in excess of 5% of the total amounts unpaid on all accounts theretofore purchased (including any held by any assignee thereof from Company) and is also in excess of $500.00, such excess may be withdrawn by Dealer, provided that at the time of such withdrawal no obligations of Dealer secured by said reserve shall be overdue and unpaid and none of said accounts shall have more than two installments overdue.
At any time that said reserve is less than $500.00*1196 but is in excess of the total of all amounts unpaid on all accounts theretofore purchased (including any held by any assignee thereof from Company) such excess may be withdrawn by Dealer.
Company shall be under no obligation whatsoever to pay at any time whatsoever any portion of the purchase price of any account held in said reserve, except to permit the withdrawal of the same in accordance with the terms hereof.
At any time that any obligation secured by said reserve shall be due and unpaid, Company may apply said reserve or any part thereof to said obligation.
Dealer shall not be entitled to interest on said reserve. Any of said accounts and any of said obligations secured by said reserve may be assigned by Company and the benefit of this agreement shall inure to any such assignee, and Dealer's right to withdraw said reserve under the terms hereof shall be the same as if no assignment had been made. * * *
With the exception of the manner in which the amount of the reserves was computed, this being changed slightly from time to *419 time by riders or otherwise, the agreement under which the petitioner sold notes to the C.I.T. Corporation was embodied in a communication*1197 from the petitioner to that corporation which was accepted by the latter at Chicago, Illinois, and provided as follows:
To: C.I.T. Corporation:
1. You propose to buy from us paper acceptable to you covering new and used cars, and this agreement states the basis of purchase.
2. All paper will be endorsed and assigned without recourse, except that paper covering commercial cars of more than one and one-half tons capacity, busses, cars used for taxi, jitney or "drive-yourself" service, cars sold or leased to one of our employes or household, or cars on which the down payment in cash and/or trade-in allowance at fair valuation is less than your regular published minimum, will bear our full recourse endorsement and in such cases you may make any necessary correction in our endorsement.
3. Except on full recourse endorsements, we shall purchase from you each repossessed or recovered car tendered at our place of business; or if we are out of business or are in default to you cars may be tendered by registered [*] notice sent to our last known address. The purchase price, payable on demand and in any event withing 30 days after tender, shall be as follows: the unpaid balance*1198 due on the car (a) if tendered within 90 days after maturity of the earliest installment still unpaid, or (b) if temder is delayed by a redemption period, litigation, or any existing or future law or executive proclamation. In any other case, the purchase price shall be the "as is" value of the car. Until paying you we will store the car at our risk and expense and as your property and will deliver it to you on demand.
4. We have no responsibility on converted or confiscated cars until they are repossessed or recovered and tendered as above. you will allow us the cost of repairing actual direct collising damage necessitating repossession, in excess of $50; allowance is not to exceed the unpaid balance due on the car after deducting the "as is" value plus $50 plus any deferred certificate or other special holdback relating to the car. Where the resale value of the repaired car (excluding overhead and salesman's commissions) exceeds the unpaid balance, the excess will be deducted from the collision allowance.
5. Your standard rate charts under your 6% Budget Plan, or your Special Used Cal Schedule, will include the following reserves for our protection.
New Passenger Cars, *1199 --- Commercial Cars;
(Insert Name)
and Used Cars (Under "Special Used Car Schedule") -
On paper maturing in 12 months (or less) - 1 1/2% of the first $500. of the Unpaid Cash Balance (i. e., Cash Selling Price Less Down Payment) plus 1/2% of such Balance in excess of $500.
On paper maturing in more than 12 months - 2% of the first $500. of the Unpaid Cash Balance plus 1% of such Balance in excess of $500.
For used cars not under "Special Used Car Schedule" - $10.00 flat per car.
Three times in each twelve months period, if we are not indebted to you, you will pay our accumulated reserves in excess of 3% of the aggregate unpaid balances on paper purchased from us except where we have an existing arrangement regarding payment of such reserves. Where such an arrangement is in effect you shall as to all paper heretofore or hereafter sold to you pay us our reserves in accordance therewith; and we shall pay, when due, any sums payable by us prior to the respective reserve payment dates. If we stop selling you our *420 paper or you stop buying it, you may hold and apply all reserves until liquidation of all paper purchased from us.
6. If the total amount paid you, *1200 plus allowance for repairs authorized by you in writhing, for repossessed passedger cars whcih we have so purchased from you, covered by paper sold you in any 12 successive-month period, exceeds the total resale price of such cars plus the amount of our reserves for said period plus 3% of the volume of our paper sold you during said period, you shall reimburse us for such excess, provided we have resold the cars for their reasonable value within 90 days after delivery to us. We shall credit total profits on resales against total net losses. This paragraph applies only to cars covered by paper we have sold you on the basis of your standard rate charts and reserves, and covering at least 100 cars during such period; if we perform all of our obligations to you; and if before incurring such excess losses we give you written notice of the offered price of each car and the opportunity to resell it.
7. We shall have full recourse endorsement liability if we make any settlement ment with a purchaser without your written consent, disclose any provision of this agreement to the purchaser, or breach any provisions of the assignment to you, and in such cases you may make any necessary correction*1201 in our endorsement.
8. This agreement shall apply to all paper hereafter sold to you and endorsed without recourse, and, except as to reserves, to all paper previously sold you on the basis of your standard rate charts, irrespective of transfers between purchasers, or extensions to purchasers, and until the paper is liquidated. No waiver or change of any provision shall be binding on you unless evidenced by writhing signed by one of your officers and this agreement shall inure to and bind our respective successors and assigns and any company affiliated with you which may transact business hereunder and shall be construed as a contract under the laws of the State where accepted by you.
In addition to purchasing notes from the petitioner the C.I.T. Corporation, to some undisclosed extent, provided funds under what was designated the "C.I.T. Floor Plan", to enable the petitioner to obtain Nash and LaFayette automobiles from the manufacturer or distributor of such automobiles.
Under date of October 26, 1936, the petitioner and the C.I.T. Corporation entered into an additional agreement wherein it was agreed that the C.I.T. Corporation might hold all reserves and amounts payable*1202 to the petitioner under deferred certificates until all of the petitioner's then existing and future obligations to the C.I.T. Corporation, secured by used cars under the "C.I.T. Quick Turn Over Plan - Used Car Wholesale" (a plan not explained in the record) should be fully paid and performed and that this agreement should continue until the parties agreed otherwise.
On June 30, 1937, the C.I.T. Corporation was carrying notes in the amount of $51,609 which it had purchased from the petitioner under the terms of its agreement with the petitioner and the General Corporation was carrying like notes in the amount of $17,806.85.
On June 30, 1937, the reserves credited to the petitioner on the books of the C.I.T. Corporation amounted to $1,274.75 and on the books of General Corporation amounted to $977.50, or a total of $2,252.25. *421 These amounts were composed of sundry small amounts which had been credited to the petitioner on the books of the respective companies during the fiscal year 1937, of which credits the petitioner had been advised by memoranda by the companies in connection with each particular transaction. At the close of the petitioner's fiscal year no part*1203 of the foregoing amounts credited to the petitioner by the companies had been paid to the petitioner but the entire amounts were held by the respective companies for the purposes and in accordance with the terms of their contracts with the petitioner.
The petitioner keeps its books on the accrual basis and its accounting practice is to treat as income earned and accrued each year only such part of the reserves credited to it by the finance companies as is released to it by them during the particular year. No part of the amounts of $1,274.75 and $977.50 had been released to the petitioner on June 30, 1937, and neither amount was carried through or reflected in the gain and loss account on the books of the petitioner. However the amounts were carried as memorandum accounts on the petitioner's books and shown in its balance sheet as of June 30, 1937, prepared in conformity with the standard form of accounts furnished it by the Nash Automobile Co., which it represents. The amounts were shown in the balance sheet as assets under the item "Due from Finance Companies" and as liabilities under the item "Repossession Losses", the latter item apparently being carried as a reserve on the*1204 balance sheet.
OPINION.
TURNER: According to the facts, the petitioner is a dealer in new and used automobiles, and was so engaged during the taxable year. In payment for automobiles sold it received notes of the purchasers, which notes it subsequently sold to either one of two finance companies. It is stipulated that petitioner kept its books of account and reported its income on the accrual method. With respect to proper treatment for income tax purposes of proceeds from sales made by a concern which keeps its accounts and makes its returns on the accrual basis, the Supreme Court, in Spring City Foundry Co. v. Comminnioner,292 U.S. 182, had the following to say:
* * * Keeping accounts and making returns on the accrual basis, as distinguished from the cash basis, import that it is the right to receive and not the actual receipt that determines the inclusion of the amount in gross income. When the right to receive an amount becomes fixed, the right accrues. When a merchandising concern makes sales, its inventory is reduced and a claim for the purchase price arises. Article 35 of Regulations 45 under the Revenue Act of 1918 provided: "In the case*1205 of a manufacturing, merchandising, or mining business 'gross income' means the total sales, less the cost of goods sold, plus any income from investments and from incidental or outside operations or sources."
On an accrual basis, the "total sales", to which the regulation refers, are manifestly the accounts receivable arising from the sales, and these accounts *422 receivable, less the cost of the goods sold, figure in the statement of gross income. If such accounts receivable become uncollectible, in whole or part, the question is one of the deduction which may be taken according to the applicable statute. * * *
The petitioner being on the accrual basis, we assume that such profit as may have been realized on the sale of the automobile itself was accrued on petitioner's books when the sale was made and the subsquent sale of the notes to the finance company was a new and separate transaction. The selling price of the automobile having been so accrued, however, it may seem difficult on first impression to understand just how the notes received in payment of the selling price of the automobile can result in further gain to the dealer unless the finance company purchasing*1206 the notes pays a premium therefor or the notes include some charge or fee in excess of the selling price of the car. The parties have failed to submit a full stipulation of facts in that connection and no proof was offered at the hearing. From the respondent's notice of deficiency, however, it is to be inferred that the notes included a charge or fee over and above the selling price of the automobile. From the notice of deficiency we quote the following:
The reserve for repossessions, $2,252.25, is offset on the balance sheet by an equal amount shown as Retained by Finance Companies. Since your corporation reports income on the accrual basis, the amount due from finance companies should be included in taxable income.
Attention is called to General Counsel Memorandum 9571 (Cumulative Bulletin X-2, 1931, page 153) which is summarized as follows:
Under the plan outlined in the instant case, where a sale of an automobile is made on a credit basis, the purchaser executes a note or notes for the deferred payments, including a service charge. The notes are endorsed by the dealer and turned over to the finance company, which then remits to the dealer the unpaid portion*1207 of the selling price, not including the service charge. The finance company maintains a reserve account and, upon taking over such notes, credits the dealer therein with a portion of the service charge.
The credit thus given by the finance company to the dealer is properly to be included and taken up as income on an accrual basis of accounting, when the credit is made in favor of the dealer by the finance company.
In any event, there is no suggestion or claim that the amounts withheld by the two finance companies upon the purchase of the notes from the petitioner, the amounts so withheld being the amounts here in controversy, do not represent profit on the disposition of the said notes and do not, in fact, constitute income to the petitioner if, as, and when the said amounts become properly accruable, the claim of the petitioner rather being that General Counsel's Memorandum 9571, C.B. X-2, p. 153, is not to be accepted as laying down a general rule of law, and further that the instant case is distinguishable from the case dealt with in G.C.M. 9571 in that the payment of the reserves *423 withheld by the finance companies in the instant case were so contingent*1208 that they might never be paid and should not, therefore, be accrued as income until their actual release and payment.
There is nothing to indicate and, in fact, there is no contention that the price at which any given notes were sold was not agreed upon and did not become fixed at the time of the sale. The withholding of the reserve credit had to do with the time of payment and in no way affected or changed the selling price of the notes. It is true that the release or payment of the reserve credit did not automatically follow the payment or reduction of the notes of any particular automobile purchaser, but contrary to the inference to be drawn from the petitioner's brief, we are unable to conclude that the reserve credits were any the less absolute credits by the finance companies to the petitioner, payable without limitation, than in the case dealt with in G.C.M. 9571, supra.In that case it was pointed out that the dealer received the full benefit of the reserve credit either by actual payment or through credit on his liability as endorser in the event the purchaser of the automobile failed to meet his obligation on the notes. *1209 In the case here the petitioner was not even liable as endorser with respect to certain of the notes sold by it to the C.I.T. Coration, the said notes having been sold and endorsed to that corporation without recourse, and in the event of default on those notes by the purchaser of the automobile, the only apparent recourse that the C.I.T. Corporation had against the petitioner was to repossess the automobile covered by such notes and to require the petitioner to purchase the automobile at a price and subject to the conditions specified in the contract between it and petitioner. Furthermore it appears that the C.I.T. Corporation not only purchased deferred payment notes from the petitioner, but extended credit to petitioner in connection with the acquisition of new cars from the manufacturer and with respect to another activity designated as the "C.I.T. Quick Turn Over Plan - Used Car Wholesale", and the reserve retained by the C.I.T. Corporation out of the purchase price of the deferred payment notes was held in part at least as security for the credit or advances so made. Obviously where the reserve credit retained out of the purchase price of deferred payment notes becomes a reserve*1210 securing credits or advances otherwise granted or made to the petitioner by the C.I.T. Corporation, there is no basis whatever for the claim that the said reserve credit retained from the purchase price of the notes is contingent and may never be paid. Cf. Luther Bonham,33 B.T.A. 1100; affd., 89 Fed.(2d) 725.
From the above it is, in our opinion, apparent that the sale of notes of automobile purchasers to the finance companies was as much a part of the business carried on by the petitioner as the sale of the automobiles themselves, cf. Hercules Motors Corporation,40 B.T.A. 999, and, *424 the petitioner being on the accrual basis, we find nothing in this case to justify the conclusion that the profit from the sale of such notes is not accruable when the notes are sold. Spring City Foundry Co.v. Commissioner, supra;Rouss v. Bowers, 30 Fed(2d) 628. For although the amount of the reserve credit is not immediately paid and does not become immediately payable, there is no showing that it will not be collectible when due or that its collection in the future is improbable. The decisions*1211 in Commissioner v. Cleveland Trinidad Paving Co., 62 Fed.(2d) 85, and other cases of similar import discussed by the petitioner in its brief are not applicable here.
Decision will be entered for the respondent.