*63 Decision will be entered for the respondent.
Amounts withheld by finance companies out of sums due on purchase of notes from petitioner, an accrual basis trailer dealer, which amounts were held as "dealer's reserves" and credited to petitioner's account on the finance companies' books, held, includible in petitioner's taxable income.
*123 This proceeding involves deficiencies in income taxes of $ 9,750.50 and $ 20,021.28 for the respective calendar years 1949 and 1950. Certain *124 adjustments in each year have not been put in issue. The remaining question is whether amounts withheld by finance companies in purchasing from Blaine Johnson trailer notes and security instruments, which amounts were credited to his reserve account on the companies' records, are taxable income in 1949 and 1950.
FINDINGS OF FACT.
Some of the facts have been stipulated and are hereby found.
Petitioners are husband and wife, residing at Naval Base, South Carolina. They filed joint income tax returns for the calendar years 1949 and*64 1950 with the collector of internal revenue for the district of South Carolina.
From September 23, 1946, through December 31, 1948, Blaine Johnson, hereafter called petitioner, and J. B. Coffey, as equal partners, bought and sold new and used trailers. The gross trailer sales of this partnership for the respective calendar years 1946, 1947, and 1948 were $ 47,185.44, $ 233,189.36, and $ 395,560.99.
As of January 1, 1949, petitioner purchased Coffey's one-half interest in the partnership and thereafter operated the business as a sole proprietorship under the name Johnson Trailer Sales. During 1949 and 1950 he maintained his principal place of business at Charleston, South Carolina, with branches in Fayetteville, North Carolina, and Savannah, Georgia. During these years he sold almost all of his trailers on the installment basis. In such cases the purchaser executed a note for the unpaid purchase price including insurance, interest, and, in some cases, other charges, and gave a chattel mortgage on the trailer as security for payment of the note. Under conditional sale agreements, title to the trailers remained in petitioner until all provisions of the agreements were fulfilled. *65 At no time since petitioner entered the trailer business has he been financially able to hold purchasers' notes until maturity. For this reason, it has been necessary that he discount the purchase money notes with finance companies able to hold them until maturity.
The business of financing trailer paper has developed practically since World War II. There was a tremendous demand by trailer dealers for the financing of trailer paper, and 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.
On the dates set forth below petitioner (or, if prior to January 1, 1949, the partnership) entered into written or oral agreements with certain finance companies for the sale to them of notes received from *125 retail purchasers for the deferred purchase price of the trailers, which price included insurance, interest, and other charges:
| Finance company | Date of agreement | Nature of contract |
| Lower Main Street Bank | October 4, 1946 | Oral |
| Michigan National Bank | June 20, 1949 | Oral |
| Minnehoma Financial Company | October 1948 | Written |
| Pioneer Finance Company | July 1948 | Oral |
| Union Bank of Michigan | September 1949 | Oral |
*66 Petitioner was not required to do business with these companies. Michigan, Minnehoma, and Union all deal in considerable paper of the nature of that purchased from petitioner. Minnehoma was created to assist dealers in financing retail contracts obtained through the sale of a certain brand of house trailers.
As each note was transferred to it the finance company remitted to petitioner the amount due him on the selling price of the trailer, less the amount which was credited on its books to petitioner's reserve account. This reserve account, which was provided for in petitioner's contracts with the finance companies, was required by the companies to protect themselves against losses. The amount withheld and credited to the reserve account was usually 5 per cent of the unpaid balance on each note, although the percentage sometimes varied with the finance company, the kind of trailer, and the length of the finance period.
The agreements with Union, Pioneer, and Michigan provided that the money in the reserve account would be reassigned to petitioner whenever all indebtednesses for which it was security had been discharged. Lower Main was entitled to hold the reserve account so *67 long as petitioner was liable in any manner to it. The original agreement with Minnehoma, executed on October 4, 1948, did not provide for the withholding of a portion of the note as a reserve. However, it was amended by a letter on February 16, 1949, to set up a reserve account to which 5 per cent of the unpaid note plus one-sixth of the finance charge would be credited. The establishment of this reserve account was a requirement imposed by the financial institution which financed Minnehoma. This arrangement continued until a new agreement was executed on May 24, 1950. The new agreement provided that the discounted portion of the note was still to be credited to the reserve account, but Minnehoma agreed, without obligating itself, to place a part of the finance charge in the reserve account. Another agreement, similar to the preceding one, was executed with Minnehoma on November 1, 1950.
Under the agreement with Minnehoma petitioner would be paid the excess in the reserve account when the account exceeded 20 per cent, later changed to 15 per cent, of the total of the balance of paper *126 outstanding that had been purchased from petitioner. The oral agreements with Pioneer*68 and Union provided that they would let petitioner have that portion of the reserve which exceeded 10 per cent of the total balance outstanding on the notes. Michigan would return all sums in the reserve in excess of 10 per cent of the gross unpaid balance of all contracts outstanding on March 31 of each year if, in the bank's opinion, petitioner was in good standing.
All the agreements with the finance companies provided that in the event the retail purchasers' contracts became due and unpaid, the finance company could charge petitioner's reserve with the unpaid balance; that in the event petitioner had a matured financial obligation of any nature to the companies that the amount of the obligation could be charged to petitioner's reserve; and that repossession losses could be charged to petitioner's reserve. Each finance company could look to petitioner's reserve to satisfy any default by petitioner on his guaranties and obligations to the finance company, as well as any default by the makers of the notes. Petitioner's reserve at Michigan is carried in the finance company's escrow fund as a liability of the finance company. The money in the reserve does not belong to it and the*69 finance company does not take the reserve into its income. All of petitioner's agreements with the finance companies provided that the ultimate balance of the reserve after payment of all notes by the purchasers and payment of all amounts due by petitioner to the finance company was to be paid to petitioner.
A typical trailer sale transaction is illustrated as follows:
| Sales price of trailer | $ 4,500.00 |
| Downpayment or trade-in allowance | 1,500.00 |
| Balance due petitioner | $ 3,000.00 |
| Insurance for one year | 90.00 |
| $ 3,090.00 | |
| Interest on note for 48 months ($ 3,090 at 6% for 4 years) | 741.60 |
| $ 3,831.60 | |
| Insurance on remainder of loan | 270.00 |
| Total amount of note | $ 4,101.60 |
| Balance due petitioner | $ 3,000.00 |
| Credited to petitioner's reserve | 150.00 |
| Cash paid petitioner by finance company | $ 2,850.00 |
Petitioner was sent a memorandum of the amount credited to his reserve with the check for the net amount due him at that time. He received periodic statements from Minnehoma, Michigan, Union, *127 and Pioneer as to the status of his reserve. At all times pertinent hereto petitioner (by way of illustration) recorded the sale of the trailer and the sale of the note *70 on his books as follows:
| Cash | $ 1,500 | |
| Contracts receivable -- Finance Co | 3,000 | |
| Trailer sales | $ 4,500 |
When the finance company remitted its check, the following entry was made:
| Cash | $ 2,850 | |
| Finance reserve | 150 | |
| Contracts receivable -- Finance Company | $ 3,000 |
On petitioner's books of account and tax returns his sales were recorded on an accrual basis.
On December 31 of each year, when petitioner's books were closed for the purpose of determining profit or loss for the year, the "Finance Reserve" account was closed and transferred to "Profit and Loss." When petitioner received any portion of the reserves held by the finance companies, he credited the "Finance Reserve" account. On petitioner's tax returns and financial statements, the debits to the "Finance Reserve" account for notes sold were deducted from gross sales and the credits in the "Finance Reserve" account were shown as other income.
In financing a specific note for petitioner at its usual rate, the finance companies do not give any consideration to the fair market value of the individual piece of paper. On the sale of a note received on sale of a trailer, generally petitioner endorsed*71 the note to the finance company either with recourse or with his guaranty of the unpaid balance of the note. Petitioner was liable for all amounts that were unpaid on the notes.
In the 1949 through 1952 balance sheets, which were used for credit purposes, petitioner showed the dealer reserve accounts as assets of his trailer business. The 1949 balance sheet did not include as an asset dealer reserves deducted by the finance companies during 1949. The balance sheets for 1950, 1951, and 1952 included the accumulated dealer reserves as an asset with the footnote that since January 1, 1949, the reserve deductions have been treated as a deduction from income on the profit and loss statements. The accumulated dealer reserves were shown on the 1950, 1951, and 1952 statements in the way they were because the finance companies, which discounted trailer paper for petitioner and to which these statements were sent, had requested information concerning the amount of the accumulated dealer reserves, and had requested that the accumulated reserves be shown on the statements in this manner.
*128 When petitioner purchased Coffey's interest in the partnership on January 1, 1949, he acquired*72 the benefits and obligations of the Lower Main, Minnehoma, and Pioneer agreements. On that date the aggregate of the reserves with Lower Main and Pioneer, which were the only dealer reserves of the partnership, amounted to $ 11,220.27. This amount was received by petitioner from Lower Main and Pioneer in payments of $ 2,984.78, $ 1,673.42, and $ 6,562.07 made in 1949, 1950, and 1951, respectively. Prior to January 1, 1949, the reserves were carried on the books of the partnership as accounts receivable. The amounts added to the reserves prior to that date were considered as income when credited and, therefore, were not reported as taxable income by petitioner when collected in 1949, 1950, and 1951. In addition to the above amounts, petitioner received $ 2,000.08 in 1951 and $ 2,115.41 in 1952 from reserves with Lower Main and Pioneer, which amounts were reported by petitioner as taxable income in the returns filed by him and his wife for those years. Prior to filing petitioner's return for 1949, the first year during which petitioner had operated the trailer business as a proprietorship, petitioner's accountant concluded that the finance company discounts should be treated as*73 deductions from the sales and set up petitioner's books to reflect this accounting method.
During the calendar years 1949 and 1950 petitioner was at no time delinquent in any payments due the finance companies, and most of the trailer purchasers were paying their notes when due. However, a number of delinquent notes were charged to petitioner's reserves by the finance companies. On the 1949 and 1950 income tax returns petitioner took deductions for specific bad debts among which in 1950 were default payments made good to the finance companies.
Due to the manner in which the reserve is handled by the finance company, payments made to petitioner out of the reserve account cannot be attributed to any specific discounted note or notes that were paid off. Petitioner did not receive any cash payments during the years 1949 through 1952 from the dealer reserves at Minnehoma, Union, or Michigan. He did receive part of the reserve with Union in 1954, and then only because he had stopped doing business with Union. During 1949 through 1952 the finance companies were in such sound financial condition that they were able to pay any amounts which might have been due and payable to petitioner.
*74 As of December 31 of each of the years 1948 through 1952, the reserve balances (excluding the additional reserve credits made by Minnehoma) as shown by the records of petitioner (or, if prior to January 1, 1949, the partnership) were as follows: *129
| Year ended December 31 | |||||
| Finance company | |||||
| 1948 | 1949 | 1950 | 1951 | 1952 | |
| Lower Main | $ 7,665.32 | $ 6,963.42 | $ 5,862.75 | $ 1,415.41 | $ 918.00 |
| Michigan | 2,329.95 | 11,250.92 | 22,783.42 | 34,319.47 | |
| Minnehoma | 6,641.35 | 20,165.55 | 37,417.21 | 56,181.45 | |
| Pioneer | 3,554.95 | 5,806.81 | 5,806.81 | 1,692.00 | 1,436.80 |
| Union | 153.00 | 1,282.39 | 2,948.28 | 3,681.65 | |
| Warren | 361.20 | 361.20 | 361.20 | 361.20 | |
| C. I. T | 5,755.20 | ||||
| Total | $ 11,220.27 | $ 22,255.73 | $ 44,729.62 | $ 66,617.52 | $ 102,653.77 |
Petitioner discontinued the sale of notes to Lower Main during the period October 9, 1950, to October 1, 1952, and to Pioneer during the period November 12, 1949, to May 1, 1952. During 1949 and 1950 substantially all of his sales contracts were sold to Michigan or Minnehoma.
Excluding the additional reserve credits made by Minnehoma, the finance companies credited $ 14,020.14 in 1949 and $ 24,147.41 in 1950 to petitioner's reserve*75 accounts on their books. On their tax returns for 1949 and 1950, petitioners deducted these amounts from gross sales as follows:
| 1949 | 1950 | |
| Gross sales | $ 510,586.41 | $ 767,554.74 |
| "Less finance discounts on commercial paper sold | ||
| to various finance companies" | 14,020.14 | 24,147.41 |
| Net sales | $ 496,566.27 | $ 743,407.33 |
In computing the deficiencies, respondent returned these amounts to net income.
Minnehoma credited petitioner's reserve account with $ 4,816.32 and $ 12,112.80 in 1949 and 1950, respectively, as petitioner's portion of the finance charges for those years. Petitioner did not include these amounts in income on the respective tax returns nor did he make any entry on his books for the credits. In the notice of deficiency, respondent included these amounts in income for the respective years.
During 1951 and 1952 petitioner's gross sales continued to increase so that gross sales in 1951 amounted to $ 1,214,982.36, and in 1952 amounted to $ 1,411,399.07.
OPINION.
Respondent determined the deficiencies here involved by restoring to petitioner's net income the "dealer reserves" withheld by finance companies from trailer paper they bought from petitioner. *76 *130 This determination, which is supported by , the only published opinion of this tribunal dealing with the present question, is resisted by petitioner, an accrual basis taxpayer, 1 on the ground that that case is distinguishable for the reason that dealer reserves in the automobile financing field differ from those in the trailer field. Though the trailer dealer may receive no more than the full face value of this paper while the automobile dealer may receive a profit on its sale, such difference relates only to the amount the dealers may ultimately receive and not to the treatment to be accorded the dealer reserves by accrual basis beneficiaries of these reserves. Although a distinction of this nature was accepted in , the distinction is not supportable logically; and neither the facts in , nor the circumstances here support it.
*77 Petitioner's arrangement with Minnehoma, for example, provided for a payment to him in excess of the face value of the notes. But the treatment of the dealer reserves by both petitioner and respondent has been the same whether the dealings with the finance companies resulted in receipt by petitioner of the face value of the note, only, or of a bonus in addition; and we shall do likewise. On the present facts there is thus no basis for a distinction between sales of paper at its face value and sales in which the dealer also receives a bonus.
The only reason that the profit or bonus to the dealer on the sale of automobile paper was separately treated in , was that respondent in charging the taxpayer there with income not only included the profit on the sale of the car without deduction for any dealer reserve but also included an additional amount which the Board of Tax Appeals assumed to be a profit on the sale of the paper. That merely simplifies the present question with respect to the notes sold for their face value. As to them, in the words of the Shoemaker-Nash opinion:
The petitioner being on the accrual basis, *78 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 subsequent sale of the notes to the finance company was a new and separate transaction. * * *
And we do not reach the question posed by the further comment:
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 * * *
*131 The entire issue, however, was decided on a theory and in language completely dispositive of this case:
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 * * * and, 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*79 notes is not accruable when the notes are sold. * * * 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. * * * [Emphasis added.]
To this we need only add that if because of uncollectible notes some part of the reserve is withheld, petitioner's compensation for that part will come by way of a specific bad debt charge-off.
Petitioner endeavors to justify the dealer reserves as analogous to a reserve for bad debts. 2 But the opposite seems to us more reasonable. Petitioner's system of bad debt charge-offs in fact demonstrates that the reserves should be included in income. Assume he were correct that the amount of the dealer reserves was not a part of his income either on the theory that their receipt was not sufficiently certain to warrant accrual or that the fair market value of the dealer paper was no greater than the amount actually received by him. If, as an example, the dealer reserve were 10 per cent and petitioner, having received 90 per cent, took only that amount as his current income, bad *80 debts as they arose would be charged against this 10 per cent. There would thus be no reason for him to charge off as a specific bad debt any part of the discounted paper until the bad debts exceeded the 10 per cent which was there to absorb them and had not been included in income in the first place. But the fact is that it was petitioner's practice to charge off immediately on a specific bad debt approach each item on which a charge was made to the reserves and which was found to be uncollectible. Perhaps another way of stating the same thought is that the dealer reserve constituted a kind of bad debt reserve for petitioner. Such a reserve is inconsistent with the charge-off of individual and specific bad debts. See , reversed on other grounds (C. A. 1) . Were these reserves to be excluded from petitioner's net income either as deductions or reductions in his gross income, he would in effect be securing the benefit of the two inconsistent practices.
*81 *132 The arguments advanced on behalf of petitioner have been considered and rejected. We are limited by the authority of the Shoemaker-Nash case and for that reason,
Decision will be entered for the respondent.
Footnotes
1. Petitioner argues at some length that its books of account were not maintained on an accrual basis. But the facts show otherwise, and we have so found. Inventories were an essential part of petitioner's accounting and for that reason, if for no other, its bookkeeping and reporting would necessarily be based upon an accrual theory. See , certiorari denied .↩
2. It cannot be too emphatically reiterated that the present issue is not whether petitioner is entitled to establish a reserve for bad debts; or even whether such a reserve might be reasonable if it were based upon the same percentage as the dealer reserves withheld by the finance companies. Petitioner established no such reserve and, in fact, operated on a specific charge-off approach inconsistent with a reserve method.↩