*869 INSTALLMENT BASIS. - During the taxable years petitioner sold printing machinery, taking a small cash payment and a series of installment notes for the sale price. The notes were endorsed in blank by petitioner, and immediately thereafter and within the taxable year discounted at banks or deposited as security for loans. Held, as to the notes discounted at banks, while the original sale of the machinery was on the installment plan, petitioner by converting the notes into cash realized all the profit from such transaction in the year of sale and is not entitled to return its income on the installment basis, notwithstanding it remained contingently liable as endorser or guarantor on the transferred notes. Held, further, in respect of the notes deposited as security for loans, since the parties have stipulated that an unascertainable number and face amount thereof were paid by the makers prior to the close of the taxable years, there is in any event no basis for determining petitioner's tax liability by the installment method.
*931 This proceeding*870 involves the redetermination of deficiencies in income and profits taxes for the years 1918, 1919, and 1920, in the amounts of $164,151.57, $9,665.83, and $20,630.38, respectively. The issues raised by the pleadings are (1) whether petitioner is entitled to report its income for the taxable years upon the installment basis instead of the accrual basis, and (2) whether respondent has correctly *932 determined petitioner's profits tax for each of said years under the provisions of section 328 of the Revenue Act of 1918.
On motion of the respondent, duly granted, the hearing in this case was, in the first instance, confined to the issue other than special assessment of the profits tax.
FINDINGS OF FACT.
At the hearing the parties filed a stipulation of facts, to which certain exhibits were attached. Such stipulation, including the attached exhibits, is by reference adopted in full as a part of our findings of fact, but only so much thereof is set forth herein below as is deemed material to a discussion of the issue, viz:
1. The petitioner is and was during the years 1918, 1919 and 1920 a corporation organized and existing under the laws of the State of Pennsylvania*871 and was engaged in the manufacture and sale of machinery, etc, for printers.
Sales were made for cash and also for cash and notes. In the case of sales for cash and notes, a contract was entered into with the Purchaser in the form and manner shown by Exhibit "A" attached hereto and made part hereof. A cash payment was made by the Purchaser, which in no case exceeded 25% of the sales price, and four negotiable promissory notes were executed for the balance of the sales price, except in rare instances in which notes payable monthly consecutively over a period of time were executed for the entire purchase price. The first three of the series of four notes were made payable in one, two and three months after date, respectively, and were in equal amounts, representing a fixed proportion of the sales price. The fourth note was made payable four months after date and was for the balance of the sales price, after deducting the cash payment and the amount of the three notes referred to. By the terms of the sales contract, Exhibit "A", the Petitioner agreed that if the first three notes were paid and an amount equal to one of these notes was paid on the fourth note at maturity, the Petitioner*872 would renew the fourth note as to the balance by accepting a new series of four notes, executed by the Purchaser, the first three of which would be in the same amount each as the previous three notes and the fourth for the remaining balance of the sales price. This process was to be renewed until the full sales price had been paid. The three notes, in all instances, were in the same amounts. The Petitioner's officers devised this plan of the fourth month note in order to meet the requirements of Petitioner's Banks pursuant to the re-discount provisions of the Federal Reserve Act. Conditional bills of sale or chattel mortgages were in all instances executed by the Purchaser and were retained by the Petitioner until the entire sales price was paid or the property repossessed.
2. The Petitioner accounted for the foregoing transactions in its books of account in the following manner:
When a sale was made for cash and notes, as aforesaid, the Petitioner credited the full amount of the sales price to "Sales" and charged a like amount to "Accounts Receivable". Upon receipt of the cash payment and the notes, "Accounts Receivable" were credited and "Cash" and "Notes Receivable", *873 respectively, were debited. Except as stated in paragraph 3 below, the Petitioner immediately upon receipt of notes and within the same taxable year, discounted these notes at banks with which it did business at their face value, endorsing the same in blank. These banks also held the *933 personal written guarantee of the Petitioner's President, F. F. Nicola, in the form and manner set forth in Exhibit "B" attached hereto and made a part hereof. When the notes were discounted at the banks, the Petitioner credited "Notes Receivable" with the face value thereof and charged its "Cash" account. Upon presentation for payment by holder thereof and default in payment by the maker of any of the notes due in one, two and three months, the Petitioner's bank account was either charged by the bank, or the Petitioner issued its check in payment to the bank for the face amount of the note plus the interest due thereon to maturity. The Petitioner thereupon charged the purchaser in its "Accounts Receivable" account with the amount of the note and interest, and thereafter attempted to make collections thereon, and in the event such collections were not made, charged the amount off its books*874 as a bad debt, after giving effect to the value of any property repossessed.
In the case of the fourth note, payable four months after date, the Petitioner, on or prior to its due date, issued its check to the bank for the face amount of the note plus interest thereon to its maturity and the bank delivered the Purchaser's note to the Petitioner, the Petitioner having previously notified the maker of its obligation to make the required payment on said note and requesting the maker to execute a new series of four notes as aforesaid, and as provided by Exhibit "A". The Petitioner credited "Cash" with its check so issued and charged the maker of the note in its "Accounts Receivable" account. Upon the execution by the Purchaser of a new series of notes and the receipt thereof by the Petitioner, it immediately and within the same year, discounted these notes at its bank at their face value, and the process outlined above was repeated for each series of notes until the entire purchase price had been paid.
3. On May 6, 1918, the Petitioner executed a general loan and collateral agreement with the Chase National Bank of New York in the form and manner set forth in Exhibit "C" attached*875 hereto and made a part hereof. Pursuant to said agreement, the Petitioner, from time to time, made applications for loans from said Chase National Bank and delivered to said Chase National Bank customers' notes as collateral security.
The method of handling these transactions with respect to the one, two and three months notes was as follows:
From ten days to three weeks before maturity of each customer's note, the bank withdrew this note from the collateral, at the same time charging the "Cash Deposit" account of the Petitioner with the face amount of the note plus interest to maturity, and palced the note in its usual collection channels. At the same time, the bank also credited on its books a corresponding amount to the Petitioner's Loan account. The amount of the notes above mentioned, plus interest, when and as collected by the bank, was credited by the Bank to the Petitioner's Deposit Account. If there was a default by the customer in the payment of any note, said note was returned to the Petitioner, which proceeded to attempt its collection in the same manner as described with respect to the notes covered by Paragraph 2 above.
With respect to the four months' note, *876 which in practically every instance was made payable at the office of the Petitioner, the Bank for a part of the period of the three years at issue, forwarded these notes to its correspondent, the Mellon National Bank of Pittsburgh, and the Petitioner paid them there by its check covering the face amount of the note plus interest to maturity. At other periods during the same time, the Petitioner forwarded its check to the Chase National Bank prior to the maturity of the note in payment of the same at its face amount plus interest.
* * *
*934 Of these notes deposited * * * with the Chase National Bank during the respective years, a considerable and unascertainable number and face amount thereof was paid by the makers prior to the close of the said years. There was also, in many instances, a renewal of the four months' notes by acceptance of a new series of notes, some of which were disposed of as set forth in paragraph 2, and some of which were disposed of as set forth in this paragraph * * *.
At the end of each month a bill was received from the Chase National Bank for the amount of interest due by the Petitioner for the preceding month on daily balances of the collateral*877 loans made by the bank on customers' paper, which bill the Petitioner paid by its check.
During the year 1920, the Petitioner also secured a loan in the amount of $51,068.04 from the First National Bank at Pittsburgh, on a demand note signed by an individual maker and endorsed by the Company, giving the bank as collateral, customers' notes which amounted with interest to maturity to the amount loaned. The method of handling this loan was as follows:
Those customers' notes which matured in one, two, and three months were forwarded by the bank for collection through its usual channels, and if paid, credit was given by the bank to the Petitioner's Loan Account. If any note was defaulted by the customer, Petitioner gave the bank its check therefor and proceeded to attempt collection from the customer. The four-month notes were, on or before maturity, lifted from the bank by the Petitioner paying for the same by check, at which time the Bank applied a corresponding credit to Petitioner's Loan Account. The Petitioner itself then proceeded to arrange renewal with the customer, as previously outlined in Paragraph 2.
The petitioner accounted on its books for the transactions described*878 herein in exactly the same manner as described in Paragraph 2.
4. The Petitioner's books of account were kept upon the accrual basis of accounting for all years. Its original returns for the years 1916 and 1917 were filed in accordance with the books, the income reported therein being computed upon the accrual basis of accounting.
For the year 1918 the Petitioner changed its method of reporting income and filed its original return and computed the income shown therein upon the installment basis of accounting.
The income for the years 1919 and 1920 was likewise reported in the original income tax returns for such years upon the installment basis of accounting.
While the Petitioner's books were kept for all years upon the accrual basis of accounting, they contained sufficient information to determine the income on the installment basis.
5. The consolidated net taxable income for the years 1918, 1919 and 1920, computed upon the accrual basis of accounting, is as set forth in the deficiency letter and is in the amounts of $531,136.49, $963,105.47 and $1,135,766.85, respectively.
6. It is hereby stipulated and agreed between the parties hereto that if it should be*879 judicially determined that there should not be included in taxable income for the respective years covered by this Appeal any part of the profit on sales included in the total face amount of notes which had not been paid by the makers thereof at the close of the respective taxable years, either to the Petitioner or the bank, or banks, with which such notes had been discounted and/or deposited as collateral security for loans, the net taxable income was $286,331.64, $787,704.42 and $935,791.72 for the years 1918, 1919 and 1920 respectively, except as the amount for 1918 may be modified by the stipulation under Paragraph 7.
*935 7. For the purpose of the application of the provisions of Section 705 of the Revenue Act of 1928, it is hereby stipulated and agreed by and between the parties hereto that the profit on sales made in prior years which was included in the face amount of notes collected in the year 1918 is $154,419.61.
It is further stipulated that the foregoing amount is not included in the sum of $531,136.49 set forth in paragraph 5 above or in the sum of $286,331.64 stipulated in paragraph 6 hereof.
In addition to the stipulation, the following facts were established*880 by the testimony of witnesses:
During the taxable years petitioner carried a deposit account in the Diamond National Bank of Pittsburgh, and the bank discounted its customer's notes from time to time. This bank did not check the ratings of the makers of the notes, but discounted them on the strenght of F. F. Nicola's guarantee. Any paper taken was guaranteed or endorsed by Nicola. The bank would not have discounted a note on the endorsement of the petitioner corporation.
During the taxable years none of the notes taken by petitioner from its customers were disposed of to finance companies, or in any other way except as stated in the stipulation. The Colonial Trust Co. discounted notes on the faith and credit of the petitioner and of Nicola.
OPINION.
TRAMMELL: The issue here is whether petitioner is entitled, under the facts above set forth, to have its tax liability determined on the installment basis of reporting its income for the taxable years, under the provisions of sections 212(d) and 1208 of the Revenue Act of 1926. 1 The facts were stipulated by the parties or established by undisputed testimony, and the question presented is purely one of law.
*881 *936 During the taxable years the petitioner sold printing machinery on the installment plan, taking a small cash payment and four negotiable promissory notes for the agreed sale price, under the circumstances detailed in our findings of fact.
Petitioner contends that under those facts it is entitled to have its tax liability determined on the installment basis, according to the provisions of the quoted statute, while respondent asserts that petitioner is not entitled to such basis, but that in any event by converting the installment notes into cash petitioner received the entire profit from its sales in each year, and is taxable on the full amount thereof, whether or not the sales were originally made on the installment plan.
In , we held that where the taxpayer sold automobile trucks on a basis of 25 percent cash and the balance in deferred payment notes and immediately transferred the notes to a finance company for their face value, the entire profit should be reported as income in the year of sale, and that, while the sales may have been on the installment basis, they became closed transactions and income*882 arose upon receipt from the finance company of the full purchase price. This decision, as well as our later decisions following it, was predicated upon the theory that the proceeds from the sales of the installment notes at face value effected realization of the taxpayer's entire profit on the original sales. ; ; affd. (C.C.A., 2d Cir.), ; ; reversed (C.C.A., 2d Cir.), ; ; affd. (App. D.C.), ; ; reversed (C.C.A., 9th Cir.), .
In reversing our decisions in , and , the courts took the view (1) that the taxpayer's privilege of reporting upon the installment basis depends upon the transaction between the taxpayer and the purchaser, and is not in any wise conditional upon any subsequent disposition that may be made by the taxpayer of the installment*883 notes; and (2) that the transactions by which the purchase notes are sold, discounted or otherwise disposed of are separate and independent, and themselves form the basis for a return of profit or loss.
In both cases, however, the courts held in effect that while the original transactions constituted installment sales and the taxpayers were entitled to report their profits on that basis, nevertheless to the extent that the installment notes were sold or disposed of at face value during the taxable period, profit was realized from such transactions in amounts equal to the profit represented by the notes so *937 disposed of and must be included in the taxable income for that year. Accordingly, our decisions were reversed only to the extent of requiring that the profit represented by notes not sold or disposed of in the taxable period should be accounted for on the installment basis.
It would follow under the principle established by those decisions that where all the installment notes are disposed of at face value in the taxable year, such transactions give rise to profit in exactly the same amount as that derived from the original sale and represented by the installment*884 notes.
In the case of , the court said:
Therefore, as we interpret section 212(d), the privilege of reporting on the installment basis depends upon the transaction between the vendor and purchaser of the land during the taxable period; it is not made conditional upon what disposition the vendor may make of the purchaser's evidences of indebtedness by transactions with third parties during the taxable period in which the land was sold. Such transactions are separate and independent and will themselves be the basis for a return of profit or loss.
In the case of , the court said:
* * * We * * * therefore hold that even though petitioner remained liable as guarantor on the notes transferred, the gain included in the installment notes [transferred] for the real estate at their face value should have been included in petitioner's income tax return for the year 1927.
Petitioner seeks to distinguish the case at bar from those above cited because of the fact that it remained contingently liable as endorser or guarantor on the notes, and because the notes were discounted or hypothecated for*885 loans largely on the faith and credit of petitioner's principal stockholder, Nicola. This position, we think, is not well taken. More or less the same argument was advanced in some or all of the cited cases. The principle is well established that "a taxpayer should return income in the year in which it is received without regard to the fact that there may be claims against it not determinable until a subsequent year." , supra, citing ; ; . And in the Alworth-Washburn Co. and Robinson cases, supra, it was specifically held that the contingent liability of the taxpayers on the transferred installment notes did not prevent the profits realized from being taxed in the years of receipt.
The present case is distinguishable from those above cited only by the fact that the four-month notes discounted at the banks were reacquired by the petitioner on or before the due dates for the purpose of renewal*886 by the acceptance of a new series of notes, which new notes were immediately discounted at the banks. However, there is nothing to show that there was any different legal relationship between *938 the petitioner and the banks than in the case of ordinary discounted notes. The petitioner received in money the full face value of all the notes, and was secondarily liable thereon as endorser. It was legally liable to the banks with respect thereto only in the event the makers did not pay.
We think the distinction above referred to is insufficient to justify computation of the petitioner's tax liability on the installment basis. The first three notes of each series were treated as ordinary discounted notes. The fourth note of each series, being for the remaining balance of the purchase price, was taken up and a new series of notes by the same maker substituted therefor. This process was repeated peated until final payment was made by the purchaser. In our opinion this method of handling the notes was no different in any material respect from ordinary discounted notes.
Hence, we held that as to the installment notes discounted by petitioner, and in respect of which it*887 thereby derived gain equal to the entire profit from its sales in each year, petitioner is not entitled to have its tax liability determined on the installment basis.
Petitioner further contends that, whatever may be the decision as to the "discounted" installment notes, it is in any event entitled to report on the installment basis in respect of the notes on which it obtained "loans."
Whether or not petitioner's contention on this point is sound, as a matter of law, it is unnecessary for us to decide here. Even if there be any legal distinction between loans and discounts materially affecting petitioner's tax liability, we can afford it no relief on that account for the reason that the record does not disclose what amount of profits was represented by the notes on which it obtained "loans" from the banks and which remained unpaid at the end of the taxable years. The parties have stipulated that:
Of these notes deposited * * * with the Chase National Bank during the respective years, a considerable and unascertainable number and face amount thereof was paid by the makers prior to the close of said years. There was also, in many instances, a renewal of the four months' notes*888 by acceptance of a new series of notes, some of which were disposed of as set forth in paragraph 2 [discounted], and some of which were disposed of as set forth in this paragraph [deposited as collateral for loans] * * *.
As to those notes paid by the makers prior to the close of the respective years in which deposited as collateral for loans, or which were renewed by acceptance of a new series of notes which were thereupon discounted instead of being redeposited, petitioner received all of its profit in those years and is not entitled to the installment basis. And if we should hold that petitioner is entitled to report on the installment basis in respect of the notes deposited for loans and not paid by the makers or renewed and discounted during the taxable years, it is apparent that there is no basis for determining *939 the number and face amount of such notes which remained as security for the payment of the "loans."
In the instant case, since the number and face amount of the notes deposited as security for loans which were paid or renewed and discounted prior to the close of the taxable years are not ascertainable, the facts necessary to establish what the true*889 deficiency is are not susceptible of proof.
Conceding, for the sake of argument, that the respondent's determination is erroneous in part with respect to the installment notes deposited as collateral security for loans, to the extent that such notes were not paid or renewed and discounted during the taxable years, it is stipulated that a basis for apportionment is unascertainable. We are then left to find that the entire deficiency is due, or that no deficiency is due, with respect to the notes deposited as collateral for loans. We know that there is some deficiency with respect thereto, and hence we can not say that there is no deficiency. Yet the deficiency determined by the respondent may not be correct, in that it may, to some unascertainable extent, be excessive.
By order of May 3, 1935, this proceeding was set down for further hearing to enable the parties to submit further evidence to show the number and amount of notes deposited as collateral security which were paid during the respective taxable years, and on May 15, 1935, the parties filed a stipulation stating that it had been found that there is no evidence available tending to establish the facts in question. *890 In this situation we uphold the deficiency. The fault lies more with the taxpayer than with the Commissioner. The Government should not be made to suffer because the taxpayer did not keep proper records to show its correct tax liability. On this principle, unexplained bank deposits are held taxable in the absence of proof of the actual net income. ; ; ; ; . And in , we held that where a taxpayer failed to prove facts from which the true deficiency could be determined by the installment sales method, the Commissioner's determination by another method must stand.
In , the Court said with respect to a situation somewhat similar to the instant case:
We can not agree that the impossibility of establishing the specific fact, made essential by the statute as a prerequisite to the allowance of a loss, justifies a decision for the taxpayer based upon*891 a consideration only of the remaining factors which the statute contemplates. * * * The impossibility of proving a material fact upon which the right to relief depends simply leaves the claimant upon whom the burden rests with an unenforceable claim, a misfortune to be borne by him, as it must be borne in other cases, as the result of a failure of proof.
*940 Respondent's action on the issue submitted for decision is approved.
The parties have stipulated that the consolidated net taxable income for the taxable years, computed on the accrual basis of accounting, is as set forth in the deficiency letter, which amounts will be reflected in the redetermination of the deficiencies.
In respect of the issue of special assessment, since it appears from the record that the parties agree that the petitioner is entitled to have its profits tax determined as provided in section 328 of the Revenue Act of 1918, the only issue is as to the correct amount thereof.
Reviewed by the Board.
Further proceedings will be had under Rule 62(d).
Footnotes
1. SEC. 212. (d) Under regulations prescribed by the Commissioner with the approval of the Secretary, a person who regularly sells or otherwise disposes of personal property on the installment plan may return as income therefrom in any taxable year that proportion of the installment payments actually received in that year which the total profit realized or to be realized when the payment is completed, bears to the total contract price. In the case (1) of a casual sale or other casual disposition of personal property for a price exceeding $1,000, or (2) of a sale or other disposition of real property, if in either case the initial payments do not exceed one-fourth of the purchase price, the income may, under regulations prescribed by the Commissioner with the approval of the Secretary, be returned on the basis and in the manner above prescribed in this subdivision. As used in this subdivision the term "initial payments" means the payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable year in which the sale or other disposition is made.
SEC. 1208. The provisions of subdivision (d) of section 212 shall be retroactively applied in computing income under the provisions of the Revenue Act of 1916, the Revenue Act of 1917, the Revenue Act of 1918, the Revenue Act of 1921, or the Revenue Act of 1924, or any of such Acts as amended. Any tax that has been paid under such Acts prior to the enactment of this Act, if in excess of the tax imposed by such Acts, as retroactively modified by this section, shall, subject to the statutory period of limitations properly applicable thereto, be credited or refunded to the taxpayer as provided in section 284. ↩