1986 Tax Ct. Memo LEXIS 495 | Tax Ct. | 1986
Petitioner, a State-regulated natural gas utility company, collected customer deposits from customers who did not have established credit records. An order by the Georgia Public Service Commission required petitioner to refund a customer deposit if the customer established a record of prompt payment for a period of 24 months. If service was terminated before a customer established such a record, then petitioner's practice was to first apply the customer deposit to any outstanding balance in the customer's account and then refund any remaining amount of the customer deposit to the customer.
(2) The customer deposits are advance payments (
(3) Treatment of the customer deposits as advance payments constitutes a change in petitioner's method of accounting for that item. Respondent's
MEMORANDUM FINDINGS OF FACT AND OPINION
CHABOT,
After settlement of other issues, the issues for decision 21986 Tax Ct. Memo LEXIS 495">*497 are as follows: (1) Whether customer deposits received by petitioner are includable in petitioner's income. (2) If so, then (a) in what years the payments are includable, and (b) whether there has been a change of accounting method which results in a
FINDINGS OF FACT
Some of the facts have been stipulated; the stipulations and the stipulated exhibits are incorporated herein by this reference.
When the petition was filed in the instant case, petitioner's principal office and place of business was in Columbus, Georgia.
Petitioner is an intrastate public utility company regulated by the Public Service Commission of Georgia (hereinafter sometimes referred to as "the PSC"). Petitioner's primary business is, and during the years involved in the instant case was, the acquisition, distribution, and sale of natural gas to residential, commercial, and industrial customers in that part of the metropolitan Columbus, Georgia, area that is in Georgia.
Petitioner maintains its books and prepares its Federal corporate income tax returns using the accrual method of accounting. Petitioner also maintains its books of accounts 4 in accordance with the Uniform System of Accounts as prescribed by the National Association of Railroad and Utility Commissioners 5 (hereinafter sometimes referred 1986 Tax Ct. Memo LEXIS 495">*498 to as "NARUC"). NARUC's Uniform System of Accounts follows the Federal Power Commission's 6 system of accounts with respect to liquid natural gas properties.
During the years in issue in the instant case, petitioner required customer deposits from any customer who did not have an established credit record with petitioner. 71986 Tax Ct. Memo LEXIS 495">*499 Petitioner would not furnish gas to a customer who was required to make a customer deposit if the customer could not make such a deposit or get someone to guarantee payment of the bill. Petitioner required these customer deposits in order to insure payment of the customer's final bill of account. During the years in issue in the instant case, petitioner had customer deposits from about two-fifths of its total residential customers.
The amount of the customer deposit required by petitioner rose over the years. During the period from 1971 until 1975 or 1976, the required deposit generally was $25. This amount was designed to cover a 2-month bill. The generally required amount was increased to $35 at some point in 1975 or 1976. 8
When a customer made a customer deposit with petitioner, the customer signed a document entitled "CUSTOMER'S DEPOSIT RECEIPT". This document contains the following agreement:
As security for the performance of a certain contract for service supplied at the above address, or continuation of similar service at other addresses. Said amount to be returned at date of discontinuance, provided all bills are paid to that date and all terms of said contract have been duly complied with. Interest to be paid on this amount at the rate and in the manner 1986 Tax Ct. Memo LEXIS 495">*500 prescribed by the Georgia Public Service Commission.
This receipt is not transferable, and must be returned when refund of deposit is requested, and is void when the deposit is refunded or applied on account.
This Receipt is Not Negotiable 9
Account 235 of NARUC's Uniform System of Accounts provides that the customer deposits account maintained by utility companies "shall include all amounts deposited with the utility by customers as security for the payment of bills." This account is a current liability account. During the years in issue in the instant case, customer deposits received by petitioner were not reflected in petitioner's books as income or included in taxable income, but were carried on its books as liabilities.
When petitioner received the customer deposits, it deposited them in its general bank account, thus commingling the customer deposits funds with petitioner's other funds. Until and unless it came time to refund the customer's customer deposit, petitioner's use of the customer deposit funds was unrestricted.
On December 16, 1937, the PSC first prescribed a standardized rate of interest 1986 Tax Ct. Memo LEXIS 495">*501 which electric and gas utility companies had to pay to customers on their customer deposits. In early 1971, the PSC considered prescribing a higher rate of interest on all customer deposits held by electric and gas utility companies operating in Georgia. On March 24, 1971, the PSC held a hearing on this matter. Petitioner was one of the utility companies which appeared at the PSC's hearing in opposition to the proposed interest rate increase. Testimony introduced by petitioner at this hearing showed that some of the customer deposits and the accumulated interest thereon were applied to reduce the net charge-off of uncollectable final bills.
In an order dated May 26, 1971, regarding the increase in interest rate, the PSC stated that it had received numerous complaints and charges alleging that the utility companies used the customer deposits as a source of low-interest capital funds. In response to this, the PSC stated in its order the following:
While intentional accumulation by a utility company of large sums in the customer deposit account, without regard to the original purpose for which this account is provided, would indeed constitute misuse of such funds, the use of those 1986 Tax Ct. Memo LEXIS 495">*502 funds made available in the normal course of business is, and has been for many years, treated by regulatory agencies as consistent with the public interest and with prudent utility management. Additionally, a blanket customer deposit policy is not intended as a substitute for the responsibility of a utility's management to protect itself diligently against unnecessary loss or to relax its efforts to collect all funds due on dilinquent accounts. There is at present no evidence before this Commission of any such violations by the utility companies involved in this proceeding.
The PSC ordered that the then-current practices of utility companies relating to customer deposit accounts be changed as follows:
Petitions for rehearing, reconsideration, and oral argument were filed by two utility companies. The PSC granted the petitions and a rehearing was held on July 19, 1971. The 1986 Tax Ct. Memo LEXIS 495">*505 following points were raised by the utility companies at the rehearing:
1. There were various mechanical and procedural problems related to implementing the May 26, 1971, order by that order's effective date--July 1, 1971.
2. Automatic refunds should be allowed to be made to customers on the anniversary date of their deposits during 1972.
3. Interest should be paid on deposits only when held for six months or more.
4. The refund provision should apply only to residential customers and not to industrial and commercial customers.
On reconsideration, the PSC issued another order (dated August 4, 1971) replacing the May 26, 1971, order. The August 4, 1971, order provides in pertinent part as follows:
Petitioner fully refunded a customer's deposit, plus any accrued interest, in only two situations. The first situation was when the customer established a record of 24 months of prompt payments. The full refund in this situation was required under the PSC's August 4, 1971, order. In this first situation, a full refund was made even though service continued. The second situation was when the customer terminated 1986 Tax Ct. Memo LEXIS 495">*508 service, while the customer deposit was being held, 10 and the customer had fully paid the final bill.
Petitioner partially refunded a customer's deposit, plus any accrued interest, when the service was terminated 11 and there was an outstanding bill for services. In such a situation, petitioner applied enough of the customer deposit to cover the unpaid balance and, pursuant to the PSC's August 4, 1971, order, was required to refund any remaining amount to the customer.
In a relatively small percentage of cases, a customer's deposit was not claimed. Under Georgia law, such unclaimed deposits escheat to the State of Georgia after 15 years. 121986 Tax Ct. Memo LEXIS 495">*509
The receipts, refunds, and credits regarding petitioner's customer deposit account for taxable years 1971 through 1975, are shown in table 1:
Table 1
Customer | Customer | ||||
Deposits | Customer | Customer | Deposits | Customer Deposits | |
Taxable | Beginning | Deposits | Deposits Refunds | Ending | Balance Increase |
Year | Balance | Receipts | and Credits | Balance | or (Decrease) |
1971 | $229,905 | $235,505 | $ (218,640) | $246,770 | $16,865 |
1972 | 246,770 | 192,720 | (207,070) | 232,420 | (14,350) |
1973 | 232,420 | 181,395 | (172,305) | 131986 Tax Ct. Memo LEXIS 495">*510 241,710 | 9,290 |
1974 | 241,710 | 167,805 | (168,265) | 241,250 | (460) |
1975 | 241,250 | 172,370 | (164,740) | 248,880 | 7,630 |
On its income tax returns for taxable years 1971 through 1975, petitioner reported its cost of goods sold as shown in table 2:
Table 2
Cost of Goods Sold | TAXABLE YEARS | ||
Categories Listed on | |||
Petitioner's Tax Returns | 1971 | 1972 | 1973 |
Cost of gas appliances | |||
sold | $ 324,726.73 | $ 430,192.87 | $ 305,369.89 |
Natural gas purchases | 5,003,407.88 | 5,211,836.75 | 4,715,705.27 |
Propane gas expenses | 60,077.24 | 16,816.51 | 34,289.54 |
Other gas supply expenses | 3,207.44 | 2,603.77 | 3,326.80 |
Other storage expenses | |||
TOTAL | $5,391,419.29 | $5,661,449.90 | $5,058,691.50 |
Cost of Goods Sold | TAXABLE YEARS | |
Categories Listed on | ||
Petitioner's Tax Returns | 1974 | 1975 |
Cost of gas appliances | ||
sold | $ 270,202.03 | $ 337,388.33 |
Natural gas purchases | 5,815,768.54 | 7,051,996.04 |
Propane gas expenses | 6,044.68 | 1,142.40 |
Other gas supply expenses | 2,566.28 | 5,625.38 |
Other storage expenses | 75,181.59 | |
TOTAL | $6,094,581.53 | $7,471,303.74 |
The primary purpose of the customer deposits is prepayment for goods and services.
OPINION
We must decide whether petitioner's customer 1986 Tax Ct. Memo LEXIS 495">*511 deposits are includable in petitioner's taxable income. If we conclude they are, then we must also decide in what taxable year they are to be included and whether a change in method of accounting has occurred and has triggered an adjustment under
Respondent contends that petitioner's customer deposits are includable in petitioner's income because their primary purpose was to act as a prepayment for goods and services. Respondent further contends that the taxable year of inclusion is controlled by
Petitioner contends that its 1986 Tax Ct. Memo LEXIS 495">*512 customer deposits are not includable in income. Petitioner argues that three elements in the instant case are enough "to invalidate the characterization of the customer deposits as income." Firstly, the customer deposits were required of only about two-fifths of petitioner's customers. Secondly, the customer deposits were "required only for lack of credit rating, retained * * * only until creditworthiness had been established, and applied to the payment of gas bills in a minority of cases." Thirdly, the PSC ordered the customer deposits to be refunded after a customer had established a record of 24 months of prompt payments. As to the taxable year of inclusion, petitioner contends that the customer deposits do not meet the definition of "advance payment" under
We agree in large part with respondent.
The Court of Appeals 1986 Tax Ct. Memo LEXIS 495">*513 for the Eleventh Circuit, to which an appeal in the instant case would lie, considered the issue of includability of customer deposits in income in a case factually similar to the instant case in
The Court of Appeals concluded that customer deposits to gas utility companies often serve mixed purposes--i.e., as prepayments for goods and services and also as security for the performance of nonincome-producing covenants or against property damage.
Both parties agree that the opinion of the Court of Appeals in
The following facts which we have found,
1. The parties stipulated (and we have found,
2. The document which the customer signed when making a customer deposit contained an agreement which stated, in part, that the customer 1986 Tax Ct. Memo LEXIS 495">*515 deposit was security for the performance of the contract of service between petitioner and the customer. The agreement further indicated that the customer deposit could be applied against the customer's account. The agreement does not mention whether the customer deposit could be applied toward property damage or any other nonincome-producing covenant.
3. Under NARUC's Uniform System of Accounts, the account for customer deposits is to include "all amounts deposited with the utility by customers as security for the payment of bills."
4. Petitioner testified before the PSC that, in fact, it did apply customer deposits to reduce the charge-off of uncollectible final bills.
5. As part of petitioner's policy of refunding customer deposits, in certain cases it applied the customer deposit toward an unpaid final bill, refunding any remainder.
Petitioner contends that three factors distinguish the instant case from
As we understand the Court of Appeals' opinion, customer deposits must be categorized either as prepayment for goods and services, on the one hand, or as security for the performance of nonincome-producing convenants or against property damage, on the other hand. The Court of Appeals' test does not allow for other categories. 161986 Tax Ct. Memo LEXIS 495">*517 Thus, it is not enough for petitioner to show that the distinctions in the instant case mean that there is less than a good fit for the customer deposits in the prepayment category. Petitioner must also show that as a result of the distinctions, there is a better fit in the security category.
To begin with, based on the record in the instant case, we are unable to find that the primary purpose of the customer deposits is as security against property damage or for performance of nonincome-producing covenants. We note, for example, an absence of any mention of this possible purpose in the agreement contained in the document a customer signed upon making a deposit, as well as in the PSC order.
Further, we do not see how the three distinctions petitioner points to show that the purpose of the customer deposits fit better in the nonincome-producing category rather than the income category. In fact, as to the third distinction raised by petitioner--i.e., that the customer deposits were subject to refund under order by the PSC--the Court of Appeals concluded that the 1986 Tax Ct. Memo LEXIS 495">*518 possibility of a refund under certain circumstances was not enough to exclude the customer deposits from income.
Petitioner contends that it treats the customer deposits as liabilities on its books, pursuant to the NARUC Uniform System of Accounts, and that this is inconsistent with taxing the customer deposits as income. The Court of Appeals of the Eleventh Circuit specifically rejected this argument in
Petitioner contends that the customer deposits, even if they are advance payments, are not income so long as petitioner's right to retain them is contingent. The Court of Appeals for the Eleventh Circuit specifically rejected this argument in
We conclude that the primary purpose of the customer deposits was securing prepayment for goods and services; thus, the customer deposits are includable in petitioner's income.
We hold for respondent on this issue.
We have held 1986 Tax Ct. Memo LEXIS 495">*519 that the customer deposits are includable in petitioner's gross income. Under section 451(a), 17 the customer deposits received during a year are includable in petitioner's income for that year, unless, under petitioner's method of accounting, the customer deposits are "to be properly accounted for as of a different period."
Respondent contends that the customer deposits are advance payments (as defined in
Petitioner maintains that the customer deposits do not meet the definition of advance payments under the regulation. 18 Petitioner does not, however, suggest when the customer deposits are includable 1986 Tax Ct. Memo LEXIS 495">*520 in income if we conclude that they are not advance payments under
The definition of advance payments, under
We consider these requirements seriatim. Firstly, in substance the customer deposits were looked to as payment for any unpaid final bill for the sale and purchase of gas under the agreement between petitioner and the customers. As we found,
Secondly, under both the PSC August 4, 1971, order and petitioner's refund policy, customer deposits 1986 Tax Ct. Memo LEXIS 495">*523 could be applied to unpaid bills for the sale and purchase of gas. It was more than just "a mutually covenient way of closing out the account", as petitioner contends. In fact, as we have found,
Thirdly, the parties have stipulated (and we have found) that petitioner's primary business was "the acquisition, distribution, and sale of natural gas to * * * customers". On its income tax returns for each of the years in issue, petitioner reported costs of goods sold and each year substantially all (upwards of 92 percent) was described by petitioner as "Natural gas purchases". (See table 2,
Petitioner contends that "goods" means only "goods on the taxpayer's shelves or in his warehouse or to be manufactured by the taxpayer or by someone 1986 Tax Ct. Memo LEXIS 495">*524 else and sold through the taxpayer to the customer in the future, as in Example 2 under Reg.
Firstly, the language of the regulation is not so limited. Secondly, although
We conclude that the third part of the definition is satisfied and, thus, the customer deposits in the instant case constitute advance payments for purposes of
Respondent, in the notice of deficiency, determined that the customer deposits were advance payments for inventoriable goods and so qualified for the limited deferral from inclusion in income provided under
Petitioner contends that if we conclude that respondent is correct as to the taxable year of inclusion, then because of petitioner's refund policy "we would be presented with the anomolous [sic] situation that * * * petitioner would be required to report as income
We hold for respondent on this issue.
Respondent contends that his "change in petitioner's treatment of customer deposits constitutes a change in petitioner's method of accounting, requiring adjustments pursuant to
Petitioner does not contest (and thus, apparently concedes), that if we conclude (as we have), that the customer deposits are includable in income as advance payments, then a change in petitioner's method of accounting occurred and an adjustment under
totally overlooked the nature of the customer deposits as individual transactions. Pursuant to the order of [PSC], on or immediately following January 1, 1972, petitioner refunded all deposits to customers having satisfactory payment records for more than 24 months, and continued such refunds through the remainder of FYE 8/31/72. Thus, with the negligible exception of deposits of customers with unsatisfactory payment records, no deposit on hand on 8/31/72 had been held by the [petitioner] for more than 24 months, i.e. since September 1, 1970. Petitioner earnestly maintains that the customer deposits are not advance payments at all; but if they should be held to be income, none of the customer deposits on the books prior to 9/1/70 can properly be considered, and the most that should be found to be attributable to the deposits on hand on 8/31/72 would be the excess of the $232,420 on hand at 8/31/72 over the balance on September 1, 1970 of $229,905. [See table 1,
We agree essentially with respondent.
To calculate the
Petitioner's detailed approach would have the effect of allowing petitioner to deduct the September 1, 1970, customer deposit balance of $229,905 even though petitioner had never taken these customer deposits into account on either an individual or net basis. If petitioner's general approach were correct, then the entire August 31, 1972, customer deposit balance of $232,420 should be taken into account in petitioner's taxable year 1973, since all of this amount was still on hand at the beginning of this taxable year and none of this amount had previously been taken into income.
We do have one problem, however, with respondent's 1986 Tax Ct. Memo LEXIS 495">*533 calculation--the year respondent used for purposes of the opening balance. If a change in method of accounting is initiated by respondent, rather than initiated by the taxpayer, then the last clause of
We hold for respondent on this issue, with 1986 Tax Ct. Memo LEXIS 495">*534 the above-described modification. 24 To reflect the foregoing and the settlement of other issues,
Footnotes
1. Unless indicated otherwise, all references to taxable years are to petitioner's fiscal years ending August 31.↩
2. The amount of petitioner's allowable net operating loss carryback from taxable year 1974 to taxable year 1971 depends both on the issue for decision and on the settled issues.
3. Unless indicated otherwise, all section references are to sections of the Internal Revenue Code of 1954 as in effect for the years in issue.↩
4. So stipulated. The parties have not enlightened us as to what differences there are between petitioner's books and petitioner's books of accounts. ↩
5. This organization is now known as the National Association of Regulatory Utility Commissioners. ↩
6. This organization is now known as the Federal Energy Regulatory Commission.↩
7. A customer who wanted to establish a credit record with petitioner could give petitioner credit information which petitioner would then check. If a credit record was established, then the customer could obtain service without making a customer deposit.
8. Petitioner has required customer deposits at least as far back as its taxable year 1953. Originally, the amount required was $5. By 1968, the amount had risen to $15. By 1970, the amount had risen to $20.↩
9. This phrase is printed in slightly larger and slightly bolder capital letters.↩
10. A customer's deposit was held as long as the customer had not established a record of 24 months of prompt payment.↩
11. Service might be terminated either voluntarily by the customer (e.g., when the customer moved) or involuntarily by petitioner (e.g., when there was a bad payment record and collection efforts were unsuccessful).↩
12. The parties do not explain, and the record does not show, when this 15-year period begins to run, nor does the record show whether any such escheats were properly accrued during any of the years in issue. If this matter affects the amount of any deficiency for any of these years, then the parties are to resolve this matter as part of the computation under Rule 155.
Unless indicated otherwise, all rule references are to the Tax Court Rules of Practice & Procedure.↩
13. So stipulated. Since the taxable year 1973 beginning balance ($232,420) plus the receipts ($181,395) less the refunds and credits ($172,305) equal $241,510--$200 less than the stipulated ending balance--it is evident that there is an error. The record in the instant case does not enable us to determine whether the error lies in the receipts amount, the refunds and credits amount, or the ending balance amount. (If the error is in the ending balance amount, then the balance increase for the year would be $9,090.) This discrepancy does not affect our analysis,
infra.↩ The parties are directed to resolve this matter as part of the computation under Rule 155.14. Section 61(a) provides, in relevant part, as follows:
SEC. 61. GROSS INCOME DEFINED.
(a) General Definition.--Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items:
* * *
(2) Gross income derived from business;↩
15. As to the significance of petitioner's commingling of the customer deposit funds with its other funds, and petitioner's unrestricted use of the customer deposit funds, see
, 689 F.2d 943">948↩ n. 7 (CA11 1982).City Gas Co. of Florida v. Commissioner, 689 F.2d 943">689 F.2d 94316. See
, 973, 53 P-H T.C. Memo par. 84,044).City Gas Company of Florida v. Commissioner, T.C. Memo. 1984-44 (47 T.C.M. (CCH) 971">47 T.C.M. 971↩17. SEC. 451. GENERAL RULE FOR TAXABLE YEAR OF INCLUSION.
(a) General Rule.--The amount of any item of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under the method of accounting used in computing taxable income, such amount is to be properly accounted for as of a different period.↩
18. Petitioner does not challenge the validity of the regulation and we see no basis for doing so in the instant case. See, e.g.,
, 750↩ (1969).Bingler v. Johnson, 394 U.S. 741">394 U.S. 74119.
Section 1.451-5(a), Income Tax Regs. , provides, in relevant part, as follows:Section 1.451-5 . Advance payments for goods and long term contracts.(a)
Advance payment defined. (1) For purposes of this section, the term "advance payment" means any amount which is received in a taxable year by a taxpayer using an accrual method of accounting for purchases and sales * * * pursuant to, and to be applied against, an agreement:(i) For the sale or other disposition in a future taxable year of goods held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, * * *
(2) For purposes of subparagraph (1) of this paragraph:
(i) The term "agreement" includes * * * (b) an agreement which obligates a taxpayer to perform activities described in subparagraph (1)(i) * * * of this paragraph and which also contains an obligation to perform services that are to be performed as an integral part of such activities; and
(ii) Amounts due and payable are considered "received".↩
20. The amounts used by respondent were the ending balances of the customer deposits accounts. (See table 1,
supra.↩ ) The ending balance figure is calculated by taking the opening balance of the customer deposits, adding to it the amounts of customer deposits received during the fiscal year, and subtracting from it the amounts of customer deposits refunded or credited to customers.21. Respondent determined that the first year for which petitioner did not correctly report the customer deposits as advance payments (and for which the statute of limitations period evidently has not run) was taxable year 1971. Under
section 1.451-5(c), Income Tax Regs. , however, the first year that petitioner's taxable income was changed was taxable year 1973, because of the 2-year deferral rule. The year of the change in the taxpayer's method of accounting is defined as "the taxable year for which thetaxable income of the taxpayer iscomputed under a method of accounting different from that used for the preceding year."Section 1.481-1(a)(1), Income Tax Reg.↩ (emphasis added). Accordingly, in the instant case the year of change is taxable year 1973 (not 1971)--which is what respondent determined.22.
SEC. 481 . ADJUSTMENTS REQUIRED BY CHANGES IN METHOD OF ACCOUNTING.(a) General Rule.--In computing the taxpayer's taxable income for any taxable year (referred to in this section as the "year of the change")--
(1) if such computation is under a method of accounting different from the method under which the taxpayer's taxable income for the preceding taxable year was computed, then
(2) there shall be taken into account those adjustments which are determined to be necessary solely by reason of the change in order to prevent amounts from being duplicated or omitted, except there shall not be taken into account any adjustment in respect of any taxable year to which this section does not apply unless the adjustment is attributable to a change in the method of accounting initiated by the taxpayer.↩
23. The opening balance that respondent used in the notice of deficiency was as of September 1, 1953, or the beginning of petitioner's taxable year 1954.
24. Petitioner has not claimed the benefits of the ameliorative provisions of subsections (b) and (c) of
section 481↩ , and so we do not address the applicability of these provisions.