Respondent Indianapolis Power and Light Co. (IPL), a regulated
Indiana utility and an accrual-basis taxpayer, requires customers
having suspect credit to make deposits with it to assure prompt
payment of future electric bills. Prior to termination of service,
customers who satisfy a credit test can obtain a refund of their
deposits or can choose to have the amount applied against future
bills. Although the deposits are at all times subject to the
company's unfettered use and control, IPL does not treat them as
income at the time of receipt, but carries them on its books as
current liabilities. Upon audit of IPL's returns for the tax years
at issue, petitioner Commissioner of Internal Revenue asserted
deficiencies, claiming that the deposits are advance payments for
electricity and therefore are taxable to IPL in the year of
receipt. The Tax Court ruled in favor of IPL on its petition for
redetermination, holding that the deposits' principal purpose is to
serve as security rather than as prepayment of income. The Court of
Appeals affirmed.
Held: The customer deposits are not advance payments
for electricity, and therefore do not constitute taxable income to
IPL upon receipt. Although IPL derives some economic benefit from
the deposits, it does not have the requisite "complete dominion"
over them
at the time they are made, the crucial point for
determining taxable income. IPL has an obligation to repay the
deposits upon termination of service or satisfaction of the credit
test. Moreover, a customer submitting a deposit makes no commitment
to purchase any electricity at all. Thus, while deposits eventually
may be used to pay for electricity by virtue of customer default or
choice, IPL's right to retain them at the time they are made is
contingent upon events outside its control. This construction is
consistent with the Tax Court's longstanding treatment of sums
deposited to secure a tenant's performance of a lease agreement,
perhaps the closest analogy to the present situation. Pp.
493 U. S.
207-214.
857 F.2d 1162 (C.A.7 1988), affirmed.
BLACKMUN, J., delivered the opinion for a unanimous Court.
Page 493 U. S. 204
Justice BLACKMUN delivered the opinion of the Court.
Respondent Indianapolis Power & Light Company (IPL) requires
certain customers to make deposits with it to assure payment of
future bills for electric service. Petitioner Commissioner of
Internal Revenue contends that these deposits are advance payments
for electricity, and therefore constitute taxable income to IPL
upon receipt. IPL contends otherwise.
I
IPL is a regulated Indiana corporation that generates and sells
electricity in Indianapolis and its environs. It keeps its books on
the accrual and calendar year basis. During the years 1974 through
1977, approximately 5% of IPL's residential and commercial
customers were required to make deposits "to insure prompt
payment," as the customers' receipts stated, of future utility
bills. These customers were selected because their credit was
suspect. Prior to March 10, 1976, the deposit requirement was
imposed on a case-by-case basis. IPL relied on a credit test but
employed no fixed formula. The amount of the required deposit
ordinarily was twice the customer's estimated monthly bill. IPL
paid 3% interest on a deposit held for six months or more. A
customer could obtain a refund of the deposit prior to termination
of service by requesting a review and demonstrating acceptable
credit. The refund usually was made in cash or by check, but the
customer
Page 493 U. S. 205
could choose to have the amount applied against future
bills.
In March, 1976, IPL amended its rules governing the deposit
program.
See Title 170, Ind.Admin.Code 4-1-15 (1988).
Under the amended rules, the residential customers from whom
deposits were required were selected on the basis of a fixed
formula. The interest rate was raised to 6%, but was payable only
on deposits held for 12 months or more. A deposit was refunded when
the customer made timely payments for either nine consecutive
months or for 10 out of 12 consecutive months, so long as the two
delinquent months were not themselves consecutive. A customer could
obtain a refund prior to that time by satisfying the credit test.
As under the previous rules, the refund would be made in cash or by
check, or, at the customer's option, applied against future bills.
Any deposit unclaimed after seven years was to escheat to the
State.
See Ind.Code § 32-9-1-6(a) (1988). [
Footnote 1]
IPL did not treat these deposits as income at the time of
receipt. Rather, as required by state administrative regulations,
the deposits were carried on its books as current liabilities.
Under its accounting system, IPL recognized income when it mailed a
monthly bill. If the deposit was used to offset a customer's bill,
the utility made the necessary accounting adjustments. Customer
deposits were not physically segregated in any way from the
company's general funds. They were commingled with other receipts
and at all times were subject to IPL's unfettered use and control.
It is undisputed that IPL's treatment of the deposits was
consistent with accepted accounting practice and applicable state
regulations.
Upon audit of respondent's returns for the calendar years 1974
through 1977, the Commissioner asserted deficiencies. Although
other items initially were in dispute, the parties were able to
reach agreement on every issue except that of
Page 493 U. S. 206
the proper treatment of customer deposits for the years 1975,
1976, and 1977. The Commissioner took the position that the
deposits were advance payments for electricity, and therefore were
taxable to IPL in the year of receipt. He contended that the
increase or decrease in customer deposits outstanding at the end of
each year represented an increase or decrease in IPL's income for
the year. [
Footnote 2] IPL
disagreed and filed a petition in the United States Tax Court for
redetermination of the asserted deficiencies.
In a reviewed decision, with one judge not participating, a
unanimous Tax Court ruled in favor of IPL. 88 T.C. 964 (1987). The
court followed the approach it had adopted in
City Gas Co. of
Florida v. Commissioner of Internal Revenue, 74 T.C. 386
(1980),
rev'd, 689 F.2d 943 (CA 11 1982). It found it
necessary to "continue to examine all of the circumstances," 88
T.C., at 976, and relied on several factors in concluding that the
deposits in question were properly excluded from gross income. It
noted, among other things, that only 5% of IPL's customers were
required to make deposits; that the customer, rather than the
utility, controlled the ultimate disposition of a deposit; and that
IPL consistently treated the deposits as belonging to the
customers, both by listing them as current liabilities for
accounting purposes and by paying interest.
Id. at
976-978.
The United States Court of Appeals for the Seventh Circuit
affirmed the Tax Court's decision. 857 F.2d 1162 (1988). The court
stated that
"the proper approach to determining the appropriate tax
treatment of a customer deposit is to look at the primary purpose
of the deposit based on all the
Page 493 U. S. 207
facts and circumstances. . . ."
Id. at 1167. The court appeared to place primary
reliance, however, on IPL's obligation to pay interest on the
deposits. It asserted that
"as the interest rate paid on a deposit to secure income begins
to approximate the return that the recipient would be expected to
make from 'the use' of the deposit amount, the deposit begins to
serve purposes that comport more squarely with a security
deposit."
Id. at 1169. Noting that IPL had paid interest on the
customer deposits throughout the period in question, the court
upheld, as not clearly erroneous, the Tax Court's determination
that the principal purpose of these deposits was to serve as
security, rather than as prepayment of income.
Id. at
1170.
Because the Seventh Circuit was in specific disagreement with
the Eleventh Circuit's ruling in
City Gas Co. of Florida,
supra, we granted certiorari to resolve the conflict. 490 U.S.
1033 (1989).
II
We begin with the common ground. IPL acknowledges that these
customer deposits are taxable as income upon receipt if they
constitute advance payments for electricity to be supplied.
[
Footnote 3] The Commissioner,
on his part, concedes that customer deposits.that secure the
performance of non-income-producing covenants -- such as a utility
customer's obligation to ensure that meters will not be damaged --
are not taxable income. And it is settled that receipt of a loan is
not income to the borrower.
See Commissioner v. Tufts,
461 U. S. 300,
461 U. S. 307
(1983) ("Because of [the repayment] obligation,
Page 493 U. S. 208
the loan proceeds do not qualify as income to the taxpayer");
James v. United States, 366 U. S. 213,
366 U. S. 219
(1961) (accepted definition of gross income "excludes loans");
Commissioner v. Wilcox, 327 U. S. 404,
327 U. S. 408
(1946). IPL, stressing its obligation to refund the deposits with
interest, asserts that the payments are similar to loans. The
Commissioner, however, contends that a deposit which serves to
secure the payment of future income is properly analogized to an
advance payment for goods or services.
See Rev.Rul.
72-519, 1972-2 Cum.Bull. 32, 33 ("[W]hen the purpose of the deposit
is to guarantee the customer's payment of amounts owed to the
creditor, such a deposit is treated as an advance payment, but when
the purpose of the deposit is to secure a property interest of the
taxpayer the deposit is regarded as a true security deposit").
In economic terms, to be sure, the distinction between a loan
and an advance payment is one of degree rather than of kind. A
commercial loan, like an advance payment, confers an economic
benefit on the recipient: a business presumably does not borrow
money unless it believes that the income it can earn from its use
of the borrowed funds will be greater than its interest obligation.
See Illinois Power Co. v. Commissioner of Internal
Revenue, 792 F.2d 683, 690 (CA7 1986). Even though receipt of
the money is subject to a duty to repay, the borrower must regard
itself as better off after the loan than it was before. The
economic benefit of a loan, however, consists entirely of the
opportunity to earn income on the use of the money prior to the
time the loan must be repaid. And in that context, our system is
content to tax these earnings as they are realized. The recipient
of an advance payment, in contrast, gains both immediate use of the
money (with the chance to realize earnings thereon)
and
the opportunity to make a profit by providing goods or services at
a cost lower than the amount of the payment.
The question, therefore, cannot be resolved simply by noting
that respondent derives some economic benefit from receipt
Page 493 U. S. 209
of these deposits. [
Footnote
4] Rather, the issue turns upon the nature of the rights and
obligations that IPL assumed when the deposits were made. In
determining what sort of economic benefits qualify as income, this
Court has invoked various formulations. It has referred, for
example, to "undeniable accessions to wealth, clearly realized, and
over which the taxpayers have complete dominion."
Commissioner
v. Glenshaw Glass Co., 348 U. S. 426,
348 U. S. 431
(1955). It also has stated:
"When a taxpayer acquires earnings, lawfully or unlawfully,
without the consensual recognition, express or implied, of an
obligation to repay and without restriction as to their
disposition, 'he has received income. . . .'"
James v. United States, 366 U.S. at
366 U. S. 219,
quoting
North American Oil Consolidated v. Burnet,
286 U. S. 417,
286 U. S. 424
(1932). IPL hardly enjoyed "complete dominion" over the customer
deposits entrusted to it. Rather, these deposits were acquired
subject to an express "obligation to repay," either at the time
service was terminated or at the time a customer established good
credit. So long as the customer fulfills his legal obligation to
make timely payments, his deposit ultimately is to be refunded, and
both the timing and method of that refund are largely within the
control of the customer.
The Commissioner stresses the fact that these deposits were not
placed in escrow or segregated from IPL's other funds, and that IPL
therefore enjoyed unrestricted use of the money. That circumstance,
however, cannot be dispositive. After all, the same might be said
of a commercial loan; yet the Commissioner does not suggest that a
loan is taxable upon receipt simply because the borrower is free to
use the
Page 493 U. S. 210
funds in whatever fashion he chooses until the time of
repayment. In determining whether a taxpayer enjoys "complete
dominion" over a given sum, the crucial point is not whether his
use of the funds is unconstrained during some interim period. The
key is whether the taxpayer has some guarantee that he will be
allowed to keep the money. IPL's receipt of these deposits was
accompanied by no such guarantee.
Nor is it especially significant that these deposits could be
expected to generate income greater than the modest interest IPL
was required to pay. Again, the same could be said of a commercial
loan, since, as has been noted, a business is unlikely to borrow
unless it believes that it can realize benefits that exceed the
cost of servicing the debt. A bank could hardly operate profitably
if its earnings on deposits did not surpass its interest
obligations; but the deposits themselves are not treated as income.
[
Footnote 5] Any income that
the utility may earn through use of the deposit money of course is
taxable, but the prospect that income will be generated provides no
ground for taxing the principal.
The Commissioner's advance payment analogy seems to us to rest
upon a misconception of the value of an advance payment to its
recipient. An advance payment, like the deposits at issue here,
concededly protects the seller against the risk that it would be
unable to collect money owed it after it has furnished goods or
services. But an advance payment does much more: it protects
against the risk that the purchaser will back out of the deal
before the seller performs. From the moment an advance payment is
made, the seller is assured that, so long as it fulfills its
contractual obligation, the money is its to keep. Here, in
contrast, a customer submitting a deposit made no commitment to
purchase a specified quantity of electricity, or indeed to purchase
any electricity
Page 493 U. S. 211
at all. [
Footnote 6] IPL's
right to keep the money depends upon the customer's purchase of
electricity, and upon his later decision to have the deposit
applied to future bills, not merely upon the utility's adherence to
its contractual duties. Under these circumstances, IPL's dominion
over the fund is far less complete than is ordinarily the case in
an advance-payment situation.
The Commissioner emphasizes that these deposits frequently will
be used to pay for electricity, either because the customer
defaults on his obligation or because the customer, having
established credit, chooses to apply the deposit to future bills
rather than to accept a refund. When this occurs, the Commissioner
argues, the transaction, from a cash-flow standpoint, is equivalent
to an advance payment. In his view this economic equivalence
mandates identical tax treatment. [
Footnote 7]
Whether these payments constitute income when received, however,
depends upon the parties' rights and obligations
at the time
the payments are made. The problem with petitioner's argument
perhaps can best be understood if we imagine a loan between parties
involved in an ongoing commercial
Page 493 U. S. 212
relationship. At the time the loan falls due, the lender may
decide to apply the money owed him to the purchase of goods or
services, rather than to accept repayment in cash. But this
decision does not mean that the loan, when made, was an advance
payment after all. The lender in effect has taken repayment of his
money (as was his contractual right) and has chosen to use the
proceeds for the purchase of goods or services from the borrower.
Although, for the sake of convenience, the parties may combine the
two steps, that decision does not blind us to the fact that in
substance two transactions are involved. [
Footnote 8]
It is this element of choice that distinguishes an advance
payment from a loan. Whether these customer deposits are the
economic equivalents of advance payments, and therefore taxable
upon receipt, must be determined by examining the relationship
between the parties at the time of the deposit. The individual who
makes an advance payment retains no right to insist upon the return
of the funds; so long as the recipient fulfills the terms of the
bargain, the money is its to keep. The customer who submits a
deposit to the utility, like the lender in the previous
hypothetical, retains the right to insist upon repayment in cash;
he may choose to apply the money to the purchase of electricity,
but he assumes no obligation to do so, and the utility therefore
acquires no unfettered "dominion" over the money at the time of
receipt.
When the Commissioner examines privately structured
transactions, the true understanding of the parties, of course, may
not be apparent. It may be that a transfer of funds, though
nominally a loan, may conceal an unstated agreement that the money
is to be applied to the purchase of goods or
Page 493 U. S. 213
services. We need not, and do not, attempt to devise a test for
addressing those situations where the nature of the parties'
bargain is legitimately in dispute. This particular respondent,
however, conducts its business in a heavily regulated environment;
its rights and obligations vis-a-vis its customers are largely
determined by law and regulation, rather than by private
negotiation. That the utility's customers, when they qualify for
refunds of deposits, frequently choose to apply those refunds to
future bills rather than taking repayment in cash does not mean
that any customer has made an unspoken commitment to do so.
Our decision is also consistent with the Tax Court's
long-standing treatment of lease deposits -- perhaps the closest
analogy to the present situation. The Tax Court traditionally has
distinguished between a sum designated as a prepayment of rent --
which is taxable upon receipt -- and a sum deposited to secure the
tenant's performance of a lease agreement.
See, e.g., J. &
E. Enterprises, Inc. v. Commissioner, 26 TCM 944 (1967).
[
Footnote 9] In fact, the
customer deposits
Page 493 U. S. 214
at issue here are less plausibly regarded as income than lease
deposits would be. The typical lease deposit secures the tenant's
fulfillment of a contractual obligation to pay a specified rent
throughout the term of the lease. The utility customer, however,
makes no commitment to purchase any services at all at the time he
tenders the deposit.
We recognize that IPL derives an economic benefit from these
deposits. But a taxpayer does not realize taxable income from every
event that improves his economic condition. A customer who makes
this deposit reflects no commitment to purchase services, and IPL's
right to retain the money is contingent upon events outside its
control. We hold that such dominion as IPL has over these customer
deposits is insufficient for the deposits to qualify as taxable
income at the time they are made.
The judgment of the Court of Appeals is affirmed.
It is so ordered.
[
Footnote 1]
During the years 1974 through 1977, the total amount that
escheated to the State was less than $9,325. Stipulation of Facts �
25.
[
Footnote 2]
The parties' stipulation sets forth the balance in IPL's
customer-deposit account on December 31 of each of the years 1954,
1974, 1975, 1976, and 1977. In his notice of deficiency, the
Commissioner concluded that IPL was required to include in income
for 1975 the increase in the account between December 31, 1954, and
December 31, 1975. For 1976 and 1977, IPL was allowed to reflect in
income the respective decreases in the account during those
years.
[
Footnote 3]
This Court has held that an accrual-basis taxpayer is required
to treat advance payments as income in the year of receipt.
See
Schlude v. Commissioner, 372 U. S. 128
(1963);
American Automobile Assn. v. United States,
367 U. S. 687
(1961);
Automobile Club of Michigan v. Commissioner,
353 U. S. 180
(1957). These cases concerned payments -- nonrefundable fees for
services -- that indisputably constituted income, the issue was
when that income was taxable. Here, in contrast, the issue is
whether these deposits, as such, are income at all.
[
Footnote 4]
See Illinois Power Co., 792 F.2d at 690.
See
also Burke & Friel, Recent Developments in the Income
Taxation of Individuals, Tax-Free Security: Reflections on
Indianapolis Power & Light, 12 Rev. of Taxation of
Individuals 157 174 (1988) (arguing that economic-benefit approach
is superior in theory, but acknowledging that "an economic-benefit
test has not been adopted, and it is unlikely that such an approach
will be pursued by the Service or the courts").
[
Footnote 5]
Cf. Rev.Rul. 71-189, 1971-1 Cum.Bull. 32 (inactive
deposits are not income until bank asserts dominion over the
accounts).
See also Fidelity-Philadelphia Trust Co. v.
Commissioner, 23 T.C. 527 (1954).
[
Footnote 6]
A customer, for example, might terminate service the day after
making the deposit. Also, IPL's dominion over a deposit remains
incomplete even after the customer begins buying electricity. As
has been noted, the deposit typically is set at twice the
customer's estimated monthly bill. So long as the customer pays his
bills in a timely fashion, the money he owes the utility (for
electricity used but not yet paid for) almost always will be less
than the amount of the deposit. If this were not the case, the
deposit would provide inadequate protection. Thus, throughout the
period the deposit is held, at least a portion is likely to be
money that IPL has no real assurance of ever retaining.
[
Footnote 7]
The Commissioner is unwilling, however, to pursue this line of
reasoning to the limit of its logic. He concedes that these
deposits would not be taxable if they were placed in escrow, Tr. of
Oral Arg. 4; but, from a cash-flow standpoint, it does not make
much difference whether the money is placed in escrow or commingled
with the utility's other funds. In either case, the utility
receives the money and allocates it to subsequent purchases of
electricity if the customer defaults or chooses to apply his refund
to a future bill.
[
Footnote 8]
The Commissioner contends that a customer's decision to take his
refund while making a separate payment for services, rather than
applying the deposit to his bill, would amount to nothing more than
an economically meaningless "exchange of checks." But in our view,
the "exchange of checks," while less convenient, more accurately
reflects the economic substance of the transactions.
[
Footnote 9]
In
J. & E. Enterprises, the Tax Court stated:
"If a sum is received by a lessor at the beginning of a lease,
is subject to his unfettered control, and is to be applied as rent
for a subsequent period during the term of the lease, such sum is
income in the year of receipt even though in certain circumstances
a refund thereof may be required. . . . If, on the other hand, a
sum is deposited to secure the lessee's performance under a lease,
and is to be returned at the expiration thereof, it is not taxable
income even though the fund is deposited with the lessor instead of
in escrow and the lessor has temporary use of the money. . . . In
this situation, the acknowledged liability of the lessor to account
for the deposited sum on the lessee's performance of the lease
covenants prevents the sum from being taxable in the year of
receipt."
26 TCM at 945-946.
In Rev.Rul. 72-519, 1972-2 Cum.Bull. 32, the Commissioner relied
in part on
J. & E. Enterprises as authority for the
proposition that deposits intended to secure income-producing
covenants are advance payments taxable as income upon receipt,
while deposits intended to secure non-income-producing covenants
are not.
Id. at 33. In our view, neither
J. & E
Enterprises nor the other cases cited in the Revenue Ruling
support that distinction.
See Hirsch Improvement Co. v.
Commissioner of Internal Revenue, 143 F.2d 912 (CA2),
cert. denied, 323 U.S. 750 (1944);
Mantell v.
Commissioner, 17 T.C. 1143 ( 1952);
Gilken Corp. v.
Commissioner, 10 T.C. 445 (1948),
aff'd, 176 F.2d 141
(CA 6 1949). These cases all distinguish between advance payments
and security deposits, not between deposits that do and do not
secure income-producing covenants.