of Income and Expenses in Connection with Formation and Liquidation of Corporations, 1962, 40 Taxes 995, 996; Biblin, supra, at 407; Burke, supra, at 795; Hickman, supra, at 977-83; White, supra, at 46; Worthy, IRS Chief Counsel Outlines What Lies Ahead for Professional Corporations, 1970, 32 J. Tax. 88, 90. But see Note, 38 U. Cin. L. Rev., supra, at 112-13. Moreover, it is especially apposite because the partnership operated a business in which expenses were paid and income was earned in the accounting period prior to that in which collections were made and income was realized. Under these circumstances, taxation to the partnership would deter incorporation by generating a significant amount of taxable income for which there might be no off-setting deductions: matching expenses of post-incorporation collections would already have been deducted, and expenses subsequent to incorporation would be deductible by the transferee. Weiss, Problems in the Tax-free Incorporation of a Business, 1966, 41 Indiana L. J. 666, 681 & n.65. In addition, it seems anomalous to require the partnership to account for income which it never received and to which it cannot gain access without the declaration of a taxable dividend. Biblin, supra, at 408; Burke, supra, at 795; Tritt and Spencer, Current Tax Problems in Incorporation of a Going Business, 1958, 10 U. So. Cal. Tax Inst. 71, 95.
In support of its contention, plaintiff relies upon the persuasive force of the application of the assignment-of-income doctrine to transactions the tax consequences of which are regulated by Section 311,
and Section 337.
However, other analogies are more instructive,
especially those involving corporate reorganization.
It is also argued that taxation to the transferor will have no deleterious effect on incorporation because a rational taxpayer is unlikely to transfer items of potential income and expense to a controlled corporation in any event due to alleged uncertainty whether the Commissioner will seek to apply the assignment-of-income doctrine; whether transferred accounts payable will be deductible by the transferee upon payment;
and whether gain will be recognized upon the exchange itself to the extent that transferred liabilities exceed the adjusted basis of transferred assets.
This is without merit. In many cases, the withholding of accounts receivable would substantially impair corporate operations by making it difficult to meet working capital requirements. See Tritt and Spencer, supra, at 95; cf. Bittker, supra, at 7. Additionally, the policy of Section 351 reflects a realistic awareness that the incorporating entity is itself likely to perceive the transaction as a formal change which has little impact upon continuity of operation: the more natural inference is to simply assume the transfer of payables and receivables. However, a more basic problem is that plaintiff's predecessor did precisely that which is now asserted to be irrational. Assuming arguendo that there exist circumstances in which it makes sense to withhold income items from a controlled corporation, this hardly mandates reversing the tax consequences which naturally arise when they are in fact transferred. The partnership could have retained its receivables; having chosen to transfer them, Hempt Bros., Inc. may properly be required to accept the consequences of the exchange. Pittsfield Coal & Oil Company, Incorporated, 1966, T.C. Memo 4, 25 CCH Tax Ct. Mem. 11.
The court does not suggest that the Commissioner is powerless to make adjustments when necessary to prevent income distortion or tax avoidance. Indeed, the assignment-of-income doctrine might itself apply to transactions motivated primarily by tax advantage. Arent, supra, at 1002. However, the role of the doctrine seems relatively modest in this context, primarily because other means are available to reach the same result,
e.g., the business-purpose doctrine
and the Commissioner's discretionary power to allocate items of income and expense among related taxpayers. Int. Rev. Code of 1954, Section 482, as construed in Estate of Walling v. Commissioner, 3 Cir. 1967, 373 F.2d 190; Rooney v. United States, 9 Cir. 1962, 305 F.2d 681; National Securities Corporation v. Commissioner, 3 Cir., 137 F.2d 600, cert. denied, 1943, 320 U.S. 794, 64 S. Ct. 262, 88 L. Ed. 479.
Plaintiff's remaining arguments require only brief discussion. The decision of the Tax Court in E. Morris Cox20 is relied upon for the proposition that amounts collected on transferred receivables cannot be attributed to the corporation because to do so would be inconsistent with its accrual method of accounting, pursuant to which income is realized when earned rather than when collected. To the contrary, Cox involved an accrual-method transferor who realized income as billings were made; the court held that the corporation was not taxable upon items billed by its predecessor prior to the transfer. This is merely an application of the principle that the amount of gain realized by a Section 351 transferee is to be assessed with reference to the basis of its transferor. Since plaintiff's carry-over basis in the receivables was zero, it realized income to the full extent collections were made. See, e.g., P. A. Birren & Son, Inc. v. Commissioner, 7 Cir. 1940, 116 F.2d 718.
Furthermore, the parties agree that the Commissioner properly required the corporation to change its method of accounting in order to clearly reflect income. Int. Rev. Code of 1954, Section 446(b). Permissible alternatives include a hybrid method which contains cash and accrual elements. Int. Rev. Code of 1954, Section 446(c) (4); H. Rep. No. 1337, 83rd Cong., 2d Sess. A158 (1954); S. Rep. No. 1622, 83rd Cong., 2d Sess. 300 (1954). The only requirements are that the method be used consistently and that it properly match items of income and expense. See Treas. Reg. Sections 1.446-1(c) (1) (iv) (a) (1957) and 1.446-1(c) (2) (ii) (1957). In effect, Hempt Bros., Inc. has been placed on the accrual method with respect to income earned subsequent to March 1, 1957, and on the cash method for items transferred from the partnership. The Commissioner's decision will be set aside only when it constitutes an abuse of discretion,
and there is no abuse when a Section 351 transferee is required to accrue post-transfer items of income and expense while reporting as income amounts collected on accounts receivable acquired from its cash-method predecessor. See Ezo Products Company, 1961, 37 T.C. 385; cf. Pittsfield Coal & Oil Company, Incorporated, 1966, T.C. Memo 4, 25 CCH Tax Ct. Mem. 11.
Finally, it is asserted that the receivables are taxable to the individual partners because the stock which each received upon the exchange was allocated in proportion to respective interests in the partnership capital account rather than with reference to shares in transferred income items. Specifically, each partner was taxable upon twenty-five percent of partnership income, whereas individual interests in the partnership capital account and in plaintiff's stock were apportioned differently. The only authority cited in support of this position is Turnbull, Inc. v. Commissioner,
in which it was held that the transfer of accounts receivable among related corporations for inadequate consideration in order to utilize the transferee's large net operating loss carry-overs was a transparent tax-avoidance scheme which required attribution of income to the nominal seller. Even assuming that adequacy of consideration were to be evaluated relative to proportional shares in partnership income, the facts before the court do not resemble those in Turnbull, and plaintiff's argument is rejected.
The corporation's second major contention is that it is entitled to an opening inventory of not less than $351,266.05 for its first taxable year because the value of the stock issued in exchange for partnership property reflected the cost of transferred inventory, constituting to its predecessor the recovery of a previously-expensed item the basis of which must be restored to cost.
However, since this ground for recovery was not presented in the corporation's claim for refund, the court lacks jurisdiction to entertain it.
Filing of a timely refund claim is a prerequisite to the maintenance of an action to recover taxes alleged to have been improperly assessed or collected. Int. Rev. Code of 1954, Section 7422(a). It must set forth in detail each ground upon which a credit or refund is claimed and facts sufficient to apprise the Commissioner of the exact basis thereof. Treas. Reg. Section 301.6402-2(b) (1) (1954). A corollary of the enumerated principles is that a court lacks jurisdiction of an action to recover taxes except upon grounds reasonably encompassed by the claim for refund as originally filed or properly amended;
the purpose of this rule is to facilitate administrative determination of claims and to limit litigation to issues which the Commissioner has considered and is prepared to defend. Austin v. United States, 10 Cir. 1972, 461 F.2d 733; Herrington v. United States, 10 Cir. 1969, 416 F.2d 1029; Thompson v. United States, 5 Cir. 1964, 332 F.2d 657; Carmack v. Scofield, 5 Cir. 1953, 201 F.2d 360; Tompkins v. United States, Ct. Cl. 1972, 198 Ct. Cl. 814, 461 F.2d 1304; Union Pacific Railroad Company v. United States, 1968, 389 F.2d 437, 182 Ct. Cl. 103.
Plaintiff does not argue that its tax-benefit theory of recovery was presented to the Commissioner.
Instead, this is asserted to be irrelevant since the Commissioner is alleged to have been apprised of all the operative facts upon which the new theory depends and since, in any event, the refund claim is not intended to be a legal brief in which the taxpayer is required to elaborate all theories upon which the claim is based.
To the contrary, the Commissioner is required to examine only those points to which his attention is necessarily directed,
and this is especially apposite here because the corporation's amended claim sets forth specific reasons in support of its inventory argument the natural effect of which is to induce the Commissioner to pursue quite a different line of inquiry than is relevant to the theory upon which plaintiff presently seeks to rely. Tompkins v. United States, Ct. Cl. 1972, 198 Ct. Cl. 814, 461 F.2d 1304, 1314-15 (Dissenting Opinion). Similarly, it is immaterial that facts which might support recovery pursuant to the tax-benefit theory were before the Commissioner when he reviewed the corporation's claim. The mere availability of information is not equivalent to notice that a specific claim based thereon is being made because the Internal Revenue Service cannot be expected to discover every claim which a taxpayer might conceivably assert. Herrington v. United States, 10 Cir. 1969, 416 F.2d 1029; Nemours Corp. v. United States, 3 Cir. 1951, 188 F.2d 745; Pelham Hall Co. v. Carney, 1 Cir. 1940, 111 F.2d 944; Commercial Solvents Corporation v. United States, Ct. Cl., 192 Ct. Cl. 339, 427 F.2d 749, cert. denied, 1970, 400 U.S. 943, 91 S. Ct. 242, 27 L. Ed. 2d 247; Union Pacific Railroad Company v. United States, Ct. Cl. 1968, 182 Ct. Cl. 103, 389 F.2d 437.
For the reasons given, plaintiff's motion will be denied, and summary judgment will be entered for defendant.