Appeal from a Decision of the United States Tax Court.
Bauer, Chief Judge, and Flaum and Kanne, Circuit Judges.
The Internal Revenue Service ("IRS") assessed deficiencies against Indianapolis Power & Light Company ("IPL") for the tax years 1974-77, arguing that deposits IPL required certain customers to make in order to receive electrical services were advance payments for tax purposes that should have been included in gross income in the year IPL received them. IPL contested the deficiencies. The Tax Court ruled that the sums were security deposits and that IPL therefore properly excluded them from gross income. We affirm.*fn1
IPL generates and sells electricity in Indianapolis and neighboring areas of Indiana. It is an Indiana public utility and is therefore subject to the Rules and Regulations of Service for Electrical Utilities in Indiana ("the Rules of Service") promulgated by the Public Service Commission of Indiana ("PSCI"). During the years in question, approximately 5% of IPL's customers were required under the Rules of Service to make deposits. The receipts issued to these customers stated in part that the deposits were "to insure prompt payment" for the electrical service IPL was to provide.*fn2 The customers to whom this requirement applied were identified by a credit test. If a customer who was initially required to make a deposit later demonstrated creditworthiness, the deposit was refunded.
The specific rules governing the administration of this deposit program were amended on March 10, 1976. Prior to this amendment, IPL administered the deposit requirement on a case-by-case basis. A credit test was employed, but there were no fixed financial rules for making the creditworthiness determination. Once a customer was required to make a deposit, the customer could only obtain a refund by specifically requesting a review and then affirmatively demonstrating his or her creditworthiness. The amount of the deposit was equal to twice the customer's estimated monthly bill and IPL paid interest at an annual rate of 3% on sums held at least six months. The interest was paid at the time the deposit was refunded or alternatively, if the customer requested, annually. The manner of the refund, either by cash, check, or an offset against the customer's electric bill, was determined by the customer.
The 1976 amendments were largely designed to minimize the arbitrariness that was perceived to exist under the prior rules. Under the revised rules, IPL was required to evaluate the creditworthiness of all new residential applicants and existing residential customers. IPL required deposits from those new customers who failed the credit test furnished by PSCI and also from existing customers who had a history of late payment. Commercial customers continued to be evaluated on a case-by-case basis.
Under the amended rules, IPL refunded a customer's deposit if the customer paid his or her electric bill on a timely basis for nine straight months or for ten out of twelve months (as long as the two delinquent months were not consecutive). Alternatively, the customer could obtain a refund by later satisfying the credit test. Deposits refunded on either of these two grounds were made in cash or by check, unless the customer requested that the amount of the deposit be offset against his or her bill. On the other hand, refunds resulting from the termination of service were generally made by offsetting the deposit amount against the customer's final electric bill, unless the customer specifically requested otherwise. Customers whose deposits were held by IPL for at least 12 months were paid interest at 6% annually. Information about the deposit requirement and corresponding refunds was set forth in a pamphlet which IPL was required to provide to its customers.
The customer deposits IPL received were not segregated from its other assets in any manner, but rather IPL used them in the ordinary course of its business. IPL was an accrual basis taxpayer for the years in question and treated the deposits as current liabilities at the time they were received.*fn3 If the deposit was later used to offset a customer's bill, IPL made the necessary accounting adjustments at that time. Unclaimed deposits escheated to the state.
The issue raised by this appeal is whether IPL should have included the customer deposits in gross income in the year of receipt (with a corresponding loss when refunded) rather than recording them as a current liability.*fn4 This in turn hinges on the legal standard a court should utilize when evaluating the taxability of customer deposits. The IRS argues that the proper test for determining the tax consequences of these types of deposits is set forth in City Gas Co. of Florida v. Commissioner, 689 F.2d 943 (11th Cir. 1982).
The facts in City Gas are very similar to those in the present case. New customers of the City Gas Company and two of its subsidiaries were required to make deposits to secure the payment of all bills for service rendered to them. All three of the companies mingled the deposits they received with their other corporate funds. City Gas, but not its two subsidiaries, paid interest to its customers on their deposits at 4% annually. When a customer discontinued service the companies ...