Rev. Rul. 55-207

Advice has been requested whether, for the purposes of section 456 of the Internal Revenue Code of 1939, the excess of the proceeds from the sale of pledged cotton over the amount of the producer's loan from the Commodity Credit Corporation constitutes abnormal income attributable to a year other than the year of accrual.

In 1949, the taxpayer, a corporation keeping it books on the accrual method of accounting and reporting its income on the basis of a fiscal year ending January 31st, obtained a loan of 15 x dollars from the Commodity Credit Corporation, pledging as collateral its 1948 cotton crop. In July of 1949 the taxpayer defaulted in payment of the loan and the cotton pledged as collateral for the loan was placed in a pool by the Commodity Credit Corporation. During its fiscal year ending January 31, 1951, the cotton was sold and the taxpayer received 3 x dollars representing the proceeds of the sale, less payment of the loan and expenses. There is no showing that the sale at a price producing such proceeds was not the result of improved business conditions. The specific question presented is whether the 3 x dollars represents abnormal income attributable to other years within the purview of section 456 of the Code.

Section 456(a) of the Code provides in part:

(a) DEFINITIONS.-For the purposes of this section-

(1) ABNORMAL INCOME.-The term `abnormal income' means income of any class described in paragraph (2) includible in the gross income of the taxpayer for any taxable year under this subchapter if it is abnormal for the taxpayer to derive income of such class, or, if the taxpayer normally derives income of such class but the amount of such income of such class includible in the gross income of the taxable year is in excess of 115 per centum of the average amount of the gross income of the same class for the four previous taxable years or, if the taxpayer was not in existence for four previous taxable years, the taxable years during which the taxpayer was in existence.

Section 456(a)(2) of the Code enumerates the separate classes of income. In this instance the type of income under consideration does not appear to fall within the classes (A) to (D) enumerated therein. However, it is provided that:

* * * The classification of income of any class not described in subparagraphs (A) to (D), inclusive, shall be subject to regulations prescribed by the Secretary.

Section 40.456-2(b) of Regulations 130 provides in part:

Other income, not within a class described in subparagraphs (A)-(D) of section 456(a)(2), to which section 456 is applicable may be grouped by the taxpayer, subject to approval by the Commissioner on the examination of the taxpayer's return, in such classes similar to those specified in subparagraphs (A)-(D) of section 456(a)(2) as are reasonable in a business of the type which the taxpayer conducts, and as are appropriate in the light of the taxpayer's business experience and accounting practice.

Section 456(b) of the Code provides in part:

(b) AMOUNT ATTRIBUTABLE TO OTHER YEARS.-The amount of the net abnormal income that is attributable to any previous or future taxable year or years shall be determined under regulations prescribed by the Secretary. * * *

Section 40.456-3 of Regulations 130 provides in part:

AMOUNT ATTRIBUTABLE TO OTHER YEARS.-(a) The mere fact that an item includible in gross income is of a class abnormal either in kind or in amount does not result in the exclusion of any part of such item from excess profits net income. It is necessary that the item be found attributable under these regulations in whole or in part to other taxable years. Only that portion of the item which is found to be attributable to other years may be excluded from the gross income of the taxpayer for the year for which the excess profits tax is being computed.

(b) Items of net abnormal income are to be attributed to other years in the light of the events in which such items had their origin, and only in such amounts as are reasonable in the light of such events. To the extent that any items of net abnormal income in the taxable year are the result of such factors as high prices, low operating costs, increased demand, or decreased competition, such items shall not be attributed to other taxable years. Thus, no portion of an item is to be attributed to other years if such item is of a class of income which is in excess of 115 percent of the average income of the same class for the four previous taxable years solely because of an improvement in business conditions. * * *

Thus, two conditions must be met before any income may be considered as abnormal within the meaning of section 456 of the Code, namely, (1) the income must be abnormal in kind or amount, and (2) such abnormal income must be attributable to other years.

The loan agreement with the Commodity Credit Corporation provides, so far as is pertinent here, (1) that all holders of the note shall look solely to the cotton for satisfaction of the loan, (2) that the Commodity Credit Corporation has the right, if it so desires, to purchase the pooled cotton, and (3) that the Commodity Credit Corporation is required to remit the net proceeds, if any, to the producer. From the above it is apparent that the title to the pooled cotton under the circumstances was in the producer and not the Commodity Credit Corporation. The proceeds from the sale belonged to the producer and constituted gross income. This gross income was the normal income of the producer.

The above is in accord with I.T. 4016, C.B. 1950-2, 29, in which it is held that advances received by cotton producers under similar loan agreements are loans and not proceeds from the sale of cotton, even though the producer may not be called upon to pay any deficiency which may exist after the sale of the pledged cotton, provided the producer reduces cotton acreage in accordance with an agreement with the Secretary of Agriculture and provided he has made no misrepresentation in connection with the loan. Advances may be loans even where there is absence of personal liability and the lender can look only to the pledged securities for repayment. Also, if the producer realizes an additional amount upon liquidation of the pool, such additional amount will constitute income for the taxable year in which his right to receive it becomes fixed, if he employs the accrual method of accounting.

In this instance the net proceeds of 3 x dollars received from the sale of the producer's cotton, even if considered to be abnormal income, cannot be attributed to any year other than the fiscal year ending January 31, 1951, as to do so would be at variance with the regulations and the established accounting method of the taxpayer. See Yoba Gardens, Inc. v. Commissioner , 17 T.C. 334.

Accordingly, it is held that the 3 x dollars does not constitute abnormal income within the meaning of section 456 of the Internal Revenue Code of 1939 but constitutes normal income which can only be attributed to the taxpayer's taxable year ended January 31, 1951