The Supreme Court held unanimously yesterday that inventory practices conforming to "generally accepted accounting principles" cannot be presumed valid for purposes of federal income taxation.
"If management's election among 'acceptable' options were dispositive for tax purposes, a firm... could decide unilaterally -- within limits dictated only by its accountants -- the tax it wished to pay," the court said in voting 9-0.
"Such unilateral decisions would not just make the [Internal Revenue] Code inequitable," Justice Harry A. Blackmun wrote. "They would make it unenforceable."
The court affirmed a ruling by the 7th U.S. Circuit Court of Appeals in a cast brought by Thor Power Tool Co. against the commissioner of the Internal Revenue Service.
The chamber of Commerce of the United States and the National Association of Manufacturers, in friend-of-the-court briefs in behalf of Thor, said that the case was crucially important to thousands fo manufacturers, wholdsalers and retailers who, for tax purposes, must assign dollar values to large inventories of replacement parts.
By the NAM's count as of about a year ago, the key issue in the Thor case was also raised in 371 U.S. Tax Court cases involving alleged tax deficiencies of $25.2 million, while an additional 497 cases were pending in the IRS' Appellate Division and still others were in the courts.
In the Thor case, the company in 1964 acted in accord with "generally accepted accounting principles" to write down what it regarded as excess inventory to what it assumed would be the net if the goods were to be scrapped. At the same time, however, Thor held the goods -- mainly replacement parts -- for sale at original prices.
The write-down amounted to $926,952. It was based not on statistical evidence, but on what Thor's president termed "my experience of 20 years..." The IRS rejected the write-down in its entirety -- even though it conformed to general accounting principles -- on the ground that it failed to reflect clearly Thor's 1964 income.
"Actually," Justice Blackmun wrote for the unanimous high court, "Thor's 'excess' inventory was normal and unexceptional, and was indistinguishable from and intermingled with the inventory that was not written down.
"More importantly, Thor failed to provide any objective evidence that the 'excess' inventory had the 'market value' management ascribed to it," Blackmun continued.
"The regulations demand hard evidence of actual sales and further demand that records of actual dispositions be kept," Blackmun said. Yet Thor, making no sales and keeping no records, simply wrote down its closing inventory "on the basis of a well-educated guess," he pointed out.
"In the light of the well-known potential for tax avoidance that is inherent in inventory accounting, the commissioner in his discretion may insist on a high evidentiary standard before allowing write-downs of inventory to 'market'." Blackmun said.
In a 7-0 decision, the court set aside a ruling that the Federal Energy Regulatory Commission had said would "substantially undercut" its ability to regulate natural gas in the national market and lead to higher prices for consumers.
The court nulified a ruling by the 5h U.S. Circuit Court of Appeals that the Natural Gas Act, contrary to FERC's view, allowed the commission to grant special relief to producers to let them pass through to interstate customers increased royalty costs based upon higher intrastate prices.
The high court, acting in litigation involving United Gas Pipeline Co., Pennzoil Oil Producing Co. and Shell oil Co., sent the case back to the commission.
FERC, Justice Byron R. White wrote for the court, should "clearly enunciate whether or to what extent individual relief from area rates will be granted due to the increase royalty cost... and, if relief is to be denied... make an adequate explanation of its judgment."
Justice Potter Stewart and Lewis F. Powell Jr. did not participate in the case.