Before Biggs, Chief Judge, and Mclaughlin and Hastie, Circuit Judges.
This is a petition to review a decision of the Tax Court*fn1 sustaining a determination by the Commissioner of Internal Revenue of a deficiency in the petitioner's excess profits tax for its taxable year ending January 31, 1941. The 31-day difference between the end of the calendar year and petitioner's taxable year is of no consequence in this case. For convenience, therefore, the taxable year in question will be designated as 1940 throughout this opinion.*fn1
Petitioner, May, Stern and Company, is a corporation engaged in the home furnishings business. It makes large numbers of installment sales. Its books of account and income tax returns have always been kept on the accrual basis, except that prior to the enactment of the excess profits tax law in 1940 it had elected to report its income from installment sales on the installment basis in accordance with § 44(a) of the Internal Revenue Code, 26 U.S.C.A. § 44(a).The installment basis is essentially a modified cash basis.*fn2
In computing its liability under the excess profits tax law as enacted in 1940, petitioner was required to continue to report its income from installment sales on the installment basis. However, the Revenue Act of 1942 added § 736(a) to the Code, 26 U.S. C.A. § 736(a). Under its terms, taxpayers who had been reporting installment sales income under § 44(a) and whose installment sales volume had substantially decreased were given the election of reporting income from such sales on the accrual basis. But they were, if they chose to exercise the potion, put under an attendant obligation to make retroactively certain ad justments of their excess profits tax returns for 1940, and the subsequent years preceding this election, to conform therewith.*fn3
In 1942, petitioner exercised the election under § 736(a) and accordingly filed an amended excess profits tax return for 1940. That amended return is the basis of this controversy.
One of the factors on which petitioner's excess profits tax liability depended was its excess profits credit properly computed as equal to eight per cent of its invested capital.*fn4 One of the components of its invested capital was petitioner's accumulated earnings and profits at the beginning of the taxable year.*fn5
In its amended return for 1940, the taxpayer used the accrual method of accounting both for the computation of its taxable income from 1940 installments sales and for the computation of its income from past installment sales as that item entered into the earnings and profits component of its credit. This computation resulted in the inclusion of $1,297,745.79 of uncollected profits on pre-1940 installment sales in earnings and profits accumulated at the beginning of 1940. Relying on a Treasury Regulation*fn6 the Commissioner ruled that this inclusion was not proper and accordingly determined a deficiency in petitioner's 1940 excess profits tax. The Tax Court decided that the Commissioner was correct.
The propriety of that decision is the question before us.
I. For better understanding of the problem before the court, we consider first what legal impediments prevented this taxpayer from doing in its original excess profits tax return for 1940 that which it now seeks to do retroactively in an amended return after the 1942 enactment of § 736(a).
In its original return the petitioner reported income from installment sales on the installment basis. This had been done for normal tax income in years before the imposition of the excess profits tax. An attempt in 1940 to include uncollected installments of pre-1940 sales in accumulated earnings and profits and thus to compute the excess profits credit on the accrual basis would have been improper. It would have involved both the use of inconsistent accounting methods within the return itself and a violation of applicable statutes and regulations.
This in substance was the holding of the Supreme Court in Commissioner of Internal Revenue v. South Texas Co.*fn7 That decision sustained a Treasury Regulation which provided, in material parts, that "* * * the amount of the earnings and profits in any case will be dependent upon the method of accounting properly employed in computing net income. For instance * * * a corporation computing income on the installment basis as provided in § 44 shall, with respect to installment transactions, compute earnings and profits on such basis * * *."*fn8
To uphold the regulation the court invoked the "long established congressional policy that a taxpayer generally cannot compute income taxes by reporting annual income on a cash basis and deductions on an accrual basis," and stated explicitly that "such a practice has been uniformly held inadmissible because it results in a distorted picture which makes a tax return fail truly to reflect net income."*fn9
The taxpayer had also urged that even if the application of the regulation resulted in consistent accounting, it could not be upheld. Section 115( l ) of the Internal Revenue Code provided that: "Gain or loss * * * realized [by sale or other disposition of property] shall increase or decrease the ear)ings and profits to, but not beyond, the extent to which such a realized gain or loss was recognized in computing net income under the law applicable to the year in which such sale or disposition was made." It was argued that this section and the regulations thereunder meant that uncollected balances on installment sales entered into earnings and profits at the time of their recognition by law as gain, an ...