COMMISSIONER OF INTERNAL REVENUE, PETITIONER V. INDIANAPOLIS POWER
AND LIGHT COMPANY

   No. 88-1319

   In the Supreme Court of the United States

   October Term, 1988

   The Solicitor General, on behalf of the Commissioner of Internal
Revenue, petitions for a writ of certiorari to review the judgment of
the United States Court of Appeals for the Seventh Circuit in this
case.

   Petition for a Writ of Certiorari to the United States Court of
Appeals for the Seventh Circuit

            TABLE OF CONTENTS
   Question Presented
   Opinions below
   Jurisdiction
   Statutory provisions involved
   Statement
   Reasons for granting the petition
   Conclusion

                            OPINIONS BELOW

   The opinion of the court of appeals (App., infra, 1a-18a) is
reported at 857 F.2d 1162.  The opinion of the Tax Court (App., infra,
19a-39a) is reported at 88 T.C. 964.

                             JURISDICTION

   The judgment of the court of appeals (App., infra, 40a) was entered
on September 20, 1988.  On December 12, 1988, Justice Stevens extended
the time within which to petition for a writ of certiorari to and
including February 8, 1989.  The jurisdiction of this Court is invoked
under 28 U.S.C. 1254(1).

                     STATUTORY PROVISIONS INVOLVED

   Section 61(a) of the Internal Revenue Code (26 U.S.C.) provides in
pertinent part:

         General Definition

         Except as otherwise provided in this subtitle, gross income
      means all income from whatever source derived * * *.

   Section 451(a) of the Internal Revenue Code (26 U.S.C.) provides:

         General rule

         The amount of any item of gross income shall be included in
      the gross income for the taxable year in which received by the
      taxpayer unless, under the method of accounting used in
      computing taxable income, such amount is to be properly
      accounted for as of a different period.

                          QUESTION PRESENTED

   Whether customer deposits required by a public utility to insure
the payment of future bills are income to the utility upon receipt.

                               STATEMENT

   1. Respondent is an Indiana corporation engaged in the business of
generating, distributing, and selling electricity and steam in the
vicinity of Indianapolis, Indiana.  It is a public utility, subject to
regulation by the Public Service Commission of Indiana (PSCI).  As
part of its customary method of conducting business during the years
in issue, 1974-1977, respondent required approximately five percent of
its commercial and residential customers to pay a deposit as a
precondition to receiving service.  The customers required to pay
deposits were chosen based upon their creditworthiness, and the stated
purpose of the deposits was "to insure prompt payment" of the
customers' future utility bills.  App., infra, 2a.

   The details of respondent's deposit program changed during the
years at issue because of amendments made by PSCI to its rules of
service on March 10, 1976.  Prior to that time, respondent determined
on an ad hoc basis when it would require a customer deposit, based on
a creditworthiness analysis made by its own employees.  The amount of
the required deposit ordinarily was twice the customer's estimated
monthly bill.  Respondent refunded these deposits prior to termination
of service only if the customer specifically requested a review and
demonstrated his creditworthiness.  Upon termination of service,
respondent refunded the deposits by means of a credit to the final
bill or, if requested by the customer, by cash or check.  In addition,
respondent was required to pay interest at the rate of three percent
per year on deposits held at least six months.  This interest was
payable upon return of the deposit, or annually upon demand in writing
by the customer.  App., infra, 2a-3a.

   The PSCI amended its rules of service concerning utility customer
deposits in 1976, largely in order to reduce arbitrariness in the
system.  Under the amended rules (see Ind. Admin. Code tit. 8, r.
(8-1-2-4)-A42 (Burns Supp. 1978)), respondent was required to
determine the creditworthiness of each residential applicant or
existing residential customer according to objective criteria.  /1/
Deposits could be required of new customers only if they failed a
creditworthiness test furnished by the PSCI, and required of existing
customers only if they had a history of late payments.  The amended
rules also specified that interest would have to be paid at the rate
of six percent, but only on deposits held for more than 12 months.
App., infra, 3a.

   The amended rules of service also defined when a customer had
reached a point at which his credit record was such that retention of
a deposit should no longer be necessary.  In compliance with those
rules, respondent refunded residential customers' deposits after
timely payment for a period of either nine successive months or ten
out of any twelve consecutive months (provided that the two delinquent
months were not consecutive), or if the customer subsequently
satisfied the credit test.  These refunds generally were made by cash
or check unless the customer requested that they be credited against
his bill.  When a customer requested termination of service, however,
respondent usually applied the deposit as a credit to the customer's
final bill.  In the event of an involuntary termination of service,
respondent used the deposit to cover any unpaid balance in the
customer's account, and any surplus was returned to the customer.
Generally, an involuntary termination of service occurred when 90 days
had elapsed after a bill was sent with no payment for the charges
included on that bill or a later one.  During the years in issue,
between 57.7% and 69% of the amounts refunded were in the form of
credits against the customer's bill.  App., infra, 3a, 23a-25a.

   The customer deposits received by respondent were not segregated
from its other assets in any manner;  they were subject to its
unfettered control and were used in the ordinary course of its
business.  Respondent, an accrual basis taxpayer, treated the deposits
on its books as current liabilities, not as producing gross income.
When the deposits were refunded or applied against a customer's bill,
respondent made appropriate accounting adjustments.  App., infra,
3a-4a.  /2/

   2. The Commissioner issued a notice of deficiency asserting that
customer deposits should be treated as advance payments and reported
as income upon receipt.  See Rev. Rul. 72-519, 1972-2 C.B. 32.
Accordingly, he determined that respondent was required to include in
its income for 1975 the balance of customer deposits outstanding at
the end of the year (less the amount of deposits on hand at the end of
1954), and to adjust its income for each succeeding year by the amount
of the increase or decrease in deposits on hand at the end of the
year.  /3/ Respondent filed a petition in the Tax Court seeking
redetermination of the deficiency.

   The Tax Court ruled in favor of respondent in a reviewed opinion
(App., infra, 19a-39a).  The court followed the approach that it had
taken in City Gas Co. v. Commissioner, 74 T.C. 386 (1980), rev'd, 689
F.2d 943 (11th Cir. 1982), and explicitly rejected the approach that
the Eleventh Circuit had articulated in holding in City Gas that
deposits paid to insure the payment of future utility bills are income
upon receipt if they are under the control of the utility.  /4/ The
Tax Court concluded that, in determining whether a deposit to secure
the payment of future bills is income upon receipt, it is necessary
"to examine all of the facts and circumstances surrounding a deposit
to evaluate the rights retained by the depositor and the rights
acquired by the holder of the deposit" (App., infra, 34a).  Under this
approach, the Tax Court found that the following factors tilted toward
a finding that the deposits should not be treated as income:  the
deposits were not intended as "advance payments" because only five
percent of the customers were required to make the deposits, and they
were chosen on the basis of creditworthiness;  the customer controlled
the method of refund in that he could elect to use the deposits as an
offset or to receive a check;  respondent had no rights in the
ultimate disposition of the funds unless the customer failed to pay;
respondent treated the deposits on its books as the customer's
property;  and respondent paid interest when it refunded a deposit.
Id. at 34a-36a.  The court concluded that "the deposits were not
advance payments of income but were temporarily held by the petitioner
to secure payment of the bills and were not therefore includable in
gross income" (id. at 36a).

   3. The court of appeals affirmed (App., infra, 1a-18a).  Though
recognizing that, "in termsof the recipient's cash flow, deposits to
secure income items and advance payments are essentially the same"
(id.  at 9a), the court criticized the Eleventh Circuit's approach in
City Gas as "implicitly assum(ing) that a deposit to secure the
payment of an income item is the same as the prepayment of that income
item" (ibid.).  Instead, the court agreed with the Tax Court that each
case turns on its particular "facts and circumstances" (id. at 11a,
16a).  The court of appeals viewed the specific inquiry, however, as
one that should focus on the economic benefits that flow to the
utility from the temporary use of the customer's funds -- in order to
determine whether that use is sufficiently valuable to the utility to
justify taxation upon receipt of the deposit (id. at 11a-17a).

   Applying this economic analysis, the court identified two principal
reasons why a deposit is "valuable" to a utility:  1) the security
against possible delinquency;  and 2) the ability to obtain a "return"
(for example, by investment) on its possession of the funds (App.,
infra, 13a-14a).  The court dismissed the "security factor" as
insignificant to the inquiry, noting that it was equally present in
the case of security deposits made to insure against property damage,
which undisputedly are not treated as advance payments (see id. at 11a
n.9, 14a).  With respect to the "return factor," the court posited
what it described as an "extreme case" in which the utility was
required to invest the deposits in a particular manner and to refund
to its customers every penny of the interest earned (id. at 14a-16a).
In that situation, the court stated that there would be no return
benefit at all, and therefore the deposit should not be treated as
income.  Reference to this "extreme case" led the court to find "that
deposits to secure the payment of an income item such as rent can be a
distinct category from advance payments for tax purposes" (id. at
16a).

   The court of appeals thus concluded that it should "retain the
traditional approach of analyzing the facts and circumstances to
determine whether the principal purpose of a 'deposit' is to secure
future performance or to serve as an advance payment of income" (App.,
infra, 16a-17a).  Applying this test, the court held that the Tax
Court's decision that the deposits in this case "served as security
and were not prepayments of income is not clearly erroneous" (id. at
17a).  The court explained that the primary factor supporting this
conclusion was the payment of interest.  It also noted that the
customer (through his payment record) "'controlled' the timing of the
refund" (ibid.  (quoting id. at 34a)) and that respondent did not
regard the deposits as prepayments (id. at 17a-18a).

                   REASONS FOR GRANTING THE PETITION

   The decision of the court of appeals creates a conflict in the
circuits on an important and recurring issue of federal tax law,
namely, the tax treatment of deposits required to insure the payment
of future utility bills.  This issue is one that is likely to arise
for almost any utility that requires some or all of its customers to
deposit funds to guarantee payment for future services.  And, because
of the enormous number of customers who are required to make deposits
with public utilities, considerable sums of money turn upon resolution
of this issue.  Moreover, the decision below may have ramifications
with regard to other advance payment situations outside the public
utility context.  Accordingly, review by this Court is warranted to
provide a uniform rule of decision on this significant question.

   1. It is well established that an advance payment of income is
taxable in the year of receipt.  See, e.g., Schlude v. Commissioner,
372 U.S. 128 (1963);  American Automobile Ass'n v. United States, 367
U.S. 687 (1961).  On the other hand, a deposit paid to secure the
recipient against damage to its property, refundable if no such damage
occurs, is not income when received.  In Rev. Rul. 72-519, 1972-2 C.B.
 32, the Commissioner sought to delineate the situations in which
security deposits would be treated for tax purposes as advance
payments of income.  Relying on cases involving rental agreements, the
Revenue Ruling concluded that, "when the purpose of the deposit is to
guarantee the customer's payment of amounts owed to the creditor, such
a deposit is treated as an advance payment, but when the purpose of
the deposit is to secure a property interest of the taxpayer the
deposit is regarded as a true security deposit" (id. at 33).

   In City Gas Co. v. Commissioner, 689 F.2d 943 (1982), the Eleventh
Circuit held that customer deposits not materially distinguishable
from the ones in this case are to be treated as prepayments and taxed
as income upon receipt.  The Eleventh Circuit rejected the Tax Court's
ad hoc "facts and circumstances" approach and essentially adopted the
distinction set forth by the Commissioner in Rev. Rul. 72-519.  The
Eleventh Circuit phrased its test as follows (689 F.2d at 948):
"whether, under all the circumstances, the primary purpose of the
payments at issue was a prepayment of income items, or whether the
primary purpose was to secure the performance of nonincome-producing
covenants." Noting that it was clear that the deposits were not
intended solely to secure performance of nonincome-producing covenants
(id. at 946) and that the Tax Court had not applied the primary
purpose test, the Eleventh Circuit reversed and remanded for further
proceedings (id. at 950).  /5/ In the course of its opinion, the court
also rejected the taxpayer's argument that the payment of interest
demonstrated that the deposits should not be treated as prepayments.
The court of appeals stated that, "while the payment of interest might
have significance under some circumstances, we doubt the importance of
interest payments in this case," and it concluded that "the Tax Court
properly placed little emphasis on whether or not interest was paid in
this case" (id. at 948 n.7).  /6/

   The decision of the court of appeals below squarely conflicts with
City Gas.  First, the legal principles enunciated by the two courts of
appeals to govern the treatment of utility deposits are
irreconcilable.  The Tax Court explicitly recognized that its decision
to adhere to the "facts and circumstances" approach and rule in favor
of respondent required it to reject the Eleventh Circuit's City Gas
test (App., infra, 33a-34a).  Similarly, the court of appeals, in
looking to whether the "facts and circumstances" showed that the
payment was intended as "security," recognized that it was rejecting
the City Gas test (see id. at 18a n.13).  The Eleventh Circuit held
that a deposit intended to secure the payment of a future income item,
as opposed to securing the performance of nonincome-producing
covenants, must be treated as a prepayment of income (689 F.2d at 946;
 see also App., infra, 9a), but the Seventh Circuit held that any
deposit intended as security -- whether for an income item or a
nonincome item -- should not be treated as income upon receipt.  In
addition, the court of appeals below noted that its heavy reliance on
the payment of interest (see, e.g., App., infra, 17a n.12) is at odds
with the Eleventh Circuit's analysis, since that court in City Gas had
stated that the payment of interest is of little importance in this
context (see 689 F.  2d at 948 n.7).  App., infra, 15a n.11.

   Second, the holding below on the facts of this case cannot be
reconciled with the Eleventh Circuit's decision in City Gas.  The
deposits here are not materially distinguishable from those at issue
in City Gas, and the Seventh Circuit made no attempt to explain how
its decision could be consistent with the treatment of the deposits in
City Gas as income upon receipt.  One of the utilities in City Gas
paid interest when it refunded deposits, the deposits there were held
for an indefinite length of time, and the utilities did not treat them
as advance payments on their books.  Since these are the factors
relied upon by the court of appeals below in holding that respondent
was not required to treat the deposits as income upon receipt (App.,
infra, 17a-18a), there can be little doubt that it would have reached
the same conclusion on the facts of City Gas, in direct conflict with
the Eleventh Circuit.  See also Gas LIght Co. v. Commissioner, 55
T.C.M.  (P-H) paragraph 86,118, at 489-490 (1986) (Tax Court rejects
similar proffered distinctions of City Gas in case appealable to
Eleventh Circuit).

   2. The decision of the court of appeals is erroneous.  The Eleventh
Circuit correctly held in City Gas that deposits to secure the payment
of future bills act as advance payments of those bills and should be
taxed accordingly.  Indeed, the court of appeals acknowledged that,
"in terms of the recipient's cash flow, deposits to secure income
items and advance payments are essentially the same" (App., infra,
9a).  The deposit is taken into the possession and control of the
utility at the time it is received, and it serves as a payment of
future customer bills.  If the customer defaults in the future, the
deposit is used to cover the bill, and it is essentially the same as
an advance payment.  If the deposit is refunded, the refund may be
made in the form of a credit against future bills;  again, the deposit
is essentially the same as an advance payment.  Only if a refund is
made in the form of a cash or check payment to the customer does the
deposit appear even superficially to be different from an advance
payment.  But the economic reality of such a refund is that it is the
same as a credit against the customer's bill;  the only difference is
that in the former case there is an additional bilateral exchange of
checks between the parties in the amount of the deposit.  That
formalistic difference should not alter the treatment of the deposit
as an advance payment.

   The court of appeals viewed the deposits here as indistinguishable
from deposits made to secure the performance of nonincome-producing
covenants, such as a deposit paid by a renter to secure the owner
against property damage to the premises.  But there is a significant
difference between these two kinds of deposits with respect to the
general income-recognition principles of our tax system.  As we have
explained, a deposit to secure the future payment of funds that will
be income is essentially the same as an advance payment of income.
That is not true of a deposit to secure the owner against property
damage because the deposit is never converted into income.  If there
is no property damage, the deposit is returned to the renter.  If
there is property damage, the deposited funds are used to repair the
property, which also does not yield income to the owner.  Thus, a
deposit to secure the performance of nonincome-producing covenants
simply lacks the characteristics that make it appropriate to treat a
deposit to secure future bill payments as an advance payment.

   The court of appeals premised its holding here primarily on the
fact that respondent was obligated to pay some interest in some cases
when it refunded the deposits.  But that fact is not inconsistent with
treating the deposit payments as income upon receipt.  Unlike the
"extreme case" (App., infra, 16a) posited by the court of appeals in
which the mode of investment of the deposited funds was prescribed and
all of the interest earned on them was required to be refunded to the
customer -- and thus the deposits were essentially held in escrow
rather than within the complete control of the utility -- it is
apparent here that the interest obigation did not interfere with
respondent's use of the deposited funds or prevent it from benefiting
from that use.  Indeed, respondent was required to pay interest only
at an annual rate of either three percent or six percent, and no
interest obligation attached at all unless the deposit had been held
for some minimum period, either six or twelve months.  Plainly, such
an interest requirement does not mean that the deposited funds should
be viewed as if they were entirely the customer's property until
applied to a utility bill;  the interest requirement simply reflects
what is undisputed -- namely, that the funds were required to be paid
in advance as a security deposit to guarantee the payment of future
bills.  Accordingly, as both the Tax Court and the Eleventh Circuit
concluded in City Gas (see 689 F.2d at 948 n.7), the existence of an
obligation to pay interest is not a particularly important factor --
and certainly not dispositive -- in determining whether a deposit is
income upon receipt;  "interest may reflect compensation for the
advance payment of income items" (ibid.).

   Moreover, the approach of the court of appeals below unnecessarily
introduces uncertainty into the treatment of customer utility
deposits.  The Commissioner's ruling and the Eleventh Circuit's
decision resolve the question of the correct treatment of security
deposits by means of a principled analysis capable of even-handed
application.  The "facts and circumstances" approach of the court
below, by contrast, is much too amorphous and imprecise to provide an
acceptable level of predictability for tax planning (see, e.g., App.,
infra, 17a n.12).  Different courts attempting to apply the court of
appeals' vague balancing test are virtually certain to reach different
results in cases involving similarly situated taxpayers.  Thus, it is
appropriate for this Court to grant certiorari to restore an objective
and administrable approach to the treatment of security deposits.

   3. The decision below concerns an issue of considerable
administrative importance.  Although the court of appeals
characterized its holding as "limited" (App., infra, 16a), because it
suggests a case-by-case approach based upon examination of all the
"facts and circumstances," in reality the decision sweeps quite
broadly.  In ruling for respondent, the court relied almost entirely
on the obligation to pay interest on the deposits, but made no attempt
to explain why the particulars of the interest paid in this case
compelled this result -- even though the rate for at least part of the
period was plainly below the market rate and interest was not even
paid on all deposits.  Thus, the decision below appears to establish
the rule that an obligation to pay any interest on a deposit, or
anything more than a nominal amount of interest, is sufficient to
negate the claim that a deposit to secure the payment of future bills
is income upon receipt.  Such a rule obviously would affect the
taxation of many utilities, to the extent they require customer
deposits and pay interest thereon.  Moreover, the decision below could
have ramifications outside the utility context because it calls into
question the tax treatment even of forms of prepayment that generally
have been recognized as income upon receipt, such as prepayment of
rent, if some interest is required to be paid to reflect the fact that
payment has been made in advance.

   Because of the large number of utility customers, the issue
presented in this case involves considerable revenue, even though each
individual deposit is relatively small.  One recent case decided on
this issue in the Tax Court involved deficiencies in excess of $100
million.  See American Telephone & Telegraph Co. v. Commissioner, Tax
Ct. Mem. Dec. (P-H) Paragraph 88,035 (Feb. 3, 1988).  While the amount
at stake in that case was unusually large, the IRS estimates that
there are currently pending, either administratively or in the courts,
more than 150 cases involving more than $300 million in potential tax
liabilities in which the tax treatment of customer deposits is at
issue.  This Court should grant certiorari here to resolve this
important conflict in the circuits on an issue of industry-wide
significance.

                              CONCLUSION

   The petition for a writ of certiorari should be granted.

   Respectfully submitted.

   WILLIAM C. BRYSON

      Acting Solicitor General

   JAMES I.K. KNAPP

      Acting Assistant Attorney General

   LAWRENCE G. WALLACE

      Deputy Solicitor General

   ALAN I. HOROWITZ

      Assistant to the Solictor General

   JONATHAN S. COHEN

   WILLIAM A. WHITLEDGE

      Attorneys

   FEBRUARY 1989

   /1/ Commercial customers continued to be evaluated for
creditworthiness on a case-by-case basis (App., infra, 3a).

   /2/ If a refundable deposit was unclaimed, it escheated to the
state after seven years.  During the period in issue, $1,197,629 in
deposits was refunded by cash, check, or credit, and less than $9,324
in deposits escheated to the State.  App., infra, 24a-25a.

   /3/ This adjustment followed Rev. Rul. 72-519, supra, which
specifies that, when customer deposits are treated as advance
payments, such an adjustment is one attributable to a change in method
of accounting governed by the provisions of Section 481 of the
Internal Revenue Code (26 U.S.C.).  The amount of the adjustment in
the notice of deficiency was later recomputed to reflect the parties'
agreement as to the applicability of Treas. Reg. Sections 1.451-5 (26
C.F.R.), which provides that the inclusion in income of certain
advance payments for inventoriable goods may be deferred for up to two
years after receipt and specifies certain cost offsets.  The parties
then stipulated that respondent's returns should be adjusted by these
recomputed amounts "should the (Tax) Court determine that the customer
deposits received by (respondent) are advance payments" (Stip. para.
30).

   /4/ The Tax Court is a court of national jurisdiction and is not
bound to follow a court of appeals decision that reversed the Tax
Court in an earlier case.  The Tax Court does follow court of appeals
decisions in the circuit to which an appeal in the case at hand would
lie.  See Commissioner v. Portland Cement Co., 450 U.S. 156, 164
(1981);  Golsen v. Commissioner, 54 T.C. 742, 756-758 (1970), aff'd,
445 F.2d 985 (10th Cir.), cert. denied, 404 U.S. 940 (1971).  Thus, in
a case appealable to the Eleventh Circuit with facts closely
paralleling those in the instant case, the Tax Court held on the
authority of City Gas that the customer deposits were taxable as
income upon receipt. Gas Light Co. v. Commissioner, 55 T.C.M. (P-H)
Paragraph 86,118 (1986).

   /5/ On remand, the Tax Court found that the primary purpose of the
deposits was to secure the payment of future income and therefore that
they must be treated as advance payments and taxed as income on
receipt.  City Gas Co. v. Commissioner, 53 T.C.M. (P-H) Paragraph
84,044 (1984).

   /6/ City Gas involved three utilities whose cases were consolidated
for decision in the Tax Court.  One of those utilities paid interest
on its deposits, and the others did not.  74 T.C. at 389.  Neither the
Tax Court, which held that none of the deposits should be treated as
income on receipt, nor the court of appeals, which found that all of
the deposits should be so treated, regarded the payment of interest as
a basis for distinguishing one utility from another.

   APPENDIX