No. 98-2010
In the Supreme Court of the United States
CHARLES SCHWAB CORPORATION AND
INCLUDABLE SUBSIDIARIES, PETITIONER
v.
COMMISSIONER OF INTERNAL REVENUE
ON PETITION FOR A WRIT OF CERTIORARI
TO THE UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
BRIEF FOR THE RESPONDENT IN OPPOSITION
SETH P. WAXMAN
Solicitor General
Counsel of Record
LORETTA C. ARGRETT
Assistant Attorney General
RICHARD FARBER
PAULA K. SPECK
Attorneys
Department of Justice
Washington, D.C. 20530
(202) 514-2217
QUESTION PRESENTED
Whether the commission income that petitioner earned by carrying out trades
in stocks and other securities for its customers accrued on the date that
the trades were executed or on the settlement date when petitioner delivered
the securities or sale proceeds to its customers.
In the Supreme Court of the United States
No. 98-2010
CHARLES SCHWAB CORPORATION AND
INCLUDABLE SUBSIDIARIES, PETITIONER
v.
COMMISSIONER OF INTERNAL REVENUE
ON PETITION FOR A WRIT OF CERTIORARI
TO THE UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
BRIEF FOR THE RESPONDENT IN OPPOSITION
OPINIONS BELOW
The order of the court of appeals, which simply "adopt[s] the reasoning
of the Tax Court" (161 F.3d 1231), is not reproduced in the appendix
to the petition. The opinion of the Tax Court (Pet. App. 3a-31a) is reported
at 107 T.C. 282.
JURISDICTION
The judgment of the court of appeals (Pet. App. 1a-2a) was entered on December
9, 1998. A petition for rehearing was denied on March 17, 1999 (Pet. App.
32a). The petition for a writ of certiorari was filed on June 15, 1999.
The jurisdiction of this Court is invoked under 28 U.S.C. 1254(1).
REGULATIONS INVOLVED
1. As in effect during the years at issue, 26 C.F.R. 1.446-1(c) (1989) provided
in relevant part:
§ 1.446-1. General rule for methods of accounting.
* * * * *
(c) Permissible methods-(1) In general. Subject to the provisions of paragraphs
(a) and (b) of this section, a taxpayer may compute his taxable income under
any of the following methods of accounting:
* * * * *
(ii) Accrual method. Generally, under an accrual method, income is to be
included for the taxable year when all the events have occurred which fix
the right to receive such income and the amount thereof can be determined
with reasonable accuracy. Under such a method, deductions are allowable
for the taxable year in which all the events have occurred which establish
the fact of the liability giving rise to such deduction and the amount thereof
can be determined with reasonable accuracy. * * *
2. As in effect during the years at issue, 26 C.F.R. 1.451-1(a) (1989) provided
as follows:
§ 1.451-1. General rule for taxable year of inclusion.
(a) General rule. Gains, profits, and income are to be included in gross
income for the taxable year in which they are actually or constructively
received by the taxpayer unless includible for a different year in accordance
with the taxpayer's method of accounting. Under an accrual method of accounting,
income is includible in gross income when all the events have occurred which
fix the right to receive such income and the amount thereof can be determined
with reasonable accuracy.
STATEMENT
1. Petitioner provides discount brokerage services through its membership
in securities exchanges. As a discount broker, petitioner does not offer
the services that a full-service brokerage firm provides-such as underwriting,
market making and portfolio management. It also does not give investment
advice and does not act as a principal in securities transactions (Pet.
App. 7a-8a). When petitioner opens a customer account, the customer signs
an agreement acknowledging that petitioner does not provide investment advice.
The only service provided by petitioner under its customer agreements is
the execution of trade orders (id. at 18a).
Each of petitioner's customers is required to provide credit information
and to maintain an account with funds on deposit. If a customer fails to
make payment on an order, petitioner may liquidate the account to collect
amounts due on the trade, including the commission (Pet. App. 18a). The
commission charged by petitioner for executing trades for its customers
is accounted for under the accrual method of accounting (id. at 6a).
2. In a typical transaction, a customer calls petitioner's telephone number
and is connected with the first available representative (Pet. App. 8a-9a).
After the customer gives the representative the details of the order, the
representative transmits the order to the exchange for execution (id. at
9a). In a "market" order placed for immediate execution during
the hours that the market is open, the representative ordinarily confirms
that the trade has been executed while the customer is still on the telephone
(ibid.). The market price in effect at the time of the trade determines
the price paid or received by the customer; this price, in turn, determines
the commission earned by petitioner (ibid.). The date on which the trade
is executed is known as the "trade date" (id. at 8a).
Upon execution of a trade order, petitioner generates an automatic written
confirmation slip, which is sent to the customer on the next business day.
This written confirmation serves as a notification to the customer of the
trade and as an invoice. It itemizes the total cost of the trade, including
the commission due from the customer to petitioner, and it lists the total
"amount due." The confirmation also encloses a remittance stub
and a return envelope in which to transmit payment (Pet. App. 19a).
After the trade is executed, petitioner performs a series of administrative
functions. These consist of: (i) recording, in which each transaction is
assigned a number associated with the data needed to process the transaction;
(ii) figuration, in which the net cost of the securities, commission, taxes,
and other amounts associated with the trade are calculated (usually in batch
computer processing the night of the date the trade is executed); (iii)
confirmation, in which petitioner mails a written description of the trade,
specifying the commission, the settlement date, and other details, to the
customer (usually on the first business day after the trade date); (iv)
comparison, in which petitioner's records of the transaction are reconciled
with those of the counter brokerage firm and with the customer's order,
to resolve any discrepancies (beginning the first business day after the
trade date and continuing up to settlement); and (v) booking, in which the
transaction is entered on petitioner's records, including commissions due
(Pet. App. 9a-11a).
On the "settlement date" of a purchase of securities, petitioner
delivers the securities to the purchaser and collects the purchase price.1
If the securities are held in "street name" (that is, in the broker's
name), delivery of the securities can be made by a simple change in petitioner's
records; if not, the stock certificates are endorsed by the seller and delivered
to the buyer on the settlement date (Pet. App. 12a). During the period involved
in this case, there was no federal rule specifying the time between the
trade date and the settlement date. The exchanges, however, generally required
transactions to be settled no later than the fifth business day after the
trade date (id. at 13a).
Petitioner has a policy against allowing a customer to cancel an order placed
in accordance with the customer's instructions (Pet. App. 14a, 19a). Petitioner
has maintained in litigation with its customers that an executed order may
not be canceled (ibid.; see Yadav v. Charles Schwab & Co., Fed. Sec.
L. Rep. (CCH) ¶ 95,376 (S.D.N.Y. 1990), appeal reinstated, 935 F.2d
540 (2d Cir. 1991)). A customer's trade order may be canceled only if an
entire transaction is canceled, such as when a planned initial public offering
is canceled. In that case, the trades do not settle and petitioner collects
no commission (Pet. App. 15a).
3. During its 1988 tax year, petitioner earned $3,357,576 in net commission
income on transactions executed in that year that were settled in 1989 (Pet.
App. 15a). Petitioner failed to include this income on its 1988 return.
The Internal Revenue Service determined that this commission income should
have been reported as accrued income in 1988. A notice of deficiency was
issued based upon that determination.
Petitioner sought review of the deficiency determination in Tax Court. Following
an extensive trial involving numerous documents and lengthy testimony, the
Tax Court sustained the Commissioner's determination. Applying the "all
events" test articulated by this Court in Spring City Foundry Co. v.
Commissioner, 292 U.S. 182, 184-185 (1934), and Schlude v. Commissioner,
372 U.S. 128, 133, 137 (1963), the Tax Court determined that (i) petitioner's
right to receive the commission income became fixed on the date the securities
trades were executed and (ii) this income therefore accrued to petitioner
on that date, rather than on the subsequent date when the trades were settled
(Pet. App. 17a, 23a). The court of appeals affirmed in a brief per curiam
opinion that "adopt[s] the reasoning of the Tax Court" (161 F.3d
1231 (1998)).
ARGUMENT
The decision of the court of appeals is correct and does not conflict with
any decision of this Court or any other court of appeals. Further review
is therefore not warranted.
1. A corporation such as petitioner is required to use the accrual method
of accounting in reporting and determining its federal income tax obligations.
26 U.S.C. 448(a), 451(a). For accrual basis taxpayers, an item of income
accrues-and must therefore be reported-in the tax year when (i) all the
events occur that fix the right to receive the income and (ii) the amount
of the income can be determined with reasonable accuracy. 26 C.F.R. 1.446-1(c)(1)(ii),
1.451-1(a) (1989); United States v. General Dynamics Corp., 481 U.S. 239,
242-243 (1987); Commissioner v. Hansen, 360 U.S. 446, 464 (1959); Spring
City Foundry v. Commissioner, 292 U.S. 182, 184-185 (1934). Petitioner does
not dispute that the amounts of the commissions involved in this case were
reasonably determinable on the trade date and that the second prong of the
accrual test was therefore met on that date. Petitioner disputes only the
determination of the Tax Court, in which the court of appeals concurred,
that the first prong of this established test was also met in 1988.
a. Under the accrual method, "it is the right to receive and not the
actual receipt" of an item that determines the timing of its inclusion
in income. Schlude v. Commissioner, 372 U.S. 128, 137 (1963) (quoting Spring
City Foundry v. Commissioner, 292 U.S. at 184-185). Accord Commissioner
v. Hansen, 360 U.S. at 464; Resale Mobile Homes v. Commissioner, 965 F.2d
818, 822 (10th Cir.), cert. denied, 506 U.S. 874 (1992).
Accrual occurs at the time that a liability to pay or a right to receive
a certain amount is "firmly established." United States v. General
Dynamics Corp., 481 U.S. at 243. See also Schlude v. Commissioner, 372 U.S.
at 137. The fact that taxpayers "cannot presently compel [a debtor]
to pay to them the amounts [due]" is not controlling. Commissioner
v. Hansen, 360 U.S. at 464. Such amounts accrue as income as soon as the
taxpayers acquire "a presently enforceable right to recover" the
amounts. Ibid.
For example, in Commissioner v. Hansen, automobile dealers argued that they
were not required to accrue amounts in reserve accounts owed to them by
finance companies because the dealers did not have the right to require
present payment of those amounts. In rejecting this argument, the Court
observed: "[I]t is a normal result of the accrual basis of accounting
and reporting that taxes frequently must be paid on accrued funds before
receipt of the cash with which to pay them." 360 U.S. at 466-467. Once
an accrual-basis taxpayer has earned the right to payment for services rendered,
it must report the income as accrued even if it must later carry out mathematical
"calculations" or "ministerial acts" to complete its
undertakings. Continental Tie & Lumber Co. v. United States, 286 U.S.
290, 295-296 (1932); Resale Mobile Homes v. Commissioner, 965 F.2d at 823.
b. The courts below properly applied these established principles to the
facts of this case. The courts correctly held that it is the execution of
a trade order from a customer-by locating a seller or purchaser for a specific
security on terms acceptable to the customer- that fixes petitioner's right
to receive its commission on the trade. The sole service for which customers
agree to pay a commission to petitioner is the execution of securities trades.
After petitioner executes the order according to the customer's instructions,
the order cannot be canceled and the cost of the trade, including the commission,
is promptly billed to the customer (Pet. App. 14a, 18a-19a). The administrative
services that petitioner thereafter performs in delivering the securities
and collecting its commission are ministerial in nature. Since petitioner's
right to receive its commissions is fixed on the trade date, it is on the
trade date that income accrues to petitioner. See, e.g., Continental Tie
& Lumber Co. v. United States, 286 U.S. at 295 (income accrues regardless
of necessity of carrying out a "mere administrative procedure to ascertain
the amount to be paid"); Resale Mobile Homes v. Commissioner, 965 F.2d
at 823 ("[a]n accrual basis taxpayer must report income in the year
the right to such income accrues, despite the necessity for mathematical
computations or ministerial acts"); Dally v. Commissioner, 227 F.2d
724, 726 (9th Cir. 1955), cert. denied, 351 U.S. 908 (1956) (contractor
cannot postpone accrual of payments for units delivered in 1942 until 1943
on the basis that the units had not been certified for payment until the
later year). The application of these well-established principles to the
particular facts of this case does not warrant review by this Court.
2. Petitioner errs in contending (Pet. i, 3, 5-11) that the decision in
this case conflicts with the decision of this Court in United States v.
General Dynamics Corp., 481 U.S. 239 (1987). The issue addressed in General
Dynamics was whether a company that acted as a self-insurer for its employee
medical expenses could accrue and deduct its liability to reimburse covered
medical expenses when the employees had failed to file required claims for
reimbursement by the close of the year. 481 U.S. at 244. The Court concluded
that the last event that fixed the company's liability to pay the medical
claims was the submission of a proper claim by the employee, for the company
had no obligation to reimburse the employee in the absence of the filing
of the claim. Ibid. The Court observed that claim filing was "not a
mere technicality" because employees might fail to file proper forms
"through oversight, procrastination, confusion over the coverage provided,
or fear of disclosure to the employer of the extent or nature of the services
received." Ibid. In General Dynamics, the Court pointed out that, by
contrast, the subsequent processing of the forms by the employer was merely
a "ministerial" act that would not postpone accrual of the expenses
on the company's tax return. 481 U.S. at 244 n.4.
The holding of the courts in the present case that petitioner must accrue
commission income in the tax year in which the trades are executed is entirely
consistent with the Court's application of the "all events" test
under the different facts involved in General Dynamics. The execution of
securities trades by petitioner is the event that fixes its right to commissions.
The post-trade activities performed by petitioner are ministerial functions
which, under General Dynamics and numerous other decisions, provide no basis
to defer accrual of the commission income. See 481 U.S. at 244 n.4; Continental
Tie & Lumber Co. v. United States, 286 U.S. at 295; Resale Mobile Homes
v. Commissioner, 965 F.2d at 823. Following completion of a trade, petitioner
is required, of course, to deliver to its customer the securities purchased
by the customer or the proceeds from securities sold by the customer. The
record of this case, however, amply supports the conclusion of the courts
below that these events are of a ministerial nature because they do no more
than "effectuate the mechanics of the transfer and are merely in confirmation
of the trade executed" (Pet. App. 18a).2
This finding, in which both courts below concurred, does not warrant further
review. "[T]his Court has frequently noted its reluctance to disturb
findings of fact concurred in by the two lower courts." Rogers v. Lodge,
458 U.S. 613, 623 (1982). See also Tiffany Fine Arts, Inc. v. United States,
469 U.S. 310, 317-318 n.5 (1985).
3. It is well established, for federal income tax purposes, that petitioner's
customers must themselves recognize gain or loss from any sale of securities
on the trade date. Rev. Rul. 93-84, 1993-2 C.B. 225; S. Rep. No. 313, 99th
Cong., 2d Sess. 131 (1986); H.R. Conf. Rep. No. 841, 99th Cong., 2d Sess.
Pt. 2, at 297 (1986); Anderson v. Commissioner, 527 F.2d 198, 199 (9th Cir.
1975).3 Consistent with that general principle, the Commissioner of Internal
Revenue has long taken the position that brokerage commissions from securities
trades similarly accrue as of the trade date, not the settlement date. Rev.
Rul. 74-372, 1974-2 C.B. 147. The decisions below thus merely implement
what has been the formal position of the Internal Revenue Service for the
past twenty-five years. In this context, it is plainly unwarranted for petitioner
to assert that the decision in this case will destabilize and "confuse
the Nation's taxpayers" (Pet. 15) in determining the proper accrual
of items of income and expenses.
CONCLUSION
The petition for a writ of certiorari should be denied.
Respectfully submitted.
SETH P. WAXMAN
Solicitor General
LORETTA C. ARGRETT
Assistant Attorney General
RICHARD FARBER
PAULA K. SPECK
Attorneys
AUGUST 1999
1 On the settlement date of a sale of securities, petitioner delivers the
proceeds, net of commissions, to the customer.
2 Petitioner argues (Pet. 11) that the decisions below contradict "plain
common sense" because "[t]he 'essence' of a sale, from a customer's
perspective, is the receipt in hand of the net cash proceeds" or, in
the case of a purchase, "the delivery of the securities purchased."
This argument, however, misdescribes the nature of the transaction. Petitioner
executes securities sales and purchases solely as a broker or agent. It
does not act as a principal (Pet. App. 7a-8a).
3 Similarly, in insider-trading cases, courts have held that the trade date,
rather than the settlement date, determines whether a purchase or sale of
stock falls within the six-month short-swing profit period defined by 15
U.S.C. 78p(b). Winston v. Federal Express Corp., 853 F.2d 455, 456 (6th
Cir. 1988).