Appealed from: U.S. Claims Court, Judge Rader.
Baldwin and Friedman,*fn* Senior Circuit Judges, and Mayer, Circuit Judge.
Diebold, Inc. appeals the judgment of the United States Claims Court, 16 Cl. Ct. 193, 63 A.F.T.R.2d (P-H) 599 (1989), that, because Diebold changed its method of accounting without the Commissioner's prior consent as required by section 446(e) of the Internal Revenue Code of 1954, 26 U.S.C. § 446(e) (1982), it was not entitled to a refund of income taxes. We affirm.
Neither party suggests that summary judgment was inappropriate. Therefore, we adopt the Claims Court's statement of undisputed facts and recount only those necessary to our discussion.
Diebold, an accrual basis taxpayer, manufactures and sells automated teller machines (ATMs). To facilitate on-site repair, it designed its ATMs in modular form: an ATM is composed of several modules, each of which performs a different function, such as reading magnetic cards, accepting deposits, dispensing cash, printing receipts and transmitting customer commands. Diebold maintains a pool of replacement modules so that when a customer's ATM needs repair, Diebold can rapidly restore it to service by replacing the malfunctioning module with a spare from its pool. The defective module is then repaired and put into the pool. Diebold maintains these replacement modules were never held for sale and were installed in its customers' ATMs under service contracts for which there was an annual fee, but no separate charge for the replacement modules.
In Diebold's original tax returns for 1976 and 1977, it claimed no investment tax credit or depreciation for the cost of manufacturing its set of replacement modules. Instead, they were considered nondepreciable inventory for which there was no deduction until they were removed from service. On March 31, 1980, however, Diebold wrote a letter to the Internal Revenue agent who was auditing its 1976 and 1977 returns, explaining that the replacement modules should be treated as depreciable property to clearly reflect taxable income, and requesting that the agent take this change into account. Believing this to be an informal claim for a refund, the auditor requested that Diebold file amended returns to formalize the claim. Diebold complied and filed amended returns on October 3, 1980 for these tax years, claiming both a depreciation deduction and an investment tax credit for the replacement modules, giving rise to a refund. By letter dated April 18, 1983, the regional commissioner disallowed the claims for refund, and Diebold filed this suit in the Claims Court.
In granting summary judgment for the government, the Claims Court held that Diebold was not entitled to a refund because it did not secure the consent of the Commissioner before changing its method of accounting, as required by section 446(e) of the Internal Revenue Code and Treasury Regulation § 1.446-1(e). This judgment was based on the fact that Diebold had consistently accounted for the replacement modules as inventory during the tax years in question, and then sought, by way of amended returns, to treat them as depreciable assets without having filed the required Form 3115 to request the Commissioner's consent to the change.
Diebold tells us it did not change its method of accounting within the meaning of section 446(e) of the Internal Revenue Code, but simply corrected an error in the application of a pre-existing method of accounting by filing amended tax returns for the years going back to the first year in which the mistake was made. But we believe the Claims Court was correct that Diebold's claim for refunds was based on an impermissible change in the method of accounting on the basis of which Diebold regularly computed its taxable income within the meaning of section 446(e) and Treasury Regulation § 1.446-1(e). The relevant texts of these provisions are set out in the margin.*fn1
The argument that Diebold sought merely to correct a "posting error" by shifting the rotatable pool of replacement modules from the inventory account to the pre-existing capital account is not persuasive. In contrast to the cases it relies on, e.g., Gimbel Bros. v. United States, 210 Ct. Cl. 17, 535 F.2d 14 (1976), later Proceeding, 211 Ct. Cl. 383 (1976); and Standard Oil Co. (Indiana) v. Commissioner, 77 T.C. 349 (1981),*fn2 Diebold does not seek to account for the replacement modules in the same manner that it accounts for other similar items or to correct the omission of an item from a method of accounting that it otherwise consistently applies to a single category of related items. In Gimbel Bros., the taxpayer sought to change from the accrual method to the installment method of reporting the income from its rotating charge accounts. The court found that these accounts had "substantially similar characteristics" to other charge accounts that the taxpayer already reported on the installment method. 535 F.2d at 15 n. 2, 22. In Standard Oil Co., the court characterized the taxpayer's error simply as a "failure to report similar items consistently under a fixed method of accounting". 77 T.C. at 383.
Here, there is no assertion, nor can there be, that Diebold's replacement modules are similar to or in the same category as other items in the capital asset account. In fact, Diebold accounted for replacement modules as nondepreciable inventory in 1974 and 1975, years for which it claimed no refund. 16 Cl.Ct. at 195. Similarly, Diebold accounted for spare parts for its physical security equipment (another line of business) in its inventory account.
Diebold also relies on Korn Industries, Inc. v. United States, 209 Ct. Cl. 559, 532 F.2d 1352 (1976), in support of its "posting error" argument, but this case is also different from ours. There, the taxpayer mistakenly omitted three materials costs from the calculation of the cost of finished goods in inventory. These three elements of cost were included, however, in the raw materials inventory, the work-in-progress inventory and the supplies inventory. Therefore, it was obvious that the taxpayer had established the omitted items as materials costs and that it had merely made a posting error when it left them out of the calculation of the cost of finished goods in inventory. In contrast, Diebold has established the inventory method of accounting for the replacement modules and seeks to change to a different method by treating the modules as depreciable assets rather than as inventory. The argument that it seeks to correct a substantive error independent of its choice of accounting procedures is simply wrong.
It is not clear that Diebold's original tax treatment of its replacement modules was improper. However, even if it were correcting an erroneous characterization of the replacement modules, the correction would still be considered a change in the method of accounting. Treas.Reg. § 1.446-1(e)(2)(i); see Witte v. Commissioner, 168 U.S. App. D.C. 133, 513 F.2d 391, 394 (D.C. Cir. 1975); see also cases cited by the Claims Court, 16 Cl.Ct. at 201. Therefore, Diebold's argument that the replacement ...