THOR POWER TOOL CO. V. COMMISSIONER 439 U.S. 522 (1979) CASE BRIEF

THOR POWER TOOL CO. V. COMMISSIONER

439 U.S. 522 (1979)

NATURE OF THE CASE: Thor (P) appealed a decision of the United States Court of Appeals for the Seventh Circuit, which affirmed the IRS's (D) disallowance of petitioner's write-down offset and bad-debt deduction, alleging that offset and deduction were proper under 172 and 166(c).

FACTS: P is a Delaware corporation with principal place of business in Illinois. It manufactures hand-held power tools, parts and accessories, and rubber products. P maintains inventories of raw materials, work-in-process, finished parts and accessories, and completed tools. P has used, both for financial accounting and for income tax purposes, the 'lower of cost or market' method of valuing inventories. P produced liberal quantities of each part used in the equipment to avoid subsequent production runs. Additional runs entail costly retooling and result in delays in filling orders. In 1960, P instituted a procedure for writing down the inventory value of replacement parts and accessories for tool models it no longer produced. It credited 10% of each part's cost for each year since production of the parent model had ceased. In late 1964, new management took control and promptly concluded that P's inventory in general was overvalued. P wrote off approximately $2.75 million of obsolete parts, damaged or defective tools, demonstration or sales samples, and similar items. D allowed this write-off because P scrapped most of the articles shortly after their removal from the 1964 closing inventory. D allowed this write-off because P scrapped most of the articles shortly after their removal from the 1964 closing inventory. This left some 44,000 assorted items. P concluded that many of these articles, mostly spare parts, were 'excess' inventory, that is, that they were held in excess of any reasonably foreseeable future demand. P wrote down all its 'excess' inventory of the items left at once. It did not immediately scrap the articles or sell them at reduced prices, as it had done with the $3 million of obsolete and damaged inventory, the write-down of which P permitted. P retained the 'excess' items physically in inventory and continued to sell them at original prices. P also disposed of some of these items as scrap. P contended that, by writing down excess inventory to scrap value, and by thus carrying all inventory at 'net realizable value,' it had reduced its inventory to 'market' in accord with its 'lower of cost or market' method of accounting. P disallowed the write-down in its entirety, asserting that it did not serve clearly to reflect P's 1964 income for tax purposes. The Tax Court found as a fact that P's write-down of excess inventory did conform to 'generally accepted accounting principles'; indeed, the court was 'thoroughly convinced . . . that such was the case.' The court held that conformance with 'generally accepted accounting principles' is not enough; 446 (b), and 471 prescribe, as an independent requirement, that inventory accounting methods must 'clearly reflect income.' It rejected the argument that its write-down of 'excess' inventory was authorized by Regulations. The court of appeals affirmed and the Supreme Court granted certiorari.

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LEGAL ANALYSIS:

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