                         105 T.C. No. 17



                     UNITED STATES TAX COURT



HACHETTE USA, INC., AS SUCCESSOR TO HACHETTE PUBLICATIONS, INC.,
AND CURTIS CIRCULATION CO., SUBSIDIARY, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent

HACHETTE USA, INC., AS SUCCESSOR TO HACHETTE DISTRIBUTION, INC.,
AND CURTIS CIRCULATION CO., SUBSIDIARY, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent


     Docket Nos. 11693-94, 11694-94.    Filed September 25, 1995.


          Ps filed their consolidated Federal income tax
     returns electing under sec. 458, I.R.C., to exclude
     from gross income the sales revenue attributable to
     magazines that were returned by the purchasers shortly
     after the close of the tax year. In computing gross
     income Ps originally made correlative adjustments to
     cost of goods sold pursuant to sec. 1.458-1(g), Income
     Tax Regs. Subsequently they filed amended returns
     recomputing gross income without the cost adjustments
     required by the regulation, taking the position that
     the regulation is invalid.
                                  - 2 -

          Held: Because Congress did not intend to
     prescribe or preclude rules for the treatment of costs
     under the sec. 458, I.R.C., election, the regulation
     does not conflict with this section and is valid.



     Daniel M. Davidson and John Wester, for petitioners.

     John A. Guarnieri and Douglas A. Fendrick, for respondent.



                                 OPINION


     LARO, Judge:    These cases were consolidated for trial,

briefing, and opinion, and submitted to the Court without trial

pursuant to Rule 122(a).1      Hachette USA, Inc. (Hachette USA), and

its subsidiary Curtis Circulation Co. (Curtis) petitioned the

Court for redetermination of the following Federal income tax

deficiencies determined by respondent:

                           Docket No. 11693-94:

               Taxable Year               Deficiency

                    1987                   $665,225

                           Docket No. 11694-94:

               Taxable Year               Deficiency

                    1987                   $139,502

               Tax Year Ended             Deficiency

                Nov. 30, 1988             $2,535,928


     1
       All Rule references are to the Tax Court Rules of Practice
and Procedure and, unless otherwise indicated, section references
are to the Internal Revenue Code for the years at issue.
                               - 3 -

     After concessions, the issues for decision are:    (1) Whether

section 1.458-1(g), Income Tax Regs., which requires a taxpayer

to reduce cost of goods sold when it elects to exclude sales

income under section 458, is invalid; and (2) even if it is

invalid, whether a taxpayer must obtain the Secretary's consent

under section 446(e) before recomputing its taxable income

without the erroneous cost of goods sold adjustments.   Because we

hold that the regulation is valid, we find it unnecessary to

reach the second issue.

                    Stipulations by the Parties

     The facts have been fully stipulated and are so found.    The

stipulation of facts and the exhibits attached thereto are

incorporated herein by this reference.2   Petitioner Hachette USA

is a Delaware corporation whose principal place of business on

the date the petitions in this case were filed was in New York,

New York.   Petitioner Curtis was organized under Delaware law on

May 28, 1986.   From that time until June 30, 1987, it was a

member of an affiliated group of corporations whose parent was

Hachette Publications, Inc., a New York corporation (HPI).

Curtis' income and deductions from May 28 through December 31,

1986, were included in the consolidated Federal income tax

return, Form 1120, U.S. Corporation Income Tax Return (Form

1120), filed by HPI for HPI's 1986 taxable year.   Curtis' income

     2
       Respondent contested the relevance of petitioners'
Exhibit 10. Accordingly, this exhibit is not incorporated.
                               - 4 -

and deductions for the 6-month period ended June 30, 1987, were

included on Form 1120 filed by HPI for HPI's 1987 taxable year.

     On June 30, 1987, HPI transferred all of its stock in Curtis

to Hachette Distribution, Inc., a Delaware corporation (HDI).

Curtis' income and deductions for the 6-month period ended

December 31, 1987, and for the 11-month period ended November 30,

1988, were included on Forms 1120 filed by HDI for HDI's 1987 and

1988 taxable years, respectively.   In a merger consummated on

November 30, 1988, Hachette USA, succeeded to all the assets,

claims, debts, and liabilities of HPI and HDI.

     At all times relevant to these cases, Curtis was a national

wholesale distributor of magazines.    Its customers were local or

regional distributors who sold the magazines acquired from Curtis

to retail merchants.   In accordance with established industry

practice Curtis billed its customers for the full number of

copies that it shipped to them, but granted them the legal right

to receive full credit for copies of magazines that they were

unable to sell.   Curtis, in turn, was entitled to receive full

credit from the magazine publishers for these unsold copies.

Thus, the financial risk associated with returned merchandise was

ultimately and solely borne by Curtis' suppliers.

     In computing its income for the taxable years in issue

Curtis properly elected under section 458 to exclude from gross

income the full amount of the sale price of copies returned by

its customers within the first 2-1/2 months of the following
                               - 5 -

taxable year.   On Forms 1120 filed for HPI's 1986 and 1987

taxable years and HDI's 1987 taxable year, Curtis also reduced

its cost of goods sold by the amount of the credits that it was

entitled to receive and in due course did receive from the

magazine publishers with respect to the returned magazines.

These correlative cost adjustments were in accordance with

section 1.458-1(g), Proposed Income Tax Regs., 49 Fed. Reg. 34523

(Aug. 31, 1984) (the Regulation).    In early 1989 Curtis learned

that the Government had conceded a refund action involving

another taxpayer's attempt to make the section 458 election

without offsetting cost adjustments.    In reliance upon this

concession, Curtis filed a Federal income tax return, Form 1120X,

Amended U.S. Corporation Income Tax Return (Form 1120X), for

HPI's 1986 and 1987 taxable years and HDI's 1987 taxable year

covered by its section 458 election, on which it recomputed the

amount of the gross income exclusion without regard to the

requirements of the Regulation and claimed refunds for

overpayment of tax and interest.    With respect to HPI's 1987

taxable year, respondent refunded the full amount claimed, but

she has not allowed the claim with respect to the HDI 1987

taxable year.

     On Form 1120 for HDI's 1988 taxable year Curtis computed the

exclusion for returned merchandise without offsetting adjustments

for the credits it was entitled to receive from its suppliers.

On April 13, 1994, respondent timely mailed notices of deficiency
                                - 6 -

to HPI and HDI.   In the notice sent to HDI respondent disallowed

the claim for refund with respect to the HDI 1987 taxable year.

On July 5, 1994, Hachette USA, as successor to HPI and HDI, and

Curtis timely filed petitions with the Court.

     All of the deficiencies and overpayments in dispute turn on

the application of the Regulation to the computation of gross

income under the section 458 election.   The parties agree that if

Curtis was required to follow the Regulation, there are

deficiencies of $665,225 for HPI's 1987 taxable year, $135,804

for HDI's 1987 taxable year, and $2,535,928 for HDI's 1988

taxable year.    If the Regulation is invalid, and Curtis was not

required to secure the Secretary's consent to recompute its

taxable income on the Forms 1120X, there are no deficiencies, and

there is an overpayment for HDI's 1987 taxable year in the amount

of $1,165,475.

                       Legislative Background

     Section 458 was added to the Code by section 372(a) of the

Revenue Act of 1978, Pub. L. 95-600, 92 Stat. 2763, 2860.    The

specific problems to which it was addressed are explained in the

legislative history.   Under general tax principles accrual basis

taxpayers must include sales revenues in income for the taxable

year when all events have occurred which fix the right to receive

the income and the amount of the income can be determined with

reasonable accuracy.   See sec. 451(a); sec. 1.451-1(a), Income

Tax Regs.   The seller has some flexibility in determining when to
                               - 7 -

account for sales, such as, for example, at the time of shipment

or title passage or acceptance, but the expectation that some of

the merchandise may be returned after the date of sale for credit

or refund does not warrant the postponement of accrual.   The way

that the accrual method of accounting corrects the overstatement

of income resulting from the return of merchandise is by allowing

the seller a deduction in the year of return for the amount of

the credit or refund given to the purchaser.   In periods of

generally rising sales and fairly constant rates of merchandise

returns this method of accounting leads to persistent

overstatement of income.   In the print and sound recording

industries, where merchandise returns regularly constitute a

substantial percentage of total sales, the general accrual

principles were perceived to be inconsistent with economic

realities and unfair.

     The Senate Finance Committee report accompanying the Revenue

Act of 1978 gave its assessment of the problem as follows:

     Reasons for change

          Publishers and distributors of magazines,
     paperbacks, and records often sell more copies of their
     merchandise than it is anticipated will be sold to
     consumers. This "overstocking" is part of a mass-
     marketing promotion technique, which relies in part on
     conspicuous display of the merchandise and ability of
     the retailer promptly to satisfy consumer demand.
     Publishers usually bear the cost of such mass-marketing
     promotion by agreeing to repurchase unsold copies of
     merchandise from distributors, who in turn agree to
     repurchase unsold copies from retailers. These unsold
     items are commonly called "returns".
                               - 8 -

          The generally accepted method of accounting for
     returns in the publishing industry is to record sales
     at the time merchandise is shipped and to establish an
     offsetting reserve for estimated returns. The effect
     of this accounting treatment is to report sales net of
     estimated returns. Tax accounting rules, however, do
     not permit gross income to be reduced for returns until
     the returned items are received, which may not occur
     until a taxable year subsequent to that in which the
     sale was recorded.

          The committee believes that the present method of
     tax accounting for returns of magazines, paperbacks,
     and records does not accurately measure income for
     Federal income tax purposes and that it adversely
     affects publishers and distributors of these items.
     [S. Rept. 95-1278, at 4 (1978).]

     The basic formula of section 458 was already developed in

the 93d Congress in a provision that the House Ways and Means

Committee included in its unreported tax reform bill of 1974.    An

identical provision was reported by the Committee in the 94th

Congress as H.R. 5161 and was passed by voice vote of the House

of Representatives in 1976.   Miscellaneous Tax Bills:   Hearings

Before the Subcommittee on Miscellaneous Revenue Measures of the

House Ways and Means Committee, 95th Cong., 1st Sess. 218 (Sept.

7 and 9, 1977) (hereinafter Ways and Means Committee Hearings).

The provision would have allowed accrual basis publishers and

distributors of periodicals to elect not to include sales income

attributable to copies sold for display purposes which are

returned within 2-1/2 months after the close of the tax year.    A

sale for display purposes was defined as a sale which was made in

order to permit adequate display of the periodical, if at the

time of the sale the taxpayer had a legal obligation to accept
                                    - 9 -

returns of the periodical.    H. Rept. 94-1354, at 6-7 (1976).   The

Senate Finance Committee, however, did not act on the bill, and

it languished, partly because of the efforts of the paperback

book and record industries, with the support of Treasury, to

extend its coverage.    Ways and Means Committee Hearings, 218-220.

The bill was resurrected, however, in the 95th Congress as H.R.

3050 and, after its coverage was extended to these industries, it

was passed by both committees and incorporated in this form into

the Revenue Act of 1978.

     Section 458 provides, in pertinent part:

          SEC. 458(a). Exclusion From Gross Income.--A
     taxpayer who is on an accrual method of accounting may
     elect not to include in the gross income for the
     taxable year the income attributable to the qualified
     sale of any magazine, paperback, or record which is
     returned to the taxpayer before the close of the
     merchandise return period.

          (b) Definitions and Special Rules.--For purposes
          of this section --

          *      *        *     *           *   *   *

               (5) Qualified sale.--A sale of a magazine,
               paperback, or record is a qualified sale if--

                       (A) at the time of sale, the
                       taxpayer has a legal
                       obligation to adjust the sales
                       price of such magazine,
                       paperback, or record if it is
                       not resold, and

                       (B) the sales price of such
                       magazine, paperback, or record
                       is adjusted by the taxpayer
                       because of a failure to resell
                       it.
                                - 10 -

                (6) Amount excluded.--The amount
                excluded under this section with respect
                to any qualified sale shall be the
                lesser of --

                      (A) the amount covered by the
                      legal obligation described in
                      paragraph (5)(A), or

                      (B) the amount of the
                      adjustment agreed to by the
                      taxpayer before the close of
                      the merchandise return period.

                (7) Merchandise return period.--

                      (A) * * * the term
                      "merchandise return period"
                      means, with respect to any
                      taxable year--

                            (i) in the case of
                            magazines, the period of
                            2 months and 15 days
                            first occurring after the
                            close of the taxable
                            year, ***

          *       *     *       *        *      *     *

           (c) Qualified Sales to Which Section Applies.--

                (1) Election of benefits.-- * * *
                An election under this section may
                be made without the consent of the
                Secretary. * * *

     Regulations under section 458 were proposed on August 31,

1984.   49 Fed. Reg. 34520.   Final regulations were published in

the Federal Register on August 25, 1992, and made retroactive to

the date of the proposed regulations.        57 Fed. Reg. 38596; sec.

1.458-1(a)(2), Income Tax Regs.     Paragraphs (c) and (g) of
                                  - 11 -

section 1.458-1, Income Tax Regs., remained essentially identical

in the final version.       They provide:

     (c) Amount of the exclusion -- (1) In general. Except
     as otherwise provided in paragraph (g) of this section,
     the amount of the gross income exclusion with respect
     to any qualified sale is equal to the lesser of --

          (i) [same as section 458(b)(6)(A)]

          (ii) [same as section 458(b)(6)(B)]

     *        *         *         *         *    *      *

     (g) Adjustment to inventory and cost of goods sold.
     (1) If a taxpayer makes adjustments to gross receipts
     for a taxable year under the method of accounting
     described in section 458, the taxpayer, in determining
     excludable gross income, is also required to make
     appropriate correlative adjustments to purchases or
     closing inventory and to cost of goods sold for the
     same taxable year. Adjustments are appropriate, for
     example, where the taxpayer holds the merchandise
     returned for resale or where the taxpayer is entitled
     to receive a price adjustment from the person or entity
     that sold the merchandise to the taxpayer. Cost of
     goods sold must be properly adjusted in accordance with
     the provisions of sec. 1.61-3 which provides, in
     pertinent part, that gross income derived from a
     manufacturing or merchandising business equals total
     sales less cost of goods sold.

The correlative adjustments contemplated by the Regulation are

illustrated by examples in subparagraph 2.      In Example 1, which

we shall adapt somewhat for the purposes of our discussion,

publisher sells 500 copies of its publication to distributor at

$1 each in year 1.   Under the sale agreement publisher has an

obligation to refund to distributor the full sales price for any

copies which distributor does not resell and returns, or from

which distributor removes and returns the cover, during the
                                - 12 -

statutory merchandise return period in year 2.     Distributor

returns the covers from 100 copies within the merchandise return

period.   Publisher's cost is 25 cents per copy.

     In the absence of a section 458 election, publisher would

compute its gross income for year 1 ($375) by taking the

difference between sales revenues ($500) and cost of goods sold

($125).   Pursuant to section 458, publisher is entitled to

exclude $100 from gross income.    Under these facts, no cost of

goods sold adjustment is required because publisher does not hold

the "returned" merchandise for resale.    Accordingly, its gross

income is $275 ($400 - $125).    By contrast, if distributor

returned unsold copies intact and publisher held them for resale

to other customers, the Regulation would require publisher to

compute its gross income ($300) as follows:    gross receipts

adjusted for the exclusion ($500 - $100) less cost of goods sold

adjusted for the addition to closing inventory ($125 - $25).

     As Example 2 makes clear, if distributor resold the

publications to retailer under a similar right-of-return

arrangement, in no case would distributor be entitled to exclude

the sales proceeds attributable to copies returned by retailer

unless distributor reduced its cost of goods sold.     This is

because, unlike publisher in the first variant of Example 1,

distributor's costs are fully reimbursed.

     The preamble to the final regulations acknowledged that

during the period for public comment on the proposed regulations
                              - 13 -

a number of commentators had urged the Secretary to omit the cost

of goods sold adjustment.   The provision was retained, the

preamble explains, because the language of section 458(a)

indicates that the exclusion is determined on the basis of gross

income, which for a seller of merchandise is defined in section

1.61-3(a), Income Tax Regs., as sales revenue less cost of goods

sold, and because, in the Secretary's opinion, the cost of goods

sold adjustment is necessary to clearly reflect income in

accordance with section 446(b).   57 Fed. Reg. 38595.

                            Discussion

Congressional Intent With Respect to Cost Issues

     We must decide whether the correlative cost of goods sold

adjustment required by the Regulation contravenes the statute.

"Under the test articulated in Chevron U.S.A. v. Natural Res.

Def. Council, 467 U.S. 837 (1984), the first question a court

must ask when reviewing an agency's construction of a statute is

whether Congress has directly spoken to the precise question at

issue and has expressed a clear intent as to its resolution."

Western Natl. Mut. Ins. Co. v. Commissioner, 102 T.C. 338, 359

(1994), affd.     F.3d      (8th Cir., Sept. 1, 1995); NationsBank

v. Variable Annuity Life Ins. Co., 513 U.S.     ,       , 115 S. Ct.

810, 813-814 (1995).

     Petitioners contend that Congress has directly spoken to the

precise question at issue in these cases.   Petitioners' main

argument runs as follows.   Section 458(a) provides for an
                               - 14 -

election to exclude the income attributable to returned

merchandise.   "If the statute stopped there, the question of how

to determine 'the income attributable to' the returned items of

merchandise might well be a proper subject for further

elaboration in regulations.    The statute does not, however, stop

there."   Rather, in section 458(b)(6) it provides an explicit and

unambiguous formula for determining the adjustment to income.

The adjustment specified by Congress is the amount of the credit

against sales price which the taxpayer is obligated to grant to

the purchaser; the language of section 458(b)(6) leaves no room

whatever for interpretation.    Nevertheless, the regulations

substitute their own formula for the formula specified by

Congress.   The formula for determining the "gross income

exclusion" under section 1.458-1, Income Tax Regs., is the same

as that for determining the statutory "amount excluded", "except

as otherwise provided in paragraph (g)".    Sec. 1.458-1(c), Income

Tax Regs. (emphasis added).    The offsetting cost adjustments

required by paragraph (g) have the effect of "transform[ing] the

'amount excluded' from the amount of the credit given the

retailers for returned items to an amount equal to the

distributor's gross profit on those items."    The Regulation does

not validly interpret the statute; it changes the statute.

     Petitioners' argument succeeds in demonstrating that the net

effect of the cost adjustments required by the Regulation is to

reduce gross income by the amount of the gross profit on returned
                                - 15 -

merchandise (what the regulations call "gross income exclusion"

or "excludable gross income"), which amount is less than the full

sales price adjustment (the statutory "amount excluded").     But

this proposition was not in dispute.     Respondent concedes it, and

it is openly acknowledged in paragraphs (c) and (g) of the

regulations themselves.

     On the other hand, petitioners' conclusion that the

Regulation is inconsistent with the statute does not necessarily

follow.    There is no inconsistency unless the statute precludes

any further adjustment in the computation of gross income.       It is

the express premise of the Regulation that the statute has no

such effect, because it purports to deal only with the method of

accounting for gross receipts.     The argument outlined above does

not even challenge this premise, let alone persuade us that it is

wrong.

     The approach of the Regulation proceeds from the fundamental

principle that the determination of gross income by a taxpayer

who uses inventory comprises two separate calculations:

inclusion of gross receipts and subtraction of cost of goods

sold.     Sec. 1.61-3(a), Income Tax Regs.   Within this analytical

framework it makes no sense to say that rules prescribing the

treatment of costs "change" the determination of includable

receipts.     There is no question that the cost of goods sold

adjustment provided for by the Regulation operates to offset, in

whole or in part, the exclusion provided for by the statute.      But
                              - 16 -

it is no more appropriate to conclude that this cost adjustment

"changes the amount excluded" than to say that section 162 or

section 263A "changes" the treatment of items under section 61.

Thus, if the premise of the Regulation is correct, there is no

conflict.

     Petitioners' contention that there is a conflict depends

upon proof that the amount of gross income that may be excluded

is equal to the full "amount excluded" of section 458(b)(6).    The

statute does not say so explicitly:    it does not define the

"amount excluded" as the amount of gross income that a taxpayer

may elect not to include; what it provides is that the "amount

excluded" is the amount a taxpayer may elect not to include in

gross income.   If petitioners are correct to assume that when the

statute speaks of items included in, and excluded from, gross

income, Congress intended to refer to amounts of "gross income"

within the meaning of section 1.61-3(a), Income Tax Regs., and

not merely amounts of gross receipts, this intention ought to be

discernible from the legislative history.

     When one reviews the legislative history, not only is there

no evidence that Congress regarded the "amount excluded" as an

amount of gross income rather than gross receipts; one is struck

by the complete absence of any explicit reference to the cost

side of the relevant gross income computation.    A few examples

will suffice to illustrate that Congress appears to have been
                                - 17 -

concerned exclusively with the gross receipts side of the

returned merchandise problem.

     Both the House Ways and Means Committee report and the

Senate Finance Committee report on H.R. 3050 contain

substantially identical language describing the tax treatment of

returned merchandise under prior law.    It reads:

     Under present law, sellers of merchandise who use an
     accrual method of accounting generally must include
     sales proceeds in income for the taxable year when all
     events have occurred which fix the right to receive the
     income and the amount can be determined with reasonable
     accuracy. [H. Rept. 95-1091, at 3 (1978); S. Rept. 95-
     1278, at 4 (1978); emphasis added.]

An earlier report prepared for the House Ways and Means Committee

by the Joint Committee on Taxation contains the following

passages on current law:

     When sold goods are returned to a taxpayer during a
     taxable year the return generally is treated as a
     reduction of gross sales for purposes of financial and
     tax accounting. * * *

     * * * The Internal Revenue Service has taken the
     position that accrual basis publishers and distributors
     must include the sales of the periodical in income when
     the periodicals are shipped to the retailers and may
     exclude from income returns of the periodicals only
     when the copies are returned by the retailer during the
     taxable year. [Staff of the Jt. Comm. on Taxation,
     Description of Technical and Minor Bills Listed for a
     Hearing before the Subcommittee on Miscellaneous
     Revenue Measures of the Committee on Ways and Means on
     September 7 and 9, 1977, at 28-29 (1977); emphasis
     added.]

Identical language appears in H. Rept. 94-1354, at 2-3 (1976).

     When the committees stated that under current law sales

proceeds are included in income, they did not mean that the sales
                              - 18 -

proceeds represented the amount of the seller's gross income

attributable to the sales.   We must presume that they were well

aware that gross income from sales of inventory equals sales

proceeds minus cost of goods sold.     That they were referring only

to the tax treatment of receipts is also inferable from their

formulation of the relevant all events test; it would not make

sense to apply this test to accrual of costs.    Similarly, when

the committees stated that the return of excess copies is

accounted for by a "reduction of gross sales" or "exclu[sion]

from income", they could not have meant that gross income was

reduced by this amount, since the seller's cost of goods sold

must be reduced as well.   Sec. 1.471-1, Income Tax Regs.   If

Congress was not referring to amounts of gross income when it

discussed the accrual of income under current law, it is only

reasonable to infer that Congress was also not referring to

amounts of gross income when it defined the scope of the election

not to accrue.

     For whatever reason, Congress did not choose to formulate

the problem of merchandise returns in terms of gross income.     We

can only conclude that Congress simply was not concerned with the

inventory and cost accounting issues that the returned

merchandise problem involved, and consequently could not have

possessed a specific intent to prescribe, or preclude, rules to

handle these issues.
                               - 19 -

     Petitioners read the legislative history differently.    In

their view, these materials disclose that Congress specifically

intended that taxpayers electing to exclude sales proceeds also

continue to be entitled to deduct the cost of goods sold in the

year of the sales.    The asymmetrical treatment of revenues and

costs that the Regulation seeks to correct was actually a

deliberate choice to remedy the problem as Congress perceived it.

Petitioners' argument attaches great significance to the

characterization of excess copies as promotional materials which

appears in all of the committee reports, the hearings, and the

text of the original bills.    H.R. 5161 and H.R. 3050, before

their amendment in the second session of the 95th Congress, would

have applied to "sales of magazines or other periodicals for

display purposes."    The House and Senate reports on H.R. 3050

described the deliberate overstocking of retailers by

distributors as "a mass-marketing promotion technique".    H. Rept.

95-1091, supra at 3; S. Rept. 95-1278, supra at 4.    Petitioners

conclude from this evidence that Congress "chose, through section

458, to treat the transfer of * * * [excess copies] to retailers

as a promotional device, not as a sale.    Accordingly, section 458

eliminates the sale proceeds but not the distributors' cost for

the display items."    We are not persuaded.

     What is clear from the legislative history is that Congress

believed that the shipment of excess copies by publishers and

distributors to retailers with no expectation that they would be
                              - 20 -

sold should not be treated as a sale for purposes of the accrual

of income.   See H. Rept. 94-1354, supra at 3.   It does not

follow, however, that Congress believed these shipments should be

deductible as promotional expenses.    Reading the many statements

characterizing the distribution of excess copies as a promotional

device in context, we think it likely that they were intended

only to provide a reason why treatment of the transaction as a

sale for tax purposes was inappropriate, and not a reason why the

costs should be deductible.   Were we to accept petitioners'

interpretation arguendo, the very fact that such statements are

so numerous in the legislative history would make it all the more

puzzling that there is no explicit statement of petitioners'

conclusion that costs attributable to the excess copies should be

deducted in full in the year of shipment.

     Petitioners' argument fails to explain why Congress did not

expressly provide for the deduction which, in their view,

Congress intended.   We gather from petitioners' brief that they

believe Congress felt it unnecessary to act to secure the cost of

goods sold deduction for excess copies because this deduction

would be available under the general principles of inventory

accounting set forth in section 1.471-1, Income Tax Regs.      We

think it unlikely that Congress would have understood section

1.471-1, Income Tax Regs., and the other applicable provisions of

the Code and regulations to apply in this way.
                               - 21 -

       The purpose of maintaining inventories is to assure that the

costs of producing or acquiring goods are matched with the

revenues realized from their sale.      Hamilton Indus. v.

Commissioner, 97 T.C. 120, 130 (1991); Rotolo v. Commissioner,

88 T.C. 1500, 1515 (1987).    Inventory accounting accomplishes

this by accumulating production or acquisition costs in an

inventory account rather than allowing an immediate deduction for

the costs when they are incurred.    When the related goods are

sold, these costs are removed from the inventory account and

recorded as costs of sale, which reduce taxable income for the

year of sale.    The matching principle is fundamental to inventory

accounting and is required by the definition of gross income for

a manufacturing or merchandising business.     Sec. 1.61-3(a),

Income Tax Regs.    An item is not removed from closing inventory

and reflected in cost of goods sold until the income from the

item is realized under the taxpayer's method of accounting.

       Accounting for inventories is governed by sections 446 and

471.    Section 446(b) provides that the taxpayer's method of

accounting must clearly reflect income in the opinion of the

Secretary.    Section 471 provides that inventories shall be taken

on such basis as the Secretary prescribes and establishes "two

distinct tests to which an inventory must conform.     First it must

conform 'as nearly as may be' to the 'best accounting practice,'

a phrase that is synonymous with 'generally accepted accounting

principles.'    Second, it 'must clearly reflect the income.'"
                               - 22 -

Thor Power Tool Co. v. Commissioner, 439 U.S. 522, 532 (1979).

Sections 1.471-1 and 1.471-2, Income Tax Regs., provide general

guidance for determining the timing of inventory adjustments in

order to satisfy the requirements of section 471.    Thus, as a

general matter, the seller must remove an item from inventory

when title passes to the purchaser.     If the item is returned, it

is included in inventory for the year of return.

     When a taxpayer elects to exclude sales revenue attributable

to an item under the section 458 election, removing the item from

inventory and deducting its cost would not be consistent with the

requirements of section 471.   First, such treatment would deviate

from generally accepted accounting principles.    Under these

principles, sales with right of return are accounted for by

symmetrical reductions in both the sales account and the cost of

goods sold adjustment account to reflect estimates of future

returns.   See SFAS No. 48 (June 1981); Jarnagin, Financial

Accounting Standards 610-612 (16th ed. 1994); Kay & Searfoss,

Handbook of Accounting and Auditing 13-11 to 13-12 (2d ed. 1989).

Second, the mismatching of income and expense would not clearly

reflect income.   Petitioners' argument requires us to assume that

Congress intended a result that would have conflicted with

section 471.   Thus, it was not in reliance on general inventory

accounting principles that Congress omitted to provide for the

cost deduction that petitioners believe Congress intended.      On

the other hand, if it was Congress' intention to create an
                               - 23 -

exception to section 471, they would have done so expressly.

They did not.   In short, petitioners have offered no plausible

explanation, and we can find none ourselves, that would account

for the fact that the language of section 458 does not reflect

the purposes that they ascribe to Congress.

     Moreover, even if we assumed that Congress did intend costs

incurred through overstocking to be deductible, we would not be

persuaded that the Regulation is inconsistent with that intent.

The Regulation allows a taxpayer to forgo correlative cost

adjustments with respect to excess copies to the extent that the

taxpayer actually bears the costs.      Petitioners would have us

believe that Congress intended the same promotional costs to be

deducted twice:   once by the publisher who actually bore them and

once by the distributor like Curtis who is fully reimbursed.

This treatment obviously has the potential to become an abusive

tax shelter:    one can imagine a lengthening of the distribution

chain through the interposition between publisher and retail

merchant of additional, unnecessary wholesalers that enjoy the

benefit of a deduction without committing any resources or

bearing risk.   In the absence of any direct evidence, we refuse

to believe that Congress would have been so indiscriminate and

foolhardy in the bestowal of tax benefits.

     Finally, we find some evidence in the legislative history

that contradicts the view that Congress intended asymmetrical

treatment of revenues and costs.    Most importantly, as respondent
                                - 24 -

points out, one objective of the returned merchandise election

legislation seems to have been to reconcile the tax treatment of

merchandise returns with the financial accounting treatment.   The

need for greater consistency was discussed in the House Ways and

Means Committee report on H.R. 5161:

          Your committee recognizes that the tax accounting
     rules contain numerous variances from generally
     accepted accounting principles which should be the
     subject for legislative review so that those variances
     which are not appropriate may be eliminated. * * * In
     the meantime, your committee believes that the attempt
     by the Internal Revenue Service to tax the periodicals
     sold for display purposes could produce a significant
     distortion of income. * * * Thus, your committee does
     not believe it is appropriate to delay this legislation
     until a general solution to accounting problems is
     found. [H. Rept. 94-1354, at 3 (1976).]

The approach adopted by Congress was not identical to the reserve

for estimated returns recognized under generally accepted

accounting principles, even though its effect was intended to be

substantially the same.   As the House Ways and Means Committee

report on H.R. 3050 observed:

          The method of accounting provided for under the
     election differs from that used for financial reporting
     purposes, in that the amount of reduction in gross
     income pursuant to the election is limited by actual
     returns during the merchandise return period, while
     under financial accounting rules, the reduction may be
     based on an estimate of future returns. [H. Rept. 95-
     1091, at 4 (1978).]

     The Report mentions only this difference, however.

Petitioners' position implies that the effect of the legislation

was to harmonize tax accounting with financial accounting in one

respect while creating a new discrepancy in another respect.   The
                              - 25 -

inconsistency between an asymmetrical treatment of revenues and

costs for tax purposes and the symmetrical treatment required by

generally accepted accounting principles would not have gone

unnoticed.   Surely, Treasury or the committee staff would have

believed such a discrepancy required explicit justification.

Their unanimous silence indicates that no such discrepancy was

anticipated, let alone intended.

     For all the foregoing reasons, we find petitioners' reading

of congressional intent wholly unpersuasive, and we reject it.3

     3
       Petitioners attack the Regulation on a number of
additional grounds. First, they argue that other provisions of
the regulations under sec. 458 adopt their view. In particular,
they point to sec. 1.458-1(e), Income Tax Regs., which deals with
the operation of the suspense account required by sec. 458(e) as
a transitional adjustment mechanism. Because sec. 1.458-1(e),
Income Tax Regs., tracks the statutory language closely in
explaining the derivation of the "amount excluded" and fails to
mention cost of goods sold adjustments, petitioners conclude that
respondent has implicitly conceded that cost of goods sold
adjustments do not comport with the statutory scheme. We
disagree. The reason there is no reference to correlative
adjustments under par. (g) in the discussion of the suspense
account mechanics in par. (e) is that the cross-reference appears
in par. (g). Sec. 1.458-1(g)(2), Income Tax Regs. A careful
reading of par. (g) leaves no doubt whatever that the Regulation
requires correlative cost adjustments to be made in the
computation of gross income using the suspense account.

     Second, petitioners argue that the Regulation is
inconsistent with sec. 458(c)(1), which provides that "An
election under this section may be made without the consent of
the Secretary." Petitioners read this provision as prohibiting
the Secretary from establishing additional requirements for the
election. We think this argument represents a misunderstanding
of sec. 458(c)(1). This paragraph deals only with procedural
matters: a taxpayer must make an election to claim the benefits
of the statute; the election shall be made in such manner as the
Secretary prescribes, and no later than the deadline for filing
                                                   (continued...)
                               - 26 -

Secretary's Authority To Resolve Cost Issues

     This Court and others have struck down regulations that did

not harmonize with the language, origin, and purpose of the

statute which they purported to interpret.     United States v.

Vogel Fertilizer Co., 455 U.S. 16, 24-25 (1982); Western Natl.

Mut. Ins. Co. v. Commissioner, 102 T.C. 338 (1994); Hughes Intl.

Sales Corp. v. Commissioner, 100 T.C. 293 (1993); Jackson Family

Found. v. Commissioner, 97 T.C. 534 (1991), affd. 15 F.3d 917

(9th Cir. 1994); Durbin Paper Stock Co. v. Commissioner, 80 T.C.

252 (1983).   Petitioners have attempted to cast these cases in

the mold of those decisions.   Thus, petitioners argue that the

Regulation represents an impermissible attempt to amend rather

than merely interpret the statute, quoting language from our


     3
      (...continued)
the tax return for the year to which the election applies. From
the context it is quite clear that Congress did not intend this
provision as a substantive limitation on the Secretary's
rule-making authority.

     It is likely that Congress added this provision out of a
consideration for administrative efficiency. Sec. 458(c)(4)
provides that computation of taxable income under an election
shall be treated as a method of accounting. The election would
therefore constitute a change in method of accounting, which
ordinarily would require the taxpayer to follow procedures for
obtaining the Secretary's consent. Sec. 446(e). Congress
anticipated a large number of similarly situated taxpayers would
make the election and did not believe that review of each
applicant's particular circumstances would be necessary.
Petitioners' reading would imply that the Secretary could not
disallow use of the method of accounting under sec. 458 even if
the taxpayer was using it in a manner that conflicted with other
provisions of the Code and regulations. There is no evidence
that Congress intended sec. 458 to supersede all other tax law.
                                - 27 -

decisions:    "'[R]espondent has no power to promulgate a

regulation adding provisions that he believes Congress should

have included but did not."    Durbin Paper Stock v. Commissioner,

supra at 261.    "Respondent may not usurp the authority of

Congress by adding restrictions to a statute which are not

there.'"     Id. at 257 (quoting Estate of Boeshore v. Commissioner,

78 T.C. 523, 527 (1982)).    "[T]he regulation may not construct an

amendment to the statute."    Jackson Family Found. v.

Commissioner, supra at 538.

     Petitioners' reliance on this line of cases is misplaced.

In each of the cases cited the regulation directly conflicted

with the statute it purported to interpret.     United States v.

Vogel Fertilizer, supra at 26 ("regulation is fundamentally at

odds with the manifest congressional design"); Western Natl. Mut.

Ins. Co. v. Commissioner, supra at 360 ("The statute here is

neither silent nor ambiguous with respect to the specific issue

in question"); Hughes Intl. Sales Corp. v. Commissioner, supra at

305 ("The legislative history directly undercuts section 1.993-

6(e)(1), Income Tax Regs."); Durbin Paper Stock Co. v.

Commissioner, supra at 257 ("Where the provisions of the statute

are unambiguous and its directive specific, there is no power to

amend it by regulation.").    We have already explained at length

why we believe the Regulation in these cases is not inconsistent

with the statute.    Here there is no unambiguous, specific
                                - 28 -

statutory directive and no manifest congressional design with

respect to the treatment of costs under a section 458 election.

     To invoke these passages from our decisions for the general

proposition that regulations may not add rules not found in the

statute and not precluded by the statute is to misread them.

Indeed, supplementation of a statute is a necessary and proper

part of the Secretary's role in the administration of our tax

laws.     As the Supreme Court stated in Chevron, U.S.A. v. Natural

Res. Def. Council, 467 U.S. at 842-843:

        If the intent of Congress is clear, that is the end of
        the matter, * * * if the statute is silent or
        ambiguous with respect to the specific issue, the
        question for the court is whether the agency's answer
        is based on a permissible construction of the statute.

             "The power of an administrative agency to
        administer a congressionally created . . . program
        necessarily requires the formulation of policy and the
        making of rules to fill any gap left, implicitly or
        explicitly, by Congress." * * * [Citations omitted.]

        "Treasury Regulations 'must be sustained unless unreasonable

and plainly inconsistent with the revenue statutes.'"

Commissioner v. Portland Cement Co., 450 U.S. 156, 169 (1981)

(quoting Commissioner v. South Texas Lumber Co., 333 U.S. 496,

501 (1948).     There is no evidence that the Regulation conflicts

with either the language or the purpose of section 458.     We

believe the Regulation provides an eminently reasonable solution

to a problem that the statute does not address.     The correlative

cost adjustments it requires follow settled principles of tax

accounting and are consistent with generally accepted accounting
                               - 29 -

principles.   The limited application of the requirements reflects

a sensible distinction between costs that are actually borne and

costs that are not.   The Secretary possessed the authority to

promulgate section 1.458-1(g), Income Tax Regs., and exercised

that authority reasonably.

     We have considered petitioners' other arguments and find

them to be without merit.    To reflect the foregoing,


                                     Decisions will be entered

                                under Rule 155.
