                         T.C. Memo. 2004-185



                       UNITED STATES TAX COURT



             HERBERT C. HAYNES, INC., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 11304-01.                Filed August 18, 2004.


     Fred R. Becker and Shawn P. Travis, for petitioner.

     Mary P. Hamilton, for respondent.



                         MEMORANDUM OPINION


     VASQUEZ, Judge:    Respondent determined deficiencies in

petitioner’s Federal income taxes as follows:    (1) For the tax

year ending May 31, 1995 (FYE 1995), $1,269,108;1 (2) for the tax



     1
        All amounts are rounded to the nearest dollar. All
section references are to the Internal Revenue Code in effect for
the years in issue, and all Rule references are to the Tax Court
Rules of Practice and Procedure.
                                - 2 -

year ending May 31, 1996 (FYE 1996), $527,216; and (3) for the

tax year ending May 31, 1997 (FYE 1997), $718,914.

     After concessions,2 the issue for decision is whether

respondent abused his discretion by requiring petitioner to

change its method of accounting from the cash receipts and

disbursements method of accounting (cash method) to the accrual

method of accounting (accrual method).      Subsumed in this issue is

the question of whether petitioner is required to maintain

inventories for tax purposes.

                            Background

     The parties submitted this case fully stipulated pursuant to

Rule 122.   The stipulation of facts and the attached exhibits are

incorporated herein by this reference.      At the time the petition

was filed, petitioner’s principal place of business was in Winn,

Maine.

Herbert C. Haynes, Inc.

     Petitioner is a closely held Maine corporation engaged in

the logging business.   Petitioner was incorporated in 1963.

Before incorporation, Herbert C. Haynes, Sr. operated the logging

business as a sole proprietorship.      Herbert C. Haynes, Sr.,

president and founder of petitioner, is the majority shareholder

of petitioner.   He owned between 97 and 89 percent of the stock



     2
        The parties filed a stipulation of settled issues
resolving all other issues.
                                - 3 -

during the years in issue.    The other shareholders are Virginia

Haynes--wife of Herbert C. Haynes, Sr. --and Herbert C. Haynes,

Jr., Ginger Haynes Maxwell, and Barbara Haynes French, children

of Herbert C. Haynes, Sr.    Herbert C. Haynes, Jr., is the vice

president of petitioner.    He holds a degree in forestry.   Ginger

Haynes Maxwell is the secretary-clerk of petitioner.     Virginia

Haynes is the treasurer of petitioner.

     During the years in issue, petitioner employed approximately

60 employees.   Herbert C. Haynes, Sr., and his three children are

full-time employees of petitioner.      Three employees of petitioner

hold degrees in forestry.    Petitioner employed log purchasers,

truck drivers, mechanics, bulldozer operators, excavators, and

office staff.

Petitioner’s Woodland Ownership

     During the years at issue, petitioner owned at least 26,000

acres of woodland in Maine.    Additionally, Herbert C. Haynes,

Sr., individually owned approximately 13,000 acres of woodland in

Maine.   Lakeville Shores, Inc., a corporation owned 100 percent

by Haynes children, and Five Islands Land Co., a corporation

owned 100 percent by Herbert C. Haynes, Sr., also owned woodland

in Maine.3   Petitioner maintains that its shareholders and the

corporations owned by petitioner and by petitioner’s shareholders


     3
        Haynes Oil Co. is a fully owned subsidiary of petitioner.
Winn Logging, Inc., is a corporation owned by the Haynes
children. These corporations do not own woodland.
                                - 4 -

(collectively, related entities) owned approximately 110,000

acres of woodland in Maine and other States.

Petitioner’s Business Activities

     Most of petitioner’s business activities relate to the

cutting of timber4 and transporting the resulting “wood product”5

(logs or wood) to the appropriate mills.    Petitioner supervised

the cutting of timber on its own land and on land owned by

others.

     Petitioner had contracts and arrangements with approximately

100 mills.    Under the contracts and arrangements, petitioner

agreed to deliver logs to the mills for an agreed-upon price.

These mills were located in Maine, Vermont, New Hampshire,

Quebec, and New Brunswick.

     For example, in petitioner’s contract with International

Paper Co., petitioner agreed to sell specified quantities of logs

and wood (such as pulpwood, sawtimber, poles, and piling) to

International Paper Co. for a set price.    The duration of the

contract was 6 months, divided into six 1-month order intervals.



     4
        The parties define “timber” as standing trees containing
wood available and suitable for marketing and use. “Hardwood” is
defined as broadleaved, deciduous trees. “Softwood” is defined
as trees that have needles, such as pine, spruce, and fir.
“Stumpage” is defined as a standing tree, and “stumpage value” is
defined as the “economic value of standing trees”. “Pulpwood” is
defined as “paper wood” or “smaller timber that is chipped up and
used primarily to make paper”.
     5
          Once timber is cut, it becomes a “wood product”.
                                - 5 -

International Paper Co. would issue a wood delivery order and/or

a log delivery order within 1 week of the interval to petitioner.

The order specified the species, volume, delivery points, and

other specifications for deliveries to be made each week during

the interval.   International Paper Co. or its designee scaled or

weighed all wood delivered by petitioner upon delivery.

International Paper Co. had the right to refuse to accept

delivery of all or a portion of the wood if it did not meet the

specifications agreed to in the contract.

     Petitioner supplied the mills with logs through various

business activities.   These included:   (1) Cutting timber on land

owned by petitioner or related entities; (2) cutting timber on

land owned by third parties--i.e., landowners not related to

petitioner, petitioner’s shareholders, petitioner’s subsidiaries,

or petitioner’s shareholders’ corporations (collectively,

unrelated entities); and (3) purchasing wood from unrelated

entities.    Petitioner generally received payment for logs within

2 to 4 weeks of delivery.

     The trees cut by petitioner grew at a rate of 3 percent per

year.   It takes 30 to 50 years for these trees to reach maturity.

Petitioner’s business activities did not include the planting of

new trees.   Petitioner was not in the business of operating a

nursery or sod farm.   Petitioner was not in the business of
                                - 6 -

raising or harvesting trees bearing fruit, nuts, or other crops

or ornamental trees.

     1.     Timber Cut on Land Owned by Petitioner or Its
            Related Entities

     A portion of petitioner’s business activities related to

cutting timber on land owned by petitioner or its related

entities.    For this portion of petitioner’s business activity,

petitioner’s foresters examined tracts of land to cut, marked

trees to cut, and supervised cutting.    The crews that cut the

trees were not employees of petitioner; they were employed by

corporations under contract to petitioner.    The corporations

petitioner hired to cut the trees were either related entities

(such as Winn Logging, Inc.) or unrelated entities.    Trucks and

other heavy equipment owned by or leased to petitioner

transported the cut logs to mills designated by petitioner.

     2.     Timber Purchase Arrangements With Unrelated Entities

     A second business activity involved petitioner’s timber

purchase arrangements with unrelated entities that owned

woodland.    Under these contracts, petitioner’s foresters (or the

landowner’s foresters) identified the merchantable timber and

oversaw the cutting crews.    Petitioner’s trucks delivered the

logs to mills that petitioner had contractual arrangements with.

Petitioner used either one of two pricing arrangements under

these timber purchase contracts:    (1) Fixed-price or lump-sum

arrangements; or (2) “pay-as-cut” or stumpage permits.
                                  - 7 -

            a.     Fixed-Price Arrangements

     In a fixed-price or a lump-sum arrangement, petitioner paid

a fixed price or a lump sum to cut timber for a fixed period.

Petitioner assumed the risk of loss if the land produced an

insufficient yield of timber.

            b.     “Pay-as-Cut” Arrangements

     In a pay-as-cut or stumpage permit arrangement, petitioner

paid the landowner for the timber as it was cut.     Foresters

identified the timber to cut, and petitioner’s foresters oversaw

the cutting crews.

     Although petitioner’s contractual arrangements for

purchasing timber varied, petitioner’s typical stumpage permit

granted petitioner the right to cut timber on a designated parcel

of land.    Petitioner paid the landowner for the logs at the time

of cutting.      The stumpage permit granted petitioner the right to

enter the property with labor and equipment to cut and remove the

timber.    Petitioner indemnified and held harmless the landowner

from all liabilities, claims, judgments, or liens associated with

its work on the premises.     Petitioner also covenanted to observe

all Federal, State, and local laws, ordinances, and regulations

relating to the cutting of forest products and the removal of all

products and related waste from the premises.

     Petitioner obtained stumpage permits from major timber

landowners such as J.M. Huber Corp., Great Northern Paper Co.,
                                - 8 -

and International Paper Co., and from smaller landowners.     For

stumpage permits with major timber landowners, the landowner’s

foresters identified the trees to be cut.     For stumpage permits

with smaller landowners, petitioner’s foresters identified the

trees to be cut.

     3.   Financing Arrangements

     As another business activity, petitioner entered into

purchase financing arrangements with unrelated entities.     Under

these arrangements, petitioner lent the unrelated entity funds to

purchase woodland.   The unrelated entity paid interest to

petitioner, gave petitioner a security interest in the land and

logs, and sold the logs to petitioner.     Petitioner’s foresters or

log buyers surveyed the property and identified and priced the

marketable timber.   In some arrangements, petitioner hired

cutting crews.    In other instances, petitioner merely identified

and purchased the marketable timber and then sold and delivered

it to the mill.

     4.   Cutting Agreements With Unrelated Landowners

     Petitioner also derived revenue from cutting agreements with

unrelated landowners.   Under these cutting agreements, a

landowner hired petitioner to cut and transport timber to the

mills designated by the landowner.      The landowner paid petitioner

a fixed rate per unit delivered.
                                   - 9 -

     5.      Purchased Wood

     Another business activity petitioner engaged in involved

logs that petitioner purchased and then resold.          Petitioner had

no involvement in the cutting of the logs under this business

activity.     Petitioner purchased the cut logs from an unrelated

entity.     The unrelated entity delivered the logs to mills

petitioner designated.      The mills purchased the logs from

petitioner under an existing contract petitioner had with the

mill.     The mill paid petitioner for the logs.     Petitioner then

paid the unrelated entity for the logs, at a price less than what

the mill paid petitioner.

     6.      Petitioner’s Estimated Costs From Its Business
             Activities

     The parties stipulated the following:

          Because of the scope of petitioner’s activities
     and the entrepreneurial nature of the industry, it is
     impossible to describe a single business model.
     Further, the extent of petitioner’s activities * * *
     will vary from year [to year] and involve many unique
     transactions.

     Petitioner estimates the direct costs associated with the

various business activities as follows:

    Business Activity            FYE 1995     FYE 1996        FYE 1997

Trees from petitioner’s land   $12,333,559   $12,136,789     $9,050,143
Trees from related party land   24,667,118    24,273,578     22,647,858
Trees from unrelated party land 12,333,559    12,136,789     13,588,715
  Subtotal                      49,334,236    48,547,156     45,286,716
Purchased wood                  23,099,969    18,079,103     28,757,169
  Total                         72,434,205    66,626,259     74,043,885
                                   - 10 -

As a percentage, petitioner estimates the direct costs associated

with the various business activities as follows:

     Business Activity            FYE 1995      FYE 1996    FYE 1997

Trees from petitioner’s land         17%           18%         12%
Trees from related party land        34            36          31
Trees from unrelated party land      17            18          18
  Subtotal                           68            73          61
Purchased wood                       32            27          39
  Total                             100           100         100

Financial Accounting

      The firm of Haverlock, Estey & Curran prepared petitioner’s

financial statements for FYE 1995, FYE 1996, and FYE 1997.                 The

financial statements note, in the first footnote, that “The

company * * * is on the cash basis of accounting for financial

statement and tax reporting.        Consequently, accounts payable,

receivable and inventory are not recognized in these statements.

The estimated figures for each * * * are as follows:”

                              FYE 1995          FYE 1996          FYE 1997

Accounts receivable         $1,576,000        $3,200,000        $3,500,000
Accounts payable                --—               --—               ---
Inventory1 (cost, FIFO)      1,862,892         1,477,361         1,862,892
      1
         The parties agree that if respondent prevails and petitioner is
      required to maintain inventories, the closing inventory figures
      are as follows: (1) For FYE 1995, $1,862,892; (2) for FYE 1996,
      $610,950; and (3) for FYE 1997, $587,334.

Income Tax Returns

      On petitioner’s Forms 1120, U.S. Corporation Income Tax

Return, for the years at issue, petitioner listed its business

activity as “wood operator” and its product or service as

“pulpwood and logs”.      Since its inception, and including the

years at issue, petitioner has maintained its books and records
                                 - 11 -

and filed its Federal income tax returns using the cash method.

For FYE 1995, petitioner had gross receipts of $82,693,253 and

cost of operations of $78,340,960.        For FYE 1996, petitioner had

gross receipts of $76,677,330 and cost of operations of

$72,745,121.   For FYE 1997, petitioner had gross receipts of

$86,123,392 and cost of operations of $81,561,495.

                               Discussion

I.    Evidentiary Issue

      Attached to petitioner’s opening brief are exhibits which

were not included in the stipulation of facts and exhibits

submitted pursuant to Rule 122.      Petitioner’s requests for

findings of fact and argument refer to these exhibits.

      The submission of a case without trial under Rule 122(a)

does not alter the requirements otherwise applicable to adducing

proof.   Rule 122(b).     Statements in briefs do not constitute

evidence.   Rule 143(b); Evans v. Commissioner, 48 T.C. 704, 709

(1967), affd. per curiam 413 F.2d 1047 (9th Cir. 1969); Chapman

v. Commissioner, T.C. Memo. 1997-147; Berglund v. Commissioner,

T.C. Memo. 1995-536.      Accordingly, the additional exhibits

attached to petitioner’s briefs are not part of the record and

will not be considered by the Court.

II.   Burden of Proof

      Petitioner appears to argue that respondent bears the burden

of proof on the issue of whether petitioner must maintain
                                   - 12 -

inventories.    Petitioner argues that this issue is a “new matter”

not contained in the notice of deficiency.             Our resolution of

this case does not depend on which party bears the burden of

proof.    Nonetheless, for the sake of completeness, we will

address this issue.

     Petitioner bears the burden of establishing that

respondent’s determinations of deficiencies, as contained in the

statutory notice of deficiency, are incorrect.             See Rule 142(a);6

Welch v. Helvering, 290 U.S. 111 (1933).

     The notice of deficiency states:

                                 Schedule A-1
                          Explanation of Adjustments

     a.   Change of Accounting Method    5/31/95        $1,576,300.00
                                         5/31/96        $1,623,700.00
                                         5/31/97          $300,000.00

           The cash receipts and disbursements method of accounting you
     used to keep your books and records does not clearly reflect
     income; but the accrual method of accounting clearly reflects your
     income. Therefore, your taxable income is increased
     $1,576,300.00, $1,623,700.00 and $300,000.00 for 5/31/95, 5/31/96
     and 5/31/97, respectively.

     b.   Cost of Sales                  5/31/95         $1,862,892.00
                                         5/31/96        ($1,862,892.00)
                                         5/31/97        ($1,477,361.00)

           Since you are being required to use the accrual method of
     accounting, the values of your opening and closing inventories for
     the tax year ending 5/31/95 is $0.00 and $1,862,892.00. For the
     tax year ending 5/31/96, your opening and closing inventories are
     $1,862,892 and $1,477,361.00. For the tax year ending 5/31/97,
     your opening and closing inventories are $1,477,361.00 and
     $2,419,747.




     6
        The examination in this case commenced before July 22,
1998. Accordingly, sec. 7491 is inapplicable. See Warbelow’s
Air Ventures, Inc. v. Commissioner, 118 T.C. 579, 582 n.8,
(2002), affd. 80 Fed. Appx. 16 (9th Cir. 2003).
                                  - 13 -


     c.   Cost of Sales                 5/31/96     $1,477,361.00
                                        5/31/97     $2,419,747.00

           Since you are being required to use the accrual method of
     accounting, the values of your opening and closing inventories for
     the tax year ending 5/31/95 is $0.00 and $1,862,892.00. For the
     tax year ending 5/31/96, your opening and closing inventories are
     $1,862,892 and $1,477,361.00. For the tax year ending 5/31/97,
     your opening and closing inventories are $1,477,361.00 and
     $2,419,747.

     [Emphasis added.]

     The language regarding the adjustments to the cost of sales

specifically refers to the value of petitioner’s inventories.

We find respondent determined in the notice of deficiency that

petitioner is required to maintain inventories.          This is not a

new issue.

III. Whether Petitioner’s Accounting Method Clearly Reflects
     Income

     A.     Applicable Law

     Respondent asserts that the cash method does not clearly

reflect petitioner’s income.      Under section 446,7 the


     7
          Sec. 446 provides in pertinent part:

          SEC. 446(a). General Rule.--Taxable income shall
     be computed under the method of accounting on the basis
     of which the taxpayer regularly computes his income in
     keeping his books.

          (b) Exceptions.--If no method of accounting has been
     regularly used by the taxpayer, or if the method used does
     not clearly reflect income, the computation of taxable
     income shall be made under such method as, in the opinion of
     the Secretary, does clearly reflect income.

          (c) Permissible Methods.--Subject to the provisions of
     subsections (a) and (b), a taxpayer may compute taxable
     income under any of the following methods of accounting--
                                                  (continued...)
                               - 14 -

Commissioner has broad powers to determine whether an accounting

method used by a taxpayer clearly reflects income.     See

Commissioner v. Hansen, 360 U.S. 446, 467 (1959); Ansley-

Sheppard-Burgess Co. v. Commissioner, 104 T.C. 367, 370 (1995).

Courts do not interfere with the Commissioner’s determination

under section 446 unless it is clearly unlawful.     See Thor Power

Tool Co. v. Commissioner, 439 U.S. 522, 532 (1979); Cole v.

Commissioner, 586 F.2d 747, 749 (9th Cir. 1978), affg. 64 T.C.

1091 (1975); Ansley-Sheppard-Burgess Co. v. Commissioner, supra

at 370.

     Whether respondent abused his discretion is a question of

fact.    See Ansley-Sheppard-Burgess Co. v. Commissioner, supra at

371; Ford Motor Co. v. Commissioner, 102 T.C. 87, 91-92 (1994),

affd. 71 F.3d 209 (6th Cir. 1995).      The reviewing court’s task

is not to determine whether, in its own opinion, the taxpayer’s

method of accounting clearly reflects income but to determine

whether there is an adequate basis in law for the Commissioner’s

conclusion that it does not.    See Ansley-Sheppard-Burgess Co. v.



     7
        (...continued)
                 (1) the cash receipts and disbursements method;

                 (2) an accrual method;

                 (3) any other method permitted by this chapter; or

                 (4) any combination of the foregoing methods
            permitted under regulations prescribed by the
            Secretary.
                              - 15 -

Commissioner, supra at 371.   Consequently, to prevail, a

taxpayer must prove that the Commissioner’s determination is

arbitrary, capricious, or without sound basis in fact or law.

See id.; Ford Motor Co. v. Commissioner, supra at 92.

     To resolve this dispute, we consider sections 446 and 471

and the regulations thereunder.   Under section 446(a), a

taxpayer computes taxable income on the basis of the method of

accounting it uses in keeping its books.   Section 446(c)

describes the various accounting methods that a taxpayer may use

in computing taxable income, including the cash and accrual

methods.

     Section 1.446-1(c)(2)(i), Income Tax Regs., provides that a

taxpayer who is required to use inventories must also use the

accrual method with regard to purchases and sales.   Under

section 471 and section 1.471-1, Income Tax Regs., a taxpayer

must account for inventories if the production, purchase, or

sale of merchandise is an income-producing factor in the

taxpayer’s business and the taxpayer has acquired title to the

merchandise.

     We consider the facts and circumstances of each case in

deciding whether an item is merchandise that is an income-

producing factor.   See Honeywell, Inc. v. Commissioner, T.C.

Memo. 1992-453, affd. without published opinion 27 F.3d 571 (8th
                                - 16 -

Cir. 1994); Wilkinson-Beane, Inc. v. Commissioner, T.C. Memo.

1969-79, affd. 420 F.2d 352 (1st Cir. 1970).

     B.     Whether Petitioner Must Maintain Inventory

     Respondent contends that, because the logs and wood are

merchandise that is an income-producing factor in petitioner’s

business, petitioner must maintain inventories and report its

taxable income under the accrual method.

     Petitioner failed to respond in its reply brief to

respondent’s arguments regarding this issue.    In its opening

brief petitioner argues that the purchased wood is not inventory

because petitioner does not possess title to it.       Petitioner’s

only statement on this issue is:

     It seems reasonably far-fetched to contend that a
     person that harvests trees on land not owned by
     Petitioner and delivers them to a mill under
     Petitioner’s contract, which Petitioner first learns
     about when it is presented a scale slip, somehow
     resulted in Petitioner receiving title to a log that is
     probably pulp before Petitioner’s obligation to pay
     arises. Indeed, we are unsure what this inventory
     argument truly brings to the clear reflection of
     anything since the “inventory” seems to be sold before
     it is received and the Petitioner never has the risk of
     loss or the benefits and burdens of ownership.

     For the reasons stated below, we agree with respondent that

petitioner maintains inventory and must use the accrual method.

                  1.   Purchase, Production, or Sale

     It is undisputed that petitioner purchases the purchased

wood.     Petitioner then resells the purchased wood to the mills.

Additionally, in evaluating the substance of the transactions,
                                - 17 -

we believe petitioner bought wood in its other business

activities as well.    Petitioner’s activities related to cutting

wood on land owned by unrelated entities, under the numerous

business activities such as the fixed price arrangements and

pay-as-cut arrangements, are also forms of purchasing wood

products for resale.    Petitioner “bought” the timber (standing

trees) on the unrelated entity’s land, supervised cutting of the

timber, removed the logs using its own equipment and trucks, and

delivered the logs to the mills.

                2.     Merchandise

     The logs and other wood products are merchandise to

petitioner.   Although not specifically defined in the Internal

Revenue Code or the regulations, courts have ruled that

“merchandise”, as used in section 1.471-1, Income Tax Regs., is

an item acquired and held for sale.      See, e.g., Wilkinson-Beane,

Inc. v. Commissioner, supra.     Whether an item was acquired and

held for sale is governed by the substance of the transaction

and not its form.     Honeywell, Inc. v. Commissioner, supra.

Thus, to determine whether an item is “merchandise”, we must

take into account the particular facts and circumstances of the

taxpayer in each case and the manner and context in which the

taxpayer operates the business at hand.      Wilkinson-Beane, Inc.

v. Commissioner, supra; Thompson Elec., Inc. v. Commissioner,

T.C. Memo. 1995-292; Honeywell, Inc. v. Commissioner, supra;
                               - 18 -

J.P. Sheahan Associates v. Commissioner, T.C. Memo. 1992-239.

Possession of title to goods, even if only for an instant, is

sufficient to require a taxpayer to inventory the goods.

Addison Distrib. Inc. v. Commissioner, T.C. Memo. 1998-289;

Middlebrooks v. Commissioner, T.C. Memo. 1975-275; see also sec.

1.471-1, Income Tax Regs.

     Petitioner stipulated that it acquired the purchased wood.

Petitioner stipulated that it sold the purchased wood it

acquired.    We have also found that petitioner bought and sold

the wood it cut on land owned by unrelated entities.     The terms

of a typical contract between petitioner and a mill state:

     For the period and upon the terms and conditions
     hereinafter set forth, SELLER undertakes and agrees to
     sell and deliver unto PURCHASER, and PURCHASER
     undertakes and agrees to purchase and accept from
     SELLER, those certain quantities of pulpwood,
     sawtimber, poles and piling (herein called “wood”) as
     are hereinafter more particularly set forth and
     described.

     Petitioner obtains title to the wood before it sells it to

the mills.    See Me. Rev. Stat. Ann. tit. 11, sec. 2-401 (West

1995) (passage of title).    For petitioner to purchase and resell

the wood, title had to pass from the logger who cut the wood to

petitioner and then from petitioner to the mill.     See also

Tebarco Mech. Corp. v. Commissioner, T.C. Memo. 1997-311.

     Petitioner’s income tax returns indicate that its product

or service was “pulpwood and logs”.     The logs are not consumed

by petitioner in its business.   Petitioner has not asserted that
                                - 19 -

it is in a service business or that the logs are incidental to

its business activity.    To the contrary, petitioner is in the

business of buying and selling logs.

     The substance of the transactions demonstrates that

petitioner acquired logs and wood and held them for sale.

                3.     Income-Producing Factor

     In evaluating whether merchandise is an income-producing

factor in a taxpayer’s business, we compare the cost of the

merchandise to the taxpayer’s gross receipts computed under the

cash method.   See Wilkinson-Beane, Inc. v. Commissioner, supra.

In Wilkinson-Beane, Inc. v. Commissioner, 420 F.2d 352 (1st Cir.

1970), the Court of Appeals affirmed our holding that

merchandise the cost of which (in different taxable years)

constituted 14.7 percent and 15.4 percent of the taxpayer’s

gross receipts was a significant income-producing factor in the

taxpayer’s business.    See also Knight-Ridder Newspapers, Inc. v.

United States, 743 F.2d 781, 790 (11th Cir. 1984) (wherein

newspapers, the cost of which constituted 17.6 percent of the

taxpayer’s total revenues, were considered a material income-

producing factor).

     Here, the cost of the purchased wood was stipulated by the

parties as $23,099,069, which is 28 percent of petitioner’s

gross receipts for FYE 1995; $18,079,103, which is 23.6 percent

of petitioner’s gross receipts for FYE 1996; and $28,757,169,
                              - 20 -

which is 33 percent of petitioner’s gross receipts for FYE 1997.

The business activity related to purchased wood was a

substantial income-producing factor to petitioner.

      Considering the cost of the purchased wood plus the

business activities of cutting trees on land owned by unrelated

entities, the cost of the wood that petitioner purchased was 43

percent of the gross receipts for FYE 1995 ($23,099,969 +

$12,333,559), 39 percent of the gross receipts for FYE 1996

($18,079,103 + $12,136,789), and 49 percent of the gross

receipts for FYE 1997 ($28,757,169 + $13,588,715).

      Considering wood that petitioner purchased from related

entities, these percentages are even higher.

      Accordingly, petitioner must maintain inventories and use

the accrual method to account for purchases and sales.

Petitioner’s use of the cash method does not clearly reflect its

sales income.

IV.   Other Arguments Raised by Petitioner

      Petitioner claims that it is a grower and harvester of

trees.   Petitioner argues that “the Code literally, explicitly,

and intentionally permits a company that ‘harvests’ timber to

use the cash method of accounting” and that respondent cannot

force petitioner to change an accounting method specifically

authorized by the Internal Revenue Code.     Petitioner cites

sections 447 and 448 in support of this argument.
                                - 21 -

     A.   Section 447--Method of Accounting for Corporations
          Engaged in Farming

     Section 447 provides that taxable income from farming of a

corporation engaged in the trade or business of farming “shall

be computed on an accrual method of accounting”.     Sec. 447(a).

Section 447, however, does not apply to the trade or business of

harvesting trees that are not fruit or nut trees.     Id.     We agree

with petitioner that section 447 does not require petitioner’s

use of the accrual method.

     We disagree, however, that section 447 “literally,

explicitly, and intentionally” permits petitioner’s use of the

cash method under the facts and circumstances presented.

Section 447 sets forth conditions that require use of the

accrual method, not authorization to use the cash method.

     B.   Section 448–Whether Petitioner Is a
          “Farming Business”

     Section 448 provides that a C corporation shall not compute

its taxable income using the cash method.     Sec. 448(a)(1).    An

exception exists for C corporations engaged in a “farming

business.”    Sec. 448(b)(1).   “Farming business” includes “the

raising, harvesting, or growing” of timber.     Secs. 448(d)(1)(B),

263A(c)(5).    Timber includes “trees raised, harvested, or grown

by the taxpayer” other than trees that bear fruit or nuts, and

other than trees in a nursery.     Sec. 263A(c)(5), (e)(4).

     Petitioner contends that it should be allowed to use the
                                - 22 -

cash method because section 448 does not bar it.     “The fact that

section 448 does not preclude petitioner from using the cash

method does not authorize it if * * * the cash method does not

clearly reflect income.”     Thompson Elec., Inc. v. Commissioner,

T.C. Memo. 1995-292.     When a taxpayer has inventories, the

taxpayer may not use the cash method, even though so permitted

under section 448, if the cash method does not clearly reflect

its income.    See id.

     Indeed, the regulations under section 448 emphasize that

other sections may limit a taxpayer’s entitlement to use the

cash method.

     Nothing in section 448 shall have any effect on the
     application of any other provision of law that would
     otherwise limit the use of the cash method, and no
     inference shall be drawn from section 448 with respect
     to the application of any such provision. For example,
     nothing in section 448 affects * * * the requirement of
     § 1.446-1(c)(2) that an accrual method be used with
     regard to purchases and sales of inventory. Similarly,
     nothing in section 448 affects the authority of the
     Commissioner under section 446(b) to require the use of
     an accounting method that clearly reflects income
     * * *. For example, a taxpayer using the cash method
     may be required to change to an accrual method of
     accounting under section 446(b) because such method
     clearly reflects that taxpayer’s income, even though
     the taxpayer is not prohibited by section 448 from
     using the cash method. * * * [Sec. 1.448-1T(c),
     Temporary Income Tax Regs., 52 Fed. Reg. 22767 (June
     12, 1987).]

     We have found that petitioner must maintain inventories.

Accordingly, the cash method does not clearly reflect

petitioner’s income.     Section 448 does not “literally,
                                  - 23 -

explicitly, and intentionally” permit petitioner’s use of the

cash method.

     C.     Section 1.471-6(a), Income Tax Regs.--Whether
            Petitioner Is a “Farmer”

     Petitioner cites various cases in which we held that the

taxpayers were farmers and thus were entitled to use the cash

method.   In Maple Leaf Farms, Inc. v. Commissioner, 64 T.C. 438

(1975), we held that a duck grower was entitled to use the cash

method under section 1.471-6(a), Income Tax Regs.     We looked to

other sections to determine whether the duck grower was a

“farmer” and whether the place where the duck growing process

occurred was a “farm” for purposes of section 1.471-6(a), Income

Tax Regs.    Id. at 447 (citing sections 175(c)(2), 180(b),

182(c), and 6420(c)(2) and (3) and sections 1.61-4(d), 1.175-3,

1.180-1(b), and 1.182-2, Income Tax Regs.).     In Maple Leaf

Farms, Inc., the facts evidenced that the taxpayer was

integrally involved in the process of growing ducks it raised on

its own property and in the process of growing ducks it supplied

to independent growers.     Id.   The taxpayer also bore a

substantial risk of loss.     Id. at 448.   Thus, the taxpayer’s

“participation in the activities of its growers was sufficient

to constitute it a ‘farmer’ and accordingly it may use the cash

receipts and disbursements method of accounting in respect of

its ducks.”    Id. at 452; see also sec. 1.471-6(a), Income Tax

Regs.
                                - 24 -

     In Hi-Plains Enters., Inc. v. Commissioner, 60 T.C. 158

(1973), affd. 496 F.2d 520 (10th Cir. 1974), and Cameron v.

Commissioner, T.C. Memo. 1982-259, two cases decided before the

enactment of section 447, we held that taxpayers who operated

commercial feedlots were “farmers” and the feedlot was a “farm”

under the Internal Revenue Code.    The taxpayers were permitted

to use the cash method pursuant to section 1.471-6(a), Income

Tax Regs.

     The facts of the aforementioned farming cases are

distinguishable from the facts of this case.    In the farming

cases, the taxpayers engaged in the business activity of

farming, as defined in sections 175(c)(2), 180(b), 182(c), and

6420(c)(2) and (3) and sections 1.61-4(d), 1.175-3, 1.180-1(b),

and 1.182-2, Income Tax Regs.    Section 1.471-6(a), Income Tax

Regs., permits taxpayers who meet the definition under these

sections to use the cash method.    See Maple Leaf Farms, Inc. v.

Commissioner, supra at 447.

     Unlike the taxpayers in Maple Leaf Farms, Inc., Hi-Plains

Enters., Inc., and Cameron, petitioner does not operate a

“farm”, and its business activities do not meet the definition

of “the business of farming” or “farming” under these sections.

For example, in section 175(c)(2), which the Court cited in

Maple Leaf Farms, Inc., “land used in farming” means “land used

* * * by the taxpayer or his tenant for the production of crops,
                              - 25 -

fruits, or other agricultural products, or for the sustenance of

livestock.”   Under the facts of this case, petitioner does not

use the woodland it owns to produce crops, fruits, or other

agricultural products.   Likewise, in sections 1.182-2 and 1.175-

3, Income Tax Regs., “A taxpayer is engaged in the business of

farming if he cultivates, operates, or manages a farm for gain

or profit * * * A taxpayer engaged in forestry or the growing of

timber is not thereby engaged in the business of farming.”8

Indeed, these regulations specifically exclude petitioner from

the definition of “business of farming” for purposes of those

sections.

     Petitioner engages in a variety of business activities.

Petitioner’s business activities do not qualify petitioner as a

“farmer” for purposes of section 1.471-6(a), Income Tax Regs.

Further, some of petitioner’s business activities specifically

require it to maintain inventories.    Thus, section 1.471-6(a),

Income Tax Regs., does not permit petitioner’s use of the cash

method under the facts and circumstances presented herein.




     8
        We note that the other sections cited in Maple Leaf
Farms, Inc. v. Commissioner, 64 T.C. 438 (1975), provide similar
definitions for “farming” and “the business of farming”.
Petitioner does not meet these definitions either. See secs.
180(b), 6420(c)(2) and (3); secs. 1.61-4(d), 1.180-1(b), Income
Tax Regs.
                                - 26 -

     D.      Use of Both Cash and Accrual Methods

     Petitioner argues that it should be permitted to use the

cash method for the business activity of cutting trees on its

own land.     “Where a taxpayer has two or more separate and

distinct trades or businesses, a different method of accounting

may be used for each trade or business, provided the method used

for each trade or business clearly reflects the income of that

particular trade or business.”     Sec. 1.446-1(d)(1), Income Tax

Regs.     “No trade or business will be considered separate and

distinct * * * unless a complete and separable set of books and

records is kept for such trade or business.”     Sec. 1.446-

1(d)(2), Income Tax Regs.

     Petitioner does not maintain separate businesses or

separate books and records for its various business activities.

Indeed, petitioner stipulated:     “Because of the scope of

petitioner’s activities and the entrepreneurial nature of the

industry, it is impossible to describe a single business model.

Further, the extent of petitioner’s activities * * * will vary

from year [to year] and involve many unique transactions.”

     Petitioner engages in various business activities.       In

Wilkinson-Beane, Inc. v. Commissioner, 420 F.2d at 355, the

Court of Appeals for the First Circuit, the court to which an

appeal of this case would lie, held that the taxpayer had to use

the accrual method where its business involved providing funeral
                                - 27 -

services and supplying caskets for the funeral services.     In

Knight-Ridder Newspapers, Inc. v. United States, 743 F.2d at

790, the Court of Appeals for the Eleventh Circuit held that a

newspaper that provided the service of presenting information to

its readers had to use the accrual method where the cost of

newsprint and ink was 17.6 percent of the total cash receipts.

In Ward AG Prods. v. Commissioner, T.C. Memo. 1998-84, affd.

without published opinion 216 F.3d 1090 (11th Cir. 2000), we

held that a taxpayer who operated a business that sold farming

seed, fertilizer, and equipment and provided certain services to

farmers was not a farming business and had to maintain

inventories and use the accrual method.

     Some of petitioner’s business activities involve no growing

of trees, no harvesting of trees, and no ownership of the land

on which the trees are grown.     Other business activities involve

a combination of the above.   The business activities related to

buying and selling wood generate merchandise for petitioner.

The merchandise is an income-producing factor to petitioner.

Thus, the facts and circumstances of this case are analogous to

those described in Wilkinson-Beane, Inc. and Knight Ridder

Newspapers.

     Petitioner must use the accrual method of accounting for

all of its business activities.    See Thompson Elec., Inc. v.

Commissioner, T.C. Memo. 1995-292.
                             - 28 -

     In reaching all of our holdings herein, we have considered

all arguments made by the parties, and to the extent not

mentioned above, we find them to be irrelevant or without

merit.9

                                   Decision will be entered

                              under Rule 155.




     9
        We note that secs. 611 and 631 and the regulations
thereunder contain special rules of accounting for the timber
industry. See secs. 611, 631; sec. 1.611-3, Income Tax Regs.
(relating to cost depletion of timber), sec. 1.631-1, Income Tax
Regs. (creating an election to consider the cutting of timber as
a sale or exchange); see also RLC Indus. Co. v. Commissioner, 98
T.C. 457 (1992) (analyzing taxpayer’s method of computing timber
depletion under sec. 611), affd. 58 F.3d 413 (9th Cir. 1995).

     Neither party argued in its briefs that these code sections
are dispositive of the issues presented in this case.
Additionally, neither party addressed the interplay of these code
sections with secs. 447 and 448, or the rules regarding inventory
in the regulations under secs. 611 and 631. Accordingly, we will
not address these issues.

     We note that while petitioner mentioned sec. 631(a) in
passing in its reply brief, petitioner did not raise the
aforementioned issues. Furthermore, we will not consider issues
that are raised for the first time in a reply brief. See Foil v.
Commissioner, 92 T.C. 376, 418 (1989), affd. 920 F.2d 1196 (5th
Cir. 1990); Markwardt v. Commissioner, 64 T.C. 989, 997 (1975).
