INTEREST ON A DEFICIENCY CAUSED BY APPLYING AN OVERPAYMENT ACCRUES WHEN RETURN IS FILED.

                 IN THE UNITED STATES DISTRICT COURT

FACTS

[2] The parties stipulate to the following facts relevant to this matter. Scott filed its 1983 Federal income tax return on September 17, 1984, showing an overpayment of $7,456,035. Scott indicated on its 1983 return that the overpayment should be applied to its estimated taxes for 1984.

[3] Like most taxpayers of any size that are not subject to withholding of taxes, Scott was required to make estimated quarterly tax payments. Scott's 1983 return did not indicate that the overpayment should be applied to any particular quarter. Without the overpayment, Scott's 1984 estimated tax installments were 1) $11,000,000, 2) $23,000,000 3) $5,500,000 and 4) $15,000,000. The IRS applied the overpayment to Scott's first installment for 1984.

[4] Subsequently, the IRS determined a tax deficiency for Scott for 1983. Scott and the IRS agreed to a $7,148,081 deficiency on October 18, 1991. Therefore, Scott's estimated tax payments in 1983 were sufficient to comprise all of Scott's estimated tax for that year. The IRS also assessed $14,693,267 of interest based upon the 1983 deficiency. This dispute concerns the amount of interest charged to Scott. The IRS charged interest commencing on March 15, 1984, the date that Scott's original 1983 tax return was due. The IRS now concedes that interest calculation should have commenced April 16, 1984, the date that Scott's first installment of estimated taxes was due. Scott contends that interest calculation should have commenced September 17, 1984, the date that the believed overpayment of 1983 taxes was directed to be applied to Scott's estimated taxes for 1984.

LEGAL STANDARD

[5] Under Fed. R. Civ. P. 56(c), summary judgment "shall be rendered forthwith if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." This court is required, in resolving a motion for summary judgment pursuant to Rule 56, to determine whether "the evidence is such that a reasonable jury could return a verdict for the nonmoving party." Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986). In making this determination, the evidence of the nonmoving party is to be believed, and the district court must draw all reasonable inferences in the nonmovant's favor. See id. at 255. Furthermore, while the movant bears the initial responsibility of informing the court of the basis for its motion, and identifying those parties of the record which demonstrate the absence of a genuine issue of material fact, Rule 56(c) requires the entry of summary judgment "after adequate time for discovery and upon motion, against a party who fails to make a showing sufficient to establish the existence of an element essential to that party's case, and on which that party will bear the burden of proof at trial." Celotex Corp. v. Catrett, 477 U.S. 317, 322-23 (1986). As the parties have stipulated to the facts in this matter, it is now ripe for decision on summary judgment.

DISCUSSION

[6] The IRS is allowed to charge a taxpayer interest upon a tax deficiency to compensate the government for the taxpayer's use of money that rightfully belongs to the government. Vick v. Phinney, 414 F.2d 444, 448 (5th Cir. 1969). Interest is not to serve as a penalty. Id. Therefore, the IRS can only assess interest when the taxpayer has the use of funds that rightfully belong to the government. Avon Products, Inc. v. United States, 588 F.2d 342 (3d Cir. 1978). "Interest shall begin running when a tax becomes both due and unpaid." Id. at 344.

[7] In Avon Products, the taxpayer filed its 1967 tax return on September 15, 1968. Avon paid approximately $44.5 million in estimated taxes and its return showed a tax liability of approximately $44.483 million. Avon directed that the $115,000 overpayment be credited against Avon's quarterly estimated tax payment due September 15, 1968. When the IRS subsequently determined that Avon's tax liability for 1967 was, in fact, approximately $44.483 million, Avon paid the additional $99,000 due but had still overpaid its 1967 tax liability by approximately $17,000. The IRS assessed interest beginning June 15, 1968, the date that Avon's 1967 taxes were paid.

[8] Two recent cases have addressed similar circumstances to those present in both Avon Products and the instant matter. In May Department Stores Co. v. United States, 36 Fed.Cl. 680 (Ct. Cl. 1996), the taxpayer elected to credit a purported $7.9 million overpayment to its first installment of 1984 taxes. The IRS later determined that the proper overpayment was only $2.98 million. The IRS assessed interest starting May 15, 1984, the date that the first estimated payment for 1984 was due. The taxpayer asserted that the interest assessment should start on October 15, 1984, the date that the taxpayer made its election to apply the overpayment as a credit. May Dep't Stores, 36 Fed. Cl. at 680-81. Likewise in 1984, the taxpayer filed its return on October 15, 1985, claiming an overpayment of $5.8 million to be applied to the first installment of 1985 taxes. The IRS subsequently determined that the taxpayer had underpaid its taxes by $740,592. The IRS assessed interest starting May 15, 1985, the date that the first estimated payment for 1985 was due. The taxpayer asserted that the interest assessment should start on October 15, 1985, the date that the taxpayer made its election to apply the overpayment as a credit. Interest on the $740,592 deficiency commencing on April 15, 1985 was not in dispute. Id. at 681-82.

[9] The Court of Claims held, following Avon Products, that the taxpayer's taxes were not due and unpaid during the periods from April 15 through October 15. Consequently, the IRS was not entitled to collect interest during that period. May Dep't Stores, 36 Fed.Cl. at 689. In reaching this conclusion, the Court of Claims rejected many of the arguments urged by the IRS here.

[10] Like the taxpayers in Avon Products, May Dep't Stores and the present case, Sequa Corporation ("Sequa") reported a $8.7 million overpayment in 1990 which is applied to its 1991 tax liability. Subsequently, Sequa filed an amended return overpayment in 1990 which it applied to its 1991 tax liability. Subsequently, Sequa filed an amended return with an additional tax liability of $1.7 million. The IRS collected interest upon the $1.7 million from the date Sequa's 1990 tax was due, March 15, 1991, through the date Sequa's return was filed, September 15, 1991. Sequa Corp. v. United States, 1996 U.S. Dist. Lexis 5288, *1-2 (S.D.N.Y. April 19, 1996). ¹ On this motion to dismiss, the district court followed Avon Products and held that if Sequa's allegations were turn, it would be entitled to a refund of interest because its taxes were not both due and unpaid. Sequa corp., at *6.

[11] The IRS argues that Avon Products and Sequa support its position on the present facts. May Dep't Stores, it argues, was wrongly decided. The Court finds that these three cases support the inescapable conclusion that the IRS can only assess interest when a tax is both due and unpaid.

[12] The IRS argument that Avon Products supports its position here rests upon the factual distinction that in Avon Products, the IRS was attempting to collect a tax deficiency for two months before it credited Avon's purported overpayment on September 15, but in the present case, the IRS credited Scott's purported overpayment on April 16 and assessed interest from that date. The holding in Avon Products limits the IRS' ability to assess interest to those circumstances where "a tax is both due and unpaid." Avon Products at 344. Here, the IRS had the interest free use of Scott's purported 1983 overpayment from April 16 through September 17, 1984. At the time that Scott's taxes were due on April 16, 1984, they were fully paid. The event that made the taxes unpaid was the filing of the tax return on September 17, 1984 and the application of the purported overpayment to Scott's 1984 taxes. The distinction urged by the IRS does not alter that Scott had fully paid its 1983 taxes until it elected to apply its overpayment to its 1984 estimated taxes.

[13] The IRS argues that if Avon Products does not compel a decision in its favor, then Avon Products is expressly overruled by section 413 of the Internal Revenue Code. Section 413 states:

     The application of the Internal Revenue Code of 1954 with

[14] The IRS' argument then is that since section 413 allows a taxpayer to credit an overpayment to an installment before an election is made, a taxpayer should not be allowed to credit an overpayment at the time of an election. In addressing this question, the May Dep't Stores Court held that section 413 allows a taxpayer to apply an overpayment against any installment due before the election upon filing the tax return, but after the overpayment occurred. May Dep't Stores, 36 Fed.Cl. at 685. There is no clearly expressed intent in section 413 to overrule Avon Products. May Dep't Stores, 36 Fed.Cl. at 688. Rather, consistent with section 413,

     . . . the fact that May used its purported overpayments to

[15] The IRS argues that allowing Scott to apply its 1983 overpayment to its September 17, 1984 estimated tax payment would result in a double benefit to Scott. The double benefit appears to result from the potential that Scott, if its estimated tax payments for 1984 were insufficient, could apply the overpayment to the April 16, 1984 quarterly payment and avoid interest payments on a 1984 tax deficiency. There is no evidence in the record that Scott is attempting to apply its overpayment to two liabilities at one time. Therefore, this is not a case where the taxpayer is trying to obtain a double benefit. Rather, it appears that the IRS is in fact trying to obtain the double benefit of having use of Scott's purported overpayment as well as receiving interest from April 16 through September 17.

[16] The IRS also argues that Revenue Rulings 84-58 and 88-98 compel Scott to apply its purported overpayment to its first tax installment for 1984, absent an election to the contrary. It is, however, undisputed that (1) Scott had no means to make such an election on its 1983 tax return, (2) even if Scott had made such an election, the IRS computer would have automatically credited the overpayment to March 15, 1984 ² and (3) Scott did not need to apply its overpayment to satisfy either its first or second tax installments for 1984. All of this evidence suggests that Scott, at the very least, did not intend the evils that the IRS suggests are possible if Scott is allowed to apply its overpayment to the September installment. There is no evidence that Scott intended to either sit back and apply the overpayment when circumstances determined that the application of the overpayment would be most beneficial or that Scott was attempting to receive a double benefit upon its overpayment.

[17] Scott acted consistent with applying the overpayment to its September installment in its response to the November 1984 survey of estimated taxes forwarded to Scott by the Secretary of the Treasury. While this document is not an election, it is relevant to rebut the inference argued by the IRS that Scott is now attempting to create a more favorable election of when to apply its overpayment.

[18] "Revenue Rulings are entitled to great deference, but courts may disregard them if they conflict with the statute they purport to interpret or its legislative history, or if they are otherwise unreasonable." In re Kaplan, 104 F.3d 589, 599 (3d Cir. 1997). Giving these Revenue Rulings the effect urged by the IRS, at least absent any showing of evidence that a taxpayer was attempting to apply the overpayment to two liabilities at one time, would result in Scott having to pay interest on a tax that was not both due and unpaid. To the extent that Revenue Rulings 84-58 and 88-98 require Scott to apply an overpayment to its first tax installment for 1984, absent an election to the contrary, they are unreasonable. Further, the application of the overpayment to the first installment pursuant to Revenue Rulings 84-58 and 88-98 would exalt form over substance by requiring Scott, as a taxpayer with no tax due, to pay interest upon a deficiency at a time that a deficiency did not exist.

CONCLUSION

[19] Based upon the stipulated facts in this matter, the Court finds that Scott did not have a tax obligation that was due and unpaid from April 16, 1984 through September 17, 1984. Consequently, Scott is entitled to a refund of $762,830 of interest erroneously assessed for that time period, as well as statutory interest. The Court is not unmindful of the possibility that a taxpayer in similar circumstances may attempt to apply an overpayment to two different tax obligations. There is no evidence, however, that such a scenario is present in this case.

ORDER

[20] AND NOW, this 17th day of March, upon consideration of the Cross-motions for Summary Judgment filed by Plaintiff Kimberley-Clark Tissue Company and Defendant United States of America, the various responsive papers filed by the parties, the Stipulation of Facts and the January 21, 1997 Oral Argument held in this matter, it is ORDERED:

     1. The Motion for Summary Judgment filed by Defendant United

² This is, in fact, the reason that Scott was originally assessed interest from March 15, 1984.