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anticipate that a royalty will be paid for such amount, petitioner
fails to satisfy the section 461 "all events test" with respect to
the reserve amount as of the end of the taxable year. Therefore,
its annual tax accrual for royalty expense must be reduced by such
amount. Respondent agrees that a book reserve based upon GAAP
principles is not normally taken into account for tax purposes,
but where, as in this case, the contracts establishing the
taxpayer’s liability specifically reduce that liability by the
amount of the reserve, it is the contract terms and not GAAP
principles that require the same reduction in liability for tax
purposes. Respondent summarizes his position as follows:
Quite simply, an accrual taxpayer cannot accrue as an
expense what it does not legally owe, and petitioner
does not owe payment for the "reasonable reserve for
returns" that is to be subtracted from the royalty
payment when payment is made.
Petitioner counters that "the logical and plain reading" of
those portions of the author contracts that pertain to author
royalties is that Random House and its subsidiaries owe royalties
for all books sold and not actually returned by the end of each
6-month royalty accounting period, but that the obligation to pay
a portion of these royalties is deferred to a later period as
security against the possibility of future returns. Petitioner
argues that respondent erroneously treats that reduction in the
amount of royalties payable to authors as a reduction in the
amount of royalties owed to the authors as of the end of the
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