Power Equipment Co. v. U.S.

• Decision Date: 05 February 1985
• Docket Number: Nos. 83-5168,83-5169,s. 83-5168
• Citation: 748 F.2d 1130
• Parties: -381, 53 USLW 2290, 84-2 USTC P 9980 POWER EQUIPMENT COMPANY, Plaintiff-Appellee, v. UNITED STATES of America, Defendant-Appellant.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 1130

748 F.2d 1130

55 A.F.T.R.2d 85-381, 53 USLW 2290, 84-2

USTC P 9980

POWER EQUIPMENT COMPANY, Plaintiff-Appellee, v. UNITED STATES of America, Defendant-Appellant.

Nos. 83-5168, 83-5169.

United States Court of Appeals, Sixth Circuit.

Argued Feb. 21, 1984.

Decided Nov. 29, 1984.

Rehearing and Rehearing En Banc Denied Feb. 5, 1985.^*

John W. Gill, Jr., U.S. Atty., Knoxville, Tenn., Robert T. Duffy, Bruce R. Ellisen, argued, Robert E. Rice, Glenn L. Archer, Jr., Tax Div., U.S. Dept. of Justice, Washington, D.C., for U.S.

Charles A. Wagner, III, argued, Gentry & Wagner, Knoxville, Tenn., for Power Equipment Co.

Before KENNEDY and WELLFORD, Circuit Judges, and COOK, District Judge. ^*

WELLFORD, Circuit Judge.

The United States appeals the Magistrate's judgment awarding Power Equipment Company (PEC) a refund of income taxes paid in 1975 on interest income received from various local Tennessee governmental units in connection with sales to those units of heavy construction equipment. The Magistrate found that PEC was entitled to exclude these interest payments from its gross income under I.R.C. Sec. 103(a)(1) as interest on governmental obligations. The Magistrate decided this action on the following stipulated facts:

"1. Power Equipment Company is a corporation incorporated under the laws of the State of Tennessee and has its principal office and place of business on Alcoa Highway, Knoxville, Knox County, Tennessee.

"2. This Court has jurisdiction and venue pursuant to 28 U.S.C. Secs. 1346(a)(1) and 1402(a)(1) and (2).

"3. Plaintiff is primarily engaged in the business of sale and maintenance of heavy construction equipment. In the course of its business, plaintiff sells construction equipment to various City, County and State governmental entities. Many of these sales are made on a deferred payment basis, with the governmental entity paying specified interest charges to plaintiff. In connection with these deferred payment sales, during tax years 1975-1978, the governmental entities paid and plaintiff received certain interest payments, and these interest payments were reported on plaintiff's timely filed corporate income tax returns for each of the tax years as excluded from gross income pursuant to Sec. 103 of the Internal Revenue Code, 26 U.S.C. Sec. 103, which provides in pertinent part as follows:

(a) General rule.--Gross income does not include interest on-- (1) the obligations of a State, a Territory, or a possession of the United States, or any political subdivision of any of the foregoing, or of the District of Columbia.

* * *

"4. On or about November 2, 1978, defendant, United States of America, acting by and through its Internal Revenue Service, sent a notice of deficiency to plaintiff .... That notice asserted that certain amounts ($32,465.00 for 1975 and $25,085.00 for 1976) received by plaintiff from political subdivisions of the State of Tennessee, which had been excluded by plaintiff as interest under Sec. 103 of the Internal Revenue Code, were not properly excludable and made demand upon plaintiff for the payment of corporate income taxes on such amounts in the total amount of $27,624.28 ($15,583.28 for 1975 and $12,041.00 for 1976).

"5. On or about April 9, 1979, plaintiff paid to the defendant the alleged deficiency for 1975 and 1976 in the amount of $27,624.48. On or about April 13, 1979, plaintiff filed with the Internal Revenue Center its form 1120X claiming a refund of income taxes paid in the amount of $15,583.28 for 1975 and $12,041.00 for 1976, resulting from the inclusion of amounts received by plaintiff as interest payments from political subdivisions of the State of Tennessee ... By letters dated March 1, 1980, ... plaintiff's claims for refund were disallowed.

"6. Defendant, by and through its Internal Revenue Service, included in plaintiff's gross income the sum of $27,762.56 for tax year 1975 and $24,987.64 for tax year 1976 which constituted interest payments from political subdivisions of the State of Tennessee, thereby resulting in taxes assessed against plaintiff in the amount of $13,326.02 for tax year 1975 and $11,994.06 for tax year 1976. A breakdown of the amounts and source of the interest proceeds included as gross income and the taxes which defendant assessed are listed below:

                                    
                                                    1975        1976
                City of Chattanooga, (Tenn.)     $10,687.15
                Anderson County, (Tenn.)           1,292.36
                Houston County, (Tenn.)              691.50
                Warren County, (Tenn.)             6,378.84
                Lincoln County, (Tenn.)            2,097.45
                City of Hendersonville, (Tenn.)               $5,031.89
                Hamilton County Highway (Dept.)                6,483.23
                City of Knoxville, (Tenn.)           621.20    1,708.63
                Scott County Highway (Dept.)       4,044.40    3,366.80
                City of Lawrenceburg, (Tenn.)                  5,084.16
                Monroe County Highway (Dept.)        400.46      191.31
                Lawrence County Highway (Dept.)    1,002.08
                Lincoln County Highway (Dept.)       425.42
                Smith County Highway (Dept.)                     633.95
                Van Buren Highway (Dept.)            121.70    2,487.67
                                                 ----------  ----------
                                                  27,762.56   24,987.64
                                                       X.48        X.48
                                                 ----------  ----------
                   Tax                           $13,326.02  $11,994.06
                Total Tax                              $25,320.08
                                                       ----------
                 * * *
                

These transactions and the resulting legal documents attached ... were not approved by the legislative or other governing body of each respective county or city nor by the state director of finance.

"7. On or about September 22, 1981, defendant, United States of America, acting by and through its Internal Revenue Service, sent a notice of deficiency to plaintiff .... That notice asserted that certain amounts ($10,513.63 for 1977 and $11,815.24 for 1978) received from political subdivisions of the State of Tennessee, which had been excluded by plaintiff as interest under Sec. 103 of the Internal Revenue Code, were not properly excludable and made demand upon plaintiff for the payment of corporate income taxes on such amounts in the total amount of $10,986.76 ($5,316.44 for 1977 and $5,670.32 for 1978).

"8. On or about December 14, 1981, plaintiff paid to defendant the alleged deficiency for 1977 and 1978 in the amount of $10,986.76. On or about December 14, 1981, plaintiff filed with the Internal Revenue Service Center its form 1120X claiming a refund of the income taxes paid in the amount of $5,316.44 for 1977 and $5,670.32 for 1978 resulting from the inclusion of amounts received by plaintiff as interest payments from political subdivisions of the State of Tennessee .... By letters dated January 6, 1982 ... plaintiff's claims for a refund were disallowed.

"9. Defendant, by and through its Internal Revenue Service, included in plaintiff's gross income the sum of $11,488.39 for 1977 and $11,181.59 for 1978 which constituted interest payments from political subdivisions of the State of Tennessee, thereby resulting in taxes assessed against plaintiff in the amount of $5,514.43 for 1977 and $5,367.16 for 1978. A breakdown of the amounts and source of the interest proceeds included as gross income and the taxes which defendant assessed are listed below:

                                
                                                1977        1978
                Van Buren County, (Tenn.)        $  172.08   $  288.75
                Van Buren County, (Tenn.)         2,186.10    1,894.62
                Scott County, (Tenn.)             3,030.12    1,271.69
                City of Lawrenceburg, (Tenn.)     4,519.20    6,213,90
                Giles County, (Tenn.)               171.00       85.50
                Knoxville City Zoo, (Tenn.)         621.32
                Lincoln County Highway (Dept.)      158.57    1,427.13
                Polk County Highway (Dept.)         630.00
                                                ----------  ----------
                                                $11,488.39  $11,181.59
                                                      X.48        X.48
                                                ----------  ----------
                Tax                             $ 5,514.43  $ 5,367.16
                Total Tax                             $10,881.59
                                                      ----------
                 * * *
                

These transactions and the resulting legal documents ... were not approved by the legislative or other governing body of each respective county or city nor by the state director of finance."

The Magistrate first reviewed and rejected the government's contention that the sales transactions between PEC and the state entities violated various Tennessee statutes and therefore were not "obligations" of the entities within the meaning of I.R.C. Sec. 103(a)(1) because they were not issued "by constituted authorities empowered to issue such obligations," as required by Treas.Reg. Sec. 1.103-1(b) (1954 Code) (emphasis added). Although the Magistrate found that PEC had conceded that the transactions at issue violated Tennessee law, particularly that the "county purchasing agents entering the sales contracts violated the prohibition against commiting [sic] the county beyond the fiscal year in question [Tenn.Code Ann. Sec. 5-14-108(m) (1980) ], and that they entered purchase contracts which exceeded $500.00 without prior approval of the county legislative bodies [Tenn.Code Ann. Sec. 54-8-107 (1980) ]," he concluded:

While it may be true that at some point these contracts might have been voided by the cities and counties involved [because they violated Tennessee law], they are now wholly executory. The equipment has been delivered and fully paid for, with interest. There is no suggestion of fraud. Where contracts are fully executed, and no fraud exists, the rights of the parties which have been established...