Fairbanks, Morse & Co. v. Harrison

• Decision Date: 13 December 1945
• Docket Number: No. 4828,44C1442,44C1568,4829,4828
• Citation: 63 F. Supp. 495
• Court: U.S. District Court — Northern District of Illinois
• Parties: FAIRBANKS, MORSE & CO. v. HARRISON, Collector of Internal Revenue (two cases). MUNICIPAL ACCEPTANCE CORPORATION v. SAME (two cases).

63 F. Supp. 495

FAIRBANKS, MORSE & CO. v. HARRISON, Collector of Internal Revenue (two cases).

MUNICIPAL ACCEPTANCE CORPORATION v. SAME (two cases).

Nos. 4828, 44C1568, 4829, 44C1442; Consol. No. 4828.

District Court, N. D. Illinois, E. D.

December 13, 1945.

COPYRIGHT MATERIAL OMITTED

Poppenhusen, Johnston, Thompson & Raymond, of Chicago, Ill., for plaintiffs.

J. Albert Woll, U. S. Atty., of Chicago, Ill., Hon. Samuel O. Clark, Jr., Asst. Atty. Gen., Andrew D. Sharpe and George J. Laikin, Sp. Assts. to Atty. Gen., and John B. Stephan, Asst. U. S. Atty., of Chicago, Ill., for defendant.

CAMPBELL, District Judge.

This is a consolidated action involving four separate suits for the recovery of federal income and excess profits taxes:

Cause No. 4828.

On November 6, 1942, plaintiff, Fairbanks, Morse & Company, a corporation, filed its complaint in two counts. The first count alleges that on July 13, 1937, this plaintiff filed its income and excess profits tax return reporting an income tax liability of $355,774.76, which was duly paid. In reporting its gross income for the year 1936, the plaintiff claimed a deduction of $188,722.22 as a bad debt loss. This amount is claimed as the balance left due and owing to the plaintiff from Fairbanks, Morse Home Appliances, Inc., a corporation (whose stock was wholly owned by the plaintiff), after the complete liquidation and dissolution of the subsidiary corporation during 1936 and the application of its remaining assets to the partial payment of its open account with the plaintiff. In this count it is also alleged that plaintiff claimed a loss in its 1936 tax return of $7,110 which represented the cost to it of the capital stock of the subsidiary. Subsequently, the Commissioner disallowed these deductions and assessed additional tax and interest against the plaintiff in the sum of $82,444.10, which plaintiff paid. This assessment included an additional tax and interest thereon of $57,893.06 on the plaintiff's reduced claim of $128,466.63 as bad debt and investment loss in the subsidiary. Plaintiff contends that the bad debt and investment loss is properly deductible from gross income under Section 23(f) of the Revenue Act of 1936, 26 U.S.C.A. Int. Rev. Code, § 23(f), and now seeks to recover the tax that was assessed and paid on this amount.

In the same count, the plaintiff alleges that in its tax return for the year 1936, it failed to exclude from gross income the sum of $12,101.54 which it received in that year on bad debts that had previously been charged off in the tax years of 1931, 1932, and 1933. It is alleged that the charge offs did not result in tax benefit to the plaintiff because of large losses sustained in those years. Recovery is sought under what plaintiff contends to be an established principle of law as well as under Section 116 of the Revenue Act of 1942 which amended Section 22(b) of the Internal Revenue Code, 26 U.S.C.A. Int.Rev. Acts.

Also in the first count in Case No. 4828 plaintiff alleges that in its tax return for 1936 it failed to exclude from its gross income the sum of $24,645.98 which it received in 1936 as tax exempt interest on obligations of municipalities and other political subdivisions of the various states; that these obligations consisted of notes, warrants, certificates, bonds and other instruments executed and delivered by said municipalities and political subdivisions to the plaintiff in payment of the purchase price for machinery and equipment which they had bought, installed, operated and maintained as plants or facilities for the production of heat, water, light or power; that in the first instance general purchase agreements were executed whereby the municipalities became obligated to pay plaintiff the purchase price or unpaid portion thereof of the machinery and equipment and subsequently the notes, warrants, bonds, certificates or other instruments were issued by the municipalities pursuant to the terms of the purchase agreement; that with respect to such interest, the obligations are divided into two classes: (1) Instruments which bear interest by the terms thereof; and (2) instruments which do not specifically provide for the payment of interest but in the face amount thereof actually include interest to maturity on the unpaid balance of the purchase price. Plaintiff filed its claim for refund of taxes on the foregoing items and subsequently received from the Commissioner of Internal Revenue notices of disallowance and rejection after which the additional tax was assessed and paid.

In the second count of Case No. 4828 it is alleged that in its income and excess profit tax return for the calendar year 1938 plaintiff reported an income tax liability of $583,539.66 which was duly paid; that in the year 1937, plaintiff sustained a bad debt loss of $478,506 which it failed to deduct in tax return for that year; that the loss was sustained on an open account with its wholly owned subsidiary, Fairbanks, Morse & Company, Ltd., of London, England, which since 1909 had bought and resold plaintiff's products in the United Kingdom. It is also alleged that the plaintiff sustained a further loss of $24,200 which represented the cost to plaintiff of the capital stock of the London Company, and that it likewise failed to deduct this loss in its 1937 tax return, that both losses resulted from the liquidation and dissolution of the subsidiary in January 1937, by reason of the assets remaining after the payment of other debts being insufficient to pay the balance of its open account with plaintiff.

Also in the second count plaintiff seeks recovery of tax on $26,606.02 which it received as interest on municipal obligations similar to those involved in the first count. The total tax sued for in the second count is the sum of $160,116.02 and interest.

Cause No. 4829.

On November 6, 1942, plaintiff in this case, Municipal Acceptance Corporation, filed its complaint seeking recovery of the sum of $20,036.63 in income and excess profit taxes for the calendar year 1937. It is alleged that on March 15, 1938, plaintiff filed its income and excess profit tax return for 1937 showing tax liability of $34,255.10 which was paid; that in the return plaintiff failed to exclude from gross income tax exempt interest in the sum of $73,983.27, which it received during 1937 from municipalities of the various states; that the interest was paid on obligations issued by such municipalities for (1) cash advanced by plaintiff to the municipalities which was used to purchase machinery and equipment chiefly from Fairbanks, Morse & Company for the construction, maintenance and operation of municipally owned power and water plants; or (2) on obligations issued by such municipalities to Fairbanks, Morse & Company in payment for such machinery and equipment which obligations were then purchased by plaintiff, Municipal Acceptance Corporation.

Since both of the above causes, insofar as the claims for recovery of taxes paid on interest alleged to be exempt are concerned, involve common questions of law and fact, they were by this court ordered consolidated for trial on March 22, 1943, as consolidated Cause Number 4828. Thereafter, a hearing was had on the issues in the consolidated cause and an agreed stipulation of facts was filed. Subsequently briefs were filed with the court by both parties. The briefs indicated a difference in the opinions of the parties with respect to the effect of the facts set forth in the stipulation and therefore this court ordered a further hearing on the issues to clarify all objections of the parties to the testimony heard or exhibits introduced, as well as to the contents of the stipulation of facts.

Cause No. 44 C 1442.

On November 28, 1944, the Municipal Acceptance Corporation filed its complaint seeking recovery of $11,755.95 in income and excess profit taxes on income which it failed to exclude from gross income in its tax return for the calendar year 1938. The income was in the form of interest received by the plaintiff from municipalities and the issues involve facts similar to those in the preceding Causes Nos. 4828 and 4829.

Cause No. 44 C 1568.

On December 15, 1944, plaintiff Fairbanks, Morse & Company filed its complaint seeking recovery of an overpayment of $4,511.43 in taxes on income received in the calendar year 1938, in the form of interest on obligations issued by municipalities in circumstances, manner and form similar to those set forth in Complaint No. 4828. In this complaint, plaintiff also seeks to recover the tax paid on recoveries in 1938 of bad debts in the sum of $2,143.89 which it failed to deduct in its income tax return for that year. It is alleged that these debts had been deducted in tax returns for 1931, 1932 and 1933, without tax benefit.

On April 3, 1945, the latter Causes Nos. 44 C 1442 and 44 C 1568 were on agreed motion of all parties by order of this court consolidated for trial with Causes Nos. 4828 and 4829, and these four causes are now before the court as Consolidated Cause No. 4828.

After the four causes were consolidated, the plaintiff introduced further testimony into the record pertaining to the value of the assets received by the plaintiff after the dissolution of the two subsidiary companies and which were applied toward payment of their respective open accounts with plaintiff. With respect to the claims in the latter suits, No. 44 C 1442 and 44 C 1568, for recovery of taxes paid on interest received on municipal obligations, a supplemental stipulation of facts was filed by the parties. The supplemental stipulation also contains certain statements which relate to the character of the entries made by the plaintiff Fairbanks, Morse & Company on its books with respect to the recoveries of bad debts claimed as deductions in the first count of Cause No. 4828.

While it is claimed that the liquidation of the two subsidiaries, Fairbanks, Morse Home Appliances, Inc., and Fairbanks,...