Kitchin v. Commissioner, Docket No. 93733-93735.

• Decision Date: 23 December 1963
• Docket Number: Docket No. 93733-93735.
• Parties: Jack F. Kitchin and Wilma H. Kitchin v. Commissioner.
• Court: U.S. Tax Court

22 T.C.M. (CCH) 1738 (1963)

T. C. Memo. 1963-332.

Jack F. Kitchin and Wilma H. Kitchin^* v. Commissioner.

Docket Nos. 93733-93735.

United States Tax Court.

Filed December 23, 1963.

Fortescue W. Hopkins, 509 Mountain Trust Bldg., Roanoke, Va. and H. Clyde Pearson, for the petitioners. Donald P. Krainess and Charles R. Hembree, for the respondent.

Memorandum Findings of Fact and Opinion

SCOTT, Judge:

Respondent determined deficiencies in petitioners' income tax for the years and in the amounts as follows:

                                                      Taxable
                  Docket                               year
                  number       Petitioner             ended      Deficiency
                  93733    Jack F. Kitchin and
                            Wilma H. Kitchin         12/31/58    $ 8,490.18
                  93734    Kitchin Equipment
                            Company of Virginia
                            Inc. ...............      3/31/59     20,354.80
                  93735    Motor Crane Service
                            Company, Inc.             3/31/59      5,105.55
                                                                 __________
                                                                 $33,950.53
                                                                 ==========
                

Petitioner Kitchin Equipment Company of Virginia, Inc., claims an overpayment of $794.74.

The issues for decision are:

(1) Whether payments received by each of the petitioners under certain contracts involving the furnishing of equipment for use of a contractor are includable in petitioners' income in the year accrued as rental receipts.

(2) If the payments received by petitioners do not represent rentals received, are petitioners entitled to deductions in the taxable years here involved for depreciation on the equipment for the period after the execution of the agreement under which the equipment was furnished to the construction contractor.

Findings of Fact

Some of the facts are stipulated and are found accordingly.

Jack F. Kitchin and Wilma H. Kitchin, husband and wife residing in Norfolk, Virginia, filed a joint Federal income tax return for the calendar year 1958 with the district director of internal revenue at Richmond, Virginia.

Kitchin Equipment Company of Virginia, Inc., a corporation (hereinafter referred to as Kitchin Equipment) and Motor Crane Service Company, Inc., a corporation (hereinafter referred to as Motor Crane) each filed its corporate income tax return for its fiscal year ended March 31, 1959, with the district director of internal revenue at Richmond, Virginia.

During the year 1958 Jack F. Kitchin engaged in business under the name of Norfolk Contracting Company (hereinafter referred to as Norfolk) and was also the president and owner of all of the outstanding capital stock of Kitchin Equipment and Motor Crane. Norfolk, Kitchin Equipment, and Motor Crane each kept its books and computed and reported its taxable income on an accrual method of accounting.

Norfolk, Kitchin Equipment, and Motor Crane (sometimes hereinafter referred to collectively as petitioners) each had for several years prior to the taxable years here involved been engaged in the business of leasing construction equipment to contractors, most of the equipment leased being heavy construction equipment. Each of these companies leased equipment on either a bare rental basis or a fully operated basis. When equipment was leased on a fully operated basis, the company leasing the equipment would furnish the operators of the machines and would furnish all services in maintaining the machines leased. None of the three companies had any dealership franchises with any equipment manufacturer and none of them had in any way attempted to sell heavy equipment to contractors. Very often these companies would receive referrals for their rental business from equipment dealers and for this reason did not desire to sell equipment in competition with such dealers.

From the latter part of 1955 throughout the year here involved, one of the principal customers of each of the three companies Norfolk, Kitchin Equipment, and Motor Crane, was M. W. Kellogg Company (hereinafter referred to as Kellogg), a company engaged in the building of major construction projects. On February 21, 1958, Kellogg entered into an agreement with Kennecott Refining Corporation (hereinafter referred to as Kennecott) under which Kellogg as contractor agreed to construct a plant for Kennecott at Baltimore, Maryland. Under this agreement, Kellogg was to be reimbursed by Kennecott for the cost of the project and in addition was to receive a fixed fee. The construction agreement which Kellogg entered into with Kennecott provided among other things that insofar as possible, all equipment rental agreements by Kellogg with third parties should give Kennecott the option of straight rental or rental with option to purchase with rentals previously paid being applicable against the purchase price, the amount of purchase price to be mutually agreed upon with the lessor and approved by Kennecott's project manager.

In the early summer of 1958 Kellogg advised Norfolk, Kitchin Equipment, and Motor Crane that it desired to lease equipment from each of them in connection with the construction of a plant for Kennecott at Baltimore. Kellogg further advised these three companies that under the terms of its contract with Kennecott, it would be necessary that the lessors of equipment grant it an option to buy each item leased, applying rentals paid to a previously established purchase price which was referred to as a "recapture" price.

At the time Kellogg requested petitioners to grant an option to it to purchase the equipment which it proposed to rent, petitioners had never entered into any type of leasing contract which granted to the lessee any right to purchase the equipment leased. After consideration of Kellogg's offer, petitioners agreed to the inclusion of the option in their rental agreement with Kellogg, for machinery to be used on work on the Kennecott plant but added the additional condition that Kellogg would reimburse petitioners for major maintenance expense incurred by petitioners during the leasing period with respect to such equipment as it exercised the option to buy, hereinafter sometimes referred to as recaptured equipment.

Petitioners also had an understanding with Kellogg that no transportation costs would be charged for equipment except with respect to items of equipment returned by Kellogg to petitioners in a period of less than 6 months. In confirming in writing their agreement with Kellogg to agree to the recapture clauses being included in leases of equipment to be executed with respect to equipment to be used by Kellogg on construction of the Kennecott plant, petitioners stated in part as follows:

You are already aware, of course, that we are not equipment dealers and that we confine our equipment operations to rentals. Ordinarily, we would not be interested in granting purchase options in any of our rental agreements, but in view of our very pleasant relations in the past and our earnest desire to continue to serve you wherever we can, we have decided to go along on this job and include the recapture clause as requested. Therefore, on any equipment which you may decide to rent from us for this job, it may be understood that you will have the privilege of purchasing same at any time during the rental period and that 100% of any rentals paid will be applied to the purchase price.

Of course, as previously explained to you, we would expect to be reimbursed for any maintenance expense we might have incurred during the rental period in the event you decide to exercise the recapture clause on any particular piece of equipment. Your exercising the recapture clause would have the effect, actually, of converting a lease into an outright purchase at the inception of the so-called rental period, inasmuch as 100% of the rentals would apply to the recapture price, and we do not feel that we should be expected to bear any expense of maintenance on a piece of equipment that is, in effect, your own equipment.

Thereafter each of the petitioners as lessor and Kellogg as lessee entered into equipment rental agreements for equipment to be used by Kellogg on work on the Kennecott plant. Each such agreement entered into was entitled, "Equipment Rental Agreement" and each contained 12 separate articles. Article 1 contained a description of the equipment to be rented; article 2 set forth the rental rates and basis providing for a schedule of rental rates for each of the items of equipment and rental rates on a monthly, weekly, or daily basis; article 3 dealt with payments providing for monthly payments of rental upon invoices to be rendered by lessor unless payment at more frequent intervals was agreed upon; article 4 provided for the condition of the equipment at the time of delivery to the job site and on the return of the equipment; article 5 dealt with repairs due to normal wear and tear of the equipment and provided that such repairs would be for the account of the lessor; article 6 concerned operation and maintenance of the equipment and provided that if the lessor were to furnish any operating or maintenance service, the particular service and charge applicable were to be as stated in a schedule attached to the agreement and further provided for the operation and maintenance to be furnished by the lessor where the equipment was rented on a fully operated basis; article 7 dealt with rental terms, outlining the date the rental period began and the date it concluded and contained a provision that it was specifically understood that Kellogg made no representations or guarantee as to the length of the rental time or amount of rental which would accrue under the agreement for any item of equipment, it being the intent that the equipment was to be rented for as long as Kellogg required the use of the particular item in connection with the performance of the construction contract. Article 9 dealt with assignment of the agreement; article 10,...