Newlin Mach. Corp. v. Comm'r of Internal Revenue
| Decision Date | 28 June 1957 |
| Docket Number | Docket No. 63750. |
| Citation | 28 T.C. 837 |
| Parties | NEWLIN MACHINERY CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
John A. Ross, Esq., for the petitioner.
Ray H. Garrison, Esq., for the respondent.
1. Petitioner, a corporation, sold heavy machinery and related equipment to political subdivisions in Missouri and Kansas. The unpaid portion of the purchase price was paid in semiannual installments under lease arrangements. Some transactions were not evidenced by any written obligation to pay interest. Some transactions were evidenced by signed purchase orders providing for the payment of interest. Held, of the amounts in dispute, the amounts attributable to transactions not evidenced by written obligations which, on their face, provided for the payment of interest, are not tax exempt within the meaning of section 22(b)(4), 1939 Code. Held, further, of the amounts in dispute, the amounts attributable to transactions evidenced by signed purchase orders providing for the payment of interest, constitute tax-exempt interest within section 22(b)(4).
2. Respondent's determination of the proper allowances for additions to petitioner's reserve for bad debts is sustained.
Respondent determined deficiencies in income and excess profits taxes for the fiscal years ended June 30, 1952 and 1953, in the amounts of $5,966.19 and $8,383.36, respectively.
The questions to be decided are as follows:
1. Whether all or part of certain payments from political subdivisions which petitioner received in each of the taxable years were ‘interest’ paid upon ‘obligations' of the political subdivisions, within the meaning of section 22(b)(4), 1939 Code, so as to be exempt from tax.
2. Whether respondent properly reduced the amounts added by petitioner to its reserve for bad debts for each of the taxable years.
Issue 1. Tax-Exempt Interest.
The petitioner is a corporation, organized under the laws of Kansas in the year 1946, with its principal place of business located at Kansas City, Kansas. Petitioner filed its income tax returns for the taxable years with the collector of internal revenue for the district of Kansas. It was and is engaged in selling and servicing heavy construction machinery, such as road-grading equipment and tractors, in Missouri and Kansas.
On its income tax returns for the fiscal years ended June 30, 1952 and 1953, petitioner excluded the amounts of $7,934.92 and $5,102.25, respectively, as ‘tax exempt interest from municipalities.’ Respondent, in his deficiency notice, disallowed these amounts in their entirety. However, respondent now concedes that the amounts of $1,717.33 and $1,449.21 for fiscal years ended in 1952 and 1953, respectively, which were received from political subdivisions in the State of Missouri, constitute tax-exempt interest. The amounts remaining in issue, therefore, are $6,217.59 for the fiscal year ended in 1952, and $3,653.04 for the fiscal year ended in 1953.
Petitioner sold heavy construction equipment and related items to political subdivisions in the States of Missouri and Kansas. Some of these sales took the form of lease arrangements. For all intents and purposes, the lease arrangements constituted conditional sales, and the rental payments made thereunder were deferred payments made on the purchase price of the machinery.
It was the general procedure for petitioner and the political subdivisions to execute a purchase order as the first step. The completed purchase order set forth the total price of the machinery purchased, the amount allowed for trade-ins, the amount of the downpayment, and the unpaid balance. In addition, it provided for payment of the unpaid balance in semiannual installments.
In some of the transactions, the purchase orders contained the provision that ‘notes, warrants, or other evidence of indebtedness,‘ if any, ‘shall bear interest from the date thereof at the rate of 6% per annum until maturity.’ According to respondent's Exhibits H and G, incorporated herein by this reference, $2,827.53 and $1,034.81 for fiscal years ended in 1952 and 1953, respectively, represent that portion of the amount in dispute attributable to transactions evidenced by such purchased orders.
After the completed purchase order was approved, a lease agreement was drawn and sent to the political subdivision to be signed by the proper officials. In the lease agreement, the political subdivision agreed to pay semiannually as ‘rental for the use of’ the purchased property specified amounts which were set forth in the instrument together with the due dates for payments. The lease agreement did not provide for interest on its face.
At the end of each semiannual period, petitioner sent the political subdivision a bill, or rental invoice, covering the amount of the rental payment then due. Petitioner, on its account books, allocated a portion of each rental payment to an account designated as ‘interest earned from municipalities.’ Petitioner's credit manager computed the amount of the allocation, and made the book entry. However, the face of the rental invoice contained no reference to interest or to the allocation made by petitioner's credit manager.
According to respondent's Exhibits I and J, incorporated herein by this reference, $3,390.06 and $2,618.23 for fiscal years ended in 1952 and 1953, respectively, represent that portion of the amount in dispute attributable to transactions not evidenced by any written obligation to pay interest. As to the above amounts, the only evidence of interest paid by a political subdivision to petitioner are the entires by petitioner, on its books, in the account designated ‘interest earned from municipalities.’
The amounts of $2,827.53 and $1,034.81 received from various political subdivisions in fiscal years ended in 1952 and 1953, respectively, were payments of interest.
Issue 2. Bad Debt Reserve.
Petitioner computes its bad debts on the reserve basis. For the fiscal year ended June 30, 1952, petitioner added the sum of $20,000 to its reserve for bad debts, and charged $7,214.20 against the reserve. The remaining total reserve for bad debts amounted to $18,894.65. Respondent's agent determined that the addition to the reserve for bad debts was excessive in the sum of $12,697.56.
For the fiscal year ended June 30, 1953, petitioner added the sum of $15,301.44 to the reserve for bad debts, and charged $16,133.70 against the reserve. The remaining total reserve for bad debts amounted to $20,000. Respondent's agent determined that the addition to the reserve for bad debts was excessive in the sum of $11,016.43.
Respondent's determinations were based upon petitioner's past experience. For the taxable year 1952, the agent took the accounts receivable for the period 1949-1952, totaled the percentage of losses and bad debts actually incurred during that period, and applied the percentage to the outstanding accounts receivable at the end of the taxable year in issue. The resulting amount was determined to be a reasonable addition to the bad debt reserve for the taxable year ended in 1952. For 1953, the same computation was made based on the period 1949-1953.
The following tables show petitioner's original computations as contrasted to respondent's corrections based on the above formula:
FN1 Return for taxable year ended June 30, 1953, indicates that $16,133.70 was the amount charged against reserve during taxable year ended June 30, 1953.
Respondent's additions to the bad debt reserve in the amounts of $7,302.44 and $4,285.01 for fiscal years ended in 1952 and 1953, respectively, were reasonable and adequate for those years; and respondent's refusal to allow petitioner's additional amounts was not arbitrary.
Issue 1. Tax-Exempt Interest.
Petitioner sold heavy machinery and related equipment to political subdivisions in the State of Missouri and Kansas. In some instances, the municipalities entered into lease agreements in order to pay the purchase price, or unpaid portion thereof, in semiannual installments over a period of years. Petitioner claimed in its returns for the fiscal years ended June 30, 1952 and 1953, that receipts by these political subdivisions in the amounts of $7,934.92 and $5,102.25, respectively, constituted tax-exempt interest within the meaning of section 22(b)(4), 1939 Code.
Respondent now concedes that, of the above-stated amounts, $1,717.33 and $1,449.21, received during fiscal years ended in 1952 and 1953, respectively, have been properly excluded as tax-exempt interest. As to the remaining amounts, i.e., $6,217.59 for the fiscal year ended in 1952, and $3,653.04 for the fiscal year ended in 1953, respondent makes the following contention: The contracts under which...
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