THOMAS MACHINE MANUFACTURING COMPANY v. Commissioner, Docket No. 91035.
| Decision Date | 12 October 1964 |
| Docket Number | Docket No. 91035. |
| Citation | 23 TCM (CCH) 1630,1964 TC Memo 269 |
| Parties | Thomas Machine Manufacturing Company v. Commissioner. |
| Court | U.S. Tax Court |
Sidney B. Gambill and Joseph G. Robinson, 747 Union Trust Bldg., Pittsburgh, Pa., for the petitioner. Lawrence L. Wilson, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined a deficiency in the income tax of petitioner for the taxable year 1957 in the amount of $16,395.42.
The issues presented for our consideration are: (1) Whether $2,600 paid by petitioner to George P. Thomas in the taxable year 1957 constituted payment of interest on indebtedness of petitioner under section 163, Code of 1954;1 and (2) whether compensation paid by petitioner to its officers in 1957 constituted reasonable compensation for services rendered to petitioner by such officers under section 162, Code of 1954.
Some of the facts have been stipulated and are incorporated herein by this reference.
Petitioner, a corporation, was organized in 1917 under the name of Thomas Spacing Machine Company and, since that time, has been engaged in the business of machine work and manufacture of machinery and machine tools at its plant located at Glenshaw, Pennsylvania. The corporate name was changed to Thomas Machine Manufacturing Company during 1937.
Petitioner was incorporated with an authorized capital stock of $350,000 represented by 3,500 shares of common stock having a par value of $100 per share. Upon its incorporation petitioner issued 3,224 shares of the authorized stock for property with a value of $125,000, and cash of $197,400. The 3,224 shares have been outstanding since the petitioner was incorporated, except that in 1956 there was a stock dividend of one share for each share outstanding.
At all times petitioner has kept its books and records and filed its tax returns on an accrual method of accounting.
Petitioner's income tax return for the taxable year ended December 31, 1957, was timely filed with the district director of internal revenue, at Pittsburgh, Pennsylvania.
The notice of deficiency for 1957 was mailed to petitioner on December 23, 1960.
George P. Thomas (hereinafter sometimes referred to as Thomas) has been the president and chairman of the board of directors of petitioner since its organization in 1917, and at all times relevant herein has made the final decisions on all matters of policy and administration affecting petitioner.
Throughout the years the petitioner has been engaged in the manufacture of machinery and machine tools and in doing machine work. Its primary business has been the designing and building of metal working machinery used principally by structural fabricating plants in the United States and in foreign countries. The machines are built in various sizes for different purposes. The most important machine built by petitioner is a punching machine used for punching holes in steel structural plates such as steel beams and angles. Several years ago Thomas developed an "automatic spacing table," a machine or device that pulls the structural beams and angles under a punching machine and automatically spaces the rivet holes in accordance with drawings without marking the member to be punched. Later he improved this machine to the extent that the petitioner at the time of the instant proceeding was building a model which is numerically controlled.
Prior to the development of the Thomas spacing machine it was necessary for a "layer-out" man to read the drawings and place the mark on each beam for each rivet hole. The beam was taken to a punching machine and each hole was punched separately. The machine developed by Thomas did all of this automatically, punching multiple holes. The machines and improvements developed by Thomas were patented by him and were made available to petitioner without compensation.
Ordinarily machines built by the petitioner are built from specifications furnished by its customers. It usually requires from 60 to 90 days to build a machine. The prices of said machines are as high as $200,000. Petitioner also builds a regular line of fabricating machines from its own detailed drawings, modified to meet the requirements of the customers. Prices of said machines vary from $5,000 to $125,000.
For several years prior and subsequent to 1920, Thomas operated a sole proprietorship under the name "Thomas Company" engaged in buying and selling used industrial machinery. Thomas, acting individually, between the time the petitioner was incorporated and 1920, purchased 13 large machines and a 15-ton overhead traveling crane. Prior to January 15, 1936, said machinery was leased by Thomas to the petitioner by a series of leasing agreements. Petitioner paid rent to Thomas for the use of the machinery.
On January 15, 1936, Thomas was the holder of six percent first mortgage bonds of the petitioner in the amount of $54,000. Prior to January 15, 1936, petitioner made an application to the Reconstruction Finance Corporation (hereinafter referred to as RFC) for a loan. A loan of $144,800 was approved by the RFC on January 17, 1936. Said loan was secured by a first mortgage on the real estate, plant, machinery, and equipment of the petitioner, and was conditioned upon an agreement of Thomas to postpone the enforcement of his rights to the payment of the principal and interest on the aforesaid first mortgage bonds in the amount of $54,000 held by him until the RFC was paid. Such an agreement was executed by Thomas. Another condition to the RFC loan was that Thomas would transfer to petitioner the 13 machines and crane which he was leasing to the petitioner and which were installed in petitioner's plant. The loan was guaranteed by Thomas and was to be repaid over a period of five years. Said loan was fully satisfied on December 29, 1941.
In compliance with the conditions of the RFC loan, petitioner, Thomas, and Citizens Deposit and Trust Company of Pennsylvania, Trustee, made an agreement whereby Thomas postponed all rights to principal and interest on petitioner's six percent mortgage bonds held by him during the existence of the RFC loan. Citizens Deposit and Trust Company, as trustee, was the holder of a mortgage of petitioner to secure petitioner's bonds.
In compliance with conditions of the RFC loan, Thomas agreed to convey by bill of sale to petitioner for the sum of $99,273 the 14 items of machinery which were being leased from Thomas. Petitioner agreed to pay $99,273 to Thomas when the RFC loan was satisfied and also agreed to pay Thomas $1,500 per year as interest until the purchase price was paid, such amount being the maximum allowed by the RFC to be paid.
On January 15, 1936, Thomas gave petitioner a bill of sale for the machines and received petitioner's note for $99,273.
The amount of $99,273, stated as the purchase price, was based upon an appraisal of the machines made in 1934 by the Manufacturers' Appraisal Company, but such appraisal did not include a 15-ton Cleveland Overhead Crane included as one of the 14 items of machinery transferred by Thomas.
On January 15, 1936, petitioner and Thomas made an agreement that upon full satisfaction of the RFC loan, petitioner would reassign the machinery to Thomas, and the note for $99,273 would be cancelled.
The transfer of the machinery from Thomas to petitioner on January 15, 1936, was not intended by the parties to the transaction as a bona fide sale.
In 1936 petitioner's books contained an account labeled "Accrued Machinery Rent — George P. Thomas," and an account labeled "Deferred Liability on Machinery Assigned from George P. Thomas." Accruals of machinery rent were made in the former account up to December 13, 1942, based upon six percent per year of the balance of the latter account. The balance of such latter account was $99,273 until June 30, 1941, when it was reduced by $2,639.25 to $96,633.75 to reflect an adjustment created by a sale of a machine described as a Newton Cold Saw during April 1940.
Although petitioner was precluded from paying principal or interest to Thomas on its bonds during the period the RFC loan was unsatisfied, petitioner accrued interest to Thomas at the rate of six percent on such bonds during such period and during 1942.
As of December 13, 1938, and December 31, 1941, the following denominated accounts on the books and records of the taxpayer had the following balances:
12-31-38 12-31-41
Bonds outstanding (253) ........ $45,000.00 $45,000.00
Accrued interest on bonds
— George P. Thomas
owner of bonds (13) ........... 11,400.00 19,500.00
Deferred liability on machinery
assigned from George P. Thomas*
(251A) ........................ 99,273.00 96,633.75
Accrued machinery rent —
George P. Thomas (262A) 20,778.04 32,636.26
Notes payable — G. P
Thomas (252D) ................. 3,185.23 3,185.23
Accrued interest — G. P
Thomas note (262B) ............ 971.53 1,497.02
Accounts Rec. — Thomas
Co. (7) ....................... 2,982.69 2,982.69
* During April 1940, a machine described as
a Newton Cold Saw was sold for $900. The account
on the books of the taxpayer, denominated
Deferred Liability on Machinery assigned
from George P. Thomas, was debited in the
amount of $2,639.25 on June 30, 1941. $900
representing proceeds of such sale, was paid to
Thomas by the taxpayer
On March 1, 1942, petitioner gave Thomas a note in the amount of $6,908.06 which covered accrued interest on bonds and notes and accrued machinery rent, all for the year 1941. The note was paid December 31, 1942.
During 1942 Thomas offered a plan for liquidation of amounts shown on the petitioner's books as being owed to him. The plan was outlined in the minutes of a directors' meeting held July 21, 1942.
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