Northern States Power Co. v. Commissioner

Northern States Power Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. The Minneapolis General Electric Company, Petitioner, v. Commissioner of Internal Revenue, Respondent Northern States Power Co. v. Commissioner Docket Nos. 29054, 32107, 32106 United States Tax Court 18 T.C. 1128; 1952 U.S. Tax Ct. LEXIS 94; September 25, 1952, Promulgated *94 Decisions will be entered under Rule 50. 1. Excess Profits -- Abnormal Deductions in Base Period -- Section 711 (b) (1) (J) -- Interest on Late Tax Payments. -- Statutory interest on late tax payments deducted by a public utility in its base period is of a different class of deductions for purposes of section 711 (b) (1) (J) from interest paid and deducted by the utility on its borrowed capital but is not different in class from interest deducted on account of other past due state and Federal tax payments with the result that the deduction is not disallowable because abnormal as to class within the meaning of section 711 (b) (1) (J) (i) but is disallowable to the extent that the deduction is abnormal as to amount within the meaning of section 711 (b) (1) (J) (ii). 2. Excess Profits -- Abnormal Deductions in Base Period -- Section 711 (b) (1) (H) -- Interest on Late Tax Payments. -- A base period deduction for interest paid on late tax payments is not disallowable as an abnormal deduction attributable to a claim within the meaning of section 711 (b) (1) (H). G. Aaron Youngquist, Esq., and Frederick W. Thomas, Esq., for the petitioners. Edward C. Adams, Esq., for the*95 respondent. Murdock, Judge. MURDOCK *1128 The Commissioner determined deficiencies in excess profits tax as follows: Jan. 1, 1941- Dkt. Aug. 29, 1941 No. Petitioner [1943] 29054 Northern States Power Co $ 219,262.08 $ 309,440.26 32106 Minneapolis General Electric Co $ 5,737.82 *1129 The Commissioner also determined that Northern States Power Company (Docket No. 32107) was liable as transferee for the deficiency determined against Minneapolis General Electric Company. The issues for decision are: (a) Whether interest of $ 419,631.11 for Northern States Power Company, $ 124,666.95 for Minneapolis General Electric Company, and $ 15,913.03 for St. Croix Falls Minnesota Improvement Company, accrued, paid, and deducted in 1938 on additional Federal taxes for the years 1924 through 1933, also paid and accrued in 1938, is (1) abnormal as a class under section 711 (b) (1) (J) (i), or (2) excessive under the provisions of 711 (b) (1) (J) (ii), or (3) abnormal as a class or excessive under section 711 (b) (1) (H); (b) Whether the abnormality or excess, if any, was a consequence of a change at any time in the type, manner of operation, *96 size, or condition of the business engaged in by the taxpayers within the meaning of section 711 (b) (1) (K) (ii). FINDINGS OF FACT. Northern States Power Company, hereafter called Northern States, is a Minnesota corporation operating as a public utility in the State of Minnesota and adjacent states. Minneapolis General Electric Company, hereafter called Minneapolis, was a New Jersey corporation operating as a public utility within the State of Minnesota, all of the stock of which was owned by Northern States Power Company. Those two corporations and St. Croix Falls Minnesota Improvement Company, hereafter called St. Croix, were merged on August 29, 1941, and the assets and businesses of all three corporations have been owned and operated since that time by Northern States. The excess profits tax returns of the taxpayers for the taxable years were filed with the collector of internal revenue for the district of Minnesota. The excess profits credits of Northern States for 1942 and 1943 included the base period incomes of the subsidiaries. The books of account of the taxpayers and their returns were filed on an accrual basis of accounting. The Commissioner of Internal Revenue proposed*97 additional income and declared value excess-profits taxes against Northern States and affiliated corporations prior to 1938 in the total amount of $ 2,027,903.59 for the consolidated return years 1924 through 1933. The taxpayers resisted the imposition of those taxes by filing protests and other documents with the Commissioner and attending conferences with his representatives but agreed with the Commissioner in 1938 to settle their controversy by the payment of additional taxes of $ 1,239,054.99 for the years in controversy, plus interest as provided by law, and the taxpayers executed agreements waiving the restrictions of section 272 (a) and consenting to the assessment and collection of the taxes *1130 due. $ 1,159,609.53, representing the portions of the total due from Northern States, Minneapolis, and St. Croix was paid to the collector in 1938, pursuant to notice and demand from him, and at the same time interest thereon was paid in the following amounts: Northern States $ 419,631.11 Minneapolis 124,666.95 St. Croix 15,913.03 $ 560,211.09 No notice of deficiency was issued in relation to those taxes. The following table shows the interest paid by the three*98 companies involved herein on past due taxes during the years 1934 through 1938, and during the tax years. The taxes, where not described as a deficiency, are the difference between the estimated installments paid when due and the additional amount shown on a return filed at a later date. Northern Kind of tax States Minneapolis St. Croix 1934: State income $ 1,756.19 $ 205.86 $ 41.75 Federal excise 4.67 1935: State prop 1,530.53 Federal income 3.98 1936: State income 112.72 Federal income 6.63 4.57 Federal capital stock 806.33 245.83 14.75 1937: State income 79.42 State income deficiency 267.10 86.70 Federal income .24 Federal capital stock 788.37 239.74 15.01 1938: State income 36.38 2.64 Federal income 36.11 4.79 Federal income deficiency 419,631.11 124,666.95 15,913.03 Federal capital stock 789.04 246.58 19.73 1941: Federal excise deficiency 5,731.91 Federal capital stock deficiency 197.91 1942: State income 331.42 State income deficiency 1 10,938.21 Federal income 2 25.03 Federal income deficiency 2 1,893.21 Federal excise deficiency 1,542.19 1943: State income 285.98 Federal capital stock deficiency 274.31 *99 A large part, but less than one-half of the operating capital of most public utilities, including the three involved herein, is obtained from long term loans at relatively low interest rates. Northern States, in addition to the interest shown on past due tax payments in the above table, incurred interest expense in the amount of $ 2,874.950 for 1938 and the two taxable years, and for the years 1934 through 1937 an average of about $ 4,662,000, on its funded debt; *1131 $ 72,903.36 for the taxable years and 1938, and for the years 1934 through 1937 more than $ 74,000 annually, on advances from affiliated companies on open account; and for the years 1934 through 1938 and for the taxable years amounts ranging from a little over $ 13,000 to a little over $ 34,000 on consumers' deposits. Minneapolis, in addition to the interest shown on past due tax payments in the above table, incurred interest expense of over $ 1,600,000 for 1934 and 1941, and $ 2,524,200 for each of the years 1935 through 1938 to Northern States, and to others almost $ 300,000*100 for 1934, on funded debt; on advances on open account from Northern States, $ 987,365.33 for 1934, $ 40,131.24 for 1935 and 1936, $ 64,662.51 for 1937, $ 200,040.88 for 1938, and $ 126,392.64 for 1941; and on consumers' deposits an average of about $ 11,500 for the years 1934 through 1938, and about $ 6,000 for 1941. St. Croix, in addition to the interest shown on past due tax payments in the above table, incurred interest expense of $ 70,000 for each of the years 1934 through 1938 on funded debt to Minneapolis; $ 31,336.70 for the years 1934 through 1936, $ 11,605.44 for 1937 and $ 8,442.61 for 1938, on a note to Minneapolis; and from $ 16.98 to $ 33.49 for the years 1934 through 1938 on consumers' deposits. The amounts deducted on the tax returns as interest of Northern States for the years 1934 through 1938 ranged from a low of about $ 3,500,000 for 1938 to a high of about $ 5,500,000 for 1935, and during the taxable years averaged about $ 3,055,000. Northern States, in computing its excess profits credit based on income on its excess profits tax return for 1942, excluded interest in the amount of $ 547,379.67 as a deduction for the base period year 1938, that amount being the *101 excess of $ 560,211.09, the interest paid by it and its two affiliates in 1938 on their share of the additional taxes for the years 1924 through 1933, over $ 12,831.42, representing interest on Federal and state income tax deficiencies paid by it in 1942, and in computing its excess profits credit based on income on its excess profits tax return for 1943 it excluded as a deduction the entire $ 560,211.09 paid in 1938. Minneapolis, in computing its excess profits credit based on income on its return for the period January 1 to August 29, 1941, excluded as a deduction for the base period year 1938, $ 124,666.95, representing the interest paid by it in 1938 on additional taxes for the years 1924 through 1933. The Commissioner, in determining the deficiencies, refused to disallow the interest deductions for 1938 claimed by the two taxpayers. All amounts paid by Northern States, Minneapolis, and St. Croix during the years 1934 through 1938 and during the taxable years as interest on taxes paid after the due date thereof is classified separately *1132 from other interest payments of those companies for the purpose of section 711 (b) (1) (J) of the Internal Revenue Code. Deductions *102 of that class for 1938 were not abnormal for those taxpayers. The excess of such deductions for 1938 over 125 per cent of the average amount of the deductions of that class for the four previous taxable years was in no case a consequence of an increase in the gross income of the taxpayer in its base period, a decrease in the amount of some other deduction in its base period, or a change at any time in the type, manner of operation, size or condition of the business engaged in by the taxpayer. All facts stipulated by the parties are incorporated herein by this reference. OPINION. These petitioners, like most other public utilities, obtained a large part of their working capital by borrowing money for long terms at low rates of interest. These loans are rather permanent investments. It was normal for the petitioners to have large deductions for interest on such borrowings, but in the base year 1938 they had another large interest deduction which was unusual. Tax liabilities for the years 1924 through 1933 were settled and paid, as was interest on those liabilities in the amount of $ 560,211.09. Thus, they paid an extraordinarily large amount of interest of this particular kind in*103 the one base year 1938 and that payment brings them within the spirit of section 711 (b) (1). Cf. Frank H. Fleer Corporation, 10 T. C. 191. They seek to have a part of their interest deduction for 1938 disallowed and their income of that base period year made more nearly normal by reason of the elimination of that deduction which was at least abnormal in amount. Is it proper to classify interest on past due tax payments separately from the other interest payments of these taxpayers for the purpose of section 711 (b) (1) (J)? The cases cited by the respondent considered only the classification of interest on the regular borrowings in the course of a business and did not hold that no subclassification of interest can ever be made. Cf. section 711 (b) (1) (H) where interest is subdivided. The utilities willfully borrowed the large amounts of funds which were regularly used by them to obtain equipment and as working capital. They at least participated in the setting of the low interest rates on those borrowings. The funds were obtained and used in order to carry on the business. Interest on their belated tax payments is different in a number of ways*104 from interest of the kind just described. The taxpayer has no intention of borrowing any money and does not seek to borrow money when it pays past due taxes. It probably does not know that interest is owed until *1133 long after it has begun to accrue and it can not accrue and deduct the interest currently. It miscalculated the amount of tax which it owed, failed to pay the full amount of the taxes imposed upon it by law, and was, in a sense, penalized for not making its payments on time by the legal requirement that it pay interest on the belated payments from the time they were due until the time they were paid. The interest for many years became deductible in only one year. The relatively high rate of interest in such cases is not agreed upon by the parties but is fixed by law. If a taxpayer could always compute correctly the amount of tax which it owed prior to the date upon which payment of the tax was required, it would never have to pay any such interest and it would be better off from a financial standpoint. Yet these taxpayers, like most others, have not always been able to do that and, consequently, they have sometimes had to pay interest on past due taxes in*105 order to discharge their obligations under the taxing laws. While in a sense they had the use of money due the Government, still the purpose of Congress can be carried out by classifying the interest on past due tax payments separately from other interest. However, interest of this class was normal rather than abnormal for the taxpayers since they were required to pay interest of that kind from time to time. Therefore, section 711 (b) (1) (J) (ii) applies. The petitioners contend that interest on "tax deficiencies" should be classified separately from all other interest for present purposes. But to classify interest on tax deficiencies separate from interest on other belated tax payments draws too fine a distinction for the purpose of section 711 (b) (1) (J). Cf. Walter Motor Truck Co., 16 T. C. 645. The petitioners also have argued, perhaps as an alternative to reach about the same result, that section 711 (b) (1) (H) applies in that the interest paid in connection with the 1938 tax settlement was interest on a "claim." Section 711 (b) (1) (H) entitled "Payment of Judgments, and So Forth" provides that: Deductions attributable to any claim, award, *106 judgment, or decree against the taxpayer, or interest on any of the foregoing, if abnormal for the taxpayer, shall not be allowed, and if normal for the taxpayer, but in excess of 125 per centum of the average amount of such deductions in the four previous taxable years, shall be disallowed in an amount equal to such excess; The petitioners might gain a greater advantage here from the application of that section than from the holding of the Court that section 711 (b) (1) (J) (ii) applies. One of the definitions of a claim is "A demand for something due or supposed to be due" and the petitioners argue that the taxes paid in 1938 come within that definition because the taxes were due and the Commissioner made a demand for them. *1134 No deduction is allowed for Federal income taxes. They are imposed by law. The taxpayers were told that the Bureau thought they owed additional taxes. The subject was discussed between the parties and an agreement, as to the amount of taxes due, was reached. Only thereafter was any "demand" made for additional taxes. There is no necessity or good reason for regarding interest on such taxes as coming within the meaning of section 711 (b) (1)*107 (H) so that taxpayers who resist sufficiently the taxes imposed upon them would obtain especially favorable treatment under that provision while others, who realize their mistake earlier and pay their taxes before the Commissioner takes any action, would not. A bill for an amount admittedly due is not necessarily a "claim" within the meaning of section 711 (b) (1) (H) nor is every assertion that an amount is due. The taxes here were collected by voluntary agreement between the tax collecting agency and the taxpayer. Section 711 (b) (1) (J) (ii) will give proper relief in this case. The parties have stipulated that the excess, if any, under section 711 (b) (1) (J) (ii) is not a consequence of an increase in the gross income or a decrease in the amount of some other deduction in its base period. The evidence shows and a finding has been made that the excess is not a consequence of a change at any time in the type, manner of operation, size, or condition of the business engaged in by the taxpayers within the meaning of section 711 (b) (1) (K) (ii). Effect must be given to section 711 (b) (1) (K) (iii) in determining the amount to be disallowed. Decisions will be entered under *108 Rule 50. Footnotes 1. Applicable $ 6,953.08 to Northern States, $ 3,832.83 to Minneapolis, and $ 152.30 to St. Croix.↩ 2. Applicable to Minneapolis.↩