R. B. George Mach. Co. v. Commissioner

R. B. GEORGE MACHINERY COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. R. B. George Mach. Co. v. Commissioner Docket No. 61218. United States Board of Tax Appeals 26 B.T.A. 594; 1932 BTA LEXIS 1285; June 30, 1932, Promulgated *1285 Where petitioner received deficiency warrants from the State of Texas and its political subdivisions in payment for machinery, and used such warrants as security in obtaining a loan, the interest paid on such loan constituted a deductible expense, and was not paid on indebtedness incurred to carry obligations or securities "the interest upon which is wholly exempt from taxation." Richard B. Barker, Esq., for the petitioner. E. L. Corbin, Esq., for the respondent. ARUNDELL *594 Notice of deficiency in income taxes for the calendar year 1929 in the amount of $1,149.35. Respondent's action in disallowing as a deduction an item of interest in the sum of $13,543.04 paid by petitioner to the Republic National Bank and Trust Company is cited as error. The facts were stipulated. FINDINGS OF FACT. The petitioner is a corporation, organized and incorporated January 1, 1924, and now existing under and by virtue of the laws of the State of Texas, with its principal place of business at 1135 South Lamar Street, Dallas, Texas. During the taxable year 1929, and prior thereto, the petitioner was engaged in the business of selling, at wholesale, tractors, *1286 farm machinery and road machinery, selling extensively to the State of Texas, certain counties and municipalities. In payment for some of the machinery sold to the State of Texas, counties and municipalities, the petitioner received deficiency warrants of the said State of Texas, counties and municipalities, thereby depriving it of cash necessary properly to operate its business. In order to obtain the necessary cash to operate its business, petitioner, ascertaining that such cash could only be obtained by transferring the deficiency warrants in the manner set forth below, entered into a contract with the Republic National Bank & Trust Company of Dallas, Texas, wherein it was agreed that the petitioner transfer to the bank the warrants received from the State of Texas, counties and municipalities, in payment for machinery sold, in consideration that the bank advance to the petitioner cash to the extent of 95 per cent of the face value of the warrants. The contract also contained what was termed a 90-day repurchase agreement. All of the contracts between the bank and the petitioner in relation to the *595 deficiency warrants of states or political subdivisions during*1287 1929 were executed on a similar form. A typical form of contract used between the petitioner and the bank is set forth as follows: BILL OF SALE AND INDEMNITY CONTRACT THE STATE OF TEXAS COUNTY OF DALLAS $6,175.00 This contract, entered into by and between R. B. GEORGE MACHINERY COMPANY, hereinafter called Seller, and the Republic National Bank and Trust Company, of Dallas, Texas, hereinafter called the Bank, WITNESSETH: That the Bank has purchased of and from the Seller the following described securities, upon the terms and conditions hereinafter set out: $6,500.00 Comanche County Road warrants dated February 12, 1929, and numbered from One (1) to Five (5) inclusive, bearing interest at the rate of six per cent annually payable February 15th, 1930 and semi-annually thereafter on August 15th and February 15th of each year; maturing $500.00 2-15-30: $1500 2-15-31: to 34 inc. That the Bank has paid the Seller for such securities the sum of Six Thousand one hundred and seventy five - Dollars in cash, which is hereinafter called the purchase price, receipt of all of which by the Seller is hereby acknowledged. In making said sale to the Bank, the Seller unqualifiedly guarantees*1288 to the Bank; (a) That such securities, each and all, are in all respects valid and genuine; (b) that all of said securities will at all times during the period of one year from the date hereof be readily salable in the open market for a sum in cash not less than said purchase price plus interest from the date hereof until the date of sale at 6 per centum per annum, together with the expenses of sale, if any, minus the interest, if any, collected on same by the Bank before such sale; and if, during such time, the Bank, when it desires to sell them does not find a ready sale for them at such price, either in open market or private sale, then the Seller, upon demand of said Bank, will pay it the difference between such sum and the price actually received by the Bank in making sale thereof. If at any time during 90 days from date hereof, said Bank desires to sell said securities, it shall request Seller to make sale for it; and provided said Seller makes such sale for a price not less than the purchase price of same plus 6 per centum thereof from the date hereof to the date of sale, minus the interest on same, if any, collected by said Bank before such sale, which sale shall be for*1289 cash actually received by the Bank within five days from the date of such request, the Bank agrees to pay said Seller a commission therefor equal to the amount the price at which such sale is made by said Seller, either to third parties or it itself, plus the interest, if any, on same collected by the Bank before such sale, exceeds the original purchase price plus 6 per centum thereon from the date hereof to such date of sale; provided that should such sale be not made by the Seller within such five days from the date of such request and the Bank at any time thereafter itself, or through other parties, sell such securities, no commission on such sale shall be payable to the Seller hereunder. Nothing herein provided shall ever be construed to authorize said Seller, herein requested by the Bank to sell said securities, to sell them at a price less than the original *596 purchase price plus 6 per centum thereon from the date hereof to the date of sale, minus the interest collected on same, if any, by said Bank before such sale. If, upon the expiration of 90 days from the date hereof, the Bank has not sold said securities, the Bank agrees, upon demand of the Seller within five*1290 days immediately following said 90 days from the date hereof, to resell said securities to said Seller at a price equal to the purchase price plus 6 per centum thereof from date hereof to date of such demand, less the interest on same, if any, collected by said Bank before said demand. The Seller expressly covenants that the Bank may at any time within such period of 90 days, charge the account of the Seller with any sum deemed necessary by the Bank to insure the full and prompt performance by the Seller of any and all obligations by the Seller herein undertaken; and further, that the Bank shall have the right, during said period, to hold any other securities owned by the Seller and in the possession of the Bank, as additional security for the performance of every and all of such undertakings of the Seller in any manner arising hereunder. As a part of the consideration for the purchase of said securities by the Bank from the said Seller hereunder, said Seller agrees and covenants that it will indemnify and save harmless the Bank from any and every liability, loss, claim, damage, counsel fees, and other expense of any character which said Bank may incur by reason of having purchased*1291 said securities, or in any manner arising from or incident to its purchase of said securities, or attempt to collect the same, or the proceeds thereof. IN TESTIMONY WHEREOF, This instrument is executed this - day of April, 1929. R. B. GEORGE MACHINERY COMPANY, Seller. REPUBLIC NATIONAL BANK AND TRUST COMPANY OF DALLAS, TEXAS, By ROB'T. WILLIAMS, Vice President. In pursuance of the contracts referred to above, the Republic National Bank and Trust Company of Dallas, Texas, advanced money to the petitioner. The petitioner paid $13,543.04 to the said bank during the year 1929 as interest on the money so advanced. In the income-tax return filed by the petitioner for the year 1929 a deduction is claimed for the interest so paid in the amount of $13,543.04. In his final determination the Commissioner has disallowed the deduction. If the Board should find that the petitioner is not entitled to deduct from its gross income for 1929 the $13,543.04 expended by it in 1929 for interest on the money advanced to it by the Republic National Bank and Trust Company of Dallas, Texas, in computing its taxable income, then the Commissioner's determination of a deficiency*1292 of $1,149.35 for the calendar year 1929 is correct. If the Board should find that the petitioner is entitled to deduct from its gross income for 1929 the $13,543.04 mentioned above, then *597 the petitioner has overpaid its 1929 Federal income taxes in the amount of $340.38. OPINION. ARUNDELL: The answer to the question is to be found in the proper construction of section 23(b) of the Revenue Act of 1928, which reads as follows: Interest. - All interest paid or accrued within the taxable year on indebtedness, except on indebtedness incurred or continued to purchase or carry obligations or securities (other than obligations of the United States issued after September 24, 1917, and originally subscribed for by the taxpayer) the interest upon which is wholly exempt from taxation under this title. The parties have proceeded on the theory that the money obtained from the bank by petitioner was a loan, with the deficiency warrants of the state and its political subdivisions being hypthecated as security therefor. This we think is the correct approach. Prior to the transaction in question the various state and municipal obligations had become the property of petitioner*1293 and were fully paid for by it, as they represented payments to petitioner for machinery sold to the state and its subdivisions. It is quite apparent, then, that the money advanced to the petitioner on the warrants did not represent "indebtedness incurred or continued to purchase * * * obligations or securities * * * the interest upon which is wholly exempt from taxation * * *." This brings us to the real question, and that is, Was the interest here in controversy interest paid on "indebtedness incurred or continued * * * to carry obligations or securities * * * the interest upon which is wholly exempt from taxation?" We have been referred to no authoritative decision on the question. Opposing counsel both referred to ; affd., ; and to , but these cases offer little help. , construed section 214(a)(2) of the Revenue Act of 1921, which section corresponds to section 23(b) of the Revenue Act of 1928, but the facts there involved, as well as the question, were different. *1294 The statute was manifestly designed to prevent the purchaser of tax-exempt securities from deducting interest paid for borrowed money, which money was used to acquire securities the interest on which could not be taxed by the Federal Government. We think the exception in the statute should not be construed more broadly than to effect its obvious purpose. It was not intended to penalize legitimate business or to deny to it the right to deduct interest paid for borrowed money, which money was used for the purpose of carrying on its regular functions. The warrants *598 held by petitioner were received in payment for goods sold and they were apparently given because the state or its subdivisions could not at the time pay cash. They in no true sense of the word represented investments by petitioner, as it preferred at all times to get its cash out of them. The fact that in making the loan the petitioner hypothecated the warrants does not alter the fact as stipulated that the cash as borrowed was for the purpose of operating its business. It was not used to buy or secure the warrants in any sense of the word. It follows that*1295 interest paid by petitioner in the amount of $13,543.04 constitutes a proper deduction. An order will issue finding an overpayment of tax for the year 1929 in the sum of $340.38.