Kurtz Bros. v. Commissioner

KURTZ BROS., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Kurtz Bros. v. Commissioner Docket No. 100187. United States Board of Tax Appeals 42 B.T.A. 561; 1940 BTA LEXIS 983; August 16, 1940, Promulgated *983 Petitioner was in the business of selling school supplies and in the course of such business sold supplies to certain school districts, political subdivisions of the State of Pennsylvania, on open account. Some of these accounts were past due and in the taxable year petitioner invoiced these school districts with interest charges and collected thereon certain sums which it failed to return for taxation on the ground that it was exempt under section 22(b)(4) of the Internal Revenue Code, Title 26. The evidence does not show that the school districts had executed and delivered to petitioner any promissory notes or other written agreement in which they agreed to pay petitioner any interest on unpaid accounts. held, the alleged interest was not paid pursuant to any obligation executed the delivered by the respective school districts in the exercise of their borrowing power, and the interest in question is not exempt from taxation. Commissioner v. Meyer, 104 Fed.(2d) 155, and Kings County Development Co. v. Commissioner, 93 Fed.(2d) 33, distinguished. Pressly R. Baldridge, Esq., for the petitioner. William A. Schmitt, Esq.*984 , for the respondent. BLACK *562 The Commissioner has determined a deficiency in income tax for the year 1937 against petitioner in the amount of $234.88. The deficiency results from the addition of $1,196.57 to the income reported by petitioner on its income tax return for 1937, which the Commissioner describes in his deficiency notice as follows: (a) Interest income on open accounts with various school districts of the Commonwealth of Pennsylvania, in the total amount of $1,196.57, received by you during 1937 has been held to be taxable income. Petitioner contests this action by the Commissioner upon the ground that the income in question is exempt from taxation. FINDINGS OF FACT. Petitioner is a corporation, duly incorporated under the laws of the State of Pennsylvania, with its principal place of business located at Clearfield, Pennsylvania. It was and is engaged chiefly in the business of manufacturing and selling school supplies, and also doing general commercial printing. On March 15, 1938, the petitioner filed a timely corporation income tax return for the calendar year 1937 with the collector of internal revenue at Pittsburgh, Pennsylvania, *985 disclosing a tax liability in the amount of $3,256.93, which was paid in quarterly installments as follows: March 15, 1938 $814.24 June 14, 1938 814.24 Sept. 13, 1938 814.24 Dec. 13, 1938 814.21 The alleged interest included in income by the respondent was received by the petitioner on open accounts against various townships, boroughs, and school districts of the State of Pennsylvania. *563 The alleged interest charges were represented by invoices which petitioner rendered to the respective townships, boroughs, and school districts to which it had made sales of goods and merchandise. Typical of these invoices, which totaled $1,196.57, is invoice No. 18406, dated March 1, 1937, rendered to the Sandy Township School District, Clearfield County, Charles Lines, Secretary, DuBois, Pennsylvania, and reads as follows: We charge your account with 4% Interest as follows: $1,537.66 from 2/1-37 to 3/1-37 $5.13 374.14 893.20 1,267.34 from 8/23-36 to 3/1-37 26.47 130.35 from 9/ 1-36 to 3/1-37 2.61 11.29 11/ 1-36 to 3/1-37 .15 37.18 11/21-36 to 3/1-37 .41 27.09 11/26-36 to 3/1-37 .29 7.05 12/ 1-36 to 3/1-37 .07 71.41 11/28-36 to 3/1-37 .74 8.37 12/23-36 to 3/1-37 .06 31.00 12/31-36 to 3/1-37 .21 3.64 12/28-36 to 3/1-37 .03 2.60 1/14-37 to 3/1-37 .01 297.00 12/22-36 to 3/1-37 2.28 488.17 2/15-37 to 3/1-37 .87 39.33 We credit your account with 4% Interest as follows: 200.00 from 2/9-37 to 3/1-37 .49 $38.84 *986 Some of these invoices charged the customer with interest at the rate of 4 percent per annum and others at the rate of 6 percent. OPINION. BLACK: Petitioner contends that the alleged interest which it collected from various political subdivisions of the State of Pennsylvania is exempt from taxation under section 22(b)(4) of the Internal Revenue Code, Title 26, which is printed in the margin. 1 *987 *564 Petitioner contends that the provision of the statute in question that "Interest upon (A) the obligations of a State, Territory, or any political subdivision thereof" shall be exempt from taxation, is broad enough to include interest which a taxpayer receives on open account from a political subdivision of a state. Petitioner contends that the words "the obligations" mean not only bonds, debentures, and the like, but also open accounts, and cites in support of such contention, among other cases, Commissioner v. Meyer, 104 Fed.(2d) 155, and Kings County Development Co. v. Commissioner, 93 Fed.(2d) 33. In Commissioner v. Meyer, supra, the court affirmed the decision of the Board, and held that interest on notes issued by a municipality in connection with the purchase of land by it was exempt from tax under section 22(b)(4) of the 1934 Act, overruling the Commissioner's contention that the notes were not the kind of obligations covered by the statute because they were not executed in the exercise of the borrowing power of the municipality, like authorized bonds which are issued and sold for the purpose of*988 borrowing money. In Kings County Development Co. v. Commissioner, supra, the court reversed the Board and held that interest received in 1930 from the Tulare Lake Basin Water Storage District on deferred payments in purchase of real estate, not represented by bonds or other securities of the district, was exempt from income tax under section 22(b)(4) of the Revenue Act of 1928. The court held that Congress did not intend to limit the exemption as to interest on obligations of a state or political subdivision thereof only to interest on such obligations as are evidenced by some particular form of obligation, but that the exemption applies equally to an obligation evidenced by an ordinary written agreement of purchase and sale, in which the political subdivision agreed to pay interest. Neither of the above cited cases goes so far as to hold that interest paid by a political subdivision on an open account would be exempt from income tax because it was interest paid on an obligation of the state or political subdivision thereof. The court in *989 Commissioner v. Meyer, supra, in discussing the meaning of the word "obligations", as used in the statute, said: It is manifest that the word "obligations" in the statute was not intended to extend to every obligation which included the payment of interest but only to those obligations which were created in the exercise of the borrowing power. See Helvering v. Stockholms Enskilda Bank,293 U.S. 84, 55 S.Ct. 50, 79 L.Ed. 211. But where credit is obtained in consideration for a promise to pay money in the future, together with interest on that money, there is no valid ground for making a distinction between interest paid on bonds duly issued and interest paid on notes duly delivered. *565 Again, the court said in the concluding paragraph of its opinion, speaking of the obligation of the village of Suffern to pay interest on its notes executed and delivered to Meyer: * * * Its obligations were "issued" within the above regulations when its notes were delivered to the respondent to obtain credit on obligations incurred under its borrowing power. Such circumstances bring the interest paid on the notes within the scope of the above*990 statute and make it exempt from taxation. Kings County Dev. Co. v. Commissioner, 9 Cir., 93 F.2d 33; Norfolk Nat. Bank v. Commissioner, 4 Cir., 66 F.2d 48. In the instant case there were no promissory notes executed by the political subdivisions of Pennsylvania upon which they agreed to pay interest to the creditor, as there was in the Meyer case, nor was there any written agreement to pay interest on the deferred payments, as there was in the Kings County Development Co. case, supra. In the instant case we simply have a situation where certain townships and school districts of the State of Pennsylvania purchased certain goods and merchandise from petitioner on open account. These accounts were apparently not paid when due, whereupon petitioner sent invoices for interest to these several townships and school districts. The invoices for interest were paid to the extent of $1,196.57. Under such circumstances, we do not think it can be said that the interest was paid upon "the obligations of a State, Territory, or any political subdivision thereof" within the meaning of the statute. There is no evidence that any of these*991 townships or school districts had executed in the exercise of their borrowing power any written agreement with petitioner that they would pay interest on their past due accounts. Some of them were invoiced with interest at 4 percent per annum and some were invoiced with interest at 6 percent per annum. This difference in interest rate is not explained. There is no evidence that this was done pursuant to any written agreement between petitioner and the respective debtors but was done according to the decision of petitioner. The word "obligations" as used in the statute, we think, means some kind of a written instrument executed by the state or a political subdivision thereof, in the exercise of its borrowing power. The statute was intended to exempt from taxation interest paid upon such an obligation. For the reason that the evidence does not show that the alleged interest involved in this case was paid pursuant to obligations executed and delivered by the respective political subdivisions in the exercise of their borrowing power, we hold that the amount in question is not exempt from taxation. Decision will be entered for respondent. Footnotes 1. (4) TAX-FREE INTEREST. - Interest upon (A) the obligations of a State, Territory, or any political subdivision thereof, or the District of Columbia; or (B) obligation of a corporation organized under Act of Congress, if such corporation is an instrumentality of the United States; or (C) the obligations or the United States or its possessions, * * * In the case of obligations of the United States issued after September 1, 1917 (other than postal savings certificates of deposit) and in the case of obligations of a corporation organized under Act of Congress, the interest shall be exempt only if and to the extent provided in the respective Acts authorizing the issue thereof as amended and supplemented, and shall be excluded from gross income only if and to the extent it is wholly exempt from the taxes imposed by this title. ↩