The Michigan Department of Veterans of Foreign Wars must pay taxes on part of the income earned from selling Christmas cards to members, the U.S. Tax Court has ruled.

Siding with the Internal Revenue Service, the court held that the VFW, which is normally exempt from tax, was subject nevertheless to a special tax on unrelated business income.

The court concluded that the annual Christmas card drive was a trade or business, that it was regularly carried on in competition with commercial suppliers and that the card project was unrelated to the VFW's reason for being tax-exempt.

The ruling, made public yesterday, was the latest attempt by the courts to interpret the "unrelated business income tax."

A House Ways and Means subcommittee last week concluded five days of hearings in which commercial businesses claimed the tax was being applied so loosely that their operations were suffering at the hands of a variety of tax-exempt organizations, ranging from the YMCA to major colleges.

The Michigan VFW contended that its annual sale of Christmas cards to members was merely a means of requesting additional voluntary dues; that there was no unfair competition with a commercial enterprise, and that the project was "substantially related to the petitioner's {VFW's} exempt purpose of promoting comradeship amongst petitioner's members." The dispute covered the years 1974-76.

Each year, VFW contracted with a card company to mail a box of cards to each member, along with a letter urging the recipient to send $2 (in 1974) or $3 (in 1975 and 1976).

Although federal law says a recipient of such unsolicited mail has no obligation to pay, the letter said the cards "should not be considered unsolicited."