DocketNumber： No. 390-74
Judges： Bennett, Nichols, Skelton
Filed Date： 3/23/1977
Status： Precedential
Modified Date： 11/4/2024
delivered the opinion of the court:
The stipulation of facts is relatively short and rather than attempt to summarize its contents, we deem it advisable to reproduce it in full, minus exhibits, so that all facts agreed upon may appear in this opinion. The stipulation of facts, which describes the nature of this controversy, is as follows:
It is hereby stipulated and agreed by and between the parties hereto, by their respective attorneys, that for the purposes of this case only the following facts shall be taken as true and that such facts, together with the appended exhibits, which are submitted to show the agreed contents of such documents, represent all of the facts necessary for the Court’s disposition of this matter. No further proof is to be offered by either party.
1. Plaintiff is a national banking corporation having its only office in Waco, Texas. As a national bank, plaintiff offered a full line of commercial banking services during the years in question, 1968 and 1969. During 1968 and 1969, the approximate loan limit of the plaintiff was $800,000, or 10 percent of its capital and surplus accounts under applicable banking regulations.
2. American Amicable Life Insurance Company (American Amicable) is a life insurance company having its principal office in Waco, Texas. The principal office of American Amicable is located approximately one-half block from the office of the plaintiff in Waco, Texas.
4. American Amicable annually published financial statements which were kept on file by the plaintiff at its office. Plaintiffs president during the years in question, Walter G. Lacy, was a stockholder and a former director of American Amicable.
5. During 1968 and for many years prior thereto, American Amicable maintained a substantial investment in municipal bonds issued by various municipalities and school districts of the State of Texas. These Texas municipal bonds were purchased by American Amicable primarily as long-term investments to obtain the benefit of tax-exempt interest from the bonds. American Amicable periodically purchased these bonds at the then current market price through various brokerage firms in Waco, Texas. These brokerage firms presented to the officers of American Amicable comprehensive background information on the bonds including the credit standing of the issuing municipality, the coupon or stated interest, the current yield, the yield to maturity, the net yield, the par amount of the bonds, and the then present market price of the bonds. American Amicable also occasionally sold the Texas municipal bonds at the then current market price through brokerage firms in Waco, Texas.
6. Plaintiff, acting through its president, Walter G. Lacy, similarly at various times purchased municipal bonds issued by various municipalities and school districts of the State of Texas in prior years and during 1968. These Texas municipal bonds were purchased at the then present market price by the plaintiff primarily for short-term investment from various brokerage firms in Texas. Plaintiff confined its acquisition of Texas municipal bonds to maturity periods of less than 10 years, and it generally
7. At all relevant times, American Amicable was a subsidiary company of the parent holding corporation, Great American Corporation. E. Grant Fitts, the chief executive officer of Great American Corporation, exercised effective control over the management of American Amicable. Shortly before May 22, 1968, Mr. Fitts made a commitment on behalf of American Amicable to purchase $5,000,000 in notes issued by the LTV Corporation. This commitment was made by Mr. Fitts without prior consultation with Franklin Smith, the then president of American Amicable. After making the commitment, Mr. Fitts informed Mr. Smith that it had been made. Mr. Smith notified Mr. Fitts that American Amicable did not have sufficient cash to meet the commitment deadline. As the superior of Mr. Smith, Mr. Fitts insisted that American Amicable obtain the money to honor its commitment. Mr. Fitts told Mr. Smith to obtain the cash for American Amicable by selling its stocks or bonds.
8. Because of the close banking relationship between American Amicable and the plaintiff, Mr. Smith met with Mr. Lacy, president of the plaintiff, and informed him that American Amicable needed cash to fulfill its commitment to purchase notes or debt obligations of the LTV Corporation. As president of American Amicable, it had been Mr. Smith’s policy not to borrow money on behalf of American Amicable. Mr. Smith stated to Mr. Lacy that he did not want a loan; he wanted to sell a block of municipal bonds held by American Amicable to the plaintiff for cash. Mr. Smith and Mr. Lacy agreed that American Amicable would transfer to the plaintiff various municipal bonds issued by political subdivisions of the State of Texas with a total par value in the amount of $2,227,000 plus accrued interest, and that plaintiff would furnish American Amicable with
9. In a letter of May 22, 1968, from Mr. Smith, president of American Amicable, to Mr. Lacy, president of the plaintiff, Mr. Smith stated as follows:
In accordance with our conversation and agreement, this Company is currently selling to your bank a group of Texas Municipal Bonds at par value plus accrued interest. These bonds have an average coupon rate of 4.74 per attached list.
In connection with this sale and additional sales, this Company guarantees to repurchase these Bonds on the same basis upon demand from your bank.
In tabular form, Mr. Smith listed on the attachment to his letter the Texas municipal bonds with their par value, coupon or stated interest rate, annual interest, year or years of maturity, and the months in which the bond interest would be paid.
10. According to Mr. Lacy, he insisted that American Amicable be committed to reacquire these Texas municipal bonds at the same par amount plus accrued interest upon demand of the plaintiff because of the plaintiffs concern with liquidity. Since many of the deposits with commercial banks can generally be withdrawn upon demand by their depositors, commercial banks must constantly be aware of their obligations to pay cash upon the request of the depositors. Commercial banks, therefore, are required to maintain a substantial portion of their assets in cash or in
11. Under its commitment to reacquire the Texas municipal bonds at the same par value amount upon demand of the plaintiff, American Amicable incurred the risk of loss if the market price of the municipal bonds was less than the total par amount of the bonds. While there was no discussion or agreement among the parties as to the remedy of the plaintiff in the event of a highly improbable default by American Amicable under its bond reacquisition commitment, the plaintiff was fully aware that it had an enforceable obligation against American Amicable.
12. Plaintiff entered into this transaction with American Amicable because of the attractive average overall coupon interest rate of 4.74 percent on the Texas municipal bonds. In 1968, plaintiff was in the 52-percent corporate income tax bracket, and its average annual interest rate charged on commercial loans at that time was 8 percent. Assuming that the coupon interest on the Texas municipal bonds would be tax-exempt income for the plaintiff, the net yield to the plaintiff after income taxes would be approximately 9-yz percent, or a much more favorable return than its taxable 8-percent interest return on loans to corporate borrowers.
13. On or about May 22, 1968, American Amicable actually transferred to the plaintiff municipal bonds issued by various Texas municipalities and school districts with a total par amount of $2,227,000, plus accrued interest, and plaintiff transferred cash in the amount of $2,227,000, plus accrued interest, to the account of American Amicable.
15. As of May 22, 1968, American Amicable was highly solvent, and there was no reasonable probability that it would be unable to fulfill its commitment to reacquire the Texas municipal bonds at the same par amount upon demand by the plaintiff. Both the plaintiff and American Amicable anticipated when the plaintiff acquired the municipal bonds that American Amicable would rapidly reacquire these bonds as permitted by its cash flow. At the aforementioned meeting between Mr. Smith and Mr. Lacy, Mr. Smith notified Mr. Lacy that American Amicable would reacquire these Texas municipal bonds as fast as it could justify, depending upon its normal cash flow. American Amicable wanted to reacquire these municipal bonds because they represented a good, safe investment with a tax-exempt interest yield. In reply, Mr. Lacy explained to Mr. Smith that the plaintiff was entering into the transaction based upon the overall, average coupon interest rate of 4.74 percent on the bonds. Consequently, he expected American Amicable to keep this overall average coupon interest rate intact as it reacquired the bonds. Plaintiff would have strongly objected if American Amicable had proceeded to initially reacquire the higher coupon interest bonds and thereafter reacquire the smaller coupon interest bonds. American Amicable reacquired the municipal bonds in an equitable manner with respect to the maintenance of the average overall coupon interest rate.
16. Plaintiff never made a demand upon American Amicable to reacquire the Texas municipal bonds in question. As permitted by its cash flow, American Amicable throughout 1969 regularly reacquired these municipal bonds by making requests for reacquisition of such bonds to the plaintiff by telephone or in person. Although there was
17. The last two municipal bonds held by the plaintiff were reacquired by American Amicable on December 11, 1969. As American Amicable reacquired these municipal bonds, the only necessary computation for the parties was the calculation of accrued interest because the par value of the bonds was the same.
18. The transaction in question between the plaintiff and American Amicable furnished financial assistance to American Amicable by making available cash needed to purchase the notes of the LTV Corporation.
19. Although Mr. Smith and Mr. Lacy believed that the plaintiff was free to sell or otherwise dispose of these bonds to parties other than American Amicable, the plaintiff made no effort to dispose of these bonds. The plaintiff merely held these bonds until reacquired by American Amicable and collected the interest income from the bonds.
20. During 1968, the plaintiff collected interest on the Texas municipal bonds in the amount of $40,287.25. During 1969, the plaintiff collected interest from the Texas municipal bonds in the amount of $64,250.48.
21. On its federal income tax returns for the years 1968 and 1969, the plaintiff treated such interest as tax-exempt income which it excluded from its gross income under Section 103(a)(1) of the Internal Revenue Code of 1954. On audit, the Commissioner of Internal Revenue, among other adjustments, included in plaintiffs gross income for the years 1968 and 1969 the interest income collected by the plaintiff from the municipal bonds in question.
22. The Commissioner determined income tax deficiencies against the plaintiff for the years 1968 and 1969.
23. Plaintiff paid an income tax deficiency of $30,292.75, plus assessed interest in the amount of $5,577.18, for a total of $35,869.93 on May 16, 1972, with respect to its calendar year 1968, and plaintiff paid an income tax deficiency of $61,586.40, plus assessed interest in the amount of $7,623.21, for a total of $69,209.61 on May 16, 1972, with respect to its calendar year 1969.
25. If the plaintiff should prevail in its contention that its transaction of May 22, 1968, with American Amicable constituted a bona fide sale rather than a secured loan for tax purposes, the amounts of income tax and deficiency interest to be refunded to the plaintiff, which are attributable to inclusion in its gross income of the interest income from the municipal bonds, will be computed in proceedings under Rule 131(c).
The defendant contends that the transfer of the bonds by American Amicable (Amicable) to the Bank was not a sale but was a loan made by the Bank to Amicable to either purchase or carry the bonds, which were held as collateral by the Bank to secure the loan, all of which resulted in a double tax exemption prohibited by Section 265 of the Internal Revenue Code of 1954, which provides as follows:
§ 265. Expenses and interest relating to tax-exempt income.
No deduction shall be allowed for—
* * * * *
(2) Interest.
Interest on indebtedness incurred or continued to purchase or carry obligations * * * the interest on which is wholly exempt from the taxes imposed by this subtitle. [26 U.S.C. § 265 (1970)]
Defendant contends further that in collecting the interest from the issuing municipalities, the Bank was acting as the agent of Amicable.
The defendant also argues that there was an agreement between the parties (by implication) that the Bank was required to resell the bonds to Amicable at any time that Amicable requested it.
§ 103. Interest on certain governmental obligations.
(a) General rule.
Gross income does not include interest on—
(1) the obligations of a State, a Territory, or a possession of the United States, or any political subdivision of any of the foregoing, or of the District of Columbia;
* * * * *
[26 U.S.C. § 103(a)(1) (1970)]
The main issue to be decided is whether the transaction was a sale or a loan. We have concluded that it was a sale. Counsel for the government has made an ingenious argument that it was a loan, however,' the facts do not support his loan theory, but point the other way. It occurs to us that defendant’s loan theory is just a "theory” that is based largely on speculation, surmise, inference and what might have been the situation, assuming certain vital facts existed. There were too many material facts, some present and some lacking that show the transaction was not a loan. Many of them, some of which overlap, may be listed as follows:
1. There was no debt, existing or created, due by Amicable to the Bank.
2. No note or written evidence of debt existed.
4. No date for the payment of money or repurchase of the bonds existed.
5. There was no mortgage or pledge agreement of the bonds by Amicable to the Bank.
6. No evidence existed that Amicable pledged the bonds as collateral for any kind of loan.
7. There was no provision for default or foreclosure if Amicable did not repurchase the bonds.
8. The president of Amicable stated in the beginning he did not want a loan, but wanted to sell the bonds to the Bank.
9. The transaction was in the form of an outright sale.
10. Amicable was the owner of the bonds when the transaction occurred.
11. The Bank did not advance money to Amicable to buy the bonds from the issuer.
12. The Bank did not buy the bonds from the issuing authority for the account of Amicable.
13. The Bank did not hold the bonds for the account of Amicable, but for its own account as its own property.
14. The Bank did not advance money to Amicable to carry the bonds, as the Bank was not required to resell the bonds to Amicable on demand or otherwise.
15. The Bank collected the interest from the municipalities for its own account and not as agent of Amicable.
16. In collecting the interest on the bonds, there is no evidence whatever that the Bank acted as agent of Amicable. No agency agreement existed.
17. The Bank never accounted to Amicable for interest it collected from the municipalities, nor was it required to do so.
18. Amicable never paid the Bank any interest whatever, except accrued interest on the bonds at the time of repurchase, which is customary in financial circles when bonds are purchased.
19. The Bank never requested Amicable to repurchase the bonds, even though it could have done so.
20. The Bank had the right to sell the bonds to third parties and retain any profit made on such sale as its own property.
21. There is no evidence that Amicable made any entry on its books that it owned the bonds or that it owed the Bank anything on the bonds after they were transferred to the Bank. If its books and records were not correct in this regard, it would no doubt have been in violation of the insurance laws of Texas.
23. Amicable did not deduct any interest on the tax-exempt bonds from its income tax during the time they were owned by the Bank.
Defendant relies on the decisions in American National Bank of Austin v. United States, 421 F.2d 442 (5th Cir. 1970), cert. denied, 400 U.S. 819; First American National Bank of Nashville v. United States, 467 F.2d 1098 (6th Cir.1972); Union Planters National Bank of Memphis v. United States, 426 F.2d 115 (6th Cir. 1970), cert. denied, 400 U.S. 827, to support its position. These cases involve different facts, are distinguishable from the instant case, and do not control our decision, as will be shown below. The cases called to our attention that have been decided in this area of the law are the following: American National Bank of Austin, supra; First American National Bank of Nashville, supra; Union Planters National Bank of Memphis, supra; Third National Bank in Nashville, 71-1 USTC 9248 (1971); First National Bank in Wichita v. Commissioner, 57 F.2d 7 (10th Cir. 1932), cert. denied, 287 U.S. 636; Brown-Crummer Co., 19 B.T.A. 750 (1930), petition dismissed on motion of the Commissioner, 63 F.2d 996 (1933); Commissioner v. Bank of California Nat. Ass’n., 80 F.2d 389 (9th Cir. 1935), aff’g, 30 B.T.A. 556; and Commissioner v. Wells Fargo Bank & Union Trust Co., 80 F.2d 390 (9th Cir. 1935), aff’g, B.T.A., Memo Docket Nos. 49880, 63038.
The Fifth Circuit Court of Appeals pointed out in American National Bank of Austin, supra, at 445, that the decided cases on sale-repurchase agreements of municipal bonds announce various criteria for determining where ownership of bonds reside in these situations, and while they are helpful, no single criterion is controlling. We agree that this question must be decided on the facts in each case and that is the procedure we follow in the instant case. The court in the above case decided against the bank and held that the transactions were loans and not sales. However, the facts in that case were vastly different to those in the instant case. There, various bond dealers bid on municipal bonds and in many cases sold the bonds to
The Union Planters National Bank of Memphis, supra, is also distinguishable from the case before us. That case, like the American National Bank of Austin, supra, involved transactions between the bank and bond dealers. In fact, the court stated that many dozens of transactions were involved (see 426 F.2d 115, n. 3 at 117). The facts in that case show that the bank would purchase bonds from dealers under agreements that the bank could require the dealers to repurchase the bonds at any time without loss to the bank. The district judge also found that the dealers
* * * It is clearly more consistent with the characterization of these transactions as loans than as sales [426 F.2d at 117.]
During the times the bank held the bonds, it collected the interest due thereon from the issuing authorities and excluded it as tax-exempt interest in its income tax. The court held this to be improper, as the transactions had no economic substance as sales, but were in fact loans. It should be pointed out that this practice continued over a period of several years and involved many dozens of transactions, with the obvious result that the bank was advancing money to the dealers to finance their purchases and sales of bonds to the general public and that the bank held the bonds for the account of the dealers and subject to their order and that the money advanced by the bank was in fact loans to the dealers to carry on their bond business. No such facts exist in the case at bar.
Bond dealers were also involved in First American National Bank of Nashville, supra. We think that case is also distinguishable from the case before us. There the transactions that were involved, other than certain transfers to trust accounts not material here, were of two categories as follows: "(1) Instead of purchasing municipal bonds for which they had successfully bid, certain bond dealers orally agreed with appellant that the bank would buy the bonds from the issuers and later sell them to the
The court, relying on the American National Bank of Austin case and the Union Planters National Bank of Memphis case, discussed above, held that the transfers to the bank were not sales, that the bank advanced and loaned money to purchase the bonds and held the bonds until redeemed in connection with loans instead of sales. It appears from these facts that as to the first category the bank furnished money to purchase the bonds from the issuer which runs afoul of Section 265(2) of the Code so as to deny tax-exemption to the bank as to interest on the bonds. It is not clear whether the bank furnished money to purchase the bonds from the issuer in the second category, but in any event, the bank furnished money to the bank’s customers to carry the bonds, which prevents the interest from being tax-exempt under Section 265(2) of the Code. None of these facts exist in the instant case.
Other cases cited by defendant are Third National Bank in Nashville v. United States, 27 Am. Fed. Tax R.2d 71-818 (M.D. Tenn. 1971), and First National Bank in Wichita v. Commissioner, 57 F.2d 7 (10th Cir. 1932), both of which also involve the financing by banks of bond dealers in the sale of bonds and are distinguishable from the instant case in much the same way the preceding cases have been distinguished. It is significant that the cases relied on by defendant all involve the financing of bond dealers by banks in connection with the sale of tax-exempt bonds to the general public. This contrasts with the instant case where we have a single isolated transaction where no one is involved except Amicable and the Bank. The deal
The Bank cites Commissioner v. Bank of California, 80 F.2d 389 (9th Cir. 1935), aff’g, 30 B.T.A. 556, and Commissioner v. Wells Fargo Bank & Union Trust Co., 80 F.2d 390 (9th Cir. 1935), aff’g, B.T.A., Memo Docket Nos. 49880, 63038 in support of its position. In the Bank of California case, the bank bought certain tax-exempt bonds by bills of sale, absolute on their face, purporting to transfer and assign the bonds to the bank at the prices specified therein. The bank collected the interest on the bonds and deducted it from its income tax as exempt income. The Commissioner of Internal Revenue contended that although, in form, the transactions were purchases and sales of bonds, they were intended to be, and were in fact, loans of money by the bank to the seller, secured by a pledge of the bonds and that the bonds never were, in fact, the property of the bank, and that the bank was not entitled to deduct the interest from its gross income. The bank contended that it purchased the bonds and became the owner thereof and, consequently was entitled to treat the interest on the bonds as tax-exempt income. The Board of Tax Appeals upheld the bank (30 B.T.A. 556) and the Commissioner appealed. On appeal, the Ninth Circuit Court of Appeals affirmed the Tax Court, saying:
* * * The Board found that the transactions referred to were actual purchases, not loans of money secured by pledge, and that the bonds belonged to and were the property of respondent. [The bank.] This finding is*253 supported by substantial evidence and is, therefore, conclusive. [Cases cited.] [80 F.2d at 390.]
In the Wells Fargo case, the Ninth Circuit Court stated:
The question presented in this case is identical with that presented in Commissioner v. Bank of California (C.C.A.) 80 F. (2d) 389, decided this day. What we said in that case is applicable here. [80 F.2d at 390.]
The defendant attacks these cases as being old and out of date and not in step with more modern decisions of the Supreme Court that hold that economic substance of a transaction controls instead of the form of the transaction. This argument is unpersuasive in the instant case, because we hold that the sale of the bonds to the Bank had economic reality and substance.
The Bank points to Rev. Rul. 74-27, 1974-1 C.B. 24 as supporting its position. That ruling, says the Bank, lists conjunctively the factors that must be present in a sale-repurchase agreement in order for the transaction to be a loan instead of a sale, as follows: The seller could require the bank to resell; the bank could require the seller to repurchase; a definite remedy was provided in the event of default of either party; the seller agreed to pay interest at a stipulated rate on the funds advanced by the bank; and the value of the securities sold did not necessarily equal the amount advanced by the bank. The Bank contends that all of these features must be present in the agreement in order for the transaction to be a loan, and says that only two were present,- namely (1) agreement of the seller to repurchase, and (2) want of equality of purchase price and market value of the bonds. Three of the listed features are not present says the plaintiff, which are: (1) agreement of the bank to resell, (2) payment by the seller of specified interest on the amount paid, and (3) agreed remedies in case of default. The plaintiff argues that since all of the listed features are not present, the ruling supports the Bank’s contention that the transaction was a sale and not a loan.
Defendant counters with the argument that the ruling was grounded upon the economic realities of the underlying transaction and that the policy of the Internal Revenue
* * * As frequently happens, however, where federal tax issues turn on the essential nature of a particular transaction, this case involves some indicia pointing each way. * * * [Id. at 18.]
( At the same time, plaintiffs counsel was frank enough to say in his brief:
* * * While the repurchase agreement in the present case contains some of the listed features [in the Ruling], it lacks others. [Id. at 14.]
The court commends counsel for both parties for their candor and forthrightness to the court and to each other in conceding that there are certain facts in the case before us that are favorable to each of the parties. It is now our duty to sift the facts and decide which predominate and control.
The Bank places great emphasis on the fact that it was not required to resell the bonds to Amicable, but could sell them to a third party and keep the profit, if any, due to market value if it desired to do so. The defendant says there was an "implied” agreement that the Bank could be required to resell the bonds to Amicable. This argument is unpersuasive because there is no evidence to support it. We conclude that the Bank was not required to resell the bonds to Amicable. This is a very important fact in this case. It tends to prove and indicates that the Bank was the owner of the bonds and could keep them to maturity or sell them to Amicable or anyone else. Also, this circumstance shows that the Bank did not advance money to Amicable to carry the bonds.
Defendant says that the Bank insulated itself from loss by providing that Amicable would repurchase the bonds at par value on demand. While this arrangement did insulate the Bank from loss, there is no evidence that this was the reason for this provision. Rather, the stipulation of facts (paragraph 10) shows that the Bank wanted to keep itself
The defendant makes a point that the sale and resale of the bonds were made at par value without regard to their market value. However, there was no proof of the market value of the bonds at any time. If market value was material to defendant’s claim, it had the burden of showing such value and its materiality. Having failed to discharge this burden, we must assume that such value was not material to any issue in this case.
While we have no doubt as to the meaning of the provisions of the Code involved here as applied to the facts of this case, should there be any doubt it must be resolved in favor of the taxpayer. See Porter v. Commissioner, 288 U.S. 436, 442 (1933); United States v. Merriam, 263 U.S. 179, 188 (1923); and Luzier’s, Inc. v. Nee, 24 F.Supp. 608, 610 (W.D. Mo. 1938).
We hold that the transaction involved in this case was a sale, with economic substance, of the bonds by Amicable to the Bank and not a loan made by the Bank to Amicable to purchase the bonds from the issuer or to carry the bonds, and that there was no double tax exemption in the case. We hold further that the Bank as owner of the bonds was entitled to collect the interest from the issuer and deduct it from its gross income under Section 103(a)(1) as tax-exempt income.
Conclusion
Judgment is entered for the plaintiff against the defendant for the recovery of the deficiency assessment and interest thereon in connection with the bonds in question, together with statutory interest until paid. The case is remanded to the trial judge for a determination of the amount of income tax and deficiency interest to be
It has been agreed between the parties that if the plaintiff prevails in this action the amount of its income tax recovery and assessed interest, plus statutory interest will be computed in proceedings under our Rule 131(c).
This circumstance is not present in the instant case.