First Nat'l Bank of Lawrence Cnty. v. Comm'r of Internal Revenue

• Decision Date: 24 January 1951
• Docket Number: Docket No. 24005.
• Citation: 16 T.C. 147
• Parties: FIRST NATIONAL BANK OF LAWRENCE COUNTY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

16 T.C. 147

FIRST NATIONAL BANK OF LAWRENCE COUNTY, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 24005.

Tax Court of the United States.

Promulgated January 24, 1951.

Prior to the taxable year petitioner, a bank, had charged off with tax benefit to a certain extent, certain corporate bonds held by it; and in the taxable year the bonds were redeemed and the petitioner recovered more than its basis, including the amount charged off with tax benefit. Held, that to the extent of the tax benefit the recovery was taxable as ordinary income and not capital gain and that the recovery above petitioner's basis in the bonds is capital gain. John A. McCann, Esq., for the petitioner.

Kalman A. Goldring, Esq., for the respondent.

OPINION.

DISNEY, Judge:

This case involves income tax for the calendar year 1944. Deficiency was determined in the amount of $4,347.45. The petitioner claims overpayment of $5,652.47. The only question presented is whether the sum of $58,117.73, received in the taxable year by the petitioner from retirement of bonds, after the bonds had been charged off, with tax benefit, in previous years, is taxable as ordinary income or capital gain. All facts were stipulated and are found by us as so stipulated. Only such as are regarded as necessary of statement in discussion of the issue will be set forth here.

The petitioner is a national banking corporation doing business at New Castle, Pennsylvania. Its Federal income tax return for 1944 was filed with the collector of internal revenue at Pittsburgh, Pennsylvania. Petitioner in 1935 acquired 6 per cent bonds of Pennsylvania Engineering Works in the face amount of $179,000. Petitioner's basis therein was $170,050. In 1936 petitioner received similar additional bonds of Pennsylvania Engineering Works of a face value of $5,500 in lieu of interest on bonds held. Petitioner reported the fair market value, $5,225 as interest income for 1936 and paid income tax thereon. From 1936 through 1941 petitioner charged off and deducted, as worthless debts, on income tax returns its entire cost basis in the bonds, i.e., $175,275. It received no tax benefit as to $81,057.27 but the charge-offs and deductions, to the extent of $94,217.73, did result in reduction of petitioner's taxes.

The bonds acquired in 1935 were acquired in a transaction set forth in the excerpts of minutes of petitioner's board of directors, as follows: Prior to April 2, 1934, petitioner held the collateralized promissory note of Pennsylvania Engineering Works for $165,000, and on that date Pennsylvania Engineering Works was authorized by petitioner to execute a collateral note for $165,000, for the former note, and to pledge interim certificates for the approximate amount of bonds the bank had agreed to take if a bond issue was consummated, the note to be secured also by various collateral. On April 9, 1934, petitioner's directors authorized acceptance of the endorsement of Pennsylvania Engineering Corporation on the collateral note of Pennsylvania Engineering Works as stated in the minutes of April 2, 1934. On June 24, 1935, petitioner's directors approved the purchase of various bonds including $179,000 of Pennsylvania Engineering Works. On July 8, 1935, petitioner's directors approved an agreement subscribing for, and agreeing to accept Pennsylvania Engineering Works bonds at 95 per cent of face value ‘in payment of the principal of the indebtedness and obligation of Pennsylvania Engineering Works‘ to petitioner, and agreeing that upon delivery of the bonds the obligation, interim certificates and all collateral held should be surrendered to Pennsylvania Engineering Works. Petitioner's note record shows the note of $165,000, dated May 16, 1934, and paid, in the amount of $165,000, on June 19, 1935. Petitioner's collateral loan record shows the note as withdrawn by Pennsylvania Engineering Works. Petitioner's discount record for demand collateral loans shows entry of payment of the $165,000 note under date of June 19, 1935. Petitioner's daily journal for June 19, 1935, shows the transactions involving the note and bonds, and petitioner's bond register shows the history of the bonds from acquisition until written off.

In 1944 the issuer of the bonds redeemed and retired a part of the bonds held by petitioner in the face amount of $146,500, and redeemed and retired the balance in 1945.

The $146,500 exceeded, by $7,325, the original cost, $139,175, of the bonds so retired. The $139,175 had been written off in prior years by petitioner.

The petitioner and respondent agree that of the $139,175 basis recovered $81,057.27 constitutes recovery exclusions (section 22(b)(12), Internal Revenue Code) and that this controversy relates entirely to the proper income tax treatment of the $58,117.73, the balance of the recovery of the $139,175 basis, and petitioner's claim for overpayment.

Petitioner treated $43,654.73 of the amount recovered in 1944 as ordinary income on its income tax return, but claims an overpayment by reason thereof in the amount of $5,652.47. The respondent agrees with the petitioner that the $7,325 excess of $146,500 over the $139,175 basis is capital gain, but treated $58,117.73, previously charged off with tax benefit, as ordinary income. The petitioner contends that it also is capital gain.

The petitioner's argument is, in short, that the amounts received in 1944 fall squarely within the language of section 117(f) of the Internal Revenue Code. ¹ The statute, petitioner argues, is clear and admits of no change by interpretation or construction, which would be to legislate. Tax statutes, it is argued, cannot be extended beyond clear import of the language used, and if clear, plain, and unambiguous may not be construed to cover what is deemed to be even an absurd omission, through addition by the Court of any further limiting provision.

The respondent in substance argues that section 117(f), relied on by the petitioner, does not apply; that a particular statutory provision prevails over a general one; that banks are treated differently from others in deduction of losses and recovery of debts previously written off; that section 117(i) specifically deals with banks and provides that a net loss from sale or exchange of bonds shall not be considered sale or exchange of a capital asset; that here there was no sale and the entire amount written off in prior years was collected; that the bonds evidence a loan and not an investment because they were received in exchange for a previous promissory note with collateral security, of the same debtor, the bonds thus representing a continuance of the previous loan, so that the payment of the bonds in the taxable year was nothing more than a payment of a loan, the excess of payment over principal being interest. To respondent's arguments the petitioner replies, in effect, that respondent errs in contending that there was continuation of old loan in the bonds and that the petitioner's records show that the bonds were purchased, the collateral was drawn and petitioner had after the transaction a different asset, a bearer bond, a long term obligation with coupons attached. Petitioner also argues that respondent has admitted that the bonds are capital assets by recognizing that $7,325 received by petitioner in excess of its basis is capital gain; that respondent has omitted section 117(c) and (d), and that petitioner agrees that a particular provision takes precedence over a generality but that section 117(i) is particular, taking precedence over section 117(d), and section 117(f) is a special provision taking precedence over any other general provision. The cases cited by the respondent, petitioner says, do not involve redemption of bonds and assets not defined as capital assets.

The crux of petitioner's view is based upon section 117(f). We have analyzed this statute, as well as the others involved, and the interesting question raised, with care, and we cannot agree with the petitioner that section 117(f) is altogether unambiguous in requiring the conclusion desired by petitioner, that is, that amounts received from the retirement of bonds are capital gains. The section does not so state. It says nothing as to capital gain. It merely says that the amounts received by the holder upon bond retirement ‘shall be considered as amounts received in exchange therefor. ‘ Every exchange however does not result in capital gain. Such result requires an exchange of capital assets— which section 117(f), at least does not so denominate the bonds. Unless the amount is received in exchange for a capital asset, the income is ordinary. Obviously, we think, the section clearly requires interpretation before any conclusion can be reached that the gains from bond retirement are capital in nature, for we must first inquire whether the bonds, in this case were capital assets. This point the petitioner assumes. We cannot so do. Even if there is retirement (and the parties so agreed) and even if there was exchange (and the section supplies that element), it must still be demonstrated before we can arrive at the capital gains desired by the petitioner that capital assets were exchanged. It is obvious that bonds are not always capital assets for in the hands of one who held bonds primarily for sale to customers in the ordinary course of his trade or business, they would, as is clear from section 117(a)(1)(A), be excluded from the definition of ‘capital assets‘. We are therefore required in logic to examine the instant situation to see whether there is justification for the assumption that capital assets were exchanged, resulting therefore in capital gain.

What then was the nature of the bonds which were retired in 1944 as to whether they are capital assets or otherwise. It is true that under section 117(a)(1) the term ‘capital assets‘ means ‘property held by the taxpayer‘ with certain exceptions, but under the ordinary rule of...