Parnell v. United States, Civ. A. No. 2292

• Decision Date: 29 October 1958
• Docket Number: 2452.,Civ. A. No. 2292
• Citation: 187 F. Supp. 576
• Parties: Riley L. PARNELL et ux., Plaintiffs, v. UNITED STATES of America, Defendant. J. H. REED, Jr., et ux., Plaintiffs, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — Middle District of Tennessee

187 F. Supp. 576

Riley L. PARNELL et ux., Plaintiffs, v. UNITED STATES of America, Defendant.

J. H. REED, Jr., et ux., Plaintiffs, v. UNITED STATES of America, Defendant.

Civ. A. Nos. 2292, 2452.

United States District Court M. D. Tennessee.

October 29, 1958.

William Waller, Sr., of Waller, Davis & Lansden, Nashville, Tenn., for plaintiffs.

Fred Elledge, Jr., U. S. Atty., Nashville, Tenn., and Leo M. McCormack, Tax Division, Dept. of Justice, Washington, D. C., for defendant.

WILLIAM E. MILLER, District Judge.

1. Plaintiffs in each of these cases, which were consolidated because they involve the same legal question, seek the recovery of alleged overpayments of income taxes with interest. The year involved in the Parnell case was 1952. The year involved in the Reed case is 1954. In each case the plaintiffs, in computing their income taxes, claimed as a deduction for amortizable bond premium the difference between the cost of bonds purchased by them and the lower of two alternative prices at which the bonds might be called prior to their maturity. The entire premium was deducted in the year of purchase because the bonds were callable at either the regular call price or the special call price on thirty days published notice, and the bonds were purchased more than thirty days before the end of the year. The statute involved in the Parnell case is Section 125, Internal Revenue Code of 1939, 26 U.S. C.A. § 125. The statute involved in the Reed case is Section 171, Internal Revenue Code of 1954, 26 U.S.C.A. § 171. The Parnell case involves First Mortgage Bonds, 3¾% Series, due June 1, 1981, of Appalachian Electric Power Company, dated June, 1951, which were purchased by the plaintiff, Riley L. Parnell, on September 23, 1952. The Reed case involved Georgia Power Company First Mortgage Bonds, 3 3/8 % Series, due 1977, dated December 1, 1947, which were issued in 1947 and purchased by plaintiff, J. H. Reed, Jr., on October 29, 1954. In each case the Commissioner of Internal Revenue disallowed a part of the deduction on the theory that the regular call price of the bonds should have been used rather than the special call price in determining the amount of amortizable bond premium. The regular call price of the Appalachian bonds effective in September, 1952, at the time they were purchased by plaintiff, Riley L. Parnell, was the principal amount plus 5 5/8 % and the special call price was the principal amount plus 2 3/8 %.

2. It has long been customary for corporate bonds to contain provisions whereby they may be called or redeemed prior to maturity at descending scales of call prices specified in the indenture. The so-called regular call price is usually higher than the so-called special call price. This is because the purpose of the general call price is to permit the borrowing company to refinance the indebtedness at a lower interest rate or on better terms. Investors whose bonds are called for this purpose must obtain other investments, and a so-called penalty is provided to compensate them for the lower interest rate they will obtain. This penalty also serves to discourage the borrower from refinancing merely because of a slight change in interest rates. The special call price, on the other hand, is for the purpose of permitting the borrowing company to utilize, in retiring indebtedness, cash generated from operations and paid into sinking funds and similar funds, according to specified formulae, as well as cash derived from the sale of properties, insurance proceeds, etc. A corollary purpose is to protect the bondholders' security by requiring the aggregate indebtedness to be reduced before maturity, unless additions are made to the mortgaged properties to compensate for the failure to reduce the indebtedness. There are innumerable variations in bond indentures with respect to the conditions under which bonds must be or may be called at the special call prices. It is frequently required that a certain per cent of the original indebtedness be called each year at the special call price out of a sinking fund (or other fund) required to be set aside for that purpose. The company is frequently authorized to tender bonds into the sinking fund (or other fund) in lieu of cash. If cash is deposited, it may customarily be used to purchase bonds if available at a price lower than the special call price. The company may also be permitted to certify property additions to the trustee in lieu of cash, or to withdraw cash against certification of property additions. In any such event, the property additions may not thereafter be used as the basis for issuing additional bonds, as would otherwise be permitted. Cash not used for these purposes must be used to call bonds. Provisions of this type are customary in public utility bond indentures.

3. Section 20 of the supplemental indenture securing the Appalachian bonds involved in the Parnell case required that, on or before March 1 of each year beginning with the year 1953, the company deposit with the corporate trustee an amount in cash or principal amount of the bonds of that series equivalent to 1% of the greatest principal amount of that series at any time outstanding but with the privilege to the company of certifying property additions in lieu of depositing cash or bonds. In many indentures the term "sinking fund" is used to describe such deposits, but in the Appalachian indenture this terminology is not used. Section 40 of the indenture further required the company, subject to the privilege of certifying property additions, to make annual deposits in cash or principal amount of bonds of any series equal to the amount by which a defined percentage of the base operating revenues during the preceding calendar year exceeded the aggregate amounts expended for repairs and maintenance. The indenture also required the deposit with the corporate trustee of the proceeds of sale of released properties and fire insurance proceeds, but permitted this cash to be withdrawn against certification of property additions. Cash held by the corporate trustee and not withdrawn against certification of property additions was required to be used either to call bonds at the special call price or to purchase bonds for retirement. Up to the time of the hearing the company had consistently exercised its privilege of offsetting the annual deposits of cash, which would otherwise have been required, by credits for property additions and waiver of authentication of bonds and by withdrawing proceeds of sale of released properties and insurance for property additions. During the three years 1952, 1953 and 1954 the requirements under Section 20 and Section 40 and the proceeds of released property aggregated $3,150,056.94, so that Appalachian Electric Power Company had the right under the indenture during these three years to call $3,150,056.94 of its bonds of the 3¾% Series, due 1981, at the special call prices, and might have chosen to do so instead of spending this amount of money for property additions and certifying these property additions to the trustee. The company could have used these property additions as the basis for the authentication by the trustee of a new series of bonds, and in that event the company would have deposited cash or bonds with the trustee under Section 20 and Section 40. There were only $17,000,000 bonds of this issue and the company would normally have called them at the special call prices rather than at the regular call prices, if it desired to call them at all, because the special call prices were lower. At the time of the hearing none of the bonds had been called at either the special call prices or the general call prices.

4. The indenture securing the Georgia Power Company bonds contains similar provisions except, that, beginning in 1950, the company was required to deposit cash in the sinking fund and was not permitted to certify property additions in lieu thereof. It was, however, permitted to certify property additions for maintenance fund purposes. Cash in these funds could be used to call bonds of any series at the special call price, or to purchase such bonds on the open market. During the years 1950-1958, $13,399,340 in cash was deposited in the sinking fund. Of this amount, $13,064,118.20 was used to call bonds of series other than the series here involved at the special call prices, and $234,165 to purchase bonds of other series. None of the bonds of this particular series have as yet been called at either the special call...