Hanover Bank v. Commissioner of Internal Revenue, 224

Decision Date21 May 1962
Docket NumberNo. 224,224
Citation369 U.S. 672,8 L.Ed.2d 187,82 S.Ct. 1080
PartiesThe HANOVER BANK, Executor, et al., Petitioner, v. COMMISSIONER OF INTERNAL REVENUE
CourtU.S. Supreme Court

Theodore Tannenwald, Jr., New York City, for petitioners.

Stephen J. Pollak, Washington, D.C., for respondent.

Mr. CHIEF JUSTICE WARREN delivered the opinion of the Court.

Despite the seemingly complex factual composition of the two cases consolidated herein,1 this opinion deals with a relatively simple question of taxation: The extent to which a taxpayer may deduct, through amortization under the Internal Revenue Code of 1939, the premium he has paid in purchasing corporate bonds. In 1953, prior to December 1, the petitioners purchased fully taxable utility bonds at a premium above maturity value.2 The bonds were callable at the option of the issuer at either a general or special call price, and at either price they were callable upon 30 days' notice. The term 'general call price' is used to designate the price at which the issuer may freely and unconditionally redeem all or any portion of the outstanding bonds from its general funds. The lower, 'special call price,' is the amount the issuer would pay if the bonds were redeemed with cash from certain specially designated funds.3

In computing net income, the 1939 Code permits a taxpayer to deduct, through amortization, the premium he has paid in purchasing corporate bonds.4 Section 125 of the Code, set forth in pertinent part in the margin,5 pro- vides that the amount of bond premium to be amortized 'shall be determined * * * with reference to the amount payable on maturity or on earlier call date.' Pursuant to this Section, the petitioners elected to claim on their 1953 income tax returns a deduction for bond premium amortization computed with reference to the special redemption price and to the 30-day redemption period appearing in the bond indentures. The respondent did not question the petitioners' use of the 30-day amortization period, but he disallowed the computation based upon the special redemption price and recomputed the amount of bond premium using the higher, general call price.6 The Court of Appeals for the Second Circuit affirmed the Tax Court's orders sustaining the Commissioner's deficiency determination. 289 F.2d 69. However, in cases presenting the identical legal issue, the Courts of Appeals for the Third (Evans v. Dudley, 295 F.2d 713) and Sixth (United States v. Parnell, 272 F.2d 943, affirming D.C., 187 F.Supp. 576) Circuits allowed amortization taken with reference to the special redemption prices.7 To resolve this conflict, we granted certiorari. 368 U.S. 812, 82 S.Ct. 53, 7 L.Ed.2d 21.

Bond premium is the amount a purchaser pays in buying a bond that exceeds the face or call value of the bond.8 When a bond sells at a premium, it is generally because the interest it bears exceeds the rate of return on similar securities in the current market. For the right to receive this higher interest rate the purchaser of a bond pays a premium price when making the investment. However, interest is taxable to the recipient, and when a premium has been paid the actual interest received is not a true reflection of the bond's yield, but represents in part a return of the premium paid. It was to give effect to this principle that Congress in 1972 enacted Section 125 of the 1939 Code,9 which for the first time provided for amortization of bond premium for tax purposes.

By providing that amortization could be taken with reference to the 'amount payable on maturity or on earlier call date' (emphasis added), Congress recognized that bonds are generally subject to redemption by the issuer prior to their maturity. In electing to allow amortization with reference to the period the bonds might actually be outstanding, Congress, through the words to which we have lent emphasis, provided that a bondholder could amortize bond premium with reference to any date named in the indenture at which the bond might be called.10

A bond indenture might contain any number of possible call dates, but we need only to be concerned in this case with the issuer's right to call the bonds on 30 days' notice at either a general or special call price. Unquestionably, both general and special redemption provisions have a legitimate, though distinct, business purpose, and both were in widespread use well before the enactment of Section 125. The general call price is employed when the issuer finds that the current rate of interest on marketable securities is substantially lower than what it is paying on an outstanding issue. The issuer may then call the bonds at the general price and, following redemption, may refinance the obligation at the lower, prevailing rate of interest. In contrast, the provision for special funds from which bonds may be redeemed at the special call price, serves an entirely different purpose. Bond indentures normally require the issuer to protect the underlying security of the bonds by maintaining the mortgaged property and by insuring that its value is not impaired. This is done, first, through the maintenance of a special sinking fund, to which the issuer is obligated to make periodic payments, and, secondly, through the maintenance of other special funds, to which are added the proceeds from a sale or destruction of mortgaged property, or from its loss through a taking by eminent domain.11 Although the issuer normally reserves an alternative to maintaining these special funds with cash, circumstances may dictate that the only attractive option from a business standpoint is the payment of cash and, to prevent the accumulation of this idle money, the indenture provides that the issuer may use it to redeem outstanding bonds at a special call price. It is evident that just as prevailing market conditions may render redemption at the special call price unlikely at a given time, the same or different market conditions may also cause redemption at the general call price equally unlikely,12 particularly in an expanding industry such as utilities. During the period the petitioners held their bonds, none were called at either price, but the risk incurred that they would be called was present with equal force as to both the general and special call provisions. The market for bonds reflects that risk, and the Section of the Code we are asked to interpret takes cognizance of that market reality.

Turning to the specific problem in the instant case, we are asked to determine whether the special price at which the bonds may be redeemed by the issuer from the limited sinking fund account and from the other special funds made available upon the occurrence of certain contingent events (see note 3, supra) is an 'amount payable * * * on earlier call date' within the meaning of Section 125. For the reasons stated below, we answer this question affirmatively and hold that there is no basis either in the statute, in the legislative history, or in the respondent's own prior interpretations of the statute, for a distinction between reference to a general or special call price in computing amortizable bond premiums under the 1939 Code.

First, we note that the Government has made certain important concessions which lighten considerably the task before us. It does not question the right of the petitioners to amortize bond premium with reference to the 30-day call period, nor does it question amortization to the general call price.13 In addition, in requesting a rule which will apply to the 'generality of cases,' 14 it professes to have abandoned its argument below which became the rationale of the Second Circuit in holding against the taxpayers, that the statute calls for an analysis into the 'likelihood of redemption' before amortization at a special call price will be permitted.15 Moreover, the Government does not contend that the transactions entered into by the petitioners were a sham without any business purpose except to gain a tax advantage.16 Rather, the Government's position in this Court is that before an 'earlier call date' is established with reference to the special call price, the taxpayer must show that 'there is an ascertainable date on which the issuer will become entitled to redeem (a particular) bond at its option.' The Government asserts that it is not enough that the issuer has the right to call some bonds at the special redemption price. Rather, '(i)t must have the right to call the particular bond for which amortization is claimed, for otherwise that bond has no 'earlier call date." The Government's primary reason for urging this interpretation of Section 125 is that the statute has created a tax loophole of major dimension that should be closed short of allowing the deduction sought in this case. While this assertion might have been persuasive in securing enactment of the amendments to the statute made subsequent to the time the transactions involved here took place (see discussion, infra), it may not, of course, have any impact upon our interpretation of the statute under review. We are bound by the meaning of the words used by Congress, taken in light of the pertinent legislative history. In neither do we find support for the Government's interpretation.

This Court was first called upon to construe Section 125 in 1950 in Commissioner v. Korell, 339 U.S. 619, 70 S.Ct. 905, 94 L.Ed. 1108. The taxpayer there had purchased bonds at a premium which reflected in large part not a higher yield of interest, but, rather, the attractiveness of the convertible feature of the bonds. The bonds were callable on 30 days' notice and the taxpayer amortized the premium accordingly. In contesting the deduction thus taken, the Commissioner contended that Section 125, in establishing a deduction for 'amortizable bond premium,' did not include premium paid for the conversion privilege. In rejecting this contention, the Court made it clear that Section 125 was not enacted solely to enable a...

To continue reading

Request your trial
190 cases
  • United States v. Nesline
    • United States
    • U.S. District Court — District of Maryland
    • July 12, 1984
    ...to have used words in the revenue acts according to their ordinary everyday meaning. See, e.g., Hanover Bank v. Commissioner, 369 U.S. 672, 687, 82 S.Ct. 1080, 1088, 8 L.Ed.2d 187 (1962); Avery v. Commissioner, 292 U.S. 210, 214, 54 S.Ct. 674, 676, 78 L.Ed. 1216 (1934); Matala v. Consolidat......
  • Van Raden v. Comm'r of Internal Revenue
    • United States
    • U.S. Tax Court
    • March 29, 1979
    ...and bricks have economic substance, the economic or financial inducement of the tax advantage can provide the mortar. Hanover Bank v. Commissioner, 369 U.S. 672, 682 (1962). Fn. ref. omitted.]7 Additionally, I am constrained to mention that it is arguable whether the issue of business purpo......
  • Pierre v. Comm'r of Internal Revenue, No. 753–07.
    • United States
    • U.S. Tax Court
    • August 24, 2009
    ...disregarded entity as a transfer of an interest in the disregarded entity's assets, see, e.g., Hanover Bank v. Commissioner, 369 U.S. 672, 686, 82 S.Ct. 1080, 8 L.Ed.2d 187 (1962) (“[Private letter] rulings do reveal the interpretation put upon the statute by the agency charged with the res......
  • Commissioner of Internal Revenue v. Brown
    • United States
    • U.S. Supreme Court
    • April 27, 1965
    ...Helvering v. William Flaccus Oak Leather Co., 313 U.S. 247, 249, 61 S.Ct. 878, 880, 85 L.Ed. 1310; Hanover Bank v. Commissioner, 369 U.S. 672, 687, 82 S.Ct. 1080, 1088, 8 L.Ed.2d 187; Commissioner v. Korell, 339 U.S. 619, 627—628, 70 S.Ct. 905, 909—910, 94 L.Ed. 1108; Crane v. Commissioner,......
  • Request a trial to view additional results
1 firm's commentaries
  • Camp’s Market Discount Proposal Is A Mixed Bag For Distressed Debt
    • United States
    • Mondaq United States
    • March 24, 2015
    ...common law."). 23 See IRC § 6110(k)(3) (private letter rulings "may not be used or cited as precedent"). 24 See Hanover Bank v. Comm'r, 369 U.S. 672, 686 (1962) ("[A]lthough the petitioners are not entitled to rely upon unpublished private rulings which were not issued specifically to them,......
2 books & journal articles
  • Timothy A. Rybacki, Separation Anxiety: the Repatriation of Foreign Tax Credits Without Associated Income via the Technical Taxpayer Rule's Joint and Several Liability Provision
    • United States
    • Emory University School of Law Emory International Law Reviews No. 19-3, December 2005
    • Invalid date
    ...court. These rulings, however, do serve as interpretive evidence of the language of the regulations or tax code. Hanover Bank v. Comm'r, 369 U.S. 672, 686 (1962). 154 I.R.S. Chief Council Advice 199922027 (Mar. 1, 1999) (emphasis added). 155 Id.; Guardian Motion for Summary Judgment, supra ......
  • Taxpayer FSA use.
    • United States
    • The Tax Adviser Vol. 33 No. 7, July 2002
    • July 1, 2002
    ...put upon the statute by the agency charged with the responsibility of administering the internal revenue laws. (Hanover Bank, 369 US 672 In that case, the Supreme Court found that the letter rulings were "further evidence that our construction ... is compelled by the language of the statute......

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT