369 U.S. 672 (1962), 224, Hanover Bank v. Commissioner
|Docket Nº:||No. 224|
|Citation:||369 U.S. 672, 82 S.Ct. 1080, 8 L.Ed.2d 187|
|Party Name:||Hanover Bank v. Commissioner|
|Case Date:||May 21, 1962|
|Court:||United States Supreme Court|
Argued February 27, 1962
CERTIORARI TO THE UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
The Internal Revenue Code of 1939 permits a taxpayer to deduct, through amortization, the premium he has paid in purchasing corporate bonds, and § 125 provides that the amount to be amortized "shall be determined . . . with reference to the amount payable on maturity or on earlier call date." In 1953, prior to December 1, taxpayers purchased at a premium corporate bonds which were callable on 30 days' notice, either at a "general call price" or at a lower "special call price," and elected on their 1953 income tax returns to claim deductions for bond premiums computed with reference to the 30-day call period and the special call price.
Held: they were entitled to do so, since the special call price at which the bonds here involved could be redeemed from a limited sinking fund and from other special funds made available upon the occurrence of certain contingent events was an "amount payable . . . on earlier call date" within the meaning of § 125, and there was no basis in the statute, in the legislative history, or in the Commissioner's prior interpretations of the statute for a distinction between a reference to a general or special call price in computing amortizable bond premiums under the 1939 Code. Pp. 673-688.
289 F.2d 69, reversed.
WARREN, J., lead opinion
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
[82 S.Ct. 1082] 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 provides
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 [82 S.Ct. 1083] 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 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.
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 [82 S.Ct. 1084] 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 [82 S.Ct. 1085] 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 was 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" [82 S.Ct. 1086] 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...
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