Commissioner of Internal Revenue v. National Alfalfa Dehydrating and Milling Company 8212

Citation94 S.Ct. 2129,40 L.Ed.2d 717,417 U.S. 134
Decision Date28 May 1974
Docket NumberNo. 73,73
PartiesCOMMISSIONER OF INTERNAL REVENUE, Petitioner, v. NATIONAL ALFALFA DEHYDRATING AND MILLING COMPANY. —9
CourtUnited States Supreme Court
Syllabus

Respondent corporate taxpayer, pursuant to a recapitalization plan, issued $50 face value 5% sinking fund debentures in exchange for its outstanding unlisted $50 par 5% cumulative preferred shares, which at the time were quoted at approximately $33 per share on the over-the-counter market. Based on the exchange, respondent claimed on its income tax returns for several years deductions for debt discount under § 163(a) of the Internal Revenue Code of 1954, which allows deductions for interest paid on indebtedness. Respondent asserted that the debt discount, measured by the difference between a claimed $33 per share value for the preferred, and the face amount of the debentures, amortized over the life of the debentures, constituted deductible interest within the purview of that provision. The Commissioner disallowed the deductions, and was upheld by the Tax Court, but the Court of Appeals reversed. Held: Respondent did not incur amortizable debt discount upon the issuance of its debentures in exchange for its outstanding preferred stock. Pp. 142—155.

(a) In determining whether debt discount arises in the situation presented here, the relevant inquiry must be whether the corporate taxpayer has incurred, as a result of the transaction, some cost or expense of acquirng the use of capital. P. 147.

(b) The propriety of a deduction does not turn upon general equitable considerations, such as a demonstration of effective economic and practical equivalence to what actually occurred, but rather 'depends upon legislative grace; and only as there is clear provision therefore can any particular deduction be allowed.' New Colonial Co. v. Helvering, 292 U.S. 435, 440, 54 S.Ct. 788, 790, 78 L.Ed. 1348. Pp. 147—149.

(c) This Court will not speculate as to what the market price and the investor reaction to any sales of the debentures or purchases of the preferred by respondent in the open market would have been, since there is nothing in the record to establish the cash price at which the debentures could have been sold upon the market or to indicate that respondent would have been able to purchase all its outstanding preferred on the open market, or at what price that stock would have been purchased in light of the impending exchange; moreover, when a corporation issues to its preferred shareholders its own new debt obligations in exchange for the outstanding preferred, the claimed fair market value of both securities is somewhat artificial since the exchange is effectively insulated from market forces. Pp. 149—151.

(d) Absent any evidence that the difference between the claimed $33 per share of the preferred and the face amount of the debentures is attributable to debt discount or that the discount rate was determined by such factors as respondent's financial condition at the time of the exchange and the availability and cost of capital in the general market as well as from the preferred shareholders, rather than simply having been predicated on the preferred's par value, the requisite evaluation of the property to be exchanged cannot occur and debt discount cannot be determined. P. 151.

(e) The alternation in the form of the retained capital did not give rise to any cost of borrowing to respondent, since the cost of the capital invested in respondent was the same whether represented by the preferred or by the debentures, and was totally unaffected by the market value of the preferred received in exchange. Pp. 151—155.

10 Cir. 472 F.2d 796, reversed.

Stuart A. Smith, Washington, D.C., for petitioner.

Charles White Hess, Kansas City, Mo., for respondent.

Mr. Justice BLACKMUN delivered the opinion of the Court.

A corporate taxpayer in 1957 issued $50 face value 5% sinking fund debentures in exchange for its oustanding $50 par 5% cumulative preferred shares. At the time, the preferred apparently had a fair market value of less than $50 per share. This case presents the question whether, under § 163(a) of the Internal Revenue Code of 1954, 26 U.S.C. § 163(a),1 the taxpayer is entitled to an income tax deduction for amortizable debt discount claimed to be the difference between the face amount of the debentures and the preferred's value at the time of the exchange.

I

The facts are stipulated. The respondent, National Alfalfa Dehydrating and Milling Company (hereinafter called 'NAD' or the 'taxpayer'), is a Delaware corporation organized in May 1946. It has its principal office at Shawnee Mission, Kansas. It is engaged in the business of dehydrating and milling alfalfa.

At its organization, NAD was authorized to issue $50 par cumulative preferred shares and $1 par common shares. The preferred was entitled to preferential dividends at the rate of 5% per annum and was redeemable, in whole or in part, at the discretion of the board of directors or through the operation of a sinking fund, at a stated, variable price which, in 1957, was $51 per share plus accrued dividends. The sinking fund provision required that 20% of net earnings (after the payment of the preferred's dividends) was to be set aside and employed for the redemption of preferred. Any shares so redeemed were to be retired and could not be reissued. If there was a dividend arrearage, the preferred could not be purchased, redeemed, or otherwise acquired for value by the corporation unless the holders of 50% of the preferred shares consented, or unless NAD notified all preferred shareholders of its desire to purchase and invited tender offers. Upon voluntary liquidation, the preferred was entitled to $50 per share plus accrued dividends before any distribution was made to holders of the common shares.

Prior to July 23, 1957, NAD had outstanding common shares and 47,059 preferred shares on which there were dividend arrearages of $10 per share. The preferred outstanding thus had an aggregate par value of $2,352,950 as of that date.

On April 8, 1957, NAD's board of directors adopted resolutions2 'to effectuate a reorganization of the Company by way of recapitalization.' App. 56. The plan proposed by the board had three steps: (1) an amendment of NAD's articles of incorporation to eliminate the preferred as of August 1, 1957, to increase the par value of the common from $1 to $3 and the number of shares of common authorized from 763,000 to 1,000,000, and to authorize the issue of warrants for the purchase of common shares; (2) the indentured issuance of $2,352,950 principal amount of 18-year 5% sinking fund debentures due July 1, 1975, with one $50 debenture to be exchanged for each share of outstanding $50 preferred; and (3) the issuance, to the holder of each share of preferred, of a warrant to purchase one-half share of common at $10 per share in lieu of the $10 dividend arrearage. The members of the board would have testified that the 'principal business purpose behind the 1957 exchange of debentures for the preferred stock was to enable National Alfalfa to expand its eastern producing areas.' Id., at 25.

After the board had taken this action, NAD and Fidelity-Philadelphia Trust Company, as trustee, executed a trust indenture dated July 1, 1957, pursuant to which the aforementioned debentures were to be issued in exchange for NAD's outstanding preferred.3

Fidelity-Philadelphia Trust Company, on behalf of NAD, requested a ruling from the United States Treasury Department as to the federal income tax consequences of the plan. A responsive letter-ruling over the signature of the Chief, Reorganization and Dividend Branch, was forthcoming on May 29, 1957. The request had sought a ruling that all aspects of the plan would be tax free. The ruling, however, was to the effect that the exchange of the $1 par common for $3 per common 'will constitute a recapitalization and, therefore, a reorganization, within the meaning of section 368(a)(1)(E), of the Internal Revenue Code of 1954,' 26 U.S.C. § 368(a)(1)(E), and that, as a result thereof, under § 354(a) of the Code, 26 U.S.C. § 354(a), no gain or loss would be recognized on that exchange by NAD or by its common shareholders. App. 20. The ruling went on to state, 'Assuming but not determining that the 5% debenture bonds to be issued qualify as securities (create a genuine relationship of debtor and creditor), gain or loss will be recognized to the preferred stockholders (under § 302(a) of the Code, 26 U.S.C. § 302(a)) from the exchange' of the preferred and the dividend arrearage for the debentures and warrants. The gain or loss so to be recognized would be 'measured by the difference between the cost or other adjusted basis of the preferred stock surrendered and the fair market values of the debentures and warrants received.' App. 20—21.

Shareholder approval of the plan proposed by the board was forthcoming in due course. Accordingly, NAD's articles were amended; on July 23, 1957, the holder of each share of preferred received, in exchange therefor, a $50 face value 5% debenture due July 1, 1975, and a warrant to subscribe to a half share of common at $10 per share in lieu of the dividend arrearage; and the preferred was eliminated and canceled as of August 1. This was reflected on NAD's books by a debit to the preferred stock account for $2,352,950, thereby eliminating that account, and by a credit to the liability account for the 18-year 5% debentures in the aggregate amount of $2,352,950.

NAD's preferred shares were not listed. During the period from July 15—30, 1957, the bid quotation for the preferred on the over-the-counter market ranged from a low of 29 to a high of 33, and the offering quotation ranged from a low of 32 to a high of 35. App. 161.4 On July 23, when the exchange was effected, the midpoint between the bid and offering quotations on the over-the-counter market was 33. The National Stock...

To continue reading

Request your trial
246 cases
  • Pierre v. Comm'r of Internal Revenue, No. 753–07.
    • United States
    • United States Tax Court
    • August 24, 2009
    ...so, he must accept the tax consequences of his choice, whether contemplated or not.” Commissioner v. Natl. Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 149, 94 S.Ct. 2129, 40 L.Ed.2d 717 (1974). I would hold petitioner to her choice. Finally, the majority overlooks the broad scope of th......
  • Mark O. Haroldsen, Inc. v. State Tax Com'n, 870468
    • United States
    • Supreme Court of Utah
    • November 27, 1990
    ...might have occurred." 143 Vt. at 274-75, 465 A.2d at 1102 (emphasis added) (quoting Commissioner v. National Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 148, 94 S.Ct. 2129, 2137, 40 L.Ed.2d 717 (1974)). See also Comptroller of the Treasury v. Equitable Trust Co., 296 Md. 459, 484, 464 ......
  • Blitzer v. United States, 426-76.
    • United States
    • Court of Federal Claims
    • July 14, 1982
    ...been done otherwise." And, as the Supreme Court reiterated in another context in Commissioner v. National Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 149, 94 S.Ct. 2129, 2137, 40 L.Ed.2d 717 (1974) This Court has observed repeatedly that, while a taxpayer is free to organize his affair......
  • Chernin v. U.S., s. 97-1913
    • United States
    • United States Courts of Appeals. United States Court of Appeals (8th Circuit)
    • July 10, 1998
    ...Co. v. Commissioner, 429 U.S. 569, 579, 97 S.Ct. 850, 51 L.Ed.2d 48 (1977) (quoting, Commissioner v. National Alfalfa Dehydrating, 417 U.S. 134, 148-49, 94 S.Ct. 2129, 40 L.Ed.2d 717 (1974) ) ("[A] transaction is to be given its tax effect in accord with what actually occurred and not in ac......
  • Request a trial to view additional results

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