Campbell v. Cen-Tex, Inc.

• Decision Date: 26 April 1967
• Docket Number: No. 23014.,23014.
• Citation: Campbell v. Cen-Tex, Inc., 377 F.2d 688 (5th Cir. 1967)
• Parties: Ellis CAMPBELL, Jr., District Director of Internal Revenue, Appellant, v. CEN-TEX, INC., Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

377 F.2d 688 (1967)

Ellis CAMPBELL, Jr., District Director of Internal Revenue, Appellant, v. CEN-TEX, INC., Appellee.

No. 23014.

United States Court of Appeals Fifth Circuit.

April 26, 1967.

Richard M. Roberts, Acting Asst. Atty. Gen., Lee A. Jackson, Meyer Rothwacks, I. Henry Kutz, Jonathan S. Cohen, Attys., Dept. of Justice, Washington, D. C., Melvin M. Diggs, U. S. Atty., Abilene, Tex., for appellant, Martha Joe Stroud, Asst. U. S. Atty., of counsel.

A. E. Aikman, J. J. French, Jr., of Locke, Purnell, Boren, Laney & Neely, Dallas, Tex., for appellee, Frederick H. Stone, Springfield, Ill., of counsel.

Before TUTTLE, Chief Judge, and JONES and GEWIN, Circuit Judges.

JONES, Circuit Judge:

The appellee, Cen-Tex, Inc., claimed interest deductions in computing its income tax for its fiscal years ending April 30, 1961, and April 30, 1962. The claimed deductions were disallowed, deficiency assessments were made and paid, claims for refund were filed and disallowed, and an action for a refund was brought. The district court entered judgment for the taxpayer. The District Director has appealed.

There are no differences between Cen-Tex and the Internal Revenue Service as to the happenings out of which this controversy arose. The material facts were stipulated. During the tax years the Hellinghausen family owned all of the stock of Cen-Tex in the following percentages:

  William G. Hellinghausen          55%
                  Donald M. Hellinghausen           20%
                  Robert F. Hellinghausen           20%
                  Elizabeth Hellinghausen Hoffman    5%
                

William, his wife Kathleen, their sons Donald and Robert and their daughter Elizabeth made up the Board of Directors and were the management personnel¹ of their company. During the fiscal year ending June 30, 1961, Cen-Tex, during the first of the two tax years, adopted a deferred compensation plan providing that in the event of the death of William, Donald or Robert, Cen-Tex would pay $750 per month to the surviving spouse or lineal descendants of the decedent for a period of ten years. By a stock option and redemption agreement dated June 7, 1961, the stockholders gave Cen-Tex a right of refusal of any stock they might desire to sell. The agreement contained provisions obligating the company to purchase and redeem, at book value, the stock of any deceased stockholder.

Cen-Tex decided to meet the obligations which it had undertaken by the deferred compensation plan and the stock purchase agreement by the purchase of insurance on the lives of the five Hellinghausens. Applications were made to Franklin Life Insurance Company. William was found to be uninsurable and a policy on his life owned by him was purchased and taken over by Cen-Tex. Franklin issued policies, dated April 17, 1961, and issued about that date, payable to Cen-Tex, on the lives of Donald, Robert, Kathleen and Elizabeth. The death benefits under the policies increased substantially, year by year, for twenty years. Premiums were substantially greater during the first twenty years than thereafter. The increased premiums gave to the policies additional death benefits and larger loan values. Cen-Tex paid the first annual premium on each policy and prepaid the next four annual premiums, discounted at three per cent. Cen-Tex then borrowed the loan value on each of the policies at a four per cent rate. The following year Cen-Tex prepaid another annual premium on each policy and made additional policy loans to the extent of the increased loan values. Interest was paid on the policy loans.

The district court held that the prepayment of premiums, the borrowing of loan values and payment of interest had a very real and discernible substantial business purpose. It held that the interest payments were, in economic substance and actuality, the payment of interest and were not the equivalent of, or in substance, the premium cost of the insurance protection afforded by the policies. The district court decided that the interest payments were not sham in fact or in law, but were for the use or forbearance of money and as such were deductible for income tax purposes during the tax years in question.

The subject of initial inquiry should be the effect of Congressional enactments. The Internal Revenue Code of 1939, as amended in 1942, had specific provisions denying deductions for interest paid or accrued on indebtedness incurred or continued to purchase or continue a single premium life insurance or endowment contract. There was a proviso that the payment of substantially all premiums within four years from the purchase would be considered a single premium. 26 U.S.C.A. (I.R.C.1939) § 24(a) (6) as amended by Internal Revenue Act of 1942 § 129. The Internal Revenue Code of 1954 carried forward the prior provisions.² Amounts of interest paid or accrued to pay or carry an annuity contract were included in deductions to be disallowed. The 1954 provision treats as a single premium contract one where a deposit is made to pay a substantial number of future premiums, as well as where substantially all of the premiums are paid within the first four years of the contract. Section 264 of the Internal Revenue Code of 1954, as originally enacted, note 2 supra, is the statute in force when the insurance policies were issued and during the tax years of Cen-Tex which are here involved. By the Revenue Act of 1964, it was provided, with certain exceptions which need not be mentioned, that with respect to contracts purchased after August 6, 1963, no deduction shall be allowed for any amount paid or accrued on indebtedness incurred or continued to purchase or carry a life insurance, endowment or annuity contract (other than a single premium contract or a contract treated as a single premium contract) pursuant to a plan of purchase which contemplates the systematic direct or indirect borrowing of part or all of the increases in the cash value of such contract. 26 U.S.C.A. § 264(a) (3).

The interest deduction claimed by Cen-Tex was not prohibited by statute. The loophole, of which Cen-Tex attempted to avail itself, was not Congressionally plugged until the passage of the 1964 Act. In the consideration of this measure the Congress believed it was intended to make a change in the law and to deny an interest deduction which was previously available.³ Unpublished rulings, repudiated by the Commissioner subsequent to issuance, authorized deductions. Commentators so construed the law.⁴ The Tax Court seemingly has given credence to the Congressional construction and permitted interest deductions to be allowed in a situation not dissimilar to the case here on appeal. Kay v. Commissioner of Internal Revenue, 44 T.C. 660. This Court has spoken for the taxpayer. United States v. Bond, 5th Cir. 1958, 258 F.2d 577. While there is no doubt as to the authority wielded by the legislative history of an act of Congress, its views interpreting prior legislation are scarcely persuasive. United States v. Price, 361 U.S. 304, 313, 80 S.Ct. 326, 4 L.Ed.2d 334. The Commissioner is not bound by his unpublished rulings, except to the taxpayers for whom they were made. Bookwalter v. Brecklein, 8th Cir. 1966, 357 F.2d 78; Minchin v. Commissioner of Internal Revenue, 2nd Cir. 1964, 335 F.2d 30. We are told that the Kay decision of the Tax Court has been ignored as a precedent. The Bond decision of this Court is no longer stare decisis. United States v. Salley, 5th Cir. 1961, 290 F. 2d 708.

There was a time when Congressional action was generally required to plug those loopholes in the Federal revenue acts which permitted tax avoidance. Now, in no small measure, Knetsch⁵ is availed of by the Internal Revenue Service as a thumb-in-the-dike to thwart the use of tax escape devices. Karl F. Knetsch, in 1953 at the age of sixty, purchased from an insurance company ten 30-year maturity deferred annuity savings bonds, each in the amount of $400,000, bearing 2½ per cent interest. The purchase price was $4,004,000 which was paid by Knetsch's check for $4,000 and his nonrecourse notes for $4,000,000 bearing 3½ per cent interest. This interest for the first year, $140,000, was required to be, and was, paid in advance. This increased the loan value by $99,000 which Knetsch promptly borrowed, giving a check for $3,465, a year's advance interest. In the three succeeding years interest was paid and the loan values were borrowed. If the loans had been repaid, Knetsch would have been entitled at the maturity of the bonds, when he would have been 90 years old, to a monthly payment of $90,171. If, however, he had continued to borrow and to pay interest the value of the contracts, at their maturity, would be $1,000 which would have produced an annuity of $43 per month to sustain him during his declining years. In his income tax returns for 1953 and 1954⁶ Knetsch claimed interest deductions for the amounts paid at interest during those years. The deduction was disallowed by the Commissioner and paid by Knetsch who sued for a refund. The judgment of the district court was affirmed by the Court of Appeals. Knetsch v. United States, 9th Cir. 1959, 272 F.2d 200. Because of a suggested conflict with the Bond decision, supra, of this Court, the Supreme Court granted certiorari. The Court held that the indebtedness created by the borrowings was fictional, and in reality a rebate of a substantial part of the so-called interest payments. The annuity contracts were likewise fictional because their value was reduced to and, by the annual borrowings, kept at "the relative pittance" of $1,000. The transaction did not, said the Court, appreciably affect his beneficial interest except to reduce the tax. Nothing of substance was to be realized by him beyond a tax deduction. The sums retained by the insurance company were said to be its fee for providing the facade of "loans" for the attempt at tax reduction. The transaction was determined by the Court, with three judges dissenting, to be a sham.

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