Cleaver v. Commissioner of Internal Revenue

• Decision Date: 07 April 1947
• Docket Number: No. 9132.,9132.
• Citation: 158 F.2d 342
• Parties: CLEAVER v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Seventh Circuit

158 F.2d 342 (1946)

CLEAVER v. COMMISSIONER OF INTERNAL REVENUE.

No. 9132.

Circuit Court of Appeals, Seventh Circuit.

December 3, 1946.

Writ of Certiorari Denied April 7, 1947.

Malcolm K. Whyte, Herbert C. Hirschboeck, Warner H. Hendrickson, and Charles E. Prieve, all of Milwaukee, Wis., for petitioner.

Douglas W. McGregor, Asst. Atty. Gen., Helen Goodner, Asst. to Atty. Gen., J. P. Wenchel and Rollin Transue, Bureau of Internal Revenue, both of Washington, D. C., and Sewall Key, A. F. Prescott, and Louise Foster, Sp. Assts. to Atty. Gen., for respondent.

Before MAJOR and MINTON, Circuit Judges, and LINDLEY, District Judge.

LINDLEY, District Judge.

Petitioner, a taxpayer on a cash basis, seeks review of a decision of the Tax Court of the United States disallowing his deduction from income for interest paid in the year 1941, raising the question whether the interest deducted was paid in that year within the meaning of Section 23(b) of the Internal Revenue Code, 26 U.S.C.A. Int.Rev.Code, § 23(b). Under that section interest paid by a taxpayer accounting on a cash basis is deductible in the year the interest is paid.

In 1941 the taxpayer gave to his bank promissory notes for $68,950, due at the end of five years. The bank charged interest in advance at the rate of 2¼ per cent, amounting to $7756.88, deducted that amount from the face of the note and credited it to a reserve account known as "interest or discount collected in advance." Each day it took from that account the amount of interest earned and credited it on its books to its earnings account. The bank credited to the taxpayer the net proceeds of the loan $61,193.12. No part of the notes was paid in the year 1941. The taxpayer deducted the item of $7756.88 as interest paid in the year 1941. The Tax Court held this deduction improper for the reason that no interest was actually paid in the year 1941 and approved the Commissioner's determination of a deficiency in income tax resulting from the deduction. The only question submitted to us is whether the evidence submitted to the Tax Court and reflected by its findings of fact supports a conclusion that the taxpayer, accounting for income taxes on a cash basis, did not actually pay any interest in the year 1941.

There is no question that, as between the parties and as a matter of mercantile law, the transaction between the taxpayer and the bank was completed at the time of the borrowing and the execution of the notes. In commercial practice the discount deducted was interest at the given rate on the face of the note from its date until maturity. From time immemorial it has been the custom of banks to make loans, deduct the interest included in the face of the note and credit the borrower with the remainder of the face of the note after deduction of the interest and treat the interest as paid in advance. Fleckner v. Bank, 8 Wheat. 338, 5 L.Ed. 631. But we are not called upon to decide a mercantile or contractual question as between the borrower and lender or any question of the rights of the borrower or the lender or even of the rights of third parties against either the borrower or the lender. We are dealing with a revenue law. Our question is whether, under proper interpretation of the statute enacted by Congress, a taxpayer who is on a cash basis may deduct interest with which he has been charged but which will not be actually paid in cash until the note has been paid. That such is our inquiry is shown by Hart v. Commissioner of Internal Revenue, 1 Cir., 54 F.2d 848, 851, where the court said: "Federal taxing laws cannot be controlled by state statutes, or by rules of law governing decisions in state courts. Fidelity-Philadelphia Trust Co. v. Commissioner, 3 Cir., 47 F.2d 36, 38, wherein it is said: `It is well settled that a state law cannot be given an effect for tax purposes which conflicts with the provisions of a federal revenue law and defeats the collection of the tax.'"

The governing principles have been announced in various authoritative cases. Thus in United States v. Mitchell, 271 U.S. 9, 12, 46 S.Ct. 418, 419, 70 L.Ed. 799, the court said: "It was not the purpose of the Act to permit gross income actually received to be diminished by taxes or other deductible items disbursed in a later year, even if accrued in the taxable year." In Massachusetts Mutual Life Insurance Co. v. United States, 288 U.S. 269, 53 S.Ct. 337, 77 L.Ed. 739, the court held that interest credited by a life insurance company to its...