Consolidated Edison Co. of New York, Inc. v. U.S.
| Decision Date | 23 November 1993 |
| Docket Number | D,No. 1622,1622 |
| Citation | 10 F.3d 68 |
| Parties | -330, 93-2 USTC P 50,644 CONSOLIDATED EDISON COMPANY OF NEW YORK, INC., Plaintiff-Appellee, v. UNITED STATES of America, Defendant-Appellant. ocket 93-6028. |
| Court | U.S. Court of Appeals — Second Circuit |
Bernard W. Bell, Asst. U.S. Atty., New York City (Roger S. Hayes, Acting U.S. Atty., S.D.N.Y., Richard W. Mark, Asst. U.S. Atty., of counsel), for defendant-appellant.
David M. Wise, New York City, for plaintiff-appellee.
Before: PIERCE, WALKER, and JACOBS, Circuit Judges.
The United States appeals from a judgment entered in the United States District Court for the Southern District of New York (Kimba M. Wood, Judge ), granting summary judgment to Consolidated Edison Company of New York, Inc. ("Con Edison") on its $1,207,087 tax refund claim. This appeal considers the proper treatment under the Internal Revenue Code of discounts Con Edison received from New York City (the "City") in exchange for prepayment of its real property taxes in 1975 and 1978. The district court ruled that the discounts were exempt from taxation as interest on municipal obligations and could be deducted from Con Edison's gross income as real property taxes paid or accrued during the tax years in question. We reverse in part and affirm in part the judgment of the district court.
From 1975 through 1979, the City experienced a severe fiscal crisis. In May of 1975, with the public credit market closed to it, it appeared that the City would be unable to meet its payroll obligations. The Association for a Better New York ("ABNY"), an association of New York-based companies including Con Edison, offered to help the City acquire the needed funds. The Chairman of ABNY suggested that major property taxpayers purchase City-issued certificates of deposit that could be turned in as payment of real estate taxes when tax obligations became due. Several major property owners, including Con Edison, declined to purchase the certificates for fear that if the City declared bankruptcy, they would not be able to use the certificates to extinguish their tax liabilities.
The Chairman of ABNY then proposed that, instead of purchasing the certificates, the property owners directly prepay their taxes. During the relevant period, City real estate taxes became due and payable in four installments throughout the City's fiscal year: on August 1, October 1, January 1, and April 1. On each due date, a tax lien in favor As a condition to participating in the prepayment plan, Con Edison required that its taxes be discounted in an amount approximating the prime interest rate in order to make the company whole for its costs of borrowing the funds needed to make the prepayment. The City Council thus amended the relevant City Charter provision to allow property owners to prepay the first installment of property taxes before July 1, 1975, the start of the fiscal year, and to provide an 8% per annum discount rate from the date of payment until August 29, 1975, the end of the grace period following the installment due date. 1 N.Y.City Charter & Admin.Code Ann. Sec. 1518(5) (Williams Press 1976).
of the City automatically arose on the taxed property and remained in place until the taxes were paid. However, the City provided a thirty day "grace period" after each due date during which taxpayers could satisfy their tax liability without incurring interest charges and penalties. Consequently, many taxpayers with large obligations waited until the end of the grace period to make payments.
As another prerequisite to prepayment, Con Edison secured a legal opinion from the City's Corporation Counsel stating that "the prepayment of first quarter 1975/1976 real estate taxes ... will constitute fully enforceable and valid payments of such taxes and will extinguish and satisfy such taxes to the extent of the amount of such prepayments plus the 8% per annum discount based thereon and cannot be set aside or modified by any litigation ... or by a proceeding under Chapter IX of the Bankruptcy Law."
On June 6, 1975, Con Edison prepaid a portion of its real property taxes in the amount of $50,000,000, and the City provided Con Edison with a receipt for payment of $50,937,814, which accounted for the 8% discount. The receipt provided that the prepayment "constitutes a fully enforceable and valid payment of such taxes ... and ... completely extinguishes Con Edison's liability for real estate taxes which would otherwise become payable on August 1, 1975." To bolster its position at the time that the transaction was not a loan to the City, Con Edison treated the amount of the discount as income in its books of account, placing it under an account headed "miscellaneous non-operating income," rather than "interest income."
Con Edison made five subsequent prepayments under terms similar to the June 1975 prepayment, but under different City Charter provisions. 1 N.Y.City Charter & Admin.Code Ann. Sec. 1518(6) (Williams Press 1976); 1 N.Y.City Charter & Admin.Code Sec. 1519(3) (1985-86 Cum.Supp.Ann.). These later provisions stated that upon prepayment, the taxpayer's real estate taxes were satisfied and extinguished to the extent of the amount prepaid plus the discount provided for therein. In its books of account, Con Edison again treated the amount of the discounts as income.
On its federal income tax returns, Con Edison excluded the prepayment discounts from calculation of its gross income under 26 U.S.C. Sec. 103(a), which provides, with exceptions not relevant here, that "gross income does not include interest on any State or local bond." In addition, Con Edison deducted the undiscounted amount of its real estate taxes (the amount it prepaid plus the discounts) from its gross income under 26 U.S.C. Sec. 164(a)(1), which permits taxpayers to treat as a deduction real property taxes "paid or accrued" during the tax year.
The Internal Revenue Service ("IRS") audited Con Edison's 1975 and 1978 tax returns and concluded that the company had erroneously characterized the discounts as interest on a municipal obligation. The IRS did not challenge Con Edison's treatment of the discounts as property taxes. The IRS assessed a deficiency against the company, which Con Edison subsequently paid. Con Edison then filed refund claims, which the IRS denied.
On August 29, 1988, Con Edison filed its complaint in the United States District Court for the Southern District of New York, asserting that the discounts were tax exempt interest on municipal obligations under Sec. 103(a). The United States interposed an affirmative defense that Con Edison was not entitled to a refund because it improperly deducted the discounted amounts as real property taxes "paid or accrued" under On November 20, 1991, the district court issued an opinion ruling that Con Edison properly excluded the discounts from its gross income as tax exempt interest on municipal obligations, but improperly deducted the discounts as real property taxes paid or accrued during the tax year. On November 19, 1992, the district court issued a second opinion reversing its conclusion on the second issue. The court determined that Con Edison could deduct the discounts as property taxes because they constituted part of Con Edison's tax obligations, which had fully "accrued" by the end of the relevant tax years. On December 9, 1992, the district court entered judgment in favor of Con Edison in the amount of $1,207,087.
Sec. 164(a)(1). Both sides moved for summary judgment.
This appeal followed.
We review the district court's grant of summary judgment de novo "to determine whether a genuine issue of material fact exists and whether the law was applied correctly below." National Union Fire Ins. Co. v. Turtur, 892 F.2d 199, 203 (2d Cir.1989). The Supreme Court has stated that "[t]he general characterization of a transaction for tax purposes is a question of law subject to review." Frank Lyon Co. v. United States, 435 U.S. 561, 581 n. 16, 98 S.Ct. 1291, 1302 n. 16, 55 L.Ed.2d 550 (1978). In this case, the facts are undisputed; the parties disagree only about their legal significance.
The parties do not seriously dispute that the prepayment discounts constituted gross income to Con Edison within the meaning of 26 U.S.C. Sec. 61. Section 61 provides that gross income includes "all income from whatever source derived." 26 U.S.C. Sec. 61. That section lists various examples of gross income, including interest income. Con Edison contends that the prepayment discounts were interest income, although exempt from taxation under 26 U.S.C. Sec. 103(a) as interest on a municipal obligation. As a threshold matter, we believe that the discounts fall within the definition of gross income under Sec. 61 since, as discussed further, infra, Con Edison derived a "readily realizable" economic benefit upon prepayment of its real estate taxes. See Rutkin v. United States, 343 U.S. 130, 137, 72 S.Ct. 571, 575, 96 L.Ed. 833 (1952).
We next address whether the income was tax exempt under Sec. 103(a) as interest on a municipal obligation. Section 103(a) provides a tax exemption only for interest paid by a state, territory, or possession of the United States, or a political subdivision thereof, on an obligation incurred under the political unit's borrowing power. See Commissioner v. Meyer, 104 F.2d 155, 156 (2d Cir.1939). The IRS contends that the City did not exercise its borrowing power in the course of the prepayment plan and that the discounts were simply compensation for the early payment of taxes.
The district court rejected this view as "unduly formalistic," ruling that if one looks at the substance of the transactions, the prepayments were essentially loans to help provide the City with capital that it could not obtain elsewhere. The court thus viewed the transactions as the equivalent of a three-step...
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