Evans v. Dudley, 13559.

• Decision Date: 08 November 1961
• Docket Number: No. 13559.,13559.
• Parties: T. M. EVANS and Josephine S. Evans v. Alexander J. DUDLEY, Individually, and as Former District Director of Internal Revenue. United States of America, Intervenor, Appellant.
• Court: U.S. Court of Appeals — Third Circuit

295 F.2d 713 (1961)

T. M. EVANS and Josephine S. Evans v. Alexander J. DUDLEY, Individually, and as Former District Director of Internal Revenue.

United States of America, Intervenor, Appellant.

No. 13559.

United States Court of Appeals Third Circuit.

Argued September 21, 1961.

Decided November 8, 1961.

Douglas A. Kahn, Washington, D. C. (Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson, Melva M. Graney, Attorneys, Department of Justice, Washington, D. C., Hubert I. Teitelbaum, U. S. Atty., Daniel J. Snyder, Asst. U. S. Atty., Pittsburgh, Pa., on the brief), for appellant.

C. McKenzie Lewis, Jr., Pittsburgh, Pa. (John A. McCann, McCann, Garland, Ridall & Burke, Pittsburgh, Pa., George D. Lockhart, N. K. Parker, Jr., Michael F. Butler, Kirkpatrick, Pomeroy, Lockhart & Johnson, Pittsburgh, Pa., on the brief), for appellee.

Before GOODRICH, McLAUGHLIN and HASTIE, Circuit Judges.

GOODRICH, Circuit Judge.

The United States appeals from a judgment of the District Court for the Western District of Pennsylvania ordering a refund to the taxpayer of money which he claimed was improperly collected from him. 1960, 188 F.Supp. 9.¹

In 1954 the taxpayer, in two transactions, bought $2,000,000 worth of public utility bonds at a premium. These bonds had been issued prior to January 22, 1951, and were callable on thirty days' notice at a price lower than the purchase price. Mr. Evans put up $118,000 cash of his own and borrowed the remainder of the purchase price from the Mellon National Bank and Trust Company in Pittsburgh. That the loan was completely bona fide and represented an obligation from borrower to lender is not questioned. After holding the bonds for thirty days Mr. Evans, still in 1954, donated $1,250,000 face amount of the bonds to charities, $700,000 going to Yale University and $550,000 to the T. M. Evans Foundation on the condition that the charities assume the indebtedness on the bonds. No doubt is raised that each of these recipients was a proper subject of a charitable donation. The taxpayer, in his return for 1954, took a deduction under Section 171 of the Internal Revenue Code of 1954 by way of amortization of the premium which he had paid on the acquisition of the bonds. This deduction is squarely within the language of Section 171 of the 1954 Code.² He also took a deduction for his contributions to Yale and the T. M. Evans Foundation.

The Government feels very badly that the taxpayer thus secured a double deduction. It suffers even more because the taxpayer, being in the highest tax bracket, really made a profit, tax-wise, out of the combined deductions.³ Mr. Evans frankly admitted that the thing which caused him to set up the transactions the way he did was the possibility of the double deduction and that he had been advised about it through both investment and legal counsel.

It is this motivation of tax avoidance which is the basis of the Government's insistence that Mr. Evans is not entitled to the amortization deduction on his bonds. Great point is made of Gregory v. Helvering, 1935, 293 U.S. 465, 55 S.Ct. 266, 79 L.Ed. 596, and some of the language in that decision.

It is to be noted, however, that there was no pretense about the transaction by which the taxpayer acquired these securities. As the district court pointed out, he had all the rights and obligations of ownership. If the bonds declined he stood to suffer loss.⁴ Conversely, he was entitled to the benefit of any advance in market value and to the income from the bonds during the time he held them. He had no commitment to sell the bonds or to give them away. Whatever plan he had was only in his mind. Neither Yale University nor the T. M. Evans Foundation could have forced the gift. In other words, here is a man who had become the full owner, in a straightforward commercial transaction, of a purchase of utility bonds which he was privileged either to keep or to give away. He gave them away. The only basis of attack on the deduction which the plain words of the statute give is the fact that he was motivated by a desire to avoid taxes and got competent advice to accomplish it. If tax avoidance, within the rules, is to take a case out of a deduction provided by statute, we think every legally advised taxpayer is going to find himself in very hot water. The point in this case is that the purchase of these bonds by the taxpayer was a real and not a feigned transaction.

At the time this case was argued before us the taxpayer could rely upon the Seventh Circuit's decision in Maysteel Prods., Inc. v. Commissioner, 1961, 287 F.2d 429, and the Sixth Circuit case of Parnell v. United States, D.C.M.D.Tenn. 1958, 187 F.Supp. 576, affirmed per curiam 1959, 272 F.2d 943. In the meantime, however, the First Circuit has decided for the taxpayer in three cases, all of which were handled in the same opinion and all of which support the district court result in this case. See Fabreeka Prods. Co. v. Commissioner; Friedman v. Commissioner; Sherman v. Commissioner.

The provision of the 1954 Code contained a limitation on the deduction in the case of bonds issued after January 22, 1951.⁵ The Technical Amendments Act of 1958, § 13, 72 Stat. 1610, made a further modification.⁶ As Judge Aldrich says in concluding the First Circuit opinion: "Granting the government's proposition that these taxpayers have found a hole in the dike, we believe it one that calls for the application of the Congressional thumb, not the court's."

This leaves us with the further difficult point, however, of whether the taxpayer is to have amortization on the basis of the "general" call price of the bonds or the lower "special" call price, which results in a larger deduction. As we understand it, a general call is one which a corporation employs when it finds that the current rate of interest on bonds is substantially less than what it is paying on an outstanding issue. If there is a provision in the bond permitting it to be called, the debtor may call it and refinance his obligations at a lower interest rate. Of course, the general call price must be high enough to compensate the lender for the loss of his now-profitable investment. On the other hand, a special call is one by which, subject to the terms of the original contract, bonds may be called and paid for out of special funds set up by the terms of the indenture and to which the debtor is obligated to make periodic payments. A typical example would be a sinking fund to which the debtor each year makes a stipulated payment. A purchaser, when he buys bonds on the market, does not know whether his bonds will be called at all before maturity or, if they are, whether it will be at the special or the general call price.

The district court in this case allowed the taxpayer to amortize the difference between the premium and the special call price, which gave him a larger deduction than if he had been allowed only the general call price. This result has the support of the Sixth Circuit in Parnell v. United States, 1959, 272 F.2d 943, affirming per curiam D.C.M.D.Tenn.1958, 187 F.Supp. 576. It is contrary, however, to the Second Circuit's decision in Estate of Gourielli v. Commissioner, 289 F.2d 69, certiorari granted, Hanover Bank v. Commissioner of Internal Revenue, 82 S.Ct. 53, in which Judge...