Golden Nugget, Inc. v. Comm'r of Internal Revenue, Docket Nos. 8027–81

Decision Date18 July 1984
Docket NumberDocket Nos. 8027–81
Citation83 T.C. 28,83 T.C. No. 4
PartiesGOLDEN NUGGET, INC., AND SUBSIDIARY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
CourtU.S. Tax Court

OPINION TEXT STARTS HERE

Golden Nugget, Inc., in 1974 exchanged debentures due in 1994 for about 11 percent of its outstanding common stock and here claims an annual deduction for original issue discount with respect to the difference between the principal amount of the debentures and the fair market value of the common stock at the time of the exchange.

Held: Petitioner's exchange of the debentures for the common stock was a reorganization in the form of a recapitalization under sec 368(a)(1)(E), I. R.C. 1954, and hence under sec. 1232(b)(1), I.R.C. 1954, the issue price of the debentures was their stated redemption price at maturity; therefore, the debentures were not eligible for original issue discount treatment under sec. 1.163–4(a)(1), Income Tax Regs., regardless of the tax consequences to the shareholders. Microdot, Inc. v. United States, 728 F.2d 593 (2d Cir. 1984), followed. Martin T. Goldblum, for the petitioner.

Cruz Saavedra, for the respondent.

OPINION

FEATHERSTON, Judge:

Respondent determined deficiencies in petitioners' Federal income tax as follows:

+--------------------+
                ¦Year  ¦Deficiency   ¦
                +------+-------------¦
                ¦      ¦             ¦
                +------+-------------¦
                ¦1975  ¦$12,974      ¦
                +------+-------------¦
                ¦1976  ¦12,974       ¦
                +------+-------------¦
                ¦1977  ¦12,973       ¦
                +------+-------------¦
                ¦1978  ¦12,973       ¦
                +--------------------+
                

The only question for decision is whether there was original issue discount, as defined in section 1232(b)(1)1, with respect to debentures issued by petitioner in 1974 in exchange for a portion of its common stock in the transaction more fully described below. The resolution of that question will require us to decide whether that transaction was a reorganization in the form of a recapitalization within the meaning of section 368(a)(1)(E).

All of the facts are stipulated.

Petitioner Golden Nugget, Inc., which had its principal place of business in Las Vegas, Nevada, when it filed its petition, is the parent of an affiliated group of corporations filing consolidated Federal income tax returns with the Internal Revenue Service Center, Ogden, Utah. Golden Nugget, Inc.'s subsidiary is also a petitioner in this case, but hereinafter all references to petitioner in the singular will refer only to Golden Nugget, Inc., because only its affairs are involved in the present controversy.

In September 1974, petitioner had outstanding 1,592,321 shares of common stock with a par value of $2.50 per share. The stock was publicly traded on the Pacific Stock Exchange. From the beginning of 1974 through September 20 of that year, its price on the exchange ranged from a low of $5.125, to a high of $7.50 per share.

On October 1, 1974, petitioner made an offer to its shareholders to exchange $10 principal amount of newly issued 12-percent subordinated debentures due in 1994 (the debentures) for each share of petitioner's common stock. The debentures were redeemable by petitioner at its election at any time after October 15, 1975. The purpose of the exchange offer, as set forth in an offering circular dated October 1, 1974, was as follows:

Purposes of Exchange

Management believes that the GN Common Stock is presently undervalued and that its purchase for a consideration consisting of the Debentures will benefit the Company, its remaining stockholders and the Debenture holders. Management also believes that it is in the best interests of stockholders to afford them a choice either to become holders of the Debentures, or to remain stockholders subject to possible increased risks and potential for increased benefits that may result from the increased indebtedness of GN resulting from the issuance of the Debentures and the concomitant decreased amount of GN Common Stock to be outstanding. In addition, management believes that future discussions concerning the sale of the Company, if any, would involve terms more favorable to remaining stockholders than would have been the case had the Exchange Offer not been consummated. There are at present no such discussions. * * *

Petitioner agreed to accept all shares which were tendered up to 400,000 and had the option to accept any shares in excess thereof up to a total of 800,000 shares.2 Pursuant to the exchange offer, petitioner acquired a total of 181,718 shares of its common stock by the end of October 1974 (the 1974 exchange). The shares were not retired but were held by petitioner as treasury stock.

At the time of the exchange offer, the value of the common stock, based on the price at which it was traded on the Pacific Stock Exchange, was somewhat in excess of $7 per share. The excess of the principal amount of the debentures ($10 principal amount for each share of stock) over the market value of the common stock acquired by petitioner amounted to $540,573 (the “discount amount”).

After the 1974 exchange was consummated, petitioner claimed deductions for the amortization of the discount amount for the remainder of 1974 and for the balance of the period here in controversy. The determined deficiencies arise from the disallowance for each year in dispute of $27,029 deducted by petitioner as amortization of the discount amount.

Section 163(a) provides for the deduction of “all interest paid or accrued within the taxable year on indebtedness.” If a bond is issued for an amount less than its face amount, the amount of the difference, called “original issue discount,” represents interest expense and may in general be amortized and deducted as interest over the life of the obligation. See Commissioner v. Nat. Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 145 (1974); Helvering v. Union Pacific Co., 293 U.S. 282, 284 (1934); Seaboard Coffee Service, Inc. v. Commissioner, 71 T.C. 465, 470 (1978); sec. 1.163–4(a), Income Tax Regs.3

The term “original issue discount” is defined in section 1232(b)(1) as “the difference between the issue price and the stated redemption price at maturity.” The “issue price” of bonds issued for property other than money was defined in section 1232(b)(2), in pertinent part, as in effect for the years in question, as follows:

In the case of a bond or other evidence of indebtedness, * * * (other than a bond or other evidence of indebtedness * * * issued pursuant to a plan of reorganization within the meaning of section 368(a)(1) * * *, which is issued for property and which—

(A) is part of an issue a portion of which is traded on an established securities market, or

(B) is issued for stock or securities which are traded on an established securities market,

the issue price of such bond or other evidence of indebtedness or investment unit, as the case may be, shall be the fair market value of such property. Except in cases to which the preceding sentence applies, the issue price of a bond or other evidence of indebtedness * * * which is issued for property (other than money) shall be the stated redemption price at maturity.

See also sec. 1.1232–3(b)(2)(iii), Income Tax Regs.

Thus, where the “established securities market” requirement of section 1232(b)(2) was satisfied and the bond was not issued pursuant to a statutory reorganization, the issue price of a bond issued for property was the property's fair market value; in those circumstances, the difference between the fair market value of the property and the principal amount of the bond was original issue discount. On the other hand, if the bond was issued pursuant to a plan of reorganization, its issue price was deemed to be the stated redemption price, meaning, of course, that there could be no original issue discount.4

By its terms, section 1232 applies only to the income to be recognized by the bondholder. The Income Tax Regulations provide, however, that the definition of “original issue discount” found in section 1232(b)(1) also applies with respect to the interest expense deductions of the issuer. Sec. 1.163–4(a)(1), Income Tax Regs.5 Accordingly, the question whether there was original issue discount on the issuance of the debentures in the 1974 exchange turns on whether the debentures were, within the meaning of old section 1232(b)(2), “issued pursuant to a plan of reorganization within the meaning of section 368(a)(1).”

Respondent contends that the debentures were issued as part of a reorganization in the form of a recapitalization under section 368(a)(1)(E), and, accordingly, that the debentures' issue price was equal to their redemption price.6 Petitioner argues that there was no section 368(a)(1)(E) reorganization, and that the debentures' issue price was equal to the fair market value of the stock for which they were exchanged. We hold for respondent.

The term “recapitalization” as used in section 368(a)(1)(E) is not itself defined in the Code and the regulations do not attempt a definition except by way of illustration. Sec. 1.368–2(e), Income Tax Regs. The Supreme Court has, however, explained that the term denotes a “reshuffling of a capital structure, within the framework of an existing corporation”. Helvering v. Southwest Consol. Corp., 315 U.S. 194, 202 (1942).

In a number of decided cases, exchanges by corporations of newly issued debentures for outstanding stock have been held to qualify as reorganizations described in section 368(a)(1)(E) (hereinafter E reorganizations). Microdot, Inc. v. United States, 728 F.2d 593 (2d Cir. 1984) (new debentures for outstanding common stock); Berner v. United States, 151 Ct.Cl. 128, 282 F.2d 720 (1960) (new debentures for preferred stock); Davis v. Penfield, 205 F.2d 798 (5th Cir. 1953) (new debentures for preferred stock); Hickok v. Commissioner, 32 T.C. 80 (1959) (new debentures for common stock); Seide v. Commissioner, 18 T.C. 502 (1952) (new debentures for preferred stock); Wolf Envelope Co. v. Commissioner, 17 T.C. 471 (19...

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  • Capitol Fed. Sav. & Loan Ass'n & Subsidiary v. Comm'r of Internal Revenue
    • United States
    • U.S. Tax Court
    • February 13, 1991
    ...States, 218 Ct. Cl. 517, 589 F.2d 1040, 1043 (1978); Carpenter v. United States, 495 F.2d 175 (5th Cir. 1974); Golden Nugget, Inc. v. Commissioner, 83 T.C. 28, 43-44 (1984). The application of the rule set forth herein will not have an adverse effect upon the ability of the Commissioner to ......

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