Goodstein v. Comm'r of Internal Revenue

• Decision Date: 28 August 1958
• Docket Number: Docket No. 61466.
• Parties: ELI D. GOODSTEIN AND MOLLIE L. GOODSTEIN, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

30 T.C. 1178

ELI D. GOODSTEIN AND MOLLIE L. GOODSTEIN, PETITIONERS,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 61466.

Tax Court of the United States.

Filed August 28, 1958.

John P. Allison, Esq., and Sandow Holman, Esq., for the petitioners.

John M. Doukas, Esq., for the respondent.

1. Deductions— Interest.— Transaction whereby petitioner purported to purchase $10,000,000 face amount of United States Treasury notes, giving his note for all but $15,000 of the purchase price, held, lacking in substance and insufficient to create indebtedness. Disallowance of claimed interest deductions approved.

2. Capital Gain— Redemption of Debentures.— Gain on redemption of debentures in registered form acquired at a discount and held for more than 6 months, held properly reported as long-term capital gain. George Peck Caulkins, 1 T.C. 656,affd. 144 F.2d 482, followed.

ATKINS, Judge:

The respondent determined deficiencies in income tax for the calendar years 1952 and 1953 in the respective amounts of $29,118.51 and $126,586.96. The petitioners allege that the respondent erred in disallowing deductions claimed for interest paid in those years in the respective amounts of $50,000 and $170,511.82, in connection with the purchase of United States Treasury notes, the interest on which is fully taxable. Alternatively, they allege that the respondent erred in failing to allow as a loss deduction for 1952 an amount of $14,722.02 paid in connection with the acquisition of the Treasury notes and in failing to exclude from taxable income of the year 1953 an amount of $120,787.29 included by them as interest on Treasury notes.

The respondent, by amendment to his answer, raises a separate issue by alleging that he erred in accepting the petitioners' treatment of gain on the redemption of certain debentures in 1952 as long-term capital gain. He now seeks to treat the gain realized on the redemption as ordinary income, and claims an increased deficiency.

FINDINGS OF FACT.

Some of the facts are stipulated and are incorporated herein by this reference.

The petitioners are husband and wife who reside in Fitchburg, Massachusetts. They filed joint income tax returns on the cash method for the calendar years 1952 and 1953 with the district director of internal revenue at Boston, Massachusetts. The husband, Eli D. Goodstein, will herein be called the petitioner. For many years he has been treasurer of a lock company with offices at Fitchburg. He is an accountant by profession. He was not a dealer in securities, but he had purchased and sold Government securities prior to 1952.

The Interest Issue.

In October 1952, the petitioner first met M. Eli Livingstone who was engaged as sole proprietor in business in Boston as a broker and dealer in securities, operating under the name of Livingstone & Company, hereinafter called Livingstone.

Eli Livingstone informed the petitioner that United States Treasury 1 3/8 per cent notes, maturing on March 15, 1954, were then selling below par, and that he could arrange for the financing of the purchase of such notes upon a small downpayment by the purchaser. These Treasury notes carried interest coupons which matured every 6 months, in March and September, and such interest was not exempt from Federal income tax. They discussed the amount of notes to be purchased, the amount of the downpayment, and the income tax consequences of such a transaction.

Thereafter the petitioner entered into a transaction, the detailed steps of which were in the form as hereinafter described. All the steps, except as noted, occurred on October 27, 1952.

The petitioner gave Livingstone an order to buy for him $10,000,000 face amount of the 1 3/8 Treasury notes maturing March 15, 1954, and gave to Livingstone his check for $15,000, bearing the notation ‘To apply purchase U.S. Treasury 1 3/8 %.’ Livingstone, as agent, placed an order with C. J. Devine & Co. (herein called Devine), bond dealers for the purchase from that company of $10,000,000 of the Treasury notes. Livingstone issued to Devine a confirmation slip showing the purchase by it, as agent, from Devine of $10,000,000 of the Treasury notes. Livingstone also issued to the petitioner a confirmation slip showing a purchase, as petitioner's agent, of that amount of the Treasury notes. Both confirmation slips showed the price as 99 4/32, which amounted to a principal sum of $9,912,500, plus accrued interest on the Treasury notes in the amount of $16,712.71, making a total purchase price of $9,929,212.71. Neither showed any commission charged. Devine, by letter dated October 29, addressed to Livingstone, confirmed the sale to Livingstone of the $10,000,000 of Treasury notes for the account of the petitioner, stated that the notes had been delivered to the Guaranty Trust Company, acknowledged payment, and set forth the serial numbers of the notes.¹

The petitioner executed and delivered to Seaboard Investment Corp., hereinafter more fully described and referred to as Seaboard, his promissory note in the sum of $9,914,212.71, payable on March 15, 1954, with interest at the rate of 2 3/8 per cent per annum. The note recited that the petitioner had deposited with Seaboard as collateral the Treasury notes in the amount of $10,000,000. It was provided that all payments received by the obligee directly from or indirectly for the account of the petitioner should be applied first to the payment of interest and any balance to principal, as the petitioner might elect. The note permitted prepayment upon the payment of interest at the rate of 1/4 of 1 per cent per annum from date of prepayment to maturity. It contained the following provisions:

The undersigned gives to the obligee a lien against the securities pledged for the amount of the obligations set forth herein, and gives to the obligee the right to hypothecate and use the securities pledged for any purpose while so pledged. Said right is not to be inconsistent in any manner with the ownership by the undersigned of said collateral, and with the right to the undersigned to obtain the return of the collateral at any time upon tender of payment of the principal and interest due hereunder.

The petitioner addressed a letter to Livingstone directing that the Treasury notes be delivered to Seaboard against payment by that company of $9,914,212.71. He also addressed a letter to Seaboard directing that company to receive the Treasury notes from Livingstone against payment to Livingstone of $9,914,212.71, ‘which is the proceeds of my loan with you.’ Actually neither the petitioner nor Livingstone nor Seaboard obtained physical possession of the Treasury notes. Instead, they were delivered by Devine to Guaranty Trust Company of New York, pursuant to directions in a letter from Livingstone to Devine that they be delivered for Livingstone's account as agent for the petitioner. On the same day Livingstone, by letter, instructed Guaranty Trust Co. to receive the Treasury notes from Devine, account of the petitioner, against payment to Devine of $9,929,212.71, and instructed that its (Livingstone's) account be charged in that amount.

The function of the Guaranty Trust Company in the transaction was to clear securities (receive and deliver securities), according to instructions of Livingstone, who had an account with the bank for that purpose. For its services Guaranty Trust Company received a fee. The Treasury notes were received from Devine by Guaranty Trust Company, which duly charged Livingstone's account on its books with the sum of $9,929,212.71 and credited Devine's account with the same amount.

On the same date, October 27, 1952, by another letter to Guaranty Trust Company, Livingstone instructed Guaranty Trust Company to deliver to Devine, from its (Livingstone's) account, the $10,000,000 face amount of Treasury notes against payment of $9,927,650.21. In accordance with these instructions the same Treasury notes were redelivered on the same day by Guaranty Trust Company to Devine. Devine made payment by its check on the Guaranty Trust Company, certification of which was based upon the amount of the credit to Devine's account above referred to which was made when it delivered the Treasury notes earlier in the day. On the same day Livingstone issued a confirmation slip to Seaboard stating that as agent for Seaboard it had sold for Seaboard's account $10,000,000 face amount of Treasury notes at 99 7/64 for a total principal price of $9,910,037.50, plus interest in the amount of $12,500, resulting in a net selling price of $9,915,150.21.² The petitioner did not give an order for such sale and was not aware of it at that time.

The books of Seaboard contain entries under date of October 27, 1952, recording a note receivable from the petitioner in the amount of $9,914,212.71 and crediting ‘Accounts Receivable— L. & Co.‘ in the same amount ‘To record liability to L. & Co. for bonds delivered to Guaranty Trust Co.’

Between October 1952 and May 1953 the petitioner issued his checks to Seaboard on the dates and in the amounts noted below. Each check bore a notation that it was in part payment of interest and each was accompanied by a letter of transmittal in which the petitioner stated that the check was in part payment of interest on the note of October 27, 1952. Over the same period the petitioner received from Seaboard payments, apparently by check, in the amounts set forth below and gave his promissory notes therefor to Seaboard. The dates of payments by Seaboard to the petitioner are those indicated by the records of Seaboard.

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Checks of           Payments received by
                petitioner
                                    petitioner from Seaboard
                

Date          Amount     Date cashed   Date          Amount
                Oct. 30, 1952 $40,000.00 Nov. 10, 1952 Oct. 14, 1952 $40,000.00
                Dec. 12, 1952 10,000.00  Dec. 17, 1952 Dec. 18, 1952 10,000.00
                Jan. 2, 1953  10,000.00  Jan. 7, 1953  Jan. 5, 1953  10,000.00
                Jan. 19, 1953 10,000.00

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