Halle v. United States

• Decision Date: 31 May 1965
• Docket Number: No. 9687.,9687.
• Citation: 346 F.2d 543
• Parties: Milton L. HALLE and Rachel N. Halle, his wife, Appellants, v. UNITED STATES of America, Appellee.
• Court: U.S. Court of Appeals — Fourth Circuit

346 F.2d 543 (1965)

Milton L. HALLE and Rachel N. Halle, his wife, Appellants, v. UNITED STATES of America, Appellee.

No. 9687.

United States Court of Appeals Fourth Circuit.

Argued January 8, 1965.

Decided May 31, 1965.

Eugene H. Schreiber and Charles M. Cahn, Jr., Baltimore, Md. (Blades & Rosenfeld, Baltimore, Md. on brief), for appellants.

Marco S. Sonnenschein, Atty., Dept. of Justice (Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson and David O. Walter, Attys., Dept. of Justice, Thomas J. Kenney, U. S. Atty., and Robert W. Kernan, First Asst. U. S. Atty., on brief), for appellee.

Before SOBELOFF and BOREMAN, Circuit Judges, and HUTCHESON, District Judge.

BOREMAN, Circuit Judge.

Taxpayers,¹ Milton L. and Rachel N. Halle, appeal from a judgment of the District Court denying them the claimed right to recover income taxes plus interest alleged to have been improperly assessed and collected.²

The facts were stipulated in the lower court. Prior to 1954 Halle had made charitable contributions to Damil Foundation, Incorporated (herein called the Foundation), an exempt charitable corporation. Interested in continuing the donations, taxpayer was advised of the tax benefits flowing from transactions in which he engaged as hereinafter recited. So minded, on November 24, 1954, Halle purchased from Livingstone & Company, a sole proprietorship, of Boston, Massachusetts, Mississippi Power Company bonds of the face value of $100,000 at a price of $110,000, plus accrued interest of $500. The bonds had been issued prior to January 22, 1951, had a maturity date in 1979, were callable at 100½ at any time on thirty days' notice, and earned interest at three percent (3%) per annum. To purchase the bonds Halle borrowed $100,500, the call price of the bonds, from Guaranty Trust Company of New York. For this loan he gave his personal note and pledged as collateral security the bonds purchased and a cash deposit. Interest on the loan was payable at 3¼% per annum. The remainder of the purchase price, $10,000, was paid by Halle from his personal funds. Incident to and simultaneous with the purchase of the bonds, Halle obtained an irrevocable "put" option from Livingstone whereby the latter agreed to repurchase the bonds at any time before January 5, 1955, at a price of 108 plus accrued interest.

On December 28, 1954, thirty-four days after the date of purchase, Halle donated the bonds to the Foundation subject to the lien of $100,500 held by Guaranty Trust Company, at the same time assigning the irrevocable "put" option to the Foundation. On the following day, December 29, the Foundation exercised the option by selling the bonds to Livingstone at 108 plus accrued interest. On that day Livingstone sent the Foundation a check for $8,181.33, the net proceeds due it from the sale. Of course, the Foundation discharged the bank's lien on the bonds and extinguished Halle's indebtedness to the bank.

Relying on section 171 of the Internal Revenue Code of 1954,³ 26 U.S.C.A. § 171, Halle elected to amortize the bond premium of $9,500 (the difference between the purchase price of $110,000 and the call price of $100,500) to the nearest possible call date which was December 24, 1954, thirty days after the date of purchase. As a result of the transaction, on the federal income tax return for 1954 Halle claimed deductions for amortization of bond premiums of $9,500, interest expense of $500 and charitable contributions of $8,225. (The accuracy of the figures is not disputed.) Upon auditing the return the Internal Revenue Service allowed the deduction for charitable contribution but disallowed the deductions for interest expense and amortization of bond premium. Consequently, additional tax of $3,999.12, plus interest of $1,282.35, was assessed against the taxpayer. He paid these sums, filed his claim for refund which was denied and brought this action to recover the total. The District Court upheld the disallowance of deductions of interest expense and bond premium amortization on the ground that the transaction was a sham. We think this was error.

The Government admits that this transaction meets the literal requirements of the provisions authorizing the deduction for amortization of bond premiums. It contends, however, that the transaction lies outside the plain intent of the statute because Congress in enacting section 171 intended that economic risk must be incurred before bond premiums could be so amortized, and in the case at bar the "put" option eliminated any "risk of loss." The District Court apparently agreed for it stated:

"In the instant case the `put\' option protected taxpayer against the risk of loss from the possible call of the bonds, that is, the `market reality\' of which the applicable section of the Code `takes cognizance\'." (232 F.Supp. at 464).

In Industrial Research Products, Inc. v. Commissioner, 40 T.C. 578 (1963), the transaction, including a "put" option, was factually similar to that before us in the instant case. At page 587 the Tax Court stated:

"Respondent Commissioner supports his present computation of the amount of the bond premiums by an argument that amortization of bond premium is limited to the amount of economic risk incurred and he argues that by reason of the put agreements petitioners incurred no economic risk greater than the difference between the bases of the bonds and the respective put prices. There is no merit in the argument. There is nothing in the statutes or in the legislative history of the pertinent sections which gives the slightest hint that the purpose of the legislation, allowing a bond premium deduction, is to allow a tax-free recovery of an amount that is subject to the risk of loss. In Hanover Bank v. Commissioner, 369 U.S. 672 82 S.Ct. 1080, 8 L.Ed.2d 187 the Supreme Court interpreted section 125 of the Internal Revenue Code of 1939 and reviewed its legislative history and subsequent amendments and also its earlier opinion interpreting the same statute in Commissioner of Internal Revenue v. Korrell, 339 U.S. 619 70 S.Ct. 905, 94 L.Ed. 1108. The purpose of this legislation is to allow the bond purchaser to recover a capital investment he makes in the form of the premium. * * *"

"The fact that petitioners had a contract with their seller which might insulate them against loss in the event of a call, has no effect on the amortization of the bond premium. * * *" (Note: Section 125 of the 1939 Code was the forerunner of Section 171 of the 1954 Code.)

The Tax Court found nothing in either Hanover or Korell, in which the Supreme Court was considering and interpreting Section 125 of the 1939 Code, the forerunner of Section 171 of the 1954 Code here involved, which persuaded it that the deduction for amortization of the bond premium should be disallowed. The Government sought no review of the Tax Court's decision in Industrial Research.

Although the District Court stated and the Commissioner argues that the Tax Court in the above cited case had not considered the "sham" argument now advanced by the Government, it is clear from the briefs filed in the Tax Court that the Government did present the same arguments there as in the case at bar as to that portion of the amortized premium covered by the "put." This decision of the Tax Court, which the Government permitted to stand unchallenged, is the only one which has come to our attention where the purchaser of bonds sought to provide some measure of protection through an agreement on the part of the bond seller to repurchase the bonds within a specified time at a stipulated price if so requested.

In Hanover Bank v. Commissioner⁴ and Commissioner of Internal Revenue v. Korell,⁵ the Court undertook to review the legislative history of the then pertinent Code sections providing for income tax deductions of amortized bond premiums. From our examination of those cases, we conclude that the primary concern of Congress was to equalize taxes between owners of tax-exempt bonds and owners of taxable bonds; that Congress was legislating for the "generality of cases"; that it not only created a new deduction but also required that the basis be adjusted to the extent of the deduction allowable for taxable bonds and disallowable for tax-exempt bonds; that, even if Congress had expected that some loss of revenue to the Government might be entailed, it might have decided that more equal treatment of taxpayers was more important than possible revenue loss; that it could not be argued that Congress lacked the legislative discretion to have reached such a conclusion. In Hanover, the Court observed that a bond premium is the amount a purchaser pays in buying a bond in excess of the face or call value of the bond; that bond interest is taxable to the recipient and when a premium has been paid the actual interest is not a true reflection of the bond's yield but represents in part a return of the premium paid. "* * * It was to give effect to this principle that Congress * * * enacted Section 125 of the 1939 Code, which for the first time provided for amortization of bond premium for tax purposes." (369 U.S. at 677, 82 S.Ct. at 1083.) The Court recognized, just as the Government contended, that Section 125 had created a tax loophole of major dimensions but stated that the words used by Congress, taken in the light of pertinent legislative history, were binding. The Court concluded: "* * * Nevertheless, the Government now urges this Court to do what the legislative branch failed to do or elected not to do. This, of course, is not within our province." (369 U.S. at 688, 82 S.Ct. at 1089.)

In the earlier case, Commissioner v. Korell (339 U.S. 619, 70 S.Ct. 905), to which the Tax Court referred also in Industrial Research, the taxpayer had purchased bonds at a premium which reflected the attractiveness of the convertible feature of the bonds rather than a high interest yield. The bonds were callable on thirty days' notice and the taxpayer amortized...