Iglesias v. U.S.

• Decision Date: 01 June 1988
• Docket Number: D,No. 642,642
• Citation: 848 F.2d 362
• Parties: -1264, 88-1 USTC P 9389 Andres IGLESIAS, Plaintiff-Appellee, v. The UNITED STATES of America, Defendant-Appellant. ocket 87-6182.
• Court: U.S. Court of Appeals — Second Circuit

Page 362

848 F.2d 362

61 A.F.T.R.2d 88-1264, 88-1 USTC P 9389

Andres IGLESIAS, Plaintiff-Appellee, v. The UNITED STATES of America, Defendant-Appellant.

No. 642, Docket 87-6182.

United States Court of Appeals Second Circuit.

Argued Feb. 26, 1988.

Decided June 1, 1988.

William Hoppen, New York City (Jillson, Bedford & Hoppen, Nathaniel F. Bedford, Robert M. Willan, of counsel), for plaintiff-appellee.

Susan P. Johnston, New York City, Asst. U.S. Atty., S.D.N.Y. (Rudolph W. Giuliani, U.S. Atty., S.D.N.Y., Nancy Kilson, Asst. U.S. Atty., of counsel), for defendant-appellant.

Before FEINBERG, Chief Judge, PRATT, Circuit Judge, and GLASSER, ^* District Judge.

GLASSER, District Judge:

Plaintiff, Andres Iglesias, brought this action for a refund of the income tax paid on prejudgment interest recovered by plaintiff pursuant to a United States court judgment. Plaintiff, a nonresident alien, maintains that the prejudgment interest he received was not taxable income under Sec. 861 of the Internal Revenue Code, 26 U.S.C. Sec. 861 (1986), and Treasury Regulation Sec. 1.861-2(a)(1). The district court held that plaintiff was entitled to a tax refund and granted plaintiff's motion for summary judgment. We hold that the prejudgment interest plaintiff recovered falls within the category of income Congress intended to tax under I.R.C. Sec. 861 and reverse the judgment of the district court.

Facts

In 1965 and 1966, plaintiff purchased shares in a Netherland Antilles mutual fund through First National City Bank (New York) ("Citibank"). The mutual fund shares were exempt from United States income tax. Citibank sold the shares in 1971 to satisfy debts owed to Citibank by corporations with which plaintiff was associated. Claiming that Citibank had converted his mutual fund shares, plaintiff sued Citibank in the United States District Court for the Southern District of New York. The district court, in an opinion filed June 22, 1979, held that Citibank had converted plaintiff's shares, and judgment was entered on July 12, 1979, awarding plaintiff (1) the value of the shares when they were converted, (2) the increase in the market value of the shares prior to trial, (3) interest on the principal from the date of conversion to satisfaction of the judgment, and (4) costs. After this court affirmed the district court's judgment, Citibank paid plaintiff $324,344.70 in satisfaction of the judgment. The prejudgment interest component of that amount was $106,429.91.

Plaintiff paid, under protest, $47,928.71 in United States income taxes, as well as interest, on the prejudgment interest component of the judgment and simultaneously filed for a refund. On October 17, 1985, plaintiff filed this action to recover the income tax and interest plaintiff had paid. In a decision dated April 29, 1987, Iglesias v. United States, 658 F.Supp. 856 (S.D.N.Y.1987), the district court granted plaintiff's motion for summary judgment, denied defendant's cross-motion, and held that plaintiff was entitled to an income tax refund. The defendant appeals, claiming that the prejudgment interest received was taxable as income from a source within the United States under Sec. 861 of the Internal Revenue Code.

Discussion

As a nonresident alien, plaintiff is obligated to pay income tax only on income "derived from sources within the United States" or "effectively connected with the conduct of a trade or business within the United States." 26 U.S.C. Sec. 872. Section 861 of the Internal Revenue Code includes within the definition of income from sources within the United States "[i]nterest from the United States or the District of Columbia and interest on bonds, notes, or other interest-bearing obligations of noncorporate residents or domestic corporations," with certain listed exceptions not applicable here. 26 U.S.C. Sec. 861(a)(1). Section 862(a)(1) provides that "interest other than that derived from sources within the United States as provided in section 861(a)(1)," shall be deemed to be income from sources without the United States.

Treasury Regulation Sec. 1.861-2(a)(1) (1975) provides in relevant part:

Interest.

(a) In general.

(1) Gross income consisting of interest fron the United States or any agency or instrumentality thereof ..., a State or any political subdivision thereof, or the District of Columbia, and interest from a resident of the United States on a bond note, or other interest-bearing obligation issued or assumed by such person shall be treated as income from sources within the United States. Thus, for example, income from sources within the United States includes interest received on any refund of income tax imposed by the United States, a State or any political subdivision thereof, or the District of Columbia. Interest other than that described in this paragraph is not to be treated as income from sources within the United States....

(emphasis added).

Plaintiff maintains that the prejudgment interest he received from Citibank is not taxable because it stands in place of nontaxable dividends which plaintiff would have received had Citibank not converted plaintiff's mutual fund shares. Plaintiff also maintains that the judgment directing Citibank to pay plaintiff prejudgment interest is not an "interest-bearing obligation issued or assumed" by Citibank as described in Treasury Regulation Sec. 1.861-2(a)(1) because Citibank did not voluntarily take on the obligation to pay interest.

Defendant argues that the prejudgment interest paid to plaintiff is income from a source within the United States under the plain language of Sec. 861 because the interest was paid by a United States resident, Citibank. Defendant contends Treasury Regulation Sec. 1.861-2(a) does not narrow the scope of Sec. 861. Defendant also maintains that the prejudgment interest component of the judgment awarded plaintiff did not constitute compensation for lost dividends.

In granting plaintiff summary judgment, the district court apparently considered both the tax-exempt nature of the converted securities as well as the language of Sec. 861. The court held:

Defendant offers no policy reason, and I can find none, for straining the statutory language to reach such an unjust result. The language "interest-bearing obligations of residents" does not in terms or in the context of 26 U.S.C. Sec. 861(a)(1) mean a judgment against a resident which includes prejudgment interest. If Congress had intended to tax the otherwise exempt income of non-resident aliens when the income was misappropriated by a United States resident, it would not have used the language of 26 U.S.C. 861(a)(1).

658 F.Supp. at 857-58.

Plaintiff's contention that the prejudgment interest was a substitute for the nontaxable dividends declared on his converted offshore shares and therefore that interest should similarly be nontaxable has no merit as the discussion which follows will, it is believed, demonstrate.

The modern law of conversion is derived from the common law action of trover which redressed an interference with one's interest in a chattel that was substantial enough to justify compelling the wrongdoer to pay for it as in a forced sale. That is to say, the measure of damages to which the plaintiff was entitled was the value of the property at the time and place of the conversion. For a more extended discussion, see Prosser, The Nature of Conversion, 42 Cornell L.Q. 168 (1957).

Although initially only chattels could be the objects of conversion, the tort was eventually extended to include documents which embodied an intangible right, such as stock certificates and bonds. Pierpoint v. Hoyt, 260 N.Y. 26, 182 N.E. 235 (1932); W. Prosser & W. P. Keeton, The Law of Torts 91 (5th ed. 1984); Comment, Conversion of Choses in Action, 10 Ford.L.Rev. 415 (1941). Where the subject of the conversion had a fluctuating value, the measure of damages was its value at the time of conversion or within a reasonable time after the discovery of the conversion, whichever is higher. "To hold otherwise would enable the defendants to enjoy the proceeds of their own wrong and deprive the plaintiff of any compensation if the converted securities should depreciate in market value after the date of the conversion." German v. Snedeker, 257 App.Div. 596, 597, 13 N.Y.S.2d 237, 238 (1st Dep't), aff'd, 281 N.Y. 832, 24 N.E.2d 492 (1939); Wright v. Bank of Metropolis, 110 N.Y. 237, 249, 18 N.E. 79 (1888); In re Salmon Weed & Co., 53 F.2d 335, 340-41 (2d Cir.1931).

Iglesias is correct in contending that it has long been the New York rule that to indemnify the plaintiff completely, interest is recoverable of right in an action for conversion. Flamm v. Noble, 296 N.Y. 262, 268, 72 N.E.2d 886, 888 (1947); Wilson v. City of Troy, 135 N.Y. 96, 104-05, 32 N.E. 44 (1892). As Flamm, Wilson, and countless other cases make plain, however, the award of interest is to indemnify the plaintiff for his property that was converted and not as a substitute either in amount or character for the yield the converted property would have produced.

Other legal principles compel the conclusion that the plaintiff's position has no merit. It is well settled that when the defendant satisfies the judgment obtained against him in an action for conversion, title vests in him as of the time of the conversion which is "the date fixed by law for the compulsory purchase." 1 F. Harper, F. James, & O. Gray, The Law of Torts 171 (2d ed. 1986). The satisfaction of the judgment in the plaintiff's action against Citibank vested title to the converted shares in Citibank as of the date of the conversion and the plaintiff had nothing more to do with those shares. W. Prosser & W. P. Keeton, The Law of Torts 89-90 (5th ed. 1984).

The interest awarded by the terms of the judgment that was entered by the district court was 7 1/2% from December 22, 1971, to August 31, 1972, and 6% from September 1, 1972, to the date of the satisfaction of the judgment. The interest...