Morgan Guaranty Trust Co. of New York v. US

• Decision Date: 18 October 1978
• Docket Number: No. 460-73.,460-73.
• Citation: 585 F.2d 988
• Parties: MORGAN GUARANTY TRUST COMPANY OF NEW YORK v. The UNITED STATES.
• Court: U.S. Claims Court

585 F.2d 988

MORGAN GUARANTY TRUST COMPANY OF NEW YORK v. The UNITED STATES.

No. 460-73.

United States Court of Claims.

October 18, 1978.

Lydia E. Kess, New York City, attorney of record, for plaintiff; Davis Polk & Wardwell, John A. Corry, and H. Reed Wasson, New York City, of counsel.

Robert S. Watkins, Washington, D. C., with whom was Asst. Atty. Gen. M. Carr Ferguson, Washington, D. C., for defendant; Theodore D. Peyser, Donald H. Olson, Patricia B. Tucker, and James S. Maxwell, Washington, D. C., of counsel.

Before DAVIS, KASHIWA and KUNZIG, Judges.

OPINION

KASHIWA, Judge:

This income tax refund suit is before the court upon a joint stipulation of facts. Although the legal issues presented by the case are not new, they are by their very nature difficult. After a careful review of the stipulations, exhibits, briefs, and oral arguments presented, we find plaintiff is entitled to recover with the amount of recovery to be determined in a proceeding pursuant to Rule 131(c).

The case involves two separate issues. The first issue is whether plaintiff's March 15, 1962, gift to a charity of the right to receive all future payments on awards made by the Mixed Claims Commission (hereinafter referred to as MCC) constitutes an anticipatory assignment of income to the donee, a charitable trust, so as to justify the Internal Revenue Service's inclusion of the future payments in plaintiff's income in the year (1964) the payments are received by the donee.¹ Collateral to this issue is defendant's contention that if we hold for plaintiff on the assignment of income question because actual receipt of the payments was highly questionable at the time of the gift, then defendant is entitled to an offset against the refund owed under the doctrine of equitable recoupment. The second issue is whether plaintiff, an accrual basis taxpayer, must include in its 1964 gross income prepaid interest (i. e., interest actually received from its customers during the 1964 taxable year, but which was not earned or accruable under general accrual accounting principles until plaintiff's 1965 taxable year). Finally, since we find that plaintiff is entitled to recover on both issues, we must address defendant's contingent contention of whether part of plaintiff's refund recovery is barred by the statute of limitations.

The genesis of the assignment of income issue is traceable to the establishment of the MCC in 1922 to determine the amount to be paid by Germany in satisfaction of Germany's financial obligations to the United States and its nationals for losses and damages sustained during World War I.² During the 1920's and the 1930's the MCC determined the amounts of awards to be paid to United States nationals in respect of claims against Germany which it determined to be valid. Under the Settlement of War Claims Act of 1928, as amended,³ all payments by Germany in respect of such awards were deposited in a German special account in the United States Treasury. The Secretary of the Treasury was authorized to make payments to award holders from such account in accordance with certain priority rules prescribed by the statute.

In 1930 under the terms of a separate agreement, the German government issued bonds to the United States in amounts believed sufficient to pay all the awards made and to be made by the MCC.⁴ These bonds were to mature serially from 1930 to 1981, but no payments were ever made on account of any bonds maturing after September 30, 1931.

In 1953, after more than 20 years during which the German government made no payments in respect of the awards, a new agreement was entered into between the United States and the Federal Republic of Germany to settle the obligations for MCC awards still outstanding.⁵ The Federal Republic of Germany agreed to pay $97,500,000 in 26 annual installments from April 1, 1953, through April 1, 1978, and issued 26 non-interest bearing bonds to the United States to evidence this obligation. All of the payments under these bonds (except for a fee of one-half of 1 percent which the United States was authorized to deduct from each payment to an award holder) were to be applied by the United States in respect of amounts due to United States nationals and would suffice to amortize a substantial portion, but not all, of the awards.⁶

The parties have stipulated that by 1962 the long-term obligations of the Federal Republic of Germany (such as the ones issued to fund the 1953 settlement agreement) held no greater risks for the United States investors than long-term obligations of any of the most stable and highly industrialized foreign countries. While the market price of long-term obligations of the Federal Republic of Germany in 1962 reflected the risks inherent in any long-term obligation, the price did not reflect any specific concern as to the probability that the obligations would be met. The full faith and credit of the Federal Republic of Germany stood behind the serial bonds issued in 1953. Further, from the time of the 1953 agreement the Federal Republic of Germany has paid each payment when due on the bonds. No event had occurred prior to March 15, 1962 (the date of the charitable gift in issue here), which would indicate it would fail to meet the remaining obligations.

Under the Settlement of War Claims Act of 1928, as amended through 1947, the amount owed to each award holder was determined by adding to each award interest accrued to January 1, 1928. To this total, termed "statutory principal," there was added simple interest of 5 percent per annum on the unpaid statutory principal. All payments prior to August 6, 1947, were applied to reduce statutory principal. After that date payments were made on account of unpaid interest on statutory principal; however, for purposes of calculating additional interest on statutory principal, such payments were deemed to reduce unpaid statutory principal. By May 1972 all unpaid interest was finally satisfied and subsequent payments were applied on account of unpaid statutory principal.

On March 15, 1962, the records of the MCC showed that principal of $1,330,215.32 and interest of $1,231,063.02 remained unpaid in respect of awards owned by plaintiff for a total of $2,561,278.34. About 67 percent of the total awards held at that time had been made as compensation for the loss of accounts in German banks at the outbreak of World War I. Some of this 67 percent was acquired by plaintiff by purchase and some was awarded plaintiff with respect to its own accounts. Of the remaining awards, about 30 percent of the total were acquired by taxpayer because of legal actions taken against debtors in default on loans. The remaining awards, which accounted for about 3 percent of the total, were made as compensation for plaintiff's loss on Prussian Treasury bills held at the beginning of World War I.

Plaintiff did not ascribe tax bases to the awards when they were originally made in the 1920's and 1930's. Rather, as payments on the awards were received over the years, they were used to reduce the plaintiff's tax bases in the underlying accounts.⁷ Plaintiff's bases in the underlying accounts were reduced to zero by 1939. Accordingly, the annual payments received by plaintiff from 1953 to 1962 constituted taxable ordinary income to plaintiff when received.

On March 15, 1962, plaintiff irrevocably assigned all of its remaining interest in its awards of the MCC to the Morgan Guaranty Trust Company of New York Charitable Trust (hereinafter referred to as Trust). The Trust is a tax-exempt entity qualifying under section 501(c)(3) of the Internal Revenue Code, as amended. Plaintiff retained no interest whatsoever in the awards and all collections thereafter were received directly by the Trust.

In plaintiff's 1962 taxable year it claimed, and was allowed, a charitable deduction for the fair market value of the awards ($1,050,000) it donated to the Trust. The fair market value of the assigned awards was arrived at by discounting the projected receipts by 10 percent.

In 1964 the Trust collected $118,208 from the awards. Plaintiff did not report the $118,208 payment received by the Trust as income in 1964. On audit of the plaintiff's tax return, the Internal Revenue Service determined that the donation of the awards to the Trust in 1962 constituted an anticipatory assignment of income and, consequently, that the payment of $118,208 was 1964 taxable income to plaintiff.⁸ Accordingly, the Internal Revenue Service issued a deficiency notice.

The facts surrounding the prepaid interest issue are not as historically involved. Basically, plaintiff utilizes the accrual accounting method in accounting for interest income for financial reporting and federal income tax purposes and has done so for more than 50 years. The Federal Reserve Board requires plaintiff to use the accrual method of accounting for interest income for financial reporting purposes. Except where collection seems unlikely, plaintiff credits interest to income as earned, regardless of the time of receipt. On occasion, borrowers voluntarily pay interest on some loans, principally demand loans, in advance of the specified interest payment date; and such interest received in advance of the period to which it relates is included in income by plaintiff subsequently as earned. If the interest is never earned because the loan is called or because the borrower prepays the loan, plaintiff refunds the unearned portion of the interest to the borrower.

On its federal income tax return for taxable year 1964, plaintiff included in income $159,070.01 of interest received during prior taxable years but attributable to interest earned with respect to loans outstanding during 1964. On its federal income tax return for taxable year 1964, plaintiff did not include in income $165,739.75 of interest received in advance payments in 1964, to be earned in 1965, in accordance with the accrual method of accounting for interest which...