National Life and Accident Insurance Co. v. United States, Civ. A. No. 3304.

• Decision Date: 27 July 1965
• Docket Number: Civ. A. No. 3304.
• Citation: 244 F. Supp. 135
• Parties: The NATIONAL LIFE AND ACCIDENT INSURANCE COMPANY, Plaintiff, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — Middle District of Tennessee

244 F. Supp. 135

The NATIONAL LIFE AND ACCIDENT INSURANCE COMPANY, Plaintiff, v. UNITED STATES of America, Defendant.

Civ. A. No. 3304.

United States District Court Middle District Tennessee, Nashville Division.

July 21, 1965.

As Corrected July 27, 1965.

Walter M. Robinson, Jr., and James R. Tuck, Associate General Counsel, National Life & Accident Ins. Co., Nashville, Tenn., for plaintiff.

George A. Hrdlicka, Tax Division, Department of Justice, Washington, D. C., and James F. Neal, U. S. Atty., Nashville, Tenn., for defendant.

WILLIAM E. MILLER, Chief Judge.

Plaintiff taxpayer qualifies as a life insurance company under provisions of the Internal Revenue Code (Sections 801 et seq. of the 1954 Code) which impose upon such companies a plan of taxation substantially different from that imposed upon individual and corporate taxpayers generally. This action is to recover income taxes alleged to have been erroneously collected under such plan for the tax year 1957. The total recovery sought is $29,332.75 plus interest. The Government has conceded that plaintiff is entitled to a refund of $7,361.68 plus interest at the per annum rate of six per cent, but contests plaintiff's right to recover the balance. Plaintiff's claim for the balance arises out of the redemption prior to maturity of certain United States bonds.

An identical claim for tax refund has been presented in another district court by two other life insurance companies. That court denied any recovery. Equitable Life Ins. Co. and Bankers Life Co. v. United States, D.C., 232 F.Supp. 150 (S. D.Iowa 1964). The Court of Appeals of its circuit affirmed. 340 F.2d 9 (8th Cir. 1965). This Court reaches substantially the same result but for entirely different reasons.

The bonds in question are of two series, 2½% Treasury Bonds, Investment Series A, and 2½% Savings Bonds, Series G. Treasury Department Circulars applicable to each series and the bonds themselves provide that full face value cannot be obtained upon redemption unless the bonds are held to maturity. A table on each bond sets out fixed redemption values which vary with the length of time the bond is held, full face value not being attained until maturity. For example, the redemption value of a savings bond with a face value of $5,000 varies from a low of $4,735 during the fourth year after issue to a high of $5,000 at maturity twelve years after issue. The redemption value of a similar investment bond which matures in eighteen rather than twelve years varies from a low of $4,634 to a high of $5,000 at maturity. With both series of bonds interest is paid semi-annually at the per annum rate of 2½%.

In 1957 plaintiff presented for redemption prior to maturity bonds of both series which it had purchased from the Treasury Department in prior years. All of the bonds had been purchased for face value. Plaintiff received less than face value upon redemption in accordance with the redemption value tables discussed above. The total amount by which face value exceeded redemption value for all of the bonds so redeemed in 1957 was $286,120.

A cash basis taxpayer, plaintiff did not reflect these bond redemptions in the computation of its income tax liability for 1957 at the time that it prepared its original return. It now claims the right to do so to the full extent of the $286,120 on the basis of statements in Treasury Department circulars that the difference between face and redemption value is a refund of interest previously paid. The pertinent language cited which appears verbatim in the offering circulars for both bond series is as follows:

"A table of redemption values appears on each bond, and the difference between the face amount of the bond and the redemption value fixed for any period represents an adjustment (or refund) of interest."

This statement is amplified in the circular cited which sets out the regulations governing the investment series bonds as follows:

"Full advantage of interest at the rate specified may be secured only if the bond is held to maturity. If the bond is redeemed before maturity, the difference between the face or full maturity value and the current redemption value then payable in accordance with the table printed on each bond will represent an adjustment of interest to the rate appropriate for the shorter term, as set forth in the table attached to the circular announcing the offering of the bonds."

Tables attached to the offering circulars set out the per annum interest rate (captioned "Investment Yield") resulting from each redemption value. For both series of bonds the resulting interest rate is graduated from an initial low of 0.1%, reaching 2½% at maturity.

These provisions clearly indicate that the redemption value tables were an integral part of the agreed plan of compensation for the use of the plaintiff's and other bondholders' money. The varying redemption values were the means selected to adjust the per annum interest rate for the length of time the bonds were held. It is not at all unusual for interest rates to be dependent in part upon the length of time for which capital is used and this practice of the financial world has been recognized by the courts in income tax litigation. E. g., Pattiz v. United States, 311 F.2d 947 (Ct.Cl. 1963); Equitable Life Assurance Society of United States v. United States, 181 F.Supp. 241 (Ct.Cl.1960). Thus, the Court is of the opinion that upon redemption prior to maturity plaintiff did not incur a loss on the bonds themselves but did indeed refund a portion of the interest it had previously received. This interpretation is identical to that of the Internal Revenue Service rendered over twenty years ago in a ruling under section 23(e) of the 1939 Code (section 165 (c) of the 1954 Code), I.T. 3504, 1941-2 Cum.Bull. 93:

"Upon such a redemption before maturity, although there is for the sake of convenience paid over to the bondholder only the net difference, he in effect or constructively receives the full face amount of the bond and simultaneously refunds previously realized interest to the extent of the difference between the face amount of the bond and the net amount he actually receives at the time of the redemption.

* * * * * *

"Accordingly, it is held that, in so far as the bond itself is concerned, a purchaser of such a bond has no gain or loss, either ordinary or capital upon its redemption."

Under this construction of the contract between the Treasury Department and the bondholders, plaintiff was paid interest at the per annum rate of 2½% subject to the condition subsequent that the bonds be held to maturity. This conclusion is also in accord with the interpretation of the Internal Revenue Service contained in the ruling cited above:

"The obligation on the part of the bondholder to refund, in the event of redemption of the bond before maturity (except in certain cases upon death), a certain portion of the interest previously paid to him is a condition subsequent in determining whether he was entitled to receive and use as his own such interest payments."

If this condition subsequent is not fulfilled and a bond is surrendered prior to maturity, a lower per annum interest rate becomes applicable and the bondholder is contractually obligated to repay the difference between what he is entitled to retain at the resulting lower rate and what he has received at the higher 2½% rate.

This ruling of the Internal Revenue Service not being applicable to life insurance companies for reasons which will be discussed below, the Government in this action contends that the repayment of previously received interest is not recognizable for income tax purposes because such repayment was voluntary, the taxpayer being under no obligation to present the bonds for redemption prior to maturity. It is on this ground that the District Court for the Southern District of Iowa denied recovery. Equitable Life Ins. Co. and Bankers Life Co. v. United States, supra.

The only authority cited in the present action for this proposition is a decision by the Court of Appeals of this circuit, United States v. Simon, 281 F.2d 520 (6th Cir. 1960). In addition to Simon, the Iowa District Court relied upon Crellin's Estate v. Commissioner, 203 F.2d 812 (9th Cir. 1953) and Grandview Mines, 32 T.C. 759 (1959). All three of these decisions are clearly distinguishable from the present action. Simon involved rental income the refund of which the Court of Appeals recognized had no legitimate business purpose but was designed solely to obtain a tax advantage for the lessors and/or the lessee, a corporation wholly owned by the lessors. Crellin's Estate involved the payment of dividends by a corporation under the mistaken belief that doing so would reduce its tax liability and the repayment of such dividends by the shareholders upon discovery of the mistake. Both of these decisions involved refunds which clearly had no legitimate business purpose but rather served tax manipulation ends. They do not require a finding that the repayments of interest in the present action were made "voluntarily" as they define that term merely because there was no legal obligation to surrender the bonds before maturity. It is not contended here that the surrender of the bonds was not a bona fide transaction. As a result of its decision to surrender the bonds before maturity, plaintiff taxpayer became contractually obligated to repay a portion of the interest it had previously received. The total amount so repaid was but a small percentage of the value of the bonds surrendered and the tax benefit which plaintiff now seeks is in turn but a small percentage of the amount repaid. Such repayment does not fall within the definition of "voluntary" established by Simon and Crellin's Estate.

Nor does Grandview Mines alter the result. The taxpayer there had received income in one year under a contract which entitled it to 50% of the net income derived from the operation of its mines. The...