Paine v. Commissioner of Internal Revenue, 15332

• Decision Date: 10 July 1956
• Docket Number: 15333.,No. 15332,15332
• Citation: 236 F.2d 398
• Parties: F. Rodney PAINE and Anna H. Paine, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. Cecil B. MYERS TRUST u/w Lucy Myers, Deceased, Cecil B. Myers, James S. Matteson and Northern Minnesota National Bank, Trustees, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Eighth Circuit

236 F.2d 398 (1956)

F. Rodney PAINE and Anna H. Paine, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Cecil B. MYERS TRUST u/w Lucy Myers, Deceased, Cecil B. Myers, James S. Matteson and Northern Minnesota National Bank, Trustees, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Nos. 15332, 15333.

United States Court of Appeals Eighth Circuit.

July 10, 1956.

John W. Hughes, Chicago, Ill. (John E. Hughes and Harold R. Burnstein, Chicago, Ill., with him on the brief), for petitioners.

David O. Walter, Atty., Department of Justice, Washington, D. C. (H. Brian Holland, Asst. Atty. Gen., Ellis N. Slack and Hilbert P. Zarky, Attys., Department of Justice, Washington, D. C., with him on the brief), for respondent.

Before WOODROUGH, JOHNSEN and VOGEL, Circuit Judges.

JOHNSEN, Circuit Judge.

The Tax Court held, 23 T.C. 391, that each of two unrelated trusts had derived ordinary income, and not capital gain as reported in their tax returns, from sales of similar notes made by them in the years 1947, 1948 and 1949. Both situations, in their tax consequence, are before us on petitions to review the Tax Court's decision.

Such differences in details as exist between the two situations are admittedly without significance on the result here, so that the facts can for present purposes be stated generally, in common application to both cases.

Niles Land Co. was the owner of a number of tracts of land in the iron-range section of Minnesota. So far as its ownership was concerned, the property apparently had no use or value, except in relation to the ore which it contained. Niles accordingly engaged in making leases with mining companies, under which it would receive a fixed royalty per ton on all ore removed, with provision for a minimum sum to be paid to it annually under each lease.

On the two tracts related to the present situation, Niles had entered into such leases, on May 1, 1902, with Chemung Iron Co., for a 50-year term. Chemung later assigned the leases to Oliver Mining Co. In 1915, Niles made claim that one of the leases had been breached and sought to have it cancelled, but the court held that no violation of the lease provisions had occurred. See Niles Land Co. v. Chemung Iron Co., 8 Cir., 234 F. 294. Thereafter (perhaps, among other reasons, to escape further lease controversies) Oliver negotiated with Niles for a purchase of the land. The two leased tracts were resultingly sold by Niles to Oliver on July 2, 1917, with deeds of conveyance being made to Oliver and purchase-money mortgages being executed in favor of Niles.

The record contains a stipulation that the agreed purchase price for the one tract was $4,739,978.25, and for the other $1,347,325.00. According to the stipulation, these purchase prices were arrived at by taking the number of tons of ore which mining engineers, representing the parties, estimated that each tract contained and multiplying this quantity by a value for the ore of 25 cents per ton. Niles further agreed that the royalties which had theretofore been paid to it under each lease should be credited as payments upon the purchase price. Promissory notes, with Oliver as maker and United States Steel Corporation as guarantor, were duly issued to the order of Niles for the balance, aggregating as to the one tract $4,461,853.25, and as to the other $1,314,935.00, and secured respectively by the mortgages referred to above.

The notes of each transaction were in serial form, with equal amounts of the purchase price maturing every six months, up to July 1952, and with a provision in each instrument that it was "without interest until after maturity." There was an impairment-of-security clause in the mortgages, to the effect that, if, at the maturity date of any note, more ore should have been removed from the land than an amount equal in value, at 25 cents per ton, to such part of the purchase price as had up to that time been paid, the mortgagor should forthwith make payment, upon the next maturing notes, of "a sum equal to the value of such excess quantity of ore at the rate of twenty-five (25) cents per ton * * as advance payments upon said notes."

The mortgagor was not, however, entitled to any allowance or deduction from the face amount of the notes, by reason of such advance payments being made upon them before their maturity. Nor was there a right to any allowance or deduction from the face amount of the instruments for any other prepayments which the mortgagor might desire to make. Also, under the acceleration clause of the mortgages, the mortgagor was liable for payment of all the notes in their full amount at any time, in case of a default on its part, for more than 30 days after written notice by the mortgagee, in failing to make payment of any individual note at its maturity, or in failing to make advance payments upon the notes for ore removed in excess of the amount of the purchase price which had up to that time been paid, or in failing to keep taxes and assessments current as required by the mortgage — if the mortgagee elected "to declare the entire amount of the said promissory notes to be due and payable."

Thus, Oliver and United States Steel, as its guarantor, were subject to an absolute obligation to pay the full face amount of the notes under all conditions — whether the instruments should be paid before their maturity dates by advance payments made because of diminution in the amount of the security or otherwise, or whether they might acceleratedly be caused to become due from a default, even though this should occur only six months after their issuance. The significance of this aspect will be apparent later, in our discussion of the Tax Court's holding that part of the face amount of the notes "was intended as a payment of interest"; that such part "is not explainable as, and could not constitute a portion of, the purchase price"; and that the amount thereof accordingly would, at whatever time it was received (here on sales made by the holders of the notes shortly before their maturity dates), represent ordinary income and not capital gain derived from holding the securities. 23 T.C. at page 400.

The stipulation in the record further states that, upon conveyance of the lands being made to it, Oliver had set up on its books and records, as its basis for the property in each case, the face amount of the notes and mortgage, and that this basis had been used by it continuously, since 1917, for depletion purposes. And in this connection, it may incidentally be observed that the record is without even so much as an intimation that Oliver had at any time claimed, against Niles, or for its own tax purposes, or in any other connection, that any part payable on the notes represented in the transactions something other than agreed and deferred purchase price, either interest or other element.

Niles — as would naturally be done, we think, in respect to any such long-term, noninterest-bearing securities, for tax purposes and to facilitate the distribution which it contemplated making of the notes to its stockholders — immediately set up a basis for the notes of less than their face amount, computed in the particular situation by applying 5 per cent (the year was 1917) equivalently as a discount rate to each year of the term of the note. The parties give this illustration in their stipulation: "For example, the July 20, 1917 value of the note due on July 20, 1948 one of those here involved in the face amount of $31,943.01 was computed by multiplying 5 per cent times $1 for 31 years, arriving at a result of $1.55. This amount, $1.55 plus $1, or $2.55, divided into $31,943.01, equals $12,526.63." The difference between the face amount of the note and the basis or value which Niles thus computed therefor (in the case of the note used as an example this difference was $31,943.01 less $12,526.63) was what the Tax Court held as to each of the notes here involved "was intended by Oliver and...