Preston v. Commissioner of Internal Revenue, 85.

• Citation: 132 F.2d 763
• Decision Date: 31 December 1942
• Docket Number: No. 85.,85.
• Parties: PRESTON v. COMMISSIONER OF INTERNAL REVENUE.
• Court: United States Courts of Appeals. United States Court of Appeals (2nd Circuit)

132 F.2d 763 (1942)

PRESTON v. COMMISSIONER OF INTERNAL REVENUE.

No. 85.

Circuit Court of Appeals, Second Circuit.

December 31, 1942.

Allin H. Pierce, of New York City, for petitioner.

Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key, A. F. Prescott, and Irving I. Axelrad, Sp. Assts. to Atty. Gen., for respondent.

Before L. HAND, SWAN, and CHASE, Circuit Judges.

SWAN, Circuit Judge.

The question presented is whether the petitioner in computing his taxable net income for the year 1937 is entitled, under section 23(b) of the Revenue Act of 1936, 26 U.S.C.A. Int.Rev.Code, § 23(b), to deduct as "interest paid * * * on indebtedness" payments made on a bond under seal by which he acknowledged himself indebted to United States Trust Company of New York as trustee in the sum of $125,000 and covenanted to pay said sum on October 15, 1954 with interest thereon at 4 per cent. per annum payable in quarterly instalments beginning on December 15, 1934.

Because of circumstances which need not be detailed, the petitioner, with commendable generosity, desired to set up a trust for the benefit of his sister-in-law, Alice, the widow of his deceased brother Jerome. On October 18, 1934, he borrowed $125,000 from a bank and delivered it to the United States Trust Company as trustee to be held pursuant to the terms of a trust indenture executed by him on the same date. The income of the trust was to be paid to Alice, with limitations over in case of her death or remarriage. The trustee was given broad powers of investment and was expressly authorized in its absolute discretion from time to time to loan money to the settlor on his unsecured note or bond maturing in not more than twenty years. On October 19, 1934 the settlor delivered to the trustee his bond under seal for $125,000 and interest, as above described, and received the trustee's check for $125,000, which he endorsed to the bank from which he had borrowed the same sum the day before. He also paid the bank $20.83 as interest on the demand loan for one day. On December 15, 1934 and quarterly thereafter, the petitioner caused the interest payments required by his bond to be made to the trustee It entered the payments as "interest" on the cash receipts and disbursements account which it kept for the trust, and it filed a fiduciary income tax return for the year 1937 showing receipt during the year of $5,000 as interest, the expenditure of $125.25 for commissions and expenses, and the distribution of the balance to the life beneficiary. For the year 1934 the petitioner filed a gift tax return in which he reported a gift of $125,000 to United States Trust Company as trustee, and paid the gift tax so reported.

In the opinion of the Tax Court, 44 B.T.A. 973, the basic question was whether or not the petitioner's bond was a legally enforceable obligation, and the conclusion was reached that it was unenforceable either by the trustee or the beneficiary. On the strength of later cases the Commissioner now concedes that the Tax Court erred in its view of the applicable New York law relating to a covenant under seal.^* His present contention is that the decision should be affirmed on the theory that the payments made as interest were not "interest on indebtedness" within the meaning of the tax law but were gifts, which the bond obligated the petitioner to make on the designated "interest" dates.

Under the findings of facts and opinion of the Tax Court we must take it that the "loan" by the trustee cannot be deemed consideration for the petitioner's covenant to pay the trustee $125,000 on October 15, 1954 and 4 per cent. annual interest before maturity. While the findings of fact as such do not include a finding that the trustee agreed on receipt of the money to lend it immediately to the petitioner, the opinion states that this is the only reasonable inference to be drawn from the steps taken and the carefully drafted provisions of the trust indenture. We cannot say that such inference is wholly unsupported by the evidence. Generally, loans by the Trust Company as trustee required approval by its investment committee. There is no proof that the committee functioned as to the loan in question, and the time element was so short that it is probable it did not. Failure to procure action by the committee is difficult to explain unless the trustee had already agreed to make the loan. If it had so agreed, the settlor never lost control of the sum he turned over to the trustee and, except for the seal, the case would fall exactly within our decision in Johnson v. Commissioner, 2 Cir., 86 F.2d 710. See also Guaranty Trust Co. v. Commissioner, 2 Cir., 98 F.2d 62. We therefore accept the Tax Court's view that "the practical effect of what was done was to set up a trust composed solely of petitioner's bond."

In Commissioner v. Park, 3 Cir., 113 F.2d 352 it was held, with Judge Biggs dissenting, that payment of interest on a gratuitous demand note, enforceable because under seal, entitled the obligor to interest deductions under the Revenue Acts of 1932 and 1934, whose provisions on this subject were identical with those of section 23(b) of the 1936 Act. The Commissioner attempts to differentiate the Park case because there the note was payable on demand while here maturity is deferred. He argues that payments made for the creditor's forbearance to demand immediate payment of the Park note could be deemed "interest," while here there has been no forbearance since the petitioner's note is not yet due. So far as forbearance is concerned we cannot see that it makes any difference whether the obligor bargains for a fixed forbearance or merely gets it de die in diem through grace of the creditor. The statutory language, "interest on indebtedness" does not...