Swenson Land & Cattle Co. v. Comm'r of Internal Revenue
| Decision Date | 30 July 1975 |
| Docket Number | Docket No. 2309–71. |
| Citation | 64 T.C. 686 |
| Parties | SWENSON LAND AND CATTLE CO., INC., PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
T Corp. incurred interest expenses on account of its long outstanding bond indebtedness, which indebtedness T Corp. was empowered to prepay in whole or in part on Dec. 31 of each year. During several of the years in which T Corp. continued its bond indebtedness, it invested a large portion of its available funds in short-term (less than 1 year) tax-exempt securities. Held, in the circumstances of this case, T Corp. did not incur or continue its indebtedness for the purpose of carrying tax-exempt securities as contemplated by sec. 265(2), I.R.C.1954. S.L. Warhaftig, for the petitioner.
Walter C. Welsh and Peter W. Mettler, for the respondent.
The Commissioner determined deficiencies of $15,625.70 and $14,812.23 in petitioner's Federal income taxes for the calendar years 1967 and 1968, respectively. At issue are: (1) Whether portions of the interest expense deductions claimed by petitioner for the taxable years should be disallowed because they represent interest on indebtedness “continued to purchase or carry” tax-exempt obligations within the meaning of section 265(2), I.R.C.1954, and if so, (2) how those portions should be determined. The question of the average fair market values of petitioner's assets, should that become relevant to the computation of disallowed interest deductions, has been severed for separate trial.
The parties have filed stipulations of fact which, together with the accompanying exhibits, are incorporated herein by this reference.
Petitioner Swenson Land & Cattle Co., Inc., is a New York corporation which had its principal office in New York, N.Y., at the time it filed its petition herein.
Petitioner, originally known as Swenson Texas Corp., was organized in 1926 by two brothers, Eric P. and Swen A. Swenson, and their sister, Mrs. Eleanora S. Towne. At that time they transferred their jointly owned cattle business to the corporation. Each of the organizers received a third of petitioner's stock which has since been passed to his or her descendants and to the descendants' families although, due to certain sales within the family, the relative holdings of the family groups in respect of one another has been altered. During the years at issue petitioner had outstanding 900 shares of class A common stock and 900 shares of class B common stock. The two classes were alike in all respects except that only the class A stock had voting rights.
At the time they organized petitioner, the original three stockholders also transferred land to petitioner in exchange for which petitioner issued bonds to them in the principal amount of $3,800,000, divided about equally among them. By the terms of the governing Debenture Bond Agreement, executed on December 31, 1926, by petitioner and the National City Bank of New York as trustee for the bondholders, the bonds had a maturity date of December 31, 1966, and bore interest at the rate of 5 percent per annum payable on December 31 each year, provided there were sufficient earnings available. During the years 1967 and 1968, petitioner's outstanding bonds (the maturity dates of which had meanwhile been extended, as hereinafter explained) were held by six trusts, under the terms of each of which the trustee was required to distribute to the beneficial owners of the bonds, on a current basis, all interest and principal payments with respect to the bonds. Since the time that petitioner issued the bonds, the only beneficial owners have been petitioner's organizers, their descendants, and their descendants' family members, although in different proportions and, in some cases, by different individuals than in the case of the petitioner's stock.
The original terms of the Debenture Bond Agreement of 1926 remained in effect until 1959 at which time petitioner, concerned that it might not be able to accumulate sufficient funds to redeem the bonds at their maturity in 1966, negotiated an amendment to the agreement with the trustee (then known as the First National City Bank of New York). The Supplemental Trust Agreement, dated December 31, 1959, made the obligation to pay interest of 5 percent per annum unconditional and provided for the repayment of principal, pro rata among the bonds, according to the following schedule:
+-------------------------------------+
¦$100,000 on Dec. 31, 1959 ¦
+-------------------------------------¦
¦100,000 on Dec. 31, 1960 ¦
+-------------------------------------¦
¦100,000 on Dec. 31, 1961 ¦
+-------------------------------------¦
¦100,000 on Dec. 31, 1962 ¦
+-------------------------------------¦
¦100,000 on Dec. 31, 1963 ¦
+-------------------------------------¦
¦100,000 on Dec. 31, 1964 ¦
+-------------------------------------¦
¦100,000 on Dec. 31, 1965 ¦
+-------------------------------------¦
¦300,000 on Dec. 31, 1966 ¦
+-------------------------------------¦
¦1,000,000 on Dec. 31, 1976 ¦
+-------------------------------------¦
¦1,800,000 on Dec. 31, 1986 (maturity)¦
+-------------------------------------+
Under the amended agreement petitioner was empowered without penalty to pay additional amounts of principal on December 31 of any year, such payment to be apportioned pro rata among the bonds. Moreover, any such payment was to be applied to reduce the amount due upon maturity, and upon fully repaying that amount, to reduce the next latest installment payment remaining unpaid.
Petitioner made each of the installment payments scheduled from 1959 through 1966, thereby reducing the unpaid principal to $2,800,000 as of 1967.
During all of the relevant years petitioner was engaged primarily in a phase of the cattle industry referred to as a cow-calf operation, which it conducted on four ranches consisting of about 250,000 acres of land in west Texas. Maintaining a herd of about 10,000 cows, petitioner sold each year's calf crop, after weaning, to feeders. The feeders, most of whom were located in the Midwest, fed and fattened the calves for eventual slaughter.
Petitioner conducted its cow-calf operation in such manner that all of the calf crop was ready for shipment at approximately the same time each year. Petitioner priced its calves in late August and delivered the purchased calves from late September through early November. Customarily, petitioner required a small deposit, $500 or $1,000, with each order as earnest money, with the balance of the purchase price payable shortly after delivery. Normally, the total amount of earnest money received in a single year ranged from $15,000 to $20,000.
Expenses for the cow-calf operation during the first 9 or 10 months of the year, during which time it generated little or no income, normally amounted to about $50,000 per month. As a result, petitioner had to have approximately $450,000 or $500,000 of working capital on hand at the start of each year. Additional cash or liquid reserves, perhaps as much as about another $400,000, were also considered essential since cattle prices might be unexpectedly low in a particular year or a drought or other unfavorable weather condition might adversely affect grazing on the ranches making it necessary to purchase additional feed for the cattle. During 1956 and 1957, for example, petitioner's cow-calf operation was severely impaired by droughts, which not only forced petitioner to purchase supplemental feed for the cattle but also to reduce the size of its herd. At no time, however, did petitioner establish special reserves on its financial statements either for working capital or for contingencies.
The working capital needs created by the seasonal nature of the cow-calf operation were alleviated in part by substantial rents and royalties which petitioner received each year from various oil companies to which it had leased the mineral rights under its ranches. Petitioner did not itself engage in any exploration or drilling operations. In the years 1951 through 1973 petitioner, on the cash basis method of accounting, earned income from cattle sales and received rents and royalties 1 as follows: 2
+------------------------------------------------+
¦ ¦ ¦Income ¦ ¦
+------+---------------+-------------+-----------¦
¦ ¦Receipts from ¦from cattle ¦Rents and ¦
+------+---------------+-------------+-----------¦
¦Year ¦cattle sales ¦operations ¦royalties ¦
+------+---------------+-------------+-----------¦
¦ ¦ ¦ ¦ ¦
+------+---------------+-------------+-----------¦
¦1951 ¦$322,678 ¦$123,471 ¦$123,782 ¦
+------+---------------+-------------+-----------¦
¦1952 ¦1,109,719 ¦38,372 ¦205,875 ¦
+------+---------------+-------------+-----------¦
¦1953 ¦435,389 ¦369,387 ¦192,673 ¦
+------+---------------+-------------+-----------¦
¦1954 ¦596,790 ¦(40,746) ¦238,873 ¦
+------+---------------+-------------+-----------¦
¦1955 ¦683,211 ¦19,235 ¦257,929 ¦
+------+---------------+-------------+-----------¦
¦1956 ¦688,265 ¦(257,712) ¦277,829 ¦
+------+---------------+-------------+-----------¦
¦1957 ¦498,052 ¦(239,658) ¦297,547 ¦
+------+---------------+-------------+-----------¦
¦1958 ¦643,820 ¦96,447 ¦290,386 ¦
+------+---------------+-------------+-----------¦
¦1959 ¦496,239 ¦(219,041) ¦195,446 ¦
+------+---------------+-------------+-----------¦
¦1960 ¦628,252 ¦(45,571) ¦605,178 ¦
+------+---------------+-------------+-----------¦
¦1961 ¦690,676 ¦(114,293) ¦146,429 ¦
+------+---------------+-------------+-----------¦
¦1962 ¦977,638 ¦140,499 ¦207,285 ¦...To continue reading
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