Union Planters Nat. Bank of Memphis v. United States

• Decision Date: 04 May 1970
• Docket Number: No. 19409.,19409.
• Citation: Union Planters Nat. Bank of Memphis v. United States, 426 F.2d 115 (6th Cir. 1970)
• Parties: UNION PLANTERS NATIONAL BANK OF MEMPHIS, Plaintiff-Appellee, v. UNITED STATES of America, Defendant-Appellant.
• Court: U.S. Court of Appeals — Sixth Circuit

426 F.2d 115 (1970)

UNION PLANTERS NATIONAL BANK OF MEMPHIS, Plaintiff-Appellee, v. UNITED STATES of America, Defendant-Appellant.

No. 19409.

United States Court of Appeals, Sixth Circuit.

May 4, 1970.

Richard B. Stone, Dept. of Justice, Washington, D. C., for defendant-appellant; Johnnie M. Walters, Asst. Atty. Gen., Lee A. Jackson, William Friedlander, Louis M. Kauder, Attys., Dept. of Justice, Washington, D. C., on brief; Thomas F. Turley, Jr., U. S. Atty., Memphis, Tenn., of counsel.

Cooper Turner, Memphis, Tenn., for plaintiff-appellee; John C. Kimbrough, Memphis, Tenn., on brief; Canada, Russell & Turner, Memphis, Tenn., of counsel.

Before CELEBREZZE, McCREE, and COMBS, Circuit Judges.

McCREE, Circuit Judge.

This appeal presents the question whether coupon interest collected by a bank as owner of municipal bonds subject to repurchase agreements is exempt from taxation under § 103(a) of the Internal Revenue Code. We hold that under the circumstances of this case it is not, and accordingly we reverse the decision of the District Court, 295 F.Supp. 1151 (W.D.Tenn.1968). Since 1938 or 1939, appellant Bank has purchased municipal bonds¹ from local bond dealers, subject to agreements permitting the Bank to require repurchase by the dealer at any time at the price paid by the Bank. The evidence does not disclose an instance when the Bank invoked this provision. Rather, as the District Judge found, "it was the intent and practice that the bonds be re-acquired by the dealer upon the dealer's request * * *." 295 F.Supp. at 1152. The dealer usually repurchased the bonds when he had found a customer for them. The Bank invariably resold to the dealer at the same price it had paid him (this price was either the dealer's cost or a lower figure), and the dealer's repurchase at this price protected the Bank from experiencing any loss on the transaction.

During the period in which the Bank held the bonds, it would clip bond coupons as they matured and collect and retain the interest. On repurchase by a dealer, the Bank would be credited with the pro rata interest accruing from the last coupon redemption date until the date of repurchase. The tax treatment of coupon interest realized by the Bank in this manner in the years 1961-64 is the subject of this appeal.

The Bank claims that since it was the owner of the bonds and the coupons, the interest income from them should be exempt from taxation under § 103(a). The Government, on the other hand, insists that each transaction between the Bank and the dealers was in reality a loan secured by what was in effect a pledge of the bonds. Thus, the coupon interest belonged to the dealers and, when they permitted the Bank to keep it, they were paying the Bank what was in effect ordinary interest on the loan, which is income not exempt from taxation under § 103(a). Viewed in this context, the Government argues, the transactions constitute an attempt to avoid the effect of § 265(2) of the Internal Revenue Code. This provision disallows deductions of interest paid on loans the proceeds of which are used to buy municipal bonds. Its obvious purpose is to deny the recipient of tax exempt income the further tax benefit of deducting the cost of money employed to purchase the securities which produce it. Accordingly, if the dealer had borrowed the money to purchase the bonds, the coupon interest would be tax-free to him, but he would not be able to deduct the interest paid to the Bank for the loan; and the Bank, of course, would be taxed fully on the income represented by that interest. But if the transactions are characterized as sales-repurchases, the Government contends, the Bank will avoid paying tax on the coupon interest, which in economic effect is equivalent to interest paid for the use of its money, and the dealer will have obtained the funds to purchase the bonds without paying interest. Thus, if the parties' characterization of these transactions is accepted as decisive for federal income tax purposes, they would be able to enjoy the benefit of the double tax advantage which Congress intended to prevent.

The form of these transactions tends to support the Bank's arguments. And the Government does not dispute the fact that the Bank held title to the bonds in a property law sense. Moreover, the Bank did not list these transactions on its books as "loans" except when required to do so by the Comptroller of the Currency from 1957 to 1964.²

However, other facts found by the District Court support the Government's position. The bond dealers would list these bonds for sale in trade publications in the same manner as bonds to which they held legal title. When a dealer found a customer for the bonds, he would repurchase them from the Bank which never refused to resell although, under the written repurchase agreements, it was not bound to do so. The District Judge found that it was understood between the parties that the Bank would always consent to such repurchases. Most important, the Bank was protected under the repurchase agreements from suffering any loss, and its gain was limited to the amount of coupon interest accruing during the time it held the bonds.³ In some cases, when the market price of the bonds was falling, the Bank required the dealer to pay, in advance of repurchase, money sufficient to protect it in the declining market. Obviously this practice served the same purpose as the requirement of the posting of additional margin by a borrower whose security is decreasing in value. It is clearly more consistent with the characterization of these transactions as loans than as sales.

The District Court, in ruling for the Bank, held that "the determination of this case requires an inquiry into the intent of the parties." 295 F.Supp. at 1152. We do not agree that subjective intent is decisive here. The intent of the parties may be important in determining just what their contractual relations inter sese were, but there is little dispute here about what obligations and rights the parties expected their agreement to confer. This case hinges, rather, on the legal characterization, for...