Stanton v. Commissioner

34 T.C. 1, 1960 U.S. Tax Ct. LEXIS 178

• Court: United States Tax Court
• Decided: April 7, 1960
• Docket: Docket No. 68914
• Status: Published

Opinions

OPINION.

Murdock, Judge:

Lee sold the C.I.T. notes in 1953 and reported for that year on that transaction a long-term capital gain. The Commissioner, in determining the deficiency for that year, taxed the gain as interest instead of allowing it to be included in the sales proceeds of the notes for tax purposes. He eliminated the gain as a long-term capital gain. The Commissioner’s action is supported by the decision of this Court in F. Rodney Paine, 23 T.C. 391. Cf. Charles T. Fisher, 19 T.C. 384, affd. 209 F. 2d 513, certiorari denied 347 U.S. 1014, and Arnfeld v. United States, 163 F. Supp. 865. The Paine case was reversed by the Court of Appeals for the Eighth Circuit, one Judge dissenting, see 236 F. 2d 398, but the grounds on which it was reversed are not present in this case.

The petitioners argue that our decision in George Peck Gaulkins, 1 T.C. 656, affd. 144 F. 2d 482, is in direct conflict with our decision in the Paine case, but this Court in the Paine case explained how the two are distinguishable. The grounds given there for distinguishing the Paine and Gaulkins cases would likewise apply to distinguish the present case from the Gaulkins case. Cf. Commissioner v. Morgan, 272 F. 2d 936, reversing 30 T.C. 881. The Commissioner’s determination on this issue has not been shown to have been in error.

The only other issue that need be decided is whether the Commissioner erred in disallowing deductions for 1952 and 1953 for interest paid in those years on indebtedness. Section 23(b) of the Internal Revenue Code, applicable to all years involved herein, provides that in computing net income there shall be allowed as a deduction—

All interest paid * * * within the taxable year on indebtedness, except on indebtedness incurred or continued to purchase or carry obligations (other than obligations of the United.States issued after September 24, 1917, and originally subscribed for by tbe taxpayer) tbe interest upon wbicb is wholly exempt from the taxes imposed by this chapter.

No contention is made or could be made that the exception quoted above applies here, nor does section 24(a) (6) apply. Those are the only exceptions to the general rule allowing the deduction of “all interest paid * * * on indebtedness.” Congress having enacted the only exceptions it desired to make, the maxim of interpretation, “Inolusio unius est exclusio alterius’¹'’ applies, e.g., Congress intended no other exception or limitation on the deductibility of interest on indebtedness. All interest paid within the taxable year on genuine indebtedness of any other kind thus entitles a cash basis taxpayer to a deduction of the amount of interest paid. The Commissioner here concedes, as he must, “the reality and validity of the series of transactions.” Thus the payments of principal and interest were enforcible. Cf. W. S. Oilman, 18 B.T.A. 1277, affd. 53 F. 2d 47; William Park, 38 B.T.A. 1118, affd. 113 F. 2d 352. Congress has indicated that this deduction is not dependent in any other way upon the purpose or motive of the borrower, or the use made of the borrowed funds. Lee borrowed the money here involved for a purpose not prohibited by any provision of the Code and is entitled to the deductions claimed.

$56,387.50 of the borrowed money was not used to buy the Treasury notes. Actually, Lee did not use the rest of it for any evil, immoral, or illegal purpose, if that makes any difference. Congress has included no requirement in the Code that the borrowed money be used in con-: nection with a transaction entered into for profit or that it cannot be borrowed for personal or non-business purposes or used in a transaction involving tax benefits, cf. Commissioner v. Park, 113 F. 2d 352, and the Tax Court has no authority to write or read such requirements into the law.

The legislative history of section 23(b) shows that Congress has repeatedly considered and ultimately rejected limitations somewhat comparable to the one now urged by the Commissioner. The House, for example, proposed to restrict the interest deduction in the 1924 Act to interest paid or incurred in carrying on a trade or business and other interest which, when added to nonbusiness losses, exceeded tax-exempt interest received. The Senate struck this out and inserted a limitation on indebtedness incurred or continued for the purpose of evading the payment of taxes when the purchaser carried tax-exempt securities other than certain United States obligations. But the reference to “indebtedness incurred' or continued for the purpose of evading the payment of taxes” was stricken out in conference. The House proposed another limitation for the 1926 Act, but again the Senate refused and the House concurred. The 1932 Act broadened the restriction to deny deduction for interest on indebtedness incurred or continued in connection with, the purchasing or carrying of an annuity. The House proposed to broaden the restriction in the 1934 Act, but the Senate refused and also struck out all reference to annuities. The House at the same time proposed in section 24(a) (5) to disallow any deduction allo-cable to any class of income wholly exempt from tax, but the Senate amended to preclude the application of this provision to the deduction for interest and the House accepted the amendment. See also Revenue Act 1921, section 206(a)(3) and (4), and Revenue Act 1924, section 208(a)(3), (5), and (6), which imposed certain restrictions afterwards dropped from the law and never reenacted. Cf. sec. 24(a) (5) and (6) of the 1939 Code.

The Internal Revenue Code imposed heavy taxes upon Lee and he sought a legal way within the provisions of the Code to make a profit for himself after taxes, the only kind of profit which can do any taxpayer any good. His Treasury note transactions would have been profitable before taxes, if events had happened as he anticipated they would at the time of entering into the transactions. He had reasons, which seemed sufficient to him at the time, to believe that the out-of-town banks would allow him to terminate his loans with the return to him by the banks of the unearned interest at any time he chose to sell the Treasury notes and pay off his bank loans, as the New York banks had done. A deduction for the actual interest which he paid over the term of the loans could not have been denied to him, if that had happened. The taxability of the excess of the amount realized from the sale of the Treasury notes in 1954 over their cost is not an issue in this case, but it was a transaction entered into for profit, and which resulted in a profit, if that is material here. What reason is there for penalizing Lee and deviating from the plain words of the Internal Revenue Code merely because the unexpected action of the banks wiped out Lee’s real gain by requiring him to pay about $126,000 of additional interest?

All of Lee’s borrowings involved herein were genuine and resulted in real indebtedness within the meaning of section 23(b). There was no collusion. The lenders actually advanced the money borrowed for Lee’s use. The money was used in the outright purchase of securities at market. The securities became the property of Lee. They were held as security by the lenders of the money. Lee had all the benefits and risks of ownership. All dealings were “at arm’s length.” Once he entered into the transactions he was required to do all that he did do, and no step which he took was lacking in substance or legal effect. He was strictly within the law at all times, and the interest deductions which he took for 1952 and 1953 were in exact accordance with the express provisions of section 23 (b). The Commissioner concedes all of this. How then does the Commissioner attempt to justify his disregard of the plain provisions of the Internal Kevenue Code whereby he taxes interest received and capital gains on the transactions but denies deductions for all interest paid ? He says:

This Court has already approved determinations of respondent comparable to the one at issue herein. Of. Eli D. Goodstein (1958) SO T.C. [1178], No. 124, afC’d (CA 1, 1959) - F. 2d -, 3 A.F.T.R. 2d 1500; Abraham M. Sonnabend, T.C. Memo. 1958-178, aff’d per curiam (CA 1, 1959) - F. 2d -, 3 A.F.T.R. 2d 1505; John Fox, T.C. Memo. 1958-205; Matthew M. Becker, T.C. Memo 1959-19; George G. Lynch (1959) 31 T.C. [990], No. 98 (On appeal); Leslie Julian (1959) 31 T.C. [998], No. 99 (On appeal); Egbert J. Miles (1959) 31 T.C. [1001], No. 100 (On appeal); See also W. Stuart Emmons (1958) 31 T.C. [26], No. 4 (On appeal). Respondent submits that the principles applied in the above decisions are controlling and dispositive of the case at bar.

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In the light of the foregoing discussion, respondent submits that as a matter of substantial commercial reality, Stanton did not purchase any CIT Notes and Treasury Notes, incur any indebtedness, pay any interest, or sell any CIT Notes and Treasury Notes, which were significant or recognizable for tax purposes. George G. Lynch, supra; Egbert J. Miles, supra; W. Stuart Emmons, supra.

The facts in each of the cited cases distinguish it from the present case. The Emmons case bears no resemblance to the facts here. The leading case cited is Eli D. Goodstein, 30 T.C. 1118, affd. 267 F. 2d 127, but important differences rob it of all effect as an authority here. The alleged Goodstein transactions were collusive shams throughout arranged by Eli Livingstone.¹ The Treasury notes were “purchased” and “sold” practically as one transaction in which no real money passed on behalf of the taxpayer. The alleged lender corporation had no money to lend. Ho Treasury notes were held as security or otherwise by that corporation. Goodstein was not the owner of any Treasury notes during the time the “loan” was supposed to be in effect. He was not entitled to receive and did not receive the benefit of any interest on Treasury notes. There was no indebtedness of $10 million. The whole matter of “interest” was merely an empty bookkeeping device to create the illusion of indebtedness, interest, and long-term capital gain. However, the Court in affirming the Goodstein case, 267 F. 2d 127, expressed the thought that Goodstein, despite the recognized shams, might be entitled to a deduction for some loss in a later year not before the Court. See also Lynch v. Commissioner, 273 F. 2d 867, affirming the Lynch and Julian cases (George C. Lynch, 31 T.C. 990, Leslie Julian, 31 T.C. 998), both of which involved similar shams arranged by-Livingstone.

The Commissioner quotes language from the Tax Court opinion in the Egbert J. Miles case (31 T.C. 1001) to the effect that “if petitioner did purchase the bonds and incur an indebtedness he did so but for one reason, to realize a tax deduction” and that being so, the interest was not deductible within the intendment of section 23(b). That part of the opinion was not necessary in denying the deduction since the facts disclosed a repetition of the collusive shams in the Goodstein case. The Court of Appeals for the Second Circuit, in affirming the Lynch and Julian cases, did not rely on any such reasoning and did not rely upon Gregory v. Helvering, 293 U.S. 465, which, it said, “the government construes as establishing a doctrine forbidding generally the recognition for tax purposes of transactions entered into for the sole purpose of tax avoidance.” It relied instead “on the more fundamental ground” that there was no genuine indebtedness. The Goodstein, Julian, Lynch, and Miles cases were all correctly decided on the “fundamental ground” that there was no real indebtedness in any of them but merely collusive shams to create a supposed appearance of indebtedness on which supposed interest was paid. Anything contrary to the holding here was not necessary in the Lynch, Julian, and Miles cases and is not binding in this case although those cases and the Goodstein case were correctly decided on their own facts.

Knetsch v. United States, 272 F. 2d 200, certiorari granted 361 U.S. 958, decided by the Court of Appeals for the Ninth Circuit, involved a transaction in which the taxpayer purchased 2y2 per cent annuity savings bonds from a life insurance company by borrowing the necessary money from the life insurance company at 31/2 per cent. The Court affirmed the judgment of the District Court which had held that the amount paid to the insurance company was not interest in fact but the purchase price of a tax deduction. The Court of Appeals said it agreed with the opinion in Weller v. Commissioner, 270 F. 2d 294. The Weller case affirmed 31 T.C. 33 and also affirmed W. Stuart Emmons, 31 T.C. 26. The taxpayers in the Emmons and Weller cases had purchased annuity contracts and borrowed money from banks to prepay at a discount all future premiums and then received the loan value which the contract would have accumulated up to the time the prepaid premiums would be due. They then used a part of this money to pay off the loans at the banks. The interest on the bank loans was not m controversy. The taxpayers were disallowed claimed deductions for “interest” on the amounts they allegedly borrowed from the insurance companies, since no money was in effect loaned to them by the insurance companies. The Court of Appeals for the Fifth Circuit in United, States v. Bond, 258 F. 2d 577, in a situation similar to that involved in the Knetsch case, held that the interest on the borrowing from the insurance company was deductible. The payments involved in all of the above four cases were on alleged loans from the insurance companies so that the whole transaction in each case was between the taxpayer and the insurance company. No genuine indebtedness existed on which interest was paid. Such cases are distinguishable factually from the present case. The present taxpayer bought securities on the open market and borrowed money from banks without any collusion to avoid income taxes between him and any person with whom he dealt. His indebtedness was genuine and section 23(b) allows a deduction for interest paid on such indebtedness.

Reviewed by the Court.

Decision will he entered wider Bule 50.

1 Statements in dissents hereto that Livingstone had something to do with this case are improper inferences from Stanton’s testimony which I alone heard.