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Lloyd v. Commissioner of Internal Revenue.

decided: March 4, 1946.

LLOYD
v.
COMMISSIONER OF INTERNAL REVENUE.



Author: O'connell

Before GOODRICH, MCLAUGHLIN, and O'CONNELL, Circuit Judges.

O'CONNELL, Circuit Judge.

This petition for review of the Tax Court's decision presents a rather narrow question for our consideration. We are required to pass on the correctness of the Commissioner's holding that proceeds from the sale of certain unmatured coupons clipped from tax-exempt municipal bonds (later sold) were includible in taxable income of the seller. The taxpayer contends that the proceeds in question were tax-exempt as being interest upon the obligation of a political subdivision of a State within the meaning of Section 22(b) (4) of the Internal Revenue Code.*fn1

Taxpayer is a partner in the banking firm of Drexel & Company of Philadelphia. Drexel & Company joined a Syndicate which entered into an agreement with the City of Philadelphia in 1941 to act as sole agent in effecting a refunding of its outstanding bonds. The mechanics, briefly summarized, were as follows: the Plan called for the refunding of certain City bond issues aggregating $131,064,000, bearing interest at rates varying from 4 per cent to 4 1/2 per cent and maturing at divers dates from 1952 to 1977 but which were callable at the City's option during the years 1942 to 1947. The City would issue new refunding bonds and exchange them for such old outstanding bonds as might be surrendered. The refinancing would be accomplished solely through the Syndicate which was given the right to charge old bondholders who desired to make the exchange a fee of 1 per cent of the principal amount of each new bond so issued.*fn2 The Syndicate was also permitted to buy and sell and otherwise deal in both the outstanding and the new refunding bonds for its own account. Because the new bonds provided for interest at different rates,*fn3 those issued in coupon form*fn4 had attached to them two types of coupons designated "A" and "B". The A coupons represented interest to be paid during the life of each new bond at the reduced rate provided for in the Plan. The B coupons represented the difference between the new reduced rate of interest and that carried by the old bonds. The B coupons ran from July 1, 1941 until the respective first optional call date of the old bonds.*fn5 There were two compelling reasons for the use of the two sets of coupons. The first was to provide for a reduction in the interest rate only after the respective first optional call date of the old bonds. The second was to make it possible for bondholders to detach the B coupons and thus have instruments carrying a single rate of interest which would be familiar to investors and which would permit trading the bonds in the market, thereby providing inducement to the old holders to make the exchanges desired by the City.

During 1941 the Syndicate purchased old bonds of the face value of $15,017,400 for $17,159,994.59. These were exchanged for new refunding bonds of the face value of $15,017,400. The new refunding bonds were sold by the Syndicate for $16,517,164.46. But before the new refunding bonds were offered for sale, the B coupons were detached. For convenience in distribution to each of the 39 members of the Syndicate, an arrangement was made with The Philadelphia National Bank so that, at intervals when sufficient detached B coupons were on hand, the Bank would discount them on a 1 1/4 per cent basis. The Syndicate sold under this arrangement to The Philadelphia National Bank, at a discount, B coupons having a face value of $666,896.65 and received as proceeds of these unmatured coupons $647,630.38. All of these transactions were consummated in 1941. Is this sum to be computed in determining the gain or loss on the sale of the new refunding bonds?*fn6

Taxpayer contends that it is tax-exempt "interest" and that, therefore, a net loss resulted from the entire transaction. The Commissioners maintains that the proceeds of the sale of the unmatured B coupons did not represent "interest", and therefore were not tax-exempt. It is important to note that no contention is made that these proceeds include any money received for accrued interest. We have no evidence fixing the exact period the Syndicate held the coupons or bonds. It is clear that both were held for only a short period of time, at the most less than a year. The Tax Court found, "Almost simultaneously the Syndicate purchased old outstanding bonds, exchanged them for new refunding bonds with A and B coupons attached, detached the B coupons, sold the new refunding bonds with A coupons attached at a loss, and then sold $666,896.65 face value of B coupons at a discount of 1 1/4 percent and received therefore $647,630.38." And again, "During 1941 the Syndicate sold to the Philadelphia National Bank at a discount B coupons having a face value of $666,896.65 and received from the Philadelphia National Bonk the sum of $647,630.38. During 1941 the Syndicate also received the face value of B coupons maturing January 1, 1942, in the sum of $15,314.22."

There is no question here as to the taxability of the face value of the coupons which matured on January 1, 1942. The precise question for our determination is thus whether the Syndicate, which was only an intervening holder of the bonds and unmatured coupons, could claim exemption to the extent of the entire proceeds of the coupon sale at discount to The Philadelphia National Bank. The Tax Court held that these proceeds were nonexempt.

Claiming an exemption from a tax, the taxpayer has the burden of satisfying the requirement that the facts fit clearly within the exempting clause of the statute, United States v. Stewart, 1940, 311 U.S. 60, 71, 61 S. Ct. 102, 109, 85 L. Ed. 40: "Yet those who seek an exemption from a tax must rest it on more than a doubt or ambiguity. Bank of Commerce v. [State of] Tennessee, 161 U.S. 134, 146, 16 S. Ct. 456, 460, 40 L. Ed. 645; Id., 163 U.S. 416, 423, 16 S. Ct. 1113, 1116, 41 L. Ed. 211. Exemption from taxation cannot rest upon mere implications. United States Trust Co. v. Helvering, 307 U.S. 57, 60, 59 S. Ct. 692, 693, 83 L. Ed. 1104. As stated by Mr. Justice Cardozo in Trotter v. Tennessee, 290 U.S. 354, 356, 54 S. Ct. 138, 139, 78 L. Ed. 358. 'Exemptions from taxation are not to be enlarged by implication if doubts are nicely balanced.' And see Pacific Co. Ltd. v. Johnson, 285 U.S. 480, 491, 52 S. Ct. 424, 426, 76 L. Ed. 893."

We do not believe that the taxpayer has met this burden under the circumstances of the case.Opinion appears uniform that the term "interest", in its general usage, means "compensation for the use or forbearance of money", Deputy v. DuPont, 1939, 308 U.S. 488, 498, 60 S. Ct. 363, 368, 84 L. Ed. 416; and see Old Colony R. Co. v. Comm., 1931, 284 U.S. 552, 560, 52 S. Ct. 211, 214, 76 L. Ed. 484; where the Supreme Court stated, "And as respects 'interest,' the usual import of the term is the amount which one has contracted to pay for the use of borrowed money."*fn7 The taxpayer has not proved to the satisfaction of the Tax Court - nor to ours - that the $647,630.38 in question here was paid and received as "compensation for the use of money." That this sum of money was many times greater than the amount of 1941 interest the obligor was required to pay on the B coupons supports this conclusion. Moreover, this sum of money was not paid to the Syndicate by the obligor (the City, which was a stranger to the transaction whereby the unmatured coupons were sold to The Philadelphia National Bank). Finally, the Syndicate's money was invested in the City bonds for but an indefinite, short period of time in "an almost simultaneous" operation through which the Syndicate bought and held the new refunding bonds, detached the B coupons and then sold both the bonds and coupons to different purchasers. Obviously, the Syndicate could not have, simultaneously, a return of its capital investment and compensation for the use of such money. Consequently, we cannot conclude logically that the Syndicate received the $647,630.38 as "interest" on the new City bonds.

Rather, we believe the sale of the unmatured coupons to the bank really constituted a bargain of a right to receive certain moneys in the future from the City. Evaluation of this right and, in the last analysis, how much the Syndicate obtained for it, depended upon and was the result of the combination of several factors, including capital investment and some measure of sagacity. Gains thus arising are taxable. Willcuts v. Bunn, 1931, 282 U.S. 216, 227, 228, 51 S. Ct. 125, 75 L. Ed. 304, 71 A.L.R. 1260.

We see no inconsistency in this result with the cases cited as authorities by the taxpayer.*fn8 Perhaps the only one which really bears on the question before us is Clyde C. Pierce Corporation v. Commissioner, 5 Cir., 1941, 120 F.2d 206, where a securities dealer bought certain defaulted tax exempt bonds with matured coupons attached. The dealer detached the coupons, sold the bonds, and then collected the proceeds of the coupons from the obligor.These proceeds were held computable in determining gain or loss on the purchase and sale of the bonds. The proceeds of the past due coupons were clearly not interest to the taxpayer because they were not compensation for the use of his money. They represented, rather, proceeds resulting from the combination of several factors, including capital investment and very likely, a considerable measure of sagacity. What the Court there stated is here pertinent: "The fact that the accrued coupons are paid as interest is without significance. The real question, the only one for tax purposes, is what was the gain or loss made on the purchase. This is to be determined by taking into account all receipts on account of the purchased securities, including not only what was received from the sale of the bonds but what was paid by the debtor on account of the accrued interest."*fn9 Clyde C. Pierce Corporation v. Commissioner, supra, 120 F.2d at page 208. The same reasoning applies here. We must view the bonds and coupons transactions for tax purposes as synthesized: taxpayer purchased certain securities and sold part of each instrument to one purchaser and part to another. To determine what gain or loss was realized from such transactions it is obvious that the proceeds from all the sales must be totaled.

We think the Tax Court's estimate of the situation was correct, whether we treat the problem as one for our independent judgment or as one predetermined under the principle of Dobson v. Commissioner, 1943, 320 U.S. 489, 64 S. Ct. 239, 88 L. ...


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