Document: 40 L.Ed.2d 717 94 S.Ct. 2129 417 U.S. 134 COMMISSIONER OF INTERNAL REVENUE, Petitioner,v.NATIONAL ALFALFA DEHYDRATING AND MILLING COMPANY. No. 73—9. Argued Jan. 14, 1974. Decided May 28, Syllabus Respondent corporate taxpayer, pursuant to a recapitalization plan, issued $50 face value 5% sinking fund debentures in exchange for its outstanding unlisted par cumulative preferred shares, which at the time were quoted approximately $33 per share on over-the-counter market. Based exchange, respondent claimed income tax returns several years deductions debt discount under § 163(a) of Internal Revenue Code 1954, allows interest paid indebtedness. asserted that discount, measured by difference between preferred, and amount debentures, amortized over life constituted deductible within purview provision. The Commissioner disallowed deductions, was upheld Tax Court, but Court Appeals reversed. Held: did not incur amortizable upon issuance stock. Pp. 142—155. (a) In determining whether arises situation presented here, relevant inquiry must be taxpayer has incurred, as result transaction, some cost or expense acquirng use capital. P. 147. (b) propriety deduction does turn general equitable considerations, such demonstration effective economic practical equivalence what actually occurred, rather 'depends legislative grace; only there is clear provision therefore can any particular allowed.' New Colonial Co. v. Helvering, 292 435, 440, 54 788, 790, 78 L.Ed. 1348. 147—149. (c) This will speculate market price investor reaction sales purchases open would have been, since nothing record establish cash could been sold indicate able purchase all market, stock purchased light impending exchange; moreover, when corporation issues shareholders own new obligations fair both securities somewhat artificial effectively insulated from forces. 149—151. (d) Absent evidence attributable rate determined factors respondent's financial condition availability capital well shareholders, than simply having predicated preferred's value, requisite evaluation property exchanged cannot occur determined. 151. (e) alternation form retained give rise borrowing respondent, invested same represented totally unaffected received exchange. 151—155. 10 Cir. 472 F.2d 796, Stuart A. Smith, Washington, D.C., petitioner. Charles White Hess, Kansas City, Mo., respondent. Mr. Justice BLACKMUN delivered opinion Court. 1 A 1957 oustanding shares. At time, apparently had less share. case presents question whether, 26 U.S.C. 163(a),1 entitled an 2 * facts are stipulated. National Alfalfa Dehydrating Milling Company (hereinafter called 'NAD' 'taxpayer'), Delaware organized 1946. It principal office Shawnee Mission, Kansas. engaged business dehydrating milling alfalfa. 3 organization, NAD authorized issue shares $1 common preferential dividends annum redeemable, whole part, discretion board directors through operation fund, stated, variable which, 1957, $51 plus accrued dividends. required 20% net earnings (after payment dividends) set aside employed redemption preferred. Any so redeemed retired reissued. If dividend arrearage, purchased, redeemed, otherwise acquired unless holders 50% consented, notified desire invited tender offers. Upon voluntary liquidation, before distribution made 4 Prior July 23, 47,059 arrearages $10 thus aggregate $2,352,950 date. 5 On April 8, NAD's adopted resolutions2 'to effectuate reorganization way recapitalization.' App. 56. plan proposed three steps: (1) amendment articles incorporation eliminate August 1, increase $3 number 763,000 1,000,000, authorize warrants shares; (2) indentured 18-year due 1975, with one debenture each preferred; (3) issuance, holder warrant one-half lieu arrearage. members testified 'principal purpose behind enable expand eastern producing areas.' Id., 25. 6 After taken this action, Fidelity-Philadelphia Trust Company, trustee, executed trust indenture dated aforementioned preferred.3 7 behalf NAD, requested ruling United States Treasury Department federal consequences plan. responsive letter-ruling signature Chief, Reorganization Dividend Branch, forthcoming 29, 1957. request sought aspects free. ruling, however, effect 'will constitute and, therefore, reorganization, meaning section 368(a)(1)(E), 1954,' that, thereof, 354(a) Code, 354(a), no gain loss recognized shareholders. 20. went state, 'Assuming bonds qualify (create genuine relationship debtor creditor), stockholders (under 302(a) 302(a)) exchange' arrearage warrants. 'measured other adjusted basis surrendered values received.' 20—21. 8 Shareholder approval course. Accordingly, amended; received, therefor, subscribe half arrearage; eliminated canceled 1. reflected books debit account $2,352,950, thereby eliminating account, credit liability $2,352,950. 9 listed. During period 15—30, bid quotation ranged low 29 high 33, offering 32 35. 161.4 effected, midpoint quotations 33. Stock Summary October showed 100 wanted offered 167. nominal figure want them four dates August. 168. fiscal ended 30, 1958, 1967, inclusive, it regarded interest, reason debentures. amounted $800,003 ($2,352,950 $1,552,947 preferred). then straight-line addition year unamortized currently repurchased redeemed. See Rev.Rul. 70—353, 1970—2 Cum.Bull. 39. forth margin;5 those earlier losses carried 1967. 11 audit return $109,804 $321,657 carryovers prior taxable debt-discount years. resulted substantial deficiency 1967 tax. 12 petition redetermination, unanimous reviewed opinion, Commissioner. 57 T.C. 46 (1971). Adopting reasoning Claims Erie Lackawanna R. States, 422 425, 190 Ct.Cl. 682 (1970), Missouri Pacific 427 727, 192 318, modified rehearing, 193 257, 433 1324 cert. denied, 402 944, 91 1618, 112 (1971), held if equal relevance. 13 appeal, Tenth Circuit, divided vote, 796 (1973). Relying American Smelting & Refining 130 883 (C.A.3 1942), Atchison, T. S.F.R. 443 147 (C.A.10 1971), court borrowing, qualified properly We granted certiorari resolve indicated conflict. 414 817, 152, 38 49 II 14 we here concerned, where obligations, namely, obligations' amount, 15 Section 163(a), n. supra, statute seeks invoke order benefit claims discount. relates 'all indebtedness.' obviously debt, stated semiannually just gross 163(a). also entitled, further deduction, 'interest accrued,' appropriately portion $17 16 Original-issue typically issuer sells obligation obligation. difference, obviously, simple example 6% $1,000 10-year bond $950 cash. obliged pay bondholder receive, annual 6%, $60. That includable payee's received. But additional issuing money borrowing. spread amounts $5 year. Accepted accounting practice treats 163(a).6 17 1939 predecessors provide expolicitly amortization successive regulations, beginning Art. 150 Regulations 33 (revised 1918), Act 1916, provided issuer.7 18 first statutory recognition appeared 1232(b)(1) 1954 Code. provides: 'For purposes subsection (a), term 'original discount' means maturity. . .' 19 1232(b)(2) defines 'issue price' detail.8 20 incurred money. Helvering Union Co., 293 282, 55 165, 79 363 (1934), considering described 'loss' 'prorated sold,' referred procured issue.' U.S., 286, S.Ct., More recently, Midland-Ross Corp., 381 54, 85 1308, 214 (1965), clarified ambiguity may interest-loss approach id., 57, 1310: 'Earned original serves function .. (I)t 'compensation forbearance money.' Deputy duPont, 308 488, 498 (60 363, 368, 84 416).' 21 observed 'despite expressions indicating contrary view, often interest.' 66, 1315 (footnote omitted). 22 ultimately purchaser,9 obligation, issuer. 23 While established ensue cash, never decided Those courts passed reached opposing conclusions. Compare Nassau Lens Commissioner, 39 (C.A.2 1962); 1942); Southern Fertilizer Chemical Edwards, 167 F.Supp. 879 (M.D.Ga.1955), available, Natural Gas 412 1222, 1235—1239, 188 302 (1969); Montana Power 159 593, 141 620, 358 842, 76 (1958); Mortana 232 541 (C.A.3) (en banc),10 352 843, 77 51, 59 (1956), available. This, course, broader present case, need not, do decide issue. instead, narrow 24 determine said arise situation, becomes necessary recognize factor thought justify deduction. resemblance, function, bears Acts Codes allowed Although, noted, descriptive confusion their references 'interest,' 167, seemed describe capital' 'loss resulting funding operation,' issuer-taxpayer acquiring now turn. III 25 position arose It, Appeals' majority, look calls 'economic realities' transaction incurred. likened (or preferred) used retire F.2d, 802. claimed, whatsoever result. argued deny similar treatment take place, direct shareholder, require future engage complex expensive series transactions entitlement argument, two steps reluctant unwilling take. First, rejection principle given accord occurred might occurred. Second, us about they 27 Even assume, arguendo, hypothetical posed indistinguishable, matter reality, required, alone, equavalence. Rather, therefor Ice 1348 (1934); du Pont, 493, 60 366, 416 (1940). repeatedly while free organize his affairs he chooses, nevertheless, once done so, accept choice, contemplated Higgins 473, 477, 355, 357, 406 (1940); Old Mission Portland Cement 289, 293, 158, 160, 367 Gregory 465, 469, 266, 267, 596 (1935), enjoy route chosen follow not. 'To make taxability depend determination existed alternative create burden uncertainty.' Founders General Corp. Hoey, 300 268, 275, 457, 460, 81 639 (1937); Television Industries, Inc. Revenue, 284 322, 325 1960); Interlochen 873, 877 (C.A.4 1956). Gray Powell, 314 402, 414, 62 326, 333, 86 301 (1941). 28 Both rationale wisdom Court's attitude toward attempts reconstruction particularly demonstrated case. absence actual even attempted events been. There reasons why this: establishing sale. current status borrower pertinent premium) contrasted closed transaction. 30 quantity Gulf, M. O.R. 339 489 (S.D.Ala.), final decision 31 A.F.T.R.2d 73—436 (1972), pending appeal C.A.5 deferred awaiting case; Cities Service 316 61 (S.D.N.Y.1970) 362 830 (S.D.N.Y.1973), C.A.2 pending. stipulated quotations, 4, cited Summary, most thin hardly representative entire outstanding. total $61, almost double Third, forces intracorporate private nature Missiouri 730—731, Ct.Cl., 324—325. economics underlying adjustment prescribed instrument prevailing money, because too sell San Joaquin Light McLaughlin, 65 677, 679 (CA9 1933). Thus, implicit concept assumption, indeed requirement, subject exigencies competitive Here, (laying moment aformentioned difficulties arriving determination) As T.C., 52 6, issuance. Other considered include including profits prospects, Normally, itself performs evaluative process. Aside fact processes, attempt show view these Cf. supra; F.Supp., 881. IV merely replaced paid-in From perspective corporation, ome participation another. assets neither increased nor diminished.11 34 To sure, assumed fixed oblication date certain. perhaps something more mere reshuffling corporation's structure, see Southwest Consolidated 315 194, 202, 546, 551, 789 (1942), creditor substituted ownership interest.12 again, viewed perspective, regardless former deem irrelevant, retaining old St. Louis-San Francisco 444 1102, 1106, 195 343, 350 404 1017, 92 678, 665 (1972). 35 obvious explanation this, originally Although obligated repay sum provisions articles, redemption-liquidation provisions. books, together attendant obligations. bore funds hand. 'freed' cancellation transferred No involved. Claussen's, 469 340 (C.A.5 1972).13 36 true change structure. Henceforth, receive whereas deductible. benefited elimination premium payable retirement. Yet great. worked diminutions available mature comparable. 'was fairly highly equivalent characteristics into converted.' Penfield Davis, 105 292, 311 (N.D.Ala.1952), aff'd, 205 798 1953). Accordingly recognizing alteration conclude substitution previously without more, excess committed, base arise. 37 sum, NAD. worth neighborhood consequence, go able, instead obtain canceling equity transferring account. sense newly differ, sense, property. Such property—for example, inventory another corporation—does equate previous contribution continue utilized hold, accordingly, judgment Judgment ordered. 41 STEWART concurs Parts I, II, opinion. '§ 163. Interest. '(a) rule. 'There shall resolutions full Appeals. (C.A.10, 1973). subordination, redemption, fund. Specifically, subordinate bank loans materials, services, labor supplied normal course business. They after interest. 1959, annually, lesser sufficient redeem $196,080 consolidated year, proviso latter became applicable cumulative. default performance $581,300 remained rest retired. 29. Date Bid Offer 1958 were: Unamortized Discount Bonds Currently Straight- Year Repurchased Line Ended Redeemed Amortization Total 4/30/58 --0-- $37,037 4/30/59 $20,104 43,273 63,377 4/30/60 17,007 42,310 59,317 4/30/61 28,743 4/30/62 14,062 27,751 41,813 4/30/63 4/30/64 26,624 25,562 52,186 4/30/65 37,903 22,168 60,071 4/30/66 4,139 21,761 25,900 4/30/67 98,824 10,980 109,804 --------- $505,999 28. H. Finney Miller, Principles Accounting, Intermediate 263 (6th ed. 1965); W. Meigs et al., Accounting 683—688 (3d 1974). 544 45, promulgated 1918; 545(3)(a) 62, 65, 69, promulgated, respectively, 1921, 1924, 1926; 68(3)(a) 74 77, 1928 1932; 22(a)— 18(3)(a) 86, 94, 101, 1934, 1936, 1938; 29.22(a) 17(3)(a) 111, 1939. 541, 546—548 (C.A.3), (1956). Under Income 1.61—12(c)(3) concerning income: 'If should prorated bonds. Since T.D. 6984, 1969—1 38, language 1.163—3(a) (1). Code's amended Interest Equalization Act, Pub.L. 88—563, 5, Stat. 845, Reform 1969, 91—172, 413(b), 83 611, evidences indebtedness 27, 1969. amended, statute, part reads: 'In (other 368(a)(1)), which— '(A) traded '(B) 'the Except cases preceding sentence applies, money) maturity.' Inasmuch 1969 unsettled realized owner ordinary gain. Caulkins, 144 482 (C.A.6 1944), surrender installment certificate circuits, thereafter income. See, Real Estate Investment 334 986 (C.A.1 1964), 911, 1529, 432 (1965); Dixon 333 1016 68, 1301, 223 Harrison, 304 835 1962), 372 934, 881, 765 (1963); Rosen 288 658 1961); Morgan, 272 936 (C.A.9 1959). settled earned Congress, enacting 1232 different referring 'a income' S.Rep.No. 1622, 83d Cong., 2d Sess., (1954). 1232(a)(2), sale taxed noncapital asset. purchaser maturity, taxed, up taxed. De Kosmian, Original Issue Discount, Lawyer 339, 340—347 Zafft, Bonds—Ordinary Capital Gain?, L.Rev. 51 (1955). Judge Kalodner, joined Staley, observed, 'The respect limited facts.' 546. affiliate concluded affiliated corporations filed return. related single purchasing Because, viewing affiliates taxpaying entity, 'could afterwards deduct, income, bonds, anticipation 160. Here implying equivalent, past noted investment unsecured slight degree, diminished when, subordinated. John Kelley 326 521, 66 299, 90 278 (1946). 'We overlook complete lack substance here. Its penny, either Fuqua (thus, presumably reducing price). company bond-holders anyone dividend, partial capital, 'boot' tax-free reorganization. deduct out become liable anybody.' 344 11.

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