Case Name: Barry L. BATTELSTEIN and Jerry E. Battelstein, Plaintiffs-Appellees, v. INTERNAL REVENUE SERVICE, Defendant-Appellant
Court: United States Court of Appeals for the Fifth Circuit
Jurisdiction: United States
Decision Date: 1980-12-03
Citations: 631 F.2d 1182
Docket Number: No. 77-3212
Parties: Barry L. BATTELSTEIN and Jerry E. Battelstein, Plaintiffs-Appellees, v. INTERNAL REVENUE SERVICE, Defendant-Appellant.
Judges: Before COLEMAN, Chief Judge, BROWN, AINSWORTH, GODBOLD, CHARLES CLARK, RONEY, GEE, TJO-FLAT, HILL, FAY, RUBIN, VANCE, KRAVITCH, FRANK M. JOHNSON, Jr., GARZA, HENDERSON, REAVLEY, POL-ITZ, HATCHETT, ANDERSON, RANDALL, TATE, SAM D. JOHNSON, and THOMAS A. CLARK, Circuit Judges.
Reporter: Federal Reporter 2d Series
Volume: 631
Pages: 1182–1188

Head Matter:
Barry L. BATTELSTEIN and Jerry E. Battelstein, Plaintiffs-Appellees, v. INTERNAL REVENUE SERVICE, Defendant-Appellant.
No. 77-3212.
United States Court of Appeals, Fifth Circuit.
Dec. 3, 1980.
M. Carr Ferguson, Asst. Atty. Gen., Gilbert E. Andrews, Acting Chief, Appellate Section, Robert A. Bernstein, Gayle P. Miller, William Friedlander, Attys., Tax Div., Dept, of Justice, Washington, D.C., for defendant-appellant.
Marc E. Grossberg, David Cowan, Hugh M. Ray, Houston, Tex., for plaintiffs-appel-lees.
Before COLEMAN, Chief Judge, BROWN, AINSWORTH, GODBOLD, CHARLES CLARK, RONEY, GEE, TJO-FLAT, HILL, FAY, RUBIN, VANCE, KRAVITCH, FRANK M. JOHNSON, Jr., GARZA, HENDERSON, REAVLEY, POL-ITZ, HATCHETT, ANDERSON, RANDALL, TATE, SAM D. JOHNSON, and THOMAS A. CLARK, Circuit Judges.
Judge Jerre S. Williams has become a member of the Court since June 24, 1980, when this case was taken under submission. He does not wish to participate in the decision.

Opinion:
FRANK M. JOHNSON, Jr., Circuit Judge:
This case arose out of Chapter XI petitions in bankruptcy filed by Barry L. Bat-telstein and Jerry E. Battelstein in the United States District Court for the Southern District of Texas. In the ensuing proceedings, the Internal Revenue Service (IRS) filed proof of claims against each. The Battelsteins objected to the claims and their objections were consolidated for trial. The bankruptcy judge denied the IRS claims after trial and the denial was affirmed by the district court. In response to an appeal filed by the IRS, a panel of this Court reversed the district court's decision denying the IRS claims and remanded the case to the district court for a calculation of tax liability. Battelstein v. Internal Revenue Service, 611 F.2d 1033 (5th Cir. 1980). The panel's decision was vacated when the Court granted the Battelsteins' petition for rehearing en banc. Battelstein v. Internal Revenue Service, 616 F.2d 253 (5th Cir. 1980). The case was taken under submission by the Court en banc following additional briefing by the parties.
The facts are not in dispute. As the panel opinion explained, the Battelsteins were land developers. Gibraltar Savings Association was their lender. In 1971, Gibraltar agreed to loan the Battelsteins more than three million dollars to cover the purchase of a piece of property known as Sharpstown. Gibraltar also agreed to make to the Battelsteins, if desired, future advances of the interest costs on this loan as they became due. The Battelsteins never paid interest except by way of these advances. Each quarter, Gibraltar would notify the Battelsteins of the amount of interest currently due. The Battelsteins would then send Gibraltar a check in this amount, and, on its receipt, Gibraltar would send the Battelsteins its check in the identical amount.
The controversy stems from the Battel-steins' deduction of the amount of these checks under authority of Internal Revenue Code § 163(a), 26 U.S.C. § 163(a). Section 163(a) allows cash basis taxpayers such as the Battelsteins to take a deduction for interest paid within the taxable year on indebtedness. The issue in this case is whether the Gibraltar-Battelstein check exchanges resulted in interest being paid within the taxable year. The bankruptcy judge and the district court decided that the exchanges had such a result. We conclude, as did the panel, that this decision was incorrect.
It is plain that the check exchanges relied on by the Battelsteins could not themselves extinguish the Battelsteins' interest obligations to Gibraltar. What happened at the time of each of the exchanges, as the Bat-telsteins now concede, is that the Battel-steins gave Gibraltar their note promising to-pay the amount of interest then due, plus interest, in the future. It is well established, however, that such a surrender of notes does not constitute the current payment of interest that Section 163(a) requires. The Supreme Court has repeatedly held, as long ago as 1931 and as recently as 1977, that payment for tax purposes must be made in cash or its equivalent. Don E. Williams Co. v. Commissioner, 429 U.S. 569, 577-78, 97 S.Ct. 850, 855-56, 51 L.Ed.2d 48 (1977); Eckert v. Burnet, 283 U.S. 140, 141, 51 S.Ct. 373, 374, 75 L.Ed. 911 (1931). See also Battelstein v. Internal Revenue Service, 611 F.2d at 1035 n.3 (citing additional cases). The 1977 decision explained that, "The reasoning is apparent: the note may never be paid, and if it is not paid, 'the taxpayer has parted with nothing more than his promise to pay.' " Don E. Williams Co. v. Commissioner, 429 U.S. at 578, 97 S.Ct. at 856. The Battelsteins attempted to avoid such a characterization of their interest transactions here by adding to their surrender of notes the inconsequential exchanges of identical amount checks. In ignoring these exchanges, we merely follow a well-established principle of law, viz., that in tax cases it is axiomatic that we look through the form in which the taxpayer has cloaked a transaction to the substance of the transaction. See, e. g., Republic Petroleum Corp. v. United States, 613 F.2d 518, 524 (5th Cir. 1980); Redwing Carriers, Inc. v. Tomlinson, 399 F.2d 652, 657 (5th Cir. 1968) (citing cases). As the Supreme Court stated some years ago in Minnesota Tea Co. v. Helvering, 302 U.S. 609, 58 S.Ct. 393, 82 L.Ed. 474 (1938), "A given result at the end of a straight path is not made a different result because reached by following a devious path." 302 U.S. at 613, 58 S.Ct. at 394. The check exchanges notwithstanding, the Battelsteins satisfied their interest obligations to Gibraltar by giving Gibraltar notes promising future payment. The law leaves no doubt that such a surrender of notes does not constitute payment for tax purposes entitling a taxpayer to a deduction.
As the panel concluded, the Battelsteins' reliance on the line of Tax Court cases beginning with Burgess v. Commissioner, 8 T.C. 47 (1947), is misplaced, even assuming that the Burgess cases constitute good law. In the Burgess cases, the Tax Court was faced with situations in which taxpayers had obtained first one loan and then another from the same lender, and then had attempted to claim a deduction for interest paid on the first loan, even though the interest was possibly paid with funds obtained as part of the second loan. Under the Code, a taxpayer may be entitled to a deduction in such a situation only if the second loan was not for the purpose of financing the interest due on the first loan. If the second loan was for the purpose of financing the interest due on the first loan, then the taxpayer's interest obligation on the first loan has not been paid as Section 163(a) requires; it has merely been postponed. In many cases, it is not apparent what the purpose of a subsequent loan was-whether it was to finance the interest payments on a previous loan for which deductions are being claimed, or whether it was to fulfill some other unrelated objective. In the Burgess eases, the Tax Court attempted to establish a formula to be used in making such a determination. The formula has been subject to criticism for being too easy to manipulate by taxpayers and thus as unduly inviting tax evasion. Whether or not this criticism is valid, it is clear that it is unnecessary to apply the formula here, or that if applied here in light of its purpose it could yield only one result. This is because the subsequent loans made by Gibraltar to the Battelsteins-the checks issued by Gibraltar to the Battelsteins as part of the check exchanges, in the exact amount of the Battelsteins' current interest obligations-were plainly for no purpose oth er than to finance the Battelsteins' current interest obligations to Gibraltar. See note 1, supra. Even under Burgess, the' Battel-steins' check exchanges cannot be said to have resulted in the payment of interest required for a deduction by Section 163(a).
In announcing our decision, we note that, contrary to what has been suggested, neither the Court nor, for that matter, the panel has considered the Battelsteins' 'entrepreneurial style' to be an issue in this case. For business men to defer payment of interest obligations in the way the Bat-telsteins have done may well be a sensible way in which to do business. Whether it is or is not, what is relevant here is that interest obligations so deferred cannot be claimed for tax purposes as interest obligations paid. Under the Code, cash basis taxpayers such as the Battelsteins are entitled to a deduction for interest paid on indebtedness only if that interest is paid within the taxable year. The Battelsteins simply do not qualify.
We note further that even were this Court of the opinion that there are, as has been suggested, equitable considerations in this case favoring the Battelsteins, it has long been established that we may not allow such considerations to play a part in our decision. As panels of this Court have recently had occasion to reiterate, citing recent and established Supreme Court precedent, tax deductions are matters of legislative grace and must be narrowly construed. The taxpayer bears the burden of proving his entitlement to a particular deduction. Equity cannot supply a deduction when the Code does not grant one. See, e. g., Lettie Pate Whitehead Foundation v. United States, 606 F.2d 534, 539 (5th Cir. 1979); C.A. White Trucking Co. v. Commissioner, 601 F.2d 867, 869 (5th Cir. 1979).
The only question before us is whether the Battelsteins' check exchange scheme resulted in the payment of interest Section 163(a) requires. A review of the scheme under the familiar standards of appraisal mandated by the Supreme Court permits no conclusion other than that no interest was paid, and thus that no deduction may be allowed.
REVERSED AND REMANDED FOR A CALCULATION OF TAX LIABILITY.
. The Battelsteins do not assert, nor do we find it possible to infer, any other purpose for the check exchanges.
. In addition to Burgess, see Burck v. Commissioner, 63 T.C. 556 (1975), aff'd on other grounds, 533 F.2d 768 (2d Cir. 1976), and Wilkerson v. Commissioner, 70 T.C. 240 (1978).
. In other words, the obligation as between the taxpayer and the lender remains but-like a note promising payment in the future, which does not qualify for a deduction, see supra -merely in another form. Compare the situa- . tion in which a taxpayer borrows money from a certain lender, and then borrows money from a third party in order to pay the original lender the interest. In such a situation the interest is considered paid and deductible because the obligation as between the taxpayer and the original lender has not been postponed, it has been extinguished. See, e. g., Crain v. Commissioner, 75 F.2d 962, 964 (8th Cir. 1935); McAdams v. Commissioner, 15 T.C. 231, 235 (1950).
.In Burgess and its progeny, the Tax Court held that interest may be considered paid even though the taxpayer may have paid it with money subsequently borrowed from the initial lender, so long as the money subsequently borrowed actually passed into the hands or bank account of the taxpayer, was commingled with other funds of the taxpayer and thus became subject to the taxpayer's unrestricted control. Burgess v. Commissioner, 8 T.C. at 49-50. See also Wilkerson v. Commissioner, 70 T.C. at 257-61; Burck v. Commissioner, 63 T.C. at 559-60.