Opinion ID: 330160
Heading Depth: 1
Heading Rank: 4

Heading: amortization of debt discount

Text: 61 Finally, we turn to the propriety of the district court's exclusion, in computing the deduction to be allowed to Cities for the years 1953 and 1954, of amortization of debt discount attributable to the pre-1953 years. Cities did not claim on its tax returns for the years prior to 1953 a deduction for amortization of discount resulting from the issuance of the debentures in 1947. For the reasons below, we affirm the district court's exclusion of such amortization of debt discount for the pre-1953 years. 62 The issue presented is essentially one of accrual accounting. It involves the interplay of Section 163(a) of the Internal Revenue Code of 1954 19 on the one hand and Sections 446 and 461 of the 1954 Code 20 on the other. Section 163(a) provides: 63 There shall be allowed as a deduction all interest paid or accrued within the taxable year on indebtedness. 64 The Treasury Regulations currently in effect, Treas.Reg. § 1.163-3 (1968), 21 dealing with the tax treatment of debt discount are substantially similar to those in effect in the tax years in question. See Chock Full O'Nuts Corp. v. United States, supra, 453 F.2d at 302. The regulations provide not only for annual amortization of debt discount, but also for an adjustment in the year of retirement by repurchase in order to close out the artificial accounting charge allowed for debt discount amortization. 65 The district court here computed the deductible amounts for 1953 and 1954 by combining the annual amortization of debt discount attributable to debentures outstanding at the end of each year plus the difference between the repurchase price of the debentures retired each year and their issue price (based on its finding as to the value of the preferred to Cities). The court excluded discount on the retired debentures attributable to years prior to 1953 but not claimed by Cities in those years. 66 Cities argues that this was error. It contends the regulations provide that in the year of repurchase a deduction is to be allowed for the difference between the repurchase price and the issue price, less any amount actually deducted in prior years. If no deduction was taken, so the argument goes, this amount should be included in the adjustment allowed in the year of repurchase. Cities' claim in short is that debt discount may be amortized and deducted over the life of the debentures or it may be recovered in the year of premature retirement through repurchase (or, as a logical extension of this, even at maturity). 67 While Treasury Regulation § 1.163-3 arguably is susceptible of the interpretation urged by Cities, we reject it as contrary to the intent of the statute. Section 446 provides that the method of accounting used in computing taxable income shall be that under which the taxpayer's books are kept unless that method does not clearly reflect income. Section 461(a) provides in pertinent part: 68 The amount of any deduction . . . allowed . . . shall be taken for the taxable year which is the proper taxable year under the method of accounting used in computing taxable income. 69 Under these two sections, the object to be attained is the clear reflection of income for the taxable period . . . . Planet Line, Inc. v. Commissioner, 89 F.2d 16, 17 (2 Cir. 1937); see Lucas v. North Texas Lumber Co., 281 U.S. 11, 14 (1930). 70 At all times here relevant Cities kept its books and filed its federal income tax returns on an accrual basis. With respect to stated interest accruing on indebtedness over a term of years but payable only at maturity, a taxpayer on an accrual basis may not deduct the full amount in the year of payment but must claim annual deductions of the interest as it accrues. Planet Line, Inc. v. Commissioner, supra; Miller & Vidor Lumber Co. v. Commissioner, 39 F.2d 890 (5 Cir.), cert. denied, 282 U.S. 864 (1930); 2 Mertens, The Law Of Federal Income Taxation § 12.95, at 351 (Zimet & Barton rev. 1967); cf. United States v. Anderson, 269 U.S. 422 (1926). The Supreme Court has recognized the economic resemblance between discount and stated interest. Commissioner v. National Alfalfa Dehydrating & Milling Co., supra, 417 U.S. at 147; United States v. Midland-Ross Corp.,381 U.S. 54, 57, 66 (1965). We see no reason to treat discount differently from interest. To allow a deduction for the entire amount of the discount in the year of retirement would not clearly reflect the taxpayer's true income. Helvering v. Union Pacific Co., 293 U.S. 282, 288 (1934); Planet Line, Inc. v. Commissioner, supra, 89 F.2d at 17. In short, a taxpayer that uses the accrual method of accounting must amortize debt discount and take deductions annually over the life of the indebtedness. 71 Here Cities failed to deduct the amortizable discount for the years prior to 1953 in its returns for those years. We hold that it may not take advantage of that failure in its returns for 1953 and 1954. 22 The deduction for debt discount must be taken in the years to which it is attributable--as Judge Wisdom aptly put it, not in the year when the taxpayer decides that it is convenient or good business to accrue the discount. Guardian Investment Corp. v. Phinney, 253 F.2d 326, 330 (5 Cir. 1958). 72 We affirm the district court's exclusion of amortization of debt discount attributable to the pre-1953 years.