Court Opinion

ID: 9466344
Source: CourtListenerOpinion
Date Created: 2023-08-05 01:12:54.961255+00
Date Added: 2024-06-11T17:39:40.783588
License: Public Domain

FRANK M. JOHNSON, Jr., Circuit Judge:
Barry L. Battelstein in November, 1976, and Jerry E. Battelstein in April, 1977, filed Chapter XI petitions in bankruptcy 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. In June, 1977, after trial, the bankruptcy judge denied the IRS claims. In August, 1977, the district court affirmed this denial. The IRS filed this appeal.
The controversy stems from deductions claimed by the Battelsteins for interest paid on indebtedness. 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 Sharps-town. Gibraltar also agreed to make to the Battelsteins, if desired, future advances of the interest costs on this loan as they became due.1 As it happened, the Battelsteins never paid interest except by way of these advances. Each quarter, Gibraltar would notify the Battelsteins of current interest 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. Although the 1971 agreement provided that these advances were to be evidenced by new notes, it is unclear whether new notes were ever executed.2 The bankruptcy judge and the district judge found that the Battelsteins were correct in deducting the amount of the interest as interest paid on indebtedness. This finding was clearly in error.
Under § 163(a) of the Internal Revenue Code of 1954, 26 U.S.C. § 163(a), cash basis taxpayers such as the Battelsteins may take a deduction for interest paid within the taxable year on indebtedness. The dispute in this case turns on whether or not the Gibraltar-Battelstein arrangement resulted in interest being “paid.”
The Battelsteins do not contend, nor could they seriously, that any of the notes that they may have given Gibraltar for the interest advances could have resulted in payment. As the Supreme Court recently *1035reiterated in a related context, payment for tax purposes must be made in cash or its equivalent, and a note promising payment of cash in the future is not cash or its equivalent. Don E. Williams Co. v. Commissioner, 429 U.S. 569, 577-78, 97 S.Ct. 850, 51 L.Ed.2d 48 (1977).3 The Court ex-, plained that the note may never be paid, and if it is not paid, the taxpayer has parted with nothing more than his promise. Id. at 578, 97 S.Ct. 850, quoting Hart v. Commissioner, 54 F.2d 848, 852 (1st Cir. 1932).
The Battelsteins strenuously argue that the exchange of checks with Gibraltar did result in interest being “paid.” This argument is without merit. The Battelsteins have asserted business reasons for putting off the interest payments,4 but they do not assert, nor is it possible to infer, any purpose other than tax avoidance for the check exchange method employed to do so. Although there are a great many transactions which may properly be undertaken principally with a view to minimizing taxes, e. g., buying tax-free municipal bonds instead of higher-yielding corporate securities, or selling property at the close of one year rather than the start of another in order to accelerate the recognition of a loss, creating a superficial payment structure solely to reap the benefits of § 163(a) is not one of them. See Knetsch v. United States, 364 U.S. 361, 367, 81 S.Ct. 132, 5 L.Ed.2d 128 (1960); Salley v. Commissioner, 464 F.2d 479, 480, 482-83 (5th Cir. 1972); Gold-stein v. Commissioner, 364 F.2d 734, 740 (2d Cir. 1966).5 To give significance to the check exchange would be to exalt artifice over reality and deprive § 163(a) of all serious purpose. Cf. Gregory v. Helvering, 293 U.S. 465, 470, 55 S.Ct. 266, 79 L.Ed. 596 (1935). Given its sham nature, the exchange should be ignored. See Waterman Steamship Corp. v. Commissioner, 430 F.2d 1185, 1192 (5th Cir. 1970); Owens v. Commissioner, 568 F.2d 1233, 1240 (6th Cir. 1977); Gilbert v. Commissioner, 248 F.2d 399, 411 (2d Cir. 1957) (Hand, J., dissenting). When the exchange is ignored, it is obvious that the Battelsteins’ arrangement resulted in nothing more than promises to pay and not, as the Supreme Court has required, actual payment. See Don E. Williams Co. v. Commissioner, supra, 429 U.S. at 578, 97 S.Ct. 850. Accordingly, the deductions should not have been allowed.
The Battelsteins’ reliance on the line of Tax Court cases beginning with Burgess v. Commissioner, 8 T.C. 47 (1947), is mis*1036placed.6 The Burgess cases establish an exception inapplicable to the facts of this case. 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, supra, 8 T.C. at 49-50. See also Wilkerson v. Commissioner, 70 T.C. 240, 257-61 (1978); Burck v. Commissioner, 63 T.C. 556, 559-60 (1975), aff’d on other grounds, 533 F.2d 768 (2d Cir. 1976). Here the last condition was not satisfied. Because Gibraltar did not issue the Battelsteins its check until it had their check already in hand, it cannot be said that the interest money advanced by Gibraltar ever became commingled with the Battelsteins’ other funds and subject to the Battelsteins’ unrestricted control. Moreover, it should be kept in mind that the Burgess conditions were apparently developed as a guide to distinguish sham payments from legitimate payments. The conditions notwithstanding, the Battelsteins’ check exchange was, as noted above, obviously a sham.
Even if applicable, the Burgess exception is of doubtful validity.7 The principal distinction between the Burgess cases and the Don E. Williams Co. cases8 is that in the Burgess cases the payment of interest claimed by the taxpayer was alleged to have occurred not through a paper transaction with the lender of the principal, such as the giving of a note or the withholding of interest from principal, but by an actual exchange of funds. See Burgess v. Commissioner, supra, 8 T.C. at 49-50. This distinction has no creditable basis. Id. at 50-51 (Kern, J., dissenting). The lender’s additional loan and the taxpayer's ‘payment’ of interest add up to no more than a postponement, not payment, of the taxpayer’s interest obligation to the lender. Cf. Minnesota Tea Co. v. Helvering, 302 U.S. 609, 613, 58 S.Ct. 393, 395, 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.”) Contrary to the Battelsteins’ claims, the distinction is not saved by analogy to the well-established rule that, where a taxpayer borrows money from a third party to pay interest due his original lender, the interest is considered paid and deductible. See, e. g., McAdams v. Commissioner, 15 T.C. 231, 235 (1950). This rule is clearly inapposite. In the third-party situation, deduction is appropriate because the obligation as between the borrower and the original lender has not been postponed, it has been extinguished. A default by the taxpayer would not revive it. Crain v. Commissioner, 75 F.2d 962, 964 (8th Cir. 1935). This is not the case where the taxpayer ‘satisfies’ his interest obligation with additional borrowings from his original lender. The obligation as between the borrower and the lender remains but, like a note promising payment in the future, merely in another form. Burgess provides an opportunity for tax avoidance that § 163(a) clearly did not intend. Were we to find, as did the district court, that Burgess is here applicable, we would decline to follow it and disallow the Battelsteins’ deductions.
REVERSED AND REMANDED FOR A CALCULATION OF TAX LIABILITY.

. In partial consideration of its entrance into the agreement Gibraltar was promised a 19 per cent profit participation in the value of the property when finally sold.

. The Battelsteins testified that they could not recall,

. In the Williams case, the Court relied on two earlier decisions articulating the same principle: Helvering v. Price, 309 U.S. 409, 60 S.Ct. 673, 84 L.Ed. 836 (1940), and Eckert v. Burnet, 283 U.S. 140, 51 S.Ct. 373, 75 L.Ed. 911 (1931). Based on Price, Eckert, or other precedent established on their authority, courts have refused to consider “paid” and deductible interest satisfied by a note promising future payment, Hart v. Commissioner, 54 F.2d 848, 850-52 (1st Cir. 1932); interest “withheld” by the lender from the original loan, Parks v. United States, 434 F.Supp. 206, 211 (N.D.Tex.1977); Heyman v. Commissioner, 70 T.C. 482, 485-87 (1978); Rubnitz v. Commissioner, 67 T.C. 621, 628 (1977); Hopkins v. Commissioner, 15 T.C. 160, 181 (1950); Cleaver v. Commissioner, 6 T.C. 452, 454 (1946), aff’d, 158 F.2d 342, 344 (7th Cir.), cert denied, 330 U.S. 849, 67 S.Ct. 1093, 91 L.Ed. 1293 (1947); interest “withheld” by the lender from a subsequent loan, Keith v. Commissioner, 139 F.2d 596, 597 (2d Cir. 1944); Nat Harrison Associates, Inc. v. Commissioner, 42 T.C. 601, 623-25 (1964); or interest paid by an increase in the original principal, England v. Commissioner, 34 T.C. 617, 621 (1960). In Williams, the Court noted the Cleaver decision, 429 U.S. at 578 n. 9, 97 S.Ct. 850, and quoted from Hart, id. at 578.

. The bankruptcy judge found that the loan agreement was “clearly no sham business deal conceived solely to render the debtors a tax deduction,” and explained that the business purpose of the interest advances was “to enable the owners of the Sharpstown property to maintain ownership of the property for an extended period of time, and to make improvements, including the addition of utilities.”

. Section 163(a) is an accounting provision and, like tax accounting provisions generally, it invites evasion. In the cases cited, taxpayers structured elaborate loan transactions in order to create indebtedness giving rise to interest deduction opportunities. Finding that the transactions had no purpose other than tax avoidance, the courts disallowed the interest deductions in full. In this case, the indebtedness and interest opportunities apparently had business substance; it was the check exchange method claimed to have “paid” them'that did not. The distinction is unimportant.

. Burgess was followed in Burck v. Commissioner, 63 T.C. 556 (1975), aff'd on other grounds, 533 F.2d 768 (2d Cir. 1976), and again in Wilkerson v. Commissioner, 70 T.C. 240 (1978).

. The exception has been much criticized. See Burck v. Commissioner, 533 F.2d 768, 770 n. 3 (2d Cir. 1976); Goodstein v. Commissioner, 267 F.2d 127, 131 (1st Cir. 1959); Burgess v. Commissioner, supra, 8 T.C. at 50-51 (Kern, J., dissenting for himself and five other Tax Court judges).

. See note 3 supra.