Court Opinion

ID: 4597061
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:18:23.914353+00
Date Added: 2024-06-11T07:51:43.791679
License: Public Domain

JAMES E. SAGUE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Sague v. CommissionerDocket No. 19648.United States Board of Tax Appeals23 B.T.A. 736; 1931 BTA LEXIS 1835; June 16, 1931, Promulgated *1835  1.  The profit derived from the exchange of deposit receipts for bonds of the State of West Virginia in 1920 was taxable in that year.  2.  Profit derived upon the sale or exchange of securities representing the obligations of a State is taxable.  3.  Interest paid to purchase or carry "tax-exempt securities" is not deductible from income.  4.  Bonds issued by a State cannot be broken down into elements of principal and interest with respect to the cause for which they are issued so that part of the proceeds of sale of such bonds may be treated as a collection of interest.  Sanford Robinson, Esq., for the petitioner.  J. E. Marshall, Esq., for the respondent.  GOODRICH *736  This proceeding involves the determination of petitioner's income-tax liability for the calendar years 1920 and 1921.  Respondent asserted deficiencies of $372.33 for the year 1920 and of $115.69 for the year 1921.  Later, by amended pleadings, respondent sought to increase the deficiency for the year 1920 in an amount not stated.  Petitioner denied liability for both the deficiencies asserted, and later, by amended pleadings, claimed a refund for the year 1921 of the*1836  entire tax previously paid amounting to $1,915.27.  The issues involved in this case are as follows: (1) Whether petitioner is liable for tax in 1921 on profits derived by him from the sale of bonds of the State of West Virginia which he had received in 1920 in exchange for banker's deposit receipts for Virginia debt certificates; (2) whether said exchange in 1920 of banker's deposit receipts held by petitioner for West Virginia bonds resulted in a taxable profit to petitioner; (3) the cost basis to be used in ascertaining profit either upon the sale of said bonds in 1921 or the exchange of said receipts for said bonds in 1920; and (4) whether interest paid by petitioner during each of the years 1920 and 1921 for the purpose of purchasing or carrying said deposit receipts and/or said bonds is properly deductible from income for each of said years.  *737  The cause is submitted upon the pleadings, testimony and certain stipulated facts.  FINDINGS OF FACT.  Petitioner is a resident of Poughkeepsie, Duchess County, N.Y.  In 1914 and 1919 he purchased, on the New York Stock Exchange, Brown Brothers & Company's deposit receipts for Virginia debt certificates of a par value of*1837  $73,144.03 for the sum of $43,137.73.  On October 4, 1920, he exchanged the said deposit receipts for twenty-year 3 1/2 per cent gold bonds of the State of West Virginia of the par amount of $66,484.85 which then had a fair market value of $53,574.80.  On February 10, 1921, he purchased a fractional amount of $15.15 of said bonds for $12.27, thus making the par value of his holdings of said bonds $66,500, and the cost thereof $43,150 (including the cost of the deposit receipts exchanged therefor as aforesaid).  In 1921 petitioner sold said bonds for $53,587 and in his return for that year reported a profit from said sale of $10,437.  On January 1, 1861, the Commonwealth of Virginia had outstanding upwards of $30,000,000 of bonds.  When the State of West Virginia was formed out of the Commonwealth of Virginia, the latter asserted that the new State became liable for a share of this bonded indebtedness.  This liability was denied by the State of West Virginia.  During the period from 1871 to 1892 the present Commonwealth of Virginia settled with its bondholders but allocated one-third of the old debt to the State of West Virginia and issued deferred certificates known as "Virginia*1838  Debt Certificates" to its bondholders, which certificates represented that part of the total debt which it sought to charge to the State of West Virginia.  West Virginia continued to deny liability for any portion of the old Virginia debt and for said debt certificates.  In 1897 a committee was formed, of which John Crosby Brown of New York City was chairman, for the purpose of effecting a settlement of this one-third part of the old debt which had been charged against West Virginia.  Brown Brothers & Company were appointed as depositary of the "Virginia Debt Certificates" under the agreement and issued receipts from time to time as the certificates were deposited with them.  These receipts were negotiable and were listed on the New York Stock Exchange.  Neither the Commonwealth of Virginia nor the State of West Virginia was a party to this "West Virginia Debt Settlement" agreement.  The State of West Virginia refused to deal with the committee or with the Commonwealth of Virginia, and in 1906 a suit was brought in the Supreme Court of the United States by the Commonwealth of Virginia to compel the State of West Virginia to pay the share of *738  the old debt for which Virginia*1839  asserted West Virginia was liable.  In 1915 the Supreme Court rendered a decision holding the State of West Virginia liable in the sum of $4,215,622.28, principal of the debt, and $8,178,307.22, interest accrued from 1861 up to the entry of judgment (see ). This decision allowed interest on the sum of $12,393,929.50 from July 1, 1915, until paid at the rate of 5 per cent per annum. In 1919 the State of West Virginia issued its twenty-year 3 1/2 per cent gold bonds at par in payment of said judgment and interest, together with interest in the amount of $2,168,937.66, which had accrued since July 1, 1915.  From these figures it is apparent that of the par value of the bonds issued by the State of West Virginia approximately ten-fourteenths was in payment of interest, both upon the original indebtedness and upon the total judgment.  During the year 1920 petitioner paid $1,805.34 interest on money borrowed to carry his purchase of Brown Brothers & Company's deposit receipts up to October 4, 1920, the date of exchange.  He also paid $575.38 interest on money borrowed to carry his West Virginia bonds*1840  from October 4, 1920, to the end of the year.  The total of these two items, being $2,380.72, petitioner deducted in his 1920 income-tax return, as interest paid, which deduction respondent disallowed.  During the year 1921 petitioner paid $819.94 interest on money borrowed to carry his West Virginia bonds and deducted this amount in his tax return for 1921 as interest paid, which deduction respondent disallowed.  During both the years here involved petitioner kept his accounts and made his tax returns upon a cash receipts and disbursements basis.  OPINION.  GOODRICH: The law controlling the principal issues of this case has been determined by recent decisions of the Supreme Court.  In , it was held that profit realized from the disposition of state or municipal bonds is subject to Federal income tax.  In , distinguishing , it was held that interest paid to purchase or carry tax-exempt securities is not deductible from income.  The Denman-Nauts case involved sections 213(b)(4) and 214(a)(2) *1841  of the Revenue Act of 1921.  The same provisions of the Revenue Act of 1918 contain no material differences affecting the instant case.  Clearly, therefore, any profit derived upon the sale or exchange of his tax-exempt securities is taxable to petitioner; and amounts paid as interest to *739  purchase or carry such securities are not deductible from his income.  In the light of these decisions, only the following problems remain for determination by us in the case at bar: (1) Whether the exchange made by petitioner in October, 1920, of his holdings of Brown Brothers & Company's receipts for bonds of the State of West Virginia was a transaction giving rise to taxable profit or deductible loss.  (2) Whether any part of the bonds of the State of West Virginia so acquired by petitioner may be regarded as interest upon a State's obligation so that the receipts of proceeds of a sale thereof would amount to a collection by him of nontaxable interest; and, (3) Whether the interest paid by petitioner in 1920 upon money borrowed to purchase or carry his Brown Brothers & Company's receipts is deductible from income.  The exchange of deposit receipts for bonds was made by petitioner*1842  in 1920 and is subject therefore to the provisions of the Revenue Act of 1918.  Section 202(b) of that act provides in part as follows: When property is exchanged for other property, the property received in exchange shall for the purpose of determining gain or loss, be treated as the equivalent of cash to the amount of its fair market value, if any * * *.  Section 213(a) of the same act provides that gross income shall include "gains, profits and income derived from * * * sales, or dealings in property * * * or any source whatever." Under these provisions of the statute it seems clear that profits arising from this exchange in 1920 were taxable, provided only that the property (bonds) received in the exchange had a fair market value.  It is stipulated that the bonds on the date of the exchange had a fair market value of $53,574.80.  We find, therefore, that the taxable profit derived by petitioner upon said exchange in 1920 was $10,437.07, being the difference between $53,574.80, the then fair market value of the bonds, and $43,137.73, the cost of the deposit receipts exchanged therefor.  See *1843 ; ; ; ; . We can not agree with petitioner's argument that the sale of the bonds of West Virginia, so far as they represent interest on the old Virginia debt, is equivalent to a sale of interest coupons, or a collection of interest upon the obligations of a State and so tax exempt.  There was here a complete novation.  West Virginia discharged its obligation under the judgment rendered against it by the issue of its bonds.  These bonds were sold on the open market at a certain price and some of them were acquired by petitioner in exchange for his Brown Brothers Company receipts, which had a certain cost.  This, as we have pointed out, was a taxable exchange of property, establishing a new basis for the property (bonds) received *740  in the exchange.  We believe it immaterial for what purpose the State of West Virginia issued its bonds.  It issued them in certain denominations; they had a certain market value and they can not be broken*1844  down into elements of principal and interest with respect to the cause of their issuance.  These bonds were complete and legal evidences of an obligation of the State, each to the amount of its face value or denomination, and we must treat them as such.  In our opinion the interest paid to purchase or carry the receipts issued by Brown Brothers & Company to represent Virginia debt certificates is not deductible from petitioner's income.  These receipts, beyond doubt, represented the beneficial interest in the "certificates" which were obligations of the Commonwealth of Virginia.  Examination of the "Deposit Receipts" and "Deferred Certificates" discloses that the receipts were issued only as certificates were deposited, and identified by number and amount the certificates which each represented, and that Brown Brothers & Company assumed no liability of any kind except to hold the deposited certificates in accordance with the terms of the agreement.  Brown Brothers & Company were mere depositaries, issuing, for certificates of beneficial interest in and to securities held in trust, negotiable receipts so that the interests of the owners of the certificates passed by delivery of the*1845  receipts.  That being so, interest paid by petitioner to purchase or carry his "Deposit Receipts" was in fact expended to purchase and carry obligations of the Commonwealth of Virginia and, under the decisions above cited, is not deductible from his gross income.  Reviewed by the Board.  Decision will be entered under Rule 50.