Court Opinion

ID: 4478783
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:13:17.51018+00
Date Added: 2024-06-11T14:52:43.986600
License: Public Domain

Pierce, J., dissenting: I respectfully dissent from the Court’s conclusions and holdings with respect to the principal issue, wherein it rejected the Commissioner’s determination that petitioner is not entitled to the benefit of the interest deduction provision of section 23(b) of the 1939 Code, in connection with his transactions involving the C.I.T. notes and the United States Treasury notes. (1) This case, in my view, is one of major importance in the administration of our Federal income tax system. It presents squarely the question: Whether a taxpayer who is faced with large surtax liabilities under the income tax statutes, may successfully contrive to reduce such potential tax liabilities, at such time or times and by such amounts as he may himself elect, through use of preconceived step-by-step transactions which are not entered into for any business, investment, or personal purpose whatsoever, other than to avoid income taxes; which in themselves are not intended or expected to produce any gain, profit, or income, but rather are expected to produce losses; and from which the only benefit must come from an interplay of the provisions of the tax statutes, and from severing the “costs” and outlays for such transactions from the proceeds thereof, and then deducting such “costs” against the taxpayer’s gross income from other sources, to which the anticipated large surtaxes would otherwise be applicable. The nub of such prearranged step-by-step transactions is to make arrangements with banks, at a relatively small “cost” or outlay by the taxpayer, for short-term “loans” aggregating several million dollars, which are rendered practically “risk proof” both to the banks and to the taxpayer, by the following other steps of the preconceived plan: (1) Arrangements are made for the banks to immediately apply the amounts of such loans in payment for certain readily marketable investment notes of exceedingly high quality, which yield little or no interest and are therefore selling at a discount, but which have short-term maturities and will appreciate in value as they approach the early maturity dates; and further (2) for the taxpayer to prepay to the banks the “interest cost” of the loans to their maturities, authorize the banks to retain and apply all interest which may accrue on the securities during the periods of the loans, and also authorize the banks to satisfy the remaining principal out of the proceeds from sale of the securities at the conclusion of the entire transaction. Thus the banks will have on hand at all times, an amount represented by the prepaid interest and the value of the readily marketable high-grade securities, which will aggregate more than 100 per cent of the amounts of the loans. The period of the loans is arranged to extend for at least 6 months, so that capital gain benefits may be claimed by the taxpayer on the proceeds from disposition of the securities. And arrangements also are made for the loans to begin in one taxable year and end in another, so that the prepayments of interest and the receipts from disposition of the securities will not be reportable on any one income tax return of the taxpayer.1  With these preliminary steps for elimination of risk having been taken care of, little remains to be done, except for the taxpayer to set up the transaction on his income tax returns. In the C.I.T. transaction here involved, petitioner prepaid approximately $144,000 “interest cost” on loans aggregating $8,888,925, for the privilege of picking up appreciation on the pledged securities, in the lesser amount of about $107,450. Tie conceded on cross-examination, that he anticipated suffering an economic loss from the transaction (which mathematically had to be true); and the amount of this loss was about $36,500. However, the mechanism by which he expected to convert this loss into a tax advantage, was this: He severed his above-mentioned “interest cost” of the transaction from the anticipated appreciation on the C.I.T. notes, instead of offsetting one against the other to reflect his above-mentioned economic loss; and he then applied such “costs” as a deduction against his gross income from other sources, to which the high surtaxes would otherwise be applicable. Thus, assuming that his surtax rate would otherwise have been about 75 per cent, he estimated that the actual cost to him of the transaction, after receiving the anticipated tax benefits from deduction of the $144,000 prepaid “interest,” would be only 25 per cent thereof or about $36,000. He further anticipated that the $107,450 appreciation on the pledged securities would be taxed at the 25 per cent capital gains rate, so he could retain, after taxes, 75 per cent thereof or about $80,000. Accordingly, he concluded that from the entire step-by-step transaction, he would, if his plan were successful, not only obtain the valuable tax deduction of about $144,000, but also actually make approximately $44,000 (being the difference between the $80,000 retained after taxes out of the appreciation realized from the securities, and the $36,000 representing the “net cost” to him of carrying out the transaction). By repeating this process from time to time, or by increasing the amounts of the “loan” transactions, he could practically “write his own ticket” as to income tax liabilities. He was, in substance, purchasing income tax deductions. The United States Treasury note transaction was of substantially the same character. As to this, petitioner arranged with four banks for loans aggregating $5 million which were to bear interest at 3^ per cent to their due date of March 15, 1955, in order to carry 1% per cent Treasury notes that were to mature on the due date of the loans. It was realized that the net 2 per cent “interest cost” of carrying the transaction to its conclusion would exceed the proceeds to be derived therefrom (the appreciation of the Treasury notes to their maturity) ; but the benefits were intended to be derived, as in the case of the C.I.T. notes, from deducting the “interest cost” from the petitioner’s income from other sources. In this transaction, the petitioner contended that he might have derived an economic gain, if he could have sold the Government notes prior to their maturity and could have obtained a refund from the banks of part of the “interest” which he had prepaid. However, he had no legal right to obtain such an adjustment from the banks, and all four banks refused to terminate the transaction prior to its maturity, without being compensated therefor. Thus, the transaction still produced an economic loss. (2) The record in the instant case clearly establishes that the present transactions were not unique to the petitioner, and that they were not of the same character as those in which he normally engaged. Prior to the trial herein, counsel for both parties represented to this Court on motion, that this was a “key case”; and that it had been selected for trial out of a group of 13 cases pending before this Court, in which the taxpayers were represented by the same counsel, and in which there were common issues. Pursuant to the motion, this “key case” was advanced for trial. Petitioner had engaged in financial business for at least 36 years; but he conceded on cross-examination that he had never, prior to the years involved, entered into- any transaction involving the type of arrangement here presented. When petitioner was asked how he became aware of this type of transaction, he replied that it was “common talk around Wall Street” — which tends to indicate that transactions of this character were sufficiently unusual to stimulate discussion even in a major financial center. Other statements of petitioner on cross-examination show that the present transactions were entered into by petitioner following a discussion with a man named Livingstone, who was the architect of similar transactions involved in the “so-called ‘Livingstone’ cases.” 2 Petitioner acknowledged that Livingstone came to his office “a short time prior” to the time when he (petitioner) entered into the present C.I.T. note transactions; and that Livingstone there described to petitioner and his partners the type of transactions involving Treasury notes which he had himself entered into. In addition to petitioner’s entering into both the C.I.T. note transactions and the Treasury note transactions here involved, one of petitioner’s partners entered into a O.I.T. note transaction, and more than half of the 18 partners of petitioner’s firm entered into Treasury note transactions. Thus, the present case is of more widespread importance to the Federal tax system than might appear, on first impression. (3) During the past 2 years, a multiplicity of cases involving tax avoidance by use of the interest deduction provisions of section 23(b), have been decided by this and other courts. These include: Eli D. Goodstein, 30 T.C. 1178, affd. 267 F. 2d 127 (C.A. 1); George G. Lynch, 31 T.C. 990, affd. 273 F. 2d 867 (C.A. 2); Leslie Julian, 31 T.C. 998, affirmed sub nom. Lynch v. Commissioner, supra (C.A. 2); Sonnabend v. Commissioner, 267 F. 2d 319 (C.A. 1), affirming T.C. Memo. 1958-178; Egbert J. Miles, 31 T.C. 1001, on appeal (C.A. 2); John Fox, T.C. Memo. 1958-205; and Matthew M. Becker, T.C. Memo. 1959-19. Also, the Court of Claims recently decided a similar case, Broome v. United States, 170 F. Supp. 613, in which that court expressly approved of the views of this Court in the Goodstein case, supra. See also W. Stuart Emmons, 31 T.C. 26, affirmed sub nom. Weller v. Commissioner, 270 F. 2d 294 (C.A. 3); and Knetsch v. United States, 272 F. 2d 200 (C.A. 9), certiorari granted 361 U.S. 958, in which the court affirmed the judgment of the District Court in which it was held that the “alleged interest was not interest in fact, but the purchase price of a tax deduction.” All these cited cases, though they presented variations of fact, detail, and approach, involved the same basic question here presented. All were decided adversely to the taxpayer. All reflected (to use the phraseology of Justice Cardozo in Burnet v. Wells, 298 U.S. 670) “the Government’s endeavor to keep pace with the fertility of invention whereby taxpayers had contrived to * * * be relieved of the attendant [tax] burdens.” See also in this connection: Helvering v. Gregory, 69 F. 2d 809 (C.A. 2), aff'd. 293 U.S. 465; and Helvering v. Clifford, 309 U.S. 331. (4) I believe that it was never intended that the Internal Eevenue Code should be employed as a vehicle by which high-income taxpayers might, through transactions like the present, reduce or indeed eliminate their share of the Federal tax burden. The purpose of the Code is to provide the Government with needed revenues through taxation of gains, profits, and income; and it should not be presumed to bear within itself the means for frustrating such purpose. The problem here, as I see it, is not whether, but by what approach, such transactions should be disapproved. I think that this Court, in deciding the present case, placed too much emphasis on the formalisms and labels under which the transactions were conducted; and that it failed to give adequate consideration of the realities of what actually was done, and what objectives were intended to be attained. There is no merit to the suggestion that courts are helpless to deal with such situations; and that, under the separation-of-powers • doctrine, relief can be afforded only through action of Congress. Such a suggestion was rejected by the Second Circuit in Helvering v. Gregory, supra, wherein the court said: It is quite true, as the Board has very well said, that as the articulation of a statute increases, the room for interpretation must contract; but the meaning of a sentence may be more than that of the separate words, as a melody is more than the notes, and no degree of particularity can ever obviate recourse to the setting in which all appear, and which all collectively create. * * * Also, in Helvering v. Clifford, supra, the Supreme Court held that the mere fact that .Congress, in dealing with a specific section of the statute, had chosen either to provide or not to provide for certain situations to which a “rule of thumb” might be applied, did not render the courts powerless to apply the general intent of the section involved, in other situations for which Congress had not specifically provided. Hence the maxim of “Inclusio unius est emelmio dlterius,” upon which the majority of this Court has so heavily relied, is not applicable. (5) There would appear to be several avenues available for judicial approach to the present problem. One approach would be to hold that allowance of the claimed deductions under section 23(b) would violate the spirit and intent of the statute. In Holy Trinity Church v. United States, 143 U.S. 457, the Supreme Court said: It is a familiar rule, that a thing may be within the letter of the statute and yet not within the statute, because not within its spirit, nor within the intention of its makers. This has been often asserted, and the reports are full of eases illustrating its application. This is not the substitution of the will of the fudge for that of the legislator, for frequently words of general meaning are used in a statute, words broad enough to include an act in question, and yet a consideration of the whole legislation, or of the circumstances surrounding its enactment, or of the absurd ,results which follow from giving such broad meaning to the words, makes it unreasonable to believe that the legislator intended to include the particular act. * * * [Emphasis supplied.] Another approach would be to regard the present transactions as mere shams, as was done in Eli D. Goodstein, supra, and the other cases hereinabove cited in connection therewith. Apposite to this approach is the following statement of the Supreme Court in Gregory v. Helvering, 293 U.S. 465: The rule which excludes from consideration the motive of tax avoidance is not pertinent to the situation, because the transaction upon its face lies outside the plain intent of the statute. To hold otherwise would be to exalt artifice above reality and to deprive the statutory provision in question of all serious purpose. A third approach would be to treat petitioner’s “interest” payments (which were his only outlay toward attaining his objective through the step-by-step transactions) as his “cost” of picking up the appreciation on the securities which he employed, and then offsetting such costs against his proceeds, in order to truly reflect the income or loss from the transaction as a whole. The fact that an item has been labeled “interest,” even when all formalities have been meticulously observed, is not conclusive as to the item’s true character. Emanuel N. (Manny) Kolkey, 27 T.C. 37, affd. 254 F. 2d 51 (C.A. 7). I deem it unnecessary in this dissenting opinion, either to select or to develop the one solution which would be most appropriate. It seems sufficient to state respectfully, that of all the possible solutions, the one which in my view most clearly appears to be wrong, is that of approving the claimed deductions. I would have approved the determinations of the Commissioner, HaRROn, J., agrees with this dissent.   Another feature of petitioner’s C.I.T. transaction was Ms arrangement to “sell” the notes on dates which ranged from 4 to 6 days prior to the notes’ maturities. It is obvious that few assignees, other than brokers interested in handling charges, would pay out approximately $9 million merely to receive less than 6 days’ appreciation on the notes (which this Court, under the other issue of this case, has held to be ordinary income). Such transparent attempt to convert ordinary income into capital gain, is substantially the same device which was employed in the recent case of Commissioner v. Phillips, 27.5 F. 2d 33 (C.A. 4), reversing 30 T.C. 866.    This nickname of “Livingstone cases” was employed in petitioner’s brief; and it has reference to such cases as the Goodstein, Lynch, Julian, Sonnabend, Broome, Miles, Fox, and Becker cases, which are hereinafter mentioned. The nickname arises from the fact that in all these cases, the tax avoidance plans involved were developed by M. Eli Livingstone, whose activities are described in said cases.