Court Opinion

ID: 4615301
Source: CourtListenerOpinion
Date Created: 2020-11-21 02:32:04.091769+00
Date Added: 2024-06-11T07:54:55.457847
License: Public Domain

ERNEST W. BROWN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Brown v. CommissionerDocket No. 75962.United States Board of Tax Appeals36 B.T.A. 178; 1937 BTA LEXIS 758; June 18, 1937, Promulgated *758  1.  Petitioner was the owner of certain debenture bonds of a corporation of which he was the principal stockholder.  The bonds contained a provision that they were redeemable at par at any time before maturity on any interest date in multiples of $1,000 at the option of the company.  In the taxable year the corporation by appropriate resolution authorized and directed the treasurer of the corporation to use certain sums then in the sinking fund of the corporation in the retirement of its debenture bonds.  Petitioner thereupon surrendered to the corporation certain of its debenture bonds which he had owned and held for more than two years and received in payment therefor the par value of the bonds.  Held, the transactions constituted a redemption by the corporation of the bonds surrendered and not a sale or exchange thereof by the petitioner to the corporation; held, further, following John H. Watson, Jr.,27 B.T.A. 463, that the gain resulting therefrom to petitioner is taxable as ordinary income and not as capital gain.  2.  The provisions of section 117(f) of the Revenue Act of 1934 are not retroactive to cover such a situation as described above and have*759  no application to transactions which arose under the Revenue Act of 1928.  David I. Mackie, Jr., Esq., for the petitioner.  John H. Pigg, Esq., for the respondent.  BLACK *179  In this proceeding the Commissioner has determined a deficiency of $4,789.38 in petitioner's income tax for the year 1931.  In the petition three errors were assigned but at the hearing petitioner abandoned errors (b) and (c) and left only one issue for us to decide.  That issue is raised by petitioner's assignment of error (a) and may be stated briefly as follows: Whether, under the provisions of the Revenue Act of 1928, the transactions whereby the petitioner during the calendar year 1931 delivered to Ernest W. Brown, Inc., $35,000 par value of its debenture bonds and received therefor cash and securities having an aggregate fair market value of $35,000, constituted "sales or exchanges" entitling the petitioner to have said sum of $35,000 taxed at the capital gains rate of 12 1/2 percent.  At the hearing a stipulation of facts was filed and petitioner testified orally.  Some of the facts stipulated would be pertinent only if petitioner were still contending that none*760  of the $35,000 received in 1931 in satisfaction of the debentures which he surrendered to Ernest W. Brown, Inc., were taxable to him.  Petitioner no longer makes that contention and concedes that the debentures had no cost basis to him and that the entire $35,000 received was taxable gain.  Therefore the facts in the stipulation which relate to that phase of the issue will be omitted from our findings of fact.  From the facts stipulated and the oral testimony at the hearing, we make the following findings of fact: FINDINGS OF FACT.  Throughout the calendar year 1931 the petitioner was a resident of the City, County, and State of New York.  On or about March 15, 1932, the petitioner duly filed with the collector of internal revenue for the third district of New York his Federal income tax return for the calendar year 1931.  Prior to August 31, 1922, the petitioner was individually engaged in the business of acting as attorney in fact and manager of various organizations of reciprocal insurance underwriters.  Ernest W. Brown, Inc., is a corporation which was duly organized under and pursuant to the laws of the State of New York on August 22, 1922.  At a special meeting of the*761  board of directors of Ernest W. Brown, Inc., held on December 28, 1923, there was submitted to the directors a letter addressed to Ernest W. Brown, Inc., by the petitioner dated December 27, 1923, containing an offer by the petitioner to resign as attorney in fact and manager of the New York Reciprocal Underwriters and Individual Underwriters and to procure the appointment of Ernest W. Brown, Inc., as of January 1, 1924, to act as attorney in fact and manager for said underwriters, in consideration *180  of the issuance to the petitioner of $500,000 par value of 20-year 6 percent fully paid notes or debentures of Ernest W. Brown, Inc., dated December 31, 1923.  Pursuant to the following resolution, which was duly adopted by the board of directors of Ernest W. Brown, Inc., at said meeting, the offer was accepted: RESOLVED, that upon receipt by this corporation of the underwriters' agreements in form approved by counsel, appointing it as of January 1, 1924, attorney-in-fact for New York Reciprocal Underwriters and Individual Underwriters, it issue in form approved by counsel and deliver to E. W. Brown, $500,000 par value fully paid twenty year 6% notes or debentures of this corporation, *762  dated the 31st day of December 1923, containing provision for a sinking fund whereby fifty (50) percent of the net earnings of the corporation for each year beginning January 1, 1926, shall be set aside to amortize such debenture issue; provided, however, that after December 31, 1933, not more than $50,000 shall be so set aside and used for sinking fund purposes in any one year.  On or about December 28, 1923, the petitioner procured the appointment of Ernest W. Brown, Inc., as of January 1, 1924, as attorney in fact and manager for the New York Reciprocal Underwriters and Individual Underwriters.  Immediately thereafter there were issued to the petitioner by Ernest W. Brown, Inc., $500,000 par value of its 20-year 6 percent fully paid notes or debentures, dated December 31, 1923, in denominations of $1,000 each.  Each of the debentures contained a provision reading as follows: This debenture is one of a duly authorized issue of debentures of the company, the aggregate amount thereof is limited to the principal sum of Five Hundred Thousand Dollars ($500,000).  Said issue is redeemable at par at any time before maturity on any interest date in multiples of one thousand dollars*763  ($1,000) at the option of the company.  This debenture and all others of this issue shall be paid from a sinking fund to be created as follows: * * * The minutes of a special meeting of the board of directors of Ernest W. Brown, Inc., held on January 20, 1931, read in part as follows: The Chairman stated that approximately $20,000 had been accumulated and was now held in the sinking fund available for the retirement of debenture bonds.  It was thereupon, on motion duly made, seconded and unanimously adopted.  RESOLVED: That the Treasurer of the corporation be and hereby is authorized and directed to apply as of January 1, 1931 to the retirement of debenture bonds, the sum of $20,000 now in the sinking fund available for such purpose.  Pursuant to the foregoing resolution of January 20, 1931, the petitioner, on January 23, 1931, delivered to Ernest W. Brown, Inc., $20,000 par value of the aforesaid notes or debentures, and Ernest W. Brown, Inc., on the same date, delivered to the petitioner (1) its check for $612.50, drawn to the order of the petitioner, which check *181  was deposited by him in his individual bank account, and (2) certain marketable securities the*764  fair market value of which, on January 23, 1931, was $19,387.50.  The minutes of a special meeting of the board of directors of Ernest W. Brown, Inc., held on June 30, 1931, read in part as follows: The Chairman stated that approximately $25,000 had been accumulated and was now held in the Sinking Fund available for the retirement of debenture bonds.  It was thereupon, on motion duly made, seconded and unanimously adopted.  RESOLVED: That the Treasurer of the corporation be and hereby is authorized and directed to apply as of July 1, 1931 to the retirement of debenture bonds, the sum of $15,000 now in the Sinking Fund available for such purpose.  Pursuant to the foregoing resolution of June 30, 1931, the petitioner, on July 2, 1931, delivered to Ernest W. Brown, Inc., $15,000 par value of the aforesaid notes or debentures, and Ernest W. Brown, Inc., on the same date, delivered to the petitioner its check for $15,000 drawn to the order of the petitioner, which check was deposited by him in his individual bank account.  The $35,000 par value notes or debentures in controversy in this proceeding are a part of the $500,000 notes or debentures acquired by the petitioner, as*765  set forth above, and were continuously owned by him until January 23, 1931, and July 2, 1931, respectively.  Between January 1, 1929, and January 1, 1931, Ernest W. Brown, Inc., acquired $150,000 par value of the aforesaid notes or debentures.  The following discloses the manner in which the said notes or debentures were carried on the balance sheets of Ernest W. Brown, Inc., as at the beginning and close of the calendar year 1931: 1/1/3112/31/31Assets - Debenture bonds redeemed (other)$150,000.00$185,000.00Liabilities - 6% Debenture bonds (other)$500,000.00$500,000.00Said notes or debentures were similarly reflected on the balance sheets of Ernest W. Brown, Inc., for the years 1929 and 1930.  None of said notes or debentures have ever been delivered to the registrar for cancellation.  In his income tax return for the calendar year 1931 the petitioner reported, as a capital net gain, the sum of $35,000, representing the amount of cash and the fair market value of the securities received by him under the circumstances described above.  In his determination of the deficiency involved, the Commissioner determined and held that the*766  transactions by which Ernest *182  W. Brown, Inc., acquired the $35,000 par value of its notes or debentures during the year 1931 represent and constitute a redemption of said notes or debentures, and that the amount of $35,000 so reported by the petitioner as a capital net gain, represents and constitutes ordinary income, subject to both normal and surtax.  In explanation of the Commissioner's action, the notice of deficiency contains the following statement: In regard to the status of the proceeds received in 1931 from Ernest W. Brown, Inc., for debenture bonds received from the corporation in 1923, you are advised that the Bureau holds that the amount received is ordinary gain and as such is subject to normal tax and surtax.  The transaction through which you received the income cannot be considered a sale or exchange as provided in section 101(c)(1) of the Revenue Act of 1928.  The information in the case clearly discloses that whereas there is no evidence to indicate that there was an authorized call to redeem the bonds prior to maturity, it is evidenced that a fixed sum was set aside by the corporation each year to amortize the bond issue in question and that the cash*767  paid you in excess of the value of other securities was from such fund and the transaction was redemption of bonds as stated on your return.  Therefore, your contention with reference to this item has been denied.  In support of this action your attention is directed to the decision of the United States Board of Tax Appeals in the case of John H. Watson, Jr., published in United States Board of Tax Appeals reports, volume 27, page 463.  Since the bonds in question were acquired without cost the entire proceeds, including the market value of stock received in the transaction, is held to be taxable.  The transactions by which petitioner transferred to Ernest W. Brown, Inc., $35,000 par value of the corporation's 20-year 6 percent debenture bonds during the year 1931 were not sales or exchanges of capital assets within the meaning of section 101(c)(1) of the Revenue Act of 1928.  The transactions constituted a redemption by the corporation of $35,000 of its 20-year 6 percent debenture bonds.  OPINION.  BLACK: The Commissioner has determined that the transactions enumerated in the foregoing findings of fact did not constitute a "sale or exchange" of capital assets by petitioner*768  to Ernest W. Brown, Inc., and therefore petitioner is not entitled to have the gain resulting from such transactions taxed at capital gain rates.  There is no dispute that petitioner had owned and held the debentures for more than two years prior to the date of their redemption by the corporation.  But the Commissioner contends that the facts connected with the transactions show that the $35,000 debentures were redeemed by the corporation rather than acquired by purchase and exchange and therefore the rule announced by the Board in , and , is applicable. *183  Petitioner contends that those cases are distinguishable on their facts.  Petitioner says in his brief that: Each of those cases involved an actual payment, discharge and cancellation of the obligations there in controversy, and that here the obligor had no legal right to demand that payment of the face value of the debentures be accepted on January 23 and July 2, 1931.  On the contrary as a result of a purely voluntary agreement between the parties, one group of debentures was exchanged for securities and a small*769  amount of cash and the other group was sold to the corporation for cash.  The obligation of the indebtedness was never cancelled or discharged but on the contrary the debentures were kept alive in the corporate treasury for such proper uses as the corporation might see fit to make of them.  A redemption of the debentures was never intended either by the corporation or the petitioner.  We can not agree to the validity of the distinction which the petitioner seeks to draw.  It is true that in both the Watson case and the Braun case there was a formal call of bonds for redemption in accordance with the terms of the bonds.  Here there was no formal call of the bonds for redemption, but in each instance there was a resolution adopted by the board of directors of the corporation authorizing and directing the treasurer of the corporation to apply to the retirement of debenture bonds the sum named in the resolution as being available for that purpose.  The bonds themselves contained a provision that they were redeemable at par at any time before maturity on any interest date in multiples of $1,000 at the option of the company.  It is true that the redemption of the $35,000 bonds*770  in question appears to have been in accordance with a voluntary agreement between petitioner and Ernest W. Brown, Inc., the obligor of the bonds, but it seems to us that, viewing all the facts in the case, the bonds were being redeemed in much the same manner as had originally been contemplated and that there is nothing in the facts which we have here which would serve to distinguish this case from the Watson and Braun cases referred to above.  We do not think that the fact that, in the redemption on January 23, 1931, of $20,000 of the debentures petitioner there was paid only $612.50 in cash and the balance was paid in marketable securities at their fair market value, would serve as a valid distinctiton.  Petitioner contends in the alternative that if we hold that the facts of the instant case do not distinguish it from the Watson and Braun cases, we should overrule those cases and go back to the rule announced by the Board in , which was itself overruled by the Watson case.  One of petitioner's arguments as to why we should do this is that Congress in the 1934 Act, section 117(f), has dealt with the very situation*771  which we have here and had provided that sums received *184  in the retirement of bonds shall be considered as amounts received in exchange therefor.  Section 117 of the Revenue Act of 1934 deals with capital gains and losses and subsection (f) of that section reads as follows: (f) RETIREMENT OF BONDS, ETC. - For the purpose of this title, amounts received by the holder upon the retirement of bonds, debentures, notes, or certificates or other evidences of indebtedness issued by any corporation (including those issued by a government or political subdivision thereof), with interest coupons or in registered form, shall be considered as amounts received in exchange therefor.  There is nothing to indicate that it was the intent of Congress that the provisions of this subsection should be retroactive or that Congress considered the subsection as being declaratory of what was already existing law.  We have examined the House Ways and Means Committee Report which accompanied H.R. 7835, which with certain changes became the Revenue Act of 1934, and this report does not shed any light on the reasons for the enactment of subsection (f) of section 117, of the Revenue Act of 1934. *772  The Report of the Senate Finance Committee is likewise silent upon the subject.  We see no reason to give retroactive application to the provisions of said subsection or to hold that it was merely declaratory of existing law and by reason thereof we should overrule the Watson and Braun cases.  Therefore for the reasons above stated, we sustain the determination of the Commissioner on the only issue submitted to us for decision.  Reviewed by the Board.  Judgment will be entered for the respondent.