Docket No. 11988.
Roger K. Powell, Esq., for the petitioner. Philip J. Wolf, Esq., for the respondent.
Petitioner, or its trustee under a supplemental mortgage agreement, purchased in the taxable year ended December 31, 1949, certain of its bonds at less than their face value. Both before and after such purchases it was solvent. The bondholders' intent in disposing of petitioner's bonds was not to release something for nothing, but to obtain the highest available price for their claims. Held, the difference between the face amount of petitioner's bonds and the lesser amount paid by either petitioner or its trustee under the mortgage for their purchase is includible in its gross income for Federal income tax purposes. Commissioner v. Jacobson, 336 U.S. 28. Roger K. Powell, Esq., for the petitioner. Philip J. Wolf, Esq., for the respondent.
The respondent determined a deficiency in petitioner's income tax for the year ended December 31, 1940, in the amount of $699.85. The deficiency resulted from the respondent's disallowance in part of a deduction taken by petitioner in that year for accrued real estate taxes. That adjustment is not contested by petitioner in this proceeding. Petitioner contends, however, that respondent erred by failing to exclude from its gross income an amount which it claims was erroneously reported as taxable income in its return. Only one question therefore is presented: Is the difference between the face value and purchase price of certain of petitioner's bonds which were purchased either by petitioner or its trustee under a mortgage during the year ended December 31, 1940, taxable income of the petitioner for that year?
The income tax return for the taxable year involved was filed with the collector of internal revenue for the eighteenth district of Ohio, at Cleveland. Part of the facts have been stipulated and they are so found.
FINDINGS OF FACT.
Petitioner is a corporation, with its principal office in Columbus, Ohio. It was organized in 1917 under the laws of the State of Ohio, for the purpose of acquiring, leasing, and holding real estate.
By assignment in 1917 it became the owner of a leasehold on certain premises located in Cleveland, Ohio, and in that year it constructed on the property a two-story building, which it subsequently rented. In 1922 it issued interest-bearing bonds in the aggregate principal amount of $400,000, which were secured by a mortgage on the leasehold estate and were to mature on March 1, 1932. When these bonds matured they were canceled and new bonds were issued in their place in an equal aggregate principal amount, maturing March 1, 1942, and secured by the leasehold estate.
In 1937 petitioner was reorganized under section 77-B of the Act of Congress relating to bankruptcy. At that time the entire issue of $400,000 in bonds was still outstanding. Under the reorganization a supplemental mortgage agreement was executed by the petitioner and the Central National Bank of Cleveland, as trustee. At all times material herein that bank operated as trustee under the provisions of that supplemental mortgage agreement. The plan of reorganization provided in part as follows:
(4) The supplemental mortgage shall provide for a minimum sinking fund to be paid to the trustee of $2,000. per month, from and after March 1, 1937, to be used and applied, semi-annually after March 1, 1937, first, for the payment of interest on the bonds, and, second, for the retirement of principal of bonds, either by purchase in the open market or redemption, as provided in the mortgage; provided, however, that during each semi-annual period from and after March 1, 1937, after the trustee shall have accumulated sufficient funds to pay the next maturing coupons on all outstanding bonds except the $23,000. face amount of bonds which are to be subordinated as hereinafter provided, then and in every such case the trustee may use all or any part of funds held by it as trustee, to reimburse the Building Company to the extent of its actual cost, (not exceeding the face amount of the bonds and accrued interest) for all bonds tendered to the trustee for cancellation.
On February 14, 1940, the trustee circularized all known bondholders, informing them that funds were on deposit in the sinking fund for the purchase of bonds and inviting the tender of bonds to the trustee for purchase. In response to the circulars the Cleveland Trust Co. tendered to the trustee bonds of a face value of $1,600 for a price of $1,088, such price being $68 per $100 face value. In addition, F. L. Miller, then treasurer of petitioner, tendered to the trustee bonds of a face value of $15,000. The tender prices of those bonds were $5,000 face value of $15,000. The tender prices of those bonds were $5,000 face value at $70 per $100 face value, $2,000 at $71 1/2, $1,000 at $72 1/2, $2,000 at $73 1/2, and $5,000 at $74 1/2, the total tendered price being $10,850. The trustee accepted the tender of the Cleveland Trust Co. and in March 1940 purchased bonds of a face value of $1,600 for a price of $1,088. Of the bonds having a face value of $15,000 which were tendered by F. L. Miller, treasurer of petitioner, the trustee purchased bonds having a face value of $13,500 for various sums.
On April 4, 1940, petitioner purchased from the brokerage firm of L. J. Schultz & Co. bonds of a face value of $2,500 for a price of $1,975, plus accrued interest in the sum of $9.44. The ‘Confirmation and Statement‘ sent to petitioner by that company in connection with the sale above mentioned stated that such sale of bonds had been made by L. J. Schultz & Co. ‘as principal and for our account.‘
Petitioner in a letter dated August 15, 1940, signed by F. L. Miller in his capacity as treasurer of petitioner, tendered to the trustee for cancellation in accordance with the terms of the supplemental mortgage above set forth bonds of petitioner of a face value of $7,800. Petitioner stated in the letter that it had purchased the bonds at a cost of $79 per $100 face value, plus accrued interest. It requested that it be reimbursed by the trustee to the extent of that cost. The trustee accepted such tender on August 19, 1940, and it remitted to petitioner as the purchase price for the bonds the amount of $6,162 plus $143 for accrued interest.
Included in the $7,800 in bonds tendered to the trustee by the petitioner on August 15, 1940, were certain bonds of the face value of $1,000 which had been included in the purchase of bonds by petitioner from L. J. Schultz & Co. on April 4, 1940. The remaining $6,800 in bonds of the $7,800 in bonds above mentioned had been the property of F. L. Miller in his individual capacity prior to the tender made on August 15, 1940.
None of the sellers of the bonds above mentioned intended to transfer or release something for nothing. They intended to get the highest available price for their entire claims against the petitioner as represented by the bonds. Petitioner was solvent both before and after the bonds were purchased.
Petitioner, in its tax return for the year ended December 31, 1940, deducted the amount of $4,241.57 for accrued real estate taxes. Respondent disallowed the deduction and on the basis of that and certain other adjustments determined a deficiency in petitioner's income tax for the year ended December 31, 1940, in the amount of $699.85. Petitioner does not contest those adjustments in this proceeding. In the same return it reported as income the amount of $5,416.67 which purportedly represented gain from the purchase in 1940 of certain of its bonds for less than their face or issuing value. In its petition it assigned as error the failure of respondent to exclude from income for the year involved such gain, and on the basis of that assignment of error it claims an overassessment of income tax in the amount of $193.90.
Petitioner assigned as error respondent's ‘failure to exclude from petitioner's income gain on purchase in 1940 of petitioner's bonds at a discount, in the amount of $5,416.67.‘ The respondent denies that he erred thereby.
The transactions involving the purchase of petitioner's bonds at less than their face value, which it contends resulted in the gain erroneously represented in its 1940 income tax return as income, may be summarized as follows:
(a) $1,600 face value in bonds purchased by the trustee from the Cleveland Trust Co. in March 1940 at a price of $1,088. The amount of the accrued interest is not shown.
(b) $13,500 face value in bonds purchased by the trustee from F. L. Miller in March 1940 at a price not disclosed by the record.
(c) $2,500 face value in bonds purchased by the petitioner from L. J. Schultz & Co. on April 4, 1940, at a price of $1,975, plus accrued interest in the sum of $9.44.
(d) $6,800 face value in bonds purchased by the petitioner from F. L. Miller in August 1940 at a price of $5,372, plus accrued interest in an amount not disclosed by the record.
It is not possible to determine from the above tabulation how petitioner arrived at the figure of $5,416.67 as representing the gain realized through the transaction involved. However, this is the amount represented in its income tax return for the taxable year involved as gain realized through the transaction above tabulated and no question is raised as to the correctness of this figure. Therefore, we accept it as correctly reflecting the total amount of discount at which petitioner and/or its trustee purchased certain of its outstanding bonds.
We think that the decision of the Supreme Court in Commissioner v. Jacobson, 336 U.S. 28, compels that that amount be included in its taxable income for the year involved. The Jacobson case differs from this one only in the fact that the taxpayer there was an individual and not a corporation, as here. The Court pointed out, however, that:
* * * The nature of the gain derived by a debtor from his purchase of his own obligations at a discount is the same whether the debtor is a corporation or a natural person. * * *
Thus, the petitioner here can escape taxability of the amount of such discount as income only if it is shown that such discount constituted a gift.
SEC. 22. GROSS INCOME.(b) EXCLUSIONS FROM GROSS INCOME.— The following items shall not be included in gross income and shall be exempt from taxation under this chapter:(3) GIFTS, BEQUESTS, AND DEVISES.— The value of property acquired by gift, bequest, devise, or inheritance (but the income from such property shall be included in gross income).
The situation in each transaction is a factual one. It turns upon whether the transaction is in fact a transfer of something for the best price available or is a transfer or release of only a part of a claim for cash and of the balance ‘for nothing.‘ * * *
We have found as a fact that the bondholders did not intend to transfer something for nothing; on the contrary, we think the evidence affirmatively shows that the ‘transaction (was) in fact a transfer of something for the best price available.‘ Commissioner v. Jacobson, supra.
To support its contention, petitioner relies principally upon the decision of the United States Court of Appeals for the Seventh Circuit in Jacobson v. Commissioner, 164 Fed.(2d) 594, which affirmed in part and reversed in part our decision in Lewis F. Jacobson, 6 T.C. 1048. The Supreme Court reversed the Circuit Court in Commissioner v. Jacobson, supra; consequently the decision of the Circuit Court is of no weight here.
It follows that respondent did not err in his determination.
Decision will be entered for respondent.