Opinion
Docket No. 74212.
1960-05-24
JACK L. AND JEAN SHERMAN, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Kenneth W. Bergen, Esq., Josiah A. Spaulding, Esq., and M. Gordon Ehrlich, Esq., for the petitioners. Raymond T. Mahon, Esq., and John M. Doukas, Esq., for the respondent.
Kenneth W. Bergen, Esq., Josiah A. Spaulding, Esq., and M. Gordon Ehrlich, Esq., for the petitioners. Raymond T. Mahon, Esq., and John M. Doukas, Esq., for the respondent.
1. Deductions for amortization of bond premium held properly disallowed. Cf. Maysteel Products, Inc., 33 T.C. 1021; Fabreeka Products Co.,34 T.C. 290.
2. Deductions for interest actually paid held allowable. Fabreeka Products Co.,34 T.C. 290.
Respondent determined deficiencies in petitioners' income tax for 1954 and 1955 in the amounts of $6,161.80 and $5,025.08, respectively. The questions are: (1) Whether, under section 171, I.R.C. 1954, petitioners are entitled to deductions claimed for the amortization of bond premiums in 1954 and 1955. (2) Whether, under section 163, I.R.C. 1954, petitioners are entitled to deductions claimed for interest in 1954 and 1955.
FINDINGS OF FACT.
Certain facts have been stipulated and are incorporated herein by reference.
Petitioners, husband and wife residing in Lowell, Massachusetts, filed joint income tax returns for 1954 and 1955 with the director of internal revenue for the district of Massachusetts. Jack L. Sherman, hereinafter referred to as petitioner, is also known as Jacob L. Sherman. He is treasurer and a stockholder of the Phyllis Shoe Company, in Lowell, Massachusetts, a corporation with which he has been associated since 1929.
James D. Glunts & Co., an accounting partnership doing business in Boston, has been, and was during the years under review, the accountant for petitioner. Gerald I. Glunts (hereinafter referred to as Glunts) is a partner in that firm and a nephew of James D. Glunts, the senior partner; he is also a certified public accountant registered in Massachusetts, an attorney at law admitted to practice before the Supreme Judicial Court of Massachusetts, and a member of the American Institute and the Massachusetts Society of Certified Public Accountants. Prior to 1954, Glunts did some accounting work for one of petitioner's companies, and in 1954, he began doing work for petitioner personally; he informed, advised, and assisted petitioner in carrying out the securities transactions involved in this case.
During 1952, Glunts became interested in the ‘tax-saving’ possibilities of transactions utilizing ‘amortizable’ corporate bonds which were callable on not less than 30 days' notice. Realization of the contemplated ‘tax savings' depended upon the following capital factors: (1) Payment of an abnormally large premium by a taxpayer upon purchase of such bonds; (2) the deductibility of the premium, after a holding period of 30 days, on the theory that the applicable sections of the Internal Revenue Code and regulations permitted ‘amortization’ of the premium down to the earliest call date on the bonds; and (3) the existence of a ready market for the bonds when the taxpayer sought to dispose of them. These elements were basic to at least three different types of transactions ultimately entered into by Glunts' clients, as follows:
(1) A corporation might purchase bonds of the type described above by furnishing from its own funds that portion of the purchase price equivalent to the ‘amortizable’ premium, borrowing the remainder, and pledging the bonds as collateral for the loan. After 30 days, the corporation would declare the bonds as a dividend in kind to shareholders, subject to the loan, and claim a deduction for the premium. The shareholders would then assume the indebtedness against the bonds, sell them, and pay off the loan with part of the proceeds, distributing the remainder of the proceeds to themselves. This form of transaction was geared to produce a tax deduction to the corporation for an otherwise nondeductible dividend distribution.
(2) A ‘high-bracket’ individual taxpayer might purchase these bonds, also by putting up cash in an amount equivalent to the premium and borrowing the remainder of the purchase price. After 30 days, the taxpayer would claim a deduction for the premium. He would then contribute the bonds to a charity, subject to the indebtedness against them, and claim a charitable deduction for the value of his equity in the bonds. The charity would sell the bonds, pay off the loan with a portion of the sales proceeds, and keep the remainder. This form of transaction was intended to produce two deductions the ‘tax savings' from which, in the case of a ‘high-bracket’ taxpayer, would exceed the amount paid by him towards the purchase price of the bonds.
(3) After taking the amortization deduction, the same ‘high-bracket’ taxpayer might decide to hold the bonds until 6 months had elapsed from the date of purchase at which time he would sell the bonds and report a capital gain in the amount by which his sales proceeds exceeded his basis in the bonds as adjusted for the amortization deduction. Part of the sales proceeds would be used to pay off the loan, the remainder being gain to the taxpayer on the sale. The capital gains tax incurred upon sale of the bonds would, in the case of a ‘high-bracket’ taxpayer, be more than offset by ‘tax savings' from a amortization deduction.
In response to a request from Glunts, J. Benn Keizer of Keizer & Co., Inc., compiled a list of bonds of the type required for the contemplated transactions. Keizer & Co., Inc. (hereinafter referred to as Keizer), is a corporate brokerage firm doing business in Boston; it is registered with the Securities and Exchange Commission as a trader-dealer, but is not a member of the New York Stock Exchange. J. Benn Keizer is a director and 20 per cent stockholder of Keizer. Together, Glunts and J. Benn Keizer investigated the indenture provisions of those bonds which appeared to fit their requirements. Among the bonds discussed by Keizer and Glunts were Illinois Power Company 1978 series 3 1/8 per cent first mortgage bonds (hereinafter sometimes referred to as Illinois bonds). These bonds had been issued in the face amount of $15 million on February 1, 1948, by the Illinois Power Company, an Illinois utilities corporation with principal offices in Decatur, Illinois. They are callable in whole or in part on not less than 30 nor more than 60 days' published notice for general as well as sinking, property, maintenance, and renewal fund purposes. The general call price for the 12 months ending February 1, 1955, was 103 and the sinking fund call price during this period was 100.43. The general call price for the 12 months ending February 1, 1956, was 102.95 and the sinking fund call price during the period was 101.41.
On October 29, 1952, Glunts wrote a letter to the Treasury Department requesting a ruling as to (1) the amortization of premiums on specified bonds callable on at least 30 days' notice; and (2) an assumed situation involving the contribution of such bonds to an organized charity. However, the Rulings Division refused to issue a ruling until Glunts identified the taxpayer on whose behalf the ruling was requested. A subsequent letter from Glunts, dated January 27, 1953, indicated that the ruling was being requested on behalf of several of his clients, but did not identify them by name. Finally, by letter dated February 10, 1953, Glunts changed his request to state that he was the taxpayer interested in the purchase of the bond issues described. On March 4, 1953, the following ruling was issued by Glunts as the interested taxpayer:
Based on the information furnished, it is the opinion of this office that, since each of the bonds may be called on at least 30 days' notice, at either the general redemption price or the special redemption price, you may, under the provisions of section 125 of the Internal Revenue Code, amortize the premium on such bonds to the lowest price at which the bonds may be legally redeemed on the earliest call date, which would be either the date specified in any notice of redemption properly issued by any of the companies or, if no notice has been received at the time the decision to amortize bond premium with respect to such bonds is made, the thirty-first day following the date on which such decision is made. * * *
The ‘information furnished’ included the identification and description of the bonds with respect to which the ruling was requested and both the general and special redemption prices applicable thereto, but it did not include the amount (nor any estimate of the amount) of the premium to be paid for the bonds. Nor did such information include a description of the transactions in which Glunts planned to utilize the bonds. As to the assumed situation involving the contribution of the bonds to charity, the Rulings Division deemed it ‘inadvisable to rule without a complete statement of facts regarding the proposed arrangements, understandings, or contracts involved, the business purposes of the proposed transaction, and all other relevant details.’
After receipt of the ruling, Glunts began contacting his clients for purposes of recommending to them that they enter into transactions such as those previously described. He usually showed them the ruling which he had obtained, in order to interest them in the ‘tax saving’ possibilities of the transactions he was recommending. Of those clients contacted and shown the ruling, approximately 30 or 35 agreed to enter into some variation of the recommended transactions.
Petitioner was one of the clients contacted by Glunts. In October or November 1954, Glunts showed petitioner the aforementioned ruling and informed him that he could reduce his income tax liability through a plan involving the purchase of amortizable bonds. According to the transaction outlined by Glunts, petitioner would purchase bonds from Keizer at a premium, paying a portion of the purchase price from his own funds and borrowing the remainder through a loan which Keizer would arrange; the bonds would be held for at least 30 days in order to claim an amortization deduction for the premium; petitioner would then either (a) donate the bonds to a charity subject to the loan, and claim a charitable deduction in the amount by which the market price of the bonds at the time of contribution exceeded the amount of the loan, or (b) continue to hold the bonds until 6 months had elapsed from the date of purchase at which time he would sell the bonds and report a long-term capital gain in the amount by which the sales proceeds exceeded his basis, as adjusted for the amortization deduction. Glunts suggested to petitioner that his most advantageous purchase would be in the approximate amount of $60,000 face value of the bonds. On the hypothesis that the market price of the bonds would be the same at the time of disposition as at the time of purchase, Glunts computed and showed petitioner the approximate income tax reductions that he could expect to derive from the alternative transactions. Glunts did not discuss the investment aspects of the bonds with petitioner except to inform him that the bonds were ‘double A.’
No difficulty was anticipated in reselling the bonds. Although Keizer did not enter into a written agreement with petitioner to repurchase the bonds, both Glunts and Keizer expected and understood that Keizer would repurchase. With one or two exceptions, Keizer had sold bonds to, and repurchased them from, all of Glunts' clients involved in similar transactions, and Keizer anticipated repurchasing petitioner's bonds in oder to sell them again.
On November 23, 1954, petitioner purchased from Keizer $60,000 face value of Illinois bonds at a price of 116 for each $100 of face value. The total purchase price of the bonds was $70,219.79, comprising a principal cost of $69,600 and accrued interest to settlement date of $619.79. On the same date, Maurice Artenstein, another client of Glunts', also purchased $60,000 face value of Illinois bonds from Keizer at a purchase price of 116. Artenstein was a business associate of petitioner; he was president and a stockholder of the Phyllis Shoe Company.
Prior to purchasing the Illinois bonds, it had been arranged by Keizer, through Simmons, Bourne & Co., a note brokerage firm in Boston, for petitioner to borrow $60,258 for 6 months from the Harvard Trust Company, Arlington, Massachusetts (hereinafter referred to as Harvard Trust). The amount of the loan corresponded to the lowest call price on the bonds as of the 31st day after purchase, that is, 100.43 for each $100 face value of the bonds. The bonds were to serve as collateral for the loan. An identical loan had been arranged for Artenstein at Harvard Trust.
The settlement date for the purchases by petitioner and Artenstein was scheduled for November 30, 1954. On that date, petitioner executed and delivered to Harvard Trust his negotiable, recourse promissory note for $60,258. The note, executed on a standard form used by Harvard Trust, entitled ‘Non-Purpose ‘Stock’ Collateral Time Loan,‘ was due May 31, 1955, and bore interest at 3 1/4 per cent. Simmons, Bourne & Co. charged a commission of 1/4 of 1 per cent for placing the loan, brining the overall charge incurred by petitioner on the loan to 3 1/2 per cent. Artenstein executed a similar note. By check dated November 30, 1954, petitioner paid $1,066.23 to Simmons, Bourne & Co. as advance payment of the overall charge. Petitioner also sent a check dated November 30, 1954, to Keizer for $9,961.79, representing that part of the purchase price of the bonds which petitioner furnished from its own funds. Keizer was instructed to deliver the bonds purchased by petitioner to Harvard Trust against receipt of $60,258 (the amount of petitioner's loan), and Harvard Trust was instructed to pay the amount of the loan to Keizer against receipt of the bonds from Keizer or its order.
However, delivery to Harvard Trust of the bonds purchased by petitioner and Artenstein, and payment by Harvard Trust of the respective loans, was postponed until December 27, 1954, when certain bonds then serving as collateral for a loan to Fabreeka Products Company (hereinafter called Fabreeka) became available as collateral for the loans to petitioner and Artenstein. (On November 16, 1954, a week prior to the purchases by petitioner and Artenstein, Fabreeka, a corporate client of Glunts', had purchased $170,000 face value of Illinois bonds from Keizer at a price of 118. That portion of the purchase price representing ‘amortizable’ premium was furnished by Fabreeka from its own funds, and the remainder, representing the lowest call price on the bonds, was borrowed from Harvard Trust on Fabreeka's note due December 27, 1954; the bonds were pledged as collateral for the loan. It was Fabreeka's plan to hold the bonds for 30 days so as to claim the amortization deduction, and then distribute the bonds to its shareholders as a dividend; the shareholders would assume the indebtedness to Harvard Trust, and an agent for the shareholders would then sell the bonds, pay off the loan, and distribute the remaining proceeds ratably among the shareholders. The purpose of this plan was to produce a deduction for Fabreeka in the approximate amount of its yearend dividend, thereby reducing Fabreeka's income taxes for 1954. On December 27, 1954, James D. Glunts, as agent for Fabreeka's shareholders, sold the bonds back to Keizer at a price of 115, and used an allocable portion of the sales proceeds to pay off the loan. The amortization deduction and other deductions incident to the transaction which Fabreeka claimed on its 1954 return are in issue in Fabreeka Products Company, Docket No. 72087, decided this day, the record in which has been incorporated herein by stipulation of the parties.)
The serial numbers of the Illinois bonds held in bearer form by Harvard Trust as collateral for the Fabreeka loan were numbers 12001 through 12100,13101 through 13150, and 13181 through 13200. These bonds had come from Keizer's inventory which was in effect an open account maintained by Keizer with the firm of Josephthal & Co. (hereinafter referred to as Josephthal), a New York brokerage house with an office in Boston and memberships in the New York and other stock exchanges. Josephthal customarily served as clearing agent for Keizer, acting upon Keizer's instructions to receive or deliver securities and to make or receive payments for Keizer's account.
On December 23, 1954, Keizer instructed Josephthal to deliver $60,000 face value Illinois bonds to Harvard Trust for the account of petitioner and to receive payment of $60,258. Similarly, Harvard Trust was instructed to receive these bonds and to pay Josephthal the $60,258 which it had previously agreed to lend to petitioner. Corresponding instructions were issued to cover the Artenstein loan.
On December 27, 1954, Josephthal paid Harvard Trust the amount required to discharge the loan to Fabreeka and received the $170,000 face value Illinois bonds held by Harvard Trust as collateral for that loan. The delivery to Josephthal was accomplished by the physical transfer of the bonds to Josephthal's messenger who, after holding them for about 5 minutes, redelivered $120,000 face value thereof to Harvard Trust as security for the loans to petitioner and Artenstein. Those bonds bearing serial numbers 12001 through 12060 were held as collateral for petitioner's loan, and those bonds with serial numbers 12061 through 12100, and 13101 through 13120, were held as collateral for Artenstein's loan.
In its loan arrangement with petitioner and Artenstein, Harvard Trust required a minimum margin of 10 points; that is, the bid price on the bonds pledged as collateral had to exceed the amount of the loan by 10 points at all times during the term of the loan, or additional collateral would be required. According to a notation on the Harvard Trust collateral loan card for petitioner's loan, the bid price on Illinois bonds ascertained by Harvard Trust as of December 27, 1954, was 104. To comply with the minimum margin requirements, petitioner deposited additional collateral of $3,858 with Harvard Trust to secure his note; he delivered his check for $858 on November 30, 1954, which was cashed by Harvard Trust on December 28, 1954, and he delivered another check for $3,000 on January 10,1955, which was cashed by Harvard Trust on January 12, 1955. Identical deposits of additional collateral were made by Artenstein.
On May 24, 1955, petitioner sold his $60,000-face-value Illinois bonds back to Keizer at a price of 114. Net proceeds of the resale were $68,958.54, computed as follows: Principal proceeds ($68,400), plus accrued interest to settlement date ($588.54), less Federal documentary stamp taxes on the resale ($30). Artenstein also sold his $60,000-face-value Illinois bonds back to Keizer. The settlement date for both transactions was also May 24, 1955.
On the same day, May 24, 1955, petitioner again purchased $60,000 face value of Illinois bonds from Keizer, this time at a price of 115. The total purchase price was $69,604.16 (principal purchase price of $69,000 plus accrued interest of $604.16). Artenstein also again purchased $60,000 face value of Illinois bonds from Keizer. The settlement date for these purchases was May 27, 1955.
On June 1, 1955, Harvard Trust mailed its treasurer's check to petitioner for $937.80, covering the proceeds of coupons due February 1, 1955, on the bonds held as collateral for petitioner's loan. On June 2, 1955, pursuant to previous instructions, Harvard Trust delivered to Josephthal the $120,000 face value of Illinois bonds theretofore held as collateral for the loans to petitioner and Artenstein, and Josephthal paid Harvard Trust $120,516 to discharge those loans. Delivery and payment were made through the Hanover Bank in New York City, and were confirmed by Josephthal in a notice to Keizer dated June 16, 1955. On June 6, 1955, Harvard Trust returned to petitioner his canceled note and a treasurer's check for $3,858 representing the additional collateral theretofore deposited by him. On June 7, 1955, Simmons, Bourne & Co. sent petitioner a bill for $17.57 for 3 days overdue interest on his note to Harvard Trust, and for $13.50 for charges of forwarding petitioner's bonds to Hanover Bank in New York City; petitioner paid this bill on June 10, 1955.
The difference between the net proceeds to petitioner from his resale of Illinois bonds ($68,958.54) and the amount required to repay his loan from Harvard Trust ($60,258) resulted in a balance of $8,700.54 which was credited to petitioner's account with Keizer.
With respect to the purchases from Keizer by petitioner and Artenstein on May 24, 1955, the details are as follows:
Prior to these purchases, and in order to provide funds with which to pay for them, Keizer arranged, through Simmons, Bourne & Co., for petitioner and Artenstein each to borrow $56,400 for 6 months from the First Wisconsin National Bank of Milwaukee, Wisconsin (hereinafter referred to as First Wisconsin).
On June 3, 1955, petitioner borrowed $56,400 from First Wisconsin and executed and delivered to it his negotiable, recourse promissory note for the amount of the loan. The note, which was executed on a standard printed form, bore interest at 3 3/8 per cent and was due December 3, 1955; the commission charged by Simmons, Bourne & Co. for placing the loan was included in the 3 3/8 per cent charged by First Wisconsin. Artenstein executed an identical note to First Wisconsin on the same day. By check dated May 26, 1955, petitioner paid $972.90 to Simmons, Bourne & Co., representing advance payment of the overall charge on the loan.
On or before the settlement date of May 27, 1955, petitioner had delivered to Keizer his check for $4,503.62. This amount, together with the loan of $56,400 from First Wisconsin and the credit of $8,700.54 in petitioner's account with Keizer, equaled the total purchase price of $69,604.16.
On or before June 16, 1955, pursuant to appropriate instructions, Josephthal delivered $60,000 face value of Illinois bonds for petitioner's account to Chase Manhattan Bank, New York City, safekeeping for First Wisconsin. Delivery was made against payment of $56,400, the proceeds of petitioner's loan from First Wisconsin. The serial numbers of the bonds so delivered were numbers 12061 through 12100, and 13101 through 13120. These were the same bonds that Keizer had repurchased from Artenstein on May 24, 1955.
Similarly, on or before June 16, 1955, Josephthal delivered $60,000 face value of Illinois bonds for Artenstein's account to chase Manhattan Bank, safekeeping for First Wisconsin. Delivery was made against payment of $56,400, the proceeds of Artenstein's loan from First Wisconsin. The serial numbers of the bonds so delivered were numbers 12001 through 12060. These were the same bonds that Keizer had repurchased from petitioner on May 24, 1955.
On August 5, 1955, First Wisconsin forwarded to petitioner its draft on the National City Bank of New York for $937.20, covering the proceeds of the August 1, 1955, coupons on the Illinois bonds held as collateral for petitioner's loan.
By letter dated August 30, 1955, First Wisconsin requested petitioner to deposit additional collateral of $1,000 ‘because of the recent price decline’ of Illinois bonds. Petitioner forwarded his check for $1,000 to First Wisconsin on September 2, 1955, and the bank applied that amount to reduce the balance of petitioner's loan to $55,400. Artenstein also deposited the amount of $1,000 and the balance of his loan was similarly reduced.
On or before September 28, 1955, prior to lapse of the 6-month holding period, petitioner informed Glunts that he wanted to sell his bonds, regardless of the effect such sale might have on his tax situation. Petitioner was concerned with the possibility of a decline in the price of Illinois bonds, and Glunts felt that ‘there was nothing to say’ which would dissuade petitioner from selling.
Accordingly, on September 28, 1955, petitioner sold his $60,000 face value of Illinois bonds back to Keizer at a price of 109 1/2; settlement date on this transaction was October 4, 1955. The net proceeds of this resale were $65,998.13 (principal proceeds of $65,700, plus accrued interest on the bonds to settlement date of $328.13, less Federal documentary stamp taxes of $30). Artenstein also sold his $60,000 face value of Illinois bonds back to Keizer on the same date.
As of October 6, 1955, pursuant to previous instructions, Chase Manhattan Bank, safekeeping for First Wisconsin, delivered to Josephthal the $60,000-face-value Illinois bonds held as collateral for the loan to petitioner. Delivery was made against payment of $55,080.12 which represented the balance of $55,400 due on petitioner's note, less $319.88, the amount of interest refunded by First Wisconsin to petitioner upon his prepayment of the note. Similarly, Chase Manhattan Bank delivered Artenstein's bonds to Josephthal against receipt of the amount required to discharge his loan.
By check dated October 11, 1955, Keizer paid petitioner the amount of $10,918.01 which represented the difference between the net proceeds from the sale of September 28, 1955 ($65,998.13), and the amount which had been repaid to First Wisconsin ($55,080.12). On October 13, 1955, First Wisconsin returned to petitioner his canceled note.
According to the National Monthly Bond Summary and the National Daily Quotation Service, the following bond houses quoted bid and asked prices for Illinois bonds from October 20, 1954, through May 31, 1955, as follows:
+----------------------------------------------------------------+ ¦Bond house ¦Date ¦Bid ¦Asked ¦ +------------------------+-------------+------------+------------¦ ¦Asiel & Co., N.Y ¦Oct. 20, 1954¦(1 ) ¦20 @ 111 1/2¦ +------------------------+-------------+------------+------------¦ ¦Spencer Trask & Co., N.Y¦Oct. 25, 1954¦1 @ 112 ¦(1 ) ¦ +------------------------+-------------+------------+------------¦ ¦White Weld & Co., N.Y ¦Oct. 28, 1954¦112 3/4 ¦(1 ) ¦ +------------------------+-------------+------------+------------¦ ¦Lee Rand & Co., N.Y ¦Nov. 29, 1954¦50 @ 106 1/2¦50 @ 107 1/2¦ +------------------------+-------------+------------+------------¦ ¦Harriman Ripley, Chic ¦Mar. 29, 1955¦102 3/4 ¦(1 ) ¦ +------------------------+-------------+------------+------------¦ ¦Frane Investors Co., N.Y¦Apr. 27, 1955¦(1 ) ¦25 @ 104 ¦ +------------------------+-------------+------------+------------¦ ¦Bache & Co., N.Y ¦May 10, 1955 ¦(1 ) ¦50 @ 108 ¦ +------------------------+-------------+------------+------------¦ ¦Lee Rand & Co., N.Y ¦May 25, 1955 ¦50 @ 109 ¦50 @ 109 3/4¦ +------------------------+-------------+------------+------------¦ ¦Schwamm & Co., N.Y ¦May 31, 1955 ¦(1 ) ¦50 @ 110 ¦ +----------------------------------------------------------------+ FN1 None.
According to Standard & Poor's Corporation Records Manual the range of bid prices on Illinois bonds during the year 1954 was between a high of 106 3/4 and a low of 96 1/2; the range of bid prices reported for the year 1955 was between a high of 109 and a low of 100.
According to Moody's Public Utility Manual, the range of bid prices on Illinois bonds for the year 1954 was between a high of 112 3/4 and a low of 96; for the year 1955, the reported range was between a high of 102 1/2 and a low of 95. Asked prices were not quoted in either Moody's or Standard & Poor's.
Illinois bonds were not listed on any securities exchange and were sold only over the counter; the bid and asked prices quoted above do not necessarily encompass the price range within which all purchases and sales of Illinois bonds took place during the periods noted.
On November 26, 1954, First Boston Corporation bought $20,000 face value of Illinois bonds at 107 1/2 and, on the same day, sold them at 108. First Boston had handled the original issue of these bonds in 1948, but this was its only purchase and sale of Illinois bonds in 1954.
On November 30, 1954, Keizer purchased $200,000 face value of Illinois bonds at 105 7/8. On November 4, 1954, Keizer purchased $69,000 face value of Illinois bonds at 114 1/2. Both purchases were accomplished through Josephthal.
On May 24, 1955, Keizer placed an order with Josephthal to purchase $100,000 face value of Illinois bonds at 109 3/4, and on the same day Josephthal acquired that amount of bonds at 109 3/4 and sold them to Keizer at 110.
Petitioner was interested solely in the ‘tax savings' to be derived from his 1954 and 1955 bond transactions. He had never before purchased corporate bonds and, in entering the transactions involved herein, he relied completely on Glunts' advice. He did not investigate the condition of the bond market prior to his 1954 and 1955 purchases, nor was he interested in the name of the bonds which he purchased, or the source from which they came. He did not know how much he was paying for the bonds, or whether the bond market was rising or falling at the time of his purchases. Moreover, he did not know how much interest he was paying on his loans from Harvard Trust and First Wisconsin, nor the amount of interest he was receiving on the Illinois bonds. Glunts himself never attempted to check the price of Illinois bonds with any source other than Keizer.
On his income tax return for 1954, petitioner claimed an interest deduction of $1,686.02 and an amortization deduction of $9,342. The claimed interest deduction was computed by adding the amounts of $1,066.23 (representing the advance charge of 3 1/2 per cent incurred by petitioner on his loan from Harvard Trust), and $619.79 (representing the amount of accrued bond interest included in the total purchase price paid by petitioner for the Illinois bonds acquired on November 23, 1954). The claimed amortization deduction was computed as the difference between the principal purchase price paid for those bonds ($69,600) and the lowest call price on the bonds as of the 31st day after purchase ($60,258).
On his income tax return for 1955, petitioner claimed an interest deduction of $670.59 and an amortization deduction of $8,767.50. The claimed interest deduction was computed as follows: The advance charge of 3 3/8 per cent incurred by petitioner on his loan from First Wisconsin ($972.90), plus the amount paid by petitioner on June 7, 1955, for 3 days' overdue interest on his loan from Harvard Trust ($17.57), less the amount of interest refunded to petitioner by First Wisconsin on October 6, 1955 ($319.88). The claimed amortization deduction was computed as the difference between the principal purchase price paid by petitioner for the Illinois bonds acquired on May 24, 1955 ($69,600), plus the amount paid by petitioner on June 7, 1955, to cover forwarding charges from Harvard Trust to Hanover Bank ($13.50), less the lowest call price on the bonds as of the 31st day after purchase ($60,246).
Petitioner entered into the above-described bond transactions solely for the purpose of reducing its income tax liability. Respondent disallowed the deductions claimed by petitioner for interest and amortization of bond premium in 1954 and 1955, respectively.
OPINION.
RAUM, Judge:
1. As in Fabreeka Products Co., 34 T.C. 290, decided this day, the deduction for so-called amortization of bond premium must be disallowed on the authority of Maysteel Products, Inc., 33 T.C. 1021. This case presents merely a variation of the device which Glunts masterminded, and which was used in the Fabreeka case. When viewed as a whole the transaction seems utterly unreal. For example, why should Sherman have sold $60,000-face-value Illinois bonds to Keizer on May 24, 1955, at a price of 114 and on the very same day have purchased $60,000-face-value Illinois bonds of the identical issue from Keizer at 115? He knew very little about what he was buying and selling, except that he expected, upon Glunts' advice, to acquire a tax deduction. We need not go into further detail. The record speaks for itself. And it is a matter of no consequence that Sherman became panicky and was willing to sustain a loss on the second block of bonds by selling them prior to the expiration of the 6 months' holding period applicable thereto. That the plan failed in part, for whatever reason, to produce the anticipated results does not give Sherman a preferred status in relation to this issue.
2. Petitioner, however, is entitled to deduct the interest which he actually paid on the loans that were made in order to carry out the principal, although taxwise abortive, transactions. Fabreeka Products Co., 34 T.C. 290, decided this day.
Reviewed by the Court.
Decision will be entered under Rule 50.
DRENNEN, J., concurs in the result.
ATKINS, J., concurring: A close analysis of the detailed steps taken in pursuance of the plan devised by Glunts, coupled with the apparently arbitrary prices at which the petitioner ‘purchased’ the bonds from Keizer and ‘sold’ them back to him (these prices being at wide variance with the prices paid by others and with the bid and asked prices at or about the same times) shows that the purchases and sales were not at arm's length and lacked substance. A taxpayer may not take advantage of the bond premium deduction provisions of the statute by such artificial transactions as are here involved. However, the indebtedness created was real and the statute specifically permits deduction of the interest thereon. See L. Lee Stanton, 34 T.C. 1. Cf. Eli D. Goodstein, 30 T.C. 1178, affd. (C.A. 1), 267 F.2d 127; Sonnabend v. Commissioner, (C.A. 1) 267 F.2d 319, affirming T.C. Memo. 1958-178; Becker v. Commissioner, (C.A. 2) 277 F.2d 146; and Broome v. United States, (Ct.Cl.) 170 F.Supp. 613.