American National
Bank of Austin v. United States (1970)
AMERICAN NATIONAL BANK OF AUSTIN,
Plaintiff-Appellee, v.
UNITED STATES of America,
Defendant-Appellant
No. 27301
UNITED STATES COURT OF APPEALS FOR
THE FIFTH CIRCUIT
421 F.2d 442; 70-1 U.S. Tax Cas. (CCH)
P9184; 25 A.F.T.R.2d (RIA) 482
January 19, 1970
SUBSEQUENT HISTORY:
Petition for Certiorari Denied, Reported at 400 U.S.
819. Petition for Rehearing Denied, February 18, 1970.
DISPOSITION: Reversed and remanded.
CORE TERMS: bond, dealer, issuing, customer, bid,
municipal bonds, ownership, municipal, collected, comptroller, repurchase,
successful bidder, new-issue, bidder, sell, sale-repurchase, purchase
price, new issues, depositary, handling, gross income, transmitted,
subsidiary, borrowing, invoice, banking, deposit, ledger, refund, acquired
JUDGES: Gewin, Thornberry and Ainsworth, Circuit
Judges.
OPINIONBY: AINSWORTH
OPINION: AINSWORTH, Circuit Judge:
The issue presented in this case is whether certain
transactions of taxpayer, a national bank, with various municipal bond
dealers during the years 1962-1964 are correctly characterized as
salerepurchase transactions, as the District Court concluded, n1 or
whether they should be held to be secured-loan transactions for tax
purposes, as the Government contends. If they were sale-repurchase
transactions, the municipal bond interest collected by taxpayer during the
years 1962-1964 should have been excluded from taxpayer's gross income as
interest received on state governmental obligations owned by taxpayer.
Int. Rev. Code of 1954, @ 103(a)(1). On the other hand, if they were
secured-loan transactions, this interest should have been included in
taxpayer's gross income as taxable income realized by taxpayer from bond
dealers for advancing funds on their behalf. Int. Rev. Code of 1954, @
61(a)(4).
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n1 American National Bank of Austin v. United States,
W.D. Tex., 1968, 296 F. Supp. 512, 518.
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This is a tax refund suit brought by taxpayer, the
American National Bank of Austin, against the United States to recover
income taxes and interest assessed against it and collected by the
Commissioner of Internal Revenue in the amount of $788,031.77 for the
taxable years 1962, 1963, and 1964. After a nonjury trial at which oral
testimony and exhibits were received, together with a stipulation of facts
and attached exhibits, the District Court agreed with taxpayer's
contentions and ordered the refund. From this judgment the Government
appeals.
During the years 1962-1964 taxpayer received income in
the form of interest it collected or accrued on municipal bonds n2 while
these bonds were in its possession. In its income tax returns for these
years taxpayer excluded this interest from its gross income and computed
its tax liability in reliance upon section 103(a)(1) of the Internal
Revenue Code of 1954, which provides that a taxpayer's gross income does
not include interest on municipal bonds. n3 The Commissioner determined
that taxpayer was not entititled to the section 103(a)(1) income exclusion
on the ground that taxpayer never acquired ownership of the bonds.
Accordingly, he found deficiencies in taxpayer's reported tax liability
for the years here in issue. Taxpayer paid the deficiencies and made
refund claims asserting that the Commissioner's determination was
erroneous. This suit followed the Commissioner's disallowance of
taxpayer's claims.
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n2 As used here, the term "municipal bonds"
refers to all types of state, county, and municipal obligations in which
taxpayer dealt in the transactions here in issue.
n3 Section 103 of the Internal Revenue Code of 1954
reads in pertinent part as follows:
"(a) General rule. -- Gross income does not
include interest on --
(1) the obligations of a State, a Territory, or a
possession of the United States, or any political subdivision of any of
the foregoing, or of the District of Columbia; * * *."
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Since sale-versus-loan cases turn upon their own
particular facts, United States v. Ivey, 5 Cir., 1969, 414 F.2d 199, the
decided cases n4 which have considered the precise question presented here
offer little directional guidance toward a proper resolution of this case.
We therefore take the route of ad hoc exploration through an expanse of
essentially undisputed facts, see United States v. Winthrop, 5 Cir., 1969,
417 F.2d 905, to find that taxpayer was not entitled to the section
103(a)(1) income exclusion. The judgment appealed from must consequently
be reversed.
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n4 Commissioner of Internal Revenue v. Bank of
California, etc., 9 Cir., 1935, 80 F.2d 389, aff'g B.T.A., 1934, 30 B.T.A.
556; Commissioner of Internal Revenue v. Wells Fargo Bank & Union
Trust Co., 9 Cir., 1935, 80 F.2d 390; First Nat. Bank in Wichita v.
Commissioner of Internal Revenue, 10 Cir., 1932, 57 F.2d 7, aff'g B.T.A.,
1930, 19 B.T.A. 744; Union Planters National Bank of Memphis v. United
States, W.D. Tenn., 1968, 295 F. Supp. 1151. An appeal by the
Government in Union Planters is pending before the
Sixth Circuit.
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I.
Taxpayer is a national banking association. n5 Its
banking house is located in Austin, the state capital of Texas, where
practically all bond issues floated by political subdivisions of that
state are examined, certified, and executed. Taxpayer's business in
connection with municipal bonds began in the late 1930's when many Texas
municipalities had bond issues outstanding which they desired to refund
with new issues. Under then existing law, these municipalities could not
refund issues piecemeal, but had to refund entire issues at one time. As a
condition precedent to refunding, someone, a single concern or syndicate,
had to acquire all the bonds in an issue.
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n5 The parties prepared an extensive stipulation of
facts subject to the following proviso: "The use of the words
'purchase', 'buy', 'bought', 'sell', 'sale' and 'sold' and words of
similar import in this stipulation with reference to the transactions
whereby [taxpayer] obtained possession of municipal bonds subject to a
repurchase right in dealers or whereby other banks acquired bonds from
[taxpayer] shall not be deemed an admission by [the Government] that an
absolute sale occurred." In summarizing the facts here, we have
attempted to avoid the use of words of such conclusory import.
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When taxpayer began obtaining bonds to be refunded, it
opened in its general ledger an account styled "Refunding Bonds
Purchased." Taxpayer maintains this account as an asset account in
which a balance is struck daily showing the book balance of bonds on hand
at the close of the business day. Although taxpayer now engages in few
transactions involving refunding, the account retains its original name,
and into it are entered as assets all bonds that have come into taxpayer's
possession as a result of the transactions here in issue. n6 Aided by its
location, taxpayer has vigorously pursued its muncipal bond activity and
now engages in transactions involving from 50 to 80 per cent of all bonds
issued by Texas political subdivisions. During the years 1962-1964
taxpayer concluded with bond dealers approximately 4500 transactions
involving issues of municipal bonds in bearer form. Approximately 90 per
cent, by dollar volume, of taxpayer's bond transactions involve new
issues. The remainder of its transactions involve transfers from dealers
rather than from issuing
authorities. n7
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n6 The record shows that taxpayer's holdings of
municipal bonds were grouped in three categories. On December 31, 1963,
for example, taxpayer held $14,664,501.36 worth of municipal bonds that
were the subject matter of the transactions here in issue. Taxpayer's
annual report for 1963 shows
$16,583,244.13 debited to the asset account styled
"State, County and Municipal Obligations." The difference
between these two amounts --
$1,918,742.77 -- was apparently owned by taxpayer free
of any so-called repurchase option. The 1963 report also shows an asset
account styled "Other Bonds and Securities," in which
$174,250.00 is debited. Taxpayer purchased the last-mentioned bonds to
obtain the coupon-paying agency of their issuers.
n7 For tax purposes we see no distinction between
taxpayer's activities in the newissue and secondary bond markets.
Accordingly, for the sake of simplicity we here concentrate on taxpayer's
dealings in new issues. The legal consequences of both kinds of activity
are the same.
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The distribution of a new issue of municipal bonds in
Texas is commenced by the issuing authority when it publishes the official
notice of sale. Such a notice generally will include statements of the
amount of the issue to be floated, types of bids and interest rates,
requirements regarding a good-faith deposit by the successful bidder, and
the place designated for delivery of the bonds. As a general rule, bonds
are made deliverable to taxpayer's banking house. If taxpayer's banking
house is so designated, taxpayer first becomes involved in the
distribution of an issue when the issuing authority notifies it of the
successful bidder and authorizes it to deliver the bonds to the purchaser
against payment of the specified bid price. The depositary bank of the
issuing authority then advises taxpayer regarding transmittal to the
depositary of the proceeds derived from the bond flotation. The bonds,
following their approval and certification by the appropriate state
officers, are then delivered to taxpayer. Upon receiving the bonds,
taxpayer performs numerous functions on behalf of the issuing authority
and the successful bidderdealer. For example, it examines the bonds for
printing errors, determines whether the correct number of coupons have
been attached, obtains an opinion letter on the validity of the issue, and
receives an undated receipt for payment of the purchase price to the
issuing authority by the bond dealer.
Taxpayer concluded its new-issue transactions with
bond dealers in either one of two ways during the years in issue. First,
the successful bidder might pay taxpayer the purchase price of the bonds
for transmittal to the depositary bank of the issuing authority. In this
situation taxpayer would simply transmit the payment to the depositary and
deliver the bonds to the dealer or at the dealer's order. For its services
taxpayer would receive from the dealer a handling charge of 25 cents per
$1,000 of par value and reimbursement for the expenses, such as insurance,
postage, and wires, it had incurred. n8 Secondly, the successful bidder
and taxpayer might agree that taxpayer's funds, rather than the bidder's
funds, would be transmitted to the depositary of the issuing authority in
payment of the purchase price bid by the dealer.
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n8 Transactions of this type are not in issue here.
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During the years 1962-1964 dealers occasionally wrote
to taxpayer to request that taxpayer "make payment" to the
issuing authority for bonds the dealers had been awarded and "accept
delivery for our account" or "take [the bonds] up for our
account." Usually, however, communications between the parties were
by telephone. Taxpayer and the dealers made no written agreements
regarding their various rights and obligations with respect to new issues.
All these agreements, however, were the same.
Upon receiving the successful bidder's notification,
taxpayer, if satisfied with the credit rating of the issuing authority,
would pay with its own funds the full bid price to the authority and
retain the bearer bonds in its possession. Taxpayer normally would agree
to such arrangements with dealers if the issue was rated "BAA"
or higher. Relying upon this rating, taxpayer would make no credit
investigation of the dealer obligated to buy the bonds. n9 The dealer
would transmit no payment to the issuing authority, receive no payment
from taxpayer, and execute no debt instrument of any kind. n10 After
paying the issuing authority, taxpayer would send to the successful bidder
a form notice captioned "The following securities were purchased
today," which fully identified the purchased bonds.
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n9 Taxpayer occasionally would receive unsolicited
credit reports on dealers, but made no attempt to obtain such reports.
n10 At trial taxpayer's president testified that all
the bank's loans are evidenced by some kind of debt instrument. He
recalled no loan taxpayer made to a dealer during the relevant years which
was secured by municipal bonds. He recalled only one loan made to a dealer
for the purpose of providing him funds with which to acquire municipals.
Taxpayer's statutory loan limit was $450,000 until March 1964, at which
time it was increased to approximately $610,000. Aside from the
transactions here in issue, taxpayer, with infrequent exceptions, did not
during the years 1962-1964 make advances to or on behalf of anyone that
did not maintain a banking relationship with it. Such a borrower was
normally required to maintain a compensating balance -- generally equaling
at least 10 per cent of the loan. Taxpayer would require a compensating
balance for the purpose of maintaining sufficient liquidity rather than as
a safety measure.
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Generally the official notice of sale would provide
for a good-faith deposit by the successful bidder. At one time the notice
normally specified that this deposit would be applied against the purchase
price of the issue. During the years 1962-1964, however, the issuing
authority in approximately 90 per cent of the new-issue transactions in
which taxpayer was involved returned the successful bidder's deposit to
the bidder upon receipt of payment from taxpayer. In approximately 9 per
cent of these transactions the issuing authority sent the bidder's check
to taxpayer. In approximately 1 per cent of the transactions the issuing
authority negotiated the bidder's check in partial payment of the purchase
price. When the issuing authority either sent the check to taxpayer or
negotiated it, taxpayer made the dealer whole.
Taxpayer does not employ bond salesmen or sell bonds
to the public. It cannot legally sell bonds to the public because it does
not have a securities license. Although taxpayer legally may bid for new
issues, it does not. Throughout the history of taxpayer's business in
connection with new-issue bonds, the bonds for which taxpayer paid the
original purchase price were offered and sold to the public by the dealers
who had successfully bid for them. These dealers offered bonds for sale to
their customers both before and after taxpayer had made payment for them
to the issuing authority. When a dealer was awarded an issue, he would
begin selling bonds immediately for future delivery. Ordinarily a
substantial portion of an issue would be sold before the bonds were
actually issued and before taxpayer had paid the issuing authority for
them. Dealers would offer bonds for sale in two ways. First, they would
list the bonds in The Blue List of Current Municipal Offerings. Secondly,
they would mail offering circulars to prospective customers. These
circulars were customarily prepared and mailed before the bonds were
issued.
Taxpayer would retain bonds in its possession until
the bidder-dealer effected their disposition to its customers. During this
period, usually no longer than thirty days, taxpayer accrued the interest
income on the bonds at the coupon rate and credited the interest to a
general account styled "Exempt Interest Earned." Taxpayer's
accounting procedures reflected its possession of the bonds and accrual of
interest on the bonds as follows. When taxpayer transmitted to the issuing
authority's depositary its cashier's check in payment for an issue,
taxpayer's Bond Department would send a charge memo to its cashier which
showed a memorandum charge in the amount of the purchase price to the
"Refunding Bonds Purchased" account in taxpayer's general
ledger. Taxpayer further maintained a subsidiary ledger sheet pertaining
to each bond issue. On such a sheet taxpayer would initially enter the
name of the issuer, the name of the successful bidder-dealer, the nature
of the bonds, the rate or rates of interest, maturity dates, the first and
subsequent coupon dates, and the par value and purchase price of the
bonds. As the dealer sold bonds in the issue to the public, its sales
would be individually shown on the subsidiary ledger sheet by entries
recording the par value of the bonds sold, the dealer's sale price, the
par balance remaining, and the book balance remaining. Similar entries
recording each sale would be made in the general account. The interest
that taxpayer accrued on the bonds would be entered as a debit in the
subsidiary ledger, thus increasing the book balance. When coupons were
clipped, the collections made thereon would be entered as a credit in the
subsidiary ledger, thus decreasing the book balance.
As a dealer found customers for the bonds for which it
had bid, it would prepare an invoice made out to the customer and send
this invoice to taxpayer. Taxpayer would then send the invoice and the
bonds purchased by the customer to the bank at which the customer was to
tender payment. It would also instruct the collecting bank to deliver the
bonds to the designated purchaser against payment of the dealer's invoice
price and to remit or credit the purchase price to taxpayer. Under
taxpayer's instructions, interest on bonds was accrued only until the date
the sale and purchase was closed. As a result, taxpayer would accrue
interest on bonds committed by the dealer for future sale only during the
period (a few days) required for completion of the paper work precedent to
actual disposition of the bonds. Taxpayer would not accrue interest while
the customer's funds were in transit from the collecting bank to taxpayer.
With respect to bonds not sold until after the date of their issuance,
taxpayer would accrue interest from the date of issuance until disposition
of the bonds by the dealer was effected.
With respect to every sale by a dealer to the public
of bonds for which the dealer had bid and taxpayer had paid the issuing
authority, taxpayer would send the dealer an invoice showing the bank to
which the bonds were sent, the name of the issue, the name of the dealer's
customer, the payment date, daily additions for interest, the selling
price to the customer, and the name of the dealer. After the customer's
payment was transmitted to taxpayer from the collecting bank, taxpayer
would enter this payment as a credit reducing the book balance of the
particular issue in its subsidiary and general ledgers.
When all the bonds of an issue had been sold by a
dealer to its customers, a closing statement would be prepared by taxpayer
and furnished to the dealer which reflected the final settlement between
them. This statement would show the dealer's gross profit or loss on the
issue and include taxpayer's specific charges for insurance, handling,
postage, and wires together with the interest accrued since the last
monthly accrual date, or since the date of issuance if that was subsequent
to the last monthly accrual date. Finally, the statement would show a
balance due either the dealer or taxpayer. When a balance was due the
dealer, taxpayer, at the dealer's election, would either remit it to the
dealer or credit it to the dealer's account with taxpayer, if there was
one. When a balance was due taxpayer, the statement would serve as a bill
to the dealer.
Computation of the balance due either the dealer or
taxpayer was made as follows. To taxpayer the dealer would owe an amount
equal to the sum of (1) the book value of the bonds, (2) the accrued
interest not reflected on taxpayer's books, (3) taxpayer's handling
charge, and (4) taxpayer's wires, postage, and insurance expenses. The
term "book value," as used here, means the bid price of the
bonds adjusted upward for the interest accrued after the date of issuance
and reduced by the interest actually collected by taxpayer. Thus the
amount due taxpayer was computable without regard to the relative success
or failure of the bond flotation. Taxpayer would owe the dealer the sum of
the payments transmitted by the dealer's customers in return for the
bonds. This sum depended entirely upon the public's demand for the bonds.
Whether a balance would be due the dealer or taxpayer would also depend
entirely upon the price at which the dealer could sell these bonds to the
public. The closing statement, therefore, reflected the dealer's degree of
success or failure in disposing of bonds for more than the fixed amount it
would pay taxpayer.
Throughout the history of taxpayer's business with
dealers in connection with new-issue bonds for which the dealers had bid
and taxpayer had paid the issuing authority, taxpayer never refused to
transfer bonds at the direction of the bidding dealer once the dealer
caused taxpayer to be paid the book value of the bonds and taxpayer's
handling charge and sales expenses. During the years 1962-1964 no dealer
who had successfully bid on bonds for which taxpayer paid the bid price to
the issuing authority failed to protect taxpayer against the risk that the
bonds could not be sold to the public for at least the value assigned them
on taxpayer's books. Indeed, only twice in the history of taxpayer has a
dealer failed to cause taxpayer to be paid the book value of bonds for
which taxpayer had paid, together with taxpayer's handling charge and
incidental expenses.
During the years 1962-1964 taxpayer occasionally
arranged for the participation of two other Texas banks in paying to an
issuing authority the purchase price of bonds for which a dealer had
successfully bid. These banks would either credit taxpayer's accounts with
them or remit the price to taxpayer, who would then pay the entire bid
price to the issuing authority. Taxpayer would retain in its possession
the bonds paid for by the other banks and issue a safekeeping receipt to
the other bank or banks participating in the transaction. Such a receipt
would show the name of the issue, the interest rate, the maturity date,
and the specific bond numbers of the bonds for which the other
participating banks advanced payment. As the dealer who had bid for the
issue found customers for the bonds covered by the safekeeping receipt,
these banks would send an invoice to the dealer, charge taxpayer's account
on their books in the amount of the book value of the bonds sold, and
instruct taxpayer to deliver the bonds at the dealer's instruction. Like
taxpayer, these banks always followed the instructions of the dealer
having a customer for bonds for which they had paid the issuing authority.
n11
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n11 During the years 1962-1964 the only bonds a
national bank could sell subject to a repurchase agreement to another bank
were federal government bonds. The banks dealing with taxpayer, however,
always honored taxpayer's agreements with the bond dealers.
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Since taxpayer is a national banking association, its
municipal bond transactions during the years 1962-1964 were subjected to
the scrutiny of the Comptroller of the Currency. n12 For years both the
Comptroller and the Federal Reserve System Board of Governors had agreed
that a transaction in which a bank bought securities under an agreement to
resell constituted, for banking regulation purposes, a loan by the bank
and a borrowing by the "seller." n13 In 1963, however, the
comptroller reversed direction and ruled n14 that such a transaction did
not constitute a loan transaction subjecting a "purchasing" bank
to statutory lending limitations n15 and a "selling" bank to
statutory borrowing limitations. n16 Instead, the Comptroller determined
that such transactions "in form as well as legal effect" were
purchases and sales rather than lendings and borrowings. n17 Consequently,
the Comptroller viewed taxpayer's "Refunding Bonds Purchased"
account as an investment account and its agreements with dealers and other
banks in connection with new-issue municipal bonds as sale-repurchase
agreements.
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n12 See generally 12 U.S.C. @@ 1, 24, 81-95b (1964),
as amended (Supp. IV, 1968).
n13 See, e. g., Comptroller's Digest of Opinions para.
650(b):
"The purchase of investment securities under
resale agreements permitting or requiring the purchasing national bank to
sell the securities back to the seller are considered to be loan
transactions and must be kept within the limitations provided in [12 U.S.C.
@ 84] and shown as loans on the books of the bank. * * *"
n14 U.S. Dep't of Treasury, Comptroller's Manual for
Nat'l Banks para. 1131 (1965). See generally Hackley, Our Baffling Banking
System, 52 Va. L. Rev. 565, 598-599 (1966).
n15 12 U.S.C. @ 84 (1964), as amended (Supp. IV,
1968).
n16 12 U.S.C. @ 82 (1964), as amended (Supp. IV,
1968).
n17 Hearings Before the Subcomm. on Bank Supervision
and Insurance of the House Comm. on Banking and Currency and the House
Comm. on Banking and Currency on H.R. 107 and H.R. 6885 With Respect to
Consolidation of Bank Examining and Supervisory Functions, 89th Cong., 1st
Sess. 397 (1965).
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In the court below the District Judge heard testimony
from two of taxpayer's officers, a vice-president of one of the banks that
engaged with taxpayer in transactions of the type here in issue, and
officers of three bond dealers with whom taxpayer had dealt. As we
construe the District Judge's opinion, the District Judge found, in
addition to the stipulated and otherwise undisputed facts, that (1)
successful bidders for municipal bonds sold their right to these bonds to
taxpayer in exchange for taxpayer's assumption of their obligation to pay
the issuing authority for them; (2) dealers were motivated to make these
sales because of the "unique service" taxpayer could provide
them in the marketing of bonds; (3) these dealers retained options to
repurchase the bonds, but were not even tacitly obligated to exercise
these options; (4) if dealers failed to exercise their options, taxpayer
would absorb any loss or enjoy any gain on the subsequent sale of the
bonds; (5) taxpayer entered these transactions to put idle funds to use as
short-term investments; (6) that dealers invariably exercised their
options to repurchase, even at a loss to themselves, reflected not an
obligation to repurchase, but instead "sound business judgment based
on the desire * * * to maintain [their] relationship with
[taxpayer]"; (7) the language used by dealers in transacting with
taxpayer was "trade language" signifying a sale-repurchase
agreement; and (8) taxpayer and the dealers treated these transactions as
sale-repurchases rather than as secured-loan transactions. On the basis of
these findings, the District Court determined that
"The rule of law established by court decisions
when applied to the facts before this Court can result in no other
conclusion than a decision that [taxpayer], in form and substance, was the
owner of the municipal obligations and the interest income received by it
was interest on the municipal obligations and therefore exempt to it under
the provisions of section 103."
296 F. Supp. at 518.
We disagree with the District Court's conclusion for
reasons we will point out in detail.
II.
This Court has not previously dealt with the problem
of whether a bank paying an issuing authority for municipal bonds awarded
to dealers and subsequently sold by these dealers to their customers is
for tax purposes to be considered as the owner of the bonds while it holds
them or as a secured lender. The decided cases on this question announce
various criteria for determining where ownership of the bonds resides in
this situation. At most these tests of ownership are helpful, but we
decline to regard them as "talismans of magical power," Georgia
Southern & F. Ry. Co. v. Atlantic Coast Line R. Co., 5 Cir., 1967, 373
F.2d 493, 498, cert. denied, 389 U.S. 851, 88 S. Ct. 69, 19 L. Ed. 2d 120
(1967); accord, Tyler v. Tomlinson, 5 Cir., 1969, 414 F.2d 844, 848, and
we consider no single criterion to be controlling. See John Kelley Co. v.
Commissioner of Internal Revenue, 326 U.S. 521, 530, 698, 66 S. Ct. 299,
304, 90 L. Ed. 278 (1946); Tyler v. Tomlinson, supra. Accordingly, we
analyze this case in light of the statutory mandate that "Except as
otherwise provided * * * gross income means all income from whatever
source derived * * *." Int. Rev. Code of 1954, @ 61(a).
Regarding the proper scope of our review, taxpayer
contends that the question of ownership is one of fact, determined by the
trial court in its favor, which should not be set aside unless clearly
erroneous. Fed. R. Civ. P. 52(a). We recognize that the characterization
of taxpayer's transactions with the dealers and other banks is at least
partially a question of fact.
Nevertheless,
"* * * the district court's finding on this
ultimate issue * * * is not to be garrisoned by the clearly erroneous
rule. Though it has factual underpinnings this ultimate issue is
inherently a question of law. Obeisance to the clearly erroneous rule must
yield when the facts are undisputed and we are called upon to reason and
interpret. This is the law obligation of the court as
distinguished from its fact finding duties. * *
*"
United States v. Winthrop, 5 Cir., 1969, 417 F.2d 905.
See also Bullock v. Tamiami Trail Tours, Inc., 5 Cir., 1959, 266 F.2d 326,
330; Thomas v. Commissioner of Internal Revenue, 5 Cir., 1958, 254 F.2d
233, 236. Since the basic facts in this case are stipulated or otherwise
undisputed, we are obliged to inquire into the ultimate conclusions
reached by the District Court.
Only persons having the rights and incurring the risks
that ownership of municipal bonds entails may treat the interest realized
by them on the municipals they own as tax-exempt income under section
103(a)(1). Congress exempted interest on municipals from federal income
taxation in part to aid states and their political subdivisions in
borrowing from private investors the money needed to finance the business
of government. See, e. g., Holley v. United States, 6 Cir., 1942, 124 F.2d
909, 911. Section 103(a)(1) offers taxpayers an incentive to purchase
municipals as investments by relieving them of the tax burden that would
otherwise be imposed on the return they receive for putting their money to
this particular use. See Int. Rev. Code of 1954, @ 61(a)(4). To protect
the revenue against "artful devices," the section 103(a)(1)
income exclusion must be narrowly construed, cf. Commissioner of Internal
Revenue v. P.G. Lake, Inc., 356 U.S. 260, 265, 78 S. Ct. 691, 694, 2 L.
Ed. 2d 743 (1958), and the substance of transactions rather than the form
they take are controlling for federal tax purposes. Id. Gregory v.
Helvering, 293 U.S. 465, 55 S. Ct. 266, 79 L. Ed. 596 (1935). Therefore,
for purposes of section 103(a)(1), ownership must have a genuine basis in
reality. Cf. Tyler v. Tomlinson, 5 Cir., 1969, 414 F.2d 844, 850.
In this case the Commissioner determined that taxpayer
never acquired "ownership" of the municipal bonds involved in
the transactions in issue. This determination was subject to a presumption
of correctness in the court below which taxpayer had the burden of
rebutting. See, e. g., Cummings v. Commissioner of Internal Revenue, 5
Cir., 1969, 410 F.2d 675, 679. In light of the well-established principles
stated above, we must interpret the undisputed facts here to determine
whether taxpayer overcame this presumption.
We note first that more than the legal opinions and
otherwise selfserving testimony of the trial court witnesses about their
past intention to transfer "ownership" is required under the
circumstances here to rebut the presumption that the Commissioner's
determination was correct. Cf. United States v. Smith, 5 Cir., 1969, 418
F.2d 589. Even if we were to accept the opinion testimony at face value,
we would nevertheless be obliged to determine "* * whether the intent
and acts of these parties should be disregarded in characterizing [their]
transaction[s] for federal tax purposes." United States v. Snyder
Brothers Company, 5 Cir., 1966, 367 F.2d 980, 982-983, cert. denied, 386
U.S. 956, 87 S. Ct. 1021, 18 L. Ed. 2d 104 (1967), citing Kraft Foods
Company v. Commissioner of Internal Revenue, 2 Cir., 1956, 232 F.2d 118,
123. Similarly, that the Comptroller of the Currency has placed his
imprimatur on the denomination of these transactions as salerepurchases
for banking regulation purposes is not conclusive that they were
sale-repurchases for tax purposes.
The substance of the new-issue transactions involved
in this case we find to have been as follows: (1) the successful
bidder-dealer for a new issue was entitled to delivery of the bonds upon
payment of the bid price; (2) if payment was not made to the issuing
authority according to the terms of sale, the dealer's good-faith deposit
with the authority was subject to forfeiture; (3) the dealer, however, was
not required to produce the purchase price of bonds coming into its
inventory until after it had acquired funds received in payment for these
bonds from its customers, because taxpayer paid the dealer's bid price to
the issuing authority and retained the bonds, already in its possession at
the direction of the issuing authority, until payment was transmitted from
the dealer's customers; (4) taxpayer collected for itself the interest
accruing on the bonds while it held them; (5) the dealer, regardless of
whether it profited or lost upon sales to its customers, invariably caused
taxpayer to be paid the bid price of the issue (a bid in which taxpayer
played no part as to the purchase price the dealer agreed to pay if his
bid was successful), adjusted for interest, and its handling charge and
incidental expenses. As a result of transactions of this type, the
distribution of new issues to the public was facilitated by means of the
use of taxpayer's funds and the dealers' selling efforts. Taxpayer looked
solely to the interest accruing on the bonds for its profit. The dealers
profited if they could sell the bonds for more than their adjusted bids,
but bore the risk that the bonds could not be sold for at least that much.
In short, taxpayer was in effect a lender secured by collateral in its
possession. Under these circumstances, we would be blinding ourselves to
reality if we did not see quite clearly that taxpayer's role here was that
of a lending institution, making its funds available to bond dealers who
bid successfully on new issues, retaining the bonds as collateral until
the dealers had disposed of them to customers and reimbursed the bank,
incurring no profits or risks due to market fluctuations, and being paid
interest only for advance of its funds. We cannot indulge the fiction that
the bank was the actual owner of the bonds under the undisputed facts,
even if the parties to the transactions wish to term it so. How there
could be a sale-repurchase transaction between the bank and a dealer when
ordinarily a substantial portion of each bond issue was sold to the
dealer's customers before the bonds were issued, and possession obtained
by taxpayer, is hard to understand. Certainly the bank did not intervene
as a "purchaser" of these bonds. The dealer exercised complete
dominion over the bonds after they came into the bank's possession. He
sold them at his pleasure, at prices he determined, and without reference
to the bank, except that the proceeds were collected from the customer by
the bank and applied to the dealer's account. Obviously the inventory of
bonds was being held by the bank for the dealers and subject to their
disposition. To us the bank was simply a lender of its funds to the
dealers. For this service it was paid interest by the borrowing dealers.
Taxpayer took only the risks of a lender in these transactions. We must,
therefore, look beyond the forms and terms which the bank and the dealers
attributed to these dealings to the real substance thereof. When we do,
the conclusion is inescapable that taxpayer was not entitled to the
section 103(a)(1) income exclusion.
The only real risk that taxpayer incurred during the
course of its transactions with the bond dealers was that the successful
bidder for high-grade ("BAA" or above) bonds would, in a falling
market, be either financially unable to take the bonds from taxpayer or be
indifferent to the consequences of not taking them. Taxpayer enjoys a
position of predominance in the distribution of municipal bond issues in
Texas. Its refusal to provide its unique services to a bond dealer would
bode ill for that dealer's business in the Texas bond market. The record
shows clearly that dealers, so long as they desired to continue marketing
new issues of Texas municipal bonds, insulated taxpayer from market
fluctuations in the price of bonds that taxpayer held. The testimony of
taxpayer's own witnesses establishes that bond dealers understood that
taxpayer's continued participation with dealers in new-issue transactions
depended upon the continued protection of taxpayer from the risk of loss
in a falling market. Thus the basic risk of ownership of the bonds was
incurred by the dealers.
The District Court considered two appellate decisions
involving the tax effect of transactions between banks and bond dealers of
the general type here in issue and concluded that one, Commissioner of
Internal Revenue v. Bank of California, Nat. Ass'n, 9 Cir., 1935, 80 F.2d
389, aff'g B.T.A., 1934, 30 B.T.A. 556, was conclusive of this case, while
the other, First Nat. Bank in Wichita v. Commissioner of Internal Revenue,
10 Cir., 1932, 57 F.2d 7, aff'g B.T.A., 1930, 19 B.T.A. 744, was
distinguishable. Unlike the District Court, we discern no rule of law in
these cases which is controlling here. n18
- - - - - - - - - - - - - - - - - -Footnotes- - - - -
- - - - - - - - - - - - -
n18 Both Bank of California, decided in favor of the
taxpayer, and First Nat. Bank in Wichita, decided in favor of the
Commissioner, were initially determined by the Board of Tax Appeals, an
administrative board whose findings of fact were conclusive upon appellate
courts at that time, "if the evidence was legally sufficient to
sustain them and there was no irregularity in the proceedings."
Phillips v. Commissioner of Internal Revenue, 283 U.S. 589, 600, 51 S. Ct.
608, 613, 75 L. Ed. 1289 (1931). See also Revenue Act of 1926, @ 1003 (b),
44 Stat. 110; Revenue Act of 1924, @ 900(g), 43 Stat. 253. Because
judicial review of Board decisions was so circumscribed, we attach little
significance to the action of the Circuit Courts in affirming the Board in
these cases.
- - - - - - - - - - - - - - - - -End Footnotes- - - -
- - - - - - - - - - - - -
In First Nat. Bank in Wichita the Board of Tax Appeals
formulated the question for decision as follows:
"The question here, as we view it, is not
dependent upon who held the bare legal title to the bonds during the dates
of sale and repurchase, but rather upon the broader issue as to whom,
under the understanding between the bank and its customers, was entitled
to receive, and who, as carried out, did receive the interest payments
made by the issuing authorities of such bonds when collected and paid. * *
*"
19 B.T.A. at 749. In Bank of California the Board also
relied upon the manner in which the bank and the bond dealers treated the
bond interest as support for its conclusion that the bank
"owned" the bonds. 30 B.T.A. at 561. In our view, in the cited
cases the Board placed undue emphasis on the intent and acts of the
parties. As we said in United States v. Snyder Brothers Company, 5 Cir.,
1966, 367 F.2d 980, 982-983, the question with which courts must be
concerned in cases such as this is whether the intent and acts of the
parties should be disregarded in characterizing their transactions for tax
purposes. Under the circumstances here, taxpayer's "ownership"
of these bonds was without substance; therefore, it was not entitled to
treat bond interest earned as tax-exempt income.
To summarize, we hold that taxpayer failed to
establish in the court below that it was entitled to treat the income
received by it in the form of interest it collected on municipal bonds as
excludable from its gross income under section 103(a)(1) of the Internal
Revenue Code of 1954. Section 103(a)(1) requires that
"ownership" have a genuine basis in reality which is absent here
when all the facts and circumstances are carefully examined. Accordingly,
the judgment of the District Court is reversed. Since the District Judge
did not consider taxpayer's claim for the allowance of an addition to its
reserve for bad debts, the case is remanded for a ruling on this issue.
Reversed and remanded.
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