Opinion
Docket No. 2843.
1945-02-26
H. GATES LLOYD, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Jesse R. Fillman, Esq., Wm. Clarke Mason, Esq., and Owen Biddle, Esq., for the petitioner. William H. Best, Jr., Esq., for the respondent.
Petitioner during the taxable year 1941 was a member of a partnership which became a member of a syndicate. The managers of the syndicate entered into an agreement with a political subdivision of a state to act as agent in bringing about the refunding of the latter's outstanding bonds at lower interest rates. A plan was adopted whereby the new refunding bonds to be exchanged for the old bonds had attached thereto two kinds of interest coupons, A and B. Under the plan the syndicate was also given the right to deal in old and new bonds for its own account. Under this latter provision, the syndicate during the taxable year purchased old bonds, exchanged them for new bonds, detached the B coupons, sold the new bonds with the A coupons attached, and them sold the B coupons at a discount. Held, in determining the partnership's distributive share of the income of the syndicate and petitioner's distributive share of the income of the partnership, the proceeds from the discount of B coupons is not tax-free interest to be excluded from gross income under section 22(b)(4), I.R.C., but must be considered along with the selling price of the new bonds with the A coupons attached in determining the gain or loss from the entire transaction, and any gain resulting therefrom is to be included in gross income under section 22(a). Jesse R. Fillman, Esq., Wm. Clarke Mason, Esq., and Owen Biddle, Esq., for the petitioner. William H. Best, Jr., Esq., for the respondent.
This proceeding involves the determination by the respondent against petitioner of a deficiency in income tax for the calendar year 1941 in the amount of $4,054.80.
The deficiency is the result of an addition of $5,890.52 to petitioner's net income, which addition it labeled ‘Income from partnership‘ and is explained in a statement attached to the deficiency notice as follows: ‘(a) Your taxable net income has been increased in accordance with revised distributable income from the partnership Drexel and Company.‘ By appropriate assignments of error petitioner contests this adjustment.
FINDINGS OF FACT.
Most of the facts have been stipulated. The stipulation and the exhibits thereto are incorporated herein by reference.
Petitioner is an individual residing in Haverford, Pennsylvania. He filed his income tax return for the calendar year 1941 with the collector of internal revenue for the first district of Pennsylvania. In schedule A of his return he reported tax-free interest from all sources of $22,912.99; and as a part of item 9, he reported income from the partnership of Drexel & Co. in the amount of $86,597.37.
During the entire calendar year 1941 petitioner was a member of the partnership of Drexel & Co. of Philadelphia. Drexel & Co. filed a partnership return of income for the calendar year 1941 and reported thereon ‘Ordinary Net Income $429,468.67.‘ Among the many items of deductions and income which made up this net amount, which items were referred to on the return by the partnership as debit and credit items, respectively, were the following:
+-----------------------------------------------------------------------------+ ¦Drexel & Co. 4% participation in net profit of ¦ ¦ ¦ ¦$147,641.81 in the City of Philadelphia Bond Exchange ¦ ¦ ¦ +--------------------------------------------------------+---------+----------¦ ¦Group Account: ¦DR. ¦CR. ¦ +--------------------------------------------------------+---------+----------¦ ¦Group commissions ¦ ¦$14,680.13¦ +--------------------------------------------------------+---------+----------¦ ¦Wholly tax exempt interest ¦ ¦28,701.86 ¦ +--------------------------------------------------------+---------+----------¦ ¦Group expenses ¦$3,801.74¦ ¦ +--------------------------------------------------------+---------+----------¦ ¦Joint managers' compensation paid ¦7,107.49 ¦ ¦ +--------------------------------------------------------+---------+----------¦ ¦Principal loss on bonds sold ¦25,713.21¦ ¦ +--------------------------------------------------------+---------+----------¦ ¦Managers' compensation received (City of Philadelphia ¦ ¦ ¦ +--------------------------------------------------------+---------+----------¦ ¦Bond Exchange) ¦ ¦89,783.26 ¦ +--------------------------------------------------------+---------+----------¦ ¦Tax exempt interest (other than City of Philadelphia ¦ ¦ ¦ +--------------------------------------------------------+---------+----------¦ ¦Bond Exchange) ¦ ¦16,141.54 ¦ +-----------------------------------------------------------------------------+
The sum of the two items listed above as tax-exempt interest if $44,843.40. In schedule J attached to the above mentioned return, Drexel & Co. reported the distributive shares of income of the partnership among the five partners as follows:
+------------------------------------------------------+ ¦ ¦Ordinary ¦Tax exempt¦Other income¦ +-------------------+----------+----------+------------¦ ¦ ¦income ¦interest ¦ ¦ +-------------------+----------+----------+------------¦ ¦H. Gates Lloyd ¦$96,693.74¦$10,096.37¦$86,597.37 ¦ +-------------------+----------+----------+------------¦ ¦Four other partners¦332,774.93¦34,747.03 ¦298,027.90 ¦ +-------------------+----------+----------+------------¦ ¦Total ¦429,468.67¦44,843.40 ¦384,625.27 ¦ +------------------------------------------------------+
During the calendar year 1941 Drexel & Co. became a member of a syndicate known as ‘City of Philadelphia Refunding Bonds of 1941, Drexel & Co., Lehman Brothers, Joint Account Managers.‘ The syndicate is sometimes referred to in the record as the ‘Group‘ and sometimes as the ‘Account,‘ but most of the time as the ‘Syndicate.‘ There were 38 other members of the syndicate, all of which were financial firms located in nine different states of the Union. Drexel & Co. and Lehman Brothers of New York were the managers of the syndicate. Drexel & Co. had a 4 percent interest in the operations of the syndicate. The syndicate was terminated on or about June 15, 1942.
The syndicate filed a partnership return of income for the calendar year 1941 and reported a ‘Net Profit per Books‘ of $147,641.81, in schedule form as follows:
$131,064,000
CITY OF PHILADELPHIA REFUNDING BONDS OF 1941 STATEMENT OF GROUP ACCOUNT TAXABLE INCOME FOR THE CALENDAR YEAR 1941
+-----------------------------------------------------------+ ¦Proceeds of Sale of $15,017,400.00 Bonds ¦$16,517,164.46¦ +--------------------------------------------+--------------¦ ¦Principal Cost of $15,017,400.00¦¦ ¦17,159,994.59 ¦ +--------------------------------++----------+--------------¦ ¦ ¦¦ ¦ ¦ +--------------------------------++----------+--------------¦ ¦ ¦¦(Loss) ¦$642,830.13 ¦ +--------------------------------++----------+--------------¦ ¦Group Commissions Received ¦¦ ¦367,003.25 ¦ +--------------------------------++----------+--------------¦ ¦ ¦¦ ¦ ¦ +--------------------------------++----------+--------------¦ ¦ ¦¦(Loss) ¦$275,826.88 ¦ +--------------------------------++----------+--------------¦ ¦Expenses: ¦¦ ¦ ¦ +--------------------------------++----------+--------------¦ ¦Legal Fees ¦¦$50,000.00¦ ¦ +--------------------------------++----------+--------------¦ ¦Advertising ¦¦14,972.77 ¦ ¦ +--------------------------------++----------+--------------¦ ¦Composition and Proofs ¦¦9,196.48 ¦ ¦ +--------------------------------++----------+--------------¦ ¦Postage and Insurance ¦¦5,171.14 ¦ ¦ +--------------------------------++----------+--------------¦ ¦Group Member Expense ¦¦198.56 ¦ ¦ +---------------------------------+----------+--------------¦ ¦Telegraph, Telephone and Teletype¦3,459.80 ¦ ¦ +---------------------------------+----------+--------------¦ ¦Travel, etc ¦¦5,816.14 ¦ ¦ +--------------------------------++----------+--------------¦ ¦Miscellaneous ¦¦6,228.66 ¦ ¦ +--------------------------------++----------+--------------¦ ¦ ¦¦_ ¦95,043.55 ¦ +--------------------------------++----------+--------------¦ ¦ ¦¦ ¦_ ¦ +--------------------------------++----------+--------------¦ ¦ ¦¦(Loss) ¦$370,870.43 ¦ +-----------------------------------------------------------+
Ordinary Net Income for Income Tax Reconciliation to Book Profits: Wholly tax-exempt Interest Received: Bonds held by Account $310,700.71 Less Accrued Interest paid on Bonds Purchased 256,098.87 $54,601.84 Proceeds from discount of“B” Coupons 662,944.60 Unallowable Deductions: $717,546.44 Interest paid on borrowed money to carry tax-free bonds $21,346.87 Joint Managers' Compensation 177,687.33 199,034.20 518,512.24 Net Profit per Books $147,641.81
Attached to the return of the syndicate was a schedule of shares of income and credits of the members thereof, as follows:
+---------------------------------------------------+ ¦ ¦Ordinary Net ¦Wholly ¦ +--------------------+------------------+-----------¦ ¦Name ¦Income or Net ¦Tax-exempt ¦ +--------------------+------------------+-----------¦ ¦ ¦Loss ¦Obligations¦ +--------------------+------------------+-----------¦ ¦Drexel & Co ¦Profit¦$67,840.95 ¦$28,701.86 ¦ +--------------------+------+-----------+-----------¦ ¦Lehman Brothers ¦Profit¦65,961.76 ¦28,701.86 ¦ +--------------------+------+-----------+-----------¦ ¦37 remaining members¦Loss ¦504,673.14 ¦660,142.72 ¦ +--------------------+------+-----------+-----------¦ ¦ ¦Loss ¦$370,870.43¦$717,546.44¦ +---------------------------------------------------+
(It may be noted from the above two schedules that the syndicate reported $717,546.44 as tax-free interest and a loss for tax purposes of $548,557.76 ($370,870.43 plus $177,687.33); that Drexel & Co.'s share of the so-called tax-free interest was 4 percent thereof or $28,701.86; that Drexel & Co.'s share of the so-called loss was 4 percent thereof or $21,942.31; that when this loss of $21,942.31 is considered with Drexel & Co.'s share of the managers' compensation received in the amount of $89,783.26, the result is a profit to Drexel & Co. of $67,840.95; and that this amount corresponds with the above mentioned items that were reported by Drexel & Co. on its return as follows:
+---------------------------------------------------------------------------+ ¦Group Commission (4% of $367,003.25) ¦ ¦$14,680.13¦ +------------------------------------------------------+---------+----------¦ ¦Managers' Compensation received ¦ ¦89,783.26 ¦ +------------------------------------------------------+---------+----------¦ ¦Total ¦ ¦104,463.39¦ +------------------------------------------------------+---------+----------¦ ¦Deductions: ¦ ¦ ¦ +------------------------------------------------------+---------+----------¦ ¦Group expenses (4% of $95,043.55) ¦$3,801.74¦ ¦ +------------------------------------------------------+---------+----------¦ ¦Managers' Compensation (4% of $177,687.33) ¦7,107.49 ¦ ¦ +------------------------------------------------------+---------+----------¦ ¦Principal loss on bonds sold (4% of $642,830.13) ¦25,713.21¦ ¦ +------------------------------------------------------+---------+----------¦ ¦ ¦ ¦36,622.44 ¦ +------------------------------------------------------+---------+----------¦ ¦Taxable profit reported by Drexel & Co. from Syndicate¦ ¦67,840.95)¦ +---------------------------------------------------------------------------+
In the year 1940 the city of Philadelphia, hereinafter sometimes referred to as the city, desired to refund some of its outstanding bonds in order to take advantage of low money rates then in existence. After consideration of other plan which had been submitted, the city by ordinance on June 9, 1941, adopted a ‘Refunding Plan,‘ hereinafter sometimes referred to as the plan, which had been prepared by Drexel & Co. and Lehman Brothers and was first presented to the city on April 10, 1941.
Pursuant to the ordinance of June 9, 1941, the city executed a contract, hereinafter sometimes referred to as the refunding and exchange contract, with Drexel & Co. and Lehman Brothers, acting as joint managers on behalf of the syndicate consisting of themselves and associates as constituted from time to time. In such contract the syndicate agreed to undertake to effect the exchange of new refunding bonds for such old outstanding bonds of the city as might be surrendered in accordance with the terms of the plan and the city agreed to authorize the issuance of such new refunding bonds and to pay the expenses in connection with the issuance. In the refunding and exchange contract the city agreed to effect the exchange of bonds solely through the syndicate. The contract gave the syndicate the right to charge holders of old bonds who desired to accept the offer of exchange a fee of one percent of the principal amount of each new bond issued in exchange, except that the commissioners of the sinking fund of the city should have the option to make exchanges without payment of any commissions, and except that any member of the syndicate in transmitting bonds for exchange only had to turn in to the syndicate a fee of one-half of one percent of the principal amount. The contract also provided as follows:
* * * It is expressly understood, however, that the Group shall have the right to buy and sell and otherwise deal in both the outstanding and the Refunding Bonds for its own account and at its own risk without restriction.
The plan called for the refunding of bonds of various issues of the city aggregating $131,064,000 which bore interest at rates varying from 4 percent to 4 1/2 percent and which matured at various dates from February 16, 1952, to August 1, 1977, but which were callable at the option of the city during the years 1942 to 1947, inclusive. The plan provided for new bonds to be issued in series A to Q, inclusive, in exchange for old bonds. Under the plan the new bonds provided for interest at the rate provided in the old bonds, and for interest at reduced rates varying from 2 1/4 percent to 3 1/4 percent thereafter. The new bonds, except series M, which was noncallable, were callable at the option of the city during the years 1948 to 1958, inclusive, and matured at different dates from January 1, 1949, to January 1, 1973.
The new refunding bonds were issued by the city in both coupon and registered form. The bonds issued in coupon form had attached thereto two types of coupons, designated respectively A and B. The A coupons represented interest during the life of each new bond at the reduced rate provided for in the plan. The B coupons represented the difference between the new reduced rate of interest and the rate of interest of each old bond, and ran from July 1, 1941, until the respective first optional call date of the old bonds. The purpose of the two sets of coupons was, first, to provide for a reduction in the interest rate only after the respective first optional call date of the old bonds and, second, to make it possible for investors to detach the B coupons and thus have instruments carrying a single rate of interest which would be familiar to investors and which would enable the bonds to be traded in on the market, thus providing inducement to the holders to make the exchanges desired by the city.
As a sample of all the new refunding bonds issued in coupon form, a series Q bond is attached to the above mentioned stipulation of facts as Exhibit 10-J. The series Q bonds matured on January 1, 1970, with first optional call date on January 1, 1958. They were to be exchanged for old outstanding bonds bearing interest of 4 1/4 percent and maturing on August 1, 1977, with first optional call date on August 1, 1947. The series Q bonds had attached thereto 57 A coupons for $16.25 each. Coupon No. 1-A was payable, ‘unless the bond hereinafter mentioned shall have been called for previous redemption,‘ on January 1, 1942, and each succeeding number up to and including No. 57-A was payable, ‘unless the bond hereinafter mentioned shall have been called for previous redemption,‘ at the end of each succeeding 6-month period up to and including January 1, 1970. The series Q bonds also had attached thereto 12B coupons for $5 each, with the printed statement on each coupon saying ‘being 6 months' interest then due,‘ and one B coupon for 83 cents with the printed statement thereon saying ‘being 1 months' interest then due.‘ Coupon No. 1-B was payable on January 1, 1942, and each succeeding number up to and including No. 12-B was payable at the end of each succeeding 6-month period up to and including July 1, 1947. Coupon No. 13-B for 83 cents was payable on August 1, 1947. All coupons, both A and B, were payable to bearer. The bond itself (series Q) provided in part as follows:
THE CITY OF PHILADELPHIA, PENNSYLVANIA, for value received hereby acknowledges itself indebted and promises to pay on the First day of January, 1970, to bearer, or if this bond be registered as to principal, then to the registered owner hereof, at the office of The Philadelphia National Bank, Philadelphia, Pennsylvania, the sum of ONE THOUSAND DOLLARS ($1000), and to pay interest thereon at said office from the date hereof to the maturity hereof, unless called for previous redemption, at the rate of THREE AND ONE-QUARTER PER CENT. (3 1/4%) per annum, upon presentation and surrender of the coupons hereto attached (designated ‘A coupons‘) payable semi-annually on the First days of January and July in each year, as they severally mature, and in addition, to pay interest at the rate of ONE PER CENT. (1%) per annum from the date hereof to AUGUST 1, 1947, upon presentation and surrender of the coupons hereto attached (designated ‘B coupons‘), payable semi-annually on the First days of January and July of each year until JULY 1, 1947, and thereafter on AUGUST 1, 1947, as they severally mature. Any or all of the aforesaid B coupons may be detached and negotiated prior to maturity without impairing the negotiability of this bond.
During the year 1941 Drexel & Co., through membership of one or more of its partners, was a member of the New York Stock Exchange and the Philadelphia Stock Exchange, an associated member of the New York Curb Exchange, was registered under the Pennsylvania Securities Act as a dealer in securities in the State of Pennsylvania and as a broker or dealer in securities under the Securities Exchange Act of 1934, and was a member of the National Association of Security Dealers, Inc. Every other member of the syndicate was a recognized and qualified dealer in municipal securities.
During the year 1941 approximately $80,000,000 of the $131,064,000 face value of old outstanding bonds of the city were refunded under the plan.
During the year 1941 the syndicate, as agent for the city under the refunding and exchange contract, effected exchanges of old bonds for new bonds, and in this connection it received commissions in the amount of $367,003.25.
During the year 1941 the syndicate purchased bonds of the city in the face value of $15,017,400. The principal cost of these bonds was $17,159,994.59. At the time of the purchase of the above described bonds the syndicate paid to the sellers thereof the sum of $256,098.87 representing accrued interest to the dates of the purchases. While holding the above described bonds the syndicate received as interest on the bonds the sum of $310,700.71.
The syndicate during 1941 exchanged old bonds which it had purchased for new bonds in coupon form, that is, with A and B coupons attached. As sufficient blocks of bonds accumulated during the year, notice was given to members of the syndicate that bonds were available for sale. Notices of offerings were prepared and circulated among members of the syndicate. The bonds were offered by the syndicate without the B coupons attached.
The syndicate detached the B coupons from the new bonds which it acquired in coupon form. Because of the impracticability of distributing the large number of varying types of coupons pro rata to each of the 39 members of the syndicate, the syndicate made arrangements with the Philadelphia National Bank that at intervals when sufficient detached B coupons were on hand the Philadelphia National Bank would discount them on a 1 1/4 percent basis. During 1941 the syndicate sold to the Philadelphia National Bank at a discount B coupons having a face value of $666,896.65 and received from the Philadelphia National Bank the sum of $647,630.38. During 1941 the syndicate also received the face value of B coupons maturing January 1, 1942, in the sum of $15,314.22.
During 1941 all of the new refunding bonds of the face value of $15,017,400 received by the syndicate in exchange for the old outstanding bonds of like face value that had been purchased by the syndicate as stated above were sold and the proceeds of sales of such bonds totaled $16,517,164.46. At least $14,441,000 face value of such bonds were sold ex the B coupons. The remainder of about $576,400 consisted of those bonds that were issued in registered form and are not here in question.
All of the old outstanding bonds of the city purchased by the syndicate were purchased at substantial premiums above par, with the exception of a few bonds which were callable within six months, on which the premium was relatively small. All of the new refunding bonds which the syndicate sold during the year 1941 were sold at substantial premiums above par.
Under the terms of the agreement entered into by the members of the syndicate, each member could be called upon to put up for the purchase of bonds the amount of his respective interest in such bonds, but the syndicate did not find it necessary to call upon members to supply the purchase price of the bonds. Drexel & Co. and Lehman Brothers initially made advances for the account of the syndicate, and the bonds purchased were pledged to secure money borrowed from the Philadelphia National Bank. Interest paid by the syndicate to the Philadelphia National Bank on account of such borrowing amounted to $21,346.87 in the year 1941. As profits accumulated in the account of the syndicate, they were retained in the account and used in connection with the purchase of bonds. The advances so made by Drexel & Co. and Lehman Brothers to the syndicate totaled #1,000,000. The total of the loans made by the Philadelphia National Bank to the syndicate was $15,899,600, in the form of short term loans paid off from time to time.
Upon the audit of the return of the syndicate for the year 1941, the internal revenue agent in charge for the Philadelphia division determined that the ‘Proceeds from discount of 'B’ coupons‘ in the amount of $662,944.60 should be considered as taxable income of the syndicate and not as tax free interest. Upon the audit of the return of Drexel & Co. for 1941 the said revenue agent determined that the partnership income should be increased in accordance with the report made upon the audit of the return of the syndicate, which, as stated by the revenue agent, resulted in changing Drexel & Co.'s ‘distributive share of the syndicate tax exempt interest from $28,701.86, as reported to $2,184.07, or an increase in taxable income of $26,517.79.‘ The latter figure is 4 percent of $662,944.60. The revenue agent also determined that Drexel & Co. was entitled, as a result of this addition to income of $26,517.79, to a deduction for net additional accrual of city of Philadelphia income tax of $397.27. The net result of these two adjustments was to increase the net taxable income reported by Drexel & Co. of $384,625.27 to $410,745.79. The revenue agent then determined that petitioner's distributive share of this adjusted net taxable income of $410,745.79 was $92,487.89 instead of $86,597.37 as had been reported by the partnership and by petitioner, or an increase in partnership income of $5,890.52. These determinations of the revenue agent were adopted by the respondent in the latter's determination of the deficiency here in question.
OPINION.
BLACK, Judge:
Petitioner is a partner of Drexel & Co., which partnership became a member of the syndicate mentioned in our findings. During the taxable year 1941 the syndicate sold at a discount $666,896.65 face value of B coupons for $647,630.38. The principal question at issue is whether petitioner's ultimate share of the proceeds of $647,630.38 should be included in gross income under section 22(a) of the Internal Revenue Code, or whether it should be excluded therefrom under section 22(b)(4) as representing tax-free interest. In the alternative, the respondent contends that if the proceeds from the discounted B coupons be held to represent tax-free interest, from the discounted B coupons be held to represent tax-free interest, then the loss sustained on the sale of the bonds from which the B coupons were detached should be considered as a ‘short-term capital loss‘ under section 117(a)(1) and (3) of the code, and, under section 117(d)(2), ‘allowed only to the extent of short-term capital gains.‘
The material provisions of section 22 are set forth in the margin.
The parties are in substantial agreement as to the facts set out in our findings. They also agree that there is no decided case directly in point on the principal question here presented.
SEC. 22. GROSS INCOME.(a) GENERAL DEFINITION.— ‘Gross income‘ includes gains, profits, and income derived from salaries, wages, or compensation for personal service, of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. * * *(b) EXCLUSIONS FROM GROSS INCOME.— The following items shall not be included in gross income and shall be exempt from taxation under this chapter;(4) TAX-FREE INTEREST.— Interest upon (A) the obligations of a State, Territory, or any political subdivision thereof, * * *
The new refunding bonds of the city were obligations of a political subdivision of a state. The A and B coupons attached to these obligations represented the ‘interest‘ which the city had agreed to pay on the several dates therein specified. If the syndicate had held the bonds and the coupons until the due date of the latter and then collected the amount stated on the coupons, there would be no question as to the tax-exempt status of such collections. As a matter of fact the syndicate did hold $15,314.22 face value of B coupons until they matured and then collected the full value thereof, and the respondent now concedes in his brief ‘that the said sum of $15,314.22 is tax-exempt interest to the Syndicate under the provisions of Section 22(b)(4) of the Internal Revenue Code and should be adjusted under Rule 50. ‘ But as to $666,896.65 face value of B coupons, the syndicate saw fit to sell them. These coupons ran from July 1, 1941, and matured at various dates from January 1, 1942, to August 1, 1947. The syndicate did not hold these coupons until maturity. Almost simultaneously the syndicate purchased old outstanding bonds, exchanged them for new refunding bonds with A and B coupons attached, detached the B coupons, sold the new refunding bonds with A coupons attached at a loss, and then sold $666,896.65 face value of B coupons at a discount of 1 1/4 percent and received therefor $647,630.38. Under such circumstances, is the receipt of $647,630.38 by the syndicate the receipt of tax-free interest separable from the computation of gain or loss on the sale of the new refunding bonds? We do not think it is.
The usual import of the term ‘interest‘ is ‘the amount which one has contracted to pay for the use of borrowed money.‘ Old Colony Railroad Co. v. Commissioner, 284 U.S. 552. In Deputy v. DuPont, 308 U.S. 488, ‘interest on indebtedness‘ was said to mean ‘compensation for the use or forbearance of money.‘ It can hardly be said that the $647,630.38 in question was received by the syndicate for the use of money it had loaned. After it sold the new refunding bonds it was no longer a creditor of the city as far as those bonds were concerned. It sold those bonds before any appreciable amount of interest, if any, had accrued thereon.
We think that in selling the B coupons at a discount the syndicate merely sold the right to collect interest in the future, and that the proceeds from such sales must be treated the same as the proceeds from the sales of the bonds themselves with the A coupons attached.
Petitioner is not claiming, as such, the benefit of the rule that where municipal bonds are sold between interest dates, and the agreement of sale specifies a division between the principal sum of the bond and accrued interest, the latter will be regarded as being received tax-free. See I.T. 1337, Internal Revenue Cumulative Bulletin I-1, p. 29. The bonds here involved all ran from July 1, 1941, and matured from 1949 to 1973, with first optional call dates from 1948 to 1958. As previously stated, the B coupons ran from July 1, 1941, and matured semiannually from January 1, 1942, to August 1, 1947. The syndicate both acquired and disposed of all new bonds and coupons during the latter one-half of 1941. It is thus apparent that very little interest, as such, could have accrued while the syndicate held the bonds. In any event, petitioner is not making any such limited claim for the exemption of any interest that might have accrued while the syndicate actually held the bonds, and if such claim were made the evidence would be insufficient to determine the amount of such accrued interest, if any. Furthermore, the evidence does not show that the sale agreements specified any division between the principal sum of the bonds and accrued interest, and it is not altogether clear as to what may be included in ‘Wholly tax-exempt Interest Received: Bonds held by Account $310,700.71,‘ which the syndicate reported on its return and which the Commissioner has not disturbed.
It is, therefore, our opinion that when the syndicate purchased the old bonds, exchanged them for new bonds with A and B coupons attached, detached the B coupons, sold the new bonds with the A coupons attached, and then sold the B coupons at a discount, it was dealing in property, and the sale price received for that property was the total amount received for the refunding bonds with A coupons attached, plus the amount received for the B coupons. We do not think it is permissible to set apart the amount received for the detached B coupons as exempt interest. In making the above statement it is, of course, to be understood that any interest on either the A or B coupons which accrued while the bonds were in the syndicate's hands and which was collected by the syndicate from the purchasers in the sale of the bonds as a separate accrued interest item, was in fact interest and is exempt from taxation. The Commissioner so concedes.
It is our opinion that under section 22(a) of the Internal Revenue Code and the rationale of Willcuts v. Bunn, 282 U.S. 216, any gain or profit derived from the transactions as a whole must be included in gross income. In determining this gain or profit the proceeds from the discount of the B coupons should be included at $647,630.38 instead of $662,944.60, for the reason that the Commissioner now concedes that $15,314.22 was tax-exempt interest.
It is proper to point out, we think, that this is not a case where the city of Philadelphia issued its bonds at a discount, thus making applicable G.C.M. 21890, Internal Revenue Cumulative Bulletin 1940-1, p. 85, where it is ruled that:
Where interest-bearing State bonds were purchased by A at a discount and, pursuant to provisions contained in the bonds, they were redeemed in 1938 at a premium and accrued interest prior to maturity, the accrued interest and the discount received upon redemption of the bonds constitute interest upon the obligations of a State and are exempt from Federal income tax under section 22(b) 4 of the Revenue Act of 1938.
In his brief petitioner refers to the foregoing G.C.M. and to G.C.M. 10452, Internal Revenue Cumulative Bulletin XI-1, p. 18, but we do not think that they have any application to the facts which are present in the instant case.
None of the refunding bonds to which the B coupons were attached were issued at a discount. Therefore, the $647,630.38 which is involved in the present controversy did not represent the collection of ‘discount‘ as that term is used in G.C.M. 21890 or G.C.M. 10452, supra. Cf. M.C. Parish & Co., 3 T.C. 119, in which this Court, in holding that the amounts there involved did not represent true bond discount, but represented trading profits, relied upon Willcuts v. Bunn, supra. There is no issue in the instant case concerning petitioner's right to exclude from his gross income any interest which had accrued while the bonds were in the hands of the syndicate and which was collected by it during the taxable year. The Commissioner concedes that the $15,314.22 par value of B coupons which the syndicate held to maturity and cashed in 1941 is tax-exempt interest, and that amount is no longer in controversy.
Petitioner, in support of his contention that the proceeds from the discount of the B coupons in the amount of $647,630.38 are tax-free interest under section 22(b)(4) of the code, argues that the transfer of a right to receive income will not change the position of the transferor under the income tax law, either by shifting the tax burden if the transfer is a gift or by altering the character of the income if the transfer is made for consideration, and cites Helvering v. Horst, 311 U.S. 112; Hyman v. Nunan, 143 Fed.(2d) 425; Gibson v. Commissioner, 133 Fed.(2d) 308; and Hort v. Commissioner, 313 U.S. 28. In the Horst case the taxpayer detached unmatured coupons from a bond and made a gift of them to his son, who collected them at maturity. The question there was whether the father or the son was taxable on the interest when collected at maturity. The Supreme Court held that the father was taxable. The Hyman case reached the same result with respect to the donor of the right to receive corporate dividends undeclared at the date of gift. In the Gibson case the taxpayer, as a shareholder, received from a corporation certain warrants entitling her to purchase newly authorized convertible preferred stock of the corporation. The taxpayer did not exercise the rights to subscribe, but instead sold them. The question before the court was whether the proceeds of the sale were taxable as a dividend or as capital gain. The decision was that the taxpayer had acquired an option to receive a corporate distribution, not taxable upon the mere receipt of the option, which was realized upon the sale, hence the proceeds were taxable as a dividend. In the Hort case, the lessor taxpayer agreed to cancel a lease in consideration of a lump sum to be paid to the lessor by the lessee. The Supreme Court held that the amount received by the lessor did not constitute a return of capital, but that the lessor was required to report the amount as gross income received. We do not regard these cases as helpful in deciding the issue before us. The effect of petitioner's argument is that, if under certain circumstances the realizations on the B coupons be held to be tax-free interest, then all realizations thereon must likewise be held to be tax-free on the ground that the character of the income from the coupons never changes. That this does not follow is illustrated by Pierce Corporation v. Commissioner, 120 Fed.(2d) 206, affirming a memorandum opinion of the Board of Tax Appeals in which coupons attached to defaulted municipal bonds which had accrued before and those which had accrued after the purchase were treated entirely differently for tax purposes. See also R.O. Holton & Co., 44 B.T.A. 202.
Petitioner seeks an exemption from tax. ‘The rule is that, in claims for exemption from taxation from under legislative authority, the exemption must be plainly and unmistakably granted; it cannot exist by implication only; a doubt is fatal to the claim.‘ Chicago Theological Seminary v. Illinois, 188 U.S. 662, 672. Section 22(b)(4) of the code exempts ‘only interest.‘ United States v. Stewart, 311 U.S. 60. We do not think the $647,630.38 in question under the facts narrated in our findings of fact was interest. It follows, therefore, that petitioner's share of this amount is not exempt from tax, and we so hold. It thus becomes unnecessary to consider the respondent's alternative contention.
Reviewed by the Court.
Decision will be entered under Rule 50.