PRESTON v. COMMISSIONER OF INTERNAL REVENUE.
No. 85.
Circuit Court of Appeals, Second Circuit.
Dec. 31, 1942.
132 F.2d 763
No. 85.
Circuit Court of Appeals, Second Circuit.
Dec. 31, 1942.
Allin H. Pierce, of New York City, for petitioner.
Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key, A. F. Prescott, and Irving I. Axelrad, Sp. Assts. to Atty. Gen., for respondent.
Before L. HAND, SWAN, and CHASE, Circuit Judges.
The question presented is whether the petitioner in computing his taxable net income for the year 1937 is entitled, under
Because of circumstances which need not be detailed, the petitioner, with commendable generosity, desired to set up a trust for the benefit of his sister-in-law, Alice, the widow of his deceased brother Jerome. On October 18, 1934, he borrowed $125,000 from a bank and delivered it to the United States Trust Company as trustee to be held pursuant to the terms of a trust indenture executed by him on the same date. The income of the trust was to be paid to Alice, with limitations over in case of her death or remarriage. The trustee was given broad powers of investment and was expressly authorized in its absolute discretion from time to time to loan money to the settlor on his unsecured note or bond maturing in not more than twenty years. On October 19, 1934 the settlor delivered to the trustee his bond under seal for $125,000 and interest, as above described, and received the trustee‘s check for $125,000, which he endorsed to the bank from which he had borrowed the same sum the day before. He also paid the bank $20.83 as interest on the demand loan for one day. On December 15, 1934 and quarterly thereafter, the petitionеr caused the interest payments required by his bond to be made to the trustee. It entered the payments as “interest” on the cash receipts and disbursements account which it kept for the trust, and it filed a fiduciary income tax return for the year 1937 showing receipt during the year of $5,000 as interest, the expenditure of $125.25 for commissions and expenses, and the distribution of the balance to the life beneficiary. Fоr the year 1934 the petitioner filed a gift tax return in which he reported a gift of $125,000 to United States Trust Company as trustee, and paid the gift tax so reported.
In the opinion of the Tax Court, 44 B.T.A. 973, the basic question was whether or not the petitiоner‘s bond was a legally enforceable obligation, and the conclusion was reached that it was unenforceable either by the trustee or the beneficiary. On the strength of later cases thе Commissioner now concedes that the Tax Court erred in its view of the applicable New York law relating to a covenant under seal.* His present contention is that the
Under the findings of facts and opinion of the Tax Court we must take it that the “loan” by the trustee cannot be deemed consideration for the petitioner‘s covenant to pay the trustee $125,000 on October 15, 1954 and 4 per cent. annuаl interest before maturity. While the findings of fact as such do not include a finding that the trustee agreed on receipt of the money to lend it immediately to the petitioner, the opinion states that this is the only reasonable inference to be drawn from the steps taken and the carefully drafted provisions of the trust indenture. We cannot say that such inference is wholly unsupported by the evidence. Gеnerally, loans by the Trust Company as trustee required approval by its investment committee. There is no proof that the committee functioned as to the loan in question, and the time element was sо short that it is probable it did not. Failure to procure action by the committee is difficult to explain unless the trustee had already agreed to make the loan. If it had so agreed, the settlor nevеr lost control of the sum he turned over to the trustee and, except for the seal, the case would fall exactly within our decision in Johnson v. Commissioner, 2 Cir., 86 F.2d 710. See also Guaranty Trust Co. v. Commissioner, 2 Cir., 98 F.2d 62. We therefore accept the Tax Court‘s view that “the practical effect of what was done was to set up a trust composed solely of petitioner‘s bond.”
In Commissioner v. Park, 3 Cir., 113 F.2d 352 it was held, with Judge Biggs dissenting, that payment of interest on a gratuitous demand note, enforceable because under seal, entitled the obligor to interest deductions under the Revenue Acts of 1932 and 1934, whose provisions on this subject were identical with those of
A majority of the court believes that case to have been correctly deсided. The words “interest on indebtedness” should be accorded their usual, ordinary and every day meaning. See Old Colony R. Co. v. Commissioner, 284 U.S. 552, 561, 52 S.Ct. 211, 76 L.Ed. 484; Deputy v. Du Pont, 308 U.S. 488, 498, 60 S.Ct. 363, 84 L.Ed. 416. We think that the ordinary business man would consider an enforceable obligation to pay monеy on demand or at a fixed future date as an “indebtedness,” whether the obligation were created in exchange for a valuable consideration or gratuitously, and that periodic payments agreed to be paid as interest thereon are properly described in common parlance as payments of “interest on indebtedness.” While it may be possible to view the petitioner‘s bond as an obligation to make a series of annual gifts of $5,000 and a gift of $125,000 in 1954, such a concept seems to us as esoteric as the “effective interest” concept which the Supreme Court rejеcted in the Old Colony case, supra. When a donor transfers as a gift the bond of a third person, we do not view the annual interest payments thereon as a series of gifts reduced to possession by the donee in the year of receipt, and we see no reason why this should be the view when the donor gives his own legally enforceable bond. His gift is complete when the bond is delivered whether his own obligation оr another‘s is the subject of the gift. Nor do we see any valid reason for supposing that Congress wished to restrict the meaning of “indebtedness” to that contracted “for an adequate and full consideration in money or money‘s worth.” Where that was its intent Congress expressly so stated.
It is urged that the purpose of
The order of the Tax Court is reversed.
L. HAND, Circuit Judge (concurring).
If the transaction between Preston and the trustee had been such that if Preston had changed his mind after giving the trustee the chеque and had refused to give the bond, the trustee would have still been obliged to return the money, I think I should have said that the payments were not interest. But I do not so understand the facts, nor did the Appellate Divisiоn so understand them in United States Trust Co. v. Preston, 264 App.Div. 152, 34 N.Y.S.2d 646. Although the trustee had agreed to lend the money in exchange for the bond, Preston could not have reclaimed it without executing the bond, and the trustee would have been liable to thе beneficiaries if it had returned the money gratis: being bound to lend is not being bound to give. Hence it seems to me that the transaction was like any other loan and that the interest was interest in the strictest sensе.
Moreover I do not see how such a transaction could ever be made the means of tax evasion. If Preston had used as the trust res the securities, on whose pledge he raised the money in thе first place, he need not have included any interest or dividends accruing upon them in his income tax; the beneficiary would have paid the tax. If the trustee—being authorized in its discretion to lend the monеy to Preston, but not being bound to do so—had nevertheless chosen to lend it to him, any tax on the interest would also have been payable by the beneficiary and Preston could certainly have deduсted it. It would have been deductible as part of the cost of obtaining whatever profit he might make by using the borrowed money. The only gift would have been made when the money was put where Preston had tо execute the bond to get it back. Nor do I see why the result should be different because the trustee was bound to lend the money in exchange for the bond; any more than if its discretion in investing had been limited in аny other way. If the interest reserved had been higher than Preston had any bona fide expectation of earning on the money, it would have been pro tanto a colorable device merely to make gifts, but there is no suggestion of anything of that kind. For these reasons I concur.