HANOVER BANK v. COMMISSIONER
Legal provision: Internal Revenue Code
Argument of Theodore Tannenwald, Jr.
Chief Justice Earl Warren: Number 224, The Hanover Bank, Executor, et al., Petitioner, versus Commissioner of Internal Revenue.
Mr. Theodore Tannenwald, Jr.: Mr. Chief Justice, members of the Court, I approach this argument with some trepidation after the spirit of exchange took place with Mr. Doolittle and Mr. Dietz.
This is a rather straightforward tax case which comes here on writ of certiorari from the Second Circuit.
It does, however, involve the issue of how far the Commissioner of Internal Revenue may go in extending the clear language of the statute and it also involves the conflict of Circuits and that the Third and the Sixth Circuits have decided this case differently than the Second Circuit.
The single issue that is presented here is the question of whether a taxpayer who pays a premium for a bond, which is subject to both a general call at one price and a special call at one -- at another price, lower price, may deduct the difference between the amount that he pays or -- and the amount of the general call price.
Or whether he may, as petitioners contend under Section 125 of the Internal Revenue Code of 1939, deduct the difference between what he paid and the lower special call price.
Our position, we submit, is supported by both the express language of the statute and the legislative history.
And furthermore is supported by the Commissioner's own publicly announced position, during the tax year involved in this case, a position which he did not reversed until 1956, three years after the year in question.
Justice John M. Harlan: How long had the administrative interpretation going on?
Mr. Theodore Tannenwald, Jr.: Between the years 1951 through 1956.
First ruling was issued in 1951.
The Commissioner reversed this position in 1956.
I should add in all fairness Mr. Justice Harlan that the earlier rulings commencing in 1951, were not formally published rules.
They were issued to individual taxpayers, but they were widely circulated and published in financial and tax services and were generally known to the public.
And in fact, into this particular record, there is evidence that at least petitioner Gourielli relied on the ruling that he had read about.
In both of these cases, the taxpayers purchased approximately half a million dollars worth of bond.
Mr. Gourielli paid 117 and a half.
Mr. Goldfarb paid 110 on the average.
In both cases, the bonds were callable at a general call price on 30 days notice at approximately 105.
And in both cases, the bonds were also callable at a special call price out of certain sinking funds which the issuer was required to maintain and which I will deal with it in some detail later at 102.
The Government conceives that the taxpayers were entitled to deduct the difference between what they paid in Mr. Gourielli's case 117 and in Mr. Goldfarb's case approximately 110, and the general call price 105 in the year in question.
The Government, however, denies the further right of the taxpayer to deduct down to the special call price which in one case was 102 and the other case approximately 101.
Justice Potter Stewart: There was a privilege of call in 30 days notice --
Mr. Theodore Tannenwald, Jr.: In either case --
Justice Potter Stewart: -- in either case.
Mr. Theodore Tannenwald, Jr.: -- Mr. Justice Stewart in --
Justice Potter Stewart: And the --
Mr. Theodore Tannenwald, Jr.: Either case.
Justice Potter Stewart: -- and maturity on the other hand was several years away.
Mr. Theodore Tannenwald, Jr.: The maturity was in one case in 1983, and then the other case 1981.
Justice Potter Stewart: Yes.
Mr. Theodore Tannenwald, Jr.: The fact of the matter is that in a particular period during which the taxpayer purchased these bonds, the economics of the market were such, the interest rate being above the current rate -- current rate being paid on these bonds.
That these bonds were not likely to be called at either the general call price or the special call price.
The Second Circuit and the Tax Court before --
Justice Potter Stewart: You mean because to refinance would have cost more money --
Mr. Theodore Tannenwald, Jr.: In the case of the general --
Justice Potter Stewart: -- of the issue --
Mr. Theodore Tannenwald, Jr.: -- call price, the interest rate being larger.
It was unlikely that the companies, the issuers, would refinance --
Justice Potter Stewart: Right.
Mr. Theodore Tannenwald, Jr.: -- the issue.
In the case of the sinking funds which were required to be created either out of annual deposits of 1% of the face amount or out of property additions, both companies were expanding.
And it was it -- during the period of an expanding economy and their cash could be used to much more profitability in the expansion of their current operation --
Justice Potter Stewart: Rather than the retirement of their --
Mr. Theodore Tannenwald, Jr.: Correct.
Justice Potter Stewart: -- their indebtedness.
Mr. Theodore Tannenwald, Jr.: The fact is that in the tax year in question accept for a rather -- rather modest amount of some $184 in the appellation issue which was involved in the Gourielli case, there was no cash in the sinking fund.
Before I proceed to the details of my argument, I would like to emphasize two elements which I think are rather important in this case.
The real issue is, what was the law in 1953 when these transactions took place, and not as the respondent has consistently tried to make it.
What the law should have been in 1953.
It may well be --
Justice Felix Frankfurter: It's conceded is it, common ground between you that -- that what the -- that 1953 is the decisive year for determining this?
Mr. Theodore Tannenwald, Jr.: Yes Mr. Justice Frankfurter.
These bonds were purchased in 1953 more than 30 days prior to the end of the year.
And if the taxpayers are entitled to a deduction with respect to the special call on in deep the general call as far as this case is concerned, they were entitled to in that year.
Justice Potter Stewart: And the Government does concede a good deal of your case actually, doesn't it?
Mr. Theodore Tannenwald, Jr.: The Government concedes that we were entitled to deduct the difference between what was paid in the general call price.
Justice Potter Stewart: Because --
Mr. Theodore Tannenwald, Jr.: What --
Justice Potter Stewart: -- the bonds were purchased within 30 days at the end of the year and there was -- these were callable on 30 days notice.
Mr. Theodore Tannenwald, Jr.: That is correct.
It may well be Mr. Justice Stewart that if this case were being considered de novo, Congress might have well legislative differently and precluded the call -- the deduction both with respect to the general call and the special call.
Justice Potter Stewart: It has subsequently --
Mr. Theodore Tannenwald, Jr.: It has indeed.
In 1954, it narrowed the permissible deduction for bond premium, and in 1958, it foreclosed it completely except with respect to the right to amortize over the period to maturity or to the earlier call date if that produced the lesser deduction.
The second thing that I would like to emphasize is that this is not a case of a sham transaction.
There isn't the slightest suggestion in this record that the taxpayer's purchases of the bonds were not bona fide --
Justice William J. Brennan: Well the government doesn't argue that, does it?
Mr. Theodore Tannenwald, Jr.: No, but I think this is important Mr. Justice Brennan to know that aside from the -- my second point which I was coming to is that the special call provisions that were included in these bonds were not tax gimmicks.
They were not put in by issuers for the purpose of stimulating the sale of their bonds because of the tax advantages.
They were put in and that's been in bond issues long before this taxable year.
Indeed, back in 1942 when Congress first dealt with the problem, one of the witnesses testified.
Justice William J. Brennan: And that of course, the government's argument was that it was sham but (Inaudible) --
Mr. Theodore Tannenwald, Jr.: Precisely.
Justice William J. Brennan: -- they had in that year.
Mr. Theodore Tannenwald, Jr.: Precisely.
No, we don't but I think it's important to realize that the vice that this taxpayer is charged with is that he took advantage of what he considered to be the clear mandate of the statute in the regulations of the commissioner to convert ordinary income into capital gain.
Justice William J. Brennan: And the Government said, "Yes you may --"
Mr. Theodore Tannenwald, Jr.: In that --
Justice William J. Brennan: -- in relation of the general call price but not to the special call price.
Mr. Theodore Tannenwald, Jr.: Special call price.
Although in the particular year that he did it, the Government said he could do it even to the special call price and there was no place that he could have gone in that year to have gotten a different answer.
Justice Potter Stewart: Well, the Government said to many other taxpayers that they could do it?
Mr. Theodore Tannenwald, Jr.: That is correct.
But these were widely circulated.
They were known.
And the fact is that if this particular taxpayer had seen fit to ask for a ruling, he would have gotten precisely that answer.
Justice John M. Harlan: Has the Third Circuit case been published in the federal circuit yet?
Mr. Theodore Tannenwald, Jr.: I have not been able to find the citation Mr. Justice Harlan.
I don't believe it is.
Our citation is one of the tax services (Voice Overlap) --
Justice John M. Harlan: And that serves (Inaudible) --
Mr. Theodore Tannenwald, Jr.: -- only one I know.
Section 125 of the Internal Revenue Code of 1939, under which these taxpayer -- these taxpayers claim their right of deduction, provides that the amount of the bond premium which shall be deducted, quote, "Shall be determined with reference to the amount of the basis of such fund and with reference to the amount payable on maturity or on earlier call date."
We believe that the statute means what it says.
It says, "Earlier call date."
These bonds were callable on 30 days notice, both of the general and the special call.
And we believe that the taxpayer was entitled to choose either under regulations of the Commissioner which gave him that privilege.
We believe that the amount payable as we argued in our brief, main brief in this Court means the amount payable at the special call price.
Respondent, however, has pursued a rather peripatetic course as to how this case should be approached.
In the lower courts, he contended that what was needed was a realistic premium that the amount payable was not realistic.
The special call price was not realistic.
And therefore, should not be taken into account.
He contended that there was no likelihood of redemption at the special call price, and therefore the special call price should not be used.
Apparently, the respondent had second thought, although he won this particular case in the lower courts.
And he now admits that the issue of likelihood is immaterial or at least he says he does.
He concedes that just as economic likelihood has no bearing on the right of the taxpayer to use the general call price so it has no bearing on the right of the taxpayer to use the special call price.
He does suggest rather wistful -- wistfully that maybe the right to amortize down to the general call price was the wrong rule but he also concedes that it is too late in the game to change that rule.
What he now says is that the legal probabilities must be such that the issuer can call all of the bonds of the particular issue at the special call price at the special call date.
What he is really doing if I understand it correctly is to say that the phrase "earlier call date" in Section 125 means unconditional and unlimited earlier call date.
He admits that the likelihood of redemption is immaterial but he says that, "In the case of the general call price, the taxpayer may use this price because the issuer is legally entitled to call the entire bond issue and therefore, taxpayer's particular bonds at anytime on 30 days notice."
Justice John M. Harlan: What percentage of the bonds were subject to the other -- outstanding issue was subject to the special call?
Mr. Theodore Tannenwald, Jr.: The issuer was required either through cash or through property editions to deposit 1% of the face amount of the bonds in the -- in the Appalachian Power and Light, this was 1% of 17 million in the Arkansas Power & Light, it was 1 % of 18 million, each year or in lieu thereof property additions.
However, the issuer was also entitled to have used out of the sinking fund, the proceeds of the takings by eminent domain, the proceeds of destroyed property that was not replaced and the insurance proceeds that came in, the proceeds of released property that were released from the land of the indenture and so in accordance with permission that was granted in the indenture.
In other words, there were many sources of funds which might have found themselves in the sinking fund and which could have been used to redeem the bonds at the special call price.
In fact, the respondent in its brief, I think is a bit unfair because it makes the -- he makes the point that the chance of the taxpayers bonds in this case being redeemed in particular year were one out of a hundred.
Now, this might or might not have been true.
In the first place, in the case of bonds that were issued say 10 years previously, the issuer might have deposited the 1% each year for 10 years before he decided to use the money to redeem many funds.
He did not have to use them in a particular year that the deposit was made.
In which event, the chance of a particular issue -- taxpayers' bonds being redeemed could have been one out of ten or after 20 years, one out of five, or if some of this property had been destroyed and not replaced, the proceeds of insurance might have provided the possibility of all of the taxpayers bonds being redeemed.
In other words, what the respondent seems to say is that because there was no legal right to redeem all of the taxpayers' bonds at the special call price, no unconditional and unqualified right this price could not be used.
Justice John M. Harlan: That's a little different from Judge Friendly's rationale, is it?
Mr. Theodore Tannenwald, Jr.: Judge Friendly's rationale seems to be that on the question of realism, there was no realistic possibility.
In other words, the respondent's rule is, it's either 100% or nothing.
I have already pointed out, however, that there were other possibilities which could have produced enough funds to have increased the chances of res -- of taxpayers' bonds being redeemed to far more than one out of 100.
Justice Potter Stewart: But your basic argument is, that does make any difference, isn't it?
Mr. Theodore Tannenwald, Jr.: Precisely because whether you talk about the economic possibilities or the legal probabilities as the respondent would talk about.
Justice Potter Stewart: Yes.
Mr. Theodore Tannenwald, Jr.: And he uses the words contingent and limited.
What you come down to Mr. Justice Stewart is the issue of likelihood and you can't run away from the decision, the bond --
Justice Potter Stewart: And you say that that is an issue that's --
Mr. Theodore Tannenwald, Jr.: That is an issue (Voice Overlap) --
Justice Potter Stewart: -- not properly to be considered --
Mr. Theodore Tannenwald, Jr.: -- not -- not --
Justice Potter Stewart: -- in this law.
Mr. Theodore Tannenwald, Jr.: -- proper under the statute as particularly as interpreted by this Court in the Korell case.
Respondent tried to narrow the interpretation of Section 125 in 1950, and came to this Court in Korell against the Commission.
In that case, the taxpayer had bought American Telephone and Telegraph convertible bonds at 121 which were redeemable on 30 days notice in 104 and with respect to which the taxpayer had the right to convert it by the -- into stock by the payment of $40 a share.
Interestingly enough to market for the stock at that point was 61, so that it was perfectly clear that the premium that was being paid for these bonds was not premium in the sense of a cost for payment for higher rate of interest which was being paid on the bond, but rather it was being paid for the convertibility feature.
And this -- the respondent came to this Court and urged that what Congress meant in the statute when it used the phrase "bond premium" was through bond premium, and this Court categorically rejected the respondent's contention.
The Court held that Congress was legislating for the generality of the case and that a separate analysis of each case would lead to narrow -- to use the Court's language, "To narrow and quite possibly unfair distinction between varying bond issues without warrant in the general language employed or in the legislative history."
Also, the Court said that, "If there was a loophole, the amendment must obviously be enacted by Congress and not by the Commissioner of Internal Revenue or this Court."
Respondent made a great deal in that case of the fact of revenue loss which might be produced by giving the taxpayer the benefit of the bond premium, deduction, just as he has adverted to this -- in this case.
And I think that the language which this Court used in the Korell case might appropriately be referred to at this point.
The Court stated, "We cannot reject the clear and precise avenue of expression, actually adopted by the Congress, because in a particular case, we may know that the public revenues would be maximized by adopting another statutory approach."
The interesting thing to me about the Korell case as applied to this case, is this, respondent would deny the taxpayer, the right to take the amortization down to the special call price in this case.
Although there was admittedly a possibility that he might be deprived in the taxable year of his premium, admittedly perhaps an unreal possibility or an unlikely one that we said.
But this Court permitted the taxpayer to take the premium in the Korell case, although there was absolutely no way that the issue where could have deprive the taxpayer of the premium which he paid in that case, or of the tax benefit that he achieved.
Because, under the terms of the bond issue in the Korell case, if the bonds were called, the taxpayer had the right between the date of the call and the actual date of con -- con -- of redemption to convert into stock and thereby fully protect his premium.
In other words, there was absolutely no possibility in the Korell case that the premium which the taxpayer paid and which this Court said he was entitled to deduct in 120 -- under 125 could have been taken away from him.
Justice John M. Harlan: What do you think of Judge Friendly's distinction in the Korell case?
Mr. Theodore Tannenwald, Jr.: Mr. Justice Harlan, I must say that it took me a fair amount of time to understand Judge Friendly's distinction.
His only comment was -- as I recall that the Korell case -- in the Korell case, we were dealing with the minuend and not with the subtrahend.
I think the language was quite as clear -- is quite as clear in 129 as to the meaning of bond premium which is the minuend in Judge Friendly's definition.
And the meaning either of amount payable or earlier call date which would be the subtrahend in Judge Friendly's term.
So that I simply don't agree with his distinction.
Justice John M. Harlan: Well, I was hoping you'll give me some light in this either.
Mr. Theodore Tannenwald, Jr.: I thought he --
Justice John M. Harlan: Because I didn't understand it, I didn't --
Mr. Theodore Tannenwald, Jr.: Well, I didn't either Your Honor.
If there is need for interpretation, I would like to remind this Court that the legislative history bears out.
That Congress was on notice as early as 1942, that the special call prices were used.
Respondent gives the testimony of Mr. Osgood of the Finance Committee of the Chamber of Commerce before the Senate Finance Committee in 1942, the back of his hand.
But I would remind this Court that if in 1950 in deciding the Korell case thought that Mr. Osgood was deserving of better treatment, because it cited Mr. Osgood itself as evidence of the legislative history.
Furthermore, in 1954, Congress was on notice of the special call provisions.
And indeed in beginning to narrow the gap or to close the door, referred to the fact that Section 125 permitted the deduction of bond premium in the case where the call features were "nominal or inoperative."
What could be more descriptive of what we are talking about here -- than of what we are talking about here.
Thus Congress did not do anything about it in 1942, did not do anything about it in 1954 when it had the chance and it was not until 1958 when Congress finally closed the door completely that the privilege which taxpayers seeks in this case was eliminated.
There's an interesting contrast between Congress' action and the respondent's action in terms of retroactivity.
Congress in narrowing the gap or commencing to narrow the gap both in 1954 and 1958 very carefully made their actions prospective only to prevent in their terms unfair retroactive application to previous investment.
This is in sharp contrast to the position of the respondent, who refers to the previous rulings as being inoperative because my client or our clients did not rely on that.
Respondent misunderstands the thrust of our argument.
We are not saying that our taxpayers are entitled to rely on these prior rulings in and of themselves.
But we do say that if the interpretation of Section 125 is necessary, there is no better evidence of what a reasonable interpretation would be then respondent's own interpretation during the tax year in question.
Finally, I would like to point out in terms of specifics that respondent is playing fast and loose on its retroactivity.
As our brief show, as our main brief and our reply brief, there have been five other cases before the courts in which the special call price was used.
Now, it is true that in those cases respondent's main thrust was to deny the amortization deduction completely.
But the fact of the matter is that if -- as it subsequently turned out, respondent was unsuccessful in designing all amortization.
The issue of the special call price against the general call price would have become absolutely critical and yet not once in those five cases did respondent choose to raise the issue of the special call price.
Justice William J. Brennan: In what courts were these cases -- the District Court or --
Mr. Theodore Tannenwald, Jr.: That were three courts in the first -- the three cases in the First Circuit Your Honor, Maysteel was -- I believe Fabreeka Products, Friedman and Sherman were in the First Circuit, Gallun was --
Justice William J. Brennan: In the Court of Appeals?
Mr. Theodore Tannenwald, Jr.: -- decided in the Seventh Circuit Court of Appeals and Maysteel, I'm sorry to say I forgotten which Circuit --
Justice William J. Brennan: These were all Court of Appeals cases?
Mr. Theodore Tannenwald, Jr.: All Circuit Court of Appeals case.
Maysteel was Seventh as well.
In summary then, before I go to summary, if I may, there is one point adverted to in our brief which -- in which we make the point that if respondent -- that under respondent's regulations, the taxpayer was required to choose the call date at the beginning.
And if he -- once he chose one, he had to stick with it.
The Solicitor General's office has informed me just before this argument last evening that they will point out or point out in oral argument to a ruling which provides that this is not true and interprets this regulation without belaboring the point because I do not consider that it is particularly essential to our argument.
Let me remind the Court that the ruling to which the Solicitor General representative will refer to is a ruling that deals not with two call prices that were simultaneously available, but to -- but a serious of call prices.
In other words the right to redeem in the first year, let's say the 109, in the second year at 108, the third year at 107.
So Your Honors by way of summary, I come back for the simple nubbin of this case.
The respondent in the courts below decided these -- these cases on what they would have like the law to have been, not on what the statute said.
I openly admit that my clients received the tax benefit.
They converted all the ordinary income through a deduction into capital gain by holding and selling the bond.
But this is what the owners of real estate do by taking depreciation.
This is the consequence of the capital gain structure.
And I don't believe that it's my function or the function of respondent to argue the policy of whether capital gains are good or bad as a matter policy.
Our point is that the same problems of likelihood with respect to the special call existed in a different form with respect to the general call.
The general call, it depended upon the like -- the economics of the interest market.
In the special call case, it depended upon the likelihood of certain other events.
Our point is that as the -- this Court said in the Korell case, and as we believe Congress said in the statute likelihood is immaterial, and the Congress was legislating for the generality of the case.
And I see no point Your Honors as to why this Court should narrow the doctrine of the Korell case and go back from where it was in 1950 and where Congress said it should be particularly in a case where the respondent is trying to apply its rules retroactively and changing the signals in the middle of the stream.
Thank you very much.
Chief Justice Earl Warren: Mr. Pollak.
Argument of Stephen J. Pollak
Mr. Stephen J. Pollak: Mr. Chief Justice, may it please the Court.
First let me answer the question of Mr. Justice Harlan the Evans case, the Third Circuit case was reported in 295 F.2d 713.
The Government does not come to this Court, this morning asking for a decision because of policy or tax avoidance.
There is a statute under which this 30-day tax benefit bonds, and that's the petitioner's word for the bonds, were sought to be used to convert a capital gain into a much more valuable ordinary income deduction.
And it is that statute, Section 125 of the Code which is to be interpreted.
We suggest that the answer to petitioner's argument, that Congress didn't do anything in 1942 and in 1954, because Congress didn't need to do anything, amortization because of a special call right, because of a right to redeem a fraction of the bonds was never permitted by this statute.
And it need not -- Congress need not have rewritten the statute to meet a problem which did not exist.
Chief Justice Earl Warren: Was that the consistent interpretation of the Commissioner?
Mr. Stephen J. Pollak: It was not the consistent interpretation of the Commissioner.
The petitioners have mentioned this morning and of course in the lower courts that there were so-called private rulings in which the Commissioner approved the amortization to a special call date.
I might say that the argument is made in terms of a virtual blizzard of these rulings and our search in which we endeavour to be diligent has disclosed what I would call a few errant snowflakes.
These rulings --
Justice John M. Harlan: Did those snowflakes reach Congress?
Mr. Stephen J. Pollak: Those snowflakes did not reach Congress Your Honor.
Justice Potter Stewart: But they -- they do reach the tax services and the --
Mr. Stephen J. Pollak: Those -- I hate to keep calling them snowflakes but they're labeled with it now.
They reached the tax service to our knowledge or to my knowledge in one instance --
Justice Potter Stewart: (Inaudible) -- I'm talking about the CCA's in the Prentice Hall --
Mr. Stephen J. Pollak: That's -- that's right --
Justice Potter Stewart: -- and the practitioners of -- in the --
Mr. Stephen J. Pollak: Subsequent --
Justice Potter Stewart: --bill of (Voice Overlap) --
Mr. Stephen J. Pollak: to the transactions in issue here.
One private ruling reached the tax service involving the Elizabeth River tunnel bonds, I believe in Norfolk.
Those were tax exempt bonds that -- that's somewhat different than the taxable bonds here in issue.
But that ruling reached the tax services and as I say after the transactions in issue.
But I would like to state the specific facts of the administrative history as we understand it.
In December of 1952, the Commissioner issued a private ruling approving the amortization to the special call date.
He issued one further private ruling prior to the transactions and issue.
Thereafter, we know of two more private rulings, and in September of 1954, the Commissioner have denied amortization to the special call date and it was establishing a corrective process which led to the first published revenue ruling that there ever was on this question.
Justice Felix Frankfurter: Would you mind telling me what issuing of private ruling means?
Mr. Stephen J. Pollak: Yes.
As -- as I understand, the practice permits taxpayers to request an opinion from the rulings branch of the Internal Revenue Service.
The taxpayer sets forth the facts of a taxable transaction in which the taxpayer proposes to engage and ask what the tax consequences will be.
It has been the practice for some years to issue private rulings --
Justice Felix Frankfurter: The word "issue" bears with it to mean more than ex parte --
Mr. Stephen J. Pollak: Yes.
Justice Felix Frankfurter: -- undisclosed of --
Mr. Stephen J. Pollak: I --
Justice Felix Frankfurter: -- legal opinion.
Mr. Stephen J. Pollak: Well, then I do not want to use the word "issue".
Justice Felix Frankfurter: Well I don't -- whether you should or shouldn't depend on what --
Mr. Stephen J. Pollak: Yes.
Justice Felix Frankfurter: -- you could do.
Mr. Stephen J. Pollak: These private rulings or if I might say that -- they are private.
They are meant to be good for the taxpayer who requests them.
The regulations provide that they will not be binding on the Commissioner or -- or pertain to other taxpayers than the taxpayer to whom the private ruling is issued.
The -- this is a well-known fact in the tax practice --
Justice Felix Frankfurter: They have a way of getting out, don't they?
Mr. Stephen J. Pollak: Your Honor, I know that they are, at least in this case, there was this ruling published and I'm sure that the capable tax services keep up with the Internal Revenue Service's views.
But I want to state that the -- this tax ruling that was issue, it was part of a yearly total of some 40,000 private letters.
And rather than use the word issue, I really would like to say write a letter.
There are 40,000 of those letters issued written a year, in order to carry that practice which is engaged in to be helpful to taxpayers.
The authority to write those letters must be delegated the lowest possible level in the service.
And it is only when the Commissioner's office issues what they refer to as a published revenue ruling that the rule is meant to have general applicability.
There are some 500 to 700 published revenue rulings a year.
These are reviewed thoroughly and meant to have general applicability.
A private written letter is not a general rule.
It is not meant to be a general rule, and when relied upon, these petitioners had advice when relied upon the advise is chargeable I submit with knowledge that those are private letters.
Chief Justice Earl Warren: Are we entitled to assume that if-- if the taxpayers in this case have asked for such a -- a letter that they would have been permitted to make this deduction?
Mr. Stephen J. Pollak: Mr. Chief Justice the -- I think that is in part of function of the number of requests for these rulings.
The tax people in the rulings branch, if they received two, made an interpretation of the law as they understood it.
If I submit, they received 20 or more, I submit they would boost the question to a higher level which it was submitted to in the September 1954 instance in which event, the Chief Counsel's office for the first time met the question and that that instance saw the mistake and set the corrective process in motion.
Justice Felix Frankfurter: Do I infer that to Chief Counsel may not know what is contained in these 40,000 letters?
I'm just interested in the -- in the administrative or --
Mr. Stephen J. Pollak: Yes.
Justice Felix Frankfurter: -- or mental process.
It seems to me --
Mr. Stephen J. Pollak: I -- I don't --
Justice Felix Frankfurter: I infer -- I inferred from what you say that a letter may be written today and when it does get to the Chief Counsel's office on review, he may say that's all wrong and bring litigation opposed to that which was recommended in the -- of authorizing a letter, is that right?
Mr. Stephen J. Pollak: Mr. Justice Frankfurter, I don't know in any particular instance whether the Chief Justice sees a private ruling -- pardon me the Chief Counsel.
I know that in this instance, the Chief Counsel first saw one of these private ruling requests.
Justice Felix Frankfurter: Who signed these things (Inaudible) Mr. Pollak?
Mr. Stephen J. Pollak: They are signed by sometimes the chief of the rulings branch, by somebody or --
Justice Felix Frankfurter: Do you think with Gregory we'd get into a lot of trouble, would that establishes (Inaudible)
Mr. Stephen J. Pollak: Let -- let me answer the second part of your question sir, the regulations and published revenue rulings which established the procedures for these private ruling letters, state that the taxpayer who obtains a private ruling may rely on that ruling if he has correctly stated the facts.
The litigation which would stem from a judgment that there was a mistake on the law which was the judgment in this case will be as to other taxpayers who obtained no private rulings.
I want to mention or go back to the statute which is being interpreted.
It was enacted in 1942 and provided the taxpayers who purchased these bonds at a premium may deduct so much of that premium as qualifies as an amortizable bond premium.
There's a established a three --
Justice Potter Stewart: Could I return Mr. Pollak just a moment to the Chief Justice's question to you about few minutes ago.
Isn't it -- isn't it fair to say that the only fair answer to his question as to whether -- if these taxpayer had asked for a ruling in 1953, all the evidences that he would have gotten to the ruling that he could have amortized to the special call price, because every other taxpayer who did ask for one up to and including that time did get such a -- such letter.
Isn't that correct?
Mr. Stephen J. Pollak: I -- I can't -- I can't say that he would have gotten that ruling.
Justice Potter Stewart: Well, am I right factually that every (Voice Overlap) --
Mr. Stephen J. Pollak: You are right factually and that I know of two taxpayers who requested such rulings and obtained, yes.
They obtained private letters authorizing the deduction.
The case in which the issue was presented to the Chief Counsel involved the same time period of a purchase of bonds as is present here.
I don't suppose that's surprising since the tax returns of the year 1953 were questioned and the deduction which was permitted --
Justice Potter Stewart: In 1954 or later --
Mr. Stephen J. Pollak: Yes.
Justice Potter Stewart: Yes.
Mr. Stephen J. Pollak: A deduction which was permitted by the private ruling letter was found to be a mistake of law.
Justice Felix Frankfurter: Is your -- is your -- is the implication of what you didn't say that while the petitioner may have availed himself of this procedure getting private advice which is binding on the Treasury, on the Gover -- on the Commissioner, in fact he didn't so therefore we reverted back to the statute.
Mr. Stephen J. Pollak: Precisely.
This petitioner --
Justice Felix Frankfurter: I'm not saying what I think the statute is but --
Mr. Stephen J. Pollak: No.
Justice Felix Frankfurter: -- that's the answer.
But if you have this opportunity of getting an ad hoc ruling which is controlling, and if you don't avail yourself of it, that fact?
Mr. Stephen J. Pollak: The taxpayers are chargeable with knowledge of the opportunity to obtain private rulings which in their private cases will be afforded to binding effect if the facts --
Justice Felix Frankfurter: And under --
Mr. Stephen J. Pollak: -- and other circumstances.
Justice Felix Frankfurter: And I'm not suggesting that Mr. Tannenwald's argument doesn't have to be met by you.
But when we go to the statute, the construction placed upon it in whatever form or whatever volume, I'm -- I assure you that it was very relevant as to meaning.
Mr. Stephen J. Pollak: Yes.
Justice Felix Frankfurter: But the fact that they might have got this controlling private information by the mean that they did get it.
Mr. Stephen J. Pollak: I would -- I would like to turn to the statute.
Justice Potter Stewart: It does means the other taxpayers in the same year got -- got this in tax advantage, does it not?
Mr. Stephen J. Pollak: Taxpayers --
Justice Potter Stewart: Other taxpayers in the same calendar taxable year?
Mr. Stephen J. Pollak: I know that taxpayers in the year 1953 had their returns questioned, because these are taxpayers in that year --
Justice Potter Stewart: Yes, but --
Mr. Stephen J. Pollak: I know that the taxpayers who in 1952 and in October 1953 got private letters.
I know no reason to think that they did not obtain the very deduction which we are questioning --
Justice Potter Stewart: Well, I for one don't want to tell you because the really important part of this case is not this part but it's what the statute of regulations mean, isn't it?
Mr. Stephen J. Pollak: I believe that is so.
The statute provides a three-step process for the determination of this amortizable bond premium.
The first step is the election of the period for amortization that is whether to maturity or if the indenture provide to an earlier call date.
Once the election of the period is made, then the second and third steps follow simply.
The second step is the identification of the price payable at the conclusion of the period selected and the third step is the subtraction of that price from the price paid for the bond.
I might illustrate just quickly with a simple case of a $100 face value bond purchased at 120 and callable at 105 on 30 days notice.
The first step would be the taxpayers' election to take the 30-day period for amortization and the identification that the bond was callable at the end of 30 days.
The second step would be the selection, the identification of the price payable 105 at the conclusion of the 30 days period.
The third step would be the substraction of that price payable from the cost giving a --
Justice John M. Harlan: I wonder what you call three steps were really isn't just fragmentizing one step, I don't understand what the three step is --
Mr. Stephen J. Pollak: Well, I --
Justice John M. Harlan: What that adds to the argument?
Mr. Stephen J. Pollak: I just -- I thought that it might be helpful to approach in that way.
Justice John M. Harlan: Use it --
Mr. Stephen J. Pollak: I'm just -- I don't mean to confuse you.
Justice John M. Harlan: (Inaudible)
Mr. Stephen J. Pollak: The case this morning is concerned with the identification of when a bond is subject to an earlier call date.
For the statute provides that the premium will be deducted over the period to maturity or to an earlier call date.
The question is what rights of redemption provided in the indenture with respect to a particular bond constitute a right to call that bond and thereby establish an earlier call date permitting the amortization to be taken.
In this case, the rights of special call were of two kinds.
First, the issuers retain the right to use funds in the sinking fund to purchase bonds in 30 days notice at the special call price.
The right to place money in the sinking fund was severely limited to 1% of the outstanding bonds, thus 1% over a year period.
Thus the right to purchase funds at the special price, was a right to purchase 1% of the outstanding issue drawn by lot each year that is the most that was afforded under that sinking fund redemption provision.
The second right was a right to use funds on deposit in three property funds.
And I would like to pass quickly over that although I will take time if it's necessary the right to put money in the three property fund was a contingent right.
It arose only if property was taken by eminent domain, if property was released formally from the indenture or if property was destroyed by a casualty.
This right to use funds and the property fund did not come into being until one of those contingencies occurred.
Now, in this case, we believe that the right of the issuers to use these funds to purchase 1% of the bonds on 30 days notice at the special call price, 1% drawn by lot did not establish for the entire issue for all the bonds an earlier call date.
We contend that when the statute refers to earlier call date, it means a date on which the bond is callable.
That the right of the issuer to call 1% drawn by lot doesn't permit a man who purchases 100 bonds to amortize the premium on the 100 bonds or man who purchase of 1000 or 10,000 just because the issuer if it elects an option, and we're not talking probabilities.
We faced the -- I see there --
Chief Justice Earl Warren: We'll recess now Mr. --
-- continue with your argument.
Mr. Stephen J. Pollak: Mr. Chief Justice, Section 125 provides for an amortizable bond premium deduction where the bond is subject to an earlier call date.
This is meant rich dividens for high bracket taxpayers.
In the example I mentioned before the recess of the $100 bond purchased at 120 and callable on 30 days at 105, the 80% tax bracket taxpayer obtains the deduction of $15 worth $12.
If he sells the bond at the end of the 30-day period, which he used for amortization, and he has offsetting short-term capital losses, he pays a tax of -- or what is the equivalent of $3.75, thus he has a tax profit on the 30-day purchase and sale of $8.25.
But of course, these transactions aren't engaged in -- in $100 amounts.
At issue in this case are two different taxpayers each of whom purchased a half a million dollars of bonds.
The limits of these deductions really knew no bounds, ingenuity afforded a double deduction, where taxpayers purchased bonds subject to call on 30 days notice, amortize them over the 30-day period, and then gave the bonds to charity.
Thus, again with the $100 bond purchased at 120, callable at 105, a taxpayer would borrow all but the $15 amount of the premium.
He would hold the bond 30 days and deduct the amortizable bond premium of $15.
Then, he would give the bond subject to indebtedness to charity and receive another deduction for his equity or for $15, so he'd get on the 30-day purchase and contribution to charity, he would get $30 of deduction worth to the 80% bracket taxpayer $24.
Of course, he'd also get the reward of feeling that he made the contribution to charity.
One of the cases in the courts, Evans involved the purchase of $2 million face amount of bonds at a premium of $200,000.
The bonds were subject to call on the 30 days.
The taxpayer invested $118,000 of his money, borrowed the rest.
He took the amortizable bond premium deduction, gave the bonds to charity and came out with some $200,000 or a little bit over of deductions for an investment, an out of pocket investment of $118,000.
Justice Potter Stewart: Well, absent the special call price, you don't question the absolute legality of all of these, do you?
Mr. Stephen J. Pollak: We -- we do not --
Justice Potter Stewart: And of the year 1953.
Mr. Stephen J. Pollak: We do not question the legality of the amortization to the general call date --
Justice Potter Stewart: I say absent the question of a special call price.
Mr. Stephen J. Pollak: That's right.
Justice Potter Stewart: So what -- what's the point of all this?
Mr. Stephen J. Pollak: The point of this Mr. Justice Stewart is that petitioners attempt to make these devices for deductions available were bonds are, in our judgment not subject to call.
We contend that the Commissioner or the facts and history show that the Commissioner accepted deduction to the general call date because all bonds were subject to call because for each bond, there was an ascertainable date where the issuer had the right to call the bond.
What petitioner seeks in this case is the extension of this right of deduction to a case where bonds are not subject to call.
And I want to make the point that --
Justice Potter Stewart: (Inaudible) -- well, I don't quite understand it.
We're talking now about different call price, not different call dates --
Mr. Stephen J. Pollak: Well --
Justice Potter Stewart: -- in this case, aren't we?
Mr. Stephen J. Pollak: Mr. Justice Stewart in our -- in our judgment, the price only becomes pertinent when the call date is identified.
In this case, the bonds were subject to call on 30 days notice at a general call price.
The indenture also provides that the issuer could use funds in the sinking fund if any --
Justice Potter Stewart: In certain other funds?
Mr. Stephen J. Pollak: In certain other funds, to purchase bonds drawn by lot --
Justice Potter Stewart: Yes.
Mr. Stephen J. Pollak: -- on 30 days notice at 102.
Justice Potter Stewart: At a different price.
Mr. Stephen J. Pollak: Yes.
And we contend that the issue present --
Justice Potter Stewart: But each on 30 days notice?
Mr. Stephen J. Pollak: That's right.
That the issue presented is whether the rights to purchase on 30 days notice at the special call price where a right to purchase at an earlier call date in being as to identified bonds.
Whether there was as to the bonds for which the redemption -- the amortization was claimed an earlier call date.
I -- I started to make the point that the Government is not contending that amortization to the special call price can be denied.
We are arguing about the timing of this, the petitioner seek to anticipate as to all their bonds a special call because the issuer has a right to redeem each year 1% or on contingencies some others and take that deduction in 30 days after purchase.
The Government's position is that where there is no -- that there is no earlier call date provide and that as to this special calls, the purchaser funds must wait until there is an actual call and then deduct the premium over the 30 days following the actual call.
The premium deduction is not denied once an actual call is made.
We contend that Congress did not afford the deduction as to all the bonds of an issue every 30 days merely because the issuer retain the right to call 1%.
Justice John M. Harlan: Are these special call provisions (Inuadible) -- unusual kinds of bonds?
Mr. Stephen J. Pollak: Mr. Justice Harlan, I do not believe that they are unusual in the public utility industry.
These were bonds issued by Appalachian and Arkansas Power & Light.
They have them and I seen indentures of Louisiana and several others that also had a special call provision and a general call provision.
There are many indentures and perhaps doing the financial policy book states that most bond indentures do not provide both special and the general call.
I -- I think that it is the other way for the public utility bonds.
The words of the statute to which upon the final analysis this question comes, provide that the amount of the bond premium shall be determine with reference to the basis of such bond.
And with reference to the amount payable on maturity or an earlier call date.
They are expressed -- Congress expressed itself in the singular, not in the plural or not in the averages or not in the probabilities.
We contend that the petitioners are required to establish under the law that the bond for which they claim amortization was subject to call.
They cannot and have not met that requirement.
They cannot show as to any bonds on which they claim the deduction to the special call price that those bonds were subject to call.
The statute further provides that the method of amortization must be reasonable.
We believe that Judge Friendly for the Second Circuit put to rest once and for all the petitioners' contention that they have adopted a reasonable method.
He said, "Taxpayers have cited no authority", and I'm quoting that, "It is sound accounting practice to provide within 30 days after acquiring a bond are reserved large enough to meet not only every risk of call that could eventuate during the amortization period but also one that could not."
We believe that it is patently unreasonable to claim amortization on 100,000 or 10,000 bonds because the issuer has a right to redeem 1% of them drawn by lot each year.
The statute was passed to remedy and inequity in the prior tax law where taxpayers who purchased bonds at a premium because the bonds carried a higher interest rate than that on the market, were required to recognize the full interest as income.
They were not able to amortize the premium against that income instead they were afforded in artificial capital loss on sale.
Of course, the 30-day amortization doesn't have any relation to interest income.
The petitioners don't pay the higher price because of the rate of interest.
They don't expect interest or at least buy them for that purpose.
They sell them after 30 days and at most received of small amount of interest.
However, the argument that this was not the purpose for which Congress enacted the statute was made in the Korell case was not successful and we don't rely on it although we do believe in it.
We believe that the 30-day amortization does not serve the purpose for which Congress enacted the law.
We believe conclusive, however, the words of the statute, the fact that Congress three times was confronted by interpretations of the law going beyond the sound accounting principles which led to its passage and three times amended the statute.
In fact, after the Korell decision, Congress was so certain of its position as to the purpose of this law that its Committee within 10 days had issued a report and an amended version of the law which amendment was enacted some two months later.
The claims of these petitioners are, we believe, unwarranted.
They made a deduction to the special call price and it was denied.
The deductions afforded them were respectively $64,000 and $27,000 under their right conceded by the Government in this case to make a deduction to a date on which the bond was callable, the general call date.
They contend that they are entitled to more respectively $18,000 and $20,000 because their bonds were subject to a right in the issuer each year to draw by lot and choose 1%.
We contend that that is not a date for earlier call as to any ascertainable bond.
We contend that the deduction claimed is unwarranted under the statute and that the Court of Appeals should be affirmed.