The opinion
Fay, J., dissenting: I respectfully disagree with the majority opinion of this Court. The majority held the amounts in question are not interest and further concluded even if these amounts are interest, the deduction is limited by sections 404(a)(5) and 404(d). I find the amounts in question are interest and are deductible as permitted by section 163, without limitation by sections 404(a)(5) or 404(d).
As the majority correctly pointed out (majority op. at 419), this Court severed the retroactive revocation issue, 1 holding a trial only with respect to the interest characterization and deductibility issues. At trial both parties expended substantial time and energy presenting evidence with regard to the interest issue, and at the trial’s conclusion, this case stood submitted. As trier of fact I found the amounts in question to be interest.
Upon further consideration, this Court decided to take evidence on the arbitrary retroactive revocation issue. I set the case for a second trial in Boise, Idaho. However, when the case was called from the calendar, petitioner conceded the arbitrary retroactive revocation issue. 2 This concession involved a substantial sum of money amounting to hundreds of thousands of dollars. Petitioner, in the presence of respondent, disclosed in great detail to the Court the reasons for conceding the revocation issue. The abandonment of that claim highlights the importance petitioner placed on obtaining a definitive determination on the interest characterization and deductibility issues. 3
Factually, the amounts deferred under the DCA’s must be interest. “[I]nterest is * * * paid because of delay in the receipt of funds.” Aames v. Commissioner, 94 T.C. 189, 193 (1990). Under the facts of the instant case, it is obvious the additional amounts accrued under the DCA’s were accrued because of delay in the receipt of funds. While I do not quarrel with the majority’s definition of interest, the majority’s finding the amounts are not interest is contrary to the facts of this case. 4
A common fact pattern is useful to illustrate this point.
B wants to purchase a piece of real property from S. The property has a value of $45,000. B cannot pay the full purchase price immediately. S and B enter into a contract on January 1, 1983. S agrees to transfer title and possession to B on February 1, 1983. B agrees to pay S $10,000 upon transfer of title plus $100,000 due in ten years. B and S agree the $100,000 is comprised of $35,000 towards the purchase price and $65,000 of interest (10.5% compounded daily).
This example is indistinguishable from the facts of the instant case. In the example, S transferred the real property to B, thus providing the consideration that gave rise to S’s immediate right to the delayed payment from B. In the instant case, the employees and directors transferred to petitioner their promises of services and their actual performances of services.
It is important to stress that, in both the example and the instant case, the seller (whether of realty or services) never had the right to current possession of the buyer’s funds. Yet the majority apparently would concede that there has been a forbearance in the example. There is the same forbearance in the instant case.
The majority’s discussion of constructive receipt (majority op. at 422) appears to be accurate, but it is quite irrelevant to the dispute before us. In neither the example nor in the case before us has there been constructive receipt; in both there has been forbearance that should lead to the conclusion that the disputed amounts are interest.
One final note on the interest issue, we find the majority’s reliance on Goldsmith v. United States, 218 Ct. Cl. 387 , 586 F.2d 810, 816 (1978), and Oates v. Commissioner, 18 T.C. 570 , 585 (1952), affd. 207 F.2d 711 (7th Cir. 1953), puzzling at best. Neither case involved the deduction side of the transaction and neither dealt with the interest element of deferral plans.
Having found the amounts in question are interest, the statute is clear: the deduction is not limited by sections 404(a)(5) and 404(d), and the majority offers no support for its contrary conclusions. In his concurring opinion, Judge Halpern argues that allowing an employer to deduct interest in advance of inclusion by employees frustrates the matching principle, but it is the prerogative of Congress, not this Court, to change the statutory result of section 404(a)(5).
Section 404(a)(5) limits deduction of only those amounts described under section 404(a). Sec. 1.404(a)-12(a), Income Tax Regs. Section 404(a)(5) in relevant part provides:
SEC. 404(a). General Rule.— * * * if compensation is paid or accrued on account of any employee under a plan deferring the receipt of such compensation, such * * * compensation shall not be deductible under section 162 (relating to trade or business expenses) or section 212 (relating to expenses for the production of income); but, if they satisfy the conditions of either of such sections, they shall be deductible under this section, subject, however, to [certain] limitations as to the amounts deductible in any year: * * *
By reading section 404(a) as prohibiting deductions otherwise permitted by section 163, the majority opinion effectively amends section 404(a) to read as follows:
if compensation is paid or accrued (or if interest or other earnings on such compensation is paid or accrued) on account of any employee under a plan deferring the receipt of such compensation, such * * * compensation shall not be deductible under section 162 (relating to trade or business expenses), section 163 (relating to interest expenses) or section 212 (relating to expenses for the production of income) * * *
Such judicial amendments of the statute are improper, ill-advised, and imprudent. “It is best, we may observe, where the laws are enacted upon right principles, that everything should, as far as possible, be determined absolutely by the laws, and as little as possible left to the discretion of the judges.” Aristotle (384-322 B.C.), The Rhetoric, bk. 1, ch. I (J.E. Welldon trans.). Moreover, such an amendment is contrary to regulations issued by the Secretary of the Treasury on the proper application of section 404(a). Section 1.404(a)-1(b), Income Tax Regs., summarizes the requirements for a deduction under 404(a) as follows:
Contributions may * * * be deducted under section 404(a) only to the extent that they are ordinary and necessary expenses during the taxable year in carrying on the trade or business or for the production of income and are compensation for personal services actually rendered. [Emphasis added.]
Based on these regulations, section 404(a) limits deduction of “only * * * compensation for personal services actually rendered.” The deferred amounts accruing under petitioner’s DCA’s are in part deferred compensation for personal services and in part interest. Therefore, petitioner may deduct the interest portion as it accrues under the DCA plan.
Further support for deductibility can be found in section 1.404(a)-12(b)(l), Income Tax Regs. That regulation concerns the application of section 404(a)(5) and provides as follows:
(b) Contributions made after August 1, 1969 — (1) In general. A deduction is allowable for a contribution paid after August 1, 1969, under section 404(a)(5) only in the taxable year of the employer in which or with which ends the taxable year of an employee in which an amount attributable to such contribution is includible in his gross income as compensation, and then only to the extent allowable under section 404(a). See sec. 1.404(a)-l. For example, if an employer A contributes $1,000 to the account of its employee E for its taxable (calendar) year 1977, but the amount in the account attributable to that contribution is not includible in E’s gross income until his taxable (calendar) year 1980 (at which time the includible amount is $1,150), A’s deduction for that contribution is $1,000 in 1980 (if allowable under section 404(a)).[ 5 ] [Emphasis added.]
Thus, in his own regulations, the Secretary of the Treasury applies section 404(a)(5) to limit only the $1,000 contribution for personal services. While the additional $150 is not specifically identified in the example, it is accepted practice for an employer to accrue interest with respect to compensation deferred under a DCA. 6 Implicitly, an accrual method employer may deduct the $150 interest component as that interest accrues.
In accordance with the foregoing, I would find the amounts in question are interest and are deductible under section 163, without limitation by sections 404(a)(5) and 404(d).
Chabot, Swift, Wright, and Wells, JJ., agree with this dissenting opinion. On June 14, 1982, petitioner submitted to respondent a request for a change in method of accounting (from cash to accrual) for the interest element of the DCA. On Aug. 26, 1983, respondent granted petitioner’s request for a change of accounting method. On Jan. 29, 1986, respondent revoked its letter granting approval of petitioner’s change of accounting method.
The parties presented no new evidence concerning the interest characterization and deductibility issues.
The extensive amicus brief filed by Northwest Mutual Insurance Co. highlights the importance other taxpayers place on these issues.
In recent years Congress has been attempting to identify hidden interest. See secs. 163, 467, 483, 1272, and 7872. To deny an interest element in this transaction would be to stand history on its head.
The Commissioner approved of this treatment in granting permission to petitioner to change his method of accounting. This permission was later retroactively revoked.
See also B. Bittker & L. Lokken, Federal Taxation of Income, Estates, and Gifts, par. 60.2.1, p. 60-11, (2d ed. 1989) “To reflect the time value of money, deferred compensation agreements often inflate the amount to be paid, either implicitly (by designating a sum larger than would be reasonable if the compensation were paid immediately) or explicitly (by crediting the employee’s account with interest at a specified annual rate). [Emphasis added]. See also N. Mancoff & D. Weiner, Nonqualified Deferred Compensation Arrangements, sec. 10.04 at 14-15, and sec. 10.09 at 30 (1987); Rev. Rul. 60-31, 1961- 1 C.B. 174 ; Rev. Rul. 69-650, 1969- 2 C.B. 106 ; and Rev. Rui. 71-419, 1971- 2 C.B. 220 .