Petition for Writ of Certiorari — French Line v. New Zealand Insurance

Supreme Court brief1963

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Office Supreme Court US

FILED

ee ee

NAR

JOHN F. DAVIS. CLERK

in the Supreme Court

«of the United States

~ OCTOBER TERM. 1962

t ’ >

}

AMOR. F. PIERCE and, IDA MAE PIERCE, PETITIONERS,

vq?

+ .

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2 : J

COMMISSIONER OF INTERNAL REVENUE

PETITION FOR A WRIT OF CERTIORARY TO THE

UNITED STATES COURT OF APPEALS FOR

THE NINTH CIRCUIT

9 :

e W. LEE McLANE, JR.

NOLA’ McLANE ~

THADDEUS ROJEK

27 North Country Club Drive |

Phoenix, Arizona ~

Counsel tor Petitioners

a“

SUBJECT INDEX

PAGE

Opinions below. ak ei Acen venrntreriaes Ser eZee l

Jurisdiction 0 2

Question ‘presented 2

Statutes involved Det on rer pe en ees Sauitapageneves

RMIT 5525 once t. REL Terie. Were mey

Reasons tor granung the writ eee ieee vero 7

— Conclusion ...........--...-- Peeener Sarre i)

Appendix ..:2........2.---- eer Asti PyS eee

; TABLE OF AUTHORITIES CITED

Cases: ; s

Buh! v. Kavanateby-l ls F. 2d 315 eee |

Commissioner v. Court Holding Co., 324 U.S. $31 11

Emmons v. Commissioner, 31 T.C. 26. . Meets F 4

Gilbert v. Commissioner, 248 F. 2d 399.» 45

Gregory v. Helvering, 293 U.S. 465 '& } 9,15

. Heller, Walter S. vy. Commissioner, 2 T.C. 371.......4.. 10

_ Higgins v. Smith, 308 U.S. i, aes ref

_ Knetsch v. United States, | .

364 US. 361... .......6, 7, 8,9, 10; IL, F2, 14, 15, 16

Krate Foods Co, v. Commissioner, 232 -F. 2d 118 10

Miller vy. Commissioner, 103 F. 2d 58... 10

Prairie O:l & Gas Co. v. Morter, 66 F. 2d 309 10

Stanton, L. Lee v. Commissioner, 34 TX: 1... >)

United States v. S. §. White Dental Mfg. Co..

274 US. 398... . 12

Weller v. Commissioner, 270 F.c2d 294 11

Staturgs: | :

Internai Revenue Code ot 195 F 6

Sectton 163(a) 2

= Section 264(a} (2) 2?

Miscellaneous: \

Blum. “Knetseh v. United States: A Pronountement

On Tax Avoidance,’ The Supreme Court

Review (1961) . 16

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En the Supreme Court -

nf the Muiten States

oe]

_ OcroBeR TERM, 1962

es tee ane eee

, AMOR F. PIERCE and IDA MAE PIERCE,

\ .. Petitioners,

v. : are

COMMISSIONER OF INTERNAL REVENUE

i _ Respondent.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS FOR -

; THE NINTH CIRCUIT

The Petitioners pray that a writ of certiorar® issue to review

the judgment of the United States Court of Appeals tor the

Ninth Circuit entered in the above-entitled case on December

98,1962. :

OPINIONS BELOW

The findings of fact and opinion of the Tax Court of the

United States are reported. at 47 T.C. 1039. (R. 36.3 The

opinion of the Court ct Appeals is reported at 411 F. 2d 89-1.

_ (Appendix, mfra: R. 1-43.) :

2 ee

JURISDICTION

' The Judgffient of the Court of Appeals was entered on De-

cember 28, 1962. (Appendix, infra; R. 145.) The jurisdiction

of this Court is invoked under 28 U.S.C. 1254.

QUESTION PRESENTED

- Whether the court below could properly refuse to rule on +

the question before it of whether $220,140 of net cash value

in annuity contracts with a face value of $600,000 was suf-

ficient to appreciably affect the: petitioners’ beneficial interests -

so as to qualify the transaction as an “annuity arrangement with

nontax substance” within the meaning of Knetich v. United

States, 364 U. S. 361. :

_ STATUTES*INVOLVED BA

Internal Revenue Code of 195-4:

“Section 163. INTEREST ye

{ (a) General Rule.-—There shalf‘be allowed as a deduction

\¥ all interest paid or accrued within the taxable year on indebt-

_ edness.”

4 Section’ 264. CERTAIN AMOUNTS PAID IN CON-

~ NECTION WITH INSURANCE CONTRACTS.

(a) General Rule. —No deduction shall be allowed for-

* * #* ;

ect (23 Any amount paid or accrued on indebtedness in- :

curred%r continued to purchase or carry a single premium

life insurance, endowment,. of annuity. contract. Para-

graph (2) shall apply in respect of annuity*contracts only os

° as to contracts purchased after March 1, 195+4.”

STATEMENT ° 5 we

_ The controversy involves the proper determination of pe- Ps

titioners’ Liability for federal income taxes for the calendar »

8 year 1954. a a

a , ee ;

’

8 3

~*~

”

On December 13, 1954, Amor F. Pierce. hereinatrer referred

to as petitioner, applied to the All Service Lite Insurance Corpo-

ration, Phoenix, Arizona hereinafter reterred to as All Service,

for six (6) retirement. annuity contracts. The consideration

specified for each contract was $100,000, pay able in six annual

installments of $16,666.67 each, or a total consideration tor the

six contracts of) $100,000. As payment of the first annual con--

sideration of $100,000 All Service, on December 13, 1954,

_ gaccepted petitioner's 6° demand promissory note in the face’

amount of $100,000. (R. 12, 37, Exs. 1-A, 2-B, 3-C).

Ail Servic®, on December 13, 1954, accepted petitioner's ap-

plication and issued to him six (6) retirement annuity contracts,

dated December 1, 195-4. Petitioner's daughter, ten years of age

at the time, was designated as the annuitant in three of the con- _

tracts.and petitioner’ ‘'gson, one year of age at the time, was desig, *

nated as the annuitant in the other three contracts. Each of the

contracts provided therein that the maturity dates of the con-

tracts may be accelerated at any time by option of the owner

_and annuitant. er, is — as the Owner of each of °

the six contracts. (R. 4, 37, 38; Ex. 4-D»

On December 13, 195 i, All Service agreed to and did loan

_ petitioner $117,441 pursuant to the terms of six contract loan

agreements executed by him, each in the amount of $19, 573.50.

As sole collateral security tg@ said loans the petitioner assigned to:

All Service the six annuity, contfacts. None of /said loans were

non-recourse in nature. The contracts prov iged that all or’ any.

part of the loans might be repaid at any time while the contracts

were in force and that the interest rate on the loans Was & guar:

anteed rate. (R. 412, 38;*Exs. 4-D, 5-E, 7G).

All Service, purs:.ant to petitioner's instructions, applied

$100,000g0f the ¢ oceeds of the lean to the payment of the

demand promissory note which petitioner had delivered in pay:

“ment of the first annual consideration and, on December 28.

* 1954, delivered its.check in.the amount of $1754 11> Sepapeent-

‘ ing the balanv®e of the : loan proceeds to the Farmers and Stock-

mens Bank, Phoenix, ‘Arizona for credit to petitioner's account

therein. (R. 13, 38; Ex\7-G). *

On December 28, 1954, petitioner paid to All Service the

sum of $24,718 as interest on the loaf of $1 17,4 41 for six (6)

years in advance at the rate\of 3.75°C per annum, with interest

paid for more than one year tn advance discounted at the rate of

2.75% per annum, monary annually. (R. 13, 39, Exs.

9-I, 10-J). On their joint federal income tax return for the cal-

endar year 1954 petitioners claimed a deduction in the amount

of $24,718 as interest paid to Alll Service. Said deduction was

disallowed by the Commissioner of Internal Rev enue. (R. A 4,

40; Ex. 1-A).

In each of. the following five years (1935 through 1959) ©

additional new loans were made by petitioner with the annuity

contracts being assigned as the sole collateral] security therefor |

and $100,000 of the proceeds of said contract loans was applied

each fear either to the payment of promissory notes which had

been tendered in payment of the annual consideration then due

or directly to the payment, of the annual consideration then due.

The remaining balance of the.loan proceeds was delivered to the

petitioner or his bank for credit to his account therein. In each

of the years fram 1955 through 1959 petitioner paid interest on

the then existing indebtedness for one ‘additional year in advance

and on the newly created indebtedness for five or six years in

advance. As of the end of the year, 1959, the total outstanding

indebtedness created by the foregoing-described transaction was

$794,702.04. (R. 15-31, 40; Exs. 11-K through 39-MM in-

clusive, Ex. 43). »

In December,1960, an additional new loan in the amount of ,

$20,202 was made, with the annuity. contracts being assigned

_ as the sole collateral security therefor. Consequently, the total

outstanding indebtedness secured by the six annuity contracts as

of the end of the year 1960 was $754,904.0-4. As of the same

Air >

time, interest on the then outstanding indebtedness had been

paid by petitioner through and to December 1, 1965. (R. 32,

33, 41; Exs. 40-NN, 41-OO, 43). :

In response to an inquiry, initiated by him, petitioner was ad-

vised by All Service that it would be possible for him, upon his

election to do so, to convert the annuity Contracts into retirement

annuities for himself. (R, 133).

Qn February 29, 1961, All Service received from petitioner a

” check drawn on the account of [Investors StockFund payable to

the order ot petitionersand properly endorsed to All Service in

the amount of $132,596.11,.On February 23, 1961, All Service

received from petitic ner axproperly, endorsed, cashier's check in

the amount of $34,360.19. All Service, pursuant to- petitioner's

instructions, applied these remittances totaling $166,956.30 to

the partial repayment of the existing indebtedness secured by the

six annuity contracts, thereby oreducing said ‘indebtedness to

$587,947.74. As a result of this reduction of indebtedness

$39,767, of the previously prepaid interest became refundable

- and was likewise applied to the-repayment of the outstanding

_ sindebtedness, reducing it still-further to $548,180.74, CR. 43).

On March 28, 1961, All Service received from petitiofier a

* properly endorsed cashier’s chetk in the amount of $23,663.77,

which remittance was’ applied to the partial repayment of the

then existing indebtedness, reducing it thereby to $524,516.97.

As a result of this reduction in indebtedness, $3,955 of the pre-

viously prepaid interest became refundable and was applied to

the further repayment of the then existing indebtedness, théte-

4) reducing the indebtedness to $520,561.97. CR. 13).5

As of the date of trial, July 6, 1961, the outstanding indebt- .

edness secured by the annuity contracts was) approximately

$520,562 and the net cash value of the stx annuity contracts Was

$220,140.00, (R. 44). |

Sometime during the period February 20, i901 ta March 25,

1961 the-annual increase in the net cash value of the annuity

contracts began to exceed the anntual interest charges on the

indebtedness secured by the centracts. (R. 44).

Ac the trial the*profit, pqtential of the annuity contracts was

demonstrated and the Tax Court accordingly tound as. tact:

(a) If the remaining indebtedness secured by the annuity

contracts were ‘repaid by the application thereto of a part of the

cash surrender value of the six annuity contracts ahd, the remain-

ing net reserve vdlue of $220,060 allowed to sccymulace, to

maturity in accordance with thie terms of the contracts, a month-

ly @nriuity would be payable to petitioner's son at his age 65 in

the-amount of $3,176.89 for the remaindersof his life with ten

years’ payments guaranteed and a similarly guaranteed monthly -

annuity would be payable to petitioner's daughter at her age 45

in the amount-of $2,220.23. If the optional retirement benefit

of a monthly annuity for ten years certain were exercised at

maturity, petirioner’s son would receive a monthly 2.anuity of

| $4,828.45 and petitioner's daughter would receive a monthly

annuity of $3,782.43. Under such option, the net profit, from

the annuity gransaction would approximate $780,750.00.

J a

(b) It petitioner makes no further payments in reduction of

the indebtedness secured by the annuity contracts, but does pay’

one year of interest in advance each year hereafter through the

year 1975 and thereafter lets the prepaid interest earn itself out

through December |, 1980, the net cumulative earnings of the

contracts will exceed their net cumulative cost sometime during

the period December |, 1967 to December |, 1968, and the net

profit trom the annuity transaction as of the year 1980 will ap-

proximate $1 34,353.00. aa -, a

the indebtedness secured by the annuity contracts, allows thé

prepaid intetest to earn itself out through*December 1, 1965,

and’ theréatter makes a payment of enc year_ot interest in ad-

vatice tach year throuyit December |. 1979, the nettumularive

earnings of the contracts will exceed their net cumulative dest

- o

. a

Sometime during the, period December 1, 1968, to December Is

- 1969, and the net profit trom the annuity transactions as ot the

year 1980 will approximate $108,268.00. (R. 44, 45).

Nonetheless, the Tax Court held that the Commissioner's: ‘dis-

allowance of petitoners: Claimed interest deduction was not in

error tor thereason that "there was the same lack ot substance in

petitioners’ purported annuity purchases, koans and d ipterest pay-

ments as was found.in Knetseh.” (Knetsch v. U inittd States, 30-4

U.S. 361. ) (R. 46), The Tax C outt s decision -was aftirmed by

the Coure of ae (R. 1. 13): . " ;

REASONS. FOR GRANTING THE WRIT

In Knetsch v: United States. 36-4 U.S. 361, this Court denied

an interest deduction to the purchaser of $41,00Q,000 of single

premium annuities: Why’ Because, said the opinign, the dis-

puted annuity transaction was a sham and.tiction. Why? Be-

cause, the opinion went on, the “nef cas valuc had been kept

at the relative pittance of $1,000", and ’ ‘therefore Knetel's

transaction" did not appr¢ciably aftect his beneficial interest ex-

cept to reduce his tax . .” :

‘

On the other hand, in the instant case, the petitioner -pur-

chased only $600,000 of annuity contracts which had a net cash

value of $220,140 at the ume of trial and appeal. This net.cash

value ot $220, [40 sel exists. Yer the Court below disallowed

the interest deduction paid on the annuity transaction in 195-4.

How, and on what authority’ r

It did so by first c6ncluding thac the instant case was control-

led by Knetsch v. United States. supri. and retusing to rule on

'The Court was careful to po:ne out that) “There may well be single

rémiu i) annuity arrangements with nontax ‘substance which Create an

indebtedness for the purposes of § %3 (b) of the 1939 Code and

$03 (a) of the 1964 Code. Bur this one ts a sham.” (464 U.S. at

300.) “ 4

The Tax fart determined thar die instant case ts controlied by the

case of Knetsch v. United States, 404 US. 361 (1960). We agree” ~

(311 F. 2d 895, Emphasis supplicd.)* Gas % as to whether Kuetsc/

e- . 2

- the question of whether $220,140 was a sufticient net cash

valuc® in. $600,000 worth of annuitics to quality the trans-

actions, as this Court said, as “annuity arrangements with nontax

substance.” This ‘retusal to rule was based on the following

language:

;

iter the decision of the Supreme Court in Knetsch and

while the case was pending betore the Tax Court, the taxpayer

decided to fut ‘some substance’ into the transaction, by in-

creasing his payments ‘to All Service. Weagree with the Tax

Court that ‘such payments, obviously made with a view to—

influencing the outcome of this very case, can-hardly impart

4retroactive vitality to a transaction. that Jacked substance in

1954." (P. 896.)

In other words, atter this Court in Knetsc/* S Riied States,

supra, told all taxpayers that the “net cash value” in such an-

nuities must be sufficient to “appreciably” affect their beneficial

imterest and petitioner complied by increasing his “net cash

“value” in $600,000 of annuities to $220,140, the Court below

held that it did not make any difference. Why nat?

Because the Court below ruled either (1) that nothing done

after the taxable year (1954) could give “retroactive vitality”

to a transaction which # said lacked substance in 198 ior (2)

- -

is in fact controlling. in Kvetycr the annuity loans. were non-re-

course, here they were wot. Knetsch had to live to age 90 to collect

an anaquity; here the maturity dare of any’or all of the annuity contracts

could be accelerated at any time by the taxpayer. Knetsch’s contracts

had been terminated and by reason thereof was seen that he never

had more than $1,000 of “net cash value” im the contracts as com-

_ pared to $4,307.000 of indebtedness as of he late of surrender, here

. the contracts are still in force and, as of dpe dare of trial, the “net cash

value thereof was $220,409 as compared®to $520,562 of indebtedness

secured thereby.,In Kmetsc the annual interest on the loan at all times

exceeded the accumulation on the annuittes, here, beginning in 1961

and prior to trial, the annual interest charges: are exceeded by the

annual accumulation on the annuities, resulting in an annual net profit

Knetsch's initial outiay was never recouped, here petitioner s initial

outlay or cost will be completely recouped by 1967 when the net

cumulative earning will exceed the net cumulative cost of the annuities

™~

- is disallowed. Cm

that petitioner's motive in 1961 was “bad” when he paid ott

a sufficient amount in loans to put $220,140 of “net cash’valuc”

into $600,000 of annuities. In either event, the Court below

was wrong. a

wy : o-

It ac ruled as it did-because of petitioner's motive,’ then it

acted contra to this Court's opinionat both Knetse/ 1. United

States, supra, and Gregory v. Helve¥ing. 293 U.S. 465, 469. In

Kanvtsch, supra, the opinion stated:

“We put. aside a finding by. the District Court that

Knetsch's only motive in purchasing these 10 bonds was to

attempt to secure an interest deduction. As was said in

Gregory v. Helrvering, 293 U.S. 465,469: ‘The legal right ot

a taxpayer to decrease the amount of what otherwise would

be his taxes, or @lrogether avoid them, by mgans which the

Jaw permuts, agmnot be doubted . . .”

Thus, it the Court below retused to rule on whether $220,140

of “net cash value” in annuitigs totaling $600,000 was sut-

ficient to appreciably attect petitioner's beneticial interest be-

cause of his motive in putting the $220,140 of net cash valuc

into the annuities,’ then it has violated AKuetsch. supra. and

~ Gregor) v. Helvering, supra. Certainly a retusal to answer the

question of what constitutes a sufficient “net cash value” be-

cause of the taxpayer's motive 1s the same as holding that where

taxpayer's motive is to avoid taxes the claimed interest deduction

‘There is a strong indication that the Coure below ruled as it did -be-

use of a motive of which it disapproved. This 1s shown by the

language in the opinion staung. “We agree wigh the Tax Court that

‘such paymertts obvionsiy) made with av tren ty imtivencine the out

come of this case, can hardly impart retroactive vitality to 4 transacuon

that lacked substance in 1954.4 j

“It should be nored that the record in the Tax Court ts totally déveid ot

any evidence, much less substantial evidence. to. support the statements

ot the Court below respecting pétiuoners reasons tor purting the

$220,140 of “net cash valuc” in the annuities. That is why the (Sur

below torctd to use the term “obviously.

10 mt

Furthermore, the comment of the Court, below that the “net

cash value” was put into the annuities atter this Court's decision

in Knetsch, supra, is — out of place. In Kraft Foods Co. 7.

Commissioner, C.A. 2, 1956, 232 F. 2d 1f8, the Court held

* hat where the transaction attacked had heen entered into by

-entities that'could not be characterized as sham entities and had

engaged in acts which affected their respective legal relations,

“the transaction should not be disregarded merely because the

transaction was entered into in response to a change in govern-

ing tax law,” In so holding, the Court noted (at téotnote 19;

that:

‘

“There is no doctrine that taxpayers cannot adjust their

affairs in response to a change in the tax laws’ so as to reduce

taxes. Indeed, the structure of the tax law deliberately recog-

‘mizes tax-conscious motivations and seeks both to encourage

them (e.g., rapid amortization of defense facilities, $ $ 12.4,

124A, and charitable deduction for gifts of appreciated prop-

erty) ard to discourage them (¢.x., surtax on unreasonable

accumulation of surpluses, ® 102, and provisions in $ $ 24

and 45 relating to transactions Between related ‘taxpayers )

o> QP. E28.) ss

Theretore, regardless.of what petitioner's motive was when he

placed $220,140 of*"net cash value” in the annuities, it is 1r-

relevant. sg

€

Conversely, if the Court below retused to rule on the issue ot

‘whether $220,140 in “net cask, valuey appreciably aftected

petitioner's beneficial interest on the ground that nothing which

ocgurs after the taxable year involved (195-1) can be viewed,

even though the annuity transaction is a continuing onc, then

it. contravened not only Knetseh +. U nited States, supra. but the

well established doctrine of tax law that “for income tax pur-

poses the component steps of a single transaction are not to be

treated separately.” Miller v. Commusstoner. C.A. 6, 1939, 103

F. 2d 58, 59; Pratrte Oil & Gas Co. v. Motter, C.A. 10, 1933,

66 F. 2d 309, 311; Walter S. Heller +. Commissioner. 2 T. C.

”

371, 381, aff'd. 47 F.2d 376, cert. den. 325 U.S. 868. Stated

in another tashion, the rul® is chat where the incidence ot tax-

ation depends upon the substance of acransacuon .... the trans

acuon must be viewed as a whole.” Commusssaner t. Court

Holding Company, 324 U.S. 331, 334 Furermore, the rule

has been interpreted to meagathat the principle that one trans-

action may not be broken up io various elements to avoid a

tax is not a single, but a double edged sword, as it also may not

be broken into various,clements to create a tax.’ Bad! 1. Kava

nauch, C.A. 6, 1941, LES FE. 2d 315, 320.

1 he ' :

Nor is the rule limited to corporate reorganizations where it,.<

originated, bur includes the arca of the disputed annuity transs

actions. Thus, in Weller 2. Commusstoner, CLA. 3, 1959, 2708 5% eB

F. 2d 294, 297, the Court held that the > Substingy ot the énnk

transaction must be viewed.” And this Court itself in Awetses: :

U'mited States. supra, looked at all ot the vears ot the annuity

transactions including 1955 and 1956 even though the tax-

able vears involved were 1955 and 195 4, and rested its decision

denyins the interest deduction on the tact that Knetsch’s “an-

nual dorrewings kept the nec cash valuc, on which any annuity

of insurance payments would depend, at the relative pittance of

$1,000." In tact, this Court, in tootnote +. resected Kanétschs

contention that the annuities bad non-tax cconomn substance ’

since in 10 years the net cash valuc would exceed the intetest

paid in because of the wholly unlikely assumption that Knetsch

would have paid oft im cash the ormine! $1,000,060 loan.” In

short, the majority Opinion in Kyetic/ examined the annuity

transaction as a whole. and did not retuse to look bevond the ~

taxable years involved, 1953 and 195): :

Consequently, the Court below cannot retuse to apply the

* In the instante case, and i ali’ 1. cases ke at. both the Gsovernment

and the Courts have disallowed the clammed interest deduction on the

authoriwy of the doctrine thar substance controls over torn _p huss

its hardly possible at this stage tor the Government to contend other

WISe. ;'

+ Si

iz ¢

bs a

rule announced in Knetsch v. United States, supra. whilevat the

same time claiming that its decision .rests upon the Knetsch

case. Aside from the prohibition set torth in the authorities cited

above, it is only necessary to test what the Court below has done

by looking at the other side of the coin. Suppose that a taxpayer

had purchased $600,000 of annuities on Decerfber 15, 1954

and at that time made payrpents sufficient to retlect a net cash

value” therein in the amount of $220,140 and thereafter, on

either January 15, 1955 or in February ot 1961, borrowed back

all but $1,000 of the net cash value. Could the Court below,

y undes the applicable law requiring that ‘the transactson be

viewed as a whole, rule in favor ot the taxpayer on the ground

that nothing which occurred after 1954 could “mppart™ retro-

active lack of substance to a transaction which had substance in

195727 The answer is not only a negative one, bur it ts obvious

that the Court below would not even attempt to invoke such a

dogtrine. Instead, it has refused to apply ‘che transaction must be

Viewed as a whole” doctrine here because, if applied here, the

“taxpayer, father than the Government, would be the beneticiary.

The accuracy @f this conclusion 1s clearly shown by language

from Tax, Court ofinions dealing with the subject annuity trans-

actions. “5

J In Emmons 2. Commassioner. 31 T.C. 26 (1958), in ieview

ing one of the instant annuity intefest deduction cases. the Tax

Court ruled that:

« “Interest deductions will be allowed respecting rhe subject annuity

transactions re the net cash value ts suffwsent to appreciably atfect

the taxpayer s beneficial interest

TIn‘a similar vein, if. under the facts of this case. the issue raised was

whether the taxpayers ‘are entitled to a deduction for the “economic

loss’ which the Court has held was susta:ned,.n 1954, would the Court

in that event, examine all or merely part of the transaction to deter

mine whether the claimed Joss had been realized’ Or would the Court

consider itself bound by the rule that for income tax purposes whether

a transaction has the effect of producing a loss may not be determined

by viéwing only a portion of the tfansaction’ Hager: + Smsth, 308

US 473, 475. Unsted States : SS White Dental Mtg. Co. 274 US

598 : ‘

, -

* 13

. ° ‘ °

At the time ts praceding Was heard, thie alicged loan

had not be repaid. (pp. 28.) ¢

4 t a

Then it went on to state that.

Wie triadoit tar PMT Md ei that the alle; ved loan

has not been repard. op. 7S. Emphasis supplied. +

Howes cr, in the instant case. the Tax Court said

The purported loam repayments made to All Service carly

in }O61——more than six years after tho tunable vear here mm’

issuc. only a tew, months after the Supreme Court has de-

Clared the Knetdth transacuon 4 sham, and less than six

months betore ihe trial hereine—are in ne ba) agoeer isive ot

the economic reality of the transaction presently under con-

; sideration. Such payments. o/c roa @made with a view to

influencing the Outcome.of this very Gise, can hardly impart

retroactive Vitality to a transaction that was 4 sham in 1954.

It these 1UGL payments have any significance for our INqUITY,

they merely underscore the ahse me of 4 comparab vie Invest--

ment in the annuity transaction in 19540 (Emphasis sup-

plied. }

In other words, as tar as the Court below and the Tax Court are

concerned, the taxpaver loses whether the com comes up head or

tails. It the loan has not heen repaid at the time of trial. that

tact. will be deemed sivnitiant and support 4 tinding that the

transaction is a sh tam Gonversely, if the taxpaver doagrepay

the loan prior to trial, tet tact cannot impart retroactive Vr

tality toa transaction thet ac‘ sharon 1054. > and will sup-

porta conclusion that suc repayment -merels proves there was

no substance to the transaction in 1954 9

Is it possible tor tne language of the Court below amd the

‘Tax Court to spell put more « learly that tee taxpayer is damned

if he Goes not and damage! it be does.” and that the Governmeng

is bein: accorded a preterred status in the applicanon ot the

“the Court is asked to notnwe that the phrase Was a sham in 1954

assumes the result te the very issue betere the Coys helow. 76... 35

$220.140 a suftiment “net cash value to remove Une transaction trom

tit “sham and tation category

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legal principle that where the incidence of taxation depends up-

on the substance of a transaction the transaction must be viewed

as a whole?

In the instant case the petitioner did exactly what this Court

held was required if an annuity transaction was not to be treated

as a sham and a fiction. Within a few months after Knetsch t.

United States, supra, was decided, he increased the net cash value

to $220,140 out of a total face value of $600,000 1n annuities

by repaying with large amounts of cash about one-third of the

outstanding loans. If this does not make any ditferencgand will

riot even be considered by the Court below, except to prove

time to review Knetsch v. United States. supra, and telling tax-

payers what must be done for such annuity transactions to quali-

fy for interest deductions? Surely it was not to sender and

| ad hoc decision against Knetsch. That result could have been

reached. simply by refusing to grant certiorari. In short, why

should petitioner not be entitled to a ruling on whether or not

$220,149 in net cash value out of $600,000 in annuities 1s a

sufficient “net cash value” to appreciably affect his beneficial

interest, unless the real rule ot law being applied in these cases

is, just as the Government orally argued in K netich, that where

a taxpayer's motive is to avoid taxes, no interése* deduction Is

allowéd?” If that is the dogtrine which is in fact being applied,

then it should e-announced so that counsel tor taxpayers can

intelligently advise taxpayers whether to continue lingating

“these cases.” As it is, the state of the law respecting the doc-

ed . Ss

* That it is. is clearly shown by the lengths to which the Court below

had to go in order to avoid facing the issue of wherher the $220.140

is a sufficient “net cash value” to appreciably affect petuioner s inter:

est. .

' At the present time there are many Casts pending betore the Appel-

jate Division ot the Internal Revenue Service, and the lower courts,

on which action has been stayed pending disposition of the instan:

case with the ous that a Tule enunciated therein will expedite the

‘disposition of the‘said pending cases.

° 15 ws . ’

aa ot “substance dver torm” 1s hopelessly comtused insotar as

the subject. annuity sransactions are concerned.’ Presently the

lower courts are paying lip service to the doctrine that motuve

'! For example. the tower courts decision herein thar the transaction

must be disregarded tur tax: purports becuse the taxpayers bene-

ficial interests were not apprectably attected since “tke investment

7 °

gp resulted in a net cconomic joss to the taxpayer reflects confusion as

to the meaning and application et dy: “economic reality doctrine.

That confusion, peritioncrs submit. results from a misreading of not

only the Kyeiso) opines bur also the dissenting op nion of Judge

Learned Hand in Ga he Be. Covumimoner, 248 F. 2d 499, Al l. relied ¢

on by this Court in the Kuerc come Ir is truc that Judge Hand in

the Galbert case said “

It the taxpayer enters mito a transaction that does not ap-

preciably attect hits beneticial interest exept to reduce his tax, the

law will disregard it, for we cannot suppose that it Was part of the

purpose of the acr to prov ide an escape from the liabihaes thac ie.

2 sought to impose. Gregory ¢ Hels ering

2 However, in ox winding on the Greo™® docrrine. Judge Hand

JUG

added immediately atter the above quoted language the following

When a taxpayer supposes that the transaction, i addition to. ,

its effect on bis gx will promote his boneficral interests in the

venture, he will oF eourse secure the desired reduction, for it would

be absurd to hold thar he must deny himself an economic advantage

unless he pay the tax based upon the facts that have ceased to EXIst

corer, he all also be ve leored fh he suppors that the trans

-acipm will, on may. otc’ hom a less, although in that eveng it ts

true that his only motive will by to avon Yh tax * The Gregory

doctrine) covers only those transactigs thar do mot appreciably

change the taxpayer s position, «2/7764 benefrcralsy or derrmentalls”

-( Emphasis supplied).

: 2 v2)

Thus. under the, cconomic rent) doctrine a transaction in whichy a

tas has been deliberatciy Suffered tovobrain a tax advantage may. not

on that account be disregar fed. See Lo Lew Stamton. 44 TC. 1 i900)

in which it was held that the taxpayer Was ent ‘led te the clamed

interest deduction despre the fin fing chor asidgtrom the tax conse

quences the transaction would result in 4 toss. Consider further. the

examples of (1) 4 vite at apprectited seccuriries to a charitable or-

ganization motivated by the face that the lonor rs in pocket moge

atter taxes than if he fad sold the assets and kept the proceeds,

and (2) a sale or pledge of, taxable se urittes . nJ investment of the

proceeds IN TaAX-CKEMPt secur. ties where the cransaction makes e¢co-

nomic sense only because of the mx trertment of the income from

the latter. S:

16 °

must be set aside in applying the “substance over form” rule,

- and then immediately proceed to rule against taxpaycrs because

of their motive.

In addition, as pointed ouy by Professor Walter J. Blum of

the University of Chicago Law School in an article entitled

“Knetsch v. United States: A Pronouncement On Tax Avoid-

ance,” The Supreme Court Review ( 1961) at pp. 135 et seq.,

despye this Court's ruling in the Knetsch case, there remains

a great deal of uncertainty and confusion.on the part of the

trial and appellate courts in the application of the “altered bene-

ficial interests” test and, therefore,*a need for further guidel!

exists. Professor Blum’s prophesy. that “almost certainly

i a doubt will arise over what quantum of commercial sub-

stance or effect on beneficial interests Is required” has come to

pass. In the instant case both the‘trial and the appellate courts

were in such doubt as to how much a taxpayer's interests must

be altered before an annuity transaction will be held to have

“commercial substance” that they each, in turn refused to rule

on the question of whether $220,140 of net cash value in

$600,000 of annuities is sufficient net cash value to “appreci-

ably” affect the petitioners: beneficial interest. They refused to

so rule even though, in the posture in which the case came be-

fore them, that was the only issue to be decided. Thus, the in-

stant case points up, in the strongest manner possible, the need

for further pronouncements in this area of tax law and, thus,

provides the Court with an opportunity for supplying .the

needed guidelines. ;

17 ° :

CONCLUSION

° . ‘ ° %

For the foregoing reasons, this peation for a writ of certiorari

should be granted.

s ¢

. Respecttully submitted,

’

; 3 W. LEE McLANE, JR.

: rs NOLA McLANE .

THADDEUS ROJEK

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19 -

: APPENDIX

€ UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

i} :

——

ARMOR F. PIERCE AND IDA-MAE PIERCE,

» g ‘ .

as Petitioners.

VS. ve ni No. 17,951

y Dec. 28, 1962

COMMISSIONE ROP INTERNAL REVENUE,

Respondent.

@ ’

Petition to Review a Decision of the

Tax Court of the United States.

Before: ORR, MERRILL and DUNIWAY, Circuit Judges.~

PER CURIAM:

The question presented is whether deductions from gross 1n-

come claimed on petitioners’ federal joint income tax return tor

che calendar year 1954 for pafTenes made by them to the All

Service Life Insurance Corporation. ot Phoenix, Arizona consti-

tuted “interest paid on indebtedness” within the meaning ot *sec-

tion 163(a) of the Internal Revenue Code of 1954. The stipu-

lated facts of the case are set out in the’ Tax Court's opinion. 37

TC. 1039. | ay: |

by the case of Knetsch v. United States, 3614 U.S. 361 (1960).

We agree. The transaction involved in the instant case, as.in

Knetsch, lacked economic. signiticance. There was nothing ot

substance realized by the taxpayer beyond tax deductions. See

Kaye v. Conjmissioner, 287 F.2d 40 (Oth Cir. 1961). in Asoth

the present case and Knetsch, taxpayers purchased from an in-

surance company long. term deterred annuity contracts of large

denominations, executed notes secured only by the annuity con-

tracts, promised to pay interest in advance, and promptly bor-

rowed back the iricrease in the value of the — resulting

- ftom the advance payment of interest.

' Acthe end of the taxable year in question, 195.4, the net cash

_-alue of the six annuity contracts was $5,520. Taxpayer's out-

of-pocket cost of these contracts was $7,277. Without consider-

‘ing the alleged interest deduction of $24,718, the investment

resulted in a net economic loss to the taxpayerof $1,757. Tax-

—~payer's net economic loss from 1954 through 1960 was

$31,058. His transaction with All Service did not, therefore,

“appreciably affect his beneficial iaterest except to reduce his

tax.” Knetsch v. United States, supra at 366 (quoting from dis-

senting opinion in Gilbert.v. Commissioner, 248 F. 2d 399, 411 .

“(2d Cir. 1957)). Because the underlying transaction lacked "

commercial substance, an indebtedness within™ thé meaning of

‘section 1634) was not created. ;

. After the decision of the Supreme Court in Knetsch-and while

the case was pending before the Tax Court, the taxpayer decided

to put “some substance” into the transaction by. increasing his

payments to All Service. We agree with the Tax Court that

“such payments, obviously made with a view to influencing the

* outcome of this very case, can hardly impart retroactive vitality

to a transaction” that lacked substance in 1954. 37 T.C. at 1045.

Under the agreement, taxpayer had an election whether to put

- in more money or not. The case would be different and the re-

sult might be different if he were obligated to increase his pay-

ments in 1961.

Affirmed.

(Endorsed) Per Curiam Opinion Filed Dec. 28, 196%

Frank H. Schmid, Clerk.

"21

& UNITED STATES COURT OF APPEALS:

' FOR THE NINTH CIRCUIT

a - 4 ian . = — — * a

AMOR F. PIERCE, and IDA MAE PIERCE,

° Petitioncrs, :

Vv. : No. 17.951

COMMISSIONER OF 4NTERNAL JUDGMENT

REVENUE, ;

Respondent.

ae Sense ers <_ ; 4

s E .

Upon Petition to Review a Devision ot The Tax Court ot,

the United States,

This Cause came on to be heard on the Transcript of the

Record from The Tax Court of the United States, and was duly

submitted. j

he , -

On Consideration Whereot, it is now here ordered and

adjudged by this Court, that the Decision of the said Tax Court

of the United States in this Cause be, and hereby is affirmed.

Filed and entered, December 28, 1962.

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.