Petition for Writ of Certiorari — Ballagh v. United States

ates) 7 : vy SS CHtice Supreme Court, US

ee FAILED. ~

| Ga os “AUG 6 1964

IN THE _ JOHN F. DAVIS, CLERK |

_ Supreme Court of the United States

October Term, 1964.

2

No. 354

9

- THOMAS C. BALLAGH and VERA REED BALLAGH,

Petitioners,

v.

THE UNITED STATES OF AMERICA,

. Respondent.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF CLAIMS.

Water B. Gippons,

Frank J. Eustace, JR.,

1242 Fidelity-Philadelpbia Trust Bldg.,

123 S. Broad Street,

Philadelphia, Pa. 19109, | ‘

Counsel for Petitiomers.

‘International, 711 So 50th St, Bhila, Pa. 19143

be

INDEX.

Citation To Opinion BELow ..... PE EArt een pet

JURISDICTION Me) eS Pan ea ae Cae hee ee OREN Se

QUESTION PRESENTED Weel suigaet acne ken cas euacaaewaeuesy

STATUTES INVOLVED ....c-cceccecccecceccersneeesseress :

STATEMENT «000 pecccccccceccccsecccccecececeuscesenios

REASONS FOR GRANTING THE MSO leaew ss Pie eae Petey

Cee ON oc i csi vanced stn cusceusectaccsacnes ee ee

’ APPENDIX ee a a, oS ea

Appenpix B—Opinion and Judgment Below Citations .......

‘TABLE OF CASES CITED.

. - Page

Doyle v: Commissioner, 286 Fed. 2d 654 ....... See ey 4

- Hanover Bk. Ex. v. Commissioner, te Se 4

Est. Pat E. Hooks;-22 T. C. 502 0... 0ceschees0.-5.. aSirere "g

Herbert: Humphreys v. Commissioner, 301 Fed. SS

Knetsch v. U.S., 364 U..S. 361 ................ 3,5, 6, 7,8, 10, 12

Loughran v. Commissioner, 19 T. C. M. 1193 .......... rtm

Ludens v. U. S. A., 196 Fed. Sup. 525 ....2.0.....00.00... 4

_ Maysteel Products v. Commissiongs, 287 Fed. 2d 429.002... 4

Stanton v. Cominissioner, 34 T.C.1.......... Kvkedeae kone 4

STATUTES CITED. ie

Page

Act of June 6, 1932, 47 Stat. 179, Sec. en eee 8.

Act of May 10, 1934, 48 Stat. 688, Sec. 23b .....0.......... 9

Act of August 16, 1954, 68 Stat. 77, Sec. 264(a) (ed wh knees oe

Act of February 26, 1964, P. L. 88, P. Se ee 4,8,9

Ys

4

ams

w IN THE. ‘

on

Supreme Court of the United States.

' . ° Octoser Term, 1964.

No.

———

THOMAS C. BALLAGH anp

VERA REED BALLAGH,

Petitioners,

a

THE UNITED STATES OF AMERICA, .

. Respondent.

a

PETITION FOR A WRIT-OF CERTIORARI TO THE

~ UNITED STATES COURT-OF CLAIMS.

Thomas C. Ballagh and Vera Reed Ballagh pray that

a Writ of Certiorari issue to review the judgment of the

United States Court of ( ‘aims, entered in the above-entitled

ease on May 15, 1964.

CITATION TO OPINION BELOW.

The opinion of the Court of Claims printed in Appen-

dix B hereto, infra p. 15, is reported in 331 Fed. 2d 874.

JURISDICTION.

The judgment of -the United States Court of Claims

was entered on May 15, 1964: -p. 34, infra. The jurisdic-

tion of this Court is invoked under 28 U.S. C., Section

.. 1255(1).

2 "Petition for a Writ of Certiorari

QUESTION PRESENTED. _

Is a taxpayer whose primary purpose is to obtain

retirement income, who considers tax deductibility of in-

_ > terest in ecaleulating the cost und would not have taken. ~~

_ the contract otherwise, entitled to an allowance of an in-

come tax deduction for interest paid an insurance com-

_ pany ona loan for prepayment of premiums on an annuity

contract-where ‘he did not borrow back any of the cash

' surrender value during the seven years before the ‘dispute, .

and thereby obtained a substantial annuity?

STATUTES INVOLVED.

Statutory Provisions are cited and quoted in Appendix ;

A, infra, pp. 13-14. eos

STATEMENT.

_ Pet:tion was filed in the United States Court of Claims

requesting refund of income tax paid after final disallow-

ance of deductions (for payment of interest on loan to

prepay annuity wheré there was no borrowing back).

Petitioners in 1947, having tlie primary purpose of

’ obtaining retiremcut income, and considering the deducti-

bility of interest payments. in the total cost (Findings of

Fact. 12 and 14), vought an annuity contract, paid $10,000,

the' first premium, borrowed $236,000 from a bank to. pre-

pay forty years’ prefiiiums, executed a loan agreement for

the $236,000 to the Standard Life, which repaid the bank

(Finding of Fact 5). Petitioners paid Standard Life inter-

est on the loan, and in 1947 deducted it on their income tax

return. After an audit when the contract and loan agree-

ment was examined, that deducticn was allowed. A

similar deduction was allowed in 1952 (Finding of "act 24).

: Petitioners paid $9,769.97 interest in 1952 and $19,-

084.84 interest in 1954, and deducted these payments on

their 1953 and 1954 returns (Finding of Fact 1). These

deductions were finally disallowed and the petitioners paid

Petition for a Writ of Certiorari 3

Lt = er aye

the resulting additional assessments with interest in the

amount of $25,755.48 on December 23, 1959, and brought

this action in the Court of Claims for its recovery (Find-

ing of Fact 2). — = .

The transaction is similar to that ruled on in Knetsch -

v. U. S., 364 U. S. 361, with this important difference, that

from its inception in 1947 Mr. Ballagh never borrowed back

the ¢ash surrender value. Knetsch bought his contract De-

cember 11, 1953 and thereafter as he paid his interest, he

borrowed back all of the increase in cash surrender value,

which returned to his’ pocket most of the money he had

paid as interest, and which destroyed any chance of the

contract’s. producing an annuity ( which annuity depended _

ov the increase of the cash surrerder value). |

The Supreme Court in denying Knetsch a deduction

of the interest, calledit a

*. ... fiction, because each year. Knetsch’s an-

‘nual borrowings kept the net cash value, on which

annuity or insurance, payments would depend,: aly the

relative pittance of $1,000.00... . . It is patent that

there “was nothing of substance to be realized by -

~ Knetseh from this’ transaction beyond a-tax deduction

99 —

Mr. Ballagh, however, never borrowed back at any

time from 1947 to 1954, his interest payments were out of

vocket payments, and the eas surrender value ‘inereased

’ Pe

cach year: ( by the payment of premiums from the premium

deposit fund established by the original loan) ‘so.that when

in De ember 1956 he cancelled_his Joan’and took a paid-up

contract, he had an annuity which at sixty-five will pay

him $621.88 a month, or both petitioners and the survivor

err -

$092.29 a month.

The Supreme Court said in the Knetsch ease:

‘There may well be single premium annuity ar-

rangements: with- non-tax substance. which create an

4° Petition for a Writ of Certiorari

‘inidebtedness’ for. the purpose of See. 23(b) of* the

‘1939 Code and Section 163(a) of the 1954 Code. But

this one is a sham.’”

We submit that Mr. Ballagh’s case is such a a, case ‘‘with

’* non-tax substance’’,

There have been’ numerous decisions since the Knetsch

case in which it has been applied or distiaguished.

In every one cited at the trial and argument in-this ©

case (and every one the writer has found), where the de-

duction of interest was disallowed, there was ‘borrowi ing

- back”’ of substantially all ef the cash surrender value or in

_the securities loan cases, there were no actual securities to

be held as a pledge, but merely ‘“‘wash”’ sales. In other

‘words, “what was done”’ established the fact of ‘‘sham’’.

On :the other hand, the deduction of interest was al-

lowed in the one ca%e of an annuity contract -loan. where

there was no borrowing back.

Loughran v.-Commissioner, 19 T. C. M. 1193, and in

humerous cases where the pledged securities were actually

in existence. ;

Doyle v. Commissioner, 286 Fed. 2d-654

Maysteel Products v. Commissioner, 287 Fed. 24 429:

. Herbert Humphreys v. Commissioner, 301 Fed. 2d 33:

- Ludens v. USA, 196 Fed. Supp. 525; |

Hanover Bank Ex. v. Commissioner, 369 U. S. 672;

Stanton av. Commissioner r,34T.C.1

We submit that this decision of the Court of Claims

{1} is contrary to the spirit and language of the A netsch ;

case, (2) eonflicts with the Laws of Congress as they ex-

- usted when. the contract and the interest payments were

niude and makes the Acts of 1954 and 1964 retroactive in ;

violation of its restrietion to the future, and (8) although

by its findings of fact establishes tliat the Wwanesetion Was |

legitimate and had non-tax substarce, yet ends with a con.

¢lusion of law that is contrary to such findings of faet.

}

Petition fora Writ of Certiorari ”

REASONS FOR GRANTING THE WRIT.

I. The Decision Is Contrary to the Spirit and Language

of the Supreme Court’s Decision in Anetsch vr. U'. 8.,

.364U.S8.361. | | ——

in Knetsch, **what was done’’, the borrowing back not

only restored mest of the interest money to Knetseb. im- ;

mediately, but it eliminated the non-tax purpose: of estab-

lishing an annuity, by taking out all of ,the cash surrender

value on which. the. annuity depended.

Mr. Ballagh from 1947 to 1954 never borrowed back .

at all (and was-out of pocket his interest),“but allowed =

the cash surrender value to inerease so that it would and

did prov ide him with a substantial annuity.

It is clear that in 1947 and under every Revenue Act

from 1984 to 1954 interest onoans t6 create or maintain

annuities Was att CTIBLE. Thee reasons for this may be

the same undef which’ Congress now permits exelustons

for retirement deposits, The result -is really postpone

ment of taxation to,a time when brackets may he lower.

This is not theoretical in Mr. Bailagh’s case, becausé his

contraet and loan agreement were reviewed in 1947 and

the deduetion of interest was allowed. We hasten to state

that this is not an ‘argunient for estoppel, but it shows that

practice followed the Acts of ‘Congress. |

When, therefore, the Act of 1954 changed the law for

futur ¢ ¢ontracts and the Internal Revenue Commissioner

sought to deny ‘interest dednetions on annuity loans, he.

could do’ so only where, as in Knetsch, he could show that

the only purpose of the transaction was the tax deduction.

“The law is.clear that 'f there was non-tax substance aswell

_as-the tax deduction, the taxpayer could not be denied the

deduction.

%

. 4

6 Petition for a Writ of Certiorari

Knetsch stands for the proposition thet whese there

is no non-tax substance (as where the form is merely a-

sham) and the only purpose to be served is: tax saving,

.the deduction should be disallowed. ;

The spirit and language of A'netsch are contrary to

the decision here, which in spite of a finding that the

primary purpose was to obtain an annvity, the seven

year conduct of non-borrowing which supported that ,pur-

pose, and the end result of producing an annuity, ends

‘ith a conchision of law denying the deduction.

_ As we have noticed above, the decisions sinee the

Ruvisch ease (except this Ballagh ease) have interpreted

the Anetsch decision to apply only where there is no non-

tax substance. |

~The opinion of the Court of Claims lists three points:

1. The opinion states that taxpayer’s motive (although

legitimate) is not controlling. |

Whereas here taxpayer's primary purpose was to

obtain an annuity at the least cost, and what he did actually

accomplished this—-there cannot logically be a finding that.

the transaction was a sham. On the contrary it was real,

it had a/real purpose, it hagh non-tax substance and ‘*what

was done’? was consistent with and accomplished that

non-tax purpose,

The Kunetsch case held thet regardless of the way the

transaction started out (regardless of the motive. in that

sense) “what was done’’ Le. the borrowing back, destroyed

the possibility of. carrying out any motive or purpose to

get an annuity, and in that sense the existence of a purpose

could net stand against the fact of what was done, which

frustrated such purpose.

' In the Knetsch cage, with the possibility of an annuity

destroyed, the Court said there-was nothing of non-tax

“'substanee left and the only purpose was the tax deduction.

Here Mr. Ballagh'’s conduct supported and did not

destroy the non-tax substance but the result like the: pur-

pose and ‘tw hat was done’? was an annuity.

. Petition for a Writ of Certiorari 7

2. The opinion having findings of fact that the primary

purpose was to obtain an annuity and ‘that the non-

horrowing increased cash value which produced an annuity,

says that it was no sham to buy the annuity, but it was a

sham to borrow on it. .

“This has no basis in Jogie.

(a) There could be no interest: hence no deduction

unless there was a borrowing.

It makes meaningless the Acts of Congress from 1934

to 1994, which by eliminating annuities, permitted dedue-

tion of interest. In Peet , it.makes tke Acts of 1954 and

1964 retroactive in Kpite of their restriction to the future.

It is also tantamyunt to denying the statement of the

Kuetsch vase

“There may well be single premium annuity’ ar-

rangements with noOytax. substance which create an

‘indebtedness’ for the purpose of See. 23(b) of the

1939 Code and Section 163(a) of the 1954 Code.’

(hb) There is implicit in this part of the opinion, the

argument that the petitioners had no right to consider the

deductibility of interest payments at all.

This is, contrary to law. : | ;

Taxpayers have the right to decide whether to mort-

gage, even though they have cash, whether to lease rather

than buy, even though they Have the cash, because measur-

ing the choices the deductibility of interest makes the

mortgage or lease cheaper than buying outright with eash-

The Court says that Mr. Ballagh could have bought.

his annuity and paid annual premiums annually,.and that

the borrowing feature with the tax deductibility of interest

could have been left out. ‘That statement would apply to

“any loan. The Findings of Fact 12 and 14 show that Mr.

Ballagh would not have taken the contract without these

features.» This was a permissible decision. .

| It is contrary to the law and to common sense, that

the making of a lvan constitutes a sham merely because it

a Petition for a Writ of Certiorart -

will reduce cost. (or postpone taxes) by making interest

payments deductible.

8. The opinion distinguishes. the Loughran decision

(supra) where deduction of interest was allowed, on the

ground that the loan was left with the bank instead of

being transferred to the insurance company.

In effect this says that if Mr. Ballagh had left his

Joan with the bank that originally had it, his payments -

of interest would have been deductible. -We submit that

whether the bank held the loan or-the insurance company

held it could make no legal difference.

We are all familiar with borrowing on a life insurance

policy. It can be done by, having the company grant the

loan or by assigning the policy to a bank which makes the

loan. In either case, the interest is deductible (except that

where the interest is not paid in cash, but is merély added

to the loan by the insurance company, it-is not deductible).

The Courts have held that whether a loan is with the

‘ insurance company or a stranger makes no difference.

Est. Pat E. Hooks, 22 T. C. 502.

: The Revenue Act of 1964, P. L. 8&, 272 likewise makes

no difference between loans ‘‘from insurer or others’’.

We submit that nore of these points in the opinion

answers the Findings ot Fact 12 and 14 which establish a

non-tax purpose, carried tu a successful ‘completion by

‘‘what was done’? (Finding of Fact 13) at all times. con-

sistent with such non-tax purpose atid non-tax result, and

that the Opinion is in conflict with the Auetsch case and

the Acts of Congress. , °

II. The Decision Attempts to Change the Statutory Law

to Make Retroactive the Acts of 1954 and 1964, Which

‘ Specifically Restrict Their Effect to the Future, and

Nullifies. the Effect of the Act of 1934, Which by Omit- -

ting Annuities When Reenacting the 1932 Act, Per-

mitted Deduction of Interest on Annuity Loans.

By the Act of June 6, 1932, 47 Stat. 179, See. 23¢b)

excluded as a permitted deduction

Petition for a Writ of Certiorari 9

‘All interest paid. . . (2) jon indebtedness incurred

or continued in conner tion with the purchase or Carry.

ing of an. . . annuity.’

However, thix was promptly deleted by the Revenue

Act of May 10, 1934,- Stat. 688, wiich changed Section

22(b)(2) by omitting the word annuity. During all of the

period from 1934 to 1954, the Acts of Congress omitted

the prohibition against deducting payments of, interest on

annuity loans. ’

We submit that this is an area in which € ongress acted

and it had a right if it <aid so to encourage retirement

savings, by. postponement of tax (for Mr. Ballagh will

eventually pay tax although presumably in lower brackets).

In the Revenue Net of 1964, P. 1. S8,: p. a Congress

spoke again

“See, 215 Interest on Loans Incurred to Purchase

Certain Insurance and Annuity Coutracts

(a) Disallowance of Interest Deduction— See-

tion 264(a) (relating to certain amounts paid in con

nection with insurance comtract:) is-amended

“(1) by inserting after paragraph (2) the fol-

lowing new paragraph: ,

(3) Exeept as provided in subsection (¢), any

amount paid or acerued on indebtednes= ineurred or

continued to purchase or carry a life insurance, en-

dowment or annuity contract (other than a <ingle

premium contract or a contrac: treated as a single

premium contract) pursuant to a plan of purchase

. which contemplates the systematic direct or indireet

borrowing of part or all of the increases in the cash

value of such contract (eifher from the insurer or

_ otherwise.”’

‘6(2) by adding at the end thereof the following

new sentence;

‘Paragraph (3) shall apply only in respect of |

contracts purchased after August 6, 1965.""

~ 10 Petition for a Writ of Certivrari -

This later Act again emphasize. the restriction to the

future, and emphasizes that the thing that is wrong about

such transactions is the ‘‘systematic 2. | borrowing of

increases in the cash value of such contract (either

from insurer or otherwise) ”’. ;

We submit that this Act showed that Congress ‘in

enacting this Act in effect t approved Mr. Ballagh’s claim

for deduction,

The answer to ail this is that Mr. Ballagh had a valid

transaction. Under his partner's identical contract, iden-

tically treated, claim for identical deduction of identical

Rayments in the identical’ years Was approved. Only in

those cases where borrowing back vitiated the contraet

has it been held othe: wise. And when the Congress finally

spelled out the basis for refusing the deduction, if meee “de

out the borrowing back restriction.

This Baliagh decision is specifically contrary to what

Congress hus said.

The reasoning of this opinion would simply make the

ray of 1954, which is specifically limited to future contracts.

“roactive or would reenact the 1952 Act skipping the |

i! Oo and intervening Acts.

We submit that in the Anetsch ease, the Supreme Court

did not do this.

In effect, it did not deny the right to deduct interest

ou an annuity loan where there. was non-tax substance in

the transaction.

In fact, the Supreme Court held that jo deny it, the

Commissioner had to éstablish and the Court had to find

that the transaction. had no non-tax substance and was a

‘sham’. In the absence of this (and we submit it-was

_ absent under Findings of Fact 12, 18, 14 in the wanagh

case) the deduction of interest was allowable.

The Act of 1964 follows what I have said ubout the

meaning Of the Anetsch case.

Petition fora Writ of Certiorari 11

Ill. The Decision Is Contrary to the Findings of Fact in

the Ballagh Case Which Establishes as a Matter of

Fact That the Transaction Was Not ‘‘Sham”’.

i ae . He had determined. to buy an annuity

contract that would provide him a satisfactory income

ut age 60, and in entering into the contract . . . he

took into account the total cost of the annuity contract,

including the deductibility of iiterest paid under the

‘loan agreement.

“13.°Mr. Ballagh has never borrowed against the

increasing cash value of his insurance. contract with. .

Standard Life, although he had a right to do so under

the terms of, the policy’.

“14. The efdence as a whole shows that Mr.

Ballagh’s primary purpose in entering into the. trans-

actions with Standard Life was to provide a satisfac-

tory retirement income at age 65, but the deductibility

of the interest payments from his income tax was

_ conside red by him as an important factor in the total

cost of prov iding such retirement income, and he would

not have purchased the policy, nor entered into the

other transactions connected therewith had he known

that the interes, payments would not be deductible. ’’

p “0. . . . The insurance contraet is still in foree,

and if Mr. Ballagh elects to begin the receipt of arinui-

ties dt age 65, the contract will pay him an annuity of

$H21FS per month, or will pay to petitionérs and sur-

Viver au annuity of $552.29 per month”?

These findings establish non-tax substance in the begin-

ning, in ‘*what was done’’ and jn the result,

We incorporate here by reference the discussion of the

three points, which the Opinion proposes against this. We

submit that none’ of them overcomes the said Findings of

Fact.

a Petition for a Writ o fCertiorari

The Court should grant this petition for certiorari to

make clear the limits of the Knetsch decision, to affirm the

supremacy of the Acts of Congress limiting the Acts of.

— 1954 and 1964 under its own restrictions to the future and

* to avoid the inconsistency of a decision where thé Findings

of Faet entitle plaintiff to reeover but are von’ by clearly

ine onsistent conclusions of law. ;

CONCLUSION.

For the foregoing reasons, this Petition for a Writ of

Certiorari should be granted.

: é Respectfully submitted,

Wacrter B. Gissons,

Frank J. Eustace, Jr.,

Counsel for Petitioners.

“e

Wek?

APPENDIX A.

Act of June 6, 1932, 47 Stat. 179, See. 23(b)

‘In computing net income there shall be allowed

.as deductions:

‘*(b) Interest—All interest paid or accrued within

the taxable year on indebtedness, except (1) on indebt-

edness incurred or continued to purchase or carry ob-

ligations or securities (other than obligations of the

United States issued after September 24, 1917, and

vriginally, subseribed for by the taxpayer) the interest

upon which is wholly exempt from the taxes imposed

by this title, or (2) on indebtedness incurred or contin-

ned in connection with the purchasing or carrying of ©

an annuity, 4

“Revenue Act of May 10, 1934, 48 Stat. 688, See. 23(b)

‘In computing net income there shall be allo d

as deductions:

‘“*(b) Interest--All interest paid or aecerued within

the taxable year on indebtedness, except on indebted-

ness incurred or continued to purchase or ¢arry obli-

gations (other than obligations of tae United States

‘issued after September 24, 1917, and originally sub-

seribed for by the taxpayer) the interest upon whieh

ix Wholly exempt from the taxes imposed by this title.”

Act of August 16, 1954, 68 Stat. 77 See. 264

(a) General Rule—No deduetion shall be allowed

eee ,

‘*(2) Any amount paid or accrued on indebted.

ness incurred or continued to purchase or carry a

single premium . . . annuity contract .

(13)

14

y,

Appendix A

‘Paragraph (2) shall apply in respect of annuity

contracts only as to contracts purchased after March

1, 1954.

‘*¢b) Contracts treated as Single Premium Con-

tracts—For purposes of sub-<ection (a)(2) a contract

shall be treated.as a single premium contract—

‘*(1) if substantia!ly all the premiums on the con-

| tract are paid within a period of four years from the

The

date on which the contract is purchased.

“*(2) if an amount is deposited after March 1,

1954, with the iusurer for payment of a substantial

number of future premiums on the contract.’’

ites Act of February 26, 1964, P: L. 88972

“*See. 215. “Interest on Loans Incurred to Pur-

chase Certain Insurance and Annuity Contraets

‘*(a) Disallowance of Interest Deduction. Section

164(a) (relating.to certain amounts paid in connec-

tion with insurance contracts) is amended—

‘*(1) by inserting after paragraph (2) the follow-

ing new paragraph:

**(3) Except as prov ided in subsection (e) any

amount paid or accrued on indebtedness incurred or

- continued tu purchase or carry a life insurance, endow-

ment or annuity contract (other than a single premium

contract ora contract treated as a single premium con-

tract) pursuant to a plan. of purchase which contem-

plates the systematic direct or indirect borrowing of

part or all of the increases in the cash valué of such

contract (either from the insurer or otherwise).’’

Appendiz BO”

APPENDIX B.

(331 F.2d 874)

IN THE UNITED STATES COURT-OF CLAIMS

No. 393-60

(Decided May 14, 1964) +

———77

THOMAS ©. BALLAGH AND VERA REED BALLAGH

| v.

THE UNITED STATES

Frank J. Fustace, Jr., for plaintiffs.

David D. Rosenstein, with whom was Assistant Attor-

ney General Lows F. Oberdorfer, for defendant. Edward

S. Smith, Lyle M. Turner, and Philip R. Miller were on

the brief. ;

Before Jones; Chief Judge, Writaker, Laramore, -

Durrer, and Davis, Judges. ;

OPINION

- Jones, Chief Judge, delivered the opinion of the court :'

Plaintiffs, husband and wife who filed joint tax returns

for the periods here pertinent, brought this suit to recover

$25,792.02 as alleged overpayment of Federal income tax

and interest for the calendar years 1953 and 1954. ‘In their.

returns, plaintiffs claimed deductions in the amounts of

$2,769.97 for the year 1953 and $19,584.84 for the year 1954 _

as interest payments. The Internal Revenue. Service dis-

16° Appendix B

allowed these deductions and determined a deficiency for

each year. Plaintiffs paid the deficiencies and brought this

action for.refund. The sole issue for our determination is

whether these payments were ‘‘interest paid * * * on in-

debtedness”’ within the meaning of § 23(b) of the Internal

Revenue Code of 1939 and § 163(a) of the Internal Revenue

_Code of 1954.1. Thomas C. Ballagh will hereinafter be re-

ferred to as plaintiff.

On December 20, 1947, plaintiff and Standard Life In-

surance Company of Indiana (hereinafter referred: to as

Standard Life) entered into an insuranee contract which

provided for a life annuity of $6,813.18 per month to be paid

_to plaintiff commencing December 20, 1988, in exchange for

41 annual premiums of $10,000 each. On the day of the,

contract, plaintiff paid the initial year’s premium of $10,900

to put the policy into effect. According to the contract

plainttff had the right to prepay any amount of the pre-

miums which would be due in the future, and the amount

so prepaid would bear interest‘at a minimum rate of 2%

pereent per year or at such higher rate as Standard Life |

declared. In fact, plaintiff was allowed a compound dis-

count of 2.85 percent on prepaid premiums.

_ At he time of the contract, and with .ne compound dis-

count rate of 2.84 percent, $236,856 was the amount which

was required to prepay. all future premiums. On the same

_day plaintiff entered into the contract, the Corn Exchange

National Bank and Trust Company of Philadelphia (here- -

inafter referred to as the Bank) issued a cashier’s cheek in

‘ the amount of $236,856, payable to plaintiff’s order, in ex-

change for plaintiff’s demand note for the same amount,

secured by the insurance policy referred to-above. It was

a condition.of the loan that plaintiff would immediately

endorse the cashier’s check over to Standard Life. He did

1. Plaintiffs being calendar-year taxpayers, the 1954 Code is ap-

plicable to their 1954 tax return by virtue of §7851(a)(1)(A).

However, 2s the Supreme Court has noted in Anetsch v. United

States, 364 U. S. 361, 362, footnote 1, “jt}he relevant words of the

two sections are rie same * des Hi

Ap pe ndiz B | 17

so, and the Bank credited the $236,856 to the account of

Standard Life. On December 26, 1947, Standard Life ae-

knowledged receipt of $236,856 as a deposit by plaintiff in

full payment of 40 annual premiums on the insurance con-

_ tract from December 19,-1948 to December 19, 1988. "This

" $236,856 was placed in a ‘premium deposit account” Phich -

‘was increased by the compound interest of 2.95 percent per

year, and-deereased by the amount of annual premiums as

‘they became due. The total value of the contract, then!

was the sum of the amount in the premium deposit account

plus the tabular cash value of the policy.

On December 27, 1947, plaintiff and Standard Life exe:

cuted a ‘Loan Agreement,’’ under the provisions of which

plaintiff. was to pay Standard Life $236,856, with interest

_at.the rate of 4 percent per annum on the portion secured

by the amount remaining in‘the premium deposit account

and at the rate of 6 pereent. per annum on the portion se

cured by the tabular cash value of the policy. .By the terms

of the loan agreement, the débt would be payable and en-

foreeable solely out of the security which was the insuratice

contract plaintiff had with Standard Life. In return,

Standard Life was to pay, and did pay on December 27,

1947, $236,856 to the Bank. ‘ Thereafter, the Bank cancelled

. plaintiff’s demand note, and plaintiff paid the Bank $184

as one week’s interest on the $236,856. :

Additionai terms of the loan agreement — “dl plain-

tiff to prepay interest at a compound discount of 2 percent

‘per’ year, but he could not, prepay more than 10 percent of

the principal amount of the loan in any one year. On

. December. 27, 1947, plaintiff made out five separate. checks

to Standard Life in the total amount of $45,568.04.) Bach

of these checks contained a statement that by endorsement

thereon the check was accepted by Standard Life in prepay-

ment of one year’s interest on ‘the loan. Thereafter, in

December of each of the years 1952, 1953, and 1954, plain-

tiff paid the sums of $9,693.04, $9,769.97, anid KLOSS4SE,

respectively, to Standard Life. These were prepayments

| / Appendix B

: . ”%

_ of interest due under the loan agreement. The ‘*interest

payments’’ plus the initial premium of $10,000, or an ag-

gregate of $94,615.89, were the only sums paid by plaintiff

to Standard Life.~ The amounts’ paid in, 1953 and 1954 are

the subject of this suit. , . .

At the end of the above series of transactions, plaintiff

had an insurance contract with Standard Life, and all of

the premiums which would have been due thereon had been

prépaid by a deposit of $236,856 in a premium deposit ac-

count. This $236,856. was borrowed from Standard Life

and plaintiff was. obligated to repay Standard Life the

$256,806, plus interest, but this pbligation was enforceable

solely out of the cash or loan Fine of the insurance con-

tract. Standard Life was paying plaintiff interest of 2.85..

pereent on the $236,856 plaintiff had deposited in- the

“premium deposit accounts while plaintiff! was: paying

Standard Life infetest of 4 to 6 percent on the $226,856. he-

borrowed froma Standard Life. The role of. the Bank was

that of a middleman: There was an agreement between the

general agent of Standard Life and the Bank, whereby the

Bank agreed to facilitate transactions (involving such

insurance plans; and it was understood by all parties that

the loan would ultimately be -carried by Standard: Life

rather than by the Bank. fs

On Decer aber 20, 1956, at the request of ptaintiff, the

loan agreement was: cancelled and the policy under the

insurance contract was converted to paid-up for its net

cash value of $66,388.89, This paid-up’ policy is still in

force, . a 9 .

it was found by the trial commissioner, and not dis-

puted by the parties, that had plaintiff not engaged ‘in the

transaction involving the loan of $236,856, and had he

paid Stendard Life all the payments he actually made as

prepayments of premiums rather then as interest under the

loan agreemezit, tae net cash yalue of the insurance contract

would have been $98,359.86, on December 20, 1956. ° Thus,

Standard Life's ‘*fee??? for its arrangement of the loan

ae ee ———

2. Knetsch v. United States, 364, U. S. 361, 366 (1900).

Appendi« Bo - |. ive

transaction was $31,970.97, the differenee between

£98,359.86 and $66,388.89. Although plaintiff ended up with

a policy having less ¢ash value, he also benefited from the

_loan transaction. Plaintiff realized a tax saving of $59 427

as a result of deducting ‘‘loan interest’? of $45,568.04 from

his gross income for 1947, plus a further* tax saving of

$7,598 as a result of deducting the $9,693.04 ‘loan interest”

from his gross income for 1952. Therefore, plaintiff had a

net profit, to date, fer his participation in the loan trans-

action of about $15,000, the difference between the total tax

savings realized and Standard Life’s J‘fee”’ for arranging © *

the loan transaction. |

The Government dees not concede that any of the pay —

ments plaintiff made to Standard Life were properly de

ductible as ‘interest’? payments. However, the st: atute of

limitations now bars additional assessments for the vears °

prior to 1953. We are concerned, therefore, only with the

‘interest payments”? for the yeats 1953 and 19: OH.

The fa: ‘ts of the present case-are very similar to tho-e

of Kuetsch v. United States, 364 U.S. 361 (1960), Ih

Kuetsch, the f taxpayer bought deferred annuity savine~

bonds “in 1953) from = an- insurance company totaling

$4,080,000 in face value, and, bearing interest at 2'2

percent compounded annually. The purchase jprice war

$4,004,000. Knetsch gave the ¢ company his check for $4,000,

and signed $4,000,000 of nonrecourse annuity loan note x for

the balance. The notes bore.3844 percent interest and were

secured by the annuity bonds. .The interest was payable

in advanee, and Knetsch paid the first year’s $140,000 in

térest at the time of the purchase. Unaer the terms of

the bonds, their cash or loan value at the end of the first

contract year was té be $4,100,000. The contract terms

permitted Knetsch to borrow the exc@ss 6f this valie above

his indebtedness without waiting until the end of the con-

tract year. Five days after the purchase Knefseh bor-

rowed from the company $99,000 of the $100,000 excess

over his $4,000,000 indebtedness, for Which he gave his

Y

aA a ppendia B,

notes bearing 34% percent interest. This interest was also

payable in advance anc on the same day he prepaid the

first year’s interest of $3,465. Thus, at-the end of the

first contract year, Knetsch had bonds with a cash value of

$4,100,009 and an indebtedness of $4,099,000, [In his tax

return for 1953, Knetsch deducted the sum of the two

interest payments, or Pays, as ‘interest’? under © 23(b)

of the 19539 Code. ;

The above described process, except for the initial pur-

chase, was eerener in 19! D4 at the beginning of the second

contract year. Again Knetseh. ought to deduct the two

interest payments, under § 163(a) of the 1954 Code, which

was then applicable. | oan,

The Commissioner of Internal Revenue disallowed the

~ deductions and determined a deficiency for each ‘year.

Knetsch paid the deficiencies and sued in the District Court

for refund. The District Céurt’s judgment for the United

States was eventually affirmed by the emprone Cars. The

Supreme Court ex: umined “what w as done”? in- Anetsch and

found that:

Plainly, therefore, Knetsch’s transaction with the in-

surance company did ‘*not appreciably affect his bene-

ficial interest exeept to reduce his tax... 27’ Gilbert ©

Commisstoner, 248 F.2d 399, 411 (dissenting opinion).

For it is patent that there was nothing of substance to

he realized by Knetsch from this transaction beyond a

tax deduction. What he was oste nsibly ‘lent’? back |

was in reality only the rebate of a substantial part of

the so-called ‘interest’? payments. The $91,570 differ-

ence retained by the company was its fee for providing

the facade’of ‘loans’? whereby the petitioners sought

to reduce their 1953 and 1954 taxes in the total sum of

$233,297.68.9

oe -

We believe that the Supreme Court’s hoiding in

AWuckscl is ¢ complete ly dispositive ot the present case, Plain-

a, re at 366.

Appendix B , 21

tiff’s' doan transaction with Standard Life did ‘*not appre-

ciably affect his beneficial interest except to reduce his tax

** er To paraphrase the District Court’s conclusion of

law in Fretsch,. quoted in the Supreme Court’s opinion,’

we find that ‘while in form the payments to Standard Life

were compensation for the use or forbearance of money,

they were not in substance. As a payment of interest, the

transaction was a sham.”’ |

Plaintiff attempts to distinguish the Auetsch efise from

the present situation by contending that his transaction with

Standard Life was a valid, as distinguished from a sham,

transaction. As support for this contention he points to

various. findings by the trial commissioner to the effect thai

plaintiff’s primary purpose in entering into the transac-

tien with Standard Life was to prov ide for a retirement

income, but that the deductibility of the interest payments

was considered in computing the total cost of the plan; and

that plainiif never borrowed against the increasing cash

~ value of his policy, as did Kne ‘tsch, which borrowin® would

have destroyed the purpose‘of prov jding. retirement income,

We think that canines *s ev idence does not ‘support his

contention.

In the first place, the taxpayer’ s motive, in cases such

as the present one, is Hot controlling. The often quoted

laiguage of the Supreme Court in Gregory v. Helvering.

293 U.S. 465, 469, is appropriate here :

The legal right of a taxpayer to dé ‘erease the amouit of

what otherwise would be his taxes, or altogether avoik

them, by means which the law permits, cannot be

doubted...) . But the question for determination is

whether what was done, apart from the tax motive,

was the thing which the’ statute intended.

This point. was specifically, reaflirmed by that Court in

Knetsch, in putting aside a finding, by the Distriet Court on

Knetsech’s motive.

4. Id. at 365.

5 ld. at 365.

’

22 Appendix B

In the second place, plaintiff is wide of the mark in

Supposing that his primary purpose of providing retire-

ment income can make valid what would otherWise be a

sham: For the transaction which we find to be a sham is

not the initial insurance contract but the prepayment of

all of the premiums and. tbe loan agreement. We do not

question that plaintiff’s motive in buying the policy was a

legitimate one. However, the subsequent prepayment of

all premiums by borrowing from the insurance company

itself was not recessary in so providing retirement income,

and we find that such loan transaction did ‘‘not appreciably

affect his beneficial interest except to reduce his tax.’’

Since the payments made were part of the loan transaction.

which we have found to be a sham, we may disregard the

payments for the purposes of the tax statute. Gilbert v.

Commissioner, 248 F. 2d 399, 411 (dissenting opinion) ;

Gregory v. Helvering, 293 U.S. 465; Higgins v. Smith, 308

U.S. 473, 477: Griffiths +. Commissioner, 308 U.S. 355;

Basleye. Commissioner, 331 U.S. 737.

Finally, we think the fact that p’intiff never borrowed

against the increasing eash value ot his policy isnot per-

tinent in considering the deductibility of these payments.

To hold otherwise would be to ignore the. teachings of the

Supreme Court in the Knetsch ease. The Court there con-

cluded that what Knetsch was ostensibly ‘‘lent’? back wa~ in

reality only the rebate of a substantial part of the so-called

“interest? payments. We hold that it makes no difference

in these cases whether the taxpayer receives the rebate in

the form of a loan or whether he receives it in the form of

cash value in the policy,

There remain for our cons:deration the-two cases cited

by plaintiff ax supporting his contention. Loughran +.

Commissioner, 19'T. C. M. 1193 (deeided October 10, 1960) ;

Stonton v. Commissioner, 34 T. C. 1 (decided April 7, 1960).

Both of these cases are distinguishable from Kunetsch on the

facts. In Loughran, and in Stanton, there were actual bank

loans with interest paid to the banks. .As the Tax Court

Appendix B a

has pointed out in Stanton,’ in the Knetsch line of cases the

interest on the bank loans was not in controversy. Since

the present dispute does not involve the $184 plaintiff paid

to the Bank, Loughran and Stanton are not apposite.

Plaintiffs are not entitled to recover and their petition

is dismissed.

FINDINGS OF FACT

The court, having considered the evidence, the report

of Trial Commissioner Wilson Cowen, and the briefs and

argument of counsel, makes findings of fact as follows:

1. The plaintiffs, husband and wife, filed jeint indi-

vidual income tax returns with the Distriet Director of

Internal Revenue in Philadelphia, Pennsylvania, for the

calendar years 1953 and 1954. In such returns they claimed

deductions in the amouiits of $9,769.97 for the year 1953 and

$19,584.84 for the year 1954 as interest paymeits made to

the Standard Life Insurance Company of Indiana during

those years.

2. Upon audit and examination, the Internal Revenue

Service on Ocfober 2, 1958, disallowed the claimed deduc

tions. As a result thereof income tax deficiencies in the

amount of $6,933.30 and $12,844.32 were assessed against

the plaintiffs for the yéars 1953 and 1954, respectively. On

December 23, 1959, plaintiffs paid these deficiencies, plus

assessed interest thereon, or a total of $9,299.08 and

$16,492.94 for the years 1953 and 1954, respectively, to the

District Director of Internal Revenue at Philadelphia Penn

sylvapia. On January 25, 1960, the plaintiffs filed claims

for refund of the amounts thus paid, and by certitied niail

dated September 29, 1960, the claims for refund were dis

allowed. On Oetober 11, 1960, interest of $36.54 was re-

funded to the plaintiffs.

3. Since 1933 Mr. Ballagh has been the partuer of

Grant Thrall. Mii he vy were and are in the “export business

6. 34 TOC. at 10.

24 Appendix B

performing services as manufacturers’ representatives in

nearly all of the countries of the free world. Due to chang-

ing conditions in foreign countries and other factors, the

income from this business was subject to wide fluctuation.

» 4. The year 1947 was a good year in the partnership

business, the partnership earning a good deal more money

than.during the preceding year. Mr. Ballagh and Mr, Thrall

wished to provide some plan which would provide a regular

income upon their retirement. Edwin D. Parker, an insur-

ance broker who had sold them other insurance, presented

to them a plan in December 1947 for an annuity contract

with the Standard Life Iasurance Company of Indiana,

hereinafter referred to as Standard Life.

In the last 2 weeks of the year 1947 Mr. Baliagh en-

‘tered into a series of transactions with Standard Life and

the Corn Exchange National Bank and Trust Company of

Philadelphia, hereinafter referred to as the Corn Exchange

Bank. These transactions were part of the comprehensive

plan which was outlined to Mr. Ballagh by Mr Parker, the

insurance broker. These transactions were as follows:

(A) Qn December 20, 1947, Mr. Ballagh and Standard

Life entered into an insurance contract which provided for

adife annuity of $6,818.18 per mouth to be paid to Lim com-

meneing on December 20, 1988. The stated consideration

‘for the contract was an annual preniium of $10,000 for 41

years. Under the terms of the policy the cash value thereof

increased from year to year’as the annual premiums were

paid. “Ihe contract also contained a provision entitled

Premium Deposit Fund*’, under which’ Mr. Ballagh had

the right to prepay apy amount be chose on premiums there-

after duc, It further provided that any amounts so. pre-

paid would bear interest at a minimum rate of 2's percent

per year or at such higher raté as the company declared.

Mr. Ballagh was allowed ui compound discount of 285

percent on preps ud premiums. :

Appendix B <3

(B) Gn December 20, 1947, Mr. Ballagh deposited with

- Mr.. Parker, the insurance broker, a eheck for $10,000 in

payment of the initial year’s premium on the policy, and

this payment put the policy in force.

(C) On December 20, 1947, Mr. Ballagh executed a de-

mand note in the amount of $236,856, payable to the Corn

Exchange Bank. Th.s sum was equal to the amount. re-

quired to prepay all.premiums which weuld in the future

become due on the policy. In exchange for his note, the

(‘orn Exchange Bank issued a cashier’s check in the amount

of $236,856, payable to the order of Mr. Ballagh. Collateral —

~ security for this loan was the insurance pelicy referred to

in (A) above.

(D) A condition of the loan was that Mr. Ballagh

would immediately endorse the cashier’s check over to

Standard Life. He did so, and the Corn Exchange Bank

credited the $236,856 to the account of Standard Life.

(EK) On Jiecember 26, 1947, Standard Life acknowl-

. edged receipt of $236,856 as a deposit by. Mr. Ballagh ‘in

“full payment of 40 annual premiums on the insurance con-

tract from December 19, 1948 to December 19, 1988.

(F) On December 27, 1947, Mr. Ballagh and Standard

Life executed a document entitled ‘-Loan Agreement’’,

under the provisions of which he: was obligated to pay

Standard Life $236,856, with interest at the rate of 4 per-

cent per annum on the portion secured by the premiums

deposited and at the rate of 6 percent per annum on the

portion secured by the tabular,cash value of the policy. As

security for payment Mr. Ballagh assigned the insurance

contract and all premiums deposited thereunder to Stand- .

ard Life.

(G) On or about December 27, 1947, Standard Life

paid $236,856 tothe Corn Exchange Bank, whereupon the

demand note given by Mr. Ballagh to the benk was can-

26 | Appendis B

celled. No others money or property was received by him

‘from Standard Life in return for his promise under the

loan agreement to pay Staridard Life the $236,856, plus

interest thereon.

‘GH On or about December 29, 1947, Mr. Ballagh’s

cancelled note Was returned to him, and he paid the Corn

Exchange Bank #184, representing one week's interest on

. the $236,856.

6. Mr. Batlagh was entitled to prepay interest due

under the loan agreement at a compound discount-of 2 per-

cont per annum. On December 27, 1947, he executed five

separate checks payable to Standard Life in the total

amount of $45,068.04. Each check contained a statement

that by endorsement thereon the check was accepted in -

prepayment of one year’s interest on the loan to Standard -

Life. ne :

On December 10, 1952, December 10, 1953, and Decem-

her 3, 1954, plaintiffs eid the sums of $9,693.04, $9,769.97,

and $19,584.84, respectively, to Standard Life Each of the

~ cheeks*contained a statement that the check was issued as’

“a prepayment of interest due under the loan agreement.

The amounts paid in 1953 arid 1954 are the subject of this’

suit.

The ‘amounts ‘shown in the preceding finding, plus

the initial premium of $10,000, or’ an aggregate of $94,-

f1o89, were the only sums paid by plaintiffs to Standard

Life. 4

8. On December 20, 1956, the following endorsement

was placed on the. insurance contract ;

On the request of Thomas C. Ballagh, the annui-

tant, this policy is converted: to paid-up for its net éash

value oof SQ6.888.89 as at December 20,1956. as pro.

vided herein.

Appendix B

Concurrently, the loan agreement attached to the insurance

contract was cancelled. sone —

’

9, At the time the insurance contract was converted the

net cash value of $66,388.89 represented the cash value of

the policy as of December 20, 1956, plus the surrender value

of the premium deposit account on the same date, less the

$236,856 owing to Stanuard Life under the lean agreement.

The insurance contract is sti] in force, and if Mr. Ballagh

elects to begin the receipt of annuities, at age 65, the corr

tract will pay him an annuity of $621.88 per month, or will

pay to plaintiiTs and survivor an annuity of soo2.20 per

month.

10. At the time he entered into the transaction- in

volved herein Mr. Ballagh was 44 years old and was con

cerned about retirement income because of the fluctuating

nature of his business, As a self-employed person he was

at that time eligible for social security.

The plan presented by Mr. Parker, the insurance

broker, was outlined to Mr. Ballagh and to Mr. Thrall at

the same time and both entered into an identical series of

transictions, Mr. Parker had known the partners for a

numbe ‘roof years and had previous sly discussed the matter

of providing a retirement plan for them. In the course of

the discussions regarding the Standard Lifp plan, Mr.

Parker showed Mr. Ballagh copies of letters that had heer

sent by the Deputy Commissioner of Inte rad Reveaine to

other persons who were buying or. had hought similar in

~urance Contracts. The letters stated that'interest paid on

loans obtained for the purpose of paying premiums in ad

vance on such insurance annuity contracts would be dedue

tible under the provisions of section 23(b) of the -Internal

ReQrue Code of 1939.

. . . id .

At the conelusion of the transactions entered inte -

with the Corn Exchange Bank and Standard Life, it wa-

28 | Appendix B

Mr. Ballagh's understanding that he had an annuity con-

tract with Standard Life on which premiums had been pre-

paid for 40 years and that on the security of the contract,

he had received a loan on which he would be obligated to

pay interest. He also understood that he had aright to

prepay interest on the loan at a’discount and that in any

‘future year selected, he could pay off the loan and receive

a paid-up annuity. On the basis of the information he re-

ceived, he believed that ihe interest payments made to

Standard Life under the loan agreement would be deducti-

ble on his Federal income tax yeturns. Before he . tered

into the insurance contract with Standard Life, he obtained

some figures from an actuary showing the net cost of the

policy without considering the deductibility of interest pay- |

ments on a loan secured by the policy He had det. rmined

to buy an-annuity contract that would provide him a satis-

factory incone at age 65, and in entering into the contract

with Standard -Life and the other transactions described

herein, he tock into account the .total cost. of the anos

contract, including the deductibility of i interest paid under

the loan agreement.

:

18. Mr. Ballagh has never borrowed against the in-

creasing eash value of his insurance contract with Stand- .

ard Life, although he had a right to deso under the terms.

of the policy. Had he borrowed ae ge repaid, part of

the cash value, the annuities payable under the policy

would have been reduced.

Se,

14. The evidence as a whole shows that Mr. Ballagh’s:

primary purpose’ in entering Into the transactions with

Standard Life was to provide for a satisfactory retirement

income at age 65, but the deductibility of the interest “pay-

ments from his income tax was considered by hint as an

important factor in the total cost of providing such retire-.

Appendiz B- . 29

ment income, and he would not have purchased the policy,

nor entered into the other transactions connected therewith

had he known that the interest payments would not be de-

ductible.

15. The following table illustrates the amount ‘that

would have been paid to Mr. BaHagh under the insurance

contract with Standard Life upon surrender of the policy

at the end of each policy year over a period of 9 years, on

the basis of the total payments, including premiums and °

prepaid ihterest, which he made to Standard Life:

Q) (2) (3) (4) (3)

Amounts , * Yearly in-

paid by tax- Netcash Prepaidin- Total pay- _ crease. (')

pauyersto value of con- te st payable able on sur- Decrease in

Standurd tractatend on surrender render ((3) total payable

Contract year. Ltfe of each year * at end of year plus (4)) on surrender

1 1 $55,568.94 $ 6,751.13 $37,001.60 $43,752.73 $43,762.73

2 15,408.93 28,077.92 43,686.85 (65.80)

3 22,371.48 18,975.17 41,346.65 (2,340.20)

4 29,236.06 — 9,618.24 38,854.30 (2,492 35)

5 36,399.88 - 36,399.88 (2,454.42)

6 9,693.04 43,560.07 , 43,560.07 7,160.19

7° 9,769.97 50,913.68 50,913.68 7,353.61

8 19,584.84 58,557.66 . 9,930 46 68,488.12 17,574.44

y) 66,388.87 66,388.89 (2,099:23)

1Jncludes the $10,000. initial premium, paid ‘and interest prepayment of

$45,568.04. ;

* These figures represent the sum of the premium deposit account plus the

, tabular cash value of tne contract less the amount of loan outstanding against

* the contract.

16. As stated in a preceding finding, the insurance

-contract with Standard Life ineluded a provision entitled

‘*Premium Deposit Fund’’, under which he was entitled to

prepay future premiums. Any amount so prepaid would

bear interest at a minimuin rate of 24% percent per year.

The following table illustrates what Pes results would have -

been had Mr. Ballagh entered into the insurance contract

when he did, had not engaged in the transactions involvi ing’

the loan of $236,856, and had paid Standard Life all the

30 Appendix B

payments he actuallly made as prepayments of premiums

rather than as interest under the loan agreement:

*

ad) (2) (3) (4) (5) (6)

Amounts Premium ° Total pay-

“paid by tax- deposit Tabular — able on sur- Yearly in-

payers to account at cash render atend crease in

Standard end of each value atend of each year total payable

Contract year . Life year of each year ((3) pius (4)) on surrender

; 1 $55,568.04 $46,707.24 $46,707.24 $46,707.24

@ "37,624.92 $12,000 * 49,824.92 3,117.68

3 28,315.54 22,400 50,715.54 890.62

4 _ 18,773.43 32,800 51,573.43 857.89

5 8;992.77 43,600 52,592.77 1,019.34

6 9,693.04 ~ 8,902.96 54,500 63,402.96 10,810.19

7 9,769.97 — 8,889.75 65,700 74,589.75 11,186.79

8 19,584.84. 18,936.45 77,300 96,236.45 21,646.70

~

~

9,159.86 89,200 98,359.86 2,123.71

17. Had the plan illustrated in the foregoing table

‘been followed, Mr. Ballagh would have received a paid-up

annuity in the amount of $98,359.86 at the end of the ninth

year that ‘the policy was in force in return*for payments

aggregating $94,615. ‘As shown in defendant’s exhibit 8,

Mr. Ballagh calculated that the total value of the plan he

. actually followed was $113,373, consisting of a paid-up

annuity as of December 20, 1956, of $66,388.89, plus a tax .

saving of $39,427.as a result of paying $45,568.04 «s loan

interest in 1947, plus a further tax saving ef $7,558 as a

result of paying $9,693.04 as loan-interest in 1952. He

calculated the net cost of the plan as $94,799, representing

$94,615 paid to Standard Life and $184 paid to the Corn

Exchange Bank.. His conclusion was.that he had a net

profit or an increased value over cost of, $18,584.

18. As shown in finding 5(D) Mr. Ballagh did not have

free use of the $236,856, which he borrowed from the Corn.

. Exchange Bank on December 20, 1947, since it was a coidi-

tion of the loan that ne would promptly endorsé the cash-

ter’s check over to Standard Life. Although he had done

business with the bank for a numlcr of years prior:to the:

Joun in question, he had not previously borrowed from the

a,”

Appendix B_ - | 31

‘bank. The balance i in his account ori December-20, 1947 yin.

the bank was not ‘sufficient to cover a demand loan of *

$236,856. . There was an agreement between the general

agent of. Standard Life and the Corn Exchange Bank, :

whereby the bank agreed to facilitate transactions involving

such insurance plans, and it was understood by all parties.’

that the loan would ultimately be carried by Standard Live

rather than by the bank.

19, The loan suceniens. which is in evidence as exhibit

6 to the stipulation and is made a part hereof, provided :

The entire debt evidenced by this note or any balance

due thereon shall be payable, and enforceable by the

payee, solely out of the security hereinafter mentioned.

As security for the loan agreement Mr. Ballagh-as-

signed the insurance contract and all premiums deposited:

thereunder to Standard .Life.

The loan agreement also provided that if the interest

on the principal was not paid when due, such interest would

be added to the principal and if and when the principal

exceeded the cash or loan value of the security, the security

would be ‘applied in full payment of the debt and the joan

agreement would be re ‘turned to Mr. Ballagh merked ‘* Paid

in Full’... . os

20. The loan agreement also contained a provision

limiting the amount which could be prepaid on the loan in

any I year to not more thay 10 percent of the principal

amount of the loan, This provision is unusual in insurance

loan contracts, which generally provide that a lo: Wi may be

repaid at any time before default in. payment. of the

premiums. Mr. Ballagh-did not repay any part of the

principal due under the loan agreement prior to the time

the insurance policy was converted to a-paid up annuity

on December 20, 1956, when the lean agreement was

cancelled. — . -

.

.

“~e 4 . s

32 ” Appendix B

21. Under the arrangement Mr. Ballagh entered into

with Standard Life, he received a discount of 2.85 percent

interest on prepaid premiums held in the premium deposit

fund, but under the terms of the loan agreement he was

required to pay Standard Life interest on the loan at a rate

which would increase from 4 percent to 6.percent. Each

year Standard Life made a profit on the difference between

the discount he was allowed on prepaid premiums and the

interest he was required to pay on the outstanding loan.

No risk of loss was incurred by Standard Life, since his

obligatior to pay was secured by the premium deposit

fund and the cash value of the policy.

Poo

22. The. tabular cash value of an annual -premium

policy increases only through interest on accumulated net

premiums and the additional premiums which the insurance

company receives cach year. Net premium is the. gross

* premium, less whatever portion thereof that is deducted

by the i insurance company to pay for agent’s commissions,

home office administrative expense, and other expenses.

_Althéugh the only out-of-pocket premium paid by Mr.

Ballagh was the initial-annual premium of $10,000 paid in

1947, the cash value of his insurance contract increased

from year to year due to the payment of annual” premiums

out of the premium deposit fund.

23. On November £ 28, 1956, Standard Life sent plain-

tiffs a letter advising them of. at joint life and survivor

annuities available under the insurance contract. The

lette ‘r stated in part as follows:

We have given the figures both on the assumption that

- »you will leave the policy unchanged and pay only on

the Joan interest as it becomes due, and also th ¢ you

convert the policy to paid-up on December 20, 1996

and make no futher [sic] payment~ on it. -

4“

A ppendix B ae

The figures submitted were as follows:

Jornt Lire anb Survivor Annuity Guaranteep 10 Years Avarrasie Dic. 26

Male born Aug. 11, 1903. Female born Nov. 16, 1903

Monthly payments

: Reducing to

Year Cash value Level two-thirds -

If no change and loan interest paid

1956 a $66,388.89 $272.88 $303.40

1967... 74,404.16 ~ 311C1 345.908

1958 ; - 82,700.17 . 352.30 392.00)

1959 ". 1,273.52 - 395.21 $46.85 .

196) 100,120.71, ; 442.53 493°

: If policy converted’to paid-up-Dec. 20, 1956 +

1956 $66,388.89 $272.86 $503.40

1957 68,380.56 , 285:85 317.97

a 70,431.98, 300.04 : 333.85

1959 72,544.94 © 314.12 350.39

1900 0 74,721.26 + 330.27" _ 368.38

The figures shown in the upper table under the column

entitled ‘Cash Value’? represent the sum of the tabular

cash value of the policy and the cash surrender value of the *

premium deposit fund, less the $236,856 owed to Standard

‘Life under the loan agreement... The figures for the years

1957-1960 in ye lower table under the column entitled

-**Cash Value’’ represent in each instance the figure for the

preceding year, plus: interest accumulated thereon at 3

percent per annum. |

24. Plaintiffs’ income tax return for 1947, if which

$45,968.04 paid to Standard Life under the loan agreement

was claimed.as an interest deduction, was,audited and ap-

proved by the Internal Revenue. Service. In plaintiffs? 1952

income tax return they also claimed-a deduction for the.

- $9,693.04 paid as interest to Standard Life under the loan

agreement.. Although the evidence does not show whether

‘the 1952 return was audited by the Internal Revenrie Serv-

ice, no deficiénties were assessed against plaintiffs for that,

year. |

24 Appendix B

Plaintiffs’ income tax returns for 1958 and 1954 were

andited and examined in 1958. However, if the OXIME

agent of the Internal Revenue Service had audited the re-

turns 6 or S months earlier, he would probably have allowed

the payments made by plaintiffs to Standard Life as inter:

est deductions. However, shortly before the audit, the

Assistant Regional Commissioner issued a diree ‘tive, stating

in effect that the examining agents should disallow dedue

tions claimed as interest) payments on such insurance

contracts, ;

». The insurance broker who sold the Standard Lite

insurance contract to Mr. Ballagh sold an identical poliey

and plan to W. Stewart Emmons in 1951, 'T he mechanics of

the transactions Mr. Emmons entered into with Standard

Life and the Corn Exehange Bank were the same. as cin

Mr. Ballagh’s transactions deseribed in these findings.

However, cach year Mr. Emmons borrowed back from the

~ increasing eash-value- of his policy the full amount th: th was

permitted by the terms of the poliey. As a result yhen his

policy was surrendered -or converted, he had an equity of

only $1,000 therein.

~

CONCLUSION OF LAW

Upon the foregoing findings of fact, whieh are made a

part of the judygtnent herein, the court coneludes as a

matter of law that plaintiffs are not entitled to recover and

the petition is dismissed.