Petition for Writ of Certiorari — Goldstein v. Commissioner

FILED.

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27 1966.”

“In _— - JOHN F. DAVIS. @LERK

* Sunes Court nf the Mnited Stites eae

Ocronee Tam, 1966 Spee eee

KaPen GOLDSTEIN ah TILE Gorpstiawx,

| Petitioners

—against—- *

- Comnuissiowee OF ‘INTERNAL REvEnve,

é Responden t. i wi 7 : \.

—~ : _ “ : & & : \

ae Barnett and EsrHer BARNETT, .

eats Ada : | Petitioners,

- *_ Commissioner or InTerNat RevEeNvE, s ey By \

| Momsen J. Tepito and. AGNES IPPOLITO,

“Petitioners; Ae See

Comaissionze or INTERNAL REVENUE, Ee aN ;

PETITION FOR WRITS OF CERTIORARI TO THE i ee

: Pe FOR, THE SECOND CIRCUIT ee ire &

sO

a 3 me Oe

“I. ‘i Pincus, * _ - _ BERNARD SPRnMAN a

_ Attorney for Peliitonds ie . Attorney for Pilitioners

515 Madison Avenue > *. 911 Fifth Avenue -

New York, N. Y. 10022 2 New York, N. bi 10022 Le - §

LL. «9 B- foe bere: eres. a g a

——$——

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OF Counsel : SD eee MERE TSA TORIC REET ROT — A:

_ ARNoL”D BROsER - at. ae the Sg:

_ . + 711 Fifth Avenue eat ate :

New York, N. Y. 10022 4 REM LENS as

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RDG AS Rea hem GAN AL hey aot Wat, Se RA eR

Reasons for Granting the: Writ, me Hd : 16 See fe

: Ippolito and Barnett—The Issue of “Sham” Satie a =<

Concnueeon” we : SERS ES SOG aie |

~ Cases: we Ue ee ees 2 NPR OR IE ate oa a

dicitalenas v. ‘Commissioner, 1959, 358 U. S. 498 | eileen 9 oe Fe :

: Depts, et al. v. du Pont, "1939, 308 U. Ss. 488 eee

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Sad y

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AEM eo ction NR

Opinions Below . se SES siherois ys Busre eye gh? - Y hoe

wee La. ei 6 hae . 2

Statute Involved :.. i Seah “a “a . Kk : : |

The Facts (Kapel Goldstein, et al. v: Commissioner) .... 2 . oe |

‘Qiiestions Presented ee oe 5 3) t = Me

Prelithinary

?

The Facts as Barnet et al. NV: Commision) ax : " 2 a

~—— oe eS

The Facts (Michael J. Ippolite, et al. v. Commissioner) 25 ate

6 SPE SOS UP ee

Nog a gin BEE < Ci ON

wee ee ‘CITATIONS: se Fateh take Serise, Gs

Be

eo

Commissioner v. Clay B. Brown, - 1965, 380. U.S. 563 . 9, 20

Crane v. Commissioner, OT, 33 U. S. i. = : 21

fee

Wibedie Pisdibte. Co., “1961, c. A x (904 F. 2d 876, ; mae

_ rev’g 34.T. C. 456 ....22.... rs 16, 19, 30,31

"Friedman, Sadie S., 1960, 34 T. ©. 456 (1960) remanded — :

‘on anothier ground, 1961, C. A.1 1, 24 Pad 816. weight °- =

Gilbert, ‘et al. v. Commjssioner, 1957, C. A % 248 F.

2d 399 oe. 18

tein; Hi D, ‘80 T. C. 1178, aff'd, C. A. 1, 1959, .

> ae “967 ‘FF. 2d 127. (1st Cir. 1959): : Sacha Ae

Gregory’: v. Helverinig, 1935, °298 U.S. wah om ~ 10

Hanover Bank v. Commissioner,. 1962, 369 U. S, 672. i Abed

-~ Hood v. Conimissionér, 20 T. €. M. 1140 (1961) 12

- Knetsch, v. United States, 1960, 364 U.S. 361.16 18,19 -

. Kraft Foods Conipany v. Commissioner, 1956, €. A.

ined 0:

_ 232, F. 2d 118

Libson Shops, tes: ‘Vv, ‘ Koabiie, 1957, 353 U. Ss. 382 .. an.

-Lykes yé U. S., 1952, B43 U. B 218 wc... yaar owe: tl :

Lyne, George @., 31 T. C. 990, aff'd, 1960, C. A. 2, :

278 F. 2d 867 oe pose . , eon

: MacRae, Gordon, 34 T: ¢ 20: rate: aff'd, 1961, C. A. one

9, 294 F.2d 56, cert. denied : 2-0, 29°

_ Maysteel Products, Ine., 33 T.'C.. 1021, rev'd, 1961, ©. A. Ie

. 1, 287 F. 2d 429 ' ) 16, 31

Maxwell Hardware Co. v. Commissioner, 1965, 0. A. 95,

343 F. 2d 713 Seer Be es pecsajee 8 :

Meyer v. U. S., 1964, 375 U.S. 232 sia ce

Old’ Colony R.R. Co. 1 v. Deter paacaats 1932, 284 Uv. S. ;

: 582. ses vi 9

“Rudolph v. U. 8. 1962, 870 U: §, 269, nnrinneenne a

‘Stanton, L. Sis. 34 T: ac. 1 (1960) appeal dismissed

(1961, C. A 2) se -10, 11, 12, 21

Statutes:

“Revenue ‘Act of 1921: ¢ | ae a Hebe se

_ Internal Revenue Code of 1989: ..°)

" Sevtion. 23(b) LM sweet AL

| Section 117 Ses Oo

2 Internal Revenue. Gode of 1954: Ce

Section 163. .... a 2 6,7, 9,10, 11, 18,16, 17, 19, 1

+ Section 165 nents jonpctscndoasoesfenteanspaidl ae

age Section 171 Sitesi octenentesonrensnen 16,17"

Section $0 So ee

‘Section 267 Be We Th

Section 0 oh

"» Section 1091 ee seni pened 11,19

_

2 G. Lake, i v. Commissioner, 1958, 356 U. - 260 . 1 =

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hye yee ene fete Sons beer hae hoes

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s! Interne Revenue Code of 1984:

" Section 11684, ee ee

# Miscellanesue] 7 : ie |

_ Federal Reserve Bulletin ia 1966 eisstebsn Se ae

Statistics of ‘Tneoine—1963; U.-S. “‘Tredsury, Depart. :

ment’ [publication No. 79. (1-66)]. . nice, 24

H. Report No. 2333, 77th ~~? Od Sess., at pp. 92-95 - 16

et ,. Karen GoupsTEnn’ and Tnuie Gomera,

fe ee

ye

| Sipreme Court at te ited 2 ten

ae _ Ocrosen Tan, 1966 Soe

No. EE an ee es 1. etie

— ae

- Conassronin.o OF ‘Iwrenwat, REVENUE, -

Cos! Respondent.

Petitioners,

‘ SRS, i ‘s

Max Barnerr and Esruze Bunxerr, | .

DO Geiate e PIAO oaeea _Peitoners,

ee ih cea

hie | Comansstowin OF ‘Tyraewat aptehias P

boi : A : é i ‘ .

| Micxan J: Trpousro. and Agnes we ;

ste OE NECA SS Batak td ORE Ne ‘Petitioners, :

- Comanssioxzs 0 OF InreRwan aa :

_ PETITION FOR WRITS: OF - CERTIORARI TO THE

- UNITED STATES COURT OF APPEALS

ate rine aes SECOND CIRCUIT, r

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ah 2% 7 &

“The petitioners pray that writs: of certiorari issue to’ «

review judgments of the United States Court of Appeals

for the Second Circuit, entered i in the above-entitled cases, *

sustaining the disallowance of interest deductions on valid :

indebtedness.. J re was entered i in rua case on J uly ;

22, _. ; 7

oa : i Osis 1 Below ° | :

‘The findings of faet and opinion ot t the Tax Court in

, ‘Kapel Goldstein, et al. v. Commissioner are ‘worse re-

ported ues 44 ei 284. f

The findings of fact and opinion of the Tax tant in

* Max Barnett, et. al. v. Commissioner are officially reported

as 44 T.C. 261. :

"The findings of fact and opinion of the Tax Court in ©

Michael J. Ippolito; .et al. v. Commissioner are peewee

‘as T. C. Memo., No. 1965-167.

“The opinions of the Court of Appeals have not etn

4 officially re as ‘yet.

8s. Statute Involved

ere Trmewat Revenve Cone or 1954 ;

- Sec.- 163 (a) GENERAL Rurz.—There shall be allowed.

as ,a deduction all interest paid or accrued within the

ey taxable year on indebtedness. ;

pte: * *#

8

The ests | °.

( Riedl Goldstein, et al. v. Commissioner* )

Tillie Goldstein (hereinafter petitioner) and her hus-

_ band, Kapel Goldstein filed. a joint Federal income tax re-._

-* "The facts in the other two cases are ha cae stated, beginning

at page 22.

7 ae

oan turgigfor ‘the year 1958 employing the ‘cash “receipts. arid

disbursements method of accounting. In the fall of 1958

Petitioner won thé Irish Sweepstakes and ‘collected. $140,-

218. 75; In all of. the transactions hereinafter described,

Petitioner was represented by her son Bernard Goldstein |

s (hereinafter Bernard), a certified Pablie accountant, who iy

acted as her agent.

>

“Or or about ee 31, 1958 Bernard oad for

petitioner $500,000 face amount, U. S. Treasury Notes, °

146% due October 1, 1962 through Garvin, Bantel.& Co.

j (hereinafter Garvin, Bantel) members of the New York

4 and American Stock Exchanges engaged -in the securities

business. Garvin, Bantel were also money brokers. The

v purchase price was $464,687.50 plus accrued interest of |

$1,875.00 for a total of $466,562. 50. On or about December

31, 1958 Petitioner borrowed $465, 000.00 from the First

National Bank ‘of Jersey City (hereinafter Jersey City .

eS Bank) to complete the payment for-the Treasury Notes.

The loan was evidenced by a promissory note, signed by

petitioner, due October 15, 1961 with interest at 4% per

‘annum and sécured by a pledge of the Tréasury Notes. The ‘ ‘

note was with full: recourse and further: provided ’ that

_ either party could accelerate the maturity of the note after.

. thirty days. On or about December 30, 1958, petitioner.

' paid, by certified check, to Jersey City Bank, the sum of

‘$52,596.61 as interest. Me advance ‘to the ance of the

note. ¢ ;

/

During May, 1959, petitioner was sitvined that the J ersey~)

_ City Bank would exercise its call privilege. Gn or about

June 9) 1959, petitioner refinanced the J ersey:City Bank -

.,loan‘with Gruntal & Co., securities brokers (hereinafter _

Gruntal) on a month to month basis. Jersey City Bank |

|

|

4

j

4%

4 .

delivered the Ciccsuey Notes to Giaiial ‘agninet payment

‘of the note together with its check to petitioner for “2, ~

_ 944.61 representing a rebate of'a as of the interest .

previously paid by petitioner. .

’ On or about December 1 111959, petitioner sold the Trea- .°

sury Notes for a price of $458,894.37. plus accrued interest

of $1,270.49 for a total. of $460,254.86 which amount was

credited to Petitioner’ s account with Gruntal. On the same

day, petitioner purchased $500,000.00 face amount U. S. |

Treasury Bonds, 24%% due November 15, 1961 (herein- i

after Treasury Bonds) for a price of $477,109.38 plus

accrued interest of $583.79 for a total of $477,693.17, which

amount was charged to petitioner’s account with Gruntal.

On or about February 4, 1966, petitioner sold $250,000.00 i

- face value of the Treasury Bonds for a total of $242,657.97

including accrued interest. On or about June 13, 1960, peti-

9 tioner sold the remaining $250,000.00 Treasury Bonds for

a total of $247,384.51 including: accrued interest. ‘The pro-

_ ceeds from both sales were credited to petitioner’ s account

with Grantal.. Saka 4,

| Ye es.

li or about December ‘31, 1958, petitioner purchased

from Royal State Bank’ of New York (hereinafter Royal —

State) $500,000.00 face amount U.S. Treasury Ni otes, 144%

due October 1, 1961. The purchase price was $475,937.50

plus accrued interest of $1,875. 00 for a total of $47 7, 812. 50.

Petitioner paid the purchase price by borrowing $480, 000.00

om from Royal ‘State and executed.a full recourse. note due

June 30, 1960, secured by a pledge of the Treasury Notes,

with interest at 4% per annum. On or about December 30,

621958, petitioner paid, by certified check to Royal State the

sum of $28,800.00 as interest in advance to the signet

of the note “

&

9)

On or about J une 9, », 1960, petitioner sold the, Treasury

Notes for a price of $487,187. 50 plus aecrued interest in

‘the amount of $1,434.43 for a total of $488,621.93. The

proceeds were used to pay off the $480, 000.00 loan from

Royal State and the balance, together. with a rebate ‘of.

a portion of the. interest, previously prepaid by petitioner, ,

in the amount of $1, 200.00, was remitted to petitioner.

At no time did awe of the lenders or brokers involved ~~ :*

in the foregoing transactions sell short the’ subject or

equivalent securities as a means of financing the loan to :

~ petitioner; petitioner retained ownership of the Notes and

. Bonds for periods ranging from three months to 18 months; *. ¥*

all transactions were affected at the’ prevailing market

prices for the days involved; all transactions were -exe-

cuted upon the instructions of Bernard acting as agent

_ for-petitioner; and there were née prior arrangements or

commitments .of any kind by any party with respect to ‘thy

ownership: or disposition of the securities.

Petitioner, in the joint. income tax return for 1958, _de-

ducted the interest paid to Jersey City Bank and Royal

State in the amounts of $52,596.61 and $28,800.00 respec- |

tivély, or a total of $81,396.61. All-rebates of interest and

gains on the sales of the ‘securities were reported in the ~

-Income tax returns of petitioner for the years in which

realized. : 3

~ Questions Presented

‘Is it proper to deny the daddies, ane Section 163

of the Internal Revenue Code of 1954, of interest. prepaid

on loans obtained from banks to pay -part of the- -purchase-

price of United States Treasury securities where the sub-

_ ject, transactions are regular in every respect, but the tax-

6

; 2

payer’ s.sole inintive in entering ‘into the transaction is

'_ presumed to be the avoidance, of income tax.

e PRS bas »

>

These cases*involve the deductibility of interest under

Section 163 of the Internal Revenue:Code of 1954 (herein- ©

after 1954 Code). In each of the cases, the petitioner placed

. orders ‘with a broker to purchase U. 8S, Treasury Certifi-

cates. The orders were. duly executed and in each case.

. moneys were borrowed from a bank.to pay part of the

purchase price and interest was prepaid on the borrew-

ing. The petitioners duly exécuted and delivered promis-

sory notes for the amount of the loans to the Descapabta

lenders with full recourse. The interest was paid in cash.

. The hypothecated securities were retained by the aa

- ing banks until, the taxpayers sold their securities and paid

‘off their loans with t the proceeds.

The three cases joined in this petition were heard to-_

gether by the Court of Appeals. The principal decision was. .

issued by the Court i in the case 2 case of Kapel Goldstein, etal,

_ with subsidiary “decisions i in the other two cases, following “

' Goldstein, and making certain further. observations... The -

essential question in the three cases is the same, although

the Court held the transactions in Barnett and-in I ppolito

- "were “sham”, but not in Goldstein. In compliance with Rule

23, the three.‘cases are consolidated in this one petition.

(separate appendices are provided), which is frafned> in

terms of petitioner Goldstein alone in -the interest of

clarity. A brief addendum deals with*the i igsue of “sham”

in the other cases. ¥ reese

:. :

Petitioner’s purchase of Treasury securities is no ‘differ-

_ ent in form or substance from thousands of such purchases

‘ made by taxpayers every day. : inal

There was no short saleby anyone.’ Petitioner’s securi-.

.. _ ties were pledged for purchase-money loans with two banks,

as is the common every-day custom. The transactians were oh

regular—ordinary. —=—=— , ioe

-@ ° - — In fact, the Second Circuit so found, rejecting the Tax

x Court’s view that the. transactions were “sham”. Instead, —

eee -it endorsed Judge Fay’s dissenting view that the loan ar- _

rangements were “‘-. . . regular and, moreover, indis- .

tinguishable from any other legitimate loan transaction

contracted for the purchase of government securities.’ 44 -

T. C., at 301...” (App., Goldstein, 70a). Buratine Z

* The: Second.Circuit, nevertheless, disallowed: the interest

paid by petitioner on this wholly regular indebtedness as a

_ déduction under Section 163. Postulating the existence: of

~ a “close question,” the Court looked to-the Congressional

__purpose_underlying Section 163 and concluded’ that peti-

'_tioner’s: interest payments, altliough entirely real—in no

“respect sham—were not deductible because her borrowings

——

——-

*In certain earlier’ cases, United States government obligations .

purchased and then pledged by taxpayers.were oi short by the .

pledgees and the proceeds of such sales were advanced to the ©

pledgors as “loans” with which to pay the obligations. Deduction .

. Of the interest paid on such “loans” by the pledgors has been denied

in such cases. Cf. Goodstein v. Com., C. A. 1, 1959,/267 F. 24 127;

Lynch v. Com., 1960, C. A.°2, 2738F. 2d. 86,. aff’g 31 T. C. 990; *

MacRae v. Com., 1961, C. A. 9, 294 F. 2d 56, aff 34 T. C. 20, -

cert. den., ete. As stated by the Tax Cour in MacRae, supra

(at p. 27), the short sale by the dealer neutralizes the ‘original pur-

chase by-the taxpayer-pledgor. This is not such.a case ; the securities

purchased by the. petitioner in this case were pledged with a bank

which retained the securities as collateral in the usual way through-

out the duration of the loan. = baat re ct dal

see

- were not “purposive.” The deduction is allowable, the Court ey.

said, if the taxpayer’s desire to ier ee an interest deduc-.

| tion ‘is “only one of mixed motives” for the borrowing— .-

if there i is “some substance. to ‘the loan arrangement beyond .

the taxpayer’ s desire to secure. the deduction” (App. 78a).

_ Phis i is a-new ‘and far-reaching thesis, superimposed on

the interest deduction after a half century of its ap- -

plication ang,interpretationi It is, we submit, ill-founded,

- resting oli'a series of invalid assumptions. It ignores.time- _

tested: precepts laid down by this Court. It is in hard,

conflict’ with the principle applied in serdlte! docksidnk: by

other Courts of Appeal._It:advances an irrational and im- |

practical_test of mischievous potential for many investors

“and for the security markets, particularly the market for

United States obligations. All-of this is readily apparent,

_ The. first false premise of the ‘decision below is that a

“close question” exists. As the Court conéeded, ‘petitioner’s

transactions were “regular” and “indistinguishable from

any other legitimate loan transaction.” Interest is de- .

ductible on “other” legitimate transactions and the statute

provides no visible basis for differentiating one legitimate .

loan transaction from another. a

The statutory language is clear and ‘uncomplicated. | But

_the court ignored its plain directive and obviously gave:

_ thought to the; moral aspect—whether the statute shoud

allow the deduction in view of petitioner’s. presumed mo-

tive. On that basis, the question may be close, but it is .

wholly: irrelevant.’ The taxpayer. is entitled to the ponies: |

of the statute as it is written.

2 Of. Mazwell Hardware Co. v. Com., 1965, C. A. 9, 343 F. 2d.

713,720, viz. : “Taxation is peculiarly a matter of statutory law,

a

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No possible ambiguity appears in Section 168 to require

an external search for its meaning. Long-standing pre-

_ cepts of this Court bar’ such a search where the meaning is

‘plain.’ Close analysis of the lower Court’s unorthodox in-

_. terpretation confirms the wisdom of those precepts, ‘See -

. infra, - nc a - ae

A second false premise appears in the Court’s statement

of the Congressional purpose. “The underlying notion”, <

as the Court puts it, of Section 163 is that, “if an individual . -

or corporation desires to engage in purposive activity, there

is no reason why a taxpayer who borrows for that purpose :

should fare worse ‘ . . than one who finances the venture

.

and in applying gt law to the determination and computation of.

income and dedué@ns, the Courts do not make moral judgments. ¢

..'.. It is not d matter of ‘conscience. but of statute and the deter-

mination of Congressional intent.” ee Path as ;

*In Old Colony Railroad Company v. Com., 1932, 284 U..S. 552, .

* 628. Ct. 211, this Court held that in construing the phrase “interest,

. ++, 0n its indebtedness” as used in section 234,°1921 Act (cognate”:

to present section 163), “(T)he legislature must.be presumed to.

_. use words in their known antl ofdinary. signification, Leiy’s Lesect

v. M’Cartee, t. 102, 110... .” and this “. . . is always to-be. —

preferred to curious, narrow,. hidden sense that nothing but —

the exigencies of a-hard case and the ingenuity and study of an

* aeute and powerful: intellect would Giscover,.. . . DeGanay v.

Lederer, 250 U..8. 376, 381.” Sifnffarly : Deputy, et al. v. du Pont,’

1939, 308 U. S. 488, 60 S. Ct. 363. Cf. Com. v. Clay B. Brown, 1965, |

380 U.S. 563, 85 S. Ct...1162, where this Court recently said. of.

_ the term “sale” as used, in Section 117, 1939 IR: €. (relating to .

capital gains and losses) : “A ‘sale’, however, is a°common event in. _

the non-tax world ; and since it is used in the Codé without limiting -

> definition and without legislative history indicating a contrary:

result, its common and ordinary meaning should at least be .per-

suasive of its meaning as used in the Internal Revenue Code. Gen- .

erally speaking, the language in. the Revenue Act, just as in any

statute, is to be given its ordinary meaning. ...-. (cit.).” eye"

It may be supposed that plain language in a statute serves

as a beacon to the taxpayer which becomes a trap for the unwary

if a*hidden or twisted meaning is applied. ———— Px

5 er

ea —_—_ to ae or avoid inco

‘10

with capital: that. would otherwise have beens yielding in- Ee

come” (App. 788),

The flaw -in the Court’s Statement is the proviso, i.e.,

that the intexest deduction was intended to apply only if a

. taxpayer desires to engage in “purposive” activity. The.

_ Court offers no reference to any specific Committee Re- .

- port. or other authority for “its. statement.. Others have —

. stated the Congressional purpose. differently.« The Court’s -

- “statement begs. the question, assuming what needs to be

‘proved. What -we are given, obviously, is the Court’s con-

*. eeption of. the “Congressional intent”, .tailored to fit its-

-. own moral view of what the statute should provide, rather

; ‘than what Congress did, in fact, provide.

The: thesis - of the lower Court does. not fit the statute |

ae ‘as written, but rather, contradicts its plain and rational —

»* meaning. The Court has introduced “motive” as an ele-.

‘ment in Section 163, although the provision makes no men-

tion of it and this Court has: long taught that motive is

irrelevant in. applying a tax statute.*vThe test that the

Court ‘has interposed is essentially, “motive to make a

profit.” But.“indebtedness” in Section 163 has always and

: negessarily éncompassed personal borrowings. Can-the sin- :

gle, indivisible word be FeRany interpreted to require a

a 6a if

*In L. Lee Stanton, 34 T. C. 1, at page 7, Judge Murdock wrote

for the majority that, apart from the: requirement that -the trans-

action he real, “Congress has indicated that this deduction‘is not

dependént in any other way upon the purpose or motive of the

borrower or the use made of the borrowed 1 money.” Cf. Judge:Fay’s

dissent in Goldstein to the effect that there is no legislative history * "

_ .. indicating an intent that contradicts the plain ene of Section

. 168 (App. 58a). nee ‘x

- 5Cf. Gregory v. Helvering, 1935, 293 U. Ss. 465, 55. s. Ct. 266.

‘Where Congress ‘has desired to thoes a test relating to “motive”’,.

it has done so explicitly, as iri the \ease of Section | ig ne to”

tax.” * |

as

Pt

« id oT

f ee 3 Bes 11

-profit motive in some transactions; but not in others? To at- -

_ tribute such a schizophrenic intention to Congress surely

demeans the legal process itself ;* no less,-an interpretation

which: validates personal borrowings to gamble, for ex-

ample, or for a variety of other antisocial purposes—with- ae

out semblance of restriction on motive—but would dif-

ferentiate one legitimate loan to pay. for United’ States

. securities from another on the basis of presumed motive.

Indeed, the conclusion of the Court below, that Congress. |

did not intend to allow the interest deduction in a trans-

action motivated -solely. by tax avoidance is flatly contra-

dicted by the legislative history of the statute.’ :

_ © The- Commissioner’s own regulations provide categorically :

Ҥ1.163-1. Interest deduction in general. -{a) Except as otherwise

provided in sections 264 to 267, inclusive, interest paid or acerued

within the taxble year on indebtedness shall be allowed as a

deduction in computing income .. ..” The present case does not :

fall within any of the express exceptions stated in Sections 264-267

of thé. Code. When; for example, Congress desired to limit ‘the -

deduction for losses in respect: to certain business, profit and per-

sonal classifications, it did so by explicit enumeration. Section 165, —

194LRC.

"The legislative history of Section 23(b) (identical antecedent

“of present Section 163) is traced at length in the case of L. Lee

Stanton, supra, at pp. 7-8. This shows that proposed amendments

. to the provision, designed to bar the. interest deduction on “ine.

- debtedness incurred or continued for the ‘purpose of evading the .

payment of taxes”, were repeatedly stricken from proposed Rev, —

enue bills. hth

_ Whenever Congress desired to limit the allowance’of a deduction

for interest, it has repeatedly done so by specific legislation. It has

done this over the years by denying a deduction for interest on

indebtedness to purchase or carry tax exempt securities (Section

265(2)); by denying a deduction for’ interest on. indebtedness to

_ purchase single premium annuity contracts’ (subsequently further

- modified) (Section 264 (a) (2) ) ; by denying a deduction for interest

on indebtedness incurred to purchase certain types of life insurancée

(Section 264(a)(2)), ete. It has denied a deduction for losses

sustained in,“wash sales” (Section 1091), ete. Instances of this sort

are, of course, too common and numerous to be detailed in full here.

2

. We qabenif! ‘that the prinsigle’ of this. ease is, nice ir

: “rational; it may be expected to beget uncertainty.and con-

fasion in the administration of Section 163. It is, more-

“over, impractical and ' latently ‘mischievous.

Given the condition that a taxpayer knows at the outset 7

that any economic loss he may sustain on his investment - 3

will be offset by the deduction for interest paid, we submit Be

‘’ that no one—né mortal, at least—may be reasonably sure

‘what his true motive was in making the purchase, not even,

| perhaps, the individual himeelf. ‘The certainty of redemp-

human being to-ignore. How is one’ to probe the innermost

thoughts of each investor ? : Gis ae

The case of L. Lée Stanton, s supra, is significant on this. ;

' .tion from loss is too strong an incentive for ‘the ordinary,

oe

Stanton, a floor broker for an. odd-lot house on the ‘New ..

York. Stock Exchange, bought $5,000,000 face. amount of

‘U.S. Treasury - Vip % Notes maturing in two years, for

_ $4,921,968.75, plus accrued interest. He. borrowed ‘$5,000,000. |

~ from four banks at 3% interest, nearly twice his yield of

1.55%, to pay for the Notes. ‘Stanton realized a .pre-tax -

(economic) loss on the resale of the Notes, but a profit after

deduction of the: ‘interest he paid on his loan. i: i

The Tax Court held Stanton could’ euiarly -dedaet the

"interest “paid on his loan.’ Four judges dissented. While .

finding that" Stanton had expected to realize a profit before

_ taxes (at p- 4) and concluding that “it was a transaction en-’.

" tered into for profit” (at p. 8), the majority went to great:

~ lengths i in. tracing the legislative history-of the interest de-.

* duction DAANIRION, and analyzing, its language, concluding :

‘ 8 See also Hood v. Com’r (1961), 20 T. C.-M. 1140 ahd Sadie 8°"

_ Friedman v: Com. (1960), 34 T. C. 456 Feifpres on another ..

_ ‘ground, © A. Jyl961, 294 F. 2d 876.

®. - 9

‘ag "

&

/ ar

: “Con ress has included no , requirement in the Code:

» that the borrowed money: be used in connection with a

transaction entered into. for Profit or that it cannot .

be borrowed for nonbusiness purposes or used in an

action entered into for profit or that’ it cannot be bor-

; Towed for personal or nonbusiness purposes or used En

| in a transaction involving - tax benefits, cf. Commis-. =

sioner v. Park, 113 F. 2d 352, and the Tax Court has —

4 ‘ authority “to read ot write such Tequirements into

Cr. ,

:

°

In light of its jaa that Stanton. did in fact wiih

pre-tax: profit, the majority’ s” painstaking analysis of the

cases (Pierce, J., at p..17 )* (2)! It strongly suggests that. |

: 1,

statement i in the tnajority ape

“The ‘Internal ‘Bevenuel Code iieael heavy. taxes

upon Lee and he sought a legal way within the provi-

. sions of:the Code to make a profit for himself after

: ‘taxes, the only kind of “siete a can do any tax-

payer” any good” (at p..8). Ws ey

he impractizality of. asking 1 revenue ane to niki on |

} fair determination as: to the true motive Af a particular a1

‘taxpayer. in this situation is. evident. Or is the Revenue

©

be

‘history and language of. the statute and its positive con-*; <

clusion that the deduction is: not. dependent on profit mo-

tive evidently reflect -two facts:. (1). -The four dissenting |

Judges strongly questioned Stanton’s ‘true motive; one went .

_ 80. far as to suggest ‘thatgStanton had been, motivated yy

Livingstone—the entrepeneur of the. short-sale transactions |

- at issue in Goodstéin v. Com., Supra, and.a host* of other.

¢ the Majority, ‘itself, was rit entirely sure of Stanton’s “ -

- motive. That inference ‘is strengthened “by, this fagfher

ene , 4

Service now: to instruct its field? agents ta give wealthy

brokers ‘the benefit.of the ddabt, and to disallow the “dedue-

tion, automatically to all ‘Sweepstake winners?. What about .

the. ordinary investor? “An odd lot floor broker like Mr.

Stanton has no’greater expertise in the Government securi-

' ; ties area by. reason of his calling than many an amateur

or sémi-professional. investor. with a bit of native acumen

about money. and a habit of reading the, seer news.® .

‘There is the problem. wie

The ordingry investor who may: feel dere” is a profit

+ stented! in'a margin purchase:of Treasury securities might fe

well hesitate if he’s prudent or well-advised, and ask him-.

- self: “Will.they believe my inotive was to make a profit?

I can’t risk losing the deduction for the interest Pu have- ?

'. to pay, since then Pil havea certain loss.” ‘~*~

Multiply this by the hundreds, /or oe ee and the

rule @pplied here must, in due course, alter the. breadth

‘and liquidity of the evel Ye government obligations..

It is not humanly practical to determine with any cer- :

. tainty what motivated a taxpayer in. these transactions. The

- pri le laid down by the Second. Circuit defies reason, |

als6, supposing that tax motive may be the sole reason

“in any case. “ .. . the interest deduction. should be per-

mitted,” the Court wrote, “whenever it can be said that the

taxpayer’s desire. to secure an interest deduction is only

one of mixed motives that prompts the taxpayer to borrow

funds” (App. 78a).. Petitioner was denied her deduction

on that premise. The fallacy of. this“ is that, whatever: the

+A

canes

° The function of an ‘odd lot floor broker on the New Yo! Stock: .

~ Exchange ,is to buy and sell round lots of securities (muléples of ~

100 shares) as odd lot orders (under-100 shares) are received from

‘+ * nember firms, in order to keep the securitiés position of se firm

- in the desired balance. a .

©

> 6

> .¢ eae

ee

_ -

ae

"15

odds, the possibility of profit ne when obligations. of.

the United ‘States are bought, whatever the price. The ”

_- securities have a free market that fluctuates. with various

influencés, particularly the condition of: the money market. -

It is unrealistic to suppose that one who buys these obliga-

tions with partly borrowed money simple exercises all

. hope and ‘expectation of realizing the potential economic

profit, apart from the interest deduction, from ‘his mind .

and heart. If the. possibility exists, the hope also exists.

_ The hypothesis of the lower Court-that there : may be a pure |

_ tax motive ina

sgAike this is fanciful.

a |

There is thus presented here the question- whether titer.

est paid. on a lean to pay for Dnited States Treasury

securities may be denied ‘asa deduction where the tax-

payer’s motive in entering into the transaction is presumed .

Petitioner submits that since no proper basis appears

to differentiate between Section 163 and. various other pro- |

visions of the Internal Revenue Code, the question really.

presented is whether any transaction may be disregarded.

_ + for tax purposes where the sole motive ty be presumed ae

to be tax avoidance.

By granting certiorari in this case,. this Court can dear “i

away a great burden of uncertainty and confusion. The -

» broad character of sabe wl ga dist and the funda- .

mental ground of legislative purpose on which the decision -

purports to rest make it a potentially important precedent... ,

not only for the interest deduction but for other areas as

well. The uncertainty and confusion are likely to be aggra-

i °

*

6

to be solely to avoid income tax—slthough the transaction ee

is in no way sham. | | ae

vated by the conflict that exists between the Second Cireuit

~ and two others as to the validity of the principle applied

and, also, by the evident misapplication by the Second Cir- .

cuit of this Court’s decision in Knetsch v. U. S., 1960, 364

"U.S. 361, 81 S. Ct..132. See infra. -

; “Réesons for pane the ‘Writ

o ; *

| 1. A-conflict in piatrolling. itidatnts exists between this

- ease and Fabreeka Products Co., et al. v. Com., , 1961, C, A.

1, .294 F. 2d 876. The facts of the two ‘cases ‘are not the i

same, but the conflict is, nevertheléss, direct and outright,

demonstrating the “broad reach of the principle | at issue.

"In Fabreeka Products, the First Circuit held that a pur-

- ‘chaser: of securities is entitled to the tax benefits of Sec- ©

‘tion 171 of the 1954 Code’even though it was properly found |

_ that the purchase was made solely to obtain the tax benefit.” -

Section 171, as then constituted, gave a taxpayer who pur-

chased callable bonds at a premium the right to amortize

the premium to the earliest call date, whether the bonds

were called or not." ‘The Fabreeka Company had purchased

_ public utility bonds callable in 30 days at a premium, held

‘the bonds for 30 days (they were: not called), and then dis-

tributed them as a dividend to its shareholders. The -re-

cipients. promptly sold the bonds for about the same pre-

_ mium as the Company had paid. The Commissioner af teeta :

a ewe

o

20 Similarly : Maysteet Produets; Ine. Vv. enti. 1961, C..- A. 7, :

287 F. 2d 429, rev’g and rem’g 33 T. C. 1021.

11 This was intended. to compensate for that part of the-< coupon :

interest received which exceeded the actual yield of the bonds to

the particular purchaser, reflecting the premium paid, which was

taxed as ordinary income. H. Rept. No. 2333, 77th ‘Cong., 2d Sess.,

at pp. 92-95; Hanover Bank v. Com.,-369 U. S. 672 (1962).

wa

17

Fabreeka’s deduction of the premium it had paid because

’ the sole motive of the transaction was tax reduction. |

~ While recognizing that the Commissioner’s charge was

“amply supported,” the Court of Appeals nevertheless held >

the taxpay er’s motive did not ‘make ‘its transaction shan.

It. said:

“Unless ‘Congress makes it abundantly clear, we do not

think that tax consequences should, be dependent ypon

the. discovery of a purpose or-state of mind, whether .

it be elaborate or simple. The limitation which the”

government asks us to read into the statute even if,

appealing in a particular instance, might’ readily, as we

- said in. another connection in Eaton v. White, 1934,

70. F. 2d 449 at 452, ‘create’ difficulties and *uncertain-

ties niore objectionable in their results than any scem-

ing: inequities" which would ‘be. ‘eliminated or ‘pre-

vented’. eit

Section 163 and Section..171..are similar in design’ and

purpose. * Section 163 was’ designed to put borrowers on

a par with those who use capital, Section 171 was enacted _

to put purchasers of non-exempt bonds on a par with pur-

chasers of tax-exempt bonds, in respect of a premium paid;

__it-:permitted amortization of the premium in lieu of a capi-

tal loss. Thus, each provision was designed to cure an in- |

equity.” Neither. refers expressly to motive. Both cases

were decided on the premise that the taxpayers parchased |

--the bonds with no motive save tax avoidance. In Fabreeka,

_the First Cireuit held. the taxpayer’s motive was imma-

terial; here, the Second Circuit made it the « crux of the deci-: °

sion. The conflict 1 is clear.

12 Amortized bond premium is a cost of carrying the bond similar —

to interest. ‘

ae

—

~

2. The conflict between the two circuits gains significance

_ from another fact: Each Court offers'as authority for its

own contrary position the decision of this Court in Knetsch, _

supra. It thus appears in plain view that the lower courts

are confused, and in: disagreement, as to the true meaning

of Knetsch. This ease, we submit, reflects a plain misappli- eds

cation of the doctrine of Knetsch.

In Knetsch, the taxpayer reborrowed all of his own pay-

; ments on an: ostensible $8,000,000 annuity, leaving a ne aa

cash value of about $1,000, and this Court concluded that,

“Knetsch’s transactions with’ the insurance company did

not affect his beneficial interest except to reduce his tax.”

There was no substance to the claimed. iridebtedness. In.

this ease, the petitioner borrowed ‘money to pay for securi-

ties which she purchased and which she continued to’ own

at all relevant times—an arrangement which the lower

' court itself deomed-<indistinguishable from any other legiti-

‘mate loan transaction.” The lower Court has obviously mis- - oe

conceived the true meaning of Knetsch in this case. mas. A

‘In Knetsch, also, this Court “put aside. a finde. . that

Knetsch’s only ‘motive in ‘purchasing [the ssanityy was to

— to secure | an interest deduction.” ‘The Second Cir-

pee

18Jn Knetsch; this Court adopted the test ‘tessa by Judge

Hand dissenting i in Gilbert, et al. v. Com., C..A. 2, 1957, 248 F. 2d

399; 410-411, i.e., that the transaction must appreciably affect the

taxpayer’ s beneficial interest. It is clear that this Court held in

‘Knetsch that the interest was not deductible because the trans-

action was essentially unreal and not because the taxpayer had

seught to avoid the tax. Similarly, in his Gilbert dissent, Judge

Hand stated that the taxpayer, “will also be relieved, if he supposes

. that the transaction will, or may cause him a loss, although i in that

event it is true that his only motive will be to ayoid the tax.” The

decision of the Court below in this case-is clearly contrary to ced

ee in ‘principle. .

-

19

cuit evidently interpreted this as leaving open. for con-

sideration the question of taxpayer’ s motive. The First

Circuit clearly understood that Knetsch precludes con- -_

sideration of the taxpayer’s motive. The confrontation of

the Circuits over the meaning of Knetsch is direct and

bold. The significance of the issue as presented i in this case,

‘for the orderly administration: of ‘the revenue, for inves-

_ tors and for. the govérnment bond market, make it an ap-

- propriate medium for the clarification of Knetsch, as well

as for the resolution of the conflict between the First and ;

Second Circuits.

3, ‘The full ramifications of the decision in this ease are

‘hard to measure, but they are necessarily broad. The iden- .

tity of: basic issue with Fabreeka Products, arising under

a different Code provision, fairly attests this. Nothing in

the terms or history of Section 163 makes the ‘principle

peculiar to the interest deduction. It is common, for ex-

ample, for-taxpayers to sell securities at a profit i in order

to. offset prior capital lossés which are non-beneficial, and

then to repurchase the same securities after a short interval

-. in order. to continue the investment. Such a sale and pur- —

chase are clearly effected solely for tax purposes, yet have

‘always been recognized as valid and effective., ae?

‘What if a corporation’ issues debentures as a dividend

to its stockholder solely to obtain a deduction for interest

“thereafter paid on such debentures, i in lieu of. non-deduct- *

ible dividendst. That poole question was urease in

ou Tn respect to lies at a eaid Colinas enacted the so-called:

“wash-sale” Tule, barring deduction of the loss if substantially

- identical securities are acquired by the taxpayer within a period .

beginning 30 days before the date of sale and ending 30 days after

‘such date. Section 1091, 1954 - R. C.° :

2

D> & a

mtn yen ately actin ca

20

Kraft Foods Co. v: Com., 1956, 232 F; 24 118. The Second

Cireuit there held that the debentures might -not be dis® .

regarded for tax purposes, rejecting the Commissioner’s. _

complaint that the sole purpose of the transaction was to.

' minimize. taxes. The divergence of principle bétween: that |

case and this one must certainly confound the application

of Section 163 for taxpayer and Revenue. Service alike.

Which rule shall apply in future cases of variant facts re :

identical’ tax-saving issue? |

The circumstances in which transactions may be carried. .

_ out solely for tax purposes, or which are practical solely: by

reason of the tax consequences, appear highly diverse.’*

_ The importance of the issue herein cannot be exaggerated,

generally, as well as for the interest deduction specifically.**

-18.Cf, Com. v. Clay B. Brown, supra, in which this Court held

that the sale of a business to a tax-exempt organization, to be paid

-. for out of the income of the business within 10 years, provided

@ capital gain to the seller. As Mr. Justice Harlan, wrote .in his

coneurring opinion, “were it not for the tax laws, the respondent's

transaétion with the Institute would_make no sense, except as one

arising from a charitable impulse”” AS oes 13

16 The importance of the issue is attested by published reports of

the Federal Reserve Board, which show that in the month of

oo

. April, 1966, alone, New York. Stock Exchange member firms ex- ~

tended credit to customers,-on securities pledged as collateral, in

the total amount of $5,671,000,000. In the same month banks

extended credit to customers (other than brokers and dealers) in

‘ the total of $2,283,000,000. Of these amounts, $26,000,000 and a

$105,000,000 in Joans were made on‘ the collateral of U. 8S. Govern-

ment: securities. During this same period, brokers and dealers

_ borrowed $108,000,000 on the security of U. S. Government bonds.

(Federal Reserve Bulletin, August 1966.) This does not take into — .

account security loans extended by institutions other than Stock

‘Exchange firms or banks. Moreover, the importance of the interest

deduction generally is reflected in statistics released by the Treasyry

Department, showing that the deductions for interest claimed: by .

all taxpayers on Federa] income tax returns in 1963 amounted to

. $10,274,461 000, accounting for approximately 25% of all itemized

gt

4, The status of the Stanton case is also in n urgent néed

- of clarification. The Second Cireuit’s opinion: makes no

reference to Stanton." This, plus the equivocal character . a

of the majority opinion in Stanton leaves the issue in a -

state of uncertainty. The implicit threat of the tax avoid-

ance test advanced by the Second Circuit can only. be: ex-

pected to have a dampening effect on investing and trad-

_ ing in ‘United States Treasury obligations—a matter of.

obvious importance to the Féderal Government, as well: as

to investors ‘generally. and the securities business. “This -

effect may be hard to, measure, but investors and their ad- \

visers will be aware of the threat and may be expected to

be wary of incurring an-jnevitable loss because of disallow-

-ance of the interest deduction. The uncertainty attending.

the issue is reflected in the fact that four separate opinions |

were written in the Stanton case. The impracticality of the

principle adduced here and the burdens it imposes on the ~

administration of the Revenue, with the attendant poten-

tial for discrimination, compound the need for clarification.

e

- deductions (Statistics of Income—1963 ; U.S: Senans Department

[publication No. 79 (1-66)]).

This Court has frequently granted certiorari on the basis that

* the cases represented important federal tax questions. Such

ceases include: Crane v. Commissioner, 1947, 331 U. S. 1, involving

basis of property; Libson Shops, Inc. v. Koehler, 1957, 353 U. S. .

382, involving the carryover of net operating losses: P. G. Lake,

Ine. v. Commissioner, 1958, 356 U..S. 260, involving assignment of

oil royalty payments ; Camnarano v. Commissioner, 1959, 358 U. S.

498, involving deductions for amounts paid to influence legisla-

tion; Rudolph v. U. 8., 1962, 370 U.'S: 269, involving definition of

income and ordinary ‘and necessary business expenses; Meyer v.

U. &., 1964, 375 U. S. 233, involving tax liens; Lykes v. U. S., 1952,

343%). Ss. 118, involving deductibility of legal mia

17 The Commissioner filed an appeal i in the Stanton case, ‘but this”

was later withdrawn.

te)

i

2b op NO en EG EZ

ee

The Facts

¢ Maz Barnett, et al, “We Cominteriqner d

Max’ Barnett : ceabatinn: Petitioner) i in 1957 was the

recipient of a. $50,000. prize pursuant .to a..contest con-—

- o ducted by” a New York newspaper. Pétitioner filed a joint .

Federal i income tax’ réturn with his wife for the year 1957, «

- employing the cash reonipts and disbursements method of

accounting. |

On or about Desens 20, 1957 outthionks purchased: from,

the Gibraffar Financial Corporation (hereinafter GFC)

$750,000 face. ‘amount of U.S. Treasury Certificates of In-

debtedness, 334% due December 1, 1958 (hereinafter Trea-

sury Certificates) at a “price of 100.23 plus accrued interest -

’ for a total of $757,090.49. GFC. was,a dealer in Municipal, .

State and Federal bonds. Petitioner paid GFC $9,199.86

by check, as margin on the purchase of ‘the Saat

Certificates:

: Petitioner: ae a note for - $747, 890. 63 wi. to . a

., GEC, dated December’ 23, 1957, for the balance of the pur- _ « __-

chase price, bearing - interest at the rate. of. 53%4% per

annum and due September 23, 1958. The note provided,

. among other things, that petitioner could prepay the: ‘prin-

cipal of the loan at any time without penalty except that

if prepaid within thirty. days from the date of the note he.

would be: liable for thirty days interest; and if the interest

due 6n the note was prepaid, the interest rate would be ~ ©

reduced to 542% or 552% depgnding on when prepaid. On.

' . . December 26, 1957 petitioner paid GFC: $30, 850.49 by check

as interést in advance to the maturity of the note.

~On December 20, 1957, GFC: purchased $750,000 face

amount of Treasury Certificates from The First Boston 7

G

3.

| “Corporation, a well kno wn: dealet in 1 government aie.”

On December 23, 1957, re borrowed $740,000 at 4% in-

terest from Cleveland Trust: Company which it used to

finance - ‘the $747,890.63 loan to petitioner, *° ~

“Petitioner pledged the Treasury Certificates, which he

had purchased, with GFC to collateralize his loan for .

$747,890. 63 giving to GFC, among other things, the Tight

. to hypothecate and re-hypothecate those securities. ‘GFC

re-hypothecated the Treasury Certificates with Cleveland

Trust to collateralize its $740,000 loan. | !

Pech: did not ‘sell these or equivalent ‘Treasury Certifi-?

s “short”. Chemical Bank, as the correspondent of ... :

Geuiand teak at all times during the term that the loan | -

- to GFC was in force, held the Treasury Certificates de- :

' livered by GFC (which were { ledged by petitioner) i in iden-

tical ‘form as security for

C’s loan with Cleveland Trust.:

pgements, between petitioner, GFC or

There were no arr.

anyone else conc

sition of the Treasury Certificates ; and the ultimate dis-

_ position thereof was ‘solely within the control of petitioner..

All ‘transactions were affected . at the nic Hag Ny market :

prices forthe days involved.

“On January 2, 1958 petitioner sold to @Fc $250, 000 han

value of. the Treasury Certificates at a price of 100.25 plus

accrued interest for -a total of $252,803.06. The proceeds

‘from such sale were used in part to reduce petitioner’s

loan with GFC, and the balance refunded to him. On Janu-

_ ary 3, 1958,,GFC-mailed its eheck to petitioner in the

amount of $3,506. 18 which represented his profit on the

purchase and sale plus one third of, the margin deposit

isin! put up by him.

ing the continued ownership or dispo- . ‘

a@*

+

24 e

On J antiary 17, 1958, petitioner sold to GFC: the 3 re

| ing $500,000 face value Treasury ‘Certificates at a price, ef |

101 plus accrued intérest for a total, of $507,575.55. The

" proceeds from such sale*were used in part to reduce peti-

tioner’s loan with GFC, and the balance refunded to ‘him.

On January 20, 1958" GFC mailed its check to petitioner,

ie in the amount of :$8,981. 80 which represented his profit

on the purchase and sale plus the balance a the margin

deposit originally put up by him.

Following the sales by petitioner and the ‘repayment of 4

his loan from GFC, petitioner received refunds, of. interest

representing the unearned portion sa canons prepaid on |

“December 26, 1957, as follows:

January 3, 1958 ........ PR Ser $ 9,140.89

January 20, 1958 ne . 18,282.17

” $97,493.06

: -Petifioner deducted} in. his 1957 joint Federal income :

tax return, interest in the amount of $30,850.49 represent-_

ing the amount paid as interest to GFC on December 26,

1957. All rebates of interest and gain on the sale of the

securities were reported i in their 1958 joint Hederal i income »

- taxreturn: Wwe | Leia : |

“~

~

a tii The. Facts si

ee Michael J. Ippolito, et al, v. Commissioner) \ \

-. Michael J, Ippolito (hereinafter petitio: EES

to be the holder of a winnitig ticket on tik Irish Sweep\ ‘3

stakes and, in 1955, collected $138,567.50, Petitioner filed. -

a joint Federal income tax return with his - wife for the ae,

year 1957, employing the ca eeipts and disbursements

_ Inethod of accounting.. — wR Sepia) COMORES 7,

* + On or ‘about December 23, 1955, petitioner, through his =~

accountant, purchased from thé Gibraltar Financial Gér- ei

_ poration (hereinafter GFC) $1,000,000 face amount 9£47, S. ~

Treasury Certificates of Indebtedness, 254 percox#due De-

‘ cember 1, 1956 (hereinafter Treasury Certificates) at a.

‘price: of 100.1 plus accrued ‘interest for a fotal of $1,001,-

864.75. GFC was a dealer in Municipal, State and. Federal -

cree ee MR Talet ATNT AO CORE Ne on

Petitioner executed a noté, with recourse,’ dated De-

cemiber 27, 1955, for $1,000,000 payable to GFO for part

of the -purchase price, bearing interest at the rate of 4

percent per annum and dué December 1, 1956. The note

provided, among other things, that petitioner. could. prepay —

- the principal sum of the loan at any time without penalty:

_ except that if prepayment occurred within 30. days from

"the date of the note, he would be liable for 30 days’ interest.

Petitioner paid GFC $1,864.75 by eheck as margin.on the

purchase of the Treasury Certificates, and pledged the 3

Treasury Certificates to collateralize. his loan; giving to —

GFC the right to hypothecate and rehypothecate the securi- °

_ ties.-On or before December. 27, 1955, petitioner paid GFC.

$37,777.77 by check as interest in advance on the note for

) ’ Mea - ve . @.

a

% ee:

HD + Gwe ge:

$1,000,000 t®the maturity of the note; and on thé same date

; paid GFC $2, 500 by check as'a loan placement fee. —

Onor about Deseigy*t 23, 1955, GFC purchased $1,000,000

- face anfount of Treasury Certificates from C. J. Devine: & -

Co., a well-known dealer in Government bonds. On or |

' about December 27, 1955, GEC borrowed from Cleveland |

a Trust Company a total of $1,945,000 -on a 34% percént in-:

- teres demand note pledging as collateral security therefor

$2,000,000 face amount of Treasury Certificates, ‘As part -

of such borrowing, GFC rehypothecated the $1,000,000 face

amount of the Treasury Certificates previously pledged

with it by petitioner to secure $965,000 of the aforesaid total

loan of $1,945,000 ithe Portion of the loan obtained for

- petitiofier’s: account]. Ei eae Hips 8

On or about Sieaen 12; 1956, petitioner sold to GFC

e

”

, the $1,000,000 face amount of Treasury Certificates-ata ~~

® price of 100-3/64 for a total price of ” 000,468.75 plus”

accrued interest of $3,084.02. Age 7 a are

-Qn-or about January 17; 1956, ‘GFC mailed to petitioner .

its cheek i in the amount of $3,240.27, representing the bal-

ance in petitaonet: s ‘account after the sale of the Securities.

’ .o

On the same 2 day GFC, mailed its check i in the amount of

$34, 444, 47 to petitioner as. a rebate of interest previously

; Epis ceowk in ‘accordance with the. terms. of the note.

Petitioner deducted, in hiis© 1955: joint ‘Federal income

tax return, interest in the amount of $37,777.77, represent-

- ing the amount: paid as interest. to GFC en December 27,.

°1955, together with the. $2, 500 Joan placement fee. All re-

bates of interest. and- gains on the’ sales of the securities -

were e reported ; in their 1956 joint income tax return,

Bow ag

i : a

’ ‘ ..¢

, i % ° °

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. _‘.. @FC did not at any time sell short the same or equiva-

lent securities as the Treasury certificates purchased” by

_ petitioner which are here in issue. Cleveland Trust Com-

pany, at all times here ‘material held $1, 000,000 of these

Treasury certificates as collateral for its loan, to- GFC.

ae transactions of the: petitioner here at issue were

? effected at the market prices: prevailing for the day of exe-

cution. Neither petitioner nor his accountant had any ar-

Paps. rangements with GFC concerning ‘the continued ownership

' | >... . or disposition of the treasury certificates (other than the

| " usual protective provisions : ‘set forth. in petitioner’ s note),

el . and the ultimate disposition thereof was anny within ‘the

) -. eontrol of petitioner. ce ge

Ippolito and: Barnett—The Issue of “Shatin”

romans’ ae ae %

. The faet differences. between the cases ‘of Yopolito ind 7

Barnett and. that of Goldstein’: are: (1) the latter held .

~. the original Treasury. Notes, which she had purchased, for _

approximately 12 months in-one instance and 18 months

_ in the second instance; Ippolito -held his securities. 25° days

and Barnett for 12 to 30. days. (2) Goldstein obtained her -.

* loans. directly from.the banks concerned. Ippolito and. °

Barnett obtained their loans from the broker who had pur- .

chased the Securities; the broker rehypothecated the securi- ©

ties with the Cleveland Trust Company which retained them .

throughout thé duration of the transactions at issue. |

_ There was no short sale by anyone, of the securities pur-

chased by either” Barnett or r Ippolito, or. aan ssivwiant

securities. yee ! e

. In Barnett, the Tax Court noted that ‘the certificates e

ae | ae, eo in the’ name of the broker, GFC, and that

ee . 0 o

ie :

neither thé broker nor Barnett had possession—the cer-

- tifieates were held by | Chemical Corn Exchange. Bank in

New York, as correspondent for the lender bank, Cleveland

Trust Co. The Court found that: “Petitioner did not have

any control at.any time over the $750, 000.00 of cértificates ; 8

also, that petitioner failed to: prove that the arrangements -

- with GFC amounted to anything more than a- “paper trans-

action” (App., Barnett, 22a-24a). ee.

' The Tax Court found, further, that the iano

had no substance and bona fides - apart from income tax .

purposes. |

The Court of Appeals agibed with the last jialinitiin and .

said, “it follows from what we said in Goldstem that. the -

Tax Court’s disallowance’ of: the deduction must be id

firmed” (App., Barnett, 42a). :

In Ippolito, where Judge ‘Pay of the Tax Court had not .

“made such a finding, the Court of Appeals nevertheless

concluded that, “the facts the Tax Court did find fully ©

: warrant the same conclusion” (App. is Ippolito, 14a).

It is thus clear that the Court of Appeals has, applied

. the same principle in these cases as in Goldstein. |

‘The Court of Appeals further concluded in the Barnett.

S ease that the nature of the arrangement between the tax-:

payer and his broker, plus the extremely short duration

of the loan transaction,.lead to the coftclusion that “the

purported loan transaction here was indeed without sub-

stance and was a ‘sham’ of ‘the discredited Goodstein

variety . -, 738 (App.,. Barnett, 43a).

Petiisstat submit that this conclusion i is ‘wholly without

factual basis. “The einer case was. one of those in

/ Gectetin v. Com., supra, ‘referred to. i the Coprt; should not

_ be confused with the Goldstein case now before this Court. .

‘ ad

7

29

_ which the pledgee-lender sold short the’ same securities

as were pledged with it, borrowed the pledged securities

to make delivery against its sale and advanced the pro-

ceeds to the pledgor; this advance was the loan at issue

in Goodstein and like cases. The Courts took the position

that the sale by the pledgee-lender could. properly be at- :

tributed to the taxpayér-pledgor and the short sale by the

pledgee thus nullified the investment by the taxpayer and

there was ‘ho real indebtedness based on.an hypothecated

investment. See MacRae v. Com., supra at page 27.

. The fact simply is that-there was no short sale by anyone. -

. in the Barnett or Ippolito cases, any more than in Goldstein. —

Examination of the ‘facts in either of these cases will show |

that the dealings between the taxpayers and the broker .

were no different from those in any. other of the thousands ~ :

of margin transactions that tame pace every single business a

day. — ; i HG

It is evident that the lower Courts ‘ste labelled the trans..

- actions in Barnett and Ippolito as “sham” not because of a

lack of substance or reality in the purchase of the Trea-—

sury Certificates or of their hypothecation, but because of

the ‘tax avoidance motive of the transaction. This is made

clear by this further statement in athe Vonrt of Appeals’ :

opinion in Barnett: a |

“This plan is similar to, but significantly more trans-

parent than the plan devised by the taxpayer and her

advisors in Goldstein v. Commissioner, —— F. 24 ——

(2 Cir. 1966), also decided coe, ll +

| ‘Since the Court held that the transactions ‘in Goldstein

were real, not sham, it is clear that when it referred to

the instant transactions as “more transparent” than Gold-'

a

stem, it meant only that the tax saving purpose was more |

obvious—more readily.visible to the naked eye. Petitioners -

_ agree that this is so; but it does not disqualify their trans-

. actions for the Section 163 deduction. As stated by the

First Circuit Court in -Fabreeka capone. = in a

Similar. context :

“But this describes neither a sham transaction, nor one -

‘unmarked by events or risks beyond the control of the

taxpayer nor one. different in substance and effect from

_what it appeared to be on its face. Cf. Commissioner

v. Tower, 1945, 327 U. S. 280; Johnson v. Commis-

sioner, 2nd Cir. 1936, 86 F. 2d 710; Gregory v. Helver-

ing, 1935, 293 U. S. 465; Knetsch v, United States,

1960, 364 U. S. 361.”

Thése tat ciatla kept their securities for less than a

month. But there is no requirement in Section 163 as to .

the time that hypothecated securities must be held to qual-

- ify. Many margin securitiés transactions.last no more than —

+ a day, yet, the interest paid is allowable.as a deduction, and

“it is- regularly allowed. Facts cited by the Courts as indica-

tive of “sham”, such as that petitioners did not have pos-

session of their securities (App., Barnett, 28a, Eppolito,

14a), merely describe the normal margin transaction. i

These petitioners purchased their securities validly and

obtained legal, enforceable bank loans through their broker.

to pay portions of the ae ana elec They paid the in-

terest in cash.

‘The lower Courts have manifestly equated tax avoidance -

motive with “sham” in these cases, gontrary to law. Cf.

Fabreeka Products, Inc. v. Com., ore

The real issue in these cases is the same as in Goldstein:

Whether petitioners’ tax saving motive disqualifies the .

interest which they paid on their indebtédness a8°a de-

duction under Section 163. Certiorari should be granted

in all three cases to determine that question in view of its

importance and the conflict with the Fabreeka and Maysteel :

cases, supra, as well as the other grounds here advanced.

CONCLUSION m ;

eae

For nee reasons set forth, it is respectfully urged that

a writ of certiorari issue to the Court of Appeals for the

aes Circuit in each of the cases. herein joined.

De 43 Respectfully submitted,

I. Mever Puncus BERNARD , :

_ Attorney for Petitioners Attorney for Petitioners

_515 Madison Avenue — 711 Fifth Avenue

New York, N. Y. 10022". | New York, N. ¥. 10022

: Of Dail

ARNOLD Seine pees

711 Fifth Avenue

New York, N. Y. 10022