Hanover Bank v. Commissioner of Internal Revenue/Opinion of the Court

Despite the seemingly complex factual composition of the two cases consolidated herein, this opinion deals with a relatively simple question of taxation: The extent to which a taxpayer may deduct, through amortization under the Internal Revenue Code of 1939, the premium he has paid in purchasing corporate bonds. In 1953, prior to December 1, the petitioners purchased fully taxable utility bonds at a premium above maturity value. The bonds were callable at the option of the issuer at either a general or special call price, and at either price they were callable upon 30 days' notice. The term 'general call price' is used to designate the price at which the issuer may freely and unconditionally redeem all or any portion of the outstanding bonds from its general funds. The lower, 'special call price,' is the amount the issuer would pay if the bonds were redeemed with cash from certain specially designated funds.

In computing net income, the 1939 Code permits a taxpayer to deduct, through amortization, the premium he has paid in purchasing corporate bonds. Section 125 of the Code, set forth in pertinent part in the margin, provides that the amount of bond premium to be amortized 'shall be determined * *  * with reference to the amount payable on maturity or on earlier call date.' Pursuant to this Section, the petitioners elected to claim on their 1953 income tax returns a deduction for bond premium amortization computed with reference to the special redemption price and to the 30-day redemption period appearing in the bond indentures. The respondent did not question the petitioners' use of the 30-day amortization period, but he disallowed the computation based upon the special redemption price and recomputed the amount of bond premium using the higher, general call price. The Court of Appeals for the Second Circuit affirmed the Tax Court's orders sustaining the Commissioner's deficiency determination. 289 F.2d 69. However, in cases presenting the identical legal issue, the Courts of Appeals for the Third (Evans v. Dudley, 295 F.2d 713) and Sixth (United States v. Parnell, 272 F.2d 943, affirming D.C., 187 F.Supp. 576) Circuits allowed amortization taken with reference to the special redemption prices. To resolve this conflict, we granted certiorari. 368 U.S. 812, 82 S.Ct. 53, 7 L.Ed.2d 21.

Bond premium is the amount a purchaser pays in buying a bond that exceeds the face or call value of the bond. When a bond sells at a premium, it is generally because the interest it bears exceeds the rate of return on similar securities in the current market. For the right to receive this higher interest rate the purchaser of a bond pays a premium price when making the investment. However, interest is taxable to the recipient, and when a premium has been paid the actual interest received is not a true reflection of the bond's yield, but represents in part a return of the premium paid. It was to give effect to this principle that Congress in 1972 enacted Section 125 of the 1939 Code, which for the first time provided for amortization of bond premium for tax purposes.

By providing that amortization could be taken with reference to the 'amount payable on maturity or on earlier call date' (emphasis added), Congress recognized that bonds are generally subject to redemption by the issuer prior to their maturity. In electing to allow amortization with reference to the period the bonds might actually be outstanding, Congress, through the words to which we have lent emphasis, provided that a bondholder could amortize bond premium with reference to any date named in the indenture at which the bond might be called.

A bond indenture might contain any number of possible call dates, but we need only to be concerned in this case with the issuer's right to call the bonds on 30 days' notice at either a general or special call price. Unquestionably, both general and special redemption provisions have a legitimate, though distinct, business purpose, and both were in widespread use well before the enactment of Section 125. The general call price is employed when the issuer finds that the current rate of interest on marketable securities is substantially lower than what it is paying on an outstanding issue. The issuer may then call the bonds at the general price and, following redemption, may refinance the obligation at the lower, prevailing rate of interest. In contrast, the provision for special funds from which bonds may be redeemed at the special call price, serves an entirely different purpose. Bond indentures normally require the issuer to protect the underlying security of the bonds by maintaining the mortgaged property and by insuring that its value is not impaired. This is done, first, through the maintenance of a special sinking fund, to which the issuer is obligated to make periodic payments, and, secondly, through the maintenance of other special funds, to which are added the proceeds from a sale or destruction of mortgaged property, or from its loss through a taking by eminent domain. Although the issuer normally reserves an alternative to maintaining these special funds with cash, circumstances may dictate that the only attractive option from a business standpoint is the payment of cash and, to prevent the accumulation of this idle money, the indenture provides that the issuer may use it to redeem outstanding bonds at a special call price. It is evident that just as prevailing market conditions may render redemption at the special call price unlikely at a given time, the same or different market conditions may also cause redemption at the general call price equally unlikely, particularly in an expanding industry such as utilities. During the period the petitioners held their bonds, none were called at either price, but the risk incurred that they would be called was present with equal force as to both the general and special call provisions. The market for bonds reflects that risk, and the Section of the Code we are asked to interpret takes cognizance of that market reality.

Turning to the specific problem in the instant case, we are asked to determine whether the special price at which the bonds may be redeemed by the issuer from the limited sinking fund account and from the other special funds made available upon the occurrence of certain contingent events (see note 3, supra) is an 'amount payable * *  * on earlier call date' within the meaning of Section 125. For the reasons stated below, we answer this question affirmatively and hold that there is no basis either in the statute, in the legislative history, or in the respondent's own prior interpretations of the statute, for a distinction between reference to a general or special call price in computing amortizable bond premiums under the 1939 Code.

First, we note that the Government has made certain important concessions which lighten considerably the task before us. It does not question the right of the petitioners to amortize bond premium with reference to the 30-day call period, nor does it question amortization to the general call price. In addition, in requesting a rule which will apply to the 'generality of cases,' it professes to have abandoned its argument below which became the rationale of the Second Circuit in holding against the taxpayers, that the statute calls for an analysis into the 'likelihood of redemption' before amortization at a special call price will be permitted. Moreover, the Government does not contend that the transactions entered into by the petitioners were a sham without any business purpose except to gain a tax advantage. Rather, the Government's position in this Court is that before an 'earlier call date' is established with reference to the special call price, the taxpayer must show that 'there is an ascertainable date on which the issuer will become entitled to redeem (a particular) bond at its option.' The Government asserts that it is not enough that the issuer has the right to call some bonds at the special redemption price. Rather, '(i)t must have the right to call the particular bond for which amortization is claimed, for otherwise that bond has no 'earlier call date." The Government's primary reason for urging this interpretation of Section 125 is that the statute has created a tax loophole of major dimension that should be closed short of allowing the deduction sought in this case. While this assertion might have been persuasive in securing enactment of the amendments to the statute made subsequent to the time the transactions involved here took place (see discussion, infra), it may not, of course, have any impact upon our interpretation of the statute under review. We are bound by the meaning of the words used by Congress, taken in light of the pertinent legislative history. In neither do we find support for the Government's interpretation.

This Court was first called upon to construe Section 125 in 1950 in Commissioner v. Korell, 339 U.S. 619, 70 S.Ct. 905, 94 L.Ed. 1108. The taxpayer there had purchased bonds at a premium which reflected in large part not a higher yield of interest, but, rather, the attractiveness of the convertible feature of the bonds. The bonds were callable on 30 days' notice and the taxpayer amortized the premium accordingly. In contesting the deduction thus taken, the Commissioner contended that Section 125, in establishing a deduction for 'amortizable bond premium,' did not include premium paid for the conversion privilege. In rejecting this contention, the Court made it clear that Section 125 was not enacted solely to enable a bondholder to amortize 'true premium,' but that by 'the clear and precise avenue of expression actually adopted by the Congress' (339 U.S., at 625, 70 S.Ct. at 908), the legislation was adopted with 'no distinctions based upon the inducements for paying the premium.' (Id., at 628, 70 S.Ct. at 910).

The decision in Korell led to congressional re-examination of Section 125, and the enactment of Section 217(a) of the Revenue Act of 1950 (64 Stat. 906), which eliminated amortization of bond premiums attributable to a conversion feature. However, response to the Korell decision was specifically limited to the convertible bond situation; no further change was made in the statute which would reflect on its interpretation in the case before us.

In 1954, in enacting the successor to Section 125, Section 171 of the Internal Revenue Code of 1954 (26 U.S.C., 1958 ed., 26 U.S.C.A.), Congress again took cognizance of the tax benefit in question, and determined to eliminate the abuses inherent in permitting amortization with reference to 30-day call periods. Thus Congress further narrowed the loophole by providing that the premium on callable bonds could be amortized to the nearest call date only if such date was more than three years from the date of the original issue of the securities. With particular relevance to the Government's argument in the instant case, it is worthy of note that Congress understood the operation of the statute to the taxpayer's advantage, but limited correction of the abuses inherent in it to elimination of the quick write-off. The House Report accompanying H.R. 8300, which was to become the Internal Revenue Code of 1954, stated (H.R.Rep. No. 1337, 83d Cong., 2d Sess. 26), U.S.Code Cong. and Adm. News 1954, p. 4051:

'Under existing law, a bond premium may be amortized with     reference to the amount payable on maturity or on earlier      call date, at the election of the taxpayer. In the case of     bonds with a very short call feature, such as those providing      for call at any time on 30-day notice, the entire premium may      be deducted in the year of purchase.

'This provision has given rise to tax-avoidance     opportunities. Substantial bond issues have been made subject     to a 30-day call, permitting the purchaser to take an      immediate deduction for the entire premium against ordinary      income. Where the call feature is nominal or inoperative this     permits a deduction for an unreal loss, since the market value of the      bonds ordinarily remains fairly stable over considerable      periods. The bonds may then be resold after 6 months subject     to longterm capital gain treatment. The writeoff of premium     thus affords a gratuitous tax saving, equivalent to the      conversion of a corresponding amount of ordinary income into      capital gain. This process may be repeated indefinitely.

'To curb this type of abuse, your committee's bill provides     that the premium on callable bonds may be amortized to the      nearest call date only if such date is more than 3 years from      the date of original issue of the securities. This provision     will apply only to bonds issued after January 22, 1954, and      acquired after January 22, 1954.' (Emphasis added.)

Not only did Congress fail to make the distinction between general and special call provisions urged by the respondent, but it expressly recognized that deductions could be taken under Section 125 with reference to a call date that was 'nominal or inoperative.' It did not remotely imply that a showing of a right to call all or any part of the outstanding bonds was necessary for operation of the statute. Furthermore, the change that it did adopt was to operate prospectively only.

Finally, in 1958, by adoption of Section 13 of the Technical Amendments Act of 1958, 72 Stat. 1610, Congress eliminated entirely the right to amortize to call date, permitting amortization to be taken only over the period to maturity. Again, the legislative change was prospective only and again no distinction was made with respect to general and special call dates or with respect to a right to call all or a part of the outstanding bonds.

Persuasive evidence that we are correct in our interpretation of Section 125, as bolstered by its legislative history and subsequent amendments, may be found in the respondent's own prior construction of the statute. As is true with the language of the statute itself, the respondent's regulations contained not the slightest hint of the distinction urged upon us here. The Commissioner defined 'earlier call date' in Treas.Reg. 118, § 39.125(b)-2 (see note 10, supra) as any call date prior to maturity, specified in the bond. The regulations in effect in 1953 give no support to the Government's present contention that the taxpayer must show an unconditional right in the issuer to call the outstanding bonds at a particular redemption price before amortization with reference to that price would be permitted. Furthermore, although the petitioners are not entitled to rely upon unpublished private rulings which were not issued specifically to them, such rulings do reveal the interpretation put upon the statute by the agency charged with the responsibility of administering the revenue laws. And, because the Commissioner ruled, in letters addressed to taxpayers requesting them, that amortization with reference to a special call price was proper under the statute, we have further evidence that our construction of allowable bond premium amortization is compelled by the language of the statute.

A firmly established principle of statutory interpretation is that 'the words of statutes-including revenue acts-should be interpreted where possible in their ordinary, everyday senses.' Crane v. Commissioner, 331 U.S. 1, 6, 67 S.Ct. 1047, 1051, 91 L.Ed. 1301. The statute in issue here, in plain and ordinary language, evidences a clear congressional intent to allow amortization with reference to any call date named in the indenture. Under such circumstances we are not at liberty, notwithstanding the apparent tax-saving windfall bestowed upon taxpayers, to add to or alter the words employed to effect a purpose which does not appear on the face of the statute. Moreover, the legislative history, too, is persuasive evidence that the statute, as it appeared in 1953 when these deductions were taken, allowed the deduction refused these taxpayers. Simply stated, an informed Congress enacted Section 125 with full realization of the existence and operation of special call provisions, but chose not to make any distinction between them and general redemption rights. Neither did the Commissioner. Nevertheless, the Government now urges this Court to do what the legislative branch of the Government failed to do or elected not to do. This, of course, is not within our province.

The judgment is reversed.

Mr. Justice FRANKFURTER took no part in the decision of this case.

Mr. Justice WHITE took no part in the consideration or decision of this case.