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Tax Lien Certificate |
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Paul K. Ashby and Gretchen G. Ashby v. Commissioner Thomas
B. Roberts, Esq., for the petitioners. Donald W. Wolf, Esq., for
the respondent. BRUCE,
Judge: This
proceeding involves deficiencies in Federal income tax for the
years 1955 and 1956 in the amounts of $125.59 and $133.65,
respectively. After certain concessions by petitioners the sole
issue remaining is whether the amounts of $382.17 and $653.85,
which represent a 4 percent statutory penalty received by
petitioner in 1955 and 1956, respectively, upon redemption of
certain parcels of real estate purchased by petitioner at
delinquent tax sales and held for more than 6 months, constitute
capital gain or ordinary income. Findings of Fact The
stipulated facts are so found and are incorporated herein by this
reference. Paul
K. and Gretchen G. Ashby, husband and wife, are residents of Paul
K. Ashby, hereinafter referred to as the petitioner, has been in
the real estate business for approximately 30 years and is a
licensed real estate broker regularly employed by Paul C. Shay
Realty Co., Number of Total
Year Parcels Bid For Amounts Bid
1951 .... 1 $ 40.47
1952 .... 8 548.12
1953 .... 39 2,680.65
1954 .... 115 7,811.13
1955 .... 77 6,768.66
Such
delinquent tax sales were conducted by In
bidding for properties at delinquent tax sales petitioner's idea
was not that he would own them, but that delinquent taxpayers
would redeem them. Petitioner's sole objective in purchasing such
properties was to obtain profit from the 4 percent penalty and the
6 percent interest. Shortly
after the tax sales petitioner contacted the delinquent owners to
have them redeem their property. Approximately 60 percent of the
delinquent owners redeemed their property within 6 months after
the tax sales held in December of 1952, 1953, 1954, 1955, and
1956. Virtually all of the parcels of real property were redeemed,
but occasionally, when certain parcels were not redeemed,
petitioner surrendered the certificate of purchase to the During
the years 1955 and 1956, 111 and 129 parcels of real estate,
respectively, were redeemed by the delinquent owners thereof by
making payment to the auditor of Polk County, Iowa, of the amounts
for which such parcels were sold plus 4 percent of such amount as
a penalty, with 6 percent interest per annum on the whole amount
from the date of sale, plus the amount of all general taxes paid
by petitioner on any of said parcels for any subsequent year or
years, with a similar penalty added to the amounts of the payments
for each subsequent year and 6 percent interest per annum on the
total amount from the time of payment. All of these redemptions
occurred more than 6 months after the dates on which petitioner
purchased the redeemed parcels at tax sales and more than 6 months
after the date on which he paid the general taxes assessed against
such parcels for the year or years subsequent to the year for
which the general taxes involved in the tax sales were assessed.
The aforementioned amounts originally bid by petitioner and
subsequent taxes paid by him as well as penalties and interest
thereon for the years 1955 and 1956 were as follows: Taxes for
Year Amount Bid Subsequent Years Interest Penalty
1955 .... $ 7,847.52 $1,843.47 $ 612.47 $382.17
1956 .... 10,001.51 6,485.36 1,374.54 653.85
During
the years 1955 and 1956 petitioner received payments from the Polk
County auditor in the respective amounts of $22,140.57 and
$23,753.34, plus interest of 6 percent, as a result of the
redemption of real property successfully bid for at tax sales in
the respective amounts of $21,289 and $22,839.75. The
profits resulting from the aforementioned redemptions were
reported by petitioners on their joint tax returns for the years
1955 and 1956 as follows: Interest Income Long-Term Capital
Year (6% Interest) Gain (4% Penalty)
1955 .... $1,122.61 $851.57
1956 .... 2,683.78 913.59
The
amounts of $382.17 and $653.85, representing a 4 percent statutory
penalty received by petitioner upon redemption of certain parcels
of real property by the owners thereof during the years 1955 and
1956, said parcels having been bid for by petitioner at delinquent
tax sales more than 6 months earlier, constitute ordinary income. Opinion The
sole issue presented concerns the taxability of the 4 percent
penalty received by petitioner upon redemption of properties
purchased by him at delinquent tax sales and held by him for more
than 6 months. Petitioner contends that the property interest
represented by the certificate of purchase constitutes a capital
asset under section
1221 , Internal Revenue Code of 1954, and that the 4 percent
penalty paid to petitioner upon the redemption thereof constitutes
capital gain under section
1222 . Respondent contends that the certificates of purchase
were not "capital assets" as defined by section
1221 , and that even assuming they were capital assets, there
was no "sale or exchange" within the meaning of section
1222 , and, therefore, the amounts received by petitioner
constituted ordinary income. These statutes, so far as relevant,
are set forth in the margin. 1 We
agree with respondent, under the facts and circumstances presented
herein, that the certificates of purchase or the interests
evidenced by them, which are involved herein, were not
"capital assets," as defined by section
1221 , and consequently there was no "sale or exchange of
a capital asset" within the meaning of section
1222 , such as would entitle petitioner to capital gain
treatment of the gain realized by him upon redemption by the
owners of the real estate involved. Section
1221(1) provides that "the term 'capital assets' means
property held by the taxpayer (whether or not connected with his
trade or business), but does not include--(1) stock in trade of
the taxpayer or other property of a kind which would properly be
included in the inventory of the taxpayer if on hand at the close
of the taxable year, or property held by the taxpayer primarily
for sale to customers in the ordinary course of his trade or
business." [Italics supplied.] We need not determine
whether the certificates of purchase, or the interests represented
by them, were "property of a kind which would properly be
included in the inventory of the taxpayer if on hand at the close
of the taxable year," as suggested in the alternative by
respondent, for, in our opinion, petitioner was clearly in the
business of buying tax liens, with the expectation of realizing
gain from the redemption or other disposition thereof (cf.
Intercounty Operating Corp. [Dec.
14,138 ], 4 T. C. 55), and assuming, for the purposes of this
case but without determining, that the certificates of purchase or
the interests evidenced by them were "property" and that
the redemptions by the owners of the real estate involved were
"sales," as contended by petitioner, it is clear that
such certificates of purchase or interests were "held"
by petitioner "primarily for sale to customers in the
ordinary course of his trade or business" and accordingly
were not "capital assets" within the meaning of section
1221(1) . In
determining whether or not property was held primarily for sale to
customers in the regular course of a taxpayer's trade or business,
the courts have evolved a number of criteria among which are the
intent of the seller with respect to the particular asset or
assets in question; the purpose for which the property was
acquired, held, and sold; the volume, frequency, continuity, and
substantiality of the sales; the proximity of sale to purchase;
and the extent of sales activity on the part of the seller or his
agents. These factors are to be viewed in the light of all the
facts and no single factor is controlling. Eline Realty Co.
[Dec. 24,388 ],
35 T. C. 1; W. T. Thrift, Sr. [Dec.
17,863 ], 15 T. C. 366; Boomhower v. United States [48-1
USTC ¶9133 ], 74 F. Supp. 997 (N. D. Iowa). Equally material
to a proper consideration of the question is a recognition of the
fundamental objective of the capital gain provisions of the Code,
that is, to grant preferential treatment to gains realized upon
those transactions which are not normally the source of business
income. Referring to these objectives, the Supreme Court, in Corn
Products Refining Co. v. Commissioner [55-2
USTC ¶9746 ], 350 Since
this section [section
117 , I. R. C., 1939] is an exception from the normal tax
requirements of the Internal Revenue Code, the definition of a
capital asset must be narrowly applied and its exclusions
interpreted broadly. Petitioner
is a licensed real estate broker and has been in the real estate
business for approximately 30 years. He began attending delinquent
tax sales in 1949 or 1950. During the years 1951, 1952, 1953,
1954, and 1955, he was the successful bidder and received
certificates of purchase on 1, 8, 39, 115, and 77 parcels of real
property, respectively. During the years 1955 and 1956, 11 and 129
parcels, respectively, on which petitioner had held certificates
of purchase for more than 6 months, were redeemed by the
delinquent owners of the read estate. The 4 percent penalty
receipts in issue were derived from these redemptions. It
is quite clear from the record presented that petitioner acquired
the certificates of purchase at delinquent tax sales with the
intent of having them redeemed by the delinquent taxpayers as soon
as possible. His primary objective was to make the profit
represented by the 4 percent penalty, with the 6 percent interest
as an ancillary objective. With this in mind he contacted the
delinquent taxpayers shortly after the tax sales and suggested
early redemption. He was not interested in waiting passively for
the expiration of the substantial period of time (approximately 5
years) necessary to secure a tax deed and clear title. He took
active steps to produre an early redemption. Approximately 60
percent of all the delinquent owners whose properties were sold in
1952 to 1956, inclusive, and for which petitioner received
certificates of purchase, redeemed their properties within 6
months of the tax sales. The redemption involved (111 in 1955 and
129 in 1956) were made more than 6 months after the tax sales but
apparently before the expiration of the 3-year period when
petitioner would have been entitled to a tax deed. The redemptions
were frequent and continuous. They were not casual transactions,
but very much a part of petitioner's trade or business of
purchasing and disposing of interests in delinquent tax
properties. While the tax sales occurred only once annually, the
redemptions were more frequent, as was petitioner's contacting of
the delinquent owners. Petitioner also testified he contacted
owners prior to the tax sales, apparently for the purpose of
ascertaining the probabilities of early redemption. The total
effect of all his activities compels the conclusion that he was in
the trade or business of buying and disposing of tax liens and
that the property interests acquired by him at the tax sales were
held by him primarily for sale to customers in the ordinary course
of his trade or business. Whether or not such activity was a part
of his regular employment as a real estate broker is immaterial;
it is well established that a person may be engaged in more than
one business at the same time. Joseph M. Philbin [Dec.
21,942 ], 26 T. C. 1159; Friend v. Commissioner [52-2
USTC ¶9428 ], 198 F. 2d 285 (C. A. 10, 1952), affirming a
Memorandum Opinion of this Court [Dec.
18,688(M) ]. Nor is it material that the business or
occupation in question does not take all his time or is seasonal
and not active the year round. Snell v. Commissioner [38-2
USTC ¶9417 ], 97 F. 2d 891, affirming a Memorandum Opinion [Dec.
9509-C ] of the Board of Tax Appeals. He devoted whatever time
was necessary to carry on the business. Solly K. Finally,
there is no merit in petitioner's argument that the delinquent
owners who redeemed their properties were not
"customers" within the meaning of section
1221(1) . While it is true the "redemption" was
limited to the owners of the real estate or one having a
redeemable interest therein, for the purposes of this case, they
were nevertheless "purchasers" of the outstanding tax
liens and therefore "customers." The fact that the owner
of the real estate was the most likely purchaser and that in him
petitioner had a ready made market did not prevent such a
purchaser from being a customer. Moreover, petitioner could have
assigned the certificates of purchase to others prior to
redemption. Section 446.31, Reviewed
by the Court. Decision will be entered for the respondent. 1 SEC. 1221
. CAPITAL ASSET DEFINED. For
purposes of this subtitle, the term "capital asset"
means property held by the taxpayer (whether or not connected with
his trade or business), but does not include-- (1)
stock in trade of the taxpayer or other property of a kind which
would properly be included in the inventory of the taxpayer if on
hand at the close of the taxable year, or property held by the
taxpayer primarily for sale to customers in the ordinary course of
his trade or business; * * * SEC.
1222 . OTHER TERMS RELATING TO CAPITAL GAINS AND LOSSES. For
purposes of this subtitle-- * * * (3)
Long-term capital gain.--The term "long-term capital
gain" means gain from the sale or exchange of a capital asset
held for more than 6 months, if and to the extent such gain is
taken into account in computing gross income. * * * TIETJENS,
Judge, concurring: In
my opinion, the redemption of the certificates of purchase by the
property owners was not a sale or exchange of such certificates
and the gains realized by petitioner on his transactions
constituted ordinary income. See Kanawha Valley Bank [Dec.
14,199 ], 4 T. C. 252. WITHEY,
FISHER, MULRONEY, and DRENNEN, Judges, agree with this concurring
opinion.
Intercounty Operating Corporation v. Commissioner H.
B. McCawley, Esq., for the petitioner. F. S. Gettle, Esq., for the
respondent. Respondent
determined that petitioner was a personal holding company and
liable as such for surtax on its income under section 500 of the
Internal Revenue Code, in the amount of $670.68 for the fiscal
year ended Findings of Fact The
petitioner is a corporation organized in 1937 under the laws of All
of petitioner's capital stock has always been owned by five
individuals. Petitioner
was engaged in the real estate business and the purchase of tax
liens, but its principal business was the purchase of tax liens on
real properties located in The
procedure which was followed by the respective three counties in
making its sales of tax liens to petitioner, and the procedure
which was followed by petitioner in making its purchases of such
liens, and in receiving amounts in redemption thereof are as
hereinafter set out. In
In
In
In
all three counties the tax sale was for state, county and school
taxes. In all three counties the holder of the tax sale
certificate would, upon surrender of the certificate, obtain a
deed from the proper official after the expiration of the period
of redemption had expired and the property had not been redeemed. The
excess of the amounts received by the petitioner in the taxable
years from the redemption of tax liens held by it above the
amounts paid by it in the purchase of such liens did not
constitute interest. In
the spring of 1940 petitioner acquired title through foreclosure
of tax liens, to certain unimproved real estate in the City of
Yonkers, New York. Petitioner retained this title throughout the
taxable year. The tax liens were purchased by it in the spring of
1938 and the particular real estate covered by such tax liens,
with the cost of the liens to petitioner, are as follows: 12 lots
in "Lawrence Park",--cost $8,113.53; a four acre tract
known as "Valley Farms",--cost $4,739.92; and two lots
identified in the record as Items 5358 and 5365 at a cost
respectively of $311.14 and $212.57. As
of January 1941 the fair market values of the properties were as
follows: " As
of January 1941 taxes for three years had accrued on certain of
the properties as follows: On " Petitioner
after acquiring the titles to these properties in the spring of
1940 made continuous efforts, during the remainder of 1940, to
sell the "Lawrence Park" properties through the medium
of newspaper advertisements, real estate brokers, and the use of
the exclusive services of a person employed for that purpose; and
petitioner also during the same period made efforts to sell the
"Valley Farms" tract through the medium of advertising
and the mailing of several thousands of descriptive circulars.
Petitioner also made efforts during this same period to sell Items
5358 and 5365. All of these efforts were unavailing and none of
the properties was sold. After acquiring the " Petitioner's
president submitted to its board of directors a report dated "RESOLVED that the said report of the President dated "FURTHER RESOLVED that in accordance with the
recommendations contained in the President's said report and for
the reasons therein stated, this Corporation abandon as of (Here is set out description of the above mentioned
properties and their book cost of $13,377.16.) Respondent
disallowed $11,001.77 of the $13,337.16 loss claimed by petitioner
on its original return for the fiscal year ended The
petitioner's interest in the " Opinion TYSON,
Judge: There
is no controversy between the parties as to the excess of the
amounts received by petitioner in the taxable years from the
redemption of tax liens by it above the amounts paid by it in the
purchase of such liens; and petitioner does not deny that such
excess was gain, but denies that it was interest as is contended
by respondent. It is also undisputed that all of petitioner's
outstanding stock was then owned by not more than five individuals
and that over 94 per cent of its gross income for the fiscal year
ended January 31, 1940 and over 99 per cent of its gross income
for the fiscal year ended January 31, 1941 consisted of such
excess, thus bringing petitioner, with regard to such stock
ownership and percentages of gross income, within the provisions
of section
501(a)(1) and (2) 1
of the Interal Revenue Code relating to the definition of a
personal holding company and its income within section
502 of that code if such excess constituted interest. The
first issue therefore is whether such excess constituted interest
within the meaning of section
502(a) of the Internal Revenue Code. 2 On
the first issue respondent contends that the New York statutes
designate as "interest" the amount of the gain realized
by petitioner through the redemption of its tax sale certificates,
represented by certain percentages upon the amount paid for such
certificates, and that for that reason alone such gain should be
held to be interest within the meaning of section
502(a) , supra, and in the amount of at least 80 per
cent of petitioner's gross income under section
502(a)(1) , supra. He also contends that the gain
constitutes such interest within the broad meaning of section
502 independently of the provisions of the We
will first consider the effect of the New York statutes on the
question of whether the gains, represented by the percentages on
the amounts paid by petitioner for the tax lien certificates, and
received by it from redemption of its tax liens constitute
interest includable in petitioner's personal holding company
income under section
502(a) , supra. Chapter
477 of the Laws of New York of 1932 operative during the years of
the purchase of the tax lien certificates and the redemptions of
the lands involved, dealing with the sale of lands for taxes and
the redemption of same in Nassau County, New York, amending section
85 of chapter 541 of the Laws of 1916, as added by chapter 154
of the Laws of 1919, provides, in part, as follows: Section
85 . * * * Such lands shall be sold for an amount sufficient
to pay all the taxes and assessments due thereon for the years for
the taxes of which said sales shall be made with interest thereon
to the time of sale, and all costs, expenses and charges accrued
thereon and * * * said amount paid for such property shall carry
and bear the maximum interest and penalties as follows: Ten per
centum on the purchase price, if redeemed within 6 months of date
of sale. An additional 10 per centum on the purchase price if
redeemed after the expiration of six months and within twelve
months of the date of sale * * * (followed by similar language
with regard to additional percentages covering each six months
until four years have expired) * * * The rate of interest at which
any person or persons shall offer to take the lot or parcel of
land to be sold shall be established by his bid. The rate thus
established shall be the rate of interest up to the time of the
redemption of the property purchased and until the expiration of
four years. Section
89 . The owner of, or any person interested in, * * * any real
estate sold for taxes * * * as aforesaid, may redeem the same at
any time within forty-eight months after the date of such sale
upon the following terms: If redeemed within Forty-five months by
paying to the county treasurer the sum for which such property was
purchased with the interest or penalties thereon, * * * calculated
and added to such purchase price as provided in section eight-five
hereof. * * * The
provisions of chapter 175 of the Laws of New York, 1937, section
45 , and chapter 152 of the Laws of New York of 1929, section
49 , with reference to the sale of lands for unpaid taxes and
their redemption in Suffolk County, New York, are, in effect,
identical with sections
85 and 89 of
the Laws of New York, 1932, chapter 477, above quoted, except that
the maximum rate of interest and penalties is six per cent instead
of 10 per cent and the period of redemption is 36 instead of 48
months. The
provisions of chapter 175, supra, above referred to, were
in effect, as agreed by the parties on brief, during the years of
the purchases of the tax lien certificates and the redemption of
the lands involved. Chapter
441 of the Laws of New York of 1938, as amended with regard to Section 20. Payments and fees--The purchasers at such sale
shall pay the amounts of their respective bids to the said
treasurer immediately after the sale, and after such payments
shall have been made the said treasurer shall and a penalty of ten
per centum thereto for the benefit of the said purchasers, and
shall give the purchaser of any such real estate a certificate
describing the lands purchased, the sum paid and the penalty
attached thereto, * * * Section
22 . Redemption of lands for unpaid taxes--At any time within
two years after the last day of any sale of land for taxes as
aforesaid, any person may redeem the same by paying to the county
treasurer, for the use of the purchaser, * * * the sums mentioned
in his certificate, with interest thereon at the rate of ten per
cent per annum from the date of such sale. Section
31 . Lien holders may redeem.--Any person having an interest
in or lien upon premises sold for taxes, pursuant to the
provisions of this act, and remaining unredeemed after the
expiration of the two year period prescribed in section twenty-two
of this act, may thereafter and at any time before proceedings are
instituted by any purchaser to obtain possession and title of
lands sold for unpaid taxes * * * redeem said land by paying into
the county treasury such consideration money with the addition of
thirty-five percentum thereon * * *. The
above provisions of Chapter 441, or their counterparts in Chapter
107, supra, were in effect, as agreed by the parties on
brief, during the years of the purchases of the tax lien
certificates in Monroe County by petitioner and the redemption of
the lands in that county from such liens. The
contention of respondent that the gains of petitioner from the
redemption of its various tax lien certificates constitute
interest within the meaning of section
502(a) , supra, because the New York statutes designate
the percentages received by petitioner, (which represent such
gains), as interest is fallacious for the reason, if none other,
that those statutes do not designate the percentages as being
comprised of interest alone, but designate them as including
interest and penalties without any allocation of the percentages
as between interest and penalties and without providing a method
by which they could be allocated except possibly as to Monroe
County. However,
there is another and conclusive reason why this contention of
respondent is fallacious, even if the percentages were plainly
designated in the New York statutes as interest, that reason being
that such designation would not control the interpretation of the
meaning of the word interest as it is used in section
502(a) , supra. The well established rule applying to
the interpretation of a Federal statute such as is here being
considered is stated in Burnet v. Harmel, 287 U. S. 103,
100 [3
USTC ¶990 ], as follows: It is the will of Congress which controls, and the expression
of its will in legislation, in the absence of language evidencing
a different purpose, is to be interpreted so as to give a uniform
application to a nationwide scheme of taxation. * * *. State law
may control only when the federal taxing act, by express language
or necessary implication, makes its own operation dependent upon
state law. See
also Lyeth v. Hoey, 305 Section
502(a) , supra, "neither says nor implies that the
determination of" what is interest thereunder is to be
controlled by state law. "For the purpose of applying this
section * * *, the Act of Congress has its own criteria,
irrespective of any particular characterization," Burnet
v. Harmel, supra, by the law of Kieselbach v. Commissioner, 317 U. S. 399 [43-1
USTC ¶9220 ], cited by respondent in support of his
contention that the state law controls as to what constitutes
interest under section
502(a) , supra, is not in point. The issue in that case
was whether an amount computed as interest on a condemnation award
under the provision of the charter of Greater New York,
designating the amount as "interest", was capital gain
or ordinary income. The definition of interest as relating to
personal holding company income was not involved and nothing was
even decided as to the meaning of the word as used under the
general definition of "gross income" which was there
involved, the Court stating: "In any event, the question here
is not whether these sums are interest. They may not be interest
and yet be other than part of the sale price." We
will now consider the crucial question presented by the first
issue, i.e., whether, on redemption of its tax lien certificates
the gains realized by petitioner, comprised of certain percentages
of the amounts paid by it for the certificates, come within the
meaning of the word "interest" as used in section
502(a) , supra, and without regard to the New York law. Interest
is defined as "The price or rate of premium per unit of time
that is paid by a borrower for the use of what he borrows; specif.,
a rate per cent of money paid for the use of money or the
forbearance of demanding payment of a debt." Webster's New
International Dictionary. "Congress apparently used the word
in its usual and commonly accepted sense, DeGanay v. Lederer,
250 In
New York v. Jersawit, 263 U. S. 493, the State of New York
filed a claim against the estate of a bankrupt domestic
corporation for an annual tax laid by a New York statute on the
corporation for the privilege of exercising its franchise in the
state, and for interest on the tax in the total amount of certain
per centums named in the statute. Prior to becoming a bankrupt the
corporation had exercised its privilege for somewhat less than two
months and the annual tax therefor had become payable in advance
for the year beginning on Since,
under the provisions of the Bankruptcy Act, interest on a claim
for a debt, such as that filed by the state for the annual tax,
was allowable against the estate of a bankrupt, while a penalty
thereon was not, and since the claim of the state included
additionally all the per centums charged by the statute for
failure to pay the tax by There can be no doubt that the additional ten per centum
charged for failure to pay by January 1 is a penalty, disallowed
by the Bankruptcy Act, §57j, but it is urged that the one per
centum for each month of default is statutory interest and that
the State is entitled to that and otherwise would be entitled to
none. As the one per centum is more than the value of the use of
the money and is added by the statute to the ten to make a single
sum it must be treated as part of one corpus and must fall with
that. It
is to be noted that the "additional ten per centum charged
for failure to pay by January 1", referred to in the above
quotation is not denominated in the New York statute to be a
"penalty", as the Court held it to be, but the statute
merely provided that such per centum should be paid "in
addition to the amount of such tax." From this it would seem
that the Court, while assigning no special reason for its holding,
had in mind as the basis for such holding, the principle, perhaps
deemed so elementary as to need no statement, that the immediate
addition on January 1 of the ten per centum to the amount of the
tax was computed "without reference to lapse of time."
That such was the basis of the holding is clearly recognized in Meilink
v. Unemployment Comm'n., 314 In
District Bond Co., 1 T. C. 837 [Dec.
13,078 ], the taxpayer owned municipal bonds which, in
conformity with the California Improvement Act under which they
were issued, contained a provision that in the case of any default
in the payment of principal or interest "there shall be
immediately added to such defaulted amount, five per cent of the
amount thereof, and on the first day of each month following such
default there shall be added a further penalty of one per cent of
such defaulted amount." Of the five per cent, two and
one-half per cent was to go to the bondholder and two and one-half
per cent to the city. Each bond provided that in case of default
the holder would be entitled to have the parcel of land securing
the bond advertised and sold as provided by law. A question
presented was whether two and one-half per cent received by the
taxpayer on defaulted amounts under the quoted provision
constituted tax exempt interest upon the obligations of a state or
its political subdivisions. In deciding that such two and one-half
per cent did not constitute interest we said, after stating that
the two and one-half per cent which went to the city was not
interest: The 5 per cent penalty that was added immediately to
defaulted amounts not only is designated a penalty in the bonds
and statute but lacks the usual characteristics of interest. * * *
Moreover, the full 5 per cent is a "fixed ad valorem
amount taking no account of time," Meilink v. Unemployment
Reserves Commission, 314 The
New York statutes applying to tax sales in Nassau and Suffolk
Counties redemptions from which are made within a six months
period provide that the amount paid for a tax lien certificate
"shall carry and bear the maximum interest and penalties as
follows: * * * per centum on the purchase price if redeemed within
six months of date of sale"; the "maximum interest and
penalties" mentioned being 10 per cent in Nassau County and
six per cent in Suffolk County. It is obvious that the effect of
the terms of those statutes, i.e., "if redeemed within six
months of the date of sale", is that even if on the next day
after the sale of a tax lien certificate the property covered
thereby is redeemed the full amount of the maximum percentages of
ten per cent in the case of Nassau County and six per cent in the
case of Suffolk County, or the full amount of a lower percentage
if the bid for the certificate carried such lower rate, would be
immediately added to the amount paid for the certificate, and a
party redeeming would be compelled to pay such total amount if
redemption occurred the next day after the sale of the
certificate. The same New York statutes provide with reference to
redemptions made after the expiration of the six months period
that the amount paid for a tax lien certificate "shall carry
and bear the maximum interest and penalties as follows: * * * an
additional * * * per centum on the purchase price if redeemed
after the expiration of six months and within twelve months of the
date of sale"; the additional per centum mentioned being 10
per cent in Nassau County and six per centum in Suffolk County.
The statutes also provide for similar additional percentages after
the expiration of each succeeding six months period until four
years have expired. It is clear that the effect of these
provisions is that on the next day after the expiration of any six
months period there would immediately accrue an additional
percentage of 10 per cent in the case of certificates purchased in
Nassau County and an additional percentage of six per cent in the
case of certificates purchased in Suffolk County, or an additional
lower percentage if the bid for a certificate carried such lower
percentage; and that it would be necessary for a party redeeming
on that day to pay such additional percentages. In
view of the authorities cited, and assuming, but not deciding that
the tax lien certificates represented an indebtedness upon which
interest could be imposed, the effect of the New York statutes as
to Nassau and Suffolk Counties is, in our opinion, that the
percentages fixed therein although denominated "interest and
penalties" are, in reality, merely amounts "in addition
to" the principal due, as in the New York statute considered
in the Jersawit case, and "added immediately to"
the principal due as in the bond and California statute considered
in the District Bond case, and that they do not constitute
interest, but penalties, as did amounts in question in those two
cases; and this because such "interest and penalties" in
the statutes relating to Nassau and Suffolk Counties constitute a
"fixed ad valorem amount taking no account of
time" rather than "interest which does depend on
time", and are to be computed "without reference to the
lapse of time." Meilink v. Unemployment Comm'n., supra. The
fact that the statutes relating to Nassau and Suffolk Counties
denominate the "per centum on the purchase price" as
"interest an penalties" is not controlling as to the
character of that per centum. United States v. La Franca,
282 U. S. 568, 572 [2
USTC ¶679 ]; In Re J. Menist & Co., 290 Fed. 947,
949; In re Ashland, Emery & Corundum Co., 229 Fed. 829.
The principal is concisely expressed as follows in Menist &
Co., supra, reversed in United States v. Childs, supra,
but without the principle being questioned: It is a matter almost too plain to require citation that an
exaction may be a penalty without being called by that name. Fontenot
v. Accardo, * * * 278 Fed. 871, at page 874. The question is
often one of degree, for no one would doubt that, if the statutory
rate for whthholding a tax was 1 per cent. a day, the requirement
would be treated as a penalty. The
New York statute applying to sales in Monroe County provides that
"the purchasers at such sale shall pay the amounts of their
respective bids to the said treasurer immediately after the sale
and after such payments have been made the said treasurer shall
add a penalty of ten per centum thereto for the benefit of the
said purchaser, and shall give the purchaser * * * a certificate
describing * * * the sum paid and the penalty attached
thereto." The statute further provides that redemption may be
made either: (1) within two years by paying in addition to the bid
price and the ten per centum penalty "interest thereon at the
rate of ten per cent per annum from the date of such sale",
or (2) at any time after the expiration of the two year
period, and before proceedings are instituted by the purchaser to
obtain possession of and title to the land, by paying "the
consideration money with the addition of thirty-five per centum
thereon * * *." Under
the terms of the statute providing for redemption within the two
year period, the ten per centum immediately added to the cost of
the certificate is not a "penalty" merely because so
designated by the statute, but is a "penalty", rather
than "interest", because it is a flat ad valorem
addition to the cost of the certificates computed without
reference to lapse of time, a principle discussed above in
connection with redemption in Nassau and Suffolk Counties. New
York v. Jersawit, supra; Meilink v. Unemployment Comm'n., supra.
Even if redemption is not made until the last day of the two year
period, and it be assumed that the "ten per cent per annum
from the date of such sale" required by the statute to be
paid, in addition to the purchase price of the certificates and
the ten per centum penalty, is in fact "interest" for
the purposes of personal holding company income classification, it
is apparent that any income petitioner may have derived from
Monroe County redemptions, if any, within the two year period
would have been derived from the 10 per centum "penalty"
and "interest" of not more than 10 per centum per year
for two years, or twenty per centum interest for the two year
period. As this "interest" is calculated on the cost of
the certificate plus the 10 per centum penalty, the income
resulting from such interest for two years would actually amount
to twenty-two per centum of the cost of the certificate. Such
total income derived from "penalties" and
"interest" would thus consist of 10/32nds
"penalty", in either and both of the taxable years
involved and 22/32nds "interest" or less than 69 per
cent interest of any gains or gross income realized by petitioner
on redemptions, if any, within two years of its certificates in
Monroe County. Under
the terms of the statute providing for redemption in Monroe County
after the expiration of the two year period and at the beginning
of the three year period there is immediately added to "the
consideration money" paid for the tax certificate
"thirty-five per centum thereon." Up to the time of the
expiration of the two years only 20 per cent interest would have
been added to such consideration money plus the 10 per cent
penalty. It is thus apparent that immediately upon the expiration
of the two year period and immediately upon the commencement of
the three year period 15 per cent would be added to the amount
paid for a tax lien certificate and this would, as we have held
with regard to Nassau and Suffolk Counties and for the same
reasons, not constitute interest, but a penalty. It would thus
seem to be clear that as to the 35 per cent added to the cost of a
tax lien certificate immediately after the expiration of two
years, not more than 20 per cent could possibly be said to
constitute interest at 10 per centum per annum for the two year
period. Consequently not more than 20/35ths, or approximately 57.1
plus per cent of any gains or gross income received by petitioner
from any such redemptions, if any, in Monroe County could have
been, or was, derived, after the expiration of the two year
period, from interest. It
is shown that the excess of the amounts received by petitioner
from redemptions in the three counties above what it had paid for
the tax liens comprised over 94 per cent of its gross income for
the fiscal year ended The
ratio of interest to gross income from the two sources would be
correspondingly less in the fiscal year ended The
next issue presented is whether petitioner is entitled to deduct
for the fiscal year ended Respondent
in his deficiency notice disallowed the amount of $11,001.79 of
petitioner's claimed loss on the ground that the real estate was
"not determined worthless" and on brief contends that
the disallowance was proper because "the evidence is not
convincing that all value of the real property * * * was
extinguished during the taxable year in question." Respondent
makes no suggestion that the properties became worthless in
a year prior to the taxable year; but bases his contention
entirely upon the claimed fact that the properties were not
worthless in the taxable year; and there is nothing in the record
showing that the properties became worthless in a prior year.
Respondent concedes on brief that tax liens in favor of the City
of Yonkers were existing against the property during the taxable
year and that there "was no great disparity between the
admitted value of the petitioner's property and the amount of tax
arrears due on the property", but argues that "there is
no evidence of record which shows that the value of the property
in question may not increase in value at some future date". In
our findings we have set forth the market values of the respective
properties in January 1941 as well as the fact that there were
three years delinquent taxes on such properties and from those
facts it appears that the delinquent taxes at that time which
constituted a lien against the "Lawrence Park" and
"Valley Farms" properties were in amounts largely in
excess of their respective market values. We
have also found that in January 1941 the properties here involved
were abandoned by petitioner. From
these facts and all facts of record, we conclude, and hold, that
the "Lawrence Park" and "Valley Farms"
properties became worthless in the fiscal year ended In
Helvering v. Gordon, 134 Fed. (2d) 685 [43-1
USTC ¶9376 ], affirming 46 B. T. A. 1201 [Dec.
12,535 ], practically the same contention was made by the
Commissioner with reference to whether or not the real estate
there involved became worthless in the taxable year as is made
here by respondent. There the amount of delinquent taxes on the
property involved exceeded the value of the property, as is the
case here with reference to the "Lawrence Park" and
"Valley Farms" properties. The Court in holding the real
estate there involved to have become worthless in the taxable year
said with reference to Commissioner's contention: But, we are told that "real estate always has potential
value and so long as a taxpayer retains title to such property he
is in a position to profit from future favorable
developments." Assuming the truth of this assertion with
respect to an unencumbered interest in land, it cannot stand the
practical or realistic test which is met when the interest is
subject to superior liens or encumbrances that exceed its real
value. In such a case the value of the equity is extinguished as
effectually as the interest which a stockholder retains who holds
title to shares in an insolvent corporation that has no reasonable
expectation of recovery. In one case, as in the other, the loss
has taken place and the retention of the bare legal title becomes
a circumstance without significance that should not prevent the
taxpayer from taking the deduction in the year in which the loss
occurs or permit him to postpone it at will to some later year
when it will produce a larger reduction of tax liability. The Court cited as supporting its view as above expressed, Denman
v. Brumback, 58 Fed. (2d) 128 [3
USTC ¶931 ]; Rhodes v. Commissioner, 100 Fed. (2d) 966
[39-1
USTC ¶9256 ]; Bickerstaff v. Commissioner, 128 Fed.
(2d) 366 [42-2
USTC ¶9504 ]; Commissioner v. Hoffman, 117 Fed. (2d)
987 [41-1
USTC ¶9280 ]; and Commissioner v. Peterman, 118 Fed.
(2d) 973 [41-1
USTC ¶9387 ]; and distinguished Commissioner v. McCarthy,
129 Fed. (2d) 84 [42-2
USTC ¶9586 ], cited here by respondent. We
are not able to reach the same conclusion with regard to Items
5358 and 5365 as that rendered with regard to the "Lawrence
Park" and "Valley Farms" properties, for the reason
that while it is shown that three years taxes on those items had
accrued in January 1941 the amounts of such taxes are not shown.
We are thus left uninformed as to a factor vital to a proper
determination of whether or not those items became worthless in
the taxable year, and therefore approve the determination of
respondent with reference to these items. Reviewed
by the Court. Decision will be entered for the petitioner in Docket No. 110381; and in
Docket No. 112302 decision will be entered under Rule 50. 1 SEC. 501 .
DEFINITION OF PERSONAL HOLDING GOMPANY. (a)
General Rule.--For the purposes of this subchapter and chapter 1,
the term "personal holding company" means any
corporation if-- (1) Gross Income Requirement.--At least 80 per centum of its
gross income for the taxable year is personal holding company
income as defined in section
502 ; but if the corporation is a personal holding company
with respect to any taxable year beginning after (2) Stock Ownership Requirement.--At any time during the last
half of the taxable year more than 50 per centum in value of its
outstanding stock is owned, directly or indirectly, by or for not
more than five individuals. 2 SEC. 502 .
PERSONAL HOLDING COMPANY INCOME. For
the purposes of this subchapter the term "personal holding
company income" means the portion of the gross income which
consists of: (a)
Dividends, interest (other than interest constituting rent as
defined in subsection (g)), royalties (other than mineral, oil, or
gas royalties), annuities. [Dissenting Opinion] MURDOCK,
and TURNER, JJ., Dissenting: We
think that in all instances a part of the petitioner's recovery
was interest for present purposes.
Private Letter Ruling Number: 9540006 Internal Revenue Service JUN 29, 1995 Internal
Revenue Service Department
of the Treasury PO.
Box 7604 Ben
Washington,
DC 20044 This
letter is in response to your request for a private letter ruling
dated January 23, 1995, submitted on behalf of the above
referenced taxpayer. In that letter you requested four (4)
rulings. For the reasons discussed below, we are only able to
respond to the fourth ruling requested. The Internal Revenue
Service has published formal guidelines in Revenue Procedure 95l,
1995-1 I.R.B. 9, which taxpayers must follow in order to obtain a
private letter ruling from the National Office. In general, the
Service will not issue letter rulings on problems that are too
factual in nature: See- section 7.00 of Rev. Proc. 95-1. In
addition, the Service will not issue letter rulings with respect
to any matter dealing with the question of whether property is
held primarily for sale to customers in the primary course of a
trade or .business. See section 4.02 of Rev Proc. 953, 1995-1
I.R.B. 85. Based on the submission provided and as indicated to
you in a phone conversation with a representative of this office
on With
respect to your request as to whether the proceeds from the
redemptions of tax lien certificates (described herein) by the
property owners result in income recognition by the taxpayer at
any time before redemption occurs the facts are as described
below. The
taxpayer is a calendar year, accrual basis limited partnership in
the business of purchasing certificates or other documentation
("Tax Lien Certificates") that evidence liens for unpaid
local taxes on parcels of real property. As purchaser of a Tax
Lien Certificate ("TLC"), the taxpayer
has the right to obtain title to the property if the property
owner does not redeem the TLC prior to the statutory redemption
period. The
taxpayer intends to earn a profit by purchasing a TLC on property
which may be redeemed by the property owner at the . purchase
price of the TLC plus (i) interest on the purchase price of the
TLC at a rate determined at the auction at which the taxpayer
purchases the TLC, (ii) a percentage of the purchase price of the
TLC which varies based on the amount of the purchase price, (iii)
any premium paid by the purchaser of the TLC, and (iv) subsequent
taxes and actual costs incurred and paid by the holder of the TLC.
The taxpayer intends to foreclose on and acquire the property if
no redemption occurs. The
taxpayer currently intends to purchase TLCs sold in the State of
New Jersey but may purchase TLCs in other states in the future.
The rules with respect to the creation, enforcement and collection
of tax liens are set forth in N.J.S.A. 54:5-1 through 54:5-129.
Pursuant to N.J.S.A. 54:5-6, "taxes on land shall be a
continuous lien on the land on which they are assessed and all
subsequent taxes, interest, penalties and costs of collection
which thereafter fall due or accrue shall be added to and be a
part of such initial lien." Interest accrues on tax liens
held by the municipality at 18 percent per annum. N.J.S.A.
54:5-34. In the State of New Jersey, if a property owner fails to
pay local property taxes, a municipality holds a public auction to
sell a TLC on the property. N.J.S.A. 54:5-42. The transaction's
form is a sale of the property by the municipality to the
purchaser subject to the built-in right of the property owner to
redeem the property by paying off the tax lien's current balance. Although
the transfer of a tax lien is in the form of a sale of the
property to the purchaser, the property owner will nevertheless
continue to be liable for any future real property taxes with
respect to the property as if no sale had been made. N.J.S.A.
54:5-39. A
tax sale certificate does not operate to give the purchaser
thereof title to the land and does not divest the tax delinquent
owner of his title. It merely vests in the purchaser of the tax
sale certificate with an inchoate right or interest and gives him
the right to proceed to foreclose the equity of redemption
pursuant to the established regulatory scheme. [Citations
omitted.] In the meantime the purchaser has no right of entry on
the property and has no right to the rents issues and profits
therefrom. [Citation omitted.] In fact a claim to such right to
possession or rents would constitute a criminal offense N.J.S.
2A:111-23. Introductory
Statement - Assembly, No. 1815--L.1979, c. 142, see N.J.S.A.
54:5-39. However, in order to protect his interest in the TLC, the
purchaser of the TLC must pay all subsequent taxes on the property
as if the purchaser of the TLC were the owner of the property,
otherwise a separate TLC with respect to the same property pill be
sold by the municipality. The
State of New Jersey allows a purchaser of a TLC to earn interest
at a rate of up to a maximum of 18$ of the purchase price of the
TLC during the period the purchaser holds the TLC which is to be
paid by the property owner in order to redeem the TLC. N.J.S.A.
54:5-32-34. In addition, in order to redeem the TLC, the property
owner must pay the purchaser of the TLC an amount from 2% to 6% of
the purchase price of the TLC depending on the amount of the
purchase price of the TLC. N.J.S.A. 54:561. The purchase price of
the TLC paid at an auction is the sum of (i) the unpaid taxes on
the property, (ii) accrued interest and penalties on the unpaid
taxes, and (ii) any costs incurred by the local taxing authority
in collection of the taxes. N.J.S.A. 54:5-6. The
bidding at an auction in the State of New Jersey begins at the 18$
interest rate, the legal maximum, and the TLC is sold to the
bidder offering the lowest interest rate. N.J.S.A. 54:519, 32-34,
and 112-113. The interest rate could be as low as zero percent,
entitling the purchaser to hold the certificate without the
potential of an interest payment upon redemption. In addition, the
purchaser could pay a premium over the purchase price to obtain
the TLC which is expressed in terms of dollars and cents. N.J.S.A.
54:5-33. The TLC must be recorded at the office of the clerk of
deeds of the county in which the property is situated; the TLC
will be indexed as a mortgage. N.J.S.A. 54:5-50. The
property owner has two years to redeem the property after which
the owner of the TLC can move to foreclose on the property.
N.J.S.A. 54:5-54 and 86. At foreclosure the purchaser of the TLC
will receive the deed to the property and becomes the absolute
owner of the property. The purchaser of the TLC is not required to
remit any proceeds to the property's former owner even if the
property is subsequently sold for an amount substantially in
excess of the purchase amount of the TLC. Section
451 of the Internal Revenue Code provides that generally, the
amount of any item of gross income shall be included in the gross
income for the taxable year in which received by the taxpayer,
unless, under the method of accounting used in computing taxable
income, such amount is to be properly accounted for as of a
different period. Section
1.451-1 of the Income Tax Regulations provides that, in general,
gains, profits, and income are to be included in . gross income
for the taxable year in which they are actually or constructively
received by the taxpayer unless includible for a different year in
accordance with the taxpayer's method of accounting. Under an
accrual method of accounting, income is includible in gross income
when all the events have occurred which fix the right to receive
such income and the amount of such income can be determined with
reasonable accuracy (the "all events test"). Section
1.451-1(a) of the regulations. All
the events that fix the right to receive income occur when (1) the
required performance occurs, (2) payment therefor is due, or (3)
payment therefor is made, whichever happens earliest. Rev. Rul.
74-607, 1974-2 C.B. 149. The
taxpayer is an accrual basis taxpayer and-as such must recognize
income in the taxable year when all the events have occurred which
fix the right of the taxpayer to receive the income and the amount
of such income can be determined with reasonable accuracy. Rev.
Rul. 70-63, 1970-1 C.B. 36, holds that the "tax sale" of
property wherein the owner may redeem the "tax title"
within two years is not a closed and completed transaction that
gives rise to a gain or loss inasmuch as there is no identifiable
taxable event before the expiration of the redemption period. The
TLC in this case is indistinguishable from the "tax
sale" in Rev. Rul. 70-63. The
taxpayer as purchaser of the TLC acquires at the time of the
purchase, no fixed and determinable right to income, nor does it
acquire immediate title to the property. The property owner
remains in possession of the property and is entitled to any rents
and profits therefrom until the redemption period expires. In
addition, the property owner continues to be liable for any future
real property taxes with respect to the property. Thus, as long as
the right to redemption exists, all events have not occurred which
fix the right of the taxpayer to receive either income or
property. Based
on the language in the New Jersey Statute and the taxpayer's
representations, it is clear that the taxpayer is not entitled to
receive income from the redemption of a TLC until such redemption
occurs. The taxpayer as purchaser of a TLC holds only an inchoate
right to a conveyance of the real property which would mature only
in the event that after a two year period redemption is not made.
Thus., the taxpayer, at the time the TLC is purchased, has only an
expectancy that it will eventually receive either income or
property. No
opinion is expressed as to the tax treatment of these items (or
transactions) under the provisions of any other section of the
Code or regulations which may be applicable thereto, or the tax
treatment of any conditions existing at the time of, or effects
resulting from, the items (or transactions) described which are
not specifically covered in the above ruling. Specifically, no
opinion is expressed as to the deductibility of. any amounts paid
by the taxpayer or as to the characterization of proceeds from any
foreclosure or redemption. A
copy of this letter should be attached to the federal return for
the year in which the transactions in question occurs. In
accordance with the provisions of a power of attorney currently on
file, we are sending a copy of this ruling letter to your
representative. This
ruling is directed only to the taxpayer who requested it. Section
6110(j)(3) of the Code provides that it may not be used as
precedent. Sincerely,
Assistant
Chief Counsel (Income
Tax & Accounting) [45-1 USTC ¶9104]The First National Bank of Birmingham, as Trustee for
Roebuck Improvement Company, Inc., Plaintiff, v. United States of
America, Defendant United States District Court for the Southern Division of the
Northern District of Alabama, Civil 5383, 59 FSupp 49, Cabaness
& Johnston, First Nat. Bldg., Birmingham, Ala., for plaintiff.
Jim C. Smith, U. S. Attorney, for defendant. Before
MULLINS, District Judge. Findings by the Court This
cause came on to be tried, upon the facts without a jury, and upon
consideration and pursuant to Rule 52 the Court finds the facts
specially and states its conclusions of law thereon with direction
for the entry of the appropriate judgment as set forth below. Findings of Fact 1.
Plaintiff is a national banking association with trust powers,
organized and existing under the laws of the United States, with
its principal office and place of business at Birmingham, in the
Southern Division of the Northern District of Alabama. 2.
On, to-wit, 3.
The Company was dissolved and plaintiff thereupon consummated the
sale to the City of Birmingham of the premises and properties
theretofore occupied by the Roebuck Country Club. The property
(hereinafter referred to as the "park") was purchased by
the City for and has been continuously used by it as a public
park. The City did not have the funds necessary to pay for the
park and therefore was under the necessity of pledging its
investment and market equity in the property as security for the
deferred payments. In consideration for the conveyance of the park
the City paid to plaintiff on closing the transaction the sum of
$13,500 in cash and executed and delivered to plaintiff sundry
lien certificates evidencing and secured by vendor's lien reserved
in and by the deed conveying the part (herein called vendor's lien
certificates) aggregating $186,500 principal amount, representing
the remainder of the purchase price agreed upon for the transfer
of the park property. Said vendor's lien certificates were each
for the principal amount of $9,325, bore interest at the rate of
5% per annum payable semi-annually, were numbered serially and
matured over a period of years, each of said certificates
representing an unpaid installment of the purchase price of the
property. A representative copy of said vendor's lien certificates
is attached as Exhibit B to the complaint. 4.
The vendor's lien obligation by which the City was enabled to
purchase the park property were all duly paid, with interest, on
the basis originally stipulated and as they matured until refunded
as of Interest Paid by
Year City to Plaintiff
1935 .... $7,693.13
1936 .... 7,226.88
1937 .... 6,760.62
1938 .... 6,294.38
1939 .... 7,188.03
1940 .... 1,561.94
In
its income tax returns filed for the years involved plaintiff took
the position that the interest received from the City of
Birmingham was exempt under Section 22(b)(4) of the Internal
Revenue Code which provides in material part as follows: "(b)
Exclusions from gross income.--The following items shall
not be included in gross income and shall be exempt from taxation
under this chapter: "(4)
Tax-free interest.--Interest upon (A) the obligations of a
State * * * or any political subdivision thereof * * *." 5.
The Commissioner of Internal Revenue, reversing his position taken
with respect to the initial years, contended that the interest so
paid was not exempt and that plaintiff was liable for the payment
of income tax thereon, and on, to-wit, Deficiency
based on Interest on Total
Year city interest deficiency assessed
1935 .... $ 572.53 $145.95 $ 718.48
1936 .... 480.68 93.70 574.38
1937 .... 514.96 69.48 584.44
1938 .... 667.94 50.05 717.99
1939 .... 1,099.98 16.41 1,116.39
1940 .... 218.67 218.67
*$3,930.35
The
foregoing assessed deficiencies and interest thereon were paid by
plaintiff to the Collector of Internal Revenue at Birmingham,
Alabama, on 6.
On, to-wit, 7.
Under date 8.
At the time of the execution and delivery by the City of
Birmingham of the vendor's lien certificates representing and
securing the deferred payments for the purchase price of the park
property at the closing of the purchase on or about 9.
The city's investment equity was in addition to any market equity
existing and any additional investment equity reflected in the
expenditures by the City of Birmingham for the improvement of the
park property. 10.
Under the terms of the vendor's lien certificates the City of
Birmingham was under no obligation to appropriate public funds of
the City for the purpose of paying the certificates or interest
thereon. The vendor's lien certificates executed by the City
contained the following provision: "Neither this certificate, nor any installment of said
purchase price, nor any installment of said interest, is a general
or other obligation or liability of the City of Birmingham, but
the sole security for the payment of this certificate, and of the
installment of the purchase price which it represents and of
interest thereon, is said vendor's lien reserved upon the land
herein or in said conveyance described." The deed conveying the park to the City contained the
following provision: "It
is further understood that the purchase of the property
hereinabove described is made by the City of Birmingham under the
provisions of Section 4 of an Act of the Legislature approved The
Court finds however, that the City could make default in the lien
obligation represented by the certificate only at the risk of
losing any market or investment equity in the public park. 11.
Under the decisions of the Supreme Court of Alabama it is held
that "revenue" or "special fund" bonds of this
general class, which do not on their face constitute a direct
pecuniary obligation of the State, its subdivisions or agencies,
and which expressly disclaim any charge on the general taxing
power or credit of the subdivision or agency, are nevertheless
"debts" within the meaning of the State Constitution,
requiring a vote of the people or subject to limitation as to
amount where the revenues of an existing public system or the
system itself, such as a system of waterworks, is pledged or
mortgaged.--Oppenheim v. Florence, 229 Alabama 50, 155
Southern 859. 12.
The payment of principal and interest of the vendor's lien
certificates involved here is deemed compulsory upon the City
which issued them as the only method of avoiding loss of the
City's equity in its public park property, although the
certificates disclaimed any direct pecuniary obligation. The City
of Birmingham refunded as of "(2)
In consideration for said conveyance the City paid to the Bank the
sum of $13,500 in cash and executed and delivered to the Bank
sundry lien certificates evidencing and secured by vendor's lien
reserved in and by the park deed (herein called vendor's lien
certificates) aggregating $186,500, principal amount, representing
the remainder of the purchase price agreed upon for the transfer
of the premises conveyed, herein called the park property; "(3)
Said vendor's lien certificates were each for the principal amount
of $9,325, bore interest at the rate of 5% per annum, payable
semi-annually on the first day of July and January of each year,
were numbered serially from 1 to 20, inclusive, and matured
respectively 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 15,
16, 17, 18, 19, and 20 years after 13.
"No-recourse" obligations or securities censtitute a
familiar fiscal device in the financing of public undertakings by
the subdivisions and agencies of the State of Alabama, made
necessary by constitutional limitations upon the amount of full
recourse obligations permitted in various instances, including
municipalities. The practice of issuing "revenue bonds",
payable as to principal and interest out of special funds or
special taxes (such as gasoline taxes) or secured solely by lien
upon property acquired by the State or its subdivisions is an
established source and means of public credit in Alabama for
governmental purposes. The
Bureau of Internal Revenue originally took the position with
respect to the returns of the taxpayer in this matter for the
years 1931 and 1932 that the interest was not exempt but on
protest reversed this view and accepted the claim of exemption as
applied to the years 1931 and 1932. Upon reconsideration of the
returns for 1933 and 1934 the Government by letter dated 14.
Section 225 of the Alabama Constitution of 1901 lays a prohibition
against municipalities incurring direct pecuniary indebtedness in
excess of a stated ratio of the total assessed value of local
property. The radical recession in assessed values due to the
depression left a large proportion of the counties and
municipalities in Alabama without any margin or insufficient
margin for additional "general credit" obligations. The
no-recourse or revenue bonds has been the prevailing means by
which Alabama municipalities have in recent years acquired water
works systems. The extent to which this type of security has been
employed in Alabama may be seen from the following decisions in
each of which the public subdivision or authority has, upon the
face of the security, disclaimed pecuniary obligation, but has
pledged the property or special revenue or expected appropriations
as security. Alabama State Bridge Corporation v. Smith,
217 Ala. 311, 116 So. 695. (Note:
The bonds issued under the Act there construed (Act approved Smith v. Guin, 229 Ala. 61, 155 So. 865. Oppenheim v. Florence,
229 Ala. 50, 155 So. 859. State v. Mobile, 229 Ala. 93, 155 So. 872. Bankhead v. Sulligent,
229 Ala. 45, 155 So. 869. In re Opinions of Justices, 226 Ala. 18, 145 So. 481; 226
Ala. 570, 148 So. 111; 228 Ala. 140, 152 So. 901. Camden v. Fairbanks,
204 Ala. 112, 86 So. 8; 206 Ala. 293, 89 So. 456. Isbell v. Shelby County,
235 Ala. 567, 180 So. 567. Lyon v. Shelby County,
235 Ala. 69, 177 So. 306. Herbert v. Perry County,
235 Ala. 71, 177 So. 561. Burleson v. Marion County,
235 Ala. 567, 180 So. 572. Similar
statutes are found in the Alabama Bridge Corporation Act, supra
(Acts 1927, p. 278) and in the group of acts authorizing counties
to issue bridge securities and acts adopted at the request of the
Public Works Administration in order to qualify municipalities for
the federal public works program, including, among others, the
following: Craft
Act: Goodwyn
Act: Goodwyn
Act: November 8, 1932, Acts 1932, p. 254; sewerage systems. Hubbard
Act: March 10, 1933; Acts 1933, p. 22; waterworks construction or
acquisition. Hubbard
Act: March 10, 1933; Acts 1933, p. 299; sewerage systems. Kelly
Act: March 29, 1933; Acts 1933, p. 88; waterworks, water supply,
sewer, gas systems. ib:
Amended, Acts 1935, p. 108. Carmichael
Act: approved April 6, 1933, Acts 1933, p. 100; electric systems,
subsequently made basis of TVA negotiations. Poole
Act: approved February 7, 1935; Acts 1935, p. 110; electric
systems. Coleman
Act: approved February 8, 1935; Acts 1935, p. 126; slum clearance
and housing. Lee
Act: approved June 26, 1935; Acts 1935, p. 195; causeways,
tunnels, viaducts, highways, parks, etc. Wallace
Act: approved September 7, 1935; Acts 1935, p. 785; to free toll
bridges. 15.
The local history of the depression evidences many public works
obligations issued by public authority to secure construction of
public works for governmental purposes under a plan involving
deferred payments in the form of liens on the works or on the
revenue from the works such as bridges, waterworks and other
municipal utilities, which on their face disclaim any general tax
or general credit liability. 16.
The Tennessee Valley Authority has extended its system of electric
distribution through the purchase of construction by
municipalities in the area of distribution systems through the
issue of no-recourse obligations secured by the system or its
revenue. No instance has been cited in which any municipality
within the State of Alabama has acquired any public works project
by any other method than the deferred payment, interest bearing,
revenue or special fund obligation of this type. 17.
Thus, in the case of the Fiorence Bridge Bonds, issued by the
Alabama Bridge Commission, the statute authorizing the issue
contained this provision, repeated in the face of the bond:
"It shall be plainly stated on the face of each bond that the
same has been issued under the provisions of this Act and that the
bond and interest thereon does not constitute any indebtedness of
the State or any municipality, county or political subdivision of
the State within the meaning of any constitutional or statutory
provision of the laws of the State" (Sec. 4, Act No. 44,
approved February 7, 1935; Acts 1935, p. 97). That
issue has from the outset been interpreted as exempt by the Bureau
of Internal Revenue under the statute in question. (Letter of
January 28, 1937.) "The bonds will be payable solely from the revenues
derived from the toll bridge and when the revenues shall have
liquidated the bonds, the bridge will cease to be a toll bridge
and will become free." The
State Statutes which authorized the City to acquire park property
on the security by means of deferred payments secured by the
property is as follows: "Section
4. For any or all of the purposes mentioned in this Act, any such
city upon the recommendation of the park and recreation board may
purchase on time or partly for cash with balance on time or
deferred payments, or otherwise acquire any real property or
interest in real property, within or without the limits of such
city, securing the note or notes, claim or claims for deferred
payments and interest thereon, with mortgages or deed of trust on
the land purchased, or with or by means of an instrument in
writing retaining title thereto in the vendor, or enter into any
other contractual arrangement whereby provision is made that such
note or notes, claim or claims, or other instruments for deferred
payments and interest thereon, and all lawful charges, shall not
be a charge or charges against the general credit of the city or
be a general liability thereof, but that the liability shall only
extend to and be a charge against the land so purchased or
acquired. Such method of acquisition provided for in this section
shall not be considered or deemed exclusive, but cumulative and in
addition to all other methods of acquisition of lands or interests
therein for public purposes heretofore, hereafter or by other
provisions in this Act provided." (Section 4, Act No. 529,
Acts of 1923, page 707.) Conclusions (1)
The vendor's lien certificates signed and issued by the City of
Birmingham in the instant matter are not distinguishable in
principle or substance from the more conventional form of
no-recourse bond or obligation secured by a mortgage upon public
property purchased. (2)
The vendor's lien certificates in question were at the outset
secured by lien on the City's invested equity in the park property
which for the tax year 1936 amounted to $60,125 and by 1940 had
increased to $95,000. The pledge or subjection of this increasing
equity, with no evidence of any intention by the City to abandon
the governmental function served by the park, gave the
certificates the status and characteristics of "debts"
within the meaning of the constitutional system of Alabama and
"obligations" within the purview of Section 22(b)(4) of
the Internal Revenue Code. (3)
The mechanism of "no-recourse" securities issued by the
State of Alabama, its agencies and sub-divisions, secured by
pledge or lien upon special revenue or special funds or secured by
the public equity in property of a public or governmental
character, constitute a customary and in many instances an
indispensable device for obtaining public credit. (4)
The express exclusion or exemption of interest upon the
obligations of the States and their subdivisions reflected in
Section 22(b)(4) of the Internal Revenue Code has remained
unchanged notwithstanding general use of the
"no-recourse" form of security by the States ot
implement their credit and the general acceptance by the Treasury
of this class of securities as exempt. (5)
Plaintiff is entitled to recover from defendant the amount of
taxes and interest paid as recited in the fifth finding of fact
($3,930.35), with interest as provided by law. Judgment
is directed accordingly. |