AINSWORTH, Circuit Judge:
The issue presented in this case is whether certain transactions of taxpayer, a national bank, with various municipal bond dealers during the years 1962-1964 are correctly characterized as sale-repurchase transactions, as the District Court concluded,
This is a tax refund suit brought by taxpayer, the American National Bank of Austin, against the United States to recover income taxes and interest assessed against it and collected by the Commissioner of Internal Revenue in the amount of $788,031.77 for the taxable years 1962, 1963, and 1964. After a nonjury trial at which oral testimony and exhibits were received, together with a stipulation of facts and attached exhibits, the District Court agreed with taxpayer's contentions and ordered the refund. From this judgment the Government appeals.
During the years 1962-1964 taxpayer received income in the form of interest it collected or accrued on municipal bonds
Since sale-versus-loan cases turn upon their own particular facts, United States v. Ivey, 5 Cir., 1969, 414 F.2d 199, the decided cases
Taxpayer is a national banking association.
When taxpayer began obtaining bonds to be refunded, it opened in its general ledger an account styled "Refunding Bonds Purchased." Taxpayer maintains this account as an asset account in which a balance is struck daily showing the book balance of bonds on hand at the close of the business day. Although taxpayer now engages in few transactions involving refunding, the account retains its original name, and into it are entered as assets all bonds that have come into taxpayer's possession as a result of the transactions here in issue.
The distribution of a new issue of municipal bonds in Texas is commenced by the issuing authority when it publishes the official notice of sale. Such a notice generally will include statements of the amount of the issue to be floated, types of bids and interest rates, requirements regarding a good-faith deposit by the successful bidder, and the place designated for delivery of the bonds. As a general rule, bonds are made deliverable to taxpayer's banking house. If taxpayer's banking house is so designated, taxpayer first becomes involved in the distribution of an issue when the issuing authority notifies it of the successful bidder and authorizes it to deliver the bonds to the purchaser against payment of the specified bid price. The depositary bank of the issuing authority then advises taxpayer regarding transmittal to the depositary of the proceeds derived from the bond flotation. The bonds, following their approval and certification by the appropriate state officers, are then delivered to taxpayer. Upon receiving the bonds, taxpayer performs numerous functions on behalf of the issuing authority and the successful bidder-dealer. For example, it examines the bonds for printing errors, determines whether the correct number of coupons have been attached, obtains an opinion letter on the validity of the issue, and receives an undated receipt for payment of the purchase price to the issuing authority by the bond dealer.
Taxpayer concluded its new-issue transactions with bond dealers in either one of two ways during the years in issue. First, the successful bidder might pay taxpayer the purchase price of the bonds for transmittal to the depositary bank of the issuing authority. In this situation taxpayer would simply transmit the payment to the depositary and deliver the bonds to the dealer or at the dealer's order. For its services taxpayer would receive from the dealer a handling charge of 25¢ per $1,000 of par value and reimbursement for the expenses, such as insurance, postage, and wires, it had incurred.
During the years 1962-1964 dealers occasionally wrote to taxpayer to request that taxpayer "make payment" to the issuing authority for bonds the dealers had been awarded and "accept delivery for our account" or "take [the bonds] up for our account." Usually, however, communications between the parties were by telephone. Taxpayer and the dealers made no written agreements regarding their various rights and obligations with respect to new issues. All these agreements, however, were the same.
Upon receiving the successful bidder's notification, taxpayer, if satisfied with the credit rating of the issuing authority, would pay with its own funds the full bid price to the authority and retain the bearer bonds in its possession. Taxpayer normally would agree to such arrangements with dealers if the issue was rated "BAA" or higher. Relying upon this rating, taxpayer would make no credit investigation of the dealer obligated to buy the bonds.
Generally the official notice of sale would provide for a good-faith deposit by the successful bidder. At one time the notice normally specified that this deposit would be applied against the purchase price of the issue. During the years 1962-1964, however, the issuing authority in approximately 90 per cent of the new-issue transactions in which taxpayer was involved returned the successful bidder's deposit to the bidder upon receipt of payment from taxpayer. In approximately 9 per cent of these transactions the issuing authority sent the bidder's check to taxpayer. In approximately 1 per cent of the transactions the issuing authority negotiated the bidder's check in partial payment of the purchase price. When the issuing authority either sent the check to taxpayer or negotiated it, taxpayer made the dealer whole.
Taxpayer does not employ bond salesmen or sell bonds to the public. It cannot legally sell bonds to the public because it does not have a securities license. Although taxpayer legally may bid for new issues, it does not. Throughout the history of taxpayer's business in connection with new-issue bonds, the bonds for which taxpayer paid the original purchase price were offered and sold to the public by the dealers who had successfully bid for them. These dealers offered bonds for sale to their customers both before and after taxpayer had made payment for them to the issuing authority. When a dealer was awarded an issue, he would begin selling bonds immediately for future delivery. Ordinarily a substantial portion of an issue would be sold before the bonds were actually issued and before taxpayer had paid the issuing authority for them. Dealers would offer bonds for sale in two ways. First, they would list the bonds in The Blue List of Current Municipal Offerings. Secondly, they would mail offering circulars to prospective customers. These circulars were customarily prepared and mailed before the bonds were issued.
Taxpayer would retain bonds in its possession until the bidder-dealer effected their disposition to its customers. During this period, usually no longer than thirty days, taxpayer accrued the interest income on the bonds at the coupon rate and credited the interest to a general account styled "Exempt Interest Earned." Taxpayer's accounting procedures reflected its possession of the bonds and accrual of interest on the bonds as follows. When taxpayer transmitted to the issuing authority's depositary its cashier's check in payment for an issue, taxpayer's Bond Department would send a charge memo to its cashier which showed a memorandum charge in the amount of the purchase price to the "Refunding Bonds Purchased" account in taxpayer's general ledger. Taxpayer further maintained a subsidiary ledger sheet pertaining to each bond issue. On such a sheet taxpayer would initially
As a dealer found customers for the bonds for which it had bid, it would prepare an invoice made out to the customer and send this invoice to taxpayer. Taxpayer would then send the invoice and the bonds purchased by the customer to the bank at which the customer was to tender payment. It would also instruct the collecting bank to deliver the bonds to the designated purchaser against payment of the dealer's invoice price and to remit or credit the purchase price to taxpayer. Under taxpayer's instructions, interest on bonds was accrued only until the date the sale and purchase was closed. As a result, taxpayer would accrue interest on bonds committed by the dealer for future sale only during the period (a few days) required for completion of the paper work precedent to actual disposition of the bonds. Taxpayer would not accrue interest while the customer's funds were in transit from the collecting bank to taxpayer. With respect to bonds not sold until after the date of their issuance, taxpayer would accrue interest from the date of issuance until disposition of the bonds by the dealer was effected.
With respect to every sale by a dealer to the public of bonds for which the dealer had bid and taxpayer had paid the issuing authority, taxpayer would send the dealer an invoice showing the bank to which the bonds were sent, the name of the issue, the name of the dealer's customer, the payment date, daily additions for interest, the selling price to the customer, and the name of the dealer. After the customer's payment was transmitted to taxpayer from the collecting bank, taxpayer would enter this payment as a credit reducing the book balance of the particular issue in its subsidiary and general ledgers.
When all the bonds of an issue had been sold by a dealer to its customers, a closing statement would be prepared by taxpayer and furnished to the dealer which reflected the final settlement between them. This statement would show the dealer's gross profit or loss on the issue and include taxpayer's specific charges for insurance, handling, postage, and wires together with the interest accrued since the last monthly accrual date, or since the date of issuance if that was subsequent to the last monthly accrual date. Finally, the statement would show a balance due either the dealer or taxpayer. When a balance was due the dealer, taxpayer, at the dealer's election, would either remit it to the dealer or credit it to the dealer's account with taxpayer, if there was one. When a balance was due taxpayer, the statement would serve as a bill to the dealer.
Computation of the balance due either the dealer or taxpayer was made as follows. To taxpayer the dealer would owe an amount equal to the sum of (1) the book value of the bonds, (2) the accrued interest not reflected on taxpayer's books, (3) taxpayer's handling charge, and (4) taxpayer's wires, postage, and insurance expenses. The term "book value," as used here, means the bid price of the bonds adjusted upward for the interest accrued after the date of issuance and reduced by the interest actually collected by taxpayer. Thus the amount due taxpayer was computable without regard to the relative success or failure of the bond flotation. Taxpayer would
Throughout the history of taxpayer's business with dealers in connection with new-issue bonds for which the dealers had bid and taxpayer had paid the issuing authority, taxpayer never refused to transfer bonds at the direction of the bidding dealer once the dealer caused taxpayer to be paid the book value of the bonds and taxpayer's handling charge and sales expenses. During the years 1962-1964 no dealer who had successfully bid on bonds for which taxpayer paid the bid price to the issuing authority failed to protect taxpayer against the risk that the bonds could not be sold to the public for at least the value assigned them on taxpayer's books. Indeed, only twice in the history of taxpayer has a dealer failed to cause taxpayer to be paid the book value of bonds for which taxpayer had paid, together with taxpayer's handling charge and incidental expenses.
During the years 1962-1964 taxpayer occasionally arranged for the participation of two other Texas banks in paying to an issuing authority the purchase price of bonds for which a dealer had successfully bid. These banks would either credit taxpayer's accounts with them or remit the price to taxpayer, who would then pay the entire bid price to the issuing authority. Taxpayer would retain in its possession the bonds paid for by the other banks and issue a safekeeping receipt to the other bank or banks participating in the transaction. Such a receipt would show the name of the issue, the interest rate, the maturity date, and the specific bond numbers of the bonds for which the other participating banks advanced payment. As the dealer who had bid for the issue found customers for the bonds covered by the safekeeping receipt, these banks would send an invoice to the dealer, charge taxpayer's account on their books in the amount of the book value of the bonds sold, and instruct taxpayer to deliver the bonds at the dealer's instruction. Like taxpayer, these banks always followed the instructions of the dealer having a customer for bonds for which they had paid the issuing authority.
Since taxpayer is a national banking association, its municipal bond transactions during the years 1962-1964 were subjected to the scrutiny of the Comptroller of the Currency.
In the court below the District Judge heard testimony from two of taxpayer's officers, a vice-president of one of the banks that engaged with taxpayer in transactions of the type here in issue, and officers of three bond dealers with whom taxpayer had dealt. As we construe the District Judge's opinion, the District Judge found, in addition to the stipulated and otherwise undisputed facts, that (1) successful bidders for municipal bonds sold their right to these bonds to taxpayer in exchange for taxpayer's assumption of their obligation to pay the issuing authority for them; (2) dealers were motivated to make these sales because of the "unique service" taxpayer could provide them in the marketing of bonds; (3) these dealers retained options to repurchase the bonds, but were not even tacitly obligated to exercise these options; (4) if dealers failed to exercise their options, taxpayer would absorb any loss or enjoy any gain on the subsequent sale of the bonds; (5) taxpayer entered these transactions to put idle funds to use as short-term investments; (6) that dealers invariably exercised their options to repurchase, even at a loss to themselves, reflected not an obligation to repurchase, but instead "sound business judgment based on the desire * * * to maintain [their] relationship with [taxpayer]"; (7) the language used by dealers in transacting with taxpayer was "trade language" signifying a sale-repurchase agreement; and (8) taxpayer and the dealers treated these transactions as sale-repurchases rather than as secured-loan transactions. On the basis of these findings, the District Court determined that
296 F.Supp. at 518.
We disagree with the District Court's conclusion for reasons we will point out in detail.
This Court has not previously dealt with the problem of whether a bank paying an issuing authority for municipal bonds awarded to dealers and subsequently sold by these dealers to their customers is for tax purposes to be considered as the owner of the bonds while it holds them or as a secured lender. The decided cases on this question announce various criteria for determining where ownership of the bonds resides in this situation. At most these tests of ownership are helpful, but we decline to regard them as "talismans of magical power," Georgia Southern & F. Ry. Co. v. Atlantic Coast Line R. Co., 5 Cir., 1967, 373 F.2d 493, 498, cert. denied, 389 U.S. 851, 88 S.Ct. 69, 19 L.Ed.2d 120 (1967);
Regarding the proper scope of our review, taxpayer contends that the question of ownership is one of fact, determined by the trial court in its favor, which should not be set aside unless clearly erroneous. Fed.R.Civ.P. 52(a). We recognize that the characterization of taxpayer's transactions with the dealers and other banks is at least partially a question of fact. Nevertheless,
United States v. Winthrop, 5 Cir., 1969, 417 F.2d 905. See also Bullock v. Tamiami Trail Tours, Inc., 5 Cir., 1959, 266 F.2d 326, 330; Thomas v. Commissioner of Internal Revenue, 5 Cir., 1958, 254 F.2d 233, 236. Since the basic facts in this case are stipulated or otherwise undisputed, we are obliged to inquire into the ultimate conclusions reached by the District Court.
Only persons having the rights and incurring the risks that ownership of municipal bonds entails may treat the interest realized by them on the municipals they own as tax-exempt income under section 103(a) (1). Congress exempted interest on municipals from federal income taxation in part to aid states and their political subdivisions in borrowing from private investors the money needed to finance the business of government. See, e. g., Holley v. United States, 6 Cir., 1942, 124 F.2d 909, 911. Section 103(a) (1) offers taxpayers an incentive to purchase municipals as investments by relieving them of the tax burden that would otherwise be imposed on the return they receive for putting their money to this particular use. See Int.Rev.Code of 1954, § 61(a) (4). To protect the revenue against "artful devices," the section 103(a) (1) income exclusion must be narrowly construed, cf. Commissioner of Internal Revenue v. P. G. Lake, Inc., 356 U.S. 260, 265, 78 S.Ct. 691, 694, 2 L.Ed.2d 743 (1958), and the substance of transactions rather than the form they take are controlling for federal tax purposes. Id. Gregory v. Helvering, 293 U.S. 465, 55 S.Ct. 266, 79 L.Ed. 596 (1935). Therefore, for purposes of section 103(a) (1), ownership must have a genuine basis in reality. Cf. Tyler v. Tomlinson, 5 Cir., 1969, 414 F.2d 844, 850.
In this case the Commissioner determined that taxpayer never acquired "ownership" of the municipal bonds involved in the transactions in issue. This determination was subject to a presumption of correctness in the court below which taxpayer had the burden of rebutting. See, e. g., Cummings v. Commissioner of Internal Revenue, 5 Cir., 1969, 410 F.2d 675, 679. In light of the well-established principles stated above, we must interpret the undisputed facts here to determine whether taxpayer overcame this presumption.
We note first that more than the legal opinions and otherwise self-serving testimony of the trial court witnesses about their past intention to transfer "ownership" is required under the circumstances here to rebut the presumption that the Commissioner's determination was correct. Cf. United States v. Smith, 5 Cir., 1969, 418 F.2d 589. Even if we were to accept the opinion testimony at face value, we would nevertheless
The substance of the new-issue transactions involved in this case we find to have been as follows: (1) the successful bidder-dealer for a new issue was entitled to delivery of the bonds upon payment of the bid price; (2) if payment was not made to the issuing authority according to the terms of sale, the dealer's good-faith deposit with the authority was subject to forfeiture; (3) the dealer, however, was not required to produce the purchase price of bonds coming into its inventory until after it had acquired funds received in payment for these bonds from its customers, because taxpayer paid the dealer's bid price to the issuing authority and retained the bonds, already in its possession at the direction of the issuing authority, until payment was transmitted from the dealer's customers; (4) taxpayer collected for itself the interest accruing on the bonds while it held them; (5) the dealer, regardless of whether it profited or lost upon sales to its customers, invariably caused taxpayer to be paid the bid price of the issue (a bid in which taxpayer played no part as to the purchase price the dealer agreed to pay if his bid was successful), adjusted for interest, and its handling charge and incidental expenses. As a result of transactions of this type, the distribution of new issues to the public was facilitated by means of the use of taxpayer's funds and the dealers' selling efforts. Taxpayer looked solely to the interest accruing on the bonds for its profit. The dealers profited if they could sell the bonds for more than their adjusted bids, but bore the risk that the bonds could not be sold for at least that much. In short, taxpayer was in effect a lender secured by collateral in its possession. Under these circumstances, we would be blinding ourselves to reality if we did not see quite clearly that taxpayer's role here was that of a lending institution, making its funds available to bond dealers who bid successfully on new issues, retaining the bonds as collateral until the dealers had disposed of them to customers and reimbursed the bank, incurring no profits or risks due to market fluctuations, and being paid interest only for advance of its funds. We cannot indulge the fiction that the bank was the actual owner of the bonds under the undisputed facts, even if the parties to the transactions wish to term it so. How there could be a sale-repurchase transaction between the bank and a dealer when ordinarily a substantial portion of each bond issue was sold to the dealer's customers before the bonds were issued, and possession obtained by taxpayer, is hard to understand. Certainly the bank did not intervene as a "purchaser" of these bonds. The dealer exercised complete dominion over the bonds after they came into the bank's possession. He sold them at his pleasure, at prices he determined, and without reference to the bank, except that the proceeds were collected from the customer by the bank and applied to the dealer's account. Obviously the inventory of bonds was being held by the bank for the dealers and subject to their disposition. To us the bank was simply a lender of its funds to the dealers. For this service it was paid interest by the borrowing dealers. Taxpayer took only the risks of a lender in these transactions. We must, therefore, look beyond the forms and terms which the bank and the dealers attributed to these dealings to the real substance thereof. When we do, the conclusion is inescapable that taxpayer was not entitled
The only real risk that taxpayer incurred during the course of its transactions with the bond dealers was that the successful bidder for high-grade ("BAA" or above) bonds would, in a falling market, be either financially unable to take the bonds from taxpayer or be indifferent to the consequences of not taking them. Taxpayer enjoys a position of predominance in the distribution of municipal bond issues in Texas. Its refusal to provide its unique services to a bond dealer would bode ill for that dealer's business in the Texas bond market. The record shows clearly that dealers, so long as they desired to continue marketing new issues of Texas municipal bonds, insulated taxpayer from market fluctuations in the price of bonds that taxpayer held. The testimony of taxpayer's own witnesses establishes that bond dealers understood that taxpayer's continued participation with dealers in new-issue transactions depended upon the continued protection of taxpayer from the risk of loss in a falling market. Thus the basic risk of ownership of the bonds was incurred by the dealers.
The District Court considered two appellate decisions involving the tax effect of transactions between banks and bond dealers of the general type here in issue and concluded that one, Commissioner of Internal Revenue v. Bank of California, Nat. Ass'n, 9 Cir., 1935, 80 F.2d 389, aff'g B.T.A., 1934, 30 B.T.A. 556, was conclusive of this case, while the other, First Nat. Bank in Wichita v. Commissioner of Internal Revenue, 10 Cir., 1932, 57 F.2d 7, aff'g B.T.A., 1930, 19 B.T.A. 744, was distinguishable. Unlike the District Court, we discern no rule of law in these cases which is controlling here.
In First Nat. Bank in Wichita the Board of Tax Appeals formulated the question for decision as follows:
19 B.T.A. at 749. In Bank of California the Board also relied upon the manner in which the bank and the bond dealers treated the bond interest as support for its conclusion that the bank "owned" the bonds. 30 B.T.A. at 561. In our view, in the cited cases the Board placed undue emphasis on the intent and acts of the parties. As we said in United States v. Snyder Brothers Company, 5 Cir., 1966, 367 F.2d 980, 982-983, the question with which courts must be concerned in cases such as this is whether the intent and acts of the parties should be disregarded in characterizing their transactions for tax purposes. Under the circumstances here, taxpayer's "ownership" of these bonds was without substance; therefore, it was not entitled to treat bond interest earned as tax-exempt income.
To summarize, we hold that taxpayer failed to establish in the court below that it was entitled to treat the income received by it in the form of interest it collected on municipal bonds as excludable from its gross income under section 103(a) (1) of the Internal Revenue Code of 1954. Section 103(a) (1) requires
Reversed and remanded.