United States of America, Appellant, v. Robert Rutherford Bond and Margaret E. Bond, Appellees, 258 F.2d 577 (5th Cir. 1958)

The question here is whether amounts paid by Taxpayer to a Texas life insurance company under an Annuity Savings Bond and Annuity Loan Note were deductible as interest under Section 23(b) of the Internal Revenue Code¹  of 1939. In the suit for refund, the District Court held for the Taxpayer.

The facts are uncontradicted and were largely stipulated. The Taxpayer in December 1952 purchased²  from the Sam Houston Life Insurance Company (in Texas) a single-premium, thirty-year maturity, Annuity Savings Bond of a stated guaranteed cash value of $209,700 at maturity at a premium cost of $100,100 of which he paid $100 in cash and executed an Annuity Loan Note in the amount of $100,000. The Note provided that interest be paid in advance at the rate and as provided in the Bond. During 1952 Taxpayer paid as interest $2,750 at the rate of 2¾% of the principal amount of the Note.

Under the Annuity Bond, the Company agrees to pay, on the thirtieth anniversary, an annuity of $1,830.68 per month with a Cash Value on the Original Maturity Date of $209,700. At any time before the thirty-year Maturity Date, the annuitant may elect to receive in a single sum the net cash value at the time, or to receive a reduced annuity computed, according to the then age of the annuitant, upon the net cash value. There are various alternatives on the death of the Bondholder. If after payments start, the Bondholder dies, payments will continue to the beneficiary; if she dies, payments will be made to the estate of the last to die of the Bondholder or beneficiary. In either event, the aggregate sum payable will be the net cash value on maturity of the Policy. If the Bondholder or Annuitant dies before the Maturity Date, a death benefit will be paid to the beneficiary or to his estate of the then net cash value.

The Cash Value was determined by a table³  in the Bond specifying the Cash or Loan Value at the end of each contract year from 1 through 30. The term "Net Cash Value" was defined to "mean the Cash Value * * * on the date as of which it is being computed and decreased by the amount of any indebtedness to the Company against this Contract."

The Annuity Loan Note recites the receipt of $100,000 advanced by the Company "as a loan on the sole security of and in accordance with the provisions contained in Annuity Savings Bond Number * * *," and which sum the Company is directed to apply to pay the remaining premiums of the Annuity Savings Bond. The Maker of the Note expressly assigns the Annuity Savings Bond and all sums due under it to the Company as security for the repayment of the loan and interest. Interest is payable at the rate and at the time provided in the Bond. The principal of the loan becomes due and payable whenever the Bond shall become due and payable or whenever the total indebtedness on the Bond shall equal or exceed the guaranteed Cash Value of the Bond. In the event the Bond lapses or becomes forfeited, the amount of the Loan with interest is to be deducted from any Cash Surrender Value of the Bond. It expressly states "* * * that there is no personal liability upon the makers of this note for the payment thereof, the sole recourse being against the said Annuity Savings Bond."

Taking as its dominant theme, which recurs in major and minor key, the oft-quoted generality, frequently repeated with an uncritical regard for the case which gave it birth, that "as respects `interest,' the usual import of the term is the amount which one has contracted to pay for the use of borrowed money," Old Colony Railroad Co. v. Commissioner, 284 U.S. 552, 560, 52 S. Ct. 211, 214, 76 L. Ed. 484, 489, and its paraphrase that "In the business world `interest on indebtedness' means compensation for the use or forbearance of money," Deputy v. Dupont, 308 U.S. 488, 498, 60 S. Ct. 363, 368, 84 L. Ed. 416, 424, the Government insists that this is not an indebtedness. The annual payments, denominated interest, are something else since no money was loaned or borrowed nor were other economic benefits actually advanced to Taxpayer by the Company. On this approach, if this is not indebtedness, the annual payment could not be interest, and since neither of the dual requirements of Section 23(b), note 1, supra, is present, the meaning, application, or historical development of Section 24(a) (6) of the 1939 Code⁴  is of no importance at all.

In the determination of the interest status of these annual payments, it is not, in our view, proper to divorce Section 23(b) from Section 24(a) (6) since both are a part of a single Code coming to bear here on a single subject. That being so, a proper regard for the historical development of these Code provisions as well as the intrinsic nature of this Annuity Bond contract will establish that the District Judge was right in declaring this to be deductible interest.

The Government would have us believe that this was an artificial transaction with nothing but a swapping of ostensible interest charges and offsetting credits or payments. Since the amount of the Note, representing the premium, must first be deducted, it is claimed that the so-called Cash Value is an illusion, that the Taxpayer could not derive any benefit from it, nor could the Company retain or invest it as it saw fit or lend it to Taxpayer or others as money belonging to the Company. This is especially true, it says, since payment of the Note is secured solely by assignment of the Bond without personal liability of the Maker.

The Government contrasts this to the case in which, prior to the 1954 Code, see note 20, infra, one desiring to procure a single premium Annuity could borrow the full amount of the premium from a bank, use the proceeds to pay the premium to the company and deduct the interest. It is not at all articulate in pointing out what are the distinguishing comparative factors.⁵  We could hardly believe that they are the fact that no money actually passes, that a check from the lender is not issued, deposited by the borrower, and then a new check in payment of the single premium drawn by lender and delivered to the company issuing the Annuity Bond. Nor can the mere fact that the Maker of the Note has no personal liability deprive the annual payment of its interest status.⁶ 

But this Bond is not the mere sham supposed. It was, and is, a legitimate Annuity Contract, the issuance of which in Texas subjects the Company to the status of a regulated life insurance company.⁷  As such, it is mandatory that the annuity or insurance contract provide that the company will "* * * advance upon proper assignment of the policy and upon the sole security thereof at a specified rate of interest a sum equal to * * * the cash value of the policy."⁸  A Texas insurance company is also required to invest in Texas securities 75% of the aggregate amount of the legal reserve⁹  required to be maintained on Texas contracts. Under the Insurance Code "Texas securities" expressly includes "* * * loans made to policyholders on the sole security of the reserve values of their policies."¹⁰  Stringent limitations are placed on the nature and amount of investments, yet loans made to policyholders on the sole security of the policy reserves are automatically permitted.¹¹ 

Indeed, to show that these are accepted Texas insurance contracts, we are not left to mere inference from these laws and regulations. The record here shows as an uncontradicted exhibit¹²  that these very Bonds have been expressly approved as to content as well as the fiscal treatment of policy reserves, cash loan, asset and liability values. Moreover, these contracts confer real and genuine benefits in excess of the amounts paid in by the Annuitant.¹³ 

When we make this same realistic approach to an understanding and application of the Code, it becomes clear as a matter of Congressional intent that from 1934 to 1954, Congress has purposefully distinguished deductibility of interest charges on single premium payments for annuity contracts from those incurred to purchase a single premium life insurance or endowment contract.

A brief tracing of the legislative transmutations will demonstrate this. Section 214(a) (2) of the Revenue Acts of 1924 and 1926 and Section 23(b) of the Revenue Act of 1928 are identical with Section 23(b) of the 1939 Code, note 1, supra. Section 215 of the Revenue Acts of 1924 and 1926 and Section 24 of the Revenue Act of 1928 are similar to Section 24 of the 1939 Code, except that which was added to it by the Revenue Act of 1942 now appearing as Section 24(a) (6), note 4, supra, and which excludes "any amount paid or accrued on indebtedness incurred or continued to purchase a single premium life insurance or endowment contract."

However, a change was made in 1932. There, for the first and only time until 22 years later was any reference made to "indebtedness incurred or continued in connection with the purchasing or carrying of an annuity." And at that time it was introduced as a part of Section¹⁴  23 (b).

But it was scarcely a part of the law until it was deleted by the Revenue Act of 1934. Its short life was due to the change in 1934 of Section 22(b) (2) concerning the taxability of annuity income.¹⁵  In the meantime, in dealing with the problem of taxability of income and possible correlative deductions or disallowances, Congress recognized that this related to the three distinctive contracts for life insurance, endowment and annuity, one of which was momentarily singled out for special treatment on disallowance of interest, but all three of which were purposefully lumped¹⁶  together in 1934 for treatment of income taxability.

Thus it stood in 1934, and for each occasion when the Revenue Acts of 1936, 1938, and the Internal Revenue Code of 1939 was enacted. This continued right down to the enactment in 1942 of Section 24(a) (6) of the 1939 Code, note 4, supra. And when the 1942 change was made, Congress, which had ten and eight years previously shown an articulate appreciation for the distinction between the three types of contracts, this time mentioned but two — life insurance and endowments — and omitted reference to the one — annuities — previously, but briefly, covered.

That this is a fair reading of the legislative purpose gets persuasive support from the administrative handling of this problem. The Regulation¹⁷  under Section 23(b) dealt solely with "single premium life insurance or endowment" contracts, and at least one ruling¹⁸  in 1947 allowed as a deduction interest paid on a single premium annuity contract as did the later one in 1952 issued to a fellow officer and business associate of Taxpayer concerning this identical Annuity Bond and Annuity Loan Note.¹⁹  It was not until Revenue Ruling 54-94, 1954-1 Cum.Bull. 53, of March 1, 1954, that interest paid respecting single premium annuity contracts was disallowed. It was this precise ruling that was the stated basis for the disallowance in May 1954 of the deduction by Taxpayer of these interest payments for the year 1952.

The imprimatur of Congress was placed on this historical reading of Section 23(b) and 24(a) (6) by its action in enacting the 1954 Code. For Congress, 22 years after momentarily specifying annuity contracts, 20 years after annuity contracts were deleted, and 12 years after specifying but two types of contracts, now for the very first time put all three together with respect to deductibility of the carrying charges.²⁰  And the words carefully used as well as the contemporary expressions in House and Senate Reports²¹  manifest that Congress was aware that under the prior law interest for annuity contracts, as distinguished from life insurance and endowment contracts, was deductible, that the purpose of the 1954 Code was to change that law to disallow the deduction, and that such change should not be effective prior to March 1, 1954, which was the date of Revenue Ruling 54-94.

We emphasize that whether and to what extent interest deductions are to be permitted involves consideration of many complex, intricate, and sometimes technically significant factors which Congress, the weaver, evaluates as it weaves and unweaves the seamy web men call tax law. In that process Congress has purposefully distinguished between annuity contracts and the other two. In that light Section 23(b) and 24(a) (6) reflect a purpose to treat payments of the kind made here as interest and allow them as a deduction.

Affirmed.

WISDOM, Circuit Judge (dissenting).

With all due deference to my able associates, it seems to me that the majority opinion does not meet the issue squarely.

The case presents the question: Were the amounts the taxpayer paid the insurance company interest under Section 23(b)? This question is not answered by showing that Section 24(a) (6) does not prohibit deductions for amounts paid on indebtedness to purchase an annuity contract, as distinguished from a life insurance or endowment contract. Section 24(a) applies to specific items that are not deductible. It does not purport to say what items are deductible. As I see it, regardless of Section 24(a) (6), the taxpayer's payments must still qualify as interest under Section 23(b).

The issue is not met by showing that the contract was a legitimate annuity and that the Sam Houston Company complied with the Texas Insurance Code. On the contrary, as a legitimate annuity, the payments produced the same insurance effects ordinary annual premiums produce. All premiums, of course, "confer real and genuine benefits in excess of the amounts paid." There is no pretense, however, that delivery of the note for $100,000 produced the effect of payment in cash of a single premium for that amount. The taxpayer's payments were no more than annual premiums, the purchase price of the contract on a deferred payment plan. And, interest is not purchase price.

It seems to me that this Court must say what interest is under Section 23(b) and why the taxpayer's payments come within or fall outside of the definition.

The Supreme Court has defined interest as "the amount which one has contracted to pay for the use of borrowed money". Old Colony Railroad Co. v. Commissioner, 1932, 284 U.S. 552, 52 S. Ct. 211, 214, 76 L. Ed. 484. It has the same meaning in the market place. "In the business world `interest on indebtedness' means compensation for the use or forbearance of money". Deputy v. Dupont, 1940, 308 U.S. 488, 497, 60 S. Ct. 363, 368, 84 L. Ed. 416. That is the dictionary meaning of "interest". There is nothing to indicate that it has a different meaning on Capitol Hill.

The majority opinion quotes this language from the Supreme Court, but accents "indebtedness" and states that "the Government insists that this is not an indebtedness". True enough, the government argues that "there was no real indebtedness". The crux of the case for the government, however, is that, for purposes of tax deduction, interest is confined to payments made for the use of borrowed money. Here, since no money or other economic benefits were advanced to the taxpayer by the company, the payments were not interest.

Some legal terms should be as expansible and contractible as an accordian. But not the term "interest" in a taxing statute. Taxpayers and tax collectors should have the benefit of certainty of meaning; well, as much certainty as a clear definition by the Supreme Court carries.

I respectfully dissent.