Commissioner v. National Alfalfa,
417 U.S. 134 (1974)

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U.S. Supreme Court

Commissioner v. National Alfalfa, 417 U.S. 134 (1974)

Commissioner of Internal Revenue v.

National Alfalfa Dehydrating & Milling Co.

No. 73-9

Argued January 14, 1974

Decided May 28, 1974

417 U.S. 134


Respondent corporate taxpayer, pursuant to a recapitalization plan, issued $50 face value 5% sinking fund debentures in exchange for its outstanding unlisted $50 par 5% cumulative preferred shares, which at the time were quoted at approximately $33 per share on the over-the-counter market. Based on the exchange, respondent claimed on its income tax returns for several years deductions for debt discount under § 163(a) of the Internal Revenue Code of 1954, which allows deductions for interest paid on indebtedness. Respondent asserted that the debt discount, measured by the difference between a claimed $33 per share value for the preferred and the face amount of the debentures, amortized over the life of the debentures, constituted deductible interest within the purview of that provision. The Commissioner disallowed the deductions, and was upheld by the Tax Court, but the Court of Appeals reversed.

Held: Respondent did not incur amortizable debt discount upon the issuance of its debentures in exchange for its outstanding preferred stock. Pp. 417 U. S. 142-155.

(a) In determining whether debt discount arises in the situation presented here, the relevant inquiry must be whether the corporate taxpayer has incurred, as a result of the transaction, some cost or expense of acquiring the use of capital. P. 417 U. S. 147.

(b) The propriety of a deduction does not turn upon general equitable considerations, such as a demonstration of effective economic and practical equivalence to what actually occurred, but rather "depends upon legislative grace; and only as there is clear provision therefor can any particular deduction be allowed." New Colonial Co. v. Helvering, 292 U. S. 435, 292 U. S. 440. Pp. 417 U. S. 147-149.

(c) This Court will not speculate as to what the market price and the investor reaction to any sales of the debentures or purchases of the preferred by respondent in the open market would have been, since there is nothing in the record to establish the cash price at which the debentures could have been sold upon the

Page 417 U. S. 135

market or to indicate that respondent would have been able to purchase all its outstanding preferred on the open market, or at what price that stock would have been purchased in light of the impending exchange; moreover, when a corporation issues to its preferred shareholders its own new debt obligations in exchange for the outstanding preferred, the claimed fair market value of both securities is somewhat artificial, since the exchange is effectively insulated from market forces. Pp. 417 U. S. 149-151.

(d) Absent any evidence that the difference between the claimed $33 per share of the preferred and the face amount of the debentures is attributable to debt discount or that the discount rate was determined by such factors as respondent's financial condition at the time of the exchange and the availability and cost of capital in the general market as well as from the preferred shareholders, rather than simply having been predicated on the preferred's par value, the requisite evaluation of the property to be exchanged cannot occur, and debt discount cannot be determined . P. 417 U. S. 151.

(e) The alteration in the form of the retained capital did not give rise to any cost of borrowing to respondent, since the cost of the capital invested in respondent was the same whether represented by the preferred or by the debentures, and was totally unaffected by the market value of the preferred received in exchange. Pp. 417 U. S. 151-155.

472 F.2d 796, reversed.

BLACKMUN, J., delivered the opinion of the Court, in which BURGER, C.J., and DOUGLAS, BRENNAN, WHITE, MARSHALL, POWELL, and REHNQUIST, JJ., joined, and in Parts I, II, and III of which STEWART, J., joined. STEWART, J., concurred in the judgment.

Page 417 U. S. 136

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