Prime v. Commissioner

*488 The Commissioner determined a deficiency in income tax liability of William A. Prime, deceased, for the calendar year 1933, in the amount of $560.45. It is alleged that the Commissioner erred in disallowing a deduction in the amount of $12, 418.54 claimed as "interest paid" during the taxable year on certain life insurance policy "loans."

FINDINGS OF FACT.

In addition to certain documents, the parties have filed a written stipulation of facts and the findings of fact set forth below are stated in accordance with the written stipulation.

The original petitioner, William A. Prime, resided in New York, New York. He died*1026 on May 2, 1936. Nina Cornelia Prime was appointed executrix under the last will and testament of William A. Prime by the Surrogate of New York County, New York, on May 15, 1936, and was substituted as petitioner in this proceeding by order of the Board September 2, 1936.

The decedent was a general trader and broker. He kept his books on the cash receipts and disbursements basis. On February 14, 1933, he was indebted to the Aetna Life Insurance Co., in the following amounts:

On February 14, 1933, the decedent gave a new note to the Aetna Life Insurance Co. in the amount of $40,100 as a loan on policy No. N-182563. This amount was applied by the insurance company against the three items listed above, and the balance of $1,119.65 was paid to the decedent by check of the insurance company.

On July 1, 1933, the decednet was indebted to the Massachusetts Mutual Life Insurance Co., Springfield, Massachusetts, in the amount of $5,300.02, representing a loan of $5,145.65 against policy No. 221384, together with interest of $154.37 due on April 1, 1933. *1027 On July 1, 1933, the decedent gave a new note in the amount of $5,300.02 to the Massachusetts Mutual Life Insurance Co. to cover the amount of the previous loan with interest thereon.

On December 28, 1933, the decedent was indebted to the Massachusetts Mutual Life Insurance Co. in the amount of $5,459.02, representing the amount of the note described in the preceding paragraph, with interest of $159 thereon. On December 28, 1933, the decedent gave to the Massachusetts Mutual Life Insurance Co. a new note in the amount of $5,459.02 as a loan against policy No. 221384 to cover the amount of the previous loan with interest thereon.

*489 On November 16, 1933, the decedent was indebted to the London Life Association, Ltd., with which is associated the Metropolitan Life Assurance Society of London, England, for interest in the aggregate amount of Pound 1,375.5.3 on various policy loans. He was indebted to the same companies in the aggregate amount of Pound 476.9.7 for premiums and revival charges, making a total of Pound 1,851.14.10. On November 16, 1933, the decedent gave to the insurance companies mentioned above a note for Pound 985 as a further loan on policies Nos. 41515, 41788, and*1028 42726; a note for Pound 670 as a further loan on policy No. 50852; and a check of C. T. Bowring & Co., Ltd., in the amount of Pound 196.14.10, making an aggregate of Pound 1,851.14.10.

The rate of exchange on November 16, 1933, was $5.46 1/2 per Pound. In 1933 the total amount of interest due on all of the above insurance policy loans was $12,418.54.

The decedent, in his income tax return for the year 1933, deducted the amount of $12, 418.54 as interest paid in the taxable year. The deduction was disallowed by the Commissioner, with the following explanation:

You had loans on seven life insurance policies on which interest of $12,418.54 became due in 1933. In each instance the interest was satisfied by an increase in the loan. The examining officer proposed to disallow this amount, inasmuch as your records are kept on a cash receipts and disbursements basis and no actual payment for interest was made.

The Commissioner also disallowed a claimed deduction of $257.50 reported as a loss on the exchange of automobiles. Petitioner does not contest this determination.

OPINION.

HARRON: The statutory provision under which the deduction is claimed allows a taxpayer on a*1029 cash basis deduction from gross income come of interest paid in the taxable year on an indebtedness. ¹ Petitioner's decedent made his income tax return on the cash receipts and disbursements basis. Petitioner contends that the addition of interest accrued and unpaid to the amount of indebtedness and the giving of new notes constituted "payment" of interest within section 23(b). Petitioner makes a further contention that there was a constructive payment of interest by the decedent. Respondent concedes that decedent was "indebted" to the insurance companies on account of the policy loans and raises no question on this point.

*490 The facts are stipulated. They show that in 1933 petitioner's decedent gave new notes to several insurances companies "to cover the amount of the previous loan with interest thereon:, and in some instances to cover "further loans", meaning further advancements and not interest. The notes are not in evidence. *1030 There is no evidence relating to what entries or treatment the various insurance companies made on their books in their reserve accounts in 1933 with respect to the taking of new notes for interest due and unpaid. Only the policies purchased from the American insurance companies are in evidence. It is assumed that all the policy loans were made upon the terms that appear in the evidence. It is noted that, under the loan provisions of the insurance contracts, interest not paid when accrued was to be added to the amount of the principal of the loan and reckoned as part thereof.

The same question was before this Board in . This facts in that case are, in several respects, different from the facts in this proceeding. But there was involved there, nevertheless, the question whether the giving of a new note in an amount including accrued interest constitutes such payment of interest in the taxable year as the statute contemplates in providing for an income tax deduction. Subsequent to the decision in the Hermann case, this Board reviewed the question of whether interest is paid by the giving of a new note to cover interest accrued*1031 and unpaid, in . The Board held that the giving of a new note represents another "promise to pay" and does not satisfy the provisions of the statute allowing a deduction for "interest paid." The Thomason case overruled the Hermann case and is controlling in the determination of the question in this proceeding. See also, ; ; ; ; , on the point that the stamping "paid" on a bill for interest does not establish a payment entitling the taxpayer to a deduction for interest paid where his return is on a cash basis; ; ; , on the point that the depostiting of collateral out of which a sum may be paid in the future does not constitute*1032 a payment for purposes of an income tax deduction. Cf. ; .

Petitioner's argument goes to a theory that a constructive payment of interest accrued is accomplished by the addition of the unpaid interest to the principal of a policy loan and the giving of a new note. The constructive payment theory has seldom been approved in claims of a taxpayer on a cash basis for a deduction which presupposes an *491 expenditure by the taxpayer. See the . The distinction between the accrual and receipts and disbursements methods of accounting is made controlling in the revenue statutes. ; affd., . See also, section 43 of the Revenue Act of 1932. ² The significance of this distinction is stated by the Supreme Court in its opinion affirming the lower court in , as follows:

It is settled beyond cavil that taxpayers other than insurance*1033 companies may not accrue receipts and treat expenditures on a cash basis, or vice versa. Nor may they accrue a portion of income and deal with the remainder on a cash basis, nor take deductions partly on one and partly on the other basis.

In this proceeding, petitioner's decedent, who was on a cash basis, made no cash disbursement on account of the various accrued interest charges. Nor does the record disclose any facts upon which it could be convincingly argued that he made a constructive payment. The adding of the accrued interest charges to the principal of the loans effected a compounding of the interest for future years. (See dictionary definitions of compound interest.) But the liability to pay the interest charges was not extinguished any more than in the ordinary*1034 loan situation which was considered in the Thomason case. It must be concluded that there are no factors present in this proceeding which justify either departing from the rule adopted in the Thomason case, or applying a constructive payment theory in the face of views expressed by the Supreme Court in the Massachusetts Mutual Life Insurance Co. case.

The case cited by petitioner, , is not in point.

It is held that there was no payment of interest on indebtedness in the taxable year within the provisions of section 23(b). Respondent is sustained.

It should be pointed out that there is failure of proof as to the deduction claimed for interest owed to the London Life Association, Ltd. The amount of pound 1,375.5.3 represented accrued interest and pound 476.9.7 was due for premiums and revival charges. In the taxable year decedent paid by a check of C. T. Bowring & Co., Ltd., Pound 196.14.10. That was less than the amount due for premiums and revival charges and there is no evidence that any of that amount was paid upon accrued interest.

Decision will be entered for the respondent.*1035