SCOTUS Reports

Tag: Letters of Credit

  • Imported Wines Corp. v. Commissioner, 14 T.C. 53 (1950): Determining Borrowed Invested Capital for Excess Profits Tax

    Imported Wines Corp. v. Commissioner, 14 T.C. 53 (1950)

    For excess profits tax purposes, a taxpayer can include accepted drafts under letters of credit as borrowed invested capital because these drafts represent an outstanding indebtedness evidenced by a bill of exchange.

    Summary

    Imported Wines Corp. sought to include outstanding letters of credit and accepted drafts under those credits in its borrowed invested capital calculation for excess profits tax purposes. The Tax Court held that while the letters of credit themselves did not constitute borrowed capital, the drafts accepted by banks under those letters did, as they represented an outstanding indebtedness evidenced by a bill of exchange, thereby increasing the taxpayer’s excess profits credit. This case clarifies what constitutes borrowed capital under Section 719 of the Internal Revenue Code.

    Facts

    Imported Wines Corp. (petitioner) applied for and obtained irrevocable commercial letters of credit from banks to finance the import of goods. Banks issued these letters of credit, and drafts were drawn under them. Upon acceptance of these drafts by the banks, the banks turned over the bills of lading to the petitioner. The petitioner claimed that both the outstanding letters of credit and the accepted drafts should be included in the computation of its average borrowed invested capital for excess profits tax purposes.

    Procedural History

    The Commissioner of Internal Revenue determined a deficiency in the petitioner’s excess profits tax. The Commissioner disallowed the inclusion of the banks’ outstanding letters of credit in the borrowed invested capital. The petitioner appealed to the Tax Court, contesting the deficiency. The Commissioner then amended the answer to assert that the accepted drafts should also be excluded from borrowed invested capital.

    Issue(s)

    1. Whether outstanding irrevocable commercial letters of credit issued by banks pursuant to the petitioner’s applications constitute borrowed capital under Section 719 of the Internal Revenue Code?

    2. Whether banks’ accepted drafts under said letters of credit constitute borrowed capital under Section 719 of the Internal Revenue Code?

    Holding

    1. No, because the letters of credit themselves do not represent an outstanding indebtedness evidenced by a bond, note, bill of exchange, debenture, certificate of indebtedness, mortgage, or deed of trust until a draft has been drawn and accepted.

    2. Yes, because the accepted drafts represent an outstanding indebtedness of the taxpayer evidenced by a bill of exchange.

    Court’s Reasoning

    Regarding the letters of credit, the Court reasoned that until a draft is drawn and accepted, the letter of credit does not represent an “indebtedness” as defined by Section 719. The Court emphasized that while the petitioner had an obligation to reimburse the bank, this obligation was conditional until a draft was actually drawn. The Court cited Deputy v. DuPont, 308 U.S. 488, noting that “although an indebtedness is an obligation, an obligation is not necessarily an ‘indebtedness.’”

    Regarding the accepted drafts, the Court found that these did represent an outstanding indebtedness of the taxpayer. The Court acknowledged the Commissioner’s argument that the acceptances were the banks’ bills of exchange, not the petitioner’s. However, the Court stated that the statute only requires that the indebtedness be that “of the taxpayer” and that it be “evidenced by” one of the specified instruments. The fact that the bank was also liable did not negate the petitioner’s indebtedness. The court noted, “True, the bank was liable for the indebtedness, but so was petitioner. It had been contracted for petitioner’s account and in a very true sense was petitioner’s indebtedness. Petitioner was the one that ultimately had to pay.”

    Practical Implications

    This case clarifies the treatment of letters of credit and accepted drafts in the context of excess profits tax calculations. It establishes that a taxpayer cannot include letters of credit as borrowed capital until they are converted into actual indebtedness through accepted drafts. This decision is vital for businesses that utilize letters of credit for financing imports or other transactions and need to accurately calculate their excess profits credit. Later cases may distinguish this ruling based on specific contractual language or variations in the financial arrangements, but the core principle remains that the indebtedness must be real and directly tied to the taxpayer.

  • Wm. A. Higgins & Co. v. Commissioner, 4 T.C. 1033 (1945): Defining Borrowed Capital for Excess Profits Tax

    4 T.C. 1033 (1945)

    For excess profits tax purposes, outstanding indebtedness evidenced by bank acceptances of drafts drawn under letters of credit constitutes borrowed capital, while the open letters of credit themselves do not.

    Summary

    Wm. A. Higgins & Co., an importer, sought to include the amounts of open letters of credit and bank acceptances in its borrowed invested capital for excess profits tax calculation. The Tax Court held that while the bank acceptances of drafts drawn under the letters of credit represented outstanding indebtedness evidenced by bills of exchange (and thus qualified as borrowed capital), the open letters of credit themselves did not constitute borrowed capital because they were not ‘outstanding indebtedness’ evidenced by a specified instrument. This distinction significantly impacted the company’s excess profits tax liability.

    Facts

    Wm. A. Higgins & Co. financed its foreign purchases using irrevocable commercial letters of credit. They established lines of credit with several banks. For each purchase, Higgins contracted with a foreign seller, agreeing to provide an irrevocable letter of credit. Higgins then applied to a bank for the letter of credit, which, upon approval, was sent to the seller. The seller drew drafts on the bank, attaching order bills of lading. The bank accepted the draft, returning it to the seller and giving the bills of lading to Higgins, who issued a trust receipt. Higgins was required to maintain sufficient funds to cover the accepted draft by its due date. The bank charged fees for this service.

    Procedural History

    Higgins claimed an average borrowed capital of $684,070 in its excess profits tax return, including amounts related to letters of credit and bank acceptances. The Commissioner of Internal Revenue disallowed the inclusion of open letters of credit in borrowed capital, resulting in a deficiency. The Commissioner later amended the answer to also disallow the inclusion of bank acceptances. Higgins petitioned the Tax Court, contesting the initial deficiency and the increased deficiency claimed by the Commissioner.

    Issue(s)

    1. Whether outstanding irrevocable commercial letters of credit issued by banks pursuant to Higgins’ applications qualify as ‘borrowed capital’ under Section 719 of the Internal Revenue Code?

    2. Whether the banks’ accepted drafts under the letters of credit also qualify as ‘borrowed capital’ under Section 719 of the Internal Revenue Code?

    Holding

    1. No, because the open letters of credit did not represent ‘outstanding indebtedness’ evidenced by a bond, note, bill of exchange, debenture, certificate of indebtedness, mortgage, or deed of trust as required by Section 719.

    2. Yes, because the bank acceptances did represent outstanding indebtedness of the taxpayer evidenced by bills of exchange.

    Court’s Reasoning

    The court reasoned that a letter of credit is a request for someone to advance money or give credit to a third person with a promise to repay. Although Higgins had an obligation to reimburse the bank for payments made under the letter of credit, this obligation did not constitute an ‘indebtedness’ until a draft was drawn and accepted. The court quoted Deputy v. DuPont, 308 U.S. 488, stating, “although an indebtedness is an obligation, an obligation is not necessarily an ‘indebtedness’.” The court emphasized that the statute required ‘outstanding indebtedness’ evidenced by specific instruments. Once the drafts were accepted, Higgins became indebted to the full extent of the drafts, and these acceptances qualified as bills of exchange. The court stated, “The statute requires that the indebtedness has to be the indebtedness ‘of the taxpayer,’ but it does not require that the specific type of instrument mentioned in the statute be that ‘of the taxpayer’. All that the statute requires is that the outstanding indebtedness of the taxpayer be ‘evidenced by’ one of the specific types of instruments.”

    Practical Implications

    This case clarifies the definition of ‘borrowed capital’ for excess profits tax purposes, establishing a distinction between open letters of credit and bank acceptances. It underscores the importance of demonstrating that indebtedness is evidenced by a specific type of instrument listed in the statute (bond, note, bill of exchange, etc.). For businesses, this ruling highlights the need to carefully structure financing arrangements to maximize eligibility for borrowed capital treatment. This case serves as precedent for interpreting similar provisions in subsequent tax laws, emphasizing a strict interpretation of the statutory requirements. Subsequent cases would need to analyze whether specific financing arrangements create an ‘indebtedness’ and whether that indebtedness is ‘evidenced by’ a qualifying instrument. The case also demonstrates the importance of the substance over form when evaluating tax liabilities.