Dix v. Commissioner

George C. and Irmgard O. Dix, Petitioners, v. Commissioner of Internal Revenue, Respondent Dix v. Commissioner Docket No. 70245 United States Tax Court 34 T.C. 837; 1960 U.S. Tax Ct. LEXIS 96; August 12, 1960, Filed *96 Decision will be entered under Rule 50. Recovery date of prewar German bonds presumed lost on outbreak of war under section 127, I.R.C. 1939, held, on the facts, to be no later than the time of deposit of the bonds for validation pursuant to the agreement with the new German Government for resumption of payments, so that holding period after recovery exceeded 6 months. George C. Dix, pro se. Herbert Rothenberg, Esq., for the respondent. Opper, Judge. OPPER *837 The determination of a deficiency in income tax for 1954 in the amount of $ 1,415.91 is contested by petitioners, although the entire amount is not in issue. The only question is whether gain realized upon the exchange of certain bonds was long- or short-term capital gain. Most *97 of the material facts have been stipulated. FINDINGS OF FACT. The stipulated facts are hereby found. The stipulation, in essence, reads as follows: the sole issue is whether petitioner [George C. Dix, hereinafter referred to as petitioner] is entitled to long term or short term capital gain on the exchange of nine (9) German External Loan 1924 7% bonds, hereinafter sometimes referred to as the 9M Dawes bonds, and ten (10) 5 1/2% Loan 1930 5 1/2% bonds, *838 hereinafter sometimes referred to as the 10M Young bonds, for new bonds of the Federal Republic of Germany. The only dispute between the parties is the date on which petitioner's holding period commences for the 9M Dawes and 10M Young bonds in question. 3. Prior to September 30, 1940 petitioner purchased the 9M Dawes bonds for $ 1,617.50. 4. In June, 1940 petitioner purchased 10M Young bonds for $ 1,650.25. 5. In September, 1941 petitioner made application for registration of the 9M Dawes and 10M Young bonds with the Federal Property Control of the United States Treasury. Certificates were affixed thereafter by the United States Treasury indicating that these bonds were physically located in the United States. 6. At the*98 end of World War II, various issues of German external debt were outstanding, including dollar bonds issued or guaranteed by the German Reich and bonds issued by German states. On December 11, 1941, following the declaration of war by the United States against Germany, the Securities and Exchange Commission requested securities exchanges and securities dealers throughout the United States to cease handling transactions in German bonds. Until January 12, 1954 [by SEC Release dated Jan. 11, 1954] those restrictions had not been removed and because of them there has been no market for German dollar bonds in this country for more than 12 years. German dollar bonds have sporadically and to a limited extent been traded during that period in Switzerland on an over-the-counter basis and, after the war, in some other European countries. However, no well established market for them has existed in the United States. In 1951 the Federal Republic of Germany (hereinafter referred to as Federal Republic) accepted its liability for the prewar external debt of the German Reich, including debts of other issuers subsequently to be declared liabilities of the Reich, and confirmed its desire to resume*99 payments thereon. Thereafter, the Governments of the United States, United Kingdom and France established the Tripartite Commission on German Debts, for the purpose of preparing a plan for the orderly overall settlement of German external debts. An international conference on German External Debts was held in London from February 28, 1952 to August 8, 1952, among the Federal Republic, the Tripartite Commission, and representatives of other interested governments and of creditor and debtor interests. As a result of the London conference, a settlement plan was agreed upon, which is embodied in an agreement dated February 27, 1953, between the various interested governments, and which is known as the London Agreement on German External Debts 1953 (hereinafter called the London Agreement). The ratification or approval of the London Agreement by the Federal Republic and the Governments of the United States, the United Kingdom and France has been completed and it is now in effect. The London Agreement and Annex I thereto provide that the Federal Republic will undertake to pay and transfer certain specified amounts in respect of the principal of and interest on the outstanding German*100 dollar bonds of the following two issues (hereinafter called Old Bonds): 1 (1) German External Loan 1924 7 percent. Bonds, due October 15, 1949 (the Dawes Loan). (2) German Government International 5 1/2 percent Loan 1930, 5 1/2 percent Bonds, due June 1, 1965 (the Young Loan). *839 Such undertaking is to be carried out by offers of several issues of new dollar bonds of the Federal Republic (hereinafter called New Bonds), representing the amounts so specified in the London Agreement, in exchange for outstanding Old Bonds and, in certain cases, for accrued unpaid interest on such Old Bonds. Except as indicated in the London Agreement, the terms of the original contracts of the Old Bonds will be maintained. The issuance of the New Bonds and the undertakings of the Federal Republic to be contained in the proposed exchange offers have been duly authorized by the "Law Concerning the Agreement*101 on German External Debts dated February 27, 1953", of the Federal Republic, enacted August 27, 1953. Substantial amounts of the original issues of the Old Bonds had been repatriated prior to 1945. In the confusion that existed in Germany during the latter days of the war, many of those repatriated bonds which had not yet been cancelled were lost or looted. For that reason, it has been necessary for the Federal Republic to establish a procedure for the validation of Old Bonds in order to assure that those lost or looted bonds cannot be circulated or otherwise presented as valid and outstanding obligations. The New Bonds will be offered in exchange only for Old Bonds and appurtenant coupons which are legally outstanding at the date of exchange and which shall have been validated pursuant to the procedure for validation established under the "Law for the Validation of German Foreign Currency Bonds", of the Federal Republic dated August 25, 1952, and regulations issued thereunder, except that Fractional Certificates for Conversion Office for German Foreign Debts, 3 percent Dollar Bonds, due January 1, 1946, will not require validation. The application of that procedure in the United*102 States is based on an agreement between the Government of the United States and the Federal Republic, dated February 27, 1953, which established a board for the validation of German dollar bonds. This board has authority to validate Old Bonds and appurtenant coupons which were held outside of Germany on January 1, 1945, its denial of validation being subject to review. A further agreement between the Governments of the United States and the Federal Republic, dated April 1, 1953, provides that external pre-war German Dollar Bonds therein referred to, including the Old Bonds and appurtenant coupons, shall not be enforceable unless they shall be validated in accordance with the procedure referred to above. The United States Senate has advised and consented to the ratification of this agreement, and it has entered into force on September 16, 1953. 7. On December 11, 1941 all United States stock exchanges suspended trading in the Dawes and Young bonds as well as all other German bonds. 8. On December 1, 1953 petitioner delivered to Joseph Mayr & Co., Investment Securities, 50 Broad Street, New York, New York, for transmittal to J. P. Morgan & Company, New York, New York, the 9M Dawes*103 and 10M Young bonds for validation, said J. P. Morgan & Company being the agent appointed by Germany for validation of the bonds in question. 9. Shortly thereafter, Joseph Mayr & Company delivered the bonds in question to J. P. Morgan & Company. 10. On May 6, 1954 the 9M Dawes and 10M Young bonds were validated by the Validation Board. 11. On May 19, 1954 the Validation Board returned to Joseph Mayr & Co. petitioner's 9M Dawes bonds with validation certificates attached. On May 25, 1954 the Validation Board returned to Joseph Mayr & Co. petitioner's 10M Young bonds with validation certificates attached. 12. On May 21, 1954 Joseph Mayr & Co. returned to the petitioner the validated 10M Dawes bonds. On May 25, 1954 Joseph Mayr & Co. returned to petitioner the validated 9M Young bonds. *840 13. On June 24, 1954 petitioner presented the validated 9M Dawes and 10M Young bonds to J. P. Morgan & Company for exchange into new bonds in the Federal Republic of Germany. 14. The Validation Board first began validating Young bonds on December 12, 1953 and Dawes bonds on December 19, 1953. However, there was no public market in the United States for these bonds prior to January 12, 1953. *104 The adjustment in controversy was made in the deficiency notice in the following language: Unallowable deductions and additional income * * * * (f) Capital gains $ 3,124.37 * * * * EXPLANATION OF ADJUSTMENTS * * * * (f) It has been determined that you received a short-term capital gain when you exchanged in June 1954, nine (9) German External Loan 1924 7% Bonds (the Dawes Loan) and ten (10) German Government International 5 1/2% Loan 1930 5 1/2% Bonds (the Young Loan) for new bonds of the Federal Republic of Germany. Accordingly your capital gain has been adjusted as set forth in the Schedule attached to the 30-day Letter. OPINION. Several aspects of the situation presented to us remain obscure or entirely unexplained. The parties, however, are in complete if not emphatic agreement as to the sole issue for our decision and we shall of course accept the controversy in its present posture and dispose of that issue as best we may. But the statement of it may demonstrate the incidental questions which we shall not attempt to answer. Petitioner's exchange of his old German bonds for new ones on June 24, 1954, appears to be viewed by the parties as the taxable event giving rise to capital*105 gain, presumably measured by the difference between the basis of the old bonds and the value of the new. No dispute arises as to either of these figures, though they do not appear in the record. The sole issue, as repeatedly stated, is whether this gain is long-term or short-term, which in turn depends on how long the old bonds are deemed to have been held, which on its part is to be determined by when the old bonds were "recovered" within the meaning of section 127, I.R.C. 1939. This is because, although continually in existence and in fact in the physical possession of petitioner during a period that commenced before the war, they are considered as having been "destroyed" at the outbreak of hostilities, and as having been nonexistent during the war and for some time thereafter, Kenmore v. Commissioner, (C.A. 2) 205 F. 2d 90, affirming Ervin Kenmore, infra -- just how long is the only question. *841 The primary purpose of the recovery provision appears not to affect this case at all. That, of course, was to ensure that losses which had been allowed as deductions against ordinary income and had hence reduced the tax payable by the taxpayer*106 in some prior year would be taken up in income when what had been "lost" was finally "recovered." Basically the aim was to restore the revenue to its original position. "* * * § 127(a)(2) is to be read as though the property had ceased to exist during the period of enemy occupation. The plan of the statute was to treat its value on the date of the declaration of war as a deductible loss, and to treat any 'recovery' as income or gain * * *." Kenmore v. Commissioner, supra. The significance of the "recovery" in the instant situation, is however not to determine what should be reported by petitioner as income on that account, nor when it should be so reported, nor even its value at the time of recovery for the fixing of basis. We must assume that no problems have arisen in any of these areas. The importance of the recovery date is solely that it establishes the time of a kind of constructive acquisition, and hence marks the beginning of petitioner's holding period for capital gains tax purposes. Nevertheless, petitioner says: "In his 1954 Tax Return Petitioner paid tax on the January 11, 1954 value of the old bonds as long-term capital gains." *107 (Emphasis added.) Now one of the curious elements is that January 11, 1954, is the same date as that upon which respondent contends the old bonds were recovered. But recovery is not the taxable event, as far as he is concerned. Rather, that is, as we have said, and as apparently petitioner agrees, the subsequent exchange for the new bonds. And petitioner's contention -- now, at least -- is that January 11, 1954, was not the date of recovery of the old bonds at all, but that this occurred sometime in 1953 at the latest. There is no suggestion, however, as to whether anything was -- or should have been -- reported as income in that year on account of the recovery of the old bonds. On the narrow issue actually before us, we think petitioner must prevail. Recovery is not defined or clarified in the statute as the original loss was. We called attention to this distinction in Ervin Kenmore, 18 T.C. 754, 758, for example, where we went on to say: In such circumstances, we think that Congress meant that, in order for subsection (c) to apply and in order that a taxpayer be required to include the value of the property previously considered as having been*108 lost or destroyed in gross income, there should be the occurrence of some act of repossession, or the obtaining again of actual control, before there would be recovery within the meaning of the statute * * * Respondent's counsel made it clear at the time this case was presented that the issue here was to be treated as purely one of fact. But under the present circumstances, we shall not, as in Ervin Kenmore, *842 , be able to isolate the determinative fact by resort to an "act of repossession" or the reacquisition of "actual control." It was not the loss of possession or control that caused the destruction here, but rather the presumed repudiation and unwillingness to pay on the part of the debtor. The bonds, if not the debt they represented, belonged to petitioner and were physically in his possession all the time. What was required to reconstitute the property in this case was a restoration of status to the debt. Just as its validity was lost for practical purposes because it became uncollectible when war was declared, see Bella Feinstein, 24 T.C. 656; Ervin Kenmore, supra,*109 so we think the recovery arose when the validity of the debt was restored by the acknowledgment by the debtor and the establishment of machinery for recognition of that acknowledgment and for the resumption of payments. We need not say which of the long series of steps leading to this ultimate accomplishment might be thought of as decisive -- the German declaration, negotiation of the agreement, passage of the German enabling legislation, ratification by the United States, the President's proclamation, 1 or even the date when validation commenced. At least by the time petitioner's bonds were submitted for validation early in December 1953, with the assurance that they would be accepted 2 and returned, we think all the necessary steps to the "recovery" had been taken, and that accordingly the holding period was in excess of 6 months. *110 Decision will be entered under Rule 50. Footnotes 1. Five issues were involved in the London Agreement but only the Dawes and Young issues are involved in the instant case.↩ 1. The agreements were published under Presidential Proclamation of Nov. 4, 1953, as being effective Sept. 16, 1953, 4 U.S. Treaties (Part 1, 1953) 794.↩ 2. "[The] subsequent validation would simply confirm the fact that the bond was valid on the recovery date." (Rev. Rul. 54-501, 1954-2 C.B. 197↩, 201.)