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PETERSON v. UNITED STATES

October 30, 1985

MERLE F. PETERSON AND DELORES F. PETERSON, PLAINTIFFS,
v.
UNITED STATES OF AMERICA, DEFENDANT



The opinion of the court was delivered by: OVERTON

 Plaintiffs instituted this action pursuant to 28 U.S.C. § 1346(a)(1) for the recovery of Internal Revenue taxes allegedly erroneously, illegally and improperly assessed and collected from them. Plaintiffs claim that the transactions they entered into do not constitute an industrial development bond under Section 103(b) of the Internal Revenue Code and, therefore, the interest paid to them is exempt from federal income taxation under the general provision of Section 103(a). Both parties agree that there are no genuine issues of material fact and that the case should be decided on the cross motions for summary judgment as the only remaining issue is whether plaintiffs' transactions constitute an industrial development bond.

 The undisputed facts appear to be as follows:

 In 1976, plaintiffs, the City of Dumas, Arkansas, and Belden Corporation entered into multi-faceted agreements. The Petersons sold property to the City of Dumas. At the same time, Dumas leased the property to Belden for twenty years. When the lease expired, Belden had the option to buy the property from Dumas for whatever amount of money Dumas still owed the Petersons on the sale. If Dumas owed nothing to the Petersons, Belden could buy the property for only $100.00 (Exhibit A, "Contract and Agreement", Article III, §§ 302 and 303; Exhibit B, "Lease and Agreement", Article XVIII, § 1801.) When Dumas bought the property, it gave the Petersons a promissory note providing for forty consecutive semi-annual installment payments. (Exhibit A, Article II, § 201, Exhibit C, "Contract", Article III, § 301.) The contract was a special obligation of Dumas, i.e., the city only had to use rent payments by Belden to make its payments to the Petersons. (Exhibit C, Article III, § 304.) The only security given to the Petersons was the property itself, and "all rights, revenue and income" which Dumas obtained from the property. (Id., Section 305.)

 Section 103(a) of the Internal Revenue Code of 1954 exempts from gross income interest on the obligations of a state or its political subdivisions. However, exempt obligations do not include an industrial development bond, which is defined as --

 
any obligation --
 
(A) which is issued as part of an issue all or a major portion of the proceeds of which are to be used directly or indirectly in any trade or business carried on by any person who is not an exempt person (within the meaning of paragraph (3)), and
 
(B) the payment of the principal or interest on which (under the terms of such obligation or any underlying arrangement) is, in whole or in major part --
 
(i) secured by any interest in property used or to be used in a trade or business or in payments in respect of such property, or
 
(ii) to be derived from payments in respect of property, or borrowed money, used or to be used in a trade or business.
 
Section 103(b)(2) of the Internal Revenue Code of 1954 (1976 ed.)

 In response to the government's motion for summary judgment, and in support of their motion, plaintiffs challenge two specific points. First, the Petersons argue that Section 103(b) does not include land and buildings within its definition of "proceeds", and second, that the obligation of the City of Dumas was not "issued as part of an issue."

 Plaintiffs offered no evidence or case law to support their theory that real and/or personal property was not to be included within the Section 103(b) definition of "proceeds" or that the definition was limited to cash money. The United States Supreme Court, in a case involving the construction of a will, noted that the term "proceeds" was one of "great generality" and held that it did not have to be cash, but could be land. Phelps v. Harris, 101 U.S. 370, 380-381, 25 L. Ed. 855 (1879). The government cited cases in various contexts which have not limited the definition of proceeds to cash money. See, Perkins v. Clinton State Bank, 593 F.2d 327, 335-336 (8th Cir. 1979) (in a case construing an escrow agreement held that "proceeds" could be real estate notes); Mesa Farm Company v. United States, 475 F.2d 1004 (9th Cir. 1973) (in the context of the ...


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