Frank Lyon Co. v. United States, 435 U.S. 561 (1978)

CERTIORARI TO THE UNITED STATES COURT OF APPEALS

FOR THE EIGHTH CIRCUIT

Syllabus

A state bank, which was a member of the Federal Reserve System, upon realizing that it was not feasible, because of various state and federal regulations, for it to finance by conventional mortgage and other financing a building under construction for its headquarters and principal banking facility, entered into sale and lease-back agreements by which petitioner took title to the building and leased it back to the hank for long-term use, petitioner obtaining both a construction loan and permanent mortgage financing. The bank is obligated to pay rent equal to the principal and interest payments on petitioner’s mortgage, and has an option to repurchase the building at various times at prices equal to the then unpaid balance of petitioner’s mortgage and initial $500,000 investment. On its federal income tax return for the year in which the building was completed and the bank took possession, petitioner accrued rent from the bank and claimed as deductions depreciation on the building, interest on its construction loan and mortgage, and other expenses related to the sale and lease-back transaction. The Commissioner of Internal Revenue disallowed the deductions on the ground that petitioner was not the owner of the building for tax purposes, but that the sale and lease-back arrangement was a financing transaction in which petitioner loaned the bank $500,000 and acted as a conduit for the transmission of principal and interest to petitioner’s mortgagee. This resulted in a deficiency in petitioner’s income tax, which it paid. After its claim for a refund was denied, it brought suit in the District Court to recover the amount so paid. That court held that the claimed deductions were allowable, but the Court of Appeals reversed, agreeing with the Commissioner.

Held: Petitioner is entitled to the claimed deductions. Pp. 572-584.

(a) Although the rent agreed to be paid by the bank equaled the amounts due from the petitioner to its mortgagee, the sale and lease-back transaction is not a simple sham by which petitioner was but a conduit used to forward the mortgage payments made under the guise of rent paid by the bank to petitioner, on to the mortgagee, but the construction loan and mortgage note obligations on which petitioner paid interest are its obligations alone, and, accordingly, it is entitled to claim deductions therefor under § 163(a) of the Internal Revenue Code of 1954. Helvering v. Lazarus & Co., 308 U.S. 252, distinguished. Pp. 572-581.

(b) While it is clear that none of the parties to the sale and lease-back agreements is the owner of the building in any simple sense, it is equally clear that petitioner is the one whose capital was invested in the building, and is therefore the party entitled to claim depreciation for the consumption of that capital under § 167 of the Code. P. 581.

(c) Where, as here, there is a genuine multiple-party transaction with economic substance that is compelled or encouraged by business or regulatory realities, that is imbued with tax-independent considerations, and that is not shaped solely by tax-avoidance features to which meaningless labels are attached, the Government should honor the allocation of rights and duties effectuated by the parties; so long as the lessor retains significant and genuine attributes of the traditional lessor status, the form of the transaction adopted by the parties governs for tax purposes. Pp. 581-584.

536 F. d 746, reversed.

BLACKMUN, J., delivered the opinion of the Court, in which BURGER, C.J., and BRENNAN, STEWART, MARSHALL, POWELL, and REHNQUIST, JJ., joined. WHITE, J., filed a dissenting statement, post, p. 584. STEVENS, J., filed a dissenting opinion, post, p. 584.