Hastings, Chief Judge, Duffy, Circuit Judge, and Beamer, District Judge.
Appellant, Knowles Electronics, Inc., brought this action in the district court for a refund of taxes alleged to have been erroneously and illegally assessed and collected. The Government, prior to answer, filed a motion to dismiss under Rule 12(b)(6), Federal Rules of Civil Procedure, 28 U.S.C.A., for failure to state a claim upon which relief could be granted. After consideration, the district court entered an order, without opinion, dismissing Knowles' complaint on the ground that it was barred by the applicable statutes of limitation,*fn1 which had not been affected by the statute of limitations mitigation provisions of §§ 1311-1315 of the Internal Revenue Code of 1954.
On appeal, Knowles contends that the facts alleged in its complaint state a cause of action not barred by the statutes of limitation because of the mitigation provisions of §§ 1311-1315.
Briefly stated, the facts are as follows. In its fiscal year 1955, Knowles engaged in a "Livingstone" transaction, a device used to reduce taxes by claiming deductions for alleged payment of interest on loans financing the purchase of government securities. The Livingstone transaction, which this circuit has discussed in Dooley v. C.I.R., 7 Cir., 332 F.2d 463 (1964); Lewis v. C.I.R., 7 Cir., 328 F.2d 634 (1964); and Rubin v. United States, 304 F.2d 766 (1962), is in substance a sham transaction lacking commercial reality, the only purpose and effect of which is to reduce taxes. Tax deductions claimed on account of such transactions have not been allowed. See Dooley, Lewis, and Rubin, supra.
In this particular case, Knowles, in its fiscal year 1955, "purchased" $4,200,000 face value 2 1/2 per cent U.S. Treasury bonds from M. Eli Livingstone & Co. for a promissory note payable to Corporate Finance & Loan Corp. in the amount of $4,037,250. Finance received the bonds from Livingstone against purported payment to Livingstone of $4,037,250. Livingstone received $10,500 as consideration for an irrevocable offer to buy back the Treasury Bonds on May 15, 1956 at a price of 99 5/8. Knowles prepaid Finance $151,396.88 as interest on its promissory note.
In May of 1956, Livingstone "purchased" back the bonds for $4,184,250, satisfied Knowles' promissory note, and paid the remaining $147,000 to Knowles.
Over the whole transaction, Knowles paid out or lost approximately $15,000, but was able to claim on its tax return for fiscal 1955 a deduction of $151,396.88 with respect to the prepaid interest and, on its return for fiscal 1956, to report a capital gain of $136,500.
In April, 1959, the Commissioner of Internal Revenue disallowed the deduction for fiscal 1955. On July 20, 1955, Knowles filed a petition with the Tax Court contesting, inter alia, the disallowance. On or prior to September 26, 1962, Knowles and the Commissioner filed a stipulation with the Tax Court that Knowles was not entitled to an interest deduction with respect to the prepaid interest. On September 26, 1962, the Tax Court entered a decision and order, Docket No. 81971, determining a deficiency for Knowles for fiscal 1955 in the amount of $78,726.38.
On January 16, 1963, Knowles filed a claim for a tax refund of $34,125, the amount of capital gains tax paid for fiscal 1956 attributable to the $136,500 Knowles "realized" in the disposition of the Treasury bonds. Knowles, in effect, based its claim on the ground that since the whole Livingston transaction was in effect a nullity, and since, for taxation purposes, the whole transaction should have been taken into account, it had made an error in reporting the $136,500 as a capital gain. Since the statute of limitations had run on fiscal 1956, Knowles relied on the statute of limitations mitigation provisions of §§ 1311-1315 of the Code.
Knowles' refund claim was disallowed on the ground that the Tax Court decision and order did not constitute a determination of deficiency within § 1313(a) and, alternatively, if it did constitute a determination, it was not a determination described in any of the subparagraphs of § 1312.
The essential problem before us is to determine whether Knowles' "error" is an error under the particular circumstances set forth in detail in § 1312. Specifically, Knowles argues that the circumstances of adjustment specified in § 1312(4) is applicable to the facts of this case.
Sections 1311 and 1312 of the Code, which are relevant here and which are set out in the margin,*fn2 were considered by this court in Olin Mathieson Chemical Corp. v. United States, 7 Cir., 265 F.2d 293 (1959). There, at 296, we stated:
"Of course, Congress did not intend by §§ 1311-1315 to provide relief for inequities in all situations in which just claims are precluded by statutes of limitations. This is no more than a truism. Statutes of limitations are an indispensable element of practical tax administration, and both hardships to taxpayers and losses of revenue may and do result from their application in the field of taxation. 'Such periods [of limitations] are established to cut off rights, justifiable or not, that might otherwise be asserted and they must be strictly adhered to by the judiciary.' ...