*26 Decision will be entered for respondent.
Petitioner corporation was organized by A for the purpose of acquiring all of the stock of X, a foreign personal holding corporation, which had been organized by A some years before. A had transferred certain securities to X in return for X's stock and serial debentures bearing interest payable upon the maturity of the debentures. Events having transpired which made X's existence no longer necessary, it was decided by petitioner, petitioner's sole stockholder, A, and X that X should transfer all of its assets to petitioner to be held by petitioner instead of by X, that petitioner would surrender to X all of X's stock for cancellation, that X would thereupon dissolve, and that petitioner would assume all of X's obligations, including X's debentures owned by A, together with unpaid interest thereon. This agreement was executed. Thereupon petitioner paid A the interest due upon the debentures, including interest due and payable by X prior to the transaction in question. Both petitioner and X used the cash method of accounting. Held, the amounts paid by petitioner as interest upon the debentures of X are not deductible by petitioner*27 as interest paid under section 23 (b), Revenue Act of 1938; nor are the amounts so paid to be considered as dividends in determining petitioner's undistributed Title IA net income under section 405, Revenue Act of 1938.
*1020 The Commissioner determined a deficiency in petitioner's income tax in the amount of $ 1,372.91, a deficiency in petitioner's excess profits tax in the amount of $ 585.62, and in personal holding company *1021 surtax in the amount of $ 24,201.03, all for the calendar year 1938. These deficiencies resulted from respondent's disallowance of a deduction taken by petitioner as interest paid, pursuant to section 23 (b), Revenue Act of 1938.
FINDINGS OF FACT.
We adopt as our findings the stipulation of facts which was filed herein, and only set forth herein those facts which are necessary to an understanding of the problems involved.
The petitioner, a Delaware corporation having an office in New York City, filed its returns on a cash basis with the collector of internal revenue for the second district of New York.
In 1930 Ruth Brady Scott, a*28 citizen of the United States, married a British subject and went to England to live. In order to avoid a British income tax on the same income on which she paid income tax to the United States Government, she caused the organization under the laws of the Colony of Newfoundland of a corporation known as Gladstone Co., Ltd., and subscribed to 20 shares of its capital stock for the cash consideration of $ 2,000. In addition, she then and later transferred to Gladstone certain securities in consideration of the remaining 80 shares of its capital stock and of the issuance to her of a debenture bond, bearing no interest, in the principal sum of $ 100,000, numbered A, and a series of 4 percent debenture bonds of the total principal amount of $ 564,000, numbered 1 to 47, inclusive. Each such bond was in the principal amount of $ 12,000, and was dated January 1, 1931, the first one maturing April 1, 1931, and one maturing every three months thereafter, to October 1, 1942. The bonds provided that the interest would become due and payable at maturity and upon presentation and surrender of the bonds.
On or about February 19, 1931, the petitioner, Rodney, Inc., was organized at the instance*29 of Mrs. Scott, and she transferred to it the 100 shares of Gladstone stock, in consideration of the issuance by petitioner to her or her nominees of its entire capital stock, consisting of 100 shares.
Prior to June 17, 1938, Gladstone had redeemed debenture bond A, for $ 100,000, and had redeemed serial debenture bonds 1 to 24, inclusive, and had paid $ 9,500 on No. 25. It had also paid interest on serial debenture bonds 1 to 9, inclusive.
On or about June 17, 1938, Mrs. Scott's husband having died and she having resumed her residence in this country, the reason for the existence of Gladstone had disappeared. The board of directors of Rodney, Inc., which held all of the stock of Gladstone, decided that Gladstone should be liquidated, and passed a resolution to that effect.
Pursuant to section 112 (i) of the Revenue Act of 1938, the plan of dissolution of Gladstone was described to the Commissioner of *1022 Internal Revenue in a letter, and the Commissioner, in reply, advised that the proposed liquidation and dissolution of Gladstone was held not to be in pursuance of a plan having as one of its principal purposes the avoidance of Federal income taxes. The effect of this pronouncement*30 was to render the transaction nontaxable under section 112 (b) (6).
Gladstone transferred all of its assets to petitioner, and petitioner assumed all of the liabilities of Gladstone as of June 17, 1938. Petitioner returned to Gladstone all of its capital stock, which was canceled, and Gladstone was thereupon dissolved.
On December 21, 1938, petitioner paid the balance due on serial debenture bond No. 25, maturing April 1, 1937, and also paid in full the principal amounts of serial debenture bonds Nos. 26 to 36, inclusive, which by their terms matured on July 1, 1937, and quarterly thereafter to January 1, 1940.
On the same day petitioner paid to Mrs. Scott the sum of $ 34,380, which represented the interest due from January 1, 1931, to December 21, 1938, on the bonds which it had paid off and redeemed on that date.
In its income tax return for 1938 petitioner claimed a deduction for interest in the amount of $ 34,380. The respondent disallowed $ 32,569.33 of that amount, representing that portion of the interest on the bonds which was attributable to the period prior to June 17, 1938.
Gladstone had filed its income tax returns in the United States during its corporate existence *31 on a cash basis, and had not, therefore, claimed any deduction for the interest incurred but not paid on these bonds.
OPINION.
The single question presented for decision here is whether petitioner is entitled to a deduction for interest paid by it on obligations issued by a corporation all of the stock of which was owned by petitioner and which was later liquidated, its obligations, including the bonds, principal and interest, being assumed by petitioner.
The applicable section of the Revenue Act of 1938 is as follows:
SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
* * * *
(b) Interest. -- All interest paid or accrued within the taxable year on indebtedness, except on indebtedness incurred or continued to purchase or carry obligations (other than obligations of the United States issued after September 24, 1917, and originally subscribed for by the taxpayer) the interest upon which is wholly exempt from the taxes imposed by this title.
Petitioner caused its wholly owned subsidiary corporation to liquidate and dissolve, thereby becoming entitled to the assets of the subsidiary *1023 after the satisfaction of the latter's liabilities. *32 The corporate resolution of petitioner was to the effect that its subsidiary should be dissolved and that petitioner should take over all of the assets of the subsidiary and should assume all of its liabilities, including debenture bonds and interest thereon. Thereupon the subsidiary transferred to petitioner all of its assets, and petitioner surrendered to the subsidiary all of the latter's stock for cancellation. Petitioner also assumed all of the liabilities of the subsidiary as of June 17, 1938. On December 21, 1938, petitioner paid to the holder of the debenture bonds an amount representing interest due upon these bonds from January 1, 1931, to December 21, 1938, and deducted this payment from its gross income as interest paid. Respondent disallowed that part of this amount paid by petitioner which represented interest due upon these bonds for the period January 1, 1931, to June 17, 1938, but allowed that part which represented interest due for the period June 18, 1938, to December 21, 1938.
In spite of the ingenious argument advanced by the learned counsel for petitioner, we must approve respondent's determination.
It happened that in the instant case the holder of the *33 subsidiary's debenture bonds was also the owner of the stock of petitioner and the original owner of the assets transferred to petitioner by its subsidiary. It was satisfactory to her as a creditor of the subsidiary to have its assets transferred to petitioner and to look thereafter to the petitioner for payment of the principal and interest of the subsidiary's bonds which she held. However, in the ordinary case where a wholly owned subsidiary is liquidated by a parent corporation, the latter is entitled by virtue of its stock ownership to only those assets of the subsidiary remaining after the payment of the subsidiary's obligation. So in the instant case, although because of the peculiar facts here present to which we have referred, the obligations of the subsidiary then payable were not paid prior to or as a part of its liquidation, the creditor of the subsidiary was nevertheless entitled at that time to their payment from the subsidiary's assets, and the later payment by petitioner of the obligations of the subsidiary existing and payable at the time of the latter's liquidation, both as to principal and interest, was merely a convenient means of satisfying obligations to which*34 the creditor of the subsidiary was entitled as a matter of law at the time when the subsidiary was liquidated.
Therefore it must be considered that the petitioner received as a result of the liquidation of its subsidiary only the amount of the assets of the subsidiary in excess of its then existing liabilities, and any payment of such liabilities made by petitioner after the liquidation was in the nature of a capital adjustment and was not to be charged against income.
*1024 Petitioner advances an alternative contention with regard to the deficiency in personal holding company surtax determined by respondent as a result of his disallowance of the deduction for interest paid which we have just discussed. Petitioner argues that, if we should hold that the payment of $ 32,569.33 by it to the holder of the debenture bonds representing interest there on for the period January 1, 1931, to June 16, 1938, was not an interest payment deductible by petitioner, then the payment was in fact a dividend and petitioner's undistributed Title IA net income should be adjusted to reflect this amount as "dividends paid." For the reasons outlined above in our discussion of petitioner's first contention, *35 we are unable to agree.
Decision will be entered for respondent.