Nashville, Chattanooga, & St. Louis Ry. v. Commissioner

THE NASHVILLE, CHATTANOOGA & ST. LOUIS RAILWAY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Nashville, Chattanooga, & St. Louis Ry. v. Commissioner

Docket No. 33799.

United States Board of Tax Appeals

24 B.T.A. 856; 1931 BTA LEXIS 1579;

November 23, 1931, Promulgated

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">*1579 1. Where a taxpayer kept its books of account and made its income-tax returns for 1921, 1922, and 1923 upon the accrual basis and deducted from gross income the interest paid upon all bonds outstanding, and also an amount representing the amortization of discount in respect of certain bonds issued in the years 1917 to 1921, inclusive, there should be included in the gross income of each of the taxable years under consideration an amount representing the annual amortization of the premium received upon bonds issued in 1915 and 1916.

2. In 1921 the petitioner filed with the Director General of Railroads a claim for rental interest on additions and betterments made to petitioner's property by the Director General during the period of Federal control. The claim was allowed by the Director General of Railroads in 1921 in the amount of $121,289.72 and said amount was received by petitioner in that year. Held, that the amount did not constitute a part of the petitioner's taxable income of 1921.

Chester A. Gwinn, Esq., for the petitioner.

D. A. Taylor, Esq., for the respondent.

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SMITH

">*857 This proceeding is for the redetermination of deficiencies">*1580 in income and profits tax for 1922 and 1923 in the respective amounts of $43,351.77 and $12,188.12. The petition raises four issues designated under paragraph 4 as subparagraphs (a), (b), (c), and (d). The answer of the respondent raises affirmatively an issue wherein it is alleged that the respondent in computing the statutory net loss of the petitioner for the year 1921 erroneously allowed the petitioner as a deduction from gross income interest in excess of that paid.

The respondent admits that in computing amortization of discount upon petitioner's bonds applicable to the year 1921 he, through a mathematical error, understated the deduction from gross income on that account to the extent of $787.13. The respondent also admits that during each of the years 1921, 1922, and 1923 the petitioner received donations in the form of spur tracks, side tracks, etc., the value of which amounted to $23,861.23 in 1921, $43.87 in 1922, the $1,157.47 in 1923, all of which has been included in gross income by the respondent in the computation of tax liability and deficiencies. The respondent now concedes that said amounts do not constitute taxable income. The petitioner also concedes that">*1581 in determining the petitioner's statutory net loss for 1921 the respondent overstated the amount of petitioner's interest deduction to the extent of $19,903.69, as alleged in paragraph 6 of the respondent's answer to petitioner's amended petition. The points remaining in issue for our consideration are:

(1) Does the annual portion of premiums received in 1915 and 1916 by reason of the sale by petitioner of its First Mortgage Five Per Cent bonds constitute income for each of the years 1921, 1922, and 1923? As stipulated, the annual portion of the premium received in 1915 amounts to $3,980.12 and the annual portion of the premium received in 1916 amounts to $3,930.31, or a total of $7,910.43 for both years.

(2) Does the allowance in 1921 by the Director General of rental interest on completed additions and betterments for the period of Federal control in the sum of $121,289.72, which was a part of the final settlement between petitioner and the Director General executed under date of December 5, 1921, constitute income for the year 1921?

The facts are stipulated.

FINDINGS OF FACT.

The petitioner is a railroad corporation and was organized under the laws of the State of">*1582 Tennessee on December 11, 1845.

The petitioner keeps its books in accordance with the rules prescribed by the Interstate Commerce Commission and rendered its income-tax returns for the calendar years 1921, 1922, and 1923 on the accrual basis.

">*858 On July 5, 1915, September 28, 1916, and December 1, 1916, the petitioner sold its First Mortgage Five Per Cent bonds maturing in 1928 at premiums amounting to $56,250, $31,500, and $13,500, respectively, and incurred expenses of $5,503.42 in connection with the sale thereof. The aliquot portion of said premium, less said expense, applicable to each of the years 1921, 1922, and 1923, is $7,910.43 as determined by the respondent. At various and divers times during the period July 13, 1917, and February 10, 1921, both inclusive, the petitioner made additional sales of its First Mortgage Five Per Cent bonds at a discount and incurred certain expenses in connection therewith. The respondent correctly determined the annual portion of said discount and expense allocable to the years 1921, 1922, and 1923 to be $38,441.38 (to be increased as mentioned in paragraph 3 of the stipulation filed), $44,581.38, and $58,751.89, respectively. ">*1583 In arriving at the petitioner's deductions on account of said amortization of said premiums and discount in computing the petitioner's net loss for the year 1921 and petitioner's net income for the years 1922 and 1923, the respondent determined that said annual amoritized portion of said discount and expense should be reduced by the said annual amortized portion of said premiums, thereby allowing as a deduction for each of said years the difference therein, or $30,530.95 (to be increased as mentioned in paragraph 3 of the stipulation filed), $36,670.95, and $50,841.46, respectively.

In its income-tax returns for the years 1921, 1922, and 1923, the petitioner deducted from gross income in accordance with its books of account the net difference between the annual amortized portion of said discount sustained and the annual amortized portion of said premiums received on its sale of said First Mortgage Five Per Cent bonds.

By proclamation dated December 26, 1917, the President of the United States, acting under the powers conferred on him by the Constitution and laws of the United States (especially by section one (1) of the Act of Congress, approved August 29, 1916, entitled: "An">*1584 Act Making Appropriations for the Support of the Army, for the Fiscal Year Ended June 30, 1917, and for Other Purposes," and the joint resolutions of the Senate and House of Representatives bearing dates April 6, 1917, and December 7, 1917, respectively, declaring a state of war to exist against the Imperial German Government, and against the Imperial and Royal Austro-Hungarian Government), took possession and assumed control at 12:00 o'clock noon, December 28, 1917, of certain railroads and systems of transportation, including the transportation system of the petitioner, as described and set out in a certain contract with the Director General of Railroads, dated April 10, 1919, made under the authority contained ">*859 in the Act of Congress, approved March 21, 1918, generally designated "The Federal Control Act," and the Proclamation of the President, made under the authority of the said Act on March 29, 1918.

In accordance with the terms of an Act of Congress, approved February 28, 1920, as amended, commonly called the "Transportation Act of 1920," the President, on March 1, 1920, relinquished possession of the system of railroads of the petitioner and turned back to the">*1585 petitioner and its subsidiaries all of the properties then comprising its said system.

Subsequent to the relinquishment of the said properties by the Director General, and on January 22, 1921, the petitioner filed a claim with the Director General of Railroads setting out amounts claimed to be due to and from the petitioner from and to the Director General, among which was a claim of $155,956 due to the petitioner on account of rental interest on additions and betterments made to the petitioner's property by the Director General during Federal control based upon section 7(d) of the above mentioned contract dated April 10, 1919. On November 16, 1921, the petitioner submitted to the Director General a revised claim in which the petitioner made no change in its claim for rental interest on additions and betterments as above set forth. On December 5, 1921, the petitioner and the Director General of Railroads entered into a final settlement of all matters set forth in said claim of the petitioner. In said final settlement the Director General allowed to the petitioner on its claim for rental interest on additions and betterments the amount of $121,289.72. The amount allowed the petitioner">*1586 by the Director General as rental interest on additions and betterments was settled by virtue of the said final settlement agreement dated December 5, 1921.

The Commissioner, in arriving at the net loss of the petitioner for the year 1921, included in petitioner's gross income the said sum of $121,289.72.

OPINION.

SMITH: 1. The petitioner admits that our decision in Chicago & North Western Railway Co.,22 B.T.A. 1407">22 B.T.A. 1407, is controlling with respect to its contention that $3,930.31 of the aliquot part of the premiums in issue for each of the years 1921, 1922, and 1923 should be included in gross income of those years. In that decision we held that amortization of premium on bonds issued subsequent to March 1, 1913, shown by petitioner's books of account as an accrual of 1920, constituted taxable income of 1920. The petitioner contends, however, that no portion of the premium received in 1915 ">*860 from the sale of petitioner's bonds should be added to the petitioner's gross income for the years 1921, 1922, and 1923, or, what amounts to the same thing, that no portion of such premium should be deducted from the discount permitted as a deduction from gross">*1587 income by the Commissioner's regulations, article 545 of Regulations 62.

Since this proceeding was submitted and since briefs were filed, the Circuit Court of Appeals for the First Circuit, on June 10, 1931, decided the case of Commissioner v. Old Colony R.R. Co., 50 Fed.(2d) 896. The court stated:

The question to be solved in the case at bar is whether profit arising from the sale of the bonds [sold between 1893 and 1904] may be taken into account in determining the expense to be allowed the Old Colony as a deduction [for 1921]. If the books were kept on a cash basis the deduction allowable would be the interest paid on the bonds, and only that, as that would be the cash disbursement for the year. The Commissioner contends, however, that the real expense in connection with the payment of the interest on the bonds is the amount of it less an aliquot part of the profit, apportioned to the year 1921, amounting to $6,960.64, as the bonds cost the company less than the amount represented by the rate of interest.

* * * In ">*1588 Western Maryland Ry. Co. v. Commissioner,33 F.(2d) 695, a corporation whose bonds were sold at a discount was allowed to figure the proportionate part of the discount as an expense for the year. The same principle applies to the case at bar. If a corporation is allowed to show a greater expense for a given year by adding a proportionate part of a loss on the sale of bonds, there seems no reason to deny to the taxing authorities the right to show a smaller expense by deducting the proportionate part of a gain on a sale of bonds.

Such a result may seem contrary to the case in this circuit of Commissioner v. Old Colony Railroad Company,26 F.(2d) 408, which involved a similar state of facts. The decision was that a profit made in 1904, before the passage of the Sixteenth Amendment to the Constitution of the United States, could not be taxed. The court's attention was not called to the fact that the profit made in the early years was not being taxed, but that it was being used only to determine the expense for the year 1921 of the payment of interest on the bonds. This is not a tax but an allocation, under proper accounting methods for">*1589 books kept on the accrual basis, of the expense chargeable to the year 1921. See Chicago, Rock Island & Pacific Ry. Co.,13 B.T.A. 989">13 B.T.A. 989, 13 B.T.A. 989">1029.

The above cited case is confirmatory of the Commissioner's regulations, article 545 of Regulations 62. By including in the gross income of the taxable years 1921, 1922, and 1923 an aliquot part of the premiums received by the petitioner in the years 1915 and 1916 the respondent is not attempting to again tax as income an amount of income upon which the petitioner has already paid income tax, but is simply attempting to reach a correct net income under the methods of accounting employed by the petitioner in keeping its books of account for 1921, 1922, and 1923. Clearly, from an accounting standpoint, it is as correct to include in the gross income an aliquot part of the premium upon bonds issued many years before ">*861 as it is to permit a deduction from the gross income of an aliquot part of the discount upon bonds which may have been issued many years before. The Commissioner has not attempted to disallow the deduction from gross income of any part of the discount upon the petitioner's bonds outstanding, regardless">*1590 of the date of issue. The contentions of the respondent upon this point are sustained. See Connecticut & Passumpsic Rivers Railroad Co.,24 B.T.A. 394">24 B.T.A. 394.

2. The second issue involved is whether or not the respondent erred in arriving at the net loss of the petitioner for 1921 by including in petitioner's gross income for that year $121,289.72 received by the petitioner from the Director General of Railroads in final settlement of the matters growing out of the period of Federal control of petitioner's properties, as rental interest on the cost of additions and betterments made to the petitioner's properties by the Director General during the period of Federal control.

The agreement between the Director General of Railroads and the petitioner, dated April 10, 1919, provided in section 7(d) that:

Upon the cost of additions and betterments, less retirements in connection therewith, and upon the cost of road extensions, made to the property of the Company during Federal control, the Director General shall, from the completion of the work, pay the Company a reasonable rate of interest, to be fixed by him on each occasion. In fixing such rate or rates he may take">*1591 into account not merely the value of money but all pertinent facts and circumstances, whether the money used was derived from loans or otherwise, provided that to the extent that the money is advanced by the Director General or is obtained by the Company from loans or from the proceeds of securities the rate or rates shall be the same as that charged by the Director General for loans to the Company or to other companies of similar credit.

Pursuant to the provisions of the agreement, and subsequent to the relinquishment of the petitioner's property by the Director General, and on January 22, 1921, the petitioner filed a claim with the Director General setting forth the amount claimed to be due to and from the petitioner from and to the Director General, among which was a claim of $155,956 due to the petitioenr on account of rental interest on the cost of additions and betterments made to petitioner's property by the Director General during the Federal control period. On November 16, 1921, petitioner filed a revised claim in which it made no change in its claim for rental interest. On December 5, 1921, petitioner and the Director General entered into a final settlement of all matters">*1592 set forth in the claim of the petitioner, by which the Director General allowed to the petitioner the amount of $121,289.72 on its claim for rental interest. In the computation of petitioner's tax liability for 1921 the respondent included in the petitioner's gross income the above amount of $121,289.72. The record does not show whether this amount was taken up on the petitioner's books of account ">*862 as income of 1921 or of prior years. The petitioner claims that such an item was not income to it in 1921 but that the amount thereof should be spread over the period of Federal control during which the interest was earned by the petitioner.

This issue is decided in favor of the petitioner, in accordance with Texas & Pacific Railway Co.,9 B.T.A. 365">9 B.T.A. 365; 13 B.T.A. 989">Chicago, Rock Islana & Pacific Railway Co., supra;Old Dominion Steamship Co.,16 B.T.A. 264">16 B.T.A. 264; affd., 47 Fed.(2d) 148; Indiana Harbor Belt Railroad Co.,16 B.T.A. 279">16 B.T.A. 279; Kansas City Southern Railway Co.,16 B.T.A. 665">16 B.T.A. 665; ">*1593 Missouri Pacific Railroad Co.,22 B.T.A. 267">22 B.T.A. 267.

Judgment will be entered under Rule 50.