*166 Decisions will be entered for the respondent.
Held, the evidence does not establish that petitioner corporations were "in an unsound financial condition" and entitled to exclude from gross income the gain realized on the retirement of their own bonds. Sec. 215, Revenue Act of 1939, amending section 22 (b), Internal Revenue Code.
*476 The respondent determined deficiencies in income tax against Twin City Rapid Transit Co. (New Jersey) and its subsidiaries for the period January 1 to December 7, 1939, and against Twin City Rapid Transit Co. (Minnesota) and its subsidiaries for the period December 7 to December 31, 1939, in the respective amounts of $ 8,724.40 and $ 15,309.74. The sole issue is whether, under section 215 of the Revenue Act of 1939 1 (amending section 22 (b) of the Internal Revenue Code by adding subsection 9 thereto), the gain realized by the petitioners upon the reacquisition of their bonds during the periods June 30 to December 7, 1939, and December 7 to December 31, 1939, is excludable from their gross income. The parties*167 have stipulated that if the gain so realized is determined to be nontaxable, the allowable depreciation set forth in the respective notices of deficiency is excessive in the amount of $ 1,791.53 in Docket No. 109388 and in the amount of $ 1,956.03 in Docket No. 109389.
*168 FINDINGS OF FACT.
The facts, consisting in large part of exhibits, were all stipulated by the parties, and are found to be as stipulated. For our purposes the following statement will suffice to present the question:
The petitioner, Twin City Rapid Transit Co., a New Jersey corporation, was organized prior to January 1, 1939, and until December 7, 1939, was the parent of seven subsidiary corporations. By merger and consolidation, effective December 8, 1939, the petitioner, Twin City Rapid Transit Co., a Minnesota corporation, succeeded the New Jersey corporation as parent of the same subsidiaries. The only change effected by the merger was the change of the name of the *477 parent corporation and of the state of its incorporation. Both corporations had the same assets and liabilities and the same capital stock. The principal office of each petitioner was at 1 South 11th Street, Minneapolis, Minnesota, and a return was filed by each for the period stated with the collector of internal revenue for the district of Minnesota. By reason of the above facts and the fact that the companies are for practical purposes identical, we sometimes refer to the two petitioners herein as*169 "the petitioner."
The business of the petitioners and their subsidiaries was the ownership and operation of a public transportation system in the area consisting of the cities of Minneapolis and St. Paul, Minnesota, and adjacent territory.
During the period in controversy the petitioner had issued and outstanding 250,000 shares of capital stock divided into 30,000 preferred shares, with a par value of $ 100 per share, and 220,000 common shares of no par value but with an aggregate stated value of $ 11,000,000. The preferred stock bore 7 percent cumulative dividends. On December 31, 1939, dividends on this stock were in arrears in the sum of $ 35 per share, representing five years' dividends and a total of $ 1,050,000. No dividends have been paid on the petitioners' common stock since 1930. Petitioners paid dividends of $ 210,000 on their preferred stock in 1942 and $ 105,000 on July 1, 1943.
Petitioners' secured first lien and refunding 5 1/2 percent gold bonds, series A, in the principal amount of $ 18,000,000, were issued on December 1, 1927, at $ 91.50 for each $ 100 principal amount, a total discount of $ 1,530,000. Petitioners' secured first lien and refunding 5 1/2 percent*170 gold bonds, series B, in the principal amount of $ 64,200, were issued in 1934 at par and without discount. In addition, certain of petitioners' subsidiaries had outstanding bond issues, not here in controversy, upon which petitioners were liable, and as of December 31, 1936, the petitioners' bonded indebtedness amounted to $ 21,200,600.
Petitioners' series A bonds were listed and sold on the New York Curb Exchange at prices well below their issued price. Their average price was 85 15/16 in 1936, 79 5/8 in 1937, 56 1/3 in 1938, and 59 1/2 in 1939. The average during the years 1930 to 1940, both inclusive, was 56. During the years 1934 to 1940, both inclusive, the series B bonds were sold on the New York Curb Exchange and, while not traded in substantial numbers of shares, showed an average price of three or four points below the series A bonds. The petitioners' preferred stock was sold on the New York Stock Exchange at an average price per share of 87 in 1936, 66.5 in 1937, 30 in 1938, and 26.4 in 1939. The average price of the same stock for the years 1930 to 1940, both inclusive was 37.8 per share. The average price per share of the common stock was 12 3/4 in 1936, 10 1/8*171 in 1937, 4 5/16 in 1938, and 2 7/8 in 1939. *478 During the years 1930 to 1940, both inclusive, the average price of this stock was about 7 1/4 per share.
The petitioners' net operating income (or loss) and their surplus as at the close of the years designated, shown by their annual reports to their stockholders, were as follows:
| Year | Income or | Surplus |
| (loss) | ||
| 1936 | $ 649,486.89 | $ 2,883,242.39 |
| 1937 | 459,961.27 | 3,134,504.87 |
| 1938 | (43,842.19) | 3,011,044.18 |
| 1939 | 149,552.22 | 3,456,229.91 |
| 1940 | $ 111,582.76 | $ 3,640,775.14 |
| 1941 | 237,301.74 | 3,984,349.90 |
| 1942 | 1,071,036.85 | 5,049,630.96 |
The petitioners' consolidated balance sheet for 1939, together with comparative figures for 1938, was as follows:
| Dec. 31, 1939 | Dec. 31, 1938 | ||
| ASSETS | |||
| Road and equipment * | $ 56,470,169.77 | $ 56,765,394.35 | |
| Deposits in lieu of mortgaged property sold or | |||
| destroyed | 1,026.74 | 1,026.74 | |
| Deposit with trustee for sec. div notes: | |||
| First lien and ref. 5 1/2% series B bonds | 11,800.00 | 12,800.00 | |
| Miscellaneous physical property | 5,681.29 | 5,681.29 | |
| Other investments (at cost) | 411,481.09 | 417,114.89 | |
| Current assets: | |||
| Cash | $ 1,837,319.53 | $ 679,472.26 | |
| Loans and notes receivable (employees) | 1,651.25 | 1,872.50 | |
| Interest receivable | 2,779.92 | 2,985.75 | |
| Miscellaneous accounts receivable | 56,993.87 | 62,077.40 | |
| Material and supplies (at cost) | 740,387.51 | 787,917.85 | |
| 2,639,132.08 | 2,534,325.76 | ||
| Injuries and damages reserve fund | 118,665.90 | 108,683.40 | |
| Deferred assets, including rents and insurance | |||
| paid in advance | 38,261.82 | 19,099.62 | |
| Discount and expense on funded debt in process | |||
| of amortization | 785,446.50 | 893,783.80 | |
| 60,481,665.19 | 60,757,909.85 | ||
| LIABILITIES | |||
| Capital stock -- authorized and outstanding: | |||
| Common stock -- 220,000 shares | |||
| (no par value) | $ 11,000,000.00 | $ 11,000,000.00 | |
| Preferred stock -- 30,000 shares (par value | |||
| $ 100 each) 7% cumulative | 3,000,000.00 | 3,000,000.00 | |
| Funded debt unmatured | 15,997,600.00 | 16,874,900.00 | |
| Secured dividend notes not presented | 11,800.00 | 12,800.00 | |
| Current liabilities: | |||
| Audited accts, and wages payable | 82,751.38 | 37,594.87 | |
| Miscellaneous accounts payable | 4,217.81 | 15,280.75 | |
| Accrued interest (not due) | 85,192.01 | 89,435.73 | |
| Tax liability | 864,655.67 | 993,408.18 | |
| 1,036,816.87 | 1,135,719.53 | ||
| Reserve accounts: | |||
| For injuries and damages | 274,779.33 | 243,666.16 | |
| For depreciation | 16,806,275.59 | 16,586,737.79 | |
| Unadjusted credits (unredeemed tokens | |||
| and tickets) | 179,438.82 | 174,317.52 | |
| Capital surplus (created by reduction | |||
| in capital) | 8,718,724.67 | 8,718,724.67 | |
| Profit and loss | 3,456,229.91 | 3,011,044.18 | |
| 60,481,665.19 | 60,757,909.85 |
*479 On May 1, 1939, for taxation purposes, the Minnesota State taxing authorities determined the true and full value of the real and personal property of the petitioners' principal subsidiaries, Minneapolis Street Railway Co. and the St. Paul City Railway Co., to be as follows:
| Minneapolis Street Ry. Co | $ 9,644,184 |
| The St. Paul City Ry. Co | 5,191,917 |
| Total | 14,836,101 |
The Minnesota Railroad & Warehouse Commission's depreciated values for rate making purposes of the properties of the Minneapolis Street Railway Co. and the St. Paul City Railway Co., together with the petitioners' original cost of these same properties, according to their corporate records, are shown in the following table, as of the date therein stated:
| Minneapolis Street Ry. Co. | ||
| Description | Original cost | Commission |
| valuation | ||
| 1/1/25 undepreciated value | $ 25,119,688.82 | $ 30,393,726.44 |
| 1/1/39 " " | 26,369,243.95 | 30,621,280.73 |
| 1/1/40 " " | 26,237,337.08 | 30,426,038.96 |
| Commission depreciation as of 1/1/25 | 3,606,498.50 | |
| (128,970.83) | ||
| Depreciated value | 26,108,366.25 | 26,819,540.46 |
| Increase in depreciation accrual | ||
| since 1/1/25 to 1939 | 1,456,564.00 | |
| Depreciated value Jan. 1, 1940 | 25,362,976.46 | |
| St. Paul City Ry. Co. | ||
| 1/1/25 undepreciated value | $ 15,496,630.52 | $ 18,246,722.11 |
| 1/1/39 " " | 15,798,098.12 | 17,984,294.16 |
| 1/1/40 " " | 15,657,901.15 | 17,806,896.24 |
| Commission depreciation as of 1/1/25 | 2,050,631.62 | |
| Depreciated value | 15,756,264.62 | |
| Less increase in depreciation reserve balance | 932,696.00 | |
| 14,823,568.62 |
*173 The petitioners borrowed no amounts on and after December 1, 1927, except the amounts secured by the series A and B bonds. They *480 were able to meet all current liabilities as they matured, and during the years 1936 to 1942, both inclusive, purchased new equipment and made other additions in the amounts set forth below:
| 1936 | $ 641,392.99 |
| 1937 | 649,152.17 |
| 1938 | 596,040.55 |
| 1939 | 611,086.00 |
| 1940 | $ 692,019.51 |
| 1941 | 1,036,944.84 |
| 1942 | 1,078,262.86 |
During the year 1937 the cable consolidated bonds of the St. Paul City Railway Co., not here in controversy, maturing January 15, 1937, were paid and retired by the petitioners in the principal amount of $ 2,208,000. At the same time there was extended $ 1,500,000 principal amount of said bonds at 4 1/2 percent interest, to mature $ 150,000 annually for 10 years. After the bonds were extended, petitioners in 1937 purchased them and held in their treasury all of the extended bonds as of December 31, 1937, except $ 15,000 thereof, which were retired during the year. In 1938 $ 135,000 of the said bonds were retired, and since that time they have been retired at the rate of $ 150,000 per year.
The petitioners' series A and B *174 bonds bore maturity date of December 1, 1952. Since the date of issue and to December 31, 1939, the petitioners reacquired these bonds of a face amount of $ 2,682,400, or about one-sixth of the total, and reduced their total bonded indebtedness to $ 15,977,600. The cost of reacquisition of these bonds was $ 1,726,834.46, resulting in a gain to the petitioners of $ 955,565.54. Petitioners realize additional profits upon reacquisition of their bonds in the years 1940, 1941, and 1942 in the aggregate amount of $ 798,478.12.
This reduction of the bonded debt gave rise to a large saving in the petitioners' annual interest liability. In 1931 this annual liability amounted to $ 1,185,280. By the end of 1939, solely through the acquisition of the series A and B bonds, the interest liability had been reduced to $ 898,200, a saving of $ 287,080.
All gain realized by the petitioners upon the reacquisition of their bonds prior to June 30, 1939, the date on which section 215 became effective, was duly reported and the tax due thereon was paid. During the period June 30 to December 31, 1939, both inclusive, the petitioners reacquired their series A and B bonds of a face amount of $ 413,400*175 at a profit of $ 140,154.99. Of this amount $ 73,642.74 was received by the petitioner, Twin City Rapid Transit Co. (New Jersey), and $ 66,512.25 by the petitioner, Twin City Rapid Transit Co. (Minnesota). The petitioners elected to exclude the amounts so received from their gross income for 1939 and filed the consent provided for in the statute. The respondent determined that the gain was taxable, and assessed the deficiencies above mentioned.
*481 OPINION.
Section 215 of the Revenue Act of 1939 permits a corporation in an "unsound financial condition" 2 to exclude from its gross income the amount of any income attributable to the discharge, during the taxable year, of an indebtedness. To take advantage of this section a corporation which has discharged an indebtedness evidenced by a security, and filed a consent to the regulations prescribed by the section, either must prove to the satisfaction of the Commissioner that it was in an unsound financial condition during the period involved, or must have this fact certified to the Commissioner by any Federal agency authorized to make loans on behalf of the United States to such corporation or which has regulatory power over*176 the corporation.
Petitioner corporations had discharged an indebtedness evidenced by a security and had filed the required consent. No certification was made here by any Federal agency, and hence we are concerned only with the sufficiency of the petitioners' proof that they were in an unsound financial condition during the periods for which the deficiencies were determined.
The term "unsound financial condition" is at best a vague one. The statute does not define it, nor, we believe, can a general definition be formulated. Each case must necessarily rest upon its own facts.
Section 19.22 (b) (9)-1, Regulations 103, provides in part:
A corporation may be an unsound financial condition, within the meaning of section 22 (b) (9) and this section, even though the fair market value of its assets exceeds its liabilities or it is able to meet its current liabilities as they mature. *177 Thus, highly indicative (but not conclusive) of an unsound financial condition would be the fact that bonds of the taxpayer are selling in a free market at prices substantially below their issue price and below the market price of similar issues of similar businesses.
These regulations were largely adapted from the Report of the House Ways and Means Committee on this section, 3 and are virtually in the language of the report.
We deem the criteria prescribed by the regulations to be suggestive only, not exclusive of other tests. Adequately and accurately to gauge a condition as elusive and difficult of definition as that under consideration requires resort to every reasonably promising source of aid. What then is the present situation?
Tested by the above regulations, it is found that the proof establishes that petitioners' bonds were selling substantially below their issuing price. To this extent the proof satisfies the regulations. *482 However, more is required. *178 There must be evidence of the market price of similar issues of similar businesses for the purpose fairly of comparing the market price of petitioners' bonds with those of other companies similarly situated. Here we have some evidence of the market prices of the bonds of other companies, but the proof that these issues were similar is almost wholly lacking. We have no evidence permitting us to say that any of these companies were proper comparatives. Thus petitioners fail to meet one of the tests found in the regulations.
We turn then to other possible evidences indicative of petitioners' financial condition.
A study of petitioners' balance sheet as presented to its stockholders does not, of itself, reveal an unsound financial condition. The ratio of fixed assets to bonded debt is not so disproportionate as to focus attention. On the contrary, the presence of a surplus of $ 12,000,000 among total liabilities of $ 60,000,000, in the absence of some circumstance lessening the weight normally to be given such fact, argues strongly against petitioners' contention. We find no explanation minimizing the weight of this fact. There is the further fact that, excepting the series A and*179 B bonds, petitioners have not been obliged to borrow any money since 1927. They have bought in large amounts of their own bonds and have made large purchases of new equipment, all out of current earnings.
No adequate explanation is offered why dividends on preferred stock could not have been paid as they accrued, nor is there any evidence from which we could conclude that the valuation fixed by the Minnesota Railroad & Warehouse Commission for rate-making purposes is too high. These are all matters which might have been made the subject of testimony.
When all of the above mentioned factors are considered, we find ourselves unable to hold that petitioners have proved that they were in an unsound financial condition in 1939.
Decisions will be entered for the respondent.
Footnotes
1. SEC. 215. DISCHARGE OF INDEBTEDNESS.
(a) Income from Discharge of Indebtedness. -- Section 22 (b) of the Internal Revenue Code (relating to exclusions from gross income) is amended by adding at the end thereof the following new paragraph:
"(9) Income from discharge of indebtedness. -- In the case of a corporation, the amount of any income of the taxpayer attributable to the discharge, within the taxable year, of any indebtedness of the taxpayer or for which the taxpayer is liable evidenced by a security (as hereinafter in this paragraph defined) if --
(A) it is established to the satisfaction of the Commissioner, or
(B) it is certified to the Commissioner by any Federal agency authorized to make loans on behalf of the United States to such corporation or by any Federal agency authorized to exercise regulatory power over such corporation,↩
that at the time of such discharge the taxpayer was in an unsound financial condition, and if the taxpayer makes and files at the time of filing the return, in such manner as the Commissioner, with the approval of the Secretary, by regulations prescribes, its consent to the regulations prescribed under section 113 (b) (3) then in effect. * * *"*. Road and equipment includes substantial intangibles charged before 1903.↩
2. The necessity for proving a corporation to be in "an unsound financial condition" was eliminated from the statute by the Revenue Act of 1942.↩
3. 1939 H. R. 855, 76th Cong., 1st sess.↩