*285 Decision will be entered under Rule 50.
1. Deductions, Interest. -- Debenture notes issued by petitioner in a reorganization for value received, held to be in form and substance an indebtedness and interest payments thereon deductible, section 23 (b).
2. Invested Capital -- Borrowed Capital. -- Held, that petitioner's debenture notes constituted borrowed capital, section 719.
3. Deficiency -- Excess Profits Tax, Deferred. -- Held, that where the section 722 claim has been rejected and is no longer pending and the excess profits tax deferred by reason of the application of section 710 (a) (5) has been determined as correctly imposed, such amount constitutes a deficiency.
*1228 The respondent has determined deficiencies against the petitioner in the amounts and for the calendar years, as follows:
| Declared | ||
| Year | value excess-profits | Excess profits |
| tax | tax | |
| 1942 | $ 4,559.94 | |
| 1943 | $ 10.99 | 70.69 |
| 1944 | 844.01 | 10,556.52 |
| 1945 | 14,537.76 | |
| Totals | $ 855.00 | $ 29,724.91 |
The issues remaining in controversy present the following questions: (1) Whether certain debenture notes issued by petitioner in the face amount of $ 251,600 on December 31, 1943, pursuant to a reorganization constitute an "indebtedness" within section 23 (b), Internal Revenue Code, so that the alleged interest paid or accrued thereon during 1944 and 1945 is deductible for those years; (2) Whether such debenture notes constitute "borrowed capital," within section 719 of *1229 *287 the Code, for excess profits tax purposes for the years 1944 and 1945; and (3) Whether the amount of $ 4,559.94 excess profits tax for 1942, deferred by petitioner by reason of section 710 (a) (5) of the Code, constitutes a "deficiency" for that year within section 271 of the Code. The petitioner has abandoned certain allegations of error.
A portion of the facts has been stipulated.
FINDINGS OF FACT.
The stipulated facts are so found.
The petitioner, a Michigan corporation, is engaged in the business of publishing a daily newspaper, the Royal Oak Daily Tribune, and maintains its principal office and place of business in Royal Oak, Michigan. Its tax returns for the years involved herein were filed with the collector of internal revenue at Detroit for the district of Michigan.
Petitioner was incorporated on December 31, 1943, with an authorized capital stock of 15,000 shares of $ 10 par value voting common stock pursuant to a plan of reorganization, as the successor to two Michigan corporations, namely, one theretofore bearing the same name as petitioner and hereinafter referred to as the Old Company, and the Royal Oak Photo-Engraving Company hereinafter referred to as the Photo Company. *288 The Old Company was incorporated in 1919 and engaged in publishing a weekly newspaper until 1925 and thereafter a daily newspaper serving the city of Royal Oak and surrounding communities in Oakland County, Michigan. On December 31, 1943, the Old Company's capital stock consisted of 1600 shares of $ 25 par value common stock of which 63.8 per cent was owned by two brothers, Floyd J. and Lynn S. Miller, and the balance by eighteen other persons. The Photo Company was incorporated in June 1936 and engaged in the business of photoengraving, in Royal Oak. On December 31, 1943, the Photo Company's capital stock consisted of 483 shares of $ 10 par value common stock of which 66.6 per cent was owned by the Miller brothers and the balance by one other person. In connection with the plan of reorganization the interested parties agreed that the fair value of the net assets of the Old Company and the Photo Company was approximately $ 348,000 and $ 5,000, respectively, on December 31, 1943, based on an appraisal made for that purpose.
The plan of reorganization was duly adopted by resolutions of the stockholders and directors of the Old Company, the Photo Company and the petitioner. The*289 plan recited as reasons therefor, inter alia, that the circulation of the Royal Oak Daily Tribune newspaper had more than doubled in the years recently preceding the end of 1943 and substantially increased all operations connected therewith; that anticipated continued growth of the population of the community and circulation of the newspaper necessitated increased plant facilities, *1230 including photoengraving, and made it desirable to merge into the new company, petitioner, the business and facilities of the Old Company and the Photo Company on a basis of the stockholders' relative proportionate interests therein; and that the growth of the business would require capable new executives and made it desirable that the agreed fair value of the tangible and intangible assets of the Photo Company and the Old Company, including the latter's circulation and goodwill, be capitalized and represented in the proportion of about 28.6 per cent in voting common stock and 71.4 per cent in debenture bonds of the new company, petitioner, in order to make voting common stock available to new executives at an acceptable price.
The plan of reorganization was carried out by the parties thereto*290 on December 31, 1943, by a series of formal corporate resolutions and legal agreements. Pursuant to the plan and as duly authorized petitioner, on December 31, 1943, issued a total of 10,064 shares of its common stock (par value $ 100,640) and a total of $ 251,600 face value of its authorized 25 year 6 per cent debenture bonds pro rata to the stockholders of the Old Company and the Photo Company in exchange for all their stock in those companies and in the proportion of 9,920 shares (par value $ 99,200) and $ 248,000 face value debentures to the stockholders of the Old Company and 144 shares (par value $ 1,440) and $ 3,600 face value debentures to the stockholders of the Photo Company. Further, in pursuance of the plan and immediately upon petitioner's acquisition of all the stock of the Old Company and the Photo Company, they were liquidated, on December 31, 1943, by transfer of all their properties and assets, subject to liabilities, to petitioner in exchange for the stock of those companies, respectively, which companies were thereupon dissolved.
The debentures issued by petitioner in the total face amount of $ 251,600 were all dated December 31, 1943, and except as to the face*291 amount, they were all in identical form, as follows:
The undersigned, THE TRIBUNE PUBLISHING COMPANY, of Royal Oak, a Michigan corporation, (hereinafter called the "Company") for value received, hereby acknowledges itself to be indebted and hereby promises to pay to the registered owner hereof, as shown by the books of the Company, at the office of the Company in Royal Oak, Michigan, on the 31st day of December, A. D. 1968, the principal sum of
* * * *
in lawful money of the United States of America, with interest thereon at the rate of six per centum per annum from the date of issuance of this note, hereinafter endorsed hereon, payable semi-annually, at the office of the Company in Royal Oak, Michigan, on the 30th day of June and the 31st day of December in each year following the date of issuance until maturity or until this note is called for redemption as hereinafter provided.
The principal of this note, if not paid when due, shall bear interest after maturity at the rate of six per centum per annum until paid.
*1231 This note is one of a duly authorized issue of notes of the Company known as its Twenty-five-year Six percent Registered Debenture Notes, in a total authorized*292 amount of $ 300,000.00, which debenture notes are all of equal standing; * * * all of said notes being of like tenor excepting as to number and amount.
* * * *
This note is subject to call for redemption and payment at any time before maturity at the option of the Company, at the principal amount and interest accrued to date of redemption plus a premium equal to one per centum on said principal amount if redemption is made at any time within five years from date of issuance hereof. Provided, however, no premium shall be paid on redemption before maturity if said redemption is made after five years from date of issuance. The intention to redeem this or any one or more additional notes may be given by the Company by mailing notice to the owner hereof at the address of the owner hereof as shown by the books of the Company at least thirty days prior to the time fixed for said redemption; * * *
* * * *
IN WITNESS WHEREOF, THE TRIBUNE PUBLISHING COMPANY of Royal Oak, Michigan has caused this note to be executed in its corporate name by its President, and its corporate seal to be hereunto affixed, and to be attested by its Secretary.
Date of issuance of this note is December 31, 1943.
*293 The Tribune Publishing Company of Royal Oak, Michigan
Attest:
LYNN S. MILLER
Secretary
By FLOYD J. MILLER
President
In connection with the reorganization, the petitioner's issuance of its par value stock and face amount debentures in the total amount of $ 352,240, as above mentioned, was based on an appraisal in the amount of $ 357,522.44 as the fair market value on or about December 31, 1943, for all of the net assets transferred to petitioner as of that date pursuant to the plan. The appraisal was made by a firm known as Palmer & Palmer, Inc., having wide experience over a long period of years in buying, selling, merging, and appraising newspapers and particularly the goodwill and circulation structure of newspapers. The appraised value included, as to the Old Company, a value of $ 168,810 for the name, goodwill and circulation structure of the Royal Oak Daily Tribune as determined by Palmer & Palmer, Inc., a value of $ 141,000 for land and buildings as determined by an independent experienced real estate dealer and appraiser; a value of $ 65,977.40 for machinery and equipment as determined by a separate firm of widely experienced valuation engineers and appraisers of newspaper*294 and industrial equipment; the amount of $ 103,077.04 for current and certain other assets and the amount of $ 126,342 for current liabilities as shown on the books of the Old Company; and also included as an asset the amount of $ 5,000 as the value of the engraving plant of the Photo Company. The appraisal of the newspaper's name, goodwill, and circulation structure at a value of $ 168,810 was determined *1232 on a basis of a value of about $ 10 per paid subscriber for the newspaper after consideration of many factors, including the plant facilities, the population growth, the circulation volume and price rate, the advertising volume and price rate, the efficiency of the management, the editorial and typographical excellence of the paper, and also the then and prospective earnings of the paper. Throughout the years 1939 to 1943 the Old Company's books reflected land at cost; buildings, machinery, and equipment at cost less depreciation; and good will in the amount of $ 4,000 which represented cost in 1919, when the newspaper was acquired as a weekly paper with a circulation of 1,200.
In opening its accounts the petitioner set up on its books and records the various assets at*295 cost and the liabilities assumed and depreciation reserves as shown on the books of its predecessor companies, except that as to the item of "Goodwill and Circulation" it set up an amount of $ 286,838.74, representing the appraised market value thereof plus the excess of the appraised market value of the plant and equipment over the depreciated cost thereof to its predecessors. Petitioner's liabilities, inter alia, embraced under the heading of "Long Term Obligations" certain amounts for a land contract and a chattel mortgage and "Long Term Notes $ 251,600," and disclosed outstanding capital stock in the amount of $ 100,640.
The comparative growth of the newspaper business during the last 5 years of the Old Company and the first 5 years of petitioner as indicated by gross newspaper revenues and also the net profits from all sources, before Federal income taxes, as shown by profit and loss statements, was as follows:
| Old company | Petitioner | |||
| Source | ||||
| 1939 to 1943 | 1944 to 1948 | |||
| Advertising | $ 95,692.78 | $ 159,154.33 | $ 215,777.81 | $ 467,056.50 |
| Circulation | 28,614.44 | 80,915.29 | 97,968.79 | 162,524.62 |
| Miscellaneous | 583.28 | 812.41 | 1,381.92 | 1,012.38 |
| Total gross | $ 124,890.50 | $ 240,882.03 | $ 315,128.52 | $ 630,593.50 |
| Net Profit | $ 4,967.01 | $ 67,251.09 | $ 97,931.34 | $ 112,143.26 |
*296 The circulation of the Old Company increased from 10,133 paid subscribers with total paid circulation of 3,100,698 in 1939 to 16,904 paid subscribers with total paid circulation of 5,189,727 in 1943. The circulation of petitioner increased from 16,515 paid subscribers with total paid circulation of 5,070,315 in 1944 to 18,701 paid subscribers with total paid circulation of 5,760,166 in 1948.
*1233 The Old Company paid dividends in the amounts of, none for 1939, $ 6,078 for 1940, $ 9,117 for 1941, $ 2,532.50 for 1942, and $ 5,065 for 1943.
During the years 1944 to 1948 inclusive, the petitioner had outstanding par value shares of capital stock and paid dividends thereon and also had outstanding face value debentures and paid interest thereon, in the following amounts:
| Year | Par value | Dividends | Debentures | Interest |
| shares | paid | |||
| 1944 | $ 100,640 | $ 3,019.20 | $ 251,600 | $ 15,096.00 |
| 1945 | 100,020 | 3,000.60 | 250,400 | 15,060.00 |
| 1946 | 100,640 | 3,019.20 | 250,400 | 15,024.00 |
| 1947 | 100,640 | 15,096.00 | 249,625 | 15,024.00 |
| 1948 | 100,640 | 15,096.00 | 249,625 | 14,977.50 |
During the taxable years 1944 and 1945 and subsequent years, several sales of shares of petitioner's capital*297 stock were made by the owners thereof without including their debenture notes and also separate sales of debentures were made without including stock therewith.
The debenture notes issued by petitioner on December 31, 1943, and outstanding during the taxable years 1944 and 1945, constituted evidences of that corporation's indebtedness in the face amount thereof.
In his determination of petitioner's tax liability for each of the years 1944 and 1945, respondent determined that petitioner's debenture notes did not afford a basis for the claimed deductions for interest paid thereon nor a basis for the claimed borrowed capital for excess profits tax purposes.
The Old Company filed a claim for relief for the year 1942 under section 722, I. R. C., dated March 15, 1943. This claim has been rejected.
The Old Company filed its excess profits tax return for 1942, reporting thereon the amount of excess profits tax as computed by it and deferred payment of 33 per cent thereof by reason of the application of section 710 (a) (5) of the Internal Revenue Code. Respondent determined the amount of excess profits tax for 1942 and a deficiency therein in the amount of $ 4,559.94 attributable solely *298 to the above-mentioned deferment by petitioner.
OPINION.
The first question is whether the petitioner's debenture notes issued on December 31, 1943, under the circumstances herein and outstanding in the face amounts of $ 251,600 at the close of 1944 and $ 250,400 at the close of 1945, constituted an "indebtedness" *1234 within the meaning of section 23 (b), Internal Revenue Code, 1 so that the petitioner's payments of $ 15,096 in 1944 and $ 15,060 in 1945 as interest thereon are deductible under that section.
The respondent concedes, for the purposes of this proceeding, that there was a reorganization pursuant to which the petitioner was organized on December 31, 1943, and on the same date acquired all of the tangible and intangible assets of the Old Company and Photo Company as the successor corporation. *299 Respondent finds no fault with and makes no argument as to the validity and bona fides of petitioner's issuance of 10,064 shares of its capital stock of the par value of $ 100,640 in connection with the reorganization. Further, with reference to the $ 251,600 face value debentures respondent concedes that in form and terminology they appear to be negotiable promissory interest bearing notes. However, respondent argues that the terminology is not controlling because the debentures were not issued against either borrowed money or assets of any value received by petitioner, but, instead, were issued without consideration and against an arbitrary write-up of good will and circulation from the amount of $ 4,000 as carried on the Old Company's books to $ 286,838.74 as set up on petitioner's books. Respondent contends that the debentures, which in his view were issued without consideration, did not represent an "indebtedness," within the meaning of the Code, and that the payments denominated interest thereon were, in fact, distributions of dividends on securities in the nature of preferred stock.
Petitioner contends that in both form and substance the petitioner's debentures constituted*300 an indebtedness for Federal tax purposes, that is, an unconditional and legally enforceable obligation for the payment of money.
Both parties recognize the issue to be essentially one of fact and their well-prepared briefs indicate the difficulty of reconciling results reached in cases dealing with apparently similar fact situations.
The debentures provided that petitioner for value received acknowledged itself to be indebted and promised to pay the owner a stated principal sum of money on a fixed maturity date with interest payable semiannually at the rate of 6 per cent per annum until paid in full. The debentures contained no limitation, qualification, or condition upon payment of principal or interest, or the source of the funds for such payments and contained no voting or proprietary interest usually associated with shares of stock in a corporation. On petitioner's books the debentures were carried as a liability under the heading of "Long Term Notes" and the semiannual 6 per cent *1235 payments thereon were treated as interest paid. Aside from respondent's concession as to the form of the debentures, and based upon our findings herein and applicable prior cases, 2 we*301 conclude that petitioner's debentures in fact created a debtor-creditor relationship -- unless it may be said that such relationship should not be recognized for Federal tax purposes because the debenture issue wholly lacked substance in that it was without consideration, as argued by respondent.
In the instant case the reorganization which brought petitioner into being was essentially a recapitalization of the newspaper business which petitioner's predecessor, the*302 Old Company, had acquired in 1919 and built up through the succeeding years with tangible and particularly intangible asset values far in excess of the cost basis thereof reflected on the latter's books. The uncontradicted testimony of well qualified witnesses in support of the appraised fair market value of the Old Company's net assets as of December 31, 1943, establishes to our satisfaction that such value was at least equal to the amount of the stock and debentures issued by petitioner. Accordingly, we conclude that the petitioner's debentures in the face amount of $ 251,600 were issued for value received. The conclusions reached in this and the next preceding paragraph are the reasons for our finding of fact that the petitioner's debenture notes constituted evidences of that corporation's indebtedness in the face amount thereof during the taxable years.
On the first question we hold that petitioner is entitled to the deductions claimed for interest paid on its debentures outstanding in the taxable years 1944 and 1945. Toledo Blade Co., 1079">11 T. C. 1079, affd. 180 F. 2d 357, certiorari denied October 19, 1950. On this *303 issue respondent erred.
The second question is whether, in determining the petitioner's average invested capital including borrowed invested capital, under the applicable provisions of the Internal Revenue Code, for excess profits tax purposes for the years 1944 and 1945, the above-mentioned debenture notes constitute "Borrowed Capital" within section 719 of the Code 3 in effect for those years. The respondent makes the same contention on this question as on the first question.
*304 *1236 Our conclusion on the first question brings the petitioner's outstanding debenture bonds squarely within the express statutory provision of section 719 (a) (1), that borrowed capital includes "The amount of the outstanding indebtedness * * * of the taxpayer which is evidenced by a bond, note, * * * debenture, * * *" On the second question we sustain petitioner's contention and hold that respondent erred in denying its claimed borrowed capital for excess profits tax purposes for 1944 and 1945.
The third question presented herein is whether the asserted deficiency of $ 4,559.94 in excess of profits tax for 1942, representing the amount of excess profits tax deferred by petitioner by reason of the application of section 710 (a) (5) of the Internal Revenue Code, 4 constitutes a "deficiency" for that year within section 271 of the Code.
*305 The term "deficiency" is defined by section 271 (a) prior to amendment by section 14 of the Revenue Act of 1944, as meaning, the amount by which the tax imposed by chapter 1 of the Code exceeds the amount shown as the tax by the taxpayer upon his return, and was made applicable to excess profits taxes imposed by chapter 2 of the Code by section 729 (a). Section 710 (a) (5) specifically provides, "For the purposes of section 271, if the [excess profits] tax payable is the tax so reduced [by the deferment], the tax so reduced shall be considered the amount shown on the return." (Emphasis added.) The statutory language is clear in providing that to the extent that the deferred tax is later determined to be correctly imposed, it shall be considered as being in excess of the tax shown on the return and thus constitutes a "deficiency."
In the instant case a claim for relief under section 722 was filed by the Old Company thus making applicable the provision of section 710 (a) (5) for the deferment. Petitioner conceded at the hearing that this claim was rejected. Accordingly, the reason for the deferment *1237 no longer exists and the amount of the deferment having been determined*306 as correctly imposed, it constitutes a deficiency in excess profits tax for 1942. This conclusion is in accordance with the principles announced in California Vegetable Concentrates, Inc., 10 T. C. 1158, wherein the section 722 claim was still pending.
On the third question respondent's determination is sustained.
Decision will be entered under Rule 50.
Footnotes
1. 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, * * *↩
2. Kelley Co. v. Commissioner, 326 U.S. 521">326 U.S. 521, affirming 1 T. C. 457; Commissioner v. Hood & Sons, Inc., 141 F.2d 467">141 F. 2d 467, affirming 1 T. C. 1214; Lansing Community Hotel Corporation, 183">14 T. C. 183, affirmed 187 F.2d 487">187 F. 2d 487; Pierce Estates, Inc., 16 T. C. 1020 (appealed C. A. 3, 10/12/51); and Clyde Bacon, Inc., 4 T. C. 1107↩.
3. SEC. 719. BORROWED INVESTED CAPITAL.
(a) Borrowed Capital. -- The borrowed capital for any day of any taxable year shall be determined as of the beginning of such day and shall be the sum of the following:
(1) The amount of the outstanding indebtedness (not including interest) of the taxpayer which is evidenced by a bond, note, bill of exchange, debenture, certificate of indebtedness, mortgage, or deed of trust, plus,
* * * *
(b) Borrowed Invested Capital. -- The borrowed invested capital for any day of any taxable year shall be determined as of the beginning of such day and shall be an amount equal to 50 per centum of the borrowed capital for such day.↩
4. SEC. 710. IMPOSITION OF TAX.
(a) Imposition. --
(1) General rule. -- There shall be levied, collected, and paid, for each taxable year, upon the adjusted excess-profits net income, as defined in subsection (b), of every corporation (except a corporation exempt under section 727) a tax * * *
* * * *
(5) Deferment of payment in case of abnormality. -- If the adjusted excess profits net income (computed without reference to section 722) for the taxable year of a taxpayer which claims on its return, in accordance with regulations prescribed by the Commissioner with the approval of the Secretary, the benefits of section 722, is in excess of 50 per centum of its normal tax net income for such year, computed without the credit provided in section 26 (e) (relating to adjusted excess profits net income), the amount of tax payable at the time prescribed for payment may be reduced by an amount equal to 33 per centum of the amount of the reduction in the tax so claimed. For the purposes of section 271, if the tax payable is the tax so reduced, the tax so reduced shall be considered the amount shown on the return. Notwithstanding any other provision of law or rule of law, to the extent that any amount of tax remaining unpaid pursuant to this paragraph is in excess of the reduction in tax finally determined under section 722↩, such excess may be assessed at any time before the expiration of one year after such final determination.