*725 This proceeding, which involves the redetermination of a deficiency in income tax for the year 1925 in the amount of $22,716.84, was heard by this Board and decision entered on June 27, 1931, in favor of the petitioner, the Board's findings of fact and opinion being reported in 22 B.T.A. 373">22 B.T.A. 373. The respondent appealed, and on December 17, 1932, the United States Circuit Court of Appeals for the First Circuit, on the authority of Kirby Lumber Co. v. United States,284 U.S. 1">284 U.S. 1, decided by the Supreme Court subsequent to this Board's decision, reversed the Board's decision and remanded the case to us for a new hearing on the facts and such further proceedings as were not inconsistent with its opinion. Accordingly, a hearing was had, at which time an agreed statement of facts was read into the record and certain documents were received in evidence.
FINDINGS OF FACT.
On February 20, 1922, the Coastwise Transportation Corporation purchased a fleet of coastwise vessels from the American-Hawaiian Steamship Co. at the following*1079 prices:
| Steamship Suffolk, built in 1911 | $200,000 |
| Steamship Middlesex, built in 1912 | 200,000 |
| Steamship Hampden, built in 1914 | 200,000 |
| Steamship Coastwise, built in 1910 | 175,000 |
| Steamship Bristol, built in 1916 | 175,000 |
| Steamship Transportation, built in 1910 | 175,000 |
| Steamship Norfolk, built in 1913 | 142,500 |
| Total cost price | 1,267,500 |
These were the only vessels owned by the petitioner and their operation was the only business engaged in by this petitioner.
*726 In payment of the foregoing cost price, the petitioner paid in cash $507,000, leaving $760,500 to be paid. The balance of the purchase price was represented by ten notes of the face value of $76,050 each, delivered to the seller, the American-Hawaiian Steamship One of these notes matured each year, the first on February 20, 1923, and the last on February 20, 1932. Interest at the rate of 7 percent was payable, semiannually, upon the unpaid balance of the purchase price. These notes were held by the American-Hawaiian Steamship Co. and secured by mortgage upon the above described fleet of vessels.
The petitioner sustained a net loss for Federal tax purposes of $100,338.25 for the*1080 calendar year 1924. Its loss for 1924, as shown by its books, was $69,808.49, exclusive of additional depreciation of $30,529.76 claimed and allowed, computed as set out in the return for 1924. The total depreciation for 1924 was $87,161.96.
The net loss was incurred in the regular conduct of the petitioner's business, which consisted of the operation of the vessels named above, with the exception of $18,363.30, deducted in 1924 under the caption "proportion earnings - S. P. Burton & Company", in line 22(e) of the 1924 return.
The cost of the vessels, less depreciation to December 31, 1924, was as follows:
| Steamship Suffolk | $166,687.39 |
| Steamship Middlesex | 166,230.14 |
| Steamship Hampden | 170,464.72 |
| Steamship Coastwise | 161,412.35 |
| Steamship Bristol | 153,554.74 |
| Steamship Transportation | 141,194.22 |
| Steamship Norfolk | 123,876.17 |
| Total | 1,083,419.73 |
The depreciation of the above vessels, between the date of purchase and December 31, 1924, is the difference between the sum of $1,083,419.73 and the original cost of $1,267.500, or $184,080.27.
On October 24, 1924, Harris Livermore, who was president of petitioner, sent the following telegram to the American-Hawaiian*1081 Steamship Co.:
After much negotiation with principal stockholders have succeeded in getting them to double their subscriptions provided entire outstanding issue is purchased four hundred fifty thousand stop Impossible to interest any outside purchasers owing to discouraging state of New England business and bad outlook for future stop In my opinion this absolute limit you can get and offer must be accepted or rejected before close and pay cash on or before November fifteenth stop You must bear in mind these steamers and fitted only for very few docks and limited in business owing to size and deep draft.
*727 On October 28, 1924, C. W. Cook, of the American-Hawaiian Steamship Co., replied by telegram as follows:
Upon authority our Board of Directors I accept your offer of four hundred fifty thousand dollars payable in cash on or before November fifteenth next.
A special meeting of the directors of petitioner was held on November 10, at which time Mr. Livermore, the president, stated to the meeting that:
* * * a syndicate had been formed to acquire the outstanding serial notes of the Corporation secured by the preferred mortgage to American-Hawaiian Steamship Company*1082 dated February 20, 1922 and that the syndicate requested the Company to join with it on certain terms and conditions in the purchase of the outstanding notes of the face value of $608,400 for $450,000. It was now contemplated that the corporation pay $76,050 as part of the consideration of $450,000 to be paid to the American-Hawaiian Steamship Company and to receive as consideration therefor the cancellation of the third and fourth installments due under the terms of the mortgage of February 20th. Mr. Livermore stated that by the payment of the said amount of $76,050 the Company would cancel liabilities amounting to $152.100 which would otherwise become due one-half on February 20, 1925 and the other half February 20, 1926 and that it seemed for the best interests of the Corporation to take advantage of this opportunity.
After discussion, upon a motion duly made and seconded, it was voted that the corporation pay not exceeding $76,050 for the notes due in 1925 and 1926.
It was then stated to the meeting that it was necessary for the corporation to borrow $75,000 to meet the payment called for by the above vote and it was thereupon voted that the proper officers be authorized*1083 to borrow in the name of and on behalf of the corporation, $75,000, and such officers were authorized to mortgage or pledge assets as security therefor.
The syndicate raised $375,000, which, together with the $75,000 contributed by the petitioner, was paid to the American-Hawaiian Steamship Co. for the balance of the outstanding notes given by petitioner in payment for its fleet of ships. Petitioner paid the $75,000 on the purchase price of the vessels on November 20, 1924, and thereby retired the notes due February 20, 1925 and 1926, which were marked "Cancelled, Harris Livermore, Syndicate Manager."
On January 5, 1925, the syndicate addressed a letter to the petitioner as follows:
The undersigned, Coastwise Transportation Corporation Refunding Syndicate (Harris Livermore, Syndicate Manager, State Street Trust Company, Depositary) is the owner and holder of $456,300 face amount of the serial notes of your company secured by First Preferred Mortgage dated February 20, 1922 which it is understood are all of such serial notes now outstanding.
The Syndicate hereby offers to surrender to your company for cancellation all such serial notes, together with a proper discharge of*1084 the mortgage *728 securing the same, in consideration of the delivery to it or on its order of an entire issue of First Mortgage 7% Serial Gold Bonds (in coupon form) of your company limited in the aggregate to $375,000 of principal dated as of and bearing interest from November 15, 1924 and maturing serially over a period of ten years in equal annual instalments of $37,500 of principal beginning with November 15, 1925, which shall be secured by a closed first "preferred" mortgage on the seven vessels owned by your company running to State Street Trust Company as Trustee for the bondholders and in form approved by the Syndicate Manager.
The letter than describes the denominations in which the temporary and permanent bonds are to be issued, approves the forms of indenture of trust and mortgage temporary and permanent bonds submitted by counsel for petitioner, and conditions the offer upon acceptance prior to January 15, the issuance of temporary bonds prior to February 1, and of permanent bonds as soon thereafter as practicable.
The letter and the forms of the indenture of trust and mortgage temporary bonds and permanent bonds were presented the meeting of the board of*1085 directors on January 6, 1925, and the necessary votes taken to accept the offer and authorize the issuance of the temporary and permanent bonds and the execution of the indenture of trust and mortgage.
On January 19, the petitioner issued $375,000 principal amount of 7 percent gold bonds secured by a mortgage on the vessels purchased from the American-Hawaiian Steamship Co. and its serial notes in the amount of $456,300 were canceled. The bonds were dated November 15, 1924, and bore interest from that date.
The mortgage on the fleet of vessels which was given to the American-Hawaiian Steamship Co. as security for the payment of the installments of the purchase price represented by the notes, was canceled at the time that the mortgage indenture took effect. The notes held by the American-Hawaiian Steamship Co. as part of the purchase price of the vessels were returned to the Coastwise Transportation Co. at the same time that the mortgage to secure the bond issue of $375,000 took effect.
The payment of $75,000 in November 1924, and the issuance in January 1925, of bonds dated November 15, 1924, in the face amount of $375,000, were made in carrying out the agreement of October*1086 1924, to settle the balance of the purchase price for $450,000.
The balance sheet of the company, as of December 31, 1923, shows "Mortgages Payable", $684,450, which is the original amount of the notes given to the American-Hawaiian Steamship Co. as a part of the purchase price, reduced by the payment of the note paid February 20, 1923, of $76,050. It also shows a deficit of $73,340.24.
*729 The "Mortgage Payable" item at December 31, 1924, is $456,300, which shows the reduction by the installment of the purchase price paid February 20, 1924, of $76,050, and also the further reduction of the installments to become due in 1925 and 1926, totaling $152,100, by the payment of $75,000 in cash as above set forth. The deficit as of December 31, 1924, after taking into consideration the reduction in the mortgage payable, was $113,883.31.
The balance sheet of December 31, 1925, shows "First mortgage seven percent bonds, $337,500." This entry was made after the issuance of $375,000 gold bonds as above set forth and the payment therewith of $456,300, the balance due on the purchase price of the vessels. The face of the bond issue of $375,000 was reduced on November 15, 1925, by*1087 the payment of 10 percent, or $37,500, on account of the principal called for by the mortgage indenture. There was a surplus at the close of 1925 of $49,452.52.
The respondent reduced the net loss of the petitioner for the year 1924 from $100,338.25 to $23,238.25, treating the difference between the outstanding notes due in 1925 and 1926, $152,100, and the amount paid in cash, $75,000, in cancellation of them, or $77,100, as a profit realized by the petitioner. In 1925 the respondent found a profit of $81,300 resulting from the difference in the face amount of the bonds, $375,000, issued in that year and the outstanding serial notes, then $456,300, in substitution for and cancellation of which the bonds were issued.
OPINION.
MATTHEWS: The Circuit Court, in reversing the former decision of this Board, stated:
* * *
From the record in this case and the findings of fact by the Board, and in accordance with its recent practice since the decision in the Kirby Lumber Co. case, it is clear, we think, the Board should have sustained the ruling of the Commissioner.
It is urged by the taxpayer, however, that there was no release of free assets by the transactions involved*1088 in this case; that the petitioner lost a large sum of money in 1924, the inference being that its assets had thereby been depreciated; and it is further urged that the substitution of bonds of the face value of $375,000 for serial notes of the face value of $456,300 was in the nature of a reorganization of the taxpayer. But the stipulated facts and the findings of the Board do not sustain this. What the petitioner could have shown in this respect we do not know. Under the Board's practice prior to the decision of the Supreme Court in the Kirby Lumber Co. case, it was not necessary to stipulate or determine such facts.
Upon the record before this court and the facts agreed upon, we think the case is controlled by the Kirby Lumber Co. case, and the decision of the Board of Tax Appeals must be reversed and the case remanded to the Board for a new hearing on the facts and such further proceedings as are not inconsistent with this opinion.
*730 The question now before us is whether, upon the facts disclosed upon the new hearing, the rule of the Kirby Lumber Co. case applies.
The reorganization issue was not argued at our original hearing of the case, nor is*1089 it raised before us now. Since the facts do not suggest, even remotely, a reorganization of petitioner, it is not necessary to consider this question.
In addition to the other points urged before the Circuit Court, counsel for the petitioner contends (1) that the decision of the Supreme Court in United Statesv. Kirby Lumber Co., applied to a situation totally different from that existing in this case; (2) that the settlement of a balance due upon the purchase price of property for an amount less than the original agreed price, does not constitute income to the purchaser; (3) that petitioner did not purchase its own bonds in 1924 and 1925, but merely paid part of the agreed purchase price for a fleet of vessels, in full settlement of the original price thereof; (4) that the entire transaction through December 31, 1924, resulted in a loss, and even if the transaction dealt with the purchase of securities, it is within the exception of the rule in the Kirby case and comes within the decision in Bowers v. Kerbaugh Empire Co.,271 U.S. 170">271 U.S. 170.
On the first point, counsel for petitioner argues that the Kirby case and the article of the regulations*1090 which it approves, refer to cases where a corporation sells its bonds or notes as commodities, receiving money therefor, and then repurchases then for less than the price at which sold. He points out that the decisions of this Board rendered since the Kirby decision and following it, which were cited by the first circuit in its decision in this case, all relate to cases where the corporation had issued its bonds for money and retired them for less than the issuing price.
We agree with petitioner that the transactions merely amounted to a reduction in the purchase price of the fleet of vessels, that there was no release of free assets by the transactions involved, and that the operation in 1924 resulted in a loss.
Under the agreement of October 1924, the seller agreed to accept $450,000, payable in cash on or before November 15, 1924, in settlement of the outstanding notes amounting to $608,400. The money was paid, petitioner contributing $75,000 cash (which it had to borrow), and the syndicate (made up of petitioner's stockholders) contributing the balance. The syndicate obtained all the purchase money notes outstanding and immediately canceled and turned over to petitioner*1091 the two notes due in 1925 and 1926. Shortly thereafter, upon the issuance of bonds in the amount of $375,000, the balance of the notes were canceled and delivered to petitioner. As we view the transactions, the payment of the $75,000 in November 1924, and *731 the issuance of bonds in the amount of $375,000 in January 1925, which were dated and bore interest from November 15, 1924, were nothing more than steps in the settlement of the balance of the purchase price for $450,000. Petitioner's financial condition was such that it could not have paid the cash in November 1924. By the method followed, however, petitioner was able to obtain the benefit of the reduction in purchase price. This benefit, while reducing petitioner's liabilities, was not sufficient to wipe out the deficit. It did not, therefore, release any free assets.
The petitioner had a deficit at the close of 1923 of over $73,000. Its operating loss for 1924 was over $100,000. The deficit at the end of 1924, taking into consideration the reduction in the mortgage payable that year of $77,100, was $113,883.31. If it had not been for the cancellation of the two notes in the amount of $152,100 by payment*1092 of $75,000, thus reducing liabilities by $77,100, the deficit at the end of 1924 would have been $190,983.31. And applying the $81,300 by which the liabilities were further reduced on January 19, 1925, to the deficit of $113,883.31 as of December 31, 1924, there would still remain a deficit of $32,583.31. It is not likely that the operation of the corporation the first part of January was sufficiently profitable to have wiped out the 1924 deficit. Furthermore, the vessels had suffered depreciation to December 1924, on the basis of the original purchase price, in an amount in excess of the reduction in price. And even if depreciation at the same rate were computed on the reduced cost price, the difference would not be sufficient to wipe out the deficit.
In the Kirby Lumber Co. case, the taxpayer issued its own bonds for which it received their par value. Later, in the same year, it purchased in the open market some of the same bonds at less than par, the difference of price being held a taxable gain in the year of purchase. The court approved the regulations covering such a situation. In distinguishing the Kerbaugh case, Holmes, J., said:
* * * At the time of payment*1093 the marks had fallen in value, which so far as it went was a gain for the defendant in error, and it was contended by the plaintiff in error that the gain was taxable income. But the transaction as a whole was a loss, and the contention was denied. Here there was no shrinkage of assets and the taxpayer made a clear gain. As a result of its dealings it made available $137,521.30 assets previously offset by the obligation of bonds now extinct. We see nothing to be gained by the discussion of judicial definitions. The defendant in error has realized within the year an accession to income, if we take words in their plain popular meaning, as they should be taken here. Burnet v. Sanford & Brooks Co.,282 U.S. 359">282 U.S. 359, 364.
Here, the transaction as a whole - the purchase and operation of the ships - was a loss. There was a shrinkage in assets. The reduction in purchase price in the instant case did not make available *732 to petitioner $158,400 of assets offset by the notes retired. It merely reduced the liabilities and thereby diminished the loss.
Since the decision by the Circuit Court in this case, a similar question has been passed on by the Second*1094 Circuit in Commissioner v. American Chicle Co., 65 Fed.(2d) 454. In that case the taxpayer had bought all of the assets of another company and assumed its debts; these included an issue of bonds which provided for an annual amortization by purchase in the market. In the years 1924 and 1925 the taxpayer, in accordance with its obligations, bought a number of these bonds for less than their face and so retired them. The Commissioner charged the corporation with income - the difference between the face of the bonds and the amounts at which they were bought. The taxpayer appealed and the Board sustained the petitioner. On appeal by the Commissioner, the court held that the question depended on the scope of the decision of the Supreme Court in Kirby Lumber Co. After referring to the decision of the First Circuit in the instant case, and the regulations, the court said:
We can see no difference between bonds retired in the same year and later; nor between those issued in payment for property, and an existing mortgage assumed by the buyer when the property is transferred. But the distinction does seem to us critical between obligations whose consideration is*1095 money, and those issued or assumed for property which the obligor still holds. Every increase in the value of property might indeed be treated as a "gain", though that would involve appraising taxpayers' property each year; but such is not the notion underlying our system of taxation. The gain must be "realized", either by sale of the property for money, or by its exchange for something else. Section 395, Title 26, U.S. Code. When a taxpayer gets money by issuing an obligation which he later discharges for less than its face, the transaction is completed, because money need not be sold or exchanged to be "realized." So we read U.S. v. Kirby Lumber Co., supra (284 U.S. 1). But if he buys property by an obligation in the form of a bond, note, or the like, and if it remains in kind after the debt is paid, there can be no "gain." The cost has indeed been definitely settled, but that is only one term of the equation; as long as the other remains at large there is no "realized" gain.
Here the notes were given in purchase of a fleet of ships, property. The unpaid notes were settled for $158,400 less than their face. Under the American Chicle decision, cost alone has*1096 been established. No income was realized.
By remanding this case for a new hearing, to determine from the facts whether there was a release of free assets by the transactions involved and whether the assets had been depreciated by the loss in 1924, we take the First Circuit's view to be that, if there was no release of free assets and if the assets had depreciated, no income was realized from the transaction. Under either the view of the *733 First Circuit or that of the Second Circuit in the American Chicle case, petitioner realized no gain in the transactions either in 1924 or 1925.
Reviewed by the Board.
Judgment will be entered for the petitioner.
ARUNDELL and BLACK concur in the result.