*2245 1. A taxpayer in 1917 issued mortgage bonds for assets in reorganization and before the end of the year it purchased such bonds for less than their face amount. Held, no income.
2. Taxpayer's property was in 1917 requisitioned by the Government, and the compensation was more than cost. Taxpayer made no application to the Commissioner and gave no bond covering a replacement fund, as required by the regulations prescribed under the statute. Held, the excess was income and no deduction was allowable.
*787 Respondent determined a deficiency of $534,587.52 income and profits tax for the period of eleven months ended December 31, 1917, by (1) treating as income the difference of $1,385,725 between the face value of petitioner's bonds and the lower price at which they were purchased by petitioner in the taxable year, and (2) treating as income $610,035.07, being the excess over cost received by petitioner in the taxable year from the Government for ships requisitioned.
The parties have filed a stipulation*2246 of facts, which facts are hereby found in the terms stipulated, as follows:
1. Petitioner, Eastern Steamship Lines, Inc., is a corporation which was organized under the laws of the State of Maine in January, 1917, to acquire the properties and business of a corporation owning coastwise steamship properties, the business of which was then being operated by receivers. The steamships plied between Boston and New York and Boston and various points on the Atlantic seaboard.
2. Petitioner was organized pursuant to a plan of reorganization worked out by a committee for the bondholders of Eastern Steamship Corporation. This committee was organized under an agreement dated April 17, 1915. A correct copy of the report of such bondholders' committee, dated August 28, 1916, setting forth such plan of reorganization is introduced in evidence as an exhibit, to be marked Exhibit A.
*788 3. The plan of reorganization set forth in Exhibit A was carried out substantially as therein proposed. Substantially all the properties of Eastern Steamship Corporation and all the cash raised by the bondholders' committee pursuant to the plan of reorganization, were acquired by petitioner. *2247 For acquisition of such properties and cash, petitioner issued all its securities, which securities were distributed among the security holders of Eastern Steamship Corporation in accordance with the plan of reorganization. The securities of petitioner so issued and distributed were:
$5,700,000 face value first and Consolidated Mortgage 30-Year Non-Cumulative Income Gold Bonds;
$740,000 face value Five-Year 5% Debenture Notes;
$3,750,000 par value Preferred Stock, being 37,500 shares of a par value of $100 each;
$1,687,500 par value Common Stock, being 67,500 shares of a par value of $25 each.
4. The $5,700,000 face value First and Consolidated Mortgage 30-year Non-Cumulative Gold Bonds were issued under an Indenture, a correct copy of which indenture is introduced in evidence as an exhibit to be marked Exhibit B.
5. On or about December 4th and 5th, 1917, petitioner had outstanding in excess of $542,900 facevalue of the above mentioned First and Consolidated Mortgage 30-Year Non-Cumulative Income Gold Bonds issued under the above mentioned indenture and in the form therein set forth.
6. On or about December 4th and 5th, 1917, petitioner purchased from the holders*2248 thereof, through the sinking fund trustee, $5,542,900 face value of such income bonds for the total amount of $4,157,175 in cash. Such bonds were retired shortly after acquisition by petitioner.
7. The excess of the face amount of such income bonds over the amount of cash paid therefor was $1,385,725. Such amount of $1,385,725 is the $1,385,725 included by respondent as taxable income of petitioner and referred to in Assignment of Error marked (a) in paragraph 4 of the petition herein, and also referred to in subdivisions (c) and (d) of paragraph 5 of the petition herein.
8. On April 29, 1918, the Board of Directors of petitioner, acting under Article II of the Indenture copy of which is attached hereto as Exhibit B, found that there was no available net income for the year ended December 31, 1917, applicable to the payment of interest on the income bonds issued under said Indenture, and that no interest was due thereon.
9. No interest for the year 1917 was paid by petitioner on account of any of the above-mentioned income bonds outstanding on April 1, 1918.
10. In November and December, 1917, the President of the United States, by virtue of the power and authority*2249 vested in him by the Act entitled "An Act making appropriations to supply urgent deficiencies in appropriations for the military and naval establishments, etc., approved June 15, 1917", acting through the Secretary of the Navy, requisitioned and took title to, for use of the United States, for vessels theretofore owned by the above-named petitioner.
11. Such vessels were then known as the "Massachusetts", "Bunker Hill", "Old Colony" and "Boothbay".
12. Pursuant to the notices of the taking of such vessels, appraisals were made by the United States Navy Board of Appraisal to determine the just compensation for each vessel.
13. The amount of compensation so determined for each of said vessels was as follows:
| Massachusetts | $1,350,000 |
| Bunker Hill | 1,350,000 |
| Old Colony | 1,150,000 |
| Boothbay | 100,000 |
| Total | 3,950,000 |
*789 14. The amount of compensation so determined for such taking of the above mentioned vessels was paid by the United States to and received by the petitioner in November and December, 1917.
15. The amount of the excess of the compensation so determined and paid in the case of each such vessel over the value as shown by petitioner's*2250 books of each such vessel is shown by the following table:
| Steamer | Award | Book value | Depreciation | Net difference |
| Bunker Hill | $1,350,000 | $1,252,044.40 | $33,480.91 | $131,436.51 |
| Massachusetts | 1,350,000 | 1,251,917.90 | 33,343.26 | 131,425.36 |
| Old Colony | 1,150,000 | 1,000,152.00 | 28,400.52 | 178,248.52 |
| Boothbay | 100,000 | 75,865.80 | 2,342.33 | 26,476.53 |
| 3,950,000 | 3,579,980.10 | 97,567.02 | 467,586.92 |
16. In December, 1917, an entry was made upon petitioner's books in respect of such steamships, "Massachusetts," "Bunker Hill," "Old Colony" and "Boothbay" -
"to record on the books the difference between the amount awarded by the United States Government and the book value, less depreciation accrued to the date the vessels were commandeered, which amount is reserved as a replacement fund."
A correct copy of such journal entry is introduced in evidence as an exhibit to be marked Exhibit C.
17. During the year 1918 the United States paid additional allowances of compensation aggregating $39,036 on account of supplies, ships' stores, etc., on board the above mentioned vessels when taken by the United States. A correct copy of the journal entry made by*2251 petitioner with respect to the receipt of such additional allowances is introduced in evidence as an exhibit to be marked Exhibit D.
18. A correct copy of the balance sheet of petitioner as at December 31, 1917, as shown by petitioner's books and as adjusted by respondent, together with the adjustments resulting in such adjusted balance sheet, is introduced in evidence as an exhibit to be marked Exhibit E.
19. The schedule marked Exhibit F correctly sets forth the specifications referred to therein of the vessels - "Massachusetts," "Bunker Hill," Old Colony," and "Boothbay." Such schedule is introduced in evidence as an exhibit to be marked Exhibit F.
20. During the years 1919, 1920, 1921, 1922, 1923 and 1924 petitioner expended in the acquisition of vessels for use on its lines the sum of $5,270,559.66.
21. The expenditures in the acquisition of vessels aggregating $5,270,559.66 were for seven vessels, five of which were constructed for petitioner by shipbuilders under contracts and two of which were existing vessels. The names of the five vessels constructed under contract were the SS Norwalk, SS Cornish, SS Wilton, SS Boston, and SS New York. The names of the existing*2252 vessels were the SS H. F. Dimock and SS H. Winter.
22. A correct statement of the dates and amounts of expenditures in acquisition of each of the vessels just referred to is set forth in Exhibit G. Such *790 schedule is introduced in evidence as an exhibit to be marked exhibit G. As shown in such schedule amounts aggregating $39,807.37 were expended on account of the SS Boston and the SS New York in 1925 and 1926. This amount is in addition to the $5,270,559,66 expended during the years 1919 and 1924, inclusive.
23. The schedule marked Exhibit H correctly sets forth the specifications referred to therein and dates of delivery to petitioner of the vessels, "Norwalk," "Cornish," "Wilton," "H. F. Dimock," "H. Winter," "Boston" and "New York." Such schedule is introduced in evidence as an exhibit to be marked Exhibit H.
24. In the audit of petitioner's return for the year 1917 it was determined by respondent that vessel depreciation in excess of that deducted on petitioner's books was properly deductible. A correct copy of the "Revised schedule on sale of vessels to U.S. Government" prepared by the agent of respondent showing the excess of the amounts received on*2253 account of the steamships Massachusetts, Bunker Hill, Old Colony and Boothbay as above set forth, over the revised net book value resulting from increased allowances for depreciation, is introduced in evidence as an exhibit to be marked Exhibit I.
25. Exhibit I shows a figure of $610,035.07 as "Revised replacement reserve". This amount is the $610,035.07 added by respondent to the income shown on petitioner's return included by respondent in petitioner's taxable income, and referred to in petitioner's assignment of error, subdivision (b) of paragraph 4 of the petition herein and also referred to in sub-paragraphs (c) and (h) of paragraph 4 of such petition.
26. Petitioner's return did not include as taxable income any amount on account of the payments received for the Massachusetts, Bunker Hill, Old Colony and Boothbay. The respondent first asserted that a taxable profit was realized in this connection in his thirty-day letter, dated March 7, 1923, the original of which is introduced in evidence as an exhibit to be marked Exhibit J. The amount of taxable profit asserted by respondent in such letter on account of such vessels was $506,622.92.
27. On or about March 27, 1923, petitioner*2254 filed its appeal in the Bureau from the decision of the Income Tax Unit evidenced by Exhibit J and attached thereto as Memorandum No. 1, a memorandum dealing with "Replacements", in which memorandum petitioner set forth certain facts and its position that on account of the expenditures and commitments referred to in such memorandum in the acquisition of vessel property, such sum of $506,622.92 should not be included in taxable income.
28. In such memorandum the petitioner made the following statement:
"8. Leave to file bonds, etc., deemed necessary by Bureau requested.
"While the Company is of opinion that the facts herein outlined are sufficient to show compliance with the provisions of statute for the non-taxation of the proceeds of involuntary conversion here involved and is satisfied that such facts demonstrate that the Bureau is fully protected in any requirement in this regard, the Company hereby respectfully requests that an opportunity be afforded to file such bonds and take such other steps as may be deemed necessary by the Bureau."
Prior to the filing of such memorandum the petitioner had made no application for permission to set up a replacement fund or file*2255 bonds.
29. During the years 1923 and 1924 hearings were had before the Income Tax Unit, the then Solicitor of Internal Revenue and the Committee on Appeals and Review of the Bureau of Internal Revenue in regard to petitioner's claim that the proceeds of the requisitioned vessels should be excluded from taxable income, but such claims were denied.
*791 30. On December 15, 1924, petitioner filed with the respondent an application the original of which is introduced in evidence as an exhibit, to be marked Exhibit K. The application evidenced by such Exhibit K was denied by respondent under date of December 12, 1925.
The following facts are found from the evidence:
31. The Massachusetts, Bunker Hill, and Old Colony, were combined passenger and freight vessels especially available for use in the Boston to New York service, which required steamers of large capacity and a speed of at least twenty knots per hour.
32. The petitioner did not intend to abandon the service but always intended to replace the requisitioned vessels. Efforts to do this were constantly made by petitioner, beginning in 1919.
OPINION.
STERNHAGEN: 1. *2256 The first issue arises from the respondent's determination that petitioner's income should include the difference between the face value of its outstanding mortgage bonds ($5,524,900) and the lower price ($45,157,175) for which it bought them. The bonds were issued within the taxable year as part of the reorganization plan by which it acquired the properties of the predecessor corporation. Before the close of the year it discharged this capital obligation by paying less. Under circumstances less favorable to the taxpayer, the Board has in several cases decided that there is no gain to be included in income. Independent Brewing Co.,4 B.T.A. 870">4 B.T.A. 870; New Orleans, etc., Ry. Co.,6 B.T.A. 436">6 B.T.A. 436; Houston Belt, etc., Co.,6 B.T.A. 1364">6 B.T.A. 1364; National Sugar Mfg. Co.,7 B.T.A. 577">7 B.T.A. 577; Petaluma, etc., R.R. Co.,11 B.T.A. 541">11 B.T.A. 541; General Manifold, etc., Co.,12 B.T.A. 436">12 B.T.A. 436; American Seating Co.,14 B.T.A. 328">14 B.T.A. 328; Douglas County Light, etc. Co.,14 B.T.A. 1052">14 B.T.A. 1052; *2257 John F. Campbell Co.,15 B.T.A. 458">15 B.T.A. 458.
Following those decisions, we hold the respondent in error on this issue.
2. The important fact in the second issue is that stipulated in paragraph 28 - that prior to March 27, 1923, the petitioner had made no application for permission to set up a replacement fund or file bonds.
We have no doubt that an amount received by a taxpayer as compensation for property requisitioned is, to the extent of any excess over cost (or, in a proper case, value on March 1, 1913), with proper adjustments for depreciation, properly to be regarded as income. It is properly to be included in the statutory definition of gross income from whatever source derived, and this is none the less so if, in arriving at net, the statute provides, as in the Revenue Act of 1921, section 234(a)(14), for a deduction of the portion of gain *792 used or to be used in replacement. Pelican Bay Lumber Co. v. Commissioner, 31 Fed.(2d) 15; affirming 9 B.T.A. 1024">9 B.T.A. 1024; certiorari denied, 279 U.S. 870">279 U.S. 870. Cf. *2258 Lehigh & H. R. Ry. Co.,13 B.T.A. 1054">13 B.T.A. 1054. We find no support in United States v. Supplee Biddle Hardware Co.,265 U.S. 189">265 U.S. 189, for a contrary view. That decision was based squarely on the construction of the statute that a special treatment of the proceeds of life insurance expressly accorded to individuals was also applicable to corporations. The discussion contained in the opinion as to the nature of such proceeds did not reach a definitive conclusion and there is no reason to expand it beyond the life insurance there under consideration. Cf. Lucas v. Alexander,279 U.S. 573">279 U.S. 573.
Under the Revenue Acts of 1916, 1917, and 1918, the gain in compensation for requisitioned property was regarded by the Treasury Department as income, provision being made for relieving it from tax in certain circumstances. Regulations 33 (revised), article 94; Treasury Decision 2706, 20T.D. 348; Regulations 45, articles 49 and 50. The validity of this favorable treatment prior to the Revenue Act of 1921, it is not necessary to consider here, see *2259 Pelican Bay Lumber Co. v. Commissioner, 31 Fed.(2d) 15.
The Revenue Act of 1921 was the first to embody a provision in respect of involuntary sale or conversion. Section 234(a)(14) is as follows:
SEC. 234. (a) That in computing the net income of a corporation subject to the tax imposed by sectin 230 there shall be allowed as deductions:
* * *
(14) If property is compulsorily or involuntarily converted into cash or its equivalent as a result of (A) its destruction in whole or in part, (B) theft or seizure, or (C) an exercise of the power of requisition or condemnation, or the threat or imminence thereof; and if the taxpayer proceeds forthwith in good faith, under regulations prescribed by the Commissioner with the approval of the Secretary, to expend the proceeds of such conversion in the acquisition of other property of a character similar or related in service or use to the property so converted, or in the acquisition of 80 per centum or more of the stock or shares of a corporation owning such other property, or in the establishment of a replacement fund, then there shall be allowed as a deduction such portion of the gain derived as the portion of the*2260 proceeds so expended bears to the entire proceeds. The provisions of this paragraph prescribing the conditions under which a deduction may be taken in respect of the proceeds or gains derived from the compulsory or involuntary conversion of property into cash or its equivalent, shall apply so far as may be practicable to the exemption or exclusion of such proceeds or gains from gross income under prior income, war-profits and excess-profits tax Acts.
The last sentence, it will be noted, applies the treatment as deductions retroactively to similar situations occurring under prior acts. It is by virtue of this statutory provision alone that petitioner can make a plausible claim of right against the deficiency. Under it *793 actual immediate expenditure in replacement or the establishment of a replacement fund permitted the deduction; but only "under regulations prescribed by the Commissioner with the approval of the Secretary." Such regulations, from T.D. 2706, in 1918, through Regulations 45 (T.D. 2831, in 1919, and T.D. 3146, in 1921) into Regulations 62, under the 1921 Act, required application to and approval of the Commissioner of Internal*2261 Revenue and the giving of a bond. The statute provided no deduction otherwise; and since such requirements had been imposed by the Treasury Department in its regulations, the only reasonable construction of the conditions contained in the 1921 Act is that these requirements were expressly intended as conditions of the deduction. The petitioner did not fulfill this condition, and the Commissioner may not be required to compute the deficiency as if it did. "Men must turn square corners when they deal with the Government," Rock Island, etc., Co. v. United States,254 U.S. 141">254 U.S. 141; Botany Worsted Mills v. United States,278 U.S. 282">278 U.S. 282.
The determination on this point is sustained.
Judgment will be entered under Rule 50.