*1534 1. A corporation became financially involved and its bondholders instituted foreclosure proceedings for the protection of their interests. The bondholders also formed the petitioner (a corporation) for the purpose of acquiring the property, secured by the mortgage under which their bonds were issued, should it be the successful bidder at a sale under the foreclosure proceedings. At the time of the sale, the face value of the bonds outstanding was $2,755,000. The petitioner bid $1,000,000 for the property and a sale to it was confirmed on that basis. At or about that time petitioner acquired substantially all of the bonds of the old corporation through the issuance of its bonds of the same par value therefor, and the bonds so acquired were used by the petitioner in the satisfaction of the bid price for the property of the old corporation, except as to a small amount of cash required to be paid to the minority bondholders who did not become parties to the plan for the acquisition of the property. Held, that the bid price of $1,000,000 is not conclusive as to the measure of cost of the property to the petitioner, but that what occurred was an exchange of property (bonds of*1535 the old corporation) for property (assets of the old corporation) and that the basis for depreciation and depletion of the assets so received was the fair market value of the assets at the time of their receipt by the petitioner.
2. Depreciation and depletion as determined by the Commissioner approved.
3. Where a corporation purchases and retires its own bonds at less than their issuing price, the excess of the issuing price over the purchase price is taxable income in the year in which such bonds are purchased and retired. United States v. Kirby Lumber Co.,284 U.S. 1">284 U.S. 1.
*376 This proceeding involves deficiencies in income tax as determined by the Commissioner for 1921, 1922, 1923 and 1924 in the respective amounts of $3,019.29, $35,783.73, $31,703.84 and $6,581.72.
The questions involved, some of which are divided into more than one issue in the pleadings, are as follows: (1) Depreciation allowable on sawmill and equipment and depletion on timber - this question*1536 relates not only to the proper cost basis which is to be used in arriving at the amounts to be returned to the petitioner through these allowances, but also to the rates to be used for depreciation purposes; (2) whether the petitioner realized taxable income through the purchase and retirement of its own bonds at less than their face value; and (3) whether the petitioner is entitled to accrue the interest on certain income bonds and have the same allowed as a deduction from gross income. No profits tax was determined by the Commissioner for 1921, though it is alleged by the Commissioner that in the event his contention with respect to the cost of assets to the petitioner is sustained a profits tax for 1921 will result.
FINDINGS OF FACT.
The petitioner, a Delaware corporation, with its principal office at Waynesville, North Carolina, was organized on April 26, 1918.
The Champion Lumber Company, a Delaware corporation, was organized prior to 1911 and had extensive timber holdings in North Carolina. On or about April 1, 1911, it issued bonds in the face value of $3,250,000, but by or before December 20, 1916, the amount of the bonds outstanding had been reduced to a face value*1537 of $2,755,000, the difference having been retired through the operation of a sinking fund.
On or about April 1, 1911, and March 24, 1913, the Champion Lumber Company placed its entire assets (consisting of timber lands, together with all mills, buildings, railways, equipment, etc., then, or *377 thereafter to be built, connected with or placed on the real estate covered by a mortgage) in trust with the Provident Life & Trust Company of Philadelphia and John Way, trustees, to secure the bonds referred to in the preceding paragraph.
On September 11, 1916, the Champion Lumber Company was declared a bankrupt on petition of certain creditors other than the bondholders and a receiver was appointed who continued to operate the properties until December 20, 1916.
On October 1, 1916, the Champion Lumber Company defaulted on certain of its bonds and as a result on December 20, 1916, foreclosure proceedings were instituted by the trustees under the trust deed heretofore referred to. In furtherance of the foreclosure proceedings, certain of the bondholders acquired the claims of the complaining creditors in the bankruptcy proceedings in order that the assets might be sold free*1538 and clear of such claims, and in the decree of foreclosure (hereinafter referred to) the following statements appear with respect to chaims against the Champion Lumber Company:
That as appears by the pleadings in this case, divers bondholders for the purpose of protecting their interests and promoting the adjustment and settlement of claims asserted to have priority over the liens of the mortgages here in process of foreclosure, have joined together as a bondholders Board of Reorganization Managers and have acquired the claims and all of them asserted and preferred against the defendant Champion Lumber Company by North Carolina Mercantile Company and Carolina Supply Company, claimants herein, and now hold and own all and singular such claims: and the said bondholders Board of Reorganization Managers have consented as the owners of such claims to withdraw, and have withdrawn the claims of said North Carolina Mercantile Company and Carolina Supply Company, and this Court has dismissed the same out of this proceeding, to the end that the mortgaged property herein described may be sold free and clear of such claims and so that the proceeds of such foreclosure sale may stand discharged*1539 from such claims; but without prejudice nevertheless in any other cause or in any other form to prosecute such claims against other property or against any other person as they may be advised.
On September 15, 1916, a bondholders' protective committee was organized for the purpose of protecting the interests of the bondholders and most of the bondholders joined in an agreement which was entered into. The aforementioned committee engaged in various activities in furtherance of the purpose incident to its creation and subsequently, in 1916 or 1917, was succeeded by a board of reorganization managers, which continued to carry on the activities theretofore carried on by its predecessors. In the meantime the petitioner corporation was formed by bondholders of the Champion Lumber Company for the purpose of acquiring the properties of the Champion Lumber Company through the foreclosure proceedings which had been instituted and the petitioner, acting with the board *378 of reorganization managers, was authorized to bid not less than $250,000 or, in its discretion, $1,000,000 for the said properties.
On August 10, 1918, the United States District Court for the Western District*1540 of North Carolina entered a decree of foreclosure and ordered the property sold on September 23, 1918. Among the provisions in the decree with respect to the sale were the following:
The complainants, as trustees in said mortgages or deeds of trust, and any holder or holders of bonds or coupons, secured by said mortgages or deeds of trust, or any party to this suit, or any Committee of Bondholders, or any Board of Reorganization Managers acting for and in behalf of the bondholders or any of them, or any corporation or joint stock company organized by or in the interest of the bondholders or by or in the interest of any of them, may bid and purchase at such sale.
The commissioners shall seasonably file a report of all their actions, in carrying out this decree, in the office of the Clerk of this Court, at gr eensboro, North Carolina, as soon as may be after said sale. Either said commissioners or the successful bidder, or any party to this suit, may make application to the Court for confirmation of the sale, at any time after the expiration of ten days from date of filing of said commissioners' report. During said period of ten days, the Court will receive any bids for the property*1541 so sold, which shall exceed the bid of the successful bidder at such sale by an amount of at least the sum of ten per cent, of the bid of such successful bidder. Any such bid, so made within such ten days, must be addressed to the said commissioners, and filed with the Clerk of this Court, at Greensboro, before the expiration of said ten days, and shall be accompanied by a deposit of One Hundred and Twenty-Five Thousand Dollars ($125,000) in the same form as the deposit hereinafter required from bidders at said sale. If any such bid is so made within said period of ten days, accompanied by such deposit, the Court may refuse to confirm the sale, and may order a resale of said property, in which case said deposit shall be held as a guaranty that at such resale a good bid shall be made of at least the amount so bid within said period of ten days, but in any such case a new offering of the mortgaged property shall be had after due legal notice. After the acceptance of any bid and the confirmation of the sale to a purchaser or purchasers, or their successors or assigns, and after application of any amount deposited at the time of bid, and after making such payment or payments in cash, *1542 on account of the purchase price, as the Court may at the time of the confirmation of such sale, or from time to time thereafter direct, the purchaser or purchasers or their assigns shall pay the entire balance of purchase price so bid, at such time or times and in such manner as the Court shall direct, but no such payment shall be required to be made until ten days after the confirmation of sale.
The purchaser or purchasers, or their successors or assigns, may satisfy and make good the balance of the purchase price above the amount required to be paid in cash by the terms of this decree, or by any decree or order of this Court hereafter entered, in accordance with the provisions of this decree, by delivering to said Commissioners receivers' certificates heretofore authorized by this Court, and any of the bonds duly certified and issued under the terms of said mortgages or deeds of trust, dated April 1, 1911, and March 24, 1913, and any coupons thereto appertaining, which bonds and coupons may be entitled to participate in the proceeds of such sale in the proportions and with the priorities hereinafter defined and decreed. All bonds so delivered shall, if registered, be *379 *1543 duly assigned and endorsed by the registered holders thereof and shall be accompanied by all unpaid coupons thereto respectively appertaining; such receivers' certificates, bonds and coupons, whether delivered to said Commissioners at the time of sale or subsequently, to be received at such prices or value as shall be equivalent to the sum which would be payable out of the net proceeds of such sale if made for money, to the holder or holders thereof, for his or their just share and proportion of the net proceeds and upon a due accounting and apportionment of said proceeds.
If there shall be received from the sale of said property a net amount applicable to the payment of said coupons and bonds, sufficient to pay the entire amount due upon said coupons and bonds, for principal and interest, then and in that event the said coupons and bonds shall be cancelled and retained by the Commissioners, or cancelled and delivered by them to the complainants, as trustees under the mortgages or deeds of trust securing said bonds. If the entire amount necessary to pay all sums due upon said coupons and bonds in full is not realized upon a sale and applied upon the purchase price, then and in such*1544 case the said commissioners shall stamp or write upon each bond the amount which is so applied, and shall so return said bonds to the purchaser or purchasers from whom the same were received.
The said Commissioners shall, before accepting any bid, require the bidder to make a cash deposit of one hundred and twenty-five thousand dollars ($125,000), as a pledge that he will make good his bid, in case of its acceptance. In lieu of such cash deposit, such Commissioners may accept a check drawn to their order, as Commissioners, upon a National Bank, in good standing, and having a capital of at least one hundred thousand dollars ($100,000), and deposit has been made of a portion of the purchase price shall not be confirmed deposit has been made of a portion of the purchase price shall not be confirmed by the Court, such deposit of a portion of the purchase price shall be returned to the bidder, and the deposit of any unsuccessful bidder shall be returned to him when a bid other than that made by him shall be accepted. In case any successful bidder or purchaser shall fail to make good his bid, after confirmation by the Court of the sale to him by making the additional necessary payments*1545 in consummation of his purchase, then the sums paid and deposited by such bidder or purchaser shall be held by the Commissioners and applied towards the payment of the expenses of resale, including the disbursements thereof, and towards making good any deficiency or loss, in case the property shall be sold at a less price upon such resale, and for any other purpose which the Court may direct.
At the sale held on September 23, 1918, the highest bidder was the petitioner, which bid $1,000,000 for the property. Subsequently, but within ten days of the date of the sale, the Champion Fibre Company, on Ohio corporation, and in compliance with the requirements of the decree of foreclosure, offered the sum of $1,100,000 for the property, such amount (exclusive of the cash deposit of $125,000) to be paid over a period of ten years. On October 15, 1918, the court entered a decree in which the offer of the Champion Fibre Company was rejected and gave the following reasons for such action:
It appearing to the Court from the written bid of said Champion Fibre Company that while it engages and appropriately obligates itself upon a resale of *380 said property to bid therefor the sum*1546 of $1,100,000, it does not bid or engage or bind itself to pay said purchase price in cash, but only to pay in cash in event it should become purchaser, its aforesaid deposit of $125,000 and to pay the balance of the purchase price, to wit, $975,000 in equal annual installments of $100,000 at one, two, three, four, five, six, seven, eight, and nine years from the date of confirmation and the last installment of $75,000 ten years from date of confirmation, with interest thereon from said date of confirmation until delivery, paid at the rate of six per cent per annum semi-annually, and to be secured by a first and paramount lieu upon said property, assets and effects; and,
It appearing to the Court that the prolonged extension of time involved in and stipulated for in the bid of said The Champion Fibre Company for the payment of the balance of the purchase money, notwithstanding the increased amount of the bid over that of the Suncrest Lumber Company, would not only not benefit the outstanding bondholders of the Champion Lumber Company in whose behalf and for whose protection this suit was primarily instituted and who, upon a foreclosure, are entitled to their ratable participation*1547 in the proceeds of a sale in cash, but would, in fact, as affording them no additional margin of security beyond the $125,000 deposit, tend to defeat the primary object of this suit; * * *
At the same time the bid of the petitioner was confirmed. In December, 1918, pursuant to the court decrees in the foreclosure proceedings and the sale made thereunder, the property of the Champion Lumber Company was conveyed to the petitioner. A report of the Commissioners who conducted the aforementioned sale showed that on December 16, 1918, of the outstanding bonds of the Champion Lumber Company of the face value of $2,755,000, the petitioner had deposited with them bonds of a face value of $2,625,000, thus leaving nondepositing bondholders to the extent of $130,000. The report provided that $45,028.10 be set aside out of the cash deposit of $125,000 made by the petitioner as the pro rata portion of the purchase price which was to be paid on account of principal and interest on the bonds of the nondepositing bondholders. Certain pertinent parts of the report follow:
| Principal of all bonds outstanding as per report of Phil C. Cocke, Special Master | $2,755,000. |
| Principal of bonds filed with Commissioners by Suncrest Lumber Company | 2,625,000. |
| Principal of non-deposited bonds | 130,000. |
| Total purchase price | 1, 00,000. |
| Amount paid on purchase price in cash | 125,000. |
| Amount of balance of purchase price paid in bonds and coupons | 875,000. |
| Amount distributable by Commissioners on 2625 bonds of the par value of $1000 each and deposited with them by the purchaser | 909,221.25 |
| Amount necessary to pay balance of purchase price | 875,000.00 |
| Amount distributable to purchaser on bonds deposited in excess of the balance due on purchase price | 34,221.25 |
| Amount of interest and principal distributable to non-deposited bonds of the face value of $130,000, or the equivalent of $130,000 bonds of denomination of $1000 cach at the rate of $346.37 of interest and principal per bond | $45,028.10 |
| CASH AVAILABLE TO PAY ALL COSTS, ALLOWANCES, ETC., AND NON-DEPOSITINGBONDHOLDERS. | ||
| Cash deposit on bid | $125,000.00 | |
| Cash in hands of The Provident Life and Trust Company of Philadelphia | 21,581.25 | |
| Total available cash | 146,581.25 | |
| Allowances, costs, etc., as per exhibits above | 67,316.37 | |
| Necessary cash to pay off non-depositing bondholders | 45,028.10 | |
| 112,344.47 | ||
| Balance of cash returnable to Suncrest Lumber Company, Purchaser | 34,236.78 |
*381 Your Commissioners would further report that Suncrest Lumber Company has on its part complied with the terms of the decree of foreclosure and of the decree of confirmation entered in this cause on August 10 and October 14 respectively to the extent that such terms are now ripe for compliance with and to the extent required by the terms of said decree, to entitle it to conveyance of the property sold, and subject to the terms of said decrees, by paying the said required deposit in cash of One Hundred and Twenty Five Thousands ($125,000) Dollars, on September 23, 1918, and by delivering into the hands of your Commissioners "bonds duly certified and issued under the terms of said mortgages or deeds of trust*1549 dated April 1, 1911, and March 24, 1913, and any coupons thereunto appertaining," which bonds and coupons are entitled to participate in the proceeds of such sale in the proportions and with the priorities in said decree of foreclosure specified; and that said bonds and coupons so deposited are more than sufficient to pay off the balance of the purchase price remaining over and above said deposit of One hundred and twenty-five thousand ($125,000) Dollars, when "Received at such prices or value as shall be equivalent to the sum which would be payable out of the net proceeds of such sale if made for money," as is apparent from the detailed exhibit hereinbefore set forth.
Your Commissioners therefore respectfully report that pursuant to section 26 of the decree of foreclosure of August 10, 1918, and sub-division (a) thereof, they have made the detailed disbursements on account of expenses hereinbefore shown, and on account of allowances, fees, etc., as per former orders of the court fixing and allowing same, and have in hand funds adequate in amount to pay non-depositing bondholders, as is hereinbefore shown, and have in hand bonds of Champion Lumber Company adequate in amount on the*1550 basis of distribution hereinbefore shown more than sufficient to pay the balance of the purchase price in full.
* * *
That your Commissioners have in hand for payment of interest and overdue interest, and the payment of principal of $130,000 of bonds which have not been deposited, and the holders and owners of which bonds are unknown to your Commissioners. Your Commissioners therefore ask that they be authorized *382 to pay said amount into the registry of the Court for account of the holders and owners on non-deposited bonds as may hereafter be made to appear.
Your Commissioners would further report that "all claims heretofore duly filed before Phil C. Cocke, Esq., Special Master, and heretofore adjudged entitled to be a lien against the property sold in priority to the lien of the said outstanding bonds, secured by deeds of trust hereinbefore mentioned" were heretofore paid off by the Receivers in this cause, as they have ascertained and verified, and your Commissioners have found no claims of the character mentioned and falling within sub-division (b) of Section 26 of the decree of foreclosure.
They accordingly recommend that they be authorized to execute, acknowledge*1551 and deliver deed to the purchaser, Suncrest Lumber Company, conveying all of the property, assets, rights, franchises, moneys, effects, etc., referred to and described in said decree of foreclosure of August 10, 1918, and being the property offered and sold by your Commissioners on September 23, 1918, and of which Suncrest Lumber Company became the purchaser under its bid and under the decree of confirmation entered in this cause on October 14, 1918, and subject to all of the terms, conditions and provisions of said decree of foreclosure and said decree of confirmation, and to all of the reservations therein and thereby made; and that the Court make an order directing H. A. Cleaver and R. G. Rogers as Receivers, upon exhibition to them of the deed of your Commissioners duly executed, acknowledged and delivered, and with the joinder of Champion Lumber Company, James G. Campbell, Trustee in Bankruptcy of Champion Lumber Company, the Provident Life & Trust Company of Philadelphia, and John Way, Trustees, to turn over and surrender to said Suncrest Lumber Company all of the property, assets, and effects therein described, as of midnight on the 18th day of December, 1918, and that the accounts*1552 of the said Receivers with the said property be terminated as of the same time.
Later, additional bonds of the Champion Lumber Company to the extent of $39,500 were deposited with the said commissioners by the petitioner and proper adjustment was made therefor, as shown by the following paragraph from a supplemental report filed June 6, 1919:
That when the report of your Commissioners of December 16, 1918, was submitted to the Court, counsel for Suncrest Lumber Company were unable to supply your Commissioners with information as to the precise and exact amount, par value, of outstanding bonds owned by Suncrest Lumber Company; and for the purposes of that report, Suncrest Lumber Company was credited simply with the minimum amount of bonds, par value, that would enable it to comply with and perform its bid for the property foreclosed; and as was shown in said report, upon deposit by said Suncrest Lumber Company of bonds, with your Commissioners, of the aggregate par value of two million, six hundred and twenty-five thousand ($2,625,000) dollars, it became entitled, as also shown by said report, to a refund, after paying all allowances and court costs and other expenses, of thirty*1553 four thousand, two hundred thirty six ($34,236.78) dollars and seventy-eight cents, which was paid to it by check of your Commissioners under date of December 19th, 1918. There was also shown in said report, as distributable to nondepositing bondholders, the sum of forty five thousand no hundred and twenty eight ($45,028.10) dollars and ten cents, which your Commissioners, under the decree of December 16th, 1918, were directed to pay into the registry of the Court for the benefit and account of said non-depositing *383 bondholders. This was not done by your Commissioners at the time, however, for the reason that the representative of Suncrest Lumber Company, who delivered into the hands of your Commissioners the physical bonds heretofore mentioned as filed by said Company, expressed the opinion that Suncrest Lumber Company would shortly thereafter file with your commissioners all, or nearly all, of the remaining outstanding and non-deposited bonds; but up to this time it has filed only thirty nine thousand, five hundred ($39,500) Dollars, par value, in addition to those with which it was credited as having filed, in the report of December 16th, 1918; but has requested your*1554 Commissioners to pay to it the ratable participation of said bonds, on the basis of the report of December 16th, 1918, amounting in the aggregate to thirteen thousand, six hundred and eighty one ($13,681.61) dollars and sixty one cents; and your Commissioners would respectfully recommend that they be authorized so to do.
The plan of "reorganization" of the board of reorganization managers contemplated that the petitioner, in case it was the successful bidder at the sale under the foreclosure proceedings, would issue bonds, exchange these bonds for old bonds of the Champion Lumber Company, and apply these old bonds so acquired in satisfaction of the bid price for the property other than the part which would be satisfied through the payments to minority bondholders. By September 21, 1918, there had been deposited with the board bonds of the Champion Lumber Company of the face value of $2,613,000 and on the same day the board indicated its willingness to transfer the said old bonds to the petitioner on the condition that they be used in the manner indicated above. On the same day the petitioner was authorized to issue bonds in furtherance of the above purposes, and on or about October 1, 1918, such*1555 bonds were issued. In the meantime, as shown above, the petitioner's bid for the property had been accepted and by the time final settlement came to be made for the property old bonds had been deposited with the board of reorganization managers in the face amount of $2,664,500. These bonds were turned over to the petitioner in exchange for its bonds, Series B-II (hereinafter described), the exchange being made on a par-for-par basis, and these old bonds of the Champion Lumber Company were applied by the petitioner in the satisfaction of the purchase price in the manner indicated in the court proceedings heretofore quoted. The bonds of the petitioner which were issued in exchange for the bonds of the Champion Lumber Company were in turn delivered to the individuals who formerly held bonds of the Champion Lumber Company.
Among the authorizations provided by petitioner's charter was the following:
To acquire the bonds, notes, certificates of indebtedness, due bills and other evidences of debt of any corporation and particularly of Champion Lumber Company and to sell or to pledge, or to collect and compose, or otherwise to dispose of the same.
*384 The authorization of*1556 the petitioner on September 21, 1918, for the issuance of bonds heretofore referred to, provided not only for bonds of Series B-II which were used in effecting the purchase of the property in question, but also for two other classes of bonds, namely, Series A and B-I.
Series A bonds consisted of an issue of 500 bonds of a face value of $1,000 each, that is, a principal sum of $500,000. They bore interest at the rate of 6 per cent and had precedence over bonds of Series B, both as to appropriation of sinking fund for redemption and as a lien upon the property mortgaged. These bonds were not sold to the public, but were used as collateral for loans. None of them were outstanding during the years here in question (1921, 1922, 1923, and 1924).
Bonds of Series B-I consisted of an issue of 100 bonds of a face value of $1,000 each, that is, a principal sum of $100,000, and they bore an interest rate of 6 per cent. These bonds were issued on March 31, 1919, and retired in September, 1919. They had precedence over bonds of Series B-II.
Bonds of Series B-II consisted of an issue of a face value of $2,755,000, of which but $2,695,500 was actually issued. Upon the payment of the*1557 other two issues mentioned above these bonds became first mortgage bonds. The trust indenture under which all of the bonds were issued provided, inter alia, as follows:
The obligation to pay interest semiannually upon bonds of Series A and of Series B Class I is absolute and unqualified. But interest at the rate of six per centum per annum shall be paid semiannually upon bonds of Series B Class II, only in the event that the net income of the Company shall thereunto suffice after all fixed charges and operating expenses have been paid and after such allowances have been deducted for depreciation of its buildings and machinery and also for the depreciation (if any) of the personal property hereby mortgaged or intended so to be. And the coupons attached to the said bonds of Series B Class II, as they are issued this first day of March, 1918, shall not be construed to be a promise to pay interest except upon the conditions hereinafter imposed, but are attached to and delivered with said bonds to serve as convenient receipts for such installments of interest as may from time to time be payable thereon as hereinafter provided.
At least twice each year (once in the first*1558 half of its fiscal year and once in the second half) the Board of Directors shall meet and shall by resolution specifically set apart from net income as hereinbefore described such sums as may be spared therefrom to pay interest upon bonds of Series B Class II, or, if none can be spared, the board shall specifically find that the net earnings do not justify the appropriation of any moneys to such interest payment.
If the sum so set apart shall be sufficient to pay a semiannual installment of interest at the rate of six per cent. per annum, it shall be so applied by the Board of Directors and the Trustees so notified, and the semiannual coupon next thereafter accruing shall be paid, detached and canceled. If the sum set apart in any six months' period is less than the amount of any semiannual *385 interest charge upon the bonds of Series B Class II such sum shall be passed to a separate account and shall be carried forward and added to the amount set apart in the next six months' period; and when the aggregate of the moneys so specifically appropriated to pay the interest of bonds of Series B Class II shall suffice to pay a semiannual installment of interest upon all the*1559 bonds of Series B Class II then outstanding, the coupon by its terms next maturing shall be paid in due course, and if the moneys so set apart thereunto suffice, two or more consecutive coupons, the last of which matures on the date of the payment, may be paid at the same time. But any coupon which shall not be paid in its order shall thereupon become null and void and shall not constitute an obligation of the Company. It is made a covenant between the Company and each original holder and each person who becomes a subsequent holder of any bond or bonds of Series B Class II that the obligation to pay interest is a current obligation to pay interest out of current net earnings, and that if the net earnings as they accrue do not suffice to pay interest as it accrues the obligation to pay interest lapses. The Company shall give notice by publication at least once in a newspaper of general circulation published in the City of Chicago of its intention to pay, on presentation, the specified interest coupon or coupons.
The discretion to determine what are net earnings and to fix the amount thereof is unreviewable and is hereby lodged in the Board of Directors of the Company. The subsequent*1560 provisions of this mortgage giving the bondholders divers privileges in case of the default of the Company in payment of interest shall be apply to any bonds of Series B class II until the Board of Directors in the manner hereinbefore provided has specifically appropriated moneys out of net income to the payment of such interest.
No interest was ever paid on the bonds of Series B-II, but on each semiannual interest date a resolution was adopted by the petitioner's board of directors to the effect that in their opinion no income was available from the operations of the preceding six months from which interest could be paid and therefore the interest coupons for such period should be declared null and void. The resolution on account of the period from April 1, 1921, to October 1, 1921, which is similar to those adopted on other occasions, follows:
WHEREAS, we, the undersigned, constituting all or a majority of the Board of Directors of the Suncrest Lumber Company, having examined the monthly profit and loss statements of the company for the first eight months of the year 1921 and finding that the operations for that period, after charging depreciation and full depletion, show a*1561 deficit of $52,577.48, and in view of such deficit no net earnings can be realized by the company for the six months period from April 1, to October 1, 1921, and having in view the necessity of ample reserve for operations, finds that the application of any money to the payment of interest on October 1, 1921, upon bonds of Series B, Class II, is not justified.
THEREFORE BE IT RESOLVED: That the interest coupon voucher for interest on that date be declared null and void.
Upon request of the Union Trust Company, Trustees, the Secretary of our company is hereby authorized and directed to send by mail on or about September 24, 1921, to each bondholder of whom he may record a printed letter reading as follows:
*386 Your Board of Directors respectfully report that we have examined the profit and loss statements taken from the Company's books of account to August 31, 1921, and find that no net earnings will be realized for the six months from April 1 to October 1, 1921, in view of which, as well as the necessity for ample reserve for operations, the application of any money to the payment of interest on October 1, 1921, upon bonds of Series B, Class II, will not be justified, *1562 and the coupon voucher for interest on that date has therefore been declared null and void.
In order to provide for the payment of the principal of the aforementioned bonds at or in advance of their maturity, provision was made for the creation of a sinking fund through the payment to a trustee of certain amounts as the timber on the petitioner's properties was cut. The indenture contained the following provision with respect to the administration of the sinking fund:
Sinking fund, as and when paid to Union Trust Company, one of the Trustees, shall be administered as follows: It shall be used only to pay principal of the bonds hereby authorized, and the Company out of its other resources shall make adequate provision for the payment of interest; it shall be applied as rapidly and economically as possible to the payment by lot of bonds of Series A; when all the bonds of Series A have been paid it shall be applied to the payment in their numerical order of bonds of Series B, Class I; when all the bonds of Series B, Class I, bonds have been paid, one-half of such sinking fund shall be applied ratably in installments of not less than five per centum of the stipulated face thereof*1563 to the payment of bonds of Series B, Class II; and the other half shall be used by the Trustee in the purchase in the open market of bonds of Series B, Class II, at the lowest price at which, after public notice, they may be offered.
As a result of the operation of the foregoing sinking fund, bonds were purchased in the open market and retired and profit reported therefrom in petitioner's returns as follows:
| Year | Par value at time of purchase | Purchase price | Profit reported in tax returns |
| 1922 | $316,725.00 | $129,678.75 | $187,046.25 |
| 1923 | 84,530.00 | 50,172.70 | 34,357.30 |
| 1924 | 74,855.00 | 49,558.47 | 25,296.53 |
When the properties of the Champion Lumber Company were transferred to the petitioner, the latter set up the depreciable and depletable assets on its books and claimed depreciation and depletion thereon on the basis of cost to the Champion Lumber Company. Depreciation was computed by the Commissioner and allowed in his deficiency notice at the rate of 10 per cent on costs as shown below for the following depreciable assets:
| 1921 | 1922 | 1923 | 1924 | |
| Railroad equipment | $192,311.33 | $199,314.04 | $210,915.41 | $213,634.84 |
| Woods equipment | 109,686.23 | 109,134.03 | 109,063.53 | 109,329.38 |
| Sawmill and equipment | 232,604.54 | 233,641.16 | 234,332.37 | 236,104.57 |
| Planing mill | 46,581.19 | 45,788.94 | 45,138.94 | 45,238.94 |
| Machine shop | 15,250.08 | 15,250.08 | 15,250.08 | 15,250.08 |
| Fire and electric equipment | 6,704.76 | 6,704.76 | 6,704.76 | 6,704.76 |
| Furniture and fixtures | 6,771.28 | 6,813.78 | 6,978.78 | 6,923.78 |
| Yard 6 storage tracks | 6,651.63 | 6,651.63 | 6,651.63 | 6,651.63 |
| Heating plant | 879.25 | 879.25 | 879.25 | 879.25 |
| Building and equipment | 86,003.11 | 95,262.83 | 95,170.21 | 96,519.16 |
| Plant and equipment No. 2 | 46,359.36 | 45,999.10 | 55,006.46 | 73,549.76 |
| Crestmont property | 11,121.58 | |||
| Total | 749,802.76 | 765,439.60 | 786,091.44 | 821,907.73 |
*1564 *387 The total depreciation allowed by the Commissioner, claimed by the petitioner, and disallowed by the Commissioner is shown by the following schedule:
| Item | 1921 | 1922 | 1923 | 1924 |
| Allowed by the Commissioner | $75,762.13 | $77,571.54 | $80,816.51 | $81,569.90 |
| Claimed by the petitioner | 114,815.93 | 116,342.42 | 122,378.25 | 122,615.22 |
| Disallowed by the Commissioner | 39,053.80 | 38,770.88 | 41,561.74 | 41,045.32 |
The foregoing differences (aside from certain cost adjustments not questioned by the petitioner) arise from the fact that the petitioner used a rate of 15 per cent as compared with that of 10 per cent used by the Commissioner. The plant and equipment in question had been in operation for some years prior to the time it was taken over by the petitioner on December 20, 1918, and was operated, during the years here under consideration, on what is referred to as the Sunburst tract. The operations by the petitioner on this tract continued for a period of seven years, namely, from the time it was acquired as heretofore indicated until December, 1925. At or about that time the petitioner made an exchange of land and timber with the Whitmer Parsons*1565 Pulp and Lumber Company through which the petitioner secured a location for its plant at Waynesville, North Carolina. By this means a tract of timber, known as the Cataloochee tract, which was not accessible for operation at the Sunburst operation with the type of equipment then being used, now became accessible for manufacture at Waynesville. The value of the machinery which was moved from the Sunburst operation to Waynesville for use in the Cataloochee operation was approximately $200,000.
The Sunburst tract and the Cataloochee tract each contained approximately 35,000 acres. Shortly after the acquisition of the *388 properties in question by the petitioner a cruise was made of the timber, from which the following approximate estimates were determined:
| Species | Sunburst | Cataloochee |
| Feet | Feet | |
| Spruce | 150,000,000 | 60,000,000 |
| Hemlock | 30,000,000 | 110,000,000 |
| Hardwood | 20,000,000 | 130,000,000 |
| Total | 200,000,000 | 300,000,000 |
In addition, it was estimated that certain other parts of the Sunburst burst tract which were not available for logging at the Suncrest operation contained the following footage of timber:
| Feet | |
| Spruce | 3,000,000 |
| Hemlock | 13,000,000 |
| Hardwood | 34,000,000 |
| 50,000,000 |
*1566 It was also estimated that there would originate at the mill and come out of the forest approximately 830,000 cords of by-products from the above tracts.
From 1920 to 1924, inclusive, the following timber was cut from the Sunburst tract:
| Year | Spruce | Hemlock | Hardwood | Total | Cord wood |
| Feet | Feet | Feet | Feet | Cords | |
| 1920 | 16,856,628 | 341,867 | 67,917 | 17,266,412 | 6,604.88 |
| 1921 | 27,020,014 | 805,255 | 203,026 | 28,028,295 | 5,991.28 |
| 1922 | 22,350,964 | 899,544 | 3,514,354 | 26,764,862 | 9,200.48 |
| 1923 | 22,397,610 | 2,754,796 | 6,325,387 | 31,477,793 | 10,434.77 |
| 1924 | 27,414,466 | 2,445,988 | 4,336,900 | 34,197,354 | 7,760.07 |
| Total | 116,039,682 | 7,247,450 | 14,447,584 | 137,734,716 | 39,991.48 |
The total depletion claimed by the petitioner and allowed by the Commissioner is shown by the following schedule:
| Year | Depletion claimed | Depletion allowed | Depletion disallowed |
| 1921 | $257,512.78 | $101,094.67 | $156,418.11 |
| 1922 | 271,637.47 | 98,277.26 | 173,360.21 |
| 1923 | 261,443.48 | 115,389,66 | 146,053.82 |
| 1924 | 327,269,29 | 123,570.78 | 203,398.51 |
OPINION.
SEAWELL: The first issues presented in this proceeding relate to the depreciation*1567 and depletion allowable as a deduction from gross *389 income in each of the years here involved, the contention of the petitioner being that the deductions allowed on that account in the deficiency notice are inadequate, and that of the Commissioner being that such allowances are excessive. A consideration of the contention advanced by the Commissioner will show the several questions which are here to be disposed of.
As shown from our findings, the petitioner acquired certain properties from the Champion Lumber Company through foreclosure proceedings which were instituted by the bondholders of the Champion Lumber Company. The bid price by the petitioner at such sale held on September 23, 1918, was $1,000,000 and it is the Commissioner's contention that this bid price represents cost of the properties to the petitioner and would accordingly provide the starting point or base for the computation of depreciation and depletion allowances for subsequent years. Some of the argument advanced was to show that the transaction through which the properties were acquired constituted a purchase and not a reorganization, and with this position we are in accord. Whether the bondholders*1568 in the Champion Lumber Company were also its stockholders and in the same proportion does not definitely appear, though it does appear that only the bondholders as such as distinguished from the stockholders participated in the acquisition of the properties. That is, the bondholders took the various steps incident to their protection, which included the organization of the petitioner for the purpose of having the properties acquired by it, and the stockholders as such were entirely eliminated. There thus came into ownership of the properties not only a new corporation, but also new interests in such corporation which were essentially different from those in the old corporation. Under such circumstances, we have no hesitancy in saying that cost of such properties to the petitioner when acquired through the foreclosure sale in 1918 rather than cost to the Champion Lumber Company must be our starting point in the determination of a depreciation and depletion allowance as well as for invested capital purposes. Cf. .
A question presenting more difficulties, however, is to determine what was cost to the petitioner to be used as*1569 the basis for its future depreciation and depletion. In the first place, is such cost fixed, as the Commissioner contends, by the bid price at the foreclosure sale of $1,000,000? We think not. In short, what occurred was that the Champion Lumber Company became financially involved, and on the petition of certain of its creditors (other than its bondholders) it was declared a bankrupt on September 11, 1916. At or about that time the bondholders became active in an effort to protect their interests as represented by bonds then outstanding of a face value of some $2,755,000. A bondholders' protective committee *390 was first organized, which was later succeeded by a board of reorganization managers, and through these organizations the petitioner was formed for the purpose of taking over the property of the Champion Lumber Company, should it be acquired at a foreclosure sale. In the meantime, there was a default on the bonds and the foreclosure proceedings were instituted. In due course the property was ordered sold and the petitioner, in conjunction with the board of reorganization managers, was authorized to bid $250,000, or, in its discretion, $1,000,000, for the property. *1570 Further, the charter of the petitioner contemplated the acquisition by it of the bonds of the Champion Lumber Company. In order to raise the cash deposit of $125,000 required to qualify the petitioner as a bidder at the sale, the board of reorganization managers gave a collateral note secured by bonds of the Champion Lumber Company. At the sale the highest bid and the only bid (in so far as appears from the record) was that of $1,000,000 by the petitioner. No part of the bid price in excess of the cash deposit was paid in cash, and even the part of the cash deposit which was not required to pay court and foreclosure costs and satisfy the small minority which did not join in the acquisition of the property was turned over to the petitioner. The remainder of the purchase price was satisfied by the petitioner through the issuance of its bonds for bonds of the same face value held by the bondholders of the Champion Lumber Company and the delivery of these old bonds to the court. In other words, the bid price of $1,000,000 was not satisfied through the payment of that amount, but in another manner as indicated above. We must look to what was done rather than to what might have been*1571 done in order to find the correct solution to the problem, and when that is done, the answer is evident that $1,000,000 may not be considered as the conclusive measure of cost.
In reaching the conclusion that the bid price of $1,000,000 may not be considered as the measure of the cost to petitioner, we are not overlooking the fact that within ten days after the sale a bid of $1,100,000 was submitted, but aside from the fact that such bid was rejected by the court and that we are not advised as to any relationship which may have existed between the bidder (Champion Fibre Comapny) and the Champion Lumber Company, the bid was not one which, if considered better than that of the petitioner, would have meant that such bidder thereby became the purchaser, but rather that the property would again be offered for sale. Under such conditions the bondholders would still have been able to take further steps for the protection of their interests by bidding, if they desired, at the subsequent sale. Besides, as indicated by the court in rejecting the higher bid, such bid gave to the bondholders no *391 additional margin of security beyond the $125,000 deposit, and therefore its acceptance*1572 would have tended to defeat the primary object of the foreclosure proceedings. Nor have we disregarded the fact that all bondholders did not join in the purchase through foreclosure proceedings, but a small number elected to take their pro rata payments in cash. However, when we consider the small minority, which apparently was made up of a considerable number of small bondholders in various parts of the country, we do not think this material.
We are also of the opinion that this case is easily distinguishable from that of ; affd., ; certiorari denied, on which much reliance is place by the Commissioner in substantiation of his contention that the bid of $1,000,000 is conclusive as to cost to petitioner. That case involved a situation where in 1915, after a corporation was adjudged a bankrupt, its property was sold at public action and bid in by a new corporation which had been formed. The money which was used by the new corporation in paying the purchase price was advanced by three stockholders of the old corporation, who had held 63 per cent of the stock of such*1573 old corporation. In consideration for such advancement, the three old stockholders had issued to them the entire capital stock of the new corporation, In 1917 these same stockholders sold their stock, and the question presented was the basis to be used in determining the gain to them on account of the sale in 1917, the contention of the stockholders being that the gain would be represented by the difference between the March 1, 1913, value of the stock in the old corporation and the selling price of the stock of the new corporation in 1917, whereas, the Government contended that the cost of the stock sold in 1917 was the amount paid by the new corporation for the assets at the receiver's sale in 1915. The court rejected the contention of the stockholders, held that there was no reorganization through the receiver's sale and acquisition of the stock by the new corporation, and entered judgment for the Government, concluding its opinion with the following summary of its view of the situation:
That the company was adjudged a bankrupt in 1915 and all stockholders lost their investment and the stock was rendered valueless; that the new corporation directly became the purchaser of*1574 all the assets of the old corporation, including the leasehold; that plaintiffs financed the transaction with their private funds; that the new corporation issued its entire capital stock to the plaintiffs for the amount advanced by them in financing the transaction; that this amount was the cost of the stock to them; that subsequently the stock sold at an undisputed figure upon which they have paid an income tax.
It is a hard case because plaintiffs lost a large amount of money in the Black Diamond Coal Company and were unable under the law to deduct that *392 loss from the profit made by them in the sale of the stock in the new corporation in 1917, just two years later. If the entire transaction cannot, under the authorities, he held a reorganization, there is no relief to be had.
The court further said that the old stock was worthless in 1915 and that a complete loss resulted to the old stockholders at that time. On appeal the judgment was affirmed in part, on the ground that the question was improperly presented for review, but in rendering its opinion the court said:
* * * A judgment for defendant upon facts found can be erroneous only when judgment for plaintiff*1575 is imperative. Identity and continuity of investment, before and after, are not here found as ultimate facts; the form of the transaction contradicts such continuity; and in view of the presumption that the Commissioner's computations of cost and value are correct, we cannot say that there was such a clear mistake as compels a court to overrule him.
We are not here concerned with a receiver's sale where the entire investment of the party (or those whom it represented) who bid in the property had become valueless, but rather a sale under foreclosure proceedings where the party (or those whom it represented) had not lost its entire investment and where the sale was being conducted for its benefit and the remaining value of its interest in the property was in a very substantial amount. In fact, in the Petree case the entire bid price was satisfied through new money advanced for that purpose by the party (or its representatives) who had lost its original investment, whereas, in the instant case the acquisition of the property was accomplished without the advancement of additional money other than for court and foreclosure costs and a small amount paid to minority bondholders. *1576 On the whole, we are convinced that the Petree case can not be considered controlling in the case at bar.
When we look to what here occurred we find that the petitioner first acquired substantially all of the bonds of the Champion Lumber Company ($2,664,500 of bonds outstanding in the amount of $2,755,000) through the issuance of its bonds therefor. After the petitioner had secured the aforementioned old bonds, these old bonds (together with the small amount of cash paid to minority bondholders) were used in satisfaction of the bid price and the property of the Champion Lumber Company was conveyed to petitioner. In other words, there was an exchange of property for property, namely, bonds of the Champion Lumber Company for the assets of the Champion Lumber Company, and gain or loss to petitioner on such transaction would be computed as the difference between the cost of the old bonds (plus the small amount of cash paid) and the fair market value of the property received in exchange (section 202 of the Revenue Act of 1918), and the starting point or cost to petitioner *393 on account of the property so acquired was its fair market value at the time of its receipt.
*1577 Both the petitioner and the Commissioner introduced evidence for the purpose of showing the value of the properties in question. The greater part of the evidence on the part of the petitioner was on account of a valuation of the depletable properties and to that end its general manager, who had been with petitioner since 1919, testified in detail as to such valuation, using as a basis a cruise made by him of the properties in 1919 or 1920. Based upon the number of feet which he considered then available and a market value per thousand feet, he gave as his opinion that the depletable properties had a value at the date of acquisition of $4,272,017. He was further of the opinion that the depreciable properties had a value at the same time of some $700,000, thus making a total valuation for both classes of property of approximately $5,000,000. We have further the testimony of two witnesses for the Commissioner, one of whom testified to a fair market value of the timber properties in 1918 of $1,372,000, and the other, of $1,600,000. The book value as shown in petitioner's capital stock return for the year ended December 31, 1919, was approximately $3,900,000, but it was stated in*1578 such return that "These values were inflated beyond all reason [in setting them up on the books of the petitioner] and in making the tax return were cut down to a fair value." The fair value as stated in such return was approximately $1,800,000. While we do not know the exact cost used in determining the depletion allowance as shown in the deficiency notice, it is stated in the Commissioner's brief that the cost allocated to depletable properties was $1,900,000, and from other evidence in the case as to timber cut, amount of depletion allowed and the agreement of the parties as to the rate used by the Commissioner, we are convinced that the allowance has been made approximately on the foregoing basis. The cost of depreciable property as used in the deficiency notice for 1921 in determining the depreciation allowance was approximately $750,000, thus making total costs for depletable and depreciable properties of approximately $2,650,000. We have carefully considered all evidence introduced, including not only the expert testimony and documentary evidence referred to above, but also the facts relating to the sale and the expenditures made in connection therewith, and we have reached*1579 the conclusion that the costs as used by the Commissioner are fair and reasonable and they are accordingly sustained.
We do not understand that there is any material disagreement between the parties as to the quantities of timber to be used in computing the depletion allowance, the issue being as to the cost of such *394 property, which has been determined as shown above, and since the depletion allowance as fixed by the Commissioner appears reasonable on the basis of the costs herein determined, the amounts as allowed by the Commissioner are approved. A further question is raised as to depreciation allowance, wherein the petitioner contends that the Commissioner based his allowance on a useful life of the sawmill plant and equipment of 10 years, instead of upon the time required to take the timber from the Sunburst tract. However, the rate claimed by the petitioner takes no account of a residual or further useful value for the property at the termination of the Sunburst operation, which was shown at approximately $200,000. The petitioner's position is that such further useful value should be disregarded in this case, because it was not known until 1925 that a location*1580 could be secured at Waynesville, to which this plant could be moved for operation on the Cataloochee tract. The last named tract was owned from the beginning of the operation at Sunburst and it seems only reasonable to think that consideration would be given to some use of such of the Sunburst equipment as could ordinarily be used in the manufacture of lumber on the Cataloochee tract, which was of about the same size. At any rate, when we consider the evidence offered as to the value of the depreciable assets (the highest value being approximately $700,000 and one value being as low as $300,000) and the fact that the Commissioner allowed depreciation on the basis of a cost of approximately $750,000 at the rate of 10 per cent, without regard to any residual value, we are of the opinion that the allowance as made is ample to care for all depreciation sustained and it is accordingly affirmed.
The foregoing discussion also disposes of the issue with respect to invested capital, since under the determination as made by the Commissioner invested capital would become a factor only in the event that income is increased materially through the disallowance of depreciation and depletion*1581 by the use of $1,000,000 (or approximately that amount) as a cost basis for such allowance and also the use of the same amount as the starting point for invested capital purposes, but since we have rejected the bid price at the foreclosure sale of $1,000.000 as fixing cost to petitioner, we are satisfied that no finding is necessary with respect to invested capital.
The next issue arises on account of the purchase by the petitioner of its own bonds at less than their face value and the retirement of the same. The difference between the price at which purchased and retired and their face value was reported by petitioner as taxable income, but it is now contended that such amount should not have been so reported and should have been excluded by the Commissioner in his determination. Since the hearing was had in this proceeding, *395 the Supreme Court decided the case of , in which it was held that where a corporation purchases and retires its own bonds at a price less than the issuing price (which was face value), the excess of such issuing price over the purchase price constitutes taxable income. See also*1582 . The bonds here in question were issued at their face value for the bonds of the Champion Lumber Company, and no contention is made nor was evidence produced by the petitioner to the effect that the petitioner did not receive the full face value for its bonds when issued. In fact, the evidence produced by the petitioner was for the purpose of showing that the assets securing the bonds of the Champion Lumber Company and a value much greater than such bonds, and we have found a value for those assets approximately equal to the par value of the bonds. In view of the foregoing, we are of the opinion that the action of the Commissioner in approving the inclusion by the petitioner in taxable income of the difference between the face value of its bonds and the smaller amount at which they were purchased and retired should be sustained.
The final issue presented is the contention of the petitioner that, if it is determined that it otherwise realized taxable income for the years here under consideration, such income should be reduced by allowing a deduction on account of accrued interest on Class B-II bonds. We can*1583 see no merit to this position. The pertinent features of the trust indenture with respect to the payment of interest on these bonds are set forth in our findings and show clearly, in our opinion, that these bonds are income bonds upon which no interest liability attaches until the board of directors meet and "by resolution specifically set apart from net income as hereinbefore described such sums as may be spared therefrom to pay interest upon bonds of Series B Class II, or if none can be spared the Board shall specifically find that the net earnings do not justify the appropriation of any moneys to such interest payment" and "any [interest] coupon which shall not be paid in its order shall thereupon become null and void and shall not constitute an obligation of the company." The indenture further provided that "The discretion to determine what are net earnings and to fix the amount thereof is unreviewable and is hereby lodged in the Board of Directors of the Company." Not only was interest neither accrued on its books nor paid on any of the bonds during the years under consideration, but, also, at each semiannual interest date the board of directors determined that no earnings*1584 were available for such purposes and declared that the interest coupons due on such dates should be considered null and void. In view of the foregoing, we fail to see how at this time it could be said *396 that liability for interest attaches on account of coupons heretofore declared null and void by the parties who acted with unreviewable discretion in regard thereto, even though it should now be determined by the Commissioner and this Board that the petitioner is taxable on income in excess of that previously determined by the petitioner's board of directors.
Reviewed by the Board.
Judgment will be entered for the respondent in the amounts shown in the deficiency notice.
Smith concurs in the result.