*72 Decision will be entered under Rule 50.
1. The petitioner was involved in a 77-B reorganization in the United States District Court for the Eastern District of New York for the period 1936 to 1945. In 1950 the judge of that court, who had presided over the reorganization proceeding, delivered to petitioner's attorney a letter addressed to the Commissioner of Internal Revenue stating that in 1940 and 1941 petitioner was in an "unsound financial condition." The letter was mailed to the Commissioner by one of its officers 3 days before the hearing in this proceeding. Held, that such letter was not a certification to the Commissioner by a "Federal agency authorized to exercise regulatory power over such corporation [petitioner]" that petitioner was in an unsound financial condition in 1941, such as contemplated by sec. 22 (b) (9), I. R. C. (amended by the Revenue Act of 1942).
2. Held, further, following our prior decision in a proceeding brought by petitioner for the year 1940 (7 T.C. 793">7 T. C. 793), that petitioner was not in an unsound financial condition in 1941, and therefore realized taxable gain on the purchase of its own bonds in that year at less*73 than issue value.
3. Held, further, following 7 T. C. 793, that certain additions which petitioner made in 1941 to a reserve for reorganization expenses are not deductible as business expenses of that year.
*485 This proceeding involves a deficiency of $ 17,198.40 in income tax for 1941. Some of the issues raised by the pleadings have been either withdrawn or canceled or otherwise settled by agreement of the parties. The concessions made by the respondent are said to eliminate all but an insignificant portion of the deficiency. The petitioner contends, however, that it has overpaid its taxes for 1941 by the amount of $ 29,682.77 which it is entitled to have refunded.
The issues remaining for our determination are as follows:
*486 1. Did the petitioner realize taxable gain in 1941 of $ 158,706.55 on the purchase of its own bonds at less than par value?
2. Is petitioner entitled to a deduction of $ 26,426.13, representing charges made to a "Reserve for Reorganization Expenses" in connection with its 77-B reorganization?
3. Is petitioner entitled to an interest deduction of $ 132,613.67 in connection with the payment to its trustee, in satisfaction of deferred sinking fund installments, of bonds which it purchased from its bondholders at a discount?
4. *75 Is petitioner entitled to an increase in its net operating loss carry-over from 1939 and 1940 over the amounts determined by this Court in an earlier proceeding involving the taxable year 1940?
5. Is our prior determination res judicata as to the specific issues in this proceeding?
FINDINGS OF FACT.
Most of the facts are contained in a written stipulation of facts reading in material part as follows:
2. In 1941 petitioner had its principal office in New York City and filed its income tax, declared value excess profits tax, and defense tax returns with the collector of internal revenue for the second district of New York. It kept its books on an accrual basis of accounting. Petitioner owns and operates sixteen loft buildings in Brooklyn, renting space to manufacturing and industrial concerns, and furnishing steam, electricity, and freight-handling services to its tenants. The buildings are multiple story buildings of steel and concrete construction, approximately 75% of which were constructed prior to 1913. They are located on land adjacent to the Brooklyn-New York waterfront, and adjoin the property of Bush Terminal Company.
In addition to these sixteen buildings in Brooklyn, *76 petitioner in 1941 also owned an office building at 100 Broad Street in New York City, and an office building in London, England, called Bush House which latter building represented in 1941 an investment of $ 1,925,498.94.
In 1941 approximately 75% of petitioner's gross income consisted of rents, and approximately 25% consisted of payments for services to tenants.
In 1941 the Bush Terminal Company, then a separate and independent company from petitioner, owned and operated terminal facilities, consisting of piers and warehouses, and rental space for manufacturing and industrial concerns located adjacent to petitioner's property. In 1940 and 1941 the Bush Terminal Company was an active competititor of petitioner for tenants of industrial space.
From 1910 to 1926, petitioner issued first mortgage 5% sinking fund bonds due in 1960, secured by a lien on all its properties, in a total face amount of $ 12,000,000, for $ 10,984,000. On January 1, 1941, there were outstanding bonds in the principal amount of $ 6,880,000. During 1941, petitioner purchased, in the open market, on the New York Stock Exchange, its bonds in the principal amount of $ 749,000. for a price of $ 563,812.50. The*77 highest price at which these bonds were listed on the New York Stock Exchange in 1941 was $ 785. per $ 1,000 principal amount. Petitioner paid prices in 1941 ranging from $ 660. to $ 785. per $ 1,000 principal amount for the bonds which it purchased in 1941. The *487 average price paid by petitioner for these bonds in 1941 was 75% plus of face value. The unamortized discount on the bonds purchased in 1941 was, as of January 1, 1941, $ 26,480.95. The difference between the par value of the bonds purchased in 1941 and the amount paid for them, plus unamortized discount, amounted to $ 158,706.55.
The bonds were at all times guaranteed as to payment of principal and interest by the Bush Terminal Company. The interest has always been paid by petitioner when due. The highest and lowest price at which these bonds were listed on the New York Stock Exchange during 1941 were as follows:
| Year | High | Low |
| 1941 | 78 1/2 | 66 |
In November of 1934, Bush Terminal Company, then owner of petitioner's common stock (10,000 shares of the par value of $ 5. each), the only stock then having voting rights, filed in the District Court of the United States for the Eastern District of New York*78 its petition for reorganization under section 77B of the Bankruptcy Act. On or about October 1, 1936, petitioner filed in the same cause its petition for reorganization under section 77B, in which it stated that petitioner was not insolvent in a bankruptcy sense, but was unable to meet its debts as they matured. By an order of the Court approving the filing of the petition, petitioner was continued in possession of its properties and assets with the powers of a trustee, subject to the control of the Court, and no other trustee was ever appointed for petitioner.
A plan of reorganization was thereafter proposed by Bush Terminal Company and a Protective Committee representing the holders of petitioner's 7% preferred stock, which was approved with modifications, as of April 21, 1937, as a result of which petitioner was restored to full possession of its properties, but the carrying out of the plan of reorganization was placed in the hands of "Reorganization Managers" appointed by the Court.
The reorganization plan did not result in a reduction of petitioner's liabilities or obligations but did defer the due dates of sinking fund installments due under petitioner's mortgage, and increased*79 the requirements for the sinking fund payments by adding interest at the rate of 5% to the deferred installments. These modifications were embodied in a supplemental mortgage given by petitioner to Irving Trust Company, Trustee, on April 21, 1937. By the terms of this supplemental mortgage the due dates of the sinking fund installments originally due on November 1, of each of the years 1935 to 1939, inclusive, were extended to April 1, 1940, and provided that they should become due, with 5% interest, on April 1, 1940, but only to the extent of 80% of petitioner's net income for the period January 1, 1937 to December 31, 1939, as therein defined. Subject to this limitation, the total principal amount of the sinking fund installments due in each of the years 1935 to 1939, inclusive, and payable April 1, 1940, was $ 990,000. and the interest thereon as of that date was $ 119,625. The sinking fund installments due November 1, 1940, November 1, 1941, and November 1, 1942, amounted to $ 231,000. in each of said years. Petitioner had no net income for the period 1937-1939 as defined in the supplemental mortgage. Petitioner could at its option deliver bonds to the trustee in lieu of*80 the installments, and be credited with the cost of the bonds to it. Until all the sinking fund installments were paid petitioner could not pay any dividends on its common or preferred stock.
* * * *
As of January 1, 1941, petitioner's investment in its wholly-owned English subsidiary, Bush House, Ltd., was $ 1,925,498.94. All of petitioner's stock in *488 Bush House, Ltd., except for qualifying shares, was pledged with Irving Trust Company, trustee under the mortgage, under the supplemental mortgage as security for payment of the deferred sinking fund installments. From 1935 through 1940 Bush House, Ltd., had annual operating profits in excess of $ 85,000. The office building which was Bush House, Ltd.'s, principal asset and was the largest office building in England, was in danger of damage by bombing during 1941, but it was covered by war risk insurance. It was damaged by a bomb in 1944.
Petitioner paid no dividends on its 7% cumulative preferred stock in 1940 or 1941, and had not paid any dividends on its said preferred stock since 1933. Bush Terminal Company, which had guaranteed the dividends on petitioner's 7% cumulative preferred stock, issued as a part of the plan*81 of reorganization approved in its bankruptcy proceedings 14,000 shares of Bush Terminal Company's 6% preferred stock to the holders of petitioner's 7% preferred stock in satisfaction of its said guarantee.
3. At the time of filing its income tax return for each of the calendar years 1940 and 1941, petitioner filed with each of said returns, in the manner prescribed by the Commissioner's regulations then in effect, its consent on Form 982 to the adjustment of the basis of its property under Section 113 (b) (3) of the Internal Revenue Code.
* * * *
5. Pursuant to the amendment to the petition, filed in this proceeding on March 20, 1950, respondent concedes:
(1) That the additional or increase in "Net operating loss deduction" of $ 101,192.48, shown in respondent's Notice of Deficiency * * *, should be increased in the amount of $ 22,259.40, representing net additional repair and maintenance expenses for 1939 and 1940; and that said increase ($ 22,259.40) is an additional deduction from petitioner's taxable income in 1941; and
(2) That petitioner had further and additional repair and maintenance expenses, due to be deducted from its taxable income in 1941, of $ 33,202.82, -- which*82 said amount represents repair and maintenance expenses for 1941 not heretofore allowed as a deduction for that year.
6. The parties agree that they do not intend by the use of the words "Interest on the unpaid sinking fund installments of $ 990,000, as of April 1, 1940", as set forth herein above, to stipulate that the term "interest" constitutes interest on indebtedness within the meaning of Sec. 23 (b) of the Internal Revenue Code.
The parties have further stipulated that:
The entire record and findings of fact pertaining to the "Bond Purchase Issue" set forth in the prior proceeding of this Court in the case of Bush Terminal Buildings Company v. Commissioner, Docket No. 6806, and reported in 7 T. C. 793-819, are herein stipulated as true and are incorporated herein by reference as a part of this proceeding, -- except that:
(a) The Interest on the unpaid sinking fund installments of $ 990,000. as of April 1, 1940, was $ 119,625, instead of $ 107,250 as set forth in the findings of fact in Bush Terminal Buildings Company, supra; and
(b) The office building owned by petitioner in New York City is located at*83 100 Broad Street in said city instead of 100 Broadway as shown in said findings of fact; and
(c) In 1940 the Bush Terminal Company was not the "parent" of the Bush Terminal Buildings Company; and
(d) Bush Terminal Company's ownership of the common stock of petitioner (10,000 shares of the par value of $ 5. each) was at all times after *489 March 1940 conditional, and all but 100 shares of said stock was subject to surrender and retransfer to petitioner in the event petitioner's preferred stockholders voted on or before March 15, 1942, not to merge with the Bush Terminal Company. Said preferred stockholders did so vote, and accordingly said common stock was surrendered and retransferred to petitioner in 1943, -- except 100 shares thereof which the Bush Terminal Company had previously pledged as part security for payment of one of its bond issues; and
(e) In 1940 the common stock of petitioner was not the only stock which carried voting rights. In 1940 the holders of the preferred stock of petitioner were in voting control and were entitled to elect five (5) of petitioner's seven (7) Directors. The common stock was entitled to elect only two (2) of such Directors in 1940.
*84 The facts found by this Court in 7 T. C. 793 are incorporated herein by reference and will not be repeated in this proceeding.During all the years 1940 and 1941 the petitioner was in bankruptcy under section 77-B of the Bankruptcy Act under the jurisdiction of the United States District Court for the Eastern District of New York. The bankruptcy proceedings were terminated December 27, 1945.
On September 15, 1950, petitioner's attorney gave one of its officers, Malcolm B. Varney, assistant treasurer, a letter dated September 12, 1950, addressed to the Commissioner of Internal Revenue and signed by Chief Judge Robert A. Inch, of the United States District Court for the Eastern District of New York, reading as follows:
Pursuant to the provisions of Section 22 (b) (9) of the Internal Revenue Code prior to its amendment by the Revenue Act of 1942, this is to CERTIFY that during all of the years 1940 and 1941 the Bush Terminal Buildings Company, a New York corporation, with offices at 100 Broad Street in New York City, was in bankruptcy under Section 77B of the Bankruptcy Act, and was in an unsound financial condition; and that during all of said years the United*85 States District Court for the Eastern District of New York had jurisdiction of and exercised regulatory power and control over the said Bush Terminal Buildings Company.
Varney mailed the letter to the Commissioner by registered mail on September 16, 1950.
OPINION.
We will first consider the question of res judicata. In the prior proceeding, Bush Terminal Buildings Co., 7 T.C. 793">7 T. C. 793, involving the year 1940, we found certain facts either identical with or closely related to facts upon which some of the issues now before us must be decided. For instance, as to the bond purchases, we found that petitioner was not in an unsound financial condition in 1940, and therefore realized taxable gain on the purchase of its bonds at less than par value in that year. We now have the same question for 1941. As to reorganization expenses, we determined in the prior proceeding that certain expenses incurred in 1940, in connection with the 77-B reorganization, were capital expenditures not deductible in that year *490 as business expenses. The same question is presented in this proceeding as to 1941 expenditures. In the prior proceeding we sustained the Commissioner's*86 determination of the amount of the 1939 net operating loss carry-over to 1940, disallowing the petitioner's claim to an additional deduction in 1939 on account of certain interest payments. We now have the question of the amount of 1939, as well as 1940, net loss carry-over available for 1941.
First, petitioner argues that the doctrine of res judicata, or collateral estoppel, does not apply here because we have before us a different tax year from the one previously under consideration.
Gain on Bond PurchasesThe first issue on the merits is whether petitioner realized taxable gain on the purchase of its own bonds for less than par value in 1941. That question depends upon the facts as they existed in 1941. The bond purchases under consideration in the prior case were those made in 1940. Since the conditions then existing may have changed and, in in fact, did change in 1941, the doctrine of res judicata does not apply.
In holding that the bond purchases in 1940 resulted in taxable gain we made a careful study of petitioner's financial situation and concluded that the evidence did not show that petitioner was "in an unsound financial condition," within the meaning of section*87 22 (b) (9) of the Internal Revenue Code, as amended by section 215 of the Revenue Act of 1939. We pointed out that although the petitioner was then undergoing a 77-B reorganization under the Bankruptcy Act it was not insolvent; that it had a net worth in 1940 in excess of $ 9,000,000 and a gross income of two and a quarter million; that the real estate securing its outstanding bonds of $ 7,000,000 at the end of 1940 had a value in excess of $ 12,000,000; that there were other assets of a value of more than $ 3,800,000, and that petitioner's purchases of bonds in 1940 far exceeded its current obligations under the sinking fund agreement.
The evidence now shows that petitioner was in an even better financial condition in 1941 than in 1940. Its surplus as shown in its balance sheets increased from $ 1,399,110.66 in 1940 to $ 1,806,871.04 in 1941; its funded indebtedness was reduced from $ 6,880,000 in 1940 to $ 6,131,000 on December 31, 1941; and the average price at which petitioner purchased its bonds increased from approximately sixty-four per cent of the face value in 1940 to approximately seventy-five per cent of the face value in 1941.
Thus, on the evidence, we must conclude *88 on authority of our prior decision for 1940 that the petitioner was not in an unsound financial condition in 1941. Our prior decision was not appealed and has now become final.
*491 Petitioner has raised a new question in this proceeding upon which it seems to place considerable reliance. It claims that there was a certification to the Commissioner by a Federal agency having regulatory powers over petitioner that petitioner was in an unsound financial condition in 1941, in compliance with section 22 (b) (9), 1 added to the Code by section 215 (a) of the Revenue Act of 1939. This claim is based on the letter which Judge Inch, of the United States District Court for the Eastern District of New York, allegedly wrote to the Commissioner of Internal Revenue regarding petitioner's financial condition in 1941. This letter is quoted in full in our findings of fact. A copy of the letter, duly signed by Judge Inch and certified by the clerk of his court, was offered in evidence by counsel for the petitioner but was strenuously objected to by counsel for the respondent. Respondent's chief objection to the admission of the letter was based on the "best evidence" rule and on the fact*89 that petitioner's counsel did not make a demand on the respondent to procure the original of the letter until the hearing on September 19, 1950, whereas, the letter, although dated September 12, 1950, was not mailed until September 16, and could not have been received by the respondent in Washington until September 18.
*90 The letter was identified by petitioner's assistant treasurer, who testified it was given to him by petitioner's counsel and that he mailed the original to the Commissioner of Internal Revenue, Washington, D. C., by registered mail. The witness further testified that he had no authorization from the writer of the letter to mail it. Petitioner's attorney stated at the hearing that he got the letter on the 12th or 13th, had it certified by the clerk of the court on September 15, and gave it to the assistant treasurer for mailing to the Commissioner *492 on September 16. The letter was received in evidence. That is not to say, however, that we regard the letter as foreclosing the issue against the respondent. We do not believe that the letter meets the statutory requirement for a certification to the Commissioner of petitioner's unsound financial condition by a "Federal agency authorized to exercise regulatory power over such corporation." Sec. 22 (b) (9) (B), I. R. C.
In the first place, there is a serious doubt, we think, that the term "Federal agency," as used in the statute, was intended to include the Federal judiciary. See report of Senate Finance Committee (1939-2 C. B., p. 527),*91 set out in part below:
Many corporations (such as railroads) that will endeavor to bring themselves under the provisions of the new paragraph (9) are corporations that have had, and continue to have, considerable dealings with the Federal Government, where the financial condition of such corporations is an important factor in such dealings. It seems desirable to utilize information obtained by various agencies of the Government and thus relieve the Commissioner of Internal Revenue from the necessity of making an independent finding in each case as to the financial condition of the corporate taxpayer. To carry out this policy, a committee amendment to this section provides that a corporation may obtain the benefits of the new paragraph (9) if it can establish that it was in an unsound financial condition at the time of the discharge of its indebtedness, by the presentation of a certification to the Commissioner by any Federal agency which is authorized to make loans on behalf of the United States to such corporation, or by any Federal agency authorized to exercise regulatory power over such corporation.
Although Federal courts may in a literal sense fall under the classification*92 of agencies of the Government they are not commonly referred to as such. As usually employed the term agency means an agency in the administrative branch of the Government, such as the Interstate Commerce Commission, the Reconstruction Finance Corporation, and the Securities and Exchange Commission. The statute refers to Federal agencies "authorized to exercise regulatory power over such corporation." At the time the letter in question was written the United States District Court was not authorized to exercise regulatory power over the petitioner. The bankruptcy proceeding under which it may have exercised such powers had been terminated approximately five years previously. In the meantime, this Court had ruled that petitioner was not in an unsound financial condition in 1940.
The time for the petitioner to have made or to have procured a certification to the Commissioner of its unsound financial condition was when it filed its return, or, at the latest, when the matter was subject to administrative disposition by the Commissioner. This was clearly the intent of the statute, its purpose being to relieve the Commissioner of the burden of making an independent investigation of *93 the financial condition of taxpayers seeking to bring themselves under the section. See report of Senate Finance Committee, supra. The taxpayer took *493 no such steps until long after the Commissioner had closed his action on the 1941 return and on the eve of the trial before this Court. The petitioner, or its attorney, must have been fully aware that the letter which the United States District Court was asked to provide would, if serving the purpose for which it was intended, stand as a complete contradiction of the determination already made by this Court that petitioner was not in an unsound financial condition in 1940. The petitioner was under the jurisdiction of that court in both years and its financial condition in 1941 had improved over 1940.
In view of our prior determination that petitioner was not in an unsound financial condition in 1940, and the fact that it was in a still better financial condition in 1941, we must conclude that it was not in an unsound financial condition in 1941 and that it is not entitled to relief from tax under section 22 (b) (9) upon the gain which it derived from the purchase of its bonds in 1941.
The petitioner further contends that*94 the amendments made to section 22 (b) (9) of the Code by section 114 of the Revenue Act of 1942, removing the "unsound financial condition" as a requirement for exclusion of the gain from the discharge of such indebtedness, are retroactive to 1940 and 1941. This identical question was considered in the prior proceeding and was decided against petitioner's contention. We said in that case:
We think section 29.22 (b) (9)-1 of Regulations 111 correctly interpreted the amendments to apply only to taxable years beginning after December 31, 1941.
It is our conclusion, therefore, that that provision of section 22 (b) (9) of the code, before the 1942 amendment, required petitioner to establish the unsoundness of its financial condition in 1940.
Reorganization ExpensesPetitioner claims the deduction of $ 26,426.13 which it charged to a reserve for reorganization expenses in connection with the 77-B reorganization. In the prior proceeding we disallowed deductions for 1939 and 1940 additions made to this same reserve for the same type of expenditures. We said that the expenses of reorganization were capital expenditures and were not deductible as business expenses, citing a number of*95 authorities for that proposition. Following our ruling in that case we must disallow the similar deductions now claimed for 1941.
Interest on Deferred Sinking Fund ObligationsBy an amendment to its petition, petitioner claims a deduction of $ 119,812.50 as interest paid on its deferred sinking fund installments. Respondent contends that no such interest was paid and therefore none is deductible.
Under the terms of the reorganization agreement, and the supplemental mortgage, interest was payable at the rate of 5 per cent on *494 petitioner's deferred sinking fund installments. This interest was payable to the trustee along with the principal amount due on the sinking fund installments. It was also provided in the reorganization and mortgage agreements that petitioner might at its option deliver its own bonds to the trustee in payment of its sinking fund installments and receive credit therefor equal to the cost of such bonds. During 1941 petitioner turned in to the trustee bonds which it had purchased at a discount at a cost of $ 911,812.50 and received credit for that amount on its sinking fund obligations. The trustee in its accounts credited $ 779,198.83 of that *96 amount to principal and $ 132,613.67 to interest. The bonds were canceled by the trustee.
Petitioner does not contend that it paid any interest to the bondholders from whom it purchased the bonds, and the facts do not show that it did. Cf. Helvering v. Midland Mutual Life Insurance Co., 300 U.S. 216">300 U.S. 216; Harold M. Blossom, 38 B. T. A. 1136. Petitioner claims that it paid the interest by turning over the bonds to the trustee. This might be said to raise the question as to whether petitioner's obligation to pay the trustee interest on the deferred sinking fund installments was an "indebtedness" within the meaning of section 23 (b), Internal Revenue Code. It was with this question in mind that the parties have stipulated, as set out in paragraph (6) of the stipulation above, that they did not intend to stipulate that the term "interest," as used in connection with the sinking fund installments, means "interest on indebtedness within the meaning of Sec. 23 (b) of the Internal Revenue Code."
That question, we think, need not be decided here. In determining petitioner's gain on the purchase of the bonds at less than the issue*97 price the respondent allowed as cost the full amount which petitioner paid for them. If petitioner is now permitted to treat a part of that cost as interest paid, there must be a corresponding reduction in the cost of the bonds to petitioner and a like increase in petitioner's gain on their purchase. Thus, in the end, petitioner's tax liability would not be affected.
Net Loss Carry-OverThe adjustments sought in the net loss carry-over from 1939 and 1940 involve the same questions of the deduction of reorganization expenses and gain on the purchase of bonds already decided adversely to petitioner's contention both in the prior proceeding and in connection with the year now before us. Accordingly, no adjustment of the net loss carry-over as determined by the respondent is required except as may be effected by the above stipulation.
Decision will be entered under Rule 50.
Footnotes
1. SEC. 22 (b) (9), I. R. C.:
(9) Income from discharge of indebtedness. -- In the case of a corporation, the amount of any income of the taxpayer attributable to the discharge, within the taxable year, of any indebtedness of the taxpayer or for which the taxpayer is liable evidenced by a security (as hereinafter in this paragraph defined) if --
* * * *
(B) it is certified to the Commissioner by any Federal agency authorized to make loans on behalf of the United States to such corporation or by any Federal agency authorized to exercise regulatory power over such corporation.
that at the time of such discharge the taxpayer was in an unsound financial condition, and if the taxpayer makes and files at the time of filing the return, in such manner as the Commissioner, with the approval of the Secretary, by regulations prescribes, its consent to the regulations prescribed under section 113 (b) (3)↩ then in effect. In such case the amount of any income of the taxpayer attributable to any unamortized premium (computed as of the first day of the taxable year in which such discharge occurred) with respect to such indebtedness shall not be included in gross income and the amount of the deduction attributable to any unamortized discount (computed as of the first day of the taxable year in which such discharge occurred) with respect to such indebtedness shall not be allowed as a deduction. As used in this paragraph the term "security" means any bond, debenture, note, or certificate, or other evidence of indebtedness, issued by any corporation, in existence on June 1, 1939. This paragraph shall not apply to any discharge occurring before the date of the enactment of the Revenue Act of 1939, or in a taxable year beginning after December 31, 1942.