*192 Decision will be entered for the respondent.
Petitioner is a corporation, organized primarily for the conducting of horse racing in Arkansas. In the period from 1920 through 1933, Arkansas law prohibited wagering on horse races and, consequently, petitioner conducted no such races in that period. It borrowed from its stockholders approximately $ 140,000 to cover its losses during those years and paid no interest on the indebtedness. It keeps its books and reports its income on the cash basis. After a change in Arkansas law to permit betting on horse races, petitioner in 1934 resumed the conducting of such races. By 1937 interest due petitioner's stockholders on their loans amounted to about $ 81,000. Of that amount, petitioner paid approximately $ 26,000 in 1937 and the balance of $ 55,000 in 1938. In its excess profits tax returns for 1941 and 1942 petitioner claimed these amounts as abnormal deductions in toto. Held, the interest deductions were abnormal only in amount under subparagraph (J) (ii) and were not abnormal by class under subparagraph (J) (i) of section 711 (b) (1), Internal Revenue Code.
*1129 This case involves petitioner's excess profits tax liability for the calendar years 1941 and 1942. The respondent has determined deficiencies of $ 4,880.54 and $ 15,092.25, respectively. The issue is whether certain interest deductions during petitioner's base period years were abnormal by class, or only in amount.
FINDINGS OF FACT.
Petitioner is an Arkansas corporation, with its principal office at St. Louis, Missouri. Its returns for the periods here involved were filed on the cash receipts and disbursements basis with the collector of internal revenue for the first district of Missouri. Petitioner's accounting period is the calendar year. It computed its excess profits tax credit for the years 1940, 1941, and 1942 on the income method, which exceeded the credit*194 based on invested capital.
Petitioner was incorporated in 1905 for the purpose of conducting horse races in Arkansas. For all the years here pertinent it owned property in Hot Springs, Arkansas, consisting of land, grandstand, paddock and stall facilities, and a nine-hole golf course located inside the race track.
From 1920 until March 1934, petitioner did not conduct horse races in Arkansas because the state law prohibited wagering on the results of horse races. After a change in the state law to permit wagering, petitioner resumed the conducting of horse races in 1934.
From 1920 through 1933, when petitioner was not conducting races, it sustained net losses (exclusive of depreciation) aggregating $ 142,652.77, as shown on its books, in the following amounts:
| 1920 | $ 4,210.38 |
| 1921 | 10,284.81 |
| 1922 | 15,890.39 |
| 1923 | 9,618.66 |
| 1924 | 16,802.48 |
| 1925 | 16,744.19 |
| 1926 | 11,872.28 |
| 1927 | $ 10,845.00 |
| 1928 | 7,928.18 |
| 1929 | 16,541.69 |
| 1930 | 4,984.37 |
| 1931 | 3,892.24 |
| 1932 | 7,780.01 |
| 1933 | 5,258.09 |
In that period petitioner derived no income from the conducting of horse races, but received small amounts of revenue from the rental of its premises for county fairs and the operation of its golf *195 course. It incurred and paid expenses in the nature of maintenance costs, *1130 taxes, insurance, etc., which were substantially in excess of its income. In order to cover its net losses, petitioner, in the period from July 12, 1922, to December 5, 1933, borrowed sums aggregating $ 144,676.95 from its stockholders, the Southern Real Estate & Financial Co., owning two-thirds of its stock, and the Condon interests, owning the remaining third. No interest was paid on that indebtedness prior to 1937.
By 1937 interest due to the stockholders on their loans amounted to $ 81,935.69. Pursuant to corporate resolution adopted at a special meeting of its board of directors on December 17, 1937, petitioner in that year paid $ 26,935.69 of the interest due. Of that amount, $ 26,279.85 was due on the indebtedness incurred from July 12, 1922, to December 5, 1933. The remaining $ 655.84 was interest on an amount of $ 18,046.70 reborrowed by petitioner from the Southern Real Estate & Financial Co. in the period from April 7, 1934, to February 12, 1935, after petitioner discovered that a $ 27,517.53 principal payment it had made on the original indebtedness after resuming horse racing in *196 1934 was not justified by its then financial condition.
In 1938, pursuant to corporate resolution adopted at a special meeting of its board of directors on December 29, 1938, petitioner paid the $ 55,000 balance of the interest due on its indebtedness to the stockholders. No interest was paid after 1938 on that indebtedness.
After petitioner resumed the conduct of horse races in March 1934 its books showed net profits (exclusive of depreciation) during the years 1934 to 1942, as follows:
| 1934 | $ 53,343.72 |
| 1935 | 45,087.50 |
| 1936 | 58,775.31 |
| 1937 | 90,539.02 |
| 1938 | 52,063.80 |
| 1939 | $ 72,127.66 |
| 1940 | 65,659.71 |
| 1941 | 118,006.51 |
| 1942 | 185,910.56 |
In the years 1932 to 1942, inclusive, petitioner paid and deducted on its Federal income and excess profits tax returns the following amounts of interest:
| Year | Interest paid on -- | Amount |
| 1932 | None | |
| 1933 | None | |
| 1934 | Bankroll loan | $ 290.83 |
| 1935 | Bankroll loan | 459.17 |
| 1936 | Bankroll loan | 612.50 |
| Federal income tax deficiency | 239.23 | |
| 1937 | Bankroll loan | 340.82 |
| Federal old age benefit tax | 2.96 | |
| Federal income tax deficiency | 207.74 | |
| Dividend note | 309.06 | |
| Amount paid pursuant to resolution | 26,935.69 | |
| 1938 | Dividend notes | 625.57 |
| Federal excise tax | 2.57 | |
| Amount paid pursuant to resolution | 55,000.00 | |
| 1939 | Dividend notes | 198.29 |
| 1940 | None | |
| 1941 | None | |
| 1942 | None |
*197 *1131 The "Bankroll loan" referred to in the preceding schedule represents amounts borrowed by petitioner to provide necessary funds for making change during the racing season. "Dividend notes" represent notes issued by petitioner to its stockholders in payment of dividends declared by it in 1936 and 1937. No dividends were declared by petitioner from 1920 through 1935, and the first cash dividend after the resumption of horse racing was declared in 1938. The item of $ 26,935.69 in 1937 and that of $ 55,000 in 1938, labeled "Amount paid pursuant to resolution," represent interest paid to the stockholders on their loans pursuant to the corporate resolutions of December 17, 1937, and December 29, 1938, mentioned above.
The abnormality or excess of petitioner's interest deductions in the base period years was not a consequence of an increase in the gross income of petitioner or a decrease in the amount of some other deduction in its base period, nor was it a consequence of a change at any time in the type, manner of operation, size, or condition of the business engaged in by petitioner.
OPINION.
Essentially, the question here is whether the abnormality is one of kind or only *198 of degree. In the computation of excess profits credit on the average income method, section 711(b) of the Internal Revenue Code provides for certain adjustments to the income of the base period years 1936 through 1939. Subparagraph (J) of section 711(b)(1)1 provides for the elimination and consequent restoration to base period income of certain abnormal deductions. Part (i) of subparagraph (J) "disallows" in toto deductions of the base period which were abnormal by class. Part (ii) "disallows," in the case of deductions abnormal in amount, the excess over 125 per cent of the prior four-year average. The parties here have stipulated that any abnormality or excess, whether by class or in amount, was not a consequence of an increase in income or a decrease in other deductions during petitioner's base period or of a change at any time in the type, *1132 manner of operation, size, or condition of petitioner's business. Accordingly, no question arises here as to the application of subparagraph (K)(ii) of section 711(b)(1).
*199 Petitioner contends that interest payments in the amount of $ 26,279.85 in 1937, and $ 55,000 in 1938, were abnormal by class, and should be "disallowed" in toto under subparagraph (J)(i), because they related to indebtedness incurred by petitioner to cover its net losses during the period when petitioner was not conducting horse races -- a period which petitioner calls its "dormant" period. Respondent contends to the contrary. He admits, however, that the interest payments were abnormal in amount under subparagraph (J)(ii) and has determined the deficiencies accordingly.
In support of its position, petitioner relies on Green Bay Lumber Co., 3 T. C. 824. Respondent, on the other hand, relies on Arrow-Hart & Hegeman Electric Co., 7 T. C. 1350. Both cases were reviewed by the full Court.
In the Green Bay case, this Court said that Congress did not intend that the classification of deductions under section 711 (b) (1) (J) should follow the pattern established by section 23 of the code, and that bad debts do not necessarily all fall in the same class. There it was held that a bad debt arising out of loans made to*200 the taxpayer's employees for the purpose of purchasing stock in another corporation was of a different class from bad debts arising from trade accounts; that the former was abnormal by class and should be disallowed in toto.
In the Arrow-Hart case, issue 6, the question was presented whether interest paid on a sum of a million dollars borrowed by the taxpayer for the purpose of retiring its preferred stock was of a class different from interest paid on moneys borrowed for current operations. It was held that the interest on the note was of the same class as the interest on the current operation loans.
It is thus apparent that the Arrow-Hart case was a direct ruling on the question of interest deduction, the same question involved here, whereas the Green Bay case was concerned only with the question of bad debts. However, even if it may be said that any conflict in principle exists between the two cases, the Arrow-Hart case must be taken as the later expression by the full Court on the matter. If, as in that case, interest on money borrowed for the retirement of preferred stock was not of a class different from interest on money borrowed for current operations, *201 then we do not see how it could be said that in this case interest on money borrowed to cover net losses during the so-called "dormant" period is of a class different from the other interest paid by petitioner as shown in our findings. On the authority of the Arrow-Hart case, therefore, we conclude that the respondent did not err in holding that the interest deductions were abnormal only in amount and not by class.
Decision will be entered for the respondent.
Footnotes
1. SEC. 711. EXCESS PROFITS NET INCOME.
* * * *
(b) Taxable Years in Base Period. --
(1) General rule and adjustments. -- The excess profits net income for any taxable year subject to the Revenue Act of 1936 shall be the normal-tax net income, as defined in section 13 (a) of such Act; and for any other taxable year beginning after December 31, 1937, and before January 1, 1940, shall be the special-class net income, as defined in section 14 (a) of the applicable revenue law. In either case the following adjustments shall be made * * *
* * * *
(J) Abnormal Deductions. -- Under regulations prescribed by the Commissioner, with the approval of the Secretary, for the determination, for the purposes of this subparagraph, of the classification of deductions --
(i) Deductions of any class shall not be allowed if deductions of such class were abnormal for the taxpayer, and
(ii) If the class of deductions was normal for the taxpayer, but the deductions of such class were in excess of 125 per centum of the average amount of deductions of such class for the four previous taxable years, they shall be disallowed in an amount equal to such excess.↩