1931 BTA LEXIS 2145 | B.T.A. | 1931
Lead Opinion
The petition in this proceeding, as amended, raises 32 issues, each of which was numbered. The answer raised an issue which has been numbered 33. So far as seemed possible the facts have been set out under each numbered issue, but in several instances the same facts affect two or more issues. In such cases the facts are included under the earlier number and not repeated. We discuss the issues in the order in which they are numbered, except that all issues arising out of the Federal control settlement are grouped.
Under issue No. 3 the petitioner claims that the Commissioner committed error in reducing its deduction for operating expenses by $84,985.54. This is an amount which was set up on its books of account as representing the cost of transporting men and materials used in connection with betterments and improvements chargeable to capital account. The rate charged is a matter of estimate, but subject to control by the Interstate Commerce Commission. This issue was raised and fully discussed by the Board in Great Northern Railway Co., 8 B. T. A. 225, and by the Circuit Court of Appeals
Issue No. 4 involves the question as to whether petitioner was affiliated with American Refrigerator Transit Company during the year 1920, and entitled to include the income and invested capital of that corporation in a consolidated return under section 240 of the Revenue Act of 1918. This same question was before us upon petition filed by American Refrigerator Transit Company, Docket No. 19019, in which proceeding the petitioner herein was permitted to intervene. There it was held that the two corporations were affiliated. American Refrigerator Transit Co., 14 B. T. A. 616. In the present proceeding the parties have stipulated into the evidence a transcript of the evidence introduced in that proceeding. We have incorporated into our findings in this proceeding the findings made in the prior proceeding. Since both the parties now before us were parties in the case mentioned, we consider our decision there as binding on them.
Issue No. 5, involving the right of petitioner to deduct payments made to the Association of Railway Executives, is presented in a similar manner. The evidence on this point consists of the testimony of a witness as given in a prior proceeding and cross-examination of the same witness in a later proceeding, all incorporated into the record here by stipulating a transcript of such testimony. The cross-examination adds nothing to the record first made. We have incorporated as our findings those made in such prior proceeding (Los Angeles & Salt Lake Railroad Co., 18 B. T. A. 168) upon the same testimony and upon authority of our decision in that case hold that the petitioner is entitled to deduct as an expense the amount contributed to the Association.
The sixth issue raises the question of the right of petitioner to deduct annually a part of the discount at which bonds had been issued by predecessor corporations, secured by property which was acquired by petitioner upon reorganization. Payment of such bonds was assumed by the petitioner. The respondent relies upon our decision in Western Maryland Railway Co., 12 B. T. A. 889, while the petitioner relies upon the decision of the Circuit Court of the Fifth Circuit reversing that decision, Western Maryland Railway Co. v. Commissioner, 36 Fed. (2d) 695.
It is conceded that the obligations in question, consisting in part of equipment trust notes and in part of mortgage bonds, were sold at a discount and that the corporations issuing such bonds were en
It will be noted that in the present case over 40 per cent of the stock of the petitioner was issued to those who were not stockholders of the predecessor companies but bondholders or creditors. The reorganization involved a very substantial shifting of interests and under the decision of the Supreme Court in Marr v. United States, 268 U. S. 536, it would appear that for tax purposes, as well as for other purposes, regard must be had for the fact that petitioner is a new entity, separate and distinct from its predecessors, although succeeding to their properties and obligations.
The Circuit Court of Appeals in its decision laid some stress upon the fact that in that case there was, among the assets shown by the books of the predecessor, the amount set up as bond discount; that the Interstate Commerce Commission required the unextinguished discount to be carried on the balance sheet of the company and be amortized by a charge against income for the remaining life of the bonds; and that such deduction was to be allowed as a basis for rate-making and for determining the rights of the Government under the recapture clause of the Transportation Act. In the present case it appears that the discount was charged off immediately upon sale of the bonds and was not carried upon the books of the company. This treatment of this item was likewise in accordance with the regulations of the Interstate Commerce Commission, wherefrom it would appear that the Commission permits the item of discount to be either charged off immediately or over the life of the bonds. Here the first alternative was adopted for the purpose of accounting to the Interstate Commerce Commission and the petitioner is without the advantage, if any, enjoyed by the Western Maryland Bailway Company by reason of its method of accounting for this item.
By reason of the large amount of stock issued by the petitioner to those who were not stockholders in the predecessor company and because of its system of accounting, the petitioner appears to be in a less favorable position to claim the deduction here involved than was
The seventh issue, raises the question of the right of petitioner to deduct, as a part of its ordinary and necessary expenses, payments made to railroad Young Men’s Christian Associations maintaining their organizations at division points of the petitioner’s railroad and furnishing its employees with eating and rooming facilities and social and recreational activities not otherwise available. The testimony is to the effect that the officers of the petitioner considered some such facilities to be necessary at division points, that they served as a means of keeping local employees satisfied at those points, and that if it had not been for the payments made by the petitioners to such Y. M. C. A.’s it would have been necessary for it to have maintained similar facilities. In like circumstances we held that such payments were a part of the ordinary and necessary expenses of operating the railroad in Indiana Harbor Belt Railroad Co., 16 B. T. A. 279, and Terminal Railroad Association of St. Louis, 17 B. T. A. 1135. The action of the Commissioner in refusing to allow such deductions is reversed.
Next we consider the questions which arise out of the settlement made by the Director General of Railroads for the period of Federal control. Pursuant to law, the President of the United States, acting through the Director General, took possession and assumed control of the railroads and transportation facilities of the petitioner and its affiliated companies on December 28, 1917, although for purposes of economy it was subsequently agreed that settlement should be made as of midnight December 31,1917. By an act known as “ The Federal Control Act,” approved March 21, 1918 (40 Stat. 451), Congress provided that the President be authorized to enter into agreements for the payment of just compensation for the use of the properties taken over, such payments to be made from time to time in reasonable installments. The act also provided that such agreements make provision for maintenance, repair, renewals and depreciation of the property at the expense of the Director General, and for the reimbursement of the United States for the cost of ad
For our purpose the items which went to make up the sum total of the settlement are divisible into three classes: (1) those which are clearly income; (2) those which are clearly of a capital nature and which do not affect the computation of the taxable income; and (3) those which involve both capital and income items. In the first class are the unpaid balances due upon account of the agreed compensation for the use of the properties, adjustment of interest upon balances, and the so-called rental interest on completed additions and betterments. In the second class are the balances due upon open accounts, and the expenditures made by the Director General for additions and betterments. In the third class fall such items as road property and equipment retired, adjustments upon account of materials and supplies taken over and either not returned in kind or returned in an excessive amount, and the very substantial claim for undermaintenance of the properties. •
Since the lump-sum settlement reflected both items of income and items of capital, it seems necessary that it be broken down in some manner for the purpose of determining what income the companies received or what losses they sustained. It is manifest that the situation would not be met by requiring the amount paid by the Director General to be returned as income or permitting any amount paid by the companies to be deducted as a loss. It well might be the settlement would result in a payment to the Director General because of the expenses of additions .made to the railroad property in an amount greater than the agreed compensation, or because of advances made to the companies or bonded indebtedness paid on their account. On the other hand, there might be a large sum due the companies by reason of the retiring and scrapping of portions of
The first difficulty comes when the attempt is made to put the principle into practice. The Commissioner has been under the necessity of making the allocation in auditing the income tax returns of the railroads. It has appeared in similar cases which we have previously had before us, as it did in this case, that after the settlement was reached between the parties the Director General had placed upon his books an allocation of the settlement to the various items of the claim. This was done without consulting with the railroads and for several years they were denied any information as to the allocation made. In such previous cases, as in this case, it has appeared that the Commissioner has followed the breakdown made by the Director General and entered upon his books. In Terminal Railroad of St. Louis, supra, the petitioners urged that since the entries upon the books of the Director General were made ex parte and represented no more than the opinion of the Director General and his staff as to a proper allocation, they were not binding upon the railway and therefore might not be received in evidence to show the basis of the settlement. There the contention of the petitioner was sustained and the petitioner permitted to show by evidence what would be a proper allocation. A like contention is made here and is also sustained. There is, however, a presumption that the adjustments made by the Commissioner in determining the income of the petitioner are correct, and this presumption is not overcome by showing that the information upon which it was based was an ex parte statement not binding upon the taxpayer. The taxpayer may overcome the presumption by proof, but to the extent that the presumption is not overcome the determination of the Commissioner must be accepted. The Commissioner has determined that the settlement made in 1921 should be allocated as follows:
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The principal differences between the parties were with respect to the adjustment to be made upon account of materials and supplies and for undermaintenance of the properties. There was also the question whether the carriers were entitled to depreciation on equipment based on replacement values, and to be recompensed at replacement cost for property retired.
The evidence submitted by the petitioner does not establish that the allocation made by the Commissioner of the lump sum paid in settlement is not proper; indeed, his evidence tends to support it as reasonable.
Having arrived at some basis on which the lump sum settlement may be apportioned, it becomes necessary to consider the various items and determine how each affects the income and in what year it is to be reflected in the computation of taxable income.
The issue numbered 11 raises a question as to the year in which compensation received from the Director General for use of the property of petitioner and its affiliated corporations should be returned as income. This property was taken over by the Director General on January 1, 1918. By the terms of the Federal Control Act, the President was authorized to enter into agreements with such roads for the payment, as compensation for their use, of an annual sum not exceeding the average annual railway operating income for the three years ended June 30,1917. The act provided for the ascertainment of such income by the Interstate Commerce Commission, and the method to be used in certain cases. Sections 2 and 3 made provision for compensation where such an agreement was not made.
It appears that in the instant case the Interstate Commerce Commission gave a certificate which tentatively fixed the annual income during the test period at $14,312,435.01, and substantially this amount was returned as income by the companies in 1918 and 1919. Subsequently, in 1920, the tentative certificate was superseded by a final certificate fixing the annual income for the test period at $14,100,227.29. The Commissioner computed the income for 1920 from this source upon the basis of the amount fixed by the final certificate. The petitioner contends that such amount should be reduced by the excess amounts returned by it as income in 1918 and 1919. This is substantially the same question which was involved in Illinois Terminal Co., 5 B. T. A. 15; New Orleans, Texas & Mexico
Issue 12. The petitioner complains of the action of the respondent in allowing it to deduct only $7,981,636.33 as the cost of materials and supplies consumed during 1920 in the maintenance of its properties. The evidence discloses that on January 1, 1918, the Director General took over the materials and supplies then on hand. These had cost the petitioner $7,981,636.33. At the close of the period of Federal control the Director General returned to the petitioner materials and supplies which the petitioner entered upon its books at $11,318,447.62. It is .stipulated that these materials and supplies were used by the petitioner during the taxable year and the single question involved is whether petitioner may deduct the larger amount.
The agreement provided that at the close of Federal control the Director General should return materials and supplies equal in quantity, quality and relative usefulness to those taken over. It has been held that where the Director General returned a smaller quantity than he took over and paid for the shortage, there was taxable gain measured by the difference between the cost of the materials and supplies not returned and the amount paid therefor to the company. Lehigh & Hudson River Railway Co., 13 B. T. A. 1154. It has also been held that to the extent that the materials and supplies returned equal in quantity, quality and relative usefulness those taken over, there is no taxable gain. Indiana Harbor Belt Railroad, 16 B. T. A. 279. This is so regardless of the fact that, because of price changes, the property returned has a greater monetary value than the equivalent property had when taken over. The property returned merely takes the place of the property previously owned. It follows as a corollary that the cost of the property returned is the cost of the property which it replaces.
The Commissioner has determined that the materials and supplies returned at the end of the period of Federal control were equal in quantity, quality and relative usefulness to those delivered to the Director General at the close of 1917, and that in the final settlement the petitioner was neither charged nor credited with any
Issue No. 13 involves the addition to income for 1920 to $161,498.30 as an amount received by the petitioner and its affiliated companies from the Director General upon account of property retired and not replaced during the period of Federal control. The Commissioner concedes that this amount should be reduced to $96,256.59. There is some discrepancy with respect to this item between the statements appearing in the body of the notice of deficiency and in Schedule A attached -thereto, which schedule sets out the Commissioner’s determination of the manner in which the amount of the lump-sum settlement shall be allocated. Considering the whole record, however, it
Issue No. 14 raises a question as to the correctness of the action of the Commissioner in adding to the taxable income for the year 1920 the amount of $38,925.90 representing interest on quarterly balances payable by the Director General to the companies. There is
The question whether such interest was taxable was considered at length in Kansas City Southern Railway Co., supra, and our decision in that case is controlling here. The action of the Commissioner in including the amount in dispute in taxable income for 1920 is approved.
Issue No. 15 raises the question whether the Commissioner correctly reduced the operating expenses claimed by the petitioner for maintenance of way and structures and maintenance of equipment during the year 1920. The agreement under which the Director General operated the properties provided in substance that they should be maintained in such condition as would permit their return to the carriers in as good condition of maintenance as when taken over. When the petitioner came to present its claim to the Director General it took the position that the Director General had failed to fulfill this obligation and that by reason thereof it was entitled to receive $14,082,370.66. The Commissioner determined that in the lump-sum settlement the companies had been allowed $4,532,809 for undermaintenance of way and structures and $6,154,912.54 for undermaintenance of equipment. He further determined that the petitioner had expended these amounts during 1920 in restoring the properties to their previous condition of maintenance and held that the amounts so expended were not deductible. In Terminal Railroad of St. Louis, supra, we had before us a similar situation. There we reached the conclusion that the amount paid for undermaintenance was in reality a payment to the petitioner for its property and was not income except perhaps to the extent of the excess of payment over cost. It is by no means clear that a payment for undermaintenance would be taxable even to that extent but that question was not before us for decision either in that case or in this. In the same case we held that while the company was entitled to deduct its maintenance expenditures, ordinarily and necessarily incurred during the year, it was not entitled to deduct also expendi
The proof upon this issue is very lengthy and we do not propose to discuss it in detail. The petitioner produced as witnesses the men whose duty it was to oversee the maintenance of the properties, men who were thoroughly familiar with the petitioner’s properties at the time they were taken over, at the time returned, and during all of 1920. Their testimony was in substance that the average condition of maintenance of the properties at the close of 1920 was no better than on March 1, 1920. In detail they explained what was done and why more was not done. Counsel for the Commissioner points out that their testimony discloses that many of the worst conditions existing when the roads were returned were corrected as soon as possible. While this was done, the testimony is that it was at the expense of less pressing items of current maintenance. Amounts available for maintenance were expended where most needed. Primary lines were improved while the secondary lines suffered still further undermaintenance. It is quite evident that the question can not be solved merely by looking at particular items of maintenance or undermaintenance. The real question is whether the average condition of maintenance was improved during 1920. The testimony of these witnesses was supported by detailed statistical studies which disclosed that after adjusting the purchasing power of the dollar in terms of labor and materials and giving effect to the increase in traffic, the amount expended for maintenance in 1920 was practically
To dispose of the issue arising out of the Federal control settlement, we next take up for discussion the issues numbered 32 and 33. The first of these is the claim of the petitioner that it sustained uncompensated losses as result of Federal control, which it is entitled to deduct in 1920. The petitioner arrives at the conclusion that it sustained a loss computed as follows:
*299 Amount of its claim as shown in findings of fact_$36, 625, 891. 79
Add: Rental interest on computed additions and betterments_ 149, 052. 42
Total_ 35, 774,944. 21
Amounts admitted to be due to Director General as shown in its claim (the same amount was used by the Commissioner in his set up of the settlement)_ 14,412,109. 51
Balance due petitioner- 21, 362, 834. 70
Amount paid in settlement_ 9, 000, 000.00
Loss claimed as a deduction_ 12,362, 834. 70
The basis for the computation of a deductible loss, for income tax purposes is the cost or March 1, 1913, value of the property. Where property is disposed of the loss is the difference between the amount realized and such basis.
A substantial part of the claim filed with the Director General is based upon the claim that the railroad is entitled to be repaid at replacement values. As we understand the situation there was no substantial dispute as to the right of petitioner to be compensated for depreciation of its equipment upon the basis of cost or to be paid on that basis for property retired. Its claim includes these amounts and also includes, as separate items, additional amounts based upon the replacement values of equipment and of property retired. There could be no loss for tax purposes because the Director General failed to pay such claims. These two total $3,364,867.80. The claim for undermaintenance of the property, amounting to $14,082,370.66, was also based in substantial part upon replacement costs. The item of interest on balances, set out in the claim at $1,600,804.59, was a claim for' an item which, if paid, would be income. Failure to pay would not be a deductible loss for tax purposes. The taxpayer would lose nothing which it had previously had; it would simply fail to collect income, and would be required to report only the amount collected. It is thus demonstrated that if we take the settlement as a whole and compare the amount received with that portion of the claim which is shown to be based upon costs to the petitioner, no deductible loss is established. If, however, we accept the breakdown of the settlement made by the Commissioner, as we must do in the absence of evidence that it is incorrect, there is some evidence that the petitioner did in fact sustain a loss in the settlement made upon materials and supplies. While the Commissioner has treated the materials and supplies returned as being the equivalent of those taken over, it is doubtful if this was so in fact. If those returned were less than those taken and petitioner was not compensated for the cost of those not returned, if sustained a loss in the amount of such cost. Such a loss would.be deductible.
We do not think it necessary to pass upon the question whether, if there had been any loss, it would accrue or be incurred in 1920 or in 1921.
Issue No. 33. The agreement of February 28, 1920, provided that costs of additions and betterments should be paid for by the railroad companies and that, in addition to the agreed compensation, the railways should be paid “ a reasonable rate of interest,” to be fixed by the Director General, upon the amount of such costs. The rate of interest was not finally determined until 1920. The amount so to be paid is described throughout the record by the term “ rental interest.” -It is the present position of the Commissioner that, since the amount of such rental interest could not be determined until the rate was fixed in 1920, the entire amount, whether accrued for 1920 or for prior years, is taxable as 1920 income. In his amended answer the Commissioner prays that the income for 1920, as determined by him, be increased accordingly. The petitioner admits that it is liable to return as income for 1920 the rental interest computed for the months of January and February, 1920. Its counsel points out that the contention now made by the Commissioner, that the rental interest which was earned in 1918 and 1919 should be returned as 1920 income, is inconsistent with the position taken by the Commissioner with respect to issue No. 11. Counsel urge that the Commissioner can not be right as to both and contends that the error lies in the position of the Commissioner with respect to issue No. 11. We have already held that the action of the Commissioner in respect of such issue should be affirmed, basing our conclusion upon a number of prior decisions of the Board and the Circuit Court.
Under issue No. 16 the petitioner alleges that the Commissioner committed error in including in its income amounts collected by it from assets standing upon the books of the predecessor companies and not entered upon its books at the time of the reorganization. The items so included are set out in our findings of fact. The petitioner admits that the Commissioner correctly included the second item and concedes as to the third that the record fails to show the cost or March 1, 1913, value of the property. The testimony with respect to the first item is that it represents amounts collected upon accounts due to predecessors of petitioner, which accounts were not transferred to the books of petitioner because they were uncertain as to collectibility. The basis of the petitioner’s contention is that these were all items which entered into the income of the predecessor companies, that the petitioner stands in the shoes of its predecessors and should not be required to return these collections as income. The circumstances with respect to reorganization are set out in connec
Issue No. 17 involves the right of a subsidiary company, Western Coal & Mining Company, to deduct $500 paid by it to the Mount Carmel Hospital in the Pittsburg field where the properties of the mining company were located. That company was required by the Workmen’s Compensation Act to provide hospital care for its injured employees. Without the facilities offered by the hospital it would have been under the necessity of providing such facilities at its own expense. The payment was made, not from the standpoint of philanthropy, but rather of self interest. We are of the opinion that in the circumstances the payment is properly treated by the mining company as a part of its ordinary and necessary expenses and not as a charitable contribution. The deduction claimed should be allowed. Franklin Mills, 7 B. T. A. 1290; Sugarland Industries, 15 B. T. A. 1265; Corning Glass Works v. Commissioner, 37 Fed. (2d) 798.
Issue No. 30 raises the question whether amounts certified by the Interstate Commerce Commission as due to the petitioner and its affiliated companies under the guaranty provisions of section 209 of the Transportation Act are taxable as income in 1920. This question was before the Board in Gulf, Mobile & Northern Railroad Co., 22 B. T. A. 233, decided this day. Our decision there is controlling in this case and the action of the Commissioner in including the guaranty payment as income is affirmed.
Reviewed by the Board.
Decision will be entered under Rule 50.
An amount spent for maintenance is deductible as an ordinary and necessary expense of tbe business. Amounts spent to improve tbe property, to replace or restore property destroyed or damaged and for tbe destruction or damage of -which taxpayer has been or is to be recompensed by another can not be so classified.