Atchison, Topeka & Santa Fe Ry. Co. v. Comm'r of Internal Revenue, Docket No. 73138.

• Decision Date: 29 June 1961
• Docket Number: Docket No. 73138.
• Citation: 36 T.C. 584
• Parties: THE ATCHISON, TOPEKA AND SANTA FE RAILWAY COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

36 T.C. 584

THE ATCHISON, TOPEKA AND SANTA FE RAILWAY COMPANY, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 73138.

Tax Court of the United States.

Filed June 29, 1961.

ACCRUAL BASIS— INTEREST FROM SUBSIDIARY.— Petitioner's wholly owned subsidiary, Gulf, was delinquent in payment of interest due from 1931 to 1941 to petitioner on loans. In 1942-1946 petitioner collected all Gulf's earnings and credited against arrearages. In 1931-1945 petitioner and subsidiaries filed consolidated returns; in 1946 and later years, separate returns. In 1947 petitioner decided to forego collection of arrearages and in the taxable years 1948 and 1949 accrued only current interest. Held, petitioner is not required in 1948 and 1949 to accrue Gulf's net income or a part of it as interest to be applied against arrearages. William P. Tilton, Jr., Esq., Charles B. McInnis, Esq., G. Kibby Munson, Esq., Roger H. Muzzall, Esq., John J. Schmidt, Esq., and Jonathan C. Gibson, Esq., for the petitioner.

Don S. Harnack, Esq., Cornelius C. Shields, Esq., and Theodore W. Hirsh, Esq., for the respondent.

TIETJENS, Judge:

The respondent determined deficiencies in income tax for the calendar years 1948 and 1949 in the respective amounts of $1,216,173.51 and $1,377,204.78. The sole issue remaining for decision is whether the respondent erred in determining that the petitioner should have accrued additional interest income from a subsidiary in those years.

The petitioner's corporation income tax returns for 1948 and 1949 were filed with the collector of internal revenue at Wichita, Kansas.

FINDINGS OF FACT.

The stipulated facts are found accordingly and the exhibits to the stipulation are incorporated by this reference.

The Atchison, Topeka and Santa Fe Railway Company, herein referred to as Atchison, is a corporation organized under the laws of Kansas with its principal office in Chicago, Illinois.

Gulf, Colorado and Santa Fe Railway Company, herein referred to as Gulf, is a corporation organized under the laws of Texas with its principal office in Galveston, Texas.

At all pertinent times Atchison and Gulf were engaged in the railroad business and were class I common carriers by railroad subject to regulation by the Interstate Commerce Commission, herein referred to as the ICC. Atchison operated approximately 9,100 miles of railroad in Illinois and California and certain other States exclusive of Texas. Gulf operated approximately 2,100 miles of railroad in Texas, Louisiana, and Oklahoma.

All the capital stock of Gulf, except for directors' qualifying shares, was owned by Atchison.

During 1948 and 1949 certain officers of Atchison were also officers of Gulf.

At all pertinent times Atchison and Gulf were required to maintain their accounts in accordance with the system of accounts prescribed by the ICC. They kept their books and filed their Federal income tax returns on an accrual basis and for calendar years. For the years 1924 through 1945, consolidated returns were filed covering the Santa Fe System, herein referred to as the System, which included Atchison and Gulf and other corporations owned by Atchison. For the years 1946 through 1949 separate returns were filed by Atchison and by Gulf and other corporations of the System.

Under a general mortgage dated in 1924 Gulf issued to Atchison bonds in the amount of $42,310,000 bearing interest at 6 percent, amounting to $2,538,600 annually. These were pledged by Atchison under its mortgage as partial security for its bonds maturing in 1995. Gulf was also indebted to Atchison in varying amounts represented by a certificate of indebtedness. From 1930 to the end of 1940 this was in the amount of $4 million. In 1941 this was reduced to $2,080,050.57 and remained at this amount until 1953. Atchison also made capital advances to Gulf. The amount of Gulf's debt to Atchison at the end of the years 1943 to 1949 and interest due each year were as follows:

+-----------------------------+
                ¦    ¦Yearend   ¦Interest due ¦
                +----+----------+-------------¦
                ¦    ¦total debt¦in year      ¦
                +----+------------------------¦
                ¦Year¦Thousands of dollars    ¦
                +----+------------------------¦
                ¦1943¦$44,810   ¦$2,579       ¦
                +----+----------+-------------¦
                ¦1944¦45,386    ¦2,586        ¦
                +----+----------+-------------¦
                ¦1945¦44,854    ¦2,614        ¦
                +----+----------+-------------¦
                ¦1946¦45,024    ¦2,566        ¦
                +----+----------+-------------¦
                ¦1947¦44,851    ¦2,624        ¦
                +----+----------+-------------¦
                ¦1948¦56,049    ¦2,597        ¦
                +----+----------+-------------¦
                ¦1949¦56,688    ¦3,156        ¦
                +-----------------------------+
                

Gulf was obligated to pay rental for the use of railroad properties owned but not operated by certain other subsidiaries of Atchison. The amount of rental was determined in part by the amount of interest accruing on bonds of the lessors held by Atchison and on advances to the lessors by Atchison. A portion of the rental, based upon the interest obligation of the lessors, was paid over to Atchison by Gulf for account of the lessors and was recorded by Atchison as interest income.

From 1924 until 1953 Gulf charged all interest owed, whether or not paid, to an account entitled ‘Interest on Funded Debt’ or to an account entitled ‘Interest on Unfunded Debt,‘ herein referred to collectively as Interest on Debt account and charged rentals owed to an account entitled ‘Rent for Leased Roads and Equipment.

In each of the years 1928, 1929, and 1930 Gulf earned net income in excess of all current interest and rental charges and paid in full the current interest due from it to Atchison in amounts in excess of $3 million each year. In these years Atchison recorded such interest to an account entitled ‘Income from Funded Securities,‘ herein referred to as the Income from Securities account, and by setting up the same amounts as a current asset in an account entitled ‘Interest and Dividends Receivable.’

In these years the amounts of current interest were included in the consolidated tax returns as mutually offsetting intercompany items and were not eliminated either as expense or income in determining consolidated taxable net income.

In each of the years 1931 through 1941 Gulf earned less than its current interest expense. Gulf paid to Atchison, on account of interest, its earnings per books for 1931 and for 1932 before current interest expense, and also paid the amount of certain credits to profit and loss in 1931.

In 1931 and 1932 Atchison included the amount of current interest due it from Gulf as Income from Securities and as Interest and Dividends Receivable. At the end of each year the difference between the amount of Gulf's earnings, plus credits to profit and loss, and the total of the current interest was transferred by Atchison to an account entitled ‘Deferred Income-GC&SF Ry. Co.’ After such transfer that portion of Income from Securities account attributable to interest on Gulf indebtedness included the earnings of Gulf plus the credits referred to. The amount of Gulf's earnings for 1932 was applied by Atchison to the earliest matured installment of unpaid interest which was for the year 1931.

In 1933 and in each year thereafter through 1941 Gulf made no payment to Atchison on account of interest. In each of the years 1933, 1934, 1935, and 1940 Gulf had a loss per books after rentals but before interest. In each of the years 1936 through 1939 and in 1941 Gulf had earnings per books after rentals but before interest and such earnings were less than the amount of current interest.

In 1934 Atchison's book accounting was changed. In the period 1934 through 1948 entries of interest due from Gulf were made directly to the Deferred Income account, thereby eliminating the yearend adjustments such as was made for 1931 and 1932.

In the preparation of the consolidated Federal income tax returns for the years 1931 and 1932, the excess of the expense taken from the Interest on Debt account of Gulf over that portion of the income taken from the Income from Securities account of Atchison which represented Gulf interest, was eliminated in determining consolidated taxable net income. To the extent that the interest income of Atchison and the interest expense of Gulf were mutually offsetting, they were not eliminated either as expense or income in determining consolidated taxable net income.

In the preparation of the consolidated Federal income tax returns for the years 1933 to 1941, inclusive, the total amount of the Interest on Debt account on the books of Gulf was eliminated in computing consolidated taxable net income. No part of Atchison's Income from Securities account included Gulf interest during that period.

At the end of 1941, interest owed to Atchison by Gulf but unpaid exceeded $27 million.

In 1942 and in each year through and including 1945, Gulf earned net income in excess of its current interest charges.

In 1942 and in each year thereafter through and including 1945, Gulf regularly paid to Atchison, on account of interest, its net income after rentals and before current interest.

The amounts so paid were transferred by Atchison from the Deferred Income-GC& SF Ry. Co. account to the Income from Securities account at the end of each year 1942-1945, inclusive, and were applied by Atchison to the earliest matured installment of unpaid interest.

In the preparation of the consolidated Federal income tax returns for the years 1942 to 1945, inclusive, the portion of Atchison's Income from Securities account which represented interest on Gulf indebtedness and the total amount of Gulf's Interest on Debt account were both eliminated in determining consolidated taxable net income.

In 1946 and in each year thereafter through and including 1953, Atchison and Gulf filed separate Federal income tax returns.

In 1946, Gulf had earnings per books after rental and before current interest expense in an amount less than such interest. For the year 1946, Gulf paid to Atchison on...