Baltimore & OR Co. v. Commissioner of Internal Rev.

• Citation: 78 F.2d 460
• Decision Date: 18 June 1935
• Docket Number: No. 3777.,3777.
• Court: United States Courts of Appeals. United States Court of Appeals (4th Circuit)
• Parties: BALTIMORE & O. R. CO. v. COMMISSIONER OF INTERNAL REVENUE.

78 F.2d 460 (1935)

BALTIMORE & O. R. CO. v. COMMISSIONER OF INTERNAL REVENUE.

No. 3777.

Circuit Court of Appeals, Fourth Circuit.

June 18, 1935.

Hugh C. Bickford, of Washington, D. C. (R. Kemp Slaughter, of Washington, D. C., on the brief), for petitioner.

Carlton Fox, Sp. Asst. to Atty. Gen. (Frank J. Wideman, Asst. Atty. Gen., and Sewall Key, Sp. Asst. to Atty. Gen., on the brief), for respondent.

Before PARKER, NORTHCOTT, and SOPER, Circuit Judges.

NORTHCOTT, Circuit Judge.

This is a petition to review a decision of the United States Board of Tax Appeals involving income taxes of the petitioner for the year 1927 in the amount of $502,498.56. The decision of the Board is reported in 29 B. T. A. 368, and the petition to review was filed May 8, 1934, pursuant to the provisions of sections 1001 and 1003 of the Revenue Act of 1926, c. 27, 44 Stat. 9, as amended by section 1101 of the Revenue Act of 1932, c. 209, 47 Stat. 169 (26 USCA § 1224 and note, and § 1226).

There is no dispute as to the facts, and three main questions are involved in this appeal:

(1) Is the amount of the reduction in the subscription price of an issue of petitioner's capital stock deductible from gross income as interest paid on an indebtedness of the petitioner said to have been incurred by it to the subscribers to its stock as a result of the fact that in accordance with the subscription offer they paid for the stock in advance of its issue?

(2) Are underwriting commissions or expenditures to bankers for the insurance of an issue of capital stock and other expenditures made by petitioner in connection with the issuance of its capital stock deductible from its gross income, either as losses or business expenses?

(3) Whether a part of the compensation received from the city of New York for property condemned for public purposes is taxable as income in the year in which it is received, and whether there was any error in the procedure before the Board in the hearing on the question of fixing the value of the property as of March 1, 1913?

The petitioner is a Maryland corporation engaged in the business of operating a railroad and transportation system, either directly or through wholly-owned subsidiaries. It has kept its books on the accrual system of accounting in accordance with the system of accounting prescribed by the Interstate Commerce Commission. It filed a consolidated return for the purposes of taxation for the year 1927.

As to the first point involved, the facts are as follows:

On June 9, 1927, petitioner's board of directors resolved to issue and sell 632,425 shares of its authorized but unissued common stock of a par value of $100 a share, and to offer to its common and preferred shareholders the right to subscribe therefor to the extent of a certain percentage of their holdings at the price of $107.50 a share, payable as indicated in a notice to shareholders. The shareholders were advised of their subscription rights and were given the option in exercising them either to pay $106.83 on or before July 21, 1927 (which is the full subscription price less a deduction of interest on the par value at the rate of 6 per cent. per annum from July 21, 1927, to September 1, 1927, when certificates were to be delivered, and the subscribers could participate in dividends), or to pay $32.25 on or before July 21, 1927, and $74.60 on December 1, 1927 (which is the balance of the full subscription price less a deduction of interest on 30 per cent. of the par value at the rate of 6 per cent. per annum from July 21, 1927, to December 1, 1927).

Petitioner's shareholders purchased 614,925 shares of the issue. Petitioner claimed the amount credited by it to its stockholders, as a result of having received the subscription in advance of the issuance of stock, as a deduction from its gross income under section 234 (a) (2) of the Revenue Act 1926, 26 USCA § 986 (a) (2). The Commissioner of Internal Revenue denied this deduction and the Board approved his action, holding that this amount was not interest, even though it was so treated on the books of the petitioner, and holding that the money petitioner received was not loaned or borrowed, but represented the purchase price of stock sold by it to be delivered in the future. The Board further held that the price of $107.50 per share was only nominally fixed at that amount, reasoning that the subscribers could not have recovered the amount paid as a debt, but only if there had been a breach of petitioner's contract; that the offer was a mere formula, which does not suffice to create indebtedness that does not in fact exist, or to transform a discount in price into interest on indebtedness. It is claimed on behalf of petitioner that the subscribers to the issue of stock were not stockholders until the stock was actually issued and that there was a period of several months during which the petitioner was in possession of and had the right to use the money thus advanced, upon which money it made certain payments which should have been considered as interest on the money thus advanced. Section 234 (a) (2), Revenue Act 1926, provides for deduction from gross income of "all interest paid or accrued within the taxable year on its indebtedness," and the question presented is whether, as a result of the payment to it of the subscriptions in advance of the issuance of the stock as required by the offer, the petitioner incurred an indebtedness to the subscribers, and the stated reduction in the price of stock, paid for in advance, represents the payment of interest upon such indebtedness within the meaning of the statute.

It is well settled that deductions are only allowed as provided by statute and that in securing them the taxpayer must bring himself clearly within the terms of the statute. New Colonial Ice Co. v. Helvering, 292 U. S. 435, 54 S. Ct. 788, 78 L. Ed. 1348; Burnet v. Thompson Oil & Gas Co., 283 U. S. 301, 51 S. Ct. 418, 75 L. Ed. 1049; Woolford Realty Co. v. Rose, 286 U. S. 319, 326, 52 S. Ct. 568, 76 L. Ed. 1128; Ilfeld Co. v. Hernandez, 292 U. S. 62, 66, 54 S. Ct. 596, 78 L. Ed. 1127.

We are of the opinion that the petitioner has not brought itself within the terms of any statute allowing the deduction here claimed. The fixing of the price at which the stock could be bought and the determining of a certain percentage of that price as interest was a bookkeeping transaction of the petitioner, and there is no substance in the transaction. No recovery of the amount so paid could have been had unless the petitioner had breached its contract for the delivery of the stock, and it was not an actual indebtedness incurred to the subscribers. A mere formula will not suffice for the purpose of securing the deduction. Old Colony R. Co. v. Commissioner, 284 U. S. 552, 52 S. Ct. 211, 76 L. Ed. 484, and Henrietta Mills v. Commissioner (C. C. A.) 52 F.(2d) 931.

The petitioner did not receive the sum as a loan, and it did not actually pay out interest thereon, or on the par value of the stock. We agree with the decision of the Board of Tax Appeals when it says: "The statute requires that there should be an indebtedness, that there should be interest upon it and that it should be paid or accrued within the taxable year."

The action of the Commissioner in disallowing the deduction and of the Board in approving the action of the Commissioner were correct.

We now come to the consideration of the second point involved. In connection with the sale of the stock issue mentioned above, the petitioner in the taxable year paid underwriting commissions or fees aggregating $1,422,956.25 to two New York banking houses and incurred and paid expenses for printing, etc., amounting to $17,053.80, and claimed these amounts as deductions as ordinary and necessary expenses of its business for the taxable year. In its petition for review by this court, it is claimed on behalf of petitioner that the deduction should have been allowed either as a business expense under section 234 (a) (1) of the Revenue Act of 1926, 26 US CA § 986 (a) (1), or as a loss under section 234 (a) (4) of said Revenue Act 1926, 26 USCA § 986 (a) (4).

The pertinent section of the Revenue Act of 1926, c. 27, 44 Stat. 9, is as follows:

"Sec. 234. (a) In computing the net income of a corporation subject to the tax imposed by section 230 section 981 of this title there shall be allowed as deductions:

"(1) All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. * * *

"(4) Losses sustained during the taxable year and not compensated for by insurance or otherwise. * * *" U. S. C. App., title 26, § 986 (a) (1, 4), 26 USCA § 986 (a) (1, 4).

That these expenditures were not ordinary and necessary expenses is well settled, and we know of no authority to the contrary. Simmons Co. v. Commissioner (C. C. A.) 33 F.(2d) 75, 76, certiorari denied 280 U. S. 588, 50 S. Ct. 37, 74 L. Ed. 637, and Corning Glass Works v. Lucas, 59 App. D. C. 168, 37 F.(2d) 798, 68 A. L. R. 736, certiorari denied 281 U. S. 742, 50 S. Ct. 348, 74 L. Ed. 1155.

We think that the principles laid down in these cases, of which we approve, also settle conclusively the fact that these expenditures were not losses. As was said in the Simmons Co. Case: "Commissions paid for marketing stock simply diminish the net return from the stock issue. Financially, they are equivalent to an issue of stock at a discount from par; the par value must be carried as a liability without an offsetting, equal, amount of cash or property."

The Supreme Court said in the case of Helvering v. Union Pacific Ry. Co., 293 U. S. 282, 55 S. Ct. 165, 168, 79 L. Ed. 363: "There is no occasion for deduction of commissions from gross income at a later time unless the total amount realized by the sale of the bonds is less than their par value. In that case the difference alone is the amount to be amortized and deducted from gross income in the annual...