Adrian & James, Inc. v. Comm'r of Internal Revenue

• Decision Date: 02 February 1945
• Docket Number: Docket No. 685.
• Citation: 4 T.C. 708
• Parties: ADRIAN & JAMES, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

4 T.C. 708

ADRIAN & JAMES, INC., PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 685.

Tax Court of the United States.

Promulgated February 2, 1945.

1. In 1925 and during a period from September 29, 1932, to April 21, 1937, petitioner, a personal holding company, purchased gold notes of a transit company with interest coupons attached. Default was made in payment of the notes and the final coupons attached on September 1, 1932, when they all matured, and shortly thereafter the transit company was placed in receivership. After receiving various payments on the indebtedness during the receivership, which payments were derived from interest on the bonds pledged as collateral to the notes and coupons, petitioner sold the notes and the final coupons. Held, that certain parts of those payments constituted a return of capital (by which petitioner's cost basis of the notes and coupons was reduced for the purpose of ascertaining its gain on the sale) and that certain other parts of such payments constituted interest.

2. In March 1937 petitioner paid Federal income tax due for 1936 from a corporation which had been merged into petitioner on December 31, 1936, under an agreement of merger entered into in conformity with a statute of Delaware. Under the agreement and the statute all the debts and liabilities of the predecessor corporation attached to the surviving merged corporation and were enforceable against it. Held, that the amount of income tax of the predecessor corporation paid by petitioner as the surviving corporation should be deducted, under section 406(a)(1) of the Revenue Act of 1938, from its net income in determining its Title 1A net income for the purpose of determining its dividend carry-over from 1937 to 1939.

3. In computing its dividend carry-over from 1938 to 1939 petitioner is entitled to have the carry-over computed on the basis of its adjusted net income as defined in section 13(a) of the Revenue Act of 1938. Elden McFarland, Esq., for the petitioner.

Jonas M. Smith, Esq., for the respondent.

Respondent determined deficiencies in petitioner's income tax and in personal holding company surtax for the calendar year 1939 in the amounts of $2,874.28 and $9,813.89, respectively.

The issues are (1) whether the payments, or a portion thereof, received by petitioner with respect to the Interborough Rapid Transit Co. 7 percent gold notes and attached coupons while that company was in receivership, which payments were made out of interest collected on the bonds pledged as collateral thereto, constituted a return of capital rather than interest, for the purpose of ascertaining the cost basis of the notes and coupons in connection with the sale thereof; (2) whether payment by petitioner of the income tax of a corporation which had merged with petitioner is deductible as an income tax of petitioner for the purpose of computing the amount of petitioner's dividend carry-over from 1937 to 1939; (3) whether interest received by petitioner in 1938 on obligations of the United States should be excluded from its adjusted net income for 1938 in computing the amount of petitioner's dividend carry-over from 1938 to 1939.

The proceeding has been submitted on a stipulation of facts and oral evidence adduced at the hearing. Such of the stipulated facts as are not set forth herein are included by reference.

FINDINGS OF FACT.

The petitioner is a Delaware corporation, with its principal office at 40 Journal Square, Jersey City, New Jersey. The returns for the period here involved were filed with the collector for the fifth district of New Jersey.

On October 26, 1925, petitioner purchased $10,000 face value of Interborough Rapid Transit Co. (hereinafter sometimes called Transit Co.) 7 percent gold notes at a cost of $9,100.63. Each note was of the fact value of $1,000. At the time of the purchase final interest coupon No. 20, in the face amount of $35, as well as other coupons, was attached to each of said notes. The maturity date of the notes was September 1, 1932. The due date of coupon No. 20 was September 1, 1932.

On September 1, 1932, the obligor, Transit Co., defaulted in the payment of the principal of the notes and in the payment of the final interest coupons No. 20 attached thereto. No prior default in payment of interest or principal had occurred.

Subsequent to the foregoing default, and during the period from September 29, 1932, to April 21, 1937, petitioner acquired additional 7 percent gold notes of the Transit Co. of the same character in the total face amount of $38,000, at a total cost of $24,910. Final interest coupon No. 20 in the face amount of $35 was attached to each of said notes. These notes and coupons were acquired on the dates, in the amounts, and at the cost below tabulated:

+------------------------------+
                ¦Face value ¦Date    ¦Cost     ¦
                +-----------+--------+---------¦
                ¦of notes   ¦acquired¦         ¦
                +-----------+--------+---------¦
                ¦$4,000     ¦9/29/32 ¦$2,410.00¦
                +-----------+--------+---------¦
                ¦3,000      ¦10/ 1/32¦1,807.50 ¦
                +-----------+--------+---------¦
                ¦10,000     ¦10/19/32¦5,862.50 ¦
                +-----------+--------+---------¦
                ¦2,000      ¦11/ 3/32¦1,095.00 ¦
                +-----------+--------+---------¦
                ¦2,000      ¦8/23/33 ¦1,385.00 ¦
                +-----------+--------+---------¦
                ¦2,000      ¦11/10/33¦1,235.00 ¦
                +-----------+--------+---------¦
                ¦1,000      ¦11/10/33¦622.50   ¦
                +-----------+--------+---------¦
                ¦3,000      ¦11/13/33¦1,867.50 ¦
                +-----------+--------+---------¦
                ¦2,000      ¦11/14/33¦1,245.00 ¦
                +-----------+--------+---------¦
                ¦2,000      ¦11/15/33¦1,245.00 ¦
                +-----------+--------+---------¦
                ¦5,000      ¦12/26/35¦4,600.00 ¦
                +-----------+--------+---------¦
                ¦2,000      ¦4/21/37 ¦1,535.00 ¦
                +-----------+--------+---------¦
                ¦           ¦        ¦         ¦
                +-----------+--------+---------¦
                ¦38,000     ¦        ¦24,910.00¦
                +------------------------------+
                

All the Transit Co. 7 percent gold notes purchased by petitioner were issued as of September 1, 1922, to mature in 10 years. There were originally attached to each $1,000 note 20 interest coupons of $35 each, maturing in successive semiannual periods; that is to say, the first coupon covered interest on the principal of the note to which it was attached for the first 6 months and each successively numbered coupon covered such interest for a later 6-month period.

Shortly after September 1, 1932, the obligor on the notes was placed in receivership in the United States District Court for the Southern District of New York. A receiver was duly appointed by the court, and the Bankers Trust Co., trustee under the collateral indenture of the Transit Co. dated September 1, 1922, continued to act as such trustee.

On December 3, 1935, the court issued an order in that proceeding reciting that the trustee has petitioner ‘for instructions as to the proper distribution and allocation of monies received and to be received by said Trustee from the Receiver herein as interest upon Bonds pledged as collateral under said Indenture.‘ The court then ‘FOUND, ORDERED, ADJUDGED AND DECREED‘ that the Bankers Trust Co., as trustee, and the holders and owners of the secured 7 percent gold notes and coupons of the Transit Co. had a valid claim against that company ‘for the principal amount of said Notes and for interest upon said Notes and upon all of said interest coupons from and after their respective maturities.‘ The order provided further that ‘so far as such claim is for interest, it accrues at the rate of seven (7%) per cent. per annum.‘ The order further provided that:

3. The holder or registered owner of each Note or coupon is entitled to share in each distribution of collateral, its income and its proceeds, on the basis of the face amount of such Note or coupon with interest thereon from maturity at the rate of seven (7%) per cent. per annum.

4. The pro rata participation of the holders of coupons matured prior to September 1, 1932, in each distribution should include simple interest thereon from their respective maturities to the date of such distribution, so far as the same has not theretofore been paid.

5. The monies received and to be received by Bankers Trust Company, as Trustee, from the Receiver herein should be allocated first to interest upon all of the Notes and coupons accrued from their respective maturities to the date of any distribution, and then in reduction of the principal amounts of the Notes and coupons pro rata between the principal amount of each Note and coupon * * * .

The order instructed the trustee to allocate on its records any distributions theretofore or thereafter made as against the obligor, Transit Co., and as between the respective holders and owners of the notes and coupons, ‘upon the principles hereinabove set forth‘ and illustrated by a schedule detailing the amount and application of each semiannual distribution beginning January 1, 1933, to and including July 1, 1935. A typical excerpt from the schedule is as follows:

+-----------------------------------------------------------------------------+
                ¦                                      ¦Principal of    ¦Final      ¦Total    ¦
                ¦                                      ¦note            ¦coupon     ¦         ¦
                +--------------------------------------+----------------+-----------+---------¦
                ¦                                      ¦                ¦(#20)      ¦         ¦
                +--------------------------------------+----------------+-----------+---------¦
                ¦September 1, 1932, there became due   ¦$1,000.00       ¦$35.00     ¦$1,035.00¦
                +--------------------------------------+----------------+-----------+---------¦
                ¦January 1, 1933:                      ¦                ¦           ¦         ¦
                +--------------------------------------+----------------+-----------+---------¦
                ¦Post-due interest--4 mos. at 7%       ¦23.33           ¦.82        ¦24.15    ¦
                +--------------------------------------+----------------+-----------+---------¦
                ¦Total amount due January 1, 1933

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