Fahs v. Martin
| Decision Date | 30 June 1955 |
| Docket Number | No. 15343.,15343. |
| Citation | 224 F.2d 387 |
| Parties | John L. FAHS, Collector of Internal Revenue for the District of Florida, Appellant, v. John W. MARTIN, Trustee in Bankruptcy for Florida East Coast Railway Company, Appellee. |
| Court | U.S. Court of Appeals — Fifth Circuit |
COPYRIGHT MATERIAL OMITTED
James L. Guilmartin, U. S. Atty., Miami, Fla., Lee A. Jackson, Elizabeth B. Davis, Ellis N. Slack, Special Assts. to Atty. Gen., H. Brian Holland, Asst. Atty., Gen., Edith House, Asst. U. S. Atty., Jacksonville, Fla., for appellant.
Charles T. Akre, Robert N. Miller, Washington, D. C., Russell L. Frink, Harold B. Wahl, Jacksonville, Fla., F. O. Graves, Miller & Chevalier, Washington, D. C., of counsel, for appellee.
Before HUTCHESON, Chief Judge, and TUTTLE, Circuit Judge.
The former Internal Revenue Collector for the State of Florida here appeals from a judgment of the trial court in favor of the Trustee in Bankruptcy for the Florida East Coast Railway Company for a refund of income and/or excess profits taxes for the years 1943, 1944, 1945 and 1946.
The trial was by the court without a jury on stipulated facts. The questions may be simply stated even if they require something more than simple answers:
1. Where a railroad company, all of whose property was in Florida, executed and delivered in New York a mortgage indenture on such property to secure certain first and refunding coupon bonds which were also executed, delivered and made payable in New York, and where the mortgage indenture expressly provided the proceeds of foreclosure sale should be applied not only to the amounts of principal and interest due, but also to interest on overdue installments of interest, and where the railroad trustees accrued on its books the interest on overdue coupons representing installments of interest, are such trustees entitled under Section 23 of the Internal Revenue Code to deduct in 1947 and 1948 the interest so accrued for those years on the defaulted interest coupons?
2. Is the taxpayer, when carrying back net operating losses from 1947 to 1945 and from 1948 to 1946, entitled for excess profits tax purposes, to deduct the full amounts of those losses or is it required to reduce them by 50% of the interest on borrowed capital by reason of the provisions of Section 711(a) (2) (L) of the Internal Revenue Code?
Appellee agrees that appellant's statement of the case is correct. We shall, therefore, adopt that statement from appellant's brief.
The suit below was instituted by Scott M. Loftin and John W. Martin as trustees in bankruptcy for the Florida East Coast Railway Company, hereinafter referred to as the taxpayer. During the pendency of the proceeding, Mr. Loftin died and by order of the court John W. Martin, as sole trustee in bankruptcy, was substituted as the sole party plaintiff.
The taxpayer is a railway corporation whose real property is in the State of Florida, and which has no property in other states. On January 25, 1941, a petition for reorganization of the taxpayer under Section 77 of the Bankruptcy Act was filed in the District Court for the Southern District of Florida, stating that the debtor was insolvent and unable to meet its obligations. For about nine years prior to that time the corporation had been operating in receivership proceedings instituted in the District Court. The reorganization proceeding is still pending and the property of the debtor is being operated by the trustee.
The taxpayer has outstanding $45,000,000 first and refunding mortgage gold bonds dated September 1, 1924, and maturing September 1, 1974. These bonds were issued in New York and payable in New York. The bonds are secured by a mortgage covering all of the property used by the company for railroad purposes. The mortgage was executed in New York and the trustees under the mortgage indenture were a New York bank and an individual, a resident of New York. The mortgage provides for entry by the trustees upon the property after default and that in case the principal sum of the bonds shall not have become due at the time income shall be applied to the payment in default "with interest thereon at the same rates, respectively, as were borne by the respective bonds on which such interest shall be in default." It further provided that any proceeds of sale by the trustees should be applied after expenses of the sale had been paid, etc., to the payment of the amounts of principal and interest due, together with interest on the principal and overdue installments of interest.
On November 10, 1943, the trustees petitioned the District Court for the Southern District of Florida, sitting in bankruptcy, for authority to accrue the interest on interest, the coupons having become in default. This interest on interest is hereinafter referred to as penalty interest. On November 18, 1943, an order was entered by the District Court, the material parts of which are as follows:
For the calendar years 1947 and 1948, the trustees filed income tax returns showing net operating losses in the amount of $3,887,056.10 for 1947 and $2,113,406.53 for 1948. In arriving at these net operating losses there were deducted the sums of $1,620,622.94 for 1947 and $1,697,028.03 for 1948, as interest on matured and unpaid coupon interest, otherwise known as penalty interest. The Commissioner of Internal Revenue determined net operating losses for 1947 and 1948, which were allowed as carry-backs to 1945 and 1946, but disallowed the penalty interest claimed on the returns for 1947 and 1948.
The Commissioner allowed the total amount of the net operating losses for 1948 as a carry-back against the normal tax income for 1946, and allowed the total amount set forth above for 1947 as a carry-back deduction against the normal tax income for 1946. However, he allowed a 1947 net loss carry-back of only $874,206.89 as a deduction against the 1945 excess profits net income, the difference representing 50% of the interest on borrowed capital for 1947 accrued as a liability by the taxpayer. He did not allow any carry-back from 1948 as a deduction against the 1946 excess profits net income as 50% of the borrowed capital exceeded the amount allowed as a deduction against ordinary net income. As a result of these adjustments, the Commissioner determined overpayments which were refunded and not involved in this suit.
The refunds just mentioned were made in 1951. On June 9, 1949, the trustees had filed claims for refund for the years 1943, 1944, 1945 and 1946. The claims for 1945 and 1946 were based on carry-backs of net operating losses of approximately $3,800,000 from 1947 to 1945, and approximately $2,100,000 from 1948 to 1946, upon the ground that the taxpayer was entitled to deduct the interest on interest claimed in its returns for those years. The claims for 1943 and 1944 were based on carry-backs to those years of unused excess profits credits for 1945 and 1946. These claims for refund, to the extent not allowed, were rejected on May 11, 1951.
On August 13, 1951, the trustees filed with the Collector of Internal Revenue supplemental claims for refund for the years 1943, 1944, 1945 and 1946. These claims were based upon the contention that the Commissioner erred in reducing the net operating losses for excess profits tax purposes by 50% of the interest on borrowed capital. These claims were disallowed on March 18, 1952. The original complaint in this case, based on the first claims, was filed on March 11, 1952, and the amended complaint filed on April 15, 1952.
None of the penalty interest, which has been in default since September 1, 1931, has ever been paid. At various times the District Court has entered orders directing the trustees to pay in cash the unpaid coupon interest. The latest order was July 31, 1952, ordering the payment of interest matured through September 1, 1936. Each of these orders contain the following provision:
"The Court expressly reserves for future determination the claim of holders of First and Refunding Mortgage bonds to be paid interest upon the overdue installments of interest upon said bonds since the maturity thereof and this order shall not be construed as affecting the rights of said bondholders with respect thereto; nor shall acceptance by the holders of the First and Refunding Mortgage bonds of an amount equal to the face value of the coupons, nor the delivery by them to the Trustees of any coupon or coupons on said bonds, constitute an estoppel against or a waiver of, or in any way prejudice or affect the claim of the holders of said bonds and coupons for interest on overdue coupons or the installments of interest herein ordered to be paid."
Ordinarily, of course, a taxpayer on the accrual basis must accrue interest in the year in which it becomes due, and such an accrual is a deduction within the provisions of Section 23 of the Internal Revenue Code of 1939, 26 U.S.C.A. § 23.
The Government's contention that such deduction is not...
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