Illinois Terminal Railroad Company v. United States

• Decision Date: 14 April 1967
• Docket Number: No. 16-64.,16-64.
• Citation: 375 F.2d 1016
• Parties: ILLINOIS TERMINAL RAILROAD COMPANY v. The UNITED STATES.
• Court: U.S. Claims Court

375 F.2d 1016 (1967)

ILLINOIS TERMINAL RAILROAD COMPANY v. The UNITED STATES.

No. 16-64.

United States Court of Claims.

April 14, 1967.

Robert T. Molloy, Washington, D. C., attorney of record, for plaintiff. Gerald J. O'Rourke, Jr., and Robert E. Simpson, Washington, D. C., of counsel.

Edna G. Parker, Washington, D. C., with whom was Asst. Atty. Gen., Mitchell Rogovin, for defendant. Philip R. Miller, Washington, D. C., of counsel.

Before COWEN, Chief Judge, and LARAMORE, DURFEE, DAVIS, COLLINS, SKELTON and NICHOLS, Judges.

OPINION

PER CURIAM.

This case was referred to Chief Trial Commissioner Marion T. Bennett with directions to make findings of fact and recommendation for conclusion of law. The commissioner has done so in a report and opinion filed on April 25, 1966. Exceptions to the commissioner's findings, opinion and recommendation for conclusions of law were filed by plaintiff. The case was submitted to the court on the briefs of the parties and oral argument of counsel. Since the court is in agreement with the opinion, findings and recommendation of the commissioner, with modifications, it hereby adopts the same, as modified, as the basis for its judgment in this case, as hereinafter set forth. Plaintiff is, therefore, not entitled to recover and the petition is dismissed.

Commissioner Bennett's opinion,^* as modified by the court is as follows:

At issue in this tax refund case is whether plaintiff corporation shall be denied the benefits of section 163(a) of the Internal Revenue Code of 1954, 26 U.S.C. § 163(a) (1964), which permits a deduction for "all interest paid or accrued within the taxable year on indebtedness" because of the limitation imposed by section 265(2) of the Internal Revenue Code of 1954:

No deduction shall be allowed for —

(1) * * *

(2) Interest.

Interest on indebtedness incurred or continued to purchase or carry obligations (other than obligations of the United States issued after September 24, 1917, and originally subscribed for by the taxpayer) the interest on which is wholly exempt from the taxes imposed by this subtitle. * * *

Plaintiff was organized under the laws of Delaware and has its principal offices in St. Louis, Missouri. Plaintiff is a common carrier by railroad operating in interstate commerce and subject to the jurisdiction of the Interstate Commerce Commission, hereinafter referred to as the I.C.C. At all times pertinent, it filed its federal income tax returns on the accrual method of accounting and on the basis of the calendar year ending December 31. Plaintiff was incorporated in 1954 by a group of 11 trunkline railroads which had offered to purchase the assets and assume the liabilities of an Illinois corporation (plaintiff's predecessor) for $20,015,635 in cash. On April 2, 1956, the I.C.C. approved the sale, authorized plaintiff to issue 2,000 shares of capital stock to the trunkline railroads and permitted them to endorse plaintiff's note for a sum not to exceed $20,015,635. The sale was consummated on June 15, 1956. Among the assets so acquired was approximately $3,000,000 in cash, some $2,500,000 of which plaintiff used to invest in government securities and commercial notes. Among the physical assets that plaintiff acquired were locomotives, freight and passenger cars, depots, tracks and rights-of-way in Missouri and Illinois. In addition, plaintiff acquired the McKinley Bridge, which spanned the Mississippi River at St. Louis, Missouri, and connected St. Louis with Venice, Illinois.

The McKinley Bridge carried railroad tracks and a highway. It was the largest single asset that plaintiff acquired, and at the time of the I.C.C. approval, plaintiff had intended to sell the bridge to the Bi-State Development Agency for $13,500,000 and to obtain an exclusive lease-back of the railroad track and other rail facilities for 40 years or other term to be agreed on by the parties. The sale was to occur contemporaneously with the purchase of assets from plaintiff's predecessor and was intended to finance $13,500,000 of the $20,015,635 purchase price, with the remaining $6,515,635 to be borrowed from the Mercantile Trust Company. But Bi-State, created under a compact between Illinois and Missouri, became embroiled in litigation in the state courts, and the sale was never completed.

The full $20,015,635 purchase price of the assets had to be financed by a loan for that amount from the Mercantile Trust Company. The loan was obtained on June 15, 1956, for plaintiff's unsecured, 2-year, 4-percent promissory note, plus the endorsement of the group of railroad company shareholders. The debt was originally intended to provide interim financing until the bridge could be sold. But the bridge was not sold until November 21, 1958, and the note was extended from June 15, 1958, to December 15, 1958.

Finally, on November 21, 1958, the bridge, which had been allocated a cost basis of $8,531,370.93 by the Internal Revenue Service, was sold to the city of Venice, Illinois. The city paid plaintiff $9,000,000 in cash and $11,000,000 par value of the city of Venice's Subordinate Bridge Revenue Bonds, Series "B," dated October 1, 1958, and due October 1, 1998, bearing interest at 2 percent from October 1, 1960. The interest on these Series "B" bonds was and still remains excludible from gross income for purposes of the federal income tax. The $9,000,000 in cash was applied by plaintiff to its outstanding debt, causing the debt to be reduced to $11,015,635.

The ordinance which authorized the issuance of the Series "B" bonds by the city of Venice provided for their redemption prior to maturity upon certain conditions without the approval of the bondholders. It also permitted the modification of the ordinance with the approval of the City Council and holder or holders of 75 percent —

* * * in principal amount of each series of the Bonds then outstanding, * * * provided, however, that no such modification or alteration shall extend the maturity of or reduce the interest rate on, or otherwise alter or impair the obligation to pay the principal or interest or redemption premiums, if any, at the time and place and at the rate and in the currency provided therein of any Bond, without the express consent of the holder or registered owner of such Bond, or reduce the percentage of Bonds required for the affirmative vote or written consent to a modification or alteration, or alter or impair the covenants set forth in Section 5.01 hereof. * * * Article X, § 10.02.

Plaintiff's present bondholdings represent 70.9 percent of the Series "B" bonds issued.

Rail facilities on the bridge were leased back to the plaintiff at the time of the sale under terms which created a 50-year leasehold and options in perpetuity to renew the lease for successive terms of 50 years. The McKinley Bridge is very important in plaintiff's operations, and a substantial part of its revenues are earned by reason of having access to that bridge for transriver shipments.

Due to delays in arranging for permanent financing, the maturity date of plaintiff's debt was extended from December 15, 1958, to December 15, 1959, with interest at 4¼ percent. On December 31, 1958, plaintiff sold some of its capital assets and United States Treasury bills for cash and used $515,635 of the proceeds to reduce the balance on its promissory note to $10,500,000. Then, in January of 1959, plaintiff requested offers from two investment firms to purchase $4,000,000 par value of the Series "B" bonds. Both firms had shown an earlier interset in the bonds and both submitted bids. The higher bid of 30.799 percent of par "flat" was submitted by B. J. Van Ingen & Company, Inc., which had previously shown an interest in purchasing all or part of the $11,000,000 par value Series "B" bonds and which reiterated its interest in purchasing any future offerings of the bonds. Plaintiff refused to make any commitments about the prospects for additional sales, but because Van Ingen was the highest bidder for the current offerings, plaintiff sold and Van Ingen purchased $3,200,000 par value of the Series "B" bonds for $985,568. This sale served the additional function of establishing an overall value of $3,387,890 for the $11,000,000 face amount of the Series "B" bonds, which value plaintiff and the Internal Revenue Service used in computing the tax arising from the sale of the bridge in 1958.

The sale to Van Ingen was consummated on March 10, 1959. Plaintiff used $500,000 of the proceeds to reduce the balance on its promissory note to $10,000,000. The note was further reduced to $9,000,000 on April 14, 1959, when plaintiff sold certain notes and applied the proceeds against the debt.

During 1959, plaintiff received two communications expressing an interest in purchasing a portion of plaintiff's Series "B" bondholdings. One inquiry was from the First Boston Corporation while the other was from McCormick & Company, which made a firm offer. No action was taken on either the inquiry or the offer.

After extending the note to December 15, 1960, with interest at 5½ percent, plaintiff reduced it by $500,000 on October 14, 1960, leaving a balance of $8,500,000. Plaintiff was still unable to arrange permanent financing, however, and had to extend the maturity date on the promissory note continually, first to December 15, 1961, with interest at 5 percent, then to December 15, 1962, and finally to December 15, 1963.

Early in 1962, plaintiff received an offer from Van Ingen to purchase $1,800,000 par value of the Series "B" bonds for 50 percent of par, plus accrued interest. This offer was considerably more than either the First Boston Corporation suggested or McCormick & Company had offered. Moreover, Van Ingen offered to purchase all or part of the remaining $6,000,000 par value for similar cash terms or substituted securities. The offer was declined. Plaintiff continues to receive inquiries about, and offers to purchase, the Series "B" bonds. No action has...