Monon R.R. v. Comm'r of Internal Revenue
| Decision Date | 25 November 1970 |
| Docket Number | Docket No. 5589-65. |
| Citation | 55 T.C. 345 |
| Parties | MONON RAILROAD (FORMERLY CHICAGO, INDIANAPOLIS AND LOUISVILLE RAILWAY COMPANY), PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Charles F. Marquis and Arthur I. Gould, for the petitioner.
Nelson E. Shafer, for the respondent.
The petitioner, a publicly owned corporation, issued 50-year 6-percent income debentures in exchange for most of the outstanding stock of one class. Interest on the debentures was accrued and paid for a period of 15 months prior to their issuance. Held, the debentures are instruments of indebtedness on which interest is deductible when accrued, including the interest attributed to the 15-month period prior to issuance.
The respondent determined deficiencies in the income tax of the petitioner as follows:
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¦TYE. Dec. 31— ¦Deficiency ¦
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¦ ¦ ¦
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¦1953 ¦$10,701.85 ¦
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¦1954 ¦78,943.98 ¦
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¦1955 ¦387,851.04 ¦
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¦1956 ¦325,324.92 ¦
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The respondent also redetermined the petitioner's income for the taxable years ended December 31, 1957, December 31, 1958, and December 31, 1959. In each of these 3 years, the petitioner incurred a loss according to both its income tax return and the respondent's statement of adjustment; however, the respondent's redeterminations for such years affected the net operating loss carryback available for the earlier yeas for which deficiencies were determined. The only issue remaining for decision, after concessions by both parties, is whether the petitioner may deduct, as interest, amounts paid or accrued in 1958 and 1959 with respect to certain 6-percent income debentures issued by the petitioner in 1958. We must decide: (1) Whether the so-called income debentures constitute a debt obligation or a form of equity, and (2) if they are debt obligations, whether the petition- can deduct that portion of the so-called ‘interest’ paid with respect to the 15-month period prior to the issuance of the debentures.
Some of the facts have been stipulated, and those facts are so found.
The petitioner, Monon Railroad, is an Indiana corporation which had its principal place of business in Chicago, Ill., at the time the petition was filed in this case. It filed its Federal income tax returns for the taxable years 1953 through 1959, using the accrual method of accounting, with the district director of internal revenue, Chicago, Ill.
The petitioner, which was organized in 1897, is a publicly held corporation, whose stock is listed on the New York and Midwest Stock Exchanges. It is engaged in the business of operating as a common carrier by rail in interstate commerce, and is subject to the jurisdiction of the Interstate Commerce Commission.
In 1933, the petitioner instituted proceedings in the U.S. District Court for the Northern District of Illinois, Eastern Division, for a reorganization under section 77 of the Bankruptcy Act. In 1945 and 1946, that court approved and confirmed a plan of reorganization pursuant to such section for the petitioner. The plan was effective as of January 1, 1943.
The new capitalization of the petitioner, pursuant to the plan of reorganization, was as follows:
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¦Equipment-trust obligations (unchanged from previously) ¦$70,000 ¦
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¦First-mortgage series A 4-percent income bonds ¦7,613,800 ¦
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¦Second-mortgage series A 4 1/2-percent income bonds ¦8,914,496 ¦
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¦Class A 5-percent common stock, $25 par value, 343,713.80 shares ¦8,592.845 ¦
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¦Class B common stock, no-par value, stated value of $25 per share,¦ ¦
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¦195,746 shares ¦4,893,650 ¦
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¦Total ¦30,084.791¦
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The petitioner was required to pay interest on the first-and second-mortgage income bonds for any particular year to the extent of ‘available net income’ for that year, as that term was defined in the indenture. Interest for a year was payable on April 1 of the following year. Lacking available net income, the petitioner was authorized to pay interest on the bonds out of any funds lawfully available therefor, providing that all prior obligations were satisfied. Such optional payments were at the discretion of the board of directors. The first-mortgage bonds were to mature in 1983; the second-mortgage bonds in 2003. Interest on the first-mortgage income bonds was fully cumulative to the extent not paid whether or not earned; unpaid interest on the second-mortgage income bonds could accumulate only to 13 1/2 percent. Unpaid accumulated interest with respect to a prior year or years was required to be paid in the event there was available net income in a subsequent year. On both types of bonds, accumulated interest was payable at the same time as principal. When accumulated unpaid interest reached 12 percent of the principal with respect to the first-mortgage bonds, or 13 1/2 percent of the principal with respect to the second-mortgage bonds, the holders of that series of bonds were given the right to nominate three members of the board of directors, who were to be elected by class A shareholders. This right was to continue until the accumulated interest was paid. A noncumulative sinking fund was provided for the retirement of each class of income bonds. The first- and second-mortgage income bonds were secured by first and second liens, respectively, on almost all property owned by the petitioner. Holders of both class A and class B stock were entitled to receive cash dividend payments, when and if declared. Class A stock was entitled to dividends of $1.25 per share per year before any dividends were paid or declared on the class B stock. After dividends of like amounts were paid on class B stock, class A and class B stock were to share equally in any further dividend distributions that year. Dividends on the class A stock were cumulative up to $1.25 per share to the extent earned in any calendar year but not paid. In the event of liquidation, the Class A shareholders were entitled to receive $25 per share, plus accrued but unpaid dividends, before any distribution was to be made to the class B shareholders, but were not entitled to any further participation in the assets.
The petitioner's board of directors consisted of 11 members. The plan of reorganization provided that, other than in exceptional circumstances not here relevant, 8 of the directors were to be elected by the combined vote of class A and class B shareholders, each share having one vote; and that the class B shareholders, voting as a class, were entitled to elect the other 3 directors. On all other matters, holders of class A and B stock were entitled to one vote per share.
The prebankruptcy shareholders received no interest in the petitioner under the bankruptcy plan of reorganization. The class A and class B stock was issued to the former creditors of the petitioner, with the class A stock (which carried voting control) allocated principally to those who were senior creditors prior to the reorganization.
Pursuant to the plan of reorganization approved by the District Court, all of the shares of class A and class B stock were subject to a trust from 1946 to 1956. The voting rights to such stock were granted to three designated trustees, and trust certificates were issued to persons otherwise entitled to receive the stock. The trustees were authorized to sell up to 50 percent of the class A stock and not less than 50 percent of the class B stock, and to purchase for retirement part or all of the class A stock. The purpose of the trust was to provide a mechanism whereby, it was hoped, a successful railroad company or system could acquire a controlling stock interest in the petitioner. Efforts were made during the trusteeship toward this end, but to no avail. The stock trust agreement terminated on January 10, 1956, and at that time, the holders of the trust certificates received stock in exchange therefor.
As early as 1943, the ICC saw the advisability of the retirement of the class A common stock, to the extent that the petitioner's financial condition would permit. It believed that the retirement of the class A stock would expedite the desired acquisition of a controlling stock interest in the petitioner by another railroad. The ICC empowered the trustees to propose to the purchasers of the trusteed stock that the reorganized company (the petitioner) purchase and retire part or all of the class A stock, or that a certain percentage of future earnings be employed toward the eventual purchase and retirement of such stock.
At the meeting of the petitioner's board of directors on November 10, 1954, the chairman of the board stated that the suggestion of converting class A stock to debentures had been under consideration, and that although such a conversion would be advantageous, he suggested that action on it be postponed until after the termination of the stock trust agreement. At the meeting of the board on...
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