Montana Power Company v. United States

• Decision Date: 28 March 1956
• Docket Number: No. 11443.,11443.
• Citation: 232 F.2d 541
• Parties: The MONTANA POWER COMPANY, Appellant, v. UNITED STATES of America.
• Court: U.S. Court of Appeals — Third Circuit

232 F.2d 541 (1956)

The MONTANA POWER COMPANY, Appellant, v. UNITED STATES of America.

No. 11443.

United States Court of Appeals Third Circuit.

Argued February 21, 1955.

Reargued March 5, 1956.

Decided March 28, 1956.

E. Roy Gilpin, New York City (Schmid & Bourne, Summit, N. J., K. William Kolbe, New York City, on the brief), for appellant.

Walter Akerman, Jr., Washington, D. C. (Charles K. Rice, Acting Asst. Atty. Gen., Lee A. Jackson, Atty., Dept. of Justice, Washington, D. C., Raymond Del Tufo, Jr., U. S. Atty., Newark, N. J., H. Brian Holland, Asst. Atty. Gen., Ellis N. Slack, Sp. Asst. to the Atty. Gen., on the brief), for the United States.

Before BIGGS, Chief Judge, and MARIS, GOODRICH, McLAUGHLIN, KALODNER, STALEY and HASTIE, Circuit Judges.

KALODNER, Circuit Judge.

Under long-standing Treasury Regulations a corporation which issues bonds at a discount can prorate or amortize such discount over the life of the bonds.

Sec. 19.22(a)-18(3) (a) of Treasury Regulations 103, applicable in the tax years here involved, provides:

"If bonds are issued by a corporation at a discount, the net amount of such discount is deductible and should be prorated or amortized over the life of the bonds."

The instant appeal involves the application of the aforementioned Treasury Regulations.

The undisputed facts, established by the record, may be summarized as follows:¹

American Power & Light Company ("American") a public utility company, on November 30, 1936, owned 100 per cent of the stock of the Montana Power Gas Company ("Gas") and 99.75 per cent of the common stock of Montana Power Company ("taxpayer"). On the date mentioned, Gas transferred to taxpayer certain natural gas properties which it had acquired in December, 1932, from American² and received in payment for the transfer $10,589,900 principal amount of taxpayer's 30-year 5 per cent debentures. The transaction was a tax-free reorganization under a plan submitted to and approved by the Federal Power Commission, which embodied in its approval, and in the agreement of transfer between Gas and taxpayer, the specific condition that if the cost of the transferred property to American was not established Gas would return to taxpayer "such amount of said $10,589,900 principal amount of debentures as shall be in excess of said cost so established.³ Taxpayer in its 1936 tax return scheduled the net value of the assigned assets at $10,589,900 in a "Statement of Assets and Liabilities Transferred November 30, 1936, by Montana Power Gas Company to the Montana Power Company under Plan of Reorganization" appended to the tax return. The cost to Gas of the transferred assets was $11,183,595.53.⁴

In 1945, nine years after the debentures were issued, they were retired by taxpayer by payment of their principal amount of $10,589,900 to certain banks then in ownership. As an incident of the prior tax-free reorganization, under Section 113(a) (7) of the Revenue Act of 1936, 26 U.S.C.A.Int.Rev.Acts, page 863, taxpayer was required to take the same adjusted tax-cost basis for the assets acquired from Gas as they had in the latter's hands — $7,044,544.44.

Taxpayer claimed that it was entitled, under the Treasury Regulations, to a bond discount deduction of $3,545,355.56 — the difference between the tax-cost basis of the assets acquired from Gas and the principal amount of the debentures which it had issued in payment for them. It premised its claim upon the proposition that, where a non-taxable reorganization is involved, bond discount is determinable solely by reference to the transferor's adjusted basis for the property exchanged for the debentures, which the transferee, issuer of the debentures, is required to use.

The District Court rejected taxpayer's contention and held that under our decision in American Smelting & Refining Co. v. United States, 3 Cir., 1942, 130 F.2d 883, taxpayer could only be entitled to a discount if it could establish that the debentures in question exceeded the actual "fair market value" of the assets acquired from Gas. On consideration of the evidence adduced by taxpayer the District Court made the factual finding that it had failed to establish that the "actual fair market value" of the assets acquired by taxpayer was less than the total of the issued debentures; it ruled that "Unless Montana, within thirty days, shall apply to establish by further evidence the fair market value of the gas properties at the time of their transfer to it by Gas Company, judgment will go for defendant." Taxpayer having failed to act within the time fixed by the District Court, it dismissed its action and entered judgment for the United States. Taxpayer appealed.

On this appeal taxpayer has summarized its position as follows: "It was settled by American Smelting & Refining Co. v. United States * * * that discount may arise when debt is issued for property"; "* * * the measure of said discount, when bonds are issued for property, is the difference between the amount realized and the principal amount of the debt"; "* * * the amount realized by the plaintiff (taxpayer) upon the issuance of its debentures is the tax-cost basis ($7,044,544.44) of the gas properties received in exchange for plaintiff's (taxpayer's) debt, which basis the plaintiff (taxpayer) was required to use for all relevant purposes under the tax law"; "The fair market value of the properties is not relevant in this case" and finally, "The fact that certain of the transactions took place between affiliated corporations neither changes said result nor renders it inequitable".⁵

The sum of the government's position is that "the fallacy of the taxpayer's argument is that it rests upon the premise that all the taxpayer acquired for its bonds was a tax-basis, when, in fact, what the taxpayer acquired was property having a fair market value in no way related to the adjusted basis which the taxpayer was required to use solely because of its having chosen to participate in a non-taxable reorganization" and the taxpayer having failed to meet the burden of establishing, under the American Smelting decision, that the fair market value of the property acquired in exchange for the debentures was less than their principal amount is not entitled to a discount.

In the American Smelting case we laid down the rule that in instances where the discount regulation is applicable the taxpayer bears the burden of establishing that the fair market value of that for which the bonds were issued was less than their principal amount.

Here the taxpayer failed to introduce at the trial any evidence of the fair market value of the property received in exchange for the debentures which it issued and it further failed to do so within the thirty-day grace period granted by the District Court.

The taxpayer urges that application of the "fair market value" doctrine "upsets the balance of the tax situation" because Gas was required to hold the debentures at $7,044,544.44 (tax-cost basis) and was thus subject to tax on the difference between that amount and the proceeds of the debentures, on disposition or retirement, while it, the taxpayer, could never recover more than $7,044,544.44 through deductions or depreciation or as an offset against the proceeds from re-sale of the property. In other words, says the taxpayer, the government would be directly taxing Gas on $3,545,355.56 (assuming that it realized the principal amount of the debentures) and would in effect tax it on an additional $3,545,355.56 in the manner above stated.

The District Court 121 F.Supp. 583 in dealing with this same contention observed that "`The tail goes with the hide'"; that Gas, the taxpayer and their holding company, American, "must be presumed to know the law * * * they decided to take advantage for their own benefit of this tax-free reorganization * * * even had this reorganization worked out in other aspects to their disadvantage, it was they who made the decision in the light of the law" and "They could not complain now, even were a tax disadvantage to counter-balance the advantage, which they chose to take."

We agree with the District Court on this score. It is well-settled that a taxpayer is free to adopt such organization for his affairs as he may choose but having done so he must accept the tax consequence of his choice; this is so whether he contemplated such consequence or not.⁶ And on that score it must be noted that allowance of deductions does not turn upon general equitable considerations and that such allowance "depends upon legislative grace; and only as there is clear provision therefor can any particular deduction be allowed."⁷

We should like to note, however, that in our view the result reached is not inequitable in the instant situation. During the four years that Gas owned the assets which it transferred to the taxpayer in November, 1936, it had, using round figures, reduced their cost basis by approximately $4,000,000, from $11,000,000 to $7,000,000, via depreciation and depletion allowances, amortization of lease costs and capitalization development costs. The deductions, of course, reduced Gas' annual income taxes during the years in which they were taken. American, as parent of Gas and taxpayer, could have avoided the "balance of tax" dilemma of which taxpayer complains had it caused the latter to issue debentures for $7,000,000, the tax-cost basis of the transferred assets. However, instead, indulging in practices all too prevalent in the free-booter days of the holding company era, in a Tinker-to-Evers-to-Chance play, American arranged to have the taxpayer pay, again using round figures, $10,500,000 (in debentures) for assets which had a tax-cost basis of $7,000,000 utilizing the reorganization revenue statute to make it all tax-free. And then, American (in 1937) liquidated Gas into it and became the direct owner of taxpayer's debentures.⁸ By the steps taken, American, assuming eventual realization in full of the principal...