UNION PACIFIC RAILROAD COMPANY v. United States

• Decision Date: 18 October 1968
• Docket Number: No. 310-62.,310-62.
• Citation: 401 F.2d 778,185 Ct. Cl. 393
• Parties: UNION PACIFIC RAILROAD COMPANY v. The UNITED STATES.
• Court: U.S. Claims Court

185 Ct. Cl. 393, 401 F.2d 778 (1968)

UNION PACIFIC RAILROAD COMPANY v. The UNITED STATES.

No. 310-62.

United States Court of Claims.

October 18, 1968.

Robert J. Casey, New York City, attorney of record, for plaintiff. Thomas E. Tyre, John A. Craig, Thomas J. McCoy, Jr. and Clark, Carr & Ellis, New York City, of counsel.

Theodore D. Peyser, Jr., Washington, D. C., with whom was Asst. Atty. Gen., Mitchell Rogovin, for defendant. Philip R. Miller and Joseph Kovner, Washington, D. C., of counsel.

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

SKELTON, Judge.

The plaintiff, Union Pacific Railroad Company, was and has been at all times pertinent hereto, a corporation organized and existing under the laws of the State of Utah, with its office and principal place of business in New York. It brought this action to recover, among other items, $4,187,159.68 in income and excess profits tax and assessed interest thereon paid for the calendar year 1942, together with statutory interest thereon, and $9,222,801.78 in statutory interest on refunds or credits of tax previously made for 1942.

Both plaintiff and defendant (The United States of America) have moved for partial summary judgment with reference to the claims set forth in Counts XXIX and XXX of plaintiff's first amended petition. The consideration and disposition of these motions is all that is before the court for decision at this time.

In our opinion decided January 19, 1968, we held that this court had jurisdiction over the issues embraced in these two counts solely as offsets to the defendant's offsets.¹ These issues involve the problem of what should be included in plaintiff's equity invested capital for purposes of determining its excess profits tax credit under the provisions of the World War II Excess Profits Tax Act. It naturally follows that the greater plaintiff's equity invested capital, the more credit it will receive and the less taxes it will have to pay. Under these circumstances, it is to plaintiff's advantage to show as large an amount of equity invested capital as possible. It seeks to do this by the following facts set forth in Counts XXIX and XXX of its amended petition.

In Count XXIX, it is shown that in 1901, plaintiff issued $100 million in ten-year four percent bonds convertible at the option of the holder into $100 par value common stock. The bonds could be converted into or exchanged for stock on the basis of one share of the $100 par value common stock for each $100 principal amount of the bonds. The plaintiff received $100 million in cash for these bonds. From 1901 through 1907, holders of the bonds converted $99,450,000 principal amount of the bonds into 994,500 shares of plaintiff's common stock which plaintiff issued to them on the basis specified in the bonds when they were originally issued (i. e., $100 par value share of stock for each $100 amount of bonds). The plaintiff computed its excess profits tax credit based on equity invested capital for the year 1942 and its unused excess profits carryovers from 1940 and 1941 by including in money and property paid in for the issuance of the 994,500 shares of stock, the sum of $99,450,000. This was approved by the Commissioner of Internal Revenue. However, in its first amended petition, filed herein December 14, 1966, plaintiff claims for the first time that the Commissioner, in computing plaintiff's excess profits tax credit based on equity invested capital, should have included in money and property paid in for stock an additional $28,662,393.68, which is alleged to be the excess of the fair market value of said stock over its par value at the time the bonds were converted into stock.

In Count XXX, plaintiff alleges that in 1907 it issued $73,762,000 in twenty-year four percent bonds convertible at the option of the holder into $100 par value common stock at the rate of one share of stock for $175 face value in bonds. The plaintiff received $73,762,000 in cash for these bonds. During the years 1908 through 1914, the holders of $46,926,775 principal amount of the bonds converted them into 268,153 shares of common stock which were issued to them by the plaintiff for the bonds. (The sum of $46,926,775, divided by the conversion rate of $175, equals the 268,153 shares of stock so issued.) The plaintiff computed its excess profits credit based on equity invested capital for the year 1942 and its unused excess profits carryovers from 1940 and 1941 by including in equity invested capital $175 for each of the 268,153 shares of stock in the total sum of $46,926,775. This was approved by the Commissioner of Internal Revenue.

When plaintiff filed its first amended original petition on December 14, 1966, it claimed for the first time in Count XXX that the Commissioner should have increased plaintiff's money and property paid in for stock, in computing its excess profits tax credit based on equity invested capital for the year 1942, and in computing its unused profits tax credit carryovers from 1940 and 1941 by the excess of the fair market value of the stock so issued over its par value in the total sum of $19,403,421.

In short, the problem before us in the motions is to determine the amount of money or property that was paid in on account of the issuance of the 1,262,653 shares of common stock from 1901 through 1914 by the conversion of the two types of taxpayer's convertible bonds. We might point out that the differences in the two types of bonds are immaterial, because the same principles are involved as to both. We shall, accordingly, treat them for all practical purposes, as if they were one type or one issue.

The plaintiff contends that it is entitled to include in its equity invested capital for the purpose of determining its excess profits tax credit under the World War II Excess Profits Tax Act, ch. 757, § 201, 54 Stat. 974 (1940), the fair market value of its stock issued in exchange for, and upon conversion of, the bonds issued by it. In the alternative, plaintiff says it is entitled to include in its equity invested capital the fair market value of the bonds converted as of the time of the conversion, and, in the further alternative, of their cost to the transferors, who were the last holders of the bonds.

On the other hand, the government contends that the amount to be included in the plaintiff's equity invested capital is the cash paid to the plaintiff at the time the bonds were originally issued and sold. It argues that the conversion did not add anything to or subtract anything from plaintiff's assets, but it merely substituted a stock liability for a debt. It points out that the taxpayer acquired nothing but the converted bonds when it issued the stock and surrendered nothing but the stock, which was issued at the ratio prescribed in the bonds. The bonds were immediately canceled when plaintiff received them. Defendant says that the value of the bonds and the stock at the time of the conversion is immaterial, because the money paid in for the bonds at the time they were originally issued was the money and property paid in for equity invested capital purposes and nothing more was paid in at the time of the conversion. Both parties agree that the bonds and the stock were of approximately the same value at the time of the conversion. However, both had increased in value many times since the bonds were first issued.

This is a case of first impression on the problem before us. No case has been cited to us, and we have found none, that involves the precise question to be decided here.

The plaintiff bases its case primarily on Section 718(a) of the 1939 Code of Internal Revenue, which is as follows:

Sec. 718 as added by Sec. 201, Second Revenue Act of 1940, 54 Stat. 982, and amended by Sec. 218, Revenue Act of 1942, c. 619, 56 Stat. 798. Equity Invested Capital.

(a) Definition. — The equity invested capital for any day of any taxable year shall be determined as of the beginning of such day and shall be the sum of the following amounts, reduced as provided in subsection (b) —

(1) Money paid in. — Money previously paid in for stock, or as paid-in surplus, or as a contribution to capital;

(2) Property paid in. — Property (other than money) previously paid in (regardless of the time paid in) for stock, or as paid-in surplus, or as a contribution to capital. Such property shall be included in an amount equal to its basis (unadjusted) for determining loss upon sale or exchange. If the property was disposed of before such taxable year, such basis shall be determined under the law applicable to the year of disposition, but without regard to the value of the property as of March 1, 1913. If the property was disposed of before March 1, 1913, its basis shall be considered to be its fair market value at the time paid in. If the unadjusted basis of the property is a substituted basis, such basis shall be adjusted, with respect to the period before the property was paid in, by an amount equal to the adjustments proper under section 115(l) for determining earnings and profits;²

* * * * * *

The plaintiff also relies on the following portion of Treasury Regulation 112, Section 35.718-1, which relates to the above-quoted Section 718 of the 1939 Code:

If the basis to the taxpayer is cost and stock was issued for the property, the cost is the fair market value of such stock at the time of its issuance.³

The 1939 Code provides that all provisions of law applicable in respect of the taxes imposed by Chapter 1 of such Code shall be applicable in respect of the tax imposed by Subchapter E (Express Profits Tax).⁴

Plaintiff contends that for the taxable year 1942 involved here, its basis for loss (unadjusted) is to be determined under Section 113 of the Revenue Code of 1939, which provides:

Sec. 113. Adjusted basis for determining gain or loss.

(a) Basis (unadjusted) of property. — The basis of property shall be the cost of such property; * * *

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