United Gas Improvement Co. v. Commissioner of Int. Rev.

• Decision Date: 31 December 1956
• Docket Number: No. 11957.,11957.
• Citation: 240 F.2d 312
• Parties: The UNITED GAS IMPROVEMENT COMPANY, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Third Circuit

240 F.2d 312 (1956)

The UNITED GAS IMPROVEMENT COMPANY, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 11957.

United States Court of Appeals Third Circuit.

Argued October 19, 1956.

Decided December 31, 1956.

Brady O. Bryson, Philadelphia, Pa., Morgan, Lewis & Bockius, Philadelphia, Pa. (Alfred J. McDowell, Thomas V. Lefevre, Philadelphia, Pa., on the brief), for petitioner.

S. Dee Hanson, Washington, D. C. (Charles K. Rice, Asst. Atty. Gen., Lee A. Jackson, A. F. Prescott, Attorneys, Department of Justice, Washington, D. C., on the brief), for respondent.

Before MARIS, GOODRICH and McLAUGHLIN, Circuit Judges.

MARIS, Circuit Judge.

This case poses the question whether sums advanced by the taxpayer to a controlled subsidiary corporation over a period of years pursuant to the taxpayer's assumption of another's guarantee of the subsidiary's preferred stock dividends were to be regarded as further payments on the purchase price of the common stock of the subsidiary which the taxpayer had previously acquired. The same question is raised with respect to an additional payment made by the taxpayer for a release from future liability on the guarantee. The Tax Court held that these payments were all to be so regarded and that, as worthless stock losses, they were deductible for income tax purposes only from capital gains and not from gross income, as would have been possible had they been ordinary losses or bad debts. 25 T.C. 229. The taxpayer has brought the case here for review. We are satisfied that the facts of the case, all of which were stipulated, do not support the decision of the Tax Court.

The guarantee of dividends which is the basis of the controversy was originally given by The Koppers Company to the preferred stockholders of The Connecticut Gas & Coke Securities Company in 1926 upon the organization of that company. It appears that Koppers, a holding company, desired to enter the business of producing and selling gas and coke in Connecticut through subsidiaries and hoped to secure New Haven Gas Light Company as a customer for the gas. Koppers accordingly organized another holding company, the Securities Company, to acquire control of New Haven Gas Light Company, in which it already owned some common stock, and also to hold the stock of other public utilities operating in Connecticut. This was done pursuant to an offer, revised September 1, 1926, to New Haven Gas Light Company and its stockholders providing (a) that Koppers was to organize the Securities Company with 200,000 shares of $3 cumulative preferred stock and 300,000 shares of common stock, the preferred stock to have no voting power unless four quarterly dividends were in arrears in which event it should have sole voting power until the default was cured, (b) that Koppers was to receive 200,000 shares of common stock of the Securities Company "in exchange for 20,000 shares of the stock of the New Haven Gas Light Company and 14,000 shares of the stock of the Hartford City Gas Light Company," owned by it, (c) that the Securities Company was to issue all its preferred stock and the remainder of its common stock to the public holders of stock of New Haven Gas Light Company in exchange for their stock, (d) that Koppers was to incorporate a company, Connecticut Coke Company, to erect and operate a by-product coke and gas plant at New Haven, (e) that Koppers agreed to guarantee the dividends on the preferred stock of the Securities Company for 25 years with the right to substitute the coke company as guarantor, and (f) that Koppers offered to purchase at $25 per share any or all of the common stock of the Securities Company which was acquired by the public in exchange for New Haven Gas Light Company stock, the offer to continue for 90 days after the first delivery of gas by the coke company to New Haven Gas Light Company. The offer was accepted as of October 1, 1926, the exchanges of stock were made and Koppers' guarantee was endorsed on the certificates of preferred stock issued by the Securities Company.¹ The coke company was never substituted as guarantor.

The taxpayer, a holding company, did not come into the picture until 1927. At that time it had various subsidiaries, one of them being The Connecticut Light and Power Company, which were engaged in the manufacture, transmission and distribution of gas in Connecticut. Koppers, as we have seen, was also in this field and the two corporations, desiring to cooperate, entered into an agreement on July 11, 1927, under which the taxpayer agreed to purchase from Koppers the common and preferred stock of the Securities Company and the stock of Hartford City Gas Light Company owned by Koppers "in exchange for 38,461 shares of the capital stock" of the taxpayer. The agreement also provided that the Light and Power Company should "indemnify and save Koppers harmless on account of its * * * guarantee of dividends" on the Securities Company preferred stock. The agreement further provided that the taxpayer or the Light and Power Company would assume Koppers' existing obligation to purchase the common stock of the Securities Company at $25 per share, and that a series of contracts should be executed providing for the manufacture of gas by the coke company subsidiary of Koppers and the distribution and sale of the gas by the Light and Power Company, the taxpayer's subsidiary, and its affiliates.

Pausing at this point in our chronological statement of events we note that the consideration for the acquisition by the taxpayer of the stock of the Securities Company was expressly stated to be the issuance of its own stock to Koppers and that the taxpayer did not at this time assume the dividend guarantee. On the contrary, it was expressly agreed that the guarantee should be assumed by the Light and Power Company, the company which was the major participant in this cooperative arrangement with Koppers.

Between 1927 and 1935 the Securities Company earned and paid its full preferred stock dividends and the Light and Power Company was not called upon to make any payments on the Koppers guarantee which it had assumed. During this period Koppers went through various corporate changes which are not here material. On January 11, 1935 Koppers and the taxpayer entered into another agreement under which the taxpayer itself agreed "to indemnify and hold Koppers harmless on account of its * * * guarantee of dividends" on the Securities Company preferred stock, and the Light and Power Company was released from its obligation under the agreement of July 11, 1927 to do so. However, no change was made in respect to the guarantee itself and Koppers remained liable to the preferred stockholders of the Securities Company thereon. Beginning in the year 1936 and in every subsequent year until its dissolution under the mandate of the Public Utilities Holding Company Act of 1935, 15 U.S.C.A. § 79 et seq., the Securities Company failed to earn its full preferred stock dividends. The taxpayer, pursuant to its assumption in 1935 of Koppers' guarantee of those dividends, advanced to the Securities Company from March 9, 1936 through September 30, 1947 the additional funds needed to pay the full dividends, amounting in all to $1,376,233.66. These advances were made under letter agreements between the taxpayer and the Securities Company whereby the latter agreed to repay the advances when and if it had earnings in excess of preferred dividends then due, other than the arrearages which had been paid by the taxpayer's advances.² No return of any part of these advances was ever made by the Securities Company to the taxpayer. The taxpayer treated these amounts as yearly expense items and during the early years attempted to deduct them for federal income tax purposes as expenses, which the Commissioner denied. Thereafter the taxpayer treated the amounts as unallowable deductions for income tax purposes but continued to deduct them from income annually as expenses for the purposes of its own accounts. The Securities Company did not set up these payments as liabilities on its books but showed the amounts on its balance sheet as a contingent liability.

Under the Public Utility Holding Company Act of 1935 the taxpayer was required to divest itself of its interest, through the Securities Company, in New Haven Gas Light Company. This it did by a plan, filed May 6. 1947, approved by the Securities and Exchange Commission on December 9, 1947, and enforced by the United States District Court for the District of Connecticut on January 19, 1948, under which the Securities Company was to be liquidated and its assets were to be distributed to its preferred stockholders, whose claims in liquidation were determined to exceed the total value of the company's net assets. The plan accordingly treated the common stock of the Securities Company as worthless. Finally, the plan provided for the release of Koppers as the guarantor of the dividends on the preferred stock of the Securities Company from and after October 1, 1947, and of the taxpayer's liability under the agreement of January 11, 1935 as indemnitor on the guarantee. The release was made in consideration of the transfer to the Securities Company for distribution to its preferred stockholders of the taxpayer's stock in New Haven Gas Light Company and Hartford City Gas Light Company, the payment of cash needed for liquidation expenses and the release of the taxpayer's claims against the Securities Company for certain loans and for the sums advanced to pay unearned preferred stock dividends. The plan was carried out and the Securities Company was liquidated and dissolved. The cash and securities transferred to the Securities Company by the taxpayer under the plan and the cancelled debt of the Securities Company for loans other than the advances for the payment of unearned dividends, had an aggregate market value of $621,408.88 on December 9, 1947 when the Commissioner approved the...