Wis. Elec. Power Co. v. Wis. Dep't of Taxation

• Decision Date: 18 November 1947
• Citation: 29 N.W.2d 711,251 Wis. 346
• Parties: WISCONSIN ELECTRIC POWER CO. v. WISCONSIN DEPARTMENT OF TAXATION.
• Court: Wisconsin Supreme Court

251 Wis. 346

29 N.W.2d 711

WISCONSIN ELECTRIC POWER CO.

v.WISCONSIN DEPARTMENT OF TAXATION.

Supreme Court of Wisconsin.

Nov. 18, 1947.

Appeal from a Judgment of the Circuit Court for Dane County; Alvin C. Reis, Judge.

Affirmed in part; reversed in part.This is a proceeding under Ch. 227, Stats. for review of a decision and order of the Wisconsin board of tax appeals which modified and affirmed an additional assessment of income taxes against the respondent Wisconsin Electric Power Company for the years 1937 to 1939, inclusive. The circuit court in part affirmed and in part reversed the order of the board of tax appeals.

The respondent, a domestic corporation, was organized in 1866 as The Milwaukee Electric Railway and Light Company. Its name was changed in 1938 incident to a merger with another corporation under sec. 196.80(1)(c), Stats. The other corporation will be denominated the ‘old electric company.’ For many years prior to the merger the respondent was engaged in the operation of a street railway and bus system in Milwaukee and the surrounding territory, operation of electric interurban lines to neighboring communities, and a general electric utility business. Its common stock was owned by North American Edison Company, a Delaware corporation. At the time of the merger respondent's outstanding bonds and preferred stock were in the hands of the public, with the exception of treasury preferred stock of 17,028 shares. Prior to and during 1938 certain of its interurban services were discontinued. Rails, bridges and other salvageable items were removed from the rights-of-way, but the grading and ballast were, of course, not removed. The fee simple title was retained and the rights-of-way were used as such for the company's power lines. In some instances the gravel on the abandoned railway grades has been leveled and the grades used by the respondent's trucks in servicing the power lines.

The respondent's business developed to the extent that in 1920 additional electrical generating facilities were needed. It could not finance the additional facilities because of its existing mortgage indebtedness, and the old electric company was organized for the purpose of financing the Lakeside power plant. The common stock of the old electric company consisted of 400,000 shares of the par value of $20 per share, and was held by respondent's parent, North American Edison Company. Thus, from 1920 to 1938 North American Edison Company was the parent of both respondent and the old electric company. The old electric company issued bonds to finance construction of the Lakeside plant secured by a mortgage and by a pledge of rentals payable by respondent under a lease of the plant to respondent. These bonds were sold to the public. The old electric company had no source of revenue other than rentals under the lease and no customers other than respondent.

In 1938 it became desirable for respondent to re-finance its outstanding bonds at a lower rate of interest, and in order to accomplish that result it divested itself of its transportation properties and entered into a merger with the old electric company. Respondent brought about the merger by transferring its preferred stock of an aggregate par value of $9,220,400 to North American Edison Company in exchange for the entire common stock of the old electric company of a par value of $8,000,000. Thereupon the respondent, with the consent of the public service commission, filed the certificate required by sec. 196.80(1)(c), Stats. in the office of the secretary of state.

The certificate was filed October 21, 1938. On that day and shortly preceding the filing of the certificate, the board of directors of the old electric company held a meeting and adopted ‘a plan of complete liquidation through merger of this company’ and cancelled its stock effective upon completion of the merger. A few minutes later the board of directors of respondent met and action was taken adopting ‘a plan of complete liquidation’ of the old electric company ‘to be effected by the merger.’ The necessary resolution of merger was adopted by respondent's directors changing its corporate name to Wisconsin Electric Power Company and assuming the obligations of the old electric company. A certificate of merger was issued by the secretary of state on October 21, 1938.

On October 28, 1938 new bonds were issued by respondent to replace its own outstanding bonds and those of the old electric company. The money derived from the sale of the new bonds was used to retire the old ones which were called and paid as of December 1, 1938. During the interval, October 28 to December 1, interest totaling $309,499.01 was paid on the old bonds in addition to the interest on the new ones. On its books the respondent charged the interest on the old bonds to unamortized debt discount and expense and deferred it over the life of the new issue.

On its income tax return for 1938 respondent took deductions:

1. For interest paid on the new and old bonds during the period October 28 to December 1;

2. For unamortized cost of the grading and ballast on the rights-of-way from which the tracks had been removed;

3. For the discount and expense incurred by the old electric company upon the issue of its bonds and not recovered through amortization when the bonds were retired by the refinancing.

In its returns for 1938 and 1939 deduction was taken in the amount of the unpaid federal and state income, capital stock and social security taxes of the old electric company, which respondent had paid after the merger. Of such taxes, $38,368.29 were paid in 1938 and $427,593.61 were paid in 1939.

As the result of a field audit these deductions were disallowed by the Department of Taxation. The department also took the position that the transactions involved in effecting the merger constituted a liquidation of the old electric company and imposed an additional assessment on that basis. The net additional assessment, including some items not here in dispute, was $334,443.53 based upon additional income of $4,777,765. An application for abatement was followed by a revised audit fixing the additional income at $3,245,690 and the additional tax at $227,198.28. Otherwise the application was denied. Upon a review the board of tax appeals affirmed the appellant Department of Taxation except as it held that the unamortized cost of grading and ballast constituted a proper deduction, and determined that respondent realized a taxable gain in the merger transaction in the amount of $1,421,599.38 instead of the $1,696,499.72 found by the department. The board modified the assessment accordingly and affirmed it as so modified. This proceeding was then instituted under Ch. 227, Stats. to review the decision and order of the board.

The circuit court held that:

1. The unamortized cost of grading and ballast was not an allowable deduction;

2. The federal taxes of the old electric company paid by the respondent after the merger were deductible;

3. Interest on the old bonds during the period October 28 to December 1, 1938 when the new and old bonds overlapped was not an allowable deduction;

4. The amount of bond discount and expense incurred by the old electric company upon the issuance of its bonds and not recovered through amortization when they were retired, was an allowable deduction;

5. The transaction under which the assets and properties of the old electric company were taken over by respondent constituted a tax-free transaction under sec. 71.02(2)(i) 3, Stats.

Judgment was entered accordingly. The department appeals from those portions of the judgment embodying findings 2, 4 and 5, as set out above. The respondent asks review of the portions embodying findings 1 and 3.

John E. Martin, Atty. Gen., and Harold H. Persons, Asst. Atty. Gen., for appellant.

Shaw, Muskat & Paulsen, of Milwaukee, for respondent.

RECTOR, Justice.

The various items in dispute will be discussed in the order in which the circuit court findings are set forth.

1. The unamortized cost of grading and ballast.

The question involves the application of sec. 71.03(3), Stats. which says:

‘71.03 Deductions from gross income of corporations. Every corporation, * * * shall be allowed to make from its gross income the following deductions: * * *

‘(3) Losses actually sustained within the year and not compensated by insurance or otherwise, * * *.’

The respondent contends on its motion to review that the ballast and grading have lost their original value through the abandonment of interurban service and scraping of rails, ties and bridges. It claims that they have no value as improvements and that therefore the cost unrecovered by depreciation allowances became a deductible loss at the time service was abandoned. In support of the argument cases are cited dealing with provisions under the federal tax law which permit reasonable allowances for obsolescence. United States Cartridge Co. v. United States, 1932, 284 U.S. 511, 52 S.Ct. 243, 76 L.Ed. 431;Gambrinus Brewery Co. v. Anderson, 1931, 282 U.S. 638, 51 S.Ct. 260, 75 L.Ed. 588. Obsolescence is diminution in value occasioned by changed conditions, etc., United States Cartridge Co. v. United States, supra, and may extend to an extinguishment of value. So long as there is something less than a total extinguishment deduction for obsolescence may be made for income tax purposes only under statutory provisions for such allowances, Wisconsin Box Co. v. Wisconsin Tax Comm., 1929, 198 Wis. 439, 224 N.W. 483, and there are no such provisions applicable here. Where there is a total extinguishment established by an identifiable event accompanied by abandonment of the property, there is a loss within the meaning of sec. 71.03(3), Stats. Commissioner of Internal Revenue v. McCarthy, 7 Cir., 1942, 129 F.2d 84. But a loss claimed by reason of diminution in value as distinguished from extinguishment of value must be established by sale. Pugh v....