Opinion
Docket No. 110002.
1943-11-22
TERMINAL INVESTMENT COMPANY, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
John H. Freeman, Esq., for the petitioner. Samuel G. Winstead, Esq., for the respondent.
Pursuant to a 1935 reorganization under section 77B, Bankruptcy Act, noncumulative, nondetachable scrip certificates were attached to petitioner's outstanding bonds. They represented a portion of the past due interest on the bonds and were payable during the extended life of the bonds in installments, only out of net earnings if any remained after payment of stated prior obligations. Because of the contingencies, nothing ever became payable on the certificates. In the taxable year the petitioner, with borrowed funds, purchased its outstanding bonds at less than par and the unmatured certificates were surrendered therewith. Held, the bankruptcy proceedings in 1935 canceled the obligation to pay the past due interest and the deductions taken therefore in prior years can not be restored to income in 1939 to the extent of the face amount of the unmatured certificates. Held, further, because of their contingent nature the certificates did not constitute an indebtedness and were without value, and the petitioner did not realize taxable income upon their surrender with the bonds in 1939. John H. Freeman, Esq., for the petitioner. Samuel G. Winstead, Esq., for the respondent.
This proceeding involves an income tax deficiency for the calendar year 1939 in the amount of $2,738.28. Certain adjustments are uncontested and will be taken care of under Rule 50.
The case was presented upon stipulated facts and exhibits. The stipulated facts not set forth in our findings of fact are incorporated therein by reference.
FINDINGS OF FACT.
The Terminal Investment Co. (hereinafter referred to as Terminal or petitioner) was a Texas corporation organized in 1923, domiciled in Houston, Harris County, Texas. It was dissolved on December 31, 1941, and is now in the hands of trustees for the purpose of terminating its affairs. Its present address is 1201 State National Bank Building, Houston, Texas. The return for 1939 was filed with the collector of internal revenue for the first district of Texas on the accrual basis of accounting.
On February 1, 1926, Terminal issued a series of 6 percent first mortgage real estate gold bonds, in the aggregate principal amount of $600,000, bearing semiannual interest coupons payable February 1 and August 1. These bonds were issued and sold at the price of 94 cents on the dollar, and Terminal received as proceeds thereof the aggregate sum of $564,000. The discount on the bonds was amortized over the period ending in 1934. The bonds matured serially over a period of ten years, the last maturity date being February 1, 1936. The proceeds of the bonds were used in the erection of the Ben Milam Hotel in Houston. The building and land were first leased to a nonaffiliated hotel operating company, but due to financial difficulties the lessee relinquished the lease in 1932 and Terminal itself operated the hotel from 1932 through the taxable year herein involved.
On November 23, 1934, Terminal filed a petition in the United States District Court for the Southern District of Texas under section 77B of the Bankruptcy Act and submitted a plan of reorganization. At that time Terminal was in default with respect to $60,000 principal of bonds that had matured and $44,550 of interest, being the interest installments which had become due August 1, 1933, and February 1 and August 1, 1934, upon the balance of its bonds then outstanding ($495,000). It deducted $14,850 and $29,700 of the accrued interest in its returns for the years 1933 and 1934, respectively. The return for 1933 showed a net loss of $15,915.65 and that for 1934 a net loss of $8,088.79.
The District Court entered its decree in the reorganization proceedings under date of January 26, 1935. A supplemental indenture was executed immediately following the entry of said decree, effective as of August 1, 1934. The decree and supplemental indenture provided for the renewal and extension of the maturities of Terminal's bonds so that they became payable ‘on or before August 1, 1944.‘ They also provided that:
All of the interest coupons heretofore originally attached to said bonds shall be detached and cancelled by the Trustee or under its authority (and said detached interest coupons shall be held by the Trustee until the payment of the bonds to which they were attached and thereupon returned to the Mortgagor) and the Trustee shall cause to be endorsed upon all of said outstanding bonds (or by attachment thereto of appropriate certificate) provision for extension of maturity and as to interest on same in accordance with the terms hereof and shall cause to be executed proper interest coupons for said bonds evidencing the semiannual interest to accrue and become payable on the first day of February and the first day of August of each year from 1935 to 1944, inclusive, and shall cause to be attached to each of said bonds certain ‘scrip certificates‘ hereinafter described providing for payments to be made contingently upon the conditions, in the manner, and at the times as hereinafter stated.
In accordance with said decree and indenture, the following endorsement was placed upon the bonds, being printed in the margin thereof:
The terms and provisions of the within bond and the Trust Indenture securing payment have been modified by Supplemental Indenture. Maturity of this bond has been changed and it is now due on or before August 1, 1944. Interest and principal except 4% guaranteed interest (payable upon surrender of the coupons therefor attached contemporaneously with the making of this endorsement) are payable only to the then registered owner of the within bond as shown from time to time by the registration books of the Trustee, either personally or by mailing directly to said owner at his registered address. Four percent per annum interest from August 1, 1934, evidenced by said coupons, is fixed and guaranteed by the maker; additional two percent per annum interest from August 1, 1934, and certain ‘scrip‘ payments are contingent, non-cumulative, payable only from earnings in the manner and to the extent provided by the Supplemental indenture— to which reference is here made for all purposes.
Likewise ‘extension interest coupons‘ were attached to each of the bonds providing for 4 percent interest payable semiannually on February 1 and August 1, unless provision for the redemption of the bond therein described had theretofore been made.
The plan of reorganization outlined in the petition filed on November 23, 1934, contained the following paragraph pertinent to the past due interest:
In view of the fact that certain interest amounts maturing up to and including August 1, 1934, have not been paid, and since no other provision is being made to care for said back interest items,— provisions are to be made whereby there will be also attached to all of said first mortgage bonds appropriate obligations of Debtor corporation (commonly referred to as ‘scrip‘) which will evidence a further payment of additional contingent interest not to exceed one-half of one per cent per annum, non-cumulative, on August first of each year, beginning 1935 and continuing for eight years thereafter (that is up to and including August 1, 1942) and continuing not to exceed one per cent per annum, non-cumulative, on August first of each of the years 1943 and 1944,— all of which payments will be provided in said scrip to be paid only out of net earnings of said property operated by Debtor if such net earnings are sufficient in amount to provide the additional funds for payment of such additional amounts of said scrip and other payments as outlined herein. Suitable scrip is to be attached to each of said first mortgage bonds and is to become a part thereof and to become void if disattached therefrom.
The decree of the court approved the attachment to each bond of a scrip certificate of which the following, attached to a $1,000 bond, is typical:
NON-DETACHABLE SCRIP CERTIFICATE.
This Scrip Certificate, issued under the terms of a certain Supplemental Indenture dated as of August 1, 1934, between the undersigned and the St. Louis Union Trust Company as Trustee, to which reference is hereby made for all purposes, entitles the registered holder of the first mortgage bond of the undersigned bearing the same number as this Scrip, and upon the happening of contingencies as provided to receive certain annual payments on August 1st of each year (aggregating not more than Sixty Dollars ($60.00) beginning in 1935, and ending in 1944, which payments will when entitled to be paid be mailed directly to the registered holder of the bond bearing the same number as this Scrip Certificate, and the payment of which is dependent (as set forth in said Supplemental Indenture) upon the earnings of the property described in said Supplemental Indenture and the Deed of Trust securing the payment of said bond. Payments on this Scrip are non-cumulative and detachment from said bond renders this Scrip Certificate of no value in the hands of any transferee thereof.
The decree and the supplemental indenture provided in section 7 that all the monthly net earnings of Terminal, as therein defined, should be deposited with the St. Louis Union Trust Co., such funds to be applied as follows:
FIRST: To the creation of reserves for (as hereinafter set forth) and/or the payment of Trustee's and Depositary's fees, taxes and insurance upon the mortgaged property and payment of fixed guaranteed interest upon the outstanding bonds at the rate of four percent per annum (from August 1, 1934) payable semi-annually on February 1st and August 1st of each year upon the presentation and surrender of the respective ‘extension interest coupons‘ therefor.
SECOND: The balance then remaining, up to $10,000.00 in any Semi-annual Sinking Fund Period, shall be applied to the retirement (as hereinafter more specifically provided) of bonds (with all unaccrued extension interest coupons and ‘scrip certificates‘ thereto attached) under sealed tenders or offers to sell received by the Trustee during the sixty day period following February 1st and August 1st of each year, respectively, at the lowest prices for which said bonds may be obtainable at less than par. If, after purchase of all bonds tendered in any such sixty day period, there by any amount still available for retirement of bonds, it shall be used to call and redeem an appropriate number of said bonds by lot at par as hereinafter provided.
THIRD: Any balance then remaining in any Semi-Annual Sinking Fund Period shall, to the extent required therefor, be applied to payment of additional interest proportionately upon all bonds then outstanding for the current semi-annual period at the rate of two percent per annum, non-cumulative, * * *
In the event there still remains any further balance on February 1st of any year (after payments and provision for payments as set forth in First, Second and Third paragraphs above) then such further balance shall be retained along with subsequent ‘Monthly Net Earnings Deposits‘ and used for payment and liquidating of maturities, et cetera on August 1st following as provided for in Paragraphs ‘FIRST‘ to ‘fifth‘, inclusive, of this Section 7.
FOURTH: Any balance then remaining in any Annual Sinking Fund Period— after providing for the payment of the foregoing,— shall, to the extent required therefor, be applied to payment proportionately upon account of the non-cumulative ‘scrip certificates‘ attached to said outstanding bonds for the then current annual period. Following August 1st of each year, beginning in 1935, and continuing up to and including 1944, if after payment or provision for payment of all matters specified under FIRST‘, SECOND,‘ and ‘THIRD‘ of this Section 7, there by any balance remaining of said fund in the hands of the Trustee, such balance shall be paid to the respective owners of outstanding bonds pro rata up to but not in excess of one-half of one percent of the face value of such bonds in any one year, non-cumulative, except that in the years 1943 and 1944 the payments may be made at a rate up to but not in excess of one percent in each such year, non-cumulative. Such payments upon ‘scrip certificates‘ shall be made solely from (and only if there be) balances remaining after payments or provision for payment of all matters specified under ‘FIRST‘, ‘SECOND‘ and ‘THIRD‘ as aforesaid. * * * All of said ‘scrip certificates‘ provide if and when paid, an amount in the aggregate equal to accrued interest upon said bonds at the rate of 4% per annum for all the period up to August 1, 1934, for which interest had not heretofore been paid, said ‘scrip certificates‘ being payable contingently, in installments, as herein provided.
FIFTH: Any balance then remaining in any Annual Sinking Fund Period, after payments provided for in Paragraphs ‘FIRST‘ to ‘FOURTH‘, inclusive, of this Section 7, shall be returned or paid over by the Trustee to the Mortgagor during the sixty day period following August 1st of each year.
At the end of each Semi-annual Sinking Fund Period, the Sinking Fund Depositary, shall estimate the amount that will reasonably be required, if any, in its judgment to be retained from net earnings already deposited, as reserves to pay or assist in paying when and as the same shall become due and payable, taxes, insurance and Trustee's and Depositary's fees referred to in the foregoing paragraph ‘FIRST‘ of this Section 7. In making such estimates the depositary shall take into account the future net earnings deposits that in its judgment may reasonably be expected or anticipated. Said estimate shall be in the sole and exclusive discretion of the Depositary, for the exercise of which it shall have no liability.
‘Monthly net earnings‘ were defined in the decree and supplemental indenture to mean the excess of gross monthly earnings over operating expenses; and ‘operating expenses‘ were defined to mean:
(1) The usual and proper costs, expenses and charges on account of the operation and maintenance of the mortgaged property; and
(2) The cost of repairs, upkeep and necessary improvements to the mortgaged property.
Mere book charges for depreciation or obsolescence were expressly excluded from operating expenses.
The decree and supplemental indenture further provided that if the monthly net earnings of Terminal were insufficient to pay the obligations and liabilities described in paragraph ‘FIRST‘ of section 7, above, Terminal should nevertheless be bound to provide funds from other sources to pay such obligation and liability.
The decree also provided that each bond and the trust indenture securing the same were thereby ‘modified and changed from their original tenor, reading and effect so that henceforth they shall in all respects accord with and conform to the terms, conditions and provisions embodied in said plan of reorganization hereinabove set forth.‘
At the time of the entry of the decree, Terminal had outstanding of the bonds above described $495,000 par value. The guaranteed or fixed interest of 4 percent provided by the decree and supplemental indenture was paid regularly as it matured upon all of the bonds from time to time outstanding from the date of the decree to the retirement of the last of the bonds in 1939. Retirement of bonds through operation of the bond retirement fund, as provided by the decree and supplemental indenture, was made in the following amounts in the respective years stated:
+--------------+ ¦1935 ¦$28,500 ¦ +-----+--------¦ ¦1936 ¦24,500 ¦ +-----+--------¦ ¦1937 ¦24,000 ¦ +-----+--------¦ ¦1938 ¦25,000 ¦ +-----+--------¦ ¦ ¦ ¦ +-----+--------¦ ¦Total¦102,000 ¦ +--------------+
leaving a balance of $393,000 par value of bonds outstanding at the commencement of the calendar year 1939.
‘Net earnings‘ of Terminal, as set out in the decree and supplemental indenture, were not sufficient in any of the years from 1935 to 1938, inclusive, to provide any amount toward payment of the additional 2 percent per annum interest conditionally provided for in such indenture and in the court decree, and no such ‘additional interest‘ was paid upon any of the bonds in those years. Payments on account of the ‘nondetachable scrip certificates‘ were also not made, for there were no funds available therefor. In 1939 Terminal was not required to pay the additional 2 percent per annum additional interest or any amount on the script certificates, since all of the bonds in question were purchased by Terminal and retired prior to August 1 1939. Terminal reported net income of $41,414.34 for 1939, $45,773.19 for 1940, and $31,145 for 1941. The monthly remittances to the trustee totaled $48,409.23 for 1938. The remittances for the months of January, February, and March 1939 totaled $11,578.80.
After the entry of the decree in the section 77B proceedings above mentioned an account was opened on the books of Terminal entitled ‘Accrual Interest Scrip Payable,‘ showing a credit balance of $29,700, which was $44,500 accrued interest matured on August 1, 1933, February 1 and August 1, 1934, reduced by one-third in order to reflect a reduction in rate of accrual from 6 percent to 4 percent per annum. There was charged off from such account each year an amount equal to the amount that would have been payable that year on the nondetachable scrip certificates had the net earnings been sufficient to authorize such payment. The dates of such charge-offs and the amounts thereof are as follows:
+----------------------------+ ¦December 31, 1935 ¦$2,377.50¦ +------------------+---------¦ ¦December 31, 1936 ¦2,275.00 ¦ +------------------+---------¦ ¦December 31, 1937 ¦2,150.00 ¦ +------------------+---------¦ ¦December 31, 1938 ¦2,030.00 ¦ +------------------+---------¦ ¦ ¦ ¦ +------------------+---------¦ ¦Total ¦8,832.50 ¦ +----------------------------+
These amounts were credited to donated surplus on the books of Terminal but were not included as taxable income in returns filed in the respective years. Also, there was charged off from such account each year the remaining amount of scrip certificates attached to bonds retired during that year through operation of the bond retirement fund or otherwise. The dates of such charge-offs and the amounts thereof are as follows:
+----------------------------+ ¦December 31, 1935 ¦$1,665.00¦ +------------------+---------¦ ¦December 31, 1936 ¦1,282.50 ¦ +------------------+---------¦ ¦December 31, 1937 ¦1,140.00 ¦ +------------------+---------¦ ¦December 31, 1938 ¦1,060.00 ¦ +------------------+---------¦ ¦ ¦ ¦ +------------------+---------¦ ¦Total ¦5,147.50 ¦ +----------------------------+
These amounts were credited to profit on the books of Terminal and were returned as taxable income in returns filed in the respective years. By these charges the account referred to was reduced year by year until at the beginning of the year 1939 the amount of the account was $15,720.
During the first three months of 1939 Terminal refinanced the then outstanding bond obligations by means of a new loan and purchased and retired all of the outstanding $393,000 par value of bonds, with unmatured scrip certificates attached. The difference between the par value of $393,000 and the purchase price of $390,920, or $2,080, was reported as income for the year 1939. The balance of $15,720 remaining in the ‘Accrued Interest Scrip Payable‘ account was charged off by a credit to profit on the books of Terminal, but the amount was not included in taxable income.
The Commissioner, for the year 1939, included as a part of Terminal's taxable income the sum of $15,720, explaining the adjustment in the deficiency notice as follows:
In your income tax return for 1939, you reported a profit on purchase of bonds in the amount of $2,080.00. It has been determined that this profit was realized on the purchase of your own bonds with scrip certificates attached at a total cost of $390,920. Your records as of January 1, 1939, showed your liability on these obligations to be $408,720 and therefore it is held that, on purchase and retirement of your obligations at less than face value you realized a taxable profit in the amount of $17,800.00 instead of $2,080.00 reported by you.
OPINION.
ARNOLD, Judge:
On August 1, 1933, the petitioner had outstanding $495,000 par value of its bonds and on that date semiannual interest coupons at the rate of 6 percent, totaling $14,850, were payable but were not paid. Petitioner accrued this interest on its books and took a deduction in that amount on its income tax return for 1933. On February 1 and August 1, 1934, additional interest coupons, totaling $29,700, became payable but were unpaid. This interest obligation was also accrued and deducted on petitioner's 1934 return. In 1935 petitioner underwent a reorganization the past due interest coupons, totaling $44,550, were ordered to be canceled. In addition to other modifications in the bonds effected by the reorganization including extension of the redemption date to on or before August 1, 1944, and adjustment of the future interest rate, there were attached to the bonds nondetachable, noncumulative scrip certificates, calling for limited annual payments, subject to certain contingencies set forth in detail in our findings, which, if all the contingencies were met and none of the bonds were redeemed until the final redemption date, would eventually equal two-thirds of the past due and canceled interest, or $29,700. No payments upon the scrip certificates for the years 1935 through 1938 were made, because the contingencies precedent to payment were not met in those years. Because of the non-cumulative feature of the scrip certificates, no obligation to pay was carried over to subsequent years. Also in the years 1935 through 1938 the petitioner redeemed some of its bonds with the scrip certificates attached thereto. At the beginning of 1939 the petitioner had $393,000 par value of its bonds outstanding, with unmatured scrip certificates attached which would have totaled $15,720 if none of the bonds were redeemed prior to August 1, 1944, and if all of the contingencies precedent to payment upon the scrip certificates had occurred in the years 1939 through 1944.
During the first three months of 1939 the petitioner borrowed sufficient funds to enable it to purchase and retire at that time all of its outstanding bonds. The amount expended for this purpose was $390,920, or $2,080 less than the par value of the bonds. The petitioner reported the $2,080 difference as taxable income upon its return for 1939. The scrip certificates, being nondetachable, were surrendered with the bonds when redeemed. The respondent determined that the petitioner realized income in 1939 in the amount of $15,720 from the surrender and cancelation of the scrip certificates.
The parties have argued this case along several alternative and mutually exclusive lines, each line of argument being premised upon a different view of the effect of the reorganization and of the nature of the scrip certificates. To clarify these arguments, we deem it necessary at the outset to determine from the facts what effect the reorganization had upon the past due interest obligation and the nature of the obligation, if any, arising from the scrip certificates.
Terminal's obligation to pay interest on the bonds was fixed and determined when the interest coupons fell due on August 1, 1933, February 1, 1934, and August 1, 1934, and such interest was, therefore, properly accrued upon the books and taken as deductions in the respective years. Sec. 43, Internal Revenue Code; United States v. Anderson, 269 U.S. 422 (1926); Newaygo Portland Cement Co., 27 B.T.A. 1097. The plan of reorganization refers to the unpaid interest installments and states that the only provision being made therefor is the attachment of scrip certificates to the bonds ‘which will evidence a further payment of additional contingent interest * * * to be paid only out of net earnings,‘ if sufficient. The decree of the bankruptcy court ordered that all of the interest coupons theretofore attached to the bonds be removed and canceled and that various changes be made in the bonds, including the attachment of the scrip certificates. In other words, the past due, fixed, and ascertainable obligation was canceled and partially converted into a highly contingent obligation, payable in future noncumulative installments out of net earnings only. In 1935, when the scrip was issued, no part thereof properly could have been accrued and deducted. Sec. 43, Internal Revenue Code; cf. Lucas v. American Code Co., 280 U.S. 445 (1930); United States v. Anderson, Supra; Stern-Slegman-prins Co. v. Commissioner (C.C.A., 8th Cir. 1943), 134 Fed.(2d) 817, affirming 46 B.T.A. 629; Concord Electric Co., 7 B.T.A. 1027. We must conclude that the 1933 and 1934 accruals and deductions were completely canceled and wiped out in 1935. The latter year is not before us and we need not consider whether the reorganization, by canceling the past due interest and the accruals and deductions dependent thereupon, could have given rise in that year to any taxable income.
Our conclusion that the past due interest obligation was wiped out in 1935 disposes of the contention of respondent to the effect that in 1939 there occurred a cancellation of a portion of the deductions taken in 1933 and 1934 and that the amount so canceled, to the extent of $15,720, must be restored to income for 1939. The accruals and deductions had already been completely canceled in 1935.
Our next preliminary consideration pertains to the nature of the scrip certificates and the obligation, if any, which arose therefrom. This must be gathered from the provisions of the scrip certificates and all of the attendant facts and circumstances. As concluded previously, the bondholders' right to receive payment upon their past due interest coupons was terminated by the reorganization. Substituted therefor was a highly contingent undertaking to pay limited amounts out of future net earnings. The scrip certificates can not be said to have revived to any extent the obligation to pay the past due interest. This would have been inconsistent with the apparent purpose of the reorganization, which was to lighten the debtor's burden by relieving it of some of its financial obligations. No immediate obligation to pay arose out of the issuance of the scrip certificates, nor did any obligation arise in any year subsequent to their issuance, because the contingencies precedent to payment never occurred in any such year.
Furthermore, there was no acceleration provision in the event of redemption prior to the final expiration date. No such right is expressed in the pertinent documents and there are no data from which an intention to create such a right can be inferred. We are therefore unable to find any merit in arguments which would postulate such an acceleration as a basis for requiring that the petitioner include in its income for 1939 amounts which it was not then obligated to pay and which it might never be required to pay, even if the scrip certificates remained outstanding. Petitioner's income tax liability for 1939 must be determined in the light of the events which occurred in that year. Each taxable year must be treated as a unit. Burnet v. Sanford & Brooks Co., 282 U.S. 359 (1931). ‘We must view the facts as they were and not as they might have been.‘ McConway & Torley Corporation, 2 T.C. 593, 596.
The manner in which the petitioner treated the scrip certificates upon its books, as described in our findings, is also not determinative of petitioner's taxable income for 1939, although reliance is placed thereon in the deficiency notice. Mere bookkeeping entries, though in some circumstances of evidential value, are not determinative of tax liability. They can not alter the legal effect of transactions, nor create income where none in fact exists. Helvering v. Midland Mutual Life Insurance Co., 300 U.S. 216 (1937). The petitioner's ‘Accrual Interest Scrip Payable‘ account was evidently opened and maintained under a mistaken theory as to the legal effect of the scrip certificates.
The respondent relies most strongly upon United States v. Kirby Lumber Co., 284 U.S. 1 (1931), which held that the taxpayer therein involved derived taxable income from the purchase at less than par of its bonds previously issued at par, to the extent of the difference between the par value of the bonds and their purchase price, this representing the increase in its net assets previously offset by the extinct obligation. Cf. Helvering v. American Dental Co., 318 U.S. 322 (1943), which emphasized the ‘increase in net assets‘ as the test of taxability in the Kirby Lumber Co. case. In the Kirby case the obligation was fixed and not contingent as here and the principle of the Kirby case was recognized by petitioner here when it reported as income the difference between the cost and par value of the bonds. It is apparent from the facts before us that the Kirby Lumber Co. case is not applicable for the purpose of determining whether the petitioner herein realized any income in 1939 from the receipt of the scrip certificates attached to the bonds redeemed in that year. The scrip certificates had given rise to no charge upon petitioner's assets when issued, nor had any such charge subsequently arisen therefrom, for at no time had petitioner become obligated to make any payments upon the scrip certificates. Consequently the surrender of the certificates with the bonds in 1939 did not, to any extent, increase petitioner's net assets.
Other authorities cited by the respondent, namely, Helvering v. Jane Holding Co. (C.C.A., 8th Cir., 1940), 109 Fed.(2d) 933; certiorari denied, 310 U.S. 653; rehearing denied, 311 U.S. 725; B. F. Avery & Sons, Inc., 26 B.T.A. 1393; Beacon Auto Stores, Inc., 42 B.T.A. 703; and Howard Paper Co., 43 B.T.A. 545, are also not in point. It is not necessary to discuss at length the effect which the Supreme Court's holding in Helvering v. American Dental Co., supra, had upon these cases. Suffice it to say that they stem in principle from United States v. Kirby Lumber Co., supra, and are distinguishable from the case before us in the same manner in which that case has just been distinguished.
The respondent also relied strongly upon section 19.22(a)-14 of Treasury Regulations 103, which provides in part:
The cancellation of indebtedness, in whole or in part, may result in the realization of income. If, for example, an individual performs services for a creditor, who in consideration thereof cancels the debt, income in the amount of the debt is realized by the debtor as compensation for his services. A taxpayer realizes income by the payment or purchase of his obligations at less than their face value. * * *
A corresponding provision has been in the income tax regulations since Regulations 94 under the Revenue Act of 1936. A substantially similar regulation was approved in United States V. Kirby Lumber Co., supra.
Assuming the validity of the regulation, the question to be decided is whether, as the respondent contends, it is controlling in the factual situation before us. It is obviously inapplicable if, under the facts, no indebtedness was canceled in 1939.
The term ‘indebtedness‘ is not defined in section 19.22(a)-14 of Regulations 103. It is defined, however, in almost identical language, both in section 19.27(a)-3 of Regulations 103, pertaining to the dividends paid credit, and in section 19.504-2, pertaining to the undistributed profits tax. As defined in these sections, ‘indebtedness‘ means ‘an obligation, absolute and not contingent, to pay on demand or within a given time, in cash or other medium, a fixed amount.‘ It is reasonable to assume that the term was used in the section of the regulations now being considered in the same sense in which it was defined and used elsewhere in said regulations. See also the definition of ‘indebtedness‘ contained in Gilman v. Commissioner (C.C.A., 8th Cir., 1931), 53 Fed.(2d) 47, 50. It is obvious that the scrip certificates, because of their extreme contingency, could have given rise to no indebtedness, nor may they be treated as ‘obligations,‘ as therein used, must mean such obligations as have given rise to an ‘indebtedness.‘
The general language of the regulations relied on to the effect that the cancellation of indebtedness may give rise to income must also be considered as having been limited in its application by the recent case of Helvering v. American Dental Co., supra, wherein it was held that the gratuitous cancellation of an obligation must be treated as a nontaxable gift and not as an accesion of taxable income. It is well settled that a ‘promise of future money payments wholly contingent upon facts and circumstances not possible to foretell with anything like fair certainty‘ has no ascertainable fair market value. Burnet v. Logan, 283 U.S. 404, 413 (1931); Cassatt v. Commissioner (C.C.A., 3d Cir., 1943), 137 Fed.(2d) 745; Bedell v. Commissioner (C.C.A., 2d Cir., 1929), 30 Fed.(2d) 622, 624. The nature of Terminal's scrip certificates was such that they could have had no ascertainable fair market value either in 1935, when they were first issued, or in 1939, when those with which we are now concerned were finally surrendered and canceled, and it can not be said that any part of the consideration which petitioner paid for its bonds can be apportioned to scrip certificates having no value. Under these circumstances, we must conclude that the scrip certificates were surrendered without consideration. Under Helvering V. American Dental Co., supra, such a gratuitous cancellation can not give rise to taxable income.
In view of our above analysis of the facts and the law, we conclude and hold that the respondent erroneously determined a deficiency with respect to petitioner's receipt of its scrip certificates in 1939.
Reviewed by the Court.
Decision will be entered under Rule 50.