Docket No. 53702.
11-21-1933
THE BALTIMORE AND OHIO RAILROAD COMPANY AND AFFILIATED CORPORATIONS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Hugh C. Bickford, Esq., and R. Kemp Slaughter, Esq., for the petitioner. Orris Bennett, Esq., for the respondent.
Hugh C. Bickford, Esq., and R. Kemp Slaughter, Esq., for the petitioner.
Orris Bennett, Esq., for the respondent.
Respondent determined a deficiency of $329,451.83 in petitioner's income tax for 1927. Petitioner contends (1) that in making this determination respondent erred in disallowing as a deduction from gross income (a) the cost of preparing stock certificates and other similar expenses, (b) amounts called interest, allowed by it as a price deduction, on advances of money made by stock subscribers prior to the issuance of the certificates, and (c) amounts paid to bankers as underwriting fees; (2) that in computing gain on awards paid its subsidiaries for certain water front properties, respondent determined too low a value as of March 1, 1913, as basis for gain; and, in the alternative, (3) that no profit is taxable since the awards were made by a state government. Respondent, affirming, prays for the addition to income reported of interest received from the city of New York on the awards.
FINDINGS OF FACT.
Petitioner is a Maryland corporation, with principal office at Baltimore, and during 1927 was the parent of 99 affiliated corporations. It had on file with respondent a written agreement that all taxes of the group be assessed against it. The group is engaged in the operation of a railway transportation system, with terminals and related facilities, and keeps its books on an accrual basis in accordance with the system of accounting prescribed by the Interstate Commerce Commission.
1. On June 9, 1927, petitioner's board of directors resolved to issue and sell 632,425 shares of its authorized but unissued common stock of a par value of $100 a share and to offer to its common and preferred shareholders the right to subscribe therefor to the extent of 30 percent of their holdings as of June 30, 1927, at the price of $107.50 a share, payable as indicated in a notice to shareholders. On the same date the shareholders were by notice advised of their subscription rights, effective until July 22, 1927, and were given the option in exercising them either to pay:
$106.83 on or before July 21, 1927, (which is the full subscription price less a deduction of interest on the par value at the rate of 6% per annum from July 21, 1927, to September 1, 1927)
when certificates were to be delivered, and the subscribers could participate in dividends, or to pay
$32.25 on or before July 21, 1927; and $74.60 on December 1, 1927, (which is the balance of the full subscription price less a deduction of interest on 30% of the par value at the rate of 6% per annum from July 21, 1927, to December 1, 1927).
Certificates were deliverable on payment of the second installment and the holders thereof were entitled to participate in all dividends payable after December 1, 1927.
On June 9, 1927, Kuhn, Loeb & Co. and Speyer & Co. of New York agreed to underwrite the subscription and to take any unsubscribed shares at the same price and on the same terms as offered the shareholders, including "the adjustment of interest," in consideration of an amount equal to $2.25 a share for all the shares offered. Petitioner's proposed issuance and sale of common shares was thereafter duly approved by the Interstate Commerce Commission. 131 I.C.C. 27.
On September 1, 1927, 599,422 so stipulated of the common shares were issued to subscribers electing the full subscription plan, and on December 1, 1927, 33,033 so stipulated shares were issued to subscribers electing the installment plan. Of the 632,425 issued, petitioner's shareholders purchased 614,925 and the banking firms purchased 17,500, for which they paid cash directly to petitioner. In accordance with the underwriting agreement, petitioner, on July 25, 1927, paid the bankers $1,422,956.25 for their services. The Interstate Commerce Commission instructed petitioner to charge this amount "against the amount realized from the sale of the stock at 107½, making the net premium creditable to account 753, `Premium on Capital Stock' 5¼ per cent." The "deduction of interest on the par value at the rate of 6% per annum from July 21, 1927, to September 1, 1927" and the "deduction of interest on 30% of the par value at the rate of 6% per annum from July 21, 1927, to December 1, 1927" offered to the purchasers under the two respective subscription plans, amounted to $422,927.40. The petitioner declared and paid dividends on its common stock during the years 1925, 1926, 1927, 1928, and 1929 at the rates of 5, 5¼, 6½, 6, and 6¼ percent, respectively. The 6½ percent dividend paid during 1927 included a 6 percent regular and a one half of one percent special March 1, 1927, dividend to bring dividends for the fiscal year 1926 to $6 per share.
Prior to the issuance of the 632,425 shares of common stock petitioner expended the following amounts for:
Printing stock certificates______________________________ $3,290.00 Printing subscription warrants___________________________ 5,530.00 Printing letters to stockholders_________________________ 1,078.95 Listing shares on New York Stock Exchange________________ 6,900.00 All other expenses_______________________________________ 254.85 _________ Total_____________________________________________ 17,053.80
Respondent disallowed as deductions from gross income the $1,422,956.25 paid the banking firms for underwriting, the $422,927.40 described as interest on the stock subscription advances, and the $17,053.80 representing expenses connected with the preparation and issuances of the shares.
2. and 3. On July 1, 1919, petitioner's subsidiary, the Staten Island Railway Co., owned parcels of water front property on Staten Island, designated on Exhibit No. 2 as parcels 1 and 12, which it had acquired prior to March 1, 1913. Parcel 1, containing 1,082,703.03 square feet, consisted of land under water, extending from the physical bulkhead to the pierhead line; parcel 12, containing 5,599.07 square feet, consisted of filled land on Front near Canal Street. Petitioner's subsidiary, the Staten Island Rapid Transit Railway Co., owned parcels designated as 2, 21, and 22, acquired prior to 1913. Parcel 2, containing 926,733.45 square feet, consisted of land under water extending to the pierhead line; parcel 21, containing 102,156.46 square feet, consisted of land under water and land filled, improved by a frame passenger station; parcel 22, containing 45,010 square feet, consisted of land partly under water, partly filled, and was encumbered with several easements. Petitioner's subsidiary, the New York Transit & Terminal Co., owned parcels designated as 17, 18, and 20, acquired prior to 1913, containing 393,579.36, 14,505.65, and 1,543,564.80 square feet, respectively; all were located at Tompkinsville on Staten Island and were partly under water and partly filled, and extended to the pierhead line.
On July 1, 1919, the Commissioners of the Sinking Fund of New York City authorized proceedings which resulted in the condemnation of these properties for public use, and title thereto became vested in the city of New York on October 11, 1919. In Re Lands on Upper New York Bay in City of New York, 215 App. Div. 204, 438; 213 N.Y.S. 486; 214 N.Y.S. 234. On July 20, 1927, the New York Court of Appeals affirmed the judgment of the Supreme Court, awarding the subsidiaries the following compensation for the properties taken, together with interest at 6 percent per annum from October 11, 1919, until date of payment, all of which they received in 1927:
----------------------------------------------------------------------------------- | Compensation | Interest -----------------------------------------------------|---------------|------------- Staten Island Railway Co.___________________________ | $716,153.25 | $302,435.69 Staten Island Rapid Transit Ry. Co._________________ | 735,270.08 | 310,663.64 New York Transit & Terminal Co., Ltd________________ | 1,677,586.80 | 708,293.46
The fair market value of said properties on March 1, 1913, was as follows:
Staten Island Railway Co. Parcel No. 1__________________________________________________ $482,336.77 Parcel No. 12_________________________________________________ 5,599.07 Staten Island Rapid Transit Ry. Co. Parcel No. 2__________________________________________________ 433,418.72 Parcel No. 21_________________________________________________ 59,707.62 Parcel No. 22_________________________________________________ Nil New York Transit & Terminal Co., Ltd. Parcel No. 17_________________________________________________ 220,404.44 Parcel No. 18_________________________________________________ 8,123.16 Parcel No. 20_________________________________________________ 864,396.29
Respondent computed a taxable gain realized on the awards, using as a basis the March 1, 1913, value of the properties taken, which he determined as follows:
Staten Island Railway Co_________________________________ $541,351.51 Staten Island Rapid Transit Ry. Co_______________________ 463,366.72 New York Transit & Terminal Co., Ltd_____________________ 1,026,903.13
In computing the tax, respondent failed to include in gross income any amount representing the interest paid on the awards.
OPINION.
STERNHAGEN:
1. The petitioner claims three classes of deductions growing out of its issue of common shares in 1927: (a) $422,927.40, which it calls interest on prepaid stock subscriptions; (b) $1,422,956.25 underwriting and service fees to the bankers, and (c) $17,053.80 printing and listing costs. In our opinion, none of these amounts is a proper deduction under the statute, Revenue Act of 1926, section 234, and the decision as to each is governed by prior decisions.
(a) Despite the petitioner's characterization in the notice to shareholders of the subscription price as the full price less interest, this seems to us to be merely a mathematical method of arriving at the actual price to be paid under each of the two elective methods of payment. There was no "interest paid or accrued within the taxable year on its indebtedness." What the petitioner did, apparently, was to figure out a price which would embody the fair consideration at the dates of payment and the time of issuance in relation to a basic figure of $107.50 a share — for full cash before July 21, $106.83, and for part cash and part deferred, $106.85. That this may have been arrived at by using a mental concept of interest, or that mathematically the figures are the same as if par of $100 (not the assumed base figure of $107.50) were paid and interest thereon paid before delivery of the shares, is not determinative. The statute requires that there should be an indebtedness, that there should be interest upon it, and that it should be paid or accrued within the taxable year. A formula is not enough. Commissioner v. Old Colony R.R. Co., 284 U.S. 552; Henrietta Mills, Inc. v. Commissioner, 52 Fed. (2d) 931; 20 B.T.A. 651; Daniel Bros. Co. v. Commissioner, 28 Fed. (2d) 761; 7 B.T.A. 1086; Carl Lang, 3 B.T.A. 417; Marsh & Marsh, Inc., 5 B.T.A. 902; Anderson & Co., 6 B.T.A. 713. In Eastern Rolling Mill Co., 5 B.T.A. 663, payments were actually made by the taxpayer which the Commissioner conceded were interest on advance payments for stock and deductible. It was held that the amount was not part of invested capital. Paramount Knitting Mills, 17 B.T.A. 91, involved the deducibility of accrued interest on subsisting notes. Neither of these decisions cited by petitioner supports its claim.
(b) and (c). It is the petitioner's claim that both the amounts paid to the bankers and the costs of printing and listing, all of which were incidents of the issuance of common shares, are deductible. Many decisions have held to the contrary. Simmons Co. v. Commissioner, 33 Fed. (2d) 75; certiorari denied, 280 U.S. 577; Corning Glass Works v. Lucas, 37 Fed. (2d) 798; certiorari denied, 281 U.S. 742; Continental Pipe Mfg. Co. v. Poe, 59 Fed. (2d) 694; Surety Finance Co. of Tacoma, 27 B.T.A. 616. Cf. Hershey Mfg. Co. v. Commissioner, 43 Fed. (2d) 298. But the petitioner insists that such decisions are wrong, and that the law should now be brought back to its proper course. We adhere to the rule. We say only, in respect of the petitioner's argument, that the deduction depends upon whether the outlay is an "ordinary and necessary expense of carrying on trade or business" and not upon whether it is a so-called capital item. It is quite possible that a given item eludes definition or clear accounting classification and hence can not be called either an expense or a capital expenditure. Cf. Commissioner v. Field, 42 Fed. (2d) 820. But its deducibility is not proven by showing that it results in no capital addition or investment or that a conservative accounting policy would require that it be written off.
2. The petitioner claims that the respondent's determination of the fair market value on March 1, 1913, of the lands on Staten Island was too low, with a resulting overstatement of gain realized by the award. The issue was tried entirely by the use of expert witnesses for both sides, whose opinions differed widely and whose methods of appraisal varied as to the factors of value regarded as significant and the emphasis placed upon them. It is said, for instance, by one, that the Brooklyn water front is an important factor and that there is a natural and recognized relation in the values on both sides of the channel, while another denies this and says that in long experience he never heard of the use of such a relation. The relative importance of transactions in the vicinity as indices of value is fraught with detailed dispute, the merits of which it would serve no useful purpose to discuss. All of the evidence, consisting both of facts and opinions, has been given careful study and full consideration. Petitioner is apprehensive that a finding may be arrived at by splitting the difference between the opposing sides. The fear is unjustified. There has been no inclination to avoid the thought which the helpful briefs of counsel have provoked, and the findings represent our conclusions from the evidence. The value results from the use of 48 cents a square foot for the disputed portion of parcels 1 and 2 which is not in the area of projected streets, and 56 cents a square foot for parcels 17, 18, 20, and 21.
3. The constitutional validity of the tax upon the award and interest has been sustained by earlier decisions in which the subject has been adequately discussed. United States Trust Co. of New York v. Anderson, 65 Fed. (2d) 575; John J. Bliss, 27 B.T.A. 803, and cases there cited. There was no error in respondent's inclusion of the gain and interest in petitioner's taxable income. Likewise, we think the entire amount of interest received in 1927 should be included. Its accrual goes along with the award itself, which occurred in 1927 when the decree became final and the principal and interest were fixed and received.
Judgment will be entered under Rule 50.