Kentucky Natural Gas Corp. v. Commissioner , 47 B.T.A. 330 ( 1942 )

KENTUCKY NATURAL GAS CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Kentucky Natural Gas Corp. v. Commissioner

Docket No. 103308.

United States Board of Tax Appeals

47 B.T.A. 330; 1942 BTA LEXIS 701;

July 16, 1942, Promulgated

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1. Reorganization under section 112(i)(1) of the Revenue Act of 1932 was effected when a new corporation acquired substantially all the assets of an insolvent corporation then in receivership pursuant to a reorganization plan consummated with the aid of the courts in which receiverships were pending. The foreclosure sales did not break the continuity of interest, as prior thereto the creditors of the old corporation had stepped into the shoes of the stockholders when the latter lost their participation rights by reason of the insolvency of the debtor corporation. It is immaterial that the assets were acquired at the foreclosure sales by a bondholders' committee who transferred them to the new corporation. The bondholders and unsecured creditors of the old corporation received all the stock of the new corporation. The separate steps were integrated parts of a single scheme. Helvering v. Alabama Asphaltic Limestone Co.,315 U.S. 179">315 U.S. 179.

2. In 1931, 1932, and 1933 petitioner's transferor corporation during the construction of its main transmission lines incurred certain interest charges for borrowed money which it capitalized on its books as a part of the cost of construction of these lines. None of the interest so capitalized was deducted in its Federal income tax returns for the years 1931, 1932, and 1933. Held, that under the Revenue Acts of 1934 and 1936, which are the applicable acts to the taxable years involved in this proceeding, none of the interest charges so incurred can be included as a part of the cost to petitioner's transferor of the property in question in computing the depreciation deductions to which petitioner is entitled. Central Real Estate Co.,17 B.T.A. 776">17 B.T.A. 776; affd., 47 Fed.(2d) 1036, followed.

John P. Ohl, Esq., for the petitioner.

T. F. Callahan, Esq., for the respondent.

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BLACK

The Commissioner has determined against petitioner deficiencies in income and excess profits taxes as follows:

Year	Income tax	Excess profits tax
1935	$12,095.56
1936	59,475.76
1937	120,159.28	$3,267.32

The deficiency for 1935 is due to the following adjustments made by the Commissioner in the income tax return filed by petitioner for that year:

Unallowable deductions and additional income:
(a) Decrease in depreciation allowable	$184,987.70
Nontaxable income and additional deductions:
(b) Additional interest expense	401.32
(c) Additional compensation of officers	7,200.00

The deficiency for 1936 is due to the following adjustments made by the Commissioner in the income tax return filed by petitioner for that year:

Unallowable deductions and additional income:
(a) Lease rentals	$368.58
(b) Decrease in depreciation allowable	208,970.64

The deficiencies in income and excess profits tax for 1937 are due to the following adjustments made by the Commissioner in the income and excess profits tax return filed by petitioner for that year:

Unallowable deductions and additional income:
(a) Decrease in depreciation allowable	$219,487.84
(b) Additional profit on sale of assets	189,731.04
(c) Indiana Tax accrual disallowed	1,411.16

The Commissioner in his deficiency notice explained his action in disallowing $184,987.70 of the depreciation claimed by petitioner for 1935 in the following language:

(a) It is held that the transaction by which, as of November 1, 1933, you acquired the assets of the Kentucky Natural Gas Company from the bondholders of said corporation, by the exchange of stock issued by you for bonds and unsecured indebtedness held by bondholders and creditors of the Kentucky Natural Gas Company, did not constitute a reorganization within the provisions of Section 112(b) of the Revenue Acts of 1934 and 1936, or as defined under Section 112(i)(1) of the Revenue Act of 1932, as contended for by you.

A similar explanation is made by the Commissioner in his determination of the deficiencies for 1936 and 1937.

By appropriate assignments of error petitioner contests for each year the action of the Commissioner in using, as the basis of cost for depreciation and in determining gain or loss from sales, the bid price at foreclosure sales rather than using as the basis of the cost of the assets their adjusted cost to petitioner's transferor, the Kentucky Natural Gas Co. Petitioner does not contest the correctness of any of the other adjustments made by the Commissioner in his determination of the deficiencies.

The respondent on his part contended at the hearing that he did not err in using, as the basis of costs of the assets in question, the bid prices which were made by petitioner's nominees at the foreclosure sales. He denied that the assets were acquired in a statutory reorganization. Respondent in the alternative contends that, if he did err in using as the basis of cost the bid prices at foreclosure sale and if the Board should hold that the basis of cost to be used is the adjusted cost of such assets to petitioner's transferor corporation, then in that event, costs as shown on the books of the transferor corporation were overstated by the amount of interest included in the cost of construction of the "main transmission lines" of petitioner's predecessor corporation.

FINDINGS OF FACT.

Petitioner is a corporation incorporated under the laws of the State of Delaware on October 4, 1933, and has its principal office and place of business in Owensboro, Kentucky.

It filed its income and excess profits tax returns for the years 1935, 1936, and 1937 with the collector of internal revenue for the district of Kentucky at Louisville, Kentucky.

On or about the 3d day of June 1931, the Kentucky Natural Gas Co., a corporation incorporated under the laws of the State of Delaware, executed and delivered to Peoples-Pittsburgh Trust Co. and Moorhead B. Holland (herein sometimes called the trustees) a mortgage and deed of trust dated as of April 1, 1931 (herein sometimes called the mortgage), whereby, for the purpose of securing an issue of bonds known as its two-year 6 percent mortgage gold bonds (herein sometimes called the bonds), in an authorized principal amount of not to exceed $7,000,000, dated April 1, 1931, maturing April 1, 1933, and bearing interest at the rate of 6 percent per annum, it conveyed to said trustees its right in certain real and personal property of the Kentucky Natural Gas Co. and certain rights of the Kentucky Natural Gas Co. under divers contracts, leases, and licenses, all as more specifically described in the aforesaid mortgage. The trustees duly accepted the trust created by this mortgage and the mortgage was duly recorded.

On or about the 3d day of June 1931 the Kentucky Natural Gas Co. executed its two-year 6 percent mortgage gold bonds in the aggregate amount of $4,591,000, payable April 1, 1933, bearing interest at the rate of 6 percent per annum, and all of the $4,591,000 principal amount of such bonds was delivered into the hands of numerous bona fide holders thereof who were entitled to enforce payment thereof and share in the security of the mortgage. These bonds were secured by a mortgage on substantially all of the assets of the Kentucky Natural Gas Co.

On March 18, 1932, the book value of Kentucky Natural Gas Co.'s assets was $7,342,238.82, which was exceeded, to the extent of $911,747.26, by its liabilities which (exclusive of its capital stock) aggregated $8,253,986.08. The aggregate fair market value of such assets was less than their book value.

On March 18, 1932, the Kentucky Natural Gas Co. had authorized 10,000 and issued and outstanding 1,000 shares of its 7 percent $100 par value preferred stock, and authorized, issued, and outstanding 10,000 shares of its common stock without par value, all of which was owned by the Missouri-Kansas Pipe Line Co.

On or about February 12, 1932, the Board of directors of the Kentucky Natural Gas Co. duly adopted a resolution authorizing the proper officers of that company to appear on its behalf in principal and/or ancillary proceedings which might properly be instituted against it, to retain counsel, and to execute and file answers to bills of complaint, admitting the truth of the allegations of the said bills and joining in the prayer for relief and consenting to the entry of an order or orders for the appointment of a receiver or receivers.

On March 18, 1932, a bill of complaint for the appointment of a receiver entitled "Ralph B. Innis, Inc., a corporation, Complainant, against Kentucky Natural Gas Company, a corporation, Respondent" was filed in the Court of Chancery for the State of Delaware in and for the County of New Castle. Said court is a court of record.

The answer of the Kentucky Natural Gas Co. was filed March 18, 1932, admitting each and every allegation in the bill of complaint and joining in the prayers thereof, including the prayer for the appointment of a receiver. On the same day, the chancellor of the court signed a decree finding the company insolvent and appointing a receiver (herein sometimes called the Delaware receiver).

On March 17, 1932, a creditors' bill for the appointment of an ancillary receiver was filed in the United States District Court for the Western District of Kentucky, and on March 19, 1932, the Kentucky Natural Gas Co. by its answer filed therein, admitted the allegations of said bill and joined in the request for the appointment of an ancillary receiver. Thereupon, on March 19, 1932, the court appointed an ancillary receiver (herein sometimes called the Kentucky receiver).

On March 23, 1932, an action to foreclose the mortgage and for the appointment of a receiver of the mortgaged property was instituted in the United States District Court for the Western District of Kentucky and on March 30, 1932, the court appointed the Kentucky receiver as receiver for the mortgaged properties as well.

Thereafter action similar to that taken in Kentucky was taken in Indiana by the institution of ancillary proceedings in the United States District Court for the Southern District of Indiana, Indianapolis Division, the receiver appointed in said Indiana proceedings being herein sometimes called the Indiana receiver.

The appointment of receivers with the consent of the Kentucky Natural Gas Co., as hereinbefore set forth, constituted an event of default under the provisions in the aforesaid mortgage. Thereupon, and on or about March 21, 1932, the trustees, pursuant to the request in writing of holders of more than 25 percent in principal amount of the bonds outstanding, and in accordance with the provisions of section 2 of article VIII of the mortgage, did declare the principal amount of $4,591,000, being the principal amount of all of the said bonds then outstanding, to be forthwith due and payable and the principal amount of all of these bonds then outstanding did then and thereupon become due and payable. The failure of the Kentucky Natural Gas Co. to pay the principal amount of these bonds when the trustees declared the principal amount of the bonds to be due and payable as aforesaid likewise constituted an event of default as described in said mortgage. Further, the April 1, 1932, and subsequent interest payments on the bonds of the Kentucky Natural Gas Co. were in default.

The properties of Kentucky Natural Gas Co. were operated by the receivers appointed by the Court of Chancery of the State of Delaware, by the United States District Court for the Western District of Kentucky, and by the United States District Court for the Southern District of Indiana, Indianapolis Division.

On December 31, 1932, the book value of the Kentucky Natural Gas Co.'s assets was $6,904,237.10, which was exceeded to the extent of $1,741,422.79 by its liabilities which (exclusive of its capital stock) aggregated $8,645,659.89. The aggregate fair market value of such assets was less than their book value.

On or about March 30, 1932, a committee was formed from among the holders of the bonds of Kentucky Natural Gas Co. which was active in formulating the "Plan and Reorganization Agreement dated December 29, 1932", to which the holders of all the outstanding bonds of the Kentucky Natural Gas Co., except $364,000 principal amount held by the W. G. Maguire & Co., and the holders of substantially all the unsecured indebtedness of the Kentucky Natural Gas Co. (of which 97 percent was held by the receivers of the Missouri-Kansas Pipe Line Co.) assented. This plan and reorganization agreement was approved by the United States District Court for the Western District of Kentucky on May 12, 1933, and by the United States District Court for the Southern District of Indiana, Indianapolis Division, on July 13, 1933, and by the Court of Chancery for the State of Delaware in and for the County of New Castle on June 28, 1933.

The committee declared the holders of a sufficient percentage of bonds of the Kentucky Natural Gas Co. had assented to the "Plan and Reorganization Agreement dated December 29, 1932" to satisfy the condition expressed in 12(a) thereof.

The "Plan and Reorganization Agreement dated December 29, 1932" was approved by the respective courts which appointed the receivers of the Missouri-Kansas Pipe Line Co.

The committee caused the Kentucky Natural Gas Corporation, petitioner herein, to be incorporated under the laws of the State of Delaware on October 4, 1933, with an authorized capital of 88,000 shares, all without par value, of which 46,000 shares were $7 cumulative preferred stock (herein called preferred stock) and 42,000 shares were common stock.

At the first meeting of the board of directors of the Kentucky Natural Gas Corporation, held on October 5, 1933, the chairman stated that the Kentucky Natural Gas Corporation had been formed pursuant to the "Plan and Reorganization Agreement dated December 29, 1932", and a copy of the plan was presented to the meeting and ordered attached to the minutes of the meeting as an exhibit. The chairman stated that it was contemplated that the Kentucky Natural Gas Corporation would acquire all or substantially all of the assets and properties of the Kentucky Natural Gas Co. pursuant to sales thereof in foreclosure ordered by the United States District Courts for the Western District of Kentucky and for the Southern District of Indiana, Indianapolis Division, to be held on October 9 and 10, 1933, respectively, and pursuant to the receivers' sale ordered by the Court of Chancery for the State of Delaware, to be held on October 14, 1933.

The Kentucky Natural Gas Corporation acquired substantially all of the assets and properties of the Kentucky Natural Gas Co. pursuant to foreclosure sales ordered by the United States District Court for the Western District of Kentucky, the United States District Court for the Southern District of Indiana, Indianapolis Division, and the Court of Chancery for the State of Delaware.

The Kentucky Natural Gas Corporation's acquisition of the properties of the Kentucky Natural Gas Co. was pursuant to a "Plan and Reorganization Agreement" and the adjusted basis of such properties in the hands of the Kentucky Natural Gas Co., the transferor, at the date acquired by the Kentucky Natural Gas Corporation was $6,641,422.49, being the difference between $7,386,717.88, the gross basis of such assets, and $745,295.35, the amount of the reserves for depreciation, amortization, and bad debts, subject to necessary adjustments, if any, required to be made under paragraph 29 of the agreed statement of facts.

The properties of the Kentucky Natural Gas Co. were bid in for $1,189,081 by nominees of the committee for the Kentucky Natural Gas Corporation pursuant to an agreement between the Kentucky Natural Gas Corporation and the committee dated October 5, 1933. The fair market value of the properties thus acquired was $4,227,000.

The holders of $4,227,000 principal amount of bonds and of $3,144,779.27 of unsecured claims assented to the "Plan and Reorganization Agreement", and the assenting bondholders received 42,270 shares of preferred and 21,135 shares of common stock and the assenting unsecured creditors received 18,781 shares of common stock of the Kentucky Natural Gas Corporation pursuant thereto.

The shares of capital stock (1,000 of preferred and 10,000 of common) of the Kentucky Natural Gas Co. were not exchanged and nothing was received in respect thereof under the plan and organization agreement.

The Kentucky Natural Gas Corporation assumed, and later paid, the Kentucky Natural Gas Co.'s accrued taxes, current accounts payable, and all reorganization expenses and issued, pursuant to its agreement of October 5, 1933, an aggregate of 42,270 shares of its preferred stock and 39,916 shares of its common stock called for under the plan and reorganization agreement.

All shares of the capital stock of the Kentucky Natural Gas Corporation, preferred and common, had equal voting rights, share for share, on all matters.

The properties of the Kentucky Natural Gas Co. were transferred to Kentucky Natural Gas Corporation by instruments of conveyance which ran from the special masters appointed to conduct the respective foreclosure sales, from the receivers of the properties of the Kentucky Natural Gas Co., and from the Kentucky Natural Gas Co. itself to the Kentucky Natural Gas Corporation.

The properties of the Kentucky Natural Gas Corporation classified as field and tributary lines depreciated at the rate of 12 percent annually, as deducted in its tax return, rather than at the rate of 4 percent, as set forth in the Commissioner's notices of deficiency.

The additions and retirements of the Kentucky Natural Gas Corporation from November 1, 1933, through and including the years 1935, 1936, and 1937 are as set forth in Exhibit F, attached to the agreed statement of facts.

There was included as part of the cost of construction of the "main transmission lines" interest incurred during and prior to the completion of such properties. The amount of such interest included in cost and in the reserves for depreciation to November 1933 is as follows:

	Cost	Reserve
1931:
Prior to August 6	$270,177.95	$26,117.20
Subsequent to August 6	46,219.50	4,467.89
1932	1,179.00	66.81
1933	190.92	3.18
	317,767.37	30,655.08

The above interest charges represented interest at the rate of 6 percent on money borrowed by the Kentucky Natural Gas Co., none of which was deducted in its Federal tax returns for the years 1931, 1932, and 1933. The Kentucky Natural Gas Co.'s tax returns were made and its books of account were kept on the accrual basis.

The foregoing facts are found from stipulations of fact filed at the hearings and from the oral testimony of one witness. Any of the stipulated facts not incorporated herein are made a part of these findings by reference.

OPINION.

BLACK: The two questions which we have to decide in this proceeding are:

(1) Whether the plan of reorganization of the Kentucky Natural Gas Co. and the steps taken in consummation thereof, pursuant to which the Kentucky Natural Gas Corporation, the petitioner herein, acquired substantially all the assets of the Kentucky Natural Gas Co. in exchange for shares of its voting preferred and common stocks, constituted a "reorganization" within the meaning of section 112(i)(1) of the Revenue Act of 1932? If this question is answered in the affirmative, the principal issue in the case must be decided in favor of the petitioner. If question (1) is decided in favor of petitioner, then respondent has raised question (2). It is:

(2) Whether interest incurred during construction of the Kentucky Natural Gas Co.'s main transmission lines may be properly capitalized as a part of the cost thereof and used in computing depreciation deductions?

We shall first take up issue 1.

The Kentucky Natural Gas Corporation acquired its properties in 1933 from the Kentucky Natural Gas Co.

The primary question involved, as we have already stated, is whether the transaction in question constituted a "reorganization" under that portion of section 112(i)(1) of the Revenue Act of 1932 which provides:

The term "reorganization" means (A) a merger or consolidation (including the acquisition by one corporation of * * * substantially all the properties of another corporation) * * *.

Section 112(b)(4) provides:

* * * No gain or loss shall be recognized if a corporation a party to a reorganization exchanges property, in pursuance of the plan of reorganization, solely for stock or securities in another corporation a party to the reorganization.

Section 113(a)(7) provides that the basis of property shall be the cost of such property, except that:

* * * If the property was acquired after December 31, 1917, by a corporation in connection with a reorganization, and immediately after the transfer an interest or control in such property of 50 per centum or more remained in the same persons or any of them, then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made. This paragraph shall not apply if the property acquired consists of stock or securities in a corporation a party to the reorganization, unless acquired by the issuance of stock or securities of the transferee as the consideration in whole or in part for the transfer.

The taxable year 1935 was governed by the Revenue Act of 1934. Section 113(a)(12) provides as follows:

* * * If the property was acquired, after February 28, 1913, in any taxable year beginning prior to January 1, 1934, and the basis thereof, for the purposes of the Revenue Act of 1932 was prescribed by section 113(a)(6), (7), or (9) of such Act, then for the purposes of this Act the basis shall be the same as the basis therein prescribed in the Revenue Act of 1932.

As to the years 1936 and 1937, they are governed by the Revenue Act of 1936 and a like provision is to be found in section 113(a)(12) of the act.

Since the hearings in the instant case the Supreme Court has decided Helvering v. Alabama Asphaltic Limestone Co.,315 U.S. 179">315 U.S. 179; Palm Springs Holding Corporation v. Commissioner,315 U.S. 185">315 U.S. 185; Marlborough Investment Co. v. Commissioner,315 U.S. 189">315 U.S. 189; and Helvering v. Southwest Consolidated Corporation,315 U.S. 194">315 U.S. 194 (all Feb. 2, 1942). The parties were given leave to file briefs following the Supreme Court's decisions in these cases. The petitioner has filed a brief in which it relies upon Helvering v. Alabama Asphaltic Limestone Co., supra, as a case particularly in point and controlling as to the disposition of the primary issue here involved. The commissioner has not filed any beief.

The "reorganization" considered in the Alabama Asphaltic Limestone Co. case was governed by section 112(i)(1) of the Revenue Act of 1928, which is identical with section 112(i)(1) of the Revenue Act of 1932. We think it is clear that the Supreme Court's decisions in the Alabama Asphaltic Limestone Co. and the Palm Springs Holding Corporation cases are decisive in petitioner's favor as to issue (1).

The decisions of the Supreme Court in Marlborough Investment Co. v. Commissioner, supra, and Helvering v. Southwest Consolidated Corporation, supra, decided the same day as the Alabama Asphaltic Limestone Co. and Palm Springs Holding Corporation cases, supra, are distinguishable both from the latter two cases and from the instant case.

Marlborough Investment Co. v. Commissioner, supra, is distinguishable in that the Court there found that the property was not acquired by the committee or the new corporation from the Marlborough Investment Co., the old company. The Court stated:

For the reasons stated in Helvering v. Alabama Asphaltic Limestone Co., supra, this transaction clearly would have been a "reorganization" within the meaning of § 112(i)(1) but for one fact. That fact is that the property was not acquired by the committee or the new corporation from Marlborough Investment Co. * * *

Helvering v. Southwest Consolidated Corporation, supra, is distinguishable in that it arose under the Revenue Act of 1934, wherein the meaning of "reorganization" was differently defined. The Court recognized that had the reorganization been governed by the Revenue Acts of 1928 or 1932 (the acts involved in Alabama Asphaltic Limestone Co. and Palm Springs Holding Corporation, supra ) there would have been a reorganization in the Southwest Consolidated Corporation case. On this point the Court said:

Under the statute involved in Helvering v.Alabama Asphaltic Limestone Co., * * * decided this day, there would have been a "reorganization" here. For the creditors of the old company had acquired substantially the entire proprietary interest of the old stockholders. * * *

The Court went on to state that a change was made in the definition of "reorganization" by the Revenue Act of 1934, which laid down a much stricter test. Since the facts there showed that the new company had given class A warrants to unsecured creditors and class B warrants to stockholders, the new company there was not in a position to contend that it had acquired all or substantially all of the assets of the old company "solely for voting stock", and consequently there was no "reorganization." Cf. Helvering v. Cement Investors, Inc.,316 U.S. 527">316 U.S. 527.

Having decided issue (1) in petitioner's favor, it becomes necessary to decide issue (2), which respondent raised as an alternative issue.

The Kentucky Natural Gas Co., the transferor of the properties of the Kentucky Natural Gas Corporation, constructed certain so-called "main transmission lines", and as a part of the cost thereof it included interest incurred during the period and prior to the completion of the construction of such properties. The amount of such interest included in the cost of construction and in the reserves for depreciation to November 1933 is stated in our findings of fact above.

By a reference to our findings of fact, it will be observed that the interest capitalized is segregated as between that incurred prior to August 6, 1931, and that incurred subsequent thereto. The reason for such segregation is that T.D. 4321, X-2 C.B. 169, amended article 561 of Regulations 74 so as to provide an exception in favor of the allowances of carrying charges paid or incurred, as the case may be, prior to August 6, 1931.

In March 1931 the Fifth Circuit, in Central Real Estate Co. v. Commissioner, 47 Fed.(2d) 1036, affirmed the Board's opinion at 17 B.T.A. 776">17 B.T.A. 776, and held that the regulations had been incorrect in including carrying charges such as taxes and interest in the basis of the property. The treasury recognized the force of the Central Real Estate Co. case as applied to future carrying charges, but despite the holding of the decision, took a view that items prior to August 6, 1931, which had not been deducted as expenditures might be included in the capital amount. T.D. 4321, X-2 C.B. 169 (Aug. 6, 1931), amended Regulations 74 of the 1928 Act, as follows:

In computing the amount of gain or loss, however, the cost or other basis of the property shall be properly adjusted for any expenditure, receipt, loss, or other item properly chargeable to capital account, including the cost of improvements and betterments made to the property since the basic date. Carrying charges, such as interest and taxes on unproductive property, may not be treated as items properly chargeable to capital account, except in the case of carrying charges paid or incurred, as the case may be, prior to August 6, 1931, by a taxpayer who did not elect to deduct carrying charges in computing net income and did not use such charges in determining his liability for filing returns of income. [Emphasis supplied.]

It is petitioner's contention that under the foregoing amended regulations it has the right to capitalize the interest charges incurred prior to August 6, 1931, in the construction of its main transmission lines, although conceding that the remainder of the interest incurred in 1931 could not be capitalized. We do not agree that the foregoing regulation is applicable. The taxable years before us are 1935, 1936, and 1937. The Treasury regulations applicable to the year 1935 are contained in Regulations 86, covering the Revenue Act of 1934. Article 113(b) - 1 of those regulations contains the following provision:

* * * In the case of unimproved and unproductive real property, carrying charges, such as taxes and interest, which have not been taken as deductions by the taxpayer in determining net income for the taxable year, or a prior taxable year, are properly chargeable to capital account. [Emphasis supplied.]

Article 113(b)(1) of Regulations 94, covering the Revenue Act of 1936, contains an identical provision. These provisions of the regulations simply carry out section 113(b)(1)(A) of the Revenue Act of 1932, which is identical in the Revenue Acts of 1934 and 1936. Section 113(b)(1)(A), Revenue Acts 1932, 1934, and 1936, read as follows:

(1) GENERAL RULE. - Proper adjustment in respect of the property shall in all cases be made -

(a) for expenditures, receipts, losses, or other items, properly chargeable to capital account, including taxes and other carrying charges on unimproved and unproductive real property, but no such adjustment shall be made for taxes or other carrying charges for which deductions have been taken by the taxpayer in determining net income for the taxable year or prior taxable years. [Emphasis added.]

Now, if the "main transmission lines" of petitioner's predecessor corporation can be classed as "unimproved and unproductive real property" then undoubtedly under the above quoted statute and regulations petitioner should be allowed to capitalize the interest which it claims. Cf. Queensboro Corporation,46 B.T.A. 1216">46 B.T.A. 1216. See also discussion in P18.172, Paul and Mertens Law of Federal Income Taxation.

As a matter of fact, petitioner does contend in its brief that the small expenditure of $1,179 in 1932 for interest and that of $190.92 in 1933 in connection with the construction of these transmission lines should be capitalized under the provisions of section 113(b)(1)(A) of the Revenue Act of 1932. This, of course, would only be allowable on the ground that the "main transmission lines" in question are "unimproved and unproductive real property." We think it is clear that these transmission lines do not fall into such classification and petitioner's contention in that respect can not be sustained. To avoid misunderstanding, it should be made plain that petitioner does not claim that the $270,177.95 interest expended by its predecessor prior to August 6, 1931, should be capitalized under section 113(b)(1)(A) of the Revenue Act of 1932. As has already been stated, petitioner contends that such interest should be capitalized under Regulations 74, article 561, as amended by T.D. 4321, already quoted in this opinion. Obviously, Regulations 74 does not apply to either of the taxable years which we have before us. As we have already said, the applicable regulations governing the years which we have before us are Regulations 86 and 94, and these regulations only provide for the capitalizing of interest which has been expended in the carrying of unimproved and unproductive real property and has not been taken as a deduction in determining net income of the taxpayer for some prior year.

Under the Board's decision in Central Real Estate Co., supra, affirmed by the Fifth Circuit, we think issue 2 must be decided in favor of the Commissioner.

Decision will be entered under Rule 50.