Hummel-Ross Fibre Corp. v. Commissioner , 40 B.T.A. 821 ( 1939 )

HUMMEL-ROSS FIBRE CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Hummel-Ross Fibre Corp. v. Commissioner

Docket No. 93077.

United States Board of Tax Appeals

40 B.T.A. 821; 1939 BTA LEXIS 798;

October 25, 1939, Promulgated

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Pursuant to a plan of statutory reorganization, and essential thereto, petitioner, on May 31, 1934, exchanged its newly issued preferred stock, carrying cumulative dividends from January 1, 1934, in consideration for its second mortgage bonds on which petitioner had accrued the interest from January 1 to May 31, 1934, in the aggregate amount of $18,186.67. Dividends covering all of 1934 were declared and paid on the preferred stock in 1935. Held, petitioner is entitled to deduct the accrued interest as such, under section 23(b) of the Revenue Act of 1934.

Frank J. Albus, Esq., and James H. Rindfleisch, C.P.A., for the petitioner.

R. M. McMillan, Esq., for the respondent.

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LEECH

This is a proceeding to redetermine deficiencies in income taxes for the calendar years 1934 and 1935, in the total amount of $19,480.36, and a deficiency in excess profits tax of $626.83 for the calendar year 1934. Petitioner has waived all assignments of error contained in the petition except as to the disallowance by respondent of a deduction claimed for 1934 in the amount of $18,186.67. The only issue, consequently, is whether the petitioner, a corporation, is entitled to deduct the foregoing sum as accrued interest on outstanding second mortage bonds which were exchanged during the taxable year with coupons attached for a new issue of petitioner's preferred stock. Pursuant to a stipulation of the parties and attached documentary evidence, we make the following findings of fact.

FINDINGS OF FACT.

Petitioner is a corporation, organized under the laws of Virginia, with its principal place of business at Hopewell, Virginia. Its books of account are kept on the accrual basis. On January 1, 1934, it had two outstanding bond issues, one secured by a first mortgage on the property of petitioner, and the other secured by a second mortgage on the property of petitioner. The first mortgage bonds bore annual interest at the rate of 6 1/3 percent and represented a total indebtedness of $400,000. The second mortgage bonds, which are concerned in this controversy, bore interest at the rate of 8 percent per annum and represented a total indebtedness of $723,500. Interest on these latter bonds was in arrears from March 1, 1932.

In January 1934 it was decided to readjust petitioner's funded indebtedness. Pursuant to appropriate corporate resolutions adopted at special meetings held in Milwaukee, Wisconsin, on January 19 and March 16, 1934, which resolutions were subsequently ratified by the stockholders at a meeting held in Hopewell on April 6, 1934, the second mortgage bonds, with coupons representing accrued interest attached, were planned to be exchanged for preferred stock. The plan covering the above exchange was not to become effective until 80 percent of the second mortgage bondholders signified their consent thereto by depositing their bonds in escrow. On May 22, 1934, the bondholders were notified that the required percentage of bonds had been deposited and that the plan was effective. The holders of bonds to the extent of a face value of $41,500 refused to surrender their bonds and interest coupons under the plan, and as to them petitioner continued to accrue interest at the rate of 8 percent per annum.

The preferred stock, of a par value of $100 per share, carrying cumulative dividends at the rate of 6 percent, and redeemable when petitioner should choose, was issued on May 31, 1934, after an amendment of petitioner's charter had been duly made under the laws of Virginia. As an essential part of the plan, petitioner, on that date, exchanged 6,820 shares of this stock in consideration of $682,000 par value, second mortgage 8 percent bonds, together with coupons covering the interest from January 1, 1934, attached thereto. These bonds were to be canceled upon receipt and the mortgage securing them was to be released pro tanto.

The dividends on the preferred stock were to be paid at the rate of 6 percent per annum, commencing with January 1, 1934, and were cumulative. They were payable on March 1, 1935, and on every succeeding March 1, if and when earned and declared. The interest on the second mortgage bonds, in accordance with the regular practice of the petitioner, was entered on its books monthly, as an accrued interest expense. The aggregate of these entries during 1934 was $18,186.67. On August 10, 1935, at a special meeting of the board of directors of petitioner, it was resolved that a dividend of 6 percent be paid on the preferred stock over the period January 1 to December 31, 1934, which amount was paid, in cash, to the preferred stockholders before the end of the year 1935.

OPINION.

LEECH: Respondent disallowed petitioner's deduction of $18,186.67 as accrued interest. He did not question in his deficiency notice, nor has he since questioned, either the fact or the propriety of the accrual of this amount as interest. Both are apparently conceded. He supports the disallowance only on the ground that, though this interest was properly accrued, it was never paid, but, after its accrual, it was forgiven and canceled during the taxable year.

The Revenue Act of 1934 is controlling. Section 23(b) provides that, in computing net income, "All interest paid or accrued within the taxable year on indebtedness * * *" is deductible.

It is clear that payment of accrued interest is not a necessary premise to its deduction under the quoted section. ¹ The contention that petitioner's liability or obligation to pay the accrued interest was forgiven and so canceled during the tax year is not supported by the evidence. We think this record discloses conclusively that the obligations evidenced both by the bond and interest coupon, were both, in fact, transferred to petitioner, for one consideration, i.e., preferred stock. We have so found as a fact.

But that exchange occurred after the right to deduct the admittedly properly accrued interest was complete, under the quoted statutory provision.

It may be observed that respondent has not attempted to tax gain to petitioner on this exchange. The reason, obviously, is that, though petitioner's satisfaction of the bond and the them accrued interest obligations, by transfer of its preferred stock, may have resulted in a realized gain to petitioner in the sum of the difference between the then fair market value of the stock and the amount of those obligations ² - the realization of gain here is immaterial. The exchange change in which that transfer occurred was a statutory reorganization under section 112(g)(1) of the Revenue Act of 1934, and petitioner was a party thereto, since the reorganization consisted of a recapitalization of petitioner. , and cases cited therein. The exchange was an essential part of that reorganization and the plan including it. Consequently, gain, even if thus realized, was not recognized. Revenue Act of 1934, sec. 112(b)(3).

Decision will be entered under Rule 50.

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Footnotes

• 1. This is not so, however, under the Revenue Act of 1937. By virtue of an amendment contained in section 301 of that act, no deduction of accrued interest, under section 23 (b), is permissible "If not paid within the taxable year or within two and one half months after the close thereof." ↩

• 2. See ; . ↩