Opinion
No. J-184.
June 19, 1933.
Ralph J. Baker, of Harrisburg, Pa. (Hause, Evans Baker, of Harrisburg, Pa., on the brief), for plaintiff.
James A. Cosgrove, of Washington, D.C., and Charles B. Rugg, Asst. Atty. Gen., for the United States.
Before GREEN, LITTLETON, WILLIAMS, and WHALEY, Judges.
Suit by Central Iron Steel Company against the United States.
Judgment for plaintiff.
Plaintiff sues to recover $146,373.45, tax and interest alleged to have been illegally collected for 1917, with interest. The controversy arises from the disallowance by the Commissioner of Internal Revenue of a deduction of $306,168.01 from income for 1917. This amount was part of a total of $355,466.24 distributed by the receivers of plaintiff during 1917 as interest on the claims of unsecured creditors pursuant to authority given by the court of common pleas of Pennsylvania by decree of October 17, 1916. The distribution was made to four classes of unsecured creditors whose claims antedated the appointment of the receivers on February 6, 1912. These claims were: (a) General merchandise creditors for $1,000 or over, (b) bank creditors, (c) other creditors, claims deposited with the reorganization committee, and (d) other creditors whose claims were not so deposited. The aggregate principal of these four classes of claims was $1,427,285.15. This existing indebtedness of the corporation was bearing interest at the time the receivers were appointed and took over the business and assets of the corporation; however, interest was not accrued upon the books of the receivers nor paid by them until the termination of the receivership in 1917.
Plaintiff contends that interest on this unsecured indebtedness of the corporation did not accrue as a liability against the receivers during the time they had possession and control of the property from February 6, 1912, to May 28, 1917, until a surplus in the assets and cash was created on the last-mentioned date, and that the payment by the receivers in 1917 of $355,466.24 from such surplus created after January 1, 1917, as interest to these unsecured creditors out of a surplus in their hands after all of the principal claims against the corporation had been paid, was a legal and proper deduction from gross income for 1917 under the pertinent sections of the revenue acts.
The defendant contends that the interest-bearing indebtedness of the corporation outstanding at the time the receivers were appointed was a fixed liability and that interest thereon accrued, as a fixed and certain liability against the receivers, ratably during the receivership and should have been entered upon the books periodically and deducted from income for each year from 1912 to 1917. It is insisted, therefore, that only the interest which accrued on the indebtedness during 1917 prior to its payment by the receivers in that year constituted a proper deduction from gross income for 1917.
In the alternative the defendant contends that inasmuch as the first claim for refund filed July 14, 1923, was based upon a determination of the tax for 1917 under section 210 of the Revenue Act of 1917 ( 40 Stat. 307), this court has no jurisdiction under that claim and the plaintiff cannot recover any portion of the original tax paid for 1917; that if plaintiff is entitled to recover on the merits judgment can be rendered in its favor for only $61,074.80, being the additional tax and interest paid October 10, November 10, and December 14, 1926, for which a claim for refund was filed March 7, 1928.
Special Findings of Fact.
1. Plaintiff, a Pennsylvania corporation with principal office and place of business at Harrisburg, was in the hands of receivers appointed by the court from February 6, 1912, until May 28, 1917. Prior to and during the receivership, and since that time, the business carried on was the manufacture of articles of iron and steel.
By a decree entered February 6, 1912, the court of common pleas of Dauphin county, Pa., appointed C.L. Bailey, Jr., James M. Cameron, and J.V.W. Rernders receivers of plaintiff. The receivers duly qualified and entered upon their office, continuing thereafter as such receivers in possession and operation of the properties of the corporation until May 28, 1917, on which date a decree was entered by the court discharging them and replacing and revesting the property of the corporation in its officers, directors, and stockholders on conditions therein stated.
By the decree of February 6, 1912, the persons above mentioned were appointed receivers "of all the property, legal and equitable interests, things in action, effects, money, receipts, earnings, privileges, and franchises of the corporation defendant, wherever the same or any part thereof may be situate, with all the powers, rights, and duties of receivers in like cases and particularly with the powers, rights, and duties as herein expressly set forth"; and were directed forthwith to "enter upon and take possession of all and singular the property, legal, and equitable interests, things in action, effects, money, receipts, earnings, privileges, and franchises, and have and hold, use and operate, and manage the plant, furnace, rolling mills, and appurtenances of corporation defendant until further order of the court."
The decree further provided:
"That the said defendant corporation, its officers, directors, agents, or employees, or whoever may have possession thereof, shall forthwith deliver to the said receivers all and every part of the property, real and personal, interest, effects, moneys, receipts, earnings and all books, vouchers, and other papers, touching the same or any part thereof; and said corporation defendant, and its officers, directors, agents, and employees, and each and every of them, are hereby cautioned and enjoined from in any way or manner interfering with the sole and exclusive control, management, and possession of the property aforesaid by said receivers. * * *
"That said receivers from any moneys or income coming into their possession shall pay all taxes assessed upon said property, and are hereby authorized to pay for such repairs, supplies, labor, and services as shall in their judgment be necessary and proper to conserve the property and operate the plant, furnaces, rolling mills, and other property of the corporation defendant; and said receivers shall further have power to enter into contracts for the purchase of material and supplies for the operation of the plant aforesaid and manufacture, through the operation of said plant, product from materials so purchased or now on hand and sell the same, and generally to control and manage the operation of the said plant and the business heretofore conducted by said corporation defendant until otherwise ordered."
2. At the time the receivers were appointed the plant and assets of the corporation were carried on its books at approximately $3,909,000 as follows:
Real estate and plant ......................... $2,684.000 Currents assets: Cash ............................. $ 25,000 1,200 shares Mohawk Mining Co. 200,000 Accounts receivable, inventories, and miscellaneous .............. 1,000,000 __________ 1,225,000 __________ $3,909,000
The 1,200 shares of stock of the Mohawk Mining Company were then pledged as security for a bank loan of $140,000 made by the corporation in May 1910. At the same time the approximate indebtedness of the corporation shown by its books was $3,119,000 made up of 5 per cent. mortgage bonds of the corporation of $1,239,000 and current liabilities of $1,880,000. This indebtedness of the corporation was exclusive of its liability as guarantor of principal and interest on $545,000 in principal amount of bonds of the Connellsville Basin Coke Company then outstanding and held by outsiders. Eventually the receivers paid in excess of $359,000 under this guaranty. Sinking-fund payments under the mortgage securing the corporation's own bonds were then in arrears. The current liabilities of $1,880,000 eventually had to be met and were later found to understate the corporation's indebtedness, chiefly on account of state taxes of $15,000.
At the time the receivers were appointed the property of the corporation was old. It had been allowed to deteriorate and was in a bad physical condition. Intrinsically it was not worth the mortgage indebtedness at the time. On that basis the other indebtedness of the corporation of approximately $1,880,000 could have then been paid only to the extent of approximately 66 cents on the dollar from its current assets of approximately $1,225,000, if the latter amount could then have been realized therefrom, without considering the liability of the corporation on the guaranty of bonds of the Connellsville Basin Coke Company.
3. The receivers operated the plant and property of the corporation, and the result of such operation by them was a profit of $34,000 for the fiscal period, February 6, 1912, to February 28, 1913, a loss of $55,000 for the fiscal year ending February 28, 1914, a loss of $208,000 for the fiscal year ending February 28, 1915, and a profit of $202,000 for the fiscal year ending February 29, 1916, or a net loss of $27,000 over a period of slightly more than four years. These figures were arrived at before any deductions for depreciation, depletion, or obsolescence, for which no reserves were ever set up by the receivers, and before any allowance or adjustment for the liability on the guaranty of bonds of the Connellsville Basin Coke Company. The business of the receivers was poor during 1914 and the first half of 1915, about which time it gradually improved and the gain made in the fiscal year 1916 was largely in the latter months of that period.
From February, 1916, forward, there was an increased demand for ship plates which constituted the greater portion of the business of the receivers from which their earnings were derived. These earnings increased as the business improved, and by the summer of 1916 it appeared as if the receivers could make a favorable termination of the receivership. By the fall of 1916, however, a changed situation was brought about by the war in Europe and the receivers thought it probable that if the war continued they could earn sufficient profits to pay every one in cash.
4. In September, 1916, the receivers agreed with the reorganization committee of the corporation and others in interest upon a suggestion to be made to the court of common pleas of Dauphin county that the court give the receivers authority to begin distributions out of their earnings for the purpose of paying obligations of the corporation, the receivers, and the reorganization committee.
This suggestion was made to the court in a petition filed October 17, 1916. When it was presented the receivers informed the court that while they thought it probable that they could make sufficient earnings to carry out the proposal, they were not certain and that this all depended upon the war and the continuance of demand on that account for their products. They also informed the court as to how rapidly they thought they could make distribution. The plan suggested to the court was approved by its decree of October 17, 1916. It provided for gradual payment of the principal of such obligations over a future period. A small amount estimated at $14,785 representing one class of principal indebtedness of the corporation was to be paid at once, with an allowance for interest thereon; 25 per cent. of substantial amounts representing other classes of principal indebtedness of the corporation was to be paid at once, and a balance, or 75 per cent. of the principal of the indebtedness, was to be paid at 10 per cent. a month, thus contemplating spreading the payment thereof over a period of seven to eight months. Payment of one large amount of principal of $386,476.57 was postponed until after payment in full of such other amounts of principal, and until after payment of current interest on bonds of the corporation and payments to the sinking fund under its mortgage securing such bonds. Only after all of these payments had been made in full was an allowance for interest on such of the principal amounts of the indebtedness of the corporation as were to be given such allowance to be paid and distributed if earnings were sufficient for that purpose, except only that on the above small amount of $14,785.
5. In the aforementioned petition to the court the receivers stated:
"The result of the operations of the plant since February 29th, 1916, has been a further increase in the earnings of the company (receivers), sufficient, in the judgment of your petitioners (receivers), to furnish adequate working capital, even under the present conditions of extensive production.
"Contracts made by your petitioners as receivers will provide a sum in excess of the amount necessary to conduct the business, pay the expenses of the receivership, the interest and sinking fund upon the bonds secured by the mortgage of the company (plaintiff) to Girard Trust Company, dated August 1st, 1905, upon which default has been made in the payments of the sinking fund and interest, and sufficient to warrant the belief that the arrears of the sinking fund and the unsecured indebtedness may also be paid.
"The reorganization committee, acting under said agreement on behalf of the holders of said bonds, claims, and notes deposited with it, and Edward Bailey, the holder of the claim of $386,476.57, representing together over ninety-five percent (95%) of the said indebtedness of the company (plaintiff), have respectively notified your petitioners (receivers) that they desire the receivership to be continued and payments to be made from the earnings now in the hands of the receivers and from the net proceeds of the operation of the company's business hereafter (received) by them, of the arrears of sinking fund, the claims of merchandise creditors, the notes held by banks, and the claims of other creditors, as hereinbefore set out, and that they assent to the prayers of this petition.
"The reorganization committee has also notified your petitioners that it will not proceed in behalf of the holders of said bonds upon any default or defaults which have heretofore occurred under the said mortgage, so long as and if payments are made of the arrears of sinking fund as hereinafter set out, the sinking-fund payments are made as required by the mortgage, and the interest is paid upon all of the bonds as they shall respectively hereafter become due and payable."
The prayer of said petitioner was: "Wherefore your petitioners pray that they be authorized and directed from the earnings now in their hands and from the net proceeds of the business of the company hereafter received by them" — to make the payments as and in the manner and order set out in finding 6 hereof.
The decree entered by the court on October 17, 1916, upon the petition, was as follows:
"First. That the receivers, from the earnings now in their hands and from the net proceeds of the business of the company hereafter received by them, shall" (followed by paragraphs I to VI inclusive, in respect of payments as and in the manner and order set out in finding 6 hereof).
"Second. That the receivers be, and they are hereby, authorized to and directed to make payments under the plan hereinbefore set out in this decree of any other claims of the same or like character and upon a greater or less amount of indebtedness should it appear that the claims and such indebtedness are equally entitled to such payment with the claims and indebtedness above set out.
"Third. That the receivers are further authorized to compromise, settle, and adjust any claims against or indebtedness of the company with the assent and approval of the reorganization committee, and to apply to the court from time to time for such further order in the premises as may seem fit, meet, and desirable."
6. The payments or distributions to be made under the plan so proposed and under numbered parts of the decree so entered by the court were as shown in the tabulation below, the respective principal amounts mentioned in the decree being shown in column (1) and the amounts eventually paid and distributed by the receivers therefor being shown in column (2):
Of this amount, $90.90 was paid as interest thereon.
Amount mentioned in and paid under decree of November 17, 1916.
Cash balance at October 1, 1916.
7. By petition of November 17, 1916, the receivers represented to the court that in order to meet the contingent liability of the corporation under its guaranty of bonds of the Connellsville Basin Coke Company, and acting under part IV of the decree of October 17, 1916, they had set aside $312,693.75 and expected soon to be able to add thereto a sufficient amount to pay all overdue interest on such bonds and all arrears of sinking fund due under the mortgage securing the guaranty bonds, and petitioned the court that part IV of the decree be modified so as to at once authorize the receivers to pay over $149,875 to the trustee under the mortgage to be immediately applied by it to pay all outstanding and overdue interest coupons on the bonds, and also to pay $210,000 to such trustee on account of the sinking fund under the mortgage. By decree entered November 17, 1916, the prayer of the petition was granted and part IV of the decree, as first entered, was modified accordingly. Pursuant thereto, in November, 1916, the receivers paid to the trustee the amounts of $149,875 and $210,000, a total of $359,875.
8. The program or plan of payment or distribution was as set out in the petition to the court on October 17, 1916, herein before mentioned, and in the decree entered on that date as modified in part IV by the decree of November 17, 1916, which at that time the receivers thought they might be able to carry out. Their ability to do so, however, was contingent upon the continuance of the war which had brought about the demand for ships and, hence, for ship plates, constituting the principal business being done by the receivers, to which their earnings were primarily due. Based upon the experience of the receivers to that time, the observations they had made of conditions then existing in Europe and knowledge of the orders they were then receiving, they did not believe that the business would continue longer than the war. They had informed the court that it was probable that they would be able to take care of the indebtedness of the corporation outlined in such plan and decree, but their ability to do so depended upon conditions, which, in turn, depended on and were all based on a continuance of the war. Had there been a sudden armistice and the war had ended, the business being done would have collapsed and the orders would have been canceled. In the fall of 1916 the business was profitable, but the war, in which the United States was not then engaged and in which it did not engage until April, 1917, was the condition which made the business profitable and affected the ability of the trustees to make profits.
9. When the decree of the court was made October 17, 1916, and thereafter, there was no certainty that the receivers would be able to carry out the program or plan of payment or distribution set forth therein. This depended entirely upon how long the war lasted. There was not at any time prior to January 1, 1917, any certainty that the receivers could carry out such program or plan, or that they could pay even the principal of the claims against the corporation.
10. There was not at any time prior to January 1, 1917, any certainty that the creditors or proposed payees would ever receive the entire amount of the principal of their claims or would receive anything for interest on their claims against the corporation under part VI of the decree entered October 17, 1916, whether viewed from the standpoint of such creditors or payees or from that of the receivers and the reorganization committee, who had the greater information.
11. As matters turned out, the receivers anticipated the program or plan and made the payments more rapidly than the court had directed and, also, more rapidly than the reference in the decree to 10 per cent. a month had indicated. By May, 1917, the receivers had paid every one in full and had also paid in cash or notes the interest authorized under part VI of the decree. The receivers accelerated the payments under the decree as much as they possibly could in a businesslike way and as rapidly as they had resources and money on hand, consistent with their need for money to carry on the business and make earnings therefrom. The payments made, however, very materially reduced the cash held by the receivers. After May 1, 1917, the amount of $136,476.57, being a portion of the amount specified in part V which was payable in cash under the decree, was paid in notes for the reason that the receivers did not have cash with which to pay them and because they wished to pay or satisfy the creditors under part V so they could begin to make payments under part VI of the decree. The receivers thus accelerated the time when interest authorized in part VI of the decree became payable, and, under that part, in May, 1917, they paid $158,229.72 in cash, and, not having cash to pay the balance of $193,149.02, arranged to give notes therefor to three creditors entitled to payment in cash of such balance. The notes so given under parts V and VI were notes of the receivers. These notes were assumed by the corporation on discharge of the receivers by the court on May 28, 1917, and were later paid.
12. Payments under the respective parts of the decree entered October 17, 1916, as modified in part IV by the decree of November 17, 1916, were made by the receivers in the months of October, 1916, to May, 1917, inclusive. The subtotals given for parts I to IV, inclusive, represent the totals for parts which, under the decree, were given priority over part V thereof, which, in turn, was given priority over part VI. The subtotals for parts I to V, inclusive, represent the totals for parts which, under the decree, were given priority over part VI. No payments whatsoever were made under either part V or part VI of the decree until after January 1, 1917. The earliest payment made under part V of the decree was in March, 1917, and the earliest payment made under part VI was in May, 1917.
13. The cash available to the receivers to make payments under the respective parts of the decree at September 30, 1916, and at the close of each month thereafter to May 31, 1917, was as shown in the tabulation below in which are also shown the payments made in cash in each month under the respective parts of the decree.
Exclusive of $1,990 in petty cash fund.
Balance of $136,476.57 for which notes given, paid in full in 1917, subsequent to May 31.
Balance of 193,149.02 for which notes given, paid in full in 1917, subsequent to May 31. Interest of 4,078.63 paid on said notes in 1917, subsequent to May 31. ____________ 333,704.22 2,368,479.94 total deductions under court decree above. ____________ 2,702,184.16 total paid or distributed thereunder; finding 6 hereof.
Cash balance at May 31, 1917.
14. The net earnings of the receivers from the operation of the plant and the conduct of business in each of the months of October, 1916, to May, 1917, inclusive, were as shown in column (1) of the tabulation of the end of this finding, the same being without deduction for depreciation or similar reserves.
The resources of the receivers at September 30, 1916, and at the close of each month thereafter to May 31, 1917, consisting of cash on hand at September 30, 1916, plus cumulative total of such monthly net earnings of the receivers, were as shown in column (2a) of the tabulation below in which such earnings are included as a resource whether held in the form of cash or represented by increases of accounts receivable, inventories, or fixed assets purchased out of earnings or of similar items.
The resources of the receivers at September 30, 1916, and at the close of each month thereafter to May 31, 1917, consisting of cash on hand at September 30, 1916, plus the cumulative total of such monthly net earnings of the receivers, were as shown in column (2a) of the tabulation below in respect of which monthly net earnings, however, adjustments have been made by (a) adding for increases in current liabilities and reserves, and (b) deducting for increases in accounts receivable, inventories, and fixed assets purchased out of earnings as at the close of each of the above months in comparison with amounts for these respective accounts at September 30, 1916. The effect of such adjustment is that the figures in column (2a) were the resources available to the receivers at the several dates for use to make payments under the respective parts of the decree of October 17, 1916, as modified, after inclusion of the entire parts of net earnings in column (1) actually available to the receivers for that purpose.
The balances left as of the end of each month from October, 1916, to May, 1917, inclusive, from the entire amount of the resources of the receivers shown in column (2), after deducting therefrom total amounts shown in column (3) paid under parts I to V, inclusive, of the decree to the respective dates shown, were as shown in column (4). Balances left at the same dates from the entire amount of the resources of the receivers shown in column (2a), after the same deductions, were as shown in column (4a).
Balances remaining unpaid under parts I to V, inclusive, of the decree as of the end of each such month were as shown in column (5). A deficit or excess of balances of resources (shown in columns (4) and (4a), respectively), over such balances so unpaid were as shown in columns (6) and (6a) and columns (7) and (7a).
Balances remaining unpaid under part VI of the decree as of the end of each such month were as shown in column (8). The deficit or excess of such balances of resources (after application thereof to balances unpaid under parts I to V, inclusive), over such balances so unpaid under part VI, were as shown in columns (9) and (9a) and columns (10) and (10a).
15. The total resources, consisting of cash and assets actually available to the receiver to make payments under the respective parts of the decree, as modified, were not sufficient to enable them to make in full the payments required under parts I to V, inclusive, thereof at any time prior to March 31, 1917, and were not sufficient, after having made the payments required first to be made under parts I to V, inclusive, to enable them to begin making the payments required under part VI thereof at any time prior to March 31, 1917, or to complete the same until after April 30, 1917. Payments under parts I to V, inclusive, were, under the decree, required to be made in full before any part of the payment authorized under part VI of the decree was due and was authorized to be paid.
16. Disregarding the fact that portions of the monthly net earnings of the receivers were not actually available to them to make payments under the respective parts of the decree but were represented only by increases in accounts receivable, inventories, and fixed assets purchased out of such earnings, the total resources of the receivers (including month by month, as earned, their entire net earnings for the months of October, 1916, to May, 1917, inclusive) were not sufficient to enable them to make in full the payments required under parts I to V, inclusive, thereof at any time prior to February 28, 1917, and were not sufficient, after having made the payments required first to be made under parts I to V, inclusive, to enable them to begin making payments authorized under part VI thereof at any time prior to February 28, 1917, or to complete the last-mentioned payments until after March 31, 1917.
17. Unfilled orders in net tons and dollars of value accepted by the receivers, and to be filled in operating the plant and carrying on the business of which they were in charge, fn1 fn4
Cum. addn. of monthly net earnings.
Column (8), — column (7).
Includes notes given for $136,476.57.
Column (8), — column (7a).
--------------------------------------------------------- | Net tons | Dollar value -------------------------------|----------|-------------- 1916 | | | | Sept. 30 ..................... | 11,762 | $ 889,677.68 Oct. 31 ..................... | 15,289 | 1,184,591.72 Nov. 30 ..................... | 12,285 | 1,005,158.70 Dec. 31 ..................... | 11,396 | 907,577.44 | | 1917 | | | | Jan. 31 ..................... | 11,399 | 924,914.86 Feb. 28 ..................... | 12,157 | 954,810.78 Mar. 31 ..................... | 11,664 | 985,024.80 Apr. 30 ..................... | 12,274 | 1,149,337.36 May 31 ..................... | 10,393 | 1,052,395.18 ---------------------------------------------------------
18. The total current assets of the receivers consisting of cash, accounts and notes receivable, inventories, and miscellaneous items; their total current liabilities, consisting of accounts payable and accrued current liabilities; and their net working capital — were as follows at the respective dates shown, the figures being in thousands of dollars rounded to the nearest even thousand:
------------------------------------------------------------ | Current — | |------------------------| Net working | Assets | Liabilities | capital ----------------------|---------|--------------|------------ | | | 1916 | | | | | | Sept. 30 ............ | $2,094 | $ 272 | $1,822 Oct. 31 ............ | 1,857 | 279 | 1,578 Nov. 30 ............ | 1,498 | 346 | 1,152 Dec. 31 ............ | 1,540 | 428 | 1,112 | | | 1917 | | | | | | Jan. 31 ............. | 1,688 | 460 | 1,229 Feb. 28 ............. | 1,767 | 529 | 1,238 Mar. 31 ............. | 1,926 | 644 | 1,282 Apr. 30 ............. | 2,031 | 660 | 1,371 May 31 .............. | 2,097 | 1,226 | 871 --------------------------------------------------------------
19. The ratio of current assets of the receivers, consisting of cash, accounts and notes receivable, inventories, and miscellaneous items, to their current liabilities, consisting of accounts payable and accrued current liabilities, and the ratio of such cash to such current liabilities, were as follows at the respective dates shown:
----------------------------------------------------------- | Ratio of | | current | Ratio of | assets to | cash to | current | same | liabilities | ----------------------------|---------------|-------------- | | 1916 | | | | Sept. 30 .................. | 7.71 to 1 | 2.70 to 1 Oct. 31 .................. | 6.65 to 1 | 2.27 to 1 Nov. 30 .................. | 4.33 to 1 | 0.55 to 1 Dec. 31 .................. | 3.60 to 1 | 0.02 to 1 | | 1917 | | | | Jan. 31 ................... | 3.67 to 1 | 0.37 to 1 Feb. 28 ................... | 3.32 to 1 | 0.25 to 1 Mar. 31 ................... | 2.99 to 1 | 0.38 to 1 Apr. 30 ................... | 3.08 to 1 | 0.39 to 1 May 31 .................... | 1.71 to 1 | 0.06 to 1 -----------------------------------------------------------
20. The receivers made payments under the respective parts of the decree of the court, as modified, as and in the order of priority established in the decree as rapidly as they had money and resources available to do so consistent with the maintenance of reasonable cash balances on hand for the operation of the business.
21. The receivers of the corporation were not in a position to pay nor were they able to pay any amount under part VI of the decree of October 17, 1916, as modified in part IV by the decree of November 17, 1916, at any time prior to January 1, 1917.
22. The entire amount of the paid-up capital stock of the corporation and one-half of its interest-bearing indebtedness outstanding as to both items at the close of the calendar years 1912 to 1917, inclusive, were as shown in columns (2) and (3), respectively, of the tabulation below; the totals of such items were as shown in column (4); the amounts representing interest on such totals for one year at 5 per cent. are shown in column (5), and at 6 per cent. in column (6). All paid-up capital stock of the corporation outstanding at the close of each such year was common stock of the par value of $100 a share, and there was no preferred capital stock or other capital stock in the nature of preferred capital stock outstanding at the close of any such year. The interest-bearing indebtedness includes only formal bond indebtedness of the corporation itself, and at the close of the calendar years 1912 to 1915, inclusive, a note for $140,000 secured by deposited collateral and given by the corporation prior to February 6, 1912; 5 per cent. was the rate of interest on the bonds and the note; 6 per cent. is the legal rate of interest in Pennsylvania.
---------------------------------------------------------------------------------------------------------------------- | | One half of | | Amount for interest for | | interest-bearing | Total of | one year on col. (4) at — At Dec. 31 — | Paid-up | indebtedness | col. (2) and |------------------------------- | capital stock | | col. (3) | 5% | 6% (1) | | | | | | (2) | (3) | (4) | (5) | (6) | | | | | ------------------------------|-----------------|--------------------|----------------|---------------|--------------- 1912 ........................ | $2,245,400 | $689,500 | $2,934,900 | $146,745 | $176,094 1913 ........................ | 2,245,400 | 689,500 | 2,934,900 | 146,745 | 176,094 1914 ........................ | 2,245,400 | 689,500 | 2,934,900 | 146,745 | 176,094 1915 ........................ | 2,245,400 | 689,500 | 2,934,900 | 146,745 | 176,094 1916 ........................ | 2,245,400 | 489,500 | 2,734,900 | 136,745 | 164,094 1917 ........................ | 2,245,400 | 292,500 | 2,537,900 | 126,895 | 152,274 ---------------------------------------------------------------------------------------------------------------------- 23. The amounts deducted for interest or amounts in the nature thereof in returns of net income for the years 1912 to 1917, inclusive, under the Revenue Acts of 1916 and 1917 and prior revenue acts, by the receivers of the corporation or by plaintiff, were as shown in column (2) of the tabulation below. The portions thereof allocated as applicable to the respective years on a pro rata time basis, regardless of whether, in view of the receivership of the corporation from February 6, 1912, to May 28, 1917, the portions actually and legally accrued in the years as a liability of the corporation or of the receivers, were as shown in columns (3) to (8), inclusive, in the tabulation. The amounts representing interest for one year at 5 per cent. and 6 per cent., respectively, as shown in columns (5) and (6) of the tabulation with the preceding paragraph hereof for the respective years are also shown in the tabulation below: ------------------------------------------------------------------------------------------------------------------------------------ Deducted in returns | Portions of amount in col. (2) applicable as above in — ------------------------------------------------------------------------------------------------------------------------------------ For year | Amount | 1912 | 1913 | 1914 | 1915 | 1916 | 1917 | | | | | | | (1) | (2) | (3) | (4) | (5) | (6) | (7) | (8) | | | | | | | ----------------------|---------------|---------------|---------------|---------------|---------------|---------------|------------- 1912 ................ | $ 65,475.35 | $ 65,475.35 | ............. | ............. | ............. | ............. | ............ 1913 ................ | 67,723.93 | ............. | $ 67,723.93 | ............. | ............. | ............. | ............ 1914 ................ | 30,975.00 | ............. | ............. | $ 30,975.00 | ............. | ............. | ............ 1915 ................ | 0 | ............. | ............. | ............. | ............. | ............. | ............ 1916 ................ | 165,470.55 | ............. | ............. | 30,975.00 | $ 61,950.00 | $ 72,545.55 | ............ 1917 ................ | 403,457.07 | 57,082.17 | 62,271.46 | 62,271.46 | 62,271.46 | 62,271.46 | $ 97,289.06 |---------------|---------------|---------------|---------------|---------------|---------------|------------- | 733,101.90 | 122,557.52 | 129,995.39 | 124,221.46 | 124,221.46 | 134,817.01 | 97,289.03 | | | | | | | Amounts under | | | | | | | col. (5) and | | | | | | | col. (6), preceding | | | | | | | paragraph: | | | | | | | Col. (5) at 5% | ............. | 146,745.00 | 146,745.00 | 146,745.00 | 146,745.00 | 136,745.00 | 126,895.00 Col. (6) at 6% | ............. | 176,094.00 | 176,094.00 | 176,094.00 | 176,094.00 | 164,094.00 | 152,274.00 ------------------------------------------------------------------------------------------------------------------------------------ 24. Of the items of indebtedness of the corporation included in part II of the decree of October 17, 1916, and set out in column (2) in the tabulation in finding 6 hereof, as items (b), (c), and (d), the items or portions thereof shown in column (2) below had borne interest prior to the appointment of the receivers of the corporation:
------------------------------------------------------------------------ | | | Portion | | Total of | above Item | Brief description | item | referred to | | (1) | (2) | | | ------|-----------------------------------|---------------|------------- b. | Claims of merchandise | | | creditors of $1,000 or | | | greater ....................... | $507,183.85 | $179,613.75 c. | Notes held by banks ............. | 165,500.00 | 165,500.00 d. | Claims of other creditors | | | deposited with | | | reorganization committee ....... | 368,124.73 | 368,124.73 | |---------------|------------- | | ............. | $713,238.48 ------------------------------------------------------------------------
No portion of the interest deduction of $403,457.07 paid in 1917 and deducted in the return for that year, $306,168.01 of which was disallowed by the commissioner and is involved in this case, was deducted or claimed as a deduction for any year prior to 1917.
The item of indebtedness of the corporation to Edward Bailey of $386,476.56, included in part V of the decree, had borne interest prior to the appointment of receivers on February 6, 1912.
The sums of $713,238.48 and $386,476.57 represented in part interest accrued thereon to that date but not subsequent thereto or during the receivership. Immediately upon the appointment of receivers any accruing of interest on either of these two sums ceased on the books, records, and accounts of the corporation or the receivers. No interest was accrued on such books, records, and accounts either before or after the appointment of the receivers on the balance of $327,570.10 left from the above sum of $507,183.85 after deducting $179,613.75 therefrom.
The only two items of indebtedness of the corporation on which any interest was accrued, or for which any liability for interest was set up on the books, records, and accounts of the corporation or the receivers after their appointment, were (a) on the first-mortgage bonds of the corporation, and (b) on the secured note of the corporation for $140,000 held by a bank and given before the appointment of receivers, and, in addition, on borrowings made by the receivers themselves.
No interest was paid during the receivership upon any items except the two specifically mentioned in the preceding paragraph thereof, and upon such borrowings of the receivers, until after the decree of the court entered on October 17, 1916, and until payments were made under parts I and VI.
The above-mentioned bonds of the corporation, dated August 1, 1905, antedated the appointment of the receivers and were secured by a first mortgage on the property and plant of the corporation, subject to foreclosure. The interest paid thereon during the receivership was paid in order to conserve the plant and property of the corporation.
The above-mentioned note for $140,000 was given in May, 1910, and also antedated the appointment of the receivers, and was paid by the receivers in May or June, 1916; 1,200 shares of stock of the Mohawk Mining Company, owned by the corporation and carried on its books at $200,000, had been pledged as collateral for such note and remained so pledged when the receivers were appointed. The interest paid on the note during the receivership was paid to conserve the collateral as an asset, and the account for this interest so nominated it. During the portion of the period of the receivership that the note remained outstanding, dividends received by the receivers on the pledged stock were more than twice the amount of interest paid on the note by the receivers, and in the year following payment of the note the dividends received were equal to the entire interest paid.
25. It is a recognized principle in receivership accounting that interest on claims of unsecured creditors incurred by the debtor prior to appointment of receivers is not an accruing liability of the receivers after such appointment and does not accrue during the term of the receivership, whether or not the accounts of the debtor or the receivers were or are kept and federal tax returns were or are made on the accrual basis. Accounting statements for receiverships are not prepared so as as to include an accrual of interest on unsecured claims as a liability. In such case no liability for such interest exists unless and until the receivers have funds available over and above those required to meet their own liabilities as receivers, the costs and expenses of the receivership, and the principal of claims against the debtor with which to pay such interest allowance. Uncertainty whether such funds will be available affects not merely the time of payment of such interest but the existence of the liability itself to pay such interest, and goes to whether there will be anything to pay and whether there will be any liability at all. This is true notwithstanding that by the decree of the court having jurisdiction payment for such interest by the receivers has been authorized, if sufficient funds are available therefor; it remains a contingent liability until such funds are available, and, until they are, there remains a contingency as to whether an actual liability therefor will occur. Until that contingency is removed, there is no liability even though the accounts of the debtor or the receivers are kept on an accrual basis.
26. April 1, 1918, plaintiff filed income and profits tax returns on forms furnished by the Treasury Department for the calendar year 1917, which included the portion of such year prior to the termination of the receivership. This return showed a net income for income-tax purposes of $3,167,249.90 and a net income for excess profits-tax purposes of $3,137,249.90, and an invested capital of $3,816,910.96. The excess profits credit under section 203(a) of the Revenue Act of 1917 ( 40 Stat. 304) was computed at 7 per cent. of the invested capital. And applying to the foregoing amounts the returns, adjustments, and computations provided in the Revenue Acts of 1916 and 1917, the returns showed an excess profits-tax liability of $1,438,988.27 and an income tax of $102,495.70, or a total tax liability of $1,541,483.97. This tax was duly assessed in April 1918.
With the returns for 1917 plaintiff filed a claim for abatement of $14,351.58 based on the computation of the excess profits tax credit at 9 per cent. of the invested capital in lieu of 7 per cent. By computing the credit at 9 per cent., the total taxes shown by the return would have been $1,527,132.39, which amount was paid by plaintiff to the collector in Philadelphia June 15, 1918.
In arriving at the net income shown in the returns for 1917, plaintiff deducted from income for that year under item 6(a) on the income-tax return the sum of $403,457.07, being the amount actually paid by the receivers during 1917 to creditors of the corporation in excess of the principal of their claims as hereinbefore set forth.
By letter of December 29, 1919, the Commissioner of Internal Revenue notified plaintiff of his refusal to compute the excess-profits tax credit at 9 per cent. and required that it be computed at 7 per cent. and, accordingly, rejected the claim for abatement of $14,351.58. Thereafter the collector made demand for payment of the last-mentioned amount and for interest of $2,583.28 thereon. Plaintiff paid the tax January 28, 1920, and the interest on February 3, 1920, making a total payment of $1,544,067.25 for 1917.
27. December 23, 1922, the commissioner made a preliminary audit of the return for 1917 and notified plaintiff by letter that he had consolidated it with the Connellsville Basin Coke Company, an affiliated corporation, and that, as a result of such audit, he had made no change in the net income reported on the return of plaintiff and had determined the consolidated net income of the two companies for excess-profits tax purposes to be $3,247,074.68 and the consolidated invested capital to be $3,049,401.56, and had determined an excess-profits tax due by plaintiff for 1917 of $1,540,039.91 and an income tax of $96,432.60, or a total tax of $1,636,472.51. This amount was $94,988.54 in excess of the total tax shown on the returns filed by plaintiff for 1917, previously assessed and paid with interest. The additional tax of $94,988.54 was assessed against plaintiff in January 1924. No portion of this additional assessment was collected until October 10, 1926, as hereinafter stated in finding 30, except $1,051.82 collected by credit February 24, 1924, as stated below.
In this letter of December 23 the commissioner also notified plaintiff that he had allowed an overpayment of $1,051.82 for 1916. This letter was a preliminary thirty-day notice and the profits tax disclosed thereby was not computed under section 210 of the Revenue Act of 1917 and the interest deduction of $403,457.07 claimed in the return for 1917 was not disturbed. The 1916 overpayment was credited against the additional assessment for 1917 on February 24, 1924.
28. July 14, 1923, plaintiff duly filed a claim for refund of $400,000, alleged to be the amount of income and profits taxes theretofore paid by it for 1917 in excess of the amount legally due. This claim stated as follows: "Application has been made to the Commissioner of Internal Revenue for relief under section 210 of the Revenue Act of 1917 ( 40 Stat. 307), on the basis of which the amount of tax assessable for the year 1917 will be substantially reduced. This claim is accordingly filed to protect our rights under section 252 of the Revenue Act of 1921 ( 42 Stat. 268) pending the final disposition of the case."
Theretofore on July 6, 1923, plaintiff had filed with the commissioner an application for determination and computation of its tax for 1917 under section 210 of the Revenue Act of 1917.
During further consideration by the commissioner of the returns for 1917 in connection with plaintiff's application for assessment under section 210 and its claim for refund, the commissioner advised plaintiff that the application for determination of the tax under section 210 would be allowed and indicated that the amount deducted from income in the 1917 return for interest paid in that year to creditors of the corporation, after the payment of the principal of their claims, was excessive and that only the interest which accrued upon such claims in the year 1917 prior to payment by the receivers constituted a proper deduction from gross income. As a result of this advice, and at the commissioner's suggestion, the plaintiff, on October 2, 1924, prepared and filed with the commissioner in connection with its claim for refund of $400,000 theretofore filed a detailed statement of the facts and reasons against the disallowance of any portion of the deduction taken in the return for 1917 on account of interest paid in that year by the receivers on the principal of the claims against the corporation in accordance with the request of the commissioner's office.
29. After further consideration and review of the tax liability for 1917, the commissioner formally allowed plaintiff's application for computation of the tax under section 210 of the Revenue Act of 1917 but denied its claim for the deduction of interest paid by the receivers in 1917 to the extent of $283,349.79. He notified plaintiff of this determination on March 12, 1925, by a preliminary thirty-day letter which gave plaintiff the right to appeal from such determination under section 250(d) of the Revenue Act of 1921 ( 42 Stat. 265). In this letter of March 12, 1925, the commissioner advised plaintiff that he had determined its net income for the calendar year 1917 for incometax purposes to be $3,450,599.65 and its net income for excess-profits tax purposes to be $3,529,774.27; that he had determined and computed the tax under section 210 of the Revenue Act of 1917, and as a result thereof, he had determined an excess-profits tax of $1,470,127.32 and an income tax of $117,628.34, or a total income and profits tax for the calendar year 1917 of $1,587,755.66. This letter to plaintiff stated, in part, as follows:
"Net income disclosed by Department letter dated December 23, 1922 ................ $3,167,249.90 As corrected .................................... 3,450,599.65 _____________ Net additions; interest ......................... $ 283,349.75 Additions: (a) Interest deducted on creditors' claims .................................. 355,466.24 Interest allowed (Article 180, Regulations 33) ..................................... 72,116.49 _____________ $283,349.75
"Interest allowed has been computed on a principal of $1,442,329.74 at 5% per annum.
"Your request for relief under the provisions of section 210 has been granted and the excess profits tax determined is based upon the experience of a group of representative concerns which in the aggregate may be said to be engaged in a like or similar trade or business to that of your company."
The interest deduction mentioned in the letter quoted above involved the interest paid by the receivers as hereinbefore stated under part VI of the decree of the court of common pleas.
The aforementioned determination of the commissioner showed an overassessment for 1917 of $48,716.85 on the basis of the total tax assessed and paid on the original return and the additional assessment of $94,988.54 in January, 1924.
Had the commissioner allowed plaintiff's claim for refund as supplemented and amended by the detailed statement of facts and reasons filed October 2, 1924, claiming a deduction of the interest paid by the receivers in 1917, in addition to the computation of the profits tax under section 210, there would have resulted an overpayment of tax for 1917 in respect of the tax and interest theretofore paid in cash or by credit of $85,298.65 and a total overassessment of $179,235.37. The total tax and interest paid in cash on June 15, 1918, and January 28, 1920, and by credit on February 23, 1924, amounted to $1,545,119.07.
April 6, 1925, plaintiff appealed and filed with the commissioner a detailed written statement of facts and grounds in connection with its claim for refund theretofore filed against the determination with specific reference to the disallowance of $283,349.75 of the deduction of $403,457.07 for interest payments made in 1917 by the receivers. All the detailed facts with respect to the total amount claimed as a deduction were furnished to the commissioner and specific exceptions were taken to such disallowance, and written argument with reference thereto was filed. This statement was received, considered, and acted upon by the commissioner.
April 9, 1926, the commissioner, after further consideration of the return and the tax liability for 1917, and the claim for refund of $400,000 for 1917, as supplemented and amended by the statements of facts and arguments in support of the interest deduction claimed on the return, made his final determination with respect to the tax liability for 1917 and notified plaintiff by letter of that date that he had finally determined its net income for income-tax purposes to be $3,473,417.91 and for excess-profits-tax purposes to be $3,552,592.53; that he had computed the tax under section 210 of the Revenue Act of 1917 at 41.65 per cent. in the amount of $1,479,631.13 and an income tax of $118,427.21, or a total income and profits tax liability of $1,598,058.34. In this determination the commissioner increased the amount of interest disallowed as a deduction for 1917 from $283,349.75 to $306,168.01 and determined an overassessment for 1917 of $38,414.17 on the basis of the original assessment of $1,541,483.97 and an additional assessment of $94,988.54.
The determination set forth in this notice, in so far as the interest item was concerned, was as follows:
Net income disclosed by office letter dated March 12, 1925 ............................ $3,450,599.65 As corrected ................................ 3,473,417.91 Addition: Interest deduction adjusted ....... 22,818.26 _____________ Interest deducted on return ................. $ 403,457.07 Interest accrued on claims in 1917 as shown in your brief dated April 6, 1925 97,289.06 _____________ Interest disallowed ......................... $ 306,168.01 Previously disallowed ....................... 283,349.75 _____________ Reduction ................................... $ 22,818.26
The commissioner advised the plaintiff his reasons for the final decision reached, as follows:
"Reference is made to your protest dated April 6, 1925, and the hearing held in this office with your representative on June 4, 1925, relative to the disallowance of interest on creditors' claims paid in 1917 for prior years and the result of the allowance of your application for assessment of your excess-profits tax for 1917 under the provisions of section 210 of the Revenue Act of 1917.
"After a careful review of your protest and of all the evidence submitted in support of your contentions you are advised that the Bureau holds:
"1. That the liability for payment of interest on creditor's claims accrued annually although payment was not authorized by the court until 1917 [1916]. Accordingly, only the interest which accrued on such claims during 1917 can be allowed as a deduction from income in that year.
"2. That the corporations used in the determination of your profits tax liability under section 210 are proper and representative concerns within the meaning of that section."
Accordingly the commissioner allowed an overassessment of $38,414.17, which was abated, and disallowed and rejected the claim for refund of $400,000 in full.
The question as to the propriety of the deduction of the interest paid in 1917 under part VI of the decree of the court of October 17, 1916, was first raised in connection with the adjustment given under section 210 of the Revenue Act of 1917. The interest deduction in question was raised by the commissioner as a counterbalancing item against the overassessment and overpayment resulting from the determination of the tax under section 210.
Had plaintiff's claim for deduction of interest paid by the receivers in 1917 not been disallowed in part by the commissioner in his final determination upon the claim for refund, the total income and profits tax due for 1917, after computing the profits tax under section 210 as was done by the commissioner, would have been $1,459,820.42. The total income and profits tax theretofore collected in cash and by credit for 1917, plus interest of $2,583.28, was $1,545,119.07. On this basis there would, therefore, have been an overpayment of $85,298.65 in respect of the tax and interest collected for 1917 and covered by the claim for refund as originally filed and supplemented prior to rejection by the written statements of fact filed October 2, 1924, and April 6, 1925. There would also have been an overassessment of $179,235.37 instead of the additional tax stated in the next finding.
30. As a result of the commissioner's final determination allowing an overassessment of only $38,414.17, as disclosed in his letter of April 9, 1926, plaintiff was required to pay a further tax for that year of $55,522.55 plus interest thereon of $5,552.25, totaling $61,074.80. This amount was paid as hereinafter stated.
On June 21, 1926, the collector made demand on plaintiff for payment of $61,074.80, being the unpaid balance of $55,522.55 of the total income and profits tax of $1,598,058.34 determined by the commissioner for 1917 and interest of $5,552.25 thereon. The amount demanded was paid by plaintiff on October 10, November 10, and December 14, 1926.
The total overpayment made by plaintiff in respect of the tax and interest collected thereon for 1917 as a result of the reduction in the amount of tax due by the computation of the profits tax under section 210 of the Revenue Act of 1917 and the increase thereof, by including in income the interest paid of $355,466.24, was $146,373.45.
31. Waivers of the statute of limitation for 1917 were filed by plaintiff on various dates between January 14, 1921, and January 22, 1925, the last waiver extending the period of limitation to December 31, 1925.
32. March 7, 1928, plaintiff filed a claim for refund for 1917 of the tax and interest paid, as set forth in finding 30. No action has been taken on this claim by the commissioner. The grounds set forth in this claim for refund were as follows: "Said payments so made were illegally demanded and exacted and were not due and payable by taxpayer and should be refunded because the Commissioner of Internal Revenue erred in disallowing deduction of interest in sum actually paid therefor by, and which became an obligation or liability of, taxpayer in year 1917, as properly deducted upon its return. Taxable net income so returned was correct, and therefore, pursuant to relief granted by Commissioner under section 210 of Revenue Act of 1917, the above total at item 3 of taxes assessed against and paid by taxpayer for period shown, exceeds by $138,282.26 the amount properly assessable and due therefor, of which excess amount and interest thereon, both illegally assessed and collected, payment was made by taxpayer," as stated in finding 30.
33. In determining the net taxable income shown on the return for 1917 plaintiff deducted under item 6(a) thereof $403,457.07, which represented the amount actually paid during 1917(1) to holders of bonds issued by plaintiff corporation prior to the appointment of receivers, (2) to creditors whose claims arose before such appointment, and (3) to holders of certain bills or notes payable incurred during the receivership. The aforesaid payment of $403,457.07 was made (a) to the extent of $46,449.21 in respect of interest on the issuance of bonds in and for the year 1917; (b) to the extent of $355,466.24 under part VI of paragraph first of a decree or order of the court of common pleas of Dauphin county, Pa., entered October 17, 1916, which provided in part as follows: "Pay, after all the foregoing payments I to V, inclusive, have been made, from any funds available therefor, interest at five percent (5%) per annum from February 6, 1912, the date of the appointment of the receivers, upon the said claims of creditors, banks, and Edward Bailey; * * *" and (c) to the extent of $1,541.62 in respect of interest on bills or notes payable incurred by the receivers.
The amount of $403,457.07 was paid on indebtedness of the three classes aforesaid to an amount of such indebtedness as follows:
----------------------------------------------------------- | Amount of — |------------------------------- | Indebtedness | Interest paid ---------------------------|----------------|-------------- Bonds of plaintiff ....... | $ 979,000.00 | $ 46,449.21 Bills payable of receivers | | ......................... | 100,000.00 | 1,541.62 Claims of creditors of | | plaintiff ............... | 1,427,285.15 | 355,466.24 |----------------|-------------- | $2,506,285.15 | $403,457.07 -----------------------------------------------------------
34. In the final determination of the tax liability as set forth in the commissioner's letter of April 9, 1926, the items of $46,449.21 and $1,541.62, and $49,298.23 of the item of $355,466.24 referred to in finding 31 were allowed as deductions from income in 1917, leaving a balance thereof of $306,168.01 which was disallowed. The item of $355,466.24 represents the total amount paid during 1917 under part VI of paragraph first of the decree of the court of October 17, 1916, as referred to in the preceding paragraph on indebtedness, as follows:
----------------------------------------------------------------------- | Principal | Rate | Amount of | | | interest --------------------------------|---------------|---------|------------ Bills payable (interest-bearing | | Percent | notes) ....................... | $ 713,238.48 | 5 | $169,983.12 Edward Bailey | | | (open account) ............... | 386,476.57 | 5 | 100,986.87 Creditors' claims | | | (open accounts) .............. | 327,570.10 | 5 | 80,417.62 Paid as interest on | | | notes given for | | | portions of above | | | items ........................ | ............. | 5 | 4,078.63 |---------------|---------|------------ Total ...................... | $1,427,285.15 |.........| $355,466.24 -----------------------------------------------------------------------
The above-mentioned indebtedness and amount of interest were paid in cash prior to the discharge of the receivers May 28, 1917, except to the extent of $136,476.57, principal, and $193,149.02, amount of interest, for which notes were given. These notes were subsequently paid by plaintiff during 1917, subsequent to May 31, as was the above $4,078.63.
35. The sum of $306,168.01 disallowed as a deduction in 1917 represented that portion of the amount of $355,466.24 which was applicable on a pro rata time basis to the period from February 6, 1912, the date of the appointment of the receivers, to December 31, 1916. The balance thereof, which was allowed as a deduction in 1917, represented the amount applicable to that year on such basis.
36. The books of account and records of plaintiff both prior and subsequent to the receivership and the books of the receivers during the receivership were kept on the accrual basis, and prior to, but not during or subsequent to, the receivership interest was accrued and set up on the books on the bills payable account (notes) and Edward Bailey account. The sums of $713,238.48 and $386,476.57 shown in finding 34 hereof represent in part such accrued interest.
37. The entire amount of par or nominal value of the paid-up capital stock of plaintiff outstanding at December 31, 1917, was $2,245,400, no part of which was preferred capital stock or in the nature thereof; the interest-bearing indebtedness of plaintiff then outstanding, consisting of bonds, was $585,000, one-half thereof being $292,500, and the amount of such indebtedness, consisting of bonds outstanding at the beginning of 1917, was $979,000.
38. Plaintiff is the sole owner of the claim presented in this case and no transfer or assignment of the whole or any part thereof, or interest therein, has been made.
The first question is whether interest of $306,168.01 on unsecured claims of an insolvent corporation paid by the receivers thereof on May 28, 1917, was a proper deduction in that year or whether it was an accrued expense annually for income and excess profits tax purposes from February 6, 1912, when the receivers were appointed.
Plaintiff contends that interest on such indebtedness of an insolvent corporation does not accrue or become a fixed liability of the receivers at any time during which the estate is in the custody of the law, unless and until there is a surplus in the total assets in the hands of the receivers over the amount necessary to satisfy the principal indebtedness due.
The defendant contends that where the books are kept on the accrual basis, interest on the principal of all indebtedness of the insolvent estate accrues during the receivership and is deductible, if at all, from gross income in each taxable year and may not be deducted in whole or in part only in the year in which a surplus is created, or in the year in which it is paid. The allowance of interest compensation to unsecured creditors after the appointment of equity receivers is contingent and depends upon the creation of a surplus in the estate after payment in full of the principal of the unsecured claims, and, in our opinion, the right of the creditors to interest and the obligation of the receivers to pay such allowance do not exist until such surplus has in fact been created. In this case the Central Iron Steel Company was insolvent and receivers were appointed by the court of common pleas of Pennsylvania February 6, 1912. The facts show that the estate of the corporation was insolvent and insufficient to pay the principal of the secured claims (first-mortgage bonds) and the unsecured claims, and remained so until about May 28, 1917; that only by good management and with the aid of extraordinarily favorable conditions were the receivers able to create a surplus in the estate after January 1, 1917, which resulted solely from large earnings in the manufacture of ship plates for which the war in Europe brought about an unprecedented demand. The receipt of these earnings was entirely dependent on the continuance of the war and the demand for ship plates, and this condition alone made it possible for the receivers to pay from the insolvent estate even the principal of the unsecured claims. The ability of the receivers to make earnings to create an estate sufficient to pay the principal indebtedness of the corporation was not certain until after January 1, 1917. No surplus whatsoever in excess of the principal of the claims against the corporation existed until after that date. Until such surplus existed there was no certainty that any interest would ever be paid and, under the well-established rule in equity receiverships or in bankruptcy, that provable claims of unsecured creditors not entitled to priority do not include interest after the date of appointment of receivers or of filing of the petition, there was no liability to pay any compensation or interest to creditors due to delay in the payment of the principal indebtedness caused by the receivership. Thomas v. Western Car Co., 149 U.S. 95, 116, 13 S. Ct. 824, 833, 37 L. Ed. 663; Sexton v. Dreyfus, 219 U.S. 339, 344, 31 S. Ct. 256, 257, 55 L. Ed. 244; Board of Com'rs of Shawnee County, Kan. v. Hurley (C.C.A.) 169 F. 92, 94, and Tredegar Co. v. Seaboard Air Line Ry. et al. (C.C.A.) 183 F. 289.
In Sexton v. Dreyfus, supra, the court said, "No one doubts that interest on unsecured debts stops," and in Thomas v. Western Car Co., supra, the court pointed out that, "As a general rule, after property of an insolvent passes into the hands of a receiver or of an assignee in insolvency, interest is not allowed on the claims against the funds." In Brown v. Leo (C.C.A.) 34 F.2d 127, 128, a bankruptcy case, the court held that: "It is true that ordinarily the creditors of a bankrupt cannot be paid in full, and that interest on unsecured claims stops when the petition is filed. With the exception of after-accruing interest on the security held, this applies to secured claims as well. Board of Com'rs of Shawnee Co., Kan. v. Hurley (C.C.A.) 169 F. 92 [supra]; Sexton v. Dreyfus and Sexton v. Lloyds Bank, 219 U.S. 339, 31 S. Ct. 256, 55 L. Ed. 244 [supra]. The manifest reason for this is that on that date each creditor has an equitable interest in the bankrupt estate, which is that proportion of the net assets that the amount of his provable claim bears to the total of the provable claims."
In Pintsch Compressing Co. v. Buffalo Gas Co. (C.C.A.) 280 F. 830, 844, the court allowed interest on unsecured claims in an equity receivership only to the day before the appointment of receivers, saying that: "As, in the case at bar, it is apparent that the claims of creditors cannot be paid in full, interest on the principal will run [only] to September 24, 1914." This rule is applied and followed in Pennsylvania. Jamison Co.'s Estate, 163 Pa. 143, 29 A. 1001; Murphy Co.'s Estate, 214 Pa. 258, 265, 63 A. 745, 5 L.R.A. (N.S.) 1147, 6 Ann. Cas. 308; Fulton's Estate, 65 Pa. Super. 437; Interest on Bonus on Capital Stock, 12 Dauphin Co. Rep. 259; McGinnis v. Corporation Funding Finance Co. (D.C.) 8 F.2d 532, 541; Pearsall v. Central Oil Gas Co. of America (D.C.) 23 F.2d 716.
In the case of Interest on Bonus on Capital Stock, supra, the court held that interest was not allowable after appointment of a receiver, even upon the claim of the state for a bonus theretofore due on an increase of capital stock. The rule is adopted generally and no departures from it have been found where claims entitled to priority had not been involved. In 2 Tardy's Smith, Receivers (2d Ed.) p. 1678, after stating the rule relating to creditors with priority claims, it is said that: "However interest is not allowed to members of a class if the class fund is not sufficient to allow interest to all; thus general unsecured creditors, whether their claims bear interest by contract or simply by way of damage for delay in payment, are not allowed interest in case of insolvency."
In Gillett v. Chicago T. T. Co., 230 Ill. 373, 82 N.E. 891, 906, a receivership case, the court said with respect to the claim to interest after appointment of receivers that: "The rights of all the creditors are fixed when the court takes jurisdiction of the property. * * * It is therefore inequitable that interest should thereafter be allowed on the claims where certain of the claims draw interest at one rate and others draw interest at a lower rate or do not draw interest at all. If interest under such circumstances was allowed at the rate fixed by the contract, and the litigation extended, as here, through many years, the mere lapse of time would enable those holding claims drawing a high rate of interest to materially lessen the proportion of the assets which would pass to those holding claims drawing a lower rate of interest or drawing no interest at all. This is not permitted."
It is only when a surplus has actually been realized from the estate, after payment in full of claims having priority, if any, and after payment in full of the principal due unsecured and general creditors, that the question arises as to the right of these creditors to interest after appointment of the receivers, unless, under some plan or arrangement with the approval of the court, the property and business are turned back to the corporation which agrees to pay all indebtedness and liabilities, as was the case in American Iron Steel Mfg. Co. v. Seaboard Air Line Railway, 233 U.S. 261, 34 S. Ct. 502, 505, 58 L. Ed. 949. When a surplus has in fact been realized some measure of compensation is given by the court to these creditors on an equitable basis, after the deduction of which the residue, if any, is returned to the corporation or to the bankrupt. In such case the rule is established that equity requires such compensation to be given and that only the balance remaining will be awarded to the corporation upon closing the receivership. Johnson v. Norris (C.C.A.) 190 F. 459, L.R.A. 1915B, 884; Ohio Savings Bank Trust Co. v. Willys Corp. (C.C.A.) 8 F.2d 463, 44 A.L.R. 1162. In all such cases, however, the right to interest compensation depends upon whether a surplus has been created over the principal of the claims. The existence in fact of a surplus is the basis of an obligation to pay and the right to receive.
In Re Murray, 6 Paige (N.Y.) 204, quoted and approved in Johnson v. Norris, supra, it was said that: "As to subsequent interest, if the debts are not paid at that time, and the fund which is afterwards realized by the assignee is more than sufficient to pay the amount thus found due at the time of the assignment, the interest on all the debts subsequent to the assignment should be paid rateably out of the surplus." See, also, People v. Merchants' Trust Co., 187 N.Y. 293, 79 N.E. 1004; U.S. Fidelity Guaranty Co. v. Carnegie Trust Co., 161 App. Div. 429, 146 N.Y.S. 804, 809; Green v. Stone, 205 Ala. 381, 87 So. 862; First National Bank v. Campbell Co., 52 Tex. Civ. App. 445, 453, 114 S.W. 887; Lippitt v. Thames Loan Trust Co., 88 Conn. 185, 206, 90 A. 369; Huff v. Bidwell (C.C.A.) 218 F. 6.
The defendant relies almost entirely on American Iron Steel Mfg. Co. v. Seaboard Air Line Ry., supra, in support of its contention that the interest on the unsecured claims of the insolvent corporation was an accrued liability of the receivers during each of the years from February 6, 1912, to May 28, 1917; but we think that case supports the rule above mentioned rather than the proposition for which it is cited. The question in that case was whether the American Iron Steel Company was entitled to interest on its claim for the period of the receivership for supplies theretofore sold to the railroad company on a credit of "30 days, 1 percent. Discount allowed for payment in 10 days." There was no question as to whether there were sufficient funds to pay interest, and interest had been paid on other claims. The American Iron Steel Company filed its claims with the special master in receivership proceedings relying upon a statutory lien under the Labor and Supply Lien Statute, Code of Virginia [1887] § 2485, and the special master reported against the allowance of interest on the claim. Subsequently, on the petition of the railway company, a decree was entered approving "a plan of adjustment" of the finances of the company, and providing for the turning back to the company of its property and for the ending of the receivership at a certain time. From time to time during the receivership and at the ratification of the plan of adjustment and as a part thereof all interest due at the time of appointment of the receivers and accruing during the receivership on all the funded and many of the floating obligations of the railway company was paid in full. The amount so paid as interest aggregated some millions of dollars. The decree approving the plan of adjustment provided that the company should pay in due course of business all its obligations, liabilities, and indebtedness and reserved the right, in the event of default in that regard, to any claimant aggrieved by such default to present his petition to the court to have his claim enforced "to the same extent as though the receivership had continued." After the termination of the receivership the steel company filed its petition in the court praying that its exceptions to the special master's report be sustained and for the enforcement of its claim, including interest thereon during the period of the receivership, and seeking to enforce it not upon the doctrine of an equitable lien but as a statutory lien. The Circuit Court refused to allow interest for the period of the receivership and this action was reversed by the Supreme Court. The railway company insisted that the indebtedness did not bear interest, and that interest could not have been recovered on the claim even in an action at law; that the right to interest was a matter of agreement and could be recovered as a part of the debt only where it had been reserved in the contract or where a promise was implied from the character of the note or the instrument evidencing the debt; that, whether treated as a part of the debt or allowed as damages, interest could only be charged against the railway company because of delay due to its own fault, and that in this instance the failure to pay was due to the act of the law in taking its property into custody and operating the same by receivers in order to prevent the disruption of a great public utility. The Supreme Court recognized and followed the general rule that after property of an insolvent is in custodia legis interest thereafter accruing is not allowed on debts payable out of the funds realized by the sale of the property, not because the claims had lost their interest-bearing quality during that period but because of a necessary and enforced rule of distribution, due to the fact that in case of receiverships the assets are generally insufficient to pay debts in full, and stated, "But that rule did not prevent the running of interest during the receivership; and if as a result of good fortune or good management, the estate proved sufficient to discharge the claims in full, interest as well as principal should be paid" — a proposition which is not controverted in the present case. The American Iron Steel Mfg. Company Case simply recognizes and applies the rule that interest on interest-bearing indebtedness accumulates during the period of the receivership, which is not questioned by plaintiff in the instant case, and that if a surplus exists and the estate proves sufficient to discharge the claims in full, interest, as well as principal, should be paid. Moreover, in the American Iron Steel Mfg. Company Case, supra, the indebtedness involved was secured by a lien and was a claim "of the highest dignity." In addition it appears that the question presented in this case was not involved in the American Iron Steel Mfg. Company Case, — namely, whether interest accrues and becomes an absolute liability of the receivers until there is a surplus, where the estate is insufficient to pay the principal of the indebtedness. In that case interest of several millions of dollars accruing during receivership was paid by the receivers on the indebtedness of the corporation under the plan of adjustment, under which the property was turned back to the railway company, and the decree of the court; such plan and decree provided that the company "should pay in due course of business all its obligations, liabilities, and indebtedness," and reserved the right, in the event of default by the railway company to pay any such obligations, liabilities, or indebtedness, to any claimant aggrieved by such default to present its petition to the court to have its claim enforced. The railway company was therefore liable for interest on its interest-bearing indebtedness during the period of the receivership. In conclusion, the court said: "As a fact interest was paid on the floating indebtedness, out of earnings made by the receivers appointed first under a bill which asked that the property be taken in charge by the court so that ultimately all creditors would be paid in full. We must assume that the court had the right to make these payments, and if so it had a like right in the case of the claim for railway supplies. No question is raised as to the power of the court to require payment of the principal of appellant's debt, and, if the court could require a payment of the principal, it could also enforce the payment of the interest, which was but an incident of that debt. If the property had remained in the hands of the receiver the lienor might have been permitted to intervene and share in the fund realized by the sale of property in the hands of receivers appointed, first, on the application of the railway, in the interest of all creditors, and continued by an order entered in the bill to foreclose the mortgage." (Italics ours.)
In view of the settled principles of law applicable to equity receiverships, as announced in the foregoing cases, we are of opinion that the interest compensation distributed by the receivers to unsecured creditors from a surplus created after January 1, 1917, did not accrue as a liability under the applicable revenue laws and regulations in any year between February 6, 1912, and January 1, 1917. Lucas v. American Code Co., Inc., 280 U.S. 445, 449, 50 S. Ct. 202, 74 L. Ed. 538; Burnet v. Logan, 283 U.S. 404, 413, 51 S. Ct. 550, 75 L. Ed. 1143. The essentials necessary to constitute accrual of liability or accrual of income under the revenue acts are to be judged by the general rules of law applicable to the circumstances of the transaction in question, and the parties to it, and the rules which have been established by the decisions to test the existence or nonexistence of accrual. From the stand-point of proper reflection of income the payments that were ultimately made by the receivers of plaintiff in the calendar year 1917 under part VI of said decree, so modified, would not, at any time before January 1, 1917, have been stated as a liability, or been included in stating the liabilities as of any time before said date. Such payments would not have been a liability to have been accrued in a statement of liabilities made at any time prior to January 1, 1917. At all times prior to the year 1917 the liability of the receivers to pay interest or the right of the creditors to receive the same was only a mere possibility, wholly contingent upon facts and circumstances not possible to foretell with anything like certainty. It is thus apparent that although under a general rule of law there may be a possibility of right in the creditors to receive payment in the future or of obligation of the receivers to pay in the future, as long as the facts and circumstances to determine such possibility cannot be foretold with any degree of certainty there is neither income nor liability under the revenue acts in respect of the subject matter. Lucas v. American Code Co., Inc., supra; Burnet v. Logan, supra. In the circumstances of this case it is our opinion that interest on the unsecured claims of the corporation while in the hands of the receivers was not at any time prior to January 1, 1917, an item as to which the rights of the persons to receive it or the obligation of the receivers or the corporation to pay it had become definite, certain, and free from dependency on uncertain future events within the meaning of the revenue acts so that it was either accrued income to a creditor on the accrual basis ultimately receiving part payment in 1917, or an accrued liability of the receivers or the corporation also on the accrual basis. Any other conclusion would require that the administrator of every estate taken into receivership or bankruptcy, or under assignment for the benefit of creditors, must accrue as a liability a charge for interest on the indebtedness against the estate, whether secured or unsecured, whether with or without hope of payment, and regardless of the insolvency of the estate, provided only that such administrator keeps his books and records and makes the federal tax rate on the accrual basis. Such a view would also require that creditors of an insolvent estate accrue and report as income interest which they might never receive and which is wholly dependent on the course of future events. Lucas v. American Code Co., Inc., supra; North American Oil Consolidated v. Burnet, 286 U.S. 417, 52 S. Ct. 613, 76 L. Ed. 1197; Lucas v. North Texas Lumber Co., 281 U.S. 11, 50 S. Ct. 184, 74 L. Ed. 668; Malleable Iron Range Co. v. United States, 62 Ct. Cl. 425; S. Naitove Co., Inc., v. Commissioner, 59 App. D.C. 53, 32 F.2d 949; United States v. Block Kohner Mercantile Co. (D.C.) 33 F.2d 196; Commissioner v. R.J. Darnell, Inc. (C.C.A.) 60 F.2d 82, 84; Great Northern Ry. Co. v. Commissioner, 8 B.T.A. 225; Northwestern Improvement Co. v. Commissioner, 14 B.T.A. 79.
The next question raised by the defendant is that if the interest paid by the receivers in May, 1917, on unsecured claims of creditors of the corporation from a surplus created after January 1, 1917, to the extent of $355,466.24 and disallowed by the commissioner to the extent of $306,168.01 was a proper deduction in 1917, the plaintiff is entitled to a total deduction of only $126,895, or $29,605.94 in excess of the amount of $97,289.06 allowed by the commissioner as interest accrued in 1917 under the limitation of section 12(a)(3) of the Revenue Act of 1916 ( 39 Stat. 768) as amended by the Revenue Act of 1917 ( 40 Stat. 334, § 1207). We cannot agree. The limitation contained in section 12(a)(3) of the Revenue Act of 1916 is a limitation upon the amount of the principal of indebtedness applicable as a basis, and not a limitation upon the amount of interest which may be deducted. The principal may not be larger than the paid-up capital stock at the close of the tax year plus one half of the interest-bearing indebtedness then outstanding. The principal upon which interest may be deducted may not be larger than the paid-up capital stock at the close of the year plus one half of the interest-bearing indebtedness at the close of such year.
The obvious purpose of this limitation, which had also been contained in the act of 1913, 38 Stat. 166, has been stated by this court in Brilliant Coal Co. v. United States, 59 Ct. Cl. 481, 492, and, so far as we have been able to find, has not since been questioned, and is as follows: "It was a provision which accomplished a purpose in that it imposed a limitation on corporations having a small capital stock but reaping excessive profits from the employment of borrowed capital in large and disproportionate amounts." The court also held at page 493 of 59 Ct. Cl., that "a limitation [is] on the principal sum." It was held that the limitation must be determined by the application of limitation separately as to each year over which the calculation of interest is made on a time basis. The decision on this point has never been questioned. Two points were involved in that case. The first was whether bond interest coupons due in years prior to 1917 but paid in that year were distributable in the return for 1917 and the second was the interpretation of limitation on section 12(a)(3) of the 1916 act. Although one phase of the decision in that case seems to have been that the deduction was allowable whether the taxpayer employed the accrual or the cash-receipts basis of accounting, we may disregard this part of the decision since the taxpayer before the court in that case in fact employed the cash receipts and disbursements method of accounting, and, for this reason, the government dismissed its perfected appeal. United States v. Brilliant Coal Co., 269 U.S. 588, 46 S. Ct. 12, 70 L. Ed. 427. As the legal liability to pay the interest on the legal dates of maturity of coupons was fixed and subjected to no contingency, the result on this point would not be followed if in fact the accrual basis of accounting were used. United States v. Anderson et al., 269 U.S. 422, 46 S. Ct. 131, 70 L. Ed. 347; Cumberland Glass Mfg. Co. v. United States, 44 F.2d 455, 71 Ct. Cl. 44. However, the construction by the court of section 12(a)(3) as being a limitation upon the amount of the principal of indebtedness applicable as a basis was correct as applied to a taxpayer on a cash basis or to a case like the present where there was no fixed liability to pay the interest in any year prior to 1917 and, therefore, no accrual within the meaning of the revenue acts at any time prior to January 1, 1917. The decision of this court in United States v. Brilliant Coal Co., supra, should therefore be properly considered as one involving a taxpayer on a cash basis who had in the taxable year paid interest on indebtedness including interest coupons accruing in earlier years. On this basis the taxpayer was entitled to the deduction claimed unless reduced by the limitation provided in section 12(a)(3), supra. The decision of this court, however, is authority that the construction of section 12(a)(3) now contended for by the defendant is not correct. It follows from the decision in the Brilliant Coal Company Case that even though the taxpayer is on an accrual basis, if the so-called interest was subject to a contingency which prevented it from accruing as a liability until the taxable year in question, the taxpayer is entitled to the deduction of such interest in such year as if it were on a cash basis. The contingency operates in defining the year of a deduction in the case of a taxpayer on an accrual basis to produce the same result as payment in case of a taxpayer on a cash basis. When the taxable year is thus defined the problem of limitation is precisely the same regardless of distinction between a cash and an accrual basis. In each case therefore the only remaining problem is the limitation. If, as the court decided in the Brilliant Coal Company Case, and the government conceded by dismissing the appeal, the mere limitation upon the principal sum does not prevent the entire deduction in one case, it does not prevent it in another. That decision governs the question presented in this case and the limitation in question does not bar the deduction of the full amount claimed by plaintiff. Arts. 180 and 181, Regs. 33, accord with this view.
We conclude, therefore, that the limitation in section 12(a) (3) is properly to be considered a limitation upon the principal of indebtedness upon which interest may be deducted, and not upon the amount of interest deductible, provided the amount claimed as a deduction has been paid in the taxable year on a cash basis or has become an accrued liability in such year on the accrual basis, and, if properly applied, the principal of indebtedness limitation be not exceeded in respect of any year drawn into the calculation of interest on a time basis; when so applied the entire amount paid, if upon a cash basis, or the entire amount accrued, if upon an accrual basis, is deductible in such taxable year. The findings show that the present case fully meets the requirements of the limitation and that the total interest claimed as a deduction for 1917 is not affected.
The last question in the case concerns the defendant's contention that in any event plaintiff cannot recover more than $61,074.80, being the tax and interest paid October 10, November 10, and December 14, 1926 (finding 32), for which a claim for refund was filed March 7, 1928, upon which the commissioner rendered no decision. It is the contention of the defendant that the first claim for refund for $400,000 filed July 14, 1923, related wholly to the computation of the tax under section 210 of the Revenue Act of 1917, and that this court has no jurisdiction of the subject matter of such claim; that the sworn statements of fact and the grounds filed in connection with the first claim for refund on October 2, 1924, and April 6, 1925, with specific reference to the right to the deduction of the interest involved in this case, cannot be considered as amplifying or enlarging the ground of the original claim for refund so as to entitle the plaintiff to maintain this suit for the recovery of any portion of the original tax or interest paid.
We are of opinion that plaintiff is entitled to maintain this suit under the claims for refund made and under the original and amended petitions filed herein, and to recover the total overpayment of $138,237.92 for 1917 and the overpayments of interest collected thereon in the amount of $8,135.53. July 6, 1923, plaintiff filed with the commissioner an application for computation of its profits tax for the calendar year 1917 under section 210 of the Revenue Act of 1917 on the ground that its invested capital could not be satisfactorily determined, and on July 14, 1923, it filed a claim for refund of $400,000, stating the only specific ground for a refund existing at that time, namely, that the invested capital could not be satisfactorily determined and that the profits tax should be computed under section 210. In addition, the claim also stated as a general ground that "this claim is accordingly filed to protect all rights under section 252 of the Revenue Act of 1921 pending the final disposition of the case." The last-mentioned ground was of necessity general because the taxpayer did not know at that time what adjustments the commissioner might make in the audit of the tax liability for 1917 which might offset any overpayment to which it might be entitled under the specific grounds stated in the claim, and as to which it might desire to amend. See Lewis v. Reynolds, 284 U.S. 281, 52 S. Ct. 145, 76 L. Ed. 293; Bemis Brothers Bag Co. v. United States, 289 U.S. 28, 53 S. Ct. 454, 77 L. Ed. 1011, decided March 13, 1933. The case proceeded before the commissioner and the plaintiff submitted facts and argument in support of its application for computation of its tax under section 210. In the course of consideration and audit the commissioner allowed the application for computation of the profits tax under section 210 and in September, 1924, advised the plaintiff at a conference on the case that determination under section 210 would be allowed, but, in his opinion, the entire amount of interest paid by the receivers in May, 1927, on claims against the corporation was not a proper deduction for 1917 and that income should be accordingly increased. The question of the propriety of this deduction was first raised by the commissioner in connection with the reduction in the tax paid through the computation of tax under section 210 of the Revenue Act of 1917 and was brought forward by the commissioner as a counterbalancing item against the overpayment resulting from the determination of the tax under section 210; whereupon the plaintiff, on October 2, 1924, prepared and filed with the commissioner a sworn statement of facts and grounds in connection with its claim for refund as an amplification and amendment of the general ground stated in such claim supporting its claim that the deduction of the interest paid in 1917 was proper. The statute of limitation for filing a claim for refund had not expired at this time. The purpose of this enlargement of the claim for refund was to protect plaintiff's right to any overpayment resulting from the allowance of its application for determination of the tax under section 210 and its right to sue for the overpayment thus resulting if the same should be offset by an increase of income through an adjustment in the interest deduction. The first amplification and amendment of the general ground for refund was filed October 2, 1924, at the express request of the commissioner and was accepted and considered by him. Thereafter, on March 12, 1925, the commissioner formally advised plaintiff by a letter of that date that he had allowed its application for computation of its profits tax under section 210 which showed a reduction in the tax paid and, in the same letter, advised that income had been increased by the disallowance of a portion of the interest paid by the receivers in 1917 and claimed as a deduction from gross income for that year, which operated to wipe out the reduction in tax liability through the allowance of the application under section 210. This was a preliminary determination, and, upon the receipt of notice, plaintiff immediately renewed its claim that the entire amount of interest paid in 1917 constituted a proper deduction in that year and that the overpayment resulting from a determination of the tax under section 210 should be refunded. On April 6, 1925, also before the statute of limitation for filing a claim for refund for 1917 had expired, plaintiff again filed with the commissioner a detailed statement of facts and grounds in connection with its claim for refund and in support of its contention that the interest deduction was proper. Further hearings were had thereon, at which the issue involved in this suit was fully stated, argued, and submitted to the commissioner and was considered and decided by him. Thereafter the commissioner, on April 9, 1926, made his final determination on the claim for refund, as amplified and amended, in which decision he specifically acted on the issue involved in this case. In this final determination the commissioner computed the tax under section 210 of the Revenue Act of 1917, which action reduced the tax liability, including the interest collected, below the amount which had been collected in cash or by credit, and offset such reduction by increasing the income through the disallowance of $306,168.01 of the interest paid in 1917 and claimed as a deduction in that year. The commissioner's action in increasing income by disallowing as a deduction a portion of the interest paid in 1917 wiped out the reduction in tax and interest theretofore collected in cash or by credit through the computation of tax under section 210 and showed a further tax of $55,522.55 due for 1917. In his final decision of April 9, 1926, the commissioner disallowed and rejected in full the claim for refund as amplified and amended. In due course plaintiff was compelled to pay and did pay, in October 1926, the balance of $55,522.55, together with interest of $5,552.25, in November and December, 1926. Thereafter, on March 7, 1928, plaintiff duly filed a claim for refund of the total of these amounts upon which claim the commissioner took no action.
On April 6, 1928, this suit was instituted. The original petition stated a cause of action to recover the overpayment of tax and interest theretofore collected which would have resulted, had the commissioner not increased income by the amount of $306,168.01 through the disallowance of that amount of interest paid by the receivers in 1917 and claimed as a deduction in that year.
This original petition set forth in substance the facts with reference to the actions taken as hereinbefore detailed. At the time this petition was filed the commissioner had rendered no decision on the second claim for refund of the balance of the tax and interest collected in 1926 and the six months' period allowed by the statute for such action before suit had not expired and did not expire until after the statute of limitation for instituting suit upon the disallowance of the first claim on April 9, 1928. Thereafter, on September 3, 1929, more than six months after the filing of the second claim for refund on March 7, 1928, and within four years after collection of the tax and interest in October, November, and December, 1926, plaintiff filed an amended petition repeating the grounds set forth in the original petition and also the necessary facts with reference to the payment of the additional tax and interest in 1926 and the filing of the claim for refund thereof.
In these circumstances we are of opinion that the original claim for refund, as amplified and amended, and the second claim for refund fully support the cause of action set forth in the original and amended petitions; that this court has jurisdiction to consider and render judgment under the first claim for refund as amplified and amended under the cause of action stated in the original petition and, also, in the amended petition; and that plaintiff is entitled to judgment for the overpayment of tax and interest resulting from the erroneous increase of income for 1917 through the disallowance by the commissioner of a portion of the interest paid by the receivers in that year.
The cause of action stated in the original petition was not based upon the refusal of the commissioner to compute the tax under section 210 of the Revenue Act of 1917. He allowed plaintiff's application for a determination of its tax under that section and made the computation accordingly. The case of Williamsport Wire Rope Co. v. United States, 63 Ct. Cl. 463; Id., 277 U.S. 551, 48 S. Ct. 587, 72 L. Ed. 985, is not, therefore, applicable. The statutes with reference to the filing of claims for refund and the bringing of suits upon disallowance thereof should not, in a case of this character, be so construed as to deprive a taxpayer of the right to go in court to recover an overpayment on a ground which was fully brought to the attention of the commissioner, and fully considered and decided by him, in connection with a claim for refund. Compare Illinois Terminal Co. v. United States, 53 F.2d 904, 73 Ct. Cl. 263; National Fire Insurance Co. v. United States, 52 F.2d 1014, 72 Ct. Cl. 517. Ordinarily where a claim or protest filed with the commissioner against a proposed increase of income through the disallowance of a deduction taken on a return would result in an additional tax, it would be necessary for the taxpayer to make payment and file a claim for refund before suit could be instituted. But where, as here, a claim for refund has been filed and one of the grounds thereof is allowed which produces an overpayment and other adjustments in the income are proposed by the commissioner, and the taxpayer amplifies and amends the claim for refund filed so as to draw into controversy in connection with its claim for refund the propriety of such adjustments and the commissioner disallows such claims and contentions, a suit may be legally predicated upon such claims and the action of the commissioner to recover the overpayment that would have resulted from the allowance by the commissioner of the claim for refund in part, but for his action with reference to other items specifically brought to his attention. If it were otherwise, taxpayers who file claims for refund, which are subsequently allowed on the grounds specified, would be denied the privilege which we think the statutes clearly intended to give to test the correctness of the commissioner's action upon a claim for refund where all the facts and grounds made the basis of the suit were brought to his attention and considered and decided by him.
In this case the decision of the commissioner in allowing the claim for computation of tax under section 210, as set forth in the first claim for refund, produced a reduction in the total amount of tax and interest theretofore collected in cash and by credit for 1917 of $85,298.65 and a total overassessment for 1917 of $179,235.37; but this reduction in the tax liability was wiped out by the action of the commissioner in increasing the income for that year through the disallowance of a portion of the deduction for interest taken on the return. The interest item was fully brought to the attention of the commissioner in connection with the claim for refund and the original petition filed in this case stated a cause of action for recovery of the overpayment of $85,298.65 based on the alleged erroneous increase of income by the commissioner in connection with the interest item. We think, therefore, that the suit was proper.
The balance of $61,074.80 sued for and included in the amended petition arises as a result of a further tax and interest exacted by the defendant as a result of the aforesaid action by the commissioner with reference to the interest item. In due course, after all the requirements had been complied with, the amended petition was timely filed for the additional payments totaling this amount.
Plaintiff is therefore entitled to recover $146,373.45, consisting of an overpayment of tax of $138,237.92 and overpayment of interest collected thereon of $8,135.53. Judgment will therefore be entered in favor of plaintiff for $146,373.45 with interest at 6 per cent. per annum on $67,311.97 from June 15, 1918, on $14,351.58 from January 28, 1920, on $2,583.28 from February 3, 1920, on $1,051.82 from February 23, 1924, on $55,522.55 from October 10, 1926, on $4,441.80 from November 10, 1926, and on $1,110.45 from December 14, 1926, to such date as the Commissioner of Internal Revenue may determine in accordance with the provisions of section 177(b) of the Judicial Code, as amended by section 615(a) of the Revenue Act of 1928 (28 USCA § 284(b). It is so ordered.
BOOTH, Chief Justice, did not hear this case on account of illness and took no part in its decision.