Opinion
Suit by the Allegheny Steel Company against the United States.
Petition dismissed.
Clarence E. Frey, of Washington, D. C. (George B. Furman of Robertson, Furman & Murphy, of Washington, D. C., on the briefs), for plaintiff.
J. W. Blalock, of Washington, D. C., and Robert H. Jackson, Asst. Atty. Gen. (Robert N. Anderson and Fred K. Dyar, both of Washington, D. C., on the brief), for the United States.
Before BOOTH, Chief Justice, and GREEN, LITTLETON, WILLIAMS, and WHALEY, Judges.
This case having been heard by the Court of Claims, the court, upon the evidence adduced, makes the following special findings of fact:
1. Plaintiff is a Pennsylvania corporation with its principal office and place of business at Brackenridge, Pa.
2. Plaintiff was engaged in the manufacture and sale of sheet steel, and for some 20 years prior to 1929 it had been a direct competitor of the West Penn Steel Company which operated a similar business on adjacent property. In 1929 negotiations were begun by the two companies which culminated in their merger and consolidation. The merger and consolidation were accomplished on the basis of a written agreement entered into April 16, 1929, between the two companies pursuant to resolutions duly adopted by their respective boards of directors. After the agreement had been executed by the officers and directors of the two companies, it was submitted to the stockholders of the respective corporations, who, by a majority vote, ratified it, and no May 6, 1929, the merger became effective, letters patent being issued on that day to the merged company under the name of the Allegheny Steel Company, plaintiff herein. A substantial minority of the stockholders of the West Penn Steel Company did not vote in favor of the merger.
The merger agreement contained the following provision:
'Fifth. The manner of converting the capital stock of each of said corporations into the stock of the Merged Company shall be that upon said merger and consolidation becoming effective as hereinafter provided, the holders of the present outstanding capital stock of the West Penn Company shall surrender their said stock by delivering the certificates therefor, duly endorsed in blank for transfer, or accompanied by suitable instruments of transfer executed in blank, to The Union Trust Company of Pittsburgh, Pittsburgh, Pennsylvania. Each holder of common or preferred stock of the West Penn Company shall be entitled to receive, for each share of common stock so surrendered, seven and one-half (7 1/2) shares of the common stock of the Merged Company, and for each share of preferred stock so surrendered, at his option, either two shares of the common stock of the Merged Company, or one hundred ten dollars ($110) in cash, with interest on said preferred shares at the rate of seven dollars ($7) per share per annum from April 1, 1929, to the date when said stock is so surrendered; provided, however, that no interest shall be paid after a period of thirty (30) days after the merger is approved by the stockholders of the respective companies. Fractional amounts of common stock of the Merged Company, to which any such stockholder of the West Penn Company shall be entitled, to be adjusted in cash at the rate of fifty dollars ($50) per share for such stock of the Merged Company. Each such preferred stockholder of the West Penn Company who shall not expressly elect to take common stock of the Merged Company, in the manner, and on or before the date hereinabove provided, shall receive cash, at said rate of one hundred ten dollars ($110) with interest as aforesaid, for each share of preferred stock of West Penn Company surrendered. * * *'
A minority of the common stockholders of the West Penn Steel Company refused to deliver their stock upon the basis provided in the agreement, and shortly thereafter in 1929 brought a suit in equity to have the value of their stock determined by court decree. A small number of stockholders withdrew, and a somewhat larger number entered, after the suit was started, with the result that at the termination of the suit 2,182 shares were involved. A decree nisi was rendered by the court November 22, 1930, requiring that the complaining stockholders be paid $428 for each share of stock held by them, with interest thereon at 6 per cent. per annum from May 6, 1929. Plaintiff was dissatisfied with the value as fixed by the court, and, after application by plaintiff for a rehearing, a revised and final decree was entered by the court February 19, 1931, which read as follows:
'1. That the defendants, Allegheny Steel Company, a corporation, and West Penn Steel Company, a corporation, forthwith pay to the complainants named in the 6th finding of fact the sum of $421 for each of the 2,120 shares of the common capital stock of the West Penn Steel Company owned by them as therein set forth, to wit, the total sum of $892,520.00, together with interest thereon, at the rate of 6% per annum, from May 6th, 1929.
'2. That the defendants, Allegheny Steel Company, a corporation, and West Penn Steel Company, a corporation, forthwith pay to Suffolk Securities Company. a corporation, the sum of $421, for each of the 62 shares of the common capital stock of the West Penn Steel Company assigned to said Suffolk Securities Company since the filing of this suit, to wit, the total sum of $26,102, together with interest thereon, at the rate of 6% per annum, from May 6th, 1929.
'3. That the defendants, Allegheny Steel Company, a corporation, and West Penn Steel Company, a corporation, pay the costs of this proceeding.'
3. After the termination of the suit, namely, March 18 and April 28, 1931, plaintiff paid the minority stockholders on the basis of the court decree set out in finding 2. Included in such payments was interest in the amount of $103,331.62, which is properly allocable to the following periods in the following amounts:
4. After the suit referred to in findings 2 and 3 had been instituted, plaintiff estimated its liability thereunder and expenses connected therewith at $900,000 and set up a reserve on its books at December 31, 1929, in that amount, 'Earned Surplus from West Penn Steel Company' being charged with that amount and 'Reserve for West Penn Steel Co., Minority Interests' being credited in the same amount. The amount of the reserve was determined by plaintiff on the basis of its estimate of the value of the stock, namely, $375 per share (which was likewise the amount plaintiff had indicated its willingness to pay to dissatisfied stockholders), plus interest to be paid from the date of the merger and plus expenses of the suit.
May 6 to December 31, 1929 .................
$36,355.16
January 1 to December 31, 1930 ..............
55,521.48
January 1 to March 18 and April 28, 1931 ....
11,454.98
-----------
$103,331.62
When the payments were made as shown in finding 3, the reserve account was charged with the amount of such payments which included the interest payment shown in finding 3. The various charges to that account as well as the credits were as follows:
Charges
Credits
Feb. 28, 1930 ........
$700.00
Dec. 31, 1929 ....
$900,000.00
Apr. 16, 1930 ..........
93.75
Mar. 18, 1931 .......
4,921.87
Apr. 25, 1930 .........
137.50
Mar. 18, 1931 .....
117,679.59
May 22, 1930 .........
468.75
Apr. 28, 1931 .........
737.51
Mar. 18, 1931 ...
1,021,201.46
Apr. 28, 1931 .......
6,750.65
Apr. 28, 1931 .......
7,488.16
-------------
-------------
$1,030,089.62
$1,030,089.62
5. Plaintiff duly filed its income tax return for 1929 showing a tax liability of $344,146.06, which was paid in installments as follows:
March 14, 1930 .......
$86,036.52
June 12, 1930 .........
86,036.52
September 9, 1930 .....
86,036.51
December 13, 1930 .....
86,036.51
----------
$344,146.06
Thereafter the Commissioner assessed an additional tax for 1929 of $3,182.12, which was paid by plaintiff November 25, 1931.
6. Plaintiff duly filed its income tax return for 1930 showing a tax due of $192,771.90, which was paid in installments as follows:
March 13, 1931 ........
$48,192.98
June 13, 1931 ..........
48,192.98
September 13, 1931 .....
44,861.70
October 2, 1931 .........
3,331.28
December 13, 1931 ......
48,192.96
----------
$192,771.90
Thereafter the Commissioner assessed an additional tax for 1930 of $3,261.46, which was paid by plaintiff September 15, 1932.
7. September 3, 1931, plaintiff filed a claim for refund for 1929 of $3,999.07, assigning the following basis therefor:
'On May 6th, 1929, West Penn Steel Company and Allegheny Steel Company were merged. Early in June 1929 holders of 2,198 shares of stock of West Penn-Steel Company brought suit for the cash value of their shares. Suit was not brought to trial until June 1930 and decided in November of that year. There was no basis for determining what value would be fixed by the Court and therefore we had no basis for accruing interest during 1929. The interest on the judgment, from which no appeal was taken, amounted to $103.331.62 and was paid in or about March 1931. The interest was figured from the date of the merger, May 6th, 1929, until the date the judgment was satisfied. The amount of interest covering the period from May 6th, 1929, to Jan. 1st, 1930, is $36,355.16, and the tax assessable thereon for 1929 is $3,999.07, which is the amount for which refund is desired.'
8. August 28, 1931, plaintiff filed an amended return for 1930 which showed a tax liability of $186,109.33; that is, $6,662.57 less than that shown on the original return. The difference between the original return and the amended return was that in the original return a deduction had not been claimed for the item of interest for 1930 of $55,521.48 referred to in finding 3, whereas that amount was claimed in the amended return.
December 16, 1931, a claim for refund was filed for 1930 of $6,662.57, the difference between the tax liability shown on the original return and that shown on the amended return, and reference was made in that claim to the amended return as a basis for the refund.
9. April 7, 1933, the Commissioner advised plaintiff that the claims referred to in findings 7 and 8 would be disallowed, the letter of rejection reading in part as follows:
'As a result of considering the information submitted in conference of November 8, 1932, the Bureau holds that no liability existed until 1931 when finally decided by the court and there was no principal amount on which interest could be calculated until the court, in its final decree, determined the amount.'
The claims were disallowed on a schedule dated June 21, 1933.
10. Plaintiff kept its books and rendered its returns on the accrual basis. No charges were made on its books for the items of interest referred to in finding 3 prior to the termination of the suit in 1931, and likewise no deduction was claimed in the original returns for 1929 and 1930 for the interest items, though claim therefor was made in the timely claims for refund heretofore referred to for 1929 and 1930. With respect to 1931 the parties have stipulated that 'Plaintiff was unable to take said interest deduction in 1931 because for the year 1931 plaintiff's income tax return reflected the net loss without the benefit of said interest deduction.'
GREEN, Judge.
Plaintiff brings this suit to recover alleged overpayments of income taxes for the years 1929 and 1930, claiming that this overpayment resulted from the refusal of defendant's officials to permit proper deductions for interest payments which had accrued in those years.
The facts are not in dispute. It appears that about April 16, 1929, the plaintiff, which is a corporation, entered into an agreement for the merger and consolidation with it of the West Penn Steel Company, another corporation, and through this agreement it succeeded to all of the property rights and franchises of the last-named company. The agreement provided that the stockholders of the West Penn Steel Company should receive for each share of common stock in that company seven and one-half shares of the common stock of the plaintiff and be paid for fractional shares at the rate of $50 a share, which had the effect of fixing the valuation for the common stock of the West Penn Steel Company at $375 a share.
A large but minority group of the common stockholders of the West Penn Steel Company refused to accept the terms in the merger agreement, and in July of 1929 instituted suit in equity in a Pennsylvania court to recover payment for the 'real value' of their stock. To offset any amount which might be recovered against it in this suit, the plaintiff on December 31, 1929, set up on its books a reserve of $900,000 accompanied by a ledger entry showing that it was intended to cover the amount involved in the suit begun by the minority stockholders and then pending. The amount of this reserve so set up was fixed on the basis of the valuation of $375 a share provided for by the original contract of merger with an additional allowance for interest and expenses of the suit. The action proceeded to judgment, and on February 19, 1931, a final decree was entered whereby the plaintiff was ordered to pay to the stockholders bringing suit $421 a share for the shares owned by them, together with interest thereon at the rate of 6 per cent. per annum from May 6, 1929. The amount of interest paid by plaintiff under the court decree was $103,331.62, which plaintiff asks be allocated over the period of pendency of the suit as follows:
1929 ..
$36,355.16
1930 ...
55,521.48
1931 ...
11,454.98
Plaintiff paid its taxes for the years 1929 and 1930 without any deduction being allowed on account of such interest. Later it duly filed claims for refund in the respective sums of $3,999.07 for 1929 and $6,662.57 for 1930. The Commissioner rejected these claims, and this suit followed.
The ultimate issue in the case is whether the plaintiff is entitled to allocate the payments of interest for 1929 and 1930 as stated above and be allowed a deduction accordingly as for interest which had accrued during the taxable year.
One defense which is set up by defendant is that, although the judgment recovered against the plaintiff by the minority stockholders awarded a certain amount which was denominated in the decree as interest, this was not in fact interest in the ordinary meaning of the word but merely a sum granted to the plaintiffs in the suit as compensation for the delay in obtaining their rights. The suit was one in equity in which some of the stockholders of the West Penn Steel Company sought to recover what they claimed was the real value of their common stock in that company which they had lost by the merger. The equity courts of Pennsylvania hold that they have jurisdiction to grant relief in such transactions. Lauman v. Lebanon Valley R. R. Co., 30 Pa. 42, 72 Am.Dec. 685; Barnett v. Philadelphia Market, 218 Pa. 649, 67 A. 912. But the defendant contends that the sum specified as interest forming a part of the total amount awarded by the judgment in favor of the minority stockholders was not in fact interest in the ordinary sense of the term but merely a measure of what would compensate these stockholders for the delay in obtaining the value of their stock, and that the situation is similar to cases against the United States in which the plaintiff is found to be entitled to 'just compensation,' and as a part of this just compensation is awarded interest as an appropriate measure of the amount which will recompense him for the delay in obtaining what is due him. This rule has been applied in many cases, the citation of which is not necessary here, as we do not think it is necessary to determine on what basis the Pennsylvania court awarded 'interest' to the plaintiffs in the equity suit, for the reason that we consider that the defendant has a good and sufficient defense to plaintiff's suit on another ground.
The defendant also contends that, even if it be held that the Pennsylvania court did in fact award the plaintiffs in the equity suit 'interest' in the ordinary signification of the term, nevertheless the plaintiff is not entitled to recover, for the reason that such interest was neither paid, accrued, nor incurred in the taxable years for which plaintiff seeks to have it allowed as a deduction. The plaintiff, on the other hand, contends that as the liability upon which the judgment was rendered was clearly established and the plaintiff set up a reserve on its books to the amount of $375, a common share plus interest from the date of the merger, the interest accrued as time went on, that the amount thereof was merely a matter of mathematical calculation, and having been subsequently paid it was deductible in the years for which the award was made.
We do not wish to be understood as holding that the plaintiff actually sustained a loss. In obtaining from the majority of the stockholders of the West Penn Steel Company their stock for an equivalent of $375 a share when it in fact, in accordance with the decision of the court, was worth $421 a share, it would seem at first glance as if the plaintiff actually made a very large profit in the transaction; also that when it paid the minority stockholders $421 a share for their stock it paid only what the court adjudicated it was fairly worth, and hence lost nothing on the transaction as a whole by reason of the judgment of the court. But the case has been submitted on the assumption that plaintiff did sustain a loss, and we think it can be correctly disposed of on that basis.
The plaintiff kept its books and made its income tax returns on an accrual basis and, if the interest included in the judgment had actually 'accrued' within the meaning of the law during the years it now seeks to have it allowed as a deduction, the contention of the plaintiff must be sustained.
We have been unable to find any decisions made in cases where a question arose as to the deductibility of interest awarded against the taxpayer as part of a judgment. There are, however, numerous cases in which as we think the same principle is involved. In these cases a judgment was rendered against the taxpayer after a more or less extended litigation upon a cause of action which originated some years prior to the entry of the judgment.
In Lucas v. American Code Co., 280 U.S. 445, 50 S.Ct. 202, 74 L.Ed. 538, 67 A.L.R. 1010, the taxpayer sought to deduct as a loss from its 1919 gross income the amount for which a judgment was recovered against it in 1922 on a contested liability for breach of contract in 1919. having in that year set up a reserve to meet this contingent liability, but the Supreme Court held this could not be done, and said (at page 450 of 280 U.S., 50 S.Ct. 202, 203, 74 L.Ed. 538, 67 A.L.R. 1010): 'It may be assumed that, since the company kept its books on the accrual basis, the mere fact that the exact amount of the liability had not been definitely fixed in 1919 would not prevent the deduction, as a loss of that year, of the amount later paid. But here there are other obstacles. Obviously, the mere refusal to perform a contract does not justify the deduction, as a loss, of the anticipated damages. For, even an unquestionable breach does not result in loss, if the injured party forgives or refrains from prosecuting his claim. And, when liability is contested, the institution of a suit does not, of itself, create certainty of loss.'
And also (at page 452 of 280 U.S., 50 S.Ct. 202, 204, 74 L.Ed. 538, 67 A.L.R. 1010): 'The prudent business man often sets up reserves to cover contingent liabilities. But they are not allowable as deductions. * * * It cannot be said that the loss actually paid by the company in 1923 was, as a matter of law or of undeniable fact, sustained in 1919.'
The doctrine stated in the Lucas Case, supra, has been somewhat extended and amplified. It was applied by this court in the case of Daniels & Fisher Stores Co. v. United States, 56 F. (2d) 477, 74 Ct.Cl. 233, where it was sought to deduct as a loss the amount of a judgment upon a claim that had been made against the plaintiff some years previous, and it was held that losses which depend on the result of a contested action in court are not definitely fixed prior to the rendition of judgment therein. In the case of John Thatcher & Son v. Commissioner, 30 B.T.A. 510, it appeared that the taxpayer held a bond under which he claimed to be entitled to be reimbursed for the default of certain subcontractors. Suit was begun on the bond and was terminated some years later by a judgment against plaintiff which had the effect of establishing a loss for the amount thereof. It was held that plaintiff was entitled to deduct the loss in the year the judgment was rendered.
The cases which we have cited above all pertain to the deduction of losses, and the language of the statute upon which they depend necessarily is not the same. The principle, however, has been applied in other instances. The case of Brown v. Helvering, 291 U.S. 193, 54 S.Ct. 356, 360, 78 L.Ed. 725, involved a question as to the right to deduct certain expenses from gross income in making up a return. It appeared that the plaintiff was a general agent for an insurance company and derived part of his income from a so-called 'overriding commission' on the net premiums derived from business written through the local agents. These commissions were subject to deductions on account of subsequent cancellations of business through which they had been received and it appeared that a fair estimate could be made as to the extent the policies would be canceled in future years. The plaintiff's books were kept on an accrual basis, and the year's income for overriding commissions was reduced by the estimated amount of the refunds which would have to be made in future years. Plaintiff claimed the right to take this deduction under the statutory provision which allowed a deduction from gross income for the amount of 'necessary expenses paid or incurred during the taxable year.' Revenue Act 1921, § 214(a)(1), 42 Stat. 239. The language is not quite the same as is used with reference to deductions for interest, which allows 'all interest paid or accrued within the taxable year' (Revenue Act 1921, § 214(a)(2), 42 Stat. 239), but there is no difference in principle, only one of wording. Expenses are 'incurred,' interest has 'accrued.' The Supreme Court held in effect in the Brown Case, supra, that the liability was contingent, as it certainly was in the case now before us, and said: 'Except as otherwise specifically provided by statute, a liability does not accrue as long as it remains contingent.'
In the instant case plaintiff's liability in the equity suit commenced against it depended upon a number of matters which entered into the value of the stock of the West Penn Steel Company and was also contingent upon the equity court sustaining the legal contentions of the minority stockholders. Until the case was finally decided, there was no way of ascertaining whether any liability would be established, or if one were established what would be the amount thereof. Where there is a contingency as to whether any award will be made by judgment, necessarily there is a contingency as to whether any interest will be allowed thereon. We think the principle laid down in the cases cited above is applicable to the instant case and hold that the interest which the plaintiff was obliged to pay did not accrue until judgment was entered for it. It follows that plaintiff's petition must be dismissed and it is so ordered.