MINNEAPOLIS, ST. PAUL & SAULT STE. MARIE RAILROAD COMPANY v. THE UNITED STATES, 164 Ct. Cl. 226

Laramore, Judge, delivered the opinion of the court: This suit is brought to recover the amount of $4,439,869.62 of Federal income tax, and $487,582.11 in deficiency interest paid thereon, together with interest on both sums as provided by law, paid by plaintiff for its tax calendar years 1950-1952, 1954-1955, inclusive. This case can be properly categorized as a study of the toils and tribulations of the railroad industry throughout its undercapitalized expansionary period to its present fight for survival.

The presently contested issues involve certain items which the taxpayer claims to have become worthless in 1952 or alternatively in 1954, thus entitling it to a deduction from gross income under

section 23 of the Internal Bevenue Code of 1939. The items in question are taxpayer’s secured and unsecured claims against Wisconsin Central Bailway and taxpayer’s common stockholdings in that company. Since the questions we are confronted with involve factual determinations, i.e., did each item become worthless within the asserted taxable year, and since some of the items in dispute had their origin in the early 1900’s, a lengthy discussion of the facts is required. In 1909, the taxpayer’s predecessor, the Minneapolis, St. Paul & Sault Ste.

Marie Bailroad Company, was the owner of railway extending throughout various midwestern states. (Both the taxpayer and its predecessor will be referred to as the “Soo” or taxpayer.) At this time Soo was still engaged in extending its railway facilities. These costs proved a financial drain upon it. Thus, in order to avoid these large expenditures, Soo’s management initiated steps to acquire permanent managerial and operational control over all the assets of Wisconsin Central Bailway (referred to hereinafter as Wisconsin Central).

The lines of Soo and the Wisconsin Central were so situated as to facilitate their connection and operation as one continuous line. During the early months of 1909, Soo acquired 81,000 shares out of a majority of the 161,263 shares of the Wisconsin Central’s total outstanding common stock for a total cost of $3,658,337.09. In 1924, Soo acquired 78,088 common shares from the minority shareholders in exchange for its 25-year five and one-half percent Gold Notes and pledged said shares as collateral.

As these notes matured serially and were paid off in cash, Soo acquired complete title free of pledge to 22,319 shares at a cost of $965,157.44. During the years 1927-1930, Soo acquired 266 additional shares of Wisconsin Central common stock for $6,046.60 in cash. Soo thus acquired a total of 103,583 shares of Wisconsin Central common stock, having an original cost basis of $4,629,541.13.

Soo, in 1909, also acquired the right to vote a majority of Wisconsin Central’s 112,659 outstanding shares of preferred stock by issuing its own four percent leased line stock certificates to those exchanging Wisconsin Central preferred stock therefor. By December 1932, all except 95 shares of Wisconsin Central preferred stock had been exchanged. Soo’s purpose in acquiring and retaining its holdings of Wisconsin Central common and preferred stock was to effectuate and perpetuate operational control over Wisconsin Central’s assets.

The method ultimately chosen, following the pattern for railroad amalgamations, was that of a long-term lease between Soo, as lessee, and Wisconsin Central, as lessor. Under the lease, Soo acquired both possession of and control over the assets of Wisconsin Central for a period of 99 years beginning on April 1,1909. The lease did not provide for a fixed rental.

However, it contained a provision that at the termination of the lease, Soo agreed that it would “surrender to the lessor * * * [the leased properties] free from floating indebtedness incurred for maintenance or operating expenses * * From April 15,1909 forward, Soo operated its own properties, together with those of Wisconsin Central, as a single integrated system with income and expenditures being pooled. At the end of each calendar month, a balance was struck and net income distributed.

When Wisconsin Central’s gross income was insufficient to cover its necessary monthly expenditures, funds of Soo were temporarily advanced, such advances normally being repaid from the earnings and funds of Wisconsin Central during the immediately succeeding months. When Wisconsin Central’s running monthly balances fell in arrears for an extended term, it became the practice of Soo to reimburse itself for the advances thus made to Wisconsin Central from the proceeds of bond issues floated by Wisconsin Central.

By March 31, 1912, the Wisconsin Central’s monthly balances reflected net sums due Soo amounting to $1,246,000. These monthly borrowings were repaid in April of 1912 from the net proceeds of a public issue of Wisconsin Central’s four percent first and refunding mortgage bonds. Soo guaranteed the payment of interest on these bonds when they were sold to the public. Between April 1912 and February 1921, Wisconsin Central was able from operating income to pay for all of its own expenses and charges.

After February 28, 1921, however, Wisconsin Central’s earnings having again declined, the adverse credit balances in the monthly running account reflected net sums due Soo. By May of 1924, Wisconsin Central was indebted to Soo in the amount of $4,126,110.66. This entire sum was repaid to Soo by Wisconsin Central in June of 1924, partially from the proceeds of Soo’s sale to Dillon, Read & Co. of 3-year five and one-half percent secured Gold Notes in the amount of $3 million issued to and acquired by Soo from Wisconsin Central and guaranteed by Soo.

This issue of indebtedness by Wisconsin Central and S'oo was approved by the Interstate Commerce Commission (hereinafter referred to as the ICC or Commission) as required by law. Although the balance of the running account between the Wisconsin Central varied from month to month after November 30, 1925, the balance never was in Wisconsin Central’s favor. On December 2,1932, a bill of complaint was filed by a bondholder of Wisconsin Central in the District Court, alleging Wisconsin Central’s inability to pay interest on its bonds and praying for an appointment of a receiver.

Accordingly, on the same day, the District Court appointed a receiver who took immediate possession of Wiconsin Central’s properties. As of the end of December 1932, the adverse balance in. the running monthly account with Soo totaled $7,685,142.78.

This total was comprised of $804,942, representing five percent interest charged on Wisconsin Central’s adverse monthly balances since November 30, 1925, pursuant to a resolution of the Board of Directors of both corporations; $1,375,000 of interest on Wisconsin Central’s five percent refunding bonds accrued during 1930-1932, inclusive; and $5,505,200.78, representing monthly sums advanced by Soo over the term December 1,1925 to December 31, 1932.

The delayed receipt of sums earned by Wisconsin Central prior to December 2, 1932, but thereafter reduced to possession, continued until 1948, amounting in all to $135,609.18 and, upon receipt, these sums were applied by Soo in reduction of Wisconsin Central’s adverse monthly balances. A further reduction of $500,000 was effected as of February 28, 1939, when the receivership court determined that cash in that amount advanced to Soo by Wisconsin Central in October of 1917 represented Wisconsin Central’s share of materials and supplies for the system.

Thus, the net balance in favor of Soo as of the onset of Wisconsin Central’s receivership on December 2, 1932 was ultimately ascertained to be $7,049,533.60. The same day the receiver took over, Soo entered into a new operating agreement with the receiver (and subsequently, when Wisconsin Central went into bankruptcy proceedings, with the trustee) and continued to operate the properties of Wisconsin Central under the new agreement.

The operating revenues of Wisconsin Central, subsequent to being placed in receivership, proved sufficient to provide for its part of the cost and expenses under the new operating agreement.

After being placed in receivership, Wisconsin Central defaulted in the payment of the April 1,1933 interest installment due on $5,816,000 maturity value 'of its 1912 four percent refunding bonds. (Soo in 1912 had guaranteed the payment of interest on these bonds.) Soo thereupon, pursuant to its express guarantee, paid the interest coupons maturing on this 1912 issue between April 1,1933 and October 1,1937, at a total cost of $1,142,260. No further interest payments after October 1, 1937 were made by Soo. On December 31, 1937, Soo filed a voluntary petition for reorganization under

section 77 of the Bankruptcy Act. On October 14, 1938, Soo filed its proof of claim against Wisconsin Central, claiming the amount of the recorded balances adverse to Wisconsin Central. Wisconsin Central’s receiver filed objections to Soo’s unsecured claims in their entirety, but no hearings thereon were ever held in the receivership proceeding because the court was of the opinion that up to that time the question appeared to be moot and, therefore, unnecessary to be litigated. On March 17,1942, the ICC approved a plan of reorganization for Soo.

As part of its report on the plan for reorganization of Soo, the Commission was required to value the assets of Soo. In connection with such valuation, in its report the Commission found: The record shows that there are certain unpledged assets of the debtor, concerning which there is doubt as to whether they are subject to the liens of the debtor’s mortgages.

Included among these is a claim by the debtor against the Wisconsin Central, which is in receivership, for interest paid by the debtor as guarantor on the latter company’s bonds, which is carried on the debtor’s balance sheet at $10; $7,104,081 of open-account advances to the Wisconsin Central against which a counterclaim for approximately $16,000,000 against the debtor has been filed by the receiver of the Wisconsin Central; 103,585 shares of Wisconsin Central common stock, carried on the debtor’s balance sheet at cost, $4,629,541, but of doubtful value, if any, since the Wisconsin Central is in receivership; * * *.

The examiner found that the value of the above-enumerated items is “highly speculative.” * * * Wisconsin Central’s equity receivership was superseded as of September 30,1944, by a trusteeship which resulted in the debtor’s reorganization under

section 77 of the Bankruptcy Act, on March 1, 1954. Extended litigation between Wisconsin Central’s numerous classes of creditors added materially to the time required to effect Wisconsin Central’s reorganization. On March 1,1945, Soo filed its secured claim against Wisconsin Central then in trusteeship. It also renewed its unsecured claim for the amount of the recorded running balances adverse to Wisconsin Central. Soo’s secured claim was for the payment by Soo, as guarantor, of interest in the amount of $1,142,280 on Wisconsin Central’s 1912 four percent refunding bonds.

Soo claimed that it was entitled to a lien against the mortgaged properties next subordinate to the lien of the holders of the bonds. Subsequently, Soo conceded that its secured claim was subordinate to the claims of holders of the refunding bonds (both four and five percent issues) for principal and interest. Finally on August 21, 1952, it was judicially determined by the TJ.S. District Court, sitting as a bankruptcy court in Wisconsin Central’s reorganization, that Soo’s claim for payment of interest coupons was a secured claim.

On April 13,1945, Wisconsin Central’s trustees filed their objections to Soo’s claims. Contemporaneously, claims against Wisconsin Central were filed by the debtor’s other creditors, both secured and unsecured. Wisconsin Central’s trustees recommended to the District Court that no action be taken on Soo’s claim unless and until it should first be determined that there were sufficient assets of the debtor available for general creditors or that the value of Wisconsin Central’s assets were sufficient to permit Soo to participate in the reorganization plan.

The District Court signed an order setting for hearing the claims of the other secured creditors but fixed no hearing on any claim of Soo. These claims of the other secured creditors were not finally resolved until 1950. By 1945, hearings before the ICC had already commenced on a proposed plan of reorganization for Wisconsin Central. An. IOC examiner’s proposed report on Wisconsin Central’s reorganization recommended that all claims against Wisconsin Central having preference over general claims (but not over bonds), all general claims and all preferred and common stocks be found to have no value.

This prompted Soo, on August 26, 1946, to submit a memorandum to the Commissioner of Internal Revenue relating to the deducti-bility of losses sustained by it on certain claims against Wisconsin Central. The memorandum referred to Soo’s holdings of Wisconsin Central’s common stock, its claim against Wisconsin Central for the running balances, and the secured claim for the guaranty of interest.

However, in its income tax return for the calendar year 1946, Soo claimed bad debt losses only on account of interest in the sum of $1,142,280 it had paid as guarantor on Wisconsin Central’s first and refunding four percent bonds. By a letter dated April 4, 1947, the Commissioner of Internal Revenue ruled that Soo was not entitled to deduction for worthlessness of either the claim for advances or the claim for the interest paid on the Wisconsin Central’s bonds from 1933 to 1937. On June 3, 1947, the ICC issued its report and order approving a plan of reorganization of Wisconsin Central.

The report stated, in part: Our analysis of the record discloses no free assets. Inasmuch as the total amount of new securities issuable under the plan is insufficient to satisfy the claims of secured creditors, we find that there is no value attaching to any claims not entitled to priority over the mortgages. Thus, we find that the claims of unsecured creditors, and the debtor’s preferred and common stock have no value and the holders thereof may not participate in the reorganization.

The plan of reorganization allocated neither cash nor securities to Soo’s claim for interest on the four percent bonds paid and held by Soo, its unsecured claim, and its stock. Soo did not file a petition for reconsideration, rehearing, or modification of the ICC order of June 3, 1947. The ICC report valued Wisconsin Central’s assets, as of December 1, 1943, at a total of $60,959,000. Against these assets, the ICC reported that as of June 30, 1945, liabilities of the receiver and of Wisconsin Central secured by mortgage were a total of $65,836,892.

Due to a marked improvement in Wisconsin Central’s economic position, the ICC ordered a reopening of the proceedings on Wisconsin Central’s reorganization. The ICC observed that under the reorganization plan which it had approved in 1947, the value for the reorganized company warranted a capitalization of only $46,840,600. However, the forecast of normal year earnings upon which the 1947 reorganization plan had been based, had been completed in 1942 and had been predicated on Wisconsin Central’s earning experience from 1923 to 1941.

The ICC determined that Wisconsin Central’s assets as of the end of 1946 totaled $65,826,000, in lieu of the $60,959,000 determined in the 1947 report based upon 1943 data. The ICC concluded that the value of Wisconsin Central’s assets could support a new capitalization of $59,000,000 rather than the $46,800,000 it had previously approved in 1947. Thus, the ICC authorized a total of 208,000 new common shares in the reorganized Wisconsin Central and allocated 173,930 to secured creditors and Soo’s interest claim.

Some 34,070 shares were allocated to three unsecured claims; among them was Soo’s unsecured claim for advances. Early in March of 1952, after having resolved the claims of the other secured creditors of Wisconsin Central, the District Court turned to Soo’s claims against Wisconsin Central. A 3-day hearing was held. Thereafter, on May 12, 1952, all of the parties in interest, except Wisconsin Central itself and a committee of its preferred stockholders, executed a “Stipulation and Agreement” which fixed an upper limit upon the extent of any possible recovery by Soo upon its claims against Wisconsin Central.

The agreement was approved by the District Court and the opposition’s appeal therefrom was dismissed by the Court of Appeals. Under the agreement the parties, among other things, all bound themselves to support the then pending ICC proposed plan for Wisconsin Central’s reorganization. The parties further agreed that the claim of the Soo, based on its payment of interest on Wisconsin Central’s four percent 1912 bonds, was to be allowed as a secured claim in the amount of $1,142,260, without interest thereon.

As to Soo’s claim for advances to Wisconsin Central, the parties agreed that it should be allowed in the principal amount of $750,000, without interest, as an unsecured claim. Both claims were to be satisfied in accordance with the priority provisions of the proposed reorganization plan. The plan accorded no recognition to the holders of Wisconsin Central’s preferred and common stock.

In approving the agreement between the parties, the District Court noted the possibility that the preferred stockholders and Wisconsin Central, who had not participated in the agreement, since the ICC found no equity available for them, might have the order of approval of the plan of reorganization vacated. The court determined that Soo’s claim for payment of interest was a secured claim, without interest.

Under the reorganization plan of Wisconsin Central as finally consummated March 1, 1954, Soo’s recovery on account of its $1,142,260 secured claim was limited to a maximum of 14,849.38 shares of the Wisconsin Central’s new common stock, and to a maximum of 9,000 shares of such new common stock on account of its unsecured claims to the extent of the $750,000 thereof accorded recognition, or a maximum total in all of 23,849.38 shares. This maximum sum, however, was at all times expressly made subject to reduction depending on the outcome of a claim against Soo by other creditors.

The fair market value of the shares of Wisconsin. Central’s new common stock was $40 per share. Thus, as of 1952, the value of the maximum of 14,849.38 common shares issuable for the Soo’s $1,142,260 claim for interest it made as guarantor was $594,000, and the value of the maximum of 9,000 shares attributable to the $6 to $7 million claim for advances and interest thereon, stipulated to be recognized to the extent of $750,000, was $360,000. The total maximum value was, therefore, $954,000 for the 23,849.38 shares.

However, the bond holder who claimed the right to be subrogated to Soo’s recovery received 5,800 of the escrowed shares in a 1960 settlement among the parties. Thus, Soo actually received 18,500 shares which, at the 1952 value of $40 per share, totaled $722,000. Of this amount, $362,000 was attributable to its secured claim. As noted above, Wisconsin Central’s plan for reorganization, which was duly consummated March 1, 1954, accorded no recognition to the holders of Wisconsin Central’s old preferred and common stock, and these stockholders in fact received nothing whatsoever for their holdings.

In each of its tax calendar years 1950-1955, inclusive, Soo retired from service certain of its roadway property subject to depreciation under the retirement method of accounting. Upon the audit of Soo’s tax returns for those years, the Commissioner of Internal Revenue disallowed a portion of Soo’s tax basis of this retired roadway property equal to the depreciation such property had undergone prior to March 1, 1913, totaling $47,382.66.

For the year 1953, Soo paid into the Treasury of the United States nothing in income taxes by reason of having realized a net operating loss for that year in the amount of $680,982.43, none of which amount has ever been allowed to Soo either as a carry-back or as a carry-over. Within the time provided by law, Soo filed formal refund claims for the years 1950, 1951, 1952, 1954 and 1955. The Commissioner formally disallowed all of these claims by statutory notice dated June 27, 1958.

Soo’s refmid claims consisted of: (1) extra depreciation deductions for the years 1950-1955, inclusive, on the retirement of roadway property subject to depreciation under the retirement method of accounting on the ground that no adjustment of its deductions was proper on account of pre-1913 depreciation; (2) a deduction in 1952, and alternatively in 1954, on account of its advances made to Wisconsin Central prior to December 3, 1932, having first become wholly worthless in 1952 or 1954; (3) a deduction in 1952, and alternatively in 1954, on account of its secured claims against Wisconsin Central represented by bond interest coupons having first become wholly or partially worthless in 1952 or 1954; (4) an ordinary deduction and alternatively a capital loss deduction in 1952, and alternatively in 1954, on account of its holdings of Wisconsin Central’s old common stock having first become wholly worthless in 1952 or 1954; (5) appropriate carry-backs or carry-overs of net operating losses and capital loss carryovers depending on which year or years its advances, secured claims, and stock investments became wholly worthless.

As noted above, the Commissioner formally disallowed these claims for refund and taxpayer has timely brought suit thereon. The claims for extra depreciation (claim (1), supra,), and for a proper carry-back and carry-over for losses sustained by Soo in 1953, have been conceded by the defendant. We are met here with the problem of whether Soo’s claims, both secured and unsecured, against Wisconsin Central and its common stock investment in that company became worthless in 1952 or alternatively in 1954, thereby allowing Soo to take a deduction from gross income under

section 23 of the Internal Revenue Code of 1939. The test of worthlessness prior to the 1942 amendments was deemed to be a subjective rather than objective one, and the taxpayer could properly claim the deduction in the year in which there was a bona fide ascertainment by the taxpayer of the worthlessness of a debt irrespective of whether its worthlessness could have been ascertained prior to the year when it was discovered, so long as taxpayer exercised reasonable judgment. E.g., Herskovits v. Commissioner, 110 F. 2d 272 (2d Cir. 1940); Moore v. Commissioner, 101 F. 2d 704 (2d Cir. 1939). But see Curry v.

Commissioner, 117 F. 2d 307 (2d Cir. 1941). This subjective test was rejected by the Supreme Court in Boehm v. Commissioner, 326 U.S. 287, 292 (1945).

The Court reasoned that the language of the statute (after the 1942 amendments) and the regulations promulgated under it require that the loss to be deductible “must have been sustained in fact during the taxable year.” (Emphasis by the Court.) We interpret this as meaning that the taxpayer now not only has the burden of proving that the debt had some intrinsic value at the beginning of the year it allegedly became worthless and that it became worthless in the taxable year in question, but also that the taxpayer must show that throughout the entire life of the debt, the evidence reasonably available to him pointed out that it was possessed of some value and had not become wholly worthless.

Cf., Redman v. Commissioner, 155 F. 2d 319 (1st Cir. 1946); Wathins v. Glenn, 88 F. Supp. 70 (W.D. Ky. 1950). It is obvious that there is no precise test for determining worthlessness within the taxable year and neither the statutory enactment, its regulations, nor the decisions attempt such an all-inclusive definition^ From the numerous decisions, we are taught that a determination of whether or not a debt becomes worthless in a particular year must be confined to the fact of the particular case.

Furthermore, it is often impossible to select a single factor or “identifiable event” which clearly establishes the time at which a debt becomes worthless and thus deductible. More often it is a series of events which in the aggregate present a picture establishing that the debt in question has become worthless. Such a decision of necessity requires a practical approach, not a legal test. Boehm v. Commissioner, supra.

It must be flexible in nature, varying according to the circumstances of each particular case, so that whatever inferences a court plight draw from a particular fact in another case are not binding on the examining court, although the same fact may be present. The Tax Court has aptly said that “worthlessness is not determined by an inflexible formula or slide rule calculation, but upon the exercise of sound business judgment.” Washington Institute of Technology, Inc., 10 T.C.M. 17, 20 (1951).

In making such a determination the taxpayer must follow a rule of reason, avoiding alike the Scyllian role of the “incorrigible optimist” and the Chary-bdian character of the “stygian pessimist.” United, States v. S. S. White Dental Mfg. Co., 274 U.S. 398, 403 (1927); Ruppert v. United States, 86 Ct. Cl. 396, 403, 22 F. Supp. 428,431, cert. denied 305 U.S. 630 (1938). To be deductible, a debt need not be proven worthless beyond all peradventure, since a bare hope that something might be recovered in the future constitutes no sound reason for postponing the time for taking a deduction. Montgomery v.

United States, 87 Ct. Cl. 218, 228 (1938), 23 F. Supp. 130, 135, cert. denied 307 U.S. 632 (1939) ; Curry v. Commissioner, supra. The taxpayer is not required to postpone his entitlement to a deduction in the expectancy of uncertain future events nor is he called to wait until some turn of the wheel of fortune may bring the debtor into affluence. It appears that the taxpayer must strike a middle course between optimism and pessimism and determine debts to be worthless in the exercise of sound business judgment based upon as complete information as is reasonably obtainable.

Once it appears from all the surrounding circumstances that a debt has become worthless, we cannot look to subsequent events to determine if a debt in fact became worthless. The possibility of collection is tested by the facts known at that time and not by hindsight. However, subsequent events may be used to evaluate the soundness of our determination that a debt became worthless in a certain year. See 5 Mertens, Law of Federal Income Taxation,

section 30.37 (Rev. Ed.). Thus our inquiry must be focused on each year in which the debts were in existence without the benefit of subsequent events to help us arrive at our determination. With this in mind, we now turn to the specific items alleged by the taxpayer to have become worthless in 1952, thus entitling it to a deduction from gross income under

section 23 of the Internal Revenue Code of 1939. We shall consider each of the disputed items separately. A. Soo's secured claim against ~Wisconsvn Central As we have stated above, the taxpayer, in determining the point at which a debt became worthless, must exercise sound business judgment based upon as complete information as is reasonably obtainable. Once it appears from all the surrounding circumstances that a debt has become in fact worthless, the taxpayer cannot postpone his entitlement to the deduction.

We believe that in the instant situation Soo could not have established from the surrounding circumstances that its secured claim had in fact become worthless. Nor do we believe that Soo’s secured claim did in fact become worthless prior to 1952. The secured claim had some value at the beginning of the year (1952) it allegedly became worthless. It is also clear that the execution of the settlement agreement in 1952 effectively rendered the debt wholly worthless.

The area of conflict with respect to this item is centered around the question of whether the debt had become wholly worthless prior to 1952 and thus deductible at that time. The Government points out that in the original plan for reorganization of the Wisconsin Central, the ICC allocated no securities to this claim. Thus, the Government argues that the secured claims had in fact become worthless. Con-cededly, we can infer from this that Soo’s secured claim had become worthless. However, we cannot blind ourselves to the remaining facts and not look into what served as a basis for the ICC’s report.

The Commission, in its subsequent plan, which superseded the 1947 plan for Wisconsin Central’s reorganization, reported that the asset valuation had been completed in 1943 based on pre-1942 data showing total assets of $60,9/59,768. Against these assets the ICC reported liabilities of the receiver and of Wisconsin Central secured by mortgage in the amount of $65,836,892. However, this determination was made late in 1945. A more realistic comparison would be if the 1946 asset valuation of $65,826,000 were used. From this we cannot say whether the debt in fact had become worthless.

The Government argues that we can infer worthlessness of the secured claim from the fact that in its 1946 income tax return Soo claimed a bad debt deduction on account of its secured claim having then become worthless. Soo on the other hand contends that the ICC examiner’s original report, supra, prompted it to take such a course of action. The Government also points out that Soo valued this claim on its books and balance sheet at a nominal $1 value and that Soo did not interpose any objection to the original IOG plan for reorganization which failed to allocate securities to its secured claim.

These contentions are based on taxpayer’s attitude and conduct as to what it thought was the status of the debt and are not determinative of the issue whether or not the secured debt had in fact become worthless. We believe that some weight should be given to taxpayer’s actions in our evaluation, but “a determination of whether a loss was in fact sustained in a particular year cannot be made by confining the trier of facts to an examination of the taxpayer’s beliefs and actions.” Boehm v. Commissioner, supra, at 292.

What is of primary importance, however, is whether taxpayer, in the exercise of sound business judgment based upon as complete information as was reasonably obtainable, could have determined that the debt in fact had become worthless. The facts available to the taxpayer in the instant situation at best pointed both ways. We believe that under these circumstances Soo could not, in the exercise of sound business judgment, have determined that the debt had become wholly worthless prior to 1952.

The secured claim had a substantial value at the beginning of 1952, and in this respect we note that Soo ultimately received $362,000 worth of new common stock of Wisconsin Central on a secured claim of $1,142,260. The execution of the settlement agreement and subsequent approval by the District Court eflec-tively rendered wholly worthless the debt, except for the specified recovery allowable under the agreement. Moreover, the taxpayer could not have determined that the debt in question had become in fact totally worthless prior to 1952.

We say this because Soo’s priority participation as a secured creditor was not determined until 1952. Not until 1945 were the claims of the other secured creditors of Wisconsin Central filed. These claims were not finally resolved until 1950. Consequently, throughout the existence of its secured claim, Soo could have reasonably looked to Wisconsin Central’s assets for at least partial satisfaction of its secured claim. This is not a situation where the taxpayer is postponing his entitlement to a deduction in the expectancy that some turn of the wheel of fortune may bring the debtor into affluence.

Throughout this period, taxpayer could have reasonably looked to the debtor’s assets for satisfaction. The fact that at one point the assets appeared to be less than the claimed secured debts is not controlling, since neither the total amount nor the priority of participation of the other secured creditors was finally determined until 1950. A determination that the debt had become totally worthless prior to 1952, in view of the conflicting evidence available, runs contrary to the fact that there was ultimately a substantial recovery on the debt in question.

Consequently, we hold that Soo is entitled to take a deduction from gross income in 1952 as provided by

section 23 (

k) of 'the Internal Revenue Code of 1939, for the loss it suffered on account of its secured claim against Wisconsin Central becoming totally worthless, except for the specified amount recovered under the settlement agreement. B. Advances by Soo to Wisconsin Central In considering when debts are deductible, the first problem is to determine whether the taxpayer is owed a debt since it is obvious that a taxpayer cannot take a deduction for a worthless debt unless there is a valid debt arising out of an actual debtor-creditor relationship.

The defendant strongly urges that the debtor-creditor relationship which might have existed between Wisconsin Central and Soo on account of the monthly running balances, ceased to exist when the lease was terminated. The defendant supports this assertion by making references to the lease agreement between the parties which required Soo to turn over the leased properties at the termination of the lease free from floating indebtedness. There is no dispute that the lease was terminated when the Wisconsin Central went into receivership in 1932.

Thus, the defendant contends, whatever sums might have been owing Soo from Wisconsin Central, incurred on account of their joint operation of the leased properties, were wiped out by the provision of the lease. The taxpayer counters by calling our attention to a resolution of the Board of Directors of Wisconsin Central stating in effect that Wisconsin Central acknowledged that the sums paid by Soo from revenues belonging to it in discharge of current liabilities of Wisconsin Central were to be treated as temporary loans and to be repaid from whatever sources.

In the alternative the taxpayer contends that if the sum advanced are not treated as debts and thus deductible under

section 23 (

k) of the 1939 Code, Soo is entitled to a loss deduction under

section 23(

f) of the 1939 Code. We need not decide this issue since we are of the opinion that even if there was a valid debtor-creditor relationship and the debt survived the termination of the lease, the debt became totally worthless prior to 1952. It is apparent that Soo assumed the Scyllian role of the “incorrigible optimist” with respect to such advances. Here it was the burden of the taxpayer to establish the fact that there was a deductible loss in 1952. It was incumbent upon it to establish not only that the debt had some value in 1952, but also that it had not become worthless prior to that time.

Furthermore, the taxpayer had to show that it had become wholly or partially worthless in 1952. The taxpayer contends that this unsecured claim was possessed of substantial value at the beginning of 1952, pointing out the fact that there was a recovery of over $300,000 on a $7 million claim. The taxpayer then argues that the execution in 1952 of the settlement agreement, and its subsequent approval by the District Court, effectively rendered wholly worthless the debt in question, except for the specified recovery allowable under the agreement.

However, we are unable to say that the taxpayer has offered any evidence to support its burden of proof that the debt in question always had some value throughout its existence. The taxpayer asserts that from 1982 to 1948, there were substantial recoveries on the open running account, i.e., some $685,000, thus arguing for the continued value of the debt. We are aware that where there are substantial recoveries on an outstanding debt, we are able to draw the inference that the debt in question has not become totally worthless during that period, due to the debtor’s ability to repay part of the debt.

However, we are unable to draw such an inference in the case at bar. The stipulated facts show that of this sum, $500,000 was due to a determination in 1939 by the receivership court that Wisconsin Central was entitled to return of this amount for materials and supplies advanced to Soo in 1917. The reduction of the alleged outstanding debt was accomplished by a mere bookkeeping entry. Under these circumstances, the resulting reduction of the outstanding debt does not indicate the debtor’s ability to repay the debt.

We reach the same result with reductions resulting from the delayed receipt of sums earned by Wisconsin Central prior to 1932. Soo had to look for the satisfaction of its unsecured claim to Wisconsin Central’s assets which would be left over after the secured creditors’ claims had been satisfied, since it is clear that Wisconsin Central could not meet its obligations from its own revenues. Thus, at that time, it was incumbent upon Soo to make a determination based upon as complete information as was reasonably available, as to the possibility of recovery on the outstanding debt.

The evidence shows that throughout Wisconsin Central’s receivership and part of its trusteeship, the total value of the assets was not sufficient to satisfy the claims of all the secured creditors. The general creditors were never allocated any securities under the first ICC reorganization plan. The Commission expressly stated that the recapitalization was due to the improved financial position of Wisconsin Central.

The mere fact that there were assets at a later date, due to the debtor’s improved financial condition, does not change the result, since the possibility of collection is tested by the facts known at that time and not by hindsight. Soo was not required to postpone its entitlement to a deduction in the expectancy that some turn of the wheel of fortune might bring the Wisconsin Central into affluence, an unlikely event at that time in view of its long history of losses.

Thus, the fact of worthlessness could have been reasonably established from all the available information, and it is clear that this event occurred prior to 1952. It follows that the claimed deduction is not available in the years asserted. C. Soo's holdings of Wisconsin Central common stock Since we have held that Soo’s unsecured claims became totally worthless prior to 1952, it follows, a fortiori, that Soo’s holdings of Wisconsin Central common stock became also totally worthless prior to 1952.

If no value can be attached to claims of unsecured creditors who have priority over the shareholders of a corporation, then of necessity such stock has also become valueless prior to the date in which the deduction is claimed.

EINDINGS OF EAOT The court, having considered the evidence, the report of Trial Commissioner Richard Arens, and the briefs and argument of counsel, makes findings of fact as follows: INTRODUCTION The entire factual record in this case consists of a Stipulation of Facts filed with the court on October 13, 1960, together with some 39 separate exhibits thereto annexed, plus a Supplementary Stipulation of Facts filed with the court on November 8, 1960, together with 10 additional exhibits thereto annexed.

Four additional exhibits offered by defendant were admitted into evidence, subject to plaintiff’s continuing objection, as to two of these exhibits, by the commissioner on December 8, 1961, the record having been reopened to receive additional evidence by order of the court dated December 8, 1961, pursuant to defendant’s request dated November 29, 1961. FINDINGS OE FACT 1. Plaintiff, Minneapolis, St. Paul & Sault Ste.

Marie Railroad Company, is a railroad corporation organized on July 18, 1944, to effectuate a court-approved plan of reorganization, and subsequently existing under the laws of the State of Minnesota. Plaintiff’s principal offices are located in Minneapolis, Minnesota, and since 1944, plaintiff has been continuously engaged in operating as a common carrier by rail of freight and passengers in interstate and foreign commerce subject to the jurisdiction of the Interstate Commerce Commission (hereinafter referred to as “I.C.C.”). 2. Plaintiff’s predecessor, Minneapolis, St. Paul & Sault Ste.

Marie Railway Company (hereinafter sometimes referred to as “predecessor”), was a railroad corporation organized on June 11, 1888, under, and subsequently existing pursuant to, the laws of the States of Wisconsin, Michigan, Minnesota, and the Territory of Dakota. Predecessor was a common carrier by rail of freight and passengers in interstate and foreign commerce subject to the jurisdiction of the I.C.C.

On December 31,1937, predecessor filed a voluntary petition with the United States District Court for the District of Minnesota, Fourth Division (hereinafter referred to as the “District Court”), seeking reorganization under

Section 77 of the Bankruptcy Act, as amended. The District Court thereupon assumed custody of predecessor’s assets and operated them through the agency of a trusteeship. Until reorganized in 1944, predecessor in trusteeship (hereinafter sometimes referred to as “bankrupt predecessor”) was operated by Trustee or Trustees under the jurisdiction of the I.C.C. and the direction of the District Court as a common carrier by rail of freight and passengers in interstate and foreign commerce. 3.

Effective at 12:01 a.m., central standard time, September 1,1944, plaintiff, pursuant to order of the District Court, acquired all of the assets of bankrupt predecessor “of every kind and description, whether real, personal, or mixed, whether tangible or intangible, and whether of present or future interests, and all rights, privileges, and franchises of the Debtor.” Both plaintiff and bankrupt predecessor at the time of the September 1, 1944, reorganization were railroad corporations as defined in

Section 77 (

m) of the Bankruptcy Act, as amended, and the transfer of bankrupt predecessor’s assets to plaintiff was made pursuant to an order of the District Court having jurisdiction in a proceeding under

Section 77 of the Bankruptcy Act, as amended. 4. Wisconsin Central Kailway Company (hereinafter sometimes referred to as “old W.C.”) was a railroad corporation organized in 1899 under, and subsequently existing pursuant to, the laws of the State of Wisconsin. Old W.C. after its organization acquired, through receivership proceedings, the properties of a number of small railroads which old W.C. operated prior to April 1,1909. 5.

On December 2,1932, a bill of complaint was filed by a bondholder of old W.C. in the District Court, alleging old W.C.’s inability to pay interest on its bonds and praying for the appointment of a receiver of old W.C.’s properties. Old W.C. and predecessor joined in the bondholder’s prayer and the District Court accordingly on the same day appointed a receiver who took immediate possession of old W.C.’s properties. Old W.C. during the course of its receivership is sometimes hereinafter referred to as “old insolvent W.C.” 6.

Old insolvent W.C.’s receivership was superseded on September 30, 1944, by a trusteeship under

Section 77 of the Bankruptcy Act, as amended. Old W.C. during the course of its trusteeship is sometimes hereinafter referred to as “old bankrupt W.C.” The

Section 77 reorganization of old bankrupt W.C. took place under a plan certified by the I.C.C. to the District Court on September 26,1952, and consummated March 1, 1954, pursuant to an order of the Distinct Court. .7. Wisconsin Central Eailroad Company (hereinafter sometimes referred to as “W.C.”) is a railroad corporation organized on February 19, 1954, under the laws of the State of Minnesota to effectuate a plan of reorganization. From March 1, 1954, forward, W.C. has continued to own the railroad properties so acquired on March 1, 1954, from old bankrupt W.C. 8. On March 1, 1954, old bankrupt W.C. and W.C. were railroad corporations as defined in

Section 77 (

m) of the Bankruptcy Act, as amended. The transfer of old W.C.’s assets to W.C. was made pursuant to an order of the District Court having jurisdiction in a proceeding under

Section 77 of the Bankruptcy Act, as amended, to effectuate the court’s approved plan of reorganization. 9.

Plaintiff, predecessor, bankrupt predecessor, old W.C., old insolvent W.C., old bankrupt W.C., and W.C. have at all times since the Eevenue Act of 1913 kept their respective corporate books of account in accordance with the classification of accounts prescribed by the I.C.C.; have filed their respective Federal income and escess profits tax returns in accordance with the methods of accounting employed in keeping their respective books; and at all authorized times have employed the accrual method of accounting and the calendar year basis for the keeping of their respective accounts and the filing of their respective Federal income and excess profits tax returns. 10.

Plaintiff, predecessor, and bankrupt predecessor will, in the interests of clarity, be hereinafter referred to indiscriminately as “Soo.” Old W.C., old insolvent W.C., old bankrupt W.C., and W.C. will, in the interests of clarity, be hereinafter referred to indiscriminately as “Wisconsin Central.” 11. In 1909, Soo was the owner of a railway extending from the Twin Cities of Minneapolis and St. Paul eastward to Sault Ste.

Marie, Michigan, westward to the Missouri Si ver, and northwest and north across North Dakota and Minnesota to the Canadian border interconnecting at various points with the Canadian Pacific Sailway. Soo also owned an almost completed branch from its main line west of Minneapolis extending from Brooten, Minnesota, northeast across that State to the cities of Superior and Duluth, together with other branch lines in North Dakota, Wisconsin, and Michigan. Wisconsin Central at this same time was the owner of a railway extending from the cities of Ashland, Superior, Duluth, Minneapolis, and St.

Paul in a generally southerly direction to Milwaukee and Chicago, together with branch lines in the States of Wisconsin, Minnesota, and Michigan. The then existing lines of Soo and Wisconsin Central were so situated as to facilitate their connection and operation as one continuous main line. 12. In 1909, Soo was still engaged in constructing its lines of track, building bridges and tunnels, and in erecting or improving terminal buildings, passenger stations, warehouses, and other terminal tracks and facilities.

These costs proved a financial drain upon Soo which, accordingly, cast about for ways of avoiding duplicating those terminal costs and facilities already undertaken by competitor roads. At this same time, Wisconsin Central was engaged in the construction and extension of its line into Superior and Duluth, having already acquired terminals in both cities. In addition, Wisconsin Central upon completion of its track building program would by the fall of 1909 have had the shortest route between Chicago and Duluth as well as entrances to both Chicago and Milwaukee which Soo lacked.

To avoid duplicating terminal acquisition and operation costs, to effect economies of operation and to improve its competitive position through the use of more direct rail routes; to secure an entrance into the gateway rail centers of Chicago and Milwaukee; and to secure an entry into the rich agricultural areas of Wisconsin, Soo’s management in 1908 initiated steps to acquire permanent managerial and operational control over all the assets of Wisconsin Central to the end that they might be integrated with Soo’s. 13. During the latter part of 1908, Soo took steps to secure control of Wisconsin Central.

This latter company had never prospered, and the group of eastern capitalists then headed by the late Jules S. Bache, Newman Erb, and J. Augustus Barnard, all of New York, and N. W. Jordan of Boston (hereinafter referred to as “the eastern syndicate”) , which controlled Wisconsin Central, had already approached a number of other railroads with a view to disposing of their holdings. The method ultimately fixed upon and placed in execution was that of a long-term lease between Soo as lessee and Wisconsin Central as lessor dated April 1, 1909, for a term of 99 years.

A lease of assets rather than a merger or consolidation was fixed upon because in 1909 the industry pattern for railroad and telegraph amalgamations was, and long had been, that of the long-term lease.

This pattern, evolving since about 1850, was attributable directly to the inadequacy of early corporate merger and consolidation laws, especially where the corporate parties involved were incorporated in different States; regional provincialism and the dictates of local State pride which required local incorporation of all important public utilities, of which railroads were then the chief examples, and which led directly to the multi-state incorporation of many roads with the result that it often proved legally impossible to satisfy the divergent merger laws of all affected States; the relative ease with which the lease, in contrast with the more formal and cumbersome merger or consolidation, route could be successfully pursued; and the then absence of the severe income tax disadvantages of net lease arrangements which were to appear only after the enactment of the Sixteenth Amendment. 14.

On January. 20, 1909, Soo for $1 million acquired 25,000 shares of Wisconsin Central common stock. Additional purchases were made thereafter so that by April 1, 1909, Soo had acquired a majority of Wisconsin Central’s outstanding common stock, i.e., 81,000 out of a total outstanding issue of 161,263 such shares. Soo’s total cost for its 81,000 shares of Wisconsin Central common stock was $3,658,337.09. 15.

Soo acquired the right to vote a majority of Wisconsin Central’s 112,659 outstanding shares of preferred stock through the means of an Agreement dated April 1, 1909, between Soo, Wisconsin Central, the eastern syndicate, and the Bank of Montreal as Trustee. This 1909 Agreement contained an invitation to the then holders of Wisconsin Central’s preferred stock to deposit their shares with the Trustee and to receive in exchange therefor an equivalent number of Soo’s 4-percent Leased Line Stock Certificates (hereinafter referred to as “4-percent Certificates”).

Holders of Soo’s 4-percent Certificates were entitled to receive $4 per annum for each share of Wisconsin Central preferred stock surrendered, while Soo was entitled to vote the deposited Wisconsin Central preferred and to receive all dividends paid thereon. Dividends were paid on Wisconsin Central’s preferred stock at the rate of $4 per share per annum for each of the years 1909 to 1921, inclusive, but equal amounts had to be paid over to the 4-percent Certificate holders.

As of June 30, 1910, some 111,316 shares of Wisconsin Central preferred stock had been exchanged for Soo’s 4-percent Certificates, and as of December 2, 1932, when Wisconsin Central’s equity receivership commenced, all of its preferred stock except for 95 shares had been so exchanged. 16. The lease dated April 1, 1909, was approved by the directors and stockholders of Wisconsin Central at meetings held prior to the time Soo took over control.

The recitals of the lease stated, among other things, that “* * * it is deemed for the best interests of the parties hereto that [the lines of railway of the lessor and the lessee] should be operated together, while still retaining the separate corporate existence and status in law of the parties hereto;” and that “* * * in order to effectuate and carry out such purpose, it is essential that there should be but one management and one dstration of the operation of the two systems of rail- * * * » way;

Article One provided that Wisconsin Central leased unto Soo all the lines of railway and all of the property of the lessor, including properties which it might thereafter hold, together with all rights appertaining thereto, for a term of 99 years.

Article Two provided as follows: The Lessee shall, immediately upon the execution of this agreement have sole control of all said properties and of all operations of said railways, and of every part thereof, and all officers, agents and employees of the Lessor having to do with such control and operation, shall yield prompt and complete obedience to the authority of the Lessee with respect to the control and operation of said railways, and other properties covered hereby.

Article Three provided as follows: The Lessee shall be entitled upon the execution hereof to the sole control of all the funds and other assets of the Lessor, whether current or accumulated, and also of all earnings of said leased railways and other properties during the term hereof (including any proceeds from the sale, rent or royalties of any and all lands now held and owned by the Lessor or held in trust for its benefit, or which it shall acquire during the term of this lease over which the Lessor has or may have control) to be used, however, wisely and prudently according to its best judgment for the sole purpose of operating, maintaining and improving the railways and other properties hereby leased, and for meeting and discharging the taxes, charges, liabilities and obligations of the Lessor pertaining thereto and any interest payable on account of the same, and, so far as may be legally possible, for the payment of such dividends on the outstanding capital stock of the Lessor as the Board of Directors of the Lessor may from time to time declare, provided, however, that the Lessee shall not in any event, commingle said earnings, funds or assets with its own, and that it shall keep and maintain with respect thereto, a separate and complete system of accounting and auditing during the full term of this lease.

But said earnings, funds and assets shall stand charged in favor of the Lessors with the payments to be made for the said puiposes or for other purposes in accordance with the provisions contained in this lease.

Article Four provided that the lessor was obligated to maintain its corporate existence and organization during the existence of the lease and provided that “All necessary and reasonable expenses of the due performance of the covenants and agreements * * * which the said Lessor undertakes to do and perform, shall be paid out of the earnings of the railway and other properties hereby leased, or other income of the Lessor.”

Article Five provided as follows: Subject only to the covenant to maintain a separate accounting and all other covenants and agreements to be by it kept and performed in accordance with the terms and conditions of this lease, the Lessee shall have the right to manage, operate and administer all of the railways and other properties covered by this lease, or any extensions or additions thereto; as a part of the railway owned and operated by the Lessee: Provided, however, that if in the judgment of the Lessee it becomes necessary or expedient to operate any of said railways, terminal facilities or other appurtenances owned by the Lessor, or the use of which is secured to it by lease or other contract, permit or privilege, by and through the corporate organization of the Lessor, the Lessee shall have the full right and power to require such operation by the Lessor under the direction and supervision, however, of the Lessee; and, Provided further, that all expense of such management and administration shall be paid out of the earnings of the properties hereby demised.

Article Ten provided as follows: The Lessee shall have the right out of the earnings of the Lessor, or from the proceeds of any bonds or stocks that may be hereafter issued by the Lessor with the consent of the Lessee, to purchase for use upon the railroads hereby demised any and all motive power, rolling stock and equipment which the business of the said railroads and the increase thereof may require; and the Lessee shall have the right to place on all the rolling stock, motive power and equipment of the Lessor, its own name or trademark, or both, in such form and manner as it shall deem best; Provided, however, that it shall also place thereon in some plain and conspicuous place the name of the Lessor; and Provided fu/rther, that all the rolling stock, motive power and equipment now or hereafter owned by the Lessor shall be for the exclusive use of the railroads hereby leased, so far as the interchange of traffic, according to the custom of railroads, will permit, and except that in cases of emergency or unusual conditions of traffic, and when the same can be done without prejudice to the business on the railways hereby demised, the Lessee may hire the use of motive power or cars of the Lessor temporarily upon payment of a fair rental therefor.

Article Eleven provided that the directors of the lessor may declare dividends on the capital stock of the lessor company payable out of the net earnings of the leased properties, and that the lessee may pay such dividends out of such net earnings.

Article Fourteen provided that the lessee would continuously during the term of the lease operate the leased railroads as required by law and at all times keep, maintain, and preserve the leased railroads in good condition and repair, and would, when necessary, renew, replace, or rebuild the same, and that the renewed, replaced, and rebuilt structures should at once become and be the property of the lessor.

Article Fifteen provided that the lessee should, out of the earnings of the leased properties, pay all costs of managing, maintaining, and operating the leased property; and that all expenses that might be incurred for the joint benefit of the railway of the lessor and the railway of the lessee “* * * shall be borne by the Lessor and Lessee in such fair and equitable proportion as may be agreed upon by [them]. In the event of any disagreement as to the fair and equitable proportion of such expenses to be borne by the Lessor, the same shall be determined by arbitration * *

Article Sixteen provided as follows: The Lessee shall and will out of said earnings from time to time, and when the same shall become due, pay all sums of money payable by the Lessor on account of any agreement or liability now or hereafter existing, and all interest on the outstanding bonds and obligations of the Lessor and on all bonds or other obligations of the Lessor hereafter issued to renew the same or for other purposes hereby authorized and, so far as may be necessary or advisable, the principal of all such bonds and also all license fees, taxes, duties, and assessments, of whatsoever nature, that may be levied, exacted, required, charged or assessed, by or through the United States, or by or through any State, county, city or town, or by or through any other municipal or legal authority, on the said demised property, or any part thereof, or on the gross earnings of said demised properties or anv part thereof.

Article Twenty-one provided that the lessee should keep separate books of account with respect to all business transacted by or through the use of the leased railways.

Article Twenty-three provided that if the lessee should fail or omit to keep and perform any of its covenants and agreements for a period of 90 days, the lessor had an option to immediately terminate the lease, and that the leased railroads and all additions and improvements which shall have been made to the same should revert to the lessor.

Article Twenty-four provided as follows: The Lessee covenants, promises and agrees to and with the Lessor, that at the end of said term or sooner termination of this lease, the Lessee will deliver and surrender to the Lessor the said demised railroads and property free from floating indebtedness incurred for maintenance or operating expenses, taxes and fixed charges and in at least as good order and condition as when delivered to the Lessee under this indenture, and with all such additions, betterments and improvements as shall have been made thereto, reasonable and usual depreciation as to any of said property subject to depreciation alone excepted, and will fully account to the Lessor for all earnings, surplus, and other assets received by the Lessee under the provisions hereof.

Article Twenty-five provided that except for the obligations of the lessee under

Article Twenty-four, the lessee was not to be financially responsible for the expenses arising from the operation and management of the leased railway properties, but that all such expenses were to be paid by the lessee out of the earnings of the railways and other properties of the lessor. There was no provision in the lease for the payment of rental and none was ever paid by Soo. 17. Soo came into possession of tbe Wisconsin Central properties on April 15, 1909. Soo acquired and duly exercised the full right to operate all of the assets of Wisconsin Central jointly with those of its own.

Soo submerged the name of its lessor and spread its own name over Wisconsin Central’s properties, including rolling stock, motive power, stations, timetables, and tariffs. After April 15, 1909, Soo treated its own properties and those of Wisconsin Central as a single system. Earnings of both companies were, in the first instance, placed in a common pool.

Charges incurred for wages, materials, taxes, interest, supplies, additions and betterments to roadway property and equipment, bond sinking funds, and other items were from day to day paid out of the common pool as they became due, without regard initially to which company was responsible for them. When the accounting for each month had been completed, the net income remaining was divided.

When Wisconsin Central’s share of net earnings was insufficient to cover all of its own obligations, Soo used its own funds and then charged Wisconsin Central with the sums so spent, reimbursing itself thereafter from funds of Wisconsin Central in subsequent months. When advances were made, they were not earmarked for additions, betterments, or other pur-posfes.

From 1925 through 1948, Wisconsin Central recorded the running credit balances adverse to it on its balance sheets under I.C.C. account 757 as “Non-negotiable debt to affiliated companies” and from 1944 through 1952 under I.C.C. account 770 as “Other deferred liabilities.” 18. Following execution of the 99-year lease of all of Wisconsin Central’s assets, Soo provided the system with an appropriate freight terminal in the city of Chicago at a cost of about $8 million.

Adequate switching facilities were rendered available to Wisconsin Central in Chicago at minimum cost by Soo’s 1912 acquisition of a one-twelfth interest in the capital stock of The Belt Bailway Company of Chicago upon the formation of that major switching and terminal company in Chicago. By October 1913 Soo had also acquired a majority of the capital stock of Central Terminal Bailway Company, a corporation then possessed of such needful facilities, with. Soo completing its full ownership of all such terminal corporation’s stock by April 1922.

Both of these steps were taken with a view to enhancing the competitive position of Soo directly and as lessee of all of Wisconsin Central’s assets. 19. After Soo’s lease of Wisconsin Central’s assets, no dividends were ever paid on the common stock of Wisconsin Central. Wisconsin Central’s minority common stockholders formed a protective committee in an effort to improve their position.

Under pressure from this committee, which attacked Soo’s control over Wisconsin Central’s assets, Soo in 1924 agreed to issue its own 25-year, 5y2 percent Gold Notes in exchange for Wisconsin Central’s common stock held by the minority at the rate of $43.25 maturity value of Gold Notes for each share of Wisconsin Central common stock surrendered in exchange. Soo acquired an additional 78,088 shares of Wisconsin Central common stock, which shares were pledged as collateral for Soo’s Gold Notes.

Taken with Soo’s earlier purchases of Wisconsin Central common stock, Soo thus came to possess 159,088 shares of Wisconsin Central common stock out of a total of 161,263 such shares outstanding. As those Notes matured serially and were paid off in cash, Soo acquired complete title free of pledge to 22,319 shares at a cost of $965,157.44. The balance of the Wisconsin Central common stock, i.e., 56,420 shares, pledged as collateral for Soo’s Gold Notes, was surrendered to the holders of the unpaid Gold Notes in 1944 during the course of Soo’s reorganization under

Section 77 of the Bankruptcy Act, as amended. During the years 1927-1930, Soo acquired 266 additional shares of Wisconsin Central common stock for $6,046.60 in cash. Soo thus acquired a total of 103,583 shares of Wisconsin Central common stock, having an original cost basis of $4,629,541.13. 20. At the close of each calendar month from June 1909 to September 1910 the balances favored Wisconsin Central, except for the two months December 1909 and July 1910, which slightly favored Soo.

The monthly figures during this early period of the lease’s operation reflect only normal delays in accounting for revenues and expenditures. Commencing, however, with September 1910, the monthly figures for some time represented amounts resulting from the inadequacy of Wisconsin Central’s monthly revenues. The expected revenues of Wisconsin Central initially failed to materialize with the speed and in the volume that had been anticipated. 21.

On April 11, 1911, Wisconsin Central gave Soo a promissory note for $225,000, bearing interest at the rate of 4y2 percent per annum and due one year after date, for advances theretofore made by Soo to Wisconsin Central. Subsequently, Soo advanced further sums to or for Wisconsin Central until the amount thereof totaled $1,246,000 at March 31, 1912, secured by the debtor’s deposit with the lender of $1,384,400, maturity value of Wisconsin Central’s 4-percent First and Refunding Mortgage Bonds, as authorized by Wisconsin Central’s board of directors on June 22, 1911.

Soo, in April 1912, sold these bonds to the general public accompanied by its own guarantee of interest payment, and gave appropriate credit on the books to Wisconsin Central. 22. From April 1912 through February 1921 Wisconsin Central was able from operating income to pay for all of its own expenses and charges.

The monthly credit balances again merely reflected usual accounting delays in effecting settlement in the running monthly balance account between Soo and Wisconsin Central throughout the period April 30, 1912 — February 28,1921, exclusive of the intervening period of Federal control and guarantee extending from December 28,1917, through August 31,1920. 23. After February 28,1921, however, Wisconsin Central’s earnings having again declined, the adverse credit balances in the monthly running account generally reflected net sums due Soo.

On March 10,1922, Wisconsin Central’s board of directors adopted a resolution which recited that during the period from September 1, 1920, to January 31, 1922, the lessor sustained “net losses from the operation” of its properties in the sum of $1,236,782.69; that during the same period, various Federal, state and local taxes had been “levied and assessed against the railways and railway properties of the Lessor” which aggregated $1,368,301.09; that payment had been made “by the Lessor on account of interest, dividends and sinking funds * * * aggregating $2,349,545.03”; and payments had been made “by the Lessor on account of the principal of its Equipment Trust obligations * * * aggregating $705,-988.43”; and that all such amounts were “disbursed from month to month out of revenues belonging to” Soo “in discharge of current indebtedness of” Wisconsin Central “as temporary loans from” Soo to Wisconsin Central, “to be subsequently repaid by the latter out of funds or revenues which might be available to it.” The resolution further reads as follows: Resolved, that the foregoing disbursements in behalf of this Company, out of revenues belonging to the Minneapolis, St.

Paul & Sault Ste. Marie Railway Company, be, and they hereby are, ratified and recognized by this Company as temporary loans to this Company, to be repaid to the Minneapolis, St. Paul & Sault Ste. Marie Railway Company out of revenues and funds which may in the future be available to this Company from any source whatsoever, and/or to be charged against this Company in mutual settlements and adjustments of accounts between the two companies; and Whereas, it appears that further disbursements of the above described character, out of revenues belonging to the Minneapolis, St. Paul & Sault Ste.

Marie Railway Company, in behalf of this Company, may have been or may become necessary in order to properly maintain and operate the railways and railway properties of this Company: Resolved, that such further disbursements of the above described character, out of revenues belonging to the Minneapolis, St. _ Paul & Sault Ste. Marie Railway, in behalf of this Company, as may have been or may become necessary in order to properly maintain and operate the railways and railway properties of this Company, are hereby requested and recognized as temporary loans, to be subsequently repaid to the Minneapolis, St.

Paul & Sault Ste. Marie Railway Company out of revenues and funds which may in the future be available to this Company from any source whatsoever, and/or to be charged against this Company in mutual settlements and adjustments of the accounts between the two Companies. 24. In May 1924 Wisconsin Central and Soo applied jointly to the I.C.C. for an order authorizing the issue and sale by Wisconsin Central of $6 million of 3-year 5%-per-cent secured Gold Notes with Wisconsin Central and Soo both assuming obligation and liability therefor.

In the application it was stated that additional funds were needed for certain betterments and that Wisconsin Central “is indebted to the Soo Company for advances made in excess of $3,000,-000, repayment of which is urgently needed by the latter company in order that it may care for expenditures on its own lines.” As collateral security for the notes, Wisconsin Central pledged $8 million of its first and refunding mortgage 4-percent bonds, upon which Wisconsin Central and Soo jointly and severally agreed to pay interest. On May 24, 1924, the I.C.C. authorized the issuance of the foregoing secured Gold Notes.

The I.C.C. found that the issuance and sale of notes and the assumption of joint and several obligation and liability by both railroads “(

a) are for lawful objects within their respective corporate purposes, and compatible with the public interest, which are necessary and appropriate for and consistent with the proper performance by the Soo Company of service to the public as a common carrier, and which will not impair its ability to perform that service, and (

b) are reasonably necessary and appropriate for such purposes.” These notes were sold to Soo, which thereupon guaranteed them both as to principal and interest and sold them to Dillon, Read & Co. The books of account of Soo show that the sum of $3 million was credited as of June 30, 1924, to Wisconsin Central against the recorded monthly balances which then favored Soo. By May 31, 1924, the running monthly balances showed that there was due Soo from Wisconsin Central the sum of $4,126,110.66, and that on June 30, 1924, $606,154.56 was due Wisconsin Central from Soo. In 1926 Wisconsin Central filed with the I.C.C. the report, required under

Section 20a of the Interstate Commerce Act, for the year 1925 of the disposition made of securities authorized under the Act, which report reads in part as follows: 3. Total net proceeds of securities-$5, 849,086. 51 4. Purpose to which applied: Additions & Betterments_ 2, 849,086.51 Repayment of advances to M.St.P. & S.S.M. Ry. Co_ 3, 000, 000.00 25.

The running account monthly balance favored Wisconsin Central for the four months ending June, July, August, and September 1924, but did not again return to a balance favoring Wisconsin Central until September 30, 1925, thereafter remaining favorable to Wisconsin Central only for the next two succeeding months. As of November 30, 1925, the running monthly account balance favored Wisconsin Central in the sum of $166,070.10, which was then owing from Soo, and this was the last date upon which credit balances in the running monthly account ever stood in Wisconsin Central’s favor. 26.

In 1927 Wisconsin Central sold to Soo, which in turn sold to Dillon, Read & Co., $7,500,000 maturity value of its 3-year 5%-percent secured Gold Notes, guaranteed as to principal and interest by Soo. The books of account of Soo show that the sum of $718,000 was credited as of January 31,1927, to Wisconsin Central against the recorded monthly balances which then favored Soo. As of January 1,1930, Wisconsin Central sold to Soo $10 million maturity value of Wisconsin Central’s first and refunding 5-percent mortgage bonds for $8 million.

Of the $8 million, Soo credited $500,000 as of January 31, 1930, to Wisconsin Central against the recorded monthly balances which then favored Soo. Wisconsin Central used the remaining $7,500,000 to retire its 1927 issue of 3-year secured Gold Notes. To pay for the Wisconsin Central mortgage bonds, Soo sold its own 5%-percent bonds, pledging Wisconsin Central’s 5-percent mortgage bond issue as collateral. At the end of the year 1928 Wisconsin Central filed with the I.C.C. the report, required under

Section 20a of the Interstate Commerce Act, for the year 1928 of the disposition made of securities authorized under the Act, which report reads in part as follows: 3. Total net proceeds of securities_$7, 267, 471. 56 4. Purpose to which, applied: Retire $6,000,000 3 Yr. 5%% Gold Notes A&B $912,457.56, Pay’t to Soo Line for advances $718,000.00_ 7, 630, 457. 56 In May 1928 Wisconsin Central paid over to Soo on account the sum of $65,000. In June 1928 Wisconsin Central paid over to Soo on account the sum of $269,768.83. In March 1930 Wisconsin Central paid over to Soo on account the sum of $10,000.

In April 1931 Wisconsin Central paid over to Soo on account the sum of $25,000. As of July 1, 1931, Wisconsin Central transferred to Soo title to certain equipment used by Soo under the lease having a then depreciated value of $4,717,767.67, against which equipment trust indebtedness of $1,945,966.29 was outstanding. At the time of the transfer, Wisconsin Central was unable to make good defaulted principal and interest on the equipment which had an original cost of $6,411,501.06. The defaulted principal and interest exceeded the equity of Wisconsin Central in the equipment at the time of the transfer.

As a result of this transfer, Soo’s payments on the equipment between 1926 and 1931 in the sum of $2,771,802 which had been recorded as advances to Wisconsin Central were canceled. 27. Wisconsin Central was unable to meet the interest accruing on its $10 million maturity value of 5-percent mortgage bonds sold to Soo as of January 1, 1930. To avoid a default, both debtor and creditor recorded the interest obligation as paid in their respective books of account for April 1 and October 1, 1930, 1931, and 1932.

Soo reported this interest as income in its Federal income tax returns, which showed no tax due, as follows: Amount of Soo’s tax interest calendar year: reported 1930_ $375, 000 1931_ 500,000 1932_ 500, 000 1,375, 000 Wisconsin. Central reported the above interest as deductions from income in the consolidated income tax returns filed by Wisconsin Central and Soo. 28. Soo in the early days of the lease had not charged Wisconsin Central with interest on the balances favoring Soo.

On July 14, 1924, the respective boards of both Soo and Wisconsin Central adopted resolutions reading as follows: Whereas, On account of the existing relationship between the Wisconsin Central Eailway Company and the Minneapolis, St. Paul & Sault Ste.

Marie Eailway Company and the management and operation of the former company by the latter company, it has been and is necessary to maintain certain open accounts between the two companies on which there is outstanding at times a balance owing from the one company to the other or vice versa, and it is fair and proper for the debtor company to pay interest to the creditor company on such balances.

Eesolved, That the Comptroller be instructed to ascertain in each month the balance which was owing at the end of the month before from either company to the other on each of such open accounts; and to charge interest at the rate of 5% per annum against the debtor company on any unpaid portion of such balance beginning at the end of the month following; charging no interest on any portion of any such balance which may be paid during the month in which the balance is ascertained.

Thereafter, interest was recorded on the corporate books of account of both companies as follows: Amount of interest accrued' at annual rate of 5% against Wisconsin Central on its Calendar year: adverse balances favoring Soo 1926-$26,541.82 1927- 33,908.74 1928- 99,191.71 1929- 144, 806.22 1930- 197,225.15 1931- 262,107.71 1932- 41,160.65 Total. 804,942.00 Soo ceased to accrue interest on its corporate books of account as of February 28, 1932.

The foregoing sums were reported by Soo as interest income in the consolidated Federal income tax returns for the tax calendar years 1926-1932, inclusive, and deducted by Wisconsin Central in the same consolidated returns. 29.

On November 30, 1932, Soo by directors’ resolution notified Wisconsin Central that the latter’s properties could not then be operated so as to yield sufficient revenues to meet the operating and maintenance expenses thereof, that Soo was not obligated to meet the deficits out of its own revenues, that Soo would cease to operate and maintain the Wisconsin Central’s properties unless satisfactory arrangements were forthwith made to furnish it with funds with which to meet the deficits to be incurred, and that Soo stood ready to deliver the possession of said properties to Wisconsin Central upon demand.

Soo’s conclusion precipitated Wisconsin Central into receivership on December 2,1932. 50. As of the end of December 1932, the adverse balance in the running monthly account with Soo totaled $7,685,14-2.-78. This total was comprised of $804,942 representing 5-percent interest charged on Wisconsin Central’s adverse monthly balances since November 30, 1925; $1,375,000 of interest on Wisconsin Central’s 5-percent refunding bonds accrued during 1930-1932, inclusive; and $5,505,200.78, representing monthly sums advanced by Soo over the term December 1, 1925-December 31, 1932.

The delayed receipt of sums earned by Wisconsin Central prior to December 2, 1932, but thereafter reduced to possession, continued until 1948, amounting in all to $135,609.18 and, upon receipt, these sums were applied by Soo in reduction of Wisconsin Central’s adverse monthly balances.

A further reduction of $500,000 was effected as of February 28,1939, when, pursuant to order of the District Court, it was determined that cash in that amount advanced to Soo by Wisconsin Central in October 1917 represented Wisconsin Central’s share of materials and supplies for the system and that Wisconsin Central was not entitled to receive a physical share of materials and supplies on account of this 1917 cash deposit with Soo.

Thus, the net adverse running monthly balance in favor of Soo as of the onset of Wisconsin Central’s receivership on December 2, 1932, was ultimately ascertained to be $7,049,533.60. 31. The order of the District Court which effected the reductio

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