MISSOURI PACIFIC RAILROAD COMPANY v. THE UNITED STATES, 167 Ct. Cl. 725

Laramore, Judge, delivered the opinion of the court: This is an action for the refund of Federal income taxes for the year 1954 in the amount of $2,480,183.29, together with deficiency interest in the amount of $121,182.52, plus statutory interest on these amounts. The question presented centers on the deductibility under

section 163 of the 1954 Code of so-called “pre-issue” interest resulting from a railroad insolvency reorganization. The Missouri Pacific Railroad Company, the taxpayer here, has been continuously engaged in operating a railroad in interstate commerce since its organization in 1917. From July 1, 1933 to March 1, 1956, taxpayer and 24 subsidiary railroad corporations, together constituting taxpayer’s railroad system, were parties to a reorganization proceeding under

section 77 of the Bankruptcy Act. Over the years, three separate plans of reorganization were proposed and rejected. A fourth and final plan of reorganization, to be effective as of January 1,1955, was approved by the Interstate Commerce Commission on July 29, 1954. It was not until March 1,1956, that the Bankruptcy Court was able to enter its Consummation Order and Final Decree, making the reorganization effective as of January 1, 1955. Thus, final approval of the plan of reorganization was not obtained until after the effective date of the plan.

Pursuant to the Consummation Order, taxpayer was recapitalized and all of its subsidiaries in trusteeship, except one, were merged into the recapitalized taxpayer as the surviving corporation and the new operating company.

In accordance with the provisions of the plan as adopted, taxpayer’s old common stockholders received a reduced number of taxpayer’s new Class B common stock; taxpayer’s old preferred stockholders exchanged their shares plus accumulated dividends for an equal stated value of taxpayer’s new Class A common stock; old unsecured general creditors received equivalent face value of taxpayer’s new securities consisting either of mortgage bonds or debentures.

Each class of the old security holders of taxpayer’s system, with the exception of one class, received cash plus new securities of the recapitalized taxpayer equivalent to the principal amount of the old obligations, plus interest accrued to the effective date of the system’s reorganization plan. Thus allowances for accrued interest up to the effective date of the plan were reflected in the face value of the new bonds and cash. Interest on the old securities beyond December 31, 1954 was generally “not authorized for payment” by the court.

Accordingly, under the plan, interest on the new securities was generally payable from January 1, 1955. However, where the court authorized current payment of interest in cash on some of the old securities after December 31, 1954, interest on the substituted new securities ran from the date of the last interest payment on the old securities. All members of taxpayer’s system joined in the filing of consolidated Federal income tax returns for the calendar years 1954-56 inclusive.

Also throughout this period, taxpayer and all members of its affiliated group kept their respective corporate books of account on the basis of the calendar year and in accordance with the accrual method of accounting. In arriving at its taxable income for the calendar year 1955, taxpayer in its consolidated income tax return for its affiliated group took deductions for the accrual of interest on its debt as provided for in the old securities, which were later exchanged pursuant to the plan of reorganization consummated on March 1, 1956. This was duly allowed by the Commissioner on audit.

However, these accruals of interest were never actually paid in 1955. On its consolidated income tax return for the calendar year 1956, taxpayer’s affiliated group likewise deducted accruals of interest on its outstanding debt obligations.

Of the total interest so deducted and allowed by the Commissioner for 1956, part of it was attributable to the accrual of interest on the system’s old debt for the period January 1, 1956 to February 29, 1956, and the remainder (for the period March 1 through December 31,1956) constituted interest on taxpayer’s new debt as provided by the plan of reorganization consummated on March 1, 1956. As stated earlier, all of taxpayer’s new securities with the exception of two bore interest from the plan’s effective date, January 1,1955.

Accordingly, taxpayer paid to the holders of its new securities amounts equivalent to interest for the period from J anuary 1,1955 (the effective date of the plan) to March 1, 1956 (the date of the Consummation Order). Taxpayer did not deduct these amounts on its 1956 Federal income tax returns, although it now contends (and the Government denies) that it is entitled to deduct the entire amount.

Taxpayer filed a claim for refund for the calendar year 1954 in which it contended that this amount of so-called “pre-issue” interest on the new obligations which was paid in 1956 to account for interest running during the period between the effective date of the plan and the consummation date should be allowed as a deduction in 1956 thereby creating a net operating loss carryback to 1954. This claim was formally rejected by the Commissioner of Internal Revenue, and the instant action was timely brought.

The Government now concedes that taxpayer, in computing its income for 1956, is entitled to a deduction for the interest it paid on its new securities for the period J anuary 1,1955 to February 29, 1956, but only to the extent that the amounts paid are in excess of the amount it originally accrued as interest obligations for such periods. Thus we are only concerned with whether or not taxpayer is entitled to the further deduction.

It appears to us that what taxpayer attempts to do here runs contrary to the fundamental principle of income tax law that a taxpayer may not take more than a single deduction for a single item of expense. Cf., Charles Ilfeld Co. v. Hernandez, 292 U.S. 62, 68 (1934); Ford v. United States, 160 Ct. Cl. 417, 311 F. 2d 951 (1963).

Taxpayer concedes tbat it is not entitled to a double deduction for interest but attempts to avoid the application of this doctrine to the instant situation by arguing that the interest accrued in 1955 and from January 1, 1956, to February 29, 1956, and that paid in 1956 related to two different debts. From this taxpayer argues that by virtue of I.T. 3635, 1944 Cum. Bull. 101, it was entitled to deduct interest on its old obligations to the date of the consummation of the reorganization and that upon the authority of Commissioner v.

Philadelphia Transportation Co. it is entitled to deduct this so-called “pre-issue” interest accruing on its new obligations. At first blush, taxpayer’s argument seems to have some merit if we treat each deduction involved as a separate and independent transaction. For I.T. 3635, supra, appears to represent the current administrative practice of allowing all railroads undergoing

section 77 reorganization to accrue and deduct interest on outstanding debts despite default and despite the unlikelihood of ultimate collectibility. Moreover, Commissioner v. Philadelphia Transportation Co., supra, is authority for the proposition that under certain circumstances “pre-issue” interest on new securities issued in a reorganization is deductible. However, before the cited authority can support taxpayer’s conclusion that it is entitled to deduct interest on both the old and the new securities for the period between the effective date and the consummation date of the reorganization, the interest so deducted as an item of expense under

section 163 must relate to two independent obligations, since interest is the premium paid for the use of money, or in the words of the Supreme Court interest “is the amomit which one has contracted to pay for the use of borrowed money.” We think that the determinative factor in this case is that during the period from the effective date of the plan and its final approval, taxpayer and its affiliates were obligated to pay interest only once on its outstanding bonded indebtedness.

The old and new securities were not independent obligations existing at the same time, but instead evidenced the same indebtedness in which one was to be substituted for the other in the event final approval of the plan was achieved. Consequently, when taxpayer made the accruals of interest for the period January 1, 1955, to February 29, 1956, it was clear that its interest obligations were payable either as prescribed in the pre-existing securities, or, if final approval was achieved, its liability for interest would be determined as provided for in the new securities predated to the effective date of the plan.

It is clear that taxpayer was never liable under both. Here the accrual of interest for the period in issue with its concomitant deduction was taken as provided for in the old securities; payment and satisfaction of this accrued obligation was accomplished as prescribed by the new bonds. To the extent that this interest payment was in satisfaction of the prior accrued liability it was not a new or additional expense accruing for the first time in 1956, and as such cannot support an additional deduction.

For a taxpayer using the accrual method of accounting may only deduct an item of expense accrued within the taxable year and it is not entitled to a deduction when the item is paid in the later year. United States v. Olympic Radio & Television., Inc., 349 U.S. 232 (1955); Security Flour Mills Co. v. Commissioner, 321 U.S. 281 (1944). Taxpayer attempts to avoid the application of this rule of law by arguing that the interest it now attempts to deduct first accrued in 1956 and, as such, we camiot view the transaction as payment of the prior accrual.

The fallacy of taxpayer’s argument is that the old and the new securities were not independent obligations but were designed to be a substitute for each other, as to both principal and the interest encompassed by the period in issue. A mere substitution in the form of the evidence of indebtedness is not the creation of a new and increased obligation supporting an additional deduction for interest. Cf., City of Los Angeles v. Teed, 112 Cal. 319, 327, 44 Pac. 580, 582 (1896).

In other words, when the old securities were exchanged for the new, the total amount of taxpayer’s “outstanding indebtedness” did not increase by the principal amount of its new securities. Consequently, the interest paid pursuant to taxpayer’s new securities for the period in issue, to the extent already accrued as provided by the old securities, did not first accrue when the new securities were exchanged for the old. The deduction claimed would permit taxpayer to use the same item of expense twice for the reduction of its taxable income.

If allowed, this would amount to a double deduction for the same item of expense. Such a result would be contrary to the fundamental principle of income tax law that a taxpayer may not take more than a single deduction for a single expense. Moreover, properly viewed, the Philadelphia, Transportation Oo. case, swpra, gives no comfort to taxpayer. It argues that that decision stands for the broad proposition that “pre-issue” interest, issued in a reorganization, is always deductible. However, it is apparent from the controlling facts in that case that no such broad

interpretation is warranted. The deduction allowed in that case did not in any way involve the question of a double deduction. There, for the most part, non-interest bearing equity securities were exchanged in >a reorganization for debt securities. “Pre-issue” interest was accrued on the newly created debt. No deduction on the pre-existing non-interest bearing securities was ever claimed or taken. Judge Goodrich, writing for the majority of the court, carefully pointed out that in that case taxpayer, as a new corporation, created its new indebtedness.

It did not assume existing liabilities on which interest had already accrued against the predecessor companies. * * * * * * [N] either the present taxpayer nor any of its predecessors was in a position to take advantage of a 1939 deduction for the interest payments in question. [174 F. 2d at 256]. In the present case the taxpayer is seeking, as demonstrated above, to take a double deduction for the same item of expense — a situation envisioned and explicity put apart by the majority in the Philadelphia Transportation Co. case.

Here not only interest had accrued on taxpayer’s outstanding debt but also taxpayer had taken advantage of this accrued interest as a deduction for the reduction of its taxable income. The mere fact that as the result of the reorganization the substituted form of the evidence of indebtedness was predated to the effective date of the plan is not sufficient reason to bring this case within the holding of the Philadelphia Transportation Co. case. To conclude otherwise would produce a result which would be wholly illogical and at the same time be an unwarranted extension of that case.

Consequently, we must hold that taxpayer is not entitled to deduct in computing its taxable income for 1956, the entire amount of interest it paid on its new securities for the period January 1, 1955 to February 29,1956. However, as conceded by the government, taxpayer is entitled to deduct in computing its taxable income for 1956, those amounts of interest which it paid on its new securities for this period (January 1, 1955, to February 29,1956), to the extent that the amounts paid are in excess of the amounts it originally accrued as interest under the pre-existing securities for this period.

Although a refund is not sought in the petition for 1956, it is our understanding that that year has been left open administratively. Consequently, -we now treat plaintiff’s petition in the alternative, thaJt is to say that if the deduction to which taxpayer is entitled under our opinion for 1956 is not sufficient to create a loss carry-back to 1954, taxpayer, nevertheless, is entitled to a refund which such a deduction might create for tax year 1956. Accordingly, judgment is entered for plaintiff. The amount of recovery, if any, is to be determined pursuant to Fule 47 (c) (2) of the Kules of this court.

FINDINGS OF FACT The court, having considered the evidence, the report of Trial Commissioner Saul Richard Gamer, and the briefs and argument of counsel, makes findings of fact as follows: 1. Plaintiff is a Missouri corporation organized in 1917. It was, and still is, engaged in operating a railroad in interstate commerce. ISSUE PERTAINING TO PLAINTIFF’S ENTITLEMENT TO ADDITIONAL INTEREST DEDUCTIONS FOR 19 66 YIELDING A NET OPERATING LOSS CARRYBACK TO 19 64 2.

On March 31, 1933, plaintiff filed a petition in the United States District Court for the Eastern District of Missouri (hereinafter referred to as the “District Court”) stating that it was unable to meet its debts as they matured and that it desired to effect a plan of reorganization under

Section 77 of the Bankruptcy Act (11 U.S.C. §205). On or about the same date, similar petitions were filed in the District Court by the New Orleans, Texas & Mexico Railway Company (hereinafter referred to as “New Orleans”) ; by the International-Great Northern Railroad Company (hereinafter referred to as “International”); and by 22 other subsidiary railroad corporations in plaintiff’s railroad system. 3. Plaintiff owned about 94 percent of the common stock and all of the preferred stock of New Orleans. It also directly owned all of the stock of nine other subsidiary railroad companies.

New Orleans owned all of the stock of International, which it had pledged to plaintiff for advances, and also owned all of. the stock of 14 other subsidiary railroad companies. International in turn owned all of the stock of two other railroad companies. 4. From July 1, 1933 to March 1, 1956, plaintiff and its above-mentioned subsidiaries were parties to the reorganization proceedings and were operated by a trustee or trustees, appointed by the District Court. 5.

A final plan of reorganization, to be effective as of January 1, 1955, was approved by the Interstate Commerce Commission (hereinafter referred to as “ICC”) on July 29, 1954, and, with, some slight modifications, was again approved by the ICC on November 9, 1954. 6. On February 25, 1955, the District Court entered its findings of fact, conclusions of law and opinion approving the plan of reorganization (In re Missouri Pacific Railroad Co., 129 F. Supp. 392).

The District Court’s order was affirmed on appeal on September 14,1955, and rehearing was denied October 18, 1955 (Missouri Pacific Railroad Co. 5¼% S.S.B.C. v. Thompson, 225 F. 2d 761 (C.A. 8th)). Certiorari was denied January 30, 1956 (350 U.S. 959). 7. On September 19, 1955, the District Court entered a further order confirming the reorganization plan (In re Missouri Pacific Railroad Co., 135 F. Supp. 102). This order was affirmed by the Court of Appeals on February 28, 1956 (Missouri Pacific Railroad Co. v. Thompson, 229 F. 2d 898).

On March 1, 1956, the District Court entered its Consummation Order and Final Decree making the reorganization effective as of January 1,1955. 8. (

a) Under the modified plan of reorganization, Missouri Pacific remained in existence, and the properties of all of the subsidiaries, including those of New Orleans and International, were merged into Missouri Pacific as the surviving corporation and the new operating company. Under the plan, plaintiff’s (

a) old preferred stockholders exchanged their shares plus accumulated dividends for an equal stated value of plaintiff’s new Class A common stock; (

b) common stockholders exchanged their shares for a reduced number of plaintiff’s new Class B common stock; and (

c) old unsecured general creditors received equivalent face value of plaintiff’s new securities (in the form of mortgage bonds and debentures). Each class of the old security holders of plaintiff, New Orleans, and all but one class of International’s old bondholders, received cash plus new securities of plaintiff equivalent to the principal amount of the old obligations plus interest accrued to the plan’s effective date, January 1, 1955.

The holders of International’s old Adjustment Mortgage 6% Bonds received only $29,161,862 in face amount of plaintiff’s new securities and in stated value of plaintiff’s new stock in exchange for $34,105,019 in principal and interest accrued up to January 1, 1955. New Orleans’ old unsecured general creditors received equivalent face value in plaintiff’s new securities (bonds) while the public stockholders of New Orleans received plaintiff’s new securities (bonds) in a greater face value, i.e., $1,855,861, than the amount of their claims, which totaled $859,800.

International’s old unsecured general creditors and stockholders were not entitled to participate in the reorganization and received nothing for their respective claims and interests. (

b) As modified in the Consummation Decree, the old obligations of Missouri. Pacific and all the subsidiaries were satisfied as shown in the following schedule, which was set forth in the Plan submitted to the ICC for approval : [Note. — See table No. 1 facing tbis page.] (

c) The following

schedule shows the effect of the increase approved by the Bankruptcy Court on February 25, 1955, in the allocation of Series B and Series C first mortgage bonds issuable to Little Bock & Hot Springs Western Bail-way Company bondholders: [Note. — See table No. 2 facing tbis page.] 9. The Plan of Beorganization approved by the ICC and the District Court provided: B. Effective date. — The effective date of the plan shall be January 1, 1955.

Interest on the principal of all allowed claims shall be computed to the effective date, except in the case of the New Orleans, Texas & Mexico Bailway Company first-mortgage bonds as hereinafter provided.

New securities issuable hereunder, except the first-mortgage bonds, series A (or collateral-trust notes), hereinafter described, shall be dated as of the effective date or, in the discretion of the reorganization managers and with the approval of the court, any class of new securities may be dated as of the interest-adjustment date therefor, but in the latter case, creditors who re- ceive new securities of such class shall receive the same amounts of cash and be entitled to the same rights in respect of accruals and accumulations as if the new securities of such class had been dated as of the effective date.

The new first-mortgage bonds, series A (or collateral-trust notes), shall be dated as nearly as possible as of the date of consummation of the plan and in no event more than 6 months prior thereto. 10. The Consummation Order and Final Decree of the District Court dated March 1, 1956, provided: Interest on all new debt securities referred to below will accrue from January 1,1955, except (

a) First Mortgage 4%% Bonds issuable pursuant to the Plan to holders of Missouri Pacific Railroad Company First and Refunding 5% Bonds, on which interest will accrue from July 1, 1955, and (

b) Collateral Trust Notes, on which interest will accrue from March 1, 1956. 11. The provisions set forth in finding 10 were required in part by the fact that prior to the Consummation Decree, during the year 1955, plaintiff currently paid interest on the old First and Refunding 5% Bonds as follows: 12.Although the First Mortgage 414% Bonds issued to the holders of Missouri Pacific First and Refunding 5% Bonds were dated January 1, 1955, in order to effectuate the Consummation Decree that interest should accrue from July 1, 1955, the interest coupons for the first half of 1955 were detached.

However, an adjustment was made to conform with the Plan by allocating to the holders of such bonds additional cash equivalent to the additional amount due them had interest accrued on the new bonds from the effective date, J anuary 1,1955.

The report of the ICC authorizing the issuance of the new securities stated (9th Supplemental Beport of ICC. dated February 24, 1956, unpublished) : The plan provides that its effective date shall be January 1, 1955, which date shall determine the extent to which the claims of the present creditors shall be capitalized into new securities, except that in the case of the New Orleans, Texas & Mexico Bailway Company first-mortgage bonds, the interest thereon shall be computed to January 1, 1956; that new securities issuable under the plan, except the Series A first-mortgage bonds or collateral trust notes hereinafter described, shall be dated as of the effective date or, in the discretion of the reorganization managers and with the approval of the Court, any class of new securities may be dated as of the interest adjustment date therefor, but in the latter case, creditors who receive new securities of such class shall receive the same amounts of cash and be entitled to the same rights in respect of accruals and accumulations as if the new securities of such class had been dated as of the effective date.

A voucher was made out for the equivalent of 6 months interest on the 4%-percent bonds for the period from January 1 to June 30,1955, less credit for the interest paid on the old bonds at 5 percent during the period.

The additional cash so allocated by the Consummation Order and Final Decree to the holders of the old First and Befunding Mortgage 5 percent Bonds is shown as follows under the heading “Aggregate Allocation of Cash and New Securities”: OM Securities or Claims First and refunding mortgage 5% bonds: Cash Series A_ $304, 775 Series F_1, 216, 492 Series Q_ 114,583 Series H_ 218, 750 Series I_ 1, 044, 988 13.

The collateral trust notes with respect to which the Consummation Order provided that interest should accrue only from March 1, 1956, were issued in exchange for $40,-615,900 in First Mortgage bonds of New Orleans. Pursuant to District Court orders, interest had also been paid currently on many of these bonds during 1955 and through January 1956. Thus, the Consummation Order provided that interest should accrue on the collateral Trust Notes only from March 1, 1956.

However, as of March 1, 1956, unpaid and unmatured coupons on the old bonds totaling $701,560.40 remained as follows: First Mortgage Series A and B from October 1, 1955; Series C and D unpaid from February 1, 1956. Accordingly, the Consummation Order and Final Decree of March 1, 1956, setting forth the aggregate allocation of cash and new securities, provided for an allocation of cash in the sum of $701,560 to be made with respect to the New Orleans First Mortgage Bonds as follows: Old Securities or Claims New Orleans, Tesas & Mexico Railway Co.

First Mortgage Bonds: Cash 5y2% Series A_ .$361,395 5% Series B_ 298, 873 -.5% Series C_ 19,167 4%% Series D_22,125 Total_ 701, 560 14. Throughout both of the calendar years 1954 and 1955, as well as the first two calendar months of the year 1956, plaintiff, while in trusteeship, and its subsidiaries in trusteeship, including New Orleans and International, constituted a group of corporations affiliated within the meaning of and for.the purposes of

Chapter 6 of the Internal Revenue Code of 1954 and the applicable Treasury Regulations. All members of plaintiff’s affiliated group joined in a consolidated Federal income tax return which was timely filed with the District Director of Internal Revenue, St. Louis, Missouri, for the calendar years 1954, 1955, and 1956. The group’s consolidated return for the calendar years 1954 and 1955 was filed in the. parent’s name, i.e., Guy A. Thompson, Trustee, Missouri Pacific Railroad Company, Debtor, and for 1956 in the name- of. plaintiff as parent. 15.

Throughout the years 1942-56, inclusive, all members of plaintiff’s affiliated group, including plaintiff and plaintiff in trusteeship, maintained their respective corporate books of account in accordance with the rules of accounting prescribed by the ICC, which included the keeping of their accounts on a calendar year basis under the' accrual method of accounting, and during such period filed their respective Federal income tax returns and, where appropriate, their Federal excess profits tax returns, in conformity with the methods upon which their corporate books of account were maintained, i.e., the calendar year basis pursuant to the accrual method of accounting. 16.

On its 1954 consolidated income tax return, the Missouri Pacific affiliated group deducted accruals of interest totaling $22,797,595.32. This was duly allowed by the Commissioner on audit. Of the total interest so deducted and allowed, $2,006,972.65 arose with respect to indebtedness represented by outstanding equipment trust certificates and conditional sales agreements, neither of which class of debt was disturbed by the March 1, 1956, reorganization.

The total amount of interest expense accrued and paid by the Missouri Pacific affiliated group during 1954 on debts representing securities exchanged in the reorganization effective January 1, 1955, amounted to $23,812,899.01, but of this total, $1,015,303.69 constituted interest arising on interaffil-iate held debt and so washed itself out of the group’s consolidated Federal income tax return for 1954. 17. The 1955 consolidated income tax return of the Missouri Pacific affiliated group as adjusted on audit reflected taxable income of $8,075,248.67 and tax of $3,824,641.49.

In arriving at this income and tax, the taxpayer deducted accruals of interest totaling $22,934,637.72. This was duly allowed by the Commissioner on audit. Of the total interest so deducted and allowed, $2,166,981.78 arose with respect to indebtedness represented by outstanding equipment trust certificates and conditional sales agreements, neither of which class of debt was disturbed by the March 1, 1956, reorganization.

The total amount of interest obligations accrued by the Missouri Pacific affiliated group during 1955 on debts represented by securities exchanged in the reorganization effective January 1, 1955, but consummated March 1, 1956, amounted to $23,127,125.71, but of this total $192,487.99 constituted interest arising on interaffiliate held debt and so washed itself out of the group’s consolidated Federal income tax return for 1955.

A tabulation of such interest accruals and deductions is as follows: Throughout 1955 and through February 1956, on his monthly financial statements submitted to the District Court, the trustee who held custody of and operated the properties of Missouri Pacific, New Orleans and International, and their subsidiaries, reported the interest accruals as deductions from income, but in each instance he stated that the interest accrued was “not authorized for payment.” 18. On its 1956 consolidated income tax return the Missouri Pacific affiliated group deducted accruals of interest totaling $25,357,412.71.

This was duly allowed by the Commissioner on audit. Of the total interest so deducted and allowed, $2,333,782.44 arose with respect to indebtedness represented by outstanding equipment trust certificates and conditional sales agreements, neither of which class of debt was disturbed by the March 1, 1956, reorganization.

Of the interest deductions, $3,461,276.06 was attributable to the accrual of interest from January 1 through February 29, 1956, on debts represented by securities exchanged in the reorganization effective January 1, 1955, but consummated March 1, • 1956; while $19,562,354.21 arose with respect to interest on plaintiff’s debt for the period March 1, 1956 to December 31, 1956, inclusive, after the consummation of the reorganization. 19.

After the Consummation Decree, Missouri Pacific paid amounts equivalent to interest from January 1,1956 to February 29, 1956, to the holders of its new securities, debiting the payments to an account for Acquisition Adjustment as follows: *As described in finding 11, $1,843,210.42 was paid at various dates in 1955 to holders of old 1st and refunding mortgage bonds. Since the new first mortgage bonds exchanged for the old ones were dated Jan. 1, 1955, credit was taken for payments made on the old bonds for periods subsequent to Jan. 1, 1955.

A voucher issued in March 1956 covered: 6 months interest on new first mortgage bonds.$4,742,798.12 Less: Paid from Jan. 1, 1955, on old bonds- . 1,843,210.42 -- $2,899,587.70 Plaintiff contends (and defendant denies) that the interest paid in 1956 for the period from January 1, 1955 through February 29, 1956, to the holders of the new securities, and which was not deducted in plaintiff’s 1956 income tax return, is deductible from income for that year. 20.

On March 13 and September 7, 1958, iii response to requests from plaintiff and its Reorganization Managers, the Director of the Tax Rulings Division of the Internal Revenue Service ruled that the exchanges of securities were nontaxable transactions with respect to which neither gain nor loss would be recognized to the corporations and security holders under the Code, except to the extent of cash payments. The ruling of March 13 stated in part: (

a) Pursuant to the provisions of sections 354(a) (1) ,- 354(

c) and 356 (a) (1) of the Internal Revenue Code, any gain realized by the holders of First Mortgage Bonds, Series A, B, C and D, of New Orleans who elect to receive Collateral Trust Notes of Missouri Pacific and cash will be recognized in each case but in an amount not in excess of the cash received upon the consummation of the Plan. However, no losses will be recognized in such cases. The ruling of September 7 stated in part:

(1) The exchanges of old stocks and securities of Missouri Pacific for new stocks and securities of the said corporation constituted a recapitalization within the meaning of

section 868(a) (1) (

E) of the Internal Revenue Code of 1954 which resulted in no recognizable gain or loss to the corporation. 21. In response to a further request from plaintiff’s counsel, on March 28, 1957, the Director of the Tax Rulings Division notified plaintiff of the ruling that any payments of interest received by holders of old bonds prior to their acquisition of the new bonds on March 1,1956, would be regarded as interest income to them, but that: * * * any payments received on or after March 1, 1956, representing interest on the old bonds or new bonds accrued prior to March 1,1956, will be considered as money received in the exchange under

section 356(a) (1) of the 1954 Code, and therefore may affect the basis of the new securities under the provisions of

section 358. The gain, if any, recognized in the exchanges by reason of the provisions of

section 356 will constitute capital gain subject to the provisions and limitations of Subchapter P of

Chapter 1 of the Code. 22. Plaintiff’s affiliated group paid unrefunded Federal income taxes into the Treasury of the United States for the tax calendar year 1954, as follows: 23.Plaintiff timely filed a consolidated Federal income tax return on behalf of itself and all of the members of the Missouri Pacific affiliated group covering the entire tax calendar year 1956. Consolidated taxable income for 1956 as determined in the Eevenue Agent’s report dated December 29, 1958, totaled $10,651,801.22, which figure reflected a $25,-423.48 net operating loss carryover from prior years.

Apart from carryovers from prior years, plaintiff’s 1956 consolidated taxable income did not exceed $10,677,224.70. The allowance to plaintiff of a deduction in 1956 for the $24,892,-587.14 of interest claimed will wholly offset plaintiff’s otherwise consolidated taxable income for 1956. If such deduction is allowed as an operating loss carryback it is sufficient to offset all of the Missouri Pacific affiliated group’s otherwise taxable income for 1954. THE

SECTION 1341 ISSUE 24. During the tax calendar year 1954, plaintiff and various other land-grant members of the plaintiff’s affiliated group were required by action of the General Accounting Office (hereinafter referred to as the “GAO”) to refund to the Government the total sum of $790,904.65. This sum represented the amount by which the affected land-grant carriers were determined by the GAO to have overcharged the Government for transportation paid for during the calendar years 1942-46, inclusive.

These overcharges were included in their tax returns as income by the carriers in the earlier years when their respective rights to receive payment first accrued and a total tax of $526,122.06 was paid thereon. Such overcharges were attributable to the affected carriers’ failure properly to accord the Government the special land-grant rates to which the various shipments in question were ultimately determined to be entitled. 25.

Of the $790,904.65 repaid in 1954 by the Missouri Pacific affiliated group, $716,477.12 was recaptured by the GAO from Missouri Pacific itself, while the remaining $74,-427.53 was recouped from New Orleans and various of its affiliates which for the tax calendar years 1942-46, inclusive, joined in consolidated income and excess profits tax returns with their parent, New Orleans.

The earlier years in which the excessive charges had been returned as income were as follows: •Plus 4% of any reduction of income in 1946 by reason of the mandatory application of any unused excess profits tax credit carrybacks to 1944 from 1946. ♦Plus 4% of any reduction of income in 1942 by reason of the mandatory application of any unused excess profits tax credit carryovers to 1943 from earlier years. 26.

In the Missouri Pacific affiliated group’s consolidated Federal income tax return for the calendar year 1954, the entire $790,904.65 refunded to the Government iii 1954 was claimed, and, on audit, allowed as a deduction with a resulting tax benefit of 52 percent, or $411,270.42. The group’s consolidated taxable income for the calendar year. 1954 as finally determined by the Commissioner of Internal Keve-nue was $5,000,181.73.

For the purposes of this case, the parties have agreed that, apart from the deductions claimed in this lawsuit, the Missouri Pacific affiliated group’s consolidated taxable income for the calendar year 1954 was said sum of $5,000,181.73. 27. The parties have agreed that

Section 1341 of the Internal Bevenue Code of 1954, as amended by

Section 60 of the Technical Amendments Act of 1958, is mandatory in its operation so that these land-grant refunds made during 1954 by the land-grant members of the Missouri Pacific affiliated group must be taken as a deduction in 1954 or excluded from income in the earlier years returned, whichever treatment affords the group the greater tax benefit.

If plaintiff realized a net operating loss for 1956 sufficient in size to produce a net operating loss carryback to 1954 large enough to wipe out all of the consolidated taxable income returned for 1954 by the Missouri Pacific affiliated group, then plaintiff is entitled to a 1954 refund of the taxes paid in the earlier years 1942-46, inclusive.

If plaintiff is not entitled to a net operating loss for 1956 of the requisite amount, then the 1954 refund must be computed by treating only those land-grant refunds made in 1954 but applicable to the earlier years 1943, 1944, and 1945, as reductions of net income hi those earlier years, while the 1954 land-grant refunds applicable to the earlier years 1942 and 1946 will continue to constitute 1954 deductions as claimed in the return and as allowed on audit.

The effective combined income and excess profits tax rates applicable during each of the calendar years 1943-45, inclusive, to Missouri Pacific and to members of the New Orleans affiliated group were at least 72 percent, whereas the applicable rate of tax to the Missouri Pacific group’s taxable income in 1954 was only 52 percent, in contrast to the 38, 40, or 42 percent rate applicable in 1942 and 1946. 28.

Until it shall have been determined whether plaintiff is entitled in 1954 to a net operating loss carryback from 1956, and if so, the amount thereof, it is impossible to determine the amount of the refund due to plaintiff under the cause of action turning on the proper application of

Section 1341 of the Code, as amended by

Section 60 of the Technical Amendments Act of 1958, Public Law 85-866. 29. Refund claims covering the

Section 1341 issue and the issue pertaining to additional interest deductions for 1956 yielding a net operating loss carryback to 1954 were timely filed for the tax year 1954 by plaintiff on May 21,1959, with the District Director of Internal Revenue at St. Louis, Missouri. Both claims were formally rejected by the Commissioner of Internal Revenue by registered mail under date of November 20, 1959. This suit was timely filed on November 25,1959. Guy A. Thompson, as trustee, filed the group’s consolidated Federal income tax return for 1954 with the Collector of Internal Revenue at St.

Louis, Missouri, on September 15,1955, and thereafter plaintiff executed timely waivers of the statute of limitations controlling the time within which the Commissioner could make additional assessments, the last of such waivers expiring June 30,1960. 30. Plaintiff is the sole owner of the claims upon which recovery is sought, which claims relate to plaintiff’s right to recover for the tax calendar year 1954. 31.

With the approval of the commissioner, the parties have stipulated, pursuant to the provisions of Rule 38(c), that if plaintiff is entitled to recover, the amount of the recovery may be determined in further proceedings.

CONCLUSION OF LAW Upon the foregoing findings of fact, which are made a part of the judgment herein, the court concludes as a matter of law that plaintiff is entitled to recover, and judgment will be entered to that effect on plaintiff’s entitlement to a deduction in 1956 for interest paid on its new securities for the period January 1, 1955, to February 29, 1956, to the extent that it is in excess of the 'amounts of interest originally accrued under the preexisting securities for this period. The amount of recovery will be determined pursuant to Rule 47(c) (2) of the Rules of this court.

In accordance with the opinion of the court and a memorandum report of the commissioner as to the amount due thereunder, it was ordered on December 18, 1964, that judgment for the plaintiff be entered for $131,034.08 as a refund of income tax for its tax calendar year 1954, and $26,617.74 as a refund of deficiency interest, making a total of $157,651.82, together with interest as provided by law on $157,651.82.

Section 163, in pertinent part, provides as follows : Ҥ 163. Interest (

a) General Hule. There shall be allowed as a deduction all interest paid or accrued within the taxable year on indebtedness.” A second issue involves certain - land-grant repayments to the United States made by the land-grant members of the Missouri Pacific affiliated groups. The parties have agreed that

section 1341 of the Internal Revenue Code of 1954, as amended by

section 60 of the Téchnical Amendments Act of 1958, 72 Stat. 1606, 1647, is mandatory in Its operation so that these repayments made during 1954 must be taken as a deduction in 1954 or excluded from income in the earlier years returned, whichever treatment affords the group the greater tax benefit. The parties have further agreed that plaintiff’s rights to a tax refund for 1954 under

section 1341 shall be determined under Rule 38(c), now Rule 47(c)(2), proceedings, since the amount of plaintiff’s recovery under that claim is dependent on the issue we are called on to decide. 11 u.S.C. § 205 (1958 Ed.). This plan was again approved with some slight modifications by the I.C.C. on November 9, 1954. On February 25, 1955, the Bankruptcy Court entered an order approving the plan (In re Missouri Pacific Railroad Co., 129 F. Supp. 392 (E.D. Mo.)), and this order was affirmed on appeal on September 14, 1955 (Missouri Pacific Railroad Co. S. S.S.B.C. v. Thompson, 225 F. 2d 761 (8th Cir).

Certiorari was denied January 30, 1956 (350 U.S. 959). On September 19, 1955, the District Court entered a further order confirming the reorganization plan (In re Missouri Pacific Railroad Co., 135 F. Supp. 102 (E.D. Mo.)). This Oder was affirmed by the Court of Appeals on February 28, 1956 (Missouri Pacific Railroad Co. v. Thompson, 229 F. 2d 898 (8th Cir.)). The Natchez & Southern Railway Co., a wholly owned subsidiary of the taxpayer, was the exception.

The Internal Revenue Service, through the Director of the Tax’ Rulings Division, in a series of rulings issued in 1956, held, in response to requests filed by taxpayer and its reorganization manager, that the various exchanges which took place upon the March 1, 1956 consummation of taxpayer’s reorganization were tax free within the meaning of

section 368(a)(1)(

E) as a recapitalization.

Throughout 1955 and through February 1956, on his monthly financial statements submitted to the District Court, the trustee who held custody of and operated the properties of taxpayer’s affiliated group, reported the interest accruals as deductions from income, but in each instance he stated that the interest accrued was “not authorized for payment.” Interest on First Mortgage 4% % Bonds issued to holders of taxpayer’s First and Refunding 5% Bonds accrued from July 1, 1955, and interest on Collateral Trust Notes received by holders of New Orleans First Mortgage Bonds accrued from March 1, 1956.

These exceptions were made as some interest was actually paid during 1955 on the old obligations which these securities were issued to replace. Supra, footnote 9. 174 F. 2d 255 (3d Cir.), aff’d per curiam 338 U.S. 883 (1949). Old Colony Railroad Co. v. Commissioner, 284 U.S. 552, 560 (1932). Nor are we persuaded by taxpayer’s argument that as a result of the reorganization a new and separate debt arose since the new securities had a different rate of interest, maturity date, identity of the obligor, and assets pledged as collateral therefor.

These factors relate to the form of the evidence, of indebtedness and do not affect the amount of “outstanding indebtedness.” Except that of the Natchez & Southern Railway Company which was a wholly owned subsidiary of plaintiff.