Court Opinion

ID: 4593546
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:11:02.620276+00
Date Added: 2024-06-11T07:51:05.059400
License: Public Domain

PANHANDLE REFINING COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Panhandle Refining Co. v. CommissionerDocket No. 103637.United States Board of Tax Appeals45 B.T.A. 651; 1941 BTA LEXIS 1084; November 12, 1941, Promulgated 1941 BTA LEXIS 1084">*1084  The petitioner, an operating company, and its parent company were both upon the accrual basis of accounting.  Petitioner in the taxable years accrued on its books large amounts of interest on indebtedness to the parent company, including interest accrued in past years and added to principal.  Although heavily indebted to the parent, in amounts greater than the value of its assets, the petitioner had assets of several million dollars, was actually engaged on a large scale in the production, refining, and marketing of crude oil, and is endeavoring to make money to pay the indebtedness.  Held, that the Commissioner erred in denying deduction of the interest accrued.  Harry C. Weeks, Esq., and R. B. Cannon, Esq., for the petitioner.  John E. Marshall, Esq., the respondent.  DISNEY45 B.T.A. 651">*651  This proceeding involves income tax for the year 1936 in the amount of $12,439.18, and for 1937 in the amount of $40,263.39, in which amounts deficiencies were determined by the Commissioner.  The principal question presented is whether petitioner properly deducted certain amounts in each year as interest accrued upon indebtedness.  From evidence adduced we1941 BTA LEXIS 1084">*1085  make the following findings of fact.  FINDINGS OF FACT.  1.  The petitioner, Panhandle Refining Co., was organized under the laws of Texas in 1916.  In 1919 the Panhandle Producing & Refining Co., a Delaware corporation, was organized as a holding company to hold the stock of the petitioner and other properties taken into the company at that time.  Since that date the Panhandle Producing & Refining Co., hereinafter referred to as the parent company, has owned 45 B.T.A. 651">*652  all of the stock of petitioner, hereinafter referred to as the subsidiary.  The books of both companies have always been kept upon the accrual basis and their Federal income tax returns made and accepted upon the accrual basis.  The income tax returns of the petitioner for the taxable years were filed with the collector for the second collection district of Texas.  2.  The petitioner is an operating company engaged in the business of producing, refining, and marketing oil.  During the taxable years it owned two refineries, one of them of a capacity of approximately 3,700 or 3,800 barrels a day, the other of a capacity of approximately 1,200 barrels a day.  The larger refinery was a complete refining unit, except1941 BTA LEXIS 1084">*1086  that it did not make lubricating oil.  The petitioner also operated under lease another refinery, the capacity of which is not shown in the record.  It owned oil and gas leases, both drilled and undrilled, including a half interest in one group of leases of about 8,500 acres upon which there were approximately 85 to 90 producing wells, and recoverable reserves, as to petitioner's interest, estimated in 1937 at slightly more than 4,000,000 barrels of oil.  It produced oil from its leases and marketed its products, including gasoline, at the refineries and through wholeasale plants and retail plants.  This in general has been the situation as to its business since its inception.  At the end of the taxable year 1936 the petitioner as to quick assets was in close circumstances, but had properties of a book value of $2,103,908.01, and an actual value of approximately $4,000,000.  The value thereof increased in 1937.  Conditions were better in 1937, and the properties were at the time of the hearing in still better condition and of greater value.  Proration, with a limit of production per well, had been in effect for many years.  Petitioner's liabilities, other than to the parent company, 1941 BTA LEXIS 1084">*1087  and its reserves were $884,053.18 on December 31, 1935, $875,982.01 on December 31, 1936, and $1,025,794.85 on December 31, 1937.  Petitioner's gross business increased from about $3,200,000 in 1936 to about $3,690,000 in 1937.  Production had increased about 100 barrels per day.  At the end of 1935 the petitioner had a book deficit of $4,667,381.67; at the end of 1936 it had a book deficit of $4,619,379.03; and at the close of 1937 its book deficit was $4,480,690.99.  At the same respective dates the balances due from petitioner to its parent company were respectively $5,675,314.65, $5,826,235.89, and $6,190,371.38.  A large deficit at the beginning of 1935 was caused by material losses which had just been suffered; also earlier losses about 1922-1923.  3.  The parent company had from 1919 on made advances or loans to the petitioner as follows: In 1919 a loan of $2,250,000 and a sale upon credit of a lease for $1,300,000; in 1920 a sale upon credit to petitioner for $732,123.57 and a loan of $79,560.99.  After 1920 a large number of other advances were made by the parent to the subsidiary, resulting in the indebtedness of the petitioner to the parent company 45 B.T.A. 651">*653  in the amounts1941 BTA LEXIS 1084">*1088  above shown, in the taxable years here involved.  The account with the parent company was always recognized by petitioner as a debt and liability.  The advancements from and including 1919 up to and including 1925 consisted of two or three items each year, but thereafter they were made practically monthly.  The advancements were on open account, made by an executive committee of the parent company under the authority of a resolution of the board of directors on October 21, 1919, authorizing the officers of the company "to lend to Panhandle Refining Company such an amount of the funds of the Company as are necessary for the business of Panhandle Refining Company, in the judgment of the Executive Committee, to be hereafter appointed." Payments were made by the subsidiary to or for the account of the parent in large amounts each year, such payments from and including 1919 to the close of 1937 making a total of $3,546,155.96.  During the same period interest accrued on the petitioner's books totaled $4,360,942.29.  On the books of the subsidiary the advancements, and the repayments, appear as cash, except items otherwise explained on the books.  No payment to the parent is explained1941 BTA LEXIS 1084">*1089  on the petitioner's books as for interest, and no voucher with reference to such payments for 1936 and 1937 shows interest.  The vouchers represent payment on account, the petitioner having only one account, consisting of interest and other items.  Petitioner paid the parent company $20,377.53 during 1936 and $16,217.18 during 1937.  4.  Interest was accrued on the subsidiary's books throughout 1936 and 1937, and for several years prior thereto, upon monthly balances, at 8 percent in the earlier years and at 6 percent thereafter, except that in 1933, 1934, and 1935 no interest was recorded on petitioner's books, and in 1936 it was accrued at the rate of 3 percent.  At the end of each year the total interest accrued for the year was added to the previous amounts owing to form a balance due upon which interest was calculated, in connection with monthly balances during the succeeding year.  The accrual of interest upon monthly balances was done under the instructions of the board of directors of the petitioner.  For the year 1936 the authority was a directors' resolution adopted December 28, 1936, to the effect: That the parent company had requested the subsidiary to resume the accrual1941 BTA LEXIS 1084">*1090  of interest on its indebtedness to the parent from January 1, 1936, and that the parent be furnished a recognition of the obligation calculated at 3 percent throughout 1936; that it was therefore resolved that interest at 3 percent be accrued monthly upon the books, and appropriate entries evidencing the indebtedness for the interest so calculated; and that the officers be authorized and directed to make payments upon such indebtedness and interest when funds were available and to fix the rate of 45 B.T.A. 651">*654  interest for subsequent years by agreement with the parent company.  On December 30, 1937, the directors of the subsidiary company at a meeting discussed the matter of interest payable to the parent company on advances made by it.  The minutes recite that by agreement the rate of interest had already been fixed at 6 percent; and the acts of the officers in agreeing to pay 6 percent interest on such advances were ratified and adopted.  The amount accrued as interest on petitioner's books was $170,047.78 in 1936 and $349,523.42 in 1937.  5.  The petitioner in its Federal income tax returns for 1936 and 1937 claimed deductions for interest in the above amounts of $170,047.78 and1941 BTA LEXIS 1084">*1091  $349,523.42, respectively.  The deductions claimed were disallowed, with an explanation in each deficiency notice "that it has not been shown that there was any liability or intention to pay interest on the advances made by the Panhandle Producing & Refining Company." The parent company in its returns for the year 1936 included in its income the $170,047.78 and in its return for 1937 the $349,523.42, and in each of the two years deducted as a bad debt part of the account of the petitioner, in excess of the amount of interest accrued by it, the amount so deducted being $400,000 for 1936 and $500,000 for 1937.  The Commissioner disallowed the bad debt deductions with the explanation that the bad debt deductions "represent but arbitrary writedowns of advances to the Panhandle Refining Company which, if liabilities, became uncollectible in prior years", and excluded the amounts of $170,047.78 and $349,523.42 from the parent's income with the explanation that "the Panhandle Refining Company was insolvent and unable to pay said amounts and that it has not been shown that such was a liability of the Panhandle Refining Company." The Commissioner's statement showed a loss, and no taxable in1941 BTA LEXIS 1084">*1092  come to the parent company for 1936, after the adjustments made by him for interest and bad debt.  The petitioner is endeavoring to make money to pay the indebtedness and the prospects are growing better that the parent company will receive its money back.  OPINION.  DISNEY: The question for our determination here is whether amounts accrued on its books by the petitioner, which is on the accrual basis of accounting, as interest for 1936 and 1937 constitute allowable deductions under section 23(b), Revenue Act of 1936. 1 The petitioner contends that the situation is squarely covered by the statute.  The deductions 45 B.T.A. 651">*655  when claimed on the returns for the taxable years were disallowed, with the explanation that it had not been shown that there was any liability or intention to pay interest on the advances made by petitioner's parent company to it.  Upon brief the respondent's position is in substance that the parent company was holder of 100 percent of the stock of the subsidiary; that no actual payment of interest was ever proven; that the parent company charged off as a partial bad debt deduction a part of the principal upon which the petitioner calculated the interest1941 BTA LEXIS 1084">*1093  in each of the taxable years, and that the parent included in its income the interest accrued by the petitioner, both of which deductions by the parent were disallowed by the respondent; that the interest accrued in past years having been at the end of the year added to principal upon which interest was calculated for the succeeding year, the amounts now claimed as deductions by the petitioner constitute compound interest and are therefore not allowable.  The parties seem to agree that there was indebtedness from the petitioner to its parent, that extensive payments were made thereon during prior years and in small amounts in the taxable years, and that there was agreement to pay interest thereon, 1941 BTA LEXIS 1084">*1094  although the loans and advancements were on open account.  Is the petitioner entitled to accrue the amounts in question?  Petitioner contends in effect that the respondent denies the deduction of interest because of the bad financial condition of the petitioner and that so to do would be to add an element which does not appear in the statute.  Although the respondent suggests that the subsidiary and the parent company were not dealing at arm's length, it is not suggested that the corporate entity of the two corporations should not be recognized.  The entities appear to have been recognized throughout by the Commissioner.  We therefore do not consider it important to the question at hand that we have here a transaction between parent and subsidiary.  Nor does it appear to us controlling that the parent during the taxable years had charged off $400,000 in 1936 and $500,000 in 1937 as partial bad debt deductions.  The amounts in comparison with the total amount of the debt represent only a small fraction of the whole.  The question before us is whether the subsidiary comes within the statute as to deducting accrued interest.  Likewise, we are of the opinion that the fact of addition1941 BTA LEXIS 1084">*1095  of accrued interest in prior years to principal so that in the taxable years the amounts accrued are calculated to some extent upon an indebtedness including past interest, does not deprive the petitioner of the benefits of section 23(b), Revenue Act of 1936, giving it a right to the allowance of deduction of interest accrued upon indebtedness.  In our opinion the fact that there has been some compounding of interest does not mean that the deductions here claimed are not interest in the sense that they constitute compensation 45 B.T.A. 651">*656  for the use of money.  Petitioner had the use of the parent company's money and recognized and accrued on its books its liability therefor at a rate required both by its records and by the law of Texas.  We find nothing in ; Deputy v. du ; ; or , to indicate that the petitioner herein was not accruing interest within the meaning of the statute. Agnes I. Fox did not involve interest paid upon interest which had been added to principal, 1941 BTA LEXIS 1084">*1096  the question there being whether the petitioner could claim deduction as interest of amounts which had been interest but had been added to the principal by the creditor.  Here there is involved only the amount accrued in the taxable years, upon the indebtedness existing at the beginning of such years.  We think that the prime question here is the one suggested in the deficiency notice to the parent company, and the revenue agent's report upon which the deficiency herein was based, that is, whether the petitioner may be deprived of the deduction of accrued interest because of its precarious financial condition and the possibility, which in no event can be said to be more than a probability, and is obviously not a certainty, that the petitioner will never be able to pay such interest.  We agree with the petitioner that so to hold would be to add to the statute.  Though long in a bad financial condition, petitioner owned property of a value of several million dollars, was widely engaged in business, and had a large income from producing and refining of oil.  It was endeavoring to pay the interest.  We may well take judicial notice of the fact that the oil business is subject to great1941 BTA LEXIS 1084">*1097  variation and that petitioner's extensive properties, which were more valuable in 1937 than in 1936 (although it is true that its net debt to the parent had increased), might become sufficient to pay interest and principal.  We find ourselves unable to conclude from the record before us that interest should not be accrued upon the petitioner's indebtedness.  Ours is but to construe the statute, not to add to it.  That the creditor is not required to accrue items about which there is strong contingency as to payment, does not, we think, indicate that the debtor is not entitled to and required to accrue interest items in the year when they constitute a liability, notwithstanding the fact that the debtor's assets may not prove sufficient to discharge such liability accrued.  Obviously, the accrual is not allowable in any other year.  We conclude and hold that the petitioner was entitled to deduct the items accrued as interest in the taxable years.  It is unnecessary in the light of this conclusion to discuss the payments actually made within the taxable years.  Reviewed by the Board.  Decision will be entered under Rule 50.SMITH, TURNER, MELLOTT, and OPPER dissent.  Footnotes1. SEC. 23.  DEDUCTIONS FROM GROSS INCOME.  In computing net income there shall be allowed as deductions: * * * (b) INTEREST. - All interest paid or accrued within the taxable year on indebtedness, except on indebtedness incurred or continued to purchase or carry obligations (other than obligations of the United States issued after September 24, 1917, and originally subscribed for by the taxpayer) the interest upon which is wholly exempt from the taxes imposed by this title. ↩