
    ROBERT P. K. HORST AND HARRY H. WIGGINS, AS EXECUTORS OF THE LAST WILL AND TESTAMENT OF PAUL R. G. HORST, AND ROBERT P. K. HORST, AS EXECUTOR OF THE LAST WILL AND TESTAMENT OF ANNA C. HORST v. THE UNITED STATES ROBERT P. K. HORST AND HARRY H. WIGGINS, AS EXECUTORS OF THE LAST WILL AND TESTAMENT OF PAUL R. G. HORST v. THE UNITED STATES
    No. 300-61
    No. 117-62
    [Decided May 15, 1964]
    
      
      Harman Hawkins for plaintiff. Duer, Strong <& Whitehead were on the briefs.
    
      S. Lawrence Shaiman, with whom was Assistcmt Attorney General Loms F. Oberdorfer, for defendant. Edward S. Smith, Lyle M. Turner, and Philip B. Miller were on the brief.
    Before Jones, Chief Judge, Whitaker, Laramore, Dureee and Davis, Judges.
    
   Davis, Judge,

delivered the opinion of the court:

These companion income tax cases call upon us to construe and apply the war loss provisions of the 1939 and 1954 Internal Revenue Codes. Under Section 127 of the 1939 Code (carried over into Sections 1331-1336 of the 1954 Code), property owned by Americans in enemy countries (including interests in such property represented by securities) was deemed to be destroyed or lost upon the declaration of war— without regard to the possible return of the property, or an award of compensation, at the war’s end. The taxpayer could immediately take a war loss deduction for such enemy-held property to the extent the deduction would do him any good. The entire property was thereafter deemed, until recovered, non-existent for all income tax purposes (whether or not a war loss deduction was taken); it was treated as if the taxpayer no longer had any interest in it. Shahmoon v. Commissioner, 185 F. 2d 384 (C.A. 2, 1950) (no depreciation allowed after war loss deduction); Kenmore v. Commissioner, 205 F. 2d 90 (C.A. 2, 1953) (no fire loss allowed); Weinmann v. United States, 278 F. 2d 474 (C.A. 2, 1960); Wyman v. United States, 143 Ct. Cl. 846, 166 F. Supp. 766 (1958); Dix v. Commissioner, 34 T.C. 837, 841 (1960). During the time of loss there was a complete void; the statute “is to be read as though the property had ceased to exist during the period of enemy occupation.” Kenmore, supra, 205 F. 2d at 92. After the close of hostilities, however, it was anticipated that there could be a recovery of the war loss through repossession of the lost property or its equivalent; the Code covers the incidents and operation of such a recovery. The basis of property recovered “in respect of” war-lost property is expressly established as “an amount equal to the fair market value of such property, determined as of the date of recovery.” The recovery must be used in computing gain (in the year of recovery) but there is no taxable income until the taxpayer’s total war loss recovery exceeds his unused war loss (that part of the potential war loss deduction which did not result in a tax benefit). The part of that excess which is equivalent to the amount used for a tax benefit at the time of the war loss deduction is then taxed as ordinary income; the remainder is handled as gain from an involuntary conversion (taxed at capital gain rates, if at all).

When this country entered World War II in December 1941, Paul R. G. Horst (whom we shall designate the taxpayer) owned a sizeable amount of Japanese and Italian bonds. Under the Code’s war loss provisions, his total loss on those bonds was $746,459.25 but, since his 1941 income was much smaller, he received a tax benefit from only a minor part ($99,923.22) of this total; his “unused war loss” amounted to the difference ($646,536.03). After the war, he had a war loss recovery, it is agreed, in 1947 “in respect of” his Italian bonds (not now involved), and in 1950 for his Japanese bonds. The total basis of the property included in these recoveries was $425,891.94. Since this was considerably less than his unused war loss, he was not required to pay a tax on the recovery.

The recovery “in respect of” the Japanese bonds occurred in November 1950 when trading restrictions on those securities were lifted and trading recommenced after almost a decade. At that time, the bonds, on which no interest had .been paid since 1941, were traded flat, i.e., the quoted price included both principal and accrued but unpaid interest. This combined market value amounted, in November 1950, to $251,146.25. As we have pointed out, this sum, taken together with the earlier recovery on the Italian bonds, was considerably less than the taxpayer’s unused war loss for 1941.

Service on the Japanese instruments was not resumed until after December 22, 1952, when the Japanese Government (which had taken over all the obligations) offered to extend for ten years the maturity date on each bond, as well as on each accrued but unpaid interest coupon; the extended coupons were to be detached and treated separately from their bonds. This taxpayer accepted the offer and received extended bonds and interest coupons. Later, as the coupons which were matured but unpaid in November 1950 were honored (in 1952-1959), he reported these payments as ordinary income in the years of receipt. He also paid income tax on the coupons (and other interest obligations) which had not yet accrued by November 1950.

In the present suits, the plaintiffs seek refunds of the taxes collected on the payments of the accrued but unpaid coupons (but not of the taxes paid on the interest accruing after November 1950). The taxpayer’s position is that, under the war loss statute and the accepted rule relating to the acquisition of bonds flat, these late payments were returns of capital, not taxable income. Defendant insists that the interest payments were necessarily income by their very nature.

This question cannot be properly decided, in our view, by resting on unanchored general principles tied to the ordinary status of interest payments, while at the same time disregarding the special tax scheme established by Congress, first under the 1939 Code and then re-adopted in the 1954 Code, for World War II losses. That self-contained system is decisive; our problem must be solved within the circle of its detailed requirements.

In that special statute, Congress directed that, for federal income tax purposes, taxpayer’s Japanese bonds be “considered as destroyed or seized” in 1941; as the cases (cited supra) uniformly hold, the war loss provisions demand that, whatever the law of contracts or of negotiable instruments may say, we must act as if thereafter he had no such property until 1950. When in that year he had a war loss recovery “in respect of” his lost property, the bonds were being traded flat and their market value included the worth of the defaulted interest coupons. The statute specifically declares that taxpayer’s basis for the recovered property is “the fair market value of such property, determined as of the date of recovery.” This new value, including the unseparated portion attributable to the accrued but unpaid interest, was utilized in computing the taxpayer’s income for 1950, but he did not have to pay any tax thereon because his total war loss exceeded his total recovery. Nevertheless, the recovery was taken into account, and had to be taken into account, in determining his taxable income. Having thus passed through the income tax strainer, the bonds became capital assets, with a single basis reflecting both principal and defaulted interest (because that is what the “fair market value” of the property embraced on the recovery date). Under one of the fundamental principles of income taxation, the taxpayer is entitled to a full return of this basis before being taxed on any gain. It is also settled that those who purchase, flat, bonds with defaulted interest coupons are not required to treat later interest payments as ordinary income; the payments are but partial returns of the investment in the securities. Campbell v. Sailer, 224 F. 2d 641 (C.A. 5, 1955); National City Lines, Inc. v. United States, 197 F. 2d 754, 756, 757 (C.A. 3, 1952); Clyde C. Pierce Corp. v. Commissioner, 120 F. 2d 206 (C.A. 5, 1941); Rickaby v. Commissioner, 27 T.C. 886 (1957) (acq. 1960-2 C.B. 6). See, also, United States v. Langston, 308 F. 2d 729, 730-31 (C.A. 5, 1962); Jaglom v. Commissioner, 303 F. 2d 847, 849-50 (C.A. 2, 1962); McDonald v. Commissioner, 217 F. 2d 475, 476 (C.A. 6, 1954). Similarly, this taxpayer’s acquisition of the bonds flat in 1950 (via the war-loss-recovery statute) entitles him to recover, free of tax, the capital which became his in that year, under the special system Congress established.

We see no sufficient reason why the well-entrenched flat purchase rule should be avoided here. The taxpayer was not a purchaser, and he did not buy the bonds in 1950. By force of the statute, however, he was a “war loss recoverer” who has to be treated as if he had newly acquired the property at its fair market value in 1950. The theory of the flat purchase rule — that one who receives a bond along with accrued but unpaid interest obtains a single piece of property, not part capital and part income — fits squarely with this statutory acquisition Congress created for a war loss re-coverer. The defendant counters that the rule’s true rationale is that the later payment to the purchaser of preexisting defaulted interest is not a payment for the use of Ms money but merely satisfaction of an obligation already owing at the time he bought the bond; on the other hand, the like payments here, it is said, were for the use of taxpayer’s money (lent to the Japanese before the war) and must therefore be deemed income. This argument turns its back on the war loss statute which erases, for tax purposes, the taxpayer’s prior property and transactions, once he has a war loss; from then until the time of recovery there is, in effect, a vacuum for the world of the income tax; as of the recovery, the recoverer is placed in the same position taxwise as the purchaser of bonds flat — the accrued interest is an obligation owing at the time he acquires or re-acquires the bonds. There is no relevant distinction between the purchaser of bonds flat and the war loss recoverer.

The force of the special statute likewise undermines the defendant’s related arguments. When the taxpayer deducted his war loss on the Japanese bonds in 1941, he properly deducted only the cost of the bonds, and not the subsequently accruing interest for the period 1942-1952; it is urged, therefore, that not only did the flat bonds of 1950 cover more than the property lost in 1941 but also that the part of the 1950 cost attributable to the defaulted interest necessarily represented something not lost at all in 1941. The answer is that the statute contemplates the recovery of property other than the precise war-lost items when it refers to property recovered “in respect of” property considered as destroyed or seized. A farm with substantial new improvements, added since the loss, would be recovered “in respect of” the old war-lost farm. The flat bonds are not dissimilar. The whole value of those instruments, principal plus accrued interest, represented the “property recovered in respect of property considered as destroyed or seized” — just as with the enhanced value of the improved farm. The former property carries along, and incorporates, its integral increments. Nor is it material that, in our situation, there is no one who will pay an income tax on the accrued interest if the taxpayer is now relieved. The war loss statute, as we have explained, provides its own separate method for taxing recoveries. The recovery in 1950 had to be taken into account in determining the taxpayer’s income tax for that year. In this instance, the formula provided by the statute happened to require no tax — because of the magnitude of the total war loss as compared to the useable deduction allowed for 1941 — but the legal situation would certainly be no different if the taxpayer had had to pay a tax on the defaulted interest at the time of recovery. In any event, the applicability of the flat purchase rule cannot depend on the existence of another party available to pay a tax on the “interest.” A purchaser otherwise free of income tax on the interest, under the rule, would not become liable because his particular vendor happened to be exempt from the income tax a diplomat or a nonprofit institution) or turned out to have large counterbalancing deductions.

Still another defense is that payment of the pre-1950 interest coupons cannot be held part of a capital transaction (giving rise to capital gain once basis has been returned) because there is no “sale or exchange.” It is implicit in what we have said that one answer lies in the special war loss statute which both treats a war loss recoverer as newly acquiring the property and also instructs him to take the recovery into account in computing his income tax. A separate reply is given by Section 117 (f) of the 1939 Code:

For the purposes of this chapter, amounts received by the holder upon the retirement of bonds, debentures, notes, or certificates or other evidences of indebtedness issued by any corporation (including those issued by a government or political subdivision thereof), with interest coupons or in registered form, shall be considered as amounts received in exchange therefor.

This provision applies to the payment of accrued but defaulted interest on coupon bonds, as well as to principal, even though the taxpayer’s basis has already been recovered. Campbell v. Sailer, supra, 224 F. 2d 641, 643 (C.A. 5, 1955); Rickaby v. Commissioner, supra, 27 T.C. 886 (1957) (acq. 1960-2 C.B. 6); Rev. Rul. 60-284, 1960-2 C.B. 464. Through Section 117 (f), any requirement that there be an “exchange” is met.

Although on its surface Shafer v. United States, 204 F. Supp. 473 (S.D. Ohio, 1962), aff'd on opinion below, 312 F. 2d 747 (C.A. 6, 1963), may appear to, support defendant, in actuality it does not. The plaintiffs point out that Shafer, unlike Horst, had elected to revert to his pre-war-loss cost basis (see footnote 3, supra). That 1941 basis obviously did not reflect the subsequent defaulted interest; accordingly, when the after-accruing interest was belatedly paid, Shafer received income, not a return of his basis. This taxpayer, on the other hand, accepted the later date-of-recovery for his basis, and he is therefore entitled under the statute to recover the already-accrued interest reflected in that basis.

It follows, we think, that faithful adherence to the terms and implications of the war loss statute allows this taxpayer to treat the payments of the disputed defaulted interest as a return of capital and, once his basis was recovered, as capital gain, not ordinary income. That is what Congress has directed in enacting and re-enacting the legislation.

The parties are agreed, and we so hold, that for the three years involved in No. 117-62, the taxpayer was entitled to an exemption of $600 (for his non-resident alien wife) which he failed to take in his returns.

Plaintiffs are entitled to recover in both cases. The amount of recovery will be determined under Rule 47 (c) (2).

Whitaker, Judge,

dissenting:

I have great respect for my brethren on this court, for their learning in the law, for their impartiality, for their judicial acumen, but, after all, in common with all mankind, they are not infallible, as I think the majority opinion demonstrates.

I disagree with the opening sentence of the majority opinion: I do not think the war loss provisions of the 1939 and 1954 Internal Revenue Codes have anything to do with this case. What we are concerned with here is not the debt owed plaintiffs at the outbreak of the war, but the interest that accumulated on that debt during the war. The war loss provisions were not concerned with this interest. These provisions permitted a deduction of the debt as it existed at the outbreak of war and prescribed how, after the war was over, taxable income should be computed on any recovery of the debt deducted. It had nothing to say of income accrued in the interim and paid after the war.

So long as the war lasted there were, of course, no payments of interest on the bonds owned by plaintiffs nor any payments of principal thereon, but, of course, the taxpayers continued to hold them until the war was over, although, for income tax purposes, they deducted from their income a portion of the cost of the bonds, as securities on property seized or destroyed by the enemy, as they were entitled to do under section 127 of the Internal Eevenue Code of 1939.

During the war there was no trading in these bonds, but in 1948 trading in the Italian bonds was resumed, and in 1950 trading in the Japanese bonds was resumed. To each of the Japanese bonds there were attached coupons for interest. Of course, none of those that had matured during the war had been paid when trading was resumed, but later they were honored and paid.

The taxpayers included the amount paid on the coupons in default in their income tax returns for the years in which payments were received, as ordinary income. Later, however, they filed claims for refund on the theory that the amounts received were not ordinary income nor were they income at all, but a return of capital.

The issue is a very simple one under the facts of this case. It is simply a case of a creditor holding bonds on which the debtor defaulted but which he later honored and redeemed. When default on the Japanese bonds occurred, the creditor could take no action against the debtor; he could only hold them and hope they would be honored later, in whole or in part. This is just what happened. They were honored later and the coupons in default were paid in full.

As the case has been stated, there can be no doubt that the payments on the defaulted coupons were payments of interest and returnable 'as ordinary income.

The fact that the taxpayers deducted from their income a portion of the cost of the bonds, for income tax purposes, makes no difference. This was vis a vis the taxpayers and the United States Government; it had no effect on the creditor-debtor relationship. The debtor was still liable on the bonds and on the coupons 'attached to them according to the tenor of them and remained so liable, except that, by agreement after the war, the time for payment of them was extended for 10 years. Hence, when a defaulted coupon was paid, interest on the bonds was paid exactly as if it had been paid when the coupon matured, and in each case the taxpayers are required to report the interest received as ordinary income.

The case becomes complicated only when taxpayers seek to have their liability determined as if they had purchased the bonds on the date trading in them was resumed. This is the injection of a hypothesis contrary to the facts in this case. Taxpayers did not purchase their bonds; they already had them, and their liability must be determined on this basis. The war loss provisions treated the bonds as having been destroyed only for the purpose of the tax deduction and the computation of income resulting from the recovery upon them. The Congress knew taxpayers would hold on to their bonds and that interest would accrue in the interim, but as to this interest, no change in the law was made. Everyone, I assume, would agree that under the law prior to the enactment of war loss provisions, taxpayers would be taxable on the income on the bonds when they received it.

What taxpayers are seeking to do in this case is to convert what was interest before the war into principal after the war. This cannot be done, as was held by the District Court for the Southern District of Ohio and the Court of Appeals of the 6th Circuit in Shafer v. United States, 204 F. Supp. 473 (1962), aff'd 312 F. 2d 747 (1963). That case also involved coupons on Japanese bonds in default during the war, but later honored and paid. The only difference between that case and this one is that the taxpayer in Shafer sold the defaulted coupons, but it was held that the amount he received for them was ordinary income to him. It necessarily follows that a taxpayer, who holds on to his bonds and himself receives payment of the coupons in default, must report the receipt as ordinary income.

Before the war these Japanese bonds held by plaintiffs represented a capital asset in their hands, and the coupons attached thereto evidenced their right to receive a certain amount of income on this capital asset. The character of the bonds and the coupons never lost their identity; they remained principal, on the one hand, and income, on the other. The same is true of corporate bonds in default: what was principal before the default was principal thereafter, and what was income before was income thereafter. This was recognized in Fisher v. Commissioner, 209 F. 2d 513 (6th Cir. 1954), the court holding that the holder of corporate bonds in default who sold them “flat” was obliged to apportion the sales price between the principal of the bonds and the coupons attached to them, and that he was obliged to report as ordinary income the amount received for the coupons.

The taxpayer in United States v. Langston, 308 F. 2d 729 (5th Cir. 1962), differed from the taxpayers here in that he was not the holder but the purchaser of bonds. He had purchased bonds on which the interest coupons were in default at a “flat” price and later sold them “flat.” The decision, however, is in point in its treatment of income accrued on the bonds during the period the taxpayer held them but which was not paid before he sold them. Belying on the decision in Fisher, the court held that, while receipts of interest income during the holding period on account of coupons that had matured prior to purchase were a return of capital, the taxpayer must allocate the price he received for the bonds between the interest coupons that had matured prior to his purchase (together with the principal of the bonds) and interest coupons that matured during the time he held the bonds. As to the latter, the taxpayer must treat his receipts as ordinary income.

On the identical facts that were present in the Langston case, the Second Circuit agreed fully with the Fifth Circuit’s disposition of it. In Jaglom v. Commissioner, 303 F. 2d 847 (2d Cir. 1962), the court held that that portion of the proceeds from the “flat” sale of defaulted bonds which is al-locable to interest accrued while the taxpayer held the bonds is taxable as ordinary income. “A distinction has arisen,” the court said, “between an income-producing capital asset and the income which it produces. Gains from the sale of such an asset which has appreciated in value are capital gains, but gains flowing from the sale of an accrued right to collect the income from such an asset are not. Thus the right to collect ordinary income is not transmuted into capital gain by its sale.” Id. at 848. The court also relied on the fact that since the purchaser could treat interest payments that accrued while the taxpayer held the bond as a return of capital, these interest payments would never be taxed as ordinary income unless they were so taxed to the taxpayer. This payment to him represented, in part, compensation for his having held the bonds for a period of time and thus was money paid for the use of money and ordinary interest income.

See also Commissioner v. First State Bank, 168 F. 2d 1004 (5th Cir. 1948).

If plaintiffs had sold their bonds after the war at the “flat” price, the purchasers would have paid no income tax on the transaction until after they sold them. When they sold them their income would have been the difference between the “flat” price they paid for them and what they got for them. But plaintiffs, if they had sold the bonds at the “flat” price, would have sold not only their principal but also what was income to them. On the authority of the above cases, they would have had to allocate the “flat” price they received between principal and income. If plaintiffs paid no tax on what necessarily was income, no tax on it would be paid by anyone.

It is not possible to determine plaintiffs’ tax liability as if they were the purchasers of bonds. The basis for taxation of the seller and the purchaser is entirely different; one can not be equated with the other.

That the bonds, for which taxpayers claimed a war loss deduction, took on a new basis when they reacquired value is of no moment in the determination of tax liability arising from tbe payment of the coupons in default. It is of importance only when the taxpayers dispose of them. Then their gain or loss is measured by the difference between the new basis and the price for which sold. The acquisition of a new basis certainly does not transform a holder of bonds into a purchaser of what he already had. Taxpayers’ liability is that of the holder of bonds previously in default but later honored and redeemed.

I am of the opinion plaintiffs are taxable on amounts received on coupons in default when they agreed to the proposal for an extension of time for payment of bonds and coupons, as ordinary income, and, hence, that their claims for refund were properly disallowed.

FINDINGS OF FACT

The court, having considered the stipulation of the parties, and the briefs and arguments of counsel, makes findings of fact as follows:

CASE NO. 300-61

1. Plaintiffs, Robert P. K. Horst and Harry H. Wiggins, are the duly appointed executors of the Last Will and Testament of Paul R. G. Horst, who died on the 4th day of March, 1960.

2. Plaintiff, Robert P. K. Horst, is the duly appointed executor of the Last Will and Testament of Anna C. Horst, who died on the 18th day of September, 1956.

3. Robert P. K. Horst and Harry H. Wiggins are citizens of the United States.

4. At the time of his death and at all times herein, Paul R. G. Horst was a citizen of the United States. At the time of her death and at all times herein, Anna C. Horst was a citizen of the United States.

5. Paul R. G. Horst and Anna C. Horst, hereinafter sometimes referred to as “the taxpayers”, duly filed joint United States income tax returns for the calendar years 1952, 1953 and 1954 with the District Director of Internal Revenue, Newark, New Jersey.

6. Paul R. G. Horst and Anna C. Horst, hereinafter sometimes referred to as “the taxpayers”, duly filed a joint United States income tax return for the calendar year 1955 with the District Director of Internal Revenue, Custom House, New York.

7. Paul R. G. Horst and the Executor of the Estate of Anna C. Horst duly filed a joint United States income tax return for the calendar year 1956 with the District Director of Internal Revenue, Custom House, New York. Where appropriate herein, the term “taxpayers” will include the Executor of the Estate of Anna C. Horst in the place of Anna C. Horst.

8. The tax shown to be due on taxpayers’ completed returns for the following years was assessed, and duly and timely paid to the District Director of Internal Revenue, Newark, New Jersey by Paul R. G. Horst in the following amounts:

1952- $129,580.86
1953- 186, 220.48
1954- 179, 705.40

9.The tax shown to be due on taxpayers’ completed income tax return for the year 1955 was $177,369.65, which was assessed and duly and timely paid by Paul R. G. Horst as follows:

To the District Director of Internal Revenue,
Newark, New Jersey:
Payment-$44,500.00
Overpayment from 1954, applied to 1955 estimate_ 3,294. 60
$47, 794. 60
To the District Director of Internal Revenue,
Custom House, New York:
Payment- 133,500.00
Less overpayment credited against 1956 income tax_ 3,924. 95
129, 575. 05
177, 369. 65

10.The tax shown to be due on taxpayers’ completed return for the year 1956 was $178,358.79, which was assessed, and duly and timely paid by Paul R. G. Horst to the District Director of Internal Revenue, Custom House, New York.

11. The District Director of Internal Eevenue, Newark, New Jersey, thereafter duly paid the sum of $543,301.34, so received by him from Paul E. Gr. ITorst as set out in findings 8 and 9 above, into the Treasury of the United States and the District Director of Internal Eevenue, Custom House, New York, thereafter duly paid the sum of $307,-933.84, so received by him from Paul E. G. Horst as set out in findings 9 and 10 above, into the Treasury of the United States.

12. Taxpayers duly and timely filed their claims for refund of income taxes with the District Director of Internal Eevenue, Newark, New Jersey for the following years and in the following amounts:

1952_ $19,731.92
1953_ 38,790.00
1954_ 27,389.74

13.Taxpayers duly and timely filed their claims for refund of income taxes with the District Director of Internal Eevenue, Lower Manhattan, for the following years and in the following amounts:

$27,389. 74 HCD Ol Cl
27,389. 75 K CD VK O

14. The grounds stated in the aforesaid claims for refund for the years 1952,1953,1954,1955 and 1956 were as follows: “The amounts received by the taxpayers in each of said years on account of certain Japanese bonds were mistakenly reported by taxpayers in their returns for each of said years as income, and that the amounts so received were, in fact, returns of capital and, .therefore, not subject to tax.”

15. On the audit of the income tax return of taxpayer, Paul E. Gr. Horst, for ‘the year 1941, the Commissioner of Internal Eevenue allowed a war loss, in accordance with Section 127(a) of the Internal Eevenue Code of 1939, in the amount of the cost basis of the following Japanese securities, whose par value, description and original cost basis are as follows:

Par Value Original Description Cost Basis
$31, 000. 00 Great Consolidated Electric Power Company, First Mortgage S.E.A. 7% Bonds, due August 1, 1941_$27, 534. 75
115, 000. 00 City of Tokyo 5%% Bonds, due October 1, 1961 _ 48,300.00
17, 000. 00 Tobo Electric Power, First Mortgage, Kansai Div., S.F.A. 7% Bonds, due March 15 ,1955- 9,162. 50
150,000. 00 Tokyo Electric Power Co., 6% Bonds, due June 15, 1953_ 55, 000. 00
87, 000.00 Ujigawa Electric Power Company, Ltd., First Mortgage 7% S. F. Bonds, due March 15, 1945 _ 38,280.00
100,000.00 City of Yokohama 6% Bonds, due December 15, 1961_ 45, 000.00
223,277.25

16. On the audit of the income tax return of taxpayer, Paul R. G. Horst, for the year 1941, mentioned in finding 15 above, .the Commissioner of Internal Revenue also allowed a war loss in accordance with Section 127(a) of the Internal Revenue Code of 1939 in the amount of $523,182.00, the cost basis of Kingdom of Italy, External Loan, S. F. 7% Bonds, due December 1, 1951, City of Rome, Italy, External Loan of 1927, 6%% Bonds due April 1, 1952, and City of Milan, Italy, External Loan of 1927, 6%% Bonds, due April 1, 1952.

17. On the audit of the income tax return of the taxpayer, Paul R. G. Horst, for the year 1941, the Commissioner of Internal Revenue used the losses set out in findings 15 and 16 above to the extent of $99,923.22 to offset the net taxable income of the taxpayer for the year 1941 in the amount of $99,923.22.

18. On or about December 23, 1947, the Securities and Exchange Commission removed restrictions on the trading of Italian bonds and the trading in these bonds was commenced on that date. As of that time taxpayer, Paul R. G. Horst, had a war loss recovery of the Italian bonds mentioned in finding 16 above and coupons attached thereto in the amount of $174,745.69. On or about March 25,1948, Paul R. G. Horst exchanged all of the said Italian bonds, together with coupons attached thereto, for $442,600 par value Italian Republic 30 year bonds and $431,500 par value Italian Credit Consortium Public Works 30 year bonds, for which exchange a short term loss was reported in taxpayer’s 1948 income tax return based on the above value on the date of recovery as adjusted.

19. On November 11, 1950, the Securities and Exchange Commission removed restrictions on the trading of Japanese bonds. Trading in these bonds was commenced on November 13, 1950. When trading was commenced, the Japanese bonds were traded flat; that is to say, the quoted price included principal and accrued but unpaid interest thereon. The market value of the principal of the Japanese bonds described in finding 15 above and attached accrued but unpaid interest thereon, owned by taxpayer, Paul R. G. Horst, at the time trading commenced on November 13, 1950, was as follows:

Par Value Description Value 11/1S/50
$31, 000.00 Great Consolidated Electric Power Company, First Mortgage S.F.A. 7% Bonds, due August 1,1944, @ 40 flat_$12, 400. 00
115,000.00 City of Tokyo 5%% Bonds, due October 1, 1961, @ 51 flat_ 58,650. 00
17, 000. 00 Toho Electric Power First Mortgage Kansai Div. S.F.A. 7% Bonds, due March 15, 1955, @ 40 flat_ 6, 800. 00
150,000.00 Tokyo Electric Power Co. 6% Bonds, due June 15, 1953, @ 53% flat_ 79, 687. 50
87, 000. 00 Ujigawa Electric Power Company Ltd., First Mortgage 7% S.F. Bonds, due March 15, 1945, @ 50% flat_ 43, 608.75
100, 000.00 City of Yokohama 6% Bonds, due December 15, 1961, @ 50 flat_ 50, 000. 00
251,146.25

20. Paul R. G. Horst did not report any income with respect to his war loss recoveries in 1948 or 1950 because the total amount of these recoveries on both Italian and Japanese bonds and attached matured but unpaid coupons at their value on the recovery date of $174,745.69 and $251,146'.2'5 respectively, or a total of $425,891.94, was less than his unused war loss deduction for the year 1941, which was in the amount of $646,536.03.

21. No interest was paid on the Japanese bonds set out in finding 19 from the declaration of war against the Empire of Japan on December 7,1941 until service was commenced on these bonds on December 22, 1952.

22. On or about December 22, 1952 the Japanese government, which had assumed the obligations on all of the bonds set out in finding 19 above, made an offer of settlement to the holders of said bonds under the terms of which the maturity date on each bond and on each matured and unpaid coupon attached thereto was extended for exactly ten years. The offer reserved to the Japanese government the right to redeem the bonds prior to their new maturity date in accordance with the original terms of said bonds. The offer provided that matured and unpaid coupons, when stamped with their new maturity date, shall be detached from the bonds and may be transferred and delivered separate and apart from the bonds to which they relate. The offer further provided that interest would be paid on the bonds for the extended maturity period at the same rate and on the same semi-annual interest payment date as was originally provided and that new coupons be attached for such extended interest period.

23. Paul R. G. Horst accepted the offer of the Japanese government set out in finding 22 above and pursuant thereto submitted bonds and coupons and received them back with overprints specified in the offer on the dates and in the amounts as follows:

Date of Overprinting Description Face Value of Bond Face Value Matured, Coupons
12/29/52 Toho Electric Power_ $17, 000. 00 $11, 900. 00
12/29/52 Tokyo Electric Eight Oo_ 150, 000. 00 85, 500. 00
1/ 7/53 Great Consolidated Electric Power _ 31,000.00 21,700.00
1/ 7/53 City of Tokyo_ 115, 000. 00 60,087.50
1/ 7/53 Ujigawa Electric Power_ 87, 000. OO 60, 900. 00
1/ 7/53 City of Yokohama_ 100,000. 00 57,000. 00

Paul R. G. Horst also received interest coupons for extended periods as provided in said offer. After December 22, 1952 service was commenced on said bonds and current interest was paid on current coupons on these bonds, in addition to payments on the defaulted coupons.

24. Taxpayer did not exercise the options provided for in Section 127(c) (5) and (3) of the Internal Revenue Code of 1939 and Sections 1335 and 1333 of the Internal Revenue Code of 1954 which allow taxpayers, who exercise the option, to retain the cost basis that they had for the recovered property on the date of loss. Taxpayer took no steps whatsoever with respect to the cost basis of his property on the date of recovery. When from time to time thereafter Japanese bonds were redeemed, taxpayer reported capital gains on such redemptions, using as his cost basis the value of the bonds and attached matured but unpaid coupons on the date of recovery.

25. During the following years Paul R. G. Horst received the following amounts in payment of coupons attached on November 13, 1950 to the Japanese bonds, described in finding 19, which coupons were matured but unpaid on November 13, 1950, the date that trading in these bonds commenced.

Year Amount Received, in Payment of Coupons
1952___ $22,950.00
1953_ 43,100. 00
1954_ 30, 775. 00
1955_ 30, 775. 00
1956_ 30,775. 00

The amounts so received were reported by taxpayers as ordinary interest income in their United States income tax return for the year of receipt.

26.Appendix A attached hereto shows the amounts received by Paul R. G. Horst as payments on the matured but unpaid coupons attached to each of the Japanese bonds for the years 1952 through 1956, both inclusive, and for the years 1957 through 1959, both inclusive. All such amounts were reported as ordinary interest income in tbe taxpayers’ United States income tax return for each of the years of receipt.

27. Appendix B attached hereto shows the Japanese bonds owned by Paul R. G. Horst that were redeemed during the periods 1952 to 1956, both years inclusive, and the period 1957 through 1959, both years inclusive, together with the dates of redemption and the amounts received on redemption. The difference between the cost basis (determined as the flat value of the Japanese bonds and attached matured but unpaid coupons on November 13,1950, the date on which trading in said bonds and coupons was resumed), and the amount received on redemption, was reported as long-term capital gains on the taxpayers’ United States income tax return for the year of redemption.

28. Appendix C attached hereto shows payments received by Paul R. G. Horst on coupons described in findings 25 and 26 in excess of the full recovery of Paul R. G. Horst’s cost basis for the bonds and attached coupons, if it is assumed that cost basis is the flat price value of the bonds and attached matured but unpaid coupons on November 13,1950, the date trading in such bonds and coupons commenced. Appendix C also shows the tax on such payments computed at long-term capital gains rates. In all cases where the cost basis assumed above was fully recovered by the taxpayers, the bonds were redeemed at an amount in excess of the cost of the bonds and coupons computed as above. Since the excess received on redemption of the bonds had already been taxed in the taxpayers’ United States income tax return at long-term capital gains rates as described in finding 27, taxpayers have already recovered their entire cost basis (as computed above) for the redeemed bonds and attached matured but unpaid coupons. Appendix C therefore shows all of the payments received on the defaulted coupons attached to such redeemed bonds during the period 1952 to 1959, both years inclusive (both before and after redemption). Thus capital gains on such paid coupons and the tax tbereon are computed using a zero cost basis for such paid coupons.

29. After Japanese bonds were redeemed, as described in finding 27 above, the coupons that were matured but unpaid on the date of recovery and which were detached from the bonds to which they related, as described in finding 22, remained outstanding. These detached coupons were paid on their extended due date. A statement of the coupons paid after redemption of the bonds to which they relate during the years in question and the total amount of such payments are set out in appendix D attached hereto.

30. By registered letters, dated August 28, 1959', the District Director of Internal Revenue, 245 West Houston Street, New York, New York, duly rejected taxpayers’ claim for refunds for the years 1952, 1953, 1954 and 1955.

31. By certified mail letter, dated November 29, 1960, the District Director of Internal Revenue, 484 Lexington Avenue, New York 17, New York, duly rejected the taxpayers’ claim for refund for the year 1956.

32. No person other than the Estates of Paul R. G. Horst and Anna C. Horst has any interest in the fund and the claims involved in this suit. Neither said claim nor any part thereof has been assigned or transferred.

APPENDIX A

Payments on Defaulted Coupons Reported as Ordinary Interest Income in Taxpayer’s Income Tax Return

Total 1968 1959 1957 1956 996J 1954-1958 mi Tax Cost Basis 11118150 Par Value

$17,360 $2,170 $2,170 $2,170 $2,170 $2,170 $2,170 $2,170 $2,170 $31,000 $12,400.00 Great Cons. Elee. Power Co. 7% due August 1, 1944, Extended to 1954, at 40. — .

50,600 6,325 6,325 12,650 6,325 6,325 6,325 6,325 $115,000 58,650.00 Tokyo, City of, 5J4% due October 1,1961, Extended to 1971, at 51......

76,500 9,000 9,000 13,500 9,000 9,000 9,000 9,000 9,000 $150,000 79,687.50 Tokyo Elec. Power Co., 6% due June 15,1953, Extended to 1963, at 5314.-.-.—

9,520 1,190 1,190 1,190 1,190 1,190 1,190 1,190 1,190 $17,000 6,800.00 Toho Elec. Power, 7% due March 15, 1955, Extended to 1965, at 40_

48,720 6,090 6,090 6,090 6,090 6,090 6,090 6,090 6,090 $87,000 43,608.70 Ujigawa Elec. Power, 7% due March 15,1945, Extended to 1955, at 50#...-

48,000 6,000 6,000 12,000 6,000 6,000 6,000 6,000 $100,000 50,000.00 Yokohama, City of, 6% due December 1,1961, Extended to 1971, at 50.....

$22,950 $43,100 $30,775 $30,775 $30,775 $30,775 $30,775 $30,775 $250,700 $251,146.20

APPENDIX B

Redemption of Bonds

Total Re- On demp- Hand 1959 tions 1/1160 1958 mi 1956 9961 1954 195S mi (Date)

(M) $6,500 (!Mi)$3,000 $31,000 p.v. Great Cons. Elec. Power Co., 7%, due August 1, 1944, Extended to 1954____

$31,000 None ©4) 21,500

OM)$9,000 (M)$8,000 $115,000 p.v. Tokyo, City of, 5H%, due October 1,1961, Extended to 1971...

CM) 3,000 20,000 $95,000

(Me) 5,000 5,000 145,000 $150,000 p.v. Tokyo Elec. Power Co., 6%, due June 15, 1953, Extended to 1963...

17,000 None (Me) 17,000 $17,000 p.v. Toho Elec. Power, 7%, due March 15, 1955, Extended to 1965_

(Me) 3,000 (Me) 11,000 (Me) $50,000 $87,000 p.v. Ujigawa Elec. Power, 7%, due March 15, 1945, Extended to 1955.

87,000 None (Me) 23,000

$100,000 p.v. Yokohama, City of, 6%, due December 1, 1961, Extended to 1971.. (M) 8,000 8,000 92,000

Payments on Defaulted Coupons in Excess of Cost Basis of Bonds and Coupons, and Tax Thereon Computed at Long Term Capital Gains Rate

Total 1959 1958 1957 1958 1955 tm ms mi

$17,360.00 $420.00 $6,090.00 $2,170.00 $2,170.00 $2,170.00 $2,170.00 $2,170.00 Great Cons. Elec. Power Co., 7%, due August 1, 1944, Extended to 1954....

8,800.00 3,465.00 5,335.00 Tokyo, City of, E£4%, due October 1,1961, Extended to 1971______

2,550.00 2,550.00 Tokyo Elec. Power Co., 6%, due June 15, 1953, Extended to 1963___

9,520.00 2,380.00 1,190.00 1,190.00 1,190.00 1,190.00 1,190.00 1,190.00 Tobo Elec. Power, 7%, due March 15,1955 Extended to 1965...

48,720.00 420.00 7,350.00 16,590.00 6,090.00 6,090.00 6,090.00 6,090.00 Ujigawa Elec. Power, 7%, due March 15, 1945, Extended to 1955...

3,840.00 3,840.00 Yokohama, City of, 6%, due December 1, 1961, Extended to 1971_

$3,220.00 $14,630.00 $19,960.00 $9,460.00 $9,460.00 $12,915.00 $21,175.00 $90,790.00

$805.00 $3,667.50 $4,987.50 $2,362.50 $2,362.50 $3,228.75 $5,293.75 $22,697.60 Capital Gains Tax 25%-

APPENDIX D

Coupons Paid After Redemption of Bonds

Total 1959 1958 1957 1956 1955 7961 1953 Description Par Value

Co. Ex-Great Cons. Elec. Power 7% due August 1, 1944, tended to 1951 $31, 000

$210 $210 $210 $210 $210 $210 11/11/53 $3,000 p.v. called

455 455 455 455 455 227. 50 2/ 1/54 6,500 “

1, 505 1, 505 1, 505 1, 505 1, 505 8/ 2/54 21,500 “

$31,000

Tokyo, City of, 5}i% due October 1, 1961, Extended to 1971 $115, 000

495 $9,000 p.v. called 10/ 1/58

220 8,000 “ “ 4/ 1/59

0 3,000 “ “ 10/ 1/59

$20,000

$95,000 p.v. on hand d. of d.

$150,000 Tokyo Elec. Power, 6% due June 15, 1953, Extended to 1963

$5,000 p.v. called 6/15/59 150

1954 Par Value Description 195S 1959 Total 1967 1958 1955 1956

$17,000 Toho Elec. Power, 7 % due March 15, 1955, Extended to 1965

$1, 190 $17,000 p.v. called 3/16/53 $595 $1, 190 $1, 190 $1, 190 $1, 190 $1, 190

$87, 000 Ujigawa Elec. Power, 7% due March 15, 1945, Extended to 1955

© rH <M $3,000 p.v. called 9/15/53 210 210 210 210 210

lO CO CO 11,000 “ “ 3/15/54 770 770 770 770 770

23,000 “ “ 9/16/54 1, 610 1, 610 1, 610 1, 610 1, 610

50,000 “ “ 3/15/55 3, 500 3, 500 3, 500 1, 750 3, 500

$87,000

$100,000 Yokohama, City of, 6% due December 1, 1961, Extended to 1971

$8,000 p.v. called 6/ 1/59 240

$92,000 p.v. on hand d. of d.

Total for Year_ $595 $2, 222. 50 $7, 700 $9, 450 $9, 450 $9, 450 $10, 555 $49, 422. 50

CASE NO. 117-62

1. All of tbe facts found in the case entitled “Robert P. K. Horst and Harry H. WiggiNS, as Executors of the Last Will and Testament of Paul R. G. Horst, and Robert P. K. Horst, as Executor of the Last Will and Testament of Anna C. Horst, Plaintiffs, against The United States of America, Defendant”, Court of Claims Docket No. 300-61, are hereby found as if set out fully herein.

2. Paul R. G. Horst, hereinafter referred to as the “taxpayer”, duly filed United States income tax returns for each of the calendar years 1957 and 1958 with the District Director of Internal Revenue, Lower Manhattan, New York.

3. The taxpayer duly filed a United States income tax return for the calendar year 1959 with the Internal Revenue Service, Manhattan, New York.

4. The tax shown to be due on taxpayer’s completed returns for the following years was assessed and duly paid to the District Director of Internal Revenue, Lower Manhattan, New York, by Paul R. G. Horst:

1957_ $207,598.86
1958_ 213,083.49

5. The tax shown to be due on taxpayer’s completed return for the year 1959 was $227,076.28, which was assessed and duly paid to the Internal Revenue Service, Manhattan, New York, by Paul R. G. Horst.

6. The District Director of Internal Revenue, Lower Manhattan, New York, thereafter paid the sum of $420,-682.35, so received by him from Paul R. G. Horst as set out in paragraph 4 above, into the Treasury of the United States and the Internal Revenue Service, Manhattan, New York thereafter duly paid the sum of $227,076.28 so received by them from Paul R. G. Horst, as set out in finding 5 above, into the Treasury of the United States.

7. The estate of Paul R. G. Horst duly and timely filed its claim for refund of income tax with the Internal Revenue Service, Manhattan, New York for the following years and in the following amounts:

1957_$29,097.25
1958_ 29, 097.25
1959_ 29,097.25

8. Taxpayer’s wife, Anna C. Horst, died on September 18, 1956. Taxpayer thereafter married Eva Adam Horst, a citizen and resident of Germany, on July 9, 1957 and was at all times after such date and during the period under consideration married to her. Eva Adam Horst had no income from sources within the United States in any of the years herein.

9. The grounds stated in the aforesaid claims for refund for the years 1957, 1958 and 1959 were as follows: “First, that the taxpayer, in filing his income tax return for each year, failed to claim an exemption for his wife, Eva Adam Horst, a citizen and resident of Germany, and that taxpayer was entitled to an exemption for said wife; and, second, that the amounts received by the taxpayer in each of said years on account of certain Japanese bonds were mistakenly reported by taxpayer in his returns for each of said years as income, and that the amounts so received were, in fact, returns of capital, and, therefore, not subject to tax.”

10. The claims for refund described in the preceding paragraph claimed two $600 exemptions for Eva Adam Horst on the erroneous assumption that said Eva Adam Horst was over the age of 6'5 years. Subsequently it has been determined that Eva Adam Horst was under the age of 65 years during such years.

11. Taxpayer is entitled to one $600 exemption for each of the years 1957, 1958 and 1959 for his non-resident alien wife, Eva Adam Horst. This is in addition to the personal exemption claimed and allowed in his United States income tax returns for each such year.

12. During the following years Paul R. G. Horst received the following amounts in payment of coupons attached on November 13, 1950 to bonds described in findings 15 and 19 of the findings of fact in “Robert P. K. Horst and Harry H. WiggiNS, as Executors, etc., Plaintiffs, against The UNITED States of America, Defendant”, Court of Claims Docket No. 300-61, which coupons were matured but unpaid on November 13, 1950, the date that trading in these bonds commenced:

1967_ $30,776.00
1958_ 30,775. 00
1959- 30, 775. 00

The amounts so received were reported by taxpayer as ordinary interest income in his United States income tax return for the year of receipt.

13. Appendices A, B, C, and D attached to the findings of fact in “Robert P. K. Horst and Barry H. WiggiNS, as Executors, etc., Plaintiffs, against The United States oe America, Defendant”, Court of Claims Docket No. 300-61, and the explanations of them in findings 26, 27, 28 and 29 of said findings are hereby found as if set out herein. The word “taxpayers” therein shall mean Taxpayer Paul R. G. Horst whenever appropriate.

14. By certified mail letters dated September 1, 1961, the District Director of Internal Revenue, 484 Lexington Avenue, New York, duly rejected the claims of the estate of Paul R. G. Horst for the years 1957, 1958 and 1959.

15. There is no person other than the estates of Paul R. G. Horst and Anna C. Horst that has any interest in the fund and the claims involved in this suit. Neither said claim nor any part theref has been assigned or transferred.

CONCLUSION OE LAW

Upon the foregoing findings of fact which are made a part of the respective judgments herein, the court concludes as a matter of law that in both cases plaintiffs are entitled to recover and judgments are entered to that effect. In each instance the amount of recovery will be determined pursuant to Rule 47 (c) (2). 
      
       The two suits present exactly the same war loss issue for different years, and we shall therefore treat them as a single case. In No. 117-62, there Is also a minor issue upon, which the parties are now agreed.
     
      
       The remainder of the loss became his “unused war loss.”
     
      
       Section 1336 of tie 1954 Code provides in pertinent part:
      The unadjusted basis of property recovered in respect of property considered as destroyed or seized under Section 127 (a) of the Internal Revenue Code of 1939 shall be determined under this section. Such basis shall be an amount equal to the fair market value of such property determined as of the date of recovery, * * *.
      There is a comparable provision in Section 127 (c) (3) (A) of the 1939 Code.
      Taxpayers recovering the same property were also given an election to choose the original basis of that property, if they so desired. That election was not made by the present taxpayer.
     
      
       The statute required the taxpayer to treat his loss on the Japanese and Italian bonds as one integral loss, not as separate losses. This is true throughout the statutory scheme for war losses and war loss recoveries. The Japanese loss and the Italian loss must be considered as a unit.
     
      
       In flat purchase cases, the courts have held the seller liable for ordinary income tax on the portion of the flat price attributable to the accrued interest. Jaglom v. Commissioner, supra; United States v. Langston, supra; First Kentucky Co. v. Gray, 309 F. 2d 845 (C.A. 6, 1962).
     
      
       For these cases, Section 1232(a) o£ the 1954 Code is substantially the same.
     
      
       In this connection, the Government raises a secondary defense, as to a portion of the tax, arising out of the double fact that, under the 1952 arrangement with Japan, the bonds could be redeemed by the obligor prior to their new maturity dates but the interest coupons were detached and given separate existence. Japan did redeem certain of the bonds early, while continuing to pay the detached coupons on their extended maturity dates. (Taxpayer received, from 1953 through 1959, a total of over $49,000 in payment for such coupons relating to previously-redeemed bonds. In each instance the redemption-amount exceeded the cost basis of the bonds and the related coupons.) The defendant maintains that, at the least, gain attributable to amounts received in payment of the interest coupons after redemption of the bonds to which they relate is taxable as ordinary income. We think, however, that all the interest coupons which were accrued by the time of the war loss recovery in 1950 were part of the bonds then acquired (reflected in the bonds’ basis at that time) and the bonds were not wholly retired until these coupons were paid. This position is consistent with the basic theory of the Campbell and Rickaby decisions. See, also, Clyde C. Pierce Corp. v. Commissioner, supra, 120 F. 2d 206, 208 (C.A. 5, 1941).
     
      
       Section 127(c) of the Internal Revenue Code has no application to the issue presented in this case. The amount of the recovery on the bonds was less than the unused portion of the allowable war loss deduction, and, hence, taxpayers had no income arising from their recovery of value.
     