
    399 F.2d 214
    SAYLES FINISHING PLANTS, INC. v. THE UNITED STATES
    [No. 5-64.
    Decided July 17, 1968]
    
      
      Robert E. Jacobson, attorney of record for plaintiff. John V. Kean, Edwards ds Angelí, and Philip F. Herrich, of counsel.
    
      Edna G. Parker, with, whom was Assistant Attorney General Mitchell Rogovin, for defendant. Philip R. Miller, of counsel.
    Before Cowen, Chief Judge, Laramore, Dureee, Davis, Collins, Skelton and Nichols, Judges.
    
   Per Curiam;

This case was referred to Trial Commissioner Roald A. Hogenson with directions to make findings of fact and recommendation for conclusions of law under the order of reference and Rule 57(a). The commissioner has done so in an opinion and report filed on January 25, 1968. On June 21, 1968 the parties filed a stipulation wherein, among other things, it is stipulated that the court may enter judgment in accordance with the Trial Commissioner’s opinion, findings of fact, and recommended conclusion of law which may be adopted by the court. Since the court agrees with the commissioner’s opinion, findings and recommended conclusion of law, as hereinafter set forth, it hereby adopts the same as the basis for its judgment in this case without oral argument. Therefore, plaintiff is not entitled to recover and the petition is dismissed.

OPINION OP COMMISSIONER

Hogenson, Commissioner:

This is a suit to recover federal income taxes and assessed interest paid by plaintiff to defendant for calendar years 1955,1956, and 1957, plus statutory interest. The suit arises as a result of defendant’s disallowance in each year of a claimed deduction for interest paid. Defendant’s contention is that these payments, alleged to be interest on indebtedness, were actually distributions of profits as dividends. Thus this case presents one more variation of the familiar debt-versus-equity controversy. For the reasons hereinafter stated, it is my opinion that plaintiff is not entitled to recover.

Plaintiff is a Rhode Island corporation engaged in the textile finishing business, with its principal location in Sayles-ville, Rhode Island. Plaintiff is the ultimate successor to the business conducted at the same location by Frank A. Sayles some 50 years ago. Upon Mr. Sayles’ death in 1920, his executors caused the business to be incorporated as Sayles Finishing Plants, Inc. (referred to herein as “old Sayles”), a separate entity from the plaintiff herein. Two years later in 1922, the executors created plaintiff corporation, then named Remaw Manufacturing and Investments Company (hereinafter “old Remaw”), which was used to hold certain investments. Plaintiff as old Remaw became inactive in 1925 and remained so until May of 1930, when a plan was formulated to reorganize both plaintiff and old Sayles.

Under this plan, plaintiff as old Remaw acquired virtually all the assets of old Sayles, and changed its name to Sayles Finishing Plants, Inc., hereinafter referred to as plaintiff or new Sayles. Plaintiff then undertook the active operation of the textile finishing business. Old Sayles changed its name to Remaw Corporation and thereupon became inactive. The conduct of the business by plaintiff after this reorganization was virtually identical to that occurring previously; there were no significant changes in the plant or its operation, nor in its personnel or management, nor in the business activities.

The reorganization was essentially in the form of a sale to plaintiff of all the stock of old Sayles, accompanied by a recapitalization of both companies. Neither corporation was in financial difficulty at the time, and the plan did not involve any new investment of money in either company. Prior to the reorganization, the executors of Mr. Sayles’ estate (sole stockholders of both old Sayles and old Eemaw) had transferred all the stock of both corporations to the trustees of four trusts created under eighth clause of Mr. Sayles’ will. Immediately after the reorganization, the eighth clause trustees held all of plaintiff’s stock, as well as $7,000,000 in 6 percent demand notes of plaintiff. Plaintiff in turn held all the stock of new Eemaw, hereinafter called Eemaw.

The trustees devised the above-mentioned plan of reorganization and recapitalization as a means of affording greater protection to the trust beneficiaries. This was deemed advisable in light of the financial and economic outlook as of May 1930.

One year later, in May of 1931, additional changes were made whereby Eemaw authorized and issued an additional 4,998 shares of common stock and an issue of 70,000 shares of preferred stock, both of $100 par value per share. Plaintiff subscribed to the common for $100 per share in cash, and also paid $200 for the two shares of Eemaw common it already held (and which had been all of the authorized and issued common stock of Eemaw). The preferred stock was issued to the trustees, in exchange for the $7,000,000 in plaintiff’s demand notes, which the trustees transferred to Eemaw. Thus Eemaw became active as a holding company for investments.

In June of 1934, another plan of recapitalization and reorganization was conceived and put into effect. Of the 5,000 shares outstanding of common stock of Eemaw, 4,500 were retired, and the eighth clause trustees purchased the remaining 500 shares from plaintiff. Then plaintiff issued 6 percent registered bonds having an aggregate face value of $7,050,000 in exchange for all the assets of Remaw (except Remaw’s corporate charter and any claims it might have for tax refunds). Remaw’s assets at this time consisted of the $7,000,000 in plaintiff’s demand notes of 1930, and other assets having a net value of approximately $50,000. Plaintiff’s bonds were issued directly to the trustees, upon the surrender to Remaw by the trustees of all the outstanding stock of Re-maw (70,000 shares of preferred and 500 shares of common). Remaw promptly canceled this stock and then amended its articles of association to authorize instead capital stock of four shares, par value $100 per share. These four shares were issued to the trustees, whereupon Remaw became completely inactive, remaining so until its dissolution in 1960.

In the 1934 transactions, plaintiff acquired from Remaw plaintiff’s 1930 demand notes of $7,000,000 face value, which were then canceled. The issue of $7,050,000 in plaintiff’s 'bonds were in registered form, transferable only on the books of the corporation; they provided for interest at the rate of 6 percent per annum (payable quarterly) and were due and payable on June 1, 1939. These bonds are the subject matter of the present suit.

The economic depression of the 1930’s affected the New England textile industry quite adversely, and plaintiff was no exception, for it suffered losses throughout most of this period. Because of this, the 1934 bonds were modified twice during the 1930’s. In 1935, the bondholders (the trustees) and Sayles agreed that, until maturity, interest should be payable annually from net income only (before deduction of that interest and any dividends paid), and that such interest would not 'be cumulative. Likewise, when the bonds became due, on June 1, 1939, a similar agreement was reached whereby interest on $6,050,000 of the bonds would thereafter be payable (at the rate of 6 percent per annum) from net income only, on the same terms as the 1935 agreement imposed. The remaining $1,000,000 was not affected by the 1939 agreement, and interest on this portion of the bonds became due and payable (also at a 6 percent annual rate) regardless of net income. Neither the 1935 modification nor that of 1939 conferred any additional rights or privileges upon the bondholders, and no consideration was paid in this connection.

No payments have been made on the principal of the bonds, and none has been demanded by the bondholders. Plaintiff has made purported interest payments on the bonds in accordance with their terms, as modified, in each of the taxable years involved here, 'as well as in prior and subsequent years. Income tax returns filed by plaintiff for 1955, 1956, and 1957 claimed a deduction of $423,000 in each year as interest accrued and paid on these bonds. Upon audit of these returns, the Commissioner of Internal Kevenue disallowed the claimed deductions for interest paid, on the ground that these payments were actually profit or dividend distributions.

On November 12, 1959, deficiencies totaling $656,188.60 (plus interest thereon of $105,405.57) were assessed, and plaintiff paid these amounts that same day. Timely refund claims were filed on October 30, 1961, and these were disallowed on January 8, 1962.

Subsequently, on audit of plaintiff’s 1958 federal income tax return, the Commissioner determined that a net operating loss existed, which would be carried back to reduce plaintiff’s 1955 and 1956 tax liabilities. Accordingly, on April 28,1961, the District Director tendered to plaintiff checks totaling $998,179.32, representing refunds of income taxes paid for 1955 and 1956, plus interest thereon. Plaintiff accepted the checks by letter dated May 5, 1961, reserving its right to further contest its tax liability for, those years.

On January 6, 1964, plaintiff filed its petition with this court, seeking (1) a judgment against the defendant in the amount of $349,907.96 (the amount of the rejected refund claims) with interest, and (2) a specific finding by the court that refund of said amount and the above-mentioned refund of April 28, 1961, result in whole or in part from allowance of the disputed interest deduction, and only in part from carryback of the 1958 net operating loss.

The sole issue for determination is whether plaintiff’s interest payments arose from actual indebtedness to its bondholder-stockholders, as contended by plaintiff, or whether such payments were actually distributions of dividends by way of purported interest payments on instruments which represented capital investment in plaintiff, as defendant insists. As stated by this court in Cuyuna Realty Co. v. United States, 180 Ct. Cl. 879, 884, 382 F. 2d 298, 301 (1967), the inquiry in most of the decided cases involving the debt-versus-equity controversy has been whether at the time of issuance of the disputed instruments, the parties intended to create a real debtor-creditor relationship; but such inquiry is not the ultimate test; and the real issue is whether there is “indebtedness” within the taxable year, on which purported interest deductions are allowable. This court further held that the federal income tax law looks to events in each taxable year, so in applying § 163, it is proper for courts to inquire for each taxable year whether there is indebtedness, and interest ceases to be deductible as a real cost of producing income, if with the passage of time it becomes apparent that the parties have no intention of continuing the debtor-creditor relationship.

However, as the court recognizes in the Cuyuna case, supra, full consideration must be given to all relevant and material facts in this case, as the law is well established that the debt-versus-equity problem is basically a question of fact, to be determined in the light of all the facts and circumstances of the particular case, with no single factor being determinative. Id. 180 Ct. Cl. at 883, 382 F. 2d at 300; Jack Daniel Distillery v. United States, 180 Ct. Cl. 308, 325-334, 379 F. 2d 569, 580-585 (1967). In applying this rule in a case involving the distinction between debt and equity on the issue of deductibility of a bad debt, American Processing & Sales Co. v. United States, 178 Ct. Cl. 353, 362-363, 371 F. 2d 842, 848 (1967), this court stated:

There is no dearth of cases in this province of tax law. So large is their number and disparate their facts, that for every parallel found, a qualification hides in the thicket. At most they offer tentative clues to what is debt and what is equity for tax purposes; but in the final analysis each case must rest and be decided upon its own unique factual flavor, dissimilar from all others, for the intention to create a debt is a compound of many diverse external elements pointing in the end to what is essentially a subjective conclusion. * * *

Upon consideration only of tbe form of the disputed bonds, as originally issued and before their modification by the 1935 and 1939 agreements, it would be concluded that the parties involved intended thereby to create indebtedness. The form of the bonds satisfied the well-stated definition of debt set forth in Gilbert v. Commissioner, 248 F. 2d 399, 402 (2d Cir. 1957), as follows:

The classic debt is an unqualified obligation to pay a sum certain at a reasonably close fixed maturity date along with a fixed percentage in interest payable regardless of the debtor’s income or lack thereof. While some variation from this formula is not fatal to the taxpayer’s effort to have the advance treated as a debt for tax purposes, * * * too great a variation will of course preclude such treatment. * * * [Citations omitted.]

However, the familiar tax principle that substance prevails over form, Higgins v. Smith, 308 U.S. 473, 477 (1940), calls for consideration of the prior, contemporaneous, and subsequent circumstances relating to the execution and issuance of the disputed instruments. Affiliated Research, Inc. v. United States, 173 Ct. Cl. 338, 341, 351 F. 2d 646, 648 (1965) ; Cuyuna Realty Co. v. United States, supra.

The textile finishing business as operated by old Sayles was in sound financial condition at the time of the 1930 transactions. It was not in need of new funds. The beneficial owners of this business, both when operated in corporate form of old Sayles and hi that of plaintiff, were the beneficiaries of the four trusts under the eighth clause of the will of Frank A. Sayles, even though prior to the reorganization, all of the stock of old Sayles was held by the sole surviving executor, and thereafter by the eighth clause trustees. No new capital was added to the 'business by the transactions which transferred such going business unchanged in its personnel, assets and operations from old Sayles to plaintiff. The only accomplishment of apparent substance in the reorganization of the two corporations (old Sayles and plaintiff) was the purported conversion of equity interests of the beneficial owners of the business into purported instruments of indebtedness, by the issuance to the trustees as a result of involved paper transactions of the demand notes of plaintiff in the aggregate sum of $7,000,000. The trustees (one of whom was the sole surviving executor) had in mind only one benefit to the business, i.e., the tax advantage of deducting interest payments on the purported indebtedness. From the standpoint of plaintiff corporation, or the business involved, no other substantial business purpose appears from the evidence. The deliberately planned benefits to the stockholders were to afford greater protection to the trust beneficiaries in that in the event of insolvency or bankruptcy of the business, the trusts would have the right to participate with other creditors to the extent of the $7,000,000 demand note obligations of plaintiff; that if the trustees desired to extract capital from the finishing business, they believed that they could retire up to $7,000,000 of the notes without taxation; and that the trustees would be afforded a convenient means of realizing a part or all of their investment in the business, if they so desired, by selling the demand notes to a third party, in which event they would still have retained control of the business.

Plaintiff’s demand notes were transferred in May of 1931 by the trustees to Eemaw (old Sayles) in involved paper transactions concerning creation and issuance of additional Eemaw common stock to plaintiff and new Eemaw preferred stock to the trustees. As previously, the beneficial owners of both Eemaw and plaintiff were the beneficiaries of the four eighth clause trusts. The trustees had complete control of both plaintiff and Eemaw, and the officers and directors of both corporations were the same. When the paper work had been completed, plaintiff held all of the common stock of Eemaw, just as it had before Eemaw was caused to increase its common stock; Eemaw held the demand notes ($7,000,000) of plaintiff; and the eighth clause trustees (in addition to the previously held common stock of plaintiff) held the preferred stock of Eemaw. While cash was transferred from plaintiff to Eemaw, there was no new money involved in the overall transactions.

As related above, plaintiff’s disputed bonds in the aggregate amount of $7,050,000 were issued to the eighth clause trustees in June of 1934. Here again, mere paper transactions were involved. As before, the ultimate control and ownership of both plaintiff and Remaw were vested in the four eighth clause trusts. In effect, Remaw was caused by the trustees to transfer all of its assets (the $7,000,000 demand notes of plaintiff plus $50,000 in other undefined assets) to plaintiff; all of Remaw’s stock (preferred and common) was transferred by plaintiff and the trustees to Remaw and thereupon canceled; Remaw (without assets) issued four shares of common stock to the trustees, but thereafter remained inactive until dissolved in 1960; and plaintiff acquired and canceled its own demand notes, and issued the disputed bonds to the trustees. Thus, the bonds replaced the demand notes as instruments of the purported indebtedness in dispute in this case. Except to the extent of the $50,000 in other undefined assets transferred from Remaw to plaintiff, no additional money was invested in plaintiff in these transactions. No contention is made that to the extent of $50,000, the disputed bonds are a valid indebtedness, but rather is the issue presented here on an all or nothing basis.

The parties agree, and it cannot be doubted, that under the facts of a particular case, a stockholder (or stockholders) can also be a creditor (or creditors) holding taxwise a valid indebtedness against their corporation. Plaintiff cites various cases. In Gloucester Ice & Cold Storage Co. v. Commissioner, 298 F. 2d 183 (1st Cir. 1962), a corporation (to acquire the outstanding stock of a competitor) borrowed money from a bank and also issued debenture bonds which were in part exchanged for its outstanding preferred stock and otherwise sold to individuals not stockholders, and the court held that the debentures were evidences of indebtedness in tihe hands of the non-stockholders and equally so in the hands of the stockholders. In Rowan v. United States, 219 F. 2d 51 (5th Cir. 1955), the taxpayers had over a period of years made advances in the form of loans to their wholly owned corporation, and the court held that the unpaid portion of such advances was deductible as a worthless debt in the taxable year involved, after a careful review of the evidence on the premise that whether such advances were loans or capital contributions depended on the intent of the patties, to be ascertained from all relevant facts and circumstances. In Wilshire & Western Sandwiches, Inc. v. Commissioner, 175 F. 2d 718 (9th Cir. 1949), taxpayer corporation was incorporated to engage in the restaurant business, and its four incorporators (who became its sole stockholders) advanced $30,000, half of which was to be capital stock contribution and half a loan, and taxpayer’s promissory notes were issued for the purported loan to each stockholder accordingly. The court 'held that the transaction involving the promissory notes was a loan, interest on which was deductible, recognizing, however, that a lending transaction between stockholders and their corporation subjects such transaction to close scrutiny as to the tax effect, but concluding that while there were features both ways as to whether the pertinent advances were loans or stock purchases, those sustaining the loan conclusion greatly preponderated, chief of which was the intent of the parties at the time of entering into the transaction.

Obviously, the facts and circumstances in this case do not parallel the facts and circumstances of the cases cited by plaintiff and reviewed in the foregoing paragraph, and considerable doubt exists as to whether the parties here had a bona fide intention to create indebtedness at the time of the issuance of plaintiff’s demand notes or its disputed bonds. Moreover, there were no advances made by plaintiff’s stockholders to plaintiff for the issuance of either the demand notes or the disputed bonds.

Conversion of equity interests into evidence of indebtedness does not necessarily defeat tax treatment of the resulting relationship between a stockholder or stockholders and the corporation as a bona fide indebtedness. Here again, all of the facts and circumstances of the particular case must be considered. Even the fact that no new money was invested in the business does not require a holding that issuance of corporate debentures was a capital transaction, but such debentures are to be allowed tax treatment as indebtedness when the other factors in the case establish a true indebtedness. Kraft Foods Co. v. Commissioner, 232 F. 2d 118, 126 (2d Cir. 1956) ; Luden's, Inc. v. United States, 196 F. Supp. 526, 530-531 (E.D. Pa. 1961). However, in an appropriate case, lack of new money can be a significant factor in holding a purported indebtedness to be a capital transaction, particularly when the facts otherwise show that the purported indebtedness was merely a continuation of the equity interests allegedly converted. Golden Belt Lumber Co., 1 T.C. 741, 746 (1943) ; Briggs Co., 5 T.C.M. 366, 372 (1946) ; Wetterau Grocer Co. v. Commissioner, 179 F. 2d 158, 160 (8th Cir. 1950) ; R. C. Owen Co. v. United States, 149 Ct. Cl. 96, 101-102, 180 F. Supp. 369, 372 (1960), cert. denied, 363 U.S. 819. The disputed bonds in this case were clearly a continuation without change of the equity interests of the 'bondholder-stockholders, without new money contributed to plaintiff, and without any change in the operations of the business, with the only benefit or advantage to plaintiff being the tax de-ductibility of interest paid on the'bonds.

Even if the disputed bonds had been valid indebtedness at their inception, subsequent conduct of the parties belie their status as a debt in the taxable years here involved. Though purporting to represent a fixed obligation falling due in 1939, the bonds have remained wholly unpaid up to the present time; at no time have the bondholders even made a demand for payment in whole or in part. While the presence of a maturity date is significant evidence of the presence of debt, this factor loses importance when it is observed in form only. While a reasonable extension of the time for payment is not fatal in itself to plaintiff’s contentions, Wilshire & Western Sandwiches, Inc. v. Commissioner, supra, at 720-721, an extension for an inordinate period gravitates against the presence of a debt. Plaintiff has offered explanations as to why it saw fit to retain cash for other purposes rather than retiring these bonds, but these explanations are not convincing.

As reasons for nonpayment, plaintiff points to the “adverse business and financial circumstances” at the maturity date, and the “hazardous” nature of its business, necessitating a high degree of liquidity to guard against possible adverse trends. Furthermore, plaintiff asserts that it required large cash balances to enable i't to make advances to its subsidiary, American Bleached Goods Company. While the state of the economy in 1939 could conceivably be a valid reason for postponement, plaintiff’s explanation for its continuing failure to pay reveals an attitude implying the presence of an equity interest. By leaving this $7,050,000 to the risks of this “hazardous business,” the bondholders were playing the role of stockholders rather than creditors, for this is a basic distinction between the two types of investors.

In addition, the circumstances surrounding the advances to American Bleached Goods show that plaintiff could act the part of a debtor when such was deemed necessary. On several occasions it borrowed money for this purpose and on each occasion the loan was repaid in full. One such loan in the early 1950’s amounted to $2.4 million.

Proportionality of bondholdings and stockholdings will not void an otherwise valid debt, but it will render the relationship suspect, George E. Warren Corp. v. United States, 135 Ct. Cl. 305, 312, 141 F. Supp. 935, 939 (1956). Here the identity of the bondholders and stockholders appears to be the only substantial factor which would permit such prolonged nonpayment of an alleged debt. Under the circumstances it seems clear that an ordinary creditor would not permit such a prosperous debtor to ignore a $7,000,000 obligation over such a number of years. The evidence shows that from 1939 to 1957 plaintiff had on hand large amounts of cash and liquid assets. While it appears that the needs of the business and principles of sound management required some degree of liquidity, the amounts involved were so large and of such duration as to be inconsistent with an issue of bonds. As with the other factors, nonpayment at maturity is not controlling, but it is effective evidence of an equity interest in situations where no convincing explanation is offered. Thomas Machine Mfg. Co., 23 T.C.M. 1630, 1641-1642 (1964).

During the period in which the alleged bonds were overdue plaintiff paid out substantial amounts as dividend distributions (amounting to over $13 million between 1939 and 1957). Yet no demands were ever made for payment of the bonds; again the inference is that this “debt” could not have been regarded as a serious obligation by the parties. Plaintiff contends that it paid these dividends because it feared imposition of an accumulated earnings tax, since (plaintiff argues) the state of the tax law during the World War II period of prosperity raised doubts as to whether such bond retirement would be a proper purpose for accumulation, sufficient to avoid the accumulated earnings tax. There is arguable authority for the proposition that an accumulation to pay off a debt which could be refinanced is not a reasonable accumulation within the meaning of the accumulated earnings tax provisions, Helvering v. Chicago Stock Yards Co., 318 U.S. 693 (1943). Nevertheless, if it had regarded the bonds as a binding obligation, plaintiff would have felt itself compelled to retire them regardless of the tax consequences. Likewise, a true creditor would not normally consider his debtor’s unfavorable tax aspects of repayment. Having chosen to cast their relationship in the form of a debt, the parties were required to accept the bad with the good. Their unwillingness to do so suggests that a debt was not really present.

Considering the facts as a whole, it is concluded that the “unique factual flavor” of this case is that of equity investment. It is doubtful that plaintiff’s bonds were taxwise a valid indebtedness at the time of their issuance, and certainly by the taxable years involved they should be considered equity capital. Thus, there was no indebtedness upon which interest accrued within the taxable years 1955-1957.

Findings or Fact

1. Plaintiff, Sayles Finishing Plants, Inc., is a corporation organized under the laws of the State of Ehode Island, with its principal place of business located at Saylesville in the town of Lincoln in that state. At all times material herein, plaintiff maintained its books of account and filed its federal income tax returns on the accrual basis and for a fiscal year ending December 31.

2. Plaintiff brings this suit for refund of federal income taxes and assessed interest for calendar years 1955,1956, and 1957 in the amount of $349,907.96, plus statutory interest. Pursuant to agreement of the parties, the trial of this case was limited to the issues of law and fact relating to the right of plaintiff to recover, reserving the determination of the amount of recovery, if any, for further proceedings.

3. On June 16, 1934, plaintiff issued to Nobert B. Dresser, Sinclair Richardson, and Industrial Trust Company, as trustees of each, of the four trusts under the eighth clause of the will of Frank A. Sayles, deceased, certain written instruments in the form of bonds. These instruments are by their terms transferable only at the office of the plaintiff, by the registered owner thereof, in person or by attorney, on the books of the corporation, and are thus referred to as 6 percent “registered” bonds. This refund suit arises from defendant’s disallowance of deductions for interest paid by plaintiff to its stockholders upon said issue of bonds.

4. The aforementioned trusts were trusts for the benefit of Mary A. S. Booker, Martha F. S. Nicholson, Nancy Sayles Day, and Hope Sayles, respectively, and each of such trusts received from plaintiff a portion of the bonds in the principal amount of $1,762,500.

5. Upon the death in 1947 of Martha F. S. Nicholson, beneficiary of one of the aforementioned trusts, the bonds held by the trustees for her benefit were reissued to the trustees in proportionately equal amounts for the benefit of each of her three children, Paul C. Nicholson, Jr., Martha S. N. Livingston 'and W. Sayles Nicholson, in three separate trusts. Up through the years involved in this suit, no other transfers were made.

6. The aforementioned Frank A. Sayles died testate on March 9,1920, leaving as the largest single asset in his estate a textile finishing business conducted in Saylesville, Bhode Island.

7. At the time of Frank A. Sayles’ death, this business was conducted in the form of a “Massachusetts” business trust created in March of 1917. On December 28, 1920, the executors of Mr. Sayles’ will caused the business to be incorporated as Sayles Finishing Plants, Inc., although the will granted this authority not to them, but to the eighth clause trustees. This corporation (hereinafter referred to as “old Sayles”) is not the plaintiff in this suit. As hereinafter related, old Sayles changed its name to Bemaw Corporation. Plaintiff is sometimes hereinafter referred to as new Sayles.

8. Until 1925, the executors of Mr. Sayles’ will and the trustees thereunder were the same individuals. Thereafter different individuáis were involved. After the will was probated, no new executor was appointed. The surviving executors or executor had authority to act and acted for the estate. The surviving executors or executor also continued to act as trustees or trustee, but upon the death of any trustee, appointment was made of a new trustee to fill such vacancy as authorized by the will. By May 15, 1930, there was but one surviving executor, James E. MacColl.

9. On June 10, 1922, the executors caused Eemaw Manufacturing and Investments Company to be incorporated, hereinafter called “old Eemaw.” This corporation was created for the purpose of holding certain investments, but it became inactive in February of 1925 and remained so until May of 1930. Plaintiff (with its present name) is a reorganization of old Eemaw.

10. On May 15, 1930, the sole surviving executor, James E. MacColl, transferred to the trustees of the four trusts under the eighth clause of the will of Frank A. Sayles (Mr. MacColl, Eobert A. Dresser, and Sinclair Eichardson) certain stocks, including all of the issued and outstanding stock of old Sayles (40,000 shares of common stock) and of old Eemaw (100 shares of common stock).

11. Meanwhile, on May 14,1930, the day before the above-mentioned stock transfers, old Sayles gave its consent to old Eemaw to use its name. On the same date, plaintiff as old Eemaw amended its articles of association so as to (a) change its name to Sayles Finishing Plants, Inc., and (b) provide for corporate purposes substantially the same as those of the old Sayles, and (c) authorize capital stock of 35,000 shares of preferred stock of par value of $100 each, and 40,000 shares of common stock of par value of $100 each.

12. The eighth clause trustees made an offer on May 15, 1930, to sell to plaintiff (now Sayles Finishing Plants, Inc., formerly old Eemaw) all of the outstanding stock of old Sayles in exchange for:

(1) $7,000,000 in 6 percent demand notes of plaintiff (new Sayles), and

(2) 30,000 shares of new Sayles’ $100 par preferred stock, and

(3) 20,000 shares of new Sayles’ $100 par common stock (which included the 100 shares of old Eemaw which the trustees had already received from the surviving executor).

Both the demand notes and the stock were to be issued to the trustees, proportionately distributed among the four trusts under the eighth clause of Mr. Sayles’ will.

The trustees’ offer was accepted by new Sayles (old Eemaw) on the same day. The $7,000,000* in demand notes and the shares of common and preferred stock of new Sayles were issued to the trustees for the four trusts. There were two demand notes for each trust, one of $1,000,000 and one for $750,000, with interest payable quarterly-yearly at the rate of 6 percent per, annum.

13. On May 26, 1930, old Sayles amended its articles of association to change its name to “Eemaw Corporation” and to change its authorized capital stock to two shares, with a par value of $100 each. Those two shares were held by new Sayles, which in turn was owned by the trustees. Thereafter, on May 31, 1930, Eemaw Corporation transferred to new Sayles all of its assets except its corporate franchise and any claims it might have had for refund of federal taxes.

14. The operation of the finishing business conducted in Saylesville in the town of Lincoln in the State of Ehode Island after May 15, 1930, was substantially the same as that conducted prior to such date; the same plant, the same personnel, and the same managers were employed. Except for an interim period between May 14 or 15,1930, and May 31, 1930, the officers and directors of new Sayles were the same as those of old Sayles, the only variation being that new Sayles had one additional directorship, which was held by Sinclair Eichardson. After May 31, 1930, the officers and directors of Eemaw Corporation were the same as those of new Sayles.

15. Before May 15,1930, the sole stockholder of old Sayles was James E. MacColl, the sole surviving executor of the will of Frank A. Sayles. Immediately after May 15, 1930, all outstanding shares of new Sayles were owned by the eighth clause trustees. Shortly thereafter, on June 24, 1930, 250 additional shares of preferred stock of new Sayles were issued to the trustees of another trust, created under the seventh clause of Mr. Sayles’ will. Subsequently, on January 2, 1954, 2,223 additional shares of new Sayles preferred stock and 4,800 additional shares of new Sayles common stock were issued to the eighth clause trustees.

16. The comparative balance sheets of new Sayles as of December 31, 1930, and of old Sayles as of December 31, 1929, were as follows:

Assets New Sayles Old Sayles

Capital assets:

Land. $541,832.09 $646,961.37

Buildings.. 4,055,188.31 4,048,481.78

Equipment. 6,610,563.09 6,670,674.02

Water purification system — . 311,890.48 310.873.88

Dams and reservoirs. 179,144.89 179.144.89

Tenement properties_ 1,320,002.37 1,392,702.26

Additions in progress. 268,936.98 62,824.29

Total. 13,277,557.21 13,111,662.49

Less — Reserves for depreciation. $4,648,164.27 $4,299,239.69

Net property account. 8,629,392,94 8,812,422.80

Investments in owned companies — Capital stocks. 3,959,001.00 3,959,001.00

Other investments:

XT.S. Government securities..... $413,320.00 $413,320.00

Other bonds.. 144,610.27 868,853.61

Certificates of deposits and savings account— 1,051,684.93

Loans to affiliated companies.. 335,000.00

Other loans. 139,287.42 303,791.06

Deposits with mutual insurance companies... 43,734.20 44,267.04

Miscellaneous investments, less reserves. 202,724.25 239,354.26

Total... 2,330,361.07 1,859,685.96

Current assets:

Inventories of materials and supplies... $772,984.49 $838,088.23

Accounts receivable — less reserves.. 580,268.85 634,787.01

Current trade accounts of owned companies.. 83,983.73 133,825.08

Accrued charges on uncompleted work. 182,298.99 248,689.77

Cash in banks, on hand. 354,160.62 682,369.00

Accrued interest. 11,690.28 8,300.57

Total...... 1,985,386.96 2,646,960.66

Deferred charges_ 109,948.03 62,065.68

Total assets. 17,014,090.00 17,239,036.00

Liabilities

Capital stock:

6 percent nonoumulative preferred stock. $3,025,000.00

Common stock..... 2,000,000.00 $6,907,905.38

Total.. 6,025,000.00 6,907,905.36

Assets New Sayles Old Sayles

Purchase money demand notes payable to stockholders (6%). $7,000,000.00

Current liabilities:

Accounts payable. 146,893.72 $148,156.22

Accrued expenses. 63,627.89 133,572.93

Reserve for Sayman Company commissions.,-107,689.26

Reserve for federal income taxes. 68,127.47 173,237.54

Total. 278,649.08 562,655.94

Surplus Reserves:

New powerplant, Saylesville.. 600,000.00 500,000.00

Plant development, Saylesville. 600,000.00 600,000.00

Water purification development. 300,000.00 300,000.00

Inventory fluctuations. 100,000.00 200,000.00

Total. 1,600,000.00 1,500,000.00

Paid in surplus. 3,362,764.44

Earned Surplus or (operating deficit). (152,323.62) 9,268,474.70

Total liabilities and capital-..-_ 17,014,090.00 17,239,036.00

17. The valuation of assets of old Sayles reflected in its balance sheet as of December 31, 1929, was based on historical costs.

The valuation of plaintiff’s (new Sayles’) assets reflected on its balance sheet as of December 31,1930, was a carry forward of historical costs of such assets acquired from old Sayles and related generally to plaintiff as a going concern.

18. Old Sayles was in sound financial condition at the time of the various transactions in May of 1930. The stockholders’ equity as of December 31,1929, was $16,676,380 (total assets of $17,239,036, less current liabilities of $562,656). In addition to capital assets (land, buildings, equipment, etc.) of over $8,800,000 and investments in owned companies of almost $4,000,000, those assets included some $1,859,000 in other investments (Government securities, bonds, etc.) and some $2,545,000 in current assets. This asset value of $16,676,380 was reflected on the liability side of the balance sheet of December 31,1929, as follows:

Capital stock_$5,907, 905

Surplus reserves_ 1, 500, 000

Earned surplus- 9,268,475

The value of the assets of old Sayles was carried forward into new Sayles, but was reflected on the liability side of the balance sheet of plaintiff as of December 31, 1930, as follows:

Capital stock-$5, 000, 000

Demand notes_ 7,000,000

Surplus reserves- 1,500, 000

Paid-in surplus (less $152,324 operating deficit shown on balance sheet)_ 3,210,441

Total_16,710,441

During 1930 increases and decreases in the valuation of assets resulted from additions to and dispositions in the normal operations of the pertinent finishing business. Both ;of the balance sheets of December 31, 1929 and 1930, reflect application of the same rates of depreciation to capital assets to reduce the book value of such assets.

19. At the time of the May 1930 transactions, no new money was invested in the pertinent finishing business by the estate of Frank A. Sayles, by the eighth clause trustees, or by anyone else. No new money went to Sayles or Bemaw.

20. The economic depression, which started early in 1930 and lasted for almost the nest 10 years, had a very adverse effect upon the textile industry, particularly in New England. In this context, the transactions of May 1930 were devised by the eighth clause trustees in an attempt to afford greater protection to the trust beneficiaries. These transactions were undertaken in the belief first, that the issuance of $7,000,000 of demand notes would give to the trustees, in the event of plaintiff’s insolvency or bankruptcy, the right to participate with creditors to the extent of $7,000,000; second, that the interest paid upon these notes would be deductible in plaintiff’s income tax returns; third, that if the trustees desired to extract some of 'the capital which they had invested in the finishing business they could retire up to $7,000,000 of the notes without taxation; and, fourth, that the trustees had a convenient means of realizing a part or all of their investment, if they so desired, by selling the notes to a third party, in which event they would still have retained control of the business.

21. In May of 1931, the following transactions occurred:

(a) On May 29,1931, plaintiff (new Sayles) made an offer to Remaw Corporation (old Sayles) to subscribe to 4,998 shares of Remaw’s $100 par value common stock at $100 per share, payment therefor to be made in cash and said stock to be issued on June 1, 1931, and also to pay $200 for the two shares of Remaw common stock then already held by plaintiff.

(b) On the same day, Remaw amended its articles of association to increase its common stock to 5,000 shares of $100 par value and to authorize 70,000 shares of $100 par value preferred stock.

(c) Also on the same day, the eighth clause trustees made an offer to Remaw Corporation to exchange the $7,000,000 demand notes of new Sayles for 70,000 shares of Remaw’s preferred stock, such stock to be issued equally to the four eighth clause trusts.

(d) Likewise on May 29, 1931, at a Remaw stockholders’ meeting (plaintiff as t'he sole stockholder) and at a Remaw directors’ meeting it was voted to amend the articles of association as indicated above, to accept plaintiff’s offer referred to above, to accept the trustees’ offer referred to above, and to resume the carrying on of business. At that time the officers and directors of plaintiff were the same as the officers and directors of Remaw.

Each of the foregoing transactions was consummated. Plaintiff then held all of the common stock of Remaw, just as it had before Remaw increased its common stock from 2 to 5,000 shares; Remaw held the demand notes ($7,000,000) of plaintiff; and the eighth clause trustees (in addition to the previously acquired common stock of plaintiff) held the preferred stock of Remaw. While cash was transferred from plaintiff to Remaw for Remaw’s common stock, there was no new money involved in the overall transactions.

22. From 1931 to 1934, Remaw Corporation was utilized for the purpose of holding investments, and plaintiff continued to be engaged in the textile finishing business.

23. On June 16, 1934, the following transactions occurred: (a) Plaintiff (which was the holder of all of the Remaw common stock, and was itself solely owned by the eighth clause trustees) caused Remaw to retire 4,500 shares of the total number of 5,000 shares of common stock by distributing certain securities to plaintiff.

(b) Eemaw Corporation, by a special joint meeting of its preferred stockholders (the eighth clause trustees) and its common stockholders (plaintiff), and by a meeting of the Eemaw directors, voted to retire 4,500 shares of its common stock as indicated above.

(c) The eighth clause trustees made an offer to plaintiff to purchase the remaining 500 shares of common stock of Eemaw Corporation. The trustees’ offer was accepted by plaintiff, and the transaction was consummated.

(d) A plan of recapitalization and reorganization of plaintiff and Eemaw was determined, involving the following transactions, which were consummated: (1) Plaintiff was to issue its 6 percent registered bonds of an aggregate face value of $7,050,000 (the instruments involved in this suit); and (2) said instruments would be exchanged for all the property and assets of Eemaw Corporation, except Eemaw’s corporate franchise and any claims it might have for refund of federal taxes. The assets of Eemaw consisted of the $7,000,000 in demand notes of new Sayles, and other assets having a net value over and above liabilities of slightly over $50,000.

(e) The common stockholders of plaintiff (eighth clause trustees) approved the sale of all of the remaining Eemaw common stock to the trustees, and approved the above-mentioned plan of recapitalization and reorganization. At this time, the officers and directors of plaintiff were the same as those of Eemaw. For example, plaintiff’s offer to Eemaw was signed by Ethelbert Harman, treasurer of Sayles Finishing Plants, Inc., and Eemaw’s acceptance of the offer was signed by Ethelbert Harman, treasurer of Eemaw Corporation.

(f) The aforementioned bonds were to be, and were, issued by plaintiff in the amount of $1,762,500 for each of the four eighth clause trusts. These bonds were to be, and were, delivered to the trustees upon the surrender to Eemaw by the trustees for retirement and cancellation of all the outstanding stock of Eemaw (70,000 shares of preferred and 500 shares of common).

(g) The articles of association of Bemaw Corporation were then amended to cancel the 70,000 shares of preferred stock and the 500 shares of common stock, and to authorize instead capital stock of four shares with a par value of $100 per share. Thereafter, these four shares were held by the eighth clause trustees. After June 16,1931, Bemaw Corporation became completely inactive and remained inactive until its dissolution on December 80,1960.

24. As a result of the June 16,1934, transactions, plaintiff acquired and cancelled its eight demand notes dated May 15, 1930, which had been outstanding in the aggregate principal amount of $7,000,000. Except to the extent of $50,000 representing the net value of other assets transferred by Bemaw, no additional money was invested in plaintiff in connection with the aforesaid plan of recapitalization and reorganization.

25. After 1930 and until World War II, the general business situation confronting the textile industry in New England was very serious, and many textile plants were closed during this period. At the time of the 1930 transactions plaintiff was in sound financial condition, but thereafter business conditions deteriorated and (except for 1936) plaintiff incurred losses up to 1940.

26. On March 1,1935, the eighth clause trustees and plaintiff entered into an agreement whereby it was agreed that interest at the rate of 6 percent per annum was to be paid annually on the principal amount of $7,050,000 of the bonds involved in this suit, but only from net income (before deduction of that interest and any dividends on the company’s stock), determined in accordance with usual accounting practice, and that such interest was not to be cumulative. At that time, a notation was placed on the face of each instrument, reading as follows:

By the terms of an agreement between the Trustees under the Will of Frank A. Sayles and Sayles Finishing-Plants, Inc., dated March 1, 1935, to which reference is hereby made for a more complete statement of its terms, interest on this bond is, after such date, to be paid annually and only if and to the extent earned during each year, and is not to be cumulative.

27. At the time the 1935 agreement was executed, the trustees and the beneficiaries of the eighth clause trusts did not receive any money or any additional rights or privileges in regard to the disputed bonds.

28. These bonds became due and payable in the aggregate principal amount of $7,050,000 on June 1, 1939. At that time, plaintiff did not have the funds with which to pay off the bonds, and did not know if it would have the money to pay the interest thereon.

29. On June 2, 1939, the eighth clause trustees and plaintiff entered into a written agreement which referred to a portion of the disputed bonds as “Income Bonds,” such portion being held by the trustees in the principal amount of $1,512,-500 under each of the four trusts (a total of $6,050,000). This agreement provided that a long as said Income Bonds remained unpaid, (a) interest should be payable thereon at the rate of 6 percent per annum (in lieu of the interest which would otherwise be payable by operation of law), (b) that each such payment of interest should be made only from plaintiff’s net income (before the deduction of said interest and any dividends on plaintiff’s stock) for each calendar year or shorter period, determined in accordance with usual accounting practice, and (c) that such interest should not be cumulative.

This agreement did not apply to the remaining bonds of an aggregate principal amount of $1,000,000; accordingly, interest on such remaining bonds became payable regardless of the amount of net income earned. Plaintiff has accrued and paid the interest on these bonds, regardless of income, for each year (or shorter period to which such accruals were applicable) from and after June 2,1939.

30. At the time the 1939 agreement was executed, the trustees and beneficiaries of the eighth clause trusts did not receive any additional money or any additional rights or privileges in regard to the disputed bonds.

31. During the period from 1935 to 1962, inclusive, plaintiff has accrued on its books and paid to the holders of the disputed bonds certain sums representing its computation of interest on sucb bonds at the rate of 6 percent per annum, as set forth in the following schedule:

Year of Accrual Income Other Total Bonds Bonds

1936 . $70,600 $70,500

1936 $423,000 . 423,000

1937

1938

1939 53,443 35,000 88,443

1940 . 60,000 60,000

1941 363,000 60,000 423,000

1942 363,000 60,000 423,000

1943 363,000 60,000 423,000

1944 363,000 60,000 423,000

1946 363,000 60,000 423,000

1946 363,000 60,000 423,000

1947 363,000 60,000 423,000

1948 363,000 60,000 423,000

1949 363,000 60,000 423,000

1960 363,000 60,000 423,000

1961 363,000 60,000 423,000

1962 363,000 60,000 423,000

1953 363,000 60,000 423,000

1964 363,000 60,000 423,000

1955 363,000 60,000 423,000

1956 363,000 60,000 423,000

1967 363,000 60,000 423,000

1968 . 60,000 60,000

1959 363,000 60,000 423,000

1960 . 60,000 60,000

1961 363,000 60,000 423,000

1962 363,000 60,000 423,000

Until the March 1, 1935, agreement, the disputed bonds provided unconditionally for interest. The $70,500 item in 1935 in the foregoing schedule represente interest on all of the bonds ($7,050,000) at 6 percent per annum for the period from January 1, through February 28, 1935. Since no net income was earned in 1935, and since the March 1, 1935 agreement eliminated interest on all of such bonds under such circumstances, no further interest was paid for 1935.

The $423,000 item in 1936 was interest paid on all of the bonds ($7,050,000) pursuant to the March 1,1935 agreement.

The $53,443 item in 1939 represents interest for the first 5 months of that year on all of the bonds. The $35,000 item in 1939 was interest for the last 7 months of that year on the $1,000,000 principal amount of bonds to which the June 2, 1939, agreement did not apply. During the last 7 months of 1939, no interest was payable or paid on the $6,050,000 principal amount of Income Bonds pursuant to the June 2,1939, agreement.

The items of $363,000 and $60,000 in the foregoing schedule for the years 1940 through 1962 represent respectively interest on the $6,050,000 of Income Bonds and $1,000,000 of other bonds.

32. During the period 1940 to 1962 inclusive, plaintiff has paid dividends on its preferred and common stock as follows:

6% Noncumulative Preferred Stock Common Stock Total Dividends Paid

1940-

1941. $181,500.00 $181 600.00

1942-181,600.00 181, 600.00

1943. 181,500.00 $100, 000.00 281, 600.00

1944-181,500.00 100, 000.00 281, 600.00

1945. 181,600.00 100, 000.00 281, 600.00

1940_. 181,600.00 2,000, 000.00 2,181, 500.00

1947-181,600.00 1,500, 000.00 1,681, 600.00

1948-181,500.00 1,300, 000.00 1,481, 500.00

1949. 181,600.00 1,200, 000.00 1,381, 600.00

1950. 181,500.00 1,200, 000.00 1,381, 600.00

1951-181,600.00 400, 000.00 581, 600.00

1952.. 181,500.00 450, 000.00 631, 600.00

1953. 181,500.00 300, 000.00 481, 600.00

1954-194,838.00 297, 600.00 492, 438.00

1956. 194,838.00 496, 000.00 690, 838.00

1956-, 194,838.00 297, 600.00 492, 438.00

1957-, 194,838.00 297, 600.00 492, 438.00

1958-

1969-48,709.60 148,800.00 197.609.50

1960-48,709.50 148,800.00 197,609.60

1961-194,838.00 347,200.00 642,038.00

1962-178,546.50 178.646.50

33. From June 16, 1934, to the present time, all shares of plaintiff’s common stock have been held by the eighth clause trustees for the beneficiaries in the same proportions as the $7,050,000 disputed bonds of plaintiff have been held 'by the same trustees for the same beneficiaries.

During this same period, all shares of plaintiff’s preferred stock have been held 'by the eighth clause trustees for the beneficiaries in the same proportion as said bonds, except that 250 shares of preferred stock, issued on June 24, 1930, have been held as follows: (1) From June 24, 1930, until December 12, 1950, the 250 shares were held by the seventh clause trustees. (2) On December 12, 1950, 10 of tlie 250 shares were transferred to Tarsco Corporation, a Rhode Island corporation; and these 10 shares are now held by plaintiff as treasury stock. (3) On January 10, 1951, the remaining 240 shares were transferred as follows: (a) 60 shares to the Estate of Hope Sayles; (b) 60 shares to the trustees of an inter vivos trust established March 10, 1941, by Mary A. S. Booker; (c) 60 shares to the trustees of an inter vivos trust established March 10, 1941, by Nancy S. Day; and (d) 20 shares to the trustees for each of the three children of Martha F. S. Nicholson under an inter vivos trust established by her on March 10, 1941. (4) On August 22,1957, the 60 shares then held 'by the Estate of Hope Sayles were transferred as follows: (a) 15 shares to the eighth clause trustees for each of the trusts for Mary A. S. Booker, Nancy S. Day, and Hope Sayles, respectively, and (b) 5 shares to said eighth clause trustees for each of the trusts for Paul C. Nicholson, Jr., Martha S. N. Livingston, and W. Sayles Nicholson, respectively.

34. The eighth clause trustees are not, and were not, textile men. They normally do not take, and have not taken, any part in the conduct of the business of Sayles Finishing Plants, Inc., and its subsidiaries, except to determine certain major policies to be followed. In regard to such major policies, the trustees from time to time have issued to plaintiff and its subsidiaries a “Statement of Policy.” Matters such as the employment and discharge of executives and important employees, as well as the question of their salaries and any increases or decreases thereof, are normally discussed with the trustees. The trustees decide all questions which are within the functions of stockholders and decide any other questions which the company management submits to them from time to time.

35. Plaintiff owned all the stock of American Bleached Goods Company, a Delaware corporation with offices in New York City, which was engaged in the converting business. In the textile industry, it was a converter’s function to buy unfinished goods (known as “grey goods”) from a cotton mill and send them to a finisher, such as Sayles, to be finished, i.e., to be dyed, bleached, or mercerized. The material processed by a finisher was thus supplied by a converter, who retained title to the goods. After finishing, the goods were sold by the converter to its own customers. Plaintiff finished grey goods for many converters, and American Bleached Goods supplied a substantial part of those grey goods.

36. From time to time in 1935 and 1936, plaintiff borrowed money from the trustees to enable the company to advance money to American Bleached Goods Company, Inc. These loans have been repaid to the trustees.

37. In the early 1950’s, plaintiff made substantial advances of money to American Bleached Goods, Inc., and for this purpose borrowed an amount of $2,400,000 from the Industrial Trust Company (one of the eighth clause trustees). This loan has been repaid.

38. The $7,050,000 principal amount of the disputed bonds became due and payable on June 1, 1939. No payment of principal was made at that time, and no such payment has yet been made. The trustees have not, at any time on or after June 1,1939, demanded payment of the principal amount of these bonds.

39. From 1939 until 1957, inclusive, plaintiff had on hand (1) cash and marketable securities and (2) miscellaneous investments primarily in the form of United States government securities, ‘as follows:

Year Ending December 31 Cash and Miscellaneous Marketable Investments Total Securities

1939. $518,184 $518,184

1940. 426,438 426,438

1941. 237,977 237,977

1942. 1,602,164 1,502,164

1943. 3,269,715 $770,503 4,040,218

1944. 2,609,396 1,270,503 3,879,899

1945. 2,855,665 3,035,000 5,890,655

1946. 2,542,546 3,585,000 6,127,646

1947. 1,990,139 4,051,564 6,041,703

1948. 1,654,059 3,485,000 5,139,059

1949. 1,019,554 3,050,000 4,069,564

1950. 1,235,074 1,500,000 2,735,074

1951. 1,834,406 1,500,000 3,334,406

1952. 1,629,454 800,000 2,429,454

1953. 1,550,467 2,604,000 4,154,467

1954. 1,381,089 3,402,032 4,783,121

1955. 2,072,741 3,202,176 5,274,917

1956. 3,250,335 2,904,000 6,154,336

1957. 892,416 6,500,000 7,392,416

40. Pursuant to extension of time granted, plaintiff filed its federal income tax return for the calendar year 1955 on June 15, 1956, and made payment of the tax thereby shown to be due in the amount of $651,282.70 to the District Director of Internal Revenue a't Providence, Rhode Island, in installments as required by law on or before that date. On or about August 20,1957, plaintiff paid an additional tax assessed for the year 1955 in the amount of $8,070.70.

41. Pursuant to extension of time duly granted, plaintiff filed consolidated federal income tax returns for itself and subsidiary companies for the years 1956 and 1957, and made payment of the amounts of tax thereby shown to be due to said District Director, as set forth below:

Year Date of flllng Amount of Tax

1956. September 13,1957. $17,885.40

1957. September 15, 1958. 2,323.00

42.In preparing its federal income tax returns and computing its net taxable income and the taxes thereon for the years 1955, 1956, and 1957, as indicated above, plaintiff claimed as a deduction in each return the amount of $423,000 as interest accrued and paid on the aforementioned issue of disputed bonds. Upon audit of plaintiff’s income tax returns for the years 1955,1956, and 1957, the Commissioner of Internal Revenue disallowed those deductions on the ground that those payments constituted distributions of profits as dividends and not payments of interest on indebtedness. By letters dated September 25,1959, the District Director, acting for the Commissioner, notified plaintiff of proposed tax deficiencies as follows:

For 1955_$219, 960. 00

For 1956_ 227, 536. 60

For 1957- 208, 692.00

Plaintiff has at no time agreed to the correctness of such tax deficiencies and has at no time executed or filed any assent or agreement thereto.

43. Tbe proposed tax deficiencies were assessed on November 12,1959, and that same day plaintiff paid the deficiencies and assessed interest as follows:

Year Tax Assessed Total Deficiency Interest

1955. $219,960.00 $48,303.82 $268,263.82

1956. 227,636.60 36,315.46 263,852.06

1957. 208,692.00 20,786.29 229,478.29

Totals. 656,188.60 105,405.67 761,694.17

No contention is made by defendant that the aforesaid payments by plaintiff were voluntary.

44. As the result of an audit of the federal income tax return of plaintiff and its subsidiary companies for the year 1958, the Commissioner of Internal Revenue determined that there was a net operating loss to be carried back and applied, as prescribed by statute and regulations, in redetermining the net taxable income and tax thereon of plaintiff for the year 1955 and of plaintiff and its subsidiaries for the year 1956. On April 28, 1961, as a result of that redetermination, the Commissioner, acting through the District Director, issued certain Notices of Adjustment on Form 1331-B to plaintiff for itself and its subsidiaries, setting forth in section I thereof (entitled “Computation of Overassessments”) adjustments as follows:

Overassessment OÍ Income Tax OI Interest Year

$705,834.02 $11,431.91 1955.

171,386.88 8,907.42 1966.

877,220.90 20,339.33 Totals..

With these notices, the District Director tendered to plaintiff, for itself and its subsidiaries, certain checks for the amounts set forth in. section II of said Form 1331-B (entitled “Disposition, of Overassessments and Overpayments”), described therein as follows:

Year Tax Interest Total

1955. $717,265.93 $85,454.61 $802,720. 54

1956..... 180,294.30 15,164.48 195,458.78

Totals.... 897,560.23 100,619.09 998,179.32

Plaintiff acknowledged receipt of those cheeks by letter, dated May 5,1961, which letter stated that plaintiff accepted the checks and the refunds of tas and interest thereon without prejudice to its right further to contest the determination of the amount of tax and the basis thereof for the year in question, and the findings of fact and Jaw upon which that determination had been based. In that letter, plaintiff reserved the right to recover, by suit or otherwise, any additional refunds to which it might be entitled.

45. On October 30, 1961, plaintiff filed with the District Director claims for refund of income taxes paid for the years 1955, 1956, and 1957, together with interest thereon. Those claims'recited that refunds for the years 1955 ‘and 1956 based upon net operating loss adjustments had been received by plaintiff, as indicated above, and that further refunds were due and owing plaintiff and its subsidiary companies in the following amounts:

1955_$36, 871. 91

1956_ 83, 557. 76

1957_ 229,478.29

Total_ 349,907.96

In each of these claims plaintiff requested a finding by the Commissioner of Internal Kevenue that such refunds and previous refunds were based upon the allowance of deductions for interest paid by the taxpayer and not upon the carryback of net operating losses from later years, except that the refund claim for 1957 made no reference to a carry-back of net operating losses.

46. Oil January 8,1962, tbe Commissioner, acting through the District Director, disallowed those claims for refund. Plaintiff’s petition in this suit was filed within two years from the disallowance of its claims for refund.

47. Plaintiff is and has been at all times the sole and absolute owner of this claim and has not assigned or transferred the claim or any interest therein. Except as set forth above, no other action has 'been had on the claim which is the subject of this suit, in Congress or by any government department or in any judicial proceeding, including any action in the Tax Court of the United States.

Ultimate FINDING of Fact

48. Plaintiff’s bonds do not actually represent valid debts of the corporation but represent in effect equity interests in plaintiff. The amounts accrued and paid to the trustees as holders of such bonds were not interest payments, but rather distributions of profits or dividends.

CONCLUSION OF Law

Upon the foregoing findings of fact and opinion, which are adopted by the court and made a part of the judgment herein, the court concludes as a matter of law that plaintiff is not entitled to recover, and the petition is dismissed. 
      
       Section 163 of the Internal Revenue Code of 1964, 68A Stat. 46, provides for deduction of all interest paid or accrued within the taxable year on indebtedness.
     