# Appendix — Union Pacific Railroad v. United States

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URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385004_0008%3A2

## Record

- **Collection:** Supreme Court brief
- **Document type:** Appendix
- **Published:** January 1, 1976
- **Citation:** 429 U.S. 827

## Text

f iy Or ia7&
In THE oe |

Supreme Court of the United States!!!
Ocroper Term, 1975

No. 25> 1 v4 | 8

—

Union Paciric Ramroap Company,
Petitioner,
—V.—
THe Unirep Staves or AMERICA,
Respondent.

PETITION FOR A WRIT OF CERTIORARI TO THE
UNITED STATES COURT OF CLAIMS

APPENDIX B

Opinion of Court of Claims

Rosert J. Casey,
Attorney for Petitioner,
330 Madison Avenue,
New York, N. Y. 10017.

Joun A. Craic,
Suea Goutp Ciimenko Kramer & Casey
330 Madison Avenue,
New York, N. Y. 10017
Of Counsel

—

ee see LO Bee

ee POE ee Eee eee ye eee De ek Vee fee

43

The source of both the professional preference and legal re-
quirement for an annual charge to income is the character of
bond discount as interest, a cost of borrowing, and the conse-
quent feeling that both types of interest—coupon interest and
the discount variety—should equally be reflected in the in-
come account by an annual expense item, else income 1s
overstated. An immediate write-off against earned or paid-in
surplus, in effect a charge to past income or to capital, is an
over-statement of income by the annual cost of the borrowing.
Plaintiff’s charge of the entire discount to surplus was thus
inconsistent with the nature of discount and cannot give
grounds for characterizing it as an asset. =
In a final effort to show that discount is an asset, apy
ur with support in the expert testimony given on trial,
that the ated portion of bond discount would have
value to a purchaser of the business, as a source of future tax
deductions. Such value is surely limited. Unamortized dis-
count would have no value to a purchaser of the assets, no
weight to a lender considering a loan. It has not been bought
or paid for, it produces no income and it could not be sold or
assigned. The value it might have to a purchaser of the going
business, as a source of income tax deductions, could only be
realized if profits were made by the use of the admitted assets
of the enterprise. That purchase, moreover, would find the
same “value” in the obligation to pay the fixed, coupon rate
of interest, which like the annual accumulated share of dis-
count, must each year be a charge on income. Discount, actu-
ally a cost to be defrayed in the years to come, has the same

f failure to include accruing discount in interest charges. It

= ¢oecometinelinnntn to accrue the entire amount of discount at one stroke
by a charge to income or surplus, and if income and surplus are not avail-
able in sufficient amount the result is a deficit. Similarly, if premium has not
been amortized this means that there has been no recognition of the oe
Mability from issue price to maturity value—that profits have been un “
stated throughout the life of the business by failure to exclude from —
charges the amortization of premium. It then becomes necessary to ry -
entire amount of premium to income or _— in one figure as a
orrection of the proprietary equity.” Jbid., .
. “Cole phen pe omer-n accepted accounting principles, bond discount and
expense should be written off over the life of the issue by periodic —
against income. In the past, debt discount and expense was often c ame
off to earned surplus at the date of issue, or at a later date; this procedure
is no longer acceptable.” N. J. Lenbart & P. L. Defilese, Montgomery’s
Auditing, eupro note 15, 811-12.

44

type of value, as a source of income tax deductions, as the
corporation’s contracts with its executives, the lease of its
premises, its pension plan, or, for that matter, a large tax loss
carried over from past years. All give rise to tax savings.
Since such “value” does not make an asset of next year’s tax
loss, it cannot transform unamortized bond discount from
unpaid interest to an asset, at least for purposes of an excess
profits tax based on concepts of invested capital and total
assets,

There remains the unamortized bond expense. It, too, must
be regarded as is unamortized bond discount—as a non-asset.

Bond issuance expense may differ factually from bond
issuance discount, in that expenses are actually paid out for
services such as printing, legal fees and commissions, and,
sometimes or always to an extent, are paid out by the issuer
itself as distinguished from the issuer’s underwriter. Accord-
ingly, some accounting authorities distinguish between dis-
count and expense, and hold the latter to be a genuine asset.2?

If the question were open for fresh decision, perhaps the
unamortized portion of bond expense paid out by the issuer
(as distinguished from expenditures for services by under-
writers which merely reduce the proceeds of sale paid over
to the issuer) might be held to be an asset. Plaintiff has, how-
ever, failed to show that the bond issuance expenses here
involved were of any different character than those held in

=“It is common practice to lump actual discount with the legal fees,
printing costs, underwriting commissions, and other charges associated with
the issuing of bonds, but this is not good accounting. The various service
costs which must be incurred in ralsing capital are a genuine asset (not a
money fund but a legitimate cost factor) and should be dealt with accordingly.
Where such costs are incurred in issuing a terminable security it is reasonable
to assume that their significance expires during the life of the security, and
complete amortization in this period is therefore indicated.” W. A. Paton,
Advanced Accounting, supra note 17, 612.

“Charges connected with the issue of new bonds—euch as legal expenses in
preparing the bond contract and mortgage, cost of printing certificates, regis-
tration costs, commission to underwriters, etc.—are costs of tie use of
capital obtained for the whole life of the issue and should be written off
over that period. * © *¢

“It ls common practice to lump these costs with actual discount (or net
them against premium, as the case may be). Good accounting requires careful
distinction between a true asset and bond discount, which f{« properly an
offset to the maturity value of the bonds.” R. Wixon, W. G. Kell, & N. M.
Bedford, Accountants’ Handbook, supra note 17, 20.39.

45

Helvering v. Union Pacific R.R. Co., supra, to be as much
interest as bond issuance discount.**

In Helvering v. Union Pacific R.R. Co., the Supreme Court
held that commissions paid out on the issuance of bonds, one
of the customary bond issuance costs, were to an accrual tax-
payer (as is the instant plaintiff) to be capitalized, amortized
over the life of the bond and the amortized amount deducted
annually from income. The decision has been applied in this
court to bond issuance costs generally. Chicago, Milwaukee
R. Co. v. United States, 186 Ct. Cl. 250, 262, 404 F. 2d 960,
967 (1968).

The Supreme Court in its opinion said that discount and
expense were both “factors in arriving at the actual amount
of interest paid for the use of capital procured by a bond
issue” which “must be added to the aggregate coupon pay-
ments in order to arrive at the total interest paid.” 293 U.S.
at 286. The Court went on as follows (293 U.S. at 286-87) :

But even if the commissions, unlike discount, may, as
the Government insists, be rded as a contemporary
expense of procuring capital, it is one properly charge-
able to capital account. ractice it is taken out of the
proceeds of the bonds by the banker. But in any case it
must be deducted from the selling price to arrive at the
capital realized by the taxpayer from the sale of the
bonds, in return for which he must, at maturity, pay the
face value of the bonds. The effect of the transaction in
reducing the capital realized, whether through the pay-
ment of commissions or the allowance of discount, is the
om °° * aS

Here the commissions, when paid, were properly
chargeable against capital, and reduced by their amount
the capital realized by the taxpayer from the bond issue.
They come out of the pocket of the taxpayer only on
payment of the bonds at maturity. But, unlike the pur-
chase and sale of property, the transaction contemplated

a

f the copy ed date, the due date of the
bende at which the difference between the net amount of

= The burden of proof on the issue, though raised by defendant's setoff,
is on the plaintiff-taxpayer, for the contested issue is obviously one of sub-
stance and is involved in the very tax return on which plaintif! seeks a
refund. Missouri Pactfio Railroad Co. v. United States, 168 Ct. Cl. 86, 338 F. 2d
668 (1964).

46

capital realized upon the issue and the par value of the
bonds must be paid to bondholders by the taxpayer.

*_* *

Given the Supreme Court’s ruling on the essentia] same-
ness of discount and expense, albeit in an income tax case, the
decision in the instant case can only be that expense goes with
discount, and since discount is surely not an asset, expense,
too, is not an asset. |

Accordingly the defendant is entitled to prevail on ad-
ditional defense 9.

IX. DISCOUNT AND PREMIUMS

In additional defense 6, also involving bond discount and
expense, the Government contends that plaintiff erroneously
failed to treat as “interest,” under section 711(a)(2)(B) (26
U.S.C. § 711(a)(2)(B) (1952)), amortized bond discount
and expense for 1940-42 (excess profits tax credit carryovers
for 1940 and 1941 are involved, in addition to 1942 taxes),
and call premiums and unamortized bond discount paid out
when certain bonds were retired in 1940 at their face value
plus a premium, as required by their terms on an early
retirement.

Under section 719(b) (26 U.S.C. §719(b) (1952)) only
50 percent of borrowed capita] may be included in invested
capital and, consistently, when invested capital is the method
used (as it is here) to determine the excess profits credit
(which in turn is the basis of the tax), interest deductible

from excess profits net income is required by section 711(a)

(2) (B), supra, to be reduced by 50 percent of the interest on
borrowed capital. In other words, since only half of borrowed
capital may be included in invested capital for purposes of
the credit, only half of the interest paid on borrowed capital
is allowed to be deducted from income for purposes of this
tax. See Amana Refrigeration, Inc. v. United States, 152 Ct.
Cl. 406, 410, 285 F. 2d 770, 772 (1961).

Plaintiff and its subsidiaries deducted in full—that is, did
not reduce by 50 percent—a certain sum of $10,253,706.34,
composed of $546,273.70, the amount of amortized bond dis-
count and expense in the tax years 1940-42, $3,265,051.46, the
amount of unamortized bond discount remaining in 1940, the

47

year of the retirement of a certain bond issue, and paid on
the retirement, and $6,442,381.18, the call premium paid in
that year on the retirement.

In additional] defense 6, defendant contends that these de-
ductions were all for “interest” and pursuant to section 711
(a)(2)(B) must be halved. Plaintiff maintains, to the con-
trary, that amortized discount and the call premiums were
ordinary and necessary business expenses under section 23 (a)
of the 1939 Code, and that the unamortized bond discount on

the bonds reacquired at face value plus call premiums wasa __

loss under section 23(f) of the 1939 Code.

The regulations provide that on retirement of bonds issued
at « discount the excess of the price paid over the issue price
plus the amount of discount already deducted is a deductible
expense, Treas. Reg. 111, § 29.22(a)-17(3) (1943). The regu-
lations are not helpful in determining whether the amounts
are deductible as “interest.”

Bond discount has already, in the preceding section of this
opinion, been noted to be essentially interest. Helvering v.
Union Pacific R.R., 293 U.S. 282, 286 (1934). See Frie Lacka-
wanna R.R. v. United States, 190 Ct. Cl. 682, 686, 422 F. 2d
425, 427-28 (1970). To the seller the difference between the
discounted purchase price of a promissory note and the higher
sale price is held to be ordinary interest income. United States
v. .idland-Ross Corp., 381 U.S. 54 (1965). The precise ques-
tion has been several times decided, in favor of the Govern-
ment. Discount has repeatedly been held to be interest under
section 711(a)(2)(B) or its successor in the Excess Profits
Tax Act of 1950, section 433(a)(1)(O), ch. 1199, 64 Stat.
1187, 1148, 26 U.S.C. §433(a)(1)(O) (1952). Central
Stations Signals, Inc. v. Commissioner, 10 T.C. 1015, 1020-21
(1948), affirmed per curiam, 174 F. 2d 479 (2d Cir. 1949) (fi-
nance charge for factoring contract held interest under sec-
tion 711(a)(2)(B) and not expense) ; Warne? Co. v. Com-
missioner, 11 T.C. 419, 432 (1948), affirmed per curiam, 181
F. 2d 599 (3d Cir. 1950) (amount of state tax on loans, im-
posed on bond purchaser but paid by issuer in addition to in-
terest, held interest under section 711(a)(2)(B) and not a
tax); L-R Heat Treating Co. v. Commissioner, 28 T.C. 894,
897 (1957) (negotiated bonus for loan withheld by lender

48

from loan proceeds, in addition to 6 percent interest, held
interest under 26 U.S.C. § 433(a)(1)(O) (1952 ed.) ; Ring-
master, Inc. v. Commissioner, August 6, 1962, T.C. Memo
1962-187, 21 TCM 1024, 1030-32, dismissed per curiam, 319
F. 2d 860 (8th Cir., 1963) (amounts paid as commissions for
securing loans held interest under § 433(a) (1) (O), not bro-
kerage fees).

The amounts of bond discount already amortized are thus
to be deducted as interest. It may well be that an interest ex-
pense is also an ordinary and necessary business expense, but
it is interest on borrowed capital and thus within the intent
and subject to the reach of section 711(a) (2) (B).

Unamortized bond expense on bonds reacquired, and call
premiums payable and paid at such retirement prior to
maturity, are no different in principle from amortized bond
discount. When an issuer sells bonds at a discount, the en-
tire difference between issue price and face value is interest,
to be paid at maturity, and to be charged to income each
year and accumulated over the life of the bonds. Whether the
bonds are early retired, pursuant to the terms of the issuance,
by payment of face value plus a call premium, or are retired
on maturity by payment of face value alone, there is no dis-
tinction to the lender or borrower between the constituent
parts of the amount of discount on the loan.

What has been said indicates that call premiums, too, are
additional interest, in this case payable for the privilege of
converting a longer term loan to a shorter. A payment closely
similar to a bond call premium, a charge paid by a borrower
when he prepays, before maturity, the principal of a mort-
gage or promissory note, has been held in this court to be
“interest” gross income to an insurance company. In Equit-
able Life Assurance Society v. United States, 149 Ct. Cl. 316,
319, 181 F. Supp. 241, 242, cert. denied, 364 U.S. 829 (1960),
the court held:

The precise —— before us was considered by the

Tax Court in General American Life Insurance Com-
pany, 25 T.C. 1265 (1956). That court decided that pre-

yment are in reality an additional fee for the
use of the len money for a shorter period of time
than originally upon, and that this fee represents
the generally er cost of a short-term, as opposed to a

49

roar by vane loan. The charges are part of the compensation

to the lender for the use of money. Deputy v. duPont, 308

U.S. 488, 498; Old Colony R. Co. v. Commissioner, 284
U.S. 552, 560-61. They are thus directly related to the
economic cost of borrowing money and are not merely
incidental to the loan transaction, but fall within the
statutory term “interest.”

See also The Prudential Insurance Co. of America v.
United States, 162 Ct. Cl. 55, 65-66, 319 F. 2d 161, 166-67
(1963) ; United Benefit Life Insurance Co. v. McCrory, 242
F. Supp. 845, 850-51 (D.C. Neb., 1965) (penalty payment for
early repayment of mortgage held interest income of life in-
surance company). Contrary dicta in Central & South West
Corp. v. Brown, 249 F. Supp. 787 (D.C. Del., 1965), cannot
prevail over the cited authorities.

There would be no rational basis, in the light of the es-
sential sameness of character between discount and call
premiums, for holding one to be and the other not to be inter-
est under section 711(a) (2) (B). The sums over the original
amount of the loan constitute compensation for the use of the
money—interest—payable when the loan is repaid, whether
earlier than contemplated or on schedule. The early repay-
ment is for the convenience of the borrower and works no
change in the nature of the payment as interest. The deci-
sion here is, I believe, all but concluded by the decision of this
court that difference between agreed redemption price and
issue price (in a case of non-interest-bearing debentures re-
deemed a year after iseue) is income “in lieu of the payment
of interest,” because it constituted “the agreed compensation
for the use of the purchaser’s money for the prescribed pe-
riods.” Pattiz v. United States, 160 Ct. Cl. 121, 127-28, 311 F.
2d 947. 950 (1963). If part of that difference is a loss, it is a
loss which is in the form of additional interest payable for
the privilege of early retirement. Cf. Helvering v. Union
Pacific R.R., 293 U.S. 282, 286 (1934) .**

* Both commissions and discount, as the Government concedes, are factors
in arriving at the actual amount of interest paid for the use of capital
procured by a bond issue. The difference between the capital realized by the
issue and par value, which is to be paid at maturity, must be added to the
aggregate coupon payments in order to arrive at the total interest paid.
Both discount and commissions are included in this difference. If the dif-
ference be viewed as a loss resulting from the funding operation, it is one
which is realized only upon the payment of the bonds at maturity.”

594-093—75——4

50

Against the foregoing wealth of authority, plaintiff puts
forward only inferences from the legislative history of a
nearby section, section 711(b)(1)(D), added by section 201
of the Second Revenue Act of 1940, ch. 757, 54 Stat. 974,
26 U.S.C. §711(b)(1)(D) (1952). Section 711(b) (1)
(D), not involved in the instant case, disallows certain de-
ductions from taxable income of expenses and losses on the
retirement or discharge of bonds, issued at a discount and
outstanding for more than 18 months, in computing excess
profits income for base period years beginning before Janu-
ary 1, 1940, the computation of which is necessary where the
excess profits credit is based on average income rather than
invested capital.

The House bill which became section 711(b)(1)(D) read
much as does the section in final form, and affected only the
computation of excess profits net income for base period
years, not here involved. H.R. Rep. No. 2894, 76th Cong., 3d
Sess. 13, 14, 19 (1940). The Senate Finance Committee, how-
ever, extended the provision to the computation of excess
profits net income for the later years as well-—the years in-
volved in the instant case—to apply whether income was to
be based on either income credit or invested capital method,
thereby proposing an amended section 711(a) (2) which had
it been enacted would have disallowed “the deduction other-
wise allowable under section 23(a) for expenses paid or
incurred in connection with such retirement or discharge
(including any premium paid upon any such retirement or
discharge), the deduction for losses otherwise allowable in
such connection, and the deduction otherwise allowable on
account of the issuance of the bonds or other evidence of
indebtedness at a discount.” S. Rep. No. 2114, 76th Cong.,
3d Sess. 11-12 (1940). At the same time the committee was in
the quoted words speaking of disallowing “expenses” and
“losses,” plaintiff emphasizes, the committee spoke of “inter-
est” as the subject matter of section 711(a) (2) (B). S. Rep.
No. 2114, supra, at 12. The conference committee report elim-
inated the proposed change for all years, retaining it only in
section 711(b)(1)(D) for the base years. H.R. Conf. Rep.
No. 3002, 76th Cong., 3d Sess. 46 (1940).

51

Plaintiff would see in the Senate’s bill an understanding of
Congress that the deductions for amortized bond discount,
unamortized bond discount and call premium were expenses
and losses rather than interest. In other words, that proposed
change in the law was on the premise that discount and pre-
mium were not, as interest, already subject to section 711(a)
(2) (B).

The contention aggrandizes an ambiguous legislative inci-
dent into the full-blown status of an intent of the whole Con-
gress of material significance on the construction question
which is presented. It may be, as plaintiff contends, that the
premise and thus the understanding of the framers of the
Senate bill was that call premiums and unamortized bond dis-
count were not interest covered by section 711(a) (2) (B).
It may also be that though believing that such items, as inter-
est, were subject to section 711(a) (2) (B) and thus to halving
only, the draftsmen desired to change the law and achieve a
100 percent disallowance, and thought that section 711(b)
(1)(D) was a convenient vehicle because discount and the
like were also expenses and losses. We do not know the prem-
ise of the Senate bill. We do know that the conference com-
mittee rejected the bill as drawn in the Senate, and so what-
ever was the premise of the Senate bill, it was not Congress’
premise, |

The conference committee’s thinking is equally unknown.
Its report gives only the fact of what it did.** We do not
know if it felt that discount and call premiums were interest,
already covered by 711(a) (2) (B), and should not be treated
as losses and expenses under section 23, or whether it felt that
such items were not interest, but should nevertheless not be
disallowed in full. But whatever were the conference com-

* The committee said :

“(2) The adjustment requiring that certain deductions otherwise al-
lowable on account of the retirement or discharge of bonds, etc., should
be excluded from the computation has been eliminated for taxable years
after the base period. As retained relative to taxable years in the base
period, it has been redrafted so as to make certain that the excluded
deduction on account of the issuance of bonds, etc., at a discount relates
only to discount unamortized on the date of the retirement or discharge.
The ordinary deduction for amortization of bond discount accrued for
that portion of the taxable year preceding the retirement or discharge
is not to be excluded from the computation.” H.R. Conf. Rep. No. 3002,

supra, at 46.

52

mittee’s views, it cannot be said that it concurred in the ver-
sion of the Senate’s view which squares with the plaintiff’s
position.

The Senate’s view, whatever it was, was surely not the
intent of Congress in enacting or construing section 7i1(a)
(2) (B). The understanding of existing law by one house in
the course of legislation, at least in such ambiguous circum-
stances as are here present, cannot be given effect as the intent
of Congress. Too many doubts and questions would surround
the result, and as nas been said, it is the function of legislative
history to resolve doubts and not to create them. The indeci-
sive evidence of legislative intent presented by plaintiff may
not gainsay the abundant authority, set out above, supporting
the conclusion that amortized bond discount, unamortized
bond discount and call premiums paid on retirement of bonds
are, all, interest under section 711(a) (2) (B).

The Government is entitled to prevail on additional
defense 6.

X. DONATIONS AND CREDITS

By count 17 and related counts, plaintiff seeks to add
$3,675,562.72 to its equity invested capital for the year 1942
and $9,798,364.02 and $9,891,701.23 to the equity invested
capital of its subsidiaries and itself for the respective years
1940 and 1941, when it filed returns consolidated with its
subsidiaries.** The additions would decrease plaintiff’s tax
by increasing its excess profits tax credit for 1942 and its
unused consolidated excess profits tax credit carryover from
1940 and 1941 to 1942.27

* Counts 17, 21 and 24 directly seek the increase in equity invested capital
described in the text. Counts 19, 22 and 25 seek consistent treatment for pur-
poses of computing total assets.

To put the issue in ite context, it may be sald that the Excess Profits
Tax Act of 1940, as amended in 1942, levied a tax of 90 percent (subject to a
post-war credit of 10 percent and an overall ceiling of 80 percent on combined
income and excess profits tax) on corporate “excess profits net income” remain-
ing after an allowance of an exemption and an excess profits credit represent-
ing normal profit. Title II, Second Revenue Act of 1940, as amended, § 710
et seq., 54 Stat. 974, 975, as amended, I.R.C. (19389) as amended, § 710 et #eq.,
26 U.8.C. (1940 ed. and Supp. II). The taxpayer wae given the alternative of
computing the credit on the basis either of average income over a base period
or (the method chosen by plaintiff) “invested capital.”

53

These sums are the account balances, as of the close of the
years in question, representing facilities which were con-
structed with or composed of the cash and property trans-
ferred by nonstockholders to plaintiff and its subsidiaries in
literally thousands of “donations and grants” from non-
shareholders during the years 1914 through 1942. No income
tax was paid on the receipts. They were recorded as assets in
the books of plaintiff and its subsidiaries (henceforth, to-
gether, called the plaintiff) and were held in the tax years in
question for use in plaintiff’s trade or business.

The Commissioner of Internal Revenue with a few
exceptions disallowed the inclusion of these manifold dona-
tions and grants in plaintiff’s equity invested capital. Plain-
tiff challenges the disallowance. In a defense of setoff, the
Government challenges the Commissioner’s allowance of the
inclusion in equity invested capital of six donations and
grants.

The parties have by agreement reduced the thousands of
transfers involved to 56, to represent all the transfers, and
they have also agreed, in the course of their proposals for
findings, upon individual transfers to represent the several
classes of transfers. These classes are as follows, the amounts
stated being those for transfers made prior to January 1,
1940:

Class 1, by far the largest, accounting for $5,992,110 of the
$9,798,364 involved, is governmental transfers to relocate line
on account of dams. It is represented by transactions in which
the Federal Government paid the plaintiff the cost of relocat-
ing or protecting such parts of its line as would be flooded or
threatened by a rise in water level by reason of a Govern-
ment dam about to be built.

The Act took a historical approach to the computation of invested capital ;
it would be composed of “equity invested capital” or the total money and
property paid in and left in the corporation (excluding “inadmissible assets”
such as stocks and bonds), a prescribed percentage of outstanding borrowed
capital and accumulated earnings and profits up to the beginning of the taxable

ear.
: Once invested capital is determined, graduated percentages are applied to
determine the excess profits tax credit. The percentages in 1942 were 8 percent
of the first $5 million of invested capital, 7 percent of the next $5 million,
6 percent of the next $190 million and 5 percent of amounts over $200 million.
The Act was repealed in 1945. 59 Stat. 556, 558.

54

Class 2, $251,669, governmental transfers to relocate line
on account of highways, is represented by a case in which the
City of Long Beach, as part of a plan to build a new high-
way, by agreement paid the plaintiff $240,000 for the latter’s
right to operate on certain streets and the right to use, for
pedestrian and vehicular traffic, the plaintiff’s drawbridge
across a harbor entrance.

Classes 3 and 4, $1,947,206, governmental transfers for
highway underpasses and other highway construction, are
represented by transfers in which a state or city, in the inter-
est of public convenience and safety, and in many cases us-
ing federal funds made available for the purpose, paid the
cost of railroad highway crossings such as a new grade cross-
ing or the replacement of a viaduct with a highway subway
under the railroad’s line. These transfers are governed by
United States v. Chicago, Burlington & Quincy R.R.,
412 U.S. 401 (1973), in which substantially identical ** trans-
fers were held not to effect contributions to capital.

Class 5, $320,601, governmental miscellaneous transfers,
is divisible as follows: (1) 12 percent is represented by trans-
fers substantially identical with classes 3 and 4; (2) 87.2 per-
cent is represented by payments for fences and street lights
on land leased from the plaintiff, cables for utility lines,
water mains and irrigation waterways under the right-of-
way, and (3) 0.8 percent is represented by a transfer to build
sanitary facilities on the plaintiff’s premises.

Class 6, $891,354, private transfers for spur and other
tracks, is represented by several transfers by shippers for
the construction of spur tracks to the transferor’s plant or
installation and two transfers by nonshippers, one identical
with those in class 1, supra, except that the transferor was a
private power company, and the other a railroad with whom
plaintiff maintained a joint installation at a highway crossing.

Class 7, $395,422, private miscellaneous transfers, is repre-

It is of no consequence that it does not appear in the instant case, as it
did in Ohicago, Burlington 4 Quincy R.R., supra, that in all of the transfers
the taxpayer railroad assumed a contractual obligation to maintain and repair
the facility which was the subject of the transfer. There is every reason to
expect that a railroad will in fact maintain, repair and renew the facilities
which it owns, in this context typically that portion of a subway structure
upon which its track rests or that portion of a grade crossing which it owns.

55

sented by vransfers involving payments for street lights on
leased property paid for by the lessees; a private road and
gates across the right-of-way for the use of, and paid for by,
the owner of the land on both sides; feed racks and a scale
paid for by a stock yard for its use; a culvert needed and
paid for by a water company; a storage facility and a power
line for the use of an express company, paid for by it; and a
retaining wall needed for a spur track to a shipper’s plant,
paid for by the shipper.

The issue is whether the facilities built with the cash and
property transferred may properly be treated as “money”
and “property” “paid in” by nonshareholders “as a contribu-
tion to capital,” and thus includible in equity invested capital
under the 1939 Code.** See Treasury Regulations 112
§ 35.718-1 (1944).

The dispute centers first on classes 1 and 2 of the transfers
in question. As noted above, classes 3 and 4 are governed by
Chicago, Burlington & Quincy R.R., supra, and classes 5-7
are of a miscellaneous nature whose disposition will best
be discussed after decision on classes 1 and 2.

In briefs filed before the decision of Chicago, Burlington &
Quincy R.R., supra, plaintiff contended that the transfers
were made to induce the construction and operation of its
railroad for the service and safety of the public and were
therefore contributions to capital under Edwards v. Cuba
R.R., 268 U.S. 628 (1925). See Tewas &: Pacific Ry. v. United
States, 286 U.S. 285 (19382). Edwards v. Cuba R.R., supra,
held that payments of money and property by the Govern-

*=§ 718, Equity invested capital—(a) Definition.

The equity invested capital * * * shali be the sum of the following
amounts * * *

(1) Money paid in.

Money previously paid in for stock, or a# paid-in surplus, or as a contribution
to capital ;

(2) Property paid in.

Property (other than money) previous!y paid in (regardless of the time
paid in) for stock, or as paid-in surplus, or as a contribution to capital. Such
property shall be included in an amount equal to its basis (unadjusted)
for determining loss upon sale or exchange. If the property was disposed of
before such taxable year, such basis shall be determined in the same manner as
if the property were still held at the beginning of such taxable year. If such
unadjusted basis is a substituted basis it shall be adjusted, with respect to

- the period before the property was paid in, in the manner provided ia section

118(b)(2); °° °"

56

ment of Cuba to a railroad corporation, conditioned on the
construction of a railroad line—so much per mile—were
made as reimbursement for capital expenditures rather than
as a gift or to obtain rate concessions and in consequence were
not profits or gains taxable as income. The distinctive feature
of the transaction was that the Cuban Government was act-
ing deliberately to induce the construction of a railroad, and
to promote its success by making a grant towards its capital.
The transfers were akin to those made by Congress to the
first Union Pacific Railroad, in the Pacific Railway Acts in
the last century. Such transfers are utterly unlike those pres-
ently in question. Edwards v. Cuba R.R. is therefore not
helpful.

The remaining arguments of the parties are based on
Detroit Edison Co. v. Commissioner, 319 U.S. 98 (1943) and
Brown Shoe Co. v. Commissioner, 339 U.S. 583 (1950), from
which the Supreme Court in Chicago, Burlington & Quincy
L.R., supra, recently distilled a number of the characteris-
tics of a contribution to capital under the Code.*°

A contribution to capital, the court wrote, “must become
a permanent part of the transferee’s working capital struc-
ture”; it “may not be compensation, such as a direct payment
for a specific, quantifiable service provided for the trans-
feror by the transferee.” It “must be bargained for” {and
thus assets granted by a governmental body for replacement
of existing facilities, where none otherwise would have been
deemed necessary, are not contributions to capital), and the
asset transferred “foreseeably must result in benefit to the
transferee in an amount commensurate with its value.” Fi-
nally, “the asset ordinarily, if not always, will be employed

© The decision in these cases, involving primarily the issue of depreciability
of assets transferred to the taxpayer, turned on whether the asset involved
was a contribution to capital, for the income tax act beginning in 1932
provided that the basis of a contribution to capital should be the basis of the
transferor, and thus the contribution to capital would be depreciable though
having had no cost to the transferee. Section 118(a)(8) as added by the
Revenue Act of 1932 c. 209, 47 Stat. 198; I.R.C. 1939, § 118(a)(8). The sec-
tion confirmed the exemption from income taxation for the class of shareholder
contributions, a class broadened by Edwardes v. Ouda R.R., eupra, to include
the nonsuareholder contributions described in the text, supra. In the 1954
Code, the former result was changed by a provision for an exclusion from
income for all contributions to capital of corporations, with the proviso that
the basis of the contribution by a nonshareholder should be zero, §§ 118,
862(c), Int. Rev. Code of 1954.

57

in or contribute to the production of additional income and
its value assured in that respect,” and thus assets intended
for the safety of the public are not contributions to capital,
because they were “peripheral to the road’s business” and
“did not materially contribute to the production of further
income by the railroad.” 412 U.S. at 413-414.

As already noted, the facts of classes 3 and 4 of the trans-
fers in the instant case are substantially identical with those
in Chicago, Burlington & Quincy R.R., supra, and thus the
decision there decides that classes 3 and 4 here are not con-
tributions to capital.

The other classes may be summarily disposed of in the
light of the characteristics of a contribution to capital set out
in Chicago, Burlington & Quincy R.f., supra.

The transfers in class 1, typified by a transfer by the Fed-
eral Government to the plaintiff to replace a portion of the
right-of-way to be flooded by a projected dam, were matter-
of-fact business transactions in which the parties made an
equal exchange, without altruism or donative intent. The
closest analogy is a condemnation proceeding ; no one would
contend that payment of a condemnation judgment or of a
sum in settlement to avoid an eminent domain proceeding is
a contribution to capital. In the words of the majority opin-
ion in Chicago, Burlington & Quincy R.R., supra, the trans-
fers in class 1 “simply replaced existing facilities” and “did
not materially contribute to the production of further in-
come by the railroad.” 412 U.S. at 414.

In Los Angeles & S.L. R.R. v. United States, 86 Ct. Cl. 87,
21 F. Supp. 347 (1947), a railroad (actually a subsidiary of
the present plaintiff) gave up a portion of its line to a min-
ing company in need of the land for an extension of the mine’s
tailings dumps and received in return a new line as a replace-

ment. This court said that the new line, though costlier than
the old, “was of no more use to the railway company than the
old line and would not produce a cent more income” or in-
crease the value of the railroad’s assets “by a single dollar.”
86 Ct. Cl. at 99-100, 21 F. Supp. at 353.

Class 2 transfers are essentially the same as those in class
1 and are equally with class 1 not contributions to capital.
Classes 3 and 4, as already noted, are not contributions to

58

capital on the authority of Chicago, Burlington & Quincy
R.R., supra; 12 percent of the transfers in class 5, found to
be essentially the same as the transfers on classes 3 and 4,
are also not contributions to capital.

Of the remaining 88 percent of the transfers in class 5,
87.2 percent are represented by these transfers: (1) a state
prison, as required by its lease of a portion of the plaintiff’s
right-of-way for use as a pasture, paid for a “hog-tight”
fence for the prison farm; (2) a state paid its share of a
municipal assessment for street lighting on the railroad’s
grounds at a railroad station, in accordance with the ease-
ment contract covering encroachment of the state’s highway
on the station grounds; (3) a municipal department of power
and light paid for the cost of cables for telephone and tele-
graph lines, to replace open wire lines; the record gives no
further details; (4) a town paid for the cost of a water main,
under the right-of-way, to the municipal stockyard; (5) and
(6) federal irrigation agencies paid for the cost of irrigation
waterways under the plaintiff’s line.

In all of these it appears that the transfers were essentially
an exchange of values or a payment for a specific quid pro
quo which left the plaintiff transferee no better off than be-
fore and did not materially contribute to the production of
further or additional income. Accordingly, under United
States v. Chicago, Burlington & Quincy R.R., supra, the
transfers did not effect contributions to the capital of the
plaintiff.

The final subgroup of 0.8 percent of the transfers in class
5 is represented by a transfer in 1938 in which a town in
Kansas furnished $129 worth of W.P.A. labor to construct
four new sanitary privies, notice having been given the rail-
road by the town to abate the nuisance of unsanitary privies.
The scanty record leaves a net impression that in this transfer
the town intended, in the interest of the users of the facilities,
to confer a benefit upon the railroad, and that the transfer
replaced existing facilities with new and better ones which
plaintiff would otherwise have been required to construct out
of its capital funds and thus that the transfer resulted in a
benefit to the transferee in an amount commensurate with its
value in that it enabled the plaintiff to avoid a capital expend-

59

iture to the value of the assets transferred. The sum whose
expenditure was avoided was employed in the production of
further or additional income. This group of transfers there-
fore meets the Chicago, Burlington & Quincy R.R. test for
a contribution to capital.

The Government maintains that in any event the thing
contributed was services, and neither “money” nor “prop-
erty,” as required by §718 for inclusion in equity invested
capital. There is authority that services compensated with
stock are neither “money” nor “property” includible in in-
vested capital. Bard-Parker Co. v. Commissioner 218 F. 2d
52 (2d Cir. 1954), cert. denied, 349 U.S. 906 (1955) ; Western
Maryland Ry. v. United States, 227 F.2d 576 (4th Cir. 1955),
cert. denied, 351 U.S. 907 (1956). The more pointed cases,
however, albeit decided under an earlier excess profits tax
act, recognize that such one-time services as those of archi-
tects and engineers which go directly into the creation of a
tangible capital asset are so sufficiently reflected in capital
assets that their value is includible in invested capital. Fed-
eval Plate Glass Co. v. Commissioner, 6 BTA 351 (1927) ;
Coatesville Boiler Works v. Commissioner, 9 BTA 1242
(1928) ; see Palomar Laundry v. Commissioner, 7 TC 1300
(1946). By the thinking of those cases, the cost of the labor
used in building the privy is, as much as the lumber and roof-
ing used, a capital asset and includible in equity invested cap-
ital. Money actually passed to workmen who labored to build
a structure which became a capital asset. No case holds the
cost of such labor not includible in equity invested capital.
No principle or policy requires that it be not includible, for
the transaction is wholly realistic, without any possibility of
exaggeration or evasion. See Union Pacific R.R. v. United
States, 185 Ct. Cl. 398, 401 F. 2d 778 (1968), cert. denied,
395 U.S. 944 (1969), rehearing denied, 194 Ct. Cl. 1021, cert.
denied, 403 U.S. 931 (1971). .

In the nongovernmental transfers, classes 6 and 7 described
above, the transfers were substantially identical to those in
class 1 and to the transfers comprising 87.2 percent of the
transfers in class 5, or were direct payments for specific things
or services. The transfers in those two classes, therefore, are
under Chicago, Burlington & Quincy R.R., supra, not con-
tributions to capital.

60

The transfers challenged in the plea of setoff, and the
decisions thereon, are as follows:

(1) $200,000 for a spur track to a smelter about to be built,
paid for in 1901 by the owner of the smelter; held a payment
for a specific quantifiable service and therefore not a capital
contribution under Chicago, Burlington & Quincy R.R.,
supra.

(2) $1,076 for railroad line from Orchard, Idaho, to Boise
Idaho, to connect with the existing line from Boise to Nampa,
to provide through train service for Boise; paid for in 1925
by the Chamber of Commerce of Boise, Idaho; held this
transfer was not a payment for a thing or a service, was bar-
gained for, resulted in benefit to the transferee in an amount
commensurate with its value, and the assets transferred were
employed in the production of further or additional income.
It was therefore a contribution to capital under Chicago,
Burlington & Quincy R.R., supra, Brown Shoe and Edwards
v. Cuba R.R., supra. See Federated Department Stores v.
Commissioner, 426 F. 2d 417, 420 (6th Cir. 1970).

(3) $28,338 for land for a new line from Rogerson, Idaho,
to Wells, Nevada, provided in 1925 by a citizens right-of-
way committee for the purpose of obtaining a more direct
outlet to the California market for Southern Idaho agricul-
tural products, and to open up for tonnage shipments numer-
ous copper mining properties adjacent to the new line, This
transfer had the same characteristics as the immediately fore-
going transfer and is equally a capital contribution.

(4) $100,000 paid by a citizens committee in 1928 to ac-
quire and transfer to plaintiff a small road which had ceased
operations, in consideration of plaintiff’s promise to operate
it permanently. This transfer was essentially similar to the
two foregoing transfers and is equally a capital contribution.

(5) $46,125 paid by the Utah Copper Company to reim-
burse the plaintiff for the additional expenses of operating a
relocated line, in the circumstances detailed in Los Angeles
& SL.R.R., v. United States, supra. This transfer is held not
a capital contribution for the reasons stated above in con-
nection with classes 1 and 2.

(6) $240,421.01 transferred by a citizens committee in 1925.

61 -

Plaintiff has conceded that defendant is entitled to prevail on
this transfer.**

XI. EQUITY INVESTED CAPITAL

Plaintiff also seeks a refund of taxes paid on excess profits
based on an alleged erroneous determination by the Com-
missioner of Internal Revenue [Commissioner] of its 1942
equity invested capital credit. Plaintiff contends that the
Commissioner undervalued its equity investment and, there-
fore, unduly restricted its credit. In a most unusual counter-
attack, defendant also asserts that the Commissicner erred
in his equity investment appraisal. However, defendant
claims that the Commissioner overvalued plaintiff’s equity.
It, therefore, seeks to “offset” any other refunds due plain-
tiff.2* Significantly, neither party supports the Commis-
sioner’s determination.

The Excess Profits Tax Act of 1940 grants taxpayers a
“credit” for equity invested capital.** The Act defines equity
invested capital as money and property “paid in” for stock.**
Where a corporation is organized by issuing stock for prop-
erty, the property received (invested capital) is valued with
reference to the fair market value of the stock issued.**

%‘Thus by agreement and by our opinion, counts 17, 19, 21 and 22 are
resolved along with additional defenses 19-22.

The Government may “offset” refunds due plaintiff by taxes underpaid.
Lewia v. Reynolds, 284 U.S. 281 (1932): Dysart v. United States, 169 Ct.
Cl. 276, 283, 340 F. 2d 624, 628 (1965). If defendant can successfully assert
its offset based upon excess profits tax credit overdeterminations, he may
“seale down” the recovery allowed plaintiff in Parts I and V, supra.

® Int. Rev. Cope or 1939, § 712.

*IxT, Rev. Cope or 1939. § 718 provides:

Equity Invested Capital.

(a) Definition.—The equity invested capital for any day of any taxable
year * * * shall be the sum of the following amounts, ees

(1) Money paid in.—Money previously paid in for stock, or as paid in
surplus, or as a contribution to capital.

(2) Property paid in.—Property (other than money) previously paid in
(regardless of the time paid in) for stock, or as paid-in surplus, or as a
contribution to capital. Such property shall be included in an amount equal
to its basis (unadjusted) for determining loss upon sale or exchange * * *.
(Emphasis added)

Int. Rev. Cope or 1939, §113(a) defines unadjusted basis for property
acquired. It provides: “The basis of property shall be the cost of such
property.’ (Emphasis added)

If the taxpayer's basis {s cost and stock was issued for the property,
then cost is the fair market value of the stock issued for such property at
the time of issuance. Treas. Reg. 112, § 35.718-1, Int. Rev. Code of 1939.

ee

62

In 1898 plaintiff received the assets of the old bankrupt
Union Pacific Railroad [U.P.]. On January 31, 1998, plain-
tiff issued 610,000 shares of $100 par common stock and
750,000 shares of $100 par, four percent preferred stock. In
return, it received the stock of the old U.P. and cash (here-
inafter referred to as the reorganization).** Later in 1899,
plaintiff acquired control of the Oregon Short Line Railroad
[Oregon] ** by issuing an additional 273,493 shares of $100
par common for the Oregon common and cash (hereinafter
referred to as the acquisition ) .**

Our problem, finding the correct amount of U.P.’s 1942
excess profits tax credit, then resolves into a determination
of the value of the U.P. stock issued in these nineteenth
century transactions.

In its return for 1942, plaintiff used par values to com-
pute the value of its stock issued for these assets ($163.3
million).** The Commissioner disputed this valuation and,
at first, attached a value of $122.5 million to the shares. He
later modified the stock values to $79.4 million, lowering
plaintiff’s valuation substantially. Plaintiff paid the 1942
deficiency and filed this refund suit claiming that its original
return was correct. In addition to the stock issued, plaintiff
also asserted that it was entitled to include the cash contribu-
tions received in the reorganization ($9.1 million) and the
acquisition ($0.8 million) in its equity invested capital.‘

Defendant claimed that the value of plaintiff’s stock was
less than even the Commissioner had determined and asserted
an offset against other amounts recoverable by plaintiff.
Defendant argued in its pleadings that the fair market value
of the U.P. stock was only $57.5 million.

* The U.P. received one share of old U.P. common and $15 in return for
one, new share of U.P. common.

* Actually the U.P. issued the shares over a period of time and gradually
acquired common stock of the Oregon. See page 16, infra. However, the
U.P. acquired control of the Oregon in 1899.

*In return for each share of U.P. common stock issued {n the acquisition,
the U.P. received one share of Oregon common and $3 cash.

* Plaintiff contended that its equity invested capital was $61 million for
the reorganization common, $75 million for the reorganization preferred, and
approximately $27.3 million for the acquisition common—a total equity
invested capital of $163.3 million.

# See notes 36 and 38, eupra.

63

During the trial, plaintiff sought to prove an even greater
valuation, and defendant continued to support the value
that it had alleged in its pleadings. Plaintiff's valuation ex-
pert testified that the proper valuation date for the re-
organization stock was January 31, 1898. However, he stated
that the true value of the stock must take into account the
U.P.’s rapid rise in fortunes during the post-reorganization
period. Thus he evaluated the U.P. reorganization and acqui-
sition stock by use of 1907 stock market figures and found
values of $175-200 per share for the common and $100 per
share for the preferred. His total value estimate was $251.7
million. Defendant’s trial expert testified that after consider-
ing all valuation techniques,*? the reorganization common
was worth $22.50 per share and the reorganization preferred,
$40 per share. Since he rated the acquisition common at $10
million, he assessed plaintiff’s total equity invested capital
at $57.5 million.

Both plaintiff and defendant contend that the Commis-
sioner’s valuation was incorrect and both ask the court to
find a per share value for the stock. Significantly, there is
absolutely no justification in the record for the Commis-
sioner’s valuation since neither party supported it.

The threshold question is whether either party’s evidence
overcomes the Commissioner's presumption of correctness.

A. Presumption of Correctness:

The Commissioner's determination of taxes due is entitled
to a presumption of correctness. Helvering v. Taylor, 293 U.S.
507 (1935); Northlich, Stolley, Inc. v. United States, 177 Ct.
Cl. 435, 442, 368 F. 2d 272 (1966). This presumption applies
to excess profits tax credit determinations. 7ri-State Realty
Co. v. Commissioner, 180 F. 2d 593 (5th Cir. 1950). However,
in our case an unusual situation is presented because neither
party supported the Commissioner's determination. Each at-
tempted to assert its own conclusion for asset valuation.

The court believes that there is sufficient evidence in the
record to rebut the presumption. Presumptions are not evi-

© Defendant's expert testified on stock market values, net asset values, price-
earnings estimates, capitalization of earnings, and comparison of the U.P.
stock with similar railroad stocks.

64

dence, and they disappear in the face of substantive evidence
tending to disprove them. United Aniline Co. v. Commis-
sioner, 316 F. 2d 701, 704 (1st Cir. 1963); Kentucky Trust
Co. v. Glenn, 217 F. 2d 462, 465 (6th Cir. 1954). Defendant
provided sufficient probative evidence of the U.P. value by
offering stock market prices for the U.P. stock to rebut the
Commissioner’s presumption of correctness.

Once we find that the presumption has been rebutted, we
must then determine whether either party has met its burden
of proof and, therefore, is entitled to a refund or offset.

B. Burden of Proof:

Where plaintiff sues for a refund he has the burden of
proving that the refund is “legally due” him. Helvering v.
Taylor, supra; Lewis v. Reynolds, 284 U.S. 281 (1932).
Where defendant counters with an offset claim, allocation of
the burden depends on the nature of the offset. If the offset
is based upon the same tax return as plaintiff’s refund claim,
the ultimate burden of proof remains on plaintiff. However,
defendant has the burden of “coming forward” with suffi-
cient facts to show that it “has a reasonable basis for its set-
off.” Missouri Pacific R.R. Co. v. United States, 168 Ct. Cl.
&6, 338 F. 2d 668 (1964). In the instant case, plaintiff has the
ultimate burden of proving that the Commissioner under-
valued its equity. Since its offset claim involves the same tax
return, defendant must “come forward” with sufficient evi-
dence to show that there is a reasonable basis for its claim
that the Commissioner overvalued the U.P. stock.

Valuation of assets is a question of fact. American Steel
Foundries vy. United States. 153 Ct. Cl. 234 (1961). The
question before the court is the value of the U.P. investment.
The court may adopt plaintiff’s conclusions, may adopt de-
fendant’s, or any reasonable value in between. 7 oronto,
Hamilton & Buffalo Nav. Co. v. United States, 116 Ct.
Cl. 184, 207-08, 88 F. Supp. 1016, 1022 (1950). We find from
the stock market prices presented by defendant that it has
met its burden of coming forward. There is sufficient evi-
dence to find a reasonable basis for defendant’s allegation
of overvaluation by the Commissioner. We also find that
plaintiff has failed to meet its burden of proving that the

et Secrest ee re

a Ft Se e e ce

= TET

AOE SRT BA Seta

2

65

Commissioner undervalued the investment. We hold that
defendant is entitled to an offset.

C. Equity Valuation:

Valuation of property is at best an inexact science or highly
imprecise art, and there are as many approaches to valuation
as there are valuation experts. Asset appraisal, therefore,
requires a reasonable or rational approximation rather than
exactitude. Primary valuation techniques include actual sale
prices, actual or original cost, replacement cost, capitalized
income, price-earnings ratios, and comparison with similar
property. I J. Bonbright, Valuation 113-269 (1937). Each
method has its own variations, strengths and weaknesses. We
have received evidence of U.P. value based upon stock market
prices, net asset values, capitalization of earnings, price-
earnings ratios and comparison of the U.P. with similar
stock.

While each valuation method has shortcomings, we find
sufficient evidence to adduce a reasonably accurate value for
U.P.’s reorganization and acquisition stock.

The departure point for our valuation inquiry begins with
the proposition that “fair market value is the rrice at which
property would change hands in a transaction between a
willing buyer and a willing seller, neither being under a
compulsion to buy or sell, and both being reasonably in-
formed as to all relevant facts.” Bankers Trust Co. v. United
States, 207 Ct. Cl. . , 518 F. 2d 1210, 1219 (1975) ;
Jack Daniel Distillery v. United States, 180 Ct. Cl.
308, 315-16, 379 F. 2d 569, 574 (1967). This court has fre-
quently used stock market prices to value stock. As Judge
Davis noted in Bankers Trust, “Where stock is freely traded
in an open, organized market, stock exchange quotations for
the valuation date generally provide the best evidence of
value.” Bankers Trust Co., supra, slip opinion at 13 citing
Moore-McCormack Lines, Inc. vy. Commissioner, 44 T.C. 745,
759 (1965) ; Southern Natural Gas Co. v. United States, 188
Ct. Cl. 302, 351-52, 412 F. 2d 1222, 1252 (1969) ; 10 J. Mer-
tens, The Law of Federal Income Taxation $§ 59.13 at 42-43,
59.14 at 47 (1970). The Bankers Trust opinion contains an
excellent analysis of the situations in which stock market

594-093—75——_5

66

values are not accurate value determinants.*? We note that
such situations are not present in the instant valuation.**

Two factors which give us pause in considering stock
market values are the “pessimistic” nature of the market in
1898-99, and the likelihood of reacquisition of the Oregon
stock at the time of reorganization. While these factors
might possibly cause some doubt as to the reliability of
market evaluation, we find that, in the instant case, they do
not. The pessimism of investors in the then current economic
situation was well-founded. The nation had undergone a
severe depression, and recovery was ot a foregone conclusion.
In addition, the U.P. itself had recently undergone bank-
ruptey and was in the process of reorganization. Its total
mileage had shrunk, and it had no West Coast outlet. The
only factors which gave the U.P. any value at all were the
possibility of economic recovery and reacquisition of branch
lines lost during bankruptcy. We conclude that rather than
being of doubtful worth in estimating the value of the U.P.
stock, the market serves as its most accurate indicator.** In
short, the stock exchange values produce the most accurate
and comprehensive analysis of the U.P. stock possible after
a lapse of some 77 years.

Having determined that we will employ stock market
values, we must then decide the dates we will use to appraise
the stock. The Excess Profits Tax Regulations mandate val-

(1) If the market is too thin to absorb the shares offered for sale;
(2y if too few sales are made to place any reliance on the validity of the
prices commanded ; (3) if restricted stock is sold; (4) if an agreement not to
resell exists: (5) if so many shares are sold that supply exceeds demand
and a “blockage discount” must be accounted for, or finally, (6) if the stock
prices increase as a result of the agreement to sell, then the market valuation
of the stock may be inadequate. Bankers Trust, supra, slip opinion at 14-20.

“In all instances, there were sufficient sales to indicate the reliability of
the market price determinations, yet not so many sales as to indicate the useful-
ness of determining any “blockage” factors.

While the reorganization and acquisition agreements themselves may have
added some value to the U.P. stock, (a main concern of Judge Kashiwa’'s
dissent in Bankers Trust) it does not appear to be significant here.

“Stock exchange quotations automatically take some cognizance of many
valuation factors. For example, good will; the nature of the business and
history of the enterprise; the economic outlook in general and that of the
specific industry in particular; estimate of dividend paying capacity; and
sales of similar stocks. Most importantly, the stock market provides a “black
and white” unbiased and contemporaneous measure of the value of the 7 P.
stock.

é
:
&
;
+
“
l

67

uation at the time of issue-** Clearly market quotations are
more reliable if they are near in time to the event in question.
10 J. Merten, Law of Federal Income Taxation, § 59.16
(1970). In the instant case, the reorganization stock was is-
sued on January 31, 1898. Reorganization preferred first
traded on February 2, 1898. Since this date is fairly contem-
poraneous with the organization, February 2, 1898 becomes
the logical date upon which to rate the reorganization pre-
ferred. We therefore adopt February 2, 1898. The reorganiza-
tion common was not traded until February 25, 1898. This is
somewhat remote. However, we can derive market values for
the reorganization common on February 2, 1898 from the
price of U.P. Trust Receipts.** Thus we again use the Feb-
ruary 2, 1898 valuation date to assess the reorganization
common.

Determining valuation dates for the acquisition common
presents another problem. The U.P. issued this stock in sev-
eral blocks over a period of ten years.*’ Here we use average
market prices during the time period that the U.P. issued
each block of shares.

After establishing valuation dates, we must next settle
upon a technique to determine the specific market price on
the date in question. Although found in the Estate Tax Reg-
ulations, a generally accepted procedure in incuine tax cases
is to use the average between high and low prices on the date
in question.*® We accept this method. The average between
high and low market values on February 2, 1898 represents
the most accurate value for the reorganization stock. The
average between high and low for each date during the sev-
eral time periods in which the U.P. issued its acquisition
stock is again the most accurate value for the acquisition
stock.

Our first measurement concerns the value of the 750,000
shares of U.P. preferred issued during the reorganization.
The reorganization preferred was first traded on February 2,

Treas. Reg. 112, § 35.718-1, supra note 35, calls for valuation of the
U.P. stock “at the time of issuance.”

* See page 15 infra.

** See chart page 16 infra.

“ Treas. Reg. § 20.2031-2(b). Bankers Trust, supra, slip opinion at page 13.

68

1898. The average between high and low for the preferred
on this date was $62.50. Thus the court finds that the 750,000
shares of U.P. preferred issued in the reorganization were
worth $46.9 million. Note that 122,644 shares of U.P. pre-
ferred were traded during the first week of issue, an average
of 24,549 per day. Although this is a fairly large block of
stock, it is nowhere near the entire amount, Thus there were
sufficient shares of U.P. preferred traded at the time of issue
to support the validity of the price set by the market, yet
not so many shares that the market failed to absorb them.

Evaluation of the reorganization common presents an-
other problem. The first shares of U.P. common were not
traded until nearly a month after the reorganization, Feb-
ruary 25, 1898. However, U.P. Trust Receipts, exchangeable
for one share of U.P. common and 15/100 of a share of pre-
ferred were traded on the market at the time of the re-
organization. Using February 2, 1898 Trust Receipt values
(an average of $36 per share), less 15/100 of the $62.50 value
found for the preferred ($9.375), we derived a value of
$26.625 for the U.P. common on February 2, 1898. Thus
610,000 shares of new U.P. common were worth $16.2 million.
Again we note that approximately 35,321 Trust Receipts
per day were traded during the week in question. Again this
is sufficient number of shares to find that the market set an
accurate trading price.

The U.P. issued the acquisition stock in blocks over a
ten-year period. Defendant has presented evidence which
permits the court to separate this stock into several blocks
and identify an average market price for each block. We
adopt this evidence and find the following values for the
U.P. acquisition stock.

From To Number of Shares Market Averace Total Value
1-26-99 2-25-99 137, 301 $46. 00 $6, 315, 846
2-26-99 3- 4-99 68, 650 47. 00 3, 226, 660
3- 5-99 3-11-99 27, 460 47. 00 1, 290, 620
3-12-99 6-30-99 31, 642 44. 00 1, 392, 248
7- 1-99 12- 1-99 1, 966 46. 00 90, 436

12- 2-99 6-30-00 3, 688 50. 50 186, 244
7- 1-00 6-30-01 2, 636 91. 50 241, 194
7- 1-01 6-30-02 50 175. 00 8, 750
7- 1-07 6-30-08 100 175. 00 17, 500

RG eenentednenacs $12, 769, 188

69

Thus the court finds that the investment in the Oregon, the
acquisition common, was worth $12.8 million.

The reorganization common, the reorganization preferred,
and the acquisition common yield total U.P. equity invested
capital of $75.9 million. The court believes that this value
is neither too pessimistic *® nor too optimistic.®® In each
case, there are sufficient market sales to bolster the validity
of the price placed upon the shares in the marketplace, yet
not so many shares traded that the market found itself unable
to absorb them.

In addition, we note that other evidence of value in the
record supports our determination. First, although unsup-
ported, the Commissioner’s value of $79.4 million is close to
that found by the court. Second, by using the net asset values
placed in the record by defendant, $116.9-$119.9 million,
plus a 15 percent estimate for going concern value and good-
will (factors ignored by defendant in its testimony on net
asset values), less debt issued by U.P. during reorganization
(881.7 million in bonds then selling at 92 or $75.2 million in
debt securities), we derive a value for the U.P. reorganiza-
tion assets of $59.2-$62.7 million. Adding the value of the
Oregon assets obtained in the acquisition, $12.8 million, we
derive a reasonable estimate of total equity based upon n.*
assets and goodwill less debt of $72.0 million to $75.5 million.
The stock market values found by the court are nearer the
$75.5 million figure. Our stock market figures for the re-
organization stock appear to be well-founded.

Finally, viewing the acquisition stock alone, various facts
in the record again bolster our determination of value. For
example, by using an 1899 average of the price-earnings
(P/E) ratios of three comparable railroads * (9.8), we find
that of the $5.12 per share U.P. earnings in 1899, some $1.4

* The court believes such valuation is not unduly pessimistic. Notably, the
value of the U.P. common and preferred actually fell during 1898 before
climbing again.

™ Defendant's expert would have the court find that the market overvalued
the U.P. stock. Since other valuation estimates tend to bolster our finding.
we believe that market prices were not unduly optimistic. Certainly by 1899
the market value of the U.P. stock had risen dramatically.

© The Southern Pacific [SP], the Northern Pacific [NP] and the Chicago
and Northwestern [CNW], three railroads which defendani 6 expert excluded
from his category of “established dividend payers” and, therefore, similar to
the U.P. The 1899 P/BP ratio for the SP was 8.5, the NP, 8.4 and the CNW,
12.6. Thus the average P/B ratio for these three railroads in 1899 was 9.8.

70

million in earnings were attributable to the acquisition com-
mon. (273,493 shares x $5.12 per share.) Multiplying the P/E
ratio for the similar stocks by the earnings attributable to the
U.P. acquisition common, we find a reasonable estimate for
the Oregon of $13.7 million.®* Certainly the stock market
values ($12.8 million) for the acquisition common are con-
servative estimates of their value.

Thus the value determined by the Commissioner, the value
based upon net assets. and price-earnings ratios lend support
to our valuation.

. In short. using stock market prices to value the equity
invested capital of the U.P. for 1942 excess profits tax pur-
poses, the court finds that the Commissioner overvalued the
U.P. stock by some $3.5 million. Accordingly, defendant is
entitled to a tax offset for the excess equity invested capital
credit granted to plaintiff in 1942 based upon this figure.

Plaintiff’s other contention is that it is entitled to include
cash contributions received in its equity invested capital
in addition. to the value of the stock issued. The court re-
jects this assertion. Since new U.P. stock was issued in ex-
change for old U.P. common, the Oregon common, and cash,
a proper measurement of the equity can be achieved by view-
ing either side of the equation; the value of the U.P. stock
issued or the value of the stock and cash received. To allow
plaintiff to include both the stock issued and the cash re-
ceived in its equity invested capital is to “add both sides
of the bargain.” Certainly the cash received by the U.P.
was a partial payment for the stock issued. We. therefore,
hold that plaintiff cannot include the cash payments received
since we value its equity with reference to the value of the
stock issued.

In summary, the court finds that there is sufficient proba-
tive evidence to establish reasonable per share values for the
U.P. stock issued in the reorganization and acquisition. We
find that defendant has overcome the Commissioner’s pre-
sumption of correctness. The court further finds that defend-
ant has met its burden of establishing that the Commissioner
overvalued the U.P. stock. We value the stock as near its issue

™ See American Steel Foundries, supra, 153 Ct. Cl. at 252 ¢
valuation technique. or use of this

71

date as possible. The reorganization preferred was worth
$62.50 per share, the reorganization common $26.625 per
share, and the acquisition common ranged from $44 per share
to $175 per share depending upon the date of issue. The total
value of the stock issued, plaintiff’s equity invested capital
for 1942 excess profits tax credit purposes, was $75.9 mil-
lion.®*

To recapitulate, we find that plaintiff is entitled to recover
on its refund claim based upon its right to “expense” mini-
mum rule property in its 1942 return (Part I). Plaintiff may
also recover on its contention that it would include stock of
certain leased line subsidiaries in its capital assets (Part V).
Finally, with regard to “donations and grants” given to
plaintiff to spur its construction, we conclude that some of
these grants were includable capital assets and some were not.
Therefore. we hold in part for plaintiff on this assertion
(Part X).

We further determine that plaintiff is not entitled to re-
cover refunds for other allegations since it cannot deduct 1943
payroll taxes in 1942 (Part IT); it cannot include certain
stock subscription rights in its earnings and profits (Part
IV): and cannot receive interest on a 1948 agreement with
the Commissioner of Internal Revenue (Part VI). Plaintiff
also may not recover an offset to setoffs claimed by defendant
because it cannot include proceeds from certain land sales in
its earnings and profits (Part VIT).

Defendant is entitled to prevail on its “additional defense”
that plaintiff erroneously included unamortized bond dis-
count and expense in its total assets (Part VIIT). Further,
we find for defendant on another “additional defense” that
plaintiff mistakenly failed to treat other bond discounts and
expenses as “interest” (Part IX). We also hold that defend-
ant is entitled to recover an offset based upon its claim that
the Commissioner overvalued plaintiff's equity invested cap-
ital (Part XT).

Finally, the court severs and remands for further consid-
eration by the trial judge the question of whether plaintiff is
entitled to increase its earnings and profits by $13 million due

® We hold for defendant on additional defense 1. Plaintiff cannot prevail
on its counts 5, 6 and 9.

72

to certain accounting errors alleged to have occurred in 1900-
1907 (Part IIT).

Accordingly, we find for plaintiff in Parts I, V and in some
sections of Part X. We deny plaintiff’s claims in Parts IT,
IV, VI and VII. We further hold for defendant in Parts
VIII, IX and XI. The amount of the recoveries will be de-
termined pursuant to Rule 131(c). Finally, we remand Part
III for further proceedings consistent with this opinion.

Nicnots, Judge, concurring in part and dissenting in part :

I concur and join in the court’s opinion except for Part V.
headed Leased Line Subsidiaries. As to this, I dissent with all
respect.

The court here adopts without change the opinion rec-
ommended by Trial Judge Schwartz. While the latter, with
his usual keenness of analysis, recognizes fully the difficul-
ties of his position, he ends up applying this court’s “source
of supply” line of decisions which extend the Corn Products
v. Commissioner, 350 U.S. 46 (1955) doctrine to cases in
which a corporation invests in stock of another corporation
to obtain a source of supply. Waterman, Largen & Co. v.
United States, 189 Ct. Cl. 364, 419 F. 2d 845 (1969), cert.
denied, 400 U.S. 869 (1970), and cases there cited. However.
in a strangely forgotten decision, Dearborn Co. v. United
States, 195 Ct. Cl. 219, 444 F. 2d 1145 (1971) a unanimous
court laid down certain lines beyond which Corn Products
and Waterman, Largen would not be applied, and instead
the normal rule would obtain, that the purchase of corporate
stock, except by a dealer in securities is a capital transaction.

Admitting that case was close, former Trial Judge Davis
distinguished it because he found the purchasing corpora-
tion was motivated by substantial investment purpose and
intent, besides the business purpose of assuring a source of
supply. The main factors supporting this conclusion were
(a) the purchaser did not pay a premium over the market
value of the stock, or in other words, the purchase, if an
investment, was not an unattractive one at the price paid,
(b) the acquisition was meant to be permanent, not to be
unloaded at the end of some temporary emergency, and (c)
the purchaser intended to benefit by receipt of dividends and

73

by exacting a management fee to run the business, not just
to integrate the subsidiary’s operations into its own and make
it a mere feeder of materials.

I do not find that Trial Judge Schwartz applied the same
tests. As I read him, the decisive factor here is that the Union
Pacific and the leased lines, run as a unified operation, could
have been and no doubt were more profitable than the same
lines controlled and operated separately. Without them, the
Union Pacific as previously known was truncated and in-
complete. To be sure! But if this is all, what we are coming
to is a rule that it is not a capital investment whenever one
corporation purchases control of another with the purpose,
alone or among others, of integrating their operations. The
kind of inquiry Trial Judge Davis made will be foreclosed
because it will be irrelevant whether the purchase is attrac-
tive, viewed as an investment, whether it was intended to be
permanent, constituting a permanent addition to the pur-
chaser’s fixed assets, and whether the purchaser will or will
not derive the benefits a prudent investor in an unrelated
enterprise would seek.

It is obvious here that the acquisition of the Oregon Short
Line and the others were intended to be permanent, and have
been so up to now. The Oregon Short Line and the others
were themselves investors in railroad securities, and as to
their investments it would appear the Union Pacific got an
investment benefit. As to the other criteria, I do not find
answers in the findings. I do not think the plaintiff has sus-
tained its burden of proof.

In penning the above few words, I have assumed, as I
must, the entire soundness of Waterman, Largen and our
other decisions as well as, of course, Dearborn, despite pre-
vious qualms. This court’s application of Corn Products in
its “source of supply” cases can roll on down the track with-
out any challenge by me, unless derailment by the Supreme
Court or by Congress occurs. This is an area of law where
stare decisis must prevail in this court. It is beyond our
proper power now to make it easy or simple to determine
whether a transaction is a capital one for tax purposes, or to
do it on the basis of objective facts and statutory language,
without inquiry or speculation into the undisclosed state of

74

mind of corporate officers, possibly ones, as here, long since
deceased, and I do not so urge. My argument is directed sim-
ply against extending Waterman, Largen uncritically to new
situations not covered by it as a precedent, and to failure to
apply standards as we applied them in Dearborn.

I agree that the decision in United States v. Mississippi
Chemical Corp., 405 U.S. 298 (1972) does not overrule Water-
man, Largen. It holds that a borrower from a Bank for Co-
operatives, obliged to purchase a stated quantity of bank
stock in lieu of a higher rate of interest, nevertheless makes a
capital investment in the stock. The situation is far removed
from that in our “source of supply” cases. The Corn Prod-
ucts doctrine is not mentioned. It may perhaps afford a slight
clue that the Supreme Court is not so enamored of expanding
Corn Products as we are.

Finpincs or Fact

JURISDICTIONAL AND GENERAL

1. Plaintiff was at all times pertinent hereto a corporation
organized and existing under the laws of the State of Utah,
with its office and principal place of business at 120 Broad-
way, New York, New York 10005.

2. Jurisdiction to hear and determine this cause is con-
ferred upon the court by section 7422(a) of the Internal
Revenue Code of 1954. Jurisdiction of the subject matter is
conferred upon the court by section 1491, Title 28, United
States Code.

3. Plaintiff seeks a judgment for (1) $13,409,961.46 (con-
sisting of $9,222,801.78 in statutory interest for 1942 and
$4.187,159.68 in income and excess profits tax) and assessed
interest thereon paid for 1942 or such other amount as
may be legally refundable for 1942, together with statutory
interest thereon.

4. For federal tax purposes, plaintiff kept its books and
reported its income on the accrual and calendar year basis.

5. On or about March 15, 1943, plaintiff filed a timely
tentative corporation income and declared value excess profits
tax return (Form 1120) and a timely tentative corporation
excess profits tax return (Form 1121). On or about June 15,

75

1943, pursuant to a granted extension, plaintiff timely filed
its final corporation income and declared value excess profits
tax return (Form 1120) and final corporation excess profits
tax return for the calendar year 1942 (Form 1121). Fay

ments of the tax shown to be due thereon and two additional
payments were made on or about the following dates:

Amount paid

¢. os Amount of Amount of

ymen oun ount o

- tax interest
Mar. 15, 1943...... Income and declared value excess profits. $10, 018, 216.50 .............---
June 15, 1943........... i cesocsnseneeusesereessessossesese 9, 221,074.86 ............----
Sept. 15, 1943 eciPoccocanceeeseoccese -- 9,619,645.68 ................
Dec. 15, 1943........... i nin aadinenenenaaenasenenereesnstese 9, 619, 645.68 ................
Dec. 1, 1944....... Excess profits. ...............-.--------- 3, 525, 000. 00 $361, 745. 90
July 16, 1946...... ie aneteiaeaneen 10, 696. 86 2141.13

6. On or about October 4, 1946, plaintiff timely filed a
claim for refund of income and excess profits taxes in the
amount of $1,807,514.54, or such larger amount as might be
legally refundable, together with statutory interest thereon
for the tax year 1942. On or about April 25, 1949, plaintiff
timely filed a claim for refund of income and excess profits
taxes in the amount of $7,394,419.35 plus assessed interest in
the amount of $361,745.90, a total of $7,756,165.25 or such
larger amount as might be legally refundable, together with
statutory interest thereon for the tax year 1942. On or about
April 10, 1951, plaintiff timely filed a claim for refund of
income and excess profits taxes in the amount of $390,828.41
or such larger amount as might be legally refundable, to-
gether with statutory interest thereon for the tax year 1942.
On or about September 11, 1953, plaintiff timely filed a claim
for refund of income and excess profits taxes in the amount
of $348,705.41, or such larger amount as might be legally re-
fundable, together with statutory interest thereon for the
tax year 1942.

7. On July 16, 1946, $12,837.99 in declared value excess
profits tax for 1942 was credited against plaintiff’s income tax
liability for 1942; $196.82 in declared value excess profits
tax for 1942 was credited against the tax liability of the St.
Joseph & Grand Island Railway Company for 1942; $45,-
685.38 in declared value excess profits tax for 1942 was
refunded to plaintiff with interest of $9,178.87; and $694,-

76

754.62 in excess profits tax for 1942 was refunded to plaintiff
with interest of $68,742.63.

8. On September 16, 1960, after the audit of plaintiff's
tax returns for 1942 was finally completed, a total of $7,793,-
219.55 was refunded or paid to plaintiff, consisting of $3,729,-
059.29 in income tax for 1942, $2,141.13 in assessed interest
thereon, $13,462.80 in declared value excess profits tax for
1942, and $4,048,556.33 in statutory interest. On Septem-
ber 16, 1960, there was assessed against plaintiff a deficiency
in excess profits tax for 1942 of $4,654,621.45 plus interest of
$300,639.16, which was satisfied by a credit of $4,206,773.93
in income tax for 1942 and a post-war credit of $748,486.68.

9. Pursuant to Form 872, “Consent Fixing Period of
Limitation Upon Assessment of Income and Profits Tax,”
timely executed on behalf of the plaintiff and the Commis-
sioner of Internal Revenue, the period for assessment of
income and excess profits taxes for the tax year 1942 did not
expire prior to June 30, 1961.

10. On December 28, 1961, plaintiff filed a timely claim for
refund for 1942 in the amount of $13,409,961.46 or such
further amount as may be refundable, together with statu-
tory interest thereon. Of the $13,409,961.46 claimed, $9,222,-
801.78 was for statutory interest on amounts previously re-
funded or credited and the balance of $4,187,159.68 was for
income and excess profits tax.

11. Statutory notices of disallowance were mailed to plain-
tiff on September 26, 1960, with respect to the claims filed on
April 26, 1949, and April 10, 1951, and on August 13, 1962,
with respect to the claim filed on December 28, 1961. No such
notice has been issued with respect to the claim filed on Octo-
ber 4, 1946. Since less than 2 years elapsed between the mail-
ing of the notices of disallowance and the filing of this suit,
this action is timely brought.

12. Ne action or suit has been commenced or is pending
in any other court on account of these claims, and plaintiff is
the owner of the claims herein stated.

13. After consideration of all refunds and credits, plaintiff
has paid for 1942 $30,481,263.37 in income tax and $7, t84,-
866.83 in excess profits tax. Plaintiff seeks to recover some
portion of these payments as well as statutory interest.

e ee oe no

Pages 77 through 107
Intentionally Omitted

108

Ix. DISCOUNT AND PREMIUMS

127. For 1940 and 1941, plaintiff and its railroad sub-
sidiaries, including the Oregon Short Line Railroad Com-
pany and the Oregon-Washington Railroad & Navigation
Company, filed consolidated income tax returns and con-
solidated excess profits tax returns. For 1942, plaintiff filed a
separate income tax return and a separate excess profits tax
return.

128. In computing net income, plaintiff deducted, on its
consolidated income tax returns for 1940 and 1941 and its
separate income tax return for 1942, the following amounts
for amortization of bond discount and expense, unamortized
bond discount and expense for bonds reacquired, United
States documentary stamp taxes, and call premiums to retire

bonds:
Annual Unamortized

Company amortization discount— Documentary Call Total Year
of bond bonds stamp taxes premiums
discount reacquired

OSL. ...-.---. ey SY errr 61,316.34 1940
O-WR&N. 111, 006.46 ........------- 2-2-0222 eon enon enn ee nese eee 111, 096.46 1940
eeccceccoce 411.06 .....-......--- 28,402.00 .....-.-------- 97,813.06 1941

OSL. -...---- Te’ eeeernrerrrrrrrr rn 61,316.34 1941
O-WR&N 111, 006.46 ..... 2222-22-22 nn nnn nnn enna ne nen en eeeceeee 111, 096.46 1941
ececeecesce 1,007.96 2.222222 22 nnn nnn n en none nen wenn enone nereeeeee 71, 097.36 1942
Totals...... 646, 273.70 3, 265, 037. 46 110,004.00 6, 442,381.12 10, 363, 696. 28 ....-.

129. On September 1, 1940, plaintiff called for redemption
two series of bonds, both with a maturity date of June 1, 2008.
The first consisted of 4 percent bonds issued in the years 1908,
1909, and 1910, at a discount and with issuance expense. To
redeem these 4 percent bonds, plaintiff paid the face amount
of these bonds plus a premium of $4,942,381.12. The second
series consisted of 5 percent bonds issued in 1923 at a discount.
To redeem these 5 percent bonds, plaintiff paid the face
amount plus a premium of $1,500,000. The total of the call
premiums, $4,942,381.12 and $1,500,000, $6,442,381.12 is shown
in the preceding finding. At the time these bonds were re-
deemed, there was unamortized bond discount and expense of
$2,741,201.39 on the 4 percent bonds and unamortized bond
discount of $517,997.28 on the 5 percent bonds. The total of
these two amounts of unamortized bond discount is $3,259,-
198.67.

109

130. In May 1936, plaintiff issued 35-year 314 percent de-
benture bonds at a discount. In October 1936, plaintiff issued
34-year 314 percent debenture bonds at a discount. In 1940,
plaintiff purchased certain of these debenture bonds at par
with moneys derived from a sinking fund and retired ther.
With respect to these bonds purchased and retired, there was
unamortized debt discount of $3,489.59 as to the 35-year bonds
and $2,349.20 as to the 34-year bonds. The total of these two
amounts of unamortized bond discount, $5,838.79, when added
to the total unamortized bond discount in te preceding find-
ing, $3,259,198.67, comes to $3,265,037.46, tne figure shown in
finding 129.

131. On its excess profits tax return for 1942, in computing
its excess profits net income for 1942 and its unused excess
profits tax credit carryovers from 1940 and 1941, plaintiff
did not treat as interest the amounts shown in finding 128,
but it treated the indebtedness with respect to these amounts
incurred as borrowed capital.

132. On audit of the returns for the years 1940 and 1941,
the Commissioner of Internal Revenue did not disturb the
action taken by plaintiff as described in these findings.

133. The $110,004 in finding 128 was deducted in full in
the years the bonds were issued and was not amortized
over the life of the bonds as bond issuance expense. Defend-
ant does not contend that these deductions were for interest
for purposes of section 711(a) (2) (B).

Portions of page 109

Intentionally Omitted

: Pages 110 through 126
Intentionally Omitted

OO Oe ae ne Le Ty

ee as

ene ee

© NEB Pe mt 4 ee ee

4 OS ees CS we

men

127

XI. EQUITY INVESTED CAPITAL

Index Noe
Be PI ARON TUE, . ccrcccccnescessesccscncssenecbeecosceseseocenceses 174
© Tar UP Ol ntnncnccaccencnnnncennesetecocncseconsesseensnn 190
(a) Issuance of the Reorganization Stock................................ 190
(b) Issuance of the Post-Reorganization Stock.......................... 207
3. Assessments on Old Stockholders. .................................. 208
i. |, \_, —_, RY “ae RR Ream: 211
(a) Qualifications of the Plaintiff’s Expert............................. 212
(b) Qualifications of the Government's Expert.......................... 218
©, Vir I ntetnitcnontanemnsunnennteibenamndttiinnoncontemeseenenen.,
(a) Plaintiff’s Valuation a Valuation as of 1907_......................... 223
(b) Plaintiff’s Under! Theory of a Reconstitutive- Reorganization __ 227
(c) The Valuation Dates Uti by the Government's Expert.......__ 235
(d usions as to Valuation Dates..........................-....... 236
6. The Dollar Valuation of the Reorganization Stock by the Government’s
Eipeeeencccscncqancecocesoccnssessossososcscosonssoonsseetcscocoosooecns 241
7. Pre- DENI Ui ccnsnnncatnapenssecseucnsnesesesosonscocescess.,, 242
(a) 1 nstruction and Capitalization.............................. 242
Tp SPIES SD candsaccccceccscoeccececnencoesosccescnsenece.., 247
.g ol ~~ _SageePeeneenengggpesssnsssseescssenserensen: 255
aa? Pant nenncanDineesnchensonsscéieersececeoene cn, 260
(e) The United States Pacific Railway Commission..............._ 265
(f) Economic Conditions—1869 to the Panic of 1893..................... 270
8. The maenvernlp Se We ccccaccocccesecnscccesscecceenan 27
— SS OO ee bobSSSSSSSESSSEbERRESEEESEséeGeEEebooucosenn 277
iy ST itnendtenindonntecendéncnsentendedendatedsenasess.ccc, 282
(ec) The LLC aI a 238
(d) The End of Reorganization, January 31, 1898.................... 292
(¢) Receivership and the U.P.’s Branch and Subsidiary Lines.._._.___ 297
9. Pe - ST inndtcasasectinncioonesdcacceossouneceennennns 300
Oe ntrtntrtinnisctescsccinstnctsnntensens.éeuse, 300
(b) The U.P.’s Increasing Prosperity...................................
10. Approaches b) .1e Government to Valuation of the Reorganize*ion Stock. 326
&) Prospects for Reacquisition of the Oregon Lines.................
(i) History of the Oregon Lines... .....................-.......... 326
(ii) The Sregon iP Ul badenecsnestsentenssanuseccionsssouan 332
CD CERES Bey Pe Rrccccccocccccevcccccsocccsencessecccoccscese,.. 337
it HPC ectnesnencnsccesseeudiseeseseseséeccseestuane.., 337
it Ji i tenccenttensnenenetnensenseasensesestenenence, 344
(ili) Value Based on Stock Market Prices......................... 348
SP Sih cits Wi inttnteintnncncnsninensthinsaccesentnensensecnne... 361
(ad) Values Based on coptteieation A TRE CR RR 366
(e) Values Based on ~ st—~ peneasititeteseshecceesesen 370
(f) Comparison of Union Pacific Preferred with Other Stocks.......__. 383
11. Conclusions on the Reorganization Stock...............................- 384
12. Valuation of the Post-Reorganization Stock............................... 386
(a) The Exchange of U.P. Stock for Oregon Stock............. .... _.
(b) The Dollar Valuations by Defendant's Expert of the U.P. Post-Re-
ID Sarthe ntnsintetintienaeepentemaiiietineden cenit +. 390
(c) Value of the Oregon Short Line at the Time of the Exchange Offer. 391
(i) Value of | ELSE IE eI 391
(li) Value of the Oregon’s Holdings in O Navigation....____ 398
(iii) —— Conclusion on the Value of the Oregon Short Line an
an Sin cdetearnsetencedeaseeoeenesesoeececsoseons
(d) Value of the U.P. at the Time of the _ eepseeereesseegetesen 408
(e) The Value of the Several Blocks of Shares Issued in the Exchange... 409
Fb ft aetna cearertnnatatianeana apatite 409
(ii) The 3,688 Shares Issued December 2, 1299-June 30, 1900__.... 418
(iii) The 2,636 Shares Issued July 1, 1900-June 30, Saeeaear

1. Definition of the Issue

174. The plaintiff’s predecessor, The Union Pacific Rail-
road Company, sometimes herein called the predecessor,
was incorporated on July 1, 1862, by the Act of July 1, 1862,

128

c. 120, 12 Stat. 489. In 1880, when it was consolidated with
the Kansas Pacific and Denver Pacific, its name was changed
to The Union Pacific Railway Company. The Company was
in receivership between 1893 and January 31, 1898, and
was succeeded by the plaintiff, as will appear. Both plain-
tiff and its predecessor are for convenience herein often
called the “U.P.”

175. Plaintiff, the Union Pacific Railroad Company, was
incorporated July 1, 1897, under the general laws of the
State of Utah, for the principal purpose of acquiring the
property, rights and franchises of The Union Pacific Rail-
way Company. In addition, plaintiff had the power to acquire
the lands and land grants, and all rights with respect
thereto, of The Union Pacific Railway Company or of its
constituent companies, and to construct, purchase or other-
wise acquire and operate branches, extensions and connect-
ing or auxiliary lines.

176. As more fully set forth hereinafter, plaintiff acquired
the property, rights and franchises of The Union Pacific
Railway Company and certain of its constituent companies,
including certain branch, extending, connecting and auxil-
iary lines.

177. Upon the conclusion of the receivership of its prede-
cessor and pursuant to the reorganization plan, the plaintiff
issued to the predecessor’s reorganization committee, for
money and property of the predecessor acquired by the com-
— mittee, $90 million in 4 percent first mortgage bonds, 610,000
shares of common stock, par value $100, with an aggregate
par value of $61 million, and 750,000 shares of preferred
stock, par value $100, with an aggregate par value of $75
million, for distribution to the predecessor’s stockholders
and other claimants. The stock sc issued—both the common
and the preferred shares—is herein called the reorganiza-
tion stock, and is the first of two blocks of stock whose valua-
tion is the subject of the instant case.

178. During the fiscal year ended June 30, 1915, plaintiff
cancelled 136 shares of its common stock, with a par value
of $13,600, and 258 shares of its preferred stock, with a par
value of $25,800, reducing the reorganization stock outstand-
ing as of June 30, 1915, to 609,864 shares of common with a

Svtsbe

ee eR

129

par value of $60,986,400 (609,864 shares at $100 par) and
749,742 shares of preferred with a par value of $74,974,200
(749.742 shares at $100 par).

179. Pursuant to an offer made by plaintiff, following the
reorganization, to issue one share of its common stock, par
value $100 per share, for one share of the common stock of
the Oregon Short Line Railroad Company plus $3, plain-
tiff issued its common stock as follows:

Number of shares of

Period of time: a oe
January 26, 1899 to February 25, 1899......______ 137, 301
February 26, 1899 to March 4, 1899_........________ 68, 650
March 5, 1899 to March 11, 1899__......___________ 27, 460
March 12, 1899 to June 30, 1899.............._...._ 31, 642
July 1, 1899 to December 1, 1899_........._.._..___ 1, 966
December 2, 1899 to June 30, 1900__......._______ 8, 688
Se &, Bae OO Ge Gk Bitieeceeccccccnsecsuncdes 2, 636
DF 50
oR ee 100

WEE ednccteeneneenmenenmnenmeneneionim 273, 493

The foregoing 273,493 shares will, either intact or minus
150 shares whose value has been agreed, herein be called the
post-reorganization stock, and is the second of the two blocks
involved in this case.

180. By other means, plaintiff acquired prior to June 30,
1908, an additional 14 shares of Oregon Short Line common.
As of June 30, 1908, no shares of Oregon Short Line com-
mon were in the hands of the public; plaintiff owned the en-
tire amount outstanding, having a par value of $27,350,700,
and the Oregon Short Line owned $109,400 par value of its
colmon stock.

181. On its excess profits tax return for 1942, plaintiff
stated the money paid in for stock, or as paid-in surplus, or
as a contribution to capital to be $321,834,100, or the par value
of $100 per share for the 3,218,341 shares of common and pre-
ferred stock outstanding during 1942, of which 1,633,099
shares of common and preferred were originally issued in
connection with the reorganization of the Union Pacific and
the acquisition of the Oregon Short Line Railroad Company.

These 1,633,099 shares were comprised of the remaining
outstanding reorganization stock, that is, (1) 609,864 of the

594—093—75——9

130

610,000 shares of common and 749,742 of the 750,000 shares of
preferred which had been issued as above-mentioned, pursu-
ant to the reorganization plan, and (2) the 273,493 shares of
common issued as above-mentioned between 1899 and 1908 to
acquire the common shares of the Oregon Short Line Rail-
road Company.

In other words, plaintiff took the position in its tax return
that the fair market value, when issued, of the then remaining
outstanding shares of reorganization and _ acquisition
stock, and thus that the fair market value, when issued. of
each of the shares comprising the reorganization stock and the
acquisition stock was its par value, $100 per share.
with a total value of $163,349,300 for the originally issued
1,633,493 shares of reorganization and acquisition stock
or a total value of $163,309,900 for the 1,633,099 re-
maining outstanding shares of reorganization stock and the
acquisition stock.

182. Upon audit the Commissioner of Internal Revenue,
determining the fair market value for the shares to be less
than the plaintiff's valuation, reduced the item of money and
property paid in for stock by $83,790,860 or from $321,834,100
as claimed by plaintiff on its excess profits tax return to
$238,043,240. Said decrease was determined by the Commis-
sioner to be attributable to the fair market value of plaintiff’s
preferred and common stock issued incident to the reorgani-
zation and to the acquisition of the Oregon Short Line Rail-
road Company common stock, that is, the reorganization and
post-reorganization stock. The decrease was thus a decrease
to $79,519,040 from the $163,309,900 at which plaintiff had
valued 1,633,099 shares still outstanding reorganization and
the post-reorganization stock.

The Commissioner determined that the aggregate fair mar-
ket value of the reorganization stock was $67,029,150 and that
the aggregate fair market value of the post-reorganization
stock was $12,489,890.

It does not appear, and it is not material for purposes of
comparisons, whether the Commissioner deemed the proper
number of shares to be valued 1,633,493 or 1,633,099 and thus
whether he valued the number of the reorganization and post-
reorganization shares originally issued or as reduced by the
cancellation of 394 shares (136 common and 258 preferred).

“ ws alee Ret 8 mee Vi ee Ube. one el

hee ee ate cho

a AN he = Ol TN, I! ln hi ep we

ee z

131

It will henceforth be assumed for purposes of comparisons
that the Commissioner valued 1,633,493 shares. In any event
the Commissioner determined the fair market value of stock
valued by plaintiff at $163.3 million, to be $79.5 million, or
less than 50 percent of plaintiff’s valuation.

183. The issue is the valuation of the reorganization and
acquisition stock for purposes of computation of plain-
tiff’. excess profits tax credit for 1940 through 1942 based
upon invested capital. The standard for determination of
value is, as determined in the conclusions of law, the fair mar-
ket value at the time of the issuance of the stock.

“Fair market value” is henceforth sometimes abbreviated
to “value”; “value” when hereinafter used refers to “fair
market value,” unless a different meaning appears from the
context.

184. Solely for purposes of the issue of valuation, it is
agreed that the 150 shares of acquisition common
issued after June 30, 1901, for Oregon Short Line common
stock had a fair market value when issued of $175 per share.

185. The 610,000 shares of reorganization common, the
750,000 shares of reorganization preferred and the 273,493
shares of acquisition common, a total of 1,633,493 shares,
are the shares issued for the money and property paid
in, and those shares are thus the shares whose valuation deter-
mines money and property paid in, without regard to any can-
cellation of such stock thereafter.

Accordingly, while these findings will address themselves
to per share values, the blocks of stock to be considered and
aggregated will be the blocks originally issued, without re-
gard to the cancellation of 394 shares after the original
issuance.

186. Plaintiff contends that the value of the reorganization
and acquisition common was $175-200 per share and
the value of the reorganization preferred was par or $100 per
share.

These values ($200 for the common and $100 for the
preferred), when applied to the total of 1,633,493 originally
issued reorganization and acquisition shares give an

aggregate total valuation of $251,698,600.

Plaintiff thus now puts a value of $251.7 million on the
stock it valued in its return at $163.3 million.

132

187. The Government has in an additional defense alleged
that the Commissioner had only partly eliminated the over-
statement in money and property paid in for stock; and that
the fair market value of the reorganization stock was
$47,450,000 and the value of the acquisition stock was
$10,000,000 or less, a total of $57,450,000.

More specifically, on the trial, the Government has con-
tended that the value of the 610,000 shares of reorganization
common was $22.50 per share or an aggregate of $13,725,000 ;
that the value of the 750,000 shares of reorganization pre-
ferred was $45 per share or an aggregate of $33,750,000; and
that the value of the 273,343 shares (all but the last-issued
150) of the 273,493 acquisition shares issued at various
times between 1899 and 1901 ranged from $35 to $112 or
an aggregate of $10,046,021.50, bringing the aggregate value
contended for by the Government to $57 521,021.50.

The Government thus now puts a value of $57,521,021.50
on the stock which the Commissioner of Internal Revenue
valued at $79,519,040. The former figure is 72.3 percent of the
latter; the latter is 138.2 (more precisely 138.24344) percent
of the former.

188. The various valuations are

$251.7 million—plaintiff’s valuation contended for on
trial

$163.3 million—plaintiff’s valuation in its return

$79.5 million—The Commissioner’s valuation

$57.5 million—the Government’s valuation contended for
on trial

189. A. comparison of the per share valuations contended
for by the Government with the per share valuations derived
from the Commissioner’s valuation is as follows. The pro
forma per share valuations by the Commissioner are ob-
tained by multiplying the Government’s per share valua-
tions of the reorganization stock by 141.19 percent, and the
Government’s per share valuations of the post-reorganization
stock by 124.33 percent, these being the percentages by which
the Commissioner’s aggregate valuations, respectively, exceed
the Government’s aggregate valuations.

Bo PS taste GD Oe Or RA CO, eR Cnt.

133
Derived valuations b
Valuation contended for the Commissioner o
Shares by the Government Internal Revenue

Per share Aggregate Per share Aggregate

— Stock: , a3,
fe 22. 50 13, 725, 000. 00 $31.76 $19,373, 600.00
750,000 preferred................ 45.00 33,750,000. 00 63.54 47,655, 000.00
a ae 47, 476, 000.00 ............ 1 67, 028, 600. 00

Post- Reorganization Stock:

Be GE iccccccconesecesos 35. 00 4, 805, 535. 00 43. 51 5, 974, 515. 71
GEr COMEIOR.. ccccccccccccccccs 35. 25 2, 419, 912. 50 43. 82 3, 008, 586. 25
27,460 common..........-...-.-. 35. 375 971, 397. 50 43. 98 1, 207, 718. 26
IT 38. 00 1, 202, 396. 00 47. 24 1, 494, 894. 64
ATTA ATE 43.75 86, 012. 50 54. 39 106, 936. 63
TESTED 72. 00 265, 536. 00 89. 51 330, 131. 32
I. cinndcancnedeecae 112. 00 295, 232. 00 139. 24 367, 052. 4%
, ea eee Seen NI (“ EEE 2 12, 489, 835. 26
SANE EET ELE SEER GREE vccuadsscscos 379, 618, 435. 00

! The actual valuation by the Commissioner of Internal Revenue was $67,029,150.00
? The actual valuation by the Commissioner of Internal Revenue was $12,489,890.00
* The actual valuation by the Commissioner of Internal Revenue was $79,519,040.00

2. Issuance of the Stock
(a) Jsswance of the Reorganization Stock

190. On October 5, 1893, 31 years after the original Union
Pacific was incorporated, three of its stockholders filed a
complaint in the Circuit Court of the United States for the
District of Nebraska, alleging that the company would fail to
meet its expenses and charges in 1893 by at least $3 million
and that the company was insolvent, and asking that receivers
be appointed for the entire system. On October 13, 1893, the
court issued an order appointing receivers as requested in the
complaint.

191. On January 21, 1895, the trustees of the Union Pacific
first mortgage filed in the same court a bill to foreclose the
mortgage. A decree of foreclosure was issued on July 29, 1897.

192. Under date of October 15, 1895, a committee headed
by Louis Fitzgerald published a plan for the reorganization
of the railroad. It proposed that a new company (or a reorga-
nized Union Pacific Railway Co.) should succeed to main
lines and lands covered by the mortgages included in the plan
and that the new company should issue to the reorganization
committee $100 million in first mortgage 4 percent bonds,
750,000 shares of $100 par value noncumulative preferred

134

stock, and 610,000 shares of $100 par value common stock. A
major portion of the new securities were to be distributed by
the reorganization committee to holders of the securities of
the plaintiff’s predecessor.

193. On January 29, 1897, the United States filed in the
court referred to in finding 228, a bill to foreclose a lien exist-
ing under certain statutes against the Union Pacific line from
Council Bluffs to Ogden. A decree of foreclosure was issued
on July 29, 1897.

194. Pursuant to the two decrees of foreclosure, the rail-
road (except for the lines and lands of the Kansas Pacific
and Denver Pacific) was sold on November 1, 1897, to Louis
Fitzgerald and Alvin Krecii, as purchasing trustees for the
reorganization committee.

195. Pursuant to the decree of foreclosure under the suit
filed by the United States, the reorganization committee
paid, for the assets involved, $40,253,605.49 in cash, as
follows:

RN BB, Bi oeenccconccencusenanuneeee $2, 000, 000. 00
OCG? O, SEPT .cncnanscocnsiicmeniaadl ae 4, 100, 000. 00
ORE 6, irre cnnccininincininnasiiiea ee 8, 538, 401. 38
atte, dhe Lg ee 8, 538, 401. 38
NEE TE, Bi cnnnncccsstenminensansaee 4, 000, 000. 00
OCT TE, We cwcnccssnnsmncemsmmaaanaee 4, 538, 401. 38
CORNED G, TB ncccccnsctestinnenade 8, 538, 401. 35

WARE. conncensnnenscensemnetéieane 40, 253, 606. 49

196. Pursuant to the decree of foreclosur> of the Union
Pacific first mortgage, the reorganization committee paid
$50,637,435 for the assets involved. Of this amount, $5,373,249
was paid in cash and the balance was apparently paid by
use of the first mortgage bonds deposited with the committee.

197. On January 17, 1898, the purchasing trustees assigned
their two bids at the sule to the plaintiff. On January 22,
1898, two deeds were executed, conveying to the plaintiff the
property sold on November 1, 1897. One of the deeds was
executed by the special master, the purchasing trustees and
the predecessor and the other (on the foreclosure under the
first mortgage) by the special master, receivers, trustees. the
purchasing trustees and the predecessor.

2. a a

as ‘

cae

135

198. Pursuant to the plan of reorganization, plaintiff is-
sued $90 million in first mortgage bonds and the reorganiza-
tion stock (750,000 shares of preferred stock and 610,000
shares of common stock) to the reorganization committee for
money and property acquired by the reorganization com-
mittee.

199. On January 31, 1898, in the foreclosure proceeding
brought by the United States, the court issued a decree ap-
proving and confirming the payment of the purchase price,
the assignment of the bid to the plaintiff and the execution
and delivery of the deed conveying to the plaintiff the prop-
erty sold on November 1, 1897.

200. On January 31, 1898, the two deeds of January 22,
1898 and plaintiff's first mortgage were recorded at Omaha
in Douglas County, Nebraska.

201. On January 31, 1898, the Mercantile Trust Company,
the depositary under the plan of reorganization, advertised
that on and after January 31, 1898 it was prepared to issue
plaintiff's new securities (its bonds and preferred stock) in
exchange for certain old bonds and the purchase money cer-
tificates, and on that day the Mercantile Trust Company in
fact issued some of the new securities.

202. At midnight at the end of January 31, 1898, plaintiff
took possession of the property sold on November 1, 1897, in-
cluding the main line from Omaha to Ogden.

203. On February 9, 1898, the Mercantile Trust Company
advertised that it was prepared as of that date to issue plain-
tiff’s preferred and common stock in exchange for certificates
of deposit of the common stock of The Union Pacific Railway
Company.

204. The plan of reorganization provided that it could
be abandoned by the committee at any time and included a
procedure for making substantial changes in the plan.

205. Ky reason of the events of January 31, 1898, described
in findings 199-202, on that day the plan was no longer con-
tingent and could no longer be abandoned or changed sub-
stantially.

206. January 31, 1898 is the date of the issuance of the
reorganization stock.

136

(b) /ssuance of the Post-Reorganization Stock

207. The dates of the issuance of the acquisition stock are
as stated in finding 179.

3. Cash Assessments on Old Stockholders

208. Under the plan of reorganization of the Union Pa-
cific Railway Company dated October 15, 1895, the common
stock was assessed at the rate of $15 per share. A holder of
one share of the old common who paid the $15 assessment
was entitled to receive one share of the new common plus
15/100ths of one share of the new preferred. In other words
each recipient of 1 new share of common was assessed $15: a
total of $9,130,275 was received on account of these assess-
ments.

209. As appears in finding 179, the post-reorganization
stock—all common—was issued on the basis of 1 new share
(acquisition common) for 1 share of Oregon Short Line
common plus $3. In other words, each recipient of one
share of post-reorganization common was assessed $3. The
sum of $815,820.62 was received on account of these assess-
ments.

210. The foregoing cash assessments of $15 and $3 were
part payment for the shares being issued or, put otherwise,
the shares being issued were issued in part for property and
in part for money, the respective cash assessment. The shares
were thus being issued for a combination of money and
property and as determined in the conclusions of law the
money—the cash assessments—is not to be included in equity
invested capital in addition to the fair market value of the
stock which was issued.

4. The Expert Witnesses

211. The value of the stock was the subject of testimony
by an expert witness for each party. The direct testimony
of these experts was exchanged before trial and the wit-
nesses began their testimony at the trial with cross-
examination. Both witnesses qualified as entitled to testify
to their opinions.

i a ee

137

(a) Qualifications of the Plaintiff's Expert

212. Plaintiff offered the testimony of Mr. Alexander Sachs
as its expert witness on the stock valuation issues. Mr. Sachs
is an independent economist, investment adviser and busi-
ness consultant. He has not held himself out to the public
as an investment adviser and is not registered as such with
the SEC.

213. He has testified before this court as a witness for the
United States, in a proceeding to determine the value of
common stock for purposes of the World War II Excess
Profits Tax Act, specifically the value at which such stock
should be included in a taxpayer’s equity invested capital
for purposes of determining its excess profits tax credit. He
also has testified before the Federal Communications Com-
mission, the New York Public Service Commission, and
the Pennsylvania Public Utilities Commission regarding a
fair rate of return.

214. Mr. Sachs was graduated from Columbia University
in 1912, and shortly thereafter became an employee of Lee
Higginson & Company, an investment firm, working on the
effect of the money market on the purchase and issuance
of various securities.

In 1915 he undertook studies in jurisprudence and ad-
ministrative law at Harvard; and in the following year he
assisted Mr. Justice Brandeis and Professor Felix Frank-
furter in work related to foreign affairs.

215. During the early 1920’s Mr, Sachs was employed in
studying individual investment situations.

In 1929 he became the chief economist and director of
investment research for a diversified investment fund,
founded by Lehman Brothers, which ultimately became the
Lehman Corporation. As director of investment research
for the Lehman Corporation he directed staff members en-
gaged in investment research, and reviewed problems in
economics, banking and the economic outlook for particular
industries and general economic conditions. He was also a
member of the portfolio committee of the Lehman Corpora-
tion. He was a director of the Lehman Corporation from
1931 to 1959 and a vice president of that company from
1936 to 1942.

138

In 1933 he headed the Economic and Planning Division
of the National Recovery Administration. In 1956 and 1957
he was a special consultant to the Federal Reserve Board
on problems of credit and credit institutions. He has par-
ticipated in various governmental and industrial committees
and conferences.

216. Mr. Sachs has also rendered advisory and consultant
services on economic and investment problems as well as on
industrial management problems to a major oil company, a
mid-western insurance company, a New York bank, a promi-
nent French bank and to various investment management
firms.

217. He has at various times been a member of various
learned societies, including the American Economic and Sta-
tistical Association, the Econometric Society, the Society of
Security Analysts, the American Political Science Associa-
tion, the Royal Economic Society, and the Conference of
Business Economists. He has lectured at the University of
Virginia, Swarthmore. St. John’s College and the Academy
of Political Science. Mr. Sachs has not published any books
or articles on the valuation of securities. He has published
numerous articles in professional journals: the titles and
subjects of some are: FINANCIAL DYNAMICS OF U.S. RECOVERY.
1937-38; LOGISTICS PETROLEUM PIPFLINE SYSTEM FOR WAR
PROSECUTION, 1942; RESTORING BCONOMIC-CULTURAL BASES FOR-
EIGN INVESTMENT, 1950; CRITIQUE OF THE CYCLE THEORY, 1953:
INFLATION AS SOURCE AND CHALLENGE, 1958: also chapter con-
tributions to AMERICA’s RECOVERY PROGRAM. OXFORD UNIVERSITY

PRESS, 1934; and to MORAL PRINCIPLES OF ACTION. Harper's
1952.

(b) Qualifications of the Government's Expert

218. The Government offered as its expert witness on the
stock valuation issues. Mr. Arthur Jansen. a general partner
of W. E. Burnet & Company, a New York City brokerage
firm. Mr. Jansen is a specialist in the analysis and valuation
of railroad securities.

219. He has testified as an expert witness in four cases
before the Interstate Commerce Commission and one case
in this court. His appearances before the ICC were on be-

139

half of railroads or railroad stockholders. One of the ICC
cases concerned the division of freight rates on transcon-
tinental shipments. He was retained by a group of eastern
railroads to present various financial aspects of ten eastern
roads and to make comparisons with seven Mountain
Pacific roads. His other testimony before the ICC concerned
the fairness of plans of railroad recapitalization or railroad
reorganization. His previous appearance in this court was
on behalf of the Government with regard to the fair market
value at the time of issuance of the preferred stock of a
natural gas transmission company, issued in 1929 through
1931 in the construction of a pipeline.

220. Mr. Jansen attended Columbia College and the Co-
lumbia School of Business, graduating with a degree of
Bachelor of Science in 1927. He has worked for Wall Street
firms in investment research since 1930. In 1930 he began
research work for a member firm of the New York Stock
Exchange. In 1938, he went with his present firm as head of
the research department. He became a partner in 1943 and
since then has been the partner in charge of research
activities.

221. His primary interest has been the railroad industry,
an interest dating back to railroad courses he took in college.
Since 1937 he has published at least 400 articles in Barron's,
a widely read financial weekly; in recent years he has con-
tributed four articles a year. About 90 percent of these
articles have been on railroads, the remainder having dealt
with public utilities and industrials. In the 1940’s many of
his articles dealt with reorganized railroads, setting values
for proposed new securities under varying conditions, and
the recovery he foresaw for the bonds of railroads which
had been in bankruptcy in the 1930’s and the depressec|
medium-grade bonds of other railroads. For some years he
also wrote for his own firm a monthly letter on railroads,
devoted mainly to trends in the industry and current develop-
ments. For several years in the 1950’s he served as editor of
the Annual Railroad Survey of “The Investment Dealers
Digest.”

In connection with his interest in the railroad industry,
Jansen has made numerous inspection trips. He has inter-

140

viewed many railroad executives and carries on extensive cor-
respondence with them. He also attends meetings of the New
York Society of Security Analysts on railroad matters and
does extensive reading on current developments in the rail-
road industry.

222. He taught financial analysis of railroads and rail-
road securities at the New York University Graduate School
of Business from 1943 until 1955 or 1956, corporation finance
at Columbia in the 1950’s, analysis of industrial securities at
the American Institute of Banking, and analysis of in-
dustrial and public utility securities at a summer course of
the Graduate Schoc! of Banking of the American Bankers
Association.

He is a jong-time member of the New York Society of Se-
curity Analysts and was chairman of its Railroad Commit-
tee from 1945 through 1950. In 1968 he passed the examina-
tion of the Financial Analysts Federation to qualify as a
Chartered Financial Analyst.

5. Valuation Dates

(a) Plaintiff's Valuation a Valuation as of 1907

223. Mr. Alexander Sachs, the plaintiff’s expert, testified
that

(a) “The 749,742 shares of Union Pacific preferred when
issued incident to its reconstitutive-reorganization, had a fair
market value, as evaluated by contemporaneously govern-
ing money rates, related to a 4 percent yield, of $100 per
share.”

(b) “The 883,357 shares of Union Pacific common stock
[a reference to the reorganization common and to the post-
reorganization stock, which was all common] when issued
incident to its reconstitutive-reorganization, had a fair
market value or investment worth, figured conservatively, in
the range of $175 to $200 per share.”

224. The witness derived his dollar figures for the pre-
ferred from a contemporaneous 4 percent money rate and for
the common from price-earnings ratios for eight selected
railroads during 1901-1907, multiplied by the total earnings
per U.P. share as determined by him. The valuations of both
preferred and common, however, were a product of the

141

witness’ concept of a “reconstitutive-reorganization” which
began in 1893 and ended in 1907.

225. (a) The witness’ theory, which he said was held
or espoused by no one else, was that only the financial or
technical reorganization of Union Pacific took place on Jan-
uary 31, 1898, and that the true reorganization was a “recon-
stitutive-reorganization,” a term apparently coined by him,
which ended in 1907, a date vainly sought in plaintiff’s post-
trial brief to be amended to 1905.

(b) In his prepared direct examination the witness testi-
fied, on the subject of the duration and terminal date of the
reconstitutive-reorganization, that “the reconstitution was,
for all intents and purposes, accomplished at the close of the
1907 fiscal year.”

(c) At the trial he testified that “[i]t is a terminal time
span, the earliest part of which is the post-Northern securi-
ties case and the retirement of the directors of the Union
Pacific from the board and the ensuing collaboration be-
tween the Northern Pacific and the Union Pacific in the
Clearwater district. ... That date was in 1905, around
May, I think, but it extended through the ensuing year...
through 1906 . . . into the end of the fiscal year 1907.”

(d) The testimony of the plaintiff’s expert must be taken
to be that the “reconstitutive-reorganization” ended in 1907.
In part this conclusion is rested on the actual words of the
testimony and in part on the substantial reliance by the wit-
ness, for his valuation, on earnings of other railroads for the
period 1901-1907 as a source of ratios to be applied to earn-
ings per share of the U.P. over the period 1901 through 1907,
and on other data with respect to groups of years ending
in 1907.

226. The valuations by plaintiff’s expert were thus valua-
tions as of 1907, not

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385004_0008%3A2. Public record. Not legal advice.