Opposition Brief — Drayton v. United States

(4)

| No.86-1119

ee.

Pp

Iu the Supreme Court of the Hu

OCTOBER TERM, 1986

RICHARD DRAYTON, ET AL., PETITIONERS

v.

UNITED STATES OF AMERICA

ON PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF AFPEALS

FOR THE THIRD CIRCUIT -

BRIEF FOR THE UNITED STATES IN OPPOSITION

CHARLES FRIED

Solicitor General

RoGER M. OLSEN

Assistant Attorney General

JONATHAN S. COHEN

JOHN A. DUDECK, JR.

Attorneys

Department of Justice

Washington, D.C. 20580

(202) 633-2217

(RRR RAR SRRUBO NEA ERED NTE TP OLE TSA ALENT IRIAN ET IE

{

QUESTION PRESENTED ~

Whether the receipt in 1981 of the interest compo-

nent of Certificates of Value, which were delivered

to the Delaware and Bound Brook Railroad Com-

pany (D&BB) as compensation for the D&BB’s

transfer of its rail properties to the Consolidated

Rail Corporation (Conrail) in 1976, constituted or-

dinary income taxable under Section 61(a) of the

Internal Revenue Code.

(1)

TABLE OF CONTENTS

Page

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a cassdaienteneinnenlplosciunabil 2

aA sade dgainseinbianecicnmnhniinnadit 7

ER BE EE Pay a OO 16

TABLE OF AUTHORITIES

Cases:

Coldwater Seafood Corp. v. Commissioner, 69 T.C.

I oa csi tuadiladsbaiunisiehddinakabeddbdiscownscnes 8

Commissioner v. Carman, 189 F.2d 363 (2d Cir.

a sa shchiddbninonpaiitatnaene 15

Commissioner V. Gillette Motor Transport, Inc., 364

I i iis aacidiasome dbapentacemiadscaes 8,9

Commissioner v. Glenshaw Glass Co., 348 U.S. 426

a a i a aia tl ceaatinileeietnihbctippornereiascninnsees 8

Commissioner V. National Alfalfa Dehydrating &

Milling Co., 417 U.S. 184 (1974) .......................... 15

Deputy Vv. DuPont, 308 U.S. 488 (1940) -................ 8

Fall River Electric Light Co. v. Commissioner, 23

EN REE SNe See OOO CO EN 8

Hort v. Commissioner, 313 U.S. 28 (1941) -............. 9

Jeffers vV. United States, 556 F.2d 986 (Ct. Cl.

pS 2 aR ARNT ASE ie ae A DE ER 16

Kieselbach v. Commissioner, 317 U.S. 399 (1943). 7, 9,

10, 13

Kingsley v. Commissioner, 662 F.2d 539 (9th Cir.

ARR ARE NI ag RR Ts eee eer DO ODE oe eae 16

Old Colony R.R. v. Commissioner, 284 U.S. 552

a i alae 8

Regional Rail Reorganization Act Cases, 419 U.S.

EER NEE PEERS eae POS OO RE IE 3, 10, 11

Solomon v. Commissioner, 570 F.2d 28 (2d Cir.

Cee adesiboolinsanin 16

Starker v. United States, 602 F.2d 1341 (9th Cir.

I a a selina bic eacliaaigaadiion 14

Cases—Continued : Page

Timbers of Inwood Forest, In re, 793 F.2d 1380

I is: IED seven abstionsiesorasetinansciimiientnaindaniaminnens 8

United States v. Midland-Ross Corp., 381 U.S. 54

AIEEE. sacsoresinsiiscnenssinasncdctonisaienresestbinilacilabiarandteianiononmaies 9

Vorbleski v. Commissioner, 589 F.2d 123 (3d Cir.

I cckcicsh sega pisces ssipeieeldensetciahcsteniposasialeloaebociaine 16

Statutes and regulation:

Act of Mar. 31, 1976, Pub. L. No. 94-253, § 1(a),

I ea a eateries 4

Internal Revenue Code of 1954 (26 U.S.C.):

I coacnsccoiesiesc nig o jchisin Mid itneaniniecieees nde anamanetanin 7

ENS | a eey orem epee ts eet 6, 7, 8, 9, 10, 18, 14

I TIT isisccin leon eicsiasen decheeaitcic mee teeamonleniopiamediebenmaemlisamiiit 6

UE sic isccsnch stcndtodlalgha lpaee Scacadateantoiaslacapaeitias 12, 13

RACED cisscorssusnmsiansencicthsinaiinesibimstlseasadctundhinlicsionibaten 4

“SRR Ann tomer error rata Surrey sme ert Wee enn MecneonO re orereem 16

Omnibus Budget Reconciliation Act of 1981, Pub.

L. No. 97-35, § 1167, 95 Stat. 686 (codified at 45

Ur hg EY cnathicicnetiaccdneceabuhasihpieiomenibetnasetinsea: 4,12

Railroad Revitalization and Regulatory Reform

Act of 1976, Pub. L. No. 94-210, 90 Stat. 31........ 3

Regional Rail Reorganization Act of 1973, 45

ee iaseciaclieepekonbdeciee

45 U.S.C. 746 (a) ........... Sa a alee ca 11

a a cs esnmcahiunmincionns 3, 5

Be Ss BI OE CIID ove ccericcssnceccsioccccenconsin 6

Be vo oiceccceerncsincnniscnccviocadcanens 5

Re re NE OD ies ccs cosacanderndnawnineoucr 5

Oe rs PE BG on hain sctciceccencinscees cis ae ae

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Iu the Supreme Court of the United States

OCTOBER TERM, 1986

No. 86-1119

RICHARD DRAYTON, ET AL., PETITIONERS

Vv.

UNITED STATES OF AMERICA

ON PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF. APPEALS

FOR THE THIRD CIRCUIT

BRIEF FOR THE UNITED STATES IN OPPOSITION

OPINIONS BELOW

The opinion of the court of appeals (Pet. App. Al-

A29) is reported at 801 F.2d 117. The opinion of

the district court (Pet. App. A30-A40) is reported

at 632 F. Supp. 95.

JURISDICTION

The judgment of the court of appeals was entered

on September 11, 1986. A timely petition for rehear-

ing was denied on October 7, 1986 (Pet. App. A43-

A44). The petition for a writ of certiorari was filed

on January 5, 1987. The jurisdiction of this Court

is invoked under 28 U.S.C. 1254(1).

(1)

2

STATEMENT

1. Petitioners are escrow agents of the Delaware

and Bound Brook Railway Company (“D&BB”). In

1879, the D&BB leased all of its rail properties to the

Reading Company for a period of 990 years. By

1973, the Reading Company, along with other major

Northeast and Midwest railroads, was in bankruptcy

reorganization proceedings. Congress addressed the

railroad crisis and superseded the normal reorganiza-

tion process by passing the Regional Rail Reorganiza-

tion Act of 1973 (Rail Act), 45 U.S.C. 701, in a

comprehensive effort to save the Nation’s railway

system. The D&BB was affected by the Rail Act be-

cause of its long-term lease with the bankrupt Read-

ing Company. Pet. App. A3, A9.

The Rail Act established a non-profit government

corporation (the United States Railway Association,

or USRA), a for-profit private corporation (the Con-

solidated Rail Corporation, or Conrail), and a special

three-judge court (the Special Court). Under the

Rail Act, USRA was charged with developing and

implementing a Final System Plan for restructuring

the railroads into a financially self-sustaining rail

system. The Final System Plan was to provide for

the transfer of certain of the properties of the bank-

rupt railroads to Conrail. In exchange, the railroads

whose properties were transferred were to receive

common and preferred Conrail stock, plus up to $500

million of USRA obligations guaranteed by the

United States. Pet. App. A3.

The bankrupt railroads’ major creditors challenged

the constitutionality of the Rail Act, principally on

the ground that the transfer of the rail properties

was an unconstitutional taking without just compen-

3

sation. In the Regional Rail Reorganizaticn Act

Cases (Rail Act Cases), 419 U.S. 102 (1974), this

Court upheld the constitutionality of the Rail Act.

With respect to the taking claim, the Court explained

that the existence of a remedy under the Tucker Act, _

28 U.S.C. 1491, precluded a finding that there was

no just compensation. 419 U.S. at 148-149.

Thereafter, Congress took action to forestall a pos-

sible flood of Tucker Act suits by amending the Rail

Act. The Railroad Revitalization and Regulatory Re-

form Act of 1976 (4R Act), Pub. L. No. 94-210, 90

Stat. 31, changed the manner of compensating the

transferor railroads. Instead of simply depositing

Conrail stock with the Special Court, the 4R Act re-

quired Conrail to deposit both Conrail stock and Cer-

tificates of Value (CVs) issued by USRA. See Pet.

App. A5. It is these CVs that are the focus of this

litigation.

The CVs were guaranteed by USRA and were

subject to redemption by USRA on December 31,

1987, or at such earlier time as USRA might deter-

mine (Pet. App. A6). Each CV had a “base value”

that was to be determined as follows (45 U.S.C. 746

(c) (4) (emphasis added) ):

(A) taking the net liquidation value, as de-

termined by the special court * * *;

(B) subtracting the value of other benefits

provided under this [Act] as determined by the

special court;

(C) adding such amount, if any, as the spe-

cial court may determine shall be required after

taking into consideration compensabie unconsti-

tutional erosion, if any * * *;

(D) adding interest from the transfer date

to the redemption date to be compounded an-

nually at a rate of 8 percent per annum; and

4

(E) dividing the resulting value by the num-

ber of certificates of value of such series dis-

tributed to such transferor.

In short, the redemption price for the CVs was to

be the difference between the liquidation value of the

transferor’s assets and the value of any other com-

pensation given to the transferor, plus an interest

adjustment. The CVs were intended to make up for

any shortfall in the compensation provided by the

original Rail Act that would result from the low

value of the Conrail stock and USRA bonds. The

CVs thus were designed to ensure that all trans-

ferors received their constitutional due without the

need for bringing a Tucker Act suit against the

United States. See Pet. App. A8.*

Thereafter, Conrail continued to be dependent upon

federal assistance, and its stock remained virtually

worthless. On August 13, 1981, in response to this

poor performance, the Rail Act was amended again.

This amendment provided that all Conrail stock

should be transferred to the Secretary of Transpor-

tation and that such stock should be deemed to have

zero value for purposes of computing the amount for

which CVs were redeemable under the Rail Act.

Omnibus Budget Reconciliation Act of 1981, Pub. L.

No. 97-35, § 1167, 95 Stat. 686 (codified at 45 U.S.C.

1115). As a result of this legislation, ownership of _

1 At the same time that Congress passed the 4R Act it also

enacted the Act of March 31, 1976, Pub. L. No. 94-253, § 1(a),

90 Stat. 295, which added Section 374(c) to the Internal Reve-

nue Code (26 U.S.C.). Section 374(c) states that no gain or

loss shall be recognized by a transferor railroad corporation

upon its receipt of Conrail stock and CVs in exchange for its

transfer of rail properties to Conrail pursuant to the Final

System Plan.

5

Conrail was vested exclusively in the federal govern-

ment, and CVs became the sole source of payment

from Conrail to the transferor railroads. See Pet.

App. AQ.

2. Pursuant to the Final System Plan, the D&BB’s

rail property was transferred to Conrail on April 1,

1976. Thereafter, USRA estimated the net liquida-

tion value of the D&BB’s rail property to be about

$1,150,000. The D&BB did not accept that figure,

however, and it filed a complaint with the Special

Court. In August 1981, shortly after the Omnibus

Budget Reconciliation Act of 1981 was passed, the

D&BB and USRA entered into a settlement agree-

ment regarding the litigation in the Special Court.

In accordance with that agreement, the D&BB re-

ceived CVs having a total worth (‘“‘Base Value”) of

$6,802,660. This “Base Value” figure consisted of

two components—the “Principal Amount of CVs”

($4,408,417) and “CV Interest” ($2,394,243).? The

_ “Principal Amount” component represented the “net

liquidation value” of the D&BB’s rail properties on

April 1, 1976, the date on which those properties

were transferred to Conrail. The “CV Interest” com-

2The D&BB and USRA agreed that “the value of other

benefits’ (VOB) conferred by the Act was zero and that

there had been no “compensable unconstitutional erosion”

(CUE). See 45 U.S.C. 746(c) (4) (B) and (C). Pursuant to

the formula set forth in 45 U.S.C. 746(c) (4), therefore, the

settlement agreement computed the “Base Value” of the

CVs as follows (C.A. App. 49):

Net VOB CUE Principal CV Base Value

Liq. Amount Interest of CVs

Value of CVs (As of (As of

ae 11/15/81) 11/15/81)

$4,408,417 -0- +-0- $4,408,417 $2,394,243 $6,802,660

6

ponent represented 8% annual interest on the “Prin-

cipal Amount” component, accruing from the trans-

fer date of the rail properties until the redemption

date of the CVs. See 45 U.S.C. 746(c) (4) (A) and

(D); Pet. App. A10-A11.

In November 1981, USRA redeemed the CVs held

by the D&BB for the full $6,802,660. After sharing

part of this money with the Reading Company, its

lessee, the D&BB liquidated its assets and distrib-

uted the proceeds to its shareholders pursuant to

Section 337 of the Internal Revenue Code.* The

D&BB subsequently sought two separate private let-

ter rulings from the IRS concerning the interest com-

ponent of the CVs. The D&BB claimed that this

component was partial payment for the transferred

rail property, thus constituting a return on capital

that should be taxed as a capital gain. The IRS dis-

agreed, however, and ruled that the interest com-

ponent represented ordinary interest income taxable

to the D&BB under Section 61(a)(4) of the Code.

The IRS also disagreed with the D&BB’s suggestion

that the interest component should be eligible for

nonrecognition treatment under Section 337 of the

Code. Pet. App. A11-A12.

In accordance with these letter rulings, the D&BB

reported the interest component of the CVs as ordi-

nary income and paid the tax thereon. Subsequently,

it filed an amended return seeking a refund of the

taxes paid. Following the disallowance of that claim

by the IRS, petitioners, as escrow agents of the

D&BB, brought this refund suit on its behalf in the

3 Unless otherwise noted, all statutory references are to the

Internal Revenue Code (26 U.S.C.), as amended (the Code

or I.R.C.).

7

United States District Court for the District of New

Jersey. Pet. App. A12.

The district court granted summary judgment in

favor of the D&BB (Pet. App. A30-A40). The court

reasoned that the interest component of the CVs was

“an integral part of the redemption, or base, value

for rail properties,” and was “not an amount in ex-

cess of the value of such properties” (id. at A389).

Accordingly, it concluded that “[u]nder the express

provisions of [I.R.C.] § 374(c), the aggregate sum

received should result in no tax consequences to

D&BB”’ (ibid.).

The court of appeals unanimously reversed (Pet.

App. Al-A29). Relying in part on this Court’s deci-

sion in Kieselbach v. Commissioner, 317 U.S. 399

(1943), the court of appeals held that the interest

component of the CVs represented payment for the

detention of money between the 1976 transfer date

and the 1981 redemption date, and therefore fell

squarely within the standard definition of interest.

It accordingly concluded that the payment must be

treated as ordinary interest income under Section

61(a) (4) of the Code. Pet. App. A14-A17.

ARGUMENT

The court of appeals correctly held that the in-

terest component of the CVs is taxable as “interest’’

income under Section 61 of the Code. The court’s

decision does not conflict with any decision of this

Court or of another court of appeals. The issue pre-

sented has little future significance because it con-

cerns the proper characterization of a payment made

under a unique, one-time program that is not likely

to be repeated. Indeed, petitioner does not cite a

single case, apart from this one, that has ever ad-

8

dressed the tax treatment of the interest component

of the CVs. There is accordingly no need for further

review.

1. Section 61(a)(4) of the Code provides that

“gross income means all income from whatever

source derived, including * * * interest.’’ Congress

has not used the term “interest” in the Internal

Revenue Code with reference to “some esoteric con-

cept derived from subtle and theoretic analysis.” Old

Colony R.R. v. Commissioner, 284 U.S. 552, 561

(1932). Rather, the term “interest” has a definite

and long accepted meaning as the “compensation al-

lowed by law or fixed by the parties for use, or for-

bearance, or detention of money” (Fall River Elec-

tric Light Co. v. Commissioner, 23 B.T.A. 168, 171

(1931) (citations omitted)). See, e.g., Deputy v.

DuPont, 308 U.S. 488, 498 (1940) ; In re Timbers of

Inwood Forest, 793 F.2d 1880, 1382 n.1 (5th Cir.

1986) ; Coldwater Seafood Corp. v. Commissioner, 69

T.C. 966, 972 (1978); see also Treas. Reg. § 1.61-7.

And the categories of income contained in Section

61 generally have been given a broad reading, with

exemptions therefrom recognized only when specifi-

cally authorized by Congress. See Commissioner v.

Glenshaw Glass Co., 348 U.S. 426, 429-430 (1955).

On the other hand, this Court has long held that a

narrow construction is to be accorded “capital asset,”

_theterm that petitioner asserts should encompass

the interest component of the CVs at issue here.

This rule accords with Congress’s intent to afford

capital gains treatment only where the taxpayer has

realized an appreciation in value that has accrued

over a substantial period of time. See Commissioner

v. Gillette’ Motor Transport, Inc., 364 U.S. 130, 134

(1960). Accordingly, this Court has consistently

construed the term “capital asset” to exclude prop-

9

erty that represents either an item of income or an

accretion to the value of an asset that is properly

attributable to income. See Commissioner v. Gillette

Motor Transport, supra (compensation awarded for

rental value of facilities during period of govern-

ment control taxed as substitute for rental income) ;

United States v. Midland-Ross Corp., -381 U.S. 54

(1965) (gain attributable to original issue discount

taxed as disguised interest income); Hort v. Com-

missioner, 313 U.S. 28 (1941) (amounts received for

cancellation of lease taxed as substitute for rental

income).

In Kieselbach v. Commissioner, 317 U.S. 399

(19438), the Court addressed a situation closely anal-

ogous to that presented here. The City of New York

had instituted a condemnation proceeding in which

payment was made several years after the actual

taking. The payment consisted of two components,

one representing the value of property at the time

of the taking and the other representing interest.

Id. at 400. The Court held that the interest com-

ponent was fully taxable as ordinary income under

the predecessor of Section 61(a)(4). The taxpayer

had urged that the interest component was taxable

as capital gain because the relevant state law pro-

vided that interest was part of the total condemna-

tion award to which the property-owner was entitled.

In rejecting that argument, this Court stated that

the interest payment was “indemnification for delay,

not a part of the sale price” of a capital asset. 317

U.S. at 404.

Similarly here, the interest component of the CVs

in question was paid under a statutory formula that

expressly provided for “interest from the transfer

date to the redemption date * * * compounded an-

10

nually at a rate of 8 percent per annum.” 45 U.S.C.

746(c)(4)(D). In contrast to true capital apprecia-

tion, the interest component here was predictable

and measurable in advance, and it represented com-

pensation for the detention or forbearance of money.

If full payment for the rail properties had been made

on the transfer date, this interest component would

obviously have been zero. Thus, the payment repre-

sented “income * * * paid to the [D&BB] in lieu of

what [it] might have earned on the sum found to be

the value of the property on the day the property

was taken.” Kieselbach v. Commissioner, 317 U.S.

at 403. In these circumstances, the court of appeals

was clearly correct in holding that the interest com-

ponent received by the D&BB on the CVs constituted

ordinary interest income taxable under Section 61 (a)

(4) of the Code.

2. Petitioners contend (Pet. 13-20) that the deci-

sion below is inconsistent with this Court’s decision

in the Regional Rail Reorganization Act Cases, 419

U.S. 102 (1974). This contention is without merit.

In the Rail Act Cases, the Court upheld the constitu-

tionality of the Rail Act on the ground that the

availability of a Tucker Act remedy ensured that the

transferors would receive just compensation for their

properties even if it turned out that the Conrail stock

and USRA bonds that they received in exchange

were not themselves adequate. The Court held that

“Tals long as creditors are assured fair value, with

interest, for their properties, the Constitution re-

quires nothing more” (7d. at 156). Petitioners here

have received “fair value, with interest, for their

properties” (ibid.), and this case accordingly pre-

sents no constitutional claim. Rather, the sole ques-

tion here concerns the proper treatment, for federal

11

income tax purposes, of the interest that petitioners

received. Since the Court in the Rail Act Cases did

not address any income tax questions, and since the

particular instruments at issue here—CVs with both

“principal” and “interest” components—were not

even created by Congress until several years after

this Court decided the Rail Act Cases, it is difficult

to see how that decision could reasonably be said to

conflict with the decision below.

The gist of petitioners’ contention in this regard

appears to be that the Court in the Rail Act Cases

viewed the Rail Act as effecting an “exchange in

furtherance of a plan of reorganization” (Pet. 13

(emphasis in ori 1)), rather than a public con-

demnation that required full and immediate cash

payment for the rail properties (see 419 U.S. at 149-

150). From this premise, petitioners deduce that the

CVs, including the interest component, are indivisi-

ble assets received in an exchange of property. The

interest component, petitioners argue, should be

viewed merely as “growth” in the value of those as-

sets and therefore eligible for capital gain treatment.

See Pet. 13-14.

This contention misses the mark for several rea-

sons. To begin with, petitioners’ contention ignores

the fact that the compensation mechanism involved

here is not the same as the one before the Court in

the Rail Act Cases. Three years after the Rail Act

Cases were decided, the 4R Act created the govern-

‘ment-guaranteed CVs at issue here, requiring USRA

to deposit them with the Special Court to fill any gap

in compensation caused by the low value of the Con-

rail stock and USRA bonds (see Pet. App. A5-A8;

45 U.S.C. 746(a)). In 1981, the statute was

amended again; the Conrail stock was deemed to

12

have zero value and 100% of that stock was trans-

ferred to the government, with the result that the

CVs became the sole source of payment from Conrail

to the transferor railroads. 45 U.S.C. 1115. Thus,

after 1981, the concept that part of the compensation

for the transfer of the rail properties would take the

form of equity in a private corporation was no longer

operative. In the end, petitioners received no equity;

and the fact that there was no “growth” in the value

of their railroad assets was clearly demonstrated by

the decline in the value of the Conrail stock to zero

by 1981. As the court of appeals observed (Pet.

App. A22-A23), therefore, it is highly questionable

whether this Court’s statement in the Rail Act Cases

characterizing the 1973 version of the Rail Act as a

bankruptcy reorganization statute should be viewed

as fully applicable to the revised statutory scheme

at issue in the present case.

In any event, even if the Rail Act were properly

characterized as a reorganization statute, the inter-

est component of the CVs would still be subject to

taxation as ordinary income. Pursuant to Section

374 of the Internal Revenue Code, the D&BB’s 1976

exchange of its rail properties for CVs and Conrail

stock was treated as a tax-free exchange, with no

gain or loss being recognized to the D&BB at that

time. At that time, of course, the value of the “in-

terest component” of the CVs was zero. But the

transaction at issue here does not concern the origi-

nal 1976 exchange of assets for CVs; rather, it

concerns USRA’s redemption of those CVs five years

later, by which time the “interest component” of the

CVs had risen to $2,394,243. As the court of appeals

correctly pointed out (Pet. App. A14-A15), the re-

demption is a wholly different transaction from the

initial exchange of rail property for securities. The

Perse

13

government is not now seeking to impose, any more

than it sought in 1976 to impose, any tax on the

“principal component” of the CVs, which corresponds

to the 1976 net liquidation value of the rail property.

What the government seeks to tax is the interest that

accrued on that principal during the subsequent five-

year period. Obviously, the fact that a taxpayer has

received a debt instrument in a tax-free reorganiza-

tion in 1976 does not mean that the interest on that

debt—either under Section 374 or under general tax

principles—is perpetually immune from tax. It was

the 1981 redemption of the CVs, not their receipt in

the 1976 exchange, that caused them to have an in-

terest component that is taxable to the D&BB under

Section 61(a) (4). Accordingly, the decision below is

fully consistent with this Court’s characterization of

the Rail Act as a “reorganization statute’ in the

Rail Act Cases.

By the same token, there is no merit to petitioners’

contention (Pet. 16) that the reorganization aspects

of the Rail Act render Kieselbach v. Commissioner,

supra, irrelevant. There is no reason why the deci-

sion in Kieselbach should be limited to condemnation

statutes. The two factors upon which the finding of

taxability in Kieselbach hinged are both present here.

First, the D&BB was not paid for its rail property

until substantially after the transfer date. Second,

as compensation for the five-year delay in payment,

the D&BB received an amount over and above the

1976 value of that property—an amount computed

at 8% per annum. In this case, as in Kieselbach, the

property owner was under legal compulsion to trans-

fer the property at a specified time and could not

withhold transfer until payment was received. To

compensate the owner for that delay, the ultimate

cash payment included an interest component. Hence,

14

condemnation proceeding or not, the rationale of

Kieselbach is fully applicable here.

Finally, we note that petitioners’ theory that the

interest component of the CVs represented “growth”

in the value of an equity investment (Pet. 15) neces-

sarily incorporates several illogical assumptions.

First, there is no reason to suppose that Congress

would have wanted to pay the transferor railroads

for capital “growth” after the transfer of their rail-

road property. Second, petitioners’ theory irration-

ally presupposes that the D&BB and the other trans-

ferors gave Conrail free use of their money for an

indefinite period subsequent to the conveyance date.

Third, as noted above, the D&BB never received any

equity investment and, even if it had received one,

the “growth” in value would have been negative,

since the value of the Conrail stock, at the time it

was transferred to the government in 1981, was zero.

The interest component of the CVs must therefore be

characterized as “interest’”? income under Section

61(a) (4) of the Code, just as Congress denominated

it. See Starker v. United States, 602 F.2d 1341, 1356

(9th Cir. 1979) (six-percent “growth” factor in land

exchange agreement held to constitute disguised in-

terest income, not capital gain) .*

* Petitioners also contend (Pet. 16-24) that the court of ap-

peals erred in failing to recognize that the D&BB had a legal

and equitable right to receive compensation in the form of

Conrail stock, as contemplated in the original Rail Act. It is

not apparent how this contention supports petitioners’ ulti-

mate view that the interest component of the CVs should not

be taxed. Even if petitioners had some legitimate expectation

of compensation in the form of equity, which the court of

appeals correctly held they did not (see Pet. App. A26-A28),

that would not affect the taxability of the CVs that they

actually received. It is well established that a transaction is

15

3. Contrary to petitioners’ assertion (Pet. 26-28),

the decision below does not conflict with the decision

in Commissioner v. Carman, 189 F.2d 363 (2d Cir.

1951). In Carman, the taxpayer bought certain rail-

road bonds, the interest on which had been in default

since 1933. In 1935, the railroad filed a petition for

reorganization under the Bankruptcy Act, and in

1939 a plan was approved by the district court. Con-

summation of the plan was delayed for five more

years by litigation, however, and it was not until

December 29, 1944, that the plan went into effect.

On that date, the taxpayer surrendered his bonds and

received in exchange new bonds, preferred stock,

common stock, and cash. The cash represented “ad-

justment payments” to compensate the taxpayer for

the five-year delay between the development of the

plan and its consummation. See 189 F.2d at 364.

Although the Tax Court held that the “adjustment

payments” were taxable to the taxpayer as ordinary

income, the court of appeals reversed, holding that

such payments were received as part of the reorgani-

zation plan and were taxable as “boot,” not as ordi-

nary income.

As the court of appeals correctly noted (Pet. App.

A24 n.9), the decision in Carman is not in conflict

with the decision below because it turned on factors

not present here. The taxpayer in Carman had full

control over his bonds between 1939 and 1944; he

could have transferred them or sold them at will.

_ He did not exchange his bonds until 1944, at which

time he was paid in full when he received new bonds,

to be given its tax effect “in accord with what actually oc-

curred and not in accord with what might have occurred.”

Commissioner V. National Alfalfa Dehydrating & Milling Co.,

417 U.S. 184, 148 (1974).

\

16

stock, and cash. Because there was no post-exchange

delay in the taxpayer’s receipt of this consideration,

the entire consideration received was logically viewed

as being received in exchange for the property sur-

rendered. There was thus no occasion in Carman to

find any “interest component” in the transaction.

Here, by contrast, the D&BB gave up all rights to

its property in April 1976, and it did not receive any

cash in exchange for that property until 1981. The

“interest component” attributable to that delay in

receiving payment was correctly treated as interest

income.*®

CONCLUSION

The petition for a writ of certiorari should be

denied.

Respectfully submitted.

CHARLES FRIED

Solicitor General

ROGER M. OLSEN

Assistant Attorney General

JONATHAN §S. COHEN

JOHN A. DUDECK, JR.

Attorneys

APRIL 1987

5 In addition, we note that Carman was decided prior to the

enactment of the unstated interest provisions of Section 483

of the Code. The courts of appeais, including the Second Cir-

cuit, have consistently held that interest is imputed under that

provision in cases involving delays with respect to the issu-

ance of securities in reorganizations. Kingsley v. Commis-

sioner, 662 F.2d 539 (9th Cir. 1981); Vorbleski v. Commis-

sioner, 589 F.2d 123 (3d Cir. 1978); Solomon v. Commis-

sioner, 570 F.2d 28 (2d Cir. 1977) ; Jeffers v. United States,

556 F.2d 986 (Ct. Cl. 1977). The result in Carman, therefore,

might well be different if it were decided today.

WU. &. GOVERNMENT PRINTING OFFicg; 1987 181483 40293