Before DUFFY, KNOCH and SWYGERT, Circuit Judges.
The Chicago North Shore and Milwaukee Railway Company brought this action for a refund of federal income taxes for the year 1945 in the amount of $198,276.93, plus interest. The district court denied the refund. Plaintiff (identified as the Railway) is the successor in interest to the Chicago North Shore and Milwaukee Railroad Company (identified as the Railroad). The facts were stipulated.
The Railroad operated an electric interurban railroad between Chicago and Milwaukee. It was organized in 1924. It had to refinance its operations in 1932. In June of that year, the Railroad issued four collateral promissory notes due April 1, 1935, and bearing interest at 6% per annum, as follows:
To: Reconstruction Finance Corporation its note dated June 10, 1932, for $1,150,000, secured by $2,056,000 principal amount of the Railroad Company's 5 1/2% Series C First and Refunding Mortgage Gold Bonds, maturing April 1, 1956, with semiannual interest coupons maturing subsequent to April 1, 1932 attached thereto.
To: Central Republic Trust Company its note dated April 1, 1932 for $545,980.58, secured by $666,000 principal amount of its above mentioned Series C bonds with semiannual interest coupons maturing subsequent to April 1, 1932 attached.
(Central Republic Trust Company assigned its note together with the collateral to Reconstruction Finance Corporation.)
To: Commonwealth Subsidiary Corporation its note dated April 1, 1932 for $300,000 secured by $333,000 principal amount of its 6% Series A and its 5 1/2% Series B First and Refunding Mortgage Gold Bonds, maturing January 1, 1955 and April 1, 1956, respectively, with all semi-annual interest coupons maturing subsequent to June 30, 1932 attached.
To: Public Service Subsidiary Corporation its note dated April 1, 1932 for $300,000 secured by $333,000 principal amount of its above mentioned Series A and Series B bonds with all semi-annual interest coupons maturing subsequent to June 30, 1932 attached.
Shortly thereafter, the Railroad was placed under an equity receivership. In 1942, the receivership proceeding was succeeded by a proceeding under Chapter X of the Bankruptcy Act. In 1943 and 1944, the bankruptcy court authorized the sale of the Railroad's bonds which secured the 1932 notes.
In December, 1943, $10,800 face amount of Series A Bonds and $77,200 face amount of Series B Bonds were sold for $20,240. In January, 1944, $45,000 principal amount of Series A Bonds were sold for $10,350. In June, 1944, the bankruptcy court gave one of the creditors full ownership of $200,000 face amount of Series A Bonds in extinction of all rights under the collateral notes which the bonds had previously secured. In January, 1944, $300,000 face amount of Series A Bonds and $33,000 of Series B Bonds were sold for $90,576.
Finally, in June, 1944, Reconstruction Finance Corporation petitioned the bankruptcy court for leave to sell the collateral (the bonds) which secured the promissory notes issued either directly to it or to Central Republic Trust Company and subsequently assigned to the R.F.C. The R.F.C. was authorized to sell $2,722,000 of face amount of Series C Bonds with coupons attached for $29 per $100 face value of the bonds. The sales of the collateral held by the R.F.C. were consummated in July, 1944. The proceeds, $900,000, were paid to the R.F.C. The trustee reported that the R.F.C. applied the proceeds to reduce interest accrued on the notes it held.
In April, 1946, a plan of reorganization of the Railroad was approved. The plan was put into effect and thereby a new company, the Railway, was formed. The assets of the Railroad were transferred to the Railway free of all liens and encumbrances, with certain exceptions such as an obligation by the Railway to pay taxes due the United States. With respect to the Railroad's obligations, the plan provided:
(1) For each $1,000 principal amount of First and Refunding Mortgage Gold Bonds, Series A, the Railway would issue 27.946 shares of common stock ...