Before BIGGS, Chief Judge, and McLAUGHLIN and STALEY, Circuit Judges.
This is an appeal by a taxpayer from a judgment of the district court denying a refund of taxes alleged to have been erroneously paid. The taxpayer, a Pennsylvania corporation, was reorganized in 1936 under Section 77B of the National Bankruptcy Act, 11 U.S.C.A. § 207, and began business as a reorganized corporation on June 8, 1936. In accordance with the plan of reorganization, it issued to creditors $2,836,400 Sixteen Year 5% Cumulative Convertible Income Debentures. Annually thereafter the corporation accrued the unpaid interest on the debentures and deducted it as an expense in its federal income tax return. All of the accumulated and current interest was paid in 1948, 1949, and 1950. Its returns filed for those years showed no deduction for payment of the accumulated interest but only for current interest. It is now claimed that the accruals were improper and that the deductions should have been taken only in the years of payment.
The district court found that the accruals and deductions in the years prior to payment had been proper for the reason that the debentures and indenture accompanying them had created a definite and fixed liability of the taxpayer for interest. Appellant contends that its obligation to pay interest was, at most, a conditional one. Of course, if this is so there must be a reversal.
The controlling legal principles are clear and undisputed. "In the case of a taxpayer on the accrual basis of accounting an item of expense is to be regarded as incurred, and hence deductible as accrued, only in the year when the taxpayer's liability to pay it becomes definite and absolute, whether or not it is presently paid or payable. On the other hand if the liability to pay the item of expense is wholly contingent upon the happening of a subsequent event the item cannot be regarded as incurred or deductible as accrued until the year in which by the occurrence of the event the contingent liability becomes an absolute one." Pierce Estates, Inc., v. Commissioner of Internal Revenue, 3 Cir., 1952, 195 F.2d 475, 477. Though its payment may be deferred, ordinarily interest accrues as expense from day to day unless the obligation to pay at all is contingent upon the happening of a later event. Pierce Estates, Inc., v. Commissioner, supra; Warner Co. v. Commissioner of Internal Revenue, 1948, 11 T.C. 419, affirmed per curiam, 3 Cir., 1950, 181 F.2d 599.
It is necessary to set out the pertinent provisions of the debentures and indenture since they are determinative of the question presented. The debenture reads, in part, as follows:
"United States of America
"Commonwealth of Pennsylvania
"National Fireproofing Corporation
"Sixteen-Year 5% Cumulative Convertible
"National Fireproofing Corporation, a corporation of the Commonwealth of Pennsylvania (hereinafter called the 'Company'), for value received, promises to pay to the registered holder hereof on May 1, 1952, - dollars in any coin or currency of the United States of America which at the time of payment is legal tender for public and private debts, and to pay interest thereon to the registered holder hereof from May 1, 1937 until the principal sum is paid, at the rate of five per centum (5%) per annum, on May 1 and November 1 in each year in like coin or currency, as the same becomes due and payable as hereinafter provided, the principal being payable at the principal office of Commonwealth Trust Company of Pittsburgh (hereinafter called the 'Trustee') in the City of Pittsburgh and Commonwealth of Pennsylvania.
"Payment of said interest semiannually shall constitute a fixed obligation of the Company only beginning on the date of final payment of the principal of and interest upon all First Mortgage Bonds of the Company issued under an Indenture dated as of November 1, 1936, to The Continental Bank and Trust Company of New York, as Trustee, or sooner upon the payment of any dividend upon the capital stock of ...