On Appeal from the United States District Court for the District of New Jersey, D.C. Civ. No. 84-3418.
Before: SEITZ, HIGGINBOTHAM, BECKER, Circuit Judges.
This income tax case arises in the aftermath of the Rail Reorganization Act. Before us on an appeal from the judgment of the district court in a tax refund suit, it requires us to determine the proper income tax treatment of the interest component of certificates of value delivered to the shareholders of the transferor railroads as compensation for their properties. The district court ruled that the interest component was non-taxable pursuant to 26 U.S.C. § 374(c) (1982). We disagree, however, and hold that the income is fully taxable as ordinary income. Hence, we shall reverse the district court's grant of summary judgment and instruct the court to enter a summary judgment for the government.
I. THE STATUTORY FRAMEWORK
A. The Rail Act through Blanchette
By the late 1960's and early 1970's eight railroads in the northeast and midwest sections of the country had fallen on hard times. Experiencing both physical and financial deterioration, they filed petitions for bankruptcy and began to undergo reorganizations in the bankruptcy courts. However, Congress superseded the reorganization process when it passed the Regional Rail Reorganization Act of 1973. Pub. L. No. 93-236, 87 Stat. 985 (1974), 45 U.S.C. § 701 et seq. (the Rail Act) (amended 1976, 1981) a comprehensive effort to save the nation's railway system through a combination of public agencies and private initiative.
The Rail Act established a government corporation, the United States Railway Association (USRA), 45 U.S.C. § 711(a) (1982), which was to develop a Final System Plan for restructuring the railroads into a "financially self-sustaining rail service system." 45 U.S.C. § 716(a)(1) (1982). The Final System Plan was to provide for the transfer of certain of the properties of the bankrupt railroads to a private railroad incorporated by the federal government, the Consolidated Rail Corporation (Conrail). Pub. L. 93-236, Title III § 301, 87 Stat. 1004 (1974), codified at 45 U.S.C. § 741 (1982). In exchange, the railroads whose properties were taken were to receive common and preferred Conrail stock, plus up to $500 million of USRA obligations guaranteed by the United States. Pub. L. 93-236, Title II, § 206(d)(1), 87 Stat. 994 (1974), codified at 45 U.S.C. § 716(d)(1) (1982); see also Pub. L. No. 93-236, Title II § 210, 87 Stat. 1000 (1974), codified at 45 U.S.C. § 720 (1982) (amended 1980).
In July, 1975, the USRA duly submitted its Final System Plan to Congress, which acquiesced to the plan by not disapproving it within sixty days of its submission. Pub. L. No. 93-236, Title II, § 208, 87 Stat. 999 (1974) codified at 45 U.S.C. § 718 (1982). USRA then submitted all of the Conrail securities and the requisite number of USRA obligations to a Special Court created by the Rail Act, Pub. L. No. 93-236. Title II, § 209, 87 Stat. 999 (1974), codified at 45 U.S.C. § 719(b) (1982).
The Special Court was assigned two primary tasks. First, it was to "order the trustee or trustees of each railroad in reorganization ... to convey forthwith [to Conrail] ... all right title and interest in the rail properties of such railroad in reorganization [as designated in the Final System Plan]," Pub. L. 93-236, Title III, § 303, 87 Stat. 1005 (1974), codified at 45 U.S.C. § 743(b) (1982). Second, railroads whose assets were transferred to Conrail and which were dissatisfied with the compensation allotted to them by USRA could file complaints before the Special Court, which had the power to determine whether the Conrail securities and the USRA bonds that the railways were to receive as compensation for their properties that had been taken by the government satisfied the constitutional minimum. The Special Court was to adjust the compensation if it determined that it was either too high or too low. See 45 U.S.C. § 743(c) (Special Court to assure that transferor railroads receive "fair and equitable" value for their rail properties and that they receive no less than the constitutional minimum).
The bankrupt railroads' major creditors challenged the constitutionality of the Rail Act almost immediately. They argued inter alia that the act was an unjustifiable taking without just compensation. In the compendious Blanchette v. Connecticut General Insurance Corps., 419 U.S. 102, 95 S. Ct. 335, 42 L. Ed. 2d 320 (1974), the Supreme Court upheld the constitutionality of the Rail Act against a variety of constitutional challenges. In responding to the just compensation challenge, the Court stated that because the Tucker Act, 28 U.S.C. § 1491 (1982), was available to aggrieved transferors, enabling them to challenge their allotted compensation in the United States Claims Court, there was no unjust compensation problem. Id. 419 U.S. at 148-49, 95 S. Ct. at 361.
B. Congressional Response to Blanchette
In the wake of Blanchette, Congress was faced with the spectre of Tucker Act suits by virtually every creditor of the defunct railroads whose properties were to become part of the Conrail system. To avoid the confusion and uncertainty that would ensue if such suits were allowed, Congress amended the Rail Act in the Railroad Revitalization and Regulatory Reform Act of 1976, Pub. L. No. 94-210, 90 Stat. 31 (1976), (the Reform Act), codified in 45 U.S.C. § 801 et. seq. (1982), which changed the manner of compensating the transferor railways. Instead of simply putting Conrail securities into the Special Court's coffers, the Reform Act required Conrail to deposit with the Special Court securities and Certificates of Value (CVs), issued by the USRA. Pub. L. No. 94-210, Title VI, § 610(b), 90 Stat. 101, 104 (1976), codified at 45 U.S.C. § 746 (1986). The CVs, which are debt instruments, were designed to give the Special Court some flexibility in compensating the transferors, so that the Tucker Act suits could be avoided. Because CVs are at the heart of this case, it is necessary to discuss them in some detail.
According to the Reform Act, each transferor of rail properties was to receive a separate "series" of CVs. Each transferor would get as many CVs as it did shares of series B preferred Conrail stock in exchange for its properties. 45 U.S.C. § 746(b). Although the CVs paid no interest or dividend, they were guaranteed by the USRA and redeemable by the USRA on December 31, 1987, or at such earlier time as the USRA might determine. 45 U.S.C. § 746(c). Each CV had a base value that was determined as follows:
(A) take the net liquidation value of a transferor's assets, as calculated by the Special Court;
(B) subtract the value of other benefits already provided to the transferor under the Rail Act;
(C) add any amount required to compensate for "unconstitutional erosion" that had occurred during the bankruptcy proceedings;
(D) add 8% interest from the date the assets were transferred to ConRail to the date the CV is redeemed; and,
(E) divide the resultant value by the number of CV's distributed to the transferor.
45 U.S.C. § 746(c)(4).*fn1 Base value is important because it is used to determine redemption value: redemption value of a CV equals its base value on the redemption date; minus (A) the sum of the fair market value of the series B preferred stock and common stock and all dividends paid on that stock, and; (B) any other sums paid the transferor for its assets; divided by the number of CV's distributed to the transferor. 45 U.S.C. § 764(c)(2). See also In the Matter of Valuation ...