Old Colony Railroad v. Commissioner

Background

A railroad company issued bonds between 1895 and 1904 at prices above face value, receiving total premiums of $199,528.08. The company had kept those receipts on its books as “Premium on Bonds.” In 1914 the Interstate Commerce Commission ordered the premiums amortized over the bonds’ lives. For 1921 the company reported a $6,960.64 annual amortization amount to the Commission but did not include it as taxable income on its tax return. The Commissioner added that sum to gross income, the Board of Tax Appeals sided with the company, and the Circuit Court of Appeals reversed. The case reached the Court for review.

Reasoning

The Court addressed whether yearly pro rata amortization of bond premiums is taxable income for the year or instead reduces the deductible interest paid by the company. The Treasury regulation called premiums “gain or income,” but the Court explained that premiums received before the relevant date become capital and cannot be treated as later income. The Court rejected the Government’s view that accounting theories about an “effective” interest rate should change the ordinary meaning of “interest” in the statute. It also said rules imposed by the Interstate Commerce Commission do not control tax liability. The Court concluded that the amortized premium is not income in the year and that a premium does not reduce the amount of interest the statute allows as a deduction.

Real world impact

The decision favors the railroad and similar companies: amortized bond premiums are not taxed as annual income, and corporations may deduct the full coupon interest they actually pay. The Court reversed the appeals court judgment and returned to the Board’s view.