Rev. Rul. 56-162

Advice has been requested whether interest accrues on a Federal tax claim after the filing of a petition in bankruptcy and whether such interest may be offset against an overassessment resulting from the allowance of a claim for refund.

The taxpayer corporation was determined to be entitled to relief from excess profits tax under section 722 of the Internal Revenue Code of 1939. The resultant aggregate overassessment of excess profits tax was 90x dollars on which interest in the amount of 20x dollars was allowed. The concurrent resultant deficiency in income tax amounted to 40x dollars on which interest in the amount of 10x dollars was assessed. During a portion of the period for which interest on the overassessment of excess profits tax was allowed and interest on the deficiency in income tax was assessed, the affairs of the corporation were administered by a Federal court in connection with a petition for an arrangement under Chapter XI of the Bankruptcy Act, 11 U. S. C. 701-799.

The taxpayer corporation takes the position that it is entitled to a refund of 1x dollars representing the amount of the interest assessed on the deficiency in income tax applicable to the period of bankruptcy administration. In support of its position the taxpayer cites the cases of City of New York v. Lewis H. Saper, Trustee et al., 336 U. S. 328, Ct. D. 1715, C.B. 1949-1, 120, and United States v. General Engineering & Manufacturing Co., 188 Fed. (2d) 80, affirmed per curiam 342 U. S. 912.

In the General Engineering case it was held that,

All of the sections of the Bankruptcy Act upon which the Supreme Court relied in the Saper case in demonstrating that tax claims in bankruptcy proceedings are debts and that interest upon them is allowable only to the date of bankruptcy are equally applicable to proceedings for an arrangement under Chapter XI.

In the Saper case, the Court held that interest accruing on Federal tax claims after the date of bankruptcy could not be allowed in a bankruptcy proceeding. Some of the language of that decision may be taken to indicate that interest does not run on such claims during the period from the date of filing a petition in bankruptcy to the date of payment of the claims. The Revenue Service, however, does not believe that the holding of the Court is to that effect. From a careful analysis of the reasoning employed by the Court, it is believed that the decision recognizes that the liability for interest continues to the date of payment of the claims, but, as a matter involving equity of distribution of assets among creditors, forbids the collection of post-bankruptcy interest where the estate being administered is insufficient to meet all claims.

In the instant case, however, we are not concerned with an attempt to collect tax out of an estate being administered by a Federal court under the Bankruptcy Act. We are concerned with an adjustment of the taxpayer's liability for income and excess profits taxes, the net effect of which has been to set up overassessments of excess profits tax. In such a situation the similar provisions for computation of interest on deficiencies in income tax and overassessments of excess profits tax, as contained in section 292(b) and section 3771(g), respectively, of the Code, indicate very clearly that the computation of interest on overassessments and complementary deficiencies is a necessary step in arriving at the correct net refund or credit due a taxpayer resulting from allowance of a claim under section 722 of the Code.

It will be noted that in the Saper case the Court cited with apparent approval the cases of American Iron and Steel Manufacturing Co. v. Seaboard Air Line Railway, 233 U. S. 261, and Sexton v. Dreyfus, 219 U. S. 339, as recognizing exceptions to the rule against allowance of postbankruptcy interest. In the American Iron and Steel Manufacturing Co. case the following language of the opinion is very significant:

* * * And it is true, as held in Tredegar Co. v. Seaboard Ry., 183 Fed. Rep. 289, 290, that as a general rule, after property of an insolvent is in custodia legis interest thereafter accruing is not allowed on debts payable out of the fund realized by a sale of the property. But that is not because the claims had lost their interest-bearing quality during that period, but is a necessary and enforced rule of distribution, due to the fact that in case of receiverships the assets are generally insufficient to pay debts in full. If all claims were of equal dignity and all bore the same rate of interest, from the date of receivership to the date of final distribution, it would be immaterial whether the dividend was calculated on the basis of the principal alone or of principal and interest combined. But some of the debts might carry a high rate and some a low rate, and hence inequality would result in the payment of interest which accrued during the delay incident to collecting and distributing the funds. As this delay was the act of the law, no one should thereby gain an advantage or suffer a loss. * * *

In Vanston Bondholders Protective Committee v. Green, et al., 329 U. S. 156, it is stated that it is manifest that the touchstone of each decision on allowance of interest in bankruptcy, receivership, and reorganization has been a balance of equities between creditor and creditor or between creditors and the debtor. Thus, it seems clear that the Government has the right to set off interest, which becomes a part of and is collectible as a tax liability, due it on a tax claim, against any refund which a taxpayer may become entitled to receive as a result of allowance of a claim under section 722 of the Code. In this connection it should be noted that section 3770(a)(4) of the Code provides that in lieu of refunding an overpayment of tax, the Commissioner may credit such overpayment against any tax due from the taxpayer.

Further support for the position that the Government may set off debts due it against a refund due a taxpayer is found in the case of Carman v. United States, 21 Fed. Supp. 239, wherein it was held that section 57(j) of the Bankruptcy Act does not provide that a claim for a penalty is extinguished, but merely provides that a proof of claim may not be allowed in the case of a penalty or forfeiture with certain exceptions. It was further held that while the government might be barred from filing a proof of claim on account of the penalty assessed, section 57(j) of the Act does not in any wise affect a penalty properly levied and retained by the United States out of funds held in its possession. The significance to the instant case is that it was a clear cut holding that the Government could set off an item which it could not collect in a bankruptcy proceeding against funds in its possession.

In view of the foregoing, it is held that interest which accrued on the deficiency in tax for the period during which the affairs of the corporation were being administered by the bankruptcy court was properly offset against the refund due the taxpayer.