The opinion of the court was delivered by: BABITT
On August 30, 1968 Laytan Jewelers, Inc. filed its petition for an arrangement under the provisions of Chapter XI of the Bankruptcy Act, 11 U.S.C. § 701 et seq. As a creditor for pre-petition liability arising from taxes then due, the United States filed a claim in those proceedings. Section 57(n) of the Act, 11 U.S.C. § 93(n). That claim set forth six separate categories of taxes due, and it was amended from time to time in certain respects not germane to the instant controversy. However, as finally amended, the government's claim included a liability for taxes for the period ending January 30, 1964 in the amount of $5,508.02 and for interest thereon to the date of the filing of the arrangement petition in the amount of $918.40 for a total of $6,426.42.
The erstwhile debtor moved before this court for an order reclassifying as a general unsecured claim the government's claim in regard of this combined liability of $6,426.42.
The essence of the debtor's position is that $6,426.42 is not entitled to priority status under Section 64(a)(4) of the Act as amended, 11 U.S.C. § 104(a)(4), with the result that the court should reclassify that portion of the claim as a general unsecured claim to share on a parity with general unsecured creditors under Section 65(a) of the Act, 11 U.S.C. § 105(a), providing for distribution of dividend on all allowed claims save those entitled to priority.
The then debtor and the United States as claimant were on common ground in assuring the court that there were no genuine issues of material fact which required an evidentiary hearing and that the issues before the court were purely issues of law arising from application of the Bankruptcy Act as amended in 1966 by Public Law 89-496, 80 Stat. 270, particularly Section 17(a), 11 U.S.C. § 35(a) and Section 64(a)(4), 11 U.S.C. § 104(a)(4).
This being so, a stipulation as to the material facts was entered into between the United States and the attorneys for the then debtor and has been filed in these proceedings.
Before turning to the merits of this controversy, it is necessary to observe that the debtor was adjudicated a bankrupt when it failed to come to a final accord with its creditors. Section 376 of the Act, 11 U.S.C. § 776. A trustee in bankruptcy is now administering this estate. The trustee in bankruptcy, resting on the papers filed, has agreed to the continuance of this litigation as indeed he should.
Among other things, Section 47(a) of the Act, 11 U.S.C. § 75(a), imposes on trustees the duty of examining all proofs of claim and objecting to the allowance of improper claims, Section 47(a)(8), and to pay dividends after they are declared, Section 47(a)(11). Section 65(a) of the Act, 11 U.S.C. § 105(a), requires that dividends be paid on all claims except such bearing priority status. This means that before the trustee may pay dividends to general creditors from the assets of the estate, he must first pay dividends to those creditors as to whom Congress has accorded priority status by reason of Section 64(a) of the Act, 11 U.S.C. § 104(a). Taxes are accorded a fourth priority under that section, and unless there are sufficient funds to pay all of the Section 64(a) priority creditors in full, there can be no yield to general creditors. Resultantly the trustee is quite correct in pursuing the challenge by the erstwhile debtor to the classification of the government's claim for, should the trustee prevail, then less of the government's claim will be accorded priority, which in turn will result in a larger fund for general unsecured creditors.
And so I turn to the agreed facts. Laytan Jewelers, Inc. filed its federal corporate income tax return on July 15, 1964 for its fiscal year ending January 31, 1964. The company reported taxable income and paid its tax liability of $4,772.12.
Three years later, on July 18, 1967, the company filed the return for its fiscal year ending January 31, 1967. That return disclosed a net operating loss in excess of $25,000 with the result that no tax liability was shown. Accordingly, the company applied for a tentative carry back adjustment whereby the loss claimed for the year ended January 31, 1967 was to be carried back to the year ending January 31, 1964, resulting in a claim for a refund for that year of $5,931.00.
The Internal Revenue Service tentatively allowed this application for refund of taxes in the amount of $4,772.12 the amount the company had paid as taxes on the 1964 return, and in keeping with the administrative practice touching tentatively allowed applications for refund of taxes based upon carry back of loss, the Service refunded $5,047.14 representing the $4,772.12 and interest for the period from January 31, 1967 to January 17, 1968 of $275.02.
The company consented to an extension until December 31, 1969 of the period of limitation on assessment.
On August 30, 1968, as has been seen, the then debtor filed its petition for an arrangement in this court.
While this debtor conducted its business under the aegis of this court in the arrangement proceedings, the Internal Revenue Service examined the company's returns for the years ending January 31, 1964 and January 31, 1967. As a result of the examinations, business expenses which the company had deducted for the year ending January 31, 1967 were disallowed. The entire loss claimed for that year was thus eliminated. This in turn eliminated the asserted loss carry back which had been the basis for the $4,772.12 refund of taxes the company had paid on its profits for the period ending January 31, 1964.
In addition and as a further result of the audit, certain expenses which the company had claimed for the year ending January 31, 1964 were also disallowed so that taxable income as shown for that period was increased from the $24,048.15 shown on the return to $29,062.15.
Consequently a deficiency of tax of $5,508.02 for the year ending January 31, 1964 was called to the attention of the debtor. The Internal Revenue Service came to this figure by concluding that $4,772.12 represented the erroneously and tentatively paid refund attributable to the company's claim that it had had a net operating loss carry back for the year ending January 31, 1967. The sum of $735.90 recognized adjustments based on disallowance of certain deductions taken by the company for the year ending January 31, 1964 less certain credits.
On June 4, 1969 the debtor was advised that the Internal Revenue Service had determined a deficiency of $5,508.02 for the taxable year ended January 31, 1964 and nine days later an assessment was made in that amount together with interest of $1,375.72.
When the government filed its proof of claim the interest amount had been increased to $1,445.63 but subsequent amendments reduced the interest to $918.40 as we have already noted.
It has been agreed that only the status of the tax deficiency of $5,508.02 and interest of $918.40 are at issue in this controversy.
Simply stated the government's position is that these items are entitled to the priority accorded taxes owing the United States under Section 64(a)(4) of the Act, as amended in 1966, 11 U.S.C. § 104(a)(4), which reads as follows:
" (a) the debts to have priority, in advance of the payment of dividends to creditors, and to be paid in full out of bankrupt estates, and the order of payment shall be . . .  taxes which became legally due and owing by the bankrupt to the United States . . . which are not released by a discharge in bankruptcy: . . ."
The trustee in bankruptcy, adopting the legal position of the erstwhile debtor presses the contention that the two items in dispute in the government's proof of claim are indeed released by a discharge in bankruptcy and consequently mandates a holding that the items in dispute come within the qualifying language of Section 64(a)(4) as amended and so are not entitled to priority. This contention is pressed on the court by reason of the 1966 amendment to Section 17(a) of the Bankruptcy Act which read and still reads in part as follows:
"a. A discharge in bankruptcy shall release a bankrupt from all of his provable debts, whether allowable in full or in part except such as  are taxes which became legally due and owing by the bankrupt to the United States . . . within three years preceding bankruptcy: . . ."
In short, the trustee maintains that the items in dispute represent "taxes . . . legally due and owing . . ." more than three years before the arrangement petition was filed and hence are dischargeable under Section 17(a) with the result that they lose their priority status under Section 64(a)(4).
The government refrains from suggesting that the mere filing of its last amended claim is dispositive of any controversy which the trustee might raise as to the claim. The definitive allowance or rejection of any claim is, of course, a judicial act required of the court which includes the referee under Section 1(9) of the Act, 11 U.S.C. § 1(9). In re Two Rivers Woodenware Co., 199 Fed. 877 (7th Cir. 1912).
And so I turn to the legal issues. The government insists, and rightly so, that there are two separate legal issues arising out of the agreed facts and the trustee's challenge to the classification of the ...