author: Smith:

text:
    Wilhelmina Worley, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 63503.
    Promulgated June 20, 1933.

      George E. H. Goodner, Esq., for the petitioner.

      Thomas S. Callahan, Esq., and E. G. Sievers, Esq., for the respondent.
   OPINION.

Smith:

This proceeding involves a deficiency in petitioner’s income tax for the calendar year 1929 in the amount of $308.16. The petitioner alleges that:

(a) In computing net income respondent has erroneously overstated the profit which petitioner realized in 1929 from certain impounded oil royalty funds and a certain oil royalty interest which she purchased in 1929, by his failure properly to determine the respective costs of each of said items and by his failure thereby to compute depletion on the correct basis.

On March 14,1929, the petitioner’s husband, H. F. Worley, acting as petitioner’s agent, executed an agreement with one Orville Hem-bree for the purchase of the latter’s royalty interest in oil lands in Pottawatomie County, Oklahoma, including certain royalty funds which were then being held by the purchasers pending the outcome of litigation to determine the ownership thereof. The agreement provides in part as follows:

Party of the first part hereby contracts and agrees to sell and convey to the party of the second part all of his royalty interest being approximately an undivided 3% acres interest, more or less, in and to the royalty in and under the West Half (W/2) of the Southeast Quarter (SE/4) of Section 19, Township 7, Range 5 East, I.M. Pottawatomie County, Oklahoma, free and clear of all encumbrances, for a consideration of $20,000.00.
The consideration to be paid as follows, to-wit:
The sum of $500.00, the receipt of which is hereby acknowledged, and the sum of $19,500.00 paid on or before the 22nd day of March, 1929, upon approval of abstract of title.
The party of the first part, Orville Hembree agrees to furnish abstract within four (4) days showing perfect title in and to the royalty interest in and to the above described royalty interest, and to execute a mineral deed convej'ing said interest, and to execute proper transfer orders and assignments conveying and transferring all monies for oil now held by Sinclair Crude Oil Purchasing Company, together with all oil and funds to be derived from other pipe lines which is now due and payable, except checks which have been issued and are in the mail.

Before entering into the agreement, H. F. Worley made an investigation and ascertained that the pending suit probably would be decided at an early date in Hembree’s favor and that the impounded royalty funds referred to in the above agreement amounted to between $20,000 and $21,000.

The terms of the purchase agreement were fully carried out and the mineral deed referred to therein was executed to the petitioner by Hembree on April 19, 1929. This deed provides in part that the grantor—

* * * does hereby grant, bargain, sell, convey, transfer, assign and deliver unto Wilhelmina Worley of Tulsa, Oklahoma, hereinafter called Grantee, an undivided 811/36960 interest in and to all of the oil, gas and other minerals in and under and that may be produced from the following described lands .situated in Pottawatomie County, State of Oklahoma, to-wit:
The North Half (N/2) of the West Half (W/2) of the Southeast Quarter (SE/4) of Section 19, Township 7, Range 5 East, containing 40 acres, more or less, and,
.an undivided 2603/36960 interest in and to all the oil, gas and other minerals in and under and that may he produced from the following described lands situated in Pottawatomie County, State of Oklahoma, to-wit:
South Half (S/2) of the West Half (W/2) of the Southeast Quarter (SE/4) of Section 19, Township 7, Range 5 East, containing 40 acres more or less:
together with an assignment of all moneys or royalties heretofore accrued or impounded or held in suspense for the sale of oil, gas or other minerals held in any pipe line or lines, lank or tanks which has been produced or sold from any and all interest that the said Orville Hembree now has or has had that has not heretofore been paid for, together with the right of ingress and egress at all times for the purpose of mining, drilling, exploring, operating and developing said lands for oil, gas, and other minerals, and storing, handling, transporting and marketing the same therefrom with the right to remove from said land all of Grantee’s property and improvements.

On April 26, 1929, H. F. Worley executed a formal assignment of his “ right, title and interest ” in the agreement of March 14, 1929, to his wife, Wilhelmina Worley, petitioner herein.

Early in May 1929, the litigation referred to above having been terminated in Hembree’s favor, the impounded royalty funds in the amount of $20,672.49 were paid over to the petitioner. Later in that year the petitioner received additional royalties from current earnings of oil in the amount of $11,196.37.

In his computation of the petitioner’s tax liability for 1929, the respondent has made no allocation of the cost as between the impounded royalty funds and the royalty interest in the oil lands, but has treated the total amount received by the petitioner during the year as royalty income and has allowed the petitioner a depletion deduction of $18,721.53, computed as follows:

Cost of interest_ $20,000
Total oil reserves_ 36,720 barrels
Production for 1929_ 34,372 “
Unit cost $.54466
Depletion sustained_$18, 721. 53

The petitioner contends: (1) That all of the $20,000 paid to Hembree under the purchase agreement should be allocated to the cost of the impounded royalties and that the royalty interest in the oil lands was therefore acquired without cost;

(2) That in any event $18,000 of the purchase price should be allocated to the cost of the impounded royalties;

(3) That the additional royalties received in that year amounting to $11,196.37 are subject to depletion at the rate of 27% percent as provided in section 114 (b) (3) of the Kevenue Act of 1928. This section of the act reads as follows:

(b) Basis for depletion.—
* * * * * *
(3) Percentage depletion sob oil and gas wells. — In tbe case of oil and gas wells the allowance for depletion shall be 27% per centum of the gross income from the property during the taxable year. Such allowance shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property, except that in no ease shall the depletion allowance be less than it would be if computed without reference to this paragraph.

The petitioner alleges that the respondent was clearly in error in treating the impounded funds in the same manner for depletion purposes as the royalties thereafter received. It is her contention that in making the purchase she was principally interested in the receipt of the impounded funds and that on her part it was somewhat of a gamble as to whether the value of royalties to be received from oil produced in the future would amount to anything. It is her further contention that immediately after receiving the impounded royalties in May 1929, the petitioner’s acquired interest in the lands was first offered for sale for $2,000, and later for $1,500, $1,000, and $500, without finding a purchaser therefor.

It is apparent from an inspection of the agreement of March 14, 1929, and of the mineral deed of April 19, 1929, that the petitioner did not purchase prior owner’s right to the impounded royalties separate from his interest in royalties to be obtained from future production. The $20,000 was paid for whatever interest the prior owner had at the time of sale in the impounded royalties and royalties on future production.

Section 113 of the Revenue Act of 1928 prescribes the basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913. There was in 1929 no sale or disposition of the property by the petitioner except such as the statute contemplates to be recovered through depletion. The respondent determined the oil reserves in 1929 to be 36,720 barrels, of which 34,372.88 barrels were produced in 1929, and that the depletion sustained in that year was $18,721.53. We are of the opinion that the allowance determined by the respondent for depletion of property is reasonable and represents a full measure of the loss sustained by the petitioner through depletion. The contention of the petitioner that any specified portion of the cost of the royalty interest is to be applied against the impounded royalties is not sustained.

Judgment will be entered for the respondent.


source: Caselaw Access Project

author: Trammell:

license: Public Domain

text:
    S. Feather Company (Delaware Corporation), Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 47171.
    Promulgated June 20, 1933.

      Milton M. Wecht, Esq., for the petitioner.

      E. A. Tonjes, Esq., for the respondent.
   OPINION.

Trammell:

This is a proceeding for the redetermination of the liability of the petitioner as a transferee under the provisions of section 280 of the Bevenue Act of 1926. The respondent determined a deficiency in income and profits taxes for the period January 1 to June 30, 1918, in the amount of $5,420.14 against the S. Feather Co., a New Jersey corporation, plus a deliquency penalty in the amount of $1,855.03, and asserts liability therefor against the petitioner, a Delaware corporation of the same name, as transferee of the assets of its predecessor, the New Jersey corporation.

The petitioner, referred to herein as the transferee, was organized in June 1918. The predecessor or transferor corporation was organized in 1916. On or about June 30, 1918, the petitioner, the Delaware corporation, took over the business and assets of the New Jersey corporation, which was soon thereafter dissolved.

On or about April 17, 1919, a corporation income and profits tax return, on Form 1120, was filed with the collector of internal revenue, purporting to be the return of the “ S. Feather Co., 110 Erie St., Camden, N.J.” for the calendar year 1918.

This return set forth the gross sales for the entire year 1918, loss cost of goods sold, and other items of gross income, in the aggregate amount of $67,714.26. It also set forth the total deductions claimed for the entire year in the amount of $37,472.22, and disclosed “ net income for the taxable year ” in the amount of $30,242.04.

Attached to the return and made a part thereof were two schedules designated “ C ” and “ D ”. Schedule C contained balance sheets of the “S. Feather Co. (of Now Jersey)” at January 1, 1918, and June 30, 1918, and also balance sheets of the “ S. Feather Co. (of Delaware)” at July 1, 1918, and December 31, 1918. In addition, schedule C contained the following statement:

(Note — S. Feather Co., a New Jersey corporation, was engaged in business until June 30, 1918, when it was reorganized. S. Feather Co., a Delaware corporation, was- then organized, acquired the assets and assumed the liabilities of the New Jersey corporation, and transacted the business from July 1, 1918. This return is for both corporations.)

Schedule D attached to the return consisted of an analysis of the surplus accounts of both corporations, disclosing that the New Jersey corporation realized profits from January 1, 1918, to June 30, 1918, in the amount of $16,256.46, and that the Delaware corporation derived profits from July 1, 1918, to December 31, 1918, in the amount of $13,985.58. The total profits so disclosed equaled the total amount of net income shown on page one of said return.

On or about March 1, 1927, a corporation income and profits tax return for the period begun January 1, 1918, and ended June 30, 1918, was filed in behalf of the New Jersey corporation, and disclosed the following: gross income, consisting of gross sales less cost of goods sold, $46,003.27; total deductions, $29,746.81; net income, $16,256.46.

The notice of deficiency which is the basis of the present proceeding was mailed to the petitioner on December 3, 1929.

In November and December 1923, an examining agent or field auditor made an examination of the books of both the New Jersey and Delaware corporations for the year 1918, as a result of which an additional tax against the petitioner was proposed, but no objection was made to the character of the return filed for that year. Thereafter conferences were held between the taxpayer and the Bureau of Internal Revenue. An agreement not having been reached, the Commissioner, on November 28, 1925, mailed a notice of deficiency for the amount of $899.78 to S. Feather Company, 110 Erie Street, Camden, New Jersey,” and on January 27, 1926, a petition for redetermination of the deficiency was filed with the Board in the names of both the New Jersey and the Delaware corporations, under Docket No. 11377. Under date of September 7, 1928, an order of redetermination was entered in that proceeding, pursuant to stipulation of the parties, that there was “ an overpayment for the period July 1, 1918 to December 31, 1918 in the amount of $10,539.32 for the S. Feather Company, a Delaware corporation, and this proceeding in so far as it relates to the year 1918 for the S. Feather Co., a dissolved New Jersey corporation, is hereby dismissed for lack of jurisdiction.”

The petitioner stipulated at the hearing that it is liable as a transferee for the payment of whatever income and profits taxes, penalties and interest may be due from the New Jersey corporation for the period January 1 to June 30,1918, provided collection of such liability is not barred by the statute of limitations.

The issue here resolves itself into the question whether the return filed by the petitioner on April 17, 1919, for the calendar year 1918, which return included in the aggregate the gross income, deductions and credits of both corporations, constituted a substantial compliance with section 239 of the Revenue Act of 1918, which provides “that every corporation subject to taxation under this title * * * shall make a return stating specifically the items of its gross income and the deductions and credits allowed by this title.”

The parties agree that if said return was the return required by the statute, the five-year period of limitation began to run on and from the date of its filing and that since the respondent did not assert liability against the petitioner as a transferee until more than ten years thereafter, assessment of such liability is now barred by the provisions of section 280 (b) (1) of the Revenue Act of 1926. On the other hand, it is agreed that if the return did not comply with the statute, the period of limitations did not begin to run prior to the filing of the separate return in behalf of the New Jersey corporation in March 1927, and assessment is not barred by the statute.

No contention is made that the two corporations in question were affiliated during any portion of the calendar year 1918, nor that they were entitled to file a consolidated return.

The facts very clearly show that the return filed in 1919 did not state specifically the items of the petitioner’s gross income nor the deductions and credits allowable to it, as required by section 239, supra. This return, therefore, did not meet the demands of the statute and did not start the running of the prescribed period of limitation. In considering a similar problem in Lucas v. Colmer-Green Lumber Co., 49 Fed. (2d) 234, the court said:

On December 15, 1921, a separate return was filed winch for the first time disclosed separate gross and net income of this taxpayer. On that date we think limitation began to run. Section 239 of the Revenue Act of 1918 * * * required every corporation to “make a return, stating specifically the items of its gross income and the deductions and credits allowed by this title ”. This information is essential to an assessment of the tax, and to procure it is the object of requiring the return. A paper which does not purport to give it can not .be considered to be a return in substantial conformity to the law requiring it. “ In providing that the period of limitation should begin on the date when the return was filed, rather than when it was due, the statute plainly manifested a purpose that the period was to commence only when the taxpayer had supplied this information in the prescribed manner.” Plorsheim Brothers Co. v. United States, 280 U.S. 453, 460, * * * Myles Salt Co. v. Commissioner, 49 Fed. (2d) 232, * * * United States v. National Tank & Export Co. (C.C.A.) 45 Fed. (2d) 1005.

In Warner Colleries Co. of Delaware, 26 B.T.A. 1047, 1052, we said:

Every return must show facts upon which an assessment for the taxable period can be made. [Citing authorities.] Where such information is given the statute begins to run. In the case of consolidated returns we have held that they must be filed in good faith and must make a substantial revelation of gross income and deductions separately for the constituent members of the affiliated group. (Citing prior decisions.) If they do not do so they are not the returns contemplated by the statute and hence do not start the running of the statute of limitations. (Citing authorities.)
Tlie return- in question set forth only the income, deductions and credits of both corporations combined. Only the balance sheets reflecting the assets and liabilities of each corporation as of March 31, 1919, were included in the return. Such information is not sufficient basis for the assessment of the tax. Therefore, the statute of limitations does not bar the assessment of the tax * * *.

In Cem Securities Corp., 28 B.T.A. 102, the same issue was considered under substantially the same facts as are presented here. That case, as here, involved two corporations of the same name, one of which was successor to the other. On February 21, 1928, the petitioner, a Delaware corporation, acquired all the assets, except cash, of its predecessor, a New York corporation. On March 13, 1929, the petitioner filed an income tax return on Form 1120 “ for the calendar year 1928.” This return showed a loss, in computing which the petitioner used as a deduction a net loss sustained by the New York corporation in the period January 1 to February 20, 1928. Among the schedules attached to the return was one showing the assets and liabilities of the New York corporation at January 1, 1928, and those of the petitioner at December 31, 1928.

We held that the return so filed by the petitioner in that case, which included the result of operations of its predecessor within the year without showing separately petitioner’s income, deductions and credits, did not comply with the statutory requirements regarding returns and was insufficient to put the statute of limitations in motion.

To the same effect, see also Norwich Woolen Mills Corp., 18 B.T.A. 303, and American Vineyard Co., 15 B.T.A. 452.

The only difference between the case at bar and those above cited is that, in the return before us here, schedule D, which consisted of an analysis of the surplus accounts of both corporations, disclosed incidentally the net profits realized during the period that each corporation was engaged in operating the business during the calendar year 1918. Assuming that the amount of net profits so shown represented the net taxable income, which may or may not be true, that fact, we think, is not material. The statute did not specifically require a corporation to show the amount of its net income, but “ the items of its gross income and the deductions and credits allowed by this title.” The above schedule does not set forth this information.

On authority of the decisions above cited, we hold that the return here in question, filed on April 1Y, 1919, for the calendar year 1918, stating the gross income, deductions and credits of both corporations combined, was not the return which section 239, supra, required the taxpayer corporation to file, and hence assessment of the liability of the petitioner as a transferee under section 280, supra, is not barred by limitation.

Judgment will be entered for the respondent.


text:
    The Michigan Central Railroad Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. The New York Central Railroad Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 19930, 19932, 34437, 62040.
    Promulgated June 20, 1933.

      C. C. Handy, Esq., Charles C. Paulding, Esq., and Leo Manville, Esq., for the petitioner.

      E. C. Algire, Esq., for the respondent.
   OPINION.

Smith:

These proceedings, duly consolidated, are for the rede-termination of the following income tax deficiencies:

The respondent, having made several affirmative allegations, duly asserts claim to any increase in the deficiencies that may result from our redetermination.

The Michigan Central Eailroad Co. is a corporation organized under the laws of the State of Michigan. The New York Central Railroad Co. is a corporation organized under the laws of the State of New York and other states. Both petitioners maintained offices at 466 Lexington Avenue, New York City. At all times material to our determination, the petitioners and their affiliated corporations kept their books on the accrual basis of accounting. The affiliated status of the several railroads involved in these proceedings is not at issue and the deficiencies have been properly asserted against these petitioners.

The respondent admits error, as alleged by the petitioners—

Docket No. 19930.

(1) in treating as income the sum of $6,079.79 designated as sidetrack donations;

Docket No. 1993%.

(2) in treating as income the sum of $31,098.04 designated as sidetrack donations;

(3) in not allowing the deduction of $110,892.46, taxes paid for lessor companies;

(4) in not allowing a depreciation deduction of $2,354.65;

(5) in not allowing the deduction of $7,757.11 for interest;

(6) in not allowing the deduction of $2,942.76 representing the amortization of cost of improvements to Pier 31;

(7) in treating as taxable income the sum of $672, bond premium amortization;

(8) in including in taxable income the sum of $113 interest on United States Government bonds;

(9) in including in taxable income $4,480.19 interest on New York City bonds;

Docket No. 31137.

(10) in including in taxable income an undermaintenance item of $7,077.37;

(11) in not allowing the deduction of $54,572.48, the amount of assessment levied by the Association of Railway Executives;

(12) in including in taxable income, $23,096.20 designated as sidetrack donations;

(13) in including in taxable income $200 designated as sidetrack donations;

(14) in not allowing the deduction of $20,378.18 for taxes paid to the Dominion of Canada by the Michigan Central Railroad Co. for its lessor;

(15) in not allowing credit for the business profits taxes paid to the Dominion of Canada by the Michigan Central Railroad Co. and the New York Central Railroad Co. in the respective amounts of $4,777.01 and $25,803.45;

(16) in not allowing a depreciation deduction of $3,336.13;

(17) in not allowing a depreciation deduction of $16,242.26;

Docket No. 620Jfi.

(18) in including in taxable income $451,534.99 representing rental interest on completed additions and betterments received by the Cleveland, Cincinnati, Chicago & St. Louis Railway Co.;

(19) in not allowing a depreciation deduction of $18,621.58;

(20) in not allowing the deduction of $6,741.65 for taxes paid to the Dominion of Canada by the Michigan Central Railroad Co. for its lessor;

(21) in not allowing credit for the business profits taxes amounting to $4,818.33 paid to the Dominion of Canada by the Michigan Central Railroad Co.

The petitioners waive the allegations of error respecting :

Docket No. 19930.

(22) the disallowance of a deduction of $318.76 for fines and penalties;

(23) the disallowance of a deduction of $404,665.25 “business profits war tax paid in 1917 based on income of petitioner in Canada i or the year 1916 ”;

Docket No. 19932.

(24) the disallowance of a deduction of $4,475.20 representing 1917 portion of amortization of the cost of a bridge;

Docket No. 31^37.

(25) the disallowance of a deduction of $4,475.20 representing 1920 portion of amortization of the cost of a bridge;

Docket No. 6Wlfi.

(26) the disallowance of a deduction of $4,475.20 as depreciation on a bridge.

(27) In Docket No. 34487 the petitioner admits the respondent’s affirmative allegation that he erred in allowing the deduction of $646,182.72 for taxes paid by the petitioner for the Mahoning Coal Railroad Co., and that the net taxable income as shown in the notice of deficiency should be increased in the sum of $486,040.99, which is the excess of the amount allowed above the amount of $160,141.73, the taxes actually paid.

(28) In Docket No. 34437 the petitioner admits the respondent’s affirmative allegation that he erred in allowing the deduction of $9,004.11 “ representing an adjustment of retirements of equipment accounted for during the Federal control period,” and that the jiet taxable income as shown in the notice of deficiency should be increased accordingly.

The parties have agreed upon the settlement of the issues respecting the allowance for depreciation of buildings in the Grand Central Terminal area, as follows:

(29) In Docket No. 19932, covering the year 1917, the respondent concedes the deduction of $115,537.48 and the petitioner withdraws its claim for the deduction of the balance of $79,616.88;

(30) In Docket No. 34437, covering the year 1920, the respondent concedes the deduction of $27,316.88 and the petitioner withdraws its claim for- the deduction of the balance of $11,025.27;

(31) In Docket No. 62040, covering the year 1923, the respondent concedes the deduction of $131,572.64 and the petitioner withdraws its claim for the deduction of the balance of $27,216.88.

(32)In Docket No. 34437, covering the year 1920, the petitioner claimed deductions for taxes and interest paid by the Hudson River Connecting Railroad Corporation during the period of construction in the respective amounts of $2,426.65 and $17,339.19. On brief, the respondent concedes error in not allowing the deduction of these amounts.

(33) In Docket No. 34437, covering the year 1920, the petitioner admits the respondent’s affirmative allegation with respect to the computation of the tax liability of the several affiliated corporations, and that the credit for taxes allowed in the deficiency letter should be reduced by $10,182.44, the amount paid by the Director General of Railroads.

(34) and (35) In the amended pleadings in Docket No. 62040, covering the year 1923, the petitioner alleges that the respondent erred in disallowing certain items paid by the Cleveland Union Terminal Co. and charged to contraction in 1932. These allegations are disposed of by the respondent on brief as follows:

Assignments oí error (e) and (d) in tlie amendment to the petition in Docket No. (52040, raise the question of whether the Cleveland Union Terminal Company, a subsidiary of the New York Central Railroad Company, is entitled to deduct taxes and interest paid and discount on bonds amortized during the year 1923 charged to construction, and whether there should be included in taxable income for said year interest received on bank balances and credited to construction. The record shows that this corporation paid taxes during the year 1923, in the amount of $173,318.61, and paid interest on its indebtedness during said year in the amount of $787,762.62. The record also shows that amortization' of discount on its bonds applicable to the year 1923, amounted to $14,563.79. All of these amounts were charged to construction * * *. The record further shows that the corporation received $84,960.43, representing interest on bank balances, which amount was credited to construction * * *. The respondent concedes that the foregoing amounts representing taxes and interest paid and discount on bonds amortized, constitute proper deductions in determining consolidated taxable income for the year 1923, and that the foregoing amount of interest on bank balances received should be included in said consolidated taxable income.

I.

Olear field Bituminous Goal Corporation Payment.

(36) In Docket No. 19932 the petitioner alleges that:

(d) The Commissioner erred in refusing to allow as a deduction the sum of $309,244.64 which the petitioner paid to the Clearfield Bituminous Coal Corporation during the year 1917 to make good the operating deficits of that Company for said year in accordance with contract dated November 25, 1911.

In 1911 the New York Central & Hudson River Railroad Co. (referred to in the contract as the “ Central Co.”), entered into an agreement with the Clearfield Bituminous Coal Corporation (referred to in the contract as the “ Coal Corporation ”), which, in so far as material here, is as follows:

Whereas the Coal Corporation is the owner of certain coal lands in the State of Pennsylvania, and is engaged in the mining of coal from said lands, all of the coal so mined being supplied to the Central Company; and
Whereas the Central Company is the owner of all the stock of the Coal Corporation; and
Whereas the Coal Corporation has recently acquired certain coal properties in the State of Pennsylvania, known as the Pennsylvania Coal & Coke Company properties, a portion of which coal properties so acquired has, in accordance with the terms of sale, been leased to the Pennsylvania Coal & Coke Corporation; and
Whereas the Coal Corporation believes it to be to its advantage that the remainder of the Pennsylvania Coal & Coke Company properties so acquired should be held by it for future needs and developments, and the Central Company also believes it to be to its advantage as stockholder of the Coal Corporation that the remainder of said lands so acquired should be so held; and
Whereas the Pennsylvania Coal & Coke Company properties and the other properties of the Coal Corporation are subject to certain mortgages given as security for the payment of certain bonded indebtednesses and the interest thereon, and by the terms of certain of said mortgages, sinking fund payments are required to be made on account of the principal of certain of said bonded indebtednesses; and
Whekeas certain annual tax payments are also required to be made by the Coal Corporation; and
Whereas it is estimated that the interest on said bonded indebtednesses, and said sinking fund and tax payments will require an annual expenditure by the Coal Corporation in excess of its present annual income; and
Whereas, being the owner of all of the capital stock of the Coal Corporation, it is to the interest of the Central Company to protect its holdings from any indebtedness which may be incurred by the Coal Corporation;
Now, Therefore, the parties hereto in consideration of the premises, and for the purpose of providing for the retention by the Coal Corporation of the properties above mentioned for future needs and developments, and for a means of meeting any excess of the interest, sinking fund and tax payments above mentioned over the income of the Coal Corporation, during the time that the said properties are so retained, do hereby agree:
1. That the Coal Corporation shall retain the remainder of the Pennsylvania Coal & Coke Company properties acquired as aforesaid for future needs and developments, and if, during the time that the Coal Corporation shall retain the said properties, the Coal Corporation shall be unable to pay, when due, any of the interest, sinking fund or tax payments above mentioned, the Central Company will, upon request of the Coal Corporation, and to the extent necessary, contribute to the Coal Corporation sufficient moneys to pay the same.

The petitioner, New York Central Railroad Co., assumed the rights and obligations of the foregoing contract upon its creation through the consolidation of the Central Co. and other railroads in 1914. The business of the Coal Corporation consisted of the operation of coal properties and the sale of the coal to the petitioner, the leasing of certain of its properties, and carrying the properties referred to in the above agreement as an investment.

In 1917 the petitioner paid $309,244.64 to the Coal Corporation pursuant to the above agreement. The payment related solely to the carrying of the unused coal lands as an investment. The petitioner’s payment is noted in the following statement:

Clearfield Bituminous Coal Corporation
Statement of cost of carrying property acquired from the Pennsylvania Coal and Coke Company by Clearfield Bituminous Coal Corpn. for the year 1917
Royalty Income_$254, 987.33
Rents_ 50. 95
Interest on Securities_ 3, 700. 00
Gross Income_$258, 738.28
Interest on Bonds and Mortgages_$402,728.37
Real Estate Taxes_ 47, 377. 89
Federal Tax on Tax Free Bonds-_ 3,346. 65
Expense (Proportion of salaries a/c supervision,
trustee’s fees, office expense etc.)_ 10,170,01
Appropriation for sinking funds to retire debt_ 114, 845.92
Expense_ 578, 468.84
Operating Deficit_$319,730. 56
Cash from New York Central Railroad Company received during 1917, per agreement, applied to 1917
deficit_ 303,086.17
Net remaining deficit_ $16,644.39
Note: Cash received from the New York Central RR Co. during 1917 totaled_$309, 244.64
Applied (as above) for 1917-$303,086.17
Applied a/e prior years_ $6,158.47

On brief, the petitioner states that:

It was a consistent practice between the Central and the Clearfield Company to make settlements for the deficit incurred in the operation of this property, the Central advancing from time to time during the year funds to enable the Clearfield Company to pay the interest on bonds and mortgages and taxes as these items became due and payable. Then, at the close of the year, the Clearfield submitted a statement of its operating deficit and the balance due the Clearfield was paid by the Central. These settlements were treated in the same manner as an ordinary business transaction between debtor and creditor and we fail to see how the Commissioner can class them as a donation.

Manifestly, the payment of $309,244.64 was not the payment of an ordinary and necessary expense of this petitioner’s business, even although it was of a recurring nature. The record is silent as to the terms of the sales of coal by the Coal Corporation to the petitioner. The above agreement specifically provides that the Central Co., being “ the owner of all the stock of the Coal Corporation; * * * believes it to be to its advantage ” for the Coal Corporation to hold the properties involved “ for future needs and developments.” The parties to that agreement recognized the expense of holding the coal properties for future use, and the petitioner’s predecessor, in order “ to protect its holdings from any indebtedness which may be incurred ” in carrying the properties, agreed to make the payment which this petitioner assumed and made in the taxable year now under consideration. The parties to that agreement did not class the payment as one necessary to the production and sale of coal to the petitioner, and beyond the statement in the premise to that agreement that “ all of the coal * * * mined being supplied to the Central Company,” there is nothing to indicate the consideration of such a factor. The payment was in the nature of a capital expenditure to protect the petitioner’s capital investment in the stock of the Coal Corporation, said investment doubtless being enhanced by the acquisition and retention of the coal properties involved. There is nothing to sustain the claim that this expenditure was an ordinary and necessary expense of this petitioner’s business. The respondent’s dis-allowance of the claimed deduction is sustained. Cf. Isabelle Hammond-Knowlton, Administratrix, 19 B.T.A. 947; Athol Mfg. Co., 22 B.T.A. 105; affd., 54 Fed. (2d) 230; W. F. Bavinger, 22 B.T.A. 1239. See also Duffy v. Central R.R. Co. of New Jersey, 268 U.S. 55.

II.

Payment bo State of Illinois ufon Issuance of Bonds.

(37) In Docket No. 19932, the petitioner alleged that:

(e) The Commissioner erred in refusing to allow as a deduction the sum of $86,568.09 which represented mortgage taxes paid during the year 1917, by the petitioner in connection with issuance of its Refunding and Improvement mortgage bonds.
In his amended answer the respondent—
(e) Admits that the petitioner is entitled to a deduction for the taxes paid to! the State of New York and the State of Michigan in the aggregate amount of $66,568.09 as set forth in subparagraphs 2 and 3 of subdivision (e) of paragraph 5 of the amended petition. Admits that the amount of $20,000.00 was paid to the Public Utilities Commission of the State of Illinois under the provisions of Section 31 of Chapter 111a of the Public Utility Law of the State of Illinois in connection with the issuance of the petitioner’s refunding and improvement bonds, but specifically denies that this amount represented taxes and that the amount was paid to the Treasurer of the State of Illinois as alleged in paragraph 1 of subdivision (e) of paragraph 5 of the amended petition, and denies that the Commissioner erred in refusing to allow the said sum of $20,000.00.

During the year 1917 the petitioner paid to “ Len Small, Treasurer of the State of Illinois ”, $20,000—

For fee of ten cents on eaeli one hundred dollars par value, payable as required by law, for permission from tbe State Public Utilities Commission of Illinois to issue * * * [$20,000,000] of Tbe New York Central Railroad Company’s Refunding and Improvement Mortgage Bonds, Series A.

Section 31 of chapter 111a of the Public Utility Laws of the State of Illinois (Callaghan’s Ann. Stats., vol. 7, par. 46, p. 6416), provides in part:

flees on issuance uf secu/rities. Sec. 31. Tbe Commission shall charge every public utility receiving permission under this Act for tbe issue of bonds, notes and other evidences of indebtedness an amount equal .to ten cents for every hundred dollars of such securities authorized by the Commission, and the same shall be paid into the State treasury before any such securities shall be issued. * * *

The payments to the States of New York and Michigan, conceded by the respondent to be deductible as taxes, were paid upon the issuance of the same “ $20,000,000. Refunding and Improvement bonds.” The respondent admitted that the respective payments were made under “ section 253 of the Tax Laws of New York State ” and a Michigan statute of 1911 “ for the assessment and collection of specific tax upon the credits founded upon and evidenced by Mortgages and Liens upon Real Property,” etc. It seems anomalous to permit the deduction of two of the three payments levied with respect to the same bond issue, as taxes and deny the deduction of the third as taxes. The respondent contends that the payment to the State of Illinois “ constitutes a fee and is consequently an expense incurred in connection with the bond issue and should be amortized over the life of the bonds,” citing Logan-Gregg Hardware Co., 2 B.T.A. 647; Emerson Electric Mfg. Co., 3 B.T.A. 932; Chicago, Rock Island & Paoific Ry. Co., 13 B.T.A. 988; affd., 47 Fed. (2d) 990. In Logan-Gregg Hardware Co., supra, it was said that the issue—

* * * must be disposed of on the assumption that the sum paid represented a fee and not a tax. * * * The fee is alleged to have been paid for the authorization to increase the capital stock, a capital transaction, and it is therefore not deductible.

The Emerson Electric Mfg. Co. case followed the earlier decision; both involved the payment of a fee levied upon the increase of capital stock. The Chicago, Rock Island & Pacific Ry. Co. case involved the amortization of expenses incident to a bond issue, but it does not appear that such expenses included such an expenditure as we are here considering.

In New York Central R.R. Co. v. Stevenson, 277 Ill. 474; 115 N.E. 633, the Supreme Court of Illinois held that to require the payment provided for in section 31, quoted above, upon the issuance of stock to take the place of stock of component companies which had made similar payments upon incorporation, amounted to “ double taxation.” The levies under the two acts there considered were discussed as taxes. The court said, inter alia:

* * * There is this distinction between the tax required under the Incorporation Fee Act and that required under section 31 of the Public Utilities Act: The payment under the former is exacted of the incorporators before the corporation comes into existence and is a condition precedent to the grant of a corporate franchise, while the tax exacted under section 31 is exacted of and paid by the corporation after it has come into existence. * * *

In Borg & Beck Co., 24 B.T.A. 995, 1004 to 1008, we pointed out that “ what the statutes of the state designate a fee may in fact be a tax,” citing Cook County v. Fairbank, 222 Ill. 578; 78 N.E. 895. We there held that a payment to the State of Illinois upon the change in that taxpayer’s capital stock constituted the payment of a tax and was deductible as such. That decision followed an earlier one, Holeproof Hosiery Co., 11 B.T.A. 547, wherein the distinction between a fee and a tax was indicated. The Holeproof Hosiery Co. case involved a similar payment to the State of Wisconsin. In harmony with those decisions we hold that the payment to the State of Illinois is a tax deductible under section 12 (a) Fourth, of the Revenue Act of 1916, as amended by the Act of October 3, 1917. Cf. United Gas Improvement Co., 25 B.T.A. 1382; affd., 64 Fed. (2d) 957.

III.

Discount on Bonds Issued by Predecessors.

The issue with respect to the deductions for discount on bonds issued by predecessor companies is raised by the following pleadings:

A.

(38) In Docket No. 19932 the petitioner alleges that:

(f) The Commissioner erred in refusing to allow as a deduction the 1917 proportion of discount on bonds issued by predecessor companies of the petitioner in the sum of $401,161.13.

(39) and (40) The same allegation is made in Docket Nos. 34437 and 62040 covering the taxable years 1920 and 1923.

B.

(41) In Docket No. 19932 the petitioner alleges that:

(g) The Commissioner erred in refusing to allow as a deduction the 1917 portion of discount on Equipment Trust Certificates sold January 1, 1913, and December 1, 1913, in the sum of $10,910.62.

(42) In Docket No. 34437 the petitioner alleges that:

(i) The Commissioner erred in not allowing as a deduction the 1920 portion of discount on Equipment Trust Certificates sold during January, 1913, and December, 1913, by predecessor companies in the sum of $7,937.14.

(43) At the hearing, the pleadings in Docket No. 62040 were amended to allege that:

The Commissioner erred in disallowing the deduction of $4,960.68 representing the portion of the discount on equipment trust certificates issued by predecessor companies of the petitioner, applicable to the year 1923.

c.

(44) In Docket No. 62040 the petitioner alleges that:

(j) The Commissioner erred in holding that the amount of $5,764.05 which represented the portion of discount on bonds issued by predecessor companies of the Cleveland, Cincinnati, Chicago & St. Louis Railway Company, is an unallowable deduction for the year 1923.

D.

(45), (46), (47), and (48), in Docket Nos. 19932 and 34437 the respondent affirmatively alleges that he erroneously allowed the deduction of $72,765 in each of the years 1917 and 1920, claimed by the petitioner as amortization of discount on the bonds of Cleveland Short Line Railroad Co. and the Jamestown, Franklin & Clearfield Railway Co. In the alternative, the respondent alleges that if the petitioner is entitled to any deduction on account of the aforesaid discount, the deduction should be limited to $29,518.97 in each year.

A.

In each of the taxable years 1917, 1920, and 1923 the petitioner claims the deduction of the yearly amortization of the discount upon certain bonds, as follows:

In computing the yearly portion of discount on all of the above bonds, the total discount of each issue was divided by the term of the bonds to obtain such yearly portion. The companies that issued these bonds charged the discount to surplus at the close of the year during which the bonds were issued, except the Indiana, Illinois & Iowa Railroad Co., which charged the discount to cost of road.

In 1906 the Indiana, Illinois & Iowa Railroad Co. and several other corporations were consolidated to form the Chicago, Indiana & Southern Railroad Co., which assumed the obligation on the bonds in question. In 1914 the Chicago, Indiana & Southern Railroad Co., the Lake Shore & Michigan Southern Railway Co., the New York Central & Hudson River Railroad Co., and other corporations were consolidated to form the New York Central Railroad Co. (the petitioner), which assumed the obligations upon the bonds in question. The petitioner did not set up any discount on these bonds in its books of account, but set up assets equal to the total liability on the bonds assumed.

B.

In 1913 the New York Central & Hudson River Railroad Co. issued certain equipment trust certificates at a discount. The discount was charged to profit and loss upon the books of the issuing company. The obligation upon the equipment trust certificates was assumed by the petitioner upon the consolidation in 1914. The equipment trust certificates mature serially and the amounts claimed as discount are determined from the petitioner’s records and in accordance with the Bureau’s method of computing discount on serial bonds. The amounts claimed as deductions for the respective years are:

1917-$10,910.02
1920- 7,937.14
1923_ 4, 960. 68

C.

The record does not clearly show the facts regarding the issuance of bonds by the predecessors of the Cleveland, Cincinnati, Chicago & St. Louis Railway Co. (petitioner’s affiliate). It appears that that company set the discount up on its books, and that the amount of $5,164.05 is the portion of the discount applicable to the year 1923.

D. Prior to 1914 the entire capital stock of the Cleveland Short Line Railroad Co. and the Jamestown, Franklin & Clearfield Railway Co. was owned by the Lake Shore & Michigan Southern Eailway Co., which in that year was consolidated with other companies to form the New York Central Eailroad Co. (petitioner). Upon the consolidation, the capital stock of the Cleveland Short Line Eailroad Co. and the Jamestown, Franklin & Clearfield Eailway Co. became the property of the petitioner and the said railroads were merged with the petitioner.

During the year 1909 the Jamestown, Franklin & Clearfield Eail-way Co. issued its first mortgage 4 percent bonds, dated June 1,1909, due June 1, 1959, having a face value of $11,000,000, to the Lake Shore & Michigan Southern Eailway Co. at 80 percent of face value in settlement of advances made to it by the latter company.

The Lake Shore & Michigan Southern Eailway Co. guaranteed the payment of the aforesaid bonds both as to principal and interest, and during March 1910, sold them to J. F. Morgan & Co. at 93 percent of face value or for the sum of $10,230,000.

During the year 1911 the Cleveland Short Line Eailroad Co. issued its first mortgage 4% percent bonds dated April 1, 1911, due April 1, 1961, having a face value of $7,000,000, to the Lake Shore & Michigan Southern Eailway Co. at 80 percent of face value in settlement of advances made to it by the latter company.

During the year 1913 the Cleveland Short Line Eailroad Co. issued its aforesaid bonds having a face value of $1,275,000 to the Lake Shore & Michigan Southern Eailway Co. at 97 percent of face value in settlement of advances made to it by the latter company.

During the year 1913 the Cleveland Short Line Eailroad Co. issued its aforesaid bonds having a face value of $3,525,000 to the Lake Shore & Michigan Southern Eailway Co. at par in exchange for the latter company’s preferred capital stock having a par value of $3,525,000.

The Lake Shore & Michigan Southern Eailway Co. guaranteed the payment of the aforesaid bonds of the Cleveland Short Line Eailroad Co., both as to principal and interest. During September 1913, it sold to J. P. Morgan & Co. $5,000,000 face value of said bonds at 91 percent of face value or for the sum of $4,550,000, and $2,350,000 face value thereof at 91% percent of face value or for the sum of $2,150,250. During February 1914. it sold $4,450,000 face value of said bonds to J. P. Morgan & Co. at 93% percent of face value or for the sum of $4,160,750.

The yearly amortization of the discount upon the issuance and upon the sale of the above bonds is $72,765 and $29,518.97, respectively. The companies issuing these bonds charged the discount to profit and loss for the year during which the bonds were issued. The petitioner claimed, and the respondent allowed, as a deduction, the amount of $72,765 as amortization of the discount upon these bonds.

A, B, C, and D.

In Missouri Pacific R.R. Co., 22 B.T.A. 267, 287, 289, we considered the issue at bar, and, despite the reversal of our earlier decision in Western Maryland Ry. Co., 12 B.T.A. 889, by the Circuit Court of Appeals for the Fifth Circuit (36 Fed. (2d) 695), adhered to our earlier ruling sustaining “the Commissioner in refusing to allow any deduction for amortization of discount upon bonds issued by the preceding owner of the property now owned by petitioner.” That ruling was also followed in Southern Ry. Co., 27 B.T.A. 673. The issue at bar is controlled by those decisions and judgment will be entered accordingly.

IY.

Deductions for Depredation and Betirement of Leased Equipment amd Property.

The issue with respect to deductions on account of leased equipment and property is raised by the following pleadings:

A.

(49) In Docket No. 19982 the respondent affirmatively alleges that he erroneously allowed deductions of $44,119.72 as depreciation and $50,384.10 as loss on retirements of equipment leased from the Boston & Albany Railroad Co. The petitioner claims that if it is not entitled to the deductions allowed by the respondent, it should be allowed a deduction of $117,061.14 for the inventory value of the Boston & Albany Railroad Co. equipment which was retired from service during the year 1917.

(50) In Docket No. 34437 the respondent affirmatively alleges that he erred in allowing in 1920 a similar deduction of $32,771.55 with respect to this leased equipment. The parties have agreed that $1,892.30 of this amount represents depreciation on additions and betterments made by the petitioner, and as such is deductible. The petitioner claims that if it is not entitled to the deductions allowed by the respondent, it should be allowed a deduction of $38,834.79 for the inventory value of Boston & Albany Railroad Co. equipment which was retired from service during the year 1920.

(51) In Docket No. 62040 the petitioner alleges that the respondent erred in disallowing the deduction of $51,499.95 “ representing depreciation and retirements ” on the leased Boston & Albany Bail-road Co. equipment; and, in the alternative, that “it is entitled to take as a deduction in the year 1923 the sum of $84,007.69 which represents the inventory value of the equipment which became obsolete and was retired from service during that year.”

B.

(52) In Docket No. 19930 the respondent affirmatively alleges that he erroneously allowed deductions of $64,719.35 as depreciation and $14,684.06 as loss on retirements of equipment leased by the Michigan Central Bailroad Co. from the Canada Southern Bailway Co. The petitioner claims that if it is not entitled to the deductions allowed by the respondent, it should be allowed a deduction of $32,679.50, the inventory value of the leased equipment retired in 1917.

(53) In Docket No. 34437 the respondent affirmatively alleges that he erred in allowing similar deductions of $52,325.09 as depreciation and $9,813.19 as loss on retirement, a total of $62,138.28, in determining consolidated net income for 1920. The parties have agreed that $1,648.25 of this amount represents depreciation on additions and betterments and as such is deductible. The petitioner claims that if it is not entitled to the deductions allowed by the respondent, it should be allowed a deduction of $46,817.60, the inventory value of the Canada Southern Bailway Co. equipment retired from service in 1920.

(54) In Docket No. 62040 the petitioner alleges that the respondent erred in disallowing the deduction of $38,238.89 “which represents depreciation and retirements ” on the leased Canada Southern Eailway equipment; and, in the alternative, that “ it is entitled to a deduction in the year 1923 for the sum of $107,744.49 which represents the inventory value of the equipment which became obsolete and was retired from service during that year.”

C.

(55) In Docket No. 62040 the petitioner alleges that the respondent erroneously disallowed the deduction of $36,512.82, representing depreciation and retirements on equipment leased from the Chicago Junction Bailway Co., by the petitioner’s affiliate, the Chicago Eiver & Indiana Bailroad Co.; and, in the alternative, that there should be allowed the deduction of $9,452.07 which .represents the inventory value of such equipment which became obsolete and was retired from service in 1923.

(56) In Docket No. 6204-0 the petitioner alleges that the respondent erroneously disallowed the deduction of $35,950.51, representing depreciation on road property, and $9,932.46, representing depreciation on additions and betterments made to the property, leased from the Chicago Junction Kailway Co. by the petitioner’s affiliate.

A.

On November 15, 1899, the New York Central & Hudson Kiver Kailroad Co. leased from the Boston & Albany Kailroad Co. all of its railroad properties for a term of 99 years from July 1, 1900. The properties were taken over and operated pursuant to the terms of the lease by the lessee, and upon the consolidation in 1914 the petitioner assumed the obligations of the lease and has since operated the leased properties. The lease contains the following provision with respect to the return of these properties to the lessor upon the termination of the lease:

* * * Tlie lessee, at the expiration or earlier termination of this lease, will return the demised road and property with all improvements and additions thereon to the lessor as a railroad between Boston and the Hudson River, with its branches, in all respects in as good condition as to its road, road-bed, bridges, lands, wharves, yards, terminal facilities, depots, stations, shops, and other structures, and as to its rolling stock, machinery, materials, tools, appliances and equipment, and other property and rights, real and personal, as the same now are or may be put in during the continuance of thisi lease and so that there shall be no depreciation in the same or any part thereof, and will also return or deliver in lieu of the personal property set out in the inventory hereinafter provided to be made, the same or other personal property of similar character, value and uses, and appropriate for the operation of the lessor’s railroads.

The parties to said lease made an inventory of the equipment in accordance with the provisions of the lease, and determined that the value of the equipment at that time amounted to the sum of $4,213,614.92. In July 1901, petitioner’s predecessor charged this amount on its books to an account for equipment acquired from Boston & Albany Kailroad Co., lessor, and offset the same with an account for liability to lessor company for equipment acquired. In 1907, pursuant to the classification of balance sheet accounts promulgated by the Interstate Commerce Commission, petitioner’s predecessor transferred the item to account 701, Investment in Equipment, and the liability is still carried as a liability to lessor company for equipment acquired.

When it was necessary to replace any equipment leased from the Boston & Albany Railroad Co., the petitioner replaced it currently with equipment out of its own funds, and as to such replacements the respondent has consistently allowed depreciation as well as loss upon retirement of such equipment. Depreciation has been computed at the rate of 2percent on the inventory value of the leased equipment in service during the tax year. The losses on retirements represented the portion of the inventory value of equipment not covered by accruals for depreciation at the time it went out of service during the tax year.

The depreciation on, the loss upon retirements, and the inventory value of the leased Boston & Albany Railroad Co. equipment, follows:

The amounts shown above for depreciation and loss upon retirements were claimed as deductions in the respective years.

B.

On August 15, 1903, the Michigan Central Railroad Co. leased from the Canada Southern Railway Co. all of its properties for a term of 999 years from January 1, 1904. The properties were taken over and operated pursuant to the terms of the lease by the lessee, the Michigan Central Railroad Co. The lease contains the following provision witli respect to the return of these properties to the lessor upon the termination of the lease:

Eighth: That it will during the continuance of this Indenture keep and maintain in use on ihe demised premises an adequate equipment of rolling stock, adapted for railroad business, that upon the termination of this Indenture, by default or otherwise, the Canada Company shall be put in possession of rolling stock and oilier railroad equipment of the same character and of equal value as that hereby leased to the Michigan Company, and that for better securing the Canada Company the full performance of this covenant an inventory and appraisement of the locomotives, cars and other movable property, machinery and tools leased shall be made and completed before the date when this Indenture is to take effect, and the said inventory and appraisement shall be identified by the respective signatures of the Presidents of the parties hereto, and shall be considered part of this Indenture, it being always understood, however, that while and so long as the railways covered by this Indenture are adequately stocked and supplied the Michigan Company is to have the right to use the rolling stock and other equipment hereby leased in its general business over any or all of the railways which it may now or hereafter operate.

The Michigan Central Railroad Co. charged off depreciation at the rate of 2y2 percent on the equipment leased from the Canada Southern Railway Co., and when a piece of equipment was retired it set up a liability to the lessor for the inventory value of the retired equipment. Offsetting that is the depreciation reserve for the amount of depreciation accrued up to the time of retirement, and the balance is charged to operating expenses and profit and loss as required by the Interstate Commerce Commission’s classification of accounts.

Depreciation on leased equipment is based upon the inventory value at the time of the lease. The loss on retirements represents the portion of the inventory value of equipment not covered by depreciation at the time said equipment goes out of service.

The depreciation on, the loss upon retirements, and the inventory value of the leased Canada Southern equipment, follows:

The amounts shown above for depreciation and loss upon retirements were claimed as deductions in the respective years.

C.

On May 19, 1922, the Chicago River & Indiana Railroad Co. (petitioner’s affiliate) leased from the Chicago Junction Railway Co. all of the latter’s railroad properties for a term of 99 years, and thereafter in perpetuity at the option of the lessee. The properties were taken over and operated pursuant to the terms of the lease, which contains the following provision with respect to the return of the properties to the lessor upon the termination of the lease:

The River Company covenants that it will maintain the premises and properties (including all equipment) by this instrument demised, in good operatable condition and repair and from time to time renew and replace the improvements thereon and the said equipment or make equivalent substitution therefor and, at the termination of the term of this lease, or of any extension thereof, whether by expiration or otherwise, except in the instance of expiration resulting from or arising by the exercise of the option of purchase provided for in Article XII hereof, will deliver and return the same to the Junction Company in as good order and condition as when received, ordinary wear and tear (with reasonable care and reasonable renewals and replacements) excepted; * * *

It was the practice of the Chicago River & Indiana Railroad Co., and the Chicago Junction Railway Co. as well, to accrue depreciation on property such as buildings, water tanks, bridges, and structures, but not roadway, and such practice was continued by the Chicago River & Indiana Railroad Co. subsequent to said lease. Such method of accounting was permitted though not required under the accounting rules of the Interstate Commerce Commission. The same practice existed and was followed with respect to the equipment demised by the lease.

The accounting procedure of the Chicago River & Indiana Railroad Co. with respect to said equipment was to set up in its books a liability to the Chicago Junction Railway Co. for the inventory value of equipment as it goes out of service in any particular year, offsetting that by a charge to the depreciation reserve thus far accrued, and the balance to operating expenses as retirements or profit and loss, as applicable, in accordance with the Interstate Commerce Commission’s classification of accounts. The liability set up by the Chicago River & Indiana Railroad Co. to the Chicago Junction Railway Co. as equipment goes out of service is handled not as a separate item, but as a credit to account 102 for improvements made by the Chicago River & Indiana Railroad Co. on the leased property during the particular year.

During the year 1923 the Chicago River & Indiana Railroad Co. was affiliated with the petitioner and in the consolidated return filed for that year there were deductions with respect to the leased Chicago Junction Railway Co. properties as follows: $35,950.51, representing depreciation of roadway properties; $28,446.35, representing depreciation of equipment; and $8,066.47, representing loss on retirements of equipment.

The inventory value of the leased equipment retired from service in 1923 was $9,452.07.

A, B, and C.

The petitioner’s claims for deductions of amounts representing depreciation and loss upon retirements of leased equipment and property, or, in the alternative, the inventory value of such equipment retired in the respective taxable years, must be denied. The lessees had no capital investment in the leased properties involved. As was said in Tunnel R.R. of St. Louis v. Commissioner, 61 Fed. (2d) 166, 174, “It may be that to all practical purposes, the petitioner is the owner, but no portion of the capital investment * * * has been paid for by the petitioner [lessee].”

While the facts involved in Weiss v. Wiener, 279 U.S. 333, may be distinguishable, the principle of that case was applied in Tunnel R.R. of St. Louis v. Commissioner, supra, by the Circuit Court of Appeals for the Eighth Circuit, and by this Board (17 B.T.A. 185), to railroad properties under leases like those involved in these proceedings. The respondent’s determination is sustained and his affirmative allegations allowed. Cf. Richmond Belt Ry. Co., 13 B.T.A. 1291; Terminal Railroad Assn, of St. Louis, 17 B.T.A. 1135, 1172; Terre Haute, Indianapolis & Eastern Traction Co., 24 B.T.A. 197, 210.

V.

Railway Mail Pay.

(57) The next issue is whether the payments received by the petitioner as back railway mail pay constitute taxable income in 1920 or in the respective years of payment. The facts on this issue are admitted.

The petitioner and its affiliated corporations, the Toledo & Ohio Central Bailway Co., the Zanesville & Western Bailway Co., and the Chicago, Kalamazoo & Saginaw Bailway Co., received $1,778,-661.65 in 1920 and $57,921.15 in 1921 in consequence of Decision 9200 by the Interstate Commerce Commission, Bailway Mail Pay, 56 I.C.C. 1, interpreting the provisions of sections 5 and 6 of the Act of Congress, approved July 28, 1916, Post Office Department Appropriation, 39 Stat. 412, 425. The said Decision 9200 was rendered. on December 23, 1919, but was not served on the interested parties or made public until January 15, 1920.

The amounts of railway mail pay received by the petitioner and its affiliates in 1920 and 1921 were accrued upon their books in the respective years of receipt and reported in the consolidated returns for those years. In determining the deficiencies, the respondent eliminated the amount reported for 1920 and now claims that he erred in so doing, and that both the amount received in 1920 and the amount received in 1921 should be included in consolidated net income of 1920.

In International-Great Northern R.R. Co., 24 B.T.A. 726, the Board held that similar railway mail payments to that carrier constituted income in the year of receipt. In Pittsburgh & Lake Erie R.R. Co., 28 B.T.A. 259, we reexamined our earlier decision, pointing out the effect of Decision 9200, and the reasonableness of the Interstate Commerce Commission’s regulations for the accrual of these items as income in the year of receipt. We believe the petitioner and its affiliates properly accrued and reported as income the amounts received in 1920 and 1921. We accordingly hold that the respondent erred in eliminating the amount received in 1920 from the consolidated net income of that year; his affirmative allegation is allowed to that extent.

VI.

Rental Interest.

(58), (59), and (60) In Docket No. 62040 the petitioner alleges that the respondent erred in holding as taxable income for the year 1923, amounts representing rental interest on completed additions and betterments received in final settlement from the Director General of Railroads for the period of Federal control. (61) In the event the petitioner’s allegation is sustained, the respondent affirmatively alleges (in Docket No. 34437) that the amount of such rental interest applicable to the two months of Federal control in 1920 should be added to the consolidated net income of that year.

During the year 1923 the petitioner and affiliated corporations received from the Director General of Railroads, in the final settlement for the period of Federal control, payments representing rental mterest on completed additions and betterments as follows:

New York Central Bailroad Co_$2, 814,337. 31
Michigan Central Bailroad Co- 887, 519. 72
Cincinnati Northern Bailroad Co_ 16, 670. 43

The respondent has included these amounts in consolidated net income for 1923.

The portions of the above amounts applicable to the period of Federal control in 1920 are as follows:

New York Central Bailroad Co_$367, 746.14
Michigan Central Bailroad Co- 115, 550.46

Except for the facts relating to the payment received by the Cincinnati Northern Railroad Co., the parties are in agreement as to the above items. The petitioner in its original petition erroneously used an item representing quarterly interest upon balances applicable to the year 1923. At the hearing upon the petitioner’s motion to amend the pleadings in this and other respects, the petitioner was allowed to amend and the above amount of $16,670.43 was substituted, and the respondent conceded error to the extent of $2,564.72 of the corrected amount, since that much of the rental interest had been taxed to the Cincinnati Northern Railroad Co. in the settlement of that taxpayer’s liability for 1920. The Cincinnati Northern Railroad Co. was not affiliated with the petitioner in 1920 and hence its tax liability for that year is not before the Board.

The parties agree that the issue is controlled by our decision in Texas & Pacific Ry. Co., 9 B.T.A. 365. We accordingly hold that the respondent erred in including the amounts representing rental interest on additions and betterments in the consolidated income of 1923, and that his affirmative allegations with respect to the admitted amounts applicable to the period of Federal control in 1920 should be allowed. See also International-Great Northern R.R. Co., supra; Union Pacific R.R. Co., 26 B.T.A. 1126; Pittsburgh & Lake Erie R.R. Co., supra.

VII.

Payment to Association of Railway Executives.

(62) The petitioner alleges that the respondent erred in disallowing the deduction of $13,190.54 which it paid to the Association of Railway Executives in 1923 (Docket No. 62040).

During the year 1923 the petitioner paid the above sum as its proportion of an assessment levied by the Association of Railway Executives upon all of the railroads of the country for the purpose of establishing at Yale University a chair of transportation in honor of the late Thomas DeWitt Cuyler.

The petitioner contends that the deduction should be allowed—

* * * because tbe apparent purpose was to promote education and instruction in tbe subject of transportation, thus serving the business of tbe railroads and creating an intangible benefit to them, much tbe same as tbe varied forms of advertising or business promotion.

The respondent argues that the payment “ was made for a specific purpose which did not result in a benefit to the corporation,” citing Los Angeles & Salt Lahe R.R. Co., 18 B.T.A. 168. The respondent points out that:

* * * Tbe evidence fails to show that tbe payment was made by tbe petitioner with tbe expectation that any direct or indirect benefit to the corporation would result, or that it did in fact receive any benefit from the expenditure. * * *

The facts of record pertaining to this issue are not sufficient to enable us to determine the extent of the benefit, if any, flowing to this taxpayer from the expenditure in question. Cf. American Rolling Mill Co. v. Commissioner, 41 Fed. (2d) 314. In the circumstances we leave the parties as we found them. Cf. Los Angeles & Salt Lake R.R. Co., supra; Texas & Pacific Ry. Co., v. United States, 52 Fed. (2d) 1040.

VIII.

Pro-fit on Beal Estate.

(63) The petitioner alleges that the respondent erroneously included in taxable income for 1928 the amount of $134,051.41, alleged profit on sale of real estate (Docket No. 62040). (64) The respondent affirmatively alleges, in the alternative, that if the above amount did not constitute income in 1923, a portion thereof was taxable income in 1917 (Docket No. 19932).

By indenture of lease dated November 20, 1922, the petitioner leased to the Inland Steel Co. certain land at East Chicago, Indiana, for a term of 999 years “ from and after the first day of January, 1923.” The rental of $58,900 for the entire term was paid in advance to the petitioner, and the amount thereof was credited to profit and loss upon the petitioner’s books in 1923. The leased land cost the petitioner $7,339.74 in 1902.

During the year 1917 the petitioner’s ore docks at Ashtabula, Ohio, were abandoned and the salvage recovered therefrom amounted to $82,491.15. This amount was credited to a suspense account in 1917 and carried therein until 1923, when it was credited to profit and loss.

In the statement attached to the deficiency notice is the following explanation of the respondent’s determination with respect to the items in controversy:

(g) Profit on sale of real estate.
Profit on sale or other disposition of the following property credited to account “ Miscellaneous Credits ” and reported as nontaxable income on your return has been restored to taxable income for the reason that no evidence has been submitted to establish the nontaxability of this profit.
Salvage account abandoning docks 1 and 7, Ashtabula, Ohio_ $82,491.15
Lease of land to Inland Steel Company, Indiana Harbor, Indiana_ 51, 560.26
Total restored to taxable income_$134,051.41

In his answer the respondent admitted that he had “ included in taxable income for 1923 an amount of $51,560.26 on account of disposition of land,” but denied other alleged facts.

In his suggested findings with respect to the Inland Steel Co. item, the petitioner states that “the evidence fails to show why the respondent reduced the amount of $58,900 to $51,560.26.” Apparently that was done by treating the transaction as a sale and deducting the cost of the property ($58,900 minus $7,339.74 equals $51,560.26).

The petitioner very properly points out that “ there was not a sale of the property, as title is still vested in petitioner.” In explanation of the low rental, the petitioner offered testimony showing that it was necessary to retain the property for railroad purposes, and that it would benefit by even a nominal rental by reason of the tonnage it might derive from an industry located on the property; perhaps these were the motivating considerations for the lease. Although the item in question was designated as rent for the entire term of the lease, there is nothing in the lease to indicate that in the event of its termination before the end of the term the lessee would be refunded any portion of the $58,900. Then, too, the petitioner treated this amount as income of 1923 upon its books. That sum was un-qualifiedly paid over to the petitioner in 1923. In these circumstances we hold that the entire amount constitutes income in 1923. Cf. Jennings & Co., 21 B.T.A. 381; affd., 59 Fed. (2d) 32; Andrew J. Pembroke, 23 B.T.A. 1176; Marvin H. Gates, Trustee, 26 B.T.A. 998.

The salvage item, according to the testimony which we have no reason to doubt, “ represents an accounting adjustment ” in 1923. The witness testified that “ it is just one of those delayed accounting items that on a big railroad it is inevitable that someone will split occasionally and omit.” We are satisfied that such was the case, and, since bookkeeping entries or adjustments do not of themselves create income even on the accrual basis, hold that the respondent erred in including this salvage item in the petitioner’s 1923 income. Cf. Fibre Yarn Co., 10 B.T.A. 479; Luther Elkins, 12 B.T.A. 1058; Worstell Co., Ltd., 15 B.T.A. 413.

In the alternative the respondent affirmatively alleges that the amount of $82,491.15, representing the salvage recovered from the abandoned ore docks, constitutes income in 1917. The respondent has offered no evidence to support his affirmative allegation, and there is nothing in the record to show the petitioner’s capital investment in the abandoned property, or that the sum in question was a realized gain upon the disposition of such properties. We can not determine whether this sum, plus the sustained depreciation, was more or less than petitioner’s capital investment in the profit. If this was a mere return of the undepreciated cost of the abandoned properties, it was a return of the petitioner’s capital investment,, and hence not the receipt of income under the rule of Burnet v. Logan, 283 U.S. 404. The respondent has failed to sustain his burden of proof and his affirmative allegation that this item constitutes income in 1917, falls.

IX. .

Depreciation Adjustment.

(Go) The remaining issue is whether the Commissioner erred in including in the 1923 consolidated income • $6,359.96 “ which represented depreciation on property retired in 1918 by the Michigan Central Railroad Co.”

The evidence with respect to this item is similar to that submitted with respect to the accounting adjustments on the items under the next preceding point in controversy. These adjustments did not create taxable income in 1923, and if any income was realized by the petitioner or its affiliate it was in the year in which the transaction took place — 1918, a year not before us. In these circumstances, the item should be eliminated from the consolidated net income of 1923.

Judgment will be entered under Rule 50.


author: Smith :

text:
    The Old Colony Trust Company, Executor, Estate of Guy W. Currier, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 55317.
    Promulgated June 20, 1933.

      Alfred P. Lowell, Esq., and J. Bond Smith, Esq., for the petitioner.

      Philip M. Clark, Esq., and Stanley B. Pierson, Esq., for the respondent.
   OPINION.

Smith :

This proceeding is for the redetermination of a deficiency of $88,463.49 in the decedent’s income tax for 1928. The only issue is whether the sale of certain stock in 1928 was a sale of capital assets. The respondent affirmatively alleges that he erroneously computed the profit upon the sale, subject to normal and surtax, and duly asserts claim to any increased deficiency that may result from our redeter-mination. The case has been submitted upon the following stipulation :

1. One Joseph P. Kennedy, having negotiated for the purchase of 40,000 shares of Class-A common stock of a corporation then known as It. C. Pictures Corporation, and 8,000 shares of its preferred stock, Class B, for an aggregate price of $1,160,000.00, made an agreement at some time during January or the early days of February, 1926, with Currier. Under the terms of that agreement Currier was to participate with said Kennedy in the purchase of said shares on a basis of 25 percent and 75 percent, respectively. On February 5, 1926, said Kennedy purchased the aforementioned shares under the terms of a written contract bearing that date, and shortly thereafter Currier paid to Kennedy the sum of $112,500.00, representing 25% of the cash sum paid by Kennedy under the terms of the said contract.
2. On July 7, 1926, Currier and said Kennedy jointly purchased 7,500 shares of the Class B common stock of the said R.C. Pictures Corporation at $4.00 per share from persons named Thompson and Poucher; and on or before July 21, 1926, Currier and Kennedy had agreed upon a 50-50 basis of participation with respect to all of the transactions described herein; and in pursuance of said agreement, and on that date or within a few days thereafter an adjustment was made between Currier and said Kennedy whereby Currier paid to Kennedy one-half of the cash consideration involved in the initial purchase of February 5, 1926. Acting in pursuance of the said agreement, on November 18, 1926, Currier and Kennedy jointly purchased an additional 2,500 shares of the Class B common stock at $12.00 per share from a Miss Williams.
3. The name of R.C. Pictures Corporation was subsequently changed to F.B.O. Productions, Inc., and said corporation is hereinafter referred to by that name.
4. Prior to October 1927, Currier and Kennedy had acquired jointly in equal shares at a cost of $30,000 the rights in a motion picture known as “ The Moon of Israel.” The contract for said rights was in the name of Kennedy. In October 1927, they caused to be organized a corporation under the name of The Cower Street Company. The corporation issued five shares each to Currier and Kennedy for cash at $100 per share. Thereafter, in December 1927, Kennedy transferred the rights in “ The Moon of Israel,” to The Gower Street Company and the Company issued therefor 300 shares, 150 of which were thereupon transferred to Currier. Concurrently with the assignment of the contract, The Gower Street Company made a contract for the distribution of said picture with F.B.O. Productions, Inc. The activities of The Gower Street Company during the period herein referred to consisted of receiving income from said picture and in the transactions relating to stock in F.B.O. Productions, Inc., herein described.
5. On or about November 9, 1927, Currier and said Kennedy jointly purchased from one Powers 40,000 shares of said Class B common stock at $7.50 a share. Oh December 30, 1927, the Radio Corporation of Americd purchased 20,000 shares of F.B.O. Productions Class B Common treasury stock for $24.00 per share. As a part of the transaction with the Radio Corporation of America, Currier and Kennedy, being the holders of all of the outstanding voting stock of F.B.O. Productions, Inc., agreed to cause a reclassification of the stock of that corporation, so that the non-voting shares purchased by Radio should be given full voting power and dividend rights, and also that certain provisions relating to the preferred stock which were disadvantageous to common stockholders should be adjusted.
6. At a meeting of the hoard of directors of The Gower Street Gompany on January 6, 1928, upon motion duly made, seconded and carried it was
Voted : That the corporation purchase from Joseph P. Kennedy and Guy W. Currier Ten thousand (10,000) shares of the common stock Glass B of F.B.O. Productions, Inc. for the sum of sixty thousand (60,000) dollars, the same being the purchase price paid by said Kennedy and Currier to Messrs. Thompson and Poucher and to Miss Williams for the said ten thousand shares.
Upon motion duly made, seconded and carried, it was
Voted: That on receipt of said ten thousand shares the treasurer be authorized and directed to sign on behalf of the corporation and to deliver to said Kennedy and Currier or their nominees a note or notes of the corporation payable on demand in the total sum of thirty thousand ($30,000) dollars.
Upon motion duly made, seconded and carried, it was
Voted: That the corporation purchase from Joseph P. Kennedy and Guy W. Currier forty thousand (40,000) shares Class B common stock of F.B.O. Productions, Inc. at seven dollars and fifty cents ($7.60) per share, the same being the price at which said Kennedy and Currier have agreed to purchase said forty thousand shares from P. A. Powers.
Upon motion duly made, seconded and carried, it was
Voted : That upon receipt of said forty thousand shares or any part thereof the treasurer be authorized and directed to sign on behalf of this corporation and deliver to said Kennedy and Currier or their nominees notes of the corporation at the rate of seven dollars and fifty cents ($7.60) per share for such stock as and when so received, to the aggregate amount of three hundred thousand (300,000) dollars for said forty thousand (40,000) shares.
•The transaction as authorized by the above vote of January 6, 1928, was thereafter on the same date carried out by The Gower Street Company and Currier and Kennedy pursuant to and in accordance with the terms of the vote:
Currier and Kennedy delivered to The Gower Street Company the stock acquired as above set forth from Thompson, Poucher and Williams and also 20,000 out of the 40,000 shares acquired from Powers, receiving therefor notes of The Gower Street Company in an amount equal to the cost to them of the stock so transferred; and thereafter, on February 9, 1928, the taxpayer and Kennedy delivered to The Gower Street Company the remaining 20,000 shares acquired from Powers as aforesaid receiving therefor notes of the corporation in an amount equal to the cost to them of said 20,000 shares.
On February 16, 1928, the B. F. Keith Corporation purchased from The Gower Street Company the 40,000 shares last referred to for $15.00 per share. The B. F. Keith Corporation was also given an agreement as to reclassification similar to that with radio.
7. At a meeting of the board of directors of The Gower Street Company on February 16,1928, upon motion duly made, seconded and unanimously carried it was
Resolved that the company buy from Joseph P. Kennedy and Guy W. Currier forty thousand (40,000) shares Common Stock Class A and eight thousand (8,000) shares Preferred Stock Class B of F.B.O. PRODUCTIONS, Ino., now held under an agreement dated July 14, 1926 between Joseph P. Kennedy, and Guy W. Currier, Reserved Assets Company, Ltd. and The National City Bank; paying the sum of eight hundred and ninety thousand dollars ($890,000) in the form of its demand notes payable one-half to Joseph P. Kennedy and one-half to Guy W. Currier, as a part of the purchase price, and assuming and agreeing to pay said bank two hundred and seventy thousand dollars ($270,000) balance due under said agreement.
The transaction as authorized by the above resolution of February 15, 1928, was thereafter on the same date carried out by The Gower Street Company and Currier and Kennedy pursuant to and in accordance with the terms of the resolution:
Currier and Kennedy on February 15, 1928, delivered to The Gower Street Company the 40,000 shares of common stock, Class A, and the 8,000 shares of preferred stock, Class B, acquired by them as aforesaid under the terms of the said contract of February 5, 1926, receiving therefor notes of The Gower Street Company amounting to $445,000.00 each and in addition The Gower Street Company assumed a liability of $270,000.00 representing the unpaid balance of the purchase price of $1,160,000.00 for said shares of stock.
8. On March 1, 1928, The Gower Street Company sold to persons other than Currier and Kennedy 2,000 shares of the Class B common stock originally acquired from Thompson, Poueher and Williams, at $15.00 per share.
9. The Gower Street Company thereafter purchased from persons other than Currier and Kennedy 14,154 shares of the Class B common stock of F.B.O. Productions, Inc., including 3,500 shares purchased from one DeWitt at $7.00 per share, which in June 1928, were converted into the same number of shares of the new 110-par-value common stock as hereinafter referred to in paragraph 10.
10. On June 9, 1928, following out the plan which had been agreed upon at the time of the sale of Class B common stock to Radio and Keith, the charter of F.B.O. Productions, Inc., was amended, the preference pertaining to the preferred stock was wiped out, and the 8,000 shares of such stock were converted into 55,475 shares of no-par-value common stock. At the same time the old common stock of both classes was converted into an equal number of shares of new no-par-value common stock.
11. As an incident to this change in capital structure the plan of recapitalization included giving to each holder of common stock, Glass B, an opportunity to purchase at $15.00' per share, out of the new stock to be created by the conversion of the preferred stock, 85/100tlis of a share of such new stock for each share of common stock, Glass B, held by him. Pursuant thereto certain persons who availed themselves of this opportunity purchased 26,950 shares out of the 55,475 shares into which the preferred stock was converted.
12. On July 7, 1928, The Gower street Company sold 5,000 shares of the no par value stock originally acquired from Thompson, Poueher and Williams at $15.00 per share.
13. On October 9, 1928, The Gower Street Company still had in its possession 3,000 shares of no par value, which were the shares converted from the old Glass B common stock originally acquired by Currier and Kennedy on July 7, and November 18, 1926, 40,000 shares of no par value, which were the shares converted from the old Class A common stock originally purchased on February 5, 1926, and 28,525 out of 55,475 shares of no par value, which were the shares converted from the old Class B preferred stock originally purchased on February 5, 1926. It also had in its possession on October 9, 1928, 3,500 shares of no par value, which were the shares converted from the old Class B common stock acquired by The Gower Street Company from DeWitt. All of these shares of no par value stock except 25 shares thereof representing those purchased from DeWitt were delivered to Currier and Kennedy by The Gower Street Company. Currier thus received 37,500 shares, out of which 1,737 were from the DeWitt shares, 34,263 were from the shares purchased on February 5, 1926, and 1,500 were from the shares purchased from Thompson, Poueher and Williams on July 7, 1926, and November 18, 1926.
Prior to October 9, 1928, the notes given to Currier and Kennedy for the Thompson, Poucher and Williams stock and the Powers stock had been paid in full and the notes given by The Gower Street Company for the voting sto'ck had been paid down to $149,667.79 each.
14. At a meeting of the board of directors of The Gower Street Company on October 4, 1928, on motion of one of the directors it was
Resolved that 37,500 shares of stock of P.B.O. Productions, Inc., be sold to Guy W. Currier and 37,500 shares be sold to Joseph P. Kennedy on the following terms and conditions. Said shares shall be sold at the cost of the first acquired 75,000 shares of P.B.O. Productions, Inc., in the treasury of the company as determined by the Treasurer; that said Kennedy and said Currier shall each surrender the notes of the Company now in his possession and pay the balance of the purchase price by each executing his demand note payable to the Company for the required sum; and upon such surrender of said notes payable of this Company and receipt by the Treasurer of said notes receivable the Treasurer shall deliver said 37,500 shares of P.B.O. Productions, Inc., to Mr. Kennedy and upon the same condition shall deliver 37,500 shares to Mr. Currier.
The transaction as authorized by the above resolution of October 4, 1928, was thereafter on the ninth day of October 1928, carried out by The Gower .Street Company and Currier and Kennedy pursuant to and in accordance with the terms of the resolution; there was no other vote or resolution of The Gower Street Company relative to this transaction:
The Gower Street Company delivered the shares of stock to Currier and Kennedy who in turn surrendered the notes of the company in their possession and executed their demand notes, the amount of Currier’s note being $257,-186.66. The aggregate amount of corporate notes cancelled and new notes given by the individuals was equal to the cost of The Gower Street Company of said shares which, except as to the shares purchased from DeWitt was the same as the original cost to Currier and Kennedy. Said aggregate amounted in all to $813,681.48 made up as follows:
15. In this transaction Currier received shares of stock in the amounts and at. a cost to him as follows:
16. This transaction disposed of all the remaining stock acquired from Currier and Kennedy and left The Gower Street Company with 10,679 shares of the 14,154 shares acquired as recited in paragraph 9. These remaining shares were disposed of by The Gower Street Company to persons other than Currier and Kennedy during the year 1928. No dividends were declared by The Gower Street Company in or payable in the year 1928.
17. Throughout the entire period and until the early part of 1930, Currier and Kennedy held the 310 shares of the stock of The Gower Street Company, each holding 155 shares. No purchases or sales of this stock were ever made during this period. Each of the two held throughout a one-half interest in the company.
18. The shares of stock of F.B.O. Productions, Inc., received from The Gower Street Company on the transaction of October 9, 1928, had a fair market value on that date of $30.50 per share.
19. On November 25, 1928, Currier sold all of the said shares at a price of $35.00 per share.
20. In the income tax return filed by Currier for the taxable year 1928 with respect to the DeWitt shares set forth in paragraph 15, the excess of the selling price over the cost, in the amount of $48,636.00, was reported as ordinary net income subject to both normal and surtax. With respect to the other shares set forth in paragraph 15 the excess of the selling price over the cost, in the amount of $857,019.55, was reported as capital net gain.
21. Respondent in determining the deficiency in tax for the taxable year 1928 involved in this proceeding reduced the amount of $857,019.55 as set forth in paragraph 20 by $15,500.00 as representing the return to Currier of his investment in the stock of The Gower Street Company; and of the remainder of $841,519.55 included $295,778.85 as dividends subject to surtax only and $545,740.70 as ordinary net income subject to both normal and surtax.

By bis affirmative allegations, the respondent claims that the entire amount of $857,019.55 should be included as ordinary net-income subject to both normal and surtax.

Under section 101 of the Revenue Act of 1928, the gain, therein referred to as “ capital net gain ”, upon the sale of capital assets is taxed at the 12% percent rate. “ Capital assets ”, as defined in section 101 (c) (8) of the Revenue Act of 1928, “ means property held by the taxpayer for more than two years.” Supplementing that definition are stated exceptions not material here.

The petitioner’s contention that the decedent Currier sold “ capital assets ” on November 25,1928, is unsupported by the record. We are asked to ignore the sales to the Gower Co. by the decedent and his associate, and the sale to them by the Gower Co., and to treat the period during which the Gower Co. held this stock as within the period that the decedent held the stock. This we can not do. It is to be noted that Currier and Kennedy did not exchange the F.B.O. corporation stock for stock in the Gower Co., but sold that stock to the Gower Co. at the cost to them — with no gain to them resulting. There were certain purchases from and sales to others than Currier and Kennedy by the Gower Co. To follow the petitioner’s contention to its logical conclusions, the gain realized upon such sales by the Gower Co. should have been taxed to the decedent and his associate. Cf. Commonwealth Improvement Co., 20 B.T.A. 1189, 1194. The Gower Co. and its stockholders, although only two in number, were separate and distinct taxable entities and we can not ignore the formal transactions between them. Burnet v. Commonwealth Improvement Co., 287 U.S. 415. In these circumstances, we hold that Currier purchased stock on October 9, 1928, for a total consideration of $406,844.45, and that when he sold this stock on November 25, 1928, at a price of $35 per share he realized a gain, taxable at both normal and surtax rates, since he had held the stock less than two years. Cf. William Kempton Johnson, 17 B.T.A. 611; affd., 52 Fed. (2d) 727.

Since the Gower Co. neither declared nor paid any dividends in 1928- and since the decedent’s capital investment in that company was not liquidated during the taxable year, the respondent’s affirmative allegations that he erred in determining the deficiency in the manner stated in paragraph 21 of the stipulation are sustained.

Judgment will be entered under Bule 50.