author: GReen :

text:
    A. C. F. Gasoline Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 5188.
    Promulgated May 13, 1927.
    Claim for paid-in surplus, based en an alleged gift of a contract by the stockholders to the corporation, denied, it appearing that tlic contract was acquired by the corporation from nonstock-holders.

      James P. Quigley, Esq., for the petitioner.

      Thomas P. Dudley, Jr., Esq., for the respondent.
    In this proceeding the petitioner seeks a redetermination of its income and profits tax liability for the calendar years 1917 and 1918, for which the Commissioner has determined deficiencies in the sums of $20,846.94 and $20,293.77, respectively.
    Two questions are involved. The first is whether the petitioner is entitled to paid-in surplus on account of a casing-head-gas contract it acquired. The second is whether the petitioner is entitled to deduct from gross income an aliquot part of the value of such contract each year on account of the exhaustion of the supply of casing-head gas.
    The pleadings raised another issue involving rates of depreciation on items of plant and equipment. However this issue was withdrawn by the petitioner at the hearing.
    The respondent in determining the deficiencies proposed, included in the invested capital of the petitioner an amount of $81,200 as the value of the casing-head-gas contract. This value has been accepted by the petitioner. However, in his answer, the respondent asked to have the deficiencies increased through the exclusion from invested capital of the above amount upon the ground that the acquisition of the contract by the petitioner did not result in paid-in surplus.
    FINDINGS OF FACT.
    The petitioner is a corporation organized in 1916 under the laws of the State of Delaware, with its principal office at Tulsa, Okla.
    About February 18, 1915, D. W. Franchot, a man experienced in the operation of oil and gas properties and who had made a careful study of the extraction of gasoline from casing-head gas, examined a property known as the “ Susie Crow ” lease, consisting of 53y3 acres of land in Oklahoma and described as follows: South half of the south half of the southwest quarter and the west thirteen and one-third acres of the north half of the southwest quarter of section 4, township 18 north, range 1 east of the Indian Base Meridian. At that time there wore six producing wells on the property, producing approximately 3,200 barrels of very fine gravity oil. The oil was produced from what was known as the Bartlesville sand, which lay at a depth of 2,600 feet below the surface and had a thickness of from 40 to 80 feet. There was also found to underlie the surface a prolific shallow sand which was called the “ latent sand,” and also a gas sand called the “ Wheeler gas sand.” There was also another oil sand called the “ Skinner sand ” which was known as a producing sand. Franchot also ascertained that the gas, which is referred to as casing-head gas, occupied the sand in which the oil was found and was produced from the wells together and coincident with the oil. In 1915, after this examination, D. W. Franchot, acting as agent for Cosden & Co., the Cushing .Gasoline Co., and D. W. Franchot & Co., purchased the lease on this property consisting of a seven-eighths interest in the oil and gas.
    Cosden & Co. was a corporation. J. S. Cosden was president and E. P. Perry vice president. The Cushing Gasoline Co. was a corporation. W. L. Curtis was president and F. A. Aiken was vice president. D. W. Franchot & Co. was a copartnership consisting of ]ST. V. V. Franchot and Douglas W. Franchot, his son.
    The ownership of the “ Susie Crow ” lease was then as follows:
    Per cent.
    Cushing Gasoline Go_ 50
    Cosden & Co_ 25
    D. W. Franchot & Co_:._ 25
    The lease was operated during the fall and winter of 1915 as an oil and gas property, the gas being used as fuel to produce power to 'operate the lease. In February, 1916, D. W. Franchot made an exhaustive physical test of the volume and gasoline content of the casing-head gas on this lease and found the gas produced from the lease had a gasoline content of “ a strong five gallons per thousand feet of gas.” He also estimated that there were “ 400,000,000 cubic feet of gas in the sand underlying the Susie Crow lease.”
    On March 5, 1916, the Franchot Gasoline Co., a corporation, was organized under the laws of the State of Oklahoma with an authorized capital of $30,000, consisting of 300 shares of a par value of $100 a share. No operations were begun and no money was paid in until about August, 1916. About August 1, 1916, the name of the corporation was changed to A. C. F. Gasoline Co. On August 7, 1916, an agreement was entered into between this company and the owners of the Susie Crow lease, Cosden & Co., the Cushing Gasoline Co., and D. W. Franchot & Co., as follows:
    Memorandum of Agreement, made and entered into this 7 day of August, 1916, by and between Cosden & Company, Cushing Gasoline Company, and D. W. Franchot & Company, parties of the first part, and A. C. F. Gasoline Company, a corporation, party of the second part. As to the sale of Casinghead Gas from the following described land, to-wit, and the building of a gasoline manufacturing plant thereon:
    The South Half of the South Half of the Southwest Quarter and the West thirteen and one-tliird (13%) acres of the North Half of the Southwest Quarter of the Southwest Quarter, all in Section Four (4), Township Eighteen (18) North, Range Seven (7) East of the Indian Base Meridian, containing fifty-three and one-third (53%) acres of land, more or less.
    Whereas, said first parties are now operating on said lands for oil and gas and certain wells thereon are productive, in addition to oil, of what is termed easing-head gas, and
    Whereas, second party agrees to build.a gasoline manufacturing plant on the above described lease and has agreed to purchase from the first parties all the casing-head gas productive of gasoline in paying quantities, as produced from the wells now on said land, or that may be thereafter, during the term of this contract, drilled thereon;
    Now Therefore, for. the purpose aforesaid, and in consideration of the rights and privileges granted herein, by first parties to second party and of the payment, covenants and promises by the party of the second part to be made, done, kept and performed, it is hereby agreed as follows:

      1st. First parties hereby agree to deliver and sell to the second party and second party agrees to purchase and take at first parties’ lease or wells on said lands, the entire production of casing-head gas as produced from the wells now, or that may thereafter he drilled, oh said premises and which are productive of casing-head gas in paying quantities; first parties agree to be responsible to the lessor in their lease, for the royalty on the easing-head gas removed from said lands.
    2nd. Second party shall pay for said casing-head gas as delivered at said lease on said land at the rate of 5‡ per 1000 cubic feet. Second party shad, on or before the 10th day of each month, render written statements with meter readings to first parties of the casing-head gas transported to its plant from said lease above mentioned during the preceding month, by mailing the same to the office of the parties of the first part, and on or before the 15th day of said month shall make payment for same. Second party shall, at its own expense, furnish, install, and at all times keep in repair a proportional meter, or meters, of standard grade, in first-class order and working condition for the purpose of measuring the casing-head gas transported from said lease through said lines; and first parties shall have at all times the right to inspect and test said meters, and to be present when readings of meters are made. Meters shall be read daily and the gas is to be measured at four to eight ounce pressure.
    3rd. First parties hereby lease, and grant unto the second party, insofar as they have the right so to do, sufficient of the surface of this land for the laying of gas lines, buildings, railroad switches, etc., necessary to enclose said machinery, as may be necessary in manufacturing of gasoline and the transportation by it of the gas from the wells of first parties to the gasoline plant owned by the second party and of the return by it of the dry gas to the lines or other point designated by first parties on said land; and the second party, if necessary, agrees to secure the consent of the land owner for the use of sufficient of the surface of said lands, as above mentioned.
    4th. Immediately upon the execution of this contract the second party agrees at its own expense to build a gasoline manufacturing plant at the place on said lands designated by first parties; to lay and install the necessary lines of pipe to connect up the wells producing Casinghead Gas of the first parties on said lands with their gasoline plant and for the return of enough dry gas, or all if required, at sufficient pressure for lease operations.
    All equipment placed by second party on said leasehold premises shall be and remain the property of second party and at the termination of this contract, it shall have the right to take up and remove the same.
    5th. Party of the second part agrees to hold first parties free and discharged from liability or damage resulting from the operations of second party and to assume all responsibility for its own acts or negligence in its business.
    6th. First parties shall, at all times, have the right to reserve whatsoever casing-head gas they may actually need for the operation of their wells. It is also understood and agreed that first parties are to exercise their own judgment in the management of their wells and property as relates to the amount of casing-head gas taken from said wells and the manner of such taking, and that if at any time they find it necessary by reason of their operations, second party is to cease taking casing-head gas from any of said wells, or that it is injurious to any of said wells to take the casing-head gas therefrom that nothing herein shall prevent them from stopping the second party from taking gas from such wells.
    7th. It is understood and agreed that if at any time during the term of this contract, payments for gas are not made in accordance herewith, or upon the violation of any of the other terms or conditions of this contract, by the party of the second part, first parties may, without notice, discontinue furnishing gas to second party.
    8th. This contract, all of the rights, benefits and privileges shall continue in full force and effect for and during the remainder of the terms of the present existing oil and gas mining lease of first parties. This ■ contract subject to a physical test te be made of the casing-head gas by party of the second part within three weeks from date and accepted by party of the second part.
    Stock in the A. C. F. Gasoline Co. was issued as follows:

      Shares

    W. L. Curtis_ 50
    B\ A. Aiken_ 50
    J. S. Cosden_100
    D. W. ITranehot_)_ 50
    N. Y. V. BTanchot_ 50
    Total_300
    The petitioner thereupon constructed a plant with all the necessary pipe lines and tanks for the collection and treatment of the gas and the extraction of gasoline therefrom. Near the close of 1916 the petitioner exercised its rights under the contract and began producing .gasoline from the casing-head gas, continuing operations during the years 1917 and 1918.
    At the time the agreement was made two types of contracts or arrangements for the sale of casing-head gas were in use in this district. One arrangement was similar to what was later called the Indian Schedule. In this schedule the price paid the owner of casing-head gas for each 1,000 cubic feet of gas, was equal to one third of the product of the number of gallons of gasoline per 1,000 cubic feet of gas at the Chicago tank-wagon prices. Another, less common, arrangement called the fifty-fifty contract, was for the owner of the casing-head gas to receive one half of the sales price of the gasoline extracted from its casing-head gas. At the time the agreement was made the prevailing Chicago tank-wagon price for gasoline was 20 cents a gallon. The value of the casing-head gas contract on the date of its acquisition by the corporation was $81,200.
   OEINION.

GReen :

The petitioner claims that it is entitled to paid-in surplus on account of the casing-head gas contract on the theory that the contract, or at least the value in excess of the prescribed royalty rate, was a gift from the stockholders to the petitioner.

The evidence shows that the Susie Crow lease was owned by two corporations and a partnership, the Cushing Gasoline Co., Cosden & Co., and D. W. Franchot & Co. These three organizations were parties of the first part in the agreement, and the A. C. F. Gasoline Co. was party of the second part. No bonus or cash payment was stipulated as a consideration in the agreement. The only consideration was the royalty rate of 5 cents a thousand cubic feet of casing-head gas. No stock was issued to the parties of the first part and none of the parties of the first part became stockholders of the petitioner corporation.

The owners of the lease were as follows:

. Per cent.
Cushing Gasoline Co- 50
Cosden & Co_ 25
D. W. Franchot & Co_ 25

The stockholders of the petitioner were as follows:

Shares.
W. L. Curtis, president, Cushing Gasoline Co_.- 50
F. A. Aiken, vice president, Cushing Gasoline Co- 50
J. S. Cosden, president, Cosden & Co-100
D. W. Franchot, partner oí D. W. Franchot & Co_ 50
N. V. V. Franchot, partner of D. W. Franchot & Co- 50

Nothing has been introduced in evidence to prove that the individuals who held stock in the petitioner were holding such stock for the benefit of the organizations of which they were stockholders. In the absence of such proof to the contrary, it must be assumed that the agreement entered into between the petitioner and the Cush-ing Gasoline Co., Cosden & Co., and D. W. Franchot & Co., was an arm’s-length transaction in which each of the parties endeavored to secure the best terms possible.

There is a provision in the agreement which reads as follows:

First parties shall, at all times, have the right to reserve whatsoever casing-head gas they may actually need for the operation of their wells. It is also understood and agreed that first parties are to exercise their own judgment in the management of their wells and property as relates to the amount of casing-head gas taken from said wells and the manner of such taking, and that if at any time they find it necessary by reason of their operations, second party is to cease taking casing-head gas from any of said wells, or that it is injurious to any of said wells to take the casing-head gas therefrom that nothing herein shall prevent them from stopping the second party from taking gas from such wells.

Pursuant to this paragraph the first party could at any time utilize all of the casing-head gas to operate its wells; it could regulate the amount of gas taken from the wells and the manner of such taking; and it could prevent the taking of gas from the wells by the second party if first party deemed it necessary by reason of its operations.

It seems clear that the petitioner secured a very favorable contract from the three organizations owning the lease,, none of which were stockholders in the petitioner corporation. Such a transaction does not give rise to paid-in surplus. The contract was not paid in by the stockholders; it was not a gift from the stockholders. It was acquired from nonstockholders, and the petitioner is no more entitled to have its value included in invested capital than the value of any other advantageous contract. The Commissioner, as alleged by him in his answer, erred in allowing .any amount to be included in invested capital as the value of the contract.

The second issue relates to depletion, or exhaustion, if any, to be allowed the petitioner. To us it appears that this is the ordinary situation of a contract, without bonus, for the payment of royalties, made after March 1, 1913. It is contended that the contract was a gift from the stockholders to the corporation. To this contention the obvious answer is that the stockholders had Do interest in the subject matter of the contract. The allowance for depletion or exhaustion is measured by the cost, where property is acquired by purchase, lease, or contract, after March 1, 1913. The petitioners have no cost other than the royalty payments and are entitled to deduct only such payments. The petitioner is entitled to no deduction by reason of the depletion or exhaustion of the value of the contract.

Judgment will he entered after 15 days' notice, under Rule 50.


source: Caselaw Access Project

author: Milliken:

license: Public Domain

text:
    Hoosier Casualty Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8786.
    Promulgated May 13, 1927.
    1. Where a stock insurance company was organized to take over the business of a mutual insurance company and where only a fraction of one share of stock out of a total issue of 2,000 shares was acquired by the members of the mutual company, held, that these facts did not constitute a reorganization.
    2. Where a stock insurance company on the day it began business took over the business of a mutual insurance company, which had been issuing combined policies of death, health and accident insurance, and on the next day took over the business of an automobile insurance company, held, that the stock company was not for the first fractional day of its existence a “ life insurance company ” as that term is defined in section 242 of the Revenue Act of 1921.
    3. The net income of an insurance company, other than a life or mutual insurance company, is taxable under section 246 of the Revenue Act of 1921 for the year 1921, at the rate prescribed by section 230 (a) of that Act.
    4. Where a stock insurance company assumed the risks of a mutual insurance company in consideration of the transfer to it of the net surplus of the mutual company, held, that the transaction was one of reinsurance and that the net surplus so received was a single net premium and was income to the stock insurance company in the year received.

      Harry A. Fellow's, Esq., and Will H. Latta, Esq., for the petitioner.

      J. D. Foley, Esq., for the respondent.
    This proceeding involves the redetermination of a deficiency in income and profits tax for the year 1921, in the amount of $35,426.71, arising from "the fact that the Commissioner has determined that the net amount of $105,959.60 received in 1921 by the petitioner from a mutual insurance company of the same name was a net premium for the reinsurance by the petitioner of the risks of the mutual company.
    BINDINGS OP PACT.
    The Hoosier Casualty Co., a mutual and nonstock insurance company, and hereinafter referred to as the Mutual Company, was organized under the laws of the State of Indiana as a mutual insurance company, in the year 1907. About 90 per cent of the policies issued by said company were what was styled “Perfect Policy.” The material provisions of this policy read:
    I-Ioosier Casualty Company.
    Ploaltli and Accident Insurance.
    Indianapolis, Indiana.
    (Hereinafter called the Company.)
    In Consideration of the policy fee of $2.00 and of the payment of the premium of 1.00 Dollar in advance, and of application hereof, copy of which is endorsed hereon and made a part of this contract,
    Does Hereby Insure John Doe, the person described in “said application,” who states his occupation to be car loader, duties handling sacks subject to all of the provisions, conditions and limitations herein contained and endorsed hereon, and not otherwise, from 12 o’clock noon, standard time, of the day this contract is dated, until 12 o'clock midnight, standard time, of the last day of September, 1916, and for such further periods, stated in the renewal receipts, as the payment of said premium as specified in “ said application ” will maintain this policy and insurance in force, to-wit:
    Accident Indemnity — Total Loss of Time.
    (a) At the rate of $30.00 dollars per month, for a period not exceeding twenty-four consecutive months against total loss of time resulting necessarily, directly and independently of all other causes from bodily injuries other than such as result in one or more of the specific losses mentioned in paragraph (c), effected through external, violent and accidental means, and which immediately, wholly and continuously from date of accident, disable and prevent the Assured from performing every duty pertaining to any business or occupation, not exceeding twenty-four (24) consecutive months for any one injury.

      Accident Indemnity — Partial Loss op Time.
    (b) But, if sucb injuries so received shall wholly and continuously from date of accident disable and prevent the Assured from performing one or more important daily duties pertaining to his occupation, or in event of like disability immediately following total disability, or in event of total disability not immediately following injury, the Company will pay the Assured for the period of any such disability, not exceeding six (6) consecutive months, fifty per cent, of the rate specified in paragraph.(a). Provided, that the maximum period for which indemnity shall be paid under paragraphs (a) and (b) hereof shall not exceed twenty-four (24) consecutive months.
    Specific Indemnity.
    (c) But, if any of the following specific losses result solely from “such injuries” as defined in paragraphs (a) or (b), within ninety days from date of accident, the amounts stated below shall be paid regardless of the length of disability or any other or additional injuries, to-wit: Por loss of Life-Three Hundred-Dollars (The principal sum). Por loss of Both Hands, by severance at or above the wrist joint—
    The principal sum. Por.loss, of Both Peet, by severance at or above the ankle joint—
    The principal sum. Por loss of One Hand and One Poot, by severance at or above said joints—
    . . . The principal sum. Por loss of Entire Sight of Both Eyes, if irrecoverably lost—
    The principal sum.' Por loss, of Either Hand, by severance at or above the wrist joint—
    One-half the principal sum. Por loss of Either Poot, by severance at or above the ankle joint—
    One-half the principal sum. Por loss of Entire Sight of One Eye, if irrecoverably lost—
    One-third the principal sum.
    Which amounts are to be paid and received in lieu of any other indemnity, and-shall measure the total liability of the Company under the circumstances stated, all -other provisions of this policy to the contrary notwithstanding.
    Double Indemnity.
    (d) But, if such injuries are sustained by the Assured (1) while passively riding as a passenger within the enclosed part of any railway passenger ear provided for the exclusive use of passengers and propelled by steam, cable, compressed air or electricity; (2) or, while so riding as a passenger on board a steam vessel licensed for the regular transportation of passengers; and such injuries. shall be due directly to or in consequence of the wrecking of such car or vessel, then the Company will pay double the indemnity, otherwise payable under paragraphs (a) or (c), as the case may be.
    Piety Per Cent Accumulation.
    ■Each consecutive yearly renewal of this policy shall add Ten Per Cent, to the original amount specified above referring to specific indemnity; but all such additions shall never exceed Piety Per Cent, of such original amounts.

      Surgeon’s Pees — Non-disabling Injuries.
    (e) Or, if “such injury” sustained by the Insured shall not disable him or entitle him to any other indemnity under this policy, but shall require surgical treatment by a legally qualified surgeon, the Company will reimburse him for the cost of such treatment in an amount not to exceed three dollars, provided, that the attending surgeon’s receipt and affidavit on the Company’s blanks are furnished the Company within ninety days from date of the accident.
    Iblness Indemnity.
    Pull Indemnity, (f-1) Or, at the rate of $30.00 Dollars per month, after the first seven days, for a period not exceeding twelve consecutive months, that the Insured is necessarily and continuously confined within the house and therein regularly visited by a legally qualified physician, solely by reason of illness or disease, other than as hereinafter referred to or provided for, that is contracted and begins after this policy has been maintained in continuous force for thirty days; and that wholly and continuously disables the Assured from performing every duty pertaining to any business or occupation.
    Partial Indemnity, (f-2) But, at One-Half the rate as provided in Clause P-1, not exceeding two consecutive months, for a period of convalescence immediately following such confinement in the house, or by reason of any non-confining illness during which the Insured shall be wholly and continuously disabled and prevented from performing every duty pertaining to any business or occupation, and is regularly treated by a legally qualified physician. Provided, that the maximum period for which indemnity shall be paid under Clauses P-1 and 2 hereof shall not exceed twelve consecutive months.
    Provided, that indemnity under this Part shall not be paid for disability due directly or indirectly to venereal disease or to any illness not common to both sexes.
    Puneral Indemnity.
    But, if the death of said member results from sickness, not exempted or otherwise provided for, in this policy, originating after this certificate has been continuously for thirty days, without delinquency, in full force and effect, immediately preceding the beginning of said sickness, the Company will pay in lieu of any other indemnity, $100.00 funeral indemnity, but if benefits accrued from sickness, according to paragraph (f), exceed the amount of the death indemnity of this contract the beneficiary shall receive said amount in lieu of said death indemnity.
    Special Diseases,
    (g) Or, if the Assured contracts rheumatism, consumption, tuberculosis, paralysis, sciatica, neuritis, Bright’s disease, lumbago, cancer, hernia or any chronic disease after this policy has been maintained in continuous force for thirty days immediately preceding, the Company will pay the Assured 'the same rate of indemnity as provided in paragraph (f), subject to the provisions and conditions of said paragraph, for a period not exceeding three consecutive months.
    The Mutual Company also issued other policies called “ Commercial Policies,” covering accidental death only, and which were issued on a quarterly or annual premium payment plan. In January, 1921, the Mutual Company had accumulated a net surplus of $105,959.61. In January, 1921, C. H. Brackett was the president of the Mutual Company, W. H. Latta was vice president, and C. W. Bay was secretary and treasurer. These persons were also directors of the Mutual Company. In the latter part of 1920, the above officers and directors controlled and operated in the same office a reciprocal insurance association, writing automobile insurance for fixe, theft, collision, and property damage coverages. They owned an agency which controlled the insurance association through contract arrangements. Being desirous of consolidating all of the business transacted by them in the same office and of acquiring sufficient funds from the Mutual Company with which to purchase the automobile insurance business, and since this could not be accomplished under the charter held by the Mutual Company, the above-named persons proposed to and did organize the petitioner company, hereinafter called the Stock Company, with a capital stock of $100,000, of which $50,000 was issued and paid for at once and the balance was to be issued as hereinafter stated. In order to effect this change, the following letter was sent to every policyholder in the company:
    O. H. Brackett, President C. W. Ray, Sec’y-Treas.
    Hoosnaa Casualty Company.
    ■Health and Accident Insurance.
    Indianapolis.
    Deab Sib:
    This is to give notice that a special meeting of the policy holders of the Hoosier Casualty Company, is to be held at the office of the Company, 1510 Fletcher Savings and Trust Company Building, Indianapolis, Indiana, on Saturday, January 1, 1921, at 9:00 A. M. The purpose of this meeting is to act upon a contract whereby the insurance of this Company will be taken over and conducted by a company to be known as Thu Hoosieb Casualty Company.
    This new company will be managed by the same persons; operated in the same manner as the present Hoosier Casualty Company, the only difference being that it will be a stock company with a capital of One Hundbed Thousand Dollaks, while the present company is a Mutual Company.
    The present company, as a mutual company, is obliged by law to have a condition in its policies giving the power to levy extra assessments. This is objectionable to the public and a disadvantage in competition for business. It is not liked by many of our policy holders.
    The new “The Hoosier Casualty Company”, as a stock company will completely do away with this condition in its policies and there can be no extra assessments. ‘ This is an advantage to you as a policy holder, a great advantage to our agency force, ¿nd a source of strength to our Company.
    The plan and contract under which these changes are to take place must, under the law, be approved by the Insurance Department of the State of Indiana, which, assures you that your interests are protected, and your policy will not be changed in any way except tha.t extra assessments can not be made.
    The changes will result in a greater, stronger and better Hoosier than is possible under the present assessment Insurance laws under which we now operate, and with
    No change in management.
    No change in the general conduct of the business.
    No change in the cost of your insurance.
    No change in benefits provided for in your policy.
    No extra assessments possible.
    Very truly yours,
    O. H. Brackett, President.
    O. W. Ray, Sec’y-Treas.
    This letter appears to have received the approval of the Insurance Commissioner of the State of Indiana, which approval he expressed in letter dated December 23, 1920. On the 30th day of December, 1920, Ele Stansbury, as Attorney General of the State of Indiana, filed his suit in the Superior Court of Marion County, Indiana, against the Mutual Company, the Stock Company, and the stockholders and officers of the Stock Company. After setting forth the incorporation of the tivo companies and that the defendant Charles H. Brackett was the president of the Mutual Company, that defendant Cyrus W. Ray was secretary-treasurer, that defendant Blanche Belser was the bookkeeper, William H. Latta was the general counsel and Flora Wredge was a stenographer in said company, and that the other defendants were wives or members of the immediate families of or close relatives of said officers, alleged that the proposed plan by which the Stock Company should acquire the assets of the Mutual Company was the result of conspiracy whereby the Stock Company would acquire and the defendants become the equitable owners of all the business, property and assets of the old company without paying any consideration therefor to the policyholders and members of the old company. The plaintiff prayed for an injunction restraining the defendants from carrying out their plan and also for a receiver for the Mutual Company. Thereafter the court issued the injunction applied for, but refused until further hearing to appoint a receiver. On the first day of January, 1920, the following order was entered in said action:
    Oome now tbe parties by counsel in the above entitled cause and submits to the Court a compromise agreement of said cause, made subject to the approval of the Court. And the Court now finds that said agreement should be approved, and pursuant to said agreement and said finding, it is now considered, adjudged and decreed by the Court that the injunction be made permanent as against further proceedings at the special meeting of the policyholders of the defendant mutual I-Ioosier Casualty Company called for nine o’clock A. M. January 1st, 1921; without further notice to said policy-holders, and that said meeting shall either be adjourned sine die, or at the option of defendants, adjourned to a date, not earlier than the 18th day of January, 1921. .
    . That if said meeting shall he adjourned, to such later date for the consideration of either the proposed re-insurance contract referred to in.the notice,of said special meeting of policy-holders theretofore given, and in plaintiff’s complaint or to consider <tny other re-insurance contract, or if another meeting shall be called by defendants or any of them for ¿ny such purpose, then or in either event ten days written notice shall be mailed to said stockholders notifying said stockholders of the date of said adjourned meeting or further meeting, and said notice shall contain a statement in such manner as the same may be fully understood and comprehended by a person of ordinary intelligence, in substance of at least the following facts:
    1. The name of the re-insuring Company.

    2. Whether a stock Company or a Mutual Company.
    3. Whether a newly organized Company or an old and established company, and if an*old and established company, the amount of insurance in'forcé;' if a new company,-a statement showing who subscribed for all the capital stock of such new company.
    4. The consideration to he paid for such re-insurance.

    5. That the policy-holders of the defendant mutual Hoosier Casualty Company are the equitable owners, of all the property, - assets and busihess of • said company, subject to the corporate right of said compahy ■ to' rise the same for its corporate purposes and to discharge its corporate obligations; the legal title being vested in said company, and that if a stock company shall reinsure the business of said defendant mutual company, in consideration of the transfer to it of the business, property and assets- of said mutual Compaivy, then' all the interests of said policy-holders in said property) ■ assets and business will be tranferred to said stock company and its stock-holders, and not to its policyholders except that same will remain a security for the insurance covered by the policy of said policy holders. ’
    6. That there is no statute authorizing the re-incorporation of the defendant mutual Hoosier Casualty Company,- and that the defendant The Hoosier Casu,-alty Company is not a re-organization of that company, and that if any of the policy-holders of said defendant Mutual Company, desire to purchase any of the stock of said new company and will forward their certified check-therefor to the president of the defendant mutual company, stock to an amount equal to an equity in the mutual company standing to the credit of -his policy, after all debts of that company are ascertained, may be purchased and will be issued to said policyholders at par.
    7. Said notice shall not contain a statement in substance or otherwise, that any State department -or officer is chargeable by law with the duty of the ssie-guarding of the interests of said policy-holders With reference -tó said matter of said reinsurance. If in fact the proposed re-insurance contract has been either submitted to or approved by the Commissioner of Insurance of the State of Indiana, said notice may so state.
    8. That if said re-insurance contract shall be approved at said meeting 'by at least two-thirds of the policy holders present in person "or represented by proxy, the business, property and- assets of the defendant, Mutual Company' will be transferred to the new or re-insuring company. If not so approved,' then the property, business and assets of said defendant mutual eompahy will'remain in it and the business-of said company will be carried on upon the assessment plan as heretofore. ’ ’

      9. The draft of such notice before being mailed out shall be submitted to the Court for its approval.
    10. And it is further adjudged that defendants pay the costs of this action. And leave is given to withdraw from the files the papers filed in this cause. [Italics supplied.]
    Thereafter, on January 6th, the following letter was sent to each policyholder of the Mutual Company:
    Hoosier Casualty Company.
    Health and Accident Insurance.
    Indianapolis.
    January 6, 1921.
    Dear Sib:
    About November 30, 1920, you received notice of a special meeting of the policyholders to consider and pass upon a proposed contract by which the business of this company was to be transferred to a new stock company to be named The Hoosier Casualty Company, which meeting was to be held January 1, 1921.
    A question has arisen as to the sufficiency of the notice given for that meeting and therefore, by agreement with the Attorney General, the meeting has been postponed to January 18, 3921.
    You are further notified that since the last notice was given you, a new company has been incorporated under the laws of Indiana, named The Hoosier Casualty Company. This is a stock company with a capital of One Hundred Thousand Dollars. There being no law by which a mutual company could be changed into a stock company, a new company was incorporated. All the stock of this new company has been subscribed by the officers and employees of the present mutual company and members of their families. Its officers are the same as the officers of the mutual company.
    The funds of the present mutual company are the beneficial property of its members, subject to being used as necessary to protect all policies and pay all claims and debts of the company. By a proposed contract to be submitted to this adjourned meeting on January 18, 1921, this new company would assume all policy obligations and claims for benefits, and all the debts of the present mutual company, and would have transferred to it all the property and funds of the mutual company as a consideration for being bound to- pay these obligations, claims and debts. The legal effect of this is that the new stock company becomes the owner of the assets and must pay the policies, claims and debts.
    This proposed contract was submitted to the Commissioner of Insurance of Indiana and has been approved by him by the following language:
    “ I have gone over this contract carefully and am pleased to give you herewith my approval of the same.”
    You are therefore hereby further notified that the adjourned meeting of the members of the mutual Hoosier Casualty Company will re-convene at the office of the company, 1510 Fletcher Savings & Trust Company Building, Indianapolis, Indiana, on January 18, 1921, at nine o’clock A. M. to consider and pass upon the proposed contract.
    If this proposed contract is approved by a two-thirds vote of all members then present, it will become effective and the new stock company will take over and own all tlie assets and will assume all policies and pay all claims whicli may now exist or arise later.
    If any policy holder desires to do so and will make application to Charles H. Brackett, President, at any time before this meeting, enclosing his certified check for his subscription, he may purchase stock in the new company at par to an amount equal to an equity in the mutual company standing to the credit of his policy after all debts of that company are ascertained and paid.
    Yours truly,
    (Signed) C. H. Brackett,

      President.

    (Signed) C. W. Bat,

      Sec’y-Treas.

    The stock of the Stock Company was subscribed for as follows:
    Shares.
    C. W. Bay_ 649
    Mrs. C. W. Bay_ 1
    C. H. Brackett_ 649
    Mrs. C. H. Brackett- 1
    W. H. Latta_ 649
    Mrs. W. H. Latta_ 1
    Girl in office (no name given)- 10
    Blanche Belser_ 10
    Boy Callahan_ 10
    Son of C. W. Bay_ 10
    Brother of C. W. Bay_ 10
    Total_2,000
    It appears that two policyholders in the Mutual Company each acquired a part of a share, the sum of both parts being less than one share, and that these fractional shares were taken from the shares issued to Mr. Latta. At the time of the organization of the company, stock to the amount of $50,000 was issued to the above persons and paid for in cash. While the company was in this condition and on January 18,1921, the following contract was entered into between the Mutual Company and the Stock Company:
    Contract of Reinsurance.
    This Agreement by and between The Hoosier Casualty Company hereinafter fully described and known as a stock company, party of the first part and Hoosier Casualty Company hereinafter fully described and known as a mutual company, party of the second part, Witnesseth :
    That Whereas, The Hoosier Casualty Company, party of the first part has been duly incorporated with an authorized capital stock of $100,000 under and pursuant to the laws of the State of Indiana, of which amount the sum of $50,000 has been paid in cash and of which payment in cash of $25,000 has been invested, as provided for in the insurance laws of the State of Indiana, and duly deposited with the Commissioner of Insurance of the State of Indiana and said Company has been duly and legally authorized by the State of Indiana to engage in the business of accident and Other insurance as provided for by the act of 1853 and is now engaged in the transaction of an insurance business under said act.
    And Whereas, Hoosier Casualty Company, party of the second part, is a Mutual Insurance Company organized under the act of 1897 and has been for a number of years conducting an insurance business under said act, and there are now outstanding numerous policies of said party of the second part and it has in its possession money, bonds, securities, and other property accumulated in said business and has various liabilities for claims arising out of its policies and otherwise.
    And Whereas, pursuant to written notice sent to each policyholder of the party of the second part more than thirty days prior to January 1st, 1921, said policyholders were each and everyone duly notified that a special meeting of said policyholders would be held at 1510 Fletcher Savings and Trust Building the City of Indianapolis, State of Indiana, at the Home Office of said Company on the first day of January, 1921, at 9 :00 A. M. to consider and act upon a contract whereby all policies of said party of the second part would be taken over and reinsured by the party of the first part and at such meeting so held at said timo and place, policyholders of said party of the second part by a majority of more than two thirds of the policyholders then present voted in favor of the execution of this contract, which contract was then and there read to and duly considered by them and whereas it was then ordered by said policyholders that the officers of said party of the second part be authorized and directed to execute and perform this contract, it is now, therefore and, hereby agreed.

    1. In consideration of the mutual agreements, and undertakings herein contained and the mutual advantages to be gained thereby The Hoosier Casualty Company, party of the first part, does hereby undertake and agree to fully assume and perform each and every policy of insurance heretofore issued by Hoosier Casualty Company party of the second part and now in force, in accordance with the terms of each and all of said policies, respectively and to pay to the holders thereof and each of them any and all sums which may fall due pursuant to the terms of said policies.
    2. The Hoosier Casualty Company, party of the first part, further agrees to assume any and all further debt of said party of the second part made on any account whatsoever, and to pay any and all sums which said party of the second part is now or might hereafter become liable for on account of said contracts, debts or obligations, and in like manner to pay and discharge all obligations of said party of the second part which may now exist or may hereafter come into existence whether by contract or otherwise to the end that said party of the second part shall be fully relieved of all such contracts, obligations and liabilities and the same shall be fully assumed and discharged by said party of the first part.
    3. And now on its part and in consideration thereof, said Hoosier Casualty Company, party of the second part does hereby make over, assign and transfer and fully vest in said The Hoosier Casualty Company, party of the first part all property, real and personal, description wherever situated, of which it may be possessed or which it may in the future be entitled to receive, to be the absolute property of the party of the first part.
    4. This contract with all obligations, rights, titles, and interests hereby transferred and created, shall be in effect as, of, and including January 1st, 1921.

      In Witness Whereof, we have executed this agreement in'duplicate, in the city of Indianapolis, on the first day of January, 1921.
    The Hoosieb Casualty Company,.

      Party of the First Part,

    Attest: By C. H. Bbackett, President.

    C. W. Bay, Secy. Treas.

    Hoosieb Casualty Company,

      Party of the Second Part.

    Attest: By C. H. Bbackett, President.

    C. W. Bay, Asst. Secy.

    Approved, January 1, 1921. , ■

      Insurance Commissioner, State of Indiana.

    On the same day the assets of the Mutual Company were transferred to the books of the Stock Company.
    At a directors’ meeting held on January 19, 1921, by-laws were adopted and the following appears on its minutes:
    Whereas, Charles H. Brackett, C. W. Bay and W. H. Latta do now offer for the sum of Fifty Thousand Dollars cash, to cause to be assigned and transferred to this company all the outstanding automobile insurance business of the United Automobile Insurance Association, excepting only its liability risks, and with the same to cause to be paid to The Hoosier Casualty Company Sixteen Thousand and Fifty Dollars from the United Automobile Insurance Association and also to be transferred to The Hoosier Casualty Company $3,950.00 par value in bonds of United States Government and also to be paid and transferred to the Hoosier Casualty Company $5,600.00 in cash, notes, and accounts from the United Auto Agency Company and also to cause to be transferred, to The Hoosier Casualty Company all the good will, agency force and pendihg business of the United Automobile Insurance Association. •
    Now Therefore the Board of Directors of the Hoosier Casualty Company ' hereby , order and direct that said offer be accepted ¡and that this Company do assume and take over all such business as-a going business in its present condition, except only the liability risks of said Association, and receive said money and assets and pay to Charles H. Brackett, C. W. Bay, and Wi H. Latta the sum of Fifty Thousand Dollars in cash therefor, all as of this date.
    There, being.no further business the meeting adjourned. ..■••
    January 19, 1921.
    Contract.
    This agreement by and between the United Auto Insurance Association by the United Auto Agency Company, its attorney in fact, party of the first part and The Hoosier Casualty Company, party of the second part witnesseth:
    First. The Hoosier Casualty Company had and does hereby, in consideration,of the-payments and agreements therein contained, assume and agree-to carry out end perform all the outstanding policies of the United Auto Insurance Association excepting only those provisions relating to the Liability of said association to third persons on account of injuries sustained for which the insured would be liable in law, and to pay any and all sums which may be now and in the future come due on account of such insurance contract^’. . ' •

      Second. The United Auto Insurance Association expressly reserves and retains its own liability on account of the liability clause in the policy and agrees to pay and discharge all claims that may arise thereunder.
    Third. The United Auto Insurance Association further expressly assigns, transfers and conveys to The Hoosier Casualty Company the good will of its Business, its agency force and agency contracts and all pending business which it may have, to be taken over by the same, The Hoosier Casualty Company as a going business.
    Fourth. The United Auto Insurance Association further contemporaneously herewith agree to and does pay to The Hoosier Casualty Company the sum of $16,050.00 in cash and does hereby assign and deliver to The Hoosier Casualty Company $3,950.00 par value in bonds of the United States Government, all from and after this date to be the property of The Hoosier Casualty Company.
    Executed in duplicate this 19th day of January, 1921.
    The United Aijto Insurance Association,
    By The Touted Auto Agency Company,

      Its Attorney in Fact.

    By (Signed) C. H. Brackett, President.

    The Hoosier Casualty Company,
    By (Signed) W. H. Latta, Vice President.

    Attest:
    (Signed) C. A. Ray, Secy.-Treas.

    On the same day (January 19, 1921) an entry appears on the journal of the Stock Company, showing bonds $3,950, cash received from United Auto Association, $16,050, and cash received from the agency company, $2,272.78.
    On February 19, 1921, a dividend was declared by the Stock Company of $50,000.
    When the remaining $50,000 of stock was issued does not appear, but it is shown to have been issued and it is also shown that a dividend was declared which is precisely the amount due on the remaining subscribed stock.
    In its verified report to the Commissioner of Insurance of the State of Indiana, the Stock Company states that it commenced business January 22, 1921. The Stock Company issued policies similar to those issued by the Mutual Company and also issued policies of automobile insurance similar to those issued by the company whose risks it took over.
   OPINION.

Milliken:

The petitioner contends (1) that since the policyholders of the Mutual Company had the right to subscribe for stock in the Stock Company the latter was essentially the same as the former; (2) that from January 18,1921, to January 22,1921, the Stock Company was a life insurance company as that term is defined in section 242 of the Revenue Act of 1921; (3) that if the Stock Company was, when it took over the risks of the Mutual Company, an insurance company other than a life or mutual insurance company and therefore falls under section 246 of the Revenue Act of 1921, then neither it nor any like company is taxable for the year 1921; and (4) that the transaction between it and the Mutual Company on January 18, 1921, was in the nature of a sale and that the net amount of assets which it received from the Mutual Company was in no sense a premium for reinsurance. These contentions will be discussed iii the order set forth.

(1) In the final order entered in the action brought by the Attorney General' of Indiana, it is stated:

6. That there is no statute authorizing the re-vneorporation of the defendant mutual Hoosier Casualty Company, and that the defendant The Hoosier Casualty Company is not a re-organization of that company, and that ii any of the policy-holders of said defendant Mutual Company desire to purchase any of the stock of said new company and will forward their certified check therefor to the president of the defendant mutual company, stock to an amount equal to an equity in the mutual company standing to the credit of his policy, after all debts of that company are ascertained, may be purchased and will be issued to said policyholder at par. [Italics supplied.]

If there is any merit whatever in petitioner’s first contention, the above excerpt from the final order in the proceedings in the Superior Court in Marion County, Indiana, together with the fact that only a fraction of one share of a total of 2,000 shares was subscribed by policyholders in the old company other than the office force and their relatives and friends, disposes of the question adversely to petitioner.

(2) The petitioner contends that from January 18, 1921, to January 22, 1921, it was a life insurance company as that term is defined in section 242 of the Revenue Act of 1921. That section reads:

That when used in this title the term “ life insurance company ” means an insurance company engaged in the business of issuing life insurance and annuity contracts (including contracts of combined life, health, and accident insurance), the reserve funds of which held for the fulfillment of such contracts comprise more than 50 per centum of its total reserve funds.

The respondent contends that under the above statute the business of the petitioner, irrespective of whether it entered into the automobile insurance business or not, was not life insurance between the dates of January 18, and January 22, 1921. He points out that by far the greater portion of the risks assumed by the petitioner was for liabilities arising from accidents and health, and that but a small proportion of the liability was for natural death. In view of the conclusions we have reached on this point, it is not necessary for us to decide this question.

The contention of the petitioner is based on the assumption that on January 18, 1921, the petitioner was doing a life insurance business, and that it did not take over the automobile insurance business until January 22, 1921. While petitioner’s secretary-treasurer testified to this effect, his testimony on this point is quite uncertain. He was-asked:

Q. Now, Mr. Ray, you may state upon what elate in January of 1921 the transfer provided for by this contract dated January 19th actually took place, the transfer to the Hoosier Casualty Company of the property and so forth of the automobile insurance company.
A. I am not so sure of the date, whether it was the 18th or 19th or 22nd. The Court proceeding upset us on those different dates.
Q. Well, to refresh your recollection, was not the mutual Hoosier Casualty Company taken over on the 18th and insurance, or automobile insurance, taken over on the 22nd?
A. X'es, I believe that is right.

Opposed to this- are the facts that the contract between the petitioner and the automobile insurance concern was made on January 19, 1921, and that the assets of that concern were set up on petitioner’s books on the same day. The question of the day on which the petitioner began business is still further confused by its verified report to the Commissioner of Insurance of Indiana, wherein it is stated that it began business on January 22, 1921. The outstanding fact is that it was the primary purpose of the office force of the.Mutual Company in organizing the new company to consolidate the automobile insurance concerns, all of which they controlled, with the insurance business of the Mutual Company. It was also their purpose to use the surplus funds of the Mutual Company in purchasing these other concerns and this purpose they could not accomplish until they had brought these funds under their control. As soon, as they were in control they voted to pay $50,000 of said surplus funds to C. H. Brackett, C. W. Bay, and W. H. Latta for, with certain exceptions, all the outstanding automobile insurance, certain specified assets, and the good will of the United Automobile Association.-

It thus appears that these transactions which took place in the space of two days were parts of a general scheme. They can not be separated. We must look to the substance and that substance is that the new corporation was organized for the purpose of acquiring the business of two existing, going concerns and this was accomplished as- soon as the funds of one concern could be used to purchase the business of the other. - -

In order to be classified as a life insurance company, section 242 requires that an insurance company be “ engaged in the business ” of issuing the character of policies therein specified. It is not necessary in this Case to decide what length of time must elapse or what acts must be done before a company can be said to be engaged in a business. It is sufficient to point out that the- petitioner was on Januáry 18, 1921, in the throes of birth, that on that date it had not adopted its by-laws, that but one night intervened between the acquisition of the risks and assets of one company and those of the other, and that the acquisition of both was necessary to the fulfillment of the Scheme. It can not be held that the petitioner was engaged in one class of business for a fraction of a day and over night changed its classification. It is clear that the petitioner, when it took over- the risks and assets of the Mutual Company, was not a life insurance company as that term is defined in section 242 of the Revenue Act of 1921.

(3) The portions of the Revenue Act of 1921 which are applicable to the petitioner’s third contention are the following:

■ Sec. ‘246. (a) That, in lieu-oí the taxes imposed by sections 230 and 1000, there shall be levied, collected and paid for the calendar year 1922, and for each taxable year thereafter, upon the net income of every insurance company (other than a life or mutual insurance company) a tax as follows:
’(1) In the cáse of such a**domestic insurance company the same percentage of its'net income- as is imposed upon other corporations by section 230.
Sec. 230. That, in lieu of the tax imposed by section 230 of the Revenue Act of 1918, there shall be levied, collected, and paid for each taxable year upon the net income of every corporation a tax at the following rates:
(a) JTor the calendar year 1021, 10 per centum of the amount of the net income in 'excess of the credits provided in section 236; and
(¡b) For each calendar year thereafter, 12% per centum of such excess amount.
Sec. 234. (a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
* * * * #
(10) In- the case-of insurance companies (other than life insurance companies), in addition to the above (unless otherwise allowed) : (A) The net adr dition required by law to be made within the taxable year to reserve funds (including in the case of assessment insurance companies the actual deposit of‘sums with State or Territorial officers pursuant to law as additions to guarantee or reserve funds) ; and (B) the sums other than dividends paid-within the taxable year on policy and annuity contracts. After December 31, 1921, this subdivision shall apply only to mutual insurance companies other than life insurance companies.

No good reason can be advanced why Congress should intend that insurance companies other than life or mutual companies should escape taxation for the year 1921, and petitioner advances none. It stands on. the cold letter of section 246. The fallacy of this contention is that it overlooks section 230, which is expressly referred to in section 246. Section 230 provides one rate of taxation for the year 1921, and' another rate for all subsequent years. It is therefore reasonable to conclude that what is meant by section 246 is that the taxes imposed therein are in lieu of the taxes imposed by section 230 for years subsequent to 1921. Petitioner also overlooks the provisions of section 234(a) (10), which give to it and similar companies a deduction peculiar to the year 1921 alone. Here we have the contention of the petitioner that no tax is imposed for the year 1921, although Congress has granted to it and similar companies a deduction which pertains solely to that year. This results in an absurdity,, and a statute should, if possible, be construed so as not to reach such a result. Thus, it is stated in section 489 of Lewis’ Sutherland Statutory Construction (2d ed.) :

A construction which must necessarily occasion great public and private mischief must never be preferred to a construction that would occasion neither » * * unless the terms of the instrument absolutely require such preference. * * * A statute may be construed contrary to its literal meaning when a literal construction would result in an absurdity or inconsistency, and the words are susceptible of another construction which will carry out the manifest intention.

Construing sections 246, 230, and 234 together, the conclusion can not be escaped that it was the intention of -Congress to tax the petitioner, together with similar companies, on its net income for the year 1921 under and at the rate provided by section 230(a).

(4) The transaction of January 18, 1921, between the petitioner and the Mutual Company was made pursuant to section 4763 of Burns’ Annotated Indiana Statutes, which in part provides:

No such corporation, association or society, organized under the laws of this state, shall transfer its risks to, or reinsure them in any other corporation, association or society, unless the contract of transfer or reinsurance is first submitted to and approved by a two-thirds vote of a meeting of the insured, called to consider the same, of which meeting a written or printed notice shall be mailed to each member, certificate or policy holder, at least thirty days before the day fixed for such meeting.

It is well to remember at this point that the funds transferred were the equitable property of the policyholders in the Mutual Company. Federal Life Ins. Co. v. Kerr, 173 Ind. 613; 89 N. E. 398, involved a contract between the Model Life Insurance Co., an Indiana mutual insurance company, and the Federal Life Insurance Co., under which the Federal Life Insurance Co. assumed the risks of the Model Life Insurance Co. only to a limited extent. The court, in speaking of the funds transferred, said:

Appellee’s insured had contributed to create the fund, and appellant had contributed nothing. In good conscience and by express statute (section 7) it was a trust fund for the policy holders of the Model, a mutual company, and is attempted to be transferred to another company without liability of the latter to account for it for the benefit of those háving an interest in it. Certainly any surplus or reserve belonged to the members. United States, etc., Co. v. Spinks (Ky.) 96 S. W. 889, 13 L. R. A. (N. S.) 1053; Parish v. N. 7., etc., Co., 60 App. Div. 11, 69 N. Y. Supp. 764.

So it appears that the policyholders of the Mutual Company agreed to the transfer of the net fund, which in equity belonged to them, to the petitioner in consideration of the fact that they were insured by the petitioner. To say that the assumption of the general indebtedness of the Mutual Company by the petitioner played any important part in the transaction would be to overlook the facts of the case and especially the letters which the office force wrote to the various policyholders. The character of a transaction like the one under consideration is thus stated by Cooley in his Briefs on the Law of Insurance, vol. I, p. 517:

Thus, where one company assumes all the risks of another company retiring from business, entering into a contract to protect the retiring company from liability on the policies assumed, this is properly a reinsurance contract or policy.

While the term “ reinsurance ” includes a contract whereby one insurance company agrees to indemnify another insurance company on account of risks which the latter is carrying and continues to carry, it also includes a contract such as we have before us. This is in accord with the decision in People v. American Central Ins. Co., 179 Mich. 371; 146 N. W. 235, where it is said:

The term “ reinsurance ” has two meanings. When a fire insurance company, with the consent of the insured, is substituted for another fire insurance company, so that the insured releases the original insurer and looks to the substituted company alone, reinsurance has been effected. A company desiring to cease doing business entirely, or in a particular state, may thus reinsure its risks.

Compare Federal Life Ins. Co. v. Kerr, supra; Federal Life Ins. Co. v. Barnett, 71 Ind. App. 613; 125 N. E. 522; Johannes v. Phoenix Ins. Co., 66 Wis. 50; 27 N. W. 414; Meyer v. National Surety Co., 90 N. J. L. 126; 100 Atl. 164; Weil v. Federal Life Ins. Co., 264 Ill. 425; 106 N. E. 246.

The net surplus was paid to the petitioner in consideration of its contract to reinsure the members of the Mutual Company. This payment falls within the following definition of the term “ premium ” found in 32 C. J., p. 1192:

The word “ premium ”, in the law of insurance, has a well settled and specific meaning which is well understood. In its proper and accepted sense it means the amount paid to the company as consideration for insurance; the consideration for a contract of insurance; the consideration paid for a policy of insurance; the amount paid or agreed to be paid in one sum or periodically to insurer as the consideration for a contract of insurance; the sum which insured is required to pay.

In McPherson Hail Ins. Co. v. Shaw, 113 Kan. 772; 212 Pac. 873, it is said:

The word “premium” appears to be the proper term to use, in designating the sum which one insurance company pays to another on its reinsurance contract. People ex rel. Continental Ins. Co. v. Miller, 177 N. Y. 515, 70 N. E. 10; St. Nicholas Ins. Co. v. Mercantile Mutual Ins. Co., 5 Bosw. (N. Y.) 238; Insurance Co. v. Insurance Co., 38 Ohio St. 11, 43 Am. Rep. 413; National Ins. Co. v. Metropolitan Ins. Co., 226 Ill. 102, 113, 80 N. E. 747.

It is clear that the supreme and controlling consideration for the transfer of the net assets of the Mutual Company was the fact that the old policyholders secured from the petitioner the same character, of insurance which had been furnished them by the Mutual Company. To put it another way, the policyholders agreed to the payment to the petitioner of the net surplus in consideration of its substituting itself for the Mutual Company. In short, the consideration for the transfer was insurance and therefore, the net surplus paid over to the petitioner was a premium paid in one sum for insurance. These views correspond with the construction placed on this transaction by the Superior Court of Marion County, Ind., in its order, set forth in the findings of fact, and in compliance with which the petitioner obtained possession of the assets of the Mutual Company.

It is contended by the petitioner that the net surplus can not be treated as a premium for reinsurance for the reason that it greatly exceeds, as petitioner asserts, the amount necessary to procure such reinsurance. This only means that the petitioner made an extremely good bargain. If so, it is a matter with which we have no concern.

Judgment will be entered for the respondent.


text:
    Connecticut Electric Manufacturing Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7549.
    Promulgated May 13, 1927.
    1. Assets determined, on the evidence, to have been set up on the books in 1914 at cost and should be included in invested capital.
    2. Claim for depreciation of current inventories denied where there is no evidence of cost.

      Edward K. Nicholson, Esq., for the petitioner.

      Thos. P. Dudley, Jr., Esq., for the respondent.
    This is a proceeding arising out of a determination of deficiencies in tax of $26,279 for the calendar 'year 1917, and $8,395.70 for the fiscal year ended June 30, 1919. Petitioner avers errors were committed with reference to the following issues: (1) The reduction of invested capital by the amount of $87,425 as of January 1, 1914, and (2) the refusal to allow depreciation in inventory in the amount of $11,806.58. , ‘ .
    FINDINGS OF FACT.
    The petitioner is a Connecticut corporation, organized in 1906 and engaged in the manufacture of about 2,500 finished articles known as electric wiring materials for bouses. Petitioner’s first factory was located at Bantam, Conn. In 1912, the petitioner moved to’Bridgeport, Conn., and erected and equipped there a factory building of the kind known as mill construction of brick and wood. The petitioner filed income-tax returns, Form 637, for the years. 1909 to 1912, inclusive, showing, for each of the years, net income less than $5,000, and Form 1033 for the year 1913 showing net income $11,200. Prior to January 1, 1914, the books of account of the petitioner consisted of two ponderous accounts receivable ledgers. In January, 1914, the bookkeeper, who had been with the petitioner since January 1, 1913, and prior thereto with the firm of engineers and architects in charge of the construction of the petitioner’s new building, opened a new set of books on the double entry system. The assets “ Building and Beal Estate ” and “ Machinery, Tools and Equipment,” were valued at cost based on the bank checks in payment for them, and compared with invoices wherever available, with the single exception that the estimated amount of $10,000 was included for the Bantam property. Cash was entered at the actual balance on hand at the bank, and accounts receivable and notes receivable were taken from the previous accounts receivable ledger. ■ The item; of raw material and finished stock on hand was entered according to information furnished by Mr. Isaac Trumbull (deceased), then Treasurer of petitioner and in charge of financial matters, the office and sales. The liabilities were ascertained from the bank, as to the mortgage, and from the bills as to the other liabilities, with the exception of the officers’ accounts, which were taken from the accounts receivable ledger. No additional liabilities as of January 1, 1914, were ever discovered. The opening entries as of January 1, 1914, were as follows:
    January 1, 1914 Journal pg. 1.
    ÍThe 'Connecticut Electric Manufacturing Co. of Bridgeport,, Conn., Ras 'this dájt changed itd books from single to double entry and the following is a record of the assets and liabilities as taken from the company’s papers and inventory furnished by I. B. Trumbull. ....
    Assets.
    buildings and Real Estate (Inc. Bantam) 28_ $107,300. 00
    Machinery and Tools and Equip. (Inc. Office Eurn.) 30_ 26,879.92
    Cash, on hand C. 5_____: 12,246.82
    Accpunts. Receivable (See Trial Balance) 56_ 98,709. .91-
    Notes Receivable (See Act. in A Ledger) 53_ 10,722.36
    Raw material on hand and Finished stock on hand 7_ 69,980. 00
    Capital stock (not issued)_$17,000 51 -
    “ “ (not subscribed)_ 125 51 17,125.00
    $342, 964.01

      Liabilities.
    Capital Stock 51_ $25.000.00
    Mortgage (City Savings Bank) 59. 35,000.00
    Notes Payable
    City National Bank $20,000. 38
    15, 000.
    7,541. Gen. Porcelain Co.
    2,275. 55 “ Eastern Meh. Screw Corp..
    2,181.68 “ Amer. Brass Co. (Ansonia) —
    10,783. 51 “ 57,781. 74 Amer. Brass Co. (Torrington)
    3,718. 33 a
    3, 604. 83 b
    4,656. 93 c 11,980.09 Surplus and Undivided Profits 62 213,202.18
    $342, 964.01
    On January 5, 1914, the petitioner’s authorized capital stock was increased to $200,000 and a dividend payable in $192,125 par' value of petitioner’s capital stock was declared. This amount of par value was credited to capital stock and charged to surplus on the petitioner’s books.
    An inventory was taken June 30,1916, and priced at selling prices. Inventories were thereafter taken on June 30 of every year, and were all priced at selling prices. A reserve was set up in 1917 of $25,000 to exclude unrealized profit in the inventory of June 30,1917. Cost records were not kept from 1916 to 1919, inclusive, and the cost of the finished goods in the inventories is not known. The petitioner filed returns for the calendar year 1917 and a fiscal year ended June 30,1919.
   OPINION.

Milliken:

The first issue for consideration is whether the respondent was justified in reducing petitioner’s earned surplus for invested capital purposes, by $87,425, because of an alleged overvaluation of its assets in 1914 when a new system of accounts was installed and new books of account opened. The petitioner commenced business in or about the year 1906, in a small plant at Bantam, Conn., with a total paid-in capital of $7,250. By 1912, the business had so increased as to necessitate the construction of a larger plant in and the removal of operations to Bridgeport, Conn. During this period and until January, 1914, the books of account were maintained upon the single entry basis, and were crude in their make-up and poorly kept. In January, 1914, a double entry system of bookkeeping was installed and new books of account opened under the new system of accounts. The first entries in the new books recorded the assets at an aggregate value of $342,964.01, the liabilities in the total sum of $104,761.83, and the net worth (capital and surplus) in the amount of $288,202.18. Thus, if the opening entries in the new books correctly reflected the facts, the business had grown, in approximately seven years, from one with a net worth in 1906 of $7,250 to one having a net worth at the beginning of 1914 of $238,-202.18, an increase of approximately $231,000. It is this very substantial increase in the net worth of the business which respondent questions, in view of the showing made by the petitioner in its excise and income-tax returns for the years 1909 to 1913, inclusive.

Each of the excise-tax returns which this petitioner filed for the years 1909 to 1912, inclusive, show a net income of less than $5,000, while the income-tax return which it filed for the year 1913 shows a net income of $11,200. Eespondent, taking into consideration the fact that the business was begun in 1906 with a paid-in capital of but $7,250, coupled with the low earnings shown in the returns for five of the seven years intervening between 1906 and J anuary, 1914, when the new books of account were opened, concluded that the increase of $231,000 in the net worth of the business, as shown by the opening entries in the new books, could not be accounted for by earnings, and that the asset values taken up on the new books of account must have included substantial appreciation or that the liabilities recorded thereon must have been substantially understated. Eespondent, therefore, arbitrarily fixed the earnings of the period from the date business was commenced to January, 1914, at $15,000 per annum, the total of which is $87,425 less than the increase in the net worth for the same period as shown by the opening entries in the new books of account, and, accordingly, reduced the earned surplus for invested capital purposes by the said sum of $87,425.

We do not know what occasioned the substantial growth in the net worth of the business between 1906 and January, 1914. It may have been brought about entirely through earnings, though seemingly quite improbable, or in part through substantial contributions of capital. There is no evidence which sheds any light on that feature of the case. However, we do not think that is an important feature, since the evidence conclusively proves that the cost of assets set up on the new books of account in J anuary, 1914, with the single exception of the estimated value of $10,000 assigned to the abandoned property at Bantam, Conn., may be properly recognized and accepted for invested capital purposes. Excepting the value assigned to the abandoned property, and probably the value of the merchandise inventory, the asset values entered in the new books of account were based upon actual costs; and the liabilities recorded therein represented all of the outstanding liabilities, no additional ones having been subsequently discovered. As to the value assigned to the merchandise inventory in 1914, relating to invested capital, we need have no concern, since whatever discrepancy it may have contained, either understatement or-overstatement, was offset by á-compensating overstatement or understatement in the earnings of the preceding year.

We are satisfied that the amount of surplus shown was substantially correct, excepting the amount of $10,000 allowed for the abandoned plant, and are of the opinion that there is no warrant for a reduction to an amount greater than $10,000 of invested capital for 1917 and 1919, attributable to overvaluation in 1914 of earned surplus and undivided profits. Accordingly, the respondent is sustained for $10,000 and reversed for $77,425.

As to the second issue, there is no evidence of the cost of the inventories taken June 30, 1916, and June 30, 1917, and the respondent is sustained.

Judgment will l>e entered on 15 days’ notice, under Rule 50.


text:
    Houston Belt & Terminal Railway Co., Petitioner, v. Commissioner of Internal Revenue, Respondent
    Docket No. 8494.
    Promulgated May 13, 1927.
    1. Tlie discount on bonds of the petitioner purchased below par and retired during the year is not taxable income.
    2. Sinking fund payments made to a trustee are to be considered . as earned, rather than paid-in, surplus.
    3. Advances by stockholders are not invested capital.
    4. Current earnings may not be allowed in invested capital.
    5. Income taxes paid by another in accordance with agreement, are income to the petitioner in the year when due and payable and, under the circumstances in this case, do not reduce invested capital.

      J. L. Lockett., Esq., for the petitioner.

      M. N. Fisher, Esq., for the respondent.
    This proceeding results from the determination of deficiencies in income and profits taxes for the years 1918 and 1919, totaling $18,-339.19. Petitioner avers errors were committed with reference to the following issues: (1) (a) The 2 per cent tax, for both years, assumable by the Director General of Railroads, was added to the income of the petitioner, and (b) the rates for the computation of the normal tax for 1918 should be 10 per cent instead of 12 per cent, and for 1919 should be 8 per cent instead of 10 per cent; (2) the discount on petitioner’s bonds, purchased below par and retired, In both years, was not taxable income; (3) The Commissioner has not allowed in invested capital for both years, the full amount of surplus properly allowable.
    ' ’ ‘ The respondent presents an added issue: (4) Whether additional taxable income was realized in 1918 and 1919 by reason of the liability of the four stockholders under the Contract of 1907 to' pay-petitioner’s income and excess-profits taxes.
    KINDINSS OF TACT.
    The petitioner is a Texas corporation, organized in 1907, with a paid-in capital stock of $25,000, owning certain terminal property, leasing other property, operating a union depot and terminal railway, and acting as a common carrier; in the City of Houston, Tex. The depot and terminal are conducted primarily.for the convenience and greater economy of four railway companies, each owning, one-fourth of the capital stock of the petitioner.
    The petitioner entered into an agreement in 1907- with the four railway companies which are its solé stockholders. The material portions of this agreement aré ás follows: ' ' '
    Whereas, the Terminal Company is the owner of certain railroad tracks and, real estate and is to acquire certain other real .estate located and situated in and near the city of Houstop, Texas, and is aboqt.to construct in said city one or more passenger stations and one or more freight stations, and to acquire by purchase or lease other railroad tracks aud terminal facilities, including the terminal facilities leased under a certain indenture of lease to be made by and between Gulf, Colorado and Santa Fe Railway Company and said Terminal Company, a copy of which is hereunto attached marked “ Exhibit A,” and made a part hereof; and , . .
    Whereas, the Terminal Company proposes tq execute, simultaneously with the execution of this agreement, to Central Trust Company , of New York, as Trustee, a mortgage or deed of trust to be known as its First Mortgage, ■covering all the property and rights of the Terminal Company now own.ed and hereafter to be acquired, including this present agreement and the rentals to be; paid hereunder and prior in right to this agreement, as hereinafter provided, to secure an issue of First Mortgage Thirty Year Five Per Cent Gold Bonds of the Terminal Company not to exceed in aggregate par value five millions of dollars; and for .the purpose of refunding or redeeming said bonds and for other purposes the Terminal Company may hereafter execute from time to time during the term of this agreement and in accordance with the provisions hereof other mortgages or deeds of trust to secure other bonds; and
    Whereas, each of the railway companies, parties of the second part hereto (hereinafter collectively referred to, as the. Railway Companies) desires,, for, purposes of greater economy and convenience, to avail itself of the use of said Passenger and Freight Stations, and all other terminal and railroad facilities now or hereafter during the term hereof owned, controlled or operated by .the Terminal Company; and the Terminal Company is willing to grant- to each of the. Railway Companies the right to use all said facilities upon the terms and conditions hereinafter set forth; .
    Now; Therefore, the parties hereto do mutually covenant and agree as. follows:
    Article I..
    The Terminal Company, in consideration of the sums to be paid by the Rail-' way Companies respectively as hereinafter provided, hereby covenants and agrees with the Railway Companies and with each of them as follows:
    Sao. 1. That it will proceed with all reasonable dispatch to acquire the necessary real estate and construct and reconstruct the necessary passenger and freight stations, railroad tracks, and all other railroad and terminal facilities, within a limit of cost and in accordance with plans and specifications as to character and location, all of which shall first have 'been accepted and approved in writing by each of the Railway Companies. The railroad and terminal facilities constructed, leased and otherwise acquired in accordance with the terms hereof, and all additions and betterments, extensions and improvements made thereto during the term and in accordance with the provisions hereof, are hereinafter called the “ Terminal Facilities.”
    Seo. 2. That it will give and grant, and it does hereby give and grant to each of the Railway Companies for and during the term beginning at the date whep the Terminal Facilities shall be ready for use, as in Section 12 of Article III hereof provided, and continuing thereafter for and during the full term of ninety-nine years from and after the date hereof, unless sooner terminated as hereinafter provided, the equal right and privilege to use the Terminal Facilities in common with the Terminal Company and with the other Railway Companies and with any other railroad companies to which similar rights hereafter may be granted by the Terminal Company in accordance with the terms, provisions, conditions and limitations in this agreement expressed.
    Sec. 3. That it will keep and maintain the Terminal Facilities at all times during said term, in good order, condition and repair and will protect the same by insurance against loss or damage by fire to a reasonable amount, the cost of such insurance being considered a part of the expense of maintaining and operating the Terminal Facilities as hereinafter provided. If any of the Railway Companies shall disagree with the Terminal Company as to the amount of insurance which should be carried on the Terminal Facilities or any part thereof, the disagreement shall be submitted to arbitration in the manner provided in Section H of Article III hereof.
    Sec. 4. That it will not do or omit to do any act, when such doing or omission will operate directly or indirectly to forfeit any of its rights, privileges and franchises under its charter or Articles of Incorporation before the expira- • tion of the same as now limited by law or which will, in any manner, impair the value of any of the privileges, rights or property, the right to use which is hereby granted to the Railway Companies; and that it will, at the expiration of the present term of its corporate existence, cause the same to be renewed and extended in manner and form as may then be provided by law, and will cause similar renewals and extensions to be made from time to time as the same shall be necessary to maintain in perpetuity the existence and power with which it is now vested.
    Sec. 6. That it will duly pay or cause to be paid the interest and principal of all mortgage bonds lawfully issued and outstanding under said first mortgage of the Terminal Company and under any other mortgage or mortgages of the Terminal Company executed in accordance herewith, and all sinking fund and other payments due and payable under said first mortgage and any such other mortgage or mortgages of the Terminal Company; all sums due and payable by the Terminal Company under said agreement, Exhibit A; all other rents due and payable by the Terminal Company; all taxes, rates, levies, benefits, assessments and other governmental charges of every kind that in any manner during said term may be lawfully imposed upon or accrue against the said Terminal Facilities or any part thereof, or which may become due and payable by the Terminal Company; and any and all other sums or debts which may at any time become due and payable by the Terminal Company.
    Sec. 6. That the Terminal Facilities will be maintained and operated as herein provided and that each of the Railway Companies so long as it pays its one-fourth part of interest, sinking fund payments, rent and taxes as hereinafter provided and its proportionate part of operating expenses as hereinafter provided, and complies with all its other obligations as herein provided shall during said term of ninety-nine years have peaceable and quiet possession an'd full enjoyment of the Terminal Facilities.
    Sec. 7. That it will repay to each of the Railway Oompanies all sums which shall have accrued and been paid by such Company under Sections 1 and 2 of Article II hereof prior to the date upon which the Railway Companies shall be notified in writing by the Terminal Company as hereinafter provided that the Terminal Facilities are ready for use.
    Article II.
    Sec. 1. Each of the Railway Companies hereby covenants and agrees to pay from time to time during said term of ninety-nine years, unless the obligations of such Railway Company under this agreement shall be sooner terminated by such Railway Company as hereinafter in Section 2 of Article IV provided, the following sums, viz:
    (a) To the Trustee under said First Mortgage dated July 1, 1907, executed by the Terminal Company, sums equal to one-fourth of the amounts which shall accrue for the respective installments of interest and sinking fund payments during each fiscal year of such period upon or in respect of all mortgage bonds lawfully issued and outstanding under said First Mortgage of the Terminal Company and issued in accordance with the terms of this agreement.
    (b) To the trustee of any other mortgage or deed of trust which may hereafter be executed by the Terminal Company in accordance with the terms hereof, sums equal to one-fourth of the amounts, which may accrue for the respective installments of interest and sinking fund payments, if any, during each fiscal year and such period upon or in respect of all mortgage bonds lawfully issued and outstanding in accordance with the terms of this agreement under any such other mortgage or mortgages; if any such mortgage shall not provide for the payment of such sums by the Railway Companies to the trustee in such mortgage, then such sums shall be payable to the Terminal Company.
    The sums to be paid by each Railway Company under this Section 1 of Article II shall be due and payable by each Railway Company within fifteen days after receipt by it of written notice from the Terminal Company stating the amount due from each Railway Company, which notice shall be given not more than twenty-five days prior to the respective dates when the respective installments of interest and sinking fund payments shall become due and payable by the Terminal Company.
    Sec. 2. Each of the Railway Companies hereby covenants and agrees with the Terminal Company to pay to the Terminal Company from time to time during said term of ninety-nine years, unless the obligations of such Railway Company under this agreement shall be sooner terminated by such Railway Company as hereinafter in Section 2 of Article IV provided, the following sums, viz:
    (a) Sums equal to one-fourth of all sums which shall be payable by the Terminal Company under said agreement (Exhibit A) and under all other agreements for the leasing or acquisition of additional facilities for the use of all the Railway Companies which shall be .entered into by the Terminal Company with the written consent and approval of each of the Railway Companies; such sums payable hereunder by any Railway Company to the Terminal Company, shall be payable within fifteen days after the rendition of bills therefor by the Terminal Company, and such bills shall .be rendered by the Terminal Company within thirty days prior to the respective dates when the respective sums payable by the Terminal Company shall become due.

      (b) Sums equal to one-fourth of all taxes, rates, levies, benefits, assessments and other governmental charges of every kind that in any manner during such period may be imposed upon or accrue against the said Terminal Facilities or any part thereof, or which may become due and payable by the Terminal Company ; such sums payable hereunder by the Railway Companies to the Terminal Company shall be payable within fifteen days after the rendition of bills therefor by the Terminal Company which bills shall be rendered within thirty days prior to the respective dates when the respective taxes or other governmental charges to which such bills relate shall be paid by the Terminal Company or shall become due and payable by the Terminal Company.
    * * * * # * *
    Sec. 6 (b) All sums which shall be received by the Terminal Company from any railroad company that hereafter may be admitted to the use of the Terminal Facilities, or any part thereof, as rent or compensation for the use thereof, or as payments in the nature of those defined in Sections 1 and 2 of this Article, and all sums that shall be received by the Terminal Company from any of the Railway Companies as rent or compensation for its or their exclusive use of any part of the Terminal Facilities, and all sums that shall be received by the Terminal Company as income or any stocks, bonds or other securities held ás a part of the sinking fund provided for in said first mortgage, dated July 1, 1907, or as a part of any sinking fund provided for in any other mortgage of the Terminal Company, shall be applied by the Terminal Company first to the reduction of the sums to be paid by the Railway Companies, respectively, under Section 2 of this Article II, and next for the purpose of reducing the sums tó be paid by the Railway Companies respectively under Section 1 of this Article II; except, however, the sums paid by other railroad companies in respect of operating expenses as defined in Section 3 of this Article II; it being the intention that' operating expenses shall, except under the conditions set forth in paragraph (a) of this section, be borne by all railroad companies using the Terminal Facilities, on the basis of use as provided in said Section 3 of this Article II.

      * * ■ * * * * *
    Article III.
    Sec. 4. Unless required bylaw to do so, the Terminal Company shall not, except with the consent in writing of each of the Railway Companies, grant to any other railroad company the right to use the Terminal Facilities, or perform any service for any other railroad company, on terms' more favorable than are hereby accorded to each of the Railway Companies.
    Article IV.
    Seo.' 2. If the Terminal Company shall fail or refuse to perform or comply with the covenant set forth in Section 1 of this Article IV, or shall fail or réfuse to perform or comply with any other of its covenants or undertakings under this agreement, and shall continue in such failure or refusal for a period of thirty days after written notice specifying such failure or refusal given to it by any of the Railway Companies, then any such Railway Company may, at its election, by notice in writing given to the Terminal Company, terminate its obligation to further use the Terminal Facilties under this agreement and all other of its obligations under this agreement. Any party to this agreement shall furthermore have the right to resort to any and all appropriate remedies at law or in equity for the enforcement of any provision of this dgreement or for redress for any breach thereof.

      Five million dollars par value first mortgage, 30-year bonds of the petitioner were issued during the years '1907 to 1911, inclusive, at a discount, the amount of which discount is not in evidence. The amount of these bonds remaining outstanding on January 1, 1918, was $4,617,000 par value; Under the mortgage the annual sinking fund payment was required to be one per cent of the total par valué of bonds previously issued, irrespective of whether or not the entire issue remained outstanding, so that for the years 1918 and 1919 annual sinking fund payments of $50,000 were due and payable; The sinking fund payments were made by the four “ tenant lines ” to the trustees and applied to the purchase, at a discount, of certain bonds which were thereupon permanently retired. ’. '
    Prior to December 31, 1917, the four stockholders paid to the petitioner an aggregate of $62,330.05, without any'understanding as to repayment, and repayment has never been demanded. The reason for the sum being paid was that the petitioner was unable to bill and collect, as promptly as originally planned, the charges for operating expenses and was embarrassed for lack of sufficient cash. Subsequent to the payments, totaling $62,330.05, a' further arrangement was effected whereby drafts for advances were'made on the stockholders, when necessary. ■
    During the calendar years 1918 and 1919 the petitioner was under Federal control. In each of the years, $50,000 accrued to petitioner as compensation due from the Director General in lieu of the payments due to trustee from the four stockholders under the contract' of 1907.
    The petitioner kept its books on the accrual basis. ■
   OPINION.

Milliken:

The respondent has admitted error, with respect to issues 1(a) and (b).

The 'question presented in the second issue was considered in the Appeal of Independent Brewing Co. of Pittsburgh, 4 B. T. A; 870, and on authority of that decision, the inclusion in the income of the petitioner of the discount on its bonds purchased at discount -.and retired, was in error. See also New Orleans, Texas & Mexico Ry. Co., 6 B. T. A., 436.

Petitioner avers that the respondent has failed to allow in invested capital for both years the full amount of paid-in surplus to which it is entitled. Admitting inability to reconcile with information available the amounts óf surplus included in invested capital by the respondent, the petitioner submits a statement of the .total invested capital claimed for each year. ■ • ■

As at the beginning of each year, the. aggregate of so much of the payments by.the four stockholders, heretofore made to the .trustee* as was applied to the principal of bonds purchased and retired, is claimed allowable in full in invested capital as paid-in surplus. The payments were regularly entered on the books. The petitioner now seeks to resolve the net credit balance of book surplus into a larger amount of paid-in surplus and a profit and loss debit balance in the nature of an operating deficit. The Circuit Court of Appeals for the Fifth Circuit, in the case of Houston Belt & Terminal Ry. Co. v. United States, 250 Fed. 1, had before it the construction of the instrument providing for the sinking fund payments, and in the light of the decision rendered it is clear that the payments made by the four stockholders of petitioner to the trustee constituted income to petitioner. Being properly classifiable as earned income reducible by operating charges and admittedly entered on the books of account in the years when earned, we are of the opinion that the respondent should be sustained.

Paid-in surplus is claimed in the amount of $62,330.05 for both years, on account of a credit balance of that amount which appears on the balance sheet as “Advances by Railroads.” It is in evidence that the occasion for these advances was a lack of sufficient cash capital due to unavoidable delays in collecting operating expenses billed to the debtors, and that later a plan of operation was devised whereby drafts were drawn and accepted for advance payments when required; while it is also in evidence that there was no understanding relative to repayment and no demand for it has been made, there is nothing in the record to indicate that the deposits may not be subject at any time to current settlement or that the advances are other than a convenient method of offsetting receivables delayed in settlement. We find no error in the exclusion of the amount from invested capital.

Petitioner claims for the years 1918 and 1919, additions to invested capital of the effective averages of sinking fund payments on or before June 1, 1918, of $50,000, and on or before June 1, 1919, $50,000. These additions are not allowable due to the express exclusion from invested capital of current earnings, contained in section 326(a)(3) of the Revenue Act of 1918. Having heretofore held that the sinking fund payments constituted income to petitioner, the payments made in the years 1918 and 1919 should be excluded from invested capital and we find no error in such decision of the respondent.

The Commissioner has decreased surplus for 1918 on account of additional taxes for 1915 and 1916 and for the effective average of the 1917 tax; for 1919 the deduction includes additional taxes for 1915, 1916, and 1917, and the effective average of the 1918 tax. In view of article II, section 2(b) of the agreement of 1907, it is evident that the four stockholders are immediately charged with an equal and offsetting liability to the petitioner with the result that petitioner can suffer no diminution of invested capital in this regard.

The respondent is reversed as to the deduction from surplus of the prior years’ additional taxes.

The amounts of Federal income and excess-profits taxes payable in 1918 and 1919 by the petitioner, for which the four stockholders were liable under the contract of 1907, are income for the years within which due and payable. Appeal of Norwich & Worcester R. R. Co., 2 B. T. A. 215, and Appeal of Providence & Worcester R. R. Co., 5 B. T. A. 1186.

Judgment will he entered on 15 days' notice, under Rule 50.