Ry. Express Agency, Inc.
Comm'r of Internal Revenue

This case is not covered by Casetext's citator
Tax Court of the United States.May 13, 1947
8 T.C. 991 (U.S.T.C. 1947)

Docket No. 7886.



Floyd F. Toomey, Esq., and John P. Lipscomb, Jr., Esq., for the petitioner. Harold D. Thomas, Esq., for the respondent.

The stock of the petitioner, organized to conduct an express business, is owned by about 70 railroads. It has individual contracts with about 400 railroads (including the 70) under which it accounts to them proportionately for the net revenues of the business. It issued its own bonds in the amount of $32,000,000 for purchase of property and operating capital. None of the railroads agreed to pay its expenses. The contracts refer to the payments made to the railroads as compensation. Additional property acquired with revenues is not shown to belong to the railroads. Held, the petitioner is not a mere creature of the railroads contracting with it, it had income, and the Commissioner did not err in adding to its income amounts of excessive depreciation deductions; held, further, that the value of petitioner's stock had adjusted declared value of zero for 1937; held, further, that the petitioner was prohibited by written contract executed prior to May 1, 1936, and expressly dealing with payment of dividends, from paying dividends, and is entitled, under section 26(c)(1) of the Revenue Act of 1936, to credit for the amount of its adjusted net income for 1937. Floyd F. Toomey, Esq., and John P. Lipscomb, Jr., Esq., for the petitioner. Harold D. Thomas, Esq., for the respondent.

This case involves deficiencies in income taxes for the calendar years 1937 and 1938 in the respective amounts of $121,369.66 and $45,943.17 and deficiencies and in excess profits taxes for the same years in the amounts of $46,079.28 and $32,973.56, respectively. The Commissioner determined the above deficiencies by adding to petitioner's reported income for 1937 and 1938, respectively, the sums of $383,994.07 and $274,779.70, as ‘depreciation decreased‘ and ‘excessive depreciation.‘ The petition asks for determination of no deficiency and of overpayment of income tax for 1937 and 1938 in the respective amounts of $93.54 and $13,966.14, and of overpayment of excess profits tax for 1937 and 1938 in the respective amounts of $391.25 and $10,449.89, alleging that the Commissioner erred in treating any portion of the receipts from the business carried on by the petitioner as income, and, alternatively, that there was error in not allowing deduction of excess profits tax, in not allowing credit under section 26(a) and 26(c) of the Revenue Act of 1936, and in not allowing deduction for losses on the sale of property and expenses in connection with retirements of property in 1938. The primary question presented is whether any portion of the receipts of the business conducted by petitioner constituted income of the petitioner subject to income and excess profits tax, which in larger part involves the question whether the respondent erred in addition to the petitioner's income the amounts of depreciation disallowed for the respective years. In his answer the respondent claims an increase of $1,500 in the deficiency in excess profits tax for 1937 on account of his allowance of an amount for adjusted declared value of petitioner's capital stock. Substantially all of the evidence is embodied in a stipulation of facts, which agreed facts are incorporated herein by reference as part of our findings of fact. Portions thereof which we consider necessary for an understanding of the issues are set forth in the findings made from other evidence.


The petitioner employs an accrual method of accounting prescribed by the Interstate Commerce Commission and known as the Uniform System of Accounts for Express Companies. The returns of petitioner for the taxable years were filed on the accrual basis with the collector for the third district of New York.

After the Federal Government took over the operation of railroads in the United States in December 1917, the Director General of Railroads notified the express companies then doing business that if they would organize one express company he would appoint it his agent to carry on the express transportation business on all the railroad lines under Federal control. Accordingly, the express companies organized a single corporation, the American Railway Express Co. (hereinafter referred to as American) to perform a nationwide express business.

As of June 26, 1918, the Director General entered into a contract with American to conduct, as the sole agent of the United States, the express transportation business on all railroads under Federal control and upon parts or all of such other systems of transportation as in the judgment of the Director General it might be necessary or desirable to include. American operated under the contract until March 1, 1920, when Federal control of the railroads was terminated.

On December 7, 1920, upon application of American, the Interstate Commerce Commission approved the consolidation of express companies. Consolidation of Express Companies, 59 I.C.C. 459. From September 1, 1920, until February 28, 1929, American operated as an independent express company for its own account. Its operations were conducted under uniform contracts, with practically all of the railroads in the United States. Express Contract, 1920, 59 I.C.C. 518. Throughout the period of operation under the contracts, the common interests of the railroads were represented by a committee of the Association of Railway Executives known as the Uniform Express Contract Committee, hereinafter referred to as the express committee. During such period the express committee began a study of the future of the express business of the railroad companies after the contractual relations with American should end on February 29, 1929.

On or about November 17, 1927, the express committee adopted a resolution, in substance, recommending the organization of a new express company under control of the railroad companies, or purchase of the stock of American; also, that the committee determine whether the railroad companies desired to organize the new company or acquire the American stock, and, if so, to negotiate with American. The resolution was approved by the Association of Railway Executives and on March 5, 1928, the express committee appointed a legal committee to prepare a plan which would provide for the purchase of the capital stock of American or for the formation of a new express company.

The plan prepared by the legal committee, hereinafter referred to as the express plan, was submitted to the express committee on June 21, 1928.

The report of the legal committee to the express committee contained the following statement:

The object sought to be attained by the plan is to make the future express agency a railroad-owned joint facility engaging in express transportation in its own name, but nevertheless acting in fact only as the agent of its railroad principals and accounting to them under the terms of the operating agreement (Exhibit D) for all of its revenues after payment of expenses. This relationship will make the railroads transporters of express as they are of freight with a consequent like status before commissions and courts.

To accomplish such object the plan provides for the organization by the agents representing the participating railroads of a new express company to be owned by such railroads and for the acquisition by it of the properties used in express operations of the American Railway Express Company.

The report also contained statements that all of the membership of the Association of Railway Executives should participate in the ownership of the express company but with the privilege available to all other railroad companies then parties to the uniform express contract to become parties to the new agreement; that the shares of the express company, proposed to be formed, were to be allotted to each railroad in the ratio that its receipts from express business bears the gross business of all the participating railroads, and that as capital stock would not constitute the basis for distributing earnings, it was proposed to limit the capital stock of the new company to 1,000 common shares, without par value.

The express plan proposed by the legal committee, provided, among other things, that:

(a) Participation in the plan be limited to the 86 member roads of the Association of Railway Executives as named, because of the impracticability of joining the very large number of other roads, which performed in the aggregate only about 2 per cent of the gross business transacted under the uniform contracts with American.

(b) Certain named individuals be appointed as agents of the railroads participating in the plan, hereinafter referred to as participating railroads, with power to carry the plan into effect, when a prescribed percentage of the railroads signed agreements, in the form attached with the agents.

(c) The participating railroads transfer to the agents all of their interest in substitute article XX of a certain contract, known as the Amended Uniform Contract for Express Operators over rail lines, between the railroads and American, containing the agreement of the latter, in the event it did not continue express operations over the railroads after February 28, 1929, to sell to each railroad, at cost, less depreciation, all property of American used in its express business located on the lines of such railroad.

(d) The agents should cause the organization of a new corporation (petitioner became such corporation) with power to acquire the property of American and to conduct, under contracts effective March 1, 1929, the business then being conducted by it.

(e) The capital stock of the new corporation should consist of 1,000 shares of no par value, and nontransferable except to petitioner or to a successor by consolidation, merger, or purchase, and be allotted to the 86 participating railroads upon the basis of express business done by them, in the past, at the price of $100 a share. (This plan of stock ownership was predicated upon conclusions of the legal committee that the property to be acquired by petitioner would be paid for by borrowed money; that the capital stock would not represent any substantial equity in the property, but merely the voting rights, and that the distribution of stock would not affect the distribution of earnings from the express business.)

(f) The bylaws of the new corporation, subject to change only by a vote of two-thirds of the outstanding stock, should provide that the board of directors consist of 15 members, of whom 6 were to be nominated by participating railroads in the eastern district, 5 by those of the western district, 3 by those of the southern district, and 1 elected at large.

(g) the agents should have broad powers to negotiate for the acquisition of property of American, or of property in lieu thereof, but were not to have power to deliver stock of the new corporation for property. On this point the proposed plan provided that:

It is deemed essential that the express operating agency shall realize no net income for distribution as dividends and this precludes the issue of its stock to any other holders than the Participating Railroads.

(h) The case required for the purchase of property for petitioner, in excess of the amount realized from subscriptions for petitioner's stock, should be raised through the sale of bonds, debentures, or notes of the new corporation to the participating railroads or to the public, and if the bonds were not sold to the public they were to be allotted to the participating railroads on the basis of stockholdings.

In addition, the report also stated that the object of the proposed operating agreements was to make the participating railroads common carriers of express, as principals, operating in the name of their common agent, the new express company; that this would accomplish the change in relationship of railroads to express business long advocated by members of the Interstate Commerce Commission; and that otherwise the operating agreement would follow generally the plan of the present uniform express contract.

The express plan became effective in October 1928, through the execution by the requisite number of participating railroads of agreement as of July 2, 1928, with the agents. The agreement contained the assent of the railroads to the express plan of June 21, 1928; appointed the individuals as their agents to carry out the plan; assigned to the agents the rights of the railroads under substituted article XX of the amended uniform contract, supra, with power of assignment of the rights to petitioner upon its organization and the agreement of each railroad to execute with petitioner a new form of operating agreement, in substantially the form attached to the express plan, for the conduct of the express business on its lines, effective March 1, 1929.

In November 1928 the agents and American reached an agreement for the purchase of properties of American. The agreement, reduced to writing as of January 23, 1929, provided for the purchase of all equipment, materials, supplies, and buildings and certain parcels of land of American, for $30,313,000, subject to certain future adjustments. The amount was arrived at on the basis of cost, less depreciation to March 1, 1929, for equipment and buildings, $8,270,000 for land, and book value on February 28, 1929, for materials and supplies. Subsequently the agents assigned their rights under the agreement to petitioner, and pursuant thereto the petitioner acquired, as of February 28, 1929, all of such properties of American.

The petitioner was organized on December 7, 1928, under the laws of Delaware, pursuant to the express plan, with authority, among other things, to engage as agent or otherwise in the express transportation business. The total authorized capital stock was 1,000 shares without par value. The certificate of incorporation provided against the transfer of stock of petitioner, other than to a successor corporation by consolidation, merger or purchase, without first offering the shares to petitioner for purchase at the issuing price and against the holding of stock, as far as might be legal, by other than railroad corporations. It also authorized petitioner to engage in a great number of activities other than the transportation of express, including to engage in any kind of manufacturing business; to deal in copyrights and patents; to deal in stocks and securities; to loan money; to enter contracts of every kind; and to carry on any business calculated directly or indirectly to promote the interests of the corporation or enhance the value of its properties.

The bylaws of petitioner provided for the election by stockholders of 15 directors, 14 of whom were to be nominated by 3 specified geographical districts. The method of selecting directors was not to be changed without the consent of the holders of two-thirds of the stock of petitioner. The board of directors was authorized to manage the business of petitioner.

On February 11, 1929, the Interstate Commerce Commission issued a report and order approving the acquisition of the capital stock and control of petitioner by the railroads participating in the express plan; the issuance of bonds by petitioner to purchase the property of American and secure working capital; and the proposed plan for pooling and dividing the earnings of the express business of petitioner in accordance with article v of the proposed operating agreement.

Shortly after March 1, 1929, the 86 railroads listed in the express plan paid for and received 999 shares of petitioner's stock. On June 12, 1929, another railroad paid for and received 1 share. Thereafter, by reason of mergers and consolidations of some of the stockholders and the admission of the Southern Railway System as a stockholder in 1938, the number of stockholders by September 20, 1938, was reduced to 70 railroad companies. Since that time the number of stockholders has remained unchanged.

At all times material herein since March 1, 1929, the petitioner operated its express business under separate identical contracts with substantially all of the railroad companies of the United States. During 1937 and 1938 over 400 railroads, including the stockholders of petitioner (hereinafter referred to as the contracting railroads), and petitioner were parties to such separate agreements, each known as ‘express operations agreement.‘ Each was identical in form with the proposed agreement attached to the express plan.

The express operations agreemement, effective for a period of 25 years from March 1, 1929, to February 28, 1954, contains, among other terms, the following provisions:

(a) Each participating railroad appointed petitioner ‘its exclusive agent‘ t conduct and transact the express transportation business upon such passenger, express, or rail trains of each railroad as may be agreed to and for the collection, disbursement, and division under the agreement of revenue accruing under the agreement.

(b) Petitioner was permitted to file tariffs on its own behalf or on behalf of the railroad or any other railroad with which the petitioner entered into a similar agreement and was appointed agent of each contracting railroad for the purpose of filing necessary tariffs relating to the transportation of express.

(c) Each contracting railroad was to receive, upon carload shipments, 85 per cent of the gross revenue accruing on its lines, and the remaining 15 per cent was to remain in the revenue of the group in which the charges accrued, the contracting railroads having been divided into four geographical groups, known, respectively, as the Eastern, Southern, Western and Mountain-Pacific.

(d) The gross revenue accruing to each railroad in the several groups was to be ascertained by crediting each railroad with the revenue earned wholly on its line and prorating, in a specified manner, the revenue involved in transportation on the lines of two or more carriers.

(e) Determinations were to be made each month of income accruing from express operations on the lines of all railroads and other instrumentalities of transportation over which or by means of which petitioner performs service within each group. The items of income consisted of the following, as defined in the uniform system of accounts of the Interstate Commerce Commissioner, or its rulings in connection therewith:

The total charges for transportation, after deducting, among other things, the 85 per cent payable for carload shipments, and certain switching, ferrying, float, or lighterage charges, not included in operating expenses; total revenue from operations other than transportation; all other income, and profit and loss credits.

(f) From the total of the above items of income, deductions were to be made for the following items of expense, as defined in the uniform system of accounts and rulings of the Interstate Commerce Commission in connection therewith:

All operating expenses of petitioner, including depreciation at the rates used on February 28, 1929, by American, or as thereafter fixed by the directors of petitioner or the Interstate Commerce Commission; compensation of carriers not parties to the express operations agreement; uncollectible transportation revenue; express taxes; other deductions; and profit and loss debits.

The classification of ‘Other Deductions‘ in the uniform system of account reads:

This item shall include accounts listed under Caption III, ‘Deductions from Gross Income‘ and under Caption IV ‘Disposition of New Income‘ except Account 329 entitled ‘Dividend Appropriations of Income‘ in the form of Income Statement.

The accounts as defined in captions III and IV of the uniform system of accounts consist of the following:


Deductions from Gross Income:

318 Rents for real property and equipment used jointly.

319 Miscellaneous rents.

320 Miscellaneous taxes.

321 Net loss on miscellaneous physical property.

322 Separately operated properties— Loss.

323 Interest on funded debt.

324 Interest on unfunded debt.

325 Amortization of discount on funded debt.

326 Income transferred to other companies.

327 Miscellaneous income debits.


Disposition of Net Income:

328 Income applied to sinking and other reserve funds.

329 Dividend appropriations of income.

330 Income appropriations for investment in physical property.

331 Stock discount extinguished through income.

332 Miscellaneous appropriations of income.

The classification of ‘profit and loss debits‘ consisted of the following accounts.

409 Surplus Applied to Sinking and other Reserve Funds.

411 Surplus Set Aside for Investment in Physical Property.

413 Debt Discount Extinguished through Surplus.

414 Miscellaneous Appropriations of Surplus.

415 Loss on Land.

416 Delayed Income Debits.

417 Miscellaneous Profit and Loss Debits.

Accounts 409, 411, 413, and 414 have never been used by the petitioner because of a belief that their use would have defeated the purpose for which petitioner was organized.

(g) After deducting the expense items above described from the above items of income, the balance remaining, designated ‘rail transportation revenue,‘ was to be distributed among the carriers in the group executing the agreement in the proportion that the gross express transportation revenues on other than carload business for the month earned on the line of each such carrier bears to the gross express transportation revenues on other than carload business earned on the lines of all such carriers in that group for that month.

(h) The petitioner was to estimate the amount payable to each carrier as its monthly proportion of the rail transportation revenue and pay the amount not later than the last of the next month, the exact amount to be ascertained by petitioner as soon as possible and any balance paid with 120 days thereafter. After the accounts were closed for any month they were not to be reopened to include adjustments affecting such month, unless in the judgment of directors of petitioner the amount of the proposed adjustment was sufficient to justify a restatement of the account.

Other necessary adjustments in the accounts were to be included in the first month's accounts after discovery. Article v, section 5, provides in part:

With respect to any and all claims, demands, charges and expenses of every kind and character whatsoever, for which the Express Company may be or become liable, or earnings in which the Rail Company may be interested, arising or growing out of the express business on the Rail Company's lines, but not ascertained, definitely fixed, or charged on the Express Company's books at the termination of this agreement, in the final settlement between the parties hereto, such claims, demands, charges, expenses or earnings shall be estimated and allowed as may be determined by the General Account Officers of the parties, and in case of their failure to agree, shall be determined as provided in Article XIV hereof.

Article XIV provides that any disagreement may be submitted to the Interstate Commerce Commission, or, upon request of any party, arbitrated, and decision by a majority of the arbitrators is a condition precedent to any further action. Each party shall pay the expense of its own arbitrator, other cost thereof to be divided equally.

Article XVIII provides in part for creation by the petitioner of committees to make recommendations to its board of directors, who shall have power to act (inter alia) under clause (D) as to ‘Allocation and apportionment of revenues and expenses, accruals and depreciation rates, accounts and statistics, as contemplated in this agreement‘; and further provides:

The several items of income, expenditures and deductions under Section 4 of Article V of this agreement shall, within a reasonable time, be subject to the objection of the Rail Company as to the nature or amount thereof, and if any differences continue to exist after consideration in respect thereto by the Board of Directors and the Committee having jurisdiction of matters mentioned under Clause (D) above, such difference shall be determined by arbitration under the provisions of Article XIV of this agreement. In the absence of fraud or concealment on the part of the Express Company, no objection contemplated by this Article, in so far as it relates to actual expenses already paid or incurred being unnecessary or excessive, shall be given a retroactive effect to a date earlier than the date such objection, after being stated in writing to the Express Company, may be reasonably and practicably complied with, but estimates and accruals when found by the Committee acting under Clause (D) above, and agreed to by the Express Company, to be excessive shall be adjusted from the dates of such estimates and accruals.

(i) The petitioner was to furnish adequate equipment and use its property and agents and employees ‘in operating an express transportation business as agent * * * ,‘ for the contracting railroads.

(j) As between the contracting railroads and petitioner, the latter was to be liable for loss or damage to its own property, or property carried under the terms of the agreement, for injury to or death of its agents or employees while engaged in its business or any of the lines covered by the agreement; and for other damage to property and injury or death to other persons, when caused by the negligence of petitioner, and when caused by the joint act or negligence of both, the responsibility was to be joint and the loss borne in proportion to the extent to which the act or negligence of each contributed to the loss.

The petitioner issued $32,000,000 or 5 per cent bonds on March 1, 1929, under a trust indenture between it and the Guarantee Trust Co. of New York, as trustee, to obtain sufficient funds for the purchase of the property from American and to obtain working capital. The bonds were sold to underwriters, who sold them to the public.

The rights of petitioner under the express operations agreements were pledged in the trust indenture as security for payment of the bonds and interest thereon, as to which petitioner was solely liable, and petitioner agreed in the indenture that it would not mortgage or pledge such rights in subordination to the lien of the instrument. Other provisions of the indenture made all indebtedness of petitioner subordinate to the bonds issued or to be issued thereunder (a total issue of $50,000,000 was provided for); contained an agreement of petitioner not to terminate or modify the express operations agreements without the written consent of the trustee; required petitioner to set aside out of rail transportation revenue for each six-month period, as a sinking fund for the bonds, an amount equal to the principal amount of bonds payable in such period, and, in the event of default, gave the trust power to take possession, hold, and operate petitioner's property and conduct its business, collect all income therefrom, and, after deducting the expense of operating the business, apply the proceeds to payment of the bonds and interest thereon in default, or, under certain circumstances, to sell the trust estate for the benefit of bondholders.

On April 11, 1929, the directors of petitioner adopted a resolution providing that there be deducted from the rail transportation revenue payable to each stockholder-railroad in February and August of each year $800 per share, such amount to be credited to the stockholder-railroad as money advanced to petitioner, and applied to the installments of principal maturing semi-annually on the bonds in the amount of $800,000, and that petitioner pay or credit on such advances interest at the rate of 5 1/4 per cent per annum. The plan was adopted as a substitute for the sinking fund required by terms of the express operations agreements. Thereafter, one participating railroad, holding one share of petitioner's stock, discontinued the operation of passenger trains and ceased doing express business on its line. To provide for the changed condition and similar cases which might arise in the future, the directors of petitioner adopted a resolution on January 31, 1933, amending the resolution of April 11, 1929, to provide, in substance, for deduction semi-annually of the amounts necessary to retire petitioner's bonds from the rail transportation revenue payable to the railroads holding petitioner's stock in proportion to stockholdings, any deficit as to any stockholder to be paid in cash or deducted from the next rail transportation revenue payable to such stockholder; and the amounts deducted and paid to be credited to the stockholders as money advanced to petitioner, with interest at 6 per cent; such advances to be subordinate to the bonds dated March 1, 1929.

At all times material the payments due on the principal of the bonds were made in the manner prescribed in the resolutions adopted on April 11, 1929, and January 31, 1933. From March 1, 1929, to December 31, 1938, petitioner's stockholders advanced about $15,200,000 under the plans, of which nearly $3,200,000 was repaid to them during such period. The amount was repaid by excess cash on hand and was not deducted from rail transportation revenue under the express operations agreement. The repayments tended to increase such revenue by savings of interest. The petitioner, in December 1938, deposited $800,000 with the trustee to pay the bonds maturing March 1, 1939, for which petitioner was reimbursed by the stockholdings railroads by advances made after December 31, 1938.

The petitioner has never paid any dividend to its stockholders.

On May 19, 1936, the Interstate Commerce Commission issued an order directing that, effective January 1, 1937, express companies should shift from the unit method of accounting for depreciation to the group method as described therein. On November 23, 1937, and January 22, 1938, the Interstate Commerce Commission issued orders fixing the rates of depreciation in accounting for depreciation on petitioner's property. The orders were effective for accounts for March 1938, with the right to apply them retroactively to January 1, 1937. Pursuant to these orders, the petitioner employed the group method of accounting for depreciation at all times during the calendar years 1937 and 1938.

During 1937 and 1938, in computing rail transportation revenue, the petitioner deducted from its items of income, as defined in section 4 of article v of the express operations agreements, all charges and items of expense as provided for therein, including $2,308,642.09 and $2,136,209.41, respectively, for depreciation computed in the manner ordered by the Interstate Commerce Commission. The balance remaining was distributed by petitioner among the railroads which executed the express operations agreements in accordance with the manner provided in article v thereof. The depreciation was claimed as deductions in returns filed by petitioner for 1937 and 1938. In his determination of the deficiencies the respondent reduced the amounts to the extent of $383,994.07 and $274,779.70, respectively and added such amounts to the taxable income reported in the returns. The parties have stipulated that the correct disallowance for 1938 is $259,305.31.

By orders executed on June 2, 1945, and October 4, 1945, the Interstate Commerce Commission ordered that, effective with the account for August 1945, its order of November 23, 1937, prescribing depreciation percentage rates for application by the Railway Express Agency, Inc., be vacated; and that, effective with the account for August 1945, the petitioner is granted permission to account for depreciation charges by including in its accounts amounts found by the Bureau of Internal Revenue to be allowable; provided ‘that nothing herein contained shall be construed as prohibiting the said Express Agency from applying the said permission retroactively to January 1, 1937.‘ No action has been taken by the petitioner under these orders, because this proceeding was pending at the time thereof, the situation has been under discussion, and questions are pending between the petitioner and the Bureau of Internal Revenue.

In 1937 and 1938 the petitioner paid fines aggregating $1,584.03 and $2,005, respectively, which were imposed by Federal and state authorities for violations of custom laws, municipal ordinances, quarantine and health laws, and the like. The amounts were accounted for under the express operations agreements in account No. 417 entitled ‘Miscellaneous Profit and Loss Debits,‘ and therefore deducted.

The return filed by petitioner for 1938 reported a net capital loss of $98,887.86, of which a deduction of only $2,000 was claimed in the return.

Some of the states in which petitioner did business required the deposit of securities to qualify as self-insurers. The petitioner purchased and used tax-exempt Government bonds to make the deposits. On December 31, 1937, and December 31, 1938, its holdings of ‘pledged bonds‘ were $455,039.07 and $389,445.47, respectively. The interest received on the bonds, some of which was tax exempt, was treated as gross income under the express operations agreements. In 1937 and 1938 the petitioner received interest on the securities in the respective amounts of $14,568.64 and $15,906.50.

Petitioner field a capital stock tax return for the fiscal year ended June 30, 1936, in which it declared $100,000 as the value of its capital stock and a like return for the fiscal year ended June 30, 1937, in which it reported an adjusted declared value of $101,617.25 for its capital stock. The latter amount was arrived at by adding to the original declared value $1,403.87, alleged to represent net income for income tax computation for the calendar year 1936, and $213.38 as 1936 income wholly exempt from income tax.

The petitioner had no income subject to income tax or excess profits tax for the calendar year 1936. In that year the excess of petitioner's deductions allowable for income tax purposes exceeded its gross income by more than $101,403.87.

In computing the excess profits tax of petitioner for 1937, the respondent allowed $100,000 as the adjusted declared value of petitioner's capital stock for the fiscal year ended June 30, 1937.

The returns of petitioner for 1937 and 1938 reported the following income and tax due, which was paid by installments in the year in which the respective returns were filed:

+---------------------------------------------------------------+ ¦ ¦1937 ¦1938 ¦ +-----------------------------------------+----------+----------¦ ¦Net income for excess profits computation¦$15,760.21¦$99,582.40¦ +-----------------------------------------+----------+----------¦ ¦Excess profits tax ¦391.23 ¦10,449.89 ¦ +-----------------------------------------+----------+----------¦ ¦Net income for income tax computation ¦1,169.31 ¦73,506.01 ¦ +-----------------------------------------+----------+----------¦ ¦Income tax ¦93.54 ¦13,966.14 ¦ +---------------------------------------------------------------+

Under account No. 104, denominated ‘Express Privileges,‘ the petitioner deducted from ‘Total charges for transportation‘ $50,420,994.05 and $57,948,646.62 in 1937 and 1938, respectively.

The returns also show approximately 75-80 structures of depreciable property owned but not used in express operations, which were depreciated on a unit basis, and not the group basis prescribed by the Interstate Commerce Commission and used on operating properties.

On March 10, 1942, the petitioner filed a claim for refund of the $24,416.03 paid for 1938 taxes.


DISNEY, Judge:

The petitioner reported taxable net income each year and paid the resulting taxes. In arriving at net income it took as deductions amounts paid to the railroads as rail transportation revenue computed in accordance with provisions of the express operations agreements. Our attention has not been called to the manner in which the amounts were reflected in the returns. Account No. 104, under the name of ‘Express Privileges‘ of the uniform system of accounts, which system was prescribed by the Interstate Commerce Commission and followed generally by petitioner in filing its returns, provides for charges thereto for amounts paid or accured to railroads ‘for the privilege of conducting an express business over transportation lines.‘ About $58,000,000 in 1937 and $50,000,000 in 1938 was claimed in the returns as deductions in account No. 104 in arriving at revenue from transportation. It seems, therefore, that rail transportation revenue distributable to the railroads under the express operations agreements was included in such deductions as business expenses. The idea is consistent with the view of respondent upon brief that rail transportation revenue was payable to the railroads for services, and included their profit, if any, for services performed by them. The petitioner also reflected in its returns tax-exempt interest, capital gain in 1938, and nondeductible fines paid, and deducted capital losses (limited each year to $2,000). The only adjustment made by the respondent in his determination of the deficiencies was to reduce each taxable year the amount of depreciation claimed. Accordingly, regardless of how rail transportation revenue was reflected in the returns as an offset against gross income, the amounts were not disturbed by the respondent and are not expressly in issue. There is no controversy as to the proper amounts allowable as deductions for depreciation.

The primary and general issue raised by the petitioner is whether any part of its receipts in the taxable years constituted income taxable to it. The claim of petitioner that it erroneously paid income taxes has its foundation in the theory that it had no income subject to tax. The substance of the petitioner's argument is that it is a creature of the railroads and, as such, acts as their agent in conducting, under uniform contracts, an express transportation business for them over their lines; that it is accountable to its principals, the railroads, for all gross revenue, less expenses, as determined in accordance with provisions of the express operations agreements, and, therefore, can not have net income available for dividends or credit to surplus. Petitioner says that under the circumstances the railroads, not it, were the beneficial owners of all of its income. Its contention does not go so far as to deny that it is a taxpayer. The effect of its whole argument is that, in substance at lease, all of its gross income and expenses, as defined in the express operations agreements, which necessarily include tax-exempt income and nondeductible expenses and losses, constitute income and expenses of the railroads and that all of any excess of income over expenses, classified as rail transportation revenue in the uniform contracts, belongs to the carriers in the proportions fixed by the agreements as the beneficial owners thereof. Such transportation revenue, with adjustments for nondeductible expenses for tax purposes, would, petitioner says, constitute taxable income of the recipient railroads.

As already indicated, this proceeding had its origin in increases of taxable net income reported by petitioner resulting from partial disallowance of deductions taken for depreciation. Without such adjustments there would not have been any deficiencies. The substance of the argument being made by the respondent to support his action is that petitioner was by nature a corporation organized for profit; that it was more than a mere agent for the railroads; that all of the petitioner's income, gross or net, is not under its charter, bylaws, or the uniform contracts distributable to the railroads as a matter of right, and that petitioner had a real surplus by at least the amount of depreciation charged in excess of the amount actually sustained. The crux of what he says is that petitioner should be regarded here as like other corporations subject to income tax liability.

The respondent, upon brief, says that ‘Where income is derived from property, the basic test for determining who is to bear the tax is that of ownership.‘ A like statement, with the same citations of authority, was made by him in Worth Steamship Corporation, 7 T.C. 654. There we agreed that the statement was ‘fundamentally correct.‘ There is little, if any, difference between it and the contention of petitioner here that the tax should be borne by the beneficial owner. See Helvering v. Horst, 311 U.S. 112; Commissioner v. Smith, 324 U.S. 117. All facts must be considered in the application of the rule. Commissioner v. Wilcox, 327 U.S. 404.

Was the petitioner a mere agent of the railroads? Its predecessor in the handling of express, the American Railway Express Co., was an independent corporation that transacted business for its own account. The railroads over whose lines substantially all of the express business of the country was handled sought to substitute for the arrangement they had with American a plan under which they could manage and control the business and at periodical times receive its net revenue. The organization of petitioner resulted from the adoption of a plan for such operation. Such railroads subscribed and paid for petitioner's nominal capital of $100,000 in proportion to the express business handled by them in the past. They are still its stockholders, except for an additional railroad system and changes resulting from mergers and consolidations, and they manage and control petitioner through a board of directors elected by them. Other funds necessary for working capital and the acquisition of property of American were raised by a bond issue of petitioner in the amount of $32,000,000 under a trust indenture.

Each express operations agreement designates petitioner as the exclusive agent of the railroad for conducting the express transportation business and for the collection and disbursement and division under the agreement of all revenue under the agreements. The qualified appointment of petitioner as agent discloses that the agency was not to extend to all matters. For instance, petitioner had authority to file tariffs and other rules and regulations with the Interstate Commerce Commission on its own behalf or on behalf of the railroads, and as between petitioner and the railroads the former was liable for loss to its own property or carried property, etc., and for injury to its own employees and agents. We see nothing in the agreement limiting the right of petitioner to appoint and exercise control over its employee. Numerous provisions of the contracts contemplate disagreements between the parties— inconsistent with a position of petitioner as mere creature of the railroads.

Property used by the petitioner in carrying out its activities was owned by it and no contention is made that the contracting railroads, as alleged beneficial owners of all of the income of petitioner, had any interest in such property. Nothing found in the express operations agreements as executed, which define the rights of the parties, gives the railroads any interest in petitioner's property.

The express operations agreements were pledged as security for the payment of principal and interest on petitioner's outstanding bonds. In case of default under the bonds, the trustee was empowered to take possession of and use and operate petitioner's properties, collect and receive all of its earnings, and, after paying expenses of operation, apply the proceeds on the payment of the bonds and interest thereon in default. If certain defaults continued for 30 days, the trustee, in his discretion, was authorized to, and, if the holders of at least 25 per cent in amount of the outstanding bonds requested it to do so, was required to, sell the trust estate to satisfy the claims of bondholders. Only petitioner was liable under the bonds. Thus the income of petitioner was, at all times important, subject to use by the trustee for payment of the bonds and interest thereon in default. Claims of the contracting railroads to rail transportation revenue were subordinate thereto. The trust indenture is independent of the express operations agreements and illustrates the absolute control petitioner had over its property and the breadth of its power to prefer claims of holders or bonds in default to rights or railroads to rail transportation revenue.

The trust indenture is dated March 1, 1929, when the express operations agreements became effective. A bond issue was provided for in the express plan, which became effective earlier, in October 1928, as of July 2, 1928, by agreement of railroads representing in the aggregate 75 per cent of about 98 per cent of the express business then being conducted. Under the circumstances it is apparent that the beneficiaries chiefly interested in the rail transportation revenue of petitioner were fully aware, not later than March 1, 1929, of the charge being placed upon revenue by provisions of the trust indenture. It is evident that petitioner's property, in which the railroads, as parties to the express operations agreements, had no interest, was a material income-producing factor. Furthermore, we find in the contracts executed nothing contrary to the view that upon any liquidation any net assets after paying claims of creditors would be distributable, not to the railroads as principals under the express operations agreements, but to petitioner's stockholders.

Terms of the express operations agreements fixed the amounts payable to the participating railroads as, briefly, gross revenue less expenses. The agreements contemplate that all income and expenses, as defined therein, including depreciation, should be taken into account in arriving at the amount distributable to the railroads in proportion to the express business each handled on its line. We discern nothing in the agreements as made or carried out entitling the railroads to gross income or any part thereof, as such, or liability for all expenses of petitioner. Certain fines were imposed upon petitioner and funds which the railroads had no unconditional present right to receive were used to pay them. If during the years the fines were imposed, and thereafter during the life of the express operations agreements, petitioner had deficits in rail transportation revenue, the burden of the deficits never would have fallen upon the railroads, parties to the agreements, in view of the fact that no provision was made in the express operations agreements imposing upon them liability to make good operating losses of petitioner.

It is evident that the participating railroads contemplated that the operations of petitioner each month would result in rail transportation revenue distributable to them; otherwise nothing would accrue to them for the part they played in earning gross income. It may be that if a deficit occurred in operations any month, the loss could be recovered from subsequent earnings of petitioner by a charge to profit and loss for use as an expense deduction the next month.

Article v of the express operations agreements authorized petitioner to deduct from the moneys received by it, as expense, certain items therein designated net income items, including appropriations from ‘net income‘ for investment in physical property (account No. 330); and to deduct certain ‘surplus‘ items, including account No. 411, for ‘surplus set aside for investment in physical property.‘ Account No. 411 has never been used by the petitioner. No evidence was submitted respecting whether account No. 330, a similar account, was used, though the returns filed by petitioner for the taxable years, in which income and expenses are identified by account numbers, contain no reference to account No. 330. The express operations agreements did, however, give petitioner the right to treat such accounts as expense deductions. Such provisions appear to enable the petitioner to increase its physical properties out of funds which would otherwise be distributable to the contracting railroads. Such permitted appropriations for property would constitute income to the petitioner. Such a situation is incompatible with a view that the petitioner is a mere creature of the contracting railroads.

The indenture contained a provision requiring petitioner to set aside out of its rail transportation revenue every six months as a sinking fund for the bonds, an amount equal to the principal amount of bonds payable in such six-month period. Other provisions made indebtedness of petitioner to the railroads which had signed express operations agreements subordinate to the bonds, and prohibited modification of the express operations agreements without the written consent of the trustee. In lieu of such a sinking fund, petitioner made interest-bearing loans every six months from its railroad stockholders to take up matured bonds. The record is silent on whether the trustee ever consented to the new plan and we, therefore, assume that the indenture was never modified in that respect. Accordingly, notwithstanding the new plan, the trustee had a contractual right to require deposits of rail transportation revenue in a sinking fund to pay bonds maturing every six months. The obligation encroaches upon the right of the railroads to all of the income of petitioner.

The petitioner owned, in large amounts, bonds, which it used to meet requirements of state laws, and upon which it received interest. There was no assumption of or agreement to pay, by the participating railroads, all of petitioner's debts or expenses. Theoretically, if not practically, the petitioner might have more expense than income, and we see no requirement that the railroads who are alleged to be principals pay such excess expense or losses, as in some cases involving this problem. The petitioner was plainly no mere department of another organization, such as in National Carbide Corporation, 8 T.C. 594, where the principal or parent furnished all necessary working capital. There are various provisions in the contract providing for settlement of disputes between petitioner and the railroads. Petitioner's returns discuss depreciable property owned, but not used in express operations by petitioner, approximately 75-80 structures. These properties were depreciated by the petitioner under the unit basis, and not under the group method prescribed by the Interstate Commerce Commission and used on operating properties. The contract refers more than once to items to be furnished by the railroads without compensation other than as provided in ‘Article v,‘ or ‘Article iv and v,‘ indicating that the payments provided by such articles as above discussed do constitute compensation from petitioner and not, as petitioner argues, mere division of profits of the contracting railroads' business. The petitioner's corporate powers were very broad, encompassing much more than an express business, and income is not all shown to be from that business. All these elements contradict, in our view, the idea that the petitioner is in all things a mere agency of the railroads in the express business, and tend to show it to be a contractor with relation to them. In our opinion, the evidence before us falls short of demonstrating that the petitioner is a mere creature of the railroads contracting with it, with no income of its own.

The case of Bowles v. Railway Express Agency, Inc., 65 Fed.Supp. 852, cited by the petitioner, involved an alleged violation of the Emergency Price Control Act of 1942 for overcharges in sales of certain miscellaneous services of a local nature. The turning point of the case was on the question of whether the defendant (petitioner here) rendered services as a seller.

The services involved in that litigation were not used by all of the railroads using the facilities of petitioner and the charges made were as nearly as possible at cost, because, if services were performed for less than cost, lines not using the service, but parties to the express operations agreements, would be required to absorb the loss. The status of the defendant as a taxpayer was not involved in the suit. The remark of the Court, that ‘The liability of the defendant as a separate corporate entity for taxes or torts is immaterial in considering whether a specific statute or regulation applies to it, ‘ discloses that the court did not regard its opinion as an authority for judging whether petitioner might have income subject to tax. Furthermore, the facts of the case disclose that the petitioner contracted for its services on terms which contemplated that its charges would be sufficient to cover all expenses, including fines, for the service, leaving no deficit to be made good by rail transportation revenue derived from its general activities.

In Horace Mill, 5 T.C. 691, the transaction was in the nature of a joint venture, in which each participant was entitled to a specified proportion of the income, without deductions for any purpose. The case of Louis C. Rollo, 20 B.T.A. 799, did not go so far as to hold that the corporation involved had no income subject to tax, or that expenses, nondeductible by it for tax purposes, must be reflected in the returns of the individuals. The corporation was treated as a separate entity, subject to tax on its gross income, and the deduction there in controversy was allowed as a business expense upon the ground that it was consideration payable under the contract that produced the gross income. The amount paid there may be likened to the rail transportation revenue paid by petitioner here to the railroads, and allowed by the respondent as a deduction. A similar case is Grey Bull Corporation, 27 B.T.A. 853. There, however, the nondeductibility for tax purposes of expenses incurred in arriving at the amounts payable under the contracts with shareholders was not involved. The case of Uniform Printing & Supply Co. v. Commissioner, 88 Fed.(2d) 75, turned on whether the amounts were rebates or dividends. We agree with petitioner that rail transportation revenues payable by it to railroads under the express operations agreements were not dividends. The respondent did not so treat them. In Worth Steamship Corporation, supra, the corporation held only record title to the vessel and merely managed and operated the property for the beneficial owners, who were joint venturers. The issue did not involve the question of whether some part of the amounts paid to the joint venturers as beneficial owners of the income derived from operation of the vessel included items nondeductible for tax purposes.

Though the general purpose of the express plan was to enable the contracting railroads to obtain the maximum amount out of the express business, and thus receive themselves the net earnings that had been going to American, petitioner's predecessor, the terms of the agreements later entered into did not go so far as to make the gross income and expenses of petitioner gross income and expenses of the contracting railroads in any proportion. Petitioner, as a taxpayer, was required to account for its gross income pursuant to provisions of the applicable revenue act and, in doing so, to disregard, if necessary, accounting rules prescribed by the Interstate Commerce Commission. Old Colony R. Co. v. Commissioner, 284 U.S. 552. The contracting railroads were entitled to the rail transportation revenue, but such amount may not, under the circumstances here, be considered merely a part of gross income earned by the contracting railroads and not the petitioner, and computed without regard to nondeductible expenses and tax-exempt income. We conclude that it was not error for respondent to treat as petitioner's income the amounts reported by it in its returns.

However, the point upon which the respondent determined the deficiencies, and involving the larger portion thereof, is whether the petitioner had income subject to tax by virtue of deduction of excessive depreciation. Aside from the more general conclusions to which we have above come as to the position of the petitioner being that of recipient of the gross income, more particular reasons also require the conclusion that the Commissioner did not err in taxing to the petitioner an amount agreed to, the amount of the excessive depreciation deduction. For even though we were to assume that it had been shown that the contracting railroads, and not the petitioner, were the recipients of the gross income involved from the express business and that in conducting such business the petitioner was doing so as agent for them, the fact still remains that in one respect, at least, petitioner was no mere agent. It contributed to the contract and to the business the use of property to the extent of millions of dollars. Most of the $32,000,000 bond issue was expended upon property. Such property belonged solely to the petitioner and petitioner was solely responsible for the bond issue with which it was purchased. Assuming that there may be question as to whether property later purchased out of the revenues of the business belonged in any sense or degree to the contracting railroads— although we find nothing in the contract specifically so providing— it appears reasonable to conclude from the evidence that far the larger portion of the property owned by the petitioner in the taxable years was free from any claim on the part of the contracting railroads. This being true, it is obvious that the depreciation items which the Commissioner reduced were deducted by the petitioner as the alleged agent of the contracting railroads, but for the benefit of itself in a different capacity, i.e., as the owner of the depreciating property.

Considering the whole contract, and particularly the way in which neither the stockholders of the petitioner nor the contracting railroads became liable for either the debts in general or the bonds of the petitioner, and the lack of provision for division of the property among all the roads at the end of the contract, we think that the petitioner as a corporate entity was the owner of the property both in form and in fact. Why should the 70 railroads owning petitioner's stock and advancing the money to discharge its bonds, provide, for the rest of the 400 roads, the property for the express operations for the benefit of all? In short, we consider the provision of the contract with each contracting railroad with respect to depreciation as a provision whereby the petitioner was to pay itself, in effect, a sufficient amount to take care of the depreciation on its own property. The contract sets a certain standard for the amount of deduction, that is, as provided by article v (D) of the contract. Thereunder depreciation shall be deducted ‘as defined in the Uniform System of Accounts or the rulings of the Interstate Commerce Commission in connection therewith.‘ It is to be noted that the deduction for depreciation is not to be designated as actual depreciation or as depreciation as determined by the Commissioner of Internal Revenue, but in accordance with Interstate Commerce Commission rules. In accordance therewith, the petitioner did, in the taxable years, deduct depreciation according to such rules. That the amount so deducted was greater than the Commissioner's determination of depreciation appears to us immaterial. In our opinion, however, much the petitioner was the agent of the contracting railroads in conducting the express business, it was dealing at arm's length with them in protecting itself against actual depreciation upon the property which it put into and used in the business, and that therefore it received, in its individual capacity, in the taxable years, the amounts which were deducted for depreciation.

There is clear demarcation between the petitioner, owned by 70 railways, and 400 participating in the express operating agreements; and demarcation in their interests. The Commissioner of Internal Revenue, upon examination of the situation, determined— and properly the parties agree— that the amounts deducted as depreciation represented considerably more than the reasonable wastage or depreciation upon the property. Thereby petitioner in our opinion, had income under the facts before us, within the broad reach of section 22(a) of the Internal Revenue Code. Petitioner is, in this respect, in no essentially different position from the ordinary taxpayer owning property used in business and upon which it deducts depreciation. If it deducts too much, the Commissioner will disallow the excess over reasonable depreciation as he determines it, adding an amount equivalent to such excess to the taxpayer's net income as reported. Petitioner, as owner, received from the contracting railroads amounts greater than those determined by the Commissioner to be reasonable depreciation deductions, and, as the agency contracts did not give the contracting railroads a right to such amounts, the excess deductions were properly added to net income as reported.

Petitioner argues, however, in effect, that the matter was subject to revision between it and the contracting railroads and, further, that in 1945 the Interstate Commerce Commission gave permission to account for depreciation charges on the basis found by the Bureau of Internal Revenue, retroactive to January 1, 1937, and so covering the taxable years. We do not think this controls the instant case. In the first place, the action of the Interstate Commerce Commission in 1945 does not, in fact, change the rules under which the petitioner deducted its depreciation under article v, section 4 (D) of the contract. Careful examination of the action by the Interstate Commerce Commission reveals that the petitioner was granted permission to account for depreciation charges on the basis found by the Bureau of Internal Revenue, ‘effective with the account for August 1945.‘ Then follows the proviso: ‘That nothing herein contained shall be construed as prohibiting said Express Agency from applying the said permission retroactively to January 1, 1945‘— which was later by amendment changed to January 1, 1937. In short, the Interstate Commerce Commission merely did not prohibit the petitioner from applying the depreciation rates and figures found by the Bureau of Internal Revenue for 1937 and 1938, the taxable years here. But this the petitioner has never done. It has refrained from revising, in this depreciation matter, its accounts with the contracting railroads. This proceeding was pending at the time the situation was under discussion, and questions are pending between the petitioner and the Bureau of Internal Revenue. In other words, the petitioner has left the contractual rights of itself and the contracting railroads as they were when petitioner deducted depreciation under Interstate Commerce Commission rules. It seems to us that the question as to whether petitioner might be required by the contracting railroads to revise its depreciation deductions for 1937 and 1938, under the Interstate Commerce Commission order of 1945 is, to say the least, an open one; and particularly that petitioner has advisedly left it open in this case, leaving itself in the position of having deducted depreciation for 1937 and 1938 according to the then rulings of the Interstate Commerce Commission and in strict accordance with its contractual right. A taxpayer receiving income under claim of right and without restriction as to disposition, is taxable thereon, even though he may later be required to return it. North American Oil Consolidated v. Burnet, 286 U.S. 417; National City Bank, Executor v. Helvering, 98 Fed.(2d) 93; Board v. Commissioner, 51 Fed.(2d) 73; Safety Tube Corporation, 8 T.C. 757, where the claim was in litigation. This we consider petitioner's position as the owner of the depreciated property, and even though there may be some liability to revise the matter later— and the words of the contract might be construed as strong basis for petitioner's denial of any such revision— that is not for us to consider controlling as to the years 1937 and 1938. Moreover, the provisions of the contract with reference to any revision are general in their nature and subject to question as to the time within which such revision may be applied. Thus, article XVIII of the contract provides for objections to deductions within a reasonable time; also provides against retroactive effect to actual expenses already paid or incurred as being unnecessary or excessive, though it provides also that estimates and accruals (which would include estimates and accruals as to depreciation rates), agreed to by the petitioner as excessive, may be adjusted from the dates thereof. Obviously, there is real question as to the rights of the parties, the petitioner and the contracting railroads, as to revision of the deductions taken by the petitioner in the taxable years. The depreciation, already deducted, might not be regarded as merely estimated, or the petitioner might not agree that it was excessive. The operations contracts, article v, section 4, contain in detail the provisions above examined, as to revenues and expenses to be deducted therefrom; article v, section 5, provides in general terms for final settlement at termination of the agreement by the general accounting officers of the parties, or if they fail to agree, as provided in article XIV; and article XIV in turn provides in general for arbitration of disputes on request ‘and the decision of a majority of such arbitration board shall be a condition precedent to any further action.‘ Thus it appears that there may be litigation— ‘further action‘— between the parties, and we can not now say that the matter of the depreciation will ever be revised. In view of the question as to the relation between petitioner and the contracting railroads as to any revision of accounts, we may not properly be required to speculate upon the attitudes and contentions which might be raised between the parties in the future. Under the principles of the cases last cited, we consider that we should not anticipate the possibility of any revision. We therefore conclude and hold that the Commissioner did not err in adding to petitioner's income as reported, the agreed amounts of excessive deductions for depreciation.

In the light of the above conclusions, there remain for disposition several alternative contentions. Several of them have been agreed upon by the parties, will be reflected in decision entered under Rule 50, and require no discussion here. The petitioner has not briefed a contention by the respondent that he erred in allowing $100,000 as petitioner's adjusted declared value of petitioner's capital stock for the year ended June 30, 1937, and that such value is zero. Moreover, the parties stipulate that for 1936 petitioner's deductions allowable for income tax purposes exceeded its gross income by more than $101,403.87. Since, under section 105 of the Revenue Act of 1935, as amended by section 401 of the Revenue Act of 1936, capital stock value originally declared shall, for a later year, be the original amount gross income, and since the original declared value was $100,000, it appears that for 1937 the proper figure is zero. The respondent's contention is sustained.

This leaves for further consideration only the question whether the Commissioner, in computing undistributed net income subject to surtax on undistributed profits for the year 1937, erred in denying credit of the amount of petitioner's adjusted net income, under section 26(c)(1) of the Revenue Act of 1936, providing for credit in connection with written contracts restricting payment of dividends. In our view, the Commissioner did so err. The petitioner had, prior to May 1, 1936, executed written contracts (with each of the contracting railroads). If such contracts contained a provision ‘expressly‘ dealing with the payment of dividends, which would be violated by the distribution of petitioner's adjusted net income, the petitioner's position is sound. The contract was not an intracorporate matter, such as a charter, bylaw, or corporate resolution, which does not cause benefit of the credit. Helvering v. Northwest Steel Rolling Mills, Inc., 311 U.S. 46; Metal Specialty Co., 43 B.T.A. 891; affd., 128 Fed.(2d) 259. It provided a method of distribution of the petitioner's income to the contracting railroads by adding together its income, and making certain deductions, by classes, and ‘other deductions,‘ which specifically included ‘accounts listed under * * * Caption IV (as defined by the Uniform System of Accounts prescribed by the Interstate Commerce Commission) 'Disposition of Net Income’ except Account 329 entitled 'Dividend Appropriations of Income.'‘ In other words, the petitioner could not deduct dividends, under the contract, before distributing its net income to the contracting railroads. In this we see the ‘prohibition on payment of dividends,‘ which forms the heading of section 26(c)(1) and the kind of contract permitting the credit. We think, contrary to respondent's view, that the contract does expressly deal with dividends. Petitioner's position is sustained.

SEC. 26. CREDITS OF CORPORATIONS.In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax—(c) CONTRACTS RESTRICTING PAYMENT OF DIVIDENDS.—(1) PROHIBITION ON PAYMENT OF DIVIDENDS.— An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. If a corporation would be entitled to a credit under this paragraph because of a contract provision and also to one or more credits because of other contract provisions, only the largest of such credits shall be allowed, and for such purpose if two or more credits are equal in amount only one shall be taken into account.

Decision will be entered under Rule 50.

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