I concur in the opinion of GRAY, J., except as to the questions hereinafter discussed.
In this case the courts below adopted the net earnings rule, so called, in determining the value of the relator's special franchise. No question has been raised upon this review as to the propriety of adopting that rule in this case. The rule has been approved by this court in cases in which the business of the corporation has been conducted honestly and economically and where the net earnings have not been dissipated by extravagance and mismanagement. Therefore, in reviewing the case it becomes our duty to see whether the rule has been properly followed and the result reached is just and fair both to the public and the relator. The rule, in brief, is to ascertain the gross earnings of the corporation and then deduct the operating expenses, together with the annual taxes paid. From the remainder there should also be deducted a fair and reasonable return on that portion of the capital of the corporation which is invested in tangible property, the result becoming the net earnings contributable to the special franchise, which, when capitalized at a rate which I shall hereafter consider, becomes the value of the intangible property of the special franchise.
The courts below have allowed the relator six per cent on the value of its tangible property as a fair and reasonable *Page 237 return for the investment. The relator claims that the rate should have been higher; that the business engaged in, of constructing and operating an elevated road, involved a great hazard, but has resulted in a great public benefit, and that investors in such an enterprise ought to be allowed a greater income therefrom than the ordinary rate of interest allowed by statute upon the loan of money. It may be, as claimed, that the confining of the income to the statutory rate of interest will operate to prevent persons having money to loan from investing in new and dangerous enterprises. But the question of the fair and reasonable return, we regard as one of fact under the control of the courts below and one which this court should not review. We, therefore, cannot interfere with the determination made upon this branch of the case.
The courts below have also held that the net earnings should be capitalized upon the basis of six per cent, the same percentage that was allowed for income on the tangible property. In this determination I think the court failed to follow the net earnings rule. That rule is not a question of fact but a plan devised for the purpose of ascertaining the value of intangible property, which has met the approval of this court in cases of this character, for the reason that it seemed just and fair, and perhaps as furnishing as safe a rule as any that has thus far been devised. Prominent authorities in discussing this method of valuing special franchises have suggested that the rate of capitalization should be at least one per cent higher than the rate of income allowed. The purpose of this is to provide against unforeseen contingencies that may arise in the prosecution of the business of the corporation, such as unusual storms, floods, fires, explosions and accidents, which may result in the impairment of net earnings, and cannot be foreseen and estimated in advance. This question was considered by this court in the case of People ex rel. Jamaica Water Supply Co. v. State Boardof Tax Commissioners *Page 238 (196 N.Y. 39), and we then reached the conclusion that such a rule was reasonable and fair to the parties and should be followed, and we consequently reversed the determination of the Appellate Division, which fixed the rate of capitalization at the same percentage allowed for income and affirmed the rate adopted by the referee. This was done, not upon the ground that it involved any question of fact, but because it was part of the plan or rule which we approved for the determination of a just result between the parties. It, therefore, seems to me that the rule should not be departed from in this case, and that the capitalization should be based upon a seven per cent rate.
In the Jamaica Water Supply Case (supra) we held that there should be an annual deduction made out of gross earnings in order to meet the general deterioration of the property and provide for its replacement. WILLARD BARTLETT, J., in delivering the opinion of the court, says: "We suppose that judicial notice may be taken of the fact that in the conduct of many industrial enterprises there is a constant deterioration of the plant which is not made good by ordinary repairs which, of course, operates continually to lessen the value of the tangible property which it affects. The amount of this depreciation differs in different enterprises, but the annual rate is usually capable of estimate and proof by skilled witnesses. No corporation would be regarded as well conducted which did not make some provision for the necessity of ultimately replacing the property thus suffering deterioration; and we cannot see why an allowance for this purpose should not be made out of the gross earnings in order to ascertain the true earning capacity." (p. 57.)
In the case of People ex rel. Third Avenue Railroad Co. v.State Board of Tax Commissioners (136 App. Div. 155), KELLOGG, J., in delivering the opinion of the Appellate Division, after referring to our decision in the Jamaica case, says that "a public service corporation, *Page 239 with reference to its property which will become worthless by use and must be replaced, is entitled to set aside each year from its earnings a reasonable sum to provide for its replacement. This is outside of the ordinary annual expenses for maintenance, renewals and repairs." (p. 158.) This case was affirmed in this court without opinion in 198 N.Y. 608. The Special Term in this case, however, adopted a plan of amortization upon which an annual sum was authorized to be set apart as a sinking fund, which, by compounding the interest thereon for a period equal to the life of the structure, tracks, engines, machinery and rolling stock, would at the end of that period create a fund sufficient to replace the property. The difficulty with such holding is that railroad corporations do not reconstruct their railroads and rolling stock in that way. In order to afford proper protection to the public they are required to maintain a high state of efficiency both in roadbed and rolling stock. The relator's railroad has been in existence already for about thirty years and some portion of its property has already suffered from decay and use to such an extent that portions thereof have to be reconstructed and made new each year. Old ties have to be removed and replaced with new ones; old rails that have become worn and battered have to be removed and their places supplied with new rails and so the work of reconstruction progresses from year to year. It is not the waiting forty or sixty years to reconstruct, during which time the amount set apart as a sinking fund may be doubled many times over by compounding the interest, but it is the annual expenditure for reconstruction which is to be paid for at the time that the construction is made. To illustrate: Suppose the average life of the tangible property of a railroad, outside of the land itself, to be sixty years and the cost of reconstruction to be sixty million dollars, it would follow that one million dollars would have to be used each year in reconstruction and that amount would have *Page 240 to be annually used for that purpose, but under the plan adopted in this case, instead of deducting from the gross earnings the amount necessarily expended for that purpose a small fraction of that sum, viz., $4,200, only is allowed to be deducted, a sum which, with the interest compounded for the next sixty years would amount to a million dollars. Under such a plan the company would be practically prohibited from annually constructing a portion of its road and thus prevented from keeping it in that state of efficiency which the public demands. Of course the necessities of reconstruction vary from year to year; some years it may be greater than others, but the assessors each year can easily ascertain the sum required for that purpose. I think, therefore, that we should adhere to the rule sanctioned in theJamaica case, and that a gross sum should be deducted annually for the purposes of reconstruction.
I am aware that some corporations have in the past met with heavy losses by reason of their machinery becoming obsolete. This is especially true with reference to those corporations using electricity for power and other purposes. Such use is the result of modern inventions which have been improved from year to year, thus rendering obsolete and practically useless expensive dynamos and machinery, but there is a difficulty in making any estimate as to the amount of depreciation in the assessable value of tangible property which may result from future invention, and, therefore, this species of property should be left to be considered when such depreciation actually occurs.
CULLEN, Ch. J., VANN, WERNER, HISCOCK and COLLIN, JJ., concur with GRAY, J., except as to rate of interest at which the net income should be capitalized to ascertain value of special franchise. All agree with HAIGHT, J., on that question, except GRAY and COLLIN, JJ.; COLLIN, J., concurring in opinion of GRAY, J.
Orders modified, etc. *Page 241