*899 Net income of a private corporation, operating water works under contract with a city, is not exempt from tax under section 116(d) of the Revenue Act of 1928 by reason of municipal ownership of part of corporation's stock and bonds, even though the city has a right under the contract to acquire ownership of the water works by purchasing the outstanding capital stock at par.
*750 In these proceedings, which were consolidated for hearing and decision, petitioner contests deficiencies determined by the respondent in the amount of $5,256.58 for the calendar year 1930 and $3,881.95 for the year 1931. The sole issue raised by the pleadings is whether the entire net income of the petitioner is exempt from Federal income tax under the provisions of section 116(d) of the Revenue Act of 1928.
FINDINGS OF FACT.
The facts have been stipulated by the respective parties, and this stipulation is incorporated herein by reference as our findings of fact. For the purposes of this decision the following statement will suffice.
Petitioner, an Iowa corporation, *900 having its principal place of business at Burlington, Iowa, was incorporated in August 1902. The purposes of incorporation, as stated in the articles of incorporation, were as follows:
The principal business of this corporation, shall be to acquire and operate, improve and extend the existing system of water works in the City of Burlington, Iowa, by and with the consent of the city, and under a contract with said city, and it shall have and exercise all the rights and powers of such a corporation, including the right of eminent domain.
By an ordinance of the city of Burlington, approved by the mayor on October 10, 1902, and accepted by the petitioner on the same date, the petitioner secured the exclusive franchise to acquire, operate, improve, extend, and maintain the existing system of water works in the city of Burlington, Iowa, for a period of 20 years. The ordinance also provides, among other things, that a special tax of 5 mills on *751 the dollar shall be annually levied upon all real estate and personal property within the water district, the boundary lines of which are to be designated by the city council; that this tax, in conjunction with the earnings of the*901 petitioner, shall constitute the "water fund"; that petitioner's capital stock shall be $330,000, of which $150,000 shall be common stock, the city of Burlington to own $50,000 thereof, and $180,000 preferred stock; that the dividends of 6 percent on the common and 5 percent on the preferred shall be cumulative; that the preferred stock shall be subject to retirement out of the water fund as the city may direct; that the petitioner may issue its bonds in the sum of $220,000; that interest at the rate of 4 percent on its bonds shall be a preferred claim upon that part of the water fund raised by taxation and shall be paid directly by the city to the bondholders; that after paying this bond interest the balance of the tax shall be paid over to the petitioner; that there shall next be paid from the water fund the current expenses of petitioner, including necessary repairs to the water works, and including also all taxes that may be levied upon the water works or upon the stock held by the stockholders in petitioner; that there shall next be paid the dividends on the preferred and common stock respectively; that the city shall have the right to terminate the contract upon one year's previous*902 written notice and take possession and control of the works, assuming all the duties and liabilities devolving upon petitioner, and repaying to its stockholders par for all outstanding capital stock, together with accrued and unpaid dividends; that upon the termination of the franchise, if the city, or some other party with its consent, shall not take the works, then the franchise shall continue; that petitioner's board of directors shall consist of five, two of whom shall be appointed by the mayor, with the approval of the city council; that for the compensation specified in the franchise, petitioner shall furnish at the several fire hydrants all the water needed for the extinguishment of fires in any portion of the city, and all water needed at any of the city offices; that petitioner is authorized to fix its own rates of charges for water furnished to individuals or corporations not to exceed prevailing charges in certain named cities of Iowa; that petitioner shall make an annual net dividend at the rates hereinbefore specified, upon all cash actually paid in upon its stock, and no more; that it must rely entirely upon the water fund for the means of making such dividends and that*903 nothing for this purpose or for defraying any of the other expenses connected with the water works shall ever be payable out of the proceeds of the general revenue of the city.
The duration of the corporate existence of Citizens' Water Co. as a corporation was renewed and extended for a period of 20 years from the 10th day of November 1922 by a certificate of renewal and articles *752 of incorporation filed for record in the office of the Secretary of State of Iowa on November 28, 1922.
The petitioner's authorized capital stock is $330,000, divided into shares of $100 each, of which $150,000 is common stock and $180,000 is preferred stock. All of this stock was outstanding during the years 1930 and 1931.
Regular dividends of 6 percent on the common stock ($9,000) and 5 percent on the preferred stock ($9,000), amounting to $18,000 in each year, were declared and paid in each of the years 1930 and 1931.
During the years 1930 and 1931 the city of Burlington owned 500 shares or $50,000 of common stock and 532 shares or $53,200 of preferred stock. The 500 shares of common stock were acquired on November 10, 1902, and the preferred stock was acquired at various dates*904 between 1904 and 1923.
The petitioner filed corporation income tax returns for the years 1930 and 1931 with the collector of internal revenue for the district of Iowa, reporting a net income of $43,804.80 for the calendar year 1930 and a net income of $32,349.55 for the calendar year 1931.
Operating revenues were received by the petitioner in the years 1930 and 1931 in the respective amounts of $162,339.30 and $159,912.33. This income was derived from the following sources:
| 1930 | 1931 | |
| Metered service | $45,415.04 | $43,766.00 |
| Unmetered service | 89,117.27 | 90,502.06 |
| Extra water service | 436.81 | 462.23 |
| Municipal service | 28,077.35 | 25,979.39 |
| 163,046.47 | 160,709.68 | |
| Less: Rebates | 707.17 | 797.35 |
| Total | 162,339.30 | 159,912.33 |
The amounts shown above as received from municipal service, to wit, $28,077.35 and $25,979.39 for the years 1930 and 1931, respectively, were derived from the tax of 5 mills levied by the city of Burlington pursuant to section 9 of the ordinance.
During the taxable years 1930 and 1931 the petitioner's first mortgage 5 percent bonds were outstanding in the amount of $148,000, of which $68,500 was owned by the city of Burlington.
*905 During the years 1930 and 1931 additions to plant were made and financed out of earnings in the amounts of $65,952.17 and $71,447.40, respectively.
OPINION.
ARUNDELL: The sole issue presented for our decision is whether the entire net income of petitioner is exempt from Federal income tax under the provisions of section 116(d) of the Revenue Act of 1928, which provides as follows:
*753 In addition to the items specified in section 22(b), the following items shall not be included in gross income and shall be exempt from taxation under this title:
* * *
(d) Income of States, municipalities, etc. - Income derived from any public utility or the exercise of any essential governmental function and accruing to any State, Territory, or the District of Columbia, or any political subdivision of a State or Territory, or income accruing to the Government of any possession of the United States, or any political subdivision thereof.
Whenever any State, Territory, or the District of Columbia, or any political subdivision of a State or Territory, prior to September 8, 1916, entered in good faith into a contract with any person, the object and purpose of which is to acquire, *906 construct, operate, or maintain a public utility -
(1) If by the terms of such contract the tax imposed by this title is to be paid out of the proceeds from the operation of such public utility, prior to any division of such proceeds between the person and the State, Territory, political subdivision, or the District of Columbia, and if, but for the imposition of the tax imposed by this title, a part of such proceeds for the taxable year would accrue directly to or for the use of such State, Territory, political subdivision, or the District of Columbia, then a tax upon the net income from the operation of such public utility shall be levied, assessed, collected, and paid in the manner and at the rates prescribed in this title, but there shall be refunded to such State, Territory, political subdivision, or the District of Columbia (under rules and regulations to be prescribed by the Commissioner with the approval of the Secretary) an amount which bears the same relation to the amount of the tax as the amount which (but for the imposition of the tax imposed by this title) would have accrued directly to or for the use of such State, Territory, political subdivision, or the District of*907 Columbia, bears to the amount of the net income from the operation of such public utility for such taxable year.
(2) If by the terms of such contract no part of the proceeds from the operation of the public utility for the taxable year would, irrespective of the tax imposed by this title, accrue directly to or for the use of such State, Territory, political subdivision, or the District of Columbia, then the tax upon the net income of such person from the operation of such public utility shall be levied, assessed, collected, and paid in the manner and at the rates prescribed in this title.
The first contention of the petitioner is that its entire net income under the terms of the ordinance accrues to and is the property of the city of Burlington and is exempt from tax under the provisions of the first paragraph of section 116(d), supra.With this contention we do not agree. This paragraph was intended to exempt the city from taxation upon income which it actually receives from any public utility or from the exercise of an essential governmental function. Cf. *908 . During the taxable years here under consideration the city of Burlington owned one third of petitioner's outstanding common stock and approximately one third of its preferred stock. The city also owned approximately one half of the petitioner's outstanding first mortgage 5-percent bonds. As a stockholder it received from petitioner dividends of 6 percent on the common stock and 5 percent on the preferred *754 stock, and as a bondholder it was entitled to receive the interest due on the bonds. These dividends and this interest represent the only part of the petitioner's income which accrued to or was received by the city during the taxable years 1930 and 1931. It is true, as petitioner points out, that the city under the terms of the ordinance could take full possession and ownership of the water works by giving petitioner one year's notice and paying par and accrued dividends on all outstanding stock, and thus get the benefit of accretions in the "water fund" arising out of the tax of 5 mills and unused earnings. But the city did not exercise this right during the taxable years here under consideration and*909 we are not, therefore, impressed with petitioner's argument that its net income accrued to and became the property of the city of Burlington. The petitioner is a private corporation and the city is one of its stockholders. It is too well settled to require citation that a corporation is a taxable entity separate and distinct from its stockholders and that the income of a corporation is not the income of its stockholders. The first paragraph of section 116(d), supra, exempts from taxation income which is received by a state or political subdivision thereof from any public utility. In our opinion it grants no exemption to a public utility corporation even though a substantial portion of its unused earnings may at some future time accrue to the benefit of a political subdivision of a state.
It is unnecessary here to discuss in detail the provisions of the second paragraph of section 116(d), supra, because under either subdivision (1) or (2) of this paragraph the entire net income of the petitioner is taxable. Under subdivision (1) the city of Burlington would be entitled to a refund if the imposition of the tax upon the net income of petitioner diminished the amount of*910 the proceeds from the operation of the water works which would accrue directly to the city during the taxable year. The city is not a party to these proceedings and the question of how much of the tax, if any, is refundable to it need not here be determined.
In support of its position that its entire net income is exempt from taxation petitioner relies on the decision of the Circuit Court of Appeals for the First Circuit in (reversing ). That decision is not controlling here as the facts in that case differ in many important respects from those here involved and it was decided under the provisions of section 213(b)(7) of the 1921 Act, which differ materially from those contained in section 116(d) of the 1928 Act. Section 213(b)(7) provided that "no tax shall be levied under the provisions of this title upon the income derived from the operation of such public utility, so far as the payment thereof will impose a loss or burden upon such state * * * or political subdivision." Section 116(d) of the 1928 Act provided that "a tax upon the net *755 income from the operation*911 of such public utility shall be levied, assessed, collected, and paid * * * but there shall be refunded to such State, * * * political subdivision an amount" etc. Under the 1921 Act the public utility was exempted from the payment of that part of the tax on its net income which would impose a burden on the state or political subdivision. Under the 1928 Act the public utility paid the tax on its entire net income and the state or political subdivision was granted a refund of the amount which it lost as a result of the imposition of the tax.
It is our conclusion that section 116(d), supra, was not intended by Congress to relieve a private public utility corporation, such as petitioner, operating a water works under contract with a municipality, from taxation on its net income. This section was in our opinion enacted to relieve states and political subdivisions thereof from the loss or burden which might result from the imposition of taxes by the Federal Government on income received by or accruing to them from any public utility or from a public utility corporation with which a contract had been negotiated prior to September 8, 1916. It grants no exemption to this petitioner.
*912 Judgment will be entered for the respondent.