*1015 1. DEDUCTION - EXPENSE. - A railroad required its subsidiary to pay over all profits in excess of $500 from the operation of motor lines. Held, the payments were not ordinary and necessary expenses of the business of the subsidiary.
2. AFFILIATION - RAILROADS. - A company operating motor buses and trucks is not a common carrier by railroad and may not be included in a consolidated return with railroads. Sec. 141(d)(3), Revenue Act of 1934.
3. CAPITAL STOCK TAX - DECLARED VALUE. - Declared value may not be changed after time for filing an amend return has expired. William B. Scaife & Sons Co.,41 B.T.A. 278">41 B.T.A. 278, followed.
*350 The Commissioner has determined deficiencies in income and excess profits taxes as follows:
| Year | Income tax | Excess profits tax |
| 1934 | $9,923.22 | $3,322.20 |
| 1935 | 11,872.72 | 4,030.18 |
| 1936 | 8,877.79 | 8,348.96 |
The principal question for decision is whether or not the Commissioner erred in disallowing deductions for each year equal to the amounts paid to the Maine Central Railroad*1016 Co., pursuant to a contract between the petitioner and that company. If the Commissioner did not so err, alternative questions are: (1) Whether or not the petitioner is now entitled to have its income tax liability for each year recomputed upon the basis of a consolidated return as an affiliate of the Maine Central Railroad Co., under section 141 of the Revenue Acts of 1934 and 1936, and (2) whether the petitioner is now entitled to amend the declared values of its capital stock for the purpose of recomputing its excess profits tax liability for each year.
FINDINGS OF FACT.
The petitioner, a corporation, was organized under the laws of Maine on October 16, 1883, as "The Kineo Company." Its name was changed to "MaineCentral Transportation Company" on December 17, 1931. Its principal office is at Portland, Maine. It filed separate income and excess profits tax returns for the years here in question with the collector of internal revenue for the district of Maine.
*351 The Maine Central Railroad Co., hereafter called Railroad, is a common carrier by railroad operating in the States of Maine and New Hampshire. Railroad at all times material herein owned all of the*1017 outstanding capital stock of the SamOset Co., the sole business of which, except as hereinafter related, was the operation of two hotels located in Maine. SamOset owned all of the outstanding capital stock of the Eastern Warehouse Co.
The petitioner's outstanding capital stock was 500 shares. Railroad owned all of those shares except qualifying directors' shares, until December 23, 1931, when they were transferred to Eastern Warehouse Co. for a nominal price of $1. Railroad reacquired the shares on November 15, 19358 for the same nominal price.
The officials of Railroad realized in 1925 that the railroad was losing revenue as a result of the increasing use in its territory of motor vehicles as a means of transporting passengers and freight and decided to inaugurate a motor bus and truck service as a supplement to and a substitute for some of its railroad operations. Railroad's charter did not permit it to engage in transporting passengers and freight in motor buses and trucks. It chose its subsidiary, SamOset, to operate the trucks and buses. Railroad and SamOset entered into an agreement on July 15, 1925, in which SamOset agreed to purchase and operate trucks and buses*1018 upon schedules and tariffs approved by Railroad; Railroad agreed to advance the necessary funds without interest for the purchase of equipment and to make up any deficits from operations; and SamOset was to have all of the profits after repayment to Railroad of any sums advanced or paid by it.
SamOset instituted service by bus and truck on a small scale in July and August 1925. It kept separate accounts for its hotel and motor transportation operations. As the service was gradually extended, the officials of Railroad decided to have the bus and truck operations carried on by a corporation which was not engaged in any other activities and which had an appropriate name identifying it with the motor transportation business. The petitioner, a defunct corporation without assets, was selected as the corporation to take over the truck and bus operations from SamOset. The stockholders of the petitioner unanimously voted at a meeting held on December 17, 1931, to alter and enlarge the corporate purposes of the petitioner in part as follows:
1. To carry and transport upon land and in the air by any means of conveyance (railroads for the common carriage of passengers and freight excepted) *1019 and upon waters by boat propelled by steam or otherwise passengers, freight, mail and express within and without the State of Maine at such times and for such parties and upon such terms and conditions as the corporation shall from time to time arrange.
SamOset's motor transportation equipment and franchises, and its agreement with Railroad were transferred and assigned to the petitioner *352 on or about December 29, 1931. The 1925 agreement was amended on November 21, 1932, to enable Railroad to charge interest on the funds advanced by it to the petitioner for the purchase of equipment.
The petitioner's franchises permit it to operate motor buses and trucks in both interstate and intrastate commerce. The interstate transportation has been under the control of the Interstate Commerce Commission since the enactment of the Motor Carriers Act of 1935. The intrastate transportation is under the jurisdiction of the Public Utilities Commission of the State of Maine. The Public Utilities Commission early adopted the view that the public interest required transportation by motor bus and truck in that state to be coordinated with and to supplement, rather than compete with, *1020 the existing services furnished by common carriers by railroad. It denied numerous applications by well financed independent companies for motor truck and bus franchises and granted them to the petitioner and SamOset because it believed that the coordination of motor and rail transportation in the area served by Railroad could be accomplished more effectively and economically by a Railroad controlled company.
The petitioner's motor buses and trucks are operated for the transportation of passengers and freight upon highways in the State of Maine and in the State of New Hampshire generally parallel to the existing or former railway lines of Railroad. Most of its revenue is derived from motor bus operations.
The petitioner has been permitted to use Railroad's terminal, traffic, and ticket office facilities without cost, although the contract is silent on this subject. Its truck and bus schedules are coordinated with the train schedules of Railroad. While the petitioner publishes a complete timetable of its own, its services and bus schedule are also advertised in the train timetables published by Railroad. The transportation of passengers by motor bus has enabled Railroad in*1021 many instances to curtail or completely eliminate the operation of passenger trains on lines parallel to the bus lines, with the result that the cost of maintaining passenger service, whether by rail or by bus, has been materially reduced.
The operation of the trucks and buses during the years 1925 to 1931 resulted in annual deficits ranging from about $3,000 to $17,000. Railroad paid those deficits. The truck and bus operations showed profits of about $12,000 in 1932 and $57,000 in 1933.
Railroad decided in 1933 that the 1925 agreement, as amended, was "one sided" in that Railroad bore all of the losses from the truck and bus operations but did not receive profits in excess of advances and payments.
The petitioner and Railroad entered into a new agreement on December 1, 1933, the pertinent provisions of which are as follows:
*353 2. The Company agrees to provide necessary and suitable equipment and to operate motor trucks and motor coaches or buses within such territory and between such points and over such routes and upon such schedules and tariffs as may be designated or approved by the Railroad, subject to the State and Federal laws from time to time applicable*1022 thereto.
3. The Railroad, in recognition of savings made by it through the substitution for train service of motor trucks and buses by the Company, agrees to advance to the Company the funds required for the furnishing of motor trucks, motor coaches or other equipment for use in said transportation service.
The Company may engage in other bus and truck activities and use its equipment in such services provided the Railroad shall not object to the same in writing.
4. The Railroad agrees to reimburse the Company for any deficits resulting from its motor truck and motor coash operations, including a reasonable and adequate allowance for depreciation and obsolescence of such motor equipment.
All profits resulting from operation of said motor truck and coach line in excess of $500.00 per annum shall accrue and be paid to the Railroad.
5. The Company shall keep records of the revenues and expenses incident to the performance of the motor truck and motor coach service covered by this agreement and statements and settlements or application of such operating losses or profits to be made monthly.
The petitioner accounted for its profits and losses on a monthly basis and*1023 paid whatever profits were due to Railroad each month in accordance with the provisions of the agreement. The total profits paid to Railroad during each of the years 1934 to 1938, after deducting depreciation at the rate of 25 percent, were as follows:
| 1934 | $72,218.92 |
| 1935 | 86,297.05 |
| 1936 | 75,245.98 |
| 1937 | 37,354.52 |
| 1938 | 4,745.50 |
Railroad entered the foregoing amounts on its books as profit from "separately operated properties."
The amounts advanced by Railroad to the petitioner for the purchase of trucks, buses, and other equipment were treated as open account loans. The unpaid amount of those loans at the close of each of the years 1925 to 1938, inclusive, ranged between approximately $19,000 and $115,000. The petitioner paid interest on the loans of from about $5,000 to $7,000 annually during the years 1933 to 1938.
The taxable net income reported by the petitioner for each taxable year was more than $500 but less than $600. The petitioner claimed as deductions from gross income in each taxable year the amounts paid by it to Railroad under the agreement of December 1, 1933. The Commissioner disallowed those deductions.
Railroad filed consolidated*1024 returns for itself and affiliated companies, not including the petitioner, in which it reported an excess of deductions over gross income of $44,831.20 for 1934, $101,021.30 for 1935, and $1,482,652.24 for 1936. It included the profits received by it *354 under the agreement of December 1, 1933, in its income for each of those years.
The petitioner filed capital stock tax returns in which it declared the value of its capital stock to be $50,000 for the year ended June 30, 1934, $50,525 (adjusted value) for the year ended June 30, 1935, and $50,000 for the year ended June 30, 1936. It did not file amended capital stock tax returns for those years within the time required for filing such returns.
OPINION.
MURDOCK: The petitioner claims the right to a deduction equal to the amount which it paid Railroad in each year under the contract of December 1, 1933. These payments, it says, are ordinary and necessary expenses paid during each taxable year in carrying on its business. Sec. 23(a), Revenue Acts of 1934 and 1936. The payments were made pursuant to the contract of December 1, 1933, and the circumstances under which that contract was entered into, as well as the terms*1025 of the contract, may show whether the payments were ordinary and necessary expenses of carrying on the business of the petitioner.
All of the capital of the petitioner was owned by a subsidiary of Railroad at the time the petitioner took over the motor lines, Later, Railroad itself became the owner of all of the stock of the petitioner. Thus, the petitioner was at all times entirely under the control of Railroad. The terms of the contract of December 1, 1933, were not agreed to by parties with adverse interests dealing at arm's length but were just what Railroad wanted them to be. The record does not show that the payments were necessary to the operation of the business of the petitioner or that they were reasonable compensation to Railroad for services rendered to the petitioner. ; affd., ; ; certiorari denied, . The contract appears to be merely a means adopted by Railroad to secure distribution to it of the profits of the petitioner. Those profits were earned by the petitioner. They were not earned*1026 by Railroad. Railroad could not relieve the petitioner from tax by merely taking over the earnings of the petitioner.
Railroad received compensation in the form of interest for the money it advanced to the petitioner. It also allowed the petitioner to use its terminal, traffic, and ticket office facilities free of charge. If the petitioner had been required to pay for the use of those facilities and the amount paid had been shown and claimed as a deduction, the decision in this case might be different. But it has not been shown that any part of the profits paid to Railroad were in payment for the use of facilities of Railroad. The two businesses complemented one another. Benefits flowed both ways. The business of *355 the petitioner reduced the expenses of Railroad. The contract stated that, in recognition of those savings, Railroad agreed to advance the funds for equipment. Even though Railroad may have deserved some compensation for the risk it took in regard to possible losses of the petitioner, nevertheless the entire earnings of the petitioner were not required as reasonable compensation for the assumption of that risk. The record does not justify the allocation*1027 of any part of the profits as compensation for that risk.
The Commissioner, in his determination of the deficiency, mentioned section 45 of the Revenue Act of 1934, which deals with the allocation of income and deductions and authorizes the Commissioner, in the case of two organizations owned or controlled directly or indirectly by the same interests, to distribute, apportion, or allocate gross income or deductions between them if he deems it necessary in order to prevent evasion of taxes or clearly to reflect the income of any such organization. Thus, even if the petitioner were otherwise entitled to the deduction which it claims, the action of the Commissioner in allocating the gross income and deductions of this petitioner so that its income may be clearly reflected, seems entirely proper under section 45.
The next contention of the petitioner is that it is entitled to have its income tax liability for each year computed upon the basis of a consolidated return as an affiliate of Railroad. Section 141(d)(3) excludes a corporation which is not a common carrier by railroad and operates a business other than that of a common carrier by railroad from an affiliated group of common*1028 carriers by railroad. The petitioner is not a common carrier by railroad within the meaning of that section. ; affd., . Thus by the express terms of the statute, the petitioner is excluded from any affiliated group, including Railroad. Furthermore, the Commissioner, in accordance with authority delegated to him in the act, has promulgated Regulations 89, containing article 10(a)(1), which provides that the privilege of making a consolidated return must be exercised at the time of making the return of the common parent corporation and under no circumstances thereafter. Article 12(b) requires that each subsidiary prepare duplicate originals on form 1122 consenting to the regulations and authorizing the common parent corporation to make a consolidated return on its behalf. No consolidated returns were filed on behalf of the petitioner for the taxable years, the petitioner did not consent to the filing of such returns, and, on the contrary, the petitioner filed separate returns for each of the years. The first alternative contention of the petitioner is denied.
The second alternative contention*1029 made by the petitioner is that it should be permitted to amend the declared value of its capital stock *356 reported in its capital stock tax returns for the years ended June 30, 1934, 1935, and 1936. It desires to increase those values so that it will have no excess profits tax to pay after taking into account the adjustments to its net income which result from our decision of the first issue. The parties are in agreement as to an adjustment under section 701(f) of the Revenue Act of 1934 of the return for the year ended June 30, 1935. The petitioner did not file amended capital stock tax returns for any of the years within the time allowed for filing such returns. Its original returns were not incorrect. , and , are not in point. The Board distinguished the Haggar case in and held that a valuation declared in the original capital stock tax return may not be changed after the expiration of the period for filing the return has expired. That decision is controlling here and it follows that the second alternative*1030 contention of the petitioner must be denied. We assume that the petitioner has abandoned its contention that it would be unconstitutional to impose the excess profits taxes upon its net income, as now determined, without a revision or adequate increase in the adjusted declared value of its capital stock. This point was the subject of an amendment to the petition, but it is not mentioned by the petitioner in its brief.
Decision will be entered for the respondent.