*1282 1. The respondent's determination of the value per cord on March 1, 1913, of petitioner's timber is sustained.
2. The respondent's action in disallowing as a deduction for 1918 the repayment of certain interest collected by the petitioner in 1916 and 1917 in excess of the amount to which it was entitled sustained, where petitioner's books were kept on the accrual basis.
3. The respondent's action in disallowing as deductions certain amounts advanced by the petitioner to a railroad company, one-half of whose stock was owned by the petitioner, sustained, where the petitioner for several years afterwards consistently treated the amounts as loans.
4. The amount of the petitioner's reserve for depreciation at March 1, 1913, determined for invested capital purposes.
5. Held that the petitioner is entitled to include in its invested capital, at cost, timber cut and remaining in the woods at the beginning of each taxable year.
6. Value of certain timber lands and water-power sites acquired by the petitioner in 1907 for capital stock determined for invested capital purposes.
7. Held, that the petitioner is not entitled to deduct from gross income for 1917 legal*1283 expenses incurred by it in defense of its president in a criminal proceeding and of itself and its president in an equity proceeding, all of which arose from their connection with and participation in the activities of a certain organization which was adjudged a combination in restraint of trade and in violation of the laws of the United States.
*560 This proceeding is for the redetermination of deficiencies in income and profits taxes of $29,366.34, $81,108 and $2,806.95 for 1917, 1918 and 1919, respectively. The petition as amended alleges that the respondent has erred in the following respects: (1) in understating the depletion allowance to which the petitioner is entitled for 1917, 1918 and 1919; (2) in disallowing as a deduction for 1918 the amount of $2,916.21 representing a repayment of interest by the petitioner to the Adirondack League Club; (3) in disallowing as deductions for 1917, 1918 and 1919 the amounts of $6,348.25, $12,750 and $16,173 respectively representing amounts advanced by the petitioner*1284 to the Glendale and Western Railroad Company under an alleged agreement between petitioner and the other stockholder of that company whereby they were to bear equally the losses of that company; (4) *561 in understating invested capital for 1917, 1918 and 1919 by setting up for invested capital purposes a depreciation reserve of $206,098.33 as at March 1, 1913, for depreciation sustained on petitioner's plant property for years prior thereto; (5) in understating invested capital for 1918 on account of an erroneous overstatement of the reserve for depreciation at the beginning of the year in the amount of $5,143.33; (6) in understating invested capital for 1918 on account of the omission therefrom of an amount of $20,639.21 representing the amount the petitioner had invested in acid towers that were under construction; (7) in understating invested capital for 1917, 1918, and 1919 by treating timber cut in prior years as the timber consumed and thereby failing to include in invested capital inventories of logs cut and remaining in the woods at the beginning of the respective years; (8) in understating invested capital for 1917 on account of an excessive deduction for inadmissible*1285 assets; (9) in understating invested capital for 1918 and 1919 on account of excessive deductions for Federal income and profits taxes for 1917 and 1918 in so far as his determinations of such taxes are erroneous because of the errors involved in this proceeding; (10) in understating invested capital for 1917, 1918 avd 1919 in the amount of $11,242.41, due to overstating the cost of assets retired by the petitioner during 1915; (11) in failing to allow as a deduction for 1919 the amount of $18,649.62 representing the New York State franchise tax which accrued against the petitioner during that year; and (12) in understating invested capital for 1917, 1918 and 1919 on account of an understatement of the value of mill property, water-power rights and timber lands acquired by the petitioner during 1907 in exchange for its capital stock.
At the hearing the respondent admitted error with respect to Nos. (5), (6), and (10) and in his brief admitted error with respect to No. (11). The petitioner waived No. (8) at the hearing. No. (9) will be adjusted automatically upon recomputation of the petitioner's tax liability under Rule 50.
In amended answers and as an assertion of a claim*1286 that the deficiencies for 1917, 1918 and 1919 should be increased, the respondent alleges that he erred (a) in allowing as a deduction for 1917 the amount of $26,210.98 taken by the petitioner in its return for that year for legal expenses and (b) in determining that the amount of the petitioner's depreciation reserve at March 1, 1913, was $206,098.33 instead of $259,039.41.
There are for our consideration the issues raised by the petition as amended and set forth in Nos. (1), (2), (3), (4), (7) and (12) and those raised by the answer as amended and set forth as (a) and (b) above.
*562 FINDINGS OF FACT.
The petitioner is a New York corporation, organized in September, 1892, and having its principal office at Lyons Falls. It is engaged in the business of manufacturing paper from timber taken from its own timber lands.
On March 1, 1913, the petitioner was the owner of certain timber lands situated on the westerly slope of the Adirondack Mountains in northern New York and hereinafter referred to as the Moose River tract and the Tug Hill tract. The Moose River tract comprised about 77,000 acres of land on which there remained uncut on March 1, 1913, 925,000 cords of*1287 merchantable soft wood timber 10 inches and over in diameter. The Tug Hill tract comprised about 30,317 acres of land on which there remained uncut on March 1, 1913, 155,490 cords of merchantable softwood timber 10 inches and over in diameter. Of the foregoing amounts of timber about 85 per cent was spruce and the remainder was balsam and hemlock.
The Moose River tract lay along the South Branch of Moose River about 30 miles east of Lyons Falls and the timber when cut was floated down this river to the petitioner's mills. The Tug Hill tract lay from 10 to 15 miles west of Lyons Falls and the logs from this tract were transported to petitioner's mills over the Glenfield and Western Railroad and the New York Central. The petitioner's mills and timber holdings were in what is known as the Watertown paper mill district.
It is the practice of the petitioner to cut only timber 10 inches and over in diameter. After the timber 10 inches and over in diameter is cut from the land the smaller timber remaining requires from 30 to 50 years to grow up to the point where it can be cut on the same basis as the preceding cut. With the large acreage which the petitioner owned and by cutting*1288 only timber 10 inches and over in diameter the petitioner had what it considered to be a perpetual supply of timber for its paper mill operations. Prior to 1913 the trend of timber prices had been gradually upward and on March 1, 1913, the prospect in the Watertown district was for a further increase in price.
In 1913 about 80 per cent of the pulpwood consumed in the Watertown district came from Canada. The Canadian wood controlled the market price of pulpwood in the district and was a factor in determining the fair market value of timber in the Adirondacks. All points in the Watertown district had a common freight rate on Canadian pulpwood. The average price from January 1, 1913, to March 1, 1913, of Canadian peeled pulpwood in four-foot lengths delivered in the Watertown district was $11.42 per cord, while the average price for the entire year 1913 was $11.58 per cord.
*563 For the five years 1910 through 1914 the petitioner's average cost per cord of cutting, preparing and delivering its own logs to its mills in the same condition as the Canadian wood was delivered was $4.996 for the Moose River tract and $5.707 for the Tug Hill tract.
Although Canadian pulpwood*1289 controlled the market price of pulpwood in the Watertown district, it was not as good as that from the Adirondacks. The latter is a closs-grain wood which weighs on an average about 4,000 pounds to the cord, while the Canadian wood weighs on an average about 2,700 pounds to the cord. The Adirondack wood contains about 85 per cent spruce, the most desirable species for the manufacture of paper, and the balance is balsam and hemlock. The Canadian wood contains about 55 per cent spruce and 45 per cent balsam. The Canadian balsam is under blight and is full of red rot, dote and shake. The Adirondack pulpwood procuces between 2,600 and 2,700 pounds of dry wood pulp, while the Canadian wood produces about 2,350 pounds. The Adirondack pulpwood is worth $1 more per cord to the paper manufacturer than the Canadian wood.
In 1896, 1897 and 1898 J. B. Todd was purchasing softwood timber for the Fisher interests at Lyons Falls, paying $2 a cord for the timber as it was cut. In 1898 Todd purchased the softwood timber on the De Camp tract, consisting of about 10,000 acres. For this he paid $2.50 a cord as it was cut. In 1904 Todd paid C. Collins Merrian of Lyons Falls $3 a cord for about*1290 200 cords of softwood timber as it was cut. All of this timber was on the westerly slope of the Adirondacks and in the same region as the petitioner's timber.
In 1907 the petitioner sold to the International Paper Company a certain area of its softwood timber in township 4 of its Moose River tract at $2.50 a cord, to be paid for as cut. This timber, amounting to about 21,000 cords, was cut by the International Paper Company between 1907 and 1913. The timber in this area was not as accessible to the petitioner's manufacturing plants as the other timber in the same township.
About 1904 or 1905 Isaac Kenwell, who had charge of the wood land department of the Union Bag and Paper Company for the State of New York, appraised and purchased for that company 5,000 acres of softwood timber land for $60,000. This land was bounded on two sides by the petitioner's Moose River tract. The stand of timber on the land acquired by the Union Bag and Paper Company was similar to that on the petitioner's lands in township 4, which Kenwell thought contained about 8 cords of spruce timber to the acre in 1907.
About 1906 the Dexter Sulphite Pulp and Paper Company purchased about 20,000 acres*1291 of softwood timber land at $6 per acre. *564 This land, which was situated near the petitioner's Tug Hill tract and comparable to it, contained from 9 to 10 cords of soft wood per acre.
On or about January 9, 1909, the State of New York appropriated for park purposes about 11,897 acres of land belonging to Taggarts Paper Company. Of the land appropriated 7,118 acres contained a virgin stand of merchantable hardwood and softwood timber. The balance consisted of lakes, burned over land and land which had been lumbered in whole or in part. These lands were about four miles from the petitioner's Moose River tract and compared favorably to that tract from the standpoint of quality of timber and logging conditions. In the exercise of its rights under the law the Taggarts Paper Company reserved for its own use all spruce timber on the appropriated land which was ten inches and more in diameter at a height of three feet above the ground. In a decision dated February 6, 1918, the Court of Claims of the State of New York found that there was on the property at the time of appropriation standing softwood timber which contained 22,184.27 cords of pulpwood over and above that reserved*1292 by the Taggarts Paper Company under the law and that this pulpwood at the date of appropriation, January 9, 1909, had a fair and reasonable market value of $4.25 per cord as it then stood.
In 1917, when the price of timber was supposed to have been higher than in 1913, John E. Johnston purchased the O'Toole tract of softwood timber land in the Tug Hill Region, containing 50 acres, for $800. At some undisclosed date Johnston bought the Schibley tract of softwood timber land situated in the Tug Hill Region and containing 25 acres, for $351. There were from 15 to 20 cords of softwood timber per acre on this land. The timber on the O'Toole and Schilbley tracts was virgin timber and similar to that on the petitioner's tracts. The topography of the land was also similar to that of the petitioner's lands.
In its original and amended income-tax returns for the years 1917, 1918 and 1919 the petitioner did not take a deduction for depletion in the space provided therefor on the returns, but variously stated that a deduction for depletion was being included, "as an operating charge," "under Raw Materials Consumed," "in cost of material," "under Pulp Wood" and "in costs." In its second*1293 amended return for 1917 and in its amended returns for 1918 and 1919 it took depletion on the basis of $4.75 per cord for each cord of timber used. This amount was the amount shown by the petitioner in its Form T, General Forest Industries Questionnaire, filed with the respondent on March 26, 1920, and in which it stated that it believed $4.75 per *565 cord was a "conservative average estimate" of the fair market value of its softwood timber on March 1, 1913.
In determining the deficiencies here involved the respondent determined, for depletion purposes, that the fair market value of the petitioner's timber at March 1, 1913, was $3.50 per cord. Owing to a misunderstanding as to the number of cords on which the petitioner had claimed depletion, an error was made in computing the amount of depletion disallowed. As a result of this the respondent allowed depletion at the rate of $1.269 per cord for the timber used in 1917, $2.107 for that used in 1918, and $3.8506 for that used in 1919.
The following is a statement of the amount of depletion allowable for the respective years on the basis of $3.50 per cord for the cords used and the amount actually allowed by the respondent: *1294
| Year | Cords used | Depletion allowable on | Depletion allowed |
| the basis of $3.50 per | by respondent | ||
| cord | |||
| 1917 | 13,187.05 | $46,154.67 | $16,739.89 |
| 1918 | 19,799.01 | 69,296.54 | 41,723.00 |
| 1919 | 28,394.38 | 99,380.33 | 109,336.43 |
Inventories of cords of timber cut but not used were not considered by the respondent in determining income for any of the years here involved.
Softwood timber cut by the petitioner during 1917, 1918 and 1919 was 36,228.68 cords, 41,860.65 cords and 20,429.52 cords, respectively.
The Adirondack League Club owned a large amount of softwood timber land lying between the petitioner's mills at Lyons Falls and its Moose River timber tract. From time to time during the period from 1910 to as late as 1918 the petitioner purchased timber from the Club. Under the contracts of purchase the petitioner from time to time advanced money to the Club. This money drew interest until the wood was taken off. In 1916 and 1917 in adjusting the accounts between itself and the petitioner the Club allowed the petitioner credit for interest in a total amount of $2,916.21 in excess of the amount to which the petitioner was entitled. On August 19, 1918, petitioner, *1295 upon demand of the club, paid to it the amount of $2,916.21 representing the amount of the credit for interest theretofore erroneously allowed. For 1918 as well as for the other years involved in this proceeding the petitioner kept its books and made its income-tax returns on the accrual basis. In its income-tax return for 1918 the petitioner took the amount of $2,916.21 as a deduction. In determining the deficiency here involved for 1918 the respondent disallowed the deduction.
*566 Throughout the taxable years here involved and for several years prior thereto the petitioner owned one-half of the capital stock of the Glenfield and Western Railroad Company. The Dexter Sulphite Pulp and Paper Company owned the other half of the stock. This railroad company was a public service corporation and was under the regulation of the Public Service Commissioner of New York State which fixed the rates that it could charge and periodically inspected its locomotives, tracks and right of way. The railroad company owned and operated a railroad about seven miles in length between Glenfield, New York, and the Tug Hill timber holdings of the petitioner and the Dexter Sulphite Pulp and*1296 Paper Company. This railroad was the only means the petitioner and the Dexter Sulphite Pulp and Paper Company had of transporting their logs from their timber lands to Glendale where the Glenfield and Western Railroad connected with the New York Central Railroad.
The revenue derived by the Glendfield and Western Railroad Company under the rates prescribed by the New York Public Service Commission was not sufficient to meet the operating expenses of the road. Their shipments of logs over the road being substantially equal and comprising the greater portion of the road's business the petitioner and the Dexter Sulphite Pulp and Paper Company during 1917 or prior thereto agreed to advance to the railroad company equally as between themselves amounts sufficient to meet the excess of the road's expenses over its revenues. Pursuant to this agreement, the petitioner advanced to the railroad company $6,348.25 in 1917, $12,750 in 1918, and $16,173 in 1919.
The amounts thus advanced by the petitioner were carried on its books and in its financial statements as indebtedness owing by the railroad company to it not only during the years here involved, but down to as late as 1921. In computing*1297 its invested capital in its returns for the years in controversy the petitioner treated the advances as assets. In determining the deficiencies here involved the respondent also treated them as assets in computing invested capital.
The cost of petitioner's depreciable assets to March 1, 1913, as shown by its books and as determined by the respondent was $1,262,884.70. No depreciation on its depreciable property was taken by the petitioner on its books for any year prior to 1909. On March 21, 1918, the petitioner entered in the depreciation account on its books the amount of $52,941.08 for depreciation for 1909. On January 25, 1912, the amount of $72,548.17 was entered in that account for depreciation for 1911. On January 18, 1913, the amount of $72,548.17 was entered as depreciation for 1912 and on January 27, 1914, the amount of $48,365.44 was entered as depreciation for 1913.
*567 In its returns of annual net income filed for 1909 through 1913 the petitioner took deductions for depreciation in the following amounts, which were allowed by the respondent: 1909, $52,941.08; 1910, $52,941.08; 1911, $72,548.17; 1912, $72,548.17; 1913, $48,365.44.
Prior to March 1, 1913, it*1298 was the practice of the petitioner to charge to expense certain expenditures which under the present methods of the petitioner would be capitalized. Between March 1, 1897, and March 1, 1913, the petitioner expended a total of $80,214.84 for replacements and additions to depreciable assets, which were thus charged to expense. Approximately one-half of the total amount expended was for replacements and additions between January 1, 1909, and March 1, 1913. No part of the $80,214.84 is included in the cost of depreciable assets at March 1, 1913, as determined by the respondent and as set forth above nor have any depreciation deductions been taken or allowed with respect to the items for which the amount was expended.
In determining the deficiencies here involved the respondent, for invested capital purposes, computed the amount of the petitioner's reserve for depreciation at March 1, 1913, to be $206,098.33, or the total of the amounts entered by the petitioner on its books for depreciation for 1909, 1911, 1912 and 2/12 of that of 1913.
For invested capital purposes the petitioner's depreciation reserve of $206,098.33 at March 1, 1913, as determined by the respondent should be*1299 increased to $259,039.41, or by the amount of $52,941.08 representing depreciation deducted by the petitioner in its annual return of net income for 1910 but not entered by it on its books.
In his computation of invested capital for each of the taxable years here involved the respondent arrived at the cost of timber included therein by deducting from petitioner's total cost the depletion sustained upon the timber cout to the end of the preceding year, computed as follows:
| Moose River tract unit | Tug hill | |||
| cost $0.5710664 | tract cost $1.3415235 | |||
| Year ended - | Cords cut | Amount of depletion | ||
| sustained | Cords cut | Amount of | ||
| depletion sustained | ||||
| Dec. 31, 1916 | 236,927.05 | $135,301.08 | 104,193 | $139,777.36 |
| 1917 cut | 29,985.68 | 17,123.81 | 6,243 | 8,375.13 |
| Dec. 31, 1917 | 266,912.73 | 152,424.89 | 110,436 | 148,152.49 |
| 1918 cut | 33,174.65 | 18,944.94 | 8,686 | 11,652.47 |
| Dec. 31, 1918 | 300,087.38 | 171,369.83 | 119,122 | 159,804.96 |
*568 At the beginning of each of the years in question the petitioner had logs in the woods which had been cut but not removed, as follows:
| Date | Moose River tract | Tug Hill tract |
| Cords | Cords | |
| Jan. 1, 1917 | 8,061.02 | 5,048 |
| Jan. 1, 1918 | 29,985.68 | 6,439 |
| Jan. 1, 1919 | 33,174.65 | 8,686 |
*1300 In his computation of invested capital the respondent excluded these logs in the woods as of the respective dates.
In the balance sheet as of December 31, 1918, attached to the deficiency letter, respondent has set out as included in his invested capital computation an item "Stumpage cut and not removed $22,064.43." This item was in fact the inventory of finished product as of December 31, 1918, and was erroneously designated in the balance sheet.
In determining the deficiencies involved in this proceeding the respondent determined the petitioner's net income and invested capital to be as follows:
| Year | Net income | Invested capital |
| 1917 | $667,761.82 | $2,596,146.48 |
| 1918 | 517,294.71 | 2,633,286.01 |
| 1919 | 808,424.03 | 2,985,852.58 |
The respondent determined that the petitioner was entitled to an excess-profits credit of 9 per cent of invested capital for 1917.
In his computation of invested capital for the respective years the respondent deducted therefrom the following indicated amounts in respect of taxes for prior years:
| Prior year's tax | |||
| Tax year | Year | Amount | Amount deducted |
| 1917 | 1916 | $2,795.97 | $2,795.97 |
| 1918 | 1917 | 149,918.34 | 82,557.03 |
| 1919 | 1918 | 238,108.47 | 100,624.64 |
| 1 1917 | 29,366.34 | 29,366.34 |
On August 24, 1907, the petitioner, in exchange for 3,400 shares of its capital stock of a par value of $100 per share, acquired from the International Paper Company about 17,000 acres of timber lands in the Adirondack Mountains and certain other property known as *569 the Kosterville property. These timber lands were about 30 miles east of Lyons Falls and were situated in township 4, which is a portion of what has heretofore been referred to as the petitioner's Moose River tract. The timber lands acquired in 1907 were in a rough section of country. A portion of them was on the divide between the Moose River basin and the Judson River basin and a portion was on the South Branch of Moose River. They constituted the most inaccessible portion of the petitioner's Moose River tract. The Kosterville property consisted of two ground woodpulp mills designated "Mill A" and "Mill B," located at Kosterville, New York, about 1 1/4 miles east of Lyons Falls, together with two developed water-power sites on the Moose River which furnished the power for operation of the mills. Along with the mills and water-power sites the petitioner acquired the land necessary*1302 for the mill sites and the water-power development. The petitioner acquired the Kosterville properties in anticipation of doubling its paper mill capacity at Lyons Falls.
On the 17,000 acres of land in township 4 acquired by the petitioner in 1907 there was at the time of acquisition a stand of timber consisting of 271,000 cords of softwood ten inches and over in diameter and 42,500 cords of the same kind of timber under ten inches in diameter. In addition there were on the land 17,000,000 feet of hardwood timber.
Shortly after acquiring the 17,000 acres of timber land in township 4 the petitioner sold back to the International Paper Company all the softwood on the most easterly portion of it for $2.50 per cord as and when cut. This timber, amounting to 21,000 cords, was, as heretofore stated, cut and removed between 1907 and 1913. The sale was made by the petitioner because this portion of the timber was over the ridge on a water shed which sloped to the east and drained into the Hudson River and was not very accessible for the petitioner to log and float the logs to its mill as in the case of the timber on the balance of the tract. This timber, however, was more valuable*1303 to the International Paper Company, since it was operating on the same side of the divide that the timber was situated on. When completing the cutting of the timber purchased from the petitioner, a representative of the International Paper Company sought to purchase additional timber from the petitioner at some undisclosed price. During 1907 and since the State of New York has been a purchaser of cut-over and burned-over timber lands in the Adirondack Mountains within the State Park area. The 17,000-acre tract acquired by the petitioner in 1907 was in this area. For certain purchases made on certain undisclosed dates the state has paid an average of $5 an acre. With respect to 4,779 acres of cut-over and burned-over *570 land and water taken over by the State of New York from the Taggarts Paper Company in 1909, the Court of Claims of the State of New York found the fair and reasonable market value to be $2 an acre. It found the fair and reasonable market value of 7,118 acres of land with the hardwood timber thereon taken over to be $8 an acre.
Mills A and B were operating in 1907 when acquired by the petitioner and have continued in operation since then with the exception*1304 of a short period at some time since 1907, when Mill B burned and was being rebuilt. These mills operate with the power from the two waterfalls on the Moose River nearby and produce ground wood pulp from the petitioner's logs that are floated down the river. The ground wood pulp is transported to the petitioner's paper mill at Lyons Falls and used to make paper.
The water-power development on the Moose River at Mills A and B which the petitioner acquired in 1907 consisted of two water-power sites, with two wooden dams thereon across the river, resting on rock foundations, together with the sluices or canals through which the water was conducted to the power-wheel installations and the power installations themselves. The dam at Mill A was 140 feet long, that at Mill B was 300 feet, and they were each from 6 feet to 8 feet in height. There was a waterfall or gross head in use at Mill A of 34.4 feet and at Mill B of 29.9 feet. The turbine installation was 1,684 rated horsepower at Mill A and 1,530 at Mill B. The total available energy at both mills on the basis of 70 per cent efficiency was 2,446 horsepower years, composed of 717 horsepower years of primary energy, or energy*1305 continuous throughout the year, and 1,729 horsepower years of secondary energy, or energy not continuous throughout the year.
The average price which paper mills in the Black River District, in which petitioner's Mills A and B were located, were paying for purchased electric power in 1907 was $30 per horsepower year for primary power and $15 for secondary power. As a general thing ground wood-pulp mills and not buy primary power in 1907, but used water power almost exclusively, since it was a cheap form of power.
There were three water-power sites on the Moose River upstream from the petitioner's Kosterville sites, which could be developed and utilized for the manufacture of ground wood pulp.
Some time subsequent to 1920 the St. Regis Paper Company sold a water-power site on the Black River to the Power Corporation of New York at a price in excess of $100 per horsepower of wheel installation. The relation between the primary power and secondary power produced on the Black River at this point was not very different *571 from that on the Moose River. The purchaser, who was engaged in the general electric business, a large part of which was supplying power to pulp and*1306 paper mills, redeveloped the properties, building a new dam and new plants and installing new machinery throughout.
Prior to the acquisition by the petitioner from the International Paper Company of the Kosterville properties and the tract of timber land as set forth above, it did not own a substantial amount of stock in the International Paper Company, nor did that company own a substantial amount of stock in the petitioner.
In amended income and profits-tax returns filed by the petitioner for 1917, 1918 and 1919 it used an amount of $439,028.90 as representing the value of the Kosterville properties and the timber lands acquired in 1907. In accordance with the vendor's valuation the petitioner apportioned $263,416.35 of that amount to the timber lands and $175,612.55 to buildings, equipment, water-power sites, etc. Of the $175,612.55 the petitioner allocated $91,192.08 to the water-power sites, leaving the remainder, or $84,420.47 applicable to buildings, equipment, etc.
In determining the petitioner's invested capital for the years here involved the respondent determined that the value of the timber land - land and timber - was $263,416.35, of the buildings and equipment*1307 (Mills A and B) was $123,112.55, and of the water-power sites was $52,500.
The actual cash value of the tract of about 17,000 acres of timber land at the time of acquisition by the petitioner in 1907 was $678,000 representing $42,500 for the land, $627,000 for the softwood timber, and $8,500 for the hardwood timber thereon. The actual cash value of the two water-power sites acquired by the petitioner at the same time was $91,192.08.
In February, 1917, the Federal Trade Commission was conducting an investigation of the newsprint paper industry as the result of the complaints of publishers throughout the United States. Coincident with this investigation, the Department of Justice was conducting in the southern district of New York a grand jury investigation of the past performances of the manufacturers of newsprint paper. Early in February, 1917, Gordias H. P. Gould, who was then president of the petitioner, consulted Henry A. Wise, an attorney in New York City, and retained him to represent the petitioner and its interests.
On April 12, 1917, the grand jury of the United States District Court for the Southern District of New York presented an indictment against Gordias H. *1308 P. Gould and several other individuals, most of whom were described therein as president and directing and *572 managing officer of certain designated corporations engaged in the manufacture of newsprint paper. Gould and the others indicted were charged with unlawfully having engaged from December 1, 1914, to the day on which the indictment was presented, in a conspiracy with each other in restraint of trade and commerce among the several states and with foreign nations. It was alleged in the indictment that the defendants had used the News Print Manufacturers Association as an instrumentality in accomplishing the crime with which they were charged. Gould was described in the indictment as the president and directing and managing officer of the Gould Paper Company, Donnacona Paper Company, Ltd., and St. Regis Paper Company, all corporations, and it was alleged that he thereby controlled the sale in trade and commerce of approximately 330 tons of newsprint paper daily.
On April 17, 1917, the defendants were arraigned and pleaded not guilty. On November 15, 1917, the jury was sworn and the trial of the defendants was commenced, but was adjourned to November 26, 1917.
*1309 Prior to November 15, 1917, the attorneys for the Government were conducting negotiations with the representatives of the manufacturers of newsprint paper whose officers had been indicted, for the purpose of arriving at some form of agreement under which the manufacturers would consent to a regulation of the industry. Throughout these negotiations Wise represented the petitioner.
Shortly before the day the trial began the manufacturers, other than the petitioner, whose officers had been indicted entered into negotiations which ultimately resulted in an agreement, dated November 26, 1917, between the Attorney General of the United States and the manufacturers, including the petitioner. The agreement provided, among other things, that the United States might file a petition in equity to enjoin any operations of the News Print Paper Manufacturers Association and of the manufacturers who were members of that association in so far as such operations were claimed to constitute a restraint of trade and that in such proceeding they (the manufacturers) would consent to a decree as prayed for, reserving the right at the time such consent to a decree was presented to the court, to make*1310 such statements, oral or written, not impairing the binding force of the decree as they were advised might be necessary to protect their interests. It was also agreed that the petition might pray for the dissolution of the News Print Manufacturers Association and that if a request was made to that end they (the manufacturers) would consent thereto. The agreement also contained provisions respecting the prices to be charged by the manufacturers for newsprint paper until April 1, 1918, after which date prices and terms of *573 contracts under the agreement would be determined by the Federal Trade Commission, subject to review by the judges of the United States Circuit Court of Appeals. Wise, as attorney for the petitioner and the Donnacona Paper Company, Ltd., signed this agreement for them. Prior to the final draft of the agreement which was accepted by the parties, numerous drafts were made and submitted to Wise, who caused to be eliminated certain features which he considered to be objectionable.
When the trial of Gould and the other defendants was resumed on November 26, 1917, certain of the defendants withdrew their pleas of not guilty and entered pleas of nolo contendere.*1311 As to another of the defendants, who was out of the country, the trial was adjourned to a later date. Upon motion of counsel for the Government the indictment as to Gould was dismissed.
On the same day, November 26, 1917, the Attorney General instituted a proceeding in equity against those individuals who were defendants in the criminal proceeding, including Gould, and against certain corporations, among which were the petitioner and the Donnacona Paper Company, Ltd., making them all defendants in such equity proceeding. In his petition in this proceeding the Attorney General alleged that such individuals and corporations had engaged in a combination in restraint of the trade and commerce among the several states and with foreign nations in newsprint paper, contrary to the Act of July 2, 1890, entitled "An Act to protect trade and commerce against unlawful restraints and monopolies." The Attorney General also asked among other things that the court find that these individuals and corporations had entered into and engaged in an unlawful restraint of trade and commerce as alleged, that the News Print Manufacturers Accociation, a voluntary association composed of all these corporations*1312 under the management of these individuals, was an unlawful combination in restraint of trade, that such association be dissolved, that the court perpetually enjoin these corporations from carrying into further effect the combination so dissolved, and that the court perpetually enjoin each of the individuals from entering into, engaging in, or carrying into effect any contract, combination or conspiracy having for its purpose the regulation, domination or restriction of the trade or commerce in newsprint paper.
On the same day Wise, as attorney for Gould, the petitioner and the Donnacona Paper Company, Ltd., filed an answer to the petition of the Attorney General, denying for the most part the allegations therein.
Thereafter on the same day, November 26, 1917, the court, with respect to all the individual defendants in the equity proceeding *574 and certain of the corporate defendants in such proceeding, including the petitioner and the Donnacona Paper Company, Ltd., entered a decree reading in part as follows:
FINAL DECREE
This cause came on to be heard at this term and was argued by counsel; and thereupon, upon consideration thereof, and upon the consents hereto in*1313 writing and in open court by the defendants * * * Gordias H. P. Gould, * * * Donnacona Paper Co., Ltd., Gould Paper Co., * * * and upon the unanimous resolution of the Executive Committee of the News-Print Manufacturers' Association consenting to this decree, and said consents having been duly given by their respective solictors to the entry of this decree before any testimony has been taken, it was ORDERED, ADJUDGED and DECREED as to said defendants so consenting as follows, viz.:
1. Defendants by becoming and acting as members of the News Print Manufacturers Association, have entered into and engaged in an unlawful combination in restraint of trade and commerce in news print paper among the several states and with foreign nations in violation of the Act of July 2, 1890, entitled "An Act to protect trade and commerce against unlawful restraints and monopolies."
2. The News Print Manufacturers' Association is an unlawful combination of the defendants in restraint of the trade and commerce in news print paper among the several states and with foreign nations, in violation of said Act of July 2, 1890; and said News-Print Manufacturers' Association shall be, and it hereby is, dissolved.
*1314 3. Each corporate defendant is hereby perpetually enjoined from carrying into further effect the combination hereby dissolved and from entering into or engaging in any like combination having for purpose or effect (a) the elimination or restriction by concert of action of competition in news print paper, or (b) the concerted working for materially higher prices for news print paper, or (c) the establishment by concert of action of uniform prices, terms or conditions for the sale of news print paper, or (d) the concerted working to discourage others from manufacturing news print paper.
* * *
6. Each individual defendant is hereby perpetually enjoined from entering into, engaging in, or carrying into further effect, any contract, combination or conspiracy having for purpose or effect to regulate, dominate or restrict the trade or commerce in news print paper of any person, firm or corporation other than the firms or corporations with which such individual defendant is or may be connected as an officer, agent or employee.
Wise attended to the framing of the final decree and was instrumental in preventing the inclusion therein of certain matters that he deemed improper.
*1315 For his services in behalf of Gould and the petitioner in the above described proceedings the petitioner, in 1917, paid Wise $25,000 and also reimbursed him in the amount of $166.18 for certain expenditures made by him during the course of his employment. In addition to the foregoing amounts the petitioner in 1917 paid through P. T. *575 Dodge the amount of $1,044.80 for legal services in connection with the litigation described above.
In its income-tax return for 1917 the petitioner deducted the amount of $26,210.98 representing the total of the amounts paid to Wise and paid through Dodge, with the explanation "Legal Expense, Re Government Indictment As Newsprint Manufacturers, Paid To Henry A. Wise, New York City, Former United States District Attorney." In determining the deficiency here involved for 1917 the respondent allowed the deduction thus taken by the petitioner.
OPINION.
TRAMMELL: The petitioner contends that in determining its taxable net income for 1917, 1918 and 1919 the respondent has erroneously understated the depletion allowance to which it is entitled for those years. There is no controversy between the parties as to the quantity or number of*1316 cords of pulpwood timber ten inches or more in diameter standing on the petitioner's Tug Hill and Moose River tracts on March 1, 1913. They are, however, in disagreement as to the fair market value per cord of such timber on that date. In amended income-tax returns for the taxable years before us the petitioner, on the timber used, took depletion on the basis of a fair market value of $4.75 per cord on March 1, 1913. In its Form T filed with the respondent, the petitioner stated that it believed that amount was a "conservative average estimate" of the fair market value of its timber on the basic date. In determining the deficiencies here involved the respondent, for depletion purposes, determined that the fair market value of the timber on the basic date was $3.50 per cord. However, due to a misunderstanding as to the number of cords on which the petitioner had claimed depletion, the amount of depletion actually allowed on the number of cords used was, for 1917 and 1918, at values below $3.50 per cord, and for 1919 at a value in excess of that amount.
In its petition the petitioner alleges that the fair market value of its pulpwood timber on the basic date was not less than*1317 $4.75 per cord. However, in its brief it asks that we find such value on that date to be from $5.50 to $6 per cord. The respondent contends that the value was not in excess of $3.50 per cord.
In support of value of $4.75 per cord as alleged in the petition and the higher value contended for in its brief, the petitioner submitted evidence indicating a value of $6.23 computed on a "back-to-the-stump" method. Under this method the petitioner takes the average price for 1913 of $11.58 per cord for Canadian pulpwood delivered in the Watertown District and subtracts therefrom the *576 average cost of $5.35 per cord for the five-year period 1910 to 1914 of cutting, preparing and delivering logs from its Tug Hill and Moose River tracts to its mills in the same condition as the Canadian wood was delivered, thereby arriving at an amount of $6.23 per cord. In this computation no allowance is made for burdens inherent in the ownership of property of this character, such as taxes, insurance and losses from fire, insects, wind and storms. The petitioner offered no evidence as to what would be a fair and reasonable allowance for such purposes, but sought to dispose of this point by*1318 submitting testimony to the effect that the growth of the timber would be sufficient to provide for these items. The evidence in the case was that the petitioner's timber was very largely virgin and that such timber would grow very little. The petitioner urges that a further element to be considered in connection with the "back-to-the-stump" value of $6.23 is that pulpwood from the Adirondacks is worth $1 per cord more than Canadian wood. Conceding that to be true, since there is testimony to support it, it is to be observed that the selling price of Canadian wood in the Watertown District included an element of profit to the Canadian producer. No allowance for selling expenses and profit is made in the petitioner's computation under its "back-to-the-stump" method. It is hardly reasonable to conclude that an intelligent purchaser would pay for property as great an amount as that which he could reasonably expect to realize from resale of it over a period of years.
The petitioner submitted testimony of four witnesses, three of whom expressed the opinion that the timber had a fair market value of $6 on the basic date. Their testimony shows that their opinions were based on a*1319 "back-to-the-stump" method as outlined above. The fourth witness testified to a value in 1913 of $5.50 per cord for the timber acquired by the petitioner in township 4 in 1907, stating that the value was about the same on both dates. This witness was also a witness in the proceedings by which the State of New York acquired the Taggarts Paper Company's timber lands, which compared favorably to the petitioner's Moose River tract from the standpoint of quality of timber and logging conditions. In 1916 he testified in that proceeding that in 1908-1909 "The Taggart wood at that time would be worth as much as any wood that you could find" and that it was worth from $3 to $3.50 a cord. When confronted in the instant case with the apparent conflict in his testimony as to value in the Taggarts case and in the instant case he at first had no recollection of testifying in the Taggarts case, or of what tract was involved. Later he was able to recall the details of the case and stated that the decision of the court in that case as to the value of the timber involved had since caused him to change his opinion upward with respect to the value of timber in that region. *577 When*1320 it is observed that the court found a value for pulpwood of only $4.25 a cord in the Taggarts case, it is difficult to understand how this witness could revise his opinion upward to such an extent as to think that the timber had a value of almost twice that testified to by him in 1916.
In further support of its contention that the respondent has determined too low a value for its timber on March 1, 1913, the petitioner relies on the decision of the Court of Claims of the State of New York in the Taggarts case, which according to the record in the instant case was rendered after a very exhaustive hearing. Although giving full consideration to that decision, we do not think it should be accepted as controlling here, since, with the exception of the instance referred to above, we do not know what the testimony was in that case. The instant case must be decided on the basis of the record made in it.
In support of his determination of a fair market value of $3.50 per cord on March 1, 1913, the respondent submitted the testimony of three witnesses. One of these was of the opinion that the timber on the two tracts had a fair market value on March 1, 1913, of from $2.50 to*1321 $3 per cord. Another was of the opinion that the timber on the two tracts had a value of $3 a cord on that date, while the third witness was of the opinion that the value of the timber on the Moose River tract on the basic date was $3 a cord.
Giving due consideration to all the evidence on this point, we are unable to find that the fair market value on March 1, 1913, of the petitioner's softwood timber ten inches and over in diameter on its two tracts was in excess of $3.50 per cord, the amount determined by the prepondent. This rate should be applied to the timber used by the petitioner during the taxable years instead of the timber cut. .
The petitioner contends that the respondent erred in disallowing a deduction for 1918 of $2,916.21 taken by it as representing a repayment made in that year to the Adirondack League Club on account of excess interest credits erroneously allowed to the petitioner in 1916 and 1917 under the circumstances set out in our findings of fact. The respondent denies that his action was erroneous. Over a period of years the petitioner was a purchaser of timber from the Adirondack League Club. Under*1322 the contracts of purchase thf petitioner advanced money to the Club from time to time. Such advances drew interest until the wood was removed by the petitioner. In 1916 and 1917, in adjusting the accounts between itself and the petitioner, the Club allowed the petitioner credit for interest in the amount of $2,916.21 in excess of the amount to which the petitioner was entitled. The record does not disclose for what years such excessive interest was allowed or what amount was allowed in 1916 and what amount *578 in 1917, nor does it disclose whether the same error was made in accruing the interest on the petitioner's books and reporting it as income as was made by the Club in allowing it. For all the record discloses the petitioner may have accrued the correct amount on its books in the years prior to the taxable year. If any amount had been received as interest in addition to what was properly accrued or accruable in those years, the record does not disclose how it was reported or treated in its return.
Where a taxpayer is on the accrual basis, as was the petitioner, interest receivable accrues ratably, and is properly reportable as income for the year or years in which*1323 it accrues. The date of receipt is immaterial. Cf. ; . If during 1916 and 1917 or prior years the petitioner erroneously accrued on its books greater amounts of interest than it was entitled to, or if during those years it accrued only the correct amounts of interest but actually collected amounts in excess of those to which ti was entitled and reported the excess as income, the proper return or returns in which to make adjustment of the error are the returns for the year or years in which the error was made and not in the return for 1918, the year in which repayment was made. A taxpayer may not erroneously overstate its income for one or more years and then correct the error by taking deductions therefor in its return for a subsequent year. The action of the respondent is sustained as to this issue.
The petitioner contends that the respondent erred in disallowing as deductions for 1917, 1918 and 1919 the amounts of $6,348.25, $12,750 and $16,173, respectively, representing advances made to the Glendale and Western Railroad Company under an agreement whereby the petitioner*1324 and the hold of the other half of the stock of that company were to advance to that company, equally as between themselves, amounts sufficient to meet the excess of the road's expenses over its revenues. The petitioner urges that the amounts thus advanced are deductible as operating expenses to it and that they constituted part of the cost of getting its logs from its Tug Hill tract to its mill. The respondent contends that the amounts are not so deductible, but represent loans made by the petitioner to the railroad company.
In support of its contention the petitioner submitted the testimony of its president and treasurer, H. P. Gould, who testified among other things to the advances and the agreement under which they were made. He also testified that the amounts advanced by the petitioner were carried on its books as indebtedness owing to it by the railroad company. No attempt was made in his testimony to reconcile such action with the contention now advanced by the petitioner.
*579 The amounts in controversy were carried by the petitioner on its books as assets, were shown as such by the petitioner in its various tax returns, and were determined to be such by the*1325 respondent in determining the deficiencies here involved. No explanation is offered by the petitioner as to why, if the amounts actually constituted operating expenses, it so consistently treated them as assets. In our opinion the evidence fails to sustain the petitioner's contention. The determination of the respondent is sustained on this issue.
In determining the petitioner's invested capital for the years here involved the respondent determined the petitioner's reserve for depreciation at March 1, 1913, to be $206,098.33, or the total of the amounts entered by the petitioner on its books for depreciation for 1909, 1911 and 1912 and for two-twelfths of 1913. Such amounts were taken as deductions by the petitioner in its returns of annual net income for the respective years and were allowed by the respondent.
The petitioner contends that the respondent has overstated the amount of the reserve for depreciation at March 1, 1913, and that the amount determined by the respondent should be reduced by $80,214.84. In support of this contention the petitioner submitted evidence showing that prior to March 1, 1913, it was its practice to charge to expense certain expenditures which*1326 under its present methods of accounting would be capitalized and that during the period between March 1, 1897, and March 1, 1913, it expended a total of $80,214.84 for replacements of and additions to depreciable assets which were charged to expense. The evidence also shows that no part of the $80,214.84 is included in the cost of depreciable assets at March 1, 1913, as determined by the respondent and that no depreciation deductions have been taken or allowed with respect to the items for which the amount was expended. The evidence however does not show what portion of the amount was for additions or what portion was for replacements. Nor does it show whether the assets that were replaced were retired from the petitioner's accounts as they were replaced or whether they were continued on the books. The evidence does not indicate whether the items for which the $80,214.84 was expended remained in use on and after March 1, 1913. Although the evidence shows the amounts of depreciation entered by the petitioner on its books for the period 1909, the first year for which depreciation was entered on the books, to March 1, 1913, we do not know what amount was sustained in years prior*1327 to 1909. From the evidence before us we are unable to find that the reserve for depreciation at March 1, 1913, as determined by the respondent should be reduced as the petitioner contends.
*580 In an amended answer the respondent claims that the reserve for depreciation at March 1, 1913, of $206,098.33 as determined by him should be increased to $259,039.41, or by the amount of $52,941.08 representing depreciation deducted by the petitioner in its annual return of net income for 1910 but not entered by the petitioner on its books. The petitioner denies that the reserve should be so increased.
The amount of $259,039.41 as now contended for by the respondent represents the total amount of the deductions for depreciation taken by the petitioner in its returns for the period 1909 to March 1, 1913, and allowed by the respondent. With the exception of the amount of $80,214.84 expended by the petitioner for additions and replacements and considered by us above, the petitioner does not contend that the deductions taken and allowed were in excess of the amount of depreciation actually sustained prior to March 1, 1913. Nor does the record indicate that such was the case. No*1328 attempt was made by the petitioner to show what amount of depreciation had been actually sustained by it prior to March 1, 1913. It simply sought to offset or reduce a portion of that determined by the respondent by submitting evidence as to expenditures for additions and replacements, which we have held above was insufficient for that purpose. The petitioner having claimed in its returns and having been allowed deductions for depreciation in the amount of $259,039.41 for the period prior to March 1, 1913, and the evidence failing to show that such amount had not been sustained, we think that it should be considered to be the proper amount of the reserve for depreciation at March 1, 1913, for invested capital purposes. ; ; affd., .
In determining the petitioner's invested capital for each of the years here in controversy the respondent arrived at the cost of timber included therein by deducting from the petitioner's total cost depletion on the total amount of timber cut to the end of the preceding year, irrespective of the fact that the petitioner had several*1329 thousand cords of timber in the woods which had been cut but had not been removed or used. This cut, unremoved and unused timber was not taken into an inventory or asset account of any kind and consequently was excluded from invested capital.
The petitioner contends that the respondent erred in excluding such timber from invested capital. The petitioner urges that the timber should be included in invested capital at its fair market value on March 1, 1913, since depletion was sustained at the time the timber was cut, because at that time it was converted from a natural resource to an asset of another form. The respondent concedes *581 that he erred in excluding the timber from invested capital, but contends that it should be included therein at cost, since to include it at the fair market value on March 1, 1913, would result in including in invested capital unrealized appreciation on the timber which was still owned by the petitioner.
To grant the petitioner's contention would in effect be holding that invested capital may include a "marking up of the valuation of assets upon the books to correspond with increase in market value," a thing the Supreme Court in La Belle*1330 Iron Works v.United States, 256 U.,.s 377, held could not be done. The cut but unremoved timber was excluded by the respondent from the petitioner's invested capital on the basis of cost. In view of the foregoing decision of the Supreme Court, we think it should be restored to invested capital on the same basis and not at its fair market value on March 1, 1913, as contended for by the petitioner.
In 1907 the petitioner, for 3,400 shares of its capital stock of a par value of $100 per share, acquired from the International Paper Company about 17,000 acres of timber lands in township 4 and the Kosterville property consisting of two ground wood-pulp mills, including buildings, equipment, etc., and two developed water-power sites which furnished the power for operating the mills. In amended returns for the years here involved the petitioner showed the value of those properties at the time of acquisition in 1907 to have been as follows: timber lands, $263,416.35; the two pulp mills, including buildings, equipment, etc., $84,420.47; and the two water-power sites, $91,192.08, or a total value of $439,028.90. In determining the petitioner's invested capital the respondent accepted*1331 the value shown by the petitioner for the timber lands, but determined the value of the two mills to have been $123,112.55 and the value of the two water-power sites to have been $52,500, or a total of $439,028.90, the same amount shown by the petitioner in its returns.
In its petition the petitioner alleges that the respondent erred in understating the value of the mill property, water-power rights and timber lands and alleges that the value of such property at the time of acquisition was at least $740,000. At the hearing and in its briefs the petitioner has accepted as correct the value of $123,112.55 determined by the respondent for the two ground wood-pulp mills, including buildings, equipment, etc. In its brief the petitioner contends that the actual cash value of the timber lands at the time of acquisition was $991,500 and that of the water-power sites was $329,060, or a total amount much in excess of that set forth in its petition. In accepting the determination of the respondent as to the value of the two mills and by contending for the foregoing amounts as values for the timber lands and water-power sites, the petitioner *582 is contending that for $340,000 par*1332 value of its capital stock it acquired assets having an actual cash value of $1,443,673.55 at the time of acquisition, or a value of $1,103,672.55 in excess of the par value of the stock issued therefor. The respondent denies that the timber lands and the water-power sites had the values contended for by the petitioner.
The amount of $991,500 contended for as representing the value of the timber lands is computed as follows: 271,000 cords of softwood ten inches and above in diameter at $3 per cord, $813,000; 17,000 acres of land with the hardwood timber and the softwood timber under ten inches in diameter standing thereon at $10.50 an acre, $178,500. The value of $10.50 an acre is composed of $5 an acre for the land, $5 for the softwood timber under ten inches in diameter ( $2 a cord for 2 1/2 cords to the acre) and 50 cents per thousand feet of hardwood timber to the acre.
There is no controversy between the parties as to the quantities of the different classes of timber acquired, but they are in disagreement as to the values of such timber as well as to the value of the land.
In support of the values contended for for the land and the timber the petitioner submitted the*1333 testimony of three witnesses. One of these, J. B. Todd, was of the opinion that the value of the softwood timber ten inches and above in diameter as well as that less than ten inches in diameter was $5.50 a cord in 1907. He placed a value on the hardwood of 50 cents per thousand feet. He valued the land with the softwood under ten inches and the hardwood thereon at $12 an acre. Since there were 2 1/2 cords per acre of softwood under ten inches and 1,000 feet of hardwood per acre, the value of such softwood and hardwood per acre according to this witness was $14.25, or $2.25 an acre in excess of the value of $12 testified to by him as being the value of the land plus the small softwood and the hardwood. His valuations would indicate that he did not consider the land as having any value. Another witness, John E. Johnston, was of the opinion that the softwood timber ten inches and above in diameter had a value in 1907 of $3 per cord; that the softwood timber under ten inches had a value of $3 a cord when removed with the larger timber, or $2 a cord when left on the land; and that the hardwood timber had a value of 50 cents per thousand feet. He was of the opinion that the land*1334 with the hardwood and the softwood under ten inches had a value in 1907 of from $10 to $12 an acre. His valuations for the softwood timber under ten inches and the hardwood timber would indicate that he considered the land as having a value of from $2.50 to $6.50 an acre. Another witness, H. P. Gould, was of the opinion that the softwood timber ten inches and *583 above in diameter had a value of $3 a cord in 1907, and that the softwood timber under ten inches in diameter had a value of from $2 to $3 a cord. He was of the opinion that the land, the hardwood timber and the softwood timber had a value in 1907 of $10.50 an acre. The use of the value placed on the hardwood by the petitioner's other witnesses and the values placed by this witness on the softwood under ten inches indicate that this witness considered the land as having a value of from $3 to $5 an acre.
In support of his determination with respect to the land and timber the respondent submitted the testimony of a witness who placed a value of $1.50 per cord on the softwood timber eight inches and above in diameter. He was of the opinion that the land, the softwood timber less than eight inches in diameter, *1335 and the hardwood timber, had no value.
In 1904 or 1905 a tract of 5,000 acres of softwood timber lands adjoining the petitioner's Moose River tract was sold for $60,000 or at the rate of $12 an acre. The witness who testified to this sale stated that the timber standing on the tract sold in 1904 or 1905 was similar to that on the petitioner's 17,000-acre tract here being considered and that the timber on both tracts was good. While he did not testify directly to the number of cords on the 5,000-acre tract, he was of the opinion that there were eight cords of softwood eight inches and above in diameter per acre on the petitioner's tract in 1907, which, when considered with his testimony as to the similarity of the two tracts, would indicate that he was of the opinion that there were eight cords to the acre on the 5,000-acre tract. Without allowing any value for the land or for any hardwood timber that might have been on it, this would have a value of not more than $1.50 per cord for the softwood timber on the 5,000-acre tract that was sold in 1904 or 1905.
About 1906 there was a sale of about 20,000 acres of softwood timber lands situated near to and comparable to the petitioner's*1336 Tug Hill tract at $6 an acre. There were from nine to ten cords of softwood timber per acre on this land. Allowing no value whatever for the land or for any hardwood that might have been on it, gives a value of from 60 cents to 66 2/3 cents per cord for the softwood timber.
While shortly after acquiring the 17,000 acres of timber lands the petitioner sold back to the International Paper Company 21,000 cords of softwood timber at $2.50 per cord, this was the price paid for the timber as and when it was cut over a period of several years and was not a price paid at the time of purchase. The International Paper Company was operating on the same side of the divide on which this timber was situated, and it was worth more to that company *584 than to the petitioner, whose operations were on the opposite side of the divide.
Considering all of the evidence in the case, we are of the opinion that the 274,000 cords of softwood timber ten inches and above in diameter on the 17,000-acre tract when acquired by the petitioner in 1907 had an actual cash value of $2 per cord; that the 42,500 cords of softwood timber under 10 inches in diameter had the same value at that time; that*1337 the 17,000,000 feet of hardwood timber had an actual cash value at that time of 50 cents per thousand feet; and that the land had an actual cash value of $2.50 per acre on the same date, or a total of $678,000 for the land and the timber thereon.
The petitioner contends that the two developed water-power sites had an actual cash value of $329,060 at the time of acquisition in 1907. In support of its contention the petitioner submitted the testimony of a witness who testified to that value. He arrived at this value by multiplying the number of horsepower years of primary energy, 717, and of secondary energy, 1,729, available at the sites by $30 and $15 respectively, representing the average prices paper mills in the Black River District were paying for purchased electric power in 1907. This gives a total of $47,445 for both classes of power per year. By capitalizing the latter amount at 12 1/2 per cent, which he considered a reasonable rate, he arrived at $379,560. From this amount he deducted $50,500, which he considered represented depreciable property such as dams, flumes and machinery, thereby arriving at $329,060 for the power sites.
*1338 We have heretofore held that the value of water-power sites may not be determined by capitalizing the estimated savings resulting from the use of water power instead of steam power or electricity. ; . To approve the method of valuation used by the petitioner's witness would require us to go a step further than we refused to go in the foregoing cases and to hold that the value of a water-power site can be determined by capitalizing an operating expense on the basis of the cost of electricity, which, so far as the record shows, might have been the most expensive kind of power that could have been used. While the evidence shows the price that paper mills paid for purchased electric power in 1907, it also shows that water power was used almost exclusively for grinding pulpwood. It also indicates that the use of electricity for that purpose would have been prohibitive from the standpoint of cost, since ground wood pulp was a cheap commodity which required a cheap form of power for its production.
The petitioner also relies on the sale of the power site by the St. Regis Paper Company*1339 to the Power Corporation of New York. As *585 this sale occurred at some undisclosed date subsequent to 1920, we are of the opinion that it is too far removed from 1907 to be of much help in determining the value of the petitioner's water-power sites at the time of acquisition.
The respondent submitted the testimony of two witnesses as to the value of the water-power sites in 1907. One of these was of the opinion that the sites had a value of $60,000 iv 1907, while the other was of the opinion that the value was $69,000.
Considering all the evidence on this point, we are of the opinion that the water-power sites had at the time of acquisition in 1907 an actual cash value of $97,192.08, the amount shown by the petitioner in its returns.
In determining the deficiency for 1917 the respondent determined that the value of the buildings and equipment composing Mills A and B was $123,112.55. This amount was accepted by the petitioner. We have determined that the actual cash value of the timber lands when acquired in 1907 was $627,000 and the value of the water-power sites was $91,192.08. The total of the values thus determined for the three groups of assets is $841,304.63. *1340 The respondent contends in his brief that, since these assets were acquired by the petitioner for $340,000 par value of its capital stock, they may not, under the limitations contained in section 207(a)(2) of the Revenue Act of 1917, be included in petitioner's invested capital for that year at any amount in excess of the amount of the par value of the stock issued therefor.
The pertinent portions of section 207 of the Revenue Act of 1917 are as follows:
That as used in this title, the term "invested capital" for any year means * * *
* * *
(a) In the case of a corporation or partnership: (1) Actual cash paid in, (2) the actual cash value of tangible property paid in other than cash, for stock or shares in such corporation or partnership, at the time of such payment (but in case such tangible property was paid in prior to January first, nineteen hundred and fourteen, the actual cash value of such property as of January first, nineteen hundred and fourteen, but in no case to exceed the par value of the original stock or shares specifically issued therefor), and (3) paid in or earned surplus and undivided profits used or employed in the business, exclusive of undivided profits*1341 earned during the taxable year.
Inasmuch as the respondent in determining the deficiency for 1917 allowed the assets in the petitioner's invested capital at a total value of $439,028.90, which is in excess of the amount of $340,000, the par value of the stock issued for the assets, the import of his contention, if granted, is to increase the deficiency without his having moved with respect to this point either at or before the hearing. To this extent his contention presents an issue not raised by the pleadings. *586 We think it is sufficient, however, to say that the question presented by his contention has heretofore been decided adversely to him in our decisions in , and .
While the petitioner did not submit any evidence directed to the actual cash value on January 1, 1914, of the timber lands and water-power sites acquired in 1907, the evidence shows that the value of properties of those classes gradually increased in years subsequent to 1907. Subject to adjustment for depletion resulting from the sale or use of timber from the timber lands, we conclude that the value on*1342 January 1, 1914, was not any less than that at the time of acquisition. For 1917, 1918 and 1919 the petitioner is therefore entitled to include the timber lands and water-power sites in its invested capital at their actual cash values at the time of acquisition as determined by us, subject to the adjustment indicated in the preceding sentence. The buildings and machinery (Mills A and B) remain in invested capital at the value determined by the respondent, since no controversy exists with respect to them.
The remaining issue relates to the deductibility of an amount of $26,210.98 deducted by the petitioner in its return for 1917 for legal expenses incurred and paid in that year. In determining the deficiency for 1917 the respondent allowed the deduction, but in an amended answer alleges that he erred in doing so and asks that we hold that the amount is not deductible and that the deficiency should be increased accordingly. The respondent contends that the amount was expended by the petitioner in defending itself, its then president, and the News Print Manufacturers Association, of which the petitioner and its president were members, in litigation prosecuted by the United States*1343 for violation of the antitrust laws. The petitioner contends that the amount was expended in defending its president in the criminal proceeding with respect to which the indictment was dismissed on motion of the prosecution and that the petitioner's president, thus not having been convicted of a criminal offense, the amount is allowable as a deduction.
The evidence shows that prior to the time any legal proceedings were instituted against the petitioner or its president, its president employed Henry A. Wise to represent the petitioner and its interests. Thereafter the petitioner's then president, along with others, was indicated, being charged with unlawfully having engaged in a conspiracy in restraint of trade and commerce. The trial of the defendants was begun on November 15, 1917, but was adjourned to November 26, 1917, at which time certain of the defendants changed their pleas to nolo contendere, but as to the petitioner's president the indictment was dismissed on motion of counsel for the Government. *587 Prior to the beginning of the trial certain negotiations were begun between attorneys for the Government and representatives of certain of the corporations*1344 whose officers had been indicted. These negotiations resulted in an agreement dated November 26, 1917, between the Attorney General and the manufacturers, the pertinent parts of which are mentioned in our findings of fact. Wise, as attorney for the petitioner, participated in the preparation of the agreement and signed it for the petitioner. Pursuant to this agreement the Attorney General, on November 26, 1917, instituted a proceeding in equity against those individuals who were defendants in the criminal proceeding, including the petitioner's then president, and against certain corporations, among which were the petitioner, alleging that such individuals and corporations had engaged in the restraint of trade and commerce contrary to the law of the United States and asking, among other things, that the court find that they had so done as alleged and that the court enjoin them from further doing so. Wise appeared as counsel for the petitioner and its then president in this proceeding and attended to the framing of the final decree. This decree recites that it was entered upon the consents thereto in writing and in open court by the defendants in that proceeding, including the petitioner*1345 and its president, and that said consents were duly given by their respective solicitors to the entry thereof before any testimony was taken. The court, as set forth in the decree, found among other things that the defendants by becoming and acting as members of the News Print Manufacturers Association had entered into and engaged in an unlawful combination in restraint of trade and commerce in newsprint paper, in violation of the Act of July 2, 1890, entitled "An Act to protect trade and commerce against unlawful restraints and monopolies," and enjoined them against a continuation thereof. From the evidence before us we think that the legal expenses incurred by the petitioner were for services rendered not only in behalf of its president in the criminal proceedings, but also in behalf of it and its president in the equity proceeding, and we have so found as a fact. While the indictment in the criminal proceeding was dismissed on motion of the Government, in the equity proceeding the court found, upon the written consents of the petitioner and its president, duly given by their counsel, in open court, that they had engaged in an unlawful combination in restraint of trade. Whatever*1346 may have been the reason of the prosecuting officer of the Government in moving the dismissal of the indictment, the petitioner and its president in the equity proceeding consented to the court entering a decree finding that they had violated the antitrust laws of the United States because of their *588 connection with the News Print Manufacturers Association, the same connection on which the indictment of the petitioner's president was based.
To be deductible the amount of legal expenses here involved must constitute ordinary and necessary expenses incurred by the petitioner in the maintenance and operation of its business and properties. These expenditures were incurred in connection with criminal proceedings against the petitioner's president and equitable proceedings against him and the petitioner. These proceedings resulted from the parties having been members of and having participated in the activities of the News Print Manufacturers Association, which organization was an unlawful combination of the petitioner, its president, and others in the restraint of trade and in violation of a Federal statute. *1347 This being true, we do not think that the legal expenses resulted proximately from the maintenance and operation of the petitioner's business and properties. Consequently, they do not constitute an allowable deduction in determining the petitioner's net income. See ; ; , affirming .
Judgment will be entered under Rule 50.
Footnotes
1. Additional. ↩