*1219 1. The taxpayer leased all of its properties for $300,000 annual rental, the lessee, a stockholder, to pay the rental directly to the stockholders of the lessor. The entire rental was income to the lessor. American Telegraph & Cable Co.,2 B.T.A. 991">2 B.T.A. 991, followed.
2. A taxpayer has no excess-profits-tax liability where facts show that although its exact invested capital is unknown it had sufficient invested capital at least to give it a credit in excess of its income. A tax is not imposed under section 328 under such circumstances.
*915 The Commissioner determined deficiencies as follows:
| Petitioner | Docket No. | 1920 | 1921 |
| Gold and Stock Telegraph Company | 29470 | $55,300.42 | $54,591.60 |
| International Ocean Telegraph | |||
| Company | 29585 | 32,997.22 | 32,655.60 |
| Pacific and Atlantic Telegraph | |||
| Company of the United States | 29586 | 14,411.22 | 14,375.60 |
| Southern and Atlantic Telegraph | |||
| Company | 29694 | 8,361.94 | 8,425.92 |
| Franklin Telegraph Company | 29695 | 4,320.74 | 4,121.60 |
Each petitioner*1220 has assigned the following errors:
1. The Commissioner erred in holding that the rental paid or due to petitioner's stockholders during the years 1920 and 1921, pursuant to the then existing lease of all of the property of the petitioner, constituted constructive income of the petitioner, subject to income or excess-profits tax.
2. The Commissioner erred in increasing the constructive gross income from the amount shown on the returns filed by the petitioner for the years 1920 and 1921 as rental paid by the lessee to the lessor by that part of the gross rental said to have been paid by the Western Union Telegraph Company to itself as a stockholder of the petitioner.
3. The Commissioner erred in computing excess-profits taxes for the two years under section 328 instead of on the basis of the petitioner's invested capital.
4. The Commissioner selected improper comparatives.
The cases have been consolidated.
FINDINGS OF FACT.
All five petitioners have their principal office in New York City.
The parties stipulated that the following facts are true:
1. Gold and Stock Telegraph Company was incorporated under the laws of the State of New York August 10, 1967, for*1221 a period of fifty years, and its charter was thereafter extended for a period of one hundred years from August 10, 1917. Its capital stock consists of 50,000 shares of common stock of a par value of $100 per share.
2. On or about December 14, 1881, the entire operating property and assets of the company were leased to the Western Union Telegraph Company for a term of ninety-nine years beginning january 1, 1882, by an agreement made *916 and executed in the City and State of New York. A copy of said agreement is attached as Exhibit A hereto.
3. International Ocean Telegraph Company was incorporated under the laws of the State of New York December 12, 1865, for a period of fifty years from December 2, 1865, and its charted was thereafter extended for a period of fifty years from December 2, 1915. Its capital stock consists of 30,000 shares of common stock of a par value of $100 per share.
4. On or about November 24, 1881, the entire operating property and assets of the company were leased to the Western Union Telegraph Company for a term of ninety-nine years beginning January 1, 1882, by an agreement made and executed in the City and State of New York. A copy of*1222 said agreement is attached as Exhibit B hereto.
5. Pacific and Atlantic Telegraph Company of the United States was incorporated as the Pacific and Atlantic Telegraph Company under the laws of the State of New York February 5, 1866, and consolidated with Monongahela Valley Telegraph Company which had been chartered by a special act of the Pennsylvania Legislature approved March 14, 1865, by agreement dated July 30, 1866, and filed in the office of the Secretary of the Commonwealth of Pennsylvania July 31, 1866. Its capital stock consists of 80,000 shares of common stock of a par value of $25 per share.
6. On or about December 16, 1873, the entire operating property and assets of the company were leased to the Western Union Telegraph Company for a term of nine hundred ninety-nine years beginning January 1, 1874, by an agreement made and executed in the City and State of New York. A copy of said agreement is attached as Exhibit C hereto.
7. Southern and Atlantic Telegraph Company was incorporated under the laws of the State of New York July 29, 1869, for a period of one hundred years from July 14, 1869. Its capital stock consists of common stock of a par value of $25 per*1223 share of which there were issued 37,962 of the aggregate par value of $949,050.
8. On or about July 10, 1876, the entire operating property and assets of the company were leased to the Western Union Telegraph Company for a term of ninety-two years beginning October 1, 1876, and thereafter, if lawful, for such further term as will make the full term of nine hundred ninety-nine years, by an agreement made and executed in the City and State of New York. A copy of said agreement is attached as Exhibit D hereto.
9. Franklin Telegraph Company was incorporated by a special act of the Legislature of the Commonwealth of Massachusetts approved March 30, 1865. Its capital stock consists of 10,000 shares of common stock of a par value of $100 per share.
10. On or about June 15, 1865, the entire operating property and assets of the company were leased to the Atlantic and Pacific Telegraph Company a corporation of the State of New York, for the term of ninety-nine years beginning May 1, 1876, and on or about January 19, 1881, the Western Union Telegraph Company acquired by purchase all of the interests of and under took the obligations of the Atlantic and Pacific Telegraph Company*1224 in said lease. A copy of said agreement of lease, which was made and executed in the City and State of New York, is attached as Exhibit E hereto.
11. Pursuant to said leases the Western Union Telegraph Company, a corporation organized and existion under the laws of the State of New York and engaged in the business of transmitting messages by telegraph lines and cables within and to and from the United States, and so engaged at all the times mentioned in these proceedings, as lessee received and took complete *917 possession and control of the telegraph systems and of all of the property and assets of the aforesaid companies, at or about the dates of the said leases; and continuously since has managed, operated and maintained the same for its, the Western Union Telegraph Company's, own profit and at its own cost and risk of profit or loss; during said period to the present time, the Western Union Telegraph Company has paid the amounts provided in said leases to the officers of the lessor corporations as administration funds, which amounts have been used to defray the expenses of maintaining the corporate organizations, and are not claimed to be taxable income. The Western*1225 Union Telegraph Company during said period regularly and punctually as provided in said leases and in the endorsements on stock certificates hereinafter mentioned, has paid the rentals claimed to be subject to tax as corporate income of the lessor corporations direct to the stockholders thereof other than itself by depositing checks therefor in the mail, in the City of New York, addressed to such stockholders at the addresses designated by them for that purpose, and has made no payments to anyone in respect of the stock of the lessor corporations which it, the Western Union Telegraph Company, has itself held.
12. The certificates of capital stock of the said lessor companies have been during said period and are in the usual form negotiable by endorsement and delivery, and the stock has been freely transferred and traded in by the general public, and the fact that payments at a fixed rate per annum per share were "guaranteed" or promised by the Western Union Telegraph Company on said stock was and is known to the general public trading in said shares The Western Union Telegraph Company was when the Federal income tax law was first enacted and at all times subsequent thereto has*1226 been a substantial stockholder, in increasing amounts, of the lessor companies. During the years involved in these cases, the facts with regard to stockholding and rentals were as follows:
| Shares owned by third | Shares owned by Western | Shares on which no |
| parties to whom payments | Union on which no payments | accruals made, the |
| or accruals made by | made. | ownership being unknown. |
| Western Union. |
Gold and Stock Telegraph Company:
| No. | Amount | No. | Amount | No. | Amount | |
| 1920 | 22,443. | $134,658. | 27,557. | $165,342. | ||
| 1921 | 21,585.75 | 129,514.50 | 28,414.25 | 170,485.50 |
International Ocean Telegraph Company:
| 1920 | 9,202 | $55,212. | 20,788 | $124,788. |
| 1921 | 9,202 | 55,212. | 20,788 | 124,788. |
Pacific and Atlantic Telegraph Company of the United States:
| 1920 | 20,980 | $20,980. | 58,877 | $58,877. | 143 | $143. |
| 1921 | 20,980 | 20,980. | 58,877 | 58,877. | 143 | 143. |
Southern and Atlantic Telegraph Company:
| 1920 | 22,317 | $27,896.25 | 15,639 | $19,548.75 | 6 | $7.50 |
| 1921 | 22,317 | 27,896.25 | 15,639 | 19,548.75 | 6 | 7.50 |
Franklin*1227 Telegraph Company:
| 1920 | 3,641 | $9,102.50 | 6,320 | $15,800. |
| (treasury stock) | 39 | 97.50 | ||
| 1921 | 3,641 | 9,102.50 | 6,320 | 15,800. |
| (treasury stock) | 39 | 97.50 |
*918 13. On or shortly after the 4th day of January, 1882, the Western Union Telegraph Company caused to be endorsed on each certificate of capital stock of the Gold and Stock Telegraph Company its, the Western Union Telegraph Company's, agreement to pay quarterly one and one-half (1 1/2) per cent of the par value of the stock represented by the certificate, and caused said agreements to be sealed with its corporate seal and signed by its Secretary. Said agreements have been endorsed upon all certificates of stock of said Gold and Stock Telegraph Company issued from said date until the present time, and were upon the certificates of stock which were outstanding at the times material to these proceedings. Said agreements or endorsements on said stock certificates were in the following words and figures:
GUARANTEE The Western Union Telegraph Company hereby, for value received, guarantees the quarterly payment of one and one-half per cent. upon the par value of the stock represented*1228 by the within Certificate, to be paid on the first days of January, April, July and October in each year, subject to the conditions and provisions of the lease made by The Gold and Stock Telegraph Company to the Western Union Telegraph Company dated the 14th day of December, A.D. 1881.
In Witness Whereof the Western Union Telegraph Company has caused its corporate seal to be hereto affixed, and the same to be signed by its Secretary.
Secretary.
14. On or shortly after the 4th day of January, 1882, the Western Union Telegraph Company caused to be endorsed on each certificate of capital stock of the International Ocean Telegraph Company its, the Western Union Telegraph Company's, agreement to pay quarterly one and one-half (1 1/2) per cent of the par value of the stock represented by the certificate, and caused said agreements to be sealed with its corporate seal and signed by its Secretary. Said agreements have been endorsed upon all certificates of stock of said International Ocean Telegraph Company issued from said date until the present time, and were upon the certificates of stock which were outstanding at the times material to these proceedings. Said agreements or*1229 endorsements on said stock certificates were in the following words and figures:
GUARANTEE The Western Union Telegraph Company hereby, for value received, guarantees the quarterly payment of one and one-half per cent. upon the par value of the stock represented by the within certificate, to be paid on the first days of January, April, July and October in each year, subject to the conditions and provisions of the lease made by the International Ocean Telegraph Company to The Western Union Telegraph Company dated the 24th day of November, 1881.
In Witness Whereof the Western Union Telegraph Company has caused its corporate seol to be hereto affixed and the same to be signed by its Secretary.
Secretary.
15. On or shortly after the 4th day of January, 1882, the Western Union Telegraph Company caused to be endorsed on each certificate of capital stock of the Southern and Atlantic Telegraph Company its, the western Union Telegraph Company's, agreement to pay quarterly one and one-half (1 1/2) per cent of the par value of the stock represented by the certificate. Said agreements have been endorsed upon all certificates of stock of said Southern and Atlantic Telegraph *919 *1230 Company issued from said date until the present time, and were upon the certificates of stock which were outstanding at the times material to these proceedings. Said agreements or endorsements on said stock certificates were in the following words and figures:
The lines and property of the Southern and Atlantic Telegraph Company are leased by the Western Union Telegraph Company, for the period of 92 years from October first 1876, at an annual rental equal to five per centum upon the Capital Stock of the Southern and Atlantic Telegraph Company, which, by the contract, is limited to nine hundred and fifty thousand dollars. The rent is payable, pro rata, to the respective stockholders, at the office of the Treasurer of the Western Union Telegraph Company, in semi-annual payments of two and one-half per centum, on the first day of April and October, in each year.
16. The five lessor companies here involved were included with the Western Union Telegraph Company in consolidated returns filed for the years 1920 and 1921, respectively. These five companies were excluded from consolidation with the Western Union by the Commissioner's final letter of December 13, 1928. By said letter, *1231 contrary to the Western Union's contentions made to the Commissioner's representatives in the course of the audit of said returns that the only taxable income involved in the rental payments under said leases was the net amount actually paid by the Western Union Telegraph Company to the stockholders other than itself, that the amount of rental attributable to the shares of stock owned by the Western Union was cancelled by its ownership of said stock, and that no part of said rental was income of the lessor companies, the Commissioner nevertheless by said final letter and as a result of the audit of the returns of the Western Union Telegraph Company in each of said years allowed, among the deductions from the income of the Western Union Telegraph Company to ascertain the net income subject to tax, as rentals paid by the Western Union Telegraph Company in respect of the properties of the Gold and Stock Telegraph Company the sum of $300,000, - the International Ocean Telegraph Company, $180,000, - the Southern and Atlantic Telegraph Company, $47,452.50, - the Pacific and Atlantic Telegraph Company of the United States, $80,000, - and the Franklin Telegraph Company, $25,000, and charged*1232 the Western Union as dividends received from the domestic corporations in respect of its stockholding in the Gold and Stock Telegraph Company the sum of $153,336, - the International Ocean Telegraph Company, $120,762, - the Southern and Atlantic Telegraph Company, $19,556.25, - the Pacific and Atlantic Telegraph Company of the United States, $59,020, - and the Franklin Telegraph Company, $15,897.50. The foregoing figures include only that portion of the rental paid in each of said years which is required by said leases to be paid to stockholders. The fifference between the sum of $165,342, hereinabove in paragraph 12 stated to be the amount of rental for 1920 in respect of the shares of capital stock of the Gold and Stock Telegraph Company owned by the Western Union Telegraph Company, on the one hand, and the item of $153,336, in this paragraph stated to have been charged to the Western Union Telegraph Company as dividend on the stock of the Gold and Stock Telegraph Company owned by it in 1920, on the other hand, was the sum of $12,006, the rental for 1920 in respect of 2,001 shares of said capital stock which were in fact owned by the Western Union Telegraph Company but which it*1233 held in a voluntary sinking fund and in respect of which shares the Western Union Telegraph Company paid or accounted to no one except itself. Said 2,001 shares were, in the computation made to determine the amount of dividends to be charged as received by the Western Union Telegraph Company, considered as though owned by *920 third parties. The same situation existed with regard to the year 1921, during which year the amount of rent called for by the lease in respect to the shares of stock of the Gold and Stock Telegraph Company owned by the Western Union Telegraph Company and held in said sinking fund, was $17,149.50; and with regard to the International Ocean Telegraph Company for both said years 1920 and 1921, the amount of rent called for by the lease on the shares so owned and held in said sinking fund was $4,026.
17. Facts which (if they have any legal relevancy to the issues herein) bear upon the question whether the invested capital of the petitioners, respectively, is determinable for the purpose of excess profits taxes for the years 1920 and 1921, are the following:
(a) Prior to October 4, 1910, and while the properties of these petitioners were being operated*1234 and used as a part of the telegraph system of the Western Union Telegraph Company, Price, Waterhouse and Company, accountants, made an investigation of the books and accounts of the Western Union Telegraph Company and of its subsidiaries, including the petitioners, with a view to determining the financial position of that Company as at June 30, 1910; and under date of October 4, 1910, said accountants made their report and presented a balance sheet of the Western Union Telegraph Company, which report and balance sheet have been the basis of all subsequent corporate accounting by the Western Union Telegraph Company and the petitioners, and were accepted as the basis of computation of the income and excess profit liability *921 of the Western Union Telegraph Company and the petitioners in their returns which were consolidated for the years 1917, 1918 and 1919, and of the income tax and excess profit liability of the Western Union Telegraph Company for said years 1920 and 1921; and in said years 1920 and 1921, the petitioners being denied consolidation with the Western Union Telegraph Company, deductions were made from the invested capital allowed by the Commissioner to the Western*1235 Union Telegraph Company in determining its excess profit liability based upon liabilities shown in said report and balance sheet in respect of petitioners' properties and assets.
(b) Said report and balance sheet included as assets the physical properties of the Western Union Telegraph Company, the book values of which had been compared by said accountants with an appraisal thereof by Westinghouse, Church, Kerr and Company, engineers. Said appraisal resulted in a valuation thereof at $127,978,617.82, which was $5,595,089.04 less than the book value, which appraisal valuation was used as the value of said assets in said balance sheet. Included in the properties so appraised and included as capital assets of the Western Union Telegraph Company, without separation, were all the properties of and leased from the Pacific and Atlantic Telegraph Company of the United States, Southern and Atlantic Telegraph Company and Franklin Telegraph Company. The par value of the shares of capital stock of these companies owned by third persons other than the Western Union Telegraph Company was included in said balance sheet as a capital liability of the Western Union Telegraph Company.
(c) In*1236 said report and account, the properties and assets of Gold and Stock Telegraph Company and International Ocean Telegraph Company were not included among the capital assets of the Western Union Telegraph Company, excepting as hereinafter in paragraph (d) appears, but were at the same time and by the same engineers and accountants appraised and set up in accounts which have been the basis of all subsequent corporate accounting by the Western Union Telegraph Company and the petitioners, and were accepted by the respondent as the basis of computations of income and excess profit liability of the Western Union Telegraph Company and the petitioners in their returns which were consolidated for the years 1917, 1918 and 1919, and of the income tax and excess profit liability of the Western Union Telegraph Company for said years 1920 and 1921, the petitioners being denied in said years consolidation with the Western Union Telegraph Company; and the pro forma balance sheets of said companies as so used and accepted by the respondent in said last mentioned computations were as follows:
| Assets: | |
| Plant and Equipment | $499,899.00 |
| Stock of other companies | 207,492.00 |
| Account receivable from Western Union Telegraph Company | 12,357,401.30 |
| Total | $13,064,792.30 |
| Liabilities: | |
| Capital stock | 5,000,000.00 |
| Surplus | 8,064,792.30 |
| Total | $13,064,792.30 |
| International Ocean Telegraph Company. | |
| Assets: | |
| Plant and Equipment | 2,370,242.00 |
| Stock of other allied companies | 4,850.00 |
| Account receivable from Western Union Telegraph Company | 25,620.00 |
| Deficit | 599,288.00 |
| Total | $3,000,000.00 |
| Liabilities: | |
| Capital stock | $3,000,000.00 |
*1237 (d) That the items shown as accounts receivable from the Western Union Telegraph Company in said balance sheets relate to the following transactions: Among the assets of the Gold and Stock Telegraph Company and the International Ocean Telegraph Company taken into possession by the Western Union Telegraph Company, as aforesaid, at or about the times of the aforesaid leases, were securities belonging to said Gold and Stock Telegraph Company and other property of said International Ocean Telegraph Company, upon which securities there accrued prior to the year 1910 stock subscription rights in the exercise of which the Western Union Telegraph Company acquired additional securities. Said securities and other property were sold by the Western Union Telegraph Company prior to the year 1910 for the total sum of $24,236,821.86, out of which proceeds there was due to the Western Union Telegraph Company on account of its advances for purchases under said subscription rights $11,853,920.56, leaving the sum of $12,382,901.30 as the net proceeds of the sales of securities and other property which was commingled with the general property of the Western Union Telegraph Company, and which upon the*1238 expirations of the leases, now limited for expiration in 1981, will be payable to the respective lessors as follows:
| Gold and Stock Telegraph Company | $12,357,401.30 |
| International Ocean Telegraph Company | 25,500.00 |
| Total | 12,382,901.30 |
*922 These figures were set up in the aforesaid report and balance sheet of the Western Union Telegraph Company as liabilities of the Western Union Telegraph Company; and in the years 1920 and 1921, said companies being denied consolidation with the Western Union Telegraph Company, deductions in the above amounts were made from the invested capital allowed by the Commissioner to the Western Union Telegraph Company, in determining its excess profits liabilities, by reason of the ownership by said companies of the proceeds of their securities and other property so sold.
18. That E. Y. Gallaher, if called as a witness, would testify, and this case is submitted with like effect as though he had been called and testified, that he is Vice-President and Comptroller of the Western Union Telegraph Company, and Vice President and Auditor of the Gold and Stock Telegraph Company and has been Auditor of the Gold and Stock Telegraph*1239 Company since 1912 and Vice President and Auditor since 1916, that in the years 1920 and 1921, and for many years theretofore, said Gold and Stock Telegraph Company had no financial transactions excepting the receipt from the Western Union Telegraph Company and the disbursement of the cost of maintaining its corporate organization as provided in the contract of December 14, 1881, referred to in paragraph 2 hereof, that is to say, the receipt in 1920 of $1,790.97 organization expenses, and the receipt in 1921 of a like item of $1,770.26, and corresponding disbursements; and that said company had no debts whatever in either the year 1920 or the year 1921, excepting only possible indebtedness to the United States Government for income and excess profits taxes in the amount of $55,300.42 for the year 1920, said to have been due and payable in the year 1921, as per the letter of the Commissioner of Internal Revenue of June 13, 1927; and that its liability for these income and excess profits taxes is in litigation in the petition filed in the Board of Tax Appeals, Docket No. 29470, one of the cases in which this stipulation is filed. The statements in this paragraph shall not be construed*1240 to affirm nor deny that the payments to stockholders provided for in said contract of December 14, 1881, were in legal effect financial transactions of the Gold and Stock Telegraph Company.
"Exhibit A" is a lease, dated December 14, 1881, between the Gold and Stock Telegraph Company, called G. & S.T. Co., and the Western Union Telegraph Company, called W.U.T. Co., whereby in consideration of a rental G. & S.T. Co. leased its property to W.U.T. Co. for a term of 99 years from January 1,1882, during which term W.U.T. Co. could operate the properties either in its own name or in the name of G. & S.T. Co. and constituting W.U.T. Co. agent of G. & S.T. Co. for the purpose of the business. The capital stock of G. & S.T. Co. was to remain fixed at $5,000,000, divided into 50,000 shares, each having a par value of $100. W.U.T. Co. agreed to pay an annual rental of $300,000, payable quarterly, being a sum equal to 6 per cent per annum on the G. & S.T. Co. capital stock. G. & S.T. Co. requested and authorized W.U.T. Co. to pay the rental by pro rata distributions to the several stockholders of G. &. S.T. Co. as they appeared on the books at the time of payment and agreed to accept such*1241 distributions in full payment of the rental. There was also an additional rental of $2,500 per annum to be used by the officers of G. & S.T. Co. for administration *923 expenses of the corporation which was to be maintained. In case of default in payment G. & S.T. Co. had the option to terminate the agreement and resume possession of the property. The property was to be surrendered in good condition upon termination of the agreement. W.U.T. Co. agreed to pay taxes lawfully imposed upon the property and to "keep the same clear from all incumbrances arising from tax, assessment, or judgment liens or from any act of W.U.T. Co. during the term" of the agreement. W.U.T. Co. was to assume and pay the principal and interest of certain bonds of G. & S.T. Co. and could require the issuance of other bonds under the same arrangement.
"Exhibit B" is an agreement dated November 24, 1881, between the International Ocean Telegraph Company, called I.O.T. Co., and the Western Union Telegraph Company, called W.U.T. Co., reciting that the two owned connecting telegraph lines which could be advantageously operated in connection with each other; W.U.T. Co. proposed to act as agent and employee*1242 of I.O.T. Co. iv operating the latter's property for a term of years in consideration of all profits in excess of an amount to be retained by I.O.T. Co., which latter amount W.U.T. Co. guaranteed to amount to not less than 6 per cent per annum during the term on the capital stock of I.O.T. Co. fixed at $3,000,000; and the proposal had been accepted by the board of directors of I.O.T. Co. W.U.T. Co. agreed to accept the agency for I.O.T. Co. and to operate and maintain its properties for 99 years from January 1, 1882. I.O.T. Co. was to retain or receive by distribution among its stockholders out of the receipts of the business the net sum of $180,000 annually, being the equivalent of 6 per cent upon its capital stock, payable quarterly, which amount W.U.T. Co. guaranteed regardless of earnings. In addition, I.O.T. Co. was to retain or receive $2,500 to cover expenses of maintaining its organization. I.O.T. Co. authorized and requested W.U.T. Co. to make the quarterly distributions pro rata among the stockholders of I.O.T. Co. appearing upon the books at the time of payment. W.U.T. Co. agreed to pay all expenses incurred in the operation of I.O.T. Co.'s property, including all taxes*1243 which might be lawfully imposed upon the same, and keep the property free of encumbrance from tax, assessment, or judgment liens during the agency. In case of default in payment, I.O.T. Co. had the option to terminate the agency and resume possession of the property. The property was to be surrendered in good condition upon termination of the agreement. W.U.T. Co. was to retain or receive as its full remuneration in the employment and agency and in operating the property all profits remaining after I.O.T. Co. had withheld, taken or otherwise received the portions above mentioned. W.U.T. Co. *924 was not to use the properties for certain purposes without first obtaining the consent of I.O.T. Co.
"Exhibit C" is a lease, dated December 16, 1873, between The Pacific and Atlantic Telegraph Company of the United States (herein called P. and A.) and the Western Union Telegraph Company (herein called W.U.T. Co.), reciting that the two owned and operated competing lines where cooperation was needed and providing for the leasing of the P. and a. properties by W.U.T. Co. for the term of 999 years from January 1, 1874, in consideration of the payment by W.U.T. Co. of $80,000 per*1244 annum, being 4 per cent per annum on the P. and A. capital stock, payable semiannually. It further provided that, in lieu of making the payments to P. and A., W.U.T. Co. should pay the rental to the P. and A. stockholders in proportion to the shares held in accordance with semiannual lists furnished by P. and A. W.U.T. Co. was also to pay the necessary expenses of maintaining the organization of P. and A. not to exceed $2,500 per annum. These payments were to be made without deduction for taxes or assessments incurred after the first Tuesday of May, 1874. In case of default, P. and A. could terminate the lease. The agreement recited that it was made in pursuance of resolutions of the board of directors and with the written consent of the holders of three-fourths of the stock of P. and A.
"Exhibit D" is a lease, dated July 10, 1876, between the Southern and Atlantic Telegraph Company (herein referred to as S. and A.) and the Western Union Telegraph Company (herein referred to as W.U.T. Co.), leasing the S. and A. properties to W.U.T. Co. for a term of 92 years from October 1, 1876, and thereafter for such further term as will make 999 years, if lawful, in consideration of an*1245 annual rental equal to 5 per cent on the S. and A. capital stock (not to exceed $850,000), payable semiannually, and expenses of maintaining the S. and A. organization not to exceed $2,500 per annum. The lease contained other provisions somewhat similar to those of "Exhibit C," including one relating to payment of the rental to the stockholders.
"Exhibit E" is a lease, dated June 15, 1876, between the Franklin Telegraph Company (herein referred to as F.T. Co.) and the Atlantic and Pacific Telegraph Company (herein referred to as P. and A.) leasing the F.T. Co. properties to P. and A. for a term of 99 years from May 1, 1876, in consideration of the payment of $25,000 per year payable semiannually to the F.T. Co. stockholders at the rate of $1.25 per share. F.T. Co. could terminate the lease upon default. P. and A. agreed to pay all obligations, liabilities and debts of F.T. Co. arising during the term of the lease, including all taxes. The lease recited that it was made in pursuance of resolutions of the board of directors and stockholders and that a majority of the F.T. Co. stock was held by or for P. and A.
*925 These exhibits contained other provisions in addition*1246 to those mentioned above.
OPINION.
MURDOCK: The American Telegraph and Cable Company leased its properties to the Western Union Telegraph Company in 1882 for a term of 50 years. The provisions of that lease were quite similar to those of some of the leases here in question. In October, 1925, the Board held that the entire annual rental for 1919 was income to the cable company. See , where the subject is discussed at length. The Court of Claims in December, 1925, held that the entire rental for 1922 was income to the lessor. . The Supreme Court of the United States denied certiorari in that case, . The same question for the years 1924 and 1925 was litigated before the Board, which held that the law was unmistakably clear in support of the Government. . No appeal was taken from that decision.
The petitioners admit that these cases are directly in point and that they are supported by the authorities cited therein, particularly *1247 , and . But they argue that the two last mentioned cases were incorrectly decided and should no longer be followed. They call our attention to the fact that the Circuit Court of Appeals for the Second Circuit in , expressed a doubt as to the correctness of the holding of the earlier cases that a tax might be assessed against the lessor as though the lessor had money. This doubt arose by reason of the decisions of the New York courts in ; affd., ; ; and ; ; affd., . In those cases the New York courts held that stockholders who had been guaranteed "dividends" by the lessee of property of their corporation derived certain rights under the "guarantee." Just how this would work out in the present cases*1248 where the lessee was also a stockholder, we do not know. Certainly as stockholder it could gain nothing from its guarantee as lessee. In some of the present cases the lessee made no direct "guarantee" to the stockholders. The petitioners nevertheless contend that under these New York cases the income belongs to the stockholders at the time of payment and therefore can not be taxed to the lessors. Some, if not all, of these cases were brought to the attention of the Board and *926 of the Court of Claims in connection with the American Telegraph & Cable Co. cases. We still feel that they do not require a different result on the question of liability of the lessors for Federal income tax. The court in , avoided decision of the income question as did the court in . We will follow the American Telegraph & Cable Co. cases at least until the First and Second Circuit Courts of Appeal reverse their earlier positions.
The agreement between the Southern and Atlantic Telegraph Company and the Western Union was in form not a lease but the employment*1249 of an agent. This difference does not distinguish the case of that petitioner from the others so far as the result to be reached is concerned. But before a contrary result could be reached this difference would probably have to be considered. A principal is liable for the income from the operation and use of its property even though an agent actually operates the property and disposes of the proceeds as directed in the contract of agency.
The other agreements are in form leases and no one suggests that they are anything else in fact. The four companies leased their properties for an agreed rent. Rent may be defined as a periodical payment for the use of property. It is specifically mentioned in the revenue acts as a part of gross income. The lessors owned the leased properties when the agreements were entered into. They still exist as corporations and they still own the properties. They have made no assignment of their leases. Being owners, they alone had the right to say what should be done with the rent. It was subject to their unfettered command. They were free to enjoy it at their option. They could have required that it be paid directly to them as owners, but instead*1250 they chose for their own purposes and convenience to specify that their right to receive should be enjoyed by others, their stockholders. Cf. . This was the exercise of a prerogative of ownership, an enjoyment, and a sufficient basis for the imposition of a tax. The income was nevertheless theirs from the use of their properties.
The petitioners concede that the rent would be income to them if paid to third parties in discharge of an obligation, as, for example, to bondholders or in payment of taxes of the lessor. ; ; . But they argue that they are under no obligation to their stockholders and therefore do not own or derive any benefit from the payments to the stockholders. The use to which money is put does not determine whether or not it was income before being so used. Nor need it determine who owned the income. Rent is income of the lessor who is entitled to say what shall be done with *927 *1251 it. Why should it make any difference what the lessee agreed to pay on behalf of the lessor, whether a debt or a dividend? In either case it has applied the rent in accordance with the wishes of the lessor. If constructive receipt applies in the one case it may just as well apply in the other. Cf. . The usual purpose of stockholders in organizing and maintaining their corporation is that they may ultimately receive its earnings. The earnings of these corporations were paid directly to their stockholders at the direction of the corporations. The corporations controlled, enjoyed, and benefited by their earnings in that they fulfilled the purpose of their stockholders and justified their corporate existence. A part of their control, having been exercised, no longer exists, but the enjoyment and benefit continue as each payment comes due and is paid in accordance with the agreements. Actual receipt of income is not a prerequisite of income-tax liability, nor is control of the income at the moment it becomes due. It matters not that the corporations, having elected to enjoy their income in one way, are no longer*1252 free to enjoy it in another. Their control, benefit and enjoyment would be no greater at the moment of payment had they contracted to have the payments made to bondholders with a guarantee by the lessee to the bondholders. Cf. .
Counsel for the petitioners tells us that the Commissioner has been consistent in his error and has allowed the Western Union Telegraph Company to deduct the full amount of the rent reserved in the leases, even though it has paid no one the portion applicable to the share held by it in the various companies. This fact need not influence us however. Suggestion has also been made that the payments are taxable directly to the stockholders as ordinary income and not as corporate distributions. This is a collateral question only, but if it were before us for decision we would have difficulty classifying the payments as something other than corporate distributions. They were not paid to the stockholders as rent for the use of their property, for they did not own the property at any time and they were not the lessors. They received them only because they were stockholders of the corporations.
*1253 The Commissioner has determined the liability of these petitioners for excess-profits taxes under section 328 because of his inability to determine their invested capital as provided in section 326. Error was assigned in this connection by each petitioner and certain facts were stipulated in paragraphs 17 and 18, but no argument was made on these facts except as they relate to the Gold and Stock Telegraph Company. That petitioner concedes that the facts essential to a proper computation of its full invested capital under section 326 are not known. But it argues that sections 327 and 328 were intended as *928 relief legislation and ought not to be construed as imposing a tax where normally none would be due. It claims that in the taxable years it had realized appreciation on its assets to the extent of $12,357,401.30, as set forth in paragraph 17(d) of the stipulation and "taking this figure alone of the assets * * * it makes up any deficiency of capital and establishes a surplus of sufficient amount under section [326] of the Act to give an excess profits credit of eight per centum thereof, plus $3,000 in excess of the total rental reserved in the lease, which was $300,000*1254 per year." Invested capital of $3,500,000 would entitle the petitioner to a credit more than sufficient to offset its income. If it can show that its invested capital would be at least that large, then we would agree that an excess-profits tax should not be computed under section 328.
The lease is not clear as to how the lessee is to account at the end of the term for the proceeds from the sale of securities belonging to the lessor. The stipulation shows, however, that the lessee in 1920 and 1921 owned an account receivable from the Western Union, payable in 1981, in the amount of $12,357,401.30. The respondent argues that this amount would have to be discounted to find its value in 1920 and 1921 for invested capital purposes. Some discounting may be proper, but the lessee is paying annually the equivalent of 6 per cent on $5,000,000 for the use of the petitioner's property, and it is clear that the petitioner's assets were worth at least $5,000,000 in 1920 and 1921. It had no liabilities. The $5,000,000 of assets which it had in these years must have been either earned or paid in under circumstances which would create invested capital under section 326. Obviously its invested*1255 capital was more than sufficient to give it a credit in excess of its income.
The petitioners made one additional point which, they confess, finds no support in the terms of the statute or in any decided case. They claim that they were not doing business during the taxable years and the excess-profits provisions were not intended to reach them. These provisions apply to all corporations not specifically exempt.
Further proceedings under Rule 62(c).