*1264 1. In the taxable period 98 percent of the stock of a railway company was owned by a coal company which in turn was 100 percent owned by a second railway company. The two railroad companies received all the output of the coal company for shipment and purchased most of their fuel requirements therefrom. Held, that the three corporations were affiliated from January 1 to April 1, 1917.
2. Petitioner having failed to show cost or value at March 1, 1913, of certain tangible properties used in the business of its predecessors, the claims for depreciation allowance for the taxable period cannot be allowed.
3. Where there is no allocation agreement, the respondent must ratably assess the excess profits tax of an affiliated group on the basis of the income of the members thereof.
*843 The respondent has determined deficiencies for a taxable period beginning January 1 and ending at March 31, 1917, in the respective amounts of $1,789.48 and $2,199.57. On motion timely made and duly granted*1265 on September 20, 1933, he filed amended answers asking that such deficiencies be redetermined in the increased amounts of $5,058.77 and $6,218.10, respectively. In each proceeding the petitioner, in its final amended petition filed on October 23, 1933, alleges that respondent has erred (1) in the determination of the deficiencies in question on the basis of a consolidated return for the period involved instead of for the calendar year 1917; (2) in the disallowance of depreciation on railway buildings, bridges, masonry, and machinery for the taxable period; and (3) in the computation of invested capital of each of the predecessors for the period involved. On the basis of the first allegation of error it has moved that both proceedings be dismissed *844 for lack of jurisdiction in this Board to redetermine the asserted deficiencies. The two proceedings were consolidated for hearing.
FINDINGS OF FACT.
The Wabash-Pittsburgh Terminal Railway Co. was a Pennsylvania corporation operating a railroad in Pennsylvania, West Virginia, and Ohio, until April 1, 1917, when it was succeeded by the Pittsburgh & West Virginia Railway Co. It was organized in 1904, in conformity with*1266 an agreement of consolidation entered into by the Pittsburgh, Carnegie & Western Railroad Co., the Cross Creek Railroad Co., and the Pittsburgh, Toledo & Western Railroad Co. Under that agreement the capital stock, properties, and franchise of the parties thereto were consolidated and merged and passed into the possession of the new corporation when formed.
The West Side Belt Railroad Co. was a Pennsylvania corporation. It operated a railway line in Pennsylvania until December 31, 1928, when it was consolidated with or merged into the Pittsburgh & West Virginia Railway Co., in conformity with an agreement of consolidation dated August 20, 1927, and duly approved by the Interstate Commerce Commission and the Public Service Corporation of the Commonwealth of Pennsylvania on December 10 and December 31, 1928, respectively. It was incorporated in 1902. Its property was operated by a receiver from June 22, 1908, to April 1, 1917.
On August 15, 1916, a reorganization committee representing the creditors of the Wabash-Pittsburgh Terminal Railway Co. purchased all the property thereof at a judicial sale. Such purchase was duly confirmed by the proper courts in August and September*1267 1916. Thereafter the committee proceeded to incorporated the Pittsburgh & West Virginia Railway Co. of West Virginia and the Pittsburgh & West Virginia Railway Co. of Pennsylvania, which were consolidated January 29, 1917. The deficiency notices herein were mailed in care of the merged corporation as the successor of the taxpayers.
On March 31, 1917, the books of the Wabash-Pittsburgh Terminal Railway Co. showed original cost of all the properties owned by that corporation in the amount of $28,358,076.72, but contained no separate accounts showing the respective costs of railway buildings, bridges, masonry, and machinery. On June 30, 1917, a report of the Interstate Commerce Commission showed the total reproductive cost as of that date, based on 1910-1914 prices of labor and materials, of the physicial properties of such company, in the total amount of $26,176,063. This report included a breakdown of the estimated costs of each of the categories as to which depreciation is claimed for the period from January 1 to March 31, 1917.
*845 In computing the amount of the claim for depreciation the petitioner has divided the reproduction cost, as reported by the Interstate*1268 Commerce Commission, into the actual cost reflected on its books and has used the resulting quotient of 1.09 as a factor in the conversion of the reproductive costs shown by the Interstate Commerce Commission for each category into alleged actual costs, and upon the basis so determined claims depreciation on buildings, bridges, masonry, and machinery for the taxable period in amounts as follows: buildings, $13,052.27; bridges, $11,197.39; masonry, $8,476.40; machinery, $2,153.98; or a total of $34,880.04. These amounts were computed by applying annual straight line depreciation rates of 3 1/2 percent on frame buildings, 2 percent on brick buildings, 8 1/3 percent on wooden bridges, 2 2/9 percent on steel bridges, 1 1/2 percent on masonry, 5 percent on power house and shop machinery, with due allowances for any salvage remaining after exhaustion of useful life.
The original cost of the physical properties of the West Side Belt Railroad Co. is not disclosed by the books of that corporation. As its bases for depreciation the petitioner has taken the reproductive costs of the various categories as of June 1, 1917, as determined by the Interstate Commerce Commission, applied the factor*1269 of 1.09 as above set out, and computed claims for depreciation in the taxable period on a basis so estimated of $959,453, at the same rates and with the same allowances for salvage that were used in arriving at the amounts of depreciation claimed for the Wabash-Pittsburgh Terminal Railway Co., with a resulting total for the taxable period in the amount of $4,308.74.
The Wabash-Pittsburgh Terminal Railway Co., West Side Belt Railroad Co., Pittsburgh Terminal Railroad & Coal Co., and several other small related corporations not involved in these proceedings, made separate income and excess profits tax returns for the year 1917. Upon audit the respondent classified all the reporting corporations into two affiliated groups, viz., the Wabash-Pittsburgh Terminal Railway Co., West Side Belt Railroad Co., Pittsburgh Terminal Railroad & Coal Co., Mutual Supply Co., Pittsburgh Terminal Land Co., and Pittsburgh Terminal Clay Manufacturing Co., from January 1 to March 31, 1917, with the Wabash-Pittsburgh Terminal Railway Co. as the parent corporation; and the Pittsburgh & West Virginia Railway Co., West Side Belt Railroad Co., Pittsburgh Terminal Railroad & Coal Co., Mutual Supply Co., Pittsburgh*1270 Terminal Land Co., and Pittsburgh Terminal Clay Manufacturing Co., from April 1 to December 31, 1917, with the Pittsburgh & West Virginia Railway Co. as the parent corporation. On this classification he held that two consolidated returns should be made *846 for the year 1917 and allocated all the tax liability due on such returns to the Pittsburgh Terminal Railroad & Coal Co. At the same time he determined that by virtue of the merger or consolidations of April 1, 1917, and December 31, 1928, the Pittsburgh & West Virginia Railway Co. became the successor of the Wabash-Pittsburgh Terminal Railway Co. and the West Side Belt Railroad Co. and so liable for the taxes of such corporations during the taxable period now under review.
On August 26, 1925, the respondent mailed a notice to the Pittsburgh & West Virginia Railway Co., advising it of an overassessment for the period from April 1 to December 31, 1917. The notice also disclosed overassessment for the same period in respect of the Pittsburgh Terminal Clay Manufacturing Co., the Mutual Supply Co., and the West Side Belt Railroad Co., all affiliated with the first named corporation. On the same date he mailed notices to*1271 the Pittsburgh Terminal Railroad & Coal Co., the Wabash-Pittsburgh Terminal Railway Co., the West Side Belt Railroad Co., and the Mutual Supply Co., asserting deficiencies in the respective amounts of $59,034.70, $2,199.57, $1,789.48, and $103.24 for the period from January 1 to March 31, 1917.
On October 23, 1925, all the corporations above enumerated joined in a single petition to this Board, which was duly received and filed at Docket No. 8349. On March 31, 1931, we dismissed the proceeding so far as it related to the Pittsburgh Terminal Railroad & Coal Co. for lack of jurisdiction. On January 27, 1933, we dismissed the proceeding at Docket No. 8349 in so far as it related to the tax liability of the Pittsburgh Terminal Railroad & Coal Co. Pittsburgh Land Co. for the year 1917, or any part thereof. At the same time we granted permission to the Pittsburgh & West Virginia Railway Co., as successor to the Wabash-Pittsburgh Terminal Railway Co., the West Side Belt Railroad Co., and the Mutual Supply Co., to file separate amended petitions at the new docket numbers, based upon the notice of deficiency covering the period from January 1 to March 31, 1917. Pursuant to such order*1272 the Pittsburgh & West Virginia Railway Co., as successor corporation, timely filed the petitions now under consideration.
In the taxable period 98 percent of the stock of the West Side Belt Railroad Co. was owned by the Pittsburgh Terminal Railroad & Coal Co., which, in turn, was 100 percent owned by the Pittsburgh & West Virginia Railway Co. The lines of the two railroad companies traversed the developed and undeveloped mineral properties of the Pittsburgh Terminal Railroad & Coal Co. and afforded transportation facilities for its production. Each of the railroad companies bought fuel from the coal company at regular market prices, but neither so *847 obtained all its requirements for such purposes. The total purchase by the railroads was much less than the production of the coal company. The offices of the two railroad companies were in the same building and the same officers directed the policy and operations of both corporations during the taxable period.
In his computation of the invested capital of the consolidated group for the taxable period under review, the respondent first determined the average invested capital from January 1 to April 1, 1917, and then*1273 used one fourth thereof in computing the deduction to which the group was entitled for the period, under the provisions of sections 201 and 203 of the Revenue Act of 1917. In the same computation the respondent used the surpluses of some members of the consolidated group to reduce the deficits of others.
In his determination of deficiencies for the taxable period, the respondent allocated all excess profits taxes to the Pittsburgh Terminal Railroad & Coal Co. The tax liability of that corporation has been settled for an amount less than the deficiency originally determined. In his answers to the amended petitions the respondent affirmatively asserts that there was no intercompany agreement for such allocation and that in conformity with the law this excess profits tax should be allocated to each member of the group in proportion to its net income, and moves to increase the deficiencies in the respective amounts of $3,269.29 and $4,018.53.
In connection with the compromise settlement of the tax liabilities of the Pittsburgh Terminal Railroad & Coal Co., Mutual Supply Co., and Pittsburgh Terminal Clay Manufacturing Co., such corporations stipulated with the Commissioner as follows:
*1274 (1) That the offer of compromise filed on or about September 2, 1932, with the Commissioner of Internal Revenue, under the caption "Pittsburgh Terminal Coal Corporation and its Affiliated Companies in the United States," is intended and shall be deemed to relate only to the tax liability of Pittsburgh Terminal Coal Corporation, Mutual Supply Company, and Pittsburgh Terminal Clay Manufacturing Company; and that it does not relate to or include, and shall not be deemed to affect, the tax liability of any of the other undersigned corporations.
(2) That the acceptance of said offer in compromise or the making of any settlement, by the Commissioner of Internal Revenue, with Pittsburgh Terminal Coal Corporation, Mutual Supply Company, and/or Pittsburgh Terminal Clay Manufacturing Company, is not intended to and shall not be deemed to adjust, determine, or fix the tax liability of any of the other undersigned corporations, jointly, severally, or as members of an affiliated group; that, notwithstanding the acceptance of said offer in compromise or the making of such settlement, the income, excess profits, and tax liability of the other undersigned corporations, jointly, severally, or*1275 as members of an affiliated group, may be computed, determined, allocated, assessed, and collected in the same manner as though such offer in compromise or settlement had not been made, considered, or accepted.
*848 (3) That the compromise or settlement of the tax liability of Pittsburgh Terminal Coal Corporation, Mutual Supply Company, and/or Pittsburgh Terminal Clay Manufacturing Company, shall be deemed to be a settlement and adjustment only of taxes properly due from said corporations under the applicable revenue statutes; it shall not be regarded as a ratification or approval of computations and allocations of tax liability heretofore made; and it shall not prevent the recomputation and reallocation, under the applicable revenue statutes, of the excess profits tax liability of the affiliated group, of which said corporations were members, or of the several liabilities of the other members of such affiliated group.
The purpose of this stipulation is declared therein to be as follows:
It is the purpose and intention of the undersigned parties, in executing this stipulation, to permit an adjustment and settlement, by the Bureau of Internal Revenue, of certain tax liabilities*1276 alleged to exist against Pittsburgh Terminal Coal Corporation, Mutual Supply Company, and Pittsburgh Terminal Clay Manufacturing Company, without in any manner affecting the computation, determination, allocation, assessment, and/or collection of the tax liabilities of the affiliated group, of which said corporations were members, or the tax liability of the other members of such group. It is desired and intended that the within stipulation shall be construed and interpreted in such manner as to effectuate that purpose.
OPINION.
LANSDON: The petitioner contends that the respondent erroneously determined that the West Side Belt Railroad Co., the Wabash-Pittsburgh Terminal Railway Co., and the Pittsburgh Terminal Railroad & Coal Co. were members of an affiliated group during the taxable period; that each was a separate corporation in existence during the entire year 1917, and entitled to make a separate income tax return; and that if such facts are established by the record the deficiency notice relating to tax liability from January 1 to March 31 is not a notice of deficiency for any taxable period of the two companies and, therefore, fails to establish jurisdiction in this Board*1277 to redetermine the deficiencies thus asserted in error. On the basis of these contentions, petitioner requests the Board to dismiss both proceedings and render decisions of no deficiencies.
The respondent has determined that the two corporations here involved were members of an affiliated group that should have made a consolidated return for the period under review. The facts show stock ownership sufficient to sustain the respondent's determination that a class A affiliation existed at least until January 24, 1917. At the hearing counsel for petitioners asserted that on that date all the stock of the Pittsburgh Railway Terminal & Coal Co. was sold at auction to a stranger to the affiliated group. On this contention the respondent demanded strict proof. The only evidence of such sale consisted of certain oral statements by the receiver of the Wabash-Pittsburgh Terminal Railway Co. and an offer of notice that the *849 stock would be sold at public auction on such date. Since transfer of title to stock is evidenced either by endorsement of stock certificates or by transfer entries on stock records, neither of which was proved for the record, we conclude that petitioners*1278 have failed to prove any change in stock ownership as of January 24, 1917.
Counsel for petitioner also argues that the facts show that the several corporations were not engaged in a closely related business, as provided in section 1331 of the Revenue Act of 1921. 1 The Revenue Act of 1917 contains no provision requiring or authorizing affiliation and counsel for petitioner argues that section 1331 is not retroactive. The language of this section disposes of the argument on this contention. In this connection petitioner also argues that if section 1331 of the Revenue Act of 1921 is retroactive, the Board should hold that the provisions thereof are unconstitutional. This question has been decided adversely to the contention of the petitioner. ; certiorari denied, .
*1279 In conformity with our conclusion above, it remains only to determine whether the corporations involved were engaged in a closely related business. It is not disputed that as to ownership of stock this was true, at least prior to January 24, 1917. The two railway companies were engaged in transporting freight and passengers as common carriers. The coal company produced and marketed coal, all of which was shipped over the lines of the railroad companies whose tracks traversed its properties. Much of the coal was purchased by the railroad companies for their own use as fuel, but at the prevailing market prices. Even so, the situation was *850 favorable to such companies, since they were able to secure their fuel supplies from a corporation owned by the same interests, without payment of freight charges other than to themselves. In these circumstances, we think, the determination of the respondent must be affirmed. The motion to dismiss because the deficiency letters were issued for the wrong period is denied.
The petitioner also contends that the Pittsburgh & West Virginia Railway Co. is not a successor to the Wabash-Pittsburgh Terminal Railway Co. and the West Side*1280 Belt Railroad Co., and, therefore, not liable for the debts of such corporations. Without any examination of the alleged facts upon which this contention is based, it is enough to point out that the deficiency notices were mailed in care of the Pittsburgh & West Virginia Railway Co., that service of such notices was accepted, and that appeals were filed by it as successor to the two corporations involved. In these circumstances it cannot now be heard to argue that it is not a successor corporation, liable for the obligations of its predecessors, as determined by the respondent. ; ; ; . This motion to dismiss is likewise denied.
Petitioner claims that the Wabash-Pittsburgh Terminal Railway Co. is entitled to depreciation allowances for the taxable period in respect of bridges, masonry, buildings, and machinery in the amount of $34,880.04. Depreciation is a question of fact. The first element in the*1281 computation of any allowance therefor is the cost or the 1913 value of the assets used in a trade or business. The property here involved was acquired over a period of nearly 20 years and to a great extent from prior corporations. The record contains no facts upon which we can find the cost at acquisition of the assets as to which depreciation allowances are now claimed. Even if the merger or consolidation of the prior companies into the petitioner corporation was effected in such a way that the successor became entitled to use the predecessor's bases for computing depreciation, the evidence of cost is still quite unsatisfactory.
A valuation as of January 1, 1917, made by the Interstate Commerce Commission, presumably for rate-making purposes, is somewhat lower than the book costs of all the tangible properties of the Wabash-Pittsburgh Railway Co., and it breaks down the whole valuation into separate categories, which include the groups in question. Petitioner undertakes to determine the cost of each group by multiplying the Interstate Commerce valuation thereof by 1.09, a factor which is developed by dividing the whole book cost by the *851 valuation as of whole. The*1282 infirmity of this evidence is obvious. The valuations of the Interstate Commerce Commission are admittedly the reproductive cost based on the prices of labor and material prevailing in 1910 to 1914, and cannot be regarded as persuasive evidence of actual cost. The same infirmity is inherent in the evidence offered in support of the claim of the West Side Belt Railroad Co. That the petitioners owned and used some part or all of the assets in their business in the taxable year may be admitted. The denial of any depreciation allowances by the Commissioner may have been a harsh ruling, but it was based on the fact that the petitioners had no records to support their claims. Even if the respondent is proved wrong, the petitioners have not established the correct bases for depreciation and their claims must be disallowed.
Petitioners contend that the respondent has erroneously computed the invested capital of the affiliated group in the taxable period. They argue that their entire invested capital should be used as an element in the computation of the excess profits deduction for the three-month period under review, instead of one fourth thereof. It is perfectly clear that the*1283 method contended for by the petitioner would result in a computation applicable to income for an entire year. As the capital here involved was used for only three months, the deduction is only one fourth of what it would be for an entire year. Petitioners also contend that in the computation of their invested capital the respondent erroneously offset the surpluses of some of the affiliated corporations by the deficits of others. No evidence on this question is in the record; therefore, any finding of fact in regard thereto is impossible.
The respondent originally allocated all the tax due by the consolidated group to the Pittsburgh Terminal Railroad & Coal Co. That corporation afterwards became insolvent and its tax liability was compromised for an amount much less than that determined by the respondent. As a condition precedent to his acceptance of the compromise, he required all the members of the affiliated group to sign a written stipulation to the effect that the compromise related only to the tax liability of the Pittsburgh Terminal Railroad & Coal Co., and that the excess profits taxes determined as to the group of affiliated corporations might be reallocated and determined*1284 as if no allocation had been previously made. This stipulation is in evidence. It indicates that the petitioners agreed to ignore the original allocation of all taxes due in the taxable period. At any rate there is no evidence that the affiliated companies had any allocation agreement. There is no such agreement in the files of the respondent and the petitioners have failed to show that one ever *852 existed. If there was no agreement, the fact that the Commissioner originally erroneously allocated all the tax to one of the members of the group does not preclude him from allocating the deficiencies in proportion to the income of the several corporations as required by law. . The respondent's motion for increased deficiencies is granted.
Decision will be entered under Rule 50.
Footnotes
1. SEC. 1331. (a) That Title II of the Revenue Act of 1917 shall be construed to impose the taxes therein mentioned upon the basis of consolidated returns of net income and invested capital in the case of domestic corporations and domestic partnerships that were affiliated during the calendar year 1917.
(b) For the purpose of this section a corporation or partnership was affiliated with one or more corporations or partnerships (1) when such corporation or partnership owned directly or controlled through closely affiliated interests or by a nominee or nominees all or substantially all the stock of the other or others, or (2) when substantially all the stock of two or more corporations or the business of two or more partnerships was owned by the same interests: Provided, That such corporations or partnerships were engaged in the same or a closely related business, or one corporation or partnership bought from or sold to another corporation or partnership products or services at prices above or below the current market, thus effecting an artificial distribution of profits, or one corporation or partnership in any way so arranged its financial relationships with another corporation or partnership as to assign to it a disproportionate share of net income or invested capital. For the purposes of this section, public service corporations which (1) were operated independently, (2) were not physically connected or merged and (3) did not receive special permission to make a consolidated return, shall not be construed to have been affiliated; but a railroad or other public utility which was owned by an industrial corporation and was operated as a plant facility or as an integral part of a group organization of affiliated corporations which were required to file a consolidated return, shall be construed to have been affiliated.
(c) The provisions of this section are declaratory of the provisions of Title II of the Revenue Act of 1917. ↩