*3787 The California state franchise tax for 1921, which was based upon gross receipts for 1920 and was due and payable in 1921, may not be deducted from income of 1920, even though taxpayer is on the accrual basis.
*541 This is a proceeding for the redetermination of deficiencies in income and profits taxes for the calendar years 1920 and 1921 in the amounts of $345.33 and $4,932.62, respectively.
The errors alleged in the petition and the supplemental petition are as follows: (1) That the Commissioner failed to allow as a deduction for the calendar year 1920, franchise taxes accrued in 1920 which were assessed and became due and payable in 1921; (2) that the Commissioner failed to allow as a deduction for the calendar year 1921, franchise taxes accrued in 1921 which were assessed and became due and payable in 1922; (3) that the Commissioner increased the gross income of the petitioner for the calendar year 1921 in the amount of $9,314.13, upon the theory or basis that income in said amount had been earned by the petitioner*3788 through the purchase of *542 $27,400 par value of bonds at less than par value; and (4) the inclusion by the respondent in petitioner's gross income for the calendar year 1921 of $4,550, upon the ground that income in said last mentioned amount had been earned by petitioner during 1921 by reason of the purchase and retirement of $13,000 par value of its bonds at less than the par value thereof. The bonds referred to in the last assignment of error are distinct from the transaction referred to in the third assignment of error.
In its original petition the petitioner assigns further errors which were waived and abandoned at the time of hearing.
FINDINGS OF FACT.
The petitioner, during the years 1919, 1920, 1921, and 1922, was a corporation organized and existing under the laws of California, with its principal office at San Francisco. Its business during those years was that of owning and operating within the State of California an electric railway for freight and passenger purposes and steamboats and barges in connection therewith.
During the years 1919, 1920, 1921, and 1922, there was in force and effect in the State of California a statute which imposed taxes*3789 upon railroads, including street railways, the pertinent provisions of which are as follows:
SEC. 3664a. Public utilities to pay state tax. - 1. All railroad companies, including street railways, whether operated in one or more counties; all sleeping-car, dining-car, drawing-room car and palace-car companies; all refrigerator, oil, stock, fruit, and other car-loaning, and other car companies, operating upon the railroads in this state; all companies doing express business on any railroad, steamboat, vessel, or stage line in this state; all telegraph and telephone companies; and all companies engaged in the transmission or sale of gas or electricity shall annually pay to the state a tax upon their franchises, roadways, roadbeds, rails, rolling stock, poles, wires, pipes, canals, conduits, rights of way, and other property, or any part thereof, used exclusively in the operation of their business in this state, computed as follows: Said taxes shall be equal to the percentages hereinafter fixed upon the gross receipts from operation of such companies and each thereof within this state.
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3. Percentages. - The percentages above mentioned shall be as follows: On all*3790 railroad companies, seven per cent; on all street railways, herein defined to include interurban electric railways and gasoline propelled railways, five and a quarter per cent * * *
SEC. 3665a. "Gross receipts from operation" defined. Hearing on claim of double taxation. - 1. The term "gross receipts from operation" as used in section three thousand six hundred sixty-four a of this code is hereby defined to include all sums received from business done within this state, during the year ending the thirty-first day of December last preceding, including the company's proportion of gross receipts from any and all sources on account of business done by it within this state, in connection with other companies described in said section.
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SEC. *543 3668. Assessment and levy of taxes. Request of bank to assess entire taxable value of shares of stock. Form. Notice of completion of assessments. - The state board of equalization must meet at the state capital on the first Monday in March of each year, and continue in open session from day to day, Sundays and holidays excepted, until the first Monday in July. Between the first Monday in March and the third*3791 Monday before the first Monday in July the Board must assess and levy the taxes as and in the manner provided for in section fourteen of article thirteen of the constitution of this state, and sections of this code enacted to carry the same into effect.
The assessments must be made to the company, person or association owning or operating the property subject to said tax, or, in the case of banks, banking associations, savings and loan societies and trust companies, to the stockholders therein; provided, however, that in the case of banks of liquidation the assessment shall be made to the receiver, trustee or officer in shares of such liquidation, as the case may be, as the representative of the stockholders thereof.
Notice of completion of assessment. - On the third Monday before the first Monday in July the said board shall publish a notice in one daily newspaper of general circulation published at the state capital, in one daily newspaper of general circulation published in the city and county of San Francisco, and in one daily newspaper of general circulation published in the City of Los Angeles, that the assessment of property for state taxes has been completed, and*3792 that the record of assessments for state taxes will be delivered to the controller on the first Monday in July, and that if any company, person, or association is dissatisfied with the assessments made by the board, it may, at any time before the taxes thereon shall become due and payable, apply to the board to have the same corrected in any particular. The board shall have power at any time on or before the first Monday in July to correct the record of assessments for state taxes and may increase or decrease any assessment therein if in its judgment the evidence presented or obtained warrants such action.
SEC. 3668b. Taxes payable, when. Taxes not fully secured by personal property. Sale of property at public auction. Notice. Bill of sale. Notice by state controller. - The taxes assessed and levied as provided in section fourteen of article thirteen of the constitution of this state, and in and by the provisions of this code enacted to carry the same into effect, shall be due and payable on the first Monday in July in each year, and one-half thereof shall be delinquent on the sixth Monday after said first Monday in July at six o'clock P.M., and unless paid prior thereto, *3793 fifteen per cent shall be added to the amount thereof, and unless paid prior to the first Monday in February next thereafter at six o'clock P.M., an additional five per cent shall be added to the amount thereof; and the unpaid portion, or the remaining one-half of said taxes, shall become delinquent on the first Monday in February next succeeding the day upon which they became due and payable, at six o'clock P.M.; and if not paid prior thereto five per cent shall be added to the amount thereof.
SEC. 3668c. Taxes lien on property and franchises. - The taxes levied under the provisions of section fourteen of article thirteen of the constitution of this state and sections of this code enacted to carry the same into effect shall constitute a lien upon all the property and franchises of every kind and nature belonging to the companies subject to taxation for state purposes, which lien shall attach on the first Monday in March of each year. * * *
At all times herein mentioned the petitioner's books of account were, and still are, kept upon the accrual basis and its income-tax *544 returns for the calendar years 1920 and 1921 were similarly made upon an accrual basis.
*3794 For the calendar year 1920, the petitioner reported its gross receipts from electric railway operations in the amount of $273,103.82, and its tax thereon at the rate of 5 1/4 per cent amounted to $14,337.94. For 1921, the petitioner duly filed its report of gross receipts from electric railway operations in the State of California in the amount of $309,749. Its tax thereon, at the rate of 5 1/4 per cent amounted to $16,261.82.
For the calendar year 1920, the respondent allowed as a deduction from gross income of the petitioner, on account of the franchise tax of the State of California, the amount which was assessed by the State Board of Equalization in the year 1920, and for the calendar year 1921, the respondent allowed as a deduction on account of such franchise tax, the amount which was assessed during the calendar year 1921.
On September 1, 1918, the petitioner executed a trust indenture to the First Federal Trust Co. of San Francisco, as trustee, by the terms of which there was authorized the issuance of bonds of the petitioner of the par value of $750,000, to be known as its first mortgage 5 1/2 per cent twenty-five year sinking fund gold bonds.
On January 1, 1921, there*3795 were issued and outstanding, pursuant to the terms of said trust indenture, bonds of the par value of $698,400. During the year 1921, the petitioner purchased in the open market $40,400 par value of its bonds for the aggregate sum of $26,112.50 at the times and in the amounts and for the price hereinafter set forth:
| July 31, 1921, $1,000 par value bonds for | $502.50 |
| November 15, 1921, 10,000 par value bonds for | 6,500.00 |
| November 27, 1921, 29,400 par value bonds for | 19,110.00 |
Of the bonds purchased as aforesaid, $13,000 par value were delivered to the First Federal Trust Co. on December 28, 1921, for cancellation, pursuant to the sinking fund provisions of the trust indenture.
The trust indenture provides for the payment of an annual stipulated amount of the surplus net earnings of the company for the redemption of bonds and further provides that in lieu of cash payments the company may, in its discretion, purchase bonds of the same issue covered by the trust indenture, at a price not to exceed 105 per cent of their face value, plus accrued interest, and deliver said bonds to the trustee for cancellation, and thereupon the amount of cash otherwise payable to*3796 the trustee for the sinking fund shall be reduced by the amount of the actual cost of said bonds to the company.
*545 The said bonds of $13,000 par value were canceled as aforesaid in December, 1921. These bonds were acquired by the petitioner at a cost of $8,500. The respondent in his notice of deficiency considered the difference between the par value and the cost of reacquisition, or, in other words, the amount of $4,550 to be "earned discount" and has included that amount in the gross income of petitioner subject to tax for the calendar year 1921.
The remaining par value of the bonds purchased as aforesaid were purchased by the petitioner for investment purposes out of surplus cash then in the hands of the petitioner. Immediately upon the purchase thereof said bonds were entered upon the general ledger of the company under the heading "Bonds Owned," and thereafter were held and considered as a current asset of the company and the bonds themselves remained for a period of more than three years thereafter in the possession of the petitioner and appealed as an asset on its balance sheet on December 31, 1921, and subsequent years.
The interest payment dates of the*3797 bonds were March 1 and September 1 of each year, and from and after the times of the acquisition by the petitioner of the said amount of $27,400 par value of its bonds for investment purposes the petitioner, on all interest-payment dates thereafter, paid to the trustee, at the time and in the manner required by the trust indenture, a sum of money sufficient to cover not only its bonds issued and outstanding in the hands of the public, but also for the $27,400 par value of its bonds which it had acquired and which were not canceled, redeemed, or retired during the year 1921.
The $27,400 par value of bonds cost the petitioner $17,662.50. The respondent in his notice of deficiency has considered the difference between $27,400 par value and the $17,662.50, cost of reacquisition, or, in other words, the sum of $9,314.13 to be "additional earned bond discount," and has included the last amount in the gross income of the petitioner subject to tax for the calendar year 1921.
The petitioner, in its return, included the amount of $423.37 as gross income arising out of the transaction upon the theory that the difference between $27,400 par value of the bonds and the amount of $17,662.50, *3798 cost of reacquisition, that is, the sum of $9,737.50, should be amortized over the remaining life of the bond, that is, over 23 years. The effect of the respondent's notice of deficiency is to include the entire amount of $9,737.50 in the gross income of the petitioner.
OPINION.
TRAMMELL: With respect to the deductibility of the State franchise tax, the question is, When did that tax accrue? It is contended by the petitioner that the franchise taxes which were assessed and *546 became due and payable in 1921 were deductible in 1920 upon the theory that they were based upon the earnings of the prior year. The petitioner relied upon the cases of United Statesv., in which the United States Supreme Court held that the munitions tax which was livied for 1916 upon munitions manufactured and sold in that year accrued in 1916, although it did not become due and payable until 1917. In that case the court said:
Only a word need be said with reference to the contention that the tax upon munitions manufactured and sold in 1916 did not accrue until 1917. In a technical legal*3799 sense, it may be argued that a tax does not accrue until it has been assessed and becomes due; but it is also true that in advance of the assessment of a tax, all the events occur which fix the amount of the tax and determine the liability of the taxpayer to pay it. In this respect, for the purposes of accounting and of ascertaining true income for a given accounting period, the munitions tax here in question did not stand on any different footing than other accrued expenses appearing on the appellee's books. In the economic and bookkeeping sense, with which the statute and treasury decision were concerned, the taxes had accrued. It should be noted that Section 13-d makes no use of the words "accrued" or "accrual," but merely provides for a return upon the basis upon which the taxpayer's accounts are kept, if it reflects income - which is precisely the return insisted upon by the Government. We do not think that the treasury decision contemplated a return on any other basis when it used the terms "accrued" and "accrual" and provided for the deduction by the taxpayer of items "accrued on their books."
In those cases the taxes were upon the profits from the manufacture and sale*3800 of munitions during 1916. In this case an entirely different situation is presented than was before the court in those cases. Here the tax which was assessed in the year 1921 was for that year. The period taxed was the year 1921 and not the year 1920. The tax for 1921 was measured by the gross receipts of 1920, but there was no liability in 1920 for the 1921 tax. In the Anderson and Yale & Towne cases, supra, all the facts occurred in 1916 which fixed the amount of the tax for that year although it was not due and payable until 1917. The tax was levied for 1916 based upon transactions which occurred during that year, but here the tax was upon franchises, railways, roadbed and other property for 1921 measured by gross receipts of 1920.
It is contended by the petitioner that on December 31, 1920, the petitioner had an absolute indefeasible liability to the State of California for a sum equal to a percentage of its gross receipts during that year and no event could have transpired to relieve it of that liability. No authority was cited in support of this contention and we have found none. On the contrary, a consideration of the statute leads us to the conclusion*3801 that there was no liability for the 1921 tax created by any facts which occurred in 1920. If the *547 corporation did not own the franchises and other property in 1921, there was no liability for the tax for that year, although the measure existed by which it could have been determined, if there was any liability. The 1921 tax was an expense of the business for that year and not for the prior year and it can not be deducted in the prior year as an accrued liability. With respect to the question as to whether the petitioner received any income from the purchase of its own bonds, the Board has heretofore decided with respect to the bonds which were purchased for investment purposes as well as for retirement purposes, that no income resulted therefrom. ; ; ; .
Reviewed by the Board.
Judgment will be entered on 15 days' notice, under Rule 50.
SMITH and STERNHAGEN dissent in part.