*554 These proceedings, which were consolidated for hearing, are for the redetermination of deficiencies in income and profits taxes as follows:
| Docket No. | Year | Deficiency |
| 31690 | 1917 | $74,408.09 |
| 1918 | 65,593.14 | |
| 34088 | 1920 | 50,295,09 |
As a result of a stipulation of counsel filed at the hearing all of the errors assigned in the petitions as amended were disposed of except (b) and (f) of Docket No. 31690 and (a) and (b) of Docket No. 34088. Error (f) of Docket No. 31690 and error (b) of Docket No. 34088 present the same question, namely, whether the *555 respondent has correctly computed the petitioner's invested capital for the years here involved. Error (b) of Docket No. 31690 and error (a) of Docket No. 34088 present the same question, namely, the right of the petitioner as a lessee to deduct from gross income minimum royalties in excess of royalties based on actual production accrued during 1918 and 1920 on certain*1624 coal leases. The case was submitted on stipulation, oral testimony and documentary evidence.
FINDINGS OF FACT.
The petitioner is a Pennsylvania corporation, with its principal place of business at Greensburg.
About two years prior to the making of an agreement entered into under date of December 22, 1909, between the Georges Creek Coal & Iron Company and the petitioner, the petitioner negotiated with that company for the purchase of its properties located in the State of West Virginia. At the time of these negotiations, the Georges Creek Coal & Iron Company endeavored to sell to petitioner all of its property, including certain property located in the State of Maryland. These negotiations terminated when the Maryland property was discussed, as petitioner did not consider such property to be of any substantial value to it.
The properties owned by the Georges Creek Coal & Iron Company in West Virginia were being operated and were in good physical condition, while those owned by that company in Maryland were not well kept. There was practically no coal of the thick vein in the Maryland property owned by the Georges Creek Coal & Iron Company. The company had to mix the*1625 thick vein coal with the thin vein coal in order to sell it. In Maryland, the Georges Creek Coal & Iron Company had about twelve or fifteen thousand acres, including mountain land. The property located in the State of Maryland did not represent more than 10 or 15 per cent of the total price asked.
By the agreement entered into under date of December 22, 1909, between the Georges Creek Coal & Iron Company and petitioner, the petitioner purchased from that company all the coal of the Pittsburgh vein or seam in and underlying all that tract of land situated in Marion County, West Virginia, adjoining the lands of the Fairmont Coal & Coke Company, the Federal Coal & Coke Company, lands formerly of the Barrackville Coal & Coke Company, now the Jamison Coal & Coke Company, Trader, et al., and lands of the Union Trust Company of Pittsburgh, trustee, containing 7,320 acres, more or less; all other veins or seams of coal underlying said tract of 7,320 acres above described, which were owned by the Georges Creek Coal & Iron Company, together with right to mine and *556 remove all of the coal so conveyed, together with all mining rights which the Georges Creek Coal & Iron Company had*1626 in connection with its ownership of said coal and all other rights in said premises; all tracts of surface lands which the Georges Creek Coal & Iron Company owned situated in Marion County, West Virginia, containing 816 acres, more or less, the same overlying the tract of coal hereinabove described or lying adjacent thereto, with such improvements as were located on said tracts of land which included all structures including shafts, ovens, machinery, tipples, railroad tracks, houses, stores, including merchandise in the stores, mining equipment and generally including all supplies and materials and equipment used in connection with the mining property of the Georges Creek Coal & Iron Company, designated and known as the Farmington property in West Virginia; all of its steel railroad cars, in number three hundred, and numbered from G-1000 to G-1299. All of said property was conveyed by good and merchantable title to the petitioner by deeds of special warranty, free from all encumbrances except as to said railroad cars, which were conveyed subject to the payment of car trust bonds amounting in the aggregate to $110,000, with interest from December 1, 1909, at the rate of 4 1/2 per cent*1627 per annum.
The total price paid by petitioner for the above mentioned property was $3,200,000, of which $50,000 was paid in cash upon the execution and delivery of the agreement, $450,000 in cash upon the execution and delivery of conveyances, and the further sum of $2,700,000 was paid upon the execution and delivery of said conveyances by delivery to the Georges Creek Coal & Iron Company of coupon bonds of the petitioner of the par value of $2,700,000 (secured by a purchase-money mortgage on the cars, the tracts of coal land and other real property described above) bearing interest at the rate of 5 per cent per annum, payable semiannually and due and payable February 1, 1930. The delivery of the deeds, the mortgage, the bonds, the payment of the $450,000 cash, and the delivery of possession, were to be made concurrently on February 1, 1910.
After the Georges Creek Coal & Iron Company sold to the petitioner its properties located in West Virginia, it sold its properties in Maryland and wound up its business. Subsequent to the delivery by the petitioner of its bonds to the Georges Creek Coal & Iron Company the bonds appeared on the Baltimore Stock Exchange.
The following*1628 resolutions were adopted by the petitioner's directors at a meeting held on December 27, 1909, and were approved at a special meeting of the stockholders on January 4, 1910:
RESOLVED that the capital stock of this Company be increased from $4,000,000 to $6,000,000, in order to place the Company in position to carry out the terms of the contract of this Company for the purchase of the Georges Creek Coal & *557 Iron Company's properties, as described in said agreement, such increase of capital stock to be issued from time to time by the Board of Directors in such manner as they shall in their judgment deem wise and proper.
RESOLVED, that the indebtedness of this Company be increased from $6,225,000 to $8,925,000 in order to carry out the terms of the contract of this Company for the purchase of the Georges Creek Coal & Iron Company's property as described in said agreement, such increase of indebtedness to be secured by a mortgage on the properties so to be acquired.
By resolution of January 4, 1910, the petitioner's directors authorized the sale of $800,000 par value of the newly authorized capital stock at par to petitioner's stockholders, said stockholders to have the*1629 right to subscribe to the extent of 20 per cent of the stock they then owned. It was further resolved that the proceeds of the sale of said stock of $800,000 be applied to the purchase of the properties of the Georges Creek Coal & Iron Company as provided by the terms of the agreement with that company dated December 22, 1909. At the same meeting, the directors declared a special dividend of 5 per cent to the holders of the capital stock. This dividend was payable in stock of the company and in the aggregate amounted to $200,000.
At a meeting of the petitioner's directors, held on the 27th day of January, 1910, the directors authorized the officers to borrow from the Union Trust Company of Pittsburgh the sum of $743,760, for the purchase of Georges Creek Coal & Iron Company's property and the general business of the company. Said loan was secured by collateral promissory notes of the petitioner, which in turn were secured by the collateral notes received by the petitioner and executed by the persons hereinafter named, in the following amounts:
| John M. Jamison | 8 notes of $18,240 each |
| W. W. Jamison | 8 notes of 13,200 each |
| Thos. S. Jamison | 8 notes of $13,400 each |
| C. H. Fogg | 8 notes of 7,900 each |
| Jas. McDermott | 8 notes of 7,900 each |
| J. B. Head | 8 notes of 2,710 each |
| C. M. Jamison | 8 notes of 5,560 each |
| R. H. Jamison | 8 notes of 5,370 each |
| Jay C. Jamison | 8 notes of 5,300 each |
| R. S. Jamison | 8 notes of 4,960 each |
| Hugh D. Jamison | 8 notes of 4,295 each |
| M. W. Head | 8 notes of 2,205 each |
| W. A. Johnson | 8 notes of 790 each |
| H. B. Jamison | 8 notes of 600 each |
| R. E. Jamison | 8 notes of 540 each |
| 120 notes aggregating | $743,760 |
*1630 together with stock of petitioner pledged as collateral thereunder.
All of the foregoing parties are or were members of the Jamison family with the exception of James McDermott, who was a director of the petitioner, J. B. Head, attorney, a director and attorney for the petitioner, and W. A. Johnson, sales manager of petitioner. *558 C. H. Fogg was the brother-in-law of John M. Jamison. M. W. Head was the son of J. B. Head.
There was no effort made to obtain additional loans on the properties of the petitioner. They were all subject to a mortgage. The new money required to consummate the purchase of the Georges Creek Coal & Iron Company was raised on the stockholders' own credit. No security was given to the stockholders for the notes which they gave to the petitioner for the purpose of pledging the same to secure the bank loan from the Union Trust Company of Pittsburgh. It was not unusual for the petitioner to use the credit of its stockholders in this manner to obtain money.
At the time of the purchase of the property of the Georges creek Coal & Iron Company, the petitioner's stockholders considered forming a new company, as all of the petitioner's holdings*1631 were in Pennsylvania except a plant known as the Barrackville plant, on the land adjoining the property purchased from the Georges Creek Coal & Iron Company, which was bought a short time before. The coal located in West Virginia was different from the quality of coal obtained from the Pennsylvania properties, and would supply people other than those who were at that time petitioner's customers. The West Virginia property was located on the Baltimore & Ohio Railroad, but the Pennsylvania property was not. As all the selling and all the orders would be from the petitioner's Greensburg office and all the business would be done by the petitioner, the stockholders could not see any need of having two separate organizations; consequently nothing was done with respect to the formation of a new corporation.
None of the stockholders of the Jamison Coal & Coke Company were stockholders of the Georges Creek Coal & Iron Company.
On December 31, 1917, a lease was made between Benjamin Thaw, Thomas Chalmers Darsie, and William Clyde Wilkins, trustees under the last will and testament of William Thaw, deceased, and of the trust herein termed and designated as the "Coke" trust, and the petitioner*1632 herein, who is described in the lease as the "Company." Pertinent provisions of the lease are as follows:
AND WHEREAS under and pursuant to the devise in said Will set forth or by conveyances since made the said Trustees are seized in fee of the premises hereinafter described for the uses and purposes in said Will designated as the "COKE TRUST," and it is in their judgment for the advantage of the Trust and those interested therein to secure the mining of said coal by entering into this present agreement:
NOW THIS INDENTURE WITNESSETH
That the Trustees, for and in consideration of the covenants hereinafter set forth on the part of the Company to be kept and performed, have granted, demised and let, and by these presents do grant, demise and let unto the Company, its successors and assigns, the tract of land (EXCEPTING all the coal and other minerals therein or thereunder) hereinafter mentioned and described *559 under the heading "Tract A," and also the exclusive right to mine and dispose of all the coal of the "Connellsville vein," or seam within the tract of coal hereinafter mentioned and described under the heading "Tract B";
* * *
* * * LEAVING THE NET AREA OF*1633 COAL LEASED HEREBY ONE THOUSAND SIX HUNDRED AND THIRTY-TWO AND EIGHT HUNDRED AND SEVENTY-TWO ONE THOUSANDTHS ACRES (1,632.872 A.).
* * *
TO HAVE AND TO HOLD unto the Company, its successors or assigns, from the date hereof and during the term of forty (40) years from January 1, 1918, YIELDING AND PAYING for the same unto the Trustees the rent or royalty, and performing covenants hereinafter mentioned and agreed by the Company to be paid, kept and performed, to wit:
FIRST. The Company does covenant, promise and agree to and with the Trustees by these presents that it, the Company, shall and will well and truly pay, or cause to be paid, unto the Trustees rent or royalty for the coal taken out as follows, to wit: For all coal mined, sold, shipped, delivered or used per ton of two thousand (2,000) pounds for the period beginning January 1, 1918, and ending December 31, 1922, the sum of 34??; for the subsequent period ending December 31, 1927, the sum of 36??; for the subsequent period ending December 31, 1932, the sum of 38??; and increasing 2?? per ton for each period of five (5) years thereafter until the said coal shall have been exhausted.
* * *
* * * But from January 1, 1918, to*1634 December 31, 1954, the rents or royalties in any one year shall in no event be less than a sum based on a minimum production of not less than 250,000 tons of coal per year, whether the actual production of coal during said year shall amount to 250,000 tons or not. For the year 1955, the rents or royalties shall in no event be less than a sum based on a minimum production of 100,000 tons of coal; for the year 1956, on a minimum production of 50,000 tons of coal; and for the year 1957, and each subsequent year thereafter until the coal is exhausted, on a minimum production of 25,000 tons of coal. If the reports, settlements and payments for any year have been for a less number of tons of coal than the minimum herein provided, the Company at the April settlement next ensuing, and as a part thereof, will pay the Trustees at the then current rate of rent or royalty for such deficiency or difference; PROVIDED, HOWEVER, that when the coal mined in any one year shall be insufficient to make the rent or royalty upon the above terms equal a sum based upon the minimum production herein provided for that year, and the Company shall have made payment for such deficiency or difference, the Company*1635 shall be entitled in the subsequent year or years of the said term or any extension thereof as provided herein, to a credit or credits of that amount by which the rents or royalties in such subsequent year or years shall exceed the minimum annual rent or royalty on the minimum production herein provided for that year or years until the total of such credits shall be equal to the amount by which the rent or royalty previously paid exceeded the rent or royalty on the coal actually mined.
SECOND. The rents or royalties to be paid under the provisions hereof are agreed to by the Trustees and the Company upon the assumption and assurance that all the coal in the tract or body of coal hereby granted or leased can and will be mined and removed so that the Trustees will receive said rates of rent or royalty on all of said coal; and the Company agrees that it will mine and remove all of said coal that can be mined and removed by proper and skillful mining and by the most approved methods, and that the rents or *560 royalties to be paid hereunder shall be for an average production or quantity of not less than 10,500 tons of coal per acre. * * * IT BEING UNDERSTOOD AND AGREED, HOWEVER, *1636 that the said minimum of 10,500 tons of coal per acre shall be based on an average for the entire tract hereby granted or leased. Should there be a deficiency in the tonnage per acre in any year, the Company shall be entitled to a credit on any excess in any preceding or subsequent year during the said term, said credit to be equal in amount to the sum paid for such deficiency. * * *
THIRD. In order that the mining of the coal hereby granted or leased shall be gradual, and in order that its exhaustion shall not occur until the end of the said term, or as nearly thereto as may be practicable, IT SHALL BE, AND IS, EXPRESSLY UNDERSTOOD AND AGREED that the product of coal from the said tract shall not in any one year exceed 500,000 net tons.
* * *
SEVENTEENTH. If at the expiration of said term of forty (40) years all of said coal shall not have been taken out and removed from the said described or demised premises, this lease shall continue in force until the said coal is exhausted.
Pursuant to the terms of the foregoing lease, hereinafter referred to as the Thaw lease, the petitioner mined and removed coal and paid to the lessors sums of money during the year 1918 through*1637 1925 as follows:
| Year | Tons of coal mined and removed | Money paid to lessors |
| 1918 | 5,869.4 | $85,000.00 |
| 1919 | 141,850. | 85,000.00 |
| 1920 | 204,570. | 85,000.00 |
| 1921 | 499,950. | 85,000.00 |
| 1922 | 285,390. | 85,000.00 |
| 1923 | 453,316. | 124,987.76 |
| 1924 | 500,111.75 | 180,040.24 |
| 1925 | 553,666.60 | 199,319.98 |
Rents or royalties paid by the petitioner for the years 1918, 1919 and 1920 under the Thaw lease in excess of those based upon the rate per ton and the actual production of coal were reflected upon the petitioner's books in the following manner:
| Advance Royalty Thaw Charges | |
| April 30, 1919 | $83,004.40 |
| April 30, 1920 | 36,771.00 |
| April 30, 1921 | 15,446.20 |
On June 15, 1918, a lease was entered into between Mary Fuller Posey and Alice K. Fuller, therein designated as "Lessors," and the petitioner, who was designated the "Company." Pertinent parts of the lease are as follows:
WITNESSETH: WHEREAS the Lessors are the owners of coal underlying certain lands situate in the Township of Perry, County of Fayette and State of Pennsylvania, and are the owners also of certain lands in part overlying coal, *561 all as hereinafter more particularly described, *1638 and the parties hereto have agreed upon the terms and conditions under which said lands shall be leased and the right to mine and remove said coal shall be granted by the Lessors to the Company,
Now THIS INDENTURE WITNESSETH: That the Lessors, for and in consideration of the covenants hereinafter set forth on the part of the Company to be kept and performed, have granted, demised and let and by these presents do grant, demise and let unto the Company, its successors and assigns, the following described premises, to wit: -
ALL the coal of the Pittsburgh vein or seam within and underlying all that certain tract of land situate in the Township of Perry, County of Fayette and State of Pennsylvania, bounded and described as follows:
* * *
ALSO, ALL That certain tract of land situate in the Township of Perry, Fayette County, Pennsylvania, in part overlying the tract of coal of the Pittsburgh vein or seam hereinabove described, bounded and described as follows:
* * *
TO HAVE AND TO HOLD unto the Company, its successors or assigns, from the date hereof for and during the term ending September 1, 1928, when said lands and coal remaining unmined shall be conveyed as hereinafter provided, *1639 yielding and paying for the same during the term ending September 1, 1928 unto the Lessors the rent or royalty and performing the covenants hereinafter mentioned and agreed by the Company to be paid, kept and performed, to wit:
FIRST: The Company does covenant, promise and agree to and with the Lessors by these presents that it shall and will well and truly pay or cause to be paid unto the Lessors rent or royalty for the coal of the Pittsburgh vein or seam taken out as follows, to wit:
For all of said coal mined, sold, shipped, delivered or used per ton of two thousand (2,000 lb.) pounds, for the period beginning June 15, 1918, and ending August 31, 1928, the sum of Thirty-five Cents (35??).
* * *
On or before October 20, 1918, and on or before the 20th day of each month thereafter, during the term of this leasehold, the Company shall render unto the Lessors or their agent, to be by them designated in writing, a statement in duplicate of the rents and royalties due upon the above terms during the period ending on the last day of the preceding calendar month, and shall pay to the Lessors, or to their agent, to be by them designated in writing, at the time of rendition of each*1640 of such statements, the amount of rent or royalty thereby shown to be due upon the above terms.
The minimum payment of rent or royalty for the period ending August 31, 1919 shall be a sum based on a minimum removal of two hundred fifty thousand (250,000) tons of coal, whether the actual production of coal during said period shall amount to 250,000 tons or not, and the minimum payment of rent or royalty in any succeeding yearly period from September 1st to August 31st shall be a sum based on a minimum removal of four hundred fifty thousand (450,000) tons of coal, whether the actual removal of coal during said year shall reach 450,000 tons or not.
If during the period ending August 31, 1919, or if in any year or years of the term thereafter, the Company shall pay for more coal than it has actually mined and removed, it shall be entitled to a credit for the same on account of coal mined in any later year or years in excess of the minimum requirement of such year or years as above provided.
*562 The Company shall pay unto the Lessors, upon the execution and delivery of this Indenture, the sum of Fifty Thousand ($50,000.00) Dollars in cash, the receipt of which is hereby*1641 acknowledged, and for which it shall be entitled to credit at the stipulated rent or royalty on account of coal mined in any year or years of the term in excess of 450,000 tons.
Any and all payments made during the term of this Indenture, to wit: prior to September 1, 1928, including the Fifty Thousand ($50,000,000) Dollars paid in cash upon the execution and delivery of this Indenture, which shall exceed the value of the coal actually removed prior to September 1, 1928, computing the value of the same at Thirty-five Cents (35??) per ton, being the rent or royalty under this said Indenture, shall be credited on account of the purchase price of the said premises as hereinafter provided.
* * *
EIGHTEENTH: For and in consideration of the premises, as well as for and in consideration of the sum of One ($1.00) Dollar, cash in hand unto them paid, the receipt of which they do hereby acknowledge, the Lessors do hereby grant, bargain and sell unto the Company, and the Company hereby agrees to purchase of and from the Lessors, the tract of coal of the Pittsburgh Vein or Seam and the tracts of land as hereinbefore described situate in the Township of Perry, Fayette County, Pennsylvania, *1642 and, for the additional consideration to be ascertained, paid and secured in the manner hereinafter expressly provided, the Lessors hereby agree to convey the same unto the Company by deed of special warranty, free of liens and encumbrances, on September 1, 1928, or within Ninety (90) days thereafter, which said instrument of conveyance shall convey in addition to the premises hereby granted, demised and let, and as herein particularly described, also all of the remaining right, title, interest and claim of the Lessors in and to a part of the said premises as granted and conveyed to Alfred M. Fuller and William M. Fuller, predecessors of the said Lessors in title, by the following deeds, to wit: Deed of Allen Carson, et ux, dated July 1, 1899, recorded in the County of Fayette in Deed Book Vol. 168, page 105; deed of Adaline Stephens dated October 8, 1895 and recorded in the County aforesaid in Deed Book Vol. 140, page 21, and deed of Hiram Rankin, et ux, dated October 8, 1895 and recorded in the County aforesaid in Deed Book 140, p. 24.
The consideration for said premises and said deed of conveyance shall be ascertained in manner following, to wit:
As of September 1, 1928, an*1643 engineer selected by the Lessors, in conjunction with an engineer selected by the Company, shall make a joint accurate survey and measurement of the coal of the Pittsburgh vein or seam remaining unmined and contained, either in the solid or as ribs and pillars, within the tract of coal of the Pittsburgh vein or seam hereby granted, demised and let as hereinbefore particularly described, which said survey and measurement shall also include the area of the exhausted portion of the said leased premises as of September 1, 1928, which said survey and measurements shall be for the purpose of ascertaining
(a). The average production in net tons per acre of the premises exhausted
(b). The quantity of coal in net tons remaining unmined in said premises, which shall be computed at the average number of tons per acre which the exhausted territory is shown to have produced.
The engineers or the respective parties shall make such survey and computation within Thirty (30) days after September 1, 1928, and in the event they are unable to agree upon the matters mentioned above within the time limited, *563 then, within Ten (10) days, they shall select a third engineer, and the decision*1644 or finding of two of the three engineers, which must be made within Thirty (30) days of the selection of said third engineer, shall be final, binding and conclusive and be accepted by the Company and by the said Lessors. If either party hereto shall fail or refuse, within Ten (10) days after September 1, 1928, to designate an engineer as above set forth, then the right to designate an engineer to represent such party so failing or refusing shall pass to and be exercised by the other party hereto, with the same force and effect as if such engineer had been chosen by the party who so fails or refuses.
Having ascertained the quantity of coal unmined in the manner aforesaid, the sum to be paid therefor by the Company shall be ascertained in the manner following, to wit:
It shall be assumed that the remaining coal unmined can be mined in equal annual quantities within five (5) years next succeeding September 1, 1928. The value of the coal in place per net ton shall be ascertained by taking the present worth as of September 1, 1928, computed at five per centum (5%) per annum of thirty-seven cents (37??) for each ton of said coal unmined, and in place in the said premises, computing*1645 said present worth as if one-fifth (1/5) of the coal unmined were to be paid for at the end of each year after September 1, 1928, at the rate of 37?? per ton.
The consideration for the remaining premises to be granted and conveyed shall be the sum of Twenty-five Thousand ($25,000.00) Dollars.
From the gross consideration as thus ascertained there shall be deducted such sum as the total payments made by the Company prior to September 1, 1928, as rent or royalty, including the Fifty Thousand ($50,000.00) Dollars paid upon the execution and delivery of this indenture, shall exceed the actual value of the coal mined and removed from said premises prior to September 1, 1928, at thirty-five (35??) cents per ton, and the net consideration thus ascertained shall be paid by the Company to the Lessors upon the delivery of the instrument of conveyance above mentioned, or, at the option of the Company, One-half (1/2) of the net consideration shall be paid in cash upon the delivery of said deed and the balance in two equal annual installments, payable one (1) and two (2) years after the date of the said deed, with interest thereon at the rate of Five per centum (5%) per annum, payable semi-annually, *1646 with the reserved right to the Company to anticipate and pay said deferred installments of purchase money in whole or in part at any time. Said deferred installments of purchase money shall be secured by the common bond of the Company and a purchase money mortgage on the premises conveyed, containing the customary default, including a Sixty (60) day Scire Facias, clauses. At the election of the said Lessors, on Sixty (60) days notice, the Company covenants and agrees to purchase or cause to be purchased from them the said bond and purchase money mortgage, paying therefor the face value of the same and accrued interest, if any, to the date of purchase.
On and after September 1, 1928, and pending the ascertainment of the remaining consideration to be paid by the Company, and the delivery of the deed of conveyance to it as hereinabove provided by the provisions of this paragraph, the Company shall continue in possession of the premises hereby let and leased and may continue to operate the mines therein and thereon and otherwise use and enjoy the said lease premises as owner.
Pursuant to the terms of the foregoing lease, hereinafter referred to as the Fuller lease, the petitioner*1647 mined and removed coal and *564 paid to the lessors sums of money during the years 1918 through 1925 as follows:
| Year | Tons of coal mined and removed | Money paid to lessors |
| 1918 | 4,876 | $51,706.60 |
| 1919 | 153,889 | 113,310.40 |
| 1920 | 206,240 | 162,018.50 |
| 1921 | 492,400 | 202,979.00 |
| 1922 | 299,820 | 102,245.50 |
| 1923 | 690,911 | 241,818.85 |
| 1924 | 799,002 | 153,065.75 |
| 1925 | 732,302 | 161,960.45 |
The rents or royalties paid by the petitioner under the Fuller lease for the years 1918, 1919 and 1920 in excess of those based upon the rate per ton and the actual production of coal were reflected upon the petitioner's books in the following manner:
| Date | Advance Royalty - No. 21. Charges |
| August 31, 1918 | $50,000.00 |
| September 31, 1919 | 59,449.25 |
| September 31, 1920 | 89,834.50 |
In determining the deficiencies here involved for 1918 and 1920 the respondent allowed as deductions rents or royalties based upon the rent or royalty rate applied to the actual number of tons of coal mined.
The main contingencies which might operate to prevent the removal of the minimum quantities of coal called for by the Thaw and Fuller leases were quality of product, market*1648 conditions, the natural conditions which may be encountered in the operating seam, labor conditions, strikes - which sometimes in these fields last as long as a year or a year and one-half, a slip or fault, and explosions, the effect of which depends upon their size.
OPINION.
TRAMMELL: The petitions as amended allege that the respondent has failed to compute correctly the invested capital of the petitioner for the taxable years 1917, 1918 and 1920. The petitions contain the following statement as the facts relied on in support of this allegation of error:
The petitioner in the year 1910 was a party to a reorganization and acquired substantially all of the property of the Georges Creek Coal & Iron Company, paying therefor in securities and cash. This reorganization took place on or about February 1, 1910. The petitioner acquired properties having a value of $16,920,659.89 as of this date, which results in a paid-in surplus of $7,945,966.66, thereby increasing invested capital of the petitioner in the sum of $7,945,966.66.
*565 It is also stated that, in determining invested capital for the years 1917, 1918 and 1920, "The petitioner is entitled to have included therein*1649 the realized appreciation of the properties of the petitioner based upon the difference between the March 1, 1913, value and cost * * *."
In his answer the respondent denies the allegation of error complained of, as well as the statement of facts relied on by the petitioner.
With respect to the issue thus presented by the pleadings the parties have stipulated as follows:
If it is held that there was a reorganization of the petitioner in 1910, its invested capital, as a result of such reorganization, should be increased as follows:
| Year | Amount |
| 1917 | $3,315,929.57 |
| 1918 | 3,186,828.56 |
| 1919 | 3,086,232.92 |
| 1920 | 2,999,877.15 |
The parties also stipulated that "The only issues for determination by the Board are * * * and (2) reorganization."
The petitioner's brief, under the caption, "Statement of Points Upon Which Petitioner Relies," contains the following: "Point 1. Petitioner was reorganized in 1910, and is entitled to have its invested capital increased as a result thereof."
Under the caption, "Argument," the petitioner's brief contains the following:
POINT I.
Petitioner was reorganized in 1910 and is entitled to have its invested capital increased*1650 as a result thereof.
The petitioner company was reorganized as of January 10, 1910, through the purchase of substantially all of the Georges Creek Coal & Iron Company property; the increase of its authorized and outstanding capital stock; the increase of its authorized and outstanding bond obligation, and the declaration of a stock dividend, all of which were essential to the plan of reorganization whereby the petitioner acquired the operating property of the Georges Creek Coal & Iron Company located in the State of West Virginia.
* * *
The agreement [the stipulation setting forth the amounts by which petitioner's invested capital is to be increased for the respective years if it is found that there was a reorganization in 1910] showing the adjustment of petitioner's invested capital by recognizing the reorganization in 1910, is a clear expression of the intention of the parties to leave for decision to the Board solely the question as to whether or not a reorganization of the petitioner had taken place in January, 1910. There is no dispute and no issue before the Board for decision relative to a modification of petitioner's invested capital on account of the reorganization*1651 of the petitioner in 1910.
*566 In his brief the respondent states the issue with respect to invested capital to be "(1) Whether a reorganization took place in the Jamison Coal & Coke Company as of January 1, 1910, which gave the petitioner the right to make a revaluation, it being stipulated that if there was such a reorganization petitioner's invested capital should be increased in the amounts of $3,315,929.57, $3,186,828.56, $3,086,232.96 and $2,999,877.15 for the years 1917, 1918, 1919 and 1920, respectively." (Italics ours.)
In his opening statement counsel for the petitioner stated: "There is a question as of January 10, 1910, whether a reorganization took place in the Jamison Coal & Coke Company, which gave us the right to make a revaluation, and it is stipulated that if it is held that there was a reorganization of the petitioner in 1910, its invested capital, as a result of such reorganization, should be increased as follows." (Italics ours.) He then stated the amounts set out in the stipulation heretofore quoted.
The foregoing statements have been set forth at length to show just what the parties consider to be the effect of their stipulation and*1652 what they consider to be the issue submitted for determination. From the petitioner's brief it appears that it considers the only question with respect to invested capital before us to be whether under the facts in the case there was a reorganization of the petitioner in 1910, while from the respondent's brief it appears that he considers the question to be whether there was such a reorganization of the petitioner in 1910 as gave it the right to make a revaluation of the property acquired in that year from the Georges Creek Coal & Iron Company. Considering the entire record, including the opening statements of counsel, we think the question to be decided by us is whether the purchase by the petitioner of the property of the Georges Creek Coal & Iron Company in 1910, together with the attendant and incidental transactions as set out in our findings of fact, so affected the petitioner's invested capital that in order for it to be correctly determined under the Revenue Acts of 1917 and 1918 it must be increased for the years here involved by the amounts stipulated by the parties. If we regarded it otherwise, it would amount to permitting the parties to stipulate the law. Stipulations*1653 can relate only to facts. We can not recognize or give effect to stipulations of law. See ; affirmed by the Circuit Court of Appeals February 16, 1931 (Prentice-Hall Federal Tax Service, 1931, p. 825); ; affirmed by the .
In its brief the petitioner devotes its argument on this issue entirely to the question of whether there was a reorganization in 1910. It *567 makes reference to the provisions of section 208 of the Revenue Act of 1917 and section 331 of the Revenue Act of 1918. These sections contain prohibitions on the inclusion of assets in invested capital at greater values than allowable to the preceding owners where such assets were acquired in the reorganization, consolidation or change of ownership of a trade or business or the change of ownership of property after March 3, 1917, and an interest or control in such trade or business or property of 50 per cent or more remained in the same persons or any of them. Even if the assets are acquired by another corporate entity, *1654 the invested capital is not increased over that of the predecessor under the conditions set out in section 208 of the 1917 Act and section 331 of the 1918 Act. But none of these sections even intimate that, where the same corporation retained the assets, a revaluation of assets would be made, notwithstanding that that corporation might have been reorganized. It may readily be conceded that, if there had been a reorganization which resulted in a new corporation in 1910 and shares of the new corporation had been issued for the assets of the old, the assets would be revalued. Section 326 of the 1918 Act would have provided for such increase by including the then value of assets paid in for stock. Although the word "reorganization" is used in the above mentioned sections of the Acts of 1917 and 1918, the petitioner admits that neither of the acts attempts to define it. The petitioner relies, however, on the definition of the term given in section 202(c)(2) of the Revenue Act of 1921 and section 203(h)(1) of the Revenue Act of 1924, especially the latter. The definitions contained in these sections specifically relate to matters concerned with the determination of gains or losses*1655 and not to the determination of invested capital. There are no provisions in any of the reorganization sections which would supersede section 207 of the Act of 1917 or 326 of the 1918 Act, relating to invested capital. In determining invested capital, which is a creature of statute, we must follow those provisions.
As we perceive the issue, it is immaterial whether the petitioner's purchase of the property of the Georges Creek Coal & Iron Company, together with the incidental transactions, constituted a reorganization in 1910.
The term "invested capital," as used in the Revenue Acts of 1917 and 1918, means (1) actual cash bona fide paid in for stock or shares (2) the actual cash value of tangible property, other than cash, bona fide paid in for stock or shares, at the time of such payment and (3) paid-in or earned surplus and undivided profits, not including surplus and undivided profits earned during the year, and (4) and (5) *568 intangible property paid in for stock or shares, subject to certain limitations. The term does not include borrowed capital; that is, money or other property borrowed, whether represented by bonds, notes, open accounts, or otherwise.
*1656 The petitioner purchased the property from the Georges Creek Coal & Iron Company for a money consideration. It was not paid in for stock. It is therefore not entitled to include such property in its invested capital at more than cost. ; ; . See also ; . It may well be that in the LaBelle Iron Works case, supra, there was such a reorganization as is contemplated by the later revenue acts, but we think that case is authority for holding that invested capital should not be increased under the facts.
No stock having been issued by the petitioner for assets other than that sold by it to its stockholders for cash, and no part of the excess, if any, of the actual cash value of the property purchased from the Georges Creek Coal & Iron Company over the purchase price paid therefor being includable in the petitioner's invested capital either as paid-in surplus or as earned surplus, we find nothing*1657 in the case to warrant the increases in petitioner's invested capital by the amounts stipulated by the parties for the respective years, or for any other amounts than those indicated in the preceding paragraph. It not having been shown that the respondent did not include such amounts in making his determination, his action is sustained as to this issue.
The petitioner contends that for the years 1918 and 1920 it is entitled to deductions of $133,004.40 and $105,280.70, respectively, representing minimum rents or royalties in excess of rents or royalties based on actual production during those years under the Thaw and Fuller leases. Of the amount contended for for 1918, $83,004.40 is applicable to the Thaw lease and $50,000 to the Fuller lease, while of the amount contended for for 1920, $15,446.20 is applicable to the Thaw lease and $89,834.50 is applicable to the Fuller lease.
The Thaw lease was for a period of 40 years from January 1, 1918. It provided for certain stipulated rents or royalties per ton of coal mined. It also provided that from January 1, 1918, to December 31, 1954, the rents or royalties in any one year should in no event be less than a sum based on a minimum*1658 production of not less than 250,000 tons of coal per year, whether the actual production of coal during said year should amount to 250,000 tons or not. For the remaining years of the lease rents or royalties on lesser amounts of minimum *569 production were provided. The lease provided that if for any year the rent or royalty paid based on the minimum production specified for that year exceeded the rent or royalty due on the actual production for such year, the excess or difference could be applied in the subsequent year or years of the lease to the rent or royalty for such year or years when the actual production exceeded the minimum specified for such years. In order that the mining of the coal contained in the leased property should be gradual and that its exhaustion should not occur until at or near the end of the term of the lease, it was provided that not more than 500,000 tons of coal should be mined in any one year. This amount, however, was exceeded in 1924 and 1925.
The Fuller lease was for the term beginning June 15, 1918, and ending September 1, 1928, when the lands and the coal remaining unmined were to be conveyed to the petitioner herein. The lease provided*1659 for a stipulated rent or royalty of 35 cents per ton for the coal mined. It also provided that the rent or royalty for the period ending August 31, 1919, should be based on a minimum removal of 250,000 tons of coal, whether the actual production of coal during that period should amount to 250,000 tons or not. The minimum rent or royalty for the yearly periods thereafter was to be based on a minimum removal of 450,000 tons of coal whether the actual coal removed reached 450,000 tons or not. The lease further provided that if during the period ending August 31, 1919, or if in any year or years of the term of the lease, the petitioner should pay for more coal than it had actually mined, it would be entitled to a credit for the same on account of coal mined in any later year or years in excess of the minimum royalty for such year or years. Any and all payments made during the term of the lease which should exceed the value of the coal actually removed prior to September 1, 1928, computing the value of the same at 35 cents per ton, being the rent or royalty under the lease, were to be credited on the purchase price of the premises. The lease also contained provisions as to how the*1660 quantity of coal remaining unmined at September 1, 1928, should be ascertained and how the amount to be paid the lessors therefor should be determined, as well as the manner in which payment of such amount should be made. Under this lease the petitioner was not only entitled to have the excess of the minimum rents or royalties over the rents or royalties on the coal actually mined for any year or years of the term of the lease applied against the rents or royalties on the coal actually mined above the minimum rents or royalties for a subsequent year or years, but was entitled to have applied against the purchase price of the property in 1928 any and all amounts paid *570 during the term of the lease in excess of the value of the coal actually removed.
Since the petitioner was to have as a credit against the purchase price of the property the excess of the amounts paid during the term of the lease over the value of the coal removed during the term of the lease, it is clear that such excess would represent payment for the property. The provisions of paragraph 18 of this lease indicate that while the instrument is designated a lease, it is in fact a contract of sale, intended*1661 by the parties as such, and as such comes within the decision in . In that case it was held that where as a result of payments made by the taxpayer under a contract of sale it acquired an equity in property, the payments constituted capital expenditures and were not allowable deductions in determining taxable income. Whether the so-called lease be considered as a lease or a sale, it was manifestly the intention of the parties that any amount paid as so-called royalties in excess of royalties on coal actually mined was to be applied as a part of the purchase price. The lessee was to have the benefit in the form of payment for property to which title was being taken or an equity acquired. On the reasoning of this case in so far as the Fuller lease is concerned, we think that the minimum royalties in excess of royalties on coal actually mined are to be treated as capital expenditures and are not deductible as expense.
With respect to the Thaw lease, since we are not bound by the State court decisions as to whether this is a lease or a sale of coal in place (see *1662 , certiorari denied), we must determine from its terms whether the payments were rentals or royalties, or purchase price. We think that, clearly, for Federal income-tax purposes the payments are to be treated as royalties.
In , where the Board considered the question of whether minimum royalties paid are deductible as expenses or should be carried in the capital account we said:
With reference to the minimum royalties, we are of the opinion that they constitute rent and are allowable deductions. It is well settled that royalties paid under the provisions of mining leases constitute rents. ; ; ; and . The mere fact that the basis of computing such rents is at a rate of so much per ton, provided a certain quantity of ore or coal is removed, or is fixed at a certain specified amount if the required*1663 quantity is not mined, does not in any way affect the nature of the payment.
*571 In the Bogle case the record discloses that the minimum royalties involved in excess of royalties on coal actually mined might be applied against the royalties due on coal mined in the later years of the lease, as is true in this case, although no reference thereto was made by the Board.
In , reversed on another point, , the Board said with respect to the inclusion of minimum royalties in invested capital:
The claim of the petitioner that certain royalties and taxes paid on inactive and undeveloped land be restored to capital is denied, first, because nothing in the lease indicates that a separate royalty was to apply to each tract or that such royalties accrued to the credit of the petitioner and could be satisfied by unlimited future shipments, and, second, because items such as annual rental and annual taxes are deductible as expense each year and are paid for benefits received during the year. The mere fact that the petitioner did not take the fullest advantage of the benefits for which it paid rentals*1664 and taxes does not change the character of the expenditures.
We think that those decisions are applicable here.
Minimum royalties are not necessarily advance royalties. They are at most only contingently advance royalties. When a minimum royalty is paid, the taxpayer does not have an absolute equity in unmined coal, as in the case where the excess payments apply on the purchase price or where an advance royalty is paid for the future. He may never have the opportunity to receive any benefits in the future. It all depends upon uncertainties and contingencies which may never happen. When the payments are made it is not known whether the excess over actual royalties can ever be recovered. The recovery clause may or may not be of any benefit, it being dependent upon unknown future conditions. If the taxpayer over the lease period was never able to acquire the benefit of excess minimum royalties over actual royalties, serious problems would arise when too late to make proper adjustment to properly reflect income. We do not think a taxpayer should be required to wait for years in the future to know how he stands with the Government on taxes. We are therefore of the opinion*1665 that the minimum royalties in the Thaw lease are deductible as expense. We must keep in mind that the tax laws are on an annual basis, and this is annual royalty or rental required to be made.
The minimum royalties are required to be paid each year for the continued use or possession of the property to which the taxpayer has not taken and is not taking title and in which it acquires no absolute equity. This brings the case within the scope of deductions allowed by section 234(a)(1) of the Revenue Act of 1918.
Judgment will be entered under Rule 50.