*4289 1. PAID-IN SURPLUS. - The actual cash values of both tangible and intangible properties contributed to a corporation in excess of the par value of stock issued become paid-in surplus but under the Revenue Acts of 1918 and 1921 the values of the intangibles so contributed may not be included in invested capital.
2. DEPRECIATION. - The reasonable allowance for the exhaustion, wear and tear, or buildings and equipment used in the newspaper publishing business of this taxpayer determined.
*1173 The Commissioner's deficiency letter dated March 14, 1925, which is the basis of this action, recites determinations of deficiencies for the years 1909 and 1912 to 1916, inclusive, in the aggregate amount of $471.18, and overassessments for the years 1910 and 1917 in a total of $2,643.18. It further recites deficiencies for the year 1919 in the amount of $795.15; for the year 1920 in the amount of $2,701.01; for the year 1921 in the amount of $423.62.
The petitioner has pleaded the statute of limitations as a complete defense against all deficiencies for*4290 1916 and prior years, and as to the years 1919 to 1921, inclusive, alleges that the Commissioner erred (1) in refusing to allow as a part of invested capital items of paid-in surplus representing the true cash value of properties paid in at the time of the organization of the corporation in respect of real estate, plant and equipment, circulation structure, Associated Press news service, and good will; (2) by reducing invested capital by the amounts of income and profits taxes for prior years and reducing *1174 the amount of current earnings available for dividends by subtracting a tentative tax computation; (3) by erroneous computations of rates of depreciation affecting both invested capital and net income; (4) other allegations of error asserted result from the foregoing and need not be recited in detail.
FINDINGS OF FACT.
The Daily Pantagraph, Inc., is an Illinois corporation organized in the latter part of December, 1907, and ever since January 1, 1908, has been engaged in publishing the Daily Pantagraph, a daily morning paper, in Bloomington, Ill. The petitioner is hereinafter referred to as the corporation.
The newspaper was established in 1846. In 1868, W. *4291 O. Davis purchased it and from that time until January 1, 1908, he published the paper and owned the same and all the property used in the publication thereof.
Immediately before the transfer of the business by Davis to the corporation, his books showed the following assets and liabilities:
| ASSETS | LIABILITIES | ||
| Cash on hand | $1,085.55 | Accounts Payable: | |
| Accounts receivable | 35,105.20 | Trade | $9,286.00 |
| Inventories | 6,137.49 | Other 43.39 | |
| Land and buildings | 25,000.00 | ||
| Plant and fixtures | 22,336.99 | Total | $9,329.39 |
| Office furniture | 4,046.49 | Surplus | 84,532.33 |
| Associated Press Member- | |||
| ship (a bond in that | |||
| association) | 75.00 | ||
| American Newspaper | |||
| Publishers Association | |||
| (an item paid on | |||
| account of membership | |||
| in that association) | 75.00 | ||
| Total | 93,861.72 | 93,861.72 |
Immediately after the transfer, the corporation's books showed the same assets and liabilities, at the same figures, except that the $84,532.33 was divided into $80,000 capital stock and $4,532.33 surplus.
The above-described assets were transferred at the end of December, 1907, by Davis to the corporation and the accounts payable items were assumed by it. The corporation*4292 issued to Davis $80,000 capital stock. No other capital stock was ever issued by the corporation.
Davis became the owner of all the stock of the corporation to which he had transferred his whole newspaper business and the property thereof, and continued throughout the remainder of his life to be the sole owner of all its stock except ten shares which he sold to C. C. Marquis. Davis incorporated his business because he was getting old and was in poor health and so that he could more readily dispose of his business property in his will. He had three children, none of whom were actively engaged in the business.
*1175 C. C. Marquis had been employed by Davis since 1877 and he had been business manager of the newspaper since sometime in the eighties. Shortly after the incorporation of the business, Davis sold Marquis ten shares of stock for $2,500, a special price with no relation to the market value, to keep him in the business, with which he was thoroughly familiar. Davis refused to sell more stock to Marquis or to sell any stock to other employees at any price for he desired to keep the stock in his family.
The business was an old and well established one which steadily*4293 made substantial net profits, averaging approximately $36,000 for the three years prior to January 1, 1908.
At the time of the incorporation of the business, Davis instructed his bookkeeper to make a statement of the tangible assets at very low figures. This was done and the above statement of assets and liabilities was prepared and used as a basis for the issuance of stock. The $80,000 capital stock was arrived at because it was the largest round figure and the $4,532.33 remained as surplus. All of the business property was to be and actually was transferred to the corporation, including good will, circulation structure and Associated Press membership, but Davis did not desire to have a large number of shares of stock outstanding for he did not intend to offer any of them for sale. His sole intention was to keep the business intact and pass the stock on to his family. The corporation stock has always been closely held, at first by Davis and Marquis and later by the family of Davis and by Marquis. Davis died in 1911.
The land transferred to the corporation consisted of a corner lot 24 feet on Washington Street, the principal street of the city, by 115 feet on Madison Street, *4294 the next important street, which lot Davis purchased in 1875, and an adjoining lot, 22 feet on Washington Street by 115 feet deep, which lot Davis purchased in 1887 for $3,000. The two lots had a value of $7,000 in 1887. Between 1887 and 1907 there was a steady increase in land values in the business section of the city. The population increased and business activity increased. In 1901, a hotel, the largest and most modern hotel in the city at that time, was constructed on the opposite corner from this property, and in 1906 an electric car line was constructed and operated on Madison Street. In 1907, the two lots had a value of at least $12,000.
The building transferred to the corporation was erected by Davis in 1887. It covers both of the above-mentioned lots as to width and depth, is three stories high, and the basement extends under the entire building and out under the sidewalks to the curbing. The basement windows extend above the sidewalks, admitting daylight. *1176 The foundation and 13-inch walls are constructed of substantial masonry, that is, of good brick and mortar. The joists and flooring are wooden and the walls are plastered. The floors are partitioned*4295 off to suit the needs of the publishing business. The presses have always been placed upon concrete foundations so as to eliminate vibration of the building. The floor on which the linotype machines are located is covered with sheet metal. The building is specially adapted to the printing and publishing business and has been always kept in good repair so that in 1907 there was no evidence of deterioration; the mortar was sound; the walls plumb and free from cracks, except for one or two minor ones; the floors were sound, and the plaster in good condition. The corporation has used the building continuously since January 1, 1908, and it is still in good condition and has an expected useful life of about thirty-six years from the present time. In December, 1907, the building had a value of at least $35,000. The Commissioner included the land and building in the corporation's invested capital at $25,000, the amount of stock issued therefor, whereas they had on December 31, 1907, a cash value of $47,000. A depreciation rate of 1 3/4 per cent from January 1, 1908, is a reasonable allowance for exhaustion, wear and tear computed on 1908 value. The cost of additions to the building*4296 since January 1, 1908, is not in dispute.
The plant and equipment transferred to the corporation in December, 1907, consisted of a press, linotype machines, and other machinery necessary to get out a daily paper, and of office furniture and fixtures. The press was the largest piece of machinery. There was a battery of five one style of type Mergenthaler linotype machines which were bought in 1897. The linotype machines were traded in for improved machines, one in 1916, one in 1920, one in 1922, and the others in 1923. All of those machines were in good working order and in regular use when disposed of. The press was traded in for a new one several times between 1900 and the present time, but this was for the purpose of taking care of the increased circulation and advertising, and also to turn out more papers in the shortest possible time. All the machinery was kept in good repair and was run for only a few hours each day. In publishing a morning paper it is essential that it go to press as late as possible so as to include the latest news items. The presses and linotype machines have a useful life of 33 years. The office furniture consisted of desks, tables, chairs, typewriters, *4297 rugs and other office equipment. The typewriters would last for two or three years. The furniture has been used for 25 years and is in good condition.
As shown by Davis' books from 1890 to December 31, 1907, the plant and equipment received by the corporation cost $49,054.70, depreciated at 3 per cent, amounting to $10,336.27, leaving a balance *1177 of $38,718.43, and the furniture received by the corporation cost $7,699.37, depreciated at 4 per cent, amounting to $2,636.64, leaving a balance of $5,062.73. The plant and equipment and the furniture were included in the corporation's invested capital at $26,383.48, the amount of stock issued therefor. The total cash value of the two items on December 31, 1907, was $43,781.16. A depreciation rate of 3 per cent on the machinery and equipment and a depreciation rate of 4 per cent on furniture is reasonable and should be used in depreciating the machinery and furniture, respectively, subsequent to January 1, 1908. The cost of additions to these two items since January 1, 1908, is not in dispute.
Davis transferred to the corporation the circulation structure of the Daily Pantagraph. It was property crucial to the corporation's*4298 business, without which it could not have made any profits. It had been built up over a period of many years and the corporation could not have acquired from anyone else the equivalent of this asset essential to the publication of its paper in Bloomington. Had the corporation attempted to build up a circulation, it would have required a large expenditure of money over a period of years. The productivity of the entire property is dependent upon the circulation, and the longer a circulation has been established, the greater is its earning power. The cost of building a circulation structure is from $10 to $15 per unit or subscriber. Prior to the incorporation, Davis audited his circulation and subsequent to January 1, 1908, the corporation has audited its circulation regularly just as the accounts receivable have been audited. These audits have been submitted regularly to the Auditors Bureau of Circulation, a newspaper publishers' organization. On the basis of this audit newspaper men determine the value of circulation structures. The circulation structure is recognized as an income-producing factor separate from the building and plant used in publishing a paper and it is sold*4299 by newspaper men for substantial sums of money. Advertising rates are dependent upon circulation. On December 31, 1907, the circulation of the Daily Pantagraph was 14,204 and had a value of $10 per unit, or $142,040.
Davis transferred to the corporation his Associated Press membership and news service, which gave exclusive rights to the Associated Press service for a morning paper, daily and Sunday, in Bloomington and territory tributary thereto. The membership could not be taken away except by the act of the member surrendering it or by violating its terms. The association had a well established and efficient news-gathering organization covering the entire world. It was essential that the Daily Pantagraph, being the only morning paper, publish news from world-wide sources. At the time the petitioner was incorporated this news could not have been secured *1178 from any other source, and without such news the corporation could not have maintained the large circulation which it had acquired. The Associated Press, a cooperative association, sold news only to its members, at cost. The corporation could not have acquired the membership from anyone other than Davis. In*4300 the purchase and sale of newspaper properties, such membership is regarded as having a substantial value and in practice the value is determinable. In 1907 the Associated Press Service was more valuable than it is at the present, for at that time there was no other source of supply of the news, whereas at the present time there are a number of such services. The news service which it furnishes, where it is an exclusive right as in this case, is in this community, worth one dollar for every head of a family in the territory served by the paper and in this instance it was worth $30,000.
Davis transferred to the corporation the good will of the Daily Pantagraph. The paper had been published for more than 50 years in a well settled agricultural community where there was little fluctuation of population; it had the confidence of its readers and was influential in the community. The paper had well established advertising connections and advertisers had become convinced of its value as an advertising medium, because of the standing and reputation which it had achieved. It had a good will which gave the business a strong income-producing power. Newspaper men in purchases and sales, *4301 give to good will a value over and above the other properties. The paper has been served to the same families for succeeding generations and the good will had a value of $25,000 on December 31, 1907.
Summarizing the foregoing, it is found that the petitioner's capital structure as of January 1, 1908, was as follows:
| Tangible properties paid in for stock | $80,000.00 | |
| Tangible properties paid in and originally entered upon the books as paid-in surplus | $4,532.33 | |
| Additional cash value of land | 5,000.00 | |
| Additional cash value of buildings | 17,000.00 | |
| Additional cash value of plant and equipment | 17,397.68 | |
| Cash value of newspaper circulation structure | 142,000.00 | |
| Cash value of associated press news service | 30,000.00 | |
| Cash value of newspaper good will | 25,000.00 | |
| Total paid-in surplus | 240,930.01 | |
| Total capitalization | 320,930.01 |
For its fiscal year ended October 31, 1916, the petitioner filed its income-tax return with the proper collector on December 30, 1916. The Commissioner's deficiency letter was issued and mailed on March 14, 1925.
OPINION.
TRUSSELL: The record of this action contains the testimony of three disinterested witnesses, all of*4302 whom were or had been engaged *1179 in the business of publishing newspapers in the smaller cities of Illinois, Iowa, Missouri, and Wisconsin, and one of them had had experience in the purchase and sale of daily newspapers in such cities during a period of 45 years. These witnesses all gave opinion testimony upon the value of thePantagraph circulation structure, Associated Press franchise, and good will. They discussed these questions from the standpoint of their personal knowledge of the business of the Pantagraph and generally from their experience and knowledge acquired in the publication and the purchase and sale of newspaper properties. All of them agreed that the circulation structure of the Pantagraph had on January 1, 1908, a value of not less than $10 per unit of individual subscriptions. One of these witnesses gave it as his opinion that the Associated Press franchise had a cash value of $30,000; another that this franchise was worth not less than $25,000. Respecting the value of petitioner's good will, one of these witnesses gave it as his opinion that it was worth $50,000; another that the going business, including tangibles and intangibles, was worth between*4303 $325,000 and $375,000; and the third testified that if he had had the money he would have been willing to pay for the going business of the Pantagraph one-half million dollars.
Concerning the value of petitioner's land, buildings, and equipment, the record contains the testimony of the general manager of the Pantagraph, another employee who had been with the business since 1882, and a disinterested witness who had been engaged in the building business in Bloomington since 1889. The last witness gave it as his opinion that the building owned and occupied by the Pantagraph on January 1, 1908, had a value of $35,000. The business manager of the Paragraph and the employee witness testified in detail with respect to all the properties and equipment of the company, showing the history of such properties from the time acquired and their condition on January 1, 1908, and the probable life of both buildings and equipment.
Upon consideration of all of this testimony we have arrived at the conclusion that the tangible and intangible properties, which were turned in to the Pantagraph Company in exchange for stock and paid-in surplus, had on January 1, 1908, a total value of $320,930.01*4304 as set forth in the findings of fact and that the probable life of the buildings and equipment was, buildings 55 years, plant and equipment 33 years, and furniture and fixtures 25 years. We, therefore, find (1) that the additional cash values of land, buildings, and plant aggregating $39,397.68, should be reflected in the invested capital computation for the calendar years 1919 to 1921, inclusive; (2) that the values of circulation structure, Associated Press service and good *1180 will, although properly reflected in paid-in surplus in accordance with the opinion and decision of the Board in , may not be, under the provisions of the Revenue Acts of 1918 and 1921, and in the opinion and decision of the Board in the case of the , included or reflected in invested capital; (3) the amount of current earnings available for dividends in any year may not be reduced by any so-called tentative tax computation. ; (4) income and profits taxes for prior years, the collection of which is not barred by the statute of limitations, may be deducted*4305 from surplus in accordance with section 1207 of the Revenue Act of 1926; (5) in the computation of net income and invested capital as affected by depreciation, the reasonable allowance for exhaustion, wear, and tear upon the petitioner's buildings should be computed at the rate of 1.8 per cent of the value here found as of January 1, 1908, and upon the plant and equipment at the rate of 3 per cent, and upon furniture and fixtures at the rate of 4 per cent; (6) the asserted deficiency for 1916 is barred by the statute of limitations. Respecting the alleged deficiencies for 1909, 1912, 1913, 1914, and 1915, and the overassessments shown for the years 1910 and 1917, the Board has no jurisdiction.
The deficiencies for the years 1919 to 1921, inclusive, may be redetermined in accordance with the foregoing findings of fact and conclusions of law.
Reviewed by the Board.
Judgment will be entered upon 15 days' notice, pursuant to Rule 50.