*726 A California water company, a public utility, kept its accounts in accord with the rules of the railroad commission of that state, which were compulsory upon it and, among other things, prescribed that depreciation should be taken on the sinking fund method. As the result of a protest made by the company, the Commissioner permitted it to make its returns under the straight line method of computing depreciation. The Commissioner adopted the costs and lengths of the useful life of the assets of the company as determined by the railroad commission. Held, that in determining the amounts of earnings available for dividend distributions the Commissioner correctly used the amounts of depreciation allowed to the corporation in computing its Federal income taxes for the several years in question; held further, that the Commissioner is not estopped from making this determination because petitioner as a stockholder of the company returned the entire dividends for taxation in the years received without claiming any part thereof as a return of capital and paid taxes thereon, and the Commissioner accepted such returns and made no changes therein.
*634 The respondent has determined a deficiency in income tax for the year 1928 in the amount of $1,227.46.
Petitioner assigns errors as follows:
1. The erroneous determination by the Commissioner that the cost basis and consequent profit to petitioner in connection with the disposition during the year 1928 of 250 shares of class A preferred *635 stock and 200 shares of class B preferred stock of the East Bay Water Co. should be reduced by an amount claimed by the Commissioner to have represented distributions paid out of capital during the years 1917 to 1927, inclusive.
2. The overstatement by the Commissioner in his deficiency notice of dividends to the extent of $502.35.
3. Petitioner also contends that respondent is estopped from adjusting the cost basis to petitioner of said shares of stock, because the petitioner rendered for income taxation the full amount of dividends received from time to time and paid taxes thereon and respondent accepted said returns filed and said taxes so paid and made no changes therein.
FINDINGS OF FACT.
The parties have agreed upon a*728 stipulation of facts, which, together with the exhibits attached, is made a part of this report by reference. We incorporate in our findings so much of the stipulation as seems pertinent:
1. During the year 1917 petitioner acquired by purchase trust certificates representing 250 shares of Class "A" 6% cumulative preferred stock of East Bay Water Company, and trust certificates representing 200 shares of Class "B" 6% non-cumulative preferred stock of East Bay Water Company, and paid for said trust certificates representing said preferred "A" stock the sum of $18,813.13, and for said trust certificates representing said preferred "B" stock the sum of $4,687.50. Shortly after the acquisition of said trust certificates, petitioner received in exchange therefor 250 shares of Class "A" cumulative preferred stock of East Bay Water Company and 200 shares of Class "B" 6% non-cumulative preferred stock of East Bay Water Company, and the original cost basis to petitioner of said 250 shares of stock was the same as the trust certificates representing said 250 shares of stock, and the original cost basis to petitioner of said 200 shares of stock was the same as the trust certificates representing*729 said 200 shares of stock.
2. Petitioner continuously held and owned said 250 shares of preferred "A" stock and said 200 shares of preferred "B" stock from the date of their acquisition until December 11, 1928, being for a period of more than two years. On December 11, 1928, petitioner received in liquidation of said 250 shares of preferred "A" stock cash or the equivalent thereof in the sum of $25,279.15 and received in liquidation of said 200 shares of preferred "B" stock cash or the equivalent thereof in the sum of $21,500.00.
3. At all times from January 1, 1917, to and including December 11, 1928, East Bay Water Company was a California corporation, engaged in the distribution and sale of water to the public in Alameda County, California.
4. Attached hereto and marked Exhibit "A" is a statement showing for each of the years 1917 to 1928, inclusive, the figures reflected by the original books of account of East Bay Water Company for (a) depreciation (exhaustion, wear and tear) charged off with respect to depreciable assets; (b) surplus at beginning of year; (c) net profit; (d) miscellaneous additions to surplus; (e) dividends on preferred "A" stock and preferred "B" *730 stock charged to surplus; (f) miscellaneous deductions from surplus, and (g) balance of surplus at end of year.
*636 Said books of account hereinabove referred to are those which were regularly kept during all of the years referred to and were in accordance with the system of accounts required to be kept by the Railroad Commission of the State of California, and were the basis for the making of annual reports by said East Bay Water Company to said Railroad Commission for said years.
Said East Bay Water Company first commenced to do business on January 1, 1917, and charged off for said year 1917 depreciation, as appears from Exhibit "A" in the sum of $192,336.17. The Railroad Commission of the State of California, upon receiving the annual report of East Bay Water Company for the year 1917, wherein there was set forth said item of depreciation hereinabove referred to, determined that, for rate fixing purposes, the charge-off for depreciation should have been approximately $80,000.00 and as a result thereof, said Railroad Commission directed that no charge-off be made for depreciation for the year 1918, and only $40,000.00 for the year 1919, so that the average for said*731 three years should be in the neighborhood of $80,000.00 per annum. No sinking fund for depreciation was ever established or maintained by East Bay Water Company. Appended hereto and marked Exhibit "F" is a true and correct copy of the opinion and order of the California Railroad Commission in Case No. 1008, decided July 1, 1918, by said California Railroad Commission.
5. Appended hereto and marked Exhibit "B" is a statement for each of the years 1917 to 1928, inclusive, of (a) the amount of depreciation claimed by East Bay Water Company as a deduction in its federal income tax returns; (b) the amount of depreciation allowed by respondent in determining the income tax liability of East Bay Water Company, and (c) the amount of depreciation used by respondent in computing earnings available for dividends in the case of this petitioner, as shown upon Exhibit "E" hereinafter referred to. The amount of depreciation for the year 1917 used by respondent in computing income available for dividends was based upon the same rates which respondent used in computing the amounts allowed as a deduction to the East Bay Water Company for years subsequent to 1917.
The amounts of depreciation*732 for the years 1918 to 1921, inclusive, allowed by respondent in computing the income tax liability of East Bay Water Company for said years were allowed as a result of a protest filed by East Bay Water Company with respondent, in which said corporation claimed depreciation on a straight line basis in the respective amounts as shown by said Exhibit "B". The amounts of depreciation so claimed by East Bay Water Company resulted from the application on a straight line method of rates based on the life, as determined by the California Railroad Commission of the depreciable assets of said company. Said California Railroad Commission, in determining depreciation upon the depreciable assets of said East Bay Water Company, used approximately the same cost figures as were used by the Commissioner in determining the amounts of depreciation for the years 1917 to 1928, inclusive. The amount of depreciation allowed by respondent for each of the years 1922 to 1928, inclusive, in computing the income tax liability of East Bay Water Company was based upon the same rates of depreciation on a straight line basis as was claimed by East Bay Water Company in said protest. For each of the years 1917*733 to 1928, inclusive, said East Bay Water Company had a net income, subject to federal income taxes, and paid to respondent income taxes. As a result of the protest above mentioned and allowance by respondent of the depreciation claimed therein, East Bay Water Company received a refund of federal income taxes for each of the years 1918 to 1921, inclusive.
East Bay Water Company maintained a memorandum record of depreciation upon the straight line basis, as allowed by respondent.
*637 6. Appended hereto and marked Exhibit "C" is a true and correct statement for the period January 1, 1917, to December 11, 1928, of all dividends declared and/or paid by East Bay Water Company, including the class of stock upon which paid, the amount of each payment, the par value of the stock on which the dividend was declared and paid, the amount of each dividend paid, the date declared and the date payable. All dividends payable were actually paid upon the date shown to be payable. Each of the dividends shown in said statements was specifically authorized by resolution of the Board of Directors of East Bay Water Company. Appended hereto and marked Exhibit "D" is a form of the resolution*734 adopted by the Board of Directors with respect to each dividend on Class "A" preferred stock and with respect to each dividend on Class "B" preferred stock. Up to and including the year 1923, dividends were charged to surplus upon the date on which they were paid, but beginning with the year 1924, the dividends were charged to surplus upon the date they were declared. All details with regard to said dividends were annually reported by East Bay Water Company to the Railroad Commission of the State of California.
7. The par value per share of said shares of Class "A" preferred stock and said shares of Class "B" preferred stock was at all times $100.00.
8. During the years 1917 to 1928, inclusive, petitioner, as the owner of trust certificates for 250 shares of Class "A" preferred stock of East Bay Water Company or 250 shares of said Class "A" stock and trust certificates for 200 shares of Class "B" preferred stock of East Bay Water Company or 200 shares of said Class "B" stock, received from East Bay Water Company dividends at the rate per share as shown in Schedule "C" with respect to each of the dividends listed therein. During each of the years 1917 to 1928, inclusive, *735 petitioner filed with the Collector of Internal Revenue at San Francisco, California, her individual income tax return and in each of said returns petitioner included within gross income, under the caption of "Dividends", the full amount of the aforementioned dividends received by her furing the year in question from said East Bay Water Company. During each of said years, petitioner paid a federal income tax to said Collector of Internal Revenue.
9. At no time did East Bay Water Company notify petitioner that any of said dividends hereinabove referred to paid to her during the years 1917 to 1928, inclusive, were paid out of capital. The first knowledge that petitioner had that it was claimed that a portion of the aforementioned dividends was paid out of capital was in the early part of the year 1930, when she received a copy of a report of the Internal Revenue Agent at San Francisco with respect to her income tax liability for the year 1928.
10. Attached hereto and marked Exhibit "E" is a statement showing the manner in which respondent has computed distributions claimed by him to have been made by East Bay Water Company out of capital, in accordance with the determination*736 of respondent as contained in the notice of deficiency herein. Petitioner concedes the correctness of the computation shown upon Exhibit "E", subject to such adjustment as the Board may determine should be made to the amount of income available for dividends by reason of depreciation, and also subject to petitioner's asserted defense that respondent is estopped from asserting the deficiency herein, insofar as the same is predicated upon claimed distributions out of capital.
11. In the computation of taxable net income as shown by the notice of deficiency herein, respondent has included two items of $279.15 and $223.20 as dividends. It is agreed that said two items should be eliminated from dividends.
In the notice of deficiency, respondent in computing profit upon the liquidation of petitioner's stock in 1928, used $25,000.00 for the preferred "A" stock and *638 $21,276.80 for the preferred "B" stock, as representing the amounts received by petitioner in 1928, whereas the correct amounts received were $25,279.15 and $21,500.00, respectively, as shown by paragraph 2 hereof. Profit on the liquidation of such stocks in 1928 should be adjusted accordingly.
12. Wherever*737 the words "dividend" or "dividends" are used herein, including any exhibits hereto, the use thereof shall not be deemed an admission by either of the parties hereto that they represented "dividends" as that term is defined in Section 115 of the Revenue Act of 1928 and in corresponding provisions of the earlier Revenue Acts.
The following are the material items contained in Exhibit "A", which is a copy of the surplus account of the East Bay Water Co., as shown by its books:
| Year | Depreciation. | Dividends on outstanding | Balance at the end of period |
| stock. | |||
| 1917 | $ 192,336.17 | $201,582.00 | $153,702.81 |
| 1918 | 201,636.00 | 357,584.50 | |
| 1919 | 40,000.00 | 274,809.70 | 469,562.45 |
| 1920 | 80,000.00 | 293,861.33 | 597,208.52 |
| 1921 | 80,000.00 | 382,725.07 | 651,653.62 |
| 1922 | 160,000.00 | 447,605.94 | 673,564.41 |
| 1923 | 160,000.00 | 553,051.02 | 736,922.37 |
| 1924 | 172,000.00 | 732,166.92 | 768,927.83 |
| 1925 | 232,000.00 | 603,488.00 | 831,258.08 |
| 1926 | 278,000.00 | 669,194.91 | 1,018,374.47 |
| 1927 | 302,000.00 | 779,232.00 | 1,099,053.60 |
| To 12/2/28 | 326,872.23 | 584,424.00 | 1,263,670.61 |
| Total | 2,023,208.40 | 5,723,776.89 |
Exhibit "B" follows and shows the amount of depreciation claimed*738 in the return of the East Bay Water Co. and as allowed by the Commissioner in the computation of net taxable income, and as allowed in computing income available for dividends:
| DEPRECIATION (exhaustion, wear and tear). | |||
| EAST BAY WATER COMPANY | |||
| Claimed in return | Allowed in computing Fed. | Allowed in computing income | |
| Inc. taxes of E.B.W. Co. | available for dividends | ||
| 1917 | $192,336.17 | $192,336.17 | $241,655.53 |
| 1918 | 218,140.67 | 256,528.73 | 256,528.73 |
| 1919 | 220,502.00 | 270,152.57 | 270,152.57 |
| 1920 | 261,612.00 | 302,362.16 | 302,362.16 |
| 1921 | 288,995.50 | 346,301.94 | 346,301.94 |
| 1922 | 328,613.88 | 357,843.29 | 357,843.29 |
| 1923 | 429,912.33 | 384,147.20 | 384,147.20 |
| 1924 | 462,491.23 | 421,959.35 | 421,959.35 |
| 1925 | 504,310.85 | 478,393.39 | 478,393.39 |
| 1926 | 483,584.67 | 527,165.37 | 527,165.37 |
| 1927 | 533,241.76 | 554,403.99 | 554,403.99 |
| 1928 | 546,683.95 | 546,683.45 | 546,683.45 |
| 4,470,425.01 | 4,638,277.61 | 4,687,596.97 |
*639 In addition to the foregoing stipulation of facts, there was certain oral testimony at the hearing, from which we make the following additional findings of fact: The East Bay Water Co. kept its properties in good condition and repairs*739 were made to keep them in a high state of efficiency. The repairs were charged to ordinary expenses of the company under classifications made out by the Railroad Commission of California. The dividends declared were recommended by its president to the board of directors and were declared by regular resolution of the board of directors, and were based on the surplus accounts as shown by the books of the company, which were kept subject to the rules of the commission.
From the stipulated facts and the oral testimony we find that the amounts of depreciation allowed by the Commissioner in computing income available for dividends of the East Bay Water Co. represented the correct amount of depreciation which had accrued on the company's assets and that the Commissioner correctly determined that the dividends paid on the stock of the East Bay Water Co. had been paid in part from capital rather than from earnings, the part so paid, amounting to $20.1277 on each share of "A" stock and $23.659 on each share of "B" stock.
OPINION.
BLACK: Issue 2 has been settled by stipulation.
The first question for decision is whether the dividends which the petitioner received from the East Bay*740 Water Co. included distributions of capital. Upon audit of the return filed by petitioner the Commissioner determined that the dividends paid on the stock of the East Bay Water Co. had been paid in part from capital, rather than from earnings, the part so paid amounting to $20.1277 on each share of "A" stock and $23.659 on each share of "B" stock, and that, therefore, the cost basis of the stock should be reduced accordingly, as provided by section 115(d) of the Revenue Act of 1928. Both sides concede that this issue depends solely on whether too much or too little depreciation was deducted in the various years. The Commissioner has allowed as depreciation for the years 1917 to 1928, inclusive, in computing income tax the total amount of $4,638,277.61, and in the computation of dividends, $4,687,596.97. The difference between these sums is fully explained in the findings of fact and arises from an adjustment made as the result of a protest filed by the company. The total depreciation for these same years shown on the books of the company is $2,023,208.40.
Both sides apparently agree that the difference between the amount allowed by the Commissioner and that which appears on*741 the books *640 of the East Bay Water Co. arises from the method in which depreciation was computed by each. The Commissioner computed depreciation on a straight line basis, whereas the company computed it, in so far as its book entries are concerned, under the sinking fund method, in compliance with the rules of the Railroad Commission of California. Under the first method, depreciation is computed on the cost or other proper basis and allocated equally over the years of the useful life of the asset, while under the sinking fund method only so much is deducted in each year as, plus interest at a given rate, will equal the cost of the asset when it is exhausted. It is stipulated that cost used by the Commissioner and that used by the Railroad Commission of California were approximately the same and that the Commissioner accepted the findings of the commission as to the length of the useful life of the various assets.
It has been stipulated that certain officers of the East Bay Water Co. filed a protest with the Commissioner which resulted in the refund of taxes for the years 1917 to 1921, inclusive, and became the basis for the computation of depreciation for income tax*742 for subsequent years. We assume that these men had a thorough knowledge of the assets of their company, and their cost and useful life, and that they were sincere and honest in making the protest and furnishing the proof which resulted in the refund. It is a pertinent fact that the sinking fund method was required by the railroad commission. Apparently it was not the company's choice. The first time its officers could exercise their independent judgment upon this question was when they appeared before the Commissioner. We think that this independent judgment of the officers of the company is entitled to greater weight than the opinion of their witnesses at the hearing. There is a wide difference between the facts of this case and those which appeared in , and the cases therein referred to, and we do not consider them controlling.
In the instant case, the East Bay Water Co. of its own volition adopted the straight line method for income tax purposes in preference to the sinking fund method, and its stockholders have obtained the benefit accruing from this election. By reduction in income taxes*743 of the corporation larger amounts were available for distribution in dividends to stockholders. We recognize that net taxable income may be one thing and that earnings and profits available for distribution may be another, and that the latter may include items which would not enter into computation of net income and also reductions which would not be allowed in its computation. It is conceded by both parties that, in the computation of both net taxable income and earnings and profits available for distribution, there is a common element *641 and that is depreciation. The question here is whether a corporation in computing its net income for taxation purposes and its income for dividend purposes can use different methods. A similar question was presented in . There a corporation, in computing its net income, adopted the method of deducting individual debts which were found to be worthless and charged off, and then sought, in computing its earnings and profits for dividend purposes, to adopt the reserve method which was permitted by the Revenue Act of 1921. The petitioner, who was a stockholder, contended that the company could*744 pursue one method in computing its net taxable income and the other in computing earnings and profits available for distribution. In reply to that we said:
* * * The fallacy of this contention lies in the fact that while these terms differ in several particulars they have elements which are common to both. Among these is a deduction of or a provision for worthless debts. Section 234(a)(5) of the Revenue Act of 1921 gave the Company the option of using for this deduction a reasonable addition to its reserve for bad debts. It did not see fit to avail itself of this option, but continued to deduct as before the passage of that act. In order to maintain its position the Company must now assert that in respect of items common to both net income and to earnings and profits it has the right to use one method of getting the benefit of its worthless debts in respect of income taxable to itself, and to use another method in computing that part of its income which is taxable to its stockholders. The Company having elected to use the charge-off method when it could have used the reserve method, either of which could have been used to compute both net income and earnings and profits, should, *745 in our opinion, be held to its election in both cases. It should be compelled to turn square corners in its dealings with the Government. ; cf. .
Petitioner asserts that a stockholder is a separate entity from the corporation and for that reason he is not bound by the action of the corporation. That is, of course, true in many situations, but, in so far as we can see, it has no special application here. The question is, What earnings did the corporation have available for distribution when it declared dividends in the years 1917 to 1928, inclusive? The depreciation sustained by the corporation on assets used in its business is the determining factor here in arriving at a conclusion of that question.
When we have determined the correct amount of depreciation sustained by the corporation during the period in question the petitioner, a stockholder of the company, is bound by it. In our findings of fact we have sustained the Commissioner in his allowance of depreciation in computing the company's income available for dividends, and of*746 course that determines the amount of petitioner's dividends which was from earnings and the amount which was paid from capital. In , the District Court of the United *642 States for the Northern District of California, Southern Division, had this same question before it. Judge Kerrigan, among other things, said:
* * * While I do not wish to go so far as to hold that the stockholder is estopped from caliming another basis of depreciation than that claimed by the corporation, under the facts and circumstances of this case, it appeals to me as meritorious that the Commissioner should use the same figures of depreciation in computing whether or not dividends were paid out of capital as were claimed by the corporation in computing its income tax. While the depreciation approved by the Railroad Commission is persuasive as to its correctness, the Commissioner of Internal Revenue is not bound by its findings and orders. . Without going into the merits of the respective methods of computing depreciation, *747 I hold and find that the depreciation claimed by the East Bay Water Company in computing its income tax is the depreciation which may properly be used by the Commissioner in computing whether or not the dividends paid included a return of the capital investment. * * *
The United States Circuit Court of Appeals for the Ninth Circuit, at 78 Fed.(2d) 934, sustained the judgment of the District Court in holding that the dividends paid on the stock of the East Bay Water Co. had been paid in part from capital rather than from earnings, the part so paid amounting to $20.1277 on each share of "A" stock and $23.659 on each share of "B" stock, and that therefore the cost basis of the stock should be reduced accordingly. That is the same question as we have here, and, while of course the question is one of evidence in each case, there being no contention that the court's opinion in the Wells Fargo Union Trust Co. case is res judicata here, we feel constrained to reach the same conclusion on the evidence before us as the court reached in that case. The respondent is affirmed on this issue.
The petitioner next asserts that the respondent is estopped to impose the tax*748 asserted on her by reason of the fact that he has consistently taxed her on the dividends received by her from the East Bay Water Co. There is nothing in the record to indicate that the respondent or any of his predecessors made any determination whatever as to the amount of dividends taxable to the petitioner. All that appears is that the petitioner has consistently in her returns reported these dividends as income, and that the Commissioner has accepted her returns at their face value. There is no merit in this contention. Cf. ; ; .
Decision will be entered under Rule 50.