*2544 1. Where evidence of the cost of assets to a predecessor corporation or of their value as of the date (prior to March 3, 1917) when such assets were taken over from the predecessor is inadequate, the determination of the Commissioner in respect to invested capital, not having been proved to be erroneous, can not be disturbed, regardless of whether the transfer of the assets to the new corporation constituted a reorganization of the old corporation or whether the corporation acquiring the assets is a new and distinct corporate entity.
2. Where earned or paid-in surplus is claimed and surplus has been allowed by the Commissioner, it must be shown that an allowance of the amount claimed would not result in a duplication, in whole or in part.
3. Value of franchises for depreciation purposes fixed.
*630 The Commissioner determined a deficiency in income and profits taxes for the calendar year 1921 amounting to $3,580.71. The errors assigned are as follows:
(1) The determination of the Commissioner that the value of*2545 assets acquired by the petitioner for stock and cash, which assets belonged to a predecessor corporation, was not in excess of $155,507.07.
*631 (2) The determination of the Commissioner that the acquisition of the assets of a predecessor corporation was not a corporate reorganization within the meaning of the Revenue Act of 1921.
(3) The determination of the Commissioner that the petitioner was not entitled to an earned surplus of $64,064.48.
(4) The disallowance by the Commissioner from invested capital of an item of $200,000, representing stock of a predecessor corporation.
(5) The disallowance of the sum of $64,064.48 as paid-in surplus.
(6) In the disallowance from invested capital of an item of $200,000 as "Franchise Account."
(7) The failure of the Commissioner to find that the capital stock of the petitioner was issued upon reorganization for both tangible and intangible assets.
(8) The failure of the Commissioner to allow a deduction for depreciation of franchises on the basis of a value on March 1, 1913.
(9) The failure of the Commissioner to allow an adequate allowance for depreciation of construction and equipment belonging to the petitioner.
*2546 FINDINGS OF FACT.
The petitioner is a corporation organized October 19, 1897, under the laws of the Commonwealth of Pennsylvania, with its principal office at Pittsburgh, Pa.
The Burrell Water Co. was a corporation organized under the laws of the Commonwealth of Pennsylvania on October 31, 1891. It owned and operated water works for the supply of water to the public in certain townships located in Westmoreland County, Pennsylvania, and it held franchises granted by the boroughs which it served, under which it was authorized to supply water to those communities at certain designated rates. The company had a capital stock of $200,000, consisting of 4,000 shares of the par value of $50 each. On June 27, 1896, T. Mellon & Sons, of Pittsburgh, acquired 2,492 shares of the capital stock of this company and subsequently acquired by purchase the remaining outstanding shares of the company, and then held shares having a total par value of $175,000. This firm also held notes of the company aggregating $60,000. The company became unable to meet its obligations and T. Mellon & Sons entered judgment on a note held by them on February 19, 1897. Under the judgment the sheriff of Westmoreland*2547 County levied upon the assets of the corporation and sold the same on March 19, 1897, to R. B. Mellon, the plaintiff in the writ, for the sum of $906. On September 10, 1897, the sheriff of Westmoreland County duly executed his deed to Richard B. Mellon, under which all personal, mixed, *632 and real property, franchises and rights of the Burrell Water Co. were conveyed to him.
On the 11th of October, 1897, Richard B. Mellon executed and delivered to the Kensington Water Co. a deed, under which he conveyed to it all of the property received by him under the deed of the sheriff of Westmoreland County. Thereafter and on July 1, 1899, Richard B. Mellon conveyed to the Kensington Water Co. in consideration of the sum of $2,000, recited in the instrument, a certain tract of land located in Lower Burrell Township in the County of Westmoreland, Pennsylvania.
On October 19, 1897, there was filed in the office of the Secretary of the Commonwealth of Pennsylvania, a certificate of organization of the Kensington Water Co. This instrument is designated "KENSINGTON WATER COMPANY REORGANIZATION AFTER JUDICIAL SALE OF THE RIGHTS, FRANCHISES AND PROPERTY OF THE BURRELL WATER COMPANY. *2548 " The amount of capital of the new corporation was fixed at $200,000 divided into 4,000 shares of the par value of $50 each. All of said 4,000 shares were issued, 3,994 of such shares being issued to R. B. Mellon and one share to each of six other persons. The certificate recites:
That four thousand (4,000) shares of the par value of fifty ( $50) each making two hundred thousand ($200,000) dollars of the capital stock to be deemed and taken in full paid stock, or to be issued to the persons for and on whose behalf said property franchise and rights were purchased in payment for their respective interests in the same, as follows.
Franchises were carried on the Burrell Water Co.'s books at $200,000. A new exclusive franchise was obtained by the petitioner to take effect December 31, 1912. The new franchise was in the form of an ordinance passed by the Town Council of the Borrough of New Kensington, which specified the rates at which water was to be furnished, and was granted on consideration that the company should maintain adequate works. The franchise ran for a period of 25 years. The value of the new franchise as of March 1, 1913, was $200,000.
As of December 31, 1912, the*2549 cost of the petitioner's plant was carried on its books at the sum of $273,217.82, and its franchise at the sum of $200,000. As of March 31, 1913, the cost of plant was carried on its books at $288,754.96 and its franchise was carried at $200,000. The books also showed additional cost of plant from January 1 to March 1, 1913, in the total amount of $10,358.09.
The individual items of physical assets as of December 31, 1912, were carried on the petitioner's books as follows:
| Construction of street mains | $14,159.25 |
| Pump station construction | 48,618.56 |
| Filter plant construction | 33,066.73 |
| Reservoir construction | $43,062.17 |
| Parnassus original construction | 31,008.11 |
| Kensington and Arnold original construction | 91,826.80 |
| Meter zone | 1,081.38 |
| Office furniture and fixtures | 527.55 |
| Tools | 1,214.04 |
| Total | 264,564.59 |
*633 The petitioner's books for the year 1912 show a gross revenue of $51,029.42, operating expenses of $21,658.89, and a net operating income of $29,370.53. During the first 2 months of 1913 there was an increase of rates of $1 per year on 2,317 accounts and $6 per year on 236 accounts.
The Commissioner made the following determination*2550 in respect to invested capital:
| Capital stock | $200,000.00 |
| Surplus | 82,585.04 |
| (Total) | 282,585.04 |
| Less franchise account capital stock | 200,000.00 |
| Invested capital | 82,585.04 |
In the statement attached to the dificiency notice the following appears: "It is held that the value of the assets acquired by the taxpayer for stock and cash was not in excess of $155,507.07."
OPINION.
MURDOCK: The first assignment of error relates to the statement in the deficiency notice that the value of the assets acquired by the petitioner was not in excess of $155,507.07. The petitioner, however, did not introduce evidence to prove the value of the assets at the time they were taken over by it. The second assignment of error alleges that the Commissioner erred in determining that the organization of the petitioner and the taking over of the assets of the Burrell Water Co. was not a corporate reorganization within the meaning of the Revenue Act of 1921. There is nothing contained in the dificiency notice or in the statement attached thereto to show that the Commissioner made any ruling with respect to whether or not the organization of the petitioner and the taking over of the*2551 assets of the old company constituted a reorganization under the Revenue Act of 1921. The petitioner laid great stress upon this feature in his brief. It seems to us however that the question is a purely academic one, since, so far as we can see, the decision of it would not affect the deficiency in tax. Counsel for the petitioner made the following statement on the record:
We are starting with the Kensington Water Company for the purpose of determining invested capital and for the purpose of determining the value of *634 the physical assets, both real and intangible, we are going back to the Burrell Water Company's original holdings.
We do not know what was meant by this statement. Is the petitioner contending that its invested capital should be computed by taking the invested capital to which its predecessor would have been entitled, or does it contend that its invested capital should be computed by using the value of the assets as of the date when they were acquired by the petitioner? In either view of this matter, however, we are left without sufficient data upon which to base an opinion, since the evidence introduced does not show what the invested capital of*2552 the Burrell Water Co. would have been for the taxable year in question, or what the value of the tangible or intangible assets was at the time the petitioner acquired such assets.
The evidence is confusing in respect to the consideration paid by the petitioner for the assets previously purchased at the sheriff's sale by R. B. Mellon. The testimony was to the effect that the petitioner paid to T. Mellon & Sons the sum of $155,507.07 for the assets of the old company, and that this money was obtained by floating a new bond issue of $200,000, $160,000 of which was sold. On the other hand, a copy of the certificate of reorganization after the judicial sale introduced in evidence contains the statement set out in our findings of fact. But which state of facts may be the correct one is immaterial, since, if the assets were paid for from funds raised by the bond issue, that would not affect invested capital, or, if, on the other hand, the stock was the consideration for the transfer of the assets, the petitioner has failed to show the value of the assets at the time paid in.
In the third error assigned the petitioner alleges that the Commissioner determined that the petitioner was*2553 not entitled to an earned surplus of $64,064.48. This error is apparently related to the fifth error, in one case the amount being designated as earned surplus and in the other as paid-in surplus. The petitioner contends in its brief that it is entitled to an invested capital amounting to $320,008.20. This figure is arrived at by adding to $200,000, the amount of the capital stock, the surplus as shown by the deficiency notice, amounting to $82,585.04, and the "earned or paid-in surplus depreciated," amounting to $37,423.16. We do not know the theory upon which depreciation is figured on surplus, but at least the petitioner claims nothing in excess of $37,423.16. It is not shown how the Commissioner arrived at the surplus of $82,585.04. We can not assume that the figure $82,585.04 did not include all or a part of the earned or paid-in surplus for which the petitioner is contending. We can not, therefore, allow any additional surplus over and above that which the respondent originally allowed.
*635 In the fourth error assigned the petitioner alleged that in computing invested capital the Commissioner disallowed an item of $200,000, representing stock issued by the Burrell*2554 Water Co., but it failed to prove what invested capital the predecessor would have been entitled to had there been a continuance of that corporate entity. The petitioner also complains of the elimination from invested capital of the $200,000 designated "franchise account," which will now be considered with the next assignment of error relating to the failure of the Commissioner to find that the capital stock of the petitioner was issued for both tangible and intangible assets. We find nothing in the record to show that the Commissioner ever made any statement with respect to the sort of assets for which the petitioner's stock was issued, except the designation "franchise account capital stock." Suppose the stock were issued for both tangible and intangible assets by the transfer to the petitioner by R. B. Mellon of all the physical assets and franchises of the Burrell Water Co., obtained by him at the sheriff's sale. We do not know the total or the respective values of the tangible and intangible assets when they were taken over on organization, or reorganization, by the petitioner. We know that the old franchises of the Burrell Water Co. were carried on its books at $200,000. *2555 No evidence was introduced however to sustain this value as of any date, and in fact the value of the old franchises has never been discussed. In the absence of any corroborative evidence we can not accept this book entry as conclusive of value; .
The Revenue Act of 1921 provides in defining invested capital, section 326(a), that it consists, inter alia, of:
(4) Intangible property bona fide paid in for stock or shares prior to March 3, 1917, in an amount not exceeding (a) the actual cash value of such property at the time paid in, (b) the par value of the stock or shares issued therefor, or (c) in the aggregate 25 per centum of the par value of the total stock or shares of the corporation outstanding on March 3, 1917, whichever is lowest.
We are unable to say what proportion of the petitioner's capital stock was issued for tangibles and what for intangibles, or whether it was issued for cash. The petitioner's assignment of error in respect to this point indicates that the stock of the petitioner was issued without distinction for both tangible and intangible assets. It would be impossible for us to apply the*2556 limitation on intangibles contained in section 326(a)(4) of the Revenue Act of 1921 even if we could find that the stock was issued for assets.
The petitioner introduced two of its balance sheets in evidence. On the one dated December 31, 1912, there is an item "Cost of plant and franchise - $473,217.82," and on the one dated March 31, 1913, *636 there is an item "Cost of plant and franchise - $488,754.96." Apparently additions to the plant were being made from time to time. These sheets do not prove the cost of the plant to the predecessor corporation, particularly in the absence of evidence in regard to the additions to the plant, if any, which might be included in these figures. Since the petitioner has not shown us what the correct invested capital for the taxable year in question would be, although it appears by the brief what figures are contended for, the invested capital as determined by the Commissioner can not be disturbed.
The petitioner complains of the failure of the Commissioner to allow a deduction for depreciation of its remaining franchise on the basis of its value on March 1, 1913. In respect to this issue it will be noted that the franchise upon*2557 which depreciation was claimed is the newest franchise. This franchise became effective December 31, 1912, to run 25 years and depreciation at the rate of 4 per cent per annum is claimed in a valuation of $200,000, making an annual deduction on this account of $8,000.
The evidence of the value of this franchise is contained in the testimony of the witness Pollock, who was general manager of the petitioner from March 1, 1913, to the present time. The testimony gives the basis for the witness's opinion as to the value and the figure arrived at is $300,000, of which the petitioner is claiming only $200,000. The witness stated that he conducted the negotiations for securing the new franchise starting in the year 1911, and in September 1911, the franchise was secured, to take effect December 31, 1912. He testified that the franchise introduced in evidence was in effect an exclusive franchise for 25 years. In forming his opinion of the value of the franchise he said he considered the earnings of the company for 1912, plus the increase from January 1, 1913, under the new ordinance; the number of consumers on December 31, 1912; the prevailing rates; and the net operating income. While*2558 the filtration plants were being installed in 1912, he was commissioned by the Aluminum Company of America, located in the territory served by the water company, to secure additional property to increase their mills, and he spent considerable time in 1912 buying nearby property for them. They acquired in this way 40 acres of first-class river-frontage property for manufacturing purposes. He knew the improvements the Aluminum Company had planned and knew what the prospects for the territory were. He also took into consideration the purchase by the petitioner of the Monessen Water Co. in connection with which transaction it had been necessary for him to go into the details of its earnings, assets and franchises. The Monessen Water Co. had a franchise similar to that of the petitioner. It expired one year and a half after the expiration of the petitioner's *637 new franchise. The Monessen situation was comparable to that at New Kensington, except that there was not quite so valuable a plant at Monessen. The population of Monessen in 1912 was about 11,000, and the population of New Kensington 13,000. The Kensington Water Co. had about 2,500 consumers and the Monessen Co.*2559 had about 1,900. The petitioner paid $475,000 for the Monessen Water Co. In this transaction the physical plant of the Monessen Water Co. was considered to be worth $183,000; the current assets, $38,000; and the franchise, $252,000, the difference between the sum of these two figures and the total amount paid. Since the petitioner's territory at New Kensington was larger, since it had a franchise comparable to that of the Monessen Water Co., and since the number of its consumers was greater, the witness Pollock fixed the value of the New Kensington franchise at $300,000. It is apparent that this witness had had long experience in dealing with water companies, having been an officer of several of such companies for many years. He was familiar with the territory covered by the New Kensington franchise and with the territory covered by the Monessen Water Co., the value of whose franchise he used for comparative purposes. It is our opinion, therefore, that the sum of $200,000 claimed by the petitioner, being considerably less than the figure fixed for the value of the franchises by the witness Pollock, may be accepted for depreciation purposes and depreciation allowed as a deduction*2560 at the rate of 4 per cent on the basis of such value.
The remaining issue relates to depreciation on construction and equipment. The petitioner alleges that with the exception of automobiles and meters only 2 per cent depreciation was allowed on plant and equipment, and it contends that it is entitled to 3 1/2 per cent "on the total cost of its plant and equipment." It alleges that the cost of the plant and equipment should include the amount of earned or paid-in surplus of $64,064.48, referred to in the petition. The difficulty with this issue, as in the case of the additional surplus claimed, is that we are unable to state what the Commissioner did. We do not know what rate of depreciation on the plant and equipment he allowed and the allegation as to his allowance of only 2 per cent is denied in the answer. Furthermore, we have no evidence in the record as to the correct amount of depreciation which should be allowed on these assets, nor can we understand why the additional claimed earned or paid-in surplus should be added to plant and equipment for depreciation purposes. We therefore decline to disturb the determination of the Commissioner in computing net income by a further*2561 deduction on account of additional depreciation.
Reviewed by the Board.
Judgment will be entered under Rule 50.