*3597 The evidence is insufficient to establish the actual cash value of a leasehold paid in for stock in 1908 or the fair market price or value thereof on March 1, 1913.
*134 The Commissioner determined deficiencies in income and profits taxes for the years 1920, 1921, and 1922, in the respective amounts of $1,464.50, $210.53, and $102.20, or a total of $1,777.23. Petitioner claims that the Commissioner erred in disallowing for invested capital and depreciation purposes any value of a certain leasehold paid in for stock. It is stipulated that aside from the alleged value of the leasehold and the depreciation deductions claimed on account thereof, the invested capital and net income of the petitioner for the taxable years involved were as follows:
| Invested capital | Net income | |
| 1920 | $127,683.39 | $22,949.06 |
| 1921 | 127,639.99 | 13,926.59 |
| 1922 | 15,221.49 |
*135 FINDINGS OF FACT.
Petitioner is a Washington corporation with its principal place of business at Spokane.
January 12, 1903, Louther W. Meyers and Mary E. Meyers, *3598 the owners in fee simple of a water-power site, located in Stevens County, Washington, made a lease of this property with T. A. Winter for a term of 20 years commencing January 15, 1903, under which the lessor agreed to allow the lessee to appropriate water for the purpose of generating electrical power to the extent of 1,500 more or less nominal horsepower, and the lessee agreed to pay $5 for each horsepower so taken. The lessee agreed to pay a minimum rental for 75 horsepower after July 1, 1903. The lease restricted the appropriation to not more than one-half the quantity of water flowing at the point of delivery at one time. It was also agreed that at the expiration of this lease, the lessee should have an option to purchase all developed water power at the rate of $50 for each horsepower of a quantity of not less than 200 nor more than 500 horsepower. The lease contained a provision giving the lessee the right of renewal for an additional ten years under the same conditions and terms as in the original lease.
February 25, 1903, T. A. Winter assigned the aforementioned lease to A. H. Sperry, Trustee, for the benefit of A. H. Sperry, Pat Welch, F. J. Finnucan, J. W. Stuart, *3599 and T. A. Winter. May 12, 1903, A. H. Sperry, as trustee, assigned this lease to the Northwestern Light & Power Co. June 26, 1903, the Northwestern Light & Power Co. and the original lessors under the foregoing lease executed an indenture under which the provision in the original lease giving the lessee the option of purchasing developed water power at the expiration of the lease was eliminated and the right of renewal was changed from 10 to 30 years. The other covenants in the old lease remained unchanged.
July 27, 1908, petitioner corporation was organized and acquired in exchange for all its common stock of 1,000 shares of par value of $100,000 and bonds of par value of $55,000, the following property:
(a) An assignment of the lease dated January 12, 1903, from Louther W. Meyers and Mary E. Meyers to T. A. Winter.
(b) An assignment of the lease dated June 26, 1903, from Louther W. Meyers and Mary E. Meyers to the Northwestern Light & Power Co.
(c) Assignment of franchise made to T. A. Winter by Stevens County, Wash., on January 12, 1903, to maintain an electric light line from Meyers Falls to Kettle Falls, Marcus, Goodwin, post Office, Colville and such other points*3600 as may be practicable for establishing electric power and light in Stevens County, Wash.
(d) An assignment of franchise made to T. A. Winter by Town of Colville, Stevens County, Wash., to operate a system of conductors for distribution of electricity in Colville.
*136 (e) An assignment of franchise made to T. A. Winter by Town of Kettle Falls, Stevens County, Wash., for distribution of electricity in the Town of Kettle Falls, Wash.
(f) All poles, wires, dynamo, water wheels, power houses, franchises, easements, leases, rights of way, machinery and fixtures of every kind and description, together with all other real, personal, and mixed property of every kind formerly owned by the Northwestern Light & Power Co.
On petitioner's books the bonds were considered as having been issued for the foregoing physical properties and the stock as having been issued for "Franchises, Contracts and Options."
February 10, 1913, petitioner and the successors in interest of the original lessors executed a new lease under which it was agreed that the prior leases, heretofore mentioned, were merged in the present lease which incorporated all of the obligations binding upon the parties*3601 thereto. This lease was for a period of 10 years commencing January 15, 1913, and gave to petitioner the right to all of the water power which it might be able to use or develop from the site in question, instead of a maximum of one-half of the available power as stated in the prior agreements. Petitioner agreed to make certain improvements, enlargements, etc., at its own expense, in connection with the further use and development of the existing and additional power which would be available, and agreed to pay $5 per horsepower for all power developed. Petitioner also agreed to pay a minimum of $5 per horsepower on 500 horsepower for the first three years of the lease and a minimum at the same rate on 600 horsepower on the second three years, and a minimum at the same rate on 750 horsepower on the remainder of the term. Petitioner was given the option to renew the lease for 30 years from January 15, 1923, under the same conditions and terms of the lease with the exception that the minimum rentals would be on the basis of a minimum of 750 horsepower at the unit rate of $5 during the period of the extension.
April 28, 1915, a new indenture was entered into between petitioner and*3602 the original lessors, or their successors in interest, which recited that the prior lease was merged into this new lease so far as its terms might be applicable. The principal difference between the prior lease and this new lease is that under the latter the term of the lease was for a term of 99 years from the date of its execution instead of for the shorter period provided in the old lease. The unit price of $5 per unit of horsepower used remained the same.
Each of the aforementioned leases contained a provision that all of the property installed on the premises by the lessee would revert to the lessors upon the termination of each lease.
No bonus or additional consideration other than the covenants contained in the various leases was given in securing the original lease or in securing the subsequent modifications or new leases. The *137 lease negotiated February 28, 1915, was in effect during the taxable years.
OPINION.
LITTLETON: The questions involved are (1) whether petitioner is entitled to include in its invested capital for the years 1920 and 1921 the actual cash value, if any, of the lease acquired in exchange for stock in August of 1908 and (2) whether*3603 it is entitled to deduct aliquot parts of the fair market value or price at March 1, 1913, if any, of such lease from its gross income for each of the respective taxable years.
The Commissioner contends (1) that by reason of the several successive amendments and mergers by which the original lease was converted into the leasehold acquired at April 28, 1915, petitioner did not own in the taxable years the property which it acquired for stock in 1908; (2) that exhaustion, if any, should be based on the value and governed by the terms of the leasehold acquired in 1915; and (3) that even if his first two contentions fail, the leasehold had no value at August, 1908, or at March 1, 1913, for invested capital or exhaustion purposes.
We find it unnecessary to pass on the correctness of the first two contentions advanced by the Commissioner for the reason that even if it should be held that the petitioner is correct in principle in claiming for invested capital purposes the cash value of the leasehold when paid in for stock in 1908, and for exhaustion purposes, the fair market value of the leasehold which it held on March 1, 1913, we should be unable to grant the relief asked by petitioner*3604 since the evidence submitted is insufficient to establish the appropriate value on either date.
At the outset it should be observed that when the original lease was acquired in 1903, no bonus or consideration other than the covenants contained therein was given for the same, and that this was likewise true with respect to the subsequent modifications, mergers or new leases obtained. In all cases the unit price of $5 per horsepower remained unchanged. No evidence was submitted to show that the rentals paid under the terms of the leases were less than would have been paid had it been necessary to negotiate new leases at the basic valuation dates claimed or that the negotiations under which the rentals were fixed were other than arm's length transactions. The record contains no evidence of sales of stock of the petitioner or of similar water-power sites and rights at or about the dates involved, nor do we have evidence as to the earnings of the petitioner and amount of horsepower developed on which the unit rental price was paid.
*138 What the petitioner relies upon as proof of value is the testimony of two of its officers and two other witnesses. Neither of the officers*3605 qualified as expert witnesses with respect to valuations of the character here in question nor did they furnish any basis for the opinions expressed that the leasehold had a value of $100,000. One of them testified that he had made no investigation as to the value of the property in question, nor did he have knowledge that an investigation had been made. The other officer who owned the leasehold prior to 1908 merely stated that in his opinion the leasehold had a value of $100,000 to him at the time he sold it. Obviously, such testimony is of little or no assistance in arriving at a fair valuation.
While the first expert witness, Logan, appeared to be fully qualified to express an opinion as to the valuations in question, it was very apparent that the character of the valuation which he had in mind was something different from the cash value of the leasehold when paid in in 1908, or the fair market price or value on March 1, 1913, as contemplated by the governing revenue act. The following statements made by him on cross-examination will illustrate the character of the valuation which he made:
Q. Now, what, in your opinion, is the definition of fair market value?
* * *
*3606 THE WITNESS: In answer to that question I would like to bring out the difference in the two definitions between fair market value and fair value. The market value of any property results from the use to which it is put, and varies with the profitableness of that use, present and prospective, actual and anticipated. That is, I believe the accepted definition of market value.
BY MR. BORDEN:
Q. Of fair market value? A. Of fair market value.Q. That is, in your opinion, the definition of fair market value?
A. Yes, sir, as distinguished from fair value, which is measured by its profitableness, present and prospective, actual and anticipated as in the other case, under fair rates.
Q. In stating your opinion of fair market value you derived that opinion so as to comply with the definition of fair market value which you have just given?
A. Yes, sir.Q. That definition which you have just given is not necessarily the price at which a willing buyer would buy and a willing seller would sell?
A. Absolutely not, as there is no relation between fair value and cost.
Q. So your opinion has entirely disregarded the question of price at which a willing buyer*3607 would buy and a willing seller would sell in a sale which was not under compulsion?
A. That is the definition, of course, for the fair market value, and I have considered that the value for any purpose, whether it is for taxation, rate purposes, or for any other purpose, must be the same and has no bearing upon the cost.
*139 Q. It is true, isn't it, your definition is somewhat analogous to a value in use, the present value in use.
A. It is.Q. So that this value in use which you have determined would practically be the same in 1903 as it would be in 1913, or any time during that interval?
A. Yes.On redirect examination this witness testified as follows:
Q. Mr. Borden has given you a definition of fair market value which he stated was that price which a willing purchaser would be willing to pay and a willing seller would be willing to accept, a sale without compulsion. I will state that just a little bit differently and say considering the definition of fair market value as follows: It is that price which a willing purchaser willing but not obligated to buy would pay to a willing seller willing but not obligated to sell; had that definition been given*3608 to you as fair market value would your answers have been just the same as to the value of the leasehold in question in August, 1908 and March 1st, 1913?
A. It would not. Q. What values would you give to that definition? A. I have not arrived at any value for that definition.Q. Is there any way you could arrive at a value following that definition, Mr. Logan, from the data in your possession and the study you have made of the water-power sites?
A. I think so. Q. How long would it take you to make that calculation? A. I would have to give it some thought.The second expert witness, Butler, testified that the factors considered by him in making the valuations were largely the same as those used by the previous witness, and on direct examination made the following statements:
Q. Mr. Butler, taking into consideration the definition of fair market value as follows: It is that price which a willing purchaser willing but not obligated to purchase is willing to pay and a willing seller willing but not obligated to sell, what in your opinion is the fair market value or fair cash value at the date of August, 1908 of this lease, more particularly described as*3609 Petitioner's Exhibits "2" and "3" which are the leases of January 12th, 1903 and June 26, 1903?
* * *
A. Why, I have not taken into consideration that definition for the value of the water right.
Q. Mr. Butler, would the value of a water right as defined be any different from any other value you might put on it?
A. The difference is this, a water right has value in my opinion because it is of a potential service to the public. If there was not a possibility of service to the public from this water right then it would not have value.
His further testimony, both on direct examination and on cross-examination, indicated that he had in mind something in the nature of an inherent potential value in use, rather than a value at which it could reasonably have been expected that the property could have *140 been sold on the market or the value at which it would have been taken in exchange for other goods or property.
In view of the character of the evidence and the lack of other evidence which might form the basis for the necessary valuations, the Board is of the opinion that the petitioner has failed to establish the cash value of the leasehold paid in for stock*3610 in 1908, or the fair market price or value of the leasehold which it owned on March 1, 1913.
Reviewed by the Board.
Judgment will be entered for the respondent.