*109 Decision will be entered under Rule 50.
Two railroad companies which owned all of petitioner's capital stock in equal shares made an agreement with petitioner in 1908 for the use of its tracks and other facilities, for which use they were to pay petitioner as rent all of the operating and maintenance expenses of petitioner based upon user by each plus an amount equal to 5 percent on petitioner's capital stock. Thereafter and until 1937 the owning companies paid as rent to petitioner their shares of operating and maintenance expenses plus $ 215,000 a year, and in each year they received as a dividend from the petitioner one-half of the $ 215,000 so paid. In 1939 the agreement of 1908 was amended, effective as of January 1, 1937, to provide that the owning companies would discontinue the payment of $ 215,000 of the rental and would waive their right to the receipt of dividends from the petitioner. Under the authority of section 45 of the applicable revenue acts, the Commissioner added to the gross income reported by the petitioner for each of the taxable years $ 215,000 plus the income taxes due thereon and determined deficiencies accordingly. Held, that the petitioner was*110 not controlled by the same interests during the taxable years and that the Commissioner is not authorized by section 45 to make an allocation of gross income of the two railroad companies; held, further, that the amended agreement did not become effective until September 27, 1939.
*558 This proceeding involves income and declared value excess profits tax deficiencies for the years 1937 to 1940, inclusive, as follows:
| Declared value | ||
| Year | Income tax | excess profits |
| tax | ||
| 1937 | $ 35,753.50 | |
| 1938 | 42,093.25 | $ 28.50 |
| 1939 | 42,215.25 | |
| 1940 | 63,833.39 | 627.52 |
The sole question in issue is whether the respondent erred in allocating to*111 petitioner a portion of the gross income of two other corporations which owned all of petitioner's capital stock in equal shares and had the use of certain of petitioner's assets.
Most of the essential facts have been stipulated.
FINDINGS OF FACT.
1. The petitioner, the Lake Erie & Pittsburg Railway Co., was incorporated under the laws of Ohio on April 30, 1903, for the purpose *559 of acquiring, building, maintaining, leasing, and operating a railroad from Lorain, Ohio, to Youngstown, Ohio. It filed its income tax returns for each of the years 1937, 1938, 1939, and 1940 on the accrual basis with the collector of internal revenue for the third district of New York.
2. The outstanding capital stock of the petitioner during the years 1937, 1938, 1939, and 1940 consisted of 43,000 shares of a par value of $ 100 each, amounting to a total par value of $ 4,300,000. During these years 21,500 shares of a par value of $ 2,150,000 were owned by the New York Central Railroad Co. and 21,500 shares of a par value of $ 2,150,000 were owned by the Pennsylvania Railroad Co.
3. An agreement dated January 10, 1908, was entered into among the Lake Shore & Michigan Southern Ry. Co., the Pennsylvania*112 Co., and the petitioner. The agreement provided in part as follows:
Seventh: The Lake Shore and the Pennsylvania will each pay to the Lake Erie, as rental for such trackage rights and use, a sum equivalent to one-half of the dividend, at the rate of five per cent. (5%) per annum, upon the amount of capital stock from time to time outstanding, and one-half of the interest upon the obligations of the Lake Erie from time to time outstanding, issued to pay the cost of the said railroad and its equipment and they shall also pay such proportion of the expense of operating and maintaining the said railroad as their car and engine mileage thereon and thereover in each year shall bear to the total car and engine mileage in that year of the Lake Shore and the Pennsylvania over the same; taxes and cost of insurance and other charges of the Lake Erie in respect of or incident to the operation or maintenance of said railroad to be included in the expense of maintenance and operation.
In determining, however, the amount to be paid by the Lake Shore and the Pennsylvania, as in this Section provided, there shall first be deducted the revenue and income of the Lake Erie from all other sources.
4. *113 The Pennsylvania Railroad Co. is the successor to the Pennsylvania Co., and the New York Central Railroad Co. is the successor by consolidation to the Lake Shore & Michigan Southern Railway Co.
5. An agreement dated September 27, 1939, was entered into among the New York Central Railroad Co., the Pennsylvania Railroad Co., and the petitioner. The agreement is as follows:
Agreement made this 27th day of September, 1939, between The New York Central Railroad Company, herein called the New York Central (successor of The Lake Shore and Michigan Southern Railway Company, herein called the Lake Shore), party of the first part, The Pennsylvania Railroad Company, herein called the Pennsylvania (successor of Pennsylvania Company), party of the second part, and The Lake Erie and Pittsburg Railway Company: herein called the Lake Erie, party of the third part:
Whereas, the Lake Shore, Pennsylvania Company and the Lake Erie did heretofore enter into an agreement dated January 10, 1908, herein called the Agreement, relating, among other things, to the construction, management, operation and use of the railroad of the Lake Erie, the election and appointment of its directors and officers, the granting*114 of trackage rights to the Lake Shore and the Pennsylvania Company and the terms and provisions in accordance with which such trackage rights were to be enjoyed; and
*560 Whereas, the parties hereto have agreed upon a modification of the provision of Paragraph Seventh of the Agreement relating to the payment of a sum equivalent to a certain dividend on the outstanding capital stock; and
Whereas, the parties hereto mutually desire to define the provision in said Paragraph Seventh of the Agreement relating to taxes;
Now, Therefore, This Agreement Witnesseth:
That the parties hereto in consideration of the premises do hereby agree to and with each other as follows:
1. That during such time as one-half of the capital stock of the Lake Erie is owned by the New York Central, its successor or nominee, and the other one-half of such stock is owned by the Pennsylvania, its successor or nominee, the New York Central and the Pennsylvania shall each be released from the payment under Paragraph Seventh of the Agreement, as rent, of a sum equivalent to one-half of the dividend at the rate of 5% per annum upon the amount of capital stock from time to time outstanding of the Lake Erie, the New*115 York Central and the Pennsylvania during such time as the capital stock of the Lake Erie is owned as aforesaid, each hereby waiving any right which it may have to participate as a stockholder of the Lake Erie in any dividend or distribution from or on account of the rental payable under Paragraph Seventh of the Agreement based upon such sum equivalent to one-half of the dividend at the rate of 5% per annum upon the amount of capital stock from time to time outstanding of the Lake Erie as aforesaid.
2. That during such time as one-half of the capital stock of the Lake Erie is owned by the New York Central, its successor or nominee, and the other one-half of such capital stock is owned by the Pennsylvania, its successor or nominee, Federal income taxes and Federal capital stock taxes of the Lake Erie shall be borne and paid by the New York Central and the Pennsylvania share and share alike; but all taxes now imposed upon the Lake Erie, other than said Federal income taxes and said Federal capital stock taxes, shall continue to be included in the expense of operating and maintaining the railroad of the Lake Erie, and shall be borne and paid by the New York Central and the Pennsylvania*116 in the manner and in the respective proportions as prescribed in said Paragraph Seventh of the Agreement in respect of the expense of operating and maintaining the railroad of the Lake Erie.
3. That this Agreement shall be effective as of January 1, 1937.
4. That as herein modified and defined the agreement of January 10, 1908, shall be and remain in full force and effect.
In Witness Whereof, the parties hereto have caused the execution of this agreement the day and year first above written.
6. On August 31, 1938, a resolution was adopted by the executive committee of the New York Central Railroad Co. authorizing the president or a vice president of the company to execute a supplemental agreement with the Pennsylvania Railroad Co. and the petitioner modifying the agreement of January 10, 1908. A resolution was adopted by the board of directors of the petitioner at a meeting held on December 28, 1938, in which the modification of paragraph seventh of the agreement dated January 10, 1908, was approved. On September 27, 1939, a resolution was adopted by the board of directors of the Pennsylvania Railroad Co. in which the execution of the agreement *561 dated September 27, 1939, *117 among the New York Central Railroad Co., the Pennsylvania Railroad Co., and the petitioner, modifying the agreement of January 10, 1908, was approved.
7. The petitioner billed and collected rent for the year 1937 under the agreement dated January 10, 1908, including the amount of $ 215,000 as rent equal to the dividend at the rate of 5 percent per annum upon the amount of the petitioner's outstanding capital stock. The petitioner paid a dividend on June 30, 1937, in the amount of $ 107,500, of which $ 53,750 was paid to the New York Central Railroad Co., and $ 53,750 was paid to the Pennsylvania Railroad Co. On January 5, 1938, the petitioner received vouchers or checks in the amount of $ 107,500, one of which was issued by the New York Central Railroad Co. in the amount of $ 53,750 and one which was issued by the Pennsylvania Railroad Co. for $ 53,750, in repayment to the petitioner of the dividends which had been paid by the petitioner on June 30, 1937.
8. The petitioner issued vouchers in the amount of $ 215,000, which were forwarded to the payees thereof on January 5, 1938, one for $ 107,500 to the New York Central Railroad Co., and one for a like sum to the Pennsylvania Railroad*118 Co. in reimbursement of the amounts which the petitioner had collected as rent for the year 1937, based upon a dividend rate of 5 percent per annum on the petitioner's outstanding capital stock. During the years 1938, 1939, and 1940 the petitioner did not make any payment of dividends and the New York Central Railroad Co. and the Pennsylvania Railroad Co. did not make any payment to the petitioner based upon a dividend rate on the petitioner's capital stock.
9. For all taxable years down to and including 1933 the petitioner reported in its income tax returns each year as rental income (together with the amount of income tax computed thereon) the amount of $ 215,000 which the petitioner received as rent equal to the dividend at the rate of 5 percent per annum upon the amount of its capital stock outstanding. For the years 1934 and 1935 the petitioner did not include such rental income in its income tax returns. The Commissioner did not concur in such action and the petitioner subsequently paid the income tax on such rental income for the years 1934 and 1935 based on the amount of $ 215,000 which the petitioner received in such years, plus the income tax computed thereon. For the*119 year 1936 the petitioner included in its income tax return the amount of $ 215,000 rental income, together with the amount of income tax computed thereon.
10. During the years 1937, 1938, 1939, and 1940 the Pennsylvania Railroad Co. and its affiliated corporations had gross income each year amounting to several million dollars and taxable net income for each of said years in excess of $ 150,000.
*562 11. During the years 1937, 1938, 1939, and 1940 the New York Central Railroad Co. and its affiliated corporations had gross income amounting each year to several million dollars, but filed returns with the Commissioner for each of such years showing net losses.
12. It is agreed that for the purpose of this proceeding the value of the assets of the petitioner during the years 1937 and 1940 is equal to the amounts of such assets as are shown in the balance sheets attached to the petitioner's income tax returns, which are as follows:
| Dec. 31, 1937 | Dec. 31, 1940 | |
| ASSETS | ||
| Cash | $ 207,975.92 | $ 95,125.41 |
| Accounts receivable | 116,600.92 | 139,164.66 |
| Special deposits | 12,706.45 | |
| Investment in road | 7,448,025.74 | 7,437,773.18 |
| Misc. physical property | 759,125.81 | 669,607.87 |
| Other investments | 9,744.89 | |
| Deferred assets | 45,999.29 | |
| Unadjusted debits | 207,317.18 | 69,684.64 |
| Total | 8,785,044.86 | 8,433,807.10 |
| LIABILITIES | ||
| Accounts payable | 301,328.04 | 85,958.01 |
| Nonnegotiable debt | 456,594.80 | 346,158.01 |
| Bonds and mortgages | 3,620,000.00 | 3,620,000.00 |
| Accrued taxes | 96,286.39 | 72,618.48 |
| Deferred liabilities | 3,123.30 | |
| Unadjusted credits | 530.00 | 1,890.00 |
| Capital stock -- common | 4,300,000.00 | 4,300,000.00 |
| Surplus -- appropriated | 7,182.33 | 7,182.33 |
| Total | 8,785,044.86 | 8,433,807.10 |
*120 The balance sheets for 1938 and 1939 show substantially the same as those for 1937 and 1940.
13. The petitioner reported no net income for each of the years 1937, 1938, 1939, and 1940. For these taxable years the petitioner reported income and deductions as follows:
| 1937 | 1938 | 1939 | 1940 | |
| INCOME | ||||
| Accrued taxes | ($ 81,198.62) | ($ 73,857.86) | ($ 71,870.21) | ($ 48,549.09) |
| Joint facility, rent | ||||
| income | 258,475.60 | 242,011.00 | 238,286.49 | 215,974.78 |
| Misc. income | 2,069.28 | 2,717.01 | 4,830.48 | 2,092.69 |
| Total | 179,346.26 | 170,870.15 | 171,246.76 | 169,518.38 |
| DEDUCTIONS | ||||
| Rent | 136.80 | 1,756.80 | 206.80 | 196.80 |
| Tax accruals | 5,565.21 | 5,421.70 | 4,897.22 | 5,561.58 |
| Interest on funded | ||||
| debt | 163,610.00 | 163,610.00 | 163,610.00 | 163,610.00 |
| Interest on unfunded | ||||
| debt | 10,034.25 | 81.65 | 2,532.74 | 150.00 |
| Total | 179,346.26 | 170,870.15 | 171,246.76 | 169,518.38 |
| Net income | None | None | None | None |
14. In order to clearly reflect the petitioner's income the Commissioner allocated gross income of the New York Central Railroad Co., and the Pennsylvania Railroad Co. to the petitioner in the following amounts: *563
| 1937 | $ 246,090 |
| 1938 | 250,475 |
| 1939 | 250,475 |
| 1940 | 266,600 |
*121 15. There was no agreement between the petitioner and its two lessees prior to September 27, 1939, modifying paragraph seventh of the agreement of January 10, 1908.
16. During the years 1937, 1938, 1939, and 1940 the Pennsylvania Railroad Co. did not own directly or indirectly any shares of the capital stock of the New York Central Railroad Co., and the New York Central Railroad Co. did not own directly or indirectly any shares of the capital stock of the Pennsylvania Railroad Co.
OPINION.
The only questions for our determination are:
(1) Whether the respondent acted within the scope of his authority in allocating any of the gross income of the New York Central and the Pennsylvania to the petitioner, and
(2) If not, whether the modification of the original agreement of January 10, 1908, dates from January 1, 1937, or from September 27, 1939, when it was formally approved.
The provisions of section 45 of the Internal Revenue Code (the same section of the Revenue Acts of 1936 and 1938) are as follows:
SEC. 45. ALLOCATION OF INCOME AND DEDUCTIONS.
In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, *122 and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Commissioner is authorized to distribute, apportion, or allocate gross income or deductions between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses.
Our first question is whether we have here "two or more organizations, trades, or businesses * * * owned or controlled directly or indirectly by the same interests" within the meaning of the statute. If not, then the respondent was without authority to make the allocation.
The statute does not define what is meant by the term "control." The Commissioner's regulations, section 19.45-1 of Regulations 103, contain the following provisions relating to the meaning and application of section 45:
Sec. 19.45-1. Determination of the taxable net income of a controlled taxpayer. -- (a) Definitions. -- When used in this section --
* * * *
(3) The term "controlled" includes any kind of control, direct or indirect, whether legally enforceable, *123 and however exercisable or exercised. It is the *564 reality of the control which is decisive, not its form or the mode of its exercise. A presumption of control arises if income or deductions have been arbitrarily shifted.
* * * *
(b) Scope and purpose. -- The purpose of section 45 is to place a controlled taxpayer on a tax parity with an uncontrolled taxpayer, by determining, according to the standard of an uncontrolled taxpayer, the true net income from the property and business of a controlled taxpayer. The interests controlling a group of controlled taxpayers are assumed to have complete power to cause each controlled taxpayer so to conduct its affairs that its transactions and accounting records truly reflect the net income from the property and business of each of the controlled taxpayers. If, however, this has not been done, and the taxable net incomes are thereby understated, the statute contemplates that the Commissioner shall intervene, and, by making such distributions, apportionments, or allocations as he may deem necessary of gross income or deductions, or of any item or element affecting net income, between or among the controlled taxpayers constituting*124 the group, shall determine the true net income of each controlled taxpayer. The standard to be applied in every case is that of an uncontrolled taxpayer dealing at arm's length with another uncontrolled taxpayer.
* * * *
(c) Application. -- Transactions between one controlled taxpayer and another will be subjected to special scrutiny to ascertain whether the common control is being used to reduce, avoid, or escape taxes. In determining the true net income of a controlled taxpayer, the Commissioner is not restricted to the case of improper accounting, to the case of a fraudulent, colorable, or sham transaction, or to the case of a device designed to reduce or avoid tax by shifting or distorting income or deductions. The authority to determine true net income extends to any case in which either by inadvertence or design the taxable net income, in whole or in part, of a controlled taxpayer, is other than it would have been had the taxpayer in the conduct of his affairs been an uncontrolled taxpayer dealing at arm's length with another uncontrolled taxpayer.
The agreement of January 10, 1908, as modified by the agreement of September 27, 1939, makes no provision for the payment*125 of dividend rental. The respondent has attempted to allocate gross income of the New York Central and Pennsylvania under section 45 of the Internal Revenue Code and prior revenue acts in order to provide a rental income for petitioner equal to a dividend at the rate of 5 percent on its capital stock. But the Commissioner is not authorized to make such an allocation except where two or more organizations, trades or businesses are owned or controlled directly or indirectly by the same interests. The question at once arises whether the petitioner and either of the lessee companies are owned by the same interests. The New York Central and the Pennsylvania are competing railroad companies. Each of them is controlled by its own stockholders. The respondent makes no contention that the stockholders of the New York Central, or any considerable number of them, are also stockholders of the Pennsylvania. The stockholders of the New York Central are not the "same interests" as the stockholders of Pennsylvania. And neither the New York Central nor the Pennsylvania has control of the petitioner. Together they do have. But that amounts to saying nothing *565 more than that the stockholders*126 of a corporation control it. We do not think that it can be said that where two or more corporations owned by different sets of stockholders control another corporation such other corporation is controlled by the same interests. Thus where two or more railroad companies own all of the capital stock of a terminal facility it can not be said that the terminal facility is owned by the same interests unless it be that the stockholders of the several railroad companies owning such capital stock are identified one with the other. Therefore we do not think that the Commissioner has authority under section 45 to allocate a part of the income of the New York Central and of the Pennsylvania to the petitioner for the purpose of giving it a taxable income.
The respondent appears to labor under the view that the New York Central and the Pennsylvania had a large investment in the petitioner corporation which was represented by its investment in the capital stock of the petitioner. He therefore assumes the right to allocate a part of the income of the two lessee railroad companies to the petitioner. We do not think that that can be done under section 45. We think it clear that if the two lessee*127 railroad companies had from the beginning operated under the agreement which was in effect from September 27, 1939, the respondent would have no ground for making an allocation of income of the two lessee railroad companies between them and the petitioner. Clearly two or more corporate stockholders owning all of the stock of a subsidiary have a right to fix the amount of the rental which the stockholders shall pay for the facilities of such corporation.
In our opinion the two lessee railroad companies and the petitioner are not owned by the same interests. The respondent's determination that they are taxable upon a fictitious income after September 27, 1939, is reversed.
The question remains as to whether the amendment made to the original agreement on September 27, 1939, was effective from January 1, 1937, as it declared it was. The petitioner submits that the amendment was under consideration by the two companies long prior to September 27, 1939, and points to the fact that the additional rental based on stock ownership was not paid to the petitioner after about the middle of 1937. It is to be observed, however, that the petitioner was on the accrual basis. Until the agreement*128 of January 10, 1908, was modified by the supplemental agreement, it was in effect. We therefore hold that the amendment to the agreement did not take effect until after it was approved by the board of directors of Pennsylvania, which was September 27, 1939.
Decision will be entered under Rule 50.
*566 Disney, J., dissenting: The majority opinion seems to me to be necessarily and essentially based upon the statement made in the opinion that "The stockholders of the New York Central are not the 'same interests' as the stockholders of Pennsylvania." I do not find a finding of fact to that effect. Since section 45 of the Internal Revenue Code authorizes the Commissioner to allocate income or deductions between corporations "owned or controlled directly or indirectly by the same interests," in the absence of a finding negativing such ownership or control, by the same interests, of petitioner corporation and the other corporations herein involved, we do not seem to me to be justified in concluding that the Commissioner erred in making the allocation. So far as the record shows -- and certainly we can not take judicial notice in this respect -- the two corporations*129 which own the petitioner may be owned or controlled by the same interests. I would sustain the Commissioner for lack of evidence. I therefore dissent.