*2175 1. During the period of Federal control the railroad properties of the petitioner were undermaintained by the Director General of Railroads. Pursuant to the contract under which such property was operated, the Director General was required to compensate the petitioner for such undermaintenance. A payment was made to petitioner for such undermaintenance which both parties agree did not represent income to petitioner. Held, that in computing the amount to be allowed as an expense of maintenance paid or incurred by the petitioner, the Commissioner correctly reduced the amount expended for maintenance by the amount which was paid petitioner for undermaintenance.
2. Materials and supplies were returned to a railroad, after the period of Federal control, which were equal in quantity, quality and relative usefulness to materials and supplies surrendered by the railroad at the beginning of Federal control. Held that the cost to petitioner of such materials and supplies received was the cost to it of those surrendered. Held, further, that the deduction allowable as an expense when such materials and supplies are expended is limited to such cost, and is not the value thereof*2176 when returned.
3. Entries made upon the books of the Director General of Railroads, which were not available to petitioner, allocating the amount of a lump-sum settlement of a claim which included numerous items among such items, held not to be admissible in evidence to show amounts paid in settlement of such items of the claim.
4. Interest and rentals are to be returned as income in the year in which they accrue when books of taxpayer are kept upon an accrual basis.
5. Deductions allowed for amortization of discount at which petitioner sold its bonds.
6. Fines paid for violation of Federal statutes held not to be ordinary and necessary expenses of business.
7. Payments made to a railroad branch of the Y.M.C.A. serving petitioner's employees, held to be an ordinary and necessary expense of its business.
8. Evidence held insufficient to establish that the March 1, 1913, value of stock was greater than the amount received in liquidation.
9. Debt held not to have been ascertained to be worthless in the taxable year.
10. Taxpayer held not entitled to deduct depreciation upon property occupied by it under lease.
*1136 The Commissioner determined a deficiency of $134,240.48 in income and profits taxes of the petitioner for 1920 and an overassessment of such taxes for 1921 of $46,923.74. The petitioner filed its petition for a redetermination of its tax liability for such years, this proceeding bearing Docket No. 26162. Upon motion of the respondent the proceeding was dismissed for lack of jurisdiction insofar as it relates to the year 1921.
The Commissioner determined a deficiency of $28,344.32 in income tax of the petitioner for 1922. The petitioner filed its petition for a redetermination of such deficiency, this proceeding bearing Docket No. 28661. Several of the issues involved arising out of the same facts, the proceedings were consolidated. The cases were submitted upon the pleadings and stipulation between the parties, supplemented by testimony with respect to several of the issues. Numerous errors were alleged in the petitions, some of which have been abandoned*2178 by *1137 the petitioner and others of which have been confessed, either in whole or in part by the respondent. The principal issues remaining for decision arise out of a settlement made between the petitioner and the Director General of Railroads of their accounts for the period during which the petitioner and its affiliated companies were under Federal control. In respect to this settlement it is contended that the Commissioner (1) in computing the taxable income for 1920 erroneously reduced deductions claimed by the petitioner and its affiliated companies for maintenance of its properties in the amount of $212,142.77, claimed by the Commissioner to represent the amount paid to petitioner by the Director General of Railroads for undermaintenance of its properties during the period of Federal control; (2) that the Commissioner, in computing the taxable income for 1920, erroneously reduced the deduction claimed for expenditures for materials and supplies used in the maintenance of petitioner's properties in the amount of $588,338.21 (the respondent now conceding that the amount so disallowed should have been $503,810.84), the Commissioner contending that the amount as reduced*2179 by him represented the cost of such materials and supplies to the petitioner; (3) that the Commissioner erroneously added to income for 1922 rental interest on completed additions and betterments in the amount of $109,082.04; and (4) that the Commissioner erroneously added to the income of the petitioner for 1922 an amount of $86,530.23, representing a repayment to petitioner of amounts expended by it during the period of Federal control for rentals.
It is also contended by petitioner that during the years 1920 and 1922 it was affiliated with St. Louis Bridge Co. and Tunnel Railroad of St. Louis and that the Commissioner erred in refusing to compute taxable income for those years upon the basis of the consolidated income and invested capital of petitioner and those companies. It is also contended that the Commissioner erred in computing taxable income for 1920 in refusing to allow as deductions fines imposed by Federal authorities in the amount of $3,083.28 and payments of $600 to a railroad branch of the Y.M.C.A. The Commissioner alleges in his answer as an affirmative defense that in computing taxable income for 1920 he erroneously allowed a deduction of $3,388.88 for amortization*2180 of a discount suffered upon the sale of bonds and charged to profit and loss prior to 1909, that he erroneously allowed as a deduction the amount of $183,833.29, representing depreciation on "Eads Bridge and approaches," and that he erroneously allowed as a deduction the amount of $18,731.70 as depreciation on "tunnels and subway," and prays that the taxable net income and the deficiency be increased accordingly.
*1138 The petitioner alleges that for the year 1922 the Commissioner erroneously refused to allow as deductions a loss of $378,912.50 sustained on account of the retirement of the stock of Interstate Car Transfer Co. and an amount of $5,090.40 as a debt of A. Leschen & Sons Rope Co. ascertained to be worthless and charged off during the year, the amount of $5,926.20 for fines imposed by Federal authorities, the amount of $720 representing amounts paid to a railroad branch of the Y.M.C.A., and the amount of $3,388.88 representing amortization of discount suffered upon the sale of its bonds. In his answer the respondent alleges by way of affirmative defense that, in computing the taxable net income for 1922, he erroneously allowed as deductions the amount of $200,000.36*2181 for depreciation of "Eads Bridge and approaches" and depreciation of $22,477.84 for "tunnels and subway."
FINDINGS OF FACT.
The petitioner is a corporation organized under and by virtue of the laws of the State of Missouri with its principal office at St. Louis, Mo. It is engaged in the business of a common carrier and its system of accounting is the accrual basis and is that prescribed by the Interstate Commerce Commission, and it is subject to the act of Congress known as the "Act Regulating Commerce and Acts Amendatory Thereof and Supplementary Thereto." During the years 1918 to 1922, inclusive, petitioner was affiliated with the St. Louis Merchants Bridge Terminal Railway Co., Wiggins Ferry Co., East St. Louis Connecting Railway Co., and St. Louis Transfer Co. The books of account of each of such affilated companies were kept upon the accrual basis during each of the years 1914 to 1922, inclusive.
The findings of fact with respect to the affiliation of the petitioner and St. Louis Bridge Co. and Tunnel Railroad of St. Louis are the same as the findings of fact made in the proceedings known as St. Louis Bridge Co., Docket Nos. 18767 and 28663, and Tunnel Railroad of St. *2182 Louis, Docket Nos. 18766 and 28662, except as such findings designate those companies as petitioners, and such findings of fact are, by reference, incorporated herein and made a part hereof as fully as if set forth herein at length.
By proclamation dated December 26, 1917, the President of the United States, acting under the powers conferred on him by the Constitution and laws of the United States, by joint resolutions of the Senate and House of Representatives, bearing dates of April 6 and December 7, 1917, respectively and particularly under the powers conferred by section (1) of the act of Congress approved August 29, 1916, entitled "An Act Making appropriations for the support of the *1139 Army for the fiscal year ending June thirtieth, nineteen hundred and seventeen, and for other purposes," took possession and assumed control at 12 o'clock, noon, December 28, 1917, of certain railroads and systems of transportation, including the railroad and transportation systems of the petitioner and of its affiliated companies named above.
On March 29, 1918, the President of the United States, acting under an act of Congress approved March 21, 1918, generally designated as, and*2183 hereinafter called "The Federal Control Act," and all other powers him thereto enabling, by proclamation, authorized the Director General of Railroads, either personally, or through such divisions, agencies or persons as he might appoint for such purpose, to agree with the carriers, or any of them, upon the amount to be paid such carriers for the assumption of control, use, maintenance and operation of such railroad and transportation systems and for the return of such properties to the carriers at the conclusion of such Federal control.
On May 19, 1919, the petitioner and its affiliated companies named above entered into such agreements with the Director General, acting for the United States. Each of said agreements was duly authorized by the respective boards of directors of the corporations therein named and by the respective stockholders of said corporations.
Such agreements recited that the Interstate Commerce Commission had certified to the President that the amount of the average annual railway operating income of the company, computed in the manner provided in section (1) of the Federal Control Act, was as follows:
| Terminal Railroad of St. Louis | $2,574,510.88 |
| St. Louis Merchants Bridge Terminal Railway Co | 412,427.56 |
| Wiggins Ferry Co., and other companies | 416,675.60 |
*2184 Each of such agreements provided for the payment to the companies of said annual compensation, subject to any increase or decrease in the standard return thereafter made by the Commission as provided in such agreements.
The Interstate Commerce Commission, in determining the annual compensation due the petitioner and affiliated companies, as provided for in said agreements with petitioner and affiliated companies, allowed as a deduction from income in determining the average net railway operating income, amounts paid or accrued by said companies for taxes, and disallowed as deductions from income, in determining the average net operating income, amounts paid or accrued by said companies for rent. Prior to July 1, 1917, the petitioner and affiliated companies did not accrue on their books of accounts any amount as representing depreciation on buildings, shop machinery and tools, and signals and interlockers, but on and after July 1, 1917, *1140 the petitioner and affiliated companies did accrue on their books of accounts depreciation on buildings, shop machinery and tools, and signals and interlockers, said depreciation aggregating, for the year 1917, $135,866.16. Said*2185 classes of property are included in and classified as part of what is commonly known as "Ways and Structures," and the classification of accounts promulgated by the Interstate Commerce Commission effective July 1, 1914, does not require the accrual of depreciation on the above-mentioned classes of property. The Interstate Commerce Commission, in determining the annual compensation due to petitioner and affiliated companies as provided for in said agreements with petitioner and affiliated companies, allowed as a deduction from income, in determining the average net railway operating income, such depreciation on "Ways and Structures" as was accrued on the books of the petitioner and affiliated companies.
Section 5 of each of such agreements provided in part as follows:
SEC. 5. (a) During the period of Federal control the Director General shall, annually, as nearly as practicable, expend and charge to railway operating expenses, either in payments for labor and material or by payments into funds, such sums for the maintenance, repair, renewal, retirement, and depreciation of the property described in paragraph (a) of section 2 hereof as may be requisite in order that such property*2186 may be returned to the Companies at the end of Federal control in substantially as good repair and in substantially as complete equipment as it was on January 1, 1918; Provided, however, That the annual expenditure and charges for such purposes during the period of Federal control on such property and the fair distribution thereof over the same, or the payment into funds, of an amount equal in the aggregate (subject to the adjustments provided in paragraph (c) and to the provisions of paragraph (e) of this section) to the average annual expenditure and charges for such purposes included under the accounting rules of the Commission in railway operating expenses during the test period, less the cost of fire insurance included therein, shall be taken as a full compliance with the foregoing covenant.
(b) The Director General may expend such sums, if any, in addition to those expenses and charges under paragraph (a) of this section (subject to the adjustments provided in paragraph (c) of this section) as may be requisite for the safe operation of the property described in paragraph (a) of section 2 hereof, assuming a use similar to the use during the test period and not substantially*2187 enhancing the cost of maintenance over the normal standard of maintenance of railroads of like character and business during said period; and the amount, if any, of such excess expenditures during Federal control shall be made good by the Companies as provided in paragraph (b) of section 7 hereof.
(c) In comparing the amounts expended and charged under the provisions of paragraphs (a) and (b) of this section with the amounts expended and charged during the test period, due allowance shall be made for any difference that may exist between the cost of labor and materials and between the amount of property taken over and the average for the test period, and, as to paragraph (a), for any difference in use between that of the test period and during Federal control which in the opinion of the Commission is substantial enough to be considered, so that the result shall be, as nearly as practicable, the same relative amount, character, and durability of physical reparation.
*1141 (d) At the request of the Director General or the Company there shall be an accounting of the amounts due by or to any of the parties under paragraphs (a) and (b) of this section at the end of each year*2188 of Federal control and at the end of Federal control.
Section 7 of each of such agreements provided a fixed annual compensation to be paid to these companies for the use of their property and provided, further, that there should be deducted from such compensation "all amounts required to reimburse the United States for the cost of additions and betterments made to the property of the companies not justly chargeable to the United States, unless such matters are financed or otherwise taken care of by the companies to the satisfaction of the Director General." Section 7 further provided that upon the cost of additions and betterments and of road extensions, made to the property of the companies during Federal control, the Director General should pay the companies a reasonable rate of interest.
Section 8 of each of the agreements provided that the Director General should reimburse the companies for the amount of any loss occurring to them by reason of expenditures for additions and betterments made to their property during Federal control.
Section 9 (b) of each of such agreements provided:
At the end of Federal control the Director General shall return to the Companies all uncollected*2189 accounts received by him from them and also materials and supplies equal in quantity, quality and relative usefulness to that of the materials and supplies which he received, and to the extent that the Director General does not return such materials and supplies he shall account for the same at prices prevailing at the end of Federal control. To the extent that the Companies receive materials and supplies in excess of those delivered by them to the Director General they shall account for the same at the prices prevailing at the end of Federal control and the balance shall be adjusted in cash.
The Congress of the United States, by an act approved February 28, 1920, entitled "The Transportation Act of 1920," directed that Federal control "shall terminate at 12.01 a. m. March 1, 1920; and the President shall then relinquish control of all railroads and systems of transportation then under Federal control and shall cease the use and operation thereof." This statute further authorized the President to make settlement of all matters arising out of Federal control.
In accordance with the terms of the act of Congress dated February 28, 1920, and referred to as "The Transportation Act*2190 of 1920," the President on March 1, 1920, relinquished possession of the railroad systems of the petitioner and its affiliated companies named above and turned back to the petitioner and said companies all of the properties then comprising said systems.
*1142 Following the relinquishment and turning back of the properties under Federal control, the petitioner, the St. Louis Merchants Bridge Terminal Railroad Co., and the Wiggins Ferry Co. (on behalf of itself, East St. Louis Connecting Railway Co. and St. Louis Transfer Railway Co.) filed with the Director General various claims setting out amounts appearing upon their books as due to them by the Director General and from them to the Director General, and in addition thereto certain other amounts not on their books but claimed by them to be due from the Director General and certain other amounts not on their books but admitted by them to be due to the Director General. The claim of the petitioner, as finally presented to the Director General, was as follows:
| Due to corporation | ||
| Compensation (Annual $2,523,002.60) 26 months | $5,459,612.17 | |
| Less Advances, Loans, etc | 5,389,375.00 | |
| 70,237.17 | ||
| Rental Interest on Completed Additions and Betterments | 72,791.15 | |
| Cash on Hand, December 31, 1917 | 420,765.07 | |
| Cash subsequent to December 31, 1917 | 1,500,000.00 | |
| Agent's and Conductor's Balances, December 31, 1917 | 164,402.18 | |
| Assets, December 31, 1917, Collected | 1,814,603.38 | |
| Corporation Working Fund | 100.00 | |
| Compensation applied as Credit to A & B | 683,000.00 | |
| Total | 4,725,898.95 | |
| Due from corporation | ||
| Additions and betterments | $1,043,111.70 | |
| Liabilities, December 31, 1917, Paid | 2,593,244.28 | |
| Corporate Transactions | 1,251,980.31 | |
| Expense Prior to January 1, 1918 | 160,106.85 | |
| Revenue Prior to January 1, 1918 | 5,725.08 | |
| Unsecured Note | 300,000.00 | |
| Total | 5,354,168.22 | |
| Balance due from Corporation of Quarterly settlement accounts | $628,269.27 | |
| Other items due to corporation | ||
| Equipment retired - Normal | $1,884.30 | |
| Equipment retired - Sales | 12,984.11 | |
| Road Property Retired and Not Replaced | 27,061.86 | |
| Allocated Equipment | 2,579.73 | |
| Additional Right of Way and Increased Rental | 86,530.23 | |
| Parking space for troop trains and Red Cross Facilities | 6,340.52 | |
| Cost of replacing 14th street viaduct | 175,000.00 | |
| Stamp tax on Note covering loan from Director General | $60.00 | |
| Additions and Betterments - Section 8 claims allowed | 130,329.19 | |
| Additions and Betterments - Section 8 claims open | 163,696.35 | |
| Additions and Betterments - Section 8 claims - AFE 792 | 317,755.19 | |
| Double tracking main line - AFE 798 | 29,141.35 | |
| Total | 953,362.83 | |
| Other items due from corporation | ||
| Material and Supplies (Excess) | $550,476.29 | |
| Interest other than Rental Interest | ||
| Total | 550,476.29 | |
| Balance due to Corporation on other Items | $402,886.54 | |
| Balance due from Corporation | 225,382.73 | |
| Trusteeship accounts due from corporation | ||
| Federal Agent's and Conductor's Balances | 78,484.67 | |
| Balance due from Corporation | 303,867.40 | |
| Depreciation obligation | ||
| Equipment | $218,456.11 | |
| Road Property | 768,364.94 | |
| 986,821.05 | ||
| Balance due | 682,953.65 | |
| Maintenance | ||
| Way and Structures - Under | 150,000.00 | |
| Net balance due to Corporation | 832,953.65 |
*2191 *1143 The claim of the St. Louis Merchants Bridge Terminal Railway Co., as finally presented to the Director General, was as follows:
| Due to corporation | ||
| Compensation | $887,541.69 | |
| Less Advances, Loans, etc., to January 17, 1922 | 750,000.00 | |
| 137,541.69 | ||
| Rental Interest on Completed A & B | 33,710.00 | |
| Cash on Hand, December 31, 1917 | 73,465.64 | |
| Agent's & Conductor's Balance, December 31, 1917 | 487,996.83 | |
| Assets, December 31, 1917 - Collected | 368,656.06 | |
| Revenue Prior to January 1, 1918 | 5,604.97 | |
| Working Fund Advances | 100.00 | |
| Compensation applied as credit to A & B | 350,000.00 | |
| Total | 1,457,075.19 | |
| Due from corporation | ||
| Additions and Betterments | $781,536.45 | |
| Liabilities, December 31, 1917 - Paid | 647,279.57 | |
| Corporate Transactions | 115,968.06 | |
| Expense Prior to January 1, 1918 | 183,438.66 | |
| Total | 1,728,222.74 | |
| Balance due from Corporation | $271,147.55 | |
| Other items due to corporation | ||
| Equipment Retired - Normal | $9,500.00 | |
| Equipment Retired - Fire Losses | 105.16 | |
| Road Property retired and not replaced - Normal | 5,569.97 | |
| Road Property retired and not replaced - Sales | 500.00 | |
| Total | 15,675.13 | |
| Other items due from Corporation | ||
| Material and Supplies | ||
| Office furniture and Fixtures purchased by D. G | ||
| Interest other than Rental Interest | $4,272.16 | |
| Total | 4,272.16 | |
| Balance due to corporation on Other Items | 11,402.97 | |
| Balance due from Corporation | 259,744.58 | |
| Trusteeship accounts | ||
| Due from Corporation: Federal Agents' & Conductors' Balances | 78,964.51 | |
| Balance due from Corporation | 338,709.09 | |
| Depreciation obligation | ||
| Equipment | $1,826.70 | |
| Road Property | 210,024.44 | |
| Total due to Corporation on Depreciation | 211,851.14 | |
| Balance due from Corporation | 126,857.95 | |
| Maintenance | ||
| Net Balance due from Corporation | $126,857.95 |
*2192 *1144 The claim of the Wiggins Ferry Co. (including East St. Louis Connecting Railway Co. and St. Louis Transfer Railway Co.) as finally presented to the Director General, was as follows:
| Due to Corporation | ||
| Compensation | $901,658.68 | |
| Less, Advances, Loans, etc | 705,000.00 | |
| 196,658.68 | ||
| Rental Interest on completed A&B | 29,925.21 | |
| Cash on hand, Dec. 31, 1917 | 85,548.68 | |
| Cash subsequent to Dec. 31, 1917 | 225,000.00 | |
| Agts. & Condtrs. Bal. Dec. 31, 1917 | 167,270.19 | |
| Assets, Dec. 31, 1917, Collected | 95,432.53 | |
| Working Fund Advances | 100.00 | |
| Compensation applied as Credit to A&B | 520,000.00 | |
| Total | 1,319,935.29 | |
| Due from corporation | ||
| Additions and Betterments | $488,073.05 | |
| Liabilities, Dec. 31, 1917, Paid | 481,546.78 | |
| Corporate Transactions | 87,915.54 | |
| Expense Prior to Jan. 1, 1918 | 91,705.93 | |
| Revenue Prior to Jan. 1, 1918 | 5,115.53 | |
| Total | 1,154,356.83 | |
| Balance due to Corporation | $165,578.46 | |
| Other items due to corporation | ||
| Equipment Retired (Normal) | $702.58 | |
| Road Property Retired & Not Replaced (Normal) | 3,620.04 | |
| Road Property Retired & Not Replaced - Fire Loss | 124.00 | |
| Interest other than rental interest | 36,126.76 | |
| Total | 40,573.38 | |
| Balance due to Corporation on Other Items | 40,573.38 | |
| Balance due to Corporation | 206,151.84 | |
| Trusteeship accounts due from corporation | ||
| Federal A&C Balances | 8,269.33 | |
| Balance due to Corporation | 197,882.51 | |
| Depreciation obligation | ||
| Equipment | $21,987.82 | |
| Road Property | 5,776.31 | |
| Total | 27,764.13 | |
| Maintenance | ||
| Net amount of claim | ||
| Balance due to Corporation | 225,646.64 |
*2193 *1145 On January 20, 1922, representatives of the petitioner conferred with representatives of the Director General (hereinafter sometimes referred to as the Railroad Administration) with respect to the *1146 claims of the petitioner and its affiliated companies. The principal items in dispute were those shown on the claim of the petitioner as due to it as follows:
| Cost of replacing 14th Street viaduct | $175,000.00 |
| Additions and Betterments - section 8 claims | 163,696.35 |
| Additions and Betterments - section 8 claims | 317,755.19 |
| Depreciation obligation | 986,821.05 |
| Ways and Structures, undermaintenance | 150,000.00 |
Shortly prior to the termination of the period of Federal control, the 14th Street viaduct in the city of St. Louis, which passed over the yard of the petitioner, had been damaged by a train to such an extent that it could not be used. This viaduct was old, and the city insisted that it should not be repaired but should be replaced by a larger and more modern structure. It was the contention of the petitioner that the city could require petitioner to erect such a new bridge to carry the city traffic over its yards. It further claimed*2194 that except for the accident to the old bridge the city would not have required the erection of a new one and upon that basis it claimed that it was entitled to be reimbursed for the estimated cost of the new structure. The Railroad Administration claimed that it was liable only to repair the damage to the old bridge.
Petitioner also claimed that the Director General of Railroads had made certain additions and betterments to its road for which it had been charged but which were of no value to it or, at least, of less value than their cost. Among these was the Wiggins Yard No. 2, constructed at a cost of $317,755.19. Plans for such a yard had been prepared before the period of Federal control, submitted to the directors of petitioner and rejected by them as an unnecessary facility. The yard was constructed by the Railroad Administration and its cost charged to petitioner. Petitioner claimed that this yard added nothing to its facilities, was unnecessary, and that it should not be charged with its cost. After the period of Federal control, petitioner continued to use such yard, carried it on its books of account at the cost shown above and claimed depreciation upon such cost. *2195 The claim of $163,696.35 was based upon a similar contention with respect to other expenditures for additions to petitioner's facilities. These claims were disputed by the Railroad Administration.
The petitioner and the Railroad Administration were in disagreement as to the proper allowance to be made for depreciation of equipment and road properties. The petitioner also claimed that its road property had not been adequately maintained during the period of Federal control and had been returned in poorer condition than when surrendered to the Railroad Administration. This *1147 was based primarily upon the use of inferior ties in making replacements in the roadbed. The Railroad Administration claimed that the road had been heavily overmaintained and returned in better condition than it was in when taken over. The petitioner claimed that the Railroad Administration owed it upwards of $800,000; the Railroad Administration claimed that petitioner owed it $175,000 and proposed a final settlement on that basis. No agreement was reached at this conference.
On February 3, 1922, the President of the petitioner wrote the Director General of Railroads as follows:
The recent*2196 conference in Washington failed to result in a final settlement because Mr. Alvord and associates did not make a proposition that seemed fair to us and therefore I could not recommend it to the Board of Directors, the main reasons being:
1. That our contracts provided for compensation aggregating $7,248,812.54 for use of our property during Federal Control, whereas only $5,591,375.00 in cash was paid over to us, the balance being offset against expenditures for additions and betterments costing $2,312,721.00. In other words, your obligation as to rental was discharged partly with cash and partly with property, and it is with respect to the property turned over in lieu of cash that we feel equitable consideration has not been given. Without going into details as to these expenditures, it is a fact that the Board of Directors disapproved the budgets because there was no way of funding them, and they were forced to borrow from banks, on demand loans, every dollar deducted by you from our compensation for additions and betterments purposes. Similarly a great many large projects were disapproved by the Board in the belief that the new money invested would not earn its interest or*2197 produce a sufficient return. It cannot be disputed that the companies themselves, had it not been for Federal control, would not, in the exercise of sound judgment, have made many of the improvements that were undertaken and completed during the period of Federal Control over the protest of the Board of Directors.
In dealing with your staff some allowance has been made on certain of these improvements, but it is insufficient and will not nearly offset the heavy burden created by the large amount of floating debt and the resultant maintenance growing out of these improvements, which in many instances have not earned interest on the invested money. Our interest and principal payments must be met periodically out of earnings (now at a minimum on account of depressed business conditions), and as we are only allowed to earn enough for interest and up-keep, it is very evident that these companies under such restricted financial arrangements can not hope to pay cash for their additions and betterments. This restricted financing also makes it essential for these companies to predetermine that money spent in improvements will either be productive of additional revenues, or decreased operating*2198 expenses sufficient at least to earn the interest on the money.
Many of the improvements were wholly the outgrowth of Federal policies adopted without due consideration as to their usefulness and productiveness at the end of the unified period, at which time the individual owners were called upon to manage and operate their properties along policies formulated by their own Board of Directors. These properties were made the nucleus of what constituted the St. Louis-East St. Louis Terminal District, which embraced *1148 many small lines other than our own, and which was supervised by a committee of managers of outside lines who made recommendations to promote operating efficiency, that, in their judgment, would make these units an important and efficient link in the National transportation system. Their recommendations were made wholly in the interest of unified operations and many of them differ materially from the ideas and views of our management and did not fit conditions at the end of this period of operation or now. Unfortunately their recommendations did not take cognizance of the final accounting for the improvements recommended, nor did they solve the financing*2199 of them, a matter which the Board of Directors must weigh along with the desirability and usefulness of an improvement.
It is my conviction that much of the money spent during Federal control for betterments and improvements was not wisely spent for projects necessary and useful to the corporation after the Federal Control period. It is pertinent to note that after the enormous expenditures made during this period is was immediately necessary for the corporation to borrow from the Commission out of the revolving fund of $900,000.00 for vital and necessary improvements in the judgment of our Board which had not been made during the period of Federal operation. The motive power of these properties was increased by 35 engines during Federal Control but the Federal budgets did not provide a dollar for enlarging the shop facilities to adequately care for these engines, and it was vital to our future operation to immediately make an expenditure of $500,000.00 for this purpose. Such an improvement, if recommended by the Federal operating officials, would have been heartily approved by the Board of Directors, but it appears it did not recommend itself to the Federal operating officers*2200 because during their use of the property the engines were new and the need for additional shop facilities was not imminent.
Conditions peculiar only to Federal control left this property with a large floating debt, including $800,000.00 equipment trust obligations, and $1,800,000.00 bank loans, diminished earnings and in poor physical condition, whereas they were taken over free of floating debt and earning sufficient revenue for all purposes. Our floating debt directly attributable to this period of operation amounts to $3,500,000.00.
2. The property was turned over with $900,000.00 invested in material and supplies and returned with $1,800,000.00 in material and supplies, a great part of which we have been unable to use and which show very heavy depreciation in value and deterioration in condition, and while we have made every effort to reduce this stock our inventory of January, 1922, indicates we still have $1,600,000.00 invested in materials and supplies; therefore the heavy overstock is a permanent drain on our resources as a large part of the excess must eventually be written off.
Finally, under these circumstances, we can not accept the proposal to pay the Administration*2201 $175,000.00 additional, as the amount you are asking us to pay could only be met through a draft on the proprietary interests, which is impossible now as all of the lines have more obligations themselves, the outgrowth of similar circumstances, than they can meet, and it would be the height of folly to call on them to share our burden. In order to close the matter I propose to wipe the slate and assume your obligation to settle with the City on the Municipal bridge claim amounting to $62,000.00, and on the 14th street viaduct claim amounting to $175,000.00, which latter is subject to further increase as the City has now decided to make the new viaduct 80 feet wide and this will increase the cost 33 1/3 per cent.
*1149 I do not believe it is the spirit or intent of the contract, or your desire, to discharge obligations by turning over property created during on period to take care of a unified condition that would not have been made by us had it not been for Federal Control, especially in view of the fact that a large part of it is not now being used and does not fit into our operating policies and is therefore not earning the interest on the investment. I am of the opinion*2202 that our contracts give you sufficient latitude and discretion to make, with respect to these improvements and the other conditions mentioned above, sufficient allowance over and above that already granted by your staff to enable you in fairness and justice to the Government and to ourselves to accept my proposition and close the whole matter.
In April, 1922, the officers of the petitioner were invited to come to Washington again and April 27th was set for further hearing. In the meantime field agents, accountants and engineers of the Government had continued their investigation of the claims of the petitioner and its affiliated companies. At this second conference petitioner and the representatives of the Director General each made substantially the same contentions advanced at the first conference and no settlement was arrived at.
Following this conference and on the following day representatives of the petitioner called upon the Director General personally. The president of petitioner repeated the proposition set forth in his letter of February 3, 1922, quoted above, which was accepted by the Director General. It was agreed that the office of the Director General should*2203 prepare the necessary papers evidencing the final settlement. Shortly thereafter, petitioner received from the office of the Director General three proposed forms of final settlement. The first of these, between the Director General and the petitioner, recited payment to the petitioner of $60,000 in settlement of its claims against the Government; another, between the Director General and the Wiggins Ferry Co., East St. Louis Connecting Railway Co., and St. Louis Transfer Railway Co., recited the payment to these companies of $145,000 in settlement of their claims against the Director General; and another, between the Director General and the St. Louis Merchants Bridge Terminal Railway Co., recited the payment by that company to the Director General of $205,000 in settlement of the claims made against it by the Director General. The president of the petitioner and its general counsel both protested to the Director General that these proposed forms of agreement were not in accordance with the settlement arrived at whereby all claims were to be withdrawn by both parties. They were advised that the procedure adopted by the Director General was a matter of accounting and necessary*2204 to permit him to close his books. The proposed forms of final settlement were accompanied by checks to the order of the petitioner for $60,000 and the Wiggins Ferry Co. and *1150 associated companies for $145,000. The petitioner and its affiliated companies executed the final settlements in the form proposed by the Director General and delivered them to him. The two checks of the Director General for $60,000 and $145,000 were endorsed to the order of St. Louis Merchants Bridge Terminal Railway Co., and by that company to the order of the Director General and returned to him with said settlement agreements.
The respondent, in his determination of the income of the petitioner for the year 1920, has disallowed as a claimed deduction from income the amount of $588,336.21 as representing the excess amount over cost to it of materials and supplies consumed in the operation of the business of the petitioner during the year 1920 and charged as an expense. It is admitted by the respondent that an error was made by him in the computation of the amount which was considered should be disallowed as a deduction in the amount of $84,527.37, which would result in the amount which should*2205 have been disallowed of $503,810.84.
The cost to the petitioner of materials and supplies delivered to the Director General on January 1, 1918, was $876,511.65 and the cost to the Wiggins Ferry Co. of the materials and supplies which were delivered to the Director General of Railroads on or about January 1, 1918, was $47,397.05, the sum of which, $923,908.70, was charged on the books of said companies to the Director General of Railroads as the cost of said materials and supplies.
In compliance with section 9 of the contracts, the Director General of Railroads returned to the petitioner, on or about March 1, 1920, materials and supplies which he deemed to be equal in quantity, quality and relative usefulness to that of the materials and supplies which he received from said petitioner and the Wiggins Ferry Co. on or about January 1, 1918.
In addition to said materials and supplies referred to in the preceding paragraph, the Director General of Railroads delivered to the petitioner, on or about March 1, 1920, units of materials and supplies in excess of those delivered on or about January 1, 1918. The petitioner prepared an inventory of such excess materials and included the*2206 amount thereof in its claim against the Director General as an item in favor of the Director General in the amount of $550,476.29. In arriving at the said sum of $550,476.29, the petitioner valued the excess inventory of materials and supplies at the prices prevailing at March 1, 1920, which produced a total of $624,050.34, which said amount was reduced by the petitioner to the sum of $550,476.20. Although the claim showed a liability for such excess materials and supplies in the amount of $550,476.29, determined as aforesaid, the petitioner asserted and claimed that this *1151 said amount of $550,476.29 should be reduced materially on account of alleged defects of quality and usefulness to the petitioner of said materials and supplies.
The petitioner on or about March 1, 1920, entered in its books of account the inventory of the materials and supplies received by it from the Director General of Railroads on or about March 1, 1920, at the value of $1,854,637.05. The petitioner did not at any time receive from the Director General of Railroads any materials and supplies other than those included in the said inventory of $1,854,637.05.
The petitioner used and consumed*2207 during the year 1920 materials and supplies received by it from the Director General of Railroads and charged the recorded value thereof as of March 1, 1920, to operating expenses and included the amount thereof as a deduction from gross income in reporting its taxable net income for the year 1920, said amount being $1,817,506.73.
The respondent determined that in said final settlement there had been paid or allowed to the petitioner and the St. Louis Merchants Bridge Terminal Railway Co. $193,765 and $18,377.77, respectively, or a total of $212,142.77, to reimburse these companies for expenditures necessary to overcome undermaintenance of their properties at February 29, 1920. During the period from March 1 to December 31, 1920, petitioner and the St. Louis Merchants Bridge Terminal Railway Co. expended $913,980.93 and $627,209.56, respectively, for maintenance of their properties. In determining the taxable income of petitioner and its affiliated companies, including the St. Louis Merchants Bridge Terminal Railway Co. for the year 1920, the respondent reduced the claimed deduction of operating expenses by disallowing $193,765 on account of the Terminal Railroad Association of*2208 St. Louis and $18,377.77 on account of the St. Louis Merchants Bridge Terminal Railway Co., representing part of the expenses incurred by those corporations in the maintenance of their properties.
During the years 1915 to 1922, inclusive, there was expended on the properties of the St. Louis Merchants Bridge Terminal Railway Co. as part of operating expenses, namely for "Maintenance of Ways and Structures," the following amounts:
| Year | Amount | |
| Year ended June 30, 1915 | $227,536.64 | |
| Year ended June 30, 1916 | 318,654.22 | |
| Cal. year ended December 31, 1916 | 399,877.06 | |
| Cal. year ended December 31, 1917 | 374,199.68 | |
| Cal. year ended December 31, 1918 | 489,078.31 | |
| Cal. year ended December 31, 1919 | 662,672.17 | |
| Cal. year ended December 31, 1920: | ||
| Jan. 1 to Feb. 29, 1920 | $124,652.03 | |
| Mar. 1 to Dec. 31, 1920 | 627,209.56 | |
| $751,852.67 | ||
| Cal. year ended December 31, 1921 | 566,707.20 | |
| Cal. year ended December 31, 1922 | 539,084.41 |
*1152 During the years 1915 to 1922, inclusive, there was expended on the properties of the Terminal Railroad Association of St. Louis as part of operating expenses, namely, for "Maintenance of Ways and Structures," *2209 the following amounts:
| Year | Amount | |
| Year ended June 30, 1915 | $248,133.05 | |
| Year ended June 30, 1916 | 387,622.96 | |
| Cal. year ended December 31, 1916 | 403,805.60 | |
| Cal. year ended December 31, 1917 | 725,140.61 | |
| Cal. year ended December 31, 1918 | 741,837.22 | |
| Cal. year ended December 31, 1919 | 898,095.18 | |
| December 31, 1920: | ||
| Jan. 1 to Feb. 29, 1920 | $123,186.60 | |
| Mar. 1 to Dec. 31, 1920 | 913,980.93 | |
| 1,037,167.53 | ||
| Cal. year ended December 31, 1921 | 1,028,144.33 | |
| Cal. year ended December 31, 1922 | 863,821.80 |
The petitioner, the St. Louis Merchants Bridge Terminal Railway Co. and the Wiggins Ferry Co. did not report as taxable income of any year or years any sum as representing interest on completed additions and betterments. The amount of such interest which accrued during the period of Federal control under section 7 of the contract and which was allowed under the final settlement was $109,082.04.
In determining the tax liability of the petitioner, the St. Louis Merchants Bridge Terminal Railway Co. and the Wiggins Ferry Co. for the calendar year 1922, the respondent increased the taxable income reported by the petitioner and its affiliated companies*2210 by the aforementioned sum of $109,082.04.
Such interest accrued in the years and in the amounts as follows:
| 1918 | $16,572.38 |
| 1919 | 73,369.05 |
| 1920 | 19,140.61 |
During the period of Federal control, to wit, from January 1, 1918, to February 29, 1920, the petitioner, the St. Louis Merchants Bridge Terminal Railway Co. and the Wiggins Ferry Co. paid or were required to pay rentals for the use of certain properties used by the Director General of Railroads in excess of rentals paid by the petitioner and said companies during the test period, to wit, from July 1, 1914, to June 30, 1917. The amount of excess rentals paid during the years 1918 and 1919 and the months of January and February, 1920, was $23,696.89.
*1153 During the test period, July 1, 1914, to June 30, 1917, the St. Louis Transfer Railway Co., a company which was affiliated with the petitioner, owned certain property which was used by it in the operation of its business and which property was taken over by the Director General and operated by him during the period of Federal control. On and after July 1, 1917, said property was owned by the City of St. Louis and under a lease or license from*2211 the City of St. Louis to said company it was required to pay a rental charge for the use of said property. The amount of rental paid by said company during the years 1918 and 1919, and the months of January and February, 1920, was $62,833.34.
The compensation due from the Director General of Railroads to the petitioner and said companies for the use of the properties described in the several contracts dated May 19, 1919, was a sum equal to the average net railway operating income of the test period determined by the Interestate Commerce Commission in accordance with section 1 of the Federal Control Act.
The increased rentals referred to above were paid by the petitioner and said companies during the years 1918, 1919, and 1920, and were taken as deductions from gross income of the years 1918, 1919, and 1920, the years in which paid, in reporting the taxable net income of the petitioner and said companies for said years, and such deductions were allowed by the respondent.
The St. Louis Transfer Railway Co. authorized the petitioner to file a claim in its own name and authorized the Director General of Railroads to consider the claim as that of the petitioner, for the said $62,833.34, *2212 which amount was included in and was a part of the claim filed by the petitioner with the Director General of Railroads on or about January 19, 1922, in the sum of $86,530.23, alleged to represent excess rentals paid during the years 1918 and 1919, and the months of January and February, 1920, which said amount of $86,530.23, consists of the said amounts of $23,696.89 and $62,833.34, referred to above.
The Interstate Commerce Commission, in determining the annual compensation guaranteed to petitioner and affiliated companies - which was the average net railway operating income of the petitioner and its affiliated companies during the period from July 1, 1914, to June 30, 1917, included taxes paid by the petitioner and its affiliated companies, and excluded the rent paid by the petitioner and its affiliated companies in accordance with section 1 of the Federal Control Act.
The respondent determined that the Director General of Railroads had allowed the petitioner the amount of $86,530.23 on account of excess rent paid, and in determining the taxable income of the petitioner *1154 and its affiliated companies for the year 1922 the respondent included as income the said $86,530.23.
*2213 The rentals referred to above as aggregating $23,696.89, and the rentals referred to above as aggregating $62,833.34, were paid in the years and amounts as follows:
| Year | Rentals | Total | |
| 1918 | $1,192.92 | $29,000.00 | $30,192.92 |
| 1919 | 18,711.93 | 29,000.00 | 47,711.93 |
| 1920 | 3,792.04 | 4,833.34 | 8,625.38 |
| Total | 23,696.89 | 62,833.34 | 86,530.23 |
The petitioner issued and sold certain of its general mortgage bonds prior to January 1, 1909, in connection with which the petitioner suffered a discount of $152,500, which said discount was at time of sale disposed of in the accounts of the petitioner by charging same to its profit and loss account. The details of the sale of said bonds are shown in the tabulation below:
| Date sold | Maturity of bonds | Face value of bonds | Discount |
| February 20, 1907 | Jan. 1, 1953 | $500,000 | $42,500 |
| March 1, 1908 | do | 600,000 | 54,000 |
| May 1, 1908 | do | 700,000 | 56,000 |
| Total | 1,800,000 | 152,500 |
The petitioner, in its amended return filed for the year 1920, claimed as a deduction from gross income the sum of $3,388.88, representing 1/45 of the said total discount of $152,500, which deduction was allowed by*2214 the respondent in his determination of taxable net income for the year 1920.
The petitioner claimed as a deduction from its income for the year 1922 the sum of $3,388.88, representing 1/45 of the said total discount of $152,500 suffered on said bonds, which deduction was disallowed by the respondent in his determination of petitioner's taxable income for the year 1922.
During the years 1920 and 1922, the petitioner and affiliated companies incurred penalties for violations of Federal statutes, which penalties were imposed in the United States District Court and were as shown below:
| 1920 | 1922 | |
| Violation of safety appliance acts | $121.50 | $3,415.96 |
| Violation of 28-hour livestock acts | 2,961.78 | 2,510.24 |
| Total | 3,083.28 | 5,926.20 |
*1155 Said violations were the result of negligence or inadvertence on the part of employees of the petitioner and affiliated companies. The petitioner and affiliated companies claimed as deductions from income the above-mentioned amounts in the years shown. The respondent, in determining the taxable income of the petitioner and affiliated companies for said years, disallowed said amounts claimed as deductions.
During*2215 1920 petitioner paid $600 and during 1922 it paid $720 to the East St. Louis Branch of the Young Men's Christian Association. Petitioner claimed these payments as deductions in computing its net income subject to tax. The Commissioner refused to allow such deductions. A necessary qualification for membership was that the applicant be identified with the railway service. Employees of the petitioner were members of this association. Its building was located near to the point where trains stopped to take on terminal engines and many employees had to lay over at this point. Living conditions in East St. Louis were bad in the years involved and the officers of the petitioner considered it good business to help provide a suitable place where their employees could get clean beds, good meals, reading matter and be off the streets and out of the saloons.
Upon its return of income for 1922 petitioner claimed a deduction of $378,912.70 as a loss sustained in that year by reason of the retirement of a part of the capital stock of the Interestate Car Transfer Co. This deduction was not allowed by the Commissioner.
The Interstate Car Transfer Co. was incorporated on July 20, 1896, under*2216 the laws of the State of Missouri. It was incorporated under the name of "Interstate Sand and Car Transfer Company," the name being changed to the "Interstate Car Transfer Company" on June 27, 1898. The purpose for which the Interstate Car Transfer Co. was formed is stated in article 7 of its articles of incorporation. Article 7 reads as follows:
Article VII. The objects and purposes for which this corporation is formed are to conduct and carry on the business of dredging and digging for sand and the sale of sand so dug, and for the filling and redeeming of low land, and generally for the purchase, sale and trading in sand and for the purchase, ownership and use of boats in such business, and for the transfer of cars and freight in car load lots, upon its boats on its own account or for hire, and as principal or agent, and for the conducting and carrying on of such general business in connection therewith as may be necessary, convenient or usual, and to purchase, hold, sell, convey, lease and otherwise enjoy or dispose of such real estate as may be necessary, usual or convenient to carry out the objects of this corporation as hereinbefore set forth, and finally to do any and*2217 all other things not herein enumerated which may tend to that end.
The authorized capital stock of the Interstate Car Transfer Co. at the date of incorporation was 900 shares of a par value of $100 *1156 each, the total amount authorized being $90,000. On June 27, 1898, the authorized capital stock of said company was increased to $300,000, represented by 3,000 shares, each share being of a par value of $100. On May 9, 1902, the authorized capital stock of said corporation was increased to $500,000, represented by 5,000 shares, each share being of a par value of $100. No stock was issued after May 9, 1902.
The capital stock of the Interstate Car Transfer Co. was issued on the dates, for the amounts, for the consideration, and at discount suffered on the stock sold, as shown in the following statement:
| Consideration received | ||||
| Date | Par value of stock | Cash | Property | Discount suffered on stock sold |
| July 20, 1896 | $90,000.00 | $28,000.00 | $62,000.00 | |
| June 27, 1898 | 210,000.00 | 113,615.00 | $96,385.00 | |
| May 9, 1902 | 200,000.00 | 150,000.00 | 50,000.00 | |
| Total | 500,000.00 | 291.615.00 | 62,000.00 | 146,385.00 |
The property in the amount of $62,000*2218 referred to above as having been received in part payment for the issue of stock of the par value of $90,000 on July 20, 1896, is shown in detail by a journal entry in the books of the Interstate Car Transfer Co. under date of January 31, 1922, which reads in part as follows:
James Y. Lockwood, par value $61,300.00
This stock was issued in payment for -
1 - Air Line (L.E. & St. L.C.R.R. Co. now Southern Railway Company) contract;
2 - Use of Tug Rescue for 5 years;
3 - Transfer Barge New Era;
4 - Inventor's right on Dredge Boat.
In the beginning these four items undoubtedly had a value and the propriety of capitalizing the amount at that time is seen. Now, however, none of the items have any value.
1. The so-called Air Line contract expired by limitation June 26, 1901. 2. The use of Tug Rescue for 5 years having been realized during the five year period it has no value. 3. Transfer Barge New Era according to the best information obtainable was subsequent to July 20, 1896, converted into a dredge boat, which was conveyed to the Union Sand Company at the time this, the Interstate Car Transfer Company disposed of its sand business in December, 1900. 4. Inventor's*2219 right on dredge boat, it is assumed, was also conveyed to the Union Sand Company at the time it acquired the sand business of the Interstate Car Transfer Company.
W. K. Kavanaugh, par value $700.00
This stock was issued in payment for services since April 1, 1896.
In February, 1903, petitioner acquired all of the capital stock of the Interstate Car Transfer Co., paying therefor $675,000.
*1157 The Interstate Car Transfer Co. owned and operated a ferry line connecting the Southern Railway Co.'s line on the east side of the river (through the Venice and Carondelet Belt Railway) with the Chicago, Burlington & Quincy Railroad and the St. Louis, Iron Mountain & Southern Railroad on the west side of the river. This ferry line was so located that it was not necessary to use the facilities of the Terminal Railroad Association of St. Louis in order to effect interchange of traffic between the Southern on the east side and the Chicago, Burlington & Quincy Railroad and the St. Louis, Iron Mountain & Southern Railroad on the west side. Prior to the acquisition of the Interstate Car Transfer Co.'s stock by the Terminal Railroad Association of St. Louis, the Interstate Car*2220 Transfer Co. was in competition with the Terminal Railroad Association of St. Louis.
At the time of this purchase the railways served by the Interstate Car Transfer Co., namely, the Southern Railway, the Chicago, Burlington & Quincy Railroad, and the St. Louis, Iron Mountain & Southern Railroad, all owned and maintained incline railway tracts for use in connection with this ferry service of the Interstate Car Transfer Co. and furnished and maintained locomotives serving these inclines. These railroads shipped practically all of their coal supplies, grain and other commodities via the Transfer Co.'s ferry. They commanded a large share of the traffic passing through the St. Louis gateway.
From 1903 until the present time the Terminal Railroad Association of St. Louis was a party to a contract with divers other railroad companies, including the Southern Railroad Co., the Chicago. Burlington & Quincy Railroad Co., and the St. Louis, Iron Mountain & Southern Railroad Co., wherein and whereby it was provided, among other things, as follows:
THIRD. The Terminal Association shall accept traffic offered to it at any junction, connection or incline, and shall handle and deliver the*2221 same with promptness and dispatch at the point of interchange designated by the deliverint line. The tariff of the Terminal Association shall be so regulated that there shall be no difference in the rate on trans-river traffic by reason of the fact that such traffic is handled by bridge or by ferry; and when a Proprietary Company owns or operates an incline or tracks directly connecting therewith, the tariff shall be divided upon an equitable basis between the Terminal Association and the Proprietary Company or Companies furnishing such property or service. * * *
About 1914 inprovements were made by the East Side Levee and Sanitary District on the Illinois side of the district. A levee was constructed, which took a number of years to build. During the construction of this levee ferry service was suspended. The work of building this levee was delayed by litigation as well. This levee was finally completed in 1921. During this time and on account of the *1158 construction of this levee the Transfer Co.'s tariffs for transriver service were inoperative. In 1915, on account of the construction of this levee, the Interstate Car Transfer Co. published a tariff discontinuing*2222 this service temporarily. During all of this time the Interstate Car Transfer Co. remained ready to resume service, by the hire of equipment, when the levee was completed, the Interstate Car Transfer Co. having disposed of all of its own equipment in 1920 and prior years. During 1921 an officer of petitioner discovered, on a personal inspection trip, that the Southern Railway Co. had dismantled the incline and taken up several miles of track leading to it. Prior to 1922 the Chicago, Burlington & Quincy Railway and the St. Louis, Iron Mountain & Southern Railroad had indicated that they did not desire this service any more.
In 1922 appropriate action was taken to reduce the capital stock of the Interstate Car Transfer Co. from $500,000 par value to $5,000 par value.
Under date of January 13, 1922, the State of Missouri, through its secretary, decreased the capital stock of the Interstate Car Transfer Co. and certified that the amount of capital stock of said company was then $5,000.
Stock of the Interstate Car Transfer Co. of the par value of $495,000, or 4,950 shares of a par value of $100 each, was acquired or redeemed and canceled, said stock having been acquired by the*2223 Interstate Car Transfer Co. from the Terminal Railroad Association of St. Louis during the month of January, 1922, for which it gave to the Terminal Railroad Association of St. Louis the sum of $366.67 in cash, and assigned to said Terminal Railroad Association of St. Louis an account due to it from the Wiggins Ferry Co., amounting to $15,000, and canceled an account due to it from the Terminal Railroad Association of St. Louis in the amount of $293,705.
In accordance with its by-laws, the Interstate Car Transfer Co. has held a regular stockholders' annual meeting in January of each year from 1922 to 1929, inclusive.
The State of Missouri has assessed against the said Interstate Car Transfer Co. regularly each year from 1922 to 1928, inclusive, an annual franchise tax which has been paid by the Terminal Railroad Association of St. Louis, its sole stockholder, and the annual return of the Interstate Car Transfer Co. has been filed with the State of Missouri for the year 1929, for which year the tax became due May 1, 1929. The Interstate Car Transfer Co. has not been assessed any tax other than the state franchise tax, for any of the years 1922 to 1929, inclusive.
In 1908 the*2224 General Railroad Association constructed a side track for A. Leschen & Sons Co., at a cost of $4,899.99. Subsequent to that time it made a small amount of repairs on this track amounting *1159 to $4.95. Bills for such amounts and also for semiannual rental payments of $30.90 were rendered by petitioner to A. Leschen & Sons Co., the last of such rental bills which are here in controversy covering the period of six months ended November 1, 1911. A. Leschen & Sons Co. declined to pay either the first bill or any of the succeeding bills. The collection of these accounts was referred to petitioner's legal department. When suit was threatened A. Leschen & Sons Co. came forward with a counter-claim and threatened to bring suit against petitioner claiming violation on the part of petitioner of a provision of a city ordinance requiring petitioner to perform certain switching services at the rate of $1 per car. Petitioner charged more for the switching service than the $1 rate named in the ordinance. After 1912 petitioner made no effort to collect these accounts from A. Leschen & Sons Co. until 1922. During that period petitioner paid to A. Leschen & Sons Co. such amounts as became*2225 due to that company from petitioner. In or about the year 1916 the Supreme Court of the State of Missouri decided that the city had no right to fix a rate by an ordinance. In 1921 the United States Supreme Court reached the same conclusion. Thereupon the president of the petitioner directed the collection of the amounts due from A. Leschen & Sons Co. by suit if necessary. Negotiations were entered into with the attorney for that company and an agreement was reached under which all bills were paid except those against which the statute of limitations had run. This agreement was carried out. The amount due in 1922 which had been barred by the statute of limitations was $5,090.40, which amount was written off the books of the petitioner as a debt ascertained to be worthless. The petitioner claimed such amount as a deduction in computing net income for 1922 and the Commissioner refused to allow such deduction.
The petitioner claimed as a deduction from its income for the year 1920, $183,833.29, and as a deduction from its income for 1922, $200,000.36, representing alleged depreciation on "Eads Bridge and Approaches," and claimed as a deduction from its income for the year 1920, *2226 $18,731.70, and as a deduction from its income for 1922, $22,477.84, representing alleged depreciation on "Tunnels and Subways," which property was used and operated by it under an assignment of an instrument termed a lease, the terms of which are set out in the findings of fact which are incorporated above by reference to the proceeding known as St. Louis Bridge Co. v. Commissioner.
The only rights which the petitioner had in the said "Eads Bridge and Approaches" and the said "Tunnels and Subways" are derived from the said assignment and the said instrument called a *1160 lease. The said "Eads Bridge and Approaches" and the "Tunnels and Subways" were not paid for or any liability therefor assumed by the petitioner other than as expressed in said instruments. The petitioner has at all times complied with the terms of said lease and assignment. The various expenditures made by the petitioner in the payment of interest, dividends, expenses, repairs, renewals, taxes, et cetera, as provided by the lease, were deducted by the petitioner from its income for the years 1920 and 1922 as expenses, and said deductions have been allowed by the Commissioner in determining the*2227 petitioner's taxable income for the years 1920 and 1922.
The amount claimed by the petitioner as representing alleged depreciation of $183,833.29 on "Eads Bridge and Approaches" for the year 1920, and the amount claimed by the petitioner as representing alleged depreciation of $18,731.70 on "Tunnels and Subways" for the year 1920, were allowed by the Commissioner in determining the petitioner's taxable income for the year 1920 which was used by him as a basis for determining the deficiency from which this appeal was taken.
The amount claimed by the petitioner as representing alleged depreciation of $200,000.36 on "Eade Bridge and Approaches" for the year 1922, and the amount claimed by the petitioner as representing alleged depreciation of $22,477.84 on "Tunnels and Subways" for the year 1922, were allowed by the Commissioner in determining the petitioner's taxable income for the year 1922, which was used by him as a basis for determining the deficiency from which this appeal was taken.
OPINION.
PHILLIPS: The petitions raise numerous issues. The parties have filed a stipulation by which much of the evidence is introduced into the record. In this stipulation petitioner*2228 abandons several of the errors assigned and the respondent confesses error, in whole or in part, as to others. Proper adjustment may be made upon recomputation of the deficiency under Rule 50.
It is urged by petitioner that during the years here involved it was affiliated with the St. Louis Bridge Co. and the Tunnel Railroad of St. Louis. This issue was before the Board in St. Louis Bridge Co. v.. By agreement of the parties the record made upon the hearing of those cases was incorporated by reference into the record in the hearing of the present proceedings. The findings of fact made in that report are incorporated by reference in our findings of fact above. Upon authority of that decision the claim of affiliation is denied.
*1161 We come next to consider the questions which arise out of the settlement made with the Director General of Railroads for the period of Federal control. Pursuant to law, the President of the United States, acting through the Director General of Railroads, took possession and assumed control of the railroads and transportation systems*2229 of the petitioner and its affiliated companies on December 28, 1917. On May 19, 1919, contracts were entered into which provided for the compensation to be paid these railroads and which contained other provisions to which we will have occasion to refer hereafter. On March 1, 1920, the railroad properties were surrendered and turned back to their owners. Thereafter negotiations were entered upon to settle the accounts between petitioner and its affiliated companies and the Director General of Railroads. Each claimed that upon such settlement the other was indebted. The nature of several items of the claims was such that there could be no exact measurement. The negotiations terminated in an understanding that each should waive any claim upon the other. The Director General was to prepare formal agreements. When these were forwarded to petitioner and its affiliated companies, it was found that they provided for payments of $60,000 to petitioner and $145,000 to the Wiggins Ferry Co. and other corporations affiliated with the petitioner and the payment by St. Louis Merchants Bridge Terminal Railway Co. to the Director General of $205,000. The petitioner, through its president*2230 and its counsel, objected to this form of settlement. They were informed by the Director General that this was a matter of bookkeeping done for the purpose of clearing the books. The two checks from the Director General which accompanied the proposed settlement agreements were endorsed by the payees to the order of the St. Louis Merchants Bridge and Terminal Railway Co. and by that company to the Director General of Railroads. The final settlement agreements were executed by the companies and the Director General and the matter closed.
The settlement which was reached between these parties involved the consideration of the several claims going to make up the total. Some of these claims affected the computation of the income of the railroad and others affected only capital accounts. For example, the railroads admittedly owed substantial sums because of additions made to their property during Federal control, for which they were liable but had not paid. On the other hand, the railroads claimed that large amounts had been expended for additions which were of no benefit to them and which should be paid for by the Director General under section 8 of the contracts. Neither of such*2231 claims affected the computation of income for the year. There were other claims which affected income but concerning which there is *1162 no dispute between the parties to the present proceeding. Other items of the claims which were in dispute in the negotiations affect the computation of the income of petitioner and its affiliated companies, and it is with these items that we are now primarily concerned. These include the items referred to as undermaintenance, materials and supplies, interest on completed additions and betterments, and additional rentals.
The contracts between the Director General and the companies provided in paragraph 5 thereof that the Director General should expend such amounts as were requisite in order that the properties might be returned to the companies in substantially as good repair and substantially as complete equipment as when taken over. If excessive expenditures were made, such excess was to be made good by the companies. If, on the other hand, the properties were not kept in as good repair and as complete equipment as when taken over, the railroads would have a claim for undermaintenance.
The petitioner claimed that its properties*2232 were undermaintained to the extent of $150,000. Its subsidiaries made no such claim. The Commissioner determined that in the final settlement the petitioner and one of its subsidiaries were allowed $212,142.77 as undermaintenance. During 1920 these companies expended amounts greatly in excess of $212,142.77 for maintenance of their properties. In determining the amount which these companies were entitled to deduct as expenses of maintenance the Commissioner reduced the amount expended by the amount which he claimed was paid for undermaintenance by the Director General.
The petitioner's first position is that the amounts expended for maintenance should not be decreased by any payment or allowance made by the Director General for undermaintenance; if this be declared indefensible, his secondary defense is that no such allowance was made.
It may be conceded that whatever payment or allowance was made to the petitioner for undermaintenance does not constitute income to it; it represents no more than a return to it of its original capital investment. There may be exceptions where such a payment might represent the donversion of an asset into a greater amount of cash than such*2233 asset cost, and, consequently, a resulting taxable gain, but there is nothing in the record that would indicate such a situation in this case, nor does either party so contend. Both are satisfied to take the position that the payment or allowance did not represent gain or taxable income. The position of the Commissioner may be simply stated. When the properties were returned on March 1, 1920, they were undermaintained; during the balance of that year over $1,000,000 was expended for maintenance; a part of this represented *1163 expenditures made to overcome the undermaintenance of the period of Federal control and to restore the properties to their normal condition and a part represented normal maintenance; to the extent that expenditures were made to overcome the undermaintenance of the period of Federal control and were paid for by the Director General of Railroads, they do not represent an ordinary and necessary expense of its business, incurred and paid by petitioner, which is deductible in computing its net income subject to tax, but rather an expense paid by the Director General. In other words, the payment claimed may have been made in the first instance by the petitioner*2234 but petitioner was later reimbursed for such expense, so that in effect the expenses for maintenance, to the extent of such reimbursement, were not expenses incurred by it. Upon this basis the Commissioner has reduced the amount expended by petitioner during the year 1920 for maintenance by the amount which he asserts was later paid petitioner to recompense it for a part of such expenditure.
We are of the opinion that the Commissioner must prevail in his contention. The statute (sec. 214, Revenue Act of 1918) provides that in computing net income of a taxpayer there shall be allowed as deductions all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. We do not understand that this would permit the deduction of expenses paid or incurred by the taxpayer for which he is reimbursed. In such a case the expenses are not his, nor are they paid or incurred by him within the meaning of the statute. The taxpayer is allowed the expenses of its business borne by it and is taxed only upon its net income after its expenses have been deducted.
There is no difference in substance between a situation where the property had been*2235 properly maintained by the lessee and one where, having been undermaintained by the lessee, such undermaintenance is overcome by the lessor at the expense of the lessee. If the Director General of Railroads had expended the amount here in question and had thereby been enabled to return the properties to the petitioner free of any undermaintenance, there would be no claim that petitioner might deduct the amount so expended. Instead, the property is returned to the lessor in a condition of undermaintenance, brought into condition by such lessor and the cost thereof paid by the lessee.
It might be pointed out that a payment made to indemnify the owner for undermaintenance of property may well stand upon a different footing from a payment made for failure to return the property or a specific part of the property taken. See , where it was held income resulted where materials and supplies taken over by the Director General and not returned were paid for at an amount in excess of *1164 cost. In the latter case there is a receipt of cash for property which amounts to a sale or other disposition of such property, *2236 which we do not understand to be the case where, as here, the property taken was returned but in poorer condition than when taken; where, for example, hardwood ties in the roadbed had been replaced by ties with a shorter life, or the lessee had failed to replace ties which had passed their useful life. These are incidents of maintenance of the roadbed, not a sale of a part of the roadbed. Where, as here, the lessor proceeds upon the return of its property to restore it to its previous condition, it is our opinion that amounts received from the lessee as indemnity for failure to keep the property in condition may properly be offset against the amount expended in determining the amount of such expenditures which are deductible in computing net income subject to taxation.
The petitioner takes the position that undermaintenance was not made good in 1920 and that any payment or credit made or allowed in the final settlement for that purpose should be allocated over other years. The only evidence we have on this point are schedules showing amounts expended in the various years. There is nothing to indicate how prices of labor and materials varied in these different years, or other*2237 information which would permit dollars to be stated in terms of physical maintenance. Such tabulations of expenditures are insufficient to overcome the presumption that the determination made by the Commissioner is correct or to permit an allocation of the expenditures made to overcome undermaintenance.
Petitioner's alternative contention is that the Commissioner erred in his determination that the amount paid or allowed for undermaintenance in the final settlement between petitioner and its subsidiaries and the Director General was $212,142.77. Involved in this is the competency, materiality and relevancy of the entries made upon the books of the Director General purporting to show an itemization of the final settlement by the allocation of amounts to each of the items making up the claims of petitioner and its affiliated companies. The parties have stipulated the entries made on those accounts, but the petitioner in such stipulation reserved his objections thereto which he renewed at the hearing. We need not repeat here the details of the negotiations which took place which will be found stated in the findings, and which led to a lump-sum settlement of the claims. The evidence*2238 shows that after an agreement had been reached between petitioner and its subsidiaries and the Director General for the settlement of their claims by each party withdrawing its demands on the other, officers of the petitioner requested information of the allocation made on the books of the Director General. Such information was refused. At no time until after this controversy *1165 arose was such information available to petitioner. The respondent now seeks to use such entries as evidence to establish the proper allocation of the settlement.
The entries in question were made after the settlement had been agreed upon. Except as to the amounts paid, concerning which there is no dispute, such entries do not record or evidence any fact or any transaction. They represent no more than the opinion of some unknown person of the proper allocation of a lump-sum settlement. There is nothing to indicate what influences caused the allocation of particular amounts to particular items of the claim. Indeed, it is difficult to conceive of the necessity for such an allocation of what was admittedly a lump-sum settlement. While books and records which record facts and transactions had*2239 by Government officers may be competent to prove such facts and transactions, as respondent contends, the entries here in question could not come under any such rule. The objections of the petitioner to the admission of such entries as evidence is sustained. See .
It is the contention of the petitioner that in the allocation of the settlement, insufficient amounts have been attributed by the Commissioner to such capital items as the cost of replacing the 14th Street viaduct, and the claim under section 8 of the contract arising out of the construction of Wiggins Yard and that excessive amounts have been attributed to items of undermaintenance and materials and supplies. The evidence submitted to us indicates that the claim of the petitioner for undermaintenance of its properties rested upon a much better basis than its claims with respect to such capital items. While these latter claims were not without merit, we believe that the evidence fails to establish that any error was committed in preferring the claim for undermaintenance over such other claims. It might be pointed out at this point that as the result of our decision*2240 set out below with respect to the proper amount of the settlement to be allocated to undermaintenance and materials and supplies, approximately $223,000 is made available for allocation to such capital items.
In his allocation of the items of the settlement the Commissioner has gone further than preferring the claim for undermaintenance over the capital items in dispute. The amount claimed by petitioner for undermaintenance was $150,000 and no such claim was made by its subsidiaries. Despite the facts that the Director General had taken and maintained throughout the negotiation the position that the properties were heavily overmaintained and had settled with the petitioner for an amount substantially less than that claimed by the petitioner, the Commissioner determined that the Director General allowed for this item $62,142.77 more than the amount claimed. In our opinion this action finds no support in the record. In view of *1166 the positions taken by the parties to the settlement and the final result reached, we are of the opinion that there can not be attributed to undermaintenance any greater amount than the amount claimed by the petitioner. The amount allowed as*2241 a deduction for maintenance in computing income for 1920 should be increased accordingly.
We come next to consider the issue arising under section 9(b) of the agreement which reads:
At the end of Federal control the Director General shall return to the Companies all uncollected accounts received by him from them and also materials and supplies equal in quantity, quality and relative usefulness to that of the materials and supplies which he received, and to the extent that the Director General does not return such materials and supplies he shall account for the same at prices prevailing at the end of Federal control. To the extent that the Companies receive materials and supplies in excess of those delivered by them to the Director General they shall account for the same at the Prices prevailing at the end of Federal control and the balance shall be adjusted in cash.
The Director General received from petitioner materials and supplies which had cost $876,511.65 and from the Wiggins Ferry Co. he received materials and supplies which had cost $47,397.04, a total of $923,908.70. At the end of the period of Federal control there were returned to the petitioner materials and supplies*2242 inventoried at $1,854,637.05. Such materials and supplies were set up on the books of the petitioner at that amount. During 1920 the petitioner consumed some or all of such materials and supplies and charged the value thereof to operating expenses. It deducted on its return of net income for 1920, $1,817,506.73 for materials and supplies used or consumed in that year. The Commissioner determined that although materials and supplies having an inventory value of $1,817,506.73 had been expended during the year, that figure did not represent the cost of such materials and supplies to the petitioner. He recomputed such cost on a basis which we understand to be as follows: The materials and supplies turned over to the Director General cost petitioner $876,511.65; at the end of Federal control there were returned to petitioner "materials and supplies equal in quantity, quality, and relative usefulness" to those surrendered and an excess of materials and supplies, which were paid for by petitioner in the amount, as contended by Commissioner, of $389,787.19, all of which materials and supplies were inventoried by petitioner and entered upon its books in the amount of $1,854,637.05; the*2243 Commissioner therefore claims that the materials and supplies which were put upon the accounts of petitioner at $1,854,637.05 cost the petitioner only $1,266,298.84; since the deduction claimed by petitioner for materials and supplies consumed during the year was based upon inventory value as entered upon its books, and since such inventory value exceeded the cost by $588,338.21 and since the *1167 Commissioner was of the opinion that only the cost of such materials and supplies could be deducted, he reduced the amount allowed as a deduction by $588,338.21. It is conceded by the respondent that by reason of certain error in the computation, the amount disallowed should have been $503,810.84. This concession does not, however, affect the principle involved, for upon the authority of our decision in , the petitioner contends that "the excess in money value of such materials and supplies is not subject to taxation." The sole question involved in that proceeding, so far as materials and supplies were concerned, was, as there stated, "whether the difference between the value of materials and supplies turned over to*2244 the Director General of Railroads on December 31, 1917, and the value of such materials and supplies turned back by him on February 20, 1920, is income to petitioner in 1920." There the Commissioner sought to tax such difference in value as a part of the gross income of the petitioner. Here there is no such attempt. Here the Commissioner contends that in determining the deduction to which petitioner is entitled for expenditures of materials and supplies, cost must be considered instead of the increased value at which such materials are turned back. While the result in the present case is substantially the same as it would have been had the Commissioner included such increased value as income, this is only so because it has been assumed (and the record does not establish that such assumption is incorrect) that all materials and supplies received in 1920 to replace those turned over in 1917 were expended in 1920. If we could assume that no part of the materials or supplies so received was used in 1920, or that only a fixed percentage was used in that year, the computation of the cost of the materials and supplies consumed during the year would have to be adjusted accordingly. The*2245 distinctions between the two positions taken in these two cases are not merely distinctions in theory, but are such as to lead to very different results in many cases. If the increase in value is income as the Commissioner contended in , it affects the taxes of only one year. But if it affects the deductions allowable, this increase in value affects the years in which the materials and supplies are consumed and is to be spread over such years in proportion to such consumption. We are of the opinion that the question now presented is entirely different from that presented in the case cited and is not controlled by the decision there reached. We are further of the opinion that the principle adopted by the Commissioner in allowing as a deduction only the cost to petitioner of materials and supplies used is sound. Cf. , *1168 and , where deductions were confined to actual losses.
With reference to this item the petitioner further contends that the Commissioner has erroneously computed the cost of its materials*2246 and supplies. Its contention is that upon the settlement with the Director General it paid $550,476.29 for materials and supplies while the Commissioner fixed the amount paid at $389,787.19. In the claim filed by petitioner with the Director General it admitted that it owed the Director General $550,476.29 for excess materials and supplies. The basis of the settlement lends no support to the theory that petitioner paid or was charged less for these materials and supplies than it admitted was due from it to the Director General. We are of opinion that the cost thereof should be increased accordingly.
During the years 1918, 1919, and 1920 there accrued to petitioner and its subsidiaries, under section 7 of the agreements with the Director General, interest on amounts expended for additions and betterments in the amount of $109,082.04. Upon the final settlement this was one of the items paid or credited to petitioner and concerning which there was no disagreement. It represents no more than a mathematical computation of interest on amounts expended for capital additions. The Commissioner treated the whole of such amount as income for 1922. At the time this proceeding was heard, *2247 the Board had promulgated its decision in , and , wherein the Board held that such interest was income in the years in which it accrued. In recognition of these decisions, it was stipulated that should the Board find that the interest should be accrued, it should also find that the income for 1920, as determined by the Commissioner should be increased by $19,140.61. The income for 1920 should be so increased and the income for 1922, as determined by the Commissioner should be reduced by $109,082.04 on account of this item.
There is a somewhat similar situation with respect to rentals. The fixed compensation to be paid petitioner for its properties was based upon operating revenues over a test period, July 1, 1914, to June 30, 1917. There were provisions for adjustments in certain cases. During the period of Federal control petitioner was the lessee of certain property for which it paid greater rent than was paid during the test period. This excess rental it was entitled to receive back from the Director General. *2248 The petitioner paid such excess rental and deducted such payments on its returns for 1918, 1919, and 1920. Such deductions were allowed by the Commissioner. Under the accrual system of accounting petitioner should also have accrued an equal amount as income in those years, being a part of the *1169 rent to be paid it. The income of the petitioner and its affiliated companies for 1922, as determined by the Commissioner, should be reduced by the amount included therein on account of such rentals, $86,530.23, and the income for 1920 increased by the amount which accrued in those years, $8,625.38.
During each of the taxable years involved petitioner claimed $3,388.88 as a deduction for the amortization of the discount at which it had sold its bonds in 1907. The Commissioner allowed the deduction in 1920 but now alleges that he committed error in doing so. He refused to allow the deduction in 1922, and this petitioner alleges was error. This same question was before us in *2249 , where we held that such a deduction is allowable where books are kept upon an accrual basis. The deductions claimed should be allowed this petitioner.
The act of the Commissioner in refusing to allow as deductions amounts paid as fines for violation of Federal statutes is approved upon authority of . and Chicago, Rock, island & .
Petitioner claims the right to deduct payments made to the East St. Louis Branch of the railroad Y.M.C.A. The Commissioner disallowed the deduction on the ground that charitable and like contributions are not allowed as deductions to corporations. The Board has repeatedly held that charitable contributions may not be deducted as such by a corporation. But there are certain circumstances where such payments may be more properly classified as ordinary and necessary expenses of the business. Where it is established that a direct benefit and convenience results to the business, the Board has held that deduction may be allowed as a business expense. *2250 , and cases there cited. Such is the case here and the deduction should be allowed.
Petitioner claims that it sustained a loss in 1922 upon the retirement of a part of the capital stock of the Interest Car Transfer Co. It appears that in 1903 the petitioner acquired all of the capital stock of that company, consisting of 5,000 shares of the par value of $100 per share, at a cost to it of $674,000. In 1922 the capital stock of the transfer company was reduced to $5,000 par value, and $495,000 par value of the stock held by petitioner was retired. In connection with the retirement of this stock the Transfer Co. gave to the petitioner $366.67 in cash, assigned to it an account due the Transfer Co. from the Wiggins Ferry Co., a subsidiary of the petitioner, amounting to $15,000, and canceled an account due to the Transfer Co. from the petitioner in the amount of $293,705, from which we conclude that upon the retirement of this stock $309,071.67 was paid over to the petitioner.
*1170 While the cost of the stock and the amount realized on its redemption were thus satisfactorily established, this is insufficient*2251 to establish any deductible loss in the absence of proof of the March 1, 1913, value of this stock. ; ; . In the stipulation filed by the parties there appears "a comparative balance sheet drawn from the books of account of the Interstate Car Transfer Company as at June 30, 1902, March 1, 1913, and December 31, 1921," "analysis of certain balance sheet accounts as at the date shown above" (which analysis indicates that a substantial part of the so-called assets carried on the balance sheet at March 1, 1913, were either not assets or were those whose life had expired prior to March 1, 1913, or was about to expire), and a schedule which purports to show the operating gain or loss and certain other information "as disclosed by the books and records of the Interstate Car Transfer Company during the years 1902 to 1921, inclusive." This schedule purports to show gain from the operation of the Interstate Car Transfer Co. from 1902 to 1908, inclusive, and a loss from 1909 to 1914, inclusive. If such schedule is considered*2252 in connection with the other schedules in the record it indicates that the Interstate Car Transfer Co. realized little, if any, profit from its operations at any time. There also appears in the stipulation the following statement:
In stipulating the facts relative to the history of the Interstate Car Transfer Company and as to the information contained in the books and records of the Interstate Car Transfer Company, the petitioner does not concede the competency, materiality or relevancy of said history and information, but on the contrary petitioner asserts that said history and information is incompetent, immaterial and irrelevant in this proceeding.
At the time of the hearing both parties agreed that a ruling upon the objections appearing in the stipulation should properly be reserved until the Board came to consider the case upon its merits and the parties had an opportunity to file their briefs. The objection which we now have under consideration was only one of several appearing in the stipulation. Facts relative to the history of the company and as to its profits and losses in the years prior to March 1, 1913, and as to its assets on that date are undoubtedly material*2253 and relevant in this proceeding for the purpose of proving the value of the stock of the company on March 1, 1913. A bare statement that books of account show certain asset values or certain profits and losses, standing by itself without any evidence that the books were kept in the ordinary course of business or accurately reflected the assets, liabilities, profits and losses of the business can scarcely be deemed competent to prove the value of the assets or the amount of the liabilities or the gains or losses of the business. This is especially *1171 so in a case such as we have here, where other entries quoted from the books establish that such books were not kept in a manner which would accurately reflect such items. We are accordingly of the opinion that the objection to the competency of such book entries must be sustained, except where the stipulation is to the effect that the facts are as shown in such entries. The effect of the ruling is to leave the record without any proof of March 1, 1913, value. It may be pertinent to state, however, that if we could assume that the facts were accurately stated in the book entries, our conclusion would be that the stock of*2254 this company had no greater value on March 1, 1913, then was realized on its redemption.
The respondent raises two other serious questions which stand between the petitioner and the allowance of the loss claimed. It is contended that the Interstate Car Transfer Co. was a subsidiary of the petitioner, was affiliated with it, and is one of the taxpayers making a consolidated return of income with the petitioner. It is urged that in such a situation the affiliated group can not take a loss resulting from the liquidation of the stock of one of its members. ; ; ; ; . As a second defense it is urged that this company continued in existence after 1922 and continued to render returns and pay an annual state franchise tax, indicating that there must have been something of value left in the company, although its books of account disclose no assets. The petitioner continued to own exactly what it had owned before the retirement*2255 of a part of the capital stock, namely, all of the capital stock of the company. In such circumstances there may be doubt whether the retirement of a part of the capital stock gives rise to a deductible loss or serves only to reduce the cost of the remaining stock. See , and . We find it unnecessary to pass upon either of these questions.
The petitioner claims the right to deduct as a debt ascertained to be worthless and charged off in 1922 amounts which became due to it from A. Leschen & Sons Co. between 1908 and 1911. When these bills were presented to the Leschen Co., their attorney set up a demand for alleged overcharges for switching operations. The petitioner did not wish to try out this issue and its conclusion with respect to this matter is set out in the memorandum from its president to its auditor, which was submitted in evidence and which reads in part:
I think we had better hold our bills against Leschen Company in suspense, so that we can use them in the claims of this firm if they determine to press *1172 them. If we press the collection of*2256 our bills they will undoubtedly enter suit for alleged overcharges in switching, which would invite suit from a great many other industries. You are authorized to hold these bills in suspense.
In a letter under date of February 29, 1916, from the president to the auditor, with respect to this account, the president stated the facts set out above, referred to his letter of June 13, 1912, quoted above, and said:
The situation has not changed since then. If we should undertake to enforce settlement through our legal department there is no question that the Leschen Company would again bring up their claim for overcharges, and if the matter should get into the court it might induce others to file similar claims. As a matter of policy I think this account should be held in suspense, and if at any time Leschen & Sons should present their claim for overcharges we can use this to offset it. If you want to get it out of your accounts you might charge it off to profit and loss and hold it in suspense in that way. It is not probable that we will be able to collect the amount without a lawsuit, which, as stated above, is something we do not want.
The situation continued the same until*2257 1921 when the issue raised in the counterclaim of the Leschen Co. was settled by the Supreme Court, whereupon the petitioner again sought to collect from the Leschen Co. That company in 1922 paid so much of the claim for rent as was not outlawed by the statute of limitations, but continued to refuse to pay for building the switch and for those rentals which were barred from collection by the statute.
Although the greater part of the indebtedness was incurred in 1908 and the statute of limitations ran upon collection in 1918, it is urged by petitioner that the indebtedness was first ascertained to be worthless in 1922. It is quite true, as petitioner points out, that the Board has determined that the running of the statute of limitations does not establish worthlessness of an indebtedness, since the statute to be effective must be pleaded by the debtor, and it is not to be assumed that debtors will plead such a statute in all circumstances. Here, however, we have a different situation. The testimony is that the debtor had repeatedly refused to pay the debt and that petitioner had determined not to bring suit but to hold the matter in suspense and that this was the situation at*2258 the time the statute of limitations ran. We are of the opinion that such indebtedness was ascertained to be worthless and should have been charged off prior to 1922. The fact that it was not charged off until the later year does not permit of its deduction then. Avery v. Commissioner, 22 Fed.(2) 6.
In his answer the respondent alleges that he erroneously computed the taxable income of petitioner for the two years involved by allowing deductions for depreciation upon the Eads Bridge and its approaches and upon tunnels and subways operated by petitioner as lessee. Respondent asks that the net income be increased accordingly. The principles applied by the Supreme Court in , *1173 would appear to govern this case. See, also, ; ; . The taxable net income should be increased by the amounts allowed as deductions for depreciation of these assets.
Reviewed by the Board.
Decision will be entered under Rule 50.