The opinion
NORTHWESTERN IMPROVEMENT CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Northwestern Improvement Co. v. Commissioner
Docket No. 12106.
United States Board of Tax Appeals
14 B.T.A. 79 ; 1928 BTA LEXIS 3030 ;
November 8, 1928 , Promulgated
*3030 Held, that in the taxable year and period here involved the petitioner derived no income from interest on the bonds of a certain railway company owned by it and that the amounts thereof were improperly accrued by the respondent in computing the deficiencies herein.
M. L. Countryman, Jr., Esq., for the petitioner.
A. H. Murray, Esq., for the respondent.
LANSDON
*79 The respondent asserts deficiencies in income and profits taxes for the fiscal year ended June 30, 1917, and for the 6-month period ended December 31, 1917, in the respective amounts of $3,001.31 and $19,557.10. The single issue is whether certain amounts representing interest due the petitioner on bonds owned by it should be regarded as accrued income in respective years in which such interest was due even though it was not paid. At the hearing the parties filed a stipulation which, among other things, includes the following:
It is hereby stipulated and agreed between the respective parties hereto by their counsel that all of the testimony and exhibits offered and received in evidence in the appeal of the Great Northern Railway Company v. Commissioner of Internal Revenue, *3031 Docket Nos. 8433 and 11850, on behalf of both parties to said appeal, relating to the question of the inclusion in income of interest due the Great Northern Railway Company on bonds of the Spokane, Portland and Seattle Railway Company, may be considered as offered and received in evidence in the above entitled appeal, subject to all objections and exceptions noted in the transcript of record in said Docket Nos. 8433 and 11850, and may be used *80 by the Board of Tax Appeals together with the facts hereinafter admitted by both parties as the basis for its findings and decision herein, such evidence and exhibits being the testimony of Geo. H. Hess, Jr., appearing on pages 65 to 73, 170 to 175, 199 to 201 and 204 to 205 of the transcript of record in said Docket Nos. 8433 and 11850, the testimony of G. R. Martin appearing on pages 212 to 216 and 227 to 229 of said transcript of record and the testimony of Robt. Crosbie appearing on pages 296 to 346 of said transcript of record, together with exhibits Nos. 43 to 67, both inclusive, and exhibits L to X, both inclusive.
From the stipulation filed by the parties and accepted by the Board we make the following
FINDINGS OF FACT.
*3032 I. Petitioner is a corporation organized and existing under the laws of the State of New Jersey, with its principal office in the State of New Jersey at No. 15 Exchange Place, in the City of Jersey City, County of Hudson, and with its principal place of business at Fifth and Jackson Streets, St. Paul, Minn.
II. Petitioner was incorporated under the laws of the State of New Jersey on October 18, 1897. The objects for which petitioner was formed are stated in its certificate of incorporation, as follows:
(1) To purchase or in any wise acquire for investment or for sale or otherwise, lands, contracts for the purchase or sale of lands, buildings, improvements and any other real property of any kind or tenure or any interest therein, and railroad depots, tracks, ways and other terminal properties or facilities and any property works or undertakings connected with the use or development of any property of the Company within the States of Wisconsin, Minnesota, North Dakota, Montana, Idaho, Washington and Oregon and within any other State or Territory of the United States; and as the consideration for the same to pay cash or to issue the capital stock, debenture bonds, mortgage *3033 bonds or other obligations of the Company; and to sell, convey, lease, mortgage, turn to account or otherwise deal with all or any part of the property of the Company.
(2) To manage, improve, develop and turn to account any land or contracts for purchase or sale of lands acquired by the Company, or in which the Company is interested, and in particular laying out townsites, establishing towns, and improving the same by laying out and preparing the same for building purposes, constructing, altering, and improving buildings thereon, and by planting, paving, draining, irrigating, cultivating, letting on building lease or building agreement, and by advancing money to, making subscriptions for and entering into contracts and arrangements of all kinds with buildings, tenants and others.
To apply for, procure and take out patents of the United States of America upon any lands in which the corporation may have any interest.
*81 (3) To construct, maintain, and operate railroads, tunnels, bridges, viaducts and like works of internal improvement or public use or utility within the States of Wisconsin, Minnesota, North Dakota, Montana, Idaho, Washington, and Oregon, and in the other *3034 States or Territories of the United States of America; to acquire, construct, maintain and operate, control and manage any water works, irrigation works, gas works, reservoirs, streets, roads, electric power, heat and light supply works, hotels, parks and other works and conveniences which the Company may think, directly or indirectly, conducive to these objects, and to contribute to or otherwise assist or take part in the construction, maintenance, development, working, control and management thereof; to obtain, accumulate, store, conduct, sell, furnish and supply water for irrigation, agricultural, mining, manufacturing, power, municipal and domestic purposes, and to take, hold, operate, lease and convey lands, canals, ditches, reservoirs, dams, water rights and water power, properties and appurtenances, and to construct canals, ditches, reservoirs, and dams suitable for and incident to any and all such purposes.
(4) To encourage, assist and stimulate immigration to and settlement upon any lands owned by this Company, or in which it may have any interest, by subscription, donation, loan or in such other manner and by such means as to the Board of Directors may seem desirable, *3035 and to facilitate and assist in the cultivation and improvement of the same.
(5) To borrow money to such amount and in such manner as to the Board of Directors may seem proper, and to secure the repayment of any securities issued or money borrowed, by mortgage or pledge of the whole or any part of the property and franchises of the Company acquired and to be acquired, and also to lend moneys or other assets of the Company upon such terms and conditions as to the Board of Directors may seem advisable.
(6) To invest and deal with the moneys and other assets of the Company upon such securities and in such manner as may be determined by the Board of Directors.
(7) To purchase or otherwise acquire, hold, sell, assign, transfer, mortgage, pledge, or otherwise dispose of the shares of the capital stocks and the bonds, securities or evidences of indebtedness of any other corporations, private or municipal, whether the nature of the business of such corporation be similar to that of this Company or otherwise; and to exercise all the rights, powers, functions and privileges of ownership of such securities, including the rifht to vote thereon.
(8) To enter into partnership or into *3036 any arrangement for sharing profits, union of interest, cooperation, joint adventure, reciprocal concession, or otherwise, with any person or company carrying on or engaged in or about to carry on or engage in, any business or transaction which this Company is authorized to carry on or engage in, or any business or transaction capable of being conducted so as directly or indirectly to benefit this Company. And to guarantee the contracts of, or in any manner assist, any such person or company, and to take security for any such guarantee or assistance, and to sell, hold, re-issue, with or without guaranty, or otherwise deal with the same.
(9) To do all such other things as are incidental or conducive to the attainment of any of the above objects.
(10) To do all or any of the above things as principals, agents, contractors, trustees, or otherwise, and by or through trustees, agents, or otherwise, and *82 either alone or in partnership or conjunction with any other person, firm or corporation.
The corporation shall have power to hold, purchase, mortgage and convey real and personal property without the State of New Jersey.
The power to make and alter by-laws for the *3037 management of the property of the corporation and the regulation and government of its affairs, is hereby conferred upon its Board of Directors.
By amendment of its certificate of incorporation, filed with the Secretary of State of New Jersey October 6, 1898, the following powers set forth in a section numbered 11 were added to the objects for which the corporation was formed, as set forth in Article "Third" of the said certificate of incorporation, to wit:
11. To acquire, by purchase or otherwise, mines and mining property and any interests therein; to improve, develop, operate and manage the same; to buy, sell, or traffic in the products of mines or mining properties; to engage in the business of buying and selling or leasing mines and mining properties; and to exercise any powers that may be incidental, desirable or necessary to the exercise of any of the powers provided for in this Section.
III. The petitioner has never engaged in business as a common carrier by railroad and is not subject to the Interstate Commerce Act, nor is it under the jurisdiction of the Interstate Commerce Commission. Its business activities have been principally the holding, management, sale *3038 and leasing of lands, the purchasing, holding and sale of securities, the operation of coal mines, the sale of coal to the Northern Pacific Railway Co., a common carrier by railroad subject to the Interstate Commerce Act, and the sale of coal commercially.
IV. The petitioner was created and incorporated at the instance of the chairman of the board of directors of said Northern Pacific Railway Co. for the purpose of holding and handling real estate which that company desired to keep free from the lien of its mortgages, and said Northern Pacific Railway Co. has at all times owned and now owns all of the capital stock and all of the bonds and other securities of the petitioner, except directors' qualifying shares.
V. The petitioner's board of directors has at all times been composed of officers and directors of said Northern Pacific Railway Co. exclusively, except that on two occasions a representative of one of the *83 New York financial institutions has served as a member of said board.
VI. The petitioner's officers have at all times been at the same time officers of said Northern Pacific Railway Co.
VII. The petitioner's general business affairs have *3039 at all times been transacted in the New York or St. Paul offices of said Northern Pacific Railway Co. and petitioner has no separate general offices of its own. The petitioner's policies and business activities have at all times been dictated and controlled by said Northern Pacific Railway Co. and all important sales or long-term leases of lands and all expenditures of any substantial sums of money by petitioner have been made only upon the recommendation or approval of the board of directors of said Northern Pacific Railway Co. The petitioner's business has at all times been conducted with a view to increasing the traffic of said Northern Pacific Railway Co., affording financial assistance to said company, and providing that company with an adequate supply of coal at a reasonable cost.
VIII. Ever since the year 1918, said Northern Pacific Railway Co. has filed consolidated income-tax returns for itself, petitioner, and its other affiliated companies and has paid the taxes assessed upon such consolidated returns.
IX. During the fiscal year ended June 30, 1917, and during the 6-month period ended December 31, 1917, petitioner held first mortgage gold bonds of the Spokane, *3040 Portland & Seattle Railway Co. in the amount of $5,000,000 par value. Said bonds bore interest at the rate of 4 per cent per annum and the interest due the petitioner thereon during the fiscal year ended June 30, 1917, was the sum of $200,000 and during the 6-month period ended December 31, 1917, was the sum of $100,000.
X. No part of the interest due on said bonds was paid during the fiscal year ended June 30, 1917, or during the 6-month period ended December 31, 1917. The petitioner did not accrue in its income *84 accounts for said respective periods any part of the interest due on said bonds for said periods.
XI. During all of the years 1916 and 1917 the Northern Pacific Railway Co. and the Great Northern Railway Co. owned in equal shares the entire capital stock of the Spokane, Portland & Seattle Railway Co., amounting to $40,000,000 par value. This stock was acquired at par. The petitioner has never owned any part of the capital stock of said Spokane, Portland & Seattle Railway Co.
XII. Prior to December 31, 1917, no interest had been paid to the petitioner on bonds of the Spokane, Portland & Seattle Railway Co. held by it. The interest due for the *3041 period from July 1, 1916, to December 31, 1917, upon said bonds mentioned above, was paid by remittances received by the petitioner during the years 1923, 1924, 1925, and 1926. No part of the interest due upon said bonds for years subsequent to the year 1918 has as yet been paid.
XIII. During all of the times herein mentioned the petitioner kept its books of accounts upon the so-called "accrual basis." It computed its net income and made its income-tax returns for the periods here involved upon the basis upon which its accounts were kept. Payments of interest upon the bonds of the Spokane, Portland & Seattle Railway Co. held by petitioner have been taken up in petitioner's income accounts and have been returned as taxable income only when and as received.
XIV. In the determination of the alleged additional tax liability of petitioner for said periods and in the determination of the proposed deficiency, respondent held that the interest due petitioner from the Spokane, Portland & Seattle Railway Co. for the fiscal year ended June 30, 1917, and 6-month period ended December 31, 1917, constituted taxable income for said periods and added the following amounts to the income *3042 of the petitioner: Year ended June 30, 1917 $200,000
Six months ended December 31, 1917 100,000
*85 The taxes in controversy are the income taxes upon said amounts for said respective periods.
XV. In the taxable year and period in question the books of the Spokane, Portland & Seattle Railway Co. and of all its subsidiary corporations showed substantial operating deficits.
OPINION.
LANSDON: The only question here is whether the books of this petitioner reflected its income in the taxable year and period. Section 13 of the Revenue Act of 1916 provides:
A corporation * * * keeping accounts upon any basis other than that of actual receipts and disbursements, unless such other basis does not clearly reflect its income, may, subject to regulations made by the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, make its return upon the basis upon which its accounts are kept, in which case the tax shall be computed upon its income as so returned.
The petitioner kept its books on the accrual basis and the controversy here hinges entirely on whether certain bond interest due it in the taxable year and period but *3043 not received for several years thereafter accrued to it in such a way that it was required to take it into its books as income and pay Federal taxes thereon. During all the time here involved the petitioner was a subsidiary but not affiliated corporation of the Northern Pacific Railway Co., which, except for qualifying shares, owned all its stock. In , we held that the petitioner in that case derived no income from interest on the bonds of the Spokane, Portland & Seattle Railway Co. during the taxable years and that the amount thereof was improperly accrued by the Commissioner in computing the deficiencies there in question.
In this proceeding the petitioner relies on the Great Northern decision and contends that the only issue here is settled by our opinion in that case. This the respondent denies and argues that the facts in the two cases are so materially different that they are readily distinguishable and that our prior decision establishes no rule for the determination of this controversy. He points out that the present petitioner is not a transportation company and therefore not subject to the rules and regulations *3044 of the Interstate Commerce Commission and that it owns none of the stock of the railway company which defaulted its bond interest in the taxable year and period.
*86 In our decision in , we said:
As indicated by the income-taxing statutes, corporations keeping books of account may make their returns upon the basis of actual receipts and disbursements or upon some other basis which truly reflects income. There are two methods of accounting in general use, (1) the cash basis commonly used by individuals and small concerns, and (2) the so-called "accrual basis." Both methods have for their object the same purpose, which is the recording of the financial transactions of a business and the summarizing of the results so as to show the effect of these transactions upon the business. The principal difference between them is the period of time to which a given transaction is allocated.
Under either method the taxpayer must have before him some definitely ascertained item of income to record before it can be reported and if a given transaction does not correspond to the definition of income then there is no income to record whether *3045 the taxpayer keeps its books on a cash or an accrual basis. Where books are kept on the accrual basis there is no requirement that there shall be accrued as income that which may never be received. The position of the respondent in this case carried to its logical conclusion would require a taxpayer keeping its books of account upon the accrual basis to accrue as income interest on bonds held as an investment which it did not collect and which in all probability it never would collect. If the theory of the respondent is correct an insolvent corporation keeping its books of account upon the accrual basis might merely by the purchase of bonds of insolvent corporations upon which interest was neither being earned or paid, easily show a large income.
In our opinion the requirement of the Interstate Commerce Commission that interest accrued on funded securities shall not be credited to income accounts prior to actual collection "unless its payment is reasonably assured by past experience, guaranty, anticipated provision or otherwise," is entirely consistent with a system of accounting which is designed to reflect any company's true income. If the petitioner had kept its accounts *3046 in the manner suggested by the respondent it would have reported to the public each year that it had earned income in excess of one million and a half dollars which, as a matter of fact, it had not received and which in all probability it would never receive. Such a system of accounting would not have reflected the petitioner's true income but would have given to its stockholders and the public a false idea of its income.
In our opinion the language cited above sustains the contention of the petitioner since we there held specifically that the requirement of the Interstate Commerce Commission is "entirely consistent with a system of accounting which is designed to reflect any company's true income." We reached that conclusion not because the taxpayer acted under compulsion of the regulations of the Commission, but because such regulations are based on a method of accounting that reflects true income. It follows, therefore, that the rule of that decision governs here.
Decision will be entered for the petitioner.