Opinion — Atlantic Coast Line R. Co. v. Daughton

ATLANTIC COAST LINE RAILROAD COMPANY v.

DAUGHTON, COMMISSIONER OF REVENUE OF

THE STATE OF NORTH CAROLINA, ET AL.

NORFOLK SOUTHERN RAILROAD COMPANY ov.

SAME.

SEABOARD AIR LINE RAILWAY COMPANY v.

SAME.

SOUTHERN RAILWAY COMPANY »v. SAME.

APPEALS FROM THE DISTRICT COURT OF THE UNITED STATES

FOR THE EASTERN DISTRICT OF NORTH CAROLINA.

Nos, 724, 727, 744, 756. Argued April 25, 1923—Decided June 4,

1923.

1. A State may, consistently with the Federal Constitution, impose

a tax upon the net income of property, as distinguished from the

net income of him who owns or operates it, although the property

is used in interstate commerce. P. 420.

2. The Income Tax Law of North Carolina directs that the “net

operating income” of railroads within the State be determined

upon the basis of accounts to be kept according to t’ » method

established by the Interstate Commerce Commission, and lays a

tax upon the “net income,” to be ascertained by deducting from

“net operating income” only uncollectible revenue, certain taxe>.

and amounts paid for car hire, thus treating the railroad property

within the State as the thing of which the income is taxed, and

taking no account of other income of the corporation owning the

railroad and making no deduction of its capital charges. Held, That

the statute, considering this distinction, does not in effect, depart

from the Commission’s definition of net income, nor, as applied to

414 OCTOBER TERM, 1922.

aS)

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Statement of the Case. 262 U.S.

interstate railroads, does it directly burden interstate commerce,

or discriminate against it, (other public service corporations, wholly

intrastate, being treated in the same way); nor does it, with other

railroad taxes of the State, make an aggregate burden violating

the commerce clause; nor does it violate that clause by departing

from the standard form of accounts prescribed by the Interstate

Commerce Commission under the Transportation Act, 1920. P. 421.

. The above statute is not obnoxious to the equal protection clause,

either in refusing to public service corporations, including railroads,

deductions of interest on funded debt, rentais and worthless debts,

which are allowed to other corporations and individuals in cal-

culating net income, or in not requiring certain short line railroads

to keep the accounts required of other railroads. P. 423.

The Constitution of North Carolina does not forbid taxing the

net income of property operated as a railroad as distinguished

from the net income of the company owning the railroad. P. 424.

. The above cited statute does not violate the uniformity clause of

the North Carolina Constitution, in that the permissible deduc-

tions in computing net income of public service corporations are

different from, and not so great as, those allowed individuals or

other corporations. /d.

. The statute is not retroactive and void under the state constitu-

tion because it lays a tax based upon the net income of the calendar

year within which it was enacted. P. 425.

. A bill in the District Court, to enjoin the collection of state taxes

alleged to be unconstitutional, will not be dismissed upon the

ground that a plain, adequate and complete remedy exists, in

paying the taxes under protest and suing to recover the amount

paid, when the statute relied on as affording such remedy is recent

and has not been construed and applied by the highest court of

the State. P. 425.

Affirmed.

AppgaLs from decrees of the District Court dismissing

the bills, after hearing the merits, in four suits brought

by railroad companies to enjoin the enforcement of a

state income tax.

Mr. Thomas W. Davis, with whom Mr. George B. EIl-

liot and Mr. Harry Skinner were on the brief, for appel-

lant in No. 724.

ATLANTIC COAST LINE v. DAUGHTON. 415

413 Opinion of the Court.

Mr. George H. Brown and Mr. Wm. P. Bynum, with

whom Mr. James S. Manning, Attorney General of the

State of North Carolina, Mr. Frank Nash, Mr. Locke

Craig, Mr. Thomas D. Warren and Mr. Sidney S. Alder-

man were on the briefs, for appellees.

Mr. W. B. Rodman for appellant in No. 727.

Mr. S. R. Prince, with whom Mr. W. M. Hendren and

Mr. L. E. Jeffries were on the brief, for appellant in No.

756.

Mr. Murray Allen, Mr. Forney Johnston and Mr. James

F. Wright filed a brief on behalf of appellant in No. 744.

Mr. Justice Branpets delivered the opinion of the

Court.

The Constitution of North Carolina (Article V, § 3, as

amended January 7, 1921) authorizes the General As-

sembly to tax incomes at a rate not exceeding six per cent.

The Income Tax Act of March 8, 1921 (Revenue Act, c.

34, Schedule D, §§ 100-904, as amended by ec. 35, Public

Laws 1921) laid upon corporations a tax equal to three

per cent. of the entire net income as therein defined and

upon individuals a progressive tax not exceeding that per-

centage. For the purpose of ascertaining the taxable in-

come the statute divides taxpayers into three classes—

individuals, ordinary corporations and public service cor-

porations (including railroads). The statute, in terms,

taxes only net income. For railréads and other public

service corporations required to keep accounts accord-

ing to the method established by the Interstate Com-

merce Commission, it makes those accounts the basis

for determining the “net operating income” (§ 202 as

amended) ; and it directs that, in order to ascertain the

“net income,” there shall be deducted from the net op-

erating income (a) uncollectible revenue; (b) taxes for

416 OCTOBER TERM, 1922.

Opinion of the Court. 262 U.S.

the income year, other than income taxes, and war profits

and excess profits taxes; (c) amounts paid for car hire.

Whether the statute is unconstitutional, because it fails

to include among the deductions from income allowed

public service corporations the capital charges, including

other rentals paid, is the main question for decision.

The first year’s tax under the act was payable in 1922,

with respect to the net income received during the calen-

dar year 1921. To enjoin its enforcement these four cor-

porations brought suit in the federal court for the East-

ern District of North Carolina against the Commissioner

of Revenue and others. Each plaintiff owns and operates

a line of railroad within the State, and is an interstate

carrier. Each assails the statute on the grounds that it

violates the commerce clause, the Fourteenth Amend-

ment and the state constitution; and only on these

grounds. Each case was heard upon the merits. And in

each a final decree was entered dismissing the bill. Ap-

peals were taken under § 238 of the Judicial Code; and

orders of the District Court stayed collection of the taxes

pending the determination of the appeals. Since the

cases are properly here on federal questions, all questions

presented by the record whether involving federal law or

state law must be considered. Southern Ry. Co. v. Watts,

260 U.S. 519.

it is conceded by appellants that taxation of the net in-

come of an interstate carrier does not violate the com-

merce clause, United States Glue Co. v. Oak Creek, 247

U. 8. 321; Shaffer v. Carter, 252 U. S. 37, 57; Underwood

Typewriter Co. v. Chamberlain, 254 U. S. 113; and by

the State, that taxation of gross receipts would be void

as burdening interstate commerce. Galveston, Harris-

burg & San Antonio Ry. Co. v. Texas, 210 U.S. 217. It

is conceded by appellants that classification of public

service corporations, and specifically of railroads, for pur-

poses of taxation does not violate the Fourteenth Amend-

ATLANTIC COAST LINE v. DAUGHTON. 417

413 Opinion of the Court.

ment; Bell’s Gap R. R. Co. v. Pennsylvania, 134 U. S.

232, 237; Southern Ry. Co. v. Watts, 260 U. S. 519; and

by the State, that an arbitrary classification is obnoxious

to the equal protection clause. Southern Ry. Co. v.

Greene, 216 U.S. 400. The contentions are that the stat-

ute, in fact, taxes gross income; that the classification as

made by it is unreasonable; and that for these, and other,

reasons it violates both the federal and the state consti-

tution. All the contentions are, in our opinion, unsound.

To appreciate the objections urged, and to present the

reasons for holding them groundless, it is necessary to

show the incidence of the tax. This may be done by ex-

amining how the assessment of $13,133.09 made upon the

Seaboard Air Line, and here assailed, was calculated.

The Seaboard being an interstate carrier, the accounts

were kept as required by the Interstate Commerce Com-

mission. Interstate business was apportioned, as cus-

tomary, according to mileage. The results of operations

within the State calculated according to the statute were

these:

Operating revenues ..... $8, 457, 328. 52

Operating expenses ..... 7, 308, 823. 29

Net operating income............... $1, 148, 505. 23

From the net operating income were de-

ducted:

Uncollectible revenue ... $6, 342. 31

1 3 SAR 410, 043. 38

RAs ee 294, 350. 02

Additional deductions............... $710, 735. 71

Net taxable income............... $437, 769. 52

Tax on $437,769.52 at 3 per cent. $13,133.09.

Thus, about one-twentieth (3) of the operating reve-

nues of the Seaboard was subjected to taxation. To this

one-twentieth the 3 per cent. income tax was applied.

NFLPA GMA BT chy

ee ea

418 OCTOBER TERM, 1922.

Opinion of the Court. 262 U.S.

The tax assessed ($13,133.09) is about one-six hundred

and fiftieth (<tc) of the total operating revenues

($8,457,328.52).

That the calculation is correct, in accordance with the

statute, is not disputed. That is, the net income earned,

in 1921, by the Seaboard’s lines in North Carolina was as

calculated $437,769.52. The Seaboard insists that it had

no net income taxable in North Carolina; but, on the con-

trary, a loss, of which $254,290.22 was apportionable to

North Carolina. The loss is figured in this way:

Net income as calculated

under the statutes....... $437, 769. 52

Non-operating income—not

taken into account under

gL Sees 539, 643. 30

ee ee SDs bv ki caecds hae uwn $977, 412. 82

From which deduct:

Capital charges (including rents paid) not

taken into account under the statute*.. 1, 231, 703. 04

Net loss or deficit................ $254, 290. 22 *

‘The items of the above non-operating income are

these:

Dividend income............... $113, 350. 45

Income from funded securities... . 97, 257. 47

Income from unfunded securities. . 13, 781.90

Income from lease of road........ 259, 525.95

Joint facility rent income........ 12, 664. 17

Rent from work equipment...... 5, 047. 23

Rent from floating equipment... . 18. 22

Rent from locomotives .......... 6, 767. 21

Miscellaneous rent income....... 22, 387.79

Misc. non-operating physical prop-

De ee at tet ee ee ee 7, 685. 69

Miscellaneous income............ 1, 157.22

ATLANTIC COAST LINE v. DAUGHTON. 419

413 Opinion of the Court.

Thus the State takes, as the entity to be taxed, the rail-

road property operated by the Seaboard within the State.

Therefore, it takes, as the primary basis for the tax, only

operating revenues; that is, the gross receipts from oper-

ating such property. The Seaboard, on the other hand,

assumes, as the entity which should be taxed, the com-

pany in respect to its North Carolina interests. There-

fore the Seaboard takes, as the primary basis for the tax,

in addition to the operating revenues of the lines within

the State, North Carolina’s proportion of the non-operat-

ing income of the company derived from other property

owned by it, wherever situated. For the Seaboard, like

* The items of the above capital charges are these:

Interest on funded debt......... $1, 179, 252. 20

Interest on unfunded debt....... 43, 823. 64

Annual allotment of discount on

ER ree oe 24, 494. 16

Rent of leased roads............ 10, 448. 12

Rents of joint facility........... 34, 480. 98

Rent of locomotives............. 19, 860. 91

Rent for floating equipment...... 2, 599. 96

Rent for working equipment..... 510. 24

Rents, miscellaneous ............ 3, 194. 86

Income charges, miscellaneous... . 685. 25

$1, 231, 703. 04

If the above items were added the total would be $1,319,350.32.

There is apparently some error in the items which is not however

material to the result.

* For the Atlantic Coast Line the calculation in accordance with

the statute shows a net income of $1,389,565.25. According to the

company’s contention the net income was $333,205.09.

For the Norfolk Southern the calculation in accordance with the

statute, it is suid, shows a net income of $653,882.17. (The correct

figures would seem to be $603,003.51.) According to the company’s

contention there was a deficit of $424,338.92.

For the Southern Railway the calculation in accordance with the

statute shows a net income of $2,384,068.71. According to the com-

pany’s contention the net income on one calculation was $554,724.41

and on another calculation was $456,798.56,

420 OCTOBER TERM, 1922.

Opinion of the Court. 262 U.S.

most other railroad systems, is, to some extent, a holding

company, as well as an operating company; and, as hold-

ing company, receives dividends from other concerns, in-

terest on bonds of other concerns, and rental from prop-

erty owned but not operated. As the State treats the

operated property as the entity, it does not concern itself

with interest charges and the rentals paid, just as it does

not concern itself with a mortgage upon the real estate

when it lays the ad valorem tax. On the other hand, as

the Seaboard treats the company—the person—as the

entity to be taxed, it undertakes to ascertain the net in-

come of the company. This includes as gross income, a

proportion of the receipts from property not within the

State and includes among the deductions from the gross

income of the company, the capital charges.

That a State may, consistently with the Federal Con-

stitution, impose a tax upon the net income of property,

as distinguished from the net income of him who owns

or operates it, although the property is used in interstate

commerce, was settled in Shaffer v. Carter, 252 U. S. 37,

44,52. There an Oklahoma statute was sustained which

laid the tax upon the net income of Oklahoma oil prop-

erty owned by a citizen and resident of Illinois. The Fed-

eral Constitution which permits to be taxed the net in-

come of property owned by an individual, although a citi-

zen of another State, obviously does not preclude such a

tax where the property is owned or operated by a corpo-

ration. It is a common provision in state income tax laws

to tax the net income of property within the State which

is owned, or operated, by non-residents.* The differences

between the parties arise, in the main, not from differ-

*The Federal Government taxes the net income of property owned

or business carried on within the United States by a citizen resident

abroad. DeGanay v. Lederer, 250 U.S. 376. The New York income

tax law involved in Travis v. Yale & Towne Mfg. Co., 252 U. S. 60,

73, taxes the net income “from all property owned . . by natural

persons not residents of the state.”

ATLANTIC COAST LINE v. DAUGHTON. 421

413 Opinion of the Court.

ence in the method of determining what is net income,

but from difference as to what is the subject of the tax.

In other words, they differ as to the thing of which the

net income is to be ascertained. This will appear from

an examination of the several grounds on which the

validity of the statute is assailed.

First. The contention that the statute is obnoxious to

the commerce clause rests upon the argument that the

State’s definition of net income differs from that adopted

by the Interstate Commerce.Commission; that the State

is without power to depart from the Commission’s defi-

nition so far as concerns interstate commerce; and that,

since the statutory definition differs, the act is unconsti-

tutional. A conclusive answer to that argument is found

in the fact that the State adopts (without modification)

the commission’s definition for the net income of that

which it taxes. For treating as the entity to be taxed,

the railroad property operated by the company within

the State, it appears that every item which the railroad

claims the statute wrongly disallowed as a deduction is

of such a character, that it is either clearly a capital

charge (as distinguished from an operating charge) or

reasonably may be deemed such as a matter of account-

ing.® The question of law thus presented is not one which

involves enquiry into the intricacies of railroad account-

*To prove that the statute, in fact, taxes some part of the gross

earnings, attention is called specifically to some minor items which

the statute does not allow as deductions. But these stand in no dif-

ferent position than the major items—interest on funded debt and

leased line rentals—discussed above. Prominent among these lesser

items is “joint facility rents” which, ir the case of the Seaboard,

amounted net to $21,816.81. Joint facility rents paid were $34,-

480.98; those received (credited as non-operating income) were

$12,664.17. This is rental paid for railroad facilities—like tracks,

terminals and roundhouses. They are needed by the carrier as a part

of the plant and, not being owned, are rented from others. The fact

that they are used jointly with others, is, of course, immaterial. This

rent, like the rent of a leased line, is paid to secure control of the

ue

422 OCTOBER TERM, 1922.

Opinion of the Court. 262 U.S.

ing. Under the commerce clause it is essential that a

state tax shall not directly burden interstate commerce

and that it shall not discriminate against interstate com-

merce. With these essentials the North Carolina act

complies. It is not assessed on gross receipts. Compare

Peck & Co. v. Lowe, 247 U.S. 165; Pullman Co. v. Rich-

ardson, 261 U. S. 330., It does not discriminate against

interstate commerce. For the taxable net income of other

public service corporations which are wholly intrastate is

determined also without allowing capital charges as a de-

duction. That there is no basis for the claim that the

commerce clause is violated by the burden resulting from

the aggregate of the several North Carolina railroad taxes

was settled in Southern Ry. Co. v. Watts, supra.

Another, and more technical, argument in support of

the contention that the statute violates the commerce

clause as applied to interstate carriers is based upon the

cases which sustain the power of the Interstate Commerce

Commission to prescribe a uniform system of accounting.’

property operated. Hire of freight cars might have been treated in

the same way, but the State, for reasons satisfactory to it, permitted

that financial charge to be deducted, and to that extent reduced the

tax.

*The term “net income,” in law or in economics, has not 4 rigid

meaning. Every income tax act necessarily defines what is included

in gross income; what deductions are to be made from the gross to

ascertain net income; and what part, if any, of the net income, is

exempt from taxation. These details are largely a matter of govern-

mental policy. As to them States differ; and there is apt to be dif-

ference of view in the same States at different times; and at the

same time a different definition of taxable net income for different

classes of taxpayers. Obviously such differences in detail do not

render obnoxious to the commerce clause a state income tax which

is otherwise unobjectionable.

"Kansas City Southern Ry. Co. v. United States, 231 U. 8. 423;

Interstate Commerce Commission v. Goodrich Transit Co., 224 U.S.

194. Also Illinois Central R. R. Co. v. Interstate Commerce Com-

mission, 206 U.S. 441, 461, 462; Union Pacific R. R. Co. v. United

States, 99 U.S. 402, 420, 427,

i

ATLANTIC COAST LINE v. DAUGHTON. 423

413 Opinion of the Court.

It is said that, since the statute in ascertaining net income

purports to follow the standard form of accounts pre-

scribed by the Interstate Commerce Commission, but in

fact departs therefrom, the statute invades the province

of Congress and conflicts with the policy expressed in

Transportation Act, 1920. There is in fact no such di-

vergence in the accounting. But if there had been, it

would not follow that every departure from the Commis-

sion’s standard classification would render unconstitu-

tional a state income tax act. The function of determin-

ing whether a tax burdens interstate commerce was not

conferred upon the Commission. Its sole function is the

regulation of carriers. For this purpose it has been em-

powered by Congress to require of them a uniform system

of accounting. The financial results of their operations

as therein disclosed are useful for many purposes. But

they are not made conclusive for all. Moreover, the Com-

mission’s standard form is not immutable. Railway ac-

counting is in process of development.®

Second. The contention that the statute is obnoxious

to the equal protection clause rests upon the argument

that the State’s definition of net income of public service

corporations (including railroads) is arbitrary. It is

alleged to be arbitrary because it allows to other cor-

porations and to individuals, certain deductions which

*See Groesbeck v. Duluth, South Shore & Atlantic Ry. Co., 250

U. S. 607, 614; 3 I. C. C. 289, 343. Power to prescribe a mandatory

accounting system was first conferred upon the Commission by the

Hepburn Act (June 29, 1906, c. 3591, § 7, 34 Stat. 584, 593). In

1888 a recommendatory classification of operating revenues, expenses

and charges was issued by the Commission; and between that date

and 1908 the form was revised from time to time. On June 1, 1908,

the Commission ordered carriers to make reports in the form pre-

scribed and furnished by the Commission. Thereafter changes con-

tinued to be made from time to time. A comprehensive and de-

tailed classification of income accounts was issued effective July 1,

1912. This was superseded by the revised classification effective

July 1, 1914, which is now in force.

a)

ean ek RW WROTE oo GEE RE RE ASS

424 OCTOBER TERM, 1922.

Opinion of the Court. 262 U.S.

are denied to public service corporations; namely, interest

on funded debt, rentals, and certain worthless debts

(§ 306, pars. 2, 3, 6 and 7). That the differentiation

results from the difference in the subject of the tax and,

hence, is not arbitrary has been pointed out above. But,

in any event, the differentiation would not render the

statute unconstitutional. The State might, consistently

with the equal protection clause, have subjected only

public service corporations to the income tax, or it might

have laid upon them a higher income tax than upon

others; as it laid upon railroads a higher franchise tax

than it did upon cther corporations. Compare Southern

Ry. Co. v. Watts, 260 U.S. 519.

The classification is also assailed as arbitrary on the

ground that § 202 defining net income applies only to

corporations required to keep records “ according to the

standard classification of accounting of the Interstate

Commerce Commission ”’; that there are in the State cor-

porations which are not required by law to keep their

accounts according to the Commission’s form, but which

own railroads of standard gauge operated by steam, and

have obtained authority to act as limited common carriers.

In support of this contention, two railroads with short

lines are instanced. They are owned by lumber com-

panies and are taxed, not as railroads, but as if part of the

lumber corporation. So far as appears the North Carolina

authorities might require them to file accounts according

to the Commission’s classification, if they deemed this

advisable. But obviously the State might reasonably

classify such railroads differently from ordinary carriers.

Third. The claim that the statute violates the state

constitution rests mainly on the contention that the tax is

not upon the net income.*® As shown above, the assump-

*The provision is: “ The general assembly may also tax . .

incomes provided the rate . . . shall not . . . exceed six per

cent.,andthere . . . shallbeallowed . . . deductions .

so that only net incomes are taxed.”

am

ATLANTIC COAST LINE v. DAUGHTON. 425

413 Opinion of the Court.

tion is erroneous. Only the net income of the property

operated as a utility is taxed. There is nothing in the

constitution of the State which precludes taxing the net

income of the property so operated, as distinguished from

the net income of the company. There is no incon-

sistency between §§ 101 and 202 of the statute. It would

seem from the decisions of the Supreme Court of North

Carolina that the uniformity clause applies to income

taxation; but that court has repeatedly held that the

uniformity clause does not prevent reasonable classifica-

tion.”° The contention that the uniformity clause is vio-

lated because the permissible deductions in the case of

public service corporations are different from (and not

so great as), those allowed individuals or other corpora-

tions ** is unfounded, for reasons stated above. So is the

contention that the statute is retroactive and void, be-

cause it was not enacted until March, 1922, but lays a

tax based upon the net income of the calendar year.

On behalf of the State it was urged that the bill was

properly dismissed by the District Court because there is

under the laws of North Carolina a plain, adequate, and

* Smith v. Wilkins, 164 N. C. 135; Caldwell Land & Lumber Co.

v. Smith, 151 N. C. 70; Lacy v. Packing Co., 134 N. C. 567; Gatlin

v. Tarboro, 78 N. C. 119. Compare State v. Williams, 158 N. C.

610; State v. Moore, 113 N. C. 697; Worth v. Railroad, 89 N. C. 291.

“Every corporation is allowed to deduct from gross income all

operating expenses,—that is, the disbursements incident to the life

and the conduct of its business. But the individual is not permitted

to deduct from gross income any part of his living expenses (except

so far as they may be covered by the exemption). Railroads and

other public corporations are allowed to deduct, as an operating

expense, the cost of tools and small equipment. Individuals and

other corporations are not. Ordinary corporations and individuals

are allowed to deduct rentals and interest paid. Compare the lim-

ited deduction for interest paid under the Federal Corporation Tax

Act. Anderson v. Forty-two Broadway Co., 239 U. S. 69; New

York, New Haven & Hartford R. R. Co. v. United States, 269

Fed. 907.

od eR Repro ae:

426 OCTOBER TERM, 1922.

Syllabus. 262 U.S.

complete remedy at Jaw by which a taxpayer may recover

the amount of an illegal tax paid by him under protest.

Our attention has been called to several North Carolina

cases and statutes bearing upon this contention. But

the statute mainly relied upon is a recent one which

appears not to have been construed and applied by the

highest court of the State. In the absence of such deci-

sion, we cannot say the remedy at law is plain and ade-

quate. Dawson v. Kentucky Distilleries & Warehouse

Co., 255 U. S. 288, 296; Wallace v. Hines, 253 U. S. 66,

68; Shaffer v. Carter, 252 U.S. 37, 47; Union Pacific R. R.

Co. v. Weld County, 247 U.S. 282; Davis v. Wakelee, 156

U. S. 680, 688. We have therefore passed upon the

merits.

Affirmed.

COLLINS v. LOISEL, UNITED STATES MARSHAL

TAN Warn hee