Old Colony R. Co. v. Commissioner

OLD COLONY RAILROAD CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Old Colony R. Co. v. Commissioner

Docket No. 18813.

United States Board of Tax Appeals

18 B.T.A. 267; 1929 BTA LEXIS 2089;

November 19, 1929, Promulgated

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">*2089 1. INCOME - LEASED PROPERTY - TAXES PAID BY LESSEE. - The amount of petitioner's Federal income and profits taxes for 1920, due and payable in 1921 and paid for its account in that year by the lessee of all of its property and business as one of the considerations for the use of the property, held to be income to petitioner for 1921. Providence & Worcester Railroad Co.,5 B.T.A. 1186">5 B.T.A. 1186.

2. Id. - BOND PREMIUMS. - Petitioner received prior to 1905 premiums on sales of certain of its bonds due and payable subsequent to the taxable year 1921. Held that no portion of such premiums represented income to petitioner in 1921. Old Colony Railroad Co.,6 B.T.A. 1025">6 B.T.A. 1025.

3. Id. - LESSEE'S TRANSACTIONS IN LEASED PROPERTIES. - Under the terms of a 99-year lease of all of its property, petitioner granted to the lessee the right to dispose of items of the leased property no longer necessary, in the opinion of the lessee, to the use of the property, the lessee being obligated, in the case of such disposals, to replace such property before or at the expiration of the lease with other property of an equal value. The proceeds of such sales were">*2090 received and retained by the lessee, and the latter made the replacements as provided. Held that from such sales during the taxable year 1921 petitioner derived no income, their effect as to it being merely an unrealized appreciation in value of its reversion in the leased property as a whole.

4. AFFILLIATION. - All of petitioner's property and business was used and operated during the taxable year 1921 by its lessee under a 99-year lease, such lessee also being the owner of 44 per cent of its capital stock and an additional 18.56 per cent of such stock being owned or controlled by stockholders of the lessee. Approximately 38 per cent of petitioner's voting stock was owned during that year by stockholders having no connection or community of interest with the lessee, but who made no effort to contest the latter's control of petitioner's business and policies and such of them as participated in the stockholders' meeting of that year voluntarily gave their proxies to the lessee. Held that the lessee did not own or control substantially all of petitioner's stock during the taxable year in question.

J. S. Y. Ivins, Esq., and Joseph D. Brady, Esq., for the">*2091 petitioner.

Arthur H. Fast, Esq., for the respondent.

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TRUSSELL

">*268 The taxes here in controversy are for the calendar year 1921, the respondent having asserted a deficiency of $17,172.75 and the petitioner an overpayment of $156,124.42. The errors assigned are upon (a) respondent's refusal to treat petitioner as affiliated with the New York, New Haven & Hartford Railroad Co. during the taxable year, and (b) his inclusion in petitioner's taxable income for that year of amounts representing (1) an apportionment of premiums received between 1894 and 1905 on sales of its bonds, (2) Federal income taxes assessed against it but paid or payable by its lessee, and (3) amounts as representing taxable gains upon sales of certain of its capital assets by such lessee.

In his answer filed to the petition respondent charges petitioner with the receipt in 1921 of $335,500.71 of income in addition to that upon which the deficiency of $17,172.75 was computed, and asks on this basis that the deficiency be increased.

FINDINGS OF FACT.

Petitioner is a corporation chartered under the laws of Massachusetts and with its principal office at South Station, Boston. The">*2092 New York, New Haven & Hartford Railroad Co., hereinafter called the "New Haven," is a corporation organized and existing under the laws of Massachusetts, Rhode Island and Connecticut and operates a railroad system in those States and in the State of New York.

On February 15, 1893, petitioner leased its railroad lines and all other property to the New Haven for a term of 99 years from March 1, 1893. The provisions of this lease, which has been in full force and effect ever since that time, appear in full in our findings of fact in the matter of the appeal of this same petitioner in respect to its tax liability for the year 1918 (), to which reference is made, and for that reason need not here be set out.

">*269 During the calendar year 1921 the railroad and property of the petitioner were under the lease operated as a part of the railroad system of the New Haven. During all of that taxable year petitioner had issued and outstanding 222,940 shares of capital stock, all of it common and voting stock. During all of that year the New Haven owned 98,132 shares of this stock. The 19 next largest stockholders owned a total">*2093 of 14,655 shares at the beginning of that year and 14,527 at the close, the largest of these 19 individual stockholdings being 4,200 shares and the next largest 1,084 shares. The balance of the stock, 110,153 shares, was owned by 4,819 different individuals and corporations, none of whom owned as many as 358 shares. In addition to the 98,132 shares owned by the New Haven, 41,390 shares or 18.56 per cent of the entire amount outstanding, were owned or controlled by 313 persons and corporations as individuals or trustees, who at the same time owned or controlled 61,757 shares of the 1,571,179 outstanding shares of stock of the New Haven.

There was but one meeting of petitioner's stockholders in 1921, this being the regular annual meeting on March 29. In calling this meeting the same procedure was followed as in preceding years and as called for by the by-laws, a notice being mailed to all holders of 75 or more shares of stock, the smaller stockholders being notified only by the regular advertisement of the meeting made in newspapers. With each notice mailed there was included a form of proxy with spaces for the names of both the attorney and the stockholder in blank. At this">*2094 meeting 138,247 shares of petitioner's stock were represented and voted. This included the 98,132 shares owned by the New Haven and for which a proxy was given by it to F. S. Curtis and A. P. Russell. Of the balance of stock voted, 143 shares were represented by a proxy returned made out to F. S. Curtis and the rest was represented by 137 proxies signed and returned with the name of the attorney in fact left blank and which were formally completed by a clerk of petitioner by the insertion of the name of E. M. Glidden in some and the name of T. W. Hoogs in others. Some of these proxies were given by individuals included among the 313 stockholders of petitioner who also owned stock of the New Haven, and some by parties who had no interest in or connection with the New Haven. The said A. P. Russell was then and is now a vice president of the New Haven and a director of petitioner. The said F. S. Curtis was then and is now the president of petitioner. He had for many years been an officer of the New Haven, resigning as vice president in 1907 to become president of petitioner. He had prior to that time, and while he was vice president of the New Haven, been a director of petitioner. ">*2095 Curtis for many years ">*270 had been, and was during 1921, president of the Union Freight Railroad, chairman of the trustees of the Boston Terminal Co., and a director of the Providence, Warren & Bristol Railroad Co. All of the stock of the Union Freight Railroad was in 1921 owned or controlled by the New Haven, which also controlled 80 per cent of the stock of the Boston Terminal Co., and was the lessee of the Providence, Warren & Bristol, Curtis being a director in the latter, nominated by the New Haven. The said E. M. Glidden was in 1921 treasurer of petitioner and also of the Union Freight Railroad Co., Boston Terminal Co., and Providence, Warren & Bristol Railroad Co. The said T. W. Hoogs was in that year an employee of the New Haven, in the office of its vice president. The 138,247 shares of petitioner's stock voted at the 1921 annual meeting were voted by Curtis, Glidden, and Hoogs, who were the only parties present at such meeting with exception of B. A. Powers, clerk of petitioner, and who is also employed by the Boston Terminal Co., and Union Freight Railroad Co., and who prepared the ballots for election of officers. All of the stock was voted similarly for the">*2096 officers elected. The procedure and result was typical of that in prior years. There was never any effort by the small stockholders to combine or oppose the control of the election by the New Haven. The directors' meetings of petitioner are held quarterly. The only business transacted at such meetings is the election of officers, declaration of dividends, and the formal approval of requests made by the New Haven in respect to matters required of them under the terms of the lease agreement between petitioner and the New Haven.

A consolidated return of the New Haven and its affiliated companies for the year 1921 would show a net loss sufficient to completely absorb the net income of petitioner for that year.

The New Haven did not own or control substantially all of the stock of petitioner during 1921 nor was substantially all of the stock of those two companies owned or controlled by the same interests during that year.

During the years 1895 to 1904 petitioner issued and sold its bonds for divers amounts, receiving therefor, in addition to the face amount of such bonds, premiums aggregating $199,528.08. Such premiums were credited to a "Premium on Bond" account and remained">*2097 there undisturbed until 1914, when the Interstate Commerce Commission required the petitioner, for the purposes of its reports to that Commission, to amortize such premiums over the periods of the respective lives of the bonds. For the purpose of meeting the requirements of the Interstate Commerce Commission, and over its protests to that Commission, the petitioner made such adjustments, ">*271 and for each year subsequent to 1914 reported a ratable proportion of such premiums to the Commission as income. On its books in each such year petitioner credited such proportion of the premiums to profit and loss account (a surplus account) and not to its income account. The amount so credited to profit and loss account for 1921 was $6,960.64. The respondent increased petitioner's taxable income for the year 1921 by such amount of $6,960.64. The New Haven as lessee paid the entire amount of interest accruing on petitioner's funded debt in 1921 and the full amount thereof was included in the gross income shown on petitioner's 1921 return.

By virtue of the provisions of the lease agreement the New Haven paid in 1922 the Federal income and profits taxes for the year 1921 upon the">*2098 net income returned by petitioner for that year. The amounts of such taxes were $156,124.42 on income of $1,561,244.20 returned for 1921 and which did not include any amount paid or accrued as Federal income or profits taxes. No part of such payment has been refunded. The taxes so paid were not due or payable until on or after March 15, 1922. In determining the deficiency here appealed from respondent included in petitioner's income for 1921 the sum of the taxes so paid. Similarly, in 1921 the New Haven paid the Federal income and profits taxes upon the income returned by petitioner for 1920, such taxes being due and payable in 1921. The taxes so paid amounted to $155,339.49 upon a net income of $1,555,394.85 and which did not include any amount paid or accrued as Federal income or profits taxes. No part of such payment has been refunded. No amount was included by respondent in the deficiency here appealed from on account of the payment of such 1920 taxes in 1921 but respondent now seeks to include the amount of such payment in petitioner's income for 1921, if it be held that the payment made in 1922 of 1921 taxes did not represent income to petitioner in the latter year.

">*2099 In 1921 the New Haven, as lessee of petitioner, paid to or for the account of petitioner, exclusive of taxes, the sum of $2,109,257.31. This sum was at once disbursed by petitioner as follows:

Dividends	$1,560,580.00
Interest	538,920.00
Organization expenses	9,757.31
	2,109,257.31

These items were included in gross income by petitioner in making its return for 1921. Petitioner also included in income in that return an item of $664.20 as a net amount of taxable profit in that year from 11 transactions as sales of real estate. Respondent in determining ">*272 the deficiency increased this profit to $7,888.13. The 11 transactions reported were as follows:

Sales of land
Property	Date acquired	Cost	Amount received
East Walpole, Mass	1891	$34.98	$50.00
Kingston, Mass	1879	364.14	300.00
Mansfield, Mass	1889	2,416.44	3,200.00
Wrentham, Mass	1889	258.00	4,000.00
Boston, Mass	1845	5,939.40	10,000.00
Boston, Mass	1871-1874	3,219.00	5,085.30
Wareham, Mass	1874	2,000.00	175.00
Roxbury, Mass	1895	922.08	862.15

Dispositions through condemnation
Property	Date acquired	Cost	Amount received
Quincy, Mass	1911	$15.84	$50.00
Wareham, Mass	1890	52.80	260.00
Boston, Mass	1845	8,890.00	40,000.00

">*2100 The first seven items listed above were sales made by the New Haven of land of petitioner and approved by petitioner's directors as provided in the lease. On all of these sales the amounts for which the property sold were received by the New Haven in 1921. The eighth item was a similar sale made in 1919 and on which the consideration was received in that year. The ninth and tenth items were lands of petitioner taken under condemnation for public use and paid for in 1921. The last item listed was an easement belonging to petitioner and condemned by the City of Boston in 1916, and after considerable litigation a compromise was effected under which the city paid in 1921 the sum of $40,000. In the case of all of these dispositions listed the consideration paid was received from the grantees by and retained by the New Haven. The total gain of $664.20 reported by petitioner as taxable gain on these transactions was computed upon the basis of an estimated March 1, 1913, value in each case determined by the real estate department of the New Haven.

In carrying out operations between petitioner and the New Haven under the lease of the former's properties by the latter, the cost of">*2101 all purchases of property by the lessee of additions to petitioner's property and the cost of all permanent improvements, which cost petitioner would be obligated upon demand of the lessee to reimburse it for by issue and sale of additional bonds or stock, was, upon such expenditures being made, charged to petitioner upon an open account maintained upon the books of each company. This ">*273 open account with the New Haven upon petitioner's books is credited with the cost of such additions and permanent improvements and debited with the proceeds of any sales of petitioner's property made by the New Haven. This open account with petitioner on the New Haven's books is debited with cost of such additions and permanent improvements and credited with the proceeds of sales of petitioner's property. When a parcel of petitioner's real estate is disposed of by the New Haven, petitioner also credits its property account with an amount equal to its cost and either debits or credits its profit and loss account, as the case may be, with the difference between such cost and the amount paid the New Haven by the purchaser. Credits to the open account upon petitioner's books with the New Haven">*2102 and representing additions and permanent improvements are also debited to petitioner's property account. Whenever the debit balance in the open account on the New Haven's books reaches an amount which, in the judgment of the officers of the New Haven, is sufficiently substantial, the petitioner, at the request of the New Haven, issues stocks or bonds, which are sold at their market value, and the proceeds paid over to the New Haven, which credits the amounts thereof to the open account with petitioner. No rights to subscribe of any value accrue to petitioner's stockholders or bondholders. The said open accounts do not carry interest.

On December 9, 1920, the New Haven placed a first and refunding mortgage on its property, including its leasehold interest in the property of the petitioner. In many instances upon the receipt of the proceeds from the disposition of petitioner's real estate, the New Haven notified the Bankers Trust Co., trustee under said mortgage, that the proceeds either had been or would be applied to a specific named improvement or addition on the line of petitioner. In all instances such proceeds were credited to the open account.

In 1895 petitioner acquired">*2103 a tract of 731 acres at Squantum (Quincy) Mass., at a cost of $206,016.29. On October 6, 1917, the President, under authority of the Act of Congress, approved on that date, 40 Stat. 345, 371, condemned and took over for immediate use for National defense purposes the title and possession of such land and under the provisions of that act determined the amount of just compensation to be paid therefor to be $400,000. The petitioner and the New Haven were not satisfied with this amount and, as permitted by the provisions of that act, elected to receive 75 per centum of the amount of the award by the President or $300,000 and to bring suit in the Court of Claims to recover of the United States the difference between this sum and such amount as would be found by the court to be just compensation for the property taken.

On or about May 22, 1918, the United States paid to petitioner and the New Haven the $300,000 elected to be received in partial payment. ">*274 On January 18, 1919, this sum of $300,000 was credited to petitioner by the New Haven upon the open account heretofore mentioned.

On February 5, 1919, petitioner and the New Haven brought suit in the Court of Claims to">*2104 recover of the United States the additional amount claimed as just compensation for the Squantum property. In this suit the court found upon stipulation of the parties that the reasonable value of the property taken was $575,000, and on May 31, 1921, entered judgment for $275,000, which sum was received by the New Haven in February, 1922, and thereupon credited to petitioner by the New Haven upon the aforementioned open account. Petitioner accounted for this transaction on its books in 1922 by crediting its profit and loss account with the sum of $335,590.70, said sum being the difference between $575,000 and the cost of the property plus expenses incident to the recovery of that amount. Petitioner computed a gain on this disposition of real property of $99,434.39, and reported this on its return for 1922, and respondent upon examination of that return increased such profit to $335,500.71 and now contends that such profit represents income for 1921. Petitioner has at all times kept its accounts upon an accrual basis.

OPINION.

TRUSSELL: Two of the issues raised by petitioner need little discussion as they each involve a question which had been heretofore presented to us and">*2105 decided upon facts similar to those here involved. One of these issues is the so-called "tax on tax" question, or whether payments of Federal income taxes by the lessee for account of the lessor, as required by the terms of the lease, constitute additional income to the lessor. That such payments represent additional taxable income was held by the Supreme Court in , and , both decided June 3, 1929, and we accordingly have for determination here the question of what income of this character received by petitioner constitutes income for the calendar year 1921. Respondent in determining the deficiency has included the amount of Federal taxes in respect of income for that year and which were due and payable in 1922 and paid in that year by the New Haven, but asks, in the event that such taxes are held not to represent income for 1921, that the deficiency be redetermined by including in petitioner's income the sum of $155,339.49 income and profits taxes of petitioner for 1920, due and paid by the New">*2106 Haven in 1921 for account of petitioner. We hold that the Commissioner was in error in including in income for 1921 the amount of Federal taxes for that year not due or payable and not paid until 1922. ; ">*275 . We further hold that the $155,339.49 of Federal income and profits taxes of petitioner for the calendar year 1920 due and payable in 1921 and paid in that year by the New Haven for account of petitioner represents additional income in that amount to the latter for 1921. ; Old Colony Trust Co. et al., executors,; .

The second issue is upon respondent's inclusion in petitioner's income for 1921 of a proportionate amount of the premiums received by it prior to 1905 on sales of its bonds which are not yet due and payable, respondent having prorated such premium over the life of the bonds and allocated $6,960.64 thereof to income for that year. In ">*2107 , this same question was presented with respect to this petitioner's tax liability for 1920 and we held that respondent's action in prorating the amount of such premiums as income of current years during the bond period was in error and this decision was affirmed by the . Under authority of that decision we held that no part of the premiums in question represented income to petitioner in 1921.

This brings us to consideration in the light of facts here proven, of the question of whether petitioner was affiliated with the New Haven in 1921. The question is a vital one in this proceeding, as it is admitted by stipulation that the New Haven sustained a net loss in this taxable year sufficient to absorb any net income found as received by petitioner, and if it be found that affiliation as defined in section 240(c) of the Revenue Act of 1921 existed, the result would wipe out the liability not only for the deficiency determined but for the tax already paid for that year. The section in question reads as follows:

(c) For the purposes of this section two or more domestic corporations">*2108 shall be deemed to be affiliated (1) if one corporation owns directly or controls through closely affiliated interests or by a nominee or nominees substantially all the stock of the other or others, or (2) if substantially all the stock of two or more corporations is owned or controlled by the same interests.

In , this same petitioner, for the year 1918, upon proof of the same facts as shown herein as to operation of its railroad and properties under this same lease and the ownership during that year by the New Haven of 98,122 shares of its stock, claimed affiliation with the New Haven, and we held this proof insufficient to show "ownership or control of substantially all" of its stock by the New Haven and denied the claim of affiliation. However, the claim is here asserted as to a different year and is to be determined upon the proof adduced as to conditions existing ">*276 in that year. We have no reason to question the correctness of the conclusion reached by us upon the proof submitted in the former case cited and if no facts in addition to those proven in that case were shown as to the year here in question, we should">*2109 hold that no affiliation existed. Petitioner, however, attempts to meet the situation by proving additional facts which it contends, when considered with the facts proven in the former case, and which are also proven on the present proceeding as existing in the taxable year now before us, show that the New Haven controlled substantially all the stock of petitioner in that year.

An examination of the facts found in the former proceeding and the evidence submitted in the present case show that similar conditions existed in the two years with respect to operation of petitioner's properties by the New Haven under the lease in question and the ownership by the latter of 44 per cent of petitioner's outstanding stock, it being the largest individual stockholder, the next largest stockholder owning 4,200 shares. In the former year it was shown that the 18 next largest stockholders owned a total of 10,521 shares and that the balance of petitioner's 222,940 shares of stock outstanding was owned by 4,666 stockholders, none of whom owned individually more than 400 shares. In the present proceeding it is shown that the 18 next largest stockholders owned at the beginning of the year a total">*2110 of 10,455, at the close a total of 10,327 shares, and that the balance of petitioner's outstanding stock, which was the same as in the former year, was held by 4,819 stockholders, none of whom owned as many as 358 shares.

It will thus be seen that up to this point the proof as to the conditions existing in 1918 and 1921 are for all practical purposes the same and it is this proof which we held in the former proceeding as insufficient to show control by the New Haven of substantially all of petitioner's stock. However, petitioner, for the year before us presents additional proof, this being that during that year, in addition to the 98,132 shares, or 44 per cent of petitioner's stock owned by the New Haven, 41,390 shares, or 18.56 per cent, was owned by 313 individuals, partnerships and corporations who, at the same time, owned or controlled 61,757 of the 1,571,179 shares of outstanding stock of the New Haven; that these stockholders usually gave their proxies to the representatives of the New Haven in the stockholders' meetings; and that in the taxable year in question all of the stock represented and voting at the annual stockholders' meeting, or 138,247 shares, was voted under">*2111 proxy by three individuals who represented the New Haven interests, these proxies having in fact been given the New Haven.

It is insisted that these facts when considered with the others showing control of petitioner's properties under the lease and the ">*277 absolute ownership by the New Haven of 44 per cent of its stock and the wide distribution of the stockholdings in small individual amounts, are sufficient to prove an actual control of substantially all of that stock by the New Haven.

With this view we can not agree. At the most such proof would only indicate ownership and control through affiliated interests of 62.56 per cent of petitioner's stock even wer we to consider that the New Haven controlled the additional 18.56 per cent of petitioner's stock by reason of the fact that it was owned by certain of its stockholders. However, the New Haven's stockholders who were also stockholders of petitioner, owned only 61,757, or less than 4 per cent of the 1,571,179 shares outstanding of the New Haven's stock and the individual owners are not shown to have been connected with the New Haven in any way other than as owners of this comparatively small amount of its stock. ">*2112 No circumstances are shown which indicate a control by the New Haven of the stock owned by these individuals and the fact that in the annual stockholders' meeting for the taxable year some of these and certain other stockholders of petitioner gave to the New Haven's representatives proxies to vote their stock does not indicate that such action was or could have been required of them. In petitioner's annual stockholders' holders' meeting in 1921 there were 138,247 shares of stock voted, all of this being represented by proxies in the hands of the New Haven's representatives, 98,132 shares being the stock owned by the New Haven and the balance being the holdings of 138 small stockholders, some of them stockholders of the New Haven. The record shows nothing to indicate that the proxies of these 138 stockholders were given other than voluntarily, and the fact that in that year, and possibly in prior years, these proxies were voluntarily given, indicates an acquiescence and approval by these stockholders, in those years, of the control exercised by the New Haven of the organization of petitioner, but not control by it of the voting rights of the stock, which we have held is the "control" ">*2113 referred to in the statute. . It will be also noted that almost 38 per cent of the outstanding stock of petitioner during this year was owned by stockholders who had no manner of connection or community of interest with the New Haven.

In , we held that a taxpayer owning approximately 68 per cent of the stock of another company which owed it large sums, whose notes were endorsed by it and whose business was completely controlled and dominated by the taxpayer through officers and directors elected by it, was not affiliated with such company in contemplation of section 240(c) of the Revenue Act of 1921. In this case, in holding that the ownership of approximately ">*278 32 per cent of the stock by minority stockholders who had no connection with petitioner, and who retained the voting rights on their stock, precluded a claim of affiliation, we said of the minority stockholder:

* * * He still has the right to vote his stock and thus oppose the wishes of the majority if he so desires. True, the votes of the minority will not determine the policies of the corporation when the majority">*2114 of the voting shares is held by one individual or corporation, but such control of the policies and financial affairs of the corporation as an entity does not amount to control of the individual stockholder or his stock. There must be a control of the voting rights. Appeal of ; .

The Circuit Court of Appeals for the Second Circuit, in approving the conclusion reached and affirming this decision, on appeal, , said:

* * * The theory of affiliation, resulting in a consolidated return for taxes, is that the income and invested capital are really the income and capital of a single enterprise, though carried on through the instrumentality of several corporations. See article 631, Treasury Regulations (1920 Ed.); Holmes, Fed. Taxes (6th Ed.) 281; Alameda Inc. Co.v. McLaughlin, 28 F., (2d) 81 (D.C.N.D. Cal.). Only when the outside interest - that is, the interest of the minority - is so small as to be practically negligible, are the two corporations to be treated">*2115 as in receipt of a single income, requiring a consolidated return.

It is undoubtedly true that under the terms of the lease in question, executed long prior to the income-taxing statutes, all of the obligations of both corporations of every character fall ultimately upon the New Haven and the income of both is produced by the New Haven in the operation of its owned and leased properties, and, from an economic standpoint, it may well be argued that for taxing purposes the income of both should be considered as one, but with that question we are not concerned. The two corporations are distinct entities and we may only construe and apply the law as enacted, and this provides the basis for affiliation, and the right to file a consolidated return, as ownership or control of substantialy all of the stock. We hold that petitioner was not affiliated with the New Haven during the taxable year in question.

The last issue is upon respondent's action in including in petitioner's income various amounts representing in each case the difference between the cost of and amount received by the New Haven for leased properties of petitioner, sold by the lessee under authority of the lease, or">*2116 taken by condemnation by governmental authority.

The lease permits the New Haven to sell items of land and improvements from time to time when deemed by it advisable. The ">*279 proceeds of such sales are retained by it and the only obligation upon it is to replace such property sold with other property of an equal value. No increase in the rental is caused by such replacement. The New Haven also makes from time to time what in its judgment are necessary capital additions or improvements to the leased property, advancing the funds therefor, and petitioner is required by the lease to issue bonds or stock when called upon by the New Haven, which are sold and the proceeds used to reimburse the latter for the advances made. The New Haven, in the case of such issue of stock or bonds, pays from that time forward an increased rental by reason of its obligation to pay all bond interest and $7 a share on all outstanding stock. Petitioner and the New Haven each carry an account on its books of the advances made by the latter for additions and improvements. This account usually represents a large amount and when, in the opinion of the New Haven, it reaches a sum justifying or calling">*2117 for an issue of stock or bonds, the call for such issue is made. However, in the meantime the New Haven is from year to year making casual sales of items of the leased property which it deems are no longer needed and the practice has consistently been to credit the proceeds of such sales to this account of advances for additions and betterments, thus reducing to this extent the sum for which additional stock or bonds would be issued at some time in the future. It follows, we think, that from the date of the credit given by the New Haven and taken by petitioner the proceeds of such sales are represented by capital additions and improvements and that upon giving such credit the New Haven has complied with its lease obligation to replace such property sold with property of a similar value. The giving and taking of the credit against the accounts of advances shows that the parties have consistently considered such to have been the result. Petitioner has in each case, upon taking such credit against the New Haven account on its books, charged the difference between the cost of the property sold and the price realized to profit and loss, as a gain or loss, depending upon whether cost">*2118 was below or above the price realized, and has carried such adjustment into its capital asset accounts.

Petitioner contends that in none of these sales, whether voluntary or by condemnation, is a profit or loss realized which may be reflected in its income in 1921, as such transactions, as to petitioner, represent not sales but exchanges of property falling within the exception provided by section 202(c) of the Revenue Act of 1921, providing:

(c) For the purposes of this title, on an exchange of property, real, personal or mixed, for any other such property, no gain or loss shall be recognized unless ">*280 the property received in exchange has a readily realizable market value; but even if the property received in exchange has a readily realizable market value, no gain or loss shall be recognized -

(1) When any such property held for investment, or for productive use in trade or business (not including stock-in-trade or other property held primarily for sale), is exchanged for property of a like kind or use; * * *

With respect to the items of gain included as pertaining to the condemnation of an easement by the City of Boston, and the taking of real estate by condemnation">*2119 exercised by the Federal Government, petitioner contends that, it being on an accrual basis, in neither case, even though it should be found that the transactions were ones on which it realized taxable profits, were such profits income in the year 1921, but pertained to the year in which the properties were taken, irrespective of the period in which the amount of compensation to be paid for the taking was determined, or the year in which such compensation was paid. It further contends with respect to the last mentioned item that the United States can not constitutionally reduce by taxation just compensation paid for property which it has taken.

In respect to the proceeds realized from the conversions under condemnation proceedings, and which constitute almost all of the amount in controversy under this issue, it is noted that the facts proven show that the entire amount realized in each instance was applied by the lessee to the cost of capital additions and improvements to petitioner's property and this amount was, from the date received, represented by such capital additions. Section 234(a)(14) of the Revenue Act of 1921 provides:

If property is compulsorily or involuntarily">*2120 converted into cash or its equivalent as a result of * * * (c) an exercise of the power of requisition or condemnation, or the threat or imminence thereof; and if the taxpayer proceeds forthwith in good faith, under regulations prescribed by the Commissioner with the approval of the Secretary, to expend the proceeds of such conversion in the acquisition of other property of a character similar or related in service or use to the property so converted, * * * or in the establishment of a replacement fund, then there shall be allowed as a deduction such portion of the gain derived as the portion of the proceeds so expended bears to the entire proceeds. * * *

Even though it should be concluded that these involuntary conversions resulted in a realization of taxable gain to petitioner, the immediate disposition of the entire proceeds of the sale by investment in property which is undoubtedly "of a character similar or related in service or use to the property so converted" would entitle petitioner to a deduction representing the entire amount of the gain realized, resulting in the elimination from its net taxable income of all of such gain.

However, the first question raised by petitioner, ">*2121 that all of the conversions are in fact, as to petitioner, exchanges of property and ">*281 not sales, affects the entire amount. If petitioner is correct in this contention, no portion of the sale price received by the New Haven for these transfers of petitioner's properties can be included in petitioner's income.

Upon consideration of this question it appears to us unnecessary to pass upon the question of whether these transactions are ones falling within the provisions of section 202(c) of the Revenue Act of 1921. Even if not exchanges of property for property of a like kind or use, the circumstances in our opinion show them to be transactions from which petitioner has derived no income.

The provisions of the lease in question show clearly that, as one of the considerations moving to it in return for the rental paid, the New Haven possesses the right to dispose of items of the leased property, whereupon it becomes obligated to replace them with similar property of an equal value. As a necessary incident of the exercise of this right by the New Haven, it is provided that petitioner will at its request execute, through its officers, the necessary conveyances. The consideration">*2122 paid by the purchaser secured by the New Haven is retained by the latter. The result to petitioner of the conversion is known and determined before the conveyance is made, this being that it will stand possessed of other assets of a character or use similar, and a value equal, to those conveyed. As we view these transactions, the New Haven does not dispose of those items of property merely as an agent of petitioner, but by its right acquired under the lease contract - a right bought and paid for in the rental reserved. It does not receive the payments made for these properties as agent for petitioner, but in its own right as funds to which it has right and title, subject merely to its obligations to convey to petitioner similar property of an equal value to that which it has sold.

Respondent insists in effect that a disposition of property under the lease provision constituted two distinct and separate transactions - first, a sale and transfer of the property by petitioner through the New Haven as its agent, for a sum of money, and the receipt of this sum by the New Haven as such agent, and, second, the investment of these proceeds of sale by petitioner, through its agent, in">*2123 other property.

With this we do not agree. Petitioner has for a stated rental granted the New Haven the use of its properties for 99 years and has given it the right to dispose of such items of property during that period as it deems have become unnecessary to the property as a whole and replace such items by ones of a similar value and for which a necessity exists. Does the fact that, during the course of the transaction under which such items of property are disposed of ">*282 and replaced, the various steps and final result of which in each case are fixed and determined before the first step is taken, certain sums of money come into the hands of the New Haven make such sums income to petitioner when it does not receive them and has no control over or disposition of them at any time? In this connection, it must be remembered that the use of these funds by the New Haven is in the discharge of its own obligation to replace the property conveyed.

We can not agree with respondent that the several steps of this transaction constitute separate transactions and that upon conveyance of the property by petitioner and the receipt of the purchase price by the New Haven under">*2124 the sale it has negotiated, the transaction is a closed one as to petitioner, who thereupon, for income-tax purposes, is in receipt of the consideration paid. Cf. ; (affd., .) As we can see it, petitioner has not then received its consideration which is the property to be conveyed to it to replace that taken. It can not be, in our opinion, charged with receipt of income in respect to the payment. At no time can it exercise an option by cancellation of the lease, and, instead of the replacement property, take the proceeds of the sale.

The court in , defines income as "not a gain accruing to capital, not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value, proceeding from the property, severed from the capital however invested or employed, and coming in, being derived, that is received or drawn by the recipient [the taxpayer] for his separate use, benefit and disposal." We can not see that petitioner, as a result of these disposals of property has">*2125 received anything meeting this definition.

The effect of these transactions, in so far as petitioner is concerned, can be at the most merely an appreciation in value of petitioner's reversion, an unrealized capital gain, by reason of the fact that the leased property as a whole is rendered more usable and consequently of greater value to the lessee and such value may possibly be maintained beyond the lease term. To consider them sales of property by petitioner, and the proceeds as gross income to petitioner, is to overlook not only the fact that the proceeds were received and used by the New Haven with no obligation upon its part except to replace the property at the expiration of the lease period of 99 years, but the fact that the property conveyed represents both the reversion of petitioner in such property and the leasehold interest therein belonging to the New Haven - its right to use for a remaining period of more than 70 years, which right would have a present value many times that of the reversion. Petitioner's participation ">*283 in or use and enjoyment of any gain realized is necessarily postponed until the termination of the lease. It receives no increased rental">*2126 by reason of the transactions.

The conclusion reached makes it unnecessary to pass upon the other questions raised by petitioner under this issue.

Reviewed by the Board.

Judgment will be entered pursuant to Rule 50.

ARUNDELL dissents on the third point.