Oswego & S. R. Co. v. Commissioner

OSWEGO & SYRACUSE RAILROAD CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Oswego & S. R. Co. v. Commissioner

Docket No. 8157.

United States Board of Tax Appeals

9 B.T.A. 904; 1927 BTA LEXIS 2493;

December 27, 1927, Promulgated

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">*2493 1. Where money was borrowed for construction purposes and was so used, interest thereon and discounts therefrom attributable to the period of construction were not for the purposes of invested capital a part of the cost of construction.

2. Section 201 of the Revenue Act of 1918 applied. Where a dividend made during the first 60 days of a taxable year can be paid only from earnings and profits accumulated prior to March 1, 1913, or from a rental accruing in the taxable year and the previous year, such dividend should be allocated to the whole period for which the rent was accruing and so much thereof as accrued in the taxable year allocated to that year.

Walter A. Staub, C. P. A., J. Marvin Haynes, Esq., and Douglas Swift, Esq., for the petitioner.

Paul I. Payton, Esq., and M. N. Fisher, Esq., for the respondent.

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MILLIKEN

">*905 This proceeding results from the determination by respondent of deficiencies in income and profits taxes as follows: for 1918, $5,740.56; for 1919, $3,450.84; for 1920, $2,407.31.

Petitioner assigns the following as error:

1. Respondent excluded from invested capital (a) that proportion of discount">*2494 on bonds issued for construction purposes which was assignable to the construction period, and (b) so much of the interest paid on indebtedness incurred in construction as was assignable to such period.

2. Respondent, in computing invested capital, allocated the whole of certain dividends distributed within the first 60 days of the taxable year to the earnings and profits of previous years, although there were no such earnings or profits legally available for that purpose.

3. Respondent deducted from invested capital for each taxable year involved, the income and profits taxes for the preceding year prorated from the date on which each installment became payable.

4. Respondent excluded from petitioner's income for each year involved, taxes assessed for such year which were due and payable in succeeding years and the payment of which had been assumed by its lessee.

5. While respondent treated taxes assumed and paid by petitioner's lessee as income and taxed them as such, he refused to allow such second tax to petitioner as income.

In his brief counsel for the petitioner withdrew contentions 3, 4, and 5.

FINDINGS OF FACT.

Petitioner is a New York corporation, ">*2495 with its principal office at New York, N. Y. Petitioner leased its entire railroad property to the Delaware, Lackawanna & Western Railroad Co. in 1869, the lease reading as follows:

LEASE

BETWEEN

THE OSWEGO AND SYRACUSE R.R. CO.

AND

THE DELAWARE, LACKAWANNA AND WESTERN R.R. CO.

DATED 13 FEBRUARY, 1869.

UNDER AUTHORITY OF THE LEGISLATURE OF NEW YORK, by General Act, Chap. 218, passed 23 April, 1839, Pennsylvania, by Special Act No. 118, approved 29 March, 1855, New York, by Special Act, Chap. 244, passed 10 April, 1855.

">*906 Approved by the Directors and Managers at meetings held February 12th and 26th, 1869, respectively.

Ratified by assent in writing of the Stockholders of the O. & S., February 15, 1869, and by the stockholders of the D.L. & W. February 21, 1871.

THIS INDENTURE, made the thirteenth day of February, in the year of our Lord, one thousand eight hundred and sixty-nine, between the Oswego and Syracuse Railroad Company, a corporation created by the laws of the State of New York, party of the first part, and the Delaware, Lackawanna and Western Railroad Company, a corporation created by the laws of the State of Pennsylvania, party of the">*2496 second part.

WITNESSETH, That the said party of the first part, for and in consideration of the payments hereinafter mentioned to be made by the said party of the second part, and of the covenants and agreements of the said party of the second part hereinafter expressed, have granted, leased and demised, and by these presents, do grant, lease and demise unto the said party of the second part, their successors and assigns, the railroad of the said party of the first part, extending from the city of Oswego, in the State of New York, to Syracuse in the same state; and also all branch and other railroads, connecting with said railroad, which are leased, owned, rented or otherwise controlled, by the said party of the first part. Together with all the lands, real estate, water fronts, water rights, superstructures, piers, docks, wharves, landings, rights of way, railroads, railways, track, bridges, viaducts, culverts, fences, depot stations, station houses, water rights, water pipes, water stations and tanks, turntables, shops, buildings, structures, tools, machinery, fixtures, locomotive and other engines, cars, rolling stock, and equipment and also all other property and rights, or">*2497 every kind and character, real, personal and mixed, whatsoever and wheresoever situate, belonging to the said party of the first part or to which the said party of the first part are wholly or in part in any manner entitled. Also all and singular the franchises, immunities, rights, powers and privileges, which have been or may be granted to or conferred upon or which may be used or exercised by the said party of the first part.

TO HAVE, HOLD, USE, ENJOY, POSSESS, AND EXERCISE, all and singular, the property, things, franchises, immunities, rights, powers and privileges, hereinbefore granted, leased and demised, with the hereditaments and appurtenances, in anywise thereunto appertaining, unto the said party of the second part, their successors and assigns, from the first day of March, eighteen hundred and sixty-nine, for and during the full term of the continuance of the charter of the party of the first part, and during the full term of the continuance of said charter, by virtue of any and all renewals thereof, that may at any time hereafter be granted or made, as fully and beneficially to all intents and purposes as the said party of the first part might, or could have, hold, ">*2498 use, enjoy, possess or exercise the same had this indenture not been made.

And the said party of the first part, for the consideration aforesaid, do hereby grant, assign and convey unto the said party of the second part, their successors and assigns, all contracts, agreements, credits and accounts, which have been made by or belong to the said party of the first part.

And the said party of the second part, in consideration of the grants, lease, demise, sale and assignments of the said party of the first part, in this indenture, contained, do covenant and agree with the said party of the first part, its successors and assigns, to assume, and they do hereby assume, and agree to pay, discharge and perform all the bonds, debts, obligations, liabilities, contracts and undertakings, for which said party of the first part on the first ">*907 day of March, eighteen hundred and sixty-nine, shall be legally or equitably liable.

And the said party of the second part does also hereby covenant and agree, to pay to the holders of the capital stock of the said party of the first part during the term of three years, commencing on the first day of February Inst. (1869), a dividend of">*2499 eight per centum per annum upon the par value of said stock, and to pay the same semi-annually, on the twentieth days of February and August, in each year, free of government tax, and thereafter they, the said party of the second part shall, during the continuance of this lease, pay to the holders of said capital stock, a dividend of nine per centum per annum upon the par value of said stock, and pay the same semi-annually on the days aforesaid (twentieth of February and August) in each year.

And the said parties hereto, do hereby, for the consideration aforesaid, further covenant and agree each to and with the other, its successors and assigns, as follows:

FIRST: That the said party of the first part, notwithstanding this lease, shall continue to maintain their organization as a corporation in the manner prescribed by their charter and the supplements thereto, and that they shall do and perform all acts and things necessary and proper in order to the maintenance of their corporate rights. And the said party of the first part shall, from time to time, during the continuance of this lease upon the request of the said party of the second part, make, execute, issue and deliver to">*2500 the party of the second part, the bonds, other obligations or stock of the said party of the first part, as the said party of the second part may request, for such amount as may be required by the said party of the second part, to pay all expenditures which are properly chargeable to construction account. And upon the taking effect of this lease, all of the books, moneys, bills receivable and other securities, belonging to the party of the first part, shall be delivered to the said party of the second part.

SECOND: That in case the said party of the second part shall at any time refuse or neglect, for the period of six months, to make any of the payments by them in this indenture agreed to be made, the said party of the first part may at their option, at any time within ninety days thereafter, but not afterwards for that default, treat this lease as at an end and at once resume and take and hold full possession and control of all the property by these presents leased and demised, free and clear of all rights and control of the party of the second part, the same as if this lease had not been made; PROVIDED, That the said party of the first part shall, during the period of at least">*2501 thirty days before taking the repossession of said property, publish in two daily newspapers printed in the city of New York, a notice to the stockholders of the party of the second part, of such default and intention to resume the possession of said property; and the party of the second part may, at any time before the expiration of the thirty days' notice above mentioned, stay all proceedings by the payment of the amount then due.

THIRD: That the said party of the first part shall, upon request of the party of the second part, issue and deliver to the party of the second part, the bonds, or other obligations of the party of the first part, sufficient to enable the party of the second part to pay and discharge at maturity the bonds of the party of the first part theretofore issued.

FOURTH: That the said party of the first part represent and agree, that the amount of their bonds outstanding on the first day of March, 1869, shall not exceed the sum of Six Hundred Thousand ($600,000) Dollars, and that the amount of stock then issued, shall not exceed Four Hundred and Eighty-Two ">*908 Thousand Four Hundred ($482,400) Dollars, and that all other obligations and liabilities">*2502 at that time, shall not exceed Fifty Thousand ($50,000) Dollars; and should said bonds, stock, obligations or other liabilities, exceed the amounts above stated, the said party of the second part shall have the right to retain whatever amount they may have to pay by reason of such excess, from the dividends hereinbefore agreed to be paid upon the capital stock.

FIFTH: That the said party of the first part shall not after the date hereof, make or issue any bond or obligation, or issue any stock, unless so requested by the said party of the second part; nor shall they, the said party of the first part, contract any liability or do any act, except upon the request of the party of the second part, whereby the interests of the said party of the second part, as lessees of said property, can be changed or prejudiced; and all stock issued after the date hereof shall be countersigned by such officer of said party of the second part as they may designate.

SIXTH: That the said party of the second part shall, during the continuance of this lease, maintain the narrow-gauge track on the railroad hereby demised, and in case the said road and property should, under the provisions of the second">*2503 article of this indenture or for any other cause, revert to and be taken possession of by the party of the first part, the same shall be surrendered in as good order and condition as the same now is.

SEVENTH: That the party of the second part shall have the right to use the name of the party of the first part in all legal proceedings, necessary to the protection of the rights of the party of the second part, and at the cost and expense of the party of the second part; and the party of the first part shall do all such acts and things at the cost of the party of the second part, as they may be requested by the party of the second part to do and perform, in order to the preservation and protection of the rights and interests of the party of the second part.

EIGHTH: That this indenture shall take effect this day, and possession of said railroad property and effects shall be delivered by the said party of the first part to the said party of the second part, on the first day of March, next, 1869.

NINTH: That all and singular the covenants, agreements, and undertakings, hereinbefore contained, shall apply and inure to the benefit of, and be binding upon the successors and assigns">*2504 of the said parties hereto respectively.

IN WITNESS WHEREOF, the said parties have caused this indenture to be signed on their behalf by their respective presidents, and their respective corporate seals to be hereto affixed, duly attested by their respective secretaries, this thirteenth day of February, 1869.

On July 1, 1867, The Oswego & Syracuse Railroad Co. issued its first mortgage bonds, due July 1, 1885, in the amount of $186,000, for the purpose of financing the construction of a third rail on its railroad property. Said bonds were sold at a discount, and the amount realized therefrom was used to pay for the construction of said third rail. Said third rail was an addition to the petitioner's railroad property and constituted new construction. The period of construction of said third rail was from July 1, 1867, to September 30, 1868. The total life of said bonds was 216 months. The total discount on said bonds was $9,250. The amount of such discount applicable to said construction period was $642.36.

">*909 During the period from May, 1869, to December 1870, inclusive, the Oswego & Syracuse Railroad Co. borrowed from the Delaware, Lackawanna & Western Railroad">*2505 Co. $57,016.57, for the purpose of financing the construction of additions and improvements to its railroad property, consisting of coal docks, piers and trestles at Oswego, N.Y. The amount so borrowed was used to pay for the construction of said additions and improvements, said additions and improvements constituting new construction. The period of construction of said additions and improvements was from May, 1869, to December 1870, inclusive. On said indebtedness, The Oswego & Syracuse Railroad Co. paid to the Delaware, Lackawanna & Western Railroad Co. interest at the rate of 7 per cent per annum. The amount of such interest applicable to said construction period was $3,174.60.

During the period from February, 1874, to October, 1875, inclusive, the Oswego & Syracuse Railroad Co. borrowed from the Delaware, Lackawanna & Western Railroad Co. $2,121.22, for the purpose of financing the construction of additions and improvements to its railroad property, consisting of coal docks, piers and trestles at Oswego, N.Y. The amount so borrowed was used to pay for the construction of said additions and improvements. Said additions and improvements constituted new construction. The">*2506 period of construction of said additions and improvements was from February, 1874, to October, 1875, inclusive. On said indebtedness, the Oswego & Syracuse Railroad Co. paid to the Delaware, Lackawanna & Western Railroad Co. interest at the rate of 7 per cent per annum. The amount of such interest applicable to said construction period was $1,815.16.

During the period from June, 1882, to September, 1883, inclusive, the Oswego & Syracuse Railroad Co. borrowed from the Delaware, Lackawanna & Western Railroad Co. $317,482.05, for the purpose of financing the construction of additions and improvements to its railroad property, consisting of coal docks, piers and trestles at Oswego, N.Y. The amount so borrowed was used to pay for the construction of said additions and improvements. Said additions and improvements constituted new construction. The period of construction of said additions and improvements was from June, 1882, to September, 1883, inclusive. On said indebtedness the Oswego & Syracuse Railroad Co. paid to the Delaware, Lackawanna & Western Railroad Co. interest at the rate of 6 per cent per annum. The amount of such interest applicable to said construction period was">*2507 $13,967.80.

Pursuant to the lease dated February 13, 1869, between the petitioner, lessor, and the Delaware, Lackawanna & Western Railroad Co., lessee, the Delaware, Lackawanna & Western Railroad Co. during each year of the lease and specifically in each year from 1913 to 1920, inclusive, has paid as rental direct to the holders of the capital stock of the lessor semiannually on the 20th days of February and August ">*910 in each year a dividend which during the first three years of the lease amounted to 8 per cent per annum on the par value of the lessor's stock, and in all subsequent years to and including 1920, amounted to 9 per cent per annum on the par value of said stock.

The amount of the dividend paid by the Delaware, Lackawanna & Western Railroad Co. to the holders of the capital stock of the petitioner on February 20 of each of the years 1918, 1919, and 1920, was $59,418; and similarly the amount of the dividend paid to the stockholders of the petitioner on August 20 of each of the years 1918, 1919, and 1920, was $59,418.

At the time of each of said payments of dividends by the Delaware, Lackawanna & Western Railroad Co. to the stockholders of the petitioner">*2508 on February 20 of the years 1918, 1919, and 1920, the petitioner had no earnings or profits accumulated during preceding taxable years, except such part of the said dividend payment made on February 20 as accrued as rental income to the petitioner from August 20 to December 31 of the preceding year.

The only earnings or profits or other income received by the petitioner since January 1, 1913, have been the amounts so paid by the Delaware, Lackawanna & Western Railroad Co., as lessee, direct to the stockholders of the petitioner as dividends semiannually each year, which amounts were constructively received by the petitioner as rental under said lease, and also interest on bonds of the petitioner, amounting annually to $33,400, paid by the Delaware, Lackawanna & Western Railroad Co., as lessee, direct to the owners of said bonds each year, which interest was constructively received by the petitioner as rental under said lease.

On January 1, 1918, the petitioner had an earned surplus, claimed by the petitioner to be $263,739.46, and claimed by the respondent to be $242,825.14, of which in either case $43,627.46 accrued for the period August 20, 1917, to December 31, 1917, and the">*2509 remainder accrued prior to the effective date of the lease executed February 13, 1869.

During the years 1909 to 1917, inclusive, the annual net income of the petitioner was $118,836, plus such amount as should properly be added thereto on account of the inclusion as income to it in each of said years of its Federal income or income and excess-profits taxes for such year or for the prior year assumed and paid by the aforesaid lessee.

The petitioner for the calendar year 1917 returned as income the sum of $118,836, on which the tax computed at 6 per cent was $7,130.16, the same being payable by the lessee, the Delaware, Lackawanna & Western Railroad Co., during the year 1918; that the aforesaid income represented all of the net taxable income of the petitioner except such amount as should properly be added thereto ">*911 on account of the inclusion as income to it in that year of its Federal income or Federal income and excess-profits taxes for that year, or for the prior year assumed and paid by the aforesaid lessee; and that upon a net income of $118,836 for the year 1917, there was no liability for excess-profits taxes under the Revenue Act of 1917.

OPINION.

MILLIKEN: ">*2510 The facts were stipulated and our findings are in accord with the stipulations.

Petitioner contends that interest paid by it on money which was used for constructing additions and betterments was, to the extent of interest paid during the period of construction, a part of the cost of such improvements. It makes the same contention with reference to the discount incurred by it in the issue and sale of its bonds. The deductibility of interest and discount incurred is not involved, but only the question of the exclusion of same from invested capital.

Petitioner's contention is in conflict with the decisions of the Board in Columbia Theater Co.,3 B.T.A. 622">3 B.T.A. 622; Ottawa Park Realty Co.,5 B.T.A. 474">5 B.T.A. 474; Spring Valley Water Co.,5 B.T.A. 660">5 B.T.A. 660; Eastern Rolling Mill Co.,5 B.T.A. 663">5 B.T.A. 663; and Arthur C. Fraser,6 B.T.A. 346">6 B.T.A. 346. The citation of and reliance upon our decided cases would suffice for the decision of this question, but the exhaustive brief filed by counsel for petitioner inclines us to a discussion of the authorities cited and relied on.

In view of the conclusions we have reached, it is not necessary">*2511 to decide whether the discount incurred stands on the same basis as interest paid insofar as invested capital is concerned.

In support of its contention, counsel for petitioner cites the following cases: Brunswick & T. Water District v. Maine Water Co.,99 Me. 371">99 Me. 371; 59 A. 537; Long Branch Commission v. Tintern Manor Water Co.,70 N.J.Eq. 71; 62 A. 474; Pioneer Telephone & Telegraph Co. v. Westenhaver,29 Okla. 429">29 Okla. 429; 118 P. 354; and Shepard v. Northern Pacific Ry.,184 F. 765. It also refers to certain decisions by state railway commissions and rules prescribed by the Interstate Commerce Commission. All these decisions and rules relate to valuations of public utilities for rate-making purposes. In all such proceedings, the controlling issue is present value and the owner is entitled to any increase in value that may have accrued since acquisition. Cf. McCardle v. Indianapolis Water Co.,272 U.S. 400">272 U.S. 400. Precisely the reverse is true in this respect as to invested capital. See ">*2512 LaBelle Iron Works v. United States,256 U.S. 377">256 U.S. 377; 3 Am.Fed. Tax Rep. 3113. This difference in viewpoint is so vital that little help can be derived from rate-making decisions in ascertaining what should be included in invested capital. The cases ">*912 cited hold that interest paid during the construction period should be taken into consideration in computing the cost of a public utility, especially when computing the cost of reproduction. But they further hold that there should be included in such cost, not only the interest actually paid, but also a fair rate of interest on the capital that was not earning income during such period. This latter conception is wholly foreign to the theory of income taxes. Thus, it was said in Walsh v. Brewster,255 U.S. 536">255 U.S. 536; 3 Am.Fed. Tax Rep. 3108:

The second transaction involved the purchase in 1902 and 1903 of bonds of the International Mercantile Marine Company for $231,300, which were sold in 1916 for $276,150. This purchase was made through an underwriting agreement such that the purchaser did not receive any interest upon the amount paid prior to the allotment to">*2513 him of the bonds in 1906, and he claimed that interest upon the investment for the time which so elapsed should be added as a part of the cost to him of the bonds. But this claim was properly rejected by the trial court under authority of Hays v. Gauley Mountain Coal Co.,247 U.S. 189">247 U.S. 189, 38 Sup.Ct. 470, 62 L. Ed. 1061.

Under the above theory, a corporation whose paid in capital was idle during the period of construction, could build up an earned surplus of theoretically earned and received income. Such a theoretically earned surplus has no place in the statutory concept of invested capital. Cf. 256 U.S. 377">LaBelle Iron Works v. United States, supra.

The rule which includes interest actually paid during the construction period is based on the same reason that includes in such cases interest on idle capital. In both cases, the dominating thought in all rate cases, to wit, value, has crept in. The reason for the rule is thus stated in 29 Okla. 429">Pioneer Telephone & Telegraph Co. v. Westenhaver, supra.

It is a matter within the observation and knowledge of all that a plant, the cost of whose physical units put together into a completed plant">*2514 approximates $100,000, cannot be constructed instantly. It requires time to assemble the physical properties, and still a greater length of time to put those units into place, where they may be used to render service. During this period, the capital invested must of necessity be idle, and no income can be derived therefrom. When the construction of the plant is completed, no willing seller, who is not forced to sell, would take for his plant the cost of the physical units and the cost of the labor in the construction, because the plant has cost him, in addition thereto, the use of the capital, or a certain part thereof, invested in the capital, or a certain part thereof, invested in the physical properties during the time of construction. A willing buyer could afford to pay, and would pay, more than the actual cost of labor and material, assuming that the plant has been economically constructed, because such cost would not represent the total expenditures the purchaser would have to make in order to construct the plant himself. In addition to such expenditures, he would have to expend the earnings of his capital during the period of construction. No case has been cited and in">*2515 our investigation we have found no case, involving this question where a reasonable amount has not been considered and allowed for loss of interest during construction as part of the cost of construction.

">*913 The controlling thought in the above decision is that since a willing buyer could afford to pay more for the constructed plant than its actual cost, therefore interest on idle capital should be taken into consideration as an element of cost. It is thus apparent that the court has confused the term value with the term cost. This is not surprising since what the court was endeavoring to arrive at was value and not cost. The same theory, if applied in 255 U.S. 536">Walsh v. Brewster, supra, would have resulted in adding to cost interest from the time of the purchase of the bonds until their delivery, at which time they first began to bear interest. The Supreme Court, however, held that such interest could not be added to cost.

The interest paid by petitioner during the period of construction was not paid for construction but for the use of the money borrowed. The cost of the improvements was one thing and the cost of the money was another. From a tax standpoint, ">*2516 we can see no difference between interest paid during the period of construction and interest paid on the same debt thereafter. The fact that during such period no income was being earned by the improvements did not change a deductible expense into a capital item in this case any more than in 255 U.S. 536">Walsh v. Brewster, supra.

Invested capital is a statutory concept. The meaning of that term is set forth specifically in section 326 of the Revenue Act of 1918. It seems clear that the sum sought to be included in invested capital does not represent (1) actual cash bona fide paid in for stock or shares - no sum was paid in for such purpose; (2) actual cash value of tangible property, other than cash, bona fide paid in for stock or shares - there was no tangible property bona fide paid in for stock or shares; (3) paid-in or earned surplus and undivided profits - the sum paid, now sought to be included in invested capital, in fact represents a diminution of earned surplus and undivided profits; (4) intangible property bona fide paid in for stock or shares prior to March 3, 1917 - certainly no intangible property was paid in for stock or shares; or (5) intangible property">*2517 bona fide paid in for stock or shares on or after March 3, 1917.

We adhere to the conclusions reached in the previous decisions of the Board. Respondent did not err in refusing to permit the inclusion in invested capital of interest paid during the period of construction and the discount on petitioner's bonds applicable to the same period.

Petitioner's second contention involves the construction of section 201 of the Revenue Act of 1918. The pertinent parts of that section read:

(a) That the term "dividend" when used in this title (except in paragraph (10) of subdivision (a) of section 234) means (1) any distribution made by a ">*914 corporation, other than a personal service corporation, to its shareholders or members, whether in cash or in other property or in stock of the corporation, out of its earnings or profits accumulated since February 28, 1913, or (2) any such distribution made by a personal service corporation out of its earnings or profits accumulated since February 28, 1913, and prior to January 1, 1918.

(b) Any distribution shall be deemed to have been made from earnings or profits unless all earnings and profits have first been distributed. Any distribution">*2518 made in the year 1918 or any year thereafter shall be deemed to have been made from earnings or profits accumulated since February 28, 1913, or, in the case of a personal service corporation, from the most recently accumulated earnings or profits; but any earnings or profits accumulated prior to March 1, 1913, may be distributed in stock dividends or otherwise, exempt from the tax, after the earnings and profits accumulated since February 28, 1913, have been distributed.

* * *

(e) Any distribution made during the first sixty days of any taxable year shall be deemed to have been made from earnings or profits accumulated during preceding taxable years; but any distribution made during the remainder of the taxable year shall be deemed to have been made from earnings or profits accumulated between the close of the preceding taxable year and the date of distribution, to the extent of such earnings or profits, and if the books of the corporation do not show the amount of such earnings, or profits, the earnings and profits for the accounting period within which the distribution was made shall be deemed to have been accumulated ratably during such period.

It is apparent, from the facts">*2519 as found, that the dividends paid on February 20 of the years 1918, 1919, and 1920, could have been paid from only two sources - either they were paid out of earnings and profits accumulated prior to March 1, 1913, or they were paid out of the earnings and profits accumulated subsequent thereto.

Under the provisions of section 201(e) the dividend in question is deemed to have been made from earnings and profits accumulated during the preceding taxable years. Under section 201(b) a corporation could not distribute tax-free its earnings and profits accumulated prior to March 1, 1913, until it had distributed all earnings and profits accumulated subsequent thereto. We entertain no doubt that the presumption set forth in 201(e) is a conclusive one. However, we must determined the extent to which it is to be applied. We do not believe that it means that a distribution made during the first 60 days was made from earnings or profits accumulated during preceding taxable years quite regardless of whether or not there were in fact any such earnings or profits. The statute certainly imposes no conclusive presumption that something was done that could not, under the stated facts in this">*2520 case, have been done. Section 201(e) simply creates a conclusive presumption that a distribution made during the first 60 days was made from earnings and profits of prior taxable years only if and to the extent that such earnings or profits actually existed. This view harmonizes with other provisions of the section. A simple illustration may clarify the situation. The "A" ">*915 corporation had, on January 1, 1918, earnings and profits all accumulated prior to March 1, 1913, amounting to $1,000, and on February 1, 1918, without having made any additional earnings and profits, it declared a dividend of $1,000. By reason of the provisions of section 201(b) such a dividend would be treated as paid out of earnings and profits accumulated prior to March 1, 1913, and would be exempt from tax. But respondent would impose the presumption contained in section 201(e). It is, of course, true that if on February 1, 1918, the corporation had earnings or profits made after January 1, 1918, to the amount of $1,000, the dividend would be deemed to have been paid out of such earnings or profits rather than earnings or profits accumulated prior to March 1, 1913, for otherwise, we would be">*2521 going contrary to the provisions of section 201(b). Cf. Mason v. Routzahn,275 U.S. 175">275 U.S. 175.

We are, accordingly, of the opinion that in each of the years in question the dividend was paid out of earnings and profits of the preceding taxable years to the extent that the earnings and profits of such years were available and the remainder was paid out of the earnings and profits of the current year to the extent they were available. The parties have stipulated that of the total surplus at January 1, 1918, $43,627.46 constituted earnings and profits of a prior taxable year, and in accordance with such stipulation we find that to such extent the dividend of $59,418, of February 20, 1918, was paid out of earnings and profits of a prior taxable year and the remaining amount thereof was paid out of the earnings and profits of the current year to the extent there were earnings available. Invested capital should be adjusted in accordance with the foregoing.

Reviewed by the Board.

Judgment will be entered on 15 days' notice, under Rule 50.