2. The payments so made by the proprietary companies as rentals which were earnings of the latter's operation "proceed from the property" of the terminal company, and constitute a profit therefrom (equally whether or not there was a net gain or net income to it), notwithstanding the agreement that they were not to be transformed into dividends and were ultimately to be a reserve fund for additions, improvements, and reconstruction of the terminal property. 3. Decision of the District Court reversed. TREASURY DEPARTMENT, OFFICE OF COMMISSIONER OF INTERNAL REVENUE, To Collectors of Internal Revenue and Others Concerned: The attached decision of the United States Circuit Court of Appeals for the Sixth Circuit in the case of Elwood Hamilton, collector, v. Kentucky & Indiana Terminal Railroad Co., is published for the information of internal-revenue officers and others concerned. Approved September 20, 1923: A. W. MELLON, D. H. BLAIR, Commissioner of Internal Revenue. Secretary of the Treasury. UNITED STATES CIRCUIT COURT OF APPEALS, SIXTH CIRCUIT. No. 3821. Elwood Hamilton, late collector of internal revenue, plaintiff in error, v. Kentucky & Indiana Terminal Railroad Co., defendant in error. ERROR to the District Court of the United States for the Western District of Kentucky. Before KNAPPEN, DENISON, and DONAHUE, Circuit Judges. KNAPPEN, Circuit Judge: Defendant in error, which we shall call the terminal company, during the years 1915, 1916, and 1917 owned and operated a bridge across the Ohio River for railroad, street-car, wagon, and foot purposes between Louisville, Ky., and New Albany, Ind. By section II A (1) [II G (a)] of the revenue act of October 3, 1913 (38 Stat. 114, 166), the terminal company was liable to a tax of 1 per cent upon its "entire net income arising or accruing from all sources" during the year 1915; by title 1, Part II, section 10, of the revenue act of September 8, 1916 (39 Stat. 756, 765), it was liable to a tax of 2 per cent upon such income during the year 1916; and by Title I, section 4, of the revenue act of October 3, 1917 (40 Stat. 300, 302), it was liable to a tax of 4 per cent upon such income during the year 1917. Taxes assessed for each of the three years were paid under protest and suit brought for their recovery. The only question presented is whether in that suit the district court rightly rendered judgment for the terminal company, upon the ground that it had not during any of the years in question any taxable income whatever. The terminal company was organized with a capital stock of $75,000 held (except as to a few qualifying shares) in equal proportions by three railroad companies (the Southern, the Baltimore & Ohio Southwestern, and the Chicago, Indianapolis & Louisville), which acquired the termiual properties (as stated in the plan of reorganization) "for the equal benefit" of the three companies, and "not for the purpose of making any pecuniary profit from the undertaking," but "with the view to secur ing to these companies terminal facilities in the city of Louisville and without any purpose of making the corporate organization a profitable one in the way of dividends upon any corporate stock to be issued by the new corporation." During the years in question the terminal company had an outstanding mortgage bond issue of more than $6,000,000, the payment of both principal and interest whereof was guaranteed by the three railroad companies to facilitate the sale. By contract between the terminal company and the three proprietary companies each of the latter was to have "full and equal rights with the others" in the terminal property, each agreeing for a period extending beyond the taxing years in question to make use of the terminal company's properties for all passenger and freight traffic within its control destined to cross the Ohio River at Louisville. Each proprietary railroad company was to be charged the same amount for switching per car, but any deficit of the terminal company was to be "made up" by the three proprietary companies in proportion to each company's use of the terminal,' the terminal company being required to render monthly bills to the proprietary companies for switching charges, and also monthly bills to each showing amounts due by each company under the clause we have quoted in the margin, each bill to include in its estimates one-twelfth part of the annual taxes and of the annual fixed charges. Provision was also made for excluding any proprietary company which defaulted in payment of such bills from further use of the terminal company's property and from enjoyment of the terminal service. It was also provided that until otherwise expressly agreed by the proprietary companies no dividend from profits should be declared by the terminal company, but that "all surplus and net earnings and income shall constitute a reserve fund for additions to and improvements and reconstruction of the property of the terminal company." If the payments so made by the proprietary companies are excluded from the terminal company's returns, that company not only had no income, but it suffered a substantial deficit during each of the years in question. If, however, the contributions by the proprietary companies constitute income, the terminal company had a substantial net income within the meaning of the statute for each of the three years, due to the fact that while the proprietary companies paid the bond interest in full, the terminal company was entitled in computing its net amount to deduct but a a trifle more than one-half of the amount of the interest so paid. The terminal company raises no question of the validity of the income tax provisions so limiting interest deductions. See Anderson v. 42 Broadway Co. (239 U. S. 69; T. D. 2261). It results that if the payment of the bond interest by the proprietary companies to the terminal company was income, the judgment below is concededly wrong and should be reversed. The case thus turns solely upon the definition of income. In Stratton's Independence v. Howbert (231 U. S. 399, 415; T. D. 1913), income was defined as "the gain derived from capital, from labor, or from both combined." In Doyle v. Mitchell (247 U. S. 179; T. D. 2723), this definition was approved when made to include profit gained through a sale or conversion of capital assets. In Eisner v. Macomber (252 U. S. 189, 207; T. D. 3010), and in United States v. Phellis (257 U. S. 156, 168-9; T. D. 3270), (both of which were stock-dividend cases), the definition above quoted was approved, being elaborated in statement (to use the language of the Phellis case) as "a gain derived from capital, not a gain accruing to capital, nor a growth or increment of value in the investment, but a gain, a profit, something of 1 The contract provided that the proprietary companies "shall pay for the use of the property and facilities of the said terminal company such sums of money as shall from time to time be required, in addition to other revenues of the terminal company, to meet all expenses of operation and maintenance of the property of the terminal company and all of its obligations for taxes and interest upon its first-mortgage bonds as the same may be outstanding from time to time; the respective amounts to be paid by each company being fixed and determined" on a basis of usage of the terminal property. 2 During the year 1915 the proprietary companies, under the contract provisions referred to paid, $363,445.59; during 1916, the sum of $361,994.47; during 1917, the sum of $534,981.16. exchangeable value, proceeding from the property, severed from capital, however, invested, and coming in; that is, received or drawn by the claimant for his separate use, benefit, and disposal." The terminal company invokes these definitions, and contends that the payments made by the proprietary companies are wholly excluded therefrom. In this connection it contends that its road was not operated for profit, and invokes the broad proposition that the income tax laws do not treat as income that which in the generally accepted sense is not income. We think these contentions overlook the substantial situation. The payments made by the proprietary companies were part of the rentals to be paid by those companies for their use of the terminal facilities. The terminal company had a substantial gross income apart from payments made by the proprietary companies. The latter needed the terminal facilities, and were willing to pay what these facilities were worth. They found it to their interest as stockholders to own equal interests in the stock, but as proprietary companies (as distinguished from their interests as stockholders) they saw fit to contract to pay to the terminal company, which owned and operated the physical properties, whatever amount was required above receipts from other sources to meet the expenses of operation, repairs, maintenance, and conservation of property, including interest upon the corporate indebtedness. These contributions were apportioned according to the beneficial use of the terminal facilities which each of the three proprietary companies enjoyed. These payments were nothing more or less than rentals of the terminal facilities. It could not well be doubted that had they been beforehand fixed in amount they would properly be treated as income. That these amounts were uncertain until fixed by experience does not alter their essential nature. Nor is it open to reasonable doubt that had the amount of these so-called deficiency payments been derived from rentals to other than the proprietary companies they would have constituted income. Upon principle, we think these payments were true income, and they did not fail of being such from the fact that as the only (at least the chosen) means of obtaining the terminal company's facilities, and the preferred rights thereunder, the proprietary companies were required to pay more for the facilities than perhaps could be obtained for casual or less complete or less important service. Nor, in our opinion, can it properly be said that the corporation was not organized for profit. The contract provision that until otherwise expressly agreed by the proprietary companies no dividend from profits should be declared, etc., does not preclude a change of policy in that regard. Nor do we think that payments such as are here in question are outside the generally accepted definition of income. We think it clear that the payments so made by the proprietary companies as rentals did "proceed from the property" of the terminal company, were earnings of the latter's operation, and did constitute a profit therefrom (and equally whether or not there was a net gain or net income), notwithstanding, according to the then existing policy, such profits were not to be transformed into dividends but were ultimately to find their way into "additions to and improvements and reconstruction of the property of the terminal company." The contemplated "reserve fund" to result from "surplus and net earnings and income" could be nothing else than profits. The fact that a net income, in a taxable sense, resulted only because the terminal company could not deduct from the rentals received all the interest paid is unimportant, as has already appeared. That statutory "net income" was directly and immediately due to the interest payments made by the proprietary companies is not important. We are not impressed with the terminal company's contentions that it acted only as distributing agent in the collection of the interest payments from the proprietary companies. The terminal company owned the terminal properties subject to the payment of the mortgages thereon. The interest money was thus paid to and used by the terminal company for meeting charges against its own property, default in whose payment might well result in the loss of the property. Had the interest payments been made by the proprietary companies directly to the bondholders or the mortgage trustee, the payments would have been none the less income of the terminal company.-Anderson v. Morris, etc., Co. [C. C. A.] (216 Fed. 83, 90). It has been held that interest on bonds of a lessor company and dividends to stockholders of such company, paid as part of rentals by a lessee company, are "income" of the lessor company.-Rensselaer, etc., Co. v. Irwin [C. C. A. 2] (249 Fed. 726); Northern Ry. Co. v. Lowe (C. C. A. 2] (250 Fed. 856). That dividends on stock paid by a lessee company directly to the lessor's stockholders, as part of an agreed rental, constitute "income" of the lessor corporation is held in West End Street Railway v. Malley [C. C. A. 1] (246 Fed. 625; T. D. 2620). Our conclusion, so far stated as on principle, that the proprietary companies' payments here involved are income within the taxing acts here in question, is fully supported by reasoned and convincing adjudications, which we are content to follow.-Boston Terminal Co. v. Gill [C. C. A. 1] (246 Fed. 664; T. D. 2671); Houston Belt & Terminal Ry. Co. v. United States [C. C. A. 5] (250 Fed. 1; T. D. 2710). The Boston Terminal case was in its facts almost identical with the instant case. The Houston Terminal case directly involved, as did the Boston Terminal case, the question of interest upon a terminal company's bonds. Every vital question here involved was presented and decided in one or both of these cases. The terminal company here makes no attempt to distinguish these cases from the instant case. It results from these views that the judgment of the district court should be reversed, and the cause remanded with directions to take further proceedings not inconsistent with this opinion. (T. D. 3519.) Income and profits tax-Revenue act of 1917-Decision of court. 1. EXCESS-PROFITS TAX-SEPARATE RETURN. Under the excess-profits-tax provisions of the act of October 3, 1917, and the regulations thereunder, an individual who receives income from a trade or business having an invested capital is required to file a separate excess-profits-tax return in addition to his income-tax return. 2. EXCESS-PROFITS-TAX RETURN-PENALTY FOR FAILURE TO FILE. Failure to file such a return under the conditions stated subjects the taxpayer to the penalty prescribed by section 3176, Revised Statutes, as amended, even though he makes an income-tax return which impliedly shows that he was not engaged in a business having an invested capital and that he did not owe any excess-profits tax upon income derived from a business having invested capital. 3. RETURN-FAILURE TO FILE-REASONABLE CAUSE For Failure. The fact that the taxpayer turned over to an expert accountant what he thought was all the data necessary to make out complete and accurate income and excessprofits-tax returns, and that through inadvertence he failed to give the accountant all the necessary facts, as a result of which his income was understated in his incometax return and no excess-profits-tax return was filed does not constitute reasonable cause for failure to file an excess-profits-tax return, the facts also showing that the taxpayer executed the income-tax return without looking at it or noting the amount thereof. 4. APPEAL AND ERROR-MATTERS CONCLUde, by JudgmENT IN TRIAL BY COURT. In an action by a taxpayer to recover a refund of a penalty of 50 per cent imposed by the Commissioner of Internal Revenue under section 3176, Revised Statutes, as amended by section 16 of the revenue act of 1916, and paid under protest, where a jury is waived, a judgment dismissing the action involves a finding of fact that the plaintiff failed to make and file a return within the time prescribed by the statute. TREASURY DEPARTMENT, OFFICE OF COMMISSIONER OF INTERNAL REVENUE, Washington, D. C. To Collectors of Internal Revenue and Others Concerned: The attached decision of the United States Circuit Court of Appeals for the Sixth Circuit in the case of James B. Beam v. Elwood Hamilton, collector, is published for the information of internal-revenue officers and others concerned. D. H. BLAIR, Commissioner of Internal Revenue. Approved September 20, 1923: A. W. MELLON, Secretary of the Treasury. UNITED STATES CIRCUIT COURT OF APPEALS, SIXTH CIRCUIT. NO. 3787. James B. Beam, plaintiff in error, v. Elwood Hamilton, collector of internal revenue, defendant in error. Error to the District Court of the United States for the Western District of Kentucky. Before KNAPPEN, DENISON, and DONAHUE, Circuit Judges. KNAPPEN, Circuit Judge: This writ brings up for review a judgment rendered in favor of the collector in a suit by plaintiff in error to recover a penalty of 50 per cent assessed (and paid under protest) for alleged failure to make a return under the revenue act of October 3, 1917 (40 Stat. 300). During that calendar year (and for many years before) plaintiff in error was the vice president and general manager of a distillery, for which service he received an annual salary of $4,200. On his shares of stock therein he drew dividends of $18,000. He was also on his own account (and for several years preceding had been) engaged in the business of registered distiller and wholesale and retail liquor dealer, and as such distiller owned and operated that individual business. He made an income-tax return showing the salary and dividends referred to and several thousand dollars of other income (not connected with his personal distillery and liquor business), showing a net taxable income of $27,472.78, on which a tax of $1,360.74 was computed and paid. No return whatever was made of his income from his personal business as distiller, etc., from which he received during 1917 an income of $51,994.70. A return thereof would have made plaintiff liable to an additional income tax of $4,333.18 (a total of $5,693.92 instead of $1,360.74), and to an excess-profits tax of $21,155.47. On discovering this situation the commissioner made a new assessment of taxes on the correct basis, adding to the taxes assessed a penalty of 100 per cent ($5,693.92) for making a false and fraudulent return, and a penalty of 50 per cent upon the excess-profits taxes for failure to make and file an excess-profits return. The entire of the additional taxes and penalties so assessed was paid under protest. In this suit to recover both items of penalties paid, the district court (which tried the case on statutory waiver of jury, under Rev. Stat. 649, U. S. Comp. Stat. sec. 1587) concluded that the return actually made was not false and fraudulent, it appearing to have been prepared by an expert accountant, plaintiff in error claiming he had given the accountant full data for the return and that he had executed the same without “looking at it or noting the amount thereof." |