"It is said that the value of these franchises depends very much upon skill in their management, and as such skill cannot be valued, and cannot be eliminated in the valuation of the franchises, there is great difficulty in estimating their value, as they would have little value but for skill in their management. But it is possible to obtain skill by the payment of salaries, which enter into the expense of management. Such property must not be valued at what it is worth under bad management, but it may be valued at what it is worth under good management. These properties must be taken for assessment for what they are, with all their capabilities and possibilities under such management as can ordinarily be obtained. A person buying one of these franchises, would consider, in fixing his price, not what it was capable of producing under poor management, but under good management. Its actual earning power, its capabilities, fix its value. It is not the use to which one of these franchises is actually put that is the sole test of its value, but the uses to which it may be put may be considered."

The Court of Appeals in the Jamaica Water Supply Co. case (196 N. Y. 39), says:

"Take, for example, the case of a corporation enjoying a special franchise which by reason of mismanagement or other causes had yielded no earnings perhaps for many years; there it might be wholly contrary to the truth to hold that the special franchise of such corporation had no value simply because there happened to have been no earnings by which that value could be measured."

Rules of valuation.-The so-called "net earnings" rule which has been applied more generally than any other is an ascertainment of the value by a capitalization of the net earnings. Another rule is the "stock and bond method," which is the multiplication of the par value of the outstanding corporate securities by their market quotations.

In People ex rel. Queens County W. Co. v. Woodbury (67 Misc. 490-501), the Court, in his opinion, gives an illustration of using the "stock and bond method" as a test.

"The issued capital stock of the company is $1,050,000, and its bonded indebtedness $500,000. Four and one-half per cent. dividends were paid on the stock last year and interest at five per cent. on the

bonds. The bonds are presumably worth par and the stock has never sold above par, the last sale of which we have knowledge being eighty cents on the dollar. As the capital stock and bonds represent all the property of the company, both tangible and intangible, its selling value is some evidence of the value of all the company's property. If it should appear that the value of the tangible property is equal to or greater than the selling value of all its stocks and bonds, this would furnish some evidence that the intangible property has no value."

Judicial comment on "net earnings" rule.-Other rules applicable to particular cases have also been invoked; for instance, where neither of the foregoing rules is applicable as in the case of a railroad constructed but not in operation. People ex rel. H. & M. R. R. Co. v. Tax Comm'rs, 142 App. Div. 220. In that case it was finally held that the structure was properly assessable at the cost of reproduction but under the circumstances no assessment should have been placed upon the franchise. People ex rel. H. & M. R. R. Co. v. Tax Comm❜rs, 203 N. Y. 119-130. Cullen, J., in his opinion in this case referring to the net earnings rule, says:

"It is also true that that method of computation is not universally applicable. Nevertheless, in ordinary cases it is the best practical method that the taxing officers and the courts have as yet been able to evolve. I have said that in some cases it would be inapplicable; for instance: We all know that a franchise to maintain a street railroad on Fifth Avenue in New York City would be worth a fortune and could be easily disposed of by the holder though not a rail had been laid or bought. If in that case the owner of the franchise were hawking it for sale, the mere privilege or franchise might probably be assessed at a large sum, its value being so great in proportion to the cost of the plant necessary for the exercise of the franchise." "The more the net earnings rule is examined, the more apparent becomes the wisdom of our appellate tribunals in holding that it does not furnish a method which is necessarily controlling in determining the value of a special franchise. It is obvious that the application of this rule reduces the value of the special franchises by the amount of every increase in the tangible property and in the business." (People ex rel. Q. C. Water Co. v. Woodbury, 67 Misc. 490, 499.)

Application of "net earnings" rule.- The "net-earnings" rule was first applied in this state by the referee in People ex rel. Brooklyn City R. R. Co. v. Tax Comm'rs, New York Law Journal, March 5, 1907, and followed by the referee in re People ex rel. Jamaica Water Supply Co. v. Tax Comm❜rs (report confirmed Albany Special Term, April 9, 1908). The Appellate Division, Third Department, modified the rule as applied by the referee in the latter case (People ex rel. Jamaica W. S. Co. v. Tax Comm'rs, 128 App. Div. 13) and the Court of Appeals approved the method adopted by the referee and modified the order of the Appellate Division. People ex rel. Jamaica W. S. Co. v. Tax Comm'rs, 196 N. Y. 39.

The definition of the net earnings rule and the method of its application as laid down in the Jamaica Water Supply Co. case (supra) is as follows:

"The net earnings rule contemplates a valuation upon the basis of the net earnings of the corporation which are attributable to its enjoyment of the special franchise. The method is thus applied:

(1) Ascertain the gross earnings.

(2) Deduct the operating expenses.

(3) Deduct a fair and reasonable return on that portion of the capital of the corporation which is invested in tangible property. The resulting balance gives the earnings attributable to the special franchise. If this balance be capitalized at a fair rate we have the value of the special franchise."

Having thus determined the value of the intangible right of the special franchise, the value of the tangible property "situated in, upon, under or above any street, highway, public place or public waters in connection with the special franchise" (Tax Law, Article I, Sec. 2, Subd. 3) is then added and the result obtained is the total value of the special franchise under the Tax Law.

Deductions in application of net earnings rule.-Many questions have arisen as to deductions allowable under this rule.

The following items have been approved by the courts: (a) Taxes.

(b) Allowance out of gross earnings for depreciation.

(c) Deduction to meet general deterioration (functional depreciation; obsolescence).

(d) Money paid for claims for personal injuries.

(e) Allowance for a return upon the investment in tangible property; what may be included therein and its valuation.

(a) Taxes.-Taxes should be deducted from the gross earnings to determine the net earnings; but not the estimated amount of the special franchise tax itself. (Re-argument of Jamaica Water Supply Co. case, 197 N. Y. 33; People ex rel. Third Avenue R. R. Co. v. Woodbury, 136 App. Div. 155.) (b) Allowance out of gross earnings for deterioration.

"Judicial notice may be taken of the fact that in the conduct of many industrial enterprises there is a constant deterioration of the plant which is not made good by ordinary repairs which, of course, operates continually to lessen the value of the tangible property which it affects. The amount of this depreciation differs in different enterprises, but the annual rate is usually capable of estimate and proof by skilled witnesses. No corporation would be regarded as well conducted which did not make some provision for the necessity of ultimately replacing the property thus suffering deterioration; and we cannot see why an allowance should not be made out of gross earnings in order to ascertain the true earning capacity." (Jamaica Water Supply Co. case, 196 N. Y. 39.)

"A public service corporation, with reference to its property which will become worthless by use and must be replaced, is entitled to set aside each year from its earnings a reasonable sum to provide for its replacement. This is outside of the ordinary annual expenses for maintenance, renewals and repairs." (People ex rel. Third Ave. R. R. Co. v. Tax Comm❜rs, 136 App. Div. 155; affirmed 198 N. Y. 608.)

In the case of People ex rel. Manhattan Ry. Co. v. Woodbury (203 N. Y. 231), Judge Haight, writing the concurring opinion, says:

"The Special Term in this case, however, adopted a plan of amortization upon which an annual sum was authorized to be set apart as a sinking fund, which, by compounding the interest thereon for a period equal to the life of the structure, tracks, engines, machinery and rolling stock, would at the end of that period create a fund sufficient to replace the property. The difficulty with such holding is that railroad corporations do not reconstruct their railroads and rolling stock in that way. In order to afford proper protection to the public, they are required to maintain a high state of efficiency both in roadbed and rolling stock. The relator's railroad has been in existence already for about thirty years and some portion of its property has already suffered from decay and use to such extent that portions thereof have to be reconstructed and made new each year. Old ties have to be removed and replaced with new ones; old rails that have become worn and battered have to be removed and their places supplied with new rails, and so the work of reconstruction progresses from year to year. It is not the waiting forty or sixty years to reconstruct, during which time the amount set apart as a sinking fund may be doubled many times over by compounding the interest, but it is the annual expenditure for reconstruction which is to be paid for at the time that the construction is made. To illustrate: Suppose the average life of the tangible property of a railroad, outside of the land itself, to be sixty years and the cost of reconstruction to be sixty million dollars, it would follow that one million dollars would have to be used each year in reconstruction and that amount would have to be annually used for that purpose, but under the plan adopted in this case, instead of deducting from the gross earnings the amount necessarily expended for that purpose a small fraction of that sum, viz.: $4,200 only, is allowed to be deducted, a sum which, with the interest compounded for the next sixty years, would amount to a million dollars. Under such a plan the company would be practically prohibited from annually constructing a portion of its road and thus prevented from keeping it in that state of efficiency which the public demands. Of course, the necessities of reconstruction vary from year to year; some years it may be greater than others, but the assessors each year can easily ascertain the sum required for that purpose. I think, therefore, that we should adhere to the rule sanctioned in the Jamaica case and that a gross sum should be deducted annually for the purposes of reconstruction."

(c) Deduction to meet general deterioration (functional depreciation; obsolescence).-In writing the concurring opinion in the Manhattan Railway Co. case (supra), Judge Haight observed further,