#### CHICAGO & ALTON RAILROAD COMPANY v. THE UNITED STATES.

[No. 33198.

Decided December 3, 1917.]

*On the Proofs.*

*Statutes; income tax.*— What constitutes taxable income under the act of August 5, 1909, 36 Stat., 112. *(Maryland Casualty Company*case, 52 0. Cls., 201, followed.)

*The Reporter's*statement of the case:

*Mr. Alexander Britton*for the plaintiff. *Britton <& Gray*were on the briefs.

The only question in the case is whether the proportionate loss under said sale is available to said company as a deduction in arriving at the net returns subject to the tax under the act of 1909 for the years 1911 and 1912.

The Commissioner of Internal Revenue has established a uniform rule of administration in arriving at the net income of corporations on which the tax is to be reckoned under said act of August 5, 1909, which requires that the profit or loss sustained by reason of the disposal of notes or bonds issued by a corporation for a price above or less than par is to be prorated yearly during the life of the bonds or notes.

The bonds or notes in question were issued in the year 1906, prior to the passage of the act authorizing the tax in question, and the agents of the defendant, after examination of the books of the claimants, reported that the losses under the above-mentioned sales at a discount were charged off in full on the books of the company in the year 1906, and solely because of this fact the application of the rule established prorating the loss yearly for the period in which the obligation is to run is held not to apply, and the claim for the refund is denied.

There is clearly no rule of estoppel that would bar the company from making a yearly deduction of the proportionate amount due to the loss under the issue of bonds when making its return of annual net income under the *42excise law, merely because of the previous memorandum respecting the issue upon its books. Ño rights of the United States were prejudiced thereby, nor did any advantage flow to the company therefrom. As a consequence, the right of both parties, the United States and the railroad company, were unimpaired by the action, which, as before stated, was entirely immaterial at the time record of the transaction was made upon the company’s books.

The principle herein contended for was sustained in *Baldwin Locomotive Works*v. McGoach, 215 Fed., 967, wherein the court held (syllabus) :

“The net income of a corporation, subject to excise tax under act Aug. 5, 1909, c. 6, §38, 36 Stat., 112 (U. S. Comp., St. Supp., 1911, p. 946), is not to be determined by bookkeeping facts, but by the real facts of gross income and actual payments therefrom for the purposes specified, to which may be added only a reasonable allowance for depreciation of property, if any. An increase in the book value of the assets of a corporation by a revaluation of property does not constitute any part of the gross amount of its ‘ income received within the year.’ On the other hand, a book charge because of the sale of an issue of bonds at less than par, or because of bad debts or for money paid out for charities, is not a part of the ‘expenses actually paid within the year out of income ’ to be deducted from gross income.”

The rule thus stated and the principle of law thus laid down is further supported by *United States*v. *Nipissing Mining*Go., 202 Fed., 803, wherein the court said:

“The suggestion that there can be no allowance for depreciation unless such depreciation is entered in the books of the company recorded from time to time, seems to be without force. The books may be very badly kept, kept in such a way as will in the end bring them into trouble-and difficulty; *but this act does not provide any penalty for bad bookkeeping.*It simply provides that 1 per cent of the net profit of the various corporations shall be turned over to the Government, and provides that in finding out that net profit there should be a reasonable allowance for depreciation.”

Again in *Forty Fort Goal Go.*v. KirhendaTl, 233 Fed., 704, in considering a case under this same act of August 5, 1909, the court said:

*43*“*The decisions under the excise tax law, and under the income tax law, are uniform to the effect that the Goyernment can not base a claim for taxes on mere bookkeeping. *Industrial Trust Go.*v. *Walsh,*222 Fed., 437; *Baldwin Locomotive Works*y. *McGoach,*221 Fed., 59. In the latter case it was decided by the Circuit Court of Appeals for this circuit that mere reappraisement of property mining corporations carry on its books can not form the basis of assessment of taxes on net income, even though the books show that during the tax year the value of the property was increased by the amount on which the Government claims the regular rate of tax.”

In *Mitchell Bros. Go.*v. Doyle, 225 Fed., 437, the court said:

“ The fact that plaintiff carried its properties upon its books at their original cost prices is neither material nor important. Mere bookkeeping entries can not preclude the Government from collecting its revenue nor are such entries conclusive upon the taxpayer, when it is shown as here that they represent and indicate ancient instead of present actual values. The bookkeeper creates nothing. His methods, figures, and records must yield to proven and established facts.”

In the light of these decisions, we feel justified in asking that this court find that mere bookkeeping should not control the payment of taxes under the act of 1909, but that such bookkeeping figures, if inaccurate, must be made to yield to the actual facts as same may be found to exist.

*Mr. Harvey D.*Jacob, with whom was *Mr. Assistant Attorney General Huston Thompson,*for the defendants.

Booth, *Judge,*

reviewing the facts found to be establishedj delivered the opinion of the court:

The claimant railroad company in 1906 issued and sold at a discount $11,000,000 refunding bonds and $1,960,000 of equipment notes. The transaction was fully consummated within the above year, and the books of the company disclose the loss under the profit and loss account. Subsequently Congress passed the act of August 5, 1909, 36 Stat., 112, the material portions of which are as follows:

> “ Sec. 38. That every corporation * * * organized for profit and having a capital stock represented by shares * * * now or hereafter organized under the laws * * * of any State or Territory of the United States * * * *44shall be subject to pay annually a special excise tax with respect to the carrying on or doing business by such corporation * * * equivalent to one per centum upon the entire net income over and above $5,000 received by it from all sources during each year, exclusive of amounts received by it as dividends upon stocks of other corporations * * * subject to the tax hereby imposed. * * * Second. Such net income shall be ascertained by deducting from the gross amount of the income of such corporation * * * received within the year from all sources (first) all the ordinary and necessary expenses actually paid within the year out of income in the maintenance and operation of its business and properties, including all charges, such as rentals or franchise payments, required to be made as a condition to the continued use or possession of property. (Second.) All losses actually sustained within the year and not compensated by insurance or otherwise, including reasonable allowance for depreciation of property, if any. (Third.) Interest actually paid within the year on its bonded or other indebtedness, * * * not exceeding the paid up capital stock of such corporation * * *. (Fourth.) All sums paid by it within the year for taxes * * *. (Fifth.) All amounts received by it within the year as dividends upon stocks of other corporations * * * subject to the tax hereby imposed.”

The claimant company, following the terms of the above legislation, made its annual returns to the Commissioner of Internal Eevenue for the purpose of excise assessment, omitting in each instance to claim a reduction of taxes because of the bond-and-note transaction now in issue. It now claims the right to a refund of a proportionate amount for the years 1911 and 1912 of the full discount suffered by it in the sale of said bonds and notes. The claim is not predicated upon any express provisions of the corporation excise act; on the contrary, relief is sought under a ruling of the Commissioner of Internal Eevenue wherein it was held that the contention now put forward by the claimant company was tenable. This court had occasion in the case of the *Maryland Casualty Co.*v. *United*States, 52 C. Cls., 201, to treat the issue here involved. We defined, in the above case, our views as to taxable income under the excise law of 1909. This case falls within the rule there laid down. It is, indeed, a much weaker case, for the claimant company prior to the passage *45of the act of 1909, *supra,*had. fully closed the transaction now insisted upon. As affecting its income or deductions therefrom in the year 1909 it was then simply one of the claimant company’s past fiscal transactions appearing upon its books to be treated under the excise law by the commissioner as its terms demanded. This, we think, we have fully discussed heretofore.

The petition will be dismissed. It is so ordered.