#### AMERICAN TELEGRAPH & CABLE CO. v. THE UNITED STATES 1

[No. D-358.

Decided December 7, 1925]

*On the Proofs*

*Income taxes; payment of rental to stockholders.*— Where one of the stockholders of a corporation guarantees the othear stockholders by indorsement on their certificates, certain dividends, and pays to said stockholders their respective proportions of an agreed annual rental which is secured by said guaranty of dividends, the rental so paid is an income of the corporation and taxable as such.

*327*The Reporter's*statement of the case:

*Messrs. Francis R. Stark*and *Sanford Robinson*for the plaintiff. *Messrs. Francis N. Whitney*and *J. Julien Southerland*were on the brief.

*Mr. Charles T.*Hendler, with whom was *Mr. Assistant Attorney General Herman J.*Galloway, for the defendant. *Messrs. Edwin S. McCrary*and *A. W. Gregg*were on the brief.

The court made special findings of fact, as follows:

I. Plaintiff is a corporation organized and existing under the laws of the State of New York, with its principal office in the Borough of Manhattan, city, county, and State of New York.

II. The plaintiff is now and at all times during the year 1922 was the owner and lessor of two certain trans-Atlantic cables and other telegraph properties described in the leasehold agreement between the plaintiff and the Western Union Telegraph Company, dated May 12, 1882, and supplemental leasehold agreement between the same parties dated November 15, 1883. Copies of said agreements are attached to the petition marked “ Exhibit A” and are made a part of this finding by reference. The third, fourth, fifth, and ninth paragraph of said leasehold agreement dated May 12,1882, it is stipulated, are not modified or in any way altered or changed by the said supplemental agreement, and these paragraphs appear in Exhibit A aforesaid. The properties described in the lease were delivered by the plaintiff to the Western Union Telegraph Company on or about the date of the lease. The Western Union Telegraph Company is still in possession of the telegraph and cable properties described in the lease and was so during the year 1922.

III. Plaintiff prepared a corporation income-tax return on Form 1120 for the calendar year 1922. Such return was filed with the collector of internal revenue for the second district of New York on or about March 14, 1923. The said return showed $73,016.25 as the total amount of tax due, upon the items of $584,530 and $1,719.19 hereafter mentioned.

*328IV. Thereupon there was levied upon plaintiff upon its income for 1922, as shown by said return, a tax of $73,-016.25, which plaintiff duly paid. Of this amount $54,-762.19 was paid in three equal installments on or about March 14,- June 15, and September 15, 1923, respectively, to the said collector of internal revenue. The fourth installment of $18,254.06 of said total tax was paid by plaintiff to the said collector of internal revenue on or about December 15, 1923, under protest.

Y. On December 15, 1923, plaintiff prepared and filed with the said collector of internal revenue an amended income-tax return, Form 1120, for the calendar year 1922, in which said amended return plaintiff reported that there was no net income for the year 1922.

VI. On December 15, 1923, plaintiff appealed to the Commissioner of Internal Revenue for the refund of $73,-016.25 paid as aforesaid, by duly filing a claim for refund in said amount on Form 843, sworn to December 15, 1923, and said claim was rejected by the Commissioner of Internal Revenue.

VII. In accordance with the provisions of said agreement, the Western Union Telegraph Company endorsed upon each certificate of plaintiff’s stock and caused to be signed by its officers a,paragraph in these words:

“ Guarantee.

“ The Western Union Telegraph Company hereby, for value received, guarantees quarterly dividends of one and one-quarter per cent payable at the end of each quarter, to wit, on the first days of September, December, March, and June, respectively, upon the par value of the capital stock represented by the within certificate, in accordance with the terms and conditions of an agreement between the said Western Union Telegraph Company and the American Telegraph and Cable Company dated May 12th, A. D. 1882.”

VIII. Throughout the year 1922 the Western Union Telegraph Company was the legal and equitable owner of 23,094 shares of the capital stock of the plaintiff of a par value of $100.00 each, amounting to $2,309,400.00. The pro rata amount of gross rental represented by the Western Union Telegraph Company’s ownership of plaintiff’s stock during *329the calendar year 1922 amounted to $115,470.00, and this proportion of gross rental was never paid or credited by the Western Union Telegraph Company either to the plaintiff or to any of its stockholders. Such amount was not entered upon the books of the Western Union Telegraph Company either as a credit to the plaintiff or as dividends charged upon plaintiff’s stock held by the Western Union Telegraph Company or in any other way. This amount is not included in the amount of $586,249.19, reported in the original tax return filed by the plaintiff. This item of $586,249.19 is made up of two items, namely, $584,530.00, which was paid by the Western Union Telegraph Company to the stockholders in the lessor company, other than itself, and a further item of $1,719.19, paid to plaintiff for operating expenses.

IX. During the year 1922 the Western Union Telegraph Company paid to each of the persons who were the stockholders of the plaintiff other than said Western Union Telegraph Company their respective proportions of annual rental provided for under said rental agreement, amounting to $584,530.00 for that year, and during 1922 the Western Union Telegraph Company also paid to the plaintiff $1,719.19 to reimburse the plaintiff for its operating expenses during the year’, which were exactly equal to that amount. Said item of $1,719.19 was the only item paid directly to the plaintiff during the year 1922.

X. Since the lease was entered into in 1882 the plaintiff has never operated its cables nor engaged in any business whatsoever except the election of officers, the filing of reports and returns required by law, and the maintenance of the organization of the plaintiff as a corporation. It has never owned any property other than that described in the lease.

XI. No part of said sum of $73,016.25 has been repaid to the plaintiff. There are no offsets or credits of any kind dué from the plaintiff to the United States except that the Commissioner of Internal Revenue has made an additional assessment of $13,176.64 for the year 1918 on the ground that the plaintiff was the recipient of additional income *330representing 5 per cent on the par value of the plaintiff’s stock owned by the Western Union Telegraph Company, which the Western Union Telegraph Company never paid to the plaintiff or to anyone else, but deducted from the total annual rental payment under the leasehold agreement of May 12, 1882, and which said assessment is still unpaid. The plaintiff has filed a claim for abatement of this tax which has not yet been acted upon by the Commissioner of Internal Revenue.

The court decided that plaintiff was not entitled, to recover.

1

 Writ of certiorari denied.

Campbell, *Chief*Justice,

delivered the opinion of the court:

The facts are practically undisputed and the question for decision is whether the plaintiff corporation was liable to an income tax under the revenue act of 1921 upon the rental for plaintiff’s properties paid by another corporation under the terms of a fifty-year lease, whereby the latter, as lessee, agreed to pay and did pay the stipulated rent to the stockholders in the lessor company. The tax in question was paid, and upon plaintiff’s appeal to the Commissioner of Internal Revenue a refund of it was refused.

By a leasehold agreement dated May 12, 1882, and a supplemental leasehold agreement between the same parties, dated November 15, 1883, plaintiff leased to the Western Union Telegraph Company two trans-Atlantic cables and certain other properties for the term of fifty years, for the yearly rental of $700,000, payable quarterly. Its undertaking in that regard appears in the fifth paragraph of the lease, as follows:

“ Fifth. The Telegraph Company hereby agrees to pay for the rental of the two trans-Atlantic cables, the land lines, equipments, and other property and assets of the Cable Company as aforesaid, the yearly sum of seven hundred thousand dollars ($700,000) in each year, in quarterly instalments of one hundred and seventy-five thousand dollars ($175,000) at the end of each quarter, to wit: On the first days of September, December, March, and June, respectively, the said payments commencing on the first day of September, 1882, and that such payments shall be made directly to the stock*331holders of the Cable Company, to secure which payments the Telegraph Company further agrees that its secretary shall sign a - guarantee and affix the seal of the company thereto for the payment of dividends at the rate of five per cent per annum, payable quarterly as above mentioned, on the certificates of the capital stock of the Cable Company, to be issued to the American Cable Construction Company, not to exceed the aggregate of fourteen millions of dollars, in payment for the two cables, in accordance with an agreement of even date herewith between those companies.”

In addition to this rental the lessee agreed to pay the lessor a further sum of not exceeding $2,500 per year, to be used for the purpose of defraying the necessary expenses of the maintenance of the organization of plaintiff as a corporation, the latter agreeing to maintain the same.

In accordance with the terms of the quoted paragraph the Telegraph Company, lessee, caused to be endorsed upon the several certificates of stock in plaintiff corporation its “ guarantee ” as follows: “ The Western Union Telegraph Company hereby for value received guarantees quarterly dividends of one and one-quarter per cent, payable at the end of each quarter ” (dates named), “ upon the par value of the capital stock represented by the within certificate, in accordance with the terms and conditions of the agreement,” above mentioned. The annual rental as it accrued has been paid to the stockholders in the lessor company except to the lessee Telegraph Company, which is itself the owner of 23,094 shares of the capital stock of lessor. Plaintiff prepared and duly filed with the collector of internal revenue for the second district of New York its tax returns, on Form 1120, for the calendar year 1922, which showed $73,016.25 as the total amount of tax. Included in the amount, upon which its net income was based, was the sum of $584,130 paid by the lessee to the several shareholders in the lessor company other than itself, it thus reporting an income of $584,130 on the rental item.

There is no contention that the stipulated rental would not be, in the hands of the lessor, income subject to the provisions of the revenue act of 1921, 42 Stat. 227, 238, 254. *Eisner*v. Macomber, 252 U.S. 189, 207. The rent was paid, by lessee, in the amount stated, not directly to the lessor, but *332to its stockholders in accordance with.the leasehold agreement. The brief for plaintiff thus states the issue: “ The tax liability of the plaintiff, under the circumstances, depends upon two questions: First, whether the stockholders of the plaintiff in case of default could sue the Western Union Telegraph Company directly in their own right instead of in the right of the corporation; and, second, whether at any time since the lease was consummated the plaintiff corporation could assert a claim - for the rental in its own right or could alter or vary the rights of any stockholder therein without the consent of such stockholder.” We do not think that because the stockholder could sue the Telegraph Company directly upon its undertaking in the guarantee *(Bowers et al.*v. *Interboro Rapid Transit*Co., 121 Misc. R. 250, affirmed 202 N.Y. Supp. 917, 208 App. Div. 768, and *Peabody*case, 212 App. Div. N.Y. 502, decided April 3, 1925), that fact becomes an essential element in the conclusion to be reached upon the question before this court. The lessee not only agreed to make payments of'the rent directly to the stockholders in lessor corporation but further stipulated to sign, and did sign, a guarantee for the payment of dividends at the stated rate on the certificates of the capital stock of the latter. This guarantee carries notice of the terms of the lease under which it is given. The relation thus arising between the Telegraph Company and the stockholder in the Cable Company rests upon the undertaking itself. In guaranteeing a dividend there is an implied admission that corporate action by the lessor is necessary in declaring it from time to time, or in the continued existence of the dividend as declared when the lease was made. The lessor was to continue in existence and the lease expressly provided it should so continue. It is an entity distinct from its stockholders, and, as was said by Walker, *Circuit*Judge, in *Blalock*v. *Georgia*Co., 246 Fed. 387, 389, due recognition may be given to this condition, without denying effect to the obvious fact that its stockholders are the real beneficiaries of its existence and activities and that such a corporation is but assuming one of its normal functions when it makes provision for a ratable distribution among its stockholders of net gains accrued, what*333ever may be the form such a provision assumes. The rent was a liability of the lessee to the lessor, because it was a return for the lessor’s property, passing by the lease. The circumstance that by agreement the lessee undertook to make payments to stockholders instead of to the corporation itself does not alter the fact that the payment is of rent, due primarily to the lessor. The failure to make these payments as agreed would be a breach of the covenant to pay rents, and in that case the other party to the contract, the lessor, would have its legal remedies. The lease recognizes that the payments for the property are rents and that the stockholders receive them as dividends, but the making of payments direct to the stockholders is merely one of method. It does not change the real substance of the transaction that the lessee is paying rent, due primarily to the lessor, for its property, in which the stockholders have no direct ownership, though they are recipients of the payments. The Telegraph Company does not pay the stockholders in lessor corporation dividends as such, because these must issue out of lessor’s corporate assets and be declared dividends by the lessor’s agencies. It does guarantee quarterly dividends by lessor in accordance with the terms of the lease. But the case is not different because of the use of the word dividends in the lease than it would be if the lessor had instructed the lessee to pay the rents as they accrue to stockholders. The designated agencies having received them, they are, in effect, received by the lessor itself. Plaintiff’s brief frankly admits that its contention has been decided adversely to it in two “ war-time ” decisions by two Circuit Courts of Appeals, citing *West End St. Ry.*v. *Malley,*246 Fed. 625; *Rensselaer & Saratoga R. R. Co.*v. Irwin, 249 Fed. 726. We think the controlling principle has been decided by other courts as well. See *Blalock*v. *Georgia Co., supra; Houston Belt & Terminal Co.*v. *United*States, 250 Fed. 1; *Northern Railroad Co. of New Jersey*v. Lowe, 250 Fed. 856. The result is that the petition should be dismissed. And it is so ordered.

Graham, *Judge;*Hay, *Judge;*Downey, *Judge;*and Booth, Judge, concur.