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NORTH PENNSYLVANIA R. CO. v. ROTHENSIES

May 28, 1942

NORTH PENNSYLVANIA R. CO.
v.
ROTHENSIES, Collector of Internal Revenue



The opinion of the court was delivered by: KALODNER

This is an action for recovery of $15,390.06 with interest, representing capital stock taxes and interest, paid by the plaintiff railroad to the Collector of Internal Revenue for the years ended June 30, 1934, 1935 and 1936.

The capital stock taxes were paid following denial of the plaintiff's claim for exemption on the ground that it was not doing business during the taxable periods involved. A jury trial was waived; the case came before the court on the pleadings, stipulation of facts, and some additional testimony.

 The issue involved is:

 What constitutes "carrying on or doing business" within the meaning of the applicable Internal Revenue Law (Sec. 701 of the Revenue Act of 1934, c. 277, 48 Stat. 680, 26 U.S.C.A. Int.Rev.Acts, page 787, and Sec. 105(a) of the Revenue Act of 1935, c. 829, 49 Stat. 1017, as amended by Sec. 401 of the Revenue Act of 1936, c. 690, 49 Stat. 1733, 26 U.S.C.A. Int.Rev.Acts, p. 943)?

 The plaintiff corporation was organized in 1852 to construct and operate a steam railroad, and was empowered to exercise "all the privileges and franchise incident to a corporation".

 In 1879 the plaintiff leased all of its tangible property -- its entire road and equipment -- to the Philadelphia & Reading Railway Company, predecessor of the present Reading Company, for a term of 999 years.

 Since that time it has not operated a railroad. Its principal activities during the tax years involved were concerned with the maintenance of its corporate organization as required by its lease; the receipt of rent from the lessee; distributing dividends to stockholders; paying interest to bondholders; retention and management of approximately $600,000 of securities and an approximate $200,000 cash fund; receiving interest on its investments; and investment and re-investment of certain funds and securities, as will appear from the stipulated facts.

 The Commissioner of Internal Revenue ruled that the investments and re-investments constituted "doing business".

 The stipulated statement of facts, which is hereby adopted as the Findings of Fact, in part, of this court, is as follows:

 1. The petitioner, The North Pennsylvania Railroad Company, is a corporation duly organized under the laws of Pennsylvania, with its office at 1421 Chestnut Street, Philadelphia, in the Eastern District of Pennsylvania.

 2. On or before August 31, 1934, pursuant to the Revenue Act of 1934, plaintiff filed its return for 1934 capital stock tax covering the period July 1, 1933, to June 30, 1934, with defendant. In said return no declared value for petitioner's capital stock was set forth because plaintiff claimed exemption from capital stock tax on the ground that plaintiff did not carry on or do business during any part of the taxable period July 1, 1933, to June 30, 1934. On or about June 4, 1935, plaintiff's claim for exemption was denied by the Commissioner of Internal Revenue and plaintiff was required to declare a value for its capital stock which it did in the amount of $4,230,000. Thereafter, capita stock tax for the period July 1, 1933, to June 30, 1934, was assessed against plaintiff in the amount of $4,230 with interest of $574.35. Thereafter, defendant sent to plaintiff a "Notice and Demand for Tax" of the amount assessed, $4,230 with interest of $574.35. On December 21, 1935, plaintiff paid under protest to defendant at Philadelphia the amount of capital stock tax assessed against it for the period July 1, 1933, to June 30, 1934, to wit, $4,230 with interest of $574.35.

 On or before July 31, 1935, pursuant to the Revenue Act of 1934, plaintiff filed its return for 1935 capital stock tax covering the period July 1, 1934, to June 30, 1935, with defendant. In said return no declared value for petitioner's capital stock was set forth because plaintiff claimed exemption from capital stock tax on the ground that plaintiff did not carry on or do business during any part of the taxable period from July 1, 1934, to June 30, 1935. On or about September 15, 1936, plaintiff's claim for exemption was denied by the Commissioner of Internal Revenue and plaintiff was required to compute an adjusted declared value for its capital stock, which it did in the amount of $4,312,019.96. Thereafter, capital stock tax for the period July 1, 1934, to June 30, 1935, was assessed against plaintiff in the amount of $4,312 with interest of $342.24. Thereafter, defendant sent to plaintiff a "Notice and Demand for Tax" of the amount assessed, $4,312, with interest of $342.24. On November 13, 1936, plaintiff paid under protest to defendant at Philadelphia the amount of capital stock tax assessed against it for the period July 1, 1934, to June 30, 1935, to wit, $4,312, with interest of $342.24.

 4.On or before July 31, 1936, pursuant to the Revenue Act of 1935, as amended by the Revenue Act of 1936, plaintiff filed its return for 1936 capital stock tax covering the period July 1, 1935, to June 30, 1936, with defendant. In said return a declared value for petitioner's capital stock was set forth in the amount of $5,734,000, but this value was set forth under protest and plaintiff claimed exemption from capital stock tax on the ground that plaintiff did not carry on or do business during any part of the taxable period July 1, 1935, to June 30, 1936. On or about February 13, 1937, plaintiff's claim for exemption was denied by the Commissioner of Internal Revenue and capital stock tax for the period July 1, 1935, to June 30, 1936, was assessed against plaintiff in the amount of $5,734, with interest of $197.47. Thereafter, defendant sent to plaintiff a "Notice and Demand for Tax" of the amount assessed, $5,734, with interest of $197.47. On March 19, 1937, plaintiff paid under protest to defendant at Philadelphia the amount of capital stock tax assessed against it for the period July 1, 1935, to June 30, 1936, to wit, $5,734, with interest of $197.47.

 5. On or about April 22, 1938, plaintiff filed with defendant at Philadelphia claims for refund of capital stock taxes paid for the periods July 1, 1933, to June 30, 1934; July 1, 1934, to June 30, 1935; and July 1, 1935, to June 30, 1936, in the amounts of $4,804.35, $4,654.24 and $5,931.47, respectively, on Forms 843, and alleged as the bases therefor that plaintiff was not subject to capital stock tax under the provisions of Section 701(c) (3) of the Revenue Act of 1934, and Section 105(a) of the Revenue Act of 1935, as amended by Section 401 of the Revenue Act of 1936, because of the facts set forth therein.Said claims for refund were filed under the provisions of Section 3220 of Revised Statutes, as amended by c. 852, sec. 619(b), 45 Stat. 878, and c. 901, sec. 3, 45 Stat. 996 (incorporated into the Internal Revenue Code as Section 3770(a) (1).A true and correct copy of the claim for refund of capital stock tax for the period July 1, 1933, to June 30, 1934, is attached hereto and made part hereof, marked Exhibit "A". A true and correct copy of the claim for refund of capital stock tax for the period July 1, 1934, to June 30, 1935, is attached hereto and made part hereof, marked Exhibit "B".A true and correct copy of the claim for refund of capital stock tax for the period July 1, 1935, to June 30, 1936, is attached hereto and made part hereof, marked Exhibit "C". In a letter dated December 1, 1938, the Commissioner of Internal Revenue advised the plaintiff that its claims for refund (Exhibits "A", "B" and "C" above) were rejected in full. A true and correct copy of the Commissioner's letter of December 1, 1938, is attached hereto and made a part hereof, marked Exhibit "D".

 6. Petitioner was organized under a special act of the Pennsylvania Legislature, approved April 8, 1852, P.L. 654, entitled "An Act to Incorporate the Philadelphia, Easton and Water Gap Railroad Company". A true and correct copy of said act is attached hereto and made a part hereof, marked Exhibit "E". Letters Patent were issued to petitioner on July 9, 1852, by F. W. Hughes, Secretary of the Commonwealth. A true and correct copy of the Letters Patent are attached hereto and made a part hereof, marked Exhibit "F". Petitioner's name was changed to "The North Pennsylvania Railroad Company" by Section 11 of a special act of the Pennsylvania Legislature, approved April 18, 1853. A true and correct copy of said section is attached hereto and made a part hereof, marked Exhibit "G". On May 14, 1879, petitioner leased all of its tangible property to the Philadelphia & Reading Railway Company (predecessor of The Reading Company, the lessee at present and during all times material to this action).A copy of said lease is attached hereto, marked Exhibit "H," and made a part hereof. From that time to the present petitioner has not engaged in the business or prime object for which it was incorporated, namely, constructing and operating a steam railroad, this activity having been carried on by the lessee company, which company was liable for and paid federal capital stock taxes for the periods here involved.

 7. Petitioner's investments represent the growth of two separate funds. The first of these, which appears on petitioner's general balance sheet (prepared in accordance with the requirements of the Interstate Commerce Commission), under the heading, "Other Investments", represents the investment of bank interest allowed petitioner by its depositaries on rental payments received from its lessee and deposited pending distribution to shareholders and bondholders. Rental payments are received by petitioner quarterly on the first of February, May, August, and November of each year. The policy of petitioner has been to make dividend distributions on the twenty-fifth of February, May, August, and November; and interest on indebtedness is payable on the first of May, July, November, and January. These differences between the dates of receipts and distributions create a situation where there has always been a substantial amount of cash in petitioner's treasury awaiting distribution, which sum has borne interest in the past at varying rates as high as 3%. These interest earnings have been invested from time to time, and the earnings thereon have been accumulated and invested.

 Deductions from dividends and resulting additions to Contingent Fund continued until August 8, 1882, when the Board of Directors adopted the following resolution: "Resolved, that on and after the payment of the dividend to be declared in May, 1883, the stockholders shall be paid the full amount of the dividend declared, provided, however, that no unforeseen or unexpected event occurs rendering it unwise to discontinue the retention of the said 5%."

 The total of this fund up to and including the dividend payment of May 25, 1883, amounted to $55,151.84. Since that time there have been no additions to this fund other than through profits on sales of securities and by the accumulation of its own earnings. At the time of the creation of the fund the Board of Directors did not define the purpose thereof other than to name it a "Contingent or Surplus Fund". In 1879, when the lease was executed, the equipment which stood on petitioner's books at approximately $1,750,000 was appraised in accordance with the terms of the lease and the amount of the appraisal, approximately $650,000, was agreed to by both parties at that time. Under the terms of the lease the lessee is required to return to petitioner only equipment of that value upon the termination of the lease. This shrinkage of $1,100,000, coupled with an impairment of capital at the time the lease was executed, required the establishment of a fund in order that no question be raised as to the propriety of dividend distributions while such condition existed, and further, its maintenance has been necessary so that petitioner will be in a position to take over and operate its property in the event of a breach of the lease.

 9. A true and correct list of all purchases, sales and maturities of petitioner's investments from January 1, 1921, through December 31, 1939, is attached hereto, marked Exhibit "I", and made a part hereof.

 10. A true and correct copy of petitioner's balance sheet as of October 31, 1880, that being the available balance sheet closest in point of time to the leasing of petitioner's property, is attached hereto, marked Exhibit "J", and made a part hereof.

 11. True and correct copies of petitioner's balance sheets as of June 30, 1934, June 30, 1935, and June 30, 1936, are attached hereto, marked Exhibits "K", "L" and "M", respectively, and made a part hereof.

 12.True and correct copies of petitioner's receipts and disbursements for the periods from July 1, 1933 to June 30, 1934; from July 1, 1934 to June 30, 1935; and from July 1, 1935 to June 30, 1936, are attached hereto, marked Exhibits "N", "O" and "P", respectively, and made a part hereof.

 13. A true and correct list of petitioner's dividend payments for the period May 14, 1879 to June 30, 1936, both dates inclusive, is attached hereto, marked Exhibit "Q", and made a part hereof.

 14. True and correct copies of all minutes of all meetings of petitioner's Board of Directors and stockholders held during the period July 1, 1933, to June 30, 1936, are attached hereto and made a part hereof, marked Exhibit "R" (36 pages).

 15. Itemized lists of securities and cash in each of the two funds referred to in Paragraphs 7 and 8 hereof, on June 30th of each of the years 1932 to 1939, inclusive, are attached hereto and made a part hereof, marked Exhibit "S" (7 pages). On June 30th of each year, the cash balance was substantial because on the next day, i.e., July 1st of each year, $74,250 was paid out as interest on petitioner's second mortgage and because by that date each year about $10,000 had been accumulated toward payment of first mortgage interest payable November 1st of each year.

 16. No part of petitioner's claim, amounting to $15,390.06, with interest on $4,804.35 from December 21, 1935, on $4,654.24 from November 13, 1936, and on $5,931.47 from March 19, 1937, has been assigned or transferred; no part thereof has been repaid to petitioner; and there are no credits or offsets against said claim.

 18. The Commissioner of Internal Revenue granted exemption to the plaintiff from the payment of capital stock tax imposed by Section 1000 of the Revenue Act of 1921, 42 Stat. 294, and Section 700 of the Revenue Act of 1924, 26 U.S.C.A. Int.Rev.Acts, page 96, for each of the years ended June 30, 1921, to 1926, inclusive, on the ground that the plaintiff was not carrying on or doing business during those years.

 In addition to the agreed statement of facts, I make the following special findings of fact:

 19. For the tax period ended June 30, 1933, plaintiff filed a capital stock tax return claiming exemption on the ground that it was not engaged in or doing business. This claim was denied by the Commissioner of Internal Revenue, who assessed capital stock tax and interest against plaintiff, which amount was paid. Subsequently plaintiff filed a claim for refund and after rejection of the claim by the Commissioner, instituted suit against the United States in this court for recovery of the tax and interest paid. Prior to trial the Attorney General conceded plaintiff's position and authorized an administrative refund of the tax and interest paid.

 20. During the tax periods involved in this proceeding there was no substantial change in the activities of the plaintiff as compared with the years ended June 30, 1919 to 1926, inclusive, and also as compared with the year ended June 30, 1933, with the exception of some slight additional activity with respect to the matter of the purchase and sale of securities for investment, due to a desire to obtain greater diversification of the investment portfolio.

 21. The principal activities of the corporation during the tax years involved were concerned with the maintenance of the corporate existence (as required under the terms of the lease); the receipt of rent from the lessee; retention and management of securities of a value of approximately $600,000, and a cash fund of approximately $200,000; distributing dividends to stockholders; paying interest to bondholders; keeping the books of account of the company; making up tax reports for filing with the federal government and with the Commonwealth of Pennsylvania; making up reports for the Interstate Commerce Commission and the Pennsylvania Public Utility Commission; keeping the stock transfer books and making the physical transfer of stock therein and issuing new certificates; keeping the registered bond transfer book and making the physical transfers therein; ...


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