the corporation during the latter years. With this statement, I come now to consideration of the question whether the plaintiff -- independent of any prior rulings of the Commissioner -- was subject to capital stock tax for the years 1934, 1935 and 1936. The government practically concedes that were it not for the activities of the plaintiff with respect to its investments, the plaintiff would be entitled to a refund. The government contends, however, that the activities of the plaintiff with respect to its investments during those years was of such a character as to bring the plaintiff within the sphere of tax liability.
The government emphasizes that the plaintiff during the three years in question maintained investments in securities in the approximate amount of $600,000, in addition to a substantial cash balance. It stresses that there were a number of changes made in the investments by means of purchases and sales of securities. The government has conceded, however, that most of the activity during the years 1934 and 1935 was due to a desire to diversify and investment portfolio, and there is ample corroboration for this fact in the testimony of the president of the plaintiff corporation. It also seems to be undisputed that some of the activities with respect to investments during the years in question were due to the necessity of reinvesting the funds received from matured securities.
The government also points to the fact that the annual income from the investments was about $25,000, which income apparently was left to accumulate as an addition to two special funds.
While concededly the officers of the plaintiff were eager to keep the funds invested in securities which yielded as high a return as possible consistent with conservative investment, there is no doubt that there was no attempt at speculation nor was there any general trading in securities in any of the years involved. Such relatively few purchases and sales as were made in these tax years were plainly for the purpose of either replacing matured securities or diversifying the investment portfolio.
I have concluded that the plaintiff since 1879 has restricted its activities to "the distribution of the avails of property and the doing only of such acts as may be necessary for the maintenance of its corporate status in a case where the corporation has reduced its activities to the mere owning and holding of specific property" Art. 43(b) (2), and that the plaintiff, which is "a company holding securities", has not in the taxable periods involved engaged in "the investment or reinvestment of surplus or other funds in excess of an amount necessary to maintain its original investments" Art. 43(B).
In making this finding I have noted that at the time of the lease of all of its road and equipment to the Reading Company, the lease provided for an appraisal of the equipment. This equipment was carried on the books of the plaintiff immediately prior to the lease in an amount of approximately $1,750,000. It was appraised at the time of the lease at $650,000, and the lease provides that at the conclusion of the term of the lease (999 years) equipment of the value of $650,000 is to be returned by the lessee to the plaintiff. There existed, therefore, a shrinkage of about $1,100,000 in the value of the equipment based upon this appraisal. In addition, the equipment naturally would become fully depreciated long before the expiration of the lease. It is obvious, therefore, that in order to maintain the capital intact, some reserve fund would be required. The evidence is that the creation of the contingent fund by the plaintiff in the year 1879 by setting aside 5% of the amount of the fixed annual dividends was to accomplish the purpose of maintaining such capital intact, and thus avoid any question with respect to the propriety of the dividend distributions (see Stipulation of Facts No. 8).
It was also stipulated that another reason for maintaining this contingent fund was for the purpose of enabling the plaintiff to be "in a position to take over and operate its property to take over and operate its property in the event of a breach of the lease" (Stipulation of Facts No. 8).
We therefore have this situation: The two funds combined (general fund and contingent fund) did not in any one of the three tax years exceed $800,000. In contrast, there was a capital impairment based upon the equipment appraisal (without considering depreciation) of $1,100,000. I have also taken into consideration the fact that the railroad equipment which was leased in 1879 had in all probability (although nothing appears on the record) become fully depreciated prior to June 30, 1934, and the balance sheets of the plaintiff corporation which are included in the Stipulation of Facts
show no other funded reserve to take care of this depreciation in equipment. There is an unfunded reserve in the amount of $400,000 shown under the liabilities which is entitled "Accrued Depreciation Equipment." It is to be noted that the liability set up for such accrued depreciation is a flat figure which has not been added to in the later years. It further appears that the book value of equipment in the amount of approximately $1,750,000 which existed as of the time of the lease (1879), is still carried in the later balance sheets at about the same figure, offset only by the said depreciation reserve. I believe it is fair to say that in all probability all of the original leased equipment was scrapped prior to the year 1934. The only obligation of the lessee is to replace equipment of a value of $650,000 at the end of the term of the lease. There seems to be little question, therefore, that the general and contingent funds which have been maintained by the plaintiff were not in excess of an amount necessary to maintain the original investments, and hence under the Commissioner's regulations the investment and reinvestment of such funds did not constitute "doing business" when added to the other activities of the corporation in the mere holding of property and the distribution of its avails.
While I have concluded that the plaintiff was not doing business in the tax periods involved within the meaning of the Commissioner's own regulations (which regulations I hold to be valid in line with the Magruder decision), it might be said that if the Commissioner is dissatisfied with the effect of these regulations in situations of the character dealt with in this case, he can very easily amend his regulations if he deems it advisable to do so, consistent, of course, with the reasonable interpretation of the taxing statute.
It may be noted that in the 1938 revision of Regulations 64 there has been some change made by the Treasury Department with respect to the wording of that portion of Art. 43 which has been applied in the present case. No opinion is expressed here with respect to the effect of such change.
The government makes no claim that that portion of the regulations which is applicable to this case is invalid, but it may be briefly stated that as far back as 1913, in the case of McCoach v. Minehill and S.H. Railway Company, 228 U.S. 295, 33 S. Ct. 419, 57 L. Ed. 842, it was held, in a factual situation very closely resembling the facts here, that a railroad company which had leased its equipment for a long period and thereafter merely maintained its corporate organization and invested its funds in securities, was not doing business within the meaning of the Corporation Excise Tax Act of August 5, 1909, 36 Stat. 11.
The decision in the McCoach v. Minehill case has been followed in a large number of other cases. While the government argues that there was a strong dissenting opinion in the McCoach v. Minehill case, and attempts to show that the trend of recent decisions is not in accordance with the views expressed in the Minehill case, I do not find that it has ever been overruled, and it appears that the case has been cited without disapproval by the United States Supreme Court in a number of later cases, including the Magruder case, supra.
It is apparent that the Commissioner's regulations (1934 and 1936 Ed.) dealing with the problem here presented were drawn in accordance with the decisions of the United States Supreme Court in cases such as McCoach v. Minehill, supra, and I have no doubt that the Commissioner's regulations are valid and cover the factual situation presented in this case.
In summary, I find:
(1) That the plaintiff had retired in the year 1879 from the business for which it was incorporated, namely, the operation of a railroad;
(2) That since that time, and particularly during the years in question, it has maintained its corporate existence primarily for the distribution of the avails of its property and for the doing of only such acts as were necessary for the maintenance of its corporate status, and has reduced its activities to the mere owning and holding of property; and
(3) That the investment or reinvestment of its funds was not in excess of an amount necessary to maintain the original investments of the company.
Accordingly, the plaintiff's operations squarely come within the provisions of Article 43(b) (2) (B) (1936 Ed.) and Art. 33 (1934 Ed.); and under the terms of these regulations the plaintiff was not "doing business" and hence not liable for federal capital stock taxes for the years ended June 30, 1934, June 30, 1935, and June 30, 1936; and is, therefore, entitled to judgment in this suit for refund.
I state the following conclusions of law:
1. This court hs jurisdiction of this case under the provisions of the Act of March 3, 1911, 36 Stat. 1092, 28 U.S.C.A. § 41(5), it being a case arising under a law providing for internal revenue.
2. During the capital stock tax years ended June 30, 1934, 1935, and 1936, plaintiff was a nonoperating railroad company which had reduced its activities to maintaining its corporate existence and collecting the interest and dividends from its investments, maintaining and reinvesting its securities, distributing to its stockholders and bondholders rental received from its lessee, and to doing only those acts which were necessary to continue that status.
3. The maintenance by plaintiff of its investments and the infrequent purchase and sale of securities not in excess of an amount necessary to maintain its original investments, does not constitute carrying on or doing business under Section 701 of the Revenue Act of 1934, and Section 105 of the Revenue Act of 1935, as amended by Section 401 of the Revenue Act of 1936, and the Treasury Regulations in effect during the years 1934, 1935, and 1936.
4. During no part of the taxable years ended June 30, 1934, 1935, and 1936, was plaintiff carrying on or doing business within the meaning of Section 701 of the Revenue Act of 1934, and Section 105 of the Revenue Act of 1935, as amended by Section 401 of the Revenue Act of 1936, and the applicable Treasury Regulations (Art. 33, 1934, Ed., and Art. 43, 1936 Ed.).
5. There was probable and reasonable cause for the act of the defendant, the Collector of Internal Revenue, in demanding and collecting from the plaintiff the internal revenue taxes and interest for the refund of which judgment is to be entered.
6. The taxes and interest sought to be recovered by plaintiff in this case were illegally assessed and collected from plaintiff by defendant, and by reason thereof plaintiff is entitled to judgment against the defendant for the amount of taxes and interest so illegally assessed and collected from plaintiff, with interest thereon at the rate of 6% per annum from the dates said taxes and interest were paid.
Defendant's exceptions have been noted and granted to the declination of the following numbered requests for findings of fact and conclusions of law:
As to requests for findings of fact: Nos. 17, 20, 21, 22 (covered), 26 (covered), 29 and 31.
As to requests for conclusions of law: Nos. 1, 2, 3, 4, 5, 6, and 7.