Ann Arbor R.R. v. Commissioner

THE ANN ARBOR RAILROAD COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. MANISTIQUE AND LAKE SUPERIOR RAILROAD COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Ann Arbor R.R. v. Commissioner Docket Nos. 25869, 35337. United States Board of Tax Appeals 29 B.T.A. 331; 1933 BTA LEXIS 958; November 14, 1933, Promulgated *958 1. The guaranty income received by a carrier under section 209 of the Transportation Act, 1920, is taxable under the Revenue Act of 1918 at 10 percent. 2. The allowance made by the Director General for undermaintenance during Federal control must be subtracted from the total maintenance expenditure for 1920 to determine the carrier's deduction for maintenance expense. L. H. Strasser, Esq., for the petitioners. E. C. Algire, Esq., for the respondent. STERNHAGEN *331 The respondent determined deficiencies in income and profits taxes of the Ann Arbor Railroad Co. and the Manistique & Lake Superior Railroad Co. for 1920 in the amounts of $88,611.79 and $516.11, respectively. The petitioners assign the following errors: (1) The disallowance of a deduction of $685.42, being an assessment made by the Association of Railway Executives; (2) The inclusion in gross income of $315,261.85 and $36,686.60, received by the petitioners from the United States under the guaranty provisions of section 209(c) of the Transportation Act, 1920; (3) Alternatively to (2), the computation of the tax upon the amounts received at the rate of 10 percent instead*959 of 8 percent; (4) The disallowance of deductions of $574,191.51 and $23,979.75, expenditures in the period March 1 to December 31, 1920, for maintenance; (5) The failure to restore to earned surplus, for invested capital purposes, $2,725,556.79, alleged cost of additions and improvements made to petitioners' properties in prior years, and charged to operating expenses of those years; (6) The inclusion in gross income of $11,877.51 and $2,082.08, credits to profit and loss and to operating expenses, respectively, on the books of The Ann Arbor Railroad Company, in connection with the sales of certain equipment to the Manistique and Lake Superior Railroad Company; (7) The inclusion in gross income of $1,452.55, alleged profit realized by the Ann Arbor Railroad Company upon the purchase and retirement of its Two Year 6% Collateral Gold Notes; (8) The omission of a deduction of $31,000, operating expenses related to the sale of a certain spur track; (9) The omission of a deduction of $37,007.36, alleged loss sustained in the sale of a certain spur track; and (10) The computation of the normal income tax at 10 percent upon the entire net income instead of 8 percent upon the*960 net income earned in January and February and 10 percent upon the balance. The petitioners withdrew the fifth assignment of error. The respondent confesses the errors charged in the first, sixth, and tenth assignments. *332 FINDINGS OF FACT. The Ann Arbor Railroad Co., hereinafter referred to as the Ann Arbor, and its subsidiary, the Manistique & Lake Superior Railroad Co., hereinafter referred to as the Lake Superior, are corporations, with their principal offices at St. Louis, Missouri. They filed a consolidated return for 1920. On January 30, 1931, they agreed in writing that any deficiencies in income and profits taxes, computed upon the basis of consolidated returns for 1920 and 1921, should be assessed against, and any overassessment of such taxes for the above named years should be abated, credited, or refunded to the Ann Arbor. The petitioners' books of account were kept upon an accrual basis. I. The petitioners accepted section 209 of the Transportation Act, 1920. Pursuant thereto the United States paid to the Ann Arbor and the Lake Superior $315,261.85 and $36,686.60, respectively, in accordance with certificates of amounts due issued by the Interstate*961 Commerce Commission, dated June 4, 1921, and December 17, 1923, respectively. II. The amounts of the guaranty income stated in findings I were, in respondent's determination, subjected with other income to normal tax at the rate of 10 percent. III. The railroad properties of the petitioners were under Federal control throughout the period January 1, 1918, to February 29, 1920, inclusive. There was no Federal control agreement with the Director General of Railroads. On August 13, 1920, the Ann Arbor filed a claim with the Director General pertaining to matters arising out of Federal control, in the aggregate amount of $1,346,515.99, made up of the following items: Deferred maintenance for the period of Federal control: Way and structures $507,968 Equipment 515,431 $1,023,399.00 Material and supplies 150,000.00 Interest and depreciation on additions and betterments 173,116.99 Total of claim 1,346,515.99 *333 On February 28, 1921, the Ann Arbor filed a supplemental claim with the Director General, in the aggregate amount of $221,661.16, made up of the following items: Increase of standard return based on adjustment of back mail pay $5,302.44 Additional amount claimed for deferred maintenance during Federal control: Equipment 216,358.72 Total of supplemental claim 221,661.16 *962 On March 23, 1921, the Ann Arbor filed another supplemental claim with the Director General, in which an additional $92,679.42 was claimed for deferred maintenance or undermaintenance of freight train cars during Federal control. That claim was accompanied by the Lake Superior's claim against the Director General for $20,631.95, an additional maintenance allowance in respect of way and structures during Federal control. On March 29, 1921, the petitioners filed their final claims and statements of accounts with the Director General, as follows: Ann Arbor Lake Superior Due to Corporation: Compensation $1,148,138.62 $46,424.46 Less advances, loans, etc 1,107,780.00 40,358.62 46,424.46 Rental interest on completed additions and betterments 8,437.77 1,614.80 Cash, December 31, 1917 149,343.41 33,107.13 Agents and Conductors balances, Dec. 31, 1917 59,893.94 13,444.77 Assets December 31, 1917, collected 283,995.32 36,141.90 Total 542,029.06 130,733.06 Due from Corporation: Liabilities December 31, 1917, paid 1,114,976.11 53,505.13 Corporate transactions 139,995,89 13,696.22 Expense prior to January 1, 1918 177,124.40 8,103.79 Revenue prior to January 1, 1918 45,162.99 1,477.55 Additions and betterments 213,369.44 28,739.33 Total 1,690,628.83 105,522.02 Balance due from Corporation on quarterly settlement accounts 1,148,599.77 25,211.04 Other items due to Corporation: Materials and supplies (net) 150,000.00 15,144.75 Accrued depreciation - Equipment 150,933.33 11,482.82 Equipment retired 46,446.72 572.07 Road property retired and not replaced 20,264.27 Interest on deferred compensation $5,699.27 Interest on open accounts due to corporation 14,505.50 Additional depreciation on equipment $123,912.80 Interest and depreciation on car ferry and equipment 183,166.99 Additional compensation account back mail pay 5,302.44 Total 680,026.55 47,404.41 Other items due from Corporation: Net interest due Government other than rental 136,359.86 Materials and supplies, February 29, 1920 24,167.42 Total 136,359.86 24,167.42 Balance due to Corporation on other items 543,666.69 23,236.99 Balance due from Corporation 604,933.08 Balance due to Corporation 48,448.03 Maintenance: Maintenance of way and structures (under) 507,968.00 20,631.95 Maintenance of equipment (under) 700,566.34 Balance due to corporation on maintenance 1,208,534.34 20,631.95 Net balance due to Corporation 603,601.26 69,079.98 *963 *334 After protracted negotiations in which all items in their claims were discussed, the petitioners, on April 1, 1921, entered into separate written agreements with the Director General, covering the complete and final settlement of all demands growing out of Federal control. By these agreements, the Ann Arbor acknowledged its indebtedness to the Director General of $600,000, and the Lake Superior acknowledged receipt of $50,000 from the Director General. The settlement was effected and accounted for by the Ann Arbor crediting $50,000 to the account of the Lake Superior on its books, and giving to the Director General its demand note for $337,000 and its time note, maturing March 1, 1930, for $213,000. The Director General did not advise the Ann Arbor how the $600,000 was determined. By journal entry of June 1921 the Ann Arbor cleared its books of all accounts with the United States pertaining to Federal control, resulting in a net credit of $463,494.02 to "Profit & Loss - 607 Miscel. Credits." By journal entries of August and November 1921 and of January 1922, the Lake Superior cleared its books of all accounts with the United States pertaining to Federal control, *964 resulting in a net credit of $23,316.83 to profit and loss. The respondent determined that the Ann Arbor and the Lake Superior, in their final settlements with the Director General, were allowed $574,191.51 and $23,979.75, respectively, for undermaintenance of their properties during Federal control. During the period March 1 to December 31, 1920, the Ann Arbor expended and charged to operating expenses for maintenance of way and structures, exclusive of any charges for insurance, $796,740.09, and for maintenance of equipment, exclusive of any charges for depreciation, insurance and retirements, $804,074.10, a total of $1,600,814.19; and the Lake Superior expended and charged to operating expenses for maintenance of way and structures, exclusive of any charges for insurance, $43,207.20, and for maintenance of equipment, exclusive of any charges for depreciation, insurance and retirements, $30,426.15, a total of $73,633.35; and the aggregate grand total of $1,674,447.54 was included in the total operating expenses of $4,298,461.44 deducted in the consolidated return for 1920. Of the total amount so deducted for operating expenses in the consolidated *335 return, the respondent*965 disallowed $574,191.51 and $23,979.75, a total of $598,171.26, on the ground that the Ann Arbor and the Lake Superior had expended such sums, respectively, to make good the Director General's undermaintenance of their properties during Federal control, and that they had been reimbursed therefor by the Director General in the final settlements of Federal control. The Ann Arbor's average expenditures (exclusive of any expenditures for insurance) for maintenance of way and structures during the test period, July 1, 1914, to June 30, 1917, excluding the months of January and February of each of those years, amounted to $244,496.46; and for maintenance of equipment, exclusive of any charges for depreciation, insurance and retirements, the average expenditures for the same period amounted to $259,390.11. In the 1920 period the Ann Arbor expended $1,631,814.19 for maintenance of way and structures and maintenance of equipment. In an average ten months of the test period the Ann Arbor expended, for the same purpose, $503,886.57. By applying to the several subdivisions of the test period figure, equation factors for the ten-month period, determined in the manner in which the Interstate*966 Commerce Commission determined the equation factors for the six-month guaranty period, the resulting equated test period figure is $1,480,721.90. The comparison of this equated test period figure with the 1920 expenditure shows that in 1920 the Ann Arbor spent $151,092.29 more for maintenance of way and structures and maintenance of equipment than the equated expenditure of the test period. The Lake Superior's average expenditures (exclusive of any expenditures for insurance) for maintenance of way and structures during the test period, July 1, 1914, to June 30, 1917, excluding the months of January and February of each of those years, amounted to $23,713.46; and for maintenance of equipment, exclusive of any charges for depreciation, insurance and retirements, the average expenditures for the same period amounted to $10,832.96. In the 1920 period the Lake Superior expended $73,633.35 for maintenance of way and structures and maintenance of equipment. In an average ten months of the test period the Lake Superior expended, for the same purpose, $34,546.42. By applying to the several subdivisions of the test period figure equation factors for the ten-month period, determined*967 in the manner in which the Interstate Commerce Commission determined the equation factors for the six-month guaranty period, and without taking into consideration the differences in amount and use of property maintained, as between the test and 1920 periods, the resulting equated test period figure is $94,473.81. The comparison of this equated test period figure with the 1920 expenditure shows that in 1920 the Lake Superior *336 spent $20,840.46 less for maintenance of way and structures and maintenance of equipment than the equated expenditure of the test period, assuming similarity in amount and use of such property. IV. At the hearing the parties stipulated as follows: On May 1, 1919, the petitioner issued and sold for $720,077.92 cash, its two-year six percent notes of the face value of $750,000, maturing May 1, 1921. At various times during the year 1920 it purchased for cash in the open market and retired $27,200 par value of these two-year notes, paying therefor $25,024. In reporting its net taxable income for the year 1920 petitioner did not include as part thereof the difference between the par value of the notes purchased, namely $27,200 and the cash*968 cost of such notes, namely $25,024, at which they were retired, said difference being $2,176. The respondent in his letter of October 27, 1922, in connection with an audit of petitioner's income tax return for the year 1920, added $2,176 to petitioner's taxable income, and the petitioner paid the tax thereon. No further adjustment of petitioner's taxable income has been made by either the petitioner or the respondent with respect to the item of $2,176 thus added to petitioner's taxable income. If, as a matter of law, the difference between the purchase price and the sales price of these notes is taxable income, the correct amount to be included in the petitioner's taxable income is $1,452.55, being the difference between the issue price of the notes $26,114.83, plus $361.72, amount of discount previously amortized, or a total of $26,476.55, and the repurchase price of the bonds $25,024, instead of $2,176, the amount which was added by the Commissioner to the petitioner's taxable income. V. On December 5, 1908, the Ann Arbor, therein referred to as the Railroad Company, and the New Haven Coal Mining Co., therein referred to as party of the second part, entered into an*969 agreement which, so far as material here, is as follows: WHEREAS, the Railroad Company has constructed, or is about to construct, a side or spur track, (a blue print map of the location of which is annexed hereto and made a part hereof) together with a bridge crossing Shiawassee River running to the mines of said party of the second part located in Shiawassee County, Michigan, through townships of Caledonia and New Haven, a distance of about seven (7) miles, and the Railroad Company agrees to operate the same on the terms hereinafter written. Now, THEREFORE, This Agreement, Witnesseth, That for and in consideration of the premises and of the mutual advantages to accrue to the parties hereto, the Railroad Company covenants that it will maintain and operate the said track and bridge upon the terms hereinafter set forth, and the party of the second part hereby licenses and consents to the construction, maintenance and operation of such track and bridge, and to the possession and use of the land upon which the same is constructed, and hereby grants and conveys to the Railroad Company, its successors and assigns, the right to enter upon said land for the purpose of constructing, maintaining*970 and operating the said track and bridge, and exercising any right existing under this agreement. *337 It is mutually Covenanted and Agreed by and between the parties hereto as follows: 1 - The party of the second part shall ship and send all freight or material to be forwarded from or destined to said siding, by the railroad of the Railroad Company. 2 - It is mutually agreed that both parties to this agreement shall have the right to serve notice that, after six (6) months from date of such notice they will cancel this agreement, and upon payment of either party to the other of all expenditures made in the construction of the spur track, and bridge, they will have full and peaceful rights and title to the spur track, bridge and right of way. 3 - The title in and to the ownership of the bridge, rails, ties, fastenings and all other material of every kind and description used in the construction of the said track are and shall remain in the Railroad Company, and the Railroad Company, its agents, servants and employees, shall have the right at any time peaceably to enter upon the premises of said party of the second part for the purpose of taking up and removing said*971 track, whenever it may determine, under the terms of this agreement, to remove the same. * * * 6 - Second party agrees to furnish all right of way without cost to the Railroad Company. Said second party further agrees to establish all drainage, to do all grading and provide a roadbed in good condition and suitable for laying track, and to furnish all cross and switch ties necessary to the construction of main track or tracks. All the cost and expense of right of way, roadbed in suitable shape to lay track, shall be paid by said second party without any liability on the part of the Railroad Company. And further the said second party agrees to fence the said right of way on each side of its property, and furnish said first party, the Railroad Company, with good and perfect titles to all right of way and real estate pertaining to said spur track, also all franchises pertaining to rights and uses of all public highways, streets and alleys that cities or corporations may have granted to the said second party through the City of Owosso, Michigan, or any other village or incorporated towns along its lines. 7 - After completion of track the second party will submit to the Railroad*972 Company an itemized statement of expense in connection with mine track. After such statement shall have been properly checked and accepted by the Railroad Company, the expense so decided upon shall be used as a basis upon which a refund shall be made to second party by the Railroad Company at the rate of One ($1.00) Dollar per car on all carload shipments over said mine track. Such refunds to be made monthly and to continue until the second party has been reimbursed for the amount of their expenditure as agreed upon for said mine track, as above outlined in this article, subject, however, to the conditions of paragraph eight (8) hereof. When spur track has been completed the Railroad Company agrees to maintain it thereafter so long as used by said Railroad Company. 8 - The Railroad Company agrees to build a bridge over the shiawassee River in connection with said spur track of such character as will be approved by the Drain Commissioners of Shiawassee County, and to maintain it thereafter so long as it is used by said Railroad Company. After the completion of the bridge the Railroad Company will submit to the Coal Company an itemized statement of expense in connection with the*973 building of the same. After such statement shall have been properly checked and accepted by the Coal Company, the expense so agreed to shall be the amount to be paid to the Railroad Company *338 by the Coal Company, and the Coal Company hereby agrees to pay said amount as follows: The One ($1.00) Dollar refund provided in paragraph seven, hereof, shall be retained by said Railroad Company until the same shall have liquidated the amount of the Railroad Company's expenditure for said bridge as agreed upon, and only after the liquidation of said amount of expenditure of said Railroad Company for said bridge, shall the refund provided in paragraph seven be paid to said Coal Company. The Coal Company agrees to furnish a satisfactory bond to insure the payment to said Railroad Company for its expenditure for the said bridge. In the event that the Coal Company do not ship a sufficient number of cars to provide for the payment of the said amount as hereinabove set forth. 9 - After the said second party shall have been reimbursed as above provided for said track, the mine track in its entirety, including the bridge, shall revert to the Railroad Company. It is understood, however, *974 that the expense borne in the first instance by the second party shall not be considered as a lien on spur track, and said spur track shall at all times remain in possession of Railroad Company in all respects as if spur track had been constructed at original and sole expense of the Railroad Company as hereinbefore provided. The bridge and spur track mentioned in the foregoing agreement were constructed between 1908 and 1910. The total amount expended by the Ann Arbor under the agreement was $28,131.73, which it charged to appropriate capital accounts. The New Haven Coal Mining Co., pursuant to paragraph seven, furnished the Ann Arbor with a statement of expenses amounting to $41,642.44. The Ann Arbor made an effort to verify the expenditures listed in that statement, and made some minor objections; but the statement was never accepted or rejected by the Ann Arbor for the purpose for which it was intended. The New Haven Co. discontinued operations and went out of business in 1912. In the interim it had rendered statements to the Ann Arbor for refunds of $2,300 or $2,400 due it under the agreement, but no cash refunds were ever made by the Ann Arbor. The Ann Arbor made no accounting*975 on its books, at the time or subsequently, to reflect the discontinuance of operations of the bridge and spur track or any effect it may have had upon its capital accounts. By agreement of September 28, 1920, the Ann Arbor sold to the Owosso Sugar Co. "all its right, title and interest in and to the right of way, track and rails, bridges, fences, and all other property of the so-called New Haven Coal Mining Spur Track of said The Ann Arbor Railroad Company," extending approximately 7.26 miles in length, for $31,000 cash. Title was conveyed by quitclaim deed of September 29, 1920. On its books of account, the Ann Arbor credited the proceeds from the sale to operating expenses subaccounts as follows: Account 214 - Rails, $15,125; Account 216 - Other track material, $5,175; Account 212 - Ties, $6,500; Account 220 - Track laying and surfacing, $4,200; and no revision of this accounting has ever been made. This accounting for the sale has never been questioned *339 by the Interstate Commerce Commission, and the original charge of $28,131.73 to capital accounts is still there. The spur track was later sold by the Oswosso Sugar Co, to the Michigan Sugar Co.; and it was abandoned*976 by the latter and taken up in 1923 or 1924. On March 1, 1913, it was worth no more than its original cost of $28,131.73. VI. The consolidated net income determined by the respondent in the deficiency notice is allocable to that portion of 1920 during which the properties of the petitioners were under Federal control, January 1 to February 29, 1920, and to that portion of 1920 after Federal control, March 1 to December 31, 1920, as follows: Jan. 1 to Feb. 29, 1920 March 1 to Dec. 31, 1920 Total Net deficit as reported on original return $5,249.31 $216,839.35 $222,088.66 Adjustments made by Bureau: Additional income or unallowable deductions: Ann Arbor Railroad Co. Railway tax accruals 6,624.57 6,624.57 Guaranty period income 315,261.85 315,261.85 Miscellaneous income 10,965.58 28,354.93 39,320.51 Undermaintenance 574,191.51 574,191.51 Property abandoned 315.62 703.03 1,054.65 Loss on equipment retired 1,237.38 1,237.38 Assessment Ass'n. Ry. Executives 685.42 685.42 Manistique & Lake Superior Railroad Co. Undermaintenance 23,979.75 23,979.75 Guaranty period income 36,686.60 36,686.60 Total additions 6,067.89 770,885.69 776,953.58 Additional deductions or nontaxable income: Ann Arbor Railroad Co. Miscellaneous income charges 32,714.12 5,747.94 38,462.06 Amortization of discount 2,778.43 13,892.17 16,670,60 Back mail pay 5,579.90 5,579.90 Interest on quarterly balances due USRA 4,768.28 23,841.41 28,609.69 Compensation 2,188.67 2,188.67 Material and supplies 29,869.40 29,869.40 Manistique & Lake Superior Railroad Co. Compensation 75.94 75.94 Material and supplies 2,223.01 2,223.01 Total deductions 42,525.44 81,153.83 123,679.27 Net income as corrected by 60-day letter 2/1/27 1 36,457.55 689,731.86 653,274.31 *977 OPINION. STERNHAGEN: As shown in the preliminary statement, several of the assignments of error have been removed from controversy. The adjustment of these matters will be reflected in the final judgment. The matters at issue are considered in this opinion under Roman numerals which are correlated to the findings of fact. I. The issue covered by the second assignment is the propriety of including the so-called guaranty income received from the United *340 States by virtue of section 209(c) of the Transportation Act, 1920, within petitioners' taxable income. In view of texas & , the petitioners now concede that the inclusion was proper, and the respondent's determination is therefore affirmed. II. The petitioners urge that the aforesaid guaranty income paid by the United States pursuant to section 209 of the Transportation Act of 1920, is subject only to an 8 percent rate of tax and not the ordinary 10 percent rate. They argue that, since the income received during Federal control as just compensation was relieved from the normal tax of 2 percent, see *978 , and the guaranty income was measured by the same standard, namely, the railway operating income of the test period, the guaranty income must be likewise relieved. Otherwise, it is said, the guaranty income will fall short of its purpose to give the carrier an equal measure of operating income with that of the pre-war period. This view can not, we think, be sustained. The statute does not so provide expressly and there is no reason for its implication. The Ontario & Western case not only involved an entirely different question, whether the express release from the normal tax of 2 percent could itself be treated as taxable income, but was founded in a special provision of the Revenue Act of 1918, which has no force here. ; . Section 230(b) was by its terms limited to the purposes of the Federal Control Act, which ended February 28, 1920, and the lower tax rate therein prescribed was clearly not, without more, to be applied to the income derived after that date. That this is true as*979 to income actually earned from operations should be beyond doubt. So that a carrier, which by reason of its adequate earnings could not invoke the guaranty, could furthermore not claim an 8 percent tax rate. See . A Congressional intent to give more than this to a carrier receiving its income through the guaranty we may suppose would be plainly stated and not left for a holdover construction of an obsolete provision covering Federal control. III. Petitioners urge that the respondent has erroneously disallowed $598,171.26 of the deduction for maintenance of way and structures and of equipment during the period of the last ten months of 1920. This amount is part of the actual expenditures for the period which were accounted for as maintenance, but the disallowance is based *341 on the respondent's determination that to this extent the petitioners' ostensible maintenance cost was really not its own, but a burden assumed by the Director General, the liability for which accrued during the ten-month period. See *980 . Unlike , there is no evidence here, outside the carriers' claim, that the Director General failed in his contractual duty to maintain the petitioners' properties adequately during Federal control. But the respondent has determined that they received, in their final settlements in 1921, allowances for undermaintenance of their properties during Federal control in the respective amounts of $574,191.51 and $23,979.75, a total of $598,171.26, and this is the amount by which the respondent has reduced the petitioners' deduction for maintenance expenses. As in New York, Chicago & St. Louis R.R. Co., the question arises not because respondent calls the Director General's allowance income, but because he reduces the petitioners' deduction for maintenance expense by the amount of the Director General's allowance. Thus the issue, as to the measure of petitioners' actual and deductible maintenance expenses, is quite different from *981 ; certiorari denied, ; ; ; ; ; and ; ; . In those cases whether gross income was received as a matter of fact (), or whether, being received in fact, the amount was gross income in law (, and ), were questions which imposed a different and less burden on the petitioning taxpayer than the question of his right, despite the respondents determination, to deduct all amounts expended for maintenance without regard for the extent to which, as determined by respondent, such expenditures embodied an amount derived from the Director General in discharge of his contractual obligation. The petitioners did not enter into the standard*982 agreement provided for by section 1 of the Federal Control Act, but by acceptance of the benefits of section 2 thereof they brought themselves within the entire provisions of the act; consequently, their properties were taken over and used by the Director General subject to the same conditions as those contained in the standard agreement so far as they provided for the return of the properties to the carriers "in substantially as good repair and in substantially as complete equipment as it was in at the beginning of federal control." At the end of Federal control, the petitioners filed claims with the Director *342 General setting forth numerous items due from and to the Director General. The Ann Arbor's claim contained, among others, a claim for undermaintenance of way and structures of $507,968, and a claim for undermaintenance of equipment of $700,566.34, a total for undermaintenance of $1,208,534.34, and claimed a net balance due the corporation of $603,601.26. The Lake Superior's claim contained an item for undermaintenance of way and structures of $20,631.95, and claimed a net balance due the corporation of $69,079.98. In the final settlement agreements, the Ann Arbor*983 acknowledged an indebtedness of $600,000 to the Director General, and the Director General acknowledged an indebtedness of $50,000 to the Lake Superior, and the account was closed by the Ann Arbor giving two notes, of a total face amount of $550,000 to the Director General. The petitioners contend that nothing whatever was allowed by the Director General for undermaintenance. They say: Instead of receiving any money as the result of the settlement, the petitioner paid a large sum to the Director General. An analysis of the claims presented and the settlement consummated leads irresistibly to the conclusion that nothing whatever was allowed on the claim for undermaintenance. The Ann Arbor Railroad Company's claim (91, Respondent's Exhibit A) contains an item of $1,208,534.34 for undermaintenance. If this item had been allowed, the net amount due the Ann Arbor would have been $603,601.26. If the claim for undermaintenance be eliminated, the statement would show a balance of $604,933.08 due the Director General, and since the Ann Arbor paid the Director General $600,000 in the settlement, it is obvious that nothing whatever was allowed petitioner for undermaintenance on its*984 claim. The Manistique and Lake Superior Railroad Company's claim (93, Respondent's Exhibit B) contained an item of $20,631.95 for undermaintenance. If this claim had been allowed, petitioner would have been entitled to receive in settlement $69,079.98. If the claim for undermaintenance be eliminated, the statement would show a balance of $48,448.03 due the railroad Company. It was actually allowed $50,000 by the Director General in the final settlement. The logical conclusion, therefore, is that the claims for undermaintenance in the case of both the Manistique and Lake Superior and the Ann Arbor Railroad Companies were wholly disallowed, and that neither company was allowed anything whatever for undermaintenance in the final settlement. This assumes that all items in the claims, except the two undermaintenance items, were allowed by the Director General, and that the claims for undermaintenance were wholly eliminated. This assumption is not justified by the evidence. The only witness on this matter was one of the Ann Arbor's representatives in the conferences with the Director General, which cluminated in the final settlement agreement. He testified: We went down; *985 the representatives of the Ann Arbor Railroad went to Washington in, as I recall it, April, 1921; I know we left on Easter Sunday morning, and we had conferences with the representatives of the Director General, Mr. Tracy being the Comptroller of the Railroad Administration at that time and Mr. Alexander Smith, I believe, was their counsel, and we sat around the table for about a week, and there was a question of give and take all the way *343 through, there was Mr. Erb, our president, he was there and he made certain concessions to the counsel for the Director General, who, in turn, of course allowed similar concessions, and when the thing all wound up there was a lump sum settlement agreed upon. Q. What was the - what credit was allowed the Ann Arbor in that settlement of the account? A. I do not know; the balance was against the Ann Arbor to the extent of six hundred thousand dollars, when the final figures were computed and agreed to by the President of the Company and the Director General's representatives. Q. Mr. Kiefaber, you testified this morning that the closing journal entry in both of these cases, or rather in the case of both petitioners recording the*986 final settlement with the Director General was made in accordance with the I.C.C. regulations issued on January 25, 1922, which has been introduced here as Petitioner's Exhibit No. 4; I call your attention to paragraph 2 of that letter, or of that order which provides that items on which the amount of settlement may be mutually agreed upon between the Director General and the carrier, whether or not previously recorded in the account, shall be recorded in the accounts in accordance with the effective accounting regulations on the basis of settlement agreed upon. Now, as I understand it, you did not record these items which you had agreed upon in accordance with the I.C.C. regulations in effect at that time, but you carried the entire net credit to profit and loss, or the net debit, as the case may be, instead of allocating these items which had been agreed upon to the accounts where they belonged; is that a fact? A. We could not identify the whole, because our inability to allocate the entire amount of six hundred thousand dollars charged by the Director General, prevented us from making a definite division of that figure, therefore all we could do was to wipe off the open accounts*987 standing on the corporation's books, and then setting up this liability for the $600,000 and calling the rest profit and loss; we have no other way of determining what the amounts were other than what were on our books. Q. In other words, you made no allocation of the net balance as between different items? A. No, sir, we did not know what the $600,000 represented. As to the Lake Superior's claim and the settlement agreed upon, the witness testified that according to notations which he made during the course of the conferences with the Director General, the items of $5,699.27 for interest on deferred compensation and $14,505.50 for interest on open accounts due the corporation were entirely eliminated. Q. Now the remaining item is maintenance of way and structures under $20,631.95; what is your recollection with respect to that? A. Apparently from my recollection of the transaction and the notations which I have on my working copy, that amount evidently was practically allowed in full by the Director General, for this reason you will note that the total of the statement to which you refer is $69,079.98 due to the corporation, the items of interest or deferred compensation*988 amounting to $5,699.27, and interest on open accounts due to corporation $14,505.50, or a total of $20,204.77, have been shown as having been deducted from the total of $69,079.98, leaving a balance of $48,875.21, due the corporation from the Director General, and in view of the fact that in setting this thing down and making final settlement *344 with the Director General, he allowed the M. & L.S. a flat figure of $50,000 and called it square, so that it would indicate that all other items had been allowed, there was only a difference of $1,200 between the amended claim and his round flat settlement figure of $50,000. That is all the evidence to indicate whether the Director General made allowances for undermaintenance. The petitioners, however, do not rest their case entirely upon the proposition that no allowances were made to them for undermaintenance, but urge that, even if the amounts in question be regarded as allowances for undermaintenance and within the field of the so-called reimbursement rule, still the respondent's action is erroneous, because "no part of the expenditures for maintenance in 1920 were made for the purpose of rehabilitating the property or making*989 good deferred maintenance, but on the other hand the entire amount included as maintenance expenses covered only the usual, ordinary and necessary maintenance expenses in the operation of petitioner's property." Upon this proposition was predicated the introduction of elaborate statistical studies and opinion testimony to show that the petitioners' maintenance expenditures during the last ten months of 1920 were no more than can properly be attributed to the current maintenance requirements of that period. The petitioners' first method of demonstrating that the maintenance charges of the last ten months of 1920 do not include restoration of the prior undermaintenance is an equated comparison with the cost figures of the test period. Applying this process, the Ann Arbor's actual average test period charges for maintenance become an equated figure of $1,480,721.90 in comparison with the 1920 figure of $1,600,814.19, and the Lake Superior's average test period charges become an equated figure, without adjustment for differences in the quantity of property used and in the extent of such use, of $94,473.81 in comparison with the 1920 figure of $73,633.35, which shows that the 1920 maintenance*990 cost was $120,000 greater for the Ann Arbor, and $20,800 less for the Lake Superior, than the normal test period cost. The Ann Arbor's greater 1920 maintenance cost, as disclosed by the statistical study, is explained by the petitioners as due to unusual conditions in that year, such as numerous derailments and breakdown of equipment, caused by the bad condition and the lack of proper maintenance of the Ann Arbor's roadway, and to excessive running (minor) repairs to equipment, which were made necessary by the Ann Arbor's failure to provide the usual classified (major) repairs. To support this explanation, there was introduced the testimony of three witnesses and several other statistical studies. Parvin, superintendent of the Ann Arbor, testified that he made weekly inspection trips over the road; that he kept himself intimately *345 acquainted with the condition of the road, from day to day and month to month; and when asked what the condition of the road was during the years 1920 and 1921, he replied as follows: Putting it mildly, the condition was bad, basing that statement on the physical condition of the road from a standpoint of maintenance during the years 1920*991 and 1921, and on the further basis of our derailment record for those two years, notwithstanding every precaution that the Transportation Department could exercise over its men, - that is the department I had charge of, educating its men to operate as cautiously and as carefully as possible, and by placing slow orders to protect bad track, some of which if it is permissible, I will insert into the record, in the year 1920 we had 122 main line derailments on our 292 miles of railroad; 391 side track derailments. I think I should qualify that, though, by the statement that for the first three months in 1920, 16 of the main line derailments were occasioned by ice on the track, - we had a very severe ice storm in the first of 1920, which resulted in sixteen derailments on that account, but in 1921 we had no unusual conditions, we had 72 main line derailments, 289 side track derailments. Your Honor has been connected with the railroad, and for your information we had departmental jurisdiction - there is always considerable controversy between the departments when you have derailments, particularly when conditions were as I have stated. By the MEMBER: Q. Do you mean controversy as*992 to which department is at fault? A. Yes, sir; also the track will contribute to other causes, such as broken arch bars on cars; broken springs on locomotives, and in several instances the Grand Trunk Railroad complained of the condition of our track because they could not keep springs under our locomotives. Conditions got to the point where our vice-president and general manager at that time, Mr. Blomeyer, walked a lot of the track with me; we walked as much as seventeen miles a day; he finally remarked that from then on when I reported a derailment due to track conditions there would not be any further argument about it. That conditions did not only exist during 1920 and 1921, but right up until 1925, when the Wabash bought the property and started rehabilitating the property. As an offset, in 1930 we had 18 main line derailments, two chargeable to track. If it would be permissible, and to support my statement as to the conditions, I could put into the record for the month, say, of November, 1921 and November 1920, the slow orders over the track that were in effect at that time, but in view of these slow orders we still had those derailments, for instance in 1920, in November, *993 we had twelve main line derailments, and in November 1921, we had ten derailments, - main line derailments, and we had a page full of slow orders at the time, as slow a speed over some of the track as five miles per hour. Q. Do you, as an experienced railroad man, attribute any relation of cause and effect, between the number of derailments you had during 1920 and 1921, and the state of maintenance of the track? A. Derailments certainly indicate poor maintenance, or lack of maintenance. Q. Now, do you have any knowledge of the state of maintenance of the mechanical and car equipment of the Ann Arbor during this same period? A. * * * I would not care to state as to the maintenance of equipment, but I can state as to the maintenance of the locomotives, which was poor and in direct line with the track maintenance. *346 Q. Can you state whether or not any rehabilitation of the Ann Arbor track or roadway was undertaken or conducted during either 1920 or 1921? A. No rehabilitation was undertaken or conducted. Q. Now, can you state whether or not any rehabilitation of locomotives, cars or other equipment was undertaken in either of these years, or conducted*994 during those years? A. In the case of locomotives there was not; in the case of cars, if you consider rebuilding some express cars, why I do not think I am prepared to say whether that would be or would not be. He further testified that the track was very poorly maintained in 1920 and 1921; that such failure to maintain "naturally would cause considerable increase in your operating expenses"; that the derailments or wrecks to which he referred tended to increase expenditures in connection with track maintenance, equipment maintenance, operation of wrecking outfits, and claim payments; and that expenses of 1920 were materially increased, due to those wrecks and derailments. On cross-examination he testified, in part, as follows: Q. Mr. Parvin, what do you understand by rehabilitation of properties? A. Go ahead and putting your property in shape to do that for which the property was intended. Q. That is to say, assuming in the beginning that it was grossly undermaintained. A. Yes. Butler, master mechanic of the Ann Arbor, testified that he inspected the power - locomotives, stationary boilers, pump stations and all of that sort of equipment - when he first became*995 associated with the company in 1922; that he found all of such equipment to be in very bad condition; that the condition of the power was such as to lead him to believe that since 1920 it had not been kept in good condition or maintained in good repair up to the best standard of condition; and that he would even say that far less than the ordinary and necessary repairs had been made since March 1, 1920. After examining petitioners' Exhibit 43, being a statement of monthly expenditures for repairs to locomotives in an average ten months of the test period and in the last ten months of 1920, segregated as between classified (major) and running (minor) repairs, he testified that the exhibit indicated to him that the power was not in proper condition either in the test period or in the last ten months of 1920; that in order to keep locomotives in proper condition, classified and running repairs should be made thereto on a fifty-fifty basis; that unless approximately the same amount of money is spent for classified repairs as for running repairs, the power is not in proper condition and you are spending too much money on running repairs trying to operate the railroad; and that, judging*996 from the condition of the equipment in 1922, it is his opinion that the locomotives had not been put in proper condition or rehabilitated in 1920. He testified: *347 Q. Do you mean anything more than this: that when you saw them in 1922 they were in bad condition and if they had been properly maintained before 1922 they probably would not have been in such bad condition? A. No, sir. Q. And from that you concluded that at some time before 1922 they were permitted to get in bad condition? A, That is right. Q. And you do not know at what time before 1922 they were permitted to get in bad condition, do you? A. No, I do not. Q. You just know they did not have as much maintenance as they should have had in the period prior to 1922? A. I know they had not been properly maintained. Q. At any time prior to 1922? A. Prior to 1922. Q. You do not have any information of any period prior to 1922, do you? They might have been in bad condition in 1916 or in 1918 or in 1920, and all of those things would result in the bad condition in which you found them in 1922? A. That is right; what I mean is if you had a bunch of fifty engines in good condition*997 that it would take more than two years to put them in the condition that I found them in. Q. So you do not know, as a matter of fact, what was done to them in 1920? A. No, sir, I was not there. Exhibit 21, containing data taken from the annual reports of the chief inspector of locomotive boilers to the Interstate Commerce Commission, shows, in respect of the Ann Arbor's locomotives, as follows: Number Number Number Percentage Ordered owned inspected defective of inspec- out of ted found service defective Test period: Average [3] Federal control period: [5] Exhibit 43, previously referred to in connection with Butler's testimony, shows repairs applied to Ann Arbor's locomotives, as follows: Repairs Classified Percent Running Percent Total Average for ten months of test period $38,100.32 33.70 $74,965.72 66.30 $113,066.04 Average for ten months of test period - equated 97,998.15 33.70 192,820.04 66.30 290,818.19 Last ten months of [1920] 124,275.51 36.01 220,847.06 63.99 345,122.57 *998 *348 Treacy, car foreman of the Ann Arbor since 1918, testified that he has been at car work since 1896, and that he supervises all of the Ann Arbor's car work; that the condition of the Ann Arbor's car equipment was "quite bad" from March 1, 1920, to the end of 1921; that the ordinary and necessary repairs were not made to the Ann Arbor's car equipment in 1920; that it was the practice in 1920 to make only necessary repairs to good cars; that during and after Federal control the cars were operated "all over the country, and when they came back to us, they were in bad condition"; that "we picked out the lightest cars [cars needing the least repairs] that we could get and made repairs and let the other ones stand"; that "we did not work full force or full time in 1920, because we did not have the money to do it with"; and that the bad order cars "coming in on the line" for repairs in 1920 were heavier than usual. Exhibits 44, 46, and 47 show that the number of Ann Arbor freight cars in bad order in March 1920 was 191, which is 9.10 percent of the number of cars owned and leased in that month; and that the number of freight cars in bad order in December 1920 was 293, which*999 is 13.88 percent of the number of cars owned and leased in that month. Exhibits 45, 46, and 47 show that the average number of Ann Arbor freight cars repaired during each month of the test period was 620, which is 26.90 percent of the average number of cars owned and leased in that period; and that the average number of cars repaired during each of the last 10 months of 1920 was 358, which is 16.89 percent of the average number owned and leased during those months. The petitioners contend that this oral and documentary evidence "discloses facts which rationally account for the excess expenditure [greater maintenance cost of the 1920 period] indicated by the result of the study [comparison of 1920 period maintenance cost with test period maintenance cost], and supports our contention that no rehabilitation of the Ann Arbor property occurred during 1920." From the foregoing, it will be observed that the petitioners' position is that maintenance expenditures of the 1920 period in an amount equal to the equated expenditures of the test period are to be regarded as having been made for current maintenance and as necessarily excluding prior undermaintenance; that the statistical*1000 study of comparative maintenance costs of the 1920 and test period discloses that all but approximately $120,000 of the Ann Arbor's 1920 maintenance expenditures was for current maintenance, and that all of the Lake Superior's 1920 maintenance expenditures was for current maintenance; that the greater 1920 maintenance cost in the case of the Ann Arbor is rationally accounted for by the facts disclosed by the oral *349 and documentary evidence; hence, there was no restoration of prior undermaintenance in 1920. This is the identical proposition which was presented in , and . It was fully and carefully considered and rejected in those opinions, the decision in , to the contrary, being pro tanto expressly overruled. Since the statistical study, or comparison of 1920 maintenance cost with test period maintevance cost, is the only evidence we have, in the case of the Lake Superior, bearing upon the question of whether Federal control undermaintenance was made good by that company in the 1920 period, it follows, *1001 in line with the decision in the Southern Ry. case, that the respondent's determination, so far as it affects that company, must be sustained. As to the Ann Arbor, it remains to be determined whether the evidence, other than the statistical study of comparative maintenance costs of the 1920 and test periods, justifies overturning the respondent's determination as to it. It is clear from the evidence that the Ann Arbor's roadway, locomotives, and freight train cars were not in good repair in 1920. As to structures, miscellaneous facilities, passenger train cars, floating equipment, and miscellaneous equipment, for the maintenance of which the Ann Arbor expended $403,115.56 in the last ten months of 1920, there is no evidence as to their condition or state of maintenance in the 1920 period, or as to any other facts pertaining to them; and, consequently, there is no proof that the expenditure of $403,115.56 for the maintenance of these facilities in the 1920 period contains nothing for restoration of prior undermaintenance. The fact that the Ann Arbor's roadway, locomotives, and freight train cars were not in good repair in 1920 does not prove that the 1920 expenditures included*1002 nothing for restoration of prior undermaintenance. The question can not be decided by reference to the condition of the facilities in 1920; for, if no more than a single item of maintenance had been performed in the 1920 period - in which event, the condition of repair might obviously be very bad - the question would still remain as to whether the particular item of maintenance performed was one which the Director General had undertaken. The proposition was considered in , and rejected in the following language: The petitioner's assistant chief engineer stated that he had inspected the railroad according to his periodic wont and found it to be in his opinion in no better condition at the end of 1920 than at the beginning. This opinion adds little or no force to the petitioner's contention, for, aside from the fact that this is an opinion of an interested person regarded by the Director General as inadequate for official recognition (Director General's Report to the President, *350 supra, p. 17), and not controlling with this Board (*1003 ), the physical appearance of the road in general is not shown to disclose whether $459,000 of the year's maintenance expense had been devoted to such restoration of road as the Director General had failed in his contractual duty to maintain. Likewise, in , it was said: The fact that there was no improvement in the average condition of maintenance by the expenditures of the 1920 period is of no importance; that, like the accounting test, indicates only that not more than the usual and normal amount of maintenance was accomplished in the period, or that such maintenance as was performed was not greater than current necessity required. The real question here is, Was the maintenance performed in the 1920 period, or some portion thereof, that which actually belonged to the Federal control period for which the petitioner was reimbursed by the Director General?; and that cannot be answered by a mere comparison of maintenance conditions at the beginning of the period with the conditions existing at the end of the period, as was held in the Missouri Pacific case, but requires*1004 an examination of particular items of maintenance performed. * * * Parvin's statement that there was no rehabilitation of the Ann Arbor's roadway and locomotives in 1920, and similar statements by Butler in respect of locomotives and Treacy in respect of freight train cars, are inconsistent with other evidence. Exhibit 33 shows the application of labor and materials to roadway in the 1920 period in greater quantities than in the test period; and Parvin testified that these were applied at points where most needed. Butler did not become associated with the Ann Arbor until 1922; and, consequently, he had no knowledge of what had been done in 1920 in respect to locomotives. his statement was based entirely upon what he saw in 1922 and his judgment that the locomotives could not have reached the condition in which he found them in 1922 had they been kept in a state of good repair after March 1, 1920. Exhibit D, however, being a photostatic copy of the supplemental claim which the Ann Arbor filed with the Director General, received in evidence without objection by petitioners' counsel, shows that of the number of locomotives turned back by the Director General at the end of Federal*1005 control in bad condition, 10 were fully repaired and 22 partially repaired between March 1 and December 31, 1920, at a cost of $157,416.32. And, as to freight train cars, Exhibit E, a photostatic copy of a further supplemental claim which the Ann Arbor filed with the Director General, also received in evidence without objection by petitioners' counsel, shows that 799 "heavy bad order cars" were "returned to our line for rebuilding during the period January 1, 1920, to January 31, 1921," and that the cost of "actual rebuilding" of 675 of said cars amounted to $351,836.58. The respondent's determination that petitioners' maintenance deductions must be cut down so as to exclude the Director General's *351 undermaintenance allowance is sustained, the disallowance of the Lake Superior being apparently properly admitted by respondent to amount of $20,631.95, instead of $23,979.75 originally disallowed. IV. The parties have stipulated that on May 1, 1919, the petitioner issued its two-year 6 percent notes, of the face value of $750,000, maturing May 1, 1921, for $720,077.92 cash; that in 1920, the petitioner purchased and retired $27,200 face value of such notes, paying therefor*1006 $25,024; that the issuing price of the notes retired in 1920 was $26,114.83; that the discount allocable to the notes retired in 1920 previously amortized is $361.72; and that if, as a matter of law, the difference between the purchase price and the sale price of the notes retired in 1920 is taxable income, the amount to be included in respect of the transaction is $1,452.55. On the brief, the petitioners concede that the amount of $1,452.55 is taxable income. . Since the amount included in income by the respondent is $2,176, net income shown in the deficiency notice should be reduced by $723.45. V. The proposed findings in this subdivision relate to the eighth and ninth assignments of error, which are considered together. In the eighth assignment the Ann Arbor contends that the deduction for operating expenses allowed by the respondent is understated by reason of an offset of $31,000, representing the proceeds from the sale of the spur track to the Owosso Sugar Co.; and in the ninth assignment it is charged that the Ann Arbor sustained a loss of $37,007.36 upon the sale of the spur track, which loss the respondent*1007 has not allowed as a deduction. The property in question was acquired prior to March 1, 1913. Under the applicable statute, the Revenue Act of 1918, the basis for determining any gain from the sale is cost or March 1, 1913, value, whichever is higher, and the basis for determining any loss is cost or March 1, 1913, value, whichever is lower. . On the brief, the petitioners contend that the cost of the track was $69,774.17; that the fair market value at March 1, 1913, was $68,494.43; and, using the alleged March 1, 1913, value as the basis, that the Ann Arbor sustained a deductible loss of $37,494.43. The alleged cost of $69,774.17 represents the $28,131.73 expended by the Ann Arbor plus the $41,642.44 alleged to have been expended by the New Haven Co. Clearly no amount expended by the New Haven Co. can be included in the Ann Arbor's cost basis, and this is not argued. The evidence shows that no cash refunds were ever *352 paid by the Ann Arbor to the New Haven Co. under paragraph 7 of the agreement. The findings show that the New Haven Co. had rendered statements of amounts due it under paragraph 7, in the*1008 total sum of $2,300 or $2,400, and the Ann Arbor's auditor testified that "I can recall there was one bill made against them [the New Haven Coal Mining Co.] for around $5,400 for a bridge, and my best recollection is that these refunds that were due them [the New Haven Coal Mining Co.] was [sic] credited to that bill as part of the track." Evidently, then, the Ann Arbor had not been reimbursed for the cost of the bridge at the time the New Haven Co. discontinued operations and went out of business. The evidence does not prove a greater cost then $28,131.73; and, since the track and bridge were disposed of for $31,000, no loss resulted to the Ann Arbor from the transaction; and none is deductible. As to the eighth assignment, we are of opinion that the basis to be used is the original cost to the Ann Arbor of $28,131.73 and that the profit of $2,868.27 is properly within its income. This transaction has nothing to do with the deduction for expenses. We are not persuaded that the theoretical construction of a figure to represent the fair market value of the property on March 1, 1913, is demonstrative of the value in fact or that the evidence establishes a value on March 1, 1913, in*1009 excess of the cost of $28,131.73. We also find no sufficient evidence to support a finding that 1,132 feet of the track were omitted from the sale. The respondent's determination in respect of the sale of the spur track is modified, by reducing the determined net income by $28,131.73. VI. The net income for January and February 1920, taxable at the rate of 8 percent, and the net income for the period March 1 to December 31, 1920, taxable at the rate of 10 percent, will be determined in accordance with the findings. Judgment will be entered under Rule 50. Footnotes 1. Net loss. ↩