
    391 F. 2d 627
    WEST VIRGINIA NORTHERN RAILROAD COMPANY v. THE UNITED STATES
    [No. 277-63.
    Decided March 15, 1968.
    Plaintiff's motion for reconsideration and to alter judgment denied June 14, 1968]
    
      
      Fred B. Tandil, attorney of record, for plaintiff.
    
      W. Stephen McOormell, with, whom was Assistant Attorney General Mitchell Bogovin, for defendant. Philip B. Miller, of counsel.
    Before Cowen, Chief Judge, Laramore, Dureee, Davis, ColuiNS, SkeltoN, and Nichols, Judges.
    
   Per Curiam : This case was referred to Trial Commissioner Mastín G. White with directions to make findings of fact and recommendation for conclusions of law under the order of reference and Rule 57(a). The commissioner has done so in ■an opinion and report filed on June 2,1967. Exceptions to the commissioner’s opinion, findings, and recommendation were filed by plaintiff and the case has been submitted to the court on oral argument of counsel and the briefs of the parties. Since the court is in agreement with the opinion, findings, and recommendation of the commissioner, with a very slight modification, it hereby adopts the same as modified as the basis for its judgment in this case as hereinafter set forth. Therefore, plaintiff is not entitled to recover and' the petition is dismissed.

OPINION OE COMMISSIONER

White, Commissioner:

The plaintiff, a West Virginia Corporation, is endeavoring in this action to obtain a refund of a portion of the income tax which the plaintiff paid for the year 1958.

It is my opinion that the plaintiff is not entitled to recover.

The question which must be answered in the case is whether the Internal Revenue Service acted properly or erroneously in partially disallowing, and assessing a deficiency with respect to, a deduction which the plaintiff claimed in its 1958 income tax return as locomotive rental.

For a proper understanding of the legal question that is before the court for determination, it is necessary to outline the background material in considerable detail.

The plaintiff was chartered in 1883. It owns and operates 11 miles of railroad (plus related facilities) running over hilly terrain in West Virginia between the towns of King-wood, where the plaintiff’s headquarters are located, and Tunnelton. The plaintiff’s railroad is operated as a feeder road for the Baltimore & Ohio Railroad, and the connection between the two railroads is at Tunnelton.

The plaintiff is primarily a carrier of bituminous (or soft) coal. It carries the coal from mines located along its line to the connection with the B&O at Tunnelton. Such shipments comprise approximately 98 percent of the plaintiff’s business.

The relations between the plaintiff and the B&O are governed by the provisions of an agreement that was first entered into between the two companies in 1911. This agreement has been revised from time to time, but no change of any significance with respect to the issues involved in this case was made in the agreement during the period of time that is pertinent to the present litigation.

The plaintiff’s income is derived almost wholly from the payments that it receives from the B&O in connection with coal shipments which originate on the plaintiff’s line and are turned over to the B&O at Tunnelton for further transportation. The plaintiff is entitled to a certain percentage of the through revenue on each such shipment, under the agreement referred to in the preceding paragraph. If the B&O is the final carrier and effects delivery of a particular shipment, the plaintiff is entitled to 11 percent of the through revenue. On the other hand, if a particular shipment, after being handled by the B&O, is transported by some other carrier or carriers before delivery is effected, the plaintiff’s percentage of the through revenue ranges between 15 percent and 3 percent, depending on the circumstances.

The B&O effects a settlement with, and issues a check to, the plaintiff on a monthly basis. These steps are accomplished not earlier than the 19th and not later than the 25th of the next succeeding month. However, a settlement is not necessarily limited to the shipments that were transferred by the plaintiff to the B&O during the particular month involved in the settlement. Occasionally, a settlement will include a shipment or shipments transferred by the plaintiff to the B&O months, or even years, prior to the month involved in the settlement.

In 1945, all of the plaintiff’s stock, consisting of 1,000 shares, was purchased for $100,000 by James Jenkins, Sr., and his four adult children, namely, James Jenkins, Jr., Mrs. Violet Oberhaus, Mrs. Eheta Leimbach, and Mrs. Marguerite Eoss. (For the sake of convenience, these five individuals will usually be referred to hereafter in the opinion as “the Jenkins family.”)

After the Jenkins family purchased the plaintiff’s stock in 1945 and gained control of the plaintiff, they made J. D. Everly superintendent of the plaintiff’s railroad. Mr. Everly had been employed by the plaintiff since 1942; and it was due principally to ids efforts that the Jenkins family had become interested in the plaintiff.

In 1945, the plaintiff had four Baldwin steam locomotives. The oldest of these was about 37 years old, and the newest was about 27 years old. Mr. Everly convinced the Jenkins family, after they acquired the plaintiff’s stock, that the plaintiff should dispose of the steam locomotives and that two new diesel locomotives should be acquired to replace them. Action to effectuate this recommendation was taken in 1946. Two identical switching locomotives were purchased by J ames J enkins, Sr., at a cost of $89,500 apiece. Each was a 1200 horsepower, diesel, electrically operated locomotive. The ownership of one locomotive was placed in the names of James Jenkins, Jr., and Mrs. Leimbach, each of whom owned a one-half interest in the locomotive; and the ownership of the other locomotive was similarly placed in the names of Mrs. Oberhaus and Mrs. Eoss.

On June 14, 1946, the plaintiff, as lessee, and the four Jenkins children, as lessors, entered into an agreement for the lease of the two diesel locomotives owned by the four Jenkins children, who were also stockholders of the plaintiff. The locomotive lease provided for the hiring of the two locomotives by the plaintiff from the owners for a term of 5 years at a rental rate of 7y2 cents per net ton of freight hauled by the plaintiff over its right-of-way. Under this agreement, the rent for the locomotives was to be computed each month, and payment was to be made by the plaintiff to the owners of the locomotives on the 15th day of the following month. The plaintiff was to maintain the two locomotives in good condition, wear and tear excepted, at the plaintiff’s expense. At the end of the lease term, the plaintiff was to deliver the locomotives to the owners in good condition, damage by the elements excepted.

Subsequently, the ownership of the two diesel locomotives was transferred to the Jenkins Equipment Company, a partnership composed of the Jenkins family.

In addition to owning the plaintiff’s stock, the Jenkins family also owned approximately 25,000 acres of coal lands in West Virginia, located about 15 miles from Kingwood. The Jenkins family, trading and doing business as Jenkins Coal & Land Company, a partnership, acquired these coal lands on or about January 9, 1946.

In 1950, Ralph R. Lewis (who will usually be referred to hereafter in the opinion was “Mr. Lewis”), a businessman and entrepreneur, obtained from the Jenkins family an option to lease or purchase their coal lands in West Virginia. Mr. Lewis had been interested for many years in the development .of oil and other natural resources, and he had been endeavoring since the end of World War II to locate a large area of “uncaptured” coal lands, with the idea of having a plant for the generation of electric power built on or near such lands, so that the power plant could utilize the coal as fuel. In connection with this project, Mr. Lewis had been negotiating with the Rural Electrification Administration, which was interested in constructing a power plant near cheap coal in West Virginia. As a result of those contacts, Mr. Lewis had learned of the approximately 25,000 acres of coal lands in West Virginia owned by the Jenkins family.

After obtaining the option referred to in the preceding paragraph, Mr. Lewis endeavored to obtain the financing that was necessary in order to consummate the deal for the acquisition of the coal lands from the Jenkins family. During the course of his endeavors, Mr. Lewis came in contact with Mr. Spencer, the president of the Spencer Chemical Company, who became interested in the option that Mr. Lewis had obtained for the leasing or purchase of the coal lands owned by the Jenkins family. When the Jenkins family learned that Mr. Spencer was interested in the proposal, they suggested to Mr. Lewis that he withdraw from the transaction and permit the Spencer Chemical Company to deal directly with the Jenkins family. Mr. Lewis was agreeable to this.

Negotiations ensued between the Jenkins family and the Spencer Chemical Company. During the course of the negotiations, it was suggested by the Jenkins family that the proposed transaction should include not only the sale or leasing of the coal lands owned by the Jenkins family, but also the sale of the stock owned by the Jenkins family in the plaintiff railroad.

The negotiations between the Jenkins family and the Spencer Chemical Company resulted in the granting of two options by the Jenkins family to the Preston Coal Company, a wholly owned subsidiary of the Spencer Chemical Company. The options were dated December 30, 1950.

One of the options mentioned in the preceding paragraph granted to the Preston Coal Company the right, exercisable on or before July 1,1951, to purchase all of the plaintiff’s outstanding stock for $500,000, payable $50,000 in cash and the balance in 15 annual installments. This agreement provided that, in the event of the exercise of the option, the optionee would agree to a 25-year extension of the locomotive lease previously referred to, at the existing rental rate of iy2 cents per ton of freight hauled by the plaintiff. However, the stock option agreement further provided that it could be exercised only if the Preston Coal Company also exercised the other option mentioned in the preceding paragraph and further described in the succeeding paragraph.

The second option which the Jenkins family granted to the Preston Coal Company on December 30, 1950 conferred on Preston the right to purchase the approximately 25,000 acres of coal lands owned by the Jenkins family at the price of $50 per acre; or, in the alternative, Preston could lease the coal lands at a royalty rate of 10 cents per ton of coal mined and sold, with a stated minimum royalty of $30,000 per year.

In consideration of Mr. Lewis’ activities in bringing the parties together and in surrendering his prior option on the coal lands owned by the Jenkins family, the Preston Coal Company entered into a letter agreement with Mr. Lewis on January 19,1951. In this agreement, Preston agreed to pay Mr. Lewis certain royalties if it exercised the coal lands option, and to assign to Mr. Lewis a certain number of shares of the plaintiff’s stock if Preston exercised the railroad option. Preston also agreed to assign to Mr. Lewis all of its rights under the two options obtained from the Jenkins family if it should decide not to exercise the options.

Subsequently, the Preston Coal Company decided not to exercise the options which it had obtained from the Jenkins family. On March 19, 1951, Preston assigned to Mr. Lewis its entire interest in those agreements.

In considering the matter of whether to exercise the options transferred to him by the Preston Coal Company, Mr. Lewis consulted Howard Eavenson, an outstanding coal engineer of Pittsburgh, Pennsylvania. Mr. Eavenson conducted an investigation and then made a report to Mr. Lewis. It was Mr. Eavenson’s opinion, as reported to Mr. Lewis, that the coal lands owned by the Jenkins family constituted the largest “uncaptured” coal area in the East; that if an efficient and economical way could be devised to clean the coal from such lands, much of it would be of sufficiently high quality to be sold at favorable prices in the markets along the Eastern seaboard, while the less desirable coal could be sold locally to an electric-power generating plant which, it was understood, was going to be built near Kingwood at Albright, West Virginia, by the Monongahela Power Company; and that, if a feasible cleaning method could be developed, a very profitable operation for the plaintiff in connection with the hauling of the coal would be assured.

Mr. Lewis also investigated and familiarized himself with the layout and physical condition of the plaintiff’s properties. At the time, the plaintiff’s physical facilities included a right-of-way, ties, tracks, rails, fastening switches, crossing signs, an office, an old frame shop building, various buildings used in connection with the maintenance of the right-of-way, and pump houses. Mr. Lewis ascertained that while such properties were not in excellent condition, the plaintiff’s superintendent, J. D. Everly, was a competent man who had in mind plans which, if he were permitted to carry them out, would improve the railroad.

Mr. Lewis realized that if he were to exercise the options, he would be required to pay $500,000 for the stock of the plaintiff. Mr. Lewis’ financial condition at the time was extremely poor. A prior business venture had been unsuccessful, and a judgment had been rendered against him, which had not been satisfied. However, the plaintiff at the time was hauling bituminous coal from 2B mines located along its route, such coal being used primarily by public utilities on the Eastern seaboard, and Mr. Lewis believed that there was a good possibility that the coal mining operations in the vicinity of the plaintiff’s line would be very successful in the future, thereby making the plaintiff’s railroad operations highly profitable. Also, Mr. Lewis had been informed that the plaintiff had an earned surplus and undistributed profit of almost $300,000 as of January 1,1951, and that the plaintiff’s gross earnings in 1951 would approximate $300,000. Since Mr. Lewis was highly optimistic about future revenues, he regarded the purchase price of $500,000 for the plaintiff’s stock as a reasonable one.

Mr. Lewis notified the Jenkins family that he intended to exercise both of the options that had been transferred to him by the Preston Coal Company. Thereupon, negotiations were begun between Mr. Lewis and the Jenkins family. The Jenkins family (each of whom then owned 200 shares of the plaintiff’s stock) were concerned over Mr. Lewis’ poor financial condition, especially in relation to the portion of the railroad option agreement to the effect that, although the purchase price was payable over a 15-year period, with only a $50,000 down payment, the stock was to be turned over to Mr. Lewis immediately, without any additional security. Furthermore, although the railroad option called for installment payments, no promissory note for the unpaid balance was required. The Jenkins family desired the execution by Mr. Lewis of a 15-year promissory note to secure the payment of the 15 annual installments. The Jenkins family also wished to prevent a distribution of the existing surplus while the purchase price remained unpaid. In addition, the Jenkins family desired, as further security for Mr. Lewis’ indebtedness to them on the purchase of the plaintiff’s stock, that the rental to be paid by the plaintiff for the two diesel locomotives be increased from 7% cents to 12% cents per freight ton hauled by the plaintiff, and that the term of the locomotive lease be fixed at 15 years (the same term as the Lewis note), without any right of cancellation by the plaintiff unless by purchase of the locomotives for $387,500.

With respect to the option for the purchase or leasing of the coal lands owned by the Jenkins family, the Jenkins family desired that this be changed so as to provide for the leasing of only 19,660.81 acres of such lands for a term of 15 years, but they were agreeable to reducing the minimum annual royalty from $30,000 to $20,000.

Mr. Lewis ultimately agreed to the revised terms desired by the Jenkins family, as summarized in the two immediately preceding paragraphs, upon the agreement of the Jenkins family that 5 cents out of the sum of 12% cents per freight ton that was to be paid by the plaintiff under the locomotive rental agreement, as revised, would be credited by the Jenkins family to the payment of the installments due on the Lewis note (or, if the time should come when no such installment was due, the 5-cent factor would be credited to the payment of the $20,000 minimum annual royalty under Mr. Lewis’ lease of the coal lands).

The settlement between Mr. Lewis and the Jenkins family, pursuant to the exercise by Mr. Lewis of the options, as revised, for the purchase of the plaintiff’s stock and the leasing of the coal lands, was accomplished on September 24, 1951. Several documents were executed at that time to finalize the transaction. As Mr. Lewis personally did not have the necessary funds with which to make the $50,000 down payment on the purchase of the plaintiff’s stock and the other financial outlays involved in the transaction between Mr. Lewis and the Jenkins family, the Jenkins family finally agreed to lend Mr. Lewis $90,000, of which the sum of $50,000 was to be used for the down payment on the purchase of the plaintiff’s stock, the sum of $20,000 was to be used to pay the minimum annual royalty for the first year under the coal lands lease, and the sum of $20,000 was to be used for expenses. The 15-year promissory note executed by Mr. Lewis covered this $90,000 loan from the Jenkins family, as well as the $450,000 representing the remainder due on the purchase price of the plaintiff’s stock, so that the total amount of the promissory note was $540,000. The note stated that the 1,000 shares of the plaintiff’s stock would be held as security by the Jenkins family for the payment of the note; and Mr. Lewis ais» executed an assignment of the stock to the Jenkins family, on the understanding that the assignment could be used in the event of a default by Mr. Lewis.

The settlement of September 24,1951 not only included the execution of documents relating to the acquisition of the plaintiff’s stock and the leasing of the coal lands by Mr. Lewis, but a new locomotive lease was also signed as part of the settlement. This new lease was for a term of 15 years, and it provided for the payment by the plaintiff of “rental” at the rate of 12% cents per ton of freight hauled by the plaintiff. The “rental” payments were to be made on a monthly basis. As previously indicated, the sum of 5 cents out of the basic “rental” rate of 12% cents per ton was to be credited to the payment of the installments due on Mr. Lewis’ promissory note to the Jenkins family in the face amount of $540,000 (or to the payment of the minimum royalty of $20,000 per year under Mr. Lewis’ lease of coal lands from the Jenkins family, if the time should come when the promissory note was fully paid).

Despite his poor financial condition, Mr. Lewis was not particularly concerned over the $500,000 purchase price for the plaintiff’s stock or over the $540,000 note which he signed on September 24, 1951. Although his plans were highly speculative at the time, Mr. Lewis was very optimistic concerning future prospects. On the basis of Howard Eaven-son’s estimates concerning the quantity of coal along the plaintiff’s right-of-way, the likelihood of a feasible plan being devised for the cleaning of the coal, and the prospect of a power plant being constructed at Albright to consume the less desirable coal, Mr. Lewis believed that at least 10 million tons of coal could be mined and hauled over the plaintiff’s line during the next 15 years. With 5 cents for each of these tons being credited against the purchase price of the plaintiff’s stock, it would thus be possible for Mr. Lewis ultimately to obtain the ownership of the plaintiff’s stock without any personal cash outlay, provided the plaintiff could haul enough coal.

After September 24, 1951, Mr. Lewis and his group took over the direction and control of the plaintiff. Thereafter, they operated the plaintiff’s railroad, retaining the services of J. I). Everly, who was promoted from superintendent to general manager. A number of steps were taken in the process of rehabilitating the physical facilities of the railroad. New rails aggregating 5 miles in length were purchased, rail fixtures were procured, 18,000 new crossties were acquired, improvements were made to existing shop buildings, and a new shop was built. Much work was done in grading the roadbed and straightening curves.

Mr. Lewis was able to interest J. K. Maust, of the Maust Coal Company, in the local situation; and that company came into the area and took over a coal mine located adjacent to the plaintiff’s line. Under the guidance of Howard Eaven-son, Mr. Maust was successful in perfecting a method of cleaning the coal. As a result, a very profitable operation was developed by the Maust Coal Company, which was able to sell the clean coal to utilities along the Eastern seaboard and to sell the coal of poorer quality to the local power plant that had been constructed at Albright by the Monongahela Power Company. The Maust operation was so profitable that several other coal companies followed a similar pattern by establishing coal cleaning plants along the plaintiff’s line. This had a materially beneficial effect on the tonnage of coal shipped over the plaintiff’s line, and the operation of the railroad became quite profitable. The increase in coal shipments likewise increased the amount of the locomotive “rental” payments that had to be made by the plaintiff to the Jenkins family at the rate of 12y2 cents per ton of freight hauled by the plaintiff.

For each month after September 24, 1951, down to and including the first 4 months of 1958, a statement of the number of tons of freight shipped over the plaintiff’s railroad was prepared by the plaintiff and sent to the Jenkins family, showing the total amount of the locomotive “rental” due from the plaintiff for the particular month under the locomotive lease, as revised in 1951, at the rate of 12 y2 cents per ton of freight hauled by the plaintiff, and a division of the total amount into the portion that was attributable to the cent rate and the portion that was attributable to the 5-cent factor. The part of the statement dividing the total payment due for the particular month into its component parts, calculated on the basis of 7% cents per ton and 5 cents per ton, was furnished to the Jenkins family so that they would know how much of the monthly payment was to be credited against Mr. Lewis’ personal obligation to them. The total amount due for the month was equally divided among the Jenkins family, and five checks were issued to them by the plaintiff.

The portions of the monthly locomotive “rental” payments attributable to the 5-cent factor were credited by the Jenkins family against the installments due on the Lewis note, throughout the period from September 24,1951 through the first 4 months of 1958.

As stated earlier in the opinion, the ownership of the locomotives was vested in the Jenkins Equipment Company, a partnership composed of the Jenkins family. In preparing and filing partnership income tax returns for the pertinent years, the Jenkins Equipment Company apportioned the amounts of locomotive “rental” received from the plaintiff during the period from September 24,1951 through the first 4 months of 1958, using for this purpose the figures shown on the monthly statements submitted by the plaintiff, and declared as gross income from locomotive rental the portions of the monthly payments from the plaintiff attributable to the rate of 7% cents per ton of freight hauled by the plaintiff. The remaining portions of the monthly payments, calculated on the basis of 5 cents per ton of freight hauled by the plaintiff, were treated as payments on Mr. Lewis’ obligation to the Jenkins family and, therefore, were not reported as ordinary income by the Jenkins Equipment Company.

Mr. Lewis never personally made any payments to the Jenkins family on account of his obligation to them in the amount of $540,000. Mr. Lewis never expected to make any payments on his obligation to the Jenkins family, but, instead, he expected the plaintiff to satisfy this obligation by payment of the 5-cent factor in the guise of locomotivo rental.

Because the payments to the Jenkins family from the plaintiff under the locomotive rental agreement, as revised in 1951, were aggregating more than $125,000 per year and were •regarded by Mr. Lewis and the plaintiff as being too high, Mr. Lewis and the plaintiff desired to modify such agreement. The Jenkins family expressed their willingness to amend the existing locomotive lease, as they wanted to extend the period of time over which they would continue to receive income.

Negotiations along the line referred to in the preceding paragraph resulted in the execution on April 30, 1958 of a series of documents by the Jenkins family, Mr. Lewis, and the plaintiff (see findings 40 and 41). One of these documents was a new locomotive lease, which became effective on May 1,1958 and which provided that the plaintiff would pay to the Jenkins Equipment Company — i.e., the Jenkins family— each month the sum of $3,750 as locomotive “rental,” for a period of 15 years commencing in May 1958. It will be noted that the 1958 version of the locomotive rental agreement altered the method of computing each monthly payment from a per-freight-ton rate to a flat monthly fee of $3,750. Accordingly, beginning in May 1958, the plaintiff paid the sum of $3,750 per month as locomotive “rental.” The monthly payments were divided equally among the Jenkins family, five checks being issued to them by the plaintiff each month.

After the revision of the locomotive rental agreement effective at the beginning of May 1958, the Jenkins Equipment Company continued, for income tax purposes, to apportion the monthly amounts received from the plaintiff under the 1958 version of the locomotive lease, and reported as ordinary income only 59 percent of the amounts so received. This percentage figure was arrived at by computing the unpaid balance of the Lewis note (after subtracting the credits based on the 5-cent factor under the 1951 version of the locomotive rental agreement) to be $277,308.19 at the end of April 1958, and the value of the 1958 version of the locomotive lease to be $675,000 (12 x $3,750 x 15 years). By dividing the total amount to be paid under the 1958 version of the locomotive lease into the unpaid balance still due on the Lewis note, the result was 41 percent. Thus, 41 percent of each monthly payment received by the Jenkins Equipment Company (i.e., the Jenkins family) under the 1958 version of the locomotive lease was deemed by the Jenkins family to be a payment on Mr. Lewis’ personal obligation to the Jenkins family, and 59 percent of each monthly payment was regarded as ordinary income from locomotive rental.

The plaintiff, on the other hand, at all relevant times deducted on its Federal income tax returns as locomotive rental the full amounts of the payments made by the plaintiff under the various versions of the locomotive lease.

The Belated Litigation

In a statutory notice of deficiency which was dated January 24, 1957 and which related to the years 1951, 1952, and 1953, the Internal Revenue Service disallowed the portions of the present plaintiff’s deductions for locomotive rental which represented the 5-cent factor under the 1951 version of the locomotive lease. The present plaintiff contested this disallowance in the Tax Court. On October 28, 1959, the Tax Court rendered a decision on the question of whether the portions of the locomotive “rental” payments for 1951-1953 attributable to the 5-cent factor constituted deductible business expenses under Section 23(a) (1) (A) of the Internal Revenue Code of 1939, as amended (26 U.S.C. § 23(a)(1) (A) (1952) ). That statutory provision stated (among other things) that in computing net income, “there shall be allowed as deductions * * * [a] 11 the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business * * The Tax Court answered the question before it in the negative, and held “that respondent [the Commissioner of Internal Revenue] properly disallowed the deduction by petitioner [the present plaintiff] of that portion of the annual payments made by it under the diesel leasing agreement as was represented by the 5-cent-per-f reight-ton factor” (West Virginia Northern Rail road Co., 18 TCM 975, 979). The Tax Court’s decision, was affirmed by the Court of Appeals for the Fourth Circuit in West Virginia Northern Railroad Co. v. Commissioner, 282 F. 2d 63 (1960); and the present plaintiff’s petition for certiorari was denied by the Supreme Court, 366 U.S. 929 (1961).

In a statutory notice of deficiency dated October 10,1962, the Internal Eevenue Service disallowed the portions of the present plaintiff’s deductions for locomotive rental which represented the 5-cent factor for the years 1954-1957. Proceedings with respect to that notice of deficiency were instituted by the present plaintiff before the Tax Court, and such proceedings are still pending at the present time.

The Claim for 1958

With respect to the year 1958, the Internal Eevenue Service issued a deficiency notice based upon the disallowance of the portion of the 1958 deduction claimed by the plaintiff for locomotive rental which represented the 5-cent factor for the first 4 months of the year under the 1951 version of the locomotive lease, and 41 percent of the payments made by the plaintiff as locomotive rental for the last 8 months of 1958 at the rate of $3,750 per month under the 1958 version of the locomotive lease.

The plaintiff paid the deficiency assessed for the year 1958, and filed a timely claim for refund. Upon disallowance of the claim by the Internal Eevenue Service, the plaintiff instituted the present litigation.

The 5-Cent Factor

In view of the Tax Court’s 1959 decision to the effect that the portions of the present plaintiff’s locomotive “rental” payments for 1951-1953 which were attributable to the 5-cent factor under the 1951 version of the locomotive lease did not constitute deductible business expenses — a decision which the Court of Appeals for the Fourth Circuit affirmed and as to which the Supreme Court denied certiorari — the defendant contends in its brief that the plaintiff is precluded by tbe doctrine of collateral estoppel (or estoppel by judgment) from relitigating in the present action the issue as to the deductibility of the portions of the plaintiff’s locomotive-“rental” payments for the first 4 months of 1958 which were attributable to the 5-cent factor under the 1951 version of the locomotive lease. The defendant relies principally on Commissioner v. Sunnen, 338 U.S. 591 (1948), in presenting this argument.

With respect to the matter of collateral estoppel, perhaps-it should be mentioned that the Tax Court’s decision was based upon Section 23(a) (1) (A) of the Internal Eevenue Code of 1939, as amended, and that, during the interval between the close of 1953 and the beginning of 1958, the 1939 Code was superseded by the Internal Eevenue Code of 1954. However, the 1954 Code contains in Section 162(a) language-virtually identical with that previously quoted from Section 23(a) (1) (A) of the 1939 Code.

In contending that the doctrine of collateral estoppel is-applicable here, the defendant is tardily attempting in its brief to assert an affirmative defense. This matter should have been brought to the attention of the plaintiff and the court in the answer which the defendant filed on November 26, 1963. At that time, Eule 15(b) declared in mandatory language that “In pleading to a preceding pleading, a party shall set forth affirmatively * * * any * * * matter constituting an avoidance or affirmative defense” (emphasis supplied) . A similar provision is now contained in Eule 19(b). Therefore, the defendant’s attempt in its brief to assert the doctrine of collateral estoppel as an affirmative defense has been made too late in the proceedings.

It is interesting to observe that the petition in the present case does not allege that the portions of the plaintiff’s locomotive “rental” payments for the first 4 months of 1958' which were attributable to the 5-cent factor constituted deductible business expenses. The plaintiff uses a different terminology for the purposes of the present litigation.

In the present case, the plaintiff primarily contends (in count I of the petition) that the payments which it made to the Jenkins family for the first 4 months of 1958 under the-provisions of the 1951 locomotive lease constituted “a cost of -operations,” since the cost of renting the locomotives required for the hauling of shipments over its line was a cost of operating the railroad and, as such, should have been deducted from gross receipts in order to determine gross income, instead of being deducted from gross income in order to determine net income (as the plaintiff actually handled this item in its income tax return for 1958). However, the plaintiff ■does not explain clearly or convincingly just how “a cost of operations” differs from a business expense that is within the purview of Section 162(a) of the Internal Revenue Code -of 1954 (successor to Section 23(a) (1) (A) of the 1939 Code).

A readily discernible fallacy underlying the plaintiff’s novel contention is that the plaintiff begins with the assumption that the entire 12% cents which the plaintiff paid to the Jenkins family on every ton of freight hauled over the plaintiff’s line during the first 4 months of 1958 constituted remuneration to the Jenkins family for the use of their locomotives by the plaintiff in the operation of the railroad. As the Court of Appeals said in West Virginia Northern Railroad Co. v. Commissioner, supra, 282 F. 2d at page 65, substance rather than form normally prevails in matters of •taxation, and the taxability of a transaction is determined by its true nature. It is clear from the circumstances surrounding the formulation of the 1951 version of the locomotive lease that, in substance, the 1951 lease provided1 for the continued payment by the plaintiff of locomotive rental at the rate of 7% cents per ton of freight hauled, and for the payment by the plaintiff to the Jenkins family of an additional •sum of 5 cents per ton toward the discharge of Mr. Lewis’ personal obligation to the Jenkins family under instruments other than the locomotive lease.

The plaintiff, for approximately 5 years prior to 1951, had been renting the two diesel locomotives from the Jenkins family at a rental rate of 7% cents per ton of freight hauled by the plaintiff. There is no evidence of any sort in the record tending to show a belief on the part of the Jenkins family that the rental rate of 7% cents per ton provided insufficient compensation for the use of the locomotives. Rather, the evidence shows that the increase in the rental rate from 7*4 cents to 1214 cents per ton was negotiated in 1951 because the Jenkins family desired additional security respecting the ultimate payment by Mr. Lewis of his indebtedness in the amount of $540,000 to the Jenkins family, based largely upon Mr. Lewis’ purchase of the plaintiff’s stock from the Jenkins family. It was clearly understood by all concerned that the sum of 5 cents out of every 12*4 cents paid by the plaintiff to the Jenkins family under the 1951 locomotive lease was to be credited to the payment of the installments due on Mr. Lewis’ promissory note to the Jenkins family in the face amount of $540,000 (or, if the time should ever come when no installment was due on the promissory note, the amounts attributable to the 5-cent factor were to be credited to the ■payment of the $20,000 minimum annual royalty due the Jenkins family under Mr. Lewis’ lease of coal lands from them).

Thus, in substance, the 5-cent factor was never intended to be remuneration for the use by the plaintiff of the locomotives owned by the Jenkins family. For that reason, it would by wholly unrealistic to regard payments based upon the 5-cent factor as a cost of operating the railroad.

Instead, it is clear from the evidence that the provision for the payment of the 5-cent factor was inserted in the 1951 version of the locomotive lease as a means of providing for the discharge of Mr. Lewis’ personal obligation to the Jenkins family. An expenditure by a taxpayer (the plaintiff here) to satisfy a personal obligation of a third person (Mr. Lewis) is certainly not a cost of operating the taxpayer’s business. Therefore, irrespective of the soundness of the plaintiff’s present contention that locomotive rental constituted “a cost of operations” deductible from gross receipts, rather than a business expense deductible from gross income, the fact remains, in so far as the 5-cent factor is concerned, that we are dealing here with payments which, in substance, did not constitute rental or compensation for the use of locomotives.

The same fallacy that has been discussed in connection with count I of the petition also underlies the alternative contentions made by the plaintiff in counts II and III of the petition.

In count II of the petition, the plaintiff alleges that the amounts paid to the Jenkins family under the 1951 version of the locomotive lease at the rate of 12% cents per ton of freight hauled over the plaintiff’s line represented a carved-out portion of the plaintiff’s receipts retained as income by the Jenkins family when they disposed of their stock in the plaintiff to Mr. Lewis; and, accordingly, that the receipts of income from the plaintiff’s settling agent, the Baltimore & Ohio Eailroad, should be reduced pro rata to eliminate from gross receipts the factor of 12% cents per ton.

In count III of the petition, the plaintiff says that the amounts disbursed to the Jenkins family under the 1951 locomotive lease were tantamount to capital investments in motive power, and, therefore, that the freight revenues subsequently received from the B&O were merely returns of capital or reimbursements of such amounts.

With respect to both of the alternative contentions made in counts II and III, the plaintiff ignores the fact that, in substance, the sum of 12% cents per ton which the plaintiff' paid to the Jenkins family under the 1951 locomotive lease on each ton of freight hauled over the plaintiff’s line was made up of two separate elements — first, the sum of 7% cents, which was intended to compensate the Jenkins family for the use of their locomotives as motive power for the hauling of freight over the plaintiff’s line, and, second, the sum of 5 cents, which was intended as a partial discharge of Mr. Lewis’ personal obligation to the Jenkins family under instruments other than the locomotive lease and1 which did not constitute, in any real sense, compensation for the use of the locomotives. We are not concerned in the present case with the segment of 7% cents that constituted the true locomotive rental, but with the 5-cent factor, which, in substance, did not constitute any part of the true locomotive rental.

It must be concluded, therefore, that the plaintiff has not established any basis on which it could properly be found that' the Internal Eevenue Service erred in disallowing that portion of the 1958 deduction claimed by the plaintiff as locomotive rental which, represented the 5-cent factor for the first 4 months of the year under the 1951 version of the locomotive lease.

The Ijl-Peroent Factor

In auditing the plaintiff’s income tax return for 1958, the Internal Revenue Service also disallowed the portion of the deduction claimed by the plaintiff as locomotive rental which represented 41 percent of the payments made by the plaintiff to the Jenkins family for the last 8 months of 1958 at the rate of $3,750 per month under the 1958 version of the locomotive lease. In count IV of the petition, the plaintiff asserts that the IRS committed error in this respect, since the plaintiff was no longer obligated, after the first 4 months of 1958, to make payments for the personal benefit of Mr. Lewis.

It is true that the new locomotive lease which became effective on May 1,1958 provided for the payment by the plaintiff to the Jenkins family of a flat monthly fee of $3,750 as locomotive “rental”; that this instrument did not provide expressly for the crediting of any portion of the monthly sum to the payment of Mr. Lewis’ personal obligation to the Jenkins family; and that, at the time when the new lease was signed, Mr. Lewis’ promissory note to the Jenkins family in the face amount of $540,000 was endorsed by the Jenkins family, “cancelled under a written agreement.” However, when all the circumstances of the 1958 settlement are considered, it appears that, in substance, a portion of each monthly payment made by the plaintiff to the Jenkins family under the 1958 version of the locomotive lease should be regarded as a partial discharge of Mr. Lewis’ personal obligation to the Jenkins family.

The negotiations that led up to the 1958 settlement were initiated because the payments to the Jenkins family from the plaintiff under the 1951 version of the locomotive lease were aggregating more than $125,000 per year and were regarded by Mr. Lewis and the plaintiff as being too high. The Jenkins family were willing to amend the 1951 locomotive lease, provided the new arrangement extended the period of time over which they would continue to receive income. As a result of the negotiations, a written agreement of settlement was executed by the Jenkins family, Mr. Lewis, and the plaintiff on April 30, 1958.

The settlement agreement of April 30, 1958 provided (among other things) that the 1951 locomotive lease between the Jenkins family and the plaintiff would be cancelled; that a new locomotive lease would ¡be entered into effective May 1, 1958; that the plaintiff would agree to purchase the two locomotives for $40,000 on or before July 1, 1973, irrespective of the condition of the locomotives; that Mr. Lewis’' promissory note in the face amount of $540,000 would be marked “cancelled and settled” and would be delivered, together with the 1,000 shares of the plaintiff’s stock, to the First Pennsylvania Bank and Trust Company; and that the bank was to retain possession of the stock under a trust agreement and return the note to Mr. Lewis. The settlement agreement further provided that, upon the completion of all the conditions set out in the agreement, any and all claims arising-out of Mr. Lewis’ purchase of the plaintiff’s stock would be “settled, ended and forever released.”

A concurrent agreement between the Jenkins family and the First Pennsylvania Banking and Trust Company provided that the bank would hold the 1,000 shares of the-plaintiff’s stock in trust to secure the performance by the-plaintiff of its obligations under the settlement agreement referred to in the preceding paragraph.

It was pursuant to the settlement agreement of April 30,. 1958 that the new locomotive lease was entered into, providing for the payment by the plaintiff to the Jenkins family of' the sum of $3,750 each month as locomotive “rental” for a period of 15 years commencing in May 1958, and Mr. Lewis’ note in the face amount of $540,000 was endorsed, “can-celled under a written agreement.”

Thus, it will be seen that the settlement agreement of April 30,1958 did not terminate Mr. Lewis’ personal obligation to the Jenkins family arising out of the purchase by Mr. Lewis of the plaintiff’s stock from the Jenkins family. Instead, such obligation was to remain in effect and the 1,000 shares of the plaintiff’s stock were to be withheld from Mr. Lewis (or his assignee) until after the fulfillment of all the conditions-established under the settlement agreement of April 30, 1958, including the payment by the plaintiff to the Jenkins family of $3,750 per month as locomotive “rental” for an additional period of 15 years. It was then — and only then— that the claims of the Jenkins family against Mr. Lewis were-to be “settled, ended and forever released.” Therefore, the conclusion seems inescapable that at least part of each monthly payment under th’e 1958 version of the locomotive lease was, in substance, intended as a partial satisfaction of Mr. Lewis’ personal obligation to the Jenkins family in connection with-the purchase of the plaintiff’s stock.

In determining the portion of the locomotive “rental” payments for the last 8 months of 1958 that represented a partial discharge of Mr. Lewis’ personal obligation to the Jenkins family, the Internal Eevenue Service compared the-balance due on the Lewis note at the end of April 1958 with the total amount payable by the plaintiff under the new locomotive lease that became effective on May 1, 1958, and concluded that 41 percent of the monthly payments under the-1958 locomotive lease represented sums paid by the plaintiff in partial satisfaction of Mr. Lewis’ personal obligation to the Jenkins family. This allocation seems reasonable.

In any event, the plaintiff, which has the burden of proof' in the present suit for a tax refund, has failed to show that the allocation by the IES was unreasonable.

Conclusion

For the reasons previously stated in this opinion, it appears that the plaintiff has not established its right to recover,, and that the petition should be dismissed.

Findings op Fact

1. The plaintiff, during the year in issue herein and at all other pertinent times, was a West Virginia corporation. It was chartered in 1883. Since that date, it has maintained its. principal place of business in Kingwood, West Virginia.. The plaintiff has also maintained, at all pertinent times, including the year 1958, an executive office in the City of Philadelphia, Pennsylvania.

2. Ralph R. Lewis (hereinafter sometimes referred to as “Mr. Lewis”) is the president of the plaintiff, and lives in Philadelphia. J. D. Everly is vice president and general manager of the plaintiff, and lives in Kingwood, West Virginia. His connection with the plaintiff dates from 1942.

3. Kingwood, West Virginia, is in the northeast central part of the State. It has a population of about 2,500 people. There is a panhandle to the east and a panhandle to the north. Maryland is 20 miles to the east, and Pennsylvania is about 25 miles to the north. Kingwood is 90 miles south of Pittsburgh, Pennsylvania, and 80 miles west of Cumberland, Maryland.

4. The plaintiff owns and operates 11 miles of railroad, plus related facilities, running over hilly terrain between the towns of Kingwood and Tunnelton, West Virginia. This line is operated as a feeder road for the Baltimore & Ohio Railroad. The connection between the two railroads is at Tunnelton.

5. (a) The plaintiff is primarily a carrier of bituminous (or soft) coal. It carries the coal from mines along its line to the B&O connection at Tunnelton. Such shipments comprise approximately 98 percent of the plaintiff’s business.

(b) The relations between the plaintiff and the B&O are governed by the provisions of an agreement that was first entered into between the two companies in 1911. This agreement has been revised from time to time, but no change of any significance with respect to the issues involved in this case was made in the agreement during the period of time that is pertinent to the present litigation.

(c) The plaintiff’s income is derived almost wholly from the payments that it receives from the B&O in connection with coal shipments which originate on the plaintiff’s line and are turned over to the B&O at Tunnelton for further transportation. The plaintiff is entitled to a certain percentage of the through revenue on such shipments, under the agreement referred to in paragraph (b) of this finding. If the B&O is the final carrier and effects delivery of a particular shipment, the plaintiff is entitled to 17 percent of the through revenue. On the other hand, if a particular shipment, after being handled by the B&O, is transported by some other carrier or carriers before delivery is effected, the plaintiff’s percentage of the through revenue ranges between 15-percent and 3 percent, depending on the circumstances.

(d) The B&O effects a settlement with, and issues a check to, the plaintiff on a monthly basis. These steps are accomplished sometime between the 19th and the 25th of the next succeeding month. However, a settlement is not necessarily limited to the shipments that were transferred by the plaintiff to the B&O during the particular month involved in the-settlement. Occasionally, a settlement will include a shipment or shipments transferred by the plaintiff to the B&O months, or even years, prior to the month involved in the settlement.

6. The plaintiff was subject to Interstate Commerce Commission regulations — -and was classified by the ICC as a public utility — at all times pertinent to this litigation. It was-designated as a Class 2 carrier, based upon annual gross income, and it was required to, and did, prepare and file various monthly and annual reports and other reports with, the Interstate Commerce Commission.

7. In 1945, all of the plaintiff’s stock, consisting of 1,000 shares, was purchased for $100,000 by James Jenkins, Sr.,, and his four adult children, namely, James Jenkins, Jr., Mrs. Violet Oberhaus, Mrs. Eheta Leimbach, and Mrs. Marguerite Boss. (These five individuals will usually be referred to hereafter in the findings as “the Jenkins family.”) The Jenkins-family had become interested in the plaintiff due to the-efforts of J. D. Everly.

8. After the Jenkins family purchased the plaintiff’s stock, in 1945 and gained control of the plaintiff, they made J. I). Everly superintendent. At that time, the plaintiff had four Baldwin steam locomotives. The oldest of these was about 37 years old, and the newest was about 27 years old. Mr.. Everly convinced the Jenkins family that the plaintiff should dispose of the steam locomotives and that two new diesel' locomotives should be acquired to replace them. This was done in 1946, when two identical switching locomotives were purchased by James Jenkins, Sr., at a cost of $89,500 apiece-Each was a 1200 horsepower, diesel, electrically operated locomotive. One of these, given the number 50, was placed in the names of James Jenkins, Jr., and Mrs. Leimbach, •each of whom owned a one-half interest in the locomotive. ■Similarly, the other locomotive, given the number 51, was placed in the names of Mrs. Oberhaus and Mrs. Ross.

9. (a) On June 14, 1946, the plaintiff, as lessee, and the four Jenkins children, as lessors, entered into an agreement for the lease of the two diesel locomotives owned by the four Jenkins children, who were also stockholders of the plaintiff. The locomotive lease agreement provided for the hiring of the two locomotives by the plaintiff from the owners for a term of 5 years at a rental rate of 7y2 cents per net ton ■of freight hauled, this being understood to mean the total ¡aggregate of the freight hauled by the plaintiff over its right-of-way. Under this agreement, the rent was to be •computed each month, and payment was to be made by the 'plaintiff to the owners of the locomotives on the 15th day of the following month. Payment was to be accomplished by mailing checks to the residences of the four lessors, or such ■other places as they might direct. The plaintiff was to maintain the two diesel locomotives in good condition, wear and tear excepted, at the plaintiff’s expense and cost. At the end ■of the lease term, the plaintiff was to deliver the locomotives to the owners in good order and condition, damage by the elements excepted. The plaintiff was not permitted to assign the agreement or to sublet the locomotives without the prior consent of the owners. In the event of a breach by the plaintiff of any of the covenants contained in the agreement, the owners had the right and authority, without any process •of law, to repossess the locomotives.

(b) Subsequently, the ownership of the locomotives was transferred to the Jenkins Equipment Company, a partnership composed of the Jenkins family.

10. In 1950, the physical condition of the plaintiff’s railroad was not nearly up to the point where it should have been for a safe and satisfactory operation, although the Jenkins family had made some repairs and had attempted to build up the property.

11. In addition to owning the plaintiff’s stock as of 1950, the Jenkins family also owned approximately 25,000 acres ■of coal lands in Preston County, West Virginia, located approximately 15 miles from Kingwood, West Virginia. The Jenkins family, trading and doing business as Jenkins Coal & Land Company, a partnership, acquired these coal lands on or about January 9, 1946.

12. In 1950, Mr. Lewis obtained from the Jenkins family an option to lease or purchase their coal lands in West Virginia. Mr. Lewis was a businessman and entrepreneur, who had been interested for many years in the development of oil and other natural resources, and who had been endeavoring since the end of World War II to locate a large •area of “uncaptured” coal lands, with the idea of having a plant for the generation of electric power built on or near •such lands, so that the power plant could utilize the coal as ■fuel. In connection with this project, Mr. Lewis had been negotiating with the Rural Electrification Administration, which was interested in constructing a power plant near cheap coal in West Virginia. As a result of those contacts, Mr. Lewis had learned of the approximately 25,000 acres of coal lands in West Virginia owned by the Jenkins family.

13. After obtaining the option referred to in finding 12, Mr. Lewis endeavored to obtain the financing that was necessary in order to consummate the deal for the acquisition of the coal lands from the Jenkins family. Mr. Lewis got in touch with a friend, who introduced him to J. P. Morgan in New York City; Mr. Morgan introduced Mr. Lewis to John Hay (“Jock”) Whitney; and Mr. Whitney, in turn, introduced Mr. Lewis to Mr. Spencer, the president of the Spencer Chemical Company. Mr. Spencer became interested in the option that Mr. Lewis had obtained for the leasing or purchase of the coal lands owned by the Jenkins family. When the Jenkins family learned that Mr. Spencer was interested in the proposal, they suggested to Mr. Lewis that he withdraw from the transaction and permit the Spencer •Chemical Company to deal directly with the Jenkins family. Mr. Lewis was agreeable to this.

14. Negotiations ensued between the Jenkins family and ■the Spencer Chemical Company. During the course of the negotiations, it was suggested by the Jenkins family that the proposed transaction should include not only the sale or leasing of the coal lands owned by the Jenkins family, but also the sale of the stock owned by the Jenkins family in the plaintiff railroad.

15. The negotiations between the Jenkins family and the Spencer Chemical Company resulted in the granting of two options by the Jenkins family to the Preston Coal Company, a wholly owned subsidiary of the Spencer Chemical Company, as outlined in finding 16.

16. (a) On December 30,1950, the Jenkins family granted an option to the Preston Coal Company, exercisable on or before July 1, 1951, to purchase all of the plaintiff’s outstanding stock for $500,000, provided the Preston Coal Company would also exercise an option, independently acquired by it from the Jenkins family, to lease or purchase the approximately 25,000 acres of coal lands owned by the Jenkins family.

(b) The stock option provided that the $500,000 purchase price was payable $50,000 in cash and the balance in 15 annual installments. It further provided that in the event of exercise, the optionee would agree to a 25-year extension of the locomotive lease (see finding 9) at the existing rental of 714 cents per freight ton hauled.

(c) The coal lands option granted the Preston Coal Company the right to purchase the approximately 25,000 acres at $50 per acre. In the alternative, Preston could lease the-properties at a royalty of 10 cents per ton of coal mined and sold, with a stated minimum royalty of $30,000 per year. Preston had the right to assign all of its rights under the option to any third party.

17. On December 30, 1950, the plaintiff’s 1,000 shares of outstanding stock were owned as follows:

Owner Shares
James Jenkins_ 200
James Jenkins, Jr_ 200
Mrs. Violet Oberhaus_ 200
Mrs. Rheta Leimbach_ 200
Mrs. Marguerite Ross_ 200
Total_1,000

18. (a) In 1951, the plaintiff was hauling bituminous coal from 28 mines located along its route. The coal was principally from the Upper Freeport vein, but some of it was from the Bakerstown vein. This coal was used primarily by public utilities on the Eastern seaboard, ranging from Bangor, Maine, to Possum Point in Virginia.

(b) The plaintiff’s physical facilities in 1951 included a right-of-way, ties, tracks, rails, fastening switches, crossing signs, an office, an old frame shop building, various maintenance of right-of-way buildings, and pump houses.

19. In consideration of Mr. Lewis’ activities in bringing the parties together and in surrendering his prior option (see findings 12 and 13), the Preston Coal Company entered into a letter agreement with Mr. Lewis on January 19,1951. In this agreement, Preston agreed to pay Mr. Lewis certain royalties if it exercised the coal lands option, and to assign to Mr. Lewis a certain number of shares of the plaintiff’s stock if Preston exercised the railroad option. Preston also agreed to assign to Mr. Lewis all of its rights under the options obtained from the Jenkins family if Preston should decide not to exercise the options.

20. The Preston Coal Company decided not to exercise the options referred to in finding 16; and on March 19, 1951, Preston assigned to Mr. Lewis its entire interest in those agreements.

21. At the time when the options were transferred to Mr. Lewis, his financial condition was extremely poor. A prior business venture had been unsuccessful, and a judgment had been rendered against him, which had not been satisfied.

22. (a) In considering the matter of whether to exercise the options transferred to him by the Preston Coal Company, Mr. Lewis consulted Howard Eavenson, an outstanding coal engineer of Pittsburgh, Pennsylvania. Mr. Eavenson conducted an investigation and then made a report to Mr. Lewis, It was Mr. Eavenson’s opinion, as reported to Mr. Lewis, that the coal lands owned by the Jenkins family constituted the largest “uncaptured” coal area in the East; that if an efficient and economical way could be devised to clean the coal from such lands, much of it would be of sufficiently high quality to be sold at favorable prices in the markets along the Eastern seaboard, while the less desirable coal could be sold locally to an electric-power generating plant which, it was understood, was going to be built near Kingwood at Albright, West Virginia, by the Monongahela Power Company; and that, if a feasible cleaning method could be developed, a very profitable operation for the plaintiff in connection with the hauling of the coal would be assured.

(b) Mr. Lewis also investigated and familiarized himself with the layout and physical condition of the plaintiff’s properties. He ascertained that while such properties were-not in excellent condition, the plaintiff’s superintendent, J. L>. Everly, was a competent man who had in mind plans which,., if he were permitted to carry them out, would improve the railroad.

(c) Mr. Lewis also investigated and considered the plaintiff’s financial condition. He concluded that the plaintiff’s financial situation was not good at the time, but Mr. Lewis believed that the financial prospects for the future were good.

23. (a) Mr. Lewis realized that if he were to exercise the-options, he would be required to pay $500,000 for the stock of the plaintiff. As indicated in finding 22, Mr. Lewis had-thoroughly investigated the plaintiff’s financial status, and. had discussed with coal engineers the future of the plaintiff and of coal mining operations in the vicinity of the plaintiff’s line. Those inquiries led Mr. Lewis to believe that there ■ was a good possibility that the coal mining operations would be very successful, thereby making the plaintiff’s railroad operations highly profitable. Mr. Lewis was informed that the-, plaintiff’s gross earnings for 1951 would approximate $300,-000, and that it had an earned surplus and undistributed profit of almost $300,000 as of January 1, 1951.

(b) Based on this information, Mr. Lewis believed that the plaintiff could operate more successfully under his control than it had under the control of the Jenkins family. He was highly optimistic about future revenues, which he felt warranted the purchase price of $500,000. Mr. Lewis’ prognosis later proved to be correct.

24. (a) Mr. Lewis notified the Jenkins family that he intended to exercise both options. This notification was timely-made prior to the expiration date mentioned in the options,, as extended.

(b) Mr. Lewis began negotiations with the Jenkins family.. He was represented in the negotiations by his attorney, Walter B. Saul. James Jenkins advised Mr. Saul that the Jenkins family felt that the terms of the stock option failed to provide them with adequate security. They were concerned primarily over Mr. Lewis’ poor financial condition,, especially in relation to the portion of the railroad option agreement to the effect that, while the purchase price was payable over a 15-year period, with only a $50,000 down payment, the stock was to be turned over to Mr. Lewis immediately, without any additional security. Furthermore, although the option called for installment payments, no note* for the unpaid balance was required, and the Jenkins family desired the execution by Mr. Lewis of a 15-year note. The Jenkins family also wished to prevent a distribution of the existing surplus while the purchase price remained unpaid.

(c) In addition, the Jenkins family desired, as further’ security for the indebtedness to them, that the rental to be paid by the plaintiff for the two diesel locomotives be increased from N/2 cents to 121/2 cents per freight ton; and that the term of the lease be fixed at 15 years (the same-term as the Lewis note), without any right of cancellation by the plaintiff unless by purchase of the locomotives for $387,500.

(d) Mr. Lewis ultimately agreed to the terms desired by the Jenkins family, upon the agreement of the Jenkins family that of the 121/2 cents per freight ton provided for in the locomotive rental agreement, 5 cents would be credited by the Jenkins family to the payment of the installments due on the Lewis note, or, if no such installment was due, to the payment then due on the minimum royalties respecting the coal lands.

25. (a) Because of the fears of the Jenkins family mentioned in finding 24, changes were made in the option agreements.

(b) The option on the coal lands was modified so as to provide for the leasing of only 19,660.81 acres for a term of 15 years at a minimum annual royalty of $20,000 (instead of the original $30,000).

(c) The stock option was modified as follows:

(1) the balance of the purchase price of $500,000, after the $50,000 down payment, was to be secured by the execution of a note payable in 15 annual installments, the plaintiff's stock serving as collateral for that note;

(2) the Jenkins family were given the right to name two directors to the plaintiff’s board for a 10-year period;

(3) except for an immediate dividend in the amount of $20,000 to the Jenkins family, the plaintiff was prohibited from paying any dividends prior to the consummation of the transaction with Mr. Lewis, unless such dividends were transferred immediately to the Jenkins family, in which event they were to be credited against the payments due on the note;

(4) the plaintiff was prohibited from increasing administrative salaries, unless the increase could be paid from current earnings, and it was also prohibited from issuing bonds and debentures superior to the stock held as collateral for Mr. Lewis’ note; and

(5) the plaintiff was prohibited from terminating the new locomotive lease with the Jenkins family during the period of the lease.

26. At a meeting of the plaintiff’s board of directors held on September 24, 1951, the new locomotive lease was read and discussed. The plaintiff’s president was then authorized to execute the lease.

27. (a) Settlement was effectuated on September 24,1951. At that time, a series of documents were executed.

(b) One document was a contract of purchase, which took the form of modifying the options. This agreement provided, in addition to the terms stated in finding 25, that the Jenkins family would lend Mr. Lewis $90,000, which was to be used for:

(1) the $50,000 down payment on the stock purchase;
(2) $20,000 for the first-year coal royalties; and
(3) $20,000 for expenses and costs.

The sum of $90,000 was to be included in the collateral promissory note, bringing the total to $540,000.

(c) Another document was Mr. Lewis’ promissory note to the Jenkins family in the amount of $540,000, payable in 15 years. The note stated that 1,000 shares of the plaintiff’s Stock would be held as security by the Jenkins family for the payment of the note. Mr. Lewis also executed an assignment of the stock to the Jenkins family, to be used in the event of a default.

(d) A third document executed on September 24, 1951 was the new locomotive lease, which provided for the increased payment at the rate of 12y2 cents (instead of 7y2 cents) per ton of freight hauled, the reduced term of 15 years (instead of 25 years), and the agreement that the monthly payments were to be made within 10 days from the receipt of checks by the plaintiff from the Baltimore & Ohio Railroad. As indicated in finding 24(c), the sum of 5 cents out of the 12y2 cents was to be credited against the installments due on Mr. Lewis’ promissory note in the amount of $540,000 to the Jenkins family (or to the payment of the minimum annual royalty under Mr. Lewis’ lease of coal lands from the Jenkins family, if the time should come when no installment was due on the promissory note).

(e) A fourth document was a lease of 19,660.81 acres of coal lands to the plaintiff for a term of 15 years, the plaintiff being obligated to pay a minimum annual royalty in the amount of $20,000.

28. (a) On September 24,1951, Mr. Lewis transferred his right, title, and interest in the plaintiff’s stock, in the contract for the purchase of such stock, and in the lease of coal lands from the Jenkins family to the Pennsylvania Company for Banking and Trusts in trust for a period of 10 years, conditioned upon the carrying out by Mr. Lewis of the agreements made by him for the purchase of the plaintiff’s stock, the lease of the locomotives, and the payment of the collateral note executed by Mr. Lewis. At the expiration of the 10-year period, the trust property was to be reconveyed to Mr. Lewis or his nominee. The trust conveyance also recited that it was understood and agreed that it was only the equity in the plaintiff’s stock that was being transferred to the trustee, the stock itself being pledged as collateral to the vendors, the J enkins family.

(b) The trust agreement referred to in paragraph (a) of this finding was a preliminary one, it being understood that a more formal trust agreement would be executed shortly thereafter.

29. At the closing on September 24, 1951, the actual stock certificates of the plaintiff were handed by the J enkins family to Mr. Lewis, who immediately handed them to a representative of the Pennsylvania Company for Banking and Trusts. This action was taken in consummation of the trust agreement referred to in finding 28.

30. (a) On October 5, 1951, the Lewis trust of September 24,1951 (see finding 28) was superseded by a more formal trust arrangement. This Memorandum of Agreement noted the recent purchase 'by Mr. Lewis from the J enkins family of the outstanding stock of the plaintiff, and stated the desire of Mr. Lewis to transfer the stock in trust to the trustee for a period of 10 years “for the purpose of assuring to the sellers of the said stock that the agreements contained in the said agreement of purchase shall be fulfilled on the part of the said Lewis.” This instrument recited, among other things, that the stock was being held for the benefit of the settlor, Mr. Lewis, his heirs and assigns, and to pay the settlor, his heirs and assigns, any profits which might accrue to the owner of the stock, in accordance with the agreement of sale. The trustee under this instrument also agreed to deliver the stock to the sellers under the collateral note, together with a power of attorney to transfer the stock, in the event there was a default in any of the conditions contained in the collateral note. Finally, it was stated that the trustee agreed that, as the registered holder of the stock, it would cause the stock to be voted at any stockholders’ meeting to carry out the terms of the agreement of sale. The settlor also reserved the right under this instrument to assign any or all of his interest in the trust, or in the stock subject to the trust, upon a written assignment filed with the trustee.

(b) On October 19,1951, Mr. Lewis and the Pennsylvania Company for Banking and Trusts formally amended the trust agreement of October 5, 1951 by extending the term of the trust from 10 years to 15 years, with all the other terms and provisions of the original trust agreement to remain unchanged. This was done to conform with the wishes of James Jenkins, Sr., and to parallel the Lewis note as to time.

31. Mr. Lewis was advised by his attorney, Mr. Saul, to transfer his interest in the plaintiff’s stock to his wife, in order to prevent attachment by his judgment creditors. Accordingly, Mr. Lewis assigned his interest in the trust mentioned in finding 80 to his wife, who paid Mr. Lewis $1,000 of her own money as consideration. Upon Mr. Lewis’ direction, Mrs. Lewis thereafter assigned to eight separate individuals income interests that totaled 49 percent in all cash or property distributions that might be made by the trustee under the deed of trust dated October 5,1951, as amended.

32. Mr. Lewis was primarily motivated to acquire the plaintiff’s stock in 1951 by the recommendations of Howard Eavenson (see finding 22(a)). Mr. Lewis believed that the various conditions specified by Mr. Eavenson to make the plaintiff’s railroad profitable could be brought about. These included the presence of an experienced coal operator who could clean the coal effectively and the building of a power plant at Albright to consume the less desirable coal, all of which would increase the tonnage to be hauled by the plaintiff.

33. Mr. Lewis was not particularly concerned about the $500,000 price for the plaintiff’s stock and the $540,000 note which he signed. Although his plans were highly speculative in 1951, Mr. Lewis was very optimistic. He knew that there was enough coal along the plaintiff’s right-of-way, on the basis of Howard Eavenson’s estimates, so that it seemed possible to mine and haul over the plaintiff’s line at least 10 million tons of coal during the next 15 years. With 5 cents for each of these tons being credited against the price for the plaintiff’s stock, it would thus be possible for Mr. Lewis to obtain the plaintiff’s stock without any personal cash outlay, provided the plaintiff could haul enough coal.

34. After the execution of the various instruments on September 24,1951 (see findings 27 and 28), Mr. Lewis and his group took over direction and control of the plaintiff. Thereafter, they operated the plaintiff’s railroad, retaining the services of J. D. Everly, who was promoted from superintendent to general manager. A number of steps were taken in the process of rehabilitating the plaintiff’s physical facilities. New rails aggregating 5 miles in length were purchased, rail fixtures were procured, 18,000 new crossties were acquired, improvements were made to existing shop buildings, and a complete new shop was built. Much work was done in grading the roadbed and straightening curves.

35. (a) Each month after the execution of the locomotive lease referred to in finding 27(d), from 1951 through the first 4 months of 1958, a statement of the number of tons of freight shipped over the plaintiff’s railroad was prepared and sent to the Jenkins family, showing the total amount due under the locomotive rental agreement at the rate of 12% cents per ton, and a division of the total amount into the portion that was attributable to the 7%-cent rate and the portion that was attributable to the 5-cent factor. The total amount due was paid by the plaintiff in the form of checks, one to each member of the Jenkins family and each check being for one-fifth of the total amount due.

(b) The statement dividing the payment into its component parts of 5 cents and 7% cents was forwarded to the Jenkins family so that they would know how much to credit against Mr. Lewis’ personal obligation to them.

(c) The amounts representing the 5-cent factor were credited by the Jenkins family against the installments due on the Lewis note, from the inception of the agreement through the first 4 months of 1958.

36. Mr. Lewis never personally made any payments to the Jenkins family on account of his obligation in the amount of $540,000. Mr. Lewis never expected to make any payments on his obligation to the Jenkins family, but, rather, he expected the plaintiff to satisfy this obligation by payment of the 5-cent factor in the guise of additional locomotive rent.

37. Mr. Lewis was able to interest J. ft. Maust, of the Maust Coal Company, in the local situation; and that company came in and took over a coal mine located adjacent to the plaintiff’s line. Under the guidance of Howard Eavenson, Mr. Maust was successful in perfecting a method of cleaning the coal. As a result, a very profitable operation was developed by the Maust Coal Company, which was able to sell the clean coal to utilities along the Eastern seaboard and to sell the coal of poorer quality to the local power plant of the Monongahela Power Company, as Howard Eavenson had predicted (see finding 22(a)). The Maust operation was so profitable that several other coal companies followed a similar pattern by establishing coal cleaning plants along the plaintiff’s line. This had a materially beneficial effect upon the tonnage of coal shipped over the plaintiff’s line. The increase in coal shipments likewise increased the amount of the locomotive “rental” payments which had to be made by the plaintiff to the Jenkins family at the rate of 12^ cents per ton of freight hauled by the plaintiff.

38. Summarizing the events after September 24,1951, Mr. Lewis’ deal with the Jenkins family worked out in just the way that Mr. Lewis had hoped. A power plant was built nearby, a method of cleaning coal was perfected and put into operation, and the plaintiff’s freight tonnage materially increased. The operation of the plaintiff’s railroad became quite profitable. The economic condition of Preston County, West Virginia, was greatly enhanced. To a considerable extent, this was the result of the efforts and foresight of Mr. Lewis.

39. Because the payments to the Jenkins family from the plaintiff under the locomotive rental agreement, as revised in 1951, were aggregating more than $125,000 per year and were regarded by Mr. Lewis and the plaintiff as being too high, Mr. Lewis and the plaintiff desired to modify such agreement. The Jenkins family expressed their willingness to amend the existing contract, as they wanted to extend the period of time over which they would continue to receive income.

40. (a) Following negotiations along the line indicated in finding 39, a written agreement of settlement was executed by the Jenkins family, Mr. Lewis, and the plaintiff on April 30, 1958. It provided, inter aim, that the then existing locomotive rental agreement between the Jenkins family and the plaintiff would be cancelled; that a new locomotive lease would be entered into effective May 1, 1958; that the plaintiff would pay to the Jenkins family $1,000 per month for 29 consecutive months, such total of $29,000 representing an amount agreed upon in settlement of a dispute involving $51,000 between the Jenkins family and the plaintiff with respect to liability for general overhaul of the locomotives; that the plaintiff would agree to purchase the two locomotives for $40,000 on or before July 1, 1978, irrespective of the condition of the locomotives; that the then outstanding note of Mr. Lewis would be marked “cancelled and settled” and would be delivered, together with the 1,000 shares of the plaintiff’s stock, to the First Pennsylvania Banking and Trust Company; and that the bank was to retain possession of the stock under a trust agreement and return the note, marked “cancelled and settled,” to Mr. Lewis.

(b) The settlement agreement further provided that, upon the completion of all the following conditions, any and all claims arising out of Mr. Lewis’ purchase of the stock of the plaintiff would be “settled, ended and forever released” :

(1) execution of the new locomotive lease by the plaintiff;

(2) payment of all rentals due thereunder;

(3) delivery to Mr. Lewis of his note marked “cancelled and settled”;

(4) delivery of the stock of the plaintiff to the First Pennsylvania Banking and Trust Company;

(5) completion of the 29 monthly payments in the amount of $1,000 each; and

( 6) the purchase of the locomotives in 1973.

(c) A concurrent agreement between the Jenkins family and the First Pennsylvania Banking and Trust Company provided that the bank would hold the 1,000 shares of the plaintiff’s stock in trust to secure the performance by the plaintiff of the payment of the monthly rentals prescribed in the new locomotive lease, the making of the 29 monthly payments in the amount of $1,000 each, and the purchasing of the two locomotives in 1973. This agreement also provided that in the event of any default with respect to payments provided for under the agreement and the failure to cure such default within 30 days after notice thereof, the trustee should deliver the railroad stock, already duly endorsed in blank by Mr. Lewis, to the Jenkins family. The agreement further provided that in 1973, upon the full performance and completion of the various conditions, the trustee should deliver the 1,000 shares of the plaintiff’s stock to the First Pennsylvania Banking and Trust Company, trustee under deed of trust executed by Dorothea G. Lewis on February 28, 1952.

(d) Mr. Lewis’ note in the face amount of $540,000, endorsed “cancelled under a written agreement,” was sent by the Jenkins family to Mr. Saul for delivery to the First Pennsylvania Banking and Trust Company.

41. (a) The new locomotive lease, which was executed in accordance with the settlement agreement of April 30, 1958 and which became effective on May 1,1958, provided that the plaintiff would pay to the Jenkins Equipment Company (i.e., the Jenkins family) each month the sum of $3,750 as locomotive “rental” for a period of 15 years commencing in May 1958.

(b) The 1958 lease differed from the 1951 lease in several respects. The significant differences were that the 1958 lease extended the period over which the Jenkins family would receive payments from the plaintiff for an additional 7-year period beyond the end of the unexpired term of the 1951 locomotive lease, and it altered the method of computing each monthly payment from a per-freight-ton rate to a flat monthly fee of $3,750.

42. At the negotiations which culminated in the 1958 agreements, Mr. Saul represented, as attorney, both the plaintiff and Mr. Lewis.

43. The plaintiff’s revenue is derived from the Baltimore & Ohio Railroad under a contract made in 1911 and approved by the Interstate Commerce Commission. No changes or amendments were made in the plaintiff’s contract with the B&O as a result of any of the agreements signed by and between the Jenkins family, the plaintiff, and Mr. Lewis in 1951 or 1958. (See finding 5.)

44. Subsequent to the execution of the 1958 locomotive rental agreement, the plaintiff prepared five checks for equal amounts each month, totalling $3,750, which were sent to the five members of the Jenkins family.

45. The plaintiff has employed the independent accounting firm of Main and Company, which conducted a certified audit of the plaintiff’s books and prepared its Federal and State income tax returns from 1951 through 1958. On its books and in its tax returns, the plaintiff has included in its gross income the total amount of money received from the B&O.

46. (a) The plaintiff filed its Federal income tax return for the taxable year 1958 on the calendar year basis, and on the accrual basis of accounting, with the office of the District Director of Internal Revenue for West Virginia at Parkers-burg, West Virginia.

(b) For the year 1958, and for all other periods of time pertinent to this litigation, the plaintiff included in gross income the full amount due the plaintiff from the Baltimore & Ohio Railroad in connection with shipments originating on the plaintiff’s line and transferred to the B&O for further transportation. (See findings 4 and 5.)

47. At the close of the plaintiff’s calendar year 1957, it reported accumulated earnings and profits in the amount of $440,022.01. During the calendar year 1958, the plaintiff reported earnings and profits, after taxes, in the amount of $59,323.14, and accumulated earnings and profits of $499,-345.15 as of the close of that year.

48. The four Jenkins children had transferred the locomotives to a partnership, the Jenkins Equipment Company, composed of the Jenkins family. In preparing and filing the partnership returns for the periods encompassed by the 1951 contracts with the plaintiff and Mr. Lewis, the Jenkins Equipment Company apportioned the amount received from the plaintiff according to the statements submitted by the plaintiff, and declared as gross income from locomotive rentals 7% cents per freight ton hauled by the plaintiff for each year. The remaining portion, i.e., 5 cents per freight ton hauled, was treated as a payment of Mr. Lewis’ obligation and, therefore, was not reported as ordinary rental income by the lessor.

49. In preparing and filing the Federal partnership tax return for the year 1958, the Jenkins Equipment Company continued to treat the income received from the plaintiff during the first 4 months as it had been doing prior to 1958. The Jenkins Equipment Company continued to apportion the amounts received from the plaintiff under the 1958 contract, and reported as ordinary rental income only 59 percent of the amounts so received. This amount was arrived at by computing the unpaid balance of the Lewis note at the end of April 1958 to be $277,308.19 and the value of the 1958 locomotive lease to be $675,000 (12 x $3,750 x 15 years). By dividing the total payments to be made under the 1958 contract into the unpaid balance, the result was 41 percent. Thus, 41 percent of each payment was deemed to be a payment on the Lewis obligation.

50. James Jenkins, Sr., died on December 15, 1961. Consistent with his treatment in preparing the income tax returns, the Jenkins family’s bookkeeper, Mr. Harvey, included the value of the unpaid balance of the Lewis note on James Jenkins’ Federal estate tax return, which was signed by two of James Jenkins’ daughters as executrices. Schedule F of the estate tax return included as taxable property an amount of $24,892.86 as the value of Mr. Lewis’ note as of December 15,1961. Mr. Harvey computed the unpaid balance by subtracting from the face value ($540,000) the payments on the note attributed to the 5-cent factor under the 1951 contract with the plaintiff, plus 41 percent of each monthly payment made by the plaintiff under the 1958 agreement, leaving an unpaid balance of $209,658.19. This amount was then discounted to arrive at a present value.

51. Similarly, consistent with their treatment of income from Mr. Lewis’ obligation under the 1951 and 1958 pacts with the plaintiff, the executrices of the estate of James Jenkins, Mrs. Leimbach and Mrs. Boss, who were also parties to the various agreements with Mr. Lewis and the plaintiff, filed a petition with the Tax Court of the United States, in which they stated under oath in part as follows:

* * * [T]he only payments due to said James Jenkins from Ealph Lewis, Philadelphia, Pennsylvania, were those as listed in the Estate Tax Eeturn for the sale of .Two Hundred (200) shares of stock of the West Virginia Northern Eailroad Company of Kingwood, West Virginia, said stock having been sold to Ealph Lewis, Philadelphia, Pennsylvania, under a non-interest bearing contract for a sum payable at the rate of Three Hundred Seven and 50/100 Dollars ($307.50) per month. As of December 15, 1961, the date of death of the decedent, under said contract there were remaining due to James Jenkins the said payment for a total of One Hundred Thirty-six (136) months, an aggregate of Forty-one Thousand Eight Hundred Twenty Dollars ($41,820.00). * * *

52. The Internal Eevenue Service audited the Jenkins Equipment Company’s partnership return filed for the year 1958. The method of reporting 59 percent of the locomotive “rental” as income and 41 percent as a return of capital was inspected and considered in this audit. The IES determined that this method of reporting the amounts received under the locomotive leases was substantially correct, and issued a “No Change Eeport.”

53. (a) The plaintiff, on the other hand, at all relevant times, deducted on its Federal income tax returns the full amount of the payments made under the locomotive lease agreements with the Jenkins family as rent for locomotives.

(b) On the reports filed by the plaintiff with the Interstate Commerce Commission for all relevant periods, the plaintiff deducted the full amount of each monthly payment to the Jenkins family as “rent for locomotives.”

54. (a) The Commissioner of Internal Eevenue disallowed that portion of the total payments deducted which represented the 5-cent factor for all years 1951 through the first 4 months of 1958. This action was first taken in a statutory notice of deficiency dated January 24, 1957, which related only to the years 1951, 1952, and 1953, while a second statutory notice of deficiency dated October 10, 1962 was issued relating to the years 1954 through 1957.

(b) The plaintiff contested the disallowance for the years 1951 through 1953 in the Tax Court. On October 28,. 1959, the Tax Court rendered a decision (18 TCM 975; P-H Memo T.C., par. 59,204), stating that it had “concluded that respondent [Commissioner of Internal Eevenue] properly disallowed the deduction by petitioner [plaintiff herein] of that portion of the annual payments made by it under the diesel leasing agreement as represented by the 5-cent-per-freight-ton factor.” This decision was affirmed by the Court of Appeals for the Fourth Circuit in West Virginia Northern Railroad Co. v. Commissioner, 282 F. 2d 63 (1960). Certiorari was denied, 366 U.S. 929 (1961).

(c) A petition was filed by the plaintiff in the Tax Court contesting the disallowance by the Internal Eevenue Service of the 5-cent factor with respect to the years 1954r-1957. This case is still pending before the Tax Court.

55. With respect to the year 1958, the Internal Eevenue Service issued a deficiency notice based upon the disallowance of the portion of the plaintiff’s deduction for locomotive rental which represented the 5-cent factor for the first 4 months of the year and 41 percent of the payments made by the plaintiff to the Jenkins Equipment Company for the last 8 months of 1958. The percentage figure referred to in the preceding sentence was computed by comparing the balance due on the Lewis note at the end of April 1958 with the total amount payable by the plaintiff under the new locomotive lease that became effective on May 1,1958.

56. The plaintiff paid the deficiency assessed for the year 1958, and filed a timely claim for refund. Upon disallowance, the present suit was timely brought in the Court of Claims.

57. In 1960, the plaintiff leased a new locomotive from the National Equipment Leasing Corporation. Although this locomotive was of the same type as the two locomotives leased from the Jenkins family, it had improvements and special equipment on it which increased its cost by approximately $40,000. The contract for this locomotive lease was negotiated by Mr. Lewis in 1958. The lease provided that the plaintiff would pay a rental of $1,998 per month for the first 7 years of the lease, and $1,000 per month for the next 5 years.

58. The plaintiff has conceded the issue raised in count V of its petition. The plaintiff now agrees that the Commissioner of Internal Eevenue properly included as income an amount of $22,000 in the plaintiff’s taxable income for the year 1958.

Conclusion of Law

Upon the foregoing findings of fact and opinion, which are adopted by the court and made a part of the judgment herein, the court concludes as a matter of law that the plaintiff is not entitled to recover, and the petition is dismissed. 
      
       Another Issue, raised In count V of the petition and relating to locomotive overhaul, was subsequently abandoned by the plaintiff.
     