Southern Ry Co v. Commonwealth of Kentucky Davis v. Same 15 16, 1926

• Decision Date: 11 April 1927
• Docket Number: Nos. 33,34,s. 33
• Citation: 71 L.Ed. 934,274 U.S. 76,47 S.Ct. 542
• Parties: SOUTHERN RY. CO. v. COMMONWEALTH OF KENTUCKY. DAVIS, Director General, v. SAME. Argued March 15-16, 1926
• Court: U.S. Supreme Court

274 U.S. 76

47 S.Ct. 542

71 L.Ed. 934

SOUTHERN RY. CO.

v COMMONWEALTH OF KENTUCKY.

DAVIS, Director General,

v. SAME.

Nos. 33, 34.

Argued March 15-16, 1926.

Decided April 11, 1927.

Mr. Edward P. Humphrey, of Louisville, Ky., for plaintiffs in error.

Mr. J. P. Hobson, of Frankfort, Ky., for the Commonwealth of Kentucky.

Mr. Justice BUTLER delivered the opinion of the Court.

A judgment against plaintiffs in error for franchise taxes imposed under the laws of Kentucky in respect of certain lines of railway was affirmed by the highest court of that state. 204 Ky. 388, 264 S. W. 850. And see 193 Ky. 474, 237 S. W. 11. Reversal is sought on the ground that, as applied, these laws contravene the due process clause of the Fourteenth Amendment.

The statutes¹ (sections 4077-4081) provide that every foreign or domestic railway company, in addition to other taxes imposed by law, shall pay an annual tax on its franchise. The provisions apply whether the privilege is exercised by the corporation in its own name or in the name of another which it adopts. A company's railway system is deemed to include lines operated, leased, or controlled, whether technically owned or not. The tax is on intangible property. Where the railroad is partly within and partly without the state, the value of the intangible property so to be taxed may be determined substantially as follows: Capitalize the net railway operating income of the entire system for the accounting year last ended; assign to Kentucky its mileage proportion of that amount; deduct the assessed value of the tangible property otherwise taxed; and the remainder is the value taken as the basis for the franchise taxes. When the railroad is wholly within the state, the capitalized net, less the assessed value of tangible property on which other taxes are paid, is taken to be the value of intangible property. Greene v. Louis. & Interurban R. R. Co., 244 U. S. 499, 510, and cases cited, 37 S. Ct. 673, 61 L. Ed. 1280, Ann. Cas. 1917E, 88; Louis. & Nash. R. R. Co. v. Greene, 244 U. S. 522, 539, 37 S. Ct. 683, 61 L. Ed. 1291, Ann. Cas. 1917E, 97.

Plaintiff in error the Southern Railway Company is a Virginia corporation. The lines of its systems of railroads, exclusive of the Kentucky mileage in question, exceed 9,500 miles, and extend from Washington, D. C., into Virginia, the Carolinas, Tennessee, Georgia, Florida, Alabama, and Mississippi. The company also has a line from New Albany, Ind., to East St. Louis, Ill. It does not own any railroad in Kentucky. The 'Southern Railway Company in Kentucky' owns 127.63 miles, all of which are in that state. Its branches connect with the line of the Cincinnati, New Orleans & Texas Pacific Railway Company, which extends from Cincinnati to Chattanooga, and connects it with the system. Its stock is owned by the Virginia company. The same persons are officers of both. The lines of the Kentucky company are reported to public authorities and are advertised as a part of the system. The Mobile & Ohio Railroad Company, the Cumberland Railroad Company, and the Cumberland Railway Company own, in all, about 53.3 miles of railroad in Kentucky, but their lines are not connected with the lines of the Southern Railway Company in Kentucky. The Virginia company through stock ownership controls these companies; but they and the Southern Railway in Kentucky, in their own names and as owners, made reports and paid in full all taxes assessed under Kentucky laws on their tangible and intangible properties.

The commonwealth brought this suit against the Virginia company and the Director General to recover additional franchise or intangible property taxes for 1918 and 1919 in respect of the Kentucky mileage of these companies. The Court of Appeals held that there was no such connection or unity of use between the system of the Virginia company and the lines of the Mobile & Ohio, the Cumberland Railroad, and the Cumberland Railway, as would justify recovery of any franchise taxes in respect of their Kentucky mileage. Stipulated facts tended to show that the Virginia company controlled the Cincinnati, New Orleans & Texas Pacific; and the court held that, by means of its lines, the railroad of the Southern Railway in Kentucky was so connected with the lines of the Virginia company as to be a part of the system. The value of intangible property adjudged to have been omitted, and on which the additional franchise taxes were calculated, for 1918 was $1,730,090.02, and for 1919 was $3,028,592.62. These amounts were arrived at as follows: The net railway operating income for the entire system was capitalized at 7 per cent.; there was deducted an amount to cover the value of shops, terminals, and double tracks outside Kentucky in excess of corresponding tangible property connected with the lines in that state; there was allocated to Kentucky such proportion of the remainder as 424.61 miles, which were attributed to Kentucky, bore to the total mileage of the system; that amount was equalized for taxation at 75 per cent. for 1918 and at 85 per cent. for 1919; and from the result there was deducted the values of tangible and intangible property (including the Kentucky mileage of the Cincinnati, New Orleans & Texas Pacific) on which taxes had been paid. But the average value per mile so deducted was less than the system average per mile. The amounts so arrived at were assigned to the 127.63 miles of the Southern Railway Company in Kentucky and the 197.5 miles in Kentucky of the lines of the Cincinnati, New Orleans & Texas Pacific. The increase per mile for 1918 was $5,334.55, and for 1919 was $9,338.34.

The Court of Appeals rightly declared that a state may tax property permanently within its jurisdiction belonging to one domiciled elsewhere and used to carry on commerce among the states; that, where property is a part of a system and has its actual use only in connection with other parts of the system, that fact may be considered, even though other parts of the system are outside the state; that the state may not tax property outside its jurisdiction belonging to one domiciled elsewhere; and that the mileage basis of apportionment cannot be adopted in the taxation of railroad franchises where the result is shown to be arbitrarily excessive. These propositions are derived from the decisions of this court. Fargo v. Hart, 193 U. S. 490, 499, 24 S. Ct. 498, 48 L. Ed. 761; Pittsburgh, etc., Railway Co. v. Backus, 154 U. S. 421, 427-431, 14 S. Ct. 1114, 38 L. Ed. 1031; Union Tank Line Co. v. Wright, 249 U. S. 275, 282, 39 S. Ct. 276, 63 L. Ed. 602; Wallace v. Hines, 253 U. S. 66, 69, 40 S. Ct. 435, 64 L. Ed. 782.

The question is whether the state made valid application of the governing principles. The value of tangible property is not involved in this case. The demand of the commonwealth against the plaintiffs in error was for taxes on intangible properties over and above the amounts that had been paid by the owning companies. And the entire amount added as a basis for additional taxes is attributable only to the lines of the Southern Railway Company in Kentucky. There was no claim for any taxes in respect of the lines of the Cincinnati, New Orleans & Texas Pacific. That company had also reported its earnings and paid taxes on its tangible and intangible properties in Kentucky. These taxes were based on values per mile in excess of the average values per mile for the system arrived at by capitalization of net railway operating income in accordance with the rule applied by the state. No part of the amounts adjudged to have been omitted could properly be assigned thereto. The Mobile & Ohio, the Cumberland Railroad, and the Cumberland Railway, were held not to be a part of the system. Plaintiffs in error insist that the enforcement of the taxes on these amounts, as measuring the additional values of intangible properties inhering in the lines of the Southern Railway Company in Kentucky, operates to tax the property of the Virginia company located beyond the borders of Kentucky, and that such amounts are arbitrarily excessive.

The value of the physical elements of a railroad-whether that value be deemed actual cost, cost of reproduction new, cost of reproduction, less depreciation or some other figure-is not the sole measure of or guide to its value in operation. Smyth v. Ames, 169 U. S. 466, 547, 18 S. Ct. 418, 42 L. Ed. 819. Much weight is to be given to present and prospective earning capacity at rates that are reasonable, having regard to traffic available and competitive and other conditions prevailing in the territory served. No intangible element of substantial amount over and above the value of its physical parts inheres in a railroad that cannot earn a reasonable rate of return on its bare bones-as the mere tangible elements properly may be called. See Omaha v. Omaha Water Co., 218 U. S. 180, 202, 30 S. Ct. 615, 54 L. Ed. 991, 48 L. R. A. (N. S.) 1084.

The amount adjudged to have been omitted equals an increase on the lines of the Southern Railway Company in Kentucky of $13,555 per mile for 1918 and of $23,730 for 1919. The 1917 average net operating income per mile for the system was the basis for determining the Kentucky franchise taxes for 1918, and the average for 1918 controlled the amount of the 1919 taxes. The average for the system was $3,642 per mile for 1917, and was $3,623 for 1918. The corresponding net income per mile of the Southern Railway Company in Kentucky for 1917 was $878. There was a loss of $4,741 per mile in 1918. The record also shows a loss in each of the years 1914, 1915, and 1916. The average for the five years was a loss of $1,230 per mile per year.

If considered alone, the railroad of the Southern Railway Company in Kentucky would be a losing venture. Its operating loss was more than $157,000 per year for the average of the five years reported in the record. But, assuming it a part of the system, it is right to take into consideration...