All fixed charges and obligations of the Automatic Company under the leases of the National Automatic Fire Alarm Company of Ohio (Cleveland plant), the National Automatic Fire Alarm Company of Cincinnati, Ohio, and of the National Automatic Fire Alarm Company of Louisville, and of the Special Fire Alarm Electrical Signal Company shall be borne by the District Company unless otherwise herein provided, and the Automatic Company, as of the date of this contract, is relieved from any further obligation in relation thereto.

ARTICLE 13.

The District Company hereby agrees that it will sell to the Automatic Company equipment for operating systems contemplated under the above schedule of contracts for export by the Automatic Company, the amount to be charged by the District Company to the Automatic Company to be equal to the District Company's total cost plus ten per cent (10%).

ARTICLE 14.

The District Company will assume and pay for, as of the date of this contract, the unfilled portion of all Automatic Company's outstanding orders for material and devices of such nature as may be required by the District Company for furnishing service of the nature provided under the above schedule of contracts. The District Company will also pay to the Automatic Company on the execution of this agreement the manufacturer's cost to it of all material and devices on hand that may be used by the District Company, and a schedule, as of the date of this contract, of the unfilled orders of the Automatic Company for such material and for such devices is hereto attached as part of this contract.

ARTICLE 15.

The District Company hereby agrees that if the American Telephone & Telegraph Company or the Western Union Telegraph Company, or the subsidiaries of either of them, engage in Sprinkler Supervisory or Valve Alarm service or Automatic Fire Alarm service of the nature contemplated under the above schedule of contracts, it will (so long as present relations or their substantial equivalent exist between the District Company and such Telephone and Telegraph Companies or either of them) pay to the Automatic Company on the gross revenue from such service performed by any such company the amounts as provided in Article 2.

ARTICLE 16.

The District Company may buy business of the nature contemplated by said schedule of contracts, and the same, whether heretofore or hereafter purchased, shall be deemed to be business of the nature of that described in Article 2 and gross returns therefrom divided accordingly unless otherwise provided.

ARTICLE 17.

The Automatic Company hereby agrees to turn over to the District Company all its subsidiary companies doing business in the United States, and all franchises owned or controlled by it or by Robert L. McElroy.

The District Company hereby agrees to accept such sudsidiary companies for its use and purpose as it may see fit, and to assume their current taxes and their obligations hereafter incurred.

The stock of such subsidiary companies has been pledged by the Automatic Company as security for the payment of an issue of four hundred thousand dollars ($400,000) of bonds, which the Automatic Company covenants and agrees to pay, and to save the District Company harmless therefrom.

ARTICLE 18.

The District Company hereby agrees to avail itself of the three (3) year option allowed it under Article 4, contract of February 18th, 1904, and Article 5, contract of April 29th, 1907, covering contracts made with subscribers in which certain excess expenditures were made by the Automatic Company, it being understood and agreed that the distribution of the revenue derived from such contracts with subscribers shall be in accordance with the terms of Article 3 of this contract.

ARTICLE 19.

The Fire Protection Development Company of Maine hereby assents to all the provisions and conditions of the foregoing agreement, and agrees to assist the Automatic Company in carrying out the same in all particulars, and said Fire Protection Development Company hereby relinquishes all its rights under its contract with the Automatic Fire Protection Company, dated April 29th, 1909, and is hereby absolved from all obligations thereunder.

In consideration of the release by the Development Co. of the taxpayer from the contract of April 29, 1909, the taxpayer agreed to pay to the Development Co. a certain percentage of its annual net income.

At the time the agreement quoted above was entered into, the taxpayer had outstanding stock of a par value of $3,600,000 and bonds in the amount of $400,000.

On several different occasions before the making of the contract of June 13, 1913, the District Co. sought to purchase the business of the taxpayer. Its first effort was made about 1907, at which time the taxpayer placed a price of $1,000,000 on the business. Some time later the District Co. sought to close the deal on that basis. The offer, however, was withdrawn and a counteroffer was made to sell at $1,500,000. Later the taxpayer increased this amount to $1,750,000. The gross rentals received from all of the service contracts for the years 1903 to 1924, inclusive, were as follows:

Since June, 1913, the business of the taxpayer has consisted of the receipt and disposition of its share of the gross rentals listed above. It has also received small miscellaneous items of income for the years 1914 to 1922, inclusive, as follows:

The expenses of the taxpayer for the years 1914 to 1922, inclusive, were as follows:

The Commissioner computed the profits tax for the years 1917 and 1918 in accordance with the provisions of sections 210 and 328 of the Revenue Acts of 1917 and 1918, respectively.

OPINION.

LITTLETON: The taxpayer assigns two errors. First, that the computation of the profits tax should have been based on the actual invested capital for those years as represented by the contract with the District Co., which it is alleged had a value of $2,000,000 on the date it was made. Second, that it should be allowed to deduct on account of exhaustion the pro rata part of the alleged value of the contract for each year the contract was to run.

Briefly stated, the term "invested capital" as defined by section 207 of the Revenue Act of 1917 and section 326 of the Revenue Act of 1918, means (1) cash paid in for stock, (2) actual cash value of

(1267) tangible property paid in for stock, (3) with some limitations, actual cash value of intangible property paid in for stock, (4) paid-in surplus, and (5) earned surplus and undivided profits, not including profits earned during the taxable year; and no amount may properly be included in invested capital for the purpose of computing the profits tax unless that amount comes within the definition of the term as expressed by Congress.

In determining this appeal we may reasonably assume that nothing of value was paid in for stock or as surplus. If cash or property of value had been paid in, it would only have been necessary for the taxpayer to have established that value as of the date of payment, in order to justify its inclusion in invested capital. No effort, however, was made to establish such value. The only information to be obtained from the record in reference to the issue of stock is that emanating from the general statement of one of the witnesses, namely, that on organization, stock was issued for patents and related property, and also from the fact that on June 13, 1913, the par value of the stock outstanding was $3,600,000. If, therefore, there is any merit in the contention of the taxpayer that its invested capital is determinable, the basis for the claim must be that the amount contended for represents earned surplus and undivided profits.

Counsel for the taxpayer have rested their claim for invested capital on the single proposition that on June 13, 1913, the taxpayer had a profitable business, which, on that date, was exchanged for a contract worth $2,000,000. We are convinced that the business in which the taxpayer was interested was profitable, and it no doubt had property of value, but that alone is not sufficient to establish the right to include such value in invested capital, for it may represent appreciation of assets. See La Belle Iron Works v. United States, 256 U. S. 377. Our conclusions, therefore, must be based entirely upon the effect of the agreement with the District Co. If the value of that contract can properly be included in invested capital as earned surplus and undivided profits, it must, in fact, be earned surplus and undivided profits. There is nothing indeterminate or vague in the meaning of these terms. The Supreme Court, in Edwards v. Douglas, 269 U. S. 204, 214, stated that surplus “may be earned surplus,' as where it was derived wholly from undistributed profits," and that "by most corporations the term ‘undivided profits' is employed to describe profits which have neither been distributed as dividends nor carried to surplus account upon the closing of the books." In other words, earned surplus and undivided profits consist of profits realized and accumulated in the business, and, if such profits are determinable, they should be included in invested capital.

Under these circumstances, it becomes necessary to examine the contract to see whether or not there was a completed transaction from which profits were realized, and, if so, whether those profits were determinable. The District Co. agreed to take over and operate the business, to bear all expenses, to assume all obligations of the taxpayer in connection therewith and to pay to the taxpayer a specified percentage of the gross rentals. By article 8 the taxpayer granted to the District Co., "the exclusive license (except for devices to be used or sold outside of the United States), to manufacture, use or sell, or cause to be manufactured, used or sold any and all of the devices" covered by patents owned or controlled by the taxpayer. Under article 9, the taxpayer assigned, transferred and set over "all of its right, title and interest in and to all contracts for service with various customers and all property owned and used therewith." This article also provided that in case of breach of any of the obligations assumed by the District Co. and failure to remedy the same after 30 days' written notice, all contracts for service should be assigned to the taxpayer. Article 11 required the District Co. to pay to the taxpayer a certain percentage on the sale of equipment and devices. By article 17 all of the taxpayer's subsidiary corporations and all franchises belonging to the taxpayer or its subsidiaries were "turned over" to the District Co. Article 10 provided that upon the expiration of the period of the contract the then existing service contracts and all equipment installed thereunder should be divided equally between the taxpayer and the District Co., and, further, that during the period of the contract no mortgage, lien, or assignment should be placed on such property "without the consent of or without recognizing or reserving the rights of the Automatic Company."

Although some of these provisions would indicate that the reasoning advanced by counsel that the taxpayer parted absolutely with the business is sound, there are other provisions which support the opposite view. Certainly no such interpretation could be placed on the contract when all provisions are considered as a unit. The taxpayer clearly has not parted absolutely with its business or with all its rights in the business assets, even though there was an assignment of all right, title, and interest in the contracts with customers and the devices used in connection with these contracts, for provision was made that all such property, at the expiration of the contract, should be divided equally between the parties. Furthermore, the provision that the property should not be encumbered during the period of the contract without first obtaining the taxpayer's consent or reserving the taxpayer's rights therein, indicates that there was no intention to make an absolute transfer. If such had been the inten