APPEAL from a judgment of the Superior Court of the County of Pima. Wm. G. Hall, Judge. Judgment affirmed in part and reversed in part.
Mr. Joe Conway, Attorney General, and Mr. Allan K. Perry, Special Assistant Attorney General, for Appellant.
Messrs. Darnell, Pattee & Robertson and Messrs. Snell & Strouss, for Appellee.
[55 Ariz. 475] LOCKWOOD, J.
This is an appeal by Arizona State Tax Commission, hereinafter called the commission, from a judgment of the superior court of Pima county modifying an order of the commission imposing an additional assessment of income tax upon the Tucson
Gas, Electric Light and Power Company, hereinafter called the taxpayer. The factual situation upon which the judgment of the court was rendered is not seriously in dispute, and may be stated as follows:
In 1911 the taxpayer became the owner of a certain public utility in the city of Tucson, consisting of an electric light plant, an artificial gas plant and the distributing lines appurtenant thereto. The stock of the taxpayer, with the exception of certain qualifying shares, was owned entirely by the Federal Light and Traction Company, hereinafter called the company, which also owned the majority of the stock of a number of other public utility companies, being what is commonly called a "holding" as distinguished from an "operating" company. The taxpayer is an operating company and has operated its plant, as aforesaid, in the city of Tucson continuously ever since the date first mentioned. Owing to the growth of Tucson and its suburbs and the many changes required by technological discoveries and inventions in the electric light and gas business, it has been necessary to gradually expand the electric light and gas system of the taxpayer, and there has been expended in such expansion approximately [55 Ariz. 476] $5,000,000 during the period aforesaid. The income of the taxpayer was not sufficient to pay for this great expansion and it, therefore, made arrangements with the company to supply the capital necessary for that purpose.
The manner in which the business relations of the two companies were carried on and the accounts kept may be stated briefly as follows: An account was opened between the two companies. From time to time as dividends were declared by the taxpayer, all of which under the ownership of stock aforesaid belonged to the company, instead of their being remitted in cash to the latter and then by it formally loaned to the taxpayer, they were permitted to remain with the latter as a cash deposit upon which the taxpayer could draw from time to time, and the company was credited on the account with the amount of such dividends. In addition thereto, the company loaned the taxpayer money and furnished the latter various managerial and engineering services, for which it made certain charges. These items were also credited the company in the account.
From time to time notes were given by the taxpayer to the company to reduce the balance in its favor on the open account, bearing 8 per cent. interest. This interest, instead of actually being paid, was compounded semi-annually, thus increasing the debt of the taxpayer accordingly. Various renewal notes were given from time to time, so that in 1931 the total amount of the notes outstanding and bearing 8 per cent. interest aggregated a little over $3,500,000. Due to the giving of the notes as aforesaid and the declaration of dividends at various times, there were times when the taxpayer had a balance to its credit in the open account, but during most of the time it was indebted in a greater or less sum to the company. When the former condition existed, the taxpayer was credited [55 Ariz. 477] with 4 per cent. interest, but in the latter it was charged 6 per cent. by the company.
The books and records of the taxpayer ever since statehood have been kept as requested by the corporation commission, and have clearly shown the above situation, and were at all times open to the commission for its examination. The Arizona Income Tax Act, hereinafter called the act, under which the present suit arose, was enacted at the First Special Session of the legislature in 1933, chapter 8. After its enactment the taxpayer continued to keep its books and records exactly as it had prior thereto, and continued to consider and report the interest on the notes and open account above referred to as an operating expense and a legal and proper deduction from income reported under both federal and state income tax acts. In 1933, and annually thereafter, the taxpayer reported to the commission its income, claiming as a deduction therefrom the interest on the notes and balances above referred to and all of the other items which are in controversy in the present action, with the exception of certain unexpended balances which resulted from contracts for extension service with various of its consumers. These balances were not reported as income nor were deductions claimed therefor.
In 1935 the commission caused a field audit and investigation to be made of the taxpayer in respect to its income for the years 1933 and 1934. It agents came to the office of the taxpayer and audited and investigated the latter's books and records. These books and records, which disclosed fully the situation above described, were open at all times to the ...