text:
    Appear of AUTOMATIC FIRE PROTECTION CO.
    Docket No. 3148.
    Submitted July 7, 1925.
    Decided April 19, 1926.
    1. On June 30, 1913, taxpayer entered into a contract with the American District Telegraph Oo. whereby the latter took over the business of installing and maintaining an automatic fire alarm and sprinkler supervisory service of the former and its subsidiaries and agreed to bear all expenses and assume all obligations in connection with said business for a period ending February 18, 1954, in consideration of the payment to the taxpayer by the American District Telegraph Oo. of a specified percentage of the gross rentals. Held,, that this was not a sale by the taxpayer of its business, and the alleged value of the contract may not be included as paid-in or earned surplus in computing invested capital of the taxpayer for 1917 and 1918.
    2. The Board is unable from the evidence to determine the deduction to which the taxpayer was entitled in the years 1917 and 1918 for exhaustion of tangible and intangible property.

      Edward T. Magaffln, Esq., and Jas. A. Councilor, O. P. A., for the taxpayer.

      Lee I. Park, Esq., for the Commissioner.
    Before James, Littleton, Smith, and Teussell.
    This is an appeal from the determination of a deficiency in income and profits tax for 1918 in the amount of $23,062.30, against which is offset an overassessment of $5,432.16 for the year 1917.
    FINDINGS OF FACT.
    The taxpayer was incorporated May 5, 1903, under the laws of the State of Maine, its principal place of business being at White-stone, Long Island, N. Y. It was organized for the purpose of furnishing an automatic fire alarm and sprinkler supervisory service, by means of which sprinkler systems were to be kept under constant supervision, thereby guaranteeing their perfect operation. These sprinkler systems consist of a series of water pipes and tanks so arranged and constructed that, in the event of fire breaking out in a building in which they are installed, the water begins to flow automatically.

      The supervisory services operate by means of a series of electrical devices and contacts connecting the sprinkler system with a central office, causing an alarm to be transmitted to such office in the event of any of the following contingencies; that the water in the tanks is freezing, that the water level drops below a predetermined point, that any valve is accidentally or intentionally closed, that water starts to flow through the pipes, indicating a leak or fire, or that there is an interruption of the supervision, as where a wire or signaling device is broken or cut accidentally or intentionally Upon receipt of a signal, day or night, the central office immediately sends one of its employees to the premises. If the signal indicates a water-flow or any other complication signifying a fire, the fire department is called. The premises are thereafter kept under constant supervision until the fire is out or the defect in the system remedied and the ordinary supervisory service reestablished.
    Prior to the incorporation of the taxpayer, Kobert L. McElroy, in collaboration with one John E. Shepherd, developed a service of the nature herein described and applied for and obtained a number of patents covering the devices used. At the time the taxpayer was organized, some of the property owned by McElroy was exchanged for some of its stock.
    On February 18, 1904, McElroy entered into a contract with the American District Telegraph Co., hereinafter referred to as the District Co., under which it was provided that, whereas McElroy and certain associates had applied for patents for certain electrical automatic, manual fire alarm and sprinkling valve signaling devices, Mc-Elroy should use such patents as should be issued in the manufacture of these devices and should deliver them to the District Co. for installation on the premises of subscribers to the service, these subscribers to be solicited by McElroy. It was further agreed that the District Co. should install the devices, make the necessary electrical connections with these devices, maintain a central office, and do all things necessary for the ordinary supervision and operation of the system. The District Co. was required to collect rentals and to turn over to McElroy 45 per cent of the gross amount. The contract, reciting one dollar and other valuable consideration,. was to terminate on February 18, 1954.
    On March 80, 1905, the agreement between McElroy and the District Co. was modified, and on April 21, 1905, the modified contract was assigned by McElroy to the taxpayer, which agreed to perform all acts previously required of McElroy. On the same date the District Co. signed an agreement acquiescing in the assignment.
    On April 29, 1901, the taxpayer, the District Co., and the General Fire Extinguisher Co. entered into a contract whereby the latter agreed to manufacture and install water flow shut-off and pressure signaling devices, and such other actuating devices and testing apparatus as should be necessary in the proper conduct of the business. Under this agreement the District Co. was required to pay to the General Fire Extinguisher Co. and to the taxpayer 25 per cent of the gross rentals received under contracts of subscribers to the service. It was also provided that this contract should expire on February 18, 1954.
    The taxpayer acquired contracts with fire alarm and protection companies of many of the larger cities whereby thNbusiness of those companies passed to it. In other cases it acquired stock in such companies in order that their business might be brought within the provisions of the contract with the District Co. and the General Fire Extinguisher Co., and, in some instances, it organized subsidiary corporations for the purpose of extending its business. On April 29, 1909, the taxpayer entered into an agreement, designated therein as a 999-year lease, with the Fire Protection Development Co., a Maine corporation, hereinafter called the Development Co. By this agreement the entire business of the taxpayer was turned over to the Development Co., which agreed to fulfill the obligations of the taxpayer to enlarge and develop the business, and to pay to the taxpayer’s stockholders annual dividends beginning at a certain rate and increasing to a specified maximum rate. This contract continued in force until June 13, 1913, when the following agreement was made:
    AGREEMENT, made this 13th day of June, 1913, by and between American District Telegraph Company, a corporation duly organized and existing under the laws of the State of New Jersey (hereinafter called the “District Company”), Automatic Eire Protection Company, a corporation duly organized and existing under the laws of the State of Maine (hereinafter called the “Automatic Company”) and Eire Protection Development Company, a corporation duly organized and existing under the laws of the State of Maine (hereinafter called the “Development Company”).
    WITNESSETH :
    Whereas, Robert L. McElroy and his assigns, the Automatic Eire Protection Company, have entered into contractual relations with the District Company as evidenced by a schedule of contracts made a part hereof, as follows:
    March 2, 1903, between Ludlow Automatic Eire Alarm Co. and the American District Telegraph Co. of New Jersey.
    Feb. 18, 1904, between Robert L. McElroy and American District Telegraph Company of New Jersey.
    Mar. 30, 1905, between American District Telegraph Co. of New Jersey and Robert L. McElroy.
    Apr. 21, 1905, between Automatic Eire Protection Co. of Maine and Robert L. McElroy.
    Apr. 21, 1905, between American District Telegraph Co. of New' Jersey and Automatic Eire Protection Co. of Maine.

      July 27, 1905, between tbe same parties and others.
    Oct. 12, 1905, between tbe same parties.
    Apr. 29, 1907, between tbe same parties.
    Apr. 29, 1907, between General Fire Extinguisher Go. of New Tort, Automatic Fire Protection Go. of Maine and American District Telegraph Go. of New Jersey;
    under which Central Station Sprinkler Supervisory and Valve Alarm service and Automatic Fire Alarm service are being furnished by operations of the District Company through its various subsidiary companies, and
    'Whereas, the Development Company has succeeded to the rights and obligations of the said McElroy, and the said Automatic Company to the said contracts,
    Now, Therefore, the parties hereto have agreed as follows:
    ARTICLE 1.
    The District Company hereby assumes the entire burden and expense of soliciting business and agrees to furnish all instruments and materials, and agrees to install all mechanisms and devices which, under the above schedule of contracts, are the obligations of the Automatic Company and of the Development Company.
    The District Company will secure all necessary permits, at its sole expense, for operating service as contemplated under the above schedule of contracts.
    ARTICLE 2.
    The rentals hereunder collected for the first three (3) years’ service under each installation hereafter made, except under contracts heretofore accepted, shall, (after deducting such sums, if any, as the General Fire Extinguisher Company shall be entitled to receive) be retained m toto by the District Company; thirty per cent (30%) of all gross rentals thereafter collected shall be retained by the District Company,'and the remainder (after deducting such sums, if any, as the General Fire Extinguisher Company shall be entitled to receive) shall be divided equally between the District Company and the'Automatic Company. Should the average rental for the first three years exceed the rental for any later year, the amount of such excess shall be deemed to be an installation fee, and all such fees, and all other installation fees shall be divided on the basis of,
    50% (less the amount which the General Fire Extinguisher Company may be entitled to receive) to the Automatic Company; and 50% to the District Company.
    article 3.
    Thirty per cent (30%) of the gross rentals hereafter collected on all installations heretofore made, or contracted to be made, shall be retained im, toto by the District Company, and the remainder (after deducting such sums, if any, as the General Fire Extinguisher Co. shall be entitled to receive) shall be divided equally between the District Company and the Automatic Company.
    ARTICLE 4.
    All contracts hereafter made relating to installations then existing, whether with the original or other parties, shall be deemed to be renewals, and the division of rentals thereunder shall be made as stated in Article 3 hereof, except that where increased revenues are received for the same or additional installations, the revenue to the extent of such increase shall be divided as stated in Article 2 hereof.
    ARTICLE 5.
    The District Company will maintain an efficient organization devoted to the promotion of and will accept and promptly install the business of Automatic Fire Alarm Service and Sprinkler Supervisory and Valve Alarm service falling within the conditions named in the contracts above recited, in the expectation that the service will grow more rapidly under the greater organization management and undivided control of that company.
    ARTICLE 6.
    The District Company will on the tenth (10th) day of each month submit to the Automatic Company a detailed statement of its gross receipts during the previous month pertaining to the business provided for in this contract, and with such statement remit the amount due thereunder. The District Company will promptly notify the Automatic Company of the commencement and of the termination of service to each subscriber. AE contracts shall be executed in triplicate by the subscriber, and one copy thereof furnished to the Automatic Company.
    ARTICLE 7.
    During the period of this contract the District Company or its subsidiaries receiving rentals from Manual Signal service in the City of New York shall account for the same up to but not exceeding the sum of $29,000 per annum under Article 3 hereof, deducting from such gross rentals also the sum of $5,000 per annum to be paid the Guardian Trust Company, Trustee.
    ARTICLE 8.
    The Automatic Company owning or controlling the patents covering the various devices required for conducting the service contemplated under the above schedule of contracts, hereby grants to the District Company 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 such patents now owned or controlled or which may hereafter be owned or controlled by it, during the pendency of this contract, Provided,, however, that all suits and all obligations arising out ■of the infringement of patents under contracts or installations existing at the date of this contract, whether such suits are now brought or hereafter to be brought, shall be taken care of and assumed by the Automatic Company; but all ■questions of infringement or obligations arising out of the use of patents under contracts or installations, or arising out of action taken after the date of this contract shall be borne by the District Company.
    It is further agreed that during the pendency of this contract the provisions of Articles seven (7) and twenty-four (24) of the contract of February 18th, 1904, shall not be effective or be enforced by either party as against the other, but shall revive and become effective only in the event of the termination of this contract prior to February 18th, 1954.
    ARTICLE 9.
    The Automatic Company shall assign, transfer and set over to the District Company all of its right, title and interest in and to all contracts for service with various customers and all property owned and used therewith, and the District Company shall from the date of this contract assume all duties and responsibilities under said contracts. All contracts with subscribers for service shall, from the date hereof, be taken in the name of the American District Telegraph Company (of New Jersey) or in the name of its subsidiary companies, and in ease of breach of any of the obligations assumed by the District Company and its failure to remedy the same after thirty (30) days written notice thereof, all the interest in Central Station Automatic Fire Alarm and Sprinkler Supervisory and Valve Alarm service given to the Automatic Company under the contract of February 18th, 1904, and contracts supplementary thereto, shall, at the option of the Automatic Company, be assigned to it by the District Company and the rights of the parties with respect to the operation of such service shall be established on the basis named in said contract of February 18th, 1904, and any contract supplementary thereto. In such event, the District Company shall also assign to the Automatic Company all contracts with subscribers relative to such service whether taken in the name of the District Company or the Automatic Company or in the name of any of the subsidiaries of either of them.
    ARTICLE 10.
    It is mutually agreed that this contract shall be in force from the date first above written until February 18th, 1954, but all then existing contracts for service of the nature contemplated under the above schedule of contracts, and all the property installed inside the buildings hereunder, shall belong one-half to the District Company and one-half to the Automatic Company, and the District Company agrees that in the meantime no mortgage, lien or assignment will be placed on such property within buildings of subscribers without the consent of or without recognizing or reserving the rights of the Automatic Company.
    ARTICLE 11.
    Sales of equipment or devices for any of the service herein referred to may be made, but for such sales or any private installations made the District Company shall pay to the Automatic Company five per cent (5%) of the gross contract price for all such sales or installations outside of cities where Central service is now or hereafter may be maintained, and ten per cent (10%) in such cities where such Central service is maintained, except in cases where competition exists, and in such cases five per cent (5%), Provided, that in case any such equipment or devices so sold, or installation is thereafter connected with the Central station service or any service rendered in relation thereto, the said Central service connection or such service shall be charged for at the then existing standard rates,, and the revenue therefrom shall be divided under the provisions of Article'3 of this contract. Standard rates for maintenance and inspection or either shall not be less than*one-half the then existing standard rates for Central station service.
    ARTICLE 12.
    All fixed charges and obligations of the Fire Protection Development Company under its contract with James G. Nolen, dated January 3d, 1911, shall be borne in the following manner: — The amount due Nolen shall be deducted from the gross revenue arising from the business under the above schedule of contracts, and the Fire Protection Development Company is relieved, as of the date of this contract, from any further obligation in relation thereto. 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 Tele'graph 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 IT.
    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. MeElroy.
    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 the1 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 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 Congres's.

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 intention, it is reasonable to presume that the patents would have been transferred outright instead of by way of exclusive license with the reservation for use in connection with the business in foreign countries.

Taking the provisions of the contract as a whole, the effect of the instrument appears to be similar to that of a lease of a going business with an absolute assignment of certain assets which, -if not assigned, might tend to prevent the lessee from operating the business to the best advantage of the parties interested. The agreement did not constitute a completed transaction from which profits were realized, but was merely an arrangement for a change in the management and operation of the business from which the taxpayer hoped to derive increased profits.

It is apparent, therefore, that the execution of the agreement of June 13, 1913, did not result in the realization of determinable profits, which could, in the form of earned surplus and undivided profits, be carried into invested capital for the purpose of computing the profits tax.

At this point it may be well to take notice of the contract of April 29, 1909, between the taxpayer and the Development Co. This contract was termed “ a 999-year lease,” but beyond that it was, as far the principal provisions were concerned, not essentially different from the contract with the District Co. By it the Development Co. took over completely assets of the same nature as those transferred to the District Co. by the contract of June 13, 1913, and assumed duties which were in effect the same as those assumed by the District Co. under the subsequent contract.

We are not able, on the evidence before us, to determine the taxpayer’s invested capital for the years 1917 and 1918,' nor can we say that the taxpayer had any invested capital for those years, within the meaning of section 207 of the Revenue Act of 1917 and section 326 of the Revenue Act of 1918. Under these circumstances, we are not disposed to disturb the computation of excess and war-profits tax.for the years in question made by the Commissioner in accordance with the provisions of section 210 of the Revenue Act of 1917 and section 328 of the Revenue Act of 1918.

In view of our findings with reference to the contract of June 13, 1913, and the value thereof, the determination of the second contention of the taxpayer becomes comparatively simple. That a corporation is entitled to deductions for the exhaustion of a contract over the life of such contract, where the cost of the contract was properly capital of the corporation, is not questioned. See Appeal of Atlantic Carton Corporation, 2 B. T. A. 380. In order, however, to obtain the benefit of such an allowance in this appeal, it is first necessary to determine the cost of the contract to the taxpayer. It is contended on its behalf that a business worth $2,000,000 was exchanged for the contract in question, but this, we have seen, does not represent the true facts. Some assets of an undetermined value were transferred and the control and operation of the business was placed in the hands of the District Co. for a period ending February 18, 1954, on which date, in accordance with the provisions of the contract, the taxpayer is to receive half of the contracts with customers and half of the property used in the performance of those contracts. Even though we should concede that the business of the taxpayer on the date the contract in question was made was worth $2,000,000, and that it was transferred for the contract, as represented by the taxpayer, it would be necessary, before we could determine the proper rate of depreciation, to place a value upon the contracts and property to be received by the taxpayer at the expiration of the contract. It is argued that it would be impossible for the taxpayer to perform the contracts returned; that the equipment received will be so much junk in the hands of the taxpayer. In our opinion, from the facts presented, there is considerable ground for believing that they will be of decided value. The taxpayer has, in our opinion, failed to show the cost of the contract in question, and it is therefore impossible to compute the proper allowance for the exhaustion thereof.

The additional argument has been presented that, in the event it be found that the contract of June 13, 1913, was not an absolute transfer of the taxpayer’s business, the taxpayer should be allowed a deduction representing the exhaustion of its property, both tangible and intangible. On this point we can only say that the taxpayer is undoubtedly entitled to a reasonable allowance for the exhaustion of wasting assets owned by it, but, because of lack of evidence, we are unable to determine what the proper allowance is. We have no information with reference to the cost of any of the assets of the taxpayer, nor can we, from the facts before us, determine their value as of March 1, 1913; nor have we any definite information as to the quantity of tangible and intangible property which is subject to exhaustion, the nature of such property, or the probable life thereof.

Order of redeterrmnation will he entered on 15 days’ notice, under Rule 50.


source: Caselaw Access Project

author: Smith:

license: Public Domain

text:
    Appeal of E. R. BERNSTEIN, Executor, Estate of MICHEL BERNSTEIN, Deceased.
    Docket No. 5722.
    Submitted February 11, 1926.
    Decided April 19, 1926.
    Tbe value of real estate at the date of death of decedent determined.

      E. W. B. Ewing, Esq., for tbe taxpayer.

      J. S. Halstead, Esq., for the Commissioner.
    Before Smith, J ames, Littleton, and Teussell. '
    This is an appeal from the determination of a deficiency in estate tax in the amount of $2,550.80. The issues are (1) the value of certain real estate at the date of the death of the decedent, July 18, 1923; and (2) the deductibility of $11,000 inheritance tax paid to the State of Louisiana.
    FINDINGS OF FACT.
    The petitioner is the executor of the estate of Michel Bernstein, his brother, who died July 18, 1923. Prior to that date the decedent and the petitioner were members of a partnership known as Bernstein Bros., which owned a large amount of real estate in Shreveport and Caddo Parish, La. The petitioner filed an estate-tax return for the estate of the decedent on July 15, 1924, in which the actual value at the date of the decedent’s death of the real estate owned by the partnership was placed at $640,014.95, to which was added accrued income on improved properties amounting to $10,995.80, making a total for the real estate and accrued income of $651,010.75. The net worth of the partnership was returned as $551,226.52 and the decedent’s one-half interest as having a value of $275,613.26.
    On April 10, 1925, the petitioner requested the Shreveport Real ' Estate Board to make an appraisement of the real estate of the partnership. Pursuant to such employment, G. M. Leadman called into his office, on April 10, 1925, five other members of the board who then and there, without personal inspection of the properties to be valued, made an appraisement of the real estate. Their appraise-ments ranged from $482,845 to $517,275.
    The estate-tax return shows the payment of inheritance taxes to the State of Louisiana in the amount of $11,000.
    The Commissioner fixed the value of the gross estate at $651,010.95, and denied as a deduction the amount of $11,000 as inheritance tax imposed by the State of Louisiana.
   OPINION.

Smith:

The petitioner, who was a partner of the decedent, filed an estate-tax return for the decedent, in which he stated that the actual value of the real estate of the partnership at the date of the death of the decedent was $640,014.95. The Board is not informed as to the basis of the determination of such value. It may have been the cost of the properties or the book value as shown by the books of the partnership. The petitioner has caused an appraisal of the properties- to be made and now claims that the value of the real estate of the partnership at the date of the death of the decedent was only $499,142.36, and that the decedent had only a one-half interest therein. The petitioner alleges error on the part of the Commissioner in refusing to accept the above-mentioned figure of $499,142.36 ‘ for the real estate, instead of the amount shown in the estate-tax return, namely, $640,014.95.

The real estate owned by the partnership of Bernstein Bros, was widely scattered throughout the City of Shreveport and Caddo Parish, and apparently consisted in large part of acreage, vacant lots, and land upon which there were few improvements. In making their appraisal, six members of the Shreveport Beal Estate Board assembled in the office of G. M. Leadman on April 10, 1925, sat around a table and, as the location of the land was pointed out to ■them, they each set down upon paper their estimate as to the value of the real estate on July 18, 1923. It is evident from the testimony of these men, as shown by their depositions, that many of them had never been upon nor seen the property which they appraised. They simply determined the location of each parcel and, from their general knowledge of real estate conditions, estimated the fair value •of it. The record contains a copy of the appraisal made by each appraiser. The lands shown by the appraisal are not described in the same manner that they are described in the estate-tax return made by the petitioner, and it is impossible to check out in all instances the exact difference between the amounts shown by the appraisers and the amounts returned by the petitioner. We are convinced from a careful examination of the entire record that the evidence adduced generally is not sufficient to prove incorrect or inaccurate the estimate of value made by the petitioner, who had sources of information of the value which undoubtedly were not possessed by any of the appraisers. We are, however, of the opinion that the value of the seventeen twenty-fourths interest in 93.8 acres of . land returned as having a value of $93,800 was in excess of the actual value. This tract was apparently well known to most of the appraisers. It consisted of an unimproved area in a colored subdivision. J. B. Emery, one of the appraisers, owned a 40-acre tract .adjoining this tract. He placed the value of the partnership’s interest in the tract at $30,000. One of the other appraisers placed .a value on the tract of $32,500. All of the others estimated the value at a less amount, one of them being only $18,'760. In view of this evidence, we think that the value of the tract was only $30,000, and that the value of all of the real estate owned by the partnership was $516,214.95 instead of $640,014.95, the amount returned.

The claim of the petitioner that he is entitled to deduct from the gross estate inheritance taxes paid to the State of Louisiana can not be allowed, since the taxing statute specifically provides that inheritance taxes may not be deducted from the gross estate. Section 403(a) (1), Revenue Act of 1921.

Order of redetermination wUl be entered on 15 days’ notice, wider Rule 50.


author: James:

text:
    Appeal of CLEARFIELD LUMBER CO.
    Docket No. 16.
    Submitted May 4, 1925.
    Decided April 19, 1926.
    1. The taxpayer, prior to March 1, 1913, acquired timberlands at a cost of approximately $3.50 per thousand feet of timber. From the evidence submitted, held, that the fair market value of said standing timber on March 1, 1913, was not more than $5.35 per thousand.
    2. The taxpayer issued $360,000 preferred stock for timber and timberlands in 1907, and $480,000 common stock for cash or its equivalent at or about the same time. Thereafter, from 1909 to 1918, inclusive, the taxpayer retired all the preferred stock and $280,000 par value of common stock for cash. Sold, that such retirement of preferred and common stock, for the purpose of computing invested capital, is properly to be deducted from capital stock as originally issued and may not be deducted from surplus.
    3. In computing inventory of logs and lumber the taxpayer used a unit value representing original cost, which was increased by the Commissioner to the unit value as of March 1, 1913, that is, from $3.50 to $5.35. Held, that this increase was justifiable and proper, for the reason that its effect is to allow depletion at a rate in excess of cost at the time when timber is sold, whereas, if the inventory were taken at cost, depletion would be allowed at the time the .timber was cut but not sold.

      Robert H. Winn, Esq., and Frank Lowson, O. P. A., for the taxpayer.

      Robert A. Littleton, Esq., for the Commissioner.
    Before James, LittletoN, and Teussell.
    This is an appeal from the determination of a deficiency in income and profits taxes for the year 1918, in the amount of $42,656.07..
    FINDINGS OF FACT.
    The taxpayer is a New Jersey corporation, organized in 1905 for the purpose primarily of acquiring and exploiting timberlands located on the Licking Eiver in the State of Kentucky. The More-head <⅞ North Fork Kailroad Co. is also a New Jersey corporation, organized in or about the year 1907, primarily for the purpose of constructing and operating a railroad running though the lands of the taxpayer and furnishing transportation for its products. During the taxable year the two companies filed a consolidated return for income and profits-tax purposes and are admitted to have been and to be affiliated.
    On June 6, 1907, pursuant to a resolution of the board of directors of the taxpayer, it acquired from A. W. Lee, W. B. Townsend, John W. Wrigley, and Carrie C. McGaughey approximately •33,966 acres in fee or timber rights • containing, as then estimated, 141,193,000 feet of merchantable timber, and issued therefor its preferred stock in a total amount of $360,000. Thereafter from time to time it issued common stock for cash or its equivalent, it bought timber or timberlands in relatively unimportant amounts, and proceeded with the exploitation of all the land so acquired, conducting extensive operations thereon from 1907 until 1922, by which time substantially all the timber had been cut or sold.
    In accordance with certain exhibits submitted by the taxpayer and received in evidence, the actual realized footage of timber bought or acquired for stock as above set forth, its cost expressed in terms of dollars of cash paid or dollars of stock issued, its cost per thousand feet, and its cost less certain charges on account of overhead which do not represent purchase money paid to sellers, are set forth in the following table, the purchases or footage acquired prior to March 1, 1913, being separated from those after that date:

    During the entire period of operation, as shown by the records kept by the taxpayer and the reports made to its stockholders, it cut in log measure 120,088,016 feet of timber and sold without cutting during the years 1916 to 1919, inclusive, a total of 15,430,856 feet, the total timber recovered as shown by its records being 135,518,812. The cut only by varieties of timber for the entire period, the period from 1907 to December 31, 1912, and for the period from January, 1913, to 1924, is as set forth in the following table, minor errors in the figures making a difference between' this table and the above-stated total footage.

    One S. B. Reese, during the year 1912 and the early part of the year 1913, purchased for cash, notes and other deferred payments, or acquired in the settlement of litigation, timberlands and standing timber on the Elk Fork of the Licking River in or around Lenox, some 4 miles from Redwine, the terminus of the More-head & North Fork Railroad constructed by the taxpayer for the purpose of its operations. The timber so acquired by Reese was across a mountain from the terminus of the taxpayer’s railroad, and was not accessible to railroad transportation. The footage of such timber amounted to not more than 42,000,000 feet log scale. As shown by recorded deeds, stated by Reese to represent the true consideration, the cost did not exceed in the aggregate $2 per thousand, and a considerable quantity thereof in small lots was bought for less than $1 per thousand. Reese organized the Roper-Reese Lumber Co., and transferred the timber so purchased and acquired to that company for $294,000 in stock. Other parties transferred other contiguous boundaries of timber for $110,000 in stock, bringing the total footaJge so transferred to not exceeding 51,140,000 feet. Thereafter, the Roper-Reese Co. undertook the construction of a railroad from Redwine to Lenox for the purpose of exploiting its timber, but failed, and, before the completion of the railroad, went into bankruptcy in the year 1915. In the schedule of assets of that company in bankruptcy the timber held by the said company was stated at 51,140,000 feet log scale, the taxpayer, among others, considering its purchase. The taxpayer offered $100,000 for the property, considered offering $110,000, and it was finally sold to the W. S. Whiting Co. for $116,300. That company thereupon completed the railroad from Redwine to Lenox and constructed a mill, but was unable to operate the property profitably, and thereafter it in turn became a bankrupt. The ultimate cost of the railroad to the Whiting and the Roper-Reese companies was something in excess of $65,000.
    The taxpayer in its returns for the years 1917 and 1918 claimed an allowance for depletion of timber on the basis of $8 per thousand feet. The Commissioner allowed depletion at the rate of $5.35 per thousand feet, both basing such allowance upon their respective valuations of the footage as of March 1, 1913.
    The value of taxpayer’s timber on March 1, 1913, did not exceed $5.35 per thousand feet.
    During 1918, the taxpayer sold a portion of its standing timber, estimated to contain 5,178,000 feet, at a price of $32,500, or $6.25 per thousand, and in connection therewith claimed a value of $8 per thousand feet as of March 1, 1913, thereby claiming a loss from the transaction. The Commissioner valued the timber so sold at $5.35 per thousand feet, and computed therefrom a taxable. gain of $4,961.90.
    As above set forth, the taxpayer in the year 1907 issued $360,000 of preferred stock for a tract of standing timber. It also, from time to time, issued common stock for cash or its equivalent in a total amount of $480,000.
    Beginning October 4, 1909, and continuing through the taxable year in question, the taxpayer purchased and retired preferred and common stock on the dates and in the amounts set forth below:

      All of the above purchases were charged against the capital stock account on the books, so that on January 1, 1919, the books showed no preferred stock outstanding and common stock outstanding in the amount of $200,000.
    Dividends were paid by the taxpayer to January 1, 1919, on the dates and in the amounts indicated:

    With the exception of the dividend paid in 1907, there were sufficient earnings available out of which' to pay all of the above dividends. There were no earnings out of which to pay the dividends of $10,800 paid in 1907.
    The total earnings of the taxpayer to the end of the taxable year were in excess of $440,859.42, and were in excess of $640,000, but were less than the total of stock retired and dividends paid.
    In the letter addressed to the taxpayer under date of February 5, 1924, wherein the Commissioner indicated the computation of the taxpayer’s tax for the taxable year under section 301, he determined the consolidated invested capital as of January 1, 1918, of the taxpayer and the Morehead & North Fork Eailroad Co. at $524,764.68, as follows:
    Capital stock_$275, 000. 00
    Surplus (Clearfield Lumber Co.)_$545,396.46
    Less deficit (M. & N. F. R. R. Co.)_ 295,631.78
    - 249,764.68
    Invested capital at Jan. 1, 1918_ 524, 764. 68
    For the year 1917 the Commissioner determined income and excess-profits tax liability of the taxpayer in the amount of $20,373.87, which amount has been paid. On February 10, 1925, the taxpayer filed a claim for refund of 1917 taxes in the amount of $14,985.25. This claim has not yet been passed upon by the Commissioner. The Commissioner reduced the consolidated invested capital for the year 1918 on account of 1917 income and profits taxes in the said amount of $20,378.87, prorated from June 15, 1918.
    In computing its inventories, the taxpayer used as a basis its cost of timber, and inventories were so figured as of the close of 1916, 1917, and 1918. Profits were returned for taxation upon that basis, cost being in all instances lower than market. The Commissioner, in adjusting the income of the taxpayer for the taxable years 1917 and 1918, computed inventories upon the basis of timber values used by him for the allowance for depletion, that is, upon the basis of $5.35 per thousand, which was in all cases higher than cost.
    In the said letter of February 5, 1924, the Commissioner fixed the war-profits credit of the taxpayer for the year 1918 in the amount of $47,397.83. The said amount was computed by adding to 10 per cent of the invested capital, as computed by him, the specific exemption of $3,000.
    Subsequent to the mailing of the letter of February 5, 1924, the taxpayer made application to the Commissioner to have its profits-tax liability for the year 1918 determined under the provisions of section 328 of the -Revenue Act of 1918. Said application was approved and the profits-tax liability was redetermined accordingly. In that determination of the deficiency from which the taxpayer appeals, the profits-tax liability has been determined in accordance with the provisions of section 328.
   OPINION.

James:

Summarized, the taxpayer complains of the determinations of the Commissioner giving rise to the deficiency in the instant appeal, as follows:

(1) That he has valued its stumpage at March 1, 1913, for purposes of depletion and computation of gain or loss on sales, at $5.35, whereas the true and correct value as of that date was $8.60.

(2) That the Commissioner made substantially the same errors in the year 1917, thereby computing a greater tax liability for that year than the taxpayer owed, and in consequence, in accordance with his usual method, decreased by too great an amount the taxpayer’s invested capital for the year 1918. The taxpayer does not assert this overpayment of 1917 tax as an offset to the 1918 tax, but only as an element affecting invested capital for the taxable year.

(3) That he deducted from capital stock the amounts of such stock purchased and retired, but should have reduced surplus by those amounts. Had the Commissioner followed this procedure, there would, not have been sufficient surplus of the taxpayer from which to deduct the deficit of the Morehead & North Fork Kail-road Co. in the amount of $295,631.78, or all of that amount, and the taxpayer claims its invested capital would have been increased by $236,577.80 had the Commissioner deducted such retirements from surplus.

(4) That the inventories of the taxpayer for 1917 and. 1918 should not have been increased from cost to the basis per thousand used by the Commissioner in computing- depletion, or from approximately $3.50 to $5.35.

Taking up first the assignment of error, which is predicated upon an erroneous computation of 1917 tax, it is sufficient to say that the points involved in respect of invested capital and claimed for 1917 are the same as those involved as to 1918. The decision on the 1918 income and invested capital questions adequately disposes of the questions raised as to the 1917 invested capital which affect 1918.

Taking up the remaining questions presented by the taxpayer in the inverse order of their importance rather than in the order in which they were presented, we will deal first with the method of inventory valuation.

The Commissioner has prescribed that inventories be taken at cost, or at cost or market, whichever is lower, deriving his power for these regulations from section 203 of the Kevenue Act of 1918. In article 1583, the Commissioner defines cost in the case of manufactured articles produced by the taxpayer as “ the cost of raw materials and supplies entering into or consumed in connection with the product, * *

Both the Commissioner and representatives of taxpayers have fallen into awkward and confusing terminology in connection with the difference between cost and March 1, 1913, values reflected in depletion allowances, terminology which appears to have added to the confusion in the instant case. It has been the habit to call this differential “realized appreciation,” whereas, in fact, it is merely tax-free income. It appears to be the intent of the statute and the regulations not only that taxpayers shall have returned to them free of tax the cost of property acquired, but, also, if acquired before March 1,1913, that they shall exclude from taxable income, as income is realized from the sale or other disposition of such property, that portion of the profits represented by the difference between cost and value on March 1, 1913. This view has been recognized by the Supreme Court. Goodrich v. Edwards, 255 U. S. 527. In the case of a sale of property, where the March 1, 1913 value is in excess of cost, the computation of taxable gain as distinguished from actual gain is readily made by subtracting the March 1, 1913, value from the selling price.

In the case of property, however, which is sold, but which, in the interim, passes through inventory, a more complicated situation in fact but not in principle arises. In the case of such property, there is still a basic cost which is to be taken into consideration in determining gain or loss from the ultimate sale, and it is that cost which enters into the ordinary merchandising accounts of the exploiter of natural resources. Cost of goods sold is still made up, in his case, of prime cost of mineral or timber, plus the cost of reduction to merchantable form. The difference between prime cost of $8.50, as in the case of this taxpayer, and $5.35, the value at March 1, 1913, is merely that amount per thousand feet of lumber which the taxpayer is permitted to receive as exempt income. If net income were computed in the first instance by the taxpayer upon the basis of cost of its depletable assets, and the resulting costs of merchandise were built upon such costs, there would appear in the taxpayer’s accounts a difference between the gain shown in its profit and loss statement and the taxable gain equivalent to the difference in the depletion rate at cost and at March 1, 1913, multiplied by the units depleted. This difference is the thing which in respect of extractive industries has come to be called “ realized appreciation,” meaning by that term that the subject matter of depletion has been extracted or severed from the land and sold, and the excess of March 1, 1913, value over cost has been realized by sale. The proceeds of that sale have become part income and part return of original capital cost, the income in turn being severable into its two parts of taxable and tax-free income.

The question then becomes one merely of determining the year in which the taxpayer shall be allowed to make effective the deduction of this differential. Under the method pursued by the Commissioner in this case, whereby the inventory of logs is taken upon the depletion basis, so much of the depletion allowance, computed as such from cutting records, as is represented by logs on hand at the end of the year, is in effect denied as a deduction in that year, and becomes cost of goods sold in subsequent years, thereby allowing the deduction for depletion, not in the year in which timber is cut, but in the year in which timber is sold. The taxpayer is here contending in effect for the allowance of depletion in full in the year in which timber is cut, without reference to the time when it is sold. Under the Commissioner’s method, it would appear superficially that a taxpayer with an increased inventory as between the beginning and end of the year would in effect be taxed upon an unrealized income and the taxpayer with a decreased inventory would be allowed an unrealized deduction of the difference between cost and March 1, 1913, value. But this is true only in appearance, and only if tbe inventory be considered separate and apart from the allowance for depletion.

Neither the statute nor-article 1583 of the Regulations specifically provides for the taking of any inventory at March 1, 1913, value. On the contrary, the Regulations clearly provide for the taking of inventories at cost or cost or market, whichever is lower. As a matter of strict interpretation of the Regulations, it would appear that the Commissioner, by using March 1, 1913, values in computing inventories in cases such as this, directly violates his own regulations. But this loses sight of the fact, as stated above, that in the extractive industries capital assets in the form of timber or mineral products are reduced first to merchantable form and then sold. The real purpose to be accomplished is so to adjust the accounting that the depletion allowance shall include a return of the cost of capital assets plus the excess of March 1,1913, value over cost, and that that depletion allowance ^should be made available as a deduction only when the timber cut or the mineral extracted is sold. This result is accomplished by the method pursued by the Commissioner in this case. We' believe it is a practicable method and a comparatively simple one for accomplishing the end desired and more clearly reflects the income of the taxpayer than would a method in which the depletion allowance would be deducted in the year of cutting or extraction without further adjustment. The Commissioner’s method does not impair an ultimate allowance of depletion in full, inclusive of value on March 1,1913.

The second point in controversy deals with the adjustment of invested capital made necessary by the taxpayer’s return to its stockholders of the amounts theretofore invested by them in its capital stock. This point would not be material to the taxpayer were it not for the fact that the Commissioner deducts from the surplus of the Clearfield Co. the deficit of the railroad company, and would not then be material were it not for the fact that the total of ordinary dividends and capital retirements exceeds the additions to surplus of the taxpayer for its entire period of operations. Because this latter is the fact it is apparent that, if all capital retirements are first deducted from surplus, together with all ordinary dividends, there results an impairment of capital originally invested, and it is claimed that therefore the deficit of the railroad company may not be deducted from the remaining capital of the taxpayer.

The Commissioner, both in 1917 and 1918, in the computation of invested capital, pursued what appears to be a wholly inconsistent course. He deducted from invested capital in their entirety all retirements of capital stock up to the beginning of the taxable year in question, but as to capital stock retired during each of those years he deducted only an amount representing the difference between tbe amount of tbe retirement and tbe earnings to tbe date of retirement. It is this latter principle which tbe taxpayer is seeking in effect to apply to the entire item of capital stock retirement.

Tbe question presented is purely legal and has to do with tbe construction of section 326 of the Revenue Act. of 1918 as affected, if at all, by section 201 thereof.

Section 326, in defining invested capital, provides that it shall include cash or property paid in for stock or shares, with certain limitations here not material, and paid-in or earned surplus and undivided profits. It further provides in section 326(d), “the invested capital for any period shall be the average invested capital for such period, * * Section 201, in which is defined the term “ dividends,” bears an important but apparently confused relation to the subject matter here under consideration. The pertinent provisions are as follows:

(a) That the term “ dividend” when used in this title * ⅜ * means (1) any distribution made by a corporation, * * * to its shareholders or members, whether in cash or in other property * * * out of its earnings or profits accumulated since February 28, 1913, * * *.
(b) Any distribution shall be deemed to have been made from earnings or profits unless all earnings and profits have first been distributed. * * *
(c) * * * Amounts distributed in the liquidation of a corporation shall be treated as payments in exchange for stock or shares, and any gain or profit realized thereby shall be taxed to the distributee' as other gains or profits.
* * * * * * * *
(e) Any distribution made during the first sixty days of any taxable year ■shall be deemed to have been made from earnings or profits accumulated ■during- pz-eceding taxable years; but any distribution made during the remainder of the taxable year shall be deemed to have been made from earnings or profits accumulated between the close of the preceding taxable year and the date of distribution, to the extent of such earnings or profits, * * *.

Interpreting the foregoing provisions of the statute, the Commissioner promulgated article 862 of Regulations 45, which reads in full as follows:

■ Purchase op Stock. — Where a corporation either directly or indirectly, as for example through a trustee, has prior to the taxable year bought its ■own stock, either for the purpose of retirement or of holding it in the treasury ■or for other purposes, the entire cost of such stock must be deducted from the aggregate invested capital as of the beginning of the taxable year, if •such deduction has not already been made. Where such stock is purchased ■during the taxable year a deduction from the invested capital as of the beginning of the taxable year and effective from the date of such purchase is required only to the extent that such stock has not been purchased out of the undivided profits of the taxable year. See article 857. The full amount •derived in cash or its equivalent from the resale of such stock may be included in the invested capital from the date of such resale, unless such stock had been purchased out of eaz-nings of the taxable year. See article 542.

It is apparent from the foregoing that Congress has nowhere directly provided for the situation here involved. It has specified that invested capital includes cash and the value of property paid in for stock or shares, and that invested capital shall be the average invested capital for the year, but it appears nowhere to have specifically considered the possible effect on invested capital of a return in cash or property to the stockholders of a going concern of all or a portion of the capital which they originally paid in. It is not surprising that this should be so, since it could become material to the computation of invested capital only in two unusual situations: (1) in cases in which capital returned was greater than the earnings; and (2) in cases in which, due to a computation of consolidated invested capital, it might become material to inquire whether losses on the one hand might be deductible from profits on the other, and the extent to which such deductions might be made. The taxpayer contends-that we are confronted with both these unusual circumstances.

It must be clear that the provisions of section 326 are not to be read literally in the sense that invested capital at all times includes all property values theretofore paid in to a corporation for stock without regard to the later history of that stock. Such a construction would defeat the manifest purpose of the provision, for capital which has been contributed and then withdrawn certainly may not after its withdrawal be said to be “ invested.” In LaBelle Iron Works v. United States, 256 U. S. 377, the court, defining invested capital, says (p. 388) :

The word “ invested ” in itself imports a restrictive qualification. When speaking of the capital of a business corporation or partnership, such as the act deals with, “ to invest ” imports a laying out of money, or money’s worth, either by an individual in acquiring an interest in the concern with a view to obtaining income or profit from the conduct of its business, or by the concern itself in acquiring something of permanent use in the business; in either case involving a conversion of wealth from one form into another suitable for employment in the making of the hoped-for gains.

Where capital has been withdrawn from the corporation, it certainly is no longer a possible source of future gains in that venture. From the standpoint of the stockholder, the capital is no longer at the risk of the enterprise, but has been reconverted to his undisputed control and use. Appeal of Minneapolis Sash & Door Co., 2 B. T. A. 505.

With this construction, we find no conflict in the provisions of section 201. The section itself is headed “ Dividends,” and certainly liquidations_ whereby capital stock is purchased and retired can not .in ordinary terms be considered to fall within the meaning of that word. The section is to be construed in the light of its title, and not by ignoring it.

It was primarily tbe intent of Congress, however, to give as broad a meaning as possible to section 201 and some of its provisions, notably subdivision (e), can have no significance except as bearing upon invested capital. Subdivision (c), quoted above, is significant only in so far as it relates to distributions in excess of the amounts paid in to the corporation for stock, and is intended to define or measure the profit realized from transactions of this character. It has only a very indirect significance, if any, in relation to invested capital.

Subdivision (e) is, then, to be read in the light of the general title of the section, and in the light of subdivision (c). We have no doubt that distributions of surplus as such come within the rule, and that a liquidating dividend involving both the retirement of stock and the payment of an excess over the values paid in therefor would be deducted from invested capital if made after 60 days from the beginning of the year only in the amount in excess of current earnings. But in the instant case, we have only a retirement of stock at par where paid in in cash or in property which the Commissioner has treated as having par value at the time paid in.

Section 201 was construed by the District Court for the Western District of Kentucky, in the case of Langstaff v. Lucas, 9 Fed. (2d) 691.

The court, in the course of its discussion, says:

This section [201(c)] strips distributions made to stockholders in liquidation of a corporation of all disguises and declares that they shall be considered for what they in effect are — purchases of all their outstanding stock by the liquidating corporations, and not dividends as generally understood, and as defined in section 201, subsection (a), and as used in section 216. So construed, subsection (c) of section 201 puts the stockholder who holds his stock up to the time of liquidation, and then in effect sells it to the corporation, upon exactly the same footing as the stockholder who sells his stock to another during the" operating life of the corporation. ⅜

And further the court says:

As generally understood and used, a dividend is a return upon the stock of its stockholders, paid to them by a going corporation without reducing their stockholdings, leaving them in a position to enjoy future returns upon the same stock. * * * In other words, it is earnings paid to him by the corporation upon his invested capital therein, without wiping out his capital. On the other hand, when a solvent corporation dissolves and liquidates, it distributes to its stockholders, not only any earnings it may have on hand, but it also pays to them their invested capital, namely, the amount which they had paid in for their stock, thus wiping out their interest in the company.

See Lynch v. Turrish, 247 U. S. 221; Lynch v. Hornby, 247 U. S. 339.

The rule as above laid down for liquidating corporations applies, we believe, equally to corporations which purchase a portion of their capital stock at the value at which it was originally paid in. In such cases, the stockholder ceases to be a holder of that stock, and ceases to have any further interest in the portion of the surplus of the corporation theretofore in effect attaching to that stock. The surplus then attaches to the stock still outstanding, to the enhancement of its value, and certainly can not be said to have been used for the purpose of retiring the stock purchased.

We are of the opinion, therefore, that the Commissioner is in error in so far as he has related the deduction from invested capital during the taxable years 1917 and 1918 to the earnings of those years, but correct in so far as he has excluded capital stock purchased and retired in its entirety from the invested capital of the taxpayer from the date of such purchase and retirement.

This brings us to a consideration of the last and principal point raised by the taxpayer in its appeal. The Commissioner has valued at $5.35 per thousand the timber holdings of the taxpayer for purposes of depletion and for the purpose of computing gain or loss on certain minor sales of standing timber. The cost was approximately $3.50 per thousand, and the taxpayer claims a value at March 1,1913, of $8.60, based upon the opinion testimony of 10 witnesses submitted in depositions. The taxpayer arrives at the figure of $8.60 by adding the values which existed in the opinion of each of its witnesses and dividing those values by 10.

The Commissioner determined the value of $5.35 from statistics gathered by him and compiled by engineers employed in the Bureau. None of this material was placed at the disposal of the Board, but the Commissioner did place on the stand the engineer who made the determination here in question. It became immediately apparent that the witness had only hearsay knowledge of the property of the taxpayer and of all timber property in that area. He had never examined the property of the taxpayer and relied entirely for his valuation upon information as to sales, which was not placed in the record, and upon the facts of the taxpayer’s operations as gathered from its books. Little weight is to be attached to this testimony.

We find ourselves, for reasons stated below, even more unable to accept the values claimed to have been proven by the testimony of taxpayer’s witnesses.

The witnesses consist of E. Q. and W. T. McGlone, S. M. Bradley, H. M. Collins, Drew Evans, T. B. Staggs, W. G. Blair, G. H. Gear-hart, S. B. Reese, and D. B. McKenzie.

E. Q. and W. T. McGlone were brothers operating small stave mills in and around Morehead, Ky., which was the northern terminus of the Morehead & North Fork Railroad Co. In that connection they purchased from time to time relatively small quantities of timber for manufacturing staves. The timber so purchased consisted principally of oak and was bought because that species was used in their operations. The witnesses had not bought stumpage in general and do not appear from their testimony to have operated on a large scale or to have any accurate idea as to the values of large timber properties. They testified solely upon the basis of their knowledge of values for their own peculiarly selected type of manufacture, the oak timber acquired for their purposes being, next to poplar, the highest valued timber in their vicinity, and they used only the higher grades of that. Their knowledge of the taxpayer’s property was limited to viewing it in a general way. How general that view was is shown by the testimony of E. Q. McGlone, who stated on cross-examination that oak timber ran 60 to 65 per cent of all the timber in that vicinity, and poplar constituted another 20 per cent, making a total of at least 80 per cent of these two high-priced species. His viewpoint is well expressed in his statement that “ with us the value of the oak represented about 90 per cent of the value of the entire timber in tracts.” It is apparent that the testimony of both these witnesses is predicated entirely upon oak timber, and that of high grade. In placing a value on taxpayer’s timber of $8.50 per thousand they both were quite plainly thinking in terms of oak and poplar without realizing that the original percentage of oak and poplar to the total timber of the taxpayer was only about 65 and that approximately 57 per cent of the oak timber was cut prior to January 1, 1913, so that on that date the oak and poplar constituted only 59⅜ per cent of the total timber of the taxpayer as shown by the table set out in our findings of fact.

S. M. Bradley was engaged in the lumber business in and around Morehead and had been a member of the Kentucky State Senate. He testified that the taxpayer’s timber had a value of from $8.50 to $9 per thousand on March 1, 1913. His recollection of his own transactions is so indefinite as to deprive his testimony of any substantial value.

The following is a fair sample of his testimony on cross-examination :

Q. Did you buy any timber in 1913?
A. Yes, sir.
Q. Where was that timber located?
A. I always had several tracts of timber, and I have bought tracts close to this Clearfield timber a good many times.
Q. When you bought close to this timber, what tracts did you buy?
A. I would have to refer to my boohs to tell you.
Q. What quantity did you buy in the vicinity of this Clearfield Lumber Company timber?
A. Well, I bought one tract on a branch that ran into a fork of the Craney, before the Clearfield Lumber Company bought this, and off of this tract, ¶ believe. I did not buy it, but Mr. Wells bought it and I furnished the money and got the lumber, etc., and helped to take it off.
Q. What size or area was it?
A. It was a pretty good boundary; but I do not remember the number of feet.
Q. Do you remember what was paid for it?
A. I could not say; I don’t remember now.
Q. About what date was that?
A. Well, sir, I think — though I won’t state positively — that it was around 1901 or 1902.

H. M. Collins, an attorney of Frankfort, Ky., had been treasurer and vice president of the Licking Coal & Lumber Co. and vice president and general manager'of the North Fork Cannel Coal Co. He testified that the timber of the taxpayer was worth on March 1,1913, at least $8 per thousand. He was not familiar in detail with the taxpayer’s property, either in 1913 or apparently at any other time. Collins is, at that, one of the taxpayer’s most satisfactory witnesses.

Drew Evans, like the McGlones, was principally a manufacturer of staves. He testified to the purchase of a tract of timber known as the Van Sant timber, containing about 925,000 feet, for which he said he gave $5,000, and stated that the timber in that tract was the ordinary run of timber, with some of the best oak and the greater part of the poplar cut out. The purchase was made in 1914. He testified that the Clearfield Lumber Co.’s timber was better than the Van Sant and was worth on March 1, 1918, about $8.50 per thousand. He testified to other purchases, but at a materially later date than March 1, 1913, some of them being purchases from the Clearfield Lumber Co. itself. He testified that the Clearfield lumber would run 60 or 70 per cent oak and about 15 per cent poplar, but could not give an estimate over the whole tract of the Clearfield Lumber Co.

T. B. Staggs is a manufacturer of hardwood flooring, has been secretary and general manager of the Salt Liver Lumber Co. for many years, and testified to a value of the taxpayer’s timber of $8.25 per thousand on March 1, 1913. He had not made a detailed cruise of the taxpayer’s timber and had gained his knowledge from general observation only of the property.

W. G. Blair is a resident of Clearfield, Ky., and was for eight years judge of the County Court of Morgan County. He had been a farmer, a merchant, and had engaged in the lumber business. He was at one time a director and president of the West Liberty Bank and had been from time to time connected professionally with the Clearfield Lumber Co. He was so employed in 1913. He testified to a value in his judgment of $8 to $10 per thousand for their timber. His testimony with reference to the character of the timber cut before and after March 1, 1913, is illuminating:

Q. Judge Blair, on the 1st of March, 1913, or about that time, had the Clearfield Lumber Company cut any of its timber?
A. Yes, it had cut quite a good deal of it.
Q. Are you enabled to say how the character of the timber that they had then cut compared with the character of timber that they had left standing?
A. Yes, sir; the timber they had in 1913 was quite a good deal better grade of timber up to that time.
Q. How did that happen to be true?
A. It had not been cut over; they had been working on farm tracts; they had to cut these tracts first on account of the time they had to take it off; and they left the best timber toward the last.

The value of this testimony in the light of the cutting records of the taxpayer is self-evident. In connection with the quantity of timber owned, the witness also stated:

Q. Do you know about what per cent of this timber would be oak?
A. Only to guess at it; I never manufactured much timber myself. I think of the timber that they owned in 1913, the oak would run around 60 per cent; that would be my idea about it.

George H. Gearhart is a stockholder in the taxpayer, a director and general manager. He places a value of $8.04 on the taxpayer’s timber as of March 1, 1913. He is a practical lumber operator, and testified in detail as to grading and quality of lumber, oak and poplar being the more valuable grades.

We come now to a consideration of the testimony of S. B. Eeese and D. B. McKenzie.

Eeese, prior to 1912, was a timber operator on a small scale, is at present living in Lenox, and has lived at Farmers or Lenox, Ky., for 24 years. In 1912 and 1913, he undertook to assemble in one lot for operation a substantial quantity of timber, variously estimated at from 42,000,000 to 62,000,000 feet, this being the timber mentioned in our findings of fact. He testified that he bought that timber in general at about $7 per thousand. It was located near Lenox some six miles from Eedwine, at that time entirely off the railroad and separated from the railroad by a mountain, over which the lumber would have to be hauled unless a railroad were built into the property. After assembling the tract in question, Eeese turned it in to the Eoper-Eeese Lumber Co. for $294,000 in stock, others associated with him turning in additional tracts also for stock, and that company undertook to construct an extension of the railroad from Eedwine to Lenox. As set forth in our findings of fact, the company became a bankrupt, the property was sold to a successor concern, and that concern in turn failed, although the railroad was ultimately built. The witness on direct examination is very positive that about 42,000,000 feet was bought for cash and that the price paid was $7 per thousand. On cross-examination, however, he became increasingly indefinite; for instance:

Q. What was the total cost of the whole of this forty-two million feet; that is your lump cost of all of it?
A. I am not able to tell you exactly what it was.
Q. That was in 1912 and 1913, and yet you don’t know what you paid for it? A. Not to the dollar; no, sir.
Q. Within a hundred dollars could you tell us?
A. No, I am not able to tell you.
Q. Could you tell us within a thousand dollars of what you paid for it?
A. I am not able to tell you the price; because I don’t know what it was sold for.
Q. You sold it to the Roper-Reese Lumber Company after you got it?
, A. Yes, sir.
•Q. What was the actual cost price, and what did it bring in 1912 and 1913, from a willing seller to a willing purchaser, for a cash consideration?
A. What is the question?
Q. I want to know how much money you put into it?
A. About $30,000.00.
Q. That was the actual cash?
A. Yes, sir.
Q. That was for the 42,000,000 feet of timber?
A. Yes, sir.
Q. That embraced your notes and cash?
A. Yes, sir.
Q. You turned that over to the Roper-Reese Company — what was the consideration there?
A. Seven dollars per thousand.
Q. How was that paid?
A. That was paid in stock.
Redirect examination:
Q. Mr. Reese, in your cross-examination you testified that for 40,000,000 feet of timber at $7.00, approximately you paid, or arranged to pay, $30,000.00. Was that what you meant to say?
A. No, sir, it was not.
Q. How did you happen to make that statement?
A. I just figured it here in my head. It should have been $294,000.00, instead of $30,000.00.
Cross-examination:
Q. Was that the price you paid for this timber?
A. Yes, sir.
Q. Did you pay for it by check?
A. Part of it by check and part by notes.
Q. Have you those checks?
A. No, sir.
Q. Do you know where they are?
A. No, sir.
Q. At what bank did you keep your money?
A. I kept my money at the West Liberty Bank.
Q. The full $294,000?
A. Yes; and in stock.
Q. You paid cash and notes?
A. Yes, sir.
* ⅞: ⅜ * * * *
Q. The deeds you tools for this property, did they recite the consideration to he paid?
A. Yes, sir.
*******
Q. What was the capital stock of the Roper-Keese Lumber Company?
A. I believe $500,000.00.
A ⅜ ⅞ ⅜ ⅜ * A
Q. They paid you $7.00 a thousand? j
A. Yes, sir.
Q. And that was $294,000.00 worth of stock?
A. Yes, sir.

X). P. McKenzie, who assisted Reese in the purchase of the timber above mentioned, testified to a value of taxpayer’s timber at “ a dollar or two more on the thousand than that was where we were buying." This the taxpayer contends is the equivalent of a value of $8.50 per thousand. McKenzie testified on cross-examination as to the purchases made by Reese as follows:

Q. You know what he was paying per thousand?
A. He bought some by the tree and some per thousand.
Q. When you bought by the tree, what did you pay?
A. For some we paid $1.50 a tree, some $1.00; and some we bought by thé whole boundary.
Q. A* tree that you would pay $1.50 for, how many feet would be in that tree?
A. We would figure that it would average around 400 feet.
* * * * * ‘ * *
Q. How many tracts, and how many thousand feet did you pay $7.00 per thousand?
A. I don’t remember; I was working by the month.
Q. If he said he paid $7.00 for the 42,000,000 feet, what would the stumpage have cost?
A. He never told me what he paid.

With reference to the relative quantity of the more valuable species, Reese testified that the Clearfield lumber was about 60 per cent oak and 20 per cent poplar, and McKenzie testified that the Clearfield lumber was 60 per cent oak.

At the hearing of the appeal subsequent to the taking of depositions, the Commissioner put in evidence certified copies of all of the deeds covering the purchases by Reese and which were subsequently transferred to the Roper-Reese Lumber Co., together with a transcript of that portion of the bankruptcy proceedings setting forth the timber assets of the bankrupt company. From these two series of documents, taken with the admission by Reese that the deeds stated the considerations paid, it is possible in a number of instances to determine with fair accuracy the truth of the testimony, extracts from which are set forth above. It appears, for instance, that in the case of 11 tracts trees were bought as stated by McKenzie. The number of trees in these tracts total 7,069, and the total consideration received is $7,901, and in five of these instances a nominal additional annual rental was required. On the basis of 400 feet per tree, the 7,069 trees above mentioned, at the consideration stated, cost $2.80 per thousand.

So much for the expert testimony offered by the taxpayer. We come now to a consideration of the circumstantial facts which lead up to the conclusion that the Commissioner has not undervalued the taxpayer’s property for purposes of the allowance for depletion, and for1 the computations of gain on sales.

In the first place, as set forth in our findings of fact, the major portion of the taxpayer’s property was acquired for stock, and it appears from the tables set forth in our findings that the timber acquired as a whole in that year shows a cost of $3.60, largely weighted, of course, by the principal tract. This is out of line with the prices paid for smaller tracts at or about the same time. At the time this timber was acquired the railroad from Morehead to Redwine had not been built, the timber was inaccessible, and in many respects the situation was similar to that surrounding the Reese timber between Redwine and Lenox in 1913. The taxpayer acquired its property in 1907. Six years later we find Reese paying between $1 and $2 per thousand for timber described as substantially liké that of the taxpayer, and we find the entire tract which Reese got together, having no railroad transportation to make it as accessible as the taxpayer’s property, sold for $116,300. The taxpayer at that time in 1915 declined to pay more than $110,000-for that large tract. Even at a most conservative estimate of 40,000,000 feet in the Reese tract, the taxpayer at that time regarded timber unaccompanied by railroad facilities as being worth less than $3 per thousand. It is shown by the testimony that the purchaser of this property, after completing the railroad at .a 'total cost of some $65,000 failed. The taxpayer, with ample resources, in a position to extend its own railroad, with an opportunity to buy a substantial ti-act of timber which that extended railroad would make available, and being manifestly the one operator best able to exploit the property, declined to pay somewhat less than $3 per thousand for it.

In considering the taxpayer’s tract as of March 1, 1913, two facts appear, one unfavorable and the other favorable to the taxpayer. To December 31, 1912, the taxpayer cut 56,546,304 feet of timber, of which 35,017,874 was oak and 6,162,425 feet was poplar, these two species being 72.6 per cent of the entire cut. To the end of its operations, the taxpayer cut 120,082,475 feet, of which 61,643,746 feet was oak, and 17,197,726 feet was poplar. In other words, up to March 1, 1913, the taxpayer had cut approximately 57 per cent of its oak, the remaining oak was less than 42 per cent of the total timber remaining, and it had cut approximately 35 per cent of its poplar. Taking the two species together prior to January 1, 1913, the percentage of oak and poplar cut was 72.6, and after January 1, 1913, it was 59.1. Basswood, walnut, and ash, described as being equally valuable with these species, were unimportant. There is no testimony as to the relative value of hemlock, chestnut and beech, the three varieties of greatest importance next to oak and poplar on the taxpayer’s property, and as to all of which there was relatively more cut after January 1, 1913, than before. In view of the fact that practically all the witnesses for the taxpayer place oak and poplar at approximately 80 per cent of the taxpayer’s timber, and testify that these are the most valuable species, it is quite apparent that their estimates are wholly unreliable in the light of the actual facts.

The other fact, favorable to the taxpayer, is the existence on March 1, 1913, of the Morehead & North Fork Railroad, and the influence which it unquestionably had on the value of the taxpayer’s timber. Considerable testimony was introduced by the taxpayer as to the cost of transportation of logs or lumber or staves over the mountains, the inference to be gathered being that the taxpayer’s timber was worth as much more than timber inaccessible by railroad as was represented by the cost of transportation to the railroad. There is no relationship between the two. The conditions surrounding a small stave operation where the finished product is hauled out are quite different from the conditions surroimding a large lumbering operation which could not possibly be carried on at a profit with the primitive facilities ^ of hauling by teams or logging on mountain streams. The true test of the difference in value between timber on and off the railroad is whether adequate transportation facilities can be carried to the inaccessible timber, the cost of such facilities charged against its exploitation, and the product still placed on the market at a profit. It is doubtful if any of the taxpayer’s witnesses, except Gearhart, had the slightest idea of this type of business thinking, and in fact it is evident that Reese’s lack of it was the reason for his failure as an operator of a large-size project.

It appears from Reese’s testimony that the extension of the railroad from Redwine to Lenox cost in all some $65,000. This seems very low, but, as the timber in Reese’s tract was worth less than $3 per thousand, the difference between that value and the value allowed by the Commissioner to the taxpayer here would still represent a differential in excess of $2.35 per thousand to allow for the cost of railroad facilities, which, on 40,000,000 feet, would be $94,000, and on 50,000,000 feet would be $117,500, or nearly twice the stated cost of the railroad from Redwine to Lenox. Under all these circumstances,, we are convinced that the Commissioner has at least not understated the value of the taxpayer’s timber as of March 1, 1913.

We believe that the taxpayer’s witnesses were endeavoring for the most part to be truthful. They were attempting, however, the almost impossible task of placing themselves in 1925 in the mental background of 1913, without accurately refreshing their recollections as-to transactions which took place about 1913, with which they were familiar at that time, and which would have furnished them with art informed judgment of values at that time. A reading of their testimony convinces us that none of the witnesses except Gearhart testified from any but the most general knowledge of conditions over a long period of years, colored necessarily by all the events which have transpired since 1913 to affect their judgment of values as of that date. It is difficult enough for the skillful expert to separate his judgment into periods when supported by detailed records of sales in the area under consideration. Here all the circumstantial facts are utterly at variance with the oral testimony.

It follows from the foregoing that the deficiency determined by the Commissioner in this appeal must be approved in all respects.

The deficiency for the year 1918 is $48,656.07. Ord^er will he entered accordingly.

On reference to the Board, Trammell did not participate.


author: Love:

text:
    Appeal of EMMONS COAL MINING CO.
    Docket No. 4137.
    Submitted November 16, 1925.
    Decided April 19, 1926.

      H. E. Toulhrod for the taxpayer.

      W. F. Gibbs, Esq., for the Commissioner.
    Before Maequette, Moeeis, GreeN, and Love.
    This is an appeal from the determination of a deficiency in income tax for the calendar year 1920, in the amount of $3,649.57. The taxpayer alleges error on the part of the Commissioner in disallowing certain expenditures as ordinary and necessary business expenses.
    FINDINGS OF FACT.
    The taxpayer is a Pennsylvania corporation and engaged in the business of operating coal mines. Affiliated with the taxpayer for the purpose of a consolidated tax return were the Emmons Coal Mining Co. of West Virginia, the Marion Center Coal Mining Co., and the Fallen Timber Coal Co.
    .During the year 1920, the taxpayer and the affiliated corporations expended the following amounts for storage-battery locomotives, mine cars, and a cutting machine:
    Emmons Coal Hilling Co. of West Virginia, storage battery locomotive _$5,412. 00
    Fallen Timber Coal Co., cutting machine_ 3, 500. 00
    Marion Center Coal Mining Co.:
    Storage-battery locomotive- 4, 398.11
    Storage-battery locomotive_ 4, 000. 00
    Mine cars_ 2,125. 00
    A statement of the tonnage produced for the years 1918, 1919, and j.920, by the said companies, as shown upon their books, is as follows:

    The Commissioner refused to allow said expenditures as ordinary and necessary business expenses.
   OPINION.

Love:

The above expenditures were proper charges to capital account and not deductible as ordinary and necessary expenses. Appeal of Winifrede Goal Co., 1 B. T. A. 566; Appeal of Union Collienes Co., 3 B. T. A. 540; Appeal of Kirk Coal Co., 3 B. T. A. 755.

The deficiency is $3,64-9.57 for the calendar year 19W. Order will 5e entered accordingly.


author: Love :

text:
    Appeal of EXCELSIOR LAUNDRY CO.
    Docket No. 158.
    Submitted September 1, 1925.
    Decided April 19, 1926.
    The evidence herein held, insuSicient to establish the rates and basis for depreciation claimed by the taxpayer.

      G. H. Pease, G. P. A., for the taxpayer.

      B. H. Saunders, Esq., for the Commissioner.
    Before Marquette, Moréis, Green, and Love.
    This appeal is from the determination of a deficiency in income and profits tax for the years 1920 and 1921, in the aggregate sum of $5,913.13. The deficiency arose from the action of the Commissioner in increasing the rate of depreciation taken by the taxpayer for the period prior to the taxable years, resulting in a decrease of invested capital for the taxable years in question.
    FINDINGS OF FACT.
    The taxpayer is an Illinois corporation with its principal place of business at Chicago. It was engaged in the business of operating a large laundry and had been so engaged for over thirty years. Its assets consisted of the usual plant and equipment of a large modern laundry, all of which was kept in good repair.

    The principal assets had been acquired a number of years prior to the date of the above inventory, but were carried at cost. Some of the assets, as indicated in the above inventory, were depreciated to some extent on December 31, 1912. The taxpayer identified one certain flat-work ironer, the original cost of which in 1904 was $2,600 and was carried on the said 1912 inventory at $2,340, which ironer was turned in on a new ironer at a valuation of $2,000 after 22 years’ service. One certain collar ironer and a metal washer had a life of 25 years. Certain shirt ironers, after 21 years’ usage, were still in service. Some of the office furniture and fixtures had been in service 30 years and were still in use. The usual life of its Ford trucks was four years,- but four of them were still in use after a four-year usage. One G. M. C. truck purchased in 1916 was still in operation. Some of the wagons and horses had lasted 12 to 15 years. There was no evidence of the life of the remaining assets.
    The taxpayer claims that the 1912 list of values should be accepted as the March 1,1913, value upon which .depreciation should be based, and depreciation taken down to 1920 at the following rates:
    Per cent.
    Laundry machinery and equipment- 6%
    Power equipment- 5
    Furniture and fixtures- 5
    Automobile and delivery equipment- 20
    For the taxable years, the taxpayer claims depreciation at the following rates:
    1920 1921
    Power machinery-14 11
    Laundry machinery_10 9
    Delivery equipment-27 14
    Office equipment-10 10
    The Commissioner allowed depreciation for the taxable years, as well as prior years, as follows:
    Per cent.
    Laundry machinery, including power equipment- 10
    Furniture and fixtures- 10
    Horses, wagons, and harness- 15
    Automobiles_ 25
   OPINION.

Love :

In this appeal the taxpayer seeks a low rate of depreciation for the period prior to the taxable years 1920 and 1921, while for these latter years it claimed in its tax returns a much higher rate. The evidence is insufficient to establish the rates or the basis of depreciation claimed by the taxpayer. Although the taxpayer was able to prove that a few of its machines had a longer life than that attributed to them by the Commissioner, there is a total failure of proof as to the remainder of the machinery and other assets. Furthermore, the testimony is strikingly inconsistent with the rates of depreciation claimed by the taxpayer for the same class of assets in the years 1920 and 1921.

The deficiencies are $<£,559.⅛3 for 19W and $3f351j..30 for 1981. Order will he entered accordingly.