Source: http://openjurist.org/338/f2d/629/united-states-v-s-and-a-company
Timestamp: 2017-04-29 18:54:29
Document Index: 463987960

Matched Legal Cases: ['§ 167', '§ 453', '§ 167', '§ 1', '§ 1', '§ 1', '§ 167', '§ 167', '§ 1', '§ 1', '§ 13', '§ 1245', '§ 1250', '§ 231', '§ 167', '§ 13']

338 F2d 629 United States v. S & a Company | OpenJurist
338 F. 2d 629 - United States v. S & a Company HomeFederal Reporter, Second Series 338 F.2d.
338 F2d 629 United States v. S & a Company 338 F.2d 629
UNITED STATES of America, Appellant,v.S & A COMPANY, Appellee.
This tax controversy centers on the unanticipated and non-customary good-faith sale, during the taxpayer's fiscal year 1956, of all operating assets used in its business of manufacturing and marketing outboard motors. The sale price was greater than the assets' adjusted basis at the beginning of the tax year and, indeed, was even greater than original cost. The question is whether, on these facts, the taxpayer is entitled to any deduction for depreciation on the sale assets in the sale year. Chief Judge Devitt found that the deduction claimed was a "reasonable allowance", within the meaning of § 167 (a) of the Internal Revenue Code of 1954, unless the sale "in and of itself creates a reason for changing the depreciation allowance". He concluded that it did not.1 218 F.Supp. 677 (D.Minn.1963). Judgment for the taxpayer in the amount of $72,590.76 was entered.
Here, once again, see General Bancshares Corp. v. Commissioner, 326 F.2d 712, 713 (8 Cir. 1964), cert. denied, 85 S.Ct. 62, it may offhand seem surprising that this question arises only now, after the modern federal income tax and depreciation as a specified deduction have been with us continuously for over fifty years. Revenue Act of 1913, § II B and G(b). Nevertheless, the point is one strenuously in contest at the present time. The cases recently decided do not appear to be uniform. The Second Circuit, in opinions simultaneously filed by two separate panels on July 15, 1964, with a different judge vigorously dissenting in each case, has upheld the disallowance of the deduction. Fribourg Nav. Co. v. Commissioner, 335 F.2d 15 (2 Cir. 1964); United States v. Motorlease Corp., 334 F.2d 617 (2 Cir. 1964). To the same effect is Killebrew v. United States, 234 F.Supp. 481 (E.D.Tenn.1964). On the other hand, three district courts, in addition to Judge Devitt here, have approved deductibility and rendered decisions in favor of the taxpayer. Wyoming Builders, Inc. v. United States, 227 F.Supp. 534 (D.Wyo.1964), on appeal to the Tenth Circuit; Kimball Gas Products Co. v. United States, 63-2 USTC, par. 9507 (W.D.Tex.1962), on appeal to the Fifth Circuit; and Motorlease Corp. v. United States, 215 F.Supp. 356 (D.Conn. 1963), which the Second Circuit reversed by its split decision, 334 F.2d 617.
Questions which are not before us. It is well to note what is not in contest here: (1) No question is raised as to the taxpayer's allocation of the sale proceeds among the several assets sold; the propriety of this is accepted. (2) No question is raised as to the taxpayer's right to report its gain on the sale by the installment method; this is assured by § 453 of the 1954 Code. (3) No question is raised as to the taxpayer's use of the straight line method of depreciation; this is permitted by § 167(b)(1) of the Code. And (4) no question is raised as to the amount of the depreciation claimed, that is, as to its reasonableness and propriety, if any depreciation is allowable at all.
Supreme Court cases. United States v. Ludey, 274 U.S. 295, 300-301, 47 S.Ct. 608, 610, 71 L.Ed. 1054 (1927), contains Mr. Justice Brandeis' characterization of depreciation6 as the "reduction" of the asset by wear and tear throughout its useful life in the business; as constituting, in theory, "a gradual sale"; and as requiring a corresponding adjustment downward in original cost, despite the absence of a specific provision to that effect in the then controlling statute.7 Massey Motors, Inc. v. United States, 364 U.S. 92, 93, 107, 80 S.Ct. 1411, 1413, 1419, 4 L.Ed.2d 1592 (1960), refines the Ludey approach with the rule that the reasonable allowance for depreciation of business property "is to be calculated over the estimated useful life of the asset while actually employed by the taxpayer, applying a depreciation base of the cost of the property to the taxpayer less its resale value at the estimated time of disposal", and that "the useful life of the asset be related to the period for which it may reasonably be expected to be employed in the taxpayer's business". Hertz Corp. v. United States, 364 U.S. 122, 80 S.Ct. 1420, 4 L.Ed.2d 1603 (1960), accompanies Massey and upholds the provision of the regulations that "in no event shall an asset * * * be depreciated below a reasonable salvage value". One must mention, also, Detroit Edison Co. v. Commissioner, 319 U.S. 98, 101, 63 S.Ct. 902, 904, 87 L.Ed. 1286 (1943), with its concise statement of the purpose of the depreciation deduction,8 repeated with approval in Massey, p. 104 of 364 U.S., p. 1418 of 80 S.Ct., and Virginian Hotel Corp. v. Helvering, 319 U.S. 523, 525-526, 63 S.Ct. 1260, 87 L.Ed. 1561 (1943), with its emphasis on the continuity of wear and tear and on the year as the unit of taxation.
We emphasize at this point that the automobiles with which Massey was concerned were not retained by those taxpayers for their economic life and had not been acquired with the intent so to retain them for that period. Thus their "salvage value was not junk value but the resale value at the time of disposal"9 and "the experience of the taxpayers clearly indicates a utilization of the asset for a substantially shorter period than its full economic life". Pp. 95-97 of 364 U.S., pp. 1413-1414 of 80 S.Ct. It was in the context of these factual observations that the Court made its references, pp. 97 and 101, pp. 1414, 1416 and 1417 of 80 S.Ct. to salvage value, at the end of full economic life, as being "ordinarily nominal"; to the conversion of amounts "from income taxable at ordinary rates to that taxable at the substantially lower capital gains rates"; to the effect that "Congress intended by the depreciation allowance not to make taxpayers a profit thereby, but merely to protect them from a loss"; and that "Accuracy in accounting requires that correct tabulations, not artificial ones, be used".
This same distinction, as to the timing of the sale, appears to have been made in Kimball Gas Products Co. v. United States, supra, 63-2 USTC, par. 9507 (W.D.Tex.1962), at p. 89127, now on appeal to the Fifth Circuit. Mr. Justice Harlan in his separate dissenting-concurring opinion in Massey observed, p. 113 of 364 U.S., p. 1427 of 80 S.Ct., 5 L.Ed.2d 78, that there "even the Commissioner does not contend that a taxpayer who happens to dispose of some asset before its physical exhaustion must depreciate it on a useful life equal to the time it was actually held". Although this statement appears in dissent, it is factual in nature and we see no reason why it is not to be accepted as true.
Wyoming Builders, Inc. v. United States, supra, 227 F.Supp. 534 (D.Wyo. 1964), now on appeal to the Tenth Circuit, and Motorlease Corp. v. United States, supra, 215 F.Supp. 356 (D.Conn.1963), reversed, as above noted, by the Second Circuit, 334 F.2d 617, are other cases where, with opposition by the government, trial courts have allowed depreciation in the year where the asset was sold at a price greater than adjusted basis at the beginning of the year.
Then came the Second Circuit's decisions in Fribourg and Motorlease, supra. Fribourg concerned a ship sold, after two years of its three year "concededly reasonable" estimated life, at a price made extraordinarily favorable because, as the Court described it, the estimate of economic life and salvage value, originally specifically approved by the Commissioner, "was thrown out of kilter by a scarcity of ships resulting from the Suez Crisis of 1956-57, which sharply inflated the values of ships normally considered obsolete". Motorlease concerned vehicles sold or traded in by an automobile lessor, as a general practice, after one or two years. In Fribourg the majority observed that, "Though perhaps logically inconsistent", its conclusion was "strongly suggested" by Cohn, and that "the increment in [the ship's] value resulted from a fortuity normally associated with capital gain". Killebrew v. United States, supra, 234 F.Supp. 481 (E.D.Tenn.) is a district court decision approving disallowance.
In addition, we note, for what it may be worth, that there is an imposing number of other older cases which reveal situations where depreciation has been computed and allowed during the year of a favorable sale. Among these are the Supreme Court cases of United States v. Ludey, supra, 274 U.S. 295, 47 S.Ct. 608, 71 L.Ed. 1054, reversing 61 Ct.Cl. 126, and Eldorado Coal & Mining Co. v. Mager, 255 U.S. 522, 526, 41 S.Ct. 390, 65 L.Ed. 757 (1921); our own case of Forrester Box Co. v. Commissioner, 123 F.2d 225 (8 Cir. 1941); apparently the Second and Third Circuit cases of Kittredge v. Commissioner, 88 F.2d 632 (2 Cir. 1937); Beckridge Corp. v. Commissioner, 129 F.2d 318 (2 Cir. 1942); and Rieck v. Heiner, 25 F.2d 453, 454 (3 Cir. 1928), cert. denied 277 U.S. 608, 48 S.Ct. 603, 72 L.Ed. 1013; the Court of Claims case of Hall v. United States, 43 F.Supp. 130, 131, 95 Ct.Cl. 539 (1942), cert. denied 316 U.S. 664, 62 S.Ct. 944, 86 L. Ed. 1740; and a number of Board of Tax Appeals cases, Grosvenor Atterbury, 1 B. T. A. 169, 171 (1924); Even Realty Co., 1 B. T. A. 355, 356 (1925); W. W. Carter Co., 1 B. T. A. 849, 850 (1925); Star Sporting Goods Co., 1 B. T. A. 1266 (1925); Keighley Mfg. Co., 2 B. T. A. 10, 11 (1925); Marchetti Roma Cafe Co., 2 B. T. A. 529, 530 (1925); Walter Frank, 2 B. T. A. 905 (1925); Cotton Concentration Co., 4 B. T. A. 121, 123 (1926); Island Line Shipping Co., 4 B. T. A. 1055 (1926); Seton Falls Realty Co., 6 B. T. A. 883, 884 (1927); Parkersburg & Marietta Sand Co., 11 B. T. A. 87, 90 (1928); Louis Kalb, 15 B. T. A. 865 (1929); Max Eichenberg, 16 B. T. A. 1368, 1369 (1929); Franklin Lumber & Power Co., 18 B. T. A. 1207 (1930), affirmed on this issue but modified in another respect, 50 F.2d 1059 (4 Cir. 1931); Herbert Simons, 19 B. T. A. 711, 712 (1930); Clark Thread Co., 28 B. T. A. 1128, 1150-1151, (1933), affirmed 100 F. 2d 257 (3 Cir. 1938); and Thos. Goggan & Bro., 45 B. T. A. 218 (1941). See Duncan-Homer Realty Co., 6 B. T. A. 730 (1927).
We recognize, of course that the Commissioner may change his interpretation of a statute to correct a mistake of law. Automobile Club of Michigan v. Commissioner, 353 U.S. 180, 183-184, 77 S.Ct. 707, 1 L.Ed.2d 746 (1957); Stevens Bros. Foundation, Inc. v. Commissioner, 324 F.2d 633, 641 (8 Cir. 1963), cert. denied 376 U.S. 969, 84 S.Ct. 1135, 12 L.Ed.2d 84. And the Commissioner would detract from the significance, if any, of these cases and rulings by urging (a) that most of them appeared in the 1920's; (b) that none occurred later than 1942 when capital gain rates were made applicable to favorable dispositions of certain business assets; (c) that in every reported case since 1942 the Commissioner has opposed the deduction; (d) that in some of these the taking of depreciation to the date of sale was no more than a "mere recitation"; and (e) that the regulations' examples, while "unfortunate" and an "inadvertency", are not in the section on depreciation and are not intended as an illustration of proper depreciation allowances.
The government's position, as we understand it, is as follows: (a) "[T]here could be no clearer and more compelling basis for a redetermination of useful life than the known fact that the asset has been withdrawn from the business and sold at a time earlier than estimated". Also, "Useful life is not a shifting concept. Either it is defined as the full economic life or as being terminated upon resale. It cannot be both". (b) It is unrealistic and absurd to say that an asset depreciates in the very year when the taxpayer by a sale actually recovers more than its adjusted basis at the beginning of that year. (c) It is even more unrealistic to allow an income tax depreciation deduction when the taxpayer, by the sale plus earlier allowed depreciation, has already recovered its cost. (d) Depreciation is the tax-free recovery of cost permitted to the taxpayer because of the use and consumption of assets producing the business income which is taxed. It is not to be misused so as to effect a conversion with consequent tax benefit, due to the interplay of statutes, of what is ordinary income into capital gain. (e) Here, with a favorable sale in excess of basis, there is no consumption of cost whatsoever during the sale year. Thus, there can be no depreciation. Instead, and in contrast, there is realized appreciation. (f) Salvage value is sale price. (g) In any event, a deduction for depreciation must be reasonable. (h) Reasonableness is to be determined "upon the basis of conditions known to exist at the end of the period for which the return is made". Reg. § 1.167(b)(O) (a). Here the end of the taxpayer's fiscal year was August 31, 1956. By then the sale had been effected and closed and existing conditions revealed its favorable character and substantial gain for the taxpayer. (i) Any claim for depreciation asserted in the sale year when the sale price exceeds adjusted basis at the beginning of the year is unreasonable on its face. (j) The language of Reg. § 1.167 (a)-1(c), which speaks of salvage value as determined at the time of acquisition, which denies a change therein merely because of price level fluctuations, and which acknowledges the possibility of a redetermination of salvage value where there is a redetermination of useful life, "is obviously concerned only with the development of reasonable estimates during the difficult period before actual useful life and salvage value become known". The Commissioner has taken this position formally in a published ruling. Rev.Rule 62-92, 1962-1 C.B. 29.10 (k) Salvage value may be redetermined without a redetermination of useful life. The language of Reg. § 1.167(a)-1(c) is not a contrary restriction. (l) A sale, under the circumstances of this case, automatically redetermines useful life. (m) Price received at an actual sale is not a mere change in price level. Instead, it conclusively effects a change in salvage value and this directly affects the depreciation allowance.
There is, as the Tax Court said in Macabe, supra, "a beguiling appeal" in the government's contention. Judge Devitt seems to agree when he said, p. 679 of 218 F.Supp., "At first blush, it would appear that the taxpayer is attempting to ride with the hares and hold with the hounds, and thus to unjustly enrich itself * * *." And Mr. Justice Harlan, at p. 107 of 364 U.S., 80 S.Ct. 1424, prefaced his opinion of dissent and concurrence in Massey with a reference to "what may be thought to be an appealing practical position on the part of the Government".
2. Cost or other basis, that is, the taxpayer's investment, not sale price, is depreciation's anchor. Both the statute, § 167(f) [§ 167(g), since the Revenue Act of 1962] and Reg. §§ 1.167(a)-1(a), 1.167(f)-1, and 1.167(b)-(O) (a) emphasize cost or other basis. Replacement of that investment by appropriate current charges against business income is the purpose of the depreciation deduction. Detroit Edison, supra, p. 101 of 319 U.S., p. 903 of 63 S.Ct. (footnote 8, supra); Ludey, supra, p. 301 of 274 U.S., p. 610 of 47 S.Ct. (footnote 6, supra); Massey, supra, p. 104 of 364 U.S., 80 S.Ct. 1411.
3. The emphasis is on the taxable year as a unit and depreciation is to be taken in each year of the depreciating asset's useful life. Reg. § 1.167(a)-10(a). "Congress has elected to make the year the unit of taxation. * * * Thus the amount `allowable' must be taken each year. * * * Congress has provided for deductions of annual amounts of depreciation which, along with salvage value, will replace the original investment of the property at the time of its retirement". Virginian Hotel Corp. v. Helvering, supra, pp. 526 and 528 of 319 U.S., pp. 1262 and 1263 of 63 S.Ct. "Finally, it is the primary purpose of depreciation accounting to further the integrity of periodic income statements * * *." Massey, supra, p. 104 of 364 U.S., p. 1418 of 80 S.Ct.; Hertz, supra, p. 126 of 364 U.S., 80 S.Ct. 1420. "[I]t is sound accounting practice annually to accrue * * *" Detroit Edison, supra, p. 101 of 319 U.S., p. 904 of 63 S.Ct.; Ludey, supra, p. 301 of 274 U.S., 47 S.Ct. 608.
5. Straight line depreciation depends upon three factors, cost or other basis, useful life, and salvage value. Cost or basis is known. Useful life and salvage value are estimates and are seemingly independent of each other. Massey, so heavily relied upon by the government here, ends with the comment, p. 107 of 364 U.S., p. 1419 of 80 S.Ct.:
This emphasizes cost, estimated useful life and estimated salvage. The Tax Court in Macabe recognized this when it said, p. ___ of 42 T.C., "The essential concept underlying the depreciation allowance as set forth in section 167 is prediction or estimation." See, also, Burnet v. Niagara Falls Brewing Co., 282 U.S. 648, 655, 51 S.Ct. 262, 75 L.Ed. 594 (1931).
8. Massey and Hertz are not authority to the contrary. They hold merely that useful life in the hands of a taxpayer who has intended to dispose of the asset before the expiration of its entire economic life terminates at the time of his disposition and that depreciation is to be estimated and computed accordingly. This view is validated by the factual observation of Mr. Justice Harlan in his separate dissent-concurrence in Massey, p. 113 of 364 U.S., p. 1427 of 80 S.Ct.:
"[E]ven the Commissioner does not contend that a taxpayer who happens to dispose of some asset before its physical exhaustion must depreciate it on a useful life equal to the time it was actually held. It is only when the asset `may reasonably be expected' to be disposed of prior to the end of its physical life that the taxpayer must base depreciation on the shorter period."
The government pins its case, instead, on the happy fact that the sale price exceeded beginning-of-year basis and it says that depreciation for the final year must therefore be "unreasonable". The favorable sale, however, does not serve to deny the correctness of the taxpayer's cost or the propriety of its useful life estimate or the propriety of its salvage value estimate. It does show that the market at the time of sale turned out to be different than that estimated. The difference may be due entirely to a fluctuating market or to other causes such as general inflation, a buyer's market, or the availability of the asset for more productive alternate uses. 48 Minn.L.Rev. 628, 635 (1964).
15. The government's position seems to emphasize hindsight and to abandon the concept that depreciation rests on prospective estimates which, to be sure, must be reasonable. It would, to use Judge Blumenfeld's words in Motorlease, p. 363 of 215 F.Supp., "set up an automatic hindsight re-evaluation which becomes a self-executing redetermination of salvage value triggered by the sale of depreciable assets".
It has been said, as to this holding, "The court's rejection of the Commissioner's position is supported by both authority and reason." 48 Minn.L.Rev. 628, 632-33 (1964)
With the addition, by the Revenue Act of 1962, Pub.L. 87-834, § 13(a) (1), 76 Stat. 1032, of what is now § 1245 of the 1954 Code, applicable to taxable years beginning after 1962, the issue no longer exists for the type of property here involved. By this specific statute, capital gain treatment is not now available. The statute, however, does not purport to affect directly the depreciation provisions of the Code. See, also, § 1250 of the 1954 Code, added by the Revenue Act of 1964, Pub.L. 88-272, § 231(a), 78 Stat. 100, and applicable to taxable years ending after 1963
Subsection (f) of § 167 has now become subsection (g). This redesignation was effected by the Revenue Act of 1962, § 13 (c) (1), Pub.L. 87-834, 76 Stat. 1034