Court Opinion

ID: 4604617
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:34:38.499991+00
Date Added: 2024-06-11T07:53:02.733932
License: Public Domain

CHICAGO AND NORTH WESTERN RAILWAY COMPANY AND CHARLES P. MEGAN, TRUSTEE OF THE PROPERTY OF THE CHICAGO AND NORTH WESTERN RAILWAY COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Chicago & N. W. R. Co. v. CommissionerDocket No. 61703.United States Board of Tax Appeals39 B.T.A. 661; 1939 BTA LEXIS 996; March 30, 1939, Promulgated *996  1.  A railroad which has consistently used the "retirement method" of accounting, in accordance with the regulations of the Interstate Commerce Commission, can not for the taxable years 1927 and 1928 obtain the benefit of deductions for depreciation and obsolescence not accounted for on its books and not taken on its returns, in respect of its docks, elevators, and office building.  Central Railroad Co. of New Jersey,35 B.T.A. 501">35 B.T.A. 501, followed.  2.  A conveyance of land by a railroad to a city for highway purposes, the effect of which is of lasting benefit by way of flood protection, accessibility to city streets, and reduced cost of crossing protection, does not entitle the railroad to a deduction of the March 1, 1913, value of the land conveyed.  Kauai Terminal, Ltd.,36 B.T.A. 893">36 B.T.A. 893, followed.  Nelson Trottman, Esq., for the petitioner.  Edner C. Algire, Esq., and Earl C. Morison, Esq., for the respondent.  STERNHAGEN *661  The Commissioner determined deficiencies of $113,002.69 and $120,181.54 in petitioner's income taxes for 1927 and 1928, respectively.  Petitioner seeks deductions, not taken on its returns, *997  for depreciation on grain elevators and docks, alleging that the method of accounting for retirements on these properties, used by it on its books and income tax returns, did not clearly reflect income.  The Commissioner affirmatively alleges an incorrect depreciation deduction on an office building.  Petitioner also seeks a deduction because of its donation of land to be used as a street.  Other issues were settled by stipulation.  *662  FINDINGS OF FACT.  The Chicago & North Western Railway Co. (herein called petitioner) is a railroad corporation organized under the laws of Illinois, Wisconsin, and Michigan, and is engaged in the business of common carrier for hire, with principal office at Chicago, Illinois.  On June 28, 1935, it filed a petition for reorganization under "Section 77, Chapter 8, of the acts of Congress relating to bankruptcy" (title 11, sec. 205, U.S.C.A.), which was approved by the District Court for the Northern District of Illinois.  On October 3, 1935, the court appointed Charles P. Megan trustee of petitioner's property, conferring upon him the power to prosecute and defend claims and suits by and against petitioner.  Petitioner's system of accounts*998  is in accordance with the accounting regulations of the Interstate Commerce Commission, and its income tax returns are in accordance with its accounts.  It is the parent of an affiliated group of eight corporations, among which is the Superior Coal Co.1.  In 1927 and 1928 petitioner owned five grain elevators, three coal docks, and a building in the business district of Chicago, in which its general offices were located.  Its largest elevator was built at South Chicago, Illinois, in 1915; rebuilt after an explosion which partially wrecked it in 1921, and was leased to the Armour Grain Co., large exporters of grain, until June 1, 1927; thereafter to the Rosenbaum Grain Co. until July 1, 1935, and then to the Cargill Grain Co.  The Cargill Grain Co., by letter dated December 27, 1938, gave notice of the termination, effective June 30, 1939, of the lease.  Petitioner's main lines and terminal are a considerable distance away from this elevator and are connected with it by a separately owned bult line, for the use of which switching charges are imposed.  Petitioner's other elevators were the Rialto Grain Elevator, at Milwaukee, Wisconsin, leased to the Donahue-Stratton Co.; the Updike*999  Grain Elevator, at Council Bluffs, Iowa; the Kinnickinnic Grain Elevator, at Milwaukee, Wisconsin, both leased to the Updike Grain Co., and the Cargill Grain Elevator at Green Bay, Wisconsin, leased to the Cargill Grain Co.  Its three docks, located at Sheboygan and Manitowoc, Wisconsin, and Escanaba, Michigan, respectively, were leased to the C. Reiss Coal Co.  The elevators and docks were constructed of reinforced concrete; they comprised 68 separate structures and 1,510 units of machinery, built or installed at various times from 1874 to 1929.  Petitioner has consistently carried the elevators and docks in account No. 701, "Investment in Road and Equipment," as prescribed by the Interstate Commerce Commission, and it so carried its office building until 1936 when that asset was transferred to account No.  *663  705, "Miscellaneous Physical Property." Petitioner has never set up accounts for exhaustion, wear and tear, and obsolescence in respect of assets carried in accounts Nos. 701 and 705, but has charged to expense all expenditures for repairs, maintenance, renewals, and replacements and for cost of all assets retired, of whatever kind, undiminished by depreciation sustained*1000  in prior accounting periods, and it has claimed and been allowed these amounts as deductions in its income tax returns, including those for 1927 and 1928, and has never sought from the Commissioner of Internal Revenue nor been granted permission to change this method of reporting.  On the same basis it has prepared its annual reports to the Interstate Commerce Commission.  Its practice in this respect, in accordance with section 7 of the Interstate Commerce Commission's "Classification of Investment in Road and Equipment," is to charge to expense an expenditure for repairs or replacements if the expenditure amounts to less than half of the value of the property as restored.  If the amount is half or more of the value of the property as restored, the original cost of the property is credited to the asset account and charged to expense, and the asset account is charged with the amount of the new expenditure plus the appraised value of the retained portions of the old facility.  Expenditures of less than $500 were regularly charged to expense unless a complete unit of property was replaced.  Petitioner's income was reflected clearly and with reasonable consistency by the use of this*1001  method.  Petitioner's books do not disclose what amounts have been charged to expense on account of replacements costing less than half the value of the property renewed, and it can not be determined from the entries of amounts expended whether the repairs and replacements prolonged the asset's useful life.  Charges on account of all retirements, whether made to operating expense, miscellaneous rent income, or profit and loss accounts, were deducted in petitioner's income tax returns for 1927 and 1928, as in other years.  Neither the books nor the returns contained any figure of annual depreciation on any of petitioner's properties.  Among replacement costs charged to expense and claimed as income tax deductions were $951,821.37 and $2,114,778.81 expended in 1921 and 1922, respectively, in rebuilding the Sough Chicago elevator after the explosion.  The Commissioner disallowed the latter amount for 1922, but did allow it for 1921 as a deductible loss sustained in the year when the explosion occurred.  Similarly the estimated or original cost of parts of the Rialto elevator, destroyed by fire in 1933, was deducted for that year.  Petitioner did not enter on its books or deduct on*1002  its tax returns any amount representing depreciation on its office building, which was constructed in 1905 at a cost of $1,344,325.  It charged to expense all expenditures for repairs and replacements as permitted by the regulations *664  of the Interstate Commerce Commission, and these amounts have been deducted on its tax returns and allowed.  After a protest was filed by it, however, the Commissioner allowed a deduction of $26,826.50 on account of depreciation on the building for 1927 and 1928.  2.  By deed dated December 16, 1927, petitioner conveyed, without cash or property consideration, to Sioux City, Iowa, for use as a street, a strip of land, 615 feet long and 83 feet wide, on the bank of the Missouri River, the fair market value of which, on March 1, 1913, was $61,000.  Petitioner reserved all riparian rights, the right to construct railway tracks across the strip if it should become necessary, and a reversionary interest in the strip if the grantee should cease to use it as a street.  The conveyance was made subject to the further condition that the grantee impose no assessment upon petitioner or its property for the original construction and paving of the street. *1003  By virtue of this improvement petitioner's right of way and tracks were protected from the danger of flood; its lands were made more easily accessible to the city's street system, and traffic across its tracks was diminished, with a resulting saving in the cost of crossing protection.  OPINION.  STERNHAGEN: The Commissioner determined the deficiencies in question for 1927 and 1928 by making numerous adjustments in the petitioner's income as shown upon its returns.  These items (except the Sioux City land item) have all been settled to the satisfaction of the parties.  1.  The petitioner, in order to overcome the full effect of the deficiencies thus determined by the Commissioner, complains that deductions should have been taken by it and allowed by the Commissioner for depreciation and obsolescence upon the specific elevators and docks enumerated in the findings, the largest and most important of which is the South Chicago elevator.  No deduction for depreciation has been taken by the petitioner on its returns because as to these properties its general accounting method, applicable to all of its properties, was what in *1004 Central Railroad Co. of New Jersey,35 B.T.A. 501">35 B.T.A. 501, was called the retirement method, fully described in that opinion. The petitioner has made a vigorous attempt to secure a different result in this proceeding from that in the Jersey Central case.  After a trial of 10 days, including the testimony of numerous witnesses and voluminous exhibits, it has submitted a 200-page printed brief, undertaking by an enalysis of the Jersey Central opinion to support a criticism of its soundness, an exposition of its extent and limitations, and a demonstration of its inapplicability in several asserted respects to the case at bar.  These have required and received the most careful *665  study, but have failed to provide any grounds either for modifying the views expressed in that opinion or for distinguishing between that case and this.  Indeed, the decision here should rest categorically upon a reaffirmance of the reasoning in that opinion.  The elaborate and detailed argument which the petitioner has made fails to obscure or overcome the primary considerations, that it has voluntarily elected to adopt and consistently to adhere to the retirement system of accounting*1005  in respect of depreciable assets; that it has omitted to seek and has failed to secure the approval of the Commissioner to change or depart from its system of accounting; that the system thus adopted is reasonably adapted to a fair and clear determination of annual income; and that the proposed exceptional treatment of the particular items in question through the use of annual depreciation allowances for the years in question would be an unwarranted exception resulting in a distortion rather than a clear reflection of income.  This conclusion follows a full study of the evidence and the briefs; but it was also intimated at a very early stage of the trial, in view of the Jersey Central opinion, then already promulgated, in order to forestall what seemed then to be an unnecessary, wasteful, and burdensome proceeding for all concerned.  Petitioner, however, insisted upon proceeding, in order that there might be a complete record in the event an appeal should be taken.  At that time, the Jersey Central proceeding was pending on appeal in the Circuit Court of Appeals for the Third Circuit, and it seemed wiser to the presiding Member to permit the record to be made as full as the*1006  petitioner demanded.  We are, however, in view of our reasoned conclusion as to the law of the case, constrained, as was the Board in the Jersey Central case, to omit, as unnecessary to a proper decision, the detailed findings of facts upon which deductions for depreciation and obsolescence, if allowed, could be computed.  The respondent's brief, with commendable thoroughness, has demonstrated the fallacy of the petitioner's contention, and, since the law has been fully expounded in the Board's opinion in the Jersey Central case, we feel more content to rest upon that opinion than to restate it here or to deal with the petitioner's attempted distinctions, none of which is substantial enough to affect the result.  The petition for review of that decision was dismissed by order of the Circuit Court of Appeals of December 6, 1937, thus making the Board's decision final.  It may be accepted, as petitioner elaborately demonstrates, that the accounting regulations of the Interstate Commerce Commission are not controlling for Federal tax purposes.  But the proposition is beside the point.  The force here given to the petitioner's accounting system is not derived from the fact that*1007 the Interstate Commerce Commission*666  has prescribed the classification of accounts, but is derived from the fact that the petitioner, for whatever reason, has adopted and consistently adhered to the system and that the system has for long been treated by the Commissioner of Internal Revenue as clearly reflecting its income.  We hold, therefore, that as to the petitioner's elevators and docks it has no right, in view of the method of accounting which it has adopted, to any deduction for exhaustion, wear and tear, or obsolescence.  This is true likewise as to its office building in Chicago, and the respondent's affirmative assignment of error in allowing such a deduction in respect of that building is sustained.  $2.  Of several donations made by the petitioner to different cities of lands to be used for streets, only one remains in controversy, the rest having been adjusted by stipulations of the parties.  The question is whether petitioner is entitled, as it claims, to a deduction for $61,000, being the stipulated value on March 1, 1913, of the land which it conveyed to Sioux City in 1927 with the conditions and reversion as shown in the findings.  There is no dispute that, *1008  if entitled to any deduction, the amount thereof is $61,000, but the question is whether the circumstances are a proper foundation for any deduction.  The conveyance resulted in no expansion to the petitioner of its annual income.  It was not the occasion for yielding to the petitioner new traffic.  Its beneficial effect to the petitioner was analogous to that of a capital investment because, as shown by the evidence, it resulted in a permanent protection of the petitioner's nearby property against the dangers of flood, greater accessibility to city streets, and a diminution in the possible cost of crossing protection.  Thus the situation is similar to that considered in Kauai Terminal, Ltd.,36 B.T.A. 893">36 B.T.A. 893, where the taxpayer conveyed a breakwater to the United States for the sake of the general benefit of a better harbor for an indefinite time.  The question here does not involve any consideration of a charitable contribution, for corporations are entitled to no such deductions.  By article 262 of Regulations 74 they are, however, permitted to deduct such contributions as have the characteristics of ordinary and necessary expenses of carrying on a trade or business. *1009  The regulations do not permit the deduction of what are essentially capital investments merely because in some way or another the conveying taxpayer can be said to derive a benefit from the conveyance.  The Commissioner's disallowance of the deduction is therefore sustained.  Decision will be entered under Rule 50.