Court Opinion

ID: 4630900
Source: CourtListenerOpinion
Date Created: 2020-11-21 03:08:29.138214+00
Date Added: 2024-06-11T07:57:38.431859
License: Public Domain

THE LOUISVILLE FIRE BRICK WORKS, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Louisville Fire Brick Works, Inc. v. CommissionerDocket No. 100482.United States Board of Tax Appeals43 B.T.A. 178; 1940 BTA LEXIS 839; December 27, 1940, Promulgated *839  Petitioner and another company acquired in 1926 rights of way and constructed a railway track extension thereon to provide transportation facilities to their respective properties.  Thereafter, in 1927, they conveyed all their rights therein to the Chesapeake & Ohio Railway for less than cost.  In 1936 the C. & O. removed the tracks after obtaining from the Interstate Commerce Commission certificate permitting abandonment.  Held, petitioner's original investment was a capital expenditure for a benefit to accrue from the existence of the railway track extension, removal of which in 1936 resulted in a loss to petitioner.  Deduction for the amount of the unrecovered cost is allowed under section 23(f), Revenue Act of 1936.  Frank A. Ropke, Esq., and J. H. McMurtry, Esq., for the petitioner.  Stanley B. Pierson, Esq., and Roy N. McMillan, Esq., for the respondent.  HARRON *178  Respondent determined a deficiency of $2,889.70 in income tax for 1936.  The sole question is whether petitioner sustained a loss in the amount of its unrecovered cost of a railroad track extension which was removed in 1936 by the Chesapeake & Ohio Railway Co., under*840  section 23(f) of the Revenue Act of 1936.  Other adjustments made by respondent are not contested.  FINDINGS OF FACT.  Petitioner is a Kentucky corporation and has its principal office at Louisville, Kentucky.  It is engaged in the manufacture of fire brick.  Petitioner filed its corporation income and excess profits tax return for 1936 with the collector of internal revenue for the district of Kentucky.  In 1926 petitioner and the Ashland Fire Brick Co., hereinafter referred to as Ashland, each owned lands located on Buffalo Creek between Carter and Gesling, Kentucky, in which were clay deposits.  They regarded these clay deposits as "reserve" deposits.  The railroad nearest to these lands was the K. & F. branch of the Chesapeake & Ohio Railway Co., hereinafter referred to as the C. & O., which did not reach to the above lands but extended only as far as Carter.  In order to develop the above lands, petitioner and Ashland considered it necessary to construct a railroad track extension from Carter into the lands containing the clay deposits, i.e., to petitioner's property and over Ashland's property.  Therefore, in June 1926 petitioner and Ashland proposed to the C. & O. that*841  they would acquire rights of way for the extension, *179  whether acquired by contract or by condemnation, and construct at their own expense a 1.8-mile extension of the K. & F. branch line to and over their clay deposit lands and that upon completion they would convey the extension to the C. & O. for $30,000.  In August of 1926 the C. & O. accepted this proposal.  On October 13, 1926, petitioner and Ashland entered into a contract which provided in part as follows: That Ashland would acquire rights of way; that Ashland would construct the extension for a total distance of 10,250 feet; that petitioner and Ashland each were to pay one-half of the construction cost and of the cost of acquiring rights of way for 8,375 feet of the extension; that Ashland was to pay all of the various costs for the remaining 1,875 feet of the extension, which was solely on Ashland's land; and that, on payment of the $30,000 by the C. & O., petitioner was to receive that proportion thereof which one-half of the cost of the 8,375 feet of the extension bore to the total cost of the entire extension.  Construction of the extension was commenced by Ashland in November of 1926 and was completed in July*842  of 1927.  The extension was 1.8 miles long and ran from Carter to Gesling.  In accordance with the above contract petitioner paid $30,126.33 as its proportionate share of the cost.  Upon completion, the track extension and the right of way upon which it was located were deeded to the C. & O. and the C. & O. paid $30,000 therefor.  Petitioner received $10,594.14 as its proportionate share.  On its books petitioner carried the difference between its proportionate share of the total cost of the extension and the proportionate share of the $30,000 paid by the C. & O., or $19,532.19, as an asset or investment.  On its income tax returns for the years 1928 to 1935, inclusive, petitioner took depreciation deduction with respect to its unrecovered cost of the extension in the total amount of $6,836.27.  It did this because, in 1927, when agents of the Bureau of Internal Revenue audited petitioner's books, they allowed depreciation at the rate of 5 percent.  Respondent allowed these depreciation deductions.  In 1936 petitioner's unrecovered cost was $12,695.92.  After the extension was conveyed to it, the C. & O. operated the extension as a part of its system.  The C. & O. established*843  an agency named Gesling at the end of the extension, published rates to and from Gesling, and held itself out as a common carrier to transport any freight which was offered to or from Gesling.  During the operation of the extension by the C. & O. little traffic was carried over the extension.  Since the fire clay deposit lands were "reserve" deposit lands, petitioner never shipped any fire clay over the extension, and subsequent to November 1928 Ashland did not ship any fire clay over the extension.  *180  On September 7, 1933, the C. & O. filed an application with the Interstate Commerce Commission to permit the C. & O. to abandon its K. & F. branch line, which included the extension from Carter to Gesling.  In April of 1934 an examiner for the Interstate Commerce Commission issued a report denying the application.  The C. & O. filed an exception to the report of the examiner in May of 1934.  In August of 1934 the extension was damaged severely by a flood.  Thereafter, the damage to the extension was never repaired by the C. & O. and no further traffic was ever carried over the extension by the C. & O.  On October 1, 1934, the Interstate Commerce Commission issued a*844  certificate permitting the C. & O. to abandon its K. & F. branch line, including the extension from Carter to Gesling.  On petition of certain local interests, not including petitioner, the proceeding was reopened by an order of the Interstate Commerce Commission on December 3, 1934.  On August 5, 1935, the Interstate Commerce Commission issued an order which modified the certificate of October 1, 1934, in part, but allowed the certificate to stand in so far as it permitted the C. & O. to abandon that part of its K. & F. branch line which included the extension from Carter to gesling.  In May of 1936 the C. & O. took up the rails, thereby completely removing the railway extension from Carter to Gesling.  OPINION.  HARRON: Petitioner claims deduction in 1936 in the amount of $12,695.92, the unrecovered cost for income tax purposes of the track extension, as a loss uncompensated for by insurance or otherwise, under section 23(f) of the Revenue Act of 1936.  The facts show that in 1936 all possible benefit to petitioner from the railway extension ended.  The extension had been deeded in its entirety to the C. & O. in 1927, without reverter of the land on which the track was laid. *845  When the track was removed in 1936 nothing remained to benefit petitioner.  Under these facts the question is whether or not petitioner sustained a deductible loss from its original investment in bringing into existence a railway extension reaching to its lands for the purpose of providing it with railway transportation facilities.  Petitioner expended $19,532.19 in excess of the sum it received upon conveyance of the extension to the C. & O.  It claims deduction of $12,695.92, having received tax deductions for depreciation in the sum of $6,836.27 in prior years.  Whether or not petitioner properly took deductions for "depreciation" in prior years with respect to this particular kind of capital expenditure is not a question in this case, and need not be considered.  *181  Respondent disallowed the deduction in 1936 on the ground that the loss, if any, was sustained in 1934.  As will be shown hereafter, this was error.  Petitioner sustained a loss in 1936 for which it is entitled to deduction.  It should be pointed out first that, while petitioner's claim for a loss deduction is sustained, it is not sustained upon the ground that the loss resulted from a "breach of contract" *846  by the C. & O. upon its removal of the track in 1936.  The agreement with the c. & O. consists of letters between the parties confirming oral agreements relating to the construction by petitioner and Ashland and the purchase by C. & O.  The material letters, dated June 30, 1926, and August 12, 1926, which are in evidence, do not state any covenant by C. & O. to maintain service over the railway extension for any period of time, or to refrain from removing the track, or any other matter from which it could possibly be concluded that the C. & O. breached its contract in 1936 or in prior years.  There is no merit to this argument of petitioner.  If there was a "breach of contract" petitioner would be presumed to have a right of recovery to compensate it for loss.  Petitioner expended in 1926 a substantial sum to construct a railway extension, with Ashland, intending to deed it to the C. & O. Railway without retention of any rights in tangible property.  Such expenditures, heretofore considered by this Board and the courts, have been held to be in the nature of capital expenditures.  See *847 ; ; affd., ; ; ; affd., . The expenditure made by petitioner was for the purpose of bringing a railway track to its lands to provide it with more accessible railway transportation facilities.  This was intended to and expected to benefit petitioner in the conduct of its business.  The expenditure was made for a benefit, and as long as the railway extension physically existed in the particular location the benefit to petitioner, actual or potential, existed.  This benefit, tangible or intangible, was an asset to petitioner and the acquisition thereof required a substantial expenditure by petitioner.  On October 1, 1934, the C. & O. obtained permission from the Interstate Commerce Commission to abandon the extension.  The certificate granted a permission.  It was not a mandate to abandon the extension.  The C. & O. could have changed its attitude.  When the C. & O. discontinued*848  service over the railway extension during 1934 and 1935 there remained the possibility that service might be resumed, for as long as the track remained in place service could be resumed.  As long as that situation obtained petitioner did not sustain a loss.  Respondent, *182  accordingly, errs in his contention that the loss, if any was sustained prior to the year 1936.  When the track was removed in 1936 there came to an end both the possibility of resumption of service and all potential benefit to petitioner from the very existence of the railway extension.  If a loss was sustained, it was sustained in 1936.  The ultimate question, whether or not petitioner sustained a loss, under the particular facts, is a question of first impression in this proceeding.  Respondent argues that petitioner can not be said to have sustained a loss because it had no tangible property interests in the railway extension, which was owned by the C. & O.  In , the court considered the question whether, as here, payments made by a coal company to a railroad company in consideration of the railroad's agreement to construct a railway line from the main*849  line to the coal mines could be treated as invested capital for the pusposes of computing income and excess profits taxes, within the provisions of section 326 of the Revenue Act of 1918.  The facts relating to the method of payment of the consideration to the railway company differed from the method of payment here, but otherwise the facts are the same.  Title to the railway extension was in the railway company.  The court held that the expenditure by the coal company constituted invested capital because, among other things, the coal company acquired a valuable right.  The court stated, in part, as follows: * * * Whether the rights acquired as a result of the railroad connection obtained are to be defined as tangible or intangible property, it is not necessary to inquire.  Intangible property, which enables a taxpayer to save or earn money, is as legitimate a form of capital investment as tangible property.  * * * The railroad connection itself is quite tangible, the rights flowing therefrom are intangible; * * * the connection and the rights incident thereto are of great value to the taxpayer, and save it many thousands of dollars annually in marketing its coal.  * * * It is*850  clear that, although the track does not belong to the taxpayer, and the contract does not provide a specific period during which the service over it shall be continued, nevertheless the laying of the track and the railroad connection resulting therefrom established for the taxpayer a relationship with the railroad of mutual advantage and of great and continuing value to the taxpayer.  The court considered, exhaustively, the various arguments against the concept of "invested capital." It concluded that what was acquired by the payments made in consideration for the construction of the railway line to the mines was not "a mere transitory service, nor a mere intangible increase in the value of property." In this case, which comes squarely within the ambit of the court's reasoning in the Gauley Mountain case, petitioner paid out money to obtain intangible rights of benefit to its business.  There can be no *183  question, under the conclusion reached in the above cited case, that its expenditure in 1926 constituted invested capital.  It is not material that petitioner's use of the rights obtained was less than it and the C. & O. anticipated, for it is evident that originally*851  the benefits were expected to extend over an indefinite period of time, looking to the future development of petitioner's lands.  (It appears that Ashland made use immediately of the rights it obtained.) Under such circumstances the removal of the track in 1936 was as much a loss of an asset to petitioner as would be true if one of its physical properties, a plant or equipment, had been destroyed.  The intangible right obtained by petitioner by an expenditure of money was capable of destruction in a real sense, for it could be terminated.  In fact, the relation with the railroad, which had a real value to petitioner and for which petitioner expended capital, was terminated by the removal of the tracks in 1936.  With the termination of the relation petitioner's capital investment was lost.  Undoubtedly, in order to obtain like rail facilities in the future, petitioner would have to make a new expenditure of capital.  In such a situation petitioner should be allowed deduction for a loss.  It is concluded that petitioner sustained a loss in the taxable year in the amount of $12,695.92 under the provisions of section 23(f).  Reviewed by the Board.  Decision will be entered under*852  Rule 50.