Opinion
Docket No. 16420.
1949-05-10
THE COPIFYER LITHOGRAPH CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Norman B. Miller, Esq., for the petitioner. Lawrence R. Bloomenthal, Esq., for the respondent.
For a number of years prior to and during the taxable years in issue, petitioner depreciated its printing equipment on the straight line basis. In 1942 and 1943 petitioner was engaged in the production of maps and other printed material for the armed forces and found it necessary to subject its machinery to greater usage, to employ inexperienced personnel, and to expend additional amounts for repairs, replacements, and the maintenance of its equipment. On the basis of these factors petitioner, in its 1942 and 1943 returns, deducted various amounts representing abnormal or accelerated depreciation. Held, that, where the taxpayer employs the straight line method of depreciation, evidence of increased usage and other unusual operating conditions does not, in the absence of a showing that such factors actually resulted in a shortening of the remaining useful life of the depreciable assets, warrant an allowance for abnormal or accelerated depreciation. Norman B. Miller, Esq., for the petitioner. Lawrence R. Bloomenthal, Esq., for the respondent.
This proceeding involves the following deficiencies:
+--+ ¦¦¦¦ +--+
1942 1943 Income tax $1,000.70 Excess profits tax 7,011.12 $7,625.83
The sole issue involved herein is whether the Commissioner was correct in disallowing deductions in the amounts of $6,755.47 and $9,414.61 claimed by petitioner in 1942 and 1943, respectively, as accelerated or abnormal depreciation on certain items of its plant equipment. Other adjustments made by respondent have been accepted by the petitioner.
FINDINGS OF FACT.
The Copifyer Lithograph Corporation is a corporation, organized and existing under the laws of the State of Ohio, with its principal office located in Cleveland, Ohio. Its income and excess profits tax returns for the calendar years 1942 and 1943 were filed with the collector of internal revenue for the eighteenth district of Ohio.
Petitioner is engaged in the business of photo lithography, in which printing is done by means of plates prepared from a photographic negative which is made by taking a photo of the material to be printed. Color process lithography requires a separate run of the material being printed for each different color. The camera equipment used in this work is known as a ‘photo composer.‘ Metal lithograph plates are first coated with a light-sensitive chemical solution. A negative taken by the photo composing apparatus is then placed over the coated plate and light is passed through the negative. Wherever the light comes through openings in the negative the coating is hardened. Chemical treatments later remove the unexposed coating and the printing is done from the hardened chemical coating which remains. The printing is accomplished on the principle that water and grease repel each other. The ink from one cylinder is deposited on the coating on the lithograph plate on another cylinder, the balance of which is damp and repels the greasy ink. The accuracy of setting certain dampers which put water on the plate within 1/1000 of an inch, together with the accuracy of the tolerances of 3/1000 of an inch in transferring the ink to the paper which is squeezed in the pieces, determines the kind of reproduction obtained.
After 1941 and during the taxable years in question petitioner's largest customer was the Government, 71 per cent of petitioner's output going to the Army Air Forces, Army Map Service, Government Printing Office, Navy, and Coast Guard.
Petitioner claimed in its returns for 1942 and 1943 deductions for depreciation in the amounts of $18,965.11 and $21,518.82, respectively. Of these amounts, $6,755.47 and $9,414.61 represented abnormal depreciation claimed by petitioner in those years.
The items of equipment involved herein and the amounts and rates of accelerated depreciation claimed by petitioner in 1942 and 1943 are as follows:
+----+ ¦¦¦¦¦¦ +----+
1942 Item Normal rate Normal Abnormal depreciation depreciation Abnormal rate Lay-out equipment 10% remaining $59.70 $29.85 5% remaining cost cost. Plate-making 10% remaining 198.50 99.25 5% remaining equipment cost cost. Photo composing 10% original 983.66 None. machine cost Press #1 10% original 1,448.73 724.37 5% original cost cost. Press #2 10% original 489.45 489.45 10% original cost cost. Press #3 10% original 784.72 784.72 10% original cost cost. Press #4 10% original 967.22 967.22 10% original cost cost. Press #5 10% original 795.00 397.50 5% original cost cost. Press #6 10% original 3,253.64 1,626.82 5% original cost cost. Bindery equipment 10% remaining 777.65 777.65 10% original cost cost. Cutting equipment 10% remaining 168.04 168.04 10% original cost cost. Bracket safety 10% original 495.05 495.05 10% original trimmer cost cost. Trucks 20% remaining 391.10 195.55 10% remaining cost cost. 6,755.47
Normal Abnormal depreciation depreciation Abnormal rate Lay-out equipment 10% remaining $50.75 $25.38 5% remaining cost cost. Plate-making 10% remaining 168.73 84.36 5% remaining equipment cost cost. Photo composing 10% original 983.86 491.93 5% original machine cost cost. Press #1 10% original 1,448.73 1,448.73 10% original cost cost. Press #2 10% original 489.45 489.45 10% original cost cost. Press #3 10% original 784.72 784.72 10% original cost cost. Press #4 10% original 967.22 967.22 10% original cost cost. Press #5 10% original 795.00 397.50 5% original cost cost. Press #6 10% original 3,253.64 3,253.64 10% original cost cost. Bindery equipment 10% remaining 646.64 646.64 10% remaining cost cost. Cutting equipment 10% remaining 134.44 134.44 10% remaining cost cost. Bracket safety 10% original 495.05 495.05 10% original trimmer cost cost. Trucks 20% remaining 391.10 195.55 10% remaining cost cost. 9,414.61
1943
Item Normal rate FN* Each of the items listed was assigned an estimated useful life of 10 years, with the exception of the trucks, which were depreciated on the basis of an estimated life of 5 years.
The presses were purchased by petitioner second-hand during the years 1935 to 1938 and were manufactured between 1922 and 1926, with the exception of one press, which was manufactured and purchased new in 1938.
Prior to December 1941 petitioner owned a light truck which it used to deliver commercial work to customers in the city. Because of the bigger volume of paper used in connection with war contracts, petitioner in 1942 obtained another used truck from a junk man, which was repaired and used to shuttle paper between the plant and the warehouse.
Before the war petitioner normally operated its machines on a single 8-hour shift, five days per week. Because of its war contracts, petitioner's plant in 1942 and 1943 was operated at various times on a multiple shift basis of two or three 8-hour shifts or two 11-hour shifts, depending upon available personnel.
The time that the press is actually turning over in printing work is regarded as ‘direct machine hours.‘ Make-up time, the time consumed in cleaning ink from the rollers, and the time between jobs are not counted as direct machine hours.
The direct machine hours worked by the petitioner's machinery from 1939 to 1945 were as follows:
+-------+ ¦¦¦¦¦¦¦¦¦ +-------+
1939 1940 1941 1942 1943 1944 1945 Photo composer 1,070 720 981 1,038 1,411 1,342 1,588 Press #1 328 1,287 2,790 3,707 3,917 3,141 Press #2 1,326 1,869 1,739 4,148 4,319 4,162 4,327 Press #3 1,457 2,394 2,047 3,936 3,869 3,337 3,715 Press #4 1,680 1,776 1,195 3,669 3,987 3,979 2,967 Press #5 2,066 2,372 1,817 2,317 2,352 2,145 2,134 Press #6 1,722 853 1,727 1,973 4,042 3,866 4,005
The term ‘budgeted hours‘ represents a nationwide industry average of productive time available for sale to customers. Budgeted hours are approximately 75 per cent of a normal work week of 40 hours for a single shift. The budgeted hours for each of petitioner's 6 presses in the years 1939 to 1941, inclusive, were 1,560 hours per year, and for the photo composer, 840 hours per year.
There was no direct correlation between the hours of productive work done by the presses and the number of hours other equipment in the petitioner's plant might be used. At most, operation of two shifts in the lay-out, camera, and plate-making departments was necessary for these departments to keep up with the presses.
Necessary repairs and maintenance work were usually accomplished on Saturdays and Sundays, when the machinery was idle, although in the event of a breakdown repairs or adjustments were made as soon as possible.
Any damage to petitioner's presses and other equipment in 1942 and 1943 was repaired. No general remodeling or overhauling of its machinery was undertaken during those years. The amounts expended by petitioner for repairs, replacements, and maintenance for 1937 to 1946, inclusive, for the items of equipment involved herein are as follows:
+----------------------------+ ¦1937¦$953.42¦1942¦$3,944.55 ¦ +----+-------+----+----------¦ ¦1938¦833.35 ¦1943¦5,036.63 ¦ +----+-------+----+----------¦ ¦1939¦694.34 ¦1944¦4,638.21 ¦ +----+-------+----+----------¦ ¦1940¦506.86 ¦1945¦6,726.94 ¦ +----+-------+----+----------¦ ¦1941¦702.97 ¦1946¦4,541.44 ¦ +----------------------------+
None of the presses on which petitioner is claiming abnormal or accelerated depreciation has ever been replaced or scrapped. The Government accepted all of the work produced for it by this equipment during the war years, and at the present time the presses are producing acceptable commercial work for petitioner's regular customers.
About a year and a half after the United States entered World War II, the Army established an essential rating for draft deferment purposes for skilled employees used in producing maps and technical orders for the Air Forces. Petitioner found it difficult to replace 10 of its press helpers who were drafted into the armed services and a number of its press operators who left its employ for other reasons. Prior to 1942 petitioner had a training program of 2 years for a press helper and 4 years for a press journeyman. During 1942 and 1943 it was not always possible to hire experienced employees or to take the time for sufficient training of new employees.
Normally petitioner employed approximately 65 people. During 1942, 263 persons were employed and 242 separated, the turnover in employees being largely due to the fluctuation in demand for maps and booklets ordered by the Government. On three occasions petitioner built up its working force to 200, but that number was not employed steadily throughout the years 1941 to 1945.
The accelerated depreciation claimed by the petitioner was not based upon a physical examination of the presses by an expert mechanic or engineer to determine whether the moving parts of each of the machines were wearing at a faster than normal rate. No uniform rule as to the probable rate of depreciation for each piece of equipment was adopted by petitioner in 1942 and 1943. The amounts of accelerated depreciation claimed were determined by petitioner's general manager upon his appraisal of the unusual operating conditions existing in 1942 and 1943, but no determination was made as to the probable remaining life expectancy of any particular piece of equipment at the end of each year.
OPINION.
ARUNDELL, Judge:
Petitioner contends in this proceeding that it is entitled to the increased deductions claimed in its tax returns for 1942 and 1943 to compensate for abnormal depreciation suffered by various items of its printing equipment in producing maps and other printed material for the armed forces during those years. The deficiencies herein result from the respondent's refusal to allow any additional depreciation for either year.
Petitioner had in prior years depreciated its items of equipment on the straight line basis, assigning to each unit an estimated life of 10 years, with the exception of 2 trucks, which were assigned a 5-year period.
The straight line method of depreciation assumes a uniform annual rate over the life of the asset and, under ordinary circumstances, no adjustments are made to reflect the increased or decreased usage of the asset during any taxable year. This method contemplates the setting aside in each year of a sufficient sum in order that at the end of the useful life of the asset the aggregate of the annual amounts of allowed depreciation, plus its salvage value, will equal its original cost. United States v. Ludey, 274 U.S. 295; Graves, Cox & Co., 27 B.T.A. 546. The straight line method having been uniformly applied by petitioner in prior years, it should not be abandoned for the years in question unless there is a cogent reason for a change. Lake Charles Naval Stores, 25 B.T.A. 173 (petition to review dismissed, C.C.A., 5th Cir.). However, petitioner contends that such factors as the excessive use of its machinery, its operation by inexperienced personnel, the demand of war work which prevented the normal stoppage of the machinery for repairs, and the increased amounts expended for repairs, replacements, and maintenance during the years involved, evidence the fact that the remaining useful life of such equipment was reduced and that petitioner is entitled to claim the additional depreciation involved herein. Essentially, the petitioner argues that the only plausible method of determining the extent of the increased wear and tear on its equipment during 1942 and 1943 was the approximate ratio between the usage in those years and the usage in prior years. The burden of showing the reasonableness of the rates of accelerated depreciation claimed rests upon the petitioner.
Had petitioner previously depreciated its equipment on a ‘unit of production‘ basis, this case would present little difficulty, as petitioner has clearly shown the increased usage of its various items of equipment during the years involved, which is the principal consideration in computing depreciation under that system. However, under the straight line basis, the principal question is whether the useful life of the equipment has been diminished, and usage is merely one factor to be considered in making such a determination. Moreover, we believe that the straight line method contemplates reasonable variations from year to year in the use of depreciable assets, so long as the remaining useful life of the assets is not reduced below or extended beyond the term of years originally selected as its normal useful life.
Therefore, to prevail herein, the petitioner must justify the increased rate of depreciation it claims by showing not only that there were increased usage and other conditions which would normally tend to accelerate the exhaustion of its equipment, but that in fact such factors actually did materially reduce its useful life. Woodside Cotton Mills, 13 B.T.A. 266. In our opinion, petitioner has wholly failed to present satisfactory evidence that the useful life of its printing equipment was so reduced by usage in 1942 and 1943 as to warrant the substitution of accelerated rates in lieu of the normal rates it had previously used in computing depreciation.
Petitioner's general manager testified that when the rates of abnormal or accelerated depreciation were selected it had no way of determining how long its machinery would last and that no effort was made in either 1942 or 1943 to determine the remaining useful life of each of the various items of equipment involved. The only witness produced by petitioner who testified on the subject stated that under normal operation the 6 second-hand presses had an estimated useful life of from 10 to 15 years. As respondent has allowed petitioner to depreciate this equipment at a normal rate of 10 per cent on a straight line basis over a 10-year period, the minimum life estimate, respondent's disallowance of accelerated depreciation does not on its face appear to have been arbitrary or unreasonable. As far as we can ascertain from the record, the machines were never thoroughly examined to determine exactly the extent of actual exhaustion during the years in question, nor is there any specific evidence as to the effect of the use of inexperienced or incompetent help on the normal wear of such equipment. In fact, no evidence of any significance has been presented by petitioner relative to items other than the photo composing machine and the 6 presses.
Petitioner points to the increased amounts expended by it on repairs, replacements, and maintenance as proof of the actual abnormal wear suffered by its machinery during 1942 and 1943. The untoward expenditures for repairs do not necessarily demonstrate the deterioration of equipment, but may, on the contrary, be evidence that such repairs adequately compensated for the increased wear and tear to which the machines were subjected. This may well be the case here, as the record shows that the cost of repairs of the equipment in question rose from $702.97 in 1941 to $3,944.55 in 1942 and $5,036.63 in 1943. Although there is some suggestion that this increase possibly was due to a rise in the cost of parts and labor, there is no evidence as to the extent of increased costs, and certainly there is no basis for assuming that these factors alone were responsible for so marked an increase in the cost of repairs.
In this connection, it is also interesting to note that this equipment was at the time of hearing still being used in the petitioner's business. Although petitioner points out that it has been unable to get delivery of new machinery ordered in 1943, there is no indication that the old equipment does not still produce work of quality acceptable to its customers.
Finally, the various rates of accelerated depreciation selected by petitioner on its different pieces of equipment were not based upon actual examination of the machinery, nor were they computed by any uniform method. The rates appear to have been determined by petitioner's general manager, following discussions with its accountant and the manufacturer's representative, and to be the result of a general appraisal of such factors as the increased usage and repairs, untrained personnel, and the other factors previously mentioned.
Petitioner requests that, if we decide that it is not entitled to the accelerated depreciation claimed, we should determine what amount or rate of accelerated or abnormal depreciation should be allowed for the years 1942 and 1943. In our opinion, the record provides no adequate basis for the computation of rates of depreciation which would be more reasonable than those which were used by petitioner in prior years under the straight line method and have been allowed by respondent for the years involved. Moreover, the computation of depreciation must be an intelligent estimate, not a mere guess. Lake Charles Naval Stores, supra.
After careful consideration of all the evidence herein, we are of the opinion that the petitioner has failed to sustain the burden of showing that it is entitled to the accelerated depreciation claimed by it in its 1942 and 1943 Federal tax returns. Therefore, respondent's determination of the deficiencies herein is sustained.
Decision will be entered for the respondent.