Opinion
Docket No. 23285.
1951-04-18
H. E. HARMAN COAL CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
George E. H. Goodner, Esq., and Scott P. Crampton, Esq., for the petitioner. George J. LeBlanc, Esq., for the respondent.
George E. H. Goodner, Esq., and Scott P. Crampton, Esq., for the petitioner. George J. LeBlanc, Esq., for the respondent.
1. Petitioner sold its tipple tracks and its delivery tracks to the Norfolk & Western Railway in 1945. Held: The sale of the tracks constituted two separate transactions. Petitioner has not proven that it sustained a deductible loss on the transaction involving its tipple tracks. Taxable gain derived from the sale of its delivery tracks determined.
2. During the years 1944 and 1945, petitioner made certain expenditures for mining machinery and equipment. Held: Certain expenses incurred in order to maintain the normal output of the mine, because of the recession of the working faces, are allowable as ordinary and necessary business expenses. Tipple alterations were capital improvements and respondent is sustained in disallowing deductions therefor as business expenses.
3. Petitioner claimed accelerated depreciation on its equipment during the years 1942-1945, inclusive. This claim was based upon increased usage of the equipment during those years. Respondent disallowed the claim. Held: Petitioner failed to show that increased usage of the equipment actually resulted in a shortening of its economic life, and respondent's action will not be disturbed. Copifyer Lithograph Corporation, 12 T.C. 728; Harry Sherin, 13 T.C. 221, followed.
4. Petitioner, which was on the accrual basis, sought to deduct on its Federal income tax return for 1941 payment made in that year to Commonwealth of Virginia in settlement of a deficiency in state income taxes for 1938 and 1939. The deficiency was determined in 1941 as a result of certain adjustments, similar to those made in 1940, by respondent. The deficiency was not contested. Held: Deduction disallowed. Standard Paving Co., 13 T.C. 425; Oregon Pulp & Paper Co., 47 B.T.A. 772, followed.
5. Petitioner, in 1949, received a refund of a portion of its excess profits tax paid for the year 1940. This refund was made under the provisions of sec. 722, I.R.C., pursuant to an agreement between the parties dated June 8, 1948. As a result of an agreement between the parties executed October 27, 1947, under the same section of the Code, an overassessment in excess profits tax liability for 1941 was determined. Held: The amounts of the refund for 1940 and the overassessment determined for 1941 are not properly includible in petitioner's accumulated earnings and profits for the purpose of computing petitioner's excess profits credit for the years 1944 and 1945 under the invested capital method.
6. Petitioner seeks a deduction for the years here involved for interest which it will be required to pay on the deficiencies determined herein to be due. Held: For deduction purposes interest on contested taxes accrues in year in which liability for such taxes is determined. Interest on taxes contested herein accrues simultaneously herewith and petitioner is not entitled to the deduction sought for any of the years here involved.
This proceeding involves deficiencies in income and excess profits taxes for the calendar years and in amounts, as follows:
+----------------------------------------+ ¦Year ¦Income tax ¦Excess profits tax ¦ +------+------------+--------------------¦ ¦1941 ¦$4,737.57 ¦ ¦ +------+------------+--------------------¦ ¦1942 ¦10,207.85 ¦$12,869.58 ¦ +------+------------+--------------------¦ ¦1943 ¦3,612.19 ¦18,569.66 ¦ +------+------------+--------------------¦ ¦1944 ¦7,613.85 ¦43,794.54 ¦ +------+------------+--------------------¦ ¦1945 ¦14,715.81 ¦74,080.36 ¦ +----------------------------------------+
At the hearing petitioner waived two of the issued raised in its petition and on brief waived another which had been raised by an amendment to its original petition. In an additional amendment to the petition subsequently added, a new issue was raised that was not before us at the time of the hearing. The pleadings as amended now present the following issues for decision:
1. Whether the sale of certain railroad tracks during the year 1945 represents one transaction or two separate transactions?
(a) Whether petitioner realized taxable gain from the sale of its so-called delivery or run-around tracks to the Norfolk & Western Railway Company on May 4, 1945, and the amount thereof?
(b) Whether petitioner sustained a loss, deductible on its income tax return for the year 1945, from the sale of its side tracks to the Norfolk & Western Railway Company on December 27, 1945?
2. Whether expenditures by petitioner for certain mining machinery and equipment during the years 1944 and 1945 represent allowable deductions or capital expenditures?
3. Whether, for the years, 1943, 1944, and 1945, petitioner is entitled to an allowance of any amount as abnormal or accelerated depreciation with respect to certain assets because of an alleged excessive use thereof during such years?
4. Whether petitioner may properly deduct on its income tax return for the year 1941 an amount paid during that year for deficiencies in state income taxes for the years 1938 and 1939, where there has been no controversy with respect thereto?
5. Whether the refund made to petitioner in 1949 of a portion of its 1940 excess profits tax and the overassessment of such tax for 1941 determined in 1947, under the provisions of section 722 of the Internal Revenue Code, are properly includible in petitioner's accumulated earnings and profits as of January 1, 1941 and 1942, respectively, and thereafter for the purpose of computing petitioner's excess profits credit under the invested capital method for the years 1944 and 1945?
6. Whether petitioner is entitled to deductions for the years 1942 to 1945, inclusive, for interest which will accrue on any deficiencies in income and excess profits taxes which may be found by the Court in this proceeding?
FINDINGS OF FACT.
Certain facts have been stipulated and those stipulated are so found and made a part hereof.
The petitioner is a corporation organized in 1934 under the laws of the Commonwealth of Virginia. It is engaged in the business of mining and selling coal, and its principal place of business is at Harman, virginia. The petitioner has, at all times material to this proceeding, kept its books and filed its Federal income and excess profits tax returns on the accrual basis of accounting and by calendar years. These returns were filed with the collector of internal revenue for the district of Virginia.
Petitioner has only one mine which is located in Buchanan County, Virginia, and covers approximately an area of 20 square miles. The two entrances to the mine are above water and the mine trains simply move into the side of the hill at short distances from the tipple. The coal mined is all from the Splash Dam seam and it is segregated by petitioner into the six or seven sizes and grades that petitioner sells. Petitioner's interest in most of this coal land is through leases, but it does own in fee a small tract of land on which its tipple and operation buildings are located. During the years here involved the petitioner employed over 1,000 men.
Petitioner sells all of its coal f.o.b. the mine and it is shipped over the Norfolk and Western Railway (hereinafter sometimes called Norfolk and Western). Petitioner's mine in 1940 had a rated capacity of about 113 railroad cars per day of 50 tons each. The railroad tracks around petitioner's mine are used only to serve the petitioner.
Prior to World War 2 the Norfolk & Western had no uniform policy with respect to the construction and maintenance of side tracks serving mines. In some cases the railroad would provide these facilities and own and maintain them while in others the mine operators were required to do so. During the period of Federal control of the railroads in 1918-1920, the Director General of the railroads established a uniform policy in regard to sidings and their construction. The industry was required to construct and maintain all sidings from the clearance point of the railroad's own tracks. This policy was continued by Norfolk & Western for a number of years until 1945. At this time the Norfolk & Western reconsidered its policy and concluded that it would acquire, maintain and operate the sidings at all coal mines.
When petitioner opened its mine in 1934 it built delivery or run-around tracks from the Norfolk & Western spur to a point beyond its tipple at a cost of $41,641.91. These tracks are to be distinguished from the side or so-called tipple tracks, referred to above. These delivery or run-around tracks are used for the delivery of empty coal cars to the empty car yards above the tipple of a coal mine and for the delivery of loaded cars to the railroad for transportation to the consignees. It had been the ordinary policy of Norfolk & Western to construct, own and maintain them. The reason for the failure of Norfolk & Western to do so in this instance is not disclosed by the record. When the petitioner's ownership of the tract came to the attention of the management of the Norfolk & Western early in 1945, it was decided that such tracks should be purchased by the railroad. Negotiations therefor resulted in its sale by petitioner to the Norfolk & Western for $29,200. This amount was the petitioner's approximate book value as of December 31, 1944, and the amount believed by both parties to be the fair value of the property. The sale was consummated by delivery of a deed on May 4, 1945. The gain realized on the transaction was $1,299.95, which amount is computed as follows:
+-------------------------------+ ¦Cost ¦$41,641.91¦ +--------------------+----------¦ ¦Depreciation allowed¦13,741.86 ¦ +--------------------+----------¦ ¦Book value ¦27,900.05 ¦ +--------------------+----------¦ ¦Sale price ¦29,200.00 ¦ +--------------------+----------¦ ¦Gain on sale ¦1,299.95 ¦ +-------------------------------+
During the year 1934 when petitioner's mines were first opened petitioner constructed the sidetracks, above mentioned, in addition to the delivery tracks involved in the transaction of May 4, 1945. The cost of this construction was $29,434.21. These sidetracks are sometimes called tipple tracks and are used for the storing of empty coal cars delivered by the railroad to the empty car yard above the tipple, the loading of the cars under the tipple and the delivery thereof to the railroad for transportation to customers. As the cars are needed for loading they are moved by gravity from the empty car yard to the tipple where they are loaded and thereafter again moved by gravity into the loaded car yard where they are accumulated until they are moved by a Norfolk & Western locomotive for transportation to the petitioner's consignees. These tracks are absolutely essential to the operation of petitioner's mine and do not have any use other than to serve petitioner's business.
Under its operating agreement with the Norfolk & Western prior to 1945, petitioner was required at a substantial expense to it to maintain all of these railroad tracks. As a result of its previously mentioned change in policy the Norfolk & Western, late in 1945, negotiated the purchase of petitioner's sidetracks for $1, a license for the continued use of such tracks without cost, and the assumption by the railroad of the substantial expense of maintaining them. The sale was consummated on December 27, 1945. Similar sales of tipple tracks for $1 and an agreement for maintenance were also made to the Norfolk & Western by other coal mines about this same time. The book value of the tracks involved in the transaction between the Norfolk & Western and petitioner was $21,637.58, computed as follows:
+---------------------------------+ ¦Cost ¦$29,434.21¦ +----------------------+----------¦ ¦Depreciation allowed ¦7,796.63 ¦ +----------------------+----------¦ ¦Depreciated book value¦21,637.58 ¦ +---------------------------------+
All of the freight on the coal sold by petitioner is paid by its customers. No changes in freight rates were made as a result of the sales of the delivery and tipple tracks. Petitioner received no money or rebates from the Norfolk & Western for coal shipped or for cars operated over the tracks involved. There were no other agreements made between petitioner and the Norfolk & Western except those referred to above, and the railroad did not agree to perform any additional services for petitioner.
Petitioner treated the sale of the delivery tracks and the sale of the tipple tracks as one over-all transaction and claimed a loss of $20,336.63 on its income tax returns for the year 1945.
The sale of petitioner's delivery tracks to the Norfolk & Western Railroad consummated on May 4, 1945, was a transaction separate and apart from the sale of its tipple tracks to the same purchaser on or about December 29, 1945. Petitioner did not sustain any loss, deductible for income and excess profits tax purposes as a result of this latter transaction. The consideration received by petitioner for its transfer of the legal title to such tracks was at least equal to petitioner's adjusted basis therefor.
Petitioner's mine was opened late in 1934 and by 1936 it was working in about four or five sections of the mine. During 1944 petitioner was working in from 12 to 15 sections of the mine and in 1945 had increased the number of sections being mined to about 17. These sections were widely scattered over an area of about 20 square miles. As the mine was thus expanded and new sections were opened there was a change in the nature of the coal seam. In one area which petitioner opened in 1944 the seam was less than 40 inches in height. In other areas which were being worked during the years under review, the petitioner was encountering very bad working conditions. There was a bad ‘parting‘ of the seam, i.e., it contained a layer of rock or other foreign matter. In some places there were two or three other small such partings. There was in the coal mine slate and refuse generally which had to be removed at the tipple. The existence of this natural condition in addition to the longer hauls, being encountered by petitioner, led to a reduction in the annual tonnage being produced since 1934 with a corresponding increase in the cost of production.
Because of the shortage of the manpower due to the war situation, the need for equipment suitable for the mining of the thin-seam coal, first encountered in 1944, and the radical change in the natural condition of the coal seam in sections of the mine in which operations were then being conducted, the petitioner in 1944 and 1945 had need of certain additional mining machinery and equipment. To meet this need petitioner purchased the following equipment:
+-------------------------------------------------------------+ ¦Purchased in 1944 ¦ ¦ +--------------------------------------------------+----------¦ ¦2 Goodman shaker conveyors ¦$10,899.30¦ +--------------------------------------------------+----------¦ ¦3 Joy loaders ¦24,987.32 ¦ +--------------------------------------------------+----------¦ ¦Payments on slate chute in process of construction¦6,634.92 ¦ +--------------------------------------------------+----------¦ ¦Total ¦42,521.54 ¦ +-------------------------------------------------------------+
Purchased in 1945 Balance of cost of slate chute completed 13,823.98 8 Goodman short-wall cutting machines 23,294.45 10 Conveyors 15,490.08 1 Slabbing machine or arc-wall cutting machine 7,139.00 50 mine cars 17,101.06 2 electric mine jeeps 2,040.00 Total 78,888.57
The expenditures for the equipment listed above were charged to expense and deduction therefor was claimed on petitioner's income and excess profits tax returns for the years 1944 and 1945. The deductions so claimed have been disallowed by respondent. Instead respondent has treated such expenditures as capital expenditures and allowed depreciation thereon as follows:
+------------------------------------------------------------------+ ¦ ¦1944 ¦1945 ¦ +-------------------------------------------------+-------+--------¦ ¦Mine cars ¦ ¦$855.05 ¦ +-------------------------------------------------+-------+--------¦ ¦State bin or chute ¦ ¦2,045.89¦ +-------------------------------------------------+-------+--------¦ ¦Mining machines (conveyors, duckbills and cutting¦ ¦ ¦ +-------------------------------------------------+-------+--------¦ ¦machines) ¦$544.96¦2,611.60¦ +-------------------------------------------------+-------+--------¦ ¦Joy loading machines ¦ ¦1,665.82¦ +-------------------------------------------------+-------+--------¦ ¦Mine jeeps ¦ ¦102.00 ¦ +-------------------------------------------------+-------+--------¦ ¦Totals ¦544.96 ¦7,280.36¦ +------------------------------------------------------------------+
The conveyors were used in conjunction with the shortwall cutting machines by petitioner to mine a thin-seam of coal— less than 39 inches high— which seam was first encountered in 1944 in a large area then being developed. Petitioner's regularly used equipment could not be utilized in seams less than 40 inches high, and petitioner's leases required that all mineable and merchantable coal be mined.
The Joy loaders were purchased because of a shortage of manpower and because of the increased number of widely separated sections being worked which made additional equipment necessary in order to avoid the uneconomic delay which would result from the moving of the equipment back and forth between working places a mile or so apart. Petitioner's actual experience with like Joy loaders purchased by it in 1939 and 1941 proved that the use thereof resulted in substantial savings in the production cost of units of coal produced with the aid of those machines as compared with hand loaded coal. The slabber machine, or arc-wall cutting machine, is used in conjunction with two Joy loading machines, and the machine purchased in 1945 was an additional machine needed because of the expansion of the mine.
The conveyors, shortwall cutting machines, Joy loaders and arc-wall cutting machines, are in the active mining area at all times. They are used in close proximity to the working place in the mine, and are in use continuously. The cutting machines are used in the process of preparing the coal for the blasting operation. After the coal is shot down, the conveyors in the low seam area carry it out of the rooms to be loaded into mine cars for transportation to the tipple. The Joy loaders load the coal directly into the mine cars. As the working face recedes, the cutting machines and loaders are moved with it. When a section is completely worked out, the machines are moved to a new section which has been previously prepared, but which may be some distance away. As the sections being worked spread out, more machinery, more locomotives, more cars, more of other equipment are needed. In so far as the cutting and loading machines (including conveyors) are concerned, it makes no difference how far the tipple is located from the working place in the mine. The distance between two working sections is determinative of the number of cutting and loading machines needed.
Construction of the slate-bin, or slate-chute, was started in 1944 and was completed in 1945. It is part of the tipple, and it enables petitioner to bring the slate and other mine refuse out of the mine with the regular coal trains, thereby eliminating the need for the storing thereof in mine cars, and makes such cars immediately available for the hauling of more slate or for more productive use. When a car of slate or other mine refuse is brought to the tipple, a lever is thrown which causes a chute to fold back and into which such slate is dumped. Such slate chute or bin has a capacity of 25 or 30 tons and is a part of the slate disposal plant, which was completed in 1944 at a total cost of $46,783.72. The slate is taken from the chute, crushed to a fine size so that it can be put onto a rubber belt, without damaging the belt, and carried to a hopper where a bucket line picks it up, carries it over the mountain, and dumps it. Such method of disposing of the slate and other mine refuse was adopted to expedite the handling thereof, and as a means of more efficient operation. It was made necessary because the natural condition of the seam was changing from year to year, and because of Federal requirements. Working conditions were getting very bad and there was a bad parting or layer of foreign matter in the seam (sometimes two or three such layers) which did not appear when petitioner went into the seam in 1935. There were more slate and more refuse in the coal which had to be taken out at the tipple. This fact is one of the reasons for the decline in petitioner's production since 1944.
The mine jeeps acquired by petitioner in 1945 ran on the tracks in the mine and were powered by electricity taken by trolley from the regular electric lines in the mines. These jeeps were used by petitioner's supervisory employees for the purpose of getting to the widely separated sections being worked without the delay of waiting for the regular coal trains to go to a particular location.
The mine cars purchased in 1945 were needed because of extended hauls, the necessity for removing a greater amount of slate and other mine refuse caused by a change in the natural character of the seam being mined, as well as by the Federal regulations with respect to slate removal, and the requirement of additional cars to serve each of the working places being worked in widely separate areas of the mine. The latter condition caused not only a need for additional mine cars, but for additional locomotives, additional mining machines and other equipment necessary to the operation of the mine.
The conveyors which were purchased in 1945 were needed to operate with the shortwall cutting machines and were used in the same low vein of coal. It was practically impossible to employ miners to do hand work in a seam as thin as that encountered by petitioner in this area, and petitioner was required by its leases to mine all the mineable and merchantable coal. The slabber machine purchased in 1945 was another arc-wall cutting machine needed because of the expansion of the mine.
Petitioner's mine prior to 1944 was developed to its full capacity. All of the above-mentioned mine equipment purchased by petitioner was needed in an attempt to maintain production as the mine spread out and the working faces in the mine receded. None of this equipment replaced other machinery, nor added to the value of the mine. Despite petitioner's best efforts, its production has decreased every year since 1944 and its over-all cost of production per ton has increased every year since 1944.
For the years 1935 through 1946, petitioner's total production and costs of production per ton were respectively as follows:
+----------------------------------+ ¦Year ¦Tons mined ¦Cost per ton ¦ +------+------------+--------------¦ ¦1935 ¦363,571 ¦$1.64 ¦ +------+------------+--------------¦ ¦1936 ¦818,142 ¦1.53 ¦ +------+------------+--------------¦ ¦1937 ¦1,077,780 ¦1.69 ¦ +------+------------+--------------¦ ¦1938 ¦891,195 ¦1.69 ¦ +------+------------+--------------¦ ¦1939 ¦1,133,094 ¦1.67 ¦ +------+------------+--------------¦ ¦1940 ¦1,121,806 ¦1.68 ¦ +------+------------+--------------¦ ¦1941 ¦1,335,975 ¦1.97 ¦ +------+------------+--------------¦ ¦1942 ¦1,470,663 ¦2.22 ¦ +------+------------+--------------¦ ¦1943 ¦1,670,986 ¦2.56 ¦ +------+------------+--------------¦ ¦1944 ¦1,893,457 ¦2.89 ¦ +------+------------+--------------¦ ¦1945 ¦1,658,280 ¦2.94 ¦ +------+------------+--------------¦ ¦1946 ¦1,369,756 ¦3.39 ¦ +----------------------------------+
Concurrently with the purchasing of the mining equipment referred to above, which petitioner treated as expenses petitioner installed at its tipple a separate slate disposal plant and a cleaning plant at a total cost of about $300,000 and capitalized all of this equipment.
Petitioner's operations have normally been on the basis of two shifts of 7 hours each per day since the opening of the mine. Operations center, to a large extent, on its one tipple since all of its coal goes over the tipple. When the tipple is running practically all of the other mining equipment is being used. Petitioner contends that it had reached a normal level of operations in 1939 and 1940 when the tipple was operated an average of 2,750 hours (about 200 days each year). The number of hours such tipple was operated during the years here under consideration, and the approximate percentage thereof in excess of the 2,750 hours operated in 1939-40, were as follows:
+----------------------------+ ¦ ¦Hours ¦Per cent ¦ +------+----------+----------¦ ¦Year ¦operated ¦increase ¦ +------+----------+----------¦ ¦ ¦ ¦ ¦ +------+----------+----------¦ ¦1941 ¦3,173 ¦14 ¦ +------+----------+----------¦ ¦1942 ¦3,658 ¦33 ¦ +------+----------+----------¦ ¦1943 ¦4,149 ¦50 ¦ +------+----------+----------¦ ¦1944 ¦5,187 ¦90 ¦ +------+----------+----------¦ ¦1945 ¦5,191 ¦90 ¦ +----------------------------+
Petitioner does not claim its normal depreciation on the basis of hours of production but claims such depreciation on the straight line basis over the estimated useful life of each separate class of assets in terms of years. In addition to the depreciation claimed by petitioner at the normal rates previously established, the petitioner claimed on its income tax returns for the years 1942, 1943, 1944, and 1945 additional depreciation of 100 per cent of such normal depreciation as to certain assets, solely by reason of the fact the hours operated in those years were in excess of 2,750, the average number of hours of tipple operation in 1939 and 1940. At the hearing, the petitioner amended its position to claim additional depreciation in the percentages shown below in lieu of the amounts claimed on its returns:
+--------------------+ ¦ ¦Additional ¦ +----+---------------¦ ¦ ¦depreciation ¦ +----+---------------¦ ¦1942¦33% ¦ +----+---------------¦ ¦1943¦50% ¦ +----+---------------¦ ¦1944¦90% ¦ +----+---------------¦ ¦1945¦90% ¦ +--------------------+
Petitioner has made no claim for additional depreciation in 1941. The items of equipment on which the additional depreciation is claimed in the years 1942, 1943, 1944, and 1945 are those directly used in the production of coal and are described generally as follows:
+-------------------------------------------+ ¦Mine cars ¦Generator sets ¦ +--------------------+----------------------¦ ¦Tipple ¦Pumps ¦ +--------------------+----------------------¦ ¦Mining machines ¦Coal crusher ¦ +--------------------+----------------------¦ ¦Heavy steel rails ¦Joy loading machines ¦ +--------------------+----------------------¦ ¦Motors (locomotives)¦Coal washing equipment¦ +--------------------+----------------------¦ ¦Shop equipment ¦New cleaning plant ¦ +--------------------+----------------------¦ ¦Trolley lines ¦Slate disposal plant ¦ +-------------------------------------------+
The petitioner is not entitled to deductions for any amounts of depreciation in excess of that computed at the rate normally allowable, and allowed by respondent, on selected classes of assets for the years 1942 through 1945. Petitioner has failed to show that any additional usage during these years has in fact resulted in a shortening of the remaining useful life of such assets.
The Federal income tax returns filed by petitioner for 1938 and 1939 were audited by respondent, and in both years he made plus and minus adjustments and determined an increase in net income. The items adjusted by respondent concerned the following subjects:
+-------------------------------------------+ ¦Workmen's compensation¦Insurance ¦ +----------------------+--------------------¦ ¦Depreciation ¦Death benefit awards¦ +----------------------+--------------------¦ ¦Capital stock taxes ¦Interest ¦ +----------------------+--------------------¦ ¦Depletion ¦ ¦ +-------------------------------------------+
As a result of these adjustments respondent asserted deficiencies for those years totaling $2,463.20, and without further discussion on the matter petitioner paid the amount.
In 1941 the Commonwealth of Virginia wrote to petitioner calling attention to the adjustments made in its 1938 and 1939 Federal income tax returns and suggesting that additional income taxes were due Virginia for those years in the total amount of $248.38. In July 1941, petitioner, without discussion of the matter, paid the Commonwealth of Virginia the additional taxes claimed. In reporting its net income for 1941 petitioner deducted this amount as taxes paid and respondent has disallowed the deduction. It was the practice of petitioner to adjust minor items of this nature in the year in which they were settled.
Petitioner's opening balance sheet as of January 1, 1941, was as follows:
+------------------------------------+ ¦Assets ¦ ¦ +-----------------------+------------¦ ¦ ¦ ¦ +-----------------------+------------¦ ¦Cash ¦$10,990.06 ¦ +-----------------------+------------¦ ¦Accounts receivable ¦149,296.25 ¦ +-----------------------+------------¦ ¦Inventories ¦55,469.39 ¦ +-----------------------+------------¦ ¦Investments ¦128,352.15 ¦ +-----------------------+------------¦ ¦Compensation trust fund¦55,704.11 ¦ +-----------------------+------------¦ ¦Depreciable assets ¦648,003.48 ¦ +-----------------------+------------¦ ¦Land ¦14,945.28 ¦ +-----------------------+------------¦ ¦Prepaid insurance ¦2,008.26 ¦ +-----------------------+------------¦ ¦Development ¦3,628.36 ¦ +-----------------------+------------¦ ¦Total ¦1,068,397.34¦ +-----------------------+------------¦ ¦ ¦ ¦ +------------------------------------+
Liabilities and Net Worth Accounts payable $120,931.88 Notes payable 95,304.02 1940 Federal income tax 24,455.02 1940 Federal excess profits tax 5,403.83 Reserve for percentage depletion 178,163.19 Reserve for depreciation 215,026.65 Capital stock 250,000.00 Surplus 179,112.75 Total 1,068,397.34
Petitioner filed an excess profits tax return for the year 1940 upon which was disclosed liability for excess profits tax in the amount of $5,558.98. Subsequently respondent determined an overassessment of $155.15 for such liability and that amount was refunded in 1947. In the meantime, on September 9, 1943, petitioner filed applications for relief under the provisions of section 722 of the Internal Revenue Code for the taxable years 1940 and 1941. The application pertaining to the year 1940 was amended on August 26, 1946. Thereafter petitioner and respondent reached an agreement that petitioner was entitled to the requested relief in part and on the amount thereof. By reason of this determination, petitioner became entitled to a refund of the net amount of excess profits tax it had paid for the year 1940, $5,403.83. Petitioner accepted this determination on June 8, 1948, and the overassessment was scheduled on or about February 25, 1949. On October 27, 1947, petitioner and respondent reached agreement concerning the partial allowability of the application under section 722 as it applied to the tax year 1941. The agreement also extended to the amount of the constructive average base period net income to be used in the computation of petitioner's excess profits credit for the latter year.
As a result of the agreement of October 27, 1947, respondent determined that petitioner overpaid its excess profits tax liability for 1941 by the amount of $13,256.61. The overassessment thus determined is attributable to the partial allowance of petitioner's application under section 722 as stated above. Respondent has determined deficiencies to be due from petitioner in income and excess profits taxes for the years in the respective amounts as follows:
+----------------------------------------+ ¦Year ¦Income tax ¦Excess profits tax ¦ +------+------------+--------------------¦ ¦1941 ¦$4,737.57 ¦ ¦ +------+------------+--------------------¦ ¦1942 ¦10,207.85 ¦$12,869.58 ¦ +------+------------+--------------------¦ ¦1943 ¦3,612.19 ¦18,569.66 ¦ +------+------------+--------------------¦ ¦1944 ¦7,613.85 ¦43,794.54 ¦ +------+------------+--------------------¦ ¦1945 ¦14,715.81 ¦74,080.36 ¦ +----------------------------------------+
No part of these proposed deficiencies was paid by petitioner during the years here involved and no refund has been made of the overassessment in excess profits taxes determined by respondent for 1941.
In determining petitioner's accumulated earnings and profits as of the beginning of the years 1944 and 1945, respondent reduced such earnings and profits by the deficiencies otherwise determined for 1943 and 1944, less the overpayment of $13,256.61 referred to above. Respondent now alleges this to have been in error, and that the amount of $13,256.61 should not have been included in petitioner's accrued earnings and profits at the beginning of the years 1944 and 1945. Petitioner's earnings and profits have not been adjusted in any of the years to allow for the overpayment of $5,403.83 relating to 1940.
Respondent has not allowed petitioner an additional deduction for interest on such deficiencies during the years following their accrual by him.
OPINION.
VAN FOSSAN, Judge:
There are six issues to be decided in this controversy. The first issue centers around the sale by petitioner of certain railroad tracks to the Norfolk & Western Railroad during the year 1945. It involves the determination of whether petitioner, in fact, realized taxable gain from the sale of its so-called delivery of run-around tracks to the Norfolk & Western on May 4, 1945, and, if any, the amount thereof, and whether petitioner sustained a deductible loss on the sale of its so-called tipple or sidetracks to the same purchaser on December 27, 1945.
The testimony herein indicates that there were two separate transaction between petitioner and the Norfolk & Western during the year 1945. These transactions resulted in the sale of all of petitioner's railroad tracks. The respective sales were negotiated at different times and for different reasons. The negotiations for the acquisition of the delivery tracks were instituted because it had been at all times the policy of the Norfolk & Western to construct, own, and maintain such tracks. The reason this policy had not been followed in petitioner's case is not shown in the record. However, when the fact that such tracks were owned by petitioner came to the attention of Norfolk & Western's management, it was decided that an effort should be made to purchase them. Accordingly, negotiations were instituted that culminated in the sale of petitioner's delivery tracks to the Norfolk & Western for a consideration of $29,200. This amount was believed by both parties to represent the fair value thereof and was the approximate book value of the tracks as of January 1, 1945. This latter date was shortly before the beginning of negotiations between the parties. Both petitioner and respondent now assert on brief that the gain realized from the transaction was in the amount of $1,299.95. The record supports such assertion, and we so hold.
The acquisition by the railroad of the tipple tracks was for an entirely different reason. At about the same time as the Norfolk & Western purchased petitioner's tipple tracks, it also purchased the tipple tracks of other coal mines in the vicinity of petitioner's mine. These other purchases were made for the same consideration and for the same reason. The record discloses that prior to World War I, the Norfolk & Western had no uniform policy with respect to the ownership and maintenance of the tipple tracks at mines served by it. In some cases the railroad owned and maintained such tracks while in others the mine owners were required to do so. Between 1918 and 1920, the period during which railroads were under control of the Federal authorities, it was the policy to require that such tipple tracks be constructed and maintained by the mine operators. The Norfolk & Western followed such a policy after Federal controls were ended and continued to do so until the middle of 1945. Because of inadequate maintenance there had been many accidents causing damage of the railroad's equipment and injury to its personnel. Accordingly, the railroad decided that the tipple tracks should be in all cases owned and maintained by it. Negotiations were thereupon commenced for the acquisition of such tracks. These negotiations included and resulted in the sale of petitioner's tipple tracks to the Norfolk & Western for the consideration of $1 plus a license to use such tracks and an agreement relieving it of the expense of maintaining the tracks. Petitioner maintains that it sustained a loss on the transaction and that it is entitled, under section 23(f) of the Internal Revenue Code,
to deduct the amount by which the adjusted basis of the property sold exceeded the cash value received. In support of this contention petitioner cites Standard Envelope Mfg. Co., 15 T.C. 41, as a parallel case and urges that under the rationale of that case the deduction sought should be allowed.
SEC. 23. DEDUCTIONS FROM GROSS INCOME(f) LOSSES BY CORPORATIONS.— In the case of a corporation, losses sustained during the taxable year and not compensated for by insurance or otherwise.
The case cited has but a superficial resemblance to the case before us. In that case the consideration for property sold, in addition to a lease back agreement was an amount which the testimony of expert witnesses showed to be close to its fair appraisal value. On the other hand, the consideration received by petitioner on the sale of its tipple tracks to the Norfolk & Western was $1, plus a license to use them and an agreement relieving it of the expense of maintaining them. One could not seriously assert that $1 represented a fair appraisal of the value of tracks or was the full extent of the value received by petitioner. Absent compulsion, a reasonably prudent business man would not be expected to sell property for less than its cash value unless other considerations equal to or exceeding the value of the property sold were also to be received. The record does not indicate the existence of such compulsion. Rather, it shows that the cost of maintaining these tracks was substantial and, from petitioner's position, that relief therefrom was a primary consideration in their sale. Certainly, there is some value to be placed upon the agreement relieving petitioner of this burden. Moreover, the license granted petitioner enabling it to use the tracks without cost is also of some value. Petitioner could not operate its mine unless it had access to these tracks.
Consideration of the substance of the transaction here in question discloses petitioner's beneficial use of the tipple tracks was substantially the same after sale as it was before. The agreement of Norfolk & Western to permit the use of such tracks to petitioner without the burden of maintaining them, if any, resulted in an improvement of petitioner's economic position. Actually, the sole effect of the transaction was the transfer of legal title to personal property which had no use other than to serve petitioner's mine. Petitioner has failed to show that its economic position has been in any way adversely affected as a result of this transaction. The record does not contain information which will enable us to place any evaluation upon the agreement of Norfolk & Western to maintain the tracks. Therefore, petitioner has not shown that the consideration received by it for the transfer of legal title to the tracks was less than its adjusted basis, and that any loss was actually sustained by it. In the absence of such a showing, petitioner must fail as to this issue. Accordingly, we hold that the respondent did not err in his determination that petitioner did not sustain a deductible loss in the above transaction.
The next question is whether the petitioner may deduct from gross income as ordinary and necessary expenses the cost of certain equipment purchased by it during 1944 and 1945. The facts show that this equipment, which included conveyors, loaders, mining machinery, mine cars, and electric mine jeeps, was acquired by petitioner in an attempt to maintain its production as the working faces in its mine receded.
Since the opening of petitioner's mine in 1934, the number of working faces or places of operation had gradually increased until by 1944 and 1945 they were widely separate and scattered throughout an area approximately twenty square miles. The length of the average haul had increased substantially. The recession of the working faces had brought petitioner to an area where the coal seam was thinner and had layers of foreign matter in it. The mine had previously been developed to its full productive capacity, and petitioner, in an effort to maintain that capacity, acquired the mine equipment set out above. This equipment included a new type machine to mine the thin coal, as well as duplications of machinery already owned, in order to make it available at the increasing number of working faces. These expenditures were deducted from gross income by petitioner as expenses incurred in operating the mine. Respondent has disallowed such expenditures as deductions on the ground that they constituted capital investments.
Ordinarily, the development expenditures in the case of mines are divided into two classes: (a) Those expenditures made during the development stage in excess of net receipts from minerals sold, and (b) expenditures for plant equipment and for replacements not including expenditures for maintenance and ordinary and necessary repairs. Both types are capitalized and recovered through depreciation. See Regulations 111, section 29.23(m)-15(a) and (b).
Regulations 111, Sec. 29.23(m)-15. ALLOWABLE CAPITAL ADDITIONS INCASE OF MINES.— (a) All expenditures in excess of net receipts from minerals sold shall be charged to capital account recoverable through depletion while the mine is in the development stage. The mine will be considered to have passed from a development to a producing status when the major portion of the mineral production is obtained from workings other than those opened for the purpose of development, or when the principal activity of the mine becomes the production of developed ore rather than the development of additional ores for mining.(b) Expenditures for plant and equipment and for replacements, not including expenditures for maintenance and for ordinary and necessary repairs, shall ordinarily be charged to capital account recoverable through depreciation. Expenditures for equipment (including its installation and housing) and for replacements thereof, which are necessary to maintain the normal output solely because of the recession of the working faces of the mine, and which (1) do not increase the value of the mine, or (2) do not decrease the cost of production of mineral units, or (3) do not represent an amount expended in restoring property or in making good the exhaustion thereof for which an allowance is or has been made, shall be deducted as ordinary and necessary business expenses.
However, it often becomes necessary to make expenditures for equipment t at would ordinarily be considered a capital asset, in order to maintain the normal output of the mine, solely because of the recession of the working faces of the mine. If such expenditures do not increase the value of the mine, if they do not decrease the cost of producing mineral units, or if they do not represent an amount expended in restoring property or making good the exhaustion thereof for which an allowance has been made, it has been held that such items are deductible as ordinary and necessary business expenses. E.g., Marsh Fork Coal Co. v Lucas, 42F2d 83; United States v. Roden Coal Co., 39F2d 425; see Regulations 111, foot note 2, supra.
The principle of expensing such equipment and allowing a deduction therefor has also been upheld in such cases as Commissioner v. Brier Hill Collieries, 50F.2d 777 (involving steel rails, mine cars, switches, and trolley wires); Preston County Coke Co., 24B.T.A. 646 (involving steel rails, blending machinery and mining machinery); West Virginia-Pittsburgh Coal Co., 24B.T.A. 234 (involving steel rails, mine locomotives, mine cars, mules, motors, pumps, etc.); Tennessee Consolidated Coal Co., 24B.T.A. 369 (involving electric locomotive, mine rails, etc.); and W. M. Ritter Lumber Co., 30B.T.A. 231 (involving mine cars, locomotives, mining machinery, motors, etc.).
We are unable to distinguish the character of most of the expenditures made by petitioner from those involved in the foregoing cases. Accordingly, under their authority the items here involved must be allowed as ordinary and necessary expense deductions. We are of the opinion, however, that the petitioner has failed to establish that the tipple alterations made during the years under review fall into the class of those items above mentioned. The tipple alterations constituted capital improvements and the respondent is sustained in disallowing deductions therefor as business expenses. W. M. Ritter Lumber Co., supra.
The next issue to be considered is petitioner's claim for accelerated depreciation on its mining equipment in addition to that normally allowed.
Throughout the period here involved petitioner depreciated its items of equipment on the straight line basis. This method of depreciation assumes annual returns on the life of the asset. It contemplates the setting aside each year of a sufficient amount which, when added to the salvage value of the asset at the end of its useful life, will aggregate its original cost. petitioner claimed and was allowed a deduction for a normal depreciation based upon this method. in addition to this, petitioner claimed on its income tax returns, for the years under review, additional depreciation of 100 per cent of such normal depreciation. At the hearing petitioner amended its position to claim additional depreciation in the percentages set out in the findings of fact in lieu of those amounts claimed on its returns.
The amount of accelerated depreciation now claimed is based directly upon the operating hours of petitioner's tipple. There was testimony to the effect that virtually all of petitioner's mechanized equipment was in use when its tipple was operating and that during each of the years 1939 and 1940, years which were considered to be normal, the tipple was operated on an average of 2,750 hours, respectively. Hence, petitioner reasons any operation of the tipple in excess of that number of hours shows a proportionately greater use of all its equipment and thereby warrants the claimed allowance for abnormal depreciation.
This Court has held in a number of cases that if a taxpayer normally employs the straight line method of computing depreciation, as here, evidence of increased usage and other operating conditions do not warrant an allowance for abnormal or accelerated depreciation absent a showing that the useful life of the depreciable asset was, in fact, thereby shortened. E.g., Copifyer Lithograph Corporation, 12 T.C. 723; Harry Sherin, 13 T.C. 221. Therefore, before petitioner can prevail herein it must justify the additional depreciation which it claims by showing not only that there was increased usage and other conditions tending to accelerate the exhaustion of its equipment but also that such factors did actually reduce the useful life of such equipment. Woodside Cotton Mills, 13 B.T.A. 266. Petitioner has failed to make this showing. It has shown in general terms that its mine was operated at an excessive pace and that proper maintenance for its equipment was not available. These two factors, however, do not prove that the remaining useful life of such equipment was necessarily shortened. To the contrary, there was not actual worthlessness or abandonment of the property, nor is there evidence that any such eventuality was likely. Assuming that there was an excessive amount of wear and tear, the indications were that this would be but temporary and petitioner so regarded it. We cannot appropriately find that the economic life of petitioner's equipment had been materially shortened or was in any danger of being exhausted. Such is necessary to sustain a claim for accelerated depreciation. See Wier Long Leaf Lumber Co., 9 T.C. 990, reversed on other issues, 173 F.2d 549. The only evidence in this respect consists of the categorical opinion of petitioner's president. This testimony was not substantiated and the qualifications of the witness to express an opinion on this subject were not satisfactorily demonstrated. It is not conclusive. The Conqueror, 166 U.S. 110.
In our opinion, the petitioner has not justified an allowance for depreciation during the taxable years in excess of that amount allowed by respondent. Accordingly, respondent's action will not be disturbed.
The fourth question concerns the propriety of the petitioner's claim to a deduction on its 1941 Federal income tax return for additional income taxes paid in that year to the Commonwealth of Virginia on its 1938 and 1939 income. Our findings show that certain adjustments were made by respondent in petitioner's 1938 and 1939 Federal tax returns from which resulted a deficiency. Thereupon the commonwealth of Virginia made similar adjustments and asserted additional tax to be due it. Petitioner paid this additional tax to Virginia in 1941. Although it is on the accrual basis, it seeks, for Federal tax purposes, to deduct such payment from its 1941 gross income.
The rule is well established that for deduction purposes taxes accrue when all events have transpired which determine the amount of the tax and the taxpayer's liability therefor. E.g., United States v. Anderson, 269 U.S. 422; Standard Paving Co., 13 T.C. 425, 447; Oregon Pulp & Paper Co., 47 B.T.A. 772, 780; Haverty Furniture Co., 20 B.T.A. 644. Here all of the events had occurred prior to 1941 which fixed the amount and the liability to pay. Petitioner's erroneous report of its proper tax would not alter the correct amount of that tax nor petitioner's liability for it. The subsequent discovery and correction of the error related back to the taxable year in which the mistake occurred. Haverty Furniture Co., supra. Petitioner's lack of knowledge of the additional tax until 1941 is not controlling. Such was true in Standard Paving Co., supra, and Oregon Pulp & Paper Co., supra. In neither case did we allow a deduction for taxes paid which had accrued during an earlier tax period.
Petitioner seeks to discount and discredit our holding in Standard Paving Co., supra. Its argument is essentially the same as the one advanced by the petitioner in that case and its reasoning follows substantially that of the dissenting opinion in Oregon Pulp & Paper Co., supra. We are of the opinion that petitioner's argument and its underlying reasoning are incorrect. Accordingly, the determination of the respondent as to this issue is approved.
We turn now to the question of whether the refund of excess profits tax in the amount of $5,403.83 relating to 1940, scheduled in 1949, and the overassessment of such tax for 1941 in the amount of $13,256.61 which was determined in 1947, should both be included in petitioner's accumulated earnings and profits throughout the years here involved. The answer to this question must be in the negative. The refund was scheduled and the overassessment determined under the provisions of section 722 of the Internal Revenue Code, pursuant to the agreements between the parties reached on or about June 8, 1948, and October 27, 1947, as to the years 1940 and 1941, respectively. In enacting this section, Congress has provided that the excess profits tax must be computed, returned, and paid without regard to any of the provisions of the section. Section 722(d), Internal Revenue Code.
Relief is then obtained by way of a refund or credit after the taxpayer has filed an application showing that the excess profits tax thus computed results in an excessive or discriminatory tax. It must also have established what would be a fair and just amount representing normal earnings to be used in the constructive average base period net income in lieu of the taxpayer's actual average base period net income. Section 722(a) Internal Revenue Code.
SEC. 722. GENERAL RELIEF— CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME.(d) APPLICATION FOR UNDER SECTION.— The taxpayer shall compute its tax, file its return, and pay the tax shown on its return under this subchapter without the application of this section, except as provided in section 710(a)(5). The benefits of this section shall not be allowed unless the taxpayer within the period of time prescribed by section 322 and subject to the limitation as to amount of credit or refund prescribed in such section makes application therefor in accordance with regulations prescribed by the Commissioner with the approval of the Secretary. If a constructive average base period net income has been determined under the provisions of this section for any taxable year, the Commissioner may, by regulations approved by the Secretary, prescribe the extent to which the limitations prescribed by this subsection may be waived for the purpose of determining the tax under this subchapter for a subsequent taxable year.
Here, the record indicates that the initial steps to establish its right to relief under the provisions of section 722 were taken by petitioner when it filed its application therefor on September 9, 1943. This application was subsequently amended on August 26, 1946. In so far as the application pertained to the year 1940, an agreement was executed on June 8, 1948, pursuant to which a refund was scheduled on February 25, 1949. Previously, on October 27, 1947, the agreement relating to the year 1941 had been executed, which resulted in the determination of an overassessment for that year. We hold that the refund granted and the overassessment determined as a result of these agreements did not accrue retroactively to petitioner as assets but rather became such assets on the dates the agreements were made.
SEC. 722. GENERAL RELIEF-CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME.(a) GENERAL RULE.— In any case in which the taxpayer establishes that the tax computed under this subchapter (without the benefit of this section) results in an excessive and discriminatory tax and establishes what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income for the purposes of an excess profits tax based upon a comparison of normal earnings and earnings during an excess profits tax period, the tax shall be determined by using such constructive average base period net income in lieu of the average base period net income otherwise determined under this subchapter. In determining such constructive average base period net income, no regard shall be had to events or conditions affecting the taxpayer, the industry of which it is a member, or taxpayers generally occurring or existing after December 31, 1939, except that, in the cases described in the last sentence of section 722(b)(4) and in section 722(c), regard shall be had to the change in the character of the business under section 722(b)(4) or the nature of the taxpayer and the character of its business under section 722(c) to the extent necessary to establish the normal earnings to be used as the constructive average base period net income.
The disputed funds (or the right to receive them) did not become subject to payment of petitioner's debts until the above agreement was reached. Until this time the Government owed no duty to petitioner to make the refund. To the contrary, from the dates that the original returns were filed until the dates of the agreements, petitioner had a positive obligation to the United states: A duty to pay the tax thus reported. The fact that the statute permitted the taxpayer subsequently to make application for and be granted relief therefrom in no way indicates that during the intervening period the taxpayer was relieved of the duty to pay this tax or was to derive any benefit from the amounts in controversy. Manning v Seeley Tube & Box Co., 338 U.S. 561. With reference to the year 1940, the abatement of the tax liability and the accrual of the refund asset did not take place until the date of the agreement, on or about June 8, 1948. Likewise, the overassessment in petitioner's 1941 excess profits tax, finally determined by the agreement of October 27, 1947, did not accrue to petitioner's benefit until that date. Accordingly, petitioner is not entitled to have these overassessments included in its accumulated earnings and profits throughout the years here involved.
The situation presented in Stern Brothers & Co., 16 T.C. 295, is not presented here. There it was held that income and excess profits taxes must be reflected in accumulated earnings carried over from the end of the year to which those taxes related. We said: ‘If accumulated earnings and profits at the start of any taxable year are to show the true financial status of an accrual basis taxpayer, an adjustment must be made for income and excess profits taxes arising in the preceding year.‘ In other words, in Stern accumulated earnings were reduced in the year in which the excess profits tax arose. Here, however, the question concerns the propriety of increasing accumulated earnings by reason of later refunds of such taxes under section 722. In the Stern case, where we said that this was not ‘ * * * usual accrual for purposes of deduction from, or inclusion in, income‘ we referred to the usual accrual question as it involves the contested tax rule, that is, that a contested tax does not accrue until liability therefor is finally determined. We said that the contested tax rule could not apply there for the taxpayer could, by contesting its liability from income and excess profits taxes, postpone accrual of such taxes until the contest was settled; this with the result that its accumulated earnings would be excessive for purposes of computation of the invested capital credit. The character of the amounts involved in the instant case is quite different, however, since they arise out of refunds of excess profits taxes under section 722. These refunds are not accruable prior to their receipt for reasons explained above in our other discussion of this issue. Such refunds cannot, therefore, relate back so as to increase accumulated earnings for prior years. The issue involving post-war refunds under section 780 of the Code also present in the Stern case is not involved here either directly or by analogy. Refunds under section 780 are automatic in the sense that they are fixed in amount by statute, based on the excess profits tax paid and thus accruable. Refunds under section 722 are not automatic in nature and clearly unlike those provided for by section 780.
The final issue concerns deductions for certain items of interest to which petitioner contends that it is entitled. The interest involved is that which petitioner will be required to pay on the deficiencies that we have herein determined to be due.
As pointed out above, the rule of the Anderson case requires that in order for a tax to be accrued, all the events which fix the amount of that tax and the liability to pay it must have happened. this rule is also applicable to the accrual of an item of interest. Thus for deduction purposes, interest on contested taxes accrues in the year in which the liability for such taxes is determined. Lehigh Valley Railroad Co., 12 T.C. 977. The liability for the taxes herein contested becomes fixed only upon the conclusion of this proceeding and the interest thereon accrues simultaneously therewith. Accordingly, petitioner is not entitled to a deduction from income for any of the years here involved for interest accruing as a result hereof, and we so hold.
Decision will be entered under Rule 50.