Opinion
Docket No. 108997.
1948-12-7
EAST KAUAI WATER COMPANY, LIMITED, PETITIONER, V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
E. J. Greaney, C.P.A., for the petitioner. A. J. Hurley, Esq., for the respondent.
DEDUCTIONS— DEPRECIATION— SECTION 23(1)— RENEWAL.— Where a lease or franchise is renewed or a new lease or franchise obtained before the expiration of the existing lease or franchise, the period over which the remaining basis of depreciable property is to be recovered is not limited to the remainder of the existing lease, but may include, if the life of the assets justifies, all or a portion of the new term. E. J. Greaney, C.P.A., for the petitioner. A. J. Hurley, Esq., for the respondent.
The Commissioner determined deficiencies in income tax and declared value excess profits tax for 1939 in the amounts of $3,088.30 and $638.41. The only issue for decision is whether the petitioner is entitled to recover the cost of its water system facilities through deductions for depreciation over the 21-year period of its initial franchise, or whether it must spread the balance of the undepreciated cost remaining at the time it was granted a second franchise over the remaining life of the first franchise plus that of the second.
FINDINGS OF FACT.
The petitioner is a public service irrigation corporation, engaged in supplying water to homesteads and sugar plantations on the Island of Kauai in the Territory of Hawaii. The petitioner used land owned by Hawaii. It held a 21-year franchise from the Territory expiring April 8, 1941, and containing no option of renewal.
The facilities of the petitioner were to become the property of the Territory in case of the petitioner's failure to perform its obligations under the franchise also upon the expiration of the franchise.
The Territory offered at public auction in 1939 a new franchise for a period of 21 years beginning upon the expiration of the petitioner's original franchise. The petitioner's bid for the new franchise was accepted by the Territory on May 29, 1939. The petitioner's original franchise was not canceled at that time, but continued in full force and effect until its expiration date. The petitioner continued to use its facilities under the new franchise.
The petitioner expended $414.472.45 in constructing its water system. The balance of that cost which remained undepreciated on December 31, 1938, was $89,728.19. The petitioner deducted $33,866.50 in its 1939 income tax return as depreciation on its water system. The Commissioner, in determining the deficiencies, disallowed $17,823.63 of that deduction. He arrived at that figure by allowing for the period January 1 to May 29, five-twelfths of the $33,866.50 claimed by the petitioner, and for the period May 30 to December 31, seven-twelfths of an annual amount computed by spreading the undepreciated cost remaining on May 31, 1939, over a period of 22 years and 10 months.
The stipulation of facts is incorporated herein by this reference.
OPINION.
MURDOCK, Judge:
The precise issue for decision is whether that portion of the cost of the petitioner's water system which remained undepreciated at the time of the acceptance of the petitioner's bid for a new franchise should be recovered over the remaining 1 year and 10 months of the original franchise, or over that period plus the 21 years of the new franchise. The petitioner contends that the shorter period should be used, first, because section 19.23(a)-10 of Regulations 103 relates only to leases which contain an option of renewal, whereas the original franchise contained no such option, and, second, because there was in fact no renewal of the original franchise, which ran its full term and expired before the new one became effective. The provision in the regulations to which the petitioner refers has nothing to do with a case such as this. The petitioner does not refer to the statute or its purpose. This Court stated in Union Electric Co. of Missouri, 10 T.C. 802, that:
* * * Section 23(l) authorizes as a deduction ‘a reasonable allowance for the exhaustion, wear and tear * * * of property used in the trade or business. ‘ The purpose of that provision is to return to the owner the cost of the assets tax-free during their useful lives through deductions from income. ‘The amount of the allowance for depreciation is the sum which should be set aside for the taxable year, in order that, at the end of the useful life of the plant in the business, the aggregate of the sums set aside will (with the salvage value) suffice to provide an amount equal to the original cost.‘ United States v. Ludey, 274 U.S. 295.
The respondent correctly contends that the longer period should be used because it became certain at the time the new franchise was granted that the petitioner's facilities would be useful to it during the term of the new lease. The petitioner does not argue that the useful life of the depreciable assets might be shorter than the period covered by the new lease. It is immaterial that the original franchise did not contain an option of renewal or that it continued in full force until it expired. The petitioner, by the acceptance of the new lease, obtained a longer period for time in which to use its properties and their remaining cost should be recovered over that longer period. Gladding Dry Goods Co., 2 B.T.A. 336; Werner & Werner Clothing & Furnishing Goods Co., 9 B.T.A. 69; E. M. Diebold, 19 B.T.A. 438.
Decision will be entered for the respondent.