Union Screw & Mfg. Co.
v.
Comm'r of Internal Revenue

Tax Court of the United States.Jan 30, 1951
16 T.C. 238 (U.S.T.C. 1951)

Docket No. 10446.

1951-01-30

UNION SCREW & MANUFACTURING COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

H. Kennedy McCook, Esq., for the petitioner. Edwin P. Friedberg, Esq., for the respondent.


Petitioner, in certain years earlier than the taxable years, claimed and was allowed certain deductions for depreciation. These deductions were on a basis greater than those determined by a revenue agent engineer for a later period. Held: The earlier deductions not shown to be incorrect under the law and facts known or reasonably to be anticipated during the years when taken and that the Commissioner did not err in disallowing claim for recomputation of the early depreciation deductions under section 718(a)(4) and 734, Internal Revenue Code, also, therefore, that petitioner is not entitled to additional depreciation deductions in the taxable years. H. Kennedy McCook, Esq., for the petitioner. Edwin P. Friedberg, Esq., for the respondent.

This case involves after certain stipulations only the following determinations of deficiency: For the year ending October 31, 1941, income tax $1,169.10 and excess profits tax $1,112.21; for the year ending October 31, 1943, excess profits tax $3,698.55. The year 1942 is only indirectly involved because petitioner claims net operating loss and unused profits credit carry-over to 1943. Several matters originally involved have been eliminated by agreement, leaving for our determination only the question as to the correct amount of excess profits credit for 1941, 1942, and 1943, which involves the problem whether depreciation deductions in certain prior years were erroneous and excessive and whether they may under sections 718(a)(4) and 734 of the Internal Revenue Code be corrected for the purpose of computation of excess profits credit. Also, petitioner contends that if depreciation deductions in the prior years are found to be excessive, it is entitled to additional depreciation deductions in the excess profits years here involved.

FINDINGS OF FACT.

A stipulation of facts was filed. By reference the stipulation is adopted and we find the facts to be as stipulated. Only such parts of the facts stipulated as considered necessary to proper statement of the pertinent facts involved will be set forth herein, with facts found from evidence adduced.

The petitioner is a domestic corporation organized September 24, 1920, under the laws of Pennsylvania. Petitioner's principal offices are located at 207 South Main Street, West End, Pittsburgh 20, Pennsylvania. The returns for the periods here involved were filed with the collector of internal revenue for the twenty-third Pennsylvania district, at Pittsburgh, Pennsylvania.

Petitioner has been engaged in the manufacture of screw machine products at all times since it commenced active operations.

Petitioner at all times has kept its books and filed its Federal tax returns on an accrual basis. For all years prior to 1935 petitioner filed its Federal tax returns upon a calendar year basis; however, thereafter the returns were filed for fiscal years ending October 31.

Petitioner at all times used the straight line method of depreciation by applying annually a fixed rate of depreciation to the cost of each depreciable asset.

The rates of depreciation applied by petitioner to its depreciable assets resulted in the following depreciation deductions in its returns for the various years:

+------------------------+ ¦Year ¦Amount ¦ +--------------+---------¦ ¦1926 ¦$5,608.96¦ +--------------+---------¦ ¦1927 ¦9,070.36 ¦ +--------------+---------¦ ¦1928 ¦9,903.02 ¦ +--------------+---------¦ ¦1929 ¦14,307.55¦ +--------------+---------¦ ¦1930 ¦16,847.22¦ +--------------+---------¦ ¦1931 ¦13,544.60¦ +--------------+---------¦ ¦1932 ¦10,273.55¦ +--------------+---------¦ ¦1933 ¦8,983.57 ¦ +--------------+---------¦ ¦1934 ¦9,971.82 ¦ +--------------+---------¦ ¦1935 (10 mo.) ¦7,799.25 ¦ +--------------+---------¦ ¦1936 ¦8,477.00 ¦ +--------------+---------¦ ¦1937 ¦9,087.38 ¦ +--------------+---------¦ ¦1938 ¦9,264.68 ¦ +--------------+---------¦ ¦1939 ¦7,190.99 ¦ +--------------+---------¦ ¦1940 ¦6,840.49 ¦ +--------------+---------¦ ¦1941 ¦11,629.97¦ +--------------+---------¦ ¦1942 ¦6,864.54 ¦ +--------------+---------¦ ¦1943 ¦11,936.36¦ +------------------------+

Respondent's engineer agent made an examination of petitioner's depreciable assets in connection with an examination of its return for the year 1935 and proposed changes in rates of depreciation for subsequent years, materially reducing the rates previously taken by petitioner. As a result thereof the petitioner used in its tax returns the rates determined by respondent's engineer, ‘based on useful life as herein shown as follows:

+----------------------------------+ ¦Building (from 1913) ¦45 years ¦ +------------------------+---------¦ ¦Automatic screw machines¦15 years ¦ +------------------------+---------¦ ¦Milling machines (small)¦15 years ¦ +------------------------+---------¦ ¦Threading machines ¦15 years ¦ +------------------------+---------¦ ¦Lathe (sic) ¦17 years ¦ +------------------------+---------¦ ¦Drilling machine ¦16 years ¦ +------------------------+---------¦ ¦Grinding ¦12 years ¦ +------------------------+---------¦ ¦Miscellaneous equipment ¦14 years ¦ +------------------------+---------¦ ¦Motors (small H. P.) ¦15 years ¦ +------------------------+---------¦ ¦Small tools ¦8 years ¦ +------------------------+---------¦ ¦Automobiles ¦4 years ¦ +------------------------+---------¦ ¦Furniture and fixtures ¦15 years”¦ +----------------------------------+

The following schedule shows the net income, or loss, on which basis petitioner's taxable years 1926 through 1940 were closed by the Commissioner:

+--------------------------+ ¦ ¦ ¦Net ¦ +----+---------+-----------¦ ¦Year¦Loss ¦income ¦ +----+---------+-----------¦ ¦1926¦ ¦$13,257.25 ¦ +----+---------+-----------¦ ¦1927¦ ¦27,046.84 ¦ +----+---------+-----------¦ ¦1928¦ ¦21,505.14 ¦ +----+---------+-----------¦ ¦1929¦ ¦26,626.93 ¦ +----+---------+-----------¦ ¦1930¦ ¦2,541.93 ¦ +----+---------+-----------¦ ¦1931¦$9,860.45¦ ¦ +----+---------+-----------¦ ¦1932¦14,770.42¦ ¦ +----+---------+-----------¦ ¦1933¦1,808.21 ¦ ¦ +----+---------+-----------¦ ¦1934¦5,526.06 ¦ ¦ +----+---------+-----------¦ ¦1935¦ ¦11,948.89 ¦ +----+---------+-----------¦ ¦1936¦ ¦15,466.17 ¦ +----+---------+-----------¦ ¦1937¦ ¦19,968.86 ¦ +----+---------+-----------¦ ¦1938¦9,272.56 ¦ ¦ +----+---------+-----------¦ ¦1939¦ ¦3,625.85 ¦ +----+---------+-----------¦ ¦1940¦ ¦4,435.32 ¦ +--------------------------+

During 1931, 1932, and 1933 the average gross sales of the petitioner were 46 per cent of the average for the previous 5 years. This was because of extremely subnormal conditions. The duration of the depression could not be foreseen. On January 6, 1937, petitioner, through its accounting firm, filed with the Internal Revenue Agent in Charge, at Pittsburgh, a claim for reduced depreciation for 1931, 1932, and 1933 by reason of reduced activity during loss years, reciting in part as follows:

As indicated above, average gross sales per year for the years 1931, 1932 and 1933 amounted to 46% of average gross sales per year for the preceding five years, on account of the extremely sub-normal conditions prevailing during the depression, which is said to have been the most drastic depression in all history. It is respectfully contended therefore that depreciation on machinery and equipment should be reduced by at least 1/3rd of the amount charged off for the years 1931, 1932 and 1933. Physical depreciation of machinery and equipment varies to a considerable extent according to the relative extent of operating use, although, of course, depreciation and obsolescence takes place to some extent with little or no operating use. The duration of the depression could not have been foreseen and the taxpayer could not have been expected, therefore, to have reduced depreciation charges in anticipation of an extraordinarily long period of very sub-normal operations. * * *

The parties have stipulated as follows:

‘It is the primary contention of the respondent that the amount of depreciation and amortization claimed by the petitioner in its return for each of the prior tax years 1926 through 1940 is the correct amount of depreciation and amortization to be used for those years in computing the petitioner's accumulated earnings for the purpose of its excess profits tax credit. If this primary contention should be determined adversely to respondent, it is agreed that the respondent shall be entitled to any additional excess profits taxes which may be due by reason of the application of the adjustment provided by section 734 of the Internal Revenue Code.

‘The accumulated earnings for the petitioner's excess profits tax years should be determined by deducting therefrom the correct excess profits tax liabilities, as found by the Court, after the application of the section 734 adjustment.

‘Should the Court find and hold that the petitioner is entitled to any of the restorations claimed in its petition, the accumulated earnings of the petitioner should be reduced by the amounts of any depreciation on such restorations which would have been allowable prior to the petitioner's taxable year 1940.

‘It is further stipulated that there are no overpayments in excess profits taxes due to the petitioner for its taxable years 1941 and 1943 under the provisions of section 722 of the Internal Revenue Code and decision may be entered accordingly.

‘It is further stipulated that the petitioner shall be allowed the following amounts as additional deductions in computing its net income for the fiscal year ended October 31, 1943:

+----------------------------------------+ ¦Amortization of war facilities¦$3,556.10¦ +------------------------------+---------¦ ¦Net Operating loss deduction ¦754.07 ¦ +------------------------------+---------¦ ¦Federal capital stock tax ¦125.00 ¦ +------------------------------+---------¦ ¦Pennsylvania capital stock tax¦150.00 ¦ +----------------------------------------+

and that appropriate adjustments for said additional deductions may be made in a recomputation under Rule 50 of the Court's Rule of Practice.

‘It is further stipulated that the income tax previously assessed, as shown in the statutory notice of deficiency for the fiscal year ended October 31, 1943, should be reduced by $1,379.79, representing an amount refunded to the petitioner on the basis of an Application for Tentative Adjustment (Form 1140), and that appropriate adjustment for said refund may be made in a recomputation under Rule 50 of the Court's Rules of Practice.‘

OPINION.

DISNEY, Judge:

The petitioner, citing Zellerbach Paper Co., 8 T.C. 511; Rosemary Mfg. Co., 9 T.C. 851; Leonard Refineries, Inc., 11 T.C. 1000, and Kawneer Co., 13 T.C. 336, together with other cases less applicable to the situation here, argues that deductions for depreciation were taken in excessive amounts in previous years, as indicated by later estimates made by respondent's engineer-agent, and that therefore the petitioner is entitled to recompute its tax liability for the taxable years, under the provisions of section 718(a)(4) of the Internal Revenue Code (as to determination of equity invested capital) and section 734 providing for adjustment in case of positions in consistent with prior income tax law. The respondent's position is, in substance, that the depreciation rates and allowances actually used by the petitioner in prior years in computing its income tax liability were correct under the then applicable law, and that therefore no adjustment is permissible under section 734.

We have studied all cases cited to us and have examined and analyzed the facts which the petitioner has presented, and in our opinion they are insufficient basis for the relief asked. Section 734(b)(2) provides particularly, in part just here pertinent, that adjustment shall be made only in case of inconsistency of position with the treatment accorded in a prior taxable year or years ‘which was not correct under the law applicable to such year.‘ We are unable to find anything incorrect in the depreciation deductions taken in petitioner's previous years, under the law applicable to such years. This statement of the statute appears to be the basis for the fact that all of the cases on this general subject, including those cited by the petitioner, appear to agree that depreciation is to be calculated on the basis of facts known or reasonably to be anticipated during the taxable year and not upon facts subsequently discovered. Lake Charles Naval Stores, 25 B.T.A. 173; Rosemary Mfg. Co., supra; Leonard Refineries, Inc., supra. The Rosemary case after referring to the above provision of section 734(b)(2) and noting that it is a limitation upon making the adjustment recites that ‘on the basis of facts known or reasonably to have been anticipated during those years,‘ that is, the previous years, we were of the opinion that the allowance then computed and deducted was reasonable. This was despite the fact that, much as in this case, the respondent and the taxpayer had later determined upon depreciation rates less than those used in the previous years. The point is accented by the distinction found between the case and the Zellerbach case, supra, in that in the latter there was ‘mistake of law and fact‘ by reason of which the net income was not correctly reported. The distinction, the Rosemary case says, is obvious. In the Leonard Refineries, Inc., supra, as to a portion of the matters involved, we held that the petitioner had not sustained the burden of proof, that depreciation deductions taken on certain items, for a year previous to the taxable years, were excessive ‘based on circumstances and conditions known or reasonably ascertainable at the end of that year.‘ In the Kawneer Co. case, supra, particularly pointed out by the petitioner, it is noteworthy that though as in this case there was later examination by a revenue agent with recommendations of adjustments as to certain years, we found as fact that: ‘There were no factors developed as a result of the analysis which the petitioner could have not known as of December 31, 1936,‘ and again, upholding the adjustment for depreciation, we referred to the ‘subsequently agreed principles as applied to the facts known during the base period years.‘ In the instant case, on the contrary, nothing indicates to us that the new depreciation rates relied upon by the petitioner because of a determination by revenue agent based upon a Government engineering report in 1939 could properly be applied to the previous years, in other words, that so far as the record before us shows the rates of depreciation actually taken were correct under all facts and circumstances known in those years. The petitioner has urged, in support of the adoption for all previous years of the rates referred to in the engineering report of 1939, that there was no reason during the entire period from 1926 why the useful life of its machinery and equipment should be either extended or shortened. This idea, however, contravenes the view indicated on a claim filed by the petitioner on January 6, 1937, for the reduction of depreciation for 1931, 1932, and 1933 ‘by reason of reduced activity during loss years‘ in which it was contended that the average gross sales per year for 1931, 1932, and 1933 were 46 per cent of average gross sales per year for the preceding 5 years ‘on account of the extremely sub-normal conditions prevailing during the depression‘ and it was, therefore, contended that depreciation on machinery and equipment should be reduced by at least one-third of the amount charged off for 1931, 1932, and 1933. The claim further stated: ‘The duration of the depression could not have been foreseen and the taxpayer could not have been expected, therefore, to have reduced depreciation charges in anticipation of an extraordinarily long period of very sub-normal operations.‘ It is clear, therefore, with reference to depreciation taken and claimed during the depression period 1931, 1932, and 1933 that as late as January 6, 1937, it was the view of the petitioner that the ‘conditions known to exist at the end of the period for which the return is made‘— the test under Regulations 111, section 29.23(1)-5 for reasonableness of a claim for depreciation— were such that the facts entering into the engineer's report and alteration of depreciation rates made later in 1939, could not have been known. Nothing in the record before us demonstrates or indicates that conditions had not changed before the adoption of the depreciation rates or that they were not correct under the circumstances and on the facts at the time they were claimed and allowed in the earlier years. Clearly the mere adoption in later years of a new depreciation schedule is of itself no indication that the previous schedules had not been correct. We conclude and hold that the petitioner has not shown facts authorizing relief under section 734. It follows that the petitioner's claim, dependent upon such relief, for additional depreciation deductions in the excess profits tax years, is not well based.

Decision will be entered under Rule 50.