Evangeline Gravel Co. v. Commissioner

EVANGELINE GRAVEL CO., INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Evangeline Gravel Co. v. Commissioner Docket No. 12806. United States Board of Tax Appeals 13 B.T.A. 101; 1928 BTA LEXIS 3310; July 27, 1928, Promulgated *3310 1. Where a corporation takes over, from an original lessee, a lease of gravel-bearing land, which gravel deposits have been discovered and examined by test borings made by the original lessee, held, such corporation is not entitled to depletion deductions on the basis of discovery value. 2. Evidence held insufficient to disturb respondent's determination as to the proper rate of deduction for depreciation of plant. W. O. Rainey, for the petitioner. Granville S. Borden, Esq., for the respondent. MARQUETTE *101 This is a proceeding for the redetermination of a deficiency in income and excess-profits taxes asserted by the respondent for the year 1920. The amount of the deficiency is $5,315.48, which arises from the disallowance by the respondent of claimed deductions for depreciation, depletion and charge-off. *102 FINDINGS OF FACT. The petitioner is a corporation, and during the year 1921 was engaged in the business of extracting sand and gravel at Alexandria, La. The petitioner was incorporated October 16, 1919, and acquired from one G. K. Force, lessee, a lease and option to purchase an 80-acre tract of land containing*3311 gravel deposit. Prior thereto, Force had sunk six test wells for the purpose of ascertaining the quality and quantity of gravel. This was necessary because no gravel showed on the surface, and a surface examination of the land would not determine the gravel content. Various other leases were made by others, and later taken over by the petitioner; but none were worked except the first, the 80-acre tract. In February, 1920, the petitioner exercised its option and purchased the 80 acres for the sum of $24,351.90. The petitioner had to pay to Force and four other original lessees, a royalty of 5 cents per ton for all sand and gravel removed from the land so acquired. The gravel content of the 80-acre tract, at the beginning of operations, was estimated by an experienced man to be 1,000,000 tons. This proved to be approximately correct. In order to work the dredges, it was found necessary to build a wooden dam in 1920. By 1921 this dam was no longer needed and was removed by pumping toward it, thus undermining it and washing it away. The plant and equipment of the petitioner were of new materials, except the rails and locomotives. There was a power plant, railway and its*3312 equipment, two dredges, a washing plant, and a gravel plant. During the year 1921 the petitioner operated one dredge 24 hours per day. No depreciation was taken by the petitioner with reference to the dam, but in 1921 the original cost was charged off as a loss. The respondent now concedes this to be a proper deduction. In its tax return for the year 1921 the petitioner claimed a deduction for depreciation with respect to its dredge, gravel plant, power plant and equipment, railway, and railway equipment, computed at the rate of 20 per cent. The respondent allowed a deduction computed at the rate of 10 per cent. The petitioner based its 20 per cent deduction upon an estimated removal of all the gravel in 5 years' time. The plant was still in use in February, 1928. There is no evidence as to its salvage value. The petitioner also claimed deduction for depletion based on discovery value under section 214(a)(10) of the Revenue Act of 1921. This deduction, also based upon an estimated 5-year economic life of the gravel deposit, was computed at 20.89 cents per ton on *103 99,116.31 tons, which was the tonnage removed in 1921. The respondent allowed a depletion deduction*3313 at the rate of 2.4 cents per ton on 104,031.59 tons, which was the tonnage removed during 1920 and 1921. This was based upon the engineer's report. OPINION. MARQUETTE: Two questions are to be determined in this proceeding, viz: (1) The proper rate of depreciation to be allowed for the year 1921 with respect to five items of the petitioner's assets, and (2) the proper rate of depletion deduction to be allowed for exhaustion of a gravel deposit for the same year. The pleadings indicate a third question relating to the total loss of the useful life of a dam; but that is now conceded by the respondent in his brief. The sections of the 1921 Revenue Act which are applicable here provide: SEC. 234. (a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions: * * * (7) A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence. In the case of such property acquired before March 1, 1913, this deduction shall be computed upon the basis of its fair market price or value as of March 1, 1913; * * * (9) In the*3314 case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case, based upon cost including cost of development not otherwise deducted: Provided, That in the case of such properties acquired prior to March 1, 1913, the fair market value of the property (or the taxpayer's interest therein) on that date shall be taken in lieu of cost up to that date: Provided further, That in the case of mines, oil and gas wells, discovered by the taxpayer, on or after March 1, 1913, and not acquired as the result of purchase of a proven tract or lease, where the fair market value of the property is materially disproportionate to the cost, the depletion allowance shall be based upon the fair market value of the property at the date of the discovery, or within thirty days thereafter: * * *. With respect to depreciation, the petitioner relies upon , wherein it was held that oil well equipment which would have no useful life or value after the oil was all extracted should be depreciated at the same rate as that at which*3315 the oil was depleted within the taxable year. That, however, does not fully cover the present situation; for we have no proof before us that the petitioner's dredges, railway and equipment, and the like, would have no useful life after the gravel pit had been exhausted. It is true, the petitioner was operating only upon one tract of the several which it had; it may also be true that the petitioner would *104 abandon the gravel business upon the exhaustion of this one pit. But, so far as the evidence shows, the machinery and equipment was usable and in good condition even after more than seven years' usage, and we can not agree with the petitioner that under the circumstances of this case the rate of depreciation should be based solely upon the so-called unit-of-production basis. As was indicated in the Golconda case supra, there is no one fixed and universal rule to be followed; but the facts in each case must be carefully considered, together with the surrounding circumstances, and then, in the light of such facts and surroundings, a deduction made which shall constitute a reasonable allowance. In the case of *3316 , it is said that: 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. The respondent, in his deficiency notice, placed the proper rate of depreciation at 10 per cent; in his answer filed in this proceeding he claims that 6 2/3 per cent is correct. In other words, that the useful life of the property in question was 15 years. He has offered no evidence to support this claim and in our opinion it is not substantiated. On the other hand, the petitioner has not offered any proof as to the salvage value of the plant. We think that a reasonable allowance for depreciation is that based upon a 10-year useful life, and, therefore, we sustain the respondent's original determination upon this point. As to depletion, the facts clearly show that the petitioner is not entitled to a deduction based upon discovery value, even though gravel deposits are within the statute. In the first*3317 place, as to discoveries after March 1, 1913, the discovery must be made by the taxpayer; secondly, the property must not be acquired by purchase of a proven tract or lease. The petitioner's status, as to both these provisions, is directly contrary to them. The statute further provides that depletion based on discovery "shall be based upon the fair market value of the property at the date of discovery or within 30 days thereafter." The petitioner has not proven such market value. A reasonable allowance for depletion is proper, however, under the statute. The burden being upon the petitioner to show the respondent to be in error in his determination of the amount of allowable depletion, and that burden not having been sustained by any evidence, we must conclude that the respondent's allowance was correct. *105 The petitioner's tax for the year 1921 should be recomputed, allowing it a deduction in full for the value of the dam destroyed in 1921, and computing depreciation and depletion at the respective rates fixed by the respondent in his deficiency notice. Judgment will be entered under Rule 50.