Philadelphia Quartz Co. v. Commissioner

PHILADELPHIA QUARTZ CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Philadelphia Quartz Co. v. Commissioner Docket No. 6677. United States Board of Tax Appeals 13 B.T.A. 1146; 1928 BTA LEXIS 3104; October 18, 1928, Promulgated *3104 1. Basis for adjusting depletion determined. Thomas Coal Co.,10 B.T.A. 639, overruled. 2. Depletion of sand deposit and depreciation of equipment determined. J. S. Lamson, Esq., and Fred D. Bullock, C.P.A., for the petitioner. T. M. Mather, Esq., for the respondent. VAN FOSSAN *1146 In this proceeding the petitioner seeks a redetermination of the income and profits taxes for the year 1919 for which the respondent has determined a deficiency of $1,443.54. The petitioner alleges error on the part of the respondent in failing to allow depletion upon the basis of the tons actually produced from the property prior to abandonment of operations, having used instead an arbitrary estimate of tonnage made by the petitioner in 1919, and in failing to allow depreciation at the rate of 20 per cent on certain equipment located at the mine. FINDINGS OF FACT. The petitioner is a corporation organized in June, 1917, for the purpose of manufacturing silicate of soda. The capital stock of the petitioner was owned in part by the Philadelphia Quartz Co. of Pennsylvania, the reason for its organization being that the latter company*3105 had customers on the Pacific coast who could be more advantageously served from a plant located in California. A plant was constructed during the years 1917 and 1918, and production began in June, 1918. One of the two principal ingredients used in the manufacture of silicate of soda is sand of the kind ordinarily known as glass sand. Sand of this character of sufficient purity was difficult to obtain, and prior to the war had been obtained, by Pacific Coast manufacturers of silicate of soda, from Belgium. Upon opening its plant in June, 1918, the petitioner obtained its first sand from Illinois. The quality of this sand was satisfactory, but due to the freight charges the cost was prohibitive and delivery was uncertain on account of shortage of freight cars. The petitioner investigated a deposit of sand at Ione, Calif., which, although somewhat inferior in quality, appeared to be an available source of supply. In the month of August, 1918, the petitioner entered into a contract with the Products Development Co. for the purchase of sand excavated from a leasehold held by that company on the sand deposit at Ione. Since it was necessary to wash the sands *1147 the petitioner*3106 installed a washing plant at a cost of $25,000, which plant was operated by the Products Development Co. In February, 1919, the Products Development Co. advised the petitioner that it had a prospective purchaser for its leasehold, and gave the petitioner 24 hours within which to decide whether or not it would purchase the property for the sum of $125,000. With such short notice it was impossible for the petitioner to explore the deposit in order to determine the quality and extent of the sands, and it had to rely on the advice of the superintendent of the sand company as to the location of certain test holes. These test holes were located on the face of the bluff within 100 feet or less of the workings. The petitioner decided to purchase the leasehold, which covered a period from September 1, 1914, to September 1, 1964. Later in the year, in June, 1919, the petitioner purchased the fee title to the property for a consideration of $45,000. At the time of this purchase no additional drill holes had been driven. The first estimate of the sand content of the mine was made in the spring of 1919. The manager and the superintendent weighted a cubic foot of sand, estimated an average*3107 thickness of 10 feet and an area of 75 acres and arrived at two estimates, one of 2,000,000 tons and the other of 1,000,000 tons, and finally agreed upon 1,250,000 tons. At the time this estimate was made there were no drill holes within the 75-acre area except those along the face of the workings. The object of the estimate was to furnish the bookkeeper with information necessary for her books. The purchase price of $125,000 included payment for certain plant and equipment on the property. The amount of this payment and of the purchase of the fee, which represented the payment for the sand deposit alone, was $81,063.21. In its original return for the year 1919 the petitioner claimed a deduction for depletion of $2,866.24. This figure was computed by charging $228.93 per month for 3 months' operation under the lease and $311.35 per month threrafter. The rate under the lease represented a proration of the capital payment of $125,000 over 546 months, the remaining life of the lease, while the charge of $311.35 for the later months was based on a total capital of $170,000, spread over an estimated life of 50 years. The respondent did not accept this basis for depletion but used*3108 the purchase price applicable to the sand deposit of $81,063.21, and an estimated tonnage of 1,275,000 tons, taken from a schedule attached to petitioner's 1919 return. This resulted in a unit rate of 6.4 cents a ton, which, multiplied by 3,032 tons, gave a depletion deduction of $194.05. In 1923 the petitioner filed an amended return for the year 1919, in which it claimed a deduction for depletion of $41,756.87. This deduction was based upon the fact that near the close of the year 1922 the petitioner abandoned operations, *1148 shut down the operations of the Ione property, and removed the plant and equipment after having extracted 11,055 tons from the property in the following annual amounts: Tons [1919] 4,856 [1920] 3,759 [1921] 1,439 [1922] 1,001 In April, 1920, it became apparent for the first time to the petitioner that a large portion of the deposit was unsatisfactory in quality, and that the quantity of satisfactory sand was limited and of a pockety character. Some additional drill holes were sunk just south of the previous workings, which disclosed a small amount of satisfactory sand. Later, a drill hole was driven about 800 feet northeast*3109 of the working face, a second drill hole about 200 feet southeast of the working face, and the third drill hole about 800 feet southeast of the working face. The northermost drill hole disclosed sand containing too much iron to be of service to the petitioner. The central drill hole indicated excessive overburden, and the souther-most drill hole indicated that the sand deposit was too shallow for profitable operation. Petitioner thereupon concluded that the sand deposit was not suitable for further operation. In the original return for the year 1919, petitioner claimed deduction for exhaustion, wear and tear of property of $24,713.91. In the amended return petitioner changed this item to $26,861.43. The respondent allowed the amount claimed in the original 1919 return. The deduction for exhaustion, wear and tear for the year 1919 to which the petitioner is entitled is $24,713.91. OPINION. VAN FOSSAN: The first question before us is the amount of depletion allowable on petitioner's sand deposit. The record indicates that at the time of filing the 1919 return no proper or dependable estimate had been made of the extent of the deposit. The facts in this case raise squarely*3110 the question whether depletion for a given year is to be based solely on facts known or estimates made at the time a return is filed or may be revised in the event of a hearing before the Board so as to comport with subsequently discovered facts. The rulings of the Board on this question are not in harmony. In the case of Stouts Mountain Coal Co.,4 B.T.A. 1292, where the facts were somewhat similar to the instant case, we held that the subsequently discovered facts might properly be employed to revise the basis of computation of depletion for the year in which the facts were developed (1921) but no intimation was given that *1149 the revision should be retroactive, although the previous tax year (1920) was also before us. In Sterling Coal Co., Ltd.,8 B.T.A. 549, the very issue above stated was before us and we there ruled that the right to revise should not be retroactively applied and said: The rule contended for by the petitioner is that in the case of mines the rate of depletion applicable for any year is contingent upon the determination of the reserves in the ground as ascertained by the development prosecuted and carried on*3111 in subsequent years. Under this rule there would be no time until the end of the life of a mine or at least there would be an indefinite length of time before a final estimate of the recoverable coal in place could be made. The petitioner contends that unless it is given the right in this case to revise its depletion allowances for 1917, 1918, and 1919 upon an estimate of reserves made in 1922, it will not have returned to it its capital tax free. In our opinion, this contention is not sound. In the first place, a taxpayer is entitled only to a reasonable allowance for depletion, and that reasonable allowance must of necessity be computed upon the basis of factors known to exist during the year for which the return was filed. It is not in our opinion the purpose of the statute to permit taxpayers to determine their net incomes for a given year on the basis of facts developed in the future. Under our decision in Stouts Mountain Coal Co. v. Commissioner, supra, if subsequent developments show that a material error has been made in the original estimates of the ore reserves, a new estimate may be made, and the capital remaining to be recovered distributed accordingly. *3112 This is in accordance with article 209 of Regulations 45, and in our opinion is a fair and reasonable interpretation of the statute. * * * The Sterling Coal Co. decision specifically overruled Kehota Mining Co.,3 B.T.A. 885. See also Kehota Mining Co. v. Lewellyn; Kehota Mining Co. v. D. B. Heiner, 28 Fed.(2d) 995. The decision of the Board in Thomas Coal Co.,10 B.T.A. 639, where the question differed from the instant case only in that it involved depreciation instead of depletion, is apparently out of harmony with the reasoning of the above-cited cases. We believe the decision in Sterling Coal Co. is sound and Thomas Coal Co. is accordingly overruled. Applying this rule to the facts of the case at bar, the record indicates that at the time of filing the 1919 return no proper or dependable estimate had been made of the extent of the said deposit. The computation made by petitioner was little more than a guess. Thus, we can not approve the computation of the respondent based on a supposed content of 1,275,000 tons. On the other hand, although the method adopted by the petitioner more nearly assures*3113 a reasonable allowance, it has employed incorrect basic figures. Applying the stipulated cost figures we arrive at a figure of approximately $1,500, which is reasonable and should be allowed as depletion in 1919. The second issue relates to depreciation. Here we are met by inadequate proof. Petitioner's testimony as to rates was exclusively *1150 directed to the depreciation on the shaker tables. Other items of property, however, were involved as to which no testimony was presented. Though the testimony indicates that 10 per cent was possibly a low rate for the tables, we are unable to say from the record that when averaged with other property 10 per cent was not a reasonable average or composite rate. Reviewed by the Board. Judgment will be entered under Rule 50. LANSDON dissents.