Simons Brick Co. v. Commissioner

SIMONS BRICK CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Simons Brick Co. v. Commissioner Docket Nos. 13973, 24509, 27247. United States Board of Tax Appeals 14 B.T.A. 878; 1928 BTA LEXIS 2888; December 21, 1928, Promulgated *2888 1. BUSINESS EXPENSE. - Contributions made to an association for the purpose of preventing strikes and promoting industrial peace are allowable deductions. 2. IDEM. - Contributions made to an association for the purpose of encouraging location of industries and residents by advertising are business expenses and deductible. 3. IDEM. - Contribution made to a citizens' committee to exercise surveillance over public works is too remote and not a business expense. 4. IMPROVEMENTS. - Where improvements are made on leased premises by a tenant at will, the cost thereof is not deductible in the year when made, but should be apportioned over the useful life of such improvements. 5. VALUATION. - Commissioner's March 1, 1913, valuation of certain properties approved. 6. DEPRECIATION. - Where the taxpayer objected to the basis used by the Commissioner in computing depreciation but failed to introduce proof that the depreciation determined by the Commissioner was incorrect, the action of the Commissioner is approved. 7. SUSTAINED DEPRECIATION AND DEPLETION. - The action of the Commissioner in reducing invested capital by depreciation and depletion sustained prior to March 1, 1913, approved. *2889 8. DEPRECIATION AND EXPENSES. - Where a company owns a cottage erected for the purpose of showing a type of construction and used for advertising purposes, although such cottage is used part of the time by officers and stockholders for their personal use, the company is entitled to depreciation and deduction of expenses connected therewith. Walter K. Mitchell, C.P.A., and Ralph W. Smith, Esq., for the petitioner. Shelby S. Faulkner, Esq., for the respondent. MILLIKEN *878 In this proceeding petitioner seeks a redetermination of income and profits taxes for the years 1920 to 1923, inclusive, for which the Commissioner has determined deficiencies as follows: 1920, $11,143.96; 1921, $20,149.52; 1922, $5,173.11; 1923, $4,420.85. The petitioner alleges error on the part of the Commissioner (1) In failing to allow as a deduction for ordinary and necessary expenses - (a) $399 contributed in 1920, and $399 contributed in 1921 to the Better American Association. (b) $250 contributed in 1921 and $250 contributed in 1923 to the All Year Club of Southern California. (c) $400 contributed in 1923 to the Greater Harbor Committee of Los Angeles. *2890 *879 (d) $24 contributed in 1921 and $20 contributed in 1923 to the Lions' Club. (e) For the year 1920, $2,177.90 expended for "molds", $217.60 for signs, $1,395.92 for alterations in an office on leased premises; during the year 1921, $1,224.07 expended in repairing automobiles; in 1923, $467.28 expended for boiler tubes to repair boilers, and one-half of $1,516.35 as traveling expenses of its president. (2) In failing to allow adequate deductions for depreciation in 1920 on "pallets" based on a cost of $4,512.16, and on "racks" based upon a cost of $1,672.75. (3) In failing to allow as a deduction for a bad debt in 1920 the amount of $300. (4) In including in plant and equipment account an amount of $700 spent in 1922 for real estate. (5) In computing deductions for depreciation for all of the years involved on the basis of the cost price of petitioner's assets less depreciation allowed in previous years, that is, by the diminishing balance method instead of computing depreciation on the basis of cost of the assets. (6) In failing to allow an adequate value at March 1, 1913, for the petitioner's clay deposits as a basis for computing depletion, and consequently*2891 in failing to allow adequate depletion allowances for the years 1920 to 1923, inclusive. (7) In failing to determine the proper invested capital of the petitioner because of the errors committed in determining depreciation and depletion for prior years. (8) In reducing invested capital on account of depletion and depreciation sustained prior to March 1, 1913. (9) In computing depletion for the years 1922 and 1923 on the clay deposits at the Montebello plant at a rate of 12.90 cents per ton instead of 14.90 cents per ton. (10) In failing to allow as a deduction from income in 1922 one-third of the depreciation sustained on a cottage known as the Beach Cottage, and one-third of the amount of $408.29 spent for supplies for the cottage, and one-third of the amount of $661.60 spent for cleaning and renovating the cottage, and also one-third of the depreciation sustained on furniture and fixtures in the cottage; for the year 1923, one-third of the depreciation sustained on the Beach Cottage and one-third of the depreciation sustained on furniture and fixtures in the cottage. FINDINGS OF FACT. The petitioner is a California corporation organized about 1898, with principal offices*2892 in Los Angeles. It is engaged in the business of manufacturing and selling brick and tile and is the owner of a number of clay-bearing tracts of land, together with the necessary plant machinery and equipment required in its business. *880 During each of the years 1920 and 1921 the petitioner contributed $399 to the Better American Federation. The Better American Federation was an organization offering advice and information relative to labor and labor conditions, which also sent representatives to the plants of its contributors in order to assist in the settling of any labor disputes. During each of the years 1921 and 1923, the petitioner contributed $250 to the All Year Club, an organization for advertising Southern California. The object of the All Year Club was to advertise Southern California and thereby bring industries into the district and induce people to come and live there. In 1923 petitioner contributed $400 to the Greater Harbor Committee, which was organized for the purpose of watching harbor developments in an effort to control the development of the harbor of Los Angeles and prevent such development from passing into the hands of local politicians. *2893 During the year 1920 petitioner expended the sum of $2,177.90 for "molds", upon which amount the Commissioner computed depreciation on the basis of a 4-year life. The life of these "molds" was only one year. During the year 1920 petitioner expended a sum of $217.60 for pasteboard signs, which amount was disallowed as an expense by the Commissioner. During the year 1921 the petitioner expended $1,224.70 for repairs made to the automobiles used in its trade or business. During the year 1923 petitioner expended $467.28 for boiler tubes to repair its boilers. During the year 1920 petitioner expended the sum of $1,395.92 in having certain changes made in an office which it rented, and under an agreement requiring that the office be restored to its original condition when vacated. The petitioner expended $4,512.16 for "pallets" in 1920. The Commissioner allowed depreciation on the "pallets" for the year 1920 at a rate of 25 per cent. The useful life of "pallets" is one year. The petitioner had expended $1,672.50 for "racks," and the Commissioner allowed depreciation for the years 1920 and 1921 at the rate of 25 per cent. The life of "racks" is two years. During the*2894 year 1922 petitioner purchased a small piece of real estate for $700, which the Commissioner in error added to the petitioner's plant account. Prior to March 1, 1913, the petitioner acquired the following tracts of land, which contained clay: In 1905 it acquired 24 acres of land known as the Santa Monica Property, at a cost of $10,618.10; in 1906 it acquired 100 acres known as Simons No. 1, at a cost of $25,350; in 1909 it acquired 15 acres known as the El Centro property, at a *881 cost of $2,072.42; it acquired 50 acres known as Simons No. 2 on October 11, 1912, at a cost of $36,250. Subsequent to March 1, 1913, petitioner acquired properties as follows: February 7, 1920, it acquired the Montebello property at a cost of $18,000. On December 30, 1922, it acquired 72 acres known as Simons No. 3 at a cost of $109,577; on July 31, 1923, it acquired 93 acres known as Simons No. 4, at a cost of $138,829. At March 1, 1913, the available clay reserves of the various tracts owned on that date were as follows: Simons No. 1, 876,468 tons; Simons No. 2, 571,655 tons; Santa Monica, 609,605 tons; El Centro, 338,470 tons. The estimated life of the deposits were: Simons No. 1, 10 years; *2895 Simons No. 2, 22 years; Santa Monica, 4 years; El Centro, 50 years. The depreciated cost of the plants of the petitioner at March 1, 1913, as shown by its books was $376,246.79. The petitioner made sales of raw clay as follows: In 1909, it sold 220 tons of raw clay for $200; in 1910 it sold 1,017.7 tons of raw clay at a price of $912.09; in 1911 it sold 944.02 tons of raw clay for $751.89; in 1912 it sold 1,409.63 tons of raw clay for $1,173.98. The Commissioner determined a value at March 1, 1913, of 4.44 cents per ton for depletion purposes of all of the clay in the petitioner's properties. The petitioner's purchase in October, 1912, known as the Simons No. 2, was made under the following conditions and restrictions: "It is provided that the premises shall not within the period of five years from this date be used for manufacturing brick, tile or for any similar purposes, and that said premises shall not be occupied by the employees or laborers, or their families, of any such factory, nor shall the same be granted, sold or leased to the employees of any such factory situated in the neighborhood of said premises." This restriction made the property thus acquired more valuable*2896 than had the restriction not existed. The fair market values of the petitioner's clay properties at March 1, 1913, and the rate per ton for depletion are as follows: Property Mar. 1, 1913, value Depletion rate Cents Simons No. 1 $38,915.18 4.44 Simons No. 2 25,375.00 4.44 Santa Monica 27,066.46 4.44 El Centro 15,208.00 4.44 During the years 1922 and 1923, the petitioner owned a piece of real estate on which it had erected a house known as the Beach House. The house was erected to demonstrate the type of brickwork that the petitioner was advocating, and to introduce a particular type of construction. It was used as a model and displayed to contractors *882 and architects, and was also featured in advertisements throughout the country. The property, since construction, was used part of the time for family purposes by the officers or stockholders and their friends or by friends of the petitioner, and was used in part for advertising and demonstration purposes. During the year 1922, the petitioner expended the sum of $661.60 for cleaning and renovating the house, and the sum of $408.29 for sundry supplies for the house. The cost*2897 of the house to and including the year 1920, was $25,612.16; to and including the year 1921, $26,269.46; to and including the year 1922, $26,493.36; to and including the year 1923, $26,601.03. The depreciation sustained on the house was as follows: During the year 1920, $320.23; during the year 1921, $648.57; during the year 1922, $659.48; during the year 1923, $663.71. The cost of the furniture, fixtures, and equipment of the Beach House to and including the year 1920 was $1,672.40; to and including the year 1921, $1,719.31; to and including the year 1922, $2,131.31; to and including the year 1923, $2,253.11. The depreciation sustained upon the furniture, fixtures, and equipment during the year 1920 was $83.62; during the year 1921, $169.59; during the year 1922, $192.53; during the year 1923, $219.22. During the year 1923 the petitioner expended $1,516.26 for traveling expenses of its president and his wife. OPINION. MILLIKEN: The expenditure of $399 in each of the years 1920 and 1921 was made to the Better American Association for the purpose of promoting good will between capital and labor, securing advice and expert assistance relative thereto, and to allay and prevent*2898 strike and other labor disturbances. These were ordinary and necessary business expenses and should be allowed as deductions. Cf. ; . The contributions of $250 in each of the years 1921 and 1923 to the All Year Club of California bore a direct relation to the business of petitioner for the years in which made, with its consequent direct benefit, and are allowable as deductions. Cf. ; . We think the benefits sought to be derived from the contribution of $400 to the Greater Harbor Committee are indirect and remote and accordingly the respondent did not err in disallowing the deduction claimed. Cf. , and . The claim for a deduction on account of contributions in 1921 and 1923 to the Lions' Club was waived by the petitioner at the hearing. Accordingly, the action of the Commissioner in disallowing these amounts as deductions is approved. *2899 *883 In 1920 petitioner expended $1,395.92 for alterations and improvements for its offices, which were in leased premises. Petitioner contends that it leased the office from month to month and that the expenditure is deductible for the year in which made. The Commissioner treated the amount as a capital expenditure and allowed a depreciation deduction of 10 per cent per year. There was no written lease and the only evidence as to the character of the lease is that it was a month to month lease, but petitioner has occupied the premises since the alterations were made in 1920 to the present. No definite term was agreed upon. In the cases of , and , we held that the cost of improvements erected by a tenant at will are not deductible in the year when made, but should be depreciated over the useful life of the improvements. The action of the Commissioner is therefore approved. The expenditures of $2,177.90 for "molds" and $217.60 for signs in 1920, and the expenditure of $1,224.07 in 1921 for repairing automobiles were conceded by the Commissioner as allowable deductions*2900 in the years when expended. During the year 1923, petitioner expended $467.28 for boiler tubes which were used in repairing boilers. This amount represented an ordinary and necessary expense to the petitioner and constitutes an allowable deduction from income for the year 1923. During September and October of 1923, W. R. Simons president of petitioner made a trip to New York for the purpose of making a general survey of the industries carrying on a business similar to that of petitioner and secure such new ideas as were possible concerning the progress being made in the industry. He was accompanied by his wife, and one-half of all of the expenses of the trip were charged to her account. We are of the opinion that one-half of such expenses or $758.18 constituted an ordinary and necessary expense and an allowable deduction for the year 1923. During the year 1920 the Commissioner allowed as depreciation on "racks" 25 per cent of $1,672.75. In the respondent's answer to the petition he admits error on this point and concedes that the depreciation for the year 1920 on this item should have been 50 per cent. During the year 1920 petitioner purchased "pallets" at a cost of $4,521.16. *2901 The respondent allowed depreciation based upon a useful life of four years. The "pallets" had a useful life of one year and the cost of the same should be allowed as a deduction for the year 1920. The issue relating to a deduction of $300 for a bad debt in 1920 was waived by the petitioner at the hearing. Accordingly, the action of the Commissioner is approved. *884 The petitioner alleges that the Commissioner used as a basis for computing depreciation the cost of the petitioner's assets less the depreciation allowed in previous years, that is, by the diminishing-balance method, instead of computing depreciation on the basis of the cost of the assets. It appears from the record that the petitioner had carried in its books the depreciated balance of the cost of its assets. It was, therefore, necessary for the petitioner to establish the total cost of its assets unreduced by depreciation. For this purpose it introduced a summary showing the cost of the several classes of assets at the end of each of the years 1919 to 1923, inclusive, which summary was made up by an accountant and taken from the books of the petitioner. There were also introduced certain rates of depreciation*2902 for the various classes of assets, and a stipulation was entered into which provided, "That the annual depreciation rates shown on petitioner's Exhibit (2) will apply during the entire period that depreciation affects invested capital." The petitioner's "Exhibit (2)" mentioned above contained the rates of depreciation previously referred to. The stipulation is not clear but it appears to deal specifically with invested capital, no mention being made of the deductions for depreciation in the years under review. It does not aid us in arriving at the annual deductions, for the reason that we are not provided with a statement showing the cost of assets actually in existence during the years under review. The corporation was organized in 1898; consequently, all the assets then existing on which a depreciation rate of more than 5 per cent is applicable would be entirely depreciated by the taxable years, and should have been eliminated from the cumulative cost accounts since they would be at least theoretically out of existence. Some of the assets have lives of three years and some of four. Therefore, assets of this character could only be included in the capital account if purchased*2903 within three or four years of the year at issue. We are not satisfied that the cumulative costs submitted by the petitioner represent the cost of assets actually in existence; and the testimony does not indicate that any adjustments have been made on account of assets totally depreciated. Consequently, we are not provided with a basis to which depreciation rates could be applied, even assuming that the stipulation, as to depreciation rates, referred to rates to be used in computing the annual deductions for depreciation. While the method employed by the Commissioner in arriving at the depreciation deductions might not be an acceptable method of computing depreciation, and might be open to serious objection, we do not have sufficient facts of record upon which we might predicate a change in the allowances made by him. The determination of the Commissioner must, therefore, be approved. *885 The petitioner contends that the March 1, 1913, value of its clay deposits was greatly in excess of the value determined by the Commissioner and asks for a depletion rate of from 14 cents to 17 cents a ton. The petitioner introduced no direct testimony as to the value of its clay*2904 lands but has endeavored to prove the value by reliance upon certain elements such as the sale of raw clay as compared with the cost thereof, the tonnage of clay in each property, the book value of the petitioner's plant and equipment at March 1, 1913, and the estimated cost of renewals and additions to the plant over the life of the deposits. Petitioner merely presents various figures, and in its brief has made some ingenious computations by which it arrives at a unit value per ton greatly in excess of that determined by the Commissioner. The respondent, on the other hand, introduces a witness who was president of the company at March 1, 1913, and who had made the purchases of clay lands, the value of which is at issue. The testimony of this witness who qualified as an expert clearly indicated that the value of $725 an acre which the Commissioner used in arriving at the unit value per ton was liberal as to each and every property involved. This cost per acre was the amount paid for the land purchased October 11, 1912, only a few months prior to March 1, 1913. The petitioner has claimed that this purchase price was less than the actual value of the clay deposit at the time on*2905 account of the restriction preventing the petitioner from extracting clay for a period of five years. This contention was not substantiated by the petitioner's witnesses. Petitioner introduced as witnesses, John B. Simons and Walter B. Simons, both connected with the taxpayer, and Frank H. Brooks, a real estate expert. The latter admitted he knew nothing about the value of clay lands and neither of the other witnesses gave positive testimony concerning the March 1, 1913, value of the lands. Their testimony was largely confined to prices paid for clay per ton at various times between 1905 to 1915, and was of little probative weight. The March, 1, 1913, value allowed by respondent is two and one-half times the cost of similar property purchased in 1906, while that claimed by petitioner based on a basis of 14 cents per ton is three and one-half times over the cost of similar property purchased a few months prior to March 1, 1913, and one and one-half times cost of similar property purchased in 1922 and 1923. As between theoretical computations and the positive testimony of a person fully conversant with the value of the property at March 1, 1913, we accept the latter. Accordingly, *2906 the value of the clay deposits at March 1, 1913, and the depletion rate determined by the Commissioner is approved. *886 The petitioner claims that invested capital should not be reduced by depreciation and depletion sustained prior to March 1, 1913, and cites in support thereof the decision in the case of . Section 326 of the Revenue Act of 1918 and corresponding sections of the 1921 Act provide that invested capital shall include (1) actual cash bona fide paid in for stock or shares, (2) actual cash value of tangible property other than cash bona fide paid in for stock or shares at the time of such payment, (3) paid-in or earned surplus and undivided profits, not including surplus and undivided profits earned during the year. The amount of the earned surplus is a fact which must be determined under facts obtaining in each case. The court, in the Ludey case, referred to depreciation as being similar to the sale of a portion of property each year, just as in the case of minerals a part of the mineral is extracted and sold each year. Consequently, the original capital invested in the asset is reduced by the amount*2907 of such loss or the amount of such sale and must be restored out of the earnings before earned surplus can be determined. Depreciation of property and depletion of a natural deposit are facts, not theories, and the loss occasioned by such depreciation or depletion must be taken care of out of earnings in order to maintain the original capital invested. On the record before us, we therefore approve the action of the Commissioner in reducing invested capital on account of depletion and depreciation sustained prior to March 1, 1913. Compare our recent decision in , and the extended discussion of , and see ; ; ; ; and . Inasmuch as we have approved the action of the Commissioner in computing depreciation and depletion, we must also approve his determination of invested capital except in so far as this decision may*2908 result in adjustments to invested capital during the years involved. During the years 1922 and 1923, the Commissioner computed depletion on the clay deposits at the Montebello plant at a rate of 12.9 cents a ton, whereas, the petitioner claims it should be entitled to 14.9 cents. No evidence was introduced by the petitioner in support of this contention. Accordingly, the action of the Commissioner is approved. The Beach Cottage which the petitioner erected was used for advertising and display purposes, and was available for such purposes at all times. The fact that it was infrequently used by officers or stockholders of the petitioner or friends for personal use does not affect the right of the petitioner to deduct depreciation and other expenses *887 connected with the cottage. It is inconceivable to us how a corporation could occupy a cottage or have a cottage occupied for personal uses. The money spent in cleaning and renovating the cottage and in acquiring supplies for the cottage are expenses necessary to aid in advertising and are business expenses connected with assets used in the petitioner's business. We are, therefore, of the opinion that the petitioner*2909 is entitled to deduct in 1922 the entire amount of depreciation suffered on the Beach Cottage amounting to $659.48; the entire depreciation suffered on furniture and fixtures amounting to $192.53; and the entire amount of $661.60 for cleaning and renovating the cottage; and the entire amount of $408.29 spent for supplies; and for the year 1923, the petitioner is entitled to deduct the entire depreciation suffered on the cottage amounting to $663.71, and the depreciation suffered on the furniture and fixtures of the cottage amounting to $219.22. Reviewed by the Board. Judgment will be entered under Rule 50.