Atwater Kent Mfg. Co. v. Commissioner

ATWATER KENT MANUFACTURING CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Atwater Kent Mfg. Co. v. Commissioner Docket No. 21551. United States Board of Tax Appeals 15 B.T.A. 881; 1929 BTA LEXIS 2772; March 15, 1929, Promulgated *2772 An amount expended in construction of new building attributable to early occupancy thereof held to be a capital expenditure exhaustible over the life of the building. Frank & Seder Co.,13 B.T.A. 1. Paxson Deeter, Esq., for the petitioner. F. R. Shearer, Esq., for the respondent. SMITH *881 This proceeding is for the redetermination of a deficiency for the year 1923 in the amount of $7,309.32. Petitioner claims as a deduction for that year an alleged amount expended to secure early occupancy of a new building constructed by it during the taxable year. *882 FINDINGS OF FACT. Petitioner is a Pennsylvania corporation with its principal office at 4700 Wissahickon Avenue, Philadelphia, Pa. Its business is manufacturing and selling radio receiving sets and parts. Until May, 1923, it manufactured the parts only, to be assembled by the purchasers. At about that time it decided to do the work of assembling the parts itself and to turn out complete radio receiving sets for the market. To carry out this plan it was necessary to make considerable additions to its plant and equipment. The radio business is, and*2773 was during the years 1922 and 1923, to a large extent seasonal, the fall and winter months being the most productive ones. For this reason the petitioner was anxious to have its plant addition ready for occupancy not later than October 1, 1923, so as to be able to secure the fall trade of that year. The firm of Ballinger & Co., architects, a partnership composed of W. F. Ballinger and others, was employed to construct the new plant. The plans proposed by them and accepted by petitioner called for the construction in four units of a complete new plant covering an entire block. A contract was let within a few days calling for completion of the first unit by September 15 if possible. The architects were to receive as compensation a fee of 10 per cent of the total cost of construction. The so-called cost-plus plan was the only one upon which Ballinger & Co. would undertake to complete the work within the time specified. The first unit was completed and ready for occupancy by October 1, 1923. It contained approximately 65,892 square feet of floor space and had cost the petitioner $5.81 a square foot. Under ordinary conditions two or three months longer would have been required*2774 for completing the work. In February, 1924, the petitioner contracted with Ballinger & Co. for the construction of the second unit. It embodied practically the same construction as the first unit and was considerably larger. It cost the petitioner $3.59 per square foot. The cost of labor and material was practically the same in both the years 1923, when the first unit was constructed, and 1924, when the second unit was constructed. The contract for construction of the second unit was secured by general bid and was not on the cost-plus plan. Under date of March 13, 1924, W. F. Ballinger, in reply to petitioner's inquiry about the comparative costs of constructing the respective units, wrote the petitioner the following letter: We have your recent inquiry in which you state that the section of the building erected last year, containing 65,892 sq. ft. cost $383,339.92, or $5.81 per sq. ft., whereas the new section contracted for last month containing 256,000 sq. ft. cost $3.59 per sq. ft., or a difference of $2.22 per sq. ft. or a *883 total excess in cost in the old section over the new of $133,115.02, and your further inquiry as to how much of this excess cost was*2775 due to the necessity for speed in construction. We have gone over our figures including estimates received from various sub-contractors, and find that the difference due to the endeavor to get the building completed and ready for occupancy by October 1, 1923, cost you $61,270 more than if there had been ample time. Contracts had to be let before drawings were completed, thereby making it difficult to secure as close competitive bids. This effect more or less was felt by all sub-contractors as it was necessary in many cases to have them work their men overtime, paying higher rates therefor; also the structural steel of 410 tons had to all be taken out of stock instead of waiting for mill rollings, and a bonus was given to the steel contractor for quick fabrication and shipment. It was also necessary to keep more labor on the job at times when they could not work to the best advantage, because of the fact that if we let them of at noon when there was not sufficient work ready for them, it was a certainty that we should not get them back next morning when we might badly need them. W. F. Ballinger died in December, 1924. His son, Robert I. Ballinger, who succeeded him in the*2776 firm of Ballinger & Co., found certain memoranda among his papers indicating that the sum of $61,270, said to represent the additional cost of the effort to complete the construction of the first unit by October 1, was arrived at as follows: Additional cost of structural steel $ 12,300 "Bonuses" or "overtime pay" for labor 15,500 Additional sums paid to subcontractors 27,900 Architect's fee of 10 per cent of total 5,570 The detailed records supporting the above figures could not be found. None of the contracts made by Ballinger & Co. with subcontractors called for any specified bonus for the delivery of materials or the completion of a job by a certain date, but all were made at prices higher than would ordinarily have been paid at that time. The excess cost of the construction of the plant due to the effort to complete it by October 1, 1923, was not less than $61,270. In its income-tax return for the year 1923 the petitioner deducted from gross income as an expense of that year the sum of $61,270, which it claimed was a sum paid for early occupancy of its new plant. The respondent disallowed the deduction. OPINION. SMITH: In its petition as amended*2777 the petitioner alleges that the respondent erred in his computation of its tax liability for the year 1923 in disallowing the deduction from gross income of the amount of $61,270 taken as an expense deduction in its return for that year, and in failing to find that "the sum of $61,270 was a proper item of depreciation of petitioner's factory for the calendar year 1923, and *884 as such deductible in computing petitioner's income tax for that year." We can not doubt from the evidence that the cost of the construction of the petitioner's building in 1923 greatly exceeded the amount which would have been paid for its construction had the petitioner mot desired to have it completed at or prior to October 1, 1923. We think that the evidence supports the contention of the petitioner that the excess cost of the construction due to the early completion of its plant was fully $61,270, and have so found. The petitioner contends that it paid this excess cost solely for the use of its plant from October 1 to November 15, 1923, and that at November 15 the value represented by the expenditure was gone; that on and after December 1, 1923, the building was worth no more than if it had*2778 been completed within the usual time, and that the excess amount paid for early completion is a direct charge against its profits for the year 1923. It contends that it is entitled to the deduction of the amount either as an ordinary and necessary expense of doing business in 1923, or as depreciation sustained within the year 1923. Section 215(a)(2) of the Revenue Act of 1921 provides as follows with respect to deductions which may be taken by individuals in making income-tax returns: (a) That in computing net income no deduction shall in any case be allowed in respect of - * * * (2) Any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate. Section 235 of the same Act provides with respect to the computation of the net income of corporations: That in computing net income no deduction shall in any case be allowed in respect of any of the items specified in section 215. We think it is clear that the entire cost of the building erected in 1923 was an amount paid for new buildings within the meaning of section 215(a)(2) of the Revenue Act of 1921, and is specifically excluded from the deductions*2779 allowable in computing net income. The fact that the cost of construction under the circumstances here was in excess of the amount that would have been paid out for the construction of the building in ordinary course, does not change the character of the expenditure. The petitioner further contends that the excess cost for early completion was a direct charge against profits for 1923, since such excess cost was paid in order that profitable operations could be carried on in the building during October and November of 1923. Granted that such operations were profitable, there is no proof that *885 the profits of the year have any direct relation to the excess cost of early completion. On the ground of indefiniteness, the contention must be and is denied. Section 234(a)(7) of the Revenue Act of 1921 provides that in computing the net income of a corporation there shall be allowed as a deduction "a reasonable allowance for exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence." In *2780 , the Supreme Court said: * * * The depreciation charge permitted as a deduction from the gross income in determining the taxable income of a business for any year represents the reduction, during the year, of the capital assets through wear and tear of the plant used. 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 theory underlying this allowance for depreciation is that by using up the plant a gradual sale is made of it. The depreciation charged is the measure of the cost of the part which has been sold. * * * This theory of the statutory deduction for depreciation is in harmony with the Commissioner's regulations under the Revenue Act of 1921, as well as prior and subsequent acts. The amount of the deduction on account of depreciation allowable in any taxable year must be determined with regard to the actual "wear and tear" of the thing used. There is nothing*2781 to indicate that the petitioner's plant here was put to any harder usage or that it actually sustained any greater depreciation in the year 1923 than in the following years. We can not say that the petitioner used up in the year 1923 all of the additional cost of constructing the plant in that year, or that no further profits from this additional cost came to the petitioner after the end of the year 1923. The petitioner cites in support of its contention , where we held that an expenditure made by a taxpayer to a prior tenant for possession of the premises for a specific period of two years preceding the time that the taxpayer would have come into possession in his own right afforded no benefits beyond the two-year period and therefore should be amortized ratably over the two-year period. In that case, the property subject to exhaustion was a leasehold for a term of years. The time element was the only factor to be considered in determining the amount of the deduction. In the instant case we are concerned with physical properties subject to wear and tear, or the gradual wasting away through usage. The deduction allowable in different*2782 years over the life of the property may vary according to the usage it is put to and according to the precautions that are taken for its preservation. The statute requires *886 only that the deduction be reasonable in amount. The distinction to be made in determining the exhaustion or depreciation deduction in respect of the two classes of property is, we believe, imperative. In , we held that the additional construction costs incurred solely for the purpose of obtaining early occupancy of a building should be exhausted over the entire life of the building. The decision in that case is controlling here. The amount in dispute here was admittedly paid out by the petitioner as a part of the construction cost and as such must be exhausted ratably over the entire useful life of the building. Judgment will be entered for the respondent.