Pittsburgh Brewing Co. v. Commissioner

PITTSBURGH BREWING COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Pittsburgh Brewing Co. v. Commissioner Docket Nos. 83386, 88626. United States Board of Tax Appeals 37 B.T.A. 439; 1938 BTA LEXIS 1035; March 3, 1938, Promulgated *1035 1. In computing the basis for gain or loss and for depreciation in 1933 and 1934, cost must be reduced by depreciation deducted for prior years which is to be regarded as "allowed", even though greater losses sustained in such prior years made such depreciation deductions unavailing to reduce taxes. 2. In a depreciation method applied to specific assets or groups and not a composite method, excess depreciation of one asset or group may not be used to reduce the basis of another. Aaron Holman, Esq., and I. Newton Brozan, Esq., for the petitioner. Edward A. Tonjes, Esq., and H. P. Miller, Esq., for the respondent. STERNHAGEN *440 The Commissioner determined deficiencies of $7,522.65 and $5,329.49 in petitioner's income taxes for the fiscal years ended October 31, 1933, and 1934, respectively. The deductions for depreciation on breweries were reduced for both years: For 1933 the gain on the sale of two breweries was increased by reducing the basis to reflect greater depreciation in prior years; and for 1934 income was increased by insurance received for the burned roof of a building, the cost of which was determined to have been*1036 fully recovered through depreciation. Other issues were withdrawn or settled by stipulation. FINDINGS OF FACT. Petitioner is a Pennsylvania corporation, with principal office at Pittsburgh, Pennsylvania. On January 15, 1920, before the Eighteenth Amendment to the Constitution took effect, it was the owner of 14 breweries. Thereafter it ceased to operate all of its plants except one, known as the Iron City Brewery, which it has continuously operated since; on November 1, 1933, it commenced the operation of two others. For the taxable years 1916 to 1919, inclusive, petitioner sought the deduction of obsolescence on its plants and equipment, and filed petitions with this Board for redetermination of deficiencies for those years. These proceedings were, on April 10, 1932, settled by a stipulation that $3,650,361.58 was deductible as obsolescence for the period January 31, 1918, to January 15, 1920; and judgments of the Board were entered giving effect to the stipulation. During the years after January 15, 1920, petitioner set up on its books and deducted on its income tax returns depreciation computed upon bases increased by the cost of additions and undiminished by any part*1037 of the obsolescence subsequently allowed as a deduction. Such depreciation deductions were regularly taken for every year from 1920 to 1931, inclusive, in respect of the operating plant, and from 1920 to 1925, inclusive, in respect of the nonoperating plants. For 1932 depreciation deductions were claimed on all plants which had not been sold. The amounts for that year, however, were upon a basis adjusted by the stipulated obsolescence for 1918 and 1919. During the whole period from January 15, 1920, to October 31, 1932, petitioner, on its income tax returns, deducted in the aggregate $1,312,218.01 for depreciation. In the years 1920 to 1931, petitioner sustained losses totaling $2,923,427.16, the loss for each year being in excess of the depreciation deduction taken. Under petitioner's bookkeeping system, separate depreciation accounts have been maintained for the buildings, brewing machinery, engine room machinery, refrigerator machinery, stationary cooperage, furniture and fixtures, and cooper shop machinery belonging to *441 each of its several breweries; and no composite depreciation method has ever been used either on the books or on the income tax returns. The*1038 depreciation rates used (about which there is no dispute) varied in respect of the several classes of assets. One-half of such rates were applied to the equipment of nonoperating plants. After the allowance of the obsolescence deduction for 1918 and 1919, petitioner, using the same rates, rewrote its plant accounts for each year from January 15, 1920, to October 31, 1932, and reduced the bases by the stipulated obsolescence. It computed depreciation separately on the several classes of assets of each brewery for each year, including its fiscal years ended October 31, 1933, and 1934. Reduced by the stipulated obsolescence, the value of petitioner's properties on January 15, 1920, appeared as $807,695.01; $618,362.56 appeared as the adjusted basis of properties still held in 1933, and $542,829.27 as the cost of additions. On this total basis of $1,161,191.83, petitioner recomputed an aggregate depreciation of $398,276.75, of which $31,326.47 was allocated to the fiscal year ended October 31, 1933, and deducted on its income tax return. As augmented by the cost of additions, the depreciable basis of the properties on October 31, 1934, appeared as $1,317,087.47, and depreciation*1039 of $43,744.03 was written off, but $60,236.62 was deducted on the income tax return. In determining the deficiencies for the fiscal years 1933 and 1934, the Commissioner allowed depreciation deductions of $4,240.85 and $25,514.16, respectively. In the computation of these amounts he took into account the deductions taken for depreciation on prior income tax returns, and finding that in some instances the deductions taken on account of depreciation and obsolescence exceeded the cost of the asset, he distributed that excess over other assets, allocating parts of it to periods prior to 1933 and 1934. In some instances this excess was applied to the cost of assets for periods prior to their acquisition. During its fiscal year 1933 petitioner sold its Latrobe and McKeesport breweries for $44,796 and $6,000, respectively. The value of the Latrobe brewery, reduced by the stipulated obsolescence, appeared as $33,920.17 on January 15, 1920. On its income tax returns for the years from January 15, 1920, until the sale, petitioner had deducted an aggregate of $15,955.45 as depreciation on this plant and equipment. In the revised accounts of 1933 the recomputed aggregate depreciation*1040 appeared as $8,664.34, and a gain of $19,540.17 from the sale was reported on its income tax return. The Commissioner, by increasing the amount of depreciation to $20,361.99, determined a gain of $31,237.82. This figure is the sum of depreciation deducted on petitioner's tax returns and the amounts shown by petitioner in *442 its revised accounts for the years 1926 to 1931, inclusive, for which no depreciation on this property was deducted on the returns. The value of the McKeesport brewery, reduced by the stipulated obsolescence, appeared as $8,899.95 on January 15, 1920. By the same method as that described above as to the Latrobe plant, a profit of $865.98 on its sale was reported, using $3,765.93 as the depreciation since January 15, 1920. The Commissioner determined that the brewery had been completely depreciated, and included the entire sale price of $6,000 in petitioner's income as gain. In 1934 petitioner received $1,500 insurance on account of the destruction by fire of the roof of the Keystone brewery building. The value of this building, reduced by the stipulated obsolescence, appeared as $47,500.52 on January 15, 1920. On its income tax returns for the*1041 fiscal years ending in 1920 to 1925, inclusive, 1932, and 1933, petitioner deducted depreciation on it aggregating $18,390.67. For the years 1926 to 1931, inclusive, for which no depreciation was deducted on the returns, it wrote off on its books, as revised, an aggregate depreciation of $7,125.06. The sum of this amount and depreciation deducted on the returns is $25,515.73; the amount of undepreciated base, so computed, is $21,984.79. In the revision of its books in 1933 petitioner wrote off a total depreciation of $16,387.64; the amount of undepreciated base, computed by the use of this figure, is $31,112.88. In determining petitioner's income tax for the fiscal year ended October 31, 1934, the Commissioner added the insurance payment of $1,500 to income "inasmuch as the entire cost of the Keystone Building was recovered through depreciation allowances of prior years * * *." OPINION. STERNHAGEN: The petitioner complains of three errors charged to the respondent in the determination of the deficiencies for the fiscal years 1933 and 1934. These, however, all turn upon the proper use or recognition to be given to the depreciation of petitioner's several plants in the years*1042 beginning 1920. The depreciation actually accounted for by the petitioner and deducted on its annual returns was computed without regard to such obsolescence as in 1918 and 1919 was properly attributable to the Prohibition Amendment, which became effective January 29, 1920. See Burnet v. Niagara Falls Brewing Co.,282 U.S. 648. Notwithstanding the fact that the petitioner had pending a claim with the Commissioner for large deductions in those years because of such obsolescence, its depreciation was computed, accounted for, an deducted irrespective of such obsolescence. The depreciation deductions taken on the returns were not disputed by the Commissioner, and remained throughout all the prohibition years undisturbed. During the years 1920-1925, the *443 depreciation deductions were substantial and applied to both the operating and inactive plants; after 1925, depreciation was no longer either recognized on the accounts or taken in the returns in respect of the nonoperating plants. The petitioner now claims that the recognition by the stipulation of 1932 of prohibition obsolescence for the years 1918 and 1919 requires a reduction pro tanto of the*1043 depreciation base of its plants, a reduction in the depreciation of all of the intervening years, and a higher remaining base at the beginning of 1933 which mathematically results therefrom. Essentially, therefore, the question is whether the petitioner's base for 1933 and 1934, both for depreciation and for the computation of its gain upon properties sold, shall be computed with reference to the depreciation sometimes actually deducted and sometimes properly deductible on its returns for prior years, as the respondent contends, or with reference to a corrected intervening depreciation computed as if the stipulated obsolescence deduction had actually been used in 1918 and 1919 and recognized thereafter. The petitioner constructs an elaborate argument upon the Supreme Court's discussion of the general principles of depreciation in United States v. Ludey,274 U.S. 295. That opinion involved a consideration of the Revenue Act of 1916, and the Court held that in the absence of an express statutory provision, "Congress doubtless intended" that the basis for determining the gain from the sale of a wasting asset should be determined upon a cost reduced by the depreciation*1044 sustained. The legislative intent in that case had not been expressed in the statute, and the Court was therefore required to make a judicial inference. Cf. Burnet v. Thompson Oil & Gas Co.,283 U.S. 301. But the present case is controlled by the Revenue Act of 1932, which, in section 113(b)(1)(B), provides that adjustment of the basis for gain or loss upon the sale of property shall in all cases be made "in respect of any period since February 28, 1913, for exhaustion, wear and tear, obsolescence, and depletion, to the extent allowed (but not less than the amount allowable) under this Act or prior income tax laws." There is no room for doubt, therefore, that the basis for gain or loss as well as the basis for future depreciation (which are identical, section 114(a), Revenue Act of 1932), must be adjusted by the intervening deductions allowable by law or any greater allowances which may in fact have been taken. Thus Congress has foreclosed any discussion of a theoretical computation of depreciation which might have been provoked by the opinion in the Ludey case. The petitioner, however, points to the fact that the depreciation deductions taken by it upon*1045 its earlier returns were wholly ineffective because its losses otherwise determined exceeded its gross income. Since, therefore, no tax was due from it in any event, the petitioner argues that no depreciation deductions have been "allowed", and *444 hence the provision of 113(b)(1)(B) is beside the point. This contention is not new. It has been considered and rejected, Hardwick Realty Co. v. Commissioner, 29 Fed.(2d) 498; dismissed, 279 U.S. 876; Franklin Lumber & Power Co.,18 B.T.A. 1207; 50 Fed.(2d) 1059. In United States Trust Co. of New York et al., Trustees,31 B.T.A. 54, the Board said: * * * If deductions for exhaustion, wear, and tear have been allowable in respect of such property since its acquisition by the taxpayer, all of those deductions must be used to diminish the basis. Cf. United States v. Ludey,274 U.S. 295; Fidelity-Philadelphia Trust Co. v. Commissioner, 47 Fed.(2d) 36, affirming *1046 18 B.T.A. 43. Thus it matters not that there was no income to be offset by the deductions allowable * * *. If there were any doubt as to the legal effect of the statutory language, the intention is made clear by the discussion appearing in the Report of the Senate Finance Committee, set forth in the margin. 1 The evidence contains various mathematical computations of the parties and there seems to be no dispute as to the mathematical application of the principle which should be applied. There appears to be agreement as to the depreciation deductions actually taken and, therefore, to be regarded as allowed, during the period 1920-1925, and that these amounts are no less than the amounts properly allowable. There appears to be no disagreement as to the amounts which for the years 1926-1931 were properly allowable, although not in fact deducted, and also as to such amounts within this latter period as were in fact deducted and allowed. For 1932 the petitioner computed the depreciation upon its operating plant upon a basis reduced by the stipulated obsolescence. The principle of this is not disputed by the Commissioner. *1047 *445 In the respondent's determination, however, appears a clear error. There was no composite depreciation used, and in a method of depreciating specific groups of assets there is no justification for applying the excessive amount computed as to one asset or group so as to reduce the basis of another. This the Commissioner has done, as shown by the findings, and the error must be corrected in a recomputation. It is manifest also that in such a system of specific depreciation the Commissioner may not reduce the basis of an asset in 1933 by applying an alleged figure of depreciation for a period prior to the acquisition of the specific asset in question. This error also must be corrected in a recomputation. One of the results of the last mentioned error of the Commissioner is the occasion for the petitioner's third complaint. The insurance of $1,500 received by the petitioner as a result of the Keystone fire has been treated by the Commissioner as income in its entirety because the Keystone plant appeared by his computation to have been entirely exhausted by depreciation. Such apparent complete exhaustion was, however, only the result of improperly applying depreciation*1048 of other properties to the Keystone plant. But at the time of the receipt of the insurance, the Keystone plant was not yet fully depreciated, and the insurance received should properly be applied against the remaining undepreciated base. No part of it is to be included in the petitioner's income for the taxable year. In summary, it results from this opinion that a recomputation should be made in which the basis of petitioner's properties in 1933 and 1934, both for the current deductions for depreciation and for the determination of gain upon such properties as were sold, shall be found by applying against the cost or properly adjusted basis all of the deductions taken by the petitioner on its returns, but not less than the amounts properly allowable where no deductions were actually taken; that such deductions are to be applied only against the specific assets depreciated and may not be shifted to other assets; that no depreciation for the purpose of reducing the basis in 1933 and 1934 may be recognized for any period prior to the acquisition of the specific asset in question; and that the Keystone insurance is to be applied to reduce the basis properly computed as above set forth*1049 and not to be treated as additional income. The stipulation as to the allowance of petitioner's bad debt deductiion should be taken into account in the recomputation. Judgment will be entered under Rule 50. Footnotes 1. SECTION 113(b)(1). ADJUSTED BASIS * * * In subparagraph (B), relating to depreciation, etc., for the period since February 28, 1913, the bill requires that adjustment be made "to the extent allowed (but not less than the amount allowable)" instead of "by the amount * * * allowable" as in the prior act. The Treasury has frequently encountered cases where a taxpayer, who has taken and been allowed depreciation deductions at a certain rate consistently over a period of years, later finds it to his advantage to claim that the allowances so made to him were excessive and that the amounts which were in fact "allowable were much less. By this time the Government may be barred from collecting the additional taxes which would be due for the prior years upon the strength of the taxpayer's present contentions. The Treasury is obliged to rely very largely upon the good faith and judgment of the tax payer in the determination of the allowances for depreciation, since these are primarily matters of judgment and are governed by facts particularly within the knowledge of the taxpayer, and the Treasury should not be penalized for having approved the taxpayer's deductions. While the committee does not regard the existing law as countenancing any such inequitable results, it believes the new bill should specifically preclude any such possibility. Your committee has not thought it necessary to include any express provision against retroactive adjustments of depreciation on the part of the Treasury as the regulations of the Treasury seem adequate to protect the interests of taxpayers in such cases. These regulations require the depreciation allowances to be made from year to year in accordance with the then known facts and do not permit a retroactive change in these allowances by reason of the facts developed or ascertained after the years for which such allowances are made. * * * [Report No. 665, 72d Cong., 1st sess., p. 29.] ↩