[336] OPINION.
Mokris :
The total depreciation charged off by the taxpayer on its books to December 31, 1917, amounted to $58,991.05. The Com[337] missioner has determined that the total depreciation sustained to the same date amounts to $136,918.04, and, therefore, he has reduced the taxpayer’s invested capital by the amount of $77,926.99 (the amount set out in the petition is $77,400.95), because of depreciation alleged to have been sustained in years prior to 1918, and which the taxpayer failed to write off on its books of account. The total depreciation of $136,918.04, which the Commissioner alleges was sustained to December 31, 1917, was determined by him in the following manner:
Total depreciation deducted on the books to December 31, 1920_$283, 606.54
Deduct: Depreciation on franchises 1903 to 1920, 18 years at $4,000 per annum- 72,000.00
Depreciation sustained from 1914 to 1920, 7 years_ 211,606.54
Annual depreciation deduction (1/7 of $211,606.54_ 30, 229.51
Add: Annual deduction for amortization of franchises_ 4, 000.00
Total annual deduction_ 34,229.51
Total depreciation sustained 1914 to 1917, 4 years_ 136, 918.04
It will be noted from the foregoing that the Commissioner has arbitrarily spread the total depreciation allowance charged off on the taxpayer’s books, to the end of 1920, ratably over the seven-year period 1914 to 1920, inclusive, although the proven facts are that the depreciation was not actually sustained in equal annual amounts and that no depreciation was sustained in the years 1914 and 1915. The taxpayer charged off no depreciation in the years 1914 and 1915, because of the large amounts it had spent in those years in bettering its equipment and which it had charged to expense on the books of account. While, in years prior to 1914, its average annual expenditure for betterment and maintenance of equipment was approximately $7,000, in the years 1914 and 1915 it expended for these purposes the sums of $19,341.03 and $29,998.74, respectively. The taxpayer considered that the expenditure of these amounts and the charging thereof to expense was sufficient to take care of any depreciation sustained during those years, and, hence it charged off no depreciation specifically as such in those years. In 1916 the impending shortage and approaching end of the source of supply of natural gas became apparent to the taxpayer. That the shortage was imminent and the time of suspension of operations could be foreseen, was not mere guesswork but was based upon experience, statistics, figures and facts from both private and public sources. From that year on, the taxpayer charged off annually increasing amounts to take care of not only the actual wear and tear suffered by its physical assets, but also the impending obsoleteness which was overtaking these assets and extinguishing their value before the expira[338] tion of their normal useful life. Thus it is apparent from these facts that any arbitrary spread of the total depreciation taken on the taxpayer’s books, during the period 1916 to 1920, inclusive, ratably over the period 1914 to 1920 as the Commissioner has done, is unwarranted and not in consonance with the actual facts.
However, it appears that the taxpayer had not, prior to 1916, charged off on its books any depreciation of franchises. These franchises were acquired in 1903 and had a value, at the date of acquisition, of $100,000. The Commissioner has determined that the life of these franchises at the date of acquisition was 25 years, and this has not been rebutted by the taxpayer. It is apparent, therefore, that at the close of the year 1915, 13 years of the life of these franchises had expired. By the very nature of these franchises, they are invariably subject to exhaustion because the life thereof is of limited duration. Unlike exhaustion in the case of such items as machinery and equipment, which may be arrested through better-ments and replacements, exhaustion in the case of franchises is definite and certain and can not be stayed. The passing of each year means the franchises have one year less of life to run and marks a proportionate loss of the capital invested in them. In the case of the franchises under consideration, the annual loss of capital occasioned by exhaustion is $4,000, and the accumulated exhaustion from 1903 to the close of 1915, a period of 13 years, was $52,000, which must be reckoned with in the computation of invested capital. Whether provision was made for exhaustion of franchises in the depreciation written off by the taxpayer for the years 1916 and 1917, we do not know. The Commissioner offered no affirmative evidence that the depreciation written off in those years was not sufficient to take care of such exhaustion; and, certainly, the method he adopted in determining the allowances to be made for depreciation in those years, affords no proof of the reasonableness or the adequacy of the deductions made by the taxpayer.
The foregoing leads us to the conclusion that the Commissioner was justified in reducing taxpayer’s invested capital for the year 1918 to the extent of $52,000, because of inadequate depreciation charged off by the petitioner on its books, through failure to make provision for exhaustion of franchises; and, since the reduction made by the Commissioner for inadequate depreciation is $77,926.99, the invested capital, as he has determined it to be, should be increased $25,926.99.
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[336] OPINION.
Mokris :
The total depreciation charged off by the taxpayer on its books to December 31, 1917, amounted to $58,991.05. The Com[337] missioner has determined that the total depreciation sustained to the same date amounts to $136,918.04, and, therefore, he has reduced the taxpayer’s invested capital by the amount of $77,926.99 (the amount set out in the petition is $77,400.95), because of depreciation alleged to have been sustained in years prior to 1918, and which the taxpayer failed to write off on its books of account. The total depreciation of $136,918.04, which the Commissioner alleges was sustained to December 31, 1917, was determined by him in the following manner:
Total depreciation deducted on the books to December 31, 1920_$283, 606.54
Deduct: Depreciation on franchises 1903 to 1920, 18 years at $4,000 per annum- 72,000.00
Depreciation sustained from 1914 to 1920, 7 years_ 211,606.54
Annual depreciation deduction (1/7 of $211,606.54_ 30, 229.51
Add: Annual deduction for amortization of franchises_ 4, 000.00
Total annual deduction_ 34,229.51
Total depreciation sustained 1914 to 1917, 4 years_ 136, 918.04
It will be noted from the foregoing that the Commissioner has arbitrarily spread the total depreciation allowance charged off on the taxpayer’s books, to the end of 1920, ratably over the seven-year period 1914 to 1920, inclusive, although the proven facts are that the depreciation was not actually sustained in equal annual amounts and that no depreciation was sustained in the years 1914 and 1915. The taxpayer charged off no depreciation in the years 1914 and 1915, because of the large amounts it had spent in those years in bettering its equipment and which it had charged to expense on the books of account. While, in years prior to 1914, its average annual expenditure for betterment and maintenance of equipment was approximately $7,000, in the years 1914 and 1915 it expended for these purposes the sums of $19,341.03 and $29,998.74, respectively. The taxpayer considered that the expenditure of these amounts and the charging thereof to expense was sufficient to take care of any depreciation sustained during those years, and, hence it charged off no depreciation specifically as such in those years. In 1916 the impending shortage and approaching end of the source of supply of natural gas became apparent to the taxpayer. That the shortage was imminent and the time of suspension of operations could be foreseen, was not mere guesswork but was based upon experience, statistics, figures and facts from both private and public sources. From that year on, the taxpayer charged off annually increasing amounts to take care of not only the actual wear and tear suffered by its physical assets, but also the impending obsoleteness which was overtaking these assets and extinguishing their value before the expira[338] tion of their normal useful life. Thus it is apparent from these facts that any arbitrary spread of the total depreciation taken on the taxpayer’s books, during the period 1916 to 1920, inclusive, ratably over the period 1914 to 1920 as the Commissioner has done, is unwarranted and not in consonance with the actual facts.
However, it appears that the taxpayer had not, prior to 1916, charged off on its books any depreciation of franchises. These franchises were acquired in 1903 and had a value, at the date of acquisition, of $100,000. The Commissioner has determined that the life of these franchises at the date of acquisition was 25 years, and this has not been rebutted by the taxpayer. It is apparent, therefore, that at the close of the year 1915, 13 years of the life of these franchises had expired. By the very nature of these franchises, they are invariably subject to exhaustion because the life thereof is of limited duration. Unlike exhaustion in the case of such items as machinery and equipment, which may be arrested through better-ments and replacements, exhaustion in the case of franchises is definite and certain and can not be stayed. The passing of each year means the franchises have one year less of life to run and marks a proportionate loss of the capital invested in them. In the case of the franchises under consideration, the annual loss of capital occasioned by exhaustion is $4,000, and the accumulated exhaustion from 1903 to the close of 1915, a period of 13 years, was $52,000, which must be reckoned with in the computation of invested capital. Whether provision was made for exhaustion of franchises in the depreciation written off by the taxpayer for the years 1916 and 1917, we do not know. The Commissioner offered no affirmative evidence that the depreciation written off in those years was not sufficient to take care of such exhaustion; and, certainly, the method he adopted in determining the allowances to be made for depreciation in those years, affords no proof of the reasonableness or the adequacy of the deductions made by the taxpayer.
The foregoing leads us to the conclusion that the Commissioner was justified in reducing taxpayer’s invested capital for the year 1918 to the extent of $52,000, because of inadequate depreciation charged off by the petitioner on its books, through failure to make provision for exhaustion of franchises; and, since the reduction made by the Commissioner for inadequate depreciation is $77,926.99, the invested capital, as he has determined it to be, should be increased $25,926.99.
For the years 1918 and 1920, taxpayer claimed deductions in its returns for depreciation in the respective amounts of $73,688.92 and $70,926.57. The Commissioner has allowed a depreciation deduction for each year in the amount of $34,229.51, determined in the manner heretofore outlined, disallowing the amounts in excess [339] thereof, thereby increasing the net income of the years 1918 and 1920 by the amounts of $39,459.41 and $36,697.06, respectively. The taxpayer contends that the allowances made by the Commissioner are clearly the result of an arbitrary mathematical allocation with no consideration of the facts and conditions as they existed at the time. It is further pointed out that the Commissioner has given no consideration to the impending obsoleteness, first ascertained in 1916, which was overtaking the physical assets and extinguishing their value before the expiration of their normal useful life. We are of the opinion that the evidence clearly sustains the contentions of the taxpayer in this respect. It seems more logical and more in harmony with the proven fact that the greater losses in value obtained with the impending shortage and approaching end of the source of supply of natural gas. As we have heretofore pointed out, the taxpayer, because of experience, statistics, figures and facts, from both private and public sources, was in a position definitely to foresee the imminent shortage of natural gas and the suspension of operations. The beginning was in 1916, when the principal source of supply of the Clarion Gas Co. of Pennsylvania commenced to fail and forced the taxpayer to rely on local gas fields, the limit of which it already knew through experience with its own gas wells, and the end was officially determined by the Public Utilities Commission of the State of Ohio, which recognized the physical impossibility of obtaining natural gas and permitted the taxpayer to give up its service. The Commissioner has offered no logical basis for the computation of the allowances for depreciation which he has made for these two years. The amounts do not purport to be based upon the useful life of the property; while no consideration whatever has been given to the above related facts. He has simply taken the total depreciation charged off on the petitioner’s books over the period 1916 to 1920, and ratably spread the same over the period 1914 to 1920* Upon the evidence before us, we are of the opinion that the depreciation deductions claimed by the petitioner for the years 1918 and 1920, arc reasonable in the light of the conditions obtaining and we are not disposed to disturb them in the absence of affirmative evidence to the contrary.
The taxpayer claims that the Commissioner erroneously excluded from invested capital for 1918, the following items:
Mineral and gas rights_$17, 500. 00
Leaseholds_ 66, 527.93
Total_ 84, 027.93
The taxpayer was unable to furnish the Commissioner affirmative proof of the cost of these assets. At the hearing, however, the taxpayer succeeded in producing the original voucher for the $17,500 [340] item and other Touchers covering $25,913.85 of the $66,527.98 item. These items appear to have been carried upon the books of the taxpayer continuously at their full face value. They show up in the balance sheet of December 1, 1913, as shown in our findings of fact, and they appear in the balance sheet of December 31, 1920, as an asset and are included in the value of the assets of the taxpayer when the stock was sold by Daly. Though the taxpayer was unable to specify the precise assets they represented, it was undisputed that it had in fact leaseholds of approximately 8,000 acres of land and numerous gas and mineral rights. In view of the fact that these assets have always been taken at their full value by all parties dealing with the taxpayer and it has always without controversy carried them upon its books, and the further fact that original vouchers have been discovered covering a portion of the full amounts, we are disposed to give full credence to the entries on the books as to the cost of these assets and allow them as invested capital, subject to reduction for any accumulated exhaustion.
The taxpayer petitions that for the year 1918 it be given special relief under section 328 of the Revenue Act of 1918. It has failed to show the existence of any abnormality affecting capital or income that would bring it within section 327(d). Its contention that invested capital can not be satisfactorily determined is not supported by the evidence. The Commissioner determined invested capital from the taxpayer’s books of account, and it has not been shown that the books do not correctly reflect the invested capital.
Judgment will he entered on 10 days’ notice, under Rule 50.
Sternhagen dissents in part.