Massey Motors, Inc. v. United States , 80 S. Ct. 1411 ( 1960 )

Mr. Justice Clark

delivered the opinion of the Court.

These consolidated cases involve the depreciation allowance for automobiles used in rental and allied service, as claimed under § 23 (1) of the Internal Revenue Code of 1939, which permits the deduction for income tax purposes of a “reasonable allowance for the exhaustion, wear and tear ... of property used in the trade or business.” The applicable Treasury Regulations 111, § 29.23 (1) — 1, defines such allowance to be “that amount which should be set aside for the taxable year in accordance with a reasonably consistent plan . . . whereby the aggregate of the amounts so set aside, plus the salvage value, will, at the end of the useful life of the depreciable property, equal the cost or other basis of the property.” The Courts of Appeals have divided on the method of depreciation which is permissible in relation to such assets, and we therefore granted certiorari to resolve this conflict. 361 U. S. 810, 812. We have concluded that the reasonable allowance for depreciation of the property in question used in the taxpayer’s business is to be calculated over the estimated useful life of the asset while actually employed by the taxpayer, applying a depreciation base of the cost of the property to the taxpayer less its resale value at the estimated time of disposal.

In No. 143, Commissioner v. R. H. and J. M. Evans, the taxpayers are husband and wife. In 1950 and 1951, the husband, Robley Evans, was engaged in the business of leasing new automobiles to Evans U-Drive, Inc., at the rate of $45 per car per month. U-Drive in turn leased from 30% to 40% of the cars to its customers for long terms ranging from 18 to 36 months, while the remainder were rented to the public on a call basis for shorter periods. Robley Evans normally kept in stock a supply of new cars with which to service U-Drive and which he purchased at factory price from local automobile dealers. The latest model cars were required because of the demands of the rental business for a fleet of modern automobiles.

When the U-Drive service had an oversupply of cars that were used on short-term rental, it would return them to the taxpayer and he would sell them, disposing of the oldest and least desirable ones first. Normally the ones so disposed of had been used about 15 months and had been driven an average of 15,000 to 20,000 miles. They were ordinarily in first-class condition. It was likewise customary for the taxpayer to sell the long-term rental cars at the termination of their leases, ordinarily after about 50,000 miles of use. They also were usually in good condition. The taxpayer could have used the cars for a longer period, but customer demand for the latest model cars rendered the older styles of little value to the rental business. Because of this, taxpayer found it more profitable to sell the older cars to used car dealers, jobbers or brokers at current wholesale prices. Taxpayer sold 140 such cars in 1950 and 147 in 1951. On all cars leased to U-Drive, taxpayer claimed on his tax returns depreciation calculated on the basis of an estimated useful life of four years with no residual salvage value. The return for 1950, for example, indicated that each car’s cost to taxpayer was around $1,650;' after some 15 months’ use he sold it for $1,380; he charged depreciation of $515 based on a useful life of four years, without salvage value, which left him a net gain of $245, on which he calculated a capital gains tax. In 1951 the net gain based on the same method of calculation was approximately $350 per car, on which capital gains were computed. The Commissioner denied the depreciation claims, however, on the theory that useful life was not the total economic life of the automobile (i. e., the four years claimed), but only the period it was actually used by the taxpayer in his business; and that salvage value was not junk value but the resale value at the time of disposal. On this basis he estimated the useful life of each car at 17 months and salvage value at $1,325; depreciation was permitted only on the difference between this value and the original cost. The Tax Court accepted the Commissioner’s theory but made separate findings. The Court of Appeals reversed, holding that useful life was the total physical or economic life of the automobiles — not the period while useful in the taxpayer’s business. 264 F. 2d 502.

In No. 141, Massey Motors, Inc., v. United States, the taxpayer, a franchised Chrysler dealer, withdrew from shipments to it a certain number of new cars which were assigned to company officials and employees for use in company business. Other new cars from these shipments were rented to an unaffiliated finance company at a substantial profit.

The cars assigned to company personnel were uniformly sold at the end of 8,000 to 10,000 miles’ use or upon receipt of new models, whichever was earlier. The rental cars were sold after 40,000 miles or upon receipt of new models. For the most part, cars assigned to company personnel and the rental cars sold for more than they cost the taxpayer. During 1950 and 1951, the tax years involved here, the profit resulting from sale of company personnel cars was $11,272.80 and from rental cars, $525.84. The taxpayer calculated depreciation on the same theory as did taxpayer Evans, computing the gains on the sales at capital gain rates with a basis of cost less depreciation. The Commissioner disallowed the depreciation claimed. After paying the tax and being denied a refund, the taxpayer filed this suit. The trial court decided against the Commissioner. The Court of Appeals for the Fifth Circuit, however, reversed, sustaining the Commissioner’s views as to the meaning of useful life and salvage value. 264 F. 2d 552.

First, it may be well to orient ourselves. The Commissioner admits that the automobiles involved here are, for tax purposes, depreciable assets rather than ordinary stock in trade. Such assets, employed from day to day in business, generally decrease in utility and value' as they are used. It was the design of the Congress to permit the taxpayer to recover, tax free, the total cost to him of such capital assets; hence it recognized that this decrease in value — depreciation—was a legitimate tax deduction as business expense. It was the purpose of § 23 (1) and the regulations to make a meaningful allocation of this cost to the tax periods benefited by the use of the asset. In practical life, however, business concerns do not usually know how long an asset will be of profitable use to them or how long it may be utilized until no longer capable of functioning. But, for the most part, such assets are used for their entire economic life, and the depreciation base in such cases has long been recognized as the number of years the asset is expected to function profitably in use. The asset being of no further use at the end of such period, its salvage value, if anything, is only as scrap.

Some assets, however, are not acquired with intent to be employed in the business for their full economic life.. It is this type of asset, where the experience of the taxpayers clearly indicates a utilization of the asset for a substantially shorter period than its full economic life, that we are concerned with in these cases. Admittedly, the automobiles are not retained by the taxpayers for their full economic life and, concededly, they do have substantial salvage, resale or second-hand value. Moreover, the application of the full-economic-life formula to taxpayers’ businesses here results in the receipt of substantial “profits” from the resale or “salvage” of the automobiles, which contradicts the usual application of the full-economic-life concept. There, the salvage value, if anything, is ordinarily nominal. Furthermore, the “profits” of the taxpayers here are capital gains and incur no more than a 25% tax rate. The depreciation, however, is deducted from ordinary income. By so translating the statute and the regulations, the taxpayers are able, through the deduction of this depreciation from ordinary income, to convert the inflated amounts from income taxable at ordinary rates to that taxable at the substantially lower capital gains rates. This, we believe, was not in the design of Congress.

It appears that the governing statute has at no time defined the terms “useful life” and “salvage value.” In the original Act, Congress did provide that a reasonable allowance would be permitted for “wear and tear of property arising out of its use or employment in the business.” (Emphasis added.) Act of Oct. 3,_ 1913, 38 Stat. 167. This language, particularly that emphasized above, may be fairly construed to mean that the wear and tear to the property must arise from its use in the business of the taxpayer — i. e., useful life is measured by the use in a taxpayer’s business, not by the full abstract economic life of the asset in any business. In 1918, the language of § 23 (1) was amended so that the words emphasized above would read “used in the trade or business,” § 214 (a)(8), Revenue Act of 1918, 40 Stat. 1067, and the section carried those words until 1942. Meanwhile, Treas. Reg. 45, Art. 161, was promulgated in 1919 and continued in substantially the same form until 1941. It provided:

“The proper allowance for such depreciation of any property used in the trade or business is that amount which should be set aside for the taxable year in accordance with a consistent plan by which the aggregate of such amounts for the useful life of the property in the business will suffice, with the salvage value, at the end of such useful life to provide in place of the property its cost . . . .” (Emphasis added.)

It, too, may be construed to provide that the use and employment of the property in the business relates to the trade or business of the taxpayer — not, as is contended, to the type or class of assets subject to depreciation. The latter contention appears to give a strained meaning to the phrase. This might be particularly true of the language in Treasury Regulations 103, promulgated January 29, 1940, under the Internal Revenue Code of 1939. Its § 19.23 (1)-1 and § 19.23 (l)-(2) ¹ complement each other and seem to advise the taxpayer how to compute depreciation and what property is subject to it. The first section not only describes the proper allowance, but sets out how it is to be computed so that depreciation “plus the salvage value, will, at the end of the useful life of the property in the business, equal the cost . . . .” (Emphasis added.) The second section specifically defines the type of assets to which the depreciation allowance is applicable. It may be said that the taxpayers’ arguments as to this regulation fail completely, since it not only specifically provides that “useful life” relates to property while used “in the business,” but also details the type or class of property included within the allowance. It appears to-cut from under the taxpayers the argument that •the term “property used in the trade or business” relates to the type or class of assets that are included within the allowance. It would be strange to say that both of these sections of Regulations 103 defined the same thing, viz., the type or class of assets subject to depreciation. On the other hand, the taxpayers point out that Regulá-tions 111, issued in 1942, deleted the words “property in the business” from § 19.23 (1) — 1 and substituted the term “depreciable property.” This might, as taxpayers claim, establish that the phrase “property used in the trade or business” merely referred to the type of property involved. Certainly when considered in isolation, this appears to be true. But the “depreciable property” phrase does refer back to the earlier identical language, still remaining in the section, of “property used in the trade or business.” It does appear, however, as the Court of Appeals in No. 141, Massey, held, that this substitution was made because Congress expanded the depreciation allowance provision of § 23 (1) to include property held for the production of income. The change in the Regulations only conformed it to this amendment of the basic statute.

It is true, as taxpayers contend and as we have indicated, that the language of the statute and the regulations as we have heretofore traced them may not be precise and unambiguous as to the term “useful life.” It may be that the administrative practice with regard thereto may not be pointed to as an example of clarity, and that in some cases the Commissioner has acquiesced in inconsistent holdings. But from the promulgation of the first regulation in 1919, he has made it clear that salvage had some value and that it was to be considered as something other than zero in the depreciation equation. In fact many of the cases cited by the parties involved controversies over the actual value of salvage, not as scrap but on resale.² The consistency of the Commissioner’s position in this regard is evidenced by the fact that the definition of salvage as now incorporated in the regulations is identical with that claimed at least since 1941. In the light of this, it appears that the struggle over the term “useful life” takes on less practical significance, for, if salvage is the resale value and a deduction of this amount from cost is required, the dollar-wise importance to the taxpayer of the breadth in years of “useful life” is diminished. It is only when he can successfully claim that salvage means junk and has no value that an interpretation of “useful life” as the functional, economic, physical life of the automobile brings money to his pocket. Moreover, in the consideration of the appropriate interpretation of the term, it must be admitted that there is administrative practice and judicial decision in its favor, as we shall point out. Furthermore, as we- have said, Congress intended by the depreciation allowance not to make taxpayers a profit thereby, but merely to protect them from a loss. The concept is, as taxpayers say, but an accounting one and, we add, should not be exchangeable in the market place. Accuracy in accounting requires that correct tabulations, not artificial ones, be used. Certainly it is neither accurate nor correct to carry in the depreciation equation a value of nothing as salvage on the resale of the automobiles, when the taxpayers actually received substantial sums therefor. On balance, therefore, it appears clear that the weight of both fairness and argument is with the Commissioner.

Our conclusion as to this interpretation of the regulations is buttressed, we think, by a publication issued by the Commissioner in 1942, the same year as Regulations 111, and long before this controversy arose. It is known as Bulletin “F” and has been reissued as late as 1955. While it does not have the authority of a regulation, its significance is indicated clearly by the fact that both the taxpayers and the Commissioner point to it as conclusive of their respective views of the administrative practice. Likewise it is widely cited by tax authorities, as well as by the Courts of Appeals. A careful examination of the entire bulletin, however, indicates that it clearly supports the administrative practice claimed here by the Commissioner. For example, the title page warns that “[t]he estimated useful lives and rates of depreciation . . . are based on averages and are not prescribed for use in any particular case.” ³ Again on page 2, Bulletin “F,” in discussing depreciation, emphasizes that it is based on “the useful life of the property in the business.” What is more significant is the simple clarity with which, on page 7, it defines salvage value to be “the amount realizable from the 'sale . . . when property has become no longer useful in the taxpayer’s business and is demolished, dismantled, or retired from service.” It even goes further to say that salvage “should serve to reduce depreciation, either through a reduction in the basis on which depreciation is computed or a reduction in the rate.”

Moreover, Congress was aware of this prior prevailing administrative practice as well as the concept of depreciation upon which it was based. Although the tax years involved here are 1950 and 1951, we believe that the action of Congress in adopting the 1954 Code should be noted, since it specifically recognized the existing depreciation equation. For the first time, the term “useful life” was inserted in the statutory provision. The accompanying House Report to the bill stated:

“Depreciation allowances are the method by which the capital invested in an asset is recovered tax-free over the years it is used in a business. The annual deduction is computed by spreading the cost of the property over its estimated useful life.” H. R. Rep. No. 1337, 83d Cong., 2d Sess. 22.

It is also noteworthy that the report states that “The changes made by your committee’s bill merely affect the timing and not the ultimate amount of depreciation deductions with respect to a property.” Id., at 25.

Moreover, as we have said, there are numerous cases in the Tax Court in which depreciation was permitted only on the useful life of the property in the taxpayer’s business.⁴ The taxpayers point to others⁵ which appear to be to the contrary. In most of these, however, the issue was factual, i. e., the time lapse before the property would wear out from use or, as we have said, its salvage or resale value. They cannot be said to prove conclusively that the Commissioner was following a physically useful-life theory; for there is no affirmative showing or finding as to the length of the physically useful life. The most that can be said is that the element of compromise probably played a predominant role in the result in each case. Moreover, there is no indication in any of these cases that the amount of depreciation would have been changed by computing it on the basis of its useful life in the business. The cases do not seem to reflect considered judgments as to the proper meaning of the terms used in the depreciation equation and we find them of little value as precedents.

Finally, it is the primary purpose of depreciation accounting to further the integrity of ^periodic income statements by making a meaningful allocation of the cost entailed in the use (excluding maintenance expense) of the asset to the periods to which it contributes. This accounting system has had the approval of this Court since United States v. Ludey, 274 U. S. 295, 301 (1927), when Mr. Justice Brandéis said, “The theory underlying this allowance for depreciation is that by using up the plant, a gradual sale is made of it.” The analogy applies equally to automobiles. Likewise in Detroit Edison Co. v. Commissioner, 319 U. S. 98, 101 (1943), this Court said:

“The end and purpose of it all [depreciation accounting] is to approximate and reflect the financial consequences to the taxpayer of the subtle effects of time and use on the value of his capital assets. For this purpose it is sound, accounting practice annually to accrue ... an amount which at the time it is retired will with its salvage value replace the original investment therein.”

Obviously a meaningful annual accrual requires an accurate estimation of how much the depreciation will total. The failure to take into account a known estimate of salvage value prevents this, since it will result in an understatement of income during the years the asset is employed and an overstatement in the year of its disposition. The practice has therefore grown up of subtracting salvage value from the purchase price to determine the depreciation base.⁶ On the other hand, to calculate arbitrarily the expected total expense entailed by the asset on the false assumption that the asset will be held until it has no value is to invite an erroneous depreciation base and depreciation rate, which may result in either an over- or an under-depreciation during the period of use. If the depreciation rate and base turn out to reflect the actual cost of employing the asset, it will be by accident only. The likelihood of presenting an inaccurate picture of •yearly income from operation's is particularly offensive where, as here, the taxpayers stoutly maintain that they are only in the business of renting and leasing automobiles, not of selling them. The alternative is to estimate the period the asset will be held in the business and the price that will be received for it on retirement. Of course, there is a risk of error in such projections, but prediction is the very essence of depreciation accounting. Besides, the possibility of error is significantly less where probabilities rather than accidents are relied upon to produce what is hoped to be an accurate estimation of the expense involved in utilizing the asset. Moreover, under a system where the real salvage price and actual duration of use are relevant, to further insure a correct depreciation base in the years after a mistake has been discovered, adjustments may be made when it appears that a miscalculation has been made.

Accounting for financial management and accounting for federal income tax purposes both focus on the need for an accurate determination of the net income from operations of a givén business for a fiscal period. The approach taken by the Commissioner computes depreciation expense in a manner which is far more likely to reflect correctly the actual cost over the years in which the asset is employed in the business.⁷

We therefore conclude that the Congress intended that the taxpayer should, under the allowance for depreciation, recover only the cost of the asset less the estimated salvage, resale or second-hand value. This requires that the useful life of the asset be related to the period for which it may reasonably be expected to be employed in the taxpayer’s business. Likewise salvage value must include estimated resale or second-hand value. It follows that No. 141, Massey Motors, Inc., v. United States, must be affirmed, and No. 143, Commissioner v. R. H. and J. M. Evans, reversed.

It is so ordered.

1 “Sec. 19.23 (1) — 1. Depreciation. — A reasonable allowance for the exhaustion, wear and tear, and obsolescence of property used in the trade or business may be deducted from gross income. For convenience such an allowance will usually be referred to as depreciation, excluding from the term any idea of a mere reduction in market value not resulting from exhaustion, wear and tear, or obsolescence. The proper allowance for such depreciation of any property used in the trade or business is that amount which should be set aside for the taxable year in accordance with a reasonably consistent plan (not necessarily at a uniform rate), whereby the aggregate of the amounts so set aside, plus the salvage value, will, at the end of the useful life of the property in the business, equal the cost or other basis of the property determined in accordance with section 113. . . .”

“Sec. 19.23 (1) — 2. Depreciable property. — The necessity for a depreciation allowance arises from the fact that certain property used in the business gradually approaches a point where its usefulness is exhausted. The allowance should be confined to property of this nature. In the case of tangible property, it applies to that which is subject to wear and tear, to decay or decline from natural causes, to exhaustion, and to obsolescence due to the normal progress of the art, as where machinery or other property must be replaced by a new invention, or due to the inadequacy of the property to the growing needs of the business. It does not apply to inventories or to stock in trade, or to land apart from the improvements or physical development added to it. It does not apply to bodies of minerals which through the process of removal suffer depletion, other provisions for this being made in the Internal Revenue Code. (See sections 23 (m) and 114.) Property kept in repair may, nevertheless, be the subject of a depreciation allowance. (See section 19.23 (a)-4.) The deduction of an allowance for depreciation is limited to property used in the taxpayer’s trade or business. No such allowance may be made in respect of automobiles or other vehicles used solely for pleasure, a building used by the taxpayer solely as his residence, or in respect of furniture or furnishings therein, personal effects, or clothing; but properties and costumes used exclusively in a business, such as a theatrical business, may be the subject of a depreciation allowance.”

2 E. g., Davidson v. Commissioner, 12 CCH T. C. Mem. 1080 (1953); W. H. Norris Lumber Co. v. Commissioner, 7 CCH T. C. Mem. 728 (1948); Bolta Co. v. Commissioner, 4 CCH T. C. Mem. 1067 (1945); Wier Long Leaf Lumber Co. v. Commissioner, 9 T. C. 990 (1947), affirmed in part and reversed in part, 173 F. 2d 549 (1949).

3 The bulletin sets out a schedule of the useful life of automobiles, listing passenger cars at five years and those used by salesmen at three years.

4 See note 2, supra.

5 E. g., West Virginia & Pennsylvania Coal & Coke Co. v. Commissioner, 1 B. T. A. 790 (1925); James v. Commissioner, 2 B. T. A. 1071 (1925); Merkle Broom Co. v. Commissioner, 3 B. T. A. 1084 (1926); Kurtz v. Commissioner, 8 B. T. A. 679 (1927); Whitman-Douglas Co. v. Commissioner, 8 B. T. A. 694 (1927); Sanford Cotton Mills v. Commissioner, 14 B. T. A. 1210 (1929). General Securities Co. v. Commissioner, 1942 P-H BTA-TC Mem. Dec. ¶ 42,219, seems to be the only case of the group that is directly contrary to the present position of the Commissioner, and there the end result money-wise would seem to be the same under either theory. Hence it only emphasizes that isolated instances of inconsistency can be found in most areas where the volume of cases is as large as it is here.

6 This industry practice is emphasized by the amicus curiae brief of the American Automobile Leasing Association in Hillard v. Commissioner, 31 T. C. 961, now pending in the Court of Appeals for the Fifth Circuit. Comprising “about 65 per cent of the long-term leasing industry in motor vehicles in the country” the Association takes the position that the depreciation allowance “is designed to return to the taxpayer, tax-free, the cost of his capital asset over the period during which it is useful to the taxpayer in his business.” A copy of the brief is on file in this case.

7 Several writers in the accounting field have addressed themselves, without reference to the income tax laws, to the problem of giving content to the terms “useful life” and “salvage value” and their conclusions support what has been said.

Grant and Norton, Depreciation (1949), 145-146:

“[Assets such as passenger automobiles] may be expected to have substantial positive salvage values. Average salvage values must therefore be estimated before straight-line depreciation rates can be established. Salvage values will depend on average lives which may in turn depend on the owner’s policy with regard to disposal of such assets. For example, if it is company policy to trade in passenger automobiles after three years, the estimation of average salvage value is simply the estimation of the average trade-in value of a 3-year-old passenger automobile.”

Kohler, A Dictionary for Accountants (1952), 371, defines salvage value as:

“Actual or prospective selling price, as second-hand material, or as junk or scrap, of fixed assets retired, or of product or merchandise unsalable through usual channels, less any cost, actual or estimated, of disposition; . . .”

Useful life is defined, id., at 440-441, as follows:

“Normal operating life in terms of utility to the owner; said of a fixed asset or a fixed-asset group; the period may be more or less than physical life or any commonly recognized economic life; service life.”

Saliers, Depreciation Principles (1939), 72:

“Salvage is the value an article possesses for some use other than that to which it has been devoted. When it can be so used it is said to possess another cycle of life. Junk or scrap value is that which an article is worth if broken up. In making allowance for depreciation the basis to be used is cost less whatever it is estimated that the salvage or scrap will amount to.”