Duvin Coal Co. v. Commissioner

DUVIN COAL CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Duvin Coal Co. v. Commissioner

Docket No. 22005.

United States Board of Tax Appeals

16 B.T.A. 194; 1929 BTA LEXIS 2621;

April 25, 1929, Promulgated

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Deduction on account of exhaustion of capital amount invested in air shaft, main shaft, railroad, development, and right of way, determined.

Attilla Cox, Esq., and E. J. Wells, Esq., for the petitioner.

Bruce A. Lowe, Esq., for the respondent.

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GREEN

In this proceeding petitioner seeks a redetermination of its income taxes for the calendar year 1922, for which the Commissioner has determined the deficiency of $846.01. Petitioner alleges error on the part of the Commissioner in failing to allow adequate depreciation.

FINDINGS OF FACT.

Petitioner is a corporation organized under the laws of the State of Kentucky, with its principal office at Providence, Ky. It owns and operates 1,710 acres of coal land located in Webster County, Ky. Operations were begun in May, 1922. With the machinery and equipment then installed, a production of 1,500 tons a day was possible. Subsequently, the machinery, equipment and development were increased so that by 1927, the mine was equipped to produce 5,000 tons a day, and was producing about 2,000 tons a day.

On account of the existing conditions and the method of operation employed by the petitioner, it was possible to recover only 4,500 tons of coal per acre. The recoverable reserve in the property amounted to 7,700,000 tons. During the year 1924, petitioner filed with the Bureau of Internal Revenue a Form E(3), in which it estimated an annual production of 300,000 tons, and a life of 25 years. There were produced from the mine in 1922, 56,000 tons; 1923, 150,000 tons; 1924, 292,000 tons; 1925, 380,000 tons; 1926, 400,000 tons.

Prior to January 1, 1922, the following assets were purchased:

Machinery and equipment	$ 39,941.19
Steel rails	1,780.95
Buildings	4,855.76
Lakes	8,496.17
Air Shaft	12,694.48
Main shaft	17,665.35
Railroad	41,683.20
Development	4,143.84
Right of way	4,100.00

During the year 1922, the following capital expenditures were made:

Machinery and equipment	$ 36,367.46
Steel rails	6,235.44
Buildings	11,374.95
Railroad	22,590.74

These additions were entered on the ledger, by months, as follows:

Year	Machinery and	Buildings	Steel rails	Railroad	Supplies
	equipment			construction 1
January	$1,284.45	$1,451.79		$2,096.03	$2,847.61
February	494.25	924.19		731.94	6,224.21
March	3,095.41	1,453.02		514.82
April	290.28	2,373.80	8,863.71
May	5,322.29	1,000.00		162.50
June	2,411.78	1,000.00	$172.50
July	3,847.00	1,000.00	1,607.34	1,200.00
August	3,634.00	1,072.90	367.52
September	4,232.00	1,099.25	2,988.08
November	5,160.00
December	6,596.00		1,100.00

The Commissioner of Internal Revenue allowed depreciation at the rate of 10 per cent on machinery, 5 per cent on steel rails, 10 per cent of buildings, 5 per cent on lakes, 2 1/2 per cent on air shaft, main shaft, railroad, development, and right of way, and allowed depreciation on the additions made during 1922 at one-half of the above rates.

Petitioner claimed for depreciation a rate of 10 per cent on machinery and equipment, 10 per cent on rails, 10 per cent on buildings, 5 per cent on lakes, air shaft, main shaft, railroad, development, and right of way. In the answer, the respondent admits that the average life of steel rails would not be more than 10 years.

The life of the air shaft, main shaft, railroad, development, and right of way is the life of the mine.

OPINION.

GREEN: There appears to be no controversy as to the annual rates of depreciation on machinery and equipment, steel rails, buildings, and lakes, since the respondent has admitted, and we so find, that the annual rate of depreciation on steel rails is 10 per cent. A controversy does arise, however, in respect to the computation of depreciation on additions made during the year. In support of its contention on this point, the petitioner submitted ledger sheets, which showed entries on various dates during the year of amounts included in the various accounts. In the case of machinery and equipment, buildings and steel rails, it is apparent from these accounts that the method employed by the Commissioner of allowing one-half the rate for a full year, which is equivalent to allowing the full rate for one-half year, works to the advantage of the petitioner and gives it a deduction in excess of that which would be allowed if depreciation were computed on each addition from the date entered. In the case of railroad construction, the advantage would be only slightly in favor of the petitioner, but this would not result in a material advantage, since the largest expenditure for the year was $8,045.08, made on April 30. In the case of railroad supplies, the expenditures were made in January and February, 1922.

The ledger sheets merely show when the expenditures were made. They do not show when the machinery and equipment, buildings, rails or supplies were actually installed, erected or consumed. Under ordinary circumstances, depreciation does not start until the equipment has actually been installed and is ready for operation. It is admitted by the petitioner that operations did not start until May, 1922, and up to that time the petitioner was not engaged in actual business operations, having mined no coal. No information has been submitted on this point, other than that operations started in May, 1922. We are, therefore, of the opinion that petitioner has failed to show that the Commissioner erred in computing depreciation on additions made during the year 1922. All that the statute requires is that the Commissioner make a reasonable allowance, and the record in this proceeding does not establish that he has not done this.

There remains the question of the proper rate to be used in determining the exhaustion of capital expended for shafts, development, railroad, and right of way. Petitioner originally, and even as late as 1924, considered that the rate should be based upon a life of 25 years. The respondent, from the data submitted by the petitioner, determined that the rate should be based upon a life of 37 years. The petitioner now maintains that, in view of the information available in 1927, the life should be about 17 years.

The witnesses for the petitioner have established that these assets, when in use and properly maintained, do not exhaust appreciably due to lapse of time, but exhaust only because of the fact that the mine exhausts. It is perfectly apparent that the exhaustion of the mine is not necessarily in equal annual amounts. Its exhaustion, during use, bears a direct relation to the mineral extracted each year. It is apparent to us that the exhaustion of the capital invested in these assets should be computed on a tonnage basis in the same manner that deduction for depletion is computed. The rate per ton should be based upon a reserve as of January 1, 1922, of 7,700.000 tons.

Judgment will be entered under Rule 50.

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Footnotes

• 1. Railroad construction account reduced by credit entry of $50.08. ↩