Ohio-Clover Leaf Dairy Co. v. Commissioner

OHIO-CLOVER LEAF DAIRY CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Ohio-Clover Leaf Dairy Co. v. Commissioner

Docket Nos. 24642, 33164.

United States Board of Tax Appeals

13 B.T.A. 1320; 1928 BTA LEXIS 3063;

October 31, 1928, Promulgated

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A lessee of chattels that has no capital investment therein, is not entitled to deduct from gross income the amount of an annual depreciation reserve established for the purpose of replacing or renewing such chattels.

Thomas O. Marlar, Esq., Harry J. Gerrity, Esq., and L. T. Konopak, C.P.A., for the petitioner.

M. E. McDowell, Esq., for the respondent.

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LITTLETON

In these proceedings, which were duly consolidated, the Commissioner redetermined deficiencies in income tax of $1,603.27 and $1,472.78 for the years 1922 and 1923, respectively. The questions are whether the petitioner, as lessee of physical assets leased under the circumstances hereinafter set forth, is entitled to deductions from gross income (1) for depreciation of the leased assets, and (a) for alleged losses resulting from the sale of certain of the leased assets.

The facts were stipulated.

FINDINGS OF FACT.

The petitioner was incorporated on February 14, 1919, under the laws of the State of Ohio. It is engaged in and operates a dairy business, its principal office and place of business being in the City of Toledo. The books of the petitioner are and have been during all of the time here in question kept on an accrual basis, and its return of income was made upon such basis.

On or about February 15, 1919, petitioner entered into a lease agreement with two corporations, known as the Ohio Dairy Co., and the Clover Leaf Dairy Co., respectively; both corporations located in the City of Toledo, Ohio, and engaged in the business of collection, pasteurization, and distribution of milk and dairy products.

The provisions of the lease pertinent to the questions presented herein are as follows:

THIS INDENTURE made and entered into this 15th day of February, 1919, by and between The Ohio Dairy Company, hereinafter called "Ohio Company", The Clover Leaf Dairy Company, hereinafter called "Clover Leaf Company," (said companies hereinafter called collectively "Old Companies") and The Ohio-Clover Leaf Dairy Company, hereinafter called "Operating Company";

WITNESSES:

* * *

1. The Ohio Company and The Clover Leaf Company respectively lease to the Operating Company the property, routes, business, good will and facilities described in the annexed schedule from the 15th day of February, 1919, to the 15th day of February, 1939, upon the rentals, considerations, terms, covenants, options, provisions and conditions herein set forth.

Each of the Old Companies for itself agrees that it will not engage in the business of buying, selling or delivering milk in the City of Toledo, Lucas County, Ohio, during such period of time as this agreement is in full force and effect, or during such period of time as the Operating Company, its successors or assigns, are engaged in the business of buying, selling or delivering milk inthe City of Toledo, Ohio, if the Operating Company shall acquire title to the properties hereby leased in accordance with the terms of Paragraph Sixteen (16) herein.

The Operating Company shall not have the right to use the trade name 'Daisy Brand" or the name "The Ohio Dairy Company" in the manufacture, sale or delivery of ice cream.

2. The Operating Company shall take over said leased property and continue the business of supplying milk and milk products in and about the City of Toledo, and supply all customers of the Old Companies and others, using for that purpose such of the employees of the Old Companies as are best fitted for the work, and making such changes in routes and other operating methods as may be best calculated to effect the economies desired.

* * *

4. The Operating Company shall use every effort to maintain the property and business turned over and leased to it hereunder so that on the termination of this agreement the business and property of the Old Companies, or its fair equivalent, can be returned to the said Old Companies in good operating condition, but on the termination of this agreement the Operating Company shall be under no obligation to return to either of the Old Companies the identical customers, sources of supplies, business or property received from such company, but it shall be at liberty to return the full equivalent of such property, customers, sources of supply and business observing in the division of the property and business upon the termination of this agreement the percentages herein used for the payment of rentals to the Old Companies, and having due regard for future operations and giving such company sufficient property and equipment to carry on its business.

5. All horses, wagons, cans, bottles and other equipment turned over to the Operating Company shall be kept in first class order and condition at all times, and the Operating Company shall at all times have on hand at least as much physical property as was turned over to it, and at least as many customers and routes as were turned over to it, and the Operating Company shall make all repairs and renewals necessary to maintain said property in said condition.

6. The Operating Company shall keep and maintain a depreciation fund sufficient in amount to keep all said property in the state, quantity and condition aforesaid, and to replace the same when worn out or obsolete, and it shall also keep and maintain at all times a contingent fund out of which bad debts, damage claims or other losses can be paid or off-set.

* * *

8. The Operating Company shall insure all property usually insured by Dairy Companies against loss or damage by fire or other casualty, free of expense to either of the Old Companies and in the event of loss or damage the insurance money collected shall be used to repair or replace the property damaged or destroyed.

No damage to or destruction of the property herein described shall operate to terminate this agreement or abate the rentals hereunder or any part thereof.

9. The Operating Company may at any time during the term of this indenture sell, lease, exchange or dispose of any items or part of the property or business hereinafter described no longer used or useful in the conduct of the business. Any such lease of real estate, buildings, or equipment shall be subject to termination on reasonable notice so that the Operating Company can restore such property to the owner in case of the termination of this agreement. It shall keep a strict account of the property thus disposed of and of the proceeds or property received in payment or exchange therefor, so that at the end of the term of this indenture the property acquired from each of the Old Companies, or its full equivalent, shall be returned. The entire property or business shall not be sold, exchanged or disposed of, but shall be kept intact as a going concern.

10. The Old Companies and each of them shall on request execute, acknowledge and deliver such instruments or papers as may be required by the Operating Company to completely carry out and perform the terms of this indenture, or to complete any sale, lease, exchange or other disposition of the property made by the Operating Company.

11. The Operating Company shall observe and comply with all the laws and ordinances applicable to the business so that the value of said business shall not be impaired.

12. The business of the Operating Company shall be conducted under a system of accounting to be approved by the Presidents of the Old Companies, so that proper records of the properties and operations shall be kept, and so that there can be a correct ascertainment of the profits or losses.

If during the term of this indenture a controversy shall arise between any of the parties as to any matters of accounting or any entries made or proposed to be made on the books of the Operating Company, and the parties shall be unable to agree, the matter in controversy shall be referred to Robert McIntosh & Company, Ernst & Ernst, or Price, Waterhouse & Company, whichever the President of the Operating Company may select, and the decision of the firm of accountants thus selected shall be final and binding upon all parties.

As rental for the use of the leased property, the Operating Company shall pay to The Ohio Company an amount equal to 55.25% of its net earnings, but in any event not less than $650.00 per month, and it shall pay to the Clover Leaf Company an amount equal to 29.75% of its earnings, but in any event not less than $350.00 per month.

Said rentals in excess of the stipulated monthly rentals shall be paid annually on the 15th day of the second month following the close of the year, except as hereinafter provided.

Said rental shall be treated on the books of the Operating Company as an expense of operation and as if a fixed amount of money had been stipulated as rent. Each month the Operating Company shall set up on its books in a rental account an amount equal to 85% of its net profits for the month, and said amount shall be credited to the Old Companies and the stipulated minimum rental shall be paid monthly subject however, to the proper and necessary adjustment to be made at the end of the year when exact net profits are to be ascertained.

The Operating Company may on request advance to either of the Old Companies an amount not in excess of 50% of the established rental accrued in favor of such Old Companies at any time, and such advances shall be charged against such Old Company and shall be deducted at the time of the annual settlement from the rentals payable to it, and if at the end of the year such advances are not repaid out of the rentals, the Old Company receiving such advances, shall reimburse the Operating Company, and the Operating Company shall have a lien upon all the leased property of said Old Company to secure a repayment of such advances in excess of the stipulated monthly minimum. If any such advances are made both companies shall have the right to demand and receive advances.

The Old Companies shall be under no obligation to refund any part of the fixed monthly rental of $650.00 to the Ohio Company or $350.00 to the Clover Leaf Company, and shall only be obligated to refund advances in excess of such fixed monthly rentals.

13. * * * Each of the Old Companies shall immediately execute, acknowledge and deliver to the Operating Company separate recordable leases of real estate and machinery, providing for the payment of nominal rentals to the Ohio Company and to the Clover Leaf Company and containing terms, provisions and conditions conforming to those herein set forth. This Indenture in any case shall be taken and held to be a part of such leases.

14. Each of the Old Companies shall pay all taxes and assessments charged against it or its property payable on December 20, 1918 and June 20, 1919, and the Operating Company shall pay all taxes and assessments payable after June 20, 1919 on the leased property.

15. The Old Companies and each of them covenant and agree that they will pay all outstanding obligations, indebtedness or liabilities, which may in any way be or become a charge upon the property described in the annexed schedules, so that the Operating Company shall take said property free of all indebtedness and claims whatsoever excepting the Clover Leaf Company bonds and the Old Companies each for themselves and not for the other warrant the title of the property in the annexed schedules, to be clear and unincumbered, except by taxes and the Clover Leaf Company bonds; that they have good right and title to enter into this Indenture, and that upon the performance of the terms, covenants and conditions hereof, and the payment of the rentals herein reserved, the Operating Company shall quietly use and enjoy such property during the term of this Indenture.

16. The Operating Company shall have the exclusive option during the term of this Indenture to acquire all of the property routes, business, good will and facilities hereby leased, but not any part thereof, for the consideration hereinafter mentioned, by giving to each of the Old Companies notice thereof by registered mail. Payment for said properties, aforesaid, shall be made by delivering to the Old Companies increased capital stock of the Operating Company, to be fully paid up and non-assessable, in such amounts as may be agreed upon by the parties and, should they be unable to agree then the amount of stock to be issued shall be determined by a board of three arbitrators consisting of the persons who shall then be the president of the Ohio Company and the Clover Leaf Company and the president or vice president of a bank or trust company in Toledo to be selected by the president of the Operating Company. The decision of a majority of such arbitrators shall be final and binding. When the amount of stock so determined has been provided by an appropriate increase of the stock of the Operating Company said amount of stock shall be issued and divided by delivering sixty five per cent. (65%) thereof to the Ohio Company and thirty five per cent. (35%) thereof to the Clover Leaf Company or their respective nominees.

Upon the exercise by the Operating Company of the option to purchase the properties, aforesaid, the Operating Company shall be relieved of any further payment of rentals and the Old Companies shall concurrently, upon delivery of such of the capital stock as above provided for, deliver to the Operating Company pursuant to the foregoing provisions good and sufficient conveyances with usual covenants of warranty as to title, the same to be free and clear from all incumbrances [with certain exceptions not material here].

17. In case the Operating Company shall not exercise its option to purchase on or before February 1, 1928, it shall immediately prepare for the return of the property at the end of the term of this Indenture by dividing the property, routes, business, supplies, customers and facilities in its hands in such manner and in such proportion as to enable it to return to each of the Old Companies the property delivered by it to the Operating Company, or the fair equivalent of such property in value and operating utility so that at the end of the term of this Indenture each of the Old Companies can take their property or its equivalent and proceed with its business without undue delay or expense.

On the termination of this Indenture the Operating Company shall restore or put the plants of the Old Companies so that each will be in at least as good condition as it is now in and so that each will be equipped to handle and care for the owners percentage of the business at and after the time of termination.

* * *

18. If the Operating Company shall fail to pay the rentals herein stipulated, or to perform the terms, covenants and provisions of this Indenture for a continuous period of three (3) months, then either Old Company may give notice of such default to both the Operating Company and the other Old Company, which notice shall specify in detail the default complained of, and if said default specified in said notice shall continue for a period of three (3) months after the date of service of said notice then and in such case said Old Company, giving notice, may at the end of said second period of three (3) months declare this Indenture terminated, and thereupon the properties of each of the Old Companies shall be returned as is provided for in case of a failure to exercise the option to purchase the property, in detail set forth in Paragraph 17 hereof. Said notices aforesaid shall be in writing and shall be addressed to the respective parties at Toledo, Ohio, and shall be mailed to the respective parties by United States Registered Mail.

* * *

The property and assets acquired by the petitioner under the lease agreement of February 15, 1919, were valued and agreed upon by the lessor corporations for the purpose of determining their respective interest in the lease, and these values were also agreed upon by all parties to the lease for the purpose of determining the minimum cost to the petitioner and its liability to the lessor corporations in accordance with paragraph 9 of the lease in the event that any of this leased property was sold by the lessee. These values were also agreed upon by all parties to the lease as the minimum cost to the petitioner for the purpose of computing depreciation and accruing the liability therefor of the lessee to the lessors. A detailed list of the property leased was compiled and the cost of each item thereon was agreed upon. (The cost of the property refers to the depreciated cost of the leased property to the lessor, since the petitioner had no acquisition cost in such leased property.) These costs were totaled and the aggregate cost for the various classes of property leased, which were agreed upon by all parties to the lease, were as follows:

Land	$10,000.00
Buildings	29,376.30
Plant equipment	120,655.97
Horses	17,375.00
Wagons	21,870.00
Auto truck	2,000.00
Stable supplies	568.90
Containers	12,753.00
Ice cream cans	$1,463.50
Bottles	3,187.50
Receiving stations	20,550.14
Office furniture and fixtures	2,058.25
Total	242,858.56

In determining its income for the taxable year ended December 31, 1922, the petitioner deducted from gross income the sum of $9,898.90 as a loss on account of depreciation sustained on the property and assets covered by the lease agreement referred to in the foregoing paragraph, and/or an accrued expense item or cost of doing business under the terms and provisions of said lease, and under the provisions of section 234(a) of the Revenue Act of 1921, and charged to an expense account for depreciation and the reserves for said depreciation were accordingly credited. Said amount deducted was computed upon the agreed valuation, as follows:

	Cost		Depreciation
	Jan. 1, 1922	Dec. 31, 1922	Rate	Amount
			Per cent
Plant equipment	$13,953.95	$13,953.95	10	$1,395.39
Horses	12,125.00	11,290.00	15	1,811.78
Wagons	21,870.00	21,870.20	20	4,374.00
Stable equipment	568.90	568.90	10	56.89
Receiving stations	20,550.14	20,550.14	10	2,055.01
Office furniture and fixtures	2,058.25	2,058.25	10	205.83
Total depreciation on leased property				9,898.90

Thereafter, on February 3, 1927, the Commissioner of Internal Revenue disallowed said deduction from income and found a deficiency in tax of $1,603.27. Said deduction for depreciation was disallowed by the Commissioner on the question of law as to whether the petitioner was entitled as a matter of right and of law to a deduction for depreciation and/or an accrued expense item with respect to the assets covered by the lease agreement dated February 15, 1919, it being stipulated and agreed that the basis for computing, the rates of depreciation, and amount, if allowable, are correct.

The cost of the leased property on hand during the year 1922, as shown in the above computation of depreciation, was determined by deducting the cost of all property sold, scrapped or completely consumed, from the total cost of all the property originally covered by the lease, and the resulting balance represents the total cost of the items on hand during 1922 and agrees with the total of the individual cost of the respective items on hand. This computation is briefly summarized as follows:

Description	Cost agreed upon for all property leased	Cost of leased property sold, scrapped, or completely consumed prior to Jan. 1, 1922	Cost of leased property on hand Jan. 1, 1922	Cost of leased property sold during 1922	Cost of leased property on hand Dec. 31, 1922
Land	$10,000.00	$10,000.00
Buildings	29,376.30	29,376.30
Plant equipment	120,655.97	106,702.02	$13,953.95		$13,953.95
Horses	17,375.00	5,250.00	12,125.00	$835.00	11,290.00
Wagons	21,870.00		21,870.00		21,870.00
Auto truck	2,000.00		2,000.00	2,000.00
Stable supplies	568.90		568.90		568.90
Containers	12,753.00	12,753.00
Ice cream cans	1,463.50	1,463.50
Bottles	4,187.50	4,187.50
Receiving stations	20,550.14		20,550.14		20,550.14
Office furniture and fixtures	2,058.25		2,058.25		2,058.25
Total	242,858.56	169,732.32	73,126.24	2,835.00	70,291.24

The property on hand in 1922 was similar in nature to other property purchased and owned by the petitioner. The life of both the property owned and the property leased for the respective classes of these properties is as follows:

	Years
Plant equipment	10
Horses	6 2/3
Wagons	5
Stable equipment	10
Receiving stations	10
Office furniture and fixtures	10

The cost of the leased property sold in the year 1922, the depreciation sustained from the date of the lease to the date of the sale, the amount received from the sales and the resulting loss from the sales were as follows:

Horses:
Cost of horses sold	$835.00
Depreciation taken	267.79
Net	567.21
Amount received from sale of horses	65.00
Loss from sale of horses		$502.21
Autos:
Cost of autos sold	$2,000.00
Depreciation taken	1,400.00
Net	600.00
Amount received from sale of autos	175.00
Loss from sale of autos		$425.00
Total loss from sale of leased property		927.21

Thereafter, on February 3, 1927, the Commissioner of Internal Revenue disallowed said deduction for loss on the sale of leased assets. Said deduction for the loss on the sale of leased assets was disallowed by the Commissioner on the question of law as to whether the petitioner was entitled as a matter of right and of law to a deduction for a loss resulting from the sale of leased assets, under the terms and provisions of said lease, it being stipulated and agreed that the basis of computing said loss, the figures used, and the amount, if allowable, are correct.

In determining its income for the taxable year ended December 31, 1922, the petitioner deducted from gross income the sum of $9,782.24 as a loss on account of depreciation sustained on the property and assets covered by the lease agreement, dated February 15, 1919, and/or an accrued expense item or cost of doing business under the terms and provisions of said lease, and under the provisions of section 234(a) of the Revenue Act of 1921, and charged to an expense account for depreciation and the reserves for depreciation were accordingly credited. Said amount deducted was computed upon the agreed valuation, as follows:

		Depreciation
Leased equipment	Cost	Rate	Amount
		Per cent
Plant equipment	$13,953.95	10	$1,395.39
Horses	11,290.00	15	1,693.50
Wagons	21,870.20	20	4,374.00
Stable equipment	568.90	10	56.89
Receiving stations	20,550.14	10	2,055.01
Office furniture and fixtures	2,058.25	10	205.83
		9,780.62
Other equipment		1.62
Total depreciation on leased property		9,782.24

The cost of the leased property on hand during the year 1923, as shown in the above computation of depreciation, was determined by deducting the cost of all property sold, scrapped, or completely consumed, from the total cost of all the property originally covered by the lease, and the resulting balance represents the total cost of the items on hand during 1923 and agrees with the total of the individual costs of the respective items on hand. This computation is briefly summarized as follows:

Description	Cost agreed upon for all property leased	Cost of leased property sold, scrapped, or completely consumed prior to June 1, 1923	Cost of leased property on on hand during 1923
Land	$10,000.00	$10,000.00
Buildings	29,376.30	29,376.30
Plant equipment	120,655.97	106,702.02	$13,953.95
Horses	17,375.00	6,085.00	11,290.00
Wagons	21,870.00		21,870.00
Auto truck	2,000.00	2,000.00
Stable supplies	568.90		568.90
Containers	12,753.00	12,753.00
Ice cream cans	1,463.50	1,463.50
Bottles	4,187.50	4,187.50
Receiving stations	20,550.14		20,550.14
Office furniture and fixtures	2,058.25		2,058.25
Total	242,858.56	172,567.32	70,291.24

The property on hand in 1923 was similar in nature to other property purchased and owned by the petitioner. The life of both the property owned and the property leased for the respective classes of these properties is as follows:

	Years
Plant equipment	10
Horses	6 2/3
Wagons	5
Stable equipment	10
Receiving stations	10
Office furniture and fixtures	10

Thereafter, on December 2, 1927, the Commissioner of Internal Revenue disallowed said deduction from income and found a deficiency in tax of $1,412.78. Said deduction for depreciation was disallowed by the Commissioner on the question of law as to whether the petitioner was entitled as a matter of right and of law to a deduction for depreciation and/or an accrued expense item with respect to the assets covered by the lease agreement, dated February 15, 1919, it being stipulated and agreed that the basis for computing, the rates of depreciation, and amount, if allowable, are correct.

OPINION.

LITTLETON: The question presented by the record is whether petitioner, as lessee of the physical assets which were held under the lease set forth in the findings of fact, is entitled, in computing its net income for the years 1922 and 1923, to deductions, (1) for depreciation of the leased assets, and (2) for alleged losses resulting from the sale of certain of the leased assets.

The Revenue Act of 1921 provides that in computing its net income a corporation is entitled to deduct a reasonable amount for the exhaustion, wear and tear of its property, and also to deduct losses sustained in its trade or business, unless compensated for by insurance or otherwise. The petitioner contends, and the Commissioner denies, that under the circumstances and conditions connected with the acquisition and possession of the assets in question, these provisions of the taxing statute authorize the deductions sought.

In support of its contention the petitioner calls our attention to the decision of the Circuit Court of Appeals, Sixth Circuit, in the case of , and urges that the decision therein is conclusive of the issues in this proceeding. The Commissioner, on the other hand, takes the position that the Board has heretofore decided adversely to the petitioner the identical issues as are herein presented.

In the Weiner case, supra, the facts were these:

Plaintiff in error [Wiener] was engaged in the business of holding property under long-term leases and subletting it for shorter terms for occupancy by or under sub-tenants. In his income tax returns for 1918, 1919, and 1920, he claimed allowances for exhaustion, wear and tear of thirteen buildings held by him under ninety-nine year leases, renewable forever. His claims were disallowed. * * *

The leases required the lessee to maintain on the premises buildings of the fair cost or value of not less than a stipulated amount (in some cases greater and in none less than the value of the existing buildings) to keep the buildings in "like condition as the same now are in," and in case of their destruction or removal from any cause, to replace them with buildings of the fair cost or value of a stated sum (equal to or greater than the value of the existing buildings). In some of the leases there were convenants to erect new buildings at future dates. * * * the lessee, however, had invested nothing in new buildings, and the only expenditures that he had made on those that were on the premises when they were leased were for rents and repairs. These expenditures were deducted from his taxable income for the years in which they were made.

The court, in holding that Wiener, the lessee, was entitled to deductions for depreciation of the leased property, stated:

The Revenue Act under which these taxes were levied permits the taxpayer, in computing net income, to set aside, tax free, "a reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence." Comp. St. Sec. 6336 1/8 g. The language of this provision would seem to prescribe but two requisites to the right of a taxpayer to this allowance: One is that the property shall have been used in his business; and the other that he is the one who must suffer and bear the burden of the loss or depreciation. This also seems true from the further point of view that the purpose of the Revenue Act is to tax only gain, and the amount thus allowed to be set aside is not gain, but is capital which has gone into gross income. [6 Am. Fed. Tax Rep. 6754]. Whether it is the capital of the one who has used the property in his business or of some one else, depends, of course, upon the environal facts. It is not necessarily the capital of the holder of the legal title, who, as in this case, may be protected by the undertakings of the lessee; nor is it the capital of a user who is under no obligation to make restitution. It is, it seems to us, the capital of the one who is responsible for the property - the owner or the person responsible to the owner for it - and who also uses and consumes it in his business; and that means of course that one may not have the legal title, or may not have paid anything for the property, and still have the right to this capital deduction, since he may have an equitable interest as valuable as the property itself, or may be so obligated to the holder of the legal title to maintain or restore the property that the investment becomes his own. This is the situation of the lessee in these cases. He is responsible for the buildings, must keep them in the condition in which they were when he took the leases, and if they are consumed, as they will be in his business, or are destroyed or removed, he must replace them. For every practical purpose they are his buildings, and in our opinion they are his capital so far as they are consumed in his business.

* * *

The Board has heretofore decided, however, that a taxpayer operating under a lease, who had no capital investment in the chattels under lease, had no basis for an allowance for wear, tear and exhaustion. ; . In those cases, just as in the case before us, the leases expressly bound the lessee taxpayers to maintain the chattels, supplies and equipment under the lease "so that on the termination of this agreement the business and property * * *, or its fair equivalent, can be returned in first class order and condition." It was apparent in those cases, as in this, that the chattels under lease could not be maintained and returned to the lessor in first class order and condition, except by renewals and replacements. In those cases, as in this, the taxpayers kept their books on an accrual basis. In , the Board said:

In order that an item may be accrued, however, a liability must actually be incurred in the taxable year. . The statute recognized the accrual basis of making returns by providing for the deduction of expenses incurred but not paid. It is apparent that no liability in praesenti was incurred under the terms of the lease in question in the years 1918 and 1919 however well known it might have been that a liability in some amount would be incurred at some time in the future. The liability to restore chattels as good as new or as good as when received when a lease is ultimately canceled or surrendered at some indefinite or indeterminate time in the future is not a present actual liability, and is not the actual incurring of an expense or liability.

* * *

In the case of a lessee of chattels who is required by the terms of the lease to make such renewals or replacements as are necessary to keep the property in as good condition as when received as additional rental or as a condition to the continued use of the property to which he has no title and is acquiring none, they are deductible, if at all, as expenses paid or incurred in carrying on a trade or business. Reserves for future unincurred expenses are not allowable as deductions under the Revenue Act of 1918.

And in , the Board said:

* * * The petitioner had no cost or capital investment in connection with the leased rolling stock. Whatever liability it may have had with respect to such chattels, it was a future, not a present liability. The petitioner's original capital would have remained unimpaired even though this depreciation reserve had not been established. We therefore sustain the Commissioner in his disallowance of the depreciation reserve. * * *

It will be observed that petitioner herein, as in the Ostheimer and Belt Railway Co. of Chicago cases, seeks to set up a depreciation reserve based upon the cost of the chattels to the lessor although the replacement cost thereof may, depending upon future events, be greater or less than the cost to the lessor. In this respect, there is, in our opinion, a material difference in the Wiener case supra in that Wiener was bound by the lease to replace property of the same "fair cost or value" as distinguished from the replacement of the "same property" which might or might not entail the same cost. In other words, in the Wiener case a depreciation reserve was set up based upon a known replacement cost whereas in this proceeding the replacement cost must, of necessity, remain unknown until such time as the property is replaced.

The Board is of the opinion that the rule laid down in the Ostheimer and Belt Railway Co. of Chicago cases, supra, is correct and that there is no statutory authority for the maintenance of a depreciation reserve by the petitioner in the circumstances of this proceeding. Accordingly, the Commissioner's action in disallowing the deductions for depreciation for the years 1922 and 1923 is sustained.

The disposition in 1922 for $240 of certain of the leased assets listed at $1,167.21 may or may not involve a loss to petitioner. This property represented no investment to it, but only a contract obligation to replace it with like property. It is obvious, of course, that until petitioner replaced the property sold in 1922 it is utterly impossible to determine the replacement cost thereof. It is possible that the property sold might be replaced for less than the selling price. The Commissioner is sustained in his disallowance of the alleged losses as deductions from gross income.

Reviewed by the Board.

Judgment will be entered for respondent.

SMITH, TRUSSELL, PHILLIPS, and GREEN dissent.