Chesapeake & Ohio Railway Co. v. Comm'r of Internal Revenue
| Decision Date | 02 June 1975 |
| Docket Number | 5646-71.,Docket Nos. 5904-70 |
| Citation | 64 T.C. 352 |
| Parties | THE CHESAPEAKE AND OHIO RAILWAY COMPANY AND AFFILIATED COMPANIES, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENTTHE CHESAPEAKE AND OHIO RAILWAY COMPANY AND SUBSIDIARY CORPORATIONS, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
James P. Holden, Paul F. Mickey, Richard E. May, John W. Tissue, Robert S. Garnett, and Kenneth Ekin, for the petitioners.
St. Clair Reeves, for the respondent.
1. T Co., a railroad, had chosen in the past and continued during the taxable years to use the retirement-replacement-betterment (RRB) method of accounting in respect of those assets, such as rail, ties, and ballast, which comprised its track structure. Under the RRB method, T was not entitled to deduct a ratable allowance for depreciation in respect of these assets as it would have had it chosen the straight-line method of depreciation. Instead, T maintained the entire initial cost of its track structure, plus any betterments thereto, in its capital accounts until its final retirement, at which time it could deduct that whole amount. In the interim, the cost of all replacements as well as maintenance was immediately deductible in full in the current year. T alleged that due to foreseeable obsolescence its entire track structure would be retired in 50 years, on account of which T sought to deduct its capitalized investment in track structure ratably over that period of 50 years in anticipation of such retirement. T did not request the Commissioner's consent to a change in its method of accounting. Held: Even if T had been able to demonstrate that its track structure would in fact be retired in 50 years, it was not entitled to anticipate such through ratable depreciation deductions. The very essence of the RRB method is that the capitalized cost of assets be deducted in the year of retirement only. T's attempt to deduct amounts prior to retirement therefore constituted a change in its method of accounting for which T failed to obtain the requisite consent of the Commissioner.
2. T's tunnel bores and grading are assets which, although not subject to physical exhaustion through use, do possess limited useful service lives. Based upon its past retirement experience in respect of these assets and their allegedly foreseeable retirement due to obsolescence, T sought to depreciate its investment in grading and tunnel bores ratably over a 50-year period. Held, through the use of statistical life studies of the type which supported the Court of Claims' decisions in two recent cases, Pennsylvania Power & Light Co. v. United States, 411 F.2d 1300, and Virginia Electric & Power Co. v. United States, 411 F.2d 1314, in which the Commissioner has acquiesced, Rev. Rul. 72-403, 1972-2 C.B. 102, T has shown that its grading and tunnel bores do have reasonably determinable useful service lives over which their costs may be meaningfully allocated. Held, further, the useful lives of T's grading and tunnel bores are determined.
3. Upon removal of T's rails from its more heavily traveled lines prior to the end of their useful lives, it has been T's practice to relay the usable portions of such rails on less demanding segments of its system. Under the RRB method of accounting, it is necessary to determine the fair market value of such ‘relay rail’ at the time it is thus removed and relaid; such fair market value is determined herein.
The Commissioner determined deficiencies in petitioner's1 Federal corporate income taxes for the years 1954 through 1963, and petitioner, by its original and amended petitions, has claimed overpayments in each of those years with the exception of 1963. The respective amounts of the determined deficiencies and the claimed overpayments are as follows:
+----------------------------------------------------------+
¦ ¦Calendar ¦ ¦Overpayment (per ¦
+------------+----------+-------------+--------------------¦
¦Docket No. ¦year ¦Deficiency ¦amended petitions) ¦
+------------+----------+-------------+--------------------¦
¦ ¦ ¦ ¦ ¦
+------------+----------+-------------+--------------------¦
¦5904-70 ¦1954 ¦$1,316,049.31¦$4,510,178.49 ¦
+------------+----------+-------------+--------------------¦
¦ ¦1955 ¦5,861,634.16 ¦2,281,363.35 ¦
+------------+----------+-------------+--------------------¦
¦ ¦1956 ¦2,368,983.46 ¦5,622,512.30 ¦
+------------+----------+-------------+--------------------¦
¦ ¦1957 ¦789,708.90 ¦4,561,570.11 ¦
+------------+----------+-------------+--------------------¦
¦ ¦1958 ¦4,315,981.24 ¦3,809,908.98 ¦
+------------+----------+-------------+--------------------¦
¦ ¦1959 ¦2,879,966.21 ¦2,733,258.60 ¦
+------------+----------+-------------+--------------------¦
¦ ¦1960 ¦2,851,642.52 ¦2,889,725.58 ¦
+------------+----------+-------------+--------------------¦
¦ ¦1961 ¦2,119,317.33 ¦73,080.33 ¦
+------------+----------+-------------+--------------------¦
¦5646-71 ¦1962 ¦2,830,011.00 ¦604,546.00 ¦
+------------+----------+-------------+--------------------¦
¦ ¦1963 ¦3,817,305.00 ¦--- ¦
+----------------------------------------------------------+
The cases were consolidated for trial. Prior to trial the parties reached agreement on all but the following issues:
(1) Whether under the so-called retirement-replacement-betterment method of depreciation accounting, by which petitioner determines deductions in respect of its investment in track structure, petitioner is entitled to a ratable depreciation allowance on account of anticipated retirement, and if so, whether petitioner has established the useful life of its track structure based upon obsolescence foreseeable in 1954.
(2) Whether petitioner's investments in grading and tunnel bores had, as a result of obsolescence foreseeable in 1954, reasonably determinable useful lives such as to entitle petitioner to depreciation deductions on account thereof, and if so, what were their useful lives.
(3) For purposes of determining the proper depreciation allowance under the retirement-replacement-betterment method of accounting in respect of its rail investment, what was the fair market value of petitioner's recovered reusable rail.
The parties have filed a stipulation of facts and four supplemental stipulations which, together with their accompanying exhibits, are by this reference incorporated herein.
Petitioner, the Chesapeake & Ohio Railway Co., a Virginia corporation, maintained its principal place of business in Cleveland, Ohio, at the times of filing its petitions herein. For each of the taxable years in issue, petitioner filed Federal consolidated corporate income tax returns with the District Director of Internal Revenue at Cleveland, Ohio.
The Chesapeake & Ohio Railway Co. is a Class I rail carrier, regulated by the Interstate Commerce Commission. Petitioner carries freight in a 7-State area extending from Virginia to Michigan as well as in a small portion of Canada. More precisely, in 1954 its main line stretched westwardly from Newport News, Va., to Huntington, W. Va., from which point separate lines proceeded westwardly to Lexington, Ky., northwardly to Chicago via Cincinnati, and northwardly into Michigan and Canada. At that time petitioner either owned or operated approximately 3,400 miles of main line. In addition to its main line, petitioner also had in service about 1,700 miles of so-called ‘branch line,’ which refers to those portions of its track which were constructed in order to provide a link from a particular area, typically a coal mine, to the main line.
Issue 1. Depreciation of Track Structure
As in the case of other eastern railroads of the United States, almost all of petitioner's rail mileage existing in 1954 was built in the latter part of the 19th century. In contrast to sophisticated techniques and equipment now available, earthmoving and excavation techniques during the era when these railroads were constructed involved mainly human labor, assisted by picks, dynamite, and horse-drawn wagons. As a consequence of these limitations, the builders of railroads sought ‘water level routes' along rivers and preferred natural contour paths around hills and mountains, both of which required a minimum of excavation. The disadvantage of this type of construction was reflected in the completed roadbed's pronounced curvature and steep grades. Thus, major portions of railroad line owned by petitioner in 1954 followed the James River and the New River while other parts passed over hilly and mountainous terrain. Accordingly, petitioner's roadbed is characterized by heavy curvature and steep grades.
Both the curvature and grade of the roadbed bear directly upon the economical operation of a railroad. Curves restrict the maximum safe speed at which a train can travel. Curvature is expressed in degrees which are correlated to the radius of a circle, the arc of which matches the curve in the roadbed. Thus, for example, a 1-degree curve fits the arc produced by a 5,730-foot radius while a 4-degree curve relates to a radius one-fourth that length and a 1/2-degree curve to a radius twice that length. The maximum safe speed on a 1/2-degree curve is 100 miles per hour, whereas on a 6-degree curve it is only 45 miles an hour. Thirty percent of the roadbed on petitioner's main lines is curved in excess of 1 degree, and the maximum curve in various sectors ranges as high as 8 degrees. As an example, on the James River main line route from Newport News to Chicago, 52 percent of the track is curved in excess of 1 degree and the maximum curve is 8 degrees.
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