St. Paul Union Depot Co. v. Commissioner of Internal Rev.

• Decision Date: 21 November 1941
• Docket Number: No. 11972.,11972.
• Parties: ST. PAUL UNION DEPOT CO. v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Eighth Circuit

123 F.2d 235 (1941)

ST. PAUL UNION DEPOT CO. v. COMMISSIONER OF INTERNAL REVENUE.

No. 11972.

Circuit Court of Appeals, Eighth Circuit.

November 21, 1941.

Arthur C. Erdall, of Minneapolis, Minn., for petitioner.

Berryman Green, Sp. Asst. to Atty. Gen. (Samuel O. Clark, Jr., Asst. Atty. Gen., and Helen R. Carloss and Joseph M. Jones, Sp. Assts. to Atty. Gen., on the brief), for respondent.

Before SANBORN and JOHNSEN, Circuit Judges, and NORDBYE, District Judge.

SANBORN, Circuit Judge.

This petition for review presents the question of the right of the petitioner, in computing its taxable income for the years 1934 and 1935, to deduct a reasonable allowance for the depreciation of the head-house and concourse of the St. Paul Union Depot, which it owns and operates in connection with its other terminal facilities in St. Paul, Minnesota. The respondent determined that the petitioner was not entitled to deduct such depreciation in computing its income for those years, (1) because the petitioner had prior to 1935 used the retirement method of accounting and had in prior years computed its income in accordance with that method and had not obtained permission from the respondent to compute its income on any other basis, and (2) because the petitioner's stockholding tenants had agreed to preserve and renew all of the petitioner's terminal facilities, including its depot, and would therefore absorb depreciation. On review, the Board of Tax Appeals affirmed the determination of the respondent upon the ground that the petitioner, during all of the years prior to 1935, had consistently kept its accounts and made its income tax returns upon the retirement method of accounting, and that, without the consent of the respondent, it had for the year 1935 changed its accounting method and had computed its income tax liability in accordance with the changed method.

The facts are virtually undisputed and may be summarized as follows:

The petitioner is a Minnesota corporation which has for many years furnished depot and terminal facilities for the railroads entering St. Paul, Minnesota. A depot built by the petitioner in 1880 burned in 1884, and was replaced by another depot, which burned in 1913. The present depot was built during the years 1917 to 1925. The head-house and concourse — which for brevity we shall call "the depot" — cost $2,735,212.06 and were mainly constructed of stone, concrete and brick. The petitioner owns no other comparable structure, and the cost of the depot represents about one-third of the cost of all of its properties subject to depreciation. The total cost of the petitioner's terminal facilities amounts to $15,575,805. From 1925 to 1935 there was a large decrease in the railroad passenger business in St. Paul, and the depot has turned out to be much larger than necessary. It had by 1935 become to a substantial degree outmoded.

The building of the depot and the enlargement of the petitioner's terminal facilities after the burning of the former depot in 1913 was financed by the nine railroad companies which owned all of the petitioner's capital stock, and which companies in December, 1918, entered into an operating agreement with the petitioner, by the terms of which they assumed its bonded indebtedness with respect to both principal and interest, and leased its facilities for 99 years. Under this agreement (as supplemented in 1918 and 1923), the stockholding tenant railroads agreed to pay, as rentals all of the petitioner's fixed charges, all expenses of maintaining, repairing and operating its terminal facilities, "and all such other expenses and liabilities as may be incurred in the preservation and management of said property and the business thereof" and "all expenses of maintenance, repairs and renewals of the facilities."

The method of accounting used by the petitioner has necessarily been that prescribed by the Interstate Commerce Commission. Under this method the petitioner has carried the cost of its depot and other properties in its investment account. All expenditures for maintenance, repairs or replacements of less than 50% of the value of any property replaced were charged to operating expense. If the replacements of trackage or other property exceeded 50% of the value of the property retired, they were capitalized and the original cost of the property replaced was charged off the investment account and charged to expense or to profit and loss, as required by the rules of the Interstate Commerce Commission. Up to and including the taxable years in suit, the petitioner made no replacements to its depot, and the expense of making necessary repairs was charged to operation. All items charged to expense were consistently deducted as current expenses in computing income tax liability.

The cost of the two old depots which had been destroyed, amounting to more than $600,000, had been capitalized upon the petitioner's books, but was not charged off its investment account until 1924, when it was set up in expense account in substantial accordance with the petitioner's method of accounting. During the years 1924 and 1926, the stockholding tenants paid the cost of the old depots to the petitioner. This was apparently done to insure adequate financing of the new depot and the enlarged terminal facilities. In its tax return for 1924 petitioner made no claim for a deduction of the cost of the old depots. The tenant lines have not reimbursed the petitioner for depreciation on its present depot, and have not expressly agreed, either in the form of rent or otherwise, to reimburse the petitioner for such depreciation.

The petitioner has always kept its books upon an accrual basis. Until it filed its income tax return for the year 1935 it had made its returns in strict accordance with the retirement method of accounting and had never claimed any deduction for annual depreciation of its depot. In 1935, for the first time, the petitioner set up on its books a reserve for depreciation of its depot, showing the annual depreciation to be one per cent of its cost, or $27,352.12. The petitioner did not at any time apply to the respondent for permission to change its accounting method or its basis for computing income on its depot. In computing its income tax for the year 1935, the petitioner took a deduction for depreciation on its depot of $27,352.12. It also filed a claim for the refund of income taxes paid in 1934, on the ground that it was entitled to a like deduction for that year. The respondent disallowed the deductions claimed, and determined deficiencies for each of the years.¹

On review, the Board ruled that the petitioner, having neither applied for nor obtained the consent of the respondent to compute its income, for purposes of taxation, upon any other accounting method than that which it had used prior to 1935, was, because of Article 41-2 of Treasury Regulations 86 under the Revenue Act of 1934,² precluded from making any change in its method of accounting, as a basis for computing and reporting income, without first obtaining permission from the respondent. The Board affirmed the respondent's determination of deficiencies for that reason.

The respondent contends that the order of the Board should be affirmed not only for the reason relied upon by the Board, but also because, under the petitioner's arrangement with its stockholding tenants, any loss from depreciation of the depot was to fall upon them, and not upon the petitioner.

If it is true that, under their agreement with the petitioner, the tenants are to bear all losses due to exhaustion, wear and tear and obsolescence of the leased properties, the petitioner would not be entitled to an allowance for depreciation.³

The agreement of the stockholding tenants of the petitioner to bear the expense of preservation and renewal of the terminal facilities, particularly when considered in connection with the relationship of the tenants to the petitioner, lends color to the respondent's contention that it is upon them that losses due to depreciation are eventually to fall. We think, however, that the more reasonable interpretation of the terms of the agreement is that the tenants are obligated to bear the expenses of making all repairs and renewals that are necessary to keep the terminal facilities in good operating condition during the term of the lease. It seems improbable that the tenants, by agreeing to bear the cost of preserving the property and of repairs and renewals to the terminal facilities, intended to bind themselves to replace the present depot at the end of its useful life or to make good to the petitioner losses caused by the exhaustion and obsolescence of that structure. Our conclusion in this regard is in accord with the decision of this Court in Helvering v. Terminal Railroad Association of St. Louis, 8 Cir., 89 F.2d 739, which involved a lease of terminal properties by the terms of which the lessees were required to "maintain and keep the premises * * * in good condition and make all necessary repairs and renewals of the same." Page 740 of 89 F.2d. It was held that that lease did not require the lessees to completely replace leased structures, but meant that the leased properties were by repairs and renewals to be kept in good operating condition and that this obligation of the lessees would not prevent the lessor from taking deductions for depreciation. Compare, Cincinnati Union Terminal Co. v. Commissioner, ...