383 U.S. 272 (1966), 3, Fribourg Navigation Co., Inc. v. Commissioner

Docket Nº:No. 3
Citation:383 U.S. 272, 86 S.Ct. 862, 15 L.Ed.2d 751
Party Name:Fribourg Navigation Co., Inc. v. Commissioner
Case Date:March 07, 1966
Court:United States Supreme Court
 
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Page 272

383 U.S. 272 (1966)

86 S.Ct. 862, 15 L.Ed.2d 751

Fribourg Navigation Co., Inc.

v.

Commissioner

No. 3

United States Supreme Court

March 7, 1966

Argued November 10, 1965

CERTIORARI TO THE UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

Syllabus

Prior to acquiring a used Liberty ship for $469,000 in December, 1955, petitioner obtained a letter ruling from the Internal Revenue Service that it would accept straight-line depreciation of the ship over a useful economic life of three years, with a salvage value of $54,000. Petitioner claimed ratable depreciation deductions from date of purchase to the end of 1955 and for the year 1956 in its income tax returns, which were not challenged by respondent. After Egypt seized the Suez Canal in 1956, ship prices rose, and petitioner sold the ship, which it delivered to the purchaser on December 23, 1957, for $695,500. Prior to the sale, petitioner adopted a plan of complete liquidation pursuant to § 337 of the Internal Revenue Code of 1954, which it carried out within 12 months, and thus incurred no tax liability on the gain from the ship's sale. By December, 1957, the shipping shortage had abated, and Liberty ships were being scrapped for the predicted salvage value. Petitioner's 1957 income tax return showed a deduction from gross income of depreciation for 357 1/2 days of 1957, and computation of capital gain by subtraction of the adjusted basis, including 1957 depreciation, from the sales price of the ship. Respondent did not question the original ruling as to useful life and salvage value of the vessel, but disallowed depreciation for 1957. Respondent argued that depreciation deductions are meant to give deductions equal to the taxpayer's "actual net cost" of the asset, and, since the sales price exceeded the adjusted basis at the start of the year, the ship's use during 1957 "cost" the petitioner "nothing." Respondent's position was sustained by the Tax Court, and the Court of Appeals.

Held: The sale of a depreciable asset for an amount in excess of its adjusted basis at the beginning of the year of sale does not bar deduction of depreciation for that year. Pp. 275-288.

(a) Respondent has commingled two distinct and established concepts of tax accounting: depreciation of an asset through wear and tear or gradual expiration of useful life, provided for in §167 of the Internal Revenue Code of 1954, and fluctuations in valuation through market appreciation. Pp. 275-277.

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(b) The Commissioner's regulatory scheme provides no basis for disallowance of depreciation when, as here, there has been no challenge to the original estimates of useful life and salvage. Pp. 278-279.

(c) Respondent's position represents a sudden and unwarranted about-face from a consistent administrative and judicial practice followed until 1962. Pp. 279-283.

(d) The Commissioner's practice must be deemed to have received congressional approval by the repeated reenactment over the same period of the depreciation provision without substantial change. P. 283.

(e) Respondent's position is not consistent: under his theory, depreciation for 1955 and 1956 would also be disallowed, since the use of the asset "cost" the taxpayer "nothing" in those years as well; nor will respondent permit additional depreciation to be taken where an asset is sold for less than its adjusted basis. Pp. 286-287.

335 F.2d 15 reversed.

WARREN, J., lead opinion

[86 S.Ct. 864] MR. CHIEF JUSTICE WARREN delivered the opinion of the Court.

The question presented for determination is whether, as a matter of law, the sale of a depreciable asset for an amount in excess of its adjusted basis at the beginning of the year of sale bars deduction of depreciation for that year.

Page 274

On December 21, 1955, the taxpayer, Fribourg Navigation Co., Inc., purchased the S.S. Joseph Feuer, a used Liberty ship, for $469,000. Prior to the acquisition, the taxpayer obtained a letter ruling from the Internal Revenue Service advising that the Service would accept straight-line depreciation of the ship over a useful economic life of three years, subject to change if warranted by subsequent experience. The letter ruling also advised that the Service would accept a salvage value on the Feuer of $5 per dead-weight ton, amounting to $54,000. Acting in accordance with the ruling, the taxpayer computed allowable depreciation, and, in its income tax returns for 1955 and 1956, claimed ratable depreciation deductions for the 10-day period from the date of purchase to the end of 1955 and for the full year 1956. The Internal Revenue Service audited the returns for each of these years and accepted the depreciation deductions claimed without adjustment. As a result of these depreciation deductions, the adjusted basis of the ship at the beginning of 1957 was $326,627.73.

In July of 1956, Egypt seized the Suez Canal. During the ensuing hostilities, the canal became blocked by sunken vessels, thus forcing ships to take longer routes to ports otherwise reached by going through the canal. The resulting scarcity of available ships to carry cargoes caused sales prices of ships to rise sharply. In January and February of 1957, even the outmoded Liberty ships brought as much as $1,000,000 on the market. In June, 1957, the taxpayer accepted an offer to sell the Feuer for $700,000. Delivery was accomplished on December 23, 1957, under modified contract terms which reduced the sale price to $695,500. Prior to the sale of the Feuer, the taxpayer adopted a plan of complete liquidation pursuant to the provisions of § 337 of the Internal Revenue Code of 1954, which it thereafter carried out within 12 months. Thus, no tax liability was incurred by the taxpayer on the capital gain from the sale of the ship. As

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it developed, the taxpayer's timing was impeccable -- by December, 1957, the shipping shortage had abated, and Liberty ships were being scrapped for amounts nearly identical to the $54,000 which the taxpayer and the Service had originally predicted for salvage value.

On its 1957 income tax return, for information purposes only, the taxpayer reported a capital gain of $504,239.51 on the disposition of the ship, measured by the selling price less the adjusted basis after taking a depreciation allowance of $135,367.24 for 357 1/2 days of 1957. The taxpayer's deductions from gross income for 1957 included the depreciation taken on the Feuer. Although the Commissioner did not question the original ruling as to the useful life and salvage value of the Feuer, and did not reconsider the allowance of depreciation for 1955 and 1956, he disallowed the entire depreciation deduction for 1957. His position was sustained by a single judge in the Tax Court and, with one dissent, by a panel of the Court of Appeals for the Second Circuit. 335 F.2d 15. The taxpayer and the Commissioner agreed that the question is important, that it is currently being heavily litigated, and that there is a conflict between circuit courts of appeals on this issue. Therefore, we granted certiorari. 379 U.S. 998. We reverse.

I

The Commissioner takes the position here and in a Revenue Ruling first published the day before the trial of this [86 S.Ct. 865] case in the Tax Court1 that the deduction for

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depreciation in the year of sale of a depreciable asset is limited to the amount by which the adjusted basis of the asset at the beginning of the year exceeds the amount realized from the sale. The Commissioner argues that depreciation deductions are designed to give a taxpayer deductions equal to the "actual net cost" of the asset to the taxpayer, and, since the sale price of the Feuer exceeded the adjusted basis as of the first of the year, the use of the ship during 1957 "cost" the taxpayer "nothing." By tying depreciation to sale price in this manner, the Commissioner has commingled two distinct and established concepts of tax accounting -- depreciation of an asset through wear and tear or gradual expiration of useful life and fluctuations in the value of that asset through changes in price levels or market values.

Section 167(a) of the Internal Revenue Code of 1954 provides, in language substantially unchanged in over 50 years of revenue statutes:

There shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence) -- (1) of property used in the trade or business, or (2) of property held for the production of income.

In United States v. Ludey, 274 U.S. 295, 300-301, the Court described depreciation as follows:

The depreciation charge permitted as a deduction from the gross income in determining the taxable income of a business for any year represents the reduction, during the year, of the capital assets through wear and tear of the plant used. The amount of the allowance for depreciation is the sum which should be set aside for the taxable year, in order that, at the end of the useful life of the plant in the business, the aggregate of the sums set aside will (with the salvage value) suffice to provide an amount equal to the original cost.

Page 277

See also Detroit Edison Co. v. Commissioner, 319 U.S. 98, 101. In so defining depreciation, tax law has long recognized the accounting concept that depreciation is a process of estimated allocation which does not take account of fluctuations in valuation through market appreciation.2

It is, of course, undisputed that the Commissioner may require redetermination of useful life or salvage value when it becomes apparent that either of these factors has been miscalculated. The fact of sale of an asset at an amount greater than its depreciated basis may be evidence of such a miscalculation. See Macabe Co., 42 T.C. 1105, 1115 (1964). But the fact alone of sale above adjusted basis does not establish an error in allocation. That is certainly true when, as here, the...

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