Commonwealth Natural Gas Corp. v. United States

• Decision Date: 07 May 1968
• Docket Number: No. 11501-11504.,11501-11504.
• Citation: 395 F.2d 493
• Parties: COMMONWEALTH NATURAL GAS CORPORATION, Appellee, v. UNITED STATES of America, Appellant (two cases). COMMONWEALTH GAS DISTRIBUTION CORPORATION, Appellee, v. UNITED STATES of America, Appellant (two cases).
• Court: U.S. Court of Appeals — Fourth Circuit

395 F.2d 493 (1968)

COMMONWEALTH NATURAL GAS CORPORATION, Appellee, v. UNITED STATES of America, Appellant (two cases).

COMMONWEALTH GAS DISTRIBUTION CORPORATION, Appellee, v. UNITED STATES of America, Appellant (two cases).

Nos. 11501-11504.

United States Court of Appeals Fourth Circuit.

Argued December 8, 1967

Decided May 7, 1968.

William A. Friedlander, Atty., Dept. of Justice (Mitchell Rogovin, Asst. Atty. Gen., Lee A. Jackson, Meyer Rothwacks, David O. Walter, Attys., Dept. of Justice, and C. Vernon Spratley, Jr., U. S. Atty., on brief), for appellant.

H. Brice Graves and Lewis F. Powell, Jr., Richmond, Va. (E. Milton Farley, III, and Hunton, Williams, Gay, Powell & Gibson, Richmond, Va., on brief), for appellees.

Before SOBELOFF, BOREMAN and WINTER, Circuit Judges.

WINTER, Circuit Judge:

The district judge, in a trial non-jury, held that taxpayers, a natural gas pipeline company and a natural gas distributing company, were entitled to depreciate certain pipeline costs, i. e., the costs of easements, including damages and the costs of clearing and grading easements, over a 30-year useful life, and gave judgment for tax refunds. In these appeals the government contends that the evidence will not support 30 years as a reasonable estimate of the continued availability of a supply of natural gas, so that no depreciation for these costs should be recognized, or, alternatively, that depreciation over a 30-year period was improper, and that taxpayers' costs in clearing and grading easements should be ascribed to land, and hence, are not depreciable. We affirm the judgments from which these appeals are taken.

Commonwealth Natural Gas Corporation ("Commonwealth") transports natural gas by pipeline and sells the gas to retail distributors. It owns 350 miles of pipeline. Commonwealth Gas Distribution Corporation, a wholly-owned subsidiary of Commonwealth, owns 15 miles of pipeline and is a retail distributor of natural gas. By stipulation of the parties, all gas reserves and resources which are available or discovered east of the Rocky Mountains are a source of supply for taxpayers' pipelines, and the parties have stipulated, further, that taxpayers will receive their fair share of these reserves and resources. The tax years in question for both taxpayers were the years 1957 to 1960, inclusive.

Before turning to the main question of depreciation, we find it convenient to dispose of the subsidiary question of whether the costs of clearing and grading easements are depreciable items. These costs were incurred after acquisition of the easements in order to put the land in shape for the pipeline to be laid. Taxpayers argue therefrom that these costs constituted a part of the costs of the pipelines, depreciable as such. The government, however, contends that the costs of clearing and grading should be ascribed to the land, or the interest in land, and that depreciation, if any, would turn on that premise. The district judge assigned these costs to the pipelines themselves and not to the intangible easements.

Standard and regulatory accounting procedures require treatment of these costs in varying ways. The uniform system of accounts prescribed by the Federal Power Commission requires that these costs be charged to land and land rights accounts; the State Corporation Commission of Virginia previously had a like requirement, although it now recognizes that if such costs are incurred in connection with the construction of a pipeline they constitute a part of the costs of the line. "Accounting Research Study No. 7," published by the American Institute of Certified Public Accountants (1965) suggests that accounts for land and land rights should include the purchase cost of land and interests in land together with other incidental costs such as clearing and grading.

The only direct authority on the question is Portland General Electric Co. v. United States, 189 F.Supp. 290, 305 (D.Ore.1960), aff'd per curiam, 310 F.2d 877 (9 Cir. 1962), where it was held that the costs of clearing easements for electric transmission lines in order to construct the facilities were properly attributable to the costs of the facilities and depreciated as part thereof. See also, Algernon Blair, Inc., 29 T.C. 1205, 1220-1221 (1958), where the government conceded that the costs of clearing, grading and landscaping in building a multiple housing project were directly related to the construction of depreciable assets and were subject to depreciation. We are persuaded to follow the Portland General Electric case in the case at bar, and we hold that the costs of clearing and grading are attributable to the cost of constructing the pipeline and depreciable with it. Distinguishable is Meyer v. United States, 247 F.Supp. 939 (D.Mass.1965), aff'd per curiam, 362 F.2d 264 (1 Cir. 1966), which holds demolition costs a part of the cost of site acquisition. The rationale of that holding is the prevention of tax avoidance because otherwise a part of the purchase price of the site would be allocated to the old building and a taxpayer would be entitled to an immediate deduction of the price so allocated upon demolition. There is no such consideration here.

We turn, therefore, to the main questions: are the costs of the pipeline depreciable, and is 30 years a proper period of depreciation?

Depreciation, as a deduction from gross income, is allowed by § 167 of the Internal Revenue Code of 1954.¹ The pertinent regulations are set forth below.² Through the successive codes and regulations thereunder there has been, over the years, little change in the provisions now obtaining. Essentially because the regulations say that an intangible asset "may" be the subject of depreciation if its length of life can be estimated with reasonable accuracy (notwithstanding that the statute says "shall"), the government argues that "the cost of an intangible asset which is known to have a useful life of a limited or finite period may be depreciated only when the length of that period can be estimated with reasonable accuracy." By that measure, the government argues that the district judge's findings with regard to finiteness and 30 years as a reasonable estimate of useful life are not supported by the proof so that taxpayers' claimed depreciation should be disallowed.

Before analyzing the proof, we find it helpful to consider what the Supreme Court has said that the statute requires in order to entitle a taxpayer to sustain a deduction for depreciation. In United States v. Ludey, 274 U.S. 295, 47 S.Ct. 608, 71 L.Ed. 1054 (1927), the Supreme Court sustained the government's argument that a depreciation allowance must be made, even though the computation was based on a "rough estimate." At issue was the cost basis of certain oil reserves which were the subject of a sale; it was held that the original cost of the property must be reduced by depreciation and depletion which Ludey was entitled to deduct, but did not claim, for earlier years.³

Four years later, in Burnet v. Niagara Falls Brewing Co., 282 U.S. 648, 51 S.Ct. 262, 75 L.Ed. 594 (1931), the test of "reasonable approximation" was approved as a test for obsolescence when the government argued that the effect of the prohibition amendment in the years immediately preceding its adoption in the brewing business could not be proved with sufficient certainty to support a deduction for obsolescence.⁴

The Ludey case was cited with approval as recently as 1966, in the case of Fribourg Navigation Co. v. Commissioner, 383 U.S. 272, 86 S.Ct. 862, 15 L.Ed.2d 751 (1966), which also cited Massey Motors, Inc. v. United States, 364 U.S. 92, 80 S.Ct. 1411, 4 L.Ed.2d 1592 (1960), and Hertz Corp. v. United States, 364 U.S. 122, 80 S.Ct. 1420, 4 L.Ed.2d 1603 (1960), as recognizing that "depreciation is based on estimates as to useful life and salvage value." Id., 383 U.S. p. 277, 86 S.Ct. at p. 866. Thus, it is clear that from the statute we must look to "estimates" which reasonably approximate what will occur; and, indeed, under certain circumstances they need be only "rough estimates." In recognition of the inexactness which may result from resort to such sources — apparent during the useful life of the property being depreciated, at the termination of such life, or at the time of disposition of such property by sale — and which may become known by application of hindsight or by some future more exact knowledge, we must keep in mind the statement in the Fribourg Navigation case that "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." Id., p. 277, 86 S.Ct. at 865. On review, our present task is only to determine in the light of present knowledge for the tax years in question if the district judge correctly determined that taxpayers have established useful life by the prescribed tests.

The district judge made three ultimate findings that are before us on review: (a) natural gas reserves exist in nature in a finite amount, (b) natural gas reserves are depleted by use and such reserves will be available for a limited time which can be estimated with reasonable accuracy, and (c) the evidence demonstrated that 30 years was a reasonable measure of the life of the natural gas reserves available to the taxpayers for the tax years in question. The government does not contest the correctness of finding (a), nor does it contest the correctness of the part of finding (b) that natural gas reserves are depleted by use and will be available for a limited time. The whole dispute revolves about whether the finiteness of natural gas reserves as to quantity and useful life can be estimated with reasonable accuracy and, if so, whether 30 years is an accurate estimate.

On these issues the taxpayers' entire case was predicated on the testimony of Dr. Bruce C. Netschert, an economist with geological training, who...