Idaho Power Company v. CIR

• Decision Date: 30 April 1973
• Docket Number: No. 26368.,26368.
• Citation: 477 F.2d 688
• Parties: IDAHO POWER COMPANY, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

477 F.2d 688 (1973)

IDAHO POWER COMPANY, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 26368.

United States Court of Appeals, Ninth Circuit.

April 10, 1973.

As Amended April 30, 1973.

Frank Norton Kern (argued), Lawrence C. Wilson, Reid & Priest, New York City, for petitioner-appellant.

William A. Friedlander (argued), Johnnie Walters, Asst. Atty. Gen., Tax Division, Dept. of Justice, K. Martin Worthy, Chief Counsel, IRS; Meyer Rothwacks, Elmer J. Kelsey, Gordon S. Gilman, Tax Division, Dept. of Justice, Washington, D. C., for respondent-appellee.

Before TRASK and CHOY, Circuit Judges, and McGOVERN,^* District Judge.

TRASK, Circuit Judge:

The taxpayer, Idaho Power Company, appeals from a Tax Court decision denying taxpayer's depreciation deduction on equipment used in the construction of capital improvements. Under the Tax Court decision the taxpayer was ordered to pay deficiencies in income taxes for the taxable years 1962 and 1963 in the amounts of $73,023.47 and $50,342.21, respectively.

The Tax Court ruled against the taxpayer on the single issue—whether the taxpayer is entitled to deduct depreciation on depreciable equipment to the extent such equipment is used in the construction of its own capital assets. The Tax Court treated the depreciation as a cost of the construction of the new facilities and ruled such costs must be capitalized as part of the basis of the property constructed under section 263 of the Internal Revenue Code of 1954.¹ We agree with the taxpayer's position that the current depreciation should be treated as a current deduction under section 167 of the Code.² The decision of the Tax Court is therefore reversed.

The taxpayer is a public utility engaged in the production, transmission and sale of electricity. Since at least 1929, the taxpayer has regularly constructed additional transmission and distribution facilities using its own employees and equipment for a major part of the work. In 1962 it constructed $7,139,940.72 worth of facilities and in 1963, $5,642,342.79 worth. In some years it has used as many as 300 employees in construction and at the time of trial 140 were engaged in such work in question. During the years, the taxpayer has owned cars, trucks, trailers and radio equipment which have been used in part to operate and maintain existing facilities and in part to construct new capital assets.

On its books the taxpayer capitalized the depreciation to the extent the equipment was used in the construction of capital assets in accordance with accounting procedures prescribed by the Federal Power Commission and adopted by the Idaho Public Utilities Commission.³ On its income tax returns for 1962 and 1963, however, the taxpayer deducted all depreciation on its transportation equipment, including depreciation on the equipment to the extent it was used in construction. Such equipment was depreciated over a composite life of ten years. All other costs allocable to the constructed facilities, except pension contributions, social security taxes and motor vehicle taxes, which were also deducted currently, were capitalized by the taxpayer. This included costs of operating and maintaining such equipment. The Commissioner of Internal Revenue disallowed and capitalized the deduction for depreciation on taxpayer's equipment to the extent that such equipment was used in the construction of capital assets and allowed instead a deduction for depreciation of the amounts so capitalized over the useful life of the property so constructed. The construction, consisting principally of transmission and distribution facilities, had useful lives of 30 years or longer. The result of this adjustment was the net disallowance by the Commissioner of depreciation claimed by the taxpayer during the years 1962 and 1963 in the respective amounts of $140,429.75 and $96,811.95.

I. THE DEPRECIATION DEDUCTION

A re-examination of the purpose of the depreciation deduction, its place in the statutory scheme and its history will assist us in solving the problem. It is the basic theory of depreciation that capital assets which are used in the business should not be exhausted without a provision for their replacement. To that end depreciation over the life of the asset provides the means by which the taxpayer can recover its cost. One way of expressing this very practical approach was that of the Supreme Court in Knoxville v. Knoxville Water Co., 212 U.S. 1, 13-14, 29 S.Ct. 148, 152, 53 L.Ed. 371 (1909):

"A water plant, with all its additions, begins to depreciate in value from the moment of its use. Before coming to the question of profit at all the company is entitled to earn a sufficient sum annually to provide not only for current repairs but for making good the depreciation and replacing the parts of the property when they come to the end of their life. The company is not bound to see its property gradually waste, without making provision out of earnings for its replacement. It is entitled to see that from earnings the value of the property invested is kept unimpaired, so that at the end of any given term of years, the original investment remains as it was at the beginning. It is not only the right of the company to make such a provision, but it is its duty to its bond and stockholders, and, in the case of a public service corporation at least, its plain duty to the public. If a different course were pursued the only method of providing for replacement of property which has ceased to be useful would be the investment of new capital and the issue of new bonds or stocks. This course would lead to a constantly increasing variance between present value and bond and stock capitalization—a tendency which would inevitably lead to disaster either to the stockholders or to the public, or both."

Although that case did not involve an income tax problem, it states the underlying theory of the deduction.

The purpose of the depreciation allowance under the Code is "to permit the taxpayer to recover his capital investment in wasting assets free of income tax." 4 Mertens, Law of Income Taxation § 23.04. The Supreme Court has said that the purpose of the depreciation deduction is to create a fund to restore the property, to the extent of the investment of the taxpayer, at the end of its useful life:

"The end and purpose of it all is to approximate and reflect the financial consequences to the taxpayer of the subtle effects of time and use on the value of his capital assets. For this purpose it is sound accounting practice annually to accrue as to each classification of depreciable property an amount which at the time it is retired will with its salvage value replace the original investment therein." Detroit Edison Co. v. Commissioner, 319 U.S. 98, 101, 63 S.Ct. 902, 904, 87 L.Ed. 1286 (1943).

In Massey Motors, Inc. v. United States, 364 U.S. 92, 96, 80 S.Ct. 1411, 1414, 4 L.Ed.2d 1592 (1960), the Supreme Court allowed a depreciation deduction on automobiles used by dealers or their employees, explaining:

"Such assets, employed from day to day in business, generally decrease in utility and value as they are used. It was the design of the Congress to permit the taxpayer to recover, tax free, the total cost to him of such capital assets; hence it recognized that this decrease in value—depreciation—was a legitimate tax deduction as business expense. It was the purpose of § 23(l) and the regulations to make a meaningful allocation of this cost to the tax periods benefited by the use of the asset."⁴

The issue here does not affect the amount of the depreciation to which the taxpayer is entitled. Whether it is spread over a ten-year life or a thirty-year life, the amount remains the same. It does affect the timing of the recovery of the depreciation and thus might have a vital effect on the ability of a taxpayer to maintain and replenish its equipment inventory without depleting its working capital or burdening its borrowing capacity.

The legislative history of the depreciation deduction clearly supports our decision in favor of the taxpayer. "Prior to the enactment of the Internal Revenue Code of 1954, the statutory provisions for depreciation were singularly brief." 4 Mertens, supra at § 23.01. Section 23(l) of the 1939 Act contained only a bare statement similar to the general rule in section 167(a) of the 1954 Act,⁵ and a two sentence paragraph stating the method of computation as between a life tenant and a remainderman. When Congress adopted the Internal Revenue Code of 1954, however, it gave particular attention to liberalized depreciation allowances. It provided for the use of new methods and rates, in addition to the standard straight line method. These included a declining balance method, a sum of the years-digits method and a fourth method which was any one consistently applied so long as the total at the end of each year did not exceed the allowances which would have resulted from the use of the declining balance method.⁶

Further, the report of the Ways and Means Committee on H.R. 8300, which became the Internal Revenue Code of 1954, stated at the beginning of its discussion of this subject:

"Your committee\'s bill provides for a liberalization of depreciation with respect to both the estimate of useful life of property and the method of allocating the depreciable cost over the years of service." H.R. No. 1337, 83rd Cong., 2nd Sess., 1954 U.S.Code Cong. & Admin.News at 4047.

The report emphasized the importance of the liberalized policies of the bill. It pointed out its reliance upon the use of an improved declining balance method of computing depreciation which "concentrates deductions in the early years of service and results in a timing of allowances more in accord with the actual pattern of loss of economic usefulness." Id. at 4048.

The report continued:

"More liberal depreciation allowances are anticipated to have far-reaching economic effects. The incentives

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