New England Tank Indus. of New Hampshire, Inc. v. Comm'r of Internal Revenue, Docket No. 134-66.
| Citation | 50 T.C. 771 |
| Decision Date | 26 August 1968 |
| Docket Number | Docket No. 134-66. |
| Parties | NEW ENGLAND TANK INDUSTRIES OF NEW HAMPSHIRE, INC., PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | United States Tax Court |
OPINION TEXT STARTS HERE
Daniel G. Holland, for the petitioner.
James E. Markham, Jr., for the respondent.
Petitioner's predecessor contracted to furnish the U.S. Government with the use of oil storage facilities and related services. The contract originally specified a fixed annual payment for a 5-year firm period and gave the Government, in return for agreed payments, the options at any time to purchase the facilities and to terminate the contract for the convenience of the Government, and successive annual options during a 15-year period to renew the contract. When petitioner's predecessor encountered financing difficulty, the contract was modified to provide for substantial increased payments during the first year. The payments during the remaining portion of the 5-year period were correspondingly adjusted downward, as were the payments to be made upon the exercise by the Government of its options. The revised contract was assigned to petitioner, who then borrowed $2 million from a commercial bank secured by an assignment of the payments to be made under the revised contract. Held, the increased payments to petitioner during the first year were income in their entirety in that year and were not loans or return of capital, nor could they be treated as income properly deferrable to subsequent years. Held, further, the period over which petitioner could depreciate the facilities was 20 years and not 5 years.
Respondent determined deficiencies in income tax as follows:
+------------------------------+
¦TYE Oct. 31— ¦Deficiency ¦
+-----------------+------------¦
¦ ¦ ¦
+-----------------+------------¦
¦1960 ¦$233,402.59 ¦
+-----------------+------------¦
¦1961 ¦626,556.97 ¦
+-----------------+------------¦
¦1962 ¦46,007.32 ¦
+------------------------------+
After concessions by the parties in regard to several items, the following issues remain for our consideration: (1) The tax treatment to be accorded $2 million paid to petitioner in the first year of its revised contract to provide the U.S. Government with certain oil storage facilities; and (2) the determination of the useful life of these facilities for depreciation purposes.
All of the facts have been stipulated. Those facts and the exhibits attached thereto are hereby incorporated by reference.
New England Tank Industries of New Hampshire, Inc. (hereinafter referred to as petitioner), had its principal office in Cambridge, Mass., at the time of the filing of the petition herein. It also had a place of business at Newington, N.H. Petitioner filed its income tax returns on an accrual basis with the district director of internal revenue, Boston, Mass. (for fiscal years 1960 and 1962) and with the district director of internal revenue, Portsmouth, N.H. (for fiscal year 1961).
As of June 19, 1959, New England Tank Industries, Inc. (hereinafter referred to as NET), entered into a negotiated contract with the Military Petroleum Supply Agency, acting for the United States of America (hereinafter referred to as the Government), under authorization of section 416, Pub. L. 968, 84th Cong., 70 Stat. 1018.1 Under the contract, NET was to furnish the use of petroleum storage facilities, including tanks, buried pipelines, and dock and truck loading facilities (hereinafter collectively referred to as the facilities), along with various services in storing and handling the petroleum, for Pease Air Force Base, Newington, N.H. The facilities were to be built by NET on land owned by it. The services included receiving the fuel from tankers and/or barges and reloading and shipping the fuel from the facilities to base storage at Pease Air Force Base. In connection with the rendition of the services, NET was required, among other things, to maintain an independent standby electric-generating system, and a security system, which included armed guards, a clock reporting system, and water-supply and firefighting equipment.
The contract was to extend for a period of 5 years from the ‘Acceptance Date’ of the facilities. The payments to be made under the contract by the Government were to commence on that date and were designated as a ‘Use Charge per Month’ for each of six storage tanks to be provided. These charges were specified to be $743,760 per year, or a total of $3,718,800 for the 5 years involved, and were to be paid in monthly installments. An additional provision called for a per-barrel payment to NET for the use of the facilities and for services applicable to petroleum in excess of 2,600,000 barrels per contract year.
Under the contract, the Government reserved certain options, which were in substance as follows:
(1) Successive options to renew the contract for fifteen 1-year periods at annual per-barrel capacity ‘use charges' upon notice by the Government at least 30 days prior to the expiration date of the contract or any renewal thereof.
(2) The option to purchase the facilities, including the underlying land, during each year of the initial 5-year period and during any renewal period, at agreed prices ranging from $3,764,000 if exercised during the first year of the contract to $295,000 if exercised during the 20th year (the last year of the renewal period).
(3) The right to terminate the contract at any time for the convenience of the Government upon the payment of agreed amounts during each of the first 5 years of the contract ranging from $3,114,000 in the first year down to $1 million in the fifth year and by payment of an amount determined by formula during any renewal period.
Subsequent to the execution of the contract, NET had serious difficulty in obtaining the money to finance the construction of the facilities. Negotiations between NET and the Government to revise the contract resulted in the tentative acceptance by both parties on November 30, 1959, of change No. 2 to the contract, which provided, in substance, the following:
(1) The schedule of payments under the contract was revised to provide payments in the first year from the ‘Acceptance Date’ totaling $2 million, rather than $743,760 as originally provided, and a reduction in payments in each of the second through the fifty years of approximately $312,000 per year.
(2) The total payments for the firm 5-year period of the contract were reduced by $166,900, primarily to offset the financing costs which the Government expected to incur in providing NET with the $1,250,000 increase in payments in the first year.
(3) The agreed prices under the option to purchase and the termination for convenience clauses were reduced for the second through the fifth years of the contract as follows:
+------------------------------------------------+
¦ ¦Option prices ¦Termination prices ¦
+----+---------------------+---------------------¦
¦Year¦ ¦ ¦
+----+---------------------+---------------------¦
¦ ¦Original ¦Change ¦Original ¦Change ¦
+----+----------+----------+----------+----------¦
¦ ¦contract ¦No. 2 ¦contract ¦No. 2 ¦
+----+----------+----------+----------+----------¦
¦2d ¦$3,115,000¦$2,203,000¦$2,500,000¦$1,548,000¦
+----+----------+----------+----------+----------¦
¦3d ¦2,585,000 ¦1,786,000 ¦2,000,000 ¦1,161,000 ¦
+----+----------+----------+----------+----------¦
¦4th ¦2,150,000 ¦1,324,000 ¦1,500,000 ¦774,000 ¦
+----+----------+----------+----------+----------¦
¦5th ¦1,515,000 ¦902,000 ¦1,000,000 ¦387,000 ¦
+------------------------------------------------+
By contract dated November 25, 1959, J. F. White Contracting Co. agreed with NET to perform all work and furnish all materials for the construction of the facilities required under the contract between NET and the Government for the sum of $2,425,000.
Sometime prior to January 15, 1960, NET organized the petitioner herein, to be the assignee of NET's interests under the contract. On January 15, 1960, NET, petitioner, and the Government entered into an agreement whereby this assignment was effectuated.
On January 19, 1960, petitioner, as successor in interest of NET, the First National Bank of Boston, and J. F. White Contracting Co., petitioner's subcontractor, entered into a construction loan agreement (hereinafter referred to as the loan agreement), which provided, inter alia, that:
(1) The bank would loan petitioner $2 million with interest at the rate of 6 percent per annum, the loan to be made by a series of advances solely to make payments to the subcontractor for constructing the facilities.
(2) The bank would make payments directly to the subcontractor.
(3) All monthly payments made by the Government to petitioner under the contract would be assigned and paid to the bank until the loan was fully paid. The bank would apply these monthly payments to the outstanding loan balance, except for $8,333 which would be credited to petitioner's account to provide operating funds.
On January 28, 1960, change No. 2, as tentatively agreed on in November, was executed by the Government.
On July 21, 1960, the completed facilities were accepted by the Government. Upon acceptance, payments by the Government under the contract commenced. These payments included the following:
+-------------------------------------------+
¦July 21, 1960 to Oct. 31, 1960¦$563,232.95 ¦
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¦Nov. 1, 1960 to Oct. 31, 1961 ¦1,541,579.30¦
+------------------------------+------------¦
¦Nov. 1, 1961 to Oct. 31, 1962 ¦386,034.96 ¦
+------------------------------+------------¦
¦Total ¦2,490,847.21¦
+-------------------------------------------+
For income tax purposes, the above payments were treated by petitioner as follows:2
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