Arkon, Canton & Youngstown R.R. Co v. Comm'r of Internal Revenue

• Decision Date: 25 June 1954
• Docket Number: Docket No. 37357.
• Citation: 22 T.C. 648
• Parties: THE ARKON, CANTON & YOUNGSTOWN RAILROAD COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

22 T.C. 648

THE ARKON, CANTON & YOUNGSTOWN RAILROAD COMPANY, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 37357.

Tax Court of the United States.

Filed June 25, 1954.

Petitioner, in a tax-free reorganization of two railroad corporations, acquired the roadway assets of its predecessors on February 1, 1944.The predecessors had used the retirement method of accounting.Under section 113(a)(20), Internal Revenue Code, the basis of the properties acquired is the same as the basis of the predecessors on January 31, 1944.Beginning with its first taxable period, petitioner adopted the straight-line depreciation method of accounting.It did not ask for or obtain the Commissioner's permission to use the straight-line depreciation method of accounting.Petitioner computed annual depreciation deductions on roadway assets based upon the basis of its predecessors which, because they used the retirement method of accounting, was the original cost.Petitioner sustained losses in 1944 and 1945 upon the retirement of certain assets which the predecessors acquired before March 1, 1913.Respondent reduced the predecessors' basis by 30 per cent for ‘depreciation accrued’ prior to February 1, 1944, under section 41 of the Code, which resulted in disallowances, in part, of the deductions for depreciation in each of the taxable years.Also, he adjusted, under section 113(b)(1)(C) for depreciation sustained prior to March 1, 1913, the basis of the properties which were retired.He makes an alternative contention that petitioner is not entitled to use the straight-line depreciation method but must use the retirement method.

It is held:

(1) That petitioner, a new taxable entity, is entitled to adopt the straight-line depreciation method of accounting without obtaining prior consent of the Commissioner; it is not obliged to use the retirement method.

(2) That petitioner is entitled to recover through equal annual depreciation allowances over the useful life of the assets remaining unexpired at February 1, 1944, the basis in its hands of the assets acquired in the tax-free reorganization without a 30 per cent adjustment of the basis of the predecessors for pre-February 1, 1944, depreciation; adjustment of substituted basis under section 113(b)(1)(B) is not ‘proper’;section 113(b)(1)(B) is not applicable.

(3) That for the computation of retirement loss deductions in 1944 and 1945, the predecessors' basis in petitioner's hands is not to be adjusted for pre-March 1, 1913, depreciation sustained, section 113(b)(1)(C) being inapplicable.Boston & Maine Railroad, 16 T. C. 1517,reversed on other grounds206 F. 2d 617, followed.Warren E. Hacker, Esq., for the petitioner.

James F. Kennedy, Jr., Esq., for the respondent.

The Commissioner determined deficiencies in income tax for the taxable periods ending on December 31 of the years 1944 through 1949, as are set forth below.The first taxable period of the petitioner was from February 1 through December 31, 1944.

+--------------------------+
                ¦Taxable period ¦Deficiency¦
                +---------------+----------¦
                ¦1944           ¦$10,343.72¦
                +---------------+----------¦
                ¦1945           ¦9,035.40  ¦
                +---------------+----------¦
                ¦1946           ¦2,029.03  ¦
                +---------------+----------¦
                ¦1947           ¦10,054.27 ¦
                +---------------+----------¦
                ¦1948           ¦9,441.31  ¦
                +---------------+----------¦
                ¦1949           ¦14,408.57 ¦
                +---------------+----------¦
                ¦               ¦$55,312.30¦
                +--------------------------+
                

The petitioner claims that it has made overpayments of income tax for each of the taxable periods involved except 1949.

The Commissioner has made claims for increases in the deficiencies in the event it is held that petitioner is required to use the retirement method of accounting.

The petitioner, a new corporation, acquired the roadway assets of two railroad corporations in a tax-free reorganization under section 77 of the National Bankruptcy Act, as amended.The predecessor corporations used the retirement method of accounting.Since its organization petitioner has used the straight-line depreciation method of accounting and contends that it is proper for it to use that method.Respondent contends that it should be required to use the retirement method.A question for decision is whether petitioner must use the retirement method of accounting.If it is held that petitioner may use the straight-line depreciation method a further question for decision is: For the purpose of computing deductions for depreciation of acquired roadway assets, is it ‘proper’ under sections 113(b)(2)and113(b)(1)(B) of the Code to reduce the basis of the predecessors by 30 per cent for depreciation actually sustained with respect to the period after February 28, 1913, through January 31, 1944?

The petitioner, in its taxable periods ended on December 31, 1944 and 1945, retired some of the roadway assets which it acquired from the predecessor corporations.The properties were acquired by the predecessors before March 1, 1913.Petitioner is entitled to deductions for losses upon the retirement of the properties.The parties disagree upon the amount of the basis for the purpose of the loss deduction.The question for decision is: Whether, for the purpose of computing losses sustained in 1944 and 1945, the basis of the property which was retired shall properly be adjusted for depreciation sustained prior to March 1, 1913, under section 113(b)(1)(C)?

All of the facts have been stipulated.

The petitioner filed its returns with the collector for the eighteenth district of Ohio.

FINDINGS OF FACT.

The facts stipulated are hereby found accordingly.The stipulation of facts and the attached exhibits are incorporated herein by this reference.

The petitioner is a new corporation.It commenced business on February 1, 1944.On that date it acquired the roadway assets of two predecessor railroad corporations in a nontaxable reorganization.The petitioner has used at all times the so-called straight-line depreciation method of accounting which is an approved standard method of accounting.

Petitioner's predecessors were The Northern Ohio Railroad Company, which was organized on August 14, 1895, and The Akron, Canton & Youngstown Railway Company, which was organized on June 6, 1907.Both were organized under the laws of Ohio.

The predecessor corporations were in reorganization under section 77 of the National Bankruptcy Act, as amended, under the jurisdiction of the United States District Court for the Northern District of Ohio from April 3, 1933, until their consolidation on February 1, 1944.All of the properties of the predecessor corporations were transferred to the petitioner on February 1, 1944, under court order, to effectuate a plan of reorganization approved by the court in the reorganization proceedings.The petitioner is a new corporation resulting from a statutory consolidation of the two predecessor corporations under section 9025, et seq., of the Ohio General Code.

The predecessor corporations at all times used the retirement method of accounting which is an approved standard system of accounting used by many railroads as well as by other utilities, and which is and was recognized by the Commissioner as a proper method of accounting for income tax purposes.Under this method of accounting, referred to hereinafter as the retirement method, (1) the cost of original items of property is charged to the appropriate asset account; (2) the cost of items costing less than a specified sum (said limit ranging from $100 to $500 at various times prior to February 1, 1944) and the cost of items which do not constitute a major part or which are not in excess of 50 per cent of the value of the unit of property affected is expensed against income regardless of the useful life of such items; (3) the cost of renewals, replacements, additions, and betterments (other than those expensed as aforesaid) is charged to the appropriate asset account; (4) upon retirement, the cost of the original item of property plus the cost of any renewals, replacements, additions, and betterments as were, under the system, charged to the asset account, is credited to the asset account and such cost, less salvage, is charged against income in the year of retirement; and (5) no depreciation account is maintained and no allowance for exhaustion, wear and tear, or obsolescence is charged to income with respect to any item or group of items of property.

The cost of the predecessors' roadway assets, hereinafter referred to as the assets, which petitioner acquired from them in the tax-free reorganization was $2,141,980.Immediately before petitioner acquired the assets, i. e., on January 31, 1944, the assets were carried in the capital accounts of the predecessor corporations at their cost, $2,141,980.Since there are no annual depreciation charges, as such, under the retirement method, no annual adjustments ever were made by the predecessor corporations on their books in the book value of the assets.

At all times since February 1, 1944, petitioner has kept its books and filed its Federal income tax returns deducting against income with respect to roadway assets an amount designated ‘depreciation’ computed on an annual basis equal to the predecessors' basis, or cost, adjusted for additions, betterments, and retirements made by petitioner after February 1, 1944, less estimated salvage, divided by the number of years of useful life unexpired at February 1, 1944.

The straight-line depreciation method of accounting is and was a standard approved system of accounting, recognized by the respondent as a proper method of accounting for income tax purposes.Under this method of accounting, deduction for exhaustion, wear and tear, or obsolescence is charged against income annually and is computed by writing off and deducting against income in equal amounts over the period of the assets' estimated useful life the basis adjusted for...