Burlington Northern Inc. v. United States, 30-72.

• Decision Date: 10 March 1982
• Docket Number: No. 30-72.,30-72.
• Parties: BURLINGTON NORTHERN INC. v. The UNITED STATES.
• Court: U.S. Claims Court

676 F.2d 566

BURLINGTON NORTHERN INC. v. The UNITED STATES.

No. 30-72.

United States Court of Claims.

March 10, 1982.

Robert A. Klayman, Washington, D. C., atty., of record, for plaintiff; Daniel B. Rosenbaum and Caplin & Drysdale, Washington, D. C., of counsel.

George L. Squires, with whom was Acting Asst. Atty. Gen., John F. Murray, Washington, D. C., for defendant; Theodore D. Peyser, Washington, D. C., of counsel.

Before NICHOLS, KASHIWA and BENNETT, Judges.

OPINION

BENNETT, Judge:

This action by taxpayer is for the recovery of federal income taxes alleged to have been erroneously assessed and collected for the calendar years 1956, 1957 and 1958. The aggregate recovery sought is $9,369,081.64, plus statutory interest.

The case is now before the court on the exceptions of plaintiff to the findings of fact and recommended opinion of Trial Judge George Willi.¹ All other issues having been resolved by agreement before trial, the only question presented for decision is whether, for the years in suit, plaintiff is entitled, under section 167(a) of the Internal Revenue Code of 1954,² to ratable depreciation deductions with respect to the costs incurred to install railroad grading and tunnel bores. The availability of such deductions depends on whether such properties can be shown to have a reasonably ascertainable useful life in the taxpayer's trade or business. Under the regulations on depreciation, a useful life capable of being estimated is indispensable for the institution of a system of depreciation. Treas.Reg. § 1.167(a)-1(b) (1964); Harrah's Club v. United States, 229 Ct.Cl. ___, ___, 661 F.2d 203, 207 (1981).

We have duly considered the briefs and oral argument of counsel and have given appropriate attention to the findings of fact and conclusion of law of the trial judge. We hold that plaintiff has herein failed to demonstrate a reasonable useful life for its railroad grading and tunnel bores. While our decision comports with the conclusion reached by the trial judge, we have chosen to present our own discussion of the issues in this case.

I. BACKGROUND

A. Facts

Plaintiff is successor in interest to the Northern Pacific Railway Company.³ Northern Pacific was a land grant railroad largely constructed in the latter part of the 19th century beginning at St. Paul and traversing the western plains of Minnesota, North Dakota and eastern Montana, across the Rockies in western Montana and Idaho, through the plains of eastern Washington, over the Cascade Mountains and into the Puget Sound area. By the period in suit its rail system covered about 6,500 route miles with approximately 9,900 miles of track. As of December 31, 1956, Northern Pacific had installed grading at a total cost of $121,894,149 and had installed, beginning in 1883, 61 tunnel bores at a total cost of $4,962,022.⁴

Railroad grading is the contoured surface prepared by man to receive the track structure (i.e., ballast, ties, rail, switches and associated track materials) on which rolling stock moves. It is the cost of creating this contoured surface, or roadbed, that is involved in this litigation.

A tunnel bore is the horizontal passageway that is made through a hill or mountain in order to accommodate the placement of a roadbed through the same. Although the construction of a railroad tunnel ordinarily includes the cost of (1) a lining, (2) ventilation and drainage systems, (3) portals and (4) lighting, it is only the cost of creating the airspace of the passageway with which this litigation is concerned.

Railroad grading and tunnels are subject to deterioration from severe weather conditions and seasonal change. Maintenance ordinarily can restore grading and tunnels which have been adversely affected by the elements, but the cost of such maintenance can be high. With proper maintenance, neither grading nor tunnel bores are susceptible to physical exhaustion through use or otherwise.⁵

Historically, railroads could capitalize the costs of their grading and tunnel bores⁶ but were unable to depreciate those items because of the uncertainties as to the length of their useful life.⁷ For these assets, railroads followed the retirement-replacement method of accounting which generally produced deductions only when an asset was retired or replaced.⁸ In 1969, Congress provided railroads with the option to amortize their grading and tunnel bores first placed in service after 1968 on the basis of a 50-year average life.⁹ This provision was amended in 1976 to permit similar amortization of grading and tunnel bores, the original use of which had commenced prior to 1969.¹⁰ However, this has never been the exclusive means by which grading and tunnel bores placed in service before 1969 could be depreciated.¹¹ Taxpayers have been permitted to depreciate these items whenever they have been able to satisfy the strict requirements of section 167.¹²

B. The Actuarial Method

At trial, plaintiff attempted to establish a reasonably ascertainable useful life for its grading and tunnel bores by means of "the actuarial method of life analysis."

The "actuarial method" purports to analyze the past retirement experience of depreciable assets for purposes of estimating their future service life and represents the application to industrial property of statistical procedures developed in the life insurance field for analyzing data on human mortality. The fundamental principle of the actuarial method is that groups of similar assets possess, on the average, similar service life characteristics.¹³ The goal of this statistical approach for determining the useful life of an asset is to generate a survivor curve¹⁴ for the particular asset and then to analyze that curve to determine that asset's useful life. Application of the actuarial method¹⁵ involves three phases: data gathering and mathematical calculations, life analysis and life estimation.

In the first phase, data is collected on the annual volume of additions to and retirements from the group of assets under study, and also on the age in years of each asset at the time of its retirement and the age of all the surviving assets.¹⁶ These assets, both those retired and those surviving, are then assigned to appropriate "age intervals," each interval representing a single year. Next, a determination as to the annual rate at which property was retired from each of these age interval groups is made. Under this procedure, the annual retirement rate is equal to retirements during an age interval divided by the total number of assets in that age interval. The survivor rate for that interval is equal to 100 percent minus the retirement rate. The survivor rate is then used to determine the percentage of property in each age interval which survives until the beginning of the next age interval. By multiplying the survivor rate for the first age interval by the survivor rate for the second age interval, and so on through all age intervals for which data is available, the percentage surviving at the end of each age interval on a cumulative basis is determined. The resulting sequence of percentages is then plotted on a graph. The horizontal axis of this graph represents the property age in years, while the vertical axis represents the percentage of all assets surviving. This plotted data is then smoothed to form the observed survivor curve which is characteristic of the property group studied during the years for which data was available. Where, as here, the historical data are insufficient to produce a complete survivor curve, an incomplete curve, or "stub" curve, results. Since an average useful life of an asset cannot be determined without a complete survivor curve, it is necessary to complete and smooth the rough curve artificially. While there are a number of acceptable methods of smoothing and extending this stub curve,¹⁷ the method used herein involves the matching of the stub curve with one of the 18 "Iowa curves." These are predetermined full-length survivor curves derived from empirical studies of numerous types of industrial properties,¹⁸ which through repeated application and testing have come to be regarded as generalized models of retirement behavior.¹⁹

The second phase of the actuarial method, life analysis, involves the selection of the Iowa curve which appears most compatible with the stub survivor curve. Selection can be done mathematically or, most commonly, visually. The analyst's judgment also contributes to the choice of the appropriate Iowa curve since selection of the curve which best represents a reasonable portrayal beyond the original data points is based, in part, on his familiarity with the property under study. Thus, the Iowa curve chosen may provide an indication of the property's probable average service life, based upon past retirement experience.

In the life estimation phase, the analyst evaluates the cause of past retirements and applies his judgment as to whether such causes may be expected to continue in the future. He also considers the impact of anticipated future developments. Any necessary adjustments or refinements are then made to the average service life reflected by the Iowa curve.

C. Prior Cases

Use of the actuarial method was first sanctioned by this court in the cases of Pennsylvania Power & Light Co. v. United States, 188 Ct.Cl. 76, 411 F.2d 1300 (1969) (hereinafter PP&L), and Virginia Electric & Power Co. v. United States, 188 Ct.Cl. 120, 411 F.2d 1314 (1969) (hereinafter VEPCO), wherein depreciation deductions were allowed for right-of-way easements,²⁰ assets previously regarded as nondepreciable.

In PP&L, plaintiff's expert witnesses calculated the useful lives of the assets in issue by applying both the actuarial method as previously described, employing the Iowa curves, and a "geometric mean" method²¹ to available data. At the outset, the court concluded that the right-of-way easements were intangible assets the useful lives of which extended beyond the lives...