Commissioner of Internal Revenue v. Idaho Power Company 8212 263

• Decision Date: 24 June 1974
• Docket Number: No. 73,73
• Citation: 94 S.Ct. 2757,41 L.Ed.2d 535,418 U.S. 1
• Parties: COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. IDAHO POWER COMPANY. —263
• Court: U.S. Supreme Court

41 L.Ed.2d 535

94 S.Ct. 2757

418 U.S. 1

COMMISSIONER OF INTERNAL REVENUE, Petitioner,

v IDAHO POWER COMPANY.

No. 73—263.

Argued Feb. 27, 1974.

Decided June 24, 1974.

Syllabus

Section 167(a) of the Internal Revenue Code of 1954 allows a depreciation deduction from gross income for 'property used in the (taxpayer's) trade or business' or 'held for the production of income,' whereas § 263(a)(1) of the Code disallows a deduction for '(a)ny amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate,' expenditures which, the regulations state, include the 'cost of acquisition, construction, or erection of buildings.' Section 161 makes the deductions specified in that part of the Code, including § 167(a), subject to the exceptions provided in the part including § 263. Respondent public utility claimed a deduction from gross income under § 167(a) for all the depreciation for the year on its transportation equipment (cars, trucks, etc.), including that portion attributable to its use in constructing capital facilities, although on its books, as required by the regulatory agencies, it charged such equipment, to the extent it was used in construction, to the capital assets so constructed. The Commissioner of Internal Revenue disallowed the deduction for the construction-related depreciation, ruling that that depreciation was a nondeductible capital expenditure under § 263 (a). The Commissioner was upheld by the Tax Court, but the Court of Appeals reversed, holding that a deduction expressly enumerated in the Code, such as that for depreciation, may properly be taken even if it relates to a capital item, and that § 263(a)(1) was inapplicable because depreciation is not an 'amount paid out' as required by that section. Held: The equipment depreciation allocable to the taxpayer's construction of capital facilities must be capitalized under § 263(a)(1). Pp. 10—19.

(a) Accepted accounting practice and established tax principles require the capitalization of the cost of acquiring a capital asset, including the cost incurred in a taxpayer's construction of capital facilities. The purpose of depreciation accounting is the allocation of the expense of using an asset over the tax periods benefited by that asset. Pp. 10—13.

(b) Construction-related depreciation is not unlike expenditure for other construction-related items, such as construction workers' wages, which must be treated as part of the cost of acquiring a capital asset. The significant fact is that the exhaustion of the construction equipment does not represent the final disposition of the taxpayer's investment in that equipment; rather such investment is assimilated into the cost of the capital asset constructed, and this capitalization prevents the distortion of income that would otherwise occur if depreciation properly allocable to asset acquisition were deducted from gross income currently realized. P. 13—14.

(c) Capitalization of construction-related equipment depreciation by the taxpayer which does its own construction work maintains tax parity with the taxpayer which has such work done independently. P. 14.

(d) Where a taxpayer's generally accepted method of acocunting is made compulsory by the regulatory agency and that method clearly reflects income, as here, it is almost presumptively controlling of federal income tax consequences. Pp. 14—15.

(e) Considering § 263(a)(1)'s literal language in denying a deduction for '(a) ny amount paid out' for construction or permanent improvement of facilities, and its purpose to reflect the basic principle that a capital expenditure may not be deducted from current income, as well as the regulations indicating that for purposes of § 263(a)(1) 'amount paid out' equates with 'cost incurred,' there is no question that the cost of the transportation equipment was 'paid out' in the same manner as the cost of other construction-related items, such as supplies, materials, and wages, which the taxpayer capitalized. Pp. 16—17.

(f) The priority-ordering directive of § 161 requires that § 263(a)'s capitalization provision take precedence, on the facts, over § 167(a). P. 17—19.

9 Cir., 477 F.2d 688, reversed.

Keith A. Jones, Washington, D.C., for petitioner.

Frank Norton Kern, New York City, for respondent.

Mr. Justice BLACKMUN delivered the opinion of the Court.

This case presents the sole issue whether, for federal income tax purposes, a taxpayer is entitled to a deduction from gross income, under § 167(a) of the Internal Revenue Code of 1954, 26 U.S.C. § 167(a),¹ for depreciation on equipment the taxpayer owns and uses in the construction of its own capital facilities, or whether the capitalization provision of § 263(a)(1) of the Code, 26 U.S.C. § 263(a)(1),² bars the deduction.

The taxpayer claimed the deduction, but the Commissioner of Internal Revenue disallowed it. The Tax Court (Scott, J., in an opinion not reviewed by the full court) upheld the Commissioner's determination. 29 T.C.M. 383 (1970). The United States Court of Appeals for the Ninth Circuit, declining to follow a Court of Claims decision, Southern Natural Gas Co. v. United States, 412 F.2d 1222, 1264—1269, 188 Ct.Cl. 302, 372—380 (1969), reversed. 477 F.2d 688 (1973). We granted certiorari in order to resolve the apparent conflict between the Court of Claims and the Court of Appeals. 414 U.S. 999, 94 S.Ct. 351, 38 L.Ed.2d 235 (1973).

I

Nearly all the relevant facts are stipulated. The taxpayer-respondent, Idaho Power Company, is a Maine corporation organized in 1915, with its principal place of business at Boise, Idaho. It is a public utility engaged in the production, transmission, distribution, and sale of electric energy. The taxpayer keeps its books and files its federal income tax returns on the calendar year accrual basis. The tax years at issue are 1962 and 1963.

For many years, the taxpayer has used its own equipment and employees in the construction of improvements and additions to its capital facilities.³ The major work has consisted of transmission lines, transmission switching stations, distribution lines, distribution stations, and connecting facilities.

During 1962 and 1963, the tax years in question, taxpayer owned and used in its business a wide variety of automotive transportation equipment, including passenger cars, trucks of all descriptions, power-operated equipment, and trailers. Radio communication devices were affixed to the equipment and were used in its daily operations. The transportation equipment was used in part for operation and maintenance and in part for the construction of capital facilities having a useful life of more than one year.

On its books, the taxpayer used various methods of charging costs incurred in connection with its transportation equipment either to current expense or to capital accounts. To the extent the equipment was used in construction, the taxpayer charged depreciation of the equipment, as well as all operating and maintenance costs (other than pension contributions and social security and motor vehicle taxes) to the capital assets so constructed. This was done either directly or through clearing accounts in accordance with procedures prescribed by the Federal Power Commission and adopted by the Idaho Public Utilities Commission.

For federal income tax purposes, however, the taxpayer treated the depreciation on transportation equipment differently. It claimed as a deduction from gross income all the year's depreciation on such equipment, including that portion attributable to its use in constructing capital facilities. The depreciation was computed on a composite life of 10 years and under straight-line and declining-balance methods. The other operating and maintenance costs the taxpayer had charged on its books to capital were not claimed as current expenses and were not deducted.

To summarize: On its books, in accordance with Federal Power Commission-Idaho Public Utilities Commis- sion prescribed methods, the taxpayer capitalized the construction-related depreciation, but for income tax purposes that depreciation increment was claimed as a deduction under § 167(a).⁴

Upon audit, the Commissioner of Internal Revenue disallowed the deduction for the construction-related depreciation. He ruled that that depreciation was a nondeductible capital expenditure to which § 263(a)(1) had application. He added the amount of the depreciation so disallowed to the taxpayer's adjusted basis in its capital facilities, and then allowed a deduction for an appropriate amount of depreciation on the addition, computed over the useful life (30 years or more) of the property constructed. A deduction for depreciation of the transportation equipment to the extent of its use in day-to-day operation and maintenance was also allowed. The result of these adjustments was the disallowance of depreciation, as claimed by the taxpayer on its returns, in the net amounts of $140,429.75 and $96,811.95 for 1962 and 1963, respectively. This gave rise to asserted deficiencies in taxpayer's income taxes for those two years of.$73,023.47 and $50,342.21.

The Tax Court agreed with the decision of the Court of Claims in Southern Natural Gas, supra, and described that holding as one to the effect that 'depreciation allocable to the use of the equipment in the construction of capital improvements was not deductible in the year the equipment was so used but should be capitalized and recovered over the useful life of the assets constructed.' 29 T.C.M., at 386. The Tax Court, accordingly, held that the Commissioner 'properly disallowed as a deduction . . . this allocable portion of depreciation and that such amount should be capitalized as part of (taxpayer's) basis in the permanent improvements in the construction of which the equipment was used.' Ibid.

The Court of Appeals, on the other hand, perceived in the Internal Revenue Code of 1954 the presence of a...