Dodge Bros. v. United States

• Decision Date: 22 May 1940
• Docket Number: 6425,6424,No. 6406,6431.,6406
• Citation: 33 F. Supp. 312
• Parties: DODGE BROS., Inc., v. UNITED STATES.
• Court: U.S. District Court — District of Maryland

33 F. Supp. 312

DODGE BROS., Inc., v. UNITED STATES.

Nos. 6406, 6424, 6425, 6431.

District Court, D. Maryland.

May 22, 1940.

COPYRIGHT MATERIAL OMITTED

Larkin, Rathbone & Perry, John W. Drye, Jr., and T. R. Iserman, all of New York City, Hershey, Donaldson, Williams & Stanley, Albert E. Donaldson, Raymond S. Williams, and Richard W. Emory, all of Baltimore, Md., for plaintiff.

Samuel O. Clark, Jr., Asst. Atty. Gen., Andrew D. Sharpe, Milford S. Zimmerman, and Arthur L. Jacobs, Sp. Assts. to Atty. Gen., and Bernard J. Flynn, U. S. Atty., and G. Randolph Aiken, Asst. U. S. Atty., both of Baltimore, Md., for defendant.

CHESNUT, District Judge.

In these four suits the plaintiff, Dodge Brothers, Inc., a Maryland corporation heretofore engaged in the manufacture and sale of automobiles, is seeking recovery of alleged overpayments of income taxes for the years 1925 to 1928, both inclusive. Different amounts are claimed for the several years but the aggregate is $2,366,630.72 with interest. The contention of the plaintiff is that the overpayments resulted from the refusal of the Commissioner of Internal Revenue to allow as deductions from gross income for the respective years two items; (1) the amount of $10,000,000 for depreciation (in the nature of obsolescence) over the four-year period on an item of intangible property consisting of what is called the "proved Dodge car"; and (2) amortization of bond discount over the four-year period in the aggregate amount of $811,026.41.

The evidence in the case consists principally of a lengthy and elaborate stipulation of facts supplemented by some oral testimony. The stipulation of facts gives in much detail the history of the manufacture and sale of the Dodge four-cylinder automobile from 1914 to 1928, and the financial and legal history of the several successive legal entities which owned and operated it. Stripped of unessential details this history may be succinctly summarized.

Prior to 1914 John F. Dodge and Horace E. Dodge as partners were engaged in Detroit, Michigan, in the manufacture of parts for the Ford automobile. In that year they withdrew from that particular business and determined to manufacture and sell an automobile of their own make. Their business was incorporated in Michigan on July 7, 1914, and until their respective deaths in 1920, they wholly owned and personally managed the business of the corporation which consisted principally of the manufacture and sale of the Dodge four-cylinder car. After their deaths the stock was owned by their respective estates and the business continued in that ownership until May 1, 1925, when all the assets of the business consisting principally of factory and equipment at Hamtranck, Michigan, was sold for $146,000,000 in cash to a syndicate of bankers headed by Dillon, Read & Co., of New York. The latter organized a Maryland corporation named Dodge Brothers, Inc., and caused all the assets of the Michigan corporation to be conveyed to the Maryland corporation in exchange for securities issued by it to the syndicate of bankers consisting of —

(a) $75,000,000 principal amount of 6% Gold Debentures, due May 1, 1940;

(b) 850,000 shares of preference stock (each share of preference stock carrying with it one share of common stock Class A);

(c) 650,000 shares of common stock Class A;

(d) 500,000 shares of common stock Class B (having sole voting power) and (e) $14,000,000 in cash. This cash was paid by the Maryland corporation from the assets of the Michigan corporation transferred to it.

The securities so issued by the Maryland corporation comprised all of the securities authorized by its charter with the exception of 1,035,000 shares of Class A common stock which was reserved specifically for the conversion of the debentures into common stock. The Maryland corporation assumed all the liabilities of the Michigan corporation. As of May 1, 1925, the fair market value of all the assets (including good-will at $1.00 only) was $105,133,160.40, and the excess of assets over liabilities (excluding debentures and stock issued) was $81,913,473.62.

The bankers organized several separate syndicates for the sale of the debentures and most of the stock to the public. Shortly thereafter the public market value of all the securities which had been issued by the Maryland corporation aggregated about $190,000,000. The banking syndicates realized a profit of over $20,000,000 in addition to the retention of some of the stock. Dillon, Read & Co., and its associate, United States & Foreign Securities Corporation, retained 472,000 shares of the Class B common stock, which alone had voting power; and six of seven directors of the Maryland corporation were persons formerly associated with Dillon, Read & Co.

The net profits of the Michigan corporation for five years prior to 1925 averaged about $12,000,000. For 1924 the amount was over $17,000,000; and for 1925 the aggregate profits of the Michigan and Maryland corporations were over $22,000,000; the net profits for the Maryland corporation for 1926 were $21,591,919.43, and for 1927 were $9,641,426.62; and for the six months of 1928 were $3,400,443.57. During 1927 it became apparent to the management of Dodge Brothers, Inc., that the great popularity of the Dodge four-cylinder car for ten years past was fast waning despite substantial improvements which were made therein and very extensive advertising. It thereupon decided to bring out a new six-cylinder car as a supplementary line to the four-cylinder car; but several successive six-cylinder models were comparatively unsuccessful; and as of June 30, 1928, the whole business was sold to the Chrysler Corporation, also largely engaged in the manufacture and sale of motor cars. The transaction took the form of an exchange of Chrysler stock for Dodge stock in the proportions of 1 share of Chrysler for 1 share of Dodge preference stock; 1 share of Chrysler for 5 shares of Dodge Class A common stock and 1 share of Chrysler for 10 shares of Dodge Class B common stock. It is said that at then prevailing market prices for the Chrysler stock the original purchasers of Dodge stock did not sustain a loss. Chrysler assumed the liability of the debentures, all of which have now been retired either by conversion through the sinking fund or called and paid off by Chrysler at a premium. All the assets of the Maryland corporation were conveyed to the Chrysler corporation which has since continued the business of manufacture and sale of Dodge cars. The corporate identity of the Maryland corporation has been continued but it has engaged in no active business since July 30, 1928. Income tax returns were duly made by the Maryland corporation for the years 1925 to 1928 inclusive, and the total amount of taxes shown thereon aggregating about $6,500,000 were duly paid. In none of these returns was any claim made by the taxpayer for deduction on account of the items of depreciation and amortization of bond discount here involved. In the current course of audit of the taxpayer's returns by the Commissioner various corrections and adjustments were made resulting in a determination by the Commissioner of a deficiency for 1925 in the amount of $477,647.95, and over-assessment for 1926, 1927 and 1928 in the aggregate amount of $922,198.99. In the course of negotiations between the taxpayer and the Commissioner the additional claims for deductions involved in this case were advanced on behalf of the taxpayer for the first time in December 1928. The theory of the deduction as to depreciation for obsolescence of the so-called "proved car" was then first formulated by the accountant for the taxpayer, a Mr. Bailey of the firm of Ernst & Ernst. The term "proved car" has no historical or technical significance in the automotive industry. The phrase was coined by Mr. Bailey as a convenient expression of his conception of an intangible item of value which he thought was capable of separate valuation and segregation from the collective item of good-will which had been valued on the books of the taxpayer at $1.00. The Commissioner rejected the contention that the item was properly depreciable, and also rejected the contention for deduction for amortization of debenture discount. Appropriate petitions for refund were in due course made, filed and rejected, and these suits have resulted. No question of limitations is presented except in one possible aspect of the cases which is not necessary to the decision.

Plaintiff's Contention as to Depreciation.

The Revenue Act of 1926, c. 27, 44 Stat. 9, § 234(a), 26 U.S.C.A. Int.Rev.Acts, pages 185, 187, reads:

"In computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions: * * *

"(7) A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence."¹

There have long been Treasury Regulations relating to depreciation allowances in the determination of income taxes.² The one most applicable here reads as follows:

"Art. 163. Depreciation of intangible property. — Intangibles, the use of which in the trade or business is definitely limited in duration, may be subject to a depreciation allowance. Examples are patents and copyrights, licenses, and franchises. Intangibles, the use of which in the business or trade is not so limited, will not usually be a proper subject of such an allowance. If, however, an intangible asset acquired through capital outlay is known from experience to be of value in the business for only a limited period, the length of which can be estimated from experience with reasonable certainty, such intangible asset may be the subject of a depreciation allowance, provided the facts are fully shown in the return or prior thereto to the satisfaction of the Commissioner. No deduction for depreciation, including obsolescence, is allowable in respect of good will."³ (Italics...