Houston Natural Gas Corp. v. Commissioner of Int. Rev.

• Decision Date: 14 June 1937
• Docket Number: No. 4153.,4153.
• Citation: 90 F.2d 814
• Parties: HOUSTON NATURAL GAS CORPORATION v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Fourth Circuit

90 F.2d 814 (1937)

HOUSTON NATURAL GAS CORPORATION v. COMMISSIONER OF INTERNAL REVENUE.

No. 4153.

Circuit Court of Appeals, Fourth Circuit.

June 14, 1937.

Irl F. Kennerly, of Houston, Tex. (Williams, Lee, Sears & Kennerly, of Houston, Tex., on the brief), for petitioner.

Ellis N. Slack, Sp. Asst. to Atty. Gen. (James W. Morris, Asst. Atty. Gen., and Sewall Key, Sp. Asst. to Atty. Gen., on the brief), for respondent.

Before NORTHCOTT and SOPER, Circuit Judges, and Harry E. Watkins, District Judge.

HARRY E. WATKINS, District Judge.

This is a petition to review a decision of the United States Board of Tax Appeals. The Commissioner of Internal Revenue determined against the Houston Natural Gas Corporation an income tax deficiency for the year 1930 of $21,646.67. The single question involved is whether certain expenditures by the Gas Corporation during the year 1930 for paying solicitors, and installing free service lines to customers, were made in the acquisition of a capital asset, and not deductible in computing income tax, as contended by the Commissioner, or were expenses of carrying on business, and deductible from gross income, within the meaning of section 23(a) of the Revenue Act of 1928 (26 U.S.C.A. § 23(a) and note), as claimed by the gas corporation.

Prior to 1927, the Houston Gas & Fuel Company (hereinafter referred to as the fuel company) had a complete monopoly of the gas business in Houston, Tex., a city having a population of 139,000 in 1920, and 292,000 in 1930. In July, 1927, the city of Houston granted a franchise to Houston Natural Gas Corporation (hereinafter called the gas corporation) to distribute natural gas within its borders. Because of opposition of the fuel company, the Houston city officials declined to issue permits to the gas corporation under its franchise for the construction of gas mains, with the result that the gas corporation was unable to serve consumers in Houston who had signed applications for gas service. The controversy between the two companies became so acute that it was the primary issue in a city election held in December, 1928. A new mayor was elected for the city, and within a short time the gas corporation obtained construction permits and thereafter began to parallel the lines of the fuel company. Both companies charged the same rates for domestic gas. On November 30, 1928, the gas corporation sold all of its properties in practically all areas except Houston, suburban Houston and Pasadena, Tex. At the time of the sale it was serving a total of 8,064 customers, of whom 1,458 were within the city of Houston, and the remaining were outside the city. Most intense competition followed. By the close of 1929, the gas corporation was serving a total of 10,490 domestic and industrial consumers, of whom 8,729 were within the city of Houston, and the remaining 1,761 were outside the city. By the close of 1930 its total consumers had increased to 15,960, of whom 13,903 were within the city of Houston, and the remaining were outside the city.

Methods pursued by both companies to secure new customers and hold the old ones included the employment of a large force of solicitors, whose duties and activities were stipulated by counsel to be as follows: "to keep informed concerning prospective new customers, to try and sell gas service to the same, cultivate and maintain the good will of old customers as well as prospective new customers, prevent their company's consumers from switching to the competing company, persuade the competing company's consumers to become consumers of their company, combat similar activities of the competing company's solicitors, and otherwise to support and increase the volume and profitableness of their company's business." During 1929, the gas corporation expended a total of $42,353.16, and during 1930, a total of $69,156.15, in payment of salaries and expenses of the solicitors so employed by it. One of the methods pursued by each company was to give away and to install service lines free of cost to consumers. A service line is a small gas transmission line, embedded in the ground from 12 to 18 inches, connecting with the gas company's distribution system at the consumer's property line and extending across his property to his meter location. In that part of Houston where the company lines did not parallel, neither of the competing companies installed free service lines to consumers. The gas corporation expended during the year 1929 a total of $97,580.17, and in 1930 a total of $111,232.75 in giving away and installing such free service lines. The respective amounts expended for the hire of solicitors were not segregated on its books between the acquisition of new customers and the retention of old, but such amounts, together with the amounts expended for free service lines, were charged on the books to an account termed "Property Account." The gas corporation deducted depreciation thereon in subsequent years on its books, but it has never made a claim for exhaustion of the item in its income tax.

These expenditures were claimed as ordinary and necessary business expenses in the returns filed for the respective years, and were allowed as deductions in 1929, but the amounts expended in 1930 were disallowed as deductions by the Commissioner, and his action was affirmed by the Board of Tax Appeals. From that action, this appeal was taken.

We are of the opinion these expenditures were correctly disallowed. Under the evidence, they must be considered not upkeep, but investment; not maintenance or operating expense, deductible under the law, but capital, subject to any proper annual allowance for exhaustion. In Gauley Mountain Coal Co. v. Commissioner of Internal Revenue (C.C.A.4th) 23 F.(2d) 574, 576, Judge Parker of this court said: "* * * we think it is clear that, to constitute invested capital, there must have been (1) a laying out of money or money's worth, and (2) the...