Norfolk Shipbuilding and Drydock Corp. v. United States

• Decision Date: 04 January 1971
• Docket Number: Civ. A. No. 647-69-N.
• Citation: 321 F. Supp. 222
• Court: U.S. District Court — Eastern District of Virginia
• Parties: NORFOLK SHIPBUILDING AND DRYDOCK CORPORATION, Plaintiff, v. UNITED STATES of America, Defendant.

321 F. Supp. 222

NORFOLK SHIPBUILDING AND DRYDOCK CORPORATION, Plaintiff, v. UNITED STATES of America, Defendant.

Civ. A. No. 647-69-N.

United States District Court, E. D. Virginia, Norfolk Division.

January 4, 1971.

COPYRIGHT MATERIAL OMITTED

Christian, Barton, Parker, Epps & Brent by Delman H. Eure, and James Edward Betts, Richmond, Va., for plaintiff.

Lynn W. Ross, Jr., Atty., Tax Division, Dept. of Justice, Washington, D. C., for defendant.

MEMORANDUM OPINION

KELLAM, District Judge.

Norfolk Shipbuilding and Drydock Corporation (Norfolk Ship) instituted this action on December 19, 1969, pursuant to 28 U.S.C. § 1346(a), for the refund of federal income taxes for 1964 and 1965. The amount claimed is $26,725.68 plus interest and costs. The action challenges determinations by the Commissioner of Internal Revenue that the costs of dredging operations incurred as part of the total cost of pier facilities were not subject to a depreciation deduction and did not qualify for the investment credit under Section 38 of the Internal Revenue Code. Norfolk Ship also attacks the Commissioner's determination that certain interest payments were not deductible because the indebtedness was incurred to permit the plaintiff to continue carrying its tax-exempt securities.

Norfolk Ship contends that the dredging is an integral and necessary part of its pier facilities and, therefore, that the costs of dredging are properly deductible under Section 167; that dredging, as an integral part of a pier facility, comes within the definition of "Section 38 property" and, therefore, qualifies for the investment credit; and that the indebtedness incurred in 1965 was motivated by business considerations unrelated to ownership of the tax-exempt securities and, therefore, that the interest paid on the loans is deductible under Section 163.

Most of the facts have been stipulated, and the legal conclusions are drawn from those facts and the evidence presented at the hearing on September 10, 1970. Norfolk Ship, a Virginia corporation, is now and was during the times involved, engaged in the business of building, converting, and repairing ships. All work is carried on at plaintiff's three locations on the Elizabeth River. Norfolk Ship works on large, ocean-going vessels up to 800 feet in length that require depths up to thirty feet. The largest vessels are brought to the Berkley Plant where Norfolk Ship's main facilities are located. Moored to the piers in the shipyard, these vessels can easily be reached by cranes, utility services, and other equipment required to complete the work. The natural depth of the river at the shipyard is too shallow to accommodate these vessels, and Norfolk Ship must have the river bottom around the piers dredged in order to make the piers accessible to the ships.

In 1963, Norfolk Ship purchased the St. Helena Annex in order to expand the facilities at its Berkley Plant. About half of the property was under water, and improvements included bulkheads, a pier, and dredging adjacent to the pier. The total cost of the St. Helena Annex was $78,119.50, of which $21,779.72 was allocated to the dredging on the basis of an appraisal made in connection with the purchase. Norfolk Ship claimed depreciation deductions on the basis of thirty years of useful life for all the improvements in the St. Helena Annex. The Commissioner disallowed the deduction for that portion of the total cost allocated to the dredging.

Norfolk Ship built Pier 6 at its Berkley Plant in 1964. The entire construction project involved removing an existing bulkhead, excavating the shoreline, dredging a new mooring slip, and installing new bulkheads, in addition to building the new pier. The total cost of Pier 6 was $1,202,263.00, and it was put into service at the end of December, 1964. Norfolk Ship claimed an investment credit for 1964, and depreciation deductions for 1965, based on thirty-five years of useful life. Of the total cost, the Commissioner allocated $135,414.14 to the dredging. The Commissioner allowed the depreciation deductions and investment credit claimed for Pier 6, except for that portion of the total cost allocated to the dredging.

During 1965, Norfolk Ship paid a total of $27,202.00 in interest on several short term notes that totalled $2,000,000.00. Throughout 1965, plaintiff owned various tax-exempt securities which had been purchased over an eight year period ending in 1961. The Commissioner disallowed Norfolk Ship's claim for a deduction under Section 163, determining that the interest expenses were incurred so that plaintiff could continue to carry its tax-exempt securities.

I

Norfolk Ship contends that the dredging costs for the St. Helena Annex and Pier 6 were incurred as part of the total cost of those facilities, that dredging is a necessary and integral part of the pier facilities, and, therefore, that the costs of dredging are depreciable on the same basis as the costs of the other pier facilities. Here, it should be pointed out that the contract to build Pier 6 specified one price for the entire project, including the dredging. Norfolk Ship contends that the cost breakdown was added only to facilitate understanding of the entire project and establish a basis for progress payments. This contention is not spelled out in the contract, but it can be inferred from the language. Norfolk Ship's contention is also supported by the president of the construction company which built Pier 6. The contractor testified that the breakdown was to acquaint Norfolk Ship with where the money was being used and that the various items made up "one single contract." The contractor also testified that dredging is "normally a part of the cost of a pier unless the pier is located where the water is already deep enough," and that Pier 6 could not have been used for the purposes for which it was designed without the dredging. Regarding the dredging in the St. Helena Annex, it is likewise apparent that the dredging is necessarily linked with the pier and that the price was for the entire "package."

The Commissioner does not contest that dredging is a necessary part of the pier facilities, since the piers would be commercially worthless if the dredging did not provide access from deep water. However, the Commissioner contends that the costs of dredging should constitute an improvement to the land and that dredging is an intangible asset without a reasonably ascertainable useful life and is not subject to exhaustion or obsolescence.

Section 167(a) of the Internal Revenue Code applies to deductions for depreciation and provides:

General rule.—There shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence)—

(1) of property used in the trade or business, or

(2) of property held for the production of income.

While there is no direct authority on this precise issue, a similar factual situation was the subject of Commonwealth Natural Gas Corp. v. United States, 395 F.2d 493 (4th Cir. 1968), where the Court of Appeals affirmed a District Court determination that costs of clearing and grading were attributable to the costs of constructing a pipeline and depreciable with the pipeline. Commonwealth Natural Gas is not the only case to hold that clearing and grading costs are deductible under Section 167. In Portland General Electric Co. v. United States, 189 F.Supp. 290 (D.Or. 1960), aff'd per curiam, 310 F.2d 877 (9th Cir. 1963), the Court held that costs of clearing easements for electric power lines in order to erect the poles were attributable to the cost of the entire operation and, therefore, were depreciable. And in Algernon Blair, Inc., 29 T.C. 1205 (1958), the Tax Court determined that the costs of clearing, grading, and landscaping in a housing development were directly related to the construction of depreciable assets and were depreciable. The Commissioner acquiesced in Algernon Blair. 1958-2 Cum. Bull. 4. Recently, in Southern Natural Gas Co. v. United States, 412 F.2d 1222, 1230, 188 Ct.Cl. 302 (1969), the Court of Claims stated: "It has long been recognized that expenditures so intimately related to, and connected with, the acquisition of a capital asset are to be treated as part of the cost of or investment in the asset." It seems fair to conclude, then, that costs (dredging) incurred in the acquisition (St. Helena Annex) or construction (Pier 6) of a capital asset which are directly related to the acquisition or construction and constitute or involve an integral part of the asset are includible in the cost basis of the asset for purposes of depreciation.

Indirectly, this conclusion is recognized by the Commissioner in this case, because that part of the total cost of Pier 6, for which a depreciation deduction was allowed, included excavating the shoreline. See also Rev.Rul. 65-265, 1965-2 Cum.Bull. 52; Rev.Rul. 65-264, 1965-2 Cum.Bull. 53. Certainly there is a distinction between clearing and grading land or excavating a shoreline and dredging a river bottom in connection with pier construction; however, it is equally certain that grading, excavating, and dredging are each essential to and a necessary part of the entire operation. It is difficult to understand why a deduction should be allowed for grading and excavating but disallowed for dredging. Yet the Commissioner contends that dredging should be treated differently from grading, clearing, and excavating because dredging is an intangible asset. Realistically, dredging is no more intangible than grading or excavating. The Commissioner bases his distinction on the facts of Commonwealth Natural Gas, supra, stating that the trial court "relied heavily on the fact that the clearing and grading would not be of significant benefit to any subsequent construction." Here, the Commissioner argues that the dredging would be "of significant benefit to any subsequent construction." The evidence...