Northern Natural Gas Company v. O'MALLEY

Decision Date13 April 1960
Docket NumberNo. 16238,16239.,16238
Citation277 F.2d 128
PartiesNORTHERN NATURAL GAS COMPANY, Appellant, v. John A. O'MALLEY, Administrator of the Estate of George W. O'Malley, deceased, Appellee. NORTHERN NATURAL GAS COMPANY, Appellant, v. James L. McCRORY, Appellee.
CourtU.S. Court of Appeals — Eighth Circuit

James W. R. Brown, Omaha, Neb., made oral argument for appellant.

John J. Pajak, Attorney, Tax Division, Dept. of Justice, Washington, D. C., made argument for the appellees.

Before JOHNSEN, Chief Judge, and VAN OOSTERHOUT and BLACKMUN, Circuit Judges.

VAN OOSTERHOUT, Circuit Judge.

These actions, consolidated for trial and upon appeal, are for the recovery of federal income taxes alleged to have been illegally assessed and collected for the years 1946 through 1951. Timely refund claims were filed and disallowed. These suits were commenced within the time permitted by law. The defendant in each action is the collector of internal revenue in office at the time the tax was paid. The collectors represented the Commissioner and acted under his direction. For convenience and simplicity, we will hereafter refer to the Commissioner as the defendant.

This court has jurisdiction to consider these appeals. 28 U.S.C.A. § 1291.

The trial court's memorandum opinion, reported at 174 F.Supp. 176, contains quite a complete statement of the pertinent facts. A full discussion of the complicated facts would unduly extend this opinion. We will discuss the essential facts during the course of this opinion.

The basic issue presented by these appeals is whether the taxpayer has established a right to a depreciation deduction based upon exhaustion of its right-of-way easements for its pipe lines used to transmit gas for considerable distances.

Plaintiff was incorporated in 1930 and since that time has been engaged in the business of acquiring natural gas from fields in Texas, Oklahoma and Kansas, and transporting it for sale by means of its pipe lines to customers in Nebraska, South Dakota, Iowa and Minnesota. Its operations are regulated and licensed by the Federal Power Commission.

Plaintiff's pipe lines were constructed over lands owned by others pursuant to easements granted plaintiff, which provide that the easements shall continue "so long as such pipe lines and appurtenances thereto shall be maintained."

The expenditures capitalized as right-of-way costs include roddage paid to grantors, payments for consent of tenants, notary fees, recording fees, abstract fees, legal fees and other expenses incurred in securing the easements. There is no dispute as to the validity of the amount capitalized as right-of-way costs which aggregated $938,004.49 in 1946 and had grown to $1,509,272.04 in 1951.

During all of the taxable years here involved, plaintiff on its books included its right-of-way costs in its depreciable operating property, and charged current income for the recovery of the cost of right-of-way at the rate of 3½% per year, and likewise deducted depreciation on such basis in its income tax returns.

From 1930 to 1943 the Commissioner permitted taxpayer to deduct depreciation on its pipe line right-of-way. Taxpayer was informed that the Commissioner had changed his position to conform to an unpublished ruling pertaining to pipe line depreciation, a copy of which ruling taxpayer was unable to obtain.

Plaintiff contends that it is entitled to a right-of-way depreciation deduction based upon exhaustion by virtue of Section 23 of the Internal Revenue Code of 1939, 26 U.S.C.A. § 23, which so far as here material provides:

"Deductions from gross income in computing net income there shall be allowed as deductions: * * *
"(l) As amended by Sec. 121(c), Revenue Act of 1942, c. 619, 56 Stat. 798 Depreciation. 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."

We shall first consider some general principles applicable to these appeals. It is well established that the Commissioner's determination is presumptively correct. The burden is upon the taxpayer to show that it is erroneous. Welch v. Helvering, 290 U.S. 111, 115, 54 S.Ct. 8, 78 L.Ed. 212; Union Electric Co. v. Commissioner, 8 Cir., 177 F.2d 269, 273.

"In a nonjury case, this Court may not set aside a finding of fact of a trial court unless there is no substantial evidence to sustain it, unless it is against the clear weight of the evidence, or unless it was induced by an erroneous view of the law." Neely v. Boland Manufacturing Co., 8 Cir., 274 F.2d 195, 201; Cleo Syrup Corporation v. Coca-Cola, 8 Cir., 139 F.2d 416, 418, 150 A.L.R. 1056.

We fully agree with the government's contention that an allowance for deductions from gross income does not turn upon general equitable considerations. Deductions are a matter of legislative grace and statutory authority must be found for such deductions. Deputy v. duPont, 308 U.S. 488, 493, 60 S.Ct. 363, 84 L.Ed. 416; Greenspon v. Commissioner, 8 Cir., 229 F.2d 947, 954.

We believe that the taxpayer has met all of the requirements of the authorizing statute in proving its claim here asserted. The right-of-way here involved constitutes property. The parties concede that the right-of-way is intangible property and we shall so assume. We observe here, however, that the statute itself makes no distinction between tangible and intangible property. If the taxpayer's income producing property is undergoing exhaustion, the statute authorizes a depreciation deduction. Neither the Commissioner nor the trial court take the position that the right-of-way is a type of property that cannot be subject to exhaustion and hence depreciation. They concede that the time will come when the taxpayer will be entitled to the depreciation deduction and that a deduction is allowable when the duration of the easement can be ascertained with sufficient definiteness.

It is undisputed that the right-of-way is used in the taxpayer's trade or business and that it is also property held for the production of income. As heretofore stated, the amount of taxpayer's investment in the right-of-way easement is undisputed.

It is clearly established by the evidence that taxpayer's right-of-way easements are assets subject to exhaustion. The trial court recognized that the useful life of the rights-of-way depended upon the period of time that the taxpayer's transmission line could be successfully operated and that this in turn depended on the supply of natural gas available to the taxpayer. The court, among other things, states:

"Natural gas is an irreplaceable natural resource. It is recognized that the production of natural gas must result in its depletion and eventually in the exhaustion of the supply. The point is underscored by the 1948 report of the National Gas Investigation, Federal Power Commission. `It is an accepted fact that natural gas is a wasting asset and that for every pool discovered, there is one less to be found.\'" Northern Natural Gas Co. v. O\'Malley, D.C., 174 F.Supp. 176, 180.
"There is no question, from what has been stated, that the taxpayer\'s rights-of-way are, in some manner, undergoing exhaustion." Id., at page 185.
"* * * accepting that the exhaustion of natural gas reserves is a condition upon which the useful life or value of the rights-of-way would cease, has the taxpayer shown with sufficient definiteness when this condition will occur?" Id., at page 185.

Judged by the express terms of Section 23(l), the finding of the existence of exhaustion upon the basis of substantial evidence entitles the taxpayer to some allowance for depreciation. The statute contains no provision requiring that the exhaustion must be capable of measurement with any specified degree of definiteness or certainty. The taxpayer's proof in support of the depreciation deduction will be discussed hereinafter.

The authorizing statute states that deduction "shall" be allowed. "Shall" is ordinarily the language of command. Anderson v. Yungkau, 329 U.S. 482, 485, 67 S.Ct. 428, 91 L.Ed. 436.

It is our belief that the statute authorizing the deduction is mandatory and not permissive, and requires the Commissioner to grant the deduction to a taxpayer who brings his claim within the provision of the statute.

In Burnet v. Niagara Falls Brewing Co., 282 U.S. 648, 51 S.Ct. 262, 75 L.Ed. 594, the Supreme Court rejected the Commissioner's contention that the obsolescence deduction, which arises out of the same statute as the one we are now considering, was not established with sufficient definiteness. In that case the obsolescence was caused largely by the impact of the prohibition amendment upon the brewery business. The court, after stating that tax laws are to be liberally construed in favor of taxpayers, continues:

"It would be unreasonable and violate that canon of construction to put upon the taxpayer the burden of proving to a reasonable certainty the existence and amount of obsolescence. Such weight of evidence as would reasonably support a verdict for a plaintiff in an ordinary action for the recovery of money fairly may be deemed sufficient. Neither the cost of obsolescence nor of accruing exhaustion, wear and tear that is properly chargeable in any period of time can be measured accurately. A reasonable approximation of the amount that fairly may be included in the accounts of any year is all that is required." At pages 654, 655 of 282 U.S., at page 265 of 51 S.Ct.

In United States v. Ludey, 274 U.S. 295, 47 S.Ct. 608, 71 L.Ed. 1054, the Supreme Court reversed the lower court decision which held that no depletion or depreciation deduction was allowable because the amount of taxpayer's oil reserves could not be definitely determined. The court states:

"The reserves are recognized as wasting assets. The depletion effected by operation is likened to the using up of raw material in making the

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