Woolrich Woolen Mills v. United States, 13331.

• Decision Date: 19 April 1961
• Docket Number: No. 13331.,13331.
• Citation: 289 F.2d 444
• Parties: WOOLRICH WOOLEN MILLS v. UNITED STATES of America, Appellant.
• Court: U.S. Court of Appeals — Third Circuit

289 F.2d 444 (1961)

WOOLRICH WOOLEN MILLS v. UNITED STATES of America, Appellant.

No. 13331.

United States Court of Appeals Third Circuit.

Argued January 24, 1961.

Decided April 19, 1961.

David O. Walter, Washington, D. C. (Charles K. Rice, Asst. Atty. Gen., Lee A. Jackson, A. F. Prescott, Attys., Dept. of Justice, Washington, D. C., Daniel H. Jenkins, U. S. Atty., William D. Morgan Asst. U. S. Atty., Scranton, Pa., on the brief), for appellant.

William J. Madden, Jr., Harrisburg, Pa. (William J. Madden, Jr., Harrisburg, Pa., on the brief), for appellee.

Before BIGGS, Chief Judge, and McLAUGHLIN and KALODNER, Circuit Judges.

KALODNER, Circuit Judge.

Is the cost of construction of a filtration plant for treatment of waste from a woolen mill made mandatory by a State anti-pollution law deductible as an ordinary and necessary business expense under Section 23(a) (1) (A) of the Internal Revenue Code of 1939, 26 U.S.C.A. § 23(a) (1) (A)?

That is the primary question presented by this appeal from the judgment of the District Court for the Middle District of Pennsylvania which answered it in the affirmative.¹

A collateral issue relates to the year or years, in which the deduction, if permissible, may be taken by a taxpayer on an accrual basis. The District Court held the cost of the filtration plant to be deductible in the year when the construction contract was awarded.

The relevant facts, as found by the District Court may be summarized as follows:

Woolrich Woolen Mills, a Pennsylvania corporation, ("taxpayer") has, since 1830, been engaged in the manufacture of woolen goods at Woolrich, Pennsylvania. The manufacturing process results in the discharge, directly into a public stream, of a large quantity of water containing dyes and short woolen fibers in suspension. At all times prior to 1950, taxpayer's woolen mill was operated without a purification plant for the treatment of this waste prior to its discharge into public waters.

In 1945, the Commonwealth of Pennsylvania enlarged the scope and tightened the enforcement machinery of its anti-pollution laws.²

On September 28, 1945, taxpayer was directed by the Sanitary Water Board of the Department of Health of the Commonwealth of Pennsylvania to discontinue all discharge of water from its mill into public streams on or before June 1, 1946, or by that date to submit satisfactory plans for treatment of the water so as to eliminate the pollution elements therefrom. Thereafter, taxpayer consulted with various state officials and with engineers of the Sanitary Water Board for the purpose of complying with the Board's directions and subsequently made plans to install a waste disposal plant.

The Commonwealth approved certain plans of taxpayer and on August 16, 1950 it was issued an Industrial Wastes Permit. During 1950, taxpayer entered into a written contract for the construction of a filtration plant. The contract amount, $108,159.02, including a few additional items, was deducted by taxpayer as an ordinary and necessary business expense in computing its taxable net income for the calendar year 1950. The Commissioner of Internal Revenue disallowed the deduction and assessed a deficiency of income tax which taxpayer paid and then brought suit for refund in the District Court which rendered judgment in its favor.

Construction of the filtration plant was completed in 1952. Its design and operation was described fully by the District Court, 178 F.Supp. at page 877, and it is unnecessary to do so here. It is located approximately one-third of a mile from taxpayer's mill. It consists of one building, enclosing a large revolving wheel covered with wire mesh, and a series of open settling tanks. The system has not worked satisfactorily and since 1952 has been in operation less than one-fourth of the time. When not in operation, the waste from taxpayer's mill is discharged directly into public waters with the knowledge and consent of Commonwealth officials. Taxpayer has attempted in good faith to make the plant work and has spent money in addition to that here involved.

The District Court found that "the plant was erected by plaintiff taxpayer solely for the purpose of preventing the Commonwealth of Pennsylvania from enjoining * * * the discharge of waste into public waters which injunction would have completely halted operation of plaintiff's manufacturing process." 178 F.Supp. at page 877. The District Court further found that "the waste plant is a permanent addition to the plaintiff's mill property constructed in compliance with the order of the Sanitary Water Board of the Commonwealth of Pennsylvania, having a life extending beyond the year in which construction thereon was completed." 178 F.Supp. at pages 877-878.

Taxpayer keeps its books and records on the accrual basis of accounting.

The District Court premised its determination "that the cost of the filtration plant is an ordinary and necessary business expense deductible in full from gross income in the year incurred" on these grounds:

"In the instant case, plaintiff taxpayer has been continuously engaged in the manufacture of woolen goods since its organization in 1830. The filtration system, the construction of which is the cause of the expenditure here involved, is completely divorced from the operation of plaintiff\'s business. Its construction did not improve, better, extend, increase or prolong the useful life of plaintiff\'s mill property." 178 F. Supp. at pages 879-880.

It is apparent from the District Court's Opinion that it gave great weight to the circumstance that the construction of the filtration plant was made mandatory by State law and thus was essential to preserve the continuation of taxpayer's business. At page 880, 178 F.Supp., of its Opinion, the District Court said:

"The facts here, in my opinion, fit perfectly in the pattern enunciated in Heininger v. Commissioner of Internal Revenue, 7 Cir., 1943, 133 F.2d 567, at page 569, where the court stated:

"`We think that where an expense is incurred which saves the life of a business, even for a time, it is, * * * not only a business expense, but a necessary business expense.\'"

Analysis of the factual situation in Heininger discloses that its holding is inapposite on the issue of whether the cost of the filtration plant in the instant case is a deductible business expense, or a non-deductible capital expenditure. In Heininger there was involved only the question of deductibility of, as 133 F.2d 569 "ordinary and necessary" expenses, legal fees paid in contesting a Post Office Department fraud order against the taxpayer, a dentist conducting a mail order business. Taxpayer there had continued his highly lucrative business during the pendency of two years of litigation seeking judicial reversal of the fraud order, and it was held that the legal fees were a "necessary business expense" because they served to permit the continued functioning of taxpayer's business.

The sum of the Government's position on this appeal is that the filtration plant is a permanent addition to taxpayer's property, having a life of more than one year, and accordingly the cost of its construction is a non-deductible capital expenditure. The Government stresses that the District Court made the fact-finding (Para. 11, Findings of Fact) that 178 F.Supp. 877 "The waste plant is a permanent addition to the plaintiff's mill property * * * having a life extending beyond the year in which construction thereon was completed."

Taxpayer contends first, that the determination of the District Court that the outlay was an ordinary and necessary business expense constituted a finding of fact, fully supported by the evidence, and must be accepted as conclusive by this Court. Second, that the cases support its position that it was an ordinary and necessary business expense because the filtration system is completely divorced from its business; it was erected solely for the purpose of preventing the State from enjoining the operation of the mill; it would not have been erected voluntarily as a matter of wise and prudent management; and it in no wise acted to insulate taxpayer from any possible liability to employees, customers, tenants, or any other person for any possible litigable danger. Taxpayer maintains that the United States is, in essence, asking this Court to hold that an outlay made to preserve the value of property is equivalent to one made to increase the value of that property.

It must immediately be noted that the District Court's "conclusion" "that the cost of the filtration plant is an ordinary and necessary business expense deductible in full from gross income in the year incurred" is in the nature of an ultimate finding of fact subject to review free of the impact of the "clearly erroneous" rule applicable to ordinary findings of fact. In re Pioch, 3 Cir., 1956, 235 F.2d 903, 905.

The year for which the deduction in the instant case is claimed being 1950, we are called upon to apply the provisions of the Internal Revenue Code of...