*1571 Obsolescence on petitioner's ferry boats allowed.
*936 In the proceeding bearing Docket No. 36411 redetermination is asked of deficiencies of $357.70 and $5,023.42 for the years 1924 and 1925, respectively. In Docket No. 48528 redetermination is sought of a deficiency of $5,429.90 for the year 1926.
At the hearing petitioner waived all contentions as to the year 1924 and agreed that the Board might redetermine the dificiency in the amount above set out.
As to the year 1925 error is alleged in two respects:
(1) In disallowing a deduction of $38,341.71 claimed as depreciation and obsolescence on two ferry boats.
(2) In disallowing a deduction of $250 contributed to the Victory Highway Association and one of $50 contributed to an employee on the occasion of his marriage.
As to the year 1926 error is alleged in the disallowance of a deduction of $52,599.57 claimed as depreciation and obsolescence on the two ferry boats.
The cases were duly consolidated for hearing and report.
FINDINGS OF FACT.
Petitioner is a California corporation*1572 which, during the taxable years, was engaged in operating a ferry for vehicles and passengers between Selby and Morro Cove on either side of Carquinez Strait, which connects San Pablo Bay with Suisun Bay, California.
*937 Petitioner owned and operated two ferry boats known as "Issaquah" and "San Jose." The facts immediately following concerning these boats were stipulated:
The steam ferry "Issaquah" was constructed in 1914.
Said steam ferry "Issaquah" was acquired by petitioner in 1918.
The cost to petitioner of said steam ferry "Issaquah" as of January 1, 1925 was $86,516.84.
Depreciation for income tax purposes had been deducted by petitioner and allowed by respondent to January 1, 1925, in the sum of $18,554.74.
In its Federal corporation income tax return for the year 1925, petitioner deducted $3,283.77 as depreciation and $16,085.28 as obsolescence on said steam ferry "Issaquah" for the year 1925.
Consistent with prior years, the respondent has allowed depreciation as a deduction from gross income for the year 1925 in the sum of $2,870.57 on said steam ferry "Issaquah" and has disallowed any and all deduction for obsolescence.
In its Federal corporation*1573 income tax return for the year 1926, petitioner deducted $18,717.75 as depreciation and obsolescence on said steam ferry deduction from gross income for the year 1926 in the sum of $2,870.57 and has
Consistent with prior years, the respondent has allowed depreciation as a deduction from gross income for the year 1926 in the sum of $2,870.57 and had disallowed any and all deduction for obsolescence.
Depreciation and obsolescence in the sum of $4,779.44 on the steam ferry "Issaquah" was deducted from gross income by petitioner in its 1927 corporation income tax return, thereby reducing the value of said steam ferry "Issaquah" on the books of petitioner to the sum of $10,000 as of April 1, 1927.
The petitioner claims a salvage value for said steam ferry "Issaquah" of $10,000 as of April 1, 1927.
The steam ferry "San Jose" was constructed in 1903.
The cost to petitioner of said steam ferry "San Jose" when acquired by petitioner from an affiliated corporation as of May 1, 1925, was $128,626.82.
In its Federal corporation income tax return for the year 1925, petitioner deducted $6,808.48 as depreciation and $30,974.80 as obsolescence on said steam ferry "San Jose" for the*1574 period May 6, 1925 to December 31, 1925.
The respondent has allowed depreciation as a deduction from gross income for the period May 1, 1925 to December 31, 1925, in the sum of $6,808.48 and has disallowed any and all deduction for obsolescence.
In its Federal corporation income tax return for the year 1926, petitioner deducted $56,674.83 as depreciation and obsolescence on said steam ferry "San Jose" for the year 1926.
The respondent has allowed depreciation as a deduction from gross income for the year 1926 in the sum of $10,212.60 and has disallowed any and all deduction for obsolescence.
Depreciation and obsolescence in the sum of $14,168.71 on said steam ferry "San Jose" was deducted from gross income by petitioner in its 1927 Federal corporation income tax return, thereby reducing the value of said steam ferry "San Jose" on the books of petitioner to the sum of $20,000 as of April 1, 1927.
The petitioner sold the said steam ferry "Issaquah" in October, 1929, for the sum of $20,000 to an affiliated corporation, Martinez-Benicia Ferry & Transportation Company.
*938 The petitioner sold the said steam ferry "San Jose" in August, 1927, for the sum of $65,000*1575 to the corporation Richmond & San Rafael Ferry Company, not affiliated or related to the petitioner. Prior to the sale of said steam ferry "San Jose" the petitioner expended the sum of $20,226.14 in alterations and improvements thereon.
In 1923 a corporation known as American Toll Bridge Company was formed and a portion of its stock was exchanged for the stock of petitioner. Thereafter all of petitioner's stockholders were stockholders in the Bridge Company. The announced purpose of the Bridge Company was to build a bridge across Carquinez Strait at approximately the site of petitioner's ferry. In December, 1924, a contract for financing the project was agreed on with some San Francisco bankers and a price for fabricating and erecting the steel was agreed on with the United States Steel Corporation. Though contracts were not actually signed until April, 1925, petitioner knew in December, 1924, that its ferry would be rendered obsolete on the completion of the bridge. The bridge was erected and opened to traffic in May, 1927. The ferry was thereupon discontinued.
Carquinez Strait, where petitioner's ferry was located, lies to the north of San Francisco Bay, is further from*1576 the ocean, and consequently is not subject to the heavy tidal currents and rough water frequently encountered in the lower Bay. For these reasons ferry boats for use in the upper reaches of the Bay could be built of lighter construction and less power than those used in San Francisco Bay. Petitioner's boats were not of a sufficient size, power or construction to permit them to be used in the lower Bay without the expenditure of large sums for changes. The "Issaquah" was of light construction, 124 feet in length, with a 39-foot beam over all and 3 1/2 foot free board (free space between bottom of the overhanging deck and the water line). Its capacity was 26 cars. The "San Jose" was 175.4 feet in length with a 54-foot or 56-foot beam over all, and built of light construction. The usual ferry boat in the San Francisco Bay region was approximately 300 feet in length, with a proportionately wider beam and from eight to eleven feet free board. They were of much heavier construction.
Realizing that the ferry would be unable to operate after the opening of the bridge, petitioner in 1925 offered its boats for sale as of 1927. As a result the "San Jose" was sold in 1927 for a gross*1577 price of $65,000, after expending $20,226.14 for reconditioning, for use as a stand-by boat on the Richmond-San Rafael ferry. The water conditions at this ferry were not so quiet as in Carquinez Strait, but much better than in the lower San Francisco Bay. The "Issaquah" was leased in 1928 to the Martinez-Benicia Ferry Company and in 1929 was sold to that company. The ferry of this *939 company was farther from the ocean than petitioner's ferry and the water conditions at that point were quieter.
During the taxable years petitioner expended the minimum amount for maintenance necessary to keep the boats in safe condition for operation.
On June 11, 1927, the Golden Gate Ferry Company filed a request with the United States Steamboat Inspection Service for permission to place the "San Jose" in ferry service between San Francisco, Sausalito and Berkeley. This request was denied. A similar request by the petitioner as to the same boat dated June 17, 1927, was also denied.
In 1925 petitioner made a gift of $50 to an employee on the occasion of his marriage and in recognition of good services rendered. It was its usual custom to make such a gift.
Also in 1925 petitioner*1578 contributed $250 to the Victory Highway Association, an organization that was endeavoring to get a new highway built through Nevada into California by a direct route. The representatives of the association located elsewhere would recommend travel by way of petitioner's ferry in preference to other routes.
OPINION.
VAN FOSSAN: The statute (section 234(a)(7) of the Revenue Act of 1924) provides for " a reasonable allowance for the exhaustion, wear and tear of property used in a trade or business, including a reasonable allowance for obsolescence." In , Mr. Justice Butler states, "the language of section 234(a)(7) is broad enough to include all obsolescence from whatever cause." And in , the same learned justice said:
* * * The word [obsolescence] is much used, and its meaning depends upon and varies with the connections in which it is employed. It has been said to be "the condition or process by which units gradually cease to be useful or profitable as a part of the property, on account of changed conditions." Obsolescence is not*1579 necessarily confined to particular elements or parts of a plant, the whole may become obsolete. Obsolescence may arise as the result of laws regulating or forbidding the particular use of the property as well as from changes in the art, the shifting of business centers, loss of trade, inadequacy, or other causes.
In the same case the court observes:
* * * The provision is general and applied alike to all taxpayers; its purpose is to guide the ascertainment of taxable income in each year. It is a familiar rule that tax laws are to be liberally construed in favor of taxpayers. [Citing cases.]
* * *
*940 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 the 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*1580 the accounts of any year is all that is required. In determining the proper deduction for obsolescence, there is to be taken into consideration the amount probably recoverable, at the end of its service, by putting the property to another use or by selling it as scrap or otherwise. There is no hard and fast rule, as suggested by the government, that a taxpayer must show that his property will be scrapped or cease to be used or useful for any purpose, before any allowance may be made for obsolescence.
There is nothing mysterious about obsolescence. It is a factor widely present in all business. Its existence is a fact to be established as other facts are established and when proven its allowability as a deduction is authorized by law.
Viewing the situation before us we have no difficulty in concluding that it is one in which a deduction for obsolescence might be proper. The intervention in petitioner's economic world of the new means of transportation across the Strait foretold the end of the economic usefulness of petitioner's ferry and the equipment used therein. The normal processes of exhaustion, wear and tear were supplemented and superseded by a very positive and actual*1581 factor in competition with which the ferry could not hope to be successful. The amount by which this factor hastened the economic demise of petitioner's equipment, less salvage value, is the measure of obsolescence.
It is our opinion that even before the actual signing of the contracts in 1925 petitioner was justified in concluding that upon the opening of the bridge for traffic May 31, 1927, its ferry would be entirely obsolete. With the obsolescence of the ferry as a means of local transportation established as a fact certain to occur, the approaching date of the obsoleteness for petitioner's purposes of the equipment used therein was likewise fixed. Knowing these facts and facing the eventuality of finding some other use for its equipment or of selling the same to the best advantage possible in the premises, neither of which avenues might return petitioner's investment without loss, petitioner took appropriate steps to minimize such probable loss and to claim an obsolescence deduction in its tax return. It offered its boats for sale as of May 31, 1927. Sale of one boat was accomplished in 1927 and of the other in 1929. These sales, having occurred before the hearing in*1582 this case, remove all speculation as to the salvage value of the equipment and of the fact of economic loss.
*941 Having concluded that petitioner was entitled to claim some amount on account of obsolescence in addition to normal depreciation, the only problem is the reasonably accurate estimation of the amount to which it was so entitled.
Though petitioner's ferry became obsolete in 1927 and its facilities were as to it also obsolete, the two boats were still useful to a degree if an appropriate place for their utilization could be found. They were not of a type and construction to be used with safety in the lower Bay, hence, their only market was for use in a location comparable with petitioner's ferry. Such a use was found for one boat in 1927 and for the other in 1929, but the proceeds from the sale were not sufficient to wipe out the unrecovered investment in the boats.
The established facts are that on January 1, 1925, the basic cost of the "Issaquah" was $86,516.84, against which there had been allowed depreciation in the amount of $18,554.74, making a net unrecovered cost of $67,962.10. The salvage value of the "Issaquah" in 1929 was $20,000. The net cost*1583 recoverable during the period January 1, 1925, to May 31, 1927, was $47,962.10. Respondent has allowed $5,741.14 as depreciation during 1925 and 1926, leaving an unrecovered amount of $42,220.96. This amount petitioner was entitled to recover over the period January 1, 1925, to May 31, 1927. This sum should be prorated over such period and covers the additional allowance on account of obsolescence.
The cost of the "San Jose" on May 6, 1925, the date of acquisition, was $128,626.82. The net salvage value ($65,000 less $20,226.14) was established by sale in August, 1927, at $44,773.86. The net cost recoverable through the period May 6, 1925, to May 31, 1927, was $83,852.96. Respondent has allowed during the period May 1, 1925, to December 31, 1926, the sum of $17,021.08 as depreciation, leaving an unrecovered amount of $66,831.88 which petitioner was entitled to recover during the period May 6, 1925, to May 31, 1927.
There remain for consideration two small items. The first, a gift of $50 to an employee on the occasion of his marriage, is disallowed. The evidence shows this to be a gift and not an ordinary and necessary expense. The second, a payment to Victory Highway*1584 Association, is allowed. The motive behind the payment was purely a business one and the payment actually resulted in increasing traffic over petitioner's ferry.
Reviewed by the Board.
Decision will be entered under Rule 50.
MORRIS, STERNHAGEN, and MURDOCK dissent.