*3639 1. The market value of public improvement bonds issued by the City of Livingston, Mont., determined.
2. Amount of allowable deduction for depreciation and obsolescence on machinery and equipment, under extraordinary circumstances, determined.
*1302 These proceedings are for the redetermination of a deficiency in income and profits tax for the year 1921, in the amount of $9,414.11, and in fact involve but one deficiency. The two cases were consolidated for hearing and determination.
Petitioner alleges five errors, only two of which present real issues. Error No. 3 was waived at the hearing. Error No. 4 is but an ultimate result of the errors alleged in Nos. 1 and 2. Error No. 5 was conceded by respondent to be well taken insofar as it involved the amount of $9,138.22 nontaxable interest on municipal bonds. As to other amounts involved therein, such amounts depend upon the disposition of issues involved in Nos. 1 and 2.
*1303 Assignment of error No. 1 alleges that the Commissioner erred in adding to income, *3640 as reported by it, $24,784.08, excessive discount as taken by petitioner on special improvement district bonds in its distribution of such bonds among its stockholders as dividends, and bonds having been received by petitioner in payment for construction work.
Assignment of error No. 2 alleges that the Commissioner erred in adding to income reported by petitioner $6,400.04, alleged to be excessive depreciation taken by petitioner on its machinery and equipment for 1921.
FINDINGS OF FACT.
The petitioner is a Montana corporation with its principal office in Livingston. It was organized under the laws of Montana on March 26, 1920, with an authorized capital stock of $50,000. Only $48,000 of the stock was issued, for which cash at par was paid in.
The corporation was organized by a number of the business men of Livingston for the purpose of certain public improvements which were to be made, among which was street paving. The city having failed to obtain from regular construction companies a satisfactory price for such work, and having declined to accept any bid so offered, the business men of the city decided to organize a corporation and, through it, do the work themselves. *3641 After organization, the company purchased the necessary machinery at a cost of $20,853.90. In its contract with the city to do the work for which it was organized, it agreed to accept the several improvement district bonds, as hereinafter described, in payment. It made arrangements with local banks for a temporary financing of operations until such bonds could be sold by it. As the work progressed and the engineer's certificate of completed units was obtained, bonds were issued and delivered in payment of such work. The work was begun in 1920 and continued until completed the latter part of 1921, at which time the last of the bonds were issued and delivered.
The total issue was of the par value of $465,000 and was usually in denominations of $1,000, $500, and a few of small, irregular amounts. As issued, the bonds were serially numbered and registered. The first bonds, that is Nos. 1 to 4, inclusive, of District No. 87, were issued and delivered to the city to go into the general fund, to reimburse it for money expended in preliminary work relative to the proposed public improvement, and in amount was about $9,000, which bonds, the petitioner had no connection with nor interest*3642 in. Those bonds, being quasi-municipal bonds, were of course issued under and in pursuance of statutory authority, and in order to get a clear understanding of their nature, the following *1304 excerpts from the General Laws of Montana are quoted as being pertinent:
§ 5240. To defray the cost of making improvements in any special improvement district, or of acquiring property for the opening, widening, or extending of any street or alley, or to defray the cost and expense of changing any grade of any street, avenue, or alley, the city council shall by resolution levy and assess a tax upon all property in any district created for such purpose, by using for a basis for assessment one of the methods set forth in section 5238 of this code. Such resolutions shall contain a description of each lot and parcel of land, with the name of the owner, if known, and the amount of each partial payment to be made, and the day when the same shall become delinquent.
The payment of assessments to defray the cost of constructing any improvements in special improvement districts may be spread over a term of not to exceed twenty years, payments to be made in equal annual installments.
*3643 § 5246. The cost and expense connected with and incidental to the formation of any special improvement district, including costs of preparation of plans, specifications, maps, plats, engineering, superintendence, and inspection, and preparation of assessment-rolls, shall be considered a part of the cost and expenses of making the improvements within such special improvement district; and it shall be the duty of the city engineer to keep an account of all costs and expenses incurred in his office in connection with every special improvement district, and certify the same to the city clerk, whose duty it shall be to prepare all necessary schedules and resolutions levying taxes and assessments in such special improvement districts.
§ 5247. Any special assessment made and levied to defray the cost and expense of any of the work enumerated in this act, together with any percentages imposed for delinquency and for cost of collection, shall constitute a lien upon and against the property upon which such assessment is made and levied, from and after the date of the passage of the resolution levying such assessment, which lien can only be extinguished by payment of such assessment, *3644 with all penalties, costs and interest.
§ 5238. To defray the cost of the making of any of the improvements provided for in this act, the city council shall adopt one of the two following methods of assessment:
(a) The city council shall assess the entire cost of such improvements against the entire district, each lot or parcel of land within such district to be assessed for that part of the whole cost which its area bears to the area of the entire district exclusive of streets, avenues, alleys, and public places; provided, however, that the city council, in its discretion, shall have the power to pay the whole or any part of the cost of any street, avenue, or alley intersections out of any funds in its hands available for that purpose, or to include the whole or any part of such costs within the amount of the assessment to be paid by the property in the district. In order to apportion the cost of any of the improvements herein provided for between the corner lot and the inside lots of any block, the council may, in the resolution creating any improvement district, provide that whenever any of the improvements herein provided for shall be along any side street, or bordering*3645 or abutting upon the side of any corner lot of any block, that the amount of the assessment against the property in such district, to defray the cost of such improvements, shall be so assessed that each square foot *1305 of the land, embraced within any such corner lot, shall bear double the amount of the cost of such improvement that a square foot of any inside lot shall bear.
In pursuance of the law as above indicated, the city council divided the City of Livingston into four improvement districts, Nos. 86, 87, 88, and 89, and, having obtained estimates of the costs of proposed improvements by proper resolutions and action, caused to be issued bonds in the aggregate amounts of such cost for each district, respectively, against each of such districts. Those bonds were alike in all essential respects, differing only in serial numbers, amount and date of registration.
A copy of one of them is as follows:
UNITED STATES OF AMERICA
No. 107.
BOND
$1000.00
ISSUED BY THE CITY OF LIVINGSTON
MONTANA
Special Improvement District No. 87 Coupon Bond Interest at the rate of six per cent per annum, payable annually.
Special Improvement District No. 87. Livingston, *3646 Montana.
The Treasurer of the City of Livingston, Montana, will pay to C. T. Heaton Construction Company, or bearer, the sum of ONE THOUSAND DOLLARS ($1000.00) as authorized by Resolution No. 629, as passed on the 6th day of October 1919, creating Special Improvement District No. 87, for the construction of improvements and the work performed as authorized by the said resolution to be done in said District and all laws, resolutions and ordinances relating thereto, in payment of the contract in accordance therewith. The principal and interest of this bond are payable at the office of the City Treasurer of Livingston, Montana.
This bond bears interest at the rate of six (6) per cent per annum from the date of registration of this bond, as expressed herein, until the date called for redemption by the City Treasurer. The interest on this bond is payable annually on the first day of January of each year, unless paid previous thereto and as expressed by the interest coupons hereto attached, which bear the engraved facsimile signature of the Mayor and City Clerk.
This bond is payable from the collection of a Special Tax Assessment which is a lien against the real estate within*3647 said Special Improvement District as described in said Resolution hereinbefore referred to.
This bond is redeemable at the option of the City at any time there are funds to the credit of said Special Improvement District Fund for the redemption thereof, and in the manner provided for the redemption of the same.
It is hereby certified and recited that all things required to be done precedent to the issuance of this bond have been properly done, happened and been performed in the manner prescribed by the law of the State of Montana, and the *1306 Resolutions and Ordinances of the City of Livingston, Montana, relating to the issuance thereof.
[SEAL.]
Dated at Livingston, Montana, this 2nd day of October, 1920.
CITY OF LIVINGSTON, MONTANA,
BY LEWIS TERWILLINGER, Mayor.
Attest:
HARRY M. SHELVER,
City Clerk.
Registered at the office of the City Treasurer of the City of Livingston, Montana, this 2nd day of October, 1920.
R. L. BAILIE, City Treasurer.
This is the form prescribed by the statute for such bonds.
In the latter part of 1921, about the time the work was completed, the petitioner negotiated a sale and did sell to Ferris & Hargrove, *3648 a firm of bond brokers, operating in Spokane, Seattle, and Portland, $225,200 par value of the first issue of bonds (other than 1 to 4, inclusive) at a price 88 cents per dollar par value, that for a total of $198,176. That was the best price obtainable for such bonds.
After that sale, and after the work was completed, the stockholders not desiring to continue in the construction work, generally, decided to liquidate and there remaining on hand in the treasury of the company bonds in the aggregate amount of $145,788.73 par value, those bonds were valued at 63 cents per one dollar, par value, and distributed as dividends among the stockholders. Those bonds so distributed were the last issued, and serially numbered and registered after those purchased by Ferris & Hargrove.
The construction was placed on the law by the city officers as well as by the bond brokers, and they appraised and handled those bonds with the understanding that they did not constitute an obligation to pay by the City of Livingston as such, or an obligation on the part of the improvement district, as such, and that the only security for the payment of the bonds was the statutory lien on the land within the*3649 respective districts. It was further understood to be the law that, in the event one owner of property in such district paid the amount of tax assessed against his property, such amount being predetermined by the number of square feet owned by him, such owner could not be required to pay any more of such improvement tax and his property was released from the statutory lien. Under such conditions the last bonds issued, being the last to be called and paid, were deemed to be subject to more hazards of default than those issued and registered earlier, and hence less valuable.
At the time Ferris & Hargrove purchased the $225,200 par value bonds, they offered for the remaining $145,788.73 a price of $90,000 which they believed was all they were worth.
*1307 The cost of machinery and equipment in 1920 was $20,853.90 and on January 1, 1921, its depreciated cost was $16,916.24. In 1921, it being the popular desire of the residents of the city to complete that public improvement as soom as possible, and the stockholders and officers of the petitioner corporation being among those residents and sharing in that desire, adopted a policy of accelerated activity and operated on double*3650 shift time, that is 16 hours per day. The result was a very heavy strain on all machinery. As a consequence of such excessive strain, when the work was completed in the latter part of 1921, that machinery and equipment was little better than a junk pile. It is still on hand and has never been used since closing down that work. The corporation has not been formally dissolved, but since 1921 has not operated. At one time in 1922, through the personal efforts of the president, an offer of $4,100 for that machinery and equipment was obtained, but for some reason, unexplained, the deal was not consummated. Aside from that offer, $2,000 has been the maximum offer.
In its return for 1921, petitioner deducted as depreciation, including obsolescence, on its machinery and fixtures, $13,384.24 estimating its salvage value of $3,200 (some little adjustments being made on account of small purchase and one small sale). Of the said amount of depreciation and obsolescence the Commissioner disallowed $6,400.04.
OPINION.
LOVE: This is purely a fact case. We are called upon to determine:
(1) The market value of $145,788.73 par value of improvement district bonds issued by the City*3651 of Livingston and taken by petitioner in payment for work done by it.
(2) The amount of allowable depreciation and obsolescence on machinery and equipment, the depreciated cost of which on January 1, 1921, was $16,916.24.
At the hearing and in the argument of counsel, a question was raised as to the legal status of the bonds in question. It was contended by counsel for the petitioner that under statutory law, as well as under the resolutions adopted by the city council relative to such bond issue, and by the terms and stipulations of the bonds themselves, that they did not constitute an obligation to pay on the part of the City of Livingston or of the several improvement districts as such; that in effect they were mere evidences of indebtedness to secure the payment of which a statutory lien on the property in the several districts was fixed; that it was only a liability against the real estate of the district, the liability of each lot or unit being measured by the number of square feet in its area; that by reason of such nature of said bonds they were not what might be termed *1308 commercial securities and hence had a less market as well as intrinsic value.
Counsel*3652 for respondent contended that the bonds constituted an obligation to pay on the part of the city, as such, and if not on the part of the city, then on the part of the several improvement districts as such, and that the real estate of the district as a whole, and not by parcels for aliquot parts of the debt, was liable, and that if such be the status of such bonds their market value as well as intrinsic value was greater than represented by the petitioner.
It was clearly shown by the evidence in the case that neither the officers of the city, the officers of petitioner, nor the bond brokers considered the bonds as contended for by counsel for the respondent, but all parties deemed them to be, and handled them as contended for by petitioner. That being true, their market value was certainly determined and fixed in the light of that view of the situation.
We deem it unnecessary to attempt to decide the legal question as to whether or not in a contest between the holder of the bond on the one side, and the city or a district on the other side, the decision would be one way or the other. We are to determine under the then existing conditions as disclosed by the evidence what the*3653 market value of those bonds was at the close of 1921. Without summarizing the evidence or analyzing it by discussion, we believe the evidence as set out in our findings of fact clearly warrants the conclusion that said bonds at the close of 1921 did not have a market value in excess of 63 per cent of their par value, and as the petitioner valued them in its return at approximately that valuation, we approve its action in that respect and reverse the action of the Commissioner.
With respect to the disallowance of depreciation and obsolescence complained of in assignment of error No. 2, we conclude that the evidence warrants the approval of petitioner's action in its return on that issue. The machinery and equipment was purchased for a specific purpose. In the year 1921 it was operated on double time and subjected to extraordinary wear and tear. Its depreciation under such circumstances must have greatly accelerated. When that work was completed, the evidence shows that it was but little better than a junk pile. Petitioner had no further use for it and there was no market for machinery in that condition. The evidence discloses the fact that the president in 1922 had an offer*3654 of $4,100 which he desired to accept, but for some cause the deal was not consummated. Aside from that offer, $2,000 was the maximum offer. In its return for 1921 petitioner estimated the salvage value at $3,200 and took a deduction on account of depreciation and obsolescence of $13,384.24, which represented the difference between said salvage value and the depreciated cost as of January 1, 1921, with some minor adjustments.
*1309 In view of all the evidence on that question we believe that the petitioner was entitled to the deduction claimed in its return, and reverse the action of the Commissioner on that point.
The third assignment of error was waived, hence, as to that issue, the action of the Commissioner is approved.
The fourth assignment of error is a mere formal one, and is determined in the determination of assignments Nos. 1, 2, and 3.
The fifth assignment of error, in part, is also a formal one, the disposition of which is controlled by our determination of assignments Nos. 1, 2, and 3, but another feature of the fifth assignment complains of the failure of the Commissioner to allow a deduction of $9,138.22, which the petitioner omitted to claim and*3655 take in its return, and which represents interest paid on the bonds (the same as those hereinbefore described) held by petitioner. At the hearing it was stipulated and agreed that that point was not in issue, as the deficiency notice, together with the computation attached, showed that the Commissioner had allowed that deduction. Referring to that computation, we find that said deduction was so made.
Accepting that stipulation at its face value, we will not further discuss that assignment of error.
Judgment will be entered under Rule 50.