*64 Decisions will be entered under Rule 50.
1. Held, installation expenses of leased gas appliances must be capitalized. Useful life of such installations redetermined.
2. Held, installation, selling, and miscellaneous expenses incurred by subsidiary corporation in connection with sales of gas appliances but paid by parent gas company may be deducted by latter where directly related to its business of selling gas. Held, further, installation expenses of the subsidiary in connection with gas appliances leased by it may not be deducted by the parent.
*850 Respondent determined the following deficiencies in income tax: *851
| Fall River | Fall River | |
| Year | Gas Co. | Gas Appliance |
| Co., Inc. | ||
| 1957 | $ 22,505.05 | |
| 1958 | $ 98,020.00 | 18,627.69 |
| 1959 | 78,028.88 | 16,038.49 |
The deficiencies are due in part to adjustments no longer in controversy. The principal remaining issues are:
(1) Whether costs of $ 21,035.76 incurred by the Fall River Gas Appliance Co., Inc., during the year 1957 for the installation of gas appliances leased by it to customers*65 are deductible as ordinary and necessary business expenses.
(2) Whether the Fall River Gas Co. is entitled to deduct as ordinary and necessary business expenses in 1958 and 1959, (a) the installation, delivery, and selling expenses of gas appliances sold during those years by its subsidiary, the Fall River Gas Appliance Co., Inc., and (b) the installation costs of gas appliances leased by that subsidiary.
FINDINGS OF FACT
Some of the facts have been stipulated, and, as stipulated, are incorporated herein by reference.
Fall River Gas Co. (hereinafter referred to as the gas company) and Fall River Gas Appliance Co. (hereinafter referred to as the appliance company), a wholly owned subsidiary of the gas company, are corporations organized under the laws of the Commonwealth of Massachusetts, and doing business at 155 North Main Street, Fall River, Mass. The income tax returns of the gas company for the years 1958 and 1959 and of the appliance company for the years 1957, 1958, and 1959 were filed with the district director of internal revenue for the district of Massachusetts. Both corporations kept their books and filed their returns on an accrual basis.
At all times material, the gas*66 company was engaged in the sale and distribution of gas to domestic and industrial users, and, prior to December 29, 1955, it was also engaged in selling and leasing gas-consuming appliances, principally hot water heaters and conversion burners for central heating. The appliance company was incorporated on December 29, 1955, and thereafter it handled the selling and leasing of the gas appliances.
At all times material, the gas company has had an exclusive franchise to distribute gas at retail in the city of Fall River, Mass., and the towns of Somerset, Swansee, and Westport, Mass. It has experienced keen competition for customers from oil and electric companies. It has endeavored to meet this competition largely by trying to increase *852 its sales of gas to existing customers and to new customers. Increases in such sales lowered the cost per unit of gas purchased by it, and increases in the amount of gas used by a customer reduced his cost per unit of gas purchased. An increase in the number of gas appliances used by existing customers or new customers had the effect of increasing their consumption of gas. In 1954, when the business of the gas company included both the*67 sale of gas and the leasing and selling of gas-consuming appliances, it adopted a policy of paying the installation costs of the appliances, and in its return for that year it treated such payments as capital expenditures. It subsequently filed a claim for refund on the theory that the installation costs should have been treated as current expenses, and its claim was allowed by the Internal Revenue Service. In its return for 1955, the last year it handled the sale and leasing of appliances, it treated the installation costs as current expenses. After the appliance company took over the sale and leasing of the gas appliances on December 29, 1955, the gas company continued to pay installation costs of leased appliances during the years 1956 through 1962.
The installation cost of a water heater averaged between $ 64.21 and $ 65.62 of which $ 8 was the cost of the connection of a gasline from an existing gasline to the heater. The rest of the cost was for the installation of water piping from an existing cold water pipe in the basement to the heater and from the heater to the upper floors, and for the installation of a flue from the heater to the chimney.
Leases of water heaters entered*68 into by the appliance company with customers provided, in part, as follows:
1. The Company shall have the right to install the Appliance in the basement at said address, will install a flue into the chimney, make necessary gas connections and run hot water pipes to the locations specified herein but will not install faucets which are to be supplied and connected by the Customer. All piping shall be exposed except where it can be concealed without increasing cost. Customer agrees to pay directly to the plumber any charges for additional work. Customer will furnish the company written permission for the work herein provided for from the owner of the premises and from any tenant thereof in whose apartment any work is to be done. Company reserves the right to refuse to rent an appliance where the installation may be considered abnormal unless the Customer agrees to pay the excess cost.
* * * *
4. The customer agrees that he will not terminate this contract prior to 12 months from the date hereof unless he shall completely vacate the premises and terminate his interest therein. If the customer shall terminate this agreement other than as provided above or shall default hereunder during*69 such initial 12 months period, the Company shall have the right to immediately bill the customer for the unexpired portion of the minimum rental period. Such rights shall be in addition to any other right of the Company arising because of default or termination.
*853 When a lease was terminated, the water heater was removed and the water and gaslines were capped. Only in a very rare case would the piping be recovered because the cost of recovery would exceed the salvage value of the pipe.
The installation cost of a conversion burner averaged between $ 87.71 and $ 93.42 per installation and in each case the cost of the gas piping to the burner was $ 8 per installation. The rest of the cost was for other labor and material. If the use of a conversion burner was discontinued the appliance company would remove the burner, replace the grates, and leave the furnace in the same condition as before the burner was installed.
Leases of conversion burners entered into by the appliance company with customers provided, in part, as follows:
1. The Company will install the Appliance in the above Customer's present furnace, install a new flue into the chimney, if required, and make all necessary*70 gas, electric connections and adjustments. All piping and wiring shall be exposed except where it can be concealed without increased cost. Should the Customer demand that the installation be made in a manner which would result in increased installation costs, the Customer shall agree to pay for such additional charges. Customer will furnish the Company written permission for the work herein provided for from the owner of the premises and from any tenant thereof in whose apartment or any assigned space work is to be done. Company reserves the right to refuse to rent an appliance where the installation may be considered abnormal unless the Customer agrees to pay the excess cost.
* * * *
7. Customer may terminate this Agreement by 24-hour notice to the Company, or by discontinuing gas service. Upon the termination in any manner whatsoever of this Lease, the Customer shall forthwith surrender the burner to the Company, complete and in good order and condition, ordinary wear and tear excepted.
The installation of water heaters and conversion burners was done by licensed plumbers.
Due principally to the vacating of rented premises, there was a turnover of customers of the gas company, *71 but the total number of its customers tended to remain the same. Installations on leased premises would serve more than one customer where new tenants moved in and took over existing installed facilities. There was nevertheless a substantial number of removals of leased appliances. During the 6-year period 1954-59 there were 9,088 installations and 1,650 removals of water heaters, and 762 installations and 121 removals of conversion burners; additional removals of both water heaters and conversion burners occurred during subsequent years. However, there was an unspecified number of occasions in which another water heater or conversion burner was installed for the benefit of a new tenant or owner after a previously installed appliance had been removed, and in such circumstances the piping, etc., left behind from the *854 original installation was used, thus calling only for nominal expenditures upon making the new installation.
The number of customers of the gas company and the average gas consumption per customer during the years 1954 through 1959 were as follows:
| Year | Number of | Usage |
| customers | (MCF) 1 | |
| 1954 | 35,423 | 25.0 |
| 1955 | 35,674 | 30.1 |
| 1956 | 35,541 | 38.4 |
| 1957 | 35,591 | 43.9 |
| 1958 | 35,652 | 53.8 |
| 1959 | 35,660 | 58.4 |
The installation costs of leased appliances for the year 1957 in the amount of $ 21,035.76 were charged by the gas company to the appliance company.
In its return for the year 1957 the appliance company reported taxable income in the amount of $ 114,275.39. In computing its taxable income it claimed deductions for the following:
| Installation expense -- appliances | $ 57,677.55 |
| Installation -- rentals | 21,035.76 |
| Selling expenses | 8,847.50 |
| Miscellaneous | 9,132.36 |
In the notice of deficiency for the year 1957 respondent determined that $ 21,035.76, representing the cost of installation of leased appliances, was a capital expenditure, and added $ 20,509.86 of this amount, representing the difference between $ 21,035.76 and an amortization or depreciation allowance of $ 525.90, to the income reported by the appliance company in its 1957 return.
In its income tax return for the year 1958, the appliance company reported total income of $ 384,082.53 and net taxable income of $ 93,244.05. Among the deductions which it claimed were the following:
| Installation expense -- appliances | $ 47,908.08 |
| Selling expenses | 10,120.80 |
In determining the deficiency*73 for the year 1958, respondent did not disallow these deductions.
In its income tax return for the year 1959, the appliance company reported total income of $ 364,355.88 and net taxable income of $ 94,300.56. Among the deductions which it claimed were the following:
| Delivery and installation expenses | $ 39,434.56 |
| Selling expenses | 8,631.44 |
*855 In determining the deficiency for the year 1959, respondent did not disallow these deductions.
In its returns for the years 1958 and 1959 the gas company in computing its taxable income deducted the following installation costs, delivery expenses, and selling expenses incurred in connection with appliance sales and leases made by the appliance company:
| 1958 | |||
| Amount | |||
| Delivery expenses (appliances sold) | $ 11,908.08 | ||
| Installation costs: | |||
| Appliances sold | $ 36,000.00 | ||
| Appliances leased | 124,822.95 | 160,822.95 | |
| Selling expenses (appliances sold) | 10,120.80 | ||
| Total | 182,851.83 | ||
| 1959 | |||
| Delivery expenses (appliances sold) | 9,434.56 | ||
| Installation costs: | |||
| Appliances sold | 30,000.00 | ||
| Appliances leased | 112,284.92 | 142,284.92 | |
| Selling expenses (appliances sold) | 8,631.44 | ||
| Total | 160,350.92 |
*74 Respondent determined these amounts were not deductible by the gas company as ordinary and necessary business expenses and, on the ground that they were capital expenditures which should be capitalized, he allowed deductions for depreciation as indicated below:
| 1958 | 1959 | ||
| Costs capitalized | $ 182,851.83 | $ 160,350.92 | |
| Less -- Depreciation allowed: | |||
| 1958 costs | 5,122.01 | 10,244.04 | |
| 1959 costs | 4,460.42 | ||
| Total | 5,122.01 | 14,704.46 | |
| Net adjustments | 177,729.82 | 145,646.46 |
The installations involving leased appliances had an average useful life of 12 years in conjunction with such appliances.
OPINION
1. Appliance company's 1957 cost of installing leased appliances. -- In 1957 the appliance company incurred various costs in connection with its sales and leases of gas appliances. As to sales, it had "selling expenses" of $ 8,847.50, "miscellaneous expenses" of $ 9,132.36, and "installation expenses" of $ 57,677.55. The Commissioner allowed the deductions of all of these expenses, and they are *856 not involved herein. The appliance company, however, claimed a further deduction in the amount of $ 21,035.76 as "installation" expenses in respect of its *75 leased gas appliances, which the Commissioner disallowed. We hold that he correctly disapproved that deduction, that the expenditures for the installation of leased appliances are capital in nature and should be recouped in the form of depreciation over the estimated useful life of the installations, i.e., over the period that the installations will be used in conjunction with the company's leased appliances.
The appliance company was in the business of both selling and leasing appliances. In relation to sales, its expenditures were related to closed transactions and were a proper charge at once against the income realized from such transactions. The situation in respect of leases is quite different. Notwithstanding that some leases were at will and others for an initial period of only 1 year, it was plainly anticipated that the leases would continue over extensive periods during which the installations would serve the leased equipment. The leases were productive of rentals to the appliance company throughout the time that the consumers used the leased appliances, and the cost of installing the appliances was clearly capital in nature, a charge against those rentals over*76 their anticipated life, to be taken in the form of annual amortization or depreciation deductions, and not as a single expense deduction in 1 year.
We reject the appliance company's contention that since the installations were basically an improvement to the customer's real estate with little or no salvage value to it the cost of installation must be treated as a current expense. It has long been held that the cost of an improvement which results in an economic benefit or advantage to a taxpayer's business extending beyond the taxable year is a capital expenditure even though title to the improvement may be vested in another. ; ; (C.A. 4), affirming ; (C.A. 7), affirming ; , affirmed (C.A. 6), certiorari*77 denied, . These cases govern here, rather than , relied upon by the taxpayer, which is distinguishable on its unusual facts and which does not appear to have been cited in any subsequent opinion up to the present time.
Even though title to the installations, consisting primarily of piping, may have passed to the owner of the building when they were made, the prospect that the company would realize rental income from the leased appliances over a prolonged period continued. While it is true that leases of hot water heaters could be terminated after 1 year and conversion burners at any time, the leases did not preclude the *857 lessees from continuing to rent the appliances as long as they desired to do so, and it was plainly expected that on the whole they would continue to do so over a substantial period of time. To be sure, a number of leases would terminate at a comparatively early time, but the company could reasonably anticipate that in some cases the new tenant would take over the rental of the appliance without removal, and even where it was removed it could *78 be reinstalled for a new tenant, at least in respect of the water heaters, with only nominal expense. Nevertheless, the figures in evidence relating to removals do support the company's position to a limited extent, but they tend to prove merely that the composite life of 20 years which the Commissioner has assigned to the installations is too long. If anything, they more than establish that the useful life of the installations as a whole is far in excess of 1 year, although probably less than 20 years.
Since we approve the Commissioner's position that the installation costs of leased appliances must be capitalized and since we disapprove of the 20-year life that he has determined, it becomes necessary to make a finding as to useful life. The materials in the record do not enable us to arrive at any scientifically accurate conclusion in this respect, but doing the best we can with the evidence before us we have found as a fact that the installations in question had a useful life of 12 years in conjunction with the leased appliances. Accordingly, the company's 1957 installation costs in issue should be spread over that period.
2. Gas company's deductions, 1958 and 1959. -- *79 For the years 1958 and 1959 expenditures in connection with appliances sold or leased by the appliance company were claimed as deductions by its parent, the gas company, as follows:
| 1958 | 1959 | |
| (i) Delivery expenses (appliances sold) | $ 11,908.08 | $ 9,434.56 |
| (ii) Installation costs (appliances sold) | 36,000.00 | 30,000.00 |
| (iii) Installation costs (appliances leased) | 124,822.95 | 112,284.92 |
| (iv) Selling expenses (appliances sold) | 10,120.80 | 8,631.44 |
| 182,851.83 | 160,350.92 |
The Commissioner disallowed these deductions in toto, capitalized the amounts involved, and allowed depreciation deductions for each of the years based on the capitalized amounts.
Items (i), (ii), and (iv), relating to appliances sold, are substantially identical in character with corresponding deductions in different amounts claimed by the appliance company in 1957 which the Commissioner allowed, and item (iii), relating to appliances leased, is of the same character as the expenditures of the appliance company in 1957 dealt with in 1, supra.
(a) The Commissioner does not dispute the fact that if the costs incurred in items (i), (ii), and (iv) had been paid by the appliance *858 company*80 rather than by the gas company, they would be deductible as expenses by the appliance company. We hold that in the circumstances of this case the gas company is entitled to a deduction in respect of its payment of these expenses. 1
Ordinarily, the separate corporate identities of parent and subsidiary preclude the parent from deducting expenses incurred or losses sustained by its subsidiary. The theory is that the payment by the parent to cover such expenses or losses is related to the business of the subsidiary and not to its own business. . Accordingly, if this were the usual situation of a parent paying expenses of its subsidiary, the deduction would have to be disallowed. For a recent example, see (portions of salaries of certain employees of*81 subsidiary paid by parent). However, the situation here is different. The gas company had a substantial interest in increasing its own sales of gas, and the expenses paid by it were intended to promote its own business wholly apart from that of the subsidiary. This distinction was explicitly noted in , and was regarded as pivotal by this Court in . We think that the expenditures involved in items (i), (ii), and (iv) which would have the quality of deductible expenses if made by the subsidiary, are similarly deductible by the parent when paid by the parent 2 because directly related to its business, and need not be capitalized under (C.A. 4), as contended by the Government.
*82 (b) As to the installation costs of leased appliances, referred to herein as item (iii), we have held above that expenditures for this *859 purpose by the appliance company must be capitalized and depreciated over a 12-year period. We see no compelling reason for a more favorable result in behalf of the parent company where it makes the expenditure instead of the subsidiary. 3 Indeed it might even be urged that the payments by the parent merely increased its capital investment in the subsidiary's stock with the consequence that no depreciation whatever would be allowable in respect thereof; however, no such issue was raised and we do not pass upon it.
*83 Decisions will be entered under Rule 50.
Footnotes
1. MCF=1,000 cubic feet.↩
1. This holding is subject to the condition that the parent actually paid these amounts. See footnote 2, infra↩.
2. Whether the expenses reflected in items (i), (ii), and (iv) were in fact paid by the parent or by the subsidiary is not clearly established. As to 1958, for example, the subsidiary claimed and was allowed on its return deductions identified as "Installation expense -- Appliances" in the amount of $ 47,908.08 and "Selling expenses" in the amount of $ 10,120.80. But items (i) and (ii), above, in the case of the parent add up to precisely $ 47,908.08, and item (iv) is precisely equal to $ 10,120.80. Thus, it would seem possible that items (i), (ii), and (iv) reflected in the parent's 1958 return are duplications of identical deductions taken on the subsidiary's 1958 return. If they are duplications, they are obviously deductible by only one of the taxpayers. Since both taxpayers are before us, we will leave it to the parties to agree among themselves under Rule 50 as to which corporation in fact paid these expenses and which is therefore entitled to the deductions. Of course, it is possible that the expenses were in fact twice the amounts involved and that each corporation paid one-half thereof. However, since all the pertinent facts are not before us, and since there seems to be a possible duplication, the parties may clarify the matter by stipulation. The decisions to be entered under Rule 50 should reflect the facts as thus clarified.
The same situation prevails as to 1959. The subsidiary deducted $ 39,434.56 as "Delivery and Installation Expenses," an amount equal precisely to the sum of items (i) and (ii) deducted by the parent as "Delivery Expenses (Appliances Sold)" and "Installation Costs: Appliances Sold." And the subsidiary also deducted $ 8,631.44 as "Selling Expenses," an amount equal precisely to item (iv) deducted by the parent as "Selling Expenses (Appliances Sold)." The Court similarly expects the parties to clarify this situation in connection with the decisions to be entered under Rule 50.↩
3. The situation is, of course, distinguishable from the payments involved in (a), supra↩, where we held that expenses of the subsidiary paid by the parent are deductible by the latter because related to its own business. The payments here are similarly related to the parent's business, but they are capital in nature and therefore not deductible as expenses. Thus, the owner of a department store may install air conditioning incurring an expense directly related to his business, which must nevertheless be capitalized rather than taken as a current expense.