*3654 Commissioner's determination that the taxpayer had not charged off sufficient amounts in former years to represent actual depreciation sustained will not be disturbed where the taxpayer's method of charging off depreciation was clearly wrong and there is no showing that the Commissioner's method reached an incorrect result.
*1248 The cases were consolidated for hearing and decision. Income and profits taxes for the calendar years 1918, 1919, and 1920, are in controversy. For 1918, the Commissioner rejected a claim in abatement to the extent of $97,981.13, for 1919, he rejected in full a claim in abatement in the amount of $22,638.84, and for 1920, he determined a deficiency of $37,728.30.
The petitioner alleged in effect that the Commissioner erred (1) in reducing invested capital for each year by the amount of the income and profits taxes for the preceding year, prorated from the dates on which the installments were due; (2) in adjusting invested capital as of the beginning of each year by a deduction of a certain amount for insufficient depreciation*3655 taken in former years, the deduction resulting from the application of a theoretical method for determining depreciation on fixed depreciable assets in place of the method used by the petitioner in keeping its books; (3) "By reason of the aforesaid adjustment" in disallowing a deduction of a certain amount being part of the total amount claimed for depreciation of fixed depreciable assets in each of the years 1918, 1919, and 1920. In regard to the year 1918, the petition alleged that "By reason of the foregoing errors [2 and 3 above] in the amount of invested capital determined and in the amount of depreciation determined for the year 1918, the Commissioner's determination by special assessment under sections 327 and 328 of the Revenue Act of 1918, is based upon an entirely different invested capital and income than actually exists in this corporation." In regard to the year 1919, it was alleged and admitted that the Commissioner erred in reducing inventories, thereby reducing correct income by $35,966.15, and in prorating 1918 taxes in the amount of $737,418.86, instead of in the correct amount of $679,550.47. In regard to the year 1920, the petitioner alleged error on the part*3656 of the Commissioner "in failing to give the petitioner credit for the sum of $120,184.46 taxes paid for the year 1920, instead of $119,151.53, the amount shown by the Commissioner as paid by the taxpayer."
*1249 FINDINGS OF FACT.
The petitioner is a Wisconsin corporation organized in 1882. Its principal office is at Milwaukee. Since its organization it has been engaged in the business of manufacturing tin and japanned sheet metal, galvanized ware, and metal stampings. During the taxable years its plant consisted of about 32 buildings containing about 496,000 square feet of floor space, and it had over 1,000 employees. It manufactured about 1,200 different kinds of articles shown by its catalogue and in addition manufactured special goods to order. Sales of special goods about equaled sales of catalogued goods. Its total sales of catalogued goods was about $3,000,000 for each of the taxable years in question. In the manufacture of its catalogued goods it used about 3,000 tools and dies.
In accounting for depreciation of its fixed assets it has used varying rates of depreciation. In some years it charged off no depreciation of these assets. The Commissioner determined*3657 that at the beginning of each taxable year depreciation had been sustained on these assets in excess of the amount of depreciation charged off the books of the corporation, as shown by the following table:
| Excess of sustained depreciation over depreciation charged off books: | |
| 1918 | $259,184.25 |
| 1919 | 233,512.77 |
| 1920 | 196,103.79 |
He reduced invested capital as of the beginning of each year by the amount of the excess determined for that year.
The fixed assets were carried on the books of the corporation and depreciation had been charged off as of the beginning of the taxable years in the amounts shown below:
| Year | Fixed assets | Depreciation |
| 1918 | $1,171,263.64 | $272,841.72 |
| 1919 | 1,187,894.11 | 358,547.47 |
| 1920 | 1,263,267.44 | 450,330.73 |
The following table shows the amount of the deduction claimed on the returns and charged off the books for depreciation of these assets, the amount claimed at the hearing, and the amount allowed by the Commissioner, for each of the taxable years:
| Year | Amount claimed on return | Amount claimed at hearing | Amount allowed |
| 1918 | $104,053.75 | $101,994.00 | $60,641.28 |
| 1919 | 113,148.95 | 106,917.41 | 54,982.49 |
| 1920 | 121,539.07 | 95,729.63 | 51,196.95 |
*3658 *1250 The petitioner accounted for depreciation on its building in an account called "depreciation fund" and for depreciation on machinery, tools, dies, fixtures, and motors, in an account called "sinking fund." The totals of these two accounts for the ends of the years 1910 to 1919, inclusive, were as follows:
| Year | Tota |
| 1910 | $133,180.53 |
| 1911 | 133,180.53 |
| 1912 | 133,180.53 |
| 1913 | 133,180.53 |
| 1914 | 133,180.53 |
| 1915 | $154,804.53 |
| 1916 | 193,890.58 |
| 1917 | 272,841.72 |
| 1918 | 358,547.47 |
| 1919 | 450,330.73 |
NOTE. - The above excludes a small fixture account in Chicago.
No depreciation was charged off the books from 1911 to 1914, inclusive.
The petitioner acquired a new brick warehouse in Chicago in 1909. It charged off no depreciation for this building until 1917, when it began to charge off depreciation at the rate of 2 per cent each year. It also acquired buildings in Milwaukee in 1909. No depreciation was charged off for these until 1915. Since 1915 depreciation was charged off at the rate of 3 per cent each year. No substantial replacements were made to these buildings up to 1918.
During the years 1910 to 1915, inclusive, the petitioner owned delivery*3659 equipment. No amount was charged off its books for wear and tear and exhaustion of these assets during this time. Thereafter it charged off certain amounts computed at various rates to represent wear and tear and exhaustion of these assets. The petitioner's books at the end of 1917 contained the following capital accounts in the following total amounts, and also contained accounts for depreciation of these assets showing the following totals, and the Commissioner determined that the proper amount of accumulated depreciation was as shown in the right-hand column below:
| Type of asset | Capital account | Book depreciation | Commissioner's depreciation |
| Tools, dies, jigs, and patterns | $199,864.77 | $89,060.83 | $182,805.25 |
| Machinery | 311,730.32 | 88,347.01 | 167,394.53 |
| Factory fixtures | 111,674.47 | 55,842.46 | 72,970.19 |
| Delivery equipment | 4,784.60 | 1,342.33 | 3,039.51 |
| Buildings | 511,148.37 | 38,249.09 | 105,816.49 |
| Total | 1,139.202.53 | 272,841.72 | 532,025.97 |
Prior to 1917 renewals and replacement were charged to expense.
The following table shows sales of catalogued goods as compared with depreciated cost of tools, dies, jigs, and patterns for three years, as reflected*3660 by the books of the corporation:
| Year | Depreciated cost of tools, dies, etc. | Sales |
| 1898 | $55,104.65 | $841,626.28 |
| 1913 | 134,347.29 | 1,429,216.18 |
| 1918 | 86,984.56 | 2,939,640.56 |
*1251 The petitioner at all times endeavored to keep its plant and equipment in the best condition possible. It had a maintenance department employing from about thirty men in the earlier years to about fifty men in the later years. The function of this department was to make repairs to the plant and equipment and also to make some new tools and equipment for the petitioner and for those contracting for special goods. It also repaired tools and dies made by it for those contracting for special goods. It made 249 new tools at a cost of $17,451.69 during the years 1916, 1917, and 1918. This department had a machine shop, tool room, pattern shop, steam fitting shop, electrical shop, and carpenter shop. The plant and equipment was in good efficient operating condition during the taxable years in question.
The Commissioner reduced the petitioner's invested capital for each year by the amount of the income and profits taxes for the preceding year, prorated from the dates on which*3661 the installments were due.
The petitioner paid $120,184.46 as income and profits taxes for 1920, whereas the Commissioner in the deficiency letter gave it credit with having paid only $119,151.53.
OPINION.
MURDOCK: In the computation of invested capital for any given year the total income and profits taxes of the preceding year should be prorated from the dates the installment payments were due. See section 1207 of the Revenue Act of 1926, and . The respondent admitted that for 1919 he prorated the wrong amount representing 1918 taxes. This error and that relating to inventories for 1919 will be corrected on final settlement of the deficiency.
The Commissioner determined that the petitioner had not charged off, in former years, sufficient depreciation on its depreciable assets to represent the actual depreciation sustained. He then applied certain "straight-line" rates of depreciation as proper for the various assets and reduced invested capital as set out in our findings of fact. The petitioner complains of this action, claims that it was the application of a theory to upset a practical method based on facts*3662 as applied by the petitioner in keeping its books, and asks this *1252 Board for relief. We have been given a most incomplete picture of the way it has accounted for depreciation of its assets. It did not offer its books in evidence, but conceded that it had used varying rates, and in some years had charged off no depreciation at all.
The circumstances as disclosed by the record in this case tend to vindicate the action of the Commissioner. Theoretical though it was, it seems superior to the taxpayer's method. Here is a taxpayer trying at one and the same time to justify charging off depreciation at high rates in the taxable years and at low rates in eighteen prior years, the average rates for the eighteen-year period in some instances being less than one-fourth of the rate for the taxable years. One of the principal witnesses admitted that the average of the rates used for machinery over the eighteen-year period was 2 1/3 per cent, 5 per cent was a normal rate, and during the taxable years 10 per cent had been charged off due to increased hours of operation and the forced employment of unskilled workmen.
The petitioner attempted to justify its failure to charge off*3663 depreciation in prior years. That it made repairs and tried to keep the equipment in good working condition is no justification. A proper rate of depreciation is based on probable useful life, taking into consideration the fact of proper repairs. Witnesses said that partial replacements and renewals were charged to expense, but from the evidence we can not determine that capital expenditures of any consequence were ever charged to expense. In regard to buildings there is evidence that no capital expenditures were ever charged to expense. One witness for the petitioner stated that no depreciation was taken on the buildings for several years because he thought the buildings were worth more than had been paid for them, another stated that the books did not show sufficient depreciation for buildings and motor vehicles, and another witness was called by the petitioner for the express purpose of showing that the method used in charging depreciation off the books was improper.
Perhaps the petitioner's chief reliance for the proof of its contention was placed upon the opinion evidence of four witnesses. In the examination of these witnesses counsel for the petitioner showed, as of*3664 the beginning of one or more of the taxable years, the percentage which the amount of depreciation charged off the books for some or all of the assets was of the amount of the book capital account for the same asset or assets, and had the witnesses express opinions that in view of the efficient operation of the corporation the amount of depreciation charged off was ample and represented the depreciation actually sustained and then that the Commissioner's charge off being a larger percentage of the capital account was so excessive as to be incompatible with efficient operation.
*1253 We attach little or no weight to the opinions of these witnesses. After each had expressed his opinion that the petitioner's charge off for depreciation was ample, the petitioner called another witness to show by supposedly expert mathematical computation that the book method of charging off depreciation was improper and did not show when assets were fully depreciated. If the capital asset account, as carried on the books, was reduced at times from cost by depreciation, the total accrued depreciation might actually exceed the amount of the capital account at times, and witnesses stating that*3665 efficient operation could not be maintained when the depreciation amounted to 50 or even 100 per cent of the capital account would be stating a paradox. The books are not before us and we do not know how they were kept. But from a portion of a brief offered in evidence, which brief was filed by the petitioner with the respondent as bearing on its tax liability for the years now before us, it appears that the books provided for depreciation upon the basis of written down values of the assets until the year 1915, and subsequently upon gross costs by means of depreciation reserves. Also the petitioner's allegations that the Commissioner's reduction of the depreciation claimed for the taxable years resulted from his increase of depreciation for former years would indicate that the assets were not carried upon the books at gross cost, and that a reserve for depreciation was not the method used in keeping the books. Two witnesses who gave opinions did not know how the books were kept, and, so far as we know, knew nothing of bookkeeping methods. One seemed to think that the operating efficiency of the plant was shown by the percentage which accumulated depreciation was of the capital*3666 asset account. The other witnesses did not seem to have any very clear thoughts on this supposed relationship, although some conceded that a machine in the last year of its useful life might be as efficient as ever it was.
Even if it be conceded that the asset accounts were carried at cost, there was no showing that the four witnesses sufficiently understood the subject of the possible relation of operating efficiency to depreciation to entitle their opinions to any weight. Their testimony rather indicated that they did not understand the subject. One witness whose deposition was introduced in evidence had not seen the assets or the operating plant until 1926, and we are not impressed by the opinions which he gave over objections which we think were well taken.
So far as the question of invested capital is concerned we will .
The petitioner's contention as to a proper deduction in the taxable years for wear, tear and exhaustion of its assets falls with its contention *1254 relating to invested capital, there being no evidence of the cost or March 1, 1913, value of the depreciable assets on hand during the taxable years to enable us to determine*3667 that the basis used by the Commissioner was wrong. The parties were in agreement as to the rates to be applied and only differed as to the basis.
The petitioner called a witness who said that prior to December, 1918, he had been an internal revenue agent and since then a tax consultant. He gave his opinion as to the correct amount of the allowable deduction for exhaustion, wear and tear of the petitioner's assets for each of the taxable years. He also made a computation in which he arrived at a cost basis for depreciation different from that shown by the books and from that used by the Commissioner. His computation, while possibly correct from a mathematical standpoint, is no solution for the problem presented in this case, since it assumes that the books showed the actual depreciation sustained and depends upon the judgment of the witness on which we have no reason to rely.
The parties entered into a stipulation as to special assessment for the year 1918, which, in view of our decision, we need not discuss.
Judgment will be entered under Rule 50.
Footnotes
1. Exclusive of small fixture account in Chicago. ↩