*1257 Held, on the facts, that the petitioner, a class I steam railroad under the Classification of the Interstate Commerce Commission, keeping its accounts upon the retirement method not reflecting depreciation, has not shown error in denial of deductions for depreciation. Central Railroad Co. of New Jersey,35 B.T.A. 501">35 B.T.A. 501; Chicago & North Western Railway Co.,39 B.T.A. 661">39 B.T.A. 661, followed.
*905 This proceeding involves income and excess profits taxes in the amounts and for the years as follows:
| Year | Income tax | Excess profits tax |
| 1934 | $35,400.40 | $2,475.00 |
| 1935 | 35,467.79 | 2,165.63 |
| 1936 | 38,843.23 | 3,170.40 |
The Commissioner determined deficiencies in the above amounts. The question involved is whether the respondent erred in denying deductions claimed by the petitioner for depreciation. From admissions in the pleadings, stipulations at the time of hearing, and evidence adduced we make the following findings of fact.
FINDINGS OF FACT.
1. The petitioner is a corporation, organized and existing*1258 under the laws of the State of Ohio, with principal office at 1301 Freeman *906 Avenue, Cincinnati, Ohio. The returns for the periods here involved were filed with the collector for the first district of Ohio at Cincinnati, Ohio. Also, the returns filed by the petitioner for the year 1933 were filed with the collector for the first district of Ohio, the original return for 1933 being filed on March 15, 1934, and an amended return for that year being filed on June 15, 1937. The period of limitations upon assessment and collection of income and excess profits taxes of the petitioner for the calendar year 1933 expired on March 15, 1936.
2. The tax liability in the amount of $15,682.23 disclosed by the amended return for the calendar year 1933 was paid to the collector of internal revenue for the first district of Ohio. Subsequent thereto, petitioner filed a claim for refund, wherein a deduction was claimed in the amount of $481,152.90 for interest and taxes accrued during the taxable year 1933, but charged to capital account. This claimed deduction was allowed by the Commissioner of Internal Revenue in the full amount, resulting in a refund to petitioner of the tax theretofore*1259 paid. The claimed interest and tax deductions exceeded taxable income for the year 1933, and are reported on the amended return, computed either with or without allowance for depreciation.
3. On November 25, 1939, petitioner paid to the collector of internal revenue at Cincinnati deficiencies in income taxes and excess profits taxes for the calendar years ending December 31, 1934, 1935, and 1936 as follows:
| Year | Income tax | Excess profits tax | Total |
| 1934 | $35,400.40 | $2,475.00 | $37,875.40 |
| 1935 | 35,467.79 | 2,165.63 | 37,633.42 |
| 1936 | 38,843.23 | 3,170.40 | 42,013.63 |
Said payments were made without prejudice to or waiver of petitioner's right to have the correctness of the deficiencies redetermined by this Board and to have all or any portion of them refunded in the event this Board redetermines petitioner's liability for income and excess profits taxes for said years in accordance with the petition.
4. The parties stipulated and we therefore find that, if the petitioner is entitled to deduct depreciation on the properties involved for the purpose of determining its net income subject to taxation for the taxable years, the correct rates of depreciation*1260 and the amount of depreciation to be allowed for each of the taxable years 1934, 1935, and 1936 are as set forth in a schedule introduced in evidence as Exhibit 9, which it is unnecessary to set forth at length herein. The schedule shows the cost of the properties, the estimated life, the rate of depreciation, date of acquisition, and amount of depreciation for each of the years 1933 to 1936, inclusive.
*907 5. The petitioner is a class I steam railroad, under the jurisdiction of the Interstate Commerce Commission of the United States, and owns and operates the union passenger terminal or depot, including depot facilities and trackage, at Cincinnati, Ohio. It has been engaged in that business since April 1, 1933. Prior to that time and from about 1927 it was engaged in the construction of the depot facilities and trackage. It has at all times been operated under an agreement between the petitioner and seven railroad companies, dated June 15, 1939.
6. Petitioner's capital structure is composed of $3,500,000 comm0n stock and $3,000,000 5 percent cumulative preferred stock, all stock being of a par value of $100, and $36,000,000 first mortgage bonds. The seven railroad*1261 companies hold the common stock in equal parts, and the public holds the preferred stock and the first mortgage bonds.
7. The principal buildings owned by the petitioner are the passenger station building, built at a cost of approximately $7,000,000, an express building costing approximately $600,000, a mail-handling building costing approximately $500,000, a powerhouse which with equipment cost approximately $475,000, and a roundhouse costing approximately $200,000. The exact figures are stipulated.
8. The cost of the properties upon which the petitioner claims depreciation was about 27 percent of the investment in tracks, bridges, and road accounts, exclusive of interest, taxes, or financing costs, and is about 24 percent of the petitioner's total investment, including road and equipment accounts, and operating properties, including interest and construction.
9. By the provisions of the agreement between the seven railroad companies and the petitioner, dated June 15, 1929, the railroads are required to pay to the petitioner all sums necessary to pay the following charges:
1. Interest charges on bonds, notes and loans issued by petitioner.
2. Total rental and other*1262 charges payable by petitioner arising out of leaseholds, leases, contracts and agreements.
3. Taxes, assessments and governmental charges required to be paid by the petitioner, except such as are chargeable to the capital account.
4. Dividends on its outstanding preferred stock and a sum equal to six per cent on the other outstanding stock of the petitioner.
5. The net costs and expenses of every kind whatsoever required for the operation and maintenance of the terminal or any part thereof, and which shall include proper depreciation and retirement charges.
6. All other costs, charges and expenses of any kind whatsoever incurred, created or for which the petitioner may be in any manner liable and including amortization of net premiums, discounts and expenses or securities issued, and expenses necessary in maintaining the corporate organization of the petitioner and protecting the rights of its stockholders and bondholders.
*908 10. The agreement between the railroad companies and the petitioner requires the petitioner to keep its accounts, and it does keep its accounts, under the rules, regulations and classifications prescribed by the Interstate Commerce*1263 Commission. Such classifications permit, but do not require, the petitioner to set up depreciation on the properties on which depreciation is claimed herein, and the petitioner did not in the taxable years set up on its accounts, or in its reports to the Interstate Commerce Commission, depreciation upon the buildings as to which depreciation is claimed herein. Petitioner never charged depreciation to the seven railroad companies. Its accounts, kept as above stated under the regulations of the Interstate Commerce Commission, were kept upon what is known as the retirement basis, under which the cost of properties retired, if no depreciation has been set up, and if the property is replaced, is charged to operating expenses of the year of retirement, and if not replaced, is charged to profit and loss.
11. In filing its original Federal income tax returns for the years 1933, 1934, and 1935, the petitioner did not use Form 1090, not knowing that there was such a form. That form coincides with the report required to be made by the petitioner to the Interstate Commerce Commission. The original returns for 1933, 1934, and 1935 made by the petitioner disclose deficits in amounts which, *1264 under the agreement with the seven railroad companies, they were required to advance to cover cost of the petitioner's operations. The original returns contained no deductions for depreciation. For the year 1936 petitioner filed a tentative return showing no taxable income, and secured an extension of time to file a definitive return. On June 15, 1937, it filed such definitive return for 1936, and amended returns for 1933, 1934, and 1935. The petitioner on each of these amended returns and the definitive return for 1936 claimed deductions for depreciation on the buildings herein involved, in the sum, for each year, of approximately $208,000. The amended return for 1933 showed net income of $270,000 before deduction of depreciation, and the amended returns for the taxable years 1934 and 1935, and the definitive return for 1936 net taxable income each showed net income of $360,000 before deduction of depreciation. Form 1090 was attached to all amended returns.
12. During the years 1933 to 1936, inclusive, the petitioner charged to the seven railroad companies from $15,000 to $20,000, approximately, because of retirements against the properties upon which depreciation is claimed*1265 in this proceeding.
13. Petitioner did not at any time make any application to the Commissioner of Internal Revenue for permission to change its basis of reporting income from the retirement basis to an accrual basis.
*909 14. The petitioner has never set up any charge on its books against the seven railroad companies for depreciation on structures; the seven companies have never paid any amount representing depreciation on structures to the petitioner; and the depreciation accounts attached to the petitioner's amended returns and claimed as deductions in the taxable years were not reflected on the petitioner's books. The petitioner did set up a charge against the railroad companies for depreciation on rolling stock, work equipment, and automobiles. This has been paid by the railroad companies.
15. The petitioner used the retirement system of accounting, under which, when a portion of a building is retired, the ledger value less the salvage, if any, is charged to profit and loss and no charge for depreciation on fixed assets other than rolling stock is set up on the books. The profit and loss charge is billed against the seven tenant railroads.
16. The petitioner's*1266 entire net expense is prorated among the seven tenant railroads which use the property on a unit basis and the petitioner collects its net expenses each month on that basis from the tenant railroads.
17. The petitioner had no net income during the period of construction, up to April 1, 1933.
18. The structures as to which depreciation was claimed on petitioner's returns for the taxable years are maintained as an operating unit and in a state of efficiency, but the repairs performed in maintaining buildings can not stop all deterioration nor account for obsolescence, unless the facility can be retired in its entirety or in certain portions. The street car ramp in the union passenger station building, although installed, was never used and that part of the building became obsolete before being actually put into operation. It can not be retired or removed without a major operation to the building itself.
OPINION.
DISNEY: The petitioner, under the principles enunciated in ; and *1267 ; also , had income in each of the taxable years in the amount of $360,000 because of the payment to the petitioner of that amount each year for distribution as dividends upon the petitioner's common and preferred stock. No question is raised in this regard. For the years 1933, 1934, and 1935 the petitioner in its original returns did not report such income, but each year reported that it was a joint facility, subject to the jurisdiction of the Interstate Commerce Commission, and was so treated in the accounts *910 of the seven named railroad companies which are the owning companies, and that therefore there was no net income to be reported as subject to tax. By amended returns for 1933, 1934, and 1935 and a definitive return for 1936 the amounts of the distributions and dividends were reported as income and for the first time deduction was claimed for depreciation on the buildings, in each of the taxable years, in the amount of approximately $208,000. This claim of depreciation respondent denied, stating in short that the railroads, *1268 for the benefit of which petitioner was operated, assumed the net costs and expenses of every kind, including depreciation and retirement charges; that any losses sustained by the petitioner by retiring the property will be charged to operating expenses or profit and loss and concurrently billed against the proprietary companies in accordance with agreement; and that therefore the assumption of such losses is ground for disallowing deductions for depreciation.
The only question here presented is whether the petitioner is entitled to deductions for depreciation upon its buildings. That there is such depreciation is not questioned, and the life of the buildings, rates, and amounts of depreciation, if allowed, are stipulated. The petitioner keeps its accounts, as a class I steam railroad, on the retirement basis of accounting, in accordance with the method prescribed by the Interstate Commerce Commission, to the jurisdiction of which the petitioner is subject. It has never set up on its books or reported to the Interstate Commerce Commission the depreciation charges now sought to be deducted, though as to rolling stock it has done so; nor has it, as to buildings, charged depreciation*1269 to the seven railroads which under contract repay to it its net expenses. To a limited extent it has, under the retirement method, charged to the railroads the cost of retirements upon the buildings here involved. The original returns for 1933, 1934, and 1935 set up no claim for the depreciation now contended for. In 1937 amended returns were filed to claim the depreciation, which was at the same time claimed in the definitive return for 1936. No application to the Commissioner for permission to change petitioner's system of accounting, or consent thereto, is shown by the record. About 25 percent of petitioner's total investment is in the structures as to which it seeks depreciation.
The petitioner of course has the burden of showing error on the respondent's denial of the deductions sought. The Board has held that a railroad which has consistently used the retirement method of accounting, in accordance with the regulations of the Interstate Commerce Commission, may not deduct for depreciation on its structures. ; *911 *1270 . In those cases, as here, the petitioners did not set up the depreciation claimed on their books, nor report it to the Interstate Commerce Commission. The petitioner urges that the cases are distinguishable on the ground, first, that those were ordinary steam railroads, whereas the petitioner has about 25 percent of its investments in buildings or structures, and therefore the reasons for the retirement method do not apply to it; and, second, that the petitioner has in fact consistently used the depreciation method "since it filed its amended return for the year 1933", and that, though the original return for 1933, 1934, and 1935 did not claim depreciation, those returns showed no net income subject to tax, even without depreciation. Petitioner stated that the items in connection with buildings which have been charged off under the retirement method "were evidently done by error and can easily be corrected." As petitioner urges, the fact that the Interstate Commerce Commission requires steam railroads to use the retirement method is not binding here. *1271 ;. The elements of that method have been set forth in our decisions above cited and need not be recited here.
After consideration of the arguments advanced by both parties and the cases cited, we are of the opinion that the petitioner has not shown error in the respondent's determination. Though some distinction has been indicated between the position of the petitioner and the steam railroads in the cited cases, yet we think the petitioner has not demonstrated that the retirement method does not fairly reflect its income, or that it is not within the rule of the two Board cases above cited with respect to consistent use of a method different from that under which deduction was claimed. The petitioner has at all times had a contract with the seven tenant railroads requiring them to reimburse the petitioner for "net costs and expenses, of every kind whatsoever, required for the maintenance of the Terminal or any part thereof, and which shall include proper depreciation and retirement charges." There is no evidence in the record*1272 that such language was not intended to cover depreciation such as is here involved, and indeed the language seems particularly designed to cover it, for it covers "net costs and expenses of every kind" for "maintenance", including "depreciation." Such depreciation is not limited to that on rolling stock, taken by the petitioner, nor is the language limited, as petitioner urges, by other language requiring the use of accounting methods prescribed by the Interestate Commerce Commission, for the reason that depreciation could have been set up under the retirement system prescribed. The use of depreciation *912 merely affects the amounts used in the retirement method, and though not mandatory in the retirement method, depreciation was permitted.
We see in the fact that the petitioner did not elect to use depreciation no helpful interpretation of the contract with the railroads as not requiring it, as to the buildings here involved. Indeed the petitioner admits that in a limited degree the depreciation in connection with buildings was reflected by retirement charges to the seven companies, but argues that this was "evidently done by error" and can easily be corrected. There*1273 is no evidence of error, and we discern not error, but intentional use of the retirement method. This is inconsistent with the contention that the retirement system was not previously used, and therefore no consent from the Commissioner required for a change. Moreover, it can not be urged with logic that there was no change merely because depreciation has been claimed since the filing of an amended return for 1933. This was not until June 1937. Up to that time the depreciation here in issue had not entered into petitioner's returns, and even now it still does not come into its books of account or its reports to the Interstate Commerce Commission. The fact that, without depreciation for the years 1933, 1934, and 1935, the returns showed no net taxable income, does not affect the fact that depreciation did not enter into the keeping of petitioner's accounts.
Section 41 of the Revenue Acts of 1934 and 1936 requires computation of net income in accordance with the method regularly employed by the taxpayer. This has not been done, but we are asked to approve deductions other than under the regular method of accounting. Nor are we shown a violation of clear reflection of income*1274 by the method used, and accepted by the Commissioner, for three years prior to any attempt to alter the method. We think there is a change attempted, and no permission is shown to have been asked or granted. The petitioner in our opinion had a clear right under its contract to charge the depreciation here involved to the seven tenant railroads. This has not been done, and is not proposed by the petitioner. It would, in the light of that contract, be anomalous to approve the deduction of depreciation not so charged nor set up in the petitioner's system of accounting. We find no error on the part of the Commissioner. Therefore,
Decision will be entered for the respondent.