*3918 1. INVESTED CAPITAL. - The true cash value of proved clay lands acquired for stock determined for the purposes of invested capital.
2. DEPRECIATION. - The respondent has allowed upon petitioner's plant construction account a composite rate of depreciation of 5 per cent. The record fails to show the original cost of items in this account as well as whether replacements have been charged to capital or deducted from depreciation reserves. It is therefore held that the depreciation reserve as computed by the respondent is sustained both for the purposes of invested capital and depreciation deductions. Depreciation claimed on the cost of a spur railroad track disallowed for lack of proof of the terms of the operating contract with a railroad company.
3. DEPLETION. - For the purposes of adjusting invested capital the depletion reserve should be computed on the basis of the cost of the clay lands as determined by this decision. For the purposes of a depletion deduction for the years under review the amount should be computed on the basis of the 1913 value of clay lands at $1,800 per acre and the difference between the depletion computed upon cost and the amount of depletion*3919 computed upon 1913 value and allowed as a deduction from income should be restored to surplus.
*1291 In this proceeding the petitioner seeks a redetermination of its income and profits-tax liabilities for the fiscal years ending June 30, 1920, and June 30, 1921, for which the Commissioner has determined deficiencies of $6,411.91 and $3,070.31, respectively. The petitioner alleges error on the part of the Commissioner, (1) in failing to allow as invested capital the true cash value of clay land acquired for cash and stock, (2) in refusing to allow a composite rate of depreciation of 7 1/2 per cent on the brick and tile plant, (3) in failing to include as invested capital depletion allowed on March 1, 1913, value of clay deposits in excess of amount computed on cost, (4) in failing to allow depreciation on an item of $4,588.20 representing the cost of a spur railroad track. FINDINGS OF FACT.
The petitioner is a corporation organized in 1906 under the laws of the State of Maine, with an authorized capital of $200,000 par value of preferred stock, and*3920 $200,000 par value of common stock. Its principal offices are at Mason City, Iowa.
On October 23, 1906, W. M. Colby secured an option contract to purchase a tract of land adjoining Mason City and containing 148 1/3 acres, known as the McCulloch farm, for $22,250, payable in three annual installments beginning March 1, 1907.
After procuring the above-mentioned option contract Colby procured the services of one Barr, an expert in the business of manufacturing clay products, and proceeded to explore the tract of land for the purpose of ascertaining whether it contained clay, sand, and other material suitable for the brick and tile business. Borings and test pits were made which developed that the tract contained large deposits of clay of a superior quality; that there were also quantities of sand and shale under the entire tract. The property upon which Colby secured an option was immediately adjoining the city limits of Mason City and adjacent to the Chicago, Milwaukee & St. Paul Ry.
After having proven the clay content of his land Colby interested other persons, who thereupon organized and caused to be incorporated the petitioner herein and he, together with one Bowder, *3921 proposed to transfer to the petitioner the contract of the purchase of the land and to procure the sale of such an amount of transferred stock of the petitioner corporation as its directors might then authorize to be sold, Bowder and Colby receiving a cash commission for the sale of the preferred stock. These negotiations resulted in the petitioner accepting a proposal made by Bowder and Colby and the transfer of the contract for purchase of the land to the petitioner, together with an agreement for the continued services of the expert, Barr. As a result of these negotiations the petitioner issued to *1292 Bowder and Colby 1,600 shares of its common stock with a par value of $100 per share and Bowder and Colby agreed to sell and did sell 1,200 shares of preferred stock of the par value of $100 per share at par, giving to the purchasers of the first 400 shares of preferred stock 1 1/2 shares of common stock and to the purchasers of the remaining 800 shares of preferred stock one-half share of common stock. The full amount of 1,200 shares of preferred stock was sold for cash at $100 per share. The petitioner as a result acquired the clay land here in question and $120,000*3922 of cash, and issued 1,200 shares of preferred stock and 1,600 shares of common stock. Petitioner took the land subject to the payments required to be made under the original contract with Colby.
The territory contiguous to Mason City had begun to be developed for the manufacture of clay and other products prior to 1900 and at the time Colby procured his option there were already in operation three brick and tile manufacturing enterprises and a large Portland Cement factory. The values of clay deposits had thus become well known in this territory prior to the time of the organization of the petitioner. In 1899 one Denison bought the White Farm for its clay deposits, at $125 per acre. In 1900 the American Brick & Tile Co. acquired a tract at $200 per acre, and in 1903 or 1904 acquired an additional tract at $500 per acre, and the respondent has found that petitioner's clay deposits had a 1913 fair market value of $1,800 per acre.
The 148 1/3 acres of clay land acquired by the petitioner for cash and stock had a cash value at the time acquired of $500 per acre, or $74,167.
The petitioner's plant construction account on June 30, 1921, as carried on petitioner's books, stood*3923 in the amount of $252,578.80, against which the books showed depreciation reserve of $182,175.01. These accounts and reserves had been revised between the beginning of the fiscal year 1919 and the close of the fiscal year 1921. The record does not show what the original figures of cost or depreciation were.
Petitioner carried on its books an asset designated as Railroad Tract, at a cost of $4,702.41, upon which it claimed depreciation at the rate of 5 per cent. This tract was procured for the benefit of petitioner's plant under a contract with the Chicago, Milwaukee & St. Paul Ry., the specific terms of which contract are not in the record.
OPINION.
TRUSSELL: It is evident from the record that Colby acquired his option contract for the purchase of the lands acquired by the petitioner at the then prevailing farm land prices. When this land was acquired by the petitioner it was a proven tract of clay, sand, and *1293 shale lands of a high grade and especially suitable for the manufacture of brick and tile. The farm land value at which Colby secured his tract is not the measure of the value of the land acquired by the petitioner. *3924 ; . The prices at which sales of comparable clay land properties, as set forth in the findings of fact, together with the testimony of witnesses having long experience in the local field in the manufacture of clay products, have led us to the conclusion that at the time petitioner acquired its clay lands, said lands had a cash value of $500 per acre, or $74,167, and that in the computation of invested capital said lands should be reflected at that figure and the invested capital for the taxable years should be built up on the basis of the land value here found plus cash paid in for stock and accumulated undivided profits.
There is testimony in the record to the effect that some of the items included in petitioner's plant construction account such as kilns had a usual useful life of about 10 years; stacks, 15 years; and that the kilns, stacks and dryers constituted between 60 and 75 per cent of the cost of the plant. The record, however, does not show the cost of any of these items of construction or equipment, nor does it show how the same were repaired or*3925 replaced, and whether replacements were charged to capital. We are, therefore, of the opinion that we are without sufficient evidence to warrant us in disturbing a depreciation computation as made by the respondent, and in respect to the railroad spur the record leads us to believe that the railroad company in operating this spur for the benefit of the petitioner provides for all the necessary maintenance to keep the same in effective working condition, and, in view of the fact that the contract with the railroad company is not shown, we do not feel warranted in allowing a depreciation of this item which the respondent has rejected.
In the adjustment of invested capital there should be reflected a depletion reserve computed upon the per acre cost of the clay deposits as determined by the findings herein. The allowance of a deduction for depletion should be computed upon the basis of the per acre value of such deposits on March 1, 1913, as found by the respondent and the difference between the depletion deduction computed upon cost and the deductions allowed upon the 1913 value should be restored to surplus for the invested capital computation. *3926 .
The deficiencies should be recomputed in accord with the findings of fact and the foregoing opinion.
Reviewed by the Board.
Decision will be entered on 15 days' notice, pursuant to Rule 50.