*3750 1. Value of lease on coal lands at March 1, 1913, determined.
2. No part of minimum royalties paid under a lease of coal property may be added to invested capital in the absence of proof that a portion of such royalties applied to inactive lands, and that such advance royalties might apply against any future shipments.
3. Electric locomotives, mine cars, steel rails and mining machines in this case are capital items and not deductible as expense.
4. Expenditures for repairs determined.
5. Computation of profits tax under section 328 of the Revenue Act of 1918 denied for lack of proof of abnormality.
*685 In this proceeding the petitioner seeks a redetermination of its income and profits taxes for the year 1920 for which the Commissioner has determined a deficiency of $19,703.86. The petitioner alleges error on the part of the Commissioner, (1) in determining that the March 1, 1913, value of a leasehold on coal and timber lands acquired in 1911 was not in excess of the cost; (2) in disallowing as a deduction*3751 from income the cost of certain locomotives and mining machines and equipment necessary to maintain the normal output of its mines, and certain expenditures made for repairs; (3) in failing to allow a deduction for depreciation on assets restored to capital in 1920 and prior years; (4) in failing to include in invested capital certain royalties and taxes paid on inactive and undeveloped lands; and (5) in refusing to compute the tax under section 328 of the Revenue Act of 1918.
Other issues raised in the petition were withdrawn by the petitioner at the hearing.
The Commissioner asks for affirmative relief by increasing net income by $19,609.27, representing capital items erroneously allowed as deductions from income less allowable depreciation thereon.
FINDINGS OF FACT.
The petitioner is a corporation organized in 1911, under the laws of the State of West Virginia, under the name of Marsh Fork Splint & Gas Coal Co. On December 31, 1914, the name was changed to Marsh Fork Coal Co. The petitioner's principal offices were at Charleston, W. Va.
*686 Prior to the incorporation of the Marsh Fork Splint & Gas Coal Co., and earlier in the year 1911, one W. H. Pettus, *3752 acting in association with T. E. B. Siler and Frank Fascinoli, entered into negotiations with the Rowland Land Co. for a lease to certain coal lands. These men having organized the Marsh Fork Splint & Gas Co., a stockholders' meeting was held August 25, 1911, and the following resolution was passed:
WHEREAS, under date of July 1, 1911, the Rowland Land Company entered into an agreement with W. H. Pettus for a lease on certain coal lands on Little Marsh Fork, in Raleigh County, West Virginia, which lands are therein described; and,
WHEREAS, the said W. H. Pettus has offered to sell all his rights under said agreement to the Marsh Fork Splint & Gas Coal Company, in consideration of $17,740.00, of which sum $2,740.00 has been paid to the Rowland Land Company upon condition that said amount shall be a credit upon any royalties to accrue under and by virtue of said lease.
THEREFORE, RESOLVED, That the proper officers of this Company be authorized to enter into an agreement with W. H. Pettus for the assignment of all his rights under and by virtue of said agreement, and pay unto the said W. H. Pettus the sum of $17,740.00, in full consideration therefor.
RESOLVED, FURTHER, That*3753 the President be and is hereby authorized to enter into a lease with said Rowland Land Company, according to the terms and conditions of said agreement of July 1, 1911, and the form of lease thereto attached.
On motion the same was duly carried.
On August 31, 1911, the petitioner entered into a lease with the Rowland Land Co. which provided in part as follows:
THIS DEED, Made this 31st day of August, 1911, between the ROWLAND LAND COMPANY, a corporation of West Virginia, of the first part, hereinafter called "the Lessor" and MARSH FORK SPLINT & GAS COAL COMPANY, of the second part, hereinafter called "the LESSEE."
WITNESSETH:
PROPERTY AND TERM
FIRST: That the Lessor, for and in consideration of Five Dollars, cash in hand paid, the receipt whereof is hereby acknowledged, and of the covenants and agreements herein contained, to be kept and performed by the Lessee, and the rents and royalty herein reserved and mentioned to be paid by the Lessee, doth hereby let and demise for coal mining and coking purposes only unto the Lessee for the term of thirty (30) years from and after the date hereof, all those certain lands and interests in land situated in Raleigh County, West*3754 Virginia, and bounded and described as follows, to-wit:
PARCEL NO. 1.
A certain tract or parcel of land lying between the Clear Fork and Little Marsh Creeks, * * * containing 787.809 acres in Clear Fork District and 678.015 acres in Marsh Fork District.
*687 PARCEL NO. 2.
Also another certain tract or parcel of land lying on the waters of Little Marsh Creek between the Four States Coal and Coke Company line, Little Marsh Creek and the Birch Fork, in Marsh Fork District, * * * containing 1401.25 acres
* * *
RIGHTS
SECOND: And for the term of this lease the exclusive right and privilege is granted by the Lessor to the Lessee to mine and dig coal in and from any and all seams of coal in and upon the hereinbefore demised premises, and to sell, carry away and ship the same, or to use the same upon the demised premises in making coke or otherwise, and to use such part or parts of the demised premises and such rights, rights of way, privileges and appurtenances thereunto belonging or in anywise appertaining as may be necessary for the purpose of making coke or other coal products thereon, and shipping such coal, coke or other coal products therefrom, and generally*3755 for any purpose the Lessee may desire properly incidental to its coal and coke business; subject, nevertheless, to the exceptions and reservations hereinafter contained with respect to rights of way and timber, oil, gas and minerals other than coal, which are or may be found upon the demised premises; and subject, also, to such reservations and exceptions as are contained in the various deeds under which, mediately or immediately, the Lessor derives title to the property hereby demised, and to the rights hereinafter reserved for roads, tramroads, railroads and uses by the Lessor or its assigns. And the Lessee shall also have the right and privilege of taking from that portion of the demised premises owned in fee by the Lessor such stone, timber, (except the timber hereinafter reserved), sand and water as may be necessary or convenient for use by the Lessee in its operations under this lease or in the construction of any buildings or improvements of any kind upon the demised premises; but no timber, stone, sand or water shall be removed from or used by the Lessee off the demised premises.
RESERVATIONS
THIRD: The Lessor reserves from the operation of this lease all the timber on*3756 the demised premises which on the first day of January, 1904, measured ten (10) inches in diameter under the bark four (4) feet from the ground, together with the right for forty (40) years from and after said first day of January, 1904, to cut, manufacture and remove said timber and to occupy so much of the surface of the demised premises as may be necessary for such roads, tramroads, and railways, and for such manufacturing plants as may be needed or convenient for the purposes aforesaid and for the removal of any of the timber now owned or that may hereafter be acquired by the persons or corporations now owning said timber on the demised premises hereby reserved, or their assigns, adjacent to said land or in that general locality, the said timber and rights have been reserved in the conveyance of the demised premises to the lessor; * * *
* * *
OPERATIONS
SIXTH: No coal or coke from lands other than the demised premises shall be by the Lessee hauled through or over the demised premises or any part thereof, or loaded into railway cars from tipples or other loading places upon *688 the demised premises; and no coal or coke mined from or made upon the demised premises shall*3757 be loaded into railway cars over any tipple or other loading place or loading tracks not upon the demised premises; and Lessee shall not remove any coal from the demised premises in order to manufacture coke or other coal products therefrom, the intent hereof being that all tipples, loading tracks, ovens and other improvements for any such purposes shall be situate upon the demised premises.
ROYALTY
SEVENTH: In consideration of this lease and the rights and privileges hereby granted, the Lessee covenants and agrees to pay to the Lessor, subject to the terms and conditions herein contained, royalty for all coal mined and shipped from or used in coke making or otherwise upon the demised premises at the rate of eight (8) cents per net ton of two thousand (2,000) pounds run of mine; and the Lessee covenants and agrees to pay Lessor a fixed or minimum rent or royalty upon the hereinbefore demised premises of Eighty-six Hundred Dollars ($8,600) for the year beinning one (1) year after rails shall be laid on a railroad up Little Marsh Fork to the upper line on said fork of the leased premises, Eleven Thousand, Four Hundred Sixty-Eight Dollars and 29/100 (.29) ($11,468.29) for the first*3758 year thereafter, and Fourteen Thousand, Three Hundred and Thirty-Five and 36/100 Dollars ($14,335.36) for the second year thereafter and each succeeding year of this lease, whether the coal mined in any year amounts, at the rate of royalty aforesaid, to the minimum rent or royalty for such year or not. And if the said Lessee shall not mine in any calendar year as much coal as shall, at the said rate of royalty, amount to the minimum royalty for such year, it shall have the right during the two (2) calendar years next succeeding of this lease to mine free of charge enough coal at the rate of royalty aforesaid to make up the difference between the royalty at the rate aforesaid on the coal actually mined in such year and the minimum royalty so paid for such year without interest; providing that no coal shall be mined free on account of any such deficiency until the amount of coal required to pay the minimum royalty for the year in which such coal is mined free shall be first mined. Payments for all coal mined under this lease shall be made quarterly on the first days of February, May, August and November in each year, for the coal mined in the three (3) months preceding the first days*3759 of the preceding January, April, July and October, respectively, and in case the royalty upon the coal actually mined in any such quarter of any calendar year does not equal, at the rate of royalty aforesaid, one-fourth (1/4) of the minimum royalty for the year in which said coal is so mined, one-fourth (1/4) of the minimum royalty for such year shall be paid on the first day of the second month following such quarter, unless a sufficient excess of coal shall have been mined in a preceding quarter of such calendar year to make up the deficiency; and in case, at the termination of this lease, the Lessee shall have paid an excess of minimum royalty over royalty upon coal actually mined, such excess shall be forfeited, and the Lessee shall not have any right to mine any coal to compensate him therefor after the termination of the lease.
* * *
RENEWAL
TWENTY-SECOND: At the termination of this lease the same may be renewed and extended for an additional period of thirty (30) years, and all the terms, conditions and provisions hereof shall apply to such extension and renewal; provided, that the lease shall not be renewed or extended unless the Lessee shall give notice in writing six*3760 (6) months prior to the termination of the same of its *689 desire that the same shall be so renewed and estended, nor if the Lessee at the termination of the lease be then in default in respect to any condition or covenant of the lease by it to be kept and performed.
The lease also provided that the lessee shall pay all taxes except on improvements placed on the property by the lessor for its own use; the buildings and improvements were to be kept insured at the expense of the lessee; the lease could not be assigned or sold without the lessor's consent; and it was required that preference be given the Chesapeake & Ohio Railway Co. in the shipment of coal.
At the time the lease was granted there were about 12 houses on the premises occupied by the logging lessee and certain people living on the land. There were about 300 acres of cleared land which the petitioner subsequently rented to its employees.
At March 1, 1913, there were about 2,000 acres of timber land containing about 2,500 feet of timber to the acre to which the petitioner was entitled. The timber covered by the lease embraced all timber other than timber 10 inches and over in diameter at 1904, so that*3761 by March 1, 1913, the petitioner would be entitled to all timber under 14 inches in diameter at that time. This was due to the growth since 1904.
There were two seams of coal in the properties leased, the Dorothy and the Thacker. The Dorothy seam comprised 650.9 acres at March 1, 1913, and contained 4,686,480 tons of recoverable coal after allowing for losses. This seam had an average thickness of about 5 feet, and was clean coal with the exception of a slate parting three-quarters of an inch thick located one foot from the roof. It is overlaid in part with about six inches of draw slate and in part with sandstone.
The coal designated "Dorothy" is found in Raleigh and Boone Counties, West Virginia, and is similar to coal designated "Coalburg", "Winifrede" and "Chilton." It is classified as Splint No. 1 by the Chesapeake & Ohio Railway Co. Such coals are especially hard and of a pure grade and will stand shipment and handling.
The petitioner's coal is especially hard and is superior to other coals in the same field and even some in the same seam. The coal burns slowly, although high in volatile matter and does not disintegrate.
Coal was produced from the petitioner's*3762 property as follows:
| Year. | Tons. |
| 1913 | 44,048 |
| 1914 | 108,719 |
| 1915 | 104,038 |
| 1916 | 95,845 |
| 1917 | 97,388 |
| 1918 | 97,319 |
| 1919 | 97,149 |
| 1920 | 107,541 |
At March 1, 1913, operators located on the Chesapeake & Ohio Railroad had difficulty in obtaining an adequate supply of railroad *690 cars to ship their product. As a result, properties which had to ship on that railroad were greatly handicapped, and were valued in the market at considerably less than the price paid for similar properties located on the Norfolk & Western Railroad.
The mining conditions on the petitioner's property were favorable and the cost of extracting and loading coal was, at March 1, 1913, about 2 cents a ton less than the average cost of Marsh Fork Coal and other coals from that same seam. The coal from this property sold at a premium over the average price of other coals.
The value of the petitioner's leasehold at March 1, 1913, was as follows:
| Value ascribable to timber on the lands | $25,000.00 |
| Value ascribable to the coal due to its advantages with respect to | |
| operations and transportations and other elements directly affect- | |
| ing the coal | 55,000.00 |
| Total | 80,000.00 |
*3763 The Commissioner in the 60-day letter had disallowed as expense $48,592.57 of the amount claimed by the petitioner, and claims that an additional sum of $21,633.99 also represented items not deductible as expense, a total of $70,226.56.
This sum consisted of the following items:
| 1920 | Charge | |
| Tenement buildings | General | $10,228.25 |
| Electric locomotive - 6-ton Goodman | Marsh Fork No. 1 | 4,893.00 |
| Electric locomotive - 10-ton Goodman | Marsh Fork No. 1 | 6,254.00 |
| Electric locomotive - 6-ton Goodman | Marsh Fork No. 1 | 4,848.00 |
| Electric locomotive - Goodman | Marsh Fork No. 2 | 4,848.00 |
| Mining machine - Goodman | Marsh Fork No. 1 | 3,625.00 |
| Total | 24,468.00 | |
| Mine cars - Kanawha Manufacturing Co., Sept. 30, | ||
| 1920. | Marsh Fork No. 1 | 4,250.00 |
| Mine cars - Kanawha Manufacturing Co., Sept. 30, | ||
| 1920. | Marsh Fork No. 2 | 2,040.00 |
| Mine cars - Kanawha Manufacturing Co., Nov. 15, | ||
| 1920. | March Fork No. 2 | 2,380.76 |
| Total | 10,670.76 | |
| Monitors - two 6-ton - Kanawha Manufacturing Co., | ||
| Nov. 30, 1920. | Thacker | 2,224.25 |
| Electric hoist - Charleston Electrical Supply Co., | ||
| Aug. 21, 1920. | Marsh Fork No. 1 | 3,100.00 |
| Conveyor equipment - Jeffrey Manufacturing Co., | ||
| Oct. 22, 1920. | Marsh Fork No. 2 | 1,041.59 |
| Conveyor equipment - Jeffrey Manufacturing Co., | ||
| Dec. 7, 1920. | Marsh Fork No. 2 | 1,852.20 |
| Total | 2,893.79 | |
| Steel rail - Cincinnati Frog & Switch Co | Marsh Fork No. 1 | $291.34 |
| Steel rail - Cincinnati Frog & Switch Co | Marsh Fork No. 2 | 303.47 |
| Steel rail - Civcinnati Frog & Switch Co | No. 2 and Thacker | 284.18 |
| Steel rail - Weller & Co., Dec. 20, 1920 | Marsh Fork No. 1 | 2,777.00 |
| Steel rail - Elkonow Supply & Engineering Co., | ||
| Jan. 14, 1920. | Thacker | 1,634.58 |
| Steel rail - Elkonow Supply & Engineering Co., | Marsh Fork No., | |
| Feb. 11, 1920. | Marsh Fork No. 2 | 1,368.78 |
| Steel rail - Elkonow Supply & Engineering Co., | Marsh Fork No. 1, | |
| May 3, 1920. | No. 2, and | |
| Thacker | 1,590.28 | |
| Steel rail - Elkonow Supply & Engineering Co., | Marsh Fork No. 1, | |
| July 30, 1920. | Thacker. | 1,716.13 |
| Steel rail - West Virginia Rail Co., Sept. 15, | ||
| 1920. | Marsh Fork No. 1 | 2,494.11 |
| Steel rail | Marsh Fork No. 1 | 634.39 |
| Total | 13,094.26 | |
| Substation equipment - Ridgeway Dynamo & Engineer- | ||
| ing Co., Apr. 13, 1920. | Thacker | 1.51 |
| Substation equipment - Ridgeway Dynamo & Engineer- | ||
| ing Co., Aug. 17, 1920. | Thacker | 40.36 |
| Substation equipment - Ridgeway Dynamo & Engineer- | ||
| ing Co., Aug. 27, 1920. | Thacker | 1,450.00 |
| Substation equipment - Ridgeway Dynamo & Engineer- | ||
| ing Co., Aug. 27, 1920. | Thacker | 25.86 |
| Substation equipment - Charleston Electrical & | ||
| Supply Co., Feb. 11, 1920. | Thacker | 199.00 |
| Substation equipment - Charleston Electrical & | ||
| Supply Co., Mar. 1, 1920. | Thacker | 80.30 |
| Substation equipment - Charleston Electrical & | ||
| Supply Co., Mar. 12, 1920. | Thacker | .52 |
| Substation equipment - Charleston Electrical & | ||
| Supply Co., Mar. 12, 1920. | Thacker | .75 |
| Substation equipment - Charleston Electrical & | ||
| Supply Co., June 1, 1920. | Thacker | 37.26 |
| Substation equipment - Charleston Electrical & | ||
| Supply Co., June 3, 1920. | Thacker | 25.12 |
| Substation equipment - Charleston Electrical & | ||
| Supply Co., June 4, 1920. | Thacker | 118.64 |
| Substation equipment - Charleston Electrical & | ||
| Supply Co., June 11, 1920. | Thacker | 8.56 |
| Substation equipment - Charleston Electrical & | ||
| Supply Co., June 12, 1920. | Thacker | .68 |
| Substation equipment - Charleston Electrical & | ||
| Supply Co., June 17, 1920. | Thacker | .46 |
| Substation equipment - Express charges | 1.19 | |
| Total | 1,991.20 | |
| Water system | General | 811.29 |
| Mules | 495.00 | |
| Telephone lines | 249,87 | |
| Total | 70,226.67 |
*3764 *692 Electric locomotives costing $15,995, mining machines costing $3,625, mine cars costing $4,250, and steel rails costing $8,650.89 were sent to Mine No. 1 to maintain the tonnage production of the mine due to the increased length of haul. Steel rails costing $898.99 were purchased to use as replacements of broken and lost steel in Mine No. 1, Mine No. 2 and Thacker. Two 6-ton monitors costing $2,224.25 were purchased to install in the Thacker mine to take the place of two 10-ton monitors which were found to be difficult to control and one of which was completely wrecked. Conveyor equipment costing $2,893.79 was installed to replace lighter conveyor equipment in Mine No. 2 which had proved to be inadequate.
Sub-station equipment costing $1,991.20 was purchased for the Thacker mine to repair the damage caused by lightning. The principal item was a starter coil costing $1,450. This coil is a part of a complete machine and surrounds a large heavy revolving figure.
The remaining items making up the total of $70,226,67 were new installation in Mine No. 2 and Thacker and one item of $3,100 for an electric hoist installed in Mine No. 1 to replace an old hoist which*3765 was used elsewhere.
OPINION.
ARUNDELL: The petitioner has attributed value to its leasehold, first because of the fair value of the coal as compared with the royalty rate specified, second, because of the position of the workings with relation to coal on other property beyond such workings, third, because of the timber rights included in the lease. Other advantages were also alleged, such as the use of houses on the property and of cleared land, etc.
A witness for the petitioner testified that the fair royalty rate on this coal in the hands of a lessor was 15 cents and that a reasonable estimate of the life of the deposit was 35 years. This witness placed a value of $125,000 on the coal rights, but in doing so made the assumption that only 8 cents a ton would be paid the lessor as royalty or rental. Under the terms of the lease, minimum annual payments were to be made regardless of the amount of coal produced. These amounted to $8,600 the first year, $11,488.29 the second year, and $14,335.36 for each succeeding year. These royalties or rental payments would amount to $493,155.17 during 35 years of operation. The estimated recoverable tonnage was 4,686,480, therefore, *3766 the total expected royalties receivable to a lessor charging 15 cents a ton would be $702,972. Deducting from this sum the total rentals payable under the lease leaves a net amount of $219,816.83 recoverable over a period of 35 years which represents the saving to the petitioner *693 under the terms of the lease and attributable to coal rights. Taking into consideration this fact and all other facts and circumstances, we are of the opinion that petitioner's interest in the coal was worth on March 1, 1913, $55,000 and depletion should be determined on this basis.
Testimony was offered to the effect that an additional value of $25,000 was attributable to the strategic position of the property, on the assumption that the petitioner could charge 3 cents a ton for bringing out through its workings the coal from the property in the rear. Article six of the lease specifically provides, however, that "No coal or coke from lands other than the demised premises shall be by the lessee hauled through or over the demised premises or any part thereof, or loaded into railway cars from tipples or other loading places upon the demised premises." We believe $25,000 represents the fair value*3767 of the timber rights on March 1, 1913, and have so found in the findings of fact.
The question of the right to deduct as an ordinary and necessary expense such items as locomotives, mine cars, mining machines, hoists and steel rails has been passed upon by the Board in the . The action of the Commissioner in treating these items as capital expenditures is, therefore, approved. The record indicates that some of the rails may have been used to replace broken and worn out rails, but to what extent we are not advised. The conveyor equipment and the monitors appear to be complete replacements and not repairs to existing machines. The expenditures for sub-station equipment on the Thacker mine amounting to $1,991.20 were made to repair an existing machine and its equipment and accordingly the entire amount is deductible as expense.
The Commissioner's action in disallowing as expense $48,592.57 is approved and his plea for affirmative relief granted except as to the item of sub-station equipment.
The petitioner is also entitled to additional depreciation for 1920 of $1,607 in respect to items of equipment restored to capital in*3768 prior years amounting to $32,139.98, in accordance with the stipulation of the parties.
The claim of the petitioner that certain royalties and taxes paid on inactive and undeveloped land be restored to capital is denied, first, because nothing in the lease indicates that a separate royalty was to apply to each tract or that such royalties accrued to the credit of the petitioner and could be satisfied by unlimited future shipments, and, second, because items such as annual rental and annual taxes are deductible as expense each year and are paid for benefits *694 received during the year. The mere fact that the petitioner did not take fullest advantage of the benefits for which it paid rentals and taxes does not change the character of the expenditures.
The petitioner has also included in its petition a contingent claim for relief under section 328 of the Revenue Act of 1918. No proof was submitted to show that the petitioner comes within the provisions of that section, therefore, its plea is denied.
Judgment will be entered on 10 days' notice, under Rule 50.