*2140 1. Rate of depreciation on buildings and equipment determined by the respondent approved for lack of evidence.
2. Where during taxable year the petitioner's board of directors adopted a resolution setting aside a certain percentage of the net profits for additional compensation to officers and providing that the persons who were to receive any of the additional compensation were to be designated by the board of directors as deemed fit and proper by them and no additional compensation or bonus was ever paid to any one or any one ever designated by the board of directors to receive any part of it, held, the petitioner is not entitled to take a deduction on account thereof.
*1340 This proceeding is for the redetermination of deficiencies in income and profits taxes of $24,316.56 and $833.11 for 1920 and 1921, respectively. The matters put in issue by the petition are the refusal of the respondent (1) to allow as deductions $2,129.74 and $3,435.19, representing a portion of the deductions taken by the petitioner for depreciation in its returns*2141 for 1920 and 1921, respectively; (2) to allow as a deduction in 1920 an amount of $32,627.79 representing a reserve for bonuses to officers; (3) to allow as a deduction in 1920 an amount of $4,000 representing the cost of a mining machine; (4) to determine the petitioner's profits tax for 1920 under the provisions of section 328 of the Revenue Act of 1918; and (5) to allow the petitioner as invested capital the value of leases turned over by the stockholders. At the hearing the petitioner waived issues (3) and (5). By prior order of the Board the hearing was limited to the issues other than special assessment. Consequently, there are for determination at this time only issues (1) and (2).
FINDINGS OF FACT.
The petitioner is an Indiana corporation with its principal office at Linton. It was organized in 1917 with a capital stock of $50,000, fully paid in cash. The land purchased for the purpose of coal mining cost the petitioner $26,131.18. On November 30, 1920, the petitioner bought additional coal land for which it paid $3,943.75. Another tract was purchased on April 30, 1921, for $340. These tracts consisted of a total of about 40 acres. In 1923, 54 additional acres*2142 of coal land were purchased for $65,000.
In December, 1917, the petitioner began coal-mining operations and thereafter mined coal as follows:
| Year | Tons |
| 1917 | 109.00 |
| 1918 | 103,814.00 |
| 1919 | 136,187.00 |
| 1920 | 172,631.25 |
| 1921 | 142,473.40 |
| 1922 | 100,133.70 |
| 1923 | 132,781.51 |
| 1924 | 122,534.05 |
| 1925 | 40,757.90 |
| 1926, about | 27,000.00 |
| 1927, about | 62,000.00 |
| 1928 | 31,181.50 |
| 1929, about | 18,000.00 |
*1341 At the beginning of operations in 1917, it was estimated that the recoverable amount of coal under the land then owned by the petitioner was 1,400,000 tons. This estimate was a little higher than the amount actually recovered. While in the early part of 1926 there remained six or eight scattering acres of this land to be worked the coal in it was practically exhausted in 1925. Only about three-fourths of the coal under the land acquired in 1920 and 1921 was recoverable, and by about April 1, 1926, it had been exhausted. The coal mined since the early part of 1926 has been taken from the land acquired in 1923. At the time of the hearing in April, 1929, some coal remained to be mined. The petitioner operated four months in 1925, seven months in 1926, five*2143 months in 1927, and four months in 1928. If it had operated continuously at an average rate of production, its coal would have been exhausted about 1927.
In 1925 part of the original machinery with which operations were begun in 1917 had to be replaced with new machinery, but the remainder has been continued in use down to the time of the hearing. The buildings and tipple were still being used in 1927.
At a special meeting of the five stockholders who were also the five directors of the petitioner, held on November 15, 1920, the following resolution was adopted:
A special meeting of the Hamilton Coal Mining Company was held in their office on Monday, November 15th, 1920 for the purpose of providing means where-by officials of said company should receive a more and just compensation for services rendered for the year 1920 with the following members present. C. S. Cunningham, Fred Cunningham, James Cunningham, D. R. Scott and W. J. Hamilton.
This being the intire board of directors as well as the intire number of Stockholders of said Company.
On motion of D. R. Scott the following resolution was presented.
Be it resolved that for the year 1920 and each ensueing year, *2144 until rescinded by the board of directors, that there be set aside from the earnings of said company for additional compensation to said officers 20% of the net income for each year, said 20% of income to be determined at the close of business, December 31st of each year. In no event shall such 20% of net income reduce the net earnings below 25% of the original Capitol Stock of said Company. That the persons who are to receive any part of such additional compensation shall be designated by said board of directors, as shall be deemed fit and proper by them.
The resolution was put up on its passage and those voting in favor were James Cunningham, Fred Cunningham, D. R. Scott and W. J. Hamilton, those against the resolution NONE.
The resolution was declared adopted and to be in full force and effect after this date.
Development of our new property was discussed and those in charge were ordered to push the work as fast as possible.
No further business appearing before the board of directors Meeting adjourned.
In adopting the above resolution, the directors had the financial welfare of the petitioner in mind.
*1342 Although it was not definitely decided at the*2145 time the resolution was adopted, it was the general understanding that the bonus was to be divided among the officers in the same proportion that the salary of each bore to the total salaries of the officers. At the time the resolution was adopted, the petitioner had been unable to pay its officers their salaries for the preceding year and it was only about August, 1920, that it had completed payment of the salary of its secretary and general manager for the year 1918. At the end of 1920, the petitioner did not have the money to pay the bonuses and at an informal meeting it was decided not to set them up as credits to the officers. Salaries for the year 1920 were as follows:
| Salary | |
| C. S. Cunningham, president | $2,500 |
| D. R. Scott, vice president | 2,500 |
| W. J. Hamilton, secretary and general manager | 12,000 |
| James Cunningham | 3,000 |
| Fred Cunningham | 2,500 |
The petitioner's capital stock consisted of 500 shares, of which Hamilton owned 250, C. S. Cunningham, 125 shares, and the remaining 125 shares were owned about equally by Scott, James Cunningham and Fred Cunningham.
At the end of 1920 the total amount of bonus was found to be $32,627.79, and a reserve for*2146 bonuses was set up on the petitioner's books. No part of the amount has ever been paid to any of the officers, nor have the directors adopted any resolution or taken any other formal action designation what amount, if any, was to be paid to each of the officers. Subsequent to 1920 no decisions regarding the distribution of the bonus have been made. The petitioner's books were kept on the accrual basis.
In determining the deficiencies here involved the respondent disallowed as excessive depreciation $2,129.74 of the amount taken for 1920 and $3,435.19 of the amount taken for 1921. He also disallowed as a deduction for 1920 the amount of $32,627.79, representing the reserve for bonuses.
OPINION.
TRAMMELL: With respect to the issue relating to depreciation, the only question is the proper rate allowable. The petitioner contends that it is entitled to take depreciation on its machinery and buildings at the rate of 12 1/2 per cent, or over a life of 8 years, whereas the respondent contends that the rate of 10 per cent as allowed by him is proper. The petitioner urges that at the beginning of operations in 1917, it estimated that 8 years would be required to exhaust the coal*2147 in the lands which it then owned; that it proceeded to take depreciation on its machinery and equipment at the rate of 12 1/2 *1343 per cent for all years; that depreciation was allowed at this rate for 1918 and 1919 and should be allowed for 1920 and 1921.
With respect to that part of the petitioner's contention as to the rate of depreciation allowed by the respondent in 1918 and 1919, there is nothing in the record to show what amount was allowed for those years and if a rate of 12 1/2 per cent had been allowed, that fact would not of itself be controlling as to the rate allowable in the years before us.
While the evidence shows that about the time operations were begun, it was estimated that the amount of the recoverable coal in the lands then owned by the petitioner was 1,400,000 tons, there is nothing in the record to indicate that it was estimated that it would take 8 years to exhaust the coal except that the petitioner is claiming the depreciation rate of 12 1/2 per cent. Whatever time, if any, it was estimated that it would take to exhaust the coal, the record shows that the recoverable coal in this land was practically exhausted in 1925 and that there were only*2148 six or eight scattering acres remaining to be worked in the early part of 1926. While additional coal lands were acquired during 1920 and 1921, the taxable years here involved, the recoverable coal in them was exhausted about April 1, 1926. While the recoverable coal in these lands was exhausted at about the time the coal in the land originally acquired was exhausted, it does not appear from the record whether it was known or estimated in 1920 or 1921 that the coal in them would be so exhausted. Other coal lands acquired in 1923 continued to provide the petitioner with a source of coal from early in 1926 down to the time of the hearing.
In determining what rate of depreciation the petitioner was entitled to for 1920 and 1921, we must base our decision on the facts known or reasonably anticipated in those years, and not on what has since transpired. ; ; ; and , affd. *2149 ; certiorari denied, . If it were known or could have been reasonably anticipated in those years that other coal lands were available to the petitioner or would be available to it at or before the time it expected to exhaust the coal in its own lands and would extend the period of operations, a lower rate of depreciation should be allowed than if conditions were otherwise. While the record shows the acquisition of additional land in 1923, or something more than a year after the years here involved, and about three years prior to the exhaustion of the coal in the lands then owned by the petitioner, it is silent as to the availability of such land during the years before us. In the absence of evidence on this point, and in view of the fact that some of the machinery *1344 with which operations were begun in 1917 is still being used in 1929, we are unable to hold that the respondent's determination is erroneous.
The remaining issue is whether the amount of $32,627.79, representing the reserve set up for bonuses to officers, is deductible, neither the amount nor the book entry setting it up being questioned. There is also*2150 no question as to the reasonableness of the compensation involved. The petitioner contends that the resolution authorizing the bonus was passed in good faith; that the amount in question constituted additional compensation to the officers and is properly deductible by it as an operating expense for 1920. The respondent contends that as no person or officer was ever designated to receive any of the bonus or any of it allocated to any one, there was no liability on the part of the corporation to pay the amount or any portion of it, and therefore the amount is not deductible.
Except in the case of insurance companies, reserves are not allowable deductions under the Revenue Act of 1918, which is applicable to the year 1920. ; ; . Clearly the amount is not allowable on the ground of being a proper reserve. If allowable at all it must be on the ground that it was a business expense incurred during the taxable year.
Here we have five men who constituted all the directors of the petitioner, all of its officers and all of its stockholders, *2151 purporting to vote a bonus to themselves, in addition to their regular salary. The resolution does not provide the basis on which the bonus was to be allocated to the officers entitled to it. By the terms of the resolution, persons entitled to receive any part of the bonus were to be so designated by the board of directors as should "be deemed fit and proper by them." Although the testimony shows that it was the general understanding among the directors that the bonus was to be apportioned among them on the basis of their annual salaries, no action was ever taken toward apportioning it among them on that or any other basis. While the resolution set aside 20 per cent of the net income, it did not direct the payment of the amount to any one, but simply provided that the persons who were to receive any part of it were to be designated by the board of directors. From our reading of the resolution we think the payment of the bonus as well as the determination of the parties to whom it was to be paid was left entirely in the hands of the board of directors, where it was before the resolution was passed. Further action on the part of the board of directors was necessary before any one*2152 of the officers would be entitled to any part of it. Until the board of directors acted, no one of the officers could claim that he was entitled to share in the *1345 bonus or that he was entitled to any particular amount of it. Where, as is the case here, the payment of a bonus as well as the designation of the parties to share in it and the extent to which they should share in it is left so completely to the future action of the board of directors, we do not think the corporation has incurred any liability for which it is entitled to take a deduction in determining taxable income. In our opinion the resolution is completely lacking in the finality of action required to establish a liability on the part of the petitioner to pay the bonuses. Inasmuch as the petitioner incurred no liability in the taxable year to pay any bonuses, we think the respondent properly refused to allow the deduction.
Further action will be had under Rule 62(b).