1969 U.S. Tax Ct. LEXIS 155">*155 Decision will be entered under Rule 50.
Petitioner placed two new oil storage tanks (number 413 and number 212) in service during the taxable year. Tank number 413 was used to blend No. 2 oil with No. 6 oil to produce No. 4 oil. Tank number 212 stored No. 2 oil, and in connection therewith was used substantially, but not necessarily predominantly, for storing oil owned by oil refineries. Held: Both tanks qualify for the investment credit under secs. 38 and 46 of the Code. Both were used respectively as an integral part of and in connection with a manufacturing or production activity during their first year in service. Revenue ruling which would require "predominant" use of tank number 212 for storing the refineries' oil, disapproved.
52 T.C. 68">*69 Respondent has determined a deficiency in petitioner's income taxes for the taxable year ended June 30, 1964, in the amount of $ 27,042.08. Concessions have been made, and the only question now remaining is whether certain oil storage tanks, purchased and placed in service during the taxable year by petitioner are "section 38" property and thus subject to the investment credit.
FINDINGS OF FACT
1969 U.S. Tax Ct. LEXIS 155">*157 Some of the facts are stipulated and they are so found.
Petitioner Northville Dock Corp. (hereinafter sometimes referred to as petitioner or Northville) is a New York corporation having its principal office at Riverhead, N.Y., at the time of filing of the petition herein.
Northville, during the year in issue, maintained its books and records and filed its income tax returns on an accrual method of accounting. It filed its Federal income tax return for the year ended June 30, 1964, with the district director of internal revenue for the Brooklyn district of New York.
Northville's major activity during the year in issue was the handling and distribution of various grades of fuel oil. Some of the oil it purchased outright for resale; some it stored and distributed pursuant to agreements executed with various oil companies.
In the course of its operations, Northville bought, sold, stored, and transported three grades of fuel oil, No. 2, No. 4, and No. 6. Number 2 oil was the most expensive of the three, and sold at about 11 cents per gallon. Number 6 was the lowest in price and sold for about 5 3/4 cents per gallon during the year in issue. Number 2 oil is a light oil which does not1969 U.S. Tax Ct. LEXIS 155">*158 need to be preheated before use in a burner. Number 6 oil on the other hand is quite viscous and needs to be preheated in order to flow properly. Number 4 oil is a blend of No. 6 and No. 2 oils, the qualities of which fall in between those of No. 6 and No. 2. During the year in issue No. 4 oil sold for about 8 cents per gallon.
All three of these grades are derived from crude oil which is vaporized and blended into various grades at refineries. Any oil burner which could handle and consume No. 6 oil could also utilize No. 4 and 52 T.C. 68">*70 No. 2 oils, but the reverse is not true, i.e., a burner using a higher numbered grade than that designed for it would not be able to properly consume the heavier fuel.
On November 3 and December 4, 1963, Northville placed two recently completed oil storage tanks in service at its plant in Riverhead. Both tanks were of steel construction and had cone roofs. For convenience the tanks will hereinafter be referred to as tank number 212 and tank number 413, respectively.
Tank number 212 had a capacity of 268,560 barrels 1 and cost $ 258,979.67, while tank number 413 had a capacity of 20,120 barrels and cost $ 33,089.57. Both tanks rested on a sand1969 U.S. Tax Ct. LEXIS 155">*159 base but were not affixed to the land, and under the conditional-sales agreement covering their purchase, they were considered tangible personal property as long as the purchase price remained unpaid. There was a market for used tanks during the year in issue and the tanks could have been dismantled and reconstructed elsewhere.
Northville was the first user of the two tanks, the construction and erection of which commenced after December 31, 1961. Both tanks were tangible property with respect to which depreciation was allowable, having expected useful lives of about 16 years.
Tank number 212 was used to store No. 2 oil which Northville had either purchased outright or was holding in storage for various oil refineries, such as Humble Oil, American Oil, and Shell Oil Co., which companies had shipped the oil to Northville direct from their refineries. At the time tank number 212 was being constructed Northville was short of storage space, and a shipment of 5,507,165 gallons of No. 2 oil from American1969 U.S. Tax Ct. LEXIS 155">*160 Oil's refinery, part of which was to be held in storage for American, had to be delayed pending completion of the tank.
Oil stored in tank number 212 was not specifically identified as owned or stored. Since oil is a fungible commodity, Northville identified oil which it stored (as opposed to that which it owned) through a system of voucher credits rather than through specific physical segregation of purchased oil from lessees' oil; consequently no specific tank needed to be or was identified as a leased storage tank or one solely used for storing Northville's property.
No evidence was introduced into the record which showed the number of gallons of No. 2 oil owned by Northville vis-a-vis the number of gallons which it stored for others, however, tank rental or storage income for the year ended June 30, 1964, from storing No. 2 and No. 52 T.C. 68">*71 6 oil was $ 427,321, while gross profits from the sale of oil was $ 1,627,591. Northville's sales of oil during this period were 146,159,803 gallons of No. 2 oil; 19,782,158 gallons of No. 4 oil; and 121,902,866 gallons of No. 6 oil. Number 4 oil manufactured during the period was 17,499,360 gallons, of which 13,080,251 were manufactured1969 U.S. Tax Ct. LEXIS 155">*161 from December 1, 1963, to June 30, 1964.
Tank number 413, like tank number 212, was used for storage purposes, storing No. 4 oil. In addition, during the year in issue, tank number 413 was used to manufacture No. 4 oil as part of a system similar to that which oil refineries used to manufacture No. 4 oil. The proper portions of No. 2 oil and No. 6 oil were introduced into pumps which discharged both oils into tank number 413 through a hole in the tank's top. After the tank was filled, the oil was circulated for various lengths of time, depending upon the oil's viscosity and temperature, by pulling the oil out from the bottom of the tank and then pumping it back in through the tank's top. When the process was completed, the oil was thoroughly agitated and had become properly mixed No. 4 oil.
In the course of its operations, Northville transported both its own oil which it had sold and oil which it had stored for others. Delivery fees were charged only in connection with No. 2 oil. The trucks it used to transport the oil were all leased. For the year ended June 30, 1964, Northville reported total income from trucking of $ 111,859.93, while claiming expenses as follows:
| Equipment rental -- delivery | $ 85,228 |
| Outside trucking | 393,605 |
| Truck maintenance and supplies | 115,745 |
| 594,578 |
1969 U.S. Tax Ct. LEXIS 155">*162 On its Federal income tax return for the taxable year ended June 30, 1964, Northville claimed an investment credit under sections 38 and 46 of the Internal Revenue Code of $ 20,444.85, based on an aggregate investment of $ 292,069.24 in tanks number 212 and 413. Its liability for income tax for the period before the credit was $ 202,571.17. In his statutory notice of deficiency, respondent disallowed the amount as follows:
You deducted an investment credit on Oil Tanks costing $ 292,069.00 with a life of 16 years. This property does not qualify as Sec. 38, I.R.C. property, subject to the credit.
ULTIMATE FINDING OF FACT
Tanks number 212 and number 413 were section 38 property during the taxable years ended June 30, 1964.
52 T.C. 68">*72 OPINION
Under sections 38 and 46 of the Code, 21969 U.S. Tax Ct. LEXIS 155">*164 a taxpayer is allowed as a credit against the income tax, a specified percentage of the cost basis of qualified property which has been placed in service during the taxable year. The qualified property is called "section 38 property" and is defined in section 48 of the Code. 3 It is petitioner's position that two oil storage tanks, numbers 212 and 413 purchased by it in 1963, qualified as section 381969 U.S. Tax Ct. LEXIS 155">*163 property and that it properly deducted $ 20,444.85 as an investment credit on its income tax return for the year ended June 30, 1964.
52 T.C. 68">*73 Respondent's position is that neither tank constituted section 38 property and therefore no investment credit with respect to either tank is allowable. Respondent does not dispute the size of the claimed deduction1969 U.S. Tax Ct. LEXIS 155">*165 if the tanks were in fact section 38 property.
As an ultimate finding of fact, we have determined that both tanks qualified as section 38 property. Section 48, inter alia, allows research or storage facilities to qualify as section 38 property if they are used in connection with "manufacturing, production, or extraction or of furnishing transportation."
Section 1.48-1(d)(2), Income Tax Regs., defines manufacturing, production, and extraction as follows:
Sec. 1.48-1 Definition of section 38 property.
* * * *
(d) Other tangible property -- * * *
(2) Manufacturing, production, and extraction. For purposes of the credit allowed by section 38, the terms "manufacturing", "production", and "extraction" include the construction, reconstruction, or making of property out of scrap, salvage, or junk material, as well as from new or raw material, by processing, manipulating, refining, or changing the form of an article, or by combining or assembling two or more articles, and include the cultivation of the soil, the raising of livestock, and the mining of minerals. Thus, section 38 property would include, for example, property used as an integral part of the extracting, processing, 1969 U.S. Tax Ct. LEXIS 155">*166 or refining of metallic and nonmetallic minerals, including oil, gas, rock, marble, or slate; the construction of roads, bridges, or housing; the processing of meat, fish or other foodstuffs; the cultivation of orchards, gardens, or nurseries; the operation of sawmills, the production of lumber, lumber products or other building materials; the fabrication or treatment of textiles, paper, leather goods, or glass; and the rebuilding, as distinguished from the mere repairing, of machinery. [Emphasis supplied.]
As we pointed out in Schuyler Grain Co., 50 T.C. 265">50 T.C. 265, 50 T.C. 265">272 (1968), on appeal (C.A. 7, Aug. 5, 1968), the above regulation, consistent with the legislative purpose behind the investment credit, defines manufacturing, production, and extraction broadly and is to be liberally interpreted.
As shown in the findings of fact, tank number 413 was both used in connection with and was also an integral part of blending two different products, No. 2 oil and No. 6 oil, in order to obtain No. 4 oil, a product whose characteristics and uses are different from the other two. We find this activity sufficient to constitute the making of property by "changing the1969 U.S. Tax Ct. LEXIS 155">*167 form of an article, or by combining or assembling two or more articles."
Respondent contends that petitioner, by blending the oils, was doing nothing more than performing a service, as No. 2, 4, and 6 oil are all derived from the same source -- crude oil. However, even if this activity were a form of service, it was also within the scope of manufacturing or production as defined by the regulations, and was 52 T.C. 68">*74 sufficient to qualify tank number 413 as section 38 property. See 50 T.C. 265">Schuyler Grain Co., supra; also cf. Murphy v. Arnson, 96 U.S. 131">96 U.S. 131, 96 U.S. 131">134.
Tank number 212 held No. 2 oil, some of which was probably used or held for use in the blending process which took place in tank number 413. Petitioner would have us find on this basis that tank number 212 was thus also used in connection with the manufacture of No. 4 oil, thereby becoming section 38 property.
Whether the connection between tank number 212 and the manufacturing process in tank number 413 is sufficient to accord tank number 212 section 38 treatment, we do not decide. We do find and hold that the tank was substantially used by various oil refineries in1969 U.S. Tax Ct. LEXIS 155">*168 connection with their refining process and as such was section 38 property.
Section 1.48-1(d)(2) above defines manufacturing, production, or extraction for purposes of the investment credit as including the oil-refining process. Under section 1.48-1(d)(5)4 where a refinery uses leased storage tanks in connection with its refining process, the tanks constitute section 38 property in the hands of the tank's owners. Rev. Rul. 68-122, 1968-1 C.B. 10, dealing with corn storage facilities leased by farmers to store harvested corn, recognizes that storage facilities leased by those engaged in manufacturing, extraction, or production can constitute section 38 property where the facilities are used to store the finished product pending its sale. The ruling also provides that the facilities be predominantly used for this purpose before the Service will recognize them as section 38 property.
1969 U.S. Tax Ct. LEXIS 155">*169 In the instant case, Northville's No. 2 oil storage facilities were used in part to store refined oil for various oil refineries. Though the evidence shows that tank number 212 was not specifically used only for storing such leased oil, we have found that it was at all times substantially used for this purpose. The evidence introduced into the record established that Northville treated all No. 2 oil on hand as a fungible commodity. Inventory records alone were used to establish which oil on hand belonged to the oil refineries and which belonged to Northville. From these facts, we have found that all of Northville's No. 2 oil storage facilities, including tank number 212, were used in part, but not necessarily predominantly, for storing the refineries' oil. Though Rev. Rul. 68-212 would require a showing by petitioner that tank number 212 was predominantly used to store the refineries' oil in 52 T.C. 68">*75 order to be section 38 property, there is no support for this requisite in the Code or the regulations. The specific language used in section 48 of the Code and the regulations thereunder provides that storage facilities will qualify as section 38 property1969 U.S. Tax Ct. LEXIS 155">*170 if the facilities are simply "used in connection with (the prescribed activities)." The term "predominantly used" or a similar term is not used in that section.
Nor can we find that the words "predominantly used" can be implied in that section, for in other provisions relating to the investment credit, the Code does specifically provide for a predominant use test.
For example, section 46, in providing for a reduced investment credit for public utility property, reads as follows:
SEC. 46. AMOUNT OF CREDIT.
(c) Qualified Investment. --
* * * *
(3) Public utility property. --
* * * *
(B) For purposes of subparagraph (A), the term "public utility property" means property used predominantly in the trade or business * * * [Emphasis supplied.]
Section 48(a)(3), in excluding property used for lodging from the credit, reads as follows:SEC. 48. DEFINITIONS; SPECIAL RULES.
(a) Section 38 Property. --
(3) Property used for lodging. -- Property which is used predominantly to furnish lodging or in connection with the furnishing of lodging shall not be treated as section 38 property. * * * [Emphasis supplied.]
The fact that a predominant-use test is specifically1969 U.S. Tax Ct. LEXIS 155">*171 provided for in these provisions would tend to indicate that if Congress wished to provide a predominant-use test for storage facilities, or section 38 property generally, it would have done so.
In addition, the regulations support the proposition that property need not be used predominantly in a specified activity in order to qualify as section 38 property. The examples under section 1.47-2(e), Income Tax Regs., concerning conversion of section 38 property to personal use, specifically postulate a situation where an automobile is used in a qualifying activity only 40 percent of the time, but is still considered section 38 property to the extent that its basis is subject to depreciation. 5
1969 U.S. Tax Ct. LEXIS 155">*172 52 T.C. 68">*76 We find and hold that, as it pertains to section 48 of the Code, the term "used in connection with" (an activity) does not require a predominant use of property in order to qualify it as section 38 property. Whether or not the use need be more than de minimis we need not decide, as the evidence in the instant case indicates that a substantial portion of petitioner's storage facilities were used for storing oil for the refineries. About 20 percent of petitioner's gross profits was attributable to storage tank rental income, a substantial portion of which was attributable to the storage of No. 2 oil. This establishes that oil storage income was more than merely incidental to petitioner's other activities.
Thus we find and hold that tanks number 212 and number 413 were used respectively and in connection with, and as an integral part of, a manufacturing or production activity during their first year in service, as defined by section 48, and consequently were section 38 property. Since both tanks were section 38 property, petitioner was entitled to deduct $ 20,444.85 as an investment credit with respect to those tanks.
These holdings are dispositive of the issue; consequently1969 U.S. Tax Ct. LEXIS 155">*173 we do not discuss petitioner's other alternative arguments, that the tanks were tangible personal property, were used in connection with a transportation business, or were both wholly used in connection with oil refining, regardless of who owned the oil stored.
Because of petitioner's concessions,
Decision will be entered under Rule 50.
Footnotes
1. 1 bbl. = 42 gals.↩
2. All references are to the Internal Revenue Code of 1954 unless otherwise indicated.
SEC. 38. INVESTMENT IN CERTAIN DEPRECIABLE PROPERTY.
(a) General Rule. -- There shall be allowed, as a credit against the tax imposed by this chapter, the amount determined under subpart B of this part.
(b) Regulations. -- The Secretary or his delegate shall prescribe such regulations as may be necessary to carry out the purposes of this section and subpart B.
* * * *
SUBPART B -- RULES FOR COMPUTING CREDIT FOR INVESTMENT IN CERTAIN DEPRECIABLE PROPERTY
SEC. 46. AMOUNT OF CREDIT.
(a) Determination of Amount. --
(1) General rule. -- The amount of the credit allowed by section 38 for the taxable year shall be equal to 7 percent of the qualified investment (as defined in subsection (c)).
* * * *
(c) Qualified Investment. --
(1) In general. -- For purposes of this subpart, the term "qualified investment" means, with respect to any taxable year, the aggregate of --
(A) the applicable percentage of the basis of each new section 38 property (as defined in section 48(b)) placed in service by the taxpayer during such taxable year, plus
(B) the applicable percentage of the cost of each used section 38 property (as defined in section 48(c)(1)) placed in service by the taxpayer during such taxable year.
(2) Applicable percentage. -- For purposes of paragraph (1), the applicable percentage for any property shall be determined under the following table:
The applicable If the useful life is -- percentage is -- 4 years or more but less than 6 years 33 1/3 6 years or more but less than 8 years 66 2/3 8 years or more 100 For purposes of this paragraph, the useful life of any property shall be determined as of the time such property is placed in service by the taxpayer.↩
3. SEC. 48. DEFINITIONS: SPECIAL RULES.
(a) Section 38 Property. --
(1) In general. -- Except as provided in this subsection, the term "section 38 property" means --
(A) tangible personal property, or
(B) other tangible property (not including a building and its structural components) but only if such property --
(i) is used as an integral part of manufacturing, production, or extraction or of furnishing transportation, communications, electrical energy, gas, water, or sewage disposal services, or
(ii) constitutes a research or storage facility used in connection with any of the activities referred to in clause (i). * * *
* * * *
Such term includes only property with respect to which depreciation ([ILLEGIBLE WORD] amortization in lieu of depreciation) is allowable and having a useful life (determined as of the time such property is placed in service) of 4 years or more.↩
4. Sec. 1.48-1(d)(5). Research or storage facilities. If property (other than a building and its structural components) constitutes a research or storage facility and if it is used in connection with an activity specified in subparagraph (1) of this paragraph, such property may qualify as section 38↩ property even though it is not used as an integral part of such activity. Examples of research facilities include wind tunnels and test stands. Examples of storage facilities include oil and gas storage tanks and grain storage bins. Although a research or storage facility must be used in connection with, for example, a manufacturing process, the taxpayer-owner of such facility need not be engaged in the manufacturing process.
5. We note that the above example only allowed sec. 38 property treatment to 40 percent of the property's basis, as only that portion was property for which depreciation was allowable. In the instant case, depreciation was allowable on the entire cost of tank number 212. Also, since the entire tank was used in connection with storage for refineries, the entire tank is used in a qualifying activity. This is not a situation where only a specified physical portion of property qualifies for the credit. See Robert E. Catron, 50 T.C. 306">50 T.C. 306↩ (1968).