*1651 1. Loss due to abandonment of coke ovens held not substantiated.
2. Depreciated cost of coke ovens as at January 1, 1920, determined for invested capital purposes.
3. Cost of mining equipment necessary to maintain the normal output of a mine allowed as a deduction from gross income.
*369 This proceeding involves deficiencies in income and profits tax as determined by the Commissioner for 1920 and 1922 in the respective amounts of $5,025.07 and $861.19. Various errors were assigned in the original and amended petitions, but some of them were either withdrawn or abandoned, leaving for our determination only the following:
(1) Did the petitioner abandon in the year 1920 certain coke ovens acquired by it at date of organization in 1905?
*370 (2) If there was an abandonment of the aforementioned coke ovens in 1920, what is the amount of the loss for income-tax purposes arising therefrom, and what is the value includable in invested capital for 1920?
(3) Are the expenditures for equipment totaling $4,207.13 and $8,368.47*1652 proper deductions in the determination of taxable net income for the years 1920 and 1922, respectively?
FINDINGS OF FACT.
The petitioner is an Alabama corporation which was organized in 1905. It has its principal office at Tracy City, Tenn., where it is engaged in the coal-mining business.
On or about May 1, 1905, the petitioner acquired a coal-mining property theretofore operated by the Tennessee Coal, Iron and Railroad Company. Among the assets so received were certain beehive coke ovens which were acquired at a cost of $73,605. Additions during 1905 cost $73.97, making a total cost of the ovens of $73,678.97. Some of the ovens were built by the predecessor owner as early as 1883 and they were operated by such owner until 1903, when a strike occurred which kept them idle until 1905. Although acquired by petitioner in 1905, they were not operated again until 1917 when they were leased to the Sewance Fuel & Iron Company. At that time there was a great demand for coke, due to the World War. The aforementioned lessee was required, under the terms of its lease, to bear the expense of placing the ovens in operating condition. It operated them during 1917, 1918 and 1919, *1653 giving up its lease and ceasing operations during the latter part of 1919.
After the Sewanee Fuel & Iron Company gave up its lease, the petitioner operated the ovens in question during the greater part of 1920, though near the end of 1920 it found the operation unprofitable and then ceased operations. The ovens were not thereafter operated for profit, though in 1922, as an incident to negotiations for the sale of its mining properties, the petitioner operated them for a short time for the purpose of demonstrating whether its coal would make coke. The railroad leading to the ovens was spiked down in 1927 and the rails were taken up in March, 1930.
The ovens in question were of the "beehive" type, which was the type in general use in that section in 1905 and for some time subsequent thereto. Their walls were constructed of heavy sandstone and the linings were of brick. Except for the linings, which had to be replaced frequently, the physical life of the ovens could be made to last almost indefinitely with proper repairs, though under the terms by which petitioner obtained them, they would revert to the prior owner at the end of 50 years unless sooner removed from the premises.
*1654 In 1913 a new type of coke oven, known as the "by-product," was first constructed in the territory where petitioner operated, but *371 this new type was not a material factor in competition with the beehive oven until about 1917. Not only could the by-product oven produce about 15 per cent more coke from the same quantity of coal, but by 1920 there were no foundries in that district which used coke carrying as much ash and sulphur as was found in beenhive coke. By the present time, the by-product oven has almost entirely supplanted the beehive oven in the South, only one or two plants of the latter type now being in use in petitioner's immediate district.
The Commissioner, in his audit of petitioner's returns for all years prior to 1920, allowed depreciation on the ovens at the rate of 7 per cent from date of acquisition in 1905, thus resulting in their entire elimination from the capital account prior to 1920, and the allowance of no deduction for depreciation nor credit for profits-tax purposes on account thereof in 1920. The balance sheets which accompanied the returns for 1920 and 1922 showed the coke ovens as carried at a value of $18,000 and the unextinguished*1655 cost at January 1, 1920, was at least that amount.
In 1920 and 1922 petitioner was operating three separate coal mines, namely, Hampton, Nunley Ridge, and Palmer. The Hampton and Nunley Ridge had been in operation for many years prior to 1920, and by 1920 had passed their peak of production and their production was then on the decline. The Palmer was opened early in 1917 and reached its peak of production in 1920. It produced 280,000 tons in 1920, while the average for the following ten years was 275,000 tons. Its electrification was started late in 1919.
During the years 1920 and 1922 the petitioner made the following expenditures:
| 1920 | ||
| Date of | Amount | |
| acquisition | ||
| Mine rails, 12 lb. (Hampton) 1 | 10/ 8/20 | $2,016.84 |
| Boiler tubes | 10/25/20 | 115.00 |
| Car wheels | 10/22/20 | 44.65 |
| Mine rails (Palmer) | 12/ 4/20 | 1,529.72 |
| Pipe 1 1/4" (Palmer) | 10/27/20 | 140.20 |
| Tie siding 14,429 feet (Palmer) | 12/10/20 | 360.72 |
| Total | 4,207.13 | |
| 1922 | ||
| Electric locomotive (Palmer) | 10/10/22 | $4,012.00 |
| Insurance on locomotive (Palmer) | 10/10/22 | 10.03 |
| Pipe 2" (Palmer) | 10/18/22 | 384.45 |
| Pipe 2 1/2" (Palmer) | 10/18/22 | 241.91 |
| Pipe 3" and 4" (Palmer) | 1/ 4/22 | 909.75 |
| Mine rails and freight (Palmer) | 1,599.83 | |
| Portable air compressor | 1,210.50 | |
| Total | 8,368.47 |
*372 All of said foregoing expenditures (except boiler tubes) were necessary in order for petitioner to maintain, or try to maintain, its normal coal output, because of the increasing distances of the haul and the extended workings. As the work advanced in the mines, more rails were necessary over which to haul the coal; more mine cars were necessary because a car could not make so many trips; more pipe was necessary in order to carry the air forward for ventilation purposes and to operate the air drills; the tie siding was used in closing up old openings between entries and airways; the new electric locomotive purchased in 1922 was necessary because the three then in use could no longer haul all the coal produced farther back in the mine, that is, it was not used to replace existing equipment, but was an addition which was required to maintain normal production; and the portable air compressor furnished additional air pressure where needed in the extended workings. None of said expenditures reduced the cost of mining nor increased the value of the mines. The boiler tubes were a necessary repair to a donkey engine used in hauling*1657 coal. Petitioner incurred similar expenditures after 1920 and 1922 in an effort to maintain its normal output of coal as its workings advanced still farther.
The foregoing items were treated as capital expenditures by the petitioner on its books, though when capitalized it was the petitioner's understanding that such action was required by the Commissioner. Each of the items had a life of more than one year and none of them has been allowed as a deduction by the Commissioner.
The petitioner kept its books and rendered its returns on the accrual basis.
OPINION.
SEAWELL: The first error assigned is that, "In computing taxable net income for 1920, the Commissioner has erroneously disallowed a loss of $52,312.06 sustained by petitioner upon the abandonment of its coke ovens in that year." We are unable to agree that the facts presented justify the deduction. The ovens in question were originally constructed in and about 1883 and were operated by the predecessor owner until 1903, when a strike occurred which kept them idle until acquisition by the petitioner in 1905. They were likewise not operated from date of acquisition by petitioner until 1917, when, apparently due to*1658 the great demand for coke, the petitioner leased them to the Sewanee Fuel & Iron Company, which operated them during 1917, 1918 and 1919, discontinuing operations in the latter part of 1919. The petitioner then attempted operations in 1920, but before the end of the year found it unprofitable and ceased operations. They were not thereafter operated except for a short period in 1922 when, as an incident to a proposed sale of petitioner's properties, they were fired for the purpose of demonstrating that petitioner's coal would *373 produce coke. In the meantime, in 1913, a new type oven, known as the "by-product," came into existence, which, because of certain advantageous features, made it very difficult by 1920 for the "beehive" oven (type here in question) to operate in competition therewith, and by 1931 had almost entirely superseded the latter type. The railroad leading to the ovens was spiked down in 1927 and taken up in 1930.
On the foregoing facts we are unable to agree that abandonment of the ovens in 1920 has been substantiated. Aside from the facts set out in our findings, further testimony was offered by petitioner's president as follows:
Q. Did you reach*1659 any determination as to these coke ovens at the end of 1920?
A. We reached the conclusion we could not operate them at a profit and therefore decided to abandon them.
Q. And did you let the fires go out and abandon them? A. We did.When the same witness was asked why the petitioner had not operated the ovens prior to 1920, he replied that "we never thought we could operate those ovens at a profit." Of course, a different situation existed in 1905 from that in 1920 due to the perfection of a new type of coke oven, but the mere fact that the ovens were found unprofitable and therefore were withdrawn from operation is not conclusive that they were not held with the intention of future use, should a favorable occasion arise. We have no evidence of corporate action tending to show abandonment other than shown above; in fact, in the balance sheets accompanying the returns for 1920 and 1922 the ovens are still carried as an asset at a value of $18,000, and apparently no deduction was claimed in the 1920 return on account of such abandonment. The first overt acts tending to show physical abandonment occurred in 1927 when the railroad leading to the ovens was spiked down and*1660 in 1930 when the rails were removed, and as late as 1922 they were still in an operating condition.
On the whole, we are not satisfied that abandonment has been shown in 1920, but even if so shown, we could not allow the loss claimed, for the reason that we have no evidence as to their value on March 1, 1913. At that time they had been idle for ten years when the petitioner was of the opinion that they could not be profitably operated. In its return for 1914 the petitioner offered the following explanation for a depreciation rate of 10 per cent claimed on "Coke Ovens & Equipment": "Equipment rotted and ovens not in use." Further, it was in 1913 that the "by-product" oven which was later to replace the "beehive" oven made its appearance. Under such circumstances, we certainly are not justified in accepting cost in 1905, even after allowing for depreciation to March 1, 1913, as the same as fair market value at March 1, 1913. It is our understanding that the loss allowable, if any, under the circumstances here presented, would be based on the lesser of two amounts, namely, cost or *374 fair market value on March 1, 1913, after proper allowance for depreciation. *1661 , and . Since we have no evidence as to the March 1, 1913, value, we are in no position to sustain the claim for deductible loss.
In the next place, it is contended by the petitioner that the Commissioner has erroneously understated invested capital in the amount of $52,312.06, representing the depreciated cost of coke ovens on December 31, 1919. The facts which give rise to this issue are that in the adjustment of the returns prior to 1920 the Commissioner determined a rate of depreciation on the coke ovens of 7 per cent, that is, an approximate life of 14 years, and since the ovens were acquired in 1905, they were considered as fully depreciated by the beginning of 1920, and therefore no credit was allowed on account thereof in determining invested capital for 1920. The contention of the petitioner is that the rate used by the Commissioner is excessive and in lieu thereof a rate of 2 per cent should be used. In support of this position, testimony was offered to the effect that, aside from the linings, the ovens would last almost indefinitely with proper repairs, *1662 but that under the terms by which petitioner obtained them they would revert to the predecessor owner at the end of 50 years unless sooner removed from the premises, and therefore a rate of 2 per cent is proper. When a rate of 2 per cent is used the residual value shown in the error assigned remains.
We, however, are not convinced that the facts presented substantiate the petitioner's contention. The statement that a given asset can be made to last indefinitely with proper repairs means little without a full showing as to what repairs were made and how they were taken care of. Apparently, the total cost of some $73,000 in 1905 included oven linings and we are shown nothing as to whether they were ever replaced or repaired other than that they constituted about the only item which would ordinarily need repair. It was further shown that when the ovens were leased to the Sewanee Fuel & Iron Company in 1917, after they had been idle for 14 years, the lessee was required to bear the cost of placing them in an operating condition, but what repairs were necessary or were made is not shown. Some contradiction appears in the testimony as to depreciation suffered while ovens are not*1663 in use. The petitioner's president testified that when not in use and without any repairs or upkeep the weather would have no effect on the ovens and that brush and small trees would not grow in the walls and cause them to separate. The testimony of the Commissioner's witness was to the contrary and this was further substantiated by his statement of what had occurred in the case of these ovens after they had been idle from 1920 to 1931. We think the latter view more reasonable.
*375 The evidence is also confusing and unsatisfactory as to the depreciation previously claimed by the petitioner. Its treasurer, who testified that he was familiar with its books and records and the various issues which had arisen with the Department since 1912, was unable to furnish, on cross-examination, any information as to the depreciation claimed prior to 1920 or the value at which the ovens were carried on the books at the beginning of 1920, though on direct examination he was able to state that 7 per cent was used by the Commissioner for all years prior to 1920 and that his action resulted in the entire elimination of the ovens from the capital account for invested capital purposes. The*1664 petitioner further insists that the returns which were submitted in evidence from 1914 to 1920 do not show an attitude inconsistent with their present position. We are not convinced that this is true. As heretofore stated in connection with another issue, the return for 1914 shows a rate of 10 per cent claimed on "Coke Ovens & Equipment," with the explanation, "Equipment rotted and ovens not in use." The petitioner insists that since both ovens and equipment were included, it does not show anything as to depreciation claimed on ovens alone, though the amount claimed, $8,000, is well in excess of 10 per cent of the agreed cost of ovens of some $73,000. In a letter written to the Collector of Internal Revenue at Nashville, Tenn., in 1914, the petitioner's president stated that it (petitioner) had more than 300 coke ovens "which had been lying idle for several years and for this reason they are depreciating even more than we have been taking credit for." Of course, we do not know what depreciation was theretofore being taken, but such a statement is hardly consistent with his present testimony to the effect that the elements have no effect on idle coke ovens and that their life is*1665 almost indefinite. Other reasons for our conclusion could be given, though we regard it sufficient to say that on the whole record as presented we are not convinced that the rate of 2 per cent claimed by the petitioner is substantiated.
On the other hand, we are of the opinion that the Commissioner was not justified in the entire elimination of the coke ovens from the asset account as at the end of 1919. While we know little of their condition prior to 1917, we do know that in 1917 they were leased to a company which placed them in operating condition and continued to operate them until the latter part of 1919. The petitioner itself operated them during 1920 and they were still in an operating condition as late as 1922. The first dismantling acts connected with the ovens seem to have occurred in 1927 and 1930. Obsolescence was, of course, an important factor by 1920, due to the perfection of an improved type of oven, but the old type was still being used by one or two operators in petitioner's district as late as 1931 and we are not convinced that petitioner's ovens were obsolete in 1920. They were *376 shown in the balance sheet which accompanied the return for 1919*1666 at a value of $18,000 as of December 31, 1919, and we are of the opinion that cost of at least that amount remained unextinguished at that date and that accordingly that amount should be allowed in determining invested capital for 1920.
The final issue relates to the deductibility of the expenditures for mine equipment set out in our findings. We are unable to distinguish the character of these items from those involved in , wherein deductions on account thereof were allowed, and accordingly the petitioner's contention on this point is sustained.
Judgment will be entered under Rule 50.
Footnotes
1. Name indicates mine in which used. ↩