Texas--Empire Pipe Line Co. v. Commissioner

The Texas-Empire Pipe Line Co., Petitioner, v. Commissioner of Internal Revenue, Respondent

Texas--Empire Pipe Line Co. v. Commissioner

Docket No. 5781

United States Tax Court

10 T.C. 140; 1948 U.S. Tax Ct. LEXIS 284;

January 23, 1948, Promulgated

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Decision will be entered under Rule 50.

In 1932 petitioner received the assets of its subsidiary upon the latter's liquidation. In proceedings before the Board of Tax Appeals the value of those assets was determined. See 42 B. T. A. 368; 127 Fed. (2d) 220; 141 Fed. (2d) 326. In decisions entered under Rule 50 in those proceedings, depreciation was allowed to petitioner on the basis of the values therein determined. Held, "going concern value" was not a separate intangible asset of petitioner's subsidiary, separately valued as such in the former proceedings, but was a criterion of value used in valuing the depreciable assets of the subsidiary; held, further, petitioner's basis for depreciation as to assets in question is res judicata by reason of decisions in former proceedings.

B. H. Bartholow, Esq., for the petitioner.

Allan T. Aiken, Esq., for the respondent.

Kern, Judge. Van Fossan, J., concurs only in the result.

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KERN

Respondent determined a deficiency in petitioner's income tax for the year 1942 in the sum of $ 57,834.24. That part of the deficiency which is here in issue results from respondent's determination that, of the deduction claimed by petitioner for depreciation in the sum of $ 919,272.54, the amount of $ 144,585.59 was excessive and should be disallowed.

The case was submitted on the pleadings and on documentary evidence introduced at the hearing herein consisting of certain parts of the record in the case of Texas-Empire Pipe Line Co. v. Commissioner of Internal Revenue, bearing Docket No. 78604 of the United States Board of Tax Appeals, and petitioner's income tax return for the year 1942. It was also stipulated by the parties "that the Court may take judicial notice of the full record and other testimony, oral or documentary, which was produced in connection with the 1932 case * * * including the pleadings." The words "the 1932 case" referred to the proceeding before the United States Board of Tax Appeals hereinabove referred to.

The evidentiary facts are not in dispute.

FINDINGS OF FACT.

We incorporate herein by reference all of the exhibits introduced in evidence herein, and the full record, including the pleadings and testimony, in the proceeding entitled "The Texas-Empire Pipe Line Co. v. Commissioner of Internal Revenue," bearing Docket No. 78604 of the United States Board of Tax Appeals.

Petitioner is a corporation organized under the laws of the State of Delaware, with its principal office at Tulsa, Oklahoma. Its Federal income and excess profits tax returns for the year 1942 were filed with the collector of internal revenue at Oklahoma City, Oklahoma.

Prior to December 1, 1932, petitioner owned all the stock in an Illinois corporation of the same name (hereinafter referred to as the subsidiary). The subsidiary owned a pipe line system, including pumping stations, communication systems, and general equipment in the States of Illinois and Indiana.

During the period of its existence the subsidiary had net income as reflected in its books as follows:

1929	$ 86,047.42
1930	1,544,921.28
1931	2,624,460.17
Jan. 1 to Nov. 30, 1932	2,048,049.79

The balance sheet of the subsidiary as of November 1932 is as follows:

Assets	Liabilities
Plant account	$ 6,921,332.11	Accrued general taxes	$ 47,041.70
Supplies	29,790.69	Accrued Federal income tax	359,541.33
Organization expense	5,804.15	Due parent company	4,701,705.44
Prepaid items	1,362.55	Capital stock	1,000,000.00
Accrued pipage	55,469.56	Depreciation reserve	899,666.44
		Surplus	5,804.15
Total	7,013,759.06
		Total	7,013,759.06

On December 1, 1932, the subsidiary conveyed to the petitioner all of its property and in return therefor the petitioner canceled the subsidiary's indebtedness to the petitioner in the amount of $ 4,701,705.44, assumed all the other liabilities of the subsidiary in the amount of $ 406,583.03, and surrendered to the subsidiary for cancellation all of the stock of the subsidiary, which had a cost of $ 1,000,000 in the hands of the petitioner.

In its income tax return filed for the year 1932 petitioner reported net income of $ 3,951,684.13. Upon audit the Commissioner increased the net income by $ 9,339,368.34, consisting of adjustments to income and disallowance of deductions as follows:

(a) Excessive depreciation	$ 12,928.56
(b) General property tax	47,179.73
(c) State income taxes	3,692.98
(d) Profit on liquidation	9,272,017.55
(e) Retirement loss disallowed	3,549.51
Total	9,339,368.34

and mailed a notice of deficiency to petitioner dated November 28, 1934.

The Commissioner had computed the profit on liquidation as follows:

Assets received:
	Plant account at cost		$ 6,921,332.11
	Material and supplies at cost		29,790.69
	Accrued pipeage and prepaid items at cost		56,832.11
	Value of intangibles		8,959,445.05
	Dividend received 11/30/32		312,572.50
	Total assets received		16,279,972.46
Less:
	Liabilities assumed	$ 406,583.03
	Depreciation reserve	899,666.44
	Advances to subsidiary	4,701,705.44
	Cost of capital stock	1,000,000.00
			$ 7,007,954.91
	Net profit on liquidation		9,272,017.55

The petitioner filed an appeal to the Board of Tax Appeals from the determination made in the aforementioned deficiency letter, which appeal was assigned Docket No. 78604. The petitioner assigned errors as follows:

4. The determination of tax set forth in the said notice of deficiency is based upon the following errors:

First Assignment of Error

The respondent has erred in determining that the liquidation of The Texas-Empire Pipe Line Company, a corporation of the State of Illinois, resulted in the receipt by the petitioner of taxable income.

Second Assignment of Error

The respondent has erred in failing to determine that the liquidation of The Texas-Empire Pipe Line Company, a corporation of the State of Illinois, resulted in a deductible loss to the petitioner.

In the answer to the petition it was denied "that the respondent erred as alleged in paragraph 4 of the petition."

Docket No. 78604 was tried at Tulsa, Oklahoma, on April 19, 1939. The facts were stipulated, except the ultimate fact of fair market value, upon which both parties introduced expert testimony.

It was stipulated that:

The total undepreciated cost of the pipe line system, including the pumping stations, tankage, communication system and general equipment, owned by the subsidiary on December 1, 1932, was $ 6,921,332.11; the depreciated cost on said date was $ 6,021,665.67; the estimated replacement cost on said date, without diminution for depreciation, was $ 5,910,000.00, and the estimated replacement cost on said date, diminished by depreciation at rates allowed for income tax purposes, was $ 5,100,000.00. Neither the original cost nor the estimated cost of replacement on December 1, 1932, with and without diminution for depreciation, includes any general overhead charges such as fees for engineering and interest during the period of construction.

The Interstate Commerce Commission fixed the value of the subsidiary's property for rate making purposes as of December 31, 1934, at $ 5,946,606.63.

Two expert witnesses testified at the trial of Docket No. 78604 as to the fair market value of the assets received by petitioner from its subsidiary, one expert testifying to a value of $ 12,300,000. The other, Albert D. Brokaw, using the average earnings of the subsidiary for 1931 and 1932, applied Hoskold's formula on a 20-year basis, with the factor for compound discount at 10 per cent, sinking fund accumulations at 3 per cent, interest on 20 years of income at the same level as maintained in 1931 and 1932, arrived at a value of $ 11,100,000 as the fair market value of the assets of the subsidiary as a going concern on December 31, 1932.

In its opinion in Docket No. 78604, promulgated July 19, 1940, the Board of Tax Appeals stated the issue which was tried to be as follows:

* * * The essential question of the case, since the cost of the subsidiary's assets is stipulated, is the fair market value of the assets on distribution to petitioner. * * *

* * * *

The whole question narrows down, therefore, to whether reproduction cost or going concern value is the proper method of determining the value of the subsidiary's assets on the basic date. * * *

The Board of Tax Appeals found as an ultimate fact that the assets of petitioner's subsidiary had a fair market value of $ 11,100,000 on their distribution in liquidation to the petitioner and stated that the decision would be rendered under Rule 50.

On August 20, 1940, respondent filed with the Board of Tax Appeals a computation under Rule 50 as follows:

Fair Market Value of Assets Received in Distribution	$ 11,100,000.00
Liquidating Dividend 11/30/32		312,572.50
Total Receipts		11,412,572.50
Less:
Liabilities Assumed	$ 406,583.03
Advances to Subsidiary	4,701,705.44
Cost of Capital Stock	1,000,000.00
		6,103,228.47
Net Profit on Liquidation		5,304,284.03

and determined a deficiency in income tax of $ 729,339.06.

On October 18, 1940, petitioner filed objections to respondent's computation and alternative computation as follows:

ADJUSTMENTS TO NET INCOME
Net income as shown by deficiency notice dated November 28,
1934			$ 13,291,052.47
Deduct:
(1) Decrease in profit in liquidation of
	Illinois subsidiary	$ 3,967,733.52
(2) Depreciation allowance on additional
	value found by the Board with respect
	to assets received upon liquidation of
	Illinois subsidiary which additional
	value constituted additional cost of
	such assets to the petitioner	20,798.79
			3,988,532.31
			9,302,520.16

EXPLANATION OF ADJUSTMENTS

(1) Pursuant to the report of the Board, the net profit on liquidation of the Illinois subsidiary has been decreased from $ 9,272,017.55 claimed in the deficiency notice to $ 5,304,284.03 as determined by the Board, or a net decrease of $ 3,967,733.52. The net profit on liquidation as determined by the Board is computed as shown in column I below, which when expanded to cover the various classes of assets received upon liquidation, as established by the deficiency notice and the record, is as shown in column II below:

		Column I	Column II
Fair market value of assets
received on liquidation	$ 11,100,000.00
Made up of:
	(a) net plant account		$ 11,013,377.20
	(b) material and supplies		29,790.69
	(c) accrued pipeage, etc		56,832.11
	Liquidating dividend 11/30/32	312,572.50	312,572.50
	Total received	11,412,572.50	11,412,572.50
Less:	Column I	Column II
	Liabilities assumed	$ 406,583.03	$ 406,583.03
	Advances to subsidiary	4,701,705.44	4,701,705.44
	Cost of Capital stock	1,000,000.00	1,000,000.00
		6,108,288.47	6,108,288.47
Net profit on liquidation	5,304,284.03	5,304,284.03

and determined a deficiency of $ 726,479.22.

On November 18, 1940, the Board of Tax Appeals rendered a decision in Docket No. 78604 as follows:

Pursuant to the Findings of Fact and Opinion promulgated in the above entitled proceeding on July 19, 1940, counsel for respondent filed, on August 20, 1940, a computation of petitioner's tax liability. On October 18, 1940, petitioner filed "Objection to respondent's computation and alternative computation." Hearing under Rule 50 was held on November 13, 1940. After due consideration of the record, it is

Ordered and Decided: That there is a deficiency in petitioner's income tax for the calendar year 1932 in the sum of $ 726,479.22.

The petitioner appealed the decision of the Board of Tax Appeals to the United States Circuit Court of Appeals for the Tenth Circuit. No cross appeal was filed by the respondent.

The Circuit Court of Appeals for the Tenth Circuit rendered an opinion on the appeal in Docket No. 78604 on March 23, 1942, reported at . In that opinion the Circuit Court pointed out that:

We are of the opinion that in the instant case, fair market value should have been arrived at upon the consideration of all available criteria, rather than solely upon the criterion of the 1931 and 1932 earnings projected over the economic life of the pipe line.

and remanded the case, "with instructions to redetermine the fair market value in accordance with the views * * * expressed" in the opinion (.

On September 25, 1942, the United States Board of Tax Appeals promulgated in Docket No. 78604 a supplemental findings of fact and opinion, in which it said:

In conformity with the instructions contained in the mandate of the Circuit Court of Appeals, we have studied conscientiously the views of the majority opinion and have re-examined the evidence in the record herein which is pertinent to the question remanded to us for decision.

After a careful study of such evidence in the light of the views expressed in the majority opinion of the Circuit Court of Appeals for the Tenth Circuit, and only for the purpose of complying with the mandate of that Court, we find the fair market value of the assets of the Texas-Empire Pipe Line Co. of Illinois on the date of its distribution and liquidation to the petitioner herein was the sum of $ 9,000,000.

In all other respects we ratify and confirm the Findings of Fact made by us herein under date of July 19, 1940.

On November 24, 1942, respondent filed a computation under Rule 50, determining a deficiency of $ 440,589.06, and decreased the profit shown on the deficiency letter by $ 6,067,733.52, with the following explanation of adjustments:

Schedule 1
Adjustments to Net Income
Net income as disclosed by deficiency letter dated November
28, 1934		$ 13,291,052.47
As corrected		7,223,318.95
Net adjustment as computed below		6,067,733.52
Nontaxable income and additional deductions:
	(a) Decrease in profit on liquidation of
	subsidiary	$ 6,067,733.52
Net adjustment as above		6,067,733.52

Explanation of Item

(a) In accordance with the decision of the United States Board of Tax Appeals promulgated July 19, 1940, the net profit on liquidation of The Texas-Empire Pipe Line Company of Illinois, has been decreased from $ 9,272,017.55 as shown in the deficiency notice to $ 5,304,284.03 as determined by the Board, or a net decrease of $ 3,967,733.52, computed as follows:

Fair market value of assets received in
distribution		$ 11,100,000.00
Liquidating dividend November 30, 1932	312,572.50
Total received		11,412,572.50
Less:
	Liabilities assumed	$ 406,583.03
	Advances to subsidiary	4,701,705.44
	Cost of Capital stock	1,000,000.00
			$ 6,108,288.47
Net profit on liquidation		5,304,284.03
Net profit shown by deficiency notice	9,272,017.55
Decrease in profit			$ 3,967,733.52
Inasmuch as the Board, in its Supplemental Findings of Fact and
Opinion, has decreased the fair market value of the assets
from $ 11,100,000.00 to $ 9,000,000.00, net income is,
therefore, decreased by the difference, or a net decrease of	2,100,000.00
Total decrease in profit			6,067,733.52

On January 1, 1943, petitioner filed objection to respondent's computation and alternative computation showing a deficiency of $ 438,932.35. The alternative computation showed net income $ 7,211,270.15, arrived at as follows:

ADJUSTMENTS TO NET INCOME
Net income as shown by deficiency notice dated November
28, 1934		$ 13,291,052.47
Deduct:
	(1) Decrease in profit on liquidation
	of Illinois subsidiary	$ 6,067,733.52
	(2) Depreciation allowance on
	additional value found by the Board
	with respect to assets received
	upon liquidation of Illinois
	subsidiary, which additional value
	constituted additional cost of such
	assets to the petitioner	12,048.80
			6,079,782.32
			7,211,270.15

Hearing was held on the difference between the computations on January 6, 1943, subsequent to which briefs were filed by the respective parties upon the depreciation question as to which the parties were in disagreement and which caused the difference between their computations. On May 1, 1943, the Tax Court of the United States (formerly the United States Board of Tax Appeals) rendered its decision in Docket No. 78604, pursuant to supplemental findings of fact and opinion, as follows:

Pursuant to mandate of the United States Circuit Court of Appeals, Tenth Circuit, and Supplemental Findings of Fact and Opinion of The Tax Court of the United States, entered in the above entitled proceeding on September 25, 1942, counsel for the parties filed computations of petitioner's tax liability on November 25, 1942 and January 1, 1943, respectively. Hearing under Rule 50 was held on January 6, 1943 and briefs were filed by counsel on February 4, and February 15, 1943, respectively. Upon due consideration of the record and briefs, it is

Ordered and Decided: That there is a deficiency in petitioner's income tax for the calendar year 1932 in the amount of $ 438,932.35.

The petitioner appealed the decision rendered by the Tax Court in Docket No. 78604 to the United States Circuit Court of Appeals for the Tenth Circuit. No cross appeal was filed by the respondent.

The United States Circuit Court of Appeals for the Tenth Circuit rendered an opinion on March 2, 1944, sustaining the decision of the Tax Court, . No certiorari was applied for.

In its income and excess profits tax returns filed for the year 1942 petitioner claimed depreciation on its physical assets having a basis of $ 23,925,824.86 in an amount of $ 774,686.95. Included in the depreciation base was an amount of $ 6,021,665.67, representing the cost less depreciation value of the physical assets acquired from its subsidiary in 1932. The petitioner claimed additional depreciation of $ 144,585.59 as being 12/240 of $ 2,891,711.55, as "additional cost not booked" as shown by the following schedule.

SUMMARY OF DEPRECIATION DEDUCTION
Depreciation in "Claimed" column above		$ 774,686.95
Depreciation on additional cost with respect to assets received
by Taxpayer upon liquidation of a subsidiary, The
Texas-Empire Pipe Line Company of Illinois, in 1932
Value of Assets received on liquidation as
determined by U. S. Board of Tax Appeals	$ 9,000,000.00
Less:
Material and Supplies	$ 29,790.69
Accrued Pipeage	56,832.11
		86,622.80
Value of Plant Account		8,913,377.20
Cost of Plant as carried on books		6,021,665.67
Additional Cost not booked		2,891,711.53
Depreciation for year 12/240ths			144,585.59
Total Depreciation allowable			919,272.54

In the notice of deficiency the Commissioner disallowed $ 144,585.59 of the depreciation claimed on the return, with the following explanation:

(a) Deduction for depreciation as claimed in your return has been determined to be excessive and has been adjusted as shown below:

Depreciation claimed in your return	$ 919,272.54
Depreciation allowable as per Exhibit "A"	774,686.95
Excessive deduction for depreciation denied	144,585.59

By amendments to the answer Commissioner has alleged that the basis of the physical assets acquired from the subsidiary for the purpose of computing allowable depreciation is the replacement cost of the pipe line system, including pumping stations, tankage, communication system, and general equipment owned by the subsidiary on December 1, 1932, and transferred in liquidation to the petitioner on that date, diminished by depreciation at rates allowed for income tax purposes, of $ 5,100,000, and that the allowable depreciation to petitioner for the year 1942 is $ 742,058.23.

The Illinois and Indiana section of the pipe line system was part of the assets used in the petitioner's trade and business during the calendar year 1942. The estimated economic life of the Illinois and Indiana section of the pipe line system was 20 years from December 1, 1932.

The cost to the petitioner of the depreciable assets received on December 1, 1932, upon the liquidation of the Illinois subsidiary was $ 8,913,377.20.

The petitioner is entitled to a depreciation deduction for 1942 in respect of $ 2,891,711.53 (the excess of the value of the assets received by the petitioner on December 1, 1932, upon the liquidation of the Illinois subsidiary over the depreciated cost of such assets on that date to the Illinois subsidiary) computed at the rate of 5 per cent per annum, in addition to the deduction for depreciation which the respondent has allowed to the petitioner in respect of the remainder of the cost of the assets.

Such deduction for depreciation to which the petitioner is entitled for 1942 is in the amount of $ 144,585.59.

OPINION.

Petitioner first contends that the issue presented by the instant proceeding was twice decided by this tribunal in decisions entered after hearings under Rule 50 in the proceeding entitled "The Texas-Empire Pipe Line Co. v. Commissioner of Internal Revenue," and bearing Docket No. 78604 of the United States Board of Tax Appeals, and, therefore, by reason of the doctrine of res judicata, we are foreclosed from reaching a contrary decision in the instant case. Since we agree with petitioner that this issue was in the former case for decision under Rule 50 proceedings therein, and since we are of the opinion that this issue was decided by our decisions entered in the former case from which no appeal was taken by respondent, we can decide the instant case under the rule of res judicata. See ; .

However, even if we are in error in considering this question res judicata, we would reach the same result if we were to decide the instant case on its merits, without relying upon the principle of res judicata.

In view of the importance of the question, both to the taxpayer and to the fisc, and of the several times when the question has entered into the field of litigation, we think it proper that our opinion upon the question be stated explicitly rather than remain a matter of inference.

The substance of the question on the merits appears from a statement of the arguments of the parties. Respondent, in effect, contends that among the assets valued by us in the former proceeding were intangible "good will" or "going concern value"; that depreciation on these items is not an allowable deduction; and that the value of the depreciable tangible assets acquired by petitioner from its subsidiary was not more than $ 5,100,000 (the subsidiary's replacement cost less depreciation as of December 1, 1932). The petitioner, on the other hand, contends that there was no separate valuation of tangible and intangible assets and, even if there had been, the intangible assets would be depreciable.

In the former case, before the United States Board of Tax Appeals, we were called upon to value certain assets transferred to petitioner by its subsidiary upon the latter's liquidation. The balance sheet of the subsidiary showed no separate intangible asset such as good will carried thereon or transferred to petitioner. In the trial of the earlier case the respondent urged that the assets transfered by its subsidiary to petitioner had a going concern value and therefore should be valued at a figure in excess of the original cost or reproduction cost of the assets in question. We agreed with respondent's contention and valued the assets distributed to petitioner by its subsidiary at $ 11,100,000. . Our decision, in so far as it related to the valuation question, was reversed by the Circuit Court of Appeals for the Tenth Circuit in , because in the opinion of the majority of that Court, we had relied solely upon the criterion of going concern value in determining the valuation of the assets transferred to petitioner and had ignored other criteria of value, such as reproduction cost. In conformity with the mandate of the Circuit Court, we again valued the assets transferred to petitioner, and in doing so we conscientiously considered and gave weight to the best of our ability to the various criteria of value mentioned in the majority opinion of that court. The figure thus reached by us in our supplemental findings of fact and opinion (set out above in our findings herein) was $ 9,000,000. Upon appeal, this decision was affirmed.

A recitation of the proceedings in the former case indicates that the lot of a trial court called upon to find fair market value is not a happy one. See, also, .

It is apparent that the process of valuation calls for the use of various criteria. To use one criterion to the exclusion of others, or to ascribe too much weight to one criterion may constitute reversible error.

The criterion of value which we used in our original opinion in the former case, and one of the criteria which we used in our supplemental opinion, was going concern value. But it must be emphasized that going concern value was a criterion or standard or guide in the process of valuation and was not a separate intangible asset of petitioner's subsidiary which was the object of the valuation. See ; . We did not fix a value for the physical tangible assets in a certain amount, and fix a value for an intangible asset in another amount, and then add the two together with a result of $ 11,100,000 or $ 9,000,000. We valued the assets transferred by the subsidiary to petitioner, consisting almost entirely of an item entitled "plant account" and not including any item separately representing good will. In reaching this value we used several criteria of value, including the criterion of going concern value, and were finally affirmed by the Circuit Court of Appeals at 141 Fed. (2d) 326.

The assets here involved were acquired by petitioner upon a taxable liquidation or exchange, and their fair market value as of the date of liquidation represents petitioner's cost as to these items, and consequently constitutes petitioner's basis for depreciation purposes. See . We have already found that a deduction on account of depreciation calculated at the rate of 5 per cent per annum is reasonable.

We reaffirm explicitly what in our opinion we have already decided by necessary implication, i. e., that the fair market value as of December 1, 1932, and consequently the cost and basis for depreciation to petitioner with regard to the depreciable assets acquired by petitioner from its subsidiary upon the latter's liquidation, was the sum of $ 8,913,377.20.

Upon the issue presented we decide in favor of petitioner.

Decision will be entered under Rule 50.