*1034 1. Upon the evidence, held, that petitioner was the owner of and abandoned certain machinery and equipment in 1920 and is therefore entitled to deduction in the amount stipulated on account thereof.
2. Upon the evidence, held further, that petitioner is not entitled to take any deduction for depreciation in 1920.
*1184 This is a proceeding for the redetermination of a deficiency in income and profits taxes for the year 1920 in the amount of $25,398.32. Petitioner also makes claim for abatement in the sum of $29,647.71 and a claim for refund of $210,022.82, both for the year 1920, and also claims to be entitled to the benefit of special relief under section 328 of the Revenue Act of 1918 in determining its ultimate tax liability for 1920.
It is alleged in the petition that the respondent erred:
1. In refusing to allow petitioner to deduct depreciation from June 8, 1920, to December 31, 1920, on a paper mill, hereinafter referred to as Telulah Mill, from its gross income for the year 1920, the amount of*1035 depreciation claimed by petitioner being $47,175.43.
2. In refusing to allow petitioner to deduct from its gross income for 1920 a loss sustained on machinery and equipment located in said mill, which machinery and equipment taxpayer was obliged to scrap during the year 1920, the amount of such loss claimed by petitioner being $140,737.75.
3. In refusing to allow petitioner to deduct from its gross income for 1920 expenditures for repairs and maintenance charged to capital in error on said Telulah Mill, the amount of such repair and maintenance claimed by petitioner being $13,543.37.
*1185 4. In refusing to permit petitioner to deduct excessive cost of repairs and alterations in and about said Telulah Mill from its gross income for 1920, which excessive cost was due to abnormal conditions and amounted to $31,425.14.
5. In rejecting petitioner's claim in full for abatement in the sum of $29,647.71 for the year 1920.
6. In rejecting petitioner's claim in full for a refund of $210,022.82 for the year 1920.
On hearing the petition was amended to allege that the respondent erred in disallowing a deduction for income taxes due the State of Wisconsin for the*1036 year 1920 in the sum of $20,599.97. The respondent confessed error in this respect and admitted the allegation of fact in reference to such assignment of error.
The hearing in this proceeding was limited to the issues defined in paragraph (a) of Rule 62 of the Board's rules of practice, on motion of the respondent on the ground that in determining the asserted deficiency appealed from the respondent allowed petitioner's application for special assessment and computed the profits tax under section 328 of the Revenue Act of 1918, that the issues presented in the petition involve claims for large reductions in net income, and that in the event the Board should decide the issues or any of them in favor of the petitioner the resulting change in the factors properly to be considered would render necessary a further hearing under Rule 62 both as to the proper rate and the question of whether the petitioner would then be entitled to special assessment.
FINDINGS OF FACT.
The petitioner is a Wisconsin corporation, with its principal office and place of business in the city of Appleton, Wisconsin. It is and was during the year 1920, and for many years prior thereto, engaged in the*1037 manufacture of high-grade writing paper out of rags.
Through 1920 the petitioner was very much oversold, having orders substantially in excess of the capacity of its then mill. Conditions prevailing at that time justified and demanded an increase in facilities and after careful consideration it was concluded to purchase the so-called Telulah Mill.
The Telulah Mill was owned by the Kimberly-Clark Co., manufacturer of paper and paper specialties. It was situated across the river from the petitioner's plant at Appleton, approximately five minutes walk from and very convenient and accessible to petitioner's plant. It had been originally built as a rag mill but had been changed and was being used for the manufacture of paper from wood pulp. A mill originally built for a rag mill can be converted *1186 into a rag paper mill more easily than a mill built for making other grades of paper in which no rags are used.
Early in 1920 the petitioner, through W. C. Wing, its president, approached the Kimberly-Clark Co. in reference to the purchase of the Telulah Mill. The Kimberly-Clark Co. was, at first, reluctant to consider a sale of the property. It had contracts to fill*1038 in 1920 which required the utmost capacity of all its equipment, including the Telulah Mill, and it expected that business would continue at the same high rate for about two or three years longer. However, it had started the erection of a paper mill at Niagara Falls, New York, which it expected to operate early in January 1921. Operations in such new mill were commenced in February 1921. It had acquired timber and water power rights in northern Ontario in June 1920 and had also committed itself to the erection of a large pulp mill in northern Ontario, the building of which was started in August 1920. Thus, it was in a position, even if business continued at the high rate prevailing at that time, to consider the sale of the property for delivery on January 1, 1921. It was also reluctant to sell because of the profit possibilities during the remainder of 1920. Between June 8, 1920, and the end of the operations of the Telulah Mill by the Kimberly-Clark Co., it realized from such operations a profit of approximately $200,000. However, negotiations finally resulted in the execution of an agreement under date of June 8, 1920, by petitioner and the Kimberly-Clark Co. as follows:
*1039 MEMORANDUM OF AGREEMENT between Kimberly-Clark Company, a Wisconsin corporation of Neenah, Wisconsin, the Seller, and the Fox River Paper Company, a Wisconsin corporation of Appleton, Wisconsin, the Buyer, each acting pursuant to authority of its Board of Directors, as follows:
The Seller hereby agrees that it will sell and convey to the Buyer all its waterpower parcel of the West, or Grand Chute Island water power, at Appleton, Outagamie County, Wisconsin, with all its privileges and subject to all its obligations therewith connected, and all its land and mills on and parcel of Grand Chute Island in said Appleton, more particularly described as follows, for the sum of Nine Hundred Fifty Thousand Dollars ($950,000.00), payable as hereinafter stated.
The Buyer agees to buy the same for the said sum of Nine Hundred Fifty Thousand Dollars ($950,000.00), payable as follows:
Fifty Thousand Dollars ($50,000.00) in cash this day paid, payment acknowledged.
Three Hundred Thousand Dollars ($300,000.00) in cash, and One Hundred Thousand Dollars ($100,000.00) in the first mortgage bonds of the Kimberly-Clark Company on January 1, 1921; and
Five Hundred Thousand Dollars ($500,000.00) *1040 of principal in five (5) equal, annual payments of One Hundred Thousand Dollars ($100,000.00) each, on or before the first day of January 1922, 1923, 1924, 1925 and 1926, with interest on each of said Five (5) One Hundred Thousand Dollars ($100,000.00) payments at the rate of Six Per Cent (6%) per annum from January 1, 1921, interest payable semi-annually.
*1187 The Seller is to retain possession and use of said property until January 1, 1921, the Seller then to surrender possession and give land contract for the conveyance of said property, free and clear of all encumbrances, on payment of the then unpaid purchase money, according to the terms and conditions above stated. Seller will, on the completion of the payments above specified, make to the buyer a warranty deed of all said property with full covenants of title against encumbrances.
Notwithstanding the fact that the Seller retains general possession and use of said property until January 1, 1921, yet in the meantime Buyer shall have the right to make such improvements to such property as may be desirable for its purposes, and as may not interfere with full operation of the paper mill plant by the Seller.
The*1041 Seller will pay taxes of 1920; the buyer thereafter. * * *
It is understood that all tools and machinery in use in the operation of the mill property conveyed shall pass to and be the property of the Buyer.
The Buyer agrees to buy of the Seller all mill supplies such as felts, wires, dryer canvasses, transmission ropes, deckle straps and jackets on hand anywhere, bought for use of said mill and peculiarly fitted for it at the prices paid by the Seller.
All other materials and supplies shall be removed by Seller within ten (10) days of January 1, 1921, if then the Buyer shall have completed payments as agreed.
The Seller shall maintain the property in good operating condition and in as good condition as the same now is, until the first day of January, 1921, excepting ordinary wear and tear and decay.
The Seller agrees to maintain upon such property insurance in approved insurance companies until the 1st of January, 1921, to the amount of Fifty-seven Thousand Dollars ($57,000.00) of tornado insurance, and insurance against fire to the amount of Five Hundred Seventy-five Thousand Dollars ($575,000.00), loss, if any, payable to Seller and Buyer as their respective interests*1042 may appear. The Buyer agrees to maintain such insurance in such companies from the first day of January, 1921, until it shall have completed payment of the purchase price of said property, loss, if any, payable to the Buyer and Seller as their respective interest may appear.
IN WITNESS WHEREOF the said parties have caused these presents to be signed by the officers authorized thereto by their respective Boards of Directors, and to be sealed with their respective seals this 8th day of June, 1920.
* * *
This agreement was signed by F. J. Sensenbrenner, vice president of the Kimberly-Clark Co., W. C. Wing as president of the petitioner, and by the respective secretaries, and was witnessed and sealed with the respective corporate seals. On behalf of the Kimberly-Clark Co. the execution of such agreement was acknowledged by the signatory officers before a notary public on June 21, 1920.
Under date of June 9, 1920, the Kimberly-Clark Co., by S. F. Shattuck, made written announcement to its employees as follows:
* * *
Old associations are not easily broken.
The Telulah Mill has been sold to the Fox River Paper Co.
We want you to have this information first from us, *1043 - particularly those of you who have been with this Company and with the Telulah Mill for many years.
*1188 Although the mill is sold, the Kimberly-Clark Co. retains possession of the property until Jan. 1st, 1921, thus more than six months remain before a change in management takes place.
We are assured by the Fox River Paper Company that all present employees of the Telulah Mill who desire to remain with the mill under the new management may do so. This, we realize, is one of the questions which will be uppermost in your mind, and we would bespeak for the Fox River Paper Co. a continuance of the good will that has marked our relations for so many years.
You, as well as we, will have other questions which will call for conference together. The Officers of the Kimberly-Clark Company desire me to assure you that they will give such time as is necessary between now and Jan. 1, 1921, to the discussion with you of any matters of mutual concern.
* * *
S. F. Shattuck, who was a vice president and director of the Kimberly-Clark Co. and in charge of personnel, was delegated to prepare the above announcement. He was holder of 15 percent of the stock of the company, which*1044 represented one of the largest individual stockholdings, the largest being about 18 or 20 percent. He was kept informed of the progress of negotiations with respect to the sale of the Telulah Mill but did not personally attend any of the conferences relating thereto.
The petitioner under date of June 10, 1920, by William C. Wing, its president, made the following announcement to the employees of Kimberly-Clark Co.:
* * *
We are glad to join in the announcement enclosed herewith and to reaffirm that we will be pleased to welcome you into our family of employees on January 1st next, when we will assume the operation of Telulah Mill.
If any questions arise in your minds relative to your future relations with our Company, please feel free to discuss same with us at any time.
* * *
Under the petitioner's bookkeeping system, journal entries are covered by vouchers, which constitute the original entry. Under date of June 9, 1920, a voucher was prepared and passed upon personally and initialed by the president of petitioner and entered or recorded in its books of account. The voucher contained the following:
| To be entered in the month of June 9, 1920 | ||
| Telulah Real Estate & Water Power | 100,000.00 | |
| Telulah Mill Buildings | 200,000.00 | |
| Telulah Machinery, Tools & Equipment | 650,000.00 | |
| To Kimberly-Clark Co. (Telulah Mill) | 950,000.00 |
*1045 On June 22, 1920, the petitioner by its president, W. C. Wing, wrote a letter to Lloyd-Thomas Co., appraisers, the body of which is as follows:
We have just purchased a nearby Mill and would like to have an immediate appraisal made on the same.
Please advise us just what you would be able to do on this, and oblige.
*1189 The purpose of having an appraisal made was to inventory the Telulah Mill property. The appraisal company under date of July 8, 1920, acknowledged receipt of appraisal order and proceeded with the appraisal shortly thereafter.
Under date of July 3, 1920, F. J. Sensenbrenner, as first vice president of Kimberly-Clark Co., in behalf of that company wrote a letter to O'Keef Orbison Engineering Co., the body of which letter is as follows:
As you are aware our Telulah Mill property has been sold to the Fox River Paper Company.
The purchasers find it necessary to use that part of Lot 11 under lease to you very promptly. We beg to notify you, therefore, that we desire you to vacate said premises at the earliest possible moment, and not later than within the time provided for by the lease after notice.
Kindly advise by return mail about when you*1046 will be able to vacate. Any adjustment that may be necessary to make in the rental you have paid, will be promptly taken care of.
About the middle of December 1920, the petitioner learned that the Kimberly-Clark Co. had about completed its contracts and was going to cease operation of the Telulah Mill. Thereupon, under date of December 13, 1920, E. G. Timme, general superintendent of petitioner, wrote the Kimberly-Clark Co. as follows:
It is my understanding through a remark that your Mr. Kranhold made, that it is your intention to shut the Telulah mill down about December the 18th. Assuming that this is correct, would you give us permission to go ahead with our plans in the repairs and remodelling?
Kindly let us know at your earliest convenience so that we may plan accordingly. This information will be greatly appreciated.
In reply to this letter F. J. Sensenbrenner, first vice president of the Kimberly-Clark Co., addressed a letter to the petitioner under date of December 17, 1920, which is in part as follows:
* * *
In response to Mr. Timme's letter, we have written him today that our present plan contemplates the shutting down of the Telulah Mill either Sunday*1047 or early next week.
As soon as shut down, and, as a matter of accommodation to you, I wrote him we have no objection to your beginning repairs and remodeling over the entire mill except that we propose to keep the power plant in operation to the end of the month as well as the roll grinding outfit both for our account; that, until the end of the month, when we make formal delivery of the plant to you, we will maintain our watchman on the premises, and, in accordance with our conversation, we will remove all supplies and material, which we are to remove under the terms of the contract, between now and the 1st.
The letter addressed to E. G. Timme, referred to above, also dated December 17, 1920, and signed by F. J. Sensenbrenner, is in part, as follows:
* * *
*1190 We now plan to shut our Telulah Mill down Saturday night or Sunday morning and will probably not restart it during this month, this being done to give us ample time to clear the Mill of such material and supplies as we are obliged to remove.
Under the circumstances we will be very glad to permit you to go ahead with your plans in the repairs and remodelling except that we shall want to continue operation*1048 of the Power Plant, that is the Water Power Plant, for our own account the balance of the month, as well as the operation of the roll grinding outfit.
We will continue our watchman on the premises until the end of the month, or until we make formal delivery of the Mill to your Company.
In view of the above permission, we want to suggest to you that you kindly employ the men now working in the Telulah Mill in your repairing and remodelling work during the balance of this month to the fullest extent possible.
* * *
Under date of December 22, 1920, E. J. Timme, general superintendent of petitioner, wrote the following letter to the Kimberly-Clark Co.:
Thank you very much for the courtesy you have shown in turning the Telulah Mill over to us with the exception of the power and grinding equipment, and which, you may rest assured, is greatly appreciated.
Under date of December 24, 1920, petitioner's president addressed a letter to F. J. Sensenbrenner, of the Kimberly-Clark Co., as follows:
* * *
Will you please give us the amount of various kinds of insurance that you have carried on the Telulah, Mill property, so that we may prepare to cover this as of January first, *1049 in accordance with our contract with you.
* * *
The reply of Kimberly-Clark Co., by its secretary, to this letter under date of December 27, 1920, is in part as follows:
* * *
Your letter December 24th:
After our contract was made with you for the sale of the Telulah Mill, we increased our fire insurance and tornado insurance on that particular property from $575,000 to $895,000 in the first instance and from $57,000 to $307,000 in the second instance.
We did this because of the fact that having made a contract for the sale of the mill and having endorsed our policies for the interest of the Fox River Paper Company, as it might appear, we felt that both institutions, in the event of loss, would want to recover all of the equities that both had in the mill, and to do this would require greater insurance than we have carried heretofore.
It is not necessary, however, for you to carry greater insurance after January 1st than the amounts specified in the contract * * *.
On June 9, 1920, the petitioner paid the initial payment of $50,000 under the contract of June 8, 1920, by its check in that amount. No further payment was required under the contract until January 1, 1921. *1050 However, with the consent of the Kimberly-Clark Co., the *1191 petitioner made and completed payment of the installment payable January 1, 1921, as follows:
August 31, 1920, check in the amount of $98,000, representing payment of $100,000, less 4 months discount at 6% in the sum of $2,000.
Nov. 6, 1920, check in the amount of $99,100 representing payment of $100,000, less 54 days discount at 6% in the sum of $900.
Dec. 31, 1920, $100,000 par value Kimberly-Clark Company first mortgage bonds with interest coupons payable January 1, 1921, detached.
Two promissory notes of petitioner each in the sum of $50,000 both dated January 1, 1921, and payable 4 months after date with interest at 6% after date, which notes were taken in lieu of cash.
Pursuant to provision contained in the contract of June 8, 1920, the Kimberly-Clark Co. delivered a "land contract" to petitioner. This contract is dated January 3, 1921, but was signed on January 20, 1921, by F. J. Sensenbrenner as first vice president of the Kimberly-Clark Co. and W. C. Wing as president of the petitioner, and countersigned by the secretaries of the respective companies and acknowledged by F. J. Sensenbrenner, *1051 first vice president, and Harry Price, secretary of the Kimberly-Clark Co., on the same date. The delay in executing the contract was caused in part by counsel for Kimberly-Clark Co., who was investigating the records as to title. This contract reads in part as follows:
LAND CONTRACT by and between Kimberly-Clark Company a Wisconsin corporation of Neenah, Winnebago County, party of the first part, and Fox River Paper Company, a Wisconsin corporation of Appleton, Outagamie County, party of second part.
Party of first part, in consideration of a cash payment, which is hereby acknowledged, and a payment of the further sum of Five Hundred Thousand Dollars ($500,000.00), with interest, to be made by the party of second part, at the times as hereinafter specified, and in consideration of the promises of the party of second part to pay said sum, hereby agrees and binds itself, its successors and assigns that on the payment of the last instalment of said Five Hundred Thousand Dollars ($500,000.00), it will cause to be executed and delivered to the party of second part, its successors or assigns, a warranty deed of the land and water power hereinafter described, subject, however, to*1052 any liens, taxes or encumbrances accruing after this date.
* * *
The land and water power herein contracted to be conveyed is
* * *
All of Lot Eleven (11) of said plat, * * * and excepting that part of said Lot Eleven (11), if any, conveyed to Edward West to Blood & Barteau by deed recorded in said Registry in Volume 12 of Deeds on page 215, and excepting that part of said Lot Eleven (11), if any, conveyed by Edward West to Miller and Johnson by deed recorded in said Registry in Volume 51 of Deeds on page 140.
* * *
The thirty-seven and one-half per cent (37 1/2%) of said water power and the right to use the same is fully described in a contract * * * and which said agreement is hereby assigned by the party of the first part to the party *1192 of the second part, and the party of the second part hereby assumes all obligations resting on the party of the first part under said contract.
This contract is to include all the land and water power owned by the Kimberly-Clark Company, parcel of Grand Chute Island and the water power maintained by the midl [sic] or West, dam whether above specifically described or not.
And for the same consideration, party of the*1053 first part will, on completion of the payments hereunder, make deed of conveyance to party of the second part of all of Lot Eleven (11) Grand Chute Island Plat lying between Vulcan Street and the south channel of Fox River.
It is understood that the property herein contracted to be conveyed is subject to a mortgage made by party of the first part to Wisconsin Trust Company, Trustee, dated Jan. 5, 1907 * * *.
The contract of June 8, 1920, was not recorded. The second contract, executed January 20, 1921, was recorded September 14, 1921, because the purchaser of bonds, effective October 1, 1921, issued by the petitioner advised the recording of such contract.
Under date of February 5, 1926, the Kimberly-Clark Co. conveyed the property described in the two agreements by warranty deed, which was recorded on February 8, 1926. This deed contained the following provisions:
* * *
And for the same consideration, said Kimberly-Clark Company conveys and quit-claims to said Fox River Paper Company all of Lot Eleven (11) of Grand Chute Plat lying between Vulcan Street and the South Channel of the Fox River.
* * *
This conveyance is made pursuant to resolution of the Board of*1054 Directors of Kimberly-Clark Company and pursuant to and in fulfilment of a memorandum of agreement dated June 8, 1920, and a certain contract dated January 3, 1921, between the grantor and grantee herein, said last designated contract being recorded in the Register of Deeds Office of Outagamie County on the 14th of September, 1921, in Volume 184 on page 128.
After the execution of the contract of June 8, 1920, the attorney for the Kimberly-Clark Co. upon investigation found a record of certain transactions affecting the title to a part of lot 11, which was a narrow strip of land about five or six feet in width, lying between Vulcan Street and the river and was of small or nominal value. With the consent of the petitioner, changes with respect to the description of lot 11 as noted were made in the second agreement and the deed. In the deed that part of lot 11 lying between Vulcan Street and the river was quitclaimed and title thereto was not warranted. The defect in title to the above strip of land was deemed of little importance by both parties. Later petitioner acquired a tax title to such strip of land.
Prior to the execution of the contract of June 8, 1920, W. C. Wing, *1055 president of the petitioner, togeher with a paper mill engineer, made a casual inspection of the Telulah Mill while it was in operation. *1193 It was assumed by the petitioner that the mill, having been built originally as a rag mill, could be converted easily into a rag mill again by making some minor changes and by adding a rag room and a water-purtifying system or filtration plant.
The Telulah Mill contained, among other equipment, two large paper machines, electrical equipment, consisting of motors, generator and accompanying equipment, trimmers, feeders, and miscellaneous equipment. The petitioner expected and intended to use all the machinery and equipment in the mill property at the time the contract of June 8, 1920, was entered into.
The paper machines consist of the paper-making section, known as the wet end, or Fourdrinier part, and the paper drying section, known as the dry end. The stock in wet form enters at the wet end and is passed along wire to the dry end for drying. The petitioner had been informed that the paper machines had been recently entirely revamped and a great deal of money had been spent on them. It was assumed that they were complete and*1056 in good shape and could be utilized. However, during August 1920, it was discovered by petitioner's general superintendent (name not given), who had gone through the mill on a Sunday, that the wet end or Fourdrinier part of one of the paper machines was in bad shape, as the rolls and bearings were very much worn. In making paper, it is necessary that it be made of even thickness. Thus the wet end of such machine was entirely worthless for use by petitioner. On August 12, 1920, the petitioner ordered a new Fourdrinier part at a total cost of $30,000, delivery thereof to be made in March 1921. The other machine was satisfactory and was used.
It was also found after June 8, 1920, that the electrical equipment in the mill could not be used by petitioner, as it was 25-cycle equipment. The Kimberly-Clark Co. furnished its power to the mill from its own power plant. The petitioner had to, and did, purchase its power elsewhere. The 25-cycle equipment is not in general use. The Kimberly-Clark Co. was the only user of 25-cycle equipment in the locality and had no corporate power to sell electric power. At the time of the contract of June 8, 1920, petitioner did not have any knowledge*1057 of the peculiar nature of the electrical equipment, but assumed it to be 60-cycle equipment and expected to use it in the operation of the mill. It was necessary for the petitioner, in order to operate the mill, to purchase and install 60-cycle electrical equipment. It purchased such 60-cycle equipment in 1920.
Immediately following the execution of the contract of June 8, 1920, the petitioner made preparations to change and rebuild the mill property for its occupancy and operation, under the supervision of a firm of paper mill engineers. The petitioner was entitled to and *1194 did enter upon the property and made such changes as it desired after June 8, 1920, as provided for in the agreement of June 8, 1920. In July 1920, the petitioner employed an engineer to give full time to the rebuilding operations of the Telulah Mill and also the Fox River Mill. This engineer commenced work about August 1, 1920.
During 1920, a new large ironclad warehouse for storage purposes was built at the Telulah Mill at a cost of from $6,000 to $7,000. The Telulah Mill was painted on the outside during the summer of 1920 to correspond with the painting and color scheme applied on three*1058 other mills owned by petitioner. On August 30, 1920, it entered into a contract for the remodeling of "old Pulp Mill and Rotary Building," a part of the Telulah Mill property, into a new rag room at a cost of $41,000, the contract providing that it was to be completed "on or before December 1, 1920." The petitioner entered into a contract for the building of a filter plant, the specifications for the construction of which provided for the completion of the plant not "later than November 15th, 1920", at a cost of labor and materials as specified of $15,148.63. Equipment for this filtration plant was purchased and installed during 1920 at a cost of approximately $25,000. During 1920, cement floors and other cement work was done and drainers were cleaned and rebuilt. No objection was made by the Kimberly-Clark Co. with respect to the work done by petitioner upon the Telulah Mill property. All the above improvements were substantially completed in 1920. The total cost of improvements to the Telulah Mill buildings incurred in 1920 was $70,872.29. The total cost of new machinery, tools, and equipment incurred by petitioner in 1920 for the Telulah Mill was $68,371.65. The Kimberly-Clark*1059 Co. closed down the Telulah Mill on the Sunday following December 17, 1920, having operated both paper machines therein up to that time.
Immediately after the Kimberly-Clark Co. ceased operations and on or about December 22, 1920, petitioner entered the mill theretofore operated by Kimberly-Clark Co. and with the crew of a hundred or more men previously employed by Kimberly-Clark Co., and under the supervision of its own engineer, commenced the work of dismantling and removing machinery and equipment which it had determined it could not use and also of remodeling. The wet end of one of the paper machines heretofore mentioned was torn out, dismantled and sold for the brass in 1920. The electrical equipment, consisting of generator, motors and rope drive, and other equipment, was taken out. As early as September 1920, petitioner attempted to sell the electrical equipment to the Kimberly-Clark Co. and others, but was unable to do so. In a letter addressed to the Kimberly-Clark Co., dated January 7, 1921, petitioner offered to sell the four *1195 motors of the electrical equipment to such company for $3,000. The motors were later sold. Some of this equipment was sold for*1060 the old iron and the brass. The generator and armature are still in the basement and other electrical equipment is in the warehouse. In 1923 or 1924, the rotor of the electrical equipment was sent to the original builders of the machine to ascertain what, if anything, could be done with it. The manufacturer sent it back in waterproof covering or packing, the same as it used to ship all electrical equipment, and when received by petitioner it was placed, so packed, in its warehouse and has been there ever since. The dismantling and removing of the electrical equipment in the mill was accomplished in about two weeks after the mill was turned over to petitioner and the Kimberly-Clark Co. ceased its operations.
During August 1920, it was found by the petitioner that machines and equipment, including the wet end of one of the paper machines, the electrical equipment, and miscellaneous equipment of the net cost of $103,524.92, after allowance for the scrap value thereof, were impracticable for its use and it determined to discard them. Other machines or parts thereof and equipment were purchased and the machines and equipment replaced were dismantled and practically all removed to*1061 the warehouse or yards or other convenient places and abandoned or scrapped during 1920. A scrap value was placed thereon and petitioner tried to sell them for whatever could be obtained. None of such machinery and equipment scrapped and abandoned was ever used by the petitioner.
In the early spring of 1921, petitioner began actual production of writing paper in the Telulah Mill. By that time all of the new equipment had been installed.
The petitioner and respondent stipulated that the following facts may be taken as true:
1. That on June 8, 1920, the Petitioner and the Kimberly-Clark Company entered into an agreement for the purchase and sale of a certain property known as the Telulah Mill, situated at Appleton, Wisconsin, for a total consideration of $950,000.
2. That included in the said purchase were buildings which cost $357,311.77 as a part of the above named consideration.
3. That included in the said purchase was mill machinery and equipment which cost $492,688.23, included in the above named consideration.
4. That a reasonable annual allowance for exhaustion, wear and tear of property on the said buildings is 4% per annum on the said $357,311.77.
*1062 5. That a reasonable annual allowance for exhaustion, wear and tear of mill machinery and equipment is 8 1/2% on the above $492,688.23. In the event that the Board shall determine that the Petitioner is entitled to a deduction of $103,524.92 for machinery and equipment scrapped during the year 1920, the basis for the computation of a reasonable annual allowance for exhaustion, wear and tear of mill machinery shall be reduced by the said $103,524.92. In *1196 other words, the said amount of $492,688.23 shall be reduced by the said amount of $103,524.92, leaving an amount of $389,163.31 as the basis upon which to compute the said exhaustion, wear and tear at a rate of 8 1/2%.
6. That in addition to the deductions heretofore allowed by the Commissioner in the determination of the tax liability of the petitioner for the year 1920 there should be allowed as ordinary necessary expenses the sum of $13,543.37.
7. That in addition to the deductions heretofore allowed by the Commissioner in the determination of the tax liability of the Petitioner there should be allowed a deduction on account of income tax due the State of Wisconsin for the said year, 1920, in the sum of $20,599.57, *1063 accrued in and for the said year.
8. That Petitioner scrapped and discarded machinery and equipment which cost net $103,524.92, after the allowance for the scrap value thereof. The said $103,524.92 was included in the consideration of $950,000, as hereinabove stated.
9. That the Commissioner in the audit of the Petitioner's return and in the determination of the deficiency in issue in this proceeding did not allow as a deduction any amount for exhaustion, wear and tear of the Telulah property in and for the year 1920 on the said cost of buildings of $357,311.77, or on the said cost of mill machinery and equipment of $492,688.23. The Commissioner did not allow any deduction in 1920 for loss due to scrapping of machinery and equipment in the amount of $103,524.22, or any other amount.
10. The petitioner kept its books and made its income tax return for the year 1920 on the accrual basis.
OPINION.
MCMAHON: The determination of two of the questions involved in this proceeding - (1) whether the petitioner is entitled to a deduction on account of depreciation on the property here involved from June 8, 1920, to December 31, 1920, and (2) whether the petitioner is entitled*1064 to a deduction of a loss claimed to have been sustained on account of the abandonment in 1920 of certain machinery and equipment here involved - is dependent upon the construction of the contracts of June 8, 1920, and January 3, 1921, entered into by the petitioner and the Kimberly-Clark Co., hereinafter referred to as the seller.
The respondent contends that the contract of June 8, 1920, constituted an executory contract providing for the sale of the mill on January 1, 1921, or a "memorandum or binder of the transaction"; that the "land contract" of January 3, 1921, executed January 20, 1921, effected the transfer of title to such property; and that therefore the petitioner, not being the owner of such property until January 1921, is not entitled to deduct from gross income for the year 1920 any loss on account of abandonment of machinery and equipment covered by the agreement of June 8, 1920, or depreciation on account of the buildings, machinery, and equipment. The petitioner contends that the sale was made on June 8, 1920, and that it was the owner of such property as of that date and is entitled to such deductions.
*1197 We will consider first the question as to*1065 whether the petitioner is entitled to deduct $103,524.92 from gross income of 1920 on account of abandonment of certain machinery, tools, and equipment covered by the agreement of June 8, 1920, under the provisions of section 234(a)(4) of the Revenue Act of 1918, which is as follows:
SEC. 234. (a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
* * *
(4) Losses sustained during the taxable year and not compensated for by insurance or otherwise. * * *
In its petition filed with the Board on October 28, 1926, the petitioner alleges that it sustained a loss in 1920 through abandonment and scrapping of machinery and equipment purchased from the Kimberly-Clark Co., as follows:
| Electrical machinery | $74,513.22 |
| Fourdrinier part of paper machine | 18,482.34 |
| Miscellaneous machinery | 45,717.94 |
| Machinery lost or stolen | 2,024.05 |
| 140,737.55 |
In a stipulation filed July 9, 1931, the parties stipulated, relative to the question of abandonment and scrapping of machinery and equipment, the following:
1. That on June 8, 1920, the Petitioner and the Kimberly-Clark Company entered into*1066 an agreement for the purchase and sale of certain property known as the Telulah Mill, situated at Appleton, Wisconsin, for a total consideration of $950,000.
3. That included in the said purchase was mill machinery and equipment which cost $492,688.23, included in the above named consideration.
5. * * * In the event that the Board shall determine that the Petitioner is entitled to a deduction of $103,524.92 for machinery and equipment scrapped during the year 1920, the basis for the computation of a reasonable annual allowance for exhaustion, wear and tear of mill machinery shall be reduced by the said $103,524.92. * * *
8. That Petitioner scrapped and discarded machinery and equipment which cost net $103,524.92, after the allowance for the scrap value thereof. The said $103,524.92 was included in the consideration of $950,000, as hereinabove stated.
9. * * * The Commissioner did not allow any deduction in 1920 for loss due to scrapping of machinery and equipment in the amount of $103,524.92, or any other amount.
Although the respondent in his answer denies the allegations contained in the petition relative to the abandonment and scrapping of machinery and equipment, *1067 it appears quite clearly from the stipulation that the petitioner satisfied the respondent that machinery and equipment costing net $103,524.92, after the allowance for scrap value, had actually been scrapped and discarded by the petitioner *1198 and that they were a part of the machinery and equipment purchased from the Kimberly-Clark Co. The machinery and equipment scrapped and discarded consisted of the wet end or Fourdrinier part of one of the paper machines, the electrical equipment, including generator, motors, rope drive, and other miscellaneous machinery, tools and equipment.
The respondent contends that no deductible loss can be claimed in 1920 on account of abandonment of this machinery and equipment, since the petitioner was not the owner of such property in that year, and that the petitioner did not in fact abandon such machinery and equipment in 1920, but in the following year or later.
The agreement of June 8, 1920, provides that:
The Seller hereby agrees that it will sell and convey to the Buyer all its waterpower * * *, and all its land and mills * * * in said Appleton, * * * for the sum of Nine Hundred Fifty Thousand Dollars * * *.
* * *
The Seller*1068 is to retain possession and use of said property until January 1, 1921, the Seller then to surrender possession * * *.
Notwithstanding the fact that the Seller retains general possession and use of said property until January 1, 1921, yet in the meantime Buyer shall have the right to make such improvements to such property as may be desirable for its purposes, and as may not interfere with full operation of the paper mill plant by the Seller.
* * *
It is understood that all tools and machinery in use in the operation of the mill property conveyed shall pass to and be the property of the Buyer. [Italics ours.]
The contract of June 8, 1920, deals with two kinds of property, viz., (1) water power and land, including buildings, and (2) tools and machinery. Neither the land contract nor the deed dated February 5, 1926, mention the "tools and machinery" referred to in the contract of June 8, 1920.
Under the provisions of the contract above quoted the seller reserved to itself the right to use and operate the "paper mill plant" and the petitioner acquired the right to enter upon the property and make such improvements thereon as might be desirable for*1069 its purposes, without interfering with the full operation of the paper mill plant by the seller. The paper mill plant did not constitute the entire property conveyed. While the seller was operating the paper mill plant, the petitioner built a new large ironclad warehouse. It entered into a contract for remodeling the "old Pulp Mill and Rotary Building" into a new rag room and for the building of a filter plant, both of which were to be completed in 1920. It laid cement floors and made other improvements, all while the seller was operating the paper mill plant. The seller therefore used so much of the Telulah Mill property as was necessary for the "full operation *1199 of the paper mill plant" while the petitioner was active upon the remaining property making it suitable for its purposes.
Although the contract did not expressly provide what machinery and equipment the seller was to use in the operation of the paper mill plant, obviously it implies, and it appears, that the parties contemplated that the seller was to use all the machinery and equipment necessary to operate the paper mill plant; and the seller did use such machinery and equipment in the operation of the*1070 mill.
While it clearly appears therefore that the seller was to use the machinery and equipment and that there was to be no interference on the part of the petitioner in its use thereof for the operation of the paper mill plant, yet the contract provides that "all tools and machinery in use in the operation of the mill property conveyed shall pass to and be the property of the Buyer." It seems to us that the clear import of the above quoted provisions of the contract, viewed in the light of all the facts and circumstances, is that, notwithstanding the reservation of the possession and use of the paper mill plant, together with the tools and machinery, nevertheless, title to the tools and machinery was to pass to the petitioner upon execution of the agreement of June 8, 1920. This is substantiated by the fact that the petitioner, after the seller vacated the plant, within a few days after December 17, 1920, took possession and exercised all the rights of ownership thereof without objection from or interference by the seller. As early as September 1920, the seller had knowledge of the fact that petitioner was trying to dispose of the electric motors and other electrical*1071 equipment, as it was offered for sale to the seller by the petitioner (the buyer) and negotiations were had between them for the repurchase thereof by the seller, while the seller was still operating the paper mill plant. Obviously, the petitioner acquired possession of the machinery, equipment, and tools in 1920, and, as shown later, exercised complete dominion and control thereof.
Furthermore, the petitioner in 1920 paid $450,000 of the purchase price of $950,000, $400,000 of which was not payable under the terms of the contract of June 8, 1920, until January 1, 1921. The seller permitted the petitioner to paint all the buildings, including the paper mill plant, in a distinctive color scheme according to custom established by the petitioner, thus permitting the property to bear publicly the petitioner's indicia of ownership. The contract provided that the petitioner "shall have the right" to make improvements upon the property and the petitioner, without any objection on the part of the seller, placed valuable and substantial improvements on the property in 1920. A few days after December 17, 1920, the petitioner had, as stated before, possession of the entire *1200 *1072 property and exercised all the rights of ownership relative thereto without objection on the part of the seller.
The principle that, in applying the provisions of the Sixteenth Amendment and the income tax laws enacted thereunder, matters of substance or the actualities of the situation or what was actually done should be regarded rather than mere form has been repeatedly enunciated by the courts and this Board. Weiss v. Stearn,265 U.S. 242">265 U.S. 242; United States v. Phellis,257 U.S. 156">257 U.S. 156; Robert C. Roebling,28 B.T.A. 644">28 B.T.A. 644; W. E. Guild,19 B.T.A. 1186">19 B.T.A. 1186; William H. Mullins,14 B.T.A. 426">14 B.T.A. 426; B. F. Saul,4 B.T.A. 639">4 B.T.A. 639; Anna M. Harkness,1 B.T.A. 127">1 B.T.A. 127.
Taking into consideration only what was done by the parties in 1920 in carrying out the terms of the contract, no other conclusion than that the petitioner became the owner of such machinery, tools, and equipment in 1920 can reasonably be reached.
The Board has held, in *1073 Reuben H. Donnelley Corp.,26 B.T.A. 107">26 B.T.A. 107; I. G. Zumwalt,25 B.T.A. 566">25 B.T.A. 566; Belridge Oil Co.,11 B.T.A. 127">11 B.T.A. 127, that whether or not there has been an abandonment depends on the intention of the owner, coupled with the act of abandonment, both to be ascertained and determined from all the facts and surrounding circumstances.
All of the property was purchased by the petitioner with the intention of using it in the operation of its business, with certain changes to make it suitable for the manufacture of paper from rags. After the execution of the agreement in 1920, the petitioner discovered that certain of the machinery and equipment was not in condition for its use and not suited for its purpose. Thereafter and in the same year the petitioner incurred substantial obligations in the purchase of machinery and equipment to replace that which it found unsuitable for its purpose. In two letters of the seller, dated December 17, 1920, addressed to the petitioner, the seller stated:
As soon as shut down, [within a few days thereafter] and, as a matter of accommodation to you, * * * we have no objection to your beginning repairs and remodeling*1074 over the entire mill * * *.
Under the circumstances we will be very glad to permit you to go ahead with your plans in the repairs and remodelling * * *.
A few days after the date of the above letters the seller turned over the paper mill plant to the petitioner. As soon as it was able to do so and immediately upon the vacating of the paper mill plant by the seller, the petitioner commenced and practically completed in 1920, the work of dismantling and removing from the plant the machinery and equipment which it did not intend to use. It disposed of such of it as it could at scrap value and the rest was thrown out or stored.
*1201 It is our conclusion that the petitioner did sustain a loss in the amount of $103,524.92 in 1920 and that such loss is deductible under section 234(a)(4) of the Revenue Act of 1918. Parma Co.,18 B.T.A. 429">18 B.T.A. 429; Winter Garden, Inc.,10 B.T.A. 71">10 B.T.A. 71; Peoples Ice & Cold Storage Co.,10 B.T.A. 16">10 B.T.A. 16; Union Bed & Spring Co. v. Commissioner, 39 Fed.(2d) 383; *1075 Wheeling Tile Co. v. Commissioner, 25 Fed.(2d) 455.
The fact that the petitioner in 1923 or 1924 sent the rotor of the electrical equipment to the manufacturer does not refute, under the circumstances, the intention to abandon it in 1920. The rotor was returned to the petitioner without charge, and placed in its warehouse, where it has remained ever since. This confirms the petitioner's claims that it was unsuitable and could not be utilized for its purposes or otherwise. Wheeling Tile Co. v. Commissioner, supra.See also Independent Brick Co.,11 B.T.A. 862">11 B.T.A. 862, 867.
In view of the stipulation entered into between the parties, it seems to us that the argument of the respondent that "The burden of proof was also upon the taxpayer to allocate the $103,524.92 representing the cost of scrapped and discarded machinery and equipment to the three items" is without merit. The machinery and equipment scrapped and discarded consisted of more than three items, but was referred to as part of a paper machine, electrical equipment consisting of various motors and other parts, and miscellaneous machinery and equipment. We fail to see*1076 how the respondent could have entered into a stipulation fixing the total cost of machinery and equipment abandoned without considering the kind, nature and character of the various machinery and equipment involved. It is impossible to determine cost without knowing what the article is, the cost of which is to be determined. These stipulations are entered into for the convenience of the parties and to eliminate long and detailed proof of facts which can more readily, and with a saving of time, effort and expense, be determined by the parties themselves. In view of the agreements reached in the stipulation we are of the opinion that the petitioner has not failed in his proof in not allocating the total cost stipulated to the various items of machinery and equipment abandoned and scrapped. In our opinion, under all the facts and circumstances, the petitioner was justified in relying upon the stipulation to the extent to which it did rely upon it.
Since we have held that the petitioner is entitled to a deduction of $103,524.92 in 1920, on account of the loss by abandonment of machinery, tools and equipment, under paragraph 5 of the stipulation, we are not here concerned with the*1077 question of a deduction on account of depreciation in that year of such property; and in what *1202 follows herein upon the subject of depreciation, our discussion is limited to the remainder of the property covered by the agreement of June 8, 1920, exclusive of the land and water power.
The next question we will consider is whether the petitioner is entitled to a deduction of a reasonable amount for depreciation of the buildings, machinery, tools and equipment exclusive of the machinery, tools and equipment abandoned in 1920, under section 234(a)(7) of the Revenue Act of 1918, which is as follows:
SEC. 234. (a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
* * *
(7) A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence;
The contract of June 8, 1920, provides in part that:
The Seller is to retain possession and use of said property until January 1, 1921, the Seller then to surrender possession * * *.
The Seller shall maintain the property in good operating condition and in as good condition*1078 as the same now is, until the first day of January, 1921, excepting ordinary wear and tear and decay. [Italics ours.]
It is to be noted that the property involved is not property which was not subject to depreciation between June 8, 1920, and the date of delivery under the contract. On the contrary, the contract covered property which had been in use prior to June 8, 1920, and, under the terms of the first contract, such property was to be used thereafter for about seven months by the seller in the operation of the mill. Furthermore, the transaction was a business transaction, the parties dealing with each other at arm's length and in the ordinary course of business. The president of the seller, who acted throughout the negotiations in behalf of the seller, testified that:
* * * We were reluctant to consider the sale of it, because we had contracts carrying us through the year, which put all of our equipment to its utmost capacity to file; so that to discharge our obligations under the contracts we could not possibly consider the sale of the mill for delivery earlier than the 1st of January.
Negotiations for the purchase and sale of the property were commenced early*1079 in 1920 and such negotiations finally resulted in the agreement of June 8, 1920. The petitioner had orders substantially in excess of the capacity of its facilities and it was desirous of increasing its facilities as soon as possible to meet its contract obligations. The position of both parties in this respect is reflected in the provisions of the contract, the seller reserving the right to use and operate the mill and the petitioner having the right to enter *1203 upon the property and "to make such improvements to such property as may be desirable for its purposes and as may not interfere with full operation of the paper mill plant by the Seller." [Italics ours.] The president of petitioner viewed the property at the time of the negotiations and execution of the first contract, and knew that as to that part of the property referred to in the contract of June 8, 1920, as the "paper mill plant", it would not, under the circumstances, be delivered to it in the same condition as it was in on June 8, 1920. The condition, at the time of delivery, of the property which was subject to the use of the seller over a considerable period of time would be a matter of grave concern*1080 to the petitioner. That this matter did not escape the attention of the petitioner is evidenced by the above quoted paragraph which describes the condition in which the property was required to be in at the time of delivery, i.e., the same good operating condition as of June 8, 1920, "excepting ordinary wear and tear and decay." [Italics ours.] The president of the seller further testified that between June 8, 1920, and the end of the operation of the mill by it, it had made a profit in "round figures, $200,000" from the operation of the mill. To retain the use and possession of the property was of substantial value to the seller, and, since the petitioner was desirous of obtaining the use and possession thereof as soon as possible, the delay therein would be a disadvantage to it in that it was unable to prepare and use the property for its own purposes as rapidly and as soon as it would have been able to do had it secured the immediate delivery of the property. Certainly all of these factors entered into the determination by the parties of the consideration to be paid for the property by the petitioner. It would be unreasonable to say that the seller, in view of the condition*1081 of its business at the time and its need for the utmost capacity of all its facilities, would have fixed the same price for the property as stated in the contract of June 8, 1920, had it been required to deliver the property on June 8, 1920, or shortly thereafter. It would not be reasonable to say that the petitioner would have agreed to pay the same purchase price for the property irrespective of the time of delivery and use thereof by some one other than itself. The officers of both the seller and the petitioner, who negotiated this deal and who acted on behalf of their respective corporations, were men of wide business experience. They certainly would know and realize that the value of the property was greater on June 8, 1920, than on January 1, 1921, to the extent of the depreciation caused by the use thereof by the seller and lapse of time. It seems to us that the conclusion is inescapable that the property actually purchased by the petitioner was the property in its condition *1204 at the time of delivery, i.e., the property in good operating condition and in as good condition as the same now is [June 8, 1920], "* * * excepting ordinary wear and tear and decay.*1082 " [Italics ours.] Hence, since the petitioner contracted to buy the property in its condition as of January 1, 1921, or in as good operating condition as of June 8, 1920, minus or excepting wear, tear, and decay, it cannot be said that the property purchased was subject to any depreciation which would have to be borne by the petitioner during the period between June 8, 1920, and January 1, 1921, or that its investment was being reduced, since its investment represented the property as of January 1, 1921. As to the condition of the property now under consideration, the petitioner bought it in its depreciated condition as of January 1, 1921. Therefore, it did not experience, suffer or sustain any depreciation of the property before that date. As a matter of pure fact it had no depreciation on the property in 1920 and hence it cannot deduct any depreciation of the property for that year.
In view of the foregoing, it is not necessary to determine, for purposes of depreciation, whether the petitioner was the owner of the property as of June 8, 1920; nor is it necessary to determine whether or not such property was "used in the trade or business" within section 234(a)(7).
All*1083 the cases cited by the petitioner and respondent have been carefully considered, but the facts in those cases are so different from the facts in this proceeding that it would serve no useful purpose to enter into a discussion of them. We base our decision on the peculiar facts of this proceeding.
It is our conclusion, therefore, that the petitioner is not entitled to a deduction in 1920 for depreciation of the buildings, machinery, tools, and equipment not covered by our disposition of the issue of abandonment.
As the respondent confessed error as to the disallowance of a deduction for income taxes due the State of Wisconsin for the year 1920 in the sum of $20,599.97, such sum, as well as the item of $13,543.37 which parties stipulated should be allowed as ordinary necessary expenses for the year 1920, should be deducted upon recomputation under Rule 50.
Redetermination of petitioner's income and profits taxes for 1920 was made by respondent under the provisions of sections 327 and 328 of the Revenue Act of 1918. On motion of respondent, the hearing was limited to the issues defined in paragraph (a) of Rule 62. Therefore, no evidence with respect to assignments of error*1084 numbered 4, 5, and 6 was adduced at the hearing. Unless motion for *1205 hearing under Rule 62(a), to be filed within 30 days, is granted by the Board.
Reviewed by the Board.
Judgment will be entered under Rule 50.
SMITH, BLACK, and MATTHEWS concur in the result.
MARQUETTE dissents.
TRAMMELL dissents on the question of depreciation.
VAN FOSSAN dissents on the question of the ownership of machinery.