*2659 1. Cost of assets subject to amortization deduction determined. Amount of deduction as a reasonable allowance for amortization of such assets determined.
2. Cost of assets determined as a basis for the deduction of an allowance for exhaustion, wear and tear thereof.
3. Where invested capital is reduced by the Commissioner by alleged additional tax for a year prior to the year for which the deficiency is determined, the burden is on petitioner to establish the correct tax liability for such prior year.
*121 In these proceedings the petitioner seeks a redetermination of its income and profits taxes for the fiscal period from May 1, to December 31, 1919, and for the calendar year 1920, for which the Commissioner has determined deficiencies of $94,661.56 and $105,185.39, respectively. The petitioner alleges error on the part of the Commissioner for the 1919 fiscal period (1) in failing to allow adequate deduction from income for amortization of war facilities; (2) in failing to allow the deduction*2660 of adequate amounts for depreciation of machinery and equipment; (3) in failing to allow proper invested capital; (4) in failing to assess the profits tax under sections 327 and 328 of the Revenue Act of 1918; and for the year 1920, (5) in failing to allow proper deduction for reasonable exhaustion, wear and tear of property, including a reasonable allowance for obsolescence; (6) in failing to allow proper deduction for ordinary and necessary business expenses, including rentals and other expenses on leased property, (7) in decreasing invested capital by alleged additional taxes for 1918 and 1919 of $121,395.45, by capital stock disallowed, $45,000, and by taxes for 1916 and 1917 of $8,208.60, and (8) in a reduction of surplus of $341,070.11.
FINDINGS OF FACT.
The petitioner is a New York corporation with its principal office at 407-410 West Street, New York City.
The Commissioner determined deficiencies in income and profits taxes against the petitioner in the amounts of $94,661.56 for the fiscal period May 1 to December 31, 1919, and $105,185.39 for the calendar year 1920, notifying the petitioner by separate deficiency letters, both dated August 12, 1925.
Petitioner*2661 was incorporated on May 29, 1917, and continued the business of a predecessor corporation, which, prior to the entry of the United States into the war, had been engaged in marine plumbing and repair work on ships, principally on merchant vessels which had been commandeered by the British, French and Italian Governments. Its equipment consisted of hand tools and a few machines, such as pipe cutters, lathe, drill press and pipe-bending machine.
With the entry of the United States into the war, the predecessor corporation immediately began to do war work on ships for the United States Government. This was largely a different type of work and included the fabrication and manufacture of many articles necessary for the transformation of vessels from freight and passenger ships into troop ships and the installation thereof.
On June 1, 1917, the petitioner took over the business of the predecessor corporation and issued therefor $50,000 par value of capital stock.
*122 The petitioner entered into a large program of manufacturing, fabricating and installing all manner of equipment necessary to turn merchant vessels into troop ships and war vessels, making and installing such*2662 things as life rafts, crows nests and observation tops, gun mounts, ventilating systems, sanitary equipment for troops, berths, galley and mess equipment, as well as piping of all kinds on old vessels and on new vessels under construction by the Emergency Fleet Corporation. For this purpose the petitioner increased its force of employees from a normal prewar roll of about 75 to as high as 3,300, and bought and installed special machinery, such as lathes, planers, milling machines, drill presses, shapers, shears, punches, plate rolls, forges, steel hammers, foundry equipment, pattern-shop equipment, etc., at a cost of not less than $100,000.
The machinery so purchased by the petitioner was used exclusively for the production of articles contributing to the prosecution of the war and petitioner was engaged 100 per cent in war work from January 1, 1918, to December 31, 1919.
With the termination of the war contracts upon which petitioner was engaged, such machinery and equipment so acquired for war purposes had a value in the open market of not more than 10 per cent of its cost. Part of such machinery and equipment was sold by petitioner for nominal prices. Part of it was transferred*2663 in 1920 to Brooklyn, where petitioner was building a shipyard, and part was abandoned or junked. Most of the machinery transferred to Brooklyn was stored or, if set up, was never used by petitioner.
A reasonable allowance for the amortization of such machinery and tools, including depreciation thereof but exclusive of depreciation on machinery and equipment acquired prior to March 6, 1917, is $90,000.
In computing the deficiencies here involved and the taxes for prior years for use in computing invested capital for the years involved, the Commissioner determined the amortization allowance for machinery and tools at $16,128.44, which he prorated over the period from January 1, 1918, to December 31, 1919, on the basis of the net income before allowance of amortization.
In 1920, the petitioner went into the business of operating a shipyard and dry dock in Brooklyn. It leased certain premises in Brooklyn for a term of 10 years at an annual rental of $125,000, the lease to begin as of April 30, 1920. On the premises so leased, the petitioner caused dredging to be done, and the erection of bulkheads, piers, and buildings of concrete and brick, and acquired a floating dry dock*2664 for use in connection therewith. The property was ready for operation in July, 1920.
*123 The cost of the Brooklyn property was as follows:
| Class of property | Amount |
| Floating dry dock | $532,500.00 |
| Dredging | 220,658.20 |
| Construction work | 261,125.97 |
In computing the deficiency for 1920 no depreciation was allowed on any of such assets.
The rental for 1920 of the property on which the dry dock was located was $93,750. During 1920 the petitioner incurred rent for the property occupied by it at New York City in the amount of $12,137.50 and miscellaneous rents of $710. The Commissioner allowed only $7,786.66 as a deduction for rentals.
In 1917 petitioner issued $50,000 par value of its capital stock for the assets of its predecessor. In computing invested capital the Commissioner reduced the paid-in capital to $5,000.
The petitioner, by its original and amended returns for the fiscal period June 1, 1917, to April 30, 1918, showed a total income and profits tax of $86,222.62.
The Bureau of Internal Revenue, by a letter dated August 12, 1925, indicated an additional tax liability for said fiscal period of $75,390.12. This computation was not*2665 final but was subject to adjustment.
The Commissioner, in computing the deficiencies here in question, reduced the petitioner's invested capital for each period by such alleged additional tax for the fiscal period ended April 30, 1918, of $75,390.12.
The Commissioner, in computing the deficiency for 1920, further reducec the petitioner's invested capital for 1920 by $70,089.49, representing .42144089 of $166,306.35, alleged to be the total tax of the petitioner for the fiscal period ended December 31, 1919.
OPINION.
PHILLIPS: These proceedings present only questions of fact for decision which probably never would have arisen except for the destruction of all petitioner's accounts for years prior to 1920, by a fire which occurred early in that year. It is not disputed that the petitioner is entitled to amortize the assets purchased for war work, nor is there any dispute as to the period over which the cost of such facilities should be amortized. The sole question in dispute is the amount which should be allowed. The petitioner is handicapped in its proof of cost by the loss of its books. While the exact amount of the cost can not now be determined, we are satisfied from*2666 the evidence that such cost was not less than $100,000. These machines and tools were purchased at a time when their cost was very high. *124 The testimony is that after the war the market was glutted with such machines and that they could be sold, if at all, only for a small fraction of their original cost. Some were sold on that basis, some were taken down and stored in the hope of a future market, and others were set up in the shipyard which petitioner established in Brooklyn, where they were used to some small extent. The greater portion of these machines, however, were either scrapped or stored in unoccupied space because there was no market for them. In the business which petitioner had carried on before the war and which it carried on after the war contracts were completed, such machines were of no use. In that business only the usual hand tools of a plumber and a few light machines were required. Such assets as these have been largely disregarded in determining the amortization allowance.
In April, 1920, the petitioner leased waterfront property in Brooklyn for a period of 10 years, upon which it erected bulkheads, piers and buildings and caused dredging to*2667 be done, all at a cost of $481,784.17. The Commissioner allowed no exhaustion or depreciation of such assets. They are of such a character that they revert to the owner of the premises on the expiration of the lease and exhaustion should be allowed, the amount to be prorated from July 1, 1920, over the life of the lease.
The petitioner purchased a floating dry dock at a cost of $532,500. It is argued that this should also be depreciated over the life of the lease. We can not follow this contention of petitioner for there is nothing which would indicate that the useful life of such property, which did not become part of the realty and could be moved from one location to another, bears any relationship to the term of the lease. Nor can we follow the suggestion of its counsel that we use a rate of depreciation taken from a text book on accounting. On the other hand the Commissioner is obviously in error in having failed to allow any depreciation or exhaustion. The principal issue between the parties was with respect to cost. In computing the deficiency the Commissioner was without any evidence of cost. This has now been established and in recomputing the deficiency for 1920*2668 it is proper that the Commissioner allow a deduction for depreciation from August 1, 1920, based upon this cost and upon what he may determine from any sources available to him to be the normal useful life of a floating dry dock.
Petitioner also contends for depreciation upon an alleged expenditure of $394,250.67 for electrical work. We are left without any knowledge as to the character of the work done or assets acquired. Whether they became part of the realty or part of the dry dock, *125 whether they will have any value beyond the life of the lease or the life of the dry dock we do not know. Moreover, it does not appear when this work was done or the assets installed. The payment was made on the last day of the year. In such circumstances there is no basis on which an allowance for depreciation may be predicated.
The rental in 1920 of the New York and Brooklyn property, together with miscellaneous rental fees for the use of city docks, was $106,597.50. The Commissioner allowed $7,786.66. The full amount paid is an allowable deduction from gross income.
Upon organization, the petitioner took over the assets of a predecessor corporation and issued $50,000 par*2669 value of its capital stock therefor. In computing invested capital the Commissioner allowed only $5,000, for assets so acquired. The statute directs that such assets be included in the invested capital at their actual cash value, not to exceed the value at which they could have been included in the assets of the predecessor. (Sections 326 and 331, Revenue Act of 1918). The petitioner introduced as evidence only its minute book, showing that the directors authorized the purchase and containing a balance sheet of the assets and liabilities of the predecessor, which balance sheet indicates assets over liabilities of some $56,000. Such records standing alone are not proof of the actual cash value of the assets acquired or their cost to the predecessor corporation and the action of the Commissioner must be sustained because presumptively correct.
Petitioner alleges that the Commissioner erred in reducing invested capital for the periods involved by taxes for a prior period, which are in excess of the amount shown by the petitioner's return to be due, the additional amount not yet having been finally determined by the Commissioner. The situation here is somewhat similar to that*2670 presented in the . In the instant proceeding it was quite possible to establish the correct tax liability for the preceding period, that the proper invested capital might be computed. The burden is on the petitioner to do so. In fact, petitioner has established that the tax proposed by the Commissioner for the preceding period is excessive, in that inadequate allowance was made for amortization in computing net income for such preceding period. The tax for such prior period should be recomputed in the light of the facts found in this proceeding, and the amount so determined will be used in the computation of invested capital for the periods here involved.
Decision will be entered on 20 days' notice, under Rule 50.
Considered by VAN FOSSAN.