1954 U.S. Tax Ct. LEXIS 59">*59 Decision will be entered under Rule 50.
On November 15, 1945, petitioner entered into a lease for 10 years beginning July 1, 1946. There was no provision for extension or renewal of the term. Buildings and equipment erected are to pass to lessor at the end of the lease. Buildings and equipment worth $ 565,221.90 were erected and placed on the leasehold. Held, petitioner is entitled to amortize its cost over the period of the lease despite the identity of corporate officers in the participating corporations.
23 T.C. 202">*202 The Commissioner has determined deficiencies in the income tax of petitioner as follows:
| Taxable year ended March 31 | Deficiency |
| 1948 | $ 7,197.11 |
| 1949 | 13,936.34 |
| 1950 | 12,362.59 |
1954 U.S. Tax Ct. LEXIS 59">*60 23 T.C. 202">*203 The sole issue to be decided is whether the petitioner is entitled to amortize the cost of buildings and equipment over the life of a nonrenewable lease or only to a deduction for depreciation based on the useful life of the improvements.
FINDINGS OF FACT.
The facts were all stipulated, are so found, and are incorporated herein by this reference.
Fort Wharf Ice Company (hereinafter referred to as Fort Wharf) is a Massachusetts corporation. It keeps its books and reports its income on the accrual method of accounting. Petitioner filed its income tax returns for the taxable years ended March 31, 1948, 1949, and 1950 with the collector of internal revenue for the district of Massachusetts.
In 1945 there was an economic need in the city of Gloucester, Massachusetts, for an artificial icemaking plant of the size and type later built by the petitioner. The commercial fishing fleet of Gloucester needs crushed ice for its operations. Certain companies, to be described more fully hereafter, related to the fishing industry (or, whose success and continued operation depended on the fishing fleet), joined to meet this need by the formation of the petitioner.
In October 1945 an application1954 U.S. Tax Ct. LEXIS 59">*61 for a loan of $ 300,000 was filed with the Reconstruction Finance Corporation (hereinafter called R. F. C.) on behalf of the proposed Fort Wharf Ice Company for the erection of an artificial icemaking plant.
Fort Wharf was organized October 26, 1945, for the purpose of manufacturing and selling artificial ice in Gloucester. Two thousand and five hundred shares of $ 100 par value capital stock were issued for cash to the following corporations:
| Stockholder | Shares |
| Marine Vitamin Products Company | 250 |
| Gloucester Dehydrating Process Company | 250 |
| Cape Pond Ice Company | 750 |
| Gloucester Ice & Cold Storage Company | 1,250 |
The subscribing corporations made their purchases of stock of the petitioner subject to two special conditions. First, sums charged by petitioner for amortization of its leasehold and for depreciation of plant and machinery were to be set aside in a special fund. This fund was to be used to pay all principal on any mortgage incurred in building and equipping the plant; and thereafter was to be used to retire the capital stock on a ratable basis. Secondly, the shares originally 23 T.C. 202">*204 purchased were to be retired 10 years from the date of purchase. The stock1954 U.S. Tax Ct. LEXIS 59">*62 was issued October 31, 1945. 1
1954 U.S. Tax Ct. LEXIS 59">*63 Marine Vitamin Products Company and Gloucester Dehydrating Process Company were Massachusetts corporations engaged in manufacturing fish byproducts from fish cuttings and fish waste. They were located in Gloucester. Both corporations were wholly owned subsidiaries of Dehydrating Process Company (hereinafter called Dehydrating). Dehydrating is a Massachusetts corporation organized in 1927. It is engaged in manufacturing fish byproducts.
Both subsidiaries transferred all of their assets to Dehydrating on December 28, 1946.
Gloucester Ice & Cold Storage Company (hereinafter identified as Cold Storage) is a Massachusetts corporation organized in 1938 and located in Gloucester. It operates a storage and fish-freezing plant.
Cape Pond Ice Company (hereinafter called Cape Pond) is a Massachusetts corporation organized in 1902 and located in Gloucester. In 1945 and years prior thereto it was engaged in the business of harvesting and selling natural ice, chiefly to the fishing fleet. It owned several ponds and ice houses located on the shores of these ponds. It also owned a wharf on Commercial Street, Gloucester, situated on the waterfront. There was a storage crusher plant on the1954 U.S. Tax Ct. LEXIS 59">*64 wharf for furnishing crushed ice to the fishing boats.
The officers of petitioner were:
| President | John Ryan |
| Treasurer | James A. Ryan |
| Clerk | Harry Bergson |
These three men constituted the board of directors.
23 T.C. 202">*205 The officers and directors of the stockholder companies during 1945 were:
| Cape Pond Ice Company | Gloucester Ice & Cold | Dehydrating Process | |
| Storage Company | Company | ||
| President | John Ryan | John Ryan | John Ryan. |
| Treasurer | James A. Ryan | James A. Ryan | James A. Ryan. |
| Clerk | Harry Bergson | Harry Bergson | Harry Bergson. |
| Directors | John Ryan | Samuel L. Deitsch | Irene Ready. |
| James A. Ryan | Harry Bergson | John Ryan. | |
| Harry Bergson | Patrick J. Ryan | S. L. Deitsch. | |
| John W. Ryan | James A. Ryan | George Solov. | |
| Samuel L. Deitsch | John Ryan | James A. Ryan. | |
| Harry Bergson. | |||
| F. J. O'Hara. |
The officers of these corporations were the same throughout the years in question and they were also directors during these years. There were some changes among the other directors.
John Ryan and his wife, Mary T. Ryan, Samuel L. Deitsch and his wife, Frances Deitsch, Harry Bergson and his wife, Augusta Bergson, and the Gloucester Ice & Cold Storage Company held stock in Dehydrating, 1954 U.S. Tax Ct. LEXIS 59">*65 Cape Pond, and Cold Storage as listed below. The total number of shares outstanding of each company is also shown:
| Dehydrating | Cape Pond | Gloucester | |
| Process | Ice | Ice & Cold | |
| Company 1 | Company 2 | Storage | |
| Company 3 | |||
| Total shares outstanding | 15,313 | 382 | 10,000 |
| H. Bergson and wife | 2,464 | 10 | 730 |
| S. Deitsch and wife | 2,076 | 15 | 1,764 |
| John Ryan and wife | 3,188 | None | 4,030 |
| Gloucester Ice & Cold Storage Company | 284 |
In November 1945 Cold Storage, which had subscribed for $ 125,000 worth of stock in the petitioner, raised $ 100,000 of this amount by selling its 7 per cent 10-year debentures to its stockholders.
On November 9, 1945, Fort Wharf entered into a contract with Cape Pond, by the terms of which Fort Wharf agreed to manufacture artificial ice exclusively for Cape Pond, which, in turn, agreed to purchase a minimum of 50,000 tons per year. Cape Pond received the use of the crushers and chutes to be constructed by Fort Wharf, free of charge. The price1954 U.S. Tax Ct. LEXIS 59">*66 of ice was set at $ 3.25 per ton. The contract was to run for 10 years from the start of operations.
Fort Wharf leased land from Cape Pond on November 15, 1945. The term was for 10 years beginning July 1, 1946. No provision was made for renewal or extension of the stated term. Rent was set at $ 100 per month. By express terms of the lease, title to the buildings 23 T.C. 202">*206 and equipment to be erected by petitioner will pass to Cape Pond at the end of the lease. The land was waterfront property on Commercial Street, Gloucester.
The R. F. C. loan of $ 300,000 to Fort Wharf was approved January 7, 1946. This loan was secured by a first mortgage on the buildings and equipment, an assignment of lease from Cape Pond to Fort Wharf, and by a pledge of all the outstanding stock of Fort Wharf. Thereafter, on May 6, 1946, Fort Wharf assigned to the R. F. C. all moneys due or to become due to it arising out of the contract to furnish ice to Cape Pond as described above. Cape Pond further secured the loan by executing a mortgage on the underlying fee in the land to the R. F. C.
Fort Wharf was required to show that it had expended $ 250,000 on the proposed plant before the R. F. C. would1954 U.S. Tax Ct. LEXIS 59">*67 advance funds. In April 1947 the following buildings and equipment had been built and installed at a total cost of $ 565,221.90. The cost of each item, the useful life, and the depreciation allowed by respondent are as follows:
| Asset | Cost | Useful life | Depreciation |
| (years) | |||
| Brick building | $ 200,000.00 | 50 | $ 4,000.00 |
| Equipment in brick building | 268,061.76 | 15 | 17,870.78 |
| Frame building | 87,160.14 | 20 | 4,358.01 |
| Equipment in frame building | 10,000.00 | 15 | 666.66 |
| $ 26,895.45 |
Petitioner claimed amortization of its total cost at 10 per cent per year beginning with the taxable year April 1, 1947, to March 31, 1948, of $ 56,522.19 as opposed to the depreciation of $ 26,895.45, as allowed by the Commissioner.
Sales began in May of 1947. During the taxable years involved, petitioner sold its ice exclusively to Cape Pond. For the taxable year ended March 31, 1948, the petitioner filed a return showing a net operating loss of $ 7,387.68. Although it had a small net profit for the taxable years ended March 31, 1949, and March 31, 1950, it paid no taxes due to the net operating loss carryover.
The real estate taxes on the leased premises were assessed by the City of1954 U.S. Tax Ct. LEXIS 59">*68 Gloucester against Cape Pond as owner of the fee and were paid by Cape Pond in the approximate amount of $ 10,000 per year.
In 1948, in accordance with the terms of their contract, Cape Pond and Fort Wharf reduced the price of ice from $ 3.25 to $ 3 per ton. The petitioner and Cape Pond used the same offices and petitioner charged Cape Pond $ 50 per month for rent of these offices.
We find as an ultimate fact that petitioner was a bona fide operating company and not a sham. The lease is for a period of 10 years and is not a tenancy at will.
23 T.C. 202">*207 OPINION.
The issue presented is whether petitioner is entitled to amortize the cost of buildings and machinery over the 10-year period of its lease, or whether it is entitled only to depreciation over the useful life of its assets. Statutory authority for these deductions is contained in section 23 (a) (1) (A) and (l) (1), Internal Revenue Code of 1939. 2
1954 U.S. Tax Ct. LEXIS 59">*69 Ordinarily a taxpayer who makes improvements of a capital nature on property that is used in his trade or business is allowed a deduction for depreciation based on the useful life of the improvements. As an exception to this rule, if a taxpayer makes improvements on property of a capital nature in a situation where he will lose the ownership or control of that property before the usefulness of the assets is exhausted, he will be allowed to amortize the cost of the improvements over the period during which he has the ownership or control of the property. Such a situation arises when a lessee for a term of years makes capital improvements to the leasehold, having a longer economic life than the term of the lease, which will pass to the lessor at the end of the lease period. Hess Brothers, 7 B. T. A. 729. See also Jos. N. Neel Co., 22 T.C. 1083; Regs. 111, sec. 29.23 (a)-10. This exception to the general rule is justified because otherwise the taxpayer would either be unable to recover his basis or would be forced to take disproportionate loss at the time when he loses the improvements.
A lessee is not always entitled1954 U.S. Tax Ct. LEXIS 59">*70 to amortize the cost of such capital improvements. For example, when the lease is for an indefinite period of time and there is no way to determine the proper period for amortization purposes, depreciation over the useful life is required. B. Kirk Rankin, 17 B. T. A. 1301; Elmira Arms Co., 7 B. T. A. 703.
Respondent does not challenge this interpretation of the law but he contends that the application of the exception to the general rule is not justified in this case. He points to the interlocking directorates, the fact that the corporate officers of all interested corporations are the same, and that three men and their wives have substantial, direct or indirect, stock interests in all the corporations here involved.
In effect, he challenges the bona fides of the companies and their shareholders in the premises. However, the record in this case convinces 23 T.C. 202">*208 us to the contrary. The petitioner company was not a mere sham, it was an operating company actively engaged in a legitimate business. Likewise, the other companies. They were all independent entities, each having an independent status in operation and 1954 U.S. Tax Ct. LEXIS 59">*71 each being engaged in a different phase of the fish business. Respondent cites neither statute nor case in support of his position, and we have been unable to find such by independent research.
The contract of lease fixed a term of 10 years. There was no provision for a renewal or extension. At the end of 10 years the improvements on the property were to go to the lessor. To avoid serious loss in the final year, petitioner asks amortization over the 10-year term of the lease. Our decision in Hess Brothers, supra, is squarely in point, even to the length of the term. See also John Junker Spencer, 19 T.C. 727. In the factual situation before us the claimed deduction for amortization is reasonable, and it is accordingly allowed.
Decision will be entered under Rule 50.
Footnotes
1. All subscriptions were in the following form:
October 31, 1945.
Fort Wharf Ice Company
10 High Street
Boston, Massachusetts.
Gentlemen:
By direction of its Board of Directors, the undersigned hereby subscribes for two hundred fifty (250) shares of your common stock, totalling $ 25,000.00, upon the following terms and conditions, namely: that all sums charged by you in your operations either for amortization of your leasehold or for depreciation of your plant and machinery shall constitute a particular fund out of which to pay first, all principal payments on any mortgage given by you for the purpose of erecting your plant, and the balance to be used for the retirement of your outstanding capital stock on a ratable basis; and upon the further consideration that within ten years from the date hereof, you will retire the shares hereby subscribed for.
Nothing in the foregoing shall be construed as affecting the undersigned's right to receive dividends from time to time out of the net earnings of the company or to receive its proportionate share of the net earnings accrued at the time its stock has been fully retired.
Very truly yours,
Gloucester Dehydrating Process Co.
By: James A. Ryan
Treasurer.
Accepted:
Fort Wharf Ice Company
By John Ryan
President↩.
1. Dehydrating Process Company had a total of 32 sharesholders.↩
2. Cape Pond Ice Company had a total of 9 shareholders.↩
3. Gloucester Ice & Cold Storage Company had a total of 61 shareholders.↩
2. SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
(a) Expenses. --
(1) Trade or business expenses. --
(A) In General. -- All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, * * *
* * * *
(l) Depreciation. -- A reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence) --
(1) of property used in the trade or business, or↩