*1673 1. Expenditures for additions to coal-mining machinery and equipment bought for the sole purpose of maintaining normal production are deductible as expenses of the year when purchased and installed.
2. The full value as of January 1, 1914, of the physical property and receivables acquired by the petitioner on May 1, 1912, together with the amount of cash then acquired, is includable in the invested capital of the petitioner for 1917.
3. The petitioner had no earned surplus at the beginning of the taxable year 1918 and made no distributions to stockholders from the date of its organization. Held that invested capital for 1918 based upon the cash value of the property at the time paid in for shares of stock should not be decreased by amounts in respect of depletion or depreciation alleged to have been sustained during prior years, nor by amounts in respect of taxes which had accrued for prior years.
4. A reduction in the amount of capital stock outstanding in 1915, without any distributions being made to the stockholders, did not operate to reduce invested capital.
*234 These proceedings were consolidated for hearing. The deficiencies asserted, together wih the amounts in controversy, are as follows:
| Year | Deficiency | Deficiency in |
| asserted | controversy | |
| 1917 | $5,195.35 | $19,233.62 |
| 1918 | 30,292.10 | 21,570.79 |
| 1919 | 1,525.36 | None. |
| 1920 | 90,777.72 | 55,206.00 |
| 1922 | 10,950.15 | 8,550.00 |
| 138,740.60 | 104,560.41 |
The amount in controversy for 1917 is stated to be $19,233.62. The petitioner claims that if it is successful in its contentions before the Board the result for 1917 will be a refund of $14,038.27. No allegation of error is made with respect to the deficiency asserted for 1919.
There are two primary issues involved, the first of which relates to the amounts allowable as invested capital for the years 1917, 1918, and 1920, and the second to income adjustments for the years 1917, 1918, 1920, and 1922. The claimed income adjustments result from *235 the action of the Commissioner in disallowing as deductions from gross income, on the grounds that they constituted additions to capital, certain expenditures made by the petitioner for items of coalmining*1675 equipment which the petitioner contends did not increase the output or reduce the cost of operation or add to the value of the petitioner's mines. It is also claimed that the petitioner's net loss for 1921 was larger than the amount allowed by the Commissioner and that by virtue thereof it is entitled to a larger deduction from the net income of 1922 than has been allowed by the Commissioner.
FINDINGS OF FACT.
1. The petitioner is a West Virginia corporation, organized January 8, 1912, having its principal corporate office at Wellsburg, Brooke County, W. Va., and an accounting office at Cleveland, Ohio, from which its tax returns for the years 1917 to 1922, inclusive, were filed.
2. On May 1, 1912, the petitioner acquired from Lewis-findley Coal Company, a West Virginia corporation, certain coal lands and other physical property of a value as of said date of $2,201,139, together with $93,619.16 in cash and miscellaneous assets and receivables of an aggregate value as of said date of $78,533.05, in consideration of the issuance of 14,900 shares of capital stock of the petitioner of a par value of $100 per share and the assumption by the petitioner of $1,000,000 face amount*1676 of the outstanding bonds of the Lewis-Findley Coal Company and of miscellaneous unsecured debts of that company aggregating $54,029.01.
3. The actual cash value of the coal lands and other physical property so acquired by the petitioner on May 1, 1912, was on January 1, 1914 $2,170,064.42, and the actual cash value as of January 1, 1914, of the miscellaneous assets and receivables acquired by the petitioner on May 1, 1912, from the Lewis-Findley Coal Company was $78,533.05.
4. The petitioner on January 1, 1917, had an accumulated operating deficit of $311,600.62.
5. On January 13, 1915, the authorized capital stock of the petitioner was reduced to 10,000 shares having a par value of $100 per share. No cash or other assets of the petitioner were paid out or distributed to the stockholders of the petitioner in connection with or as a result of such reduction of capital stock. The transaction was accounted for on the books of the petitioner by reducing its capital stock account from $1,500,000 to $1,000,000 and by reducing its book investment in coal lands and equipment by $500,000.
6. No dividends were paid by the petitioner upon its capital stock from the time of its*1677 organization to and including December *236 31, 1920, except one on August 31, 1920, in the amount of $100,000 and another on September 30, 1920, in the amount of $50,000.
7. In computing the invested capital of the petitioner for the taxable year 1918, the Commissioner decreased the amount at which the mining properties of the petitioner were to be included in invested capital by the amount of $115,003.69 in respect of depletion alleged to have been sustained by said mining properties from the time of their acquisition by the petitioner to and including December 31, 1917, the petitioner at the beginning of the year having an operating deficit.
8. In computing the invested capital for 1920, the Commissioner decreased the amount at which the mining properties of the petitioner were to be included in invested capital by the amount of $175,141.87 in respect of depletion alleged to have been sustained by the mining properties from the time of their acquisition by the petitioner to and including December 31, 1919.
9. In computing the invested capital of the petitioner for the taxable years 1918 and 1920, respectively, the Commissioner decreased invested capital by $96,199.13*1678 in respect of depreciation alleged to have been sustained on the depreciable property of the petitioner from the time of its acquisition to and including December 31, 1916. The petitioner had an operating deficit at January 1, 1918.
10. In computing the invested capital of the petitioner for 1918, the Commissioner decreased the invested capital by $17,176.90 in respect of income and profits taxes upon the petitioner for the taxable year 1917, thereby reducing invested capital below the original paid-in capital.
11. In computing invested capital for 1920, the Commissioner decreased invested capital by $893.51 in respect of income taxes upon the petitioner for the taxable year 1919, and by the amounts of $288,337.26 and $30,292.40, respectively, for additional income and profits taxes for the taxable years 1917 and 1918.
12. In determining the deficiencies shown in the notice of deficiency in Docket No. 20337, the Commissioner has allowed the petitioner as invested capital for 1917 the amount of $1,000,000, for the year 1918, $1,018,812.06, and for the year 1919, $1,092,373.63.
13. The petitioner operates in the "Panhandle" district of West Virginia. Since 1912 it has*1679 owned and operated three coal mines, all of which are located in Brooke County, West Virginia, and all of which mine on the Pittsburgh vein.
14. The mines so owned and operated by the petitioner are known respectively as the Locust Grove Mine, the Gilchrist Mine, and the La Belle Mine. All of these mines are drift mines; that is, the outcrop occurs on a hillside so that the entries and workings can be *237 driven in horizontally instead of it being necessary to sink a vertical shaft down to the coal. The coal mined is high-volatile bituminous.
15. During the years 1917 to 1922, inclusive, the Locust Grove Mine had an output capacity of approximately 1,500 tons of coal per day; the Gilchrist Mine of approximately 800 tons of coal per day; and the La Belle Mine of approximately 700 tons of coal per day.
16. The normal daily output capacity of a mine is the productive capacity of the mine as demonstrated in actual production and as contemplated by the predesigned machinery and the equipment incident to the operation.
17. During 1917 the petitioner made the following expenditures for items of mine equipment:
| Steel rails | $18,153.72 |
| Mining machines | 8,900.00 |
| Mine locomotives | 4,150.00 |
| Mules | 4,272.50 |
| Motors | 2,474.20 |
| Pumps | 2,003.20 |
| Pipe | 1,149.20 |
| Steel ties | $585.00 |
| Trolley wire | 917.07 |
| Fans | 380.83 |
| Mine car - repair parts | 8,925.50 |
| Rotary converter | 5,250.00 |
| 57,161.22 |
*1680 18. All the above items of equipment purchased in 1917, and disallowed by the respondent as a deduction in that year, were purchased for the purpose of maintaining the normal daily production of the petitioner's mines and were actually installed in the petitioner's mines during the year 1917. None of this equipment was purchased for the purpose of increasing the normal output of the petitioner's mines or for the purpose of decreasing the cost of operation thereof. The installation of this equipment did not have the effect of increasing the normal output of the petitioner's mines nor of decreasing the cost of operation thereof.
19. The expenditure of $8,925.50 for "mine car repair parts" made during 1917 and disallowed by the respondent as a deduction in that year, was for mine car wheels and car repair parts, which were purchased to repair the petitioner's mine cars. They were used for that purpose during the year 1917, and were not used for the purpose of building new cars.
20. During 1918 the petitioner made expenditures for mine locomotives of $22,587. These expenditures were charged by the petitioner on its books to operating expense. The Commissioner has disallowed*1681 these expenditures as deductions from gross income for the taxable year 1918, on the ground that they should have been capitalized.
21. These mine locomotives, purchased in 1918, the cost of which has been disallowed by the respondent as a deduction in that year, were purchased for the purpose of maintaining the normal production of the petitioner's mines and were actually installed and placed *238 in service in the petitioner's mines during the year 1918. They were necessary because of the increased length of haul consequent upon the advance of the working faces. They were not purchased for the purpose of increasing output or decreasing cost of operation, and their installation did not have the effect of increasing output or decreasing cost of operation.
22. Two 5-ton locomotives purchased by the petitioner in 1917 at a cost of $2,850, constituting part of the equipment charged by the petitioner to expense in that year and disallowed as a deduction by the respondent, were scrapped in 1918.
23. During 1920 the petitioner made the following expenditures for items of mine equipment:
| Mine cars | $41,070.72 |
| Steel rails | 31,346.26 |
| Mining machines | 12,375.00 |
| Transformers | 3,416.04 |
| Mules | 7,197.94 |
| Motor | $400.00 |
| Pumps | 2,904.30 |
| Self-starters | 791.50 |
| 99,501.76 |
*1682 These expenditures were charged by the petitioner on its books to operating expense. The respondent has disallowed these expenditures as deductions from gross income for the taxable year 1920 on the ground that they should have been capitalized.
24. The mine cars purchased in 1920 were purchased to take care of the increased length of haul consequent upon the advance of the working faces. The steel rails were purchased to extend the trackage facilities of the petitioner's mines as the working faces advanced, and to replace rails which had been worn out. The mining machines were purchased to take care of the cutting of the coal in the scattered territory opened up by the advancing working faces. The transformers were purchased for installation in additional substations which became necessary as the area of the mine increased, or to replace transformers destroyed by lightning. The mules were purchased to take care of the extra haulage due to the advance of the workings and to replace mules that had been worn out or killed. The motors were purchased to operate pumps or fans needed by reason of the advance of the workings. The pumps were purchased for use in draining the additional*1683 area opened up by the advancing working faces, or to replace pumps worn out in service or eaten out by the action of the sulphur water prevalent in the mine. The self-starters were purchased to equip motors for newly installed pumps and fans.
25. All of the above items of equipment purchased in 1920, and disallowed by the respondent as deductions in that year, were purchased for the purpose of maintaining the normal daily production of the petitioner's mines, and were actually installed in the petitioner's mines during the year 1920. None of this equipment was purchased for the purpose of increasing the normal output of the petitioner's *239 mines or for the purpose of decreasing the cost of operation thereof. The installation of such equipment did not have the effect of increasing the normal output of the petitioner's mines nor of decreasing cost of operation thereof.
26. During the year 1921 the petitioner made the following expenditures for mine equipment:
| Mine cars | $5,500.00 |
| Mine locomotives | 11,117.00 |
| Mining machines | 5,500.00 |
| Motors | 1,401.55 |
| Motor-generator set | 4,400.00 |
| Mules | $1,247.19 |
| Pumps | 525.00 |
| 29,690.74 |
These expenditures*1684 were charged by the petitioner on its books to operating expense. The respondent disallowed these expenditures as deductions from gross income for the taxable year 1921 on the ground that they should have been capitalized.
27. The mine cars, mining machines, motors, mules and pumps purchased by the petitioner during the year 1921 were purchased for the same purposes as the similar equipment purchased in 1920. The mine locomotives purchased in 1921 were purchased for the same purposes as the mine locomotives purchased in 1918. The motor-generator set was purchased in order to provide additional power to take care of the increased power requirements of the additional equipment made necessary by the increased area of the mine, and also to overcome line loss resulting from the increased length of transmission lines.
28. All the above items of equipment, purchased in 1921 and disallowed by the respondent as deductions in that year, were purchased for the purpose of maintaining the normal daily output of the petitioner's mines, and were actually installed in the petitioner's mines during the year 1921. None of this equipment was purchased for the purpose of increasing the normal*1685 output of the petitioner's mines or for the purpose of decreasing the cost of operation thereof. The installation of such equipment did not have the effect of increasing the normal output of the petitioner's mines nor of decreasing the cost of operation thereof.
29. A rotary converter, purchased in 1917 at a cost of $5,250 and charged by the petitioner to expense in that year, and disallowed by the respondent as a deduction in that year, was placed in a substation at the mine in 1917, but was never actually operated. When it was attempted to operate this machine in 1918, it was discovered that it would not operate, for the reason that it was a 25-cycle machine, whereas the only current available was 60-cycle. The machine was moved outside of the substation and never used again, and was eventually scrapped in 1921.
*240 30. During 1922 the petitioner made the following expenditures for mine equipment:
| Fan | $1,070.00 |
| Mine locomotives | 10,950.00 |
| Mine cars | 9,475.00 |
| Mining machines | 7,225.00 |
| Motors | 430.50 |
| Motor-generator set | 4,664.71 |
| Mules | $3,069.15 |
| Pumps | 225.00 |
| Replacement of drum hoist | 1,500.00 |
| Transformers | 100.00 |
| 38,709.36 |
These*1686 expenditures were charged by the petitioner on its books to operating expense. The respondent has disallowed these expenditures as deductions from gross income for the taxable year 1922, on the ground that they should have been capitalized.
31. The fan purchased in 1922 was purchased to take care of the ventilation in the increased area of the petitioner's mines so that normal production could be maintained. The mine locomotives were purchased fo the same purpose as those purchased in 1918. The mine cars, mining machines, motors, mules, pumps and transformers were purchased for the same purpose as those purchased in 1920. The motor-generator set was purchased for the same purpose as that purchased in 1921.
32. All of the above items of equipment purchased in 1922 and disallowed by the respondent as deductions in that year were purchased for the purpose of maintaining the normal daily output of the petitioner's mines, and were actually installed in the petitioner's mines during the year 1922. None of this equipment was purchased for the purpose of increasing the normal output of the petitioner's mines or for the purpose of decreasing the cost of operation thereof. The*1687 installation of such equipment did not have the effect of increasing the normal output of the petitioner's mines, nor of decreasing the cost of operation thereof.
33. The item of $1,500 disallowed by the respondent in 1922 as "replacement of drum hoist" was in fact a repair. A drum hoist is a large unit consisting of a motor, frame, gears and a spool on which the cable winds. It is used in raising and lowering mine cars along the incline leading from the mine-mouth to the tipple. The expenditure made in 1922 was for the purchase of a new spool to replace one that was worn out. The new spool was used for such replacement in 1922. The spool so replaced was only a part of the complete drum hoist.
34. The petitioner's mines had all passed out of the development stage prior to 1917; that is, sufficient surface facilities had been constructed and working places developed to permit the mines to produce their respective normal daily output capacities.
35. The output capacity of the petitioner's mines was not increased during the period from 1917 to 1922, nor was the cost of *241 operation decreased, and no expenditures were made during this period for the purpose of*1688 increasing output or decreasing cost of operation. The sole purpose of purchasing additional equipment acquired during this period was to maintain normal production and prevent an undue increase in the cost of operation.
36. Natural conditions in the petitioner's mines made it necessary for the petitioner to purchase more equipment to produce a given tonnage than would be needed in a mine where these conditions did not exist. The petitioner's mines are unusually wet, which requires numerous pumps for drainage with motors to operate them. This water has a high sulphuric acid content which attacks and rapidly corrodes all of the metal equipment with which it comes in contact. The nature of the terrain in which the petitioner's mines are located is such that the coal measure is cut by deep ravines into a so-called "oak-leaf" formation, with the result that the working places become widely scattered, and more mining machines and other equipment are needed to produce a given daily tonnage than in a mine where the coal is found in a broad unbroken block.
37. The average normal useful life of the various types of mine equipment purchased by the petitioner during the taxable years*1689 1917-1922 was not less than as follows:
| Years | |
| 60 and 70 lb. steel rail | 5 |
| 40 and 45 lb. steel rail | 4 |
| 25 lb. steel rail | 2 |
| Mining machines | 10 |
| Mine locomotives | 10 |
| Mules and ponies | 2 |
| Motors | 3 |
| Pumps | 2 |
| Wood pipe | 3 |
| Steel ties | 4 |
| Trolley wire | 6 |
| Fans | 5 |
| Rotary converters | 10 |
| Motor-generator sets | 10 |
| Mine cars | 3 |
| Transformers | 10 |
| Self-starters | 2 |
38. The production of the petitioner's mines for the years 1913 to 1920, inclusive, was in tons as follows:
| Tons | |
| 1913 | 347,024.35 |
| 1914 | 331,041.71 |
| 1915 | 367,207.29 |
| 1916 | 441,380.69 |
| 1917 | 377,591.88 |
| 1918 | 537,927.6 |
| 1919 | 603,165.3 |
| 1920 | 652,923.49 |
39. It is the general practice in the bituminous coal-mining industry to charge to current expense expenditures for additional equipment for a developed coal mine when such equipment is purchased for the purpose of maintaining normal production.
OPINION.
SMITH: The principal issue in these proceedings is whether the petitioner may deduct from gross income in the tax years involved *242 amounts paid for additional machinery and equipment to maintain the normal output of its mines. This issue is decided in favor of the*1690 petitioner, upon the authority of ; ; , inconsistent with or reversing decisions of the Board which held that such expenditures were not deductible from gross income as ordinary and necessary expenses. In view of the above cited cases, the decision of the Board in , and numerous other cases denying the deduction of such items, will not be followed in the future.
This disposition of the claimed deductions for additional items of machinery and equipment necessarily changes the computations of invested capital. Other questions relating to invested capital may be shortly disposed of. They are:
(1) Whether the full value of the coal lands and other physical property and the receivables and the amount of cash acquired by the petitioner for stock in 1912 are to be included as part of the petitioner's invested capital for 1917, 1918, and 1920;
(2) Whether the petitioner's invested capital for 1918 and 1920*1691 should be reduced by allowances for depletion or depreciation alleged to have been sustained in prior years; and
(3) Whether the petitioner's invested capital for 1918 and 1920 should be reduced by amounts in respect of taxes for prior years.
In addition, the facts of record raise two other issues which must be determined before there can be a recomputation of the deficiencies involved.
(4) Whether the reduction of the petitioner's outstanding stock in 1915 had any effect upon its invested capital for 1917, 1918, and 1920; and
(5) Whether the dividends paid by the petitioner in 1920 had any effect upon its invested capital for that year.
The last two points will be disposed of first. The reduction of the petitioner's outstanding stock in 1915 from $1,500,000 to $1,000,000 did not operate to reduce the allowable invested capital. Cf. ; .
Whether the dividends paid in 1920 affected the invested capital for 1920 depends upon the question as to whether the earnings of the company up to the date of each dividend payment had served to wipe out the*1692 operating deficit and to equal the dividend payment. . For 1920 the respondent found an invested capital of $1,092,373.63. Petitioner contends that the invested capital should be $1,319,262.20, the same as for *243 1918. It admits, however, that the determination of this question depends upon whether the petitioner had a sufficient surplus available for the payment of the dividends at the time they were paid in 1920. Whether there was a sufficient surplus will be determined on the recomputation made in conformity with this opinion.
In the computation of the deficiency for 1917, the respondent has used an invested capital of $1,000,000, which represented the par value of the stock outstanding at January 1, 1917. Counsel have stipulated that the assets acquired by the petitioner in exchange for its capital stock in 1912, had a cash value at the date of acquirement as follows:
| Coal lands and other physical property | $2,201,139.00 |
| Receivables | 78,533.05 |
| Cash | 93,619.16 |
| Total assets acquired | 2,373,291.21 |
| Less: | |
| Total liability assumed | 1,054,029.01 |
| Original paid-in capital | 1,319,262.20 |
*1693 The stipulation further shows that the actual cash value of the coal lands and other physical property acquired as above on January 1, 1914, was $2,170,064.42. The petitioner contends that the invested capital for 1917 is to be based upon the full value as of January 1, 1914, of the physical property and receivables acquired by the petitioner on May 1, 1912, together with the amount of cash then acquired (the company having no earned surplus but instead an operating deficit), which amount is found to be $1,288,187.62. The contention of the petitioner is sustained upon the authority of .
For 1918 the respondent computed an invested capital of $1,018,812.06. The petitioner had no earned surplus at the beginning of the year. It contends that the paid-in capital should not be reduced by allowances for depletion or depreciation alleged to have been sustained in prior years, nor by amounts in respect of taxes for prior years, nor by the fact that its capital stock outstanding was reduced by from $1,500,000 to $1,000,000 in 1915, there being in that year no distribution of assets or earnings to its stockholders. *1694 The Board has repeatedly distinguished between earned surplus and paid-in capital and surplus for invested capital purposes. Thus, paid-in capital or surplus is not reduced by an operating deficit. ; ; ; . The contention of the petitioner upon this point must be sustained. In , the Board stated:
*244 * * * There is no distinction, in so far as concerns invested capital, between impairment resulting from an operating deficit and impairment resulting from depletion where adequate provision has not been made therefor. If the depletion actually sustained is not charged against surplus, to that extent there is no true earned surplus. * * *
In the same opinion we stated at page 175:
* * * The amount originally invested is not involved here. When the mine is purchased the investment ordinarily represents paid-in capital which is not reduced by depletion and which amount remains in invested capital unless and until withdrawn*1695 in whole or in part by the stockholders in the way of dividends or otherwise. * * *
The parties have stipulated that at January 1, 1917, the petitioner had an accumulated operating deficit of $311,600.62. The net incomes, as found by the respondent for 1917 and 1918, were not sufficient to wipe out the operating deficit. The petitioner contends that the invested capital for 1918 should be $1,319,262.20, which as above shown, was the excess of the fair market value of the assets paid in to the corporation in 1912 for shares of stock over the liabilities assumed. The contentions of the petitioner with respect to the computation of invested capital for 1918 are sustained.
Reviewed by the Board.
Judgments will be entered under Rule 50.