*1871 1. An allowance determined for exhaustion, wear and tear of property used in the iron furnace business, including a reasonable allowance for obsolescence.
2. Expenditures incident to the restoration of petitioner's dock classified as between capital and expense items.
3. Petitioner performed certain switching service from 1905 to 1914, without receiving payment therefor, when its competitors were either receiving payment for rendering such service or the service was being rendered for them without charge. In 1911 the Interstate Commerce Commission found that the discriminatory practice existed and in 1917 ordered the railroads to pay the petitioner the cost of rendering such service from 1905 to 1914. The railroads, however, refused to pay and suits were instituted by petitioner to enforce collection. The suits were compromised in 1920 through payment to petitioner of approximately one-half of the cost found by the Interstate Commerce Commission. Held, that the entire amount received constituted income to the petitioner when received in 1920.
4. Commissioner's adjustment of invested capital under articles 845 and 845(a) of Regulations 45, sustained.
*440 These proceedings, which were consolidated for hearing and decision, involve deficiencies in income and profits tax as determined by the Commissioner for the fiscal years ended April 30, 1919, April 30, 1920, and April 30, 1921, in the respective amounts of $223,336.65, $148,274.68 and $75,047.09. Errors were assigned with respect to (1) the allowance on account of depreciation and obsolescence on plant and equipment, (2) the failure of the Commissioner to allow credits to a reserve for furnace linings as deductions in computing net income, (3) whether certain expenditures on petitioner's dock constitute capital or expense items, (4) the treatment of an amount received in June, 1920, in settlement of a certain railroad controversy, as income for the year in which received, and (5) the reduction of invested capital on account of income and profits taxes which had accrued for the various prior respective years. In addition, errors were assigned on account of the effect on invested capital of certain tentative tax computations in*1873 determining the earnings available for the payment of dividends and the purchase of preferred stock for retirement, but the Commissioner confessed error as to these items.
FINDINGS OF FACT.
The petitioner is a New York corporation and during the years involved was engaged in the business of manufacturing pig iron in Buffalo.
1. The petitioner's plant was located on a plot of ground of about 55 acres on the Buffalo River, which river is navigable for lake boats at that point. The plant itself consisted of three blast furnaces - known *441 as A, B and C - of a daily capacity of from 300 to 325 tons each. The furnaces were served by a common ore dock on the Buffalo River, two of the furnaces being adjacent to the ore dock and the third on the other side of the property to which the ore was transferred by railroad cars.
Each furnace was a complete unit, its tonnage capacity being determined by the size of the furnace hearth, and therefore, if it became necessary to construct one of the more modern furnaces (hereinafter referred to), the entire unit would have to be dismantled. With very few exceptions, the buildings were mere shells to enable the men to work with*1874 a reasonable degree of protection and in many cases were supported by the furnaces themselves. The auxiliary equipment, such as cranes, ladles and pig-casting machines, was likewise an integral part of a given furnace unit and was not adapted for use in the much larger unit. No central power plant existed for the three furnaces, but each had its own power plant as an integral part of the furnace itself. Further equipment consisted of some cars and one or two locomotives which were used for switching purposes, and certain dock equipment and facilities which are referred to in more detail under another issue.
The basic unit in each blast furnace is a vertical cylindrical steel shell which is lined with fire bricks. Iron ore, coke and limestone in varying amounts are dumped into the top of this fire-brick-lined shell. Hot air is blown into the furnace by blowing engines at the bottom, where the combustion takes place, and as fast as the combustion takes place at the bottom, which reduces the iron ore to molten iron, the mixture of ore, coke and limestone recedes from the top of the furnace. At intervals of from four to six hours sufficient iron has been melted in the bottom of*1875 the furnace so that it is tapped and the molten iron removed and cast into pigs suitable for shipment to the trade. In order to heat the air for the hot blast blown into it, each furnace has four cylinders lined with fire-brick flues. These are known as stoves. The waste gas from the furnace is piped into the stoves and used for the purpose of heating the fire-brick lining. The waste gases which come from the top of the furnace, in addition to heating the stoves, which in turn heat the blast, are also burned under boilers to supply steam to operate the blowing engines and other auxiliary equipment, consisting of a large number of pumps. The operation of a blast furnace is continuous, the only reason for shutting down being for repairs or lack of market.
The petitioner's furnaces were merchant furnaces, that is, the petitioner manufactured pig iron to sell to consumers, and consumed none of its own product. The market for its product was found largely in New York, eastern Pennsylvania, eastern Ohio, and the *442 New England States, and its product was in competition with blast furnaces located in this area and beyond it within the range of competitive transportation*1876 costs. Until about 1917 or 1918 petitioner's furnaces were of the same general type and capacity as the greater number of other furnaces with which petitioner was in competition.
The three furnaces of petitioner were originally built and owned by separate corporations in 1893, 1898 and 1900, but they had been enlarged, improved and reequipped in many respects by 1918. Owing to the great demand for iron during the war period and due to the fact that it had been demonstrated that merchant iron of a more uniform character and better quality could be manufactured in the larger type of furnace than in the existing small type of furnace, a large number of the larger and more modern type of furnace were built during the period 1918 to 1920 by petitioner's competitors or concerns which then became competitors. The newer furnaces were from 600 to 1,000 tons capacity as compared with 300 to 400 tons for the old furnaces and included many mechanical and operating improvements which resulted in more efficient operation, the utilization of gas, and other economies which greatly reduced the cost of pig iron manufactured in the new furnaces. In addition to the construction of the newer type*1877 of furnace by concerns which were engaged solely in the manufacture of pig iron for sale, some of the steel companies also installed furnaces of this type, with the result that instead of having to purchase some of the pig iron which they used they now had pig iron for sale and thus became competitors of petitioner. After 1918 the newer and heavier type of furnace became the standard of construction. A change in blast furnace construction and design comparable to that which took place from 1918 to 1920 had not taken place prior to that time.
While some smaller furnaces were remodeled in line with the newer type of furnace, in such instances it was generally necessary to dismantle them completely and build up entirely new units, since the furnace hearth does not permit of enlargement and it is the furnace hearth which determines the tonnage capacity. Petitioner's furnaces could not have been remodeled without dismantling the existing furnaces, constructing new units and reequipping them.
The physical life of a blast furnace is dependent in large measure upon industrial conditions and the extent to which repairs are made. Repairs and replacements can be made to such an extent*1878 that a given unit will last indefinitely. In the case of petitioner's furnaces much of the original furnaces had been entirely exhausted and replaced by the time involved in these proceedings, and the furnaces were comparable with the type of merchant furnaces then in general use, *443 though not with the newer type then being constructed. During the years here in question petitioner's repair work was very heavy.
During the fiscal year ended April 30, 1919, petitioner's officers were aware of the changes which were taking place in blast furnace construction and considered their effect upon the continued use of petitioner's existing plant in competition with the more modern type of furnace. The petitioner, however, had a very valuable good will that extended over a great many years and there was some prejudice in the minds of buyers of pig iron against iron made by steel companies. The petitioner's officers were accordingly of the opinion that the business could be continued for some time with the existing furnaces, though they were of the opinion that the furnaces could not be operated throughout their physical life in competition with the more modern type of furnace. *1879 The rate of 10 per cent then fixed to take care of depreciation and obsolescence was approximately that which was required to effect a recovery of cost over the period when the furnaces were continued in operation.
In 1920, the petitioner leased its plant to the Hanna Furnace Company, a subsidiary of the M. A. Hanna Company, for a period of 40 years from July 1, 1920, with the option of the lessee to purchase at any time after 20 years. It was not a lease of the plant in the ordinary sense, but was a turning over to the lessee of the assets of the petitioner, including plant, cash, working capital and all of its interests of every kind connected with the furnace business. The petitioner then had between one and one-half and two million dollars in net quick assets and a very small indebtedness. The petitioner was then also operating under a long-term contract with the M. A. Hanna Company for the supply of iron ore, which was entered into in 1914 or 1915 and was very advantageous to the petitioner. So advantageous was the contract to the petitioner that during the war period it voluntarily made some additional payments to the M. A. Hanna Company on account of changed conditions. *1880 This contract was considered one of the principal assets of the petitioner. In addition, the petitioner had entered into a contract with the United States Government for the building of a large by-product coke plant, which was to supply it with coke. That contract proved very favorable upon the termination of the war. The foregoing contracts were important considerations in the negotiation of the contract on the part of the lessee. One paragraph of the lease read as follows:
We will maintain your plant in first class condition, so that on its return to you it shall constitute a modern pig iron producing plant in first class condition capable of producing not less than 1,000 gross tons per day of pig iron by the then accepted best method and practice of the trade.
*444 During the period from 1920 to 1927 the aforementioned lessee expended approximately $750,000 to $800,000 in modernizing and making more efficient the petitioner's blast furnaces here in question and during that period the lessee's losses aggregated more than $4,000,000. Prior to October 1, 1927, the M. A. Hanna Company acquired control of the petitioner and as of October 1, 1927, the aforementioned*1881 lease with the Hanna Furnace Company was canceled.
The operation of the "C" furnace was discontinued in April, 1925, and that of the "A" furnace in January, 1928. Both furnaces were partially demolished in 1928. The "B" furnace, which manufactures a special kind of iron, was still in operation on January 15, 1930, but will not continue in operation after a stock pile of ore is consumed or the present furnace linings are consumed, whichever is sooner. The entire salvage value of the three furnaces upon abandonment, including auxiliary and dock equipment, will not exceed $50,000 or $60,000.
The petitioner's books showed the following status of the plant and reserve accounts:
| Cost of plant | Depreciation reserve | |
| May 1, 1918 | $2,769,827.78 | $664,342.63 |
| May 1, 1919 | 2,767,293.78 | 852,185.60 |
| May 1, 1920 | 2,856,207.41 | 1,123,566.49 |
| May 1, 1921 | 2,840,888.81 | 1,394,106.15 |
Before providing for depreciation for the year ending on the dates indicated, the amount of cost of plant to be recovered was as follows:
| April 30, 1919 | $2,102,951.15 |
| April 30, 1920 | 2,004,021.81 |
| April 30, 1921 | 1,717,322.32 |
The amount of plant investment to be recovered*1882 on May 1, 1921, after taking into consideration depreciation set up prior thereto, was $1,446,782.66.
Depreciation (including obsolescence) was set up by petitioner on its books and claimed as deductions in its returns as follows:
| April 30, 1919 | $269,825.44 |
| April 30, 1920 | 277,981.05 |
| April 30, 1921 | 283,922.16 |
Prior to the fiscal year ended April 30, 1919, petitioner took depreciation on its entire plant and equipment at a composite rate of 5 per cent, but in that year and for the other years here in question it increased the rate to 10 per cent in order to take care of *445 both depreciation and obsolescence. In the determination of the deficiencies with which we are concerned, the Commissioner reduced the foregoing rate of 10 per cent to 5 per cent.
In its fiscal years ended April 30, 1920, and April 30, 1921, the petitioner charged to the cost of making pig iron and deducted from income 50 cents for each ton of iron produced to take care of the expense of relining the blast furnaces and stoves. The amount charged was credited to a reserve account and when a given furnace was relined this account was charged with the cost of such relining. The*1883 aggregate amount of these deductions for 1920 was $212,734.64 and for 1921, $25,091.51. With varying rates, this has always been petitioner's uniform practice and is similarly followed generally in the industry. The average life of a furnace lining, according to petitioner's experience, is approximately from 2 to 2 1/2 years, though so many factors enter into the life of a given lining that it is difficult, if not impossible, to predict or foresee its exact life. In petitioner's experience it has had linings that were entirely consumed in three months and in other instances they have been known to last as long as five or six years. Labor and material costs necessary to replace the linings were taken into consideration in fixing the amount to be set up in the reserve. The following information was furnished with respect to this reserve account from January 1, 1910, to April 30, 1920:
| Dr. | Cr. | ||
| Balance Jan. 1, 1910 | $36,243.87 | ||
| Product "A" | 106,422 tons | ||
| Product "B" | 98,607 tons | ||
| Product "C" | 55,112 tons | ||
| 260,141 tons at 20?? | $52,028.20 | ||
| Relining "C" furnace | 25,995.55 | ||
| Balance forward Dec. 31, 1910 | 10,211.22 | ||
| 62,239.42 | 62,239.42 | ||
| Balance Jan. 1, 1911 | 10,211.22 | ||
| Product "A" | 108,578 tons | ||
| Product "B" | 104,616 tons | ||
| Product "C" | 31,593 tons | ||
| 244,787 tons at 20?? | 48,957.40 | ||
| Stove repairs, "A" furnace | 9,074.93 | ||
| Balance forward Dec. 31, 1911 | 29,671.25 | ||
| 48,957.40 | 48,957.40 | ||
| Balance Jan. 1, 1912 | 29,671.25 | ||
| Product "A" | 105,849 tons | ||
| Product "B" | 100,497 tons | ||
| Product "C" | 60,279 tons | ||
| 266,625 tons at 20?? | 53,325.00 | ||
| Stove repairs, "A" furnace | 2,580.75 | ||
| Balance forward Dec. 31, 1912 | 80,415.50 | ||
| 82,996.25 | 82,996.25 | ||
| Balance Jan. 1, 1913 | $80,415.50 | ||
| Product "A" | 102,762 tons | ||
| Product "B" | 48,137 tons | ||
| Product "C" | 94,997 tons | ||
| 245,896 tons at 20?? | 49,179.20 | ||
| Stove repairs, "B" furnace | $19,950.52 | ||
| Dec. 31 - Credit to profit and loss | 34,644.18 | ||
| Balance forward Dec. 31, 1913 | 75,000.00 | ||
| 129,594.70 | 129,594.70 | ||
| Balance Jan. 1, 1914 | 75,000.00 | ||
| Product "A" | 78,236 tons | ||
| Product "B" | 51,723 tons | ||
| Product "C" | 83,969 tons | ||
| 213,928 tons at 20?? | 42,785.60 | ||
| Relining "A" furnace | 87,093.14 | ||
| Relining "B" furnace (part) | 50,216.48 | ||
| Relining "C" furnace | 21,873.09 | ||
| Balance forward Dec. 31, 1914 | 41,397.11 | ||
| 159,182.71 | 159,182.71 | ||
| Balance Jan. 1, 1915 | 41,397.11 | ||
| Product "A" | 110,002 tons | ||
| Product "B" | 84,272 tons | ||
| Product "C" | 96,581 tons | ||
| 290,855 tons, at 20?? | 58,171.00 | ||
| Relining "B" furnace (balance) | 26,325.53 | ||
| Balance forward Dec. 31, 1915 | 9,551.64 | ||
| 67,722.64 | 67,722.64 | ||
| Balance Jan. 1, 1916 | 9,551.64 | ||
| Jan. 1, 1916, to Apr. 40, 1916: | |||
| Product "A" | 37,511 tons. | ||
| Product "B" | 35,840 tons. | ||
| Product "C" | 33,698 tons. | ||
| 107,049 tons, at 20?? | 21,409.80 | ||
| Balance forward Apr. 30, 1916 | 11,858.16 | ||
| 21,409.80 | 21,409.80 | ||
| NOTE. - Fiscal year changed Jan. 1, 1916, from a calendar year basis to Apr. 30 - 16 months reported at this time. | |||
| Balance May 1, 1916 | 11,858.16 | ||
| Product "A" | 37,536 tons. | ||
| Product "B" | 40,067 tons. | ||
| Product "C" | 41,616 tons. | ||
| 119,219 tons, at 20?? | 23,843.80 | ||
| Product "A" | 50,556 tons. | ||
| Product "B" | 39,408 tons. | ||
| Product "C" | 14,732 tons. | ||
| 104,696 tons, at 30?? (From Nov. 1, 1916) | 31,408.80 | ||
| Total product | 223,915 tons. | ||
| Relining "A" furnace (mantle up) | 34,787.05 | ||
| Relining "B" furnace | 55,199.18 | ||
| Relining "C" furnace | 39,007.17 | ||
| Balance forward Apr. 30, 1917 | 61,882.64 | ||
| 128,993.40 | 128,993.40 | ||
| Balance May 1, 1917 | 61,882.64 | ||
| Product "A" | 72,568 tons | ||
| Product "B" | 100,522 tons | ||
| Product "C" | 81,308 tons | ||
| 254,398 tons, at 50?? | 127,199.00 | ||
| Relining "C" furnace (balance) | 15,257.27 | ||
| Balance forward Apr. 30, 1918 | 50,059.09 | ||
| 127,199.00 | 127,199.00 | ||
| Balance May 1, 1918 | $50,059.09 | ||
| Product "A" | 45,837 tons | ||
| Product "B" | 107,610 tons | ||
| Product "C" | 101,250 tons | ||
| 254,697 tons, at 50?? | 127,348.50 | ||
| Relining "A" furnace | $177,377.45 | ||
| Balance forward Apr. 30, 1919 | 60,030.14 | ||
| 177,407.59 | 177,407.59 | ||
| Balance Apr. 30, 1919 | 60,030.14 | ||
| Product "A" | 74,840 tons | ||
| Product "B" | 124,281 tons | ||
| Product "C" | 106,288 tons | ||
| 305,409 tons, at 50?? | 152,704.50 | ||
| Balance forward Apr. 30, 1920 | 212,734.64 | ||
| 212,734.64 | 212,734.64 | ||
| Balance Apr. 30, 1920 | 212,734.64 | ||
| Product "A" | 15,473 tons | ||
| Product "B" | 16,992 tons | ||
| Product "C" | 14,311 tons | ||
| 46,776 tons, at 50?? | 23,388.00 | ||
| Adjustment account overrun on iron yard 4,247 tons, at 50?? | 2,123.50 | ||
| Adjustment relining reserve account - fire brick on hand | 419.99 | ||
| Balance forward June 30, 1920 | 237,826.15 | ||
| 238,246.14 | 238,246.14 |
*1884 *447 When petitioner's plant account was first opened there was included therein an amount of $184,458.98 as representing the cost of the original furnace linings, and this amount is still included in the plant account on which a composite rate of 5 per cent has been allowed by the Commissioner as depreciation, but on which a rate of 10 per cent is claimed by the petitioner. No additions have been made to this amount on account of new linings, nor has any charge been made against the plant depreciation reserve for new linings. The general practice in the industry is to include the original cost of furnace linings in the plant account and compute depreciation thereon in the manner followed by the petitioner. In the prior years the Commissioner allowed additions to the reserve as a deduction from gross income as well as a deduction for depreciation based upon a composite rate of 5 per cent on the entire plant account.
2. Along that part of the plant fronting on the Buffalo River, petitioner had an ore and limestone dock with an adjacent storage yard upon which it unloaded and stored quantities of iron ore and limestone for use in its operations. The total length of the*1885 dock was about 2,300 feet and that part of the dock used for the unloading and storage of ore and limestone was 1,450 feet. The dock itself consisted of timber crib work about 26 feet wide and 27 feet deep, filled with stone, resting on bed rock, and surmounted by concrete walls to carry on rails the front legs of the ore unloading bridges. The cribs were anchored to the rock by car axles set in the rock. *448 Extending back from this dock structure was a yard area of natural, original hard clay about 150 feet in width and running the entire length of the dock. The ore unloaders spanned this entire back area, which constituted the storage yard for iron ore and limestone.
In the fall of 1918, a portion of the dock, about 400 feet long, collapsed and slid into the river. That portion of the dock was wrecked and the iron ore, several thousand tons, subsided to bed-rock, thus displacing the earth on which it rested and forcing this section of the dock and rear area into the river. Before the restoration of the dock was accomplished it was necessary to remove the wrecked portion of the dock and the earth which had slid into the channel, and also to recover with a dredge*1886 as much ore as possible from the back area and dredge the whole area to bed rock. The dock was then restored with the same general type of construction as had been there previously. Wooden cribs of the same dimensions and materials were constructed and sunk to bed-rock and filled with stone. On these the concrete wall or super-structure and the tracks for carrying the ore bridge were restored. But after the restoration of the dock it was also necessary to restore the back area. Where there had previously been a yard of natural hard blue clay there was now a hole filled with water, about 400 feet long, 150 feet wide and about 27 feet deep. In order to restore this area to its former use and to provide storage space for the next season's operations as soon as possible, it was found most practicable to restore this back area by driving wooden piles into a loose earth or cinder fill and then placing a layer of reinforced concrete 24 inches thick over the top, thus tying together the upper ends of the piles. The piles were required in order to get a bearing surface on the bed-rock, but if piles alone had been used the weight of the iron ore on them would have pushed them aside laterally*1887 and permitted subsequent lateral movements such as had occurred. The purpose of the concrete mat was to distribute the load evenly over the piles.
No work was done beyond that necessary to restore the dock and back area to its former condition of usefulness. After the restoration was finished the dock was put to the same use as before and no greater quantities of materials or heavier loads were stored thereon. No failure or giving away of the dock or back area had occurred prior to the one referred to above and none has occurred since that time. The entire cost of the work done and materials used, exclusive of $121,537.03 expended for removing wrecked dock, dredging backfilling, recovering the ore which had subsided, etc., was as follows:
| 5,400 wood piles at $9 | $48,600 | |
| Concrete mat on piles, 5,480 yds. at $8 | 43,840 | |
| Reinforcement of concrete crib under back fill, 302 tons at $80 | 24,160 | |
| Steel pipe for sewer | 2,200 | |
| Total cost of restoring back area | $118,000 | |
| Repairing and restoring dock: | ||
| New timber cribs, complete | 51,000 | |
| Stone filling for cribs | 14,400 | |
| Replacing car axles in dock with billets | 4,690 | |
| Concrete superstructure | 19,250 | |
| Rails, ties, etc., and placing same | 7,885 | |
| Total cost of repairing and restoring dock | 97,225 | |
| Less: Depreciation on old dock | 13,335 | |
| 83,890 | ||
| 202,690 |
*1888 *449 Of the foregoing amount of $202,690, the petitioner capitalized $25,000 and charged the balance, $177,690, to expense. In the determination of the deficiency for the fiscal year ended April 30, 1919, the Commissioner disallowed the entire amount of $177,690 as a deduction on the ground that it was a capital expenditure, though at the hearing counsel for the Commissioner conceded that the petitioner should be allowed a loss of $40,005 on account of the cost of the portion of the dock destroyed which had not yet been recovered through depreciation allowances, thus leaving the amount in controversy $137,685. The Commissioner also allowed as a deduction in the year when the dock subsided the amount of $121,537.03 expended for removing wrecked dock, dredging, backfilling, etc.
3. In June, 1920, the petitioner received from a group of railroads $70,863.88 in settlement of a claim of the petitioner against the said railroads on account of switching services performed by the petitioner from August 1, 1905, to March 31, 1914. Blast-furnace coke, coal and other materials used by the petitioner were received over the railroads serving Buffalo. The cars were delivered by*1889 the trunk-line railroads on a delivery or interchange track adjacent to petitioner's plant, and at that point the petitioner's own locomotives picked them up and distributed them to the unloading points within the plant. And when they were unloaded the empty cars were returned by the petitioner to the interchange track, where they were picked up by the trunk-line railroads. In the same way, the trunk-line railroads delivered empty cars to the petitioner for loading pig iron to be shipped out to the petitioner's customers. These cars were taken by the petitioner's locomotives from the interchange track to the various points of loading in the petitioner's yard, weighed, loaded, and returned to this track for transportation by the trunk-line railroads. This switching process is known as "car spotting."
*450 During the years for which the sum received by the petitioner in 1920 was paid by the railroads, the railroads performed this switching service without charge at other blast furnaces competing with the petitioner, or paid those industries for performing the service if it was done by the industry. In some cases the railroads sent their own locomotives into the furnace*1890 yard and distributed the cars. In other cases, where it was difficult for the railroad locomotives to operate in the furnace yard, the industry performed the work and was reimbursed by the railroads for it at varying rates per car, depending upon what the service was. It was treated by the railroads as an item of expense which was a part of the transportation service to be performed by the railroads in delivering cars of commodities for transportation to and from the industry. The railroads, however, had failed to accord similar treatment to the petitioner, and prior to November 6, 1911, the petitioner filed a complaint before the Interstate Commerce Commission on account of this discrimination.
After a trial upon petitioner's complaint an order was made on November 6, 1911, by the Interstate Commerce Commission to the effect that:
The testimony shows that the furnaces of the complainant, the Buffalo Union Furnace Company, are in keen competition with those of the Cleveland Furnace Company at Cleveland, and we are of opinion, and find, that the defendants have made or given undue and unreasonable preference or advantage to the plant at Cleveland hereinbefore described, and*1891 have subjected complainant to undue and unreasonable prejudice and disadvantage, in violation of section 3 of the act, and by appropriate order will be required to cease and desist from such violation.
The secretary and treasurer of the Buffalo Union Terminal Railroad Company filed as an exhibit to his testimony a compilation which purports to be a full and complete statement of the number of cars handled by that company for the defendant railroads from August, 1905, to May, 1907, both inclusive. It will, however, be necessary to have a further hearing in the case in order to determine accurately the amount of reparation to be awarded.
An order will be entered in accordance with the foregoing conclusions commanding the defendants to cease and desist from subjecting complainant to undue prejudice and disadvantage, and the case will be held open for further hearing, on request of counsel for complainant Buffalo Union Furance Company as to the amount of reparation which should be awarded.
Prior to 1917 further hearings were held at which time petitioner was permitted to present its proof of the amount of reparation to be awarded and reports were handed down *1892 (29 I.C.C. 212">29 I.C.C. 212 and 32 I.C.C. 129">32 I.C.C. 129), but a final order was not issued until 1917. On April 9, 1917, the Interstate Commerce Commission entered its further and final order (44 I.C.C. 267">44 I.C.C. 267), in which reparation was fixed by taking into consideration the number of cars switched, and determining *451 that the petitioner had been damaged to the extent that the cost of service exceeded the charges that would have accrued at the rates for the line hauls. The railroads were ordered to pay the petitioner $139,736.98 on account of discrimination from August 1, 1905, to March 31, 1914. Certain pertinent parts of the order follow:
In the instant case no rebate is involved; the pleadings sufficiently allege damages arising out of the unlawful discrimination which we have found to exist; and there is sufficient dvidence to prove that the wrong of the carrier has in fact operated to complainant's injury.
The furnace company was in competition with the Lackawanna Steel Company, the Cleveland Furnace Company, and many other iron manufacturers located in western Pennsylvania and eastern Ohio. There was competition between these manufacturers in the*1893 purchase of coal, coke, limestone, iron ore, and various other materials. Other furnaces in the Buffalo-Black Rock switching district received their raw materials at the same line-haul rate, and the cars consigned to certain of these furnaces were spotted by the trunk lines or allowances for spotting were made to the industrial roads. The transportation charges paid by the furnace company were higher than those paid by its competitors for a service substantially similar in all respects. Complainant furnace company and these competing furnaces were engaged in manufacturing the same kinds of iron, which were sold in the same competitive markets. 21 I.C.C., 625. It was forced to meet and did meet the prices at which its competitors sold. Under such circumstances it was impossible to add the cost of performing the terminal switching to the selling price of such products. In consequence complainant was compelled to absorb that cost out of its profits. It inevitably follows that the complainant furnace company suffered a loss in profits measured by the cost of that interchange switching service, and we find that it was damaged to the extent of such cost.
* * *
Upon*1894 all the facts of record we are of the opinion and find that complainant Buffalo Union Furnace Company made the shipments as described, and paid and bore the cost of the interchange switching service performed by its plant facility, the Buffalo Union Terminal Railroad Company, which cost of service, being in addition to the rates for the line-haul movements, is herein found to have been unduly prejudicial; that it has been damaged to the extent that the cost of service herein found reasonable exceeded the charges that would have accrued thereon at the rates for the line hauls; and that it is entitled to reparation in the sums set forth in the above table, with interest. An order will be entered requiring the defendants to pay to the complainant furnace company the amounts shown in the table above, with interest calculated upon the amount stated for each period at 6 per cent per annum from the day following the close of that period.
The railroads refused to pay the amount awarded by the Interstate Commerce Commission and the petitioner brought suits against them. Before the suits came to trial, they were compromised during the fiscal year ended April 30, 1921, by the payment to*1895 the petitioner of $70,863.88 in full settlement of the award of the Interstate Commerce Commission.
*452 The petitioner expended in performing these switching services, for which the reparation was ordered, the amounts which were shown in the order of the Commission of April 9, 1917, and in addition some further amounts which were not considered by the Commission as elements of cost of this service. The cost of performing the service was taken as a deduction from gross income in the several years in question for which petitioner was required to file returns. It never received reimbursement for the difference between the amount so expended by it and the sum of $70,863.88 received from the railroads in 1920. A claim against the railroads for this switching service was accrued and carried upon the petitioner's books at an amount greater than the award of the Interstate Commerce Commission and greater than the settlement. Bills for the work were sent to the railroads in each of the years when the services were rendered. The railroads in the summer of 1916 published a formal tariff, recognizing and providing for the payment to the Buffalo Union Furnace Company of the sum*1896 of 90 cents a car for all cars thus switched by the Furnace Company, and since that time have been paying that sum towards the switching expense. The sum of $70,863.88 which was received is apportioned and prorated to the several years involved in accordance with the expenditures actually made in those years as follows:
| 1905-6 | $10,729.95 |
| 1907 | 7,166.84 |
| 1908 | 4,650.54 |
| 1909 | 11,220.90 |
| 1910 | 8,939.22 |
| 1911 | $4,832.52 |
| 1912 | 7,259.14 |
| 1913 | 13,412.75 |
| 1914 (to March 31) | 2,652.02 |
None of the amount received in settlement of the foregoing controversy was included in taxable income by the petitioner. The Commissioner, in his deficiency notice, included $48,316.55 in taxable income for the fiscal year ended April 30, 1921, on the theory that this amount was received by the petitioner on account of its expenses in switching and spotting cars from January 1, 1909, to March 31, 1914, which amount had been deducted in determining net income for those years. At the hearing, however, the Commissioner was permitted to amend his pleadings so as to allege that the taxable income as determined by him for the fiscal year ended April 30, 1921, should be increased in the amount*1897 of $22,547.33, or by the remainder of the amount received in settlement which had not theretofore been considered taxable income by him.
The petitioner kept its books and rendered its returns on the accrual basis.
In the determination of the deficiencies here in question, invested capital was adjusted by the Commissioner in accordance with articles *453 845 and 845(a) of Regulations 45 on account of taxes due and payable for the respective prior years.
OPINION.
SEAWELL: 1. The first question at issue in this case is the contention of the petitioner that it is entitled to a deduction of 10 per cent on its plant assets on account of depreciation and obsolescence, whereas the Commissioner has allowed only 5 per cent. The principal point in dispute and that to which the greater part of the evidence was directed is as to obsolescence which occurred as a result of the new type of blast furnace construction which began to be installed about 1918. There appeared to be little, if any, dispute between the parties that, leaving out of consideration the factor of obsolescence and the exhaustion of furnace linings, the composite rate of 5 per cent taken as depreciation by*1898 the petitioner for the years preceding those before us, which is the same as that allowed by the Commissioner in determining the deficiencies for the years on appeal, is fair and reasonable. That is, the Commissioner does not contend that the rate of 5 per cent is sufficient to take care of depreciation and also obsolescence, but rather that there were not substantial reasons for believing in the years before us that the assets in question would become obsolete prior to the end of their useful life. Further, it should be observed that, because of the integral character of the blast furnace units, the obsolescence with which we are concerned relates to the entire plant, with a few minor exceptions not deemed material by either party.
The statute provides (section 234(a)(7) of the Revenue Act of 1918) for a "reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence." That is, a reasonable deduction is allowable on account of the exhaustion, wear and tear of property used in a trade or business, including obsolescence, if the property is becoming obsolete, so that by the time the property reaches*1899 the end of its useful life the entire cost thereof will be restored. Like depreciation, whether property is becoming obsolete is a question of fact in each case, and when it is found that such a condition is taking place a deduction on that account can be determined by ascertaining when the property may no longer be expected, under the circumstances, to be commercially useful notwithstanding its physical condition. Columbia Malting Co.,1 B.T.A. 999">1 B.T.A. 999. See also the recent case of Burnet v. Niagara Falls Brewing Co.,282 U.S. 648">282 U.S. 648, wherein the court said:
It would be unreasonable and violate that canon of construction to put upon the taxpayer the burden of proving to a reasonable certainty the existence and *454 amount of obsolescence. Such weight of evidence as would reasonably support a verdict for a plaintiff in an ordinary action for the recovery of money fairly may be deemed sufficient. Neither the cost of obsolescence nor of accruing exhaustion, wear and tear that is properly chargeable in any period of time can be measured accurately. A reasonable approximation of the amount that fairly may be included in the accounts of any year*1900 is all that is required. In determining the proper deduction for obsolescence there is to be taken into consideration the amount probably recoverable, at the end of its service, by putting the property to another use or by selling it as scrap or otherwise. There is no hard and fast rule, as suggested by the Government, that a taxpayer must show that his property will be scrapped or cease to be used or useful for any purpose, before any allowance may be made for obsolescence.
We are satisfied from the evidence here presented that it was known to the petitioner in the fiscal year ended April 30, 1919, that the changes which were taking place in blast furnace construction would render its blast furnaces obsolete prior to the end of their useful life. At that time the heavier and larger type of furnace was replacing the smaller type of furnace and thereafter became the standard type of construction. These newer furnaces embodied many radical improvements in equipment and operation which resulted in a substantial reduction in the cost of manufacturing pig iron. Another result of this development was to bring steel mills into competition with merchant blast furnaces such as operated*1901 by the petitioner, because of the surplus product produced. The changes which were taking place were known to petitioner's officers and were discussed by them. At that time the petitioner fixed a rate of 10 per cent, and a witness who was then vice president of the petitioner testified that this was done because it was then known that the plant would become obsolete prior to the end of its useful life. The furnaces were abandoned approximately within the time provided for by the rate of 10 per cent. While to say that the latter fact establishes the rate allowable might be said to allow "hindsight" to take the place of "foresight," it is a fact which can not be overlooked in substantiation of evidence offered as to the situation known to exist during the years with which we are concerned.
Since we are satisfied that the petitioner's furnaces were becoming obsolete in the years before us and that this fact was known to petitioner, our question is as to how long it was reasonably expected by petitioner that it could operate its plant profitably without installing the more modern type of furnace. Petitioner's vice president testified that the petitioner's officers were of the opinion*1902 that they could not operate more than seven or eight years without replacing their furnaces and on this basis fixed a rate of 10 per cent. The testimony of Mr. Brassert, an expert in the construction of blast furnaces and familiar with petitioner's furnaces and plant, *455 was to the effect that a period of seven to ten years of operations was what could reasonably have been anticipated in 1919. One of petitioner's furnaces was abandoned in 1925, another in 1928, and the third was expected to be operated for only a short time after the hearing in this proceeding. On the other hand, we find that the repairs were very heavy for the years before us and that the petitioner's plant was kept in an excellent state of repair. And, too, much importance is attached by the Commissioner to the fact that on July 1, 1920, the petitioner leased its entire plant to the Hanna Furnace Company for a period of 40 years with option on the part of the lessee to purchase at the end of 20 years. The lease provided that the lessee would maintain the plant in such condition that upon its return to the petitioner at the expiration of its term it would constitute a modern pig-iron producing plant. *1903 There were, however, important considerations entering into the negotiations for the lease other than that of securing the plant for operating purposes - particularly, relief on the part of the lessee from an extremely burdensome ore contract, and the transaction in many respects was more like a sale than a lease. And even if looked at as a lease in the ordinary sense, we do not think a taxpayer can be denied obsolescence which is occurring merely because an advantageous contract is made after it has been ascertained that a given asset will become obsolete at a future date. Further, the large losses of some $4,000,000 sustained by the lessee during its period of operations, even with large expenditures for repairs, tend to confirm the fact that obsolescence was taking place as contended by the petitioner. Another factor to be considered is the petitioner's good will and valuable trade connections which were of such a nature that both the petitioner and the lessee considered them important elements in allaying to a certain extent obsolescence which would arise in connection with competition from the more modern furnace.
But before finally disposing of the foregoing issue we will*1904 discuss the claim of the petitioner that, in addition to the deduction on account of depreciation and obsolescence, it is also entitled to a further deduction on account of additions to a reserve for relining furnaces, whereas the Commissioner has disallowed all additions to this reserve. An examination of the evidence submitted with respect to this contention shows that this is not a reserve set up on the basis of the exhaustion of the furnace linings, but rather on the basis of what it would cost to replace them upon their exhaustion. In periods of constant prices or costs it would be immaterial which basis is said to be used as the same results would be reached in each instance, but where prices or costs are rising or falling the results are not the same. While the statute provides for deductions on account of the exhaustion, wear and tear of physical assets *456 to the end that the cost thereof may be restored upon the expiration of their useful life, we find no provision under which a taxpayer may set up a fund which would necessarily replace a given asset upon its ultimate exhaustion. For example, if a taxpayer has a building which cost $100,000, but at the end of*1905 its useful life cost $150,000 to replace, additions to a reserve would be allowable on the basis of the $100,000 cost, but not on the basis that $150,000 would be required to replace the original $100,000 of cost. The argument of the petitioner is that it should be allowed the additions to the reserve as ordinary and necessary expenses of carrying on its business on the ground that they are generally recognized in the industry and that without the recognition of these items costs of producing its product are understated. What items are capital and what are ordinary and necessary expenses is governed by the statute and we are of the opinion that this can not be varied because of a practice in a given industry. The contention as to the understatement of costs for the purpose of determining net income for tax purposes would be sound only to the extent that provision is not made for adequate deductions on account of the exhaustion of physical assets to the end that their cost may be restored at the expiration of their useful life. It is, of course, not correct to say that no provision is made for the exhaustion of furnace linings in the deductions as allowed by the Commissioner, for*1906 the reason that the original cost of furnace linings is included in the plant account on which a composite rate of 5 per cent has been allowed. Of itself, however, it would not be sufficient as shown by the evidence as to the average life of the linings of from 2 to 2 1/2 years, and from the further fact that the petitioner expended approximately $261,000 for furnace relinings over the period 1917 to 1920. During that period one furnace was relined once from the mantle up at a cost of $34,787.05 and completely relined two years later at a cost of $117,377.45. The total allowance by the Commissioner for all depreciation for the entire plant of approximately $140,000 per year over this period was but little more than double the furnace relining costs. It further appears that additions to the reserve were allowed by the Commissioner in prior years in addition to the composite rate of 5 per cent on the entire plant account.
When we consider the whole record on the two issues as discussed above, both of which are questions of fact, we are satisfied that the rate of 5 per cent allowed by the Commissioner on the petitioner's entire plant account was insufficient to take care of both*1907 depreciation and obsolescence and that while additions to the reserve for relining furnaces can not be allowed, consideration should be given to the life of these linings in fixing a depreciation rate for the entire plant. In *457 short, we are of the opinion that a fair and reasonable allowance for both depreciation and obsolescence (including depreciation on the furnace linings) is obtainable on the basis of 10 per cent of the plant account without the allowance of additions to the reserve for furnace linings, and we so find.
2. The next issue is the deduction to which petitioner is entitled on account of the collapse of a portion of its dock and the expenditures incident to its restoration. In substance, what occurred was that a section of petitioner's dock collapsed and slid into the river, taking with it a quantity of ore which was stored on the dock. Before the dock was restored to its former state of usefulness it was necessary to remove the wrecked portion of the dock and earth which had slid into the channel and also to recover the ore which had subsided into the river. The cost of this so-called preliminary work was $121,537.03 and this has been allowed as*1908 an expense deduction by the Commissioner. In addition, the petitioner expended $202,690 in the restoration of the dock which included not only the dock proper, but also the storage area back of the dock. The petitioner capitalized $25,000 of this amount and claimed the remainder as a deductible expense on the ground that this remainder represented incidental repairs which neither materially added to the value of the property nor appreciably prolonged its life, but were necessary merely to restore the property to its former operating condition. On the other hand, the Commissioner considered the entire amount of $202,690 as a capital item and therefore not deductible, though at the hearing he conceded that the petitioner was entitled to a loss of $40,005 as the cost of the portion of the dock which was destroyed.
The evidence is to the effect that of the $202,690 in question $83,890 was expended in restoring the dock and $118,800 the back area, and the two items will be disposed of separately. With respect to the dock restoration, we are unable to agree with petitioner that this amount represents what might ordinarily be termed a repair item. What is a repair item and therefore*1909 deductible in the year when expended and what is a replacement item and therefore to be capitalized is often difficult of ascertainment and definitions or plausible reasoning may be presented to suit the particular position sought to be upheld and no general rule can be laid down which would be applicable to all cases. As we said in Joseph E. Hubinger,13 B.T.A. 960">13 B.T.A. 960:
Counsel for petitioner cites many cases in which the word "repair" is defined and distinguished from such terms as replacements, betterments, improvements, and so on. The difficulties that lie in the way of adopting any general rule and attempting to fit all cases to it are obvious. An item, in relation to income, may in one case be so insignificant that it would be absurd to require its capitalization even though under a technical definition it might be an improvement, *458 while in another case the cost of a similar item might be sufficient to absorb all the income for the year. We can not believe that Congress intended to allow as charges against the revenues of a day or year the cost of restoring major parts of income-producing property where the restoration is of such character as to*1910 be useful over a long period of years.
And, further, we have this statement from Hubinger v. Commissioner, 36 Fed.(2d) 724 (affirming the foregoing Board decision), with respect to ordinary expenses in the case of a fire or casualty:
In other words, where a loss sufficient to be regarded as within the purview of (a)(4) or (a)(6) occurs, it is the occasion rather than the precise kind of reconditioning done that determines whether the particular outlay involves "ordinary and necessary expenses" or "losses." Any other view requires a determination in case of each serious fire which comes short of total destruction of just the extent of damage from that casualty which involves a capital expenditure to restore it and which involves a mere ordinary repair. We think the statute contemplates no such difficult classification, but places damage due to casualty in the sense we have used that term in the category of "losses." Moreover, a replacement of damage from a devastating fire while perhaps a "necessary" expense cannot be regarded as an "ordinary" one. "Ordinary * * * expenses" in the most natural meaning of the words are those due to wear and tear and trifling*1911 accidental causes.
We are of the opinion that the expenditures here made in the restoration of the dock proper come squarely within the principles laid down above and constitute replacements rather than repairs. Even conceding, as the petitioner contends, that the restored dock had no more utility value to the petitioner than that which had been destroyed and even assuming that the reconstruction could have been done in the same manner in every respect as the original construction, we do not understand that this would make the reconstruction cost deductible. What occurred was that the petitioner lost a capital asset and now has another in its place. The cost of the asset lost is a proper deduction, which we understand is being allowed in the conceded amount of $40,005, and the cost of the new asset should be capitalized in the amount of $83,890. Cf. Ben Baer,12 B.T.A. 1060">12 B.T.A. 1060; Joseph E. Hubinger, supra; and Hubinger v. Commissioner, supra.The cases of Illinois Merchants Trust C., Executor,4 B.T.A. 103">4 B.T.A. 103, and *1912 J. W. Forgeus,6 B.T.A. 291">6 B.T.A. 291, on which much reliance is placed by the petitioner, are distinguishable from the case at bar, in so far as deductions there allowed are concerned, on the ground of the difference in character of expenditures and the circumstances under which made.
And much that is said above applies with equal force to the item of $118,800, though a slightly different situation exists because of the character of that which was destroyed. The back area, which consisted of natural original clay earth, was in effect as much a part of the dock as the portion constructed of wood, steel, stone, etc., *459 though as to the former we have no construction costs, whereas this is not true as to the latter. It may be merely a fortunate circumstance that this land could be availed of for dock purposes without cost other than for the land itself, and it may be equally unfortunate that the petitioner lost through a casualty that which was necessary to be replaced through new capital construction, but we find no provision in the statute which would allow a deduction on account of damage to property other than on the basis of the cost or March 1, 1913, value*1913 of the property damaged. Whatever cost or March 1, 1913, value was applicable to the back area was perhaps small as compared with the reconstruction cost, but in any event no showing was made in this respect. Further, we are unable to agree with petitioner that the restoration of this back area was merely an incidental repair. In effect what it did, in the restoration work, was to build a new back area in the same sense that it would have been required to do had this been low ground when the original dock was built. Piles were sunk, a concrete mat was placed over the entire area, and the concrete crib under the back fill was reinforced at a cost in the respective amounts of $48,600, $43,640, and $24,160. In our opinion, these expenditures can not be viewed other than of a capital nature. The amount of $2,200 expended for the new sewer is of course a replacement and therefore should be capitalized.
3. The next issue presented relates to the treatment to be given the receipt by the petitioner in the fiscal year ended April 30, 1921, of $70,863.88, on account of a settlement with certain railroads. In short, what occurred was that from about 1904 or 1905 petitioner was seeking*1914 relief on account of certain alleged discriminatory practices on the part of the railroads, wherein the railroads were either performing or causing to be performed switching services for petitioner's competitors without charge or were making an allowance to them when they performed the service themselves, whereas similar treatment was not accorded petitioner. In 1911, on the basis of a complaint filed by the petitioner, the Interstate Commerce Commission found that the discriminatory practice existed, but left open the question of reparation to be awarded. Subsequent hearings were held before the Commission and finally in 1917 the Commission entered an order requiring the railroads to pay the petitioner the cost of rendering the service from 1905 to 1914, namely, $139,736.98. The railroads, however, refused to pay and the petitioner instituted suits to enforce collection, but before the suits came to trial they were compromised in 1920 through the payment by the railroads to the petitioner of $70,863.88. The contention of the Commissioner is that the entire amount is taxable income in the year when received as compensation for service performed in prior years, which compensation*1915 was not finally fixed and determined as a definite liability *460 until the year when received, whereas the petitioner contends that the amount received was not taxable income, but rather a partial reimbursement for the cost of expenditures made by the petitioner for the account of the railroads.
In the first place, we are unable to agree with petitioner that the expenditures for which it was reimbursed were other than its own expenses. It is, of course, true that the railroads were finally required to pay an amount as an award of damages for a discriminatory wrong which was measured by the expenditure made, but this does not necessarily make the expenditure that of the railroads. It was the petitioner who incurred and paid the expense of spotting its cars for the purpose of carying on its business, and the amount so expended was treated by it as an ordinary business expense. That because of the discrimination then being practiced by the railroads a cause of action arose in favor of the petitioner through which the amount here in question was recovered does not, in our opinion, mean that the petitioner was reimbursed for an expense which it had made on behalf of the railroads, *1916 but rather that the railroads committed a wrong through discriminatory practice and that the award of damage on account of such wrong was measured by the expenditure which the petitioner had made.
And when we come to consider the taxability of the amount recovered and, if taxable, when it should be taxed, we find it difficult to distinguish the situation presented from that considered in Burnet, Commissioner v. Sanford & Brooks Co.,282 U.S. 359">282 U.S. 359; in fact, the petitioner relies on that case as decided by the Circuit Court of Appeals (Sanford & Brooks Co. v. Commissioner, 35 Fed.(2d) 312) as authority for the proposition that the amount recovered is not taxable income, though, at time briefs were filed, the decision of the Supreme Court which reversed the Circuit Court of Appeals had not been rendered. As shown in the aforementioned case, Sanford & Brooks Company was engaged from 1913 to 1915 in carrying out a Government contract for dredging the Delaware River. During those years it included in gross income for each year the payments made to it under the contract and deducted the expenses paid in performing the contract. *1917 In 1915 work under the contract was abandoned and in 1916 suit was brought to recover for a breach of warranty of the character of the material to be dredged. Recovery was finally had in 1920 upon the contract and was "compensatory of the cost of the work of which the Government got the benefit." The court, in deciding that the entire amount received in 1920 should be taxed as income for that year, said:
That the recovery made by respondent in 1920 was gross income for that year within the meaning of these sections cannot, we think, be doubted. The money *461 received was derived from a contract entered into in the course of respondent's business operations for profit. While it equalled, and in a loose sense was a return of, expenditures made in performing the contract, still, as the Board of Tax Appeals found, the expenditures were made in defraying the expenses incurred in the prosecution of the work under the contract, for the purpose of earning profits. They were not capital investments, the cost of which, if converted, must first be restored from the proceeds before there is a capital gain taxable as income. See Doyle v. Mitchell Brothers Co., supra, p. 185.
*1918 That such receipts from the conduct of a business enterprise are to be included in the taxpayer's return as a part of gross income, regardless of whether the particular transaction results in net profit, sufficiently appears from the quoted words of ยง 213(a) and from the character of the deductions allowed. Only by including these items of gross income in the 1920 return would it have been possible to ascertain respondent's net income for the period covered by the return, which is what the statute taxes. The excess of gross income over deductions did not any the less constitute net income for the taxable period because respondent, in an earlier period, suffered net losses in the conduct of its business which were in some measure attributable to expenditures made to produce the net income of the later period.
That is, it was immaterial that no net profit was involved of an excess of the amount received under the judgment over the expenses paid, and this fully answers the contention of the petitioner that "no gain or profit could arise from such a transaction unless and until the amount received should exceed the amount paid out." While it is only "net income" as determined*1919 on an annual basis that is subject to tax, "net income" as a specific item is not set out in the statute, but rather is a derivative item arrived at under the Revenue Act of 1918 as the difference between the items to be included in gross income and the deductions allowable therefrom. In view of the broad definition of gross income as set out in section 213(a) of the Revenue Act of 1918 to include "gains or profits and income derived from any source whatever" and the definition of income as laid down in Eisner v. Macomber,252 U.S. 189">252 U.S. 189, to include the "gain derived from capital, from labor, or from both combined," we do not think it can be doubted, as the court said in the Sanford & Brooks case, that the recovery by the petitioner from the railroads constituted an item to be included in gross income. The cause of action through which recovery was made was a discriminatory wrong, but there was a discriminatory wrong because of the use of labor and the expenditure of capital by the petitioner without compensation therefor when its competitors either received payment from the railroads for rendering the service or had the service rendered for them without charge. *1920 Certainly, in the case where a competitor was paid for rendering the service, the amount received would have been includable in gross income, that is, would have constituted income, in the year in which it was received or accrued, and the expenditures made in rendering such services were ordinary and necessary expenses in the year in *462 which paid or incurred. We do not think a different rule can be applied to the petitioner. Of course, it may be desirable that income be balanced by the expenditures which produce such income to the end that only net income from a given undertaking may be taxed, but as the Supreme Court has said on many occasions (Burnet v. Sanford & Brooks Co., supra;Fawcus Machine Co. v. United States,282 U.S. 375">282 U.S. 375; and Burnet v. Thompson Oil & Gas Co.,283 U.S. 301">283 U.S. 301, the scheme of taxation with which we are concerned is predicated upon annual periods and therefore it may well happen that expenses incident to the production of income will fall in one year and the income will not be received until another year. Under such circumstances, even though the net result, if combined in a single taxable*1921 period, might be a loss, this would afford no reason for relieving the taxpayer from tax for the year in which income was received.
The income here in question was received in 1920, but since the petitioner kept its books and rendered its returns on the accrual basis the question remains as to whether it can be said that the amount received had accrued prior to its receipt and therefore must be accounted for as income prior to 1920. The petitioner says that the right to the payment received in 1920 arose when the switching was done and was definitely determined in 1911 when the Interstate Commerce Commission entered its first order to the effect that the railroads were engaging is discriminatory practice to the detriment of the petitioner. With this we can not agree. The most that can be said of what occurred in 1911 is that the Interstate Commerce Commission then found that the discriminatory practice existed and issued an order commanding the railroads to desist from such practice, but left open the question as to reparation to be awarded on account of such damage as may have been suffered. It was not until 1917 that the Commission entered its final decree fixing the damage*1922 suffered and ordering the railroads to pay to the petitioner the cost of the services rendered by it. This order was not self-executing; if the railroads refused to pay, which they did, the petitioner's remedy was an action at law wherein the Commissioner's findings were prima facie, but not conclusive, evidence, subject to be overthrown by countervailing evidence. Meeker & Co. v. Lehigh Valley Railroad Co.,236 U.S. 412">236 U.S. 412, and Atchison, Topeka & Santa Fe Railroad Co. v. Spiller,246 Fed. 1. Since the railroads refused to pay, the petitioner brought suits for collection, but before the suits came to trial a compromise was effected through which payment was made to the petitioner in 1920 of approximately one-half of the amount fixed by the Commission in full satisfaction of the damage suffered. Under such conditions, we are of the opinion that it was not known until 1920 what amount, if any, would be *463 recovered and therefore no basis for accrual existed prior to that time. United States v. Anderson,269 U.S. 422">269 U.S. 422, and *1923 Lucas v. American Code Co.,280 U.S. 445">280 U.S. 445. Whatever may be the rule laid down in Park v. Gilligan,293 Fed. 129, on which the petitioner relies, we think it is to be distinguished from the case at bar, on the ground that the amount there in controversy was found by the court to have been an accrued chose in action as an asset on March 1, 1913, and therefore the conversion of this asset into cash in 1916 could not be considered income in 1916 of the cash then received, whereas we are of the opinion that no amount had accrued in the case at bar on March 1, 1913.
In view of the foregoing, we are of the opinion that the entire amount received by the petitioner from the railroads constituted income to it; that no basis for accrual of such amount existed prior to 1920, and therefore the action of the Commissioner in seeking to include the entire amount in gross income in 1920 should be sustained.
4. In the final issue the petitioner questions the correctness of the Commissioner's action in adjusting invested capital in each of the years before us in the manner provided in articles 845 and 845(a) of Regulations 45 on account of income and profits*1924 taxes due and payable for the respective prior years. The Board has heretofore held that the validity of the regulations in question was made effective by section 1207 of the Revenue Act of 1926 (Russel Wheel & Foundry Co.,3 B.T.A. 1168">3 B.T.A. 1168), and the same regulations were recently upheld by the Supreme Court in Fawcus Machine Co. v. United States, supra.
Reviewed by the Board.
Judgment will be entered under Rule 50.
SMITH dissents.