*2357 1. Liberty bonds, purchased at par, were used at that value in payment of dividends, the market price then being less than par. Held, no loss sustained.
2. Factory alterations suggested by Government authorities supervising war work which did not increase the efficiency of the factory, and which have been continued in use, held to constitute capital expenditures.
3. Cost of removal of an engine from one part of a factory to another, held deduct ble as an ordinary and necessary expense.
4. Cost of machinery and equipment purchased and used solely for war work, which was scrapped immediately upon termination of that work, held deductible as a loss sustained during the taxable year.
5. Invested capital may not be reduced by use of a tentative tax in computing earnings available for distribution.
*75 This is a proceeding for the redetermination of deficiencies in income and profits taxes asserted by the respondent for 1918 and 1920, in the amounts of $38,296.06 and $5,643.38, respectively. *2358 The petitioner also seeks a redetermination of its tax liability for 1919, for which year the respondent has determined an overassessment of $311.20. The petition sets forth the following assignments of error:
(a) Disallowance as a deduction for 1918 of $2,708.00, representing a loss on Liberty bonds disposed of in that year;
(b) Disallowance as a deduction for 1918 of $20,565.47, representing the amount expended in changing and re-arranging certain units of petitioner's plant;
(c) Disallowance as a deduction for 1918 of $8,766.44, representing amortization sustained in that year;
(d) The reduction of invested capital for 1918 by $31,824.48, representing dividends alleged to have been paid in excess of the current earnings available at the dates of payment;
(e) The invested capital for 1919 and 1920, as now computed, will be increased on account of the reduced tax liability for 1918.
At the hearing the petitioner abandoned its claim to a deduction for 1918 for amortization, referred to in assignment (c), and substituted therefor the claim to a deduction of $4,570.45, representing the cost of certain items of plant equipment acquired in 1918 and alleged to have been abandoned*2359 in the same year. At the hearing respondent moved that the appeal as to 1919 be dismissed, on the ground that no deficiency had been determined for that year.
FINDINGS OF FACT.
The petitioner, a corporation with its principal office at Parkersburg. W. Va., is engaged in carrying on a sheet mill business, manufacturing black, blue, and galvanized sheets. During 1918 petitioner manufactured corrugated sheets, stove pipes and stove pipe elbows under Government war contracts. Approximately two-thirds of the work done in petitioner's plant, during that year, was in the production of articles under Government contracts.
On February 25, 1918, petitioner declared a special dividend of 12 1/2 per cent out of earnings of 1917, payable March 15, 1918, to stockholders of record as of March 1, 1918. The resolution provided that the dividend was to be paid in Second Liberty Loan bonds at par, with coupons attached, except that any dividend payable to any stockholder, of less than $50, was to be paid in cash. During 1918 the petitioner had outstanding capital stock of a total par value of *76 $400,000. The dividend was paid on March 15, 1918, by turning over to the stockholders*2360 Second Liberty Loan bonds of $48,750 par value and cash in the amount of $1,250. The cost of these bonds to the petitioner was $48,750. On the date of payment of the dividend, Second Liberty Loan bonds were sold on the Pittsburgh Stock Exchange at $96.20, high, and $96.10, low, for a $100 bond.
On July 22, 1918, the petitioner declared a special dividend of 7 per cent, payable July 31, 1918, to stockholders of record as of July 22, 1918. The resolution provided that the dividend was to be paid in Third Liberty Loan 4 1/4 per cent bonds, with coupons attached, except that any dividend payable to any stockholder, of less than $50, was to be paid in cash. The dividend was paid on July 31, 1918, by turning over to the stockholders Third Liberty Loan bonds of $26,500 par value and cash in the amount of $1,500. The cost of these bonds to the petitioner was $26,500. On the date of payment of the dividend, Third Liberty Loan 4 1/4 per cent bonds were sold on the Pittsburgh Stock Exchange at $95.10, high, and $95, low, for a $100 bond.
In its return for 1918 petitioner claimed a loss deduction of $1,462.50 upon the disposition of the Second Liberty Loan bonds turned over to stockholders*2361 in payment of the March 15 dividend, and a loss deduction of $1,245.50 upon the disposition of the Third Liberty Loan bonds turned over to stockholders in payment of the July 31 dividend. In each instance the loss claimed represented the difference between the cost of the bonds to petitioner and the estimated fair market value thereof at the date of disposition. The deductions have been disallowed by the respondent, on the ground that "as the bonds were distributed as dividends to the stockholders at cost to the corporation there was no loss to the company.
At the time of acceptance of Government war contracts in 1918, petitioner was carrying on its manufacturing operations in a three-story building. The greater part of the operating machinery was located on the first floor. The second and third story lofts were used principally for storage purposes, but a few of the elbow machines, about ten in number, were operated on the second floor. The building, in general, was satisfactory and adequate for the needs of petitioner's business.
Early in 1918 engineers of the United States Army, following an inspection of the plant, requsted that in order to improve the lighting conditions*2362 certain changes in the building construction and rearraging of factory rooms be made, and this request was complied with. All of the machinery on the two upper floors was removed to the first floor, necessitating a general rearrangement of machinery on the first floor. This rearrangement of machinery necessitated the *77 abandonment of certain machine foundations and the laying of new foundations, with the result that the first floor was so cut up the petitioner found it necessary to lay an entirely new floor. The second and third floors were torn out, skylights were installed in the roof, and the electric lighting system was rearranged. The tearing out of the two upper floors also necessitated a rearrangement of all line shafting for the machines. The productivity of the plant was not increased by reason of these alterations. The total cost of all work done in making the alterations amounted to $11,210.88. The alterations and changes were continued in use throughout all of the taxable years on appeal. The cost of the alterations was taken as an expense deduction in the return for 1918, but disallowed by the respondent.
Until the acceptance of Government war contracts, *2363 petitioner's bar mill was adapted to and utilized for the rolling of bars of light gauge, about 10 to 11 pounds per foot. Work under Government contracts required the rolling of bars of much heavier gauge, 18 to 20 pounds per foot. The strain of rolling bars of such heavy gauge, with that of increased or forced production, resulted in the blowing up of the engine in the bar mill with the accompanying destruction of all coupling pinions and gears. A survey of the market with the view of acquiring an engine to replace the one destroyed disclosed that it would take a long time to secure one suitable to the purposes for which it was to be used. Thereupon, petitioner removed an engine located in its sheet mill and installed it in the bar mill. The total cost of cleaning up the wreckage in the bar mill, the tearing down of the engine in the sheet mill, and its installation in the bar mill, amounted to $9,354.59, all of which was taken as an expense deduction in the return for 1918, but disallowed by the respondent.
For the production of articles under Government war contracts, the petitioner during 1918 purchased and installed special equipment for painting and drying sheets at a*2364 cost of $2,946.24, special stovepipe machinery at a cost of $537.78, and one set of bending rolls, at a cost of $800. All of petitioner's war contracts were canceled within a week or two after the Armistice. After the cancellation of these contracts, the petitioner had no further use for any of this special equipment, and before the close of 1918 all of it had been definitely abandoned and scrapped.
In addition to the items mentioned in the preceding paragraph, the petitioner in 1918 installed a system of flood lights on the grounds upon which its plant stood. The lights were so located as to give light to all parts of the premises. The purpose of the installation of these lights was to give protection against unauthorized trespassers. The total cost of installation amounted to $286.43. Since the discontinuance of work under war contracts, two of the seven lights *78 installed have not been used at all, while the other five lights have been used once or twice when flood conditions were prevalent in the vicinity of petitioner's plant.
In determining, for invested capital purposes, the amount of earnings available for distribution, at the dividend dates of March 31*2365 and July 31, 1918, the respondent deducted a tentative tax of $69,092.65.
Respondent has reduced the invested capital of 1919 by $29,501.93, on account of an income and profits-tax liability of $69,810.54 for 1918, prorated from the dates the several installments thereof became due and payable. Also, respondent has reduced invested capital of 1920 by $6,312.28, on account of additional income and profits taxes found due for 1918, and by $18,771.80 on account of an income and profits-tax liability of $44,546.27 for 1919, prorated from the dates the several installments thereof became due and payable.
OPINION.
MARQUETTE: Petitioner complains of the respondent's action in disallowing as a deduction for 1918 an alleged loss of $2,708, representing the difference between the cost to petitioner of the Second and Third Liberty Loan bonds distributed to stockholders in payment of the February 25 and July 22 dividends, and the estimated fair market value thereof at the dates of distribution. The dividend of February 25, at the rate of 12 1/2 per cent, and that of July 22, at the rate of 7 per cent, amounted to $50,000 and $28,000, respectively. Following the dividend declarations*2366 of February 25, and of July 22, and on the due dates for the payment of the dividends, the petitioner became indebted to its stockholders in the sums of $50,000 and $28,000, respectively. Both of these obligations were liquidated and settled in accordance with the terms of the declaratory resolutions, the first, by distributing to the stockholders Second Libery Loan bonds of a par value of $48,750, and cash of $1,250, and the second, by distributing to the stockholders Third Liberty Loan bonds of a par value of $26,500, and cash of $1,500. The bonds so distributed to the stockholders had been acquired by the petitioner at a price equivalent to their par value. Thus the petitioner acquired and disposed of the bonds at the same price and, under those circumstances, it suffered no loss. What the prevailing market prices may have been on stock and bond exchanges, at the dates of disposition, is not material. One may dispose of property for more or less than its fair market value. The decisive factor in the determination of whether one derives a gain or sustains a loss in a particular transaction, is the consideration received for parting with the subject matter. Here, in exchange*2367 for bonds for which it had paid a *79 price equivalent to par, the petitioner received a cancellation of its indebtedness to stockholders equivalent, in amount, to the par value of the bonds. The case of , upon which the petitioner relies, is not in point. In that case, Liberty bonds were distributed to stockholders in payment of a dividend, at their fair market value, which was less than cost. The two cases are not analagous. We find no error in the respondent's action of which the petitioner complains.
Petitioner alleges that respondent erred in disallowing the deduction as an ordinary and necessary expense, for 1918, of the cost, $11,210.88, of the alterations and changes made in the factory building in that year. Upon the record before us we entertain no doubt that the expenditures incident to making such alterations and changes are of a capital nature, and that the respondent correctly disallowed the item in question as a deduction from gross income. Various reasons are suggested by the petitioner as the basis for the allowance of the disputed item, none of which appeal to us as proper grounds for the*2368 action sought to be taken. It is contended that the making of the alterations was an involuntary act, done upon orders of engineers of the Army; that neither the efficiency, productivity, nor the value of the plant has been increased by virtue of the alterations; and that the petitioner has been placed at a decided disadvantage in making the alterations, by reason of having to provide additional storage space and of the cramped and congested operating conditions existing in the building because of the removal of all of the machinery to one floor. Assuming all such conditions and circumstances to be true, and we do not decide that they are, we still adhere to the conclusion already announced. It is undenied in the record that the general purpose for which these alterations and changes were made, the general improvement of lighting conditions in the building, has been accomplished, although, perhaps, not to the degree expected or hoped for. Furthermore, all such alterations and changes have been continued in use throughout all of the taxable years on appeal, and the record contains no hint of any subsequent abandonment. We find no error in the action of the respondent in disallowing*2369 the cost of the alterations and changes as a deduction from gross income for 1918.
In 1918 the engine in petitioner's bar mill "blew up" or "smashed through itself," carrying to destruction much of the coupling pinions and gears, due to strains of war work and forced production in excess of rated or safety capacity. The petitioner expended the sum of $9,354.59 in cleaning up the wreckage in the bar mill, and in tearing down an engine in the sheet mill and installing it in the bar mill. This item, with that of $11,210.88 disposed of in the preceding paragraph, is represented in the sum of $20,565.47 referred to in the *80 second assignment of error. In our opinion this item of $9,354.59 constitutes an ordinary and necessary expense of the business, and the respondent erred in disallowing it as a deduction from gross income of 1918.
At the hearing the third assignment of error, relating to the deduction for 1918 of amortization of war facilities, was abandoned, and the petitioner substituted therefor a claim for a loss deduction of $4,570.45, representing the cost of certain items of plant equipment acquired in 1918 and alleged to have been abandoned in the same year. *2370 The amount claimed as a deduction is made up of the following expenditures: For special equipment for painting and drying sheets, $2,946.24; for special stovepipe machinery, $537.78; for one set of bending rolls, $800; for installation of flood lights on premises, $286.43. All of this equipment, except flood lights, was acquired and installed for the prosecution of work under Government war contracts. Shortly after the Armistice, these contracts were canceled and this special equipment, unsuitable to the normal peace-time operations of petitioner's business, was abandoned and scrapped - "thrown in the graveyard," as the witness stated. Petitioner is clearly entitled to a loss deduction for 1918 of $4,284.02, representing the cost of special equipment for painting and drying sheets, of special stovepipe machinery, and of one set of bending rolls, all of which equipment was abandoned and scrapped in that year. As to the flood lights, seven in number, installed on the premises for the purpose of protection against unauthorized trespassers, it appears that five have been occasionally used subsequent to 1918. Therefore, no loss deduction seems proper in respect of these lights on*2371 the ground of abandonment. Circumstances would indicate that this facility is within the statutory provisions relating to the amortization of war facilities; but the petitioner abandoned all claim to amortization of war facilities, and that action was taken after proof was placed in the record that it had not made claim for amortization within the time prescribed by statute.
In determining, for invested capital purposes, the amount of earnings available for distribution at the dividend dates of March 31 and July 31, 1918, the respondent deducted a tentative tax of $69,092.65. This action of the respondent is contrary to the decision of this Board in , and is in error. See, also, ; .
Proper adjustments of invested capital for 1920, on account of income and profits taxes for 1918 and 1919, will be made under Rule 50, when the correct tax liability for each of those years has been redetermined in accordance with this decision.
*2372 *81 Respondent's motion to dismiss as to 1919, on the ground that no deficiency has been determined for that year, is granted upon the authority of .
Judgment will be entered under Rule 50.