*2807 1. In the absence of evidence that depreciated cost of assets is equal to fair market value, it will not be assumed that cost depreciated to March 1, 1913, is equivalent to fair market value on that date.
2. Cost of assets acquired for stock is not established by an admission of the par value of the stock issued therefor and without evidence of the actual value of the stock or the assets.
3. A computation of depreciation for the taxable years, submitted in support of a claim for an increased allowance, will not be accepted where the rate used is not shown to be the correct rate for the years involved when applied to cost as a basis and the computation ignores depreciation allowed in prior years.
4. The fact that the Commissioner applied the same rate as that adopted by the taxpayer, in part, in his computation for years prior to taxable year and in subsequent years on assets acquired thereafter is insufficient to establish correctness of rate adopted by taxpayer.
5. While a computation allocating to each year involved an amount of depreciation determined by apportioning the cost equally over the period of the expected life of the assets may be proper in this case, *2808 since the Commissioner has determined that present and future depreciation must be adjusted because of the accumulated depreciation reserve, it is incumbent upon the taxpayer to show that the Commissioner's computation is incorrect.
6. The Commissioner's computation, based upon book figures purporting to represent cost, is held to be incorrect in that it failed to take into account the March 1, 1913, value of the assets in existence on that date and on hand at the beginning of the taxable year.
7. A reduction of the depreciation base for the taxable year to an amount lower than the cost of assets purchased in preceding year depreciated at 10 per cent, held erroneous.
8. The Commissioner reduced the basis as of the beginning of the tax year to a certain figure, on the ground that depreciation allowances were exceeding physical exhaustion. During five years preceding the tax year assets were purchased at a cost in excess of the amount of the reduced basis, and the Commissioner allowed depreciation on such assets at the rate of 10 per cent. A computation of depreciation at that rate on the cost of assets purchased in each of the five years disclosed unimpaired capital*2809 in excess of the reduced basis for the beginning of the tax year. Semble, that the reduced basis should be increased by the amount of such excess.
9. The amount of invested capital to which a taxpayer is entitled on account of cash or tangible property paid in for stock is not affected by the reacquisition of the stock issued without cost.
10. Where the evidence does not show exactly what action the Commissioner has taken with respect to a claim of invested capital on account of property paid in for stock, the taxpayer is bound to establish the amount of invested capital to which it is entitled, and, in the absence of evidence from which a value can be determined, allegations of value in the pleadings, stated in terms of the par value of the stock issued for assets, are insufficient to support a determination.
11. Where assets were not shown to have had a value in excess of par value of stock issued therefor, and maximum amount allowed as invested capital for tax year for assets paid in for stock was determinable on basis of difference between stock outstanding and cash paid in for stock, and, from an examination of the computation of invested capital for succeeding*2810 year, it was apparent that Commissioner reduced earned surplus for tax year by an amount of depreciation not charged off books, which was computed on the basis of the value of the assets measured by the par value of the stock originally issued therefor rather than value allowed as invested capital, held that all depreciation in excess of that computed upon the amount allowed as invested capital should be restored to earned surplus.
12. The mere fact that a plant was not in operation during a certain period is not in itself sufficient to establish that no depreciation was sustained during that period.
13. The Commissioner's reduction of invested capital on account of the purchase by a taxpayer of its own stock for less than par value approved for lack of evidence establishing error.
14. Amounts paid to a corporation by its stockholders for which no stock was issued and which were to be repaid when financial condition of corporation permitted, held to constitute borrowed capital.
*2811 *682 These proceedings involve deficiencies in income and profits taxes as follows: $13,447.60 for 1920; $13,362.96 for 1921; $3,731.60 for 1922; $3,832.81 for 1923; and $2,199.32 for 1925. The year 1924 is not in issue. The proceedings were consolidated for hearing and decision, and all the evidence is available in each proceeding.
The petitioner assigns as errors the following actions of the respondent:
The allowance of inadequate deductions for depreciation of machinery and equipment in each of the years involved.
Understanding for 1920 and 1921 the cash value for invested capital purposes of property acquired for stock.
Understanding invested capital for 1920 and 1921 by accrued depreciation computed upon a basis greater than the value allowed as paid in for stock or shares.
Understating invested capital for 1920 and 1921 by depreciation for a period during which the plant was not in operation.
Understating invested capital for 1920 and 1921 by the excess of the value originally paid in for stock over the amount subsequently paid out to retire the stock.
Understating invested capital for 1920 and 1921 by amounts paid in by stockholders for which no*2812 stock was issued.
Understating invested capital for 1920 by failing to include any part of $2,000 cash paid in for stock during that year. The respondent admitted error in this respect.
The petitioner further assigned as error the respondent's failure to compute the profits tax for 1920 and 1921 under sections 327 and 328 of the Revenue Acts of 1918 and 1921. On motion of the respondent under Rule 62(a), hearing was confined to the other issues.
*683 FINDINGS OF FACT.
The petitioner is an Indiana corporation, organized in 1902, with its principal place of business at Evansville, Inc., and is engaged in the manufacture and sale of cotton goods.
In 1902 the Kearney Cotton Mills, located at Kearney, Nebr., then in the hands of a receiver, was possessed of machinery and equipment acquired new in 1892, and used for manufacturing purposes over operating periods aggregating at least six years prior to 1902. In September, 1902, the petitioner acquired the machinery and equipment of the Kearney Cotton Mills, issuing in exchange therefor shares of petitioner's capital stock as detailed hereinafter. Later in 1902 the petitioner acquired a factory site at Evansville, *2813 Ind., and started the construction of its plant thereon. During 1903 the petitioner was engaged in erecting the plant and in moving and reinstalling at Evansville, Ind., the machinery and equipment which it had acquired at Kearney, Nebr. In addition new equipment was acquired from various sources for cash or capital stock and was installed.
The taxpayer's capital stock was issued and retired as follows:
| Year | Issued for - | Common stock | Preferred stock | Total stock |
| (par) | (par) | (par) | ||
| 1902 | Original issue, part | $114,900 | $89,400 | $204,300 |
| 1904 | Original issue, additional | 14,300 | 60,600 | 74,900 |
| Total issued to Dec. 31, 1919 | 129,200 | 150,000 | 279,200 | |
| 1904 | Donated to treasury | 1,500 | 3,000 | 4,500 |
| 1907 | Donated to treasury | 63,300 | 63,300 | |
| 1911 | Donated to treasury | 60,900 | 60,900 | |
| 1910 | Repurchased for cash | 2,500 | 2,500 | |
| Total reacquired | 128,200 | 3,000 | 131,200 | |
| 1911 | Balance of original | 1,000 | 147,000 | 148,000 |
| 1911 | Exchanged | +147,000 | +147,000 | |
| 1911 | Outstanding, Dec. 31, 1919 | 148,000 | 148,000 | |
| 1920 | Reissued for cash at par, May 29, 1920 | 2,000 | 2,000 | |
| 1920 | Stock dividend, new issue | 300,000 | 300,000 | |
| 1920 | Outstanding Dec. 31, 1920 | 450,000 | 450,000 | |
| 1921 | Outstanding Dec. 31, 1921 | 450,000 | 450,000 |
*2814 The taxpayer's capital stock issued in 1902 and 1904 was issued for the following assets:
| Year | Issued for - | Par value of stock |
| 1902 | Machinery and equipment of Kearney Cotton Mills | $204,300 |
| 1904 | Cash at 16 per cent discount | 32,000 |
| 1904 | New machinery | 42,900 |
*684 The above three items were classified on petitioner's books at the time of acquisition as follows:
| Cash | $26,880.00 |
| Discount on stock sold for cash | 5,120.00 |
| Machinery and equipment of Kearney Cotton Mills | 204,300.00 |
| Machinery (new) | 24,917.63 |
| Discount on stock issued for new machinery | 3,682.37 |
| Bonus (with stock issued for new machinery) | 14,300.00 |
The original book values of assets acquired for stock were adjusted by book transfers as follows:
| Adjustments | ||||
| Original book | Debit | Credit | Adjusted | |
| values | book value | |||
| Real estate | $1,000.00 | $7,500.00 | ||
| 6,500.00 | ||||
| Buildings | 24,000.00 | 24,000.00 | ||
| Machinery and equipment | $204,300.00 | $24,000.00 | 179,300.00 | |
| 1,000.00 | ||||
| Machinery and equipment | 24,917.63 | 7,800.00 | 41,520.00 | |
| 3,682.37 | ||||
| 5,120.00 | ||||
| Cash | 26,880.00 | 26,880.00 | ||
| Discount on stock | 8,802.37 | 3,682.37 | ||
| 5,120.00 | ||||
| Bonus for services | 14,300.00 | 6,500.00 | ||
| 7,800.00 | ||||
| Totals | 279,200.00 | 48,102.37 | 48,102.37 | 279,200.00 |
*2815 The adjusted book values of fixed assets acquired for stock were further reduced prior to January 1, 1920, by credits as follows:
| Credits | ||||
| Assets | Adjusted | Explanation | Amount of | Book values |
| book value | credit | Dec. 31, 1919 | ||
| Real estate | $7,500.00 | Donated stock, 1904 | $1,500.00 | $6,000.00 |
| Buildings | 24,000.00 | 24,000.00 | ||
| Machinery and equipment | 220,820.00 | Donated stock, 1904 | 3,000.00 | 122,307.71 |
| Donated stock, 1907 | 63,300.00 | |||
| Sales | 30,099.92 | |||
| Rent received | 1,500.00 | |||
| Reversing charge | ||||
| for discount | 612.37 |
The capital stock of $63,300 donated in 1907 was credited to the machinery account instead of to the capital surplus account.
From time to time prior to 1914 the principal stockholders of the petitioner paid $225,568.27 to the petitioner with the understanding that the money was to be retained and used as long as needed and repaid whenever the financial condition of the petitioner would permit. Twenty thousand dollars was repaid in 1917, $105,000 in 1918, and $20,419.55 in 1919. Unliquidated loans on December 31, 1919, amounted to $80,148.72. Twenty thousand dollars of this was paid off in 1920, leaving*2816 $60,148.72 unliquidated on December 31, 1920. The respondent excluded these amounts from invested capital.
*685 The petitioner has paid only one cash dividend. This amounted to $4,410 and was paid on May 20, 1907.
The par value of stock issued by petitioner for real estate, buildings, machinery and equipment, the dates of acquisition and dates of disposal are as follows:
| Real estate | Buildings | Machinery | |
| and | |||
| equipment | |||
| 1902 | $1,000.00 | $24,000.00 | $179,300.00 |
| 1904 | 6,500.00 | 41,520.00 | |
| Total par value of stock issued | 7,500.00 | 24,000.00 | 220,820.00 |
| Less credits: | |||
| 1904. Part of 1904 stock canceled | 1,500.00 | 3,000.00 | |
| 1905. To correct 1904 charge | 612.37 | ||
| 1905. Rent received | 1,000.00 | ||
| 1905. Sold | 1,051.03 | ||
| 1906. Sold | 574.80 | ||
| 1907. Sold | 36.65 | ||
| 1908. Rent received | 500.00 | ||
| 1909. Sold | 19.50 | ||
| 1910. Sold | 104.94 | ||
| Total to Mar. 1, 1913 | 1,500.00 | 6,899.29 | |
| Balance Mar. 1, 1913 | 6,000.00 | 24,000.00 | 213,920.71 |
| 1917. Sold | 350.00 | ||
| 1918. Sold | 13,463.00 | ||
| 1919. Sold | 14,500.00 | ||
| Total | 28,313.00 | ||
| Balance held Dec. 31, 1919, and Dec. 31, 1920 | 6,000.00 | 24,000.00 | 185,607.71 |
*2817 The assets were set up on the books in these amounts.
The cost of buildings, machinery, and equipment acquired for cash and the dates of acquisition were as follows:
| Automobiles | Real estate | Buildings | Machinery and | |
| equipment | ||||
| 1904. Additions | $100,925.03 | $108,084.92 | ||
| 1905. Additions | 119.00 | 20,002.23 | ||
| 1906. Additions | 1,695.79 | |||
| 1907. Additions | 10,434.49 | |||
| 1908. Additions | 1,152.63 | |||
| 1909. Additions | 11,518.62 | |||
| 1910. Additions | 87.30 | |||
| 1911. Additions | ||||
| 1912. Additions | (4.50) | |||
| Total to Mar. 1, 1913 | 101,044.03 | 152,971.48 | ||
| 1913. Additions | ||||
| 1914. Additions | -65.00 | |||
| 1915. Additions | 5,898.17 | |||
| 1916. Additions | 42.06 | |||
| 1917. Additions | $1,162.69 | 4,976.00 | ||
| 1918. Additions | 381.72 | 2,597.98 | 2,713.23 | |
| 1919. Additions | 207.33 | 33,873.04 | ||
| Total to Dec. 31, 1919 | 1,751.72 | 103,642.01 | 200,408.98 | |
| 1920. Additions | 198.00 | 434.04 | ||
| 1,949.72 | 103,642.01 | 200,843.02 | ||
| Transfer | $1,397.00 | -1,397.00 | ||
| Total to Dec. 31, 1920 | 1,397.00 | 1,949.72 | 103,642.01 | 199,446.02 |
| 1921. Additions | 1,526.00 | 741.70 | ||
| Total to Dec. 31, 1921 | 2,923.00 | 1,949.72 | 103,642.01 | 200,187.72 |
*2818 *686 The book value of machinery and equipment on March 1, 1913, December 31, 1919, December 31, 1920, and December 31, 1921, was as follows:
| Mar. 1, 1913 | Dec. 31, 1919 | Dec. 31, 1920 | Dec. 31, 1921 | |
| Book cost to date | $366,892.19 | $386,016.69 | $385,053.73 | $385,795.43 |
| Less credit for | ||||
| donated stock | 63,300.00 | 63,300.00 | 63,300.00 | 63,300.00 |
| Net book value | 303,592.19 | 322,716.69 | 321,753.73 | 322,495.43 |
Operation of the plant at Evansville, Ind., began in January, 1904, and continued until June 30, 1910, when the plant was closed, and it remained closed until October 21, 1911, when operation was resumed. It has since continued without interruption. During 1920 and 1921 the regular equipment was in use and there were no abnormal operating conditions.
The following expenses, incurred in 1903, were in 1904 charged $5,000 to building and $7,972.81 to machinery:
| Office expense | $52.50 |
| Treasurer's salary | 4,041.67 |
| Insurance | 608.48 |
| Interest | 5,803.91 |
| General expense | 2,466.25 |
| Total | 12,972.81 |
The respondent disallowed depreciation on these items.
No depreciation was charged off on the books of petitioner prior to 1916. *2819 Depreciation of machinery and equipment was charged off on the books, and allowed as deductions by the respondent for the following years in the amounts indicated:
| For 1916, 10 per cent of $309,467.42 | $30,946.74 |
| For 1917, 10 per cent of $310,511.59 | 31,051.15 |
| For 1918, 10 per cent of $303,343.67 | 30,094.05 |
| For 1919, 10 per cent of $334,043.60 | 33,404.36 |
| 125,496.30 |
Additional depreciation on machinery and equipment was allowed as a deduction by the respondent as follows:
| For 1917, 5 per cent of $63,300 | $3,165 |
| For 1918, 5 per cent of $63,300 | 3,165 |
| For 1919, 5 per cent of $63,300 | 3,165 |
| 9,495 |
The total allowed by respondent for the years 1916 to 1919, inclusive, as depreciation on machinery and equipment was $134,991.30.
For 1913 and 1915 deductions allowed for depreciation of machinery and equipment included $14,829.17 and $15,124.09, respectively, computed at the rate of 5 per cent.
*687 The reserve on the books on December 31, 1919, for depreciation of all assets, after deducting charges to the account to reflect changes due to assets disposed of, amounted to $132,127.28.
The following is a computation of depreciation*2820 sustained for the period 1904 to 1917, inclusive, as shown by a revenue agent's report dated November 30, 1918:
| Table of rates and values | ||||
| 1904. | Equipment | $201,815.16 | 5 per cent | $10,090.76 |
| Building | 100,925.03 | 3 per cent | 3,027.75 | |
| 1905. | Equipment | 347,055.02 | 5 per cent | 17,352.75 |
| Building | 101,044.33 | 3 per cent | 3,031.33 | |
| 1906. | Equipment | 364,215.43 | 5 per cent | 18,210.77 |
| Building | 101,044.33 | 3 per cent | 3,031.33 | |
| 1907. | Equipment | 363,294.69 | 5 per cent | 18,164.74 |
| Building | 125,044.33 | 3 per cent | 3,751.33 | |
| 1908. | Equipment | 283,692.76 | 5 per cent | 14,184.63 |
| Building | 125,044.33 | 3 per cent | 3,751.33 | |
| 1909. | Equipment | 285,129.45 | 5 per cent | 14,256.47 |
| Building | 125,044.33 | 3 per cent | 3,751.33 | |
| 1910. | Equipment | 295,711.38 | 5 per cent | 14,785.56 |
| Closed for year. | ||||
| 1911. | Building | 125,044.33 | 3 per cent | 3,751.33 |
| Equipment | 296,711.38 | 5 per cent | 14,835.57 | |
| 1912. | Building | 125,044.33 | 3 per cent | 3,751.33 |
| Equipment | 296,711.38 | 5 per cent | 14,835.57 | |
| 1913. | Building | 125,044.33 | 3 per cent | 3,751.33 |
| Equipment | 296,583.48 | 5 per cent | 14,829.17 | |
| 1914. | Building | 125,044.33 | 3 per cent | 3,751.33 |
| Equipment | 296,583.33 | 3 per cent | 14,829.17 | |
| 1915. | Building | 125,044.33 | 3 per cent | 3,751.33 |
| Equipment | 302,481.65 | 5 per cent | 15,124.09 | |
| Total | 220,600.30 | |||
| 1916. | Building | 125,044.33 | 3 per cent | 3,751.33 |
| Equipment | 309,467.40 | 10 per cent | 30,946.74 | |
| Total | 34,698.07 | |||
| 1917. | Building | 125,044.33 | 3 per cent | 3,751.33 |
| Equipment | 310,511.59 | 10 per cent | 31,051.15 | |
| Auto | 650.00 | 25 per cent | 162.50 | |
| Total | 34,964.98 |
*2821 This computation was followed, under protest, by another revenue agent's report dated August 4, 1923, covering an investigation for the years 1916 to 1920, inclusive. The respondent, in accordance with these reports, has determined invested capital by applying the item of $220,600.32 to reduce earned surplus.
*688 On May 29, 1920, $2,000 par value of the original issue of common stock then held in the treasury was reissued for $2,000 cash. The respondent has not taken this item into account in computing invested capital for 1920.
The following is a summary of the petitioner's surplus account for 1920:
| Balance of Surplus Account at beginning of year | $285,223.08 | |
| Deduct debt balance of General Loss and Gain Account | 600.00 | |
| 284,623.08 | ||
| Employees pay uncalled for | $26.29 | |
| Net profit for 1920 | 187,366.34 | |
| 187,392.63 | ||
| 472,015.71 | ||
| 1919 Federal income tax | 53,838.50 | |
| Stock dividend | 300,000.00 | |
| 353,838.50 | ||
| Balance at end of year | 118,177.21 |
The surplus of $285,223.08 included credits of $60,900, the par value of stock turned in and canceled, and of $2,250, the excess of the par value of the stock reacquired in 1910 over the purchase*2822 price.
Prior years' taxes were overpaid and refunded or credited to petitioner as follows:
| Year | Disposition of overpayment | Amount overpaid |
| 1913 | Credited against 1921 tax in 1922 | $57.28 |
| 1915 | do | 137.00 |
| 1917 | do | (net) 12,793.47 |
| 1918 | Credited against 1917 tax, $1,218.81 | 12,713.62 |
| Refunded in 1924, $11,494.81. | ||
| 1919 | Refunded in 1925 | 1,390.34 |
| Total | 27,091.71 |
The reserve for depreciation on petitioner's books of account was debited and credited as follows:
| Debits | Credits | |
| 1916: | ||
| Depreciation of buildings | ||
| (charged to profit and loss) | $3,751.33 | |
| Depreciation of machinery and equipment | ||
| (charged to profit and loss) | 30,949.74 | |
| 1917: | ||
| Depreciation of machinery and equipment | ||
| (charged to profit and loss) | 31,051.15 | |
| Depreciation of buildings | ||
| (charged to profit and loss) | 3,751.33 | |
| Depreciation of automobile | ||
| (charged to profit and loss) | 162.50 | |
| Loss on folding machine sold | ||
| (credited to machinery) | $125.00 | |
| 1918: | ||
| Depreciation of buildings | ||
| (charged to profit and loss) | 3,829.26 | |
| Depreciation and machinery and equipment | ||
| (charged to profit and loss) | 30,094.05 | |
| Loss on sale of looms | ||
| (charged to profit and loss) | 9,222.10 | |
| Loss on machinery (credited to machinery) | 11,759.30 | |
| Loss on machinery sold (credited to machinery) | 277.00 | |
| Loss on automobile sold (credited to equipment) | 162.50 | |
| 1919: | ||
| Depreciation of machinery and equipment | ||
| (charged to profit to profit and loss) | $33,404.36 | |
| Depreciation of buildings | ||
| (charged to profit and loss) | 3,829.26 | |
| Depreciation of automobiles | 274.00 | |
| Depreciation of old machine | ||
| (credited to furniture and fixtures) | $75.00 | |
| Depreciation of 20 cards, sold for old iron | ||
| (credited to machinery) | 5,800.00 | |
| 1920: | ||
| Depreciation of buildings | ||
| (charged to profit and loss) | 3,829.26 | |
| Depreciation of machinery and equipment | ||
| (charged to profit and loss) | 32,135.37 | |
| Depreciation of automobile | ||
| (charged to profit and loss) | 365.37 | |
| Depreciation of machinery | ||
| (charged to profit and loss) | 40.00 | |
| Depreciation of automobile traded in | ||
| (credited to new equipment) | 320.00 | |
| 1921: | ||
| Depreciation of buildings | ||
| (charged to profit and loss) | 3,829.26 | |
| Depreciation of machinery and equipment | ||
| (charged to profit and loss) | 32,175.37 | |
| Depreciation of machinery and equipment | ||
| (charged to profit and loss) | 74.17 | |
| Depreciation of automobile | 730.75 |
*2823 *689 In 1919 profit and loss was charged, and machinery account was credited with a loss amounting to $7,679.11 with the following explanation upon the journal:
The above entry made due to the fact that 20 cards, valued at $725, were discarded to make room for new looms.
| 20 cards, at $725 | $14,500.00 |
| Sold for old iron | 1,020.89 |
| 13,479.11 | |
| Four years' depreciation at 10 per cent | 5,800.00 |
| 7,679.11 |
OPINION.
STERNHAGEN: The record in this proceeding is in the utmost confusion and it is only with the greatest difficulty that the Board has decided it. Upon discursive pleadings the evidence was submitted, consisting of identified books and reports which were said, without objection, to contain the facts. It was only when they were examined that their lack of clarity became apparent. Despite the petitioner's charge that respondent's determination was both incorrect and inconsistent, no brief or other explanation was filed by respondent. As to both parties we have in some respects been required to ascertain the scope of the issues from ambiguous and equivocal allegations and statements. Thus the disposition here made must be read in the light of*2824 the conglomerate record upon which it is based.
The first issue relates to the respondent's allowance of inadequate deductions for depreciation on machinery and equipment during all of the years before us.
The petitioner states in its brief:
The costs of machinery and equipment to March 1, 1913, and to December 31, 1919, the dates of its acquisition, and the rates of depreciation applicable to it for the taxable years are all admitted by the Commissioner as claimed by the Petitioner.
*690 Based upon what it conceives to be the admitted facts, the petitioner makes a computation of depreciation sustained during the years involved and asks that it be substituted for the respondent's computation.
There are a number of reasons why the petitioner's computation can not be accepted. In the first place, the petitioner has assumed that cost depreciated to March 1, 1913, is equivalent to the fair market value on that date. There is no evidence tending to show that the depreciated cost of the assets involved is equal to fair market value, and we are not justified in making the assumption.
Secondly, it can not be granted that cost of the assets acquired for stock has been*2825 established. The petitioner alleges and the answer admits cost only in terms of the par value of stock issued. The evidence introduced to establish that the par value of the stock, set up on the books as cost, is equivalent to cost is too meager to accomplish its purpose. Other evidence establishing the value either of the stock or of the assets acquired therefor is lacking.
But even if the Board were prepared to accept the theory underlying petitioner's computation as correct, it would avail it nothing, not only for the reasons assigned above, but also because the rate of depreciation has not been proved. The petitioner assumes an original life of 20 years and uses a rate of 5 per cent. There is not enough in the record to establish this or any other rate as the correct rate for the years involved when applied to cost as a basis. The fact that the respondent has used this rate in years prior to 1920 (in some small part) and in subsequent years on assets acquired after 1920 is not sufficient.
Finally, the petitioner's computation ignores the depreciation allowed by the respondent for years prior to 1920. In computing income for 1916, 1917, 1918, and 1919, the respondent*2826 allowed depreciation on machinery and equipment at the rate of 10 per cent, using book figures as a basis, except that in making adjustments for 1917, 1918, and 1919, 5 per cent was allowed on the $63,300 erroneously charged to the machinery and equipment accounts. For 1920 and subsequent years the respondent, apparently apprehending that depreciation allowances were exceeding the physical exhaustion of this class of assets, reduced the basis for depreciation of assets acquired prior to January 1, 1920, to a "depreciated value" as of that date of $29,306.16 and allowed depreciation at the rate of 10 per cent annually thereon, and upon assets acquired thereafter allowed depreciation at the rate of 5 per cent annually, limiting the latter allowance to 2 1/2 per cent for additions during the year.
The depreciated value of $29,306.16 was computed as follows:
| Machinery accounts shown on books Jan. 1, 1920 | $322,716.69 | |
| Donated stock credited to machinery in 1907 | 63,300.00 | |
| 386,016.69 | ||
| Less: | ||
| Discount on preferred stock debited to machinery in 1904 | $12,602.37 | |
| Organization expenses debited to machinery in 1904 | 7,972.81 | |
| 20,575.18 | ||
| 365,411.51 | ||
| Total depreciation allowed for years prior to 1920 | 336,125.35 | |
| Depreciated value Jan. 1, 1920 | 29,306.16 |
*2827 *691 It may be that a computation allocating to each year involved an amount of depreciation determined by apportioning the cost of the assets equally over the period of their expected life would be proper in these proceedings; but where the respondent has determined, as he has, that present and future depreciation must be adjusted because of the accumulated depreciation reserve, it is incumbent upon the petitioner to show that the respondent's computation is incorrect. As was said in the case of :
* * * The Board will not lightly conclude that deductions from gross income in prior years through allowances for exhaustion, wear and tear of property used in the trade or business were unwarranted and excessive, and direct adjustment thereof so that a taxpayer may in subsequent years secure the benefit of a greater deduction from income for exhaustion, wear and tear than [that] to which he would otherwise be entitled. We have held that we will not permit the Commissioner to adjust invested capital for taxable years upon the ground that the taxpayer has taken inadequate depreciation in prior years, in the absence*2828 of a clear showing that the depreciation charged upon the books or claimed in the returns was inadequate. ; ; . And, when a taxpayer claims that the Board should go back and redetermine the useful life of the property and recompute the depreciation allowance over a long period of years long since barred by the statute of limitation, so that he may obtain a greater deduction from income in the taxable year, and in fact obtain the benefit of a double deduction from income, he must satisfy the Board by clear and convincing evidence that he is in justice entitled to such adjustment. The allowance of the deduction from income for exhaustion, wear and tear of property is for the benefit of the taxpayer and when he has been given a liberal allowance in prior years, when the tax rates were high, he should not be heard to say upon a mere showing that in the taxable years the property is still in use and giving good service, that the depreciation claimed and allowed after a full consideration of the facts in prior years should be disregarded*2829 and an allowance made which will permit of the exhaustion of the same or a portion of the capital investment the second time.
To the same effect is . See also ; ; and , where questions involving deductions for depletion are similarly treated.
*692 The respondent's computation of depreciation for 1920 is, notwithstanding, obviously incorrect. It takes no account of the March 1, 1913, value of assets in existence at that time and on hand January 1, 1920, starting instead with book figures purporting to represent cost. But we are unable to direct a recomputation in this respect because of the absence of proof of value as of March 1, 1913. ; affd. .
To a certain extent error is clear. The respondent has admitted that the amount of $336,125.35, deducted from the book cost as allowed depreciation, includes depreciation on the items of $7,972.81 and $12,602.37, *2830 alleged organization expense and discount on stock, which items were specifically excluded from the base upon which depreciation was computed. This should be corrected upon recomputation.
A further error is apparent when it is noted that the respondent has reduced the entire base upon which he computes depreciation for 1920 to $29,306.16, although assets costing $33,873.04 were purchased in 1919, and depreciation for that year was allowed at the rate of 10 per cent. The error, though less apparent, is also present with respect to assets acquired prior thereto.
From 1915 to 1919, inclusive, the petitioner purchased machinery and equipment at a cost of $47,502.50. During each of those years the respondent allowed depreciation at the rate of 10 per cent. Segregating the cost by years as it appears in the findings of fact, and computing depreciation at the rate of 10 per cent thereon, with half that rate on assets during the year in which acquired, it will be found that depreciation totaling $6,013.55 has been sustained on such assets. The computation is as follows:
| Year | Amount | 1915 | 1916 | 1917 | 1918 | 1919 | Total |
| 1915 | $5,898.17 | $294.91 | $589.82 | $589.82 | $589.82 | $589.82 | $2,654.19 |
| 1916 | 42.06 | 2.10 | 4.21 | 4.21 | 4.21 | 14.73 | |
| 1917 | 4,976.00 | 248.80 | 497.60 | 497.60 | 1,244.00 | ||
| 1918 | 2,713.23 | 135.66 | 271.32 | 406.98 | |||
| 1919 | 33,873.04 | 1,693.65 | 1,693.65 | ||||
| Total | 47,502.50 | 294.91 | 591.92 | 842.83 | 1,227.29 | 3,056.60 | 6,013.55 |
*2831 Deducting the sustained depreciation of $6,013.55 from the cost of $47,502.50 leaves a remainder of $41,488.95, representing unimpaired capital. To the extent that this amount exceeds the basis of $29,306.16 used by the respondent ($12,182.79), he has restored to one group of assets excess depreciation by applying the amount to another group. This is clearly improper. The petitioner should be allowed to use a base of at least $41,488.95 for assets in existence on January 1, 1920, in the computation of depreciation on those assets for all the years here involved.
*693 The second issue relates to the partial disallowance of invested capital claimed for 1920 and 1921. Petitioner contends that the respondent understated the cash value of property acquired for stock or shares, section 326(a)(2).
For convenience, the transactions in petitioner's capital stock an be tabulated as follows:
| Par value | Value assigned | Cash paid | |
| of stock | to assets | in | |
| issued | on books | ||
| Preferred stock: | |||
| September, 1902. Issued for old machinery | $89,400 | $89,400 | |
| September, 1903. Issued for cash | 12,000 | $10,080 | |
| Do | 20,000 | 16,800 | |
| September, 1903. Issued for new machinery | 28,600 | 28,600 | |
| 150,000 | 118,000 | 26,880 | |
| March, 1904. Stock returned to treasury | 3,000 | 3,000 | |
| 147,000 | 115,000 | ||
| 1911. Stock turned in and canceled in | |||
| exchange for common stock | 147,000 | ||
| Common stock: | |||
| September, 1902. Issued for old machinery | 114,900 | 114,900 | |
| September, 1903. Issued as a bonus and | |||
| charged to asset accounts in January, 1904, | |||
| as follows: | |||
| New machinery | 7,800 | 7,800 | |
| Real estate | 6,500 | 6,500 | |
| 129,200 | 244,200 | 26,880 | |
| 1March, 1904. Stock donated to treasury | 1,500 | 1,500 | |
| 127,700 | 242,700 | ||
| 2October, 1907. Stock donated to treasury | 63,300 | ||
| 64,400 | |||
| 3December, 1910. Purchased for $250 cash | 2,500 | (250) | |
| 61,900 | 242,700 | 26,630 | |
| 4January, 1911. Stock donated to treasury | 60,900 | ||
| 1,000 | |||
| 1911. Common stock issued in exchange for | |||
| preferred stock returned | 147,000 | ||
| Outstanding, Jan. 1, 1920 | 148,000 | 242,700 | 26,630 |
| May, 1920. Sold for cash | 2,000 | 2,000 | |
| December, 1920. Stock dividend | 300,000 | ||
| 450,000 | 242,700 | 28,630 |
| Summary | |
| Par value | |
| Sold for cash (net) | $29,500 |
| Capitalized for land (net) | 5,000 |
| Capitalized for machinery (net) | 237,700 |
| 272,200 | |
| Donated to treasury | 124,200 |
| Outstanding Jan. 1, 1920 | 148,000 |
| Sold for cash in 1920 | 2,000 |
| Dividend (charged to surplus) | 300,000 |
| Total | 450,000 |
*694 For 1920 the respondent has allowed as invested capital $148,000. The deficiency notice states:
Your claim for paid-in surplus has not been allowed. Section 326(a)(1)(2)(3), Revenue Acts of 1918 and 1921. The cash value of tangible assets has not been established as being in excess of the par value of the stock originally issued therefor less donated stock.
Since the adjusted balance sheet indicates an operating deficit, capital stock constitutes the invested capital for one year. Article 860, Regulations 45.
This would seem to indicate not that the respondent has deducted the par value of stock subsequently*2833 reacquired by the petitioner without cost from the value of the assets paid in for the stock when issued, as petitioner contends in substance in its brief, but rather that he has deducted the par value of the stock reacquired from the par value of the stock originally issued, and used the difference as the measure of the value of the assets paid in for stock. The pleadings, however, disclose a situation different from that outlined in the deficiency notice. The petition alleges:
The Commissioner reduced invested capital as shown by the books by $141,200 on account of the excess of book value at date of acquisition of machinery and equipment acquired for stock, over the value assigned by the Commissioner as of date of acquisition to said machinery and equipment.
The respondent answered this allegation as follows:
Denies that the Commissioner reduced taxpayer's invested capital by the amount of $141,200, on account of the excess of book value at the date of acquisition of the machinery and equipment acquired for stock over the value alleged to have been assigned by the Commissioner as of the date of acquisition of said machinery and equipment, but avers that the said reduction*2834 of invested capital referred to in paragraph 5-2(j) of the petition, to wit, $131,200, instead of $141,200, as therein stated, is based upon taxpayer's own action in reducing its capital stock originally issued in the amount of $279,000 by the amount of $131,200, representing capital stock donated to or purchased by taxpayer as more particularly set forth in paragraph 5-2(k) of the petition, said donations being made to offset operating losses sustained in years prior to 1916.
The determination as set forth in the deficiency notice and the averment in the respondent's answer are absolutely at variance. Not only are the two repugnant in their terms, but the conclusion stated in the deficiency notice fails to follow from the reasoning averred. The amount of invested capital to which the petitioner may be entitled, under section 326(a)(1) and (2), by reason of cash or tangible property having been paid in for stock or shares, can not be affected by the reacquisition of stock without cost, , or operating losses, *2835 ; ; , and we are unable to see how the concurrence of the two can affect such invested capital. The situation is the reverse of a stock dividend declared and paid because of earnings realized *695 and retained in the business, which has no effect upon income, , or upon invested capital, ; ; .
The inconsistency between the determination and the reasons given therefor remains after examining the following computation of petitioner's invested capital for 1921, set forth in the deficiency notice:
| Capital stock outstanding | $450,000.00 | ||
| Surplus shown by balance sheet | $118,177.21 | ||
| Additions: | |||
| Overassessments - | |||
| 1917 | $14,012.28 | ||
| 1,218.81 | |||
| 12,793.47 | |||
| 1918 | 12,713.62 | ||
| 1919 | 1,390.34 | ||
| $26,897.43 | |||
| Depreciation disallowed for 1920 | 29,233.90 | ||
| 174,308.54 | |||
| Deductions: | |||
| Depreciation for 1903 to 1915 not on | |||
| books | $220,600.32 | ||
| Depreciation for 1908-1919, 12 years 5% | |||
| on $63,300 restored to machinery account | 37,980.00 | ||
| Inventory adjustment | 131,598.27 | ||
| Stock canceled | 60,900.00 | ||
| Stock, par value $2,500 purchased for | |||
| $250 | 2,250.00 | ||
| 453,328.59 | |||
| Deficit as adjusted ($300,000 stock | |||
| dividend in 1920) | 279,020.05 | ||
| Balance | 170,979.95 | ||
| Deduct 1920 taxes $23,030.94 prorated | 9,732.88 | ||
| Invested capital as adjusted | 161,247.07 |
*2836 Since the respondent makes no distinction between the various component elements of statutory invested capital, this computation is consistent with either his determination or the method stated to have been used by him, and it is not clear which of the two he regards as predominant.
Although much of our doubt is due to inability to determine exactly what action the respondent has taken, it must be recognized that in such a situation it is incumbent upon the petitioner, under the burden of proof resting upon it, to establish the amount of invested capital to which it is entitled. . The pleadings speak of the value of the assets paid in for stock or shares only in terms of the par value of the stock issued therefor and the evidence discloses no sufficient basis for a determination *696 of value. The Board must render decision on this issue against the petitioner.
The third issue relates to the alleged reduction of invested capital for 1920 and 1921 by computing depreciation upon assets acquired for stock on a basis greater than the amount allowed as value paid in for stock or shares. This is essentially*2837 an alternative to the preceding issue, for to the extent that such invested capital is increased, there is an automatic reduction of the alleged excessive amount upon which depreciation was computed.
Again we are handicapped by not knowing exactly what action the respondent has taken. Sufficient evidence has been adduced, however, to enable the Board to direct a computation upon a basis other than that adopted by the respondent. Since we do not have the respondent's computation of the operating deficit for 1920, the action taken by him with respect to that year is not at first apparent. There can be determined, however, the value of property other than cash allowed by the respondent as paid in for stock. The total amount allowable is stated to be $148,000. By deducting from this the cash paid in in the net amount of $26,630, we find that the largest amount allowable as the cost or value of other property paid in for stock is $121,370. Since the factors used in the computation of invested capital for any two successive years are necessarily the same except as to events occurring within the two years, we may properly look to the computation for 1921 to determine that for 1920*2838 the respondent has reduced earned surplus by $258,580, representing depreciation not charged off the books, including $220,600.32 for the period 1913 to 1915 as set up in the revenue agent's report of November 30, 1918. From an examination of the detailed schedule of the $220,600.32 depreciation, it will be found that it has been computed upon a basis which includes the assets paid in for stock, not at $121,370, the amount allowed as invested capital, but at the figure at which the assets were carried on the books - the par value of the stock originally issued therefor.
The error in this respect is similar to reducing invested capital by an amount of depletion in excess of cost, due to the deductions allowable in determining income having been computed upon a March 1, 1913, value in excess of cost. In , the Board, in dealing with such a situation, said:
The respondent reduced petitioner's invested capital during the exhaustion of a certain clay bank, by the amount of $9,533.33, which amount equaled the total of the allowances for depletion theretofore made, instead of by the amount of $5,400 which was the actual cost of the exhausted*2839 asset. We assume that the discrepancy between the total of the depletion allowances and the cost results from the fact that the March 1, 1913, value of the depleted asset exceeded the *697 cost. We think the Commissioner's action in this regard is erroneous. In computing invested capital, this asset was, during its existence, properly included at its cost and there is no reason upon its exhaustion for reducing invested capital by more than this amount. In the case of assets acquired prior to March 1, 1913, depletion for invested capital purposes and depletion for the purpose of computing the annual deduction from income may be two totally different things and should never be confused. We take it that the respondent would not contend, if the depletion allowances were less than cost, that the invested capital should be reduced only by the amount of such depletion allowances. This is but another example of fact that the computation of invested capital may not be made to depend entirely upon the theory of the income-tax statutes.
See also *2840 ; ; ; and .
The depreciation upon assets other than cash paid in for stock should be recomputed so as to restore to earned surplus all depreciation in excess of that computed upon the amount allowed as invested capital.
The fourth issue relates to the action of the respondent in reducing invested capital for 1920 and 1921 by depreciation sustained during the period from June 30, 1910, to October 21, 1911, when the plant was not in operation. It does not follow from the fact that a plant is not in operation that depreciation is not sustained. Depreciation to some extent usually results from the mere passage of time, regardless of use. It is not inconceivable that on the property in controversy the processes of depreciation were accelerated by nonuse. At best, however, the question is one of fact to be decided from the evidence. In the absence of any proof this issue must be decided for the respondent.
The fifth issue concerns the alleged*2841 understatement of invested capital for 1920 and 1921 as a result of adjustments made on account of the purchase by petitioner in 1910 of $2,500 par value of its own stock for $250 cash. It is alleged that the respondent omitted from invested capital for 1920 the entire amount of $2,500, and that for 1921 there has been omitted the excess of the par value over cost, $2,250.
The petitioner apparently assumes that $2,500 should be considered as having been paid in for this stock when originally issued. As has been heretofore observed, there has been no showing that any amount was paid in for stock except as to a small amount of cash, which can not be attributed to these particular shares. The respondent has allowed $148,000 as invested capital for 1920, which represents the par value of stock then outstanding. This is the result of deducting from stock originally issued all stock subsequently retired, which *698 includes the stock with which we are here concerned. Since respondent has not deducted from the $148,000 the $250 paid out, it follows that his determination is most reasonably construed as a determination that $148,250 was originally paid in, which was subsequently*2842 reduced to $148,000 when the cash was paid out for the stock. The petitioner has not shown this to be incorrect, and the burden is upon it to do so.
It appears that the respondent has arrived at the same result in his computation of invested capital for 1921. The computation starts with book surplus which includes a credit of $2,250 on account of the transaction and this amount is eliminated. This issue must be resolved in favor of the respondent for both years.
The sixth issue relates to the action of respondent in excluding from invested capital amounts paid to the petitioner by its stockholders, and for which no stock was issued. These amounts were clearly borrowings and were to be repaid when the petitioner's financial condition permitted. They are clearly borrowed capital within the meaning of section 326(b), and the action of the respondent in excluding the amounts from invested capital is sustained. ; .
The respondent admits error with respect to the seventh issue relating to failure to include in invested capital any part of $2,000 paid in for stock*2843 in 1920. This amount should be included in invested capital for that year for its effective average.
The income and excess-profits taxes for all the years involved should be computed in accordance with this opinion. In the event a further hearing is necessary under Rule 62(a), these proceedings will be restored to the general calendar.