*2482 1. The amount to be included in the petitioner's invested capital on account of certain property acquired by it in exchange for its bonds and shares of its capital stock, determined.
2. The basis for computing allowances for depletion of certain coal properties owned by the petitioner, determined.
3. The respondent's action in disallowing certain deductions taken by the petitioner, sustained.
*1 These proceedings, which were duly consolidated for hearing and decision, are for the redetermination of deficiencies in income and profits taxes asserted by the respondent in the amounts of $35,907.05 for the year 1918, $1,457.08 for the year 1919, $71,914.84 for the year 1920, and $946.68 for the year 1923. The petitioner alleges that the respondent erred: (1) In computing its invested capital for the years 1918, 1919, and 1920; (2) in not allowing in each year an adequate amount as a deduction for the depletion of the petitioner's coal property; (3) in disallowing as deductions from income the amounts credited in*2483 each year on the petitioner's books as a reserve for workmen's compensation insurance; (4) in disallowing as a deduction from income for 1919 and 1920 amounts expended for mine machinery and equipment; (5) in disallowing as a deduction from income for 1918 the amount expended in building houses for employees of the petitioner; (6) in disallowing as a deduction for 1920 amounts expended in repairing certain houses; and (7) in disallowing as a deduction for 1920 the amount of $1,654.57 taken on account of a debt claimed to have become worthless and charged off in the taxable year. The petitioner also alleges that its tax liability for 1917 is involved.
*2 FINDINGS OF FACT.
The petitioner is a corporation organized in the year 1903 under the laws of Pennsylvania with a capital stock of $100,000. Its principal office is at Clearfield, Pa. It is and has been since 1903 engaged in mining and selling bituminous coal. Until 1917 it was named Potts Run Land Co.
Prior to the year 1901 one James Kerr acquired numerous small parcels of coal and surface land which together constituted a single body of 1,833 acres of coal and 1,250 acres of surface land, the larger part of the*2484 surface land overlying the coal. Kerr developed the property, opened two mines known as Potts Run No. 1 and Potts Run No. 2, built a railway siding and a tipple at each mine, and constructed on the property the town of Boardman, which consisted of about eighty houses for miners, a water plant, and a store. Kerr also purchased a logging railroad from the Clearfield Lumber Co., rebuilt the railroad, and extended it to his coal lands. This railroad connected with the New York Central Railroad at a station some 12 or 15 miles distant from Kerr's property. The value of the entire tract of coal and surface land was greater than the aggregate values of the several parcels of which it was composed, and the value was further increased by the fact that the railroad mentioned was extended to it. The seams of coal on this property ranged from 42 inches to 48 inches in thickness and the coal was of superior quality.
On August 29, 1903, James Kerr conveyed to the petitioner the said 1,833 acres of coal and surface land, together with the town of Boardman, the sidings, tipples, mine cars, mine machinery, and equipment. He also assigned to the petitioner his right, title and interest in a*2485 contract for the purchase of coal veins under land owned by the estate of John M. Chase and by Kate Moore, aggregating about 400 acres. In exchange for said property the petitioner issued to Kerr $99,500 par value of its capital stock and $185,000 first mortgage bonds.
The fair market value of the property conveyed by James Kerr to the petitioner on August 29, 1903, was $400.000, of which $310,775 represented the fair market value of the coal and surface lands.
James Kerr died in 1908.
Potts Run No. 1 mine was opened and producing coal at the date it was acquired by the petitioner in 1903. This mine was abandoned about 1907 and in 1918 was reopened from another side of the hill. The first coal was produced from Potts Run No. 2 mine in 1903 and that mine was operated continuously until 1923. However, all of the coal was not mined out, a creek causing an inconvenience and it was decided to open further around the hill. James Kerr had *3 shipped only 1,568 tons of coal from the property prior to 1903. The total production for the years 1903 to 1923, inclusive, was as follows:
| Year | Number of tons |
| 1903 | 83,168 |
| 1904 | 102,418 |
| 1905 | 105,039 |
| 1906 | 68,661 |
| 1907 | 81,467 |
| 1908 | 71,390 |
| 1909 | 55,999 |
| 1910 | 74,504 |
| 1911 | 73,000 |
| 1912 | 103,800 |
| 1913 | 128,000 |
| 1914 | 118,157 |
| 1915 | 151,651 |
| 1916 | 188,846 |
| 1917 | 125,707 |
| 1918 | 137,265 |
| 1919 | 141,116 |
| 1920 | 145,399 |
| 1921 | 34,385 |
| 1922 | 50,460 |
| 1923 | 83,961 |
*2486 In the year 1917 the petitioner's authorized capital stock was increased from $100,000 to $250,000. In the same year the petitioner purchased from the widow of James Kerr an additional 1,500 acres of coal property lying about ten miles distant from the mines then being operated by the petitioner, but not in the same field. In exchange for said coal property the petitioner issued to the widow of James Kerr shares of its capital stock of the par value of $150,000. Said coal property had been acquired by James Kerr in 1906 or 1907 at a total cost of $75,000.
In September, 1909, there were on the books of the petitioner credits or accounts payable to James Kerr, T. H. Watkins, and C. D. Simpson, in the amounts of $31,167.30, $15,584.01, and $15,583.65, respectively. At that time the petitioner caused the following entry to be made on its journal:
The estate of James Kerr is debited with $31,167.30; T. H. Watkins account $15,584.01; C. D. Simpson account $15,583.65. The property account is credited with $62,334.96.
In June, 1913, the petitioner had accumulated earnings and paidin surplus but did not have cash available for the payment of dividends. It did not desire to pay*2487 dividends or to increase its capital stock and it therefore caused entries to be made on its books charging profit and loss with the amount of $96,020.61 and crediting its property account with the same amount.
Section 305 of the Workmen's Compensation Law of 1915, State of Pennsylvania, required employers to insure the payment of compensation in the State Workmen's Insurance Fund or in any insurance company authorized to insure such liability in Pennsylvania, but provided that if, upon application to the Bureau, any employer should satisfy the Bureau of his financial ability to pay the compensation provided by the statutes, the Bureau might exempt such employer from the requirement of taking out insurance to cover the whole or any part of his liability to pay compensation. The petitioner, *4 having applied for and obtained such exemption, set up on its books a workmen's compensation insurance reserve. This reserve was based upon the rate charged by the State of Pennsylvania to those employers who insured in the State Workmen's Insurance Fund. The petitioner added to this reserve the amounts of $8,322.82 in 1918; $6,847.90 in 1919; $12,178.17 in 1920; and $990.73 in 1923.
*2488 In the year 1919 the petitioner purchased mining machines, mine cars, and rails at a total cost of $15,740.27. In 1920 the petitioner purchased mine pumps, hoists, mining machines and a fan motor at a total cost of $12,260.08. All of the equipment so purchased was necessary to maintain the amount of production. However, the but it did not increase the amount of production. However, the power pumps and mining machines did decrease the operating cost of the mines. The new machinery was put into use as soon as it was purchased. The average useful life of the mine cars is four years. The average useful life of hoists, pumps, mining machines and fan motors is five years.
The World War called into service many unmarried men employed by the petitioner and in order to replace these men with married men it was necessary for the petitioner to construct additional houses. In the year 1918 the petitioner constructed additional houses at a cost of $26,473.43. The building costs were then greater than normal because of war conditions. The Fuel Administration at that time was urging coal producers to maintain maximum production. The said houses were used for some years subsequent*2489 to 1918 and are still standing, but they are not occupied at the present time.
In the year 1920 the petitioner expended $6,000 for repairs to its miners' houses. These repairs included replacement of some roofs and of some temporary foundations.
The petitioner filed returns of income for the years 1918, 1919, 1920, and 1923. In its returns it deducted from gross income the amount set aside as a reserve for workmen's compensation insurance; the amounts of 15,740.27 and $12,260.08 expended in 1919 and 1920, respectively, for mining machinery and equipment; the amount of $26,473.43 expended in 1918 for miners' houses and the amount of $6,000 for repairs to miners' houses in 1920. The respondent disallowed the deductions for workmen's compensation insurance, for construction and repairing of miners' houses, and for mining machinery purchased in 1920, and also disallowed $9,045.63 of the deduction of $15,740.27 for mining machinery and equipment purchased in 1919. In computing the petitioner's invested capital the respondent determined that the land acquired by the petitioner in 1903 from James Kerr cost $86,000 and that the land acquired from the widow of James Kerr in 1917 cost*2490 the petitioner $150,000. The respondent *5 allowed depletion for the petitioner's coal prior to March 1, 1913, at the rate of .0167 cents per ton and depletion subsequent to March 1, 1913, at the rate of .03467 cents per ton. Invested capital was determined by the respondent to be $378,288.29 for 1918, $358,100.98 for 1919, and $493,683.61 for 1920.
OPINION.
MARQUETTE: The first and second issues raised by the pleadings herein are as to the amounts that should be included in the petitioner's invested capital on account of the property acquired by it from James Kerr in 1903, and the proper basis for computing the allowances for depletion of the coal in place included in that property. These issues present phases of a single problem and they will be discussed together.
The respondent has determined that the land acquired by the petitioner from James Kerr had a value at that time of $86,000, of which $61,000 represented the value of the coal and $25,000 the value of the surface land, and he has allowed depletion computed on that basis. It also appears that the respondent included the entire property in the petitioner's invested capital at the amount of $99,500, as*2491 of the date it was paid in. While the evidence does not show a higher value for the surface land than that determined by the respondent, it does establish to our satisfaction that the fair market value of the property conveyed to the petitioner by Kerr, including coal and surface land, the town of Boardman, railway sidings and tipples, was at least $400,000, and that the fair market value of the coal and surface land was $320,775. The allowance for depletion of the coal should, therefore, be computed on a basic value of $295,775, beginning at the date the property was conveyed to the petitioner, and the entire property should be included in the petitioner's invested capital as of the date of acquisition at $400,000, with proper adjustment for the bonds in the amount of $185,000 which were issued to Kerr in part payment for the property.
The respondent has also included in the petitioner's invested capital for the years 1918, 1919, and 1920 the amount of $150,000 on account of the 1,500 acres of coal land that it purchased from the widow of James Kerr in 1917 for $150,000 par value of its capital stock. The respondent has amended his answer herein and now asks that the amount*2492 to be included in invested capital on account of this coal land be reduced to $75,000, for the reason that the land was acquired by James Kerr in 1906 or 1907 at a total cost of not more than $75,000. On this issue it is incumbent upon the respondent to show by competent evidence that he erred in including the *6 property in question in the petitioner's invested capital at $150,000, and in our opinion he has wholly failed to meet that burden. The petitioner purchased the property from Mrs. Kerr in 1917 and not from James Kerr in 1906 or 1907. The amount to be included in the petitioner's invested capital on account of this property is its fair market or actual cash value at the time it was conveyed to the petitioner in exchange for shares of stock, and the fact that it was purchased by Kerr some years before for $75,000 falls far short of establishing that it was not worth $150,000 in 1917. The respondent's claim is denied.
The next issue also relates to the petitioner's invested capital. The petitioner claims that in the years 1909 and 1913 it arbitrarily, by the book entries as set forth in the findings of fact, reduced its invested capital by the amounts of $62,334.96*2493 and $96,020.61, respectively. The petitioner is clearly in error in its contention relative to the effect of the entry in 1909 in the amount of $62,334.96. The evidence shows that there were at that time on the petitioner's books credits or accounts payable to James Kerr, T. H. Watkins, and C. D. Simpson in the amounts of $31,167.30, $15,584.01, and $15,583.65, respectively, a total of $62,334.96. An entry was made on the petitioner's journal debiting the estate of James Kerr with $31,167.30, T. H. Watkins account with $15,584.01, and C. D. Simpson account with $15,583.65, and crediting the petitioner's property account with $62,334.96. The effect of this entry was to reduce the petitioner's property account by $62,334.96 and to make a corresponding reduction of its accounts payable, but it did not affect the petitioner's invested capital as shown by its books.
With respect to the amount of $96,020.61 covered by the entry of June, 1913, we are of opinion that the petitioner's contention is well taken. The circumstances under which this entry was made are fully set forth in the findings of fact and need not be restated here. The entry appears to have been an arbitrary charge-off, *2494 and it resulted in decreasing the petitioner's property account and its surplus and therefore reduced its invested capital by the amount of the charge-off. The amount charged off should be restored to the petitioner's invested capital.
The next question is whether the amounts credited by the petitioner in the taxable years involved herein to its workmen's compensation insurance reserve are proper deductions from gross income. Under the laws of Pennsylvania the petitioner was required to make provision for payment of workmen's compensation insurance. Three courses were open to the petitioner - (1) to insure in the State Workmen's Insurance Fund; (2) to insure in any insurance company authorized to insure such liability in the State of Pennsylvania, or *7 (3) to obtain exemption from the requirement of taking our insurance to cover the whole or any part of its liability to pay compensation, by satisfying the Bureau of its financial ability to pay the compensation provided by the statutes. The petitioner applied for and was granted such exemption and it thereupon set up a reserve fund on its books to cover any liability for compensation to its employees that might arise. *2495 Setting up the reserve was no doubt good business policy, but it was entirely voluntary on the part of the petitioner. The reserve was a safeguard against contingent future liability and nothing more. This Board has on numerous occasions held that additions to such reserves are not deductible from income and we find no reason for changing the views heretofore expressed. See ; ; .
The next issue relates to the disallowance as a deduction for expenses of the cost of mine machinery and equipment. In 1919 the amount so expended by the petitioner was $15,740.27, of which the respondent allowed $6,694.64, and disallowed $9,045.63, which was the cost of mining machines. In 1920 the expenditures for machinery and equipment amounted to $12,260.08 and they were all disallowed by the respondent. The mining machines and the other equipment purchased in 1920 had a useful life of several years. While this new machinery may not have increased the amount of coal produced, some of it did reduce the cost of production. This Board has*2496 on several occasions passed upon the exact question presented here and has held that expenditures such as we are now considering are not deductible. See ; ; . We adhere to those decisions and sustain the respondent's determination.
The petitioner expended $26,473.43 in 1918 in constructing houses for the use of its miners. This construction was necessary because of war conditions in order to keep up the coal output. In 1920, $6,000 more was expended for "repairs" to these or other houses. The "repairs" consisted in part of replacing temporary foundations with permanent ones, and in putting on new roofs. The petitioner contends that the respondent erred in disallowing as deductible expenses the cost of the houses in 1918 and the cost of repairs in 1920.
No attempt was made to amortize the cost of the houses under the Revenue Acts of 1918 and 1921. The houses were used by the petitioner for several years after they were erected in 1918 and, although they are not at present in use, they are still standing and, inferentially at least, *2497 they are usable in case of need. In our opinion the respondent correctly determined that such building cost should be capitalized and an appropriate depreciation rate applied. As there *8 is no complaint that the rate allowed was inadequate for depreciation, the respondent's determination respecting this point is sustained.
We are also of opinion that the respondent correctly disallowed as expense the item of $6,000 for repairs to the houses in 1920. This Board has held in , that the cost of a new roof upon a building used in the taxpayer's business was a capital expenditure not deductible as a business expense; a like holding appears in , and we adhere to those decisions. The house foundations which the petitioner pur in place in 1920 were replacements of the temporary foundations used when the houses were built two years previously. The later ones were of more permanent character, with useful lives of more than one year. Properly, their cost is part of the original building costs and should be capitalized as such. Although some of the expenditures made*2498 in connection with the houses in 1920 may have been for repairs the cost of which is deductible, there is no evidence as to the amount thereof. In the absence of such evidence we are unable to determine that any amount should be deducted. The determination of the respondent is, therefore, approved.
No evidence was offered respecting the loss from bad debts alleged to have occurred in 1920. Therefore, the respondent's disallowance of this item as a deduction is sustained.
In the petition filed in Docket No. 26274 it is alleged that the petitioner's tax liability for the year 1917 is in controversy. The deficiency letter shows, however, that the respondent has not determined any deficiency for the year 1917 and the petition, in so far as it relates to that year, is dismissed.
Judgment will be entered under Rule 50.