Southern California Freight Lines, Ltd. v. Commissioner

SOUTHERN CALIFORNIA FREIGHT LINES, LTD., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Southern California Freight Lines, Ltd. v. Commissioner

Docket No. 82255.

United States Board of Tax Appeals 36 B.T.A. 328 ; 1937 BTA LEXIS 734 ; July 14, 1937 , Promulgated *734 1. The Commissioner's determination of a reasonable allowance for depreciation of a variety of rolling equipment acquired new and secondhand is not overcome by evidence of a variety of methods adopted by the taxpayer, acting upon the judgment of its superintendent, there being no evidence that such judgment was supported by actual performance and it appearing that the method adopted was not strictly followed by the taxpayer.

2. The Commissioner's composite rate of depreciation based upon an average life for a variety of items is not overcome by picking out some items with a shorter life than the average.

Henry J. Bischoff, Esq., for the petitioner.

Edward A. Tonjes, Esq., for the respondent.

STERNHAGEN *328 The commissioner determined a deficiency of $3,955.22 in petitioner's income tax for 1932. The only item in question is the reasonable allowance for depreciation on rolling equipment.

*329 FINDINGS OF FACT.

The petitioner is a California corporation with its principal office in Los Angeles, operating motor freight lines in the southern part of the state. Its rolling equipment in 1932, including purchases of equipment *735 during the year, consisted of 265 units, made up of 172 trucks and 93 trailers, semitrailers and dollys, which were taken on its books at cost figures of $342,325.95. In its return for 1932 the petitioner took a deduction for depreciation on this equipment of $55,412.82, which the Commissioner reduced by $35,627.28 in accordance with a revenue agent's audit and report. Petitioner's depreciation reserve at the end of 1932 amounted to $273,164.56, leaving an equipment balance of $55,987.85.

Of the petitioner's equipment on hand in 1932, there were originally acquired new 72 units, costing $181,511.84, consisting of 42 trucks, costing $129,996.20, and 30 trailers, costing $51,515.64. On this equipment acquired new, depreciation of $34,475.70 was taken in 1932. The remainder of the rolling equipment (159 units) had been used when acquired. A large majority (135 units) of the secondhand trucks and trailers were part of the equipment of four truck lines which the petitioner acquired in 1930 and 1931. The cost figures for secondhand units entered on the petitioner's records were the appraisals by its superintendent of operation and maintenance, who valued each piece of used equipment *736 before it was purchased and estimated its useful life, whether it was acquired singly or as a part of the total equipment of other truck lines.

Depreciation on petitioner's equipment acquired secondhand was computed separately on each unit on the basis of the useful life assigned to it by the superintendent at the time of its acquisition. Generally, the useful life assigned to secondhand trucks was two years, but each machine was treated separately, its useful life being determined by its condition at acquisition and the use to which it was to be subjected. Many of the used trucks were of a four cylinder, solid tire type, which had been rendered less practical by a larger type with pneumatic tires introduced about 1929. Numerous old trucks obtained in the purchase of other truck lines were aged five years or more at acquisition. Some used trucks of the modern design were assigned the same useful life of two years because of their condition and contemplated use on difficult routes. Two of the used trucks were assigned lives of four years because of the slight abuse they would receive in short mileage in the city. A few very old trucks were assigned lives of one year.

Similar *737 straight line depreciation was computed on each unit of used trailer equipment on the basis of the useful life assigned to it by the superintendent at acquisition. Practically all of the used trailers *330 upon which depreciation was claimed in 1932 were equipped with solid tires and an old type steering device which made them less satisfactory than modern equipment. Three years was the useful life given most of them.

Four semitrailers were given lives of only two years. Five knuckle steer trailers acquired in 1930 as part of a truck line purchase were given lives of only two years, the different treatment being unexplained.

Depreciation on a mileage basis was computed on nore than half of petitioner's trucks acquired new, and upon three of the used trucks. The superintendent prescribed this basis because of the harder service to which these machines were to be put in desert routes and fast milk hauls. Lives for the more expensive types of trucks were set at 150,000 miles, and for lighter equipment at 125,000 miles. Trucks subjected to the 500-mile daily runs, sometimes in desert country, were believed to wear out much faster than equipment on other routes. The *738 application of this mileage basis to eight similar trucks acquired in 1929, costing about $6,000 each, shows that two have been completely depreciated in 1932, while sizeable balances remain on the others. All trucks depreciated on a mileage basis were still in use at the end of 1932, though several had exhausted their estimated useful mileage. Equipment once assigned to specific routes was not shifted to a different type of operation.

Useful lives of four years for straight line depreciation were assigned to all but two of the 18 new trucks not depreciated on a mileage basis. Uniform lives of four years were assigned to light trucks on the basis of the superintendent's judgment that their value was normally exhausted in that period. A three-year life was given to one new truck because of the fast route it covered.

New trailers were given lives of four and seven years. Two old type knuckle steer trailers purchased new in 1928 were assigned useful lives of four years. Six trailers of a greatly improved design acquired new in 1929 were also assigned four-year lives. Four similar units bought in 1931 were depreciated on the basis of a seven-year useful life because the new *739 design eliminated the objectionable features of the knuckle steer. Four other trailers of this new type were given useful lives of only four years. On none of the new type units but the four acquired in 1931 did the petitioner revise its depreciation schedules to conform with its experience indicating a longer useful life than four years. A "dolly" acquired new in 1930 was estimated to have a useful life of three years. A similar piece of equipment acquired new in 1931 was depreciated on a six-year basis.

Many of petitioner's trucks and trailers, acquired both new and used, have been operated by it after the expiration of their determined useful lives. A total of 33 trucks and 20 trailers, originally *331 taken on the books at $112,275.24, were completely written off through depreciation by the end of 1931, but of these only 4 trucks, costing $12,739.14, were retired from service during 1932. Depreciation of $14,686.59 claimed on 90 other pieces of equipment in 1932 served to write off their entire original basis of $62,228.82, though only a few of them, costing $440, were retired from service by the end of the year.

The petitioner's policy of extensive repairs and *740 maintenance prolonged the life of its equipment. Twenty-eight typical units of used equipment, of which petitioner had determined an average useful life of approximately two and three-fourths years, were not actually retired from service before an average of approximately four years. It charged to expense in 1932 $90,769.45 for repairs and maintenance of its trucks and trailers, including $21,613.51 for tires and tubes. Although the superintendent recommended the purchase of new equipment, petitioner continued operation with its old equipment, bearing a high repair cost, because of its inability to finance new purchases. Petitioner generally capitalized complete reconditionings, but the records in evidence do not disclose that any such additions were charged to its equipment accounts. Trucks were kept in operation as long as possible by replacement of operating parts, such as motors and batteries, and these were charged to expense. Amounts received for discarded equipment are credited to income accounts. Accumulated depreciation on retired equipment is charged to the depreciation reserve.

The Commissioner disallowed $35,627.68 of petitioner's claimed depreciation deduction, *741 by computing straight line depreciation on the basis of his determination of the average lives of different classes of equipment. He determined a remaining life of five years, or to December 31, 1936, on all used equipment acquired in 1931 and prior thereto remaining on hand December 31, 1931, less retirements in 1932, and a similar life expiring December 31, 1936, on the used equipment purchased in 1932. This determination is based upon retirements in 1932 of 11 units, in 1933 of 23, and in 1934 of 24, out of an alleged total of 238 pieces of used equipment acquired in 1932 and prior thereto, which gives an average per year of 19 retirements. Assuming this average would be maintained, it would be 9 1/2 years before the last unit of the 180 pieces on hand at the end of 1934 would be retired, but this is adjusted by the adoption of a five-year life to December 31, 1936. Depreciation of all new equipment purchased in 1931 and 1932 is adjusted to a 7 1/2-year life from the year acquired.

The Commissioner's classification of all types of used equipment into one group is not unreasonable. A proper average useful life for used trucks less retirements in 1932, is five years, to December 31, 1936, The *742 proper average useful life for used trailers less retirements *332 in 1932, is five years, to December 31, 1936. The Commissioner's determination of depreciation of all new equipment on the basis of an average useful life of 7 1/2 years from the year of acquisition is not unreasonable.

OPINION.

STERNHAGEN: The Commissioner readjusted the petitioner's deduction for depreciation, reducing it from $55,412.82 taken on the return, to $19,698.09. The Commissioner's computation is based on an assumed remaining useful life of five years on all equipment acquired secondhand and an assumed useful life of seven and onehalf years on all equipment acquired new. The petitioner assails this determination as arbitrary and, therefore, to be set aside. But it is not arbitrary - rather may it be called formulaic - and he who attacks it must do so with something shown to be more consonant with fact and experience. An estimate of a superintendent is not enough until it is fortified by evidence of actual performance to show that in fact the estimate has in the past been in conformity with experience. *743 . In , where the Commissioner sought to readjust invested capital by the use of an arbitrary straight line basis of depreciation shown to be inconsistent with 11 years of experience, his determination was rejected as arbitrary.

In this proceeding, however, it can not be said from the evidence that the Commissioner's method is arbitrary or reaches an unreasonable allowance for the year in question. It is shown only that the result is at variance with the judgment of petitioner's superintendent. Respectable as that judgment may be - and the witness appeared to be well qualified to form a useful judgment - it is still no more than a judgment and an estimate based upon a different method rather than upon evidence of actual performance. Apparently in 1932 estimates were principally based on prophecy, and in subsequent years retirements were not made in accordance with the prophecy. This is not enough to overthrow the Commissioner's determination.

There is no need here to say whether the petitioner's mileage depreciation on trucks is proper. It may be assumed *744 that when petitioner's experience is sufficient to demonstrate its conformity to actual performance it will not be lightly or arbitrarily disapproved. But the demonstration is lacking in this record.

The Commissioner has used two composite rates on a variety of equipment; and in such a situation the Board has said in :

In attacking a composite rate of depreciation it is not sufficient that the petitioner may be able to pick out certain parts and prove that if such parts were *333 considered separately a greater depreciation rate should be allowed. The composite rate is based upon an average life for all of the parts and until error in the average is shown there is no basis upon which it can be said that the amount allowed is not reasonable.

Judgment will be entered under Rule 50.