Morris & Bailey Steel Co. v. Commissioner

*205 This is a proceeding for the redetermination of deficiencies in income and profits taxes for 1919 and 1920 in the amounts of $508.50 and $15,698.55, respectively.

The issues set forth in the assignments of error in the petition are seven in number, which were reduced to four by the abandonment of three issues by the petitioner. The remaining four issues are: The disallowance by the Commissioner as deductions in determining the petitioner's net taxable income of (1) the amount of $1,300 representing an expenditure for a screw down in 1919; (2) an item of $1,050 representing an expenditure for a set of delivery guides for a 10-inch strip mill; (3) an amount of $10,341.71 representing an adjustment of inventory of used rolls in 1920; and (4) an amount of $14,763.72 representing an expenditure for annealing covers in 1920.

*206 FINDINGS OF FACT.

The petitioner is a Pennsylvania corporation with its principal office in Pittsburgh. Subsequent to the filing of its income and profits-tax*2642 return for 1919 and 1920, the petitioner has been merged with the Oliver Iron & Steel Co. to form the Oliver Iron & Steel Corporation.

The petitioner is a manufacturer of cold rolled steel. During 1919 it expended $1,300 for a screw down for a 12-inch mill. This screw down was to take the place of another screw down which the petitioner removed during that year in order to replace with one of a newer design. The old screw down had been in use about 2 1/2 years when the new one was acquired in 1919. Some of the petitioner's mills are still equipped with screw downs similar to the one which was discontinued in 1919. The screw down purchased for $1,300 to replace the old one was still in use at the date of the hearing of this proceeding.

In 1919 the petitioner also acquired, at a cost of $1,050, a set of 16-inch delivery guides for a 10-inch strip mill to replace other guides then in use. The new guides were purchased because they embodied a new design working on an improved method which resulted in more profitable operation of the mill. The old delivery guides with a 10-inch face were in use in the mill in 1919 and one of the same style is still in use. The 16-inch delivery*2643 guides which were purchased in 1919 are still in use and the old guides were discontinued and thrown on the scrap heap.

The rolls in use in petitioner's steel plant were measured by steel calipers in 1920. The conclusion was reached that approximately 35 per cent of the life or useful diameter of all used rolls throughout the mill had been exhausted. The practice of the petitioner up to 1920 had been not to charge a roll off the books or to charge depreciation in respect thereof until such roll was worn out or broken. This method was changed in 1920 when the petitioner had the rolls calipered or measured and arrived at an estimated average of the amount worn off or exhausted in respect of rolls used in the plant. There were approximately 150 rolls in use at December 31, 1920. Some of these rolls had been used for several years prior to 1920. All of these rolls were "inventoried" as "used rolls." The estimated average of 35 per cent exhaustion took into consideration the wearing down of several years prior on some of the rolls "inventoried" December 31, 1920. The useful diameter of a roll was approximately three-fourths of an inch.

The rolls were of two kinds, some cast*2644 iron and some steel. The life of the steel rolls is estimated at about six times the life of the cast iron rolls. The petitioner inventoried its used rolls on the *207 basis of cost or market, whichever was lower, and wrote off the amount of 35 per cent of the inventory price as of December 31, 1920, which inventory price was $29,559.90. The "inventory" at the end of 1920 was the petitioner's first attempt at writing off exhaustion of its used rolls on hand and in use.

In the latter part of 1919 or the early part of 1920, the petitioner acquired 14 cast-steel annealing covers. It purchased the cast-steel covers because of its inability at that time to purchase place-steel covers. The cast-steel covers warped and let in oxygen which spoiled the annealing. The use of the cast-steel covers cut down the tonnage produced and added materially to the cost of operation. As soon as it was possible to acquire the plate-steel covers the cast-steel covers were discontinued in use and abandoned. They were removed and abandoned, not because of any exhaustion, wear and tear, but because they could not be profitably used. The covers which were abandoned cost $14,763.72. The residual*2645 value of these covers was nothing. The expense of cutting them up for salvage purposes or scrap would cost more than the amount that could be realized on the sale of same as scrap. They were effectually discarded and permanently abandoned in 1920.

OPINION.

TRAMMELL: The first question is whether the expenditure of $1,300 for a new screw down is deductible as an ordinary and necessary expense, or whether it is a capital expenditure to be depreciated over a physical life of more than one year. From the evidence we are convinced the the expenditure was for a replacement, that the asset acquired had a life of more than a year and that the expenditure constitutes a capital outlay and is not deductible in computing net taxable income for 1919. The screw down in question was still in use at the date of the hearing of this proceeding.

The matter of a deduction on account of the old screw down which was replaced by the new one is not involved in this proceeding.

On the question of the purchase of the new 16-inch guides to replace guides which at the time were in use, it appears that the new guides were in use at the date of the hearing of this proceeding and that they had been*2646 used since 1919. There is no evidence that they were not in good condition and will probably last many years longer. It is clear, therefore, that the acquisition of the said guides represents a capital expenditure which is not allowable as a deduction in determining taxable income.

There is no question presented here as to any deduction with respect to the guides which were replaced.

On the question of the inventory of used rolls, it appears that the petitioner included the same in its inventory on the basis of cost or *208 market, whichever was lower, and that it reduced its inventory by 35 per cent in 1920 on account of depreciation sustained in that year as well as in previous years, no deduction on account of the exhaustion for previous years having been taken or written off until the rolls were worn out or broken. On the rolls which were not used in 1920 no deduction had been taken.

While it may be that the actual measuring of the diameter of the rolls would be a fair and reasonable method of determining the actual exhaustion sustained, the deduction on account of exhaustion of assets can not be accumulated and taken in one year with respect to exhaustion which*2647 occurred in prior years. The amount allowable for exhaustion, wear and tear is an annual deduction and is based upon the exhaustion sustained during the taxable year. We do not agree with the petitioner that the rolls should be included in inventory on the basis of cost or market, whichever is lower. Inventories, referred to in the statute, relate to stock in trade or materials or supplies which are used in the manufacturing process and which become a part or ingredient of the manufactured article and do not refer to capital assets such as machinery which is used in manufacturing the article.

The 35 per cent reduction of the inventory price of the rolls represents an average wear or exhaustion on all the rolls whether acquired in 1920 or in prior years. There is insufficient evidence in the record to enable the Board to determine the amount of exhaustion suffered during the taxable year 1920 with respect to the rolls in use during that year. We must, therefore, affirm the determination of the Commissioner on this question.

With respect to the annealing plates, we think a preponderance of the evidence supports the position of the petitioner that these plates were actually*2648 and permanently abandoned and scrapped during the taxable year 1920. Their depreciated cost was therefore a proper deduction for that year.

Judgment will be entered on 15 days' notice, under Rule 50.

Considered by MORRIS, MURDOCK, and SIEFKIN.