MASSEY MOTORS, INC., v. UNITED STATES.
No. 141
Supreme Court of the United States
Argued March 30, 1960.—Decided June 27, 1960.*
364 U.S. 92
*Tоgether with No. 143, Commissioner of Internal Revenue v. Evans et ux., on certiorari to the United States Court of Appeals for the Ninth Circuit, argued March 29, 1960.
Howard A. Heffron argued the cause for the United States in No. 141 and for petitioner in No. 143. On the
Edgar Bernhard argued the cause for respondents in No. 143. With him on the brief were Roswell Magill, Harry N. Wyatt, Donald J. Yellon and John C. Klett, Jr.
MR. JUSTICE CLARK delivered the opinion of the Court.
These consolidated cases involve the depreciation allowance for automobiles used in rental and allied service, as claimed under
In No. 143, Commissioner v. R. H. and J. M. Evans, the taxpayers are husband and wife. In 1950 and 1951, the husband, Robley Evans, was engaged in the business
When the U-Drive service had an oversupply of cars that were used on short-term rental, it would return them to the taxpayer and he would sell them, disposing of the oldest and least desirable ones first. Normally the ones so disposed of had been used about 15 months and had been driven an average of 15,000 to 20,000 miles. They were ordinarily in first-class condition. It was likewise customary for the taxpayer to sell the long-term rental cars at the termination of their leases, ordinarily after about 50,000 miles of use. They also were usually in good condition. The taxpayer could have used the cars for a longer period, but customer demand for the latest model cars rendered the older styles of little value to the rental business. Because of this, taxpayer found it more profitable to sell the older cars to used car dealers, jоbbers or brokers at current wholesale prices. Taxpayer sold 140 such cars in 1950 and 147 in 1951. On all cars leased to U-Drive, taxpayer claimed on his tax returns depreciation calculated on the basis of an estimated useful life of four years with no residual salvage value. The return for 1950, for example, indicated that each car‘s cost to taxpayer was around $1,650; after some 15 months’ use he sold it for $1,380; he charged depreciation of $515 based on a useful life of four years, without salvage value, which left him a net gain of $245,
In No. 141, Massey Motors, Inc., v. United States, the taxpayer, a franchised Chrysler dealer, withdrew from shipments to it a certain number of new cars which were assigned to company officials and employees for use in company business. Other new cars from these shipments were rented to an unaffiliated finance company at a substantial profit.
The cars assigned to company personnel were uniformly sold at the end of 8,000 to 10,000 miles’ use or upon receipt of new models, whichever was earlier. The rental cars were sold after 40,000 miles or upon receipt of new models. For the most part, cars assigned to company personnel and the rental cars sold for more than they cost the taxpayer. During 1950 and 1951, the tax years involved here, the рrofit resulting from sale of company personnel cars was $11,272.80 and from rental cars, $525.84. The taxpayer calculated depreciation on the same theory as did taxpayer Evans, computing the gains on the sales at
First, it may be well to orient ourselves. The Commissioner admits that the automobiles involved here are, for tax purposes, depreciable assets rather than ordinary stock in trade. Such assets, employed from day to day in business, generally decrease in utility and value as they are used. It was the design of the Congress to permit the taxpayer to recover, tax free, the total cost to him of such capital assets; hence it recognized that this decrease in value—depreciation—was a legitimate tax deduction as business expense. It was the purpose of
Some assets, however, are not acquired with intent to be employed in the business for their full economic life. It is this type of asset, where the experience of the taxpayers clearly indicates a utilization of the asset for a substantially shorter period than its full eco-
It appears that the governing statute has at no time defined the terms “useful life” and “salvage value.” In the original Act, Congress did provide that a reasonable allowance would be permitted for “wear and tear of property arising out of its use or employment in the business.” (Emphasis added.) Act of Oct. 3, 1913, 38 Stat. 167. This language, particularly that emphasized above, may be fairly construed to mean that the wear and tear to the property must arise from its use in the business of the taxpayer—i. e., useful life is measured by the use in a taxpayer‘s business, not by the full abstract economic life of the asset in any business. In 1918, the language of
“The proper allowance for such depreciation of any property used in the trade or business is that amount which should be set aside for the taxable year in accordance with a consistent plan by which the aggregate of such amounts for the useful life of the property in the business will suffice, with the salvage value, at the end of such useful life to provide in place of the property its cost . . . .” (Emphasis added.)
It, too, may be construed to provide that the use and employment of the property in the business relates to the trade or business of the taxpayer—not, as is contended, to the type or class of assets subject to depreciation. The latter contention appears to give a strained meaning to the phrase. This might be particularly true of the language in Treasury Regulations 103, promulgated January 29, 1940, under the Internal Revenue Code of 1939. Its § 19.23 (l)-1 and § 19.23 (l)-(2)1 complement each
It is true, as taxpayers contend and as we have indicated, that the language of the statute and the regulations as we have heretofore traced them may not be precise and unambiguous as to the term “useful life.” It may be that the administrative practice with regard thereto may not be pointed to as an example of clarity, and that in some cases the Commissioner has acquiesced in inconsistent holdings. But from the promulgation of the first regulation in 1919, he has made it clear that salvage had some value and that it was to be considered as something other than zero in the depreciation equation. In fact many of the cases cited by the parties involved controversies over the actual value of salvage, not as scrap but on resale.2 The consistency of the Commissioner‘s posi-
Our conclusion as to this interpretation of the regulations is buttressed, we think, by a publication issued by the Commissioner in 1942, the same year as Regulations 111, and long before this controversy arose. It is known as Bulletin “F” and has been reissued as late as 1955. While it does not have the authority of a regulation, its significance is indicated clearly by the fact that both the taxpayers and the Commissioner point to it as conclusive
Moreover, Congress was aware of this prior prevailing administrative practice as well as the concept of depreciation upon which it was based. Although the tax years involved here are 1950 and 1951, we believe that the action of Congress in adopting the 1954 Code should be noted, since it specifically recognized the existing depreciation equation. For the first time, the term “useful life” was inserted in the statutory provision. The accompanying House Report to the bill stated:
“Depreciation allowances are the method by which the capital invested in an asset is recovered tax-free over the years it is used in a business. The annual
deduction is computed by spreading the cost of the property over its estimated useful life.” H. R. Rep. No. 1337, 83d Cong., 2d Sess. 22.
It is also noteworthy that the report states that “The changes made by your committee‘s bill merely affect the timing and not the ultimate amount of depreciation deductions with respect to a property.” Id., at 25.
Moreover, as we have said, there are numerous cases in the Tax Court in which depreciation was permitted only on the useful life of the property in the taxpayer‘s business.4 The taxpayers point to others5 which appear to be to the contrary. In most of these, however, the issue was factual, i. e., the time lapse before the property would wear out from use or, as we have said, its salvage or resale value. They cannot be said to prove conclusively that the Commissioner was following a physically useful-life theory; for there is no affirmative showing or finding as to the length of the physically useful life. The most that can be said is that the element of compromise probably played a predominant role in the result in each case. Moreover, there is no indication in any of these cases that the amount of depreciation would have been changed
Finally, it is the primary purpose of depreciation accounting to further the integrity of periodic income statements by making a meaningful allocation of the cost entailed in the use (excluding maintenance expense) of the asset to the periods to which it contributes. This accounting system has had the approval of this Court since United States v. Ludey, 274 U. S. 295, 301 (1927), when Mr. Justice Brandeis said, “The theory underlying this allowance for depreciation is that by using up the plant, a gradual salе is made of it.” The analogy applies equally to automobiles. Likewise in Detroit Edison Co. v. Commissioner, 319 U. S. 98, 101 (1943), this Court said:
“The end and purpose of it all [depreciation accounting] is to approximate and reflect the financial consequences to the taxpayer of the subtle effects of time and use on the value of his capital assets. For this purpose it is sound accounting practice annually to accrue . . . an amount which at the time it is retired will with its salvage value replace the original investment therein.”
Obviously a meaningful annual accrual requires an accurate estimation of how much the depreciation will total. The failure to take into account a known estimate of salvage value prevents this, since it will result in an understatement of income during the years the asset is employed and an overstatement in the year of its disposition. The practice has therefore grown up of subtracting salvage value from the purchase price to determine the
It is so ordered.
MR. JUSTICE HARLAN, whom MR. JUSTICE WHITTAKER, and MR. JUSTICE STEWART join, dissenting in Nos. 141 and 143, and concurring in the judgment in No. 283.*
This is one of those situations where what may be thought to be an appealing practical position on the part of the Government has obscured the weaknesses of its legal position, at least in Nos. 141 and 143.
The position which the Commissioner takes in these cases with respect to the basic issue of “useful life” is that contained in the regulations promulgated by him in 1956 under the Internal Revenue Code of 1954, which define the useful life of a depreciable asset as the
“period over which the asset may reasonably be expected to be useful to the taxpayer in his trade or business . . . .”1
In No. 283 the Commissioner seeks to apply this regulatory definition to the returns of the taxpayer with respect to the taxable years ended March 31, 1954, 1955, and 1956.
I agree that these regulations represent a reasonable method for calculating depreciation within the meaning of the 1954 Code, and that they are valid as applied prospectively. But since I believe that as to “useful life” they are wholly inconsistent with the position uniformly taken by the Commissioner in the past, I do not think they can be applied retrospectively in all instances. While I consider that the regulations may be so applied in No. 283, in my opinion that is not so in Nos. 141 and 143.
I.
It is first important to understand the precise nature of the issues before the Court. Both the method of depreciation contended for by the taxpayers and that urged by the Government purport to allocate an appropriate portion of an asset‘s total cost to each of the years during which the taxpayer holds it. Both methods define the total cost to be so allocated as the original cost of the asset less its salvage value at the end of its useful life. And under both methods, the total cоst to be allocated is divided by the number of years in the useful life and the resulting figure is deducted from the taxpayer‘s income each year he holds the asset. As the Court correctly notes, the practical difference in the end results of the two methods involves the extent to which a taxpayer may be able to obtain capital-gains treatment for assets sold at or before the end of their useful life for amounts realized in excess of their remaining undepreciated cost.
The difference between the two methods from a theoretical standpoint is simply this: The taxpayers define useful life as the estimated physical life of the
If an asset is held until it is physically exhausted, both methods produce exactly the same result. Similarly, both methods can result in inaccuracies if predictions of useful life and salvage value turn out to be wrong. The Government, however, contends that where it can be predicted with reasonable certainty that an asset will be disposed of before the end of its physical life, its method of depreciation is more likely to reflect the true cost of the asset to the particular business. This is said to be so because the true cost to the business, in the end, is the asset‘s original cost less the amount recovered on its resale, and the Government‘s method starts from an estimate of that amount, which is then allocated among the yeаrs involved. The taxpayers’ method on the other hand, starts from an estimate of the end cost of the asset in the general business world, and will accurately reflect such cost to the taxpayer‘s business only if the decline in market value at the time of resale can be expected to correspond roughly to the portion of the asset‘s general business end
It need not be decided whether, as an abstract matter, one method or the other is deemed preferable in accounting practice. Apparently there is a split of authority on that very question.2 It is sufficient to note that in most instances either method seems to give satisfactory results. Assuming that because of the unusual case, such as we have here, the Government‘s method on the whole may more accurately rеflect the cost to a particular taxpayer‘s business, the question for me is whether the Commissioner has nevertheless established a practice to the contrary upon which taxpayers were entitled to rely until changed by him. I turn now to the examination of that question.
II.
The Court relies on the wording of certain revenue statutes and regulations to show that the period during which depreciable assets are employed in the taxpayer‘s business, as opposed to the period of their physical life, has always been regarded as useful life for purposes of depreciation. Concededly, the term useful life did not appear in the statute until the Internal Revenue Code of 1954, and though it had appeared in the regulations as early as 1919, Treas. Reg. 45, Art. 161, was never defined therein until 1956, ante, p. 107, when the Commissioner took the position he now asserts. The Court seizes on language which was not directed to the present problem and which could equally be read to support the
The Act of Oct. 3, 1913, permitted a reasonаble allowance for “wear and tear of property arising out of its use or employment in the business.”3 It is certainly true, as the Court says, that this means that “the wear and tear to the property must arise from its use in the business of the taxpayer.” But it does not follow at all that the formula for calculating that wear and tear must be based on a useful life equal to the period the asset is held in the business. For, as noted above, a formula based on the physical life of the asset also results in an estimate of the portion of the asset‘s total cost attributable to its use in the business, and may in some circumstances yield the same tax consequences as a “holding-period” formula.
Treasury Regulations 45, Art. 161, promulgated in 1919 and continued in substantially the same form until 1942, provided that the taxpayer should set aside each year an amount such that “the aggregate of such amounts for the useful life of the property in the business will suffice, with the salvage value, at the end of such useful life to provide in place of the property its cost . . . .” In 1942, the statute was amended to permit depreciation, not only, as before, on property used in the trade or business, but also on property held for the production of income. Accordingly, the regulation was revised to delete the words “property in the business” and substitute therefor “the depreciable property.” Reg. 111, § 29.23 (l)-1. The Court says that the deleted term could not have been meant to define the type of property subject to the depreciation allowance, since that function was already performed by another section of the regulation. That may be true, but it does not show that the language was meant to define the period of useful life. If it had been so meant, the Commissioner
In light of the above, the Government‘s reliance on cases such as United States v. Ludey, 274 U. S. 295, 300-301, and Detroit Edison Co. v. Commissioner, 319 U. S. 98, 101, is wide of the mark. The language relied upon in Ludey is virtually identical to that contained in the pre-1942 regulations, and that in Detroit Edison merely says that the purpose of depreciation is to recover, by the time of an asset‘s retirement, the original investment therein. As noted above, depreciation based on either definition of useful life is dedicated to that end. The Government‘s reliance on Bulletin “F” is also misplaced. The Court refers to a statement on page 2 of the Bulletin which merely lifts from the regulation the phrase “useful life of the property in the business.” The Court also relies on a statement appearing on page 7, defining salvage as “the amount realizable from the sale . . . when property has become no longer useful in the taxpayer‘s business and is demolished, dismantled, or retired from service.” (Emphasis added.) The italicized language again reveals the assumption that assets were genеrally intended for use in the business until their physical exhaustion. The present question was never adverted to.
III.
In examining the cases, it must be borne in mind that even the Commissioner does not contend that a taxpayer who happens to dispose of some asset before its physical exhaustion must depreciate it on a useful life equal to the time it was actually held. It is only when the asset “may reasonably be expected” to be disposed of prior to the end of its physical life that the taxpayer must base depreciation on the shorter period. Reg. § 1.167 (a)-1 (b). Therefore, the only cases relevant in this regard are those in which the taxpayer‘s past experience indicated that assets would be disposed of prior to becoming junk, thus presenting the issue whether the shorter or longer period should control for purposes of depreciation.4
In four such cases, involving tax years prior to 1942, the taxpayer had a practice of disposing of assets substantially prior to their physical exhaustion. In Merkle Broom Co., 3 B. T. A. 1084, the taxpayer customarily disposed of its automobiles after two years. It attempted to depreciate them over a three-year useful life; the Com-
In Kurtz, 8 B. T. A. 679, the taxpayers customarily sold their automobiles after two or three years at substantial values. They depreciated on a four-year useful life; the Commissioner asserted a five-year life; and the court agreed.
In Sanford Cotton Mills, 14 B. T. A. 1210, the taxpayer customarily disposed of its motor trucks after two and one-half years. It claimed a three-year useful life; the Commissioner asserted a five-year useful life; and the court found that four years was reasonable.
In General Securities Co., 1942 P-H BTA-TC Mem. Dec. ¶ 42,219, the taxpayer sold its automobiles after one or two years. The court held that a reasonable useful life was three years.
It is apparent from these cases that both the Commissioner and the courts were thinking solely in terms of the physical life of the asset, despite the fact that the taxpayer customarily held the assets for a substantially shorter period. In at least some of the cases, it would have made a very real difference had depreciation been calculated on the basis that the useful life of the asset meant its holding period. For example, in the Sanford case, taxpayer‘s trucks were sold after two and one-half years at less than one-seventh of their original cost. Given the five-year useful life proposed by the Commissioner, taxpayer would have had, at the time of resale, an undepreciated basis equal to half the original cost, while the proceeds of resale would have brought it only one-seventh of original cost, thus giving rise to a loss of the difference. If the Government‘s present position had been applied, the difference between original cost and resale value would have been depreciated over two and one-half years, giving rise to no gain or loss at the end of that time. Similarly, in the General Securities case, given a three-year useful life, the
It is true that the only tax distortion present in these cases was a shift of ordinary deductions from the years in which the property was used in the business to the final year of its disposition. It is also true that had the situation been reversed, so that depreciation on a physical-life basis outran decline in market value, the resulting gain in the year of disposition would have been ordinary income, since capital-gains treatment for disposition of property used in the trade or business was not accorded by Congress until 1942.5 However, it is significant that the Commissioner‘s adherence to a physical-life method did result in a distortion of income by shifting deductions among various tax years, which often entails serious revenue consequences, and that by 1942 physical life seems to have been uniformly accеpted as the proper definition of useful life.
In light of these circumstances, four cases involving tax years subsequent to 1942 acquire special significance. In Pilot Freight Carriers, Inc., 15 CCH T. C. Mem. 1027, the taxpayer disposed of its tractors after an average of 38 months and its trailers after an average of 32.6 months. It claimed depreciation on a four-year useful life with 10% or less salvage value. The Commissioner asserted useful lives of five and six years for the tractors and trailers, respectively, and the court found that four and five years, respectively, was reasonable. It is to be noted that upon resale, taxpayer received, because of wartime inflation, amounts substantially in excess of undepreciated
In Lynch-Davidson Motors, Inc., v. Tomlinson, 58-2 U. S. T. C. ¶ 9738, an automobile dealer disposed of company cars each year when new models were brought out, yet deрreciated on a three-year useful life with salvage value of $50. The Commissioner did not dispute this method of depreciation and the court held it to be proper. In the companion case of Davidson v. Tomlinson, 58-2 U. S. T. C. ¶ 9739, taxpayers were in the automobile rental business, and kept their automobiles only one year. They also were permitted to depreciate on a useful life of three years with $50 salvage value. The striking similarity between the facts of these two cases and those of the present ones need not be elaborated.
Finally, as late as 1959, in Hillard, 31 T. C. 961, the Commissioner took the position that the taxpayer, who operated a car rental business, and who disposed of his cars after one year, should depreciate them on the basis of a four-year useful life rather than the three years contended for by taxpayer.
Thus in all these cases, as in the cases before us, the problem of offsetting depreciation deductions by capital gains existed; nevertheless the Commissioner consistently adhered to the position, adopted long prior to 1942, that physical life controlled.
The Court, however, seems tо believe that the effect of these cases is vitiated by several cases dealing with “salvage” value. In three of such cases,6 the assets were
The Court‘s view fares no better under any other of these cases. In Bolta Co., 4 CCH T. C. Mem. 1067, involving a 1941 tax year, the taxpayer disposed of several machines after they had ceased to be useful in its business but while they were still useful in other businesses. It projected an average holding period of five years and assumed no salvage value. The Commissioner acquiesced in the five-year useful life but contended that the taxpayer could reasonably have anticipated a salvage value equal to 25% of original cost. The court agreed.
In Koelling v. United States, 57-1 U. S. T. C. ¶ 9453, taxpayers disposed of cattle after they were no longer useful for breeding, and depreciated them on a useful life equal to that period, making no allowance for salvage value. The Commissioner found that it was unreasonable thus to deduct the entire cost of the animals over their breeding life, and required the taxpayers to deduct as salvage value their predicted resale price.
In Cohn v. United States, 259 F. 2d 371, taxpayers had established flying schools during 1941 and 1942 under contract with the Army Air Corps. The arrangement was expected to last only until the end of 1944, and the useful life of property used in the business was calculated on that basis, with no allowance for salvage value. The Commissioner asserted various longer useful lives for the property, varying from five to ten years. The court permitted the taxpayers to use the shorter useful life, but required them to deduct the reasonable salvage value of the equipment which would be realized at the end of that period. The Government did not appeal from the useful-
Thus in two of the relevant salvage-value cases, Bolta and Koelling, the taxpayer himself proposed a useful life equivalent to holding period but employed a hybrid version by failing to adopt the corresponding concept of salvage value. The Commissioner merely took the position that if the holding-period method was to be used, it must be used consistently by deducting the appropriate salvage value. In the third, Cohn, the Commissioner actually rejected the taxpayers’ attempt to employ the holding period and merely acquiesced when the court permitted the taxpayers to do so, provided the corresponding salvage value was deducted. However, in no case, until the present ones, does it appear that the Commissioner has ever sought to require the taxpayer to use the holding-period method where the taxpayer has attempted to use physical life. And I do not understand the Government to controvert this. To the contrary, the Commissioner has not infrequently required the taxpayer to depreciate on the basis of physical life where the taxpayer had attempted to employ a shorter period, even in instances where significant capital-gains consequences turned on the difference. Indeed, as the Lynch-Davidson, Davidson, and Hillard cases, supra, indicate, the Commissioner, until quite recently, has adhered to the physical-life сoncept in automobile cases virtually indistinguishable from the present ones. In the past the Commissioner, unsuccessfully, has merely sought to curb the capital-gains possibilities in such instances by contending that the automobiles involved were not depreciable assets subject to capital-gains treatment under § 117 (j) of the Internal Revenue Code of 1939. Having conceded that the property involved in the present cases is subject to the depreciation deduction, I do not think the Commissioner should now be permitted to defeat his own position as regards the
Accordingly, I would rеverse in No. 141 and affirm in No. 143.
IV.
The situation presented in No. 283 is, however, different. The taxable years in question there are those terminating on March 31, 1954, 1955, and 1956, respectively. All the taxable years thus ended before the promulgation of the new depreciation regulations on June 11, 1956.7 The Government concedes that Congress did not change the concept of useful life when it enacted the 1954 Code. Therefore, the question here is whether the Commissioner can, by a formal regulation, change his position retroactive only to the effective date of the statute under which it is promulgated.
Petitioner, relying on Helvering v. R. J. Reynolds Tobacco Co. and Helvering v. Griffiths, supra, asserts that where a regulation interpreting a statute has been in force for some time and has survived the re-enactment of the statute, the Commissioner cannot retroactively change
Since the statute permits use of the declining-balance method only as to property with a useful life of three years or more, it follows that the Commissioner properly disallowed use of the declining-balance method as to Hertz’ automobiles, whose useful life under the new regulation was less than three years. As to its trucks, admittedly held for more than three years, the only remaining question is whether Hertz should be allowed to depreciate them below what the Commissioner considers to be a reasonable salvage value. Given the fact that the Commissioner‘s definition of salvage value as resale price on disposition of the asset at the end of its holding period is validly applicable to Hertz, it becomes important that the declining-balance method not be construed to defeat
MR. JUSTICE DOUGLAS joins Parts I, II, and III of this opinion. He would, however, reverse in No. 283—Hertz Corp. v. United States, on the ground that the change in administrative practice involved here should not be retroactively applied under the circumstances of this case. Cf. United States v. Leslie Salt Co., 350 U. S. 383, 396.