Fribourg Navigation Company v. Commissioner of Internal Revenue/Dissent White

by Byron White

United States Supreme Court

383 U.S. 272

FRIBOURG NAVIGATION COMPANY, Inc., Petitioner,  v.  COMMISSIONER OF INTERNAL REVENUE.

 Argued: Nov. 10, 1965. --- Decided: March 7, 1966

Mr. Justice WHITE, with whom Mr. Justice BLACK and Mr. Justice CLARK join, dissenting.

In my opinion, the Court of Appeals was faithful to the congressional concept of depreciation and to the Internal Revenue Code and applicable Treasury Regulations. Accordingly, I would affirm.

Section 167(a) of the Internal Revenue Code of 1954 authorizes as a depreciation deduction only a 'reasonable allowance' for exhaustion, wear and tear, and obsolescence. (Emphasis added.) This allowance was designed by Congress to enable the taxpayer to recover his net investment in wasting assets used in his trade or business or held for the production of income to the extent that the investment loses value through exhaustion, wear and tear, or obsolescence. ^[1] In this manner the taxpayer will be taxed only on the net, rather than the gross, income produced by the depreciable asset in accordance with the general congressional scheme to tax only net income. It was not, however, the intent of Congress to enable the taxpayer to recover more than his actual net investment and thereby to convert ordinary income into a capital gain through excessive depreciation. 'Congress intended by the depreciation allowance not to make taxpayers a profit thereby, but merely to protect them from a loss.' Massey Motors v. United States, 364 U.S. 92, 101, 80 S.Ct. 1411, 1416. See also Detroit Edison v. Commissioner of Internal Revenue, 319 U.S. 98, 63 S.Ct. 902, 87 L.Ed. 1286, where the Court refused to allow the taxpayer to depreciate that portion of the initial investment of an asset that did not represent actual expenditure by it because borne by its customers. Accordingly, in judging whether a given depreciation deduction is 'reasonable,' we should determine whether the deduction is designed to recover tax-free only the actual investment in the asset, Massey Motors, supra, 364 U.S. at 105, 80 S.Ct. at 1418, 1419, or whether it is calculated instead to return a greater amount.

It would be easy enough to compute depreciation if the taxpayer were required to wait until disposition of the asset, at which time he would know with precision his net investment, before he could claim a depreciation allowance. Whether he were then required to take the entire depreciation allowance in the year of sale or permitted to reopen the previous tax years during which he held the asset and spread the allowance ratably among them, it could be ensured that he would then recover precisely, but no more than, his actual, net investment. However, both for administrative and economic reasons, Congress has chosen to allow the taxpayer to take depreciation deductions in advance of the disposition of the asset by estimating what portion of his net investment should be allocated for the use of the asset in any given year. This estimate involves two unknowns: the duration of its use by the taxpayer ^[2] and the salvage value (resale price of the asset if it is resold). ^[3] Every effort must be made, in estimating these two values, to come as close to the actual figures as possible. Massey Motors v. United States, supra. Indeed, it is reasonable to use estimates at all only because the actual figures are generally not knowable in advance. However, when the actual figures do become known and they differ materially from the estimates of them previously made and they can be substituted for the estimates with almost no inconvenience or unfairness, then it seems to me to be clearly unreasonable, and hence unauthorized by § 167, to continue to rely on the estimates. See Hertz Corp. v. United States, 364 U.S. 122, 128, 80 S.Ct. 1420, 1423.

In the present case, Fribourg knew in 1957 what its actual net investment in the S. S. Joseph Feuer would be. It knew that if it claimed the previously estimated depreciation deduction for that year it would recover more than its net investment and would be immunizing other income from normal income tax rates. ^[4] It also knew that a readjustment could be made for 1957 with finality and without significant inconvenience because the resale value and useful life had been definitely determined. Nevertheless, Fribourg continued to use the previously estimated figures, known to it to be erroneous. This, to me, was patently unreasonable and, therefore, outside the scope of § 167.

Not only did Fribourg violate the terms of the statute, it also failed to comply with the applicable, long-standing Treasury Regulations. Treasury Regulation § 1.167(a)-1(b) provides that the estimate of useful life is to be redetermined by reason of conditions known to exist at the end of the taxable year whenever the change in useful life is significant and there is a clear and convincing basis for the redetermination. As a companion provision, Treas.Reg. § 1.167(a)-1(c) provides that whenever there is a redetermination of useful life, salvage value should also be redetermined if required by facts known at the time of the redetermination. At the end of the taxable year 1957, Fribourg knew it had overestimated useful life by approximately one-third, which seems to me to be a significant error. At the same time, it knew its estimate of salvage value was only about one-thirteenth the actual salvage value. And, it had the clearest and most convincing basis possible for redetermination-it knew the actual figures. As I read the above regulations, they surely require a redetermination in this situation.

Further, Treas.Reg. § 1.167(b)-0 says that 'deductions for depreciation shall not exceed such amounts as may be necessary to recover the unrecovered cost or other basis less salvage * * *.' To the same effect are Treas.Reg. §§ 1.167(a)-1(a) and (c), which warn that 'an asset shall not be depreciated below a reasonable salvage value,' remembering that reasonableness is to be determined 'upon the basis of conditions known to exist at the end of the period for which the return is made.' Treas.Reg. § 1.167(b) 0. (Emphasis added.) See Hertz Corp. v. United States, supra. Yet here Fribourg knowingly recovered more than its 'cost or other basis' less salvage. Here, Fribourg knowingly depreciated its asset below a reasonable salvage value in light of conditions known at the end of 1957.

I think the majority misreads that provision in the regulations that says 'Salvage value is the amount 'determined at the time of acquisition) which is estimated will be realizable upon sale or other disposition of an asset * * *. Salvage value shall not be changed at any time after the determination made at the time of acquisition merely because of changes in price levels.' Treas.Reg. § 1.167(a)-1(c). That provision merely recognizes the fact that in years prior to the concluding of a resale agreement the salvage value can only be estimated and it would be administratively burdensome and frequently futile to require redeterminations each year merely because of price changes that may ultimately prove ephemeral. But those provisions certainly do not express a policy against redetermination, in the year of a premature sale, of salvage value when it can be known with finality what effect the price levels will have on the salvage value. Rev. Rul. 62-92, 1962 1 Cum.Bull. 29; Cohn v. United States, 6 Cir., 259 F.2d 371, 378. The very next sentence in that regulation seems to acknowledge the relevance of price levels, provided that such recognition does not cause undue administrative hardship: 'However, if there is a redetermination of useful life * * *, salvage value may be redetermined based upon facts known at the time of such redetermination of useful life.'

The majority opinion faults the Commissioner for having 'commingled two distinct * * * concepts of tax accounting depreciation of an asset through wear and tear or gradual expiration of useful life and fluctuations in the value of that asset through changes in price levels or market values.' In my opinion these two concepts, as used in the Internal Revenue Code, are necessarily commingled and it is unrealistic to expect that one can be isolated from the other. One of the essential elements in the concept of depreciation deductions is salvage value, Treas.Reg. § 1.167(a)-1(a); salvage value is resale price if the asset is resold, Massey Motors v. United States, supra, 364 U.S. at 105-107, 80 S.Ct. at 1418-1419; Edward V. Lane, 37 T.C. 188; and resale price is directly influenced by fluctuations in market value. To the extent that such fluctuations are predictable, they must be considered in making a reasonable estimate of salvage or resale value of the investment. See Bolta Co., 4 CCH Tax Ct.Mem. 1067. ^[5] In addition, as reflected by this case, predictable market fluctuations in value may also affect the useful life of the asset. To the extent that disposal of an asset by sale becomes more attractive through market appreciation it can be expected that useful life, as defined in Massey Motors, supra, will shorten. Although market appreciation in this case was more rapid than will normally be the case, it was predictable for more than a year before Fribourg sold its ship, and by the end of 1957 Fribourg knew exactly what effect market appreciation would have upon the resale value of useful life. In this situation market appreciation should not have been disregarded.

The majority also contends that the Commissioner's position contains an inconsistency because he disallowed depreciation only for the year in which the sale occurred and did not require a disallowance for previous years although the resale price was sufficiently high to indicate that the S. S. Joseph Feuer did not 'cost' Fribourg anything in the earlier years either. However, in the earlier tax years it was reasonable to rely on the estimated salvage value, since the actual salvage value was not then known. At any rate, it is well established that a modification of the depreciation allowance (for whatever reason) will not be applied retroactively to previous tax years. For example, if the useful life is determined to be longer than originally believed, the allowable depreciation is not modified for the prior years in which excessive depreciation had been taken, but the remaining undepreciated basis minus salvage value is spread ratably over the new estimated remaining useful life and depreciation deductions taken accordingly for the current and succeeding years. Commissioner of Internal Revenue v. Cleveland Adolph Mayer Realty Corp., 6 Cir., 160 F.2d 1012; Commissioner of Internal Revenue v. Mutual Fertilizer Co., 5 Cir., 159 F.2d 470; 4 Mertens, Law of Federal Income Taxation, § 23.47; see also Virginian Hotel Corp. of Lynchburg v. Helvering, 319 U.S. 523, 63 S.Ct. 1260, 87 L.Ed. 1561; S.Rep.No. 665, 72d Cong., 1st Sess., 29.

There is a further alleged inconsistency because the Commissioner may be refusing to allow additional depreciation in the year of sale when salvage value turns out to be less than the adjusted basis at the time of sale. This alleged inconsistency, however, should be dealt with when it is properly presented to us. ^[6]

Finally, I turn to the majority's contention that the Commissioner's position represents a dramatic departure from previous administrative and judicial practice and that congressional re-enactment of the depreciation provision during this time reflects congressional approval of that previous interpretation.

Several of the cases and revenue rulings relied upon by the majority to establish past practice were concerned with tax years previous to 1922, ^[7] when the first capital gain provision became applicable. ^[8] I would not give precedential significance to positions taken during that time because the tax saving resulting from a depreciation deduction in the year of sale would have been exactly offset by the tax liability resulting from the correspondingly greater gain upon the sale of the asset due to the lower basis. The remaining revenue ruling ^[9] and most of the remaining cases relied upon by the majority were concerned primarily with issues other than the one now before us. ^[10] In the absence of any indication that the Commissioner or the courts in those instances focused on the precise issue now before us these examples are without precedential value. There is one early decision of the Board of Tax Appeals, Herbert Simons, 19 B.T.A. 711, and one by the Tax Court, Wier Long Leaf Lumber Co., 9 T.C. 990, that did expressly consider the problem whether a taxpayer could claim depreciation in the year he sells an asset at a price above his depreciated basis for that asset. In Wier Long Leaf Lumber Co. the Commissioner challenged the right of the taxpayer to take depreciation in the year of sale and at least part of that court's opinion seems to support the Commissioner's position. ^[11] This leaves only Herbert Simons in which the Commissioner and the Board appear to take a considered position inconsistent with that now urged by the Commissioner. In my opinion that decision should be disapproved as being inconsistent with the statutory provision for depreciation and the interpretative regulations. In recent years, it should be observed, there is substantial judicial authority for the disallowance of depreciation in the year of a sale above depreciated basis. ^[12]

To the extent that the Commissioner took an inconsistent position in any of these early cases, I would certainly not now hold him to that position. ^[13] We have frequently in the past recognized the Commissioner's authority to re-evaluate a prior position upon the basis of greater experience and reflection and to adjust that position to the extent that he becomes convinced that an adjustment is necessary to comport with congressional intent, even when this results in a distinct reversal of a previous position and the taxpayer had relied upon the previous position. ^[14] Dixon v. United States, 381 U.S. 68, 85 S.Ct. 1301, 14 L.Ed.2d 223; Automobile Club of Michigan v. Commissioner of Internal Revenue, 353 U.S. 180, 77 S.Ct. 707, 1 L.Ed.2d 746. Were the Commissioner denied this authority, it would be tantamount to freezing in acknowledged error. It seems strange, therefore, that the majority today would deny the Commissioner this authority when his earlier position was not clear and when Fribourg has made absolutely no showing that it would not have made arrangements to sell the S. S. Joseph Feuer when it did but for a reliance upon the alleged previously inconsistent position of the Commissioner.

Under these circumstances, it also seems unrealistic to me to argue that, by re-enacting the depreciation provision on several occasions prior to the promulgation of Rev. Rul. 62-92 in 1962, Congress intended to give force of statutory law to the position that depreciation should be allowed on an asset in the year it is sold at a price above its depreciated basis. This reasoning has been recognized as 'no more than an aid in statutory construction,' Helvering v. Reynolds, 313 U.S. 428, 432, 61 S.Ct. 971, 973, 85 L.Ed. 1438, and as 'an unreliable indicium at best' by The Chief Justice writing for the Court in Commissioner of Internal Revenue v. Glenshaw Glass Co., 348 U.S. 426, 431, 75 S.Ct. 473, 476-477, 99 L.Ed. 483. It is a particularly unreliable aid in statutory construction unless the previous interpretation had been clearly and officially promulgated and Congress had been specifically advised of that interpretation in connection with the re-enactment of the relevant statutory provision. Higgins v. Commissioner of Internal Revenue, 312 U.S. 212, 61 S.Ct. 475, 85 L.Ed. 783; see generally, 1 Davis, Administrative Law § 5.07. Here there was no official Treasury Regulation of Treasury Decision clearly articulating the theory that depreciation should be allowed in the year of profitable sale. Indeed, as indicated earlier, the relevant Treasury Regulations seemed generally to indicate quite the opposite conclusion. Nor is there any indication that anyone asserted to Congress during a time that it was considering re-enactment of the depreciation provision that the Commissioner had embraced a position that depreciation had to be allowed on property in the year that it was sold at a price in excess of its adjusted basis. The legislative history and various requests made to Congress upon which the majority relies were directed to the capital gain provisions of the Code, not the depreciation provision. And, there are indications that Congress intended to treat the two provisions separately. See H.R.Rep.No. 749, 88th Cong., 1st Sess., 103 (1963); S.Rep.No. 830, 88th Cong., 2d Sess., 133 (1964). For example, the 'undue hardship' which prompted Congress to enact § 1231 was no doubt the hardship of paying tax on gain resulting from many years of appreciation when all of the gain is bunched into the year of sale. The Commissioner's refusal to allow depreciation in the year of profitable sale is in no way inconsistent with this attempt by Congress to alleviate hardships resulting from the bunching of income. Further, the fact that Congress was asked in the President's 1961 Tax Message to enact legislation treating gain upon the sale of depreciated property as regular income to the extent that the property had previously been depreciated should not be construed as a representation to Congress that the Commissioner did not have the authority he now claims. That recommendation was generally concerned with excessive depreciation in years 'previous' to the year of sale, an abuse that the Commissioner has never claimed to be able to correct without congressional assistance. None of the examples cited to Congress in this Message are inconsistent with the Commissioner's authority to deny depreciation in the year of profitable sale. ^[15]

In 1962 and again in 1964 Congress enacted certain recapture provisions. ^[16] These provisions indicate a congressional attitude, consistent with the Commissioner's position, that depreciation should not exceed actual, net investment and that excessive depreciation should not be permitted to convert ordinary income into capital gain. The only concrete evidence that Congress was really aware of the Commissioner's position that depreciation should be disallowed in the year of profitable sale is to be found in the House and Senate Reports considering § 1250, the recapture provision dealing with depreciable real estate. I think the comments contained in those Reports on the position taken by the Commissioner are highly relevant:

'(T)he enactment of this provision is not intended to affect the question of whether all or any part of a claimed deduction for depreciation is in fact allowable. For example, since in the year real property is sold the actual value of the property is known, it has been held that depreciation deductions should not be allowed to the extent they reduce the adjusted basis of the property below the actual amount realized. This provision, in providing for ordinary income treatment for certain additional depreciation, is not intended to affect this holding.' H.R.Rep.No. 749, 88th Cong., 1st Sess., p. 103 (1963); S.Rep.No. 830, 88th Cong., 2d Sess., p. 133 (1964). (Emphasis added.)

Congress gave to the Secretary of the Treasury or his delegate, not to this Court, the primary responsibility of determining what constitutes a 'reasonable' allowance for depreciation. When the Commissioner adopts a rational position that is consistent with the purpose behind the depreciation deduction, congressional intent, and the language of the statute and interpretative Treasury Regulations, I would affirm that position.

Notes

1. The House Report on the 1954 Internal Revenue Code has defined depreciation as 'allowances (whereby) capital invested in an asset is recovered tax-free over the years it is used in a business.' H.R.Rep.No. 1337, 83d Cong., 2d Sess., p. 22, U.S.Code Cong. & Admin.News 1954, p. 4046. (Emphasis added.) Similarly, in Virginian Hotel Corp. of Lynchburg v. Helvering, 319 U.S. 523, 63 S.Ct. 1260, 87 L.Ed. 1561, the Court discussed depreciation in terms of an amount 'which, along with salvage value, will replace the original investment of the property * * *.' 319 U.S., at 528, 63 S.Ct., at 1263. This Court has, on other occasions, spoken of depreciation in terms of a gradual sale of the depreciable asset as it is physically used up year by year in the trade or business. See Massey Motors v. United States, 364 U.S. 92, 104, 80 S.Ct. 1411, 1418, 4 L.Ed.2d 1592. However, this is to say the same thing in different words. Even if one views depreciation as representative of the physical exhaustion of an asset, it is not measured in terms of nuts and bolts but in terms of the 'financial consequences to the taxpayer of the subtle effects of time and use on * * * his capital assets.' Detroit Edison Co. v. Commissioner of Internal Revenue, 319 U.S. 98, 101, 63 S.Ct. 902, 904. Investment is not to be measured in terms of original or initial cost, but in terms of 'net investment,' Detroit Edison Co. v. Commissioner of Internal Revenue, supra, 319 U.S. at 103, 63 S.Ct. at 904, or 'actual cost,' Massey Motors v. United States, supra, 364 U.S. at 106, 80 S.Ct. at 1419. Accordingly, salvage value, Treas.Reg. § 1.167 (a)-1, and other reimbursements received by the taxpayer, Detroit Edison Co. v. Commissioner of Internal Revenue, supra, must be deducted from the taxpayer's initial investment in the asset in order to arrive at a depreciable 'net investment.' I use the word 'investment' rather than 'cost' because 'cost' may have so many different meanings, both to the accountant and to the tax lawyer, and some of those meanings would do considerable violence to the congressional purpose for depreciation allowances.
2. Useful life is to reflect the realities of the taxpayer's actual experience rather than a possibly unrealistic conceptualized idea of inherent physical life. Massey Motors v. United States, supra, n. 1.
3. As is the case with useful life, salvage value should reflect the actualities of the situation. When a depreciated asset is sold the economic reality is that the resale price is the salvage value. This practical definition of salvage value was clearly contemplated in Massey Motors, supra, n. 1, where the Court talked in terms of 'real salvage price' and 'resale' value. Id., 364 U.S. at 105, 107, 80 S.Ct. at 1418, 1419. (Emphasis added.) In Hertz Corp. v. United States, 364 U.S. 122, 127, 80 S.Ct. 1420, 1423, 4 L.Ed.2d 1603, the Court spoke in terms of 'the price that will be received when the asset is retired.' See also Treas.Reg. § 1.167(a)-1(c), which speaks in terms of an amount 'realizable upon sale * * * of an asset when it is no longer useful in the taxpayer's trade or business or in the production of his income * * *.'
4. It is in this economic sense that the Commissioner means that it 'cost' Fribourg nothing to use the S. S. Joseph Feuer in 1957. Obviously the ship suffered some physical wear and tear during use in 1957. But measured in economic terms Fribourg had already been compensated in advance for that wear and tear as it affected its net investment in the ship because excessive depreciation deductions had been taken in the earlier years. The Commissioner is asking now only that Fribourg be prevented from deliberately compounding the error innocently made in earlier years by continuing to claim depreciation deductions after it knew its entire net investment in the S. S. Joseph Feuer had already been recovered.
5. The Tax Court's current position on the relevance of predictable market appreciation at the time of a determination of useful life and salvage value is not entirely clear. Compare Smith Leasing Co., 43 T.C. 37, with Macabe Co., 42 T.C. 1105.
6. Similarly, because our situation involves appreciated market values, we are not now concerned with that sentence in Treas.Reg. § 1.167(a)-1(a) that reads, 'The allowance shall not reflect amounts representing a mere reduction in market value.' At any rate, this sentence merely reflects the congressional intent that a taxpayer be permitted to recover his net investment in an asset to the extent that the net investment represents 'exhaustion, wear and tear, (or) obsolescence.'
7. Of the rulings cited in n. 5 of the majority opinion, only one, G.C.M. 1597, VI-1 Cum.Bull. 71 (1927), involved a tax year after 1921. Both Supreme Court cases cited in n. 4 of the majority opinion, United States v. Ludey, 274 U.S. 295, 47 S.Ct. 608, 71 L.Ed. 1054; and Eldorado Coal & Mining Co. v. Mager, 255 U.S. 522, 41 S.Ct. 390, 65 L.Ed. 757, were concerned with tax years prior to 1922. Similarly, Louis Kalb, 15 B.T.A. 865, and Even Realty Co., 1 B.T.A. 355, involved tax years prior to 1922.
8. 42 Stat. 232, § 206(a).
9. G.C.M. 1597, VI-1 Cum.Bull. 71 (1927). See also Treas.Reg. § 1.1238-1, Example (1), which was designed to show the interaction between §§ 168 and 1238, not the allowance of depreciation of § 167. That example has now been retroactively amended to the date of its original adoption in 1951. T.D. 6825, 1965-1 Cum.Bull. 366.
10. Beckridge Corp. v. Commissioner of Internal Revenue, 2 Cir., 129 F.2d 318; Clark Thread Co. v. Commissioner of Internal Revenue, 3 Cir., 100 F.2d 257; Kittredge v. Commissioner of Internal Revenue, 2 Cir., 88 F.2d 632; Seymour Mfg. Co. v. Burnet, 61 App.D.C. 22, 56 F.2d 494; Hall v. United States, 43 F.Supp. 130, 95 Ct.Cl. 539; Max Eichenberg, 16 B.T.A. 1368; H. L. Gatlin, 19 CCH Tax Ct.Mem. 131; P. H. & J. M. Brown Co., 18 CCH Tax Ct.Mem. 708.
11. See also Duncan-Homer Realty Co., 6 B.T.A. 730 (1927), where the Board of Tax Appeals sustained the Commissioner's refusal to allow depreciation in the year of a profitable sale.
12. Fribourg Navigation Co., Inc. v. Commissioner of Internal Revenue, 2 Cir., 335 F.2d 15; United States v. Motorlease Corp., 2 Cir., 334 F.2d 617, pet. for cert. filed; Cohn v. United States, 6 Cir., 259 F.2d 371; Killebrew v. United States, D.C., 234 F.Supp. 481.
13. The Commissioner's acquiescence in Wier Long Leaf Lumber Co., 9 T.C. 990, can have no clearer significance than has the opinion itself, with its arguably inconsistent holdings. At any rate, at the front of each cumulative bulletin it is clearly explained that acquiescences 'have none of the force or effect of Treasury Decisions and do not commit the Department to any interpretation of the law.' See Dixon v. United States, 381 U.S. 68, 85 S.Ct. 1301, 14 L.Ed.2d 223.
14. See 26 U.S.C.A. § 7805 (1964 ed.), which gives authority to the Secretary of the Treasury or his delegate to 'prescribe all needful rules and regulations * * *, including all rules and regulations as may be necessary by reason of any alteration of law in relation to internal revenue.' Subsection (b) of that section says 'The Secretary or his delegate may prescribe the extent, if any, to which any ruling or regulation, relating to the internal revenue laws, shall be applied without retroactive effect.'
15. Similarly, the other requests addressed to Congress mentioned in the majority opinion were concerned with problems beyond the remedial power of the Commissioner to disallow depreciation in the year of profitable sale.
16. 26 U.S.C. §§ 1245, 1250 (1964 ed.).