Respondent determined the following deficiencies in income tax:
----------------------------------------------------------------------------------------------------------- | Fall River | Fall River Year | Gas Co. | Gas Appliance | | Co., Inc. -------------------------------------------------------------------------------|------------|-------------- 1957 ------------------------------------------------------------------------- | ---------- | $22,505.05 1958 ------------------------------------------------------------------------- | $98,020.00 | 18,627.69 1959 ------------------------------------------------------------------------- | 78,028.88 | 16,038.49 -----------------------------------------------------------------------------------------------------------
The deficiencies are due in part to adjustments no longer in controversy. The principal remaining issues are:
(1) Whether costs of $21,035.76 incurred by the Fall River Gas Appliance Co., Inc., during the year 1957 for the installation of gas appliances leased by it to customers are deductible as ordinary and necessary business expenses.
(2) Whether the Fall River Gas Co. is entitled to deduct as ordinary and necessary business expenses in 1958 and 1959, (a) the installation, delivery, and selling expenses of gas appliances sold during those years by its subsidiary, the Fall River Gas Appliance Co., Inc., and (b) the installation costs of gas appliances leased by that subsidiary.
FINDINGS OF FACT
Some of the facts have been stipulated, and, as stipulated, are incorporated herein by reference.
Fall River Gas Co. (hereinafter referred to as the gas company) and Fall River Gas Appliance Co. (hereinafter referred to as the appliance company), a wholly owned subsidiary of the gas company, are corporations organized under the laws of the Commonwealth of Massachusetts, and doing business at 155 North Main Street, Fall River, Mass. The income tax returns of the gas company for the years 1958 and 1959 and of the appliance company for the years 1957, 1958, and 1959 were filed with the district director of internal revenue for the district of Massachusetts. Both corporations kept their books and filed their returns on an accrual basis.
At all times material, the gas company was engaged in the sale and distribution of gas to domestic and industrial users, and, prior to December 29, 1955, it was also engaged in selling and leasing gas-consuming appliances, principally hot water heaters and conversion burners for central heating. The appliance company was incorporated on December 29, 1955, and thereafter it handled the selling and leasing of the gas appliances.
At all times material, the gas company has had an exclusive franchise to distribute gas at retail in the city of Fall River, Mass., and the towns of Somerset, Swansee, and Westport, Mass. It has experienced keen competition for customers from oil and electric companies. It has endeavored to meet this competition largely by trying to increase
The installation cost of a water heater averaged between $64.21 and $65.62 of which $8 was the cost of the connection of a gasline from an existing gasline to the heater. The rest of the cost was for the installation of water piping from an existing cold water pipe in the basement to the heater and from the heater to the upper floors, and for the installation of a flue from the heater to the chimney.
Leases of water heaters entered into by the appliance company with customers provided, in part, as follows:
1. The Company shall have the right to install the Appliance in the basement at said address, will install a flue into the chimney, make necessary gas connections and run hot water pipes to the locations specified herein but will not install faucets which are to be supplied and connected by the Customer. All piping shall be exposed except where it can be concealed without increasing cost. Customer agrees to pay directly to the plumber any charges for additional work. Customer will furnish the company written permission for the work herein provided for from the owner of the premises and from any tenant thereof in whose apartment any work is to be done. Company reserves the right to refuse to rent an appliance where the installation may be considered abnormal unless the Customer agrees to pay the excess cost.
* * * * * * *
4. The customer agrees that he will not terminate this contract prior to 12 months from the date hereof unless he shall completely vacate the premises and terminate his interest therein. If the customer shall terminate this agreement other than as provided above or shall default hereunder during such initial 12 months period, the Company shall have the right to immediately bill the customer for the unexpired portion of the minimum rental period. Such rights shall be in addition to any other right of the Company arising because of default or termination.
The installation cost of a conversion burner averaged between $87.71 and $93.42 per installation and in each case the cost of the gas piping to the burner was $8 per installation. The rest of the cost was for other labor and material. If the use of a conversion burner was discontinued the appliance company would remove the burner, replace the grates, and leave the furnace in the same condition as before the burner was installed.
Leases of conversion burners entered into by the appliance company with customers provided, in part, as follows:
1. The Company will install the Appliance in the above Customer's present furnace, install a new flue into the chimney, if required, and make all necessary gas, electric connections and adjustments. All piping and wiring shall be exposed except where it can be concealed without increased cost. Should the Customer demand that the installation be made in a manner which would result in increased installation costs, the Customer shall agree to pay for such additional charges. Customer will furnish the Company written permission for the work herein provided for from the owner of the premises and from any tenant thereof in whose apartment or any assigned space work is to be done. Company reserves the right to refuse to rent an appliance where the installation may be considered abnormal unless the Customer agrees to pay the excess cost.
* * * * * * *
7. Customer may terminate this Agreement by 24-hour notice to the Company, or by discontinuing gas service. Upon the termination in any manner whatsoever of this Lease, the Customer shall forthwith surrender the burner to the Company, complete and in good order and condition, ordinary wear and tear excepted.
The installation of water heaters and conversion burners was done by licensed plumbers.
Due principally to the vacating of rented premises, there was a turnover of customers of the gas company, but the total number of its customers tended to remain the same. Installations on leased premises would serve more than one customer where new tenants moved in and took over existing installed facilities. There was nevertheless a substantial number of removals of leased appliances. During the 6-year period 1954-59 there were 9,088 installations and 1,650 removals of water heaters, and 762 installations and 121 removals of conversion burners; additional removals of both water heaters and conversion burners occurred during subsequent years. However, there was an unspecified number of occasions in which another water heater or conversion burner was installed for the benefit of a new tenant or owner after a previously installed appliance had been removed, and in such circumstances the piping, etc., left behind from the
The number of customers of the gas company and the average gas consumption per customer during the years 1954 through 1959 were as follows:
---------------------------------------------------------------------------------------------------
Year | Number of | Usage
| customers | (MCF)1
-------------------------------------------------------------------------------|-----------|-------
1954 ------------------------------------------------------------------------- | 35,423 | 25.0
1955 ------------------------------------------------------------------------- | 35,674 | 30.1
1956 ------------------------------------------------------------------------- | 35,541 | 38.4
1957 ------------------------------------------------------------------------- | 35,591 | 43.9
1958 ------------------------------------------------------------------------- | 35,652 | 53.8
1959 ------------------------------------------------------------------------- | 35,660 | 58.4
---------------------------------------------------------------------------------------------------
1 MCF = 1,000 cubic feet.
The installation costs of leased appliances for the year 1957 in the amount of $21,035.76 were charged by the gas company to the appliance company.
In its return for the year 1957 the appliance company reported taxable income in the amount of $114,275.39. In computing its taxable income it claimed deductions for the following:
Installation expense—appliances ---------------------------- $57,677.55 Installation—rentals --------------------------------------- 21,035.76 Selling expenses ------------------------------------------- 8,847.50 Miscellaneous ---------------------------------------------- 9,132.36
In the notice of deficiency for the year 1957 respondent determined that $21,035.76, representing the cost of installation of leased appliances, was a capital expenditure, and added $20,509.86 of this amount, representing the difference between $21,035.76 and an amortization or depreciation allowance of $525.90, to the income reported by the appliance company in its 1957 return.
In its income tax return for the year 1958, the appliance company reported total income of $384,082.53 and net taxable income of $93,244.05. Among the deductions which it claimed were the following:
Installation expense—appliances ---------------------------- $47,908.08 Selling expenses ------------------------------------------- 10,120.80
In determining the deficiency for the year 1958, respondent did not disallow these deductions.
In its income tax return for the year 1959, the appliance company reported total income of $364,355.88 and net taxable income of $94,300.56. Among the deductions which it claimed were the following:
Delivery and installation expenses -------------------- $39,434.56 Selling expenses -------------------------------------- 8,631.44
In its returns for the years 1958 and 1959 the gas company in computing its taxable income deducted the following installation costs, delivery expenses, and selling expenses incurred in connection with appliance sales and leases made by the appliance company:
1958
Amount
Delivery expenses (appliances sold) ----------------------------- $11,908.08
Installation costs:
Appliances sold -------------------------------- $36,000.00
Appliances leased ------------------------------ 124,822.95 160,822.95
__________
Selling expenses (appliances sold) ------------------------------- 10,120.80
___________
Total ----------------------------------------------------- 182,851.83
-----------
1959
Delivery expenses (appliances sold) ------------------------------ 9,434.56
Installation costs:
Appliances sold --------------------------------- 30,000.00
Appliances leased ------------------------------- 112,284.92 142,284.92
__________
Selling expenses (appliances sold) ------------------------------- 8,631.44
__________
Total ------------------------------------------------------ 160,350.92
Respondent determined these amounts were not deductible by the gas company as ordinary and necessary business expenses and, on the ground that they were capital expenditures which should be capitalized, he allowed deductions for depreciation as indicated below:
1958 1959
Costs capitalized --------------------------------- $182,851.83 $160,350.92
___________ ___________
Less—Depreciation allowed:
1958 costs ------------------------------------- 5,122.01 10,244.04
1959 costs --------------------------------------------------- 4,460.42
__________ ___________
Total ---------------------------------------- 5,122.01 14,704.46
__________ ___________
Net adjustments ----------------------------------- 177,729.82 145,646.46
The installations involving leased appliances had an average useful life of 12 years in conjunction with such appliances.
OPINION
RAUM, Judge:
1. Appliance company's 1957 cost of installing leased appliances. — In 1957 the appliance company incurred various costs in connection with its sales and leases of gas appliances. As to sales, it had "selling expenses" of $8,847.50, "miscellaneous expenses" of $9,132.36, and "installation expenses" of $57,677.55. The Commissioner allowed the deductions of all of these expenses, and they are
The appliance company was in the business of both selling and leasing appliances. In relation to sales, its expenditures were related to closed transactions and were a proper charge at once against the income realized from such transactions. The situation in respect of leases is quite different. Notwithstanding that some leases were at will and others for an initial period of only 1 year, it was plainly anticipated that the leases would continue over extensive periods during which the installations would serve the leased equipment. The leases were productive of rentals to the appliance company throughout the time that the consumers used the leased appliances, and the cost of installing the appliances was clearly capital in nature, a charge against those rentals over their anticipated life, to be taken in the form of annual amortization or depreciation deductions, and not as a single expense deduction in 1 year.
We reject the appliance company's contention that since the installations were basically an improvement to the customer's real estate with little or no salvage value to it the cost of installation must be treated as a current expense. It has long been held that the cost of an improvement which results in an economic benefit or advantage to a taxpayer's business extending beyond the taxable year is a capital expenditure even though title to the improvement may be vested in another. Kauai Terminal, Ltd., 36 B.T.A. 893; 47 B.T.A. 523; Colony Coal & Coke Corp. v. Commissioner, 52 F.2d 923 (C.A. 4), affirming 20 B.T.A. 326; Cripple Creek Coal Co. v. Commissioner, 63 F.2d 829 (C.A. 7), affirming 24 B.T.A. 1096; D. Loveman & Son Export Corp., 34 T.C. 777, 806-807, affirmed 296 F.2d 732 (C.A. 6), certiorari denied, 369 U.S. 860. These cases govern here, rather than Centadrink Filters Co., Inc., 6 B.T.A. 662, relied upon by the taxpayer, which is distinguishable on its unusual facts and which does not appear to have been cited in any subsequent opinion up to the present time.
Even though title to the installations, consisting primarily of piping, may have passed to the owner of the building when they were made, the prospect that the company would realize rental income from the leased appliances over a prolonged period continued. While it is true that leases of hot water heaters could be terminated after 1 year and conversion burners at any time, the leases did not preclude the
Since we approve the Commissioner's position that the installation costs of leased appliances must be capitalized and since we disapprove of the 20-year life that he has determined, it becomes necessary to make a finding as to useful life. The materials in the record do not enable us to arrive at any scientifically accurate conclusion in this respect, but doing the best we can with the evidence before us we have found as a fact that the installations in question had a useful life of 12 years in conjunction with the leased appliances. Accordingly, the company's 1957 installation costs in issue should be spread over that period.
2. Gas company's deductions, 1958 and 1959. — For the years 1958 and 1959 expenditures in connection with appliances sold or leased by the appliance company were claimed as deductions by its parent, the gas company, as follows:
1958 1959
(i) Delivery expenses (appliances sold) --------------- $11,908.08 $9,434.56
(ii) Installation costs (appliances sold) ------------- 36,000.00 30,000.00
(iii) Installation costs (appliances leased) ---------- 124,822.95 112,284.92
(iv) Selling expenses (appliances sold) --------------- 10,120.80 8,631.44
__________ __________
182,851.83 160,350.92
The Commissioner disallowed these deductions in toto, capitalized the amounts involved, and allowed depreciation deductions for each of the years based on the capitalized amounts.
Items (i), (ii), and (iv), relating to appliances sold, are substantially identical in character with corresponding deductions in different amounts claimed by the appliance company in 1957 which the Commissioner allowed, and item (iii), relating to appliances leased, is of the same character as the expenditures of the appliance company in 1957 dealt with in 1, supra.
(a) The Commissioner does not dispute the fact that if the costs incurred in items (i), (ii), and (iv) had been paid by the appliance
Ordinarily, the separate corporate identities of parent and subsidiary preclude the parent from deducting expenses incurred or losses sustained by its subsidiary. The theory is that the payment by the parent to cover such expenses or losses is related to the business of the subsidiary and not to its own business. Interstate Transit Lines v. Commissioner, 319 U.S. 590. Accordingly, if this were the usual situation of a parent paying expenses of its subsidiary, the deduction would have to be disallowed. For a recent example, see Columbian Rope Co., 42 T.C. 800 (portions of salaries of certain employees of subsidiary paid by parent). However, the situation here is different. The gas company had a substantial interest in increasing its own sales of gas, and the expenses paid by it were intended to promote its own business wholly apart from that of the subsidiary. This distinction was explicitly noted in Interstate Transit Lines, supra at 594, and was regarded as pivotal by this Court in Fishing Tackle Products Co., 27 T.C. 638, 644. We think that the expenditures involved in items (i), (ii), and (iv) which would have the quality of deductible expenses if made by the subsidiary, are similarly deductible by the parent when paid by the parent
(b) As to the installation costs of leased appliances, referred to herein as item (iii), we have held above that expenditures for this
Decision will be entered under Rule 50.
FootNotes
The same situation prevails as to 1959. The subsidiary deducted $39,434.56 as "Delivery and Installation Expenses," an amount equal precisely to the sum of items (i) and (ii) deducted by the parent as "Delivery Expenses (Appliances Sold)" and "Installation Costs: Appliances Sold." And the subsidiary also deducted $8,631.44 as "Selling Expenses," an amount equal precisely to item (iv) deducted by the parent as "Selling Expenses (Appliances Sold)." The Court similarly expects the parties to clarify this situation in connection with the decisions to be entered under Rule 50.
Comment
User Comments