Milwaukee Brass Mfg. Co. v. Commissioner

*936 These proceedings, which were consolidated for hearing and decision, are brought to secure a redetermination of deficiencies in *937 income and profits tax for the years 1918, 1919, and 1920, and of deficiencies in income tax for the years 1921 and 1922, determined by the Commissioner in the following amounts:

Petitioner alleges that error was committed (1) in reducing its invested capital for 1918, 1919, and 1920 by an amount asserted by respondent to represent depreciation sustained in prior years; (2) in reducing the amount*4005 of depreciation claimed as a deduction in each of the taxable years involved; and (3) in refusing to restore to invested capital for 1918, 1919, and 1920 amounts expended in prior years for tools, dies, patterns, and other equipment, the cost of which had been charged to expense in such prior years, and in refusing to allow depreciation on such assets in each of the taxable years.

FINDINGS OF FACT.

Petitioner is a Wisconsin corporation with its principal office in Milwaukee. It has been engaged in the business of manufacturing plumbers' supplies since 1892. By 1900 it had acquired most of the machinery in use during the taxable years, which consisted of lathes, milling machines, buffers, strappers, blasts, moulding machines, foundry machines and other machines used in the manufacture of plumbers' supplies.

It was the practice of petitioner since the inception of its business to have its own mechanics repair and replace small tools, dies, and parts of its machinery. Whenever a tool or a part of a machine became worn or broken or unfit for use, it was repaired or replaced. The cost of material and labor used in the years from 1893 to 1922, inclusive, in replacing broken*4006 parts for the repair of machines or in replacing small tools, dies, and other such articles was as follows: 1893, $87.16; 1894, $205.93; 1895, $524.01; 1896, $804.60; 1897, $733.85; 1898, $1,009.91; 1899, $1,129.60; 1900, $743.11; 1901, $971.66; 1902, $943.27; 1903, $1,163.90; 1904, $1,360.40; 1905, $1,450.38; 1906, $1,824.85; 1907, $1,680.32; 1908, $1,733.66; 1909, $1,840.44; 1910, $1,738.80; 1911, $1,655.65; 1912, $1,672.69; 1913, $1,693.13; 1914, $1,612.96; 1915, $1,492.16; 1916, $1,920.32; 1917, $1,953.44; 1918, $1,756.08; 1919, $2.622.35; 1920, $3,375.79; 1921, $2,796.72; 1922, $2,637.61. Such costs were not capitalized but were charged off to profit and loss. Expenditures for repairs were charged off to profit and loss. The cost of new machines or of new tools or dies which were not replacements, whether purchased or made by petitioner in *938 its own shops, was capitalized. During the years prior to 1916, no provision was made by petitioner with respect to depreciation upon its assets.

Petitioner's production began to increase materially in 1917, and in that year and in the following years petitioner used its tools and equipment for more than in previous years. *4007 From 1916 to 1922, inclusive, petitioner wrote off depreciation on its tools and equipment in addition to the amount which it charged to expense for repairs and replacements.

The Commissioner computed petitioner's invested capital for the years 1917 to 1920, inclusive, by decreasing the value of the fixed assets, as shown by the books of account, by an adjustment for accrued depreciation sustained over the period from 1892 to the beginning of each of the taxable years involved by applying to the costs of the assets a rate of 2 1/2 per cent on cottage buildings, 1 per cent on main building, 2 per cent on machinery, tools and patterns, and 2 1/2 per cent on office and store fixtures.

The same rates of depreciation were used by the Commissioner in determining depreciation for the taxable years under review. The petitioner claimed in its returns the following rates of depreciation on its various assets for such years: main building, 3 per cent; machinery and tools, patterns, office and store fixtures, 5 per cent; cottage buildings, 2 1/2 per cent.

OPINION.

PHILLIPS: It is not disputed that all such assets as those with which we are here dealing have a limited life. Despite*4008 this fact no provision was made on the petitioner's books to depreciate the cost or to provide a reserve which would permit the recovery of the cost thereof out of the annual profits, except as the cost of replacements of broken parts of machines and of tools, dies, etc., was charged to expense. Whether the amounts so charged off were sufficient to provide for depreciation upon all the assets we do not know, for petitioner owned a factory building, a cottage, office and store fixtures and other assets, the cost and life of which are not shown. In such circumstances we must approve the action of the Commissioner in setting up a reserve out of earnings to provide for the exhaustion of such assets.

Petitioner contends that the rate of depreciation allowed by the Commissioner during the taxable years involved is inadequate. Counsel for the respondent concedes that it is low but not that it is inadequate. We have no evidence upon which to base a rate other than that used and therefore do not disturb respondent's determination. We are of the opinion, however, that the amounts expended *939 for replacements are properly to be restored to petitioner's machinery and tools account*4009 for purposes of computing both invested capital and depreciation during the taxable years.

In arriving at the cost of such replacements we have not included the charges for overhead which petitioner claims is properly to be attributed thereto. The items of overhead claimed, such as non-productive labor and taxes, are normally deducted in computing net income, except as they may go into an inventory. From its system of accounting it is reasonable to assume that such expenses have been deducted in computing taxable income of the petitioner not only in the years involved but in all years since taxes have been based upon its income. At best, the allocation of overhead expenses between various operations is unsatisfactory, and where it appears that the consistent practice has been to charge off such expenses as incurred we are not inclined to change the accounts in order to capitalize them.

Decision will be entered under Rule 50.