Opinion
Docket No. 3247.
1945-03-2
THE EMPIRE DISTRICT ELECTRIC COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Theodore N. Johnsen, Esq., for the petitioner. W. F. Evans, Esq., for the respondent.
Petitioner expended sums of money for surveys and engineering work in preparation for construction of a hydroelectric power plant. When petitioner decided to abandon the proposed construction, the preparation program became worthless. Held, that petitioner abandoned the project in 1936, and sustained a loss in that year of its initial investment. Theodore N. Johnsen, Esq., for the petitioner. W. F. Evans, Esq., for the respondent.
Respondent determined a deficiency in income tax for the year 1936 in the amount of $78,435.33, upon making several adjustments. Petitioner contests only the disallowance of deduction for a loss in the amount of $330,147.35, claimed as a loss from the abandonment in 1936 of an electric power development.
Petitioner filed its return for the taxable year with the collector for the second district of New York.
FINDINGS OF FACT.
The petitioner is a Kansas corporation with its principal office in Joplin, Missouri. Its business consists of producing, transmitting, and distributing electricity to users in approximately 75 communities. For that purpose, it operates a hydroelectric plant at Ozark Beach on the White River in Missouri and a steam plant in Kansas. Petitioner serves an area which extended about 100 miles north and south of Ozark Beach and 120 miles east and west. A large part of its output of electricity is sold to industrial consumers, including mining companies, oil pipe-line companies, and chemical companies.
Prior to 1923 the market for petitioner's generation of electricity was increasing to such an extent that petitioner feared that its production facilities would be inadequate in the not-too-distant future. It also believed that it would be feasible to increase the area which it served. Its management, therefore, decided to construct an additional hydroelectric plant at Table Rock, Missouri, which was about 20 miles from the Ozark Beach plant.
On March 7, 1923, the petitioner was granted a preliminary permit by the Federal Power Commission for a period of three years for a project designated in the records of the Commission as Project No. 324, to consist of a dam across the White River at Table Rock in Taney County, Missouri, and the development of a hydroelectric plant at that site. The estimated cost of the project was $16,000,000, with an additional proposed expenditure of about $14,000,000 for transmission lines, substations, and switching stations. Petitioner expected to raise the funds for the project by the issuance and sale of bonds.
On December 31, 1925, petitioner filed an application with the Federal Power Commission for a license to begin work on the project. The Commission advised petitioner in November 1926 that a license would not be issued until it made suitable arrangements with the counties to be affected by the project. The State of Missouri issued its certificate of approval, a prerequisite, in October 1928, and the counties gave their approval in July 1929. The Commission did not give its notice of intention to issue a license until January 1932. Because of the effect of the general economic depression which began in 1929 and 1930, which caused several mines, to which petitioner had sold electric power, to close, petitioner's sales of electric power produced by its Ozark Beach plant decreased. The business depression indicated that financing the proposed Table Rock project through sales of bonds would be difficult. Therefore, in February 1932 petitioner filed with the Commission an application for delay. But the application was denied and a major license was tendered in June 1932, subject to acceptance not later than December 1, 1932. Petitioner accepted the license.
Under the license the latest dates for beginning and completing construction were December 1, 1934, and December 1, 1937, respectively.
Petitioner was unable to commence construction before December 1, 1934, and filed with the Commission applications for extensions of time to December 1, 1936, and December 1, 1939, respectively. After hearings, the Commission denied the applications on June 8, 1935. Petitioner was unable to pledge itself to begin construction by December 1, 1936, because of the decrease in the demand for power and the depressed financial conditions. The Commission, on June 8, 1935, had ordered petitioner to show cause before July 15, 1935, why its license should not be terminated. Upon default by petitioner under the show cause order, the Commission terminated the license on July 16, 1935.
Petitioner's attorneys advised it that the cancellation of the license did not foreclose petitioner from making an application for a new license when conditions became favorable. It was petitioner's purpose to integrate the facilities of the new Table Rock plant with its existing Ozark Beach plant. Petitioner's managers believed there was little likelihood that any other private concern would apply for a license in the Table Rock area because petitioner was the only company whose customers were adjacent to and near the proposed project, and which could integrate the output of a new plant into an existing system. Therefore in 1935 petitioner's managers intended that in due time, when better conditions developed, petitioner would apply for and receive a new license to construct a plant at Table Rock.
Several events occurred in 1936 which caused petitioner's management to conclude that petitioner could not expect to develop the Table Rock project in the future. These events were the T.V.A. decision (Ashwander v. Tennessee Valley Authority, 297 U.S. 288), which petitioner's managers understood to hold that a Federal agency which produces publicly owned power could sell such power; and the passage by Congress of the Flood Control Act of 1936 (Public No. 738, 74th Cong.). Petitioner's managers believed that because of the general purposes of the Flood Control Act petitioner would not be granted a new license to construct the Table Rock plant by the Federal Power Commission. In the Flood Control Act specific reference was made to the area at Table Rock, Missouri, and the Secretary of War was authorized to continue surveys, studies, and reports with respect to flood-control plans and the economical development of hydroelectric power at Table Rock, as well as at other localities. There was also an announcement through the press in 1936 that $34,000 had been allocated to United States Army engineers for the purpose of studying conditions at Table Rock and elsewhere.
A meeting of petitioner's board of directors was held on December 22, 1936. At that meeting, the general manager recommended that the Table Rock project should be abandoned and that the costs, exclusive of land, should be charged against surplus. It was pointed out to the directors that, because of the events hereinabove set forth, the management believed that the Government's interest in building flood control and hydroelectric projects would not permit in the future the development of some such projects by private enterprise, and that, eventually, the Government would develop such projects. Petitioner's board of directors adopted the following preambles and resolution:
WHEREAS, the Table Rock Water Power Development project in the judgment of this Board is no longer feasible or desirable of completion; and
WHEREAS, the expenditures made include land costs in the amount of $213,447.93, and development costs (comprising taxes, interest, surveying, engineering, legal, government charges, geological investigation and other miscellaneous items) in the amount of $330,147.35; and
WHEREAS, in the judgment of this Board only land costs should be retained in the accounts of the company;
NOW, THEREFORE, BE IT RESOLVED that the project be considered abandoned and that the proper officers be and are hereby authorized to write off as a loss against surplus account, as of September 30, 1936, the development costs of $330,147.35.
The sum of $330,147.35 represented the amount invested and expended in the project, exclusive of land and real property. Following the adoption of the resolution, petitioner charged off against surplus the amount of $330,147.35. Petitioner deducted that amount as a loss in its Federal income tax return for 1936. Petitioner had not carried any reserves on its books for its investment in the project and its cost had been carried at full value.
Prior to 1929 petitioner organized two subsidiary companies to hold title to land acquired for the project, Mid-West Development Co. and Western Land & Timber Co. Petitioner and its two subsidiaries expended $212,807.93 in the purchase of land, of which sum $112,550 was expended by Mid-West. Most of the expenditures were made during 1923 to 1930, inclusive. On August 20, 1935, petitioner's directors adopted a resolution authorizing the dissolution of Western and the transfer of its assets to Mid-West Development Co. The total investment of Western in the project did not exceed $8,000, of which $1,000 represented cost of land. On May 19, 1936, petitioner's directors adopted a resolution authorizing petitioner to acquire, as of March 31, 1936, all of the assets of Mid-West Development Co. and directing the dissolution of Mid-West.
During the period from 1925 to 1930 petitioner engaged in core drilling for the dam foundations, topographical surveying, preliminary engineering, and other preparations at Table Rock. The expenses of this work, plus legal costs and costs of preparing applications for the Federal license, amounted to $330,147.35. Most of the total sum was expended prior to 1933.
After December 1936, at their request, petitioner gave United States Army engineers all of its data on the Table Rock project. On August 14, 1940, the Secretary of War transmitted to the Speaker of the House of Representatives, at the request of the Committee on Flood Control, a report on the Table Rock Reservoir with a report of the War Department Engineers recommending construction by the Federal Government of a reservoir at Table Rock for the control of floods, for development of electric power, and other uses, at a cost of $37,000,000, including the cost of equipment for the sale of electric power. Attached to the report, also, was a report of the Federal Power Commission approving a Federal project at Table Rock. The National Resources Planning Board and the Federal Board of Engineers for Rivers and Harbors also recommended such a project by the Government. The reservoir project referred to in these reports was to be constructed at the same site as petitioner's proposed project.
Petitioner sustained a loss of $330,147.35 in 1936 when it abandoned the project for which preparations had been made at Table Rock.
OPINION.
HARRON, Judge:
Respondent agrees that petitioner has sustained a loss of $330,147.35, the expenditures for preparations for the Table Rock project. The question is whether the loss was sustained in the year 1935, as respondent has determined, or in the year 1936. The issue arises under section 23(f) of the Internal Revenue Act of 1936, which allows a corporation a deduction for a loss sustained in the taxable year not compensated for by insurance or otherwise. Under this section of the statute, the taxpayer may take the deduction only in the year in which the loss is sustained. The difference between the parties arises out of their divergent views on when the loss was sustained.
Petitioner contends that the loss was sustained by virtue of the decision of the directors to abandon the project. The evidence shows that such decision was not made until 1936. Respondent contends that the administrative action of the Federal Power Commission in terminating petitioner's license to construct the project determined the loss.
A practical, not a legal, test is to be applied in determining whether a loss has been sustained in a taxable year. Lucas v. American Code Co., 280 U.S. 445. Under the circumstances and facts in this proceeding, evidence of the abandonment of the project must be given great weight. The loss for which petitioner is seeking a deduction is represented by moneys expended for surveys, core drilling, and preliminary engineering work. These preparations were of value only if the project was actually constructed. Petitioner could recover nothing out of the expenditures for preparations if the construction of the project was abandoned. In W. W. Hoffman, 40 B.T.A. 459; affd., 117 Fed.(2d) 987, we pointed out the variety of situations in which a taxpayer is entitled to a deduction for a loss, and that abandonment may be evidence of a loss, citing several cases where it was held that a loss was sustained upon the abandonment of property or of an interest in property.
The cancellation of the license by the Power Commission in 1935 was not a bar to prevent petitioner's proceeding with the project at a later time. A new application for a new license could be made. The development of the project by the petitioner was not solely dependent upon the first license which had been granted. The cancellation of the license in 1935 represented only a cause for the suspension of activities. A loss does not result from a mere suspension of operations. There may be a suspension of operations in one year and an honest intention to resume operations later. A taxpayer may suspend operations in one year, with an intent to resume them, but if he later abandons the venture, he then sustains a loss. See Reuben H. Donnelley Corporation, 26 B.T.A. 107.
When the license was canceled in 1935, petitioner intended only to postpone the work to be done, and it could hold the plan in suspension because there was little likelihood that a private competitor could or would obtain a license to build a plant at Table Rock in competition with petitioner's Ozark Beach plant. While petitioner could integrate the facilities of a new plant into one system with its Ozark plant profitably, there was no real possibility that another concern would enter the area. However, the construction of a flood-control project at Table Rock by the Government was another matter. Prior to 1936 that eventuality had not developed. When, in 1936, there were substantial indications that the Government would construct a project at Table Rock, at some time not too far in the future, the belief of petitioner's directors that petitioner's chances of obtaining a new license were doubtful, was, in our opinion a reasonable belief. The decision, in 1936, of petitioner's directors to abandon the entire project was reasonable. Effect should be given to that business judgment. See Rhodes v. Commissioner, 100 Fed.(2d) 966; United States v. Hardy, 74 Fed.(2d) 841. When it was decided to abandon the project, the potential value of the preparations was destroyed. It has been found that the loss was sustained in 1936.
It appears that respondent's argument carries an implication that petitioner's officers had really decided to give up the plan in 1935, or before, so that the cancellation of the license in 1935 was the fact which determined the loss when considered together with some such decision. The evidence does not support such theory. There is no evidence that there was an abandonment at any time prior to the date when the resolution was adopted in December 1936. Respondent's determination is reversed.
Decision will be entered under Rule 50.