decided. argued may 25 1959.: July 6, 1959.
Before KALODNER, STALEY and HASTIE, Circuit Judges.
Essentially this appeal presents two questions for review, namely: (1) whether "useful life" for depreciation purposes as used in Section 167(c) of the Internal Revenue Code of 1954, 26 U.S.C. § 167 (c) means the physical life of an asset for business purposes (the economic life), or the period during which the property is useful to the taxpayer; and (2) whether in the declining balance method of depreciation,*fn1 authorized by Section 167(b)out) of the 1954 Code, salvage value is inherent in the method or, rather, is a figure below which depreciation is not permitted.
This is an action for refund of income taxes paid by appellee*fn2 for the fiscal years ended March 31, 1954, 1955, and 1956, in the amounts of $100.15, $4,044.54, and $10,416.43, respectively. The government has appealed from an adverse judgment rendered by the District Court for the District of Delaware.*fn3
Appellee's predecessor, Connor, was organized as a New Jersey corporation on April 2, 1947, and was merged with it on July 5, 1956. During the years pertinent to the inquiry, Connor was engaged in the business of renting and leasing automobiles and trucks, without drivers, in the State of New Jersey.*fn4
The taxpayer had in operation during this period a preventive maintenance program which called for periodic inspections and servicing. However, the operative condition of the vehicles was a relatively minor factor influencing replacement of the fleet. More important in this regard was the percentage of its fleet being operated regularly; the activities of its competitors; mechanical changes; climatic conditions; strikes and work stoppages; the ability to obtain new cars; whether the country was at war or peace; economic conditions in its business area; and its financial situation. None of these factors were predictable in advance.
Under the influence of these factors the holding period of appellee's cars and trucks varied considerably. The average holding period for automobiles during the 1954-1956 period was 26.17 months, and during its entire nine-year existence, 29.36 months. The corresponding average holding periods for trucks were 38.89 months and 48.26 months.
The president of the Hertz Corporation testified concerning the car rental industry, its relative youth, highly competitive nature, and the factors that influence replacement of the vehicles. Hertz owns and operates a car rental business in approximately 170 cities and licenses operations in 650 additional cities.
Appellee also presented evidence by three certified public accountants to the effect that the term "useful life" has consistently meant and still means the economic life of the asset and not the life of the asset in the hands of the taxpayer.They further indicated that their experience with representatives of the Internal Revenue Service had been that depreciation was computed on the basis of the aggregate business life of the asset regardless of changes of ownership.
Initially, in preparing its returns for the years ended March 31, 1954, March 31, 1955, and March 31, 1956, appellee claimed depreciation on its automobiles on the basis of a four-year useful life at a 30% rate for the first two years and a 20% rate for the remaining two years. Its heavy duty trucks were depreciated on the basis of a five-year useful life, and its other trucks on the basis of a four-year useful life, both at uniform rates. The taxes so computed were paid. Subsequently, on September 14, 1956, appellee filed claims for refunds for the years 1954 and 1955, and on September 17, 1956, filed a claim for 1956. These claims for refund were based on an election in accordance with Section 1.167(c)-1(c) of the Treasury Regulations issued under the Internal Revenue Code of 1954 to utilize the declining balance method of depreciation. Inasmuch as the Commissioner failed to take any action upon the claims within a period of six months, this suit for refund was instituted.
The district court found that by 1954 the term "useful life" had come to mean the entire physical life (economic life) of the asset in question; that in enacting the Internal Revenue Code of 1954 Congress intended to change its meaning to useful life of the asset to the taxpayer; that Section 1.167(a)-1(b) of the Treasury Regulations so defining useful life was valid; that inasmuch as the Commissioner had acquiesced in the economic life construction of the term useful life, the appellee was entitled to rely thereon and the regulations could not be applied retroactively; and finally that salvage value is inherent in the declining balance method of depreciation and therefore there is no authority for application of a limit (representing reasonable salvage value) below which assets may not be depreciated. Accordingly, the district court entered judgment for Hertz for the total sum of $14,367.32.
The initial question posed for our consideration relates to the meaning to be ascribed to the term useful life which first appeared in the tax statutes in Section 167(c) of the 1954 Code, limiting the use of the declining balance method of depreciation to property with a useful life in excess of three years. The term was not defined therein.At a much earlier date, however, the term became embedded in the tax regulations relative to depreciation. Accordingly, it is essential for us to consider the history of the various depreciation provisions and the regulations implementing them.
The basic depreciation provision contained in the Revenue Act of 1913, 38 Stat. 114, 167,*fn5 has remained substantially unchanged throughout all later enactments. Later enactments added provisions regarding obsolescence and incorporated "property held for the production of income" within the purview of depreciable property. However, the theory of depreciation is the same today as it was in 1927 when the Supreme Court considered the problem in United States v. Ludey, 274 U.S. 295, 300-301, 47 S. Ct. 608, 610, 71 L. Ed. 1054:
"* * * The amount of the allowance for depreciation is the sum which should be set aside for the taxable year, in order that, at the end of the useful life of the plant in the business, the aggregate of the sums set aside will (with the salvage ...