Before BIGGS, Chief Judge, and McLAUGHLIN and KALODNER, Circuit Judges.
Is the cost of construction of a filtration plant for treatment of waste from a woolen mill made mandatory by a State anti-pollution law deductible as an ordinary and necessary business expense under Section 23(a) (1) (A) of the Internal Revenue Code of 1939, 26 U.S.C.A. § 23(a) (1) (A)?
That is the primary question presented by this appeal from the judgment of the District Court for the Middle District of Pennsylvania which answered it in the affirmative.*fn1
A collateral issue relates to the year or years, in which the deduction, if permissible, may be taken by a taxpayer on an accrual basis. The District Court held the cost of the filtration plant to be deductible in the year when the construction contract was awarded.
The relevant facts, as found by the District Court may be summarized as follows:
Woolrich Woolen Mills, a Pennsylvania corporation, ("taxpayer") has, since 1830, been engaged in the manufacture of woolen goods at Woolrich, Pennsylvania. The manufacturing process results in the discharge, directly into a public stream, of a large quantity of water containing dyes and short woolen fibers in suspension. At all times prior to 1950, taxpayer's woolen mill was operated without a purification plant for the treatment of this waste prior to its discharge into public waters.
In 1945, the Commonwealth of Pennsylvania enlarged the scope and tightened the enforcement machinery of its antipollution laws.*fn2
On September 28, 1945, taxpayer was directed by the Sanitary Water Board of the Department of Health of the Commonwealth of Pennsylvania to discontinue all discharge of water from its mill into public streams on or before June 1, 1946, or by that date to submit satisfactory plans for treatment of the water so as to eliminate the pollution elements therefrom. Thereafter, taxpayer consulted with various state officials and with engineers of the Sanitary Water Board for the purpose of complying with the Board's directions and subsequently made plans to install a waste disposal plant.
The Commonwealth approved certain plans of taxpayer and on August 16, 1950 it was issued an Industrial Wastes Permit. During 1950, taxpayer entered into a written contract for the construction of a filtration plant. The contract amount, $108,159.02, including a few additional items, was deducted by taxpayer as an ordinary and necessary business expense in computing its taxable net income for the calendar year 1950. The Commissioner of Internal Revenue disallowed the deduction and assessed a deficiency of income tax which taxpayer paid and then brought suit for refund in the District Court which rendered judgment in its favor.
Construction of the filtration plant was completed in 1952. Its design and operation was described fully by the District Court, 178 F.Supp. at page 877, and it is unnecessary to do so here. It is located approximately one-third of a mile from taxpayer's mill. It consists of one building, enclosing a large revolving wheel covered with wire mesh, and a series of open settling tanks. The system has not worked satisfactorily and since 1952 has been in operation less than one-fourth of the time. When not in operation, the waste from taxpayer's mill is discharged directly into public waters with the knowledge and consent of Commonwealth officials. Taxpayer has attempted in good faith to make the plant work and has spent money in addition to that here involved.
The District Court found that "the plant was erected by plaintiff [taxpayer] solely for the purpose of preventing the Commonwealth of Pennsylvania from enjoining * * * the discharge of [waste into public waters] which injunction would have completely halted operation of plaintiff's manufacturing process." 178 F.Supp. at page 877. The District Court further found that "the waste plant is a permanent addition to the plaintiff's mill property constructed in compliance with the order of the Sanitary Water Board of the Commonwealth of Pennsylvania, having' a life extending beyond the year in which construction thereon was completed." 178 F.Supp. at pages 877-878.
Taxpayer keeps its books and records on the accrual basis of accounting.
The District Court premised its determination "that the cost of the filtration plant is an ordinary and necessary business expense deductible in full from gross ...