MASSEY MOTORS v. UNITED STATES
Legal provision: Internal Revenue Code
Argument of Howard A. Heffron
Chief Justice Earl Warren: Number 143, Commissioner of Internal Revenue, Petitioner, versus Robley H. Evans and Juliet M. Evans.
Mr. Howard A. Heffron: Mr. Chief Justice, may it please the Court.
This case and the two following cases raise common problems of construction under the Internal Revenue Codes of 1939 and 1954.
The questions relate to the proper computation of the deduction allowed for depreciation in computation of the income tax.
This case, Evans, comes to this Court upon the Government's petition for certiorari to the Ninth Circuit.
The case which follows it, the Hertz case comes to this Court from the Third Circuit and the case which follows Hertz, the Massey Motor case from here from the Fifth Circuit.
Both the Third Circuit and the Fifth Circuit reached results contrary to that of the Ninth Circuit in the Evans case; that is in support of the Government's position.
The question which is common to all three cases is one which concerns the proper method of computation of the depreciation deduction permitted under the pertinent provisions of the Internal Revenue Code.
Now, since the depreciation is no more than in means of describing the proportionate proportion of the cost of an asset which ought to be allowed as a deduction in computing income for any given period.
We are here concerned with the proper method of allocating that cost to different taxable periods.
If the asset only lasted for the one year period which is covered by an income tax return, we would have no problem.
The cost of that asset would be deducted in full if it were consumed during that period.
The problem arises because of the nature of the tangible assets which are the subject of these three cases.
Automobiles, automobiles last more than the one year period covered by an income tax return.
On the other hand, they do not last forever.
At some period, they are discarded.
They are retired from service and the problem presented by these three cases is how to determine what proportion of the cost of an asset which lasts more than the period covered by the income tax return, what proportion of that cost shall be allocated to the income tax year covered by any particular return?
I say the problem arises because the asset itself lasts beyond the period covered by the return.
Justice John M. Harlan: Is the rule that you're advocating here is limited to automobiles or is it one of general application?
Mr. Howard A. Heffron: No.
It would be a rule of general application.
I cited automobile simply as an example of a tangible asset whose -- which lasts beyond the one year tax period normally covered by an income tax return.
It could apply to heavy machinery, could apply to any type of asset used in industry or business, which would last beyond the period covered by the return.
Now, if I can absolutely dispute at the outset in this fashion, I would say that the basic position for which the Government contends here is simply this that in determining the cost of the asset which ought to be allocated to the income tax period covered by the return, one ought to take into account as a relevant material in the persuasive factor, the total period of time the taxpayer expects to use the asset.
Having made that computation, one must take into account that portion of the assets' value which the taxpayer will get back when he disposes of the asset.
If he sells the asset, that portion which he receives upon sale proceeds represents a return of his original outlay in acquiring the asset.
To that extent, he has not incurred a cost in using the asset and therefore we must exclude the proceeds he receives as a factor in computing what his cost has actually been.
The taxpayer on the other hand as we understand it says, “No.
You must disregard the period that the tax that the -- that we will use the asset.
You must disregard the price we will receive for the asset when we dispose of it.
You must disregard that despite the most compelling evidence of it, despite the past history of our business operations” and that really is a crystallization of what dispute comes down to in these three cases.
Now, the question is of a major importance in the computation of income under the Internal Revenue Code because of dual aspects in which it affects taxpayers.
First, depreciation is a deduction from gross income so that the larger the depreciation deduction, the less the gross income.
On the other hand of course, the smaller the depreciation deduction, the greater the gross income.
Of course gross income or net income on the tax returns would be taxed at what we call the ordinary income tax rates.
Those which can go to a maximum of 52% in the case of corporations and of course a good deal higher than 75, 80 and past that in the case of individuals.
On the other hand, the question of depreciation is important in another aspect and that is when the time comes for the taxpayer to dispose of his asset, his car, his plant, his piece of equipment, his electric motor, whatever it may be, when that time comes, he has made a sale, let us say we must determine what is the gain or the loss which he has realized upon the sale.
Now, in order to do that, we must determine what the taxpayer's basis for the asset is.
Basis is another way for our purposes at least here of describing the cost to the taxpayer, if he paid a thousand dollars for it that is his basis or his cost.
On the other hand, when the time comes to sell it to the extent that he has taken depreciation deductions, to that extent he has already recovered tax-free his cost and so we must reduce the basis by the amount of depreciation and consequently the larger the amount of depreciation the larger the deduction from his cost and the lower the basis; on the other hand the smaller the depreciation deduction, the higher the basis.
Now, this is very material because in computing the gain or loss, we match the basis with the sales proceeds so that if the taxpayer has a low basis as he would if he took large depreciation deductions, he would show larger gain upon the sale.
Now, the significance of the larger gain upon the sale is simply this.
Under the provisions of the code, the gain upon the sale of these assets used in a trade or business which are subject to depreciation is taxable at capital gain rates which are a maximum of 25% so that it is to a taxpayer's advantage to increase the amount of depreciation because although by increasing depreciation he lowers basis and consequently increases profits upon a sale when he ultimately disposes of the asset, he is very, very happy to pay larger -- larger tax of 25% by -- by taking the advantage of greater depreciation deductions which are worth to him 52% in the case of most corporations and perhaps more in the case of various individuals.
Justice John M. Harlan: And the converse of that is what makes the Government unhappy that you would like to have this carry to ordinary income tax rate.
Mr. Howard A. Heffron: And well, I would what makes us unhappy is the distortion in the matching of income and costs which the taxpayer's theory produces --
Justice John M. Harlan: I'm talking about the end result as between the two positions.
Mr. Howard A. Heffron: No.
I would say that even if the -- there were no capital gain rate applicable upon the disposition of these assets, even if it with the same tax rate in each instance, there would still be a disproportion and a distortion in the report of the taxpayer's income and it would still be offensive to our notions of what the purpose of the depreciation deduction should serve.
Justice John M. Harlan: You wouldn't have such extreme economic differences as it does under the present?
Mr. Howard A. Heffron: Well, I say as a general proposition, it would not.
In a case of any particular taxpayer might be of great importance to him whether he took more for depreciation in the year one or whether he took less in the year one and had different consequence in the years two or three.
So that, I think we're dealing here with the fundamental concept which is not -- not determined by the difference in the tax rates.
I suggest that difference merely to indicate the motivation for taxpayer, in this instance taking a position which increases the amount of depreciation although at a cost of paying a greater capital gains tax when the time comes to dispose of the asset.
Chief Justice Earl Warren: So, it will make no difference to you so far as your position is concerned whether he reported as -- as ordinary income or as a capital gain?
Mr. Howard A. Heffron: I would - I would say that our position would not be different if upon a sale of the asset the taxpayer would have pay an ordinary income tax upon the gain on the sale.
Our position is not dependent upon the applicability of that difference in rate.
Our position follows, we believe, from our view with the fundamental nature of the depreciation deduction and the -- an attempt to prevent a distortion of income over the years which the taxpayer is using the asset.
Now, in the Evans' case, the case arises under the provisions of the Internal Revenue Code of 1939 and again, here, I can capsulate very simply, Evans bought cars cheaply because he was in the rental business and he could get a discount price from new car dealers.
On the other hand, when he finished using them in his rental business, he could sell them on an awfully good price in the wholesale market.
For example, in one of the years in issue, 1951, the difference is spread between what Evans paid for these cars when new and what he received for them when he sold them as used cars was only a $100 on the average.
But Mr. Evans contends that he is entitle to deduct for deprecation that is as evidencing the cost to him of using the car in his rental business $450, four and a half times what in our view is the actual cost to him.
Now the result for Mr. Evans is a very, very pleasant result.
For example in 19 --
Chief Justice Earl Warren: He bases that $450 on what?
Mr. Howard A. Heffron: He bases that $450 depreciation on the theory that he may disregard the time he actually uses the car in his rental business.
He may disregard the proceeds which he receives when he disposes of that car and computed depreciation on some other basis, a basis which I can only describe as one which envisions a hypothetical taxpayer in business who on the hypothetical conditions uses this hypothetical car for approximately on the average four years and who when he disposes of it at the end of that four-year period realizes nothing, he junks the car.
Now, taking that view, four years will allow him to deduct 25% of the cost of his asset each year.
Well, 25% of the average car let's say which cost $1600 is $400 in one year but Mr. Evans uses these cars on the average longer than one year.
On the other hand, when he sells them on the open market, he gets back only $100 less than he paid for them.
Now, it's the Government's position that you can't disregard these salient economic facts affecting Mr. Evans' business.
If he uses the car for only 15 months which is what the tax court found as to sum of these cars, it may not assume he will use it for four years.
There is no basis for it.
On the other hand, if when he sells the cars, he recoups almost all of his cost about $100, it distorts his income to permit him to reflect on his tax return that the use of the assets for the period covered by the return is actually cost him $450 rather than the $100.
Justice Felix Frankfurter: What's the four-year basis for depreciation derived from?
Mr. Howard A. Heffron: The four-year basis is derived from a publication of the Internal Revenue Service which is called probable useful lives and which defines the -- based upon the usual experience of property owners what the usual experience will reflect in terms of the years which an asset will be held and used by a taxpayer and it is precisely that.
It is a starting point, based upon usual experience which is to be modified by the pertinent economic facts affecting the particular taxpayer's situation.
Justice Felix Frankfurter: (Inaudible) his average is derived from the life use of car and mine?
Is that it?
Mr. Howard A. Heffron: No, I would say --
Justice Felix Frankfurter: -- or dealing cars with?
Mr. Howard A. Heffron: From -- from general business use, general businesses.
Justice Felix Frankfurter: Business?
Mr. Howard A. Heffron: Yes.
Well, as generally all businesses but even as to that for example --
Justice Felix Frankfurter: Do you mean, passed on by -- by the paper company, that's what you mean?
Justice Potter Stewart: And operated for example by salesman, traveling salesman?
Mr. Howard A. Heffron: Yes.
Car is operated generally in business.
Justice Felix Frankfurter: In other words, what you say an abstraction or a model; this is a tax model, is it?
Mr. Howard A. Heffron: Yes.
Justice Felix Frankfurter: What the economists call model.
This is a model to be applied to an individual although he, himself, the fact of his case do not fit the model, is that it?
Mr. Howard A. Heffron: Well, it is not to be applied in that instance.
Justice Felix Frankfurter: Isn't that the argument that you are combating, is it?
Mr. Howard A. Heffron: Yes.
I would say that the taxpayer's argument here is that they are entitled to use this model and disregard the pertinent economic facts surrounding (Inaudible) of the asset.
Justice Hugo L. Black: Do they claim that some regulation authorizes that?
Mr. Howard A. Heffron: Well, I was coming to that.
There is a -- there is a contention here that the practice authorizes that and I will come to that next in my argument.
Justice Felix Frankfurter: Say it right away, say it right away, do you contend there is no such practice or that if there is, it's to be disregarded which, don't argue that, I just want to know it.
Mr. Howard A. Heffron: We contend there is no such practice.
Justice Felix Frankfurter: All right.
Justice Charles E. Whittaker: As I understand Mr. Heffron that the issue between the issue is whether or not the taxpayer is entitled to depreciate the property over its useful right as an asset or over its like -- useful life by the particular taxpayer.
Is that enough if --
Mr. Howard A. Heffron: Well, I can only characterize the taxpayer's position as this that he urges he may depreciate the asset over its average general life for business purposes and that --
Justice Charles E. Whittaker: In all business?
Mr. Howard A. Heffron: In all businesses and that he may disregard the fact that in his business, it is the practice to dispose the cars in 15 months rather than four years.
He may disregard the fact that because he buys at a discount and sells in a different market that in fact he gets very, very substantially, the most part of his cost back when he disposes of the asset.
The taxpayer says we can disregard that because the general experience in business for all business purposes is four years with no value at the end of that four-year period.
Now, it's our position that you cannot disregard the pertinent economic facts and what could be more pertinent since this is after all an analysis into what a given asset costs a taxpayer than to determine what it is you're getting back when you finish with your use of this asset.
That is a return of your cost.
That should not be part of the computation.
Taxpayer would disregard the fact that when he sells these cars, he gets back in the year 1951 all but a $100 of what he paid for them.
We say it only has a $100 to depreciate.
Justice John M. Harlan: Could I ask you one question?
Assuming the model as Mr. Justice Frankfurter referred to it, applied, is there any -- is there any dispute between you and the taxpayer as to whether the right model was used?
In other words, this four-year of useful life that's used by the taxpayer is the proper criteria?
Is there -- You contend that it should have been five years independently as the argument you're making?
Mr. Howard A. Heffron: No, no.
The model is --
Justice John M. Harlan: -- the model is all right.
Mr. Howard A. Heffron: The model is four years.
Justice John M. Harlan: If it's -- if it's applicable?
Justice Potter Stewart: It's four years for automobiles and five years for trucks, isn't it?
Mr. Howard A. Heffron: Yes.
The model -- the model is -- is proper but I must emphasize again, the model is only a starting point.
It's a jumping off the point.
It's just a place where you begin the inquiry.
You start with four years and you modify up or down, depending upon the particular facts and circumstances concerning the taxpayer's business.
Justice Hugo L. Black: May I ask you how it works out practically because I don't quite understand, they claim an arbitrary right to take off on four-year basis.
You say they don't have that.
So the dispute comes up as the dispute have to come up between each individual taxpayer and the Government at the time they make their return, are they required to show that they do not come within the model or so-called or does the examiner look into it after they file their returns?
How do they come to (Inaudible)?
Mr. Howard A. Heffron: The -- the purpose of this -- this Bulletin “F” which is a list of models contains literally thousand of items and lists like periods.
Justice Felix Frankfurter: What is it called?
Mr. Howard A. Heffron: Bulletin “F”.
Justice William O. Douglas: Bulletin “F”.
Mr. Howard A. Heffron: Yes.
It is table of useful lives of depreciable property and it contains literally thousands of items and gives model average years.
Now the purpose of that publication was to remove as much of this questions of useful life from the area of controversy as possible.
If a taxpayer use the life period which was set forth in that model and contended that he was within the general run of the mill type of business operation and that they were no unusual circumstances concerning his method of operation which warranted a different result why then the number of years set forth in the publication could govern and a controversy would be eliminated.
On the other hand, if it would come to the attention of the agent or the taxpayer that there were particular facts and circumstances concerning his operation which warranted a different result, at that point in the examination of the return, the taxpayer would show by such basis as he could why he thought a different period was warranted.
For example, suppose the taxpayer contended that because of the climate in which his cars were operating, four years was too long.
Perhaps he operated in a dessert and he contended that dessert conditions are such that my use of the car will be limited to three years but he would -- he could show that and those factors would be taken into account.
Perhaps, his repair policy was not as intensive as the average repair policy.
Perhaps he could show that he didn't have the usual outlay for repairs.
Well, in that event, the life of the asset might have to be revised downward.
Conversely, it might have to be revised upward in the event that there were factors and circumstances which showed that the taxpayer would use the asset for a longer period of time.
A problem may arise when a new asset is acquired or it may arise at any time when the taxpayer is depreciating assets he already owns.
Justice Hugo L. Black: Do you say that the duty is on him to make a report that he is different as (Inaudible) doesn't come within the category of the (Inaudible) --
Mr. Howard A. Heffron: Yes, if the taxpayer wants to change the useful life.
Justice Hugo L. Black: Suppose he doesn't want to change it?
He is satisfied with it.
Is -- is it his duty to make a report if he had reason to suspect that he is getting more than he should (Inaudible)
Mr. Howard A. Heffron: Well, he fills out his return and he takes the depreciation he thinks he is entitled to.
Justice Hugo L. Black: But he takes it -- suppose he takes it according to this form, doesn't he?
Mr. Howard A. Heffron: If he believes that the form is applicable in his instance, he takes it according to the form.
Justice Hugo L. Black: I am -- I'm thinking of the return I started few days ago [Laughter] on a car -- on a car that the -- they fixed the value for you that -- where you make a tax return and I assume that probably although that the Government and you don't change it, they have a standard value, you're claiming here that while you do give them tentative standard burden, they do not have a right to that advantage if in fact it gives them more than they should get under the general idea of depreciation.
Mr. Howard A. Heffron: I would say that would be correct if in fact it could be shown that the circumstances were such.
For example, as in these cases where in fact it has been shown in the record that the taxpayer does not keep a car for four years.
He does not get zero for it when he disposes of it.
He keeps it on the average and in some cases, 15 months and when he disposes off the car, he gets very substantial amounts for them coming very close to his cost.
As a matter of fact, in the third case to be argued in this group, the taxpayer actually sells the cars for more than what he paid for them.
Justice Felix Frankfurter: Mr. Heffron, if our -- we will understand the practicality a little better if you tell me when Bulletin “F” was first promulgated.
Mr. Howard A. Heffron: I believe the first edition of Bulletin “F” was 1931.
Justice Felix Frankfurter: Well, whenever that was, what was -- how are the -- how are these situations dealt before there was a Bulletin “F”?
Mr. Howard A. Heffron: Well, we say they were dealt with in -- in precisely the same way.
There is no contention.
Taxpayer is not contending that.
In 1931, there was a change in the practice.
Justice Felix Frankfurter: No, no.
I'm not -- I'm not thinking of the taxpayer, I'm thinking of my own understanding.
What I want to know is what part of the Treasury go about or what were the rules for the taxpayer before there was this generalization, these categories, these classes as Bulletin “F” provided?
Did each -- was each taxpayer pay on his own that he had to make the determination, what were the Treasury policy?
Mr. Howard A. Heffron: Well, I -- I believe that while there may not had been any official publication which listed the number of years but that has always been the basis for determining what the -- what the starting point should be whether they are economic or engineering studies or what have you -- I believe there is always been some formulation here, some model.
Now, if I can give a concrete example of the results of the taxpayer's theory, let us assume that a car cost $2000, on the taxpayer's theory, he is entitled to take in the course of two years, 50% of the value of that car because he assumes it lasts four years.
So he has taken a thousand dollars as a deduction for his cost of using the car.
Well, if the taxpayer at the end of that two-year period sells the car for $1500, the car has only costing 500.
He is taking $500 too much.
One the other hand, if he sells the car for $500, but use of the car for that two-year period has cost him $1500.
He is taking $500 too little.
Now, if the objective here is the recovery of cost, we say that this method is purely arbitrary and only fortuitously by accident results in the recovery of cost.
Under the Government's theory, if you could show as has been shown in these cases that the taxpayer customarily disposed of the car in two years and that in on the one hand, he customarily received $1500 when he dispose of it, he would only deduct 500 over the two-year period.
On the other hand, another taxpayer who customarily disposed of the car in two years received $500 upon disposal, he would be entitled to deduct $1500 over the two-year period.
In this way, we say that the matching of costs and income is met because after all, what we are seeking here is to match the cost of producing particular income.
The car, the tangible asset, whatever it was, was used in producing income, that income is shown on the return.
We're concerned with matching the cost to the taxpayer producing that income.
We say the Government's theory at least theoretically permits you to recover cost in that way and have a proper matching while the taxpayer's theory results in a distortion.
Justice William O. Douglas: I notice some page here, 118 of this record, the Court of Appeals relied seemingly to some considerable extent on the legislative history.
Do you develop that in your brief?
Mr. Howard A. Heffron: Yes.
We go in -- we go into the legislative history in detail and I expect --
Justice William O. Douglas: The -- the proposals make the Congress to change this and then reduced a lot of failure, Congress (Inaudible)
Mr. Howard A. Heffron: Yes.
Those were not proposals to change the depreciation rule.
Those were proposals to change the rule that upon the sale of these business assets, the gain should be treated as capital gain.
They were not proposals to change the basic method of computing the depreciation deduction.
Justice William O. Douglas: The what?
I -- I see some -- what reference is there to accelerated depreciation but those are at the capital gains level, are they?
Mr. Howard A. Heffron: No.
The accelerated depreciation refers to a method of computing the depreciation deductions which gave greater deductions in earlier periods and that is the issue in the Hertz case which I hope to cover in my next argument.
Chief Justice Earl Warren: Mr. Bernhard.
Argument of Edgar Bernhard
Mr. Edgar Bernhard: Mr. Chief Justice and may it please the Court.
From the time allotted I hope to explore three areas in very brief fashion of course.
The first the peculiar paradox in which the Government finds itself as a result of this attempt to change the long established definitions of useful life and salvage value, a paradox resulting from the fact of the Government's brief in this case and counsel's argument this afternoon are completely irreconcilable with something which counsel did not mention, 40 years of consistent administration of depreciation law.
Second, the repeated attempts made by the Government to get Congress to bring about the result which the Government is now asking this Court to bring about in a different method, in different way entirely by the redefinition of useful life and a salvage value, all which attempts were rejected by the Congress.
Third, the very great risks the Government is taking in connection with areas of the depreciation field which are not even before the Court and that suggests and which maybe radically affected if the Government succeeds in all returning these long accepted, recognized, approved principles of depreciation in this fashion.
Now, before beginning on the first of those, I do want to say preliminarily that the third case of these three old cases, the Massey case is not in our opinion a companion case.
We are not interested in the third case.
We do not represent the taxpayer in the third case and we consider it a case completely different from Evans and Hertz.
Evans and Hertz, however, stand on the same bottom although there is a difference which we'll develop when we get into the Hertz case, a technical difference.
I also would like to make sure that counsel has not inadvertently misled the Court in describing the length of time over which the taxpayer, both in Evans and in Hertz and all taxpayers for many long years back of this take depreciation.
The depreciation deduction is of course actually taken, the dollar depreciation deduction is of course actually taken only for the number of years we retained the assets, the depreciable assets, but at the rate -- the rate of depreciation at -- the rate at which we depreciate the assets is the total useful life.
Justice Felix Frankfurter: That phrase useful life, is that in a statute or Treasury Regulation?
Mr. Edgar Bernhard: It appeared for the first time, Mr. Justice Frankfurter, in a statute in the 1954 code without definition.
And we say of course that the Government can hardly deny it seems to us that when Congress took the phrase “useful life” it actually took it from the regulations.
And when it took the phrase useful life and used it in the 1954 code for the first time in any statute without defining it, it surely took it with whatever definitions and understandings had attached themselves to that phrase, long before over this 40-year period and that is what I'd like to describe, that definition of useful life and how it was built up.
But two --
Justice John M. Harlan: This case -- this case does not involve -- your case as I understand it does not involve the 1954 code, the Hertz' case does, is that right?
Mr. Edgar Bernhard: That's right -- that's right, sir.
However, the real point is that the Government is trying to carry back even to this Evans case which arises under the 1939 code, the same concepts, the same definitions of useful life and salvage value which -- which appeared for the first time which began so far as the Government was concerned with its 1956 regulations, it is really trying to carry back the concepts in the 1956 regulations and now first this paradox, which the Government presents to this Court.
The Government is now contending for adoption of -- its definition of useful life as the taxpayer's holding period and its definition of salvage value as the value of the asset whenever it is sold, that is the price obtained for it, not the value at the expiration of the full useful life.
And to hear counsel, it would seem that there really never was any other accepted idea about useful life.
And just to make sure that we understand each other about useful life and salvage value and their connection, may I say this that really the issue, the solid issue, the important issue between the Government and the taxpayer in this case and in the -- the Hertz case is whether the useful life of the taxpayer's automobiles is the whole physical life.
The inherent functional life for general business purposes as the taxpayer contends or the period during which the automobiles are held by the taxpayer in a given case by the given taxpayer as the Government contends.
And the reason I say, that's really the solid issue between us is that the salvage value issue which of course is very important grows out of the useful life issue.
If the -- and -- and the resolution of the useful life issue will automatically resolve what is salvage value because the parties agree in this case, if the Court please, that salvage value is the residue after useful life.
Now, if the useful life is the whole useful life, the whole physical life of the asset, then, salvage value is the residue junk salvage value left at the end of the full useful life.
If the useful life, if the proper definition of useful life is as the Government contends the holding period, then salvage value is the value at the end of that period, the end of “useful life” defined that way and it is of course greater in value then than the salvage value at the end of the full physical life, the taxpayer's definition.
Justice Felix Frankfurter: Can I -- can I accurately rephrase the contention between you two that your conception of useful life is potential life and there's enjoyed life.
Mr. Edgar Bernhard: I beg your pardon.
Is what life?
Justice Felix Frankfurter: Your useful life for you is potential life and for them is enjoyed life?
Mr. Edgar Bernhard: As the measure of useful life which -- from which we ascertain the rate of the depreciation, not the amount and not the length of time we actually take depreciation, yes Your Honor.
In our briefs, we asked the Government to give us a single case in the whole history of depreciation legislation and litigation prior to this court litigation now before this Court in which at every contended for it.
Now, we didn't say establish because it is clearly never done that, but a single case in which he have had contended for the definitions for which it now contends in this case and in the Hertz case.
Not a single such instance has been cited.
On the other hand, we have included in our briefs cases decided by the Board of Tax Appeals by the Tax Court, by District Courts, by the Court of Appeal just to -- one or two of which I want to go into here in a moment in which the Commissioner was not just silent about what is useful life and what is salvage value, but in which he contended for three-year and four-year and five-year and six-year lives for automobiles which he knew had been sold when he made that contention after two years or after one year or after seven months.
In all those cases, the Commissioner was contending that the rate of depreciation to be applied was the rate established on the basis of the full physical life of the asset, if it was four years for automobiles and there is no other testimony in either, Evans or Hertz that it is anything else, four years for automobiles and the rate of depreciation said the Government in those cases was 25%.
They said that I say, knowing that the automobiles had already been sold after a much shorter period.
Now, just to take a specific example; Charlie Hillard, 31 Tax Court 961 decided in 1959.
Hillard was in the rental car business.
He held his cars for -- from seven months to one year.
What was the Government's position?
The Government contended that the useful life of those automobiles was four years.
It referred to the automobiles as being used by the taxpayer “for one-fourth of their useful lives and then sold.”
The Government was there trying to show, since after the 1954 code and after the 1956 regulations, but the Government was they're trying to show that Hillard was a dealer and it fitted best with that argument to show that useful life was the whole useful life, four years.
In the early depreciation cases before the tax --
Chief Justice Earl Warren: what year was that -- what year was that Mr. --
Mr. Edgar Bernhard: That case was decided in 1959.
Chief Justice Earl Warren: 1959.
Mr. Edgar Bernhard: In the much earlier cases in 1926, 1927, 1929 before the Board of Tax Appeals, the Government was contending for a useful life for automobiles of four years or five years despite holding periods of two-and-a-half years and three years.
It was taking the same position, our position in this case and in the Hertz case, in 1942, before the Board of Tax Appeal in 1956 in the Third Circuit and even in 1959 in the Tax Court.
But one of the most interesting examples to illustrate how completely the Government has about to face is Pen versus Commissioner, 199 F.2d. 210, a case decided in 1952.
A rent tenant erected a building at her own expense.
She proceeded to take depreciation on it at a rate based on her holding period i.e. here life expectancy.
The Commission -- the Commissioner referred to that idea of taking depreciation over a useful life defined by the holding period as “a novel contention” and said there was no basis for computing annual deductions for depreciation on the basis of the period of use by that taxpayer “rather than on a basis of the useful life of the property itself.”
Justice Hugo L. Black: What was the property there?
Mr. Edgar Bernhard: The property was a building, Your Honor.
And then the Commissioner went on his brief in that case to point out what he called, “The basic fallacy in taxpayer's argument.”
Now, taxpayer's argument, I must remind the Court, is the very argument which the Government makes these briefs in this case and in the Hertz case and which counsel makes this afternoon.
“The basic fallacy in that argument” said the Government, “was in that taxpayer's assumption that the measure of the period of depreciation was something other than the life of property itself and that the taxpayer was disregarding” as indeed, the Government now disregards, was disregarding the fact that depreciation is a matter of wear and tear of property.
And finally, the Government's brief in that case actually said, “On taxpayer's theory, every owner of the depreciable interest in property would be entitled to deduct annual depreciation at a rate based on a number of years he expects to enjoyed in, expect to live, and enjoy the income from the property instead of the number of years the property may be expected to produce income.”
And in its brief in that case, the Government actually refers to the taxpayer's theory, the holding period theory the Court just heard about from the counsel as leading to “a result repugnant to the fundamental concepts of depreciation” and I must agree completely with the Government in that case.
Justice Hugo L. Black: Why does that -- why does that apply here?
Mr. Edgar Bernhard: Because Your Honor in that case, the holding period of that building was the taxpayer's life expectancy and the Government completely inconsistently with its attempts in this case, with its attempted redefinitions in this case, held that the holding period was not to be taken as the measure of useful life, but the potential value of the building was to be taken as the useful life.
Justice Hugo L. Black: The actual wear and tear of the building from year to year?
Mr. Edgar Bernhard: Yes, Your Honor, but -- but over the whole period of the physical life of that building, that would be, in other words, if that building was 50 years which is a standard period of useful life for a building and if that useful life for 50 years or that physical life of the building were 50 years, the taxpayer said the Government in that case, “must take depreciation at 2%.”
Justice Hugo L. Black: I still think as you have more (Inaudible) denial of that thought.
Mr. Edgar Bernhard: Not at all, Your Honor.
Justice Hugo L. Black: But I can't -- I -- I still can't understand why natural thing wouldn't do that you take a depreciation on the building according to effects of life without regard to the length of interest you have in the building?
Mr. Edgar Bernhard: That's correct, Your Honor.
Justice Hugo L. Black: Your (Inaudible) said.
Mr. Edgar Bernhard: That's correct, Your Honor and that was the contention of the Government in that case I'm saying.
I'm saying that now, today, and in its brief in Evans, and in its brief in Hertz, the Government is contending as if in that Pen case it had said of course you have to take the period during which the taxpayer holds the property not the period of the whole useful life.
I'm saying that if the position is entirely inconsistent and Your Honor is quite correct, I'm sure that the problem, length, the proper useful life definition is the whole physical life of the property.
Justice Hugo L. Black: I have evidently misunderstood from -- up to this time what the difference is between them.
I feel that you wanted an arbitrary amount covering a certain arbitrary period whether depreciated that much or not and the Government was insisting that that was wrong.
Mr. Edgar Bernhard: No, Your Honor.
May I --
Justice Hugo L. Black: I evidently do not fully understand you.
Mr. Edgar Bernhard: May I -- I perfectly have made myself clear and I -- I certainly would like to.
We -- I think what has misled Your Honor is the reference to four years for automobiles and it is true that it is prescribed in Bulletin “F” by the Government as the useful life of automobiles.
It is true also that the testimony in Evans and in Hertz, both was that the useful life, the full physical life of automobiles is four years.
If we hold the automobiles for one year or two years or three years, we actually deduct depreciation from cost only of course for the length of time we hold it, but at the rate -- at the rate established by the whole physical life of the asset, and if the whole physical life of the asset is four years, then we deduct depreciation during the period we continue to use the automobiles at 25% per year.
Justice Hugo L. Black: Well, may I ask you one question.
Let's suppose that you are importunate enough in our business to be able to get less wear and tear each year then somebody else, is it your insistence that even though your wear and tear is less each year, you still take the full amount that you would get if you were the normal man?
Mr. Edgar Bernhard: Your Honor, I have to ask whether you are presuming, Mr. Justice Black, whether you're presuming excessive use or holding.
Justice Hugo L. Black: I don't understand all those words about use, useful life and so forth.
Mr. Edgar Bernhard: Well, Take automobiles for instance.
I think I can make it very clear, I hope I can, take automobiles.
If I operate my automobiles 16 hours a day, instead of eight let's say, or 24 hours a day, in a taxi cab doesn't, three chauffeurs operating the automobiles, that excessive use is wear and tear and that excessive wear and tear will reduce useful life, the whole physical life of the asset, it's true.
And the four-year period assumes normal use, normal repair policy, maintenance policy such as -- it was testified to were followed in Evans and in Hertz.
And if Your Honor is saying, if in excess business, he operates machines or automobiles or any depreciable assets at excessive use and therefore the useful life is only two years let's say, it is true then that that is the rate that -- that would be established.
That would establish the rate at which you take depreciation.
If it were two years, the rate would be 50%.
Justice Hugo L. Black: What I understood was, I guess I'm still don't understand.
I understood he was claiming -- they were claiming that what you insist on is by reason of a four-year formula or whatever it is, that you're entitled to get a greater amount of depreciation per year than you actually suffer.
You're doing it on the basis of what somebody else doesn't.
Mr. Edgar Bernhard: No.
I do think that inadvertently counsel -- perhaps gave you Your Honor the idea that we take depreciation.
That is we actually deduct depreciation over a four-year period, even if we only hold the cars for two or three.
That we do not do.
We take depreciation, actually deduct depreciation --
Justice Hugo L. Black: But do you take -- do you take more under the formula you have than you actually suffer?
Mr. Edgar Bernhard: No, Your Honor, we do not.
Justice Hugo L. Black: (Inaudible)
Mr. Edgar Bernhard: We -- we do not.
We take --
Justice Hugo L. Black: You do not -- you do not attempt than just to follow the rule that they've said is the normal rule?
Mr. Edgar Bernhard: Yes, Your Honor, we do but in a different way because we do not get more depreciation that we're entitled to for more than is reflected by wear and tear because that --
Justice Hugo L. Black: (Inaudible) that you're entitled to and -- I keep asking you this because (Inaudible) --
Mr. Edgar Bernhard: Sorry.
Justice Hugo L. Black: -- you get more what you're entitled to would you not if you are actually charging on more depreciation than you suffer in a year.
Mr. Edgar Bernhard: That's right, Your Honor.
That is not contended for here.
Justice Hugo L. Black: You say you're not doing it?
Mr. Edgar Bernhard: That is not contended.
We operate our cars on the normal basis.
We operate our cars with normal repair and maintenance and that brings us within the normal rule, the four-year rule.
Justice Hugo L. Black: Then you -- then you are insisting that the rule has to be followed whether you actually suffer that depreciation or not.
Mr. Edgar Bernhard: Yes, Your Honor.
All -- we don't suffer four years of depreciation.
I don't want to be giving Your Honor that impression.
We don't suffer four years of depreciation, but if we hold the car for two years, we suffered two years of depreciation and that is the length of time during which we deduct depreciation at a 25% rate, at a 25% rate.
Justice Hugo L. Black: Whether you suffered or not?
Mr. Edgar Bernhard: Well, Your Honor, whether we suffer or not.
Justice Hugo L. Black: I mean, you actually suffered or not?
Mr. Edgar Bernhard: Yes, Your Honor, whether we suffered or not.
Justice William J. Brennan: Mr. Bernhard, I assume there must be a dollars and cents difference between your positions here.
I mean, perhaps you can help me understand what this is all about and I don't understand it for my self.
Can you take an illustration of the automobile which cost $2000 that you hold for year and dispose of for $1000 and tell me what the difference tax wise is between you and the Government?
Mr. Edgar Bernhard: Yes, Your Honor.
An automobile -- I think we're talking about straight line depreciation now.
A depreciable asset is purchased let's say for $1000.
It has a 10-year useful life.
It is -- therefore, the rate of depreciation to be taken is 10%.
Now, it is agreed that under straight line, salvage value shall first be deducted.
And let's say that salvage value is $50 at the end of the useful life would be $50.
That is to make its salvage value as first deducted and $950 is then the adjusted basis which is to be depreciated at the rate of 10% per year.
And if the owner continues to hold it according to the counsel for the Government, for only two years, he takes depreciation on the basis of two years.
On our basis that the way --
Justice William J. Brennan: Well, then, he takes depreciation on the basis of two years.
In your illustration how much does that mean to you?
Mr. Edgar Bernhard: On the basis of a two-year life.
Justice William J. Brennan: Two-year life?
Mr. Edgar Bernhard: We held it for five years let's say which is --
Justice William J. Brennan: I wish you'd use dollars and cents, frankly I just don't get it the way you're putting it.
Mr. Edgar Bernhard: All right, Your Honor.
On our contention, the $950 would mean deduction of depreciation at the rate of $95 per year and we would take $95 for the first year and $95 for the second year and as for many years as we continue to use the asset.
Justice William J. Brennan: And I suppose you dispose of it at the end of five years.
Mr. Edgar Bernhard: At the end of five years, we would no longer be deducting depreciation and -- and if it were sold at the end of five years for $500, the difference between the $500 and the amount to which we had depreciated the asset would be taken as a capital gain.
Justice William J. Brennan: Well this -- on your hypothesis, you would have depreciated the asset $95 a year --
Mr. Edgar Bernhard: That's right –
Justice William J. Brennan: -- times five?
Mr. Edgar Bernhard: Right.
Justice William J. Brennan: $475, there would be $25 gain, is that it?
Mr. Edgar Bernhard: That's right.
Justice William J. Brennan: You sold it $500.
Mr. Edgar Bernhard: And we would have depreciated that at $475.
Justice William J. Brennan: Yes.
Mr. Edgar Bernhard: The $475 would be deducted from $100 -- from $1000, I'm sorry, it will be deducted from $1000 and the adjusted basis would be the difference i.e. $525.
If we sold it for $600, we would take $75 as the capital gain.
Justice William J. Brennan: All right, now, that's on your approach to this problem?
Mr. Edgar Bernhard: Yes, Your Honor.
Justice William J. Brennan: Now, what on the Government's approach?
Mr. Edgar Bernhard: The Government's approach -- the Government's approach results in elimination of any possibility for capital gain if salvage value is properly estimated at all.
The Government says --
Justice Potter Stewart: Well, using -- using the same figures.
Mr. Edgar Bernhard: Yes, using the same figures.
The Government says, $1000 -- $1000 asset which you estimate, you are going to hold for five years means that you can take a 20% per year deduction and therefore, you can take 20% of $950 each year while you hold it.
The deduction of salvage value however, changes the $950 figure.
It is no longer $950 figure for the Government because the Government starts with $1000, says you estimate not only your holding period, but the salvage value i.e. the price you're going to get for the asset and if you estimate that you are going to get $500 for the asset --
Justice William J. Brennan: At the end of five years?
Mr. Edgar Bernhard: At the end of five years, you take the $500 from $1000 before you begin depreciation.
So, that although you are entitled to 20% depreciation per year, you take it on $500.
Justice William J. Brennan: Which wipes it out it at the end of five years?
Mr. Edgar Bernhard: Yes, Your Honor and therefore, when you sell, no capital gain because it balances of course.
The undepreciated balance or adjusted basis will always equal, the price you get.
Justice William J. Brennan: Now, let's (Inaudible) always of the application of the Government's formula?
Mr. Edgar Bernhard: I beg your pardon.
Justice William J. Brennan: Would this be the consequence always of the application of the Government's formula?
Mr. Edgar Bernhard: Except, Your Honor, in the case of -- a misestimate.
In the case of -- an estimate of a different amount of sale price obtainable there might be a difference and one of our contentions is in fact, Your Honor that --
Justice William J. Brennan: Let's just figure out.
Mr. Edgar Bernhard: That there is a -- a reward for one who underestimates your salvage value whereas a taxpayer who correctly estimates his salvage value is going to have no capital gain.
Now, the -- it's -- the Government puts its argument always whether it is arguing for holding period as it is in Evans and Hertz, or arguing for full useful life which is the four-year definition of useful life and always puts its arguments in terms of the fundamental concept of depreciation.
In Pen, it was insisting that the fundamental concepts of depreciation required retention of this long established definition of useful life as the full physical life of the property.
And now, in Evans, it refers again although it is now saying it isn't the full physical life which determines the rate of depreciation, it's only the period in which you hold it.
It is now again saying the -- this is in keeping with the fundamental concepts of depreciation, on one occasion of this spoke of the settled concept of depreciation, but this time it's the holding period that's for -- that's the settled concept.
As to the second area of discussion, the repeated efforts of the Treasury Department to convince the Congress that it should make the changes which would lead to the same result for which it's -- asking this Court.
At least one of us appealing to Congress, the Treasury was in the right form.
It made four attempts, futile attempts, to get the Congress to make changes which would result in the result that asking for here.
The first of those was in 1947 at eight for the House Ways and Means Committee.
The Government asked Congress to reduce the effect of the capital gain section by treating gains realized on the sale of partially depreciated assets as ordinary income.
And as the Ninth Circuit pointed out below, the Treasury Department in reports to the House Committee pointed out that there was a revenue loss resolving from the taking of capital gains on the sale of depreciable assets, but the Congress took no action.
The second attempt was in 1950.
The Treasury pointed out to Congress that gains on the sale of depreciable assets are treated as capital gains, but that if the taxpayer takes a lost, he can treat it as an ordinary lost against ordinary income and asked Congress to change that so that it would not be as they said a one way street but that the loss would be a capital loss only, the Congress refused to do so.
When the third attempt was made, it was made in the Courts in the Filbert case in 1956, Third Circuit case, and also at first in this Evans' case by attempting the elimination of -- of -- or at least drastic reduction of capital gains in connection with the sale of automobiles used in renting and leasing.
Not having succeeded with Congress, it tried the courts, but the Court in Filbert would not permit them to maintain as they tried to do in Evans' also that the taxpayer in a renting and leasing business was a dealer in automobiles and therefore could not take depreciation at all and the attack was abandoned by the Government in the Evans' case.
Chief Justice Earl Warren: Mr. Heffron, would you mind just before you start to answer what the counsel had to say about never before this particular case, was there any case that the counsel could -- that you could cite where the Government have maintained its present position?
Rebuttal of Howard A. Heffron
Mr. Howard A. Heffron: Well, I was just going to say to the Court the language which has consistently appeared in the regulations and which this Court adopted through Mr. Justice Brandeis in the Ludey case some time ago, that language speaking of depreciation is the amount of the allowance to a 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 --
Chief Justice Earl Warren: In the business?
Mr. Howard A. Heffron: In the business, plant in the business, the aggregate of the sum set aside will -- with the salvage value what is received when he disposes of it, suffice to provide an amount equal to the original cost and I'd like to make three observations with respect to that quotation which is one which has appeared in the regulations consistently which this Court placed as part of its opinion in the Ludey case and which while it appeared in the regulations, saw Congress re-enact 10 times the applicable provisions of the Internal Revenue Code.
Now, first --
Justice Felix Frankfurter: Will you tell us -- will you tell us whether as a matter of Treasury practice involving situations like Evans, what actually has been the dollar and cents application of what you just read?
Mr. Howard A. Heffron: The dollar and cents application --
Justice Felix Frankfurter: Has it been your way or Mr. Bernhard's way?
Mr. Howard A. Heffron: It has been our way but I would concede that the problem raised by the rental car business is a relatively new one because this is a relatively new business, but there are analogous situations where it is quite clear that the Treasury has applied the same principles and I was going to refer to them.
Justice Hugo L. Black: As a tax court ever decided it differently to this case?
Mr. Howard A. Heffron: No.
The cases which the counsels cites are cases which used the term useful life in the sense in which Mr. Justice Frankfurter used that, in the model, in the abstract sense and -- those were cases where the question was, is the taxpayer holding the cars to sell them or is he holding them for some other purpose?
And the Government said, “Well, he's holding them less than the useful life” meaning the abstract model, useful life sense, therefore, he's not holding them to use them out.
He's holding them to sell them.
That was the only point of using the term in that way and there has to be a way to describe this abstract concept, this model useful life, but it's always applied to the taxpayer and what we are talking about in these cases are not useful life in the abstract, but the taxpayers useful life because we're trying to give the taxpayer back his cost in terms of tax deductions and to define useful life in terms which have no pertinence or relevance to the taxpayer's own cost or his own mode of operation.
It gives no guarantee whatever that he will recover his cost through the depreciation deductions because after all, the regulation provides that the proper amount is the amount which should be aggregated.
Now, we say that aggregate amount must assume that we're talking about an aggregation which will occur over a period that a taxpayer is using the property because to aggregate it over some other period makes no sense as -- for example in the taxpayer's example of asset which has a 10-year abstract life, if you know the taxpayer will sell it in two years or in five years to aggregate 10% a year for two years or five years does not give the taxpayer back his cost.
We say in that situation, you must take a period of time to with the time the taxpayer reasonably expects to use the property whether a two, five, or 10 years then you have a period whose aggregate will realize cost, otherwise, you cannot realize cost.
Justice John M. Harlan: Could I go back to the question that Chief Justice put to you?
Have you got any litigated case either in the Tax Court or in District Court where the Government has taken the position, it's taking in these cases?
Mr. Howard A. Heffron: Other than this case and the cases here --
Justice John M. Harlan: Your answer to the Chief Justice in terms of your 1942 -- you schedule that for your 1942 regulation.
The question I thought he asked was you could point to any case or litigated case where the Government has taken this position other than these three cases?
Mr. Howard A. Heffron: Well, one case which comes to me off hand is the recent Collin case in the Sixth Circuit where the Sixth Circuit adopted a view that useful life shall be the period which the taxpayers actually holding the property rather than some other abstract model period.
Argument of William R. Frazier
Chief Justice Earl Warren: Number 141, Massey Motors, Incorporated, Petitioner, versus United States.
Mr. Frazier, you may proceed.
Mr. William R. Frazier: Thank you, Mr. Chief Justice Warren, may it please the Court.
I of course, have -- have the opportunity to hear the rather voluminous arguments of my predecessors in the two cases, namely Evans and Hertz.
And I'm very much interested in it naturally.
I will attempt not to be repetitious as much as I can.
Frankly, I think, the issues have been somewhat unduly clouded.
Firstly, I would like --
Justice William J. Brennan: That's in understatement.[Laughter]
Mr. William R. Frazier: First, Your Honors, I would like to make this comment.
Apparently for some reason there, my client, Massey Motors, has gotten too hot to handle, as far as these three cases can -- are concerned, but I would like to point out Your Honors that I -- my case was a first of these cases won by a taxpayer.
And my colleagues, Mr. Bernhard here, was very, very willing to cite my case both in the Hertz case, before the lower court and it was -- and it was commented on, with approval, by the Ninth Circuit in the (Inaudible) case.
I have other of these cases too, Your Honor, which they also cite in their brief.
Namely, of Lynch-Davidson cases which are now on appeal before us -- Fifth Circuit and Davidson versus Tomlinson.
To be in with Your Honors, it seems to me that this whole point involved here today, is as much a pure question of tax law as can be brought before a court.
You can't completely, as I understand it, divorce the facts from the lawsuit.
But in this situation, we come down to almost a pure question of law.
And I'll try to state it once again.
The question, as I understand it, is for the purposes of depreciation.
The term, “useful life” under the 1939 Code, met the physical or economic life to the asset as we, the taxpayer, contend or whether as the Government contends, it is the useful life as shown by the particular trade practices of a particular individual taxpayer.
Now, the question of salvage value, of course, is a reciprocal of the definition of useful life.
It follows like day from night or night from day.
Once you determine the proper legal definition of the term, useful life for purposes of depreciation under Section 23 (l) of the 1939 Code, the reciprocal factor, namely, salvage value, will follow.
And I mean by this, if the Court should agree with the Government that for this purpose, the term useful life means the useful life in the taxpayer's business is undisputed that in the Massey case, our actual use was one year.
That Your Honors is a trade practice in the automobile industry.
All that you know, from your own common knowledge, that automobile dealers keep their personnel in current model cars and if that the manufacturers change these models approximately once each 12 months, sometimes a little more frequently, sometimes less frequently, but approximately one year.
In this rental car business, it's clear that they do likewise.
They must, as a matter of competition, keep their units that they're offering for rental, new cars.
They gain operating advantages by way of expenses that way.
They also, as a matter trade practices, make higher recoveries on the resale of those units.
And it has become almost universal practice in both the rental car business as well as the new car sales operation to use these cars one year.
Now, if the Court should agree with the Government that that useful life is one year, then we lose because the salvage value would necessarily have to be the amount that we received on the sale of the units.
On the other hand, if the Court --
Justice William J. Brennan: May I ask, Mr. Frazier?
Mr. William R. Frazier: Yes, sir.
Justice William J. Brennan: Sometimes, am I correct that -- that salvage value maybe greater than the original cost?
Mr. William R. Frazier: Yes, Your Honor.
And -- and my situation and I will touch on that briefly.
Would Your Honor like me to comment on the point?
Justice William J. Brennan: No, as your -- your own --
Mr. William R. Frazier: On the other hand, if the Court, sees fit under the 1939 Code, to agree with us that useful life means as inherent or abstract or potential useful life, then it would seem to me, on this record that we are -- that the judgment of the Fifth Circuit should be reversed.
And that we would be entitled to use an estimated useful life for purposes of computing straight-line appreciation of three years.
We, of course, would also have a question of salvage value which would necessarily cause the case to be remanded for the taking of testimonial on that point.
And that arises this way, Your Honors, I think the history of this thing is of some materiality here.
My case is a fairly early one.
You will notice from the plaintiff's Exhibit 5, which is attached to the record.
The examining agent raise this point on us in April of 1953, rather than go through other administrative procedures and remedies, we elected to pay this tax, forthwith, file the claim for refund, controverting the adjustment of the agent.
And in due course, institute in our suit in the local District Court, seeking an adjudication of this matter by way of refund suit as opposed to litigation before the Tax Court, as was done in the Evans case.
The Hertz case went -- as ours did before the District Court in Delaware.
Now, if Your Honors would examine the first page or two, of the plaintiff's Exhibit 5, you will see that examining agent didn't raise any issue as to terms of estimated useful life or salvage value, because that wasn't the practice of the Treasury then, in these cases.
There affair was that inasmuch as we are admittedly an automobile dealer, namely, operating under a franchise from Chrysler Corporation, in the Jacksonville the Florida area and incidentally one of the largest Dodge and Plymouth dealers in the country.
Since we were in that business, that these company cars remained at all time, stock in trade that they never changed their character to that of a depreciable asset and hence, we were subject, as a matter of law, to know depreciation and hence, the depreciation claim was disallowed in toto.
And our capital gain claims under Section 117 (j), were reversed to that of ordinary income.
And that, Your Honors, was the practice.
I have a number of these cases.
One of them that I had was for a corporation known as Duval Motor Company, which is a Ford dealer in the Jacksonville area, which we elected to take the Tax Court.
In that case, they used a four-year estimated useful life, with no salvage value and the case went up on the issue as to whether or not, these cars were held primarily for sale or primarily for use in the business.
If they were held primarily for use in the business, they would qualify for capital gains treatment under Section 117 (j) upheld in service for six or more, under its expressed terms.
If they were inventory property or property held primarily for sale, then the school is out, so to speak for us, we didn't qualify for Section 117 (j).
And from the facts, the Tax Court concluded that the automobiles in question, were held primarily for sale and that was the end of the case.
Had the Tax Court held the units, held primarily for use in the business, we would have been entitled to our depreciation as claimed, because that was not an issue in the case.
The first of these cases that arose was the W. R. Stevens Buick Company case which I think was decided in approximately 1951.
There, a Buick Company, having these executive company cars, claimed depreciation on them in capital gains treatment, it was disallowed.
Namely, the capital gains element was disallowed, on the same theory, namely, stock in trade.
They went to the Tax Court.
The Tax Court agreed with the Commissioner's determination and they took an appeal, I think, to the Fourth Circuit, wherein a split decision -- the decision the Tax Court was affirmed.
Interestingly enough, for the next years, the same corporation elected to pay the tax and went up through their own local United States District Court, where a contrary finding was made and they received the capital gains treatment and the Government took no appeal.
The next of these cases was (Inaudible) Chevrolet Corporation, which is the same as our case and they -- accept it was Chevrolet dealership in Knoxville, Tennessee.
There, the Tax Court interestingly enough, following its prior decision in the -- in the Stevens Buick case, held that the cars were, in fact, held primarily for use of the business and the depreciation claimed a four-year straight-line with no salvage value, was automatically allowed.
Now, I point this out to Your Honors, to show and I think almost conclusively demonstrate that this is in the nature of an afterthought.
This argument is the -- with which we are being presented here today.
I'll tell Your Honors, frankly.
I do not think that it was proper for this argument to be made in our case, because it had never, as far as I knew, up to the point that the record was closed in the District Court that we had any such issue.
The -- the case was tried on the theory that it was a (Inaudible) case namely, one of these cars were held primarily for use in the business or whether they were inventory property.
If used for business, we got our depreciation because they had been no disallowance of our three useful life.
They didn't say we should use four or five.
They didn't say it was one year.
They simply disallowed the depreciation in toto on the theory that it was stock in trade.
Now, as far as rental business is concerned, Philber Equipment Company is a leading decision in this field, is on the same footing.
There, the question was simply whether the rental cars were held primarily for sales, sets business practice showed that they were sold after approximately one year of use.
And there, the Third Circuit reversed Judge Ron's decision from the Tax Court and held the taxpayer was primarily holding those units for rental and hence, was entitled to capital gains treatment.
Now, the same argument is being made here today.
It could have been made in the Philber Equipment case, but the fact to the matter is that the Philber case arose earlier than these present cases and hence, this afterthought had not been dreamed up at that point.
Now, Your Honors -- specifically now, with respect to the resale price of these automobiles.
First, I would like to point out that the taxable years involved in my case for the calendar years 1950 and 1951, bearing in mind also, that my client is an automobile dealer franchised by Chrysler.
Hence, the units in question are purchased at factory list prices and, of course, are carried in to our depreciation schedules at that cost, which may run as much as 20% to 25% less than the -- than the normal retail price for the cars.
In addition to that, if Your Honors recall, the Korean War was in progress at that time and is common knowledge that economic conditions caused the automobile business to improve greatly, because the supply of cars was diminished and the demand accelerated very similar to the years immediately following World War II.
Hence, we had a ready market for the cars and that, of course, is true in Evans too, they can't deny it.
Their cars were sold at slightly less than cost, but percentagewise, it's very small.
Our cars in the aggregate, for the two years in question, were sold for slightly in excess operational cost without regard to the depreciation.
And we say, Your Honors, several things in that connection.
One is -- as -- a point was made in the record in this case below that at the time the case was tried, that was not the situation.
That economic condition had changed in the point that they were not recovering that full cost at all.
I would also like to point out it, Your Honors, that as far as we know, price fluctuations are not to be considered for purposes of depreciation.
For example, we know of no authority, which -- which would prevent a taxpayer from depreciating a building, for example, which happened to have been bought during the depression which today is worth many times its original cost.
As we understand it, the depreciation that's properly chargeable it's -- if it's a 25-year useful life, continues, notwithstanding the fact that the market value of the particular asset maybe great in excess of its cost.
Depreciation, after all, is - is basically a -- an accounting concept, a bookkeeping entry, if you will, where original capital cost are recovered over the estimated useful life of the asset.
Now, we readily admit, Your Honors, that this creates a rather peculiar economic situation with respect to our case for the years 1950 and 1951.
But we don't think that the whole law or practice or administrative procedure, if you will, of the Treasury for 40 years which has been discussed previously, should be upset, just because I have a rather peculiar case here today, going out of the fact that my client is an automobile dealer and gets these cars at somewhat lesser cost and the fact that we were in the Korean sellers market insofar as automobile dealers were concerned.
Justice Felix Frankfurter: Have you established this 40 year practice, for which you just eluded that's more conclusively than it has enough to this point?
Mr. William R. Frazier: Your Honor, that [Laughs] -- Mr. Justice Frankfurter, that is rather elusive point.
I would say --
Justice Felix Frankfurter: (Voice Overlap) --
Mr. William R. Frazier: -- out or rather elusive matter.
Justice Felix Frankfurter: Elusive?
Mr. William R. Frazier: I would say in answer to your question.
Justice Felix Frankfurter: The most interesting adjective, I've heard.
Mr. William R. Frazier: Yes.[Laughter]
Justice Felix Frankfurter: Fixed on what is called a 40-year practice.
Mr. William R. Frazier: Well, Your Honor, I would answer the question this way.
I think that the opinion of the Ninth Circuit in the Evans case will state that to Your Honor and more expertly than I ever could, because that -- that was a unanimous decision and in that case, the Court enumerated from the facts and record before it, that practice and came to that conclusion.
And it did so, based on primarily on one thing and that's what I want to discuss, because I think in the prior argument, this has been greatly confused.
The -- as I understand the Ninth Circuit's opinion, which we are urging the Court to adopt as its own here in derogation of our own Fifth Circuit split decision in my case --
Justice John M. Harlan: If you'd ask that --
Mr. William R. Frazier: -- I think, in reading the Ninth Circuit case, that they were relied principally on the Treasury Regulations.
And I want to state this --
Justice Felix Frankfurter: As the -- the construction be put upon.
Mr. William R. Frazier: That is correct, Your Honor.
Now, I think there's been some confusion as to what regulations we're talking about.
To begin with, I would like to point out that my case is more nearly a kin to the Evans case than the Hertz case, because as Your Honors know, both the Evans and my case arose under the 1939 Code and the regulations issued there that the Hertz case arose under the 1954 Code and the 1954 Regulations issued in 1956.
Justice Hugo L. Black: I thought both of them in denied kinship with your case?
Mr. William R. Frazier: Oh, they -- they do, Your Honor.
I -- I [Laughter] -- much too hard to handle, but I think in the final analysis, Your Honors will see that we're on identical footing.
Justice Felix Frankfurter: (Voice Overlap) they may not have realized that they would thereby the stirring sympathy for you?
Mr. William R. Frazier: I see, well I'm sorry, now [Laughs]
Justice William J. Brennan: That's too hot to handle because of this --
Mr. William R. Frazier: Being an automobile --
Justice William J. Brennan: -- recovery?
Mr. William R. Frazier: Yes, sir.
Justice William J. Brennan: Or the part of the excess of recovery and (Voice Overlap) --
Mr. William R. Frazier: I think so, Your Honor.
Justice William J. Brennan: That's right.
And that's not an appealing case in other words.
Mr. William R. Frazier: That's right, Your Honor.
To that extent I'm on somewhat weaker grounds in the -- to all these.
But -- but basically, the legal point is identical in all these cases.
Now, Your Honors, with respect to these regulations as the Court in the Ninth Circuit opinion in the Evans case, that went into great detail to point out that the regulations -- number one, that Section 23 (l) is very broad.
It simply provides, by its terms, that in computing that income, there shall be allowed a reasonable allowance for job exhaustion, wear and tear, including a reasonable allowance for -- of obsolescence.
Now, Your Honors, that is very, very general.
It really doesn't tell you much.
Justice Hugo L. Black: That statute?
Mr. William R. Frazier: Or -- that is the statute under which we -- these -- these Evans and Hertz -- or rather Evans and my case, fall Section 23 (l) of the 1939 Code.
That doesn't even use the word depreciation as I read it.
Now, that, of course, statute is intended to permit the depreciation allowance obviously and is certainly is a classic example of a provision of the Internal Revenue Law, under which the Commissioner, under the inherent powers provide Section 3791 of the 1939 Code, was entitled to issue regulations.
That is regulations which would more make the statute workable and more specific and we think, Your Honors, that those regulations issued under this Section of the law have the full force and effect of law.
If there ever was a Treasury Regulation which should be given that interpretation, under the decision of this Court in Massey versus Commissioner and Helvering v. the R. J. Reynolds Tobacco Company, we think that the regulations issued under this section are of that character.
Now, the regulations as it pointed out by the Ninth Circuit which were issued in 1919 and they were Treasury Regulations 45, dealing with this subject, are the ones with --
Justice Hugo L. Black: Is that in your brief?
Is that in your brief?
Mr. William R. Frazier: I -- we have alluded to them, Your Honor.
And they're more specifically set forth in the Ninth Circuit opinion.
It was in that -- and those Treasury Regulations, Your Honor, remained in full force and effect until 1942.
Now, in Treasury Regulations 45, with respect to depreciation, may refer to the useful life of property in the business.
And Your Honors will recall that Mr. Heffron has cited those regulations as his administrative authority in support of his position.
And they do admittedly use the term, useful life in the business.
Justice Hugo L. Black: Why do you emphasize --
Mr. William R. Frazier: I emphasize --
Justice Hugo L. Black: I don't think it --
Mr. William R. Frazier: -- it for this reason, Your Honor, that in 1942, Treasury Regulations 111 were issued replacing or repealing, if you will, Treasury Regulations 45.
And those regulations which were in effect until the adoption of the 1954 Code Regulations dropped the phrase, “useful life in the business,” and instead defined it, as the “useful life of the asset”.
Now, that phrase is inherent in these regulations which were in full force and effect during the taxable years involved in both the Evans case and the Hertz case.
Justice Hugo L. Black: I don't like to bother you, but would you mind telling me what you construe that to mean in line with your argument?
Mr. William R. Frazier: I construe it, Your Honor, at -- as -- as was expressly stated by the judges of the Ninth Circuit, they construe that --
Justice Hugo L. Black: I like to view that in your own words.
Mr. William R. Frazier: I would do it this way.
Justice Hugo L. Black: I think we like (Voice Overlap) --
Mr. William R. Frazier: That those -- that the phrase, “useful life in the business,” refers to the inherent very economic and useful life of these assets.
Useful life in --
Justice Hugo L. Black: You mean the -- the length of time they can be economically (Voice Overlap) --
Mr. William R. Frazier: That is correct, Your Honor.
Now, the Ninth Circuit judges construe that to mean simply referring to the class of assets, namely, depreciable assets which is a reasonable construction to place on this matter.
But at least the regulations under which you could come to this rather tenuous conclusion were not in a -- force and effect, during the tax years involved in this case of the Evans case.
Now, I thought at that point, perhaps had not been strong enough brought to Your Honors attention.
Now, I think --
Justice William J. Brennan: Now, in that change in the regulations in 1942 is reasonably explainable isn't it, by a statutory amendment in that year allowing depreciation on certain on business product?
Mr. William R. Frazier: That, Your Honor, was the conclusion of Judge Tuttle in the opinion of this Circuit.
Justice William J. Brennan: Now --
Mr. William R. Frazier: He -- he -- it was necessary to -- to make some such remark as that because there was an actual change.
Justice William J. Brennan: In the statute?
Mr. William R. Frazier: That's right Your Honor and he refers to -- that is Judge Tuttle, refers to a -- a legislative history of the regulations.
We point out in our brief, we don't really understand what he is referring to because we don't know of any legislative history regulations and we -- we conclude --
Justice Potter Stewart: But if --
Mr. William R. Frazier: -- that part of the Commission -- excuse me.
Justice Potter Stewart: Excuse me, is -- I -- I am right, am I not, I -- I'm correct --
Mr. William R. Frazier: Yes, you are.
Justice Potter Stewart: -- I'm right when -- factually correct in thinking that in 1942, the statute itself was amended to --
Mr. William R. Frazier: Yes.
Justice Potter Stewart: -- for the first time deduction of certain non-business property?
Mr. William R. Frazier: Yes.
Property used in the production of income.
Justice Potter Stewart: In depreciation deduction?
Mr. William R. Frazier: Yes, sir.
That is correct.
And yes, they -- well, that property of the change, we don't know.
But it's our position that as a taxpayer, bear in mind that these regulations is supposed to be read and understood by a layman, businessmen, as well as lawyers and accountants and judges for that matter.
Justice Potter Stewart: And not quite --
Mr. William R. Frazier: They, we contend, that the Treasury either advertently or inadvertently, by amending those regulations in 1942, gave us the support for our construction of the term, “useful life”.
It would mean just like Congress writes a law which gave us that right.
Maybe they did it inadvertently.
But if it's there and clear, then we're entitled to it until it changed.
And that --
Justice Felix Frankfurter: But when he's determining whether they gave it -- gave by inadvertent, may not be just or unjust if those words maybe used for reference to tax matters though I believe, most inapplicable to any form of sanitation.
May not -- the consideration of the consequences be relevant in the construction of a regulation as much so as in the construction of the statute.
Mr. William R. Frazier: Yes, sir.
I think so.
Justice Felix Frankfurter: And if you emphasize the taxes may have by inadvertence, maybe it wasn't done at all.
Mr. William R. Frazier: Well, that is -- of course, is the point.
Justice Felix Frankfurter: I mean the words maybe susceptible of the old (Inaudible).
Mr. William R. Frazier: Yes, sir.
Justice Felix Frankfurter: But -- but you're not imprisoned in the words --
Mr. William R. Frazier: No, I -- I agree, Your Honor.
In fact that, of course, is the crux of the case.
Justice Felix Frankfurter: That's the crux, indeed.
Mr. William R. Frazier: As we say it.
And of course, we are -- urge the adoption of the Ninth Circuit's in view of this matter, as opposed to the view of the Fifth Circuit and the Sixth, which incidentally, the Sixth Circuit as I read it in the Hertz case, was largely influenced by the decision of our case in the massive situation.
I would like to suggest, Your Honors, that along this line as to Treasury Regulations and their validity and -- and effectiveness on this problem, what's having assumed that the Treasury have the right to issue these regulations and that they are valid, it would seem to me that they have the right in 1956 to amend them again.
And that's where I have difficulty in seeing how you can make the same argument for a case arising under the 1954 Code, on these identical facts, as you can under the 1939 Code.
It seemed to me, the Commissioner under the 1954 Regulations has with great particularity, specified that he is now construing the term, “useful life,” first -- the first time defining incidentally, as the useful life in a particular taxpayer trade of business, and the salvage value equals the amount that he is reasonably calculated to recover.
Justice Potter Stewart: Do you refer to 1954 Regulations (Voice Overlap) --
Mr. William R. Frazier: Yes, sir.
And course --
Justice Potter Stewart: And as to the 1954 Code, but promulgated 1956 --
Mr. William R. Frazier: Yes, sir.
Justice Potter Stewart: -- is that it?
Mr. William R. Frazier: And as Your Honor knows, the District Court in the Hertz case and I think properly so, construe those regulations as operating prospectively only since they were such a radical departure from law, if you assume they have the four full force and effect of law, which certainly they were.
That could have -- those regulations could have just as well, been written in the statute, by Congress, because of that's specific and complete.
And we think they -- they are, for all intents and purposes, equivalent from the statute itself.
And therefore, there might be a difference, a -- a logical difference in deciding the Evans and the Massey case one way and the cases arising on the 1954 Code, another.
I don't urge that, but I think it would be some logic and basis for it.
Just a few comments Your Honors, because I would like to reserve a few minutes for rebuttal, if I may?
Unknown Speaker: (Voice Overlap) --
Mr. William R. Frazier: This matter before Your Honors today, even though my case is a small tax wise involves not too much money, it's mostly a matter of principle, has very far reaching implications as a matter of policy, if you will.
The -- by adopting the Government's theory, the Court will be injecting the subjective test, if you will, for purposes of computing depreciation on ad hoc method, an every man for himself method.
Now, that's going to -- that's going to probably result in more loss of revenue than they're going to pick up out of this rental car companies and my company, and related companies.
Because the taxpayers will now be able to gain accelerated depreciation on a grand scale by taking assets which normally, under the old concept, carried a 10-year useful life and actually putting him into service for five years and charging them off in five years.
Of course, the statute of limitations would bar at least a portion of the years on reexamination as far as salvage values is concerned and the -- unless the Congress changes Section 1231, which is the present counterpart of Section 117 (j).
There will be long-term capital gain treatment realized.
Conversely, it can work against the taxpayer.
He may, just as well, take an asset that would carry a 10-year useful life and everyone agrees that it did.
But as a matter of trade practice or business judgment or necessity, he might sell that machine in five years.
Well, of course, he would report any gain or loss on that as the difference between his cost and the depreciation he'd taken on a 10% basis, if it were straight line.
The treasury, they say, “Oh, no.
You can't do that because the useful life of five years, and even though you can't get a tax benefit for some of this, you've got to reduce that cost as if it they'd been set up on a 20% basis and hence, your capital gain is much larger.”
So, it will -- it will add a great deal of confusion in bickering and we think, it is a matter which should be properly disposed off after due consideration by the Congress, rather than having the -- the Government seek to get a retroactive adjudication, which will hit taxpayers out of the blue, if you will, Your Honors, by -- by court decision.
And it is for these reasons that we honestly urge Your Honors to see, if it all possible, whether you can adopt as the -- as the disposition on this matter of the theory and rational, but what I think is excellently recent decision of the Ninth Circuit.
And I think, the equally well-reasoned decision of the lower court, that is the trial court, in the Hertz case, wherein he held that under the -- the judge held, that under the 1939 Code, we would be correct.
If our case had come before him, he would have held for us, for holding that.
The regulations on the -- that four Code being valid, could operated from their date of promulgation.
Chief Justice Earl Warren: Mr. Heffron.
Argument of Howard A. Heffron
Mr. Howard A. Heffron: First, there was testimony in both the Evans and Hertz cases, if I may advert to them for a moment, that in the past, the taxpayers had used cars in the rental business for five, six, and as much as seven years.
So the absence of any -- showing here of the disallowance of the claim for depreciation, I think, has no weight whatever, until we know what precisely, the facts were with respect to the practice to any -- in any particular year.
Of course, also, the Government is not contending for a rule which would provide that if, in fact, the taxpayer disposes of a particular asset at a certain time, that fixes its useful life.
This is a rule based upon experience as all depreciation is and the fact of a disposition at a particular time only if cumulated over a rather lengthy period of time would result in a sufficient showing of past experience to provide a basis for drawing the inference that as a reasonable expectation, this taxpayer will only hold a car for a given period of time.
Now, with all the -- old board of tax field cases, which had been referred to and which is cited in the briefs, it is true that there are some mention made that the taxpayer traded in cars from time to time in two years.
Although the Commissioner was contending for a useful life of a four years, but there was never a showing in those cases that this practice had reached such dimensions and had continued for such a period of time that the Commissioner would've been warranted in saying on the basis of your past experience, we cannot apply four years, we must make it less.
There's no showing in the records in those cases that those facts were ever placed in evidence.
And this whole concept of useful life, as we define it, is based upon a factual showing of past experience.
Justice Potter Stewart: Mr. Hefforn, your statement to us just now, that you're not contending for a rule which depends upon how long the taxpayer in fact, held this particular asset.
Mr. Howard A. Heffron: No.
Not for purposes of computing the --
Justice Potter Stewart: For purposes of computing (Voice Overlap) --
Mr. Howard A. Heffron: -- depreciation reduction.
Justice Potter Stewart: -- of the rate --
Mr. Howard A. Heffron: In depreciation.
Justice Potter Stewart: Right.
Is that statement to us, intended to answer the last part of Mr. Frazier's argument in which he anticipated for us various inequitable results, both with the taxpayer and for the Government?
Mr. Howard A. Heffron: Yes.
This is not a rule based on hindsight.
If the estimate was reasonable to begin with, based upon past experience, it is not changed because in fact, taxpayer disposes of it in a shorter period of time, that this is not changed with respect to prior years, as to which deductions have already been taken.
We don't upset the (Inaudible) years later, because the taxpayer in fact, disposed of his asset in a shorter period of time.
If the reasonable expectation he had, when he acquired the asset, is found that upon past experience and an adequate body of it.
Now, contrary to what my adversary has argued, useful life had never meant -- never meant inherent or abstract useful life or as he calls it, inherent economic life.
All the regulations, all the administrative materials, Bulletin “F” and it does in different places is key to the circumstances of the particular taxpayer's operation.
It says specifically, his repair policy must be taken into account.
It says specifically, the amount of use he gives it, must be taken into account.
The needs of his growing business must be taken into account.
Inadequacy to the needs of his business must be taken into account.
In short, the concept has never been an abstract one.
It has always been a very specific detailed inquiry into all of the circumstances, those which affect the physical rate of the decay and those which affect the economic determination of life.
All of those factors have been taken into account and there is no taxpayer who can state that under the regulations or the administrative materials, or the cases that he could draw the inference that a Government would disregard every part in an economic fact relating to his business in setting the term of useful life.
That is just not so and I could state that unequivocally to the Court.
Justice Felix Frankfurter: What would you do with the new dealer whose had no experience as to whom there has been no experience.
Mr. Howard A. Heffron: Well, in that instance probably, we might have to resort to the experience in the industry.
But it has never been the case that the abstract concept of useful life applied as I read from Bulletin “F” it is a starting point because you have to have a starting point in these cases.
And as the starting point based on experience that is true, but one which always has to be modified depending upon the circumstances of the particular case.
That's why we modify it for repair policy.
That's we modify it for climate.
That's why we modify it for operating conditions.
And we say that is why we modify it because of the conditions of the rental industry, to wit, customers demand new cars or late model cars.
That's an economic fact of life.
No rental car company can disregard.
They don't disregard it in fact, because they buy and sell cars on an average of two years.
Why should they be permitted to disregard it for purposes of depreciation when we are looking for cost?
Now, Massey Motors is a case which is a kin to the other two cases.
It simply presents, in exaggerated form, the consequences of this artificial, unreal concept to of useful life.
Here is the taxpayer who buys a car for $1800.
He sells it within the year for $1900.
And he says the cost of using the car to me is in this case, he took one-third.
It is one-third of $1800 therefore, I may deduct $600, as the cost of using the car to me.
And if he's under the 1954 Code and he uses the double declining balance, he doubles the one-third.
Justice Potter Stewart: (Voice Overlap) --
Mr. Howard A. Heffron: Yes.
He doubles it to two-thirds.
And he says two-thirds of this cost or $1200 is what it cost me to use this asset during this year in my business.
In fact, he's made a profit of one year and he's used it in his business free of charge.
Now, that's precisely what this case involves and it's the Government's position that all of the materials, all of the materials, when reasonably analyzed, lend themselves to no other conclusion and that all the economic facts of life must be taken into account.
Justice Hugo L. Black: May I ask you that -- well, if the contentions of the others are right, do you think this -- the contention of this one is right or wrong?
Mr. Howard A. Heffron: If the contentions in the other two issues?
Justice Hugo L. Black: Yes.
Except the argument as to the practice and so forth, for the other two, how should this case be decided?
Mr. Howard A. Heffron: Well, this case, the concept of useful life which would govern in the other two or to govern this case.
We say that the concept of useful life is the same for all these taxpayers.
Justice Potter Stewart: Well, there is another issue here, isn't there, whether this man is a dealer -- an automobile dealer and how does that fit into this?
Mr. Howard A. Heffron: Well, the petition -- the petition which was filed by the taxpayer, he raises the issue in principle of whether our concept of useful life or his, should govern.
The question of whether the evidence of prior practice and holding period is such as to warrant the conclusion that the three-year period he used was too long or too short, was not considered by the Fifth Circuit and was not alleged as a ground for certiorari in this Court.
This Court was brought here simply for the purpose of defining the concept of useful life.
When that is done, the irrelevant evidence can be in adduced below.
Justice Potter Stewart: There is no longer an issue in here as to whether not, this is properly used in the trade or business or anything like that.
Mr. Howard A. Heffron: No.
That is not before the Court here.
We have conceded it as depreciable property.
The question is the appropriate measure.
Now, not only to only administrative materials referred to the economic facts of life here, but the tax -- the testimony in the Hertz case and in the Evans case, developed the economic facts of life.
Why do you hold cars only for two years?
One of the Hertz officials was asked.
Well, he said, “Because after two years, it cost too much to repair them, compared to what we can get for them, if we sell them.”
Well, of course, that's the reason why they hold them that short of time.
Why disregard the economic fact of life when all the other economic facts of life must be taken into account, and how could any taxpayer rationally conclude that where all the regulations, where the administrative materials were Bulletin “F” said, time and time again, that you must take into account, all of the facts pertaining to your situation.
How could he arbitrarily, exclude the fact -- the salient economic fact of life in his business, that his customers demand new cars, so he can't use them longer than two years.
We say that is -- that's the critical economic fact in this business.
It is not in other businesses.
The critical economic fact in the case decided by this Court in Munitions was that the ammunitions industry was no longer needed, the war was over.
Well, the plant was perfectly good to manufacture.
In the abstract sense, it had many years of life.
The reason this Court granted a shorter period was because it took cognizance of the particular economic facts affecting the taxpayer's business.
Now, this is not a new concept which was developed for purposes of tax law.
This is a concept that has appeared in many accounting predecease over long periods of time.
And I can cite -- and any number of them to the Court.
Or the Accountants' Handbook, in the 1934 edition, talking about the causes of depreciation, lists as among them inadequacy.
In general assets become inadequate, when changes in operating conditions and demand for product rendered them unsuited for further service under the particular conditions prevailing.
Cessation of demand, “A piece of equipment may be entirely adequate for the purpose intended and of the very latest and most improved type, but if service life is gone when the demand for the product has disappeared, well, the demand for rental cars more than two years of age disappears.
It disappears because the public wants new cars.
That's an economic fact of life.
Now, there are many other references all -- all to the same affect in many of the other accounting predecease which I've called simply at random, because this is a concept which has been -- which was figure in depreciation for a long period of time.
For example, in a Dictionary for Accountants, published in 1952, before the new code and before the new regulations.
There's a -- there's a statement by the author, “Depreciation expense computations are thus based on the assumption that every fixed asset with the exception of land, has a limited life.
The cost of the asset less whatever can be anticipated in the way of scrap is a prepaid expense that must somehow be spread over its operating life in the hands of its present owner.”
Now, there is a statement which we submit and directly supports our position.
Now, there are other statements -- there are statements in the opinions of this Court.
For example, in the opinion in the Virginian Hotel case decided in 1943.
This Court stated, “The Congress has provided for deductions of annual amounts of depreciation, which along with salvage value will replace the original investment of the property at the time of its retirement.”
Well, how can you replace the original investment in the property, if you are not computing the time of retirement based upon the economic effects or facts which affect the taxpayer?
If you based them on some abstract notion of time of retirement, you cannot recover the original investment.
So that, we say that all of the materials have indicated consistently that every economic fact of life must be taken into account and if they haven't explicitly stated it with respect to the car rental business, it has been implicit and it follows as a logical deduction.
And we submit no other conclusion could reasonably be drawn.
There is no basis for ignoring the economic facts here, which operate to the detriment of the taxpayer and taking all others into account.
Chief Justice Earl Warren: We'll recess now.
Argument of Howard A. Heffron
Mr. Howard A. Heffron: The cases in this Court and other courts (Inaudible) applied the rule that all pertinent economic factors relating to the taxpayer's business must be taken into account in determining the useful life of his property for purposes of the depreciation deduction.
That same thing is elaborated by this Court in a case decided in 1940, Real Estate Company against the United States, where it has said, “For obsolescence under the Act, requires that the operative cause of the present or growing uselessness arise from external forces which make it desirable or imperative that the property be replaced.
What these operative causes maybe will be dependent on a wide variety of factual situations.
We say that here, we have an --
Justice William J. Brennan: Is the --
Mr. Howard A. Heffron: We --
Justice William J. Brennan: (Voice Overlap) --
Mr. Howard A. Heffron: I'm sorry.
That's not in our brief.
That's at 309 U.S. 13.
Justice Hugo L. Black: What case is that?
Mr. Howard A. Heffron: Real Estate Company against the United States and the Cartridge Company case, which I cited earlier, is at 284 U.S. 511.
Justice Charles E. Whittaker: (Inaudible)
Mr. Howard A. Heffron: That is right.
The concept of depreciation subsumes within it, not simply physical deterioration, but any other operative cause which results in lowering the period -- lessening the period of usefulness to the taxpayer.
In the Munitions case, it was the cessasion of demand because of the war.
In -- in other cases, it was the power plant's inadequacy to fulfill the needs the community.
In this case, it is the inability of a three year old car to be offered for rent because customers demand more recent cars.
In all of these situations and there are a host to them, I've only mentioned a few.
All of these external causes, unconnected with physical wear and tear, have been taken into account as they bear upon a particular facts and circumstances pertaining to the taxpayer's situation.
Now, this is also a concept which has been well recognized in the accounting predecease from the earliest days in Kester, on accounting, a 1925 edition.
In discussing the various factors in depreciation and scrap value Kester says, “There is a close relation between the operation of the chief factors and depreciation on the scrap value of the asset.
Thus, if it is estimated that physical depreciation will be complete in eight years, obsolescence in 10 years and inadequacy in 12 years, scrap value would be slight.”
Yes, because physical depreciation have already have run in its course.
If however, inadequacy is the controlling factor such as in this case, becoming operative in eight years with obsolescence in 10 years and physical depreciation in 12 years, clearly scrap value might be quite appreciable.
It would be quite appreciable, of course, because when the taxpayer disposes of it after of it's inadequate for his business, full physical depreciation hasn't run its course, so it's available for use by other businesses, my other taxpayers.
Justice William J. Brennan: (Inaudible)
Mr. Howard A. Heffron: That's right.
The -- the use of the asset has caused him nothing in his business.
Justice William J. Brennan: As a matter of fact, a capital gains with (Inaudible)
Mr. Howard A. Heffron: That's correct.
Now, under Massey's theory, by taking this -- this very great deduction for depreciation, he -- he assures himself for paying a much higher capital gains tax, but he exchanges for that -- of the -- the different rates, of course.
Every dollar and excess depreciation he takes is –-
Justice William J. Brennan: (Inaudible)
Mr. Howard A. Heffron: Well, it was actually Massey -- held them for one year.
Justice William J. Brennan: One year.
Mr. Howard A. Heffron: And he was taking a third each year.
Justice William J. Brennan: (Inaudible)
Mr. Howard A. Heffron: Yes.
Justice William J. Brennan: (Inaudible)
Mr. Howard A. Heffron: That's right.
And so that each dollar would save him 52 cents, he would pay 25 cents, capital gains tax or a net profit in hand of 27 cents.
Not by a reason of any difference in his business operations.
We really have a very extraordinary proposition here, because the rule of cost is the general rule, the taxpayer is supposed to recover his cost and no more.
And the rule that all the economic factors must be taken into an account is designed to assure that cost and no more than cost is to be recovered.
Justice William J. Brennan: Now, Mr. Heffron, they say, as you say a -- a dramatic illustration of the inequity that you say exists, but it's -- and perhaps in the automobile business, it's fairly unusual, but it's not unheard of elsewhere is it?
I've just -- for example, in -- in business real estate, real estate held for rent.
It's depreciable according of what it's made of and when it was built and so on, let's say 50 years, at a straight line depreciation that's 2% a year.
But it's -- it's quite usual, isn't it, in these kind -- these of days and this kind of economic picture for you -- for a -- for an owner to be able to depreciate that from cost 20% or 30 % and then actually sell it at a profit over cost?
That's not unheard of, is it?
Mr. Howard A. Heffron: Well, that -- that can happen because we're dealing here with estimates and probabilities based on past experience and there's a -- there's a good deal of room here for -- within the area of what a reasonable estimate is.
I think that's the reason for that, but the concept, for example with buildings, buildings maybe held to be subject to a lesser amount -- to a shorter life than otherwise, because it is anticipated that there will be changes in the neighborhood.
That would be one economic factor not related to physical wear and tear, which cuts down his life.
That's a common occurrence in the case of real estate, but in the few minutes I have remaining, I wanted to point out to the Court the extraordinary proposition we have here.
The concept that all economic forces must be taken into account, to reduce the useful life of the taxpayer, has been applied in a wide variety of cases and industries, in the power industry, as I've cited.
In the munitions industry, in real estate, in every other type of -- of business which is conducted, the taxpayer's proposition then, must come down to this, that despite the fact -- despite the fact that those rules have been consistently applied and all these other cases, we, in the auto rental business, are entitled to a different rule, because of the Commissioner's practice.
Now, this is an extraordinary proposition.
It is not a contention that the regulations are invalid, because they are unreasonable, because they are not inconformity with the statute.
Indeed, the 1954 Regulations are precisely in point here and specifically set forth the concept of useful life and salvage value, for which the Government contends.
So this is an extraordinary proposition, says these regulations are invalid.
It says all this history of application and under -- other industries, may not be applied to us.
It's an extraordinary contention and of course, it results in a very great discrimination among taxpayers.
All other taxpayers can only depreciate upon the basis of cost.
Taxpayers in the car rental business, if these taxpayers sustain, can depreciate on a basis other that cost.
They can convert ordinary income in the capital gains.
Irrespective of the cost, the taxpayer who sells a car for $100 more than he pays or it, can deduct $600 or $800 in depreciation.
No one else is entitled to that.
Now, in one of the taxpayer got what does he offer this Court to demonstrate that this sort of discrimination should be applied?
He doesn't have 65% of the auto leasing industry in support, because as our evidence brief shows, the Automobile Leasing Association, which represents 65% of the industry, has stated that they are fully in agreement with the Government's position and that that has always been the rule and the practice and that they support it.
So he doesn't have that.
He doesn't have any specific cases which deal with the precise issue presented in this case.
He has a good many cases in which taxpayers traded in from time to time, cars and he says, “Well, since they, in fact, traded in the cars, why didn't you cut down their useful life?”
The answer is very simple.
We don't cut down useful life simply because in fact, the car has been traded in or disposed of in a shorter period.
Depreciation is based upon experience.
We cut it down because past experience relating to this economic factor as it does, as past experience governs the application of all of it, economic factors is the test.
Now, it is true, we haven't by some IBM method, pulled all the returns of all the taxpayers in the car rental business who has ever taken depreciation.
On the other hand, the taxpayer hasn't shown any specific car rental cases dealing with the contention of useful life, which he asserts the -- the Government made in those cases.
And as a matter of fact, the peculiar mathematics of it may -- may illustrate a very good reason why the question may not have been raised.
If a taxpayer takes a four-year useful life and in fact, disposes of the car in two years, he's taken half the value.
Well, if in fact, he disposes of it in two years and when he sells it, receives half the value, no matter with -- which method of computation you use, the Government's or the taxpayer's, the result is the same.
Because in fact, under the taxpayer's method, he's taken 50% of the full price of the car, under the Government's method, he has taken all of the spread between the price of the car and the sales proceed which is precisely the same figure.
If the car is $2000 and he takes 50% on a four-year useful life, he's deducted $1000 in depreciation.
If under the Government's theory, the useful life of that car is two years, he's entitled to deduct to the difference between $2000 and $1000, what he receives upon sale over a two-year period.
He deducts the same $1000, so that in any given instance, simply because a taxpayer has used what appears to be a lengthier period, there is no reason to assert that in fact, the computation result that in giving him the benefit of this depreciation below cost, which he is asserting, he's entitled to hear.
Because of the peculiar relation of the mathematics, you can't tell from any specific case, whether four years resulted in more depreciation under the taxpayer's theory than it would have at two years or some other period been taken, under the Government's theory.
Justice Potter Stewart: Oh, what -- introduces the problem is this extraordinarily high salvage value is that it?The problem in this cases?
Mr. Howard A. Heffron: Well, what introduces the problem in this case is the -- is both of the extraordinarily high salvage value plus the fact that the taxpayer customarily does not retain the cars for more than the period which has been --
Justice Potter Stewart: Well, they relate to that.
Mr. Howard A. Heffron: -- set forth.
They're related --
Justice Potter Stewart: Yes.
Mr. Howard A. Heffron: -- they're really reciprocals.
The longer you hold the car, the less the salvage value, the shorter the period, presumably, the more the salvage value.
But -- so we have in essence, the taxpayer contending for this extraordinary proposition that he and the auto rental business is entitled to deduct below cost, irrespective of cost, irrespective of the command of the statute for a reasonable allowance, irrespective of the restrictions placed upon lessees, upon the owners of mining property, upon the holders of bridges with franchisers, upon power plants and all the other situations to which we've adverted.
And in support of that, he offers nothing but a few cases taken from the -- and a whole board of tax appealed reports, which do not deal with this issue at all.
The mere fact that in any given record, it appears that a taxpayer is disposed of a car in any given period of time, there's no reason to change the estimate of useful life.
We're looking -- we're basing it upon the past experience of the taxpayer and we need a bulk of that experience, so we can draw that inference.
Now, we tried to show to the Court how, if the ultimate objective of depreciation is to be the recovery of cost, which has been the objective which this Court has set forth is the one -- and which is the one the objectives set forth in the regulations, which has always been the goal in this field.
The taxpayer's theory cannot result in the recovery of cost, unless purely by accident, when the taxpayer disposes of his property in two years, it happens to be at 50% if the taxpayer was taking four year life at 25% each year.
But to the taxpayer disposes of it for a little more than 50% or the taxpayer disposes of it for a little less, there's no recovery of cost here.
There's either too much or too less and because the taxpayers theory would disregard, he disregards the facts, the past experience, he would disregard what he knows he can get for the car, he would disregard what he knows is the period he will hold the car.
He -- he blinds himself to these factors making the recovery of course -- of cost an absolutely hit on this proposition.
The reason he does that is quite clear, because to the extent he can ignore reality and take larger depreciation deductions below cost, to that extent, he can convert ordinary income into capital gains.
Now, the situation is exaggerated under the 1954 Code because of the accelerated methods of depreciation.
A taxpayer who takes a four-year useful life instead of 25%, will take 50% the first year, so that if the car cost him $2000 and he sells it, he takes $1000 deduction even though he may as in the Massey Motor case, sell it for $2200 or $2500, the wholly artificial concept which has no relation to the economic facts at all and the regulations under the 1954 Code are quite clear in this regard and they spell out in detail, the Government's theory.
The taxpayers have suggested no reason why those regulations --
Justice William J. Brennan: (Inaudible)
Mr. Howard A. Heffron: Well, it is our view that the 1954 Code regulations support our position.
Explicitly, the taxpayers would be arguing that because of the prior practice which we said they haven't shown at all, but because of the -- their new regulations must be disregarded even though they maybe perfectly valid under the statute.
Now, that's the extraordinary contention.
Justice Tom C. Clark: You have to regulate those (Inaudible)
Mr. Howard A. Heffron: By the past practice?
Justice Tom C. Clark: No, by its regulations.
Mr. Howard A. Heffron: I -- I beg your pardon?
I didn't --
Justice Tom C. Clark: Separate cases arose that on the regulation entirely on, will save for this year?
Mr. Howard A. Heffron: Yes.
Justice Tom C. Clark: They would not be able to follow this old practice would they or --
Mr. Howard A. Heffron: No, of course not.
Under the new regulation --
Justice Tom C. Clark: They admit that, they were doing that.
Mr. Howard A. Heffron: (Voice Overlap) --
Justice Tom C. Clark: They don't claim the -- it's been here?
Mr. Howard A. Heffron: They do not -- they cannot claim the regulation say other than what they do say, but as I understand what they do claim is because of this practice which they refer to.
They're entitled to disregard the explicit and in the new regulations case, it is explicit.
Justice William J. Brennan: Even though --
Mr. Howard A. Heffron: Command --
Justice William J. Brennan: -- this year, these tax years?
Mr. Howard A. Heffron: Well, that would be their argument in the -- in the Hertz case as to the --
Justice William J. Brennan: Yes.
Mr. Howard A. Heffron: 1954 Code years.
The Massey Motors case follows only the 1939 Code.
But in fact, under that 1954 Code years, the argument would have to be that despite the explicit command of the regulations, they maybe disregarded not because they conflict with the statute, not because they're unreasonable, but because of this prior practice to which the taxpayers have adverted.
Justice William J. Brennan: And this was -- is precisely Hertz argument under the 1954 Code.
Mr. Howard A. Heffron: I say that's where it comes down to.
Justice Potter Stewart: Well, does it also amount to this that the contention is that the regulations make such a change that if in any event, they cannot be applied retrospectively, because --
Mr. Howard A. Heffron: Well, that is a -- that is another argument they make that --
Justice Potter Stewart: The regulations were not issued until 1956.
Mr. Howard A. Heffron: Yes.
Justice Potter Stewart: -- as I understand.
And the -- even in the Hertz case, there's no tax for a year after 1956 isn't there?
Mr. Howard A. Heffron: No.
I don't think -- I think --
Justice Potter Stewart: So we don't have the question -- the issue posed by Mr. Justice Clark.
We don't have this year and that is before us, -- that is --
Mr. Howard A. Heffron: Well, except that --
Justice Potter Stewart: -- regulations even prospectively where asked.
Mr. Howard A. Heffron: Except that theory upon which is -- that the fact that the District judge in Hertz found that you could not apply the regulations retroactive.
It was the theory which assumed that the 1954 Code had changed the law so that even as to any years which arose under the 1954 Code, we say those regulations which were inconformity with the 1954 Code, even assuming it made a change would nevertheless be applicable.
There's no retroactivity of enforcing regulations under a new statute.
Even though --
Justice Potter Stewart: (Voice overlap) we don't actually have a case under the 1956 Regulations suit, none of these cases arose under -- it was a case to which the 1956 Regulations would be at.
Mr. Howard A. Heffron: And the 1956 Regulations are in terms, applicable to all tax years arising under the 1954 Code even though those --
Justice Potter Stewart: So, that would -- that would include a year or two then of --
Mr. Howard A. Heffron: It would include the --
Justice Potter Stewart: -- that was held before it's here in the Hertz case.
Mr. Howard A. Heffron: In the Hertz case.
Even though, in fact, those years occurred prior to the promulgation of the regulations in final form.
Justice Hugo L. Black: I understood the argument to be, I may -- I maybe wrong (Inaudible) that the practice which they're claiming justice had existed for so long.
It was so well settled.
It was the same as (Inaudible) and therefore, you could no more write the regulation that you have and you could have in Congress, written their practice into its statute expressly.
Is that -- was that their argument?
I thought that was their argument.
Mr. Howard A. Heffron: Well, I -- that may have been a portion of their argument (Voice Overlap) --
Justice Hugo L. Black: (Voice Overlap) --
Mr. Howard A. Heffron: -- as I understood --
Justice Hugo L. Black: To the R.J. Reynolds case in that connection.
Mr. Howard A. Heffron: Well --
Justice Hugo L. Black: You say that it -- in fact, has the effect law.
Mr. Howard A. Heffron: The -- the --
Justice Hugo L. Black: And that you couldn't change her by this new regulation.
Mr. Howard A. Heffron: What the retroactive point is this --
Justice Hugo L. Black: I -- I didn't think that to be wrong, it might've been.
Mr. Howard A. Heffron: Yes -- no, well on the retro, I misunderstood.
Justice Hugo L. Black: The Court then should have decided in their favor on the retroactive point, one wouldn't have to reach (Inaudible) --
Mr. Howard A. Heffron: Well, if I -- on the retroactive point, the District judge said in his findings that he found that the practice started out precisely as the Government contends it did and he referred to the Mr. Justice Brandeis in the Ludey case and he reached the same conclusion the Government does.
However, he found that by 1942, there had been a change and useful life began to mean what the taxpayers said it does.
Therefore, by 1954, it had that meaning however, he found the 1954 Code changed that rule, changed it in a way that we support the Government's position back to what it had been originally.
He said therefore, the new regulations cannot be retroactively applied.
Well, the answer to that is, think that under the decisions of this Court, where a statute, a new statute has been enacted regardless of the old practice, if the statute is new and not the same as the old statute, the old regulations are not carried along with it for purposes of the new statute and where there has been a new statute, a regulation which is promulgated a few years after the new statute maybe retroactively applied.
That is what we understand the retroactive contention to be.
But in terms of the basic contention here, it has been that the regulations have always been directed to the end of recovery of cost, the 1954 Regulations were explicit, but they simply embodied the practice which had grown up and applied in all these other instances.
Chief Justice Earl Warren: Mr. Frazier.
Argument of William R. Frazier
Mr. William R. Frazier: Thank you Mr. Chief Justice, I now would like to take just a few more moments of rebuttal, if Your Honors please.
First, I'd like to point out in our brief that we file, we have re produced the relevant portions of the Treasury Regulations, which we claimed governed this matter before the Court, issued under Section 23 (l) of the 1939 Code.
And I would like to suggest this for possible consideration of the Court.
The first place, the Government today, of course, is looking back some 10 years on what was done by my taxpayers and I would like, if Your Honor would (Inaudible) time, think (Inaudible) regulations and read them casually and then project yourself into the position of my client and his auditor, with respect to this matter before the Court.
He's got regulations --
Justice Potter Stewart: What page are you looking at, Mr. Frazier?
Mr. William R. Frazier: Page 38.
Justice Potter Stewart: Thank you.
Mr. William R. Frazier: Firstly, under Regulation (Inaudible) (l)-1, you would find this.
The proper allowance for such depreciation in that amount which should be set aside for the taxable year in accordance with the reason of the consistent plan, not necessarily a uniformed rate, whereby the aggregate of the amount so set aside, plus the salvage value, will at the end of the useful life of the depreciable property, equal to cost.
Now, that phrase, “the useful life for the property,” appears again in that portion of that regulation, Section 4, which is reproduced on the page 39, reading the capitals own brief to be replaced by depreciation allowance, is the cost for all the basis of the property in respect of which the allowance is made.
Then further in Section 5, the deduction for depreciation in respect to any of depreciable property for any taxable year shall be limited to such ratable amount is -- may reason it be necessary to recover during the remaining -- remaining useful life of the property, the unrecovered cost.
Take that if you will, together with both of them.
And I think it's at page 45, that bulletin, which specifically refers to automobiles and tells (Inaudible) that out of the general guide, as the published policy of the Treasury Department, acting through his bureau then, Bureau of Internal Revenue, that if you have passenger cars, five years, salesmen cost three years.
So my company elected to use the three year, except for what in that bulletin have.
Now, that was the situation in which they found themselves and we think they were entitled three.
Thank you Mr. Chief Justice, it's been a pleasure and I hope to return again further time.
Thank you, sir.
Hope to return again.