Amicus Curiae Brief — Weiss v. Weiner

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IN THE

Supreme Court of the United States

Ocroser Tex, 1928.

No. 482.

Haney H. Weiss, Cotiecror or Intrennat Revenve,

C. F. Rourzauy, Coucecror or InrernaL Revenrvce,

Petitioners,

Us.

J. Hanny Wiewer, Respondent.

i eee

BRIEF AS AMICI CURIAE.

wee ee

Heamanx A. Firscuen, Jr.,

1565 First National Bank Bldg.,

Chicago, TL.

FE. Barrett Prerrymay,

717 Munsey Building,

Washington, D. C.

Washington, D. C.,

February 20, 1929.

Pauses of Breos &. Avaua Wasurreron, D. 0.

aw

TABLE OF CONTENTS.

Page

oe Die oe ee eupeseee boeken eke 2

Question to be Discussed .............66..00 06. 2

Ne eed ees oe ke ie eat re Map 3

Argument :

The statute permits the allowance to the user of

SP EE Secancevavevernvepenssacsee¢e.s 3

Practical considerations require allowance to

CS io ket ae tebe bebnesive sneered 4

The rental arrangement contemplates allowance

SEE Sb c6o cc cua kedrekees ch thd PEL Hee DS 6

This Court has approved allowance to lessee... 8

The Government's theory stated ............. 9

Allowance is to replace property exhausted, not

to return capital investment ............... 10

Title to property does not control allowance... 13

Past Investment not necessary to allowance.... 14

Difficulties encountered by government........ 15

PPE TUTe TTT ILE LT TTT ET 16

TABLE OF CASES.

Atterbury vs. Commissioner, 1 B, T. A. 169... ... 15

Brevoort Hotel Co., Appeal of, 1 B. T. A. 132. .2, 9, 18

Grant vs. Rose, 24 F. NS oe oe or od aad 15

Lynch vs. Alworth-Stephens Co., 267 U. 8S. 264. .4, 8, 15

Lynch vs. Alworth-Stephens Co., 294 Fed. 194.... 9

Ostheimer’s Appeal, 1 B. T. A. 18 .............. 9

Schoellkopf vs. Commissioner, 4 B. T. A. 1032.... 16

Telephone and Railroad Depreciation Charges, 118

a rn cae ben es 4b.bb 00.000 en ee eee renee 13

U.S. ws. Ludey, 274 oy GRRE 8, 11,14

Von Baumbach vs. «fatter Land Co., 242 U.S. 503 11

IN THE

Supreme Court of the United States

Ocrosper Term, 1928

No. 482

Harry H. Weiss, Couttector or Internat Revexve,

C. F. Rovrzaux, Cotzector or Ixrennan Revenve,

Petitioners,

Us.

J. Hanny Wiener, Respondent

BRIEF AS AMICI CURIAE

This brief is filed by us as amici curiae, on behalf

of The Brevoort Hotel Company, a corporation, of

Chicago, Illinois, which corporation is plaintiff in a

suit against Mabel G. Reinecke, Collector of Internal

Revenue, now pending on appeal in the Cireuit Court

of Appeals for the Seventh Cireuit (No. 4112, Octo-

ber Term, 1928) and involving in large part the ques-

tion involved in the present case. The Brevoort

Hotel Company case was originally before the United

OO —_—_—__ .

2

States Board of Tax Appeals and is fully discussed in

its reports. See 1 B. T. A. 132.

The Facts.

The basic facts are: The taxpayer during the year

1915 and for some years prior and subsequent thereto,

was lessee of certain lots and a building built thereon

by its lessor, The useful life of the building was 40

years from the date of the lease and the term of the

lease Was WY years. The lease required the lessee to

keep on the premises, in good repair and condition, a

butkiing, deseribed generally in the lease, the building

standing upon the premises at the end of the lease to

become the property of the lessor. The rental in the

Brevoort Hotel Company case was $60,000 a year for

the years, The lessee used the building in the oper-

ation of its business,

There is in the Brevoort Hotel Company case an

wdditional faet which is materially different from the

present case, amd which,we contend, would entitle that

company to the allowance even if it) be denied your

present respondent lhat faet is that the Brevoort

lease Was executed long prior to 1913, and the lessee

Was in complete possession on March 1, 1913. We shall

not diseuss that feature in this brief, since if is not in

this uae

Question To Be Discussed.

The questron to which this brief is addressed is:

Was this lessee in the computation of ite taxable net

ineome for TUES, for imecome aml profits tax Purposes,

entithy) to deduct from its cross tneome a reasonable

_ ——————

3

allowance for the exhaustion, wear, tear and obsoles-

cence of the building referred tot

Statute Involved.

The Revenue Act of 191s (e. 1s, 40 Stat. 1057) pro-

vides :

"See. 254 (a) That in computing the net income

of a corporation subject to the tax imposed by

Section 230 there shall be allowed as deductions:

. . * * . * . .

(7) A reasonable allowance for the exhaus-

tion, Wear and tear of property used in the trade

or business, including a reasonable allowance for

obsolescence ;"’

ARGUMENT

The Statute Permits the Allowance to the User

of the Property.

Qur first argument appears plainly upon the face of

the statute. The sole qualification expressed in the

statute is that the property covered by the allowance

be used in the business. The statute says nothing

whatroever about the ownership of the property. In

the present case, the property was used in the business

of the lessee, although not actually owned by him. The

fiovernment reads into the statute the additional im-

plied requirement that the property must belong to

the taxpayer. It would insert the words ‘belonging

** in the

statute. We insist that the statute as written is suffi-

to the taxpaver’’ after the word ‘‘ property

cent and that there is neither reason ner excuse for

exending its terms.

- “

— ltl st —_s od ww

4

If the right to the deduction be conditioned upon the

ownership of the property as well as its use in the bus-

iness, it is clear that no allowance for the exhaustion

of leased property would ever be permitted, since the

owner is never the user of leased property. This is

a result so unjust, unnatural and strained that it

should be accepted only upon the plainest demands of

the statute. Moreover, it is directly in conflict with the

holding of this Court in Lynch vs. Alworth-Stephens

Co. 267 U.S. 264. If the qualification desired by the

Government lie in the alternative to the expressed re-

quirement that the property be ‘‘used in the busi-

ness,’’ the proposal does not assist the solution of the

presse nt proble mh, because we must still decide whether

the owner or the user is entitled to the deduction in

this particular case. If the Government urges that

the owner share with the user to the extent of his in

terest, then in this case the total allowance would go

te the user, since the owner has released the property

for its full life, with a provision for the return of its

equivalent, and thus has no interest in its exhaustion.

We wish to emphasize at the outset that the single

expressed requirement of the statute is the use of the

property in the business of the taxpayer. All other

requirements must be written into the statute.

Practical Considerations Require Allowance to

This Lessee.

The taxpayer lessee in the situation outlined above

is confronted with a practical problem in dollars and

cents, however much the legalists may theorize over

his rights and obligations, He bax a lease on a piece

of land for ninety-nine years. On that land he has a

—

5

new building, which his lessor has built but which will

last only forty years, less than half the term of the

lease. ‘The lessor during the life of the lease will

build no more buildings on this land, This lessee must

pay his lessor $60,000 a year for the entire ninety-

nine years of the lease. Presumably the land will not

sub-rent for any such figure; otherwise the lessor

would not have included the building in that rental

figure. Furthermore, the lease requires the lessee to

keep the building in good condition and repair and to

return to his lessor whatever building is on the prem-

ises at the end of the ninety-nine years. Here then is

an economic compulsion upon the lessee to replace the

worn-out building at the end of the forty years. The

lessee's problems are: How shall he finance the con-

struction of the new building? How shall he figure his

real net profits for the first forty years of his lease?

Qur contentions are that the Revenue Act permits

the allowance for exhaustion, etc., contained in the

section above quoted, to that taxpayer whose income

is affected by the exhaustion; that the lessee in this

case is compelled to build a new building on this land

at the end of forty years, which second building is to

belong not to the lessee but to the lessor, and thus it

is the lessee in this case who must meet the loss oceca-

sioned by the exhaustion of the first building; that the

lessee must meet this expenditure out of his income

and therefore he is entitled to the allowance.

Real profit is the excess of the return over and

above every expense and Joss incurred to derive the

return. One makes no profit if his return merely

equals the expenditure he makes, or is obligated to

make, to derive the return. His expenditure may be

a current outlay for services or material, or a single

a — NEEL LEE ARES ALOE EMME TAN LENE SEE SURGE

6

disbursement for so-called capital assets consumed or

worn out or destroyed in the process of deriving the

return, In any event he has no profit until the return

exceeds the sums disbursed to derive it. This is the

simple and practical way in which the lessee taxpayer

in this case must face his problem of profit and finance.

For forty years he has an annual xross return from

his business, conducted in the building on the leased

land; he has his recurring annual rental and his cur-

rent and continuing expenses; at the beginning of the

forty years he had the use of a new building and at

the end of the forty years he must outlay the cost of

a new building. That new building belongs not to him

but to his lessor. Clearly this lessee’s real profit for

the forty-year period is the gross return less the forty

years’ rent, the current expenses and the cost of the

new building. Unless he makes an allowance for the

exhaustion of the building he is simply deluding him-

self as to the amount of profit from his business. The

figure of ostensible profit is absolutely fictitious. He

cannot shut hix eves to the enormous expenditure

which must necessarily conelude the period. Provi-

sion should be made out of gross income to meet that

expenditure,

The Rental Arrangement Contemplates

Allowance to Lessee.

The obligation upon the lessee to build a new build.

ing was, as a business matter, ax binding upon him as

his obligation to pay rent and was directly related to

the rental arrangement. When a lessor computes his

rental requirements, he must consider two factors:

(1) a return on his money and (2) the maintenance of

7

his capital intact. Where, as in this case, the lessee

is required by the very nature of the transaction to

replace the building within the life of the lease, the

lessor has by that arrangement insured the mainten-

ance of his capital, and need make no further provi-

sion out of income for that purpose. Assume that the

value of the building was $800,000 and the life 40

years; the allowance for exhaustion would be, rough-

ly, $20,000 per year. A yearly return to the lessor of

6%. upon an $800,000 building would be $48,000. This

is true income and he should pay tax upon it as such.

If the lessee is to replace the building without cost to

the lessor, there is no reason why the lessor should put

aside $20,000 of this $48,000 to maintain his capital.

Assume that the gross income of the lessee from the

operation of the build is $100,000, Of this amount he

must pay $48,000 as rent. In addition, he should set

aside $20,000 to apply upon the $800,000) which he

must pay his lessor, in the form of a new building, at

the end of the term of the lease.

The absurd result of the Government's position is

that the lessor, who receives a rental of $48,000 a vear

and is under no necessity of establishing a reserve for

replacement, is allowed a deduction (if anyone is to be

allowed a deduction) of $20,000 and pays a tax upon

only $28,000; whereas the lessee may deduct only the

$48,000 paid as rent and must pay a tax upon the $)2,-

000 of his gross income remaining, although his profit

for the vear is clearly only $32,000, At the end of the

forty vears the lessee makes a payment of $800,000

to his lessor as part of the consideration for the use

of the property but he receives for income tax pur-

poses no deduction whatsoever from that sum. The

lessor, on the other hand, has during the forty vears

a RN EE RNS IE IE SEES Ie HE I TE TARE SO NRO

been relieved of tax upon $800,000 of what was purely

a 6% return for the use of his capital. These figures

given by way of illustration are, of course, wholly fic-

titious but this is the result urged upon the Court by

the Government.

Vur contention is that, in the foregoing case, the

lessor should be taxed upon his clear profit of $48,000

annually and the lessee upon his clear profit of $32,-

000. To do otherwise is to do violence to the meaning

of the words ‘‘net income subject to tax,’’ since it

would levy a tax upon the net income of the lessee

plus $20,000 no part of which is profit to him, and at

the same time relieve from tax $20,000 of the true in-

come of the lessor, We contend that where the lessee

is to replace the building, he should receive the allow-

ance for its exhaustion: where the lessor replaces the

building he should receive the allowance.

We contend that the burden of the destruction of

the building was fixed by the parties in their contract

and that the allowance should follow the burden. That

was what Congress contemplated when it selected the

phrase ‘‘used in the trade or business" to describe the

property covered by the allowance.

This Court Has Approved Allowance to Lessee.

This Court in Lynch vs, Alworth- Stephens Co.,

supra, has considered the principles involved in this

controversy. The allowance under discussion in that

case was ‘‘depletion,’’ but, as the Court said in U.S.

vs. Ludey, 274 U.S. 295, 303, “In easence the deduce.

tion for depletion does not differ from the deduction

for depreciation.’’ Our whole contention in this case

is succinctly stated in a sentence used by the Circuit

9

Court of Appeals in the Lynch vs. Alworth-Stephens

Co, case (294 Fed. 194), and quoted with agreement

by this Court in its opinion in the case (supra, p. 370).

That statement was, ‘‘The plain, clear and reasonable

meaning of the statute seems to be that the reasonable

allowance for depletion in case of a mine is to be

made to every one whose property right and interest

therein has been depleted by the extraction.’

The lessee in the present case has a very real inter-

est in the building and his interest therein is property

which was acquired under the contract and which is

being exhausted as the life of the building runs out.

Under the circumstances of this lease, the value of the

lessee’s interest is the whole value of the building,

since the lease runs longer than the building and its

terms compel, even if they do not specifically require,

the lessee to make whole the lessor in respect to such

exhaustion,

The Government's Theory Stated.

It is in the realm of legalistic controversy rather

than in the field of practical results that the Govern-

ment takes its stand to dispute any allowance to this

lessee on account of the admitted exhaustion of the

building admittedly used in his business. The statu-

tory allowance, says the Government, is to return to

the taxpayer tax-free his capital investment. In

Ostheimer’s Appeal, 1B. T. A. 18, quoted in The Bre-

reort Hotel Company case, supra, page 135, the Board

of Tax Appeals says that thix allowance ‘‘is based

upon the principle of allowing a taxpayer a return of

the capital invested in his business before subjecting

his earnings therefrom to tax.’’ The Government

—— ARIEL LIOTTA EASA AEST OME EET LOOT POT OA TI RIE 3

10

reasons that for thirty-nine years, eleven months and

twenty-nine days this taxpayer lessee has made no

capital investment in this building; therefore, for that

period he is to be permitted no allowance; since we

have not yet reached the last day of the fortieth year,

We are not concerned with what may happen to him

on that day, or on the last day of the ninety-ninth year

of his lease.

Allowance is to Replace Property Exhausted, Not to

Return Capital Investment.

We insist that the Government's theory will not

bear critical analysis. The unmodified return-of-capi-

tabinvestment explanation of this statutory allowance,

which is the sole basis for the Government's conten-

tion in this case, is incomplete, inaccurate and unten

able. In the first place, the statute makes no refer-

ence to either capital’ or “investment.”’ The peti-

tioners’ entire conception is an insertion of an ex.

traneous theory into the otherwise clear language of

the statute. In the next place, the Government's theory

seems to treat the allowance as a capital adjustment,

whereas the statute is not so constructed. The statute

does not exclude these amounts from income, as if they

were capital, It deducts them from £TOSS income to

Ket wef income. There is no justification for an unre-

stricted return of capital out of income, There ix rea.

son and justifiertion, and even necessity, for a return

out of income of property which has been consumed or

lost or worn out in the process of deriving the income,

Such losses are opernting expenses, A building used

up in forty years is no different from a ton of coal

ised up ina week or a kilowatt of electricity consumed

11

ina minute, In the manufacture of automobiles, fac-

tory buildings are worn out; the value thus consumed

is part of the cost of the manufacture of the automo-

biles, just as is the value of the steel, the coal, the elec-

tricity and managerial skill which is consumed. In the

hotel business, which was the business of the Brevoort

Hotel Company, the value of the building is translated

into service sold the guests, just as are the values of

the stationery, soap, and servants’ hire. If capital be

consumed or lost or worn out in the winning of the

profit, there is exeuse and justification for an allow-

ance for its return out of income; if the capital be not

so consumed or lost or worn out there is neither ex-

cuse nor justification for the allowance. The sum total

of the outgo must be reckoned before a figure of profit

(wef cmcome) emerges from the gross returns. On

that basis the allowance can be justified but on no

other.

(ir suggestions in this respect are supported by the

views expressed by this Court inl’, S, Vs, Ludey, 274

UL S. 295, 200, and in Von Baumbach vs. Sargent Land

Co, 242 U8. 503. In the Ludey case the Court said.

“The depreciation charge permitted as a de-

duction from the gross income in determining the

taxable income of a business for any year repre-

sents the reduction, during a vear, of the capital

assets through wear and tear of the plant used.

The amount of the allowance for depreciation is

the sum which should be set aside for the taxable

vear, in order that, at the end of the useful life of

the plant in the business the aggregate of the

sums set aside will (with the salvage value) suffice

to provide an amount equal to the original cost.

The theory underlying this allowance for depre-.

ciation is that by using up the plant, a gradual

—_—_ BNOWALSAZE IELTS PEP PTA TLRS ET PII ENE RR TU RE te

12

sale is made of it. The depreciation charged is

the measure of the cost of the part which is sold,”’

In the Von Baumbach case (p. 524) the Court re-

ferred to depreciation as ‘‘the annual losses for wear

and tear and obsolescence of structures, machinery,

any personalty in use in the business.’

If the allowance be solely for the purpose of re-

turning capital investments, numerous complications

immediately appear. 1, Under that theory land, stock

and bonds would seem to be depreciable. 2. Under

that theory no justification appears for spreading the

allowance evenly over a term of years, as is the cus-

tom. It would seem proper to return all the invest-

ment before amy income appears. 3. The proper de-

duction would be a constitutional question, since Con-

Kress must of necessity exclude all capital from this

tax. 4. No depreciation could be taken in the compu-

tation of a net loss for a year, since no capital can be

returned out of a deficit. 5. No depreciation would be

allowable upon property acquired by gift or devise

since such property represents no investment. 6. The

198 corporation Tax Act (c. 6, Sec. 38, 36 Stat. 11)

and the 1913 Income Tax Act (c. 16, 38 Stat. 114)

would both be erroneous in their treatment of the de-

duction, since they include it in ‘losses actually sus.

tained during the vear."’ (See Section Third (fifth)

of the 1909 Act and Section G (6) (second) of the

1913 Act).

None of these difficulties appear if the purpose of

the allowance be considered to be the return of the

value of assets consumed or destroved in the deriva-

tien of income allowed to those interested in the prop-

13

erty to the extent of their several economic losses

through such consumption or destruction.

Perhaps the most complete discussion of deprecia-

tion is to be found in the report of the Interstate Com-

merece Commission on the subject (118 I. C. C. 295)

which study was made pursuant to an act of Congress.

The position we suggest as to the real nature of the

depreciation allowance is supported in that report.

Title to Property Does Not Contro] Allowance.

Following out its general theory of the nature of

the allowance, the Government necessarily insists

upon the presence in the taxpayer of the legal title to

the property. The Board of Tax Appeals in the Bre-

roort Hotel Company case, supra, conceded the per-

tinenee of our suggestions as made above, but insisted

that the pivotal question was ‘‘whose assets are con-

sumed ?’’ and answered the question by holding that

they must be the taxpayer's assets. This is a subtle

suggestion, but fallacious. It underlies the whole

opaion of the Board of Tax Appeals in the Brevoort

Motel Company case, supra, The major premise from

which the Board and the Government reason is that

the exhaustion, ete., of all property falls upon the own-

er. The fallacy is the fallacy inherent in syllogistic

reasoning; the major premise is so broad as to assume

the quod erat demonstrandum. The exhaustion of all

property does not fall upon the owner; sometimes it

falls npon some one else. In the Brevoort Hotel Com-

pany ease, supra, the Board of Tax Appeals says: ‘If

in his business A consumes the coal of B, he has no

deductible fuel cost; and if he exhausts B's building

** But plainly

if A makes an agreement with B to replace or to pay

it adds nothing to his cost of operation.

DRE ATF SO PE IIE RUINS IRR A NR RA AR

14

for at the end of a term, all of B's coal consumed by A

during the period, A has a deductible fuel cost as he

burns the coal (assuming that he is upon an accrual

basis as all these taxpayers are). Similarly with re-

spect to B's building, which is this present case.

Past Investment Not Necessary to Allowance.

The Government greatly overemphasizes the **in-

vestmment’’ feature of its theory. That, in our view,

is a non-essential. An obligation to pay is as effective

a reduction of profit as is an actual disbursement, so

long as the obligation arises in the derivation of the

income. As this building was consumed by use the

lessee concurrently incurred an obligation equal to the

consumed portion of the building. His balance be-

tween receipts and obligations was precisely the same

as it would have been if he had owned the building and

instead of incurred obligations had on his books a re-

serve for capital consumed,

The Government insists upon a past capital invest-

ment as a predicate to the allowance. Similar sophis-

try would prohibit to a stock trader selling ‘*short,’’

the tax-free return of his costs. We contend that the

tune of the investment or expenditure is totally imma

terial, so long as it is a necessary outlay to the win-

ning of the profit. The computation of profit is not

necessarily chronological; cause and result are the

criteria of its factors.

Perbaps the ‘‘short’’ stock sale is the most vivid

simile to the present situation. If, as this Court said

inf’. S. ve. Ladey, supra, the theory underlying depre

ciation is that ‘‘a gradual sale’’ is being made of the

property, then in the present case a gradual *‘ short"

15

sale is being made. As we have suggested above, there

is no difference, for income tax purposes, between a

“short’’ sale and an ordinary one. In either case the

profit is the difference between receipts and costs.

Whether the taxpayer buys first or sells first is utter-

ly immaterial. So in regard to depreciation (‘‘a grad-

val sale’’) it is utterly immaterial whether the taxpay-

er first acquires assets and then consumes them, or

whether he first consumes and then pays for them.

Difficulties Encountered by Government.

In the past the effort of the Commissioner of Inter-

nal Revenue to apply consistently his theory, inelud-

ing the insistence on both ownership and possession,

has caused him to take positions in various situations

which were so incongruous as obviously to necessitate

judicial correction. These include, (a) the refusal of

depreciation on leasehold interests acquired prior to

March 1, 19123 (1-2 Internal Revenue Cumulative Bul-

letin 90), a position which practically amounted to the

denial that a leasehold estate was property which was

corrected by the decision of Atterbury v. Commisston-

er. 1 B. T. A. 169; (b) a denial of depreciation to life

tenants (1-1 Internal Revenue Cumulative Bulletin

172) which was corrected by Grant v. Rose, 24 Fed.

Ond 115: (¢) a refusal of a deduction for depletion to

the lessee of a mineral lease (Regulations 33, p. 527,

528) corrected both by statute as applied to later years

and by Lunch v. Alworth-Stephens Co., supra; (d) in

one case the owner had absolutely eliminated any ef-

fect of depreciation on his property value by leasing

for a ten year period under a lease containing a bind-

“a

16

ing contract on the lessee’s part to purchase within

that period. The Commissioner claimed that, since

the property had depreciated during the ten years, the

owner by then obtaining the price determined at the

beginning of the ten year period had increased his

profit by an amount equal to the depreciation during

those ten years (See Schoellkopf v. Commisstoner, 4

B. T. A. 1032). Obviously this position was an argu-

mentum ad absurdum of the capital investment theory.

CONCLUSION

We contend that the gist of the statu ory allowance

is the destruction or consumption of the assets and

net merely the return of a capital investment. We

therefore contend that the taxpayer to whom the al-

lowance is made is the one who must make good the

assets destroyed and is not merely the person who

owned them,

In short, the controversy is this: The Government

insists that the allowance must be predicated upon a

prior capital investment, whereas we contend that the

allowance is purposed te restore him upon whom the

loss from the exhaustion of the property falls by rea-

son of its use in the business. We submit that the

practical features of the situation, sound cconomics, |

sound finance and the conclusions of this Court in

CS. ws, Ludew, supra, and in Lynch ve. Alworth

Stephens Co. supra, support our views. Especially do

we urge that the plain language of the statute sup

perts our view and ne reason appears for wrafting

additional qualifications upon those laid down by Con

17

gress. The judgment of the Cireuit Court of Appeals

should be affirmed.

Respectfully submitted,

Henman A. Fiscuer, Jr.,

1565 First National Bank Bldg,,

Chicago, Ill.

E. Baxnert Prerrymay,

717 Munsey Building,

Washington, D. C.

Washington, D. C.,

February 20, 1929.