1. Expenditures made by a corporate lessee, as required by the
lease, to create additions to the leased property and not for
upkeep, are not maintenance and operation expenses deductible from
its gross income of the tax year in which made, within the meaning
of § 12(a) Subd. "First" of the Revenue Act of 1916, but are
betterments under Subd. "Second " of that section -- capital
investment, subject to annual allowances for exhaustion or
depreciation. P.
268 U. S. 62
2. Neither are such payments for betterments and additions,
though made by the lessee pursuant to the lease, deductible under §
12(a), Subd. "First" as " rentals or other payments "required to be
made as a condition to the continued use or possession of
Page 268 U. S. 56
property etc., since "rental" is there used in the usual sense
implying a fixed sum, or property amounting thereto, payable at
stated times for the use of property, and "other payments" means
payments
ejusdem generis with rentals, such as taxes,
insurance, etc. P.
268 U. S.
63.
289 F. 354 reversed.
Certiorari to a judgment of the circuit court of appeals
affirming a recovery in the district court of money paid under
protest as income tax.
Page 268 U. S. 60
MR. JUSTICE SUTHERLAND delivered the opinion of the Court.
During the year 1916, respondent, as lessee, was in possession
of and operating certain railroads and branches in New Jersey and
Pennsylvania. The leases were for terms of 999 years, and bound
respondent to maintain and keep the leased property in good order
and repair and fit for efficient use. Each provided that, in the
event of a default in that respect, the lease might be terminated
by the lessor. At the same time, respondent had leases of certain
piers from the City of New York for various terms with the
privilege of renewal, not to exceed in any case 30 years in all.
One such lease required respondent to acquire and pay for the
interest of private owners in an old pier, and to construct a new
one in its place. It provided that, if the cost should be less than
$2,750,000, respondent was to pay in addition to rent 5 1/2 percent
on the
Page 268 U. S. 61
difference between that amount and the actual cost; but if the
cost should be more than $2,750,000, respondent was to be credited
on its annual rental with 5 1/2 percent on such difference for 39
years, in which event the term was to be extended under a formula
not necessary to be repeated. Respondent agreed to maintain the
premises and structures thereon or to be erected thereon in good
and efficient repair. The city was authorized to terminate the
lease at any time after 10 years, but in such case agreed to pay to
respondent such reasonable sum as might be fixed by arbitration.
Other leases required respondent to do such dredging as the
commissioner of docks considered necessary, and still others to
build extensions to the leased piers. All the leases provided that
the city could terminate them if respondent failed to pay rent or
failed otherwise to observe the covenants or agreements.
In the year 1916, respondent expended, under the railroad
leases, for additions and betterments and, under the pier leases,
for the several purposes therein set forth, the aggregate sum of
$1,659,924.33, of which $1,525,308.72 was for the acquisition of
the private rights in the old pier and the construction of the new
one.
In submitting its income tax return for that year, respondent
sought to deduct these various expenditures from its gross income
under § 12(a) of the Revenue Act of 1916, c. 463, 39 Stat. 756,
767-769, which provides, in the case of a corporation, that annual
net income shall be ascertained by deducting from the gross amount
thereof, among other things:
"First. All the ordinary and necessary expenses paid within the
year in the maintenance and operation of its business and
properties, including rentals or other payments required to be made
as a condition to the continued use or possession of property to
which the corporation has not taken or is not taking title, or in
which it has no equity. "
Page 268 U. S. 62
The collector refused to allow the deductions, and respondent,
under protest, paid the amount of the increased assessment due to
such refusal, and brought this action to recover it. Its contention
is that the expenditures were "rentals or other payments" within
the meaning of the provision above quoted, and that the whole
amount constitutes an allowable deduction for the year 1916. On the
other hand, the government contends that the disbursements were
capital expenditures, and that the only permissible deduction is an
annual allowance under § 12(a), subd. Second, 39 Stat. 768,
[
Footnote 1] for
"depreciation," but, if the expenditures are to be regarded as
additional rentals or other payments within the meaning of § 12(a),
subd. First, the amount must be prorated, under a regulation of the
Treasury Department, over the life of the improvements or the life
of the lease, whichever is the shorter. The federal district court
gave judgment for respondent, which was affirmed by the circuit
court of appeals, 289 F. 354, and the case is here on certiorari,
263 U.S. 693.
Clearly the expenditures were not "expenses paid within the year
in the maintenance and operation of its [respondent's] business and
properties," [
Footnote 2] but
were for
Page 268 U. S. 63
additions and betterments of a permanent character such as
would, if made by an owner, come within the proviso in subdivision
Second,
"that no deduction shall be allowed for any amount paid out for
new buildings, permanent improvements, or betterments made to
increase the value of any property,"
etc. They were made not to keep the properties going, but to
create additions to them. They constituted not upkeep, but
investment; not maintenance or operating expenses, deductible under
subdivision First, § 12(a), but capital, subject to annual
allowances for exhaustion or depreciation under subdivision
Second.
Nevertheless, do such expenditures come within the words
"rentals or other payments required to be made as a condition to
the continued use or possession of property"? We think not. The
statement of the court below that it was conceded by both parties
that the expenditures were "additional rentals" is challenged by
the government, and does not seem to have support in the record.
The term "rentals," since there is nothing to indicate the
contrary, must be taken in its usual and ordinary sense -- that is,
as implying a fixed sum, or property amounting to a fixed sum, to
be paid at stated times for the use of property.
Dodge v.
Hogan, 19 R.I. 4, 11; 2 Washburn, Real Property, 6th ed., §
1187, and in that sense it does not include payments, uncertain
both as to amount and time, made for the cost of improvements or
even for taxes.
Guild v. Sampson, 232 Mass. 509, 513;
Garner v. Hannah, 13 N.Y.S. 262, 266, 267;
Bien v.
Bixby, 41 N.Y.S. 433, 435;
Simonelli v. Di Ericco,
110 N.Y.S. 1044, 1045. Expenditures, therefore, like those here
involved, made for betterments and additions to leased premises,
cannot be deducted under the term "rentals," in the absence of
circumstances fairly importing an exceptional meaning, and these we
do not find in respect of the statute under
Page 268 U. S. 64
review. Nor do such expenditures come within the phrase "or
other payments," which was evidently meant to bring in payments
ejusdem generis with "rentals," such as taxes, insurance,
interest on mortgages, and the like, constituting liabilities of
the lessor on account of the leased premises which the lessee has
covenanted to pay.
In respect of the 999-year leases, the additions and betterments
will all be consumed in their use by the lessee within a fraction
of the term, and, as to them, allowances for annual depreciation
will suffice to meet the requirements of the statute. In the case
of the pier leases, the improvements may and probably will outlast
the term, and, as to them, deductions may more properly take the
form of proportionate annual allowances for exhaustion.
The judgment below cannot be sustained except for $37,781.54,
the amount of a conceded overpayment, with interest thereon as
allowed by the trial court.
Judgment reversed, and cause remanded with instructions to
modify the judgment in conformity with this opinion.
[
Footnote 1]
"Second. All losses actually sustained and charged off within
the year and not compensated by insurance or otherwise, including a
reasonable allowance for the exhaustion, wear and tear of property
arising out of its use or employment in the business . . .
Provided, that no deduction shall be allowed for any
amount paid out for new buildings, permanent improvements, or
betterments made to increase the value of any property or estate,
and no deduction shall be made for any amount of expense of
restoring property or making good the exhaustion thereof for which
an allowance is or has been made. . . ."
[
Footnote 2]
Perhaps a critical analysis of the detailed statement found in
the record might reveal items of minor importance which are of this
character, or which might be classed as "rentals or other
payments;" but since no point appears to be made in respect of such
a differentiation, we do not consider it.