Rev. Rul. 58-62

Advice has been requested whether the basis of depreciable property used by a railroad corporation in its business should be reduced, in accordance with the provisions of section 113(b)(1)(B) of the Internal Revenue Code of 1939, by the amount of excessive depreciation erroneously deducted in a prior year for which a consolidated income tax return was filed.

For the taxable years 1934, 1935 and 1936, the taxpayer, an affiliated railroad corporation, joined with its parent-corporation in the filing of consolidated returns, each of which disclosed a net loss. The return for the year 1935 reflected a deduction for depreciation of $5,000 in excess of the amount allowable on property used by the taxpayer in its business. This excessive deduction represented additional depreciation for prior years which was added to its reserve for depreciation in 1935 at the direction of the Interstate Commerce Commission. The deduction did not result in the reduction of the tax liability of the taxpayer, or that of any member of the affiliated group, for any taxable year. However, had the taxpayer not filed a consolidated return, the excessive depreciation would have diminished the taxpayer's taxable income by $5,000, resulting in a tax benefit to it. In 1952, the taxpayer filed an election under section 113(d) of the Code to adjust the basis of its depreciable property, in accordance with the provisions of clause (ii) of section 113(b)(1)(B) of the Code, by the amount of the excessive depreciation claimed and allowed for the year 1935. Separate income tax returns were filed by the taxpayer for all taxable years subsequent to 1936. The question of adjustment to the basis of the property, under the above circumstances, was raised because of the apparent conflict with the provisions of Article 38 of Regulations 89, applicable to the determination and adjustment of basis in the case of affiliated railroads filing consolidated returns.

Section 113(b) of the Code provides, in part, as follows:

(b) ADJUSTED BASIS.-The adjusted basis for determining the gain or loss from the sale or disposition of property, whenever acquired, shall be the basis determined under subsection (a), adjusted as hereinafter provided.

(1) GENERAL RULE.-Proper adjustment in respect of the property shall in all cases be made-

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(B) in respect of any period since February 28, 1913, for exhaustion, wear and tear, obsolescence, amortization, and depletion, to the extent of the amount-

(i) allowed as deductions in computing net income under this chapter or prior income tax laws, and

(ii) resulting (by reason of the deductions so allowed) in a reduction for any taxable year of the taxpayer's taxes under this chapter * * *, but not less than the amount allowable under this chapter or prior income tax laws. Clause (ii) of this subparagraph shall not apply in respect of any period since February 28, 1913, and before January 1, 1952, unless an election has been made under subsection (d). * * *

Section 3 of Public Law 539, 66 Stat. 629, 26 U.S.C. 113, 82nd Cong., 2nd Sess., approved July 14, 1952, C.B. 1952-2, 358, which enacted clause (ii) of section 113(b)(1)(B) of the Code, states as follows:

The amendments made by this Act shall apply in respect of taxable years beginning after December 31, 1938. Provisions having the effect of such amendments shall be deemed to have been included in the revenue laws respectively applicable to taxable years ending after December 31, 1931 and beginning before January 1, 1939.

Article 38 of the Regulations 89, relating to consolidated returns of affiliated railroad corporations for taxable years beginning after December 31, 1933, provides that the determination of the basis of property is required to be made as though no affiliation existed. Section (a) of Article 38 reads as follows:

(a) GENERAL RULE.

Subject to the provisions of paragraphs (b) and (c) and except as otherwise provided in article 34, the basis during a consolidated return period for determining the gain or loss from the sale or other disposition of property, or upon which exhaustion, wear and tear, obsolescence, and depletion are to be allowed, shall be determined and adjusted in the same manner as if the corporations were not affiliated (see sections 111 to 115, inclusive, of the Act), whether such property was acquired before or during a consolidated return period. Such basis immediately after a consolidated return period (whether the affiliation has been broken or whether the privilege to make a consolidated return is not exercised) shall be the same as immediately prior to the close of such period.

In Corporation of America v. Commissioner , 4 T.C. 566, acquiescence C.B. 1945, 2, a corporation recovered in 1939 amounts which it paid for documentary stamp taxes in 1930 and which it deducted in determining its net income for that year. However, the corporation joined in the filing of a consolidated income tax return for that year which showed a large consolidated net operating loss. The total recoveries secured by all corporations in the affiliated group did not equal their consolidated net loss for 1930.

In deciding the case under section 22(b)(12) of the 1939 Code, as amended by section 116 of the Revenue Act of 1942, relating to the exclusion from gross income of recoveries of bad debts, prior taxes, and delinquency amounts, the court said that the ultimate question was whether the taxpayer received any tax benefit from the deduction of the prior year taxes, rather than whether it would have enjoyed that benefit if a consolidated return had not been filed. The court stated in its opinion that the concept of an affiliated group of corporations filing a consolidated income tax return is that the affiliated group is considered as a taxable unit; and that the tax liability, and hence the tax for that year, as contemplated by the recovery exclusion statute, was the tax of the group of which the petitioner was an integral part. The court held that, since the consolidated group reported a consolidated loss for the year 1930, the taxpayer, by reason of its affiliation with other corporations in 1930, had no tax liability and no tax for that year. The taxpayer, therefore, received no tax benefit from its deduction and is entitled to exclude from its gross income for the year 1939 the amount of documentary stamp taxes so recovered.

In the instant case the consolidated return for 1935 disclosed a consolidated net operating loss which considerably exceeded the taxpayer's depreciation deduction; therefore, the taxpayer had no tax liability for that year. Applying the rationale of the Corporation of America case, there was therefore no reduction of the `taxpayer's taxes,' as required by clause (ii) of section 113(b)(1)(B) of the Code, attributable to the excessive depreciation deduction. In the circumstances described, the provisions of section 113(b)(1)(B) of the Code are not in conflict with the rule set forth in Article 38 of Regulations 89, supra .

Therefore, it is held that where an affiliated railroad corporation, which joined in the filing of a consolidated income tax return for the taxable year 1935 on which a net operating loss was reported, erroneously deducted and was allowed depreciation on property used in its business in excess of the amount allowable, for which neither it nor the affiliated group obtained any Federal income tax benefit, the corporation, pursuant to an election properly and timely made under section 113(d) of the Code, is not required to reduce the basis of the property by the amount of the excessive depreciation allowed for such year.