Rev. Rul. 68-470

Advice has been requested whether the portions of the property accounts of railroad and public utility companies that represent expenditures paid by a state or other governmental body for the construction of public highways or other public improvement have a tax basis for purposes of depreciation, gain, or loss.

In 1952, a state improved a highway which crossed a railroad company's tracks. In conjunction with this work, the state acquired a right-of-way on which an electric company had previously constructed a power transmission line. The improvement project included construction of an overpass structure over the railroad tracks and the relocation of the transmission line. Under an agreement with the railroad company, the state paid 90 percent and the company 10 percent of the total cost of constructing the overpass. Further, under a similar agreement with the electric company, the state paid 95 percent and the company 5 percent of the total cost of relocating the transmission line. The railroad and electric companies charged their respective property accounts with the full cost of the overpass and relocation, and credited their `Contributions in Aid of Construction' accounts with the respective amounts paid by the state. Neither company reported such amounts in income on its Federal income tax return.

Thus, the question presented is whether, under the facts described, the so-called `contributions in aid of construction' are gifts or contributions to capital of the taxpayers so as to have a tax basis for purposes of depreciation, gain, or loss.

Section 1015(a) of the Internal Revenue Code of 1954 provides a basis for property acquired by gift if acquired after December 31, 1920, and section 1015(c) of the Code provides a basis if acquired on or before December 31, 1920.

With respect to property acquired by a corporation as a contribution to capital, after February 28, 1913, and before June 22, 1954, section 113(a)(8)(B) of the Internal Revenue Code of 1939 and section 1052(c) of the 1954 Code, provide a basis for such property.

Section 167(g) of the 1954 Code provides that the basis on which depreciation is to be allowed in respect of any property shall be the adjusted basis provided in section 1011 of the 1954 Code for the purpose of determining gain on sale or other disposition of such property.

In Brown Shoe Co., Inc. v. Commissioner , 339 U.S. 583, (1950) Ct. D. 1731, C.B. 1950-1, 38, the taxpayer contended that cash paid and other property transferred by certain community groups to it, as an inducement to the location or expansion of its factory operations in the communities, were `gifts' under section 113(a)(2) of the 1939 Code, or `contributions to capital' under section 113(a)(8)(B) of the 1939 Code, or both. The taxpayer further contended that it was entitled to depreciation deductions on the property acquired from such contributions. The Supreme Court of the United States held that the contributions were provided by citizens of the respective communities who neither sought nor could have anticipated any direct service or recompense whatever, their only expectation being that such contributions might prove advantageous to the community at large. The Court also held that under these circumstances the transfers manifested a definite purpose to enlarge the working capital of the company, and, as such, were `contributions to capital' within the meaning of section 113(a)(8)(B) of the 1939 Code, requiring to reduction in the depreciation basis of the properties acquired. Compare, however, Detroit Edison Co. v. Commissioner , 319 U.S. 98, (1943), Ct. D. 1582, C.B. 1943, 1019, where the Supreme Court of the United States held that the payments received by the taxpayer from its customers for construction necessary to extend its electric service facilities to them were neither gifts nor contributions to capital, and that the taxpayer acquired no basis in such facility.

As a general rule, for Federal income tax purposes, the substance rather than the form of a given transaction controls. In the early case of Weiss v. Stern , 265 U.S. 242 (1924), T.D. 3609, C.B. III-2, 51 (1924), the Supreme Court of the United States stated, `Questions of taxation must be determined by viewing what was actually done, rather than the declared purpose of the participants; and when applying the provisions of the sixteenth amendment and income laws enacted thereunder we must regard matters of substance and not mere form.' See also Helvering v. F. & R. Lazarus & Co. , 308 U.S. 252 (1939), Ct. D. 1430, C.B. 1939-2, 208. Also, entries made on the taxpayer's books of account are significant only as evidence or records of transactions , but the legal effect of such transactions must be determined from the transactions themselves and not merely from the book entries concerning them . See Doyle v. Mitchell Brothers Co. , 247 U.S. 179 (1918).

In the instant case, when the state planned and constructed improvements to the highway, it entered into construction agreements with the railroad and utility companies involved. Such agreements provided for the total cost of the highway improvements to be apportioned between the state and the respective company. The total investment in the construction project by the railroad and utility was 10 and 5 percent, respectively. As far as the state was concerned the amounts it was required to pay were merely a part of the total price it had to pay in order to build its own highway . In paying its portion of the total construction costs, the state had no intent whatever of enlarging the capital of the railroad or utility company.

The railroad and utility companies, having acquired only that for which they each paid, may not include in their respective bases for the overpass and line relocation the portion of the total cost that was expended by the State. Only that portion of the cost of the construction project actually borne by the railroad and utility companies, respectively, (their respective investments in the project) is includable in such basis for Federal income tax purposes.

Accordingly, those portions of the property accounts of the railroad and public utility companies that represent expenditures paid by the state for public highways or other public improvements are neither gifts nor contributions to capital and, therefore, have no tax basis for depreciation, gain, or loss to the railroad and public utility companies.