ury very sensibly makes no attempts to fix specific rates which shall be considered satisfactory.

REGULATION. The capital sum to be replaced should be charged off over the useful life of the property either in equal annual installments or in accordance with any other recognized trade practice, such as an apportionment of the capital sum over units of production. Whatever plan or method of apportionment is adopted must be reasonable and should be described in the return.17 (Art. 165.)

"Methods of determination of depreciation:

1. The fixed percentage basis. This method is the most popular and is the one in general use. It is applied as follows:

(a) On a flat basis, e.g., if the life of a machine is ten years, onetenth, or 10 per cent, is charged off annually.

(b) On a reducing scale basis, i.e., a rate is ascertained which, when applied to the original cost and the diminished value thereof as periodically determined, will reduce the book value to scrap value at the end of the machine's estimated life.

2. Sinking fund method. If it is proposed to set aside such a sum periodically as will equal the original cost of a machine (less scrap value) at the end of its estimated life, it is customary, after taking into consideration the average rate of interest which can be secured, to pay into a fund a fixed amount periodically. The aggregate thereof, together with the accumulated interest, will equal the amount required to renew the machine in question. This method is in practice seldom followed.

There is good authority, however, for its use where a single large piece of property, such as an office building, apartment house or ship is being operated.

3. Production method. A method of making depreciation allowances which has its advantages under certain conditions is that of charging an established rate per unit of output. This is especially applicable in the case of, say, a blast furnace where the frequency with which the linings will need to be renewed depends on the extent to which the furnace is being used. If it is being run at full capacity night and day, the wear on the linings is obviously much greater than if the furnace were not in continual use during the entire fiscal period.

Another species of depreciation which may be said to come under the above caption is that caused in a plant by the exhaustion of the mines or timber lands for the operation of which the plant was constructed. Most of the value of coke ovens, for instance, is gone when the mines for which they were constructed are worked out. Consequently, in determining the amount to be written off for depreciation of mining and lumbering plants, the factor of the probable future output of the mines or lands will be an important one and it will frequently be. found advisable to base the plant depreciation charge on the output. Certainly this should be done where it is evident that the plant will outlive the exhaustion of the mines or lands. In such cases the depreciation charges should be sufficient to absorb the entire cost of the plant, less residual value, by the time the mines or lands are exhausted even though at that time the plant may still be in good operating condition. Of course, any actual residual value must be considered.

Dependence upon life of enterprise as a whole.-The "number of years constituting its life" is vitally affected in the case of some types of property by the life of the enterprise in which it is used and the permissible revaluation as of March 1, 1913. In the case of a mine or an oil or a gas well, the deposit may be exhausted before the expiration of the normal life of some of the buildings and machinery. The regulations provide that in the case of oil and gas properties the depreciation shall be such "an amount, based upon its cost or fair market value as of March 1, 1913, equitably distributed over its useful life, as will bring such property to its true salvage value when no longer useful for the purpose for which such property was acquired."18 A somewhat similar provision is made in the case of mining properties1o and timber properties.2 In the case of a building constructed on leased land, if "the life of the improvement is less than the life of the lease, the depreciation may be taken by the lessee, instead of treating the cost as rent." This, of course, is basing the depreciation rate on the life of the improvement, rather than on the duration of the lease.

20

ENTERPRISES AFFECTED BY THE CLOSE OF THE WAR.-The "useful life" of much war property did not extend beyond the end of the war. What is the proper term to use for the accruing expense or cost incident to idle plant? If a plant to manufacture war materials had not been used since the war ended and if depreciation were permitted only for wear and tear, the owner would be in a bad way.

Many contracts let by the government itself specifically provide for extraordinary depreciation rates to be included as part of the cost of production of war materials. The munitions tax law permitted the amortization of plants used for war purposes over the estimated war production.

"Reg. 45, Art. 225, see page 789. Ibid., Art. 224, see page 725. 20Ibid., Art. 227, see page 791.

"Ibid., Art. 109, see page 573.

The 1918 law takes care of depreciation due to war conditions.22 As the loss is one due to extraordinary obsolescence the matter is fully discussed in Chapter XXX.

Depreciation of plant or equipment devoted to war purposes acquired before April 6, 1917, is also discussed in Chapter XXX.

Depreciation a local issue.-The taxpayer must take local conditions into account in considering rates of depreciation. In one locality boilers may depreciate 71⁄2 per cent annually; in another the rate may be 15 per cent; and the variation may be entirely legitimate. It is not merely a question of the quality of the boilers. No engineer or boiler manufacturer could give an intelligent estimate unless he knew the use to which the boiler would be subjected, the climate, the water, the class of labor, the probabilities of shut-downs, etc. A similar situation exists in the case of almost all other classes of property which depreciate by wear and tear. Therefore, wherever rates of depreciation are mentioned in this chapter, they must be taken as suggestions only and be treated as rough approximations of what may be expected under normal conditions.

Depreciation rate affected by "overtime."—When machinery is run "overtime" there is little opportunity properly to repair and maintain the machines. Moreover, a two-shift system means divided responsibility, and with divided responsibility the machinery is sure to suffer. New workmen and those on night duty often are not so efficient as the regular staff and there is a consequent ill effect upon the machines.23 In spite of all this some inspectors have been reluctant to allow special depreciation when a plant was being run "overtime." Consequently the following ruling is of great interest:

RULING. . . . . it is obvious that in a case where machinery and equipment are operated more than the usual number of working

Section 214 (a-9).

For British practice, see page 688.

hours, a greater rate of depreciation would be applicable in determining the actual loss sustained by a corporation due to depreciation than would be the case in the event that the machinery was only operated eight or nine hours as the normal time.

Therefore you are informed that a greater rate of depreciation will be allowed in the case you mention, but no definite rulings relative thereto can be given except in record cases which are presented to this office for consideration in connection with a full statement of facts and figures relative thereto. (Part of letter to E. G. Shorrock & Co., Seattle, Wash., signed by Deputy Commissioner L. F. Speer, and dated July 12, 1918.)

Adjustment of rates used in former years.-The author believes that deductions for depreciation claimed and allowed in returns during the years preceding the taxable year should not be reopened except under special conditions. Corporations and individuals subject to the taxes in force during these years were on notice from the government as to the basis of the allowable deductions and were also on notice. from accountants and bankers that proper provision for depreciation should be made. What was done at the time, while the facts were fresh in mind, should stand unless an explainable mistake was made. Depreciation rates should not be played with nor juggled. The rates of an income tax should not (because they do not) affect depreciation rates. Unless the Commissioner is convinced that a meritorious case exists, he should not permit amended returns to be made.

The general procedure, prescribed in Regulations 45, in case depreciation is found to have been excessive, calls for a readjustment made, not through amended returns for previous years, but through an amended rate for the years of life remaining to the property.

REGULATION. If it develops that the useful life of the property has been underestimated, the plan of computing depreciation should be modified and the balance of the cost of the property, or its fair market value as of March 1, 1913, not already provided for through a depreciation reserve or deducted from book value, should be spread over the estimated remaining life of the property. . . . (Art. 166.)

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Based on the rulings in special cases it would seem that a taxpayer has the option of submitting amended returns for prior years or reducing or increasing the rates of depreciation thereafter. Circumstances may make one method more desirable than another. When obsolescence is calculated it must be assumed that full depreciation has been claimed. In case it has not, former regulations provide for deducting it through amended returns,25 but the new regulations attempt to do away with amended returns. When it is discovered that depreciation was incorrectly calculated to a substantial amount in prior years, it is not good accounting practice to make the adjustment in the taxable and subsequent years. It is not fair to the government nor to the taxpayer.

REGULATION. . . . . A taxpayer who in computing depreciation allowances in returns for years prior to 1918 has not taken ordinary obsolescence into consideration may for the year 1918 and subsequent years revise the estimate of the useful life of any property so as to allow for such future obsolescence as may be expected from experience to result from the normal progress of the art. .. (Art. 166.)

Special depreciation of excessive costs.-Ample provision. has been made for special depreciation of plants and equipment constructed or purchased "for the production of articles contributing to the prosecution of the present war."26 The question arises as to what provision, if any, has been made for plants which cannot qualify in the war work class.

Commencing in 1915, almost all classes of materials advanced in price until the cost of erecting and equipping a plant became perhaps double what is was before the war.

For example, take a plant which cost a million dollars to build and equip in 1913. The plant is duplicated in 1918 at a cost of two millions. What rates of depreciation shall be charged during 1919 on the two plants? If the proper aver

"For details of rulings and prior regulations, see Income Tax Procedure, 1919, pages 553-556.

25 Ibid.

26 See Chapter XXX.