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The chief reason for the variation is that the securities issued may be part of a larger issue or sales may be made under favorable or unfavorable conditions.

DEPRECIATION BASED ON FAIR MARKET VALUE AT MARCH I, 1913. —

REGULATION. .... Depreciation of a patent can be taken on the basis of the fair market value as of March 1, 1913,48 only when affirmative and satisfactory evidence of such value is offered. Such evidence should whenever practicable be submitted with the return.

(Art. 167.)

“Satisfactory” evidence is a reasonable requirement and must be met. The taxpayer is entitled to produce evidence of subsequent development and success as bearing on the probable value at March 1, 1913. The estimates of inventors and others as to values, while not conclusive, are prima facie evidence when it appears that such estimates were made in good faith.

The value placed upon patents by competition is difficult to ascertain but is sometimes available. The testimony of those who have valued patents, bought and sold them or participated in negotiations, is admissible.

RATE TO BE USED WHEN PATENT BECOMES OBSOLETE.

REGULATION. . . If the patent becomes obsolete prior to its expiration such proportion of the amount on which its depreciation may be based as the number of years of its remaining life bears to the whole number of years intervening between the date when it was acquired and the date when it legally expires may be deducted, if permission so to do is specifically secured from the Commissioner. Owing to the difficulty of allocating to a particular year the obsolescence of a patent, such permission will be granted only if affirmative and satisfactory evidence that the obsolescence occurred in the year for which the return is made is submitted to the Commissioner

“[Former Procedure] Depreciation was permitted only on the basis of actual cost thereof and not on estimated value as of March 1, 1913 (Reg. 33, 1918, Art. 174), but for some years the author has contended that the March 1, 1913, value was permitted by the law. (See Income Tax Procedure, 1919, pages 572-573.)

WHEN DEPRECIATION NOT TAKEN IN PRIOR YEARS.The fact that depreciation has not been taken in prior years does not entitle the taxpayer to deduct in any taxable year a greater amount for depreciation than would otherwise be allowable. . (Art. 167.)

The preliminary edition of art. 167, Reg. 45, provided that “a taxpayer may elect not to take a depreciation allowance but such election if made is final and will control the returns for all subsequent years." It is a fair statement that nothing is final in income tax practice, even regulations, because the sentence quoted was omitted from the April 17, 1919, edition of the regulations.

Taxpayers cannot be estopped from revising accounting procedure when it is discovered that past procedure did not properly reflect net income.

A patent may be purchased for $100,000. It may have ten years to run. During the first few years after purchase development work may be going on and there may be no gross income or net income and it may be decided that no depreciation has taken place, consequently none is charged. After several years the commercial use of the patent begins and gross income is received. It may then be decided that depreciation should be charged. Surely it could not be held that any depreciation in the earlier years had taken place.

Patterns, drawings, models, designs, etc.—The difficulty which the accountant encounters in the proper valuation of such patterns as are successful is to persuade proprietors to accept valuations which are reasonably conservative. Where patterns are used for stock or regular output, their value depends upon their life and upon the probability of renewed use. Where acquired or made for special jobs, the residual value is small, and the life of the patterns should be considered coextensive with the life of the jobs themselves. In every case items such as these should be looked upon with suspicion, and convincing proof must be adduced before placing any material sum on their account as an asset. An auditor often meets with strong opposition in his efforts to reduce these items to reasonable amounts, for they represent the skill and often the affections of the proprietors, who dislike to see their value depreciated on the books. But the public demand is fickle, and patterns must be made to suit the changing taste. Even what appear to be standard patterns for stable businesses often change rapidly. Engineers make almost as many alterations in their "styles” as do milliners. When the demand ceases most of the old patterns should be scrapped. This rule applies to hardware designs as well as to patterns for women's dresses.

The charges against this account are usually cumulative, i.e., they follow the output almost automatically, thus indicating that most of the old patterns, etc., are obsolete or have been discarded. Usually depreciation charges should equal the annual expenditures for new patterns, etc. Wherever feasible, the conservative course is to write down the book value to $1.

Previous regulations' have required that expenditures for successful patterns, etc., must be capitalized and specifically written off based on their effective life. The new regulations give to the taxpayer the option of charging off such items as expenses or capitalizing them.

REGULATION. A taxpayer who has incurred expenses in his business for designs, drawings, patterns, models, or work of an experimental nature calculated to result in improvement of his facilities or his product, may at his option deduct such expenses from gross income for the taxable year in which they are incurred or treat such articles as a capital asset to the extent of the amount so expended. In the latter case, if the period of usefulness of any such asset may be estimated from experience with reasonable accuracy, it may be the subject of depreciation allowances spread over such estimated period of usefulness. The facts must be fully shown in the return or prior thereto to the satisfaction of the Commissioner. Except for such depreciation allowances no deduction shall be made by the taxpayer against any sum so set up as an asset except on the sale or other disposition of such assets at a loss or on proof of a total loss thereof. (Art. 168.)

"Reg. 33, 1918, Arts. 175-177.

Printing.–The depreciation of printing plants is about the same as that in the textile industry,50 with the exception of type, printers' tools, electrotypes, plates, etc., on which about 10 to 12 per cent should be applied annually.

Professions-Physician's claims for depreciation.-In New York a physician made the following claims for depreciation which were allowed: Residence, brick construction, on part occupied as offices only

5% Automobile Books Instruments

25 Office furniture Country residence, wood construction, on part occupied

as offices only....

20

20

20

IO

Reconstruction, rebuilding, restoration. When there is rebuilding, different elements may be present. If an owner restores an old business building, theoretically it should be charged to depreciation reserve.

If no reserve exists, it may mean that no deduction for depreciation has been made in past years. If it is inadequate it means that the deduction has been insufficient. In such event, that part of the cost not covered by a reserve is an allowable deduction. This allowance, however, is strictly limited to what might be termed a repair or a renewal sufficient only to restore the building to the book cost. If more than this is done, there is an added asset and the excess represented by the improvement must be capitalized.

If a run-down property is purchased and a large amount is spent to bring it up to date, the cost will be a capital expenditure and cannot be deducted in the income tax return of the new owner. If the old owner had made the repairs and had not accumulated a reserve against which to charge them, he could have deducted the cost in his return. This is equitable, because the new owner is presumed to have insisted on a re

"See page 735.

duction in the purchase price equal to the deterioration, and the old owner is supposed to have suffered a corresponding loss.

Shipping industry

BRITISH PRACTICE.51 (a) The normal rates of allowance for depreciation are as follows: On steamers 4%

On the original cost price of the vessel plus On sailing vessels 3% s subsequent capital expenditure.

Exceptional cases are dealt with specially by the Commissioners concerned.

(b) Allowances are made year by year, until the total cost of the vessel, less the breaking up value (taken at the rate of 4 per cent in the case of steamers and 3 per cent in the case of sailing vessels), has been allowed.

(c) The net expenditure on the renewal of engines and boilers and the net cost of any structural improvements such as the lengthening or strengthening of a ship, is not allowed as a deduction for income tax purposes, but is added to the prime cost of the ship and depreciation allowed on the total amount.

(d) Where a vessel changes hands, allowances for wear and tear are granted to the new owner not exceeding the actual cost to him of the vessel (less breaking up value.)

The first reported case on the question of depreciation of ships is that of Burnley Steamship Company v. Aikin (10th July, 1894). The company were owners of the vessel "Burnley,” which is a steel ship; they had been allowed a deduction for wear and tear of 5 per cent on the diminished value. They appealed to the Commissioners, claiming a deduction of 772 per cent, and asking that in deciding upon their claim the Commissioners should consider:

(1) That ships frequently become obsolete and of less earning power before they are physically worn out.

(2) That their market or sale value might, and frequently did, fall below their value as fixed by the depreciation rate allowed in making the assessment, or even that proposed by themselves (7772 per cent).

The Commissioners considered that the words of the act of 1878 did not cover either of these cases, and they disallowed the claim of the company, and on appeal to the Court of Session the decision of the Commissioners was confirmed.

A similar question arose in Leith, Hull and Hamburg Steam

"Murray and Carter, Income Tax Practice, page 252 et seq., pages 593, 594.

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