268 U.S. 55
45 S.Ct. 429
69 L.Ed. 846
DUFFY, Collector of Internal Revenue,
CENTRAL R. CO. OF NEW JERSEY.
Argued March 13-16, 1925.
Decided April 13, 1925.
The Attorney General and Mr. Alfred A. Wheat. of New York City, for petitioner.
[Argument of Counsel from pages 56-57 intentionally omitted]
Mr. C. E. Miller, of New York City, for respondent.
[Argument of Counsel from pages 58-60 intentionally omitted]
Mr. Justice SUTHERLAND delivered the opinion of the Court.
During the year 1916, respondent, as lessee, was in possession of and operating certian 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 per cent. on the 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 per cent. 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 section 12(a) of the Revenue Act of 1916 (39 Stat. 756, 767-769, c. 463 [Comp. St. § 6336l]), 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.' 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 section 12(a), subd. Second, 39 Stat. 768,1 for 'depreciation'; but, if the expenditures are to be regarded as additional rentals or other payments within the meaning of section 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, 44 S. Ct. 34, 68 L. Ed. 510).
Clearly the expenditures were not 'expenses paid within the year in the maintenance and operation of its [respondent's] business and properties';2 but were for 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, 31 A. 268, 1059; 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, 122 N. E. 712; Garner v. Hannah, 13 N. Y. Super. Ct. 262, 266, 267; Bien v. Bixby, 18 Misc. Rep. 415, 41 N. Y. S. 433, 435; Simonelli v. Di Ericco, 59 Misc. Rep. 485, 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 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.
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. * * *
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.