parable allowances for machinery and equipment in other industrialized nations. This is well documented in the Report of the President's Task Force on Business Taxation, which unanimously concluded that this circumstance is a serious deterrent to the modernization of United States plant an equipment. American industry is today faced with intense competition in many areas from modern, wellequipped foreign industrial plants. The ADR system is an essential step toward narrowing these competitive advantages enjoyed by foreign producers.64

It is apparent, therefore, that there have been major changes since 1962 which require updating of the guideline lives. In the absence of precise data as to increasing obsolescence, but concluding on balance that there has been or is likely to be a significant increase, Treasury has adopted the ADR system to permit taxpayers to use any life within a range 20 percent above to 20 percent below the guideline lives. As previously stated, the industry-wide guideline lives and classes will be refined from time to time in the future as regular, systematic data on replacement practices becomes available under the ADR system.

VI. Legal Authority

Section 167 of the Internal Revenue Code provides for a "reasonable allowance" for depreciation including a reasonable allowance for absolescence. Section 167 also provides for issuance by the Secretary of the Treasury of regulations with respect to the manner of computing the "reasonable allowance." Section 7805 (a) of the Internal Revenue Code expressly directs the Secretary of the Treasury to prescribe "all needful rules and regulations for the enforcement" of the Code. The ADR system embodies needful rules and regulations for the enforcement of the depreciation provisions.

Report of the President's Task Force on Business Taxation at 10-11.

"The following chart indicates a comparison of cost recovery allowances in the United States prior to the 1969 Tax Reform Act, under the regulations in effect prior to ADR and under the ADR system with comparable allowances in 11 foreign

nations:

Based on existing conditions previously described, the Treasury has exercised its discretion to determine that the concept of a "reasonable allowance" is sufficiently broad for assets acquired in 1971 and subsequent years to permit a 20 percent range of tolerance above and below the guide-1.167 (a)-11 (g) (1).. lines which have been used and accepted since 1962.65 These guideline

periods and classes will be adjusted from time to time as data are collected which indicate the need for refinement and change.

65 Buildings, generally, and assets which are predominantly used outside the United States are not eligible for the ADR system. Reg. 1.167(a)-11(b)(2). The authority under §§ 167 and 7805 of the Internal Revenue Code is sufficiently general to permit the Treasury to exclude such assets from the ADR system. Moreover, § 167 (d) of the Code specifically authorizes the Internal

Revenue Service to enter into agreements with particular taxpayers with respect to depreciation of particular assets. See Reg.

Buildings are generally sold by taxpayers depreciation under section 1245 of the Code upon retirement. The rules for recapture of provide in general that gain on sales of personal property are taxed as ordinary income to the extent of all the depreciation taken on the property. Although opportunities for avoiding taxes as a result of accelerated depreciation for real estate were substantially reduced by the Tax Reform Act of 1969, the rules for recapture of depreciation as ordinary income upon the sale of buildings under section 1250 of the Code still permit a

The ADR system is an appropriate exercise of the administrative responsibility delegated to the Treasury by

significant number of taxpayers who dispose of buildings prior to the expiration of their useful lives to depreciate below the anticipated sale value of the buildings and, upon sale, to treat a substantial portion of the excess of disposition proceeds over adjusted basis as capital gains. The added flexibility provided by the ADR system which permits taxpayers to select useful lives from within a range from 20 percent below to 20 percent above the guideline life would, in the case of buildings, increase opportunities for converting deductions from ordinary income into capital gains. In addition, such flexibility would increase the opportunity for generating "tax losses" in the early years of buildings' lives. See generally, H. Rept. No. 91-413, 91st Cong., 1st Sess. Pt. 1, 165-67 (1969) [C.B. 1969-3, 200]; S. Rept. No. 91-552, 91st Cong., 1st Sess. 211-15 (1969) [C.B. 1969-3, 423]

Since buildings are generally sold upon retirement by the taxpayer, information made available through the ADR system as to retirements of assets to enable the Treasury to refine and update the estimations of useful lives will not be meaningful with respect to buildings. In addition, the administrative difficulties to be resolved by the ADR system are not present to the same extent in the case of buildings as with other busiassets such as machinery and

ness

equipment.

Income from property which is predominantly used outside the United States is generally subject to income taxation in foreign countries. Foreign capital recovery systems are far more important in decisions to retire and invest in new assets, and thus in determining the general period such assets will be used than the depreciation deductions allowed for federal income tax purposes. The administrative problems discussed supra at pages 513-515, are not present to the same extent in the case of foreign property. Other factors, such as the current trend in the United States toward stricter environmental control standards, discussed supra at pages 515-517, similarly do not apply with equal force to assets used in foreign countries. Industry experience in the United States is not so clearly a proper guide to the expected useful life of property used abroad where the mix of capital and labor as factors of production may differ because of differing wage rates and capital costs. The information gathering function of the ADR system is not served to the same extent in the case of property used abroad.

Moreover, permitting the use of shortened depreciation lives for assets used abroad could produce adverse economic effects. For example, substantial increases in foreign investment might adversely affect the balance of payments. Additional investment abroad by United States companies or their foreign subsidiaries would not increase domestic employment to the same extent as a similar amount of domestic investment. For a discussion of the economic effects which are expected to result from adoption

the Congress." The determination of a reasonable allowance for depreciation is by statute and long standing practice the administrative responsibility of the Treasury Department."

of the ADR system, see text at pages 521524, infra.

Although Treasury has concluded that these factors require the exclusion of buildings and property primarily used outside the United States from the ADR system, the reasons for rejecting the reserve ratio test as the sole method of determining useful lives apply with equal force to these assets. The reserve ratio test is a mechanical, backward looking mechanism which cannot take economic obsolescence into account. In addition, the reserve ratio test was designed primarily for multiple asset accounts composed of a wide variety of assets to measure the replacement practices of taxpayers; as a technical matter, its application to buildings often produces results which are not meaningful. See the discussion of the reserve ratio test at pages 508-512, supra.

Some written and oral comments received by the Treasury have suggested that promulgation of the ADR regulations would exceed the authority of the Treasury under the Internal Revenue Code. See, c.g., written comments on proposed ADR regulations submitted by Boris I. Bittker and Bernard Wolfman. See also, ADR Hearings at 264-310 (testimony of Bernard Woliman); Id, at 398-414 (testimony of Frank L. Chamberlin, Jr.). It has also been suggested that even if promulgation of the ADR regulations is within the Treasury's authority under the Internal Revenue Code, it should not proceed administratively, but rather legislation should be requested. See, e.g., ADR Hearings at 138-39 (testimony of Congressman Henry S. Reuss). Others have suggested that the ADR regulations are a proper exercise of Treasury's authority. See, e.g., written comments on proposed ADR regulations submitted by Frederic W. Hickman, Covington & Burling, and Marmet & Webster; ADR Hearings at 310 (testimony of John L. Ellicott).

67 A number of comments on the proposed ADR regulations suggested that the Report of the President's Task Force on Business Taxation indicated that a proposal such as the ADR system could not be adopted without legislation. On April 26, 1971, John H. Alexander, Chairman of the Task Force, submitted a written comment to the Treasury addressed to this point, stating:

"It has come to my attention that in a number of submissions questioning the authority of the Treasury Department to promulgate regulations in the form proposed, reference is made to the recommendation of the President's Task Force on Business Taxation, of which I was Chairman, that the proposals of the Task Force relating to capital cost recovery of investment in machinery and equipment be implemented by legislation rather than by administrative action.

"The specific recommendations of the Task Force were summarized on pages 3 and 4 of its Report.

"With respect to the implementation of

The history of the depreciation provisions clearly reflects an administrative rather than a legislative pattern.68 In this regard, a report of the staff of the Joint Committee on Internal Revenue Taxation submitted to the Congress in 1960 noted:

"Consistently, the statute concerning depreciation has been general, not requiring either any certain method of accounting or uniformity in annual deductions, so long as the taxpayer followed a reasonably consistent plan in recovering the original cost or other basis of his property, less salvage value, free of tax. Thus, depreciation has ar administrative rather than a legisla tive history in U.S. tax law." 69

Prior to 1934, the application of the depreciation provisions was entirely such recommendations the Report contained the following statement at page 29:

"We recommend that the proposals discussed above be implemented by appropriate amendments of the Internal Revenue Code. The proposals in section A [simplification of capital cost recovery] for substituting in the case of machinery and equipment a system of cost recovery allowances for the present depreciation system involve some matters that have been dealt with under the present system by administrative procedures and regulations rather than by changes in the statute. For example, the reserve ratio test was formally introduced in Revenue Procedure 62-21, and, although our proposal for elimination of the test could be effectuated by administrative action, we strongly urge amendment of the statute to this end. Moreover, since the shift from depreciation to cost recovery unrelated to the useful life concept does require amendment of the present law, we urge that all the matters covered in the recommendations which are related to such a shift be incorporated in the statute."

"As appears from the foregoing, the Task Force took the position that it was the shift from depreciation to cost recovery unrelated to the useful life concept that required statutory amendment. The proposed regulations retain the useful life concept and the Task Force position as to the necessity for statutory action contains no suggestion that the Treasury Department lacks authority to modify the guideline lives or to eliminate the reserve ratio test or to adopt the other provisions of the regulations proposed. Indeed, as to the reserve ratio test, the Task Force statement quoted above clearly takes the position that such authority is in the Treasury Departme.it."

68

See text at pages 504-508, supra.

Staff of the Joint Committee on Internal Revenue Taxation, Notes on Background of Existing Provisions of the Federal Income and Employment Tax Laws 13 (August 25, 1960).

conse

determined by the Treasury Department. In 1934, Congress clearly recognized the authority of the Treasury Department to modify depreciation practices by administrative action having a major effect on business tax liabilities, in lieu of legislative action which would have increased depreciation periods by 25 percent. Treasury's administrative action had relative revenue quences far greater than those attributable to the adoption of ADR. Again in 1954, Congress explicitly recognized the broad discretion of the Treasury Department in establishing a reasonable allowance for depreciation. Congress at that time acknowledged the authority of the Treasury Department to accept any lives adopted by taxpayers unless there was a clear and convincing basis for a change, and Congress again withheld taking legislative action because of the existence of this authority."1

More specifically, in the course of adoption of the Internal Revenue Code of 1954, the Senate Finance Committee deleted a 10 percent proposed statutory range of tolerance in depreciation lives which has been provided in the House bill, approved the concept of this range, but recognized the greater need for administrative flexibility. Thus, Congress did not provide for any changes in the 1954 Code with respect to the method for determining the estimated useful life of business assets. It is important to recognize the acceptance of the Treasury's authority by the Congress and the preference for administrative resolutions of depreciation problems inherent in this Congressional action.

The 1962 action of the Treasury Department in adopting the Guidelines, an action approved by Congress, is a clear precedent for the adoption of ADR by administrative action.72 The adoption of Guidelines is such a prece

TO See text at page 505, supra.

See text at page 506, supra. "The Guidelines received contemporaneous recognition by Congress in connection with the Revenue Act of 1962 [P.L. 87-834, C.B. 1962-3, 111]. See H. Rept. No. 1447, 87th Cong., 2d Sess. 8 (1962) [C.B. 1962– 3, 405]; S. Rept. No. 1881, 87th Cong., 2d Sess. 11 (1962) [C.B. 1969-3, 707].

dent because it too represented a decision to determine lives by reference to industry experience. This identity exists, notwithstanding the announcement at that time of the reserve ratio test, in view of the fact that the test was suspended for three years and, as a practical matter, has not had any substantial effect for nine years because of its exceptions and transition rules and because of its general inapplicability for more than one full asset cycle."

The ADR system has been adopted by regulation, following publication of a notice of proposed rule making, receipt of written comments, and three days of public hearings; its adoption represents a far more formal step than the adoption of the Guidelines which was accomplished by publishing a revenue procedure in the Internal Revenue Bulletin.

The wide administrative discretion in the depreciation area is consistent with other instances where broad administrative discretion has been exercised under the Internal Revenue Code, such as in the allowance of standard mileage allowances and sales tax deductions by reference to the experience of taxpayers generally."

73 See text at 508-512, supra.

76

"In the administration of the Internal Revenue Code, recourse has been made in several situations to uniform tables or formulas to determine the proper amount of certain deductions. Common examples of these are the tables included in the instructions to individual income tax return Form 1040, which provide a basis for determining the amount of state or local sales tax and gasoline tax paid by an individual for purposes of the deduction allowed by § 164 of the Code.

Under § 162 of the Code, standard mileage rates for determining automobile expenses were prescribed in Rev. Proc. 70-25, 1970-2 C.B. 506. Similarly, Rev. Proc. 7024, 1970-2 C.B. 505 prescribes the standard mileage rate for determining automobile expenses for purposes of the deductions allowed by § 170 and § 213 of the Code; and Rev. Proc. 71-2, C.B. 1971-1, 659, prescribes similar rules for purposes of the deduction allowed by § 217 of the Code.

In the situations described above, the Internal Revenue Service has prescribed rules for determining the proper amount of deductions in particular cases based on average experience applicable to all taxpayers. All of the statutes involved allow deductions only for amounts paid (or in some cases amounts paid or incurred) for particular expenses. The use by the Service of these means of approximating the proper

The very complexity of issues in the allowance of depreciation indicates the need for the wide discretion which Congress has given to the Treasury

deduction might be criticized on the ground that it departs from the theoretically exact amount paid or incurred by the taxpayer in a particular case. As an example, there may be very substantial differences in the operating expenses of different kinds of automobiles by different taxpayers, but Rev. Proc. 70-25 would allow a uniform rate per mile.

With respect to the breadth of the discretion of the Internal Revenue Service to prescribe uniform rules, § 167(a) is similar to § 166 (c), which provides that in lieu of a deduction for specific debts that become wholly or partially worthless during the taxable year, there shall be allowed (in the discretion of the Secretary or his delegate) a deduction for a reasonable addition to a reserve for bad debts. The parenthetical language in § 166 (c) refers to the Secretary or his delegate's discretion to refuse to allow a taxpayer to use the reserve method and not to the reasonableness of the deduction allowed. H. Rept. No. 350, 67th Cong., 1st Sess. at 11 (1921) stated:

"Under the present law worthless debts are deductible in full or not at all, but [the bill] would authorize the commissioner to permit a deduction for debts recoverable only in part, or in his discretion to recognize a reserve for bad debts-a method of providing for bad debts much less subject to abuse than the method of writing off bad debts required by the present law."

Section 1.166-4(b) (1) describes relevant factors for determining what constitutes a reasonable addition to a reserve for bad debts. Procedures for adopting a change to the reserve method of accounting for bad debts are described in Rev. Proc. 64-51, 1964-2 C.B. 1003, as modified by Rev. Rul. 65-92, 1965-1 C.B. 112, and as amplified by Rev. Proc. 70-15, 1970-1 C.B. 441.

Under the authority of § 166(c), the Internal Revenue Service provided by Rev. Rul. 68-630, 1968-2 C.B. 84, a uniform method for determining a reasonable allowance of deductions to commercial banks for additions to their reserve for bad debts. Rev. Rul. 68-630 has been superseded by the enactment of § 585 of the Code by the Tax Reform Act of 1969. The committee reports accompanying § 585 of the Code referred extensively to the administrative history of the allowance of bad debt reserve deductions to commercial banks. These reports evidenced an intent to reduce the allowance of deductions for bad debt reserves to commercial banks but raised no questions as to the validity of Rev. Rul. 68-630 or any prior rulings. H. Rept. No. 91-413, 91st Cong., 1st Sess. 120 (1969); and S. Rept. No. 91-552, 91st Cong., 1st Sess. 156 (1969).

See Reg. § 1.482-2(a) where the Treasury provided a 20 percent leeway in determining a reasonable interest rate on loans between affiliated taxpayers. These regulations provide that 5 percent interest will generally be considered a reasonable in

Department in this area.75 More detailed legislation prescribing depreciation allowances for particular industries seems neither desirable nor practical. One need only reflect upon the difficulties involved in rigidly setting by legislation the various allowances for percentage depletion to foresee the problems if Congress were to attempt to establish useful lives for depreciation for particular industries.76

terest rate on such loans but that no adjustment will be made if interest is charged at the rate of at least 4 percent but not more than 6 percent. If a rate of less than 4 percent or more than 6 percent is charged, the rate will be set at 5 percent. See also, Reg. §1.963-6(b)(4), which provides that "reasonable cause" for failure to receive a minimum distribution will exist if at least 80 percent of the amount of the required minimum distribution was paid.

15

Cf., S. 1532, 92d Cong., 1st Sess. (introduced in connection with introduction of S. Res. 98, 92d Cong., 1st Sess. that ADR not be made effective) which provides that the depreciation deductions under § 167 (a) shall be "based upon the estimated useful life to the taxpayer" of depreciable property. This bill gives no guidance as to the method of "estimating" useful life. Without further guidance, the Treasury would have broad discretion as under present law to administer such a provision. If, for example, the Internal Revenue Service were to apply its pre-1934 and 1954-1962 administrative practices and generally accept the taxpayer's "estimate" of useful life, this would not be inconsistent with the ADR approach. ADR provides additional guidance to the taxpayer by setting forth a range of useful lives within which the taxpayer's estimate will not be disturbed. In addition, ADR provides a comprehensive system of depreciation accounting and an administrative mechanism to insure that the ADR range provides a "reasonable allowance." S. 1532 does not amend the operative language in § 167(a) which provides for a "reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence)" of property.

70 Section 613 of the Internal Revenue Code allows a deduction based upon a specified percentage of the gross income attributable to the production of certain minerals. Although this is relatively simple in concept, even a cursory examination of the statutory provisions indicates clearly the problems Congress has encountered in applying that concept. There are, for example, seven rate categories applicable to various groups of minerals. However, within these categories it has been necessary to make numerous exceptions because the mineral may fall into different rate categories. The different rates are usually expressed in terms of the use to which the mineral is put, and generally have been enacted in order to rectify inequitable competitive situations. As a consequence of these considerations, it has been necessary

same

The reasons for abolishing the reserve ratio test, and for not seeking a substitute but looking instead to industry experience, have previously been

for Congress to amend these provisions in almost every Congress since percentage depletion was extended to all minerals in 1951.

An extreme example of the difficulty Congress has experienced in this area may be found in the history of the percentage depletion rate allowed to clay. Minerals in this general category were first made eligible for depletion in 1942, when Congress permitted "ball and sagger clay" a rate of 15 percent. This was accomplished in order to put that mineral "on the same basis as coal, oil, fluorspar and other things which are given depletion allowances." The premise for this allowance was that the items manufactured from that mineral were useful to the war effort generally as well as in everyday life. In 1947 the list of clays eligible for depletion was expanded to include "china clay." In 1951 "brick and tile clay" was added but at a rate of only 5 percent, and "refractory clay" was added at the 15 percent rate.

The 1954 Code revised the percentage depletion rate structure generally in order to "clarify present law and to provide a grouping that is administratively more feasible and competitively more equitable." H. Rept. No. 1337, 83rd Cong., 2d Sess. 57. The changes also made depletion at the rate of 15 percent available to "all other minerals," thus including all the clays that had not previously been eligible for the deduction. In 1960 it was necessary to expand the provision describing brick and tile clay to include all clay "used or sold for use in the manufacture of building or paving brick, drainage and roofing tile, sewer pipes, flower pots and kindred products," in order to limit clays used for those purposes to the 5 percent rate rather than the 15 percent rate available for "all other minerals." In 1966, this was further revised to remove "clay used or sold for use in the manufacture of sewer pipe or brick" or as "sintered or burned lightweight aggregates" from the 5 percent category and place them in a new category of 72 percent. At the same time, a rate of 23 percent was made available for clay "to the extent that alumina or aluminum compounds are extracted therefrom." The general reduction of depletion rates contained in the Reform Act of 1969 reduced the 23 percent clay to 22 percent, the 15 percent clay was reduced to 14 percent, while the 72 and 5 percent rates were left unchanged.

Notwithstanding the frequency of these changes, the administrative burden involved in applying them has not been significantly simplified. The multitude of different clays all sought the highest available rate, and numerous rulings were necessary. In addition, a number of court decisions were necessary in order to finally decide some of the issues. See, for example, Pacific Clay Products v. United States, 332 F. 2d 156 (9th Cir. 1964); Rev. Rul. 66-24, 1966-1 C.B. 157; Rev. Rul. 55-180, 1955-1 C.B. 358.

documented." The ADR regulations do not eliminate the "useful life" concept; they merely provide a method of determining "useful lives" by reference to guideline class lives established on the basis of industry experience. These guideline class lives will be updated from time to time based on data collected through the ADR system. ADR provides a range within which a taxpayer may select a useful life appropriate to him. The lives adopted by the taxpayer from the asset depreciation range period based on the guideline class life will constitute his "useful life" for all purposes of the Code.78

The ADR system is a comprehensive system for dealing with all elements of the determination of depreciation and the integrally related problem of repair and maintenance expenditures."

"See text at pages 508-515, supra.

78

See Reg. §1.167(a)–11 (g) (1), which provides that an election to use the ADR system is a useful life agreement under § 167 (d) to treat the ADR period selected as the useful life of the property for all purposes under the Internal Revenue Code, in cluding §§ 46, 47, 48, 57, 163 (d), 167(c), 167 (f) (2), 179, 312(m), 514(a) and 4940 (c). Thus, for example, since § 167(c) requires a useful life of at least three years and the ADR period selected is treated as useful life for purposes of § 167 (c), the taxpayer may use the declining balance method or sum of the years-digits method of depreciation only if the ADR period selected is at least three years.

"The ADR system provides a compre hensive new treatment of the entire area of expenditures for the repair, maintenance, rehabilitation or improvement of property in Regs. § 1.167(a)–11(d)(2). Such expenditures are deductible under §§ 162 and 212, except to the extent they constitute capital expenditures under § 263. The expenses associated with preserving and keeping in efficient operating condition (repair and property maintenance) are deductible, and certain expenditures for permanent improvements or betterments made to increase the value (as distinguished from present value and upkeep) are capital expenditures, the same as the purchase of a new asset. In between these extremes fall many expenditures which are neither clearly deductible expenses nor capital improvements or betterments. Prior to ADR, resolution of this issue has been treated as a question of fact, involving subjective or negotiated judg ments and arbitrary rules of thumb which vary from industry to industry, revenue agent to revenue agent and audit to audit. This process has traditionally led to numerous and extended controversies with taxpayers, which is necessarily the case when a factual judgment is made with respect to each of hundreds, or even thousands, of such expenditures in any particu

The adoption of such a system is within the Treasury Department's delegated authority under sections 167, 446, 451,

lar audit. This is not productive of fair and uniform treatment of taxpayers and has been a major administrative problem for the Internal Revenue Service for many years.

The annual repair allowance under the ADR system provides a simplified procedure for resolution of repair vs. capital issues. Expenditures for permanent improvements and betterments are excluded from the repair allowance and are capitalized in accordance with § 263. Regs. § 1.167(a)-11 (d) (2). There remain only the clearly deductible repairs, plus those whose status is ambiguous-those which are neither clearly deductible nor clearly capital. Under ADR, these are deductible to the extent of a specified percentage repair allowance for each guideline class with the excess capitalized. Application of an audit rule of thumb of this type on a uniform basis to all taxpayers under ADR-as contrasted with the traditional applications of varied and inconsistent comparable audit tools to individual taxpayers is a legal exercise of the Treasury's administrative authority under § 7805 to provide all needful rules and regulations for the enforcement of §§ 162, 212 and 263 and other provisions of the Internal Revenue Code.

The ADR repair allowance is clearly distinguished from the issue in F.H.E. Oil Co. v. Commissioner, 147 F.2d 1002 (5th Cir. 1945) in which the Treasury's regulations were proposed to be amended to permit the deduction of an amount which was clearly a capital expenditure. In that situation there was no factual issue of whether the expenditure was capital, and the proposed amendment to the regulations was not an exercise of statutory responsibility to provide a mechanism for resolving a factual issue. Moreover, the ADR repair allowances have been established based on Treasury's evaluation of statistical and other data reflecting industry experience with respect to such expenditures for asset guideline classes.

A comparable legal situation exists with respect to the treatment of salvage value adjustments in Treasury Regs. § 1.167(a)– 11(d)(1). The amount of depreciation which may be deducted for an asset is limited to its cost minus its salvage value. Salvage value is a matter of estimation, involving a present projection of the value of the asset many years in the future. As in the case of estimations of useful life in the future there is no one amount which is necessarily the correct estimate. There is a range of tolerance within which any estimate will be reasonable. A "reasonable" salvage value is all that has ever been required. The ADR system provides a means for resolving these factual determinations and avoiding administrative problems associated with extended controversies with taxpayers over minimal adjustments in salvage value The taxpayer's estimate will be accepted as reasonable if it is within a range of the salvage value estimated by the Internal Revenue Service. This range is equal to 10 percent of the cost of the assets in the vintage ac

461, and 7805 of the Internal Revenue Code of 1954.80

VII. Economic Effects and Revenue Considerations

Among its other effects, the ADR system will reduce the cost of capital or, equivalently, improve the after tax

count. The ADR system does not disregard a percentage of salvage value as is done by statute under § 167(f). The 10 percent adjustment limitation relates only to the resolution of the factual question whether the salvage estimated by the taxpayer is reasonable. If not, the salvage will be adjusted, taking into account the full amount of the adjustment except for the portion expressly excluded under § 167(f).

An important aspect of the ADR system-insofar as related to useful life, repairs vs. capital and salvage value is that all three are interrelated issues involving the resolution of factual questions. Because of their nature, all three must be resolved whether by a revenue agent in a particular audit or by regulation-by the use of guidelines.

80 The Supreme Court decisions in Massey Motors, Inc. v. U.S., 364 U.S. 92 (1960) [Ct.D. 1847, C.B. 1960-2, 445] and Hertz Corporation v. U.S., 364 U.S. 122 (1960) [Ct.D. 1848, C.B. 1960-2, 70], do not require a different result. These cases hold that portions of the regulations dealing with useful life were valid. These regulations provide as follows:

The

§ 1.167(a)-1. Depreciation in general. (a) Reasonable allowance. allowance is that amount which should be set aside for the taxable year in accordance with a reasonably consistent plan (not necessarily at a uniform rate), so that the aggregate of the amounts set aside, plus the salvage value, will, at the end of the estimated useful life of the depreciable property, equal the cost or other basis of the property as provided in section 167(g) and § 1.167(g)−1. . .

(b) Useful life. For the purpose of section 167 the estimated useful life of an asset is not necessarily the useful life inherent in the asset but is the period over which the asset may reasonably be expected to be useful to the taxpayer in his trade or business or in the production of his income.

The substance of clause (a) has been in the regulations since 1919, and clause (b) was added to the regulations in 1956.

Massey involved taxable years to which the Internal Revenue Code of 1939 was applicable and considered whether the taxpayer could estimate a theoretical salvage value at the end of the physical lives of cars used in its trade or business and calculate depreciation on that basis or was required to refer to its own experience in determining probable salvage value and thereby the appropriate allowance for depreciation. The Supreme Court sustained the Government's argument that salvage value must be determined as of the end of

rate of return from investing. The ADR system is calculated to result in approximately a 4.4 percent reduction in capital cost for eligible assets. Improved after tax profit prospects will result in investments in productive machinery and equipment which would have been rejected in the absence of the ADR system. ADR will also increase liquidity and increase the certainty of business tax liabilities-effects which will also encourage investment.

Liberalized depreciation is a wellrecognized means of providing a more favorable tax climate for private investment in production facilities. The 1962 Guidelines were adopted in part: to stimulate economic recovery (unemployment was about 62 percent in 1961 when liberalized depreciation was first considered), to increase the competitiveness of U.S. goods in the world markets, and to promote long run economic growth. Liberalized depreciation has been widely used in the postwar period by other industrialized nations with substantially beneficial effects on investment and economic growth. As the President's Task Force on Business Taxation pointed out, our own country's experience during the recent past following the adoption of depreciation guidelines and the investment credit suggests that such incentives significantly encourage the development and modernization of the productive capacity of a nation. The

the useful life to the taxpayer in his trade or business.

The decision of the Supreme Court in Hertz involved taxable years to which the Internal Revenue Code of 1954 was applicable and considered whether the definition of "useful life" contained in section 1.167 (a)-1(b) was valid insofar as it affected the taxpayer's eligibility to elect an accelerated method of depreciation under section 167 (b). The Supreme Court sustained the validity of the regulatory definition. The Court also held that property may not be depreciated below a reasonable salvage value even though a declining balance method is used.

Neither of these cases held that the regulations in force at that time constituted the only possible definition of useful life; in neither Massey nor Hertz was there any determination that it was inappropriate to determine "useful lives" on the basis of industry-wide experience. The holdings of Massey and Hertz are specifically preserved in the ADR regulations. See Reg. §§ 1.167 (a)-11(d) (1) and (c)(1)(i) (a).