Full opinion text
OPINION PER CURIAM: This case was referred to Trial Commissioner James F. Davis with directions to make findings of fact and recommendation for conclusions of law under the order of reference and Rule 134 (h). The commissioner has done so in an opinion and report filed on October 28, 1970. The plaintiff filed exceptions to the commissioner’s opinion with respect to the rail salvage issue and the vacation pay accrual issue. The defendant filed exceptions to the commissioner’s opinion regarding the issues of donated property depreciation, casualty loss, welded rail, protective facilities, and the Mexican tax credit. Both parties requested review of the commissioner’s opinion. The case has been submitted to the court on oral argument of counsel and the briefs of the parties. Since the court agrees with the commissioner’s opinion, findings of fact and recommended conclusion of law, with certain modifications, as hereinafter set forth, it hereby adopts the same, as modified, as the basis for its judgment in this case. Therefore, it is concluded the plaintiff is entitled to recover, together with interest as provided by law, on the claims relating to (1) § 1341 computation, (2) excess salvage value, (3) donated property depreciation, (4) casualty loss, (5) welded rail, (6) protective work, and (7) Mexican tax credit, and judgment is entered to that effect. The court further concludes that plaintiff’s recovery shall be subject to the setoffs raised by defendant with respect to (1) rail salvage value, and (2) vacation pay accrual. The amount of recovery will be determined in subsequent proceedings under Rule 131(c). Commissioner DAVIS’ opinion, as modified by the court, is as follows: This is a suit to recover income taxes paid for the year 1955. Plaintiff operates a railroad as a common carrier in interstate commerce, subject to the jurisdiction of the Interstate Commerce Commission. Plaintiff’s petition raised six issues with respect to a claim for refund timely filed with, and ultimately denied by, the District Director of Internal Revenue at Chicago, Illinois. In its answer and first amended answer, defendant asserted four setoff defenses, pursuant to Missouri Pacific R. R. v. United States, 168 Ct.Cl. 86, 338 F.2d 668 (1964). Before trial, defendant dropped one of the setoff defenses; and by pretrial stipulation, the parties resolved one issue raised in the petition. Trial was held on the remaining eight issues. After trial, defendant conceded that plaintiff is entitled to recover on one other issue raised in the petition. Remaining for resolution, therefore, are seven issues, designated as follows: (a) donated property depreciation; (b) casualty loss; (c) welded rail; (d) rail salvage value; (e) protective work; (f) vacation pay accrual; and (g) Mexican tax credit. DONATED PROPERTY DEPRECIATION ISSUE Starting about 1930, plaintiff entered into many agreements with several mid-western states for construction of highway overpasses and underpasses at highway-railroad intersections, and grade-crossing protection equipment, such as flashing-light signals and automatic gates. Though the agreements are not identical, generally plaintiff agreed to perform a large share of the construction work and the states agreed to pay most of the cost. Sometimes, part of the work was done by state highway departments. Pursuant to Federal highway aid legislation (particularly acts passed in 1933 and 1944), the Federal Government agreed to pay the governmental share of the cost. Federal funds were allocated to the states to pay for specific construction projects. E. g., the Federal Highway Act of 1944, 58 Stat. 839, ch. 626, provided that costs be apportioned between the Government and the railroads, the railroads’ share not to exceed 10 percent. Most of the agreements did not state expressly whether the respective state governments or plaintiff was to have legal title to the facilities. However, the parties have stipulated that the facilities (jetties, bridges, highway under-crossings and overcrossings, floodlights, flasher signals, and signs) were “contributed” to plaintiff by the states; and this is taken to mean that plaintiff owns them, at least for purposes here material. See Lazarus, infra. In any event, under all the agreements, plaintiff was obligated to maintain and replace as necessary, at its own expense, facilities originally built. The facilities were constructed primarily for the benefit of the public to improve safety and to expedite motor-vehicle traffic flow. The record shows, however, that plaintiff received economic benefits from the facilities, e. g., probable lower accident rates, reduced expenses of operating crossing equipment and, where permitted, higher train speed limits. Plaintiff also received intangible benefits, e. g., goodwill from the community-at-large, which was to plaintiff’s long-term economic advantage. On February 5, 1943, plaintiff requested permission of the Service to change from retirement to depreciation accounting for road property. On April 23, 1943, the Service responded by letter to plaintiff’s request and enclosed Mimeo 58, entitled “Change from Retirement to Depreciation Accounting for Road Property.” Mimeo 58 set out guidelines under which the changeover in accounting practice by the railroads would be acceptable to the Service and described information to be furnished by the railroads. Plaintiff thereafter furnished to the Service the required information which, in essence, constituted a list of properties subject to depreciation, their cost basis, salvage value, expired life, and estimated normal useful life. On September 20, 1944, the Service sent plaintiff a terms letter, incorporating the information supplied by plaintiff and some of the requirements set out in Mimeo 58. This terms letter was reaffirmed by defendant's letter of December 14, 1959. The terms letter granted plaintiff permission “to change from retirement to depreciation accounting as of January 1, 1943,” to be effective “upon receipt of a letter agreeing to all the terms and conditions set forth herein.” On April 20, 1945, plaintiff accepted the terms letter on the condition that “in the event that if any of the terms and conditions stated in said letter should be changed by statutory amendment, by operation of law, or otherwise,” plaintiff would not be precluded “from the benefits of any such changes” and would be “entitled to the benefits of any such changes regardless of the acceptance herein contained.” Mimeo 58 provided in part that “Donated property or contributions or grants in aid of construction from any source must be excluded” from the depreciable base. This statement was not included in the terms letter. However, the schedules of plaintiff’s property, submitted to the Service for which straight line depreciation was requested, did not include the donated property here at issue. Subsequently, on May 1, 1961, plaintiff submitted to the Service revised schedules for depreciable roadway property and requested the benefit of section 94 of the Retirement-Straight Line Adjustment Act of 1958. The Service responded to plaintiff’s request, noting the terms letter of September 20, 1944, and stating that plaintiff’s revised schedules were acceptable so far as relevant herein. The revised schedules of depre-ciable property submitted by plaintiff to the Service in 1961 did not include the donated property here at issue. The issue is whether the facilities are assets properly depreciable by plaintiff. Plaintiff contends they are property donated to it for use in its business and are depreciable under the rationale of Brown Shoe Co. v. Commissioner, 339 U.S. 583, 70 S.Ct. 820, 94 L.Ed. 1081 (1950). Defendant concedes that the facilities are of a character normally subject to allowance for depreciation and that to the extent they were paid for by plaintiff, appropriate depreciation deductions are proper. Defendant says, however, that to the extent plaintiff did not pay for the facilities, it cannot depreciate them, relying on Detroit Edison Co. v. Commissioner, 319 U.S. 98, 63 S.Ct. 902, 87 L.Ed. 1286 (1943). The parties have agreed to the adjusted tax basis for the facilities in the hands of the plaintiff at the time of acquisition, and the rate of straight-line depreciation applicable, if the court decides that depreciation on the full value is proper. The parties have also agreed that the issue is whether the law of Detroit Edison or Brown Shoe is applicable. Our starting point therefore is a brief discussion of the Detroit Edison and Brown Shoe cases. In Detroit Edison, the issue was whether the taxpayer could depreciate the cost of certain electric power lines. The taxpayer, Detroit Edison Company, engaged in the generation of electric power for distribution and sale to the public. It often received applications for service which, in its opinion, would require the construction of power line extensions having a cost not warranted by prospective revenues. Accordingly, the company required the applicants for service to pay the cost of line installations, in part refundable from future revenues collected. The company contended that, to the extent the cost of the lines was not refunded, the customers’ payments were gifts or contributions to the company’s capital and thus were de-preciable to it as exhaustible capital assets. The Court held, however, that the payments were not gifts or contributions to the company’s capital but rather were payments for “the price of the service,” i. e., the providing by the company of electrical power to the customers. The Court said “[i]t is enough to say that it overtaxes imagination to regard the farmers and other customers who furnished these funds as makers either of donations or contributions to the Company.” Thus, the taxpayer was not permitted the depreciation deductions it sought. In Brown Shoe, decided seven years after Detroit Edison, the issue was whether property, including buildings and equipment, donated to the taxpayer by community groups, represented “contributions to capital” and were depre-ciable within the meaning of § 113(a) (8) (B) of the Internal Revenue Code (1939). The property was donated to induce the taxpayer to set up and operate a manufacturing plant in the community. The Court held that the property constituted capital assets in the hands of the taxpayer and was deprecia-ble by it, noting that the “value which the taxpayer received were additions to ‘capital’ as that term has commonly been understood in both business and accounting practice,” and that “contributions to capital may originate with persons having no proprietary interest in the business.” The Court further noted, citing Commissioner v. McKay Products Corp., 178 F.2d 639, 643 (3d Cir. 1949), that “ * * the assets received * * * are being used by the taxpayer in the operation of its business, * * * will in time wear out, and * * * must eventually be replaced.” Finally, the Court said, in distinguishing the Detroit Edison case, that the “contributions to petitioner 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. Under these circumstances the transfers manifested a definite purpose to enlarge the working capital of the company.” Plaintiff says that the facts here fit Brown Shoe rather than Detroit Edison. Plaintiff notes, among other things, that the facilities in issue are exhaustible assets used in plaintiff’s business, are of a character normally subject to depreciation allowance, and were contributed to plaintiff by state governments whose interest was not to obtain goods or services but rather to benefit the public as a whole. Plaintiff also notes, citing Edwards v. Cuba R. R., 268 U.S. 628, 633, 45 S.Ct. 614, 69 L.Ed. 1124 (1925), that the facilities were contributed “unquestionably * * * to increase the capital position of the plaintiff taxpayer for only capital assets were contributed and not monies which could be used for the payment of dividends or expenses ordinarily payable out of earnings or income.” The court concludes that the plaintiff is correct; and although the facts are not on all-fours with Brown Shoe, the rationale of that case, rather than Detroit Edison, is controlling. Defendant says that plaintiff “has no cost for these facilities and therefore does not stand to lose any portion of its investment by their use or the passage of time * * Plainly, there is no merit to this argument. In Brown Shoe, the taxpayer had no “cost” in the donated property; yet the property was held to be assets depreciable by the taxpayer. Defendant also says that the governmental payments for the facilities “were not intended to be contributions to the capital of the railroad,” but rather were “part of the cost of the state in building its highway system” ; and that the facilities are “not related to the production of income but rather to the safety of the local community.” No doubt, the principal purpose of the facilities was to benefit the community-at-large by providing improved safety at railroad-highway intersections. But the fact remains that the facilities enlarged plaintiff’s working capital and were used by plaintiff in its business; and though they may not produce income to the same extent as other railroad property, such as track or freight cars, plaintiff derived economic benefits from them. Of principal importance, under every contract for constructing the facilities, plaintiff was obligated to maintain and replace the facilities at its own expense. This obligation places squarely on plaintiff the economic loss attendant to wear and tear of the property. As noted in the McKay Products case, supra, 178 F.2d at 643, cited in Brown Shoe, * * * the assets * * * are being used by the taxpayer in the operation of its business. They will in time wear out * * * and must eventually be replaced. Looking as they do toward business continuity, the Internal Revenue Code’s depreciation provisions * * * would seem to envision allowance of a depreciation deduction in situations like this * * * Also pertinent is Helvering v. F. & R. Lazarus & Co., 308 U.S. 252, 60 S.Ct. 209, 84 L.Ed. 226 (1939), and cases cited therein, which holds that depreciation deductions go to the party which “bears the burden of wear and exhaustion of business property,” irrespective of who may have legal title. Defendant contends alternatively that, in accordance with the requirements of Mimeo 58 and the terms letter, plaintiff submitted schedules of its depreciable property which excluded the donated property here at issue from basis. The Commissioner of Internal Revenue accepted plaintiff’s proposed basis for its depreciable road property and permitted plaintiff to make the requested accounting change. Included in the terms letter were the amounts to be included in the cost basis of plaintiff’s various road accounts, together with the proviso that “the remaining sum to be recovered through depreciation allowances shall be limited to the cost or other basis less the depreciation so accrued * * Thus, says defendant, plaintiff agreed not to take any depreciation deductions based upon donated property. Defendant also argues that the Retirement-Straight Line Adjustment Act of 1958 provides in section 94(e) that the terms and conditions of the terms letter would be binding on taxpayers such as plaintiff electing the benefits of that Act from the date of the terms letter until the date of such election. Mimeo 58 provides in relevant part that: The basis for depreciation shall be the cost of the existing depreciable property to the present taxpayer, determined in accordance with sections 113 and 114(a) of the Internal Revenue Code. * * * * * * * * * The basis may include only the investment in property which is actually depreciable. Thus excavations, dredging, expendable small tools, land improvements, land surveys, etc., are not depreciable expenditures, whereas retaining walls, drainage systems, etc., are. Donated property or contributions or grants in aid of construction from any source must be excluded. ***** * In view of the fact that it will be impossible for the Bureau to make a detailed investigation of the depreciation basis, the permission letter in-eludes a mutual understanding that the basis may be corrected to conform to the allowable basis under the Internal Revenue Code should subsequent investigation disclose errors of cost or valuation. * * * The terms letter provides in relevant part: It is mutually understood that this is an agreement in principle and that a detailed investigation of the depreciation basis has not been made by the Bureau, and that the basis may be corrected ■ to conform to the allowable basis under the Internal Revenue Code should investigation disclose errors of cost or valuation. * * * Defendant argues for too narrow an interpretation of Mimeo 58 and the terms letter. It seems clear that the purpose of the just-quoted provisions was to establish as the basis for depreciation of the road property the basis allowable under Sections 113 and 114(a) of the Internal Revenue Code of 1939. The statement “Donated property or contributions or grants in aid of construction from any source must be excluded” was only the opinion of the Service with respect to what constituted the basis allowable under the Code and does not rise to the level of a condition upon which permission to change depreciation methods would be granted. Ultimately, the Supreme Court determined that opinion to be erroneous in the case of Brown Shoe Co. v. Commissioner, supra, and held that, pursuant to Section 113(a) (8) (B) of the 1939 Code, a taxpayer was entitled to include in its basis for depreciation certain donated property. Even assuming that the statement “Donated property or contributions or grants in aid of construction from any source must be excluded” was a condition for the changeover, the provision that the basis for depreciation was to be determined in accordance with the Code should take precedence and control. As indicated, the Brown Shoe case, supra, held that certain donated property could be included in the depreciable base under Section 113(a) (8) (B) of the 1939 Code. Furthermore, the 1944 terms letter itself, which constitutes the only agreement between the parties, says nothing about excluding donated property from the basis of depreciable property. While it might be argued and inferred that plaintiff agreed by implication to such condition in the guidelines, it is just as reasonable to infer that plaintiff acquiesced in the condition, without agreeing with it, simply to avoid possible refusal of its requested change in accounting methods. Also, assuming again that the above statement was a condition for the changeover, that condition must be viewed in light of the law as it existed when the condition was accepted. As stated in Brown Shoe, supra, 339 U.S. at 589, 591, 70 S.Ct. 820, 94 L.Ed. 1081, it was the position of the Service that Detroit Edison Co. v. Commissioner, supra, settled the question that donated property could not be added to the basis for depreciation. When plaintiff accepted the terms letter in 1945, its acceptance provided that “in the event that if any of the terms and conditions stated in said letter should be changed by statutory amendment, by operation of law, or otherwise,” plaintiff would not be precluded “from the benefits of any such changes” and would be “entitled to the benefit of any such changes regardless of the acceptance herein contained.” The Supreme Court’s decision in Brown Shoe, supra, distinguishing the case of Detroit Edison, supra, and holding that certain donated property could be added to the depreciable base, produced such a change in the conditions of the terms letter and plaintiff is entitled to the benefits thereof. In sum, the facilities in issue are exhaustible assets properly depreciable by plaintiff to the full extent of their value. CASUALTY LOSS ISSUE In 1955, 13 freight cars owned by plaintiff were destroyed in accidents while on lines of other railroads. The cars were property used in plaintiff’s business and were emergency facilities subject to rapid amortization (60 months) pursuant to § 124A of the 1939 Internal Revenue Code and § 168 of the 1954 Internal Revenue Code. The cars’ cost to plaintiff was $76,007.30. At the time of the loss, amortization had accrued to the extent of $36,886.58, the adjusted basis for the cars thus being $39,-120.72. As compensation for the loss, plaintiff received $83,186.35, a gain of $44,065.63 over the adjusted basis. The issue is the tax treatment to be accorded such gain. Plaintiff says the gain should be taxed as a capital gain, pursuant to § 1231 of the 1954 Code which provides in pertinent part: If, during the taxable year, the recognized gains on sales or exchanges of property used in the trade or business, plus the recognized gains from the compulsory or involuntary conversion (as a result of destruction in whole or in part, theft or seizure, * * *) of property used in the trade or business * * * into other property or money, exceed the recognized losses * * *, such gains and losses shall be considered as gains and losses from sales or exchanges of capital assets held for more than 6 months. * * * (Emphasis added.) Defendant, on the other hand, says that the gain should be treated as ordinary income to the extent of the difference between the adjusted basis of the property under rapid amortization and what the adjusted basis would have been under normal depreciation. The parties have stipulated that under straight-line depreciation, the adjusted basis at the time of loss would have been $67,759.-94. The difference in bases, therefore, is $28,639.22 ($67,759.94 less $39,120.-72). Defendant relies on § 1238 of the 1954 Code which provides: Gain from the sale or exchange of property, to the extent that the adjusted basis of such property is less than its adjusted basis determined without regard to section 168 (relating to amortization deduction of emergency facilities), shall be considered as gain from the sale or exchange of property which is neither a capital asset nor property described in section 1231. (Emphasis added.) The parties agree that plaintiff’s gain resulted from involuntary conversion; that § 1231 applies to gains from “involuntary conversion” as well as “sales or exchanges”; but that § 1238 speaks' only of gains from “sale or exchange.” That would appear to end the matter in plaintiff’s favor since it has long been held that an involuntary conversion is not a sale or exchange. Helvering v. William Flaccus Oak Leather Co., 313 U.S. 247, 61 S.Ct. 878, 85 L.Ed. 1310 (1941). Defendant, however, says that § 1238 should be construed to include gains from involuntary conversions, as well as gains from sales or exchanges, because otherwise plaintiff will “be able to take this gain as a capital gain after haying taken deductions against ordinary income for the ‘rapid amortization’ under § 168.” Defendant points to two cases, Towanda Textiles, Inc. v. United States, 149 Ct. Cl. 123, 180 F.Supp. 373 (1960), and Kent Mfg. Co. v. Commissioner, 288 F.2d 812 (4th Cir. 1961), in which § 337 of the 1954 Code, dealing with gains from sales or exchanges by corporations during liquidation, was construed to include gains from involuntary conversions. Defendant says § 1238 should be construed the same way. Despite an appealing logic to defendant’s position, in my view it cannot prevail. Section 1238 is brief, clear and unambiguous. It was derived substantially unchanged from § 117(g) (3) of the 1939 Code. The legislative history of § 117(g) (3), enacted as part of the Revenue Act of 1950, shows that it was intended as a recapture provision to tax as ordinary income gains made upon the voluntary disposition (sale or exchange) of emergency facilities entitled to rapid amortization, to the extent such amortization reduced the basis of the property below normal depreciation. The Congressional committee report which discusses and explains § 117(g) (3) speaks only of voluntary conversions, i. e., “sales” and “exchanges,” and gives examples of each. Nothing is said about involuntary conversions. The pertinent Treasury Regulation (Treas.Reg. § 1.-1238-1) likewise speaks only of “sales” and “exchanges.” It is thus clear from the statute, the regulations and the legislative history that the purpose of § 117 (g) (3) (and later § 1238) was to prevent taxpayers who are entitled to the benefits of rapid amortization of emergency facilities from later disposing voluntarily of those facilities so to convert accelerated amortization deductions from ordinary income into capital gains. Nothing in the legislative history suggests that it was also Congress’ purpose to treat gains from involuntary conversions the same way. There is nothing surprising in this since involuntary conversions (unlike sales or exchanges) by their very nature are not events whose timing can be arranged to make inequitable gains after having had the benefits of rapid amortization. Furthermore, the very structure of the statute militates against defendant’s position. Section 1231 speaks of gains from “sales or exchanges” and “involuntary conversion.” Yet § 1238, which qualifies § 1231 and refers expressly to it, speaks only of gains from “sale or exchange.” It therefore can hardly be inferred that Congress intended “sale or exchange” in § 1238 to include “involuntary conversion,” particularly in light of well-established judicial precedent that an involuntary conversion is not a sale or exchange. Flaccus, supra. Also pertinent to the construction of § 1238 and Congressional purpose for its enactment are §§ 1245 and 1250 of the 1954 Code, added in 1962 and 1964, respectively. Those sections are recapture provisions, akin to § 1238, but deal with gains made upon the disposition of depreciable property subject to normal depreciation, rather than rapid amortization. In general, §§ 1245 and 1250 provide that gains made upon the disposition of depreciable property, which gains exceed the adjusted basis of the property, shall be taxed as ordinary income rather than capital gains. Sections 1245 and 1250 both speak expressly of gains made upon “involuntary conversion,” as well as “sale or exchange.” The inference therefore is clear that when Congress intends recapture provisions to include gains from involuntary, as well as voluntary, dispositions, it so-provides. Section 1238 does not so-provide; and courts cannot rewrite tax laws, however appealing and logical it may be. See F. W. Fitch Co. v. United States, 323 U.S. 582, 65 S.Ct. 409, 89 L.Ed. 472 (1945), Shakespeare Co. v. United States, 189 Ct.Cl. 411, 419 F.2d 839 (1969), cert. denied, 400 U.S. 820, 91 S.Ct. 37, 27 L.Ed.2d 47 (1970). Towanda and Kent, relied on by defendant, dealt with § 337 of the 1954 Code and the problem of gain derived by a corporation from an involuntary conversion during a period of complete liquidation. Section 337 provides, among other things, that during the 12-month period after a corporation adopts a plan of complete liquidation, “ * * * no gain or loss shall be recognized to such corporation from the sale or exchange by it of property within such 12-month period.” In both Towanda and Kent, property of corporations in liquidation was destroyed by fire, and insurance proceeds exceeded the basis of the destroyed property. The Government argued that the gain was taxable to the corporations because § 337 speaks only of gains from “sale or exchange,” not involuntary conversion. Both courts held that the gain was not taxable to the corporation because the purpose of § 337 was to avoid double taxation for gains recognized during corporate liquidation, i. e., taxation first to the corporation, then later to the distributee shareholders. This court said in Towanda at 128, 129, 180 F.Supp. at 376: The taxation of the gain derived from an involuntary conversion of the property into cash during liquidation is clearly contrary to the declared purpose of Congress in enacting the section [i. e., § 337], which was to avoid double taxation incident to the liquidation of the corporation, by exempting the corporation from liability for gain derived from the disposition of its capital assets, irrespective of whether or not certain formalities had been observed. Literally, an involuntary conversion is not a sale but what Congress had in mind was a conversion of a corporation’s capital assets into cash, whether voluntary or involuntary, and the distribution of the cash to the stockholders. * * * The purpose was to exempt the corporation from liability for the tax and to collect the tax from the stockholders alone. This being true, we must hold, in order to carry out the clear purpose of Congress, that an involuntary conversion comes within the intent of Congress when it exempted the corporation from liability for a tax on the gain derived from a sale of its property in liquidation. The court in Kent agreed with this court’s reasoning in Towanda, noting that a purpose of § 337 was “to avoid double taxation.” Defendant invites this court to construe § 1238 similarly to the way § 337 was construed in Towanda, and Kent. In my view, this should not be done simply because (a) Towanda and Kent dealt with a unique problem, i. e., double taxation flowing from corporation liquidation, and § 337 was construed to carry out “the clear purpose of Congress” of avoiding double taxation, and (b) § 1238, its legislative history and the regulations are clear and unambiguous, and show no Congressional purpose to include gains from involuntary conversions as one of the exceptions to the application of § 1231. In sum, the gain in question is taxable as a capital gain pursuant to § 1231 of the 1954 Code. WELDED RAIL ISSUE AND RAIL SALVAGE VALUE ISSUE These issues revolve around a method of accounting known as retirement-replacement-betterment accounting. Actually, retirement - replacement - betterment accounting is a shorthand term for three separate but interrelated accounting schemes — retirement accounting, replacement accounting and betterment accounting — by which plaintiff and other railroads determine allowable depreciation for property in track accounts, particularly rail and joint materials (angle bars, bolts and washers). To understand the issues, it is necessary to discuss in some detail the theory and practice of retirement-replacement-betterment accounting. Retirement accounting Normally, in computing depreciation for an exhaustible asset, the cost (or other basis) of the asset, less its salvage value, is spread ratably over the asset’s useful life; and through annual depreciation charges, the cost is recouped. This means that the asset’s book value decreases from year to year as depreciation charges accumulate. Capital additions and improvements made to the asset from time to time during its service life are added to the book value and, in turn, are depreciated. The theory is that at the end of the asset’s useful life, the accumulated depreciation charges plus salvage value will equal original cost. Retirement accounting, however, works differently. Rather than making annual adjustments for depreciation, the asset is carried on the books at its full value (usually cost) during its useful life. Then, at the time of retirement from service, the book value, diminished by the asset’s salvage value, is charged to current expense. Retirement accounting thus results in deferred depreciation for any given asset. However, over an extended period of time, the depreciation deductions taken under retirement accounting for all assets in the account should closely approximate conventional ratable depreciation methods. As stated in Boston & Maine R.R. v. Commissioner, 206 F.2d 617, 619 (1st Cir. 1953): * * * the underlying theory of the retirement method is that the charges to expense on account of all the items retired or replaced in any particular year are taken as a rough equivalent of what would be a proper depreciation allowance for all the working assets of the company for that year. The assumption is that once the system is functionnig normally and the retirements are staggered fairly regularly, the charges to expense on account of equipment wearing out or otherwise disappearing from service are spread out and stabilized, and hence will approximate the results under straight-line depreciation. * * * Retirement accounting is used by the railroads for their track accounts principally because it simplifies the difficult bookkeeping problem of making annual depreciation adjustments for the large number of fungible assets in such accounts, i. e., rail and joint materials, and because it complies with the accounting requirements of the Interstate Commerce Commission as set out in the Uniform System of Accounts for Railroad Companies. Replacement accounting Replacement accounting works hand-in-glove with retirement accounting. It arises when a retired asset, rather than simply being removed from service, is replaced by a like asset. From an accounting standpoint, a replacement transaction comprises two steps: the retirement of one asset and the addition (or replacement) of a like asset. Logically, the accounting treatment for such transaction should entail (a) charging off to current expense the book value of the retired asset, diminished by its salvage value, and (b) capitalizing the cost of the added (or replacing) asset. So treated, the books would tend to reflect, over the life of the account, the current value of all assets in service. However, plaintiff does not handle replacement transactions in this fashion. Rather, it takes as a current expense the cost of replacement, diminished by the salvage value of the retired asset, and leaves on the books the value of the retired asset. The theory is that each replacement, when considered in the context of the account as a whole, is a minor transaction, akin to a repair, and should be currently expensed. The result is that, after many years, the composite book value of all assets in service is a residuum of original costs, increased or decreased, as the case may be, by additions and betterments, or retirements without replacement, made from time to time over the life of the account. On reflection, it can be seen that over a long period of years of no price inflation, it makes no difference from an accounting and depreciation standpoint whether a replacement transaction is handled in one or the other of the two above-noted fashions. To illustrate, assume a section of rail having an original cost of $1,000 is retired after 40 years and is replaced by a like section of rail costing $1,000, and that the salvage value of the retired rail is $200. Under either above-described method of replacement accounting, the book value of the rail in service remains $1,000 and the current charge to expense (representing depreciation) is $800 ($1,000 less $200). In contrast, over a period of substantial price inflation, it makes considerable difference which of the two methods is used. To illustrate, assume the same facts as above except that the cost of replacement, due to price inflation, is $2,000 rather than $1,000. Now, if the accounting transaction is handled by the first method, the charge to operating expense is still $800 ($1,000 less $200), and the $2,000 cost of replacement is capitalized to become the new book value of the rail in service. On the other hand, under plaintiff’s method, the $2,000 is currently expensed, less $200 salvage value for the retired rail, leaving a current charge (representing depreciation) of $1,800; and the book value of the rail in service remains $1,000. Defendant has no quarrel with the way plaintiff chooses to handle replacement accounting. It conforms to the Interstate Commerce Commission’s requirements for accounting for road property; and, indeed, it is consistent with the theory of replacement accounting in that the cost of replacements of individual assets of a whole account are deemed minor and, for ease of accounting, are currently expensed. A dispute arises, however, over the salvage value to be assigned to rail picked up from service but not disposed of as scrap. This dispute is later discussed in detail. Betterment accounting Betterment accounting works hand-in-glove with replacement and retirement accounting. It arises in one of two situations: (a) when additional rail is laid where no rail before existed, or (b) where rail laid in replacement is of heavier weight, and thus “better,” than rail being replaced. In the first situation, the current cost of laying additional rail is capitalized, and such cost thereafter remains on the books until the rail is retired. In the second situation, the cost of the “betterment” portion of the rail laid in replacement is capitalized, while the remainder of the cost, reduced by the salvage value of the replaced rail, is currently expensed. To illustrate, if a section of 80-pound rail is replaced with 100-pound rail, the cost attributable to the extra 20 pounds is capitalized; and the remaining cost, disminished by the salvage value of the 80-pound rail picked up, is currently ex-pensed. In this way, the cost of additions and improvements is added to the books and remains in the account until retirement. Welded rail issue In 1955, as part of a continuing program of track renewal, plaintiff replaced a number of 39-foot lengths of rail with 78-foot lengths of heavier-weight rail. The 39-foot lengths which were replaced were fastened together by angle bars and bolts as had been conventionally done in the railroad industry for many years. The new 78-foot lengths were made by welding together two standard 39-foot rails as purchased from steel mills. In turn, the 78-foot lengths were bolted together in the track structure. Thus, in making the renewals, plaintiff substituted two heavier-weight 39-foot lengths of rail having a welded joint for two lighter-weight 39-foot lengths of rail having a bolted joint. Plaintiff accounted for this transaction under the retirement - replacement - betterment method as follows: It charged to current expense the portion of the rail cost and welding cost attributable to the same weight as the rail which was replaced (replacement in kind); it capitalized the portion of the rail cost and welding cost attributable to the weight of the new rail greater than the replaced rail (betterment) ; and it charged to current expense the book value of the joint materials (angle bars, bolts and washers) which were replaced by the welded joints (retirement). The cost of making welded joints in 1955 was $155,748, of which $140,808 was charged to current expense and $14,940 was capitalized, in accordance with the pro rata apportionment above described. The dispute between the parties is whether plaintiff properly accounted for the cost of welding. Defendant says plaintiff should have capitalized the entire welding cost ($155,748), rather than only part of it ($14,940), because a welded joint constitutes a “betterment” over a bolted joint within the context of retirement-replacement-betterment accounting. Defendant relies on Rev. Rul. 67-22, 1967-1 Cum.Bull. 52, which, in essence, holds that under retirement-replacement-betterment accounting, the cost of welded joints, whether laid with new rail or replacement rail, must be capitalized because “welding of rail creates something new or better by substitution or addition of different materials, reduces track renewal cost, prolongs rail and rolling stock life, reduces maintenance costs, and increases the value of the track structure.” The Revenue Ruling notes § 263 of the Internal Revenue Code (1954) which provides in pertinent part that no deductions shall be allowed for “any amount paid out * * * for permanent improvements or better-ments made to increase the value of any property or estate * * Plaintiff, on the other hand, contends that under retirement-replacement-betterment accounting, the cost of welding should be currently expensed in full because “the cost of the weld is a part of the cost of the rail itself and should be accounted for on the same basis as is the rail * * Plaintiff also says that welded joints are not betterments over bolted joints because they do not increase the value of the track structure, do not prolong the life of the rail, and do not add new and improved materials to the track system. Thus framed, it is important to point out that the issue is not whether the cost of replacing bolted joints with welded joints is a repair as opposed to a capital expenditure. The parties agree that the expense is capital in nature. The issue is simply whether welded joints, which replace bolted joints, are such an improvement or betterment to the track that their cost should be capitalized, rather than currently expensed, in accordance with the method of retirement-replacement-betterment accounting used by planitiff. Defendant agrees that if bolted joints are replaced by bolted joints, the cost of the replacement, less the salvage value of the replaced materials, is chargeable to current expense. Defendant says simply that welded joints are so different from bolted joints and are such an improvement over bolted joints that their cost must be fully capitalized and not charged to current expense until the welded rail is retired or replaced by other welded rail. The issue boils do-wn to an analysis of the differences between bolted joints and welded joints, both from a cost and technology standpoint. Functionally, the joints do the same job — they hold together the ends of pieces of rail so to make a continuous track structure. Thus, welded joints which replace bolted joints add no new or different function to the rail system. Bolted joints comprise a pair of angle bars which bridge the rail ends across the rails’ web and are fastened to the web by six bolts and washers. In 1955, it cost plaintiff about $10 to install a bolted joint, depending on the weight of the rail. Bolted joints require maintenance from time to time since they tend to come loose with wear. The record shows that bolt tightening is required the first year after installation and generally each two years thereafter. After extensive use, the bolts and washers may need replacing. Welded joints, in contrast to bolted joints, are made by fusing together the ends of the rail under intense heat. No material is added to the rail. Rather, about % inch is lost off each rail during the welding process because the rail ends are forced together under pressure, thus creating a bead of raised metal at the weld which must be ground down to make a smooth joint. In 1955, it cost plaintiff $11.83 to make a welded joint. Welded joints do not require maintenance like bolted joints; and in fact the record shows that during the first 12 years of service of welded rail (1955-1967), welded joints required no substantial maintenance at all. However, the record also shows that welded joints are not an unmixed blessing. About 1967, welded joints installed on plaintiff’s main lines in 1955 exhibited serious wear and deterioration known as secondary batter. Secondary batter results from the fact that the fused metal at the weld is harder than the rail on either side of the weld. Thus, the joint wears less rapidly than the main rail. After extensive use and track wear, the metal adjacent either side of the weld tends to dish out as the wheels of railroad cars ride over the weld, i. e., the wheels tend to batter the track downstream of the weld. Secondary batter becomes progressively worse with time and particularly if trains run both directions on the track. Though no maintenance to correct secondary batter was done by plaintiff between 1955 and 1967, the record shows that substantial maintenance will be required soon and that such maintenance will be necessary from time to time during the 40-50 year useful life of the rail. The maintenance will involve grinding down the track and weld to eliminate dished-out areas, or in extreme eases, cropping out the damaged areas and rewelding the rail ends. Against these facts, it must be concluded that the record does not support defendant’s position that welded joints vis-a-vis bolted joints constitute a “betterment” to the track system in terms of retirement-replacement-betterment accounting. From a purely monetary standpoint, the cost per welded joint is about the same as a bolted joint ($11.83 v. about $10). Though this factor alone is not determinative of the “betterment” question, plaintiff’s investment in welded joints is not substantially greater than if it had used all bolted joints, and thus shows that plaintiff has not made a substantial increase in monetary value in its track system. Defendant, however, points to other factors which it says show that welded joints are “a substantial improvement over the previous method of bolted joints.” It notes that less maintenance is required on welded joints and argues that welded joints prolong the life of the rail and rolling stock. Though, as noted earlier, welded joints require little or no maintenance during early years of use, the problem of secondary batter will ultimately require maintenance of considerable cost. Thus, it cannot be said with any certainty on this record that over the long run, i. e., the 40-50 year useful life of the rail, bolted joints will cost substantially less to maintain and repair than welded joints. As for prolonging the useful life of rail, the record does not show that rail with welded joints will last longer than rail with bolted joints if it be assumed that both types of joints are properly maintained. Useful life of rail is principally a function of the quality and extent of use of the rail itself upon which the type of rail joint, if properly maintained, would appear to have little effect. As for prolonging the life of rolling stock, the evidence is not sufficient to conclude that there has been any significant, or even measurable, reduction in rolling stock maintenance costs since the advent of welded rail, particularly in light of problems of secondary batter which has the same deleterious effects on rolling stock as worn bolted joints. Thus, while the record shows that welded joints result in some advantages over bolted joints, the advantages are not so substantial and track system so improved that welded joints should be considered a betterment over bolted joints for purposes of retirement-replacement-betterment accounting. Plaintiff may therefore charge to current expense the cost of replacing bolted joints with welded joints, in the same proportion as it charges to current expense the cost of replacing the rail itself. Defendant points to another reason why plaintiff should capitalize the cost of replacing bolted joints with welded joints. In accounting for the replacements, plaintiff charged to current expense not only the cost of the welded joints but also the book value of the replaced bolted joint materials (angle bars, bolts and washers). I. e., plaintiff treated the accounting for the replaced joint as if it had been retired without replacement. Defendant says this is improper under replacement accounting as practiced by plaintiff because the asset account must reflect the fact that a joint was replaced, rather than simply retired. Plaintiff, on the other hand, says it is proper to charge to current expense both the welding cost and the book value of the retired bolted joint materials because the bolted joint was retired and the cost of the weld is part of the cost of rail. Clearly, defendant is correct. As held above, the cost of replacing a bolted joint with a welded joint should be accounted for as a replacement, i. e., charged to current expense. Accordingly, such cost must be reduced by the salvage value of the retired bolted jonit materials. Otherwise, plaintiff would be getting what is in effect a compounded deduction for a transaction which is in fact a replacement rather than simply a retirement without replacement. In sum, the proper accounting treatment should be as follows: The cost of welded joints laid in replacement should be charged to current expense (in the proper proportion as above noted), and the charge should be diminished by the salvage value of the replaced bolted joint materials. Thus, the original book value of the joint materials remains in the account; and the accounting transaction is fully consistent with the method used by plaintiff for other replacements. Rail salvage value issue To understand this issue, a brief discussion of plaintiff’s track renewal program will be helpful. Over the years and particularly with the advent of heavier rolling stock, plaintiff has sought to upgrade its track system by replacing lighter-weight rail with heavier-weight rail. Typically, the rail on main lines is replaced from time to time with heavier new rail; and the rail picked up off the main lines is used to replace lighter rail in secondary or branch lines. In turn, rail picked up from secondary or branch lines, if still in serviceable condition, is used to lay or replace industry, spur or yard tracks. If not in serviceable condition, it is scrapped. Finally, industry, spur or yard rail is replaced when worn out and is sold as scrap. Ordinarily, a section of rail goes, through all these steps during its 40-50 year useful life before disposal as scrap. In accounting for track replacements under the Interstate Commerce Commission’s Uniform System of Accounts for Railroad Companies, plaintiff assigns on its books a salvage value to rail picked up. This salvage value is important because, as earlier discussed, the charge to current expense taken under retirement-replacement-betterment accounting for the cost of rail laid in replacement and rail retired without replacement is reduced by the salvage value of the replaced rail in order to arrive at a figure representing allowance for depreciation for Federal income tax purposes for the asset account as a whole. The salvage value assigned by plaintiff to rail picked up depends on whether the rail is to be scrapped or is to be relaid as reusable rail. In 1955 and for many years previous thereto (since about 1919), plaintiff has assigned the values of $17.86 per net ton for rail to be sold as scrap and $22.82 per net ton for reusable rail. Plaintiff does not explain how it arrived at these fgures. However, a fair inference from the record is that $17.86 per net ton was the approximate price of scrap in the 1920’s; and $22.32 per net ton was a figure somewhere between the cost of new rail and scrap in the 1920’s, and thus was deemed to be the reasonable value of reusable rail. In 1919, the price of new rail was $35.83 per net ton; during the 1920’s, the price was about $38. The issue here is the value to be assigned to reusable rail in 1955, to the extent that such rail was relaid as additions or betterments. Defendant says that $22.32 per net ton is unrealistically low because it represents a figure established many years ago when the cost of new rail and the price of scrap were but a fraction of their 1955 values. In 1955, new rail cost $93.70 per net ton and scrap sold for $43.75 per net ton. Accordingly, says defendant, reusable rail should be assigned a value somewhere between the price of new rail and the price of scrap, at a figure deemed to be the current fair market value of reusable rail. Defendant argues that such value in 1955 should be $69.40 per net ton, midway between the price of new rail and the price of scrap. Defendant cites, and relies on Rev.Rul. 67-145, 1967-1 Cum.Bull. 54, which holds that “railroads using the ‘retirement method’ of accounting for depreciation” must value reusable rail at “fair market values.” Defendant also cites and relies on Rev.Proc. 68-46, 1968-2 Cum.Bull. 961, which holds that reusable rail laid in additions or betterments must be valued at a “fair market value somewhere between the new and scrap price for such rail,” and such fair market value is determined “by averaging the new and scrap prices.” Defendant says that it is reasonable to calculate fair market value in this way because (a) there is no established price for reusable rail in the marketplace since reusable rail is not sold by the railroads, due to a shortage of rail, and (b) reusable rail is worth less than new rail and more than scrap, and a value halfway between “has the merit of simplicity, reasonableness, and ease of derivation.” Plaintiff objects to defendant’s approach to the valuation problem. While conceding that $22.32 per net ton is unrealistically low, plaintiff contends that the proper value should be the lower of cost or fair market value. Plaintiff relies on a letter of technical advice, issued in 1964 by the National Office of the Internal Revenue Service relating to an audit of plaintiff’s books for 1956-59, which holds that reusable rail should be valued at “the lower of actual costs or current fair market values.” The letter of technical advice was later superseded by Rev.Rul. 67-145 and Rev.Proc. 68-46, supra. In 1955, the average investment cost of plaintiff’s rail in place was $43 per net ton, and it is this value which plaintiff says should be assigned to reusable rail. Otherwise, says plaintiff, if fair market value is used under defendant’s formula, the book value of reusable rail laid as additions or betterments is, in effect, written up above cost and results in the taxation of unrealized appreciation. At this juncture, it should be pointed out that defendant does not challenge the value which plaintiff assigned to scrap in 1955 ($17.86 per net ton) even though the price of scrap in that year was $43.75 per net ton. The reason for this is that plaintiff reports as income the difference between the assigned scrap value and the proceeds of scrap sales so that, as a practical matter, it makes no difference what the assigned value is. Thus, the net effect is that the entire $43.75 per net ton current scrap value goes to reduce the charges to expense for replacements and retirements without replacement. By the same token, if plaintiff had assigned to scrap in 1955 a value higher than $43.75, say for example $50.75, the $7 difference, upon disposition of the scrap, would be charged to current expense, thus reflecting the fact that the decrease to current expense representing the assigning salvage value of scrap had been too high. Furthermore, defendant does not challenge the value plaintiff assigned in 1955 to reusable rail which was picked up and then relaid as replacements in kind. On reflection, it can be seen that the reason for this is that whatever value was assigned washed out of the accounting because the value assigned on pickup, which went to reduce current expense, was the same as the value charged to current expense upon relay, thus a wash. Therefore, defendant’s only concern here, as noted earlier, is the value to be assigned to reusable rail laid as additions or betterments, for this value is capitalized on plaintiff’s books and no corresponding charge to current expense is made until ultimate retirement. After careful consideration of all the arguments in the parties’ extensive briefs, I am constrained to conclude that defendant’s position is the correct one. The evidence, including the testimony of expert accounting witnesses, persuades me that the approach set out in Rev. Rui. 67-145, supra, and Rev.Proc. 68-46, supra, is sound. The issue turns on the manner in which plaintiff employs retirement - replacement - betterment accounting. As discussed earlier, plaintiff charges to expense the current cost of making rail replacements. The aggregate of such costs, reduced by the salvage value of replaced rail, thus represents the allowable depreciation deduction for such transactions for the account as a whole. After many years of an inflationary economy (particularly since World War II) and because rail has a long useful life (40-50 years), the current cost of making replacements (as opposed to retirements without replacement) bears no relationship to the historical cost of the rail in place. Thus, in 1955, plaintiff charged to current expense the $93.70 per net ton cost of laying new rail in replacement, even though the average cost of all rail in place was only $43 per net ton. The symmetry of replacement accounting demands that if the high costs of replacement are to be charged to current expense, then salvage value assigned to reusable rail for relay as additions or betterments must correspondingly be based on current values. Otherwise, the allowable deduction for depreciation for the account as a whole is distorted, will in effect tend to constitute accelerated depreciation, and thus will not reflect a reasonable allowance for “exhaustion, wear and tear (including a reasonable allowance for obsolescence),” as required by § 167 of the Internal Revenue Code (1954). Plaintiff’s argument that valuing reusable rail at current fair market value rather than historical cost results in taxation of unrealized appreciation is, at first blush, appealing but will not stand analysis for two reasons. First, under retirement - replacement - betterment accounting, as practiced by plaintiff, the value assigned to reusable rail is for the purpose of determining the extent to which the current charge to expense for replacements (and retirements without replacement) should be reduced, so to reflect a reasonable allowance for depreciation. Thus, although the net effect of valuing reusable rail at current fair market value rather then historical cost may result in less after-tax income to plaintiff, it does so not by taxing unrealized appreciation but simply by reducing a depreciation deduction to a reasonable level. Secondly, it makes no sense in the context of plaintiff’s retirement - replacement - betterment accounting method to restrict the value assigned to reusable rail laid in additions or betterments to historical cost when the charges for replacements, which are immediately expensed, bear no relationship to historical cost. Under plaintiff’s theory, reusable rail would be valued in 1955 at $43 per net ton, which is less than the price of scrap ($43.75 per net ton) for that year. This is not reasonable and, as earlier discussed, violates the symmetry of retirement-replacement-betterment accounting. Furthermore, the requirement of the Interstate Commerce Commission’s Uniform System of Accounts for Railroad Companies for valuing reusable rail is fully consistent with defendant’s proposition that reusable rail be assigned its current fair market value. Section 10.01-7 (d) of the Uniform System of Accounts for Railroad Companies, in effect in 1955, defines “value of salvage,” stating that “when such material [e. g., rail] is retained and again used by the carrier [e. g., reusable rail], the value shall be determined by deducting a fair allowance for depreciation from current prices of the material as new.” The plain meaning of this is that reusable rail in 1955 should be valued at somewhere between $93.70, the current price of new rail, and $43.75, the current price of scrap, so that its value represents the price of the material “as new” less “a fair allowance for depreciation.” Defendant’s method of estimating this value, i. e., halfway between the current prices of new rail and scrap, is reasonable and equitable since, on the average, reusable rail picked up by plaintiff from its lines has gone through about half its useful life. Plaintiff argues that new rail prices and scrap prices vary “due to wide fluctuations” and that i