trivial a nature, will be considered a conference and the engineer is directed to write and promptly forward to this office, as well as to file with the case, a copy of such report.

A report will be kept in the head office of each case on which an engineer has been called to meet the taxpayer or the taxpayer's representative and to avoid delay in keeping this record current, engineers are requested to write conference reports as soon as possible after holding the conference.

In the case of conferences where the conferee-engineer of this division and the taxpayer or taxpayer's representative do not reach an agreement, conference memorandum will bear in its upper righthand corner the word "disagreed."

The above instructions are also to apply to the chiefs of sections and assistant chiefs of sections.

S. M. GREENIDGE, Head Engineering Division.

Senator KING. I was not here when that matter was under consideration by the committee. May I ask, Mr. Manson, whether that order which you have just read will be beneficial and helpful to the Government as well as to the taxpayer?

Mr. MANSON. There is no doubt about that, in my opinion. Senator KING. I do not quite see the significance of that, now, but I will read the testimony concerning it.

Mr. MANSON. I call the committee's attention this morning to the Border Island Co. depletion on March 1, 1913, value for invested capital purposes.

I wish to offer my apologies to the department at this time for not giving them earlier notice of bringing up this case. I did not notify them until this morning. That was due to the fact that I intended to take up another case, but yesterday when I came to examine the engineers' report on the other case, I found nothing in it which I personally could criticize.

This is a small case, but it is important for the reason that, in my opinion, it represents another bad practice.

In the first place, it is a case where a value had been fixed by the appraisal engineers, and the solicitor's office assumed to set aside that valuation and fix a valuation of its own.

I hate to criticize lawyers, but I do not believe that the legal end of the Income Tax Unit is the proper place to make valuations. This case also illustrates quite clearly a matter that was discussed here some time ago, namely, the difference between the utility value of a piece of property to the owner, and the market value of it.

In this case the Border Island Co., the taxpayer, acquired an island in the Niagara River, on the line of the city of Buffalo, which island consisted of a deposit of sand and gravel. This island was acquired in June, 1912, for some $130,000, consisting of $6,000 cash, $54,000 in the stock of the Border Island Co., and a mortgage of $70,000. The mortgage was already on the island. The island was acquired subject to this mortgage of $70,000.

At the time of the acquisition of the island by the taxpayer, the previous owners had given a lease for the excavation of sand and gravel, under which they were to receive 8 cents a cubic yard for a given amount of the sand and gravel and 72 cents thereafter. This lease was to expire in 1926.

The engineers allowed for depletion purposes the sum of $127,000, which was the purchase price of the island less the value of that

portion of the island which consisted of soil that was not sand and gravel.

The value finally allowed was $196,159.99, making a difference in the tax of $10,959.

Senator KING. They allowed a depletion that was more than the property cost?

Mr. MANSON. Yes; the depletable value was $196,159.99.

As I stated, the property was acquired in June, 1912. The value was fixed as of March 1, 1913. The taxpayer-that is, the president of the taxpayer-states in an affidavit in the record that there had been no change, that the value in 1913 was the same as the value in 1912. It is manifest that there could be no change, for the reason that the island was acquired subject to the lease. The lease was a lease under which the gravel was being taken out.

If the island had doubled in value, so far as the gravel was concerned, it would not have benefited the lessor.

The value finally arrived at was determined by capitalizing the royalties to be paid under this lease and discounting them at a 6 per cent profit rate. If the receipts of royalties provided under this contract were capitalized and discounted at a 10 per cent rate, you would get an amount which was within $1,000 of the amount paid for the island.

That raises this question in my mind: In June, 1912, the owners of this property had every advantage that the Border Island Co. acquired from them, and which the Border Island Co. had on March 1, 1913. They saw fit to sell this property at a price which, under that contract, would give them a 10 per cent return on their money. The solicitor's office took the position that the property had a value which would yield a 6 per cent return on the money.

My first proposition is that the fact that this property was sold within a few months before March 1, 1913, and that the same conditions existed with respect to the lessor on March 1, 1913, as existed at the time of the sale of the property, indicated that there could be no such thing as an increase in the value of the lessor's interest in that property, namely, the reversion. The actual sale demonstrated that men are not willing to invest money in that kind of a property under those conditions, at a price which will yield them less than about 10 per cent. It must be assumed that if the former owners of this property could get a higher price for that island they would have demanded it. If the purchasers of it had been willing to pay more, the former owners would have probably received more. The mere fact that the transaction took place is conclusive of what the market value was, and is also conclusive, if you wish to appraise this property on the analytical basis, of capitalizing earnings, as to the rate of profit that the purchaser expected to make on that kind of investment.

I wish to call the attention of the committee to this fact, that the discount rate used, 6 per cent, is approximately the rate on firstclass real estate mortgages, where the value in the property is double the amount of the mortgage.

The CHAIRMAN. Do you know what the interest rate was on the $70,000 mortgage?

Mr. MANSON. I do not know. The record does not disclose it. That mortgage is not in the record, and I do not know. But a 6

per cent rate is about the rate, or approximately the rate paid upon first-class real estate mortgages, and it is inconceivable that anyone would consider investing his money in a project of this sort, where he was to receive his principal back in driblets, year by year, and at the end of that time would have nothing coming, where he was to take all chances of erosion on this island. There is constant erosion going on in the Niagara River, and all chances of erosion rested upon the owner, with the consequent liability for loss of his gravel because the lessees only paid for the amount they actually took out. He took all chances of the lessee failing to perform his contract, and I maintain that even if you had no fixed standard, as it is fixed in this case by the actual sale which took place a few months before March 1, 1913, the 6 per cent discount rate used here is manifestly ridiculous.

The CHAIRMAN. Do you want to say anything in connection with this case at this time, Mr. Hartson?

Mr. HARTSON. I think I should say this, Mr. Chairman, with particular reference to the statement of counsel that, in his judgment, it is unwise, inappropriate, and a bad policy for lawyers to sit in judgment on the engineers in the Income Tax Unit.

On that point, I desire to make this explanation: The solicitor's office is, under the present organization, divided into a number of different groups, one group being known as the review division of the solicitor's office. That division has as its backbone the former commitee on appeals and review organization and personnel. There have been changes made in it so far as personnel is concerned, but the general character and nature of the old committee on appeals and review is now incorporated in the review division of the solicitor's office. There are lawyers and accountants, and engineers in that division.

The CHAIRMAN. Was that the staff of the solicitor at the time this case was considered?

Mr. HARTSON. Yes; I so understand. This may, however, Mr. Chairman, be a case which came to the old committee on appeals and review, and was not disposed of by that committee during its organization, but was inherited, in a sense, by the solicitor's office. Mr. MANSON. That is true, Mr. Hartson?

Mr. HARTSON. It was?

Mr. MANSON. Yes.

Mr. HARTSON. Now, if that is true, this case was no doubt assigned to an engineer. The engineer heard the taxpayer on his protest, and the report of that engineer was I have no doubt, reviewed by lawyers, and reviewed by the usual reviewing agency, which the review division in the solicitor's office provides.

I quite agree with counsel that on a pure engineering question, the solicitor's office, if it were composed entirely of lawyers, would, on engineering questions, be functioning in a manner which might be unwise and inappropriate. If the lawyers reversed the engineers on pure engineering questions, I agree with counsel on that. However, our present organization does not contemplate that that be done, and I think it is not done.

The number of engineers in the solicitor's office on that work is limited, and, as a result, the engineering cases that do come up there

are not disposed of as rapidly as they would be if we had more engineers on review work. But it is true that when the cases go out under the present organization, they go out with the solicitor's name attached and from the standpoint of one looking at it superficially, the impression would no doubt be gained that a lawyer had reversed an engineer on a pure engineering question.

The CHAIRMAN. Well, was this purely an engineering question? It seems to me it was not an engineering question, but it was a question of policy as to whether this should be determined on the analytical basis, or whether it should be determined on some other basis, and that it did not involve an engineering problem.

Mr. HARTSON. Mr. Chairman, I think the determing of a value is ordinarily left in the hands of valuation experts.

The CHAIRMAN. Was it true in this particular case? Let us deal with this case.

Mr. HARTSON. Yes; and I think this is a clear example of the general statement which I made.

If a court has to pass upon a value as of a given date, experts are called to advise the court as to what is, in the opinion of the witnesses, the proper value. If the property is real estate, they call real estate experts. If, on the other hand, it is a mine or a quarry, or some natural deposit, it is customary to have engineers familiar with those deposits and the methods of their operation and development testify as to what, in their judgment, the values are.

I think this formula which Mr. Manson has referred to is a formula which has been constantly and customarily used for years in determining values and in appraising mining properties.

The rate is one which I desire to be heard on later, because, as I have said, I know nothing about the facts in this case, and I am sure the committee will give us an opportunity to reply to the criticism as to the rate used and also the formula that was used.

The CHAIRMAN. If, as a matter of fact, this case had gone to court, and there was a dispute between the engineers and the taxpayer as to whether they should have used the purchase price or the analytical system, a lawyer would have to decide it, would he not?

Mr. HARTSON. The judge would decide it, and, of course, he is a lawyer. That is true; but, on the other hand, he has the advice of the expert witnesses who are presented to the court for the purpose of testifying on this point.

The CHAIRMAN. Well, the solicitor had that advice, too, had he not, when he passed upon it?

Mr. HARTSON. Yes; he had.

The CHAIRMAN. I would like to ask Mr. Manson if there is any reason shown in the records as to why the solicitor's office overturned the viewpoint of the engineers?

Mr. MANSON. The only thing I can find in the records is the recommendation to the commissioner, signed by the solicitor. There is no report in the records of any engineer in the review section of the solicitor's office. There is nothing to indicate whether an engineer did pass on the matter of the discount rate to be used.

I wish to say this, in connection with what Mr. Hartson has just said. This matter of the discount rate to be used may not be

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purely an engineering question, but it is a matter which should be based upon information and experience. Appraisal engineers are called upon to use this formula, and the appraisal engineers are the people who have, in connection with the use of the formula, gathered information and assembled data as to what rates of profit investors in the different kinds of enterprises expect to receive. It is for that reason that I maintain that the matter of the discount rate to be used is a matter which should be passed upon by an appraisal engineer.

As to the question of whether or not, under the regulations, the actual sale price of this property a few months before March 1, 1913, should be used, or whether the analytical appraisal method should be used, I think that is a matter the legal department could properly pass on.

The CHAIRMAN. What varying rates of discount have been used by the department? We have heard a good deal about these rates of discount in the testimony. What have been the varying rates used by the department?

Mr. MANSON. The highest one that we have had brought to our attention was 10 per cent, in the case of the Graphite Co., in New Mexico.

Mr. HARTSON. I would like to ask Mr. Eddingfield to answer that question, if he knows.

Mr. Eddingfield is an engineer in the solicitor's office, and he can tell you what rates have been customarily used in the valuation under this analytical appraisal method.

Mr. EDDINGFIELD. They vary, of course, with the type of ownership. For a property which is under lease, the owner is generally allowed 6 per cent. On coal, I believe they allow a discount rate equal to 8 per cent. The highest rate I personally know about was in the case of a lessee where 35 per cent was used. In my own case, the largest I have used is 25 per cent.

The CHAIRMAN. What is the usual rate?

Mr. EDDINGFIELD. Six per cent for a case of this character. The CHAIRMAN. What is the usual rate in cases where there is not a lease?

Mr. EDDINGFIELD. For an operating owner, it would depend largely upon the circumstances, but generally about 7 or 8 per cent. The CHAIRMAN. Is it your opinion that 6 per cent and these low rates are equitable rates?

Mr. EDDINGFIELD. Yes, sir.

The CHAIRMAN. Notwithstanding all of the hazards of the business, you capitalize these properties at a very high value, so as to be able to get big depletion figures on a basis which the most conservatie invester can get on his money?

Mr. EDDINGFIELD. Well, I would not say the most conservative, because Government bonds are 4 per cent and even 32 per cent.

The CHAIRMAN. Well, a first mortgage bond is pretty conservative. Mr. EDDINGFIELD. Yes, fairly so; but they do lose money on those sometimes?

The CHAIRMAN. Not very often.

Mr. EDDINGFIELD. I have seen a great many in income tax matters, where foreclosure proceedings were had on mortgages which resulted in a loss by the mortgagor.