Schnackenberg and Castle, Circuit Judges, and Mercer, District Judge.
The single contested issue presented on this petition is the question whether a television network affiliation contract for a two-year term, which is automatically renewable, in the absence of termination by the affirmative act of either of the parties, for an unlimited number of successive two-year terms is a depreciable asset.
The purpose of the depreciation allowance permitted under the Code is to enable a taxpayer to recover the cost of a wasting asset used in his business by charging the diminution in the asset's value each year as a deduction from the gross income for that year. Detroit Edison Co. v. Commissioner of Internal Revenue, 319 U.S. 98, 63 S. Ct. 902, 87 L. Ed. 1286; Friend v. Commissioner of Internal Revenue, 7 Cir., 119 F.2d 959, cert. denied 314 U.S. 673, 62 S. Ct. 136, 86 L. Ed. 538. The end to be achieved "is to approximate and reflect the financial consequences to the taxpayer of the subtle effects of time and use on the value of his capital assets." Detroit Edison Co. v. Commissioner of Internal Revenue, supra, 319 U.S. at 101, 63 S. Ct. at 904.
Intangible assets will not usually be a proper subject of the depreciation allowance unless the useful life of the asset is definitely limited or unless the intangible asset has value in the production of income for only a limited period of time, the duration of which can be estimated with reasonable accuracy. 26 CFR § 1.167(a)(3).*fn1 Although the Internal Revenue Code contains no specific reference to intangible assets in that regard, the Treasury Regulation, first adopted under the Revenue Act of 1918, remained substantially unchanged through successive reenactments of the Code and the Regulation has thereby acquired the force and effect of law. Helvering v. Winmill, 305 U.S. 79, 83, 59 S. Ct. 45, 83 L. Ed. 52; Old Mission Portland Cement Co. v. Helvering, 293 U.S. 289, 293, 294, 55 S. Ct. 158, 79 L. Ed. 367; United States v. Dakota-Montana Oil Co., 288 U.S. 459, 466, 53 S. Ct. 435, 77 L. Ed. 893.*fn2
The Tax Court found that the contracts in issue were depreciable assets which could be depreciated by use of the straight line method over an estimated valuable life of twenty years. The Commissioner filed this petition to review that determination.
Taxpayer, Indiana Broadcasting Corporation, acquired all of the assets of WISH-TV in Indianapolis, and WANE-TV in Fort Wayne, Indiana, in November, 1956, by its purchase of all of the issued and outstanding stock of Universal Broadcasting Company, Inc., the prior owner of the two television stations. Among the assets acquired by the taxpayer were the two CBS*fn3 network affiliation contracts, one with respect to station WISH-TV and the other with respect to station WANE-TV. Each of those contracts was dated March 30, 1956, and had been renewed prior to taxpayer's acquisition of the Universal assets for terms ending, respectively, on August 18, 1958, and September 26, 1958. Each contract provided that thereafter it would be automatically renewed for additional two-year periods, unless the contract was terminated in writing by either of the parties thereto not less than six months prior to its then termination date. Both of those contracts were still in force at the time of the trial of this action.
The consideration paid by the taxpayer for the Universal assets was $11,098,800.67. Of that amount the taxpayer allocated $4,000,000 to the CBS affiliation contract with WISH-TV and $625,000 to the CBS affiliation contract with WANE-TV. In each of its taxable years ending, respectively, on November 30, 1957, 1958 and 1959, taxpayer claimed deductions for depreciation on the $4,625,000 allocated to the CBS contracts. The Commissioner disallowed the deductions and assessed a deficiency against the taxpayer for each of those taxable years. The taxpayer filed a petition in the Tax Court for a redetermination of the deficiencies charged by the Commissioner.
At the trial below, the parties stipulated into evidence an 84-page exhibit which shows the history since 1948 of affiliation contracts of all television networks in each of 84 television market areas which had three or more television stations in operation on December 31, 1962. That exhibit showed the date when each station in each area began operation and the duration of all network affiliation contracts in each of the 84 areas.
Using that history, taxpayer's statisticians prepared a two-pronged life expectancy table, i. e., the aggregate termination experiences reflected by all NBC and CBS contracts and the selected CBS experience. The latter was based upon CBS contract experience only for periods after which in any market area there had been at least one other station in operation for at least twelve months, which was neither affiliated with NBC nor owned and operated by ABC. The latter area of experience was selected because it is limited to CBS contracts after there were sufficient stations in each particular market area to permit CBS to select between its affiliated station and at least one station which was neither owned by nor affiliated with either NBC or ABC.
Those tables showed 88 terminations of NBC and CBS affiliation contracts from 1948 through 1962, and, on the selected CBS side, 19 terminations of CBS affiliations from 1948 through 1962.
The theory of the statistical tables compiled was that an annual rate of contract termination for each pertinent period could be obtained by dividing the total number of years commenced by all of the affiliation contracts during a given period into the total number of contract terminations occurring during the same period. Using that termination rate, taxpayer's witnesses testified that the average life expectancy of any given contract could be determined by applying the Poisson-Exponential Theory of Failure. The crux of that theory is that the percentage of failure of items to which it is applied is a constant. For example, assuming a termination rate from the table of 5 percent per year, 95 percent of the whole group would survive at the end of one year, 5 percent of that 95 percent would fail to survive the second year and so on.
Adopting that theory, and applying it with some modification to the statistical history, the Tax Court found that an estimated useful life of the WISH and WANE CBS affiliation contracts could be determined with reasonable accuracy, and that use of the straight-line method over 20 years was a reasonable basis for depreciation of the contracts.
We think that the Tax Court erred in its findings that an estimated useful life of these contracts could be ...