author: Love:

text:
    Rhode Island Hospital Trust Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7913.
    Promulgated October 7, 1927.
    1. Tlie amount of $31,539.38, representing interest on notes of political subdivisions of Kbode Island and Massachusetts, was erroneously reported by the petitioner as taxable income for the fiscal period ended October 31, 1921.
    2. The petitioner set up a reserve for bad debts during its fiscal year 1919 in the amount of $600,000 and made additions thereto in the amounts of $400,000 and $200,000 for the fiscal years 1920 and 1921, respectively. In its income-tax return for the fiscal year 1921 it deducted from gross income $100,000 on account of ba‘d debts ascertained to be worthless and charged oif during the year,
    . and in addition the $200,000 increase to its reserve for the fiscal year 1921. Held, that the petitioner was entitled to the deduction of debts ascertained to be worthless and charged off during the year, but not to the deduction of $200,000 representing the addition to its reserve for bad debts.
    3. The evidence fails to establish that the petitioner is entitled to a deduction for the fiscal year ended October 31, 1921, of $87,500 alleged to represent bad debts recoverable only in part.

      Ferdinand Tannenbaum, Esq., and Edmund 8. Bex, Esq., for the petitioner.

      Harold Allen, Esq., for the respondent.
    This proceeding is for the redetermination of a deficiency in income and profits tax for the fiscal year ended October 31, 1921, in the amount of $67,916.46. The petitioner alleges that in determining the deficiency the respondent erred in the following particulars : (1) In including in its taxable income for the period in question the amount of $31,539.38, which amount, it is alleged, represents tax-exempt interest derived from notes of political subdivisions of the States of Rhode Island and Massachusetts; (2) in disallowing as a deduction from gross income the amount of $200,000 representing the addition during the period in question to its reserve for bad debts; (3) in disallowing as a deduction from gross income the amount of $87,500, representing debts recoverable only in part and so charged oif under the circumstances outlined below.
    findings of fact.
    The petitioner is a trust company and conducts a general banking business at Providence, R. I. On October 31, 1921, it had outstanding over $51,000,000 in accounts receivable, loans, notes, mortgages and bonds. Of this amount $26,610,720.16 represented accounts and bills receivable and call loans.

      In the fiscal year ended October . 31, 1919, the petitioner, at the direction of its president, set up a reserve for bad debts in the amount of $600,000, which reserve, for want of a better name, was called “reserve for depreciation,” and during the fiscal year 1920 it increased this reserve by the amount of $400,000 so that the total reserve on October 31, 1920, amounted to $1,000,000. On April 30 and October 31, 1921, respectively, the petitioner added $100,000 to its reserve for depreciation. The original reserve and all additions thereto were set up at the direction of petitioner’s president, who on account of general business conditions prevailing at that time anticipated that it would suffer some heavy losses on account of notes and accounts receivable, it having outstanding at that time about $23,000,000 in short-time notes, practically all of which were contracted during the fiscal year 1921. No addition was made to its reserve fund for depreciation during the fiscal years 1922 and 1923. In its income-tax return for the fiscal period 1921, the petitioner claimed as a deduction from gross income the amount of $200,000 representing the addition to its reserve for depreciation for that year, which deduction was disallowed by the Commissioner. In addition to the deduction of $200,000 claimed by the petitioner, it ascertained to be worthless and charged off in the fiscal year 1921 the amount of $100,000 represented by bad debts, which amount the Commissioner allowed as a deduction.
    Among the petitioner’s assets on October 31, 1921, were $100,000 of Eastern Massachusetts Street Railway Co. adjustment trustees’ 3-year 6 per cent notes (hereinafter called adjustment notes) due in 1922, and acquired at a cost of $98,000 and in respect of which the petitioner claims a deduction for the year 1921 in the amount of $81,500, representing bad debts recoverable only in part.
    The petitioner acquired the adjustment notes in the following manner: In the year 1915 it purchased $100,000 of the original issue of 5 per cent gold notes of the Massachusetts Electric Companies, due April 1, 1918, for $98,000. The Massachusetts Electric Companies was the holding company of a number of street and interurban railway companies, the principal operating company' being the Bay State Street Railway Co.
    In 1918 properties of the holding company were under Federal court receivership. Under a reorganization plan dictated by the Commonwealth of Massachusetts, Special Act, Chapter 188, Special Acts of 1918, the Massachusetts Electric Companies, issuer of the 5 per cent gold notes, due April 1, 1918, was eliminated and the directors of the Bay Street Railway Co. were authorized to form a new corporation, the Eastern Massachusetts Street Railway Co., hereinafter called the new company, to acquire the railways, properties and franchises of the Bay State Street Railway Co., hereinafter called the old company.
    The common stock of the old company did not participate in the reorganization, and the 5 per cent gold notes of the eliminated Massachusetts Electric Companies did not become an obligation of the new company. However, certain provisions were made for the holders of the 5 per cent gold notes of the Massachusetts Electric Companies. The security holders, including the holders of the 5 per cent gold notes, due April 1, 1918, of the Massachusetts Electric Companies, entered into a plan and agreement with the reorganization managers, dated March 6, 1919, whereby it was provided for the issuance of adjustment trustees’ 3-year 6 per cent notes, not by the new company, of which they were not an obligation, but by adjustment trustees who were not personally liable thereon. These adjustment trustees’ 3-year 6 per cent notes were to be issued in exchange for the 5 per cent gold notes, dollar for dollar, plus accrued interest thereon to October 1, 1918, at the rate of 5 per cent per annum.
    The adjustment trustees’ 3-year 6 per cent notes were to be dated the first day of the month during which the principal properties were transferred to the new company. The properties were transferred some time in 1919, and on March 27, 1920, the petitioner received the adjustment trustees’ 3-year 6 per cent notes due in 1922 in exchange for the 5 per cent gold notes of the Massachusetts Electric Companies.
    Under the agreement of March 6, 1919, adjustment stock was provided in the face amount of $250 of adjustment stock for each $100 of adjustment trustees’ notes. It was planned to sell the adjustment stock and turn over the accumulated proceeds to the note holders when the notes became due. In the event of no sale the adjustment stock was to be turned over to the holders of the notes upon the due date thereof in the above proportions, and to be accepted as a full discharge of the note. In the event of a partial sale of adjustment stock a pro rata distribution of part cash and part adjustment stock was to be made.
    Under the agreement of March 6,1919, the adjustment stock ranked fourth, being preceded by over $7,000,000 of sinking fund stock, first' preferred, and preferred B stock.
    The adjustment trustees’ 3-year 6 per cent notes were not quoted and the interest thereon was not paid at any time. The petitioner had written down on its books of account the value of the 5 per cent gold notes and adjustment trustees’ 3-year 6 per cent notes by the following charges to its profit and loss account:
    Original cost_$98, 000
    Written off in 1918_$48, 000
    Written off in 1919- 25, 000
    Written off in 1921_ 14, 500
    Amount written off and claimed year ended October 81, 1921_ 87,500
    Bools value, October 31, 1921- 10, 500
    The petitioner also owned some of the preferred stock issued under the reorganization plan, which it sold in April, 1921, for $13 per share. The preferred stock at the time of its sale had $12 accumulated dividends on it. In 1921 the adjustment stock was not listed and there was no market for it. Due to the fact that the adjustment stock was preceded by other securities, the concensus of opinion among business men familiar with the stock was that it had in October, 1921, only nominal value.
    On November 3, 1921, the public trustees of the new company in a letter to the bondholders and stockholders, stated that:
    Tbe Public Trustees, after more than two years’ association with your property, are convinced that it cannot become a financial success with its present capital structure * * *.
    In February, 1922, accumulated dividends on the Preferred and Adjustment Stock of the Company will amount to $2,633,456 as shown in the following table:

    * * * under tlie existing conditions there is not th© slightest prospect of any dividends being paid upon any class of stock for an indefinite period.
    In 1922 the petitioner received the adjustment stock in exchange for the adjustment notes, and in 1925 sold the adjustment stock for $41,149.52.
    The amounts written off on account of the notes (gold and adjustment) were not claimed as deductions in the original returns filed by the petitioner for the fiscal period ended October 31, 1921, but were later claimed in a protest filed with the Commissioner, such claim, however, being denied.
    The petitioner loaned money to various cities and towns in Rhode Island and Massachusetts, taking their notes for the amounts loaned. Due to the fact that the petitioner handled these notes through its regular note department, tax-exempt interest from this source in the sum of $81,539.38 was erroneously included in its taxable income for the period ended October 31, 1921.
   OPINION.

Love:

It is conceded by the Commissioner that the amount of $31,539.38 represented interest derived during the fiscal period ended October 31, 1921, from notes of political subdivisions of Rhode Island and Massachusetts and as such is not taxable. The petitioner erred, therefore, in including such amount in its gross taxable income. Accordingly, the petitioner’s taxable income for the fiscal period ended October 31, 1921, should be reduced by the amount of $31,539.38.

The petitioner contends that, in addition to the amount of $100,000 taken as a deduction on account of bad debts ascertained to be worthless and charged off in the fiscal year 1921, and which deduction was allowed by the Commissioner, it is entitled to a deduction from gross income of the amount of $200,000 representing the addition to its reserve for bad debts for the fiscal year 1921. We can not agree with this contention.

The provision of the Revenue Act of 1921 which permits a corporation taxpayer to deduct from gross income a reserve for bad debts is section 234 (a) (5), which reads as follows:

Debts ascertained to be worthless and charged off within the taxable year (or in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts) ; and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt to be charged off in part.

It will be noted that the above-quoted provision of the 1921 Revenue Act gives the Commissioner discretion with respect to additions to a reserve for bad debts. In the instant appeal the Commissioner permitted the petitioner to deduct from gross income for the period in question certain bad debts in the amount of $100,000 ascertained to be worthless and charged off within the taxable period. Such action on the part of the Commissioner constitutes a valid exercise of the discretion vested in him.

The evidence adduced shows that in setting up its reserve for bad debts and in making additions thereto the petitioner apparently resorted to guess work. There is no evidence with respect to its experience as to losses over a period of years upon which a reasonable reserve might be predicated.

It has been held by this Board that the petitioner can not in a given year deduct both the addition to its bad debt reserve and debts ascertained to be worthless and charged off within the taxable year. Appeal of Transatlantic Clock & Watch Co., 3 B. T. A. 1064. We approve, therefore, the respondent’s determination in disallowing as a deduction from gross income for the fiscal period ended October 31, 1921, the amount of $200,000, representing the addition to its reserve for bad debts for that period.

The petitioner also contends that it is entitled to a deduction from gross income for the fiscal year 1921 of the amount of $87,500 on account of a bad debt by reason of the adjustment notes owned by it which, it alleges, were recoverable only in part.

The petitioner exchanged in 1920 the 5 per cent gold notes of the Massachusetts Electric Companies for adjustment notes due in 1922, of the same par or face value, the latter notes having as collateral thereto the adjustment stock. Assuming that this exchange complied with the provisions of section 202 (b) of the Revenue Act of 1918, and that no gain or loss occurred by reason thereof, we are of the opinion that the petitioner is not entitled to a deduction for the year 1921 on account of a debt alleged to be worthless in part.

In 1918, 1919, and 1920, the petitioner charged off certain amounts on account of the notes held by it at those times. The record is silent as to the basis upon which it made such charges. There is no evidence as to the value of the notes at the times they were written down on the books. The petitioner did not claim the amounts charged off as deductions for the reason that the Revenue Act of 1918 did not permit the deduction of part of a debt as worthless. At the close of the fiscal year 1921, the petitioner made a further charge against the notes and claimed the entire amount written off in 1921 and preceding years, to wit, $87,500, as a deduction for the year 1921.

It appears from the record that the adjustment notes were not due until 1922 and were secured by adjustment stock which had been provided for the retirement of the notes on the due date.

It further appears that the new company, issuer of the adjustment stock, was actively engaged in business and that the adjustment stock in October, 1921, was not in fact entirely worthless. In fact, the petitioner alleges that the adjustment stock had some value at that time. In W. P. Davis v. Commissioner, 6 B. T. A. 1267, we stated:

Petitioner’s claim of a loss in 1924 is based upon the decline in the value of stock owned by him in the Cross Mountain Coal Co. * * * Its value may have fluctuated much since that time but the decline in value of property does not give rise to a deductible loss under the statute any more than does the increase of the market value of the property owned give rise to taxable income. The evidence does not show and the petitioner does not claim that the stock was worthless at the end of 1924. Until it is clearly shown that stock owned in a corporation which is still in existence and has assets is in fact worthless and there is no probability that any portion of the investment will ever be recovered, no deductible loss under tlie statute has been sustained. See Appeal of E. O. Walgren, 4 B. T. A. 1066; J. J. Melick v. Commissioner, 6 B. T. A. 70; Appeal of George C. Ryder, 2 B. T. A. 1060. * * *

We think the Commissioner correctly denied the deduction claimed with respect to the adjustment notes secured by adjustment stock.

Reviewed by the Board.

Judgment will be entered on 15 days' notice, under Rule 50.

Milliken dissents.


source: Caselaw Access Project

author: Phillips :

license: Public Domain

text:
    Van Zandt, Jacobs & Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 6863, 11605.
    Promulgated October 7, 1927.
    1. Evidence held insufficient to establish an invested capital in excess of the amount allowed by the Commissioner.
    2. Corporations held to be affiliated.

      L. F. Speer, Esq., and Fred A. Woodis, Esq., for the petitioner.

      J. Harry Byrne, Esq., for the respondent.
    This appeal is from a determination by the Commissioner of deficiencies in income and excess-profits taxes for the years 1918, 1919, and 1921, in the amounts of $11,153.34, $2,149.93, and $6,267.90. It is alleged by the petitioner that the Commissioner erred in refusing to permit it and the Burt Shirt Co. to file consolidated returns in each of the taxable years and in the computation of the invested capital for 1918 and 1919 in disallowing a part of the value claimed for good will.
    FINDINGS OF FACT.
    Petitioner is a corporation organized under the laws of the State of New York, with its principal offices and place of business at Troy. It was organized on May 9, 1904, by Clarence E. Yan Zandt, Charles E. Yan Zandt, Walter H. Staude, and Harry E. Shumway as in-corporators, with an authorized capital stock of $500,000.
    The corporation was formed to take over the business of a certain partnership theretofore engaged' in the manufacture of collars at Troy, N. Y. The partnership was composed of J. E. Jacobs, W. H. Staude, and Clarence E. Yan Zandt. Jacobs died on July 28, 1903. The court appointed an appraiser for his estate and the value of the partnership was appraised to determine the interest of the deceased partner. The partnership books were closed January 1, 1904, on the basis of that appraisal. The present worth of the partnership as of January 1, 1904, based on such appraisal and excluding any value for good will was as follows: J. E. Jacobs, $174,597.13; Clarence E. Van Zandt, $174,597.13; W. H. Staude, $6,891.20, making a total of $356,085.46.
    After the death of Jacobs, the business was carried on by the surviving partners and the executors of Jacobs’ estate. On May 25, 1904, the board of directors of petitioner resolved to purchase on or before June 30, 1904, all of the property real and personal, including good will, of the late partnership, and including all undivided profits accrued on May 25,1904, and all profits that might thereafter accrue.
    On June 18, 1904, the corporation acquired the business, the bills of sale reciting a grant, bargain, sale and conveyance of the business, property, assets and rights, legal and equitable, and of every name and nature, of the late firm of Yan Zandt, Jacobs & Co., together with all the earnings, profits, surplus, accumulations and increase accrued and undivided on May 25, 1904, or that had since or might thereafter accrue thereon or thereto.
    The company was organized with an authorized capital stock of $350,000 common and $150,000 preferred. The preferred stock was sold for cash at par mainly to persons not theretofore interested in the business. Common stock was sold at par for cash to the following:
    Clarence E. Van Zandt_$23,300
    Charles E. Van Zandt, a son of Clarence- 4, 700
    Harry E. Shumway- 2, 000
    30,000
    Common stock of the par value of $279,200 and $13,300 was issued to Clarence E. Yan Zandt and Staude, respectively, for their interest in the partnership assets and good will, including all accumulated earnings. One hundred and sixty-five thousand dollars in cash was paid Jacob’s estate for his interest in the partnership assets and good will, including all accumulated earnings. The corporation also acquired from Clarence E. Yan Zandt and Jacobs’ estate certain real estate used in the business, paying the estate $15,000 in cash and issuing to Yan Zandt additional common stock of the par value of $27,500.
    No appraisal of the assets was made at the time they were taken over by the corporation. Assets were entered on.the books of the corporation at the value fixed in the appraisal of Jacobs’ estate to which was added an item of good will and profits of $131,414.54.

      The balance sheet was set up as of January 1,1904, as follows:

    On July 1,1904, it was ascertained that the profits from January 1, 1904 to July 1, 1904, were $90,943.84 and this amount was charged against the account known as good will and profits, reducing such account to $40,470.70. In computing invested capital for 1918 and 1919, the Commissioner has allowed $409,056.16, being the par value of the capital stock less the profits from January 1, 1904, to July 1, 1904.
    Petitioner manufactured collars while the Burt Shirt Co. manufactured shirts. The goods of both companies were manufactured in the same building and both companies had their laundry work done in the same building. Clarence Yan Zandt was president of Van Zandt, Jacobs & Co. and treasurer of the Burt Shirt Co. W. H. Staude was vice president of Yan Zandt, Jacobs & Co., and president of the Burt Shirt Co. Charles Van Zandt was secretary of both companies.' H. E. Shumway was treasurer of Van Zandt, Jacobs & Co. The board of directors of Van Zandt, Jacobs & Co. was composed of the same men who were the board of directors of the Burt Shirt Co., with the exception of one man in each company.
    All the material going into the manufacture of shirts was charged to the Burt Shirt Co., but was purchased with the credit of Van Zandt, Jacobs & Co. The Burt Shirt Co. was known by the trade as the shirt department of Van Zandt’s. The men who bought the merchandise for Burt shirts were the same men who bought the Van Zandt merchandise and the products of both companies were sold by the same salesmen. The same parties supervised the manufacturing processes in both plants. The officers of the Burt Shirt Co. were paid salaries only by Van Zandt, Jacobs & Co. The president of the latter company performed the duties of treasurer of the Burt Shirt Co. for a salary paid by Van Zandt, Jacobs & Co. The accounting for both companies was done in the same general office by the same persons, although there were individual bookkeepers for various phases and although each company had a separate set of books, so that the operations of each company could be correctly ascertained at any time. There was one credit manager for both companies. Clarence Yan Zandt handled the financial matters of both corporations. Yan Zandt, Jacobs & Co. continuously furnished funds to the Burt Shirt Co. when it was out of funds. The former company made loans to the latter company in 1918, 1919, and 1921. When the Burt Shirt Co. went out of business and liquidated, Yan Zandt, Jacobs & Co. paid its debts.
    The stock ownership of the two companies for the years 1918,1919, and 1921 was as follows:

    Dividends have been regularly paid on the preferred stock of petitioner since organization. Outside interests owned 1,093 shares of the preferred stock of petitioner and 20 shares of the preferred stock of the Burt Shirt Co. Such preferred stock was redeemable at $107 per share on 30 days’ notice. Marjorie and Gladys Yan Zandt were the daughters of Clarence Yan Zandt, who gave them the stock listed in their names. The stock in the names of his wife and of his sister, Edna Coonradt was likewise given them by Clarence Yan Zandt. The stock owned by these four persons was never voted during the j^ears involved in this appeal. Both the preferred and common stock of both companies had voting rights. The preferred stock of petitioner was sold to the public through a bank. The other holders of the preferred stock of the two companies were not represented either in person or by proxy at the stockholders’ meetings in 1917, 1918, and 1919, except one owner of 50 shares of the preferred stock of petitioner, who was also one of petitioner’s directors, and never expressed any opposition to the management or policies of the corporations.
   OPINION.

Phillips :

With respect to the issue involving invested capital, it is alleged that the Commissioner erred in disallowing $90,943.84, the amount of the profit of the business for six months during most of which time the business was conducted by the predecessor partnership. The amount seems to have been disallowed without any reason other than that it had been charged off the books. The Commissioner does not now contend that the profits of the business from January 1, 1904, to July 1,1904, may not be included in the invested capital, either as assets paid in for stock or as earned surplus. His present contention is more fundamental; namely, that the assets received in exchange for stock did not have a value equal to the par value of the stock. His counsel points out that the interest of Jacobs was appraised at $174,597.13, without giving any value to good will; that such interest was acquired for $165,000 and that for an equal interest owned by Yan Zandt the company issued to him stock of the par value of $279,200. He contends that this sale of Jacobs’ interest, made in a transaction between parties dealing at arm’s length, demonstrates that the assets had no value in excess of that at which the tangibles were carried on the books and also fixes the market value of the same interest acquired from Yan Zandt. The contention appears to be sound. The question before us is not whether the profits of the business, whether earned before or after the purchase by the corporation, may be included in the invested capital, but whether the assets paid in for stock had a value in excess of the amount allowed by the Commissioner. There is nothing in the evidence which leads us to believe that they had; in fact, so far as there is evidence, it would lead us to believe that invested capital has been overstated.

At the close of the hearing counsel for the respondent moved to amend his answer to conform to proof that invested capital had been overstated. While the proof indicates that such may have been the case, it is too indefinite to permit us to determine that such was the case, or to determine the correct invested capital. The motion is, therefore, denied.

Upon the question of affiliation the record is clear that except for 1,098 shares of the preferred stock of the petitioner in the hands of those not in the family group, the stock of both companies was controlled by the same interests. This outstanding preferred stock had paid its regular dividend since the organization of the company and the holders appear to have been satisfied to leave the conduct of the company with those who had made this possible. It represented something less than 22 per cent of the voting rights in the petitioner corporation. It was interested in the business only to make certain that its dividends were assured. It was first sold through the petitioner’s bank. It was listed on no exchange. All the circumstances indicate that it was held for investment. Without objection, these stockholders permitted the two companies to be operated substantially as one. It must be assumed that they did not regard this as in derogation of their own interests. On the liquidation of the Burt Shirt Co. they permitted its losses to be paid by the petitioner. The circumstances indicate that both the common and preferred stockholders must have regarded the two corporations as one business enterprise in which all were interested, either directly or indirectly. It is our opinion that the petitioner and the Burt Shirt Co. are properly to be considered as affiliated corporations, and that the respondent erred in failing to compute their taxes on the basis of a consolidated return.

Reviewed by the Board.

Decision will he entered on 20 days’ notice, under Rule SO.


author: Phillips:

text:
    Higginbotham-Bailey-Logan Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 4691.
    Promulgated October 7, 1927.
    1. Petitioner reduced its gross sales by 50 per centum of the sales price of goods which it had been notified, prior to the close of the taxable year, would be returned. The action of the Commissioner in disallowing such deduction approved.
    2. It was the custom of petitioner always to take advantage of cash discounts and during its existence it had computed its inventories by giving effect to such discounts. Held, that such inventories may properly be used in computing taxable income, the effect being to allow cash discount as a deduction when the goods were sold and not when payment is made.
    3. Weight is to be given to consistency of method in taking inventories.
    4. Amount paid by petitioner to secure cancellation of a lease which it had previously executed upon its building, the space being necessary to the conduct of its business, held to be deductible in the year incurred and paid and not to be spread over unexpired period of the lease.
    5. Adjustment of interest and insurance payments on basis of prorating such payments over the period for which made, approved.
    6. Principles governing ascertainment of worthlessness of indebtedness and proof thereof discussed. Some of debts claimed as deductions allowed and others disallowed.
    7. Assessment under section 328 of the Revenue Act of 1918 denied.

      Evert L. Bono, Esq., for the petitioner.

      Bruce A. Low, Esq., for the respondent.
    This proceeding involves the determination by the Commissioner of a deficiency in income and profits taxes for the fiscal year ended November 30, 1920, of $79,407.60. At the hearing, on motion of the counsel for the respondent, the answer was amended to allege that the net income was understated by $6,260, by reason of the improper allowance of a deduction of that amount, claimed as automobile expense.
    FINDINGS OF FACT.
    Petitioner is a Texas corporation, engaged in the wholesale dry-goods business, with its principal office at Dallas. It kept its accounts on the basis of the fiscal year ended November 30, and made its income and profits-tax returns on the basis of such fiscal year. The Commissioner mailed a deficieny letter to the petitioner on April 13, 1925, notifying it of his determination of a deficiency of $79,407.60 in income and profits-tax for the fiscal year ended November 30, 1920. In determining such deficiency, the Commissioner made the following adjustments in the net income reported by the petitioner in its return:
    (1) Gross sales increased-$25,113. 22
    (2) Cash discount restored to inventory- 14,295.27
    (3) Amount paid for cancellation of a lease decreased- 12, 631. 68
    (4) Insurance deduction decreased_ 1, 514. 56
    (5) Interest deduction decreased_ 9, 755.73
    (6) Bad debts deduction decreased_ 105,158.17
    (1) The increase in gross sales of $25,113.22 as made by the Commissioner represents a charge made by the petitioner against the gross sales of goods which had been shipped to customers, and which petitioner had been notified, previous to November 30, 1920, would be returned. Petitioner made a charge against the gross sales of 50 per cent of the amount of the invoices, which was the estimated profit on the goods which petitioner had been notified would be returned, and which were returned. None of the goods, however, were actually returned until after November 30, 1920. Petitioner did not include these goods in its inventory, but as the profit on same wras reflected in the gross sales, a direct charge against the gross sales was made. Petitioner’s gross profits, on an average, amounted to about 21 or 22 per cent. Petitioner, in addition to losing the profit on this merchandise, was compelled to pay the freight to and from the point of destination, and suffered the decline in the value of the merchandise which had taken place after it was shipped. The charge of 50 per cent of the amount of the sales price against gross sales was petitioner’s estimate of the profits loss, plus freight charges and plus a decline in the value of the merchandise. It had not been petitioner’s custom in former years to charge off an anticipated loss of profit on returned goods. All goods returned prior to the close of the fiscal year were included in the inventory.

      (2) The disallowance of cash discount of $14,295.27 represented the difference between the amount of cash discount deducted from the inventory at the beginning of the year, and the amount of cash discount deducted from the inventory at the end of the year, in the amounts of $19,525.56 and $33,820.83, respectively. Since 1914, when petitioner started business, it had been its practice to take advantage of discounts allowed for cash by those who sold it merchandise. It had continuously been its custom to take inventory of its merchandise on the basis of cost or market value, whichever was lower, which included the cash discount which was allowed or would have been allowed by making the purchase at the price at which the goods were inventoried, and then to deduct the average cash discount allowed by manufacturers. Petitioner followed this policy in determining its inventory for income-tax return purposes. On December 1,1919 (the beginning of the fiscal year under consideration), it deducted $19,-525.56 from its total inventory and deducted $33,820.83 at the end of said fiscal year. Commissioner contends that these amounts should be restored to inventory and has increased the net income by the difference between the amount deducted from inventory at the close of the year and the amount deducted from inventory at the beginning of the year.
    (3) The Miller Manufacturing Co. in 1916 leased a part of petitioner’s building for a period of 10 years. In 1919, the business of the petitioner had increased to such an extent that it was necessary for it to secure possession of this portion of the building. In order to secure such possession, it paid the Miller Manufacturing Co. $15,000 for the cancellation of this lease and deducted this expenditure from income. This expenditure was made to secure the possession of a building which petitioner owned, and for the cancellation of the lease on a building which -was owned by petitioner. The Commissioner held that the $15,000 bonus paid for the cancellation of the lease should be prorated over the entire period during which the lease would have been in force had it not been canceled. He allowed $2,368.32 as a deduction for the year 1920. He disallowed $12,631.68 as a deduction for that year and increased net income accordingly.
    (4) The amount of $1,514.56 insurance disallowed as a deduction from income, represents the difference between the prepaid insurance on November 30, 1919, and on November 30, 1920. It was the policy of petitioner to charge to expense the amount expended for insurance in the year in which such expenditure was incurred. It set up on its books at the end of the year the amount of unexpired insurance, but always treated the amount paid for insurance as an expense in the year in which the expenditure was made.

      (5) Petitioner borrowed considerable sums of money during the fiscal year under consideration, and paid substantial amounts of interest. In its return for the fiscal year ending November 30, 1920, petitioner claimed a deduction for interest in the amount of $175,-195.95. The Commissioner disallowed $9,755.73 of this amount. The amount paid during the year was $165,867.96.
    (6) About August, 1920, the merchandise handled by the petitioner began to decline in value, there being a decline of from 30 to 40 per cent from the beginning of 1920 to the end of that year. Serious financial depression had settled over the entire country and particularly over the cotton-growing States of Texas, Oklahoma, Louisiana, and Arkansas, which was the territory in which petitioner sold most of its goods. The price of cotton had dropped from 43.75 cents per pound in July to 15.48 cents per pound in November, 1920. Finding itself with a large inventory of goods which were rapidly decreasing in value, and preferring to take credit risks rather than to be forced to continue with its inventory,' the petitioner sold its goods without much regard for the credit of the purchaser. Because of business conditions and the consequent inability to collect accounts, many of the petitioner’s customers became unable to pay their accounts, customers became insolvent or bankrupt, and many returned merchandise because they were unable to pay for it. During the period of business depression, and prior to November 30, 1920, the petitioner’s credit man formed the opinion that certain accounts were uncollectible in whole or in part and advised petitioner to charge them off on its books. The petitioner in its return claimed as a deduction for bad debts $245,169.47. The Commissioner refused to allow $105,158.17 of this amount. In the petition it is alleged that the whole amount should have been allowed. At the hearing the petition was amended to allege that debts in the amount of $95,148.43 should have been allowed %s deductions in addition to those which were allowed.
    On November 30,1920, the balance due and owing to the petitioner from Barnes and Hambuck Co., Lone Oak, Tex., was $7,578.82. On October 15, 1920, a check for $1,500 had been received from the debtor, which was subsequently returned unpaid and charged to the account. On October 28, 1920, a check for $500 had been received. On November 19, 1920, a shipment was made to this customer amounting to $705.21. The credit manager of the petitioner directed that the account be charged off as worthless and an entry was made on the accounts, as of November 30, 1920, charging the entire balance of the account as of that date to an account known as “ reserve for losses.” A man sent to investigate into the affairs of the debtor reported that that company was “broke.” No collections were subsequently made.
    On November 30,1920, the balance due and owing to the petitioner from Hancock & Company, Haskell, Tex., was $10,019.53. On the basis of a credit report that the company was insolvent, the credit manager' of the petitioner directed that the account be charged off as worthless and an entry was made on the accounts as of November 30, 1920, charging the entire balance to the account known as reserve for losses. Collections of $1,887 and $1,138.38 were made on December 1 and December 23, 1921, respectively, and during December, 1920, credit sales of about $30 were made to this customer.
    On November 30, 1920, the balance due and owing to the petitioner from W. A. Nash & Co., Kaufman, Tex., was $12,339.97. The last payment on account had been made on July 1, 1920. On November 20, 1920, the petitioner had sold to this company on credit goods invoiced at $70. The petitioner sent an investigator to go over the affairs of this company, who reported that it had large assets and heavy liabilities. The debtor did a large credit business and had many accounts receivable which were worthless due to the condition of the cotton market. The credit manager of the petitioner directed that the account be charged off as worthless and an entry was made on the accounts as of November 30, 1920, charging the entire balance to the account known as reserve for losses. No collections were sub-scquently made.
    ,On November 30, 1920, the balance due and owing to the petitioner from Key & Co., Anson, Tex., was $7,350.26. The petitioner had received two payments of $1,000 each on this account on October 28, 1920, and November 30, 1920. On November 27, 1920, the petitioner had sold a bill of goods of approximately $58 to this customer. The credit manager of the petitioner directed that the account be charged off as worthless and%n entry was made on the accounts, as of November 30, 1920, charging the entire balance to the account known as reserve for losses. On December 15, 1920, a payment of $1,000 was received. Goods' valued at approximately $700 were also returned and credited after November 30, 1920. Prior to November 30, 1920, the petitioner had a credit report on Key & Co.
    On November 30, 1920, the balance due and owing to the petitioner from Matthews & Searls, Athens, Tex., was $7,444.26. There had been a payment of $1,000 on account on November 12, 1920. The credit manager of the petitioner directed that the account be charged off as worthless and an entry was made on the accounts as of November 30, 1920, charging the entire balance to the account known as reserve for losses.

      Collections were subsequently made on the account as follows:
    December 16, 1920_$1,000
    December 24, 1920_ 500
    December 30, 1920_ 500
    January 7,1921- 1,000
    January 21, 1921- 500
    On December 13,1920, the petitioner sold to this customer on credit goods invoiced at $12.73.
    On November 30,1920, the balance due and owing to the petitioner from Anderson, Hays, and Gray, Paris, Tex., was $9,932.04. On that date the petitioner received a cash payment of $1,122.20. The credit manager of the petitioner directed that the balance of the account be charged off as worthless, and an entry was made on the accounts as of November 30,1920, charging such balance to the account known as reserve for losses. The petitioner on December 7, 1920, soid goods to this customer on credit, invoiced at $90. No collections were subsequently made.
    On November 30,1920, the balance due and owing to the petitioner from Pecos Dry Goods Co., Pecos, Tex., was $13,990.80. The credit manager of the petitioner believed this account to be uncollectible and an entry was made on the account as of November 30, 1920, charging the balance to the account known as reserve for losses. The store of this customer was then open and doing business. Collections were subsequently made as follows:
    December 16, 1920_$1, 000
    December 30, 1920- 1, 000
    1 anuary 14, 1921- 1,000
    On December 18, 1920, goods invoiced at approximately $40 were sold to this customer on credit.
    On November 30, 1920, the balance due and owing to the petitioner from James & Reighard, Quanah, Tex., was $2,582.95. The last sale to this customer had been made on September 28, 1920, and on November 5, 1920, a cash payment of $150 had been received. The credit manager of the petitioner believed that the balance of the account was uncollectible and directed that it be charged off as worthless. An entry was made on the accounts as of November 30, 1920, charging such balance to the account known as reserve for losses. No collections were subsequently made.
    On November 30, 1920, the balance due and owing the petitioner from Cunningham, Westbrook Co., Deport, Tex., was $13,051.93. The last sale made on this account was March 17, 1919. As of November 30, 1920, there was charged from this account to the account lmown as reserve for losses, $13,057.91. Subsequently, on December 20, 1920, two checks of $1,000 each were received which were returned unpaid and charged back to the account together with protest fees of $6.
    On September 2, 1920, the balance due and owing the petitioner from E. F. Grissom, Desdemona, Tex., was $977.52. Grissom became bankrupt July 6, 1920. As of September 2, 1920, there was transferred from this account to the account known as reserve for losses, $971.42, leaving a balance of $6.10. No collections were thereafter made.
    On October 19, 1920, the balance due and owing to the petitioner from Sanders Endsley Co., Texarkana, Tex., was $5,544.15. This company had become bankrupt early in the year. On October 19, 1920, there was transferred from this account to the account known as reserve for losses, $3,500. On November 27, 1920, a dividend of $1,128.83 was received from the bankrupt estate. As of November 30, 1920, there was transferred from this account to the account known as reserve for losses, $644.15, leaving a balance in the account of $271.17.
    On October 19, 1920, there was due and owing to the petitioner from T. C. Owens, Payner, Tex., $2,568.96. This customer had failed, and under date of October 19, 1920, there was transferred from this account to the account known as reserve for losses, $1,500. As of November 30, 1920, there was further transferred from this account to the account known as reserve for losses, $768.96, leaving a balance in this account of $300. Subsequently, in 1921 or 1922 a final dividend of $376 was received on account.
    On October 19, 1920, the balance due and owing to the petitioner from W. C. Powell and Son, Queen City, Tex., was $4,104.24. On that date there was transferred from this account to the account known as reserve for losses, $3,000, leaving a balance of $1,104.24. The debtor was in bankruptcy prior to that date and thereafter the following dividends were received:
    December 3, 1920-$187.00
    December 2S, 1920- 100.29
    On October 19, 1920, the balance due and owing to the petitioner from McDavid Brothers, Overton, Tex., was $6,159.59. On that date there was transferred from that account to the account known as reserve for losses, $4,000, and as of November 30, 1920, there was transferred from that account to the account known as reserve for losses, $1,859.59, leaving a balance in the account of this customer of $300. On January 22,1921, $615.96 was recovered on this account.
    On October 19, 1920, the balance due and owing to the petitioner from Economy Store, Beaumont, Tex., was $2,487.45. On that date there was transferred from this account to the account known as reserve for losses, $1,500. On November 3, 1920, a dividend of $134.33 was received. The credit manager of the petitioner directed that the balance of the account be charged off as worthless and an entry was made on the accounts as of November 30, 1920, charging the balance of $853.12 to the account known as reserve for losses.
    On November 30,1920, the balance due and owing to the petitioner from A. J. Pass, Aubrey, Tex., was $445.82. The debtor was in bankruptcy. As of November 30, 1920, an entry was made on the account charging $420.82 to the account known as reserve for losses, leaving a balance of $25.
    On November 30,1920, the balance due and owing to the petitioner from Wagoner & Co., Maybank, Tex., was $424.05. This company was insolvent. Pursuant to the instructions of the credit manager of the petitioner, $414.05 of this amount was transferred to the account known as reserve for losses as of November 30, 1920, leaving a balance not charged off of $10. Thirty-four dollars and ninety-one cents ivas later recovered on this account.
    On November 30, 1920, the balance due and owing to the petitioner from C. E. Gray, Chireno, Tex., was $2,454.59. The petitioner had information that the debtor had become bankrupt in October, 1920. As of November 30, 1920, there was transferred from this account to the account known as reserve for losses, $2,254.59, leaving a balance in the account of $200. A dividend of $369.79 was received December 7, 1920.
    On November 30,1920, the balance due and owing to the petitioner from Strong & Strong, Henderson, Tex., was $2,056.76. The petitioner had information that the debtor was in bankruptcy prior to that date. As of November 30,1920, there was transferred from this account to the account known as reserve for losses, $1,556.76, leaving a balance of $500 in the account. A dividend of $210.45 was received on December 23, 1920, a further dividend of $210.45 was received on April 10, 1921, and subsequently, a final dividend of approximately $100 was received, making the total collection on the account approximately $520.
    On November 30,1920, the balance due and owing to the petitioner from J. H. Thompson, Lone Oak, Tex., was $1,197.04. As of that date there was transferred from this account to the account known as reserve for losses, $879.04, leaving a balance in the amount of $300. Dividends were subsequently received as follows:
    April 9, 1921_§247.21
    September 16, 1921- 25.00
    May 1, 1922, final dividend- 6.18
    On November 30, 1920, Yarborough Company, Inc., Powhattan, La., was indebted to the petitioner in the amount of $200, representing a check for that amount received by the petitioner on October 2, 1920, and returned unpaid on October 29, 1920. The account was charged off on November 30,1920, as worthless.
    On November 30, 1920, the balance due and owing from M. Vasquez, Somerton, Ariz., was $439.69. The last sales on credit on this account had been made in March and April, 1920, and the last credits to the account were made in September, 1920. The credit manager of the petitioner believed the account to be worthless before November 30, 1920, and pursuant to his instructions it was charged off in that year.
    In 1918 the petitioner shipped goods invoiced at $269.44 to Gardner & Coggins, Hollis, Okla. The purchaser claimed that such goods had never been delivered. The merchandise could not be located, and in July, 1920, the petitioner credited the account of this customer with the amount charged for the goods so shipped and claimed the amount so credited as a deduction for debts ascertained to be worthless in its 1920 tax return.
    (7) The sales of the petitioner during the fiscal year were $10,721,426.79. Its purchases were $9,859,115.85. Notes payable at the beginning of the year were $936,701.01 and at the end of the year were $2,177,200. All notes were endorsed by the stockholders. Such borrowed money was necessary to the conduct of the volume of business done by the petitioner in the taxable year. The statutory invested capital, as determined by the Commissioner and accepted by the petitioner, was $2,656,613.68. The average borrowed capital of the petitioner, computed as of the last day of each month, was $2,189,-025.25. Accounts receivable at the end of the year were $2,489,526.37. The profits tax determined by the Commissioner was $90,887.90 upon a net income of $602,295.67.
    The Perkins Dry Goods Co. was a competitor of the petitioner, engaged during the taxable year in the wholesale drygoods business in Dallas, and sold goods chiefly in Texas, Oklahoma and Arkansas. Its net sales (gross sales less returned goods) were $9,975,966.25. It paid no excess-profits tax.
   OPINION.

Phillips:

(1) The facts with respect to the first issue are found as pleaded in the petition and admitted in the answer, with some additional facts established by testimony. It appears that prior to the close of the taxable year petitioner had been notified that goods which it had sold for $50,226.44 and had shipped to customers would be returned. None of the goods were in fact returned prior to the dose of the taxable year. The petitioner’s officers estimated that the average gross profit on such goods was 21 or 22 per cent out of the sales price, that the market value was less than 80 per cent of the cost, and that, with freight and handling charges added, there would be a loss of 50 per cent of the sales price and sought to charge this off as a deduction from gross income for the year. No such deduction is allowed by the law, but it is urged by counsel that the practical effect is to reduce gross sales by the amount which petitioner was notified would be returned and to include the goods in the inventory at their market value. Even so, the deduction sought included expenses for freight, handling and overhead which were neither paid nor incurred in the taxable year and which would be properly considered in computing income of the following year.

But we can not agree with the contention that because petitioner had been notified that certain goods would be returned it could treat those goods as its own, in the same manner as if they had been returned and their return accepted. The goods had been sold and title had passed from the petitioner. It was entitled to the purchase price and was not required to accept the return of the goods. Certainly until it agreed to accept their return, there had been no reduction in the amount of goods sold, no decrease in the amount which it was entitled to demand from the purchasers and no re-vesting of title to the goods sold so that it was justified in including such goods in its inventory as its property. Mere notice that the goods would be returned would have no effect on either the liability of the purchaser to pay or title to the goods. A different situation might result if the petitioner had agreed to accept the return of the goods and the necessary steps to revest title to the goods in it had been taken. As to this we express no opinion. Here there is no proof that petitioner agreed to accept the return of the goods or that such goods had again become the property of the petitioner. The substance of the situation is that at the close of the year the petitioner anticipated that it would be forced to accept the return of certain goods, from which it would suffer a loss. It estimated the anticipated loss and claimed a deduction of the estimated amount. The tax law provides for the deduction of losses when sustained and makes no provision for the deduction of such an anticipated loss. Any loss occurred at the time when the petitioner no longer had a legal right to recover the purchase price and in place of such right, was revested with the property. The action of the Commissioner with respect to this item is approved.

(2) Petitioner, m making out its income-tax returns, consistently followed the practice of taking inventory on the basis of cost or market value, whichever was lower, without regard to cash discounts, and deducting therefrom the average discount allowed by manufacturers for cash. It had followed this method consistently since 1914 and contends that great consideration should be given to the consistency of its practice. Section 203 of the Revenue Act of 1918 provides that inventories shall be taken on such basis as the Commissioner, with the approval of the Secretary, may prescribe as conforming to the best accounting practice in the trade or business.

Article 1583 of Regulations 45, relating to taxes under the Revenue Act of 1918, provides:

Cost means: (1) In the case of merchandise purchased, the invoice price less trade or other discounts, except strictly cash discounts, approximating a fair interest rate, which may be deducted or not at the option of the taxpayer, provided a consistent course is followed. (Italics ours.)

The effect of the petitioner’s method of inventory is to take the cash discount as a deduction in the year in which the goods are sold. The adjustment made by the respondent allows the deduction in the year in which the payment is made. From a purely legalistic point of view it might be pertinent to determine whether such a cash discount is income arising from the use of money or is a reduction in the cost of the goods purchased. It seems to us, however, unnecessary to delve into such a refinement. Under either computation there is no double deduction and over a period of years the effect of either basis on net income wrould be the same. The regulations promulgated by the Commissioner pursuant to statutory authority permit either basis, if consistently followed. In the Appeal of Thomas Shoe Co., 1 B. T. A. 124, the Board pointed out the desirable features of a consistent basis for inventories. It appears that the petitioner has followed this basis since its organization and we are, therefore, of the opinion that the Commissioner erred in this adjustment.

(3) During the taxable year the petitioner paid $15,000 for the cancellation of a lease which it had previously executed upon property which it owned, which lease still had several years before expiration. It claimed this amount as a deduction. The Commissioner held that the amount paid should be amortized over the period of the lease which remained unexpired at the time the cancellation took place and allowed $2,368.32 as a deduction. In this we believe the Commissioner erred.

We have no doubt that such an expenditure made for the purpose of securing possession of the property for use in the business is an ordinary and necessary expense, nor do we understand that respondent contends the contrary. Such expenses are to be deducted when paid or incurred. Here the expense was both paid and incurred in the taxable year. Unless the petitioner acquired a capital asset with a life extending beyond the taxable year (in which event the cost of the asset is to be exhausted over its life), the expenditure is deductible.

The petitioner owned the fee of the building. It had given the lease and wished to terminate it. The cancellation of the lease did no more than give to the petitioner the possession of the property which it had leased. It created no greater title than it had previously owned. It created no new estate and no asset value which is exhaustible. This situation is to be distinguished from those where a fee is purchased subject to a lease and the lease subsequently purchased, or where payment is made to secure a lease of property owned by another. Here the payment served only to secure to petitioner what it previously had, namely, possession of its property.

(4) With respect to the adjustment made for insurance, it is our opinion that the action of the Commissioner was correct. The payment in advance of premiums for insurance results in the creation of an asset, since the policy has a surrender value. The asset value is exhausted ratably over the term for which the premium is paid. In the balance sheet such items are often carried as assets under such terms as prepaid insurance, or prepaid expense. It appears that such was the basis on which the petitioner kept its accounts. The adjustment made by the Commissioner appears to be in accordance with the method of accounting employed by the petitioner and appears further to be such that petitioner’s net income is more nearly correctly reflected than on the basis used in the return. The adjustment made by the Commissioner with respect to this item is approved.

(5) Our sole information with respect to the interest deduction is that $165,867.96 was paid during the taxable year, that $175,195.95 was deducted on the return, and that the Commissioner disallowed $9,755.73 of this amount. It is the contention of the petitioner that $175,195.95 was paid during the taxable year, that the amount allowed by the Commissioner was the amount which accrued, that its accounts were kept in such a manner that it consistently deducted interest paid and not interest accrued. None of these allegations are supported by proof.

Interest accrues ratably over the period of the loan and where, as here, the books of the petitioner are kept on a basis other than cash received and disbursed, the law provides that interest is allowable as a deduction as it accrues. The petitioner can not be sustained in its contention that it may deduct interest as it pays it. The action of the Commissioner must be approved.

In passing, it may be noted that while the petitioner claimed that interest paid amounted to $175,195.95, and deducted this amount on its return, the only evidence submitted is that the interest paid was $165,867.96, which is approximately the amount allowed by the Commissioner. The difference between the amount claimed on the return and the testimony as to the amount paid is unexplained.

(6) In its return the petitioner claimed deductions for a number of debts alleged to have been ascertained to be worthless and charged off within the taxable year. The Commissioner allowed some and disallowed others. The petitioner alleges error as to some 23 of those disallowed and issue was joined between the parties by the answer of the Commissioner denying that the amount of debt disallowed was ascertained to be worthless and charged off within the taxable year.

We are satisfied that such debts existed and that prior to the close of the taxable year the credit manager of the petitioner directed that they be charged off in whole or in part, as found in our findings of fact.

Whether the entry was made on the books of account on November 80, 1920, is not clear. It does appear that the entries were made in the usual course with the other closing entries as of November 30, 1920, and before the books were finally closed. These circumstances are, in our opinion, sufficient to meet the requirements of the statute with respect to the charge-off.

We come then to the principal question involved. The statute provides specifically for the deduction of “ debts ascertained to be worthless and charged off within the taxable year.” As previous decisions have pointed out, it is not worthlessness which controls, but ascertainment of worthlessness. Since a debt may become worthless in one year, but may be ascertained to be worthless in a different year, and since it seems certain that Congress had no intention that the deduction of the same debt should be twice allowed, it becomes incumbent upon the taxpayer whose claimed deduction is disallowed by the Commissioner, to establish that he did ascertain the debt to be worthless in the taxable year in which he claims it to be deductible.

The word “ ascertain ” is defined in Bouvier’s Law Dictionary as:

To make certain by examination; to find out. The word ascertain is held to have two meanings; (1) known; (2) made certain.

Substantially the same definition is given in Webster’s New International Dictionary. The word worthless ” is defined in the latter work as;

Destitute of worth; having no value; valueless; useless.

The burden then is upon the petitioner to establish that it did make certain during the taxable year that the debts claimed as deductions were without value. We take it for granted that when Congress authorizes this Board to decide the issues arising between a taxpayer and the Commissioner in such a case as this, such taxpayer has not established the correctness of his contention by his bald statement that he believed it to be worthless, or that he ascertained it .to be worthless or that, on undisclosed information he came to the conclusion that it was worthless. To so hold would be to put the Government in the hands of the taxpayer and substitute his judgment as to the conclusion to be drawn from the facts for that of the body created to decide the issue.

Nor is it a question whether the taxpayer believed the debt to be worthless. To so hold would be to grant an undue advantage to the pessimist or to the taxpayer who made no investigation. In our opinion the burden upon the petitioner is to show what steps he took to collect the debt, what information came to his knowledge and what other circumstances existed which led him to his conclusion. It then becomes the duty of the Board to determine whether the debt was in fact ascertained to be worthless within the meaning of the law. Appeal of Alemite Die Casting & Manufacturing Co.,1 B. T. A. 548.

Aside from the testimony as to general financial conditions in the latter part of 1920, the sole testimony in the instant case with respect to the ascertainment of worthlessness is that of the credit manager of the petitioner. As to most of such debts, he testified that he believed them to be bad and that petitioner was justified in charging them off. As to some of them he testified that he acted on the basis of credit reports, but could not either produce such reports or state what facts they disclosed. When asked the basis on which he directed debts charged off, he testified:

It was our policy to write off immediately what we would consider to be a loss, but it was always merely an estimate.
It was always our policy not to carry on our books any assets we did not think were worth the amount that they were carried at.

While the Revenue Act of 1921 and subsequent Acts allow part of a bad debt to be charged off and permit reserves to be set up for bad debts, the Board has held that this was not true under the Revenue Act of 1918 and prior Acts. Appeal of Steele Cotton Mill Co., 1 B. T. A. 299. However advisable it may be from a business standpoint to charge off portions of debts regarded as collectible only in part, or to set up a reserve for the amount estimated to be uncollecti-ble, Congress permitted the deduction under the 1918 Act only when the debt was ascertained to be worthless; not when it was of doubtful value, but when it was of no value.

The petitioner has shown the deplorable conditions in which business found itself in the latter part of 1920 in the States in which petitioner sold its goods. In such circumstances as are shown to have existed, it may be conceded that less specific information with reference to the financial condition of each of its debtors might be required in determining worthlessness than might seem necessary under normal conditions. In the light of these general principles we consider that the following debts were ascertained to be worthless in the taxable year:

Bames & Hambuck Co_$7, 578.82
W. A. Nash & Co_ 12, 339.97
E. F. Grissom_ 971.42
Sanders, Endsley Co- 4,144 15
T. C. Owens_ 2,268.96
Economy Store_$2,353.12
A. J. Pass_ 420.82
C. E. Gray_ 2,254.59
Yarborough Co., Inc- 200. 00

In the case of Hancock & Co. the report was that the company was insolvent. This means no more than that the account was probably uncollectible in part. Even an insolvent debtor may pay a substantial part of his indebtedness, as was done here.

The payments on account by Key & Co. on October 28, November 30, and December 15, all negative the conclusion that this account was worthless as does the shipment of goods on November 27, although small in amount. With no further testimony as to the information in the possession of the petitioner regarding this indebtedness, the deduction can not be allowed.

It does not appear what information, if any, petitioner had which justified it in charging off the account of Matthews & Searles. Events within the next month developed that the information was not accurate if it reported the account as uncollectible. The deduction claimed can not be allowed on the record as made before us.

Likewise we have no basis for determining whether the petitioner did in fact ascertain the account of Anderson, ITays & Gray to be worthless on November 30, 1920. A substantial payment was received on that day and without some showing of further facts, the charge-off has not been justified. Furthermore, there was thereafter a credit sale, small in amount it is true, but one does not ordinarily sell goods to another on credit if it is certain that payment never will be received. A subsequent sale on credit is consistent with the thought that collection may be doubtful but surely in the business world in the absence of some unusual situation, can not be consistent with the statement that collection never will be made.

The observations which we have made in the two preceding paragraphs apply with equal force to the account of Pecos Dry Goods Co.

The deduction claimed on the account of James & Reighard must be disallowed for lack of evidence. The same is true of the accounts of Cunningham, Westbrook Co., McDavid Brothers, Wagoner & Co.. J. H. Thompson, and M. Vasquez.

The Board has held that where the debtor is in bankruptcy, and it is apparent that the amount ultimately recovered will be comparatively small, the creditor is justified in charging off the debt, without waiting until the affairs of the bankrupt are settled. Appeals of Egan & Hausman Co., Inc., 1 B. T. A. 556, and Pacific Pipe & Supply Co., 2 B. T. A. 870. While there is no testimony directly to the point, it would appear from the amounts charged off and from subsequent collections where partial write-offs were made, that the petitioner had fairly accurate information as to the condition of the bankrupt estates. We believe' the evidence sufficient to allow the deduction of the amounts written off the accounts of the bankrupt debtors, except in the cases of Strong & Strong, and W. C. Powell & Son, where the amounts not charged off were substantial, indicating that petitioner expected to receive substantial dividends.

It appears that as to some of the debts a portion only was charged off. While this may have a bearing upon the question whether there had been an ascertainment of worthlessness, it has been held that where there was such ascertainment, but only a partial charge-off, the amount charged off may be allowed as a deduction without doing violence to the statute. Appeal of Mason Machine Works Co., 3 B. T. A. 745. W4 follow the principle laid down in that decision. It is further to be noted that the petitioner claims only the amounts charged off in the taxable year.

There remains the amount credited to Gardner & Coggins in 1920 for goods shipped to them in 1918, which they claimed never to have received. So far as the evidence before us is concerned, no more reason existed for claiming the item as a deduction in 1920, than existed in 1918 or 1919. So far as we are informed, nothing happened in 1920 except a credit on the books and no reason has been shown why the amount should be allowed either as a debt ascertained to be worthless or a loss sustained in the year before us.

To summarize, we are of the opinion that the proof is insufficient to establish that the following debts were ascertained to be worthless :

Hancock & Co_$10, 019. 53
Key & Co___ 7, 350.26
Matthews & Searls- 7, 444. 26
Anderson, Hay & Gray- 8, 809.84
Pecos Dry Goods Co_ 13, 990. 80
James & Beighard_ 2,582.95
Cunningham, Westbrook Co_ 13,057.91
McDavid Bros_ $5,859.59
Wagoner & Co_ 414. 05
J. H. Thompson_ 897.04
M. Vasquez_ 439.69
Strong & Strong- 1, 556. 76
W. C. Powell & Sons_ 3,183.00
Gardner & Coggins- 269.44

(7) Petitioner' claims that it falls within section 327 of the Revenue ’Act of 1918 and is entitled to have its tax computed by a comparison with the tax paid by representative concerns, as provided in section 328. Its argument is based primarily upon the amount of borrowed money used. It appears that during the year its invested capital was $2,656,613.61 and its average borrowed capital $2,189,-025.25; in other words, 40 per' cent of its operating capital was borrowed. In many businesses this would not be regarded as unusual or abnormal and in the absence of any evidence that it is abnormal in the wholesale dry goods business, there is nothing on which we may base an opinion as to normality or abnormality.

(8) A revenue agent who audited the return of the petitioner for the taxable year and examined its books, increased the net income by $6,260 as automobile expense disallowed. In the deficiency notice it was conceded that this adjustment was erroneous. At the hearing the answer of the respondent was amended to allege that net income as determined by the Commissioner should be increased by this item of $6,260. As to such issue, the burden of proof is upon the respondent. It was the contention of his counsel that three new automobile trucks were purchased during the taxable year, that two were traded in exchange and that the net amount paid was deducted in computing the net income. The evidence is most indefinite and unsatisfactory ; so much so that we have not felt warranted in making any findings of fact upon this issue. Should it be that the evidence is sufficient to show the purchase of such trucks, there is nothing from which we may know whether the amount was deducted in computing the net taxable income shown on the petitioner’s return. To add this item to net taxable income may be to restore an item which was not allowed as a deduction. In view of the action of the office of the Commissioner in reversing the action taken by the revenue agent, without stating the ground therefor, we should hesitate to again add this amount to net income without the clearest evidence that such action is proper and will not result in a duplication of the same item. The Commissioner has failed to show that such addition to net income should be made.

Reviewed by the Board.

Decision will he entered on %0 days’ notice, under Rule 50.


author: Smith:

text:
    Oliver Prescott and Lucius H. Beers, Executors, Estate of Emily H. Bourne, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7883.
    Promulgated October 7, 1927.
    Taxes paid by executors to tbe States of New York, Connecticut, Michigan, New Jersey, and West Virginia under their respective transfer and inheritance-tax statutes are legal deductions from gross income in income-tax returns of the estate in process of administration or settlement.

      Allen Evarts Foster, Esq., for the petitioners.

      M. N. Fisher, Esq., for the respondent.

      This appeal involves a deficiency in income tax against the estate of Emily H. Bourne for the year 1923 in the amount of $20,436.47. The entire deficiency results from respondent’s disallowing the deduction of amounts, aggregating $56,319.28, representing taxes paid by the executors to 13 different States under their respective transfer or inheritance-tax statutes. The essential facts are admitted in the pleadings.
    FINDINGS OF FACT.
    Emily H. Bourne died a resident and citizen of New York on March 23, 1922, leaving a last will and testament which was duly admitted to probate by the surrogate’s court of the County of New York, and the petitioners herein were duly appointed executors of said will.
    During the year 1923, the executors were actively engaged in administering the estate of said Emily H. Bourne and as such executors paid transfer or inheritance taxes to the following States in the amounts named:

    All of the above-mentioned taxes were paid by the executors from the residuary estate pursuant to paragraph 56 of the last will and testament of said Emily H. Bourne, which provided that all estate and inheritance taxes should be paid by the estate and that no part thereof should be borne by any of the legatees.
    In making out the income-tax return for the estate for the year 1923 the petitioners comp'uted net income of the estate by deducting from gross income the amount of $76,585.64, representing transfer or inheritance taxes paid, including the $56,319.28 disallowed by respondent.
   OPINION.

Smith:

The sole question here presented is whether the transfer and inheritance taxes paid by the executors to the different States are deductible in computing the net taxable income of the estate.

It is agreed that under section 214 of the Revenue Act of 1921 estate, inheritance, legacy and transfer taxes paid to the States are allowable deductions in computing net income for Federal tax purposes, although the statute is silent as to whether the deductions are available to the estate or to the individual distributees. Respondent’s position is that such taxes fall into two groups, one, where they are imposed upon the right or privilege to transmit, the other, where they are imposed upon the right or privilege of the heir, dev-isee, legatee or distributee to succeed to the property passing from the decedent. The former, it is contended, constitute allowable deductions to the estate, the latter, to the heirs, devisees, legatees, or distributees. Respondent further contends that the question of who shall be allowed the deduction is not affected by any provision of the testator’s will that all such taxes shall be paid by the executors out of the residuary funds of the estate.

Owing to the small amounts involved, the petitioners have waived their claim with respect to the taxes paid to the States of California, Kansas, Maine, Minnesota, Montana, New Hampshire, Ohio, and Wisconsin.

The United States Supreme Court has held, in Keith v. Johnson, 271 U. S. 1, that transfer taxes paid to the State of New York are deductible in computing the taxable income of the estate. See also Farmers Loan & Trust Co. v. United States, 9 Fed. (2d) 688, and Appeal of Farmers Loan & Trust Co., Administrator, 3 B. T. A. 97. The Board has also held in Appeal of Hamilton E. Shaver et al., Executors, 4 B. T. A. 127, that inheritance taxes paid to the States of West Virginia and Connecticut are so deductible. There remains to be decided, then, only the question of the deductibility of the taxes paid by the executors to the States of Michigan and New Jersey.

As was stated in the Appeal of Katharine N. Wurts et al., 6 B. T. A. 1118, we must in each instance look to the nature of the tax, that is, whether it falls upon the estate or upon the individual distributees, and must be guided by the statutes of the States as construed by their highest courts. Keith v. Johnson, supra.

In reaching its decision in Keith v. Johnson, supra, the Supreme Court followed the case of Home Trust Co. v. Law, 198 N. Y. S. 710, and quoted with approval the following language from the opinion in that case:

Aside from authority and theory we think it was the clear legislative intent, as indicated by the various provisions of the Tax Law, that in calculating the net income of the estate of a decedent for income tax purposes, the amount paid by an executor during the year in satisfaction of a transfer tax should be deducted. The income tax payment is made by the executor of the estate from funds of the estate and not from funds belonging to legatees, (Kings County Trust Company v. Law, 201 App. Div. 181.) The transfer tax payment is made by the executor from the funds of the estate. “The transfer tax is imposed upon the estate of the decedent as it exists at the hour of his death, and its value is to be fixed as of that time.” (Matter of Hubbard, 234 N. Y. 179.) Thus the tax is measurable not by the funds received by a legatee, but by the funds the executor receives. As the burden of paying the income tax, as well as the burden of paying the transfer tax,' is cast upon the executor, and as the taxable income of the estate is under tbe terms of tbe Tax Law measurable by gross income received less taxes paid, it would seem clear tbat tbe person paying tbe income tax, namely, tbe executor, is entitled to deduct tbe very transfer tax wbicb be bimself pays.

The Court further said:

This court will follow tbe decisions of tbe state courts as to tbe meaning and proper application of tbe state transfer tax law, any expressions in its earlier decision to tbe contrary notwithstanding.

In United States v. Mitchell, 271 U. S. 9, decided concurrently with Keith v. Johnson, supra, and under the authority of the decision in that case, the court held that the inheritance tax paid to the State of Texas was deductible in computing the taxable income of the estate, saying:

We are of tbe opinion that, in respect of tbe matter under consideration, tbe Texas inheritance tax law cannot be distinguished from tbe New York transfer tax law; and that under Keith v. Johnson decided this day, ante, p. 1, the executors are entitled to inheritance tax paid in 1919 deducted from tbe income of tbe estate received in tbat year.

In this proceeding neither counsel has referred to any decisions of the courts of Michigan or New Jersey construing the statutes involved, nor have we been able to ascertain that there are such decisions. We must, therefore, look to the statutes themselves and interpret them according to the principles established by the decisions involving similar statutes of other States.

The pertinent parts of the Michigan and New Jersey statutes are as follows:

Compiled Laws of Michigan. 1916.
Chapter 236. — Inheritance Tax and Procedure Thereon in Probate Courts.
(14624) Section 1. That after tbe passage of this act a tax shall be and is hereby imposed upon tbe transfer of any property, real or personal, of tbe value of one hundred dollars or over, or of any interest therein or income therefrom, in trust or otherwise, to persons or corporations not exempt by law from taxation on real or personal property, in tbe following cases:
First, when tbe transfer is by will or by the intestate laws of this state from any person dying seized or possessed of tbe property while a resident of this state ;
Second, When the transfer is by will or intestate law of property within the state, and tbe decedent was a nonresident of tbe state at tbe time of his death;
Lien of Taco anú, Payment Thereof
(14626) Sec. 3. Every such tax and the interest thereon herein provided for shall be and remain a lien upon the property transferred until paid, and the person to whom the property is so transferred and the administrator, executor, and trustee of every estate so transferred, shall be personally liable for such tax until its payment; * * * All taxes imposed by this act shall accrue and be due and payable at tbe time of transfer, which is the date of death: * * *
Collection of Tax by Bxeeutors, Administrators and Trustees
(14528) Seo. 5. Every executor, administrator, trustee or other person shall have full power to sell or mortgage so much of the property of the decedent as will enable him to pay such tax in the same manner as he might be entitled by law to do for the payment of the debts of a decedent or ward; * * * Any such administrator, executor, trustee or other person having in charge or in trust any legacy or property for distribution subject to such tax, shall deduct the tax therefrom; and within thirty days thereafter shall pay over the same to the county treasurer as herein provided. * * *
Compiled Statutes of New Jersey
Cumulative Supplement 1911-1924. Yol. 2.
Taxation op Decedents’ Estates.
208-537. Transfer tax on decedent’s property. — 1. A tax shall be and is hereby imposed upon the transfer of any property, real or personal, of the value of five hundred dollars or over, or of any interest therein or income therefrom, in trust or otherwise, to persons or corporations, except as hereinafter provided, in the following cases:
208-541. When tax payable — bond to secure payment of unpaid taxes — taxes a lien. — 5. All taxes imposed by this act shall be due and payable at the death of the testator, intestate, grantor, donor or vendor, unless in this act otherwise provided, * * *
All taxes levied and assessed under this act shall be and remain a lien on all property owned by the decedent as of the date of death until paid or secured by bond, as provided for in the several provisions of this act.
208-543. Deduction of tax before delivering bequest to legatee— Sec. 7. Any administrator, executor or trustee having in charge or trust any legacy or property for distribution, subject to said tax, shall deduct the tax therefrom, or if the legacy or property be not money he shall collect the tax thereon upon the appraised value thereof from the legatee or persons entitled to such property, and he shall not deliver or be compelled to deliver any specific legacy or property subject to tax to any person until he shall have collected the tax thereon, and whenever any such legacy shall be charged upon or payable out of real estate, the heir or devisee, before paying the same shall deduct said tax therefrom and pay the same to the executor, administrator or trustee, and the payment thereof shall be enforced by the executor, administrator or trustee in the same manner that the payment of such legacy might be enforced; * * *
208-544. Sale of property by executor, etc., to meet tax. — Sec. 8. All executors, administrators and trustees shall have full power to sell so much of the property of the decedent as will enable them to pay said tax in the same manner as they may be enabled by law to do for the payment of debts of their testators and intestates, and the amount of said tax shall be paid as hereinafter directed. (P. L. 1909, p. 330)

From a comparison of the passages above quoted, and others of the statutes of Michigan and New Jersey, with the statutes of New York considered in Keith v. Johnson, supra, it appears that the tax in each instance is paid “by the executor from the funds of the estate.” It is imposed upon “ the estate of the decedent as it exists at the time of his death, its value is to be fixed as of that time,” and it is measured “ by the funds the executor receives.” In neither of the statutes is there any provision that the tax due the State from the estate of the decedent shall be paid by or out of the funds of the legatees or distributees.

We are unable to see that the statutes either of Michigan or New Jersey differ in any material respect from those of New York. Compare with Appeal of Hamilton E. Shaver et al., Executors, supra. The taxes paid by the executors to the States of New York, Connecticut, Michigan, New Jersey and West Virginia are legal deductions from gross income in income-tax returns of the estate.

Reviewed by the Board.

Judgment will be entered for the petitioners on the issue raised after 16 days'1 notice, under Buie 50.


author: Trammell :

text:
    Alexander Vayssie, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9530.
    Promulgated October 7, 1927.
    Where husband and wife in California erroneously file separate returns reporting their income on the community property basis and each make payments of the tax liability shown, and the Commissioner determines that the entire income should be taxed to the husband and tenders to the wife a refund of the amount paid by her, the husband is not entitled to have the amount due the wife credited against his tax liability.

      E. D. Knight, Esq., for the petitioner.

      M. E. McDowell, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency in income taxes for the calendar years 1920 and 1921 in the amounts of $1,403.96 and $962.50, respectively. At the hearing the deficiency asserted for 1921 was conceded to be correct and any error assigned in the petition with respect to that year was waived. It was also conceded at the hearing that the correct deficiency for 1920 was $1,403.96 unless it should be reduced by the amount of $845.70, together with interest thereon, which represents a refund which has been authorized to be paid to petitioner’s wife and which amount petitioner claims should be credited on his income-tax liability in accordance with his request.

      FINDINGS OF FACT.
    For the year 1920 the petitioner and his wife, residents of California, filed separate income-tax returns in or about the first week of March, 1921. The collector sent those returns back and the checks which had been tendered in payment of the tax shown thereon, requesting that a return be made “under the community property laws of the State of California.” Prior to March 15, 1921, the petitioner filed a return in which he included all the income of himself and wife. At that time the two separate checks which had been tendered with the two separate returns filed prior to that time were again tendered with the joint return. The petitioner still maintained at that time that he had a right to file separate returns and the checks were tendered accompanied by a letter stating “ apply these two checks to the income here under consideration whether you find that to be separate income properly returned on two separate returns, or community income properly returned in this joint return.”
    At the time the original returns were filed the theory was that a single joint return should be filed by the husband. Before the returns as resubmitted were audited the Attorney General had reversed that ruling, so that, when the tentative determination of the Commissioner was made the petitioner was informed that the separate returns had been accepted and that the two checks of $845.70 each had been applied in payment of the tax as shown on the two returns and there was no deficiency.
    Thereafter the Attorney General’s opinion and the Robbins decision again reversed the situation with respect to community property in California and within the statutory period the Commissioner again sent out a deficiency letter, this time saying that the income should be returned by the husband for the community and that there was an additional deficiency. That deficiency was measured by the difference between the $845.70, the husband’s original check and the total deficiency (for 1920 and 1921) of some $2,300 found on the community returns. The Commissioner first gave credit on the husband’s return for both checks but before the matter was closed, when it was determined that the entire income should be taxed to the husband, gave credit only for $845.70, the amount of one check, and gave notice that the other payment would be the subject of a refund to the wife.
    During the time when separate returns were permitted to be filed and in the tentative closing of the case, the Commissioner accepted the separate returns and set up two accounts on the collector’s books, one for the husband and one for the wife, and applied the two checks in payment of the accounts as they then stood. Later, when the husband’s return was finally accepted by the Commissioner, the amount of the wife’s check paid on her account, instead of being credited against the tax whichever way it was determined, was made the subject of a refund on the wife’s account in order to close that account on the collector’s books. That check together with the interest which had accrued up to the time the refund was allowed is now in the collector’s hands and was refused by the petitioner on the theory that it should be applied as a credit as he had originally requested.
   OPINION.

Trammell :

Since the petitioner conceded the correctness of the deficiency for 1921, the action of the respondent in that respect is approved.

There is no controversy as to the tax liability for 1920, the only question being whether the Commissioner should credit the petitioner’s account with the amount due to the wife as a refund. In our opinion, the Board has no authority to require the Commissioner to credit the petitioner’s account with a refund due to the petitioner’s wife. The Board can not require the Commissioner to credit one taxpayer’s account with a refund due another taxpayer.

Reviewed by the Board.

Judgment will be entered for the respondent.