author: Green:

text:
    Appeal of T. C. Power & Brother.
    Docket No. 3740.
    Promulgated April 14, 1927.
    1. Cost and sale price for determination of gain or loss found.
    2. Deduction for bad debts denied.

      James A. Walsh, Esq., for the petitioner.

      R. P. Smith, Esq., for the Commissioner.
    This appeal is from the determination of a deficiency of $5,713.99 in income and profits taxes for 1919. There are two questions — (1) the amount of gain realized on the sale of shares of stock of another corporation owned by the petitioner, and (2) whether the petitioner is entitled to deduct certain alleged losses as bad debts.
    PINDINSS OP PACT.
    The petitioner is a corporation of the State of Montana with its pricipal office at Helena.
    In 1919, it owned 2,000 shares of preferred stock and 424 shares of common stock of the Montana Oil Co., each of the par value of $100 per share. The number of shares outstanding was 2,000 preferred and 1,000 common. On July 8, 1919, the holders of all the stock of the Montana Oil Co. made the following contract:
    This Agreement made and entered into and executed in triplicate this eighth day of July, 1919, by and between T. C. Power and Brother, a corporation, T. C. Power, C. B. Power, J. M. Power, T. L. Martin, E. A. Wyatt, M. C. Henderson and E. E. Hirsch, being all of the stockholders of the Montana Oil Company, a corporation organized and existing under the laws of the State of Montana, parties of tlie first part, and Edward T. Clark of Billings, Montana, party of tlie second part, Witnesseth :
    That, Whereas tlie Montana Oil Company is engaged in tlie business of dealing in petroleum products and has at various places in Montana branch establishments supplying the trade with said petroleum products, also oil tanks, warehouses and I. C. C. No. 5, gasoline shipping barrels, automobiles, trucks, office equipment, leases, options, and real estate, standing in the name of Montana Oil Company, and also the distributing and compounding plant at Kansas City, Missouri, located on land which the said Montana Oil Company has an option to purchase, and all equipment connected therewith, as appears on the books of said company on this day, and;
    Whereas the party of the second part is desirous of purchasing and acquiring all of said property and to acquire all of the stock issued and outstanding and owned by the parties of the first part herein, amounting to three thousand shares of the stock of said company of the par value of One Hundred ($100.00) Dollars each.
    Now Therefore, for and in consideration of the sum of One ($1.00) Dollar to them in hand paid and other valuable consideration, the receipt whereof is hereby acknowledged, the parties of the first part agree to endorse in blank the certificate of stock owned by them and each of them and deposit the same in escrow in the American National Bank at Helena, Montana, on this date, with instructions to said bank to deliver the same to the party of the second part upon payment, on November 1st, of the amount hereinafter designated, and upon which payment the said bank shall deliver the stock to the party of the second part herein.
    It is further agreed that the parties of the first part shall, at the same time, deposit in escrow in said bank the resignations of all the Directors of said company and the officials of the same. It is understood and agreed that before the stock of said corporation shall be delivered to the said party of the second part that the said Montana Oil Company shall assign to J. M. Power as Trustee for the other parties of the first part herein named, all accounts receivable, bills receivable and other securities, if any then owned'by the said Montana Oil Company, it being the intention that the said Montana Oil Company, when controlled by the party of the second part, shall not be the owner of the accounts receivable and bills receivable and other securities above mentioned when the stock is transferred and delivered.
    And the parties of the first part hereto further agree that they will pay all claims and accounts against the Montana Oil Company due on the first day of November, 1919, all of which shall be paid on or before the first day of January, 1920. It is further understood and agreed that the party of the second part shall pay to the parties of the first part herein the cost price of all merchandise on hand on the first day of November, 1919, which cost price and the value of merchandise on hand shall be determined by an inventory to be taken on or about that date; said merchandise consisting of such goods, wares and merchandise as is shown on the books of said company, to be carried as merchandise, including stationery and advertising matter.
    All oil tanks, warehouses and I. C. C. No. 5, gasoline shipping barrels, automobiles, trucks, office equipment, leases, options and real estate now standing in the name of the Montana Oil Company and the distributing and compounding plant at Kansas City, Missouri, located on land which said Montana Oil Company has an option to purchase, and all equipment connected therewith now owned and in the control of the said company, shall pass and remain the property of said company.

      It is further agreed that when the inventory of said merchandise is taken, the party of the second part shall immediately pay to T. 0. Power, as Trustee for the parties of the first part, the value of said merchandise, as shown by said inventory, at cost price as disclosed by the records and inventory, it being further agreed that if the said inventory is not completed on the first day of November, 1919 and at the time the party of the second part obtains possession of the said certificates of stock and of the property and affairs of the said Montana Oil Company that he shall, before being given possession of the said merchandise, either personally or as an officer of the Montana Oil Company, give the parties of the first part satisfactory security guaranteeing the payment of the amount due for said merchandise.
    It is further agreed that the party of the second part shall and he does hereby agree to assume and fulfill and carry out the contracts made by the Montana Oil Company, excepting that certain contract dated July 6, 1914 between T. C. Power, C. B. Power, T. L. Martin, J. M. Power and E. A. Wyatt and M. C. Henderson, modified by a certain supplementary contract dated February 15, 1919, and accepted by the Montana Oil Company, and a certain contract dated January 23, 1918, between the respective parties heretofore named.
    It is understood and agreed by the parties hereto that during the life time of this agreement the parties of the first part shall incur no contracts or obligations on behalf of the Montana Oil Company which shall run beyond November 1, 1919 and will not incur any additional expense or contracts for equipment save for replacement during this period.
    It is understood and agreed that on the first day of November, 1919, the party of the second part shall deposit in the American National Bank at Helena, Montana, the sum of Two Hundred Seventy-five Thousand ($275,000.00) Dollars, in full payment of the stock owned by the parties of the first part and deposited in said bank in escrow under the terms of this agreement. In the event that the party of the second part fails to deposit said sum of money on or before November 1st, 1919, then all payments made to the parties of the first part shall be forfeited and the stock held in escrow returned to the parties of the first part herein.
    It is further understood and agreed that the parties of the first part shall pay two thirds of the State, County ¿nd City taxes for the year 1919 and the party of the second part shall pay one third of said taxes.
    It is further understood and agreed that the parties of the first part shall pay that portion of the income tax which the records of the company disclose is earned up to November 1st, 1919 and any back income tax assessed against the company and collected by the United States Government.
    In Witness Whereof, the said parties hereto have executed this instrument the day and year first above written.
    T. C. Power & Bro.
    By (Signed) T. C. Power
    (Signed) T. C. Power
    (Signed) C. B. Power.
    (Signed) J. M. Power
    (Signed) T. L. Martin
    (Signed) E. A. Wyatt
    (Signed) M. C. Henderson
    (Signed) F. E. Hirsch
    (Signed) Edward T. Clark
    In the presence of
    (Signed) A. Nixon
    (Signed) W. C. Edwards

      On the same day certificates representing all of the stock, and resignations of directors and officials of the Montana Oil Oo. were delivered to the American National Bank of Helena in escrow.
    Clark assigned his rights under the contract to the Mutual Oil Co. On August 19, 1919, the latter and the stockholders in the Montana Oil Co. entered into an agreement modifying the one set out above, the complete text of which follows:
    This Agreement, made and entered into and executed in triplicate this 19th day of August, 1919, by and between T. 0. Power & Brother, a corporation, T 0. Power, 0. B. Power, J. M. Power, T. L. Martin, IS. A. Wyatt, M. O. Hender son and F. E. Hirscli, parties of the first part, and Mutual Oil Company, or. ganized and existing under and by virtue of the laws of Arizona whose principal office is at Kansas City, Mo., party of the second part, Witnesseth :
    That Whereas, the parties of the first part on the 8th day of July, 1919, entered into an agreement to sell to the party of the second part three thousand (3,000) shares of the capital stock of the Montana Oil Company, which said stock is now held in escrow in the hands of the American National Bank at Helena, Montana, to be delivered to the party of the second part in accordance with the terms of the agreement aforesaid, which said agreement provides, among other things, that payment therefor shall he made on November 1st, 1919.
    And Whereas the party of the second part is desirous of obtaining said stock and the ownership of the Montana Oil Company on September 1st, 1919 instead of November 1st, 1919.
    Now Therefore, for and in consideration of the sum of Seventeen thousand five hundred ($17,500.00) dollars and other valuable considerations, the receipt whereof is hereby acknowledged, the parties of the first part hereto do agree that the terms of the agreement of the 8th day of July, 1919, shall be amended, and are hereby so amended, to provide for the purchase of the stock on the first day of September, 1919, and that the payment of Two Hundred and Seventy-five Thousand Dollars ($275,000.00) provided in the agreement of the 8th day of July, 1919, to be made on the first day of November, 1919, shall be made on the first day of September, 1919, to the escrowee named in the aforesaid agreement, who shall hold said stock until the cost of all merchandise on hand on the first day of September, 1919, to be determined as is set forth in the agreement of July 8th, 1919, has been paid to T. C. Power, Trustee, and with reference to the payment of said merchandise, it is further definitely agreed that One hundred Thousand ($100,000.00) Dollars shall be paid on account on or before September 15, 1919, and another One hundred Thousand ($100,000.00) Dollars on account on or before October 1, 1919, and the balance remaining due for said merchandise to be paid in full on or before the first day of November, 1919.
    And it is further definitely understood and agreed that the said stock shall continue to remain in escrow until said final payment is made and settlement arrived at in full, at which time the said T. C. Power, Trustee, to whom said monies shall be paid, shall notify the escrowee that said payments have been made and settlement- arrived at and authorize him to release the said stock to said second party, it being understood and agreed that the management, control and ownership of Montana Oil Company shall vest in the party of the second part on September first, 1919, upon his payment to the escrowee of the sum designated, viz., Two Hundred Seventy-five Thousand Dollars ($275,000.00).

      It Is Further understood and agreed that the parties of the first part are obligated to pay one-balf of the State, County and City tases and Corporation License for the year 191&, and that portion of the income tax which the records of the Company disclose is earned up to September first, 1919, and any bach income tax assessed against the Company and collected by the United States Government, and the party of the second part shall pay the balance of said Taxes and Income Tax and License.
    It Is Understood and Agreed by and between the parties hereto that this agreement is supplemental to that of July 8, 1919, only in so far as relates to the time of conveyance of the stock of Montana Oil Company and the obligations mutually agreed upon to be performed on or dated from November 1, 1919, which are now designated to be performed on and dated from September 1st, 1919, and that in all other respects the agreement of July 8, 1919, shall be in full force and effect and binding upon the parties hereto.
    In Witness Whereof, the said parties hereto have executed this instrument the day and year first above written.
    T. C. Power & Bro. Ino.
    By (Signed) T. C. Power, Pres.
    (Signed) T. C. Power
    (Signed) C. B. Power
    (Signed) J. M. Power
    (Signed) T. L. Martin
    (Signed) E. A. Wyatt
    (Signed) M. C. Henderson
    (Signed) Frank E. Hirsch
    Mutuai, On. Co.
    (Signed) O. H. Williams
    President.
    In the presence of:
    (Signed) J. L. Walsh
    Up,on the execution of the first contract, Clark paid to the stockholders of the Montana Oil Co. $25,000. On or about September 1, 1919, the Mutual Oil Co. paid to the escrowee the sum of $275,000, which was by the contracts provided to be paid. It also made pay-, ments based on the cost price of the merchandise in inventory to J. M. Power, acting for the stockholders, as follows: September 15, 1919, $100,000; October 2,1919, $100,000; November 7,1919, $100,000. The cost price of the merchandise as of August 30, 1919, was ascertained to be $321,534.05. The balance of such cost price was paid subsequent to November 7, 1919, the final payments amounting to $3,000 and $325 being made in January, 1920. The stockholders paid all of the outstanding claims and accounts against the Montana Oil Co. shown by a trial balance taken August 31, 1919.
    The American National Bank delivered the certificates of stock to the purchaser on or about February 20, 1920, in compliance with instructions of J. M. Power.
    On January 6, 1920, an assignment was made by the Montana Oil Co. to J. M. Power, as trustee for the stockholders, of all its accounts receivable and bills receivable. A trial balance sheet for the trustee prepared by an examining revenue agent shows that the face value of the accounts receivable and the bills receivable as of December 31, 1919, was $84,849. Distributions were made by J. M. Power to the holders of the common stock of $60 per share on April 26, 1920, and $15 per share on April 1, 1922, on which date there remained some accounts still uncollected.
    Of the sums paid by the purchaser, the petitioner received on November 15, 1919, $200,000 for this amount par value of preferred stock. No gain resulted to it from this part of the transaction.
    Of the 424 shares of common stock held by the petitioner, 319% shares had been purchased by it at par and 104% shares of the par value of $10,412.50 had been received as stock dividends in the years 1916, 1917, and 1918. The cost, therefore, of the 424 shares was $31,987.50. Petitioner received on December 4, 1919, a payment of $200 per share on the common stock owned by it, amounting to $84,800. This sum was received as the sale price of the 424 shares of common stock and resulted in a gain to the petitioner of $52,812.50.
    The net value on December 31, 1919, of the accounts receivable and bills receivable, which were assigned to the stockholders, was $84,849. The petitioner’s share was $35,975.98. Petitioner kept its accounts on the accrual basis.
    The petitioner owned forty-four seventy-sevenths of the capital stock of the Bismarck Elevator & Investment Co., the balance being owned by one I. P. Baker. The Bismarck Elevator & Investment Co. owned one-half of the capital stock of the Benton Packet Co., the other one-half being owned, seventeen twenty-firsts by the petitioner and four twenty-firsts by Baker. Both of these companies operated at a loss for several j^ears prior to 1919. The petitioner set up on its books a general reserve to take care of losses against which advances to make up the deficits of the two companies named were charged. During 1919, $34,625.83 of such advances were charged off by the petitioner on its books. At the close of the year $40,000 was added to the reserve account to provide for unascertained and contingent losses of the character named, making a total of $74,625.83 which was claimed by the petitioner as a deduction. There was charged against the $40,000 reserve the sum of $20,000, representing amounts paid by the petitioner as endorser of notes of the two corporations which the petitioner was obliged to meet.
    A part of the claimed losses was disallowed by the Commissioner, but the evidence is not clear as to the amount disallowed.
    The Bismarck Elevator & Investment Co. was in the business of buying and selling grain and owned grain elevators along the Missouri River. The Benton Packet Co. was engaged in transporting grain on the Missouri River. It had property consisting of steamboats, gasoline boats, one or two warehouses and various equipment such as is ordinarily appurtenant to a boat line.
   OPINION.

Green:

Of the sums paid by the purchaser of the stock of the Montana Oil Co., the petitioner received $200,000 for this amount par value of preferred stock. No question was raised as to the cost of this stock or as to the basis of the allocation of this amount as the sale price. No gain or loss is shown or claimed on this part of the transaction.

The petitioner also received, on December 4, 1919, a distribution in cash equal to $200 per share of common stock. On January 6, 1920, J. M. Power, as agent or trustee of the holders of the common stock, received an assignment from the Montana Oil Co. of accounts receivable and bills receivable of the net face value of $84,849, or $84.849 per share of common stock. The Commissioner treated the sum of the cash distribution and the face value of the receivables assigned, as the sale price of the common stock. The total being $120,375.98, he found that the petitioner realized a gain from the sale of its 424 shares of common stock of $88,388.48. The petitioner contends it did not realize any profit thereon in 1919; that the purchaser paid $300,000, the par value of the outstanding stock, and $321,534 as the cost price of the merchandise, but the stockholders assumed obligations totaling $331,482, so that they really sustained a loss; and that the bills receivable and accounts receivable, if income at all, were not income in 1919, which is the year involved here.

The first question is whether the accounts receivable and bills receivable were a part of the purchase price of the stock. There is no doubt in our minds that they were not. This property came to the stockholders from the corporation and not from the purchaser of the shares of stock. It was a portion of the assets of the corporation expressly reserved for distribution to the retiring stockholders. It was testified that the investment in and the value of the plant and equipment and other physical assets (exclusive of the merchandise) was equal to the par value of the outstanding stock. Therefore, the distribution of the accounts receivable and bills receivable was a form of dividend from assets in excess of capital stock. Hyams v. Old Dominion Copper Mining & Smelting Co., 82 N. J. Eq. 507; 89 Atl. 37; affd. 83 N. J. Eq. 705; 92 Atl. 588; Cogswell v. Second National Bank, 78 Conn. 75; 60 Atl. 1059; affd. 204 U. S. 1. A division of profits is a dividend even though it is not called a dividend. 2 Cook on Corporations, sec. 534; Barnes v. Spencer & Barnes Co., 162 Mich. 509; 127 N. W. 752. However, whether it was income in 1919 or in 1920 is not quite so plain.

In section 234 of the Revenue Act of 1918 it was provided:

(а) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
*******
(б) Amounts received as dividends from a corporation which is taxable under this title upon its net income, and amounts received as dividends from a personal service corporation out of earnings or profits upon which income tax has been imposed by Act of Congress.

The Montana Oil Co. is a corporation taxable under this title and the dividends paid by it to the petitioner herein should in the computation of the petitioner’s taxable income be included in gross income and thereafter deducted pursuant to the provisions of the statute quoted above. It follows therefore that the date as to which the dividend should be included in the petitioner’s gross income is a matter of no consequence inasmuch as the petitioner’s tax for any year will not be increased by reason of its having received the dividend.

The petitioner claims the debts of the Montana Co. assumed by the old stockholders exceeded by about $10,000 the sums received as the value of the merchandise, and hence the petitioner really sustained a loss. It was testified that the outstanding liabilities on August 30, 1919, were $331,482, while the value of merchandise was $321,534. This testimony, however, can not be reconciled with other facts which appear in evidence and the discrepancies were not explained. When the second contract was signed the purchaser paid an additional $17,500 which is unaccounted for in the computations. Among the debts there was mentioned an amount owing to this petitioner of $76,500, but included in the accounts receivable was an amount due from the petitioner of $64,000, from which a distribution was made by the trustee in 1920. Also we have the fact that the holders of common stock did receive $200 per share on December 4, 1919. It is asserted in the brief filed on behalf of the petitioner that of this sum $100 per share was a dividend. There is nothing in the record to sustain this assertion and we can not assume it is so. While it is not shown how this total is arrived at, the only reasonable inference we can make from the testimony is that it was received as the sale price of the common stock. It was distributed by J. M. Power, who was acting as trustee for the stockholders under the contracts, and it does not appear that any part of it came from the corporation.

The remaining issue is whether the petitioner is entitled to deduct as bad debts advances made by it to the Bismarck Elevator & Investment Co. and the Benton Packet Co. The evidence does not sustain the petitioner’s contention that these advances were bad debts. Each of those corporations in 1919 had assets which were valuable and. the petitioner would be entitled to 'participate with other creditors in any distribution on a liquidation, so that the debts were not worthless in 1919. Also the testimony shows that the reserve set up by the petitioner was intended to provide for unascertained and future losses as well as depreciation and obsolescence of the property of the debtor corporations: The provision of the Revenue Act allowing the deduction of bad debts contemplates only debts which are in existence and have been ascertained to be worthless within the taxable year.

Judgment will he entered after 15 days' notice, under Rule 50.

Milliken did not participate.


source: Caselaw Access Project

author: Smith:

license: Public Domain

text:
    Fridolin Pabst, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 2227.
    Promulgated April 14, 1927.
    1. In determining whether a net loss, as defined in section 204 of the Revenue Act of 1918 has been sustained, losses of a personal nature and not sustained in the trade or business regularly carried on by the taxpayer may not be considered.
    2. A loss of an investment in stock, sustained by an individual in a certain year, may not be considered in ascertaining whether he sustained a net loss in that year where the stock became worthless prior to that year and the individual was not regularly engaged in the trade or business carried on by the corporation.
    3. Neither may a loss of an investment in a mine be considered for such purpose, where neither the nature of the loss nor the fact that it resulted from operation of the mine in the year for which the net loss was claimed was established.
    4. Evidence that, upon investigation during the tax year, the taxpayer was unable to locate or communicate with his debtor and ascertained that patents of the debtor, from the proceeds of the sale of which it had been agreed the debt should be paid, were unsalable, held to establish that debt had been ascertained to be worthless.

      Camden R. McAtee, Esq., and H. A. Fellows, Esq., for the petitioner.

      C. 27. Curl, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency in income tax for the year 1920 in the amount of $10,899.49. The deficiency letter shows overassessments for the years 1918 and 1919 and deficiencies for the years 1920,1921, and 1922. The petitioner alleges that the Commissioner committed error (1) in refusing to allow as a deduction for 1918 a loss of $18,740 representing the amount (cost of stock) invested by the petitioner in the stock of the Amador Copper and Gold Mining and Milling Cp.; (2) in refusing to allow as deductions from gross income of 1919, $10,600 representing the cost to petitioner of shares of capital stock of the Al. A. Boeck Co., and $3,795.65 as a bad debt loss representing advances or loans made in prior years to G. Liebmann; (3) in refusing to allow a bad debt loss from the gross income of 1920 of $1,399.51, representing loans made to H. Cordes in years prior to 1913; and (4) in refusing to allow an alleged net loss sustained by the petitioner for the year 1919, or any part thereof, as an offset against the net incomes of 1918 and 1920.
    BINDINGS OR PACT.
    1. The petitioner is an individual residing in Chicago, Ill., who was engaged in 1918,1919, and 1920 in the business of manufacturing pharmaceutical preparations for sale and in the mining business as an operating owner of mines of various kinds and as an investor in mining enterprises.
    2. The petitioner filed an income-tax return for 1919 in which he reported his net income from “ business or profession ” $78,246.60. He reported other income of $71.43 and a total net income from these sources of $78,318.03. He claimed as deductions therefrom:
    Interest paid-$7, 190.46
    Taxes paid- 496.84
    Contributions-'- 1, 090.10
    Bad debts and other deductions- 42, 836.47
    Total_51, 613. 87
    The amount of $42,836.47 bad debts and other deductions is itemized in a statement attached to the return as follows:
    Investment in Screen and Woodwork Factory of Kaimund Pabst—
    Firm failed-$22, 606.60
    E. Schlieff — Investment in Worthless Mining Stock_ 2, 358.96
    Dr. Swatek — Advance for Drilling Oil Well Proved Failure_ 2, 500. 00
    Cyrus Barker- — Advance for Mining Pyrites Proved Failure_ 1, 603.00
    A. Weiss — Advance for Manufacture of Kattol Kat Poison, Business
    Closed_ 2, 991.63
    G. Liebmann — Advance without Security Uncollectible_ 3, 795. 63
    T. Ilarbeck — Doan without Security, uncollectible_ 4, 000.00
    G. Gregg — Loan, Party has disappeared- 800.00
    One-half of up-keep of two automobiles used in connection with business- 973. 65
    Salaries paid stenographer and bookkeeper handling private affairs- 1, 207.00
    42, 836.47
    The return showed a net taxable income subject to tax of $26,704.16 upon which a tax of $3,130.83 was assessed. The net taxable income was increased by the Commissioner’s letter of January 28, 1924 (not in evidence), to $49,776.65 and reduced by the deficiency letter to a net loss of $26,367.72 by allowing as a deduction the following:
    Al. A. Boeck Co. loss_$13,802.38
    Loss on W. S. Plant_ 1, S00. 00
    One-half auto expense_ 973. 65
    Malaspena Mine loss_ 59, 868.34
    Total_ 76,144.37
    3. In 1908 the petitioner bought the Malaspena Mine in British Columbia and operated it for a number of years. A- loss in connection with this mine was allowed by the Commissioner as a deduction from gross income in computing net income for 1919. About the same time he also acquired the Redondo Mine in the same vicinity and subsequently abandoned its operation as a mine but still owns the property. In 1911 to 1914 he owned and operated a mine at Pierce, Idaho, in which he originally held stock and which property he took over' to protect his interest and now holds this property on account of timber on it. In 1917 and 1918 he operated an iron pyrites mine in Colorado, and in 1918,1919, and 1920 he shipped ore from the Redondo Mine. During these years he had several mining engineers in his employ and in charge of the mining operations, paying them substantial salaries for their' services, which were allowed as deductions in computing taxable net income. Numerous expenditures by the petitioner in connection with mining operations were claimed in the return and allowed without question by the Commissioner. The deficiency letter shows that a stock loss in the Daisy Mine was allowed for 1918, and an operating loss in the Chicago-Idaho Mine was allowed in 1921. Petitioner visited his properties from time to time as was necessary, making two trips a year to some of them.
    4. About 1905 or 1906, petitioner invested $18,740 in the stock of the Amador Copper and Gold Mining and Milling Co., which was also a holding company for other corporations. This company owned the entire capital stock of a 9-mile broad-gauge railroad leading to the Amador Mine, located about 12 miles from Missoula, Mont., and also 98 per cent of the stock of the company operating-such mine. It also owned in its own right placer claims in the vicinity of the mine, 1,000 acres of land and other tangible assets.
    In 1905 the company had cash on hand and accounts receivable totaling $221,626.86. The balance on hand in 1906 was $16,546.58. In 1908 the cash balance had been exhausted and the company was unable to sell any more stock. In 1908 a stockholders’ committee was organized and took over the business. Apparently one or more of the subsidiary companies was in the hands of the receivers for' a short while at about this time. Between the years 1908 and 1913 the holding company was never out of debt. From 1907 to 1918 the Amador Mine was in actual operation about half of the time. In 1915 a dividend was paid by the company and in 1917 a concentration plant costing $30,000 was installed. In 1918 it was definitely known that the company could not produce ore at a commercial profit. The advances of funds up to this time, or a considerable portion of them, were secured by receiver’s certificates and liens upon assets of the several cosnpanies. In 1918 steel rails were selling at $75 to $90 per ton and the holders of receiver’s certificates issued by the receiver for the railroad company instituted proceedings of foreclosure, sold the railroad, and same was dismantled in that year, leaving the mine without any transportation and causing a necessary abandonment of the enterprise.
    5. About 1907 the petitioner became interested with one Boeck, and with petitioner’s brother, a German manufacturer, in putting on the American market a wooden porch shade manufactured and imported from Germany. About 1908 the business thus begun was incorporated and the petitioner invested therein $10,600 for which there was issued to him thirteen twenty-fifths of the capital stock of $25,000 in the name of the petitioner and Boeck. The balance of the stock was issued to the brother in Germany, which was paid for in merchandise. The introduction of the porch shade was the beginning of a new business and the bringing to the American market of a new article. When additional shipments of merchandise became necessary the German manufacturer insisted that his invoices must be paid or guaranteed and petitioner accordingly offered and did guarantee to his brother payment for such shipments. The business was able to pay its ordinary overhead expenses from the proceeds of sales but not entirely to reimburse the petitioner for his guarantee advancements, which advancements were not paid through the checks of the company but were treated by petitioner as his individual obligations. The petitioner withdrew from the business in 1914, $7,100 and took same as a credit upon his advancement account. The accrued deficit of the company at the end of 1912 was $8,800. For the fiscal year ended August 30, 1913, the company had a deficit which was increased by charging-off in that year incidental items which were previously carried on its books and were considered at that time to have become losses. The deficit at the end of 1913 approximated $24,000. The imported porch shades were sold throughout the United States principally to the larger and better known department stores, from which larger orders were being received each succeeding year. After the commencement of the World War, in 1914, importations were delayed and became difficult. In 1915 the business was conducted by mail upon the basis of the merchandise in the United States and practically all sales were made upon mail orders. At the end of 1915 the remaining merchandise and the books were transferred from New York to Chicago and the New York office given up. Small sales were thereafter made by the petitioner until the stock was exhausted. In 1915 the porch shade trademark was assigned to the corporation by Boeck. In 1919, when communication with Germany was resumed, the petitioner made inquiry for the purpose of reviving the business and ascertained that his brother was unable to manufacture the required goods; that his machinery was gone; the proper woods, dyes, and cotton could not be secured; and that the completed porch shades could not be manufactured for import from Germany. In 1919 the petitioner paid to his brother $13,802.88 in settlement of his existing guarantee and the respondent has allowed this amount as a deduction from gross income in the petitioner’s tax return for 1919. The respondent has disallowed the deduction from gross income of $10,600, representing the petitioner’s investment in the stock of the company.
    6. In 1903 and thereafter until 1917, the petitioner advanced to his brother-in-law, one Liebmann, a resident of Germany, various amounts aggregating $3,795.63. Liebmann went into the German army and on his return found his business demoralized. Shortly thereafter his wife, the sister of the petitioner, died. Liebmann married again, and the petitioner, having made inquiry, determined the Liebmann debt to be uncollectible in 1919 and charged the same off in his original income-tax return. The same was disallowed by the respondent. Afterwards the petitioner made endeavors to collect his debt through his brother residing in Germany and Liebmann offered 5,000 paper marks, having a value of less than 5 cents, in settlement of the debt. No collection has since been made of the debt.
    7. Beginning in 1909 and continuing until 1912, petitioner loaned to one Cordes $1,399.51, upon the promise that when certain patents owned by Cordes were sold the debt would be paid. These patents were placed with a patent agency in Newark, N. J., for sale and Cordes returned to Europe to protect his inventions there. When the war came on communication with him was lost and not being able to hear from him in any way nor to obtain anything from the sale of the patents the petitioner charged off the debt in 1920 in his original return as a worthless debt and it was disallowed by the respondent. Subsequently petitioner continued his investigations and in 1924 received a certificate from the Dresden police to the effect that Cordes had died in that city in 1917. The petitioner has subsequently realized nothing upon the account.
   OPINION.

Smith:

The most important question for decision is whether the petitioner had a net loss for the year 1919 within the meaning of section 204 of the Revenue Act of 1918. The respondent has found that the deductions allowable from gross income are $26,704.16 in excess of the gross income; the petitioner alleges that this excess should be increased in the amount of $10,600, representing an investment in the stock of the Al. A. Boeck Co., and by $3,795.65, representing the Liebmann bad debt ascertained and charged off in 1919. The respondent does not admit that the excess of the allowable deductions over the gross income represents a net loss under section 204 of the taxing statute. That section provides in part as follows:

(a) That as used in tills section the term “net loss” refers only to net losses resulting from either (1) the operation of any business regularly carried on by the taxpayer, or (2) the bona fide sale by the taxpayer of plant, buildings, machinery, equipment or other facilities, constructed, installed or acquired by the taxpayer on or after April 6, 1917, for the production of articles contributing to the prosecution of the present war; and when so resulting means the excess of the deductions allowed by law (excluding in the case of corporations amounts allowed as a deduction under paragraph (6) of subdivision (a) of section 234) over the sum of the gross income plus any interest received free from taxation both under this title and under Title III.
(b) If for any taxable year beginning after October 31, 1918, and ending prior to January 1, 1920, it appears upon the production of evidence satisfactory to the Commissioner that any taxpayer has sustained a net loss, the amount of such net loss shall under regulations prescribed by the Commissioner with the approval of the Secretary be deducted from the net income of the taxpayer for the preceding taxable year; and the taxes imposed by this title and by Title III for such preceding taxable year shall be redetermined accordingly. Any amount found to be due to the taxpayer upon the basis of such redetermination shall be credited or refunded to the taxpayer in accordance with the provisions of section 252. If such net loss is in excess of the net income for such preceding taxable year, the amount of such excess shall under regulations prescribed by the Commissioner with the approval of the Secretary be allowed as a deduction in computing the net income for the succeeding taxable year.

We think that the contention of the petitioner that the excess of the deductions from the gross income of 1919 is a net loss under section 204 is untenable in the light of the evidence. It is not every deduction from gross income that is to be taken into consideration in determining a net loss. The petitioner’s tax return for 1919 shows the deduction of many items that clearly are not connected with any regular trade or business carried on by him.

The petitioner’s tax return for 1919 shows net income “ from business or profession,” as $78,246.60. The respondent has permitted deductions therefrom of $104,685.75 to produce a loss of $26,367.72. The petitioner contends that the deductions should be increased by $10,600 and $3,795.65 above indicated. The $10,600 represents the cost to the petitioner of shares of stock of the Al. A. Boeck Co. The evidence shows that this company was laboring under an enormous deficit prior to the war period and that it had no net income during the war period. Its merchandise was practically all sold. We are of the opinion that the stock was worthless long prior to 1919 and that the petitioner is not entitled to claim any deduction from gross income of 1919 in respect of the worthlessness of this stock. We are of the opinion, however, that the petitioner sustained a loss in respect of his loans to G. Liebmann and that this loss is properly allocated to the year 1919. It was in this year that the petitioner determined the worthlessness of the debt and claimed it as a deduction from gross income in his tax return. The petitioner therefore had legal deductions for the year 1919 of $30,163.37 in excess of gross income. In the computation of such excess the following deductions from gross income have been made:

Interest paid on personal indebtedness_ $7,190.46
Personal taxes paid- 496. 84
Contributions_ 1, 090.10
Investment in worthless mining stock_ 2, 358.96
G. Liebmann — Loan without security — uncollectible_ 3, 795.65
T. Harbeek — Loan without security — uncollectible_ 4,000. 00
G. Gregg — Loan, party has disappeared_ 800. 00
Salaries paid stenographer and bookkeeper handling private affairs_ 1,207. 00
Advance for drilling oil well (proved failure)- 2, 500.00
Advance for mining pyrites (proved failure)- 1, 603.00
Advance for manufacture of Rattol Rat Poison (business closed)_ 2,991. 63
Loss on W. S. plant- 1, 500.00
Al. A. Boeck Co. loss- 13, 802.38
Malaspena Mine loss_1- 59, 868.34
Total_ 104,204.36

It will be noted from the foregoing that many of the deductions taken by the petitioner in his return were personal in nature and were not connected with his regular business. We have held in Appeal of J. J. Harrington, 1 B. T. A. 11, that losses upon investments in shares of stock by an individual are not legal deductions from gross income in determining a net loss under section 204 of the Bevenue Act of 1921. A like ruling must be made under the Revenue Act of 1918. The petitioner was engaged in the business of manufacturing pharmaceutical preparations for sale and in the mining-business as an operating owner of mines of various kinds and as an investor in mining enterprises. The evidence is conclusive that a large part of the deductions above enumerated were not sustained in the “ operation of any business regularly carried on by the taxpayer.” The business of the Al. A. Boeck Oo. was not a business regularly carried on by the petitioner. We are not informed as to the nature of the Malaspena Mine loss. We do not know whether it resulted from the operation of the mine in 1919. It was not claimed as a loss on the original return. The evidence does not warrant any finding that the petitioner sustained a net loss in 1919 under section 204 of the Revenue Act of 1918.

In view of our decision upon this point it becomes unnecessary for us to consider whether the petitioner sustained any loss in 1918 upon his investment in the stock of the company operating the Amador Mine.

There remains to be considered whether the petitioner is entitled to deduct from gross income of the year 1920, $1,399.51 representing the loss of his loan to one Oordes many years prior thereto. There is evidence that in 1920 the petitioner endeavored to ascertain the probability of collecting anything upon this acco'unt. The patents owned by Cordes were found to be unsalable and Cordes could not be located. Acting upon such information the petitioner charged off the account as worthless and claimed the amount as a legal deduction from gross income in 1920. We think the amount was deductible from the gross income of that year.

Judgment will he entered on 15 da/ys’ notice, under Bule 50.

Phillips dissents on the ground that the evidence establishes a net loss for 1919 which is deductible in 1918.


author: Ajrundell:

text:
    First National Bank of Los Angeles, Petitioner, v. Commissioner of Internal Revenue, Respondent. Los Angeles Trust & Savings Bank, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 2817, 2818.
    Promulgated April 15, 1927.
    Deductibility of certain debts determined.

      'William A. Bowen, Esq., for the petitioners.

      A. Bolder Maekay, Esq., for the respondent.
    These are proceedings for the redetermination of deficiencies in income and profits taxes for the calendar years 1920 and 1921, as follows:

      First National Bank of Los Angeles:
    1920_$19,000.82
    1921_1_ 51,759.73
    Los Angeles Trust & Savings Bank, 1920- 4, 699. 53
    On motion of the petitioners the cases were consolidated for hearing and decision.
    At the hearing of the appeals the petitioners withdrew from issue the following items:

      First National Barilo of Los Angeles.

    1920.
    Disallowance of $85,000 claimed as loss on notes of O. H. & O. B. Fuller Oo. charged off.
    Inclusion in income of $4,000 recovered on the account of N. B. Dotson.
    Failure of petitioner to deduct the amount of $504.92 representing balance of account of J. N. Holloway.
    Inclusion in income of $380.83 recovered on the account of the McStay Supply Co.
    1921.
    Disallowance of $10,402.52 representing a partial charge-off of the indebtedness of Percy H. Clark.
    Inclusion in income of $1,030.24 recovered on the account of the Fruit World Publishing Co.
    Failure of petitioner to deduct from income $1,870.91 of the account of the McStay Supply Co.
    Inclusion in income of $1,240 realized on sale of Corona Lemon Co. stock.

      Los Angeles Trust & Savings Barilo.

    1921.
    Disallowance of charge-off of note of V. K. Morgan in the amount of $5,500
    The Commissioner, at the hearing, admitted the correctness of the claims of the petitioners as to the following items:

      First National Barilo of Los Angeles.

    1920.
    Deduction from income of $3,500 as a loss on the sale of real estate taken by ihe bank to secure the indebtedness of A. J. and H. It. Hamilton.
    Deduction from income of $1,500 as a loss on the sale of real estate taken by the bank to secure the indebtedness of Gesner Williams.
    1921.
    Deduction from profit realized on sale of real estate, taken under judgment against Baxter Todd, of the cost of maintaining the property in the amount of $2,153.68.
    Deduction of loss on the sale of real estate in the amount of $2,000.

      Deduction from income of $259.20 due to overstatement of profits and capitalizing expenses, by a revenue agent, on real estate acquired under judgment against O. W. Bowen and sold in 1921.

      Los Angeles Trust & Savings Bank.

    1920.
    Deduction from income of expenses paid in the amount of $5,365.74, carried on tbe books of the bank as “ Deferred expense.”
    The issues remaining are:
    As #o First National Bank of Los Angeles.

    Olaimed erroneous inclusion in income for 1920 of proceeds of sale of Traders Oil Oo. stock in the amount of $1,0S0, and loss on the sale of the stock in the amount of $540.
    Disallowance by the Oommissioner of notes of the Fontana Farms Oo. in the amount of $21,200 charged ofC in 1921.
    Disallowance of notes O. PI. & O. B. Fuller Oo. in the amount of $50,000 charged off in 1921.
    Disallowance of balance of indebtedness of Sutherland Fruit Co. in the amount of $7,018.32 charged off in 1921.
    As to Los Angeles Trust <6 Savings Bank.

    Disallowance of debt of Union Pipe Oo. in the amount of $8,922.21 charged off in 1921.
    FINDINGS OF FACT.
    The First National Bank of Los Angeles is a National Banking Association. The Los Angeles Trust & Savings Bank, during the years 1920 and 1921, was a corporation organized under the laws of the State of California. Both petitioners have their principal places of business at Los Angeles, Calif.
    The additional tax for 1920 was prorated among the two petitioners and another affiliated company. The additional tax for 1921 was determined against the petitioner First National Bank of Los Angeles.
    In 1916 the First National Bank of Los Angeles held notes of Matheson, Inc., aggregating $35,400. During that year it charged off $17,400 of such notes and in payment of the balance of $18,000 accepted real estate at $10,980 and 108 shares of Traders Oil Co. stock at its then market value of $65 per share, or a total of $7,020. In 1917 it wrote down the value of this stock to $5,400 and claimed the difference of $1,620 as a deduction from its gross income in its income-tax return for that year. This claim was disallowed by the Commissioner. On July 28, 1920, it sold the stock for $6,480, sustaining a loss of $540. In entering the 1920 transaction in its records it erroneously used as the cost the value of $5,400 and included a profit of $1,080 which it reported as income for that year.
    In 1921 the petitioner First National Bank of Los Angeles held the following obligations of the Fontana Farms Co.: $37,500 in unsecured notes; $20,000 in trust notes; and $75,000 in bonds. In 1920 it charged off $16,300 of the unsecured notes and in 1921 charged off the balance in the amount of $21,200. These amounts the Commissioner disallowed. On January 12, 1922, following a reorganization of the Fontana Farms Co., the petitioner received preferred stock of that company of the par value of $95,000 in exchange for the notes it held aggregating $57,500 and for one-half, or $37,500, of the bonds. The petitioner still has the stock and no dividends have ever been paid on it.
    The Fontana Farms Co. was attempting to develop and sell as orange property some six or seven thousand acres of land which it acquired about 1918 through a reorganization. In addition to land and buildings it held all the capital stock of the Fontana Lands Co. A consolidated balance sheet of the Fontana Farms Co. and the Fontana Lands Co. at December 31, 1921, was as follows:

    The value of the land includes the cost of planting, water, fertilizer, taxes and interest. The value of the land shown in the balance sheet is at least one-third greater than its actual value and the values shown for the other assets are considerably more than their true values.
    About 1920 or early 1921 the financial situation of the Fontana companies became acute, and a committee of three representing the largest holders of the securities of the companies made an investigation of their affairs. Two of the three were officers of the petitioner companies. On February 16, 1921, the committee reported that, as the Fontana Farms Co. had defaulted in payment of interest on its bonds on February 1, and the Fontana Lands Co. would be unable to meet its bond interest payment on March 1 of that year, and as funds were required for taxes and operation of the properties, a reorganization of the companies which would reduce interest-bearing securities was desirable. It recommended immediate action as it was apparent that both companies might be placed in the hands of receivers and proposed that the bondholders exchange their bonds for new bonds on the basis of 50 cents on the dollar and for preferred stock on thé same basis, the new bonds and preferred stock to be issued by a new company. It also advised the bondholders of their privilege of exchanging their bonds for land of the companies in the event they did not desire to join in a reorganization. One creditor and bondholder that had about $600,000 in notes of the Fontana Companies and $780,000 in bonds, forgave the indebtedness on the notes, took land for the bonds and gave back to the companies a contract of sale thereof. Some other bondholders turned in their bonds for land having a market value of not more than 50 per cent of the par value of the bonds surrendered. The remaining creditors and bondholders, including the petitioner, agreed to and did join in the proposed reorganization, pursuant to which the petitioner received $95,000 in preferred stock, above mentioned. Under the reorganization plans the Fontana Companies retained a part of the authorized bond issue, and from time to time issued the bonds to creditors, including the petitioner, in exchange for funds advanced to meet carrying charges and operating costs. These expenses, in every year, have exceeded the income from the property.
    The petitioner, First National Bank of Los Angeles, made loans to the C. H. & O. B. Fuller Co. and affiliated companies over a period of years. On December 31, 1921, such indebtedness to the bank was $1,075,551.11. On September 23, 1921, the bank charged off two items of this account in the amounts of $10,000 and $5,000. On December 22, 1921, it charged off two items in the amounts of $25,000 and $15,000, and on the same date restored the $5,000 item charged off in September, leaving a net amount of $50,000 of this account charged off during the year. No payments were made on this indebtedness in 1921. As collateral security for the Fuller indebtedness the bank held an assignment of credit of O. B. Fuller with the Ftdler Co., chattel mortgages on live stock, deeds of trust on real estate, and corporate stocks in amounts as follows:

      Tbe credit assigned to the bank by O. B. Fuller represented a credit in the amount of $29,115.10 due him from the Fuller Co. on account of notes he had paid for the company in previous years. The Fuller Co. was unable to pay this amount in 1921 and it was of no value as security for the Fuller indebtedness.
    The live stock on which the bank held chattel mortgages were cattle of the Flying V Cattle Co. and cattle of the Fuller Co. on the Jalama Ranch. There were two mortgages to the petitioner on the cattle of the Flying Y Co., both given in 1921 to secure a note on which $145,000 was unpaid at December 31, 1921. The cattle were worth not over $150,000 and were subject to a prior mortgage to one Marley in the amount of $47,657.27. The mortgage on the Fuller cattle on the Jalama Ranch was given to secure a note on which $120,000 was unpaid at December 31, 1921. The cattle had a value equal to the amount of the mortgage.
    The property on which the bank held deeds of trust consisted of real estate of the Pioneer Ranch, Inc., and of the Jalama Ranch Co. The trust deed on the Pioneer Ranch property was dated January 7, 1920, and was given to secure all the indebtedness of the Fuller Co. and C. H. Fuller and O. B. Fuller individually which they then owed or might owe the bank in the future. The property had a value in 1921 of $294,439 and was subject to a bond issue of $110,000. The trust deed on the Jalama property was dated November 1, 1921, and was given to secure a note of the same date in the amount of $90,000. The land of the Jalama Co. in 1921 had a value of $386,550, against which there were outstanding land purchase liabilities of $246,600.
    The capital stock of the Pioneer Ranch, Ine., the Flying Y Cattle Co., and the Jalama Ranch & Cattle Co., which the bank held, was of no value as security for the Fuller indebtedness as hereinafter shown.
    Some of the Fuller Co. notes were indorsed by C. H. Fuller and O. B. Fuller individually and some were indorsed by them jointly. Both of the Fullers were insolvent in 1921.
    The balance sheet of the C. H. and O. B. Fuller Co. at December 31, 1921, showed a deficit of $794,524.28, which included the operating loss sustained by the company in that year in the amount of $215,600.34. Deducting from this deficit the capital stock liability of $531,018.72 the balance sheet shows liabilities of $236,505.56 in excess of assets.
    Included in the assets listed were the following:
    Cattle_$317,603.87
    Accounts receivable- 20, 006. 69
    Investment — Parker Ranch- 62,627.10

      Investment — Stock, subsidiary corporations:
    Jalama Bauch & Cattle Co_$327, 072.39
    Plying Y Cattle Co- 62,238.38
    Willows Cattle Co_ 132, 953.79
    Advances to' subsidiary corporations:
    Plying V Cattle Co_ 17,104.16
    Parker Cattle Co_ 116, 393. 82
    Willows Cattle Co_ 5,820.43
    All of these assets were overstated in the balance sheet. The cattle listed at $317,603.87 had an actual value of less than half that amount. The greater part of the accounts receivable listed at $20,006.69 were worthless. At the close of 1921 the Parker Cattle Co. books showed assets of $3,500 and a deficit of $279,102.79; the Jalama llanch & Cattle Co. balance sheet showed a surplus of $7,808.91, but this was due to overstating the value of lands of the company by at least $300,000; the Flying V Cattle Co. showed a deficit of $4,050.01 plus an operating loss for the year of $600, but the value of the cattle, its principal asset, stated at $310,020.13 was not in excess of $150,000, against which there was a mortgage in the amount of $47,657.27; the .Willows Cattle Co. showed a deficit of $24,814.94 by attributing a value of $200,942.01 to its cattle which were not ■worth more than $20,000; the balance sheet of the Pioneer Eanch, Inc., showing a deficit of $261,090.34 included land at over $100,000 in excess of its fair market value. This condition was known to the petitioner in 1921 when it ascertained that more than $50,000 of the Fuller account was worthless.
    On September 24, 1918, the petitioner, First National Bank of Los Angeles, charged off a note of the Sutherland Fruit Co. in the amount of $10,000. This was not allowed as a deduction by the Commissioner. In June, 1919, the Sutherland Fruit Co. paid $2,500 to apply on the principal of its indebtedness and gave a new note for the balance of $7,500, which the petitioner charged off in its loss and recovery ledger under date of June 17, 1919. On June 3, 1920, the Sutherland Fruit Co. was adjudicated a bankrupt. As a result of the bankruptcy proceedings the petitioner received a dividend of $226.16 on March 28,1921, and a final dividend of $481.68 on October 7, 1921.
    In 1921 one E. H. Adams, doing business under the fictitious name of Union Pipe Co. was indebted to the petitioner, Los Angeles Trust & Savings Bank, in the principal amount of $8,885.00. Of this account the petitioner charged off $8,584.51 under date of December 22, 1921. A revenue agent’s report in evidence shows a disallowance of a charge-off against this account for the year 1921 in the amount of $8,922.21. The indebtedness was secured by a warehouse receipt covering secondhand pipe in storage. Following a marked decline in tbe price of secondhand pipe in 1921 the bank, in December of that year, turned the account over to an employee for collection. The employee obtained in December, as additional security, a chattel mortgage on a small amount of pipe-cutting equipment and office furniture and an automobile. At that time there was an indebtedness against the automobile, apparently prior to that of the bank, in the amount of $1,500, on which payments were due at $175 per month. In view of this situation the bank was unable to realize anything on the automobile until in May, 1922, when Adams had reduced his indebtedness on it.
    The employee in charge of this account was unable to locate any property of the debtor, other than that mentioned above against which the bank held evidences of indebtedness. He visited dealers in secondhand pipe in an effort to dispose of the pipe it had taken over but was unable to find any market for it.
    During 1922 the bank disposed of the pipe through installations in new subdivisions under contracts whereby it guaranteed payment for the labor.
   OPINION.

Ajrundell:

In 1920 the First National Bank sold 108 shares of stock of the Traders Oil Co. for $6,480. This stock had been acquired by the bank in settlement of a debt, at a cost of $7,020. Consequently, on the sale a loss of $540 was sustained, for which it is entitled to a deduction for the year 1920. Instead of claiming a loss on this transaction the bank erroneously reported a profit of $1,080 due to using an incorrect cost basis. • The income should accordingly be reduced by the amount of $1,080, in addition to allowing the loss of $540.

The First National Bank claims a deduction of $21,200, representing unsecured notes of the Fontana Farms Co., charged off in 1921. The evidence shows that the Fontana Co. was in poor financial condition and that for a number of years its operating expenses had exceeded its income. In 1921 it effected a reorganization which enabled it to reduce its interest payments and to obtain funds from its security holders to meet its carrying charges and operating costs. Some of its bondholders deemed the securities of so little value that they surrendered their bonds for land having a market value of not more than 50 per cent of the face value of the bonds.

While the poor financial condition of the Fontana companies might at first glance indicate that the unsecured notes held by the petitioner were of little value, an analysis of the Fontana balance sheet set out in the findings of fact shows substantial assets in excess of the liabilities. The evidence shows the book value ascribed to the land to have been at least one-third greater than its true' value. Allowing for this over-valuation reduces the value of the land by $1,240,000 in round numbers, and serves merely to wipe out the greater part of the book surplus. The extent of the overvaluation of the other assets is not disclosed by the evidence, but even applying to all of them, including the land, a write-down of one-third of the book values, there remains a value of $4,229,970 which is $1,666,127.69 in excess of the total bonded indebtedness and notes and accounts payable. Taking this view of the case, the petitioner has failed to establish that any part of the Fontana notes were worthless at the close of 1921 and we must sustain the respondent in his refusal to allow the deduction claimed.

The loans by the First National Bank to C. H. & O. B. Fuller Co. and affiliated companies were secured mainly by capital stock and mortgages and trust deeds on property of corporations in which the Fullers were interested. As shown by the findings of fact, these securities in the aggregate were insufficient to secure'the indebtedness for which they were held. All of the assets shown in the Fuller Co. balance sheet and the balance sheets of the other companies listed in the findings of fact were greatly overvalued. The indebtedness of the Fuller Co. to the petitioner constituted over 40 per cent of its liabilities exclusive of capital stock liability. Even if the balance sheet is taken as representing the true assets and liabilities, it works out that 40 per cent of the deficit, excluding capital stock liability, is $94,602, which, if established, is more than sufficient to warrant the allowance claimed. However, as set forth in the findings of fact, the excess of liabilities over assets was greater than shown by the balance sheet. The several companies had in fact no net worth and their stocks were of little value as security for the Fuller indebtedness. A true picture of the woeful lack of security for the Fuller indebtedness can best be shown by a summary which appears as follows:

Indebtedness-_$1,075,551.11
Security. Actual value.
Assignment of credit-None.
Flying V chattel mortgage. $102, 342. 73
Jalama chattel mortgage-120, 000. 00
Pioneer trust deed-184, 439. 00
Jalama trust deed_ 140, 050. 00
Capital stock pledged-None.
Fuller indorsements-None.
Total value as security. 546, 831.73
Deficiency in security- 528,719.38

The officers of the bank were aware of this situation and at the close of 1921 had ascertained that the Fuller account was worthless to the extent of more than $50,000. Under section 234(a) (5) of the Revenue Act of 1921 a debt which is recoverable only in part may be charged off in part. It is not necessary under this provisión, as it had been under the Revenue Act of 1918, to ascertain that a debt is worthless in whole in order to support a claim for deduction. In Appeal of John E. Saddler, 2 B. T. A. 1305, we had under consideration the partial charge off of an item under section 214(a) (7) which is identical with section 234(a) (5) of the 1921 Act. We said there,

The ascertainment of the worthlessness of a debt, either in whole or in part, is the exercise of sound business judgment based upon as complete information as is practicably obtainable.

In the case of Stieglitz, Treiber Co., 1 B. T. A. 452, where the taxpayer’s debtor was in financial difficulties and it was found that the debt at the close of the year could not be regarded “ as reasonably worth more than 50 per cent of its face amount,” the taxpayer was permitted a deduction of one-half the amount of the debt.

In view of the evidence we believe that the petitioner is entitled to a deduction in the amount of $50,000, the amount of the Fuller indebtedness that it charged off in 1921.

The petitioner, First National Bank, claims as a deduction for 1921 the amount of $7,018.32, representing the difference between a note of the Sutherland Fruit Co. for $7,500 and the amount of $481.68, which is the amount of the final liquidating dividend received in 1921 as the result of the bankruptcy of the debtor. The original indebtedness of the Sutherland Fruit Co. was $10,000. This amount was charged off in 1918 but was disallowed by the Commissioner as a deduction for that year. The bankruptcy of the Sutherland Fruit Co. and the receipt of a final dividend in 1921 constitute sufficient proof to permit the deduction of the balance of the account as a bad debt in 1921. The deduction allowable is the difference between $7,500 and the dividends of $226.16 and $481.68, received in 1921.

The last item for consideration is the claim of the Los Angeles Trust & Savings Bank for a deduction of $8,922.21 written off in 1921 as a bad debt of the Union Supply Co. The bank had as security for this account a warehouse receipt covering a quantity of secondhand, pipe and before the close of 1921 secured a chattel mortgage on some pipe-cutting machines, office furniture, and an automobile. The bank took over the assets of the debtor and attempted, without success in 1921, to sell them in order to liquidate the indebtedness. While it appears that there was no ready market in 1921 for the property taken over from the Union Supply Co. we are not satisfied that the account was ascertained to be wholly worthless in 1921. As set out above, the Revenue Act of 1921 permits the charge-off of the portion of a debt which it is ascertained can not be recovered, but in this case the evidence does not show to what extent the account had been ascertained to be uncollectible in 1921 and we can not say what portion of it may be allowed.

Judgment will be entered on IS days’ notice, u/nder Rule 60.


author: Marquette :

text:
    Appeal of H. Alfred Hansen, Executor, Estate of Hans C. Hansen.
    Docket No. 6744.
    Promulgated April 15, 1927.
    Amounts paid to the executor of and the attorneys for the estate of the decedent during the fiscal year ended January 31, 1923, under the circumstances set forth herein, are deductible in computing the net income of the estate for that year.

      Robert E. Montgomery, Esg., for the petitioner.

      M. N. Fisher, Esg., for the Commissioner.
    This appeal is from the determination of a deficiency in income tax for the fiscal year ended January 31,1923, in the amount of $22,849.26.
    FINDINGS OF FACT.
    Plans C. Hansen died testate on January 24, 1916. Plis last will and testament was admitted to probate and record in the Probate Court in and for Middlesex County, Massachusetts, on February 14, 1916. On the same date Henry Alfred Hansen, son of Hans C. Hansen, who was named in the will as the executor thereof, duly qualified as executor and has continued as such executor to the present time. The last will and testament of Hans C. Hansen, was in j! art as follows:
    3. I desire my son, Henry Alfred Hansen, to have the sole management and control of my estate, both real and personal, and especially I desire him to have the management, charge and control of the Printers Supply business heretofore carried on by me for so many years, under the name of The IT. C. Hansen Type Foundry, including the plant, machinery, fixtures, utensils, stock in trade, book debts, good-will, and effects of every nature and description connected therewith, with full power and control in every particular. I hereby give him full authority to continue said business as at present organized, for a period not exceeding eight (8) years, with the privilege of selling or closing it up at any subsequent time, and I hereby give my said son authority, should he deem it wise and expedient so to do, to, at any time within the said eight years, have a corporation organized for the purpose of purchasing, taking over and conducting the business; in such case, if shares of stock in said corporation are taken in payment for said business, said stock is to be a part of my said estate, and disposed of as herein provided, and the eight year limit herein specified for closing up said business does not apply to said corporation.

      4. I desire that when my estate is settled, as herein provided for, and the Printers Supply business is sold, either to individuals or a corporation or to a corporation to be organized for the special purpose of continuing said business, or in any other way, that there be paid to my said son, Henry Alfred Hansen, ten per cent of the net proceeds of the sale of said business, as compensation and reward for his many years of faithful past services to me, and to the business, said ten per cent to be paid to him in money, or at his option, in shares of stock, of equal value, in said corporation should such be organized.
    5. Of the rest and residue of my estate, both real and personal, and whatever I may be entitled to at the time of my decease, after the provisions heretofore specified in Sections 1, 2, and 4 of this will, I give one-third to my son, Henry Alfred Hansen, to his own use and behoof forever.
    6. The remaining two-thirds I give to my son, Henry Alfred Hansen, but in Trust Nevertheless for the following uses and purposes, namely: to hold, manage, control, invest and re-invest the same for the use and benefit of my two children, Luther A. Hansen and Christine Hansen Curtis, in manner and way following: * * *
    Henry Alfred Hansen continued the operation of the H. C. Hansen Type Foundry from the date of his father’s death to May 1, 1922. During that time there was a continuous course of purchase, manufacture, and sale of merchandise, and on May 1, 1922, the inventory of the business consisted almost entirely of goods' purchased or manufactured since January 24, 1916. On January 24, 1916, the book value of the plant assets of the business was about $230,000, and the book value of the inventory about $125,000.
    On or about May 1, 1922, Henry Alfred Hansen sold the plant assets of the H. C. Hansen Type Foundry for $250,000, and also sold the inventory of the business in bulk for $277,312-50. Later in the year 1922, after collection had been made of the amount for which the plant assets and inventory had been sold, Henry Alfred Hansen, with the approval and consent of the other persons interested in the estate, paid to himself $27,713.25, as a commission for his services in bringing about the sale of the inventory and to reimburse himself for expenses incurred in making the sale. He also paid to certain attorneys $10,000 for legal services rendered by them to the estate in connection with the sale of the plant assets and inventory.
    The amount of $27,713.25, so paid to Henry Alfred Hansen was in addition to the 10 per cent of the total sales price of the business which was paid to him under the fourth item of the last will and testament of Hans C. Hansen. The payment of the amounts of $27,713.25 and $10,000. in question have not yet been approved by the Probate Court in and for Middlesex County, Massachusetts, to which Henry Alfred Hansen must account as executor of the estate of Hans C. Hansen.
    The services rendered by Henry Alfred Hansen in connection with the sale of the inventory extended over several years and involved trips to different cities and conferences and negotiations with various persons interested in purchasing the inventory. Henry Alfred Hansen and attorneys for the estate have from time to time been allowed and paid compensation for the other services rendered by them to the estate of Hans C. Hansen.
    In the income-tax return of the estate of Hans C. Hansen for the fiscal year ended January 31,1923, Henry Alfred Hansen, as executor of the estate, deducted from gross income the amounts of $21,713.25 and $10,000 paid to himself and the attorneys for the estate, respectively, as hereinabove set forth. The Commissioner disallowed the deductions.
   OPINION.

Marquette :

The only question herein is whether or not the estate of Hans C. Hansen, in computing its net income for the fiscal year ended January 31, 1923, is entitled to deduct the amounts of $27,-713.25 and $10,000, paid to the executor and attorneys for the estate, respectively, under the circumstances set forth in the findings of fact. The Commissioner contends that the services rendered by the executor were those expressly required of him by the last will and testament of Hans C. Hansen, and that the amounts paid for such services are a part of the usual expense of administration and are not deductible from gross income. The petitioner contends that under the circumstances they are deductible, even though they are administrative expenses, but urges that they are in fact ordinary and necessary expenses of carrying on a trade of business.

This appeal is in many respects strikingly similar to the Appeal of Grace M. Knox et al., Executors, 3 B. T. A. 143. The facts in that appeal were that S. H. Knox died testate in May, 1915. In his will he named certain persons who acted as executors in the necessary proceedings for the settlement and distribution of his estate, and provided further that the same executors should become trustees of certain trusts specifically provided for and set forth in the will. The decedent knowing that the estate would continue and produce a large income annually and that the execution of the trusts provided for would extend over a period of years much longer than the period ordinarily required for the administration and settlement of an estate, provided in his will that his executors and trustees should during the period of their services in such capacity, receive as compensation a fixed annual salary in lieu of statutory fees and commissions. The trusts provided by the will were not created until the year 1921. During the year 1919 the estate of S. H. Knox had a large income, from which the executors in the income-tax return of the estate sought to deduct their compensation for that year. The Commissioner disallowed the deduction. This Board, in holding that the compensation was deductible, said:

There appears to be no provision in the statutes of the State of New York, or in the Federal tax laws, which can be urged as in any way preventing or defeating the carrying out of the testator’s purpose set forth in his will. This is not a case of a will or of an estate which is to be administered, settled, and distributed within the short time ordinarily required for such purposes. On the other hand, it is a case of the creation of long-time trusts, the execution of which must extend over such a period of years as to constitute a continuing business of handling large trust properties, collecting and receiving large incomes, and disposing of the same in accordance with the terms of the trusts. In such a case it appears to be eminently wise and proper that.the executors’ and trustees’ compensation should be determined on the basis of annual salaries, and that such salaries should be paid out of the income of the estate and trust properties.
Section 219 of the Revenue Act of 1918 laid upon the executor and trustees in this case the duty of making an income-tax return for the estate and properties under their charge, and it further provided that the gross and net income of such estate should be ascertained and computed in substantially the same manner as required of living persons. The executors and trustees are essentially employees of the estate. Their compensation is one of the ordinary and necessary expenses of the estate and properly deductible from the income thereof without regard to the fact that a portion of the estate’s income is exempt from taxation.

See also William W. Mead et al., Executors, v. Commissioner, 6 B. T. A. 752.

This is not the case of a will or an estate which is to be administered or distributed within the time usually required for such purpose. On the contrary the decedent’s will contemplated that the estate might be kept intact for at least eight years and that during that time the type foundry business would be conducted in the same manner as it had been during his lifetime. The business was in fact so conducted for more than six years and the estate, after a period of more than ten years from the date of Hans 0. Hansen’s death, is still undistributed. The executor managed and conducted the business and engaged in a continuous course of purchase, manufacture and sale, and the inventory which was sold in 1922 consisted almost entirely of merchandise which had been acquired subsequent to the death of Hans C. Hansen. A large profit was realized on the sale, and this profit which accrued to the estate was the direct result of the executor’s activities. Since the income which is sought to be taxed herein was to a large extent realized from the sale by the executor of the inventory belonging to the type foundry business, we see no reason why the compensation paid to him and the attorneys for making such sale should not be taken into consideration in determining the profit therefrom. We are therefore of the opinion that under the circumstances herein, the amounts paid to the executor and the attorneys for the estate of Hans C. Hansen are not the ordinary expenses of administration, but that they are properly deductible in computing the net income of the estate for the fiscal year ended January 31, 1923. We attach no importance to the fact that the amount in question paid to the executor is in addition to the 10 per cent of the proceeds of the sale of the plant and inventory allowed him by the will of Hans C. Hansen. That is clearly a bequest as compensation and reward for his many years of past, faithful services,” and was not intended as compensation for any services he might render the estate.

Judgment will be entered for the petitioner on 15 days’ notice, under Rule 50.


author: Van Fossan:

text:
    Joe Gilovich & Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7746.
    Promulgated April 15, 1927.
    Under the evidence, held,, petitioner was a partnership and not an association. A mining partnership is a partnership within the meaning of the term as used in the Revenue Act of 1918.

      Eugene A. Bond, Esq., for the petitioner.

      A. G. Bouchard, Esq., for the respondent.
    This is an appeal from the determination by the respondent of a deficiency of $2,727.05 in income taxes for the calendar year 1920. The Commissioner computed the tax against this petitioner as an association, denying to it the status of a partnership.
    FINDINGS OP PACT.
    The Ibex Mining Co. is a Colorado corporation owning certain gold and silver mining property in Lake County,, Colorado, divided into blocks approximately 100 feet square on the surface and extending from one mine level to another, a depth of from 60 feet to 100 feet. The company did not operate the property on its own account, but let the same out on lease or permit to individuals and groups of individuals. The petitioner herein was one of the groups of individuals operating on the property of the mining company under a lease. Persons desiring to work on the Ibex Mine made application to the company for a lease, designating the blocks desired. If the application was approved, the company would issue to the applicant a lease in the shape of .a form letter, designating the blocks and levels upon which the applicant was given permission to work, and containing at the foot thereof the names of the individuals to whom the lease was granted and the respective interests of each individual in the lease. This lease or permit incorporated by reference a form lease containing in more detail the terms and conditions upon which the company leased the property, copies of which were posted on the shaft of the mine and filed at the office of the mining company and were, at all times, open to the inspection of lessees and applicants for leases.
    The mining company, at its own expense, kept open the property and supplied the power for hoisting the ore and waste to the surface. The lessees bore all the costs and expenses of the- actual mining. Under the terms of the lease all of the ore had to be sold through the mining company, which, after deducting its charges for materials supplied, as well as the royalty provided for, paid the balance of the proceeds, if any, to the lessee.
    In December, 1918, petitioner made application for a lease upon certain blocks and the same was granted by the company. Thereafter, in January, 1919, petitioner made application for a lease upon additional ground, which was likewise granted by the company, and again in March, 1920, made application for a lease upon still further ground, which was also granted by the company.
    At the beginning of the operations of Joe Gilovich & Co. under the first lease obtained from the mining company, petitioner consisted of two individuals, namely, Joe Gilovich and John Cortellini, each owning a one-half interest. Subsequently additional individuals were taken into the group and given interests in the lease and leases subsequently acquired. The individuals so taken in were: Jack Verdolaick, John Bogunovich, and Samuel Tomasovich. All of these individuals were practical, experienced miners familiar with the conditions of this particular mine and the most of them were related to each other by some family tie. There were no formal instruments in writing under which these individuals grouped themselves for the operation of these leases, the entire arrangement between the parties being oral. The parties merely got together and agreed upon the basis on which they would operate the lease. Originally Gilovich and Cortellini agreed to work the lease upon equal shares. When they determined to take additional parties into the enterprise they approached miners whom they had known for many years, to some of whom they were related and whom they knew to be practical, experienced miners, familiar with the Ibex mining property. No formal agreements were entered into. They simply offered orally to the respective individuals an interest in the lease and those individuals accepted orally the interest offered. There were no writings evidencing the respective interests of the parties (other than as shown on the lease received from the mining company) or covering in any way the terms upon which the parties had agreed to operate the leases. The added individuals paid nothing for the interests acquired under the leases.
    The parties agreed orally to bear the expenses and to share the profits of the enterprise in accordance with their respective interests. At the end of each month a statement of all expenses was prepared and each individual contributed his share to the total expense. When there were any profits a similar statement thereof was prepared and each individual received a share of such profits.
    After Gilovich and Cortellini had taken in the additional parties named above, the respective interests of the parties constituting the petitioner herein were as follows:
    Joe Gilovicli_Three-eighths
    John Cortellini-Two-eighths
    Jack Verdolaick_One-eighth
    John Bogunovieh_One-eighth
    Samuel Tomasovich_One-eighth
    These interests remained the same through the taxable year. Some time after the taxable year Cortellini withdrew from the venture and surrendered his interest in the lease. He received nothing in payment for his interest, the only consideration being that he was thereafter relieved from his portion of the expenses of the venture. Cortellini’s interest was taken over by the other parties owning the leases and later disposed of.
    Petitioner had no capital and kept no regular set of books. The expenses of operation were paid monthly. Such books as were kept and the statements of expenses and profits rendered were made by Cortellini’s bookkeeper. There was no organization with officers or a board of directors or trustees, nor was there a managing partner. All questions pertaining to the operation of the enterprise were determined by agreement among all of the individuals.
    In the taxable year the receipts from the venture exceeded the expenses by the sum of $29,270.52. The petitioner made a partnership return showing the distribution of the net income to the individuals according to their respective interests. The individuals made individual return of their shares of the profits and paid the tax thereon.
   OPINION.

Van Fossan:

The question presented by this appeal is whether petitioner was, during the taxable year, an association or a partnership within the meaning of the Revenue Act of 1918. Petitioner contends that it was a partnership, while respondent has asserted a deficiency on the theory that it was an association and taxable as a corporation.

In the case of Eeoht v. Malley, 265 U. S. 144, 157; 68 L. Ed. 949, 957, the word “ association,” as used in section 1 of the Revenue Act of 1918, is defined as follows:

The word “ association ” appears to be used in the Act in its ordinary meaning. It has been defined as a term “ used throughout the United States to signify a body of persons united without a charter, but upon the methods and forms used by incorporated bodies for the prosecution oí some common enterprise.”

Other definitions cited in the same opinion are:

A body of persons organized, for the prosecution of some purpose, without a charter, but having the general form and mode of procedure of a corporation.
An organized but unchartered body analogous to but distinguished from a corporation.

Petitioner in this case did not conduct its business upon the methods and forms used by incorporated bodies. It had no capital stock or certificates of interest in its ownership; no officers, trustees or directors; it had no charter and was not created by declaration of a trust or writing of any kind. All of the members of the petitioner actively engaged in the operation of the business and each had a voice in its management. Under such facts we fail to see such similarity between the petitioner and a corporate organization as would warrant the holding that it was an association under the Supreme Court decision above quoted.

In view of our conclusion that petitioner was not an association, it follows that it was not taxable as a corporation. This determination disposes of the principal question in the case, and except for a contention of respondent that a mining partnership does not fall within the category of partnerships as used in the law, it would be perhaps unnecessary to decide whether petitioner was a general partnership engaged in mining, as it contends, or what is technically- known as a mining partnership, as insisted by respondent. Chancellor Kent defined a partnership as “ a contract of two or more competent persons to place their money, effects, labor and skill, or some of them, in lawful commerce or business and to divide the profits and bear the loss in certain proportions.” . A “ mining partnership ” is distinguishable ’from the ordinary commercial or trading partnership chiefly in those characteristics that flow from the fact that in a mining partnership there is no delectus personae. As stated in 40 C. J. 1147:

Except as to the few peculiarities which depend upon this distinction, the law governing a mining partnership is’ not different from that applicable to an ordinary commercial partnership, and elements of the latter are common also to the former.

On the other hand, the same work states:

There is nothing in the nature of mining which forbids the creation of a partnership by an ordinary partnership contract which would draw to the relation of the parties all the incidents of a trading partnership, including the delectus personae.

In the present case the partners were well known to each other and some of them were related by blood ties. The selection of the partners is shown to have been made by reason of the trust and confidence of each in the other. No change was made in the membership without the assent of all. Under the facts, it might well be held the petitioner was an ordinary partnership engaged in mining, rather than a “ mining partnership.” If the. contrary conclusion were reached, however, it would not, in our judgment, be fatal to petitioner’s contention, for we can not agree with the assumption of respondent that mining partnerships are not “ partnerships ” under the revenue law.

The absence of the delectus 'personae or such other element as may distinguish a mining partnership from the ordinary trading partnership is not such a fundamental distinction as to require a holding that a mining partnership is not a “ partnership ” as that term is used in section 1 of the Revenue Act of 1918. Nor do we believe that the statement of the Supreme Court in Burk-Waggoner Oil Assn. v. Hopkins, 269 U. S. 110; 70 L. Ed. 67, that “the term ‘ partnership ’ as used in these sections obviously refers only to ordinary partnerships ” was intended to confine the term to-such an extent as necessarily to exclude a mining partnership from its scope. To' accept the opposite conclusion would lead to a situation in which an organization would be without any of the specified taxable groups. We feel that such a strained and technical construction is warranted neither by the letter nor intent of the revenue law.

We have indicated above that petitioner was not an association and thus falls outside the group taxable as corporations. It is either a partnership or merely a group of individuals engaged in a mining enterprise. In either event, the persons composing the operating entity would be taxable as individuals. Petitioner has most, if not all, of the fundamental characteristics of a partnership. No logical reason has been advanced for denying it classification as such and very persuasive reasons are presented for so doing. It is our opinion that petitioner was a partnership within the meaning of the Revenue Act of 1918, and we so hold.

Judgment will ~be entered for petitioner on 15 days’ notice, under Rule 50.


author: Milliken:

text:
    Mammoth Life & Accident Insurance Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 6892, 10902.
    Promulgated April 15, 1927.
    An insurance company claiming deductions under the Revenue Act of 1918, in addition to “ reserves required by law,” must show the amounts so claimed are in fact required for the protection of policyholders.

      Attilla Gox, Esq., for the petitioner.

      John D, Foley, Esq., for the respondent.
    These proceedings have been consolidated by agreement. They involve deficiencies in income and profit taxes for the years • 1919 and 1920 in the amounts of $2,120.20 and $5,873.51,- respectively.
    findings of fact.
    The petitioner is a Kentucky corporation with its principal office in Louisville. It was organized in 1915. Its business is the issuing of policies, covering life, health, and accident insurance, combined in one policy, on the weekly premium payment plan. The number of policies it had outstanding on December 31, 1918, December 31, 1919, and December 31, 1920, the amount of risk, and the amount charged to what is shown on petitioner’s books as “ Surplus Unassigned Funds,” are as follows:

    The petitioner set up on its books no reserves as that term is known to the insurance world. The difference between the receipts and the operating expenses and losses was carried on its books under the heading “Surplus Unassigned Funds.” This net surplus for the year 1919, was $16,210.68, and for the year Í920, $30,061.21. The Commissioner allowed the petitioner as deductions in each year, an amount equal to 2 per cent of its receipts from admission fees and dues, that amount being required as a reserve by the act under which the petitioner was organized (section 662 of the Kentucky Statutes). This allowance is not in controversy. The petitioner hi aims the right to deduct the additional amounts of $16,210.68 for the year 1919, and $30,061.21 for the year 1920, both of which items appear on its books as “ Surplus Unassigned Funds.” It is asserted that these amounts are net additions to a reserve which is required for the protection of its policyholders.
   OPINION.

Milliken:

Section 234(a) (10) of the Revenue Act of 1918, allows as a deduction in the case of insurance companies, the net annual addition “ required by law ” to be made to reserve funds. Paragraph (11) of subdivision (a) of the same section permits the following additional deduction:

In the case of corporations issuing policies covering life, health, and accident insurance combined in one policy issued on the weekly premium payment plan continuing for life and not subject to cancellation, in addition to the above, such portion of the net addition (not required by law) made within the taxable year to reserve funds as the Commissioner finds to be required for the protection of the holders of such policies only.

The petitioner created no reserve funds as that term is known in an insurance account, but has thrown the funds claimed as a deductible reserve into what is in fact a profit and loss account. While it is exceedingly doubtful whether the fund claimed as a reserve, is a reserve, as that word is used in the taxing statute (United States v. Boston Insurance Co., 269 U. S. 197), it is not necessary, in this case, to decide that question.

Section 234(a) (11) permits the deduction of only such net additions to reserve funds as the Commissioner finds to be required for the protection of the holders of such policies only.” While the Board has jurisdiction to determine what net additions (not required by law) are required for the protection of policyholders, compare Appeal of Oesterlein Machine Co., 1 B. T. A. 159,. nevertheless the burden rests on the petitioner to show that the net additions claimed as deductions are required for the protection of its policyholders. The only evidence adduced on this question, is a reference to certain Kentucky statutes enacted after the organization of petitioner, and which do not affect it, and the testimony of one witness, its president. The later statutes require a- larger' reserve than is required of the petitioner bjr the law which controls it.

Whatever may be the provisions of other and later statutes of Kentucky, it appears that the Commissioner has allowed, as a deduction, all that is required as a reserve in the case of the petitioner by the laws of Kentucky. What additional reserves are required for the protection of policyholders is a purely actuarial question and little if any help is derived from the provisions of other statutes. It is a question to be resolved by the Commissioner in the first instance, and then by the Board on appeal on the facts presented. The only evidence before the Board on this question, is the testimony of the petitioner’s president. He testified as follows:

Q. Well, if I understand you, Mr. Hall, when you used the expression in your direct-examination “ set aside a reserve ” you didn’t mean that any change had been made on the books, nor that any entries segregating a special fund had been made: is that so?
A. Ves, sir,
Q. And that special fund is composed of the net earnings of your corporation from year to year?
A. Yes, sir.
Q. And you have no actuarial knowledge, statistical basis knowledge or data to advance as the basis of setting up a reserve?
A. Not any.
Q. And hence you have no information as to what reserve would be necessary?
A. Not from an actuarial stand.

Certain it is that we can not determine as a general proposition in this case, that the entire net earnings for each year in question, were required to be set aside as a reserve, in addition to the 2 per cent required by Kentucky law, as a protection for policyholders. We can not be presumed to be more competent as to the basis and amount of the reserve, than the petitioner itself, and it has given us no facts upon which the basis or amount of the reserve could be determined.

Judgment will be entered for the respondent.