author: Smith:

text:
    Appeal of H. NORTHWOOD & CO.
    Docket No. 5122.
    Decided August 3, 1926.
    1. A taxpayer keeping its books of account and making its income-tax returns for 1916 and subsequent years upon the accrual basis and deducting from gross Income for the years 1916 and 1917 royalties shown by its books of account to have accrued but not Vo have been paid, and compromising its liability for such royalties in 1921 for an amount less than the amount shown by its books of account, is not entitled to restate its net income for the years 1916 and 1917 by excluding from claimed deductions royalties accrued but not paid and to claim as a deduction from gross income of 1919 the amount of a verdict rendered against it by a jury in 1919 in respect of unpaid royalties for 1916 and 1917, upon which verdict a judgment was rendered by the court in 1920, which judgment was compromised in 1921 for less than its face.
    2. A corporate taxpayer receiving the proceeds in 1919 of a life insurance policy upon the life of its president who died during, the year did not receive taxable income from the receipt of such proceeds.
    3. A corporate taxpayer which never charged off from the boot value of its depreciable assets any amount for depreciation during the years prior to 1918, but which more than offset depreciation sustained by charges to expense of the cost of improvements, replacements, and repairs, should not have its surplus reduced in computing invested capital by an amount representing theoretical depreciation sustained.

      W. A. Seifert, Esq., for the petitioner.

      John W. Fisher, Esq., for the Commissioner.
    Before LittletoN, Shith, and Teussell.
    This is a proceeding for the redetermination of income and profits taxes for the years 1918 and 1919 in the aggregate amount of $40,-988.06. The taxpayer alleges error on the part of the Commissioner:
    (1) In disallowing a deduction from gross income for 1919 of $42,523, which was the amount of a jury verdict rendered against the taxpayer during the taxable year.
    (2) In including in gross income for 1919, $25,222.36, representing the proceeds of a life insurance policy paid on the life of one of the taxpayer’s .officers.
    (3) In deducting from invested capital for 1918 and 1919 the sum of $33,182.74, to cover alleged depreciation for years prior to 1918
    (4) In failing to include in invested capital for 1918 and 1919, $38,884.12, the amount of a reserve set up by the taxpayer on its books as royalties accrued under a contract.
    (5) In reducing invested capital for 1918 and 1919 by prorating income and profits taxes for the years 1917 and 1918 in the manner outlined in Affeal of Guarantee Construction Go., 2 B. T. A. 1145.
    BINDINGS OE FACT.
    1. The taxpayer is a West Virginia corporation with its principal office in Wheeling. It has continuously been engaged since the time of its incorporation in 1906 in the manufacture of glass novelties. It is also engaged in the making of lighting or illuminating glassware, such as glass bulbs.

      2. Under date of December 31, 1915, the taxpayer entered into a contract with the Macbeth-Evans Glass Co. by which it was granted a license to manufacture semi-translucent glass under Letters Patent Eeissue No. 13766, issued July 7, 1914, owned by the Macbet-Evans Glass Co. The term of the agreement was from the date thereof until January 1, 1918:
    * * * provided, however, that if prior to January 1, 1918, (a) a final decree in favor of the Macbeth-Evans Glass Company shall be entered in any of the suits now pending, in which the General Electric Company is defendant, or in -which The Union Stopper Company is defendant, or in which the Max Schaffer Company is defendant, and if on appeal therefrom, the same shall be affirmed; or, (b) the bill in any of said cases shall be dismissed and on appeal, the decree shall be reversed and the patent held valid; or, (c) if both the said General Electric Company, and the said Union Stopper Company, shall take a license under the said Macbeth Patent; then, and in any such event, the term of this agreement shall extend to the expiration of the said Macbeth Patent, Reissue No. 13,766; provided, however, that in case said Macbeth Patent Reissue No. 13,766 shall be held invalid by a court of final jurisdiction, or by any court from which no appeal is taken, this agreement shall thereupon become valid.
    The consideration for the license was the payment by the taxpayer of royalties each month to the licensor, such royalties being certain percentages of the aggregate amount of the selling prices of the goods manufactured under the patent. On January 27, 1916, a decree was entered in the suit pending between the Macbeth-Evans Glass Co. and the General Electric Co.- in favor of the General Electric Co., holding that the patent in question was void. Macbeth-Evans Glass Go. v. General Electric Go., 231 Fed. 183. The taxpayer paid certain royalties under its contract with the Macbeth-Evans Glass Co. Under date of February 24, 1916, it wrote to the Macbeth-Evans Glass Co. as follows:
    Regarding- our notes which you hold as well as the claim against us for accruing- royalties, in view of the recent decision of the United States District Court of the' Northern District of Ohio, Eastern Division, #303 Equity, in which suit you are the plaintiff and the General Electric Company is the defendant, we beg to advise you that our present attitude is that we are not indebted to you for royalties jnd that we must refuse to pay the notes because of there being no consideration for the same.
    In the event of your appealing the case mentioned and ultimately establishing the validity of the patent, our present attitude would of course be changed accordingly, but under present circumstances we are constrained to deny liability on the notes and under the contract dated December 31, 1915.
    In accordance with tbe notification contained in the above-quoted letter, the taxpayer made no further payments of royalties to the Macbeth-Evans Glass Co.
    The Macbeth-Evans Glass Co. took an appeal from the decision of the District Court in its suit against the General Electric Co. to the Circuit Court of Appeals, Sixth Circuit, and the decision of the lower court was affirmed by the higher court on November 6, 1917. Macbeth-Evans Glass Go. v. General Electric Go., 246 Fed. 695,
    The Macbeth-Evans Glass Co. did not acquiesce in the refusal of the taxpayer to pay royalties under the contract of December 31, 1915, and brought suit in assumpsit against it for breach of contract. On November 26,1919, the court directed the jury to return a verdict for the plaintiff in the amount of $42,523, and the verdict was returned accordingly. On May 25, 1920, the court entered judgment on the verdict. The taxpayer took an appeal to the Circuit Court of Appeals, but before any decision was rendered on the appeal the case was settled out of court, the taxpayer paying in 1921 to the Macbeth-Evans Glass Co. the sum of $25,000 in compromise of all claims of the latter company. The appeal was dismissed under date of May 20, 1921.
    The taxpayer kept its books of account on the accrual basis. Notwithstanding its refusal to pay royalties to the Macbeth-Evans Glass Co. in accordance with the terms of its contract with that company, it computed the royalties which it was obligated to pay daily and entered the amounts on its books at the end of each month as an accrued liability. The royalties were thus accrued until the date of the decision by the Circuit Court of Appeals in the case of Macbeth-Evans Glass Go. v. General Electric Go., supra. Deductions on account of these accrued, royalties were taken in the original income-tax returns filed by the taxpayer for the years 1916 and 1917. The reserve for the royalties accrued but not paid, as shown by the taxpayer’s income-tax return for 1917 at December 31, 1916, was $23,832.10 and at December 31, 1917, $38,884.12.
    In 1919 the taxpayer was advised by tax counsel, who were employed to go over its tax returns and to advise it with respect to making its income-tax return for 1919, that it should not have claimed deductions from gross income for the years 1916 and 1917 in respect of royalties accrued but not paid, but that it was entitled to deduct from gross income for the year 1919 the amount of the verdict of the jury against it for breach of contract, which verdict was rendered at the direction of the court on November 26, 1919, in the sum of $42,523. Acting upon this advice, the taxpayer filed amended income-tax returns for 1916, 1917, and 1918 (since the amount of its invested capital was changed for 1918) and paid additional taxes shown to be due for those years. It deducted from gross income for the year 1919 the amount of the jurjf verdict against it, namely, $42,523. The Commissioner disallowed the deduction of the last-named amount from the gross income shown on its income-tax return for 1919, which is the principal cause of the deficiency determined for that year.
    3. In 1913 or 1914 the taxpayer took out an insurance policy for the benefit of itself upon the life of its president, Harry Northwood. The taxpayer paid the premiums upon the policy. Harry North-wood died in 1919 and the taxpayer received the proceeds of the policy, namely, $25,222.36. In its income-tax return for 1919 it included this amount in its gross income. In its petition it allege^ error in so doing.
    4. Prior to 1918 the taxpayer never charged off from the book value of its assets any amount for depreciation of depreciable assets. It had been its policy to charge the cost of additions, renewals, replacements, and repairs to general expense. There were some few instances to the contrary. In one case an addition costing $6,500 ■ was capitalized. Large additions had been made to the plant, however, which had never been capitalized. The production of the plant in 1918 and 1919 was- practically three times the production at the date of organization in 1906. The plant was kept in good working condition from the time of its organization to the end of the taxable years herein involved. The earlier books of the company have all been destroyed. The taxpayer has no original vouchers back of the last three or four years. All of such vouchers and records were burned up in 1918, at a time when the sample room was extended and the value of the records was not realized by the person who caused them to be destroyed. In 1918 an examination of records was made for the purpose of determining the cost of additions, renewals, and' replacements, which had been charged to expense, and it was determined that the cost for the years 1914 to 1917, inclusive, was
    1914_ $17,668.36
    1915--- 11, 871. 00
    1916- 20,158. 00
    1917_ 18, 403. 00
    Total_ 68,100. 36
    The amount shown for 1914 included the cost of a new moulding shop.
    5.In his audit of the taxpayer’s returns for 1918 and 1919, the Commissioner reduced the taxpayer’s reported invested capital in the amount ’of $33,182.74, to cover alleged depreciation of plant for years prior to 1918, and did not increase the invested capital shown on the original return to the extent of $38,884.12, the amount of the reserve for royalties shown by the taxpayer’s books of account at December 31, 1917. . .
   OPINION.

Smith:

The taxpayer alleges errors by the Commissioner in the determination of deficiencies in income and profits tax for 1918 and 1919.

1. It is alleged that the Commissioner erred in disallowing the deduction from gross income of the year 1919 of $42',523, representing the amount which the District Court for the Northern District of West Virginia directed a jury to return against the taxpayer in a suit brought against it by the Macbeth-Evans Glass Co. The taxpayer contends that it erroneously deducted from gross income in its income-tax returns for 1916 and 1917 royalties accrued upon its books of account in and for those years, and that the amount of the verdict of the jury returned on November 26, 1919, was an accrued liability of 1919 and a proper deduction from gross income of that year. Under its theory of the case there was no accrual of royalties against it for the years 1916 and 1917, but there was an accrual of a liability against it in 1919 of $42,523, the amount of the verdict of a jury in a suit brought against it by the Macbeth-Evans Glass Co., which verdict matured in a judgment against it in 1920 for the amount of $42,523, and that when this judgment was settled by the payment by it to the Macbeth-Evans Glass Co. of $25,000 in 1921, it realized taxable income in 1921 of $17,523, being the difference between the judgment of the court and the compromise. The Commissioner’s position is that the royalties were properly accrued by the taxpayer in 1916 and 1917 and that deductions therefor were properly taken by the taxpayer in its income-tax returns for those years; that adjustment on account of the settlement should be made in 1921, when the liability was compromised for less than the reserve set up to meet the liability; that in no event was there an accrual of a liability constituting a legal deduction from gross income in 1919.

The taxpayer kept its books of account upon the accrual basis. In 1916 and 1917 it accrued the amount of the royalties which it was obligated to pay to the Macbeth-Evans Glass Co. in accordance with the terms of its contract with that company dated December 31, 1925. If it had paid the royalties to the licensor monthly as it had agreed to make payment there could be no question but that the amounts paid were legal deductions from gross income, Under its contract with the licensor, the taxpayer had no means of recovering back from the licensor the royalties which it had paid upon glass manufactured under the Letters Patent Reissue No. 13,766. The contract with the Macbeth-Evans Glass Co. became void on November 6, 1917, the date when the Circuit Court of Appeals for the Sixth Circuit affirmed the decision of the lower court in Macbeth-Evans Glass Co. v. General Electric Co., 246 Fed. 695; the royalties which the taxpayer accrued upon its books of account in 1916 and 1917 were legal deductions from the gross income of those years and of no other years. It is true that the facts in the instant case are materially different from those before the Supreme Court in United States v. Anderson, 269 U. S. 422. In that litigation it was not denied by the taxpayer that its method of keeping its accounts and setting up a reserve for munitions taxes reflected its true income for 1916, the year for which the reserve was set up, or that its amended return on that basis actually reflected its income and profits for that year. In the instant case the taxpayer contends that the reserve set up for royalties for the years 1916 and 1917 were not true accrued expenses of those years. This, however, is based upon hindsight and not upon foresight. The District Court for the Northern District of West Virginia, in the suit brought against the taxpayer by the Macbeth-Evans Glass Co., directed the jury to find for the plaintiff under the terms of the contract which the taxpayer had with the plaintiff, and which was dated December 15. So far as the litigation shows, the royalties were properly accrued upon the taxpayer’s books of account. The mere fact that the liability for the royalties and the liability under the judgment of the court was settled in 1921 for less than the amount of the royalties accrued affords no basis for the contention that the royalties did not accrue during the years 1916 and 1917. The fact that the jury returned a verdict against the taxpayer in 1919 for breach of its contract' did not constitute the amount of the verdict an accrued liability of that year. The taxpayer did not acquiesce in the verdict and indeed it did not become the decision of the court until 1921. The taxpayer appealed from such decision of the court and the litigation was finally settled in 1921 for an amount less than the basic judgment. In our opinion there was no accrual of a liability of any part of the amount of the verdict during the year 1919.

2. The taxpayer alleges that it erred in including in its gross income for the year 1919, $25,222.36, which represented the proceeds of a life insurance policy on the life of Harry Northwóod, its president, who died in 1919. This point must be decided in favor of the taxpayer upon the basis of United States v. Supplee-Biddle Hardware Co., 265 U. S. 189.

3. Although the taxpayer was organized in 1906, it never charged off any amount for depreciation of depreciable assets prior to 1918. By reason of this fact the Commissioner, in computing the taxpayer’s invested capital for 1918 and 1919, reduced the invested capital shown upon the return in the amount of $33,182.74 to cover alleged depreciation of plant for years prior to 1918. The taxpayer alleges error in this regard. The original records of the taxpayer for the years prior to 1918 have through accident, as indicated in the findings of fact, been destroyed. It appears, however, that it had been the practice of the taxpayer to charge most of the cost of improvements, renewals, replacements, and repairs to expense prior to 1918; that the taxpayer’s plant had been well maintained and extended, and it also appears that, for the four years prior to 1918, improvements costing $68,100.36 had been charged to expense. The cost of such improvements was in no wise reflected by the taxpayer’s capital account on its books. It is true that certain additions to the plant in the past had been capitalized, but it is equally true that the charging to capital of the cost of improvements was the exception rather than the rule. We conclude from the evidence before us that actual depreciation sustained during the years prior to 1918 had been more than offset by the cost of improvements, renewals, and replacements charged to expense. We are, therefore, of the opinion that the true earned surplus of the taxpayer at December 31, 1917, was not less than that shown by the taxpayer’s books of account so far as relates to depreciation of depreciable assets, and that the reduction of invested capital made by the Commissioner in the amount of $33,182.74 to care for depreciation not shown to have been charged off on the taxpayer’s books of account was in error.

4. With respect to the invested capital, the taxpayer also alleges that the Commissioner should include in invested capital for 1918 and 1919 $38,884.12 reserve for royalties shown upon its books of account at December 31, 1917, — this on the ground that the reserve was not a true liability and was simply a part of the taxpayer’s surplus. We have indicated above, however, that in our opinion the royalties were properly accrued for the years 1916 and 1917. We think, therefore, that the taxpayer is not entitled to the inclusion in its invested capital for 1918 and 1919 of the $38,884.12 in question.

5. The taxpayer alleges error on the part of the Commissioner in the computation of its invested capital for 1918 and 1919 by reason of the fact that he reduced the surplus at the beginning of each year by prorating the 1917 and 1918 income and profits tax amounting to $11,024.27 and $23,391.12, the prorated amounts being $6,040.70 and $9,885.08, respectively. This claim is based upon the decision of the Board in Appeal of Guarantee Construction Co., 2 B. T. A. 1145. This question has, however, been settled adversely to the taxpayer by section 1207 of the Revenue Act of 1926. Appeal of Russel Wheel & Foundry Co., 3 B. T. A. 1168.

Order of redetermination wül be entered on 15 days’ notice, under Rule 50.


source: Caselaw Access Project

author: MoRRis:

license: Public Domain

text:
    Appeal of HUTCHINS LUMBER & STORAGE CO.
    Docket No. 3307.
    Decided August 3, 1926.
    1. Amount of paid-in surplus to which the petitioner is entitled, determined.
    2. Two hundred and fifty shares of its stock were donated to the petitioner and thereafter sold for $30,000. Held, that said amount may be included in invested capital.
    3. Petitioner purchased $25,000 par value of its own stock for $60,000 cash, $45,000 of which was borrowed. Held, that invested capital should be reduced to the extent that the total amount paid exceeds the current earnings available at the date of purchase.
    4. Reduction by Commissioner of petitioner’s invested capital for income and profits taxes for prior years approved.
    5. Certain lumber on hand at the close of the taxable years in question was unsalable due to its damaged condition. Held, that the petitioner may reduce its closing inventories for those years by the amount of the cost of said lumber.

      John E. Hughes, Esq., for tlie petitioner.

      Ellis W. Manning, Esq., for the Commissioner.
    Before Maequette and Moeeis.
    This is an appeal from the determination of a deficiency in income and profits taxes for the calendar years 1919 and 1921 in the amount of $9,039.12. The deficiency results from the disallowance of bad debts, inventory adjustments and reduction of invested capital.
    FINDINGS OF FACT.
    For a considerable time prior to 1915, Ralph G. Hutchins, Eugene R. Hutchins and Carleton B. Hutchins had carried on a lumber and storage business at Blue Island, Ill., under the name of Hutchins Lumber & Storage Co. On April 22, 1915, said business acquired, at a cost of $8,076, a tract of land of approximately 8% acres, located at Blue Island, a suburb of Chicago, along tlie Dixie Highway and the main line of the Indiana Harbor Belt Railroad. When acquired, the improvements on the property consisted of a small cottage and a barn. The company immediately graded the land, filled it in with three to four feet of cinders, put a drainage ditch around the tract, and prior to September 29, 1915, further improved it with a railroad grade switch track, 1,400 feet across the property to the northwest corner thereof, with two leads with 85 pound rails off the main line of the Indiana Harbor Belt Railroad; a tight board fence about' eight feet in height, with wiring on the top, around the entire plot of land; one lumber storage building 70 by 118 feet, a mill building plant 30 by 40 feet, one office building 20 by 36 feet, all of the said building being wired for motors and light; a sawdust vault and cyclone 20 by 20 feet and 30 feet in height; and lumber foundations approximately 2,000 by 20 feet. September 29, 1915, this tract with the improvements thereon, together with the “ business, goods, Avares and merchandise, accounts receivable, and good will,” was conveyed to the taxpayer corporation, which was incorporated September 13, 1915, under the laws of Illinois with a capital stock of $50,000, divided into 500 shares of the par value of $100, in exchange for its capital stock, Ralph G. Hutchins receiving 350 shares.
    The resolution of the board of directors of the corporation accepting the property above set out in payment of the capital stock of the corporation was as follows:
    Resolved, that all of the goods, wares, merchandise accounts receivable, cash on hand, good will and real estate of the business now owned by the subscribers to the capital stock of this company may be conveyed and assigned by them to this company in full payment of their subscriptions to the capital stock of said company, all of said property having been acquired by them with the view to transferring and conveying the same to this company as soon as it was authorized to take title thereto, and that the proper officers of this company be, and they are hereby authorized and empowered to issue 500 shares of the capital stock of this company to the subscribers for the aforesaid property so conveyed and sold by them, the indebtedness of said subscribers being hereby assumed by .this company.
    The assets transferred to the corporation consisted of $9,065 in cash; miscellaneous personal property, consisting of saws and sawmill machinery, having at that time an actual cash value of $1,259.24; 648,000 feet of vertical grain running board stock car slats; 303,648 feet of sills, and 200,000 feet of other lumber, the total cash value of all said lumber being $46,491.68; and the land and improvements above described, which, at the time paid in, had an actual cash value of $36,346. Against the above items so paid in, the corporation took over a liability of $13,500.
    The stock book of the corporation shows that the 500 shares of capital stock were all issued on September 29, 1915. On November 17 and December 8, 1915, Ralph G. Hutchins donated to the corporation 50 and 200 shares, respectively, of its capital stock. December 22, 1915, the said 250 shares were sold to the Booth-Kelley Lumber Co. for a consideration of $30,000, of which $10,000 was paid in cash and $20,000 in lumber at the then market price. The cash was received by the corporation in 1915 and the lumber was delivered in lots, the last of which was received by the corporation in 1916. February 5, 1919, the petitioner agreed to repurchase from the Booth-Kelley Lumber Co. the said 250 shares for $60,000. Of the above amount, $15,000 was paid from funds in the petitioner’s treasury, and the remainder, $45,000, out of funds borrowed from the Central Trust Co. of Illinois, which amounts were repaid during 1919 and 1920.
    The petitioner’s net income for 1919 was found by the Commissioner to be $51,485.51,- and its net income for 1920, was found to be $77,079.42. The Commissioner deducted $42,227.10 from petitioner’s invested capital for 1919, because of the purchase of its own stock as above stated. The Commissioner used the following formula in ascertaining the current earnings available for the purchase of such stock.
    In re: Hutchins Lumber Storage Co., year ended December 31, 1919—
    INVESTED CAPITA!.
    Invested capital disclosed by books_$129,647.16
    As corrected_ 76,117. S3
    Net reductions as explained below_ 44, 529.33
    Additions:
    (a) Excessive depreciation to Dec. 31, 1918_$9,770.38
    (See Recapitulation of depreciation.)
    Total additions_ 9,770.38
    Reductions:
    (b) $25,000 par value stock purchased for -
    $60,312.36, Mar. 15, 1919__ 42, 733. 86
    (c) Dividend Dec. 27, 1919, paid from earnings__
    (d) Income tax, 1918_ 9,962.33
    (e) Additional income tax, 1917_,_ 1,603. 52
    Total reductions_• 54,299. 71
    Net reductions as above_ 44, 529. 33
    EXPLANATION OP ITEMS CHANGED.
    (b) $25,000 par value capital stock purchased Mar. 15, 1919, for__ $60,312.36
    Taxable net earnings for year- 55, 805.97
    Tentative tax- 21, 330. 75
    Net income.available for dividends_ 34,475.22
    Net earnings per day — 1/365=$94.4522.
    Mar. 15, 1919, $25,000 par value stock purchased for_^_ 60, 312.36
    Earnings available — 73 days_ 6, 895.04
    Amount to be deducted from Dec. 31, 1918, surplus_ 53, 417.32
    $53, 417.32 — 292 days__ 42,733. 86
    The Commissioner reduced petitioner’s invested capital for the year 1919 by the sum of $9,962.33, representing 1918 income and profits taxes of $23,573.76 prorated from the dates the four instal-ments thereof became due and payable, and. by the further sum of $1,603.52, representing additional income and excess-profits taxes for the year 1917, which were paid by the petitioner on January 8, 1920. The Commissioner also reduced petitioner’s invested capital for the year 1921 by the sum of $12,775.21, representing 1920 income and profits taxes prorated from the dates the four instalments thereof became due and payable, by the further sum of $1,603.52, additional income and profits taxes for 1917, paid on January 8, 1920, and by the further sums of $10,543.41 and $2,120.52, additional income and profits taxes for the years 1918 and 1919, respectively.
    In computing its net income for the year 1917, petitioner used an inventory as of the close of that year which was $5,126.94 less than the value of the inventory shown in its books of account. The Commissioner recomputed the net income for the year 1917 on the basis of the higher book value, showing an increase in the net income for that year, over that shown by the petitioner in its return, of $5,126.94. In computing its net income for the year 1918, the petitioner used an opening inventory in the same amount as that shown as the closing inventory in its return for the preceding year. The Commissioner recomputed the net income for 1918 on the basis of the higher book inventory, showing a decrease in the net income for that year, under that shown by the petitioner in its return, of $5,126.94. In computing the petitioner’s invested capital for the year 1919, the Commissioner reduced the earned surplus as of the beginning of the year by the amount of the decrease in the 1918 net income resulting from his adjustment of the opening inventory, but gave no recognition to the increase in the 1917 income resulting from his adjustment of the closing inventory of that year. ■
    In December, 1919, officers of the petitioner made a survey and examination of the lumber in its yard and ascertained that a certain amount was unsalable because it was cracked, imperfect, warped, dry rotted, and otherwise damaged. It charged off for the year 1919 the cost of that lumber, which was $15,315.86. In December, 1921, the officers likewise made an examination of the lumber in the yard and charged off the cost of lumber which was unsalable because of its imperfect and damaged state. The cost of the lumber so charged off for the year 1921 was $11,226.53.
    For the year 1921 the Commissioner disallowed a deduction of $6,916.42 for alleged bad debts. Included in this deduction was the sum of $4,854.70 charged off on petitioner’s books as a bad debt from an account with the United States Lumber & Box Co., located at Portland, Oreg. This $4,854.70 was an amount paid by petitioner for freight on lumber shipped by the United States Lumber & Box Co. and stored in the petitioner’s yard. Claim was made against the United States Lumber & Box Co. for the amount of the freight so paid, and the claim was finally paid during the year 1924. The balance of the so-called bad debt, amounting to $2,061.7-2, was charged off in 1921 and has never been collected and can not be collected by it.
   OPINION.

MoRRis:

The questions presented for determination in this appeal are: (1) The amount of paid-in surplus to which the petitioner is entitled; (2) whether the sale price of $30,000 for 250 shares of stock donated to the corporation by one of the stockholders and thereafter sold should be included in invested capital; (3) whether invested capital should be reduced for 1919 by $42,227.10 upon the purchase of its own stock with borrowed money; (4) whether there should be a reduction in invested capital for the years 1919 and 1921 of additional taxes for prior years; (5) whether the Commissioner erred in reducing petitioner’s invested capital for 1919, by the amount of $5,126.94, on account of an adjustment in the opening inventory for 1918; (6) whether petitioner was entitled to deduct the cost of unsalable lumber in its inventory in 1919 and 192.1; (7) whether the Commissioner erred in disallowing in 1921 the sum of $6,916.42, deducted as bad debts; and (8) whether petitioner is entitled to special relief under section 327 (c) of the Revenue Act of 1918.

On the first point it is clear from the evidence submitted that the invested capital, including paid-in surplus, is greater than the amount allowed by the Commissioner. Under the circumstances, we do not consider the sale to the Booth-Kelley Lumber Co. of one-half the capital stock for $30,000 as determinative of the value of the assets. That Compaq was a considerably larger concern whose business extended over a wide area. Its assistance and influence and removal as a competitor were thought to be extremely valuable in the further development of the petitioner’s business. Testimony concerning what was paid in to the corporation is not conflicting. There can be no doubt about the $9,065 cash, and the Commissioner has stipulated of record that the miscellaneous personal property other than the lumber at the time paid in had an actual cash value of $1,259.24. The only other items, the value of which the Board is called upon to determine, are the land with its improvements and the lumber. The expert testimony in regard to the value of the land and buildings is that the actual cash value of the real estate at the time paid in to the corporation was $36,346. The price paid for the land in April, 1915, is immaterial. Between April and September, 1915, the character of the property had been completely changed, having been converted from practically vacant land into an industrial plant. There is no evidence in the record of any sales of a similar character in the vicinity where this land was located, but we are satisfied with the expert testimony as to its actual cash value. As to the value of the lumber paid in. to the corporation, the testimony shows the market price of this grade of lumber at the time paid in, and there is no dispute as to the amount thereof. We conclude, therefore, that the actual cash value of the lumber was $46,491.68. This amount plus the actual cash value of the other assets and minus the liability of $13,500, which the corporation assumed, gives the petitioner a paid-in surplus of $29,661.92, as claimed by it.

The second point is whether or not the petitioner may include in its invested capital $30,000 received upon the sale of 250 shares of its stock donated to it by one of its stockholders and thereafter sold. The evidence shows that of the $50,000 capital stock issued in September, 1915, 250 shares thereof were, in November and December, 1915, donated to the corporation by Ralph G. Hutchins and sold to the Booth-Kelley Lumber Co. for a consideration of $30,000, of which $10,000 was paid in cash and $20,000 in lumber at the then market price. This $30,000 was paid in to the corporation for its capital stock and the Commissioner’s action in refusing to recognize it as invested capital is in error. It clearly comes within the definition of invested capital contained in section 326 of the Revenue Act of 1918.

The third question is whether the Commissioner erred in reducing petitioner’s invested capital for 1919 by the amount of $42,227.10, or any other amount, on account of the purchase by it of $25,000 par value of its own stock for $60,000 cash. The amount of the reduction which the Commissioner has made was arrived at by the use of the formula set out in the findings of fact. The petitioner contends that this stock was purchased entirely out of current earnings and borrowed funds which were repaid out of current earnings and, since no money hitherto included in invested capital was taken therefrom by this purchase, there should be no reduction in invested capital. To merely state the petitioner’s contentions is to disclose their fallacy. It lies in the fact that the petitioner is attempting to fix the character of the transaction according to the source from which the funds were derived. It is an attempt to earmark dollars. We think it immaterial whether the funds which were used in the purchase of this stock were borrowed or taken from funds already in the petitioner’s treasury. The important facts upon which we must adjudge the character of this’ transaction are — that the Booth-Kelley Lumber Co. had acquired this stock from the petitioner for the sum of $30,000, which became a part of the petitioner’s paid-in capital; that upon the repurchase of this stock the petitioner returned to the Booth-Kelley Lumber Co, the latter’s, contribution of $30,000 capital and its share in the petitioner’s accumulated surplus. It was a capital transaction involving a return to this particular stockholder of its capital contribution plus its share in the accumulated surplus, and the paid-in capital and surplus, of which these funds were a part, were lessened by the withdrawal of the same. The purchase by a corporation of its own capital stock eliminates the stockholder without substituting another in his place,.repays to the withdrawing member his share of the capital, and reduces the amount of the fund contributed to the common venture. See Appeal of Simmons & Hammond Mfg. Co., 1 B. T. A. 803.

In arriving at the amount of the reduction of invested capital the Commissioner has again invoked a theory previously considered and condemned by this Board, that of reducing the net income by a so-called tentative tax for the purpose of determining the earnings available for distribution or retirement of capital stock. Upon authority, of our decision in the Appeal of L. S. Ayers & Co., 1 B. T. A. 1135, we must hold that the Commissioner’s action in this respect is in error. Subject to this modification of the formula used by the Commissioner, we approve the Commissioner’s action in reducing petitioner’s invested capital on account of this transaction, to the extent that the total amount paid, to wit, $60,000, exceeds the current earnings available at the date of purchase.

The fourth point is whether the Commissioner erred in reducing the invested capital for each of the years under consideration on account of income and profits taxes as set out in the findings of fact. The several adjustments made by the Commissioner are in conformity Avith the provisions of the regulations in force in respect of the years under consideration, and are therefore approved. Section 1207 of the Revenue Act of 1926.

The fifth point relates to the reduction of petitioner’s earned surplus, for invested capital purposes, at the beginning of the taxable year 1919, by the amount of $5,126.94, on account of an adjustment, in a similar amount, of petitioner’s opening inventory for 1918, Avhich adjustment resulted, in a reduction of petitioner’s net income for the year 1918. The Commissioner increased the petitioner’s closing inventory for 1917 by the amount of $5,126.94, which resulted in an increase in the petitioner’s net income for that year, over that shown by the books of account, of a similar amount. To be consistent with his action in respect of the year 1917, the Commissioner increased the opening inventory for the year 1918 by the amount of $5,126.94, which resulted in a decrease in the petitioner’s net income for that year, under that shown by the books of account, of a similar amount. The increase in the 1917 net income was offset by the decrease in like amount of the 1918 net income, and petitioner’s earned surplus is not affected by these adjustments.

The sixth point is whether or not the petitioner is entitled to deduct the cost of certain lumber from its closing inventory for 1919 and 1921. The Commissioner in his answer admits that any goods in an inventory which are unsalable at normal prices or unsalable in the normal way because of damage, imperfections, etc., should be valued at bona fide selling prices, less cost of selling. The only evidence in the record in regard to this deduction was the evidence submitted by the petitioner to the effect that, during the years in question, when lumber was loaded out of its yard during the process of unstacking a pile, rotten and damaged pieces would be discovered which the customer would not accept and which were unsalable because of their condition, and that in such cases the cost of the lumber was charged off. From the evidence submitted we are of the opinion that the petitioner was entitled to deduct from inventory in 1919 the amount of $15,315.86 and in 1921, $11,226.43, the cost of this unsalable lumber.

The seventh point is whether the Commissioner erred in disallowing deductions in 1921 amounting to $6,916.42 as bad debts. Of this amount, $4,854.70 represented a freight bill paid by the petitioner on a shipment of lumber, which was stored in its yard, for the United States Lumber & Box Co., of Portland, Oreg. The evidence was not convincing as to the worthlessness of this debt. On the contrary it appears that the petitioner had some security for its final payment, which was made in 1924. We are therefore of the opinion that it is not an allowable deduction for 1921. The balance of $2,061.72 is properly deductible as bad debts in 1921, as it was charged off and the evidence is clear that it could not have been collected.

The eighth proposition submitted is whether the petitioner is entitled to special assessment under the provisions of section 327 (c) of the Bevenue Act of 1918, by virtue of having acquired a mixed aggregate of tangible and intangible property and the Commissioner’s alleged inability to satisfactorily determine the value of the intangible property. Both the bill of sale and the resolution accepting the property paid in to the petitioner, at the time of its organization, mention the good will as one of the items paid in. The Commissioner did not include any good will value in petitioner’s invested capital. The evidence is not sxifficient to convince us that the good will, if any, had a value at the date of its acquisition, which, if properly determined, could be included in invested capital. The petitioner has not proven that it is entitled to assessment under the relief provisions of the Act.

Order of redeiermination will be entered on 15 days’ notice, under Rule 50.