author: Milliken:

text:
    M. D. Rowe, Petitioner, v. Commissioner of Internal Revenue, Respondent. Mrs. M. D. Rowe, Petitioner, v. Commissioner of Internal Revenue, Respondent. W. C. Cole, Petitioner, v. Commissioner of Internal Revenue, Respondent. Mrs. W. C. Cole, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 9063, 9064, 9133, 9134.
    Promulgated August 1, 1927.
    Upon the evidence, held, that the petitioner kept its books and reported its income on the cash receipts and disbursements basis, and minor deviations therefrom do not thereby cause books to be placed on the accrual basis to reflect true income.

      Harry G. Weeks, Esq., for the petitioners.

      Thomas M. Wilkins, Esq., for the respondent

      These proceedings result from determinations by respondent of deficiencies in income tax for the calendar year 1920, as follows: M. D. Eowe/$5,215.67; Mrs. M. D. Eowe, $5,215.67; W. C. Cole, $1,068.38; Mrs. W. C. Cole, $1,068.38. Upon motion made and granted; all proceedings were consolidated for hearing and decision.
    Petitioners aver errors were committed with reference to the following issues: (1) The net income of the partnership of Eowe Drilling Co. was erroneously determined by the respondent on the accrual basis for 1920, in lieu of the cash basis on which the books were kept, with a resulting overstatement of income; (2) the net income of the partnership of Norton & Cline was incorrectly determined with resulting overstatement of the taxable income to M. D. Eowe and to Mrs. M. D. Eowe, from that source. It was stipulated by the parties that the second issue should be controlled by our decision to be rendered in the Appeal of W. D. Cline, Docket 6930, heard on January 27, 1927, and wherein the question at issue was the determination of the net income of the partnership of Norton & Cline.
    In his answer to the appeals of M. D. Eowe and W. C. Cole, the respondent averred error had been committed by him since one-half of the net income had been allocated to the respective waves on the community property basis. The issue was abandoned at date of hearing.
    FINDINGS OF FACT.
    The petitioners are individuals residing at Wichita Falls, Tex. W. C. Cole and Mrs. W. C. Cole are husband and wife, as are M. D. Eowe and Mrs. M. D. EoAve.
    During the year 1918, a partnership, known as the Eowe Drilling Co., was organized by M. D. Eowe, W. C. Cole, Oscar Fisher and F. G. Webb. In the fall of 1918, Fisher and Webb retired and the partnership was continued under the same name by Eowe and Cole; during the year 1920, each owned a one-half interest therein. The Eowe Drilling Co. was engaged in the business- of drilling oil wells by contract. The contracts were either on the so-called “straight” basis of furnishing the necessary labor and drilling equipment at a fixed price per foot of depth, or on what -was termed a “turn-key job,” wherein the driller undertook to furnish all materials, supplies, equipment, and labor, necessary to complete a well of a specified depth, for a lump sum. On either basis, payment was not due until completion of the contract and if the driller ivas unable to complete the well, the loss fell on him. Ordinarily, drilling operations are characterized by claims for extra compensation and disputes frequently arise over such charges so that it is the exception where the driller receives payment for the full amount of the bill as rendered

      lThis partnership has always kept its books on the basis of cash receipts and disbursements and no attempt to change the basis was ever contemplated. Its Federal income-tax returns for 1918, 1919, and 1920, were made on a cash basis and the Commissioner has never been requested to grant permission to change this basis. The books and the returns were under the supervision of a public accountant.
    A contract, known as the “ Larrimore ” well, was completed before the end of the calendar year 1918, and a payment amounting to $12,000 due thereon was reported as income in 1919, when the cash was received.
    At the end of 1919, there was owing to the Rowe Drilling Co. a bill amounting to $12,366 covering drilling for Chennault Rowe & Co. during 1919, and which account receivable was entered on the books and reported on the tax return as income for 1919, under the doctrine of constructive receipt due to the financial responsibility of the debtors and the ownership of an interest in the debtor partnership by M. D. Rowe, one of the partners in Rowe Drilling Co. The cash for this bill was received on January 9,1920.
    The books of the Rowe Drilling Co. showed accounts receivable amounting as follow: on December 31, 1918, $4,303; December 31, 1919, $16,367.68; December 31, 1920, $4,161.05; and liabilities as follow: December 31, 1918, overdraft at bank, $3,648.93; accounts payable, $470.03, notes payable, $14,000; December 31, 1919, nil; December 31, 1920, notes payable, $5,000. The accounts receivable on the books December 31, 1918, included $600 cash advanced F. G. Webb (a former partner) and an item of $3, due from the Gulf Production Co., of which there is no detailed information. The accounts payable on the books December 31, 1918, comprised credits to the accounts of W. C. Cole and a Mr. Wood, for cash advanced out of their personal funds used to pay partnership bills, totaling $470.03. The. accounts receivable on the books December 31, 1919, included the following: Chennault Rowe & Co., for drilling completed in 1919, $12,366; T. J. Lee and others, cash advanced for small supply bills, $41.25; J. I. Sibley, for day work and expenses, $700 (a disputed item for extra work); T. J. Lee and others, charged in error, $3,260.47; Rowe and Kendrick, cash advanced for miscellaneous items, $40. The accounts receivable on the books December 31, 1920, included the following: T. J. Lee and others, balance forwarded for supply bills, $41.25; T. J. Lee and others, $3,329.80 (being previous balance plus supplies bought for them); M. D. Rowe, $190 for a rig purchased from him; J. I. Sibley, old disputed balance, $700.
    In 1920, M. D. Rowe held a one-fifth interest in a partnership known as the Cline Oil Co., and it was for this partnership that the Rowe Drilling Co. drilled six wells in 1920, including three or four wells drilled near the close of the year. Five wells were drilled'for other parties. The account of the Cline Oil Co. on the books of the Rowe Drilling Co. showed for 1920, total charges of $81,531.15 and credits for payments totaling $60,536.85. The charges included sales of equipment and in entering them on the books, credits were carried to asset accounts as follow: boilers, $2,360, credited to tool and equipment account; automobile, $1,795, credited to automobile investment account; shack, $425, credited material and supplies account. None of the cash payments credited to the Cline Oil Co. can be identified as being specifically for the boilers, automobile and shack. As of the end of the year 1920, the balance unpaid by Cline Oil Co., amounting to $20,994.30, was debited to drilling account and credited to Cline Oil Co. account, with the following explanation on the journal:
    We make the above entry for the reason Oline Oil Company still owes this amount and we make our income tax return on cash receipts and disbursements basis. See reversed entry on page twenty-seven (27).
    After closing the books for 1920, an entry was made on the books for 1921, charging the Cline Oil Co. with the amount of the unpaid balance, $20,994.30. This account, together with additional charges in 1921 for Parker Well #2, $6,012, completed in 1920, and Parker Well #3, $9,921, completed in 1921, was closed out during 1921 by the payment of various sums in cash and a promissory note for $10,000.
    It was the custom of the Rowe Drilling Co. to pay their bills promptly each month. Expenses incurred in 1919 were paid in January, 1920, amounting to $7,940.46, and were deducted from income in 1920.
    Operations for 1921 were greatly curtailed and but one well was drilled in that year. The gross income according to the books, for 1921, from drilling, amounted to $36,127.30, which amount included the balance of $20,994.30 unpaid at the end of 1920 by the Cline Oil Co., and the charge of $6,012 entered January 2, 1921, for Parker Well #2, completed in 1920. The expenses charged on the books in 1921 amounted to $11,724.34.
    Respondent added to net income for 1920 the unpaid balance of Cline Oil Co., $20,994.30, and the charge entered in 1921 for Parker Well #2, $6,012, or a total of $27,006.30, as representing income which should have been accrued on the books on December 31, 1920.
    Inventories were not necessary and were not used in the computation of net income.
   OPINION.

Milliken:

The only issue involved in this proceeding relates to the net income for the calendar year 1920, of a partnership known as the Rowe Drilling Co. The respondent, in adjusting the partnership return to the accrual basis, contends that the books were actually maintained on that basis, and, furthermore, such basis is necessary to clearly reflect income. If this action of the respondent was not in error, the mathematical accuracy of his adjustments is not disputed.

The Revenue Act of 1918, insofar as material to the issue, provides:

Sec. 212. (a) That in the ease of an individual the term “ net income ” means the gross income as defined in section 213, less the deductions allowed by section 214.
(b) The net income shall be computed upon the basis of the taxpayer’s annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made upon such basis and in such manner as in the opinion of the Commissioner does clearly reflect the income. If the taxpayer’s annual accounting period is other than a fiscal year as defined in section 200 or if the taxpayer has no annual accounting period or does not keep books, the net income shall be computed on the basis of the calendar year.
* * * $ * * *
Seo. 213. That for the purposes of this title (except as otherwise provided in seetion 233) the term “gross income”—
* * * The amount of all such items shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under methods of accounting permitted under subdivision (b) of section 212, any such amounts are to be properly accounted for as of a different period; * * *
Seo. 218. (a) That individuals carrying on business in partnership shall be liable for income tax only in their individual capacity. There shall be included in computing the net income of each partner his distributive share, whether distributed or not, of the net income of the partnership for the taxable year, or, if his net income for such taxable year is computed upon the basis of a period different from that upon the basis of which the net income of the partnership is computed, then his distributive share of the net income of the partnership for any accounting period of the partnership ending within the fiscal or calendar year upon the basis of which the partner’s net income is computed.
The partner shall, for the purpose of the normal tax, be allowed as credits, in addition to the credits allowed to him under section 216, his proportionate share of such amounts specified in subdivisions (a) and (b) of section 216 as are received by the partnership.
* * * * * * 9ft
(d) The net income of the partnership shall be computed in the same manner and on the same basis as provided in section 212 except that the deduction provided in paragraph (11) of subdivision (a) of section 214 shall not be allowed.

The statute provides for the computation of the net income in accordance with the method of accounting regularly employed in keeping the books, upon condition, however, that the income be clearly reflected. Our problem in this proceeding is to determine the method of accounting regularly employed in keeping the books of the partnership and if the method so employed clearly reflects income.

It is not possible to adhere to absolutely definite rules in the case of all types of businesses and incomes and say that minor departure from either of the two most generally recognized and used methods of accounting may cause the scales to turn for or against the method insisted uj)on. A consideration of the question must not be characterized by a strict regard for insignificant errors or adherence to prescribed theories or methods, lest we lose sight of the controlling intendment of the statute that a method of accounting should be followed if it reflects true income.

The Rowe Drilling Co. conducted operations under contracts providing for payment upon completion of the drilling undertaken and subject to a possible total loss if the well failed of completion. There is little doubt of the financially hazardous nature of the operations due to the physical difficulties and uncertainties. The drilling of an oil well is ordinarily accomplished within a comparatively short time and the record presents no problem of accounting for long-term contracts. The business lends itself readily to a use of either the cash receipts and disbursements or an accrual method of keeping the books of account. If we find that the method of accounting regularly employed does, in fact, clearly reflect income, it is not only true that the petitioners are entitled to the use of the basis afforded by the books, but under section 212(b) of the Revenue Act of 1918, it is mandatory. Appeal of Owen-Ames-Kimball Co., 5 B. T. A. 921.

The influences so potent in leading the respondent to disregard the books and adopt an accrual basis, have little appeal to us. We are unable to hold that the deferment from one year when earned to another when paid, of an insignificant amount of income, or the determination that income was constructively received in the instance of overlapping partnership interests and ability of the debtor partnership to pay, should operate, in the absence of other considerations, as a bar to the use of a basis of cash receipts and disbursements, for such an opinion would result in the practical annulment of one of the statutory bases now allowed to the great majority of taxpayers and greater clarity or accuracy would not necessarily result. We find in the deferment until actually paid of an item of income in a previous year and, in another instance, an accrual under the doctrine of constructive receipt, actions which evidence very real efforts to adhere to a cash basis. The respondent attaches great weight to the presence on the books, of a few accounts, amounting in the aggregate to relatively minor totals, as of the end of each year, which are classified on the balance sheets as “ accounts receivable ” and relies upon the mere existence of these accounts to show that the method of accounting of the partnership, was on the accrual basis. He points out that these asset accounts were determinative of net worth and apparently is thus influenced to believe that they entered through the door of income, and being unpaid, the income must have been an accrual. We think the fact has been overlooked that an account receivable may come into existence and be recorded on books of account, including those kept on a cash basis, without the slightest- effect on income. The petitioners have endeavored to show the nature of every such account and have satisfied us that some of them covered transactions classifiable as loans or accommodation purchases chargeable at cost, and it is obvious that such are not indicative of an accrual of income. As to other accounts included in the classification, the evidence is not so clear as to enable a satisfactory determination of their relation to income. In the determination of so comprehensive a question as the method of accounting used, we are averse to drawing a presumption from the general nature of a very few accounts receivable, even where it is unfortunately true that we are left to conjecture how two debits described as “ charges in error ” and “ disputed charges ” were originally entered on the books. It is in evidence that the partnership never intentionally departed from a cash basis in determining its net income, and we conclude the record as a whole in this particular, supports the contention of the petitioners.

We do not include in the above discussion the account amounting to $12,366, which was voluntarily included in income for the year 1919, under the doctrine of constructive receipt, and which, therefore, is of no significance in a consideration of accounts alleged to be pure accruals. The respondent contends that the inclusion of this account in 1919, and the resulting exclusion from 1920, when paid, left the books in a status which determined income on a so-called “ hybrid basis. We are unable to agree with this, and are of opinion that the method of accounting fo'r this item, adopted by the partnership, is in agreement with their claims to a cash basis.

Whether the bookkeeping in 1920, was good or was bad, when the Cline Oil Co. was chaiged for drilling and equipment in advance of payment, we are not concerned, for we are satisfied that the reversing entry, as a matter of fact, cleared away the entire unpaid balance of this account and reduced the books to a cash basis. Neither is it necessary to consider the accounting procedure adopted through a reentry of the balance in the year following, for it was subsequent to and had no effect on the computation of the preceding year’s income on the cash basis, and at worst, is merely a question of bookkeeping procedure.

After a careful consideration of the record, we are of opinion that the partnership kept its books for 1920 on a cash basis, and that such basis, for the purpose of the income tax, clearly reflected its income. It follows that the distributive shares of the four petitioners should be derived from the partnership income computed on the basis of cash receipts and disbursements.

Judgment will be entered on days’ notice. under Rule 50.

Considered by Maequette, Phillips, and VaN Fossan.


source: Caselaw Access Project

author: Smith:

license: Public Domain

text:
    J. P. Badenhausen, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8346.
    Promulgated August 1, 1927.
    The petitioner was accommodation endorser on four notes given by a corporation of which the petitioner was the principal stockholder. The corporation went into the hands of a receiver in 1919 and by 1921 it was. evident that the corporation had no assets from which the notes could be paid. The petitioner had not paid the notes up to the close of 1921 and the record does not show that he ever paid them. Held, upon the record that the amount of the notes is not a legal deduction from the petitioner’s gross income of 1921.

      William G. Alexander, Esq., for the petitioner.

      M. N. Fisher, Esq., for the respondent.
    This is a proceeding for the redetermination of deficiencies in income tax for the years 1920 and 1921 in the respective amounts of $918.25 and $9,982.28. The proceeding relates to the deficiency for the year 1921 only. The question in issue is the right of the petitioner to deduct from gross income the amount of certain notes given by the Badenhausen Co., of which the petitioner was the principal stockholder, and upon which he was accommodation' endorser.
    FINDINGS OF FACT.
    The petitioner was formerly president and majority stockholder of Badenhausen Co., a Delaware corporation. In 1918 the Badenhausen Co. borrowed from the Manayunk National Bank, of Philadelphia, $48,000, evidenced by four notes, the first bearing date November 19, 1918, for $15,000, due 90 days after date; the second bearing date December 9, 1918, for $15,000, due March 9, 1919; the third bearing date December 23, 1918, for $11,000, due 90 days after date; and the fourth dated January 2, 1919, for $7,000, due April 2, 1919. All of these notes were endorsed by J. P. Badenhausen and the second one was also endorsed by Katherine C. Schneider, the petitioner’s mother-in-law. None of these notes were secured by any collateral except the second. This was secured by some collateral deposited by Katherine C. Schneider. None of the notes -was paid at maturity and all were duly protested by Manayunk National Bank, the holder, and notices of protest duly given.
    Application for appointment of a receiver for Badenhausen Co., the maker of the notes, was made in the United States District Court for the Eastern District of Pennsylvania, in the matter of Andrew Wheeler v. Badenhausen Go., December Term, 1918, No. 1885, and a receiver was appointed by the court for the company on January 20, 1919. By the decree of the court the receiver was authorized to continue the business and did continue the business until the early part of 1922. At the time the receiver was appointed, the petitioner had contracts on hand amounting to approximately two and one-half millions or two and three-fourth million dollars. It was anticipated that the company would work out of its difficulties caused by lack of cash capital about the middle of 1920. The receiver determined that it would be impracticable to take on any more contracts. The petitioner then began to conduct the manufacture and installation of boilers as an individual. In such individual business he kept his books on the accrual basis and filed his tax returns in accordance with such books of account.
    In the year 1921 the operation of the receivership, by reason of manufacturing difficulties and delays in completion, was very unprofitable, and by the end of 1921 it was evident that the creditors of the corporation would receive nothing on their claims. Nothing was ever paid to the creditors of the Badenhausen Co., nor even to the receiver’s creditors. The petitioner was employed by the receiver and was familiar with the facts of the business conducted by the receivership. On August 2, 1920, the petitioner debited “ contingent liability ” on his books of account in the amount of $48,000 and credited “ Manayunk National Reserve ” with the same amount. The petitioner, his accountant, and manager had a conference with respect to these entries shortly before the close of the year 1921. As the result of this conference, profit and loss was debited with $48,000 and capital account was credited with a similar amount. This change in the petitioner’s books of account was made in December, 1921.
    The petitioner, in his capacity as accommodation endorser on the notes of the Badenhausen Co., did not pay the amount of said notes to the bank in 1921 or in any prior year.
   OPINION.

Smith:

It is the contention of the petitioner that by reason of the fact that he kept his books of account on the accrual basis and was accommodation endorser on notes of the Badenhausen Co., of which he was president and majority stockholder, he sustained a loss in the year 1921 when the receivership of that company showed that its assets were wiped out and that no payment would be made on the notes by the receivership; that he, as endorser, was unqualifiedly liable thereon without any possibility of recoupment.

The Revenue Act of 1921 provides:

Sec. 214. (a) That in computing net income [ol individuals] there shall be allowed as deductions:
$ * # Sic $ jfc 4c
(4) Losses sustained during the taxable year and not compensated for by insurance or otherwise, if incurred in trade or business;
(5) Losses sustained during the taxable year and not compensated for by insurance or otherwise, if incurred in any transaction entered into for profit, though not connected with the trade or business;
*******
(7) Debts ascertained to be worthless and charged off within the taxable year (or, in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts) ; and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt to be charged off in part.

Considering first the question whether the petitioner was entitled to the deduction under section 214(a) (7) of the Revenue Act of 1921, it is clear that before a deduction can be taken for bad debts it is necessary that a debt be in existence. The relationship of debtor and creditor did not exist between the Badenhausen Co. and the petitioner and in the absence of this relationship it is impossible to establish the existence of a debt upon which the deduction could be predicated. Such relationship could arise only when and if the petitioner paid the amount of the notes in his capacity as accommodation endorser. Elgin National Bank v. Frank Goecke, 213 Ill. App. 559. In 8 Corpus Juris 270, par. 423, the law is stated as follows:

Whore the accommodation party has been compelled to pay the instrument, the party accommodated becomes, in consequence of the implied contract of indemnity, a debtor to the accommodation party, and the latter has a right of action against the former. Buch right accrues, however, only after payment by him, and, not on mere recovery of judgment against him. (Italics ours.)

The notes here in question were not paid in 1921 or prior years and it does not appear from the record that they have ever been paid by the petitioner.

Counsel for the petitioner has argued that the liability on the notes was absolute and not contingent. The question is not, however, as to whether the liability of the petitioner to the holder of the notes was contingent or absolute, but is whether there was a debt owing to the petitioner which was ascertained to be worthless and was charged off during the taxable year. If there was not a debt having existence in fact then the petitioner is not entitled to the deduction under subdivision (7) of the statute above quoted merely because he shows that the debt would have been worthless had it in fact existed. Luke & Fleming, Inc., 1 B. T. A. 12; Farmers’ Hardware Co., 2 B. T. A. 90; Louis Titus, 2 B. T. A. 754; Federal Fuel Co., 3 B. T. A. 814. As was stated in the Luke & Fleming, Inc., supra:

To entitle a taxpayer to deduct from gross income, as a bad debt, an item ascertained to be worthless and charged off in a given year, such a debt must have had an existence in fact. A debt which never existed can not be charged off. The right to a deduction arises from the discovery that something which had value has ceased to have it; a debt which never existed had no value to lose.

The evidence is not satisfactory that the petitioner sustained any loss in 1921 as a result of his endorsement of the notes. The most that the evidence shows is that the petitioner had a contingent liability in respect of them on December 31, 1921. The direct examination brought out nothing with reference to the payment of the notes and when counsel for the respondent attempted to cross-examine witnesses with respect to the situation which existed with respect to the notes after 1921 counsel for the petitioner stated:

I liave objection, however, to any inquiry directed to years subsequent to 1921, because we are dealing with the situation as it stood at the end of 1921, the same as judging all these situations reasonable business foresight and not from hindsight, and therefore I can’t see the slightest effect as to whether this note was paid in 1922 and 1923, or 1926 or 1927, or never paid. It may affect Mr. Badenhausen's personal tax situation. It might affect the future years in which payments partially or totally were made.

The statute permits the deduction from gross income of losses “ sustained.” It does not permit the deduction of losses which may be sustained. The evidence of record does not show that the petitioner has ever sustained any loss in respect of his endorsement upon the notes.

Judgment will be entered for the respondent.

Considered by Littleton and Love.


text:
    W. D. Collins and Wife, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 11148.
    Promulgated August 1, 1927.
    Inaccuracies in return filed due to loss of records and physical condition of petitioner held, insufficient to justify penalty for filing false and fraudulent return.

      J. M. McMillin, Esq., for the petitioners.

      Thomas M. Willdns, Esq., for the respondent.
    This proceeding results from the determination by the respondent of deficiencies in income tax for the calendar years 1919,1920,1921,1922, and 1923, in tbe amount of $25,04-9.86. For tbe years 1920 and 1921,_ tbe respondent asserts tbe 50 per cent fraud penalty pursuant to tbe provisions of section 250(b) of the Revenue Acts of 1918 and 1921. At tbe hearing of this proceeding, the petitioner conceded tbe correctness of tbe tax for all years as determined by the respondent, but assigned error in tbe imposition of the 50 per cent fraud penalty for tbe years 1920 and 1921.
    BINDINGS OF FACT.
    Petitioner and wife reside at Denison, Tex., and since 1900, have been engaged in the business of selling bank fixtures and safes. The fixtures and safes were usually sold on terms by which payments were made monthly, the payments extending from 12 to 36 months. A large volume of sales were made in the year 1918, and at the end of the year the petitioner decided to discontinue the sale of safes, discontinued the employment of traveling salesmen, and thereafter, only sold safes upon the receipt of occasional mail orders. On January 1, 1919, petitioner had on hand approximately $75,000 face value of notes taken for the sale of safes in the previous years. The notes themselves and a card record showing when the notes were due, were the only record petitioner maintained. As the notes were paid, such payments were noted on the card record and also in the cash book, although generally there were no notations on the cash book to indicate that the payment received was to be applied on a safe note. When a note was paid, the same was returned to the maker, thus leaving only a card record of the payment thereof in the office of the petitioner and a possible notation on the cash book. Many of the notes received from the sale of safes and fixtures in 1918, were finally collected in the years 1919, 1920, and 1921. Petitioners kept their books of account and reported their income for all the years, on the cash receipts and disbursements basis.
    In the year 1918, W. D. Collins suffered a serious illness and placed himself under the care of a physician, who advised an immediate operation. Collins felt that he could not take the time from his business to have the same performed in 1918. During the year, he was in a highly nervous state and could give very little time to business matters. His physical condition grew progressively worse during 1919 and 1920, and in September, 1921, he suffered a complete physical breakdown, resulting in two operations being performed on him in 1921 and two operations in 1922. Subsequent to the last operations being performed, he traveled in order to regain his health, and has not to the date of the hearing of this proceeding fully recovered.
    During the serious illness of Collins his wife attempted to attend to his business affairs. She concluded that the offices should be moved to .'Dialler quarters, and in moving the files, gave orders that all of the records relating to business of previous years be destroyed, believing them of no value. The records destroyed showed the expenditures of the business for previous years, as well as the sales made upon which collections were being made in 1920 and 1921. When the agent of the respondent, in 1924, attempted to check the records of petitioner, for years 1920 and 1921, he was unable to locate necessary records, and determined the income on a percentage basis.
    Petitioner employed a certified public accountant to assist in the audit of the respondent, and the reports of his -auditors were used largely as a basis for determining the deficiencies for the years in question.
    In making his income-tax return for 1920, Collins consulted a deputy collector for advice in the preparation of same, and estimated the amount of income received. He made his return for the year 1921, while in a hospital at Kochester, Minn., and estimated what he believed to be his true income for that year.
   OPINION.

Milliken:

The only issue presented by this proceeding, is whether the petitioner filed a false and fraudulent return with intent to evade tax for the calendar years 1920 and 1921. The tax proper is admitted. The respondent has determined the deficiencies, attributing one-half the income to the husband and one-half to the wife, with fraud penalties against each.

We are of the opinion that petitioner did not file his returns for the years 1920 and 1921 with intent to evade the payment of the proper tax due and owing. During these years he was, had for two prior years been, and still is suffering from a serious illness. During 1920 and 1921, he was able to give only scant attention to his business affairs. During the serious illness of petitioner, his wife, without knowledge of the value of his records, caused them to be destroyed. From the destroyed records, the income could have been satisfactorily determined. Collections made in 1920 and 1921 from installment notes, representing sales made in prior years, have been included in income for 1920 and 1921, but which petitioner is unable to refute, due to loss of records. When the respondent began his investigation of the returns filed the petitioner engaged the services of a certified public accountant to assist, and from the report made by such accountant the deficiencies have been largely determined.

Petitioner may have been negligent in not filing amended returns before the Government caused an investigation to be made that would have shown his true income for the years in question. Due to his physical condition during those years, we do not think this negligence on his part is sufficient warrant for the imposition of the fraud penalty pursuant to the provisions of section 250(b) of the Revenue Acts of 1918 and 1921. The respondent was in error in seeking to impose the same.

Judgment will be entered on 15 days’ notice, wider Rule 50.

Considered by Phillips, Marquette, and Van FossaN.


author: Sternhagen:

text:
    The Hub, Henry C. Lytton & Sons, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 4701.
    Promulgated August 1, 1927.

      Lawrence P. Mattingly, Esg., for the petitioner.

      Brice Toole, Esg., for the respondent.
   Sternhagen:

Deficiency of $5,473.82 for 1918. Respondent excluded from invested capital alleged value of real properties claimed to be paid-in surplus of affiliated corporations.

FINDINGS OF FACT.

The petitioner is an Illinois corporation with its principal office in Chicago.

The following corporations were organized on or about December 1, 1914, at the instance of Henry C. Lytton:

Arragon Holding Corporation.
Round Robin Realty Corporation.
High. Grade Holding Corporation.
Neverfail Realty Corporation.

Lytton owned property at 18 West 20th Street, New York City. This he conveyed to the Arragon Holding Corporation for all of its capital stock except qualifying shares.

Lytton also owned property at 8 and 10 West 19th Street, New York City. This he conveyed to the Round Robin Realty Corporation, in return for which he received all of the capital stock of that corporation of the par value of $2,500, with the exception of qualifying shares.

Lytton owned property on Lexington Avenue and at 66 West 90th Street, New York City. These properties were conveyed by him to the High Grade Holding Corporation, in return for which he received its entire capital stock of the par value of $3,000, with the exception of qualifying shares.

-Lad to;-: owned property at 172 Fifth Avenue, New York City, which he conveyed to the Neverfail Eealty Corporation, in return for which he received all of the capital stock of that corporation of the par value of $5,000, with the exception of qualifying shares.

Judgment will be entered for the respondent.

Considered by GeeeN and AeuNdell.


author: Love:

text:
    William F. B. Koelle, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 6093.
    Promulgated August 1, 1927.
    On the evidence held that the amount of $25,000, being the amount accepted by the petitioner in settlement of certain claims against his brother, was not received in the year 1923.

      Charles 8. BoeTeey, C. P. A., for the petitioner.

      W. II. Lawder, Esq., for the respondent.
    This proceeding is for the redetermination of a deficiency in income tax asserted by the respondent in the amount of $2,316.12 for the calendar year 1923. The sole issue raised by the pleadings is whether the amount of $25,000, being the amount accepted by the petitioner in settlement of certain claims hereinafter described, was received in the year 1923 as determined by the respondent,
    FINDINGS OF FACT.
    The petitioner is an individual residing in Philadelphia, Pa., and is an architect by profession.
    About the year 1916 the petitioner’s brother, Clifford Koelle, invested $5,000 in an automobile agency known as the Koelle-Greenwood Co., Germantown, Pa., which business was operated and managed by him. Of the amount of $5,000 invested by Clifford Koelle, the petitioner had furnished him with $2,500. The petitioner and his brother had an oral agreement, the nature of which is not disclosed, as to the distribution of the profits derived from the business.
    In the latter part of the year 1919, the petitioner demanded of his brother that an accounting of the profits arising from the Koelle-Greenwood Co. be made, and that the petitioner be paid the amount to which under the oral agreement he might be entitled. Clifford Koelle denied that the petitioner was entitled to participate in the profits of the business and litigation ensued. In the year 1923, the Common Pleas Court of Philadelphia County, Pennsylvania, handed down a decision in which that court held thatjiie petitioner was entitled to share in the profits of the Koelle-Greenwood Co. in the proportion which the capital contributed by him bore to the total capital of the company. The court, however, did not determine the amount to be paid to the petitioner pursuant to its judgment.
    On or about December 29, 1923, the petitioner and his brother, through their attorneys, entered into an agreement whereby it was agreed that the petitioner would accept $25,000 as the final and full settlement of all claims to profits derived from the operation of and his original investment of $2,500 in the Koelle-Greenwood Co. Pursuant to this agreement the attorneys for Clifford Koelle on January 7, 1924, transmitted by mail a check for $25,000 drawn to the order of G. C. Ladner, Esq., as attorney for the petitioner. On January 11, 1924, G. C. Ladner, Esq., transmitted to the petitioner a check for $20,000 having deducted the amount of $5,000 as a fee for services rendered and court costs in the litigation between the petitioner and his brother. Subsequently, the petitioner’s attorney refunded something less than one thousand dollars on account of the fee charged by him.
    The Commissioner determined that the settlement made by and between Clifford Koelle and the petitioner, was completed in the year 1923, and that the petitioner’s attorney, as agent for the petitioner, received the amount of $25,000 in the year 1923. Accordingly, the Commissioner asserted a deficiency in tax for that year in the amount of $2,316.12.
    During the year 1923, the petitioner kept his books of account on a cash receipts and disbursements basis.
   OPINION.

Love:

As set out in the findings of fact, the check for $25,000 given in settlement of the petitioner’s claim against his brother, did not reach the petitioner’s attorney until January 7,1924. Obviously, therefore, the respondent erred in including any part of that amount as income for the year 1923.

A copy of the deficiency notice was not attached to the petition herein, nor was it introduced in evidence at the hearing. Consequently, we are unable to determine the deficiency, if any, for the year 1923.

Judgment will be entered on 15 days’ notice, under Bule 50.

Considered by Smith and Littleton.


text:
    Mrs. J. C. Erwin, Petitioner, v. Commissioner of Internal Revenue, Respondent. J. C. Erwin, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 10250, 10251.
    Promulgated August 1, 1927.
    A demand note to cover petitioners’ proportion of a loss was given to p. bank on December 18, 1920, with instructions to charge it against petitioners’ cheeking account as soon as that account was sufficient to liquidate the note. On December 30, 1920, the checking account was large enough to liquidate the note. The note, however, was not charged against the checking account until January 18, 1921. Held, that payment of the note was made in December, 1920, and the loss was deductible in 1920.

      J. M. McMillan, Esq., J. Robert Sherrod, Esq., and W. W. Rankin, G. P. A., for the petitioners.

      Arthur H. Murray, Esq., for the respondent.
    These proceedings, duly consolidated for disposition upon the facts as stipulated by the parties hereto, involve deficiencies of $52.62 for the calendar year 1920 against each of the petitioners. The deficiencies result from the respondent’s disallowance as a deduction from gross income of each of the petitioners for the year 1920, of the amount of $1,315.65, being one-half of a loss alleged to have been sustained in that year. It is stipulated that if the respondent’s determination is approved, the deficiency in tax as to each petitioner for the year 1920, is $52.62.
    FINDINGS OF FACT.
    The petitioners are husband and wife residing in the State of Texas. All income accruing to the petitioners arose under the community property law of the State of Texas, and for the calendar year 1920, each filed a separate income-tax return reporting thereon, on a cash receipts and disbursement basis, one-half of the community income.
    On December 18, 1920, the petitioner, J. C. Erwin, gave to the Collin County National Bank a noninterest-bearing demand note for $2,631.30 to cover an indebtedness to that bank, which indebtedness is stipulated as “ Ccrilin County National Bank loss.” At the time of giving the note, the petitioner, J. C. Erwin, gave instructions to the bank that the note should be charged against his checking account when the balance in that account was sufficient to liquidate the note. On December 18, 1920, the balance in the checking account was $2,510.99 and on December 30, 1920, the balance was $2,911.82.

      On January 18, 1921, the "Collin' County National Bank charged the note for $2,631.30 against the checking account of the petitioner, J.. C. Erwin.
    The petitioners in their income-tax returns for the year 1920, each deducted the amount of $1,315.65 as a loss sustained in that year. Upon audit of the returns the Commissioner disallowed the deduction so taken by each petitioner and determined that the note for $2,631.30 was paid in 1921, and that the loss should have been deducted in that year.
   OPINION.

Love:

The petitioners contend that the balance in the checking account of the petitioner, J. C. Erwin, having been on December 30, 1920, greater than the amount of the note, the bank could and should have charged the note against that account on that day as it had theretofore been instructed to do and for’that reason it is urged that payment to the bank was made and the resulting loss sustained in the year 1920. The bank having been given authority, instructions and directions to charge the note against the checking account when that account became large enough to cover the note, the petitioners had done all that was necessary on their part and the failure of the ’ bank to make the book entry can not delay the right to take the deductions.

The question presented is one of law as there is no disagreement as to the facts. It is not disputed that a deductible loss was sustained. The year in which such loss was sustained is, however, in dispute. The question we are called upon to decide is whether J. C. Erwin, by reason of the fact that he instructed the bank to charge the demand note for $2,631.30 against his checking account when it became sufficient to liquidate the note and which was sufficient to do so on December 30, 1920, made payment to the bank and sustained, by reason of such payment, the loss in 1920 notwithstanding the fact that the bank did not charge the note against his account until January 18, 1921.

In the case at bar the petitioner had given instructions and those instructions were intended and so understood by all parties to the transaction, to be in lieu of a check, dated on the date when the account became sufficient to pay the note; and was, in effect, a check drawn against that account, as of that date, in payment of that note.

Under the facts of this case, we hold that payment of the note was made and the loss sustained in 1920.

Judgment of no deficiency will he entered for the petitioners.

Considered by Smith and Littleton.


author: Love :

text:
    E. B. Miller, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 3465.
    Promulgated August 1, 1927.
    1. Reasonable allowance for depreciation of oil-well drilling tools and equipment determined.
    2. The evidence is insufficient to sbow that Commissioner’s determination that petitioner received a dividend from the Liquefied Petroleum Gas Co. is erroneous.

      Ojiarles H. Garnett, Esq., and E. R. Willis on, G. P. A., for the petitioner.

      Robert A. Littleton, Esq., for the respondent.
    This proceeding is for the redetermination of a deficiency in income tax for the year 1919, amounting to $683.84. The errors assigned are in substance: (1) That the rate of depreciation allowed by the Commissioner on oil-drilling tools and equipment is too low; (2) the inclusion in income of a distribution received as a stockholder of the Bishop Oil Co. which was a return of capital; (3) the inclusion in income of an alleged dividend from the Liquefied Petroleum Gas Co. which was not in fact received. The second assignment was abandoned at the hearing.
    FINDINGS OF FACT.
    The petitioner resides in Tulsa, Okla. He is an oil-well driller and has been actually engaged in drilling wells for over twenty-eight years. In 1919, he was a member of two partnerships, each of which carried on the business of drilling wells.
    One of the partnerships was known as Miller & Tyrrell, and the petitioner had a one-half interest therein. This firm owned drilling tools and equipment consisting of boilers, engines, drills, cables and other items, of a total book value on January 1, 1919, of $10,521.22. During the year 1919, additions were made thereto costing $930. On November 1, one “string” of drilling tools which theretofore cost $2,862.80, was withdrawn from the partnership and turned over to another individual to use on shares. The Commissioner determined a depreciation allowance of $1,929.72. The petitioner claims a reasonable allowance would be $2,588.51.
    The other partnership was the Roland Miller Drilling Co. and the petitioner’s interest was three-eighths. This firm had an investment January 1, 1919, in drilling equipment of $3,200, to which additions costing $241.53 were made during the year. The Commissioner allowed depreciation of $734.93; the petitioner claims $830.19.

      The petitioner kept no record of the useful life of individual tools. The useful life of the various tools varied greatly in length in different territory, depending upon the character of the earth strata and the depth of the holes. Under some conditions a string of tools would last not more than two years; under other conditions they could be used from five to seven years. It also happened occasionally that tools would break or be lost in a hole while comparatively new. During 1919 the partnerships operated in the Drumright field, where deep drilling was done, and experience showed the average life of tools in that region was about four years. We find a reasonable rate for depreciation in 1919 is 25 per cent.
    The petitioner in 1919 owned stock (amount not shown) of the Liquefied Petroleum Gas Co. Prior to 1919 he had purchased $10,000 par value of such stock, for which he gave his note for $10,000. The note was paid by dividends being credited against it by the company and when so paid, the note was canceled and returned to petitioner. The testimony does not disclose when these credits were made. On January 8, 1919, the stockholders authorized an increase in capital stock from $50,000 to $1,000,000. Book entries dated August 1, 1918, show $1,000,000 capital stock, against which are offset these items:
    Surplus___ $177,887.82
    Gas contracts- 489, 592.18
    Bills payable- 316,108.71
    Dividends_ 16,411.29
    The following statements appear in a revenue agent’s report of an investigation of the Liquefied Petroleum Gas Co. which was introduced in evidence by petitioner: • -
    Bills payable, $316,108.71, represented the bills payable of the corporation which the stockholders assumed as at August 1, 1918.
    Dividend, $16,411.29, represents a debit to the dividend account in the bopks.
    On Dec. 31, 1918, a stockholders’ meeting made a 5% assessment on the $1,000,000 stock outstanding and the following entry was made in the books:
    Accounts receivable_$50, 000
    Dividend_$50, 000
    * # * * * * *
    Although the stockholders were to assume them, bills payable, $316,108.71, and interest on them were actually paid by the corporation and the transactions as well as the assessment of $50,000 were covered by debit and credit entries to the Dividend account.

      No money was ever paid into the corporation by any of the stockholders, and the total invested capital for 1918 and 1919 was represented by the earned surplus of the corporation as at the beginning of each year.
    Additional stock was issued to the stockholders in 1918 and 1919. The stockholders assumed the bills payable of the corporation and the capital stock account was credited with the amount thereof. The bills, however, were paid by the corporation and the amount was charged to the dividend account.
    The Commissioner included in petitioner’s income $6,339.74, as dividends received from the Liquefied Petroleum Gas Co. on account of the credits to dividend account above referred to. The petitioner received in 1919 three or four small dividends in cash, aggregating about $218, which he reported in his income-tax return.
   OPINION.

Love :

As appears in the findings of fact, we have found that 25 per cent is a reasonable allowance for depreciation of the drilling tools and equipment. There should be subtracted from the amount to be used as the basis for depreciation allowance for 1919, the cost of the drilling tools withdrawn for such part of the year as they were used by other persons.

The only other question is whether or not the petitioner received from the Liquefied Petroleum Gas Co. the dividend which the Commissioner has added to his income. He did not receive the amount in cash. The testimony relating to the affairs of this corporation is indefinite, but it does appear that stockholders received additional stock in 1919 for which they paid no money and that they did assume obligations of the corporation. It appears that the assumption of the obligations of the corporation by the stockholders was the consideration for the stock. The testimony shows that these obligations were thereafter discharged, not by the stockholders but by the corporation and the latter charged the amount thereof to the dividend account. This testimony, which was offered on behalf of the petitioner ngt only does not sustain his contentions, but tends to support the Commissioner’s position, and his determination on this point is therefore affirmed.

Judgment will be entered on W days’ notice, wnder Rule 50.

Considered by Smith and Littleton.


text:
    Estate of John Barnes, Jr., Joseph Barnes, Administrator, Petitioner, v. Commissioner of Internal Revenue, Respondent. Joseph Barnes, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 5266, 9577.
    Promulgated August 1, 1927.
    1. On the evidence, held,, that the husband, in good faith gave to his wife his interest in a coal mine, which under the statutes of Pennsylvania, rendered the profits from the operation of such mine her, and not his, income.
    2. Noncompliance with the “ Fictitious Names Act ” of Pennsylvania, does not render void the partnership or organization, as such.

      George W. Zeigler, Esq., and Edward J. Thompson, Esq., for the petitioners.

      John D. Foley, Esq., for the respondent.
    By stipulation, the two cases were consolidated and submitted on one record.
    These proceedings are to redetermine the deficiency in income tax for the year 1920, in the case of Estate of John Barnes, Jr., in the amount of $6,184.56, and in the case of Joseph Barnes, the amount is $5,364.74.
    The issues involved are:
    1. The bona fides of an alleged gift and transfer by John Barnes, Jr., and Joseph Barnes, each to his wife, in the latter part of 1919, of his one-third partnership interest in the Atherton & Barnes (Troy) coal mine.
    2. In the event the bona fides of the gift be established, whether under the conditions it constituted a legal transfer of such interest so as to render the wives, and not the husbands, liable for income taxes.
    *3. In the event the bona fides of the transaction be denied, whether or not the petitioners are liable to a fraud penalty.
    FINDINGS OP PACT.
    The petitioners are residents of Philipsburg, Pa. John Barnes, Jr., died since 1920, and Joseph Barnes is the executor of his estate, and as such, prosecutes this proceeding for the estate and in the companion case, prosecutes his own case.
    In 1919, besides being interested in several other businesses, John Barnes, Jr., and Joseph Barnes, each owned a one-third interest in what was known as the Troy coal mine, operated by a partnership firm composed of David Atherton, John Barnes, Jr., and Joseph Barnes. By the latter part of 1919 the Troy mine had been almost exhausted and only “ pockets ” of coal were yet to be taken out. Fox-several years prior to 1920 the coal business had been dull and small profits realized. This was particularly true of the Troy mine by reason of its almost exhausted condition.
    In the latter part of December, 1919, Mrs. Joseph Barnes suggested to her husband that she would like some income of her own. No definite response was made to that suggestion. Later, probably during Christmas week in 1919, she and her husband were at the home of John Barnes, Jr., on a friendly visit. The two wives then made the same suggestion to the two husbands, urging that they wanted to feel like they had some income of their own. The husbands then responded to the effect that each would give and did give to his wife his interest in the Atherton & Barnes (Troy) coal mine to take effect January 1, 1920, and such was the understanding thenceforward. There was no formal transfer, on the books or otherwise. After the alleged change in personnel of the partnership, there was no statement filed in conformity with the statute of Pennsylvania known as the “ Fictitious Names Act.” Atherton, the other partner was not consulted in regard to the matter and the record does not disclose the fact that he had knowledge of the claim on the part of the women.
    John Barnes, Jr., had been and continued to be the manager of the mine operations and business administration. Neither Atherton, Joseph Barnes, or the women took any part in the conduct of the mine operations. All they knew of such things came through reports usually oral reports, by John Barnes, Jr.
    The year 1920, was an exceptionally prosperous year in the coal business and Atherton & Barnes shared that prosperity. During that year the net profits of the Troy mine were paid to and received by David Atherton, Mrs. John Barnes, Jr., and Mrs. Joseph Barnes in the amount of $23,511.38 each, and each of the two women filed an income-tax return for that year, reporting that amount of income.
   OPINION.

Love :

We are convinced that John Barnes, Jr., and Joseph Barnes, in December, 1919, in good faith intended to give and did give to their several wives their several beneficial interests in the partnership of Atherton & Barnes, and that they and the wives thereafter acted upon that basis; hence, there was no fraud. The two women appeared at the hearing as witnesses. Their testimony, though varying in phraseology, was practically identical in substance, and each testified explicitly to the incidents connected with the gift by their respective husbands to themselves.

There remains, however, the question of law, whether or not in view of the facts in the case there was a legal transfer of the interest in the partnership or a gift of the profits, as and when such profits flowed from the partnership to the men, themselves, as partners.

It will be noted in the findings of fact that there was no formal transfer. There was only an informal, oral gift on the part of the husband with no delivery of anything; that the third member of the partnership was not consulted and so far as the record discloses, remained in ignorance of the claim of the women; that the women took no part in the business management, or operations of the mine. They merely claimed and received, each, one-third of the net profits.

The Uniform Partnership Act of Pennsylvania (Act of March 26, 1915), P. L. 18, Part 5, sec. 27 (1), provides:

A conveyance by a partner of bis interest in the partnership does not of itself dissolve the partnership, nor, as against the other, in the absence of agreement, entitle the assignee, during the continuance of the partnership, to interfere in the management or administration of the partnership business or affairs, or to require any information or account of partnership transactions, or to inspect the partnership books; but it merely entitles the assignee to receive, in accordance with hie contract, the profits to which the assigning partner would otherwise be entitled.

Ibid, section 26:

A partner’s interest in the partnership is his share of the profits and surplus, and the same is personal property.

It perhaps is needless to point out that the paragraph last quoted deals only with the interest in the partnership, and is not dealing with property, real or personal belonging, as an asset to the partnership. Such property is dealt with in other paragraphs of the Uniform Partnership Act.

In view of the statutes quoted and in view of the facts in this case, it seems apparent that the wives in 1920 were legally entitled in their own right to one-third of the profits which were realized from the operations of the Troy mine and being entitled to such profits, and having received those profits, they are liable for the income tax thereon.

There remains one other point raised by the Commissioner. In view of the provisions of the statute, Act of April 14, 1851, (P. L. 612, sec. 13), and in view of the fact that no statement disclosing the personnel of the partnership in 1920 was filed in the office of the prothonotary, was that partnership rendered void? That paragraph reads thus:

* * * All persons who are now doing business in a partnership capacity in this Commonwealth shall file or cause to be filed in the office of the prothonotary, in the county or counties where the said partnership is carried on, the names and location of the members of such partnership with the style and name of the same; and as often as any change of members in said partnership shall take place, the same shall he certified by the members of such new partnership as aforesaid; and in default or neglect of such partnership so to do, they shall not be permitted, in any suits or actions against them in any court, or before any justice of the peace or alderman in this Commonwealth, to plead any misnomer, or the omission of the name of any member of the partnership, or the inclusion of the names of persons not members of said partnership.

It is obvious from tbe reading of the foregoing statute that its intent was not to render void, and it does not invalidate a partnership the members of which fail to comply with its provisions. See William W. Parshall v. Commissioner, 7 B. T. A. 318.

Judgment will be entered on 10 days’ notice, u/nder Rule 50.

Considered by Smith and Littleton.


text:
    West End Pottery Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8158.
    Promulgated August 1, 1927.
    1. Petitioner purchased stock of another corporation in 1918 for $4,000 and in 1919 charged off that stock as worthless. Held, that in the absence of evidence as to the worthlessness of the stock, or as to the financial condition of the company, the stock of which is alleged to have become worthless, the cost thereof is not a proper deduction from gross income.
    2. The evidence is insufficient to show that the petitioner is entitled to a greater amount of deduction for depreciation and obsolescence than was allowed by the Commissioner.

      William H. Vodrey. Esq., for the petitioner.

      J. L. Deveney, Esq., for the respondent.
    This proceeding is for the redetermination of a deficiency in income and profits tax for the calendar year 1919 in th© amount of $2,900.34.
    The petitioner alleges that the Commissioner erred, first, in disallowing a deduction from gross income in the amount of $4,000 as a loss on account of certain corporation stock alleged to have been ascertained to be worthless and charged off in 1919; and second, in failing to allow as a deduction a reasonable amount for exhaustion, wear and tear and obsolescence of its pottery kilns.
    findings of fact.
    The petitioner is a corporation organized under the laws of Ohio, with its principal place of business at East Liverpool in that State. It has been in the pottery business for about 35 years, and its principal product has been table ware, known as Bisque China.

      There were but few changes in the method of manufacturing that type of product until recent years. Until about the year 1917, practically all potteries used what are known as standing or intermittent kilns for the purpose of firing china. An intermittent kiln is constructed of brick, circular in form, about 12 feet in diameter and about 30 feet tall. The green ware, that is, unfired china, after being moulded,' is carried into the kiln by men and placed in bundles, one on top of another, until the kiln is filled. In order to fill the kiln it is necessary for the men to climb ladders to place the china, as they approach the top.
    After the kiln has been filled it is fired for a period of 40 to 72 hours. After the firing is completed, it is necessary to remove the china. The removal of the china necessitates a laborious process similar to that required to fill the kiln. A large quantity of fuel is consumed by that type of kiln.
    The petitioner acquired its pottery in 1892, and the intermittent type of kiln has been used by it since that time. From time to time it made additions to its plant in the way of buildings as well as intermittent kilns, the last of which additions were made in 1910. 'Since 1910 it has remained practically the same.
    Some time prior to 1917 a kiln known as the “ tunnel ” type was developed. It consisted of a brick tunnel erected above ground, and having a track for cars running through it. The plan of operating, or using that kiln is to heat, or “ fire ” the tunnel, and move the cars on which the green ware has been placed slowly through the tunnel.
    The development of the tunnel type of kiln has revolutionized the pottery industry, by reason of the fact that its operation is much more economical than the use of the intermittent type. After 1917, no intermittent kilns were constructed by any of the pottery companies, of which there are about 35 in the East Liverpool district.
    In the year 1921 or 1922, the first tunnel kiln was constructed and put in operation in the East Liverpool district. Since 1917 there has been considerable development in machinery used in the pottery industry. Modern machinery is more efficient and economical than the kinds formerly used.
    In the year 1917, petitioner’s officers realized the fact that due to the development of the tunnel kiln, it would be compelled to change its method of production in order to meet competition.- With that idea in mind, it began in 1918, to charge off for depreciation and obsolescence, on account of its intermittent kilns, and its machinery, $10,000 per year, so that under that program by the year 1925 it would have charged off $70,000, leaving a salvage value $6,188.59, the kilns and machinery having in the estimation of petitioner in the year 1918, a value at tbat time of $76,188.59. By reason of the great demand for its products, during the year 1918, the petitioner was able to operate its plant with the facilities it then had and meet competition.
    Petitioner’s principal difficulty in 1918 was to procure coal to fire its kilns. In order to obtain coal from the Rachel Coal Co., it purchased stock of that company at a cost of $4,000, which stock it held until 1919, at which time it tried to sell the stock to the Rachel Coal Co. and to other parties, but was unable to effect a sale. Without making any investigation as to the financial condition of the Rachel Coal Co. or as to what assets it owned, the petitioner charged off in 1919 the cost of said stock on the theory that the stock was worthless. The stock, the cost of which was so charged off, was soon thereafter assigned by it to its secretary and treasurer.
    The petitioner has continued to operate its plant to the present time, and no part thereof has been abandoned or replaced. It is still using the intermittent kilns. In 1923, 1924, and 1925, petitioner suffered losses in the operation of its pottery plant.
    Upon the audit of petitioner’s return for 1919, the Commissioner disallowed as a deduction from gross income, for that year, $4,000 taken by petitioner on account of the alleged worthless stock of the Rachel Coal Co. Also the respondent denied the allegation that he had not allowed as a deduction from gross income for the year 1919, a reasonable amount on account of depreciation including obsolescence of petitioner’s kiln, machinery and equipment. No evidence was introduced to show what amount, if any, the Commissioner had allowed. The deficiency notice containing the Commissioner’s computation was not attached to the petition, nor was it offered in evidence.
   OPINION.

Love:

The first issue in this case is whether or not the stock the Rachel Coal Co. purchased by petitioner in 1918, at a cost of $4,000 was worthless in 1919 so as to justify the petitioner in deducting the cost thereof as a loss in that year.

The petitioner’s evidence precludes us from sustaining its contention. The petitioner’s secretary and treasurer testified to the effect that no attempt was made to determine the financial condition of the Rachel Coal Co. For aught the record shows, the stock was worth a hundred cents on the dollar. The mere fact that the stock found no ready market, or that the Rachel Coal Co. would not buy it in, certainly does not establish that it was in fact Avorthless and that fact must first be ascertained before the petitioner can, under the statute, claim a deduction of the cost thereof as a loss. Appeal of T. J. Donahoe, 2 B. T. A. 355.

The determination of the Commissioner in disavowing that deduction is, therefore, sustained.

With respect to the contention made by the petitioner that the Commissioner did not, for the year 1919, allow it a reasonable amount as a deduction for depreciation and obsolescence of its kilns and machinery, we must also approve the determination of the Commissioner.

In the respondent’s answer filed in this proceeding, it is alleged that he “ denies that the Commissioner refused to allow a reasonable amount for depreciation on an old style, upright, intermittent kiln pottery,” and he further “ denies generally and specifically each and every allegation contained in the taxpayer’s petition not hereinbefore admitted, qualified or denied.”

The deficiency notice, with computation, which forms the basis of this proceeding was not attached to the petition, nor was there any evidence introduced to show what allowance, if any, the Commissioner made for depreciation and obsolescence. Without knowledge of what allowance for depreciation and obsolescence was made by the Commissioner, we are unable to do otherwise than approve his determination, whatever that may have been. The burden of showing that the Commissioner erred is on the petitioner. Appeal of Rock Spring Distilling Co., 2 B. T. A. 207. However, had the petitioner offered evidence as to the amount of depreciation taken by it for 1919, on its kilns and machinery, and disallowed by the Commissioner, there would still exist, in the present condition of the record, an insurmountable difficulty which of itself precludes our disturbing the determination made in this respect by the Commissioner.

In order that depreciation may be allowed, it is necessary in addition to knowing the useful life of the depreciable assets, to have established the cost or March 1, 1913, value of such assets. Appeal of When Clothing Co., 1 B. T. A. 973. The burden of proof in respect of those matters is on the petitioner. Appeal of Valley Steamship Co., 1 B. T. A. 1107. In this proceeding the petitioner has proved that in 1918 it estimated the net value of its depreciable assets, at that time, at $76,188.59. The record is silent as to the March 1, 1913, value of those assets owned by the petitioner at that time. Likewise, the record is silent as to the cost of any depreciable assets acquired subsequent to March 1, 1913, and prior to 1918. It is obvious, therefore, that in view of the condition of the record, we can not disturb the Commissioner’s determination in respect to depreciation and obsolescence. Appeal of William Harris, Jr., 2 B. T. A. 156.

Judgment will he entered for the respondent.

Considered by Smith and Littleton.


author: MilliKen :

text:
    Estate of T. J. Taylor, Ella D. Taylor, Executrix, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7617.
    Promulgated August 1, 1927.
    1. A purchase-money note, secured by a vendor’s lien and a portion of the oil run, given by irresponsible parties as part payment of an interest in an oil and gas lease, valued, for purposes of determining profits from the sale, at the sum of the proceeds from the oil run to the date of the transfer of the note and all interest in the lease to third parties, following default on the note, plus the consideration received from such transfer.
    2. The disallowance of a claimed loss on the alleged sale in good faith of stock, approved, in the absence of evidence of the basic cost of such stock.
    3. An item found to have been erroneously duplicated in income.

      Don T. Haynes, Esq,, for the petitioner.

      George G. Witter, Esq., for the respondent.
    This proceeding, as originally brought, involved a deficiency in income tax for the year 1919 in excess of $10,000. Such deficiency arose from the fact that respondent treated, for income-tax purposes, a certain sale made in 1919 of an oil and gas lease as an installment sale, but included in the gross income of the decedent a proportional part of a lien note for $320,000 at its face value, and also from the fact that respondent refused to permit the deduction from gross income of the decedent of a loss of $36,000 arising from an alleged sale of stock jn the Sanders Taylor Oil Co. Petitioner further contends that respondent had twice included the sum of $1,660 in gross income. At the hearing, with the consent of petitioner, respondent amended his answer and now asserts that the said sale was not an installment sale, but was a closed transaction in 1919 and the deficiency should be so redetermined, resulting in an additional deficiency. Petitioner concedes that the sale was not an installment sale.
    FINDINGS OF FACT.
    Ella D. Taylor, who resides at 1008 Lamar Street, Wichita Falls, Tex., is the widow of T. J. Taylor, deceased, and executrix of his will. T. J. Taylor owned an interest in the Sibley Taylor Oil Association Number One, which was represented by 551/3 units out of a total of 500 units. The cost of the 55ys units to T. J. Taylor, was $16,046.66 Said association was a partnership. T. J. Taylor was the liquidating trustee of its assets. As such trustee, Taylor, in April, 1919, sold to J. W. Crotty and E. H. Shackelford the company’s assets, which consisted of an interest in an oil and gas lease dated August 20, 1918, from J. G. Hardin and M. C. Hardin, his wife. The contract of sale to Crotty and Shackelford contained the following:
    Know Am Men By These Presents :
    That, whereas, by instrument dated 20th day of August, A. D. 1918, and recorded in deed records of "Wichita County, Texas, in book-, page-, J. G. Hardin and wife, M. C. Hardin, made, executed and delivered to Floyd E. Ard an oil and gas lease on the following described land situated in the County of Wichita, State of Texas, to wit:
    Beginning at a point in the East line of the Wm. P. B. DuBose Survey at the Southeast corner of a 45 acre tract of land leased by J. G. Hardin to C. H. Clark; thence West 2260 feet; thence South 874 feet to a stake; thence East 1077 feet to the Northwest corner of the 5 acre tract of Phillips and Hardin’s North line 1833 feet to the East line of said DuBose Survey; thence north parallel with the East line of said DuBose Survey 668 feet to the place of beginning, containing 40 acres of land.
    To the record of which oil and gas lease reference is made for all purposes.
    And, Whereas, said oil and gas lease, together with all rights, titles, interests and estates conveyed thereby, insofar as same pertains to the following described portion of said forty (40) acre tract, is now held and owned by Roy A. Taylor, of Wichita County, Texas, and S. W. Sibley of Collin County, Texas;
    Now, Therefore, we the said Roy A. Taylor and S. W. Sibley, for and in consideration of the sum of Four Hundred Thirty-five Thousand ($435,000.00) Dollars to us paid secured to be paid by J. W. Crotty and E. H. Shackelford, as follows: One Hundred Fifteen Thousand ($115,000.00) Dollars in cash, the receipt of which is hereby acknowledged and confessed, and the remainder in deferred payments in the manner and at the time hereinafter more fully set forth, have bargained, sold, transferred and assigned, and by these presents do hereby bargain, sell, transfer and assign unto the said J. W. Crotty and E. H. Shackelford, both of Dallas County, Texas, said oil and gas lease above described, and all of the rights, titles, interest and estates conveyed thereby insofar as same pertains to the following described portion of said forty (40) acre tract, to wit:
    Beginning at a point 1481 feet West of the East line of the DuBose Survey at the intersection of the Southeast corner of the Clark 45 acre tract; thence West 267 feet; thence South 827 feet; thence East 267 feet to the West line of a 2% acre tract deeded to W. R. Ferguson, Trustee; thence North $03 feet to the south line of said Clark 45 acre tract to the place of beginning, containing 5 acres of land.
    * * * * * # #
    The deferred payment of Three Hundred Twenty Thousand ($320,000) Dollars above mentioned shall be evidenced by one promissory note, in the principal sum of $320,000.00 payable to the order of T. J. Taylor, Trustee, for the use and benefit of Roy A. Taylor and S. W. Sibley, at the First National Bank of Wichita Falls, Texas; said note bearing interest at the rate of 5% per annum, interest payable quarterly, and containing the usual 10% attorney’s fee clause; said note being secured by a vendor’s lien on the property hereby conveyed, and said note being executed by the said J. W. Crotty and E. H. Shackelford.
    It is understood and agreed that fifty per cent (50%) of the seven-eighths (%ths) of the oil produced from the property above described from and including April 10, A. D. 1919, shall be run into the pipe line to which the wells on said property may be connected to the credit of T. J. Taylor, Trustee, for the use and benefit of the said Roy A. Taylor and S. W. Sibley (said oil already being under contract to the Wichita Yalley Refining Company), at a price of five cents bonus on the posted price maintained in the Wichita County oil fields, which contract expires July 1, A. D. 1919. And as payment for said oil is received by the said T. J. Taylor, the amount thereof shall be credited upon said note as of the date received, and when said sales contract expires, said oil may be sold by the said J. W. Crotty and E. H. Shackelford for such price as they may be able to obtain, and to such parties as they desire, provided only that said oil shall not be sold at a price below the posted pipe line price maintained in the Burkburnett Oil Field, and shall be sold to parties whose financial standing is satisfactory to the said T. J. Taylor, Trustee, and who shall pay therefor each thirty days. This division of said oil shall continue until the said T. J. Taylor, Trustee, shall receive from the sale of said oil the sum of One Hundred Thousand ($100,000.) Dollars in cash, and during said time the remaining fifty per cent of said oil shall go to the credit of the said J. W. Crotty and E. H. Shackelford, and the proceeds thereof shall be free and clear from all obligations or liens hereby created.
    From and after the time the said T. J. Taylor, Trustee, has received from the fifty per cent of the oil above provided for the sum of One Hundred Thousand ($100,000.00) in cash, then the runs from said oil shall be divided seventy-five per cent to the said T. J. Taylor, Trustee, and twenty-five per cent to the said J. W. Crotty and E. H. Shackelford; said oil to be sold and the proceeds handled in the same way as is provided in the preceding paragraph for the first oil run from said property until the full amount of said note, and the interest thereon has been paid, whereupon the title hereby conveyed shall become absolute, and neither the grantors and the said T. J. Taylor, Trustee, shall have any further interest in same, it being expressly agreed and understood that, if the portion of the oil above specified to go to the credit of the said T. J. Taylor, Trustee, does not within the terms of said note mature same, then on April 10, A. D. 1920, the balance remaining unpaid on said note shall be due and payable.
    It is expressly agreed and stipulated that the vendor’s lien, except as to the oil going to the grantees herein, is retained against the above described property, premises and improvements until said note, together with all interest therein, is fully paid and according to its face, tenor, effect and reading, whereupon this grant shall become absolute.
    Crotty was a professional promoter. Shackelford was an oil driller. The $115,000 which constituted the cash payment, was advanced by the Wichita Yalley Refining Co. To secure this advancement, Crotty and Shackelford assigned to the Wichita Yalley Refining Co., the remaining 50 per cent of the seven-eighths of the oil which remained to them under the contract of sale. In July or August, 1919, Crotty and Shackelford became unable to pay operating expenses and material men’s liens were filed against their property on the leased premises. Crotty and Shackelford then acknowledged their inability to go further and the lease was for the remainder of the year 1919 operated under the joint management of the Wichita Valley Refining Co. and Taylor as trustee for the partnership.

      In the latter part of the year 1919 and while the lease was being operated under the joint management of Taylor, Trustee, and the Wichita Valley Refining Co., an offer was made that the former transfer to the latter the lien note and all interest in the lease, for the sum of $25,000, and the one-half of the oil that had been credited to the Wichita Valley Refining Co. This offer was accepted and the transfer consummated in the early part of 1920. The total value of the oil which had been applied to the purchase-money note of $320,000 during the year 1919, was $47,835.08 and a like amount had been credited during that year to the Wichita Valley Refining Co. on their advancement. The decedent received for the note, the total sum of these amounts, or $120,670.16, which was the value of the note when received from Crotty and Shackelford. During 1919, Taylor and his associates endeavored to sell the note to various bankers but the bankers refused to purchase it unless it was endorsed by solvent third parties. Taylor and his associates offered during the year 1919, to sell the note at 40 cents on the dollar, but such offer was refused. Crotty owed various individuals in the vicinity of Dallas, Tex., various amounts due on promissory notes, and the holders of the notes were unable to secure payment during 1919 and prior years, and the notes remained unpaid at the date of the hearing of this proceeding.
    In December, 1919, S. W. Sibley executed and delivered to T. J. Tajdor, his note for $24,000, due in six months: At the same time, Taylor delivered to Sibley 600 shares of the stock of the Sanders Taylor Oil Co. Sibley pinned the stock to the note and left both with Taylor. The note was extended, but never paid, and in 1921, by agreement between Taylor and Sibley, the note was destroyed and Taylor left in possession of the stock. During this time the stock was voted at the stockholders’ meetings by a Mr. Kell, as proxy for Sibley. The cost of this stock to Taylor is not shown.
   OPINION.

MilliKen :

T. J. Taylor died in 1922. We did not have the benefit of his testimony. Petitioner was compelled to rely on a witness, who, though a close friend and business associate, did not have that comprehensive knowledge of the transactions involved which was possessed by the decedent.

At the time the lease in question was sold, Wichita County, Texas, was experiencing the tumult of an oil boom. Excitement was rife. Chances were freely taken. The general condition was abnormal. Informal contracts involving large amounts were unhesitatingly entered into. Speculators and promoters without funds flourished. Their potential schemes seemed realities. Crotty. and Shackelford belonged to this class. While they were not financially responsible for the large sum involved in this transaction, Taylor and his associates were willing to take chances, relying on the cash payment, their vendor’s lien and their share of the oil run. Within 90 days after the sale, the promoters became unable to fulfill their obligations with the result that Taylor and his associates and the Wichita Valley Refining Co. were compelled to and did operate the lease until the final adjustment between them. The lien note was offered for sale at 60 per cent discount and the offer refused. We are of the opinion that the oil flow credited to the note in 1919, plus the price offered Taylor and his associates in 1919 for the sale of their interests, and the note, which was accepted in the early part of 1920, is the proper basis for the valuation of the note. We have accordingly fixed the value of the note in 1919 at $120,670.16.

We do not pass on the good faith of the sale of stock of the Sanders Taylor Oil Co. by Taylor to Sibley. It is sufficient to point out that the testimony does not establish the cost of the stock sold. The witness Sibley is the only one who testified as to this alleged sale. At the conclusion of his testimony, he was asked :

Mr. Milliken : Do you know, Mr. Sibley, of your own knowledge, not based upon hearsay, what the stock of the Sanders Taylor Oil Company cost Mr. Taylor?
A. Only what be told me.
Q. Only wbat be told you?
A. Yes, sir.
Q. In other words, that is the only information you have?
A. Direct information, yes, sir.

The testimony in the record is not sufficient to establish that the decedent suffered a loss in 1919 by reason of a sale of stock to Sibley.

It is evident that respondent has duplicated the income of decedent to the extent of $1,660. Upon redetermination this error should be corrected.

Judgment will be entered on W days’ notice, vrnder Rule 50.

Considered by Phillips and Marquette.