*2908 Deduction for bad debt reserve disallowed.
*781 The respondent has asserted deficiencies in income taxes for the fiscal years ended May 31, 1921, and May 31, 1922, in the respective amounts of $1,021.82 and $6,429.16. The petitioner assigns as error (1) the respondent's action in reducing invested capital for the fiscal year 1921 by the amount of $3,478.16, which is the applicable portion of the prior year's income and profits taxes; (2) the respondent's action in reducing invested capital for the fiscal year 1922 by the amount of $7,285.44, which is the applicable portion of prior year's income and profits taxes, and (3) disallowance by the respondent of a deduction for the fiscal year 1922 of $25,000 as a bad debt reserve.
At the hearing petitioner abandoned the first two allegations of error, leaving for determination only the question of deductions on account of the reserve for bad debts.
FINDINGS OF FACT.
The petitioner is a North Dakota corporation, maintaining its principal offices at Minneapolis, *2909 Minn. It operates as a grain commission merchant, selling grain for local elevator operators located throughout North Dakota, South Dakota, and Minnesota.
The wheat which was shipped to petitioner by the local elevators was secured by the latter through purchase outright or as bailee, in which case a warehouse receipt was issued to the bailor. When wheat was received by petitioner it could not tell whether the shipper was bailee or owner. Under the South Dakota statutes the petitioner was contingently liable for all wheat received from a bailee on which there was a warehouse receipt outstanding.
The petitioner financed the local elevator operators by advancing, from time to time, money for use in purchasing wheat. An open account was maintained with each elevator and money advanced was charged to the account. When a shipment of wheat was received and sold the proceeds from the sale were credited to the account. The *782 following accounts for the fiscal year ended May 30, 1922, appear upon petitioner's books as follows:
| Customer. | Balance at May 31, 1921 | Charges | Credits | Balance at May 31, 1922 |
| Farmers' Elevator Co., Athol, S. Dak | $33,675.97 | $50,965.52 | $58,838.67 | $25,802.82 |
| H. H. Persson & Co., Blunt, S. Dak | 13,628.75 | 90,151.29 | 87,524.52 | 16,255.52 |
| F. F. Coffey, Florence, S. Dak | 8,500.00 | 8,500.00 | ||
| Hegge Grain Co., Hatton, N. Dak | 11,884.56 | 52,075.90 | 49,526.13 | 14,434.39 |
| Farmers' Elevator Co., Moritz, S. Dak | 3,429.29 | 22,113.37 | 19,704.66 | 5,838.00 |
| O. B. Light, Pierpont, S. Dak | 15,578.58 | 94,795.58 | 79,288.72 | 31,085.44 |
| Total | 86,697.15 | 101,916.11 |
*2910 In its income-tax return for the fiscal year ended May 31, 1922, petitioner deducted $25,000 as a reserve for bad debts. It alleges that this deduction should be increased to $50,000.
Prior to the fiscal year 1922, petitioner followed the practice of deducting specific debts ascertained to be worthless and charged off its books during the year. In the fiscal year 1922 petitioner departed from this practice and set up a reserve for bad debts. This change was made without application to the respondent.
Each open account which petitioner maintains with an elevator operator is secured by a mortgage on the elevator property and by a note signed by several persons as surety, e.g., in the case of a corporation operating an elevator, the stockholders were required to sign the note.
Of the accounts listed above which, petitioner, contends, were worthless to an extent justifying a reserve of $25,000, all but one were continued during the years following. Foreclosure proceedings were itstituted in the accounts of F. F. Coffey, Hegge Grain Co., O. B. Light, and Farmers' Elevator Co., of Moritz, S. Dak., during the succeeding years. Accounts maintained with the elevator operators, *2911 including many of those listed above, were changed to a "bill of lading" basis at a time several years subsequent to the taxable year.
OPINION.
LANSDON: The petitioner contends that it should be allowed a deduction for the fiscal year ended May 31, 1922, in the amount of $50,000 as a reserve for bad debts. Section 234(a)(5) of the Revenue Act of 1921 provides:
SEC. 234. (a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
* * *
(5) *783 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.
The statute provides for a deduction of a "reasonable addition" to a reserve for bad debts as an alternative to a deduction for debts ascertained to be worthless and charged off during the taxable year. In no event is a deduction to be allowed on account of bad debts in an amount greater than properly belongs to the taxable period.
The petitioner seeks to establish*2912 the reasonableness of the reserve contended for by showing the balance appearing on certain of its accounts receivable, and by showing that it was subject to a contingent liability to holders of warehouse receipts for wheat purchased by petitioner from the bailee. The accounts receivable, set forth in our findings of fact, were open, running accounts, all of which carried over balances from previous years and most of which continued during succeeding years. As security for each account petitioner held a mortgage on the elevator and a note signed by others than the obligor as surety. During subsequent years foreclosure proceedings were instituted on some of the mortgages; but there is no showing that a loss ever resulted to petitioner.
There is nothing in the record to show the extent, if any, to which petitioner became liable to bailors of wheat received by it from elevator operators. It is purely a contingent liability and, under the facts of this case, is not a basis for a bad debt reserve. There is no evidence with respect to its experience as to losses over a period of years; to its gross sales; to its total accounts and notes receivable; or to the percentage of gross profit*2913 to net profit. The petitioner has failed to establish that there were any specific debts ascertained to be worthless and charged off during the taxable year.
The record offers no basis upon which we can determine the reasonableness of the amount, if any, of petitioner's net addition during the year to its reserve for bad debts. We do not think such reserve was determined in the manner contemplated by section 234(a)(5) of the Revenue Act of 1921. ; ; ; .
Decision will be entered for the respondent.