1931 BTA LEXIS 2198">*2198 BAD DEBTS. - Certain notes held by the Robert Smith Corporation became worthless during the taxable year 1925. The officers of that company, during the taxable year 1925, determined such notes to be worthless and charged them off the corporation's books. Held, the amount so determined to be worthless and charged off, was deductible from the corporation's gross income under the provisions of section 234(a)(5) of the Revenue Act of 1926.
21 B.T.A. 1400">*1400 These proceedings, upon motion made by petitioners, were consolidated. The Robert Smith Corporation is a Pennsylvania corporation, with its principal office at Philadelphia. On the date of hearing before this Board, it was still in existence, although its assets had been distributed to its stockholders, among whom were the seven 21 B.T.A. 1400">*1401 remaining petitioners in these proceedings. The respondent has determined deficiencies against the Robert Smith Corporation for the calendar years 1924 and 1925 of $3,167.55 and $6,839.99, respectively. He has also determined liabilities of like amounts against each of the1931 BTA LEXIS 2198">*2199 seven remaining petitioners under the provisions of section 280 of the Revenue Act of 1926, on the ground that they were transferees of the assets of the Robert Smith Corporation.
At the hearing it was stipulated and agreed to between the parties, that the last seven petitioners admitted their liability as transferees of the assets of the Robert Smith Corporation for any deficiency which the Board might determine to be due from the Robert Smith Corporation. No complaint is made against the respective deficiencies for the year 1924. We, therefore, affirm the respondent's determination as to that year.
The parties also agreed that the only remaining issue was whether the Robert Smith Corporation was entitled to deduct from its gross income for the calendar year 1925, as bad debts, an amount of $43,415.31 representing three notes given by the Philadelphia Malt Extract Co.
FINDINGS OF FACT.
Sometime prior to 1918, the stockholders of the Robert Smith Corporation were approached by a chemist who represented that he had a process for the manufacturing of malt syrup and kindred products which improved greatly all existing processes. He proposed the formation of a corporation1931 BTA LEXIS 2198">*2200 for the manufacture of malt syrup and kindred products. After a satisfactory investigation of the man's character and ability, and his process, it was decided to form a corporation for these purposes. The corporation, known as the Philadelphia Malt Extract Co., was organized in accordance with these plans in September, 1918.
The Robert Smith Corporation leased to the Philadelphia Malt Extract Co. a certain factory property which was vacant at that time. The rental agreed upon was $12,000 per annum, payable monthly in installments of $1,000 each.
The Robert Smith Corporation agreed to finance the Philadelphia Malt Extract Co. through the purchase of stock and loans. Pursuant to this plan, there was advanced to the latter company $93,415.31. The former company took $50,000 of this sum in preferred stock of the latter company and notes for the balance in the following amounts on the following dates:
| September 9, 1919 | $33,777.97 |
| November 26, 1919 | 1,222.51 |
| May 26, 1920 | 8,414.83 |
| Total | 43,415.31 |
21 B.T.A. 1400">*1402 On November 30, 1925, there was due and owing the Robert Smith Corporation, as unpaid rent from the Philadelphia Malt Extract Co., the sum of $56,000. 1931 BTA LEXIS 2198">*2201 On that date this item of $56,000 was transferred into the hands of the liquidating trustee of the Robert Smith Corporation, and is still unpaid.
Demands were made on the Philadelphia Malt Extract Co. for payment of the rent annually by the officers of the Robert Smith Corporation. A formal letter was written by the president of the Robert Smith Corporation to the Philadelphia Malt Extract Co., demanding settlement of this rent account.
The Philadelphia Malt Extract Co. was always in the position of a debtor company and was never able to operate on a profitable basis. Its obligations from the date of its incorporation steadily increased and the capital of the company was steadily impaired.
Their financial statement dated June 30, 1925, reads as follows:
| ASSETS | ||
| Inventory: | ||
| Raw material | $27,903.33 | |
| Engineering Dept | 1,263.82 | |
| Cooperage, cans, cartons, etc | 13,453.55 | |
| Auto operation | 211.10 | |
| Sundries | 700.02 | |
| $43,531.82 | ||
| Finished products | 11,856.13 | |
| Equipment | 18,366.10 | |
| Accounts receivable | 70,493.50 | |
| Deferred and unadjusted items: | ||
| The Robert Smith Corporation | 117,541.41 | |
| Unearned Insurance Premiums | 1,894.65 | |
| 119,436.06 | ||
| Cash on hand | 10,331.77 | |
| 274,015.38 | ||
| LIABILITIES | ||
| Accounts payable | $149,722.75 | |
| Notes payable | 51,014.63 | |
| $200,737.38 | ||
| Depreciation reserves | 2,600.82 | |
| 203,338.20 | ||
| Capital Stock | 200,000.00 | |
| Deficit | 129,322.82 | |
| 70,677.18 | ||
| 274,015.38 |
1931 BTA LEXIS 2198">*2202 21 B.T.A. 1400">*1403 The financial statement of the Philadelphia Malt Extract Co. on December 31, 1925, is as follows:
| ASSETS | ||
| Inventory: | ||
| Raw material | $20,191.78 | |
| Engineer's dept | 1,400.93 | |
| Cooperage, cans, cartons, etc | 7,376.21 | |
| Auto operation | 597.51 | |
| Sundries | 1,013.37 | |
| $30,579.80 | ||
| Finished product | 9,531.89 | |
| Equipment | 238,875.49 | |
| Accounts receivable | 51,971.00 | |
| Cash on hand | 4,411.60 | |
| 335,369.78 | ||
| LIABILITIES | ||
| Accounts payable | 121,163.41 | |
| Notes payable | 50,209.31 | |
| Deferred items | 41.78 | |
| Depreciation reserves | 128,302.06 | |
| 299,716.56 | ||
| Capital stock | 200,000.00 | |
| Deficit | 164,346.78 | |
| 35,653.22 | ||
| 335,369.78 |
The equipment shown in the financial statement of December 31, 1925, as an asset, in the amount of $238,875.49, had a value of only $25,000 or $30,000. This equipment constituted the company's principal assets and consisted of mash tubs, water pumps, meal grinders, evaporators, storage tanks, scales, boilers, cooling tower, and various pipes leading from one apparatus to another, designed to carry cold, hot water and steam, and underground pipes and wiring.
The Philadelphia Malt Extract Co. was also, in the year 1925, indebted1931 BTA LEXIS 2198">*2203 to the Froedtert Malt & Grain Co. in the sum of $60,000, representing a judgment which the latter company had obtained against the former company in that year.
Demands were made for the payment of the three notes of the Philadelphia Malt Extract Co., totaling $43,415.31, held by the Robert Smith Corporation, but no payments were made at any time to the Robert Smith Corporation by the debtor company. Neither were any arrangements made by the two companies for a settlement of the amount of this indebtedness as evidenced by the notes. The Robert Smith Corporation, after carefully considering all of the facts in connection with the indebtedness of the Philadelphia Malt Extract Co., as evidenced by the three notes totaling $43,415.31, 21 B.T.A. 1400">*1404 decided, on November 30, 1925, that the notes were worthless, and on the same date charged the amount off by making the proper entries in the books of account of the corporation. The said three notes totaling $43,415.31 had no value as of November 30, 1925. The said notes were destroyed by the Robert Smith Corporation, along with other worthless papers, some years after November 30, 1925. The Robert Smith Corporation did not endeavor to1931 BTA LEXIS 2198">*2204 effect collection of the notes through the institution of legal proceedings.
The Robert Smith Corporation, in filing its income tax return for the calendar year 1925, claimed as a deduction for bad debts the above amount of $43,415.31. The respondent disallowed the deduction and added the amount to income.
OPINION.
LOVE: The only issue remaining in these proceedings is whether the respondent's action in disallowing the amount of $43,415.31 as a deduction for bad debts, was proper. The applicable statute is section 234(a)(5) of the Revenue Act of 1926, which reads as follows:
SEC. 234. (a) In computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
* * *
(5) 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 the charged off in part; * * *
The officers of the Robert Smith Corporation, on November 30, 1925, after carefully considering everything in connection with the notes, ascertained them1931 BTA LEXIS 2198">*2205 to be worthless and charged them off the books of the corporation. The only question for us to decide is whether such action on the part of the company's officers was justified and in accord with what the ordinary prudent person would have done under the same facts and circumstances.
In the first place, the officers of the Robert Smith Corporation, being also officers of the debtor company, were in an unusually advantageous position to know the facts as to the debtor's ability to pay. The financial statements show that the Philadelphia Malt Extract Co. was holelessly insolvent. It had not been on a profitable basis from its inception. It was owing the Robert Smith Corporation $56,000 for past-due rent. The market value of its principal assets had greatly depreciated. Its obligations were increasing year by year. A judgment for $60,000 by an outside party had just been rendered against it. Demands were made by the Robert Smith Corporation for payment of the notes, but the conditions of the debtor were such that no payments could presently be made or in 21 B.T.A. 1400">*1405 all probability could ever be made. Under such circumstances, we think the officers of the Robert Smith Corporation1931 BTA LEXIS 2198">*2206 were justified in ascertaining the notes in question to be worthless and in charging them off the books of account.
The respondent, in his brief, states his position as follows: "The Commissioner's position in this case is that in view of the peculiar circumstances involving family interests, the transaction involved in this proceeding was in the nature of a capital transaction and the forgiveness and/or cancellation of an indebtedness."
Finally, the respondent contends that the record does not disclose when the notes in question were due and payable, and that in the absence of such an important fact, the case must be decided in favor of the respondent on the authority of the Board's decision in . In other words, the respondent would construe our decision in the case just cited as holding that in no case could a deduction be taken for a bad debt until the year the debt matured. We did not so hold and do not so hold. The fact that a debt has not matured is only a circumstance to be taken into consideration in ascertaining whether or not it is worthless. Such was our holding in 1931 BTA LEXIS 2198">*2207 , wherein we allowed a bad debt deduction in 1920 on account of a note which did not become due until 1921, the facts showing that the note was actually worthless in 1920, ascertained to be such and charged off in that year.
The evidence in the instant case convinces us that the officers of the Robert Smith Corporation were thoroughly justified in their ascertainment of worthlessness and subsequent charge-off, during the taxable year 1925, of the three notes in question, and that the respondent erred in refusing to allow the deduction of $43,415.31, as claimed.
Judgment will be entered under Rule 50.