1929 BTA LEXIS 2270">*2270 Deduction from gross income of 1921 of the unrecoverable portion of a debt allowed.
17 B.T.A. 599">*599 The Commissioner determined a deficiency in income and profits taxes for the calendar year 1921 of $14,178.18. The petitioner alleges 17 B.T.A. 599">*600 that the Commissioner erred in adding to net income as reported, $50,000 claimed as a deduction for the unrecoverable portion of a debt or as a reasonable reserve, and that he erred further in not allowing the deduction of $144,000 on account of this debt or a reasonable reserve therefor.
FINDINGS OF FACT.
The petitioner is a New York corporation with its principal office in New York City. Its regular business had been the importing of cresote oils which it sold for the most part to railroads for preserving wood. All of its accounts had been good and prior to 1921 it had never charged any amount off its books as a bad debt and had never had a reserve for bad debts.
Due to the war, the petitioner's regular business practically ceased. The petitioner was then brought in touch with a man1929 BTA LEXIS 2270">*2271 named Chipman who was in the weed-killer business. The railroads were also the principal customers of this business. Chipman had organized the Chipman Chemical Engineering Co., Inc., hereafter called the Chemical Co., which needed money to carry on its business. The petitioner, in January, 1918, agreed to furnish some of the needed money and acquire some stock in the company. It did both.
The petitioner, in each year after 1917, advanced substantial sums of money to the Chemical Co., some of which the latter repaid. By the beginning of 1921 the Chemical Co. owed the petitioner $144,000. The Chemical Co. was not operating at any substantial profit. It had had hopes of making a profit but due partly to the uncertainty of the arsenic market during the war and thereafter, its expected profits had never satisfactorily materialized.
The officers of the petitioner were in close touch with the affairs of the Chemical Co. For 1921 Chipman reported that the company had certain prospective business from which the profit should be about $400,000, and for which several hundred thousand dollars would be needed as operating capital. The officers of the petitioner considered the matter1929 BTA LEXIS 2270">*2272 of advancing this money. The money which their company had advanced for 1920 had been returned and yet it still had considerable money tied up in the Chemical Co. They decided to advance additional funds and by December 31, 1921, the Chemical Co. owed the petitioner $427,631.22 and had had a loss on its business for the year. Also, the petitioner had caused another company to lend $11,000 to the Chemical Co. By this time the petitioner held a little over one-half of the stock of the Chemical Co.
The balance sheet of the latter company as of December 31, 1921, taken from its books was as follows:
| Dr. | Cr. | |
| A. Garfield National Bank | $473.64 | |
| Coal & Iron National Bank | 176.60 | |
| Equitable Trust Co | 9.73 | |
| Portland cash account | 121.15 | |
| Bound Brook cash account | $769.16 | |
| Houston cash account | 65.94 | |
| New York office fund | 88.61 | |
| Portland petty cash fund | 3.36 | |
| Accounts receivable | 58,779.65 | |
| Public Service Co. of New Jersey | 295.25 | |
| Reserve for doubtful accounts | 1,309.86 | |
| Advances to officers and employees | 1,008.67 | |
| B. Inventories | 205,781.60 | |
| C. Bound Brook real estate | 4,197.00 | |
| Bound Brook buildings | 18,676.27 | |
| Bound Brook reserve for depreciation of buildings | 213.02 | |
| Bound Brook factory equipment | 17,061.32 | |
| Bound Brook factory reserve for depreciation | 5,081.38 | |
| Bound Brook laboratory | 747.46 | |
| Bound Brook laboratory reserve for depreciation | 117.74 | |
| Insecticide plant equipment | 15,398.47 | |
| Arsenic acid plant | 1,212.44 | |
| Portland factory equipment | 15,733.87 | |
| Portland factory reserve for depreciation | 376.36 | |
| Houston equipment | 33,594.65 | |
| Sprinkler equipment | 102,063.27 | |
| Sprinkler equipment reserve for depreciation | 17,093.09 | |
| Furniture and fixtures, New York | 3,539.43 | |
| Furniture and fixtures, New York, reserve for | ||
| depreciation | ||
| Furniture and fixtures, San Francisco | 307.50 | |
| Furniture and fixtures, Buenos Aires | 165.73 | |
| Buildings and plant at Ferry's Fork, Va | 473,907.20 | |
| Buildings and plant at Ferry's Fork, Va., | ||
| reserve for depreciation | 23,721.31 | |
| Good will, patents, trade-marks, rights, etc | 49,541.19 | |
| D. Arsenate of lead, manufacturing license | 2,500.00 | |
| Applied "A" expense | 5,998.99 | |
| Arsenic plant expenses deferred | 1,087.09 | |
| Advertising stationery | 1,500.00 | |
| Prepaid insurance | 975.27 | |
| Buenos Aires, consignment account | 66,036.13 | |
| Buenos Aires, current | 8,695.11 | |
| Buenos Aires, reserve | 6,496.73 | |
| Buenos Aires, acceptances pay | 2,436.63 | |
| Cuba contract | 125.13 | |
| E. Notes payable, Bernuth-Lembcke | 438,631.22 | |
| Notes payable, general | 18,716.00 | |
| Accounts payable | 49,856.74 | |
| Bernuth-Lembcke interest account | 11,595.68 | |
| Atlas Preservative Co | 300.00 | |
| Accrued interest payable | 2,994.16 | |
| Accrued mortgage interest payable | 199.50 | |
| F. Mortgage on real estate | 7,000.00 | |
| Atlas Preservative Co. 10-year debenture notes | 15,000.00 | |
| Sundry reserves | 26,698.11 | |
| G. Reserve for insurance, interest and taxes | 120.28 | |
| Reserve for insurance | 43.88 | |
| H. Debenture, 8 per cent stock | 300,000.00 | |
| Common stock | 200,000.00 | |
| Surplus | 44,847.75 | |
| Profit and loss, year 1921 | 6,075.11 | |
| 1,135,130.62 | 1,135,130.62 |
1929 BTA LEXIS 2270">*2273 17 B.T.A. 599">*601 At December 31, 1921, the Chemical Co. owed its creditors at least $573,253.17. None of the assets listed in the above statement was worth more than the amount shown as its book value.
The accounts receivable were subject to certain cattle claims, in the amount of $2,000, not shown on the above statement.
The sprinkler equipment had been hastily constructed and had been subjected to unusually hard use. It consisted of tank and flat cars equipped for spraying a solution of compound of arsenic along railroads at a certain rate. By the close of 1921 the practice was to spray much less liquid than the equipment of the Chemical Co. 17 B.T.A. 599">*602 was designed to spray. The best system then was to use atomizers which replaced much of the water formerly used with air. By the close of 1921 the sprinkler equipment of the Chemical Co. was somewhat obsolete and was not worth the amount at which it was carried on the books.
An arsenic mine owned by the Chemical Co. was shown on its books as "Bldgs. & Plant at Ferry's Fork, Va." By 1919 this mine had proven to be a complete failure for the company's purpose. The mine was not operated after the fall of 1918, but the Chemical1929 BTA LEXIS 2270">*2274 Co. continued to hold the mine property through the year 1921 and until several years thereafter when it finally sold the last of the property. From the several sales of various parts of this property it realized less than $10,000. On December 31, 1921, this asset was worth not more than $10,000.
The item shown on the statement as "Good-will, Patents, Trade Marks, Rights, etc." represented assets acquired at the time of the organization of the Chemical Co. from another company amd from Chipman. They then had considerable value but at December 31, 1921, they had little, if any, value.
The items listed as "Buenos Aires - Consignment Acct." and "Buenos Aires - Current" represented sheep dip sent to the Argentine. Before this merchandise reached its destination the price of wool fell so that there was little demand for the sheep dip. The petitioner was unable to sell this sheep dip for more than enough to pay expenses incident to its storage and sale. The officers of the Chemical Co. and those of the petitioner knew by December 31, 1921, that this merchandise was not worth more than $35,000. It was sold within the next six months for $4,000.
The total assets of the Chemical1929 BTA LEXIS 2270">*2275 Co. at December 31, 1921, were not worth more than $500,000.
In the latter part of 1921 the officers of the petitioner who were familiar with the affairs of the Chemical Co., after due consideration, decided that the petitioner would have a substantial loss on the money loaned to the Chemical Co. and $50,000 should be charged off on this account. At their instruction the bookkeeper in closing the petitioner's books for 1921 made a journal entry as follows under date of December 31, 1921:
| Profit and loss | $50,000 | |
| To reserve for bad debts | $50,000 | |
| To set up estimated loss on advances to the Chipman Chemical | ||
| Eng. Co. (Inc.) as per statement of that company and their | ||
| balance sheets. |
The petitioner on its return for the year 1921, deducted $50,000 from its gross income as the unrecoverable part of a debt. The Commissioner 17 B.T.A. 599">*603 in determining the deficiency disallowed this claimed deduction and added $50,000 to net income.
After the year 1921 the petitioner continued to lend substantial sums to the Chemical Co. The latter company was still doing business at the time of the hearing in this case, November 5, 1928.
OPINION.
MURDOCK: The1929 BTA LEXIS 2270">*2276 charge-off in question in this case is really a partial write-off of a single account rather than an addition to a reserve for bad debts and if the deduction is to be allowed it must be as a debt recoverable only in part and charged off in part. The Revenue Act of 1921, which applies here, was the first revenue act containing a provision for the deduction of a partial charge-off. In section 234(a)(5) it provided for the deduction of:
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 petitioner claims that the $50,000 was properly deducted because a debt was recoverable only in part and was charged off in part. We agree with this contention. The Chipman Chemical Engineering Co. had borrowed $427,631.22 from the petitioner at the close of 1921. This fact was clearly shown by the evidence, which included pages from the books of the two companies. In addition, the Chipman Chemical Engineering Co. owed some money to others, the total1929 BTA LEXIS 2270">*2277 amount of money which it thus owed was about $573,000, leaving out of consideration its liability to its stockholders as such. Its total assets at the time were not worth $573,000, and in our opinion were not worth more than $500,000, if indeed they were worth that much. One important reason for this insolvent condition was that the arsenic mine property carried on the books at about $450,000 was in reality worth only about $10,000. Vain efforts had been made to sell it for more. Other assets were worth considerably less than the amount at which they were carried on the books of the company. If the company had been allowed to discontinue business, much of its equipment would have been even less valuable. The officers of the petitioner, hoping to salvage some part of their company's investment in the Chipman Chemical Engineering Co., continued to advance it money even after the taxable year. But at the close of 1921 they believed that they would have a loss of at least $50,000 on the money they had already advanced. We believe they were justified in this belief and that their debt was recoverable only in part. 1929 BTA LEXIS 2270">*2278 ; . 17 B.T.A. 599">*604 The deficiency should be recomputed allowing the deduction of $50,000.
The Commissioner in his brief claims that, of the money advanced, much went as consideration for stock. We think, however, that the cost, if any, of the petitioner's stock in the Chemical Co. must be computed without including any part of the money advanced by the petitioner as loans to the Chemical Co. We have here no question of gain or loss on the stock and we need not further consider that phase of the case.
The petitioner, however, contends that it should have charged off and is now entitled to charge off more than $50,000, to wit, $144,000, either on account of a debt recoverable only in part or as a reasonable addition to a reserve. Neither the facts nor the law would, in our opinion, justify or permit a larger deduction than $50,000.
Judgment will be entered under Rule 50.