*2530 1. Respondent's action disallowing deduction taken by the petitioner on account of certain bonds claimed to have become worthless and charged off in 1921 sustained.
2. Respondent's action in adding to petitioner's income for 1921 increases and balances in certain reserve funds modified.
*1081 This proceeding is for the redetermination of a deficiency in income and profits taxes asserted by the respondent for the year 1921 in the amount of $163,073.72. The petitioner alleges (1) that assessment and collection of the deficiency are barred by the statute of limitations; (2) that the respondent erred in failing to allow as a deduction from gross income for 1921 the amount of $350,000 on account of certain bonds of the Black Mountain Corporation owned by the petitioner and which it claims became worthless in 1921; (3) that the respondent erred in adding to the petitioner's income for 1921, the additions during that year to so-called reserve accounts for labor trouble and accident liability; and (4) that the respondent erred in adding to the petitioner's*2531 income for 1921 the unexpended balances of certain miscellaneous reserve accounts.
FINDINGS OF FACT.
The petitioner is an Illinois corporation with its principal office in Chicago, Ill. Its business is merchandising coal and operating coal mines.
On August 1, 1917, the petitioner entered into a 20-year contract by the terms of which it agreed to purchase 333,333 1/3 tons of coal annually from the mines of the Black Mountain Corporation, in the eastern part of Kentucky. On the same date two other companies, the By-Products Coke Corporation, and the Middle West Utilities Co., made like contracts with the Black Mountain Corporation. The purchase price of the coal was to be cost, plus a profit of 10 per cent of such cost. The items of cost were specified and included, in addition *1082 to the ordinary expenses incident to mining coal, interest at 6 per cent per annum on a bond issue of $1,250,000 against the property of the seller; the sinking fund requirements under this bond issue; certain amounts per ton on the tonnage produced for depletion, labor trouble, accidents, administrative expense, etc.; taxes and special assessments; repairs, supplies and insurance; wages. *2532 Each of the buyers had the privilege of suspending purchases for any year by giving notice, but was not relieved of the obligation to pay its proportionate share of the interest and sinking-fund requirements. Each of the three buyers owned 3,337 shares of common stock of the Black Mountain Corporation and their aggregate holdings amounted to approximately 51 per cent of the stock outstanding at the close of 1921.
The Black Mountain Corporation was organized in 1909, and by the end of 1911 it had acquired approximately 32,000 acres of coal lands in Kentucky and Virginia. Prior to 1917 the Black Mountain Corporation did not operate any mines. About 8,000 acres of its land, lying for the most part in Virginia, were leased on a royalty basis of 10 cents per ton, but the revenues thus derived were insufficient to meet all the interest charges on outstanding purchase-price bonds, which amounted to $1,980,000. In 1917 these bonds, together with unpaid interest thereon, were refunded into a new issue due in 20 years at 6 per cent, known as the Empire Trust Co. bonds. The amount issued was $2,325,000, the authorized total being $2,500,000. These bonds were secured by a first-trust*2533 deed upon the Virginia lands, and by a second lien upon the Kentucky lands.
In 1917 the Black Mountain Corporation decided to open and operate a mine on its own behalf, with a capacity in three years time of 1,000,000 tons per year. The cost of constructing and equipping the mine was estimated at $1,000,000; and it was believed by the officers of the Black Mountain Corporation that, on the basis of the estimated output and cost, a fair return would be earned upon the investment, including interest on the bonds. In order to obtain the necessary funds to open and develop the mine, another bond issue of $1,250,000, known as the Central Trust Co. bonds, was sold to the public. These bonds were secured by a first lien upon the Kentucky lands, and by a second lien upon the Virginia lands, of the Black Mountain Corporation. The estimates of the cost of opening and developing the new mine, and of the length of time necessary to develop it to full production capacity of 1,000,000 tons per year, were made by engineers experienced in coal-mining developments, and were based upon the usual experiences of the coal industry under normal conditions. However, largely because of the abnormal*2534 wartime conditions then existing, many unexpected difficulties and delays *1083 arose which greatly impeded the work of opening the mine, and enhanced the cost. The result was that instead of having the mine ready to produce and ship coal within some months, and having it at full production capacity within three years, it was not until June, 1919, that any coal from the mine could be shipped. The production for the remainder of that year amounted to approximately 48,000 tons, and only 311,679 tons were produced in 1921. The cost of the mine by that time amounted to approximately $1,800,000.
The Central Trust Co. bonds had produced approximately $1,000,000 for the mine development. After this fund was exhausted the additional funds necessary for developing the mine were supplied by the petitioner, the Middle West Utilities Co. and the By-Products Coke Corporation. The total amount so advanced by the petitioner was $445,885.45. In November, 1920, the Black Mountain Corporation issued general mortgage bonds, running for 10 years, at 7 per cent, in the amount of $1,500,000, and having as security a third lien upon all the coal lands of the company. In May, 1921, the petitioner*2535 received $500,000 face value of these bonds at an agreed price of eighty, in payment of $400,000 of the debt due it from the Black Mountain Corporation. The balance of the debt, $45,885.45, was paid with $53,900 face value of the Empire Trust Co. bonds at eighty-five, and a small amount of cash.
In 1917, and thereafter through the year 1921, F. S. Peabody was president of the Black Mountain Corporation, and was also chairman of the board of the petitioner. His son, S. Peabody, was president of the petitioner. One J. Solari has been secretary of the petitioner since, and including, the year 1917; he is also secretary of the Black Mountain Corporation and held that office as early as the year 1920. The petitioner operated the mine for the Black Mountain Corporation, and that company's books were kept, and its accounting was carried on, under the direction and control of Charles S. Ellis, who was the auditor of the petitioner from 1900 up to and including the year 1921.
For several years war-time conditions had enhanced the price of coal, but in 1921 a sharp decline took place, and by the close of that year the market price of coal of the quality produced by the Black Mountain*2536 Corporation was only about one-half what it had been at the beginning of the year. The lands, plant and equipment of the Black Mountain Corporation were carried at a book value of $7,792,410.71, which was cost less a certain amount of depreciation and depletion. The fair value of that company's lands was approximately $1,870,000, and that of its plant and equipment was approximately $1,000,000 at the close of 1921. The liabilities of the Black Mountain Corporation at the beginning and close of the year 1921, *1084 with respect to the Empire Trust Co. bonds and the Central Trust Co. bonds, were as follows:
| Jan. 1, 1921 | Dec. 31, 1921 | |
| Empire Trust Co. bonds | $2,065,316.16 | $2,240,353.03 |
| Central Trust Co. bonds | 1,191,477.88 | 1,141,248.76 |
| Interest due | 207,876.00 | 264,360.00 |
| 3,464,670.04 | 3,645,961.79 |
The operations of the company since it began producing coal in 1918 have resulted in profit or loss as follows:
| Year | Profit | Loss |
| 1918 | $30,172.86 | |
| 1919 | $12,558.30 | |
| 1920 | 44,944.85 | |
| 1921 | 156,892.64 | |
| 1922 | 197,480.14 | |
| 1923 | 159,328.73 | |
| 1924 | $143,240.99 | |
| 1925 | $40,562.53 | |
| 1926 | 22,575.26 | |
| 1927 | 55,941.53 | |
| 1928 | 61,817.17 |
*2537 The loss in 1928 is due to changing the method of computing depletion from the tonnage to the mine-life basis. The bonded indebtedness of the Black Mountain Corporation at the close of 1921 was:
| Empire Trust Co. bonds | $2,240,353.03 |
| Central Trust Co. bonds | 1,141,248.76 |
| General mortgage bonds (third lien) | 1,500,000.00 |
| Overdue interest, Empire Trust Co. bonds | 247,110.00 |
| 5,128,711.79 |
In November, 1921, the board of directors of the petitioner appointed a committee to investigate and determine the actual value of the general mortgage bonds of the Black Mountain Corporation which the petitioner held, and that board directed that the said bonds be entered and carried on the petitioner's books "at their actual value as determined by said committee," rather than at the cost price. No formal report was made by the committee, but after some inquiries and discussions it determined that the bonds had no value and caused them to be written down from the cost price of $400,000 to $50,000 upon the petitioner's books, in the latter part of December, 1921. No interest upon these bonds has ever been paid. They may mature in 1930.
During the year 1921 the petitioner*2538 sold coal to the Commonwealth Edison Co. and to the Chicago, Rock Island & Pacific Railway Co., under contracts made prior to the year 1921. These contracts required the purchaser to pay to the petitioner the cost to it, each month, of the coal furnished during that month, plus a profit of *1085 10 per cent of such total cost. The cost of the coal to the petitioner was fixed as that proportion of the sum of certain specified items of cost on all coal produced during the month from the particular mines which the tonnage delivered to the Commonwealth Edison Co. and the Chicago, Rock Island & Pacific Railway Co. bore to the total tonnage produced from such mines during the month. Included in the specified items of cost were:
(13) Payments made by the Seller during such month as damages, costs and attorneys' fees, upon claims for personal injury to its employees and others, which injury occurs after the date effective of this agreement, including the services and expenses of claim agents, adjusters, accountants, clerks, consulting physicians and attorneys in connection with personal injuries, and for insurance against such claims, or for a charge to establish and maintain a*2539 fund for the settlement of such claims, together with all costs, attorneys' fees, services and expenses of claim agents, adjusters, accountants, clerks, consulting physicians and attorneys in connection with such claims or the administration of such fund.
(14) A charge of one (1) cent per ton of coal produced, to establish and maintain a fund to defray the expenses of labor troubles.
Said contracts also contain provisions as follows:
It is expressly understood and agreed that the sum of liquidated or unliquidated damages, costs and expenses, arising out of accidents to individuals at said mines, for which the Seller may be liable at the termination of this agreement by lapse of time or otherwise, and which remain unpaid at the date of such termination, shall be mutually agreed upon, or in case of failure to agree it shall be fixed by arbitration in the manner hereinafter set forth, and the amount of said damages, when so ascertained, shall be charged against the cost of coal produced the last month of operation under this agreement. * * *
Upon the termination of this agreement for any cause except default or breach of conditions committed by the buyer, the Seller shall account*2540 to the Buyer for the Buyer's proportionate share of any and all sums remaining unexpended and not required to discharge liabilities then existing, out of the fund to be created or payment to be made as above set forth to defray the expenses of labor troubles, and also out of the fund which may be established for the settlement of damages, costs and attorneys' fees upon claims for personal injury to its employees and others as above set forth, said proportionate share to be equal in proportion that all tonnage previously delivered to the Buyer hereunder shall bear to the entire tonnage previously mined from said mines during the term of this agreement. In case this agreement shall be terminated for any default or breach of its conditions by the buyer, no part of said funds shall belong to or be accounted for to the Buyer.
During the year 1921 the petitioner made monthly charges to the Commonwealth Edison Co. and to the Chicago, Rock Island & Pacific Railway Co. under the provisions of said contracts of approximately 6 1/2 cents per ton for the fund for the settlement of accident claims and expenses. The Commonwealth Edison Co. and the Chicago, Rock Island & Pacific Railway Co.*2541 were also billed monthly for the charges of 1 cent per ton for the labor trouble fund. The amounts *1086 charged to the Commonwealth Edison Co. and the Chicago, Rock Island & Pacific Railway Co. were deposited by the petitioner in special bank accounts, kept entirely separate from the general funds of the petitioner. Separate bank accounts were kept for each mine from which coal was sold to the Commonwealth Edison Co. and the Chicago, Rock Island & Pacific Railway Co. and also for each fund. Whenever a payment was made for accident claims and expenses or for labor troubles in connection with the operation of any mine, such payment was made from the particular fund kept for that mine and not from the general funds of the petitioner. From time to time the cash in the respective funds or bank accounts was invested in securities, and the earnings from the securities were added to the principal fund. The details of receipts and expenditures of the respective funds were kept in separate books of account by the petitioner. The petitioner then transferred monthly to its general books the aggregate of the balances in the accident liability funds, that is, the total of the cash*2542 and securities in the accident liability funds for the several mines, and made a corresponding credit of the total sum to a reserve for accident liability. The petitioner likewise transferred to its general books monthly the aggregate of the balances in the labor trouble funds for the several mines and credited this total sum to a reserve for labor trouble.
During the year 1921 there was a net increase in the reserve for labor trouble of $46,286.16 and a net increase in the reserve for accident liability of $72,041.79.
The net addition to the fund for labor troubles was $25,591.97 in respect to the Commonwealth Edison Co., and $4,061.07 in respect to the Chicago, Rock Island & Pacific Railway Co. The net addition to the fund for accident liability was $52,673.63 in respect to the Commonwealth Edison Co. and $7,348.62 in respect to the Chicago, Rock Island & Pacific Railway Co.
On May 16, 1918, the petitioner entered into a contract for the sale of coal to the Peoples Gas, Light & Coke Co. upon a cost-plus basis. The items of cost were specified and included the following:
(3) A sum equal to fifteen cents (15??) per ton of coal shipped hereunder to apply on account of*2543 overhead expenses, including salaries and wages of all officers and employees of the Seller engaged in managing its entire business, selling coal at Chicago and elsewhere, keeping its accounts, including office rent and general expenses. Adjustments of this item to be made after the termination of this contract in the manner following:
(a) As to shipments made between April 1, 1918, and December 31, 1918, take the total amount of overhead expenses for the calendar year ending December 31, 1918, and divide by the number of tons of coal originating from all sources sold by the seller during said calendar year, so as to ascertain the actual cost per ton for this item, then multiply said cost per ton by the number of tons shipped to the puyer during said nine (9) months period; and (b) As *1087 to shipments made on and after January 1st, 1919, and ending March 31, 1919, take the total amount of overhead expenses for the calendar year ending December 31, 1919 and divide same by the number of tons of coal originating from all sources sold by the seller during said calendar year, so as to ascertain the actual cost per ton for this item, then multiply said cost per ton by the number*2544 of tons shipped to the buyer during said three (3) months.
(4) A sum equal to fifteen cents (15??) per ton of coal shipped hereunder to defray the expense of income, excess-profits and other taxes which may be levied, assessed or charged by the United States Government or Federal authorities against the seller. Adjustment of this item to be made after the termination of this contract in the manner following:
(a) As to shipments made during period commencing with April 1st, 1918, and ending December 31, 1918, by taking the total amount paid or to be paid to the United States Government as shown by reports and returns of the seller for calendar year ending December 31, 1918, and dividing same by the number of tons originating from all sources sold by the seller during said calendar year, so as to ascertain the actual cost per ton for this item, then multiply said cost per ton by the number of tons shipped to the buyers during said nine (9) months period; and (b) As to shipments made between January 1st, 1919, and March 31st, 1919, take the total amount paid or to be paid to the United States Government as shown by reports and returns of the seller for calendar year ending December*2545 31st, 1919, and by dividing same by the number of tons originating from all sources sold by the seller during said calendar year, so as to ascertain the actual cost per ton for this item, then multiply said cost per ton by the number of tons shipped to the buyer during said three (3) months period.
On the same date the petitioner made a like contract with the Central Illinois Public Service Co. Both contracts expired on March 31, 1919.
Under the contracts with the Peoples Gas Light & Coke Co. and the Central Illinois Public Service Co., the petitioner charged to and collected from the buyers monthly an amount equal to 15 cents per ton of coal delivered on account of administrative and general expenses, and also charged and collected the same amount on account of profits taxes. The amounts so charged and collected were credited on the petitioner's books to reserve accounts for the purposes designated, a separate account being set up for each buyer. At the close of the year 1918 there were balances in these reserve accounts as follows:
| Peoples Gas Light & Coke Co | $33,555.50 |
| Central Illinois Public Service Co | 16,617.33 |
After the contracts expired the petitioner*2546 in the year 1919 refunded $7,000 to the Peoples Gas Light & Coke Co. and $3,000 to the Central Illinois Public Service Co. At the close of the year 1919 the credit balances in these reserve accounts were $30,440.13 and $17,538.50, respectively. There were no changes in either reserve account during 1920 or 1921.
*1088 In January, 1922, the respondent determined the petitioner's income and profits-tax liability for the years 1916 to 1920, both inclusive, and notified the petitioner, who accepted the determination. In March, 1922, the petitioner decided that there was no further need for the reserve accounts and the amounts remaining therein, $30,440.13 and $17,538.50, respectively, were transferred to the petitioner's income account for the year 1922.
On December 31, 1919, the petitioner set up on its books a reserve for the adjustment of subsidence claims in the amount of $2,650. This action was taken upon the advice of the petitioner's engineers, who had reported that the surface over certain mines operated by the petitioner had subsided and that the petitioner might be held liable for the resulting damages to the surface owners. There was no change in this reserve*2547 account until December 31, 1922. On that date the amount of the reserve was transferred to the petitioner's income account for 1922 upon the advice of the engineers that there was no probability that the petitioner would be held liable on account of such subsidence.
During the year 1920 a claim was made against the petitioner by one of its customers on account of excessive freight charged by the carrier on about fifteen cars of coal. The amount of the claim was $539.83. The claim was allowed by the petitioner, who in turn made claim against the railroad company. Anticipating other similar claims from the customer, the petitioner in December, 1920, set up a reserve in the amount of $6,600 to provide for any such claims. The claim allowed to the customer was charged against the reserve, leaving a balance of $6,060.17. No further claims on account of said excessive freight charges were made and on March 31, 1922, the petitioner transferred the balance of the reserve account to its income account for the year 1922.
In its return for the year 1921 the petitioner deducted from gross income the amount of $350,000 as a loss sustained in that year on the general mortgage bonds of*2548 the Black Mountain Corporation. The respondent disallowed the deduction. The respondent also added to the petitioner's income for 1921 the net increases in the reserve for labor trouble and the reserve for accident liability, the amounts remaining in the reserve set up by the petitioner on account of its contracts with the Peoples Gas Light & Coke Co. and the Central Illinois Public Service Co. and the amounts remaining in the reserve for subsidence claims and excessive freight, and determined that there is a deficiency in tax in the amount of $163,073.72.
OPINION.
MARQUETTE: The petitioner alleges and the respondent denies that assessment and collection of the additional tax herein are barred by *1089 the statute of limitations. The petitioner did not specifically abandon this issue at the hearing, but it introduced no evidence in support of its claim. On the record we must hold that assessment and collection are not barred.
The next contention of the petitioner is that the general mortgage bonds of the Black Mountain Corporation became worthless in 1921, and that the petitioner should be allowed a deduction on account thereof in the amount of $400,000 as a loss*2549 sustained in that year, and that in any event it should be allowed a deduction of $350,000 representing that portion of the bonds determined to be uncollectible and charged off during the taxable year.
It appears that the petitioner in its return for 1921 claimed a deduction of $350,000 as a loss on the bonds in question. It now claims that it is entitled to a deduction eigher as a loss or as a debt ascertained to be worthless and partially charged off in the taxable year.
We find no error in the respondent's determination that the petitioner is not entitled to any deduction on account of these bonds. The evidence does not, in our opinion, establish a loss sustained in 1921. The Black Mountain Corporation was not in liquidation, but was a going concern, and has continued operations up to the present time. The petitioner made no attempt to sell the bonds and although the value of the assets underlying them may have diminished, that does not establish a deductible loss under the statute. This Board held in , that:
Until it is clearly shown that stock owner in a corporation which is still in existence and has assets is in fact worthless*2550 and there is no probability that any portion of the investment will ever be recovered, no deductible loss under the statute has been sustained. The term "losses sustained" conveys the idea of a final termination of a transaction in connection with which the investment was made and the loss claimed.
The same conclusion was reached in ; ; ; . These causes are applicable and decisive in the present instance
Nor do we see any reason for allowing as a deduction in 1921 the cost to the petitioner, or any part, of the bonds as a debt ascertained to be worthless in that year. Assuming for the purpose of this opinion that bonds may be charged off and deducted as worthless debts, the evidence does not show, in our opinion, that the bonds in question were in 1921 the proper subject of a charge-off and a deduction. They do not mature until 1930. The Black Mountain Corporation is a going concern owning many thousands of acres of coal land and other assets. It appears to*2551 be true that if the corporation had liquidated in 1921 and disposed of its assets at the *1090 then prevailing market price, it would not have realized sufficient money therefrom to discharge its obligation on the first and second mortgage bonds, and the petitioner would have received nothing on its third mortgage bonds. But it does not follow that the depressed condition of the market for coal and coal lands would continue indefinitely, or that by the time the bonds matured the corporation would not have sufficient assets to pay them. We do not consider that in 1921 the bonds were worthless in whole or in part within the meaning of the Revenue Act of 1921, and the petitioner's claim is denied.
The next question is whether the respondent erred in adding to the petitioner's income for 1921 the amount of the net additions in that year to the reserves for labor trouble and accident liability. The evidence shows that the petitioner sold coal to the Commonwealth Edison Co. and the Chicago, Rock Island & Pacific Railway Co. on a cost-plus basis. Under the contracts the cost to the petitioner was to include amounts that it might be required to pay on account of labor trouble*2552 and accident liability in connection with the coal furnished. In order to meet this possible liability the petitioner collected from the buyers each month a certain amount per ton on all coal shipped to them and the amounts so collected were set aside in separate funds. Whenever a payment was made for accident claims or on account of labor trouble it was made from the particular fund kept for that purpose and not from the general funds of the petitioner. While the funds were kept separate and apart from the general funds of the petitioner, the amounts collected but unexpended in each month were transferred to the petitioner's general books and a corresponding credit was made to reserves for labor trouble and accident liability. However, no part of the amounts collected by the petitioner from the buyers to cover labor trouble and accident liability belonged to the petitioner until a liability attached on account of labor trouble or accident and then the funds became subject to the petitioner's use in an amount sufficient to discharge the liability and to that extent they became income to the petitioner. But any unexpended balance remaining in either fund did not belong to the petitioner*2553 and was not income and could not become income until the petitioner was required to use the fund for the purpose for which it had been collected. We are, therefore, of the opinion that these unexpended balances neither should be included in gross income nor added to the reserves and deducted in computing net income. As shown by the findings of fact, the net addition to the fund for labor trouble was $25,591.97 in respect to the Commonwealth Edison Co. and $4,061.07 in respect to the Chicago, Rock Island & Pacific Railway Co. The net addition to the fund for accident liability was $52,673.63 in respect to the Commonwealth *1091 Edison Co. and $7,348.62 in respect to the Chicago, Rock Island & Pacific Railway Co. These amounts will be excluded in computing the petitioner's income for 1921.
The next question involves the propriety of the respondent's action in including in the petitioner's income for 1921 the balance remaining in the reserves set up by the petitioner under its contracts with the Peoples Gas Light & Coke Co. and the Central Illinois Public Service Co. Under these contracts certain amounts were collected to cover the possible cost of administrative expenses*2554 and the petitioner's income and profits-tax liability for the years 1918 and 1919. The amounts were collected and the reserves set up during the year 1918. The contracts expired in 1919 and part of the balance remaining in the funds and in the reserves was returned to the purchaser in that year. No other change was made in the reserves during the years 1919, 1920, and 1921. In 1922 the respondent finally determined the petitioner's income and profits-tax liability for the years 1916 to 1920, inclusive. The petitioner accepted the Commissioner's determination and in March, 1922, the balances in the reserve accounts in question were transferred to the petitioner's income-tax account. In our opinion the action of the respondent can not be sustained. The unexpended balances in the reserves were either income to the petitioner in 1919, when the contracts with the Peoples Gas Light & Coke Co. and the Central Illinois Public Service Co. expired, or they were income in 1922 when the liabilities for which the reserves were maintained were determined and paid, but they were not income in 1921.
We are also of the opinion that the respondent erred in including in the petitioner's income*2555 for 1921 the amounts remaining in the reserve for subsidence and the reserve for excessive freight. These reserves were set up by the petitioner in the years 1919 and 1920 and no change was made in them in the year 1921. If they were not reserves of the kind that are recognized as proper deductions from income by the several revenue acts, they should have been restored to the petitioner's income in the years in which they were made. If they are reserves the net additions to which are allowable as deductions from income, then the unexpended balances became income to the petitioner in the year in which the reason for which they were created ceased to exist, which was in 1922. The amount of the reserves in question should be eliminated from the petitioner's income for 1921.
Reviewed by the Board.
Judgment will be entered under Rule 50.