*1073 Where the petitioner, on the accrual basis of accounting, was one of several defendants in a proceeding in a District Court which on May 1, 1937, entered a decree against all the defendants and thereafter, before the period of appeal from the decree had expired, also entered an order, consented to by the plaintiff and not objected to by any defendant, to the effect that the ultimate liability of all the defendants should be determined by the final decision of higher courts on appeals taken by any of the defendants, and petitioner herein did not file an appeal, but other defendants did file appeals which were not finally determined until 1939, held, that the amount of the judgment of the District Court against petitioner in 1937 remained a contingent liability and was not properly accruable during its fiscal year ended May 31, 1938.
*794 The respondent has determined an income tax deficiency of $3,398.57 and an excess profits tax deficiency of $292.56 for petitioner's fiscal year ended May 31, 1938. The entire amount of such deficiencies is not in controversy*1074 in this proceeding.
The sole question is whether respondent erred in disallowing a claimed deduction, for the year in question, of the amount of $9,909.17 representing the principal and interest thereon accrued on petitioner's books as its stockholders' so-called "double liability" imposed by a statute of Illinois on certain bank stock owned by it in a bank which had failed.
The proceeding has been submitted upon testimony and a stipulation of facts embracing certain exhibits, which stipulation is adopted and incorporated herein by reference as a part of our findings of fact.
FINDINGS OF FACT.
The petitioner is a Delaware corporation, with its principal office at 600 South Marshfield Avenue, Chicago, Illinois. Its annual accounting period was and is a fiscal year ending on May 31 of each year, and its Federal income tax return for its fiscal year ended May 31, 1938, was filed with the collector of internal revenue for the first district of Illinois. Petitioner's regular method of accounting was and is on the accrual basis.
Prior to 1929, in a transaction entered into for profit, petitioner purchased 94 shares, par value $9,400, of the capital stock of the Central Republic*1075 Bank & Trust Co., a banking association of the State of Illinois (hereinafter referred to as the bank). Petitioner still owned those shares on October 5, 1932, when the bank was closed by reason of its failure.
In accordance with section 6 of the Illinois General Banking Act a demand was made upon petitioner for the payment of $9,400 as the liability (commonly referred to as "stockholders liability") imposed by that act upon petitioner as a stockholder of the bank.
On November 19, 1934, in the District Court of the United States for the Northern District of Illinois, an action, bearing Equity Docket No. 14189, was instituted by the Reconstruction Finance Corporation against the bank and other defendants, including the petitioner herein, to enforce the statutory "stockholders liability" against the stockholders of that bank. In that action petitioner's liability was alleged to be $9,400 and, as one of the defendants therein, petitioner engaged counsel and actively contested the suit.
On May 1, 1937, in the above mentioned suit a decree was entered in favor of the Reconstruction Finance Corporation and the petitioner herein was thereby found liable for the payment of $9,400*1076 in accordance with the statute hereinbefore referred to.
*795 On June 9, 1937, the District Court, in the same suit in Equity Docket No. 14189, entered an order which provided, in part, as follows:
ORDER CONCERNING ACCRUAL OF INTEREST ON DECREE AND RIGHTS OF DEFENDANTS UPON APPEAL AND AUTHORIZING RECEIVER TO INVEST FUNDS IN NOTES OF THE RECONSTRUCTION FINANCE CORPORATION.
This cause came on to be heard upon the petition for instructions filed by Charles H. Albers, Receiver in this cause, and the Court having heard the arguments of counsel and being fully advised in the premises, and counsel for the Reconstruction Finance Corporation being in court and consenting and no objection having been made by any defendant, herein,
IT IS HEREBY ORDERED, ADJUDGED AND DECREED that:
FIRST: Any defendant against whom liability is adjudged in the decree entered in this cause on May 1, 1937, may pay to the said Receiver the amount of liability so adjudged against such defendant, together with the interest thereon to the date of payment and costs and shall not be required to pay any further interest irrespective of whether or not any appeal from such decree is taken.
* * *
THIRD: *1077 In the event that any defendant prosecutes an appeal from the said decree resulting in a modification or reversal thereof by the Circuit Court of Appeals or the United States Supreme Court, the benefit of such modification or reversal shall (subject to the provisions of paragraph Fifth hereof) inure to the benefit of the other defendants who have paid to the Receiver appointed in this cause the amounts respectively adjudged against them by said decree, as if they had participated in such appeal, to the extent that such modification or reversal determines issues which would affect their respective liabilities and which they could have respectively raised on appeal, but only to that extent.
* * *
FIFTH: Except pursuant to further order of the Court entered after hearing upon notice and for good cause shown, no distribution shall be made by the Receiver herein pending the time for or during any appeal to or other proceeding in the Circuit Court of Appeals of this Circuit from or concerning said decree, nor pending the time to apply for or during any review by or other proceeding in the Supreme Court of the United States of or concerning any order affirming, modifying or reversing*1078 said decree.
* * *
The period for perfecting an appeal by the petitioner herein, in the above mentioned cause, lapsed on August 1, 1937, with no appeal having been taken by it. However, prior to August 1, 1937, other defendants named in that cause and in the District Court's decree of May 1, 1937, and order of June 9, 1937, filed appeals with the United States Circuit Court of Appeals for the Seventh Circuit, which, on February 20, 1939, affirmed the decision of the District Court. On October 9, 1939, the Supreme Court of the United States denied certiorari in that cause.
On or about May 1, 1937, petitioner's counsel advised it of the District Court's decree of May 1, 1937, and also advised that an *796 appeal be filed within the three-month appeal period. Later, sometime in June of the same year, petitioner's cousel advised it that, pursuant to the District Court's order of June 9, 1937, petitioner could pay to the receiver the amount of its liability as decreed by the District Court, with interest thereon to date of payment, and that the amount so paid would be repaid to it if the District Court's decree was finally reversed, even though the petitioner did not file*1079 an appeal. On or about June 15, 1937, the petitioner determined not to file an appeal and also decided to set up on its books an accrual of a liability in the amount decreed against it by the District Court.
During the fiscal year here in question the petitioner made the following entry on its books:
| Dr. | Cr. | |
| Interest Expense | $509.17 | |
| Profit and Loss Account (Surplus) | 9,400.00 | |
| Provision for Central Republic Bank and Trust Company Stockholders' Liability | $9,909.17 | |
| To record liability on Central Republic Bank and Trust Co. stock, $9,400.00, and interest accrued thereon at 5% from May 1, 1937, to May 31, 1938, of $509.17. |
That item of $9,909.17 so set up on petitioner's books was also shown, under the caption of "Current Liabilities", on petitioner's financial statement of May 31, 1938, which was furnished to its banks and creditors.
On account of the District Court's decree of May 1, 1937, against petitioner, and pursuant to that court's order of June 9, 1937, the petitioner made the following payments to Charles H. Albers, receiver of the bank: $5,000 principal, paid on November 7, 1938; and $4,400 principal and $830.55 interest, paid on*1080 March 16, 1939.
In its return for the fiscal year ended May 31, 1938, the petitioner claimed as a deduction from gross income the amount of $9,909.17 which was accrued on its books as a liability during that year as above stated, and the respondent disallowed this deduction "because the liability therefor did not become fixed and did not become accruable during the taxable year."
OPINION.
TYSON: The parties are in agreement that a loss represented by a "stockholders liability" such as is here involved is deductible under section 23(f) of the Revenue Act of 1936 1 in the year in which the *797 amount of such loss is paid, if the taxpayer is on the cash basis, or in the year in which such loss is definitely determined and properly accrued, if the taxpayer is on the accrual basis. The petitioner's stockholders' liability was not paid during the taxable year, but its net income was computed on the accrual method of accounting and therefore the only question presented in this proceeding, is whether the petitioner's stockholders' liability actually "accrued," within the meaning of sections 43 and 48 of the Revenue Act of 1936, 2 during its fiscal year ended May 31, 1938. *1081
Petitioner contends that on August 1, 1937, when the appeal period lapsed with no appeal having been taken by it, the District Court's decree of May 1, 1937, as to petitioner's liability for payment of $9,400 with interest thereon became final as to it, notwithstanding that court's order of June 9, 1937. Petitioner further contends that it incurred*1082 its stockholders' liability and accrued the same on its books during the taxable year and that the District Court's order of June 9, 1937, merely provided for a possible future refund to it of the amounts so accrued and paid to the receiver subsequent to the taxable year.
Respondent contends that petitioner's stockholders' liability remained contingent throughout its fiscal year ended May 31, 1938, and thus was not incurred and was not properly accruable during that year, on the ground that, while petitioner did not file an appeal, the final result of the appeals taken by its codefendants ultimately fixed and determined petitioner's actual liability in a subsequent year, pursuant to the provisions of the District Court's order of June 9, 1937; and respondent further contends that this final result was the denial of certiorari by the Supreme Court on October 9, 1939.
In , a deduction claimed for amounts which were alleged to have been incurred and were accrued on the taxpayer's books as a liability for refunds of commissions which it was required to make in the event of probable future cancellations of insurance policies, was*1083 denied because the liability "was not fixed and absolute", but instead remained contingent during the taxable year.
Under the principle established in the Brown case, supra, the petitioner can prevail in the instant proceeding only upon a showing *798 that its stockholders' liability was not contingent but became "fixed and absolute" during the taxable year, and in our opinion such a showing has not been made.
The petitioner and others denied a stockholders' liability asserted against them under Illinois Statutes as the respective owners of the stock of a bank which had failed. Petitioner and its codefendants contested the suit brought to impose that liability against them in the District Court and that court, on May 1, 1937, decreed that those defendants, including petitioner, were liable, respectively. The petitioner did not file an appeal, but prior to the lapse of its appeal period the District Court, on June 9, 1937, entered an order extending certain rights to all the defendants, including petitioner, in connection with the decree theretofore entered.
The court order of June 9, 1937, was entered upon the petition of the receiver, with the consent*1084 of the plaintiff, Feconstruction Finance Corporation, and without objection by any defendant in that cause, and it was acquiesced in by petitioner. Petitioner, as a defendant before the District Court, was a party to and was affected by the terms of that order. Pursuant thereto, petitioner had the right to and, subsequent to the taxable year, did make payment to the receiver, who was directed to hold such funds during the pendency of appeals by any of the defendants. The funds in the hands of the receiver guaranteed payment to the plaintiff, Reconstruction Finance Corporation, in the event of affirmance by higher courts and also guaranteed a return to the respective defendants of the payments made by each of them in the event of a reversal. Also pursuant to the court order of June 9, 1937, the final decision in that cause by the appellate courts was to determine the ultimate liability of all of the original defendants before the District Court, including petitioner and others who did not file appeals. During the pendency of the appeals taken and until the United States Supreme Court's denial of a writ of certiorari on October 9, 1939, it was not known that there would be any liability*1085 of petitioner on account of the bank stock owned by it and, accordingly, we hold that the liability was contingent and not properly accruable during the fiscal year ended May 31, 1938. Cf. , and authorities cited therein.
The petitioner cites ; certiorari denied, , as a closely analagous case, but it is clearly distinguished from the instant proceeding. There, the Hotels Co. was billed for public utility services, under the new tariff of a public utility company increasing its rate schedule above the rates provided for in an unexpired contract between it and the Hotels Co., and the Hotels Co., while actually paying only the *799 contract rates, accrued the higher rates on its books as a liability for the year 1919 there in question. Another taxpayer, Frick, had a similar contract with the public utility company and brought suit contesting his liability for the increase in rates which was terminated in 1925 adversely to Frick. The Hotels Co. claimed a deduction for its accrued liability (difference between*1086 its contract rate and the higher rate at which it was billed) and the Commissioner disallowed the item as a legal deduction. The court held that the liability of the Hotels Co. was fixed in the taxable year there involved and was a proper accrual for that year. In reaching its conclusion the court pointed out that the Hotels Co. was not a party to the proceedings brought by Frick and that the utility was free at all times to enforce collection from the Hotels Co. without awaiting a termination of the proceedings by Frick. The court further said that the Commissioner had allowed the hotels Co. a similar deduction for the subsequent years 1920 and 1921 and there appeared no ground for a different treatment for 1919.
We hold that the respondent did not err in disallowing the claimed deduction of $9,909.17 as an accrued liability for the petitioner's fiscal year ended May 31, 1938.
Decision will be entered for the respondent.
Footnotes
1. SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
* * *
(f) LOSSES BY CORPORATIONS. - In case of a corporation, losses sustained during the taxable year and not compensated for by insurance or otherwise. ↩
2. SEC. 43. PERIOD FOR WHICH DEDUCTIONS AND CREDITS TAKEN.
The deductions and credits * * * provided for in this title shall be taken for the taxable year in which "paid or accrued" or "paid or incurred", dependent upon the method of accounting upon the basis of which the net income is computed, * * *
SEC. 48. DEFINITIONS.
When used in this title -
* * *
(c) PAID, INCURRED, ACCRUED. - The terms "paid or incurred" and "paid or accrued" shall be construed according to the method of accounting upon the basis of which the net income is computed under this Part. ↩