*738 1. An amount paid in settlement of litigation involving a controversy as to a note given in connection with the alleged purchase of stock which became worthless prior to the year of the payment, held, under the circumstances, a deductible loss in the year of accrual.
2. The difference between an amount paid in such settlement and the amount of the note, held not taxable income, and Kirby Lumber Co. v. United States,284 U.S. 1">284 U.S. 1, inapplicable.
*1263 The Commissioner determined a deficiency of $3,205.21 in petitioner's income and excess profits taxes for the fiscal year ended November 30, 1935, in part by disallowing the deduction, as a loss, of a payment made in settlement of litigation involving a note given by petitioner and an alleged purchase of shares, and in part by adding to income the difference between the payment and the amount of the note. Another minor adjustment was not assailed.
FINDINGS OF FACT.
Petitioner, a New York corporation, is a dealer in fur skins in New York City. For many years it had*739 an account with the Bank of United States; the bank discounted notes for it and extended credit to it, which at times aggregated $400,000. In 1929, in a campaign to sell the bank's stock, petitioner was urged to buy 100 stock *1264 units, each consisting of a bank share and a share of Bancus Corporation. Petitioner then owned 500 bank shares and was reluctant to take more. Assurances were given that the bank would lend the purchase price and that the shares would go up. Petitioner agreed to buy the 100 units for $21,700. A certificate for that number was issued in the name of petitioner's officer and held by the bank. The bank advised petitioner of the purchase by a form notice dated February 21, 1929. On February 25, petitioner issued its 30-day note for $21,700, payable to the bank. The bank accepted the note at a discount and retained the certificate. During the year petitioner suggested a sale of the shares, but was persuaded against it and no sale was made.
The note was renewed from month to month but never was paid, although petitioner was financially able to pay it. The certificate remained with the bank, although during 1930 petitioner's credit position*740 was strong enough to cover the amount of the note. When the note matured on November 26, 1930, petitioner refused to renew, and immediately instituted suit against the bank, demanding rescission of the purchase contract and the loan and a judgment for the interest paid, on the ground that the bank made the loan in violation of law and failed to carry out promises to guarantee the purchaser against loss.
The Superintendent of Banks of the State of New York closed the bank on December 11, 1930, because of insolvency, and on April 21, 1931, brought a countersuit against petitioner for the amount of the note, with interest. Petitioner defended on the ground that the purchase contract and loan were parts of a single transaction which should be rescinded. The proceedings were consolidated for trial and thrice adjourned. They were settled on October 15, 1935, and petitioner agreed to pay $10,850, of which $6,850 was paid in 1935 and $4,000 in 1936.
Under date of November 29, 1930, a credit of $21,700 was entered in petitioner's investment account with the explanation that the item was "transferred due to nonrecognition of debt for one hundred units of Bank of U.S. stock at $217.00." *741 During 1930 petitioner sold the other 500 bank shares at losses which it deducted on its income tax return for that year. It kept its books and filed its income tax returns on an accrual basis.
OPINION.
STERNHAGEN: The Commissioner disallowed the petitioner's deduction of 1935 of the $10,850 for which it finally in that year settled the litigation over its note. He denied the loss "for the reason that *1265 the stock to which it pertained became worthless prior to the taxable year under consideration." He then added to petitioner's gross income the other $10,850 half of the face amount of the note on the ground that this was a gain resulting from the "settlement of an obligation amounting to $21,700 for one-half the face value." The Commissioner argues that the taxpayer bought the shares in 1929, that they became worthless some time before 1935, with the result at that earlier time of a realized and deductible loss of the cost of $21,700; that the note, however, continued as a subsisting liability for its face amount, and its discharge by the payment of one-half its face brought about a gain of the other half, taxable as realized income.
If this were simply a case*742 where a taxpayer bought property, giving its note in payment, and the property became worthless, the rule would apply that a deduction for loss would be available to it only in the year the property became worthless. But the facts are not so certain. There is question whether the taxpayer bought property in 1929 and question as to its liability and the amount thereof, and this question was suspended in litigation until the 1935 compromise agreement with the state superintendent of banks. Until 1935 the loss was not actual and present by any practical test. The litigation was, so far as this record shows, bona fide. There were enough other suits involving similar sales by the bank of its own shares during the 1929 "drive" to indicate that this petitioner was not alone in doubting its ownership of the shares or its liability on the note. Whether it could have avoided either the sale or the note can not be decided in this proceeding, for the claims were compromised and legal rights were never recognized. It can not be said as a postulate that if the litigation had proceeded to judgment it would have established that petitioner invested $21,700 in the shares and owed the full*743 amount of the note. It is not clear that petitioner could rightfully have taken a deduction prior to 1935 - not clear enough to carry the correlative denial of the deduction when the final amount was definitely fixed and the loss became actual and present. . From every practical standpoint it had no loss until its liability was definitely fixed in 1935 for $10,850. It correctly took the deduction then.
This also establishes that the release of the note was not the occasion for a freeing of assets and that there was no gain under the doctrine of .
The Commissioner's determination disallowing the loss of $10,850 and adding a further $10,850 to income is reversed.
Decision will be entered under Rule 50.