*2529 Claimed bad debt deduction disallowed.
*767 Proceeding for the redetermination of a deficiency in income tax in the amount of $7,776.43 for the year 1920. Petitioner alleges that the respondent erred in increasing income by the amounts of $382.31 and $21,714.30, which amounts were claimed by the petitioner as deductions for bad debts. At the hearing counsel for respondent conceded error in the disallowance of the item of $382.31.
FINDINGS OF FACT.
Petitioner is an individual residing at Chillicothe, Ohio, and in the taxable year and for many years prior thereto was engaged in the business of wholesaling lumber and cross ties under the trade name of Harmount Tie & Lumber Co. Prior to October, 1909, petitioner was shipping cross ties to the Michigan Central Railroad Co., hereinafter called the Michigan Central, and other railroads comprising the New York Central Lines, under contracts made with a joint purchasing agent for the several railroads. The shipments originated on roads other than those in the New York Central group, which other roads*2530 are hereinafter called foreign roads. At that time petitioner's business with the Michigan Central was handled by consigning the ties from point of origin via the junction point of the foreign road and the Michigan Central to destination on the Michigan Central, from where they were distributed by the latter for use at various places on its road.
Under the terms of sale petitioner was to pay the proportion of freight accruing to the foreign lines up to the junction point, which proportion was deducted by the Michigan Central from the vouchers issued in payment for the ties. The balance of the through freight, that is, the portion covering the movement over the Michigan Central from the junction to destination, was assumed by the Michigan Central and canceled.
In October, 1909, the purchasing agent, in order to handle shipments more advantageously, directed petitioner to change the method of handling, and consign the ties to the junction point, from which point the ties would be distributed to the places where they were actually used, instead of moving over the New York Central lines *768 to the agreed destination point and from there distributed. Freight charges were*2531 to be corrected through to destination where used, and the proportion earned by the foreign lines deducted from petitioner's vouchers. The proportion accruing to the foreign lines under this changed method of handling was greater than under the method followed prior to October, 1909. Petitioner was then to make claim against the Michigan Central for the difference between the amount of freight deducted from his voucher under the changed method and the amount that would have been deducted under the previous shipping arrangements.
The amount of freight under the changed method of shipping which was in excess of that deducted under the previous shipping arrangements was part of the cost of ties to the Michigan Central, and represented the balance of the purchase price which the Michigan Central was to pay to petitioner. This same arrangement was followed in making shipments to other New York Central lines to which petitioner furnished ties.
Statements of these claims were prepared during the years 1910 and 1911, and filed with the various railroads affected by the new billing arrangements. All such claims were paid, with the exception of the account against the Michigan Central, *2532 which amounted to $21,714.30, as rendered by petitioner. During 1911 and 1912, while the account was in process of verification, corrections were agreed upon which reduced the account to $21,439.07. In 1912 or early 1913 the petitioner received from the Michigan Central copies of two vouchers which had been prepared by the railroad covering part of his claims in the aggregate amount of $15,701.73, and was advised by the purchasing department that two other vouchers had been issued covering the balance of his claims in the amount of $5,737.34. These vouchers, however, were never paid. After being advised of the preparation of the vouchers, petitioner endeavored to secure payment by conferring with various officials of the railroad until in October, 1913, when he placed the claims in the hands of his attorney.
Petitioner's claims against the Michigan Central covered shipments of approximately 321,000 ties which were shipped in about 800 cars. On a large number of the cars the freight charges had not been corrected on a through-rate basis to actual destination and the Michigan Central had deducted local freight to the junction point on a number of the shipments. After the claim*2533 was placed in the hands of petitioner's attorney the Michigan Central suggested that petitioner prepare a statement showing the difference between the freight deducted and the foreign proportion on a through-rate basis. This statement was prepared in 1914, and filed with the Michigan Central, showing the amount of $10,525.37, which amount was part of the original *769 claim of $21,714.30. The statement filed was verified and agreed upon as being correct, but payment was delayed, and in order to prevent the claim from being barred by the statute of limitations, petitioner in January, 1916, filed suit in the Michigan courts against the Michigan Central.
Because of the vast amount of detailed data needed and the expense incident to proving the large number of shipments on which petitioner based his claims, and because many of the original documents had been surrendered to the Michigan Central, petitioner and his attorney considered it necessary to secure and agreed statement of facts before proceeding to trial. Thereafter numerous conferences were held with the attorneys for the Michigan Central, but the parties were unable to agree upon a statement of facts. The last conference*2534 was held in 1920, and in that year petitioner was advised by his attorney that nothing further could be accomplished. The suit filed by petitioner against the Michigan Central has never been tried.
In 1913, petitioner borrowed from the First National Bank at Chillicothe the sum of $17,000, giving therefor his two promissory notes, dated July 28, 1913, in the amounts of $10,000 and $7,000, and as collateral security he deposited 100 shares of preferred stock of the Columbus Street Railway Corporation and assigned to the bank his claims against the Michigan Central, above described, to the extent of $21,424.02. Petitioner took these notes up on January 28, 1917, and gave the bank new notes in the same amount and secured by the same collateral.
It was petitioner's regular practice to finance his shipments of ties through banks by assigning to the banks the proceeds from his contracts with the railroads. Under this procedure the railroad vouchers were issued to the assignee bank for petitioner's account.
The First National Bank of Chillicothe, before making any loan, examined the collateral offered as security and a report thereon was made to the board of directors. In June*2535 and December of each year an examination was made of collateral on deposit and a report by the examining committee submitted to the board of directors. This procedure was followed with respect to the $17,000 loan made to petitioner. At the meeting held in the last week of June, 1920, the committee reported to the board of directors that in their opinion the petitioner's claims against the Michigan Central were worthless. The committee recommended that either the loan be canceled or that additional security be required.
In November of 1920 an officer of the bank advised petitioner that it was the opinion of the bank that the claim against the Michigan Central had become worthless and that it would be necessary to *770 give new security. On December 28, 1920, petitioner paid $6,500 of the notes, and gave the bank two new notes, one for $3,500 secured by the Columbus Railroad stock above mentioned, and one for $7,000, with personal security.
Under date of December 31, 1920, petitioner charged off on his ledger the claims against the Michigan Central, aggregating $21,714.30. This amount was claimed as a bad debt deduction in petitioner's income-tax return for 1920. The*2536 respondent disallowed the deduction claimed, on the ground that the claim against the Michigan Central had become worthless prior to 1920.
OPINION.
ARUNDELL: Petitioner seeks to deduct as a bad debt the aggregate amount of his claims against the Michigan Central Railroad Co. The explanation of how these claims arose is somewhat complicated, but, as we understand it, they represent alleged excess freight deductions from vouchers issued to petitioner in payment for railroad ties shipped in 1909, 1910, and 1911.
At the outset of the consideration of petitioner's claim there is the question of whether the relation of debtor and creditor existed between the Michigan Central and petitioner - that is, whether there ever was a debt. See . The respondent in his answer admits the petitioner's allegation that the freight claims of petitioner under the revised shipping arrangement were part of the cost of ties to consignee. Petitioner relies upon this as sufficient to establish the existence of a debt. But the respondent has not conceded that the claims of petitioner here involved are such freight claims as constitute part of the purchase*2537 price. Apparently the Michigan Central took the same view. Although vouchers were made up, we think that this action on the part of one official or department of the company can not be construed as an admission by it of liability.
But even if the admission of the respondent above referred to can be taken as admitting the existence of a debt, the petitioner still has failed to establish that the debt became worthless in the taxable year. As far as we know, the claims were as good in 1920 as they were back in 1910 and 1911 when they were filed with the railroad. The refusal of the bank in 1920 to carry the claims any longer as collateral merely indicates that the bank no longer regarded them as sufficient security for its money; it does not establish that they became worthless in that year. It may be that the bank only discovered in that year a fact that had existed all along - that the claims were no good. Nor does it seem to us that the suspension of *771 negotiations and the abandonment of petitioner's suit in 1920 establish that the claims became worthless in that year. Difficulty of proving a bad debt does not establish worthlessness, but even if it did, there is*2538 no showing that petitioner's claims were any more difficult to prove in 1920 than in the earlier years; he knew all along that he had a hard case to prove.
The respondent must be affirmed in his disallowance of the deduction claimed.
Judgment will be entered under Rule 50.