*2603 Where a taxpayer ascertains in 1923 that a portion of a debt is worthless and makes proper notation on its books of account of the amount of the charge-off, such amount is a legal deduction from gross income in its return filed for 1923.
*706 This proceeding is brought for the purpose of determining the correctness of a deficiency in income tax claimed to be due from the petitioner for the fiscal year ended June 30, 1923, in the amount of $1,766.81. The petition alleges that the Commissioner erroneously disallowed the deduction from gross income of a loss of $10,000 determined by the petitioner to be worthless as of June 30, 1923.
FINDINGS OF FACT.
The petitioner is a North Carolina corporation with its principal place of business at Rocky Mount. In 1919 and 1920 it loaned to B. G. Alford & Co. certain amounts of money upon the security of the company's notes. These notes were renewed from time to time. B. G. Alford & Co. was insolvent in May, 1923, at which time the principal of the loans represented by the notes was $50,102.36. The principal creditors*2604 of this company, of which the petitioner was one, had faith in B. G. Alford and believed that more could be realized from the company if it were not thrown into the hands of a receiver, and Alford was permitted to dispose of his assets at the best advantage possible. The creditors held a meeting in May, 1923, at which it was shown that B. G. Alford & Co. had an indebtedness of approximately $215,000, $170,000 of which was due mainly to the larger creditors who were partially secured. The indebtedness unsecured was $45,000 and, as estimated by the committee on May 31, 1923, the inadequately or partially secured debts of that $170,000 was $90,000, making a total partial and unsecured indebtedness of $135,000. To pay the $135,000 the company had assets of $26,500 unpledged. The petitioner's claim against B. G. Alford & Co., amounting to $50,102.36 plus interest, was secured by collateral of an estimated value of $25,000. The petitioner foresaw that it would sustain a relatively large loss upon the liquidation of the debtor. This loss it estimated at anywhere from $10,000 minimum to $25,000 maximum.
The board of directors of the petitioner held a meeting on June 5, 1923, at which*2605 the Alford account was extensively discussed. After such discussion the minutes of the board of directors of the petitioner as of June 5, 1923, show as follows:
Upon Motion of Dr. M. R. Braswell, seconded by Mr. George S. Edwards, it was ordered that $10,000 be set aside on June 30, as a reserve for bad debts and losses.
The petitioner had not prior to this date ever maintained a reserve against bad debts. It had been its practice to charge any debt ascertained to be worthless directly to profit and loss and then to credit the account ascertained to be worthless. The $10,000 reserve set up on the books of account pursuant to the resolution of the board of *707 directors on June 5, 1923, was debited to profit and loss and credited to a reserve for bad debts. It was understood by the board of directors and all concerned that this reserve was set up for the purpose of a charge-off of $10,000 of the indebtedness of B. G. Alford & Co. determined to be worthless at the time.
In July, 1923, certain creditors of B. G. Alford & Co. obtained judgments against the company, whereupon it appeared to be desirable to ask the court that a receiver be appointed to protect all of*2606 the creditors. Such receiver was appointed in July or August, 1923.
The collateral held by the petitioner consisted largely of personal property, although a few of the notes were secured by a first mortgage upon land. The persons having personal property such as live stock, farm implements, etc., immediately surrendered them to the bank and the bank sold the collateral at the highest market price. The land upon which the petitioner had liens was sold at auction and a few parcels were bid in by the petitioner and later sold at the best prices obtainable. The indebtedness of B. G. Alford & Co. to the petitioner was finally wound up in 1928, and the petitioner succeeded in realizing out of its claim of $50,102.36 a total amount of from $38,000 to $40,000.
In its income-tax returns for the fiscal year ended June 30, 1923, the petitioner deducted from gross income $12,001.47 for debts ascertained to be worthless in whole or in part and charged off within the year. Upon the audit of the return the Commissioner disallowed the deduction of $10,000 of the above amount representing the portion of the petitioner's claim against B. G. Alford & Co., for which the reserve had been set*2607 up as above indicated.
OPINION.
SMITH: The only question in issue in this case is the right of the petitioner to deduct from gross income in its income-tax return for the fiscal year ended June 30, 1923, $10,000 representing a portion of a debt owed to it by B. G. Alford & Co., which it claims was ascertained to be worthless in 1923, and for which it set up a reserve in its books of account of $10,000. At the hearing of this proceeding counsel for the respondent stated that it was the respondent's contention:
* * * That the claims of the petitioner in this regard are inconsistent with the real situation and facts in the case, namely that they report their income on a cash receipts and disbursements basis for that year, and the alleged loss was unascertainable during that year and had not been ascertained during that year, and that their action in passing the resolution upon which the book entries were based was not for the purpose of making a definite charge-off of the indebtedness, nor could it be properly construed under the circumstances as a charge-off.
*708 The provision of the statute under which the deduction of the $10,000 was made upon the return is section*2608 234(a) of the Revenue Act of 1921, which provides, so far as is material, as follows:
That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
* * *
(5) 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.
It was the intention of Congress in the adoption of this provision to permit a taxpayer who had ascertained a debt to be worthless within the taxable year and had charged it off its books of account within that year to deduct the same from gross income in its tax return, and that where it had been determined that a debt was recoverable only in part and the Commissioner was satisfied that the debt was recoverable only in part, the taxpayer might deduct such part from his gross income, provided it had been charged off the books of account.
We are satisfied from the evidence in this proceeding that the petitioner had ascertained prior to June 30, 1923, that at least*2609 $10,000 of its claim against B. G. Alford & Co. was worthless. We are further satisfied that the fact that the petitioner kept its books of account and made its returns upon a cash receipts and disbursements basis does not operate to bar the petitioner from the deduction claimed. The petitioner had loaned this money to B. G. Alford & Co. It was not a deduction from the gross income at the date the loan was made. It was clearly within the scheme of the statute that the petitioner should be allowed the deduction of the loss of such a loan at some time. We think that the fact that the petitioner kept its books of account and made its tax returns on the basis of cash receipts and disbursements does not prevent it from claiming the deduction of a loss of this character at some time. .
Since we are satisfied that the B. G. Alford & Co. debt was ascertained to be worthless to the extent of at least $10,000 in the fiscal year ended June 30, 1923, it only remains to consider whether there was such a charge-off of the amount as is required by the statute. The evidence of record is conclusive upon the point that the reserve*2610 of $10,000 was set up specifically to cover the Alford & Co. loss.
In , we stated:
The statute does not provide any particular manner for the charging off of a bad debt. We think that the method employed by the petitioner meets the challenge of the statute. If the petitioner were a corporation and the corporation was required to prepare balance sheets for the purpose of determining *709 invested capital and the notes receivable were included in the balance sheet at the fact value of the notes, there might be a serious question as to whether this method of charging off bad debts met the challenge of the statute. But we think that in the case of this individual for the year 1919, the notation on the note record that the note was charged off to income tax constituted a sufficient compliance with the statute to warrant the petitioner in making the deduction provided the note was ascertained to be worthless within the calendar year 1919.
In the instant proceeding we think it is immaterial whether the $10,000 be recorded as a net addition to a reserve for bad debts or as a charge-off of the debt in part. Whichever way it is*2611 considered the amount is a legal deduction from the gross income of the fiscal year ended June 30, 1923. The contention of the petitioner is sustained.
Judgment will be entered under Rule 50.