*2979 Commissioner's disallowance of deductions sustained, where petitioners in the year 1921 charged off and deducted as bad debts amounts owing from a corporation and in the same year deducted as losses the amounts invested by them in stock in such corporation, though the corporation continued to operate for over five years and additional advances were made by some of the petitioners.
*1141 The above appeals were consolidated for hearing and decision. The respondent determined deficiencies in income taxes for the calendar year 1921 against the petitioners as follows:
| Charles W. Deeds | $15,964.99 |
| E. A. Deeds | 31,334.39 |
| Charles F. Kettering | 100,298.39 |
Two issues are presented - (1) whether the amounts of certain loans made by the petitioners to the Smith Gas Engineering Co. were properly deducted by them from gross income in the year 1921 as bad debts; (2) whether amounts invested in the stock of the Smith Gas Engineering Co. held by the petitioners E. A. Deeds and Charles F. Kettering constitute proper deductions from gross income for*2980 the year 1921 as losses.
FINDINGS OF FACT.
The above named petitioners all reside at Dayton, Ohio. E. A. Deeds is the father of Charles W. Deeds. The funds of Charles W. Deeds which are involved in the transactions in question were received by him as gifts from his father, who had entire charge of the investment of such funds. Kettering also left the management of the transactions involved in these cases largely to E. A. Deeds. The judgment of E. A. Deeds was controlling in connection with such transactions.
The Smith Gas Engineering Co. was a corporation organized on December 28, 1915, under the laws of the State of Ohio, and began operating on January 11, 1916, upon the acquisition of the business and assets of another corporation known as the Smith Power Co. The business of both companies was that of manufacturing and selling what was known as a clean gas producer, a machine for the production of gas for heating purposes. This machine was devised for the elimination of the smoke and dirt found in ordinary gas. A third corporation known as the Domestic Building Co., all the stock of which was owned by E. A. Deeds and Kettering, built a new plant for the Smith Gas Engineering*2981 Co. at Moraine City, Ohio. As soon as the plant was finished the Smith Gas Engineering Co. moved into it.
In 1921 E. A. Deeds and Kettering each owned 348 shares of common stock out of 1,499 shares then outstanding of the Smith Gas Engineering Co. and each owned 360 shares of preferred stock of that company, that being the total number of outstanding shares of preferred stock. The total investment of each in this year was *1142 $77,300. The debts sought to be charged off as bad were evidenced partly by notes of the company. The balance represented cash advanced. The notes aggregated in amount $293,970. The following amounts were deducted by the petitioners from gross income of 1921 on account of bad debts:
| E. A. Deeds | $71,500 |
| Charles W. Deeds | 75,000 |
| A. F. Kettering | 150,620 |
In addition to the loans made the company on its notes, the petitioners advanced other substantial sums, no part of which was ever repaid.
The company kept its accounts on the basis of a fiscal year which terminated on June 30. For the earlier years the books of the company showed profits, but from the fiscal year ending in 1919 losses were shown of substantial amounts as*2982 follows:
| 1919 | $12,474.99 |
| 1920 | 167,378.93 |
| 1921 | 178,196.31 |
The company continued operations for five complete fiscal years after the fiscal year ending in 1921 and in the year 1927 it dissolved. In the year of dissolution a loss for the fractional period was sustained, amounting to $42,243.21.
The losses sustained by the Smith Gas Engineering Co. were attributed by those interested to the introduction of oil burners operated by a thermostat. Both E. A. Deeds and Kettering were out of touch with the corporate activities during the war. In 1921 E. A. Deeds investigated the affairs of the company and found that the business was not well conducted and that the demand for the company's product was becoming less because of the development of electric and oil burners. At the time of the investigation Deeds discovered that the company's losses were much larger than he had supposed them to be.
Upon the completion of his investigation E. A. Deeds laid the facts before his counsel, who was also counsel for the other petitioners and for the company, and as such counsel he was familiar with its affairs. At that time counsel advised that the investments of the petitioners*2983 in the company were worthless and that the loans made by the petitioners to the company were uncollectible.
In 1924 the company obtained large contracts from the Ford Motor Co. and, requiring additional capital by reason of such contracts, it raised the money by loans from the banks which were guaranteed by E. A. Deeds and by Kettering. The greater portion of these loans was repaid out of the company's funds, but a few thousand dollars had to be paid by Deeds and Kettering because of their guaranty.
*1143 The minutes of the directors' meeting contain the following entries:
DIRECTORS' MEETING.
Dayton, Ohio, Dec. 24, 1921.
Pursuant to a call of the President, a special meeting of the Directors of The Smith Gas Engineering Company was this day held at its office in Dayton, Ohio, the following Directors being present: E. A. Deeds, H. F. Smith, R. M. Chatterton, Earl E. Adams, Greer Marechal, L. C. Hopkins, and B. F. McCann.
The Treasurer stated that demand had been made on the Company by E. A. Deeds, C. F. Kettering, and Charles W. Deeds, for the payment of certain overdue notes owing by the Company, to them respectively, aggregating $293,970.00 and that the*2984 Company had advised them by letter December 20th, 1921, that it was insolvent and unable to pay anything on these notes and that any attempt on the part of the holders thereof to enforce payment would force the Company into immediate bankruptcy, whereas, if given time and better financial statement as a basis for credit the company might eventually be successful. Subsequently the holders of these notes made a written proposition to the Company offering to return the notes for cancellation, so as to enable the Company to show a better financial statement and to continue in business. Said proposition is as follows:
DAYTON, OHIO, Dec. 22, 1921.
THE SMITH GAS ENGINEERING COMPANY,
Moraine, Ohio.
DEAR SIRS:
We the undersigned holders of overdue notes of your Company aggregating $293,970.00 having made demand upon you for payment thereof, and being advised that the Company is insolvent and cannot pay any part of said notes and that any attempt to enforce payment would immediately force the Company into bankruptcy, and being the holders of $99,030.00 additional notes of the Company, and endorsers on its notes payable discounted at the banks for loans aggregating $195,000.00, *2985 hereby propose to the Company that, for the purpose of enabling it to present an improved financial statement and continue in business, the undersigned will hereby agree to surrender for cancellation the aforesaid overdue notes of the Company aggregating $293,970.00.
(Signed) E. A. DEEDS
C. F. KETTERINGCHARLES W. DEEDS.
On motion duly made, seconded and carried, it was Resolved, that the offer of E. A. Deeds, C. F. Kettering and Charies W. Deeds, to surrender for cancellation overdue notes of the Company aggregating $293,970.00 be accepted, and it was further Resolved, that the Secretary of this Company be and he is hereby instructed to forward to E. A. Deeds, C. F. Kettering and Charles W. Deeds a certified copy of this resolution.
A statement of the financial condition of the company as of November 30, 1921, excluding the $293,970 in notes, is as follows:
| Current assets | $214,574.68 |
| Fixed assets less depreciation reserves | 309,120.28 |
| Intangible assets | 144,820.99 |
| Deferred charges | 65,112.94 |
| 733,628.89 | |
| Current liabilities | $421,239.63 |
| Advance billings on partially completed contracts | 16,261.06 |
| Deficit | 26,271.80 |
| Capital stock | 322,400.00 |
| 733,628.89 |
*2986 *1144 Upon the liquidation of the Smith Gas & Engineering Co., a part of the equipment which had previously belonged to it was sole to the C. H. & D. Railroad Co. The balance of the equipment in the plant was either sold or transferred to the custody of the Gas Research Co., a corporation of which E. A. Deeds and Kettering were in control and of which they were president and vice president. Upon liquidation the petitioners received nothing on account of the indebtedness incurred to them but were obliged to advance additional sums because of the fact that they were liable as endorsers or guarantors of the company's paper.
OPINION.
MURDOCK: It is contended on behalf of the petitioners that the funds lost by them through advances made to the Smith Gas Engineering Co. and through investment in its stock were lost in 1921; that in the case of the indebtedness this loss was established by a charging off on the books and by an ascertainment of worthlessness in that year, while in the case of the stock, the company's financial condition was such at the close of the year 1921 as to warrant the assertion that the stock was then worthless and had no potential value for future*2987 years, despite the fact that liquidation did not actually occur until over five years later.
The Revenue Act of 1921 contains the following provision in regard to deductions from gross income on account of losses and bad debts.
SEC. 214. (a) That in computing net income there shall be allowed as deductions:
* * *
(5) Losses sustained during the taxable year and not compensated for by insurance or otherwise, if incurred in any transaction entered into for profit, though not connected with the trade or business; * * *
* * *
(7) Debts ascertained to be worthless and charged off within the taxable year * * *.
Our inquiry is therefore, with respect to the stock, whether the corporation's financial condition was so hopeless as to render the shares of no value, and, with respect to the indebtedness of the company to each of the petitioners, whether in each case that indebtedness was actually ascertained to be worthless and charged off within the taxable year 1921. The petitioners have cited several decisions to sustain their right to the deductions in question, all of which tend to show that the courts have been liberal in the interpretation of those *1145 portions*2988 of the statute allowing deductions of this nature. Among other authorities the petitioners have cited the case of , and . While the court in each case expressed an unwillingness to require too nice a mathematical determination of losses and in the former case expressly stated that the law did not require a taxpayer to be an incorrigible optimist, it is our opinion that the facts in these cases clearly distinguish them from the instant case.
In the , a situation somewhat similar to that presented here was before the Board. We there made the following statement:
The disinclination of a creditor to force payment does not make a debt "worthless" as that term is used in the act.
The taxpayer's contention that he has sustained a loss as the result of purchasing the stock is answered by saying that he still holds the stock of a going concern which hopes to show a profit for 1925. The transaction is not closed. The loss, if any, has not been realized. The taxpayer can have no deductible*2989 loss until such loss has been actually sustained.
Two of the taxpayers in this case owned considerable stock in the corporation, and in all cases the losses representing what are termed "bad debts" were evidenced by the company's paper. In the case of , we had before us the question of a taxpayer's right to charge off as worthless advances made by him to a corporation in which he held all the stock. In considering whether or not this right existed we stated:
To answer this question we must first accept the principle that if Mr. Ames could claim such a debt to be worthless the claim should be equally good if any other person not a stockholder had been a creditor in a like sum at that time.
We also stated:
* * * On that basis then it is clear that the "Office of Winthrop Ames, Inc.," was not a solvent corporation but it is equally clear that no creditor could have estimated at the close of 1918 the extent of his probable loss. It is apparent that at the close of 1918 the corporation "Office of Winthrop Ames, Inc.," presented the case of a going business unable to meet its current liabilities from liquid assets and indeed not expected*2990 to do so. Any creditor could, in these circumstances, have forced liquidation and the definite ascertainment of his loss. But this Mr. Ames did not do. Instead it is asked that the Board now speculate whether and to what extent the corporation was insolvent in 1918, and Mr. Ames' account represented a worthless debt. No such duty devolves upon us. The duty to determine that a debt is worthless in a definite sum is upon the taxpayer, he to support his conclusion with equally definite and certain evidence. * * *
In the case of , a situation was presented in which advances were made to a corporation after the *1146 commencement of liquidation. We there upheld the determination of the Commissioner in disallowing the loss. In , we had before us a case of a release by a stockholder of an indebtedness due him by the corporation in which he held stock. The release was given on January 1, 1919, and a deduction was sought in that year. The corporation was dissolved and its assets distributed in June, 1921. We upheld the determination of the Commissioner in disallowing the losses.
*2991 In our opinion the present case is strikingly similar to the case of While the Smith Gas Engineering Co. is now liquidated, it was far from liquidation in the year 1921, the taxable year in question. The petitioners' manager testified as to the estimated value of certain assets for liquidation purposes as of the year 1921. The liquidating values, as of 1921, were fixed by deducting varying percentages of the value of the assets from such assets, the percentages being taken in accordance with book values by the witnesses. In some instances the book value of the assets which was the basis upon which the witness fixed the liquidating value was reduced by a large percentage on the theory that it had no value to anyone but someone carrying on the same business which the company had been carrying on, or that in the event of liquidation certain materials would have only a scrap value. While the assets realized on liquidation were less than the values fixed for liquidating purposes as of 1921, this fact does not in our opinion show that such liquidating values were necessarily conservative. The witness failed to explain except in very general terms*2992 why he took the percentages of discount on the book value which he used. We can not regard this testimony as having sufficient weight to warrant us in fixing a value on the corporate assets for liquidating purposes as of the year 1921. So that in this case, as in the case of Winthrop Ames, it may justly be remarked that the petitioners failed to take steps which would have resulted in a definite ascertainment of their losses, and as in that case the Board is asked to speculate to what extent the corporation was insolvent in the taxable year in question.
It is evident that the taxpayers believed there was hope for the future at the close of the year 1921. That fact in our opinion is entirely inconsistent with a charging off of the debts in that year. Certainly, it can not be said that such debts were then ascertained to be worthless.
While the petitioners E. A. Deeds and Kettering did not own a majority of the common stock, they were in a position by reason of their advances to force the corporation into liquidation. Not only did they refrain from taking this step, but they continued to make *1147 substantial advances to the corporation during the greater part*2993 of the remainder of the corporation's existence. While some of these advances may have been necessitated by the fact the corporation paper was guaranteed, there is no way for us to determine how much of the money so advanced was necessitated by this fact, and how much was advanced voluntarily, nor is it possible to determine with certainty the total amounts of these advances either prior or subsequent to December 31, 1921, since on this point the evidence is conflicting and gives rise to much confusion. There is some showing that the petitioners were reluctant to take steps to liquidate the business because it was being conducted by friends. We are not convinced, however, that their assent to continue the corporate operations was the result of altruistic motives.
It appears from the financial statement at the close of the year 1921 that there were assets sufficient to satisfy in part the claims of the petitioners. That being the case, they could not in any event be allowed a deduction on account of the entire indebtedness and it has not been shown how much, if any, of the indebtedness could have been paid.
With respect to deducting the investment in stock, the facts are again*2994 unfavorable to the petitioners. The value or lack of value of the corporate assets not being satisfactorily shown, we can not say that the stock was worthless. ; ; ; .
Judgment will be entered for the respondent.