*3466 1. The Commissioner erroneously added to income amounts representing bad debts which have never been deducted from income.
2. The Commissioner denied the right of the petitioner to use inventories and the include certain accrued items in the computation of its invested capital and for lack of evidence his determination is approved.
*728 This proceeding is for the redetermination of deficiencies in income and profits taxes for the calendar years 1920 and 1921, in the amounts of $2,616.33 and $6,914.19, respectively. Three issues were raised: (1) Whether the Commissioner added certain amounts to income for each year representing bad debts never deducted from income; (2) whether the petitioner is entitled to use inventories in reporting its income; and (3) whether the petitioner is entitled to have certain accrued items included in the computation of its invested capital.
FINDINGS OF FACT.
The petitioner is a Maine corporation with its principal office at Bangor.
The gross income as reported on the return was not understated by the deduction*3467 of any worthless debts. No deduction for worthless debts was claimed on the return.
The Commissioner notified the petitioner in part as follows:
| 1920 | ||
| Adjustments to income | ||
| Net income reported on return | $22,600.42 | |
| Additions: | ||
| (1) Excessive depreciation | $394.47 | |
| (2) Prepaid subscription | 3,783.83 | |
| (3) Profit on automobiles | 980.00 | |
| (4) Accounts receivable charged to reserve | 2,629.34 | |
| Total Additions | 7,787.64 | |
| Total | 30,388.06 | |
| Deductions: | ||
| (5) Increase in opening inventory | $596.94 | |
| (6) Prepaid subscriptions | 4,214.85 | |
| (7) Repairs allowed as expense | 2,594.40 | |
| Total deductions | 7,406.19 | |
| Net income as adjusted | 22,981.87 |
* * *
*729 (4) Bad debts are disallowed, inasmuch as the return is made on a cash receipts and disbursement basis. See Article 22 and 23, Regulations 45.
(5) Increase in inventory is disallowed as the return is made on a cash receipts and disbursements basis. See Article 22 and 23, Regulations 45.
| Invested capital | ||
| Capital stock | $200,000.00 | |
| Deductions: | ||
| (1) Preceding year's tax, $2,295.09 (prorated) | $967.15 | |
| (2) Nonoperative deficit | 156,885.09 | |
| Total deductions | 157,852.24 | |
| Balance | 42,147.76 |
*3468 * * *
(2) The deficit caused by the payment of stock dividend and the disallowance of accounts receivable and inventory to be included in invested capital is computed as follows:
| Deficit as shown on books | $31,873.68 | |
| Add: | ||
| Accounts receivable | $78,351.36 | |
| Inventory | 7,976.05 | |
| Taxes for prior years | 5,779,75 | |
| Prepaid subscription | 3,783.83 | |
| Reserve for depreciation | 29,320.42 | |
| 125,011.41 | ||
| Deficit adjusted | 156,885.09 |
The above adjustment has been made in accordance with O.D. 1007; C.B. 5, page 285, and Article 869, Regulations 45.
| 1921 | ||
| Net income reported on return | $24,905.54 | |
| Additions: | ||
| (1) Accounts charged off | $3,573.45 | |
| (2) Decrease in Inventories | 2,944.55 | |
| (3) Prepaid subscriptions | 6,214.85 | |
| Total additions | 10,732.85 | |
| Total | 32,630.39 | |
| Deductions: | ||
| (4) Furniture and fixtures | $2,376.46 | |
| (5) Loss on automobiles | 150.00 | |
| (6) Additional depreciation | 510.22 | |
| Total deductions | 3,036.68 | |
| Net income as adjusted | 32,601.71 |
*730 (1) Bad debts charged off are disallowed as the return is made on the cash receipts and disbursements basis. See Article 22 and 23, Regulations 62.
(2) Inventories are disallowed*3469 for the same reason.
(3) Prepaid subscriptions are disallowed for the same reason.
| Invested capital | |
| Capital stock | $200,000.00 |
| (1) Less deficit | 156,198.31 |
| Total | 43,801.69 |
| Deductions: | |
| (2) Preceding years tax, $6,231.66 prorated | 2,533.50 |
| Balance | 41,166.19 |
| (1) The deficit as shown on the original balance sheet is adjusted as follows: | |
| Deficit | $9,216.00 |
| Accounts receivable | 100,658.65 |
| Inventory | 8,572.99 |
| Reserve for depreciation | 28,045.95 |
| Prepaid subscription | 4,214.85 |
| Additional tax for prior years | 5,589.87 |
| 156,298.31 | |
| Error in crediting automobile account | 100.00 |
| Deficit adjusted | 156,198.31 |
Excess-profits taxes for each year were computed under section302, as for each year the amount was less than that computed undersection 301.
OPINION.
MURDOCK: The Commissioner added $2,629.34 to the petitioner's reported income for 1920, and $3,573.45 to its reported income for1921, on the theory that the petitioner had deducted these amounts from its gross income. Apparently, he reached this conclusion from the fact that in the return for each year the petitioner in "Schedule *731 L. - Reconciliation of Net Income and analysis of*3470 changes in surplus" showed these amounts as "Accounts receivable charged off." However, counsel for the respondent stated that "the gross income reported by the petitioner for these years was the gross amount of cash receipts for those years." The returns show that gross income as reported for each year in Schedule A was not reduced by any deduction for bad debts. Consequently, the Commissioner erred in adding these amounts to income.
Evidence to support the other contentions of the petitioner is lacking. Inventories are only proper where by their use income is clearly reflected. The Revenue Acts of 1918 and 1921 provide that "the net income shall be computed upon the basis of the taxpayer's annual accounting period * * * in accordance with the method of accounting regularly employed in keeping the books of such taxpayer* * *." Without knowing anything about the method of accounting regularly employed in keeping the taxpayer's books we can not say that it was entitled to use inventories or that the Commissioner committed any error in making adjustments on account of inventories.
The returns seem to have been made upon some improper basis using a cash receipts and disbursements*3471 method for some items and an accrual method for others. The Commissioner has determined the deficiencies and computed invested capital on a cash receipts and disbursements basis. The evidence does not indicate that he has done this erroneously. A taxpayer keeping its books on a cash receipts and disbursements basis is not entitled to accrue items and thus increase its invested capital. On each of the two issues last discussed we have pointed out one fundamental reason why the petitioner failed to sustain its contention. Its proof failed to establish other important facts which we do not feel called upon to discuss. Judgment will be entered under Rule 50.