*2687 The petitioner is entitled to deduct the aggregate amount of six promissory notes found to have been worthless and charged off in 1920, irrespective of the worth of four other notes against the same debtor which it did not charge off until the years following.
*1301 This proceeding is for the redetermination of a deficiency in income and profits taxes for the year 1920 amounting to $19,814.26, and the sold question for determination is whether the respondent erred in his failure to find that the entire indebtedness of the Forbes Milling Co. was worthless, and in disallowing a deduction as a debt ascertained to be worthless and charged off, the sum of $50,500, represented by six promissory notes.
*1302 FINDINGS OF FACT.
Prior to May 15, 1925, the petitioner was a state bank, organized and incorporated under the laws of the State of Kansas, which on that date was converted into a national bank, and it has since conducted its business as such under the name of The National Bank of Topeka.
The Forbes Milling*2688 Co., debtor of petitioner, was chartered on June 1, 1917, to carry on the manufacturing and mercantile business, the conversion, sale and disposal of agricultural products by means of mills, elevators, markets, stores or otherwise, and to hold, improve and convey and dispose of property, real, personal and mixed, which may be necessary in the transaction of its business, with a total authorized capital stock of $24,000, divided into 240 shares, par value $100 each. Its mill was located in Topeka, Kans., occupying premises on the right of way of the Union Pacific Railroad under a 20-year lease entered into by its predecessor, Forbes Brothers, a partnership, November 1, 1909, at a rental of $150 per annum, which lease, among other things, provided that "the Lessee covenants that the leased premises shall not be used for any other purpose than for the site of a Mill, Gr. Ele., Coal Ho., Ware Ho., Office and Sca. and that if the lessee abandons the property hereby leased, the Railroad Company may enter upon and take possession of the same, and that a non-user, for the purpose above mentioned, of said leased premises, for thirty days by the Lessee, shall be sufficient and conclusive evidence*2689 of such abandonment."
At the time the said company was incorporated it was milling corn meal and feed only, in an old three-story, frame structure, 50 by 100 feet, having a capacity of 400 barrels a day. Immediately upon its incorporation extensive improvements and additions were begun and completed during the years 1917, 1918, and 1919, the cost of which aggregated in the neighborhood of $163,000, and after the completion of said improvements and additions the capacity of the mill was increased to 1,000 barrels of meal and 400 barrels of flour. The mill consisted of three units; an old corn meal unit, operated prior to incorporation, and also during the period when new additions were being made; the new corn meal unit, and a flour mill unit which was not completed until on or about January 1, 1919. In 1920 the corn meal unit consisted of nine stands, equipped with Wolf rolls, which were inadequate for the class of work required of them and were constantly breaking down and interfering with operations. The manufacturer of these rolls had then discontinued manufacturing the same type roll. The corn mill had two sifters which received the stock after being ground on the rolls, *2690 costing between *1303 $2,500 and $3,000. These sifters were assembled in the mill in sections and were so fixed to the building that to remove them would require tearing down a portion of the building, and being built for the particular meal manufactured by this mill, they had no resale value. The mill had four kiln driers, used for killing germs, removing moisture and sterilizing; two of them were of standard make, and good machines, but the other two were of a different type, not then in use in the milling industry, acquired during the war because others were not obtainable. They were never operated successfully. The degerminators, used by the mill for removing hulls and making separation of stock, were heavy duty machines, which deteriorated very rapidly because of the nature of the work performed. The mill used between eight and ten reels having an average life of two years. In 1920 three reels were new but the balance of them had rotted away and were unfit for use. The milling company purchased a grinder costing $2,500, which was never used because it could not be made to operate successfully. The flour mill machinery was purchased, second hand, from a small mill*2691 in Tennessee having a 75-barrel capacity and shipped to this mill for installation. The labor cost of installing the flour mill unit was approximately $60,000. Aside from its value as an operating property the mill had no value in December, 1920, except for junk, in that the lease upon the premises restricted the use thereof, that 1920 was an extremely disastrous year for milling concerns, six mills having shut down in Topeka alone and many other throughout Kansas and the United States, and that the buildings and machinery were in bad condition and improperly constructed and installed for economic operation. The Wolf machinery was purchased on a conditional sales contract with a guarantee of performance. Because of failure of performance, $10,000 or more of the purchase price remained unpaid. Nor was the entire cost of the boilers and installing them paid for. There was, therefore, an existing lien for the unpaid balance to the extent of approximately $15,000.
The Forbes Milling Co. was very successful during the period of the war and made money, a large portion of which was used for making the improvements hereinbefore related. It also borrowed money from the petitioner*2692 in varying amounts from time to time on its promissory notes, some of which were secured and some were not. During the period February, 1918, to November, 1920, the petitioner loaned the milling company $129,000, a portion of which, or $3,500, was paid in August of 1918, leaving the balance of $125,500 unpaid. The amounts still owing, for which promissory notes were held, in December of 1920, were as follows:
| No. | Date executed | Rate of interest | Amount |
| Per cent | |||
| 1 | May 10, 1918 | 7 | $4,000 |
| 2 | Feb. 11, 1918 | 7 | 2,000 |
| 3 | Feb. 19, 1918 | 7 | 7,000 |
| 4 | May 25, 1918 | 7 | 1,500 |
| 5 | Mar. 20, 1920 | 8 | 30,000 |
| 6 | June 14, 1918 | 7 | 6,000 |
| 7 | Mar. 2, 1920 | 8 | $30,000 |
| 8 | July 21, 1919 | 8 | 15,000 |
| 9 | Nov. 27, 1920 | 8 | 25,000 |
| 10 | Nov. 17, 1920 | 8 | 5,000 |
| Total | 125,500 |
*1304 All of the foregoing note were from time to time renewed by the milling company. The notes numbered 8, 9, and 10 were executed on collateral note form, bearing a notation to the effect that they were secured by inventories and book accounts, but the petitioner held no chattel mortgage or other security. The proceeds of each note were paid to the Forbes Milling Co. at the time*2693 each note was given. Each transaction was separate and distinct, and neither bore any relation to the other, except that the notes were made by the same maker. They in nowise represented or evidenced a general account.
In January of 1919 the milling company was heavily indebted to the petitioner and others, and although repeated demands had been made for payment, that company was unable to liquidate its indebtedness. As a result of these conditions the stockholders placed their stock in escrow with the Prudential Trust Co. of Topeka, and the affairs of the company were, in January, 1919, placed under the active control and supervision of J. B. Nicholson and A. H. Dillon "with a view to properly operating said property so as to pay off the corporate obligations of the Milling Company to said Bank of Topeka, and others * * *." The agreement of January 3, 1919, from which the foregoing remarks are quoted, recited, "When the total outstanding obligations of the Milling Company shall be reduced to fifty per cent (50%) or less" of its assets, a portion of the escrowed stock should be returned to the stockholders and slightly less than 50 per cent given to Nicholson and Dillon.
*2694 The mill was listed with brokers in Wichita, Kans., for sale prior to December, 1920, and continuous but futile efforts were made to sell it. On or about March 29, 1922, the Shawnee Milling Co. of Topeka took over the operation of the mill. The mill was later bid in by the petitioner at a receiver's sale for something less than $5,000 and thereafter sold for about $4,000.
In November or December of 1920 an audit of the books of account of the Forbes Milling Co. was begun at the request of the petitioner. As the auditor's work progressed he discussed the financial condition of the mill with the petitioner's officers and directed their attention to the fact that the mill had sustained an operating deficit. The auditor prepared a rough draft of his findings and brought the contents thereof to the attention of the petitioner's officers. As a result *1305 of his examination, the auditor, under date of January 10, 1921, rendered his final report, containing the following balance sheet taken from the books of account as of December 31, 1920:
| Assets: | ||
| Cash on hand | $75.00 | |
| Cash in bank | 4,128.43 | |
| $4,203.43 | ||
| Notes receivable | 2.87 | |
| Accounts receivable (net) | 13,056.90 | |
| Inventories | 22,882.99 | |
| Advances on grain | 2,201.48 | |
| Total current assets | 42,347.67 | |
| Fixed assets: | ||
| Real estate, plant, and equipment | $166,164.28 | |
| Less reserve for depreciation | 29,786.24 | |
| 136,378.04 | ||
| Milling in transit | 2,510.91 | |
| Railroad claims | 944.88 | |
| Deferred expenses | 3,597.28 | |
| Total assets | 185,778.78 | |
| Deficit from operations | 139,652.00 | |
| Total | 325,430.78 | |
| Liabilities: | ||
| Notes payable | 196,750.00 | |
| Notes payable (deferred) | 42,000.00 | |
| Accounts payable | 15,983.81 | |
| Outstanding grain checks | 515.87 | |
| Reserve for deferred interest | 16,188.85 | |
| Other reserves | 8,198.27 | |
| Current liabilities | 279,636.80 | |
| Capital: | ||
| Common stock | $24,000.00 | |
| Paid in surplus | 21,793.98 | |
| 45,793.98 | ||
| 325,430.78 |
*2695 At the close of the year 1919 the petitioner charged off on its books of account nine notes of the Forbes Milling Co. aggregating in amount $50,500, which were in all respects similar to the notes hereinabove listed and numbered 1 to 7, inclusive, except that there was a year's difference in the date of maturity, thereby reducing the total indebtedness of the milling company to the petitioner in December, 1920, to $125,500, or the amounts of the ten notes hereinabove listed and described.
The notes numbered 1 to 6, inclusive, listed hereinabove, aggregating $50,000 in amount, had, in 1920, been in the hands of an attorney for a year, who had endeavored to make collection, but without success.
*1306 The officers of the petitioner considered that all of the ten notes, aggregating $125,500, hereinabove referred to, were absolutely worthless in 1920, and so believing, notes 1 to 6 were endorsed "Cometery 12-29-20" and the amounts thereof were charged off on the books of account on December 29, 1920. Notes numbered 7, 8, 9, and 10 were not charged off in 1920 for the reason that the petitioner's officers did not care to burden the financial statement with the entire indebtedness*2696 in that year. Those amounts, therefore, were charged off, $30,000 in 1921, $15,000 in 1922, and $30,000 in 1923. There has never been any recovery on any of the ten notes in question nor have the amounts thereof been reinstated as assets of the petitioner.
The respondent disallowed the $50,500 deduction claimed by the petitioner in 1920 for the reason that "the Revenue Act of 1918 does not permit the partial charge off of debts not finally determined to be worthless."
OPINION.
MORRIS: The respondent disallowed the deduction here in controversy for the reason that it was a partial charge off of a larger indebtedness not finally determined to have been worthless in 1920. The petitioner contends that each of the six notes, aggregating $50,500, charged off in 1920, constituted a separate debt, and that irrespective of the worth of the remaining four notes, which were not charged off at that time, the amount of the notes so charged off is an allowable deduction within the meaning of the Act, and, furthermore, in the event that we do not so hold, that all ten of the notes, aggregating $125,500, were worthless in that year and, therefore, it is entitled to deduct the amount actually*2697 charged off.
The pertinent provisions of section 234 of the Revenue Act of 1918 are:
(a) 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.
The respondent's counsel filed no brief and we are, therefore, deprived of the benefit of his views. He did, however, cite a number of cases at the hearing which he presumably relies upon to set forth any views that he may have. Disposition of these cases may aid in a solution of the question presented. In view of our findings of fact that the notes were charged off December 29, 1920, which is the taxable year in controversy, the cases of , and , cited by him, may be dismissed from further consideration. , which holds that a mere order of a *1307 bank examiner to charge off a debt is not in and of itself sufficient to establish the worthlessness thereof, may also be dismissed from further consideration*2698 for the reason that we have made no finding that such an order was made in this case although we have been requested to do so by the proposed findings of fact submitted by the petitioner. Our reason for making no positive finding on this subject is that the testimony of the petitioner's witness was to the effect that the bank examiner "practically" ordered the charge-off of a portion of this indebtedness. While we believe there is no doubt but that the bank examiner had something to say with respect to these notes, and possibly urged that they be charged off, we can not find as a fact from the recorded testimony that an order was actually made by the examiner.
, cited by the respondent, held that the petitioner there had failed to adduce facts upon which a conclusion of worthlessness might be based. We believe that even a cursory examination of the facts found herein convincingly proves the worthlessness of the notes charged off in 1920. We find that the Forbes Milling Co. was organized in 1917 to engage in the milling business and that its authorized capitalization was $24,000; that it occupied premises on*2699 the right of way of the Union Pacific Railroad under a lease restricting the use thereof for a grain elevator, coal house, warehouse office and scale; that immediately upon incorporation extensive repairs were begun, and completed during the years 1917 to 1919, increasing the capacity of the mill nearly fourfold. We find further that a great deal of the new machinery installed was of the type not suited for the particular class of work performed at this mill and that the mill suffered from constant breakdowns; that a great majority of the machinery and equipment installed by the mill was second hand; that the installation of machinery and other improvements and additions were made from time to time and in such a manner that the mill could never be operated profitably. The testimony of several witnesses for the petitioner is to the effect that the mill had no other value except as an operating property or for junk; that 1920 was an extremely disastrous year for milling concerns, six mills in Topeka alone having been compelled to shut down. Certain of its machinery was encumbered by liens to the extent of about $15,000 for the payment of the balance of the purchase price thereof. *2700 In January, 1919, that company was heavily indebted to the petitioner and others, and repeated but fruitless demands for payment were made. The stock of the company was placed in escrow and the affairs thereof were placed under the management of men who were to attempt to operate the property so that the obligations to the petitioner and others *1308 might be liquidated, but even this expediency met with absolute failure and the mill later passed into the hands of the Shawnee Milling Co., which also failed. The assets were finally bid in by the petitioner at a receiver's sale for something less than $5,000, which it later sold for about $4,000. Considering these factors, together with the financial instability of the company in 1920 as set forth by its balance sheet, which shows total current assets of slightly over $42,000, and current liabilities of something over $279,000, or a ratio of nearly 7 to 1, we believe there is no question but that the notes charged off in 1920 were absolutely worthless and were known to be at that time.
Respondent's counsel cites, as authority for the proposition that the deduction claimed is a partial charge off and therefore not deductible, *2701 , and . The debt in the former case was for 30,000 pounds of cotton yarn purchased by the debtor on open account. The petitioner there determined that the balance of the account remaining unpaid was worthless and charged it off in 1920. This deduction was disallowed by the respondent. On appeal to this Board the petitioner contended, in the alternative, that it should at least be allowed to deduct the difference between the amount of a compromise agreement which it had entered into with the debtor and the amount charged off. The respondent contended there that the word "debt" as used in the Act of 1918 means a debt in its entirety and does not permit the partition thereof and the writing off of a portion and the retention of a portion, in which contention the respondent was sustained.
The Davidson Grocery Co. case also involves the deductibility of a portion of an open account determined to be worthless and charged off in 1919. The Board in that case, following *2702 , held that the amount in controversy was not deductible under the Revenue Act of 1918.
We are of the opinion that the principal enunciated in the two cases just cited and discussed does not control the issue raised here. The record shows that there were ten notes, made at different times, having different maturity dates, for varying amounts from $1,500 to $30,000, that each transaction was separate and distinct, and that neither bore any relation to the other except that they were made by the same maker, and, furthermore, that they in no wise represented or evidenced a general account. As each note was made, therefore, a separate contract was created and a separate indebtedness arose. The charge-off of a portion of any one note and the retention of a portion in the books of account would not, we believe, be deductible under the rule laid down in the cases just discussed. That, however, is not the case here. Cf. .
*1309 While we do not propose to decide the worthlessness of the total indebtedness represented by four other notes not charged off in 1920, we believe that*2703 we might have been justified in finding from the facts adduced that the entire indebtedness of $125,500 was worthless in 1920 and that the charge-off of a portion thereof was deductible under the rule laid down in ; ; and .
Judgment will be entered under Rule 50.