1931 BTA LEXIS 2194">*2194 Loss sustained on loans allowed as a deduction.
21 B.T.A. 1412">*1412 Proceeding for the redetermination of a deficiency of $287.86 in income tax for 1922. The issue is whether the sum of $1,503,180.59 is deductible from gross income as a bad debt or a loss.
FINDINGS OF FACT.
The petitioner, an Oregon corporation, was organized September 1, 1908, to take over properties belonging to Charles E. Ladd, who with members of his family, owned all of its capital stock. Ladd was also president of the Carlton Consolidated Lumber Co., hereinafter to be referred to as the Lumber Co., from the date of its organization in 1910 to 1919.
On numerous occasions between 1910 and 1921, inclusive, petitioner loaned to the Lumber Co. varying sums totaling the principal amount of $1,503,180.59, under the circumstances hereinafter more fully related.
At the time of its organization the Lumber Co. acquired by purchase from the Yamhill Timber Co. and Carlton Lumber Co., Oregon corporations, the latter being the predecessor of the Lumber Co., a 21 B.T.A. 1412">*1413 timber tract in Yamhill1931 BTA LEXIS 2194">*2195 and Tillamook Counties, Oregon, containing about 650,000,000 feet of timber, a logging railroad on the tract, a sawmill, pond, lumberyard, and machinery and equipment with which to operate the plant. One of the chief considerations for the transfer of the properties was that the Lumber Co. assume an indebtedness of $1,000,000 to the Ladd & Tilden Bank and Ladd Estate Co., Oregon corporations. Of this amount, $540,000 was to be paid to the Ladd & Tilden Bank, and was evidenced by six promissory notes dated April 16, 1910, one for $300,000 payable on demand, four in the amount of $50,000 payable on or before two, three, four, and five years, respectively, after date, and one in the amount of $40,000 payable on or before six years from its date. The remaining amount of $460,000, payable to the Ladd Estate Co., was evidenced by two notes, one for $10,000 maturing on or before six years from its date, and the other for $450,000 payable on or before seven years from date. The notes bore interest at the rate of 6 per cent per annum.
The notes were secured by a second mortgage on all the property of the Lumber Co., including the stocks and bonds of the Carlton & Coast Railroad Co., 1931 BTA LEXIS 2194">*2196 owner of the logging railroad on the timber tract, and 13,331 shares of stock of the Lumber Co. held by W. B. Dennis, and 6,666 shares held by Fred Russell, with power to exercise the voting rights of the stock of both corporations. A first mortgage was to be issued on the property to secure a serial bond issue of $650,000, of which amount $300,000 was to be used to liquidate the notes. Neither of the mortgages has ever been foreclosed.
The Lumber Co. operated the plant a short period in 1911 and 1912. From some time in 1913 until the summer of 1914, when the mill burned, the plant was operated under a lease. The mill was never rebuilt and no timber has been cut on the tract since 1914. The Carlton & Coast Railroad Co. continued to operate in order to hold its franchise and served several other mills located along its right of way. The Lumber Co. had a large stock of lumber on hand after the fire, which it retailed locally. In 1914 it started to sell its equipment. The income derived from the sales made was placed in a fund created to liquidate the outstanding notes of the Lumber Co.
The loans made by petitioner to the Lumber Co. were largely to pay its maturing serial1931 BTA LEXIS 2194">*2197 bonds and meet maintenance charges, losses sustained while the plant was under lease, damages sustained by the lessor because of the Lumber Co.'s failure to rebuild the mill after the fire, and interest on the notes held by the Ladd & Tilden Bank and Ladd Estate Co. The Lumber Co. gave petitioner an interest-bearing, demand promissory note for the amount of each advancement.
21 B.T.A. 1412">*1414 The indebtedness of the Lumber Co. on March 1, 1913, and in 1914, exclusive of its bonded indebtedness of $650,000, was $700,000 or $800,000. Thereafter its indebtedness increased, and on December 31, 1922, it owed to the Ladd Estate Co., the principal amount of $900,700, a large part of which was payable under notes acquired by purchase in 1919 from the Ladd & Tilden Bank. Some of the indebtedness, and interest thereon, was liquidated by payments made in the years between 1912 and 1926, inclusive. At the close of 1922 the Lumber Co. was indebted to the petitioner for cash advanced it for the purposes stated above, the sum of $2,109,180.14, of which amount $1,503,180.59 represented principal and the balance of $605,999.55 interest. In 1913 and 1914 the Ladd Estate Co. paid interest on the notes1931 BTA LEXIS 2194">*2198 issued prior thereto in favor of the petitioner for cash advances. Nothing has been paid on such notes since 1914. The Lumber Co. has always been in a precarious financial condition. The notes of the Lumber Co. held by petitioner were not listed in the statement of assessable personal property rendered to Multnomah County, Oregon, for the years 1918 to 1922, inclusive. The Lumber Co. was dissolved in 1928 or 1929.
On May 16, 1919, the petitioner, the Ladd & Tilden Bank, and the Ladd Estate Co. executed an instrument confirming an understanding reached at the time the Lumber Co. became obligated to the parties thereto, to the effect that any payments made by the Lumber Co. on its indebtedness to such creditors should be applied in the following order: Ladd & Tilden Bank, Ladd Estate Co., and petitioner. By an endorsement to the instrument the Lumber Co. agreed to comply with the terms of the agreement.
Prior to 1922 the Lumber Co. was constantly engaged in an effort to sell its properties and the highest offer received was in the amount of $500,000. In the summer of 1922 it started to negotiate with the Flora Logging Co. through George L. Gardner, a broker, for the sale1931 BTA LEXIS 2194">*2199 of its business. In December, 1922, the negotiations were concluded and the terms of the sale were embodied in a form of contract. On December 21, 1922, the stockholders of the Flora Logging Co. considered the proposed sales agreement and authorized its directors to purchase the business at the price and upon the terms and conditions set forth in the instrument. The form of contract approved by the stockholders of the buyer was executed on January 10, 1923, and provided for the purchase of all of the assets of the Lumber Co. for the sum of $1,000,000, payable in certain prescribed installments over a period of eleven years. At the time of the sale the assets sold had a book value of $3,551,490.62. None of the stockholders of the Flora Logging Co. held stock of the Lumber Co., Ladd Estate Co., or the petitioner.
21 B.T.A. 1412">*1415 On January 8, 1923, the Lumber Co. agreed to pay to George L. Gardner a commission of $150,000 for services performed in connection with the sale, said sum to be paid as payments were received from the Flora Logging Co. On June 7, 1927, the Lumber Co., pursuant to a resolution adopted by its directors on June 23, 1924, executed an agreement with W. B. Dennis, 1931 BTA LEXIS 2194">*2200 its vice president, confirming an oral agreement entered into at the time the negotiations were being conducted, to the effect that Dennis was to receive a commission of $20,000 for the services he performed in connection with the transaction. At some undisclosed time the Lumber Co., also agreed to pay to the Ladd & Tilden Bank, as compensation for services performed by it for the Lumber Co. in connection with the sale, a sum equal to 10 per cent of the sale price for the properties, less other commissions.
From the time of its organization until 1923 the only books maintained by the petitioner consisted of a cash book, in which was recorded cash received and disbursed, and a ledger, which did not contain a profit and loss account. In 1923 the Bureau of Internal Revenue insisted that this accounting system be changed. Accordingly, in August, 1923, petitioner started to rewrite its books from 1908 down to date so they would reflect the amount of profit realized or loss sustained each year. The books for 1922 were rewritten before the close of 1923. In rewriting the books for 1922, the principal amount of the indebtedness of the Lumber Co. was charged off as of the close of that1931 BTA LEXIS 2194">*2201 year.
In its return for 1922, filed June 15, 1923, petitioner did not claim any part of the amount due from the Lumber Co. as a deduction. The face amount of the account was claimed as a bad debt deduction in an amended return for 1922, filed on March 30, 1927. The delay in filing the amended return was due to the inability of the petitioner to more promptly determine a basis for computing a claim for depletion on certain oil wells owned by it. The respondent disallowed the deduction on the grounds that the debt was not ascertained to be worthless or charged off in 1922.
OPINION.
ARUNDELL: The evidence is clear that petitioner loaned to the Carlton Consolidated Lumber Co. in cash, $1,503,180.59. It is also established that none of this money was ever repaid. The sole point on which the parties disagree is as to the year in which the deduction may be taken. The petitioner asks for its allowance in 1922.
After the agreement of 1919 between the Ladd & Tilden Bank, Ladd Estate Co., petitioner, and the Lumber Co., wherein the bank and the Ladd Estate Co. became preferred creditors, the chances of 21 B.T.A. 1412">*1416 petitioner recovering the full amount of its advances to the1931 BTA LEXIS 2194">*2202 Lumber Co. became increasingly precarious. It is doubtful, however, whether it could be said that at any particular time the indebtedness became entirely worthless prior to December, 1922. The Lumber Co.'s assets at that time had a book value of about $3,500,000 and its total indebtedness appears to have been less than that figure. The Lumber Co., in December, 1922, entered into a definite agreement for the sale of all of its assets for $1,000,000 gross, out of which there were various selling charges to be paid, leaving a net amount of $747,000 available to the Lumber Co. The Lumber Co.'s indebtedness to the Ladd Estate Co. exceeded that amount. While the actual execution of the contract of sale of the Lumber Co.'s assets did not occur until the early part of January, 1923, both parties to that transaction had definitely and finally agreed on the terms of sale before the close of 1922. The contract was drawn and it then and there became certain that the petitioner could not hope to recover any portion of its loans to the Lumber Co. All these facts were known by petitioner within the year 1922 and the ascertainment of worthlessness is clearly established.
More difficulty1931 BTA LEXIS 2194">*2203 arises on the matter of the charge-off of this indebtedness. The petitioner kept only the simplest records, on which were entered only actual cash received and actual cash disbursed, with no profit and loss account ever made up. Under instructions from the Commissioner of Internal Revenue it installed in the year 1923 a proper accounting system, beginning with the year 1908, and in connection with the rewriting of its books in the year 1923 did charge off this amount as of the year 1922. A charge-off of a debt within a reasonable time after the close of the year in which it is ascertained to be worthless, is sufficient to meet the requirements of the statute. ; . The charge-off here was made in 1923 before the new books for 1922 were closed. The loss was sustained in 1922 and the amount thereof ascertained in 1922, and we believe that what was done in the circumstances may be said to satisfy the provisions of the statute in requiring the charge-off of a debt ascertained to be worthless. Cf. 1931 BTA LEXIS 2194">*2204 ; ; and , to the effect that where a taxpayer does not keep books, the charge-off provisions of the statute do not apply.
It has been argued in the alternative that the deduction should be allowed under the loss provision of the statute. If this be true the evidence satisfies us that the loss was sustained in the year 1922. Petitioner is entitled to the deduction.
Reviewed by the Board.
Decision will be entered under Rule 50.