*1043 1. Petitioner, which reported income on the accrual basis, had a right under contract made in the taxable year to a discount totaling $2,450, to be paid at a certain amount per case of beer, as, if and when petitioner purchased beer from the other contracting party. Held, that though the other party was liable and able to comply with its contract to deliver beer and to pay the discounts as purchases were made, petitioner had income in the taxable year only to the extent that the discount was paid in that year, the payment of future discounts lacking the definiteness necessary to true reflection of income by the accrual method.
2. Evidence of trade-in values of some items of a list of machinery upon which a composite rate of depreciation was claimed based upon the total valuation, held insufficient to overcome presumption of correctness of composite rate determined by the Commissioner.
3. Where debtors owing debts charged off in the taxable year as worthless had, in previous years, been cut off from credit, the accounts had become slow, attempts to collect had failed, and the petitioner had determined that it could not collect and had placed the accounts in a suspense*1044 ledger, and as a last effort in the year previous to the taxable year had sent them to a collection agency, held, error has not been shown in the disallowance by the Commissioner of claim for deduction as to a part of the accounts.
4. Electric coolers, put out by petitioner to its customers in order to sell spring water under a written lease for a monthly rental, with option in customer to purchase, and beer kegs and cases put out to customers purchasing beer upon deposit which was returned upon return of the keg or case, held, not assets held primarily for sale in course of trade or business, under section 117(b), Revenue Act of 1934.
*380 This proceeding involves income taxes for the calendar year 1934. Deficiency was determined by respondent in the amount of $1,117.60. An issue as to income from inventory adjustment was conceded by respondent at the hearing, and another as to certain machinery called fillers being properly determined to be capital assets was conceded*1045 by petitioner upon brief.
FINDINGS OF FACT.
1. Discounts. - The petitioner is a Wisconsin corporation, with offices at 41 Greenfield Street, Milwaukee, Wisconsin. It reports its income on the accrual basis. In the taxable year 1934 it was engaged in the business of manufacturing soda water and selling beer and spring water. It purchased beer from the Star Brewing Co., which was not incorporated, but was owned and operated by the Starr Canning Co., a corporation, "Star Brewing Co." being merely a trade name. Having had difficulties with its customers as to the quality of the beer received from the Starr Canning Co., the petitioner instituted action in the Circuit Court of Dodge County of Wisconsin against the Starr Canning Co., claiming damages for about $10,000. On July 12, 1934, the case was settled and dismissed upon the following basis, as set forth in written agreement: It was agreed that the Starr Canning Co. should pay the petitioner the sum of $3,000 (a) by delivering forthwith and upon demand 500 cases of bottled beer at the posted price of $1.10 per case with a credit memo to the petitioner for $550; (b) by allowing petitioner, to the extent of $450, a discount*1046 of 25 cents per case on additional beer purchased by it, purchase to be at the posted price, payment to be made by the petitioner upon delivery of the full posted price, but simultaneously with such payment the Starr Canning Co. to deliver to the petitioner its check for the 25-cent discount; (c) by allowing petitioner, to the extent of $2,000, a discount of 10 cents per case upon additional beer purchased, the petitioner to pay the full posted price therefor, but simultaneously with such payment to receive from Starr Canning Co. its check for the discount of 10 cents per case. The contract provided that in case petitioner refused to order any beer after delivery of the first 500 cases, such failure to order additional beer should constitute a waiver of the balance of the credit allowance, and the 500 cases should be full settlement.
During 1934 the petitioner received 500 cases of beer from the Starr Canning Co., and in addition to the 500 cases purchased from the Starr Canning Co. 710 cases of beer on which the purchase discount of 25 cents was received, making a total received in 1934 of $727.50. In 1935 the petitioner purchased on the 25-cent purchase-discount basis 1,185*1047 cases and received a total rebate of $296.25; and purchased an additional 3,193 cases upon the discount basis of 10 *381 cents per case, receiving a total discount of $319.30 on the 10 cents per case basis, making a total discount for the year of $615.55, which amount was credited to the Star Brewing Co. on the contract. Additional beer was purchased by the petitioner from the Starr Canning Co. in 1936, but the record does not show the amount thereof.
Petitioner kept an account of these purchases under the head of Star Brewing Co., in which account the $3,000 that was to be received was set up. The beer account was charged and the Star Brewing Co. was credited with the 25 cents discount and the 10 cents discount allowed on the contract. The contract on the 25-cent basis was fulfilled, but petitioner stopped purchasing beer before the contract was fulfilled as to the 10 cents per case basis. The $3,000 was credited to surplus.
Although the action filed against the Starr Canning Co. was for $10,000 for damages, the $10,000 figure represented not only damages by reason of having to refund to customers the purchase price of defective beer furnished by Starr Canning Co. *1048 , but also loss of accounts, commissions paid, freight, etc., caused by the bad beer; and no figure of $10,000 was set up on petitioner's books in 1933, when the defective beer was purchased. The matter was let ride until 1934, when the $3,000 represented by the settlement was set up on the books. In 1933 the only charge-back set up on the books was the actual sales to customers which were returned, the amount thereof not being shown in the record. The petitioner did not have sufficient customers during 1934 to require enough beer to absorb the $3,000 provided by the settlement. The Star Brewing Co. was able to comply with the contract to deliver beer and pay the discount.
2. Depreciation. - Petitioner had machinery and equipment of a total cost of $45,267.58. The dates of purchase are not shown by the record. The machinery included a "Cem Filler" having a life of five years, a "Dixie Filler" with a life of six years, a "Royal Filler" with a life of four years, and a bottle washing machine with a life of eight to ten years.
The only machine fully depreciated but still in use in 1934 was a washer originally costing about $10,700. The "Royal Filler" cost $7,750. It*1049 was traded in for new machinery at a figure of $3,000, at a time when depreciation left it a value of $5,289.84, showing a book loss of $2,289.84. The "Dixie Filler" cost $3,300, and was traded in on new machinery at a figure, or trade allowance, of $1,700 at a time when depreciation taken of $1,292.50 left it a book value of $2,007.50, at a book loss of $307.50. Miscellaneous sales of machinery were made for $340 of machinery costing $226.12, on which depreciation taken of $53.12 left a book value of $173, resulting in a profit of $167.
*382 Respondent, out of $4,409.16 depreciation claimed on machinery, disallowed $1,497.22, allowing $2,911.94.
3. Bad debts. - About August 4, 1933, petitioner made a kind of trial balance of its suspense ledger, upon which suspense ledger accounts had been placed when salesmen could not collect them, or had a little difficulty in collecting. No investigation of such accounts had been made, but they had become slow accounts, the various salesmen had tried to collect, and the salesman who made the sale, the manager, and the accountant-bookkeeper had gone over them, discussed them, and determined that petitioner could not collect*1050 them, and as a last effort, in December 1933, they were turned over to a collecting agency, Lewis & Minash, in Milwaukee, for collection. After each account on the suspense ledger appears a number, 1931, 1932, 1933, etc., indicating the year in which credit was cut off from the customer, and after which he was a cash customer.
Credit had been cut off from accounts in the years shown as follows:
| 1929 | $26.25 |
| 1930 | 2,340.15 |
| 1931 | 3,104.70 |
| 1932 | 3,496.05 |
| 1933 | $214.51 |
| 1930 and 1931 | 359.85 |
| 1931 and 1932 | 108.04 |
| No date | 184.39 |
The collector made a report about March 1934, reporting accounts totaling $5,618.71 as worthless. Of these, dates of last purchase were:
| In 1929 | $11.40 |
| In 1930 | 1,900.15 |
| In 1931 | 2,086.68 |
| In 1932-1933 | 1,601.99 |
A journal entry or write-off was made up and deduction of $5,618.71 is claimed for bad debts in 1934, in accordance with the report of the collection agency.
Petitioner, however, in its income tax report for 1934 claimed deduction for bad debts of only $2,735.72 for the reason that it was claiming under the reserve-method system rather than an actual write-off system. Petitioner therefore is now claiming*1051 an addition of $2,882.99. The respondent disallowed $2,494.82. The parties are now in agreement that petitioner is on the actual write-off system.
In September 1935 accounts totaling $2,949.81 were written off as worthless, of which $2,677.89 were marked: 1929 - $6.85; 1930 - $414.14; 1931 - $1,151.63; 1932 - $829.38; 1933 - $275.89.
4. Losses - (a) Water coolers. - During the taxable year petitioner furnished to customers electric water coolers under contracts, each of which was entitled "General Electric Water Cooler Contract", which provided that the signer, referred to as lessee, agrees to rent from petitioner, referred to as lessor, a General Electric water cooler *383 for a period of 24 months at a rental of $3.95 per month, with provision for automatic renewal of the contract unless the lessee notifies lessor in writing at least 30 days before the end of the 24-month period to remove the water cooler. Each contract also provided that the lessor grant the lessee an option to purchase the leased water cooler for $215, the option to be exercisable by lessee at any time that he is not in default of the payment of rent or in compliance of any other agreement, *1052 and if the lessee exercises said option, the lessor agrees to allow as a reduction in purchase price 50 percent of the aggregate rental theretofore paid by lessee. Other terms and conditions of the contract were that the lessee agrees not to remove the water cooler from his address without the written consent of the lessor, and for failure to pay rental the lessor may enter the premises and remove the water cooler, the lessee also agreeing to return the water cooler peaceably to lessor at the end of the lease, as well as assume all responsibility for damages to the water cooler unless caused by mechanical defects, and agrees not to injure, mortgage, sell, or sublease or part with the possession of the water cooler. The contract also provides for cancellation after 12 months by the payment of $25 and all rentals due by the lessee. Petitioner paid about $200 each for the coolers, purchasing 267 over a period of two or three years, put out about 130 of them under the contract, and at the time of hearing about 20 of the water coolers were still in the possession of petitioner. The record does not show the number of water coolers in the possession of the petitioner at the end of 1934. *1053 The water coolers were purchased for the purpose of selling spring water, and were sold to the customer for the use of spring water. A good many customers took advantage of the option.
(b) Beer Kegs and cases. - In 1933 the petitioner entered upon, and in 1934 discontinued, the manufacture of beer. Upon such discontinuance, the petitioner had on hand some kegs and cases which it sold, having no further use for them. While the kegs and cases were being used in selling beer to customers, a deposit of a certain amount was made with the petitioner for each barrel or keg and when the barrel or keg came back to petitioner, a credit was given for the deposit. The cases contained a peculiar type of bottle which the petitioner could not use after the discontinuance of the manufacture of beer.
OPINION.
DISNEY: 1. The respondent contends that the petitioner in the taxable year received a $3,000 account receivable in merchandise and discounts, that all events necessary to fix the liabilities of the parties had occurred, the Starr Canning Co. being absolutely liable, and that *384 therefore petitioner, reporting income on the accrual basis, had $3,000 income in that year; *1054 whereas the petitioner contends that there was a contingency preventing fixation of liability and accrual of income, in that the Starr Canning Co. was liable to pay the discounts only in the event of beer being ordered by the petitioner. Although we do not think the contingency in this case is of the nature involved in , cited by petitioner, or that a similar principle is involved in , or , also cited and relied upon by petitioner, nevertheless, we believe that there is lacking in the instant situation the definiteness of liability to pay, upon which the application of the accrual system of accounting is based. The underlying thought is that pecuniary obligations payable to the taxpayer are considered discharged when incurred, . These must be unconditional obligations, ; and they must be definitely payable, *1055 . The obligation of the Starr Canning Co. was not definitely payable, but depended upon and was proportionate to purchases made by the petitioner, at its volition.
It is plain from the contract that it was the intent that the discounts might materialize in years other than the taxable year, or might not be realized at all, depending upon the measure of fulfillment of a contract, optional in that respect with the petitioner. In general, income tax concerns itself with realized gains or losses. . We can not think the fact that the option was in the petitioner removes the element of uncertainty or contingency which ordinarily prohibits application of ideas of accrued income, for the contingencies of business, that is as to whether petitioner's business would, or would not, justify it in ordering additional beer from the Starr Canning Co., is a contingency as real as that of condition in liability for payment by an obligor, which is commonly held to prevent accrual of income. Taxation is practical, *1056 . Although the Starr Canning Co. was under liability to pay the discounts, this was subject to a condition - the requirements of the petitioner in its business of selling beer. Realistic approach to this question compels the conclusion that petitioner's income would not be accurately reflected by the inclusion therein of discounts, the receipt of which was not certain. Although the payment thereof could be compelled by the petitioner, it was conjoined with and dependent upon further business expenditures by it. We do not think such a contingent element should enter into the computation of income. In , in holding that there was no realization of gain until taxpayer *385 recovered the capital investment, the Court said that payments were "only conditionally promised." The promise was equally conditional here. We hold that the inclusion of any amount above $727.50 in the petitioner's income for the year 1934 was error.
2. On the question of depreciation the petitioner offered two witnesses - the first, the petitioner's bookkeeper and accountant, and the second, the*1057 accountant and credit man for a company engaged in the manufacture and sale of bottling machinery. Petitioner's bookkeeper-accountant testified in general that from his experience in keeping the books based on trade-in and "things like that" the life of most of the machinery would be seven or eight years at the most. The accountant and credit man for the bottling company manufacturing bottling machinery testified as to the value of certain machines, to wit: That the life of the "Cem Filler" was five years; that of the "Dixie Filler", six years; that of the "Royal Filler", four years; and that of a bottle washing machine, eight to ten years. Evidence as to life of four certain items of machinery with a total valuation of approximately one-half of the value of the entire machinery upon which petitioner claims depreciation (about $22,500 out of machinery with a total value of $45,267.58) does not constitute sufficient showing to overcome the presumption of the correctness of respondent's determination in disallowing $1,497.22 out of depreciation claimed of $4,409.16, we having no record of the depreciation claimed upon each piece of machinery and the figures used by both respondent*1058 and petitioner being lump sums covering all the machinery. Moreover, evidence that the "Royal Filler", which cost $7,750, was traded in on new machinery at $3,000 at a time when depreciation taken left it a book value of $5,289.84, and that the "Dixie Filler", which cost $3,300, was traded in on new machinery at $1,700 at a time when depreciation taken left it a book value of $2,007.50, does not, we think, determine the question of depreciation. Such transactions reflect, if anything, the market value of machinery at the time thereof and not the amount of depreciation suffered. Figures used in trade-in or exchange of machinery are not the criterion of depreciation. There is here, moreover, no evidence that the trade-in figure was actual fair value at the time. For the same reason the testimony of petitioner's own bookkeeper-accountant shows on its face that the witness was not qualified to give an estimate of the life of the machinery, since he based his opinion upon trade-in figures.
Although the record shows that the respondent used a basis of 12 1/2 years as against 10 years claimed by the petitioner, these percentages are composite rates, based not upon each piece of machinery, *1059 but upon the total value of all machinery, and the 12 1/2 year basis is not *386 inconsistent with the length of life as to four certain items testified to by the accountant of the company manufacturing bottling machinery. Moreover, the respondent proceeded under the regulations provided in such cases, and these have not been shown to be invalid. We think the petitioner has not shown error in the respondent's treatment of depreciation and the disallowance of $1,497.22 from petitioner's claim in that regard is therefore approved.
3. In our opinion the petitioner has not shown error in the treatment accorded by the respondent to its claim of deduction for bad debts. We do not think these debts were ascertained to be worthless in 1934. It is true that in that year they were in a sense written off, following a report by a collecting agency to whom the accounts were, as a last effort, turned over in December 1933. But long prior to that time credit had, to a large extent, been cut off from the debtors represented in these accounts, the accounts had become slow, various salesmen had tried to collect, the manager and bookkeeper had determined that petitioner could not collect*1060 the accounts, and they had been placed upon a suspense ledger in the year 1933. The respondent disallowed $2,494.82 out of $5,618.71. More than $2,494.82 was represented by accounts the last purchases in which were made in 1929, 1930, and 1931, and more than that amount is represented by accounts where credit had been cut off from the debtor not later than 1932; and petitioner has not shown the amounts marked off in 1934 not to be included in such old accounts. Moreover, there is no evidence as to what efforts were made by the collecting agency to realize upon the accounts. A person of ordinary prudence, under similar accounts where credit had been cut off from the debtor not later than taxable year. .
Under such circumstances, we hold that the petitioner has not shown error in the determination made as to bad debts by the respondent.
4. The last question for our consideration is as to whether certain losses are subject to the limitation on capital losses. First, claim is made that electric water coolers were property held primarily for sale to customers in the ordinary course of trade or business, and were not therefore*1061 capital assets. These water coolers, however, were put out by the petitioner in order to sell spring water, under a written contract which very plainly, we think, provides primarily that the contract is one of leasing and not of sale and that the sale is secondary. In addition to the fact that the contract throughout refers to the parties as lessor and lessee and to the renting of the water cooler from the lessor for a period of 24 months at a monthly rental, the contract merely gives the lessee an option to purchase. The coolers were purchased in order to sell spring water. We hold that the water coolers were not primarily held for sale in the ordinary *387 course of trade or business, and that they were capital assets, under section 117(b) of the Revenue Act of 1934.
Secondly, petitioner contends that certain beer kegs and cases were also property held by the taxpayer primarily for sale in the ordinary course of trade or business, and were not capital assets. These kegs and cases were used in selling beer to customers. A deposit was made for each by the buyer of beer contained therein, and a credit given for the deposit when the barrel or keg was returned. When*1062 the petitioner discontinued the manufacture of beer, the kegs and cases were sold. This evidence, in our opinion, clearly fails to demonstrate that these kegs and cases were primarily held for sale in the course of trade or business, and respondent's denial of such claim is affirmed.
The petitioner on brief concedes respondent's position that losses on certain fillers are capital losses, and as to the losses on such fillers respondent's determination is therefore affirmed.
Decision will be entered under Rule 50.