*2507 1. The cancellation of a debt due by a corporation to its principal stockholder constitutes a gift to the corporation, or a contribution to its capital, and does not give rise to an allowable deduction for a bad debt.
2. Amount claimed as a deduction for bad debt disallowed also for the reason that it is not shown to have been worthless and charged off as such in the taxable year.
*1215 This is a proceeding for the redetermination of a deficiency in income tax for the calendar year 1923, in the amount of $48,141.51. The sole issue is whether the petitioner is entitled to deduct from income for the taxable year 1923 the amount of $157,286.69 as a debt ascertained to be worthless and charged off in said year.
FINDINGS OF FACT.
The petitioner is a citizen of the United States, and of the State of Michigan and resides in the city of Lansing, where he also maintains an office.
In the year 1923, the petitioner charged off his books the sum of $157,286.69, and reported the same as a deduction in his income-tax*2508 return for said year, which deduction was disallowed by the respondent.
The books of the petitioner showed that said sum of $157,286.69 was the net indebtedness due him by the Ideal Power Lawn Mower Co., of Lansing, Mich., and that this amount was actually charged off his books during the year 1923.
The capital stock of the Ideal Power Lawn Mower Co. in 1923 was 30,000 shares, of the par value of $100 each, of which the petitioner owned 23,409 2/3 shares, and the remainder was owned by a number of other stockholders.
The officers of the company in 1923 were:
| Shares of stock owned | |
| Ransom E. Olds, chairman of the board | 23,409 2/3 |
| Charles E. Ecker, president | 1 |
| L. A. Ferguson, vice president | 600 |
| C. S. Smith, secretary and general manager | 1,500 |
| Clarence S. Roe, treasurer | 1 |
| M. U. Flannigan, asst. secretary-treasurer | 50 |
| F. M. Seeley, engineer | 1,300 |
*1216 On November 5, 1923, the petitioner and the Ideal Power Lawn Mower Co. entered into the following agreement:
WHEREAS, the Ideal Power Lawn Mower Company is indebted unto Ransom E. Olds, for moneys advanced from time to time in the full and just sum of $173,496.17, plus the interest thereon, *2509 and is unable to pay said indebtedness, and by reason thereof is unable to obtain the necessary credit for the successful operation of its business;
AND WHEREAS, the said Ideal Power Lawn Mower Company in the year 1920 purchased on contract property on Grand Street in the City of Lansing known as the Lansing Body Company plant, at and for the sum of $60,000.00, and has paid on account of said purchase price the sum of $20,000.00, leaving a balance due thereon of $40,000.00, plus accrued interest amounting to over $5,000.00, which said property said company now values at $100,000.00: but does not own the land and buildings on which it is now doing business on Kalamazoo Street;
AND WHEREAS, the said Ideal Power Lawn Mower Company being desirous of owning the plant wherein it is now doing business on Kalamazoo Street, and of compromising and settling the claim of the said Ransom E. Olds in order that it may re-establish its credit, has negotiated and does hereby enter into the following agreement with said Ransom E. Olds: i.e.;
In consideration of the premises and of the mutual provisions hereof, the said Ideal Power Lawn Mower Company does hereby purchase from the said Ransom E. *2510 Olds at and for the sum of $35,000.00 the land and buildings in which it is now doing business on Kalamazoo Street, and does hereby sell the said Ransom E. Olds its Grand Street plant aforesaid at and for the sum of $100,000.00, subject to the payment of the balance of the aforesaid purchase money with accrued interest thereon, upon the express condition, consideration and understanding that the said Ransom E. Olds will accept the difference between the $35,000.00 to be paid by said company for said Kalamazoo Street plant and the $100,000.00, to be paid by him for the aforesaid Grand Street plant, less the obligations against the same, in full settlement of the $173,496.17, and interest due him, thereby compromising and canceling same to the effect that the said Ideal Power Lawn Mower Company shall own the aforesaid Kalamazoo Street plant free and unencumbered and be free and clear of all indebtedness to the said Ransom E. Olds, and that the said Ransom E. Olds shall own the Grand Street plant, subject to the aforementioned outstanding indebtedness which he shall assume and relieve the Ideal Power Lawn Mower Company from paying.
In consideration of the foregoing recital, and the*2511 mutual provisions hereof, and in order to make the adjustment aforesaid, the said Ransom E. Olds does hereby agree with the said Ideal Power Lawn Mower Company to the terms of this agreement aforesaid.
Executed in duplicate this 5th day of November, 1923.
The figure of $157,286.69 was arrived at by the petitioner in the following manner: The total amount due petitioner as shown in his books was $178,462.17, and the adjustment of accounts by virtue of the agreement of November 5, 1923, gave a net credit against this of $21,175.48, which, deducted from the $178,462.17 above, left $157,286.69, which the petitioner charged off his books and took as a deduction in his 1923 income-tax return.
*1217 On November 5, 1923, the petitioner was guarantor for the Ideal Power Lawn Mower Co. on loans from banks amounting to $227,500.
The Ideal Power Lawn Mower Co. (then known as the Ideal Engine Co.) on November 8, 1920, purchased on contract a piece of property on Grand Avenue in the City of Lansing, Mich., at and for the sum of $60,000. The company paid on account of the purchase of said property the sum of $20,000 out of its own funds, and borrowed $20,000 on its equity and*2512 met the second payment. It did not make the third payment of $20,000 when it fell due on May 8, 1923. The petitioner actually purchased and took possession of the Grand Street property as agreed in the contract dated November 5, 1923. He sold a portion of said property for $21,500 in the latter part of the year 1923, and sold the remainder thereof for $80,000 in the early part of 1924.
The petitioner conveyed to the Ideal Power Lawn Mower Co. the property on Kalamazoo Street as contemplated in the agreement of November 5, 1923, above set out.
The assets and liabilities of the Ideal Co., as taken from its books at the close of its fiscal year on June 30, 1923, were as follows:
| Assets | Books | Liabilities | Books |
| Cash | $13,751.07 | Notes payable: | |
| Notes Receivable | 26,513.33 | Ransom Fidelity Co | $23,829.43 |
| Accounts Receivable | 155,670.72 | R E Olds | 173,496.17 |
| Inventories: | Wayne County & Home Savings | ||
| Merchandise | 191,935.38 | Bank | 126,500.00 |
| Mill Supplies | 26,974.90 | Mechanics & Metals Bank | 45,000.00 |
| Investments: | Capital National Bank | 80,000.00 | |
| Capital Stock Castings Co | 15,825.00 | Trade Acceptances | 5,700.00 |
| Capital Stock Golf Club | 1,547.50 | Accounts Payable | 41,241.98 |
| Other Real Estate | [*] | Contracts Payable - R E | 20,000.00 |
| Land | 20,000.00 | Capital Stock | 300,000.00 |
| Buildings | 40,000.00 | Reserve for Depreciation | 184,746.03 |
| Machinery | 87,883.54 | Surplus (Red) | 143,876.64 |
| Jigs, Tools and Dies | 51,794.88 | ||
| Patterns Models & Designs | 91,681.45 | ||
| Furniture & Fixtures, etc | 19,907.34 | ||
| Flasks | 534.82 | ||
| Auto trucks | 4,433.30 | ||
| Advances to travelers | 469.43 | ||
| Good Will | 64,986.26 | ||
| Development Expense - tractor | 21,131.05 | ||
| Development Expense - Junior | 13,431.61 | ||
| Development Expense - | |||
| Cutting Machine | 7,097.21 | ||
| 856,636.97 | 856,636.97 |
*2513 The following is the trial balance of the Ideal Co. at October 31, 1923:
| Dr. | Cr. | |
| Capital Stock | $300,000.00 | |
| Profit & Loss | $143,876.64 | |
| Bills Payable | 433,373.60 | |
| Accts. Payable | 46,489.93 | |
| Sale of Mowers | 24,959.93 | |
| Sale of Mowers Repairs | 11,137.72 | |
| Sale of Engines | 7,385.92 | |
| Sale of Engines Repairs | 7,760.20 | |
| Discount on Purchases | 290.21 | |
| Cash on Hand | $141.27 | |
| Cash in Bank | 792.98 | |
| Royal Bank of Canada | 4,910.02 | |
| Accounts Receivable | 97,610.30 | |
| Bills Receivable | 15,429.65 | |
| Bills Rec., Cap. Cast. Co | 15,825.00 | |
| Bills Rec., Golf Club | 1,547.50 | |
| Merchandise | 225,284.59 | |
| Machinery | 88,727.23 | |
| Mills Supplies | 28,152.63 | |
| Oil and Gasoline | 417.06 | |
| R.E. Olds, Bldg | 2,304.66 | |
| Jigs Tools & Dies | 51,794.88 | |
| Patterns Draft Model & Des | 92,056.45 | |
| Factory Equipment | 7,770.22 | |
| Flasks | 534.82 | |
| Sales Equipment | 2,027.63 | |
| Patent & Good Will | 64,524.26 | |
| Patent | 462.00 | |
| Chicago Office Equipment | 2,669.50 | |
| New York Cap. Stock | 5,000.00 | |
| Other Real Estate | 553.68 | |
| Grand Ave. Bldg | 514.50 | |
| Development of Tractor | 21,131.05 | |
| Development of Junior | 13,431.61 | |
| Development of Cutting Unit | 7,097.21 | |
| Auto Tracks | 4,964.43 | |
| Commissions | 1,705.63 | |
| Advertising Magazine | 1,124.44 | |
| Advertising Electros | 628.68 | |
| Advertising Printing | 341.55 | |
| Discount | 1,645.96 | |
| Draft Room Expense | 16.78 | |
| Expense | 2,193.15 | |
| Freight & Express | 2,098.17 | |
| Fuel, Light & Water | 1,457.92 | |
| Insurance | 817.37 | |
| Interest | 4,851.69 | |
| Maintenance | 157.06 | |
| Office Expense | 231.47 | |
| Office Equipment | 2,867.06 | |
| Postage | 371.50 | |
| Labor | 34,767.72 | |
| Profit & Loss Bad Debts | 228.24 | |
| Grand Street Improvement | 1,465.40 | |
| Reserve for Depreciation | 184,746.03 | |
| Salary | 12,946.40 | |
| Traveling Expense | 3,904.42 | |
| Taxes | 4,488.25 | |
| Revenue Tax | 61.06 | |
| Lawn Mower Bldg | 59,500.00 | |
| Contracts Payable, Real Estate | 20,000.00 | |
| L. A. Ferguson | 482.44 | |
| C. S. Smith | 51.62 | |
| F. M. Seeley | 103.43 | |
| J. M. Egloff | 62.50 | |
| G. A. Eaton | 75.00 | |
| Convention Expense | 1,027.66 | |
| 1,037,683.94 | 1,037,683.94 |
*2514 *1218 The difference between the item of $173,496.17 as shown in the assets and liability statement of the Ideal Co. of June 30, 1923, and used in the contract of November 5, 1923, as being due to the petitioner, and the sum of $178,462.17, as shown by the books of the petitioner, was due to the fact that the petitioner's books showed an item of interest of $4,861.49 paid on money borrowed by him and advanced to the said company which was not shown on its books, and prior to September, 1916 (the definite date not being recorded), the petitioner paid a note that was due by the Ideal Co. and an item of $104.52, interest paid on the note not entered on the books of the company. These items make up the difference.
*1219 The settlement or adjustment between the Ideal Co. and the petitioner, in pursuance of the terms of the agreement of November 5, 1923, was as follows:
| Olds took over the Grand Street property from the Ideal for | $100,000.00 | |
| Less obligations due thereon of | 43,829.43 | |
| Making him owe the Ideal | $56,170.57 | |
| The Ideal took over the Kalamazoo Street property from Olds for | 35,000.00 | |
| Leaving still due by Olds to Ideal | 21,170.57 | |
| The Ideal owed Olds as per his books | 178,457.26 | |
| Deducting from this the amount due by him to Ideal | 21,170.57 | |
| Left the item deducted by Olds in his income tax, i.e | 157,286.69 |
*2515 The petitioner gratuitously forgave the balance of the indebtedness due him from the Ideal Power Lawn Mower Co. in the amount of $157,286.69.
OPINION.
TRAMMELL: The facts were stipulated by the parties substantially as found by us above, and the only issue raised by the pleadings is whether the respondent erred in disallowing a deduction of $157,286.69 claimed by the petitioner in his tax return for 1923 on account of an alleged bad debt. The amount in question represents the balance of the indebtedness owed to the petitioner by the Ideal Power Lawn Mower Co., and which was charged off the petitioner's books in said year.
Prior to November 5, 1923, the Ideal Co. was indebted to the petitioner in the amount of $178,457.26, but by reason of the purchase and sale or exchange of the properties referred to in the contract of said date, the debt due to the petitioner by the corporation was reduced to the extent of $21,170.57, or to a balance of $157,286.69, which is the amount claimed by the petitioner for a bad debt deduction.
The respondent contends that the deduction claimed should be disallowed for two reasons - first, because the indebtedness of the corporation was gratuitously*2516 forgiven by the petitioner and constituted a contribution to its capital, and is therefore not an allowable deduction as a bad debt; and, second, for the reason that the debt was not properly ascertained to be worthless, and was not charged off because of its worthlessness, in the taxable year.
The petitioner argues that the debt was not gratuitously foregiven, but that the original amount of $178,457.26 was canceled under the contract ofNovember 5,1923, in consideration of the payment to the petitioner of $21,170.57, this being the difference in value of the *1220 real estate exchanged. And the petitioner further asserts that the balance of the debt was properly ascertained to be worthless and charged off in the year for which it was claimed as a deduction. We are unable to accept this viewpoint.
The petitioner was the principal stockholder of the debtor corporation, owning 23,409 2/3 shares or more than 78 per cent of the issued and outstanding stock. The contract executed by the petitioner and the corporation on November 5, 1923, and which is set out in full in our findings of fact, recites that the corporation was unable to pay its indebtedness to the petitioner*2517 and by reason thereof was unable to obtain the necessary credit for the successful operation of its business. It is further stated that the contract was executed upon the express condition that the petitioner accept the difference between the agreed valuation of the properties exchanged in full settlement of the indebtedness to him, "thereby compromising and cancelling same."
The evidence justifies the conclusion, we think, that the primary purpose sought to be achieved by this contract was the restoration of the corporation's credit. It is not difficult to comprehend the reasons which moved the petitioner to cancel the debt due him from the corporation. It manifestly was to his interest to maintain the value of the corporation's stock, of which he owned approximately four-fifths. He was also guarantor for the corporation on loans from banks amounting to $227,500. From the evidence before us, we can only conclude that the motivating reasons for the cancellation of his debt by the petitioner were the safeguarding of his investment in the corporation's stock and his desire to avoid the necessity of paying the corporation's obligations which he had guaranteed. The reduction of*2518 the debt by the amount of the difference in value between the properties exchanged was not the real consideration for the cancellation of the remaining indebtedness, but was merely an incident of the transaction.
There can be no doubt that the cancellation of the debt in the amount of $157,286.69 increased to that extent the value of the corporate assets. The corporation was thereby enriched, and it was so enriched at the expense of its chief stockholder.
The cancellation of the indebtedness, therefore, constituted a gift to the corporation or a contribution to its capital, and the indebtedness was charged off during the tax year because it had been canceled pursuant to the provisions of the contract of November 5. It is not an allowable deduction on account of a bad debt. ; .
There is also an additional ground on which we would be required to disallow the deduction claimed by the petitioner. Unless the debt was in fact worthless and was so ascertained and was charged *1221 off for that reason during the taxable year, it does not give rise to an allowable deduction. *2519 The statement of assets and liabilities of the Ideal Co. at the close of its fiscal year June 30, 1923, discloses that it had assets in the aggregate book value of $856,636.97, and liabilities, exclusive of capital stock and the indebtedness due the petitioner, in the amount of $527,017.44. Thus, the corporation had assets subject to the payment of the indebtedness due the petitioner, in the amount of $329,619.53, and the petitioner's debt as shown by his books amounted to only $178,457.26.
The petitioner contends that the corporation's assets could not have been sold at a forced sale for the book values, but this, even if true, we do not think is determinative of the issue. It is not shown that the book values were excessive or did not represent the true values, nor does the evidence convince us that the petitioner could not, in the taxable year, have collected a substantial portion of his debt, if not in fact all of it, if he had desired to do so.
If any substantial part of the debt was collectible, the whole amount can not be said to have been a bad debt, and the record does not establish what portion, if any, less than the whole was uncollectible or worthless. Since the*2520 entire amount of the debt is claimed as a deduction, and it is not shown that the whole amount claimed was a bad debt, the deduction must be disallowed for this reason also.
Judgment will be entered for the respondent.