*883 1. Petitioner, a corporation engaged in the business of buying, renovating and selling cotton waste, was the owner in 1934 of all the stock of a subsidiary cotton mill. In that year it entered into an agreement to sell to who of its stockholders all the stock of the subsidiary, conditioned upon a loan being procured from the R.F.C. to be used in improving the financial condition of the subsidiary and other cotton mills with which it was planned to merge it. The proposed loan from the R.F.C. was not granted and the sale by petitioner of its stock in the subsidiary was never consummated, notwithstanding book entries made by petitioner in 1934 recorded that the sale had been made. Held, that in 1935 petitioner was the owner of all the shares of stock of its subsidiary.
2. The financial condition of the subsidiary in the two years prior to 1935 was bad and the book values of the assets as shown by the balance sheet on December 31, 1934, were less than the corporation's liabilities. The corporation, however, continued in active operation of its business, until in 1935 the bondholders sued on their indebtedness and all the property of the corporation was sold in foreclosure*884 proceedings for less than enough to pay the creditors and petitioner received nothing on its stock. Held, the foreclosure in 1935 was an identifiable event which fixed the worthlessness of petitioner's stock in that year.
3. Petitioner in several years prior to 1935 filed consolidated returns with its subsidiary and its investment loss in the stock must be reduced by the amounts of operating losses of its subsidiary which have been used by the petitioner in consolidated returns for prior years to reduce its own net income.
*322 The Commissioner determined a dificiency in income tax for the year 1935 against petitioner in the sum of $12,079.46, and in excess profits tax against petitioner for the same year in the sum of $2,638.14. These deficiencies resulted from several adjustments which respondent made in petitioner's income tax return for the year 1935. The petition contests only two of these adjustments, viz.: (a) The disallowance of loss on stock of American Cotton Mills Number Two in the amount of $100,000; (b) the inclusion as taxable income*885 of suspense accounts in the amount of $2,130.92.
At the hearing petitioner waived assignment of error (b) and therefore the only issue we have to decide is whether petitioner is entitled to a deduction of a loss sustained in 1935 by reason of stock which it alleges it owned in American Cotton Mills Number Two and which it further alleges became worthless in that year. Respondent *323 contends that petitioner is not entitled to the loss which it claims for two reasons: (1) It had sold the stock in question in 1934 to two of its stockholders, Robert Goldberg and James Goldberg, and was not the owner of it in 1935; (2) that even if petitioner was the owner of the stock in 1935, the stock did not become worthless in 1935, but became worthless in a prior year.
FINDINGS OF FACT.
The petitioner is a corporation, organized and existing by virtue of the laws of the State of North Carolina, with its principal office located at Bessemer City, North Carolina. It is engaged in the business of dealing in cotton waste. In 1925 the petitioner acquired all the stock of American Cotton Mills Number Two, Bessemer City, North Carolina, at a cost of $100,000. In 1935 all the shares*886 of American Cotton Mills Number Two stood in petitioner's name, except four qualifying shares, which stood in the names of petitioner's directors. These latter shares were owned by petitioner. Petitioner's own stockholders were three brothers, Max, Robert, and James Goldberg, who owned one-third each of petitioner's capital stock. Robert and James Goldberg were interested in several other cotton mills in the same vicinity and wanted to merge American Cotton Mills Number Two with these other mills, provided they could get a loan from the Reconstruction Finance Corporation which would put the finances of the several cotton mills in better condition than they were at that time. Max Goldberg did not want to go into the merger venture and agreed that he was willing that the American Utilization Co. (petitioner here) should sell the shares which it owned in American Cotton Mills Number Two to Frank and Robert Goldberg, for the sum of two thousand dollars. This sale was conditioned upon the loan being made by the Reconstruction Finance Corporation. If the loan was not made there was to be no sale. There was no transfer on the books of American Cotton Mills Number Two of the shares*887 of stock owned in it by petitioner to Frank and Robert Goldberg, and the certificates of stock which petitioner owned in the corporation were not endorsed in blank and delivered to Frank and Robert Goldberg. The certificates of stock remained in the custody of petitioner and were not delivered in any manner to Frank and Robert Goldberg. Notwithstanding the conditional nature of the sale, the following entries were made on petitioner's books, under date of December 19, 1934: Investments were credited with $100,000; profit and loss was charged with $98,000. Frank and Robert Goldberg's accounts were charged with $2,000.
In 1935 the Reconstruction Finance Corporation definitely refused the proposed loan for which application had been made in 1934. *324 Thereafter, at some time in 1935, the foregoing entries on petitioner's books were reversed and entries were made, purportedly as of December 31, 1934, as follows: Investments were charged with $100,000; surplus was credited with $98,000; notes receivable were credited with $2,000. The explanation of the foregoing entries in petitioner's journal as recorded therein, is as follows: "To reverse entry of recording sale of stock*888 as no delivery was made; consequently, no sale, or loss as shown."
Petitioner in its income tax return for 1934 deducted $98,000 as Loss on stock sold. (Stock Am. Cot. Mill No. 2)." The Commissioner in his audit of petitioner's return for that year disallowed the claimed loss under the provisions of section 24(a)(6) of the Revenue Act of 1934. Petitioner acquiesced in this action of the Commissioner, and we do not have that year before us.
The purported sale in 1934 by petitioner to its stockholders, Frank and Robert Goldberg, was never consummated and petitioner was still the owner in 1935 of all the capital stock of American Cotton Mills Number Two.
The balance sheets of American Cotton Mills Number Two for the years 1933 and 1934 are as follows:
| Dec. 31, 1933 | Dec. 31, 1934 | |
| ASSETS | ||
| Cash | $314.17 | $366.01 |
| Accounts receivable | 742.60 | 168.07 |
| Inventory | 15,076.13 | 3,725.07 |
| Accounts receivable - affiliates | 5,497.48 | |
| Plant | 158,881.97 | 164,439.57 |
| Supplies | 4,830.32 | 6,243.08 |
| Goldberg Bros | 3,100.60 | 3,100.60 |
| Total | 182,945.79 | 183,539.88 |
| LIABILITIES | ||
| Accounts and notes payable | $16,464.91 | $20,801.85 |
| Affiliates | 103,825.73 | 132,596.03 |
| Accrued expense | 3,153.91 | 1,487.12 |
| Due officers | 523.69 | 523.69 |
| Bonded debt | 27,500.00 | 22,852.50 |
| Reserve - depreciation | 62,399.56 | 62,399.56 |
| Reserve taxes, etc | 5,429.26 | 20,178.62 |
| Capital stock | 100,000.00 | 100,000.00 |
| Deficit | (136,351.27) | (177,299.49) |
| Total | 182,945.79 | 183,539.88 |
| Surplus Analysis. | |
| Deficit 12-31-33 | $136,351.27 |
| Surplus adjustment | 566.95 |
| Loss, year 1934 | 40,381.27 |
| Deficit 12-31-34 | 177,299.49 |
Petitioner and American Cotton Mills Number Two, Inc., filed consolidated income tax returns for the years 1925, 1926, 1927, 1929, 1930, 1931, and 1933. Separate returns were filed for the years 1928, 1932, 1934, and 1935.
*325 American Cotton Mills Number Two, Inc., sustained net operating losses for every year from 1925 to 1935, inclusive, except the year 1929, for which year it realized a gain. Petitioner also sustained net operating losses for the years 1926, 1930, and 1931. During the two years of 1925 and 1933 petitioner realized taxable income in excess of the losses of its subsidiary, which losses for those years amounted to $9,683.01 and $28,434.23, respectively, and were used to reduce petitioner's taxable income for those respective years. For the year 1927 petitioner had taxable gain and its subsidiary had a small gain which was wiped out by its net loss brought forward from the year 1926, but none of this net loss of the subsidiary brought forward from 1926 was used to reduce petitioner's net income*890 in 1927. All the property of American Cotton Mills Number Two was sold at foreclosure sale in the latter part of 1935, and the price received at the sale was less than enough to pay the claims of its creditors and the stockholders received nothing. The stock of American Cotton Mills Number Two became worthless in 1935, when all of the assets of the corporation were sold under foreclosure proceedings, it ceased business, and was left wholly without assets of any kind. Petitioner in filing its income tax return for 1935 deducted $100,000 as loss on stock which it owned in American Cotton Mills Number Two. The Commissioner in his audit of petitioner's return disallowed this claimed loss and in a statement attached to the deficiency notice gave his reason for the disallowance of the loss in the following language:
Section 24(a)(6) of the Revenue Act of 1934 prohibits the deduction of losses from sales of property between an individual and a corporation in which the individual owns directly or indirectly more than 50% in value of the outstanding stock. The loss of $98,000.00, claimed on your return for 1934 as a result of the sale, was therefore disallowed as a deduction from taxable*891 income.
In your return for the year 1935 the entire cost of $100,000.00 is claimed as a deduction on the grounds, as set forth in your protest dated March 30, 1937, that the sale in 1934 was never consummated and that the stock became worthless in 1935 when the properties of the American Cotton Mill, No. 2, were sold under foreclosure proceedings.
The sale of the stock in 1934 was recorded in your books on December 19, 1934. The investigation of your 1934 return was made by the revenue agent on or about December 20, 1935, at which time the disallowance of the loss was first proposed. The purchaser of the properties of the American Cotton Mill, No. 2, took possession on December 16, 1935. On December 31, 1935, as of December 31, 1934 the entries recording the sale of stock on your books were reversed. All of the capital stock of your corporation was owned by Max, Frank and Robert Goldberg and their immediate families. Your corporation owned all of the capital stock of the American Cotton Mill, No. 2, and Frank and Robert Goldberg were officers in both corporations.
Your intention to sell the stock in December 1934 was indicated by the entry recorded on your books on December 19, 1934. *892 The deduction of the *326 loss as a result of the sale on your 1934 return, filed in May 1935, indicated a continuance of the same intention. No indication of your contention, that the recorded sale in 1934 was not consummated, was brought to the attention of the bureau prior to the proposal of the revenue agent in December 1935 to disallow the loss claimed on your 1934 return.
In view of the above the Bureau holds that the stock was sold in 1934 and that your contention, regarding the failure of delivery on your part as well as on the part of Frank and Robert Goldberg, is without merit.
OPINION.
BLACK: We shall first take up respondent's contention that petitioner in 1934 sold to two of its stockholders, Frank and Robert Goldberg, its entire holdings of stock in American Cotton Mills Number Two, and that by reason thereof petitioner did not own any stock in the corporation during the year 1935 and therefore is not entitled to the deduction of any loss by reason of the stock becoming worthless in that year. This was the reason given by respondent in his deficiency notice for his disallowance of the claimed loss and if petitioner has not overcome the correctness of*893 this determination, it loses.
We think petitioner has sustained its burden of proof on this issue. Petitioner introduced the testimony of three witnesses who testified that although entries on petitioner's books made in December 1934, showed a sale by petitioner to two of its stockholders, Frank and Robert Goldberg, of all its shares in American Cotton Mills Number Two for the sum of $2,000, that nevertheless the purported sale was only conditional and that it was understood and agreed by all parties to the transaction that unless a loan was obtained from the Reconstruction Finance Corporation, which was to be used in effecting a merger between American Cotton Mills Number Two and other cotton mills owned by Frank and Robert Goldberg, then the sale should not be consummated. The testimony was that the Reconstruction Finance Corporation definitely refused the loan in 1935, and the whole deal fell through and the sale of the stock to Frank had Robert Goldberg was not consummated. The stock book of American Cotton Mills Number Two was introduced in evidence to show that there was never any transfer on the books of that company of the shares of stock from petitioner to Frank and*894 Robert Goldberg. The stock certificates themselves were introduced in evidence and show that the stock still stands in the name of petitioner and that the certificates were never endorsed in blank and do not bear any assignment of any kind to any one.
The testimony was further to the effect that these shares of stock were never delivered by petitioner to Frank and Robert Goldberg, and that there was no agreement to deliver them unless the loan from the Reconstruction Finance Corporation was granted.
*327 The testimony further showed that, after the Reconstruction Finance Corporation declined the proposed loan, the book entries which were made in 1934 were reversed. It is true that this reversal of book entries seems to have been made after a revenue agent had audited petitioner's income tax return for the year 1934, and had informed petitioner that its claimed loss of $98,000 by reason of the alleged sale of the stock by petitioner to Frank and Robert Goldberg would be disallowed, in which action petitioner acquiesced. Inasmuch, however, as the evidence shows that the reversal of entries on petitioner's books was in accordance with the facts as they existed, we do not*895 think that the fact that these reversing entries were made after the revenue agent's audit is of any controlling significance. Book entries are evidential, but not conclusive. . We find from all the evidence in the case that petitioner was the owner of all the stock of American Cotton Mills Number Two on the basic date in question.
Respondent contends in the alternative that even if it be held that petitioner was the owner of the stock in question on the basic date, nevertheless the stock did not become worthless in 1935, but became worthless in some prior year and by reason thereof petitioner is not entitled to deduct the claimed loss. While respondent did not determine in his deficiency notice that the stock became worthless in a prior year, he did make this contention at the hearing. At any rate when a taxpayer is claiming a deduction of a loss and the Commissioner has disallowed it, it is the burden of the taxpayer to show that the loss was sustained in the taxable year. Where one is claiming a loss because of the worthlessness of stock, it is not enough to prove that the stock was worthless in that year, *896 but it must be proved that the stock became worthless in that year. . Has petitioner met its burden of proof in this respect? We think it has. True enough, the facts show that American Cotton Mills Number Two was in bad financial condition in 1934, but it was still actively operating its plant and we doubt if petitioner would have been justified in contending that the stock was worthless in 1934. Undoubtedly it had a very small value in 1934. That fact is not only conceded by petitioner, but is evidenced by petitioner's willingness to sell it to Frank and Robert Goldberg for $2,000. But mere depreciation in the value of stock, even to almost the vanishing point, does not entitle a taxpayer to take a deduction of his investment therein. This is permissible only when the stock has become entirely worthless and usually some identifiable event should occur in the taxable year to determine such worthlessness. It is true that where a corporation is insolvent and ceases business, and it is clear that the liabilities exceed the value of the assets, and there will be *328 nothing to distribute to stockholders, that is such*897 an identifiable event and the stock becomes worthless in that year, and the taxpayer who owns stock in such a corporation should take a loss in that year rather than wait for a later year when the affairs of the corporation are wound up by liquidation. Cf. ; ; ; ; affd., . But the situation is different where the corporation continues actively in business. The court in , pointed out the difference in the following language: "This conclusion is not opposed to , this court. There the company was to and did continue in operation thereafter (P. 645) while here there was no showing of any intention to operate after September 1931, and there was no business of any kind continued thereafter."
We do not wish to be understood as holding that in no case should the stock of a corporation be held to be worthless while it continues in active operation. There are situations*898 where the contrary is true, such for example as in ; affd., , where a railroad company had been operated by a bondholder's protective committee for nearly ten years prior to the taxable year in question and there was an ever mounting deficit, and during the period the corporation's unpaid and defaulted interest had more than doubled. On such facts we held that petitioner had failed to overcome the correctness of respondent's determination in disallowing the claimed loss. In the instant case, the facts are more like those in , in which the court reversed the Board's action in affirming the Commissioner's disallowance of the claimed loss on worthless stock. In that case, the court, among other things, said:
The fact that the assets were insufficient to meet the operating liabilities may properly be taken as evidence of worthlessness of stock, but it is not conclusive. Actual worthlessness should be the test, and if those in charge of the operations of the corporation, acting in good faith, believe that they might work out of their business*899 conditions wherein losses were sustained, and did so, realizing some profit and reducing the deficit, it may not be said that the stock was actually worthless. A real loss is sustained when all chances or possibilities of collection have been effectively destroyed.
In the instant case all chances or possibilities of petitioner ever realizing anything out of its investment in the stock of American Cotton Mills Number Two was effectively destroyed by the foreclosure which took place in 1935. By this foreclosure all property of American Cotton Mills Number Two was sold and the price received from the sale was less than sufficient to pay the company's creditors and there was nothing left for disbursement to the stockholders. *329 This was the identifiable event which clearly and unmistakably fixed petitioner's loss. Cf. ; .
But, although we hold that the stock of American Cotton Mills Number Two became worthless in 1935, we can allow only the loss which petitioner actually sustained. Petitioner paid $100,000 for the stock and would be entitled to deduct that*900 entire amount were it not for the fact that the two corporations filed consolidated returns for some of the years, in which returns petitioner has had the benefit of having its net income reduced by the losses of the American Cotton Mills Number Two, Inc., for those years. As we said in , "It is now well settled that the loss on the sale of the stock or liquidation of a subsidiary company must be reduced by the amount of the subsidiary's operating losses which were availed of to reduce the taxable income of the affiliated group. ; ; ; ." See also ; ; certiorari applied for May 14, 1938.
Although the cases cited above involved either the sale or liquidation by a parent company of the stock of its subsidiary and*901 did not involve the situation where the stock of the subsidiary became worthless during the taxable year, the controlling principle of law involved is nevertheless the same in the latter situation as in the former. Cf. . In so holding we are not unmindful of our decision in , wherein we allowed the parent company to deduct the full cost of the stock of its subsidiary in 1924, the year in which the stock of the subsidiary became worthless, without making any inquiry into the extent to which the consolidated group had had the benefit of the losses of the subsidiary for the years 1921, 1922, and 1923. Our holding there was, however, promulgated several years before the decisions of the Supreme Court cited above, and must be regarded as in effect modified to conform therewith. Cf. .
The record shows that for two of the years, 1925 and 1933, petitioner availed itself, in a consolidated return, of operating losses of its subsidiary to the extent of $9,683.01 and $28,434.23, respectively, or a total for both years of $38,117.24. Petitioner's*902 claimed loss of $100,000 would, in view of the above decisions, have to be reduced by this amount. For the years 1926, 1930, and 1931, petitioner itself sustained operating losses and therefore for those three years did *330 not avail itself of any deduction of its subsidiary's losses. For the year 1927 petitioner had a net taxable income and its subsidiary also had a small net income, which was wiped out by bringing forward its net loss for 1926. The evidence shows, however, that none of this net loss of the subsidiary brought forward from 1926 was used as a deduction from petitioner's net income. For the year 1929, the subsidiary had a net income and therefore petitioner had no deduction for that year of any loss by its subsidiary. The foregoing accounts for all the taxable years in which consolidated returns were filed. The net result of this evidence is that petitioner's net taxable income during the years in which it filed consolidated returns with its subsidiary, American Cotton Mills Number Two, was reduced $38,117.24 by the operating losses of the subsidiary. In a recomputation under Rule 50, petitioner's loss of $100,000 by reason of the stock of American Cotton*903 Mills Number Two becoming worthless in 1935 should be reduced by $38,117.24.
Decision will be entered under Rule 50.