1931 BTA LEXIS 1716">*1716 Upon incorporation in December, 1925, the petitioner issued its capital stock in exchange for the assets of the predecessor business carried on as a sole proprietorship. Among the assets thus acquired was a promissory note of the Fairmont Market Company in the principal amount of $11,000, together with accrued interest thereon of $330. The Fairmont Market Company was insolvent at December 31, 1924, and at December 31, 1925. In order to save the Fairmont Market Company from bankruptcy, the petitioner relinquished its claim for payment of the note and accrued interest and charged same off its books of account to surplus in 1926. Held, that the petitioner is not entitled to deduct from its gross income of 1926 any amount in respect of the charge-off made.
23 B.T.A. 1381">*1381 The petitioner has determined deficiencies in petitioner's income tax for 1926 and 1927 in the amounts of $746.69 and $277.18, respectively. The only error alleged is that the respondent has disallowed the deduction from gross income of 1926 of an amount of $13,345.95 representing alleged1931 BTA LEXIS 1716">*1717 bad debts or losses. There is no controversy with respect to 1927, except as to the deduction from gross income of a claimed net loss for 1926 carried forward into 1927.
FINDINGS OF FACT.
The petitioner was organized under the laws of West Virginia on December 30, 1925, and began business on January 1, 1926. It 23 B.T.A. 1381">*1382 was organized to take over a wholesale produce business theretofore operated by John Russo, Sr., as a sole proprietorship under the name of John Russo Fruit Company. Upon organization $49,600 par value of petitioner's capital stock of an aggregate par value of $50,000 was issued to John Russo, Sr., in exchange for the assets of the John Russo Fruit Company. The balance of the stock was issued to his sons and daughters as qualifying shares. It was held by them as issued throughout the years 1926 and 1927.
Among the assets taken over by the petitioner in exchange for its capital stock was a promissory note of the Fairmont Market Company in the principal amount of $11,000, with accrued interest to December 31, 1925, of $330. This note was acquired by the John Russo Fruit Company in settlement of an open account running to it from the Fairmont Market1931 BTA LEXIS 1716">*1718 Company in the amount of $5,000 and the assumption by the John Russo Fruit Company of an indebtedness of the Fairmont Market Company in the amount of $6,000, representing money borrowed from the Fairmont Trust Company. The note in question was secured by a chattel mortgage on the fixtures and equipment of the Fairmont Market Company.
The Fairmont Market Company was a West Virginia corporation, organized, in 1924, to carry on a business of retailing produce, meats and groceries. P. A. Sacci, son-in-law of John Russo, Sr., owned 14 of the 34 shares of the Fairmont Market Company outstanding at December 31, 1924. At December 31, 1925, John Russo, Sr., and P. A. Sacci owned, respectively, $9,500 and $1,400 par value of the $12,600 par value of the outstanding shares of stock. John Russo, Sr., had paid for his shares by canceling in the books of the John Russo Fruit Company accounts receivable from the Fairmont Market Company.
The Fairmont Market Company's income-tax return for 1924 shows total assets as at the close of the year of $28,626.17, and total liabilities (exclusive of capital stock), of $31,148.29.
In the latter part of January, 1926, one Abe Riteman (being in no1931 BTA LEXIS 1716">*1719 way related to any of the Russos), who was managing the business of the Fairmont Market Company, informed the other stockholders of the company that the business had been a failure and that its condition was such that it would have to take bankruptcy, go into the hands of a receiver, or otherwise liquidate its business. Thereupon it was ordered that an audit be made of the books of the said company for the calendar year 1925, and for the period January 1 to January 31, 1926, for the purpose of ascertaining its true and actual status. Those audits disclosed that the company was in substantially the same financial condition at December 31, 1925, as at the close of the preceding year. Total assets were found 23 B.T.A. 1381">*1383 to be $28,507.14, and total liabilities (exclusive of capital stock), $30,968.88. Thereupon John D. Russo, Jr., who was managing the affairs of the petitioner, consulted with his attorney for the purpose of being advised what would be the proper and least expensive method of liquidating the Fairmont Market Company. The attorney, after being informed that the petitioner, John Russo, Jr., and other individuals desired to carry on the business of a retail grocery and1931 BTA LEXIS 1716">*1720 continue the same in the name of Fairmont Market Company advised that the best method to be pursued would be to reorganize the Fairmont Market Company and that the petitioner charge off of its accounts for 1926 the note of the Fairmont Market Company of $11,000 plus accrued interest of $330; thereby the Fairmont Market Company would be financially rehabilitated and enabled to continue in business. The petitioner, accordingly, as of January 31, 1926, charged off its books of account to its surplus account $11,330 and on the same date the Fairmont Market Company eliminated from its liabilities the note of $11,000 by a debit to its notes payable account and a credit to its surplus account with the explanation, "To Record Cancellation by Russo of Our Note to that Company for the Above Amount." After such charge-off was made on the books of the Fairmont Market Company, its total assets as of January 31, 1926, were found to be $37,274.97 and its total liabilities (exclusive of capital stock), $19,360.44. Nothing occurred within the year 1926 affecting the value of the note of the Fairmont Market Company, which was secured by the chattel mortgage on the fixtures and equipment of that company.
1931 BTA LEXIS 1716">*1721 In its income-tax return for 1926 the petitioner deducted from gross income $13,345.95 representing alleged bad debts or loss, the deduction of which was disallowed by the respondent in the determination of the deficiency.
OPINION.
SMITH: At the hearing of this proceeding the petitioner did not produce any evidence purporting to substantiate the deductibility of any portion of the amount of $13,345.95 claimed as a deduction from gross income as debts ascertained to be worthless and charged off within the year or as a loss, except as to the note of $11,000 and accrued interest thereon of $330. In this state of the record it must be held that the petitioner has waived its claim to the deduction of $2,015.95 of the amount disallowed by the respondent.
With respect to the $11,000 note, it is to be noted that it was secured by a chattel mortgage on the fixtures and equipment of the Fairmont Market Company. The value of this security has not been shown nor is there evidence of any attempt on the part of the petitioner to take over the mortgage and property in settlement of the 23 B.T.A. 1381">*1384 note and accrued interest. 1931 BTA LEXIS 1716">*1722 Cf. . The petitioner as creditor has not shown that it had exhausted the liability on said security. See , in which the Board stated: "If a debtor has given security for a loan, either in form of collateral or a bond, it is incumbent on him to exhaust the liability on same before he is entitled to claim the debt to be worthless."
It was testified at this hearing that nothing occurred during the month of January, 1926, which would indicate that the note was any more uncollectible at the end of the month, when it was charged off, than at the beginning of the month, when it was set up as an asset on petitioner's books. See ; .
It is also significant in the instant case that on the same date the $11,000, plus accrued interest, was charged off petitioner's books, an entry was made on the books of the Fairmont Market Company crediting the surplus of that company with a like amount with the explanation, "To Record Cancellation by Russo of Our Note to that Company for the Above Amount." This would1931 BTA LEXIS 1716">*1723 indicate a cancellation by agreement of the two companies, which was held to be not deductible in .
The petitioner contends that the note was ascertained to be worthless in 1926 and that it was not known that it was worthless prior to the year 1926. In this connection it should be noted that the balance sheet of the Fairmont Market Company showed that that company was insolvent on December 31, 1924, and the result of the audit made in 1926 showed that it was also insolvent at the close of 1925. The audit only confirmed what was theretofore known. The mere fact of the insolvency of the debtor company does not, however, prove the worthlessness of the debt; for the note in this case was secured by a chattel mortgage on the fixtures and equipment of the Fairmont Market Company, the value of which is not shown by the record.
The basis for the deduction of a bad debt is its cost or value at the date of acquisition if acquired subsequent to March 1, 1913. ; affd., 1931 BTA LEXIS 1716">*1724 ; . Where the basis can not be proved, no deduction can be allowed. ; . In the instant case no cost or value as at date of acquisition has been proven and the record indicates that the note in question was worth no more at the date acquired than at the date charged off the books. Upon the record the determination of the Commissioner, that the petitioner is not entitled to deduct from its gross income any part of the $13,345.95, must be sustained.
Judgment will be entered for the respondent.