*3372 1. An amount accrued and paid in 1920 as insurance premium, although refunded in the following year on the cancellation of the contract, is a proper deduction as an expense in 1920.
2. Evidence held insufficient to redetermine the amount of depreciation on automobiles.
3. Club membership dues of the president of petitioner, paid by it, allowed as a deduction as an ordinary and necessary expense under the circumstances of this case.
*1281 This proceeding is brought to redetermine a deficiency in income and profits taxes for 1920 amounting to $2,195.89.
The issues are, (1) whether or not an amount paid as premium for indemnity insurance, which was subsequently refunded when the *1282 insurance was canceled, is a proper deduction in 1920; (2) proper allowance for depreciation of automobiles and trucks; (3) whether club membership dues of an officer of petitioner, paid by it, are deductible as a business expense.
FINDINGS OF FACT.
The petitioner is a Montana corporation, with its principal office*3373 at Butte, and is in the wholesale cigar, cigarette, and tobacco business.
Early in 1920 petitioner had owing to it accounts for goods sold amounting to between $115,000 and $125,000, which was a relatively large amount for this concern. Prior to 1920, between 60 and 65 per cent of its business had been with saloons. With the coming of prohibition, many of its former customers were retiring from business and it seemed there might be large losses through accounts becoming worthless. With a view to protecting itself against loss, its president had several conversations with agents of companies which undertake to indemnify losses of this character. After consideration by the stockholders, one of them, Newman, who was also a director, offered to insure the petitioner against such losses if it would pay to him approximately the amount that an indemnity insurance company would charge as premium for like insurance. This was agreed to orally between Newman and the other directors in July, 1920, and thereafter an account was opened in the First National Bank of Butte under the name of "Credit Insurance Indemnity Company," in which deposits were made on the dates and in the amounts following: *3374
| Aug. 30, 1920 | $825.30 |
| Sept. 30, 1920 | 825.30 |
| Oct. 30, 1920 | 699.65 |
| Dec. 8, 1920 | 785.75 |
| Jan. 3, 1921 | 847.90 |
| Total | 3,983.90 |
This account was subject only to the order of Newman. The payment of January 3, 1921, was the premium for the first quarter of 1921.
About the middle of January, 1921, there was some objection by one of the stockholders to the arrangement, and especially to its continuance, since the prospects then were that conditions with respect to its accounts were improving. There had been losses amounting to $6,000 in 1921, which Newman, under the contract, was obligated to pay. It seemed likely that if the contract were continued throughout 1921, he would have been reimbursed for the amount of his losses thereunder in 1920. It was thereupon decided, however, *1283 by mutual agreement, to cancel the whole contract, and Newman returned the money that had been paid to him and was released from liability for losses that had occurred during 1920. On January 18, 1921, he refunded the full amount that he had received. When this money was returned, an accountant, who was balancing the books, included it in the 1920 income as of December 31, 1920. *3375 An adjustment was thereafter made on the books, taking it out of 1920 income. It has been restored by the Commissioner. The petitioner employed the accrual method of accounting.
During the year 1920 it was the intention of the petitioner to contract with one Jessie Newman, a director of said company, to the effect that said Newman would indemnify the petitioner for loss on its credit accounts in the same manner as would be done by a commercial credit insurance company. Payments were charged to cash as an expense, the offset being to cash. The result of the above entries show an overdraft on the cash balance of $899.01. In making up the return for 1920 the balance sheet with the overdraft was used. Due to opposition of one of the principal stockholders, the insurance fund was abandoned. The entry on the books was made by charging cash and crediting insurance, throwing back the cash taken out and reducing the cash expense account. This adjustment results in showing an asset value to the cash account of $4,909.89. Included in this balance of $4,909.89 was a contingent fund of $850, the net difference being $3,983.90, or the amount of the insurance adjustment. The adjustment*3376 was made on the books, the books showing a profit of $3,983.90 more than shown by the returns filed. This adjustment was not taken into consideration in making income-tax returns for either 1920 or 1921. In 1921 the balance sheet showing a larger surplus as of December 31, 1920, was used.
In 1920 petitioner had three automobile trucks and five or six passenger automobiles. The trucks were used for delivering goods to customers and the passenger cars were used by its salesmen in traveling through the country soliciting orders; and they were not used for any other purpose. The automobiles were Buicks, Hupmobiles, and Stars. It does not appear of what type they were, or how many cars there were of each make. The actual depreciation on them was not uniform for the different makes and also varied with different cars of the same make, depending upon the service to which they were subjected. In 1918, the petitioner adopted the practice of ascertaining from distributors the trade-in value of each automobile at the end of the year, and it deducted the difference between such value and the unexpired book value at the beginning of the year as depreciation.
*1284 In 1920 Marx, *3377 the president of petitioner, was a member of the Silver Bow Club and of the Butte Country Club, and his membership dues were paid by petitioner. They are social clubs. He joined in 1913, when he became president, at the instance of the stockholders and with approval of the directors, with the understanding that the petitioner would pay his dues, and that he would undertake to introduce its brands of cigars into the clubs and foster their sale among the members. The petitioner regarded them as sale expenses; the Commissioner disallowed their deduction.
OPINION.
LOVE: On December 31, 1920, the contract between petitioner and Newman was in full force and effect. Petitioner had paid to him $3,136 for insurance and on that date he was liable to petitioner in the sum of $6,000. The cost of insurance of this character is a legitimate mate expense of carrying on business, and the expenditure was incurred in 1920. Also, the obligation of Newman arose within the year, and still existed at its close. The cancellation of the contract in the subsequent year does not affect the debits and credits between them which existed at the end of 1920. The expenditure is a proper deduction in*3378 1920 and the amount of Newman's obligation is a credit which properly should be reflected in income of that year.
This case is distinguishable from , and . In the first-named case the petitioner voluntarily paid sums of money as beverage taxes on sweet cider under a mistake of law. At the time of the payments and at the time of the making of its income-tax returns its liability for beverage taxes had not been determined. The amounts paid were thereafter refunded to it. In the Brown case an amount was paid as inheritance tax under a State law afterwards declared unconstitutional, and the amount was refunded before the filing of the petition. In the present case the liability of the petitioner was fixed and had accrued. The amount which it recovered in the later year came to it as part of the settlement under a new agreement between it and Newman, which was in the nature of a compromise of Newman's obligation, as well as terminating the indemnity contract as to the future.
The testimony relating to the automobiles is meager. It does not show how much the Commissioner*3379 allowed for depreciation or what amount the petitioner is now claiming. The cost of the automobiles is not disclosed, the description is too general to be of any use, and even the number of passenger cars is uncertain. There is no testimony as to the life of automobiles in petitioner's service. The only *1285 question presented is the abstract one of the propriety of the appraisal method of determining depreciation. We could not adopt such a method on the showing made in this case. The deduction authorized by the law is for the replacement of the acpital value as such value becomes exhausted. The rate of exhaustion of this value can not be based on the market value of the used article, since the market value is influenced not only by the condition of the article but by other factors as well. For example, a decrease in the price new of an automobile is bound to depress the market value of a used automobile of the same kind without relation to what its remaining life in service might be. The evidence is insufficient to enable us to determine a reasonable allowance for depreciation of these automobiles, and, therefore, we do not disturb the Commissioner's determination*3380 in this respect.
The petitioner claims Marx used his membership in the clubs mentioned above to promote the sale of its goods; and this is sustained by the evidence. There is no evidence that he used them for any other purpose. He joined at the instance of the other stockholders. Other officers of petitioner were members of clubs, but their dues were not paid by petitioner. Upon the evidence in this case, we think the deduction was proper.
Judgment will be entered under Rule 50.