*152 Decision will be entered under Rule 50.
Petitioner's payment of debts of subsidiary which had undergone 77B reorganization, the name, business, and creditors of subsidiary being closely related to petitioner, which was concerned with restoring its credit standing, held deductible either as an ordinary and necessary business expense or as a loss. Scruggs-Vandervoort-Barney, Inc., 779">7 T. C. 779, followed.
*1109 By this proceeding petitioner seeks a redetermination*153 of a deficiency in excess profits tax of $ 18,382.89 for the year ended January 31, 1944.
The only litigated question is whether petitioner is entitled to a deduction under Internal Revenue Code, section 23 (a) (1) (A) or (f), for the sum of $ 18,421.86 paid to former creditors of petitioner's subsidiary corporation which had undergone a section 77B reorganization.
The case was presented on a stipulation of facts and evidence adduced at the hearing. Those facts hereinafter appearing which are not from the stipulation were otherwise found from the record.
FINDINGS OF FACT.
The stipulated facts are hereby found accordingly.
Petitioner is a New York corporation, with offices in New York City. Since its incorporation in 1917 it has been engaged in the business of manufacturing and dealing in jewelry. The business was founded in 1892 and petitioner had a high reputation and excellent credit standing.
Petitioner's Federal income tax, declared value excess profits tax, and excess profits tax returns for its fiscal year ended January 31, 1944, were filed with the collector of internal revenue for the third New York district on April 7, 1944. Amended returns for that fiscal year were filed*154 April 29, 1944. Petitioner keeps its books and files its returns on an accrual basis.
In 1938 and 1939 petitioner owned all the outstanding stock of Heller-Deltah Co., consisting of 1,500 shares of common stock of *1110 the par value of $ 100 per share. Heller-Deltah Co. was incorporated in December 1928 and was primarily engaged in the business of selling jewelry. It also sold cosmetics and perfumes.
On May 16, 1938, Heller-Deltah Co. filed a petition in bankruptcy in the United States District Court, Southern District of New York, and on August 9, 1938, submitted a plan of reorganization pursuant to section 77B of the National Bankruptcy Act.
The plan of reorganization provided for payment to all unsecured creditors (except petitioner and any officers of Heller-Deltah Co.) of 45 per cent of the principal amount of their claims as finally allowed by the Court. Ten per cent was to be paid in cash on the entry of the final order confirming the plan, and 5 per cent each month for seven months beginning January 25, 1939, the 35 per cent to be evidenced by seven promissory notes, to be made by the debtor and endorsed by petitioner. The plan recited that petitioner had subordinated*155 its claim to the other unsecured creditors to the extent of 45 per cent of their claims, and stated "no payment shall be made to * * * [petitioner] until and unless the said 45% in the form hereinafter set forth, shall have been paid to the said unsecured creditors."
The plan of reorganization was confirmed by the District Court on October 7, 1938.
On January 3, 1939, the District Court entered its order in the proceeding terminating the reorganization under section 77B, it being declared by the court that it had been in all respects fully executed. It was:
Ordered, Adjudged and Decreed:
* * * *
3. That said debtor be and it hereby is discharged from all debts, claims, and liabilities, excepting such debts as are by law excepted from discharge;
4. That all creditors of, claimants against, and stockholders of the debtor, are hereby restrained and enjoined from pursuing or attempting to pursue, or commencing any suits or other proceedings at law or in equity against the debtor, directly or indirectly, on account of or based upon any right, claim or interest which any such creditor, claimant or stockholder may have had in, to, or against said debtor, excepting only such liabilities*156 and claims as said debtor has expressly assumed or agreed to pay pursuant to the terms of said plan of reorganization;
* * * *
Shortly after the reorganization the accountant who had been representing the creditors of Heller-Deltah Co. was asked to take care of petitioner's accounting. At that time he urged upon petitioner the wisdom of paying the remaining 55 per cent to the "jewelry" creditors.
Milton J. Heller, president of petitioner, orally promised on behalf of petitioner at the time of the compromise settlement to pay the remaining balance of 55 per cent of the claims to all the unsecured "jewelry" creditors of Heller-Deltah Co. if and when it was possible for petitioner to do so.
*1111 On May 18, 1943, petitioner paid to certain former "jewelry" creditors of Heller-Deltah Co. sums totaling $ 18,421.86. 1
Each of these creditors had received the 45 per cent above set forth, and these sums represented the remaining 55 per cent of their claims in*157 the court proceeding under 77B. There remained unpaid to other creditors of Heller-Deltah Co. the sum of approximately $ 13,000.
Members of the jewelry industry were favorably impressed by petitioner's payment of the defaulted amounts.
Petitioner's first-class credit rating had been withdrawn by the Jewelers' Board of Trade, which is a leading credit bureau in the jewelry industry. Petitioner's president consulted with the accounting manager of the Jewelers' Board of Trade, who has a great deal to do with its credit ratings, and discussed the matter of making good its promise to its creditors. He was advised that it would be to petitioner's interest to pay the defaulted amounts and that petitioner should so do at the first possible occasion. The Jewelers' Board of Trade restored petitioner to a credit rating of excellent in July 1945. The Hellers, individually, had had nothing to do with the perfumery business. The jewelry creditors had dealt with petitioner previously and extended credit to Heller-Deltah Co. in reliance upon the interest of petitioner in that company.
A number of jewelry creditors of Heller-Deltah Co. were also creditors of petitioner, and petitioner continued*158 to do business with these creditors after the failure of Heller-Deltah Co.
Petitioner now deals only in pearls and pearl jewelry, and has extensively promoted the trade name "Delta" for simulated pearls.
Petitioner originally claimed the payments aggregating $ 18,421.86 as a deduction for bad debts in its tax return for the year ended January 31, 1944, and subsequently and in its pleadings claimed the payments as a deduction for ordinary and necessary business expense under section 23 (a) or as a loss under section 23 (f). Respondent's disallowance of the deduction was on the ground that it:
* * * constitutes a capital expenditure, no portion of which is deductible in computing your net income for that year. Accordingly, the deduction under "Bad Debts" of that amount claimed in your return filed for the taxable year ended January 31, 1944, is disallowed.
The payment in question was proximately related to the conduct of petitioner's business. It was made to protect and promote petitioner's business.
OPINION.
There is evidence from which it may be concluded that petitioner's promise to some of the creditors of its subsidiary *1112 to make good their losses on the subsidiary's*159 77B reorganization was contemporaneous with the latter proceeding, and that the consent of the creditors to the reorganization was a consideration for petitioner's undertaking. If so, the payment by petitioner was pursuant to a contractual obligation, notwithstanding the principal debtor's discharge, see Abraham Greenspon, 8 T. C. 431; Welch v. Helvering, 290 U.S. 111">290 U.S. 111, footnote 1; and deduction as a loss of the amounts paid accordingly would be proper in the instant year. Charles G. Berwind, 8 T. C. 1112; Abraham Greenspon, supra.
But even if there were no binding commitments, petitioner's standing in the business community, its relationship to the jewelry trade generally, and its credit rating in particular, characterized the payments as calculated to protect and promote petitioner's business and as a natural and reasonable cost of its operation. Harris & Co. v. Lucas (C. C. A., 5th Cir.), 48 Fed. (2d) 187. As such, they are deductible in any event as ordinary and necessary business expense. Scruggs, Vandervoort-Barney, Inc., 7 T. C. 779;*160 Catholic News Publishing Co., 10 T.C. 73">10 T. C. 73.
The theory that these were capital expenditures is disposed of in the following language in Harris & Co. v. Lucas, supra:
It is argued, however, on behalf of respondent, that the expenditures were in the nature of the purchase of good will, * * * a capital asset. * * * Good will consists largely of a reputation for competence, honesty, and fair dealing, but its value is in attracting customers and not in securing credit. The establishment of credit to purchase does not at all guarantee that it will continue over a period of years. * * *
* * * *
It is perfectly plain that the payments did not constitute capital investment.
We find it unnecessary to determine whether the payment is to be more accurately and technically described as a loss or a business expense. Claim is made on both grounds. Cf. Merton E. Farr, 11 T. C. 552, 565-566. On one or another, the deduction should be permitted.
For the inclusion of computations on other issues now apparently conceded,
Decision will be entered under Rule 50.
Hill, J., dissenting: A merchant's*161 credit is built on his record as to honesty, his ability to pay, and the payment of his obligations. I do not find in the record here any direct evidence that petitioner was deficient in any of the particulars named. So far as the record here discloses, it was petitioner's subsidiary and not petitioner that was in financial difficulties.
*1113 If in the instant proceeding petitioner's credit was impaired by reason of the deficiencies of its wholly owned subsidiary, we must look for the basis for ascribing such deficiencies to petitioner. If petitioner in discharging its responsibilities of control over the subsidiary diverted the latter from the line of rectitude or sound business practices in its trade relations and thus impaired the subsidiary's ability to pay its debts, it is conceivable that an impairment of petitioner's credit standing might also result therefrom. If such impairment of petitioner's credit so resulted, it occurred from its voluntary conduct in controlling the operation of another corporation's business.
The question then is, Can the cost of remedying any such impairment of petitioner's credit be classed as an ordinary and necessary business expense of*162 petitioner? The remedy as applied, according to petitioner's contention, consisted of paying the debts of the subsidiary in order that the latter might be rehabilitated under a 77B reorganization. It is claimed by petitioner that such rehabilitation of the subsidiary was necessary to, and did, restore its own credit standing. In other words, petitioner seeks to deduct as an ordinary and necessary expense of its own business the cost of eliminating an impairment of its credit due to its own control of the business of another corporation. The foregoing, in my opinion, reflects the logical development of the theory upon which petitioner claims the deduction. I submit that such theory forecloses the right to such deduction.
However, the record discloses facts which call for the application of another legal principle which, I think, definitely denies the right of deduction claimed by petitioner.
The subsidiary was reorganized under section 77B of the Bankruptcy Act. A proposed plan of reorganization was accepted by its creditors and ordered adopted by the court. On the surface, the main points of that plan were: (a) That the unsecured creditors should be paid 45 per cent of their*163 claims out of the assets of the subsidiary; and (b) that petitioner should subordinate its claims against the subsidiary to those of other unsecured creditors to the extent of such 45 per cent. But, on the side, petitioner's president orally agreed on behalf of petitioner with such other unsecured creditors that petitioner would pay the remaining 55 per cent of their claims against the subsidiary.
Obviously, this oral agreement was made for the purpose, and had the effect, of inducing such unsecured creditors to accept the proposed plan of reorganization. It accomplished its intended purpose.
The question, if any, of whether such agreement, because it was oral, was enforceable, is eliminated for the reason that to the extent here involved it was performed.
The promise to pay and the payment by petitioner of the remaining 55 per cent of certain claims against its subsidiary was based on a consideration *1114 which petitioner must have deemed valuable and adequate. That consideration was the acceptance by the other creditors of the plan of reorganization of the subsidiary. I assume the purpose of the reorganization was to enable the subsidiary to continue in business. I can*164 conceive of no other reason for the reorganization. No doubt it was deemed financially advantageous to petitioner that the subsidiary be so reorganized as to conserve its status as the operator of a going business rather than have it run through the wringer of an outright bankruptcy proceeding.
The arrangement whereby petitioner promised to pay and paid the moneys herein involved was not to protect the business of its own operations, but the business and assets of the subsidiary. Moreover, the promise and payments in question were made pursuant to a side agreement in connection with the reorganization proceedings. It is true that the record shows representations were made to petitioner that it would be helpful to its credit if it paid the moneys which it had promised to pay. However, the fact that such payments may have had the effect of strengthening the credit standing of petitioner was merely incidental to the performance of its agreement entered into for a valuable and adequate consideration. Petitioner got what it paid for, namely, the acceptance of its plan for the reorganization of its subsidiary. It realized neither gain nor loss, nor incurred business expense, from *165 such transaction any more than if it had bought and paid for a house, a horse, or an automobile.
Therefore, it appears to me that petitioner neither sustained a deductible loss nor made the payments in question as an ordinary and necessary expense of its business. Certainly, there is no basis for a contention that petitioner is entitled to a deduction as a bad debt for the payments made.
Footnotes
1. Otherwise appearing in the stipulation as $ 18,841.26.↩