*1372 1. In 1920 petitioner's subsidiary was insolvent, and petitioner caused it to discontinue business and assumed its liabilities. Held, that petitioner is entitled to deduct the cost of its stock in the subsidiary as a loss sustained in 1920; that petitioner is entitled to a bad debt deduction in the amount owed to it by the subsidiary; and that the amount estimated to be necessary to redeem trading stamps issued by the subsidiary is deductible as an accrued expense.
2. The receipt by petitioner of its own stock in partial settlement of an account for which a bad debt deduction had been allowed in a prior year, held to constitute income to the extent of the value of the stock. The accumulated but unpaid dividends on such stock held not to be income.
*53 Proceeding for the redetermination of deficiencies of $12,345.43 and $20,527.17 in income and excess-profits taxes for 1919 and 1920, respectively. Some of the issues raised by the petition have been waived and others settled by stipulation. These matters will be reflected in*1373 the computation under Rule 50. The issues remaining relate to 1920 and are whether certain items are deductible from gross income and whether taxable income was realized by petitioner upon the transfer to it of shares of its own stock and, if so, the value of the stock.
FINDINGS OF FACT.
The petitioner, a Massachusetts corporation, during and prior to the taxable years was engaged in the operation of a department store in Boston, Massachusetts.
For several years prior to 1916 the petitioner issued to its customers trading stamps that it bought from a corporation known as the Legal Stamp Company. Differences arose between the corporations, and the Legal Stamp Company withdrew the right of petitioner to use its stamps. Prior to 1916 and during the course of petitioner's efforts to arrange for the use of other trading stamps, George C. Dutton, the then vice president of petitioner, caused a corporation to be formed to engage in the trading-stamp business. The name of the corporation so organized was changed several times and during the periods material here was known as the New England Profit Sharing Stamp Company, hereinafter referred to as the "Stamp Company." Over a period*1374 of two or three years prior to 1916 during which the Stamp Company was being organized and promoted, Dutton paid the sum of $7,500 to the organizer and promoter of the corporation to cover the general cost of promoting the corporation, including incorporation expenses, salaries, stamp printing costs, and charges incurred in acquainting customers of stores with the advantages of collecting the stamps.
In October, 1916, Dutton left petitioner's service and acquired its so-called Roxbury store. The sum of $7,500 which he had expended in the organization and promotion of the Stamp Company was allowed *54 as a credit to him in the transaction. The balancing charge was made to petitioner's stamp promotion account.
The petitioner contracted to use exclusively trading stamps issued by the Stamp Company, but subsequently decided that it could not successfully meet competition without handling trading stamps of the Legal Stamp Company. In order to place itself in a position to cancel the undesirable contract with the Stamp Company, petitioner, on April 1, 1918, purchased 605 shares (which was substantially all) of the capital stock of the Stamp Company from V. C. Brown for $25,000. *1375 Thereafter it caused the contract to be terminated, but continued to issue the stamps to customers who asked for them.
After April 1, 1918, the Stamp Company was operated with a view of preventing losses and obtaining a buyer of its stock or assets. Efforts were made to find a buyer or one willing to assume the corporation's liabilities for its assets. Failing in these things, it was decided in the summer of 1920 to close out the Stamp Company at the end of the year.
No effort was made by the Stamp Company during the last quarter of 1920 to obtain new business. Such sales as it made during that period were made to stores whose customers were still collecting its stamps. The stamp sales in December, 1920, amounted to $1,622.50, as compared with $12,520 in the corresponding month in 1917. It discontinued the sales of its stamps at the close of 1920. At the same time the stores, including petitioner, stopped issuing the stamps to their customers.
The assets and liabilities of the Stamp Company on April 1, 1918, and December 31, 1920, as shown by its books, were as follows:
| Assets | Apr. 1, 1918 | Dec. 31, 1920 |
| Cash | $630.89 | $531.41 |
| Accounts receivable | 5,442.70 | 20,682.42 |
| Supplies | 6,903.65 | |
| Fixtures | 920.20 | 598.25 |
| Good will | 63,468.49 | |
| Good will and organization | 88,468.49 | |
| Stock subscriptions | 25,000.00 | |
| Manufacturers Clearing House | 219.05 | |
| Inventory, stock | 216.00 | |
| Inventory, red stamps | 100.00 | |
| Surplus (deficit) | 53,347.41 | 35,465.15 |
| Total | 155,713.34 | 146,280.77 |
| Liabilities | ||
| Amounts payable | 716.88 | 293.95 |
| Redemption reserve | 54,996.46 | 53,782.24 |
| Houghton & Dutton redemption account | 27,204.58 | |
| Capital stock | 100,000.00 | 65,000.00 |
| Total | 155,713.34 | 146,280.77 |
*1376 *55 The Stamp Company stock was charged to profit and loss on the date of its acquisition, with the explanation that it was "worthless on account of liquidation and excessive liabilities over assets." The item of $7,500 was also charged to profit and loss in 1918, and was claimed as a deduction from gross income in that year. In computing petitioner's tax liability for that year the respondent disallowed both items. The petitioner has never recovered any part of either amount.
Petitioner purchased stamps from the Stamp Company at the rate of $2.50 per thousand stamps and issued them to customers on the basis of one stamp with each ten-cent purchase. On the face of the stamps was printed the statement "Cash Value 2 mills." Petitioner issued books for the use of customers in collecting stamps, which books carried the name of the petitioner and a statement that filled books of a thousand stamps were redeemable for $2 in cash or $2.50 in merchandise. The stamps were redeemable at either the office of the Stamp Company or at the place of business of the issuing merchant, but it was the usual practice for customers to present them for redemption to the merchant whose name*1377 appeared on the books. The Stamp Company in turn reimbursed the merchant at the rate of $2.175 per thousand for stamps redeemed. The difference between the Stamp Company's issuing price of $2.50 and the $2.175 reimbursement to the merchant represented the Stamp Company's profit.
Upon the cessation of business by the Stamp Company petitioner assumed all of its liabilities. On December 20, 1920, petitioner entered on its books as a liability an amount of $41,783.42, this figure being 77.69 per cent of the reserve carried on the Stamp Company's books for redemption of outstanding stamps. The percentage of 77.69 used by petitioner in estimating the amount of stamps it would be required to redeem was based on its experience of several years prior to 1920. It actually redeemed between 60 and 70 per cent of the outstanding stamps from January 1, 1921, to December 1, 1930, when petitioner went into receivers' hands. On January 4, 1921, the Stamp Company notified its former customers that filled books of stamps would be redeemed upon presentation to petitioner.
At the close of 1920 the Stamp Company owed petitioner $7,414.06 in excess of petitioner's indebtedness to it. This amount*1378 was credited to accounts receivable and charged to trading-stamp expense as of December 31, 1920. No part of it has ever been recovered.
The respondent determined that the petitioner and the Stamp Company were affiliated during 1918, 1919 and 1920, and computed their tax liability on a consolidated basis. In computing the consolidated *56 net income for these years he determined net losses of the Stamp Company in the respective amounts of $9,500.61, $4,408.96 and $3,327.82.
In 1916 Alexander McGregor retired as treasurer and a director of petitioner, owing it the sum of $74,960.23 for advances. In 1919 petitioner's attorney to whom the account had been referred for collection reported that the indebtedness was uncollectible. This amount was claimed and allowed as a bad debt deduction in 1919.
Clara Dutton McGregor, wife of the debtor, was bequeathed a substantial number of shares of petitioner's stock by the will of her father, B. F. Dutton, president of petitioner for twenty years prior to his death in 1915.
On April 2, 1920, Clara Dutton McGregor transferred to petitioner 250 shares of its 7 per cent cumulative second preferred stock in part payment of her*1379 husband's indebtedness to petitioner. No dividends were paid by petitioner on any of its stock from 1914 to 1917. Beginning with 1918 a dividend was paid on first preferred stock only. Sometime in 1920 a cash dividend of $53,025 was paid on the second preferred stock issue of the par value of $800,000. From 1914 to 1921 petitioner's operations showed widely fluctuating results, ranging from a loss of $277,526.35 to net income of $204,010.84. The preferred stock was not listed on any exchange and there were no sales of it between 1920 and 1922. In the latter year 98 shares changed hands at about $40 per share.
Petitioner treated the stock turned in to it as income in 1920 to the extent of $80 per share, or a total of $20,000. In determining the deficiency for that year respondent increased the valuation to $100 per share, or a total of $25,000, and increased income accordingly. Respondent also added to income an amount of $5,687.50 for accrued dividends on the stock turned in for the period January 1, 1917, to April 1, 1920.
The fair market value of the stock when received by petitioner was $80 per share.
Petitioner's books of account were kept and its income-tax returns*1380 made on the accrual basis.
OPINION.
ARUNDELL: Petitioner claims that as a result of the abandonment of the business of the Stamp Company in 1920 it is entitled to a loss deduction of $32,500, consisting of $25,000 cash paid for stock and $7,500 organization and promotion expenses; a bad debt deduction in the amount of $7,414.06, which was the amount owed to it by the Stamp Company; and, as either an expense or loss deduction, the amount of $53,782.24, being the Stamp Company's reserve for redemption *57 of stamps, or in the alternative the portion thereof, $41,783.42, which petitioner set up on its books as a liability.
Claimed Loss on Stamp Company Stock.
A loss on the stock of an affiliate either through sale () or worthlessness () is allowable on the theory that the sale or worthlessness occurs outside the period of affiliation. See , and cases there cited. We pointed out in the Liebes case that while technically affiliation might continue in the case of worthlessness, under the circumstances present there we were*1381 of the opinion that the worthlessness should be regarded as breaking the affiliation as fully as would a sale. Similarly, in , where the business of a wholly owned subsidiary during the taxable year consisted chiefly in closing up its affairs preparatory to dissolution and it did no business after the end of the year, the court held that the parent company was entitled to deduct as losses the cost of the stock and advances made during the period of affiliation, with an adjustment for an operating loss that had been claimed and allowed in a consolidated return. In that case the subsidiary was not formally dissolved until the year following the cessation of business. In the opinion the court says that "The statute governing affiliated returns contemplated its application to active companies only. It would be a legal and commercial impossibility for a going corporation to affiliate with a corpse - the mere shell of a former corporation." We see no material distinction between the Aluminum Goods case and the one before us. Within the year 1920 petitioner decided to discontinue the Stamp Company's operations*1382 and thereafter no new business was sought. At the end of the year it was entirely out of business, and was hopelessly insolvent. While the balance sheet shows assets, they were more than offset by the liabilities. In order to correctly reflect the condition of the company the so-called good will and organization item should be eliminated as an asset, and when this is done the only asset of substantial amount left is accounts receivable of $20,682.42, which was far from sufficient to meet the liabilities. It is our opinion that on the showing made in this case petitioner is entitled to deduct the cost of the Stamp Company stock as a loss sustained in 1920.
We are unable to agree with petitioner that the amount of $7,500, organization and promotion expenses, should be treated as a part of the cost of the stock. The amount in dispute was originally expended by an officer of petitioner. As far as the record shows petitioner was not contemplating the acquisition of the Stamp Company stock when in 1916 it reimbursed the officer for his outlay through a credit *58 allowance in the Roxbury store transaction. The allowance so made gave petitioner no interest in the Stamp Company*1383 and played no part in the subsequent purchase of the stock. We accordingly hold that the cost of the Stamp Company stock to petitioner was $25,000 and the loss sustained should be computed on that basis.
Claimed Bad Debt Deduction.
The amount claimed, $7,414.06, represents the amount that the Stamp Company owed petitioner at the close of 1920 in excess of petitioner's indebtedness to it. A similar situation existed in , and it was held that the amount was allowable as a loss. It seems to us that it makes no difference whether the item is characterized as a loss or a bad debt, as the essence of the transaction is that petitioner is out of pocket the sum advanced and there is no possibility of recovering it. Technically, the item involved represents a debt and we prefer to allow it as a bad debt deduction. Clearly, the account was ascertained to be worthless when the Stamp Company business was abandoned and the petitioner assumed its liabilities. It is shown that in December, 1920, petitioner credited its accounts receivable with the amount owed to it by the Stamp Company, which in our opinion constitutes a sufficient charge-off*1384 to come within the terms of the statute allowing deductions for debts ascertained to be worthless and charged off within the taxable year.
Stamp Redemption Reserve.
Among the Stamp Company's liabilities assumed by petitioner was the one for redemption of trading stamps in the amount of $53,782.24. This liability was entered on petitioner's books at $41,783.42, representing 77.69 per cent of the outstanding stamps which petitioner estimated it would be required to redeem. While this item is denominated a reserve, it in fact was a liability which, under the facts here, was properly accruable on petitioner's books in 1920. According to the evidence the Stamp Company was obligated to redeem the stamps brought in by customers at the rate of $2.175 per thousand, but the obligation to redeem was in the first instance an obligation of petitioner. The stamps issued bore a notation of the cash amount or the value in merchandise at which they were redeemable, and the stamp books issued by petitioner had its name printed thereon, with a statement that they would be redeemed upon presentation. The evidence further shows that the general practice was for customers to present the stamp*1385 book for redemption to the store or merchant whose name was printed thereon. As long as the Stamp Company continued in business there might be some question as to *59 petitioner's right to accrue the portion of the redemption value for which it was entitled to reimbursement from the Stamp Company, but when the Stamp Company ceased functioning and had no assets, it was proper for petitioner to accrue as a business expense the amount that it was required to pay. It does not appear that petitioner was ever called upon to pay any greater amount than it estimated and set up on its books, and in our opinion that amount, $41,783.42, is the proper amount to allow as a deduction.
Income Realized on Receipt of Petitioner's Own Stock.
It has been frequently held that the recovery of a debt previously charged off as worthless and allowed as a deduction constitutes income in the year of recovery. See ; affd., . In this case some $74,000 owed to petitioner by Alexander McGregor when he retired from the company was claimed and allowed as a bad debt deduction for the year 1919. *1386 In 1920 petitioner obtained a partial recovery through the act of Mrs. McGregor in turning in 250 shares of petitioner's preferred stock. Petitioner ascribed a value of $80 per share to the stock and on that basis reported income of $20,000, which respondent increased to $25,000. Petitioner now claims that it realized no income on the receipt of its own stock, citing , and . Since the submission of this case the S. A. Woods Machine Co. case has been reversed by the ). The effect of the opinion of the court is to hold that a corporate taxpayer realizes income in accepting its own stock in satisfaction of an obligation owing to it. As the present case arises in the First Judicial Circuit, that decision is controlling here, and we accordingly hold that petitioner realized income on the receipt of its stock. It may be plausibly argued that, considered from Mrs. McGregor's viewpoint the transaction represented a gift, inasmuch as she was not legally liable for the debt. But in so far as petitioner*1387 was concerned the transaction represented merely the liquidation of an account receivable and hence was income, no matter who satisfied the account.
We think, however, that the respondent erred in including the stock in income at its par value. The evidence shows that at the time of the transaction all parties interested carefully considered the matter of value and concluded that $80 per share was the market value. The history of the company and its record of earnings convinces us that the market value was no greater than that amount, and the stock should be included in income at that figure.
*60 In addition to the stock, respondent included in income $5,687.50 as dividends accrued thereon from January 1, 1917, to April 1, 1920. We are unable to perceive on what theory he did so. As far as the record shows, no dividends were declared or paid during that period, and if there were any they were the property of the then owner of the stock. Certainly, after petitioner acquired the stock it would not pay dividends on it.
Reviewed by the Board.
Decision will be entered under Rule 50.