*2548 1. INVESTED CAPITAL. - Where the taxpayer had an operating deficit at the close of the year 1920, but paid no dividends of any kind during that year or 1921 and there was no return of capital to the stockholders either directly or indirectly, held, that respondent erred in reducing the taxpayer's paid-in capital by the amount of an operating deficit and in determining a deficiency for the year 1921.
2. TRANSFEREES. - Petitioners contested the liability of the taxpayer and having proven that the taxpayer is not liable for the additional taxes in controversy, it is held that there is no liability of petitioners as transferees.
*622 The respondent reduced by the amount of $51,001.35 the invested capital of the Gadsden Ice & Coal Co. in his determination of that corporation's tax liability for the year 1921, which action resulted in a deficiency in the amount of $1,248.64 being asserted against the said corporation in a 60-day deficiency notice mailed on or about April 14, 1926, to the corporation. The said corporation was dissolved*2549 *623 in 1923, and under date of November 9, 1926, respondent mailed a notice to each of the petitioners herein, proposing to assess each in the amount of $624.32 as transferees under section 280 of the Revenue Act of 1926. The two proceedings have been consolidated for hearing and decision.
Petitioners allege that respondent erred (1) in determining any deficiency against the Gadsden Ice & Coal Co. for the year 1921 and (2) in proposing to assess against each of them the amount of $624.32 as transferees.
FINDINGS OF FACT.
At the time of the hearing on these proceedings Archibald Sherrod resided at Highpoint, N.C., and Henry Lambert Sherrod resided at Birmingham, Ala. During the years 1920 to 1923, inclusive, both individuals resided in Etowah County, Ala.
On August 6, 1920, A. Sherrod and H. L. Sherrod, as individuals, entered into a contract with the Gadsden Ice & Coal Co., an Alabama corporation, hereinafter referred to as the predecessor, for the purchase of its assets for the sum of $100,000. Those assets consisted of an operating ice-manufacturing plant, fuel storage yeards, real estate, equipment, and furniture and fixtures, all situated in the town of Gadsden, *2550 Ala.
The two petitioners organized on or about August 24, 1920, under the laws of Alabama, a corporation known as the Gadsden Ice Co., with a fully paid-in capital of $100,000. Each petitioner subscribed for 500 shares of the par value of $100 each and they paid in for such stock $40,000 in cash and $60,000 in interest-bearing notes worth their face amount. The said notes were bona fide paid in to the corporation for stock and were later paid at their face amount. In addition, they paid in $8,980 in cash for working capital. The above-mentioned contract was transferred to the corporation, the taxpayer herein, which purchased the said assets for $100,000 on the basis of $40,000 in cash and $60,000 in notes bearing interest at 8 per cent and secured by a mortgage on the assets. The taxpayer paid off its notes and after the predecessor corporation dissolved the taxpayer had its name changed from the Gadsden Ice Co. to the Gadsden Ice & Coal Co.
On August 24, 1920, the taxpayer owned and used in its business the following assets purchased from its predecessor:
| Machinery | $59,000 |
| Buildings | 10,000 |
| Real estate | 30,500 |
| Tools and supplies | 250 |
| Furniture and fixtures | 250 |
| Total | 100,000 |
*2551 *624 On the same date it had outstanding 1,000 shares of stock of a par value of $100 each. The taxpayer retained all of its assets during its existence, and it paid no dividends of any kind until a final liquidating dividend of $40,000 was paid to each of petitioners after the taxpayer was dissolved in August, 1923, because it was a losing venture. Prior to dissolution there was no return of capital invested by petitioner, either directly or indirectly.
The taxpayer's books have either been destroyed or lost and could not be produced at the hearing, except the minute book. The taxpayer filed its income and profits-tax return for the year 1921, reporting a net income of $12,863.54, and an invested capital of $100,000. It computed an excess-profits credit of 8 per cent of invested capital, or $8,000 plus an exemption of $3,000, a total of $11,000, leaving a balance of $1,863.54, on which it computed a profits tax at 20 per cent, equaling $372.71. It then computed an income tax of $1,086.35, or 10 per cent of $10,863.54, which was the balance left after deducting an exemption of $2,000 from the net income of $12,863.54. The said return showed a total tax of $1,459.06, *2552 which was paid. Attached to the return is a comparative balance sheet for the periods ending December 31, 1920 and 1921. For the period ending December 31, 1920, there is included in liabilities a deficit in the amount of $51,001.35. Respondent, in auditing the taxpayer's return for 1921, used a net income of $12,863.54 as reported, but reduced invested capital by the amount of $51,001.35, as a liquidating deficit, which action resulted in a profits tax of $1,801.49 and the total amount of the deficiency of $1,248.64 here in question.
OPINION.
TRUSSELL: The Revenue Act of 1921, section 326(a), provides that there shall be included in invested capital "(1) actual cash bona fide paid in for stock or shares; (2) actual cash value of tangible property, other than cash, bona fide paid in for stock or shares, * * *." Section 325 of the same Act provides that "The term 'tangible property' means stocks, bonds, notes, * * *." There is no question but that the taxpayer had a statutory invested capital of $100,000 on August 24, 1920, and no issue has been raised relative thereto. The first issue involves the correctness of respondent's action in reducing that statutory invested capital*2553 for the year 1921 by the amount of $51,001.35.
The record does not disclose how the taxpayer sustained the alleged deficit in amount of $51,001.35 after operation for about four months, and from the facts of record it would appear that no such deficit existed except through erroneous bookkeeping. However, in this proceeding the actual amount of the operating deficit is immaterial. *625 The facts are that the taxpayer did set up on its balance sheet of December 31, 1920, the amount of $51,001.35 as an operating deficit, and it appears that respondent assumed that that amount represented a partial liquidation and a corresponding reduction of invested capital. The respondent reduced the taxpayer's invested capital for 1921 from $100,000, as reported on its return, to $48,998.65, which action resulted in the deficiency asserted in the amount of $1,248.64.
The facts of record disclose that during the existence of the taxpayer it retained all of the assets which it had purchased from its predecessors; that it retained all of its paid-in capital; that it did not partially liquidate, and that it paid no dividends of any kind until a final liquidating dividend of $40,000 was*2554 paid to each of petitioners after the assets were sold and the taxpayer was dissolved in August, 1923. The deficit was an operating deficit and until August, 1923, there was no return of capital invested by the petitioners, either directly or indirectly.
During the year 1921 the amount invested by petitioners in the taxpayer remained unchanged and section 326 of the Revenue Act of 1921 makes no provision for the reduction of invested capital of a corporation by the amount of an operating deficit. We are of the opinion that respondent erred in reducing the taxpayer's invested capital for the year 1921 by the amount of $51,001.35. Cf. .
Petitioners have contested the liability of the taxpayer for any additional taxes and we are led to the conclusion that there is no deficiency in the tax liability of the taxpayer, the Gadsden Ice & Coal Co., for the year 1921, and accordingly there is no liability on the part of the petitioners herein as transferees under section 280 of the Revenue Act of 1926.
Judgment of no liability will be entered for petitioners.