*1082 1. Petitioner borrowed funds from a bank under conditions imposed by a letter from the bank to petitioner. The letter stated that a line of credit would be granted to petitioner on condition that petitioner would not declare further dividends until its financial condition warranted it. No other writing was involved in the contract. The letter was not signed by or for petitioner. Held, that, since petitioner did not execute a written contract prior to May 1, 1936, restricting its payment of dividends, it is not entitled to a credit under section 26(c)(1) of the Revenue Act of 1936.
2. Funds were embezzled from petitioner by one of its employees in the taxable year. In a later year petitioner was reimbursed for a portion of the embezzlements. Held, that petitioner may not deduct losses in the taxable year for which it was subsequently reimbursed. E. B. Elliott Co.,45 B.T.A. 82">45 B.T.A. 82.
*699 Respondent determined a deficiency in petitioner's income tax for the year 1937 in the sum of $13,504.83. By amended answer respondent has*1083 asked for an increased deficiency in petitioner's 1937 income tax in the sum of $14,848.75. The first issue is whether or not petitioner is entitled to a credit under section 26(c)(1) of the Revenue Act of 1936. The second issue is whether or not petitioner is entitled to a loss for amounts embezzled from it in the taxable year for which amounts petitioner was in a later year reimbursed.
Most of the facts were stipulated. Additional facts were adduced from evidence presented at the hearing.
*700 FINDINGS OF FACT.
Petitioner is a corporation organized and existing under the laws of the State of Washington and is engaged in the wholesale hardware business. Petitioner's income and excess profits tax return for the taxable year was filed on March 12, 1938, with the collector for the district of Washington at Tacoma, Washington. Petitioner paid income and excess profits tax for the year 1937 in four installments in the total sum of $12,702.03.
Petitioner has for many years borrowed money from the Bank of California, N.A., hereinafter referred to as the bank, in order to carry on its business. On or about February 6, 1936, petitioner, through Nathan Eckstein, chairman*1084 of its board of directors, with the knowledge and consent of the president of petitioner, Morton L. Schwabacher, orally applied to the bank at Seattle, Washington, for a line of credit to the extent of $200,000.
On February 8, 1936, G. L. Wakeman, the manager of the Seattle branch of the bank, telephoned Eckstein and informed him that the bank would conditionally approve a $200,000 line of credit to petitioner and that Wakeman, on behalf of the bank, would write petitioner a letter approving the line of credit on conditions to be stated in such letter. The bank, through Wakeman, then wrote the following letter, dated February 8, 1936:
Confirming our telephone conversation of this morning, we are pleased to place at the disposal of the Schwabacher Hardware Company, an open line of credit for this year, in the amount of $200,000. We also consent to the payment of a dividend in the amount of $40,000.00 at this time, with the understanding that no further dividends will be declared until the condition of the business amply warrants it, and that no further personal overdrafts will be permitted.
In granting this line of credit, we expect you to take advantage of all possible discounts, *1085 and be prepared to liquidate the bank indebtedness at your low period.
We shall appreciate your keeping in touch with us from time to time, and furnishing us with a mid-season statement of condition.
The above quoted letter of February 8, 1936, was received by petitioner on February 9, 1936. On that date petitioner was indebted to the bank on a note dated February 3, 1936, in the sum of $30,000. Following receipt of the letter of February 8, 1936, from the bank petitioner proceeded to borrow additional money.
On December 26, 1936, petitioner was indebted to the bank in the sum of $100,000. The amounts borrowed from the bank, the payments by petitioner to the bank, and the balances owed the bank by petitioner in the year 1936 were as follows:
| Additional borrowings | Payments | Balance | |
| Balance, Dec. 26, 1935 | $35,000 | ||
| Feb. 1936 | $130,000 | 165,000 | |
| Apr. 1936 | 20,000 | 185,000 | |
| May 13, 1936 | 20,000 | 165,000 | |
| Sept. 22, 1936 | 20,000 | 145,000 | |
| Oct. 31, 1936 | 15,000 | 130,000 | |
| Nov. 19, 1936 | 15,000 | 115,000 | |
| Nov. 21, 1936 | 15,000 | 100,000 | |
| Dec. 1936 | 100,000 |
*701 The balance at December 26, 1936, was comprised as follows:
| Date of promissory note | Due dates | Amounts |
| Oct. 22, 1936 | Jan. 20, 1937 | $15,000 |
| Oct. 30, 1936 | Jan. 28, 1937 | 15,000 |
| Nov. 9, 1936 | Feb. 7, 1937 | 35,000 |
| Nov. 21, 1936 | Feb. 19, 1937 | 35,000 |
| Total | 100,000 |
*1086 The amounts borrowed were evidenced by promissory notes payable 90 days after date, executed by petitioner, payable to the bank, and delivered to the bank on the respective dates of the notes.
During the year 1937 petitioner, pursuant to the terms and conditions of the letter of February 8, 1936, borrowed additional sums from the bank in the total amount of $140,000, as follows: February, $35,000; March, $50,000; April, $30,000; and June, $25,000. During the year 1937 petitioner repaid the bank a total of $155,000, as follows: January, $15,000; July, $25,000; August, $25,000; September, $25,000; October, $30,000; November, $10,000; and December, $25,000.
Petitioner failed to take discounts on merchandise purchases for the year 1937 in a total amount of $654,365.56. Petitioner's lowest indebtedness to the bank in the year 1936, after February 8, 1936, was $100,000. Petitioner's lowest amount of indebtedness to the bank in the year 1937 was $85,000.
From and after February 8, 1936, to and including the year 1937, oral conferences relative to the financial condition of petitioner were held from time to time between the bank and petitioner through Wakeman on behalf of the*1087 bank and Eckstein on behalf of petitioner. On or about June 26, 1936, petitioner furnished the bank an interim balance sheet dated June 27, 1936.
Under date of December 17, 1937, the bank, through its manager, Wakeman, addressed to petitioner the following letter, which was mailed to and received by petitioner on December 18, 1937:
Under date of February 8, 1936 we addressed a letter to you, copy herewith. Inasmuch as you will soon be closing the books of the Schwabacher Hardware Company, Inc. for the year 1937, we wish to say that we are still of the opinion that no dividends should be paid at this time.
*702 No dividend was declared by petitioner for the year 1937.
Between January 1 and April 30, 1937, an employee of petitioner embezzled funds from petitioner in the sum of $2,068.74. That employee embezzled further sums from petitioner between May 1 and December 31, 1937, in the amount of $4,767.02. Prior to January 1, 1937, that employee embezzled funds of petitioner in the sum of $17,879.12.
The sums of $2,068.74 and $4,767.02 which had been embezzled by the employee of petitioner in 1937 were charged on petitioner's books of account to freight expense*1088 and claimed as a deduction on petitioner's income and excess profits tax return for the year 1937 as a part of cost of goods sold in the amount of $1,442,209.10. In determining a deficiency in petitioner's income tax respondent made no adjustment in respect of the amount of cost of goods sold. Petitioner has received and has been allowed by respondent a deduction for the year 1937 in an amount equal to the amounts embezzled by petitioner's employee during that year. In determining a deficiency respondent allowed petitioner a deduction of $1,068.74 for the amounts embezzled by the employee during the year 1937, without taking into account the items of $2,068.74 and $4,767.02. In his notice of deficiency respondent did not take into account the amounts of $2,068.74 and $4,767.02, nor attempt to increase the adjusted net income by those amounts, or any part thereof.
At all times prior to January 1937 and up to and including April 30, 1937, petitioner was protected by a valid and existing bond issued by a solvent surety against loss sustained on account of the embezzlements during that period in the principal sum of $1,000. During the period from May 1 to December 31, 1937, petitioner*1089 was also protected by a valid and existing bond issued by a solvent surety against the losses sustained in that period on account of the embezzlements.
The embezzlements, including the nature and amount of the embezzlements, for the year 1937, as well as the embezzlements prior to 1937, were first discovered by petitioner on or about November 27, 1939, and a claim therefor was asserted against the surety by petitioner on December 22, 1939.
On or about February 28, 1940, petitioner received from the surety the sum of $13,723.61 under the terms and conditions of the following agreement:
We, Schwabacher Hardware Company, a corporation, with principal office and place of business at Seattle, Washington, hereby acknowledge receipt of $13,723.61 from Fidelity and Deposit Company of Maryland as a loan repayable, without interest, solely from and to the extent of any recovery we may hereafter make from Union Pacific Railroad Company or any other person, copartnership or corporation on account of losses sustained by us by reason of the Union Pacific Railroad Company accepting checks drawn by us and payable *703 to it, cashing the same and failing to apply the proceeds as directed*1090 thereon, including all checks shown in proof of loss heretofore submitted to the Fidelity and Deposit Company of Maryland under the date of December 22, 1939.
We hereby agree to enter and prosecute a civil action or actions against said Union Pacific Railroad Company or other persons on the aforementioned claim, with all due diligence, at the sole liability and expense and under the direction and control of the said Fidelity and Deposit Company of Maryland.
As security for the loan aforesaid, we hereby pledge any judgment we may hereafter recover on the foregoing claim against said Union Pacific Railroad Company or others and all moneys which shall hereafter be paid thereon by said Union Pacific Railroad Company or other person or persons, firm or corporation, any such recovery to be distributed as follows:
First, reimbursement of all expenses and costs of litigation incurred by Fidelity and Deposit Company of Maryland, including its attorneys' fees, and of Schwabacher Hardware Company for any liability, costs and expenses incurred by it at the request of or with the consent of said Fidelity and Deposit Company of Maryland, or that imposed by law upon Schwabacher Hardware Company.
*1091 Second, reimbursement to Schwabacher Hardware Company of all losses proved against Union Pacific Railroad Company or other defendant for which recovery is obtained over and above the amount of the aforesaid loan.
Third, out of the balance of the proceeds of the recoveries aforementioned, the aforementioned loan will be repaid.
* * *
This agreement was modified in June 1940 by a "Supplemental Agreement" which provided that there were certain claims which petitioner had against the Union Pacific Railroad Co. which petitioner did not desire to assert against such company and which were not to be considered as liabilities of the surety on its bond or bonds. The supplemental agreement also provided that petitioner receive reimbursement out of amounts which might be recovered in the suit against the Union Pacific Railroad Co. in excess of the "loan" received from the surety to the extent of $997.92.
Of the sum of $13,723.61 received by petitioner in 1940 from the surety, the sum of $4,767.02 is in respect of funds embezzled from petitioner during the period from May 1 to December 31, 1937.
Petitioner is entitled to additional deductions from its adjusted net income for*1092 the year 1937 for state excise taxes in the sum of $865.56 and social security taxes in the sum of $364.06 which accrued in 1937 but were not taken as deductions on the return because not ascertained at the time that return was made.
By amended answer, respondent seeks to eliminate the sum of $4,767.02 from cost of goods sold and to restore that amount to gross income of petitioner for the taxable year. He also requests the elimination of a deduction for $1,068.74 for loss due to embezzlement in the year 1937 which he allowed petitioner in his notice of deficiency and prays that we restore that amount to gross income. *704 In addition respondent added the sum of $103.71 representing the amount of the $1,000 received from the surety which was allocable to the embezzlements occurring between January 1 and April 30, 1937.
OPINION.
HILL: At the hearing counsel for petitioner objected to the stipulated facts regarding the receipt of funds by petitioner from the surety in 1940 on the ground of materiality. We hereby overrule the objection. The materiality of these facts will be apparent from our discussion of the second issue.
The first question presented is whether*1093 or not petitioner is entitled to a credit under section 26(c)(1) of the revenue Act of 1936. 1 Petitioner contends that it was restricted in the payment of dividends in the taxable year by a written contract executed by petitioner prior to May 1, 1936. Respondent argues that the credit must be denied on the ground that the contract which restricted payment of dividends by petitioner was not a written contract executed by petitioner.
*1094 The contract upon which petitioner relies in its claim for the credit is contained in a letter written by the bank to petitioner in which the bank, through its manager, announced that it was placing an open line of credit at petitioner's disposal and consented to an immediate payment of a $40,000 dividend, "with the understanding that no further dividends will be declared until the condition of the business amply warrants it * * *." This was the only writing involved in the contract. No one signed the contract on behalf of petitioner. In our opinion this was not a written contract executed by petitioner. In , the Supreme Court stated:
The natural impression conveyed by the words "written contract executed by the corporation" is that an explicit understanding has been reached, reduced to writing, signed and delivered.
We consider that "executed", as used in the language just quoted, means signed by or for the taxpayer.
*705 A taxpayer claiming a credit under section 26(c)(1) of the Revenue Act of 1936 must show strict compliance with the terms of the statute. *1095 . In the Union Telephone case we held that a contract was not executed by the taxpayer within the meaning of section 26(c)(1) where the taxpayer's parent corporation executed the contract for which the credit was claimed, even though it was shown that it was customary for the parent corporation to enter into contracts for its subsidiaries, which acquiesced in such action of the parent. In , we held that a contract entered into by the predecessor of the taxpayer, which had orally assumed the predecessor's liability under the contract, was not a contract executed by the taxpayer. In that case we stated:
The evidence indicates that petitioner did assume its predecessor's liabilities under that contract. But it did not do this by similar contract to which it affixed its corporate signature.
In , we held that a contract which was executed by promoters of the taxpayers prior to its incorporation and was ratified or adopted by actions of the taxpayer was not a contract executed by the taxpayer within the meaning of section*1096 26(c)(1).
Upon authority of the Union Telephone Co., Boeckeler Lumber Co., and Kolor-Thru Corporation cases, we hold that petitioner is not entitled to a credit under section 26(c)(1) of the Revenue Act of 1936.
The second issue is whether or not petitioner is entitled to a deduction for amounts embezzled from it during the taxable year for which petitioner received reimbursement from a surety in 1940. Petitioner contends that the amounts embezzled in the taxable year are deductible, since the surety did not reimburse petitioner for its losses until after that year. Respondent contends that deductions for losses by embezzlement in the taxable year should be reduced to the extent that such losses were compensated for by insurance, notwithstanding that such compensation occurred in a taxable year subsequent to that of the embezzlement.
Petitioner relies upon the case of , in which the Circuit Court of Appeals for the Ninth Circuit held that a loss for jewelry Stolen in the taxable year was deductible in toto in the taxable year, even though a claim against an insurance company for reimbursement of the loss was*1097 compromised, and the amount agreed upon paid, in the following year. That case was apparently presented and decided on the narrow question of whether the claim against the insurance company for loss by theft was accruable in the taxable year in which the loss occurred. *706 The court held, on the facts there, that the claim was not so accruable and that hence the loss was not "compensated for by insurance or otherwise" in the taxable year. That question is not involved in the consideration of our decision here.
In the instant case we hold for respondent upon the principle that deductions of a taxable year before us may be adjusted to reflect a later refund or reimbursement, even though such refund or reimbursement may occur after the taxable year involved. , and cases therein cited.
Respondent denied deductions for the amounts embezzled during the period from May 1 to December 31, 1937, on the ground that full recovery for those losses was had by petitioner from the surety in 1940. As to the amounts embezzled in the period January 1 through April 30, 1937, respondent determined that the sum of $103.71 of the $1,000 surety*1098 bond related to such losses and limited the deduction for such losses to the sum of $1,965.03. The sum of $103.71 was arrived at by determining the relation which the sum of $2,068.74, the amount embezzled from January 1 through April 30, 1937, bears to $19,947.86, the total amount embezzled prior to January 1, 1937, and through April 30, 1937, and multiplying that result by $1,000. This is the proper method of determining the proportion of the $1,000 reimbursement which relates to the embezzlements from January 1 through April 30, 1937. Petitioner has conceded that the additional deduction of $1,068.74 which respondent allowed in his notice of deficiency should be eliminated and that amount restored to gross income. On the authority of , we hold that these adjustments should be made. Although the amounts received by petitioner from the surety in 1940 were in the form of a "loan", the amounts received were repayable only out of the proceeds of a suit directed against the Union Pacific Railroad Co. There was no requirement that petitioner repay the amounts received other than from such proceeds. Accordingly, the amounts received from the*1099 surety must be deemed to be true reimbursement for the losses.
Since we have sustained respondent on both issues, we hold, in accordance with the stipulation of the parties, that there is a deficiency in petitioner's income tax of $14,848.75.
Decision will be entered under Rule 50.
Footnotes
1. SEC. 26. CREDITS OF CORPORATIONS.
In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax -
* * *
(c) CONTRACTS RESTRICTING PAYMENT OF DIVIDENDS. -
(1) PROHIBITION ON PAYMENT OF DIVIDENDS. - An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. If a corporation would be entitled to a credit under this paragraph because of a contract provision and also to one or more credits because of other contract provisions, only the largest of such credits shall be allowed, and for such purpose if two or more credits are equal in amount only one shall be taken into account. ↩