*888 During 1936 petitioner purchased installment notes and mortgages at a discount, of which over $578,000 were forged and fictitious, but were represented by the vendor to be genuine. The vendor collected the installments for petitioner, and during 1936 and 1937 paid petitioner over $150,000 as alleged collections on said fictitious notes. In April 1937 petitioner discovered that the notes and mortgages were forgeries, that the vendor was insolvent, and that the endorsement and guarantee of the notes were worthless. Held, under the circumstances the vendor obtained petitioner's money by deceit and artifice which amounted under the Missouri law to theft, and petitioner's loss was sustained in 1936 when it parted with the money.
*1190 This proceeding involves a deficiency in income tax for 1936 of $6,917.90. The issue is whether petitioner sustained losses during 1936 from its purchase of forged and fictitious notes purporting to be secured by chattel mortgages of fictitious and nonexistent persons. If entitled to the deductions in 1936, petitioner*889 asks the Board to determine that it has overpaid its tax for that year.
The principal facts were covered by stipulation, filed at the hearing, which was supplemented by oral testimony and exhibits. We adopt the stipulation as part of our findings, and from such stipulation, oral testimony, and exhibits determine the facts to be as hereinafter set forth.
*1191 FINDINGS OF FACT.
Petitioner is a Missouri corporation, with its principal office and place of business in St. Joseph, Missouri. It was organized and chartered as a loan and investment company. Its charter states that it was formed:
* * * to carry on and transact a general loan business; to loan and invest moneys upon property or security, real or personal; to issue, purchase and sell certificates, notes and written evidences of indebtedness in a manner not inconsistent with the law; to loan money and to carry on business in accordance with the Morris Plan; and in general to do any and all things pertaining to or incident to the transaction of any and all the matters and things aforesaid.
At the beginning and end of the taxable year 1936 petitioner's paid in capital, surplus, and undivided profits, before*890 discovery of or taking into account losses on the transactions with the General Drug & Appliance Co., hereinafter more fully discussed, were shown by its books as follows:
| As of Dec. 31, 1935 | As of Dec. 31, 1936 | |
| Capital | $150,000.00 | $150,000.00 |
| Surplus | 50,000.00 | 50,000.00 |
| Undivided profits | 128,193.99 | 128,654.64 |
During and prior to 1936 petitioner engaged generally in the business of purchasing for investment, at a discount, from others, notes of third persons payable in installments and secured by chattel mortgages on personal property of the makers of such notes. Approximately, three-fourths of petitioner's business came from the purchase of secured notes of this character.
The General Drug & Appliance Co., hereinafter referred to as the Appliance Co., was a Missouri corporation engaged, among other things, in selling radios, refrigerators, and other electrical and household appliances on the time payment plan. In the course of its business the Appliance Co. took notes of purchasers payable in monthly installments, secured by chattel mortgages on the articles sold to the makers of such notes. The Appliance Co. financed its operations by selling*891 such notes and mortgages at a discount, principally to the petitioner.
During 1936, in the ordinary course of business, petitioner acquired from the Appliance Co. instruments purporting to be "monthly payment promissory notes secured by chattel mortgages on articles of merchandise represented by General Drug & Appliance Co. to have been sold by it to the persons whose names appeared on said instruments as the makers of such notes and chattel mortgages, respectively; * * *." All *1192 of said instruments were in the form of combined note with chattel mortgage provisions incorporated therein, and were endorsed and guaranteed at the time of sale by the Appliance Co. in manner and form as follows:
For value received the undersigned hereby sells, assigns and transfers to the
MORRIS PLAN COMPANY OF ST. JOSEPH
all right, title and interest in and to this agreement, the amounts payable hereunder and the property therein described, and warrants that this agreement was given for the purchase of merchandise described herein and delivered to said purchaser and that he has accepted same. (The undersigned further guarantees the payment of all amounts promised herein in accordance*892 with the terms herein together with interest, attorney fees, court costs and other expenses in connection therewith.)
Signed
By
The Appliance Co. first began discounting paper of its customers with petitioner about 1933. In the course of its business with the Appliance Co. petitioner purchased many genuine notes with genuine security, which were ultimately paid out, but during the taxable year it purchased forged instruments from the Appliance Co. having a total face value of $578,832.01, paying therefor the sum of $534,486.38. During 1936 and 1937 repayments or recoveries on these forged instruments amounted to $150,825.99, of which $22,561.44 was reported as income, $16,958.31 in 1936 and $5,603.13 in 1937, and $128,264.55 was considered repayment of petitioner's investments. After April 1937 the remaining investment in these forged instruments, namely $406,221.83, was considered an investment loss.
In the general course of dealings and business relationship between petitioner and the Appliance Co. with respect to the notes so acquired, the latter made collections and periodical remittances or payments to petitioner on the discounted notes. Petitioner did not follow*893 the practice of notifying the makers, or purported makers, of such instruments of petitioner's ownership thereof. In the course of such transactions petitioner followed the uniform practice of notifying the Appliance Co. of defaults in the making of installment payments and did not notify the makers or purported makers of their defaults.
Petitioner kept a separate ledger card for each individual instrument acquired, which shows that date, amount, the household appliance sold, the name of the maker or purported maker, and the amount and date when payments were made. Petitioner credited each account with the amounts reported as paid by the Appliance Co. Some of the forged and fictitious instruments were paid in full, and all others acquired in 1936, except one, were credited with payments.
*1193 Petitioner kept its books and filed its income tax returns on a cash receipts and disbursements basis. Its income tax return for 1936 was filed with the collector on or about March 13, 1937. The return turn showed a normal tax net income of $68,667.15, and a tax liability of $9,140.08, of which $2,285.02 was paid on or before March 15, 1937. When petitioner filed its 1936 return*894 it was unaware of the forged and fictitious nature of any of the instruments purchased from the Appliance Co.
In April 1937 the petitioner discovered, and for the first time became aware of the fact, that many of the notes and mortgages acquired from the Appliance Co. in 1936 were forged and fictitious obligations, bearing signatures of nonexistent persons and describing articles of merchandise never sold by the Appliance Co., which purported articles of merchandise were, in fact, fictitious and nonexistent.
The Appliance Co. was insolvent in April 1937 when petitioner discovered the losses involved in this proceeding. Shortly thereafter it filed a voluntary petition in bankruptcy. Its assets were insufficient to pay preferred claims for taxes due the Federal, state, and local tax authorities and no assets remained from which any recovery of any part of petitioner's losses could be had.
After the discovery of the fraud perpetrated upon it by the Appliance Co. the petitioner on or about June 10, 1937, filed an amended return for 1936 showing no tax due, and a claim for refund of the $2,285.02 paid in March 1937. Thereafter, and in December 1938, petitioner filed an amended*895 claim for refund of the $2,285.02 and a second amended return for 1936. The amended claim for refund asserts that the loss sustained in 1936 resulted from theft by deceit and artifice.
In his deficiency notice respondent states that the "additional tax is due to disallowance of the claim for refund in 1936." The deficiency notice further states that, upon the filing of the amended return for 1936, the remainder of the tax shown on the return as originally filed was abated. Upon further consideration respondent determined that:
There being no evidence that any officer or employee embezzled any of the funds and the General Drug and Appliance Company being placed in the position of a debtor by signing the notes as guarantor, it is recommended that the claims be disallowed and the bad debts appear allowable in 1937 when ascertained to be worthless if all requirements of statute have been complied with.
The petition herein was filed April 6, 1939.
OPINION.
ARNOLD: There is no serious dispute in this proceeding with regard to the principal facts. Petitioner purchased notes secured by chattel *1194 mortgages, which were represented to be genuine but were later discovered*896 to be forgeries. The question we must determine is whether the transactions between the Appliance Co. and petitioner created debts, as contended by respondent, or amounted to a loss in the nature of theft by deceit and artifice, as contended by the petitioner. No contention is made by petitioner that its funds were embezzled.
Respondent concedes that petitioner is entitled to a deduction, but denies that it is so entitled in 1936. It is his theory that the transactions created debts ascertained to be worthless in 1937. Petitioner contends that the transactions amounted to theft of its funds by the misrepresentation and deceit practiced upon it by the Appliance Co. Petitioner denies that it voluntarily extended credit to or accepted the Appliance Co. as a creditor, and contends that the transactions can not be treated as loans because there was no voluntary contractual arrangement. It is urged that the manner and circumstances under which the forged and fictitious notes were sold to petitioner constituted theft or larceny of its funds.
The evidence shows that petitioner had been purchasing the paper of the Appliance Co. since 1933 and that the purchase of such commercial*897 paper constituted about three-fourths of its business. The endorsement on the back of each instrument and the testimony of record convinces us that the transactions between petitioner and the Appliance Co. were not loans but were purchases and sales of commercial paper at a discount. After a transfer of instruments the Appliance Co. was not indebted to petitioner, nor petitioner to the Appliance Co. The latter had sold a secured promissory note payable in installments for a sum less than the face amount of the note. The primary obligor on the note was the maker; the Appliance Co. was liable only in the event of the maker's default. Where valid notes were paid by the makers there was never any liability of the Appliance Co. to the petitioner. Thus the question is reduced to a determination of the rights and liabilities of the parties where the subject matter of the sale was forged and fictitious instruments.
It is stipulated that the Appliance Co. represented to petitioner that the articles of merchandise for which the notes and chattel mortgages were given were sold to persons who purportedly executed the instruments. It is also stipulated that the Appliance Co. represented*898 that the repayments were to be applied to certain designated forged and fictitious notes. The course of dealing between petitioner and the Appliance Co. facilitated the deception and fraud that were practiced upon the petitioner. Failure of petitioner to adopt the practice of notifying the makers of the notes and mortgages played directly into the hands of the Appliance Co. tp perpetrate the fraud. *1195 Notices of default to the Appliance Co. enabled it to pass additional forged and fictitious instruments, or otherwise pay up the overdue installments, and temporarily allay suspicion. In view of the stipulated facts and of the circumstances under which the transactions occurred, the endorsement and guarantee of each instrument formed a part of the scheme to defraud to the petitioner.
Whether the fraud, trickery, and deceit practiced upon petitioner amounted to theft will depend upon the Missouri law. The rule there announced is that, where possession of property is obtained by fraud and trickery with intent to convert it to the use of the wrongdoers, which is thereafter accomplished, a theft or larceny results. *899 ; ; ; ; see also . Possession of petitioner's money was obtained by deceit and trickery consisting of fraudulent representations and the use of forged instruments. Clearly there was an intent by the wrongdoers to convert it; and it seems equally clear that the conversion was accomplished. No title to the money could be found on the forgeries, , nor could the endorsement and guarantee of the instruments by the Appliance Co. in any way validate these instruments. The forging and uttering of the promissory notes and chattel mortgages, and the endorsement and guarantee thereof by the Appliance Co. were all a part of the trickery whereby petitioner was deceived and defrauded of over half a million dollars during 1936.
For the purpose of the present report, exactness in determining the nature of the crime, i.e., whether it be larceny, embezzlement, obtaining money under*900 false pretenses or otherwise, or in naming the guilty party or parties, is of less importance than the character of the deduction. The controlling fact is that petitioner sustained its loss as a result of transactions in 1936 which amounted to theft under the laws of Missouri.
Section 23(f) of the Revenue Act of 1936, under which petitioner claims the deduction, provides that a corporation may deduct losses sustained during the taxable year and not compensated for by insurance or otherwise. The issue was tried upon the question of whether the transactions created debts, or were losses ordinarily characterized as theft by deceit or artifice. The proof shows that the transactions resulted in losses in the nature of theft which occurred in 1936, and are deductible in that year.
Decision will be entered for the petitioner.