*829 DEDUCTION FOR PARTIAL WORTHLESSNESS OF BONDS DISALLOWED. - Evidence that in the taxable year a railroad was placed in receivership, that its revenues were declining, and that its bonds were quoted at a low figure is insufficient to establish partial worthlessness of bonds of the railroad in the face of the Commissioner's determination otherwise and evidence that the railroad was receiving substantial revenues, that it had a substantial surplus, that the bonds were secured by mortgages on the entire property of the railroad which was valued far in excess of bond liability, and that the bonds were further secured by a pledge of a substantial amount of collateral.
*796 These are proceedings for the redetermination of deficiencies in income tax for 1932 in the amounts of $1,298.93 in Docket No. 79853 and $893.98 in Docket No. 79854. Upon waiver of one issue in Docket No. 79853, there remains in each case the single issue of whether respondent erred in disallowing a claimed bad debt deduction on St. Louis-San Francisco Railway Co. bonds. The*830 facts were stipulated.
FINDINGS OF FACT.
The petitioners are residents of Massachusetts, and prior to March 15, 1933, each filed her income tax return for 1932 with the collector at Boston.
In 1932 each petitioner was the owner of $10,000 face value of St. Louis-San Francisco Railway Co. prior lien gold 5 percent bonds, series B, due in 1950. The bonds were acquired by the petitioners by gift, and their basis in the hands of each was $7,400. In the returns filed for 1932 each petitioner claimed a deduction of $5,400 as a deduction for partial worthlessness of the bonds. The returns were filed on the cash basis; neither petitioner kept books.
The total of authorized prior lien bonds of the railway is $250,000,000, of which $183,445,400 is outstanding. At December 31, 1932, there was outstanding $25,561,500 par value of the issue here involved, namely, prior lien 5 percent gold bonds, series B, due 1950. Each series, including series B, is secured equally by mortgage or collateral lien on the railway company's entire property, which includes 5,080.04 miles of single track, 140.38 miles of double track, branches, extensions, etc., 87.76 miles of trackage rights, and a*831 lease- *797 hold interest in 11.20 miles additional. Stocks and bonds of affiliated companies to a face amount of about $46,000,000 are pledged as collateral against the prior lien bonds.
In or about November 1932, upon the filing of a suit against the railway by a creditor, the railway joined in the suit and asked the appointment of a receiver. The petition was granted and a receiver was appointed. The petition contained the following allegations:
It [the railway company] now has become greatly embarrassed financially. Its cash resources have been reduced, its borrowing power restricted and it has neither money nor ability to borrow funds necessary to meet maturing obligations in the immediate future.
Although the properties and assets as their fair value are greatly in excess of liabilities, yet at present the company is unable to pay its obligations as they mature.
In a report on the receivership proceeding the Commercial and Financial Chronicle said:
The suit averred on information and belief that the gross income of the Frisco and its subsidiaries from operation and all other sources was $10,211.785 during 1931, or $8,347,711 below the 1930 income, and*832 that interest amounted to $13,330,491.
Estimated gross revenues for 1932 were given as $43,500,000, as compared with gross revenues of $57,000,000 in 1931.
The railway company was placed in bankruptcy on May 17, 1933, upon its petition stating that it was unable to meet its obligations.
Railway operating revenues for the years 1931 to 1936 and profit and loss balances at the close of each of those years were as follows:
| Year | Operating revenues | Profit and loss balances |
| 1931 | $54,426,916 | $16,015,473 |
| 1932 | 40,712,215 | 4,694,448 |
| 1933 | 38,731,160 | -7,786,021 |
| 1934 | $40,043,864 | $20,759,645 |
| 1935 | 40,545,500 | -34,215,729 |
| 1936 | 47,981,639 | -41,318,237 |
The railway company's assets and liabilities at the close of 1931 and 1932 were as follows:
| December 31, 1931 | December 31, 1932 | |
| ASSETS | ||
| Road and equipment | $428,472,857 | $421,649,580 |
| Investments in affiliated companies | 31,222,617 | 33,211,318 |
| Other investments | 11,622,549 | 11,629,099 |
| Deposits in lieu of mortgage property sold | 15,623 | 6,927 |
| Miscellaneous physical property | 292,482 | 234,535 |
| Current assets | 13,665,863 | 8,596,987 |
| Deferred charges and unadjusted debts | 1,943,277 | 2,142,550 |
| Total | 487,235,268 | 477,470,996 |
| LIABILITIES AND NET WORTH | ||
| Preferred stock | 49,158,300 | 49,158,300 |
| Common stock | 65,543,226 | 65,543,226 |
| Funded debt | 293,760,767 | 289,125,767 |
| Current liabilities | 17,966,417 | 24,522,466 |
| Depreciation reserves | 38,614,097 | 38,969,198 |
| Tax liability, etc | 5,020,698 | 4,400,046 |
| Appropriated surplus | 1,043,704 | 1,057,545 |
| Profit and loss - balance | 16,128,059 | 4,694,448 |
| Total | 487,235,268 | 477,470,996 |
*833 *798 Interest due on the series B bonds on January 1, 1933, was defaulted and all subsequent interest payment have been defaulted.
During the years 1930 to 1937, inclusive, the price range of the series B bonds on the New York Stock Exchange was as follows:
| Year | High | Low |
| 1930 | 104 1/4 | 92 |
| 1931 | 102 | 25 |
| 1932 | 42 | 7 3/4 |
| 1933 | 33 | 10 |
| 1934 | 30 | 12 |
| 1935 | 18 1/2 | 9 3/4 |
| 1936 | 34 1/2 | 17 1/4 |
| 1937 (to July 30) | 36 1/4 | 22 |
On December 31, 1932, the series B bonds were quoted on the New York Stock Exchange at 9.
OPINION.
ARUNDELL: The claim of these cases for a partial worthlessness deduction is made under that part of section 23(j) of the Revenue Act of 1932, which authorizes the Commissioner to allow a deduction of less than the whole amount of a debt "when satisfied that a debt is recoverable only in part * * *."
The Commissioner's regulations have long provided for deductions for entire or partial worthlessness of bonds where the owner ascertains that upon maturity he will recover none or only a part of the debt evidenced by the bonds. The same regulations have also provided that no deduction may be taken merely on account of market fluctuation. *834 Art. 154, Regulations 62, 65, 69; art. 194, Regulations 74, 77. We have followed the same rules and have refused to allow bad debt deductions based on nothing more than fluctuations in value. "Market fluctuation * * * is an unsafe criterion for determining the reasonableness of an addition to a reserve for bad debts * * *." . "Admission of a decline in value of securities prior to maturity by no means implies an admission as to the obligor's ultimate condition or that its obligations will not be paid or paid only in part upon maturity." ; affd., . In the latter case we quoted the Commissioner's regulations, art. 194, Regulations 74, and held that the requirements thereof must be met by the taxpayer. On the other hand, where the evidence satisfactorily establishes "that the debts were, at least to the extent of the charge-off, beyond recovery", we have allowed a deduction for partial worthlessness. *835 . In that case the bonds with respect to which we allowed a deduction were in default, the debtors were in receivership, and a national bank examiner directed that they be written down on the books of the bank.
*799 The question here, as in other bad debt cases, must be decided upon examination of the facts to determine to what extent there is an ascertainment of worthlessness, or, to use the view of the regulations, to what extent the taxpayer will recover upon maturity of the bonds. This question can not, as pointed out above, be solved solely by reference to fluctuation in market prices. Included in the stipulated facts in this case are profit and loss statements and balance sheets for the years 1931 to 1936, inclusive. Upon examination of these we find that while there was a drop in railway operating revenues from $54,426,916 in 1931 to $40,712,215 in 1932, nevertheless at the end of 1932 the railway company had a profit and loss balance of $4,694,448. Its balance sheet carries the same item, $4,694,448, which we construe as being the same as surplus in the balance sheets of manufacturing or merchandising*836 concerns. In determining the status of the bonds there must be added to the surplus the amount set aside for capital stock liability, which in round figures is $114,000,000. These facts alone give a surplus in excess of $118,000,000 to secure the outstanding prior lien bonds of $183,445,400. Moreover, it is stipulated that the entire issue of prior lien bonds is secured equally by mortgage or collateral lien on the railway's "entire property." The road and equipment alone are valued in the balance sheets at over $420,000,000. In addition the bonds are secured by $46,000,000 face value of stocks and bonds of affiliated companies. With these assets securing the bonds, we are of the opinion that there could have been no determination by the petitioners in 1932 that they would recover only $200 per $1,000 face value of their bonds.
Counsel for petitioners makes some argument based on liquidating value of the railway company's assets. This is purely argument, unsupported by facts. There is no evidence as to what the balance sheet values were based on. Assuming that they are going concern values, it was part of petitioners' case to prove any other values on which the decision*837 should rest. This they did not do.
Based on the stipulated facts showing the amount of bonds outstanding, the security for the bonds, and the income and general financial condition of the debtor, we hold that the petitioners have not established that a determination could have been made in 1932 that only a part of the debts evidenced by the bonds would be recovered at maturity. Consequently, we affirm the respondent.
Reviewed by the Board.
Decision will be entered for the respondent.
STERNHAGEN, dissenting: These proceedings have been submitted upon a stipulation, and there is therefore no room for dispute as to the primary or evidentiary facts. The only question is whether they *800 reasonably support a finding that the debt covered by the railroad's bonds was recoverable only in part. If they do, the finding should not be withheld through any fear that unforeseen events or possible economic conditions may perchance bring about a complete recovery of the debt at its maturity in 1950.
It seems to me clear from the evidence that at the end of the taxable year no one could reasonably doubt that the debt would not be entirely paid. Earnings*838 had been steadily diminishing, interest was defaulted, and a receiver had been appointed at the behest of a creditor. The petition for receiver averred that the interest ($13,330,491) exceeded the gross operating income ($10,211,785). There is not the slightest indication in the stipulation that conditions would improve or that the prospect for complete recovery in 1950 would become any brighter. Certainly no one in the open market was optimistic enough to appraise the chances as very good. Why then should the Board refuse to recognize what the market so realistically reflects? I do not mean to stand for the idea that fluctuations in market value of bonds are to be taken as gauges of the extent of recoverability or as measures of the statutory deductions. That idea was rejected in . But when the other evidence indicates that the debt is recoverable only in part, the market prices may help to give realistic assurance that the taxpayer's best judgment of the future is not too lugubrious.
This, I thought, is what the full Board had decided in *839 There the taxpayer's officers weighed the extent of recoverability of some railroad and other bonded debts, "which in 1931 were in default as to interest, and the debtor was, as to each, in receivership", concluded they were recoverable only in part, and wrote off and deducted the remainder of $26,050. The charge-off was made before the bank examiner had appeared and entirely on the taxpayer's own initiative. The evidence of nonrecoverability was quantitatively less and was no more convincing than this, and upon such evidence it was, after full Board review, held that the deductions were proper. In that case there was another point - a further charge-off upon the mere direction of a national bank examiner the Board held was not within the statute; but that was because it was thought that a categorical direction of a bank examiner based only upon a drop in market value was not sufficient to satisfy the revenue act. The $26,050 deduction was not affected by the bank examiner's direction but was supported by default and receivership. So that decision seems to me to be a complete precedent for a deduction here, and there*840 is no reason to discriminate between a national bank acting upon the judgment of its officers and an individual acting upon his own *801 judgment. Both must be tested by the evidence of record, and I think the evidence here supports the taxpayer's judgment no less than did the evidence there. Either that decision should be overruled (although it was not appealed, and the Commissioner acquiesced in it, % c.b. xv/-2, p. 21), or this decision should follow it. They can not consistently stand together.
As to the quantum of recoverability, it seems to me the taxpayer was well this side of the doubtful area when she adopted 20 as the recoverable part and treated only the excess above this as the non-recoverable part which she might properly deduct.
MELLOTT agrees with this dissent.