*116 Decision will be entered for the respondent.
In 1946, upon receipt of additional capital stock therefor, petitioner voluntarily canceled $ 650,000 of alleged indebtedness owed to it by its two wholly owned subsidiaries. Book adjustments were made reflecting the discharge of indebtedness and the increase in capital investment. The purpose of the debt cancellation was to enable the subsidiaries to obtain needed bank loans. Petitioner made advances to both subsidiaries after the cancellation. Such subsequent advances were repaid in full, and both subsidiaries continued to prosper. On an amended return for 1946 and by amended petition in this proceeding, petitioner claimed a bad debt deduction for the amount of the debts canceled.
Held, the voluntary cancellation of indebtedness was an additional capital contribution by petitioner to its two subsidiaries, and no deduction is allowable for a bad debt loss, in whole or in part, or for a business loss or business expense.
*1152 This proceeding involves deficiencies in taxes*117 as follows:
| Year | Tax | Amount |
| 1944 | Income | -0- |
| Excess profits | $ 573,646.89 | |
| 1945 | Income | 8.01 |
| Excess profits | 79,785.37 | |
| 1946 | Income | 248.90 |
The issues to be determined are: (1) Whether petitioner is entitled to a deduction of $ 650,000 or some part thereof, in the year 1946, for alleged bad debts which became worthless or partially worthless or for a business loss or expense, when the amount so claimed arose from the cancellation of purported loans and advances made by petitioner to its two wholly owned subsidiaries; and (2) if so, whether in computing net operating losses for 1946 and 1947 and resulting carry-backs to 1944 and 1945, petitioner is entitled to include, under section 122 (d) *1153 (6) of the Internal Revenue Code of 1939, excess profits taxes for 1945 which were paid in 1946 and 1947; and (3) whether petitioner, in computing the amount of a net operating loss carry-back from 1946 to the taxable year 1945, is entitled to reduce the 1944 net income by the amount of excess profits tax liability shown on its 1944 return, under the provisions of section 122 (b) (1) (A) of the 1939 Code.
Some of the facts were stipulated.
FINDINGS OF FACT.
The stipulated facts*118 are so found and are incorporated herein by this reference.
Lidgerwood Manufacturing Company (hereinafter referred to as Lidgerwood or the petitioner) is a New York corporation with principal offices in New York City, New York. It maintained its books and records and filed its Federal tax returns on the accrual method of accounting for the calendar years 1944, 1945, and 1946.
Separate income and excess profits tax returns for 1944 and 1945 were filed with the collector of internal revenue for the fifth district of New Jersey. A separate return and amended return for 1946 were filed with the collector for the second district of New York.
During the years in question, Lidgerwood manufactured hoisting machinery and marine auxiliaries, such as steering gears, windlasses, and deck machinery. Its principal plant was at Elizabeth, New Jersey. Its capital stock was wholly owned by one Louis D. Tenerelli.
On November 2, 1940, Lidgerwood acquired, and held during the years in question, all of the outstanding common stock of the Superior Iron Works Company (hereinafter referred to as Superior), a Wisconsin corporation located at Superior, Wisconsin.
On July 31, 1945, Lidgerwood acquired, *119 and thereafter held, all of the outstanding common stock of the Dutchess Tool Company, Inc. (hereinafter referred to as Dutchess), a New York corporation located at Beacon, New York. On September 10, 1945, the corporation's name was changed to Dutchess Bakers' Machinery Company, Inc.
Prior to World War II, Dutchess had manufactured bakers' machinery. During the war, it manufactured telemotors, used to actuate the steering mechanisms on ships. During the war, Superior and Lidgerwood manufactured materiel similar to that which they normally manufactured.
Dutchess required extensive retooling after the war in order to resume the manufacture of bakers' machinery. While the retooling was in progress during the latter part of 1945 and in 1946, the officers of Lidgerwood decided that Dutchess should manufacture 3 new products: A vibrating hair brush, an electric heater, and an air-purifying machine. Separate subsidiary corporations, owned by *1154 Dutchess, were organized to develop each product. Lidgerwood advanced money to Dutchess to help in the development of the 3 products. Each product, however, proved to be a failure.
On May 27, 1946, Lidgerwood's books showed a balance*120 due from Dutchess of $ 136,224.44. The principal amount of such indebtedness resulted from advances for the development of the hair brush, which by that time had proved a failure. Dutchess offered to issue 1,250 shares of its common stock to Lidgerwood if petitioner would cancel $ 100,000 of the indebtedness due it. Lidgerwood agreed. Its books thereafter reflected an increase in its investment in Dutchess of $ 100,000 and a corresponding reduction of the amount due from Dutchess. Dutchess' books reflected similar account adjustments by increases in the amount of outstanding capital stock and reduction of accounts payable.
Lidgerwood continued to advance money to Dutchess. On August 31, 1946, its books showed indebtedness due from Dutchess of $ 106,218.62. A substantial part of such amount resulted from advances by Lidgerwood to aid in the development of the electric heater, which by that time had proved to be a failure. Dutchess offered to issue 1,000 shares of its common stock to Lidgerwood if petitioner would cancel $ 50,000 of the indebtedness due it. Lidgerwood agreed, and appropriate adjustments were made to reflect the cancellation of that part of the debt and the *121 corresponding issuance of stock.
Lidgerwood continued to make advances to Dutchess. On October 31, 1946, its books showed indebtedness due from Dutchess of $ 271,072.41. A substantial part of such sum resulted from advances for the development of the air-purifying machine, which by that time had also proved to be a failure. Dutchess offered to issue 2,750 shares of its common stock to Lidgerwood if petitioner would cancel $ 200,000 of the indebtedness due it. Lidgerwood agreed, and appropriate book adjustments were made to reflect the debt cancellation and stock issuance.
Lidgerwood thereafter continued to advance substantial amounts of money to Dutchess.
As part of its postwar plans, Lidgerwood decided that Superior should undertake the manufacture and sale of bituminous coal-burning stokers. The program was begun in 1945. Superior contracted with Westinghouse Electric and Manufacturing Company for the electric motors for its stokers. Early in January 1946, employees of Westinghouse went on strike and production at its plants was not resumed until late in the spring. Superior was unable to get motors from any other source. Shortly after the end of the Westinghouse strike, *122 the United Mine Workers went on strike. General public doubt as to the availability of coal resulted in the cancellation of many orders for stokers. Because of the 2 strikes and the delayed production caused thereby, *1155 Superior's stoker program proved to be a failure by the fall of 1946. Lidgerwood advanced substantial sums to Superior; and, on October 30, 1946, Superior owed Lidgerwood $ 411,722.85.
Early in 1946, it became apparent to Lidgerwood that its cash position and that of its subsidiaries was very tight, principally because of some $ 900,000 of Federal tax and renegotiation liabilities. Repeated efforts were made in behalf of Dutchess and Superior to secure loans from banks or insurance companies. Those efforts failed, always because of the large amount of indebtedness which the 2 subsidiaries owed to Lidgerwood. Banks suggested that loans might be made if Lidgerwood would agree to subordinate its own indebtedness to the bank loans proposed.
Because of the need for cash, Lidgerwood decided to sell its own plant, and to operate thereafter through Superior and Dutchess. On July 17, 1946, it contracted with The Trailmobile Company for the sale of its plant for*123 $ 700,000. Lidgerwood agreed to vacate the premises by November 1, 1946. From July 17 to October 31, 1946, Lidgerwood shipped to Superior machinery and equipment of various kinds, having a depreciated value of $ 166,645.94. That amount was reflected on the books of Superior and Lidgerwood as loans and advances payable and receivable, respectively. During the same period, Lidgerwood made two $ 25,000 advances to Superior. A substantial part of such sums was used by Superior to pay freight and other costs incident to the shipment of the machinery and equipment. Lidgerwood also transferred machinery having a net book value of $ 15,074.08 to Dutchess during this period. This transfer was also recorded as a loan payable to Lidgerwood on the books of Dutchess.
Lidgerwood, at the time its plant was sold, had some $ 682,107.63 of incompleted contracts. These were transferred to Superior and Dutchess for completion.
The large inventories which had been built up during the development of products which proved to be a failure were also a factor responsible for the inability of Superior and Dutchess to obtain bank loans prior to October 31, 1946.
In addition to the cancellation of $ 200,000*124 of indebtedness of Dutchess on October 31, 1946, Lidgerwood also on that date canceled $ 300,000 of the total amount of $ 411,722.85 owed to it by Superior and received 3,500 shares of Superior's common stock. The books of the 2 companies reflected the reduction in open accounts and increase in capital stock investment.
The balance sheets of Superior and Dutchess thereafter reflected the reduced indebtedness which the 2 companies owed to Lidgerwood, and bank loans were obtained. Lidgerwood also continued to advance money to the 2 companies, which was repaid. Both companies continued to prosper after October 31, 1946.
*1156 On its income tax return for 1946, filed on June 16, 1947, Lidgerwood reported net income of $ 168,952.34. It also showed an increase of $ 647,744 during the year in the amount invested in subsidiaries. It claimed no deduction for bad debts or losses. In an amended return, filed on September 21, 1948, it reported a net loss for 1946 of $ 346,401.72. In a rider to the amended return, it claimed a loss due to cancellation of indebtedness as follows:
| Superior Iron Works Company | $ 65,354.06 |
| Dutchess Bakers' Machinery Co., Inc | 350,000.00 |
The respondent*125 disallowed such deductions for bad debts in determining the deficiencies herein. By amended petition, petitioner alleged that the amount which should be allowed it for a bad debt deduction in 1946 is $ 650,000.
Petitioner made a capital contribution in the amount of $ 300,000 to Superior in 1946 and of $ 350,000 to Dutchess in that year.
OPINION.
The petitioner introduced extensive evidence into the record with reference to the history of the corporation, detailed descriptions of the 3 new products manufactured by Dutchess, and to the stoker program of Superior. It also introduced evidence to support its allegation that the 2 subsidiaries were insolvent and unable to pay the indebtedness canceled. Petitioner requested that we make a number of specific findings of fact on those and other matters.
We have carefully reviewed all of the documentary evidence presented as well as the testimony of the petitioner's witnesses. Many requested findings have been omitted, for, while interesting, many of those facts and other items of information are extraneous and irrelevant; and their inclusion would only serve to obscure the significance of those facts which we have found and which are *126 necessary to the decision of the question presented.
Petitioner has attempted to show that the $ 650,000 of indebtedness owed to it by Superior and Dutchess was a totally worthless and uncollectible bad debt which it canceled in 1946 and argues that it is entitled to an appropriate deduction therefor. As an alternative argument, it has attempted to show that a part of the amount canceled was a partially worthless bad debt, a business loss, or a business expense.
Obviously, a "loss," in the generic sense, cannot be both a "bad debt" and a "business loss." . But the petitioner is not precluded from arguing both theories in the hope of showing the applicability of one of them to the facts presented.
In support of his determination that no part of the amount canceled should be allowed as a bad debt or loss, respondent argues: (1) That *1157 the advances by petitioner were capital contributions to Superior and Dutchess when made; (2) assuming the advances to be loans, they were not proved to be worthless; and (3) if the advances were loans when made, they became capital contributions when*127 they were canceled and stock of the subsidiaries issued therefor.
On the basis of the record before us, we think that considerable support could be found for respondent's first two arguments. We pass them, however, because his third argument presents a complete bar to petitioner's deduction of the canceled indebtedness on any of the theories it has advanced.
Assuming the advances to be loans when made, which petitioner expected to be fully repaid, and assuming also that the sums due were uncollectible when canceled, the petitioner's voluntary cancellation of the "debts" converted them into a capital contribution. (C. A. 2, 1934); (C. A. 8, 1934), certiorari denied , affirming ; (C. A. 2, 1918); ; .*128 Gratuitous forgiveness of a debt is no ground for a claim of worthlessness. , affd. (C. A. 2, 1947); (C. A. 5, 1948); .
The Auto Strop Safety Razor Co. case, of course, concerns the converse of the problem presented here, viz, the tax consequences of cancellation of indebtedness to the debtor. It is impossible for us to see, however, how the consequences to the debtor and the creditor can differ. In either instance it is the voluntary act of the creditor-stockholder which determines the character of the transaction.
The cancellation of the debt is not income to the debtor corporation; it increases the paid-in capital of the debtor and correspondingly increases the basis of the creditor-stockholder's shares. Loss, if any is eventually realized, occurs at the time such shares are sold or become totally worthless.
We are satisfied that the only purpose which motivated petitioner's voluntary cancellation of the indebtedness*129 was the desire to secure additional loans from banks. Certainly every book entry was made, as well as actual stock certificates issued, to reflect the cancellation in every possible way as a voluntary contribution to capital.
Petitioner's owner, Louis Tenerelli, testified that the advances of money to both companies and the value of the machinery transferred were transactions which, when made, created debts and that petitioner always expected to be repaid in full. He also testified that petitioner was loath to cancel the "debts," but that he and its officers "went to the *1158 limit of our capacity in trying to save [Superior and Dutchess]" and that without such drastic action, all of the companies would have failed.
Be that as it may, it does not alter the fact that the voluntary cancellation by petitioner, no matter how reluctantly made, converted previous loans into additional capital investments by it in the 2 companies.
Our determination of the first issue raised in this proceeding makes unnecessary our consideration of the other two issues raised.
We granted petitioner's motion of May 25, 1954, to file an amendment to its second amended petition. Such amendment alleged*130 that:
should the Court sustain the Commissioner by determining that there was no net operating loss in the year 1946 and that there was net income in 1946, then the Commissioner erred by failing to allow a net operating loss deduction in the year 1946 in the sum of $ 2,307.74, being the agreed amount of the net operating loss incurred by the petitioner in the year 1948.
Respondent denied such allegation. No evidence was offered by petitioner to substantiate a 1948 net operating loss carry-back, and no deduction therefor from 1946 income will be allowed.
Decision will be entered for the respondent.