*1330 INCOME - FORGIVENESS OF INDEBTEDNESS. - Forgiveness of debts for back rent and accrued interest, held, to have taken place in the taxable year rather than prior thereto; the forgiveness was not a gift; and the resulting tax liability need not be limited to the tax benefit measured in dollars received by the taxpayer in prior years when it claimed deductions on an accrual method for the rent and interest.
*425 The Commissioner determined a deficiency in income tax of $6,339.77 and a deficiency in excess profits tax of $404.31 for the calendar year 1937. The issue is whether or not he erred in adding to income $19,234.21, representing canceled indebtedness.
FINDINGS OF FACT.
The petitioner is a corporation engaged in the business of operating a laboratory where it does prosthetic work for the dental profession. It filed its return for the taxable year with the collector of internal revenue for the first district of Illinois.
The petitioner has occupied space in the Mallers Building in Chicago for a number of years. It negotiated a new lease*1331 in December 1933, at which time the annual rental was reduced from $15,200 to $8,400. There was then due from the petitioner $15,298.99 in back rent. The president of the petitioner notified the renting agent that the petitioner was unable to pay all of that amount and asked for an adjustment. The renting agent said he would make an adjustment, and, in April 1934, advised the petitioner that he would accept $7,500 in payment of the back rent and would cancel the rest. The petitioner paid the rent required under the lease after 1933 and paid $7,500 in addition in 1937 in discharge of the back rent. The $7,500 was paid as follows: $2,500 on February 26, 1937, at which time it also gave two notes each for $2,500; the one note was paid on April 23, 1937; and the other note was paid on June 25, 1937. The first time that the petitioner made any entry on its books to record the cancellation of the back rent was on February 27, 1937, at which time it made an entry showing that back rent in the amount of $7,798.99 had been forgiven.
The petitioner kept its books and made its returns upon an accrual method of accounting. It had regularly accrued its rent on its books and had taken*1332 deductions for that rent on its income tax returns. Those deductions had served to offset income in like amounts.
*426 The Mallers Building Trust, which owned the Mallers Building, credited all payments of rent which it received from the petitioner to the rent account of the petitioner in an open account without applying any particular payment to any particular charge of rent. This account continued without change or interruption at all times material hereto. An entry canceling the back rent in the amount of $7,798.99 was made in that account for the first time in 1937, when the petitioner paid the $7,500 on account of the back rent. The $7,798.99 was then charged to bad and doubtful accounts "To write off the balance of the old account as per agreement." There was then, for the first time since 1933, no balance due in the account.
The petitioner, in November 1936, owed several creditors for merchandise which they had furnished the petitioner over a perion of prior years. The petitioner had been a good customer of these creditors for many years. It had given its interest-bearing notes for the amount which it owed to each creditor. It went to three of these creditors*1333 in November 1936 and asked for cancellation of interest on the notes on the ground that the creditors had made a similar arrangement with their other customers. Three creditors agreed that they would cancel all interest accruing after January 1, 1932. The petitioner claimed a deduction on its income tax return for 1936 for interest due on the notes held by the three creditors above mentioned. The first entry that the petitioner made on its books recording the forgiveness of interest on these notes was made in December 1937, when the following accounts payable were credited with the following amounts representing interest on the notes accruing after January 1, 1932:
| Julius Aderer, Inc | $10,546.06 |
| C. L. Frame Dental Supply Co | 5,314.81 |
| Goldsmith Brothers | 1,086.87 |
The above amounts had been deducted by the petitioner on its income tax returns of previous years as the interest had accrued. Those deductions had offset income on those prior returns to the extent of $11,435.22.
The petitioner had never made any disclosure on its income tax returns showing that the rent and interest above mentioned had been canceled until its return for 1937. It did not report*1334 any of the canceled indebtedness as income on that return or on any other return. The cancellation of the indebtedness is shown for the first time on the return for 1937 under schedule B, "Reconciliation of Net Income and Analysis of Earned Surplus and Undivided Profits", as a credit to earned surplus in the amount of $25,219.65, explained "Forgiveness of debts."
The Commissioner, in determining the deficiency, held that the forgiveness of indebtedness in the amount of $25,219.65 represented *427 taxable income for 1937 to the extent that the items represented in that total had served to offset income in prior returns, and upon that theory he included in income for 1937, $19,234.21, consisting of rent in the amount of $7,798.99 and interest in the amount of $11,435.22.
The debts for the rent and for the interest were forgiven in 1937.
OPINION.
MURDOCK: The petitioner, near the end of his brief, makes what might be construed as an argument that the forgiveness of this rent and this interest was not income. That point has really not been placed in issue in this case, but, in any event, the forgiveness of indebtedness to a solvent debtor is income to the extent that*1335 it frees assets of the debtor from claim. United States v. Kirby Lumber Co.,284 U.S. 1">284 U.S. 1; Lakeland Grocery Co.,36 B.T.A. 289">36 B.T.A. 289. This rule has been applied to the forgiveness of a debt for interest. Consolidated Gas Co. of Pittsburgh,24 B.T.A. 331">24 B.T.A. 331 and 901; United States v. Little War Creek Coal Co., 104 Fed.(2d) 483; Helvering v. Jane Holding Co., 109 Fed.(2d) 933. There was no contention here that the petitioner was insolvent.
The principal contention of the petitioner is that the forgiveness of the debt for the rent and the forgiveness of the debts for the interest occurred in prior years. It contends that the rent was forgiven in 1934 when John B. Mallers, Jr., the renting agent of the Mallers Building, told the president of the petitioner to pay him $7,500 and forget about the rest of the back rent. Although the record contains what might seem to be a verbatim statement of the conversation between the president of the petitioner and Mallers in April 1934, we think that, in fairness to the witness, his statement of the conversation should be regarded as no more than his present*1336 recollection of the substance of the 1934 conversation. Counsel for the respondent apparently thought that the witness' statement of the 1934 conversation left ambiguous the question of whether or not the cancellation of the back rent was conditioned upon and was to await the payment of $7,500. He asked the witness whether or not the forgiveness of the back rent in the amount of $7,798.99 was conditioned upon the payment of the $7,500 and the witness replied in the negative. If this were the only evidence in the record, it would justify a finding that the forgiveness took place in 1934, but there is other evidence which, if it stood alone, would lead to the conclusion that the forgiveness took place in 1937 because it was conditioned upon and was to await the payment of the $7,500. This evidence consists of entries in the books of the petitioner and, particularly, entries in the books of the creditor. Those entries show further that the indebtedness for the back rent was not actually canceled on the books until 1937. Cf. Walker v. Commissioner, 88 Fed.(2d) 170; *428 certiorari denied, *1337 302 U.S. 692">302 U.S. 692. There is thus a conflict in the evidence and the Board must decide which evidence is the more reliable. The conversation took place six and one-half years before the hearing and it is possible that the recollection of the witness is not entirely accurate as to the terms of the agreement. We are unwilling on this state of the record to make the finding essential to the petitioner's argument, that the rent was canceled prior to 1937.
The same witness testified that the creditors to whom interest was owed had agreed unqualifiedly, in November 1936, to cancel all interest accruing on the notes after January 1, 1932. Here again, if his testimony stood alone, a finding that the debts were canceled prior to 1937 would be proper. But there is other evidence which casts serious doubt upon the accuracy of his testimony. The petitioner on its return for 1936, filed in March 1937, claimed a deduction for the interest accruing in 1936 on these same notes. The witness had signed that return and had sworn thereon that he had examined it and found it to be correct. Furthermore, entries on the books of the petitioner recording the cancellation of the interest were*1338 made for the first time in closing the books for 1937 and disclosure that the interest and the rent had been forgiven was made for the first time on the return for 1937. The attention of the witness was called, on cross-examination, to the inconsistency of his testimony as to the rent and interest and entries pertaining thereto on the books and returns. He was unable to reconcile the inconsistency or to give any satisfactory explanation thereof. Here again, the record does not justify a finding which would reverse the determination of the Commissioner that the debts were canceled in 1937. The petitioner next contends that the cancellation of the rent and interest items represented gifts. No evidence was introduced to show a donative intent upon the part of any creditor. The evidence indicates, on the contrary, that the creditors acted for purely business reasons and did not forgive the debts for altruistic reasons or out of pure generosity. In none of the four instances was the forgiveness a gift. Fitch v. Helvering, 70 Fed.(2d) 583; *1339 Reginald Denny,33 B.T.A. 738">33 B.T.A. 738; Rufus S. Cole,42 B.T.A. 1110">42 B.T.A. 1110; Haden Co. v. Commissioner, 118 Fed.(2d) 285.
The Commissioner has included in income only that part of the forgiven debts which served to offset income in prior years. Cf. G. M. Standifer Construction Corporation,30 B.T.A. 184">30 B.T.A. 184; Helvering v. Jane Holding Co., supra;Pittsburgh Brewing Co. v. Commissioner, 107 Fed.(2d) 155. The petitioner does not claim that a larger amount should be included in income, but he makes a contention in his brief that the tax for 1937 can not exceed the actual tax benefit in dollars which the petitioner realized by deducting these items in prior years. This contention is rejected upon authority of *429 Central Loan & Investment Co.,39 B.T.A. 981">39 B.T.A. 981, where a similar argument was made by the Commissioner. See also Estate of William H. Block,39 B.T.A. 338">39 B.T.A. 338, 341, where we said: "When recovery or some other event which is inconsistent with what has been done in the past occurs, adjustment must be made in reporting income for the year in which the*1340 change occurs."
Decision will be entered for the respondent.