*1359 The petitioner exchanged notes costing it $1,500,000 for second mortgage bonds of the value of $900,000, and claims to have thereby sustained a loss of $600,000. Held, such loss is allowable.
*178 The Commissioner determined deficiencies in income tax for the years 1924, 1925, and 1926 in the amounts of $75,412.41, $744.25, and $531.93, respectively. The deficiency for 1924 is, however, the only one now in dispute.
The petitioner contends that in computing its net income for 1924 it is entitled to a deductible loss of $600,000 and that, if in error as to this, it is nevertheless entitled to a deduction in that amount on account of a debt ascertained to be worthless in part and charged off in the taxable year. The respondent disputes both contentions. The parties to this proceeding filed a stipulation of certain facts which is incorporated herein by reference and the material portions of which, and the testimony at the hearing, are in substance, so far as material to the issues herein, set forth in our findings of*1360 fact.
FINDINGS OF FACT.
The petitioner is a national banking association, with its principal place of business in New York City. In 1920 it loaned $1,500,000 to the Atlantic Fruit Co. (hereinafter called Fruit Co.), a corporation with offices in said city, its business then and since being the raising of cane, producing fruits, and manufacturing sugar, in Nicaragua, Cuba, and Jamaica, and transporting and selling such products. No part of the aforesaid indebtedness has ever been paid and interest thereon was paid only to December 31, 1921.
Originally, this indebtedness was evidence by promissory notes, bearing 6 1/2 percent interest, maturing in 1921, when renewal notes were executed, until 1922, in which year the notes were converted into demand notes bearing same rate of interest, and were so carried until July 11, 1924, when the notes were exchanged for bonds of the successor corporation, as hereinafter set forth.
In September 1923 the West India Sugar Finance Co. of Connecticut filed a bill in the United States District Court at Wilmington, Delaware, in the nature of a friendly suit, instrituted for the purpose of placing the Fruit Co. in the hands of a receiver, *1361 following which *179 receivers therefor were appointed. In January 1924 the court ordered a sale of the assets of the Fruit Co. to the reorganization committee of the corporation for $13,000,000, of which sum $5,000,000 was to be paid and was paid in cash; the remainder ($8,000,000) was represented by the assumption of debts of the Fruit Co. in that amount by the reorganization committee. Immediately thereafter the Atlantic Fruit & Sugar Co. (hereinafter called the Sugar Co.) was organized under the laws of the State of Maryland for the purpose of taking over the properties formerly owned by the Fruit Co. and thereafter operating them. In February 1924 the order of the court was carried out and the assets were transferred to the Sugar Co.
In 1923-1924, negotiations were conducted by petitioner and other New York banks with the reorganization committee, and later with the Sugar Co., looking to the satisfaction in whole or in part of their debts against the Fruit Co., aggregating $3,500,000. These negotiations resulted in an agreement reached in the early part of 1924, under which the banks, including petitioner, were to accept second mortgage convertible income 7 percent*1362 bonds of the Sugar Co. in exchange for their notes evidencing debts of the Fruit Co. to them, par for par, i.e., the amount of bonds to be received by each creditor bank was to be equal to the principal of the indebtedness of the Fruit Co. to it. All unpaid interest on the indebtedness of the Fruit Co. to the several banks was to be canceled.
This agreement was carried out by the petitioner company and the other banks concerned. On July 11, 1924, petitioner exchanged its said notes aggregating $1,500,000, and all interest thereon, for bonds of the Sugar Co. of the class specified in the agreement.
During an examination of the petitioner bank by a national bank examiner in August and September 1922, the examiner complained of the action of the bank in carrying the indebtedness of $1,500,000 against the Fruit Co. at its face value, whereupon an arrangement was made by petitioner with the examiner under which petitioner was to create and did thereafter create a reserve of $500,000 to cover any loss that might be sustained on such indebtedness.
The next examination of petitioner bank by the national bank examiner was in October 1923, and in his report thereon he referred to*1363 the $500,000 in special reserve which had been set up as per arrangement made at the time of the former examination to care for any loss on the Fruit Co. indebtedness and stated that the bank asked permission to carry on in this manner until finally settled, as the bank was of the opinion that the loan would be realized in full.
In accordance with directions of the national bank examiner, on December 31, 1924, the following resolution was adopted by the *180 board of directors of the petitioner and journal entries made as herein indicated:
On motion duly seconded the officers were authorized to charge Profit and Loss Account and credit Stocks and Securities with the sum of $600,000, reducing the amount at which the Atlantic Fruit Company bonds are carried from $1,500,000. to $900,000., and to credit Profit and Loss Account and charge Special Reserve with a like sum of $600,000., which amount had previously been carried in Special Reserve on account of the Atlantic Fruit Company Bonds.
The copy of the journal entries of December 31, 1924, made pursuant to the foregoing resolution, were:
| Profit and Loss | Debit $600,000. |
| To conform to requirements of bank examiner and reduce price at which Atlantic Fruit & Sugar Co. bonds are carried. | |
| Other Bonds, Securities, etc | Credit $600,000. |
| To reduce price at which Atlantic Fruit & Sugar Co. bonds are carried - in conformity with requirements of bank examiner. | |
| Special Reserve | Debit $600,000. |
| Balance in this account being credited back to Profit and Loss Account, from which it will be applied to reduce price at which Atlantic Fruit & Sugar Co. bonds are carried - to conform to requirements of bank examiner. | |
| Profit and Loss | Credit $600,000. |
| Balance in Special Reserve. |
*1364 Proper postings were made at once from these journal entries.
No part of such indebtedness ($1,500,000) of the Sugar Co. to petitioner represented by said bonds has ever been paid; nor has any interest ever been paid on such bonds.
In its return for 1924, petitioner deducted from gross income $600,000, the amount of the charge-off of its debt against the Sugar Co. Respondent disallowed the deduction, such disallowance being reflected in the deficiency notice, copy of which is attached hereto and made part hereof. No deduction was claimed on account of the Atlantic Fruit Co. debt in petitioner's income tax returns for any year prior to 1924.
The total assets of the Sugar Co. and its subsidiary companies at December 31, 1924, as shown by their consolidated balance sheet, exceeded $32,000,000, with current assets of more than $5,500,000 and fixed assets, less reserve for depreciation, in excess of $25,000,000. At the close of the year 1924 the Sugar Co. had an income for that year, before allowance for depreciation and interest, of $1,242,758.21, and after payment of all expenses, including interest in the sum of $321,446.83 and provision for depreciation in the amount of*1365 $653,200.56, a net profit of $268,110.82, which, added to the surplus of $1,081,863.21, made a total surplus of $1,349,974.03. The Sugar Co. had an authorized issue of $10,000,000 first mortgage bonds, but *181 on December 31, 1924, only $5,730,000 had been actually issued, of which $3,090,000 were outstanding and the rest were in the treasury and were subsequently used as a security for collateral loans. At that date there were outstanding second mortgage 7 percent income bonds in the amount of $3,500,000, of which petitioner held $1,500,000. No interest was ever paid on the second mortgage bonds nor on Sugar Co. debentures amounting to $5,647,500.
Prior to December 1924 the petitioner made investigation of the affairs of the Fruit Co. relative to its business and prospects and also made a study of the sugar business itself. Through certain of its officers and directors (one of its directors being also a director of the petitioner), it kept in touch with the operations of the Fruit Co. The large indebtedness of the Fruit Co. to the petitioner, having been criticized, was of constant concern to petitioner and the affairs of the Fruit Co. were discussed by the petitioner*1366 with other banking institutions similarly interested as the petitioner and efforts were made, but without success, to induce two companies engaged in a similar line of business as the Fruit Co. to become interested in a merger with it or a purchase of it. In July 1924 the exchange of notes receivable of the Fruit Co. for bonds of the Sugar Co. was effected and in December following, after the exchange of the Fruit Co. notes for the bonds of the Sugar Co., the board of directors of the petitioner determined that the bonds of the Sugar Co., representing and considered of equal value as the note indebtedness for which exchanged, were worth only $900,000 and that the bank examiner was correct in his estimate of their value and thereupon the resolution of December 31, 1924 (heretofore set out), was adopted and journal entries made as stated. Such determination of the board of directors was based upon the statement of the company, its prospects, securities prior to those held by petitioner, amount of business done, and the balance sheets of the Fruit Co. for the years 1921 and 1922, there being none for 1923, as the company was then in the hands of receivers. The balance sheet of the*1367 Sugar Co. for 1924, which showed a net profit of $268,110.82, was not then available.
There were no sales in 1924 of either the first or second mortgage bonds described above and no fair market value could be determined thereby. The fair market value of the second mortgage bonds as of July and December 1924 was not more than $900,000, and the notes exchanged for the bonds on July 11, 1924, were then of the same value as the bonds for which exchanged. The Fruit Co. had large losses in 1921 and 1922 and the Sugar Co., its successor, sustained losses after 1924 approximately as follows: In 1925, $531,000; 1926, $221,000; 1927, $27,000; 1928, $1,412,000; 1929, $821,000; 1930, $1,945,000. No statement for the year 1931 was prepared, but evidence indicates the losses were very heavy.
*182 In 1931 a petition for dissolution of the Sugar Co. on the grounds of bankruptcy was filed in Baltimore, Maryland, a receiver being appointed and the assets of the company turned over to him. The record shows the assets of the company were not very valuable when they were turned over to the receiver, there being then slightly more than one hundred dollars in cash, outstanding accounts receivable*1368 less than $30,000, and a contract with the Munson Steamship Co. valued at $61,000. The fruit properties had been operated until July 1931, but the losses had been so enormous that arrangements were made to dispose of the Jamaica properties and the fruit properties in Cuba, which were separate from the sugar property, and they were turned over to the Standard Fruit & Steamship Co. The Jamaica properties were sold to pay certain bonds thereon and the Cuban fruit property was leased at a nominal rental for a period of 25 years. The Sugar Co. ceased its fruit and steamship operations in July 1931. The Cuban properties were finally sold for $50,000. The outstanding debts of the Sugar Co. amount to over twenty million dollars, and the Nicaraguan property is of very little value.
OPINION.
SEAWELL: In this proceeding the petitioner contends that in computing its income tax liability for the year 1924 it is entitled to a deduction of $600,000, being the alleged difference between the cost to it of the notes of the Fruit Co. which it held and the fair market value of the second mortgage bonds of the Sugar Co. when received in exchange therefor.
The transaction by which the notes*1369 of the Fruit Co., executed by it and delivered to petitioner for the $1,500,000 loan made it, were exchanged for the second mortgage bonds of the Sugar Co., was one which might give rise to gain or loss, depending upon the circumstances under which made. A provision of the Revenue Act of 1924 applicable in the instant proceeding is as follows:
SEC. 202. (c) The amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received.
Section 203(b)(1) of the act would be applicable to the transaction were it not excluded by the parenthetical portion of the section.
The only consideration that was received by the petitioner on July 11, 1924, in exchange for its notes of the Fruit Co. was the $1,500,000 second mortgage bonds of the Sugar Co.
The record shows that about August or September 1922 a national bank examiner criticized the action of the petitioner in carrying the indebtedness represented by notes in the amount of $1,500,000 against *183 the Fruit Co. at their face value and arrangement was thereupon made for a reserve of $500,000 to cover any loss that might*1370 result from such indebtedness and the same was so carried for quite a while, the petitioner being of the opinion that the loan or indebtedness would be realized in full.
The record shows that the resolution of December 31, 1924, which was adopted by the board of directors of the petitioner, was passed "in accordance with the directions of the National Bank Examiner." We have often, heretofore, held and now repeat that orders of a bank examiner to write assets off the books are not sufficient in themselves to warrant the allowance of such as deductions. ; ; ; .
In this proceeding, in our opinion, the record shows that while the resolution adopted by the board of directors on December 31, 1924, authorizing the officers to reduce "the amount at which the Atlantic Fruit Company bonds [evidently meaning the "Atlantic Fruit & Sugar Co." bonds, representing the debt due petitioner] are carried from $1,500,000 to $900,000" was "in accordance with directions*1371 of the National Bank Examiner," the action taken and resolution passed were not based solely on such directions, but were, after investigation and ascertainment that the bonds were not worth over 60 percent of their par value, partly based on such fact. That the bonds on December 31, 1924, and on July 11, 1924, when exchanged for notes of the Fruit Co. in the same amount, were worthless to the extent of $600,000 or 40 percent of their par value and had a fair market value of not over 60 percent of their par value, is shown by the record. In our opinion, the evidence shows that the bonds and the notes for which exchanged were at the time of exchange of the same value.
We are of the opinion and hold that the Sugar Co. bonds are shown by the record to have been worth only 60 percent of their par value or $900,000 in 1924 when received, and the notes given in exchange for the bonds having cost the petitioner $1,500,000, the petitioner is entitled, in computing its net income for 1924, to a deduction of 40 percent of the cost of its Fruit Co. notes or the amount of $600,000, as claimed by it.
In view of our determination, there is no occasion for discussing the alternative claim*1372 of petitioner relative to the charge-off in 1924 of a debt, ascertained to be worthless to the extent of $600,000.
Reviewed by the Board.
Judgment will be entered under Rule 50.
VAN FOSSAN and ADAMS dissent.