*1317 1. In computing deductions for alleged bad debts in 1920 petitioner charged off not only the debts ascertained to be worthless, but an additional sum sufficient to make up the difference between its sales and collections thereon. Held, such method was erroneous, and respondent properly disallowed such additional sum as a bad debt deduction.
2. Held, further, that collections in 1920 on accounts similarly charged off in 1919 should be included in income for 1920 and that respondent properly reduced invested capital for 1920 by reason of such deductions claimed and allowed for 1919.
*409 The respondent disallowed a portion of the bad debt deduction claimed by petitioner in its 1920 return and determined a deficiency of $198,312.04. A part of the deficiency appears to be due to adjustments other than the bad debt item, but such other adjustments are not in issue.
Petitioner alleges that respondent erroneously disallowed the deduction claimed, and, in the alternative, that if the*1318 disallowance was proper, then similar items were erroneously charged off and deducted from income in 1919 and recoveries thereon in 1920 should not be included iv income and that respondent erroneously reduced 1920 invested capital on account of such similar items.
*410 FINDINGS OF FACT.
Petitioner is a New York corporation, engaged in operating a chain of retail clothing stores. In 1919 and 1920 it operated thirty-odd stores, selling clothing for the most part on the installment plan to people of small means.
A customer making a purchase at any of petitioner's stores was required to make a down payment, the balance being payable in weekly installments over a period of some months. For each customer an account card was made out in the main office in New York showing the amount of each purchase, the payments made, and the balance. The information from which postings were made to the cards was supplied in daily reports sent in by the various stores.
Customers' account cards are carried in two files for each store. One, called the "active file" contains the accounts on which payments are current or on which the default, if any, is of less than sixty days duration. *1319 The other, called the "delinquent file" contains the cards of customers who are sixty days or more delinquent in their payments. The cards in the two files number from 70,000 to 75,000 at any one time.
For the year 1920 and several years prior thereto petitioner charged off as bad debts the unpaid balances shown on the cards in the delinquent file at the close of the year. In addition to that amount petitioner charged off and claimed as a deduction an amount which, added to the delinquent balances, approximated the difference between sales for the year and the collections on the sales.
In its return for 1919 petitioner claimed as a bad debt deduction the amount of $621,176.47. The total of the amounts unpaid in the delinquent file at the close of the year was $311,092.85. The balance, $310,083.62, was charged off the cards in the active file. Respondent allowed the amount of $621,176.47 as a bad debt deduction.
In its return for 1920 petitioner claimed as a bad debt deduction the amount of $655,800.32. Of this amount $374,923.84 was made up of unpaid balances in the delinquent file and $280,876.48 was charged off the active accounts. For 1920 sales amounted to $3,624,958.87*1320 and cash received within the year on such sales amounted to $2,973,002.79. The difference between these two amounts - with an adjustment of $3,844.24 representing bad debts of a store closed during the year - is $655,800.32, which is the amount deducted in petitioner's return. Of the deduction claimed for 1920, respondent disallowed $279,240.68 as representing the amounts charged off from petitioner's active file, which amounts respondent held were not ascertained to be worthless.
The amounts charged off from the active file were vot ascertained to be worthless in the year in which they were charged off. The *411 method of handling these charge-offs was to stamp active cards with the words "charged off," followed by figures representing a date near the close of the year. In many cases payments were made within a few days of the charge-off. In all cases payments had been made less than sixty days prior to the charge-off. The cards so stamped were not removed from the active file.
In each year petitioner included in income the collections made on accounts previously written off. In 1920 petitioner collected a total of $308,504.35 on the accounts charged off in the*1321 years 1917 to 1919, inclusive, as follows:
| 1917 | $5,459.24 |
| 1918 | 13,354.89 |
| 1919 | 289,690.22 |
| Total | 308,504.35 |
An analysis of approximately 14,000 account cards for 1919, which had been charged off at the end of the year, and on which $127,560.11 was recovered in 1920, shows that 89.7 per cent of the recoveries were on accounts which were carried in the active file at the close of the year.
Under date of August 6, 1921, Revenue Agent Morris Weiss filed a report covering his examination of petitioner's tax liability for the years 1917 to 1920 inclusive. In that report petitioner's method of arriving at the amounts claimed as bad debt deductions was described at length. The revenue agent was unable to obtain complete records for the years prior to 1920 and for each of those years he proposed the disallowance of the amount reported by petitioner as collections in the following year. For 1920 he proposed that the $279,240.68 claimed over and above the delinquent file be disallowed. For each of the years 1918 to 1920, inclusive, the agent proposed the reduction of income by the amount of the claimed bad debt deduction recommended for disallowance in the prior*1322 year.
On August 14, 1922, respondent by letter advised petitioner that he proposed to assess additional taxes for the years 1917 to 1920, inclusive, and granted the taxpayer twenty days to file exceptions to the proposed assessment. In the computations attached to the letter, the respondent treated the bad debt items for the several years in the manner proposed by the revenue agent.
In September, 1922, a conference was held in the consolidated returns subdivision of the income tax unit at which petitioner's representative protested against the assessment proposed in respondent's letter of August 14, 1922. At the conference petitioner represented that its uncollectible accounts averaged about 18 per cent of gross sales, which was approximately the percentage written off *412 and deducted in the returns. The report of the conferees on that phase of the case concludes with the statement:
The [petitioner's] representative was advised that the explanation submitted was deemed satisfactory and that, unless some further objection appeared appropriate, adjustment would be made.
On October 17, 1922, Samuel Askin, then president of petitioner, executed an affidavit, which*1323 was filed with the respondent, in which he states that the method of determining deductions for bad debts was as follows:
Scrutinizing the cards representing the Accounts Receivable and thereby determining the amount of uncollectible Accounts Receivable to be charged off at the end of each taxable year.
That the amounts charged off in no wise represented an arbitrary figure but represented the actual amount of bad debts, based upon many years of experience in this line of business, and that the amount representing the difference between sales and cash collected is not considered as bad debts and deducted for Income Tax purposes as indicated in Revenue Agent's Report.
On October 21, 1922, the respondent mailed petitioner a so-called thirty-day letter, reading in part:
Reference is made to conference held, September 16, 1922, in reply to Bureau letter dated August 14, 1922, indicating an additional tax liability for the years 1917, 1918, 1919 and 1920.
In reply, you are informed that careful consideration has been given to the data and facts submitted, and adjustments made resulting in an additional tax liability of $14,741.96 as shown in the attached Revised Schedules 1*1324 to 21, inclusive.
The assessment of $14,741.96 proposed in the above letter was for the year 1920 only. For the years 1917, 1918 and 1919 the respondent found overassessments. For each of the four years included in the above letter, respondent allowed the deductions for bad debts claimed by petitioner and which the revenue agent proposed to disallow in his report of August 6, 1921. Both income and invested capital were adjusted, as stated in respondent's letter "in view of the additional information submitted in conference of September 16, 1922." The additional tax of $14,741.96 for the year 1920 was assessed on the November, 1922, assessment list.
On May 16, 1925, respondent mailed to petitioner, a thirty-day letter proposing assessment of a deficiency of $198,312.04, for 1920 and finding an overassessment for 1921. In arriving at the deficiency for 1920 respondent disallowed claimed bad debt deductions in the amount of $279,240.68 and gave the following explanation:
| Amount disallowed by Revenue Agent in report dated August 6, 1921, and subsequently concurred in by supplemental examination | $279,240.68 |
*413 It was found that $279,240.68 represents*1325 an arbitrary deduction, being an amount over and above the total of the Delinquent file, which equals the difference between the sales and cash collected within the taxable year.
This amount is disallowed as not coming within the provisions of Article 151 - Reg. 45, in that this amount does not represent accounts which have been ascertained to be worthless, as evidenced by the collections in the succeeding year of $185,302.11.
In computing invested capital for 1920 the respondent excluded the amount of $308,504.35 which is the amount that he originally proposed to disallow as a bad debt deduction for 1919, but which was finally allowed in the letter of October 21, 1922, mentioned above.
On June 23, 1925, a conference was held in the consolidated returns audit division of the income tax unit, at which petitioner's representative protested against the proposed assessment for 1920. Respondent's conferees, after reviewing petitioner's contentions advanced at the conference and the report of Revenue Agent Weiss, recommended that the proposed assessment for 1920 be sustained.
On November 6, 1925, respondent mailed to petitioner a sixty-day letter proposing assessment of a deficiency*1326 for 1920 and finding an overassessment for 1921 in the same amounts as set forth in the thirty-day letter.
On August 22, 1929, Ely H. Schwartz, secretary and office manager of petitioner, executed an affidavit, which was filed with the respondent, reading as follows:
ELY H. SCHWARTZ, being first duly sworn, deposes and says that he is the secretary of the ASKIN & MARINE COMPANY, INC., 906 Broadway, New York, New York, and in the capacity of a secretary of this corporation he was generally familiar with the method used in charging off uncollectible accounts receivable at the end of each year; that the method employed in 1920 had been in use over a period of several years and had been found to accurately determine the amount of bad debts; that the amount of $655,800.32 charged off at the end of the year 1920 represented accounts ascertained worthless, which amount was ascertained by a method used by us for several years prior thereto and which we believed to fairly represent the bad debt account. Our experience over several years had demonstrated to us that our method was fairly accurate. We knew of no other method in such a business as ours as would better reflect the situation.
*1327 OPINION.
ARUNDELL: The respondent has determined that the sum taken from petitioner's active card file at the close of 1920 did not represent debts ascertained to be worthless and has disallowed that amount as a deduction. Petitioner alleges that this was error on the part of the respondent and claims that the total of the sum in its delinquent file plus the additional sum taken from its active cards in 1920 represented the total of its worthless accounts for that year.
*414 The evidence fully justifies respondent's disallowance as a bad debt deduction of that portion of the amount claimed which was taken from petitioner's active file for the year 1920. It is established clearly that no effort was made to ascertain the worthlessness of the the amounts written off from the active cards. The proof was so clear that counsel for petitioner in his brief says, "On the evidence the respondent is apparently correct as to 1920." We accordingly sustain the respondent's disallowance of $279,240.68 as a bad debt deduction for 1920.
The next question, raised in the alternative by petitioner, is whether the amount recovered in 1920 on similar itmes charged off for 1919 should*1328 be included in 1920 income. The same question was involved in ; reversing . The close similarity of the two cases is apparent from the following quotation from the opinion of the court:
In its returns for 1916 to 1919, inclusive, the taxpayer charged off and reported as worthless certain debts owing to it. Due allowances were made for these debts by the Commissioner in the assessment of taxes for those years. Upon the payment of the debts in whole or in part in 1920 and 1921, the Commissioner treated the amounts received as a part of gross income. The Board of Tax Appeals reversed this ruling, holding, to which there were dissents, that these payments were not a part of gross income for the years received because they were not in fact ascertained to be worthless for the years for which they were so reported and charged off.
In that case, as in this, the contention of the respondent was that the taxpayer, having asserted that the debts were ascertained to be worthless and charged off, and having received that benefit of such assertion, was estopped to deny its truth to the*1329 prejudice of the Government. The taxpayer contended, and the same contention is made here, that there was no basis for the application of the doctrine of estoppel. On this phase of the case the court held:
It is said that it was the duty of the Commissioner, before allowing the deductions in the former years, to exercise reasonable diligence to discover whether the debts were worthless, and if he had done so, he could have ascertained that they were not. While it may be conceded that the Commissioner may not blindly accept every statement which a taxpayer makes as to a fact, and by acting thereon preclude the taxpayer from showing at some other time that the statement was mistakenly made, we cannot assent to the view that a taxpayer which has been allowed a deduction for a debt, on its statement under oath that the debt has been ascertained to be worthless, is not estopped thereafter from denying the truth of the statement to the prejudice of the Government. The Commissioner of necessity does and must rely largely upon the representations of the taxpayer, and in order to estop the taxpayer from assuming a contrary position he is not compelled to look with suspicion upon all such*1330 representations and himself examine or cause to be examined the financial condition of all the taxpayer's debtors. It is the duty of the *415 taxpayer to deal fairly and truthfully with the Government. The taxpayer was in a better position to ascertain the facts in this case than the Government, and it cannot now say that the Government, by the exercise of reasonable care, ought to have done what it failed to do. The officers of the Government charged with the duty of assessing and collecting taxes have the right to assume that a taxpayer will do his duty, and we think it is to be presumed from the fact that these deductions were allowed for the years in which they were claimed that the Commissioner relied upon the taxpayer's sworn statements that the debts were worthless. It is also to be presumed, in the absence of evidence to the contrary, that the Government was prejudiced by such reliance, for it is obvious that a deduction from gross income reduces the net income subject to taxation. The purpose which the statute has in view in authorizing deductions for bad debts is to permit the taxpayer to reduce his taxable income. It is fair to infer from the fact that deductions*1331 were claimed and allowed for these debts in former years, nothing else appearing, that there was a consequent reduction in taxable income.
In the case before us the respondent has a stronger ground for invoking estoppel against a taxpayer than he had in the Liberty Bank case, for in this case, as set out in our findings of fact, the taxpayer insisted over a period of years that the deduction claimed represented debts actually ascertained to be worthless. By reason of its representations made at conferences and affidavits filed with the respondent, petitioner was able to convince the respondent of the verity of its claims and obtained the benefit of the deductions of gross income for which it asked.
In , the principle was laid down that recoveries on losses previously claimed and allowed constitute income. That decision, it is pointed out in the Liberty Bank case, is controlling in the case of recoveries on debts for which deductions had been claimed and allowed, and accords with the respondent's long established interpretation of the revenue acts. See art. 110, Regulations 33; art. 52, Regulations 45; *1332 art. 51, Regulations 62.
In view of the foregoing, we are of the opinion that respondent properly included in income for 1920 the collections in that year on the accounts making up the amount claimed and allowed as a bad debt deduction for 1919.
On the invested capital question, petitioner alleges that the accounts making up the amount of $308,504.35 collected in 1920 were good accounts receivable and as such should be included in invested capital. As we have held that the 1920 collections constitute income, it necessarily follows that the same items can not at the same time be invested capital.
Reviewed by the Board.
Decision will be entered for the respondent.
TRAMMELL dissents.
*416 MURDOCK, concurring: I do not agree that the amount collected in 1920 on accounts charged off for prior years should be included in 1920 income because of an estoppel. An estoppel must be certain and may not depend upon argument or inference. It is a matter of defense and should be pleaded and proven by the one asserting it. This same party should suffer if the proof is inadequate. In order to work an estoppel of this kind there must be, among other*1333 things, (1) conduct, acts, language or silence amounting to a representation or a concealment of material facts; (2) the truth concerning these facts must be unknown to the other party, who claims the benefit of the estoppel, and this party must be without convenient to ready means of acquiring this knowledge by the exercise of reasonable diligence; (3) the latter must also be led by his reliance on the conduct of the other to change his position for the worse. An estoppel has no application where the material facts are known to both parties. The object of the rule is to repress fraud and render men truthful in their dealings with each other.
The Commissioner was investigating the tax liability of this taxpayer for four years, the years 1917 to 1920, inclusive. The information which he obtained from the taxpayer showed that the latter pursued a consistent course in all of those years so far as the matter now under discussion is concerned. There is nothing in the record to distinguish the facts for 1920 from those for the other years. The Commissioner knew that in each year the petitioner deducted a certain amount from its income which it considered a fair amount, in the light*1334 of its experience, to represent had debts; it next absorbed this amount by charge-offs in specific accounts, first wiping out all delinquent accounts and then spreading the remainder among the active accounts; as amounts thus charged off were collected in later years, the collections were again included in income. These are the material facts. Both parties knew them. What other fact was represented or concealed which could work an estoppel? The petitioner contended that it had thus met the requirements of the act as to ascertainment of worthlessness and charge off in all years. The prevailing opinion holds that having taken this position he is estopped to take another. But this contention of the taxpayer was no more than a statement of a conclusion. The prevailing opinion seems to hold that the Commissioner may say to this taxpayer, "You have persuaded me to allow you deductions for prior years, so I include certain items in your 1920 income regardless of whether or not they are properly income for 1920 and you may not show or even contend that they are not income for that year." This would make the unequal resistance of the Commissioner to one argument on similar facts for*1335 four years the basis of an estoppel. The Commissioner is able to form his own conclusions from a given state of facts and can not claim an estoppel where another's argument made *417 him vacillate. The difficulty does not arise from any unfair advantage taken by the petitioner.
The Commissioner singled out the year 1920 and disallowed a part of the deduction for that year. We approve his action as to that year. Why he did not follow his agent's report, disallow similar parts of the deductions for other years and exclude the collections from income, I do not know. If it was on account "of the additional information submitted in conference of September 16, 1922," what was that information? Apparently without any further information the Commissioner eventually proposed the large deficiency for 1920 by disallowing the excess of the bad debt deduction over the total of the delinquent accounts as an arbitrary deduction. In this connection he pointed to collections in the succeeding year, but he had the same information for 1917, 1918 and 1919.
The taxpayer says, "If you will not adopt my consistent method, then take another consistent view, that of your revenue agent*1336 for example, whereby my income for 1920 will not be distorted." He is not estopped to make this plea. We should not support the Commissioner if these items were not income in 1920. Errors of other years need not concern us under such circumstances, for the Commissioner has not shown that any material fact was unknown to him or misrepresented when he made his determination as to those years or when his determination became final.
The Commissioner determined that proper amounts were charged off for prior years. The presumption is that he was correct. The proof does not show that the amount charged off was incorrect in the light of the circumstances known at the end of each of those years. Amounts later collected were then unknown. In my opinion the Commissioner wins the point without benefit of an estoppel.
GOODRICH agrees with this concurring opinion.