*1383 1. Taxpayer, a Tennessee corporation, owned and operated prior to November 1932 a sawmill at Memphis, Tennessee, and another at Clarendon, Arkansas, together with timber and river logging equipment. Its ledger was divided into two sections, one containing accounts pertaining to the Arkansas properties and operations and the other pertaining to Memphis properties and operations and controlling accounts. In November 1932 three of taxpayer's stockholders obtained an Arkansas charter, but other than that no steps were taken to organize the corporation. Neither taxpayer nor its stockholders paid or conveyed any money or property to the Arkansas corporation for its stock. Taxpayer set up the capital stock of the Arkansas corporation as an asset in the Memphis section of its ledger and as a liability in the Clarendon section. It continued, however, to operate all its properties as before. Held, that the Arkansas corporation neither functioned as a corporation nor operated the Arkansas properties; held, further, that even if it had been completely organized as a corporation, under the peculiar circumstances, it did not operate as a separate entity and taxpayer is entitled to*1384 deduct from its gross income the loss sustained in the taxable year from the operations of the Arkansas properties; held, further, that the loss claimed as a result of the Arkansas operations must be reduced by one-half of the depreciation claimed on the Clarendon sawmill and river logging equipment as contended by the respondent, the taxpayer having failed to adduce evidence from which the depreciation allowable could be determined.
1. Held, taxpayer is entitled to the deduction of certain accounts in the aggregate amount of $1,120.93 as bad debts ascertained to be worthless and charged off in the taxable year.
*89 The Commissioner determined a deficiency in income tax for the year 1935 in the amount of $2,640. The deficiency in tax is the result of a number of adjustments made by the Commissioner, only two of which are in controversy, i. e., (1) the disallowance of a loss deduction in the amount of $14,077.10 and (2) the disallowance of a bad debt deduction to the extent of $1,219.08.
FINDINGS OF FACT.
The petitioner was incorporated*1385 under the laws of Tennessee in 1916. Its stockholders were Eugene Woods, Sr., and members of his family. During 1935 and prior thereto the petitioner owned and operated lumber mills at Memphis, Tennessee, and at Clarendon, Arkansas. It also owned and operated river logging equipment, consisting of steamboats, barges, and derrick boats used for hauling and towing lumber for petitioner and others. The sawmill at Clarendon was purchased by petitioner in March 1932. Prior to 1932 it had also purchased standing timber in Arkansas.
On or about November 11, 1932, a charter was issued under the laws of Arkansas to the "Woods Lumber Company, Inc.," with an authorized capital of 500 shares of the par value of $100 each. The *90 application for the charter was made by Woods and his two sons, Frank E. and Eugene, Jr. After the issuance of the charter no incorporators' or stockholders' meetings were ever held, no minute book was kepts, and no officers or directors were elected. However, Woods and his two sons were designated in the charter as the directors and officers of the company and as subscribers to all its stock. Under date of November 11, 1932, stock certificates representing*1386 50 shares each were prepared as follows:
| Shares | |
| Eugene Woods, Sr | 200 |
| Eugene Woods, Jr | 150 |
| Frank E. Woods | 150 |
The certificates, however, were never detached from the stubs or removed from the stock book. No money or property was ever paid in to the company for its stock by Woods or his sons or petitioner. It never acquired any property in its name except a small piece of timber at a nominal sum paid from funds furnished by petitioner. No books of account or records were kept at the Clarendon mill except a memorandum book used for the purpose of keeping a record of cars of lumber shipped out and a stumpage record to show the timber cut.
After the issuance of the Arkansas charter, the petitioner continued to deal with the property in Arkansas and Memphis as its own and continued its operations as theretofore. Except for a few small retail sales of lumber made in Clarendon, all lumber from the Clarendon mill was sold through petitioner's office at Memphis. All bills and invoices were sent to customers by petitioner and payments thereof were made to petitioner. All funds expended at Clarendon were furnished in the course of operations by petitioner. *1387 The ledger of petitioner was divided into two sections, one containing the accounts reflecting and pertaining to the operation of the Clarendon mill and certain river logging equipment, and the other section containing the accounts pertaining to the operation of the Memphis mill, together with controlling accounts, accounts receivable, and salary accounts of Woods and his two sons. The only change made in the ledger on the issuance of the Arkansas charter was an entry setting up the $50,000 capital stock of the Woods Lumber Co., as an asset of petitioner in the so-called Memphis section of the ledger and as a stock liability in the so-called Clarendon section of the ledger. The sons employed in the operation of the Clarendon mill and river logging equipment were paid by the petitioner. An income tax return to Arkansas for the year 1935, showing a loss of $14,077.10, was filed by the Woods Lumber Co. In computing *91 the loss petitioner deducted as an operating charge 10 percent depreciation as follows:
| River logging equipment | $9,698.84 |
| Clarendon sawmill | 1,516.09 |
| 11,214.93 |
In its Federal income tax return for 1935 the separate operation of the Clarendon*1388 mill and the Memphis mill was disclosed and the amount of $14,077.10 representing the net loss sustained in the operation of the Clarendon mill and river logging equipment was deducted from gross income.
On December 28, 1936, the Arkansas charter was surrendered. In the latter part of 1938 petitioner was also dissolved and all its property and business was thereafter taken over and operated by Woods, Sr., and his wife and sons as a partnership.
In its 1935 Federal income tax return petitioner claimed a bad debt deduction in the amount of $3,418.14. Of this amount respondent disallowed the amount of $1,219.08, consisting of the following accounts:
| W. M. Davis | $259.87 |
| J. A. Jones | 179.05 |
| Rock of Ages Church | 398.79 |
| V. V. Nichols | 80.30 |
| Midwest Hardware Co | 98.15 |
| Bungalow Baptist Church | $95.08 |
| F. E. Lipscombe | 107.84 |
| Total | 1,219.08 |
An employee of petitioner in charge of credits and collections of retail accounts checked and followed up petitioner's retail accounts receivable every month. He made an investigation as to all the above accounts, excepting the account of Midwest Hardward Co., and from such investigations found no assets from which recovery*1389 could be had and ascertained and determined at the close of the year 1935 that such accounts were worthless. At his direction such accounts were charged off on the books of account of petitioner in 1935.
W. M. Davis had been a carpenter contractor, but due to business conditions he discontinued his carpenter business and finally in 1935 he hauled wood with a wagon. Until then it was thought that his account was collectible. In 1937 he paid $100 which was included in petitioner's 1937 income. J. A. Jones used the lumber purchased from petitioner in his own house. He went into bankruptcy in 1935. The account of $398.79 was secured by a second mortgage on the Rock of Ages Church. It made payments on the first and second mortgages during 1933 and 1934 but stopped payments on petitioner's account and later on the first mortgage. The first mortgagee offered to sell the first mortgage at 80 cents on the dollar but petitioner *92 declined the offer. V. V. Nichols was a carpenter contractor who got out of contracting work due to the depression. He apparently had no assets. A part of the congregation of the Bungalow Baptist Church left the church in 1935. The members remaining*1390 were unable to meet the obligations of the church. F. E. Lipscombe was employed as a contractor with some real estate firm which went out of business. He was unable to obtain employment after that. Subsequent to 1935 petitioner collected $50 on that account, which was included in its income for the year in which received.
OPINION.
ARNOLD: The Commissioner disallowed the Clarendon mill operating loss of $14,077.10 upon the ground that the Arkansas operations were conducted by a separate and distinct entity for income tax purposes. The determination was predicated on the assumption that the petitioner was the stockholder of the Arkansas company.
For income tax purposes corporations are generally treated as entities separate and distinct from their stockholders. ; ; and . However, where exceptional or peculiar factual situations prevail, form has been disregarded in favor of substance and equity. See *1391 ; ; ; ; ; 112 ; ; .
The purpose for taking steps to organize an Arkansas corporation is not disclosed. However, it was treated as existing in name only. It had no property or funds except such as were furnished by petitioner in the ordinary course of operations. It was never formally organized. It never functioned as a corporation. None of its shares of stock was ever issued to petitioner and neither Woods and his two sons nor the petitioner ever paid any money or property to the corporation for its stock. The petitioner conducted the business, consisting of the operation of the sawmill at Memphis, the sawmill at Clarendon, and the river logging*1392 equipment as its own prior to the issuance of the Arkansas charter and continued to do so without change thereafter and throughout the year 1935, except that a bookkeeping entry was made, indicating that the petitioner acquired the capital stock of the Arkansas company. Book entries are evidentiary merely and not conclusive. ; ; affd., ; . The petitioner was the actual owner of all the assets listed in both sections of its ledger and the beneficial owner of the small piece of timber taken in the name of the Arkansas company. In our opinion the Arkansas corporation neither functioned as a de jure or de facto corporation nor operated the Clarendon sawmill and river logging equipment. However, even if it had been fully organized and had acquired title to the business involved, nevertheless the peculiar circumstances disclosed by the evidence bring this case within the exception to the general rule. See *1393 , and other cases cited. We therefore conclude that for income tax purposes the operations of the business in Arkansas and Tennessee should not be treated as operations of two separate entities. See ; and .
The respondent contends that, in the event the Board determines to disregard the separate entity of the Arkansas corporation, the loss alleged to have been sustained from the operations of the Clarendon mill and river logging equipment should be reduced by one-half of the claimed depreciation of $11,214.93. Woods, Sr., testified that in his opinion, based upon his experience, the river logging equipment had a probable useful life of 10 years and that a 10 percent depreciation rate was proper. This is the only evidence in that regard except that petitioner adduced in evidence an agreement as to final determination of tax liability for the year 1928 (Form 866) entered into between petitioner and the Commissioner, with a statement attached showing the Commissioner's computation of petitioner's tax liability for that year. *1394 It appears therefrom that a 7 1/2 percent depreciation rate was allowed on a "Saw Mill Plant and Equipment No. 1" and a 10 percent rate on a "Saw Mill Plant and Equipment No. 2" and that a 10 percent rate was allowed on "River Equipment." The petitioner did not acquire the Clarendon mill until 1932. There is not sufficient evidence from which a proper rate of depreciation applicable to the property here involved could be determined. The respondent concedes that a rate of 5 percent is a reasonable allowance for depreciation. In view of the record made we hold that the operating loss of the Clarendon mill and river logging equipment must be reduced by one-half of the depreciation claimed or $5,607.47, the deductible operating loss therefor being $8,469.63.
Section 23(k) of the Revenue Act of 1934 allows the deduction of "Debts ascertained to be worthless and charged off within the taxable year." The respondent disallowed the bad debt deduction *94 claimed by petitioner to the extent of $1,219.08, for the reason that such amounts were worthless prior to 1935.
The employee in charge of credits and the collection of retail accounts was of the opinion, based upon his investigations*1395 and familiarity with the financial situation of each debtor, that the accounts, excepting the Midwest Hardware Co. account, were not worthless prior to 1935. He knew nothing about the Midwest Hardware Co. account, which apparently was a wholesale account. From the evidence it appears that the petitioner exercised diligence and care in the checking and following up of accounts. It has been held that some latitude and discretion is allowed to the taxpayer in the ascertainment of worthlessness of accounts or debts, provided that he exercises good faith, and that "there is no absolute duty on the taxpayer to ascertain worthlessness at his peril, during the same year when the debt in fact became uncollectible." , affirming . It appears that petitioner received $100 in 1937 on the Davis account and $50 on the Lipscombe account in a year subsequent to 1935. The right to a bad debt deduction is not affected by the fact that recoveries are made in a later year if the debt was ascertained to be worthless and charged off in the taxable year. *1396 ; ; ; and . Here the debts, with one exception as to which there is no evidence, were ascertained to be worthless and were charged off in the taxable year. We therefore conclude that, with the exception of the Midwest Hardware Co. account, the accounts involved herein, totaling $1,120.93, are deductible as bad debts in the taxable year.
Decision will be entered under Rule 50.