*108 Decision will be entered under Rule 50.
1. The holder of petitioner's bonds voluntarily accepted payment of interest at a reduced rate. Held, no taxable income resulted.
2. Petitioner improperly accrued interest as due under an option to purchase property. The accrued interest was deducted from income reported in earlier years. Later when the option was exercised in the taxable year, the vendor voluntarily accepted less than the full amount of interest contracted for. Held, petitioner was not by the previous deduction, with knowledge by the Commissioner of the facts, estopped from denying that the interest reduction resulted in taxable income; and no taxable income resulted by the voluntary forgiveness of interest. Helvering v. American Dental Co., 318 U.S. 322">318 U.S. 322.
*362 This proceeding involves the redetermination of a deficiency in excess profits tax in the amount of $ 614.21 for the taxable period beginning June 1, 1939, and ended April 30, 1940, in respect of which the petitioner alleges overpayments of *109 $ 4,057.10 tax and of $ 27.91 interest. The issues are as follows:
1. Did the petitioner realize income through the forgiveness of certain accrued interest on its bonds, for which it had been allowed deductions on prior returns?
2. Did the forgiveness by the petitioner's grantor of part of the amounts accrued and previously deducted as interest under an option contract for the purchase of land result in the realization of income?
3. Is the petitioner estopped to deny that the forgiveness of the amounts accrued as interest resulted in the realization of taxable income?
We adopt and incorporate herein by reference the stipulation of facts filed by the parties. Such parts thereof as are necessary to an understanding of the issues are included in our findings of fact, made also from evidence submitted at the hearing.
FINDINGS OF FACT.
The petitioner is a Florida corporation, having its principal office in Miami Beach, Florida. Its return for the taxable period here involved was filed with the collector for the district of Florida.
During a period beginning in 1924 and ending in 1930, the petitioner issued the aggregate face amount of $ 247,500 general mortgage eight percent gold bonds, *110 secured by a mortgage on its property. *363 All the bonds matured on or prior to April 1, 1931. On October 1, 1930, Miami Beach Improvement Co. purchased $ 168,000 of the bonds, and Irving A. Collins Corporation purchased $ 23,500 thereof, both from a former holder. By May 31, 1936, the petitioner had retired all other bonds of the issue with the exception of those purchased and held by the Improvement Co. and the Collins Corporation. During its fiscal year ended May 31, 1939, the petitioner retired and canceled $ 53,500 face amount of the bonds held by the Improvement Co. and $ 15,000 of those held by the Collins Corporation, reducing their respective holdings to $ 114,500 and $ 8,500, and reducing petitioner's indebtedness under the bond issue to $ 123,000.
The bonds provided for semiannual payments of interest at the rate of 8 percent per annum, for which interest coupons were attached. Until May 31, 1937, the petitioner accrued the interest on its books at the agreed rate, and deducted the amounts so accrued on its income and excess profits tax returns. With respect to the $ 123,000 face amount of bonds still outstanding on May 31, 1939, the interest accruals and deductions*111 had been in the amount of $ 6,560 for the period from October 1, 1930 (the date of the holders' purchase of the bonds), to May 31, 1931, and in amounts of $ 9,840 for each subsequent fiscal year, beginning with the year ended May 31, 1932, up to and including that ended May 31, 1937.
The petitioner's capital stock consists of 1,532 shares, of which on May 31, 1939, J. Arthur Pancoast owned 1,168 and Thomas J. Pancoast, the father of J. Arthur Pancoast, owned 350. Of the remaining 14 shares, 12 were owned by persons related by blood or marriage to J. Arthur Pancoast. The capital stock of Irving A. Collins Corporation consists of 2,000 shares. On May 31, 1939, the estate of Irving A. Collins owned 1,998 shares. Miami Beach Improvement Co.'s capital stock consists of 6,000 shares. On May 31, 1939, J. Arthur Pancoast, his father and mother, and two of his brothers owned, among them, an aggregate of 1,502 shares. Of the remaining 4,498 shares, Irving A. Collins Corporation, Irving A. Collins, his children, his brothers, and his brothers' children owned, among them, 3,650. Irving A. Collins was the uncle of J. Arthur Pancoast and the brother-in-law of Thomas J. Pancoast.
In about*112 July 1938 Irving A. Collins, for his own corporation and on behalf of Miami Beach Improvement Co., told J. Arthur Pancoast that the two corporations would agree to accept, in satisfaction of the petitioner's indebtedness to them, the face amount of their bonds with interest computed at the rate of 4 percent per annum from October 1, 1930, to the date of payment. The bonds retired during petitioner's fiscal year ended May 31, 1939, were paid and canceled in accordance with that agreement. For the fiscal years ended May 31, 1938, and *364 May 31, 1939, the interest accrued by petitioner and deducted on its returns, with respect to the $ 123,000 face amount of bonds still outstanding on May 31, 1939, was computed at the reduced rate of 4 percent and was in the amount of $ 4,920 in each year. Thus, the interest accrued on the books and deducted on the petitioner's returns, with respect to those last outstanding bonds of $ 123,000, from October 1, 1930, to the close of the year ended May 31, 1939, amounted in the aggregate to $ 75,440. In October 1939 the directors of Miami Beach Improvement Co. ratified the acceptance of interest at the 4 percent rate on the $ 53.500 of its bonds*113 theretofore paid, and adopted a resolution that $ 114,500 with interest thereon at the rate of 4 percent per annum from October 1, 1930, until the date of payment be accepted as full payment of its remaining bonds.
On June 1, 1939, the petitioner changed its accounting period to a fiscal year to end April 30 in each year, thereby making its first taxable period under the change begin June 1, 1939, and end April 30, 1940. On December 15, 1939, the last $ 123,000 of bonds were retired by the payment of their face amount, and payment of the further sum of $ 42,640, being the interest thereon from October 1, 1930, to May 31, 1939, computed at 4 percent. The bonds were retired in order to enable the petitioner to secure a new mortgage loan of $ 400,000 on its property. The new loan was obtained, and part of the proceeds was used for payment of the bonds. The reduction of interest liability effected upon the retirement of the bonds amounted to $ 32.800, the difference between the $ 75,440 accrued on the books and the $ 42,640 actually paid. The entire saving was credited to petitioner's undivided profits, but only the amount of $ 27,880 was reported as income on the return for the *114 taxable period here involved. The respondent determined that $ 4,920, the balance of the interest reduction, should be included in income for the taxable period.
On October 12, 1928, Thomas J. Pancoast granted to the petitioner an option, until September 28, 1947, for the purchase of two parcels of land in Miami Beach, Florida, for the price of $ 60,000 "plus an amount equal to interest at the rate of six percent (6%) per annum on said sum * * *" from the date of the option until the date of its exercise, and plus a further amount "equal to all State, County and Municipal taxes, liens and assessments levied against the * * *" property, from May 9, 1927, until the date of the exercise of the option. By its terms the option was to terminate if the Pancoast Hotel should ever be sold, or if ownership or voting control over the majority of the petitioner's stock should ever pass from J. Arthur Pancoast. Upon the execution of the option agreement, the petitioner set up an account on its books under the caption "Option Contract." Thereafter, interest was accrued by the petitioner and entered in that account in the amount *365 of $ 2,290 for its fiscal year ended May 31, 1929, and *115 in the amount of $ 3,600 for each of its subsequent fiscal years up to and including that ended May 31, 1939. The amounts so accrued were deducted on the petitioner's income and excess profits tax returns, the deductions therefor aggregating $ 38,290. None of the deductions has ever been disallowed.
The petitioner paid the taxes and assessments levied against the optioned lands, the payments therefor being made directly to the taxing authorities, and not to Thomas J. Pancoast. No payment of rent, as such, was ever made to Thomas J. Pancoast, although after the execution of the option agreement, the petitioner was in possession of and made use of the property. The petitioner erected some buildings on the land, consisting at first of a small workshop and a childrens' playhouse, and later of some removable cabanas and two stores. Prior to December 1939 from $ 25,000 to $ 30,000 had been spent on the erection of the buildings, of which amount about $ 22,000 represented cost of the cabanas.
In December 1939 the petitioner elected to exercise the option. Thomas J. Pancoast agreed to accept interest on the $ 60,000 computed at the rate of 4 percent per annum instead of at the 6 percent*116 rate provided in the agreement. He executed a deed conveying the land to the petitioner, under date of December 7, 1939. The petitioner paid Pancoast the adjusted amount of interest, and executed a note for $ 60,744 secured by a mortgage on the real estate, to secure the unpaid balance of the purchase price. The petitioner paid no other consideration for the conveyance of the land than the option price, the adjusted amount of interest, and the taxes and assessments levied against the property. The amounts of $ 1,500 for interest under the option contract and $ 1,350.08 for city, county, and state taxes on the optioned property have been accrued on the petitioner's books for the period June 1, 1939, to April 30, 1940.
Under date of December 15, 1939, entries debiting the option contract account and crediting undivided profits, each in the amount of $ 12,970, were made in petitioner's journal, with the following expanatory note:
| Interest set up on this contract at 6% 10/12/1928 to | |
| 5/31/1939 | $ 38,290.00 |
| Compromised at 4% | 25,320.00 |
| Canceled | 12,970.00 |
Only the amount of $ 11,770 of the credit to undivided profits was reported as income on the petitioner's return. *117 The respondent determined that the balance, $ 1,200, should have been included. The addition of that amount and of the $ 4,920, the balance of the interest *366 reduction on the bonds retired in December 1939, constitute the only adjustments made to reported net income. The amounts accrued for the taxable period as interest and taxes under the option contracts have been allowed by the respondent in the notice of deficiency.
The petitioner reported a net loss of $ 40,740.23 on its return for the fiscal year ended May 31, 1932, which amount, as subsequently amended, was reduced to $ 39,587.73. It had net income in excess of $ 6,120 in all other years, beginning with that ended May 31, 1930, up to and including the taxable period here involved. Its balance sheets reflected an excess of assets over liabilities of approximately $ 926,000 on June 1, 1939, and an excess of approximately $ 1,025,000 on April 30, 1940.
OPINION.
The first question here presented is whether the petitioner realized taxable income by reason of the forgiveness of part of its indebtedness for interest accrued on the general mortgage bonds. The petitioner contends that the cancellation constituted a gift, *118 and that it is therefore not to be included in income. If it was not a gift, the petitioner concedes that it is taxable "at least to the extent of the 'tax benefit' which it received in prior years from the accrual and dededuction of said interest." The respondent's position is that there was no gift, and that the entire credit to undivided profits is taxable income, regardless of the realization of tax benefit to the petitioner by reason of interest deductions claimed in prior years. By affirmative allegation in the answer it is averred in the alternative that, by reason of the receipt of benefits in prior years, the petitioner is estopped to change its position with respect to the inclusion of the forgiven amount in income.
In our opinion the recent Supreme Court decision in , requires a holding in the petitioner's favor on the first issue. The Court in that case held that the forgiveness of a taxpayer's indebtedness for interest on promissory notes and for back rent was a gratuitous release upon the part of the creditors, and thus constituted a gift rather than resulting in the realization of taxable*119 income. The fact that business reasons may have motivated the creditors to agree to cancel their claims was held to be immaterial. In the instant case the evidence establishes that the bondholders received no consideration for their agreement to accept less than the amounts due them. The transaction must therefore be viewed, in the words of the Supreme Court in the American Dental case, as "a release of something to the debtor for nothing, and sufficient to make the cancellation here gifts within the statute." There is no merit to the respondent's allegation that the petitioner is estopped to *367 deny that the canceled interest constituted income. He does not argue the point upon brief. There was no misrepresentation of fact by the petitioner here. The interest deductions were properly claimed on the returns for prior years. The forgiveness of part of the debt which they represented having been gratuitous, the petitioner realized no taxable gain thereby under the rule of the American Dental case, and resort to the doctrine of estoppel may not now be had to create income out of what never was income either in law or in fact. As was said in :*120
Estoppel is not an element of income but only a doctrine affecting liability. It cuts across substantive principles in order to promote an assumed fairness thought to be more important than an adherence to conventional legal considerations. It does not create a right but only affects remedy. * * *
We hold that the forgiveness of part of the accrued bond interest did not result in petitioner's realization of taxable income. Cf. ; superseded, .
We next consider the effect of the acceptance by Thomas J. Pancoast of $ 12,970 less than the amount designated as interest under the option contract. The petitioner contends that it had been in error in accruing and deducting interest under the contract in prior years, that the adjustment agreed to by Pancoast amounted merely to a reduction in the purchase price of the optioned land, and that the return as income in the taxable period of a part of the amount forgiven resulted in the overpayment of tax alleged in the petition. The respondent determined that the entire saving was taxable income. By affirmative allegations in the answer*121 it is averred, in substance, that, by reason of the receipt of benefits in prior years, the petitioner is estopped to assert that the amounts accrued as interest were not in fact interest, or to change its position with respect to the inclusion of the amount forgiven in income. It is further alleged that if no income was realized by the petitioner, then the amounts allowed as deductions for interest and taxes in the taxable period should be restored to income.
We think that it can not be doubted that the petitioner's accrual and deduction of interest under the contract was erroneous. The contract did not result in the incurrence by the petitioner of any fixed and unconditional indebtedness, without the existence of which interest may not properly be accrued. ; ; . Cf. Deputy v. du . Here, the petitioner was under no obligation, so far as the contract was concerned, until it elected to exercise its right*122 to purchase the land in the taxable year. We agree with the petitioner that the amounts *368 designated as interest and to be paid upon exercise of the option were in fact no more than additions to the purchase price, exacted by the seller for the delay in receiving payment. His ultimate acceptance of less than the amounts provided by the contract therefore amounted merely to a reduction of the agreed sale price. ; affd., ; (Ct. Cls.). Cf. . Moreover, in the light of the Supreme Court's decision in the American Dental case, the petitioner must prevail on this point even if the adjustment of interest may be viewed as a cancellation of indebtedness. Pancoast's agreement to accept less than the agreed amount was entirely without consideration, and therefore constituted a gift to the petitioner, the value of which is not to be included in income under the statute. *123
The respondent contends further, however, that the petitioner may not now assert that the interest reduction did not result in the realization of taxable income. The question for decision is whether the facts here involved justify an application of the doctrine of estoppel, or some doctrine akin to estoppel. Upon brief the respondent argues that "Whether such holding be by way of a quasi estoppel, election, or waiver is immaterial to the respondent. The facts, when considered, so closely resemble any of the above that the court could hold equally well for the respondent for any of the above reasons." The burden of proving facts justifying application of the doctrine of estoppel is upon the party asserting it as a defense. See, e. g., ; ; The facts here are that interest deductions were improperly claimed and allowed on prior returns. But the respondent has failed to show that the allowance of the deductions was in reliance upon any act or wrongful nondisclosure*124 of fact amounting to misrepresentation on the part of the petitioner, or that the Commissioner was not cognizant of all the facts. On the contrary, it appears from the evidence that his agents made examinations of petitioner's returns during the period in question, that on those occasions they had free access to and actually examined the books showing the accruals of interest, and that they were furnished with whatever information they asked for. Failing proof of bad faith on petitioner's part, the deductions must be presumed to have been claimed and allowed as the result of a mistake of law. In general such mistake will not support estoppel. , and cases there cited. Cf. .
The respondent relies upon the statement of the Sixth Circuit in *369 , that:
* * * 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, *125 he is not compelled to look with suspicion upon all such representations and himself examine, or cause to be examined, the financial condition of all the taxpayer's debtors. It is the duty of the taxpayer to deal fairly and truthfully with the government. * * *
In that case the taxpayer, having claimed and been allowed worthless debt deductions in prior years, was held to be estopped in the taxable year to deny the prior worthlessness, ascertainment, and charge-offs. The fact distinguishing the case from the instant proceeding is that there the taxpayer had made a representation of fact, namely that the debts were ascertained to be worthlesss and charged off when the deductions were claimed, and the Commissioner's reliance thereon was held justifiable. Here, the most that the petitioner may be said to have represented is that it was under obligation to pay interest under the option contract. Whether or not it was so obligated presented a question of law. The Commissioner had all the facts before him or readily available to him. His failure to examine the facts, or his erroneous conclusion with respect to them, can not now be held to constitute the basis of a representation*126 of fact by the petitioner. Cf. ; .
The cases of , and ; affd., , relied upon by the respondent, are distinguishable. In the former the taxpayer in a prior year had actually made a representation as to value upon which the Commissioner had relied. See . In the Orange Securities case the taxpayer's transferor failed to report gain on a sale of property for which he received promissory notes, and we held that he thereby in effect declared that the notes had no fair market value at that time. In that case the mistake made by the petitioner, if considered as one of law, and not as a representation, resulted in silence on the part of the petitioner in not returning income from a certain transaction, and therefore resulted *127 in ignorance of the Commissioner as to the matter, while herein the petitioner's error of law resulted in no silence misleading the Commissioner, but on the contrary resulted in affirmative action -- deduction of interest -- of which the Commissioner was immediately made aware not only by the petitioner's return itself, but also by the examination of petitioner's records later. The respondent has the burden of proving estoppel, *370 and has not shown that his agents did not see the option contract itself. Without evidence of details of the respondent's examination, we can of course not find that the complete situation was not made known to his agents. . Thus we see that only a change of position by the petitioner remains as basis for estoppel. But this resulted from a mutual mistake make by the petitioner and the respondent's agents passing upon the return and records, as to the effect of the option agreement on interest. Such mutual error of law is no logical basis for plea of estoppel. One with knowledge of the facts, agreeing in effect upon an error of law, demonstrates no reason for estoppel of the*128 other erring party merely because of such error. ; ; . Moreover, "mere inconsistency in position does not give rise to estoppel, but it is the consequences of the inconsistency which create it." 31 C. J. S. 345. The inconsistency of petitioner's position herein is merely in taking a position which the Commissioner, so far as herein shown, had full opportunity in the first instance to suggest, to the petitioner's then detriment. Having failed to do so, he may not rationally now oppose the change. The respondent finds himself in his present situation not primarily because of the change of view by the petitioner, but more proximately by reason of his failure formerly to correct the petitioner, and disallow his claim. In , all facts were disclosed to the deputy collector who helped to prepare returns, and it was held that the mistake of law, in which both parties participated, did not*129 give rise to estoppel. We find no basis for estoppel or quasi estoppel in the situation here at hand.
There remains for consideration the respondent's contention that, even if all the technical elements of an estoppel are not present, the petitioner must be held to have made an election in the handling of the interest under the contract to which he must now be held. We think that the facts present no basis for the application of such doctrine. As we said in :
* * * In order to be bound by his election a party must have had a right to elect and must have made an election with knowledge of his rights upon which the other party properly relied. The necessary right to elect, the election, and reliance are all absent in this case. * * *
So, too, the petitioner here had no right to elect. Nothing in the revenue acts permitted any choice between deducting or not deducting the interest accruals in question. There being no indebtedness, there was, as already pointed out, no right to the deductions. In claiming them the petitioner was no more making an election than is any taxpayer who takes a position for which there*130 is no basis in law. This case presents no basis for application of the doctrine of election. *371 See also , and cases there cited; affd., ;
We hold that the saving effected on the adjustment of interest paid under the option contract did not result in the petitioner's realization of taxable income. It follows that the amounts accrued as interest and taxes for the taxable period, and allowed as deductions in the determination of the deficiency, are not proper deductions.
Decision will be entered under Rule 50.