Court Opinion

ID: 4626230
Source: CourtListenerOpinion
Date Created: 2020-11-21 02:58:47.297999+00
Date Added: 2024-06-11T08:30:03.511982
License: Public Domain

WADSWORTH MANUFACTURING CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Wadsworth Mfg. Co. v. CommissionerDocket No. 13796.United States Board of Tax Appeals15 B.T.A. 1237; 1929 BTA LEXIS 2700; April 3, 1929, Promulgated *2700  Where a taxpayer had a contract for the construction of a building which provided that the building should not cost more than a specified amount and the contractor refused to complete the building, and thereafter the taxpayer expended money for the completion of it, held, that the taxpayer failed to show that it sustained a loss, and held, further, that it is not entitled to deduct any amount as a debt ascertained to be worthless even though the contractor was adjudicated a bankrupt within the taxable year.  George E. Cleary, Esq., for the petitioner.  J. F. Greaney, Esq., for the respondent.  MURDOCK *1238  The Commissioner determined a deficiency of $52,239.35 in income and profits taxes for the calendar year 1921.  The petitioner has alleged that the Commissioner erred in refusing to allow a deduction from income for the year 1921 in the amount of $242,243.08, representing a claim against the F. E. Walters Co., either as a debt ascertained to be worthless and charged off in the taxable year 1921, or as a loss sustained in that year.  Most of the facts were stipulated.  FINDINGS OF FACT.  The petitioner during the year 1921 was a*2701 Michigan corporation, but since June, 1923, it has done no business and is now in dissolution.  On August 16, 1919, it made an agreement with the F. E. Walters Co., an Ohio corporation, by which the latter company agreed to erect for the petitioner, in Detroit, Mich., a six-story concrete factory building at cost plus 8 per cent, and guaranteed that the total contract price would not exceed $679,879.  James Bentley signed a bond guaranteeing the performance of this contract by the F. E. Walters Co.  On December 10, 1919, the petitioner and the F. E. Walters Co. executed a formal contract modifying the preexisting arrangement by increasing the size of the building to be erected, and increasing the maximum price guaranteed by the F. E. Walters Co. to $946,106.  This modification of the contract was made without the consent of James Bentley, the surety on the performance bond, and he never executed a new performance bond, and although the F. E. Walters Co. agreed to furnish a new bond in the amount of $300,000, none was ever furnished.  The F. E. Walters Co. began performance of the contract but failed to complete the buildings by February 1, 1920, in accordance with its agreement. *2702  In 1920, while the building was still unfinished, it became evident that the construction of the building would cost substantially more than the guaranteed maximum price.  The F. E. Walters Co. refused to complete the construction of the building, whereupon the petitioner completed the building in 1920 and paid the remaining cost of construction, together with all charges incurred by the F. E. Walters Co. which were or would become liens on the building.  The total cost of the building paid by the petitioner was $1,218,349.08, of which $23,353.48 was paid in 1921 and the balance in 1919 and 1920.  A small part of the amount paid by the petitioner was for the removal of liens.  Some of the work done by the F. E. Walters Co. had to be done over again by the petitioner.  When the petitioner paid money in excess of the maximum guaranteed contract price, it expected to recover such excess from the F. E. Walters Co.  The total cost of the building to the petitioner exceeded by $272,243.08 the maximum cost as guaranteed by the F. E. Walters Co. in its contract.  In January, 1920, the petitioner made an offer to the F. E.  *1239  Walters Co. to assume $30,000 of the anticipated cost*2703  of the building in excess of the guaranteed maximum price, but this offer was not accepted.  Because of this unaccepted offer the petitioner reduced its claim against the F. E. Walters Co. by $30,000 and claimed that there was due it from that company, under the contract provision guaranteeing the maximum cost of the building, the sum of $242,243.08.  On May 5, 1921, the petitioner sued the F. E. Walters Co. and James Bentley in the Federal Court in Michigan, requesting a decree for payment of the amount due the petitioner by reason of the failure of the F. E. Walters Co. to limit the cost of said building to petitioner to $946,106.  James Bentley was not a resident of the State of Michigan, and was never served in this proceeding.  Counsel for the petitioner in that litigation, advised that it had no legal claim against James Bentley because the contract had been modified without his consent.  When this suit was started the petitioner expected to recover from the F. E. Walters Co. in said litigation.  On December 23, 1921, the F. E. Walters Co. on its own petition was adjudicated a bankrupt in the District Court of the United States for the Northern District of Ohio, Western Division. *2704  The petitioner was notified of this by the referee in bankruptcy, by notice mailed in Toledo, Ohio, on December 27, 1921.  On December 23, 1921, the F. E. Walters Co. filed with the court in the bankruptcy proceedings a verified statement listing, as its assets having value, $2.39 in cash and a claim for $300 against an individual whose address was unknown.  The bankruptcy proceedings terminated in 1923, the referee then reported that there were no assets for distribution to creditors, and the petitioner never recovered anything from the F. E. Walters Co. on account of this claim.  The petitioner had employed counsel in Toledo, Ohio, to keep it advised with respect to the F. E. Walters Co.  The petitioner was notified by its counsel at Toledo, Ohio, at some undisclosed time, of the filing of the petition in bankruptcy by the F. E. Walters Co. and that the schedule of assets showed practically nothing.  Immediately upon receipt of the referee's notice that the F. E. Walters Co. had been duly adjudicated bankrupt, F. E. Wadsworth, president of the petitioner, consulted H. E. Bodman, counsel and vice president of the petitioner, with respect to the status of the matter.  Bodman advised*2705  the petitioner that it had no legal claim against James Bentley, and that in view of the bankruptcy it could not proceed further against the F. E. Walters Co.  It was then decided that the claim against the F. E. Walters Co. should be written off.  This decision was made in 1921.  The suit in Michigan against the F. E. Walters Co. was not pressed by petitioner after 1921, although the *1240  suit was not actually dismissed until 1926, when the court dismissed it on its own motion and without appearance of either party, for lack of prosecution.  No claim in bankruptcy was filed solely because petitioner's counsel felt that it would be useless to file a claim.  The statement of property filed by the bankrupt company listed, as a claim having no value, a judgment against the Wadsworth Manufacturing Co.  This judgment arose out of an action started by the F. E. Walters Co. against the Wadsworth Manufacturing Co. on September 20, 1920, in the Court of Common Pleas of Lucas County, Ohio.  The Wadsworth Manufacturing Co. never appeared in said action.  The F. E. Walters Co., however, attached a debt due the Wadsworth Manufacturing Co. from the General Steel Products Co. of Toledo, *2706 Ohio, for certain building forms which had been returned to that company by the petitioner.  The F. E. Walters Co. secured a default judgment for $126,377.01, and by reason of said attachment recovered $21,629.36.  Bodman advised the petitioner not to appear in the Ohio litigation because he had no confidence in the Ohio attorneys for the F. E. Walters Co., because Bentley and the F. E. Walters Co. were residents of Toledo, Ohio, because the most the F. E. Walters Co. could recover in Ohio, if there was no personal appearance, was the $21,629.36 attached, and because he felt it was safer for the Wadsworth Manufacturing Co. to try out the merits of its much larger claim against the F. E. Walters Co. in the Michigan courts.  Bodman always regarded the claim asserted by the F. E. Walters Co. in this litigation as a bogus claim.  The petitioner maintained on its books an account with the F. E. Walters Co., to which it charged all advances made to the F. E. Walters Co. or paid out for its account in connection with the building, and to which it credited amounts paid by or for the F. E. Walters Co. on account of the construction of the building.  This account was continued until March, *2707  1921, when the last expenditures on the building were made.  The debit balances in the account were from time to time transferred to "Building Account Number 7," and the account was balanced in this way without leaving in it as a debit balance, the amount in excess of the maximum guaranteed price due the petitioner from the F. E. Walters Co.  The petitioner maintained in its accounts an account known as "Building Number 7," to which it debited all expenditures on account of the building.  Against the total cost of the building, as shown by this account of $1,218,349.08, the petitioner credited $250,833.82, representing a replacement reserve, and $19,306.98, representing a reserve for depreciation during construction, leaving the net book cost of the building transferred to the "Building and *1241  Equipment Account" in the ledger at $948,208.28.  Petitioner made no claim in its income-tax return for 1921 or any later year for depreciation on Building Number 7.  Since the petitioner had failed to set up on its books of account as an asset its claim of $242,243.08 against the F. E. Walters Co., the entry which it made, in closing its books for 1921, to write such account off*2708  as worthless, consisted of opening a new account called "Reserve for Bad Debts," to which it credited as of December 31, 1921, the amount of $242,243.08.  This was the only entry made in the account, "Reserve for Bad Debts." The corresponding debit of $242,243.08, designated "Walters Co. Account," was made in the ledger to the "Surplus Account." On its income-tax return for the year 1921 the petitioner deducted $242,243.08 as a debt ascertained to be worthless and charged off within the taxable year.  This deduction was disallowed by the Commissioner.  If the amount was a proper deduction, then there would be no deficiency for the year 1921.  The deficiency for the year 1921, is the amount found by the Commissioner, $52,239.35.  OPINION.  MURDOCK: The petitioner contends that under the Revenue Act of 1921 it is entitled to deduct the amount of $242,243.08 either as a debt ascertained to be worthless and charged off or as a loss sustained in that year.  If the petitioner at the end of 1921 had a building for the construction of which it had just paid $1,218,349.08, certainly it has not sustained a loss merely because it had had a contract guaranteeing the construction of this*2709  building for a lesser amount, which contract had been broken by the other party to it.  Failure to profit by a favorable bargain for the construction of a building does not occasion a loss within the meaning of the Revenue Act.  The petitioner further contends that (1) it had a claim against the F. E. Walters Co. which cost $242,243.08, (2) this amount was expended for the claim and was not a part of the cost of the building, and (3) the claim became worthless, was ascertained to be worthless and was charged off in the year 1921.  We disagree with the petitioner on each of these points.  That the petitioner paid $242,243.08, or any other amount for whatever claim it had against the F. E. Walters Co. has not been shown.  Where money has been paid to release liens of subcontractors or material men whom the contractor should have paid but did not, a claim against the contractor in a sense has been purchased and a loss may result.  See . But where the contractor refused to complete a building, as here, it is not accurate to say that a claim *1242  was purchased by the expenditures necessary to complete the building.  In the latter*2710  case the money was spent to complete the building, not to pay for a claim.  The claim would have been the same had no money been spent, except that the completion of the building might have been necessary in order to minimize the damages.  We do not know how much was paid by the petitioner for the release of liens and as to the balance of the claim we hold that it is not a debt which could form the basis for a deduction under section 234(a)(5) of the Revenue Act of 1921.  The respondent contends that the cost of the building was the amount which the petitioner paid for it and not the amount which the contract guaranteed would not be exceeded in the construction of the building.  This contention seems sensible and under sections 235 and 215(a)(2) it would dispose of this case.  But suppose, for the sake of argument, that the Commissioner was in error in regard to the cost of the building and also that the petitioner had a claim against the F. E. Walters Co. which cost $242,243.08, nevertheless, this amount could not be deducted in the year 1921 under any circumstances unless the claim was ascertained to be worthless in that year.  From the evidence we are unable to determine that*2711  any claim which the petitioner had against the F. E. Walters Co. was ascertained to be worthless in the year 1921.  We have found as a fact, from the testimony of a witness, that when the petitioner started suit against the F. E. Walters Co. on May 5, 1921, it expected to recover.  Not until December 27, 1921, was the petitioner notified that on December 23, 1921, the F. E. Walters Co. had been adjudicated a bankrupt on its voluntary petition and that only $302.39 of assets were listed on the statement attached to the petition.  This, so far as we have been told, was the first intimation which the petitioner had that the F. E. Walters Co. was unsound financially.  The news was no doubt disturbing, yet it seems only reasonable to expect that one having a claim of approximately a quarter of a million dollars would not take the bankrupt's statement of its assets as conclusive, but would make some more thorough investigation to satisfy itself that its claim was really worthless.  We know now that the creditors eventually received nothing, but we have not been told of facts which the petitioner knew in 1921 which would show that it then ascertained the claim to be worthless.  Counsel*2712  several times asked for such facts, but the witness never gave any satisfactory answer.  Judgment will be entered for the respondent.