Court Opinion

ID: 4609098
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:44:01.433359+00
Date Added: 2024-06-11T07:53:49.610956
License: Public Domain

FRITZ HILL, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.  C. FRED BUECHNER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Hill v. CommissionerDocket Nos. 32338, 32339.United States Board of Tax Appeals22 B.T.A. 1079; 1931 BTA LEXIS 2020; April 6, 1931, Promulgated 1931 BTA LEXIS 2020">*2020  Year in which loss sustained by partnership keeping its books and filing returns on accrual basis deductible by partners keeping books and filing returns on cash basis, determined.  Benjamin Mahler, Esq., and Isidore Schlanger, C.P.A., for the petitioners.  Maxwell E. McDowell, Esq., for the respondent.  MATTHEWS 22 B.T.A. 1079">*1079  These proceedings, which were consolidated for hearing and decision, are for the redetermination of deficiencies in income taxes for the year 1923 asserted by the respondent against Fritz Hill in the 22 B.T.A. 1079">*1080  sum of $1,551.61, and against C. Fred Buechner in the sum of $4,319.55.  The error alleged by each petitioner is the disallowance of an amount claimed as a deduction for bad debts.  The facts were stipulated.  FINDINGS OF FACT.  The petitioners are members of the firm of Hill & Buechner, a partnership which was organized in 1916.  Fritz Hill and C. Fred Buechner, the petitioners above named, had each a 43 per cent interest in the partnership.  Herman B. Scharmann had the remaining 14 per cent.  On June 30, 1921, this third partner stepped out, his interest being acquired by the petitioners herein; a new partner, 1931 BTA LEXIS 2020">*2021  to wit, Louise M. Buechner, being then admitted, with an 8 per cent interest.  Thereafter Fritz Hill had a 42 per cent interest and C. Fred Buechner a 50 per cent interest in the firm of Hill & Buechner as reorganized.  The same books of account were continued.  The partnership of Hill & Buechner always kept its books and filed its returns on an accrual basis.  The petitioners Fritz Hill and C. Fred Buechner each kept his books and filed his return on a cash receipts and disbursements basis.  The partnership acted as factor and commission merchant in the handling of cotton goods and silks and in addition purchased a special class of cotton goods merchandise and sold same to Dent & Company, located at Shanghai, China.  The merchandise thus sold to Dent & Company was sold at a profit to Hill & Buechner.  It was a practice of Hill & Buechner when merchandise was sold to Dent & Company to ship the same to the International Banking Corporation, with a bill of lading attached together with drafts or bills of exchange.  These drafts were drawn on Dent & Company, were signed by Hill & Buechner, and were payable to the order of the International Banking Corporation.  When the International1931 BTA LEXIS 2020">*2022  Banking Corporation received drafts, it presented them to Dent & Company, which accepted same.  Thereafter, as payment of each draft was made by Dent & Company, the merchandise covered by the draft was surrendered to Dent & Company by the International Banking Corporation.  Upon receipt of the merchandise accompanied by the bill of lading and drafts, the International Banking Corporation would immediately advance to Hill & Buechner the amount called for by the draft, retaining the merchandise and the draft until Dent & Company paid the draft and redeemed the merchandise from the International Banking Corporation.  The sum advanced to the partnership by the International Banking Corporation was so advanced pursuant to a general letter of hypothecation executed by the International 22 B.T.A. 1079">*1081  Banking Corporation and Hill & Buechner (a copy of which was attached to and made a part of the stipulation.) On the books of Hill & Buechner, a charge to Dent & Company was made at the time the merchandise was shipped and a credit to Dent & Company was made at the time the money was received from the International Banking Corporation, on account of the drafts.  After such credit was made, 1931 BTA LEXIS 2020">*2023  the books of Hill & Buechner showed no further balance due on account of the merchandise shipped to Dent & Company, for which money was received from the International Banking Corporation, nor did the books show any liability to the International Banking Corporation for unpaid drafts still held by that company.  On June 30, 1921, when the third partner was paid out, Dent & Company had not yet paid for all the merchandise purchased from Hill & Buechner and there was still outstanding a large amount of drafts in the hands of the International Banking Corporation against which it held merchandise previously shipped for Dent & Company.  Between July 1, 1921, and the year 1923, Dent & Company continued to pay off some of the outstanding drafts held by the International Banking Corporation, thus receiving the merchandise covered by these drafts and continuing to purchase additional merchandise from the partnership, Hill & Buechner.  These latter purchases were treated in the same manner as the purchases made prior thereto, with bills of lading and drafts attached against which advances were made by the International Banking Corporation.  These later dealings with Dent & Company were1931 BTA LEXIS 2020">*2024  recorded in the same account with Dent & Company in which the former entries had been made.  In 1923 the firm of Dent & Company became bankrupt, with no assets available for creditors.  At that time, the International Banking Corporation still held a large sum of unpaid drafts, accepted by Dent & Company, which drafts were secured by the merchandise ordered by Dent & Company from the first partnership of Hill & Buechner.  The bankrupt firm was not able to meet these drafts.  In accordance with the general letter of hypothecation, the first partnership of Hill & Buechner had previously received from the International Banking Corporation the sums of money called for by such unpaid drafts, as heretofore stated.  After Dent & Company became bankrupt and during the year 1923, the International Banking Corporation sold the merchandise which it held under the terms of the hypothecation agreement against the unpaid drafts, credited the net proceeds against such unpaid drafts, and demanded payment from the partnership for the balance remaining unpaid.  This balance totaled $65,672.77.  Under date of October 18, 1923, the petitioners herein agreed to repay this sum, giving their 22 B.T.A. 1079">*1082 1931 BTA LEXIS 2020">*2025  personal notes to the International Banking Corporation, maturing $33,000 in 1924, $24,000 in 1925, and $8,672.77 in 1926.  Each of the petitioners herein, in his return for 1923, deducted one-half of the sum of $65,672.77 as a loss sustained in 1923 or as a bad debt ascertained worthless in 1923.  The respondent disallowed this deduction to each of the petitioners and proposes to allow each of them a deduction in the years 1924, 1925, and 1926 as the amounts were actually paid to the International Banking Corporation on the notes.  The petitioners never received either directly or indirectly any dividends or payments of any kind from the bankrupt concern Dent & Company.  The partnership of Hill & Buechner paid to the International Banking Corporation, continually and quarter-annually, the interest accrued on the $65,672.77 until that sum was paid off.  The 1923 partnership return of Hill & Buechner showed a net income of $62,016.04 and distributive shares of such income of $29,667.70 to C. Fred Buechner and $26,987.06 to Fritz Hill.  The net income of the partnership for 1923 was arrived at without deducting any part of the said $65,672.77 in issue arising out of the failure1931 BTA LEXIS 2020">*2026  of Dent & Company, as heretofore described.  Such deduction was not taken through the partnership books only because the firm members did not desire to show to the trade credit agencies a loss on the year's operations and thereby weaken its credit standing.  The letter of hypothecation is dated April 14, 1921, and is signed "Hill & Buechner." The method employed by the International Banking Corporation in handling the drafts drawn by Hill & Buechner on Dent & Company, which is set out in the stipulation, is in accordance with the terms of the letter of hypothecation.  It provides that in case the International Banking Corporation has to sell the goods securing the drafts and the net proceeds are insufficient to pay the amounts which have been advanced to Hill & Buechner on such drafts, Hill & Buechner will pay the deficiency.  The letter also provides: * * * that notwithstanding any alteration by death, retirement, introduction of new partners or otherwise in the persons from time to time constituting our firm or other the style or firm under which the business at present carried on by us be from time to time continued, this Letter and the powers and authorities hereby given1931 BTA LEXIS 2020">*2027  are to hold good as the Agreement on the part of the firm as aforesaid with you, and that each negotiation of a Bill or Bills hereunder is to be treated as a renewal by or on behalf of the firm as then existing of the terms of this Agreement.  * * * OPINION.  MATTHEWS: Under the terms of the letter of hypothecation, the partnership of Hill & Buechner as constituted after June 30, 1921, was liable to the International Banking Corporation in case the proceeds 22 B.T.A. 1079">*1083  of goods held as collateral security were insufficient to cover the advances which had been made on drafts drawn by the partnership of Hill & Buechner as constituted prior to June 30, 1921.  In amended petitions filed at the hearing, both petitioners allege that the liability to repay the International Banking Corporation the sum of $65,672.77 accrued and became fixed in 1923; that it was a liability of the firm of Hill & Buechner which had been contingent since 1920, but which became definite in 1923; and that the firm of Hill & Buechner was entitled to take as a deduction in 1923 the sum of $65,672.77, either as a bad debt upon the failure of Dent & Company, or as a loss upon such failure and resulting liability1931 BTA LEXIS 2020">*2028  to the International Banking Corporation in this amount.  The respondent contends that, since each of the petitioners kept his books on the cash basis, no loss was sustained by the petitioners until the notes were actually paid.  Section 218 of the Revenue Act of 1921 provides in part as follows: SEC. 218. (a) That individuals carrying on business in partnership shall be liable for income tax only in their individual capacity.  There shall be included in computing the net income of each partner his distributive share, whether distributed or not, of the net income of the partnership for the taxable year * * *.  * * * (c) The net income of the partnership shall be computed in the same manner and on the same basis as provided in section 212 * * * (with an exception not here pertinent).  In , we held that a partner who keeps his books on the cash basis is required to report his distributive share of the partnership income computed on the accrual basis, if that is the basis adopted by the partnership for keeping its books and reporting its income, when no question is raised that such methods do not correctly reflect the income1931 BTA LEXIS 2020">*2029  of the partnership.  We believe that the facts of this case support the position of the petitioners set out in the amended petitions.  The books of the partnership were kept on the accrual basis.  Under the terms of the letter of hypothecation the partnership became liable in 1923 to pay to the International Banking Corporation a definitely ascertained amount and this accrued liability of the partnership was deductible as a loss in computing the net income of the partnership for 1923.  The petitioners agreed to pay the outstanding liability to the International Banking Corporation and executed notes maturing in 1924, 1925, and 1926.  The execution of personal notes by the partners in 1923 amounted to a satisfaction of the partnership liability to the International Banking Corporation.  The fact that no entry was made with respect to the transaction on the books of the partnership does not operate to deny the partnership the right to deduct the loss.  22 B.T.A. 1079">*1084  Inasmuch as this loss is in excess of the net income reported by the partnership, there will be a partnership loss which will be divisible by the partners in the same proportion as net income was divided by them.  The1931 BTA LEXIS 2020">*2030  correct tax liability of each petitioner should be redetermined by disallowing the amount claimed as an individual loss sustained in 1923 and by recomputing the distributive share of partnership income so as to allow to each petitioner the benefit of his proportionate share of the net loss of the partnership for the taxable year.  Judgment will be entered under Rule 50.