Court Opinion

ID: 4589987
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:02:44.118097+00
Date Added: 2024-06-11T07:50:23.216111
License: Public Domain

FOWLER BROTHERS & COX, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Fowler Bros. & Cox, Inc. v. CommissionerDocket No. 101054.United States Board of Tax Appeals47 B.T.A. 103; 1942 BTA LEXIS 731; June 16, 1942, Promulgated *731  Pro rata distribution in partial liquidation of petitioner where stock certificates were surrendered and canceled and new certificates issued in the amount of the par value of the stock less the amount of the distribution, held "properly chargeable to capital account" within the meaning of Revenue Act of 1936, section 115(c), and consequently not chargeable to earnings or profits for the purpose of a dividends paid credit under section 27(f).  George E. H. Goodner, Esq., for the petitioner.  Frank M. Thompson, Jr., Esq., for the respondent.  OPPER*103  Petitioner contests the determination of deficiencies in income tax and personal holding company surtax for the year 1937 in the respective amounts of $510.91 and $7,119.37, together with a penalty of $1,779.84 for failure to file a personal holding company return.  Petitioner claims an overpayment of its income tax for the year 1937.  The issues are whether petitioner is entitled to (1) a bad debt deduction, (2) a deduction for officers' salaries alleged to have been accrued but not paid in the tax year, (3) a dividends paid credit, and (4) a specific credit of $5,000 in computing its surtax*732  on undistributed profits.  Petitioner has abandoned the assignment of error concerning the 25 percent penalty for failure to file a personal holding company return in the event it is liable for personal holding company surtax.  FINDINGS OF FACT.  Petitioner was a Tennessee corporation organized in 1920 with its principal office in Knoxville, Tennessee.  Its income tax return for the year 1937 was filed with the collector for the district of Tennessee.  More than 50 percent of its stock was owned throughout the tax year by two individuals and more than 80 percent of its 1937 income was within the definition of personal holding company income.  Petitioner did not file a personal holding company return for the year 1937, as its president considered it to be a liquidating company and not a personal holding company.  Petitioner was engaged in the wholesale grocery business until 1932 when it disposed of all of its merchandise and inventory.  The stockholders at a special meeting held on June 2, 1932, authorized the sale of the merchandise and inventory, it being anticipated that payment of the purchase price by the vendee would be completed by the end of the year and that petitioner*733  would liquidate, to which end its president was authorized to negotiate the disposition of its remaining *104  assets to the best advantage possible.  Petitioner's principal assets remaining after the sale consisted of accounts receivable, the building in which the grocery business had been conducted and the land upon which the building was situated, and one-third of the capital stock of Pay Cash Grocery Co., the wholesale grocery company which purchased petitioner's merchandise and inventory.  Petitioner's president and secretary-treasurer began to collect its accounts receivable and endeavored to sell the other remaining assets.  Business conditions were such, however, that the remaining assets could be disposed of only at a great sacrifice, and during the next four or five years the president was of the opinion that to have accepted the prices offered for them would not have returned to the stockholders their capital investment.  During a part of this period petitioner rented its building and from time to time made collections on its accounts receivable.  The stock of Pay Cash Grocery Co. was held by petitioner during all of this period.  By 1937 it still had not succeeded*734  in selling the remaining assets.  The stockholders at their annual meetings held on January 28, 1933, and March 28, 1935, resolved that the officers be given all the time they deemed necessary to liquidate the business, and compensation for the services of the president and secretary-treasurer during the liquidation period was provided for in the following motion passed by the board of directors on January 28, 1933: The President stated that on account of the present unfavorable business conditions, it would take quite a long time to complete the liquidation of the business in its entirety, which would require much work on the part of the President and the Secretary-Treasurer.  He suggested that he be given authority to fix a reasonable fee for the services of these two officers during the period of liquidation.  Moved * * * and seconded * * * that the above authority be given to the President.  Motion carried.  The compensation so authorized was fixed by the president in accordance with the amount of services rendered and the directors agreed that the fees paid were reasonable.  The compensation was not paid at any set time or for any regular period, but the amount thereof was*735  determined and paid in 1935, 1936, and 1938, the payments in each instance representing reimbursement for services rendered during the interval following the next preceding payment.  According to petitioner's tax returns the president was paid $5,400 in 1935 and $2,400 in 1936, and the secretary-treasurer, who devoted less time to the liquidation than the president, was paid $1,200 in each of the years 1935 and 1936.  No compensation was paid or accrued on petitioner's books during the tax year 1937.  On December 23, 1938, final fees for services rendered were charged on the books and paid to the president and secretary-treasurer in the respective amounts of $3,900 and $1,500.  The officers figured that $2,400 of the amount paid the president and *105  $1,200 of that paid the secretary-treasurer constituted remuneration for their services during the year 1937.  Petitioner was not very active during 1937, the services rendered during that year by the two officers being substantially the same as had been rendered during the preceding years and consisting of the receipt of rent, attempts to collect accounts and dispose of the other assets, and general supervision and care of the*736  remaining properties.  From the time it was organized in 1920 until it discontinued the wholesale grocery business in 1932 petitioner was on the accrual basis, filed its returns on that basis, and used inventories in computing profit and loss.  After disposing of its merchandise in 1932 it had no further need for, nor did it employ, an inventory on its books.  Petitioner never applied to the Commissioner for permission to change its method of accounting from the accrual to the cash basis and no such permission was ever specifically granted.  On petitioner's income tax returns for the years 1933 to 1937, inclusive, the question "Is this return made on the basis of cash receipts and disbursements?" was answered in the affirmative.  The first three of these returns disclosed net losses and no tax liability, but those for 1936 and 1937 reported net income and taxes due thereon.  No deduction was taken in the return for the year 1937 on account of the accrual of compensation for the president and secretary-treasurer.  Juring the tax year petitioner was not on the accrual basis.  Petitioner was a depositor in the East Tennessee National Bank.  It had on deposit in a regular checking*737  account the sum of $7,972.76 in 1933 when the bank closed.  A receiver was appointed for the bank and a committee was formed to work out a reorganization, which finally resulted in the organization of the Park National Bank, to which some of the closed bank's assets were transferred.  The East Tennessee National Bank was not reopened and in 1940 the receiver was still handling its affairs.  Petitioner's deposit was reduced on January 29, 1934, to $7,175.33 by reason of a 10 percent distribution by the receiver.  Portions of the amount of the deposit were received over a period of years.  When the bank closed petitioner was indebted to it on a note which the receiver attempted to collect.  Petitioner made payments thereon, but refused to reduce the unpaid balance below the amount of petitioner's deposit in the bank, taking the position that the deposit should be used as a set-off against its liability on the note.  The receiver advised petitioner that this could not be done, stating that the note was in the hands of the Reconstruction Finance Corporation.  Efforts were made by petitioner to have the deposit set off against its note liability during the following years through and*738  beyond the tax year 1937.  The receiver was apparently willing to let the matter be carried along, and while he demanded payment of the note from time to time petitioner *106  always refused to pay it.  An attorney was representing petitioner in the matter.  Demand for payment of the note was made and refused during 1937, and the receiver in 1937 likewise refused petitioner's requested set-off.  Petitioner's president talked with three or four local attorneys who expressed the opinion that the deposit could not be offset against the note; and in 1937 the president and secretary-treasurer made the decision to charge off the deposit as a bad debt.  The charge-off was made on petitioner's books and the amount of $7,175.33 was deducted on its return for that year.  The decision to charge off this item was made in the same manner in which ordinary accounts receivable were charged off as worthless, that is, if the officers felt that an account had become worthless it was charged off, and if anything was collected on it in the next year the account was set back upon the books.  The decision to charge off the amount of the deposit as a bad debt was not based on any particular event or*739  circumstance.  Conditions looked better in 1937 than they did in 1933.  The debt was not worthless in 1937 and was not ascertained to be so.  On December 23, 1938, petitioner sold all of its remaining assets to Fowler Brothers Co., a furniture company, and surrendered its charter and dissolved.  The president of petitioner was also president of Fowler Brothers Co., and the latter company assumed all of petitioner's liabilities.  The sale was made at a price that would return to petitioner's stockholders the balance of their capital investment in petitioner, that is, the par value of its outstanding stock, or $32,572.50.  On December 23, 1938, petitioner had a book surplus of $72,362.84, which was charged to profit and loss in the closing entries on its books.  When Fowler Brothers Co. acquired petitioner's assets and assumed its liabilities in December 1938 the balance due on petitioner's note to the bank was $7,816.25.  The claim against the bank for the amount on deposit, having been charged off by petitioner in the preceding year, was not included on its books among the assets transferred to Fowler Brothers Co.  However, the latter, through its president and an attorney who*740  was employed to handle the matter, continued the efforts to secure a discharge of the note by applying against it the amount of the deposit, and these efforts were finally successful in 1940 or 1941.  The receiver by that time had paid off the bank's indebtedness to the Reconstruction Finance Corporation, and petitioner's note having been returned to the bank, it allowed the amount on deposit to be applied in payment of the note without any question.  Liquidating dividends were duly authorized and paid pro rata to the stockholders of petitioner during some of the years from 1932 to 1938.  In each instance the stock certificates were surrendered by the stockholders and canceled and new certificates in the amount of *107  the par value of the stock after deducting the amount distributed were issued.  In this manner the par value of the outstanding stock was reduced from $200,000 in 1932 to $32,572.50 in December 1938.  One of the liquidating dividends, in the amount of $10,000, was declared and paid during the tax year 1937.  Petitioner's stockholders did not repost any part of the 1937 distribution in their individual income tax returns, but applied the amounts received against*741  the bases of their stock.  Petitioner's return for the year 1937 disclosed surplus of $55,684.36 at the beginning of the year and $58,906.77 at the close of the year, but the amounts are entered both as "earned surplus and undivided profits" and as "paid in or capital surplus." During 1937 petitioner received gross income of $16,578.12, consisting of dividends on its Pay Cash Grocery Co. stock in the amount of $13,300, rent in the amount of $2,475, and collections on accounts previously charged off in the amount of $803.12.  In the notice of deficiency respondent denied petitioner's claim that $3,600 should be allowed as a deduction for compensation of officers on the ground that no payments of compensation had been made in the tax year and that its books were kept and its return filed on the cash receipt and disbursement basis.  He also determined that the deposit in the East Tennessee National Bank "was not worthless in the year 1937" and therefore disallowed the bad debt deduction claimed on that account.  He further determined that the distribution of $10,000 to petitioner's stockholders during the tax year constituted a distribution in partial liquidation and was not "considered*742  a distribution of earnings or profits." In accordance with the provisions of Revenue Act of 1936, section 27(h), he held that this distribution did not entitle petitioner to a dividends paid credit.  OPINION.  OPPER: The first issue is the deductibility of an assertedly worthless debt consisting of the balance of petitioner's deposit in a closed bank.  Simultaneously there was owed to the bank by petitioner a note at least as large as the unpaid deposit.  The record does not succeed in clarifying the facts to our satisfaction, but it does appear that from the beginning efforts had been made on petitioner's behalf to offset the one debt against the other, which if successful would, of course, be tantamount to a collection of petitioner's deposit in full.  Up to and including the tax year these efforts had been unavailing.  But the matter was still in abeyance, petitioner was still claiming, and the bank's receiver still denying the validity of petitioner's contention.  No definitive action had as yet been taken by either party to the controversy.  *108  In the following year petitioner dissolved and transferred assets and liabilities to a successor corporation with a similar*743  name, and apparently similar officers and stockholders, but even at that time the matter was still in dispute.  One of the points which remains in obscurity on the whole record, although the attention of petitioner's counsel was directed to it at the hearing, is the treatment of the deposit on this transfer.  We do not know whether it was included among the assets turned over to the new company and if so what was paid for it, and if not when or for what consideration it was subsequently transferred.  It is clear, however, that eventually it must have been obtained by the successor, for several years later the new company was successful in offsetting the deposit against the note liability which it had assumed, a result which seems to us to have been possible only on the assumption that the same entity was in a position to operate as both debtor and creditor.  Passing the point that no evidence appears upon which a determination of the financial condition of the debtor bank and of the collectibility of the deposit from the bank's assets can be independently weighed by the Board, see *744 ; , it is apparent from the record that there was no new development in the tax year respecting the ability of the bank to pay, which constituted the ground for the exercise of judgment by petitioner's officers in that year in charging off the deposit or ascertaining any impossibility of collecting it.  In answer to the question, "Did conditions in general look worse in 1937 than they did in 1933?" petitioner's president testified "No, they did not * * * they looked better." What apparently induced the 1937 charge-off, if that can be told from this record, was that petitioner's president "talked to some three or four attorneys around our town there about it and they didn't think it was possible for us to ever get it offset." This, as the later events show, was erroneous advice, and in fact petitioner and its successor did not follow it; for, as we have already indicated, the claim was never abandoned and petitioner's successor was able a few years later to accomplish the settlement.  If therefore the determinative factor relied upon to single out the tax year for*745  the chargeoff off was the assumption founded upon advice received in that year that no offset would eventuate, the conclusion must be that there could have been no ascertainment of worthlessness at that time since in fact the debt was, and later proved to be, entirely collectible.  . There is some suggestion that since the ultimate collection redounded to the benefit of petitioner's successor and since the transfer of petitioner's assets and its liquidation had intervened, the debt *109  proved to be worthless as far as petitioner was concerned.  There are numerous objections to any reasoning of that nature.  The one that we think is sufficient is that if the transfer of assets and the liquidation and dissolution which took place in a subsequent year were what deprived petitioner of the eventual payment of the debt, petitioner's loss would have to be claimed in the year when the transactions said to be responsible for it took place and not in the tax year before us.  There was no bad debt in 1937 nor in fact at any time.  Petitioner's claim of worthlessness therefore can not*746  be sustained and respondent was correct in disallowing it.  The next question is whether a deduction for officers' salaries not recorded on the books, nor claimed in petitioner's return, nor paid during the tax year, may now be allowed as a deduction.  Without disposing of his other contentions, it seems to us respondent's action must be upheld on the elementary ground that petitioner was on the cash basis and can not be permitted to deduct items not paid during the tax year.  It is true that petitioner asserts it was actually upon the accrual basis but the only foundation for this assertion is that prior to petitioner's withdrawal from active business, many years before, it had conformed to that description.  For five successive years, including the one before us, its returns contained a statement that they and its books were based on cash receipts and disbursements.  This statement is borne out by the admitted failure to show on the books of account or the return itself any item of salaries during the tax year, a procedure which would, of course, be entirely understandable only if the cash basis were used, since if salaries were due they were not actually paid.  We sustain*747  respondent * * * in denying the deduction * * * as salary * * * for we are not satisfied that petitioner's accounts were kept on an accrual basis so that this item was properly accruable in that year.  While petitioner's chief witness testified that the accounts were so kept, that testimony is in conflict with the statement sworn to on the return that the accounts were kept on a basis of cash receipts and disbursements.  This variance was not explained at trial; furthermore, the details of the return itself indicated that the statement thereon is correct.  Consequently, we have relied upon it and found as a fact that petitioner's accounts were kept on the cash basis.  The salary, therefore, is not deductible as an expense until paid.  [; affirmed per curiam (C.C.A., 6th Cir.), The attempt to convert these returns into accrual basis computations on the ground that respondent's consent to a change from the prior method of reporting was never obtained, Regulations 94, art. 41-2, must likewise fail.  Respondent's consent can be implied from his acceptance of a changed method of reporting, without*748  rejection or other indication of his nonacquiescence.  . The disallowance of the claimed deduction is approved. We are next confronted with the question whether petitioner is entitled to a dividends paid credit both for computing its undistributed surplus tax and its personal holding company tax.  Petitioner distributed the sum of $10,000 in the tax year in the course of its liquidation.  It is now settled that the fact that this was a distribution in liquidation rather than a dividend taxable to the stockholders does not of itself eliminate its use in computing the dividends paid credit.  . The provision of the Revenue Act however which authorizes this result (section 27(f)) is limited in application to "the part of such distribution which is properly chargeable to the earnings or profits accumulated after February 28, 1913." The function of this phrasing is discussed in *749 :* * * The line drawn in all of the revenue acts between profits accumulated before the enactment of the first income tax act and after that date for distinguishing capital and income furnishes the reason for the insertion of the clause in subsection (f).  Section 27 deals with a credit to the distributing corporation and the phrase finds its proper office in limiting the amount of the distribution in liquidation which may be considered a dividend from earnings or profits as distinguished from one composed of capital.  In the present case the distribution in question was one of a series which up to the close of the tax year had failed to complete the return of the capital account.  It appears from the evidence, moreover, that when the liquidation was terminated there had still been no distribution out of petitioner's earnings or profits.  Since we are dealing with distributions in partial liquidation, the provisions of 115(c) rather than necessarily those of 115(b) formulate the test to be applied. *750 . We are therefore not commanded to view these as distributions of the most recently accumulated earnings and profits, if from other circumstances we can determine whether they are properly chargeable to capital account; for, if so, section 115(c) expressly excludes them from treatment as dividends both under 115(c) and under 27(f).  . In this case we know that accompanying the payment to the stockholders was a cancellation and reissuance of the capital stock resulting in a reduction of the capital account on the books of the company and of the shares outstanding in the hands of the stockholders.  This is the most persuasive evidence that the distributions here in question were properly chargeable to capital account.  ; affd. (C.C.A., 4th Cir.), . They are not, therefore, to be treated as dividends nor as a ground for permitting a dividends paid credit under section 27(f).  *111  The remaining questions can be disposed of without difficulty.  Petitioner's assertion of error in the computation*751  of the specific credit permitted by section 14(c)(1) must be rejected on the authority of . Although not expressly conceding the legal conclusion, petitioner's admissions of fact make it clear that it is a personal holding company subject to the provisions of section 351.  And it explicitly withdraws any controversy relating to the penalty for failure to file a personal holding company return.  Decision will be entered for the respondent.