American Foundry Co. v. Commissioner

AMERICAN FOUNDRY CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. American Foundry Co. v. Commissioner Docket No. 10497. United States Board of Tax Appeals 11 B.T.A. 575; 1928 BTA LEXIS 3774; April 13, 1928, Promulgated *3774 The petitioner as of June 30, 1920, charged off an a debt ascertained to be worthless $94,619.03 owed to it by the Maxwell Motor Co. The debtor was ascertained to be in financial difficulties although not in the hands of a receiver at June 30, 1920. Held, that the amount charged off was not a legal deduction from gross income for the fiscal year ended June 30, 1920. John A. Selby, Esq., and Lawrence A. Baker, Esq., for the petitioner. J. L. Backstrom, Esq., for the respondent. SMITH *576 This is a proceeding for the redetermination of a deficiency in income and profits tax for the fiscal year ended June 30, 1920, in the amount of $33,954.20. The petitioner alleges as error in the determination of the deficiency as follows: (1) Failure to allow as a deduction from gross income for the fiscal year ended June 30, 1920, $94,619.03 claimed as a deduction on account of bad debts. (2) Failure to employ the proper comparatives in the computation of the excess profits tax for the fiscal period ended June 30, 1920, in accordance with the requirements of section 328 of the Revenue Act of 1918. FINDINGS OF FACT. The petitioner is*3775 an Indiana corporation with its principal offices in Indianapolis. During the fiscal year ended June 30, 1920, the petitioner was engaged in the business of manufacturing automobile castings. Among its customers was the Maxwell Motor Co. of Detroit, Michigan, which during the year 1919 was taking about one-third of the product of the petitioner, and during the first six months of 1920 from 60 to 70 per cent of the output. All of the capital stock of the petitioner was pledged to the Fletcher American National Bank of Indianapolis as collateral for loans made to it by that institution. Under an arrangement between the petitioner and the Maxwell Motor Co., the latter company was required to pay the petitioner twice a month, on the 10th and 25th, for castings furnished it by the petitioner between the 15th and 30th of each month, and the 1st and 15th of each month, respectively. During the last six months of 1919 and the first 90 days of 1920, the Maxwell Motor Co. paid the invoices of the petitioner corporation promptly. In the month of April the Maxwell Motor Co. defaulted in payment of invoices rendered by the petitioner corporation. It did, however, make remittances*3776 on account during April and May and, possibly, June, 1920. On June 30, 1920, the amount owed to the petitioner by the Maxwell Motor Co. for castings billed to it amounted to $94,619.03. The petitioner also claimed an additional amount from the Maxwell Motor Co. in respect of castings made for it by the petitioner but which had not been shipped and billed prior to June 30, 1920. During June, 1920, Blaine H. Miller, general manager of the petitioner, visited Detroit and called upon officials of the Maxwell Motor Co. for the purpose of collecting the outstanding account. The mission failed and Miller returned to Indianapolis and met with the board of directors of the American Foundry Co. At that meeting, *577 which was held after June 30, 1920, but before the books of the petitioner for the fiscal year ended June 30, 1920, had been closed, a resolution was passed authorizing the charge-off of $94,619.03 owed to it by the Maxwell Motor Co. on June 30, 1920. The amount thus charged off was claimed as a deduction from gross income of the petitioner for the fiscal year ended June 30, 1920, which deduction was disallowed by the respondent in the determination by him of a deficiency*3777 for such fiscal year. In August, 1920, the petitioner received from the Maxwell Motor Co. trade acceptances payable at a future date. These acceptances were discounted by the Fletcher American National Bank in order to enable the petitioner to continue its manufacturing operations. The trade acceptances were paid by the Maxwell Motor Co. prior to December 31, 1920. OPINION. SMITH: Two questions are presented by this proceeding: (1) The SMITH: Two questions are presented by this proceeding: (1) The ended June 30, 1920, $94,619.03 charged off as a bad debt, which amount represented an indebtedness to it of the Maxwell Motor Co. of Detroit, Mich.; and (2) whether the respondent failed to employ proper comparatives in the computation of the excess profits tax for the fiscal year ended June 30, 1920, in accordance with the requirements of section 328 of the Revenue Act of 1918. At the hearing of this case the petitioner waived the second point provided the Board should hold that it was entitled to deduct from the gross income of the fiscal year ended June 30, 1920, the full amount of the alleged bad debt charged off. It was the ruling of the Board that if the disallowance*3778 of the bad debt deduction was confirmed by the Board, the petitioner should have the right to a further hearing with respect to comparatives. Section 234(a) of the Revenue Act of 1918 provides in part: That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions: * * * (5) Debts ascertained to be worthless and charged off within the taxable year. The evidence of record shows that the petitioner failed to receive prompt remittances from the Maxwell Motor Co. beginning in April, 1920. The capital stock of the petitioner was pledged to the Fletcher American National Bank of Indianapolis as security for advances made to the petitioner. The bank kept in close touch with the operations of the petitioner and contrdled the board of directors. The experience of the bank had been that automobile manufacturers which had large inventories and which could not move them were *578 poor risks. Officials of the petitioner had gone to Detroit to determine the status of the Maxwell Motor Co. They found that the company was making a few sales of its product from April to June, 1920; that where the company had shipped*3779 cars to dealers with sight drafts attached to the bills of lading, the cars were being returned to the company in large quantities. They also found that although the company had large assets there was included among such assets an item of patents and good will of approximately $25,000,000. Creditors were clamoring for payment and the Maxwell Motor Co. did not have the cash with which to pay the creditors. When these facts were communicated to the board of directors of the petitioner the board of directors authorized the charge-off as a bad debt as of June 30, 1920, of $94,619.03. Subsequent events showed that the Maxwell Motor Co. was in a better financial condition than the officers of the petitioner believed to be the case. Under date of August 28, 1920, the Chase Securities Corporation addressed a letter to the Fletcher American National Bank reading in part as follows: The latest figures submitted by the Company [Maxwell Motor Co.] show current assets, including inventories but excluding all good will items, exceeding current liabilities of more than $20,000,000. We are of the opinion, however, that rather than consider the sacrifice of inventories to enforced liquidation, *3780 it will be wise to extend a part of the Company's existing obligations provided a comprehensive plan can be effected for the continuance of its business under favorable conditions. The letter also stated that Walter P. Chrysler, lately vice president of the General Motors Co., was to become associated with the Maxwell Motor Co. A creditor's belief that a debtor is in bad financial condition is not evidence of worthlessness. . In , we stated: Under the provisions of this section [section 234(a)(5)] two events must have occurred before the taxpayer was entitled to write off the balance due from the Piedmont Commission Co. as bad debt, viz: (1) The debt must have been ascertained to be worthless, and (2) it must have been charged off within the taxable year. * * * The word ascertain has a definite and common meaning, both in law and in ordinary usage, i.e., "To make certain to the mind; to make sure of; to determine." * * * * * * Before a taxpayer is entitled to take a deduction for a "debt ascertained to be worthless," he must take reasonable steps to determine*3781 that there is no probability of payment or collection and have prima facie evidence to prove that the debt has no value. Under the facts shown in this appeal, the time was too limited and the [*] too restricted for us to consider that the taxpayer had thoroughly investigaed the resources of the Piedmont Commission Co. or that sufficient effort had been made to make sure that the compromise agreement would not be fulfiled or that the company could not or would not pay. This taxpayer has not made a showing which would entitle it to consideration under this test, and is first contention must be denied. *579 The evidence in the case at bar does not in our opinion show an ascertainment of worthlessness by the petitioner of the debt due it from the Maxwell Motor Co. We may well believe that the petitioner had a serious doubt as to whether the amount owing to it by the Maxwell Motor Co. would ever be collected in full. We are persuaded, however, that the petitioner had no reasonable ground for believing that the account would not at least be collected in part. The Maxwell Motor Co. had large assets, as shown by the letter received by the petitioner from the Chase*3782 Securities Corporation under date of August 28, 1920. The fact that the Maxwell Motor Co. was doing a very large business was clearly apparent to the petitioner which was manufacturing most of the castings used by it. The charge-off made by the petitioner was apparently made through an abundance of caution and not as a result of an ascertainment of worthlessness. The disallowance by the respondent of a bad debt deduction is sustained. An order will be entered restoring this proceeding to the General Calendar for hearing under Rule 62 of the Board as to proper comparatives for the determination of tax liability under section 328 of the Revenue Act of 1918.