American Warehouse Co. v. Commissioner

AMERICAN WAREHOUSE CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. American Warehouse Co. v. Commissioner Docket No. 29330. United States Board of Tax Appeals 19 B.T.A. 8; 1930 BTA LEXIS 2483; February 24, 1930, Promulgated *2483 1. Evidence considered and held that the petitioner was justified, under conditions then existing, in charging off a debt as worthless at the close of the taxable year. 2. In fixing inventory values of goods of different grades and quality, held that an arbitrary flat rate should not be used, but that each grade should be inventoried at its proper value. R. W. Franklin, Esq., for the petitioner. R. W. Wilson, Esq., for the respondent. MARQUETTE *9 This is proceeding for the redetermination of a deficiency in income taxes, asserted by the respondent for the fiscal year which ended May 31, 1923, amounting to $1,644.72. Two errors are alleged, viz: (1) That the respondent disallowed part of a bad debt charged off during the taxable year, because the amount disallowed was subsequently collected; (2) that the respondent failed to allow net losses sustained in fiscal years which ended May 31, 1921, and May 31, 1922, through arbitrary adjustment of petitioner's inventory. FINDINGS OF FACT. The petitioner is a Texas corporation, having its principal office at Galveston, Tex. It is engaged in the general warehouse and forwarding*2484 business, and as wholesale dealer in broomcorn. Its fiscal year closes on May 31. In 1918 one Oertling organized the Crescent Broom Co. of New Orleans. All of its stock was held by members of Oertling's family. The company bought broomcorn from the petitioner, the account being guaranteed by Oertling personally. About the latter part of May, 1922, this account amounted to between $3,700 and $4,000. The petitioner's manager then made a trip to New Orleans to investigate the situation. He found the business of the Crescent Broom Co. to be in poor condition. Its manufacture had dropped from 100 dozen to 10 dozen brooms per day and it was about to sell of a part of its shop machinery. Oertling, the president, who had guaranteed the account to the petitioner, was himself widely in debt. His stock in the Crescent Co. had been hypothecated and was about to be foreclosed. Oertling exhibited some jewelry of his wife's that was easily salable and intimated that he would sell it and pay the petitioner's account, but that was not done. Notes of the debtor company covering the amount owing were taken by the petitioner and discounted at the bank; they were not paid at maturity and*2485 the petitioner was obliged to take them up. Thereafter, and shortly before May 31, 1923, the petitioner's manager went to New Orleans a second time to investigate the Crescent Co.'s debt. He talked with men at the banks where Oertling did business, was informed that Oertling had nothing, and became convinced that the debt was entirely lost. He tried to get hold of the jewelry that Oertling had showed him on his first trip, but Mrs. Oertling had already disposed of it to take care of herself. No suit was filed to enforce collection on the notes, because the petitioner was convinced that such action would be useless. At the time of the first investigation the petitioner refused any further credit to the Crescent Co. but did continue to sell small quantities of *10 goods to that company, for cash only, as the needs of the Crescent Co. required. This cash basis arrangement continued through the taxable year and for one or two years thereafter; and then the Crescent Broom Co. went out of business. The cash sales to the Crescent Co. were made at prices a little higher than would have been charged under different circumstances. At the close of its fiscal year May 31, 1923, petitioner*2486 charged off as a bad debt the amount then owing on the Crescent Co.'s notes, $3,733.73. That amount was deducted by the petitioner from its gross income in its income-tax return for the taxable year. During the following fiscal year the petitioner succeeded in collecting from the Crescent Co. on its past due notes about $1,300. The amount so collected was reported as income by the petitioner for the year which ended May 31, 1924. Of the amounts so collected about $400 was derived from a sale of some of the debtor's machinery. The respondent has allowed to the petitioner a deduction for bad debts amounting to $2,415.56. He has disallowed $1,318.17 which is approximately, if not exactly, the amount petitioner collected during the year following the taxable period. The petitioner dealt in broomcorn of four different grades. At the close of its fiscal year on May 31, 1921, the petitioner had on hand broomcorn as follows: Grade Pounds Market value Short red common 24,000 $ 840.00 Short medium quality 20,000 1,000.00 Common and medium self-working 400,000 24,000.00 Medium to good quality fully self-working to hurl 141,671 11,687.86 Total value 37,527.86 *2487 Upon a tonnage basis the average value was $128.15 per ton. The respondent has allowed a flat rate of $66 per ton as the inventory value. OPINION. MARQUETTE: In this proceeding the first question is whether the facts justify the petitioner's determination that the debt owing to it by the Crescent Broom Co. was worthless at the close of the taxable year. The Revenue Act of 1921 provides in section 234(a)(5) that in computing the net income of a corporation subject to tax, there shall be allowed as deductions debts ascertained to be worthless and charged off during the taxable year; and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt *11 to be charged off in part. The petitioner has charged off its books as worthless a debt amounting to $3,733.73 and has deducted that amount in its income-tax return. The respondent has disallowed from the claimed deduction the amount of $1,318.17, which is approximately, if not exactly, what the petitioner collected during the year following that in which the debt was charged off. The balance of the deduction claimed, $2,415.56, was allowed by the respondent. It is rather apparent*2488 that the respondent's determination, which was made in May, 1927, was based upon facts developed subsequent to the taxable year, rather than upon the circumstances as they appeared in May, 1923, before the petitioner had collected any portion of the debt. The respondent does not question the correctness of the petitioner's action in ascertaining the worthlessness of the debt due, and writing it off, to the extent of $2,415.56. If the debt was worthless to that extent in May, 1923, we can not discover anything in the record to indicate that any part of it was probably collectible in view of the circumstances at that time. This Board has defined the ascertainment of the worthlessness of a debt, in whole or in part, as "the exercise of sound business judgment based upon as complete information as is practically obtainable." . And we have further declared that: "Such an ascertainment must be viewed in the light of the surrounding facts and circumstances, which must be such as to cause a reasonably prudent business man to conclude that the debt is worthless to the extent so ascertained. A remote hope of ultimate salvage is not sufficient*2489 to deny a deduction." . In the present instance the petitioner's manager made two trips to New Orleans during the taxable year which ended May 31, 1923, to investigate the condition of the debt then due to the petitioner. This manager learned that the debtor's business had shrunk about 90 per cent in volume in a few years and was in bad condition; he learned that Oertling, a stockholder in the debtor company and its real financial backer, was himself widely in debt; he learned from banks with which Oertling did business that the whole outlook as to collecting the debt was very dubious at best; he tried to obtain some personal property of Mrs. Oertling's, but was unable to do so. He concluded from all he had thus learned that the debt was lost and that collection could not be enforced by action in court, and as a result the petitioner charged the debt off its books of account as being worthless. In our opinion such action was justified by the situation as it then existed, as an exercise of sound business judgment and discretion. As was said in *2490 : "The taxing act does not require the taxpayer *19 to be an incorrigible optimist." See ; . The determination of the respondent was erroneous and the amount of the debt charged off by the petitioner should be allowed in full. Another question here presented has reference to the correctness of the petitioner's inventory of broomcorn on hand in May 31, 1921. There is no dispute as to the quantity of goods inventoried; but the respondent has valued the goods at a flat rate of $66 per ton. The facts show that the petitioner had on hand broomcorn of four different grades, each grade having a different value, and that the average value of all grades was $128.15 per ton. The respondent's valuation, therefore, was far too low. It should be set aside and the petitioner's inventory valuation should be used in recomputing the tax. Judgment will be entered under Rule 50.