Lewis v. Commissioner

JOHN B. LEWIS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Lewis v. Commissioner Docket No. 26118. United States Board of Tax Appeals 19 B.T.A. 997; 1930 BTA LEXIS 2283; May 19, 1930, Promulgated *2283 1. BAD DEBTS - LOSSES. - Certain checks payable to the petitioner in Germany in German marks, and an open bank account standing to the credit of the petitioner in a German bank, also payable in German marks, are shown by the evidence to have depreciated during 1922 to so small a value that the conclusion of the petitioner that they were practically worthless, was justified, and since the worthlessness was sustained in 1922 and it was charged off to profit and loss in 1922, held, the deduction from income is properly allowable in that year. 2. The amount of an open account receivable upon the books of the petitioner was transferred in part to an account headed "Doubtful Accounts Receivable," at the and of 1921, and at the end of 1922 the balance of the account was similarly transferred; the account "Doubtful Accounts Receivable," however, was thereafter treated as having asset value by the petitioner, although being excluded from the net worth in computing net profits subject to commissions payable to employees. Held, the debt was not charged off to profit and loss within the taxable years and may not be allowed as a deduction. J. F. Armstrong, Esq., for the*2284 petitioner. J. L. Backstrom, Esq., and P. A. Sebastian, Esq., for the respondent. TRUSSELL *997 This is a proceeding for a redetermination of deficiencies in income taxes determined by the respondent as follows: for 1922, $3,468.45; for 1923, $533.77. Petitioner alleges error in that (1) a deduction, $2,353.20 of increase in cost of goods sold, has not been allowed in 1923; (2) a deduction amounting to $5,590.84 has not been allowed in 1922 as the amount of bad debts ascertained to be worthless and charged off in 1922, or, in the alternative, as the amount of a loss sustained in that year, or, in the next alternative, if not allowable in 1922, then the deduction should be allowed in 1923; (3) a deduction has not been *998 allowed in 1922 of a bad debt of the Seymour Chemical Co. of Providence, R.I., which was ascertained to be worthless in whole or in part, and charged off in that year. FINDINGS OF FACT. The petitioner is a resident of Providence, R.I., and is and was during the taxable years engaged in the business of importing chemicals, dyestuffs, and other materials for the purpose of resale to his customers. To facilitate his purchases*2285 in Germany incident to the operation of his business the petitioner was accustomed to purchase checks, drafts or credits payable in Germany in German marks. The petitioner purchased in this country, with United States money, checks drawn on financial institutions located in Germany and payable upon presentation in Germany in German marks as follows: On August 8, 1921, face value 200,000 marks, cost $2,505; on December 2, 1921, face value 100,000 marks, cost $447.50; on January 13, 1922, face value, 100,000 marks, cost $540, or an aggregate cost of $3,492.50. Said checks were on hand in possession of petitione on December 31, 1921, in the amount of 300,000 marks, and on December 31, 1922, in the amount of 400,000 marks, and they are still on hand and in his possession, having never been collected or otherwise disposed of. The petitioner purchased prior to August 25, 1922, an amount of 106,514.9 marks at a cost to him of $2,098.34, and deposited said marks to his credit repayable in German marks with a firm of bankers at Frankfort, Germany. This bank account has never been realized upon in any manner. During 1922 the petitioner ascertained that the said checks and bank deposit*2286 account were worthless, and charged off the cost thereof to profit and loss upon his books. The rates of exchange values for German marks expressed in United States currency were as follows: On January 1, 1922, .545 cents; on January 1, 1923, .0138 cents; on December 31, 1923, .0000000000232 cents. Prior to December 31, 1921, the Seymour Chemical Co. of Providence, R.I., was indebted to the petitioner in the amount of $7,269.13. The Seymour Chemical Co. made an assignment some time in either 1921 or 1922. Its assets were realized upon and ultimately an amount of $220.18 was collected in cash by the petitioner. No further collections or other realizations were ever made upon the account. The account was carried on the books of the petitioner in a ledger containing individual accounts receivable. On December 31, 1921, the petitioner credited the individual account receivable of the Seymour Chemical Co. with an amount of $3,653.94 and he charged the same amount to an account in the general ledger headed "Doubtful *999 Accounts Receivable." On December 31, 1922, the petitioner transferred by similar procedure the balance of the account $3,615.19 to the account headed*2287 "Doubtful Accounts Receivable," thus closing out the individual account receivable of the Seymour Chemical Co. The debit balance of the account headed "Doubtful Accounts Receivable" was carried as representing an asset in the net worth of the business in financial statements issued by the petitioner in every year until December, 1925, when it was charged off to profit and loss account. In computing commissions payable to employees based upon net profits, the petitioner excluded the amount of the debt of the Seymour Chemical Co. It is determined by stipulation of the parties that the amount of $2,353.20 was an additional cost of goods sold in 1922 which is properly deductible from income in that year, said cost having been understated through erroneous bookkeeping. In determining the deficiencies the respondent has not allowed the cost of goods sold, $2,353.20, and the claimed deductions of bad debts or losses, $5,590.84 and $7,269.13, in either of the taxable years. OPINION. TRUSSELL: The first issue is purely a fact question which arose due to erroneous bookkeeping, and which has been settled by the parties through stipulation. The increase, $2,353.20, in the cost of*2288 goods sold during the taxable year should be allowed in computing the gross income. The second issue relates to certain deductions claimed by the petitioner but disallowed by the respondent. The petitioner was accustomed to acquire from time to time foreign credits for use in paying in foreign money for its foreign purchases. During 1921 and 1922 he purchased in this country for United States money certain checks drawn upon financial institutions in Germany and payable in marks upon presentation. In another transaction in 1922 he placed to his credit in an open deposit account in a German bank an amount of marks which was repayable in marks. We are satisfied that these transactions were purely incidental to the business of the petitioner, and they were neither investments nor speculations. During 1922 the petitioner ascertained to his satisfaction that the checks and the bank account were practically worthless, due to the enormous depreciation of the German mark and the then apparent improbability of any return of value. The cost thereupon was charged off to profit and loss within the taxable year 1922. There is no dispute over the fact of ultimate loss or of the amount, *2289 and the respondent now admits that the deduction should be allowed, but claims it should be allowed in 1923 rather than in 1922. *1000 There is considerable argument between the parties of the question of law whether the deductions are allowable as "bad debts" or as "losses," the point involved being that with respect to bad debts the statute allows a partial write-off where ascertained to be worthless in part, and locates the allowance of the deduction within the year in which ascertained and charged off; on the other hand, losses are deductible only in the year in which sustained. See section 214(a)(4)(5) and (7) of the Revenue Act of 1921. The respondent offers a number of citations of cases wherein the losses claimed were required to be determined by closed transactions or there was a lack of satisfactory proof of worthlessness, or, in some of the cases, the court had under consideration provisions of the Revenue Act of 1918 which failed to include an allowance of partial worthlessness of bad debts. Because of our findings of fact, we do not think that these decisions are controlling here. We are satisfied that the petitioner delieved at the end of 1922 that the cost*2290 of the checks and the bank deposit was definitely lost and he then determined to abandon the assets as worthless. We think he had a satisfactory basis for his conclusion and was justified in consistently charging off the cost to profits and loss. We do not think that the amount of depreciation which the mark had suffered by the end of 1921 (the previous year) was sufficient to justify a partial deduction at that time; furthermore, it is admitted by the respondent that the value of the mark was fluctuating up and down at that time. At the end of 1922, however, the depreciation of the mark had reached tremendous proportions, apparently without hope of recovery, and we see no reason for a further deferment of the charge-off. Under the circumstances, then, the losses were definitely and satisfactorily determined at the end of 1922, and being sustained within 1922, ascertained within 1922, and actually charged off within 1922, they are properly allowable deductions from income whether one chooses to ticket them as "bad debts" or as "losses." The deduction claimed by the petitioner should be allowed in 1922. In the remaining issue we are required to give consideration to a claimed*2291 deduction which relates to an undisputed bad debt. The original amount of the debt and the small amount ultimately recovered thereon are in evidence, and are not in controversy. The question for decision is whether the petitioner ascertained the debt to be worthless in 1922 and, also, whether the bookkeeping procedure which he followed effected a charge-off within the taxable year as required by section 214(a)(7) of the Revenue Act of 1921. We are satisfied that the debtor made an assignment of its assets, whereupon they were inventoried, and it is probable that the petitioner at that time ascertained that the account was only recoverable in a very small part. The evidence, however, leaves us uncertain whether this ascertainment *1001 occurred in 1921 or in 1922. The books do not help in this respect, for at the end of 1921 a portion of the account was transferred to a general ledger account headed "Doubtful Accounts Receivable." At the end of 1922 the balance of the debt was similarly transferred. Without further complications it would be practically impossible to decide upon the evidence whether the bad debt deduction was allowable (1) in part in 1921, or (2) all allowable*2292 in 1922, save the amount recovered. Unfortunately, there is a further difficulty - upon a careful consideration of the evidence we think that the petitioner failed to acctually charge off the debt within either of the taxable years. The general manager for the petitioner testified that the account headed "Doubtful Accounts Receivable" had originally been opened under the name of "Bad and Doubtful Accounts Receivable," and that he considered the account to have no value whatever. On the other hand, it is freely admitted by the petitioner that the account was treated upon the books and in his financial statements as having asset value. It appears that the amount of the account was excluded from net worth in computing commissions payable to employees out of net profits, but this may be construed as merely a reservation by the parties. The provision that the bad debt must be charged off definitely within the taxable year is statutory, and may not be waived. It is clearly shown that the debt was not specifically charged off directly to profit and loss until 1925; furthermore, while we know that an amount of $220.18 was ultimately recovered, we do not know from the evidence when this*2293 recovery was made. Under all of these uncertainties and reservations we are of opinion that the deduction claimed may not be allowed in either 1922 or 1923. Judgment will be entered pursuant to Rule 50.