Merrill Trust Co. v. Commissioner

MERRILL TRUST CO. AND MAINE REAL ESTATE TITLE CO., PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Merrill Trust Co. v. Commissioner Docket No. 30151. United States Board of Tax Appeals 21 B.T.A. 1395; 1931 BTA LEXIS 2197; January 28, 1931, Promulgated *2197 Deductions claimed on account of certain investments becoming worthless allowed in part and denied in part. Herbert J. Connell, Esq., for the petitioners. John E. Marshall, Esq., for the respondent. TRAMMELL *1395 This proceeding has been brought to redetermine a deficiency in income tax for 1924 in the amount of $2,112.20, only a portion of which is in controversy. The petitioners filed a consolidated return of income for 1924. The question in issue is the right of the Merrill *1396 Trust Co. to deduct from gross income debts alleged to have been ascertained to be worthless in part and charged off in 1924, to the extent of the worthlessness determined. FINDINGS OF FACT. The petitioners are affilitated corporations organized under the laws of the State of Maine, with their principal office at Bangor. During 1922 and 1923 the petitioner, Merrill Trust Co., purchased at par debenture notes of the Bath Iron Works, Ltd., having a par value of $49,000. The debtor corporation also had issued and outstanding certain first mortgage bonds, and the interest coupons on said bonds due January 1, 1924, were defaulted, after default had*2198 theretofore been made in the sinking fund during the late summer or early fall of 1923. Thereafter interest due on the debenture notes was also defaulted. The Bath Iron Works, Ltd., owed approximately $1,210,000 represented by the first mortgage bonds, and in excess of $200,000 on notes due banks, in addition to the debenture notes, of which the $49,000 owned by the Merrill Trust Co. was a part. The debenture notes were junior to the first mortgage bonds and the notes due the banks. At the beginning of the World War the principal owner of the Bath Iron Works died, and the company was taken over by a syndicate of bankers and business men of the State of Maine, one of whom was the petitioner, Merrill Trust Co. The new owners sold to the public the first mortgage bonds and some of the preferred stock, retaining the common stock. After the close of the war, the business was in bad financial condition, and in order to provide working funds to keep the company going in the hope of improving the situation, the holders of the common stock put in additional money by purchasing the debenture notes. The petitioner, Merrill Trust Co., was trustee for the holders of the first mortgage*2199 bonds, and after the defaults in the sinking fund and interest, above mentioned, filed a bill in equity for foreclosure of the mortgage and for appointment of receivers. Three receivers were duly appointed on August 24, 1924, and on September 24, 1925, all the assets of the debtor corporation were sold under the foreclosure proceedings for approximately $265,000. The debtor corporation was thereby left without assets and was dissolved. When the foreclosure suit was instituted in 1924 by the Merrill Trust Co., as trustee for the first mortgage bondholders, it was then generally known, and the fact was particularly known to the said trustee, petitioner herein, that the assets of the iron works company would not be sufficient to pay off the first mortgage bonds. In the liquidation of the debtor company, the holders of the first mortgage bonds received *1397 about $200 per bond, or 20 per cent of their investment, and the holders of the debenture notes and the notes due the banks, as well as the stockholders, received nothing. On December 31, 1924, by order of its president, the Merrill Trust Co. charged off on its books $10,000 against the value of the debenture notes of*2200 the Bath Iron Works, Ltd., owned by it. This charge-off was the result of the different events referred to above, which convinced the officers of the Merrill Trust Co. of the practical worthlessness of the debentures in question. In 1924, the officers of the Merrill Trust Co. determined that the securities in question represented bad debts, and in compliance with the regular policy of making charge-offs once or twice a year on such securities whenever funds were available for that purpose, the charge-off was made in this case. The $10,000 charge-off on the books of account at the close of 1924 was claimed as a deduction from gross income in the consolidated return of the petitioners for 1924, and disallowed as a deduction by the respondent in determining the deficiency. On November 5, 1919, the Merrill Trust Co. bought, at a cost of $4,500, first mortgage 5 per cent bonds of a par value of $5,000 of the Dayton, Covington & Piqua Traction Co. On April 1, 1922, the bonds were presented for payment and returned unpaid and there was default in both principal and interest beginning at that time. A receiver was appointed in 1922. On December 31, 1924, a charge-off of $4,000 was*2201 made by the Merrill Trust Co. on its books against the cost of the Dayton, Covington & Piqua bonds. On July 13, 1927, the petitioner received as a final dividend from the First National Bank of Boston, trustee in final liquidation of the Dayton, Covington & Piqua Traction Co., the sum of $500. This is all the petitioner ever received on its investment of $4,500 in the bonds. The $4,000 charge-off made by the petitioner in 1924 was claimed as a deduction from gross income in the consolidated return and disallowed by the respondent in the determination of the deficiency. On January 15, 1921, the Merrill Trust Co. purchased $5,000 of the first mortgage bonds of the Rio Grande Southern Railroad Co. at a cost of $2,125. On January 1, 1922, there was default in the payment of interest. The petitioner never received anything in liquidation of these bonds. On December 31, 1924, the petitioner charged off as a bad debt $1,625 against the purchase price of the Rio Grande Southern Railroad Co. bonds. In later years other charge-offs were made, with the result that the bonds are now carried on the books as of no value. Nothing has ever been received by way of liquidation. The $1,625*2202 thus charged off in 1924 was claimed as a deduction from gross income in the consolidated return *1398 and disallowed by the respondent in the determination of the deficiency. OPINION. TRAMMELL: The deduction, which was disallowed in whole by the respondent, embraced three items, namely, (1) debenture notes of the Bath Iron Works, Ltd., (2) first mortgage 5 per cent bonds of the Dayton, Covington & Piqua Traction Co., and (3) first mortgage bonds of the Rio Grande Southern Railroad Co. In respect of the first item involved here, the record discloses that in 1922 and 1923, the petitioner, Merrill Trust Co., purchased, at par, debenture notes of the Bath Iron Works, Ltd., of the par value of $49,000. At December 31, 1924, the petitioner charged off $10,000 against the value of said notes, and deducted the amount from gross income in its return for said year. The debtor corporation at that time had outstanding $1,120,000 first mortgage bonds and owed banks more than $200,000 on its notes, in addition to the debenture notes, of which the $49,000 owned by the petitioner was a part. The holders of the first mortgage bonds and of the notes due the banks were preferred creditors*2203 over the holders of the debenture notes. The Merrill Trust Co. was a holder of common stock of the Bath Iron Works and was also trustee of the first mortgage bondholders. The petitioner was thus in a position to know accurately the financial condition of the debtor corporation. On January 1, 1924, the Bath Iron Works defaulted in payment of interest due on the first mortgage bonds and also defaulted in payment of interest due on the debenture notes, after having made default in the sinking fund late in 1923. As trustee for the first mortgage bondholders, the petitioner in 1924 filed a bill in equity for foreclosure of the mortgage and for appointment of receivers. The receivers were appointed in August, 1924, at which time it was known that the assets of the iron works company were so disproportionate to its liabilities as to render its securities practically worthless, with the possible exception of the first mortgage bonds, and that collection could probably be made of only a small portion of the par value of those bonds. Subsequent events fully established these facts. The assets of the debtor company were sold under foreclosure in September, 1925, for approximately $265,000, *2204 which paid only about 20 per cent of the first mortgage bonds. The debtor corporation was thus left wholly without assets and was dissolved. The holders of the debenture notes, as well as the holders of the other securities, including the notes due the banks and the preferred and common stock, received nothing from the liquidation. The entire amount of *1399 the investments, other than the first mortgage bonds, was a complete loss. The conditions existing in 1924 were known to the petitioner and those which subsequently occurred were reasonably anticipated, and in our opinion indicate the worthlessness in said year of its investment in the debenture notes. The petitioner is entitled, therefore, in computing its taxable net income for 1924, to deduct the said amount of $49,000 as a loss sustained in that year. The two remaining items included in the deduction here in question will be considered together. The traction company bonds were presented for payment on April 1, 1922, and were returned unpaid, default being made in payment of both principal and interest. A receiver was appointed for this company in 1922, and in 1927 the petitioner received $500 in final liquidation. *2205 The railroad company defaulted in payment of interest due on its bonds on January 1, 1922, and the petitioner has never received anything thereon by way of liquidation. The testimony submitted in respect of the railroad bonds is approximately summarized in the proposed findings of fact contained in the petitioner's brief as follows: On December 31, 1924, the petitioner charged off as a bad debt $1,625.00 against the purchase price of the Rio Grande Southern Bonds. This was because of the default in the payment of interest, together with the investigation which the company made from time to time during the year 1924 and the information obtained therefrom and from statistical sources. It was shown from the investigation that the bonds in question were not of much value. The same statement, in effect, may be made respecting the evidence in reference to the traction company bonds. The fact that default was made in the payment of interest, or principal and interest, is not alone sufficient evidence that the bonds thereby became worthless in the year of default or later, nor to show that a loss had been sustained, and we are not informed of the facts disclosed by the investigation*2206 made by the petitioner in 1924, nor what information was obtained therefrom or from statistical sources, other than it is said to have been shown that the bonds "were not of much value," which is purely a conclusion of fact. From the record before us, we can not say that the bonds in question became worthless in 1924 and the petitioner is not entitled to a deduction as a loss in that year nor in our opinion is the petitioner entitled to a deduction on account of a debt ascertained to be worthless in part. In any event, the evidence is not sufficient to show that the petitioner ascertained that they were worthless in part. We can not determine the fact of ascertainment of worthlessness, which *1400 is a conclusion which this Board much reach, from the conclusions of witnesses alone in the absence of facts upon which their conclusions were based. Reviewed by the Board. Judgment will be entered under Rule 50. SMITH dissents on the second and third points.