Pine Ridge Coal Co. v. Commissioner

PINE RIDGE COAL COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Pine Ridge Coal Co. v. Commissioner Docket Nos. 27337, 30228. United States Board of Tax Appeals 23 B.T.A. 489; 1931 BTA LEXIS 1865; May 29, 1931, Promulgated *1865 1. The petitioner having filed separate returns for 1922 and 1923, is not entitled to have its tax computed for those years on a consolidated basis. 2. Advances to, and investment in capital stock of a corporation, held on the evidence to have been made by the petitioner, and since the corporation became bankrupt in 1922 without sufficient assets to pay unsecured creditors, of which petitioner was one, the amounts so advanced and invested were proper deductions from income for the taxable year and the Commissioner erred in disallowing them. J. H. Amick, C.P.A., for petitioner. P. A. Bayer, Esq., and S. B. Pierson, Esq., for the respondent. MATTHEWS *489 These proceedings, which were consolidated for hearing and decision, are for the redetermination of deficiencies in income taxes of $8,131.33 and $1,561.49 which have been asserted against the petitioner for the years 1922 and 1923. With respect to the year 1922 the petitioner claims that it is entitled to have its tax computed upon a basis of consolidation with its totally owned subsidiary, the Hinchman Creek Coal Company (formerly known as the Arthur D. Cronin Coal Company). *1866 It is also alleged that the petitioner sustained a deductible loss in 1922 in the amount of $50,000 on account of its investment in the capital stock of the Arthur D. Cronin Coal Company, and is entitled to a further deduction for 1922 in the amount of $26,140.32 on account of bad debts. In an amended answer filed by the respondent it is alleged that the respondent erred in computing the tax liability of the petitioner for the year 1922 on a consolidated basis by including the Arthur D. Cronin Coal Company as an affiliated corporation and that the correct deficiency for 1922 is $9,658.06. With respect to the year 1923 the petitioner alleges that the respondent erred in refusing to affiliate the petitioner and the Hinchman Creek Coal Company, and further erred in refusing to allow as a deduction, in computing the taxable net income of the petitioner for 1923, net losses alleged to have been sustained by the petitioner and its affiliated corporation for the years 1921 and 1922. FINDINGS OF FACT. Petitioner is a corporation organized under the laws of the State of Michigan, with its principal office at Detroit. Petitioner is engaged in the wholesale coal business and the greater*1867 part of its business is done upon a credit basis, as distinguished from cash sales. *490 In 1920 the Arthur D. Cronin Coal Company was organized to engage in the operation of coal mines. In November, 1921, the name of this corporation was changed to Hinchman Creek Coal Company. Petitioner owned all of the outstanding capital stock of this corporation, paying therefor in cash the sum of $50,000. In May, 1922, the Hinchman Creek Coal Company was adjudged a bankrupt and its assets were sold. The proceeds were insufficient to satisfy the claims of preferred creditors. The petitioner was an unsecured creditor. The final accounting of the trustee in bankruptcy dated March 16, 1923, shows no payments made to the petitioner. At the time this company went into bankruptcy the petitioner's investment therein was approximately $76,000, which included advances and the $50,000 of capital stock. Over $20,000 had been advanced by petitioner to the Hinchman Creek Coal Company in excess of the amounts due the latter company for coal delivered to the petitioner. Due to inaccurate bookkeeping, no entry was made on the petitioner's corporate records with respect to the capital stock*1868 of the Hinchman Creek Coal Company, which was owned by the petitioner, but the $50,000 so invested was carried on petitioner's books on an open account. At the close of the year 1922 the Hinchman Creek Coal Company owed the petitioner $26,140.32, in addition to the investment in capital stock, which amounts were carried on petitioner's books as accounts receivable from Hinchman Creek Coal Company. In 1922 the petitioner ascertained the entire account to be worthless. There was charged to profit and loss and credited to the reserve for bad debts the sum of $85,985.46, which amount included the sum of $76,140.32 due to the petitioner from the Hinchman Creek Coal Company. The reserve for bad debts amounting to $85,985.46 was claimed as a deduction from income in the petitioner's income-tax return for 1922. The item of $76,140.32 was disallowed as a deduction by the respondent, on the theory that it represented the personal loss of Arthur D. Cronin. The reserve method was used by the petitioner prior to the year 1922 to record losses occasioned through bad debts and accounts receivable. For the calendar years 1922 and 1923 petitioner filed separate income-tax returns. For*1869 the fiscal years ended July 31, 1921, and July 31, 1922, the Arthur D. Cronin Coal Company also filed separate returns. The 1922 return was filed in the name of Arthur D. Cronin Coal Company, notwithstanding the fact that the name of the corporation had been changed to Hinchman Creek Coal Company in November, 1921. Upon audit the respondent determined the net income of the petitioner for the year 1922 to be $108,020.37 and determined the net *491 loss of the Arthur D. Cronin Coal Company applicable to the year 1922 to be $12,213.83. The respondent audited the return and computed the petitioner's tax liability for that year on a consolidated basis by including the Arthur D. Cronin Coal Company as an affiliated corporation and thereby reducing the net income of the petitioner by the net loss of the Arthur D. Cronin Coal Company. A deficiency of $8,131.33 was asserted against the petitioner for 1922, which the respondent now claims should be increased to $9,658.06. The petitioner's return for 1923 was audited on a nonconsolidated basis and a deficiency was determined in the sum of $1,561.49. OPINION. MATTHEWS: We are of the opinion that the petitioner, although it*1870 owned the entire outstanding capital stock of the Hinchman Creek Coal Company, elected to file separate returns for 1922 and 1923 and therefore is not entitled to have its taxes for these years computed on the basis of a consolidated return. Section 240(a) of the Revenue Act of 1921 reads: That corporations which are affiliated within the meaning of this section may, for any taxable year beginning on or after January 1, 1922, make separate returns or, under regulations prescribed by the Commissioner with the approval of the Secretary, make a consolidated return of net income for the purpose of this title, in which case the taxes thereunder shall be computed and determined upon the basis of such return. If return is made on either of such bases, all returns thereafter made shall be upon the same basis unless permission to change the basis is granted by the Commissioner. Article 632 of Regulations 62 provides in part as follows: Affiliated corporations, as defined in the statute and in article 633, for a taxable period beginning prior to January 1, 1922, are required to file consolidated returns, and for a taxable period beginning on or after January 1, 1922, may elect to*1871 file such returns. The return for the first taxable period beginning on or after January 1, 1922, may be made either upon a consolidated basis or as separate corporations, regardless of the manner in which returns for previous years were filed, but an election so made shall be binding upon the taxpayer as to the manner of reporting for subsequent years, unless express permission is obtained from the Commissioner to make a change in the method of reporting. * * * We have repeatedly held that the filing of a separate return by a taxpayer corporation constitutes a binding election under the statute and its tax must be computed upon the basis of that return. ; ; ; ; ; ; affirming . *492 It has also been held that if a return of income is made on a separate basis for 1922, returns for 1923 shall be made upon the*1872 same basis where no permission to change the basis has been granted by the Commissioner. ; ; ; ; certiorari denied, . Inasmuch as the petitioner in this case filed a separate return for 1922, the Commissioner erred in computing the petitioner's tax for that year on a consolidated basis. The petitioner's tax liability for 1922 should be redetermined on the basis of separate returns filed by the petitioner and the Arthur D. Cronin Coal Company (Hinchman Creek Coal Company). Since permission to change the basis was not granted by the Commissioner and the petitioner filed a separate return for 1923, the Commissioner did not err in refusing to compute the petitioner's tax liability for 1923 on the basis of a consolidated return. There remain for consideration the additional deductions from income for 1922 which are claimed by the petitioner, to wit, the investment in the capital stock of the Hinchman Creek Coal Company*1873 in the sum of $50,000 and the amount of $26,140.32 representing a loss on account of advances made to the Hinchman Creek Coal Company, which amounts were ascertained to be worthless and charged off by the petitioner in the taxable year. We believe that the respondent erred in disallowing these deductions. We have found that the petitioner owned all of the outstanding capital stock of the Hinchman Creek Coal Company (formerly known as the Arthur D. Cronin Coal Company) having paid therefor for the sum of $50,000. In 1922 the Hinchman Creek Coal Company owed the petitioner on open account approximately $26,000. Evidence was introduced to show that in 1922 the Hinchman Creek Coal Company became insolvent, was adjudged a bankrupt and its assets sold to satisfy creditors. The proceeds of sale were insufficient to pay the preferred creditors, leaving nothing for the unsecured creditors of which the petitioner was one. The petitioner was fully aware of the financial condition of the Hinchman Creek Coal Company and appears to have been justified in charging off the indebtedness due from that company. *1874 , and . Prior to 1922 the petitioner had employed the reserve method to record losses on account of bad debts. In 1922 the petitioner credited to its reserve for bad debts the sum of $85,985.46, which amount included the sum of $76,140.32 due to the petitioner from the Hinchman Creek Coal Company. This latter sum included the petitioner's *493 $50,000 investment in the capital stock of the Hinchman Creek Coal Company, which had been carried on the petitioner's books on an open account. This item of $76,140.32 was disallowed as a deduction by the respondent on the theory that it represented the personal loss of Arthur D. Cronin. The petitioner's bookkeeper testified that although Arthur D. Cronin had a personal account on the petitioner's books, the amount of $76,140.32 was not included therein and that it was the petitioner's check, and not that of Arthur D. Cronin, which was delivered in payment of the capital stock of the Arthur D. Cronin Coal Company. It is indicated in the revenue agent's report, which was attached to the deposition introduced in evidence, *1875 that Arthur D. Cronin owned 98 per cent of the stock of petitioner. It does not follow, however, that the loss alleged to have been sustained by the petitioner represents the personal transaction of Arthur D. Cronin for which he is individually liable. The respondent's position that the amounts advanced by the petitioner were in reality advanced on behalf of Arthur D. Cronin, and that any loss sustained may be recovered from him, is not supported by the evidence. According to the amended answer, which was filed by the respondent, the petitioner's net income for 1922, computed on a nonaffiliated basis, amounted to $108,020.37. We believe that, in computing the petitioner's liability for 1922, a deduction should be allowed in the sum of $76,140.32 for the loss sustained by the petitioner on account of the bankruptcy of the Hinchman Creek Coal Company. Judgment will be entered under Rule 50.