Huntting v. Commissioner

HENRY R. HUNTTING, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Huntting v. Commissioner Docket No. 75304. United States Board of Tax Appeals 32 B.T.A. 495; 1935 BTA LEXIS 942; April 25, 1935, Promulgated *942 1. An indebtedness on corporate bonds charged off in part because of partial worthlessness in 1931 is not subject to the provision of the statute forbidding recognition of gain or loss because the debtor corporation in a later year was reorganized and the bonds were exchanged for stock in the new corporation pursuant to the plan of reorganization then existing. 2. Failure to charge off in the taxable year corporate bonds ascertained then to be partially worthless and claimed as a deductible loss in income tax returns will not defeat the deduction of the claimed loss. 3. Where taxpayer owned debenture bonds of a corporation upon which interest was in arrears for two years, the corporation was in the hands of receivers, and such bonds were being sold to the public as low as $35 for a $1,000 bond, held a deduction for partial worthlessness was proper. William W. Johnston, C.P.A., and Andrew T. Smith, Esq., for the petitioner. G. W. Brooks, Esq., for the respondent. SEAWELL *496 This proceeding is for the redetermination of a deficiency in income tax for 1931 in the sum of $514.58. The errors alleged are the disallowance of deductions: *943 (1) partial bad debt or loss not less than $805 on Baragua Sugar Co. bond; (2) partial bad debt or loss not less than $4,908.75 on Punta Alegre Sugar Co. bonds. The error in reference to (1) was definitely abandoned by petitioner on the brief, leaving (2) as the sole issue. Petitioner alleges an overassessment of $422.76. FINDINGS OF FACT. Petitioner is an individual, residing at 29 Worthington Street, Springfield, Massachusetts. On June 9, 1928, petitioner purchased 5 1/2 debenture bonds due in 1937, par value $5,500, of the Punta Alegre Sugar Co., for which he paid $5,458.75. During the latter part of the year 1931 petitioner, in consequence of conversations with and advice of his attorney, and other information received, concluded that these bonds were practically worthless and determined to charge them off, and just before his Federal income tax return for 1931 was made out on February 4, 1932, he charged them off his book in the amount he had paid for them, $5,458.75, as of December 31, 1931, and claimed on his return the loss as a deduction from gross income for the year 1931. Respondent disallowed the whole claim for deduction. Interest on these bonds was paid*944 for one year after purchase by petitioner; the last payment of interest was made on October 1, 1929. The Punta Alegre Sugar Co. had five subsidiaries, and in 1927, it transferred all its physical properties to one or more of them and thereafter operated only through ownership of all the common stock of the subsidiaries. It was, through its subsidiaries, one of the four largest growers and producers of sugar in the Island of Cuba. Financial difficulties, however, arose and in consequence, on April 4, 1930, a plan of reorganization was formulated for it and its subsidiaries. Thereafter, on June 4, 1930, receivers were appointed for it and its subsidiaries. *497 On June 14, 1930, it was published, in reference to the affairs of the Punta Alegre Sugar Co., in the Commercial and Financial Chronicle, a trade journal recognized as reliable, that the Federal Judge in charge had on June 12, 1930, signed orders permitting the receivers to arrange temporary financing which would enable them to meet current expenses over the "dead season" (between July 1 and April 1). On June 21, 1930, the receiverships were made permanent; it was necessary for the Punta Alegre Sugar Co. to arrange*945 bank credits of approximately $8,600,000 to meet its maturing gold bonds and bank indebtedness of its subsidiaries, guaranteed by it, which arrangement could not be made except through receiverships. The condition of the sugar industry continued bad and on April 15, 1931, owing to that condition, the plan of reorganization formulated in the previous year was considered impossible and was abandoned. A new reorganization committee was appointed, and holders of securities of the company were requested to redeposit them. It was further published in the Commercial and Financial Chronicle that a dead season credit of $3,600,000 had been obtained from the banks, with a final maturity of all loans June 1, 1931; and that at the end of the dead season sugar had further declined in price, and that it was with difficulty that funds necessary to permit the grinding of the crop were obtained; and that an additional bank credit of $1,850,000, subject to cancellation by the banks, was finally obtained and additional collateral, including subordination of intercompany accounts, given the banks; and that unless there was a material improvement in the price of sugar there would be a substantial amount*946 of the 1930-31 dead season borrowings which the proceeds of the crop would be insufficient to pay. The Punta Alegre Sugar Co. debenture bonds were listed on the New York Stock Exchange. The New York Bond Record, another publication used in financial circles, shows the last sale of Punta Alegre Sugar Co. debenture bonds, such as those owned by petitioner, was made November 1, 1931, at $35 for a $1,000 bond; and that on December 24, 1931, the bonds were not quoted, "either bid or asked." The foregoing information was imparted to petitioner by his attorney in December 1931. Under the terms of the Punta Alegre Sugar Co.'s bonds it was provided that the obligor would pay the holders' state tax. In 1932 there was such state tax levied against petitioner by the State of Massachusetts amounting to $23.10, which the company failed to pay and petitioner was forced to pay. The receivers, after the sale of the company's assets as hereinafter stated, disbursed to petitioner his pro rata share of the proceeds of the sale in reimbursement of the tax in the sum of 5 cents. On April 18, 1932, the property and assets of the Punta Alegre Sugar Co. were sold at public sale and thereafter, in August*947 1932, a *498 new plan of reorganization was carried out. Petitioner, having deposited his 5 1/2 bonds with the transfer agent, as requested, was given therefor at the time of the reorganization 27 1/2 shares of the common stock of the new corporation, the Punta Alegre Sugar Corporation, and certain rights, of no value, to subscribe for other shares, which rights he never sold or exercised. On May 22, 1934, petitioner sold these 27 1/2 shares of stock for $188.79. At the hearing it was stipulated that petitioner filed his Federal income tax return for the year 1931 on February 4, 1932, upon which a total tax of $2,992.34 was assessed against and paid by him in the amounts of $613.06 each on February 4, June 15, September 13, and December 15, and $540.10 on September 24. Other stipulations were filed and evidence offered which are rendered nugatory by reason of the abandonment of the error alleged in reference to the Baragua Sugar Co. bonds. OPINION. SEAWALL: Upon the issue presented the applicable statute is section 23(j) of the Revenue Act of 1928, which is as follows: In computing net income there shall be allowed as deductions: * * * (j) Bad debts. - *948 Debts ascertained to be worthless and charged off within the taxable year (or, in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts); and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt to be charged off in part. Petitioner, upon whom the burden rests, says and contends that he has successfully carried the burden of the issue and shown himself entitled, under the statute quoted, to the deduction claimed. Respondent, on the other hand, says and contends that petitioner has failed in three different ways to carry the burden of the issue, viz: (1) Petitioner exchanged his 5 1/2 bonds for 27 1/2 shares of stock of the Punta Alegre Sugar Corporation in pursuance of a plan of reorganization; (2) petitioner never charged off the alleged bad debt within the taxable year 1931; (3) petitioner failed to prove that the debts were worthless. We will consider these questions in their order. 1. Exchange of bonds for stock pursuant to a plan of reorganization. - Under section 112(b)(3) of the Revenue Act of 1928 it is provided that no gain or loss shall be recognized if stock or securities in a corporation*949 a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation. Petitioner says, however, that he makes no claim in this proceeding for any deductible loss because of the exchange of the 5 1/2 bonds for 27 1/2 shares of stock in the new corporation; that the exchange referred to took place in a year subsequent to the taxable year here being considered. Respondent replies that receivers *499 were appointed in June 1930, and a committee submitted a plan of reorganization for approval; that the plan was later carried out, and the exchange of bonds for stock was made under the plan. Respondent cites two Board cases in support of his position, First National Bank of Champlain, N.Y.,21 B.T.A. 415, and Rockford Dairy, Inc.,26 B.T.A. 501. In these cases it appears that reorganization occurred in the same year in which the loss was claimed and that the claimed loss grew out of the reorganization. We find nothing in section 23(j), quoted above, or in section 112(b)(3), supra, which requires a holder of a bond to anticipate a reorganization of the issuing corporation, *950 even in a case as here, where a plan has been formulated and abandoned, and a new committee named to prepare another plan, and another plan has been prepared and carried out in a subsequent year. If by reason of the crippled condition of a corporation a bond has become recoverable only in part, the Commissioner may allow the bond to be charged off in part by the owner; and there is no prohibition in such case against the owner using the bond in exchange for other securities in a reorganization in a subsequent year, gain or loss on the latter transaction to be recognized only when the new security is disposed of. In the instant case, no plan of reorganization had been adopted before the end of 1931, and the reorganization finally accomplished was in 1932, after the corporate assets had been sold on April 18, 1932. We hold the exchange of the bonds for stock in the subsequent year did not affect the charge-off of partial worthlessness in 1931. 2. Petitioner never charged off the alleged bad debt in 1931. - Petitioner testified, and there was evidence of corroboration, that he ascertained in December 1931 that his bonds were "worthless, or nearly so", and that he resolved to*951 charge them off. His record of investments was kept by his bookkeeper in a small memorandum book used for the purpose, showing the stocks in which he dealt. In it was shown the following entry in reference to his Punta Alegre Sugar Co. bonds: "December 31, 1931, Profit and Loss $5,458.75." This entry was not made on the purported date, but on February 3, 1932, just before his income tax return was made out and filed. On the return he deducted as a loss the full amount paid for the bonds, $5,458.75. In his petition in this proceeding his claim for deductible loss in said bonds for 1931 is alleged to be "not less than $4,908.75." Construing section 23(j) the Commissioner has published G.C.M. 13114, Cumulative Bulletin XIII-1, p. 116, which is summarized as follows: In order for a taxpayer to have the benefit of a deduction for debts ascertained to be partially worthless there must have been an ascertainment by the taxpayer of partial worthlessness within the taxable year. The charge-off in *500 such a case being a technical requirement may be made after the taxable year. The allowability of the deduction is, of course, subject to the discretion of*952 the Commissioner. The discretion of the Commissioner, here referred to, is a legal discretion which may be reviewed by the Board and the courts. Commissioner v. Liberty Bank & Trust Co., 59 Fed.(2d) 320. In a recent case before the Board, in which the taxpayer kept a memorandum cash journal but made no charge-off in the book, or elsewhere, in reference to a partial loss claimed on a bank deposit for the year, and made no claim for deduction in her income tax return for the year, she was held, nevertheless, entitled to the deduction claimed. Allie M. Turbeville,31 B.T.A. 283. In the 1932 Revenue Act there is a change in the wording of section 23(j) which may indicate a change of policy in reference to the charge-off of partially worthless debts, but as to that we are not here concerned and intimate no opinion. We hold the charge-off, so far as required by the statute, was timely made in this case. 3. Failure of proof that the debts were worthless. - The ascertainment, under the statute, of partial (or total) worthlessness of a debt is obviously for the petitioner, in the exercise of his best judgment, first to make. *953 Dillon Supply Co.,20 B.T.A. 404. The facts and circumstances surrounding the petitioner's decision should establish it as that of a prudent person of sound judgment. Anna Bissell,23 B.T.A. 572. Evidence of the absence of assets at the time of liquidation years after the notes of the taxpayer were charged off is held admissible in confirming the taxpayer's previous decision of worthlessness at the time of the charge-off. Peyton Du-Pont Securities Co. v. Commissioner, 66 Fed.(2d) 718. In the year when the partial worthlessness of the Punta Alegre Sugar Co. bonds was claimed by petitioner interest on the bonds was in arrears for more than two years; receivers had been appointed for the company and all its subsidiaries; a plan of reorganization had been formulated and abandoned because impossible to accomplish; the receivers under the order of the court had been permitted to make temporary loans to meet current expenses and to pledge the corpus of the assets; foreclosure to meet maturing gold bonds and bank debts was imminent; loans were secured only upon hard terms; the price of sugar, the only commodity it had for sale, continued*954 to decline, and it was published in the trade journals that unless the price of sugar improved the money borrowed to harvest and manufacture the crop of cane could not be repaid out of the proceeds of the crop; bonds of the company could be sold only at *501 nominal sums, and apparently they were taken off the market soon after November 1, 1931, when the last sale was made at the price of $35 for a $1,000 bond. In the succeeding year after petitioner's income tax return for the taxable year was filed, the property of the Punta Alegre Sugar Co. was sold under order of the court; the pro rata share of the proceeds of sale to pay the unsecured debts amounted to less than one third of 1 percent; a reorganization of doubtful value was effected in 1932; petitioner's unsecured bonds of $5,500 par value were exchanged for common stock of the new corporation of one half the par value of the bonds; and this stock was sold by petitioner in 1934 for $188.79. We hold proof of partial worthlessness of the bonds in 1931 was sufficiently made. In our opinion, and we so hold, the indebtedness to petitioner on account of the bonds for which he paid $5,458.75 was not recoverable on December 31, 1931, in*955 an amount greater than $550, and petitioner is entitled to a deduction from gross income in computing his income tax for 1931 in the sum of $4,908.75. Judgment will be entered under Rule 50.