American Cent. Utilities Co. v. Commissioner

AMERICAN CENTRAL UTILITIES COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. American Cent. Utilities Co. v. Commissioner Docket No. 83642. United States Board of Tax Appeals 36 B.T.A. 688; 1937 BTA LEXIS 669; October 20, 1937, Promulgated *669 GROSS INCOME. - During the taxable year 1932 petitioner owned bonds and other interest-bearing obligations of a foreign subsidiary which was then insolvent. Petitioner accrued on its books and reported in its return as taxable income the entire amount of interest due. Held, since the obligations of the subsidiary were of doubtful collectibility, petitioner's gross income included only the amount of interest actually collected during the taxable year. Atlantic Coast Line Railroad Co.,31 B.T.A. 730, 751; affd., 81 Fed.(2d) 309; certiorari denied, 298 U.S. 656. George S. Atkinson, Esq., and M. S. Carneiro, C.P.A., for the petitioner. DeWitt M. Evans, Esq., for the respondent. HILL *688 Respondent determined a deficiency in petitioner's income tax for the year 1932 in the amount of $3,680.64, from which petitioner appeals. The adjustments giving rise to the additional tax determined by respondent are not questioned by petitioner, and respondent's determination, to that extent, is therefore approved. The sole error alleged by petitioner is the inclusion in its taxable income of the sum of $453,959.55, *670 "representing uncollected interest due petitioner for the year 1932 by Cia. Electrica Chapala, S.A., a corporation organized under the laws of Mexico, on its bonds, notes and open account." The facts were stipulated in part, and in part established by evidence, both oral and documentary. FINDINGS OF FACT. Petitioner is a Delaware corporation, chartered in 1926, with its principal office and place of business at San Antonio, Texas. The Cia. Electrica Chapala, S.A. is a Mexican corporation, hereinafter for convenience called the Chapala Co., organized prior to 1907, and in 1926 was engaged in the business of operating an electric light and power plant and a street car system in the city of Guadalajara, State of Jalisco, Mexico. About 1920 the Chapoala Co. began to experience considerable financial difficulty. About June 1926 petitioner purchased from the Banco Nacional de Mexico, and from the Banco Central Mexicano bonds, notes, and stock of the Chapala Co. for a cash consideration of $3,743,626.16, in United States currency. The face value of the obligation so purchased, excepting the stock, was $12,548,916.87 principal, and unpaid interest of $2,336,497.24, in Mexican currency, *671 being the *689 equivalent of $7,442,707.05 total principal and accrued interest (unpaid) in United States currency, based on the prevailing rate of exchange, which was then two pesos or Mexican dollars for one dollar in United States currency. On March 14, 1933, petitioner duly filed its income tax return for the year 1932, showing a tax due thereon in the amount of $31,912.13, which was paid in quarterly installments during the year 1933. Petitioner reported in its return as taxable income the amount of $585,797.30 representing interest due for the year 1932 by the Chapala Co., consisting of (a) interest on bonds in the amount of $174,486, (b) interest on note in the amount of $376,120.20, and (c) interest on current account in the amount of $35,191.10. Petitioner kept its books and records on the accrual basis for the year 1932, and accrued the interest mentioned on the basis of one dollar for two pesos. On or before February 20, 1935, petitioner duly filed a claim for refund of the $31,912.13 income tax paid for 1932, alleging that interest of $453,959.55 accrued against but not collected from the Chapala Co., reported on its return, was not taxable because of the extreme*672 doubtfulness of its collection. The interest on the obligations of the Chapala Co. was payable and was paid in Mexico. Of the sum of $585,797.30, United States currency, due to and accrued by petitioner as interest for the year 1932, petitioner collected $283,816.79, which amount was credited to the Chapala Co. on its books. Petitioner actually received in cash the equivalent in United States currency of only $153,450. In addition to the cash actually received by petitioner, it sustained an exchange loss in the amount of $118,000, paid for it by the Chapala Co., and paid through the Chapala Co. a Mexican income tax of $12,366.79. The exchange loss was claimed and allowed as a deduction, and the Mexican income tax was claimed and allowed as a credit against the United States income tax. The amount of interest accrued on petitioner's books for 1932 and reported in its return as taxable income, but not collected, was $301,980.51. At December 31, 1931, petitioner's investment in the Chapala Co. was as follows: Original cost $3,743,626.16 Accrued interest theretofore reported as income 681.579.01 Advances on open account 400,755.34 Total 4,825.960.51 *673 The rate of exchange from posos in Mexican currency to dollars in United States currency during the years 1926 to 1935, both inclusive, varied from 2.000 to 3.600. At the close of 1932 the rate of exchange was 3.210, which changed to 3.600 in 1933 and remained the same during 1934 and 1935. *690 The bonds of the Chapala Co. were issued on July 1, 1907, bearing 6 percent per annum interest, payable over a period of 50 years beginning June 30, 1917. The original issue was $6,000,000, Mexican currency, and at December 3 , 1932, payments were past due in the amount of $334,900. The purchase of the securities of the Chapala Co. by petitioner in 1926 was a speculative venture. At the time of purchase the Chapala Co. owned and operated a street car system or tramways, the operation of which became unprofitable because of transportation by buses and jitneys. The tramways became obsolete in 1930 or 1931, and the company finally "got rid" of them about 1933. The book balance of the tramways deficit at December 3 , 1932, was $939,203.98, Mexican currency. The item of Compania Occidental de Transportes, S.A., carried on the balance sheet as an asset at December 3 , 1932, in*674 the amount of $1,294,996.49, Mexican currency, was uncollectible. At December 3 , 1926, the actual assets of the Chapala Co. exceeded its liabilities by the amount of $1,193,353.64, Mexican currency, and at December 3 , 1931, and December 3 , 1932, its liabilities exceeded its assets by the amounts of $2,030,782.50 and $3,333,144.06, Mexican currency, respectively. In 1926 the Chapala Co. had an operating deficit of $806,646.36, while its operating deficits in the same currency at December 3 , 1931, and December 3 , 1932, were $4,828.698.48 and $6,131,060.04, respectively. The actual assets of the Chapala Co., exclusive of the deficits, as shown by its books, decreased from $16,521,866.74 at December 3 , 1926, to $15,059,484.27 at December 3 , 1932, Mexican currency; and during the same period its liabilities increased from $15,328,513.10 to $18,392,628.33, Mexican currency. OPINION. HILL: The sole issue for decision in this case is whether petitioner should be required to pay a tax computed on the basis of the entire amount of interest which became due and payable in the taxable year 1932 on the indebtedness owing to it by its Mexican subsidiary, the Chapala Co., or*675 whether petitioner should be taxed only on the amount of interest actually paid to it during such year. Interest in the amount of $585.797.30 became due in the taxable year, and this amount petitioner accrued on its books and reported in its return as taxable income. Interest was paid to petitioner in Mexico in the total amount of $283,816.79, but in order to get the money into the United States, petitioner sustained an exchange loss in the amount of $118,000 and paid a Mexican income tax of $12,366.79. Thus, *691 petitioner received in cash only the net amount of $153,450. However, in computing the deficiency, the exchange loss was deducted, and the Mexican income tax credited against the tax due the United States. Petitioner contends that, because of the extreme doubtfulness of its collectibility, the only part of the interest in question that should have been included in its gross income was the amount of $283,816.79, which was actually collected within the taxable year. Under the facts disclosed, we think the petitioner's contention must be sustained. A taxpayer, even though he deeps his books and makes his income tax returns on an accrual basis, is not required*676 to report in his income an amount which he may never receive. , citing . It is immaterial that petitioner in this proceeding erroneously accrued the entire amount of interest due and reported it as taxable income. If it in fact was not taxable income, an entry on petitioner's books treating it as income could not make it such. Corporate books "are no more than evidential, being neither indispensable nor conclusive. The decision must rest upon the actual facts." . Where the accounts are kept and returns made on an accrual basis, it is the right to receive and not the actual receipt that determines the inclusion of the amount in gross income, , but an item is not properly accruable unless it is good and collectible. If it is collectible at the time the right to receive arises, it should be accrued and included in gross income, and if the obligation later becomes worthless, even within the same taxable year, the*677 question then becomes one of deduction according to the applicable statutes. If the obligation is not collectible when the right to receive arises, such right is without substance and there is nothing to accrue. The amount then should be excluded from gross income and no question of deduction arises. ; affd., ; certiorari denied, . The taxation of income not actually received rests upon the basis of a reasonable expectancy of its receipt. "A taxpayer, even though keeping his books upon an accrual basis, should not be required to pay a tax on an accrued income unless it is good and collectible, and, where it is of doubtful collectibility or it is reasonably certain it will not be collected, it would be an injustice to the taxpayer to insist upon taxation." , and authorities cited. See also to 752, and decisions cited. *692 What, then, briefly are the facts in the instant case concerning the collectibility*678 of the interest obligations of the Chapala Co. as they appeared at the close of petitioner's taxable year 1932? At December 31, 1926, the subsidiary company had defaulted in the payment of interest to the extent of more than two million dollars, Mexican currency. At December 31, 1931, the interest accrued and unpaid then totaled $681,579.01, United States currency, and during 1932 the company was unable to pay interest to petitioner for that year in the amount of $301,980.51, United States currency. The Chapala Co. had not only defaulted in the payment of interest, but at December 31, 1932, payments on principal of its bonds were past due and unpaid in the amount of $334,900. At December 31, 1926, the actual assets of the company exceeded its liabilities by a substantial amount, but at the close of the years 1931 and 1932 it was in fact insolvent, its liabilities then exceeding assets in the amounts of $2,030,782.50 and $3,333,144.06, Mexican currency, respectively. At December 31, 1931, the company had an operating deficit in excess of four million dollars, and at December 31, 1932, its operating deficit exceeded six million dollars, Mexican currency. Its book assets decreased*679 approximately a million and a half dollars and its liabilities increased approximately three million dollars, Mexican currency, during the period December 31, 1926, to December 31, 1932. Many other facts indicating that the obligations of the Chapala Co. were of doubtful collectibility at the close of 1932 were established by the record, but we think those above cited are sufficient to show that the interest accrued by petitioner on its books and reported in its income tax return for 1932 certainly was not in its entirety "good and collectible." The amount of interest due should, therefore, not have been accrued on petitioner's books and only the amount actually collected during the taxable year should have been reported in its tax return. On authority of the decisions cited above, we hold that petitioner's gross income as determined by respondent in computing the deficiency here in controversy should be reduced by the amount of $301,980.51, representing interest accrued but not paid during the taxable year. The resulting tax will be entirely eliminated by applying against it as a credit the amount of Mexican income tax hereinabove referred to, and in respect of which there*680 is no controversy. It follows that there is no deficiency in but an overpayment of petitioner's income tax for the year 1932 in the amount of $31,912.13, the amount shown on its return. On the basis of the conclusions here reached, respondent so concedes. Judgment will be entered for the petitioner.