Baker's Mut. Coop. Ass'n v. Commissioner ( 1930 )

BAKER'S MUTUAL COOPERATIVE ASSOCIATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Baker's Mut. Coop. Ass'n v. Commissioner

Docket No. 33265.

United States Board of Tax Appeals

20 B.T.A. 593; 1930 BTA LEXIS 2077;

August 26, 1930, Promulgated

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Deduction of bad debt ascertained to be worthless during taxable year and charged to profit and loss allowed as a deduction, though petitioner, contrary to its business practice and without permission to change the same, credited the item to "reserve for bad debts," later making a correcting entry.

Louis E. Spiegler, Esq., and N. Norman Mayer, Esq., for the petitioner.

Bruce A. Low, Esq., for the respondent.

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VAN FOSSAN

In this proceeding petitioner seeks the redetermination of a deficiency in income tax for the period beginning February 1, 1924, and ending December 31, 1924, in the sum of $791.10. The issue is whether petitioner is entitled to deduct the amount of a certain bad debt from its income for said period.

FINDINGS OF FACT.

The petitioner is a corporation incorporated in 1904 under the laws of the State of New Jersey. It is a nonprofit organization. It acts as a cooperative purchasing agent for its members, buying bakers' materials which it distributes among its membership at approximately cost, plus operating expenses, the latter including interest on the deposits made by members to secure their credit. Such excess from time to time is returned to the members in cash or as additional credit to be used for the purpose of reducing the cost of merchandise acquired by them through the association. These credits are entered in the books of the association as "discounts."

The Jersey Bake Shops was a member of the association. On April 18, 1924, the Jersey Bake Shops owed the petitioner $5,185.03 for merchandise purchased on open account, and notes payable to the association amounting to $2,700, or a total of $7,885.03. It had on deposit with the petitioner the sum of $2,450. On said April 18, 1924, the Jersey Bake Shops was adjudged insolvent by the Chancery Court of the State of New Jersey and receivers of the insolvent corporation were duly appointed by that court. Thereupon the petitioner, deducting from the amount owed to it by the Jersey Bake Shops the sum of $2,450, the credit appearing on its books in the account of the Jersey Bake Shops, duly filed with the receivers a proof of claim for the unsecured balance of the amount owed by the Jersey Bake Shops, namely for the sum of $5,435.03.

On or about December 16, 1924, the receivers of the Jersey Bake Shops filed in the Chancery Court of New Jersey a report of all their transactions as such receivers. This report included, among other things, a statement of the assets of the Jersey Bake Shops and a statement of the receipts and disbursements of cash made by the receivers and also of the balance of cash then in their possession. Thereupon an order was issued by the court addressed to the creditors of the Jersey Bake Shops, requiring them to show cause why the report of the receivers should not be approved and why the account filed by them should not be allowed. A copy of this order to show cause, together with notice of the filing of the account of the receivers, was served on petitioner. The order to show cause coming on to be heard, on December 29, 1924, an order was duly made in chancery passing the final account of the receivers and discharging them. The report of the receivers shows that all the assets of the Jersey Bake Shops had been disposed of by them and the final account, together with the order of December 29, 1924, discloses that the receivers then had no funds or assets distributable among the unsecured creditors of the Jersey Bake Shops. The report of the receivers lists petitioner among the unsecured creditors of the Jersey Bake Shops, stating the amount of its claim as $5,435.03. No payment on account of this unsecured amount had theretofore been made by the receivers or by the Jersey Bake Shops.

The unsecured debt owed petitioner by the Jersey Bake Shops was ascertained to be worthless in the taxable period.

It was the custom of petitioner not to close its books for the calendar year until about two months after the end of the year, namely after the annual meeting of its trustees in February.

At the annual meeting of the trustees and the annual meeting of the members of the petitioner held in the latter part of February, 1925, the matter of said debt was discussed and thereupon, in accordance with the directions of the trustees, entries were made in the books of the petitioner charging the said debt of $5,435.03 to profit and loss as of December 31, 1924, and crediting the said amount to "reserve for bad debts" as of the same date. In 1921 and the following years the petitioner had charged bad debts to profit and loss and had credited their amounts to the proper accounts receivable.

The petitioner had not secured the consent of the respondent to change its method of treating bad debts as required by regulations.

In May, 1925, petitioner credited the account of the Jersey Bake Shops with the sum of $930.03, which amount represented "discounts" and interest on deposits for the year 1924. This credit reduced the amount of the debt to $4,505.

In its return for the period beginning February 1, 1924, and ending December 31, 1924, the petitioner deducted the said amount of $5,435.03. The respondent disallowed the deduction, stating that the reserve for bad debts was not authorized, none having been set up in 1921 in accordance with the provisions of article 151 of Regulations 65.

OPINION.

VAN FOSSAN: The question at issue in this proceeding is to be determined under the provisions of section 234(a)(5) of the Revenue Act of 1924. This section provides that in computing the net income of a corporation there shall be allowed as deductions:

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.

Regulations 62, promulgated by the Commissioner under the provisions of the Revenue Act of 1921, provides, in part, as follows:

ART. 151. Bad debts. - Bad debts may be treated in either of two ways - (1) by a deduction from income in respect of debts ascertained to be worthless in whole or in part, or (2) by a deduction from income of an addition to a reserve for bad debts. For the year 1921 taxpayers may, regardless of their previous practice, elect either of these two methods and will be required to continue the use in later years of the method so elected unless permission to change to the other method is granted by the Commissioner.

By article 151 of Regulations 65, promulgated by the Commissioner under the Revenue Act of 1924, it is provided, in part, as follows:

Taxpayers were given an option for 1921 to select either of the methods mentioned for treating such debts. See article 151, Regulations 62. The method used in the return for 1921 must be used in returns for subsequent years and for returns under the Revenue Act of 1924 unless permission is granted by the Commissioner to change to the other method.

In 1921 petitioner had charged all bad debts to profit and loss and had credited the amounts of the respective bad debts to the proper accounts receivable. It had continued this procedure up to the date it credited the amount of the bad debt now in question to "reserve for bad debts." Petitioner had not secured permission of the Commissioner to change its method of treating bad debts. Therefore, in view of the quoted provisions of the regulations petitioner was not entitled, in its return for the taxable period, to deduct any amount on account of the reserve for bad debts which it had set up. . Nevertheless, if the debt was ascertained to be worthless within the taxable period and was charged off within the same period, petitioner is entitled to a deduction of the amount thereof. The statutory right of a taxpayer to a deduction is not to be destroyed by its initial failure to put its claim on a technically proper basis. . In , we said:

Whether a charge-off has been effected is not dependent upon any special form of bookkeeping, * * *. The fundamental purpose in requiring the charge-off is to evidence the worthlessness of the debt. * * * The effective elimination of the debt as an asset meets the statutory requirement as to charge-off.

We have found as a fact that it was ascertained in 1924 that the unsecured balance of the amount owed to petitioner by the Jersey Bake Shops was worthless. In February, 1925, the debt was charged to profit and loss as of December 31, 1924. The charge to profit and loss evidenced the worthlessness of the debt and eliminated it from the assets of petitioner. ;. The entry charging the debt to profit and loss as of December 31, 1924, was made before petitioner's books for 1924 were closed and was made under the direction of responsible officials of petitioner within a reasonable time. This constituted it a charge-off in the taxable period within the intendment of the statute. ; ; ; ; . And we do not consider it of moment in respect to the question at issue that a credit entry was made in 1925 in the account of the Jersey Bake Shops. The amount so credited represented discounts and interest on deposits accrued in 1924 and the credit entry operated solely to reduce the amount of the unsecured indebtedness.

We are, therefore, of the opinion that the petitioner is entitled to the deduction from income for the taxable period of the amount of the debt in question, namely, $5,435.03, less the credit of $930.03 for discounts on purchases and interest on deposits.

Decision will be entered under Rule 50.