Prosperity Co. v. Commissioner ( 1932 )

THE PROSPERITY COMPANY, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Prosperity Co. v. Commissioner

Docket Nos. 45896, 59468.

United States Board of Tax Appeals

27 B.T.A. 28; 1932 BTA LEXIS 1139;

November 8, 1932, Promulgated

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Benjamin E. Shove, Esq., for the petitioner.

John H. Pigg, Esq., for the respondent.

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VAN FOSSAN

These proceedings were brought to redetermine deficiencies in the income tax of the petitioner for the years 1926 and 1928 in the sums of $11,040.18 and $34,623.15, respectively. In Docket No. 45896 the respondent's amended answer asserts that the petitioner's net income for the year 1926 should be increased by $48,000 and claims a corresponding increase in the deficiency of its tax. In Docket No. 59468 items aggregating $22,522.70 are in controversy.

In Docket No. 45896 the petitioner alleges that the respondent erred in disallowing a deduction of $90,089.47 representing expenses, losses and bad debts suffered by the petitioner through its selling agency, C. O. Reeps, Inc. This contention was abandoned at the hearing and other questions of fact were substituted and agreed upon in the stipulation of facts.

In Docket No. 59468 the petitioner alleges that the respondent erred in disallowing as a deduction the sum of $196,022.48 representing net losses of its subsidiary corporations sustained before affiliation, and, in the event that such losses are not deductible, his failure to allow as a deduction its bad debt account or worthless stock against and in C. O. Reeps, Inc.

The facts were stipulated substantially as follows:

FINDINGS OF FACT.

C. O. Reeps, Inc., was organized under the laws of the State of New York on May 1, 1926, and between that date and June 30, 1927, the petitioner was the owner of less than 95 per cent of the outstanding capital stock of C. O. Reeps, Inc. From July 1, 1927, to December 31, 1928, on which latter date C. O. Reeps, Inc., was liquidated, the petitioner was the owner of the entire outstanding capital stock of C. O. Reeps, Inc.

During the period of its existence in the calendar year 1926, C. O. Reeps, Inc., sustained a net loss, within the meaning of section 206 of the Revenue Act of 1926 and/or section 117 of the Revenue Act of 1928, of $85,082.90. During the period January 1, 1927, to June 30, 1927, prior to its becoming affiliated with the petitioner, C. O. Reeps, Inc., sustained a similar net loss of $54,975.36. During the calendar year 1928, all of which time it was affiliated with the petitioner, C. O. Reeps, Inc., sustained a similar net loss of $44,340.36.

The Prosperity Company of California was organized under the laws of the State of California, on March 11, 1925, and became affiliated with the petitioner, by the acquisition by the latter of all of the outstanding capital stock of the former, during the year 1927. From that time, and during the entire calendar year 1928, the Prosperity Company of California and the petitioner remained so affiliated.

During the calendar year 1926 the Prosperity Company of California sustained a net loss, within the meaning of section 206 of the Revenue Act of 1926 and/or section 117 of the Revenue Act of 1928, of $8,251.58. During the period in 1927 prior to the date it became affiliated with the petitioner, the Prosperity Company of California sustained a similar net loss of $7,253.86. During the calendar year 1928 the Prosperity Company of California sustained a similar net loss of $19,965.30.

C. P. Hostetter, Inc., was organized under the laws of the State of New York on September 3, 1926, and became affiliated with the petitioner, by the acquisition by the latter of all of the outstanding capital stock of the former, during the year 1927. From that time, and throughout the calendar year 1928, the petitioner continued to own all of the outstanding capital stock of C. P. Hostetter, Inc. The business of C. P. Hostetter, Inc., was liquidated during the latter part of 1927. C. P. Hostetter, Inc., was not actively engaged in business during the calendar year 1928 and had no net income for that year.

During the calendar year 1926 C. P. Hostetter, Inc., sustained a net loss, within the meaning of section 206 of the Revenue Act of 1926 and/or section 117 of the Revenue Act of 1928, of $3,155.16. During the period in 1927 prior to the date it became affiliated with the petitioner, C. P. Hostetter, Inc., sustained a similar net loss of $10,736.26.

The net income as disclosed by the income tax return filed by the petitioner for the year 1926 is understated by the amount of $48,000, cost of patterns, dies, jigs and fixtures charged to expense, but which represent capital expenditures.

The petitioner's net income for the year 1926, as disclosed by the income tax return filed by it for that year, is overstated by the amount of $22,800, representing depreciation on account of patterns, dies, jigs and fixtures, no deduction for which was claimed on the return.

The petitioner's net income for the year 1926, as disclosed by the income tax return filed by it for that year, is overstated by the amount of $77,419.96, representing expenses paid or incurred during that year and charged to a suspense account, no deduction for which was claimed on the return.

In his determination of the deficiency set forth in the notice of deficiency for the year 1926, the respondent made no adjustment with respect to any of the items referred to hereinbefore.

On December 31, 1926, the petitioner had on its books, under the classification of assets, the following accounts representing its investment in and/or the indebtedness of C. O. Reeps, Inc., to it:

Capital stock (purchase price)	$15,000.00
Open account	222,470.36
	237,470.36

Of the foregoing amount of $222,470.36, open account, the sum of $43,866.97 represents advances by the petitioner to C. O. Reeps, Inc., for operating expenses.

On July 1, 1927, there was owing to the petitioner by C. O. Reeps, Inc., on account of merchandise sold to it on open account, and advances, the sum of $225,675.58. C. O. Reeps, Inc., was liquidated on December 31, 1928, the petitioner taking over its assets on that date. As a result of such liquidation it was determined that the petitioner's investment in the capital stock of C. O. Reeps, Inc., together with the indebtedness of C. O. Reeps, Inc., to the petitioner, exceeded the assets of C. O. Reeps, Inc., so taken over by the petitioner by the amount of $248,125.83, computed as follows:

Capital stock - C. O. Reeps, Inc		$30,000.00
Accounts receivable - C. O. Reeps, Inc		243,206.52
Reserve for bad debts and losses		32,555.89
Total investment and indebtedness		305,762.41
Less:
Accounts receivable	$10,914.44
Commissions receivable	28,477.46
Inventory - used machines	1,500.00
Reserve withheld by finance company	16,744.68
Total assets of C. O. Reeps, Inc., taken over by petitioner		57,636.58
Amount of petitioner's investment in and indebtedness of C. O. Reeps, Inc., to petitioner, in excess of assets taken over by petitioner		248,125.83

We find the following additional facts: On December 31, 1928, the petitioner charged off as worthless on its journal and ledger books its open account against C. O. Reeps, Inc., amounting to $243,206.52, and the cost of its stock investment in that corporation, amounting to $30,000, but credited against such entries the sum of $25,080.69, representing the net amount of the assets of C. O. Reeps, Inc., taken over by the petitioner upon the liquidation of the said C. O. Reeps, Inc., on the above date. The net amount so charged off on December 31, 1928, was $248,125.85.

The petitioner's income tax returns for 1926 and 1928 were made on the accrual basis.

OPINION.

VAN FOSSAN: In Docket No. 45896 the petitioner abandoned its claim for a deduction of $90,089.47 covering expenses, losses and bad debts incurred in its dealings with its subsidiary, C. O. Reeps, Inc. The correct net income for the year 1926 is stipulated to be $29,559.15 and the recomputation of the tax may be made accordingly.

In Docket No. 59468 the petitioner's contention that it may deduct from its own net income for the year 1928 the net losses of its subsidiaries sustained before affiliation is governed by the decision of the United States Supreme Court to the contrary in , and consequently the only remaining issue is whether or not the petitioner may deduct the sum of $243,206.52 as a bad debt due from its subsidiary, C. O. Reeps, Inc., and ascertained to be worthless and charged off in 1928, and also the sum of $30,000 representing the cost of the capital stock in C. O. Reeps, Inc., which stock became worthless in that year. Against the said bad debt and stock loss the petitioner allows a credit of $25,080.69, the amount of the net assets of C. O. Reeps, Inc., acquired by the petitioner in the liquidation of that corporation, and also the sum of $44,340.36, the amount of the net loss of C. O. Reeps, Inc., deducted in the consolidated return of the petitioner and its subsidiaries for the year 1928. Thus the deduction claimed is reduced to $203,785.47.

The facts in the case at bar are on all fours with those of . In that case we held that both the loss on the stock of an affiliate and the bad debt due from the affiliate were proper deductions from the gross income of the petitioner, Houghton and Dutton Company. See also ; ; ; .

In the stipulated facts it was agreed that the open account of the petitioner against C. O. Reeps, Inc., on December 31, 1928, was $243,206.52 and that the petitioner's stock investment in C. O. Reeps, Inc., was $30,000. The evidence presented at the hearing showed that such items were ascertained to be worthless and charged off by the petitioner within the taxable year 1928. The loss so determined was reduced by $25,080.69, the net value of all assets of C. O. Reeps, Inc., received by the petitioner upon the liquidation of its subsidiaries. Upon such stipulation and proof the essential elements of loss to the petitioner have been established and it should be allowed. The amount of the net loss of C. O. Reeps, Inc., for 1928, or $44,340.36, has already been deducted from the petitioner's net income for that year and, therefore, the proper final deduction for losses sustained by the petitioner through C. O. Reeps, Inc., is $203,785.27.

Judgment will be entered under Rule 50.