Eastside Mfg. Co. v. Commissioner

EASTSIDE MANUFACTURING CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Eastside Mfg. Co. v. Commissioner

Docket No. 22722.

United States Board of Tax Appeals

18 B.T.A. 461; 1929 BTA LEXIS 2038;

December 9, 1929, Promulgated

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1. Upon the evidence, held that the petitioner entered into two separate sets of contracts for the purchase of cotton from which losses were sustained in two different years.

2. Forgiveness of indebtedness, held not to constitute income. Meyer Jewelry Co.,3 B.T.A. 1319">3 B.T.A. 1319, followed.

E. S. Parker, Esq., and J. L. Elliott, C.P.A., for the petitioner.

Bruce Low, Esq., and I. W. Carpenter, Esq., for the respondent.

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GREEN

In this proceeding, the petitioner seeks a redetermination of its income and excess-profits-tax liability for the calendar year 1921, and its income-tax liability for the calendar year 1922, for which years the respondent has determined deficiencies of $7,114.40 and $849.24, respectively. The petitioner claims an overassessment for 1922, in the amount of $4,640.82, making the total amount of taxes that are in controversy, $12,604.46.

The following error is assigned in the petition:

The Commissioner has disallowed a loss sustained in 1921 on certain cotton transactions, contending that the loss was sustained in 1920, rather than 1921.

FINDINGS OF FACT.

The petitioner is a corporation organized during the year 1919, under the laws of the State of North Carolina, wi h its principal office at Shelby, N.C.

In the spring and early summer of 1920 the petitioner purchased from Beane Brothers, A. C. Walker, and Charles L. O'Neale, cotton brokers, 1,650 bales of cotton at 33 1/2 cents per pound, delivery to be made in the fall of that year. During the year 1920 the price of cotton declined. By the fall of 1920 the petitioner's plant was not completed and it was not in a position either to use or pay for any of the cotton purchased. During the months of October, November, and December, 1920, negotiations were entered into Between the petitioner and the vendors of the cotton wherein the original cotton contracts were canceled and the petitioner, in settlement of the difference between the contract price and the then reduced market price, paid the cotton brokers $4,771.02 in cash and gave trade acceptances in the amount of $84,543.93. Simultaneously with the cancellation of the original contracts, the petitioner entered into new contracts with the same parties for the purchase of 1,650 bales of cotton for future delivery, as follows:

Vendor	Date of delivery	Number of bales	Total pounds	Cost per pound	Cost
Beane Bros	March, 1921	50	25,000	$0.20	$5,000
Do	April, 1921	100	50,000	.20	10,000
Do	May, 1921	100	50,000	.20	10,000
Do	June, 1921	100	50,000	.20	10,000
Do	July, 1921	100	50,000	.20	10,000
Do	August, 1921	100	50,000	.20	10,000
Do	September, 1921	100	50,000	.20	10,000
Do	October, 1921	100	50,000	.20	10,000
Do	November, 1921	100	50,000	.20	10,000
Do	December, 1921	50	25,000	.20	5,000
A. C. Walker	October, 1921	150	75,000	.20	15,000
Chas. L. O'Neale	January, 1921	150	75,000	.33 1/2	25,125
Do	February, 1921	50	25,000	.18 1/2	4,625
Do	April, 1921	100	50,000	.18 1/2	9,250
Do	March, 1921	150	75,000	.23 1/2	17,625
Do	May, 1921	150	75,000	.24 1/2	18,375
Total		1,650			180,000

On January 17, 1921, the officers of the petitioner, because of its inability to pay the amounts due on its cotton contracts, had a conference with the cotton brokers, at which conference a written agreement was entered into, whereby the brokers agreed to accept 50 cents on the dollar in full settlement of the outstanding acceptances and the petitioner's liabilities under the new contracts. The material parts of the agreement are as follows:

1. That the creditors hereby propose to accept from the debtor a cash dividend of fifty per cent on the dollar of the amounts due each of the creditors by the debtor, in full compromise of their claims as follows:

Beane Brothers	$68,625.00	50%	$34,312.50
O'Neale & Co	39,484.00	50%	19,742.00
A. C. Walker	11,125.00	50%	5,562.50
	119,234.00		59,617.00

Said payments to be made within 30 days from the date hereof, and the debtor to have ten days from the date hereof within which to accept or reject this proposition.

2. In consideration of the creditors' agreeing to accept fifty (50) per cent on the dollar of the above claims against the debtor, the debtor agrees that in case it shall fail to accept said proposition within ten days from the date hereof, that the creditors' claims against the debtor on account of cotton contracts heretofore made with the debtor, shall be as follows:

Beane Brothers	$68,625.00
O'Neale & Co	39,484.00
A. C. Walker	11,125.00

and that the above-named creditors are authorized to close out and cancel their said contracts with the debtor as of this date, upon the above basis, it being understood that the above amounts represent not only fifty per cent of the losses sustained by the creditors on account of the cancellation of said contracts, but also fifty per cent of the acceptances heretofore given by the debtor to the creditors on account of cotton contracts heretofore existing and closed out as of date of said acceptances.

3. It being expressly understood that the above amounts represent all claims of every nature and description, which above-named creditors have against debtor, and that in case debtor accepts the proposition contained in paragraph one hereof, the creditors shall contemporaneously, with the payments of the amounts above stated, surrender to the debtor the acceptances heretofore given them by the debtor and now outstanding.

The petitioner accepted the proposition mentioned in paragraph 1 of the above agreement and during February, 1921, paid the brokers the amount of $59,617, who, in turn, surrendered the acceptances given in 1920 in the amount of $84,543.93.

The petitioner at no time received any cotton on any of the contracts in question.

On January 17, 1921, the claims of creditors amounted to $119,234, as set out in paragraph 1 of the agreement of that date. This total was made up of the following items:

Acceptances given in 1920	$84,543.93
Losses on second set of contracts	34,690.07
Total claims of creditors	$119,234.00

The losses on the second set of contracts, in the amount of $34,690.07, were computed on the basis of the decline in the market price of cotton between the time the second set of contracts was entered into, and January 17, 1921, when those contracts were canceled.

During 1921 the petitioner charged to profit and loss, on account of cotton contracts, a total loss of $64,388.02, which was made up of the $4,771.02 paid in cash in 1920 and the $59,617 paid as the result of the compromise agreement of January 17, 1921.

The petitioner in its income-tax return reported a net loss for the year 1921 in the amount of $7,175.34, which the respondent disallowed and, instead, determined a net income of $47,250.82, computed and explained as follows:

Net loss reported on return		$7,175.34
Additions:
1. Profit on cancellation of cotton contracts	$24,926.93
2. Cotton losses not applicable in 1921	64,388.02
Total additions		89,314.95
Total		82,139.61
Deduct: 3. Depreciation		34,888.79
Net income as adjusted		47,250.82

EXPLANATION OF ADJUSTMENTS

1 and 2. The amount deducted on account of cancellation of contracts has been disallowed as not being a proper deduction of the taxable year. Article 111, Regulations 62.

3. Depreciation allowed in accordance with agent's report, Article 161, Regulations 62.

OPINION.

GREEN: In this proceeding the petitioner contends that there was only one set of contracts for the purchase of cotton; that the payments of $4,771.02 in cash and $84,543.93 in trade acceptances in 1920 were in the nature of margin payments on the cotton contracts; that the contracts continued and were finally closed out on January 17, 1921, when the payment of $59,617 was made; and that it is entitled to deduct as a loss in 1921 the amount of $59,617 plus the $4,771.02 paid in 1920, or a total in 1921 of $64,388.02. We do not think that the record supports these contentions. As we interpret the facts, the original contracts for the purchase of cotton were canceled in the fall of 1920, at which time new contracts for the purchase of the same amount of cotton were entered into between the same parties. Early in 1921 it was again ascertained that the petitioner was unable to meet the payments due on the contracts. It then entered into the agreement of January 17, 1921, which we have set out in our findings. Under this agreement, the petitioner paid "fifty per cent of the acceptances heretofore given" and "fifty per cent of the losses sustained by the creditors on account of the cancellation of said contracts," (Paragraph 2 of the January 17, 1921, agreement) or a total amount of $59,617, itemized as follows:

50 per cent of acceptances given in 1920	$42,271.97
50 per cent of losses sustained on new contracts	17,345.03
Total amount paid by petitioner in 1921	59,617.00

In our opinion, the respondent was correct in determining that the loss on the original contracts made up of the payment of $4,771.02 in cash and $84,543.93 in trade acceptances was sustained in 1920, when, as we have found, such contracts were surrendered. It follows that at least $47,042.99 (50 per cent of acceptances, $42,271.97, and the $4,771.02) of the $64,388.02 claimed by the petitioner as a loss in 1921 should be denied. Upon the closing of the second set of contracts by means of the agreement of January 17, 1921, the petitioner, however, sustained a loss in 1921 of $34,690.07, which was in part compensated for by the forgiveness of 50 per cent thereof on the part of the creditors. This loss to the extent of 50 per cent, or $17,345.03, should be allowed as a deduction from the petitioner's gross income for the year 1921.

We have previously held that the forgiveness of indebtedness under circumstances like those present in the instant case does not constitute taxable income. , and cases cited. No part of the acceptances given in 1920, 50 per cent of which were forgiven in 1921, should, therefore, be included in the petitioner's income for the latter year.

We determine the net income of the petitioner, for the year 1921, to be $4,978.86, computed as follows:

Net income as determined by respondent		$47,250.82
Less:
Forgiveness of indebtedness included by respondent	$24,926.93
Loss, as set forth above	17,345.03
		42,271.96
Corrected net income for 1921		4,978.86

With respect to the year 1922, the petitioner's only contention was that the respondent had erred in refusing to allow as a deduction from the net income of 1922 an alleged net loss for the previous year. Since we have determined that instead of a new loss for the year 1921 the petitioner had a net income for that year, it follows that the respondent's determination for the year 1922 should be sustained.

Judgment will be entered under Rule 50.