South Side Bank & Trust Co. v. Commissioner

South Side Bank & Trust Company, Petitioner, v. Commissioner of Internal Revenue, Respondent

South Side Bank & Trust Co. v. Commissioner

Docket No. 6993

United States Tax Court

6 T.C. 965; 1946 U.S. Tax Ct. LEXIS 201;

May 7, 1946, Promulgated

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Decision will be entered for the respondent.

Petitioner in November 1929 made a contract with Dollar Bank, which was in financial difficulty but apparently solvent, whereby Dollar Bank transferred to petitioner all of its assets and petitioner guaranteed payment in full of deposits in Dollar Bank as well as its bills payable of $ 90,000. Petitioner agreed to pay over to Dollar Bank any surplus due to excess moneys realized from the assets over and above bills payable and deposits, and Dollar Bank, as a corporation, and its directors, individually, guaranteed payment of any deficit ascertained and incurred from the sale of the assets transferred. Shareholders of Dollar Bank were not relieved of their legal liability as shareholders to creditors and depositors. Liquidation was not completed at the end of 1941. Petitioner in its 1940 and 1941 returns claimed a deduction of $ 15,000 as a partial bad debt of Dollar Bank. Held, petitioner is not entitled to the partial bad debt deduction claimed in 1940 and 1941 in the absence of evidence showing the existence of an enforceable obligation or debt owing to it.

L. E. Renard, Esq., for the petitioner.

Brooks Fullerton, Esq ., for the respondent.

Hill, Judge.

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HILL

The Commissioner determined deficiencies in income tax of $ 3,995.48 and $ 3,716.45 for 1940 and 1941, respectively. The petitioner assails the disallowance by the Commissioner of a claimed partial bad debt deduction of $ 15,000 in each of the years 1940 and 1941 and, in the alternative, claims it is entitled to deductions of $ 7,280.50 in 1940 and $ 73,868.57 in 1941 for loss allegedly sustained on the sale of assets of the Dollar State Bank & Trust Co. The facts are all stipulated.

FINDINGS OF FACT.

The petitioner, hereinafter referred to as South Bank, is a bank organized under the laws of Pennsylvania, its place of business being located in Scranton, Pennsylvania. It filed its income tax returns for 1940 and 1941 on the cash receipts and disbursements basis with the collector of the twelfth district of Pennsylvania at Scranton.

In 1929 the Dollar State Bank & Trust Co., hereinafter referred to as the Dollar Bank, was a Pennsylvania banking and trust company and had its place of business in Scranton. Both petitioner and Dollar Bank were members of the Scranton Clearing House Association and were subject to supervision by the Pennsylvania Department of Banking.

In November 1929 the Pennsylvania Department of Banking threatened to close the Dollar Bank. Pursuant to negotiations made on Sunday, November 17, 1929, by officers and directors of South Bank, Dollar Bank, and the Scranton Clearing House Association, and by representatives of the State Banking Department, an agreement dated November 18, 1929, was executed by Dollar Bank and the majority of its directors and the petitioner and a majority of its directors. In that agreement, after reciting that the Dollar Bank is in such financial condition that it is imperative that immediate action be taken in order to preserve the rights of depositors and conserve the assets of the bank and that petitioner is willing to purchase the assets of Dollar Bank and to guarantee payment of all deposits in full and the bills payable in the amount of $ 90,000, Dollar Bank assigns, transfers, sets over and sells, as of 8 a. m. November 18, 1929, to petitioner all of its assets, real and personal, of every kind and description and wheresoever situate and located, and petitioner guarantees the payment in full of and to guarantee payment of all deposits in full and the bills payable of Dollar Bank in the amount of $ 90,000. The agreement further provides, inter alia, that there shall be no liability whatsoever on the part of petitioner to the stockholders of Dollar Bank by reason of their ownership of the capital stock of Dollar Bank; that, as and when petitioner has definitely determined and ascertained the value of the assets transferred to it by reason of the agreement, then and thereupon petitioner will pay over to Dollar Bank, or its liquidating trustees, any surplus that may be due on account of excess moneys realized from the transferred assets over and above the bills payable and the deposits guaranteed by petitioner; that Dollar Bank, as a corporation, and its directors, in their individual capacity, guarantee to petitioner the payment of any deficit that may be ascertained and incurred from the sale of the assets transferred, assigned and sold to petitioner and "such sum of money as may be insufficient to pay in full the bills payable and deposits" as hereunder guaranteed by petitioner, and to that end and purpose the directors of Dollar Bank, as individuals, will sign a separate guarantee; that the execution of the agreement and consummation of the sale are not intended in any way to relieve the stockholders of Dollar Bank from their liability under the law to depositors and creditors of Dollar Bank, but that petitioner shall be subrogated to any claim or claims of the depositors and/or creditors against such stockholders; that, as one of the moving considerations for the execution of the agreement, petitioner as a corporation and its directors and officers shall in no manner whatsoever be liable for any matter or thing under the agreement except for its own willful misconduct or gross negligence; that petitioner shall have absolute power, at its sole discretion, to sell and convert the transferred assets into cash upon such prices, at such times, and in such manner as it, from time to time, determines; and:

Fifteenth: That the purpose and intent of this Agreement is to assign, transfer, set over and sell to [petitioner] * * * all of the assets of * * * [Dollar Bank] as hereinbefore enumerated and that the * * * [petitioner] is to pay all of the deposits and bills payable, as hereinbefore specified, of * * * [Dollar Bank] and that both of the parties of the first and second part, as well as their Boards of Directors and their Officers are to do any and all things that may be necessary and requisite for the purpose of saving * * * [Dollar Bank] from financial failure and insolvency so far as the same may be done with full protection to the Directors, Officers, Stockholders, Depositors and Creditors of * * * [petitioner].

On November 18, 1929, pursuant to the above agreement, petitioner took over all of the assets of Dollar Bank and also took possession of its place of business and books of account and continued to operate the Dollar Bank in its building until November 27, 1929, at which time a new general ledger was set up.

The assets and liabilities of Dollar Bank as of November 16 and November 27, 1929, as shown by its own books of account, and as of November 27, 1929, as set up in the new ledger, are as follows:

	Books of Dollar Bank
	Nov. 16, 1929	Nov. 27, 1929
Assets
Cash on hand and in bank	$ 94,394.69	$ 38,254.77
Loans and discounts	795,059.94	784,671.56
Bonds and stocks	579,292.37	839,292.37
Banking house	63,228.59	63,228.59
Fixtures	23,298.34	23,298.34
Clearing house	500.00	500.00
Cash items		7,665.16
Total	1,555,773.93	1,756,910.79
Liabilities
Deposits and dividends payable	988,330.76	838,635.25
Bills payable -- Federal Reserve	40,000.00
Bills payable -- Chemical	50,000.00	50,000.00
Bills payable -- South Side		390,000.00
Deferred credit -- Federal Reserve	262.95
Capital stock	200,000.00	200,000.00
Surplus	200,000.00	200,000.00
Undivided profits	77,180.22	78,275.54
Total	1,555,773.93	1,756,910.79

	Books
	of Dollar
	Bank	New ledger
		Nov. 27, 1929
	Less --
Assets
Cash on hand and in bank		$ 38,254.77
Loans and discounts	$ 195,663.91	589,007.65
Bonds and stocks	236,084.70	603,207.67
Banking house	46,526.93	40,000.00
Fixtures
Clearing house		500.00
Cash items		7,665.16
Total		1,278,635.25
Liabilities
Deposits and dividends payable		838,635.25
Bills payable -- Federal Reserve
Bills payable -- Chemical		50,000.00
Bills payable -- South Side		390,000.00
Deferred credit -- Federal Reserve
Capital stock
Surplus
Undivided profits
Total		1,278,635.25

The item of $ 195,663.91, designated as a "Permanent difference," represents an arbitrary reduction of loans and discounts. The item of $ 236,084.70 is designated as "Depreciation." As to the item of $ 390,000, on November 19, 1929, petitioner advanced to Dollar Bank $ 300,000 and charged the same on its own books under an account entitled "Dollar State Bank Liquidation Asset Account." Between November 18 and November 27, 1929, petitioner advanced additional funds to Dollar Bank in the amount of $ 90,000, which it charged to an account entitled "Dollar State Bank & Trust Company."

On November 27, 1929, petitioner made a debit entry on its books "Assets of Dollar State Bank" $ 1,278,635.25 and credited "Liabilities of Dollar State Bank" with the same amount. On January 30, 1929 (probably 1930) petitioner on its books debited the account "Liabilities of Dollar Bank" with savings deposits, Christmas clubs, public deposits, and business deposits of Dollar Bank in the aggregate amount of $ 666,571.67 and credited the accounts of persons (lately depositors of Dollar Bank) with the amounts lately due such depositors of Dollar Bank. After the initial debit entry of $ 1,278,635.25 on petitioner's books, the account "Assets of Dollar State Bank" was from time to time reduced by (1) net amounts realized by sale of Dollar Bank's assets after November 27, 1929, and (2) collection on notes; and increased by (1) amount of expenses incurred by petitioner in disposing of Dollar Bank's assets, (2) expenses incurred in lawsuit with broker over a brokerage account, and (3) interest on securities paying less than 3 percent. Interest charged by petitioner was as follows:

June 30, 1930	$ 3,190.80
Jan. 1, 1931	3,486.03
July 1, 1931	3,310.00
June 1, 1932	3,310.00
Total	13,296.83

Such interest items were in the respective years debited to Dollar Bank's account and credited to profit and loss account on petitioner's books.

From time to time Pennsylvania State Bank examiners in their examination of petitioner estimated the amount recoverable from the assets of Dollar Bank which had been taken over by petitioner and which had not been disposed of. Prior to 1940, at the direction of the State Banking Department, petitioner charged off on its books the following amounts on account of the liquidation of Dollar Bank:

1934	$ 10,000
1936	25,000
1937	10,000
1938	20,000
1939	5,000
Total	70,000

Petitioner took deductions as bad debts from Dollar Bank in its income tax returns for the above amounts, which were not disallowed by the Commissioner.

As a result of an examination, the State Banking Department sent a letter dated December 23, 1940, to petitioner, which in part is as follows:

The report of the examination of your institution as of the close of business November 16, 1940, has been filed in this office.

This report shows an estimated loss of $ 35,419.73 on the liquidation of the Dollar State Bank. At this time we ask that you charge off $ 15,000.00 of this estimated loss.

A charge-off of $ 15,000 in accordance with such letter was made on petitioner's books on December 31, 1940.

As a result of an examination, the State Banking Department sent a letter dated December 10, 1941, to petitioner, which in part is as follows:

A loss of $ 27,003.76 is estimated as a result of the liquidation account of the Dollar State Bank. Inasmuch as this liquidation has not as yet been completed, we will require a charge-off of only $ 15,000 at this time. * * *

In accordance with that letter a charge-off of $ 15,000 was made on petitioner's books on December 18, 1941.

The accounts "Assets of Dollar State Bank" and "Liabilities of Dollar State Bank" on petitioner's books show the following balances on the respective dates:

	Asset account		Liability account
Jan. 1, 1940	dr.	$ 227,529.87	cr.	$ 19,363.58
Jan. 1, 1941	dr.	193,065.23	cr.	14,758.14
Jan. 1, 1942	dr.	74,842.82	dr.	57,414.83

These balances reflect the items totaling $ 70,000 charged off prior to 1940, the items of $ 15,000 charged off in 1940 and 1941, and the accrued interest items totaling $ 13,296.83.

Income tax returns were filed by petitioner on behalf of Dollar Bank for every year from 1929 to 1944, inclusive. In the 1940 income tax return of Dollar Bank a net long term capital loss of $ 7,280.50 on the sale of securities was reported and in the 1941 income tax return of Dollar Bank there was reported a net long term capital loss of $ 73,868.57 on the sale of securities.

In its 1940 and 1941 income tax returns petitioner claimed a bad debt deduction designated "Dollar State Bank $ 15,000.00," which the Commissioner disallowed.

OPINION.

The petitioner contends that the agreement pursuant to which it took over the assets and assumed the liabilities of Dollar Bank constituted petitioner the creditor of Dollar Bank; that, since the relationship of debtor and creditor existed, the directives of the State Banking Department to make the charge-off of $ 15,000 in 1940 and 1941, together with the actual charge-off in each year, are conclusive as to the partial worthlessness of the debt (Regulations 103, art. 19.23 (k)-1 (c)); and that, therefore, petitioner is entitled to the deductions claimed. The respondent contends that the obligation of Dollar Bank and its directors to pay anything to petitioner is contingent upon the determination of a deficit, which has not been determined, and that, even though an unconditional debt exists, which he denies, petitioner has failed to prove that its right to reimbursement from Dollar Bank and its directors and stockholders is partially uncollectible. The respondent does not contend that no debt exists on the ground that the agreement involved constituted a sale of assets of Dollar Bank to petitioner in consideration of an assumption of liabilities, with an accounting over for any surplus realized, as in , for on brief he states:

* * * it is evidence that the persons setting up the accounts took the view that South Side [petitioner] was a liquidating trustee. He was not altogether consistent in that view, but that view is the correct view. South Side had legal title to the assets but not beneficial title. South Side was a fiduciary, was required to account for the surplus of money realized on liquidation above the liabilities of Dollar which South Side assumed and was to be reimbursed for a deficit if and when one occurred.

The agreement provides for the transfer of all the assets of Dollar Bank to petitioner in consideration of the assumption by petitioner of Dollar Bank's deposits and bills payable of $ 90,000. It further provides that "as and when" petitioner "has definitely determined and ascertained the value of the assets transferred" to it "then and thereupon" it "will pay over" to Dollar Bank, or its liquidating trustee. "any surplus that may be due owing to excess moneys realized from" the transferred assets "over and above the bills payable and the deposits" of Dollar Bank. In the agreement Dollar Bank, as a corporation, and its directors, in their individual capacity, guaranteed to petitioner "the payment of any deficit that may be ascertained and incurred from the sale of the assets" transferred, and "such sum of money as may be insufficient to pay in full the bills payable and the deposits" as guaranteed by petitioner, and to that end the directors of Dollar Bank, as individuals, agreed to sign a separate guarantee. Such separate guarantee is not in evidence. From the above it clearly appears that Dollar Bank and its directors were liable to petitioner as guarantors in the event a deficit was "ascertained and incurred from the sale of the assets" transferred to petitioner. Until such deficit occurred, petitioner had no claim against Dollar Bank or any one else for reimbursement.

The agreement was to be effective as of eight o'clock of the morning of November 18, 1929. The deposits and bills payable of Dollar Bank as of November 16, 1929, aggregated $ 1,078,230.76. Presumably, that is the amount of deposits and bills payable assumed by petitioner. The exact amount thereof as of eight o'clock of the morning of November 18, 1929, is not disclosed. As of November 16, 1929, the book value of all of the assets of Dollar Bank was $ 1,555,773.93. As of November 27, 1929, the book value of the assets was $ 1,756,910.79 and the total liabilities other than stock liability were $ 1,278,635.25, which included as bills payable $ 300,000 advanced by petitioner on November 19, 1929, and $ 90,000 advanced by petitioner between November 18 and 27, 1929. On November 27, 1929, petitioner set up a new ledger of the assets and liabilities of Dollar Bank. In setting up the new ledger the assets were reduced by $ 478,275.54 to $ 1,278,635.25. It is admitted by petitioner that the reduction of "Loans and Discounts" by $ 195,663.91 was an arbitrary reduction. There is no explanation for the reduction of "Bonds and Stocks" by $ 236,084.70 or the reduction of "Banking House" and "Fixtures" by $ 46,526.93, except that the reduction of bonds and stocks is designated as depreciation. It may be that the reduction in the assets was the result merely of the elimination of three items on the liability side of the old ledger of Dollar Bank of capital stock of $ 200,000, surplus of $ 200,000, and undivided profits of $ 78,275.54, totaling $ 478,275.54. In the new ledger an account was set up entitled "Assets of Dollar State Bank," to which the amount of $ 1,278,635.25 ($ 1,756,910.79 -- $ 478,275.54) was debited. Another account, captioned "Liabilities of Dollar Bank," was set up, to which the amount of $ 1,278,635.25 was credited. Certain items were debited and credited to such accounts, the amounts of all of which are not disclosed. The balances in each such account as of January 1, 1940, 1941, and 1942, are shown but there is no evidence to show just how these balances were arrived at. Bookkeeping entries are merely evidentiary and are not conclusive or determinative of tax liability. . As appears from the letter of the Department of Banking dated December 10, 1941, liquidation of Dollar Bank had not then been completed. There is no evidence which would support a finding that petitioner at any time definitely determined and ascertained a deficit incurred from the sale of the assets or insufficiency in moneys realized from the assets of Dollar Bank to meet or cover in full its bills payable and liability to depositors. Until petitioner did so, it had no enforceable claim against Dollar Bank, as a corporation, or against the directors of Dollar Bank. See ; . Furthermore, even if a deficit had been determined, there is no showing that the amount thereof was not recoverable under the guarantee of the directors of Dollar Bank and Dollar Bank or from the stockholders of Dollar Bank.

; , and , cited by petitioner, are distinguishable on the facts. In American State Bank of Detroit v. Aaron, a suit brought in equity to enforce the liability of shareholders for the bank's debts, the court specifically pointed out that:

* * * the proposal of the Peoples Bank [liquidating agent] provided for advancements to be made to the American Bank to meet demands of depositors before its stockholders decided upon voluntary liquidation. In so doing the Peoples Bank clearly became a creditor. * * *

In , also involving a suit in equity to enforce the liability of the shareholders for the bank's debts, the American National Bank's obligation to pay the Commercial Bank's depositors and other liabilities as and when the same were presented for payment was effective prior to, and was not dependent or contingent upon, the contemplated closing and liquidation of the Commercial Bank, and advancements were made while the Commercial Bank remained open and continued to carry on in the customary way the banking business in which it was engaged, and at the time the suit was brought all that was to be done under the contract was practically completed, save that the obligation, if any, to reimburse the American National Bank for advancing money to pay the liabilities of Commercial Bank had not been fulfilled. Under the contract herein petitioner was not specifically required to make any advancement prior to taking over the assets of Dollar Bank. Petitioner did advance $ 300,000 in November 1929, which was debited to an account captioned "Dollar State Bank Liquidation Asset Account," and also $ 90,000, which was debited to the account "Dollar State Bank & Trust Co." However, the evidence fails to show the status of such accounts in the taxable years. Furthermore, as to the $ 300,000 advancement, it is alleged in the petition that such sum was repaid to petitioner shortly after November 18, 1929, by collections of Dollar Bank's deposits in other banks, from cash on hand in Dollar Bank's vaults, and from the sale of securities. The $ 90,000 advancement may have been similarly repaid.

It is our conclusion that the evidence presented fails to show that a debtor and creditor relationship arose out of the contract, inasmuch as there is no showing that there actually was a deficit in moneys realized from the assets sold to meet the liabilities of Dollar Bank guaranteed by petitioner.

The petitioner, in the alternative, contends that, if it be held that the agreement of November 18, 1929, is a bill of sale, then it should be entitled to loss deductions of $ 7,280.50 in 1940 and $ 73,868.57 in 1941. It appears that the amounts represent the net long term capital losses from the sale of securities claimed in the income tax returns for 1940 and 1941, respectively, filed by petitioner for Dollar Bank. We have not held that the agreement is a bill of sale, and petitioner treated the securities for tax purposes as those of Dollar Bank. There is no evidence to the contrary. Upon the record as made, petitioner is not entitled to such deductions.

Decision will be entered for the respondent.