Green Bay Lumber Co. v. Comm'r of Internal Revenue, Docket No. 1315.

• Citation: 3 T.C. 824
• Decision Date: 11 May 1944
• Docket Number: Docket No. 1315.
• Parties: GREEN BAY LUMBER COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: United States Tax Court

3 T.C. 824

GREEN BAY LUMBER COMPANY, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 1315.

Tax Court of the United States.

Promulgated May 11, 1944.

The Excess Profits Tax Act of 1940, as amended, provides for enumerated adjustments to the excess profits net income of the taxpayer for the base period years. One such is the elimination of deductions of a ‘class * * * abnormal for the taxpayer‘ under section 711(b)(1)(J)(i), I.R.C. Petitioner, in one of its base period years (1939), had been allowed a deduction for bad debts in the aggregate amount of $14,739.52, $8,000 of which represented loans made to some of its employees in 1924 and 1925 to enable them to purchase stock in another corporation. Held that bad debts do not necessarily all fall into a single class and under the present facts the $8,000 may be eliminated in determining petitioner's average base period net income for the purpose of computing its excess profits tax for 1941. O. L. Dykstra, Esq., for the petitioner.

Gene W. Reardon, Esq., for the respondent.

OPINION.

MELLOTT, Judge:

The Commissioner determined a deficiency in petitioner's excess profits tax for the year 1941 in the amount of $5,092.75 and overassessments in its income tax for the years 1940 and 1941 in the aggregate amount of $1,547.11.

The proceeding was submitted upon a stipulation of facts, all of which are accordingly found. The sole issue is whether the Commissioner erred in determining that a deduction of $8,000 was not abnormal in class and therefore should not be treated as an unallowable deduction under section 711(b)(1)(J)(i), I.R.C., in computing petitioner's credit for 1941 excess profits tax purposes.

Summarizing the facts, petitioner is an Iowa corporation engaged principally in the retail lumber business, with numerous sales yards in the State of Iowa and its principal office in Des Moines, Iowa. Its income and excess profits tax returns were duly filed with the collector of internal revenue at Des Moines. During 1924 and 1925 it advanced a total of $28,500 to 12 of its principal employees for the purpose of enabling them to purchase capital stock in the Eagle Lumber & Supply Co. of Jackson, Mississippi (hereinafter called Eagle). Eagle was organized in 1924 for the purpose of operating retail lumber yards in Mississippi. Petitioner encouraged its employees to purchase stock in Eagle and during 1926 to 1935, inclusive, it also acquired such stock.

The advances to the employees were evidenced by their personal notes, due one year from date, with interest. The stock in Eagle was endorsed in blank and attached to the notes as collateral security. It was understood that there would be no personal liability of individual employees on the notes and it was the intention of all the parties that the major portion of the obligations would be paid out of dividends on the Eagle stock. While petitioner, prior to January 1926, had financed certain of its employees in new enterprises and had stood the loss when they proved unprofitable, it was resolved at a meeting of the stockholders in that month that it would not do any such financing in the future.

Dividend payments were credited on the notes referred to above and other payments were made by the employees. Four of the notes were paid in full. One of the remaining eight debtors died in 1939 and two resigned prior to 1936. Prior to 1932 payments of principal totaling $11,827.83 had been made on the notes and on January 1, 1939, a balance of $16,672.17 was due, represented by eight notes varying in amount from $500 to $4,500. In 1939 Eagle started liquidation proceedings and at the close of that year the equity of the stockholders in its assets was nominal, the book value being not in excess of $11,618.90 on January 10, 1940, as against total outstanding capital stock of $275,400. Because of the financial condition of Eagle no action was taken by petitioner to possess the collateral security behind the note obligations and on December 31, 1939, petitioner charged off the balance of employee notes, as worthless, in the amount of $16,672.17.

‘A bad debt loss on the employee obligations in the amount of $16,672.17 was claimed by petitioner for income tax purposes as a deduction from gross income for the year 1939, and the Commissioner originally disallowed the entire loss, on the premise that petitioner took no steps to enforce collection or to take over the stock, thus indicating that it did not intend to enforce collection. Upon reconsideration the petitioner's income tax liability for the year 1939 was closed based upon the allowance of a deduction in the amount of $8,000.00 of the said sum of $16,672.17 claimed on the return in consideration of * * * ‘ a collateral agreement set out in the stipulation.

The ‘collateral agreement‘ is signed only by petitioner and states that it, in consideration of the closing of its income and excess profits tax case for the year 1939 on the basis of a net deficiency of $2,616.19, agrees: (1) That it will not claim any deductions as bad debts or otherwise for any taxable year subsequent to 1939 in respect to the following debts claimed as bad debt deductions on its 1939 income and excess profits tax return (listing the eight employee notes aggregating $16,672.17); and (2) that it, ‘as an integral part of this agreement, has concurrently executed an agreement, Form 870 T.S. disclosing a deficiency in income tax * * * of $2,408.41 and * * * in excess profits of $208.58 for the year 1939.‘ The concluding paragraph is as follows:

This agreement, together with all instruments executed thereunder, constitutes an entire basis for closing the case subject to acceptance by or on behalf of the Commissioner of Internal Revenue, and in event of his failure to accept any provisions thereof, no part of this agreement shall have any force or effect.

Petitioner has been allowed the following deductions for bad debts:

+----------------+
                ¦1935¦$17,903.89 ¦
                +----+-----------¦
                ¦1936¦11,631.71  ¦
                +----+-----------¦
                ¦1937¦15,367.00  ¦
                +----+-----------¦
                ¦1938¦5,276.64   ¦
                +----+-----------¦
                ¦1939¦14,739.52  ¦
                +----+-----------¦
                ¦1940¦8,960.97   ¦
                +----+-----------¦
                ¦1941¦8,521.25   ¦
                +----------------+
                

‘The above amounts do not include any bad debts with respect to money loaned to employees or others, except that the deduction of $14,739.52 for the year 1939 includes the $8,000 loss above referred to.‘

Since the years 1924 and 1925 petitioner has not advanced money to any of its employees or to any other person for the purpose of enabling him to purchase stock. Loans made to employees have been in nominal amounts for the purpose of giving incidental financial assistance and any such have all been repaid. From time to time petitioner, in the course of its business, has made loans to its customers, including advances to contractors for pay roll and similar expenses. It also has been obliged on occasion to take possession of property in satisfaction of customers' obligations, and such property has been sold by it on installment contracts.

The ‘Excess Profits Tax Act of 1940‘ was added to the Internal Revenue Code by section 201 of the Second Revenue Act of 1940. It has since been amended by the ‘Excess Profits Tax Amendments of 1941,‘ approved March 7, 1941, by Title II of the Revenue Act of 1941, by Title II of the Revenue Act of 1942, and by chapter 279, Public Law 172, approved October 26, 1943. Subparagraph (J) was added by section 3 of the Excess Profits Tax Amendments of 1941 and made effective retroactively to the date of the enactment of the Excess Profits Tax Act of 1940.

Section 710(a), I.R.C., imposes a tax upon the adjusted excess profits net income, which term is defined in section 710(b) as the excess profits net income (as defined in section 711) minus the sum of: (1) A specific exemption of $5,000; (2) the excess profits credit allowed under section 712; and (3) the unused excess profits credit adjustment. Sections 711 to 720, inclusive, deal with the normal provisions of the act, especially determination of the excess profits credit.

The statute permits the use of an excess profits credit based either upon petitioner's income experience during its prior test period or upon its invested capital, according to whichever method of computation results in the lesser tax. Sec. 712 et seq., I.R.C. In petitioner's case the computation based on income results in the lesser tax; so the credit is 95 per centum of its average net income for the base period years, i.e., 1936, 1937, 1938, and 1939. Sec. 713(a)(1)(A). In computing the average base period net income it is necessary to ascertain the excess profits net income for each base period year. This is done by starting with the taxpayer's normal tax net income, as adjusted, and applying against it certain adjustments, by way of addition or subtraction, as provided in section 711. One of such adjustments is that provided for in section 711(b)(1)(J)(i), I.R.C., i.e., the elimination of deductions of any class which were abnormal for the taxpayer. The section (including for clarity subsection (ii)), and the regulations are shown in the margin.¹

Petitioner contends that ‘the grouping of deductions arising from non-recurring losses on money advanced * * * to employees for the purpose of purchasing stock of another corporation constitutes a class distinct and properly segregated from that of bad debts arising from trade obligations.‘ It argues that for the purpose of determining whether deductions are of a class ‘abnormal for the taxpayer‘ no requirement is made by the statute that the items be grouped under the ‘statutory deduction categories‘ (the subdivision of section 23, I.R.C.); that classification to determine abnormality should be made with reference to similarity of situation, circumstances, nature, attributes, relations and the like; that the mere fact there had been a grouping of the employees' notes with the...