Sherman & Bryan v. Blair

• Decision Date: 22 July 1929
• Docket Number: No. 210.,210.
• Citation: 35 F.2d 713
• Court: U.S. Court of Appeals — Second Circuit
• Parties: SHERMAN & BRYAN, Inc., v. BLAIR, Commissioner of Internal Revenue.

35 F.2d 713 (1929)

SHERMAN & BRYAN, Inc., v. BLAIR, Commissioner of Internal Revenue.

No. 210.

Circuit Court of Appeals, Second Circuit.

July 22, 1929.

Earl B. Barnes, of New York City, and R. S. Doyle and John Enrietto, both of Washington, D. C. (Hopkins, Starr, Hopkins & Hamel, of Washington, D. C., of counsel), for petitioner.

Mabel Walker Willebrandt, Asst. Atty. Gen., and Sewall Key and John Vaughan Groner, Sp. Asst. Attys. Gen. (C. M. Charest, Gen. Counsel, Bureau of Internal Revenue, of New York City, of counsel), for respondent.

Before MANTON, SWAN, and AUGUSTUS N. HAND, Circuit Judges.

SWAN, Circuit Judge.

The questions presented involve the construction of section 234(a) of the Revenue Act of 1918 (40 Stat. 1077). This section declares that in computing the net income of a corporation there shall be allowed as deductions from gross income:

"(4) Losses sustained during the taxable year and not compensated for by insurance or otherwise;

"(5) Debts ascertained to be worthless and charged off within the taxable year. * * *"

The taxing officials have taken the position that the foregoing clauses are mutually exclusive, and that clause (5) relates to debts wholly worthless, so that in the case of debts only partially worthless no deduction whatever may be taken in the year when such partial worthlessness is ascertained. This is evidenced by article 151 of Regulations 69, which states:

"No deduction shall be allowed for the part of a debt ascertained to be worthless and charged off prior to January 1, 1921, unless and until the debt is ascertained to be worthless and is finally charged off or is charged down to a nominal amount, or the loss is determined in some manner by a closed and completed transaction."

This interpretation of the statute was accepted by the board in Appeal of Steele Cotton Mill Co., 1 B. T. A. 299, and has been followed in later decisions. See News Publishing Co. v. Commissioner, 6 B. T. A. 1257; Davidson Grocery Co. v. Commissioner, 9 B. T. A. 390. It was applied in the instant case, the board in its opinion stating that, while it was clear that the debt could not be collected in full, there was "not a preponderance of evidence that it was ascertained to be wholly worthless in 1920."

This conclusion is based upon a finding of fact that the records of the receiver as of September 30, 1920, as indicated by a statement of assets and liabilities which was subsequently prepared, showed available for general creditors, subject to payment of receivership expenses, assets of $205,940.88, composed of $63,368.11 cash, and $142,572.77 due from the purchaser at the receiver's sale, the property having been sold in March 1920, for $290,000. A notation upon the statement showed that in December, 1920, $22,000 was allowed for master's fees, attorney's fees, and "first allowance to the receiver." Subtracting this item from the assets of $205,940.88 left $183,940.88, which the board concluded would be available for general creditors, whose filed claims amounted to $473,528.37. Because the purchaser at the receiver's sale was not shown to be insolvent, the board assumed that the $142,572.77 balance would be collected from him, although in September 1920, he was in default in payments, and the receiver then contemplated that it would probably be necessary to resell the property.

It is not clear how much of the foregoing information the board thought the taxpayer possessed in September, 1920, when the debt was charged off as worthless. There are findings that Mr. Sherman, president of the taxpayer, was familiar with the affairs of Fulton Motor Truck Company, and had knowledge of the nature of its assets and the extent of its liabilities at the time of the appointment of the receiver; that Sherman had been informed by the receiver that a resale of the property would probably have to be made because of the default in payment by the purchaser at the March sale; that Sherman estimated that preferred claims and expenses of the receivership would amount to $134,000, and claims of general creditors would total between $500,000 and $600,000; and that the indebtedness was charged off as bad, "based upon knowledge that the petitioner had received through Shepard (the receiver), its president, and other sources." But there is no finding that the taxpayer's opinion that the debt was worthless was an unreasonable conclusion from the knowledge it possessed, or was formed after an inadequate investigation of the affairs of the receivership, and the board's opinion leaves us in doubt as to the implications of the decision. Does it mean that no debt can, within the meaning of section 234 (a) (5) be "ascertained to be worthless," however reasonable the creditor's belief that it is, if in fact it appears later that some part of it was collectible, or does it mean merely that the taxpayer's belief in the instant case was an unreasonable conclusion from the facts known or ascertainable by an adequate investigation?

Mr. Sherman's testimony was to the effect that he had not seen the statement of the receiver's assets and liabilities made up as of September 30, nor were the figures used in that statement available to him. He had, however, talked with the receiver and his assistants, and had the impression that approximately $120,000 was on hand, but he believed that preferred claims and expenses would require $134,000. He knew that the purchaser at the receiver's sale was in default, and had been informed by the receiver that the assets would probably have to be resold. From such a resale Sherman apparently expected little to be realized for he testified that the original sale price of $290,000 was "a fabulous figure, being twice or more than was expected." He said he thought the claims of general creditors would amount to $500,000 or $600,000, and that Mr. McDermott, at that time the office manager and accountant of the taxpayer, had expressed the opinion that the account was worthless. McDermott was not quite so definite in his testimony, but said that on the general information he had of the affairs of the receivership in September, 1920, obtained from conferences with the receiver, Mr. Sherman, and various creditors, he believed the corporation was justified in writing off the account, and that he would do the same thing in his own business to-day under similar circumstances. No testimony was introduced by the respondent, the showing as to the actual condition of the receivership, as reflected in the above-mentioned statement of September 30, having been made by the petitioning taxpayer. It further appears that in 1921 a final distribution was made and the receivership closed, but the amount of this dividend to the petitioning taxpayer is not shown.

On this record we are asked by the taxpayer to rule that the whole indebtedness was ascertained to be worthless in September, 1920, and was reasonably so ascertained, and therefore was a proper deduction in the taxpayer's return for that year. The corollary, admitted by the taxpayer, is that the dividend received in 1921 should be treated as income of the year in which it was received. See United States v. S. S. White Dental Co., 274 U. S. 398, 400, 47 S. Ct. 598, 71 L. Ed. 1120. While we have no doubt of the bona fides of Mr. Sherman's belief that the debt was worthless, we are not convinced that he had ascertained it to be worthless, within the meaning of the statute. To ascertain is to make sure by investigation, and it is conceded that, to justify charging off a debt for tax purposes, the taxpayer must make a reasonable investigation of the facts and draw a reasonable inference from the information thus obtainable. Mr. Sherman's pessimistic view of the prospect of dividends from the receivership was apparently influenced largely by two assumptions: One as to the expenses of the receivership; the other as to...