ATHOL MANUFACTURING COMPANY v. COMMISSIONER OF INTERNAL REVENUE, Docket No. 30388.
| Decision Date | 06 February 1931 |
| Docket Number | Docket No. 30388. |
| Parties | ATHOL MANUFACTURING COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Board of Tax Appeals |
Ralph E. Tibbetts, Esq., for the petitioner.
Bruce A. Low, Esq., for the respondent.
This proceeding is for the redetermination of a deficiency for the calendar year 1924 in the amount of $3,027.49. The petitioner alleges that the respondent erred in denying a deduction on account of the net losses of its predecessor company for 1922 and the first six months of 1923; in denying the deduction of amounts paid in 1923 and 1924 upon the obligations of the predecessor company, which were assumed by the petitioner in consideration for purchase of the predecessor company's assets; and in refusing to permit the petitioner to deduct in 1923 and 1924 its actual bad debts ascertained to be worthless and charged off within the year, rather than the additions to a bad debt reserve.
FINDINGS OF FACT.
The petitioner was organized under the laws of the Commonwealth of Massachusetts on June 28, 1923. It is the successor in business of a corporation of the same name, hereinafter referred to as the old company, whose assets and liabilities it took over upon organization. The old company had issued and outstanding as of June 30, 1923, 13,815 shares of common stock and 10,408 shares of 7 per cent preferred stock. Approximately 94 per cent of both the common and preferred stock outstanding was held by the Laroy S. Starrett estate. The petitioner had an authorized capital stock of $600,000, divided into 6,000 shares of 6 per cent preferred stock of a par value of $100 each, and 15,000 shares of common stock of no par value. The common and preferred stock of each company carried voting rights.
At a special meeting of the stockholders of the old company held on June 23, 1923, the following resolution was adopted:
Voted that this corporation be reincorporated under the same name; that the president be authorized and directed in the name and on the behalf of this corporation, in such form as he by his signature thereto may approve, to offer to sell, assign and transfer to said new corporation, when formed, the entire business now carried on by this company as a going concern, with all the property, rights, assets and liabilities of all kinds wherever situate belonging to it in consideration of the issue to this company.
(1) of fifty-eight hundred and eighty 5880 shares of preferred 6% cummulative stock of the new corporation;
(2) of 10,408 shares of the new corporation's common stock, without par value, and
(3) the delivery to this company of an agreement of the new assuming and agreeing to pay as and for its own debt, all debts and liabilities of this company whatsoever.
The agreement referred to in paragraph (3) above was submitted and approved July 1, 1923. It reads as follows:
KNOW ALL MEN BY THESE PRESENTS that the Athol Manufacturing Company, a corporation duly incorporated under the laws of the Commonwealth of Massachussetts June 28th, 1923, and located at Athol in said Commonwealth as part of the consideration for the corporation of the same name incorporated and doing business at said Athol, hereby covenants and agrees to undertake, pay, satisfy, discharge, perform, and fulfill as and for its own debts or obligation, all the debts, liabilities, contracts, engagements and obligations of the said transferor, the said Athol Manufacturing Company organized and doing business prior to June 28th, 1923, whatsoever and shall indemnify the transferor against all actions, proceedings, claims and demands in respect thereof.
It was later agreed that the old company upon receipt of the shares of stock of the petitioner would immediately distribute 5,800 shares of the preferred stock to the estate of Laroy S. Starrett in payment of its indebtedness to the estate, and would transfer the common stock of the petitioner to the holders of the preferred stock of the old company share for share. The old company was then to cancel its preferred stock and dissolve. This agreement was later modified to authorize the petitioner to issue 5,880 shares of its preferred stock directly to the administrators of the Laroy S. Starrett estate in full satisfaction of the old company's indebtedness to the estate in the amount of $588,000. Upon the petitioner's organization, which was carried out substantially according to the terms of the above agreement, it continued with the business formerly carried on by the old company with the same directors and officers.
For the taxable year 1922, the old company sustained a net loss in excess of $100,000. During the period of its operation in 1923, from January 1 to July 1, 1923, it sustained a net loss of $425,979.24. Also, in the first six months of its operation, from July 1 to December 31, 1923, the petitioner sustained a net loss.
During the last six months of 1923 and during 1924, the petitioner paid out certain amounts on account of the obligations of the old company which it had assumed upon organization as part consideration for the assets of the old company (see clause (3) of the resolution of June 23, 1923, and the agreement of July 1, 1923, above). In its returns for the last half of 1923 and 1924, the petitioner claimed the deduction of these amounts as ordinary and necessary expenses. The respondent has denied the deductions, holding that they constitute additions to the cost of the assets of the old company and are therefore capital items.
For several years prior to its dissolution the old company had made a practice of setting up in its books in a reserve for bad debts an amount equal to 1 per cent of its sales. In making its income tax returns, however, it claimed the deduction of the actual bad debts ascertained to be worthless during the taxable year. The petitioner continued the practice of the old company in setting up the bad debt reserve equal to 1 per cent of its sales, but in its first return, for the six-month period ended December 31, 1923, it claimed the deduction of the additions to the reserve for that period and did not claim a deduction on account of the specific bad debts. The additions to the reserve amounted to $3,338.75, while petitioner's books showed only $52.30 of actual bad debts.
The return was prepared by an employee of limited experience who was unfamiliar with the method of treating bad debt deductions followed by the old company in its income tax returns. Correcting book entries were made in the following year by the petitioner's regular accountant. In all subsequent years, including 1924, the petitioner has continued to set up the bad debt reserve equal to 1 per cent of its sales and has claimed a deduction in its returns for the actual bad debts ascertained to be worthless and charged off during the year. The additions to the bad debt reserve in 1924 amounted to $8,434.75, while in its return for that year the petitioner claimed a deduction on account of actual bad debts in the amount of $28,266.05. An examining revenue agent who made an audit of the petitioner's books during 1926 reduced the amount of the allowable bad debts for 1924 to $20,895.21. The agent recommended that the bad debts ascertained to be worthless and charged off in 1923 and 1924, rather than the additions to the bad debt reserve, be allowed as deductions in those years. The respondent admits that the correct amount of bad debts for 1924 is $20,895.21.
The petitioner contends that it is entitled, under the provisions of section 206 of the Revenue Act of 1924, to deduct from its gross income of that year the net losses of its predecessor company for the first half of 1923 and for 1922. There is no dispute between the parties as to the fact of the losses or the amounts thereof. The controversy is over the question whether the petitioner here is the taxpayer entitled under the statute to the benefits of the deduction.
Section 206 of the Revenue Act of 1924 provides in part as follows:
(b) If, for any taxable year, it appears upon the production of evidence satisfactory to the Commissioner that any taxpayer has sustained a net loss, the amount thereof shall be allowed as a deduction in computing the net income of the taxpayer for the succeeding taxable year (hereinafter in this section called "second year"), and if such net loss is in excess of such net income (computed without such deduction), the amount of such excess shall be allowed as a deduction in computing the net income for the next succeeding taxable year (hereinafter in this section called "third year"); the deduction in all cases to be made under regulations prescribed by the Commissioner with the approval of the Secretary.
The evidence shows that the petitioner is a separate and distinct legal entity from its predecessor company. It was created under a new charter issued by the Commonwealth of Massachusetts in June, 1923. Its existence as a legal entity dates from that time. Upon organization it acquired the business and assets of the old company in exchange for its own shares of stock. These facts are not disputed, but the...
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