Calavo, Inc. v. CIR

• Decision Date: 25 May 1962
• Docket Number: No. 17345.,17345.
• Citation: 304 F.2d 650
• Parties: CALAVO, INC., and Calavo Growers of California, Successor to Assets and Liabilities of Calavo, Inc., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Ninth Circuit

304 F.2d 650 (1962)

CALAVO, INC., and Calavo Growers of California, Successor to Assets and Liabilities of Calavo, Inc., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 17345.

United States Court of Appeals Ninth Circuit.

May 25, 1962.

Goodson & Hannam, Bruce I. Hochman, and Avram Salkin, Los Angeles, Cal., for appellant.

Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson, Robert N. Anderson, Earl J. Silbert, and Harold M. Seidel, Attys., Dept. of Justice, Washington, D. C., for appellee.

Before BARNES, MERRILL and BROWNING, Circuit Judges.

MERRILL, Circuit Judge.

This case presents the question whether additions to a bad debt reserve may be made on the basis of circumstances rendering precarious (but not yet worthless) a specific item of indebtedness. The commissioner, ruling that such additions to reserve were not reasonable, determined deficiencies in income tax of Calavo, Inc., for the taxable years ending September 30, 1953, and September 30, 1955. The Tax Court upheld the commissioner and the taxpayer has petitioned for review.

Calavo Growers of California is a California corporation composed of avocado growers operating on a cooperative basis. Calavo, Inc., was a California corporation during and prior to the year 1955 and was a wholly owned subsidiary of Calavo Growers. It was engaged in the business of marketing the produce of its parent corporation and it also operated as commission sales agent for various other growers and shippers, selling pineapples, limes, dates, figs, and other produce in addition to avocados. It kept its books on an accrual method of accounting.

On September 30, 1955, a statutory merger (a non-taxable transaction under § 332(a) of the Internal Revenue Code of 1954, 26 U.S.C.A. § 332(a), was effectuated pursuant to California law by which Calavo Growers succeeded to the assets and liabilities of Calavo, Inc. Thereafter, Calavo Growers continued the business of Calavo, Inc., and the consolidated balance sheet of both organizations as of September 30, 1955, became the new balance sheet of Calavo Growers. On its books Calavo Growers thereafter carried all accounts of Calavo, Inc., for which the latter had set up a reserve for bad debts.

A. C. Duarte, Inc., a Cuban corporation, had been a large supplier of produce to Calavo, Inc. Commencing in 1954, Calavo, Inc., advanced substantial sums to Duarte in order that it might expand its operations in Cuba, particularly with respect to pineapples. As a consequence, on September 30, 1955, Duarte owed Calavo, Inc., $42,744.39.

During the summer of 1955, Calavo, Inc., became concerned about the collectibility of the Duarte account. The price of pineapples had declined with the result that after expenses very little was left from the sales of Duarte's shipments to apply upon its account. Calavo, Inc., debated whether further advances should be made and it was at first decided that the risk should be taken with the hope that recoupment of advances could be realized. In August, 1955, however, it was decided that no further money should be risked.

In November, 1955, Calavo's Cuban attorneys advised that investigation revealed that Duarte was insolvent; that it had offered its creditors fifty per cent payment and that there was doubt that it could live up to this proposal. This doubt was confirmed by further investigation in November and December, 1955. Ultimately in 1959, $4,488.59 was recovered and was the total extent of recovery.

Calavo, Inc., maintained a reserve for bad debts and this was carried over into the merged corporation. For the years 1951 through 1954 the reserve was maintained at $11,000.00. During these years additions to reserve equalled the amounts charged against reserve for debts which had become worthless during the years. The annual loss (and addition to reserve) averaged slightly less than $4,000.00.

For the taxable year ending September 30, 1955, the audit of Calavo, Inc.'s books was completed by its auditors in November, 1955. It was decided to increase the reserve for bad debts by adding the sum of $50,000.00 over and above the $11,000.00 level theretofore maintained. Losses in the sum of $2,183.80 had been suffered during the year and were charged off against the reserve. An addition to reserve was therefore made in the sum of $52,183.80, bringing the reserve to the figure of $61,000.00. No portion of the Duarte account was charged against the reserve as having become worthless during the year.

On January 11, 1956, a return was filed for Calavo, Inc., reflecting this addition to reserve. Also filed was an application for carry-back adjustment for the taxable year ending September 30, 1953. This adjustment was tentatively allowed by the commissioner.

By the deficiency notices subsequently given for both taxable years, the commissioner restored to income the entire $61,000.00 reserve on the ground that Calavo, Inc., was liquidated and dissolved at that time and that the need for the reserve thus had ceased. Before the Tax Court, however, the commissioner conceded that this was error and that such reserve was not restored income in the case of a § 332(a) reorganization. Before the Tax Court, the position taken by the commissioner was that the additions to reserve were in their entirety to be disallowed as unreasonable; that $8,816.20 ($11,000.00 less the amounts charged off against the reserve during the taxable year) constituted an adequate reserve. It was this determination which was upheld by the Tax Court and which is before us on review.

Upon the merits the dispute relates to the extent to which the circumstances particularly affecting the Duarte account must be taken into consideration in allowing additions to the reserve. Before we reach this problem, however, a preliminary contention of the taxpayer must be disposed of.

Taxpayer contends that the reasonableness of the addition to reserve has been established as matter of law since the commissioner before the Tax Court failed to show the addition to be unreasonable. Taxpayer, in justification of the addition, presented testimony that this sum was added after all accounts with its shippers had been appraised and that it represented a composite of its appraisals. The Tax Court deals with this contention in the following language:

"The testimony of Hodgkin, manager of Calavo, Inc., was to the effect that in view of the trouble Calavo, Inc. was experiencing in collecting this particular account consideration was given to all other accounts of this nature and that it was decided that a proper addition on account of this and other similar accounts should be $50,000. Actually there was no evidence presented as to how many such accounts there were or what amount had been advanced to others. Nor does the record disclose anything about the financial condition of such other shippers or the types of produce which they furnished. The only direct evidence as to uncollectibility of any amounts advanced to shippers relates solely to the amount advanced to Duarte, Inc."

Later the court reiterates:

"Furthermore, as has been indicated hereinabove, there has been no showing that the reserve should be increased because of any existing conditions affecting the collectibility of any other advances of this nature. As stated, Calavo, Inc. had had no bad debt experience with respect to similar accounts."

Taxpayer protests that the Tax Court improperly imposed upon it the burden of proof, as appears from the following language of the court:

"Section 23(k) (1) of the 1939 Code 26 U.S.C.A. § 23(k) (1) permits a deduction from income, in the discretion of the Commissioner, of a reasonable addition to a reserve for bad debts. Great latitude is extended the Commissioner in exercising that discretion; and the burden of establishing an abuse of discretion falls heavily upon the taxpayer. Union National Bank & Trust Co. of Elgin, 26 T.C. 537 (1956)."

Taxpayer contends that the Tax Court was in error in according the commissioner's determination any presumption of correctness, since that determination dealt solely with a restoration to income of the entire reserve, a concededly erroneous determination, and did not deal with the reasonableness of additions to reserve.

But, as the commissioner here points out, the Tax Court, in referring to the taxpayer's burden, was not concerned with the presumption of validity of the commissioner's original determination. It was concerned with the discretion, specifically vested in the commissioner by § 166(c) of the Internal Revenue Code of 1954, 26 U.S.C.A. § 166(c), to allow reasonable additions to reserve. A prima facie case is made by the commissioner in showing his exercise of discretion in this area. The burden is upon the taxpayer to overcome this prima facie case by demonstrating the reasonableness of the additions which the commissioner had refused to allow.¹

The taxpayer asserts that the commissioner never exercised his discretion in this area. It is true that such exercise of discretion was not evident from the notice of...