Commissioner of Internal Revenue v. MacDonald Eng. Co., 6655.

• Citation: 102 F.2d 942
• Decision Date: 01 April 1939
• Docket Number: No. 6655.,6655.
• Parties: COMMISSIONER OF INTERNAL REVENUE v. MacDONALD ENGINEERING CO.
• Court: United States Courts of Appeals. United States Court of Appeals (7th Circuit)

102 F.2d 942 (1939)

COMMISSIONER OF INTERNAL REVENUE v. MacDONALD ENGINEERING CO.

No. 6655.

Circuit Court of Appeals, Seventh Circuit.

April 1, 1939.

James W. Morris, Asst. Atty. Gen., and Robert N. Anderson, Sewall Key, J. P. Wenchel, and Ralph E. Smith, Sp. Assts. to Atty. Gen., for petitioner.

George Clark, of Berkeley, Cal., for respondent.

Before SPARKS, MAJOR, and TREANOR, Circuit Judges.

SPARKS, Circuit Judge.

The Commissioner petitions for review of a decision of the Board of Tax Appeals allowing a deduction for worthless debt from the income tax of respondent for the year 1929, contending that the debt for which the deduction was allowed was neither ascertained to be worthless in the taxable year nor properly charged off.

The MacDonald Engineering Company of California, hereinafter referred to as the California Company, is a wholly owned subsidiary of the MacDonald Engineering Company of Illinois, hereinafter referred to as the taxpayer, organized about 1919 to design and build a warehouse, grain elevator, and mill for the Western Milling Company on ground owned by the latter in Oakland, California. By 1925 the latter company had become so involved financially that refinancing was required, and in March, 1925, it was agreed between various sets of creditors that the company should give its note for $210,000 to the Webster Manufacturing Company which had several judgments against it on some of which execution had issued and sales occurred. This note was secured by deed of trust on all the real and personal property of the debtor. The debtor gave its note for $153,894 to the California and another company, secured by a second deed of trust on all the debtor's property, and a third deed of trust and note for $200,000 to three individuals for advances to be made by them to clear the property of a number of other claims. The interest of the California Company in the second note amounted to $96,094, subsequently reduced by payments to $94,418. The deeds of trust were to have priority in the order mentioned, and were so recorded.

In February, 1926, the beneficiaries under the third deed of trust assigned their note and security to one Byrnes who abandoned the security and filed an action at law against the debtor, had an attachment issued and levied upon the real property which was sold under execution in May, 1926, to Byrnes. Meantime, in March, 1926, the debtor, which had changed its name to Oakland Terminal and Elevator Company, filed suits against the holders of the first and second trust deeds to restrain sale of the property under those deeds on the ground that the notes and deeds were void because they were not authorized by the Railroad Commission whose consent is required under the Public Utilities Act of California, Gen.Laws Cal.1923, Act. 6386, § 1 et seq., for all encumbrances on public utilities. The injunctions were refused, whereupon the trustees under both deeds of trust proceeded to sell the property, the second on May 10, 1926, for $100,000, and the first on May 11, for $221,150, both of which bids were credited on the respective debts, with no cash paid. Later, the Webster Company which had the first trust deed, filed suit against Byrnes to clear title, and Byrnes filed cross complaint contending that the Webster claim was invalid for failure to obtain the approval of the commission. The lower court in this case also upheld the validity of the first trust deed, and while this was reversed by the appellate court, the Supreme Court of California upheld the lower courts and ruled that the Act as it stood in March, 1925, when the mortgages were imposed, did not extend to warehouses, hence the Webster Company had fee simple title to the property upon which it had foreclosed. See Webster Mfg. Co. v. Byrnes, 207 Cal. 630, 280 P. 101; Oakland Terminal & Elevator Corp. v. Mercantile Trust Co., 207 Cal. 794, 280 P. 107, both of which cases were finally decided in 1929. While these two cases were pending, no action was taken in the California Company case.

The result of the decisions was to give clear title to the Webster Company, leaving nothing against which the California Company could collect its claim arising out of its note and trust deed, although the property involved was found to have a market value as of March, 1925, of $600,000, and the same in 1929 when the litigation was terminated.

In December, 1929, the California Company transferred the debt to the taxpayer which thereupon credited its subsidiary with the amount of it and, at the same time, charged the entire amount off to profit and loss. In 1927, a corporation was formed for the purpose of taking title to the property involved, and the taxpayer took three-fourths of the capital stock, paying $300,000 for it. The Board of Tax Appeals found that the Western Milling Company debt to the California Company in the amount of $94,418 was ascertained to be worthless and charged off by that company in 1929.

The taxpayer filed a consolidated return, including therein the income of the California Company. As proof of the charging off of the debt of the Western Milling Company, it introduced the testimony of its treasurer for the year 1929 who read from the books of the taxpayer the entry relied upon to constitute a chargeoff: "December 1, 1929. Profit and loss, Debit $100,162.12, MacDonald Engineering Company of California; credit $100,162.12." The accompanying explanation read: "Above covers...