WF Young, Inc. v. Commissioner of Internal Revenue

• Decision Date: 23 May 1941
• Docket Number: No. 3641,3642.,3641
• Citation: 120 F.2d 159
• Parties: W. F. YOUNG, Inc. v. COMMISSIONER OF INTERNAL REVENUE. COMMISSIONER OF INTERNAL REVENUE v. W. F. YOUNG, Inc.
• Court: U.S. Court of Appeals — First Circuit

120 F.2d 159 (1941)

W. F. YOUNG, Inc. v. COMMISSIONER OF INTERNAL REVENUE.

COMMISSIONER OF INTERNAL REVENUE v. W. F. YOUNG, Inc.

Nos. 3641, 3642.

Circuit Court of Appeals, First Circuit.

May 23, 1941.

COPYRIGHT MATERIAL OMITTED

Edward J. Keelan, Jr., of Boston, Mass. (Hale & Dorr, of Boston, Mass., on the brief), for W. F. Young, Inc.

William L. Cary, Sp. Asst. to Atty. Gen. (Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key and Helen R. Carloss, Sp. Assts. to Atty. Gen., on the brief), for Commissioner of Internal Revenue.

Before MAGRUDER, MAHONEY, and WOODBURY, Circuit Judges.

MAHONEY, Circuit Judge.

This case is before this court on a petition filed by the Commissioner of Internal Revenue and a cross-petition filed by W. F. Young, Inc., to review a decision of the Board of Tax Appeals. The questions have to do with deductions taken by the taxpayer in its income tax returns for the years 1934, 1935 and 1936, also affecting its excess profits tax for the latter year, for certain advances made by it to its wholly owned subsidiary company, the Wilbur F. Young Realty Company, and the validity of an alleged claim for refund of 1934 income taxes.

The taxpayer is W. F. Young, Inc., a Massachusetts corporation which manufactures and sells a patent medicine known as "Absorbine, Jr.". In 1932 it bought all of the stock of the Wilbur F. Young Realty Company for $210,000. The principal assets of this company consisted of improved real estate in Springfield, Massachusetts, all of which was mortgaged. Its stock was owned by members of the Young family who also owned most of the taxpayer's stock. The Realty Company was operating at a deficit. One reason given for the purchase was to enable the two corporations to file consolidated returns so that the deficits of the Realty Company would reduce the tax liability of the taxpayer. Only in the year 1933 was a consolidated return filed and this showed a net loss of the Realty Company of $125,797.48, which was used to offset the income of the taxpayer.¹

After the purchase of the stock of the Realty Company, certain advances were made to it by the taxpayer to enable it to pay interest, taxes and other operating expenses, and to prevent foreclosure of mortgages, deficiency judgments, and bankruptcy of the Realty Company. In 1933 the taxpayer advanced the sum of $56,750 to the Realty Company and on December 31, 1933, the total amount due to the taxpayer from the Realty Company was $141,043.20. The taxpayer made an advance of $66,372.32 in 1934 so that at the end of that year the total amount due the taxpayer was $207,415.52. The advances made by the taxpayer in 1935 and 1936 were $30,894.88 and $58,372.23, respectively. The amounts advanced in the years in question were treated as loans on the books of the taxpayer and as liabilities on the books of the Realty Company.

The officers of the taxpayer in making the advances during the taxable years believed that the amounts would never be repaid but contended that they were necessary to protect the credit and reputation of the taxpayer because the two corporations were associated by the public with the Young family. It was argued that the bankruptcy of the Realty Company, or the foreclosure of any of the mortgages on its real estate, would reflect adversely on the faith and confidence which the public had in the patent medicine product manufactured by the taxpayer.

The taxpayer deducted from its income taxes for the taxable years involved amounts equal to the advances made to the Realty Company in the respective years as uncollectible debts which are entitled to be deducted if determined to be worthless and charged off on the books of the taxpayer during the taxable year.² The taxpayer also deducted as a loss in 1934 its stock holdings in the Realty Company which had become worthless in that year.

The Commissioner disallowed the deductions and determined deficiencies in the income taxes for the years 1934, 1935 and 1936 in the respective amounts of $9,842.12, $4,655.21 and $12,364.80 as well as a deficiency of $785.82 in the excess profits tax for the year 1936. The Commissioner contended that the deduction of the stock as worthless could not be taken because there was no identifiable event which occurred during the year 1934 which fixed the worthlessness of the stock, and that no deductions for bad debts were allowable where there was no expectation of repayment at the time the advances were made.

Upon the petition of the taxpayer for review of this and other adjustments made by the Commissioner, the Board of Tax Appeals found that the stock of the Realty Company owned by the taxpayer became worthless in 1934. The Commissioner has not appealed from this decision and the validity of the deduction as a loss in 1934 because of the worthlessness of the stock is not before us.

The Board further held that the fact that there was no expectation of repayment at the time the advances were made did not prevent the taxpayer from deducting these advances as bad debts or as losses.³ The Board decided that on a correct redetermination of the taxes for the years here involved there was a deficiency for the year 1935 of $520.86; that in the year 1936 there was no deficiency in excess profits tax and that there was an overpayment of $965.76 in income taxes; and that although there was overpayment of income taxes for the year 1934, the taxpayer was barred from obtaining a refund because of failure to file a proper claim for refund within the period allowed by law.

The petition of the Commissioner asks us to reverse the decision of the Board of Tax Appeals allowing the deduction of the advances made to the Realty Company on his original ground that such deductions are not allowable when there was no expectation of repayment at the time when the advances were made. However, he contends that if the Board were right in its decision, its holding that the taxpayer did not file a proper claim for refund in 1934 should also be sustained. Conversely, the cross-petition of the taxpayer asks us to affirm the decision of the Board allowing the deduction of the advances made but to reverse its holding that the taxpayer is barred from recovering the overpayment made in 1934.

We do not agree with the decision of the Board of Tax Appeals. The taxpayer contends that the advances made by it to the Realty Company during the taxable years here involved were proper deductions from its taxable income for those years. It asserts that the advances were deductible losses either as debts ascertained to be worthless and charged off within the taxable year, as losses sustained during the taxable year and not compensated for by insurance or otherwise, or as ordinary and necessary expenses of the taxpayer's business. We agree that the advances made represent losses to the taxpayer; but whether they are deductible losses depends entirely on the interpretation of the intention of Congress. New Colonial Ice Co. v. Helvering, 1934, 292 U.S. 435, 54 S.Ct. 788, 78 L.Ed. 1348; Sabath v. Commissioner, 7 Cir., 1938, 100 F.2d 569, 574; Brown v. United States, 3 Cir., 1938, 95 F.2d 487. We do not believe the deductions were allowable.

In its income tax returns for the taxable years here involved, the taxpayer deducted these advances made only as debts ascertained to be worthless and charged off within the taxable years. In the explanations of adjustments made by the Commissioner and shown as part of the taxpayer's Exhibit A, the Commissioner stated that the advances were not deductible "under either the bad debt or loss provisions" of the various revenue acts. The taxpayer's petition for review by the Board relies solely on the provision for the deduction of debts ascertained to be worthless and charged off within the taxable year. The Board, however, considered itself at liberty to pass upon the question whether the deductions could be allowed as losses to the taxpayer. Whether the advances were permitted to be deducted as bad debts or as losses is uncertain, as the determination was made in the alternative and no clear decision was made by the Board.

The Commissioner contends that there can be no deduction for a debt ascertained to be worthless and charged off within the taxable year when the debt was worthless when contracted and when the creditor lent the money with no hope or expectation of repayment. We agree with the Commissioner.

The Board found that "the officers of the petitioner, in making the advances during the taxable years, believed that the amounts would never be repaid"; and Mr. Caswell, treasurer of the taxpayer and vice-president of the Realty Company, testified that "It was our firm conviction that there was no hope or no likelihood of collection of that $207,000 $207,415.52 in 1934 and that we would never collect. With that knowledge or conviction that we never could collect the $207,000 we made an advance of $66,372.32 in that year and wrote it off in the same year and claimed a deduction. Under the same circumstances we advanced $30,000 $30,894.88 in 1935 and $58,000 $58,372.23 in 1936 and claimed those deductions." There could scarcely be a stronger statement of the worthlessness of these alleged debts at the moment that the advances were made.

The taxpayer, even before it made the advances, never expected to be repaid; even before it entered each transaction upon its books as a loan, it had mentally wiped it out as uncollectible. For reasons which seemed good to it, the taxpayer thought it worth while to expend this part of its income in this way. But it never expected to see this money return; it intended to eliminate the so-called loan from its books from the moment it was entered. In all the cases where alleged loans have been questioned as to their admissibility as bad debt deductions, the primary emphasis has been upon whether or not there was an expectation of repayment. Such advances, made with the belief that they would not be...