Opinion
Nos. 42493, 42548.
January 11, 1937.
William P. Smith, of Washington, D.C., for plaintiff.
John W. Hussey, of Washington, D.C., and Robert H. Jackson, Asst. Atty. Gen., for the United States.
Before BOOTH, Chief Justice, and GREEN, LITTLETON, WILLIAMS, and WHALEY, Judges.
Consolidated suits by the Art Metal Construction Company against the United States.
Petitions dismissed.
Plaintiff seeks to recover $67,350.74, alleged overpayment of taxes for 1927, 1929, and 1930. The questions are (1) whether plaintiff sustained a loss on certain patents; (2) whether it is entitled to additional deductions on account of additions to its reserve for worthless debts; and (3) whether it is entitled to a claimed credit in 1930 on account of British income tax alleged to have accrued in that year.
Special Findings of Fact.
1. Plaintiff is a corporation organized March 24, 1913, under the laws of the commonwealth of Massachusetts, having its principal office and place of business at Jamestown, N Y
On February 9, 1927, plaintiff acquired all the capital stock of the Postindex Co., Inc., a Massachusetts corporation organized in 1922, and thereafter owned said stock during the years herein involved.
The books of account of each of these corporations were kept on an accrual basis and the accounting period was the calendar year during the years in controversy.
2. On April 16, 1928, plaintiff filed a final consolidated corporation income tax return for the calendar year 1927, reporting itself as parent and the Postindex Company as subsidiary and showing consolidated net income of $685,106.01 and tax amounting to $92,489.31. The tax was paid in installments as follows:
March 14, 1928 ................. $25,000.00 June 15, 1928 .................. 23,000.00 September 14, 1928 ............. 23,000.00 December 13, 1928 .............. 21,489.31 __________ Total ....................... 92,489.31
The return did not segregate the income and/or losses of plaintiff and its affiliated company, but loss of Postindex Company for a previous year not specified, in the amount of $191,527.16, was shown to have been deducted from the consolidated income for 1927.
3. By letter dated June 27, 1930, the Commissioner of Internal Revenue notified plaintiff that the determination of its tax liability for the periods January 1 to February 9, 1927, and February 10 to December 31, 1927, disclosed a net deficiency in tax in the amount of $41,072.40. The letter disclosed that the consolidated net income reported in plaintiff's final return for 1927 was made up as follows:
Art Metal Construction Co. ................ $957,328.41 Postindex Company, Inc. (loss) ............ 80,695.24 ___________ 876,633.17 Postindex Company, Inc. (previous loss) ... 191,527.16 ___________ Consolidated net income reported in return ................................. 685,106.01
The letter further disclosed that the Commissioner had determined plaintiff's net income for 1927 as follows:
------------------------------------------------------------------------------------------------------------- | Art Metal Construction | Postindex Company, | | Co. | Inc. | Consolidated ------------------------------------------|-------------------------|---------------------|------------------ Net income for calendar year 1927 ....... | $1,015,975.41 | $29,906.88 (loss) | ................ For Jan. 1 to Feb. 9, 1927 .............. | 111,339.77 | 3,277.47 (loss) | ................ |_________________________|_____________________|__________________ For Feb. 10 to Dec. 31, 1927 ...... | 904,635.64 | 26,629.41 (loss) | $878,006.23 ------------------------------------------------------------------------------------------------------------- The Commissioner's determination showed additional tax to be assessed against plaintiff as follows:
Jan. 1 to Feb. 9, 1927 .................... $ 4,895.06 Feb. 10 to Dec. 31, 1927 (consolidated) ... 36,177.34 __________ Total .................................. 41,072.40
The additional tax, together with interest in the amounts of $733.12 and $5,418.18, or a total of $47,223.70, was assessed and was paid by plaintiff on October 2, 1930.
4. On October 10, 1930, plaintiff filed a claim for refund of the $47,223.70 additional tax and interest paid for 1927. The claim was based upon the failure of the Commissioner of Internal Revenue to allow as a deduction in computing the consolidated net income for 1927 the loss sustained by Postindex Company for the years 1925 and 1927. The Commissioner had, however, allowed the loss of Postindex Company for the period of affiliation, February 10 to December 31, 1927, in the amount of $26,629.41, as shown in finding 3 herein.
5. On November 6, 1931, prior to the Commissioner's action on plaintiff's claim filed for 1927 on October 10, 1930, plaintiff filed an amendment to the claim in which it set up numerous grounds, including claims for an addition to its reserve for bad debts for 1927, for the allowance of a loss alleged to have been sustained by Postindex Company on the sale of certain patents in 1927, and for the right to deduct from the consolidated income for 1927 the loss sustained by Postindex Company in said year prior to affiliation. In the amended claim it was contended, among other things, that the loss on patents originally claimed by the Costmeter Company in its consolidated return for 1925 to have been sustained by it in that year, which loss was later attributed to the Postindex Company for 1925 in determining plaintiff's consolidated income for 1927, was in fact a loss of Postindex Company for 1927.
6. Pursuant to a revenue agent's investigation, some of plaintiff's contentions in the amended claim for refund for 1927 were allowed, and the Commissioner of Internal Revenue redetermined the 1927 net income as follows:
---------------------------------------------------------------------------------------------------------------- | Art Metal Construction | Postindex Co., | | Co. | Inc. | Consolidated --------------------------------------------------|------------------------|-------------------|---------------- Net income for calendar year 1927 ............... | $1,011,874.57 | $42,064.64 (loss) | .............. Segregated on basis number of days involved: Jan. | | | 1 to Feb. 9, 1927 ............................. | 110,890.36 | 4,609.83 (loss) | .............. |________________________|___________________|________________ Feb. 10 to Dec. 31, 1927 ................. | 900,984.21 | 37,454.81 (loss) | $863,529.40 ---------------------------------------------------------------------------------------------------------------- Under date of May 23, 1932, the Commissioner issued a certificate of overassessment in the amount of $2,316.83, which amount of overassessment, plus interest thereon, was duly refunded to plaintiff. The balance of the amended claim, or $44,906.87, was specifically rejected. Among the contentions denied plaintiff were the alleged loss on the sale of patents, the right to deduct losses of the Postindex Company prior to affiliation in that year in computing consolidated net income for 1927, and the additional allowance to the reserve for bad debts.7. Subsequently plaintiff filed another claim for refund for 1927 in the amount of $360.87 based on the right to deduct additional New York state franchise tax of $2,673.14 accrued November 1, 1927. The Commissioner, after the filing of these suits, reduced the consolidated net income for 1927 by that amount and allowed the claim in full. The claim which is made in paragraph 5 of the petition in case no. 42493 accordingly is eliminated from this controversy.
8. April 15, 1929, plaintiff filed its consolidated corporation income tax return for the calendar year 1928 with the collector of internal revenue; this return included the income of the Postindex Company for the entire calendar year 1928. The consolidated income shown by this return was $850,541.95, of which the net income of the plaintiff amounted to $848,140.56, and that of the Postindex Company to $2,401.39. The tax shown due by this return amounting to $102,065.03 was duly paid, but no part of the 1928 tax is in issue in this suit. Subsequently the Commissioner redetermined the 1928 taxable net income of the plaintiff to be $913,273.66 and that of the Postindex Company to be $3,241.89, or a consolidated net income of $916,515.55. By reason of this adjustment a deficiency of $7,916.84 was duly assessed and paid. Pursuant to a revenue agent's supplemental report dated April 17, 1933, however, the Commissioner, having determined the net loss of the Postindex Company for the calendar year 1927 to be $42,181.57, pro rated 40/365 thereof, or $4,622.63, as applicable to the period January 1 to February 9, 1927, prior to affiliation and applied same against the Postindex Company's redetermined 1928 net income of $3,241.89, as aforesaid, thus entirely eliminating same. As a consequence thereof there was refunded to plaintiff under Schedule No. 51163, dated September 29, 1933, $389.02 of the tax paid for 1928.
9. March 18, 1930, plaintiff filed its consolidated corporation income tax return for the calendar year 1929 reporting consolidated net income of $1,170,953.32 and tax amounting to $123,364.15, which tax was paid in installments as follows: March 18, 1930, $30,842; June 16, 1930, $30,842; September 16, 1930, $30,840; December 16, 1930, $30,840.15. The return did not segregate income and/or losses of plaintiff and the Postindex Company, but a revenue agent's report dated November 30, 1931, shows same to have been composed of net income of $1,110,790.68 for plaintiff and $60,162.64 for the Postindex Company.
10. Pursuant to a revenue agent's report dated November 30, 1931, and supplement thereto, dated January 30, 1932, the Commissioner redetermined the consolidated net income for the year 1929 at $1,223,733.62, assigning $1,163,363.70 as the net income of the plaintiff and $60,369.92 as that of the Postindex Company. The deficiency in tax resulting from the Commissioner's adjustments amounted to $5,753.59, and this amount, together with interest thereon of $657.46, was duly assessed and paid by plaintiff on February 11, 1932.
11. August 17, 1932, plaintiff filed a claim for refund of $6,640.69 of the tax paid for 1929 on the ground, among others, that so much of the alleged net loss of $115,959.51 by the Postindex Company for the nonaffiliated period, January 1 to February 9, 1927, as was in excess of the Postindex net income, viz., $3,241.89, for the calendar year 1928, should be deducted in computing that company's net income for the calendar year 1929. In a revenue agent's report dated April 6, 1933, the allowable net loss for the unaffiliated period, January 1 to February 9, 1927, was determined to have been $4,622.63, or $1,380.74 in excess of the net income of the Postindex Company for 1928. Plaintiff's claim of August 17, 1932, was disallowed on the ground that the loss of $111,349.68 alleged to have been sustained by the Postindex Company on sale of patents during the unaffiliated period was not proved; and that in any case no loss for that period could be applied against income for 1929, since the taxable period January 1 to February 9, 1927, was not one of the two taxable years preceding 1929 within the purview of section 117(b) of the Revenue Act of 1928.
12. April 15, 1931, plaintiff filed a final consolidated corporation income tax return for the calendar year 1930, reporting consolidated net income of $542,828.31 and tax liability in the amount of $62,371.66 after taking a credit of $2,767.73 for income tax paid a foreign country. This tax was paid in installments as follows: March 16, 1931, $20,000; June 16, 1931, $14,124; September 16, 1931, $14,124; December 15, 1931, $14,123.66. The return did not segregate income and/or losses of plaintiff and its affiliated company.
13. March 18, 1933, plaintiff filed a claim for refund of $13,107.86 of the tax paid for 1930. This claim incorporated by reference plaintiff's letter of protest dated January 5, 1933, and a revenue agent's supplemental report dated February 27, 1933, showing an overassessment of $13,107.86. The letter and report are Plaintiff's Exhibits 34 and 45, respectively, which are made a part hereof by reference.
14. Under dates of June 22 and September 6, 1933, the Commissioner of Internal Revenue notified plaintiff that the claim for refund of $13,107.86 for 1930 would be allowed in the amount of $9,702.36 and rejected for the balance of $3,405.50 by reason of eliminating the foreign tax credit and the deduction from income of the balance of the foreign tax paid. The overassessment of $9,702.36, with interest thereon, was duly refunded to plaintiff.
November 23, 1933, plaintiff filed a claim for refund of $5,703.18, asserting by specific reference its demand for refund on account of the disallowance of part of the addition to the reserve for bad debts for 1930 claimed in the letter of protest referred to in finding 13 herein, and in effect reasserting claim for credit and deduction in that year on account of foreign tax paid. On the same day plaintiff filed its suit for $5,703.18 in this court in case No. 42548.
15. The additions to the reserve for bad debts and other relevant items as shown on plaintiff's books are as follows:
Set up out of surplus.
The additions to the reserve for bad debts as allowed by the Commissioner of Internal Revenue are as follows:
Set up out of surplus $21,597.78.
Plaintiff's business is the manufacture of specialty metal products which are used primarily in the construction and completion of the interior of buildings. These products consist chiefly of metal doors and trim, elevator inclosures both of steel and ornamental bronze, bronze entrance doors, counters, ship furniture for battleships and cruisers, interior equipment for courthouses, tellers' windows, special cages for banks, and other similar building equipment. In the disposal of its products plaintiff in some instances dealt directly with the owner of the building in which these articles were being placed, but in most instances it dealt with the contractor or subcontractor who was engaged in a particular piece of construction work. While in some instances the principal contractors, particularly on public works, were bonded to an extent generally sufficient to afford full protection to a subcontractor in the position of plaintiff, in other instances such contractors were required to give only a performance bond which did not provide adequate protection to the subcontractors. In further instances contractors had the privilege of lien rights, but those rights were sometimes waived to the prejudice of the subcontractors, and in still further instances it was necessary to waive the lien rights in order to secure a given contract. As a result of the foregoing varying conditions, the credit risk involved differed somewhat in the various states where work was being carried on by plaintiff.
Plaintiff made additions to its reserve for bad debts at the end of each year on the basis of one-half of 1 per cent. of its net sales, whereas the Commissioner reduced those additions to the amounts set out in the above tabulation. The amounts thus determined by the Commissioner and allowed as deductions in computing net income constituted reasonable additions to plaintiff's reserves for bad debts.
16. The total income tax imposed by Great Britain for the year 1930-31 (ending April 5, 1931) amounting to $8,315.85 based upon the profits of plaintiff's London branch for the year 1929 was paid on March 4, 1931. Of this tax $5,492.96 was allowed by the Commissioner of Internal Revenue as a credit against income tax for 1929 due the United States, and the balance of $2,822.89 was allowed as a deduction in computing plaintiff's consolidated net income for 1929. Plaintiff had claimed the allowance of this British tax in its 1929 return.
The total income tax imposed by Great Britain for the year 1931-32 (ending April 5, 1932) in the amount of $7,933.60 based upon the profits of plaintiff's London branch for the year 1930 was paid February 5, 1932. No part of this tax has been allowed by the Commissioner of Internal Revenue, either as a credit against the income tax imposed by the United States or as a deduction for the year 1930, because the Commissioner treated it as an accrual in 1931.
17. In or prior to 1911 J.T. Quigley invented a clocklike device called a costmeter. About 1911, J.C. Liggett came in contact with Quigley and became interested in the work which he was doing. Liggett gave Quigley financial assistance in carrying on experimental work in connection with the device. September 28, 1911, Liggett caused the Costmeter Company of California to be organized, to which were transferred patents and patent applications covering the costmeter device. Stock was issued to Liggett for his efforts and assistance. In the meantime L.K. Liggett (a brother of J.C. Liggett) also became interested in the corporation and rendered financial assistance, thereby acquiring an interest in the corporation. The corporation had outstanding capital stock of $500,000, the greater part, if not all, of which was held by the Liggetts and Quigley, and their families, approximately three-fourths being held by the Liggetts of which more than half was held by L.K. Liggett.
18. Prior to November, 1914, there had been no commercial production of the device, but a great deal of experimental and development work had been done and the promoters of the enterprise were optimistic as to the possibilities of its commercial development. November 1914 the Costmeter Company of Massachusetts was organized by the stockholders of the Costmeter Company of California, and by a bill of sale dated October 22, 1915, all of the costmeter patents and patent applications were transferred to the Massachusetts corporation in consideration for the issuance to the stockholders of the California corporation of 3,000 shares of its capital stock of a par value of $100 a share, that is, $300,000, plus the assumption by the Massachusetts corporation of liabilities of the California corporation amounting to $49,315.61, the stock of the Massachusetts corporation being issued to the stockholders of the California corporation in proportion to their holdings therein. A small amount of other miscellaneous assets, consisting of the remaining assets of the California corporation, was transferred to the Massachusetts corporation in connection with the same transaction as follows: Cash, $302.87; accounts receivable, $339.10; plant and equipment, $6,747.61; inventory, $10,230.23.
On the basis of this transaction the patents and patent applications were set upon the books of the Massachusetts corporation at $331,696.80. At the time of their acquisition by the Massachusetts corporation the costmeter patents had an average remaining life of seventeen years. At or about the date of acquisition of the assets of the California corporation by the Massachusetts corporation the latter sold to three individuals 400 shares of its stock of a par value of $40,000 for $40,000 in cash. The three individuals who purchased the stock had not been connected in any way with the California corporation.
After the above transfer of assets and liabilities from the California corporation to the Massachusetts corporation the assets and liabilities of the latter were identical with those of the former before the transfers, except as to the $40,000 in cash which had been received by the Massachusetts corporation from the sale of 400 shares of its capital stock.
19. In addition to the patent rights and applications for patents relating to the costmeter device, there was included among the assets transferred from the Costmeter Company of California to the Costmeter Company of Massachusetts on October 22, 1915, a registered application for a patent on the loose-leaf, visible file index, which was acquired by the Postindex Company, plaintiff's subsidiary, in September 1922. This patent is not involved in this suit, and the application therefor was not recognized as having any actual value at the time of its transfer in 1915, but it later developed into an asset of considerable value as hereinafter shown.
20. The Costmeter Company of Massachusetts began the manufacture of the costmeter device after it had acquired the assets of the California corporation. The device was designed to keep track of labor and overhead costs in factories. Each device or machine was an independent power unit which operated somewhat like a clock and a separate device was required for each employee. The machine was prepared so that a tape would pass through it and record thereon the time consumed on a given job as well as the money cost of the labor thereon. After a job was completed the tape would be taken out and pasted on cardboard or preserved in some other manner to show operating cost.
The devices were not sold but were rented at approximately 50 cents a month. They were manufactured and rented from time to time over the period from 1915 to 1920, but such operations were never commercially successful. They were not only cumbersome themselves but the same was also true of the tape-method of transferring and maintaining costs. In the meantime there were many changes in cost-finding methods and one or more new inventions of related types came into use. Over the period from 1915 to 1920 the gross revenue from all rentals of the device was only $14,018.25. January 3, 1920, the Massachusetts corporation ceased the manufacture of the device and none has been manufactured since that time. Prior to December 30, 1925, the patents on the device had become worthless.
21. During 1919 the Costmeter Company of Massachusetts for the first time began development of the visible file index and in 1922 it was decided to separate that business from the costmeter business. Accordingly, a new corporation known as the Postindex Company was organized under the laws of Massachusetts in 1922.
September 15, 1922, the visible file index patent and all other assets except the patent rights upon costmeters and the costmeter inventory were transferred from the Costmeter Company to the Postindex Company. The consideration for the transfer was the issuance of all the common stock of no par value of the Postindex Company to the Costmeter Company.
From September 15, 1922, until December 30, 1925, the Costmeter Company retained the costmeter patents and inventory and also held all of the stock of the Postindex Company.
22. Between September, 1922, and December 30, 1925, the Costmeter Company became indebted to the Postindex Company in the amount of $19,740.16, and on December 30, 1925, the Costmeter Company was indebted to L.K. Liggett on notes in the amount of $143,489.91 which he had previously loaned to it for operating expenses, plus $56,770.42 accrued interest.
December 30, 1925, the Costmeter Company transferred the costmeter patent rights and inventory to the Postindex Company in settlement of its indebtedness of $19,740.16 to the latter corporation. The Costmeter Company on the same day transferred all of the stock of the Postindex Company to L.K. Liggett in settlement of its indebtedness to him, and, having no other assets left, the Costmeter Company then liquidated on December 31, 1925. The Postindex Company set up the costmeter patent rights on its books at $19,640.16, the inventory being valued at $100.
23. The Costmeter Company filed a consolidated corporation income tax return for the calendar year 1925, reporting itself as parent and the Postindex Company as subsidiary. The return did not segregate the income and/or losses of parent and its affiliated company. The Costmeter Company claimed as a deduction, under Schedule B, a loss of $162,677.69. An alleged loss on the sale of the costmeter patents to the Postindex Company in consideration of the latter's cancellation of the former's indebtedness to it, amounting to $19,740.16, entered into the determination of this loss. The net loss reported in the return was $193,558.96. The Postindex Company had a net profit of $3,792.69 for that year, and the Costmeter Company a net operating loss of $29,782.65.
In computing the loss on the sale of the costmeter patents to the Postindex Company on December 30, 1925, the Costmeter Company used as cost of those patents the sum of $306,387.34. This figure did not represent a cash outlay, but was the adjusted balance of the original costmeter patent account amounting to $331,696.80 set up in 1915 upon organization of the Massachusetts corporation. The original account had been set up in an amount equal to the value attributed to the stock of the Costmeter Company, the California corporation, and for which the Massachusetts corporation had issued its capital stock of a par value of $300,000, as shown in finding 18 herein.
24. After December 30, 1925, L.K. Liggett owned all the common stock of the Postindex Company and the Postindex Company owned the costmeter patent rights, as well as the visible file index patents acquired in 1922. The officers of the Costmeter and Postindex companies were generally the same.
On February 7, 1927, the Postindex Company transferred the costmeter patents, parts, dies, equipment, and agreements to L.K. Liggett, by bill of sale for a consideration of $100. On February 9, 1927, L.K. Liggett sold all of the Postindex Company common stock to the plaintiff for a consideration of $200,000.
These two cases were consolidated for the purpose of taking testimony and submission to the court, and arise as a result of adverse action by the Commissioner of Internal Revenue on timely refund claims filed by plaintiff for income tax alleged to have been overpaid for 1927, 1929, and 1930.
Plaintiff contends, first, that a corporation later affiliated with it sustained a loss in 1927 on the disposition of certain patents, the unabsorbed portion of which should be carried forward and allowed as a deduction in computing consolidated net income for 1929. This question presents a rather involved set of facts but the essential elements upon which recovery depends involve a very narrow question of fact. Prior to 1911 one Quigley was developing a device called a costmeter, which was designed to record information necessary in the determination of labor and overhead cost in factories. In 1911 J.C. Liggett, after conferences with Quigley, became convinced that the device had commercial possibilities. Accordingly, September 28, 1911, Liggett organized the Costmeter Company of California and to that corporation were transferred the patents and patent applications on the costmeter device. In the meantime Liggett had interested his brother, L.K. Liggett, and perhaps others, in the proposition. The corporation had outstanding capital stock of the par value of $500,000, most, if not all, of which was held by the Liggetts, Quigley, and their families, more than three-fourths of the stock being held by the Liggetts of which more than a majority was held by L.K. Liggett. From 1911 to 1915 considerable experimental work was carried on for the purpose of perfecting the device.
In November, 1914, the Costmeter Company of Massachusetts was organized and to that corporation were transferred in October, 1915, all of the assets of the California corporation in exchange for stock of a par value of $300,000. The stock was apportioned among the stockholders of the California corporation on the basis of their holdings in that corporation. The Massachusetts corporation also assumed liabilities of the California corporation of approximately $49,000, and, in addition to the patents and the patent applications on the costmeter device, acquired certain miscellaneous assets having a value of seventeen or eighteen thousand dollars. The patents and patent applications were entered on the books of the Massachusetts corporation at $331,696.80, which that corporation used as cost based upon the par value of stock issued for the various assets and the liabilities assumed. About the same time the California corporation sold stock of a par value of $40,000 for cash in the same amount to three individuals who had not been previously connected with either corporation.
The Massachusetts corporation then proceeded to manufacture some of the devices and at the same time continued its experimental and development work looking to its improvement and perfection. From time to time over the period from 1915 to 1920 machines were manufactured and placed with about six business concerns for use on a rental basis of 50 cents a month. The device was never a commercial success, losses being shown consistently in connection with the venture. In 1920 all manufacture of the device under the patents ceased and none was thereafter manufactured.
In the meantime a patent on a visible file index, which came to the Massachusetts corporation through a patent application in existence at the time of the 1915 transfer of assets, had developed into an asset of value. In 1922 it was decided to transfer the visible file index business to a separate corporation. Accordingly the Postindex Company was formed September 15, 1922, to which were transferred the patent on the visible file index and all other assets of the Costmeter Company of Massachusetts except the costmeter patents and inventory, the entire capital stock of the Postindex Company being issued to the Costmeter Company of Massachusetts. The Postindex Company seems to have been profitable from 1922 to 1925, whereas in or before 1925 the costmeter business had become a hopeless venture. However, the Costmeter Company had become indebted to the Postindex Company, as well as to L.K. Liggett. As a result the Costmeter Company on December 30, 1925, transferred the costmeter patents and inventory to the Postindex Company in settlement of its indebtedness to the latter corporation and on the same day the Costmeter Company transferred all of the stock of the Postindex Company to L.K. Liggett in settlement of its indebtedness to him. Having thus disposed of all its assets the Costmeter Company liquidated on the following day. L.K. Liggett continued to own all the stock of the Postindex Company from December 30, 1925, until February 9, 1927, when he sold this stock to plaintiff. Two days before this sale the Postindex Company sold the costmeter patents to L.K. Liggett for $100.
On the basis of this sale of the costmeter patents in 1927 by the Postindex Company to L.K. Liggett plaintiff claims a deductible loss measured by the difference between the alleged cost of $331,696.80, as entered on the books of the Costmeter Company of Massachusetts in 1915, less proper adjustment for depreciation, and the sale price of $100 in 1927. On this basis plaintiff also contends such part of the loss as was not used in determining taxable income for 1927 and 1928 should be carried forward and allowed as a deduction in computing net income for 1929. On the latter point the parties agree that in the event a loss was sustained plaintiff is correct in principle as to carrying forward such loss.
Plaintiff proceeds on the theory that these patents were acquired in 1915 at a cost measured by the par value of stock issued therefor and certain liabilities assumed, and that such stock had a fair market value equal to its par value. This claim is based largely on the proposition that certain shares of stock were sold for cash at par about the date of acquisition in 1915, whereas defendant strongly urges that the evidence is not sufficient to support the claimed value.
We do not find it necessary to determine the merits of these contentions for the reason that we are convinced, and have found as a fact, that the patents had become worthless long before the taxable years involved. This conclusion is fully supported by the record. However optimistic the views of the promoters of the enterprise may have been at its inception, these hopes had been destroyed prior to the time when the Costmeter Company of California made a transfer of the assets to the Postindex Company on December 30, 1925. After about five years of effort had produced gross income from the device of only about $14,000, and the corporation had shown consistent losses therefrom over that entire period, manufacture ceased in 1920 and was not thereafter resumed. Whether the invention might have been a success if the war had not intervened and if better methods of doing the same thing had not been found is of no importance here. The controlling fact is that five years of effort, in addition to about five years of experimentation prior to the formation of the Costmeter Company of California, not only failed to produce successful results but demonstrated that financial returns could not be expected from the manufacture of this device.
The conclusion of the Costmeter Company of Massachusetts that the patents were worthless prior to their transfer to the Postindex Company is shown by statements appearing in the capital stock returns filed July 21, 1923, September 29, 1924, and July 24, 1925, wherein it is said that "The inventory is obsolete," and "Good will and patents have no value in view of the recurring deficits." The overwhelming weight of evidence to the effect that the patents had become worthless prior to December 30, 1925, more properly fixes the period within which any deductible loss was sustained than the sale in 1927 of the asset in question by a corporation to its sole stockholder for a nominal consideration. Since the loss had been sustained prior to 1927 it follows that it cannot be taken into consideration in arriving at taxable income for 1927 and subsequent years.
Plaintiff next contends that the defendant erroneously reduced the amount of the allowable deductions in 1927 and 1930 on account of additions to its reserve for bad debts. This issue arises under the provisions of section 234(a)(5) of the Revenue Act of 1926, 44 Stat. 41, and the corresponding provision of the Revenue Act of 1928, § 23(j), 26 U.S.C.A. § 23 note, which provide that in computing net income there shall be allowed as deductions "Debts ascertained to be worthless and charged off within the taxable year (or, in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts)."
The use of the reserve system in connection with deductions for worthless debts was first permitted in the Revenue Act of 1921 (section 234(a)(5), 42 Stat. 254) and has been continued in substantially the same form. Prior to 1921 deductions for worthless debts could only be allowed when they were ascertained to be worthless and charged off. The new provision for the use of reserves constituted an important departure from the former revenue acts as far as worthless debts were concerned, and also a departure from the method employed with respect to other deductions, in that, by the use of the reserve method, deductions were thereafter allowable without regard to whether evidenced by closed and completed transactions. It is not without significance, therefore, that under the quoted provisions the additions to the reserve must be reasonable and allowable only in the discretion of the Commissioner. While the Commissioner's exercise of his discretion in this respect is subject to review (cf. Blair v. Oesterlein Machine Co., 275 U.S. 220, 48 S.Ct. 87, 72 L.Ed. 249), his determination of a reasonable addition to a reserve is not to be lightly set aside. The burden is on plaintiff to show that the additions which the Commissioner has allowed to the reserve as deductions from income for the years involved are not reasonable. In this there is more than a mere presumption of the correctness of the Commissioner's determination. In addition, we are reviewing exercised discretion which has been confided in the Commissioner. Upon these principles we cannot say, upon this record, that there was any abuse of the discretion lodged in the Commissioner in the determination and allowance as a deduction of the additions to the reserves for 1927 and 1930, or that the additions for those years were other than reasonable. It is true that the addition allowed by the Commissioner for each of the three years preceding 1927, as well as for each of the three subsequent years, was $20,000, whereas the amount allowed for 1927 was only $11,680.38. Each year, however, must be judged on its own particular facts and an allowance by the Commissioner for a prior year does not bind him to approve the same allowance for a later year. C.P. Ford Company, Inc., v. Commissioner, 28 B.T.A. 156. The addition to the reserve claimed by plaintiff for 1927 was $38,591.82, whereas the total amount charged off by plaintiff from 1921 to 1927, inclusive, amounted to only $54,387.97, or an average of $7,769.71 a year, and that does not take into account the amounts recovered in each of the years on account of debts previously charged off. The balance in the reserve as fixed by plaintiff at December 31, 1927, was $177,114.51, an amount more than three times the total charge-offs for 1921 to 1927, inclusive. When, therefore, the Commissioner allowed an addition for 1927 of $11,680.38 and showed a balance in the reserve at December 31, 1927, of $84,171.28, a showing of unusual circumstances would be necessary to require a conclusion that the Commissioner had abused his discretion in making such allowance and that a reasonable addition to the reserve had not been made. The evidence fails to justify such a conclusion.
A similar analysis could be made with respect to 1930 and a like conclusion must be reached. In further support of its position with respect to the latter year, with respect to which the Commissioner allowed an addition to the reserve of $20,000 when the charge-offs in that year were $28,145.33, plaintiff calls attention to the unusual conditions brought about by the economic depression and states that the losses sustained in the three subsequent years substantiate its contention. Although what happened in those three years would not be controlling as to the proper addition in 1930 and we have not considered the facts with respect thereto sufficiently material to be incorporated in the findings, what was shown, however, tends to confirm rather than refute the accuracy of the allowance as made by the Commissioner. The actual charge-offs for 1931, 1932, and 1933 were $13,941, $53,049.03, and $23,204.27, respectively. Even after these charge-offs a substantial amount existed in the reserve at the end of 1933 and a substantial part of the charge-offs was with respect to business done for 1930 and prior years, as to which years reserves had been built up, even on the Commissioner's allowance, much in excess of the charge-offs for those years. The further argument is advanced that the plaintiff was not always fully protected through the character of bonds taken out by the party through whom it was doing work, but it should be borne in mind that protection of this character is something in addition to that ordinarily found to which a party may have recourse in the event of the failure of the debtor. In many instances, therefore, plaintiff had double protection against bad-debt losses and the relatively small losses sustained of that nature may reasonably be attributed in part to that source.
The record we think confirms rather than discredits the reasonableness of the additions to the reserve as allowed by the Commissioner of Internal Revenue.
The final question is whether plaintiff is entitled to a credit against its tax for the calendar year 1930 on account of income tax paid to the British government February 5, 1932, on earnings of its London branch for that year. Plaintiff kept its books and rendered its returns on an accrual basis and contends that the tax in question accrued at the end of 1930. The meager facts on this point are not sufficient to justify the conclusion that the taxes accrued on a date other than that fixed by the Commissioner. In order to substantiate credits for foreign taxes, it is necessary to prove the details of the law imposing the tax as well as the various factors fixing the date of accrual. Niles Bement Pond Co. v. United States, 281 U.S. 357, 50 S.Ct. 251, 74 L.Ed. 901; Law of Federal Income Taxation, Paul and Mertens, vol. 3, p. 212. Some of these essential elements are not shown. Accepting as true, however, the facts as used by both parties, some of which are not in the record, we are of opinion that the Commissioner's action was correct.
Prior to 1932 the Commissioner had proceeded on his ruling that British income tax assessable for the British year of assessment, April 6 to April 5 of the succeeding year, on the average income of "three years ending on that day of the year immediately preceding the year of assessment on which the accounts of the said trade had been usually made up," is properly accruable as at the end of the third year in the average, and where the tax for the British year of assessment is based on the income of the preceding year, the tax accrues as at the end of such preceding year. G.C.M. 5971 (C.B. VIII-1, p. 182). However, on February 4, 1932, it was held in Columbian Carbon Co. v. Commissioner, 25 B.T.A. 456, that such tax did not accrue at the end of the year preceding the year of assessment, but rather in the year of assessment, since it appeared that liability for the payment of such British taxes is dependent upon whether the taxpayer continues in business during the year of assessment. As a result of that decision, the Commissioner revoked the prior decision referred to and issued G.C.M. 10613 (C.B. XI-1, p. 173), in which he made a ruling consistent with that decision of the Board. Plaintiff filed its return for 1930 on the basis of the earlier decision, but in his audit the Commissioner made adjustments to conform to the later decision which was then in force, thereby disallowing the entire deduction for 1930 of the tax for the British year of assessment, April 6, 1931, to April 5, 1932, which was based on the earnings of plaintiff's London branch for the calendar year ended December 31, 1930, and which was paid February 4, 1932.
A tax accrues when all events have occurred which fix the amount of tax and determine the liability of the taxpayer to pay it. United States v. Anderson, 269 U.S. 422, 423, 46 S.Ct. 131, 70 L.Ed. 347. On the basis of the facts set out in the decision of the Board in the Columbian Carbon Co. Case, supra, and in the rulings of the Commissioner heretofore referred to, which facts the parties seem to have accepted as a basis for their positions, it appears that at the end of 1930 all events had occurred necessary for a determination of the amount of tax but that plaintiff's liability for tax was dependent on the happening of an event subsequent to the end of that year, namely, its continuance in business. Under such circumstances the basis for accrual did not exist until after the end of the calendar year 1930. The petitions must be dismissed. It is so ordered.