Opinion
Docket No. 35646.
1954-01-29
THE ERIE COUNTY UNITED BANK, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Roger K. Powell, Esq., for the petitioner. Robert E. Johnson, Esq., for the respondent.
Roger K. Powell, Esq., for the petitioner. Robert E. Johnson, Esq., for the respondent.
1. The petitioner was formed in 1939 under the laws of Ohio by a consolidation of The Vermillion Banking Company and The Farmers and Citizens Banking Company. Prior to the consolidation the predecessor banks involuntarily charged off on their books certain bad debts but did not take deduction therefor in their income tax returns. Petitioner collected some of the debts in each of the years here involved. Held, that the consolidation was a reorganization under section 112(g)(1)(A) of the Internal Revenue Code and that under section 113(a)(7)(B) of the Code the debts had the same basis to the petitioner that they had to the predecessor banks. Held, further, that petitioner did not realize taxable income on the recoveries.
2. The petitioner's gross income for 1944 was not understated by an amount in excess of 25 per cent of the amount properly includible therein. Held, that the period of limitations for assessment of tax for that year had expired at the time the notice of deficiency was mailed to petitioner.
The Commissioner has determined deficiencies in income tax and declared value excess-profits tax of the petitioner as follows:
+---------------------------------------------+ ¦Year¦Tax ¦Deficiency¦ +----+-----------------------------+----------¦ ¦1944¦Income ¦$8,539.73 ¦ +----+-----------------------------+----------¦ ¦1946¦Income ¦2,961.53 ¦ +----+-----------------------------+----------¦ ¦1947¦Income ¦99.19 ¦ +----+-----------------------------+----------¦ ¦1944¦Declared value excess-profits¦2,006.67 ¦ +---------------------------------------------+
By amended answer the Commissioner has moved to increase the deficiency in income tax of $2,961.53 determined for 1946 to $3,414.89.
The issues presented for determination are (1) whether recoveries of bad debts in 1944, 1946, and 1947 in the amounts of $23,352.44, $7,639, and $431.25, respectively, are taxable income, and (2) whether the period of limitations for assessment of the deficiency in income tax for 1944 has expired.
FINDINGS OF FACT.
A portion of the facts has been stipulated and is found accordingly.
Petitioner is a banking corporation organized under the laws of Ohio. It filed its income tax returns for the calendar years 1944, 1946, and 1947 and its declared value excess-profits tax return for the calendar year 1944 with the collector of internal revenue for the tenth district of Ohio.
Petitioner was formed on December 27, 1939, by a statutory consolidation of The Vermilion Banking Company, Vermilion, Ohio, hereinafter referred to as Vermilion Bank, and The Farmers and Citizens Banking Company of Milan, Ohio, hereinafter referred to as the Farmers Bank. On the same day the Superintendent of Banks (Division of Banks of the State of Ohio) issued to the petitioner a license permitting it to open its offices at Vermilion, Ohio, and Milan, Ohio, on December 28, 1939, and to perform usual banking functions. The consolidation was pursuant to an agreement of consolidation, dated December 26, 1939, which provided in part as follows:
That, in consideration of the mutual covenants and agreements herein contained, in consideration of the mutual benefits to be received and further to carry on the purposes of their respective charters, the said parties hereto (hereinafter sometimes referred to as the ‘Consolidating Banks‘) do hereby consolidate into a single new corporation under the pursuant to the laws of the State of Ohio, and by these presents do hereby covenant and agree, and prescribe the terms and conditions and mode of carrying the said consolidation into effect, which terms and conditions they mutually covenant and agree to observe, as follows:
Article Fifth. (1) Amount, classes and shares of capital stock. The maximum number of shares which the Consolidated Bank is authorized to have outstanding is 40,000 which shall be classified as follows:
(a) 24,000 shares (subject to retirement as hereinafter provided) of the par value of $2.50 each, shall be designated preferred stock, and
(b) 16,000 shares (subject to increase upon the retirement of preferred stock as provided in the second and third paragraphs of section 4 of this article Fifth) of the par value of $2.50 each, shall be designated common stock.
(12) Voting rights.— (a) Except as otherwise provided in sections 10 and 13 of this article Fifth and in this section 12, each holder of stock of any class shall be entitled to vote on all matters one vote for each share or stock of any class held by him.
(b) In all elections of directors, each holder of stock of any class shall have the right to vote the votes allocable to the number of shares owned by him for as many persons as there are directors to be elected, or, as long as any shares of preferred stock are outstanding, to cumulate such votes and give one candidate as many votes as the number of directors multiplied by the number of votes allocable to his shares shall equal or to distribute such votes on the same principle among as many candidates as he shall think fit.
(c) In case as many as two semiannual dividend payments (whether or not consecutive and whether or not earned or declared) on the preferred stock shall be in arrears (exclusive of any such dividend which may be payable at any time within three (3) months from the date of issuance of the preferred stock), then, and until all arrears of dividends upon the preferred stock shall have been paid and the full dividend on the outstanding preferred stock for the then-current semiannual dividend period shall have been declared and funds set apart for the payment thereof, and the holders of preferred stock at the time outstanding shall be entitled, as a class, to vote on all matters twice the number of the votes to which the holders of common stock, as a class, are at the time entitled, and each holder of preferred stock shall be entitled to a pro rata share of the votes to which his class is entitled.
(d) At any time while the votes of the preferred stock are increased as provided in paragraph (c) of this section 12 or in subparagraph (2) of section 13 of this article Fifth, any one or more of the directors, officers or employees of the Consolidated Bank may be removed at any annual or special meeting of shareholders, for or without cause, and their successors elected, by the affirmative vote of two-thirds of the votes to which the holders of all classes of stock, voting as one class, are at the time entitled.
Article Sixth. The manner and basis of converting the shares of capital stock of each of the Consolidating Banks into shares of the Consolidated Bank shall be as follows:
(a) The holders of the outstanding capital stock of The Vermilion Banking Company shall be entitled to receive 2,000 shares of common stock of the Consolidated Bank, and certificates representing one share of common stock of the Consolidated Bank of the par value of $2.50 for each share of capital stock of The Vermilion Banking Company represented by the certificates now outstanding shall be issued in exchange for such outstanding certificates upon the surrender for cancellation of such outstanding certificates in transferable form and, if required, properly stamped for transfer, and until such certificates are exchanged as aforesaid the outstanding certificates representing shares of capital stock of The Vermilion Banking Company shall be deemed to represent a like number of shares of common stock of the Consolidated Bank of the par value of $2.50 per share.
(b) The holders of the outstanding capital stock of The Farmers and Citizens Banking Company of Milan, Ohio, shall be entitled to receive 14,000 shares of common stock of the Consolidated Bank of the par value of $2.50 per share, and certificates representing eight shares of common stock of the Consolidated Bank of the par value of $2.50 per share for each share of capital stock of the Farmers and Citizens Banking Company of Milan, Ohio, represented by the certificates now outstanding shall be issued in exchange for such outstanding certificates upon the surrender for cancellation of such outstanding certificates in transferable form and, if required, properly stamped for transfer, and until such certificates are exchanged as aforesaid the outstanding certificates representing shares of capital stock of The Farmers and Citizens Banking Company of Milan, Ohio, shall be deemed to represent eight shares of common stock of the Consolidated Bank of the par value of $2.50 per share for each share of capital stock of The Farmers and Citizens Banking Company of Milan, Ohio, now represented by such outstanding certificates.
There shall be issued by the Consolidated Bank $60,000 aggregate par value of preferred stock, divided into 24,000 shares of the par value of $2.50 per share, which shall be sold for cash at a price at least equal to the par value thereof.
Article Eighth. The Consolidated Bank shall establish and operate a branch in the Village of Milan, Ohio, upon approval of the Superintendent of Banks and such other supervisory authority as may be necessary.
Article Ninth. Title to all assets of the Consolidating Banks shall vest in and be the property of the Consolidated Bank. Each of the Consolidating Banks, for itself and not the other, in consideration of the premises, does hereby grant, convey, assign, set over and vest in the said Consolidated Bank for the purpose of such consolidation, all of the property, rights, franchises, privileges and powers by it now held or in or to which it has any right, title, interest or claim in law or equity; and each of said Consolidating Banks hereby agrees to execute and deliver all instruments of conveyance and assignment necessary to vest in the Consolidated Bank the legal title to all of said property, rights, franchises and privileges.
Article Tenth. Each of the Consolidating Banks shall contribute to the surplus account of the Consolidated Bank an amount equal to not less than fifty per cent of the total par value of the common stock of the Consolidated Bank to which its present shareholders shall be entitled.
+----------------------------------------------------------------------------+ ¦The Vermillion Banking Company shall: ¦ ¦ +-----------------------------------------------------------------+----------¦ ¦(1) Transfer its liabilities to depositors and other creditors to¦ ¦ +-----------------------------------------------------------------+----------¦ ¦the Consolidated Bank. ¦ ¦ +-----------------------------------------------------------------+----------¦ ¦(2) Adjust the book value of all assets to an amount satisfactory¦ ¦ +-----------------------------------------------------------------+----------¦ ¦to the Superintendent of Banks, the Reconstruction Finance ¦ ¦ +-----------------------------------------------------------------+----------¦ ¦Corporation and the Federal Deposit Insurance Corporation, ¦ ¦ +-----------------------------------------------------------------+----------¦ ¦and convey them (book and non-book) to the Consolidated Bank. ¦ ¦ +-----------------------------------------------------------------+----------¦ ¦(3) Use $50,000 of its capital funds for the purpose of ¦ ¦ +-----------------------------------------------------------------+----------¦ ¦establishing reserves on the books of the Consolidated Bank ¦ ¦ +-----------------------------------------------------------------+----------¦ ¦for the following purposes: ¦ ¦ +-----------------------------------------------------------------+----------¦ ¦(a) Potential loss in settlement of contingent liability to the ¦ ¦ +-----------------------------------------------------------------+----------¦ ¦Trustees of The Bank of Vermillion ¦$30,000.00¦ +-----------------------------------------------------------------+----------¦ ¦(b) Potential loss in connection with defalcation of former ¦ ¦ +-----------------------------------------------------------------+----------¦ ¦employee ¦2,000.00 ¦ +-----------------------------------------------------------------+----------¦ ¦(c) Potential loss in acquiring title to banking house ¦18,000.00 ¦ +-----------------------------------------------------------------+----------¦ ¦ ¦$50,000.00¦ +----------------------------------------------------------------------------+
(4) Retire its outstanding Debentures.
The Farmers and Citizens Banking Company of Milan, Ohio, shall:
(1) Transfer its liabilities to depositors and other creditors to the Consolidated Bank.
(2) Adjust the book value of all assets to an amount satisfactory to the Superintendent of Banks, the Reconstruction Finance Corporation and the Federal Deposit Insurance Corporation, and convey them (book and non-book) to the Consolidated Bank.
(3) Retire its outstanding Debentures.
Article Eleventh. The consolidation of The Vermilion Banking Company and The Farmers and Citizens Banking Company of Milan, Ohio, into a single, new corporation under the name of The Erie County United Bank, as herein provided, shall be and become effective at the time that a duly certified copy of this agreement is filed in the office of the Secretary of State together with a certified copy of the approval of the Superintendent of Banks of the State of Ohio to this consolidation, and this agreement is made contingent upon the requisite actions or agreements of the shareholders and of the state banking authorities, the directors of The Vermilion Banking Company and of The Farmers and Citizens Banking Company of Milan, Ohio, respectively, at meetings thereof duly called and held, having duly authorized the officers of each of the said banks to enter into this agreement for the consolidation of the said banks, and such action having been duly authorized and approved by the votes of the holders of at least two-thirds of the capital stock of each of the Consolidating Banks cast at meetings thereof duly called and held.
On December 24, 26, 27, 28, 29, and 30, 1939, the banking offices at Milan, Ohio, previously occupied by Farmers Bank and the banking offices at Vermilion, Ohio, previously occupied by Vermilion Bank continued to be open for business without any change of name or any change of personnel. No entries were made in the books of Farmers Bank or Vermilion Bank as of December 26, 27, 28, or 29, 1939, to show any transfer of assets on those dates from them to the petitioner. In each office the records continued to be maintained in the same name and form as before.
On December 28, 1939, the board of directors of The Erie County United Bank adopted resolutions to issue preferred stock authorized by the Agreement of Consolidation and to accept an application for the purchase thereof. Prior to the contemplated consolidation, it had been informally agreed that the Reconstruction Finance Corporation would purchase this preferred stock for $60,000. On December 29, 1939, The Erie County United Bank applied for an offer from the Reconstruction Finance Corporation to purchase this preferred stock and submitted various documents supplemental to such application. The Reconstruction Finance Corporation purchased the preferred stock for $60,000 after the reorganization.
The first business day after December 30, 1939, was January 2, 1940. On the latter date, the first and opening entry was made in the General Journal of petitioner to show the assets and liabilities of the petitioner on that date.
The equity of the Vermilion Bank common stockholders on December 31, 1939, prior to the reorganization was $12,824.08. The equity of the Farmers Bank common stockholders on December 31, 1939, prior to the reorganization was $56,647.41. The equity of the common stockholders of petitioner on December 31, 1939, after the reorganization was $72,471.49.
In accordance with a resolution adopted by petitioner's board of directors income tax returns for the full calendar year 1939 were filed for Farmers Bank and Vermilion Bank. The petitioner filed no income tax return for 1939 but filed one for the calendar year 1940.
On September 5, 1940, the first common stock of the petitioner was issued to the former stockholders of Vermilion Bank and Farmers Bank.
As a result of the consolidation, the petitioner acquired all the assets, both ledger and nonledger, of each of the predecessor two banks and assumed their liabilities. The ledger assets transferred to petitioner were entered on its books at the same values at which they appeared on the books of the transferor banks. The nonledger assets were not carried on the ledgers of the transferor banks and were not included in the first general ledger entry made by the petitioner in its books on January 2, 1940, but were carried by petitioner as nonledger assets.
In 1944 petitioner received payments upon the following items which had been charged off as bad debts by the transferor banks in the indicated years and which were not carried by petitioner as ledger assets on its books:
+-----------------------------------------------------------------------------+ ¦Farmers Bank ¦ ¦Vermillion ¦ ¦ ¦ ¦ ¦ ¦Bank ¦ ¦ ¦ +-----------------------------------+----------+------------+-------+---------¦ ¦charged off ¦ ¦charged off ¦ ¦ ¦ +-----------------------------------+----------+------------+-------+---------¦ ¦ ¦ ¦ ¦1/1/39-¦ ¦ +-----------------------------------+----------+------------+-------+---------¦ ¦Name of debtors ¦1933 ¦6/9/38 ¦12/26/ ¦12/30/39 ¦ ¦ ¦ ¦ ¦39 ¦ ¦ +-----------------------------------+----------+------------+-------+---------¦ ¦Trustees of Farmers Bank & Citizens¦$19,658.05¦ ¦ ¦ ¦ ¦Banking Co ¦ ¦ ¦ ¦ ¦ +-----------------------------------+----------+------------+-------+---------¦ ¦Addison Wiles 13055 ¦ ¦$50.00 ¦ ¦ ¦ +-----------------------------------+----------+------------+-------+---------¦ ¦H. M. & Viola Weiss 12410 ¦ ¦170.45 ¦ ¦ ¦ +-----------------------------------+----------+------------+-------+---------¦ ¦Lyle Dickerhoff 7566 ¦ ¦ ¦ ¦$119.00 ¦ +-----------------------------------+----------+------------+-------+---------¦ ¦Frank L. Bond 3917 ¦ ¦ ¦ ¦306.98 ¦ +-----------------------------------+----------+------------+-------+---------¦ ¦Floyd Lardhessee 7358 ¦ ¦ ¦ ¦999.00 ¦ +-----------------------------------+----------+------------+-------+---------¦ ¦L. A. & Edna Naegele 7347 ¦ ¦ ¦ ¦225.00 ¦ +-----------------------------------+----------+------------+-------+---------¦ ¦Earl Miniger 7802 ¦ ¦ ¦ ¦199.00 ¦ +-----------------------------------+----------+------------+-------+---------¦ ¦Whitehurst Fisheries 6354 ¦ ¦ ¦ ¦100.00 ¦ +-----------------------------------+----------+------------+-------+---------¦ ¦Bert Ward 6456 ¦ ¦ ¦ ¦1,259.06 ¦ +-----------------------------------+----------+------------+-------+---------¦ ¦John Reis C5632 ¦ ¦ ¦$230.00¦ ¦ +-----------------------------------+----------+------------+-------+---------¦ ¦H. M. & Viola Weiss 12373 ¦ ¦35.90 ¦ ¦ ¦ +-----------------------------------+----------+------------+-------+---------¦ ¦Total ¦$19,658.05¦$256.35 ¦$230.00¦$3,208.04¦ +-----------------------------------------------------------------------------+
The item, Trustees of Farmers Bank & Citizens Banking Co. $19,685.05, represented a collection made by petitioner under the following circumstances. Pursuant to instructions from the Division of Banks of the State of Ohio, Farmers Bank was reorganized in 1933 and reopened on September 25, 1933. In accordance with the plan of reorganization the depositors waived 40 per cent of their deposits aggregating $160,110.59 and accepted in lieu thereof certificates of participation in certain assets having a book value of $185,763.22. Said assets had been separated from the general assets of the bank upon orders of the Division of Banks because their condition and market value did not meet the standards required for bank assets by that Division. Such assets were transferred to trustees under an arrangement which provided that upon liquidation of the assets and after payment in full of the participation certificates with interest, any amount remaining should be paid to Farmers Bank. Upon and after the reopening of Farmers Bank said assets were not carried by it as ledger assets nor were they ever carried as such by petitioner. In 1944, and after the trustees had completed liquidation of the assets and payment of the participation certificates, there remained $19,658.05 which was paid to petitioner. Farmers Bank filed a corporation income and excess profits tax return for 1933 with the collector of internal revenue for the tenth district of Ohio on March 15, 1934, in which a net loss of $6,689.04 was reported from the operations of the Farmers Bank from September 25, 1933, to December 31, 1933, and from the operations of the predecessor bank. No bad debt deduction in the amount of $19,658.05, nor any deduction including that amount, was taken in any income tax return by the Farmers Bank or its predecessor.
On June 9, 1938, Farmers Bank charged off on its books as bad debts the following
+----------------------------------+ ¦Addison Wiles #13055 ¦$174.00¦ +--------------------------+-------¦ ¦H. M. & Viola Weiss #12410¦245.47 ¦ +--------------------------+-------¦ ¦H. M. & Viola Weiss #12373¦94.00 ¦ +----------------------------------+
These amounts were claimed and allowed as bad debt deductions on the bank's income tax return for the calendar year 1938.
The items charged off by Vermilion Bank in 1939 were not claimed as deductions on its income tax return for that year.
The above mentioned payments received by petitioner in 1944, along with other items, all totaling $27,314.96, were shown in petitioner's income tax return for 1944 as nontaxable recoveries.
During 1946 the petitioner received payment of $5,300 on notes of C. S. and Emma C.Ruggles and C. S. and Esther E. Ruggles and $440 on a note of Frank L. Bond. These notes were part of the notes that Vermilion Bank charged off as bad debts on June 30, 1939, or July 19, 1939. In 1946 the petitioner also received payment of $1,700 on notes of C. S. Ruggles and Emma C. Ruggles and C. S. and Esther E. Ruggles, and $199 on a note of L. A. Naegele. These notes constituted a portion of the assets charged off as bad debts on December 30, 1939, on the records maintained on that date under the name Vermilion Bank. No deduction was taken in the income tax return of Vermilion Bank for 1939 or in any income tax return of the petitioner on account of the notes upon which the above mentioned payments were received. Said notes were not carried as ledger assets on the books of petitioner, and the above mentioned payments thereon, long with other items, all totaling $8,571.09, were shown in petitioner's income tax return for 1946 as nontaxable recoveries.
In 1947 the petitioner received payment of $31.25 on a note of W. R. Spettell which had been charged off as a bad debt on December 30, 1939, on the records maintained on that date under the name of Farmers Bank and that amount was deducted and allowed on the income tax return of Farmers Bank for 1939. During 1947 the petitioner also received additional payments totaling $400 on the note of Frank L. Bond heretofore mentioned. The foregoing payments received in 1947 along with other items, all totaling $1,068.25, were shown in petitioner's income tax return for 1947 as nontaxable recoveries.
With the exception of the recoveries in 1944 totaling $256.35 with respect to indebtedness charged off by Farmers Bank on June 9, 1938, and deductions taken and allowed therefor in that bank's income tax return for 1938, all recoveries involved herein were on account of indebtedness charged off by Farmers Bank or Vermilion Bank pursuant to orders of State banking authorities.
Petitioner filed its Federal income tax return for the calendar year 1944 on March 15, 1945, and reported therein gross income of $58,658.74. By a consent executed be petitioner on January 13, 1950, the period of limitations upon assessment of income and excess profits tax under section 275(c) of the Internal Revenue Code for the calendar year 1944 was extended to June 30, 1951. By a further consent executed by petitioner on or about January 10, 1951, said period of limitations for said calendar year was extended to June 30, 1952. The deficiency notice, with respect to which the petition involved herein was filed, was mailed to petitioner on May 29, 1951.
OPINION.
WITHEY, Judge:
The primary issue in this proceeding is whether the recovery of bad debts charged off in previous years by the consolidating banks but not deducted on their income tax returns, constituted taxable income in the years of their recovery by the petitioner, the consolidated bank.
The petitioner takes the position that the recoveries on the debts here involved did not constitute taxable income to it. In support of its position the petitioner contends that the charge-offs of the debts made by Vermilion Bank and Farmers Bank were involuntary charge-offs within the meaning of Regulations 111, section 29.23(k)-1(c)
and since those banks never deducted the debts in their income tax returns, they never lost their cost basis for the debts; that petitioner having acquired the debts by virtue of a statutory consolidation within the purview of section 112(g)(1)(A)
REGS. 111, SEC. 29.23(k)-1. BAD DEBTS.—(c) Where banks or other corporations which are subject to supervision by Federal authorities (or by State authorities maintaining substantially equivalent standards) in obedience to the specific orders of such supervisory officers charge off debts in whole or in part, such debts shall, to the extent charged off during the taxable year, be conclusively presumed, for income tax purposes, to have become worthless or worthless only in part during the taxable year, as the case may be. But no such debt shall be so conclusively presumed to be worthless or worthless only in part, as the case may be, if the amount so charged off is not claimed as a deduction by the taxpayer at the time of filing the return for the taxable year in which such charge-off takes place. If a taxpayer does not claim a deduction in its return for such a totally or partially worthless debt for the year in which such charge-off takes place, but claims such deduction for a later year, then such charge-off in the prior year will be deemed to have been involuntary and the deduction shall be allowed for the year for which claimed, if the taxpayer produces sufficient evidence to show (1) that the debt became wholly worthless in such later year or became recoverable only in part subsequent to the year of such involuntary charge-off, as the case may be, and (2) that, to the extent that the deduction claimed in the later year for a debt partially worthless was not involuntarily charged off in prior years, it was charged off in the later year.
of the Internal Revenue Code they had the same basis in its hands as they had in the hands of the transferor banks
SEC. 112. RECOGNITION OF GAIN OR LOSS.(g) DEFINITION OF REORGANIZATION.— As used in this section (other than subsection (b)(10) and subsection (1)) and in section 113 (other than subsection (a)(22))—(1) The term ‘reorganization‘ means (A) a statutory merger or consolidation * * *
and that it did not by such recovery realize income but merely recovered such basis.
SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS.(a) BASIS (UNADJUSTED) OF PROPERTY.— The basis of property shall be the cost of such property; except that—(7) TRANSFERS TO CORPORATION.— If the property was acquired—(B) in a taxable year beginning after December 31, 1935, by a corporation in connection with a reorganization, then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made. This paragraph shall not apply if the property acquired consists of stock or securities in a corporation a party to the reorganization, unless acquired by the issuance of stock or securities of the transferee as the consideration in whole or in part for the transfer.
Respondent contends that since the debts or claims were not carried on the books of the transferor banks at the time of the transfer, no consideration passed therefor; that petitioner acquired such debts with a zero basis; and that therefore the recoveries on the debts resulted in income to petitioner. Respondent petitioner. Respondent further contends that the debts in issue were charged off by the predecessor banks which were entities separate and distinct from the petitioner and, therefore, the petitioner, a new corporation, does not stand in the place of the predecessor banks and is not entitled to a ‘recovery exclusion‘ under section 22(b)(12) of the Code.
Normally recovery of a debt is not income, J. P. Bass Publishing Co., 12 B.T.A. 728, except when the debt has been previously charged off as worthless or where the basis of the debt is zero to the taxpayer. The debts had not been deducted for tax purposes by the consolidating banks but had been charged off on their books on instructions from the banking authorities of the State of Ohio. The standards of the Federal and State banking authorities for determining worthless loans are not always the same as the requirements prescribed by the Internal Revenue Code for deducting bad debts for income tax purposes. For banking purposes, bank examiners may take a conservative view and desire to have slightly doubtful accounts and notes charged off. At the same time the bank itself may have a sound basis for expecting recovery of them. In order to give consideration to both views, the respondent in Regulations 111, section 29.23(k)-1(c), has given the taxpayer the right, upon the basis of proper evidence, to determine the year that the loan became worthless and to deduct it in that year even though at the request of the bank examiners it was charged off its books in an earlier year. In such a case the charge-off is under said regulation deemed to be involuntary. We are here confronted with such a situation. The consolidating banks were instructed to charge off the loans. In obedience to such instructions, they charged them off their books but, except for $256.35 deducted in 1938, they did not deduct them in their income tax returns. They then carried the items as nonledger accounts which were part of the consideration involved in the transfer.
The first question is the basis to petitioner of the recoveries on these debts. Section 113(a)(7)(B) of the Code provides that property acquired in a reorganization shall have the same basis in the hands of the transferor increased by any gain or decreased by any loss to the transferor on the transfer. A reorganization is defined by section 112(g)(1)(A) to mean a statutory merger or consolidation. The parties have stipulated this consolidation to be a statutory consolidation but such literal designation along is insufficient to comply with the statute. The transaction must meet the ‘continuity of interest‘ test enunciated in Southwest Natural Gas Co., 14 T.C. 81, 87; and Roebling v. Commissioner, 143 F.2d 810. This requirement is met by a showing that the transferor corporation or its shareholders retained a proprietary share in the new corporation evidenced by a material interest in the affairs of the transferee corporation, and that such retained interest represents ‘a substantial part of the value of the thing transferred.‘ Helvering v. Minnesota Tea Co., 296 U.S. 378; Southwest Natural Gas Co., supra. In the case at bar, the stockholders of the Vermilion Bank received 1 share of common stock of the new corporation for each of their old shares and the stockholders of Farmers Bank received 8 shares of common stock of the new corporation for each of their old shares. The new preferred stock entitled to voting rights and issued to the Reconstruction Finance Corporation constituted 60 per cent of the outstanding voting stock. Therefore, the common stock had the remaining 40 per cent of the voting rights. We conclude that the proportion of the total consideration paid for the stock of the transferors represented by the value of the stock of the transferee corporation represents a definite and substantial interest in the petitioner and that the consolidation is within the ambit of section 112(g)(1)(A). See also Helvering v. Minnesota Tea Co., supra; John A. Nelson Co. v. Helvering, 296 U.S. 374.
Since section 112(g)(1)(A) is merely a definition and does not provide that no gain or loss shall be recognized on all reorganizations, we must look to section 112(a) which states: ‘Upon the sale or exchange of property the entire amount of the gain or loss, determined under section 111, shall be recognized, except as hereinafter provided in this section.‘ Subsection (b)(3) of section 112 of the Code, which states ‘No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization,‘ is applicable to the reorganization in this proceeding, whereby the stockholders of the consolidating banks exchanged their common stock for common stock of the petitioner. It does not appear to us that the basis in the hands of the transferor need be adjusted by any gain or loss, as provided in section 113(a)(7), as the book values of assets and liabilities were the same on the books of each of the parties to the reorganization as were thereafter carried on the books of the consolidated bank. The amounts recovered were never deducted for tax purposes, except for $256.35 deducted in 1938. They were carried as nonledger assets by petitioner as they had been by the consolidating banks and the agreement of consolidation provided that all assets, book and nonbook, were conveyed to the consolidated bank. The problems of tax benefit and recovery exclusions arising under the provisions of section 22(b)(12) are not involved in this situation since the consolidating banks never deducted the debts in question for tax purposes and therefore could not have received any tax benefit, except as to the $256.35 deducted in 1938. Therefore, the cases cited by respondent, namely, National Bank of Commerce of Seattle, 40 B.T.A. 72 and 12 T.C. 717, are not in print.
Having found section 113(a)(7) to be applicable in this case, the petitioner has the same basis as the consolidating banks prior to the consolidation. A recovery of the debts charged off prior to the consolidation would not have resulted in income to the consolidating banks and recovery by the petitioner in this case is not income to it as its basis was the same as the transferors.
Since $256.35 received by petitioner in 1944 represented recoveries on debts charged off by Farmers Bank in 1938 and a deduction therefor having been taken and allowed in its income tax return for that year, these debts, thereafter, were without any basis in the hands of Farmers Bank. Consequently, when the petitioner acquired them they had no basis in its hands. Therefore, all recoveries thereon constituted income for the year of receipt.
In determining the deficiency for 1944, the respondent increased the income reported by petitioner for that year by $26,449.87 as representing income resulting from recoveries by petitioner of bad debts charged off by the predecessor banks. In this connection the parties have stipulated that in the event the period of limitations provided in section 275(c) of the Code
for assessment of tax for 1944 has not expired, the correct amount to be included in petitioner's income on account of recoveries in that year is $23,352.44. Since under our holdings above only $256.35 of the recoveries in 1944 constituted inCOME, AND SINCE THE ONLY ADJUSTMENT MADE BY RESPONDENT TO THE reported income of the petitioner for that year was with respect to the recoveries, it is apparent that the income of $58,658.74 reported by petitioner was not understated by an amount in excess of 25 per cent. As a consequence the 5-year period of limitations is inapplicable. In review of this, and since it does not appear that the petitioner executed any consent extending the 3-year period of limitations provided in section 275(a) to or beyond the date of the mailing of the deficiency notice, we hold that the period of limitations has expired for the assessment of a deficiency for 1944.
SEC. 275. PERIOD OF LIMITATION UPON ASSESSMENT AND COLLECTION.Except as provided in section 276—(a) GENERAL RULE.— The amount of income taxes imposed by this chapter shall be assessed within three years after the return was filed, and no proceeding in court without assessment for the collection of such taxes shall be begun after the expiration of such period.(c) OMISSION FROM GROSS INCOME.— If the taxpayer omits from gross income an amount properly includible therein which is in excess of 25 per centum of the amount of gross income stated in the return, the tax may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time within 5 years after the return was filed.
The parties have stipulated that an amount of $855.39 allowed as a recovery exclusion by respondent in determining the deficiency for 1946 was improperly allowed and is to be included in petitioner's taxable income for that year. Since the respondent has moved to increase the deficiency for 1946 because of such improper allowance, effect will be given to the stipulation of the parties in a recomputation of the deficiency for that year.
Decision will be entered under Rule 50.