Opinion
Docket No. 12508.
1949-05-6
THE NATIONAL BANK OF COMMERCE OF SEATTLE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Thomas N. Fowler, Esq., for the petitioner. Douglas L. Barnes, Esq., for the respondent.
In 1933 the Marine Bancorporation owned about 90 per cent of the stock of petitioner and six smaller banks. In 1933, pursuant to a plan of reorganization, the six smaller banks transferred all assets owned by them to petitioner and petitioner assumed all their liabilities. Preliminary to the transfer the smaller banks charged off their books certain debts considered to be worthless or subject to criticism by either state or national bank examiners. In the 1933 tax returns all of these charge-offs were taken as deductions, but no reduction in taxable income resulted because the net losses of these banks were greater than the deductions thus claimed. After the transfers petitioner did not carry as assets upon its books the debts thus charged off by the transferor banks. Recoveries were made by petitioner on such debts in 1934. In a decision involving the recoveries on such debts in 1934 the Board of Tax Appeals held that the recoveries on the debts charged off by the transferor banks were income to petitioner, subject to tax. In 1942 and 1943 further recoveries were made by petitioner on account of such debts. Respondent contends that the decision in the proceedings involving the year 1934 makes the issue involving the years 1942 and 1943 res judicata. Held, that the decision in the prior proceeding is not res judicata in the instant proceeding and petitioner is entitled to raise the issue of the applicability of section 22(b)(12), I.R.C.; held, further, that, since petitioner and the transferor banks were separate entities, the petitioner is not entitled to the ‘recovery exclusion‘ provided in section 22(b)(12), and the recoveries in 1942 and 1943 on said debts are income to petitioner. Thomas N. Fowler, Esq., for the petitioner. Douglas L. Barnes, Esq., for the respondent.
The respondent determined a deficiency in petitioner's income tax for the years 1942 and 1943 in the respective amounts of $6,921.73 and $7,867.92. The deficiency is primarily due to the addition to petitioner's net income in the taxable years 1942 and 1943 of the respective amounts of $17,304.33 and $13,528.26 which were designated by it in its return as stockholders' contributions. These adjustments are explained in the deficiency notice as follows:
(a) It is held that the amounts of $17,304.33 and $13,528.26, designated as stockholders' contributions, constitute taxable income for the calendar years 1942 and 1943, respectively.
The petitioner contests these adjustments by appropriate assignments of error.
The questions presented are whether a decision of this tribunal in a prior proceeding is res judicata of the issue presented in this proceeding, and, if not, whether recoveries in 1942 and 1943 on certain debts which were owed to and charged off by predecessor banks in previous years constitute recovery exclusions under section 22(b)(12) of the Internal Revenue Code which are not includible in petitioner's income in those years.
The parties stipulated that if the petitioner's contentions in this proceeding are sustained the Court may enter its decision that there are deficiencies in income taxes due from petitioner for the taxable years 1942 and 1943 in the respective amounts of $813.25 and $2,645.14, and that if the position of the respondent is sustained the Court may enter its decision that there are deficiencies in the respective years 1942 and 1943 in the amounts as determined in the statutory notice of deficiency.
FINDINGS OF FACT.
The facts which were stipulated are so found.
The petitioner is a banking corporation, with its principal place of business in Seattle, Washington. Most of the stock of petitioner was owned by the Marine Bancorporation during the years 1933 and 1934. In the year 1933, and prior to the transfers hereinafter described, the Marine Bancorporation was the owner of 94.5 per cent of the capital stock of the Central National Bank of Commerce, 91 per cent of the capital stock of the Washington National Bank of Commerce, 94 per cent of the capital stock of the Grays Harbor National Bank, 94 per cent of the capital stock of the Bank of Elma, and 88 per cent of the capital stock of the Montesano State Bank. These banks were smaller than petitioner and had their place of business in Seattle or its vicinity.
In the early part of 1933 the Marine Bancorporation evolved a plan of reorganization with regard to petitioner and the other banks named above under which the assets of the six smaller banks were to be transferred to petitioner, subject to all their liabilities, and thereafter the business of the six smaller banks was to be carried on by petitioner through branches which would take the place of such smaller banks.
Pursuant to the plan of reorganization, the Central National Bank of Commerce and the Washington National Bank of Commerce transferred all of their assets to petitioner on April 1, 1933, the Capital National Bank and the Grays Harbor National Bank transferred all their assets to petitioner on September 1, 1933, and the Bank of Elma and the Montesano State Bank transferred all their assets to petitioner on December 1, 1933. Immediately after each of such transfers, the Marine Bancorporation was the owner of over 99 per cent of the capital stock of petitioner. At the time of such transfers petitioner assumed the liabilities of each of the banks, entering the value of the assets so transferred to it in an amount equal to the value of the ‘ledger‘ assets remaining upon the books of such transferor banks at the time of the transfers.
Immediately prior to the transfers set out above, each of the transferor banks, pursuant to the general plan of reorganization, went over its accounts and notes receivable and charged off its books all of such debts which it owned which were either worthless or, while not worthless, might be considered as subject to criticism by either state or national bank examiners, such as loans made to companies in which some officer of the bank might be interested, or real estate loans not justified by 1933 appraisals, or real estate loans in excess of 50 per cent of the value of the security. The total amounts of the debts thus charged off on the books of the transferor banks prior to the transfers in question were as follows:
+-----------------------------------------------+ ¦Central National Bank of Commerce ¦$30,074.90¦ +------------------------------------+----------¦ ¦Washington National Bank of Commerce¦18,839.49 ¦ +------------------------------------+----------¦ ¦Capital National Bank ¦32,054.59 ¦ +------------------------------------+----------¦ ¦Grays Harbor National Bank ¦169,544.37¦ +------------------------------------+----------¦ ¦Bank of Elma ¦54,505.98 ¦ +------------------------------------+----------¦ ¦Montesano State Bank ¦120,664.03¦ +-----------------------------------------------+
Each of the transferor banks claimed deductions for worthless debts in the amounts set forth above in its original 1933 income tax return. In 1936, however, each of the six transferor banks filed an amended return for the year 1933 in which deductions for worthless debts were claimed in a lesser amount, as follows:
+----------------------------------------------+ ¦Central National Bank of Commerce ¦---- ¦ +------------------------------------+---------¦ ¦Washington National Bank of Commerce¦$157.79 ¦ +------------------------------------+---------¦ ¦Capital National Bank ¦2,464.13 ¦ +------------------------------------+---------¦ ¦Grays Harbor National Bank ¦55,675.13¦ +------------------------------------+---------¦ ¦Bank of Elma ¦10,027.99¦ +------------------------------------+---------¦ ¦Montesano State Bank ¦14,418.84¦ +----------------------------------------------+
The amended returns explained that the difference between the amount of such deductions claimed therein and those claimed in the original returns for 1933 represented loans partially or fully secured, and, therefore, not deductible items. It was further explained that these items were charged off by way of capital adjustments and were deducted in the original returns by mistake.
With the exception of the Central National Bank of Commerce, each of the transferor banks sustained a net loss in the year 1933 in an amount greater than the bad debts claimed as a deduction in its original return.
After the transfers had been made to petitioner in 1933 pursuant to the reorganization, the accounts which had been charged off the books of the transferor banks and the accounts which had been charged off the books of petitioner were carried as nonledger assets of the petitioner, that is, they were charged off the general ledger of petitioner or the transferor banks and, after the transfers and the reorganization, were carried by petitioner as nonledger accounts in the form of cards which were periodically checked by officers of the bank, but they did not appear in the asset account of the bank. Many of these accounts while not carried as assets of the bank, were considered of value.
In 1934 petitioner made recoveries in the amount of $11,835.16 on accounts charged off by it in 1933 and claimed as deductions for bad debts in its original 1933 income tax return, and also made recoveries in the amount of $26,230.90 on debts charged off by the transferor banks and claimed by them as deductions for worthless debts in their income tax returns for 1933. In 1934 petitioner reported as income all of such recoveries except recoveries in the amount of $4,935.48 which were had on account of debts which petitioner had received from the Montesano State Bank.
Respondent determined that the above amount of $4,935.48 constituted income to the petitioner. In a proceeding before the Board of Tax Appeals (National Bank of Commerce of Seattle, Docket No. 89720, reported at 40 B.T.A. 72) for a redetermination of the deficiency, the petitioner contended that these transactions constituted a reorganization within the meaning of section 112(i)(1)(B) of the Revenue Act of 1932 and that its basis for the accounts was the same as that of the transferors, i.e., cost, and any recovery by petitioner should place it in the same position as if the transferors had recovered on the debts. Respondent contended that all of the debts involved therein were acquired by purchase from the banks, whose assets were then taken over by petitioner; that the purchase price was allocated by petitioner solely to the sound nonledger assets, which included the debts of unquestioned value, and not to the debts of questionable value which had been charged off as worthless by the transferor banks and which were not carried as assets on petitioner's ledger; and that, therefore, the nonledger assets cost petitioner nothing and could have no basis in the accounts of petitioner and any recovery made by the petitioner upon such nonledger assets must be considered as income. The Board of Tax Appeals agreed with petitioner's contention that the transaction constituted a reorganization, but concluded that gain or loss should be recognized in the transaction involved therein. The Board of Tax Appeals was of the opinion that whatever value the nonledger assets had was lost to the transferors at the time of the transfers and, therefore, the basis of such assets to them at that time was zero, and it followed that the basis of such assets to petitioner, the transferee, would also be zero. It was held that, since petitioner acquired by purchase accounts which had a basis of zero, any collections made by it on such accounts would constitute income. The Board of Tax Appeals was affirmed by the United States Circuit Court of Appeals for the Ninth Circuit, reported at 115 Fed.(2d) 875.
In 1942 and 1943 the petitioner made further recoveries on accounts which were charged off by the predecessor banks in 1933 before their acquisition by petitioner, and were carried as ‘nonledger assets‘ on petitioner's books after 1933. The 1933 indebtedness and the amount of the recoveries and the branches through which the recoveries were made were as follows:
+-----+ ¦¦¦¦¦¦¦ +-----+
Collections 1933 Prior Uncollected indebtedness collection on 1/1/42 1942 1943 University Branch: Chris Williamson $1,940.69 $755.01 $1,185.68 $272.04 $409.49 E.J. Tjernagle 2,000.00 405.00 1,595.00 153.72 741.28 Capital Branch: Mills & Austin 3,500.00 900.00 2,600.00 600.00 1,000.00 Grays Harbor Branch: E.D. Anderson 8,104.87 4,074.70 4,030.17 4,030.17 E.R. Beasley 1,500.00 860.00 640.00 501.80 138.20 Frank O. Dole 318.36 100.96 217.40 61.30 60.14 General Bond & Mortgage Co 15,850.00 5,166.36 10,683.64 3,975.89 6,707.75 G.W. McIntosh 941.85 5.00 936.85 700.00 John Merila 6,509.96 209.48 6,300.48 375.00 697.30 C.A. Cooper 4,250.00 1,549.65 2,700.35 2,700.35 Mrs. Lillian Wade 160.00 11.00 149.00 77.50 Montesano Branch: J.A. Chambers 610.00 610.00 525.00 Elma Branch: Elmonte Investment Co 10,000.00 5,500.00 4,500.00 4,601.31 Total 55,685.73 19,537.16 36,148.57 15,271.23 13,057.01 Reconciliation: Recoveries on which no proof is offered 1,846.30 125.00 1942 exceptions in petition at paragraph (a-4) 186.80 1943 exceptions (less Ogle & Davis $224.06 which was not included in deficiency letter and should not have appeared in the exceptions in the petition) 346.25 Total per page 2 of deficiency letter 17,304.33 13,528.26
No reduction in the taxable income of the above predecessor banks resulted from the deduction of these debts in their returns for 1933, inasmuch as said banks sustained net losses in the year 1933 which were in excess of the amounts of the debts charged off. None of the above debts on which recoveries were made in 1942 and 1943 and which are here in controversy were in controversy in the previous case of petitioner involving the year 1934, with the exception of Lillian Wade (Grays Harbor Branch) in the amount of $160, as to which $6 was in controversy in 1934.
OPINION.
BLACK, Judge:
The principal question for our determination in this proceeding is whether the petitioner herein, as the successor bank, having acquired the assets of the smaller banks in a reorganization, is entitled to certain ‘recovery exclusions‘ from its taxable income in 1942 and 1943 within the meaning of section 22(b)(12) of the Internal Revenue Code.
SEC. 22. GROSS INCOME.(b) EXCLUSIONS FROM GROSS INCOME.— The following items shall not be included in gross income and shall be exempt from taxation under this chapter:(12) RECOVERY OF BAD DEBTS, PRIOR TAXES, AND DELINQUENCY AMOUNTS.— Income attributable to the recovery during the taxable year of a bad debt, prior tax, or delinquency amount, to the extent of the amount of the recovery exclusion with respect to such debt, tax, or amount. For the purposes of this paragraph:(D) Definition of Recovery Exclusion. The term ‘recovery exclusion‘, with respect to a bad debt, prior tax, or delinquency amount, means the amount, determined in accordance with regulations prescribed by the Commissioner with the approval of the Secretary, of the deductions or credits allowed, on account of such bad debt, prior tax, or delinquency amount, which did not result in a reduction of the taxpayer's tax under this chapter (not including the tax under section 102) or corresponding provisions of prior revenue laws, reduced by the amount excludible in previous taxable years with respect to such debt, tax or amount under this paragraph.
Respondent contends that the issue herein is res judicata by reason of the prior decision of the Board of Tax Appeals in the case of this petitioner in Docket No. 89720, and, if it is not, that the recoveries in 1942 and 1943 on the debts which were owed to and charged off by predecessor banks during 1933 do not constitute recovery exclusions under section 22(b)(12) of the code which are to be excluded from petitioner's gross income in 1942 and 1943. We shall consider the issue of res judicata first.
In 1933 Marine Bancorporation owned about 90 per cent of the stock of the petitioner and six smaller banks. In 1933, pursuant to a plan of reorganization, the assets of the six smaller banks were transferred to petitioner, subject to all their liabilities, and thereafter the business of the six smaller banks was to be carried on by petitioner through branches. Immediately prior to the transfer the smaller banks charged off their books certain debts considered to be worthless or subject to criticism by either state or national bank examiners. Deductions were claimed for some of such debts in the income tax returns for 1933. In 1934 petitioner made recoveries on some of the debts which had been charged off in 1933, but in its income tax return for 1934 it claimed that such recoveries were not income, but a return of capital. Respondent determined that the recoveries should be included in income, and, on petition to redetermine the deficiency, the Board upheld the respondent, which was affirmed by the Circuit Court of Appeals for the Ninth Circuit. We found that the debts at the time of the transfer had a zero basis in the hands of the predecessor banks for the reason that they had been ascertained to be worthless and charged off in a prior year and, therefore, held that the recoveries in 1934 were taxable income to the petitioner. As we have already stated, our decision was affirmed by the Ninth Circuit in National Bank of Commerce of Seattle v. Commissioner, supra, though it followed a somewhat different line of reasoning than that used by the Board of Tax Appeals.
In Commissioner v. Sunnen, 33 U.S. 591, the Supreme Court expounded the doctrine of res judicata with particular reference to issues of tax law, stating in part as follows:
These same concepts are applicable in the federal income tax field. Income taxes are levied on an annual basis. Each year is the origin of a new liability and of a separate cause of action. Thus if a claim of liability or non-liability relating to a particular tax year is litigated, a judgment on the merits is res judicata as to any subsequent proceeding involving the same claim and the same tax year. But if the later proceeding is concerned with a similar or unlike claim relating to a different tax year, the prior judgment acts as a collateral estoppel only as to those matters in the second proceeding which were actually presented and determined in the first suit. Collateral estoppel operates, in other words, to relieve the government and the taxpayer of ‘redundant litigation of the identical question of the statute's application to the taxpayer's status.‘ Tait v. Western Md. R. Co., 289 U.S. 620, 624.
And so where two cases involve income taxes in different taxable years, collateral estoppel must be used with its limitations carefully in mind so as to avoid injustice. It must be confined to situations where the matter raised in the second suit is identical in all respects with that decided in the first proceeding and where the controlling facts and applicable legal rules remain unchanged. Tait v. Western Md. R. Co., supra. If the legal matters determined in the earlier case differ from those raised in the second case, collateral estoppel has no bearing on the situation. * * *
Since our decision in Docket No. 89720, Congress enacted section 116 of the Revenue Act of 1942 (sec. 22(b)(12), I.R.C.). This new section in effect excludes from gross income amounts otherwise taxable which are attributable to the recovery of bad debts, prior taxes and ‘delinquent amounts‘ to the extent the prior deduction or credit of such items did not reduce the tax liability of the taxpayer. In this proceeding, therefore, a different tax statute is involved, and the question is whether petitioner is entitled to its benefits. Because of this change in the law and in the issue involved, we conclude that the doctrine of res judicata is not applicable. Commissioner v. Sunnen, supra. Cf. C. D. Johnson Lumber Corporation, 12 T.C. 348.
On the merits petitioner contends that, since none of the deductions in the 1933 returns of the smaller banks involved herein resulted in a reduction of taxable income to the predecessor banks in view of other losses disclosed upon their returns, the predecessor banks, therefore, would, if they were still in existence, be entitled to the benefit of the ‘recovery exclusion‘ provided for in section 22(b)(12) and, since it acquired all of the assets of the predecessor banks in a reorganization pursuant to which the basis of the said accounts is the same in its hands as in the hands of the predecessor banks, it is, therefore, entitled to the benefit of the ‘recovery exclusion.‘ In other words, petitioner contends that for the purposes of section 22(b)(12)(D) it stands in the shoes of the predecessor banks. Section 22(b)(12(D) defines ‘recovery exclusion‘ and provides, with respect to the recovery of a bad debt, prior tax, or delinquency amount, that upon the recovery during the taxable year of such bad debt, prior tax, or delinquency amount there shall be excluded from gross income such part of the amount recovered ‘which did not result in a reduction of the taxpayer's tax.‘
The charge-off herein was made by the predecessor banks, which were entities separate and distinct from the petitioner. We think it is clear that the same entity must charge off and recover in order to be entitled to the ‘recovery exclusion‘ under section 22(b)(12). In Michael Carpenter Co., 47 B.T.A. 626; affd., 136 Fed.(2d) 51, we had a similar situation. In that case the taxpayer, pursuant to a tax-free reorganization, acquired in exchange for its capital stock the business and assets of a Wisconsin corporation. Among the assets acquired were claims for reimbursement against certain milling companies for processing taxes included in the 1935 flour prices paid by the Wisconsin corporation. During 1937 the taxpayer received directly or through the Wisconsin corporation certain amounts on account of processing taxes paid by the Wisconsin corporation to the milling companies upon flour which had been consumed by the Wisconsin corporation in its baking operations in 1935. The income tax return of the Wisconsin corporation for 1935 showed a loss of $27,768.29. Subsequent to the receipt of the payments, an amended return was filed in the name of the Wisconsin corporation by its former officers reflecting this refund, which amendment resulted in reducing the net loss from $27,768.29 to $15,861.79. The taxpayer's return for 1937 did not reflect as income the amounts received from the milling companies during that year. We determined that the claims the taxpayer acquired from the transferor constituted capital assets and that they had a zero basis in the transferor's hands at the time of the exchange, and we held, therefore, that anything realized thereon by the taxpayer in 1937 constituted taxable income. The taxpayer contended that, since the Wisconsin corporation's assets were acquired pursuant to a tax-free reorganization, all property received by it had the same basis in its hands as the property had in the hands of the transferor; that the contract rights had a basis of $1.38 per barrel in the transferor's hands and had the same basis in petitioner's hands; and that it received only $1 per barrel by virtue of the payments by the millers and, therefore, realized no taxable income. We pointed out, however, that the separate identity of the transferor and transferee must be recognized, and we held that the ‘1935 loss of the Wisconsin corporation was not transferable to or usable by petitioner, either directly or indirectly, and that the personal defense available to the transferor did not survive the transfer to petitioner.‘ The Seventh Circuit, in affirming the Tax Court, referred to section 116 of the Revenue Act of 1942 (sec. 22(b)(12) of the code), which was not before us at the time of our decision, and stated in part as follows:
Taxpayer relies heavily on this amendment. The amendment was not before the Tax Court at the time of its decision. The Government claims it is inapplicable for two reasons: (1) It was not the taxpayer's tax which had been affected by the payment, but the predecessor's; * * *
It is to be noted that the amendment provides that the exclusion shall be applicable to instances where the expense involved the reduction of taxpayer's tax.
We think also Rice Drug Co., 10 T.C. 642, supports the conclusion we have reached. In that case we said:
* * * The National Bank of Commerce, supra, is clearly authority that the same entity must charge off and recover, in order to exclude the recovery from income.
Moreover, as to the petitioner here, the debt was not bad; the petitioner had never charged off any deduction for loss, and, therefore, for that reason it was not interested in the question of restoration of income, or whether in the deduction it had a tax benefit— concepts inhering in this question. It simply acquired an asset with a basis of zero, as admitted, and, therefore, ordinarily would properly be charged with income when it recovered thereon. * * *
While in the Rice Drug Co. case we had before us section 711(a)(1)(E) of he code, relating to the excess profits tax, and did not have before us section 22(b)(12), nevertheless, we think that what we said there is pertinent here and is authority in support of respondent's position.
We hold, therefore, that, since the deductions in 1933 in question were not made by petitioner, but by the predecessor banks, the petitioner is not entitled to the benefit of the ‘recovery exclusion‘ provided for under section 22(b)(12). It follows, therefore, that the recoveries made by petitioner upon the accounts herein constitute income in 1942 and 1943. National Bank of Commerce of Seattle, supra.
Decision will be entered for the respondent.