Opinion
No. H-360.
March 12, 1930.
Suit by the Industrial Company, formerly known as the Michigan Guaranty Corporation, against the United States.
Judgment of dismissal.
This case involves a claim for a refund. The question involved is whether plaintiff has established that the debt, because of which the refund is claimed on its taxes for the year 1924, is worthless.
The case having been heard by the Court of Claims upon the report of a Commissioner and the evidence, the court makes the following special findings of fact:
1. The plaintiff is a corporation organized and doing business under the laws of the state of Michigan, with its principal office in the city of Grand Rapids in the said state, and during the years involved herein was engaged in the business of making commercial loans, discounting commercial paper, and the making of land mortgages. The plaintiff corporation was organized in May, 1920, as the Michigan Guaranty Corporation. In 1927 by an amendment to its articles of incorporation its name was changed to the Industrial Company.
2. On July 5, 1922, plaintiff loaned to the Meigs Pulpwood Company, a Delaware corporation, with its office in New York and engaged in the pulpwood business, the sum of $225,000 and received the collateral security note of the Meigs Pulpwood Company dated July 5, 1922, for $250,000 due in two years, with interest at 7 per cent. per annum, payable semiannually and secured by $250,000, face value debenture bonds, series B, and 2,500 shares no par value common stock, both of Lincoln Mills, Limited, a Canadian corporation, with its principal office at Merriton, Ontario.
The note was recorded on the plaintiff's books at $250,000 and the $25,000 difference between that amount and the $225,000 paid by the plaintiff was treated as a discount and credited to earnings.
3. On January 5, 1923, when the first interest payment on the note became due, the plaintiff, at the request of the Meigs Pulpwood Company, collected the matured coupons on the debenture bonds of Lincoln Mills, Limited, which it held as collateral, and applied the proceeds, which exactly equaled the interest due on the note, as the payment of such interest. A similar procedure was followed in connection with the interest due on July 5, 1923. The plaintiff indorsed on the note the collection of these interest amounts.
4. On January 5, 1924, the Meigs Pulpwood Company defaulted in the payment of the interest which became due on that date on its note representing its indebtedness of $250,000 to the plaintiff. The plaintiff thereupon endeavored to collect the interest on the collateral debenture bonds as it had twice done before, only to learn that the Lincoln Mills, Limited, was in financial difficulties and had defaulted on its first mortgage bonds and on its debenture bonds, series A, and that it had no available funds for the payment of interest on the debenture bonds, series B, which were held by the plaintiff as collateral. On February 21, 1924, a receiver was appointed for the Lincoln Mills, Limited, under an order of the Supreme Court of Ontario, Canada.
5. When the plaintiff learned that both the Meigs Pulpwood Company and the Lincoln Mills, Limited, were experiencing financial difficulties, a number of trips were made to New York and to Canada, both by the president of the plaintiff company and by its counsel, for the purpose of investigating the financial affairs of those two companies and for the further purpose of ascertaining what, if any, realization value was represented in the collateral hereinbefore referred to. Those trips were made during the first six months of the year of 1924. During that same period a New York representative of certain creditors of the Meigs Pulpwood Company conferred with officers of the plaintiff company at Grand Rapids.
The demands made by the plaintiff upon the Meigs Pulpwood Company for the payment of the principal and interest due on its note were fruitless. As a result of the investigations made and of the information obtained, the president, the secretary of the plaintiff corporation, and the attorney representing the plaintiff in this matter decided that the Meigs Pulpwood Company was so wholly devoid of financial responsibility that it would be futile to reduce the note of the Meigs Pulpwood Company to judgment, as it would entail a useless additional expenditure. It was their opinion that the only hope of recovery on the loan rested entirely in the Lincoln Mills, Limited, collateral.
6. On August 20, 1924, the plaintiff, after due notice according to law, sold the collateral to itself, as the highest and only bidder, and realized therefor the sum of $125,100, of which $125,000 was the purchase price of the $250,000 face value debenture bonds, series B, and $100 the purchase price of the 2,500 shares of stock of the Lincoln Mills, Limited. At the time of said sale plans were being formulated for a reorganization of Lincoln Mills, Limited, which plans contemplated the investment in that company of additional funds by the debenture bondholders.
7. Of the $125,100 so realized, the plaintiff allocated $19,736.10 to accrued interest on the note and applied the remainder of $105,363.90 against the principal, leaving a deficiency on account of principal of $144,636.10. Payment of the amount of $144,636.10 was thereupon demanded from the Meigs Pulpwood Company, but no reply or payment was ever received.
No suit was instituted by the plaintiff against the Meigs Pulpwood Company to enforce the payment of the balance due on its note, and no other action was taken by the plaintiff looking to the collection of this sum beyond a formal demand for payment. The record does not disclose that the Meigs Pulpwood Company has ever been dissolved, that receivership or bankruptcy proceedings have ever been instituted against it, or that it has ever been declared insolvent. No investigation was conducted by the plaintiff to ascertain whether the stockholders of the Meigs Company had paid the full amount of their subscriptions to its capital stock or to ascertain whether the Meigs Company had any outstanding resources which would affect its financial status.
8. Plaintiff kept a controlling account or ledger for its notes and loans receivable and a subsidiary ledger detailing the individual items. On or about August 20, 1924, it credited the $105,363.90 to the controlling account for the realization of principal on the foreclosure. A like credit was made in the subsidiary ledger to the Meigs Pulpwood Company account. On the account of the Meigs Pulpwood Company in the subsidiary ledger a pencil notation appears reading: "This company hopelessly insolvent and claim not worth taking judgment for." This notation was made by Mr. Edwin B. Sutton, the then vice president and secretary of the plaintiff company, and was based upon information which he had received from the company's president and attorney. Mr. Sutton testified that although he could not be positive as to the exact time of the making of that notation, he expressed the opinion that he placed it there at or about the time of the foreclosure of the collateral in 1924. There also appears on this account a further pencil notation reading: "M.G.C. chances of recovery lay entirely with stock of Lincoln Pulp and Paper Company." This notation was also made by Mr. Sutton in the early part of 1925. The directors of plaintiff corporation examined the records at times and the aforesaid notations were made as information to the said directors to apprise them of the fact that this account was doubtful and would sooner or later have to be charged off in the profit and loss account. The board of directors of plaintiff corporation did not, either in the year 1924 or at any time, take any action to indicate a determination that the balance remaining on the note of the Meigs Pulpwood Company was a bad debt or direct that it be charged off as uncollectible.
No entry to profit and loss was made on the books of the plaintiff in 1924 charging off the balance of $144,636.10 due on the note of the Meigs Pulpwood Company, nor was such entry ever made as to this sum.
The directors of the plaintiff company felt compelled to continue the payment of dividends in order to satisfy some of the company's stockholders who were not entirely satisfied with the company. Had the sum of $144,636.10 been written into the company's profit and loss account and had shown up in an earning statement, it would then have appeared that the payments of dividends would have been made out of capital. With this sum included in plaintiff's surplus account, it paid dividends for the year 1924. In plaintiff's income-tax return for the year 1924, which was prepared by tax accountants from its books, the sum involved here was not deducted from gross income in reporting taxable net income.
9. In May, 1925, Lincoln Mills, Limited, was reorganized, and the securities purchased by the plaintiff at the foreclosure were exchanged for 2,850 shares of preferred stock and approximately 3,000 shares of common stock in the reorganized company, the name of which was changed to Lincoln Pulp Paper Company. Plaintiff also invested the sum of $100,000 in the said reorganized company, receiving therefor 1,000 shares of prior preference stock of like value. On May 12, 1925, the amount of $144,636.10 remaining in the note account in the subsidiary ledger on the note of Meigs Pulpwood Company was transferred on the books of the plaintiff to the new stock account of the reorganized Lincoln Company. Plaintiff also transferred to this stock account the entry of $125,000 appearing in its bond account for the purchase of the debenture B bonds.
On June 3, 1925, the plaintiff also entered in this new stock account the sum of $10,262.10, which arbitrarily increased on its books the value of the exchanged stock of the Lincoln Pulp Paper Company to $280,000. This sum, together with the $100,000 par value prior preference stock in this account, reflected a total value in the new stock account of $380,000. The purpose and effect of these entries were to arbitrarily appreciate the value of the new stock acquired in the Lincoln Company by the plaintiff in order that the loss which appeared on the plaintiff's books from its loan to the Meigs Pulpwood Company might be effaced on the books of the plaintiff.
On August 30, 1927, plaintiff through appropriate entries in its stock and surplus accounts reduced the loan value of its stock in the Lincoln Company from $380,000 to $200,000 and made an explanatory entry in its adjusting journal reading: "To charge down all stock holding in Lincoln Mills to the sum of $200,000."
10. On or before March 15, 1925, plaintiff filed its income-tax return under the revenue act of 1924 for the calendar year 1924. It included as taxable income the amount aforesaid, $19,763.10, as interest received, but it omitted to claim as a deduction the loss of $144,636.10. The return showed a tax liability of $22,163.01, which amount the plaintiff paid in four installments in 1925. The payments were made on March 15, June 15, September 15, and December 15, respectively.
11. On or about September 7, 1926, plaintiff filed with the collector of internal revenue at Detroit, Mich., a refund claim for the sum of $22,163.01. Said refund was made on Form 843 provided by the Treasury Department, Internal Revenue Service, according to the provisions of law in that respect and the regulations of the Secretary of the Treasury established in pursuance thereof. In said claim, among other things, plaintiff contended for the allowance of said bad debt loss as a deduction in computing its taxable income for the year 1924.
12. Under date of February 26, 1927, the Commissioner of Internal Revenue rejected the aforesaid refund claim in its entirety and so advised the plaintiff by letter dated February 26, 1927, which letter was received by the plaintiff approximately three days thereafter.
13. There is no satisfactory proof that the debt due the plaintiff by the Meigs Pulpwood Company was ascertained to be worthless during the year 1924, nor is there satisfactory proof that this debt was charged off on the taxpayer's books in that year.
14. No other action has been had on the claim in suit either in Congress or before any department of the United States, except as herein alleged. Plaintiff is the sole and absolute owner of the claim in suit and has not made any assignment or transfer of said claim or any part thereof or any interest therein. The plaintiff has at all times borne true allegiance to the government of the United States and has not in any way voluntarily aided, abetted, or given encouragement to rebellion against the said government.
Jacob S. Seidman, of New York City, for plaintiff.
Herman J. Galloway, Asst. Atty. Gen., and Joseph H. Sheppard, of Washington, D.C., for the United States.
This case grows out of a claim for a refund by the plaintiff on the ground that it was entitled to a deduction on its income tax for 1924 on account of a bad and worthless debt.
On or before March 15, 1925, plaintiff filed its income-tax return for the calendar year 1924. It included as taxable income $19,763.10, as interest received on the note involved, but it omitted to claim as a deduction the loss of $144,636.10, the balance due on the note. The return showed a tax liability of $22,163.01, which amount the plaintiff paid in four installments in 1925.
On or about September 7, 1926, plaintiff filed with the collector of internal revenue at Detroit, Mich., a refund claim for the sum of $22,163.01. Said refund was made on Form 843 provided by the Treasury Department, Internal Revenue Service, according to the provisions of law in that respect and the regulations of the Secretary of the Treasury established in pursuance thereof. In said claim, among other things, plaintiff contended for the allowance of said bad debt loss as a deduction in computing its taxable income for the year 1924.
Under date of February 26, 1927, the Commissioner of Internal Revenue rejected the refund claim in its entirety and so advised the plaintiff by letter dated February 26, 1927, which letter was received by plaintiff approximately three days thereafter.
The findings of fact establish that there is no satisfactory proof that the debt due the plaintiff by the Meigs Pulpwood Company was ascertained to be worthless during the year 1924, nor is there satisfactory proof that this debt was charged off on the taxpayer's books in that year. In view of this finding that plaintiff cannot recover, as there is nothing to show that it has been illegally taxed. The finding of the Commissioner refusing the refund should stand, the petition should be dismissed, and it is so ordered.