Opinion
No. H-402.
February 10, 1930.
Suit by the Ledger Company, Incorporated, against the United States. Petition dismissed.
This suit is for the recovery of $1,875 income tax alleged to have been erroneously and illegally collected for 1922, together with interest as provided by law. It is claimed that the defendant erroneously refused to allow a deduction from gross income of a loss of $15,000 alleged to have been embezzled or misappropriated by the president of the plaintiff corporation.
Plaintiff, a Texas corporation with principal office and place of business at Fort Worth, is engaged in the printing business. It was organized in April, 1919, with an authorized capital stock of $25,000 divided into shares having a par value of $1 each; 8,749 shares were issued to G.P. Edgell, president, and a like number of shares were issued to a Mr. Bunker, who was associated with Edgell, and 2 shares were issued to W.B. Alley, the secretary and a director. The remaining 7,500 shares were not issued. In 1920 Edgell and Alley acquired the stock of Bunker, and from that time until his resignation on August 28, 1923, Edgell owned substantially all of the stock of the corporation. Subsequently the authorized capital stock of the corporation was increased to $150,000.
In addition to being president and a director of plaintiff, Edgell was also a director in the Security State Bank of Fort Worth and was interested in promoting various oil enterprises. From the beginning he dominated the management of the plaintiff corporation. During the first year of its existence Edgell overdrew his authorized drawing account to the extent of several thousand dollars, and at the end of the year he gave his unsecured notes to the corporation for the amount overdrawn. He continued to overdraw his account in large amounts each year thereafter and at the end of each successive year would give the corporation his note for the amount of the preceding year's note and the increased indebtedness of the current year.
In 1922 Edgell purchased an expensive automobile for his personal use and paid for it out of the corporate funds without the knowledge or consent of the other stockholders or directors of the corporation. December 10, 1922, the directors passed a resolution authorizing the corporation to purchase an automobile for Edgell and further authorized the sale of the said automobile to Edgell by the corporation. Edgell at that time in partially reimbursing the plaintiff for the money expended in the purchase of the automobile transferred to the corporation its capital stock owned by him of a par value of $1,700.
Early in 1922 Edgell proposed to the directors of the plaintiff that the corporation purchase a certain printing plant at Dallas, Tex. The directors declined to agree to the proposal. Thereafter, on March 16, 1922, Edgell, without consulting the other directors, executed and delivered, as president of the plaintiff corporation, a promissory note for $15,000 to the Security State Bank of Fort Worth, of which bank he was a director. Thereupon the bank credited plaintiff on its books with $15,000, the amount of the note. The by-laws of plaintiff provided that all borrowing by it should be approved by the board of directors and that a copy of the resolution authorizing same should be presented to the bank making the loan. This practice had theretofore been followed by the corporation in borrowing money.
On March 17, 1922, the day after the plaintiff's note had been delivered to the Security State Bank and the bank had credited the amount thereof to the plaintiff's account, the full amount of $15,000 was debited by the bank on its books against the account of the plaintiff and credited to the personal account of Edgell. This action of the bank was at the direction of Edgell but without the knowledge of the other stockholders and directors of the plaintiff. Subsequently Edgell used the $15,000 secured on plaintiff's note, and credited to his account on the books of the bank, to purchase, in cooperation with one L.H. Reardon, a printing plant at Dallas. Plaintiff at no time had any interest in the printing plant purchased by Edgell and Reardon.
In the fall of 1922 the Security State Bank of Fort Worth passed into the hands of a receiver, and thereafter, in November, 1922, the receivers charged the $15,000 loan to plaintiff, as evidenced by the note of March 16, 1922, hereinbefore referred to, against the cash balance which the plaintiff at that time had on deposit with said bank. The note was marked paid and was delivered to the plaintiff. No question was ever raised and no objection was ever made by the corporation to the validity of the loan by the bank to the corporation or to the application of a sufficient amount of plaintiff's deposit to satisfy the note held by the bank. Upon receipt by plaintiff of the canceled note from the bank, Edgell, on December 30, 1922, having withdrawn and used the money secured upon the corporation's note for his own use, executed and delivered to it his promissory note for $15,125, principal and interest, payable 60 days after date. This note was accepted by plaintiff and entered upon its books as an asset. The note of Edgell was not determined by the plaintiff to be worthless in whole or in part, nor was any portion of it charged off within the taxable year.
During 1923 plaintiff declared and paid a stock dividend, of which Edgell received $11,070, par value. At that time he owned $65,289 in par value of the total issued stock of $128,849. During the same year Edgell returned to the corporation his stock dividend of 11,070 shares, together with $3,305, par value of other stock owned by him in the corporation to be applied on his indebtedness, which at that time consisted of the note of $15,125, above referred to, other notes aggregating $12,104.75, and an open account of $4,400.53 representing money withdrawn by him from the corporation. Later during the year 1923, 33,000 shares of stock owned by Edgell, and which he had placed with the Security State Bank as collateral for the loan made by the bank to the plaintiff on March 16, 1922, were sold to the bank's receivers for $4,250 and this amount was applied on Edgell's total indebtedness.
Edgell had always received a substantial salary as president of the plaintiff corporation. During 1922 he was paid a salary of $21,500 and he received for the period January 1 to July 31, 1923, a salary of $12,900. Edgell resigned as president on August 28, 1923.
Plaintiff filed a corporation income-tax return for the calendar year 1922 which showed a net income of $100,937.68 and a tax of $12,617.21 which was duly paid. The corporation made no claim in its return for 1922 for a deduction of any amount in respect of the loan of $15,000 by the Security State Bank to it upon the note hereinbefore referred to. Subsequently plaintiff filed a claim for refund of $1,875 for 1922 upon the ground that the amount of $15,000 which it paid to the Security State Bank in satisfaction of its note for that amount executed by its president in March, 1922, should have been taken and allowed as a deduction from gross income for 1922, under section 234(a)(4) of the Revenue Act of 1921 ( 42 Stat. 255), as a loss sustained during the taxable year and not compensated for by insurance or otherwise. The claim for refund was rejected by the commissioner on November 8, 1926.
William P. Smith, of Washington, D.C., for plaintiff.
George H. Foster, of Washington, D.C., and Herman J. Galloway, Asst. Atty. Gen., for the United States.
Before BOOTH, Chief Justice, and LITTLETON, WILLIAMS, GREEN, and GRAHAM, Judges.
The issue is whether plaintiff was entitled in computing its net income for 1922 to take a deduction of $15,000 as a loss sustained within the taxable year. It claims that the amount obtained by its president, Edgell, on March 17, 1922, from its account in the Security State Bank, was a loss sustained on that date; that Edgell had embezzled or misappropriated its funds, and the execution by him of his promissory note for the amount, with interest, in December, 1922, did not change the situation. It is insisted that when Edgell had the bank debit plaintiff's account with $15,000 and withdrew the amount therefrom a loss occurred, and the amount so withdrawn was a proper deduction by plaintiff from its gross income.
We think the commissioner correctly rejected the claim for refund. Although the directors of the corporation did not authorize the loan, it appears that the action of its president in obtaining the money on its note was ratified and no objection was at that or any other time made on the ground that the directors had not authorized the loan. The corporation interposed no objection to the satisfaction of the note by the application of its funds on deposit with the bank. Since the organization of the plaintiff it had been the practice of Edgell to withdraw corporate funds for his personal use and later to give his note therefor, and, so far as appears, no objection had been interposed to this practice. There was nothing in the by-laws of the corporation that prevented its officers from borrowing from the corporation. It had been the practice of Edgell to do this and to give his note for such amounts as he may have withdrawn in the succeeding year. In this instance he withdrew from the plaintiff's account at the bank the amount of $15,000 in March, 1922, and gave his note to the plaintiff in December of the same year. This note was accepted by plaintiff and entered in its notes receivable account as an asset. It is apparent therefore that plaintiff treated and charged the amount upon its books as a debt from Edgell. Whatever the transaction by Edgell might have been technically before his arrangement with plaintiff to pay the amount which he had withdrawn, it then was considered, and apparently agreed by the plaintiff and Edgell, that it should constitute a debt. Farish Co. v. Commissioner (C.C.A.) 31 F.2d 79. And in order for plaintiff to be entitled to a deduction it was necessary for it to determine the obligation of Edgell to pay to be worthless and to charge the same off as required by the statute. This was not done. The decision of the Board of Tax Appeals in Douglas County Light Water Co., 14 B.T.A. 1052, that the giving of a note in 1921 to cover an admitted embezzlement six years before did not entitle the taxpayer to a deduction as a bad debt in 1922, is not in point. Here the corporation knew of the withdrawal of its funds by Edgell soon after it occurred and took his note for the amount with interest in the same taxable year, as had been its custom in regard to withdrawals in prior years.
Even if it could be said that plaintiff sustained a loss when its president withdrew its funds from the bank in March, 1922, we think it was compensated for such loss in the taxable year by Edgell's agreement to pay and the execution by him of his note.
The court is of opinion that plaintiff is not entitled to recover. Its petition must therefore be dismissed, and it is so ordered.
BOOTH, Chief Justice, and WILLIAMS, GREEN, and GRAHAM, Judges, concur.