Appeal from United States Board of Tax Appeals (now Tax Court of the United States).
Before BIGGS, MARIS, and GOODRICH, Circuit Judges.
In its income tax return for 1936 the taxpayer claimed a deduction for a bad debt which was disallowed by the Commissioner. The Board of Tax Appeals upheld the Commissioner and the principal question arising upon this review of its decision is whether $75,000 of the debt for which deduction is claimed in 1936 was available to the taxpayer as a deduction in that year under the provisions of Section 23(k) of the Revenue Act of 1936. 26 U.S.C.A. Int. Rev. Acts, pages 827, 828, 829.*fn1 The question arises from the following facts:
The taxpayer is a manufacturer of vitreous china plumbing fixtures. It sells most of its perfect or "A" products ot Crane Company. The consistent policy of the taxpayer has been to sell its seconds or "B" grade products in territories not served by Crane Company. For some time it sold "B" products to one Philpott in Cleveland, Ohio, but found that he was unable to absorb all the seconds it was producing. In 1910 the taxpayer's stockholders caused Occidental Company to be incorporated. the officers and directors were the same as the taxpayer's. Philpott was made manager. Through various mergers, reorganizations and transfers the taxpayer became the owner of all the Occidental stock. The taxpayer sold "B" products to Occidental at prevailing prices. Because of high operating expense and poor management Occidental operated at a loss from its inception in 1910 to its dissolution in 1936. It made payments to the taxpayer from time to time upon a running account but the indebtedness mounted steadily. In 1927 Occidental owed the stapayer more than $105,000. The taxpayer's officers, considering it deceiving to creditors to show on the books the full amount of the Occidental account as current and immediately collectible, transferred $75,000 to an account denominated "Investments." The taxpayer had a bad debts account but did not follow the practice of setting up reserves for bad, slow, or doubtful accounts. The taxpayer did not seek to deduct the $75,000 as a partially worthless debt in 1927 or in 1928. The unsegregated $30,000 remained in the taxpayer's receivables. That indebtedness in turn increased steadily. From 1929 to 1934 Occidental changed managers several times. In 1929 it changed its name to Eljer-Ohio Company. In 1934 one Dever was employed as manager and did succeed in increasing the volume of business but did not succeed in operating Occidental at a profit. In 1936 the trustee for the bondholders of the taxpayer and the taxpayer's accountants suggested and Dever insisted that the Occidental account be liquidated. It was agreed to dissolve Occidental and this was in fact formally accomplished on December 31, 1936.
In its 1936 income tax return the taxpayer deducted the sum of $84,702.62 as a bad debt charge-off computed as follows:
Balance due by Eljer-Ohio Co.
[Occidental] to taxpayer at
date of its dissolution 157,996.07
Received by taxpayer from liq-
uidation of assets 10,756.46
Balance of account charged off 147,239.61
Less tax advantage to ...