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Reporter's Statement of the Case Same; presumption of worthlessne88.-Bank assets are conclusively

presumed, for income tax purposes, to be worthless, within the meaning of the statute, when ordered to be charged off by the Federal banking authorities, in accordance with the regula.

tions of the Commissioner. Same, "charged off."-Where assets, ascertained to be worthless

by reason of the bank examiner's order to charge off said assets are still carried on the bank's books as assets and are reflected in its surplus, said assets cannot be considered to

have been "charged off.” Same.-The two conditions precedent for the allowance of a bad.

debt deduction are (1) the determination of worthlessness, and (2) a charge-off within the taxable year.

The Reporter's statement of the case:

Mr. Wilton H. Wallace for the plaintiff. Mr. E. F. Colladay, and Colladay, McGarraghy, Colladay & Wallace were on the brief.

Mr. S. E. Blackham, with whom was Mr. Assistant Attorney General Samuel 0. Clark, Jr., for the defendant. Messrs. Robert N. Anderson and Fred K. Dyar were on the brief.

The court made special findings of fact as follows:

1. Plaintiff is, and at all times hereinafter mentioned was, a corporation organized and existing under the laws of the United States with its principal office and place of business at Cumberland, Maryland.

2. Plaintiff duly filed its Federal income tax return for the calendar year 1934. That return showed a net loss of $21,793.60 with the result that no tax was shown to be due and none was then paid. Included among the deductions claimed on that return in computing that net loss was an amount, among others, of $51,034.11 representing alleged bad debts.

3. November 12, 1936, plaintiff voluntarily filed an amended return for 1934 showing a net loss of $213,537.51 with the result that no tax was shown to be due and none was then paid. Included among the deductions claimed on the amended return in computing that net loss was an amount, among others, of $242,778.02 representing alleged bad debts.

92 C. Cls.

Reporter's Statement of the Case

4. As a result of an audit by the Commissioner of Internal Revenue of plaintiff's original and amended returns for 1934, the Commissioner made certain adjustments therein and, among other things, refused to allow as a deduction in computing taxable net income the aforementioned item of $242,778.02, or any portion thereof, for the stated reason that the accounts were not written off until 1935. By reason of his refusal to allow a deduction of any portion of that bad debt item, the Commissioner asserted an additional tax liability against plaintiff in the amount of $4,520.33 which plaintiff paid March 31, 1937, plus interest of $550.61, that is, a total of $5,070.94.

5. July 22, 1937, plaintiff filed a claim for the refund of the tax and interest paid as shown in the preceding finding, namely, $5,070.94, and assigned the following basis therefor:

This claim is based upon the deduction of bad debts in the sum of $242,778.02, which, according to the taxpayer's contention, were determined to be worthless and charged off within the taxable year 1934. It is the position of the taxpayer that the action of its Board of Directors on June 27, 1934 constituted the charging off

of $242,778.02. The Commissioner rejected that claim October 6, 1937. 6. June 27, 1934, at a special meeting of plaintiff's Board of Directors, called at the request of a National Bank Esaminer, the following action was taken:

The Examiner presented a list of loans to be charged off, as follows:

(Names and individual amounts as detailed in minutes are herewith omitted.] Total charge-offs-

$242, 778. 02 The above list was read to the Board and, on motion of Mr. Finan, seconded by Mr. Hirsch, the following Resolution was adopted :

RESOLVED that these loans and losses on defaulted bonds and closed bank balances be charged off, and that the necessary funds for the charge-off of these nonbankable assets would be provided for by a reduction of $100,000.00 in the surplus account and $100,000.00 in the Reserve account, plus $42,800.00 to be taken from Undivided Profits.

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Reporter's Statement of the Case It is the intention of the Directors to increase the capital stock of this bank $200,000.00 by selling the preferred stock, class “A”. Necessary steps for the increasing of the capital in this manner will be taken im

mediately. 7. Since it was contemplated under the above action that plaintiff would readjust its capital structure and procure a loan from the Reconstruction Finance Corporation, the National Bank Examiner instructed plaintiff not to charge off the items mentioned in his list of loans to be charged off until the completion of those transactions. By March 11, 1935, the transactions were completed and on March 13, 1935, the Comptroller of the Currency instructed plaintiff as follows:

I notice that the R. F. C. has disbursed $200M for the purchase of preferred stock of your bank, and that the transaction was completed March 11.

The report of an examination of the bank, completed November 26, 1934, by Examiner Linden, shows estimated losses of $238,520.26. It has been our understanding that all of these items would be charged off, as soon as the recapitalization program was completed.

It is, therefore, requested that you immediately make the charge-offs, following which, please send me a copy of the daily statement of the bank after the entries are made on the books. I assume, of course, that some cash collections have been made on some of the items, and that, therefore, the charge-off to be made at this time will not be identical with the amount shown under the

recapitulation on Page 17 of the report. Pursuant to the instructions from the Comptroller of the Currency, the charge-offs were made in the general ledger and journal of the plaintiff on March 12, 13, 14, 15, 16, and 18, 1935.

8. In connection with the making of the general ledger and journal entries referred to in the preceding finding and pursuant to the terms of the resolution of June 27, 1934, referred to in Finding 6, plaintiff, on March 13, 1935, transferred $100,000 from its Surplus account and $100,000 from its Reserve for Contingencies account to its Profit and Loss account and then proceeded to charge off against the total credit balance shown in its Profit and Loss account, the loans referred to in Finding 6.

92 C. Cls.

Opinion of the Court

Prior to the transfer of the two amounts from Surplus and from the Reserve for Contingencies to the Profit and Loss account, the Profit and Loss account reflected a credit balance on March 12, 1935, of $102,532.17. In making the charge-offs, the explanation set out after each item in the general ledger was that they were charged off “as per instructions Examiner", or an equivalent statement.

The court decided that the plaintiff was not entitled to

recover.

WHALEY, Chief Justice, delivered the opinion of the court:

The question presented in this case is whether plaintiff is entitled to a deduction from gross income in 1934 for certain bad debts under the provisions of section 23 (k) of the revenue act of 1934 which provides for the allowance of a deduction for "Debts ascertained to be worthless and charged off within the taxable year

* *.” (48 Stat. 680, 689.)

The statute provides two conditions precedent for the allowance of a bad-debt deduction, the determination of worthlessness and a charge-off within the taxable year.

This plaintiff is a national bank subject to supervision by Federal authorities and therefore comes within the Commissioner's regulations which were first promulgated as Treasury Decision 4633 and incorporated in his subsequent regulations to the effect that where debts are charged off pursuant to the specific orders of the Federal banking authorities, "such debts shall be conclusively presumed, for income-tax purposes, to be worthless." In this case the facts show that the debts in question were charged off pursuant to specific orders of a national bank examiner and therefore, under the conclusive presumption of the Commissioner's regulations, the first condition of the statute for allowance of the deduction has been satisfied.

The Commissioner's regulations, however, further provide, consistent with the statute, that "in order that any amount of the charge-off may be allowed as a deduction for any taxable year it must be shown that the charge-off took place within such taxable year.” Regulations 94, Article 23 (k-1). Whether what occurred in this case brings plaintiff within

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Opinion of the Court that regulation and the statute is the real issue in the case. Did plaintiff charge off the debts within the taxable year 1934 ?

In 1934 plaintiff was apparently in bad financial condition and, as a result of an examination, a national bank examiner determined that additional capital should be added and that certain assets (loans) which were being carried at face value should be eliminated either in whole or in part from the assets of the bank. Pursuant to that determination, it was decided that the bank should take steps to secure a loan from the Reconstruction Finance Corporation to provide the additional capital and that when that was done certain debts designated by the examiner should be charged off plaintiff's books. Pursuant to that direction of the examiner, plaintiff took action to carry out his instructions. The examiner further directed that until the new capital was obtained the charge-offs should not be effected and those instructions were followed by plaintiff. The resolution of the bank to carry out the examiner's direction was adopted June 27, 1934, bu it was not until about March 11, 1935, that the steps incident to the procurement of the additional capital were completed. When that was done, the Comptroller of the Currency instructed plaintiff to make an immediate charge-off of the debts which were designated by the bank examiner at the meeting of plaintiff's Board of Directors on June 27, 1934. On the following day, March 12, 1935, plaintiff began to charge off the debts and the action was completed on March 18, 1935.

Our question is whether these actions by the plaintiff constituted a charge-off within the taxable year 1934. The facts are convincing that it did not. Plaintiff's position is that the resolution of June 27, 1934, constituted a charge-off in 1934, whereas the resolution merely provided that the debts be charged off as an incident to the refinancing arrangements which were then being undertaken, and the examiner specifically instructed plaintiff's officers not to charge off these items until the financial arrangements were completed. These financial arrangements were completed not in 1934 but in 1935 when the debts were charged off plaintiff's books. Until the latter date they were carried as assets on the books of plaintiff and reflected in its surplus. Obviously such action was a charge-off in 1935 and not in 1934.

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