OPINION.
Aeundell :
The errors alleged with respect to invested capital for the fiscal year ended November 30, 1918, are that the Commissioner failed to allow the inclusion as paid-in surplus of $98,000 for the period December 1, 1917, to January 10, 1918, and $98,891.76 for the period December 1,1917, to January 24, 1918.
The amount of $98,000 in dispute represents the par value of stock issued on January 11, 1918, to Buracker, a former partner, for a portion of his interest in the predecessor in excess of that part of the partnership assets turned in for stock. The amount of $98,891.76 here involved is the amount ascertained on January 24, 1918, as owing to the partners (in addition to Buracker's $98,000 paid for in stock) as the value of the partnership assets in excess of the amount thereof paid in to the petitioner corporation for stock on December 1, 1917.
The gist of the entire transaction was that the petitioner agreed to pay to the partners stock of the par value of $845,000 for a portion of the assets of the partnership, and, upon ascertaining the amount by which the assets exceeded that value, to pay such excess in cash to the partners. Thereafter Buracker decided to take' $98,000 in stock for a part of the excess due him. Subsequently the balance due in cash to the partners was ascertained and paid to them. Buracker's $98,000 was properly an item of invested capital from the time stock was issued on January 11, 1918, and was so allowed by the Commissioner. As to that item for the period prior to the date of issuance of stock and as to the item of $98,891.76 for any period, we can not see that they belong in invested capital. They were sums borrowed from the stockholders for the time being under a definite obligation to repay them and as such they constituted borrowed capital, which, under both the Revenue Acts of 1917 and 1918 is specifically excluded from invested capital.
The second question for the fiscal year ended November 30, 1918, is whether the petitioner in determining the cost of goods sold is entitled to write up its opening inventory from its cost to the predecessor to market value at December 1,1917. The petitioner's opening inventory was the same as the partnership's closing inventory, which was taken at cost of the goods to the partnership. The actual value at December 1, 1917, was considerably higher than cost. The petitioner seeks approval of the use of the higher amount which it determined in 1925 by ascertaining the actual December 1, 1917, value of a great number of items in each of four departments, applying the percentage of increase thus determined to the entire department, and adding to the sum thus obtained the cost to the partnership of the items in the two departments which were not repriced. The value of the merchandise in the two departments not repriced was less than 10 per cent of the total merchandise value and the value of those two departments had likewise increased to a figure above that at which carried on the partnership books. In many cases it was possible to ascertain the actual December 1, 1917, value by correspondence with the manufacturers of the merchandise, and in other instances the value of merchandise at that date was shown by the books of petitioner's buyers, to which reference was made in the repricing process.
We are convinced from the evidence that the petitioner's merchandise inventory at December 1, 1917, had a market value of at least $286,349.72. As the inventory, among other assets, was purchased for stock, that amount then becomes the cost of the merchandise to the petitioner, for, where goods are purchased for stock, in the absence of evidence of the market value of the stock, it is deemed equivalent in value to the property for which it was issued. Appeal of William Ziegler, Jr., 1 B. T. A. 186. The claim of the petitioner in respect of its inventory is the same as that made in Appeal of Munising Motor Co., 1 B. T. A. 286. We disallowed the claim of the taxpayer in that case for lack of evidence to prove that the actual value was the amount contended for, but on the question of law we held as follows:
The Board is of the opinion that the taxpayer had the legal right to use the actual proved cash value of the merchandise purchased by it from its predecessor as a proper inventory entry in its accounting and in computing the cost of merchandise sold by it in the business operations of its first taxable year.
We need not go so far in the present case, for there can be no question that the petitioner may value its opening inventory at cost and the cost we have found to be $286,349.72, which should be used in determining cost of goods sold for the first fiscal year.
The petitioner has failed to establish that the amounts charged in 1919 and 1920 as bad debts and disallowed by the respondent were ascertained to be worthless in those years. It was the practice of the petitioner to write off accounts which had run two or three months beyond the period for which credit had been extended or when word was received that the debtor was involved in bankruptcy or receivership proceedings. As set forth in the findings of fact, the Commissioner has allowed as deductions the amounts claimed by the petitioner, less amounts subsequently collected, except for one item of $3,251.51 charged off in 1920. The petitioner has not shown upon what facts it bases its claim that the accounts disallowed by the Commissioner were ascertained to be worthless in the years in which it charged them off. A good portion of the total allowed by the Commissioner is made up of the accounts in which the debtors were in bankruptcy or involved in receivership proceedings. In the cases of accounts disallowed, in which detailed evidence was given, it appears that the accounts were charged off at the close of the fiscal year in which the goods were sold and thereafter collections were made, in some cases within a few days after the close of the year, and in others within a month or two. In the case of the one item of $3,251.51 charged off in 1920, the only evidence offered was the advice received from attorneys in 1925 and 1926 that they were unable to collect on the judgment which had been obtained against the debtor- Such methods of charging off accounts may be commendable from the standpoint of valuing receivables conservatively in the balance sheet, but they do not establish the worthlessness of the debts.
Error is alleged against the Commissioner in reducing petitioner's invested capital for the fiscal year ended November 30, 1919, by a prorated portion of the tax determined for the previous year. The method used by the Commissioner was correct, section 1207, Revenue Act of 1926; Appeal of Russel Wheel & Foundry Co., 3 B. T. A. 1168; but adjustment should be made in the tax for 1918 by allowing the inventory value claimed by the petitioner in determining cost of goods sold. A like error is alleged with respect to the fiscal year ended November 30, 1920. This issue is governed by the same ruling as that applied to the fiscal year 1919; that is, the respondent is correct in principle, and only the amount of tax prorated requires revision.
The petitioner complains further against the Commissioner's reduction of invested capital for the year ended November 30, 1920, on account of taxes for the year ended November 30, 1918. One of the arguments of the petitioner is that the alleged " taxes " for 1918 are not taxes at all because they have never been determined to be such. The amount determined by the Commissioner to be due for any year is the tax for such year, unless contrary to the statute. The other ground advanced by the petitioner is that section 1207 of the Revenue Act of 1926 relates in terms only to taxes " for the preceding year," and hence does not allow the exclusion from invested capital for any year of tax for other than the immediately preceding year. The regulations of the Commissioner which were validated by section 1207 use the same language and refer only to taxes " for the preceding year." Article 845, Regulations 45. However, the reasoning applies to the due and unpaid taxes for all prior years, and the Commissioner's action is, in our opinion, correct.
A reduction of the income therefor will necessarily result in a reduction of surplus which will be reflected in invested capital. The invested capital as thus reduced remains throughout subsequent years and can be increased only by adding thereto such items as are allowed by statute. We have had several cases before us in which the Commissioner has reduced invested capital for the taxable year on account of unpaid taxes for more than one preceding year, and, though we did not rule in specific words on the question as raised here, we held that such reduction of invested capital was proper. E. B. Crabtree Co. v. Commissioner, 5 B. T. A. 732, and cases there cited.
The final issue is whether the Commissioner erred in the computation of invested capital for the fiscal year ended November 30, 1920, by reducing current earnings available for the payment of a dividend on February 2, 1920, by a tentative tax for that year. On this issue we must sustain the petitioner. Appeal of L. S. Ayers & Co., 1 B. T. A. 1135.
Reviewed by the Board. .
Judgment will be entered on 15 days' notice, v/nder Rule 50.