Ryan v. Commissioner

¶1*52 This proceeding is for the redetermination of a deficiency in income tax for the year 1922, amounting to $3,307.70.

¶2The question at issue is whether or not preferred stock of the Ryan-Bohn Foundry Co. purchased by the petitioner for $42,500 became worthless in 1922. In his tax return for that year petitioner claimed a deduction of $21,250, one-half of the cost, as a probable loss on said stock. In his petition petitioner alleges that said stock was entirely worthless in said year.

¶3FINDINGS OF FACT.

¶4In 1919 it became difficult for the various manufacturers of automobiles to secure sufficient castings for their business. At the suggestion of certain persons connected with the General Motors Corporation, the petitioner, who had had long experience in the operation of foundries, joined with them in the organization of the Ryan-Bohn Foundry Co., and it was promised that certain subsidiaries of the General Motors Corporation would furnish business to the new corporation.

¶5The Ryan-Bohn Foundry Co. was incorporated in 1919 under the laws of the*2481State of Michigan with an authorized capital of *53 $750,000 in preferred stock and $1,250,000 in common stock, each share having a par value of $100. Seven thousand three hundred and sixty shares of the preferred stock were sold for cash at par or issued in exchange for property. The common stock was not sold for cash but was issued as a bonus to buyers of preferred stock.

¶6The petitioner paid $42,500 in cash for preferred shares of the Ryan-Bohn Co. and received common stock as a bonus.

¶7The construction of the company's plant was completed in September, 1920. Pending the construction of the plant the petitioner, who had become the foundry company's manager, entered into a contract with the Pickands-Mather Co. for the delivery from time to time of 2,500 tons of pig iron, at $40.50 per ton, for use in the anticipated business of the foundry. In August, 1920, however, before the completion of the foundry there developed a serious depression in the automobile business and, as a result, at the time the foundry was completed in September, 1920, practically no business could be secured by it. Shortly thereafter the officers of the General Motors Corporation, who had promised*2482 to furnish business to the Ryan-Bohn Corporation, resigned from the General Motors Corporation. The depression in the automobile business continued during 1921 and 1922. During this period the market price of pig iron dropped from $40.50 per ton to $19 per ton. On May 15, 1922, the Ryan-Bohn Co. entered into a contract with the Continental Motors Co. for the production and sale to the Continental Motors Co. of cylinder blocks at $5 each, cylinder heads at $1.20 each, pistons at 15 cents each, and flywheels at $1.40 each. The contract provided for the sale of a minimum of 50,000 sets and a maximum of 100,000 sets of the castings, a minimum of 200,000 and a maximum of 400,000 pistons, and that the production of flywheels should be limited to not more than 200 per day, during the life of the contract, namely until July 1, 1923. The contract further provided for deliveries of 40,000 sets of the castings before the first of January, 1923. The provisions as to the delivery of the maximum amounts was subject to the buyers' requirements. The contract also contained the following provisions:

¶8IT IS FURTHER UNDERSTOOD AND AGREED that should the Continental Motors Corporation desire at*2483 any time to increase the maximum number of any one or all of the castings herein above set forth, it may do so for any amount not to exceed two hundred and fifty thousand sets, in which event consideration shall be given to the prices as herein set forth which are based upon Pig Iron at $23 per gross ton and labor at an average hourly wage rate of fifty cents. Therefore in fixing the prices for such additional castings or part thereof as may be desired in accordance with the foregoing, said prices shall be increased or decreased in the same proportion as the price of Pig Iron and/or the average hourly wage rate may be higher or lower.

¶9*54 In the course of manufacturing the articles specified in the contract with the Continental Motors Co., it was discovered that the cylinder blocks cost an average of $7.30 each, and that the Ryan-Bohn Co. was therefore losing about $2.30 on each cylinder block delivered under the contract. In November, 1922, the petitioner induced the Continental Motors Co. to increase the price of the cylinder blocks thereafter to be delivered to $5.75 each, thereby reducing the prospective loss on each cylinder block thereafter to be delivered to $1.55.

¶10*2484 In December, 1922, the petitioner resigned as manager of the Ryan-Bohn Foundry Co. Sometime before his resignation, however, he made an arrangement with the Pickands-Mather Co. for a modification of the contract for pig iron, referred to hereinbefore, to the effect that for every carload of pig iron delivered at $40.50 per ton the Pickands-Mather Co. would deliver three carloads at $24 a ton.

¶11During the period of plant construction the company borrowed $350,000 from the Peninsula State Bank of Detroit on the endorsement of the several directors of the Ryan-Bohn Co., of whom the petitioner was one. Thereafter, during 1921 and before the end of 1922, several of the directors of the corporation, including the petitioner, advanced to the corporation a sum of money amounting to 15 per cent of the cost of the stock respectively owned by them. These loans had not been paid by the Ryan-Bohn Foundry Co. at the end of 1922.

¶12The balance sheet of the Ryan-Bohn Foundry Co. as of December 31, 1922, was as follows:

¶13*2486 On January 11, 1923, the company's accountant, J. F. Bell, addressed the following communication to the board of directors:

¶14The balance sheet herewith shows a total loss to December 31, 1922 of $222,422.76. The balance sheet of December 31, 1921, one year ago, showed a total loss of $92,091.79, which leaves the loss for the year 1922 $130,330.97.

¶15*56 This loss does not include any depreciation on machinery, equipment, buildings, interest on stockholders notes or interest on preferred stock as I have no authority for making such entries.

¶16It will be observed that the increase in loss for the month of December as against the total shown on November 30 is $43,315.68, as is shown by the detail of loss for the month.

¶17It is perhaps fair to state that $7,800.45 of this amount would not be applicable to December in that it covers an adjustment on inventories and real estate tax. Deducting this, we would show a loss that is strictly applicable to December of $35,531.23, which is divided as follows:

¶18THE RYAN-BOHN FOUNDRY COMPANY,

¶19The land on which the*2487 plant of the Ryan-Bohn Foundry Co. was constructed cost $31,000. In 1922 its value had been arbitrarily appreciated on the books of the company to $75,000. The sum of $175,043.34 is a reasonable total amount to deduct from the value of the assets as stated on the balance sheet of December 31, 1922, to cover reduction of the value of the land to its cost, depreciation of buildings and equipment, changes in market price of goods inventoried, loss on articles in process of manufacture by reason of defects and breakage, and loss because of defective castings returned by buyers.

¶20Under its contract with the Continental Motors Corporation the Ryan-Bohn Foundry Co. was delivering from 300 to 350 castings a day and at the end of 1922 there had been delivered 36,454 castings.

¶21About March 1, 1923, the Ryan-Bohn Co. went into the hands of a receiver. The receiver operated the company for a time but at a loss of about $190,000. The corporation thereafter went into bankruptcy. During the receivership and the bankruptcy proceedings the creditors of the corporation threatened suit against the holders of common stock to enforce the liability of the latter under the laws of the State of Michigan*2488 and thereupon the holders of common stock settled with the creditors for 50 cents on the dollar, paying approximately $300,000. The petitioner borrowed $70,000 for this purpose. The stockholders had endeavored to induce the Peninsula Bank of Detroit to take the company's building in satisfaction of its loan, but the bank refused to do so and the directors of the company who were endorsers of the note to the bank were forced to pay it. Thereupon, title to the company's building was conveyed to such endorsers. The building had been offered for sale at $300,000 but at the time of the hearing had not been sold.

¶22The Ryan-Bohn Foundry Co.'s income-tax return for 1922 set out a total deficit amounting to $223,708.90.

¶23*57 In his income-tax return for 1922 the petitioner deducted $21,250 as a loss on the preferred stock of the Ryan-Bohn Foundry Co. owned by him, which sum is 50 per cent of the cost of the stock. In explanation of this deduction the petitioner stated:

¶24This company is in hands of receiver - probable liquidation value of stock is 50 per cent of cost.

¶25This deduction and the explanation thereof contained in petitioner's income-tax return for 1922 were made*2489 as a result of the advice of petitioner's counsel in a conference by telephone. At the time of such conference petitioner's counsel was not fully informed as to all the facts concerning the corporation's affairs, or as to the legal character of the stock. He was told, however, that the stock was worthless and thereupon advised the petitioner that he could deduct half of its cost in his income-tax return for 1922 and the other half in his return for 1923.

¶26The respondent refused to allow the deduction of half the cost of the preferred stock, stating that "inasmuch as the company was operating at the end of 1922 then regardless of the financial condition thereof at that time the loss on stock was not determined until the stock was disposed of or the assets sold for the benefit of the creditors. Neither of these two conditions was fulfilled at the end of 1922."

¶27OPINION.

¶28VAN FOSSAN: It is evident that the affairs of the Ryan-Bohn Foundry Co. were in a bad condition at the end of the year 1922. The evidence does not prove, however, that the preferred stock became worthless at any time during that year. The company's balance sheet of December 31, 1922, disclosed a total deficit*2490 of $222,422.76. The income-tax return filed by the corporation for the year 1922 stated practically the same deficit. If the figures stated in the balance sheet and the income-tax return had reflected truly the financial condition of the Ryan-Bohn Co. at the end of 1922 they would indicate clearly that the preferred stockholders then had an equity in the company's assets amounting to more than $500,000, or about 70 per cent of the $736,000 of outstanding preferred stock.

¶29Petitioner contends, however, that the accounts of the Foundary Company did not accurately reflect its financial condition. The land on which the company's plant was constructed had cost $31,000 and its value had been arbitrarily appreciated in the company's books to $75,000. No proper allowance on account of depreciation of buildings, equipment, inventoried articles and similar items was made in the statement of the value of the assets set forth in the balance sheet of December 31, 1922. Even if the total deficit of *58 $222,422.76 stated in the balance sheet should be increased by the sum of $175,043.34, which we have found as a fact is a reasonable amount to cover the arbitrary appreciation of the*2491 land value omitted, depreciation of buildings and equipment, and similar items, nevertheless, at the end of 1922 there would still have been a balance of assets amounting to approximately $338,000, or about 44 per cent of the cost of the issued preferred stock. The fact that there had been a shrinkage in the value of the stock is not enough to establish worthlessness nor to justify the allowance of a deduction as a loss. This is especially true where the evidence establishes the existence of assets sufficient to pay a substantial percentage of the cost of the preferred stock on liquidation.

¶30It is claimed by the petitioner that prospective losses in 1923 because of the contract for the purchase of pig iron and the contract with the Continental Motors Co. for the delivery of castings were at the close of 1922 liabilities which should now be added to the liabilities stated in the balance sheet of December 31, 1922, in order to determine the real financial condition of the Ryan-Bohn Foundry Co. on the latter date. It is argued that if such addition is made it will appear that on December 31, 1922, the Ryan-Bohn Foundry Co. was wholly bankrupt and its preferred stock was worthless. *2492 In support of this argument it is urged that on December 31, 1922, the company was losing $1.55 on each cylinder block delivered to the Continental Motors Co.; that there were still to be delivered 63,546 cylinder blocks under the contract of May 15, 1922; that the Continental Motors Co. had an option to purchase 150,000 additional cylinder blocks and that the total prospective loss on these 213,546 cylinder blocks was $330,996.30. It is also stated that since the contract price of the pig iron was $40.50 per ton, or $21.50 in excess of the market price of $19 per ton, the loss under the contract for pig iron would be $53,570.

¶31It does not appear how much of the pig iron referred to had been used by the Ryan-Bohn Foundry Co. by December 31, 1922, but the petitioner stated in his testimony that most of it had been used at that time. It would seem, moreover, that the loss on the pig iron constituted at least a part of the loss on the manufactured products. In any event, this argument, founded on prospective losses which are based on future contingencies, seems to us to be purely speculative. Though the company subsequently became bankrupt and its preferred stock became worthless, *2493 there is nothing in the evidence which discloses either that the company was bankrupt and its stock worthless at the close of the year 1922, or what the future of the company's business would be. Furthermore, in view of the statement contained in his income-tax return for 1922 to the effect that the probable liquidation value of the preferred stock was 50 per *59 cent of its cost, the evidence that the petitioner himself considered the stock worthless in 1922 is not convincing.

¶32It is true that we have held in a number of instances that corporate stock became worthless prior to liquidation of the corporation. ; ; ; . But in those cases the facts as to assets and actual liabilities, together with the attendant circumstances, justified us in holding that the stock in question became worthless in the taxable year. In the present case, however, we are of the opinion that the evidence does not justify such a decision. *2494.

¶33Decision will be entered for the respondent.