1951 U.S. Tax Ct. LEXIS 187">*187
Reduction of liabilities on petitioner's books upon running of statute of limitations against indebtedness incurred contemporaneously with acquisition of ship,
16 T.C. 1140">*1140 Petitioner seeks redetermination of deficiencies in income and declared value excess-profits tax for 1945 of $ 1,759.31 and $ 909, respectively, and in income tax for 1946 of $ 629.61. Certain adjustments are not contested. The primary issue is the deductibility of depreciation on a vessel owned by petitioner.
FINDINGS OF FACT.
Petitioner, a Delaware corporation with principal place of business in Washington, D. C., filed its returns with the collector of internal revenue at Baltimore, Maryland.
In 1927 a hotel ship known as the "Amphitrite" was owned by Marine Hotel Corporation which was in receivership. In May 1927, a plan was formulated to protect the interests of the shareholders and creditors of that corporation. The plan provided for the formation1951 U.S. Tax Ct. LEXIS 187">*188 of a new corporation, the old shareholders to have the right to subscribe to stock for cash, creditors to have the alternative of taking stock or new claims bearing 6 per cent interest, and the new corporation to acquire the ship and assume its predecessor's obligations.
In November 1927, petitioner was organized and acquired the hotel ship from the receiver under the plan. Petitioner's books of account show an original cost, plus capital additions in 1927 and 1928 totaling $ 119,132.70. That amount includes accounts payable of $ 92,913.93 owing to a trustee for creditors of the prior owner in receivership, representing obligations assumed by petitioner.
On November 29, 1929, petitioner, as "vendor," entered into an agreement with Amphitrite Operating Corporation, as "purchaser," providing for a sale of the ship for $ 100,000, consisting of a down payment in cash of $ 10,000 and notes aggregating $ 90,000, maturing at various dates in 1930 and 1931. The vessel was to be delivered by vendor and to be used by purchaser. The agreement further provided that title should not pass to the purchaser until the above payments 16 T.C. 1140">*1141 were made and that in the event of default by purchaser1951 U.S. Tax Ct. LEXIS 187">*189 the vendor could take possession and might resell the ship.
Petitioner's books show that the Amphitrite asset account of $ 119,166.10 was written off, that a claim of $ 100,000 was recorded against the purchaser, and that the sum of $ 19,166.10 was charged to a profit and loss account. Petitioner received a cash payment in 1929 of $ 10,000. Petitioner claimed, as a deduction for that year, a loss of $ 19,166.10 on the sale. The discrepancy between $ 119,132.70 and $ 119,166.10 is unexplained.
Thereafter the purchaser defaulted on all the notes. In 1932 the vessel was advertised for public sale by an attorney representing petitioner, who subsequently executed and gave to petitioner a "Bill of Sale" for the vessel, which stated that petitioner had bid the highest price of $ 1,000 at the sale.
Petitioner's 1932 tax return contains balance sheets indicating that during the year the ship was recorded on its books as an asset worth $ 1,000 and that the amount of notes receivable was reduced from $ 90,000 to $ 89,000. The balance sheets on its 1933 return show the ship as a $ 1,000 asset and indicate that during the year the amount of notes receivable was reduced to $ 88,255. The returns1951 U.S. Tax Ct. LEXIS 187">*190 for 1934, 1935, and 1936 contain balance sheets which continue to show the above items in the same amounts. The balance sheets on the 1937 tax return indicate that during the year the book value of the ship was increased to $ 99,226.11, and that notes receivable of $ 88,255 were written off the books. That return shows a net loss. No bad debt deduction was claimed. The 1938 return's balance sheets indicate that during the year the ship's book value was raised to $ 99,952.41, and it appears as an asset at that figure on balance sheets in subsequent returns.
Petitioner's tax returns for the years 1930 to 1934, inclusive, and 1937 to 1942, inclusive, contain balance sheets for those years showing a liability item of accounts payable to "Creditors Committee" in the amount of $ 97,163.99. The balance sheets on the returns for 1928, 1929, 1935 and 1936 show accounts payable to unspecified creditors, and the 1943 return contains no balance sheet. The 1944 return contains balance sheets showing that accounts payable to "Creditors Committee" of $ 97,163.99 were written off the books during that year, and the following explanation appears: "These accounts written off on advice of counsel1951 U.S. Tax Ct. LEXIS 187">*191 that statute of limitations had run against their collection." The return indicates that petitioner did not show an increase of gross income in that year resulting from that action, and it reported a normal-tax net loss for the year of $ 64,008.29.
16 T.C. 1140">*1142 Petitioner's tax returns show that it claimed the following deductions for depreciation of the hotel ship: It claimed $ 3,611.32 for 1928, alleging that the remaining life after acquisition was 50 years for the hull, 20 years for the superstructure, and lesser lives for furniture and fixtures, machinery, and tender. It claimed $ 4,961.31 for 1937, using $ 99,226.11 as the basis, with a 20-year life. It claimed $ 4,997.62 for each year in 1938, 1939, and 1940, and $ 5,059.49 for 1944.
Capital additions to the vessel were made by petitioner in the amount of $ 726.30 on January 1, 1938, and $ 545 on July 1, 1942.
Petitioner's 1945 return claimed a depreciation deduction for the ship of $ 5,021.82, stating 11 years to be the estimated remaining life. The 1946 return claimed depreciation of $ 5,488.51, giving 10 years as the estimated remaining life.
In a notice of deficiency mailed on October 7, 1948, respondent determined, among1951 U.S. Tax Ct. LEXIS 187">*192 other matters, "that indebtedness incurred in the original purchase lapsed and was unenforceable prior to January 1, 1941, and is not includible in the cost of the vessel for the purpose of depreciation," and that "the basis for depreciation on the vessel, except for $ 1,271.30 for later additions, was fully exhausted prior to January 1, 1941."
OPINION.
If this were a "cancellation of indebtedness case" under the
1951 U.S. Tax Ct. LEXIS 187">*193 It is true that if petitioner's creditors allowed their obligations to lapse because petitioner's property had decreased in value, it might have advanced the argument in the earlier year that gain on that cancelation was not taxable under the "adjustment of purchase price" approach of the
16 T.C. 1140">*1143 The record, to be sure, leaves much to be desired. We are not apprised of the value of petitioner's property either at the time the indebtedness lapsed, nor in other tax years. Nor are we informed of the reasons, if they are known, for which the creditors may have allowed the statute of limitations to run against them. But there are so many grounds upon which the failure to report as income any1951 U.S. Tax Ct. LEXIS 187">*194 gain from the cancelation in the prior year can be explained -- including the mere failure to report petitioner's income correctly -- that it does not appear warranted to make the assumption that a readjustment of purchase price, as developed in the
These are not in fact the contentions advanced by respondent but they seem to us the only ones for which any authority could be found. Respondent's actual position is that the purchase price consisted of part cash and1951 U.S. Tax Ct. LEXIS 187">*195 part obligations; that when the obligations became unenforceable they disappeared as part of the consideration, leaving only the cash as the cost of the property; and that this amount has already been recovered through previously allowed depreciation. Such a contention seems to us entirely inadmissible. Barring exceptional circumstances, the elimination of the indebtedness would have resulted in an income item in the prior year. If this were the correct treatment, it would be both unnecessary and unauthorized to add a further detriment to the taxpayer by proposing a corresponding reduction in basis.
It follows that the only theory upon which petitioner's basis could be regarded as having been reduced by the outlawing of its obligations is on an approach similar to estoppel. We should have to assume that the failure to report the cancelation as income was justified only by the
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3. As the case was presented, the burden of showing such facts as whether the obligations had in fact become unenforceable cannot in any event be placed upon petitioner. Throughout the hearing respondent's counsel made it clear that he considered the legal effect of the events connected with the abortive sale by petitioner about 1930 to be the only question in the case as to basis, and the evidence appears to have been presented by both parties with that understanding. Indeed respondent's counsel did not even mention the outlawed notes. In the course of his opening remarks, he stated that "It is our position that the sale of the ship in 1930 established the value of the ship * * *" and subsequently manifested no disagreement with opposing counsel's affirmative reply to an inquiry by the Court as to whether the issues were clear. The contention as to the effect of the 1930 transaction on the basis of the property has now been abandoned by respondent. See .↩
4. The parties agree, on brief, that a question of loss carry-back from 1947 turns upon the decision as to basis.↩
5. Both briefs take $ 100,000 to be the proper basis, after the events of 1932, and the cost of subsequent capital improvements is not in dispute.↩
6. The lower rate is the one adopted by petitioner and no claim of overpayment is made.↩