1 T.C. 71">*71 In this proceeding respondent has determined deficiencies in petitioner's income and excess profits tax liability for its fiscal year 1 T.C. 71">*72 ended March 31, 1937, in the amounts of $ 3,006.04 and $ 681.01 respectively. The petition does not contest a further deficiency determined for 1938, and that sum ($ 877.08) is not here in issue. The sole question raised by the pleadings is whether petitioner, which was on the accrual basis, realized income in the sum of $ 11,711.76 in its fiscal year ended March 31, 1937, in which its debtor paid in full a note for $ 16,443.501942 U.S. Tax Ct. LEXIS 38">*39 made on July 1, 1934, for past due interest, but which petitioner had never reported as income.

FINDINGS OF FACT.

The essential facts, most of which are stipulated and are hereby found accordingly, are as follows:

The petitioner, a corporation organized under the laws of South Carolina in 1880, had its principal place of business in Clifton, South Carolina, and filed its Federal tax returns for 1937 with the collector for the district of South Carolina.

The petitioner was engaged in the manufacture of cotton cloth. Its accounts and records are kept, and its Federal income tax returns are prepared on the accrual method of accounting. Petitioner files its returns on the basis of a fiscal year beginning April 1.

For years prior to petitioner's fiscal year 1933, the Hunter Manufacturing & Commission Co., a New York corporation, acted as selling agent for the petitioner and many other large mills. The Hunter Co. had made it a practice to charge interest on all debit balances, and to credit interest on all credit balances, of its customers. In petitioner's fiscal year 1933, the Hunter Co. became involved financially and in that year went into receivership and liquidation. At that time1942 U.S. Tax Ct. LEXIS 38">*40 the Hunter Co. owed large sums of money to the petitioner and its other customers.

As of March 31, 1933, the petitioner's books showed that there was due to it from the Hunter Co. the principal sum of $ 392,651.14, plus accrued interest thereon to January 31, 1933, in the amount of $ 29,983.71. This latter sum was not closed to profit and loss, but was included in income on petitioner's return for the fiscal year ended March 31, 1933, the return indicating a net loss for that year. The interest actually running for petitioner's fiscal year 1933 amounted to $ 30,285.90, so that all the interest for that year, except $ 302.19, was accrued and reported in its return. For the ten months prior to February 1, 1933, $ 27,129.18 accrued, and $ 3,156.72 accrued for February and March 1933.

During its fiscal year ended March 31, 1934, the petitioner did not accrue nor did it report in its tax return any interest on its credit balance with the Hunter Co. In that period the Hunter Co., although it continued to accrue on its records interest on the amounts owed its 1 T.C. 71">*73 creditors, did not add such interest to the accounts of petitioner or its other creditor mills.

In October 1934 the petitioner1942 U.S. Tax Ct. LEXIS 38">*41 received from the Hunter Co. two notes, both dated July 1, 1934, one maturing December 31, 1935, for $ 159,272.58, representing principal and adjusted interest owing the petitioner as of January 31, 1933, less payments on principal to June 30, 1934; and the other for $ 16,443.50, maturing January 31, 1936, and subordinate to the first, for interest from January 31, 1933, to June 30, 1934. On its books petitioner allocated the note for $ 16,443.50 in the following manner:

By a letter from the Hunter Co. to petitioner of October 9, 1934, the notes were transmitted, and a further letter of October 23, 1934, contains the account of petitioner on which the notes were given.

The amount of interest, $ 1,877.21, allocated as an accrual for petitioner's fiscal year ended March 31, 1935 (as shown above), was reported by it as income in its return for that year, as was all of the other interest accruing on the Hunter Co. account for the fiscal year 1935. This interest was treated by the Commissioner1942 U.S. Tax Ct. LEXIS 38">*42 as a proper accrual in petitioner's fiscal year 1935 and tax was paid thereon.

In October 1935 one of the Hunter Co.'s largest debtors negotiated a loan from the Reconstruction Finance Corporation and in that calendar year paid its debt to the Hunter Co. in the amount of approximately $ 1,000,000. Thereupon, if not before, the Hunter Co. was completely solvent and there was thereafter no reasonable doubt as to the collectibility of any of the debts owed by the Hunter Co.

By March 31, 1936, the debt of the Hunter Co. to petitioner had been reduced to approximately $ 60,000. All the interest running on the account for the fiscal year ended on that day was accrued in that year on petitioner's books and was reported in its tax return for that fiscal year, and the inclusion of the interest in the year 1936 was approved by the Commissioner.

During its fiscal year ended March 31, 1937, petitioner received from the Hunter Co. payment in full on the note for $ 16,443.50 above mentioned, but reported no part of this sum as income in its return for that year.

Interest on the note for $ 16,443.50, above mentioned, accruing for the fiscal years ended March 31, 1935, 1936, and 1937, was accrued1942 U.S. Tax Ct. LEXIS 38">*43 on the books of petitioner and was included in the income of petitioner reported on its Federal income tax returns, for each of those fiscal years, 1 T.C. 71">*74 respectively, and taxes were paid thereon in each of said years, and the inclusion of said interest in petitioner's income for said years has not been disturbed by the Commissioner in his audit of the returns of petitioner for any of those years.

The Commissioner included in petitioner's income for the fiscal year ended March 31, 1937, $ 11,711.76, which represents the $ 11,409.57 interest for the fiscal year ended March 31, 1934, and the $ 302.19 interest for the fiscal year ended March 31, 1933. This last amount, when added to the $ 29,983.91 accrued and reported for 1933, gives the correct total of interest accruing for that year. No part of this $ 11,711.76 has been returned by the petitioner as taxable income for 1937 or any other year. The Commissioner at the end of 1936 and the beginning of 1937, in investigating petitioner's returns for the fiscal year 1935, included in income for that year all the $ 11,711.76 here in question. Petitioner protested this action on the ground that it was not income in 1935, but in 19331942 U.S. Tax Ct. LEXIS 38">*44 and 1934, the periods to which it had been allocated by petitioner, on its books, as above indicated. The Commissioner took the position that if the sum were not properly includible in income in petitioner's return for the fiscal year 1935, then it should be returned for the year 1937, in which Hunter actually satisfied its note to the petitioner. It was ultimately excluded from income in the final determination of tax liability for the year 1935, but petitioner has adhered to its position and has reached no agreement with the Commissioner as to what year it should fall in.

Minutes of stockholders' and directors' meetings of petitioner held during the fiscal years 1933 and 1934 in substance show that on April 23, 1932, petitioner's president reported that a plan was under way to have Hunter turn over its management to persons selected by its creditor mills. On May 10 following it was reported that Donald Comer had been appointed manager of the Hunter Co. and that its creditors had consented to leave their balances with it. On November 30 petitioner was told that Hunter could pay "about 50 per cent of amount due them," but that the best way to liquidate the remaining assets would1942 U.S. Tax Ct. LEXIS 38">*45 be to reorganize Hunter. On January 18, 1933, petitioner's directors approved the plan for reorganizing Hunter. In May, J. C. Evins, petitioner's president, reported that:

* * * to date the Hunter Comm. Company balance has been reduced approximately 39% by cash and stock in Southeastern Cottons, Inc., and Mr. Comer who has done a remarkable piece of work is sanguine that Hunter Company will pay out, though some amounts will take some time.

At a directors' meeting on December 12, 1933:

It was explained by Mr. Evins that the Hunter Mfg. & Comm. Co. now in liquidation had paid to date in cash 54% and that the Liquidating Committee was confident that the creditors mills would be paid in full.

1 T.C. 71">*75 Evins was a member of the creditors' committee liquidating the Hunter Co.

Donald Comer, then managing Hunter and familiar with its condition, wrote on March 15, 1934, to G. E. Self, the president of Greenwood Cotton Mills (a copy of the letter going to petitioner and to one Chapman, the president of another large creditor mill), in part, as follows:

* * * I wanted to discuss with you the question of interest rate accrued against our Hunter Company account, for the period from February1942 U.S. Tax Ct. LEXIS 38">*46 1, 1933 to December 31, 1933. I had previously discussed the matter in New York with Mr. Alfred Moore and Mr. John Porter. I had an opportunity to later discuss the same matter with Mr. Elliott Springs. These gentlemen were all agreeable to using 4% as the interest rate for the time in question and for continuing to use that rate until further notice.

* * * During the operation of the Hunter Company up until February 1, 1933, we accrued to our account 6% interest and we have actually paid ourselves 65% of that amount. It is beginning to look like there is going to be something here for the preferred stockholders of the Hunter Company in the final liquidation, and I think it would be a very nice thing for us to show in the records here that the Creditors' Committee in charge of the liquidation of the Hunter Company didn't take the full legal rate.

All years before 1937 are now barred by the statute of limitations.

OPINION.

The interest due petitioner which is the subject matter of this controversy was not accrued on its books nor included in its income tax return for its fiscal year ended March 1934. During the year ended March 1935 the item was entered upon petitioner's books1942 U.S. Tax Ct. LEXIS 38">*47 and the major portion of it allocated to the preceding year, but no change was made in the status of its tax returns. When respondent's representative attempted to charge petitioner with the income for the 1935 fiscal year, as a result of an investigation subsequently conducted, petitioner protested and at that time maintained that the item was properly chargeable to 1933 and 1934. Against those years the deficiencies had by then become barred by the statute of limitations. ¹ In the fiscal year 1936 the condition of the debtor improved radically and in 1937 the debt was paid. Respondent now seeks to include the amount in the 1937 fiscal year which is before us. But petitioner contends that if not income for the earlier years, the item was chargeable at latest to the fiscal year 1936, against which it may be noted the statute of limitations has now also run.

The accruability of an item depending, as it does, in part, 1942 U.S. Tax Ct. LEXIS 38">*48 upon the probabilities of collection ² involves by its nature not only the determination of a question of fact, ³ but of a question in which there 1 T.C. 71">*76 is latitude for difference of opinion. In essence, it requires a forecast, as of a certain time, of what will happen in the future. Although it is thus a question of fact, as opposed to one of law, it is in reality more a matter of opinion than of fact. We think it not unreasonable to say that nothing dependent upon the course of future events can ever be said to be entirely certain.

The question, therefore, as of the end of petitioner's 1934 fiscal year (when this debt, having arisen during the year was open to examination as to its inclusion in income) was whether the probabilities of collection were so good that the law required it to be reported for tax1942 U.S. Tax Ct. LEXIS 38">*49 purposes. Those in the best position to appraise the situation, both because of their possession of the operative facts and because of their responsibility for making the decision in the first instance, concluded as shown by their acts, that it was sufficiently doubtful of collectibility to justify the failure to report it on petitioner's return. At least that is an inference from the facts which no evidence presented by petitioner brings into question. To us this seems the clearest indication of the reality and strength of the doubt surrounding the prospects of collection. As the Board said in Jamaica Water Supply Co., 42 B. T. A. 359, affd. (C. C. A., 2d Cir.), 125 Fed. (2d) 512:

* * * It was, of course, justified in that action if its situation was that described in Kentucky & Indiana Terminal Railroad Co. v. Commissioner, supra [C. C. A., 6th Cir., 54 Fed. (2d) 738, certiorari denied, 286 U.S. 557">286 U.S. 557]:

"* * * It did not place these items upon its books or return them as accrued income in the Federal Control years. This omission was not the result of oversight. 1942 U.S. Tax Ct. LEXIS 38">*50 It arose from the uncertainty petitioner entertained as to its duty to return the items for those years."

But, if so, that demonstrates that in the earlier years the items were so doubtful and uncertain that accrual would have been unjustified, and that only when that doubt and uncertainty was removed by settlement or payment would the inclusion in income be proper. Petitioner's own treatment of the disputed items in failing to accrue them on its books, or to include them in its return, is persuasive evidence of the correctness of respondent's position. * * *

This is not an application of the principle of estoppel which would here be foreclosed by the failure to raise the question properly. It is rather, as we see it, a rule of evidence, a reliance upon the guidance furnished by the conduct of the parties, similar to that applied long and frequently in other situations. See, e. g., Fisher v. Commissioner (C. C. A., 2d Cir.), 59 Fed. (2d) 192; Arthur L. Lougee, 26 B. T. A. 23, 26; affd. (C. C. A., 1st Cir.), 63 Fed. (2d) 112; Willkie v. Commissioner (C. C. A., 6th Cir.), 127 Fed. (2d) 953.1942 U.S. Tax Ct. LEXIS 38">*51 It seems peculiarly appropriate under circumstances which can never be all black or all white, where the determination to be made resides essentially in the realm of speculation or opinion, and where the surrounding 1 T.C. 71">*77 facts are sufficiently indecisive so that we should otherwise have difficulty in coming to either conclusion.

We do not need to say that such a rule of evidence has a universal application. Here there was clearly a basis upon which corporate officers, in good faith and in the exercise of their best judgment, could entertain serious doubt that the defaulted obligation of a debtor in the hands of a creditor's committee would be paid in full. That they did entertain this doubt, as shown by their conduct at the time, persuades us that no finding of fact that the debt was of such certain collectibility as to be accruable for tax purposes is required.

For similar reasons we reject the alternative contention that the item was returnable at the latest in 1936 because by that time the solvency of the debtor had been definitely established. The claim was still in default and, by then, was two years overdue. If the prospects of collection had improved, they could not1942 U.S. Tax Ct. LEXIS 38">*52 be said to have reached the point of absolute certainty, since petitioner had yet to receive the cash in hand. Even in that year it omitted to report the item as income. That it did not do so, is again a persuasive indication that even as of that time petitioner did not view the item as accruable.

This is not to say, however, that if the debt was regarded in a subsequent year as no longer doubtful, there would be an obligation upon a taxpayer to include it in income in advance of its receipt in cash. It may well be that one who refrains from charging his accounts with income in an earlier year, because of the doubtful character of the obligation, need not or possibly may not return it as income until a cash receipt puts it beyond the remotest doubt, even in an accrual system. It may be on the other hand that when collectibility becomes sufficiently certain, a taxpayer on the accrual basis, who reports the item as income at that time, would be allowed to do so. These are problems upon which we express no opinion since they do not arise upon this record. We say here only that the doubtful character of the amounts in issue is persuasively established by petitioner's conduct and1942 U.S. Tax Ct. LEXIS 38">*53 that by that test no year prior to the one before us gave rise to developments which required that the income be currently reported.

Decision will be entered for the respondent.

Murdock, J., concurring: This petitioner in 1934 took advantage of the rule that a creditor-taxpayer upon an accrual basis may omit reporting income accruing in that year from a debtor where, at the close of the taxable year, there was grave doubt as to ultimate payment. That rule was adopted to relieve taxpayers of a hardship. 1 T.C. 71">*78 The effect of the rule is to put the taxpayer upon a cash basis as to the questionable item, so that it is not to be reported until actually paid. Any other application would make administration of the rule by the Commissioner too difficult.

Black, J., concurring in the result: The majority opinion says, in part:

The question, therefore, as of the end of petitioner's 1934 fiscal year (when this debt, having arisen during the year, was open to examination as to its inclusion in income) was whether the probabilities of collection were so good that the law required it to be reported for tax purposes. Those in the best position to appraise the situation, 1942 U.S. Tax Ct. LEXIS 38">*54 both because of their possession of the operative facts and because of their responsibility for making the decision in the first instance, concluded, as shown by their acts, that it was sufficiently doubtful of collectibility to justify the failure to report it on petitioner's return.

Under these circumstances, I agree as the majority holds, that the item should not be set back into 1934 income, now barred by the statute of limitations.

Not having reported the interest in question as accrued income in 1934 for reasons which at that time seemed adequate, when does it become petitioner's duty to report it in income? My answer is in the year when the interest is actually collected. I think the situation is somewhat analogous to a bad debt charge-off and deduction. A taxpayer on the accrual basis ascertains a debt to be worthless and charges it off and the Commissioner allows the deduction. The taxpayer does not, merely because he is on the accrual basis, take it back into income when the debtor becomes solvent and able to pay the debt. He takes it back into income in the year when the debt is actually collected. Commissioner v. Liberty Bank & Trust Co., 59 Fed. (2d) 320.1942 U.S. Tax Ct. LEXIS 38">*55

So, in the instant case, if petitioner was justified in not accruing the interest in 1934, then it seems to me that it is not material, so far as that item is concerned, that the debtor became thoroughly solvent in 1935 or 1936. The material factor is when was the interest collected. That took place in 1937, and I concur in the majority opinion holding that it became taxable in that year.

Sternhagen, J., dissenting: I think that as a matter of law the 1934 interest accrued in that year and, since the taxpayer's books and returns were on an accrual basis, the amount was properly within its income of that year. There is no foundation for an estoppel against petitioner's 1 T.C. 71">*79 claim to that effect, and no reason for taking this item out of the petitioner's accrual system and, by treating it on a cash basis, including it in income of 1937 when it was received. This is simply to leap over the statute of limitations. I confess that the Court's decision is equitable and that the taxpayer is perhaps attempting to escape a tax which in good conscience it should pay; but to sustain that equitable deficiency the opinion adopts an impractical standard of accrual, 1942 U.S. Tax Ct. LEXIS 38">*56 i.e., that of judgment as to the probabilities of collection. But even if the standard be adopted, I think the evidence does not justify the omission of the item from accrued interest of 1934, by either the taxpayer or the Commissioner.

Kern, J., dissenting: I respectfully dissent from the conclusion of the majority. In my opinion the item in question here became properly accruable as income to petitioner not later than in October 1935, when the Hunter Co. received $ 1,000,000 from one of its own debtors. It is stipulated that "Thereafter, if not before, the Hunter Company was completely solvent and there was thereafter no reasonable doubt as to the collectibility of any of the debts owed by the Hunter Company." "An item is not accrued income as a long as there remains a substantial contingency as to its collectibility." Paul & Mertons, Federal Income Taxation, par. 11.73. Conversely, it would follow that, when there does not remain a substantial contingency as to its collectibility, an item is accrued income. Petitioner was on the accrual basis of accounting and made its tax returns on that basis. It had entered this item on its books as an account receivable from the Hunter1942 U.S. Tax Ct. LEXIS 38">*57 Co. In 1935 the Hunter Co. was completely solvent and there was no doubt as to the collectibility of any account against it. Petitioner included similar interest items in its income tax returns for the fiscal years beginning April 1, 1934, and April 1, 1935, and thus indicated that it had no doubt in 1935 as to the collectibility of accounts against the Hunter Co. Therefore, when the majority opinion holds that the failure of petitioner to report as income in 1935 the similar interest item here in question payable in the fiscal year beginning April 1, 1933, is "a persuasive indication that even as of that time [1935] petitioner did not view the item as accruable," it has taken a position which is untenable.

The majority opinion, in speaking of the situation in October 1935, says "If the prospects of collection had improved, they could not be said to have reached the point of absolute certainty, since petitioner had yet to receive the cash in hand." The implication of this statement is that a taxpayer on the accrual basis is obligated to accrue as 1 T.C. 71">*80 income only those items whose payment is absolutely certain, and the criterion of absolute certainty is the receipt of cash1942 U.S. Tax Ct. LEXIS 38">*58 in hand. This would seem to nullify the whole concept of accrual accounting as a basis of making income tax returns; unless it is restricted to cases in which a taxpayer on the accrual basis does not report an account receivable as accrued income because there is substantial doubt as to its collectibility and in a later year this doubt is removed, although no cash payment is received. As applied to such a restricted factual field the rule implied by the majority opinion would seem to be that where an item, otherwise properly accruable, is not accrued as income because of the existence of a substantial doubt concerning its collectibility, such item thereafter becomes income only when actually paid.

However, the majority opinion carefully points out that it makes no express holding to that effect and that "it may be * * * that when collectibility becomes sufficiently certain, a taxpayer on the accrual basis, who reports the item as income at that time, would be allowed to do so." In such a situation, the majority opinion suggests the possibility that the taxpayer has an election to treat itself as to the particular item as either on the accrual basis or the cash basis of accounting. 1942 U.S. Tax Ct. LEXIS 38">*59 I am unable to agree that this possibility exists.

It is my opinion that, when a taxpayer on the accrual basis of accounting fails to return an item of income, otherwise properly accruable, because its collectibility is subject to substantial doubt, and in a later year its collectibility becomes free from doubt, it is income properly and necessarily accruable in the later year, and not in an even later year when the item is paid in cash.