23 T.C. 789">*789 The Commissioner determined the following deficiencies in petitioners' income taxes: 23 T.C. 789">*790

In the original petition filed herein there was placed in issue the Commissioner's disallowance of the following deductions claimed by petitioners 1955 U.S. Tax Ct. LEXIS 252">*254 for partial bad debts of the Lone Star Lumber Company:

However, at the hearing an amended petition was filed in which petitioners abandoned any contention for the partial charge-off deductions above described. Petitioners, in their amended petition, assign the following errors to the Commissioner's determination:

(a) The Commissioner erred in refusing to allow petitioners to deduct from their income a loss of $ 50,760.00 represented by a bad debt of Lone Star Lumber Company in either 1949 or 1950.

(b) If it be determined that the bad debt loss mentioned [above] * * * was a proper deduction for 1949, then, and in that event, the Commissioner erred in failing to allow petitioners to deduct the resulting net operating loss deduction in the years 1948 and 1950 as provided by statute.

Petitioners concede that there was no error in respondent's determination with respect to the interest disallowed in 1948.

FINDINGS OF FACT.

Most of the documentary and accounting facts were stipulated and the stipulation is incorporated herein by this reference as a part of these findings.

Petitioners Martin M. and Ruth Ann Dittmar 1955 U.S. Tax Ct. LEXIS 252">*255 are husband and wife who reside in San Antonio, Texas. They filed joint income tax returns for the calendar years in issue with the collector of internal revenue for the first district of Texas. For convenience Martin M. Dittmar will hereinafter be referred to as petitioner.

Petitioner has been engaged in the operation of a retail lumber yard in San Antonio since 1937. The business was conducted as a corporation until September 1, 1941. Since that date it has been conducted by petitioner as a sole proprietorship under the trade name of Dittmar Lumber Company (hereinafter referred to as Dittmar). Dittmar's books were kept on the calendar year basis.

In 1943, there was a severe lumber shortage and petitioner found it difficult to obtain lumber for sale in his retail business. Therefore, 23 T.C. 789">*791 to assure a dependable source of lumber supply petitioner, on April 6, 1943, organized the Lone Star Lumber Company (hereinafter referred to as Lone Star) under the laws of the State of Texas to operate a sawmill and manufacture lumber from logs and standing trees. The corporation received its charter from the State on April 10, 1943. It kept its books and reported its income on the basis of a 1955 U.S. Tax Ct. LEXIS 252">*256 fiscal year ending March 31. Petitioner formed Lone Star to operate the sawmill because such a venture was speculative and hazardous and he did not wish to risk the assets of his sole proprietorship in it.

Lone Star was incorporated with $ 5,000 of paid-in capital stock, all of which was owned by petitioner save for a few qualifying shares held by members of his family. During the corporation's entire life petitioner was its president and a director. The amount of the capital investment was set at $ 5,000 because that was the price paid for the sawmill and some timber rights purchased by Lone Star when it began operations. Petitioner testified that he did not have any more capital to invest in Lone Star at the time and that the advances (discussed below) he thereafter made to Lone Star were, to a large extent, of funds prepaid to his sole proprietorship by its customers for future retail lumber deliveries.

Beginning on April 14, 1943, petitioner made a large number of advances to Lone Star over a period ending December 31, 1949. Those advances took the form either of cash payments to Lone Star, materials supplied to Lone Star, or direct payment to third parties of expenses incurred 1955 U.S. Tax Ct. LEXIS 252">*257 by Lone Star. The purposes for which the advances were made were (a) to enable Lone Star to purchase capital equipment and to lease timber rights in its first year of operation, (b) to provide Lone Star with working capital, and (c) to enable Lone Star to meet specific obligations, of one sort or another, satisfaction of which was necessary were it to remain in business. Moreover, following the destruction of Lone Star's sawmill by fire on July 4, 1945, as a result of which the mill was inoperative for part of the corporation's fiscal year ended March 31, 1946, petitioner advanced a large sum of money with which Lone Star constructed a mill having production capacity greater than the facilities destroyed. Lone Star never borrowed, or attempted to borrow, money from any source other than petitioner.

In making the advances to Lone Star petitioner did not consider the corporation's ability to repay. Rather, the only consideration was whether or not the advances would serve to increase the corporation's production of lumber and, in effect, the amount and frequency of the advances were controlled solely by Lone Star's needs. No notes were made evidencing the advances, the payment of 1955 U.S. Tax Ct. LEXIS 252">*258 interest thereon was not provided for, no specific date of repayment was set, and no security 23 T.C. 789">*792 (such as a lien on Lone Star's assets) was taken by petitioner. The advances were, however, recorded on Dittmar's (petitioner's sole proprietorship) books as an account receivable due from Lone Star, and a corresponding liability account in Dittmar's favor was maintained on Lone Star's books.

Repayments of petitioner's advances were made by Lone Star primarily with deliveries of lumber to Dittmar, the prices for which were credited to Lone Star's account receivable on Dittmar's books. This was the primary method of repayment contemplated by petitioner and, in fact, Lone Star sold practically its entire output of lumber to Dittmar, making only nominal sales to other customers. A relatively minor amount of repayments was made by Lone Star in cash and through miscellaneous means such as paying some of Dittmar's obligations.

The following data showing the amounts and nature of Dittmar's (i. e., petitioner's) advances and Lone Star's repayments, the balances owed Dittmar by Lone Star during its corporate existence, and Lone Star's earnings record and over-all financial condition, are included 1955 U.S. Tax Ct. LEXIS 252">*259 at this point:

In 1947 or 1948, petitioner realized that he could not operate Lone Star at a profit. By that time lumber was in more plentiful supply and could be purchased by petitioner from other sources more cheaply than he could obtain it from Lone Star. Consequently, in February 1949, Lone Star sold all its capital assets (sawmill, equipment, etc.) in return for specified quantities and types of lumber which the purchasers undertook to deliver to it. One of the contracts of sale, in which lumber valued at $ 8,784 was stated as the consideration to be paid for certain of Lone Star's assets, provided that deliveries of that lumber were only to be made when, and in the amounts, ordered by Lone Star. Lone Star then discontinued sawmill operations and the only functions it thereafter 1955 U.S. Tax Ct. LEXIS 252">*262 performed were liquidation of the minor amounts of its liabilities to parties other than Dittmar, and reduction 23 T.C. 789">*794 of the balance of advances from Dittmar by transfer to Dittmar of the lumber shipments it received from time to time from the purchasers of its capital assets.

There is no evidence that between December 31, 1949, and March 31, 1950, Lone Star satisfied any of its liabilities to outsiders and Dittmar's books indicate that no lumber was transferred to Dittmar during that period. Consequently, Lone Star's balance sheet as of March 31, 1950, accurately represents its financial condition on December 31, 1949. That balance sheet reveals that as of December 31, 1949, Lone Star's current assets totaled $ 2,217.08. They consisted of 64 cents in cash and $ 2,216.44 in accounts receivable, the latter representing lumber still due and expected to be received from the purchasers of its capital assets. The balance of advances from Dittmar (i. e., petitioner) on that date was $ 50,760, Lone Star owed $ 610.83 to other parties, and a liability of $ 62.83 was listed as due to Lone Star's "officers." Subsequent to the close of its 1950 fiscal year, but within the 1950 calendar year, Lone 1955 U.S. Tax Ct. LEXIS 252">*263 Star paid the $ 610.83 liability to parties other than petitioner and, with a $ 1,606.25 shipment of lumber (representing the remainder of its aforementioned current assets of $ 2,217.08), reduced the balance of the advances from petitioner to $ 49,153.75. However, the $ 1,606.25 lumber shipment was not recorded on Dittmar's books either as a credit to the Lone Star accounts receivable or a charge to purchases; but the shipment was reflected in Dittmar's closing inventory for 1950 and to that extent decreased cost of goods sold for the year.

Following transfer to petitioner of the aforementioned $ 1,606.25 lumber shipment Lone Star's only listed asset was an item of $ 188.24 in organization expense which had no value. Lone Star's liquidation was completed during the 1950 calendar year.

Petitioner and his wife filed joint income tax returns for the calendar years 1948, 1949, and 1950. In reporting "Net profit" from the Dittmar sole proprietorship (in Schedule C of the returns) they took the following deductions for partial bad debts owed by Lone Star:

The $ 49,153.75 balance of petitioner's advances to Lone Star represents 1955 U.S. Tax Ct. LEXIS 252">*264 capital contributions, not loans, and those capital contributions became worthless in the 1950 calendar year when the liquidation of Lone Star was completed and it was left without any assets. It was in 1950 when petitioner's investment loss in Lone Star was incurred.

23 T.C. 789">*795 OPINION.

On each of their joint returns for the calendar years 1948, 1949, and 1950, petitioner and his wife deducted as partial bad debts sums representing advances made by petitioner to Lone Star, his wholly owned sawmill corporation. Those deductions, which totaled $ 50,760, were disallowed by respondent.

Petitioner now contends that the entire $ 50,760 should be allowed as a bad debt deduction in 1950 and that respondent erred in failing to so allow it. He concedes that $ 1,606.25 in lumber was delivered by Lone Star in 1950, thereby reducing the balance of the advances due him from Lone Star to $ 49,153.75, and that this repayment was not recorded on the books of his sole proprietorship (Dittmar). It is manifest that Dittmar should have credited Lone Star with this $ 1,606.25 in 1950 and that when that is done, petitioner's advances to Lone Star which remained unpaid when Lone Star was liquidated in 1950 were $ 1955 U.S. Tax Ct. LEXIS 252">*265 49,153.75. We are convinced from the record that the $ 1,606.25 lumber shipment was in fact not recorded in Dittmar's purchases account but was reflected in 1950 closing inventory. To that extent petitioner's cost of goods sold for 1950 was understated and his net profit overstated. However, the proper remedy for that error is to increase purchases (and, correspondingly, cost of goods sold) for 1950 by $ 1,606.25 and we hold that such adjustment should be made. As for the matter of petitioner's advances to Lone Star, therefore, our only concern is with the actual final balance of those advances, which was $ 49,153.75.

The first question we must decide is whether petitioner's advances to Lone Star were loans or were capital contributions. Petitioner contends, and has the burden of proving, that the advances were loans and that he is entitled to a full deduction, as a business bad debt under section 23 (k) (1) of the Internal Revenue Code of 1939, of the unpaid balance thereof. Respondent, on the other hand, argues that the advances were capital contributions and that deduction for their worthlessness is limited by the provisions of sections 23 (g) and 117 of the 1939 Code. ^{11955 U.S. Tax Ct. LEXIS 252">*266 1955 U.S. Tax Ct. LEXIS 252">*267}

23 T.C. 789">*796 In Sam Schnitzer, 13 T.C. 43, affirmed per curiam (C. A. 9) 183 F.2d 70, certiorari denied 340 U.S. 911">340 U.S. 911, we said:

This question is one of fact. Cohen v. Commissioner, supra [(C. A. 2)148 F.2d 336]. And in deciding whether or not a debtor-creditor relation resulted from advances, the parties' true intent is relevant, Fairbanks, Morse & Co. v. Harrison (N. D. Ill.), 63 Fed. Supp. 495; Edward Katzinger Co., supra [44 B. T. A. 533, affd. (C. A. 7) 129 F.2d 74]; Daniel Gimbel, 36 B. T. A. 539. Bookkeeping, form, and the parties' expressions of intent or character, the expectation of repayment, the relation 1955 U.S. Tax Ct. LEXIS 252">*268 of advances to stockholdings, and the adequacy of the corporate capital previously invested are among circumstances properly to be considered, for the parties' formal designations of the advances are not conclusive, United Statesv. South Georgia Ry. Co., supra [(C. A. 5) 107 F.2d 3], but must yield to "facts which even indirectly may give rise to inferences contradicting" them. Cohen v. Commissioner, supra. * * * As the Supreme Court said, however, in Talbot Mills [John Kelley Co.] v. Commissioner, supra [326 U.S. 521]:

* * * There is no one characteristic * * * which can be said to be decisive in the determination of whether the obligations are risk investments in the corporations or debts. * * *