Docket Nos. 32109 32110.
James W. Mack, Esq., for the petitioners. Charles H. Chase, Esq., for the respondent.
James W. Mack, Esq., for the petitioners. Charles H. Chase, Esq., for the respondent.
In 1947, Rogers Utilities, Inc., sold its business to a competitor including approximately 2,700 accounts receivable. These accounts receivable were sold for $32,672.34 less than their face value. Petitioner on its return claimed a loss of $32,672.34, deductible in full. The Commissioner in his determination of the deficiency has treated the loss as a capital loss limited to the extent provided in section 117(d)(1) of the Code. Held, following Graham Mill & Elevator Co. v. Thomas, 152 F.2d 564, the Commissioner is sustained.
The Commissioner has determined a deficiency in the income tax of Rogers Utilities, Inc., for the taxable year ended August 31, 1947, of $6,114.69. The deficiency is due to one adjustment made by the Commissioner to the net income (loss) as disclosed by petitioner's return. That adjustment is explained in the deficiency notice as follows:
(a) ‘Other deductions‘ claimed in your return in the amount of $52,004.41 include the amount of $32,672.34 representing a loss sustained from the sale of accounts receivable. It is held that such amount represents a loss from the sale of a capital asset, deductible only to the extent of gains realized from the sale of capital assets. Section 117(d)(1), I.R.C. Inasmuch as you realized no gains from the sale of capital assets during this taxable year, the amount of $32,672.34 is disallowed as a deduction from income.
The Commissioner has also determined that Max Torodor and Sarah Torodor are liable as transferees for the deficiency of $6,114.69 which has been determined against Rogers Utilities, Inc., plus interest as required by law.
Petitioner Rogers Utilities, Inc., hereinafter referred to as Rogers, as well as petitioners Max Torodor and Sarah Torodor contest the correctness of respondent's determination of the deficiency against Rogers and petitioners Max Torodor and Sarah Torodor also assign error as to the Commissioner's determination that they are liable as transferees of Rogers. However, in a stipulation which was filed at the hearing they concede they are liable at law and in equity as transferees, of Rogers to the extent of the deficiency, if any, plus interest as provided by law.
FINDINGS OF FACT.
Most of the facts have been stipulated and are incorporated herein by this reference.
Petitioner Rogers Utilities, Inc., is a dissolved California corporation. Petitioners Max Torodor and Sarah Torodor are husband and wife who reside in Los Angeles, California. The return of Rogers for its fiscal year beginning September 1, 1946, and ending August 31, 1947, was filed with the collector of internal revenue at Los Angeles.
Prior to August 1, 1947, Rogers was engaged in business in Los Angeles. Its business was the retail sale of household goods and appliances, irons, blankets, radios, records, electric clocks, watches, silverware, kitchenware and like items. Practically none of its sales were made at its place of business; substantially all of such sales were solicited and consummated by its outside door-to-door salesmen out of the store. Ninety-seven per cent of its volume of sales was on an installment credit plan. Its customers were not selected credit risks, they were found among the lowest income brackets, chosen without discrimination. A down payment equal to the sales tax was required. The purchase price was payable in weekly installments of from 25 cents to $1.25 per week. When additional purchases were made the weekly installments would be increased to about $2 a week.
Debtors did not bring or send money to the home office. All amounts due petitioner were collected by seven collectors employed by petitioner who made weekly collections by calling upon the customers- If, at the time of the collection the customer was not available further personal calls were made. Further collection efforts were made by the office staff. Each of the seven collectors received $10 a day for his collection efforts. After accounts were paid down, he solicited further purchases and, if successful, was entitled to a commission upon such sales. The salesman was not entitled to retain his commission unless at least 25 per cent of the purchase price was paid in.
The time of one office employee and half of the time of another was devoted to keeping records of the installment payments and in following up collections. The cost of collection, while the business was operating, was 25 per cent of the accounts receivable. If the office staff was not successful in effecting a collection, a collection agency was then employed. It charged one-third of the collections made without litigation, one-half of the collection if litigation ensued. If the account was uncollectible it was charged off as a bad debt. In the fiscal year September 1, 1946, to August 31, 1947, the petitioner charged off $9,589.22 as bad debts. Petitioner kept its books on the accrual basis.
Petitioner Max Torodor first acquired a stock interest in the petitioner with others in April 1947. By June 11 of that year he owned all of such shares. In July 1947, petitioner Torodor determined to discontinue the business of the corporation. By agreement effective as of August 1, 1947, petitioner agreed to transfer to Murray H. Goldfarb and Edward Goldfarb, doing business as Peerless Home Supply Co., (hereinafter referred to as Peerless) the inventory, fixtures, and certain of its accounts receivable. Inventory of the book value of $5,775.66 at cost was sold to Peerless for $4,000. Of its nondelinquent accounts receivable averaging $30 each showing total indebtedness of $81,680.85, 2,700 were sold to Peerless at a 40 per cent discount. Furniture and fixtures were sold to Peerless for $1,100. Petitioner did not sell to Peerless 347 ‘skips,‘ i.e., delinquent accounts totaling $10,006.39. The average of these was $28.83. Peerless integrated the collection of these accounts with its business which was similar to that of petitioner. Two extra office employees were employed for four months and one extra office employee for one month to index these accounts and do the necessary paper work to enable its staff to make collections. This office help cost Peerless 10 per cent of the collections. Petitioner made no money on the deal. The gross cost of collection and added delinquencies approximated the discount. The 40 per cent discount on the receivables transferred to Peerless amounted to $32,672.34. Petitioner claimed it was a deduction from profits as an ordinary loss or expense on its income tax return for the fiscal year ending August 31, 1947. Petitioner explained this claimed loss on its return in the following manner:
Sale of Accounts Receivable to Peerless Home Supply Co. at a Discount of 40%:
+-------------------------+ ¦Accts. Rec ¦$81,680.85¦ +--------------+----------¦ ¦Less: 40% ¦32,672.34 ¦ +--------------+----------¦ ¦Selling Price ¦$49,008.51¦ +-------------------------+
The Commissioner disallowed $32,672.34 as a normal deduction but allowed it as a capital loss. There being no capital gains, a deficiency in the income tax for that year in the sum of $6,114.69 was assessed.
There is but one issue in this proceeding and that is whether the deficiency of $6,114.69 which respondent has determined against Rogers is correct. If it is correct, then petitioners Max Torodor and Sarah Torodor concede they are liable as transferees for the deficiency.
Petitioners contend that the deficiency is wrong because it is based upon a determination by respondent that a loss, which it is conceded Rogers incurred in its fiscal year ended August 31, 1947, in the amount of $32,672.34, was a capital loss and deductible only to the extent provided in section 117(d)(1). Petitioner contends that this determination was error. Petitioner contends that the deduction in question should be as a business expense under section 23(a)(1)(A) of the Code and that if it is not an allowable deduction under that provision of the statute, then it should be allowed as an ordinary business loss under section 23(f) of the Code.
Respondent on his part contends that petitioner sold to Peerless accounts receivable which had a face value of $81,680.85 for $49,008.51, thus incurring a loss of $32,672.34 and that this loss was deductible as a capital loss under the provisions of section 117 of the Code. The provisions of section 117 of the Code upon which respondent relies are printed in the margin. We think respondent's determination must be sustained.
SEC. 117. CAPITAL GAINS AND LOSSES.(a) DEFINITIONS.— As used in this chapter—(1) CAPITAL ASSETS.— The term ‘capital assets‘ means property held by the taxpayer (whether or not connected with his trade or business), but does not include—(A) stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business;(B) property, used in his trade or business, of a character which is subject to the allowance for depreciation provided in section 23(1), or real property used in his trade or business;(d) LIMITATION ON CAPITAL LOSSES.—(1) CORPORATIONS.— In the case of a corporation, losses from sales or exchanges of capital assets shall be allowed only to the extent of gains from such sales or exchanges.
It seems to us that section 23(a)(1)(A) of the Code which is the familiar section which provides for the deduction of ordinary and necessary expenses of a business is not applicable. Petitioners advance the novel theory that because it would have cost Rogers at least 25 per cent of the face value of these accounts to collect them and would cost Peerless at least that much, or more, to collect them, that petitioner Rogers is entitled to deduct the $32,672.34 discount at which it sold these accounts to Peerless as an ordinary and necessary business expense. We are unable to agree to the soundness of this theory and it is not sustained. It is clear from a reading of the facts which have been stipulated that Rogers sold to Peerless installment accounts which had a face value of $81,680.85 for a price which caused Rogers to incur a loss of $32,672.34
As has already been stated, petitioner contends in the alternative that this loss is deductible in full under 23(f). Section 23(f) of the Code reads:
SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
(f) LOSSES BY CORPORATIONS.— In the case of a corporation, losses sustained during the taxable year and not compensated for by insurance or otherwise. If that were all, there would seem to be no question but that petitioners are right in claiming a deduction for the full amount of $32,672.34. But it is not all. Section 23(g) which immediately follows 23(f) in the Code reads:
(g) CAPITAL LOSSES.
(1) LIMITATION.— Losses from sales or exchanges of capital assets shall be allowed only to the extent provided in section 117.
So the real question which we have here to decide is whether the approximately 2,700 accounts which Rogers sold Peerless on August 1, 1947, were capital assets. If they were, then respondent's determination must be sustained.
Respondent relies on Graham Mill & Elevator Co. v. Thomas, 152 F.2d 564, in support of his determination. We think that case does support respondent. It held that where a manufacturer operating on an accrual basis sold part of its products through four branch establishments in charge of salaried managers and each manager created a corporation which purchased the business and the manufacturer took notes and accounts receivable at appraised values below face value, since the sale was not in the course of business to customers but was a part of ending a business, transaction was a sale of ‘capital assets‘ and hence the loss was not deductible by the manufacturer as a ‘business loss.‘
Petitioner argues that the Graham Mill & Elevator Co. case, supra, is not controlling here because in that case the discount at which the sale of notes and accounts was made was to take care of any of them which turned out to be bad debts, whereas the 40 per cent discount at which Rogers sold the 2,700 accounts to Peerless was not because the accounts were bad, but because it would be an expensive matter for Peerless to collect them. We are unable to see where this difference, assuming that it does exist, makes any distinction in principal. The fact still remains that Rogers sold these accounts to Peerless and under the rationale of the Graham Mill & Elevator Co. case the sale was of ‘capital assets‘ and the resulting loss of $32,672.34 cannot be taken as an ordinary business loss but must be taken as a capital loss limited by the provisions of section 117(d)(1). As said by the Fifth Circuit in the Graham Mill & Elevator Co. case:
* * * They represented the taxpayer's business capital, but were not a part of his stock in trade. When the determination was reached to sell them in the way they were sold, they were severed from all further connection with appellant's business. When the sale was effected, the court did not err in finding capital assets were sold.
It is doubtless true that the Commissioner's determination that petitioner's loss from the sale of the accounts in question cannot be allowed as an ordinary business loss under section 23(f) but must be allowed as a capital loss, limited by section 117(d)(1), works a hardship on petitioner Rogers, a small corporation which dealt in household appliances sold on installment basis, but deductions are matters from the Congress to determine. It was Congress which wrote the limitations on losses in section 117(d) of the Code applicable to the sale of capital assets. Neither the Commissioner nor the courts have the authority to change those provisions. Congress must make any such changes by appropriate legislation.
Decisions will be entered for the respondent.