
    GEORGE E. WARREN CORPORATION v. THE UNITED STATES
    [No. 202-53.
    Decided June 5, 1956]
    
      
      Mr. Robert P. Smith for the plaintiff. Mr. Robert V. Smith, Mr. Joseph W. Kiernan, Miss D. A. Baker, and Smith, Ristig & Smith were on the briefs.
    
      Mr. Jerome Fmk, with whom was Mr. Assistant Attorney General H. Brian Holland, for the defendant. Mr. Andrew D. Sharpe was on the briefs.
   Laramore, Judge,

delivered the opinion of the court:

The plaintiff corporation sues to recover $196,686.47, with interest, as Federal income taxes overpaid for the calendar years 1942, 1943, and 1944. The issue presented is whether the Commissioner of Internal Revenue properly disallowed a deduction of $464,861.93 for 1944, which was claimed by plaintiff to be a wholly or partially worthless bad debt, or a loss in that year. If the deduction is allowed, plaintiff is entitled to a refund for 1944, and for the two preceding years because of the resulting net operating loss carryback.

The plaintiff was engaged in the wholesale coal business, buying, selling, and transiting coal. It functioned principally as a sales agent for small coal producers and its income was derived from commissions on sales of coal. It arranged for the sale of the coal to a wholesaler, or other customer, collected the sales price, and remitted to the coal producer the sale price, less its commission, subject to accounting balances. In order to keep its customers, plaintiff had to have a ready supply of coal to satisfy their requirements.

It was the custom of plaintiff, in the ordinary course of its business, to advance money to coal operators against future coal deliveries to enable the mine operators to meet current mining costs and payrolls and produce the coal required for plaintiff’s customers. Plaintiff borrowed and repaid many millions of dollars in conducting its business as factor and sales agent.

In 1936 George W. Anderson acquired at a public auction for $50,000 the plant, equipment, and lease known as the Margarette lease, from a defunct coal company. The purpose of acquiring the Margarette lease was to control the supply of coal for plaintiff’s customers. These assets were transferred to the Margarette Coal Corporation which was formed in 1936.

The stock of plaintiff and the Margarette Coal Corporation was owned directly or indirectly by George W. Anderson and George P. Oswald. They were the directors and officers of both corporations, and the books and records of both companies were kept at the principal office of the plaintiff.

The Margarette Corporation immediately began mining operations in the underground workings of the Margarette lease and continued to mine coal on a profitable basis from 1936 to 1942, when the underground workings on that lease from a profitable and practical standpoint were exhausted. On January 1, 1942, the plaintiff was indebted to the Margarette Coal Corporation in the sum of $29,166.19 for coal shipped and sold from the Margarette lease.

On January 1,1942, Margarette Coal Corporation obtained a lease known as the Frances lease. The Frances lease was not as good as the Margarette lease because the coal thinned out and existed in fewer and more isolated blocks. No consideration was paid for the Frances lease other than the royalties agreed to be paid on coal produced therefrom. Margarette Coal Corporation moved its tram road facilities and movable equipment from the Margarette lease over to the Frances lease and used the tipple on the Margarette lease to handle the Frances lease production. The operation on the Frances lease was primarily deep mining, with some limited amount of strip mining.

After the regular deep-mining operations on the Mar-garette lease had been completed in 1942, a study and examination of this property was made by Mr. Gerdetz and he advised Margarette Coal Corporation that it could recover substantial quantities of coal by strip mining the crop lines at the surface and the fringes of the underground workings, and presented a plan for such operations. Strip mining on this lease was started in 1942 and continued into 1944.

The officers of plaintiff and Margarette Coal Corporation were acquainted with the general success reported on strip-mining operations, and despite meeting with adverse conditions, continued to expect profitable stripping operations. With some variance in conditions from time to time, the cost of removing the overburden on the Margarette lease greatly exceeded the value of the coal removed and very substantial losses were sustained in the operations. The losses were due to the fact that coal was not found in many places where it was reasonably expected to be; the coal found was often not merchantable because of inferior quality, and the stripping operations were hindered by unexpected water difficulties and by running into underground workings.

In 1944 the Margarette Coal Corporation abandoned its strip-mining operations on the Margarette lease and sold and disposed of all of its stripping equipment and applied the proceeds to the account due plaintiff. Subsequently in 1944, the Bichmond Coal Company, which had no connection with plaintiff or its affiliates, entered into a royalty agreement and conducted stripping operations on the Margarette lease. The Bichmond Coal Company operations were not successful and it ceased operations in the latter part of 1944.

In 1942,1943, and 1944, as at other times, plaintiff was the exclusive sales agent for coal produced by Margarette Coal Corporation, and from time to time advanced funds on future deliveries of coal, as was done in the case of other coal producers The same commission was charged by plaintiff on sales of Margarette production as on coal from other operators, and the sales were handled in the customary manner.

The advances of cash to and credits for coal sold for Margarette Coal Corporation were carried on plaintiff’s books and records as an open account. This account for the years 1942, 1943, and 1944 is summarized below. There were no notes or other written instruments of indebtedness and no mortgages or other form of security. Interest was not charged. Plaintiff and Margarette Coal Corporation treated their relationship as that of debtor and creditor on open account.

On December 31, 1944, the open account indebtedness of Margarette Coal Corporation to plaintiff was $601,339.18. During the years 1942 through 1944 the supply of coal was short and the advances made by plaintiff to Margarette Coal Corporation and other producers were to enable the production of a needed supply. The advances to Margarette Coal Corporation went into its overall operation on both the Margarette and the Frances leases. The net advances that plaintiff made to Margarette Coal Corporation exceeded by far the advances made to coal producers who had no stock affiliation with it. The two largest losses suffered by plaintiff in making advances to coal mining companies, other than the Margarette Coal Corporation, had occurred prior to 1936, when losses were sustained amounting to $100,000 on one account, and $150,000 on another.

The officers of plaintiff and Margarette Coal Corporation reasonably and in good faith expected that the stripping operations on the Margarette lease would result in production of a substantial tonnage of coal, which, together with production on the Frances lease, would result in sufficient coal deliveries to repay plaintiff’s advances. The inability of Margarette Coal Corporation to produce sufficient coal to offset plaintiff’s advances resulted almost entirely from the failure of the strip-mining operations on the Margarette lease.

In November or December 1944, plaintiff’s chief accounting officer made a detailed investigation of the Margarette Coal Corporation’s account and prepared a schedule showing the book value of Margarette’s assets and liabilities, adjustments made by him from his investigation, and the actual values as determined from his investigation. Based on this investigation and schedule adjusted to December 31, 1944, he determined that the excess of adjusted values of Margarette’s assets over liabilities was $136,417.25, exclusive of the $601,-339.18 indebtedness to plaintiff. At that time the Margarette lease was practically exhausted and the deep-mining operations on the Frances lease were costly, and it reasonably appeared that no substantial profits would be made on the Frances operations. The plaintiff determined that the maximum part of the Margarette Coal Corporation indebtedness of $601,339.18 that could be recovered was $136,477.25, and it wrote down the account in the amount of $464,861.93 as being worthless to that extent. The plaintiff continued to advance Margarette Coal Corporation money in connection with the operation of the Frances lease. Subsequent events show that the Frances lease operation was slightly better than a break-even operation and that the $464,861.93 write-down was not recovered. Throughout its operations Mar-garette Coal Corporation never paid dividends to its stockholders.

The plaintiff claimed a deduction of $464,861.93 for worthlessness of the Margarette open account indebtedness on its tax return for 1944, and attached the balance sheet and schedule prepared by its accountant.

Upon audit of plaintiff’s 1944 return, the Commissioner disallowed the bad-debt deduction on the ground that an actual debtor-creditor relationship did not exist, and, if it did, it was not established that the debt became worthless within the year 1944. Additional assessment for 1944 was made by the Commissioner and paid by plaintiff. Timely claims for refunds were filed, rejected, and this suit followed.

The plaintiff contends that the evidence shows a bona -fide debtor-creditor relationship between itself and the Margar-ette Coal Corporation and that the $464,861.93 was deductible in 1944 either as a bad debt, wholly or partially worthless in that year, or as a loss sustained in that year. The defendant contends that a true debtor-creditor relationship did not exist, and, if it did, the plaintiff has not shown that the Commissioner of Internal Revenue was arbitrary in refusing to allow the $464,861.93 as a partial-bad-debt deduction in 1944.

The pertinent part of section 23 of the Internal Revenue Code of 1939, as amended, 26 U. S. C. 23, provides:

In computing net income there shall be allowed as deductions:
* % * Hi tfc
(k) Bad debts.. (1) General rule. Debts which become worthless within the taxable year; or (in the discretion of the Commissioner) a reasonable addition to a reserve for bad debts; and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction. * * *

The record amply supports the finding of the commissioner of this court that the plaintiff’s advances to Margarette Coal Corporation were made with a reasonable expectation of repayment and represented a true indebtedness. The defendant, in its argument on the lack of genuineness of the debt, relies on the fact that two individuals owned, directly or indirectly, both the debtor and the creditor corporations, and the fact that plaintiff’s net advances to Margarette Coal Corporation were far greater than those made to nonaffiliated companies.

The common ownership factor requires a close scrutiny of the transaction to see that it was one of substance and one that could have reasonably been made between parties dealing at arm’s length. The record shows that plaintiff dealt with Margarette Coal Corporation in exactly the same maimer that it did with other coal producers, except for the greater net advances made to Margarette. The plaintiff has shown that the advances were made because of the need for coal and the reasonable belief that sufficient coal could be mined from the Margarette and Frances leases to warrant the expense of mining it. There is no evidence indicating that a person dealing at arm’s length with Margarette Coal Corporation would have done anything different under the same conditions. Under the facts of this case there is no room for argument of tax avoidance because of the common ownership of two corporations.

The plaintiff’s contention that the $464,861.93 is deductible under the totally worthless bad-debt provision is without merit. The debt was $601,339.18, and only part of that debt was worthless.

We turn now to the question of whether the Commissioner properly denied a deduction of the $464,861.93 as a partially worthless bad debt in 1944. It is seen from section 23 (k) (1), supra, that the Commissioner has a certain amount of discretion in determining whether a debt is partially worthless and the extent thereof within a particular taxable year. His determination is not to be lightly set aside. However, he cannot arbitrarily refuse a deduction when the facts clearly show that the debt is partially worthless and the extent thereof.

The determination of whether a debt is partially worthless within a taxable year is usually a pure question of fact and depends on the circumstances surrounding the debtor and his ability to pay the obligation. The facts of the instant case show that the Commissioner abused his discretion in refusing to allow the deduction of the $464,861.93 as a partially worthless bad debt in 1944.

The commissioner of this court has found that the facts facing the plaintiff in 1944 were these. A realistic appraisal of its debtor’s assets over liabilities, exclusive of its obligations to the plaintiff, was $136,477.25. The only other potential source of repaying any of the $601,339.18 were two leases. One was the Margarette lease, which could no longer be mined at a profit. An independent coal producer attempted to mine coal under the Margarette lease and was unsuccessful and abandoned the operation in 1944. The other lease was the Frances lease, which was not wanted by anyone because it was known that the remaining coal under that lease was thinned out and existed only in isolated spots and that the cost of mining the coal would be extremely high. The fact that the lease laid idle for 7 years during a period in which there was a shortage of coal, and was obtained for nothing other than payment of royalties, indicates that it was not a very desirable lease. It was reasonable to expect that no more than the $136,477.25 could be recovered on the operations under the Frances lease.

If the plaintiff was going to allow its debtor to go out of business, most of the additional $136,477.25 would be lost because most of the equipment on the leases would revert to the lessor. Further, there was a great need for coal, and if plaintiff could have it mined, even if only on a break-even basis, it could retain its customers and make a profit on the sale and still recoup some of its $136,477.25. There is absolutely no evidence in the record to indicate that the debtor had any reasonable possibility of repaying the full advances. The fact that money was advanced from week to week to mine coal after 1944 on this lease does not in the slightest way affect the question of whether or not in 1944 there existed any reasonable expectation of repayment of the entire $601,339.18. The facts of this case clearly show that the $601,339.18 debt was partially worthless in 1944. The evidence on the extent of worthlessness sustains the $464,861.93 claimed by plaintiff.

The subsequent history of the operation of the Margarette Coal Corporation bears out the conclusion that none of the $464,861.93 was recoverable after 1944. The plaintiff is entitled to deduct under section 23 (k) (1) the $464,861.93 as a partially worthless bad debt in 1944.

The defendant argues that the question of whether the Commissioner of Internal Eevenue abused his discretion should be decided on the “record” made before him rather than on the record made before this court. The tax laws contemplate a trial de novo, and there is nothing in the partial-bad-debt provision that indicates the contrary. The taxpayer claiming a partially worthless bad debt should prove or attempt to prove that the debt was partially worthless, not come into court and show what he furnished the Commissioner of Internal Revenue to convince him that the debt was partially worthless. As a practical matter, the Commissioner of Internal Revenue generally has before him the same information that is before the court in partial-bad-debt cases since it behooves the taxpayer to convince the Commissioner. Contrary to defendant’s statement, there was far more than just a balance sheet before the Commissioner of Internal Revenue when he made his decision in this case. The Commissioner conducted a complete field audit of the plaintiff and its related corporations’ books and tax returns, had many conferences with the same individuals who testified in this case, and had the complete cooperation of plaintiff.

The plaintiff is entitled to recover, and judgment will be entered in the amount of $54,148.65 for 1942, with interest from June 12, 1945; $55,854.50 for 1943, with interest from June 12, 1945; and $86,683.32 for 1944, with interest from March 11,1953, as provided by law.

It is so ordered.

Littleton, Judge; and Jones, Chief Judge, concur.

Whitaker, Judge,

dissenting:

During the year 1944 George P. Oswald and G. W. Anderson were jointly interested in two enterprises, one, the mining of coal, and, the other, the selling of coal which they mined and which was mined by others. They incorporated each enterprise. The mining enterprise was incorporated in the year 1936 under the name of the Margarette Coal Corporation. The selling enterprise was incorporated under the name of George E. Warren Corporation. Oswald and Anderson each owned 50 percent of the stock of the two companies, either directly or indirectly.

The selling end of their business, operated as the George E. Warren Corporation, advanced money to the mining end, operated as the Margarette Coal Corporation, to enable it to produce coal for sale. These advances were repaid as far as possible from the coal mined and sold; but during the years 1942 to 1944 the mining company had fallen far behind, and by the end of 1944 was indebted to the selling company in the sum of $601,339.18.

At the end of 1944 the selling company sought to charge off as a bed debt $464,861.93 of the debt of $601,339.18 owed it by the mining company. The issue presented is their right to deduct this sum from their gross income for 1944 as a partially worthless debt, or as a loss.

At the end of 1944 the Margarette Coal Corporation, the mining end of the business, owned two coal leases, one called the Margarette lease, and the other the Frances lease, and it also owned another piece of coal mining property adjacent to the Frances lease, which was added to the Frances lease in May 1944. From 1936, when the Margarette Coal Corporation was organized, until 1942 all mining operations were carried out on the Margarette lease, but on January 1,1942, the Frances lease was acquired, and in 1944 the adjacent property was added to it, and thereafter operations were carried out on both leases. In 1942 deep mining was discontinued on the Margarette lease, and strip mining was begun. The strip mining operations, however, did not prove profitable, and they were discontinued, except through sublessees, in 1944.

Plaintiff, the selling enterprise, claims that in 1944, when it itself ceased to mine the Margarette lease, it determined that it would never be able to collect $464,861.93 of its claim against the mining company of $601,339.18, and that it is entitled to charge that amount off as a bad debt. The fundamental basis for this determination is an alleged belief that coal could not be mined profitably from the Frances lease and from subleasing the Margarette lease, or at least profitably enough for them to recover the entire $601,339.18; but they did think they could recover as much as $136,478.25.

It is difficult to see how plaintiff was able to predict with any assurance that the operations of the mine for the next 8 or 9 years would net $136,478.25, but not $601,339.18. It certainly thought the mining enterprise could still operate at a profit, for it intended in 1944 to advance it further money, and in the next 7 years plaintiff, in fact, advanced it from $400,000 to $1,400,000 a year, which was paid back, in part, from coal mined and sold. Certainly these large advances would not have been made unless they thought the mine could be operated at a profit; but how could they tell that these advances would finally net them $136,478.25, and not $601,339.18?

I think plaintiff could do no better than guess at what the future held in store. It is, of course, true that an important attribute of a successful business man is the ability to foretell the future, but bear in mind that it was plaintiff’s chief accountant who made this guess, not a man familiar with coal mining, or one in charge of operations. This chief accountant wrote down the book value of the assets of the mining venture, and as a result determined that the assets were worth $136,478.25 more than the liabilities, not counting this debt to plaintiff. Deducting this excess from the amount of the debt, he determined that the balance was a bad debt. This was the exact amount plaintiff claimed as a bad debt.

This might have been all right if it had been the intention to liquidate the mining venture; but this was not the intention; they intended to continue to operate it. The relation between assets and liabilities did not reflect potential earnings, or greatly affect them, since plaintiff intended to put up the operating capital. Where the debtor is continuing in business, the worthlessness of a debt is to be determined not only by the debtor’s financial condition at the time the debt is charged off, but by its future prospects. No one familiar with the operation of the mine was willing to make any definite prediction on the amount of the profit it might expect to realize in the near future. The nearest any one came to it was Mr. Anderson, a co-owner with Oswald. He said, “We couldn’t look forward to any substantial profit out of this property under normal competitive conditions.” Wbat he meant by “substantial” he did not explain.

One cannot but doubt that they expected to realize no more than $136,000 on their old debt, since in the following year they advanced the mining company $419,000, of which they got back only $312,000, and in the following year $538,000, of which they got back $486,000, and in the following year $1,391,000, all of which they got back and $51,000 more. The next year they advanced $1,375,000 and got back $224,000 more than they advanced. And so on. This was a lot of money to advance, with little hope of substantia] profits. How could the taxpayer look 7 or 8 years ahead and tell how much those profits would be ? Before a debt can be charged off as worthless, it must not only be uncollectible at the time, but in the foreseeable future. Treas. Reg. 111, sec. 29.23 (k)-1, as amended by T. D. 5376, 1944 C. B. 119.

But, even if the taxpayer was satisfied it would be unable to collect no more than $136,000 on the debt, it still is not entitled to deduct the part it believed it could not collect unless it could “satisfy” the Commissioner of Internal Beve-nue that so much of it was uncollectible. The statute reads (Internal Eevenue Code of 1939, as amended; 26 IT. S. C. 1952 Ed.) :

Sec. 23. Deductions from Gross Income.
In computing net income there shall be allowed as deductions:
‡ í* í-
(k) Bad Debts.—
(1) General Bute. — Debts which become worthless within the taxable year; or (in the discretion of the Commissioner) a reasonable addition to a reserve for bad debts; and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction. * * *

The taxpayer had several conferences with agents of the Commissioner of Internal Eevenue, but the record does not disclose what support for the claimed deduction was offered at them. So far as the record before us discloses, the only thing the taxpayer did to satisfy the Commissioner of Internal Revenue that the debt was worthless was to furnish him with a balance sheet of the mining company as of December 31, 1944, showing reductions in value of the assets made by the accountant, and the resulting net worth, exclusive of plaintiff’s debt. There was no supporting statement to justify the adjustments. It is true that, without the adjustments, the mining company did not have sufficient assets to satisfy plaintiff’s debt; but this is determinative only in case the mining company was to be liquidated. When a company intends to continue operations, a balance sheet is clearly insufficient to satisfy any one that the company would never be able to pay the debt.

The taxpayer intended to make further cash advances to the mining company, evidently with the expectation that it would be able to operate profitably. It is highly improbable that it would have advanced it further money unless it thought it was going to get back more than it advanced. How much more, no one could tell.

It was entirely reasonable for the Commissioner of Internal Revenue to say that he was not satisfied that the debt was partially worthless.

The Commissioner of Internal Revenue was made the judge of the deductibility of the item claimed. I cannot say that he abused his discretion in disallowing the deduction, and this, the taxpayer must show. Stranahan v. Commissioner, 42 F. 2d 729; Olympia Harbor Lumber Co., v. Commissioner, 79 F. 2d 394; Wilson Bros & Co., v. Commissioner, 124 F. 2d 606; Lehman v. Commissioner, 129 F. 2d 288. Cf. Art Metal Construction Co., v. United States, 84 C. Cls. 312; 17 F. Supp. 854.

The taxpayer is clearly not entitled to the deduction as a loss. The deduction claimed was of a debt worthless in part. The statutory provisions for the deductions of bad debts and of losses are mutually exclusive. Spring City Foundry Co., v. Commissioner, 292 U. S. 182.

For these reasons I respectfully dissent.

MaddeN, Judge, joins in the foregoing dissent.

FINDINGS OF FACT

The court, having considered the evidence, the report of Commissioner Roald A. Hogenson, and the briefs and argument of counsel, makes findings of fact as follows:

1. Plaintiff, George E. Warren Corporation, is a Massachusetts corporation with principal office at 31 St. James Avenue, Boston, Massachusetts.

2. Plaintiff was and is engaged in the wholesale coal business, buying, selling, factoring, and transiting coal and some coke and oil, and occasionally exporting and importing coal. It has branch offices at New York City and in Pennsylvania at Philadelphia, Allentown, and Scranton. It functions principally as a sales agent for coal producers, and its income is derived from commissions on sales of coal. Plaintiff arranges for the sale of the coal to a wholesaler or other customer, collects the sale price, and remits to the coal producer the sale price less plaintiff’s commission, subject to accounting balances. Generally, plaintiff does not take actual possession of the coal, and transportation is usually directly between the producer and customer. In order to keep its customers, plaintiff must have a ready supply of coal to satisfy their needs and requirements.

It was and is the custom of plaintiff, in the ordinary course of its business, to advance money to coal operators against future coal deliveries to enable the mine operators to meet current mining costs and payrolls and produce the coal required for plaintiff’s customers. The large coal operators usually maintain their own sales organization, and plaintiff generally acted as sales agent for a number of comparatively small mining companies. When such a producer was unable to meet a payroll or purchase supplies or discharge an obligation which could not be deferred, or was hard-pressed financially because of a labor strike or seasonal decline in the coal market, plaintiff was called upon to make and often made advances on future deliveries of coal.

3. The stock of plaintiff, George E. Warren Corporation, was and is owned as follows:

The above-named stockholder George E. Warren Company is a Maine corporation and is a holding company owning stock in several mining companies, including the Margarette Coal Corporation concerned in this case. The stock in this holding company was and is owned one-half by George P. Oswald and one-half by George W. Anderson, the same persons whose names are listed above as stockholders of plaintiff corporation.

4. For the conduct of its business as factor and sales agent, plaintiff has borrowed (and repaid) many millions of dollars, mainly from Brown Brothers Harriman of Boston, Massachusetts, with occasional loan transactions with other banks. Plaintiff established a line of credit with Brown Brothers for 5 or 6 hundred thousand dollars, on which it could and did draw without notice, on the distinct understanding that plaintiff would remain liquid, not own stock in any mining company, and make no permanent investments in coal mining. Plaintiff was required to and did keep Brown Brothers informed as to its assets and liabilities, and never owned stock in, any corporation or mining company.

5. In and prior to the year 1936, the Margarette Coal Company, which was in no way related to plaintiff or its affiliates, was the lessee and operator of coal mining property known as the Margarette lease, obtained from the Gauley Coal Land Company, lessors, and located near Marfrance, West Virginia. This operating company was adjudged bankrupt, and the Margarette lease and other assets including the plant and equipment owned by the defunct company were ordered sold at public auction at Charleston, West Virginia.

George W. Anderson and his associates were interested in buying the Margarette lease because they wanted to control the supply of coal for plaintiff’s customers. He caused an investigation to be made of the underground workings and plant and equipment, and found that there was a considerable amount of unmined coal of good quality and that the underground workings and equipment were in fairly good condition.

6. At the public auction in 1936, George W. Anderson submitted the highest bid in the sum of $50,000, and thereupon acquired the plant, equipment, and lease of the defunct Mar-garette Coal Company. Some time during 1936, he caused the Margarette Coal Corporation to be organized under the laws of the State of West Virginia, and the lease and property acquired at the public auction were transferred to this newly formed corporation.

7. All of the authorized stock (500 shares for $50,000) of the newly formed Margarette Coal Corporation was issued as follows:

George E. Warren Company, 372 shares for $37,200.
Material Service Corp., 125 shares for $12,500.
George W. Anderson, 3 shares for $300.

The three shares issued to George W. Anderson were described in the record as “qualifying shares”. Neither Mr. Anderson nor any of his companies had any interest in the Material Service Corporation. In 1938 the Material Service Corporation sold its stock for $21,000 to the James Coal Mining Company, a Pennsylvania corporation, the stock of which was owned 50 percent by George P. Oswald and 50 percent by George W. Anderson.

8. George W. Anderson and George P. Oswald were and are directors and officers of the plaintiff corporation, of George E. Warren Company, of Margarette Coal Corporation, and of James Coal Mining Company.

The books and records of each of these companies were and are kept at 31 St. James Avenue, Boston, Massachusetts, at the principal office of the plaintiff. Mr. A. Bandall Soderberg served as chief accounting officer and auditor of all of these corporations, and prepared their tax returns from the books and records maintained by Mm under the direction of the corporate officers.

9. After its incorporation during the year 1936, the newly formed Margarette Coal Corporation immediately began mining operations in the underground workings of the Margarette lease, and continued to extract and mine coal on a profitable basis from 1936 to 1942 when the underground workings from a profitable and practical standpoint were exhausted on the Margarette lease.

During this period, Margarette Coal Corporation was successful in its operations to the extent that plaintiff was indebted to it in the sum of $29,166.19 on January 1, 1942, for coal shipped and sold from the Margarette lease.

The Margarette Coal Corporation discontinued its regular deep-mining operations on the Margarette lease some time during the year 1942, and only limited amounts of coal were produced by tMs company from this lease by deep mining during the rest of 1942, and in 1943 and 1944.

10. By written agreement dated January 1, 1942, Mar-garette Coal Corporation obtained a lease, known as the Frances lease, from Gauley Coal Land Company on coal land immediately adjacent to the Margarette lease. The Prances lease had also been held by the defunct Margarette Coal Company and was also offered for sale at the public auction in 1936, but no bids were submitted therefor. From 1936 to 1942 the Gauley Company had held the Frances property without a tenant or operator thereon. The Frances lease was not as good for mining purposes as the Margarette lease for the reason that the coal thinned out and existed in fewer and more isolated blocks. Margarette Coal Corporation paid no consideration for the Frances lease other than the royalties agreed to be paid on coal produced therefrom. By supplemental agreement dated May 1,1944, the Gauley company and Margarette Coal Corporation added a tract of land to the Frances leasehold.

Margarette Coal Corporation moved its tram road facilities and movable equipment from the Margarette lease over to the Frances lease. The more accessible areas (those immediately adjacent to the Margarette lease) had been worked by the original Margarette operator prior to the 1936 auction sale, and it was necessary for Margarette Coal Corporation to lay the tram road across tbe surface of the Frances lease to the more distant underground workings. The tipple on the Margarette lease was used to handle the Frances lease production, and the tram road extended some 3y2 to 4 miles from the Frances underground workings to the Margarette tipple. Margarette’s operations on the Frances lease were mainly deep mining, with some limited amount of strip mining.

11. After the regular deep-mining operations on the Mar-garette lease had been completed in 1942, a study and examination of this property was made by Mr. Louis F. Gerdetz who advised the Margarette Coal Corporation that it could recover substantial quantities of coal by strip-mining operations in the areas between the crop lines at the surface and the fringes of the underground workings, and recommended and presented a plan for such operations.

After receiving the advice and recommendations from Mr. Gerdetz, Margarette Coal Corporation consulted an experienced strip-mining operator, Mr. Gasperinni, who had done stripping for many years and owned a substantial amount of strip-mining equipment, and a Mr. Davis, an experienced superintendent of stripping operations, who both examined the Margarette lease and recommended that strip-mining operations be conducted.

By agreement dated May 29, 1942, the Margarette Coal Corporation retained Mr. Gerdetz as general manager on the Margarette lease at a salary of $600 per month plus 50 percent of the net profits. Mr. Gerdetz was authorized to proceed with production of coal by the strip method, and Mr. Gerdetz then made arrangements with Mr. Gasperinni to supply sufficient equipment to do the stripping operations on a per diem basis.

On the recommendation of Mr. Gerdetz some time in 1943, the arrangements with Mr. Gasperinni were terminated because it was considered that Gasperinni was receiving too much money and that Margarette Coal Corporation and Gerdetz, on their agreed division of profits, could earn more by carrying on the operations without Gasperinni.

The stripping operations thereafter were conducted by Margarette Coal Corporation under the supervision of Mr. Gerdetz.

These stripping operations continued into 1944. Commencing in 1942, the great demand in the coal market had resulted in a mushrooming of stripping operations in the West Virginia area. The officers of plaintiff and Margarette Coal Corporation were acquainted with the general success reported in such operations, and despite meeting with adverse conditions, continued to expect profitable stripping operations. With some variance in conditions from time to time, the cost of removing the overburden on the Margarette lease greatly exceeded the value of the coal removed, and very substantial losses were sustained in the operations.

The losses in the stripping operations were due to a number of difficulties, among which were that coal was not found in many places where it was reasonably expected to be, that the coal found was often not merchantable because of inferior quality, that the stripping operations were hindered by Unexpected water difficulties, and by running into underground workings.

12. In 1944 the Margarette Coal Corporation abandoned its strip-mining operations on the Margarette lease, sold and disposed of all of its stripping equipment, and applied the proceeds to the account due and owing plaintiff.

Subsequently in 1944, the Richmond Coal Company opened negotiations with Margarette Coal Corporation and entered into a royalty agreement and conducted stripping operations on the Margarette lease. The Richmond company was not in any way related to plaintiff or its affiliated companies. The Richmond operations were no more successful than those of Margarette Coal Corporation, and the Richmond Coal Company ceased the stripping operations in September or October 1944, at which time it owed substantial sums of money to Margarette Coal Corporation for unpaid royalties.

13. The only deep-mining activity on the Margarette lease after 1944 was by intermittent sublease operations carried on by individual farmers or miners, sometimes working in small groups, who were not subject to regulations for safety, ventilation, and other matters as were mining companies. Margarette Coal Corporation itself conducted no operations, deep or strip mining, on the Margarette lease after 1944, but received small amounts of royalties and incurred no expense on coal produced by such sublessees. From 1946 to 1948 Kelly Coal Company by sublease carried on stripping operations on a portion of the Margarette lease, and paid royalties to Margarette Coal Corporation. There is no evidence as to whether any of the sublessees made profits on their operations.

14.In the years 1940 and 1941, Margarette Coal Corporation produced coal in the respective amounts of 196,631.14 and 151,542.82 gross tons, all from deep mining on the Mar-garette lease.

During 1942, Margarette produced 138,465.56 gross tons of coal, not specifically apportioned to the Margarette and Frances leases, although it is indicated that all production that year was from stripping operations.

The gross tons produced by Margarette from each of its two leases in the years 1943 and 1944 were as follows:

15.Margarette Coal Corporation’s Federal income tax returns for the years 1941 through 1944 reported net losses on its operations for each year, as follows:

1941_$11, 824. 79
1942_ 46,553.82
1943_ 256,225. 98
1944_ 160,840.49

Plaintiff and Margarette Coal Corporation did not file consolidated tax returns.

16.In 1942,1943, and 1944, as at other times, plaintiff was the exclusive sales agent for coal produced by Margarette Coal Corporation, and from time to time advanced funds on future deliveries of coal, as was and has been done in the case of other coal producers. The same commission was charged by plaintiff on sales of Margarette production as on coal from other operators, and the sales were handled in the customary manner related in finding 2.

The advances of cash to and credits for coal sold for Margarette Coal Corporation were carried on plaintiff’s books and records as an open account. This account for the years 1942, 1943, and 1944 is summarized as follows:

1942:

Advances made-$437, 973.19
Credits_ 352,563.97
Excess of advances over credits_ $85, 409. 22

1943:

Advances made- 754,943.29
Credits_ 427,050.59
Excess of advances over credits- 327,892.70

1944:

Advances made- 421, 872.66
Credits_ 233,835.40
Excess of advances over credits. 188, 037. 26
Total excess advances over credits_ 601, 339.18

There were no notes or other written instruments of indebtedness requested by plaintiff or given by Margarette Coal Corporation. Interest was not charged. Plaintiff never sought nor obtained from Margarette any chattel mortgages or other form of security with respect to its advances. Both plaintiff and Margarette treated their relationship as that of debtor and creditor on open account.

During the years 1942,1943, and 1944, plaintiff did a gross business approximating 39 million dollars, of which about 2 million was attributable to the operations of Margarette Coal Corporation.

17. During the years 1942 through 1944, and thereafter in 1946, the supply of coal was short, maximum prices were fixed by Government regulations, and plaintiff’s problem was to obtain coal to meet the great demand of its customers.

The advances made by plaintiff to Margarette Coal Corporation, as to other producers, were to enable the production of a needed supply. The strip operations on the Margarette lease and the deep mining on the Frances were both being conducted during the 1942-44 period. Supervisory and office personnel employed by Margarette contributed services to both operations and the same workmen in some instances were employed in both deep and strip mining. Movable equipment was used on both leases. Plaintiff kept no records as to the application of the advanced lands hy Margarette to the one operation or the other. The advances went into the overall operations of the Margarette Coal Corporation.

18. The net advances that plaintiff made to Margarette Coal Corporation exceeded by far the advances made to coal producers who had no stock affiliation with it. The advances made to producers were usually temporary extensions of credit against coal deliveries within about 60 days. However, each account was handled and considered according to the circumstances and assets of the individual producer, and in relation to labor problems, market conditions and any other pertinent matters. The two largest losses suffered by plaintiff in making advances to coal mining companies, other than the Margarette Coal Corporation, had occurred prior to 1936, when losses were sustained amounting to $100,000 on one account and $150,000 on another. In 1942 and 1943, plaintiff sustained no loss to an independent coal producer greater than $1,000, and thereafter none greater than $10,000.

It is apparent from the record that the officers of plaintiff and of Margarette Coal Corporation reasonably and in good faith expected that the stripping operations on the Mar-garette lease would result in production of a very substantial tonnage of coal, which, together with production on the Frances lease, would result in sufficient coal deliveries from time to time to repay the plaintiff’s advances. The removal of overburden in the stripping operations required substantial advances for payrolls and for the purchase of machinery and supplies. From time to time, plaintiff had to decide whether further advances would be made, which were necessary to the continued operations of Margarette Coal Corporation. The reasons why the advances were permitted to exceed the coal deliveries by such substantial amounts from 1942 through 1944 were that plaintiff’s officers expected from month to month that the stripping operations would become successful, and plaintiff was in great need of the coal to be produced by Margarette by both stripping and deep mining.

From the record of production of the two leases, as related in finding 14, and from all the evidence and testimony in this case, it is concluded that the inability of the Margarette Coal Corporation to produce sufficient coal to offset plaintiff’s advances resulted almost entirely from the failure of the strip mining operations on the Margarette lease.

19. On December 31, 1944, the open account indebtedness of the Margarette Coal Corporation to plaintiff, then amounting to $601,339.18, was written down on plaintiff’s books and records by debiting the profit and loss account in the sum of $464,861.93 and crediting the Margarette account in the same amount. The pertinent journal entry for that day had the following note of explanation: “To reduce the balance of the Margarette Coal Corporation due to inability of Margarette to pay.”

In November or December 1944, plaintiff’s chief accounting officer and auditor, Mr. Soderberg, made a detailed investigation of the Margarette account, and then prepared a schedule showing the book value of Margarette’s assets and liabilities, as shown on the Margarette books, adjustments made by him from his investigation, and the actual values as determined by him, as follows:

This schedule was prepared some time prior to December 31,1944, and by that date the excess of adjusted values of the assets over liabilities amounted to $136,477.25, exclusive of the Margarette indebtedness to plaintiff, which then amounted to $601,339.18.

20. The major assets of the Margarette Coal Corporation were its accounts receivable and plant and equipment, as shown in the above schedule. Of the total adjustment of the accounts receivable, $86,091 represented the indebtedness of the Richmond Coal Company to Margarette on account of Richmond’s stripping operations on the Margarette lease, related in finding 12. Mr. Soderberg discussed this account with the treasurer of the Richmond company and was advised by him and others that Richmond was insolvent. Richmond Coal Company was adjudicated a bankrupt in 1945. It is not shown whether Margarette filed a claim in the bankruptcy proceedings, but Margarette did write the Richmond indebtedness off its books in May 1945 and listed it as a bad debt in its tax return for 1945, filed May 10,1946.

With respect to the asset of plant and equipment, the $20,000 adjustment made by Mr. Soderberg resulted from his personal observation and appraisal of the Margarette plant and equipment. No inventory had been taken, but Mr. Soderberg concluded that equipment was missing and that plaintiff should further protect itself on the plant account.

Plaintiff retained no memoranda or records of the reasons for the adjustments. Mr. Soderberg presented his schedule and write-down proposal to plaintiff’s officers, who authorized and directed him to write down the Margarette account by the sum of $464,861.93.

21. At the time of the write down of the Margarette indebtedness on December 31,1944, Margarette still held both the Margarette lease and the Frances lease. The Margarette lease was practically exhausted, and the Frances lease had value only in terms of the future earning capacity of Mar-garette. The deep-mining operations on the Frances lease were costly due to haulage requirements and the thinning out of coal deposits. It reasonably appeared that no substantial profits would be made on the Frances operations. However, most of the Margarette plant and equipment, such as the tipple, tramways, and other plant fixed to the land, had value (other than for salvage) only in terms of continued operations on the Frances lease. By the terms of the Frances lease agreement, all plant and equipment permanently attached to the leasehold would revert to the lessor upon the termination of the lease.

It was upon these considerations, together with the appraisal of Margarette assets, that plaintiff’s officers estimated that the maximum part of the Margarette indebtedness of $601,339.18 that could be carried as an asset of plaintiff, was the sum of $136,477.25, and they accordingly wrote down the Margarette account in the amount of $464,861.93 as being a worthless account to that extent. Plaintiff’s officers then expected to continue making further advances to Margarette. In this respect, they were motivated by plaintiff’s need for coal to supply its customers. However, they reasonably believed in good faith that coal would be thereafter recovered only in such quantities as to repay all future advances and probably as much but not more than the amount of the Margarette account as reduced to $136,477.25. In view of the rights of Gauley Coal Land Company, as lessor of both the Margarette and Frances lease, they reasonably believed that their only substantial chance to recover the Margarette account as reduced to $136,477.25 lay in continued operations by Margarette.

Plaintiff’s officers then expected to continue making further advances to Margarette. In this respect, they were motivated in part by plaintiff’s need for coal to supply its customers. It was also necessary for them to do so in order that the Margarette Coal Corporation might operate, and it was only from further operations that they could hope to recoup any part of the advances previously made.

22. On its federal income tax return for the calendar year 1944, plaintiff claimed a deduction of $464,861.93 for worthlessness of the Margarette open account indebtedness to it, and attached the balance sheet and schedule prepared by Mr. Soderberg, the pertinent part of which is set forth in finding 19.

Plaintiff reported a net loss for 1944 in the sum of $323,-300.19. On June 12, 1945, plaintiff filed claims for refund for the years 1942 and 1943 seeking to carry back the net loss reported for 1944 as a deduction from its income in calendar years 1942 and 1943.

23. During the years 1945 through 1948, Margarette Coal Corporation recorded production of gross tons of coal from each of its two leases, as follows:

During 1946, 1947, and 1948, the Kelly Coal Company conducted stripping operations on the Margarette lease as related in finding 13, and all of the production on that lease for the years 1945 through 1948 was by sublessees.

The coal production by Margarette, on which there is no evidence of apportionment to the respective leases, during the years 1949,1950, and 1951 was in the respective amounts of 100,835.45, 117,265.40, and 93,266.45 gross tons. There is no evidence as to the amount of production after 1951.

24. In the years following 1944, the relationship between plaintiff and Margarette Coal Corporation continued as it had before, except that all advances by plaintiff to Mar-garette were for the Frances lease operations only. In fact, no operations were conducted by Margarette on the Margarette lease after 1944, and all production thereafter from that lease was by sublessees as related in finding 13. The following is a summary of the advances by plaintiff and credits to Margarette on the open account during each of the years 1945 through 1951:

1945:-

Advances made_ $419, 549.41
Credits- 312, 632.76
Excess of advances over credits_ 106,916.65

1946:

Advances made_ 538,392. 77
Credits_ 486, 201.71
Excess of advances over credits_ 52,191.06

1947:

Advances made_$1,391, 840. 48
Credits_ 1,443, 009.50
Excess of credits over advances- 51,169.02

1948:

Advances made- 1, 375,691. 08
Credits_ 1,599,922.04
Excess of credits over advances_ 224,230.96

1949:

Advances made- 692,069.01
Credits_ 627,243.86
Excess of advances over credits_ 64,825.15

1950:

Advances made_ 695,824.10
Credits_ 675,317.05
Excess of advances over credits_ 20, 507.05

1951:

Advances made_ 478,476.36
Credits_ 555, 496.76
Excess of credits over advances- 77,020.40

The $136,477.25 balance of advances over credits shown on the account on December 31, 1944, after the write down of the plaintiff’s indebtedness by the sum of $464,861.93, was carried forward into the account. The accumulated balance (excess of advances over credits) at the end of each year was as follows:

Accumulated Jtalance Excess of advances over credits
1945_$243,393.90
1946 _2_ 295,584.96
1947 _ 244,415.. 94
1948_ 20,184.98
1949_ 85,010.13
1950_ 105,517.18
1951_ 28,496.78

In none of the foregoing years did the accumulated balance ever show an excess of credits to Margarette over advances made by plaintiff. The record in this case does not contain evidence of the status of the account after 1951, except the terminal balance as hereinafter related.

By December 31, 1953, Margarette Coal Corporation had gone out of business, and its only remaining asset was a credit balance in its favor on the advance account with plaintiff in the sum of $17,000. Plaintiff expects to enter said amount upon its books as income in the way of a partial recovery of a worthless debt unless it is required to pay such amount over in satisfaction of an allegedly preferred claim being asserted by Gauley Coal Land Company against Margarette Coal Corporation. The application of the $17,000 as recovery of a worthless debt would be the only amount collected and applied upon the $464,861.93, the write down of Margarette’s indebtedness on December 31,1944.

Throughout its operations from 1936 to 1954, Margarette Coal Corporation never paid dividends to stockholders.

25. The net income or loss reported by Margarette Coal Corporation on its federal income tax returns for the years 1945 through 1953 were as follows:

The above-stated amounts include no carryover of net operating loss.

26. Upon audit of plaintiff’s 1944 tax return, the Commissioner of Internal Eevenue disallowed on December 8, 1952, the bad debt deduction of $464,861.93 claimed by plaintiff, and stated as follows:

(a) Bad Debt, $464,861.93.
The above amount represents a partial charge-off of the balance of an account receivable owed to the taxpayer corporation by the Margarette Coal Corporation and which has been disallowed.
The Margarette Coal Corporation, operators of coal mines leased from the Gauley Land Company is the outgrowth of a corporation known as the Margarette Coal Company which was petitioned into Bankruptcy in 1935. The properties of the Margarette Coal Company were sold at public auction in May 1936 and purchased by a new corporation known as the Margarette Coal Corporation for $50,000.00. The new corporation was formed by George E. Warren Company (then a personal holding company) and another creditor, the Material Service Co., distributors of coal in the Middle West. Investments in the new corporation were made by the two companies in the amount of $37,500.00 and $12,500.00 respectively. The investment by the Material Service Co. was sold in 1938 to the J ames Coal Mining Co. for approximately $21,000.00. The George E. Warren Co.. owns 600 shares Class A Voting Stock and 68 shares Class B Nonvoting Stock of the George E. Warren Corporation.
Cash advances for equipment and expenses have been made through the years by the George E. Warren Corporation to the Margarette Coal Corporation and the taxpayer corporation has in turn been supplied with most of the coal production of these mines.
As of January 1, 1942, The George E. Warren Corporation owed the Margarette Coal Corporation $29,-166.19 and as of December 31, 1944, prior to the charge off in the amount of $464,861.93, the Margarette Coal Corporation owed the George E. Warren Corporation $601,339.18. Exhibit A details the Cash Advances and Payments in coal for the period January 1, 1942 to December 31, 1946.
After the charge off, the same financial policy of advances and payments continued and are so continuing to the date of this report. It is conceded that a portion of the cash advances were for equipment necessary to work the mines and that the partial charge off is based upon salvage value of the existing equipment at the mines.
There has been no evidence submitted, however, which would show that a chattel mortgage or lien on this equipment exists which would place the taxpayer corporation in an advantageous position in the event of bankruptcy proceedings. In the light of the continuing policy under the same venture the deduction is disallowed.
* * * * ❖
The bad debt deduction of $464,861.93 claimed in your return for the year 1944 in respect of advances to Mar-garette Coal Corporation has been disallowed inasmuch as it has not been established that an actual indebtedness existed, or, if there existed a debtor-creditor relationship, that the debt became worthless within the taxable year 1944.

As a result of this disallowance and of other adjustments not in issue, the Commissioner then determined that the net taxable income of plaintiff for the calendar year 1944 was $142,555.37, and accordingly assessed against plaintiff for that calendar year a deficiency in tax of $58,621.27, plus interest thereon in the sum of $28,062.05. This total deficiency of $86,683.32 was paid by plaintiff by check dated March 9,1953.

27. On March 9,1953, plaintiff filed a claim for refund of the deficiency paid for the calendar year 1944, and on April 27, 1953, the Commissioner of Internal Revenue issued a statutory notice of disallowance of this claim.

28. Plaintiff had paid income taxes for the calendar year 1942 of $54,515.50 and for the calendar year 1943 of $57,732.84, and had pending its claims for refund of these taxes on the ground that it was entitled to carry back the net operating loss reported on its 1944 tax return.

The Commissioner of Internal Revenue, having determined that plaintiff did not have a net operating loss for the year 1944, denied these claims for refund on May 28, 1953. As a result, however, of other adjustments with respect to the 1942 and 1943 returns of plaintiff, there had been refunded to it on March 9, 1953, the sum of $366.85 with respect to its 1942 taxes and the sum of $1,878.34 with respect to its 1943 taxes. The Commissioner of Internal Revenue determined that plaintiff’s net income for the year 1942 was $135,371.64 and for the year 1943 was $139,648.48.

29. The partial-bad-debt deduction in the amount of. $464,861.93 for the calendar year 1944 should have been allowed by the Commissioner of Internal Revenue, and plaintiff is entitled to the following refund: For 1942, $54,148.65 plus interest from June 12, 1945; for 1943, $55,854.50 plus interest from June 12, 1945; and for 1944, $86,683.32, plus interest from March 11, 1953, as provided by law.

Plaintiff’s unused net operating loss for the year 1944 available for carryover after 1944 is $43,259.25.

CONCLUSION OF LAW

Upon the foregoing findings of fact, which are made a part of the judgment herein, the court concludes as a matter of law that the plaintiff is entitled to recover, and it is therefore adjudged and ordered that it recover of and from the United States for 1942, $54,148.65 plus interest from June 12, 1945; for 1943, $55,854.50 plus interest from June 12, 1945; and for 1944, $86,683.32, plus interest from March 11,1953, as provided by law. 
      
       1942:
      Advances made--$437, 973.19
      Credits--352, 563. 97
      Excess of advances over credits--$85, 409. 22 1943:
      Advances made--754, 943. 29
      Credits--427, 050. 59
      Excess of advances over credits--327, 892. 70 1944:
      Advances made--421, 872. 66
      Credits--233, 835. 40
      Excess of advances over credits--188, 037. 26
      Total excess advances over credits--601, 339.18
     