Pacific Novelty Co. v. Commissioner

*1018OPINION.

The question here presented is whether the deduction of $9,758.99, claimed by petitioner as a bad debt deduction for 1920, was an allowable deduction under section 234 of the Revenue Act of 1918. The respondent contends that the amount deducted was only a portion of a debt and as such is not deductible as a bad debt ascertained to be worthless and charged off within the year, under section 234 (a) (5). If the premise of such contention is correct, the conclusion is sound, for the reason that a part of a debt may not be claimed as a bad debt deduction, under the Revenue Act of 1918. The petitioner was one of the four principal creditors of a debtor *1019involved in financial difficulties. One of the other creditors had secured an advantage by attaching the assets of the debtor. However, such advantage could not be maintained if the other creditors instituted bankruptcy proceedings. Accordingly, the attaching creditor entered into a written agreement with one of the other creditors, providing for a compromise with the debtor. These two creditors were in turn obliged to let the third creditor in on the agreement on a similar basis. This left only the petitioner to threaten the three-cornered agreement. After a full investigation, it was agreed that in no event could the creditors recover more than 25 per cent of the amounts due them. The petitioner thereupon entered into an oral composition agreement by which the creditors agreed to accept 25 per cent of the obligations due them in full settlement. By reason of the failure to take care of certain formalities, the petitioner was not entitled to share in the bankruptcy liquidation proceedings subsequently carried out. However, it was bound by the composition contract entered into in the taxable year in question, and in no event could it have recovered more than 25 per cent of its account with the debtor.

When the petitioner became a party to the composition agreement, it was agreed to accept 25 per cent in lieu of 100 per cent of the debt. In other words, it expressed its willingness to give up all possibility of recovering all, to increase- the probability of recovering a part. The 75 per cent of the original obligation, at the time it was charged off, did not represent a portion of a debt, but was more in the nature of a loss. Thereafter, the amount continued on petitioner’s books, did not represent a fractional part of a debt. It represented the total to which the petitioner was entitled. In the following year, 1921, the debtor only owed the petitioner 25 per cent of the original debt. The remainder was no longer in existence and could not have been claimed as a bad debt deduction in such later year. That is, in 1920, the debt was reduced from 100 per cent, or $13,011.93, to 25 per cent, or $3,253.

The composition agreement was similar to a compromise agreement, in that it reduced the total amount of the obligation. We have held that the amount by which a debt was reduced in compromise, was a deductible loss in the year in which such an agreement was made, Appeal of Russel Wheel & Foundry Co., 3 B. T. A. 1168; Appeal of Manville Jenckes Co., 4 B. T. A. 765. We think the principle applied in those cases is applicable here. The deduction of 75 per cent of the original debt in 1920 was proper, as it represented a loss sustained during that year, within the meaning of section 234 (a) (4) of the Revenue Act of 1918.

Judgment will be entered on 15 days' notice, under Rule 50.