Screven Oil Mill v. Commissioner

*875 This proceeding is for the redetermination of a deficiency income tax asserted by the respondent for the fiscal year ended June 30, 1928, in the amount of $2,681.02. The errors alleged are disallowance of deductions for depreciation and bad debts. At the hearing the issue concerning depreciation deduction was abandoned by the petitioner.

The petition also sets forth a controversy with respect to the fiscal year ended June 30, 1927, but it was abandoned at the hearing.

FINDINGS OF FACT.

Petitioner is a corporation, organized in 1919. At first its business was the extraction of crude cottonseed oil. In 1920 it built and operated an ice plant. No further expansion of its business activity took place until early*1234 in the year 1923, when the manufacture and *876 sale of mixed fertilizer was undertaken. Since then petitioner's business has comprised the three lines mentioned, together with by-products such as cottonseed meal.

Prior to 1923 petitioner's sales were made almost entirely on the cash basis, or sight draft against a bill of lading. Occasionally credit was extended to customers. No reserve for bad debts was maintained, but some accumulation of bad debts was charged off in 1922.

When petitioner began the manufacture of fertilizer it was found that about 80 per cent of the sales of that product would have to be made on credit. Therefore, in 1923 petitioner established a more complete bookkeeping system and set up a reserve for bad debts. The amount of the reserve for each year was estimated, based upon reports concerning the cotton crop during the summer. The excess amount of the reserve, if any, over bad debts charged against it for each fiscal year was credited to profit and loss and included in taxable income for that year. On June 30, 1923, the reserve set up amounted to $546.35 and the losses from bad debts were slightly greater in amount. For the succeeding years*1235 the reserves set up and the bad debts charged against them are as follows:

There were some additional amounts of bad debts, but when they were charged off does not appear.

The total amount charged off in 1928 was $22,555.77, but included therein were some losses for 1927 and 1926 not previously absorbed.

Petitioner made no application to respondent for permission to establish a reserve for bad debts. For that reason respondent disallowed as a deduction the petitioner's addition to the reserve for the year ended June 30, 1928, and adjusted the bad debts item upon the basis of actual bad debts.

OPINION.

MARQUETTE: Petitioner contends that it was on a cash receipts and disbursements basis prior to June 30, 1922, and therefore was unable to set up a reserve for bad debts until after that date. It argues that its first opportunity to elect between two methods of accounting occurred in 1923, and hence it is entitled*1236 to its deductions for additions to the reserve.

*877 Section 23(j) of the Revenue Act of 1928 provides that there shall be allowed as a deduction from gross income: "Debts ascertained to be worthless and charged off during the taxable year (or, in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts) * * *."

Regulations 74, promulgated by the respondent under the provisions of the Revenue Act of 1928, in article 191 provides in part:

* * * Taxpayers were given an option for 1921 to select either of the methods mentioned for treating such debts. The method used in the return for 1921 must be used in returns for subsequent years and in returns under the Revenue Act of 1928 unless permission is granted by the Commissioner to change to the other method. A taxpayer filing a first return of income may select either of the two methods subject to approval of the Commissioner upon examination of the return.

Manifestly, petitioner's return for the fiscal year was not a "first return of income" entitling petitioner to a choice of methods, for it had filed severl returns for previous years.

The statute vests in the Commissioner discretionary*1237 power over the use of the reserve method of treating bad debts. In the exercise of that discretion he has promulgated the regulations above quoted. In so far as they affect the present proceeding those regulations are identical in wording with the Commissioner's regulations concerning the bad debts provision of the Revenue Act of 1921. Since the passage of that act and the promulgation of regulations for its administration, the Congress has enacted three further revenue statutes, in each of which the Commissioner has been given discretionary power respecting the reserve for bad debts.

Reading the statute and the administrative regulations together, it is evident from the facts before us that the petitioner has not taken the necessary and proper steps to place itself upon the reserve basis for bad debts. It followed the method of charging off debts ascertained to be worthless in its income-tax return for the fiscal year 1921 and was therefore required to continue that method until it received permission to change. The petitioner's argument that, as it was selling its products for cash prior to 1923 it had no opportunity to exercise any choice of methods prior to that year, is*1238 not convincing. The statute informed every taxpayer that use of the reserve method for bad debts was discretionary with the Commissioner. We think that warning sufficiently advised petitioner of the necessity of ascertaining what the Commissioner's discretion might require and complying therewith. Having failed to do so, petitioner is restricted to the method it first used. ; affd., ; ; .

Decision will be entered for the respondent.