1. The rights of a buyer who has prepaid a seller for
merchandise which the latter has failed to deliver are upon
contract, and are not a "debt," where neither party has abandoned
the contract; the prepayment is therefore not deductible, in
arriving at net income under Revenue Act of 1918, § 234(5), as a
"debt ascertained to be worthless and charged off within the
taxable year." P. 275 U. S.
2. When the seller proved to be irresponsible, the buyer's loss
could be deducted under § 234(4) as a "loss sustained during the
taxable year," i.e.,
the year in which his claim proved to
be worthless. P. 275 U. S.
3. Plaintiff, in 1918, paid in advance for goods which were
never delivered. He did not charge off the amount in that year on
his books, but continued to carry it in a "bills receivable"
account. The worthlessness of the claim was proved by the outcome
of litigation two years after the payment. He then sought, under
Subsection (4), § 234, Revenue Act of 1918, to deduct the amount of
the payment in an amended tax return for 1918. Held,
the deduction was not allowable because the loss was not
"sustained" during that taxable year. P. 275 U. S.
4. Trial by jury having been waived in writing, review of this
case is limited to the sufficiency of the facts specially found to
support the judgment and to the rulings excepted to and presented
by the bill of exceptions, R.S. §§ 649, 700. The Court is without
power to grant a new trial except for error thus presented. P.
275 U. S. 248
11 F.2d 493 reversed.
Page 275 U. S. 244
Certiorari, 273 U.S. 676, to a judgment of the circuit court of
appeals which reversed a judgment of the district court for the
Collector in an action brought by the Reduction Company to recover
income taxes. 8 F.2d 91.
MR. JUSTICE STONE delivered the opinion of the Court.
This case is here on writ of certiorari to the Circuit Court of
Appeals for the Third Circuit to review its judgment, 11 F.2d 493,
reversing the judgment of the District Court for Western
Pennsylvania, 8 F.2d 91, and awarding a new trial. The action was
brought by respondent to recover income taxes paid by it for the
year 1918. By written stipulation, a jury was waived, and the case
was tried to the court, which made special findings and on them
gave judgment for defendant. The principal question to be
determined is the right of the respondent, upheld below, to deduct
an admitted business loss from its gross income for 1918 in
determining its tax for that year, rather than from gross income
for a later year.
In July, 1918, respondent contracted with one Jouravleff for the
sale and delivery to it in monthly installments of a quantity of
tungsten ore. The contract required the buyer immediately to accept
a bill of exchange drawn on
Page 275 U. S. 245
it by the seller in the sum of $30,000, which was to be applied
against the purchase price of the first carload of ore shipped.
Respondent accepted the draft, and the seller negotiated it through
bankers associated with him in the transaction. Respondent paid it
at maturity, in advance of any actual shipment of ore, having
received from the broker who had negotiated the sale, a telegram
saying: "Shipment one car will be made today." Only a small
quantity of ore was ever shipped. This was received in the
following December, and, after being credited upon the amount of
the draft, left a balance of more than $27,000. In March of the
following year, respondent began three separate suits to recover
the $27,000 -- one against the seller, the second against the
broker as an alleged surety or guarantor of the seller, and the
third against the bankers. Judgment secured against the seller in
1919 remains unsatisfied. The suit against the broker resulted in a
judgment for the defendant in November, 1922. The suit against the
bankers was discontinued in 1921 as useless after they had been
adjudged bankrupt. Respondent did not charge off the $27,000 on its
books in 1918, but continued to carry it as an item it its "bills
receivable" account. It claimed no loss on account of the payment
in its tax return for that year. Upon the termination of the
litigation in 1922, it filed an amended tax return for 1918,
deducting the uncollected balance as a loss, and brought the
present suit to recover the alleged overpayment of tax.
Section 234 of the Revenue Act of 1918, c. 18, 40 Stat. 1057,
1078, provides that, in arriving at taxable income, there may be
"(4) Losses sustained during the taxable year and not
compensated for by insurance or otherwise; . . ."
"(5) Debts ascertained to be worthless and charged off within
the taxable year. "
Page 275 U. S. 246
The district court held that the loss was upon a worthless debt
deductible under subdivision (5) and not deductible for 1918
because not charged off in that year.
The respondent contends and the court below held that the loss
was not one upon a worthless debt, deductible under subsection (5),
but was deductible when "sustained" under subsection (4), and
concludes that the loss was rightly deducted as of 1918, since the
loss was sustained when respondent paid out the money for which it
received no return.
We assume, without deciding, as was assumed by both courts
below, that subsection (4) and subsection (5) are mutually
exclusive, so that a loss deductible under one may not be deducted
under the other. We may assume also that, upon the abandonment of
the contract by the seller, the buyer might have maintained an
action to recover the balance of the money which he had paid. But,
so far as appears from the record, there had been no abandonment by
the seller in 1918. Throughout that period, the buyer was calling
for deliveries, and some were made as late as in December. The
buyer's rights were upon a contract for the delivery of
merchandise, and were not a "debt" in either a technical or a
colloquial sense. We conclude that, if respondent's contract rights
became worthless in 1918, he was not required to deduct his loss as
a worthless debt under subsection (5), but was entitled to deduct
it under subsection (4) as a loss sustained in that year.
But we do not think that a loss resulting from a buyer's
prepayment to a seller who proves to be irresponsible in
necessarily sustained, in the statutory meaning, as soon as the
money is paid. The statute was intended to apply not only to losses
resulting from the physical destruction of articles of value, but
to those occurring in the operations of trade and business where
the businessman has ventured
Page 275 U. S. 247
on a course of action in the reasonable expectation that the
promised conduct of another will come to pass. Not only the future
success of the business, but its present solvency, depends on the
probable accuracy of his prophecy. Only when events prove the
prophecy to have been false can it be said that he has suffered.
His case is not like that of a man who fails to learn of the theft
of his bonds or the burning of his house until a year after the
occurrence, but, rather, resembles the position of a merchant who
buys in one year, for sale in the next, merchandise which shifting
fashion renders unsaleable in the latter. It may well be that he
whose house has been burned has sustained a loss whether he knows
it or not, and may recover a tax paid in ignorance of that material
fact. But we cannot say that the merchant whose action has been
based not merely on ignorance of a fact, but on faith in a prophecy
-- even though the prophecy is made without full knowledge of the
facts -- can claim to have sustained a loss before the future fails
to justify his hopes.
Here, the only fact relied upon to show a loss is the outcome of
the litigations two years after respondent's payment to Jouravleff.
There is nothing in the findings from which we could conclude that
the respondent, in 1918, had ceased to regard his rights under the
contract as having value, or that there was then reasonable ground
to suppose that efforts to enforce them would be fruitless. On the
findings, respondent is not entitled to recover.
At the trial, respondent offered evidence that it had conducted,
in 1918, an investigation which tended to show the irresponsibility
of Jouravleff. Inquires, variously phrased, to elicit this fact
were excluded by the trial judge both because they were irrelevant
and because the evidence offered was inadmissible as hearsay. An
examination of the bill of exceptions discloses that the proffered
testimony was rightly excluded on this latter ground.
Page 275 U. S. 248
Hence, no error was committed by the trial court in its rulings.
A trial by jury having been waived in writing, our review in this
case is limited to the sufficiency of the facts specially found to
support the judgment, and to the rulings excepted to and presented
by the bill of exceptions, Rev.Stat. §§ 649, 700; Fleischmann
Co. v. United States, 270 U. S. 349
we are without power to grant a new trial except for error thus
presented. Mueller Grain Co. v. American State Bank, post,
p. 493, reversing
15 F.2d 899. The judgment of the
district court was right for reasons other than those assigned by
it. It is affirmed, and the judgment of the circuit court of