Cleo Perfume, Inc. - Page 9

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          year.  This return reported beginning inventory of $3,074,506,              
          ending inventory of $3,673,423, and purchases of $13,758,337.               
               On its return for tax year ended June 30, 1993, petitioner             
          adjusted the beginning inventory to correct the "correcting"                
          journal entry Mr. Rosales made by reducing by $1,860,621 beginning          
          inventory and paid-in capital.                                              
          Notice of Deficiency                                                        
               In the notice of deficiency, respondent determined that                
          petitioner was liable for a $741,379 deficiency on the theory that          
          it was relieved of a $2,031,778 liability during the tax year ended         
          June 30, 1991.  Respondent also determined a section 6651(a)(1)             
          addition to tax and a section 6662(a) accuracy-related penalty.             
          Issue 1. Additional Income                                                  
               Our first task is to determine whether petitioner had                  
          additional income of $2,031,778 in its tax year ended June 30,              
          1991.  In this regard, respondent makes three alternative                   
               A.  Discharge of Indebtedness Income                                   
               Section 61(a)(12) provides the general rule that gross income          
          includes income from the cancellation of indebtedness.  Generally,          
          the amount of income includable is the difference between the face          
          value of the debt and the amount paid in satisfaction of the debt.          

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