*719 1. In each of the taxable years the Commissioner, under section 45 of the applicable revenue acts, has allocated to two subsidiary corporations of the taxpayer corporation a portion of taxpayer's executive office expenses and a portion of its expenses for national advertising of its brands of liquors in which the subsidiaries owned no interest. Held, the portion of executive expenses allocated to the subsidiaries for 1937 was without justification because taxpayer had already charged the subsidiaries their full share of these expenses for that year; held, further, a portion of such expenses for 1938 allocated to the subsidiaries was justified and is approved, and the balance is not sustained; held, further, that none of the national advertising expenses of the taxpayer corporation should have been allocated to the subsidiaries and the Commissioner's allocation in that respect is disallowed.
2. When the evidence shows that in 1938 petitioner took over all the net assets of one of its 100 percent owned subsidiaries in part payment for a debt owned petitioner by the subsidiary and dissolved the subsidiary, held, there was no distribution in complete liquidation*720 within the meaning of section 112(b)(6) of the Revenue Act of 1938, and petitioner is entitled to a "bad debt" deduction for the balance of the debt and to a "loss" deduction for its investment in the capital stock of the dissolved corporation. H. G. Hill Stores, Inc.,44 B.T.A. 1182">44 B.T.A. 1182, followed.
*213 These proceedings have been consolidated. Docket No. 101983 involves the year 1937. For this year the Commissioner determined a deficiency in petitioner's income tax of $10,033.12. The deficiency is due to three adjustments made in the income tax return filed by petitioner for the year 1937, as follows:
| (a) Excess accrual of capital stock tax | $6,796.00 | |
| (b) Additional executive expenses allocated - | ||
| California corporation | $4,974.48 | |
| New York corporation | 1,872.16 | |
| 6,846.64 | ||
| (c) Magazine advertising allocated - | ||
| California corporation | $10,073.81 | |
| New York corporation | 7,226.09 | |
| 17,299.90 | ||
| Total added | 30,942.54 |
Petitioner did not assign any error as to adjustment (a). It*721 assigns error as to adjustments (b) and (c). In addition to assignments of error as to adjustments (b) and (c), petitioner alleges in its assignment of error (c) that the respondent erred in failing to allow as a deduction from petitioner's income additional state income taxes in *214 the amount of $2,318.56 levied by the and paid to the State of Kentucky by petitioner for the year 1937.
Also, petitioner alleges in its assignment of error (d) that respondent erred in failing to allow as a deduction from petitioner's income additional taxes levied under Title IX of the Social Security Act for the year 1937, in the amount of $2,909.81.
Docket No. 105721 involves the year 1938. For this year the Commissioner determined a deficiency in petitioner's income tax of $8,597.41. The deficiency is due to five adjustments made in the income tax return filed by petitioner for 1938, as follows:
| (a) Legal expense disallowed | $800.00 |
| (b) Administration expense disallowed | 10,693.64 |
| (c) Advertising expense disallowed | 14,855.20 |
| (d) Fire loss adjustment | 22,801.37 |
| (e) Depreciation disallowed | 2,955.30 |
| Total added to income | 52,105.51 |
Petitioner assigns error as*722 to adjustments (b), (c), and (d) and does not contest the correctness of the remaining adjustments above. In addition to assignments of error contesting adjustments (b), (c), and (d), above, petitioner assigns three other errors as follows:
(d) In computing the taxable net income of the petitioner for the calendar year 1938, the respondent erred by reason of his failure to eliminate from taxable net income the sum of $313,725.63, representing the excess of insurance proceeds received over the cost of inventories destroyed by fire.
(e) In computing the taxable net income of the petitioner for the calendar year 1938, the respondent erred by reason of his failure to allow as a deduction an additional bad debt loss in the amount of $80,810.56.
(f) In computing the taxable net income of the petitioner for the calendar year 1938, the respondent erred by reason of his failure to allow as a deduction a loss sustained during the taxable year, on account of an investment in stock in the amount of $1,000.00, which stock became worthless during the year.
FINDINGS OF FACT.
Petitioner is a corporation, organized under the laws of the State of Kentucky, with its principal office in*723 Louisville, Kentucky. It filed its corporation income and excess profits tax returns for the calendar years 1937 and 1938 with the collector of internal revenue for the district of Kentucky.
Petitioner was incorporated under date of May 15, 1901. It is engaged in the business of distilling and selling spirits. The plant of the petitioner for the manufacture of the spirits is located at Owensboro, Kentucky. Its books of account are kept on the accrual basis.
On March 12, 1934, petitioner caused to be organized under the laws of the State of New York the Glenmore Distilleries Co. of New York (herein sometimes referred to as the New York company). The outstanding *215 capital stock of the New York company was 100 shares no par with a stated value of $1,000, all of which stock was subscribed for by petitioner by the payment of cash of $1,000. The business of the New York company was that of a wholesale selling distributor for the liquors manufactured by petitioner. It had exclusive jurisdiction over the wholesale distribution of liquors of petitioner for the States of New York, Connecticut, Rhode Island, Massachusetts, Maine, Delaware, and Vermont. It maintained a*724 selling office in the city of New York, which was furnished with normal office furniture. It also leased warehouse space in which to keep liquor on hand awaiting sale. The New York company kept a full and complete set of books covering its business transactions, on the accrual method of accounting, in the office of the petitioner at Louisville. The New York company had no proprietary interest in the brands under which the liquor was sold and these brands were all owned by petitioner. The New York company was dissolved as of October 1, 1938.
On December 17, 1034, petitioner caused to be organized under the laws of the State of Californiathe Glenmore Distilleries Co. of California (herein sometimes referred to as the California company). The outstanding capital stock of the California company was 100 shares of a par value of $10 per share, all of which outstanding stock was subscribed for by petitioner by the payment of cash of $1,000. The business of the California company was that of a wholesale selling distributor for the liquors manufactured by petitioner. It had exclusive jurisdiction over California, Arizona, Nevada, and Honolulu. It maintained a selling office in the*725 city of San Francisco, which office was furnished with the usual office furniture. The California company kept a full and complete set of books covering its business transactions, on the accrual method of accounting, in the office of petitioner at Louisville. It was dissolved and its assets were conveyed to petitioner September 1, 1938. The California company had no proprietary interest in the brands under which the liquor was sold and these brands were all owned by petitioner.
For the years 1937 and 1938 petitioner had executive expenses per books as follows:
| 1937 | 1938 | |
| Officers' salaries | $85,416.66 | $74,950.00 |
| Office salaries | 50,241.40 | 48,257.19 |
| Office supplies | 5,886.05 | 4,424.59 |
| Office rent | 5,037.50 | 5,100.00 |
| Postage | 4,254.94 | 4,458.07 |
| Telephone and telegraph | 8,369.22 | 8,687.68 |
| Heat, light, and water | 725.02 | 687.56 |
| Legal and accounting | 27,877.59 | 23,592.05 |
| Executive traveling expense | 2,163.12 | 2,713.06 |
| Convention expense | 3,923.98 | 1,976.65 |
| Total | 193,895.48 | 174,846.85 |
*216 For the years 1937 and 1938, the officers of petitioner were as follows:
W. O. Robertson, chairman of the board.Frank B. Thompson, president.
*726 J. A. Engelhard, secretary-treasurer. H. S. Barton, vice president.James P. Thompson, second vice president.
G. W. Duncan, assistant secretary-treasurer.The officers' salaries which are included in the above total executive expenses were paid by petitioner to the officers and in the amounts as follows:
| 1937 | 1938 | |
| Robertson | $8,666.66 | $8,200 |
| Thompson | 24,000.00 | 20,000 |
| Engelhard | 16,250.00 | 15,575 |
| Barton | 19,250.00 | 16,200 |
| Thompson | 11,250.00 | 9,500 |
| Duncan | 6,000.00 | 5,475 |
| Total | 85,416.66 | 74,950 |
During the years 1937 and 1938 none of the officers of petitioner performed any services for the New York or California companies, with the exception of Duncan, and his activities were limited to obtaining licenses for the subsidiaries and advising them on matters of accounting, invoicing, and credits.
During the years 1937 and 1938 none of the officers of petitioner made any business trips on behalf of the New York or the California companies.
The item of "office salaries" listed above was paid by petitioner to some forty-two office employees, who held positions such as stenographer, clerk, bookkeeper, multigraph operator, and other duties*727 performed in the normal office. Only three of the office employees performed any services for the two subsidiaries. One employee, W. D. Sproul, spent about two-thirds of his time keeping the books of the subsidiaries; another, Margaret Graf, spent about two days a month keeping a perpetual inventory for the subsidiaries, while the third, Clinton Wroe, spent very little time in printing some stationery forms for the subsidiaries.
The compensation paid the three office employees who performed some service for the two subsidiaries during the years 1937 and 1938 was as follows:
| 1937 | 1938 | |
| Margaret Graf. inventory clerk | $1,014.00 | $1,040.40 |
| W. D. Sproul, accountant | 2,952.00 | 2,956.54 |
| Clinton Wroe, multigrapher | 1,206.33 | 1,285.52 |
*217 The item "office supplies" listed above represents amounts spent by petitioner for office supplies at its Louisville office. None of these office supplies were furnished to either of the two subsidiaries.
The item "office rent" listed above represents rent paid by petitioner for the space occupied by it at its Louisville office.
The item of "postage" listed above represents postage for the Louisville office, and*728 the item of "telephone and telegraph" represents amounts expended for telephone and telegraph of the Louisville office. None of this expense was for the benefit of either of the two subsidiaries.
The seventh item above was "heat, light, and power" for the year 1938. It represents the expense of the Louisville office for its heat, light, water, and power.
None of the "Legal and accounting" expenses listed above were for the benefit of either of the two subsidiaries, with the exception that the charge for auditing the books of the New York company was included. The books of the New York company were audited by Wolf & Co., and the total amounts paid by petitioner to Wolf & Co., for all services rendered during 1937 and 1938 were $917.66 and $3,180.69, respectively.
The item "executive traveling expense" listed above represented amounts spent by the officers of petitioner for traveling on business of the petitioner. No portion of this expense represents any traveling expense on behalf of either of the two subsidiaries.
The item "convention expense" represents the expense of the sales convention held once a year by petitioner at its Louisville office.
For the year*729 1938 the above items of office supplies, office rent, postage, telephone and telegraph, heat, light, and power, and legal and accounting expenses did not include such expenses incurred by petitioner at its plant at Owensboro.
During the year 1937 petitioner charged to each of the subsidiaries the sum of $6,000 as executive office expense, and in its return for the year 1937 petitioner included the $12,000 as other income. No similar charge was made for the year 1938.
For the year 1937 the New York company and the California company had executive expenses per their respective books as follows:
| New York company | California company | |
| Officers' salaries | $6,750.00 | $5,616.66 |
| Office salaries | 4,681.67 | 7,720.43 |
| Office supplies | 621.69 | 2,454.44 |
| Office rent | 925.80 | 641.94 |
| Postage | 1,279.58 | 942.18 |
| Telephone and telegraph | 1,709.68 | 2,190.50 |
| Legal and accounting | 233.27 | 65.79 |
| Total | 16,20l.69 | 19,631.94 |
*218 In addition to the above each subsidiary company was charged by petitioner with $6,000 as stated above, and each subsidiary claimed such aggregate as executive expense in its return for the year 1937, which amounts were allowed as deductions.
*730 For the year 1937, by taking the sales of petitioner and the sales of the two subsidiaries as 100 percent, the following percentage of sales was made by each company:
| Petitioner | 90.28% |
| California company | 5.66% |
| New York company | 4.06% |
| Total | 100.00% |
In the statement attached to the deficiency notice for the year 1937 the respondent allocated the above mentioned executive expenses of the petitioner by taking $193,895.48 as representing 100 percent for the three companies, and he then assigned 90.28 percent to petitioner, 5.66 percent to the California company, and 4.06 percent to the New York company, thus splitting up the total executive expenses as shown by the books of the petitioner on the following basis:
| Petitioner | $175,048.84 |
| California company | 10,974.48 |
| New York company | 7,872.16 |
| Total | 193,895.48 |
The respondent disallowed as a deduction to petitioner for the year 1937 executive expenses in the amount of $6,846.64, determined as follows:
| Petitioner's executive expenses reported | $193,895.48 |
| Petitioner's expenses allowed by respondent | 175,048.84 |
| Difference | 18,846.64 |
| Executive office expenses charged to subsidiaries as explained above | 12,000.00 |
| Executive expenses disallowed by respondent | 6,846.64 |
*731 For the year 1938 the New York company and the California company had executive expenses per their respective books as follows:
| New York company | California company | |
| Officers' salaries | $4,454.12 | $4,298.67 |
| Office salaries | 2,340.00 | 4,168.93 |
| Office supplies | 301.65 | 782.36 |
| Office rent | 532.80 | 615.52 |
| Postage | 733.23 | 518.05 |
| Telephone and telegraph | 678.55 | 1,090.32 |
| Legal and accounting | 78.29 | 177.58 |
| Total | 9,118.64 | 11,651.43 |
*219 For the year 1938, by taking the sales of petitioner and the sales of thw two subsidiaries as 100 percent, the following percentage of sales was made by each company:
| Petitioner | 93.884% |
| California company | 3.035% |
| New York company | 3.081% |
| Total | 100.000% |
In the statement attached to the deficiency notice for the year 1938 the respondent allocated the above mentioned executive expenses ($174,846.85) of the petitioner by taking $174,846.85 as representing 100 percent and then assigning 93.884 percent to the petitioner, 3.035 percent to the California company, and 3.081 percent to the New York company, thus splitting up the total executive expenses as shown by the books of the petitioner as follows: *732
| Petitioner | $164,153.21 |
| California company | 5,306.60 |
| New York company | 5,387.04 |
| Total | 174,846.85 |
The respondent disallowed as a deduction to petitioner the sum of $5,306.60 which he allocated to the California company and the sum of $5,387.04 which he allocated to the New York company as shown in the preceding paragraph, thus reducing the executive expenses of the petitioner as shown by its books for the year 1938 by the total amount of $10,693.64.
For the years 1937 and 1938 the net sales of the petitioner, after eliminating sales to its subsidiaries and the net sales of the New York and the California companies, were as follows:
| 1937 | 1938 | |
| Petitioner | $10,316,776.21 | $7,575,194.48 |
| California company | 701,532.43 | 257,207.27 |
| New York company | 502,844.74 | 261,096.58 |
After allocating $6,000 executive office expenses to each of the two subsidiaries in 1937 the net income or loss (figures in parenthesis indicate loss) as originally reported by the three companies, and before any adjustments thereto were made by the respondent for the years 1937 and 1938, was as follows:
| 1937 | 1938 | |
| Petitioner | $843,225.72 | $133,190.42 |
| New York company | (60,037.16) | (15,309.73) |
| California company | (22,339.00) | (27,463.62) |
*733 *220 The officers of the New York company for the year 1937 were as follows:
Frank B. Thompson, president.
Raymond E. Deateale, vice president.
Joyce F. Oliver, secretary.
Joseph A. Engelhard, treasurer.
G. W. Duncan, asst. secretary-treasurer.John F. Shea, asst. secretary.
Oliver and Shea were permanently located in New York City.
For the year 1938 the officers of the New York company were the same, with the exception that Irving Bernstein had succeeded Shea as assistant secretary. Bernstein was permanently located in New York. On January 8, 1938, Oliver resigned as secretary, and Bernstein succeeded to this position.
The entire officers' salaries of the New York company for the year 1937, in the amount of $6,750, were paid to Oliver. For the year 1938, the officers' salaries of the New York company, in the amount of $4,454.12, were paid to Oliver to the extent of $3,791.62 and to Bernstein to the extent of $662.50.
For the year 1937 the officers of the California company were as follows:
Frank B. Thompson, president.
Raymond E. Deateale, vice president.
Joseph A. Engelhard, treasurer.
R. C. Day, secretary.G. W. Duncan, asst. *734 secretary-treasurer.
Donald Browne, asst. secretary.
Day and Browne were permanently located in California.
For the year 1938 the only change in the officers was that on April 5, 1938, when Larmar Marshall succeeded Day as secretary.
The entire officers' salaries of the California company for the year 1937, in the amount of $5,616.66, were paid to Day. Officers' salaries of the California company for the year 1938, in the amount of $4,298.67, were paid to Day to the extent of $2,016.67 and to Marshall to the extent of $2,282.
Petitioner followed the practice of selling to its subsidiaries their supplies of liquor at slightly above cost but below market.
During the year 1937 petitioner expended for national magazine advertising the sum of $177,982.56. This cost covered advertisements run in national magazines such as Life, Colliers, Time, and the New During the year 1938 petitioner expended the sum of $242,890.70 for similar national magazine advertising. Attached to the stipulation and made a part thereof and marked "Exhibit A" is a series of advertisements that appeared in national magazines which are in all essential respects similar to all of the advertisements*735 placed in the national magazines. No reference whatever was made in these *221 advertisements to either the New York company or the California company.
During the year 1937 the New York company spent for advertising the sum of $62,469.57 and during 1938, up until the time of its dissolution on October 1, 1938, the New York company spent for advertising the sum of $8,836,88. During the year 1937 the California company spent for advertising the sum of $71,931.24 and during 1938, up until the time of its dissolution on September 1, 1938, the California company spent for advertising the sum of $18,127.91. The advertising expense of the subsidiaries covered newspapers, displays, outdoor, and direct mail advertising in their respective territories.
In the determination of the deficiencies for the years 1937 and 1938 the respondent made an allocation of the national magazine advertising expense of the petitioner on the same percentage basis upon which he made an allocation of the executive expenses; that is, for the year 1937 the respondent allocated the national magazine advertising of the petitioner in the amount of $177,982.56 to the respective companies as follows:
| Petitioner, 90.28% | $160,682.66 |
| California company, 5.66% | 10,073.81 |
| New York company, 4.06% | 7,226.09 |
| Total | 177,982.56 |
*736 The respondent disallowed as a deduction to petitioner for the year 1937 the sum of $17,299.90 representing the amount of the advertising expenses which he allocated to the New York company and the California company as set forth in the preceding paragraph.
For the year 1938 the respondent allocated the national magazine advertising of the petitioner in the amount of $242,890.70 to the respective companies as follows:
| Petitioner, 93,884% | $228,035.50 |
| California company, 3.035% | 7,371.74 |
| New York company, 3.081% | 7,483.46 |
| Total | 242,890.70 |
The respondent disallowed as a deduction to petitioner the sum of $14,855.20 representing the amount of the national magazine advertising which he allocated to the New York company and to the California company as set forth in the preceding paragraph.
During the years 1937 and 1938, the petitioner, in addition to its two subsidiaries, had approximately 300 wholesale dealer representatives throughout the United States, none of which were in any way owned by the petitioner and none of which were located in the territory of the California company nor the New York company.
On August 30, 1938, the board of directors of petitioner*737 held a special meeting and adopted resolutions to dissolve the New York and *222 California companies. The minutes of the meeting, in so far as they pertain to the New York company, are as follows:
At a special meeting of the Board of Directors of Glenmore Distilleries Company, held on the 30th day of August, 1938, * * * it was resolved that Glenmore Distilleries Co. of New York, Inc., a wholly owned subsidiary of said Company, surrender its Charter to the State of New York, and that it cease to be and exist as a corporation, and that it be dissolved in accordance with the laws of the State of New York, and that Glenmore Distilleries Company, the sole stockholder, surrender its stock in the said New York Company to said Company for cancellation in exchange for the assets of said New York Company and that it assume the liabilities of said New York Company, and that Frank B. Thompson, President of Glenmore Distilleries Company, be and is hereby authorized to vote the stock of said Company held by it in the New York Company at a special meeting of the stockholders of the New York Company to be held August 31, 1938, and that said stock be voted by said Frank B. Thompson, President, *738 in such manner as to effect the dissolution of said New York Company in accordance with the laws of the State of New York, * * *
From the time when the New York company was organized and up to the time when the New York company was dissolved as of October 1, 1938, the transactions between petitioner and the New York company were recorded by petitioner in a running account on its books. When merchandise was shipped to the New York company and when expenses of the New York company were paid by petitioner, proper debits against the subsidiary were entered in the running account. As collections were made by the New York company they were transferred to petitioner at Louisville and the running account was properly credited.
Immediately prior to the liquidation of the New York company its books of account showed as an account payable in favor of petitioner an amount of $131,457.72 and the books of account of petitioner showed as an account receivable from the New York company the same amount. Exclusive of the foregoing item, the New York company had other liabilities to various creditors immediately prior to dissolution amounting to the sum of $4,935.01.
Immediately prior to dissolution*739 the New York company had assets which were carried on its books at a net figure of $55,137.53. In the liquidation of the New York company petitioner assumed the liabilities of the New York company and took over the above mentioned assets in the amount of $55,137.53. The following computation shows the amount now claimed by petitioner as a deduction for the year 1938:
| Debit balance in account of New York company on books of petitioner immediately prior to dissolution of New York company, exclusive of capital stock listed at $1,000 | $131,457.72 | |
| Indebtedness of New York company assumed by petitioner | 4,935.01 | |
| 136,392.73 | ||
| Value of assets taken over as listed above | $55,137.53 | |
| Add: Value of credit for refund covering New York franchise tax | 444.64 | |
| 55,582.17 | ||
| Amount claimed by petitioner as bad debt | 80,810.56 |
*223 The item of $444.64 listed above represents prepaid New York franchise taxes which were refunded after the New York company had been dissolved, which refund was paid by the State of New York to petitioner.
No bad debt deduction with respect to the said amount of $80,810.56 was taken on the return of the petitioner for the year*740 1938.
At all times the petitioner considered the balance in the account with the New York company as an account receivable and it so handled the account on its books. Petitioner at all times expected to receive payment. The determination to dissolve the New York company and the determination that the debt was worthless were made by the petitioner during the year 1938. The unpaid indebtedness of the New York company to petitioner was ascertained to be worthless and charged off the books of petitioner on October 1, 1938.
The capital investment of petitioner in the New York company in the amount of $1,000 and the capital investment of petitioner in the California company in the amount of $1,000 were carried on the books of petitioner in an investment account separate and apart from the running accounts in which were recorded the general transactions between the petitioner and its subsidiaries.
Petitioner's investment in the shares of stock of the New York corporation became worthless in the year 1938.
Any part of the stipulation of facts, including the exhibits thereto, not specifically set forth herein is incorporated herein by reference and made a part of these findings*741 of fact.
OPINION.
BLACK: At the time of the hearing in these proceedings the petitioner waived assignment of error (d) in the petition for the year 1937, pertaining to social security tax, and also waived assignments of error (c) and (d) in the petition for the year 1938, pertaining to a fire loss and involuntary conversion, respectively. In addition to the foregoing assignments of error disposed of by waiver, assignment of error (c) in the petition for the year 1937 is eliminated by virtue of paragraph 44 of the stipulation filed by the parties, wherein it is provided that for the year 1937 the petitioner is entitled to a deduction of $2,318.56, due to additional income taxes paid by the petitioner to the State of Kentucky. This leaves the following questions still in controversy:
*224 1. In the light of the facts in this case, did the respondent have any right to allocate to the two subsidiaries of the petitioner a portion of the so-called executive expenses incurred by the petitioner, and thus deny to the petitioner a deduction for the amount of such expenses allocated to the subsidiaries? This point is involved in each of the years 1937 and 1938.
2. In the*742 light of the facts in this case, did the respondent have any right to allocate to the two subsidiaries of the petitioner a portion of the national magazine advertising expense incurred by the petitioner, and thus deny to the petitioner a deduction for the amount of such expenses allocated to the subsidiaries? This point is involved in each of the years 1937 and 1938.
3. Is the petitioner entitled to a bad debt deduction for the year 1938 in the amount of $80,810.56, ascertained to be worthless and charged off at the time of the liquidation of the New York subsidiary on October 1, 1938?
4. Did the investment of the petitioner in the capital stock of the New York subsidiary in the amount of $1,000 become worthless in the year 1938, so that this amount is a proper deduction from income for that year?
We shall consider together questions (1) and (2).
The respondent has determined, under section 45 of the Revenue Acts of 1936 and 1938, that a part of petitioner's executive and advertising expenses should be allocated to its two subsidiaries, the New York and California companies, respectively. Section 45 is identical in both acts and is in the margin. 1 The respondent contends*743 that, since he has exercised the discretionary power vested in him, petitioner has the burden of showing that such determination was purely arbitrary and not made under any of the situations prescribed by the statute as a proper foundation for allocation of the expenses in question, citing in support thereof ; ; affd., ; certiorari denied, ; and .
*744 We think petitioner has met its burden with the exception hereinafter noted. The evidence introduced by petitioner shows that each company kept accurate records of its own expenses and that all of petitioner's expenses, with the exception of compensation paid one of the officers and three of the office employees and the accounting expense *225 of auditing the books of the New York company, were for petitioner's own exclusive benefit. The excepted expenses are as follows:
| 1937 | 1938 | |
| G. W. Duncan, asst. secretary-treasurer | $6,000.00 | $5,475.00 |
| Margaret Graf, inventory clerk | 1,014.00 | 1,040.40 |
| W. D. Sproul, accountant | 2,952.00 | 2,956.54 |
| Clinton Wroe, multigrapher | 1,206.33 | 1,285.52 |
| Accounting (Wolf & Co.) | 917.66 | 3,180.69 |
| Total | 12,089.99 | 13,938.15 |
These expenses are a part of the total executive expenses set out in our findings for 1937 and 1938 of $193,895.48 and $174,846.85, respectively. Duncan testified that he obtained the licenses for the two subsidiaries and advised them on their accounting, invoicing, and credit memoranda; that Margaret Graf kept a perpetual inventory of the New York and California warehouse, which took about two*745 days a month of her time; that Sproul spent about two-thirds of his time keeping the books of the two subsidiary companies; that Wroe now and then printed some stationery forms for them, but spent very little time in doing so; and that a part of the compensation paid Wolf & Co. was for auditing the books of the New York company.
The advertising expenses deducted by petitioner in its returns for 1937 and 1938 of $177,982.56 and $242,890.70, respectively, were for advertisements appearing in national magazines such as Life, Colliers, Time, and the New Yorker. No reference whatever was made in these advertisements to either the New York or California companies. Each subsidiary spent large sums for its own advertising. Petitioner, in addition to its two subsidiaries, had approximately 300 wholesale dealer representatives throughout the United States, none of which were in any way owned by the petitioner and none of which were located in the territory of the two subsidiaries.
Upon the evidence which we have in these proceedings we see no justification in the respondent's determination that petitioner's total executive and advertising expenses should be apportioned among the three*746 companies upon the basis which he has used. Each corporation kept its own set of books, in which were recorded the business transactions of each company, and each company filed its own income tax returns. The executive and advertising expenses which the respondent has determined should be apportioned among the three companies in the proportion that the gross sales of each company bear to the total gross sales of all three companies were all the exclusive expenses of the petitioner, with the exception of some overlapping contained in the above amounts of $12,089.99 and $13,938.15 so-called executive expenses for the years 1937 and 1938, respectively. For the year 1937 this overlapping was more than taken care of by the flat charge *226 petitioner made against the two subsidiaries of $12,000, which amount petitioner included in its own gross income and it has not been questioned by the respondent. Petitioner made no similar charge for the year 1938. We think that it should have done so by allocating some reasonable amount for that purpose. The respondent has determined that the amount of these executive expenses which should be allocated to the subsidiaries for 1938 is $10,693.64. *747 Inasmuch as the business of both subsidiaries decreased in 1938 and both were dissolved before the end of that year, we think that the amount of executive expenses which the respondent has allocated to the subsidiaries is excessive. We hold that $5,000 of these expenses should be allocated to the subsidiaries, of which $2,500 should be allocated to the California company and $2,500 to the New York company.
To summarize our holding on questions 1 and 2, it is this: None of petitioner's advertising expenses should be allocated to the subsidiaries, because this advertising expenses was exclusively for petitioner's brands of liquor and there is no reason why the subsidiaries should bear any part of this expense. They had their own large advertising expenses which properly appeared on their own books. The action of the respondent in making such an allocation was without justification. As to petitioner's executive expenses, some of these were actually incurred for the benefit of the subsidiaries. We hold that the $12,000 of these expenses which petitioner allocated to the subsidiaries in 1937 was ample to take care of the subsidiaries' share of these expenses and that the allocation*748 by the respondent of a greater amount was without justification. We further hold that $5,000 of these expenses should have been allocated by the petitioner to the subsidiaries for 1938 and that anything above that amount is excessive. Of the amount which the respondent has allocated for 1938, $5,000 is approved and the remainder is not sustained.
We shall now consider together questions (3) and (4). Under these issues petitioner contends that in 1938, when it dissolved the New York company and took over its net assets in part payment of the debt of $131,457.72 owed by the New York company to petitioner, the unpaid portion of the debt in the amount of $80,810.56 and petitioner's investment of $1,000 in the capital stock of the New York company all became worthless; that, since petitioner ascertained the unpaid portion of the debt to be worthless and had charged it off during the taxable year 1938, it is entitled to a deduction therefor under section 23(k) of the Revenue Act of 1938; and that it is also entitled to a deduction under section 23(f) of $1,000 for the worthless stock. We agree with these contentions. *749 ; . Cf. .
*227 The respondent contends that the claimed deductions are not allowable under section 112(b)(6) of the Revenue Act of 1938, the material provisions of which are as follows:
(6) PROPERTY RECEIVED BY CORPORATION ON COMPLETE LIQUIDATION OF ANOTHER. - No gain or loss shall be recognized upon the receipt by a corporation of property distributed in complete liquidation of another corporation. For the purposes of this paragraph a distribution shall be considered to be in complete liquidation only if -
* * *
(C) the distribution is by such other corporation in complete cancellation or redemption of all its stock * * *.
The respondent refers to the minutes of the special meeting of the petitioner's board of directors held on August 30, 1938, and contends that petitioner has submitted no proof that it did not surrender its stock in the New York company "for cancellation in exchange for the assets of said New York Company" as provided in those minutes. Those minutes recite, among*750 other things, that petitioner
* * * Glenmore Distilleries Company, the sole stockholder, surrender its stock in the said New York Company to said Company for cancellation in exchange for the assets of said New York Company, and that it assume the liabilities of said New York Company, * * * [Italics ours.]
The New York company at that time owed the petitioner $131,457.72, which was the balance due on a running account, and owed other outside debts of $4,935.01. The records of petitioner show that the net assets of the New York company were taken over by petitioner and used to pay the debts which the New York company owed to outsiders and the balance was applied in part payment for the debt the New York company owed petitioner. After this was done the New York company owned no assets which it could distribute in liquidation. Petitioner received no property from the New York company as a stockholder, and section 112(b)(6) was not intended to cover the transfer of assets to a creditor.
The respondent also contends that petitioner's investment in the capital stock of the New York company should be considered at not less than*751 $41,000 instead of $1,000, on the ground that, since the inventory of the New York company was never less than $40,000, it would be unreasonable to assume that the value of such inventory should be considered as an account receivable due by the New York company to petitioner. We see no merit in this contention. The parties have stipulated that at the time the New York company was organized all of its capital stock "was subscribed for by petitioner by the payment of cash of $1,000.00." There is no evidence that petitioner ever intended to pay in any more capital than the original $1,000. The running account with the New York company was bona *228 fide and was kept in the same manner as petitioner kept its other accounts receivable, and petitioner fully intended that the account would be paid in full.
We, therefore, upon the authorities cited above, decide questions (3) and (4) for the petitioner.
Decisions will be entered under Rule 50.
Footnotes
1. SEC. 45. ALLOCATION OF INCOME AND DEDUCTIONS.
In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Commissioner is authorized to distribute, apportion, or allocate gross income or deductions between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses. ↩