*878 Taxpayer is a New York corporation, with principal offices in California. In the taxable year 1936 and for several years previous thereto, the taxpayer had accumulated all net earnings. No dividends were declared to the stockholders. However, large loans were made from this accumulated surplus to the president of the corporation, who was also the principal stockholder. These loans were not primarily essential to the taxpayer's interests. Held, the taxpayer was availed of for the purpose of preventing the imposition of a surtax on its stockholders, and is therefore liable for the surtax imposed by section 102 of the Revenue Act of 1934.
*1266 This proceeding involves a deficiency in income tax liability of petitioner in the amount of $17,199.35 for the fiscal year ended July 31, 1936. The question presented is whether the petitioner was availed of for the purpose of preventing the imposition of surtax on its stockholders through the medium of permitting gains and profits, beyond the reasonable*879 needs of the business, to accumulate instead of being distributed, and is therefore liable for the surtax imposed by section 102 of the Revenue Act of 1934.
FINDINGS OF FACT.
The Wilkerson Daily Corporation, Ltd., the petitioner, is a corporation organized under the laws of the State of New York, maintaining its principal offices in Los Angeles, California, in which state it is *1267 authorized to do business. The corporation was incorporated in July 1930 under the name of Wilkerson Daily Corporation, but later changed its name to Wilkerson Daily Corporation, Ltd. In 1930 the corporation has an authorized capital stock of 100 shares, each of $100 par value. These were issued to the organizers in equal amounts, namely, 50 shares to Herbert H. Sonn and 50 shares to William R. Wilkerson.
The petitioner was organized for the purpose of engaging in the business of publishing daily and weekly trade journals for the motion picture, theatrical, radio, and related general amusement industries. "The Hollywood Reporter" is the petitioner's daily publication.
In October of 1930 15 shares of Sonn's stock were transferred to Sybil Stokes and about the same time Wilkerson and*880 Sonn each transferred 10 shares of their stock to Henry Massar. In December of the same year, when the corporation changed its name, new stock was issued as follows:
| Herbert Sonn | 25 shares |
| William R. Wilkerson | 40 shares |
| Henry Massar | 20 shares |
| Sybil Stokes | 15 shares |
On February 17, 1931, Massar endorsed his certificate for 20 shares to Wilkerson, who thereby became the owner of 60 shares. Some time thereafter Wilkerson purchased the 15 shares which stood in the name of Sybil Stokes from Daniel J. Winkler, who had previously purchased the stock from Sybil Stokes. On September 22, 1933, Wilkerson turned in the certificate he had purchased from Massar, and a new certificate for 20 shares was issued to Mary Wilkerson, the mother of William R. Wilkerson. Consideration therefor was paid by Mary Wilkerson out of her separate funds.
Differences of opinion arose between Wilkerson and Sonn concerning the petitioner's policies, which culminated in a civil action brought by Sonn against Wilkerson in New York State, in which action Sonn recovered a judgment for $2,206. Finally, in May 1935, Sonn and Wilkerson entered into a contract settling the amount due under*881 the judgment and providing for the sale by Sonn of his 25 shares of the petitioner's stock to Wilkerson for the sum of $25,000 in cash and the promissory note of the latter in the amount of $10,000.
On July 5, 1935, Wilkerson and his then wife, Edith, entered into a property settlement agreement providing for the payment of a stipulated amount to Edith in cash and the further amount of $100 or $150 weekly, dependent upon whether or not Edith remained in petitioner's employ. The agreement further provided that the stock of the petitioner corporation should remain in the name of William R. Wilkerson, and that he should retain all right and title incident thereto, but that 15 of the shares should be given in custody to the Bank of America *1268 National Trust & Savings Association of Los Angeles, California, to be held in trust for Edith Wilkerson's life, or until she remarried, or until they were sold, whichever event happened first. In the event of a sale, the proceeds were payable to her, and during the continuance of the trust she was entitled to the dividends or payments in lieu of dividends on the 15 shares. Thus, on July 31, 1936, William R. Wilkerson owned 80 shares*882 (15 of which were in custody of the bank) and his mother owned the remaining 20 shares.
From the time of its organization in 1930 and through the entire year ended July 31, 1936, the petitioner was engaged in the business of publishing a daily newspaper, which devoted itself exclusively to matters concerning the production and exhibition of motion pictures. However, the petitioner's plans also contemplated the publication of an elaborate annual motion picture production book, embracing a record of every motion picture produced in the world. Since this would require assembling information from the entire world, it would necessitate having correspondents abroad as well as in the United States. For its general business purposes and for this plan, the petitioner by 1936 had established offices in New York, Chicago, Boston, Hollywood, London, Paris, Rome, Berlin, Antwerp, and Budapest.
Petitioner's life has been a successful, though precarious, one. Prior to coming to California, Wilkerson, who was and is the publisher, editor, and active manager of the corporation, had been a half owner of a similar trade journal in New York called "Exhibitor's Daily Review." In 1930 he sold*883 his interest in that paper and came to Hollywood, hoping to build the petitioner into a valuable property. Many other weekly and daily journals had been in existence in Hollywood before Wilkerson started the Hollywood Reporter there. Experience showed that they would issue a few numbers and then go out of business for lack of funds. It was thought generally that the Hollywood Reporter would go likewise, but such was not the case. However, at times the studios, upon which the petitioner relied for its news, writing material, and a substantial part of its advertisements, refused to allow any of the petitioner's agents on their premises, with the result that the petitioner suffered from lack of material.
The petitioner's only source of revenue is from its subscriptions and advertisements. The former sell for $10 per year, but the cost of supplying these to the subscriber is $17 and, consequently, it can hope to make money only on its advertising. For this it depends upon the actors, writers, directors, and technicians, as well as the studios, and when it becomes known on a studio lot that the petitioner has been barred by a studio those who advertise in the paper frequently withdraw*884 their support because of their complete reliance on the studio for their livelihood. This severely hurts the petitioner's business and, *1269 since 1934, when the guilds were organized, has become an increasing menace.
Early in 1934, there was a period when the petitioner had outstanding and in effect advertising contracts with all the major motion picture production companies, totaling about $190,000. A misunderstanding arose between the studios and the petitioner over certain of its editorials, and as a result all of these contracts were canceled. During the year 1936 the taxpayer was intermittently barred from several studios; in 1931 there was a time when it was locked out of the studio lots and could get no news whatsoever. Because of that state of affairs and its weak financial position at the time, it gave notice to its employees on several occasions that it was going out of business. It was then that Wilkerson and Sonn each sold 10 shares of the petitioner's stock in order to raise money for the business.
An additional source of worry to the petitioner has been libel suits. In the year 1936 there were six of these suits pending, in which a total of $600,000*885 damages was demanded. The McFadden Publications sued for $500,000, Denver Dickson for $48,200, and Lucien Lamas for $150,000. This latter suit was finally settled out of court for $5,500. None of these contingent liabilities were accrued on petitioner's books. Then, in 1936, when Sinclair was running for Governor of the State of California, there was some serious talk of the motion picture industry moving to a site in New Jersey, and petitioner considered the advisability of moving its location.
Wilkerson purchased a beautiful home in Bel Air, at a cost of approximately $160,000, in which he entertained motion picture people of influence. Part of the money with which he purchased this home, to wit, the sum of $18,750, to date of July 31, 1936, was loaned to him by petitioner.
At the commencement of the fiscal year beginning August 1, 1935, Wilkerson was indebted to the petitioner in the amount of $23,903.89, and by July 31, 1936, he had increased his indebtedness to a total of $69,929.54. By March of 1938, however, Wilkerson had paid off all loans and interest, and the petitioner's account with him showed a credit balance in his favor.
Wilkerson agreed to pay a higher*886 rate of interest than could be obtained from any of the banks, which at that time had commenced paying extremely low interest rates. In addition he owned the famous Trocadero and Vendome restaurants, which he operated at rented locations. However, he did not sell or encumber them but retained them for their full unimpaired value.
Wilkerson's entry into the restaurant business was partially motivated by the desire to enable petitioner to do business on a social basis. He made his investment in the Vendome in 1931, when it was *1270 one of the better restaurants in Southern California, and under his ownership it became such a rendezvous for motion picture people that many of the available picture personages lunched there. Another motive for his entry into this business was to get a source for the news which he could print in petitioner's paper, for at the Vendome petitioner's reporters could mingle with the crowds and obtain news which otherwise would have been unattainable. Then, in 1934, when petitioner's contracts with the studios were canceled, Wilkerson thought that, if he could make an outstanding success of his restaurant and a night club as well, he would be able*887 to make an impression on the motion picture executives and convince them that he was capable of running a business outside of the paper, with the result that they might exert less pressure against him. Consequently, he opened the Trocadero that year, and it proved to be a success.
During the fiscal year of 1936 petitioner decided to purchase some property on Sunset Boulevard, but it was not thought advisable to negotiate the lease and build the building in the petitioner's name. Therefore, the Wilkerson Realty Corporation, all of whose stock was owned by Wilkerson, was organized for that purpose; but the Wilkerson Daily Corporation, Ltd., put up $18,000 of the $35,000 purchase price paid for the property. The plan was to build a building large enough to house other tenants. As a result of a conference with the Bank of America, it was planned to construct such a building at a total cost of about $105,000; bringing the total estimated cost of the property to $140,000, the bank agreeing to furnish $70,000. The petitioner tried to lease the excess space so that rents would help carry the cost of the building and defray some of the expenses, but it could lease only 60 percent of*888 the space available for rent to outsiders. Furthermore, at that time it could not get a contractor who would assume the risk of construction under bond. At the bank's suggestion, therefore, the plan was suspended, due to lack of capital, and the property was sold in the following year to one Feldman. Thereupon petitioner commenced looking around for other means for office space; but it was not until 1938 that the corporation finally purchased the front half of a building owned by the Daily Printers Ltd., all of the outstanding capital stock of which was owned by Wilkerson. The purchase price was $54,427.32 and was met by canceling an indebtedness of the Daily Printers Ltd. in the amount of $34,428.81 and paying over $19,999.51. There is no evidence establishing when or how the Daily Printers Ltd. incurred this debt to the petitioner.
This latter corporation, apparently controlled by Wilkerson alone, did all petitioner's printing. In April 1935 Wilkerson as chairman of the petitioner's board of directors, recommended that the rate of payment to the Daily Printers Ltd. be raised from $600 to $700 per week. *1271 A motion to this effect was duly made and carried. At*889 the same meeting Herbert Sonn, by proxy, proposed that suit be filed and an accounting be called for as to payments authorized by Wilkerson and made to the Daily Printers Ltd. since April 1932, together with an accounting of his dealings, financial and otherwise, with that corporation. This motion was not carried, however.
When Wilkerson commenced doing business in Hollywood, his salary was $10,400. He had turned down an offer for three times that amount to write a column for syndication, because he wanted to build up the corporation. Thereafter his salary increased as follows:
| Year ended | Salary received |
| 7/31/31 | $10,400.00 |
| 7/31/32 | 10,400.00 |
| 7/31/33 | 10,600.00 |
| 7/31/34 | $13,300.00 |
| 7/31/35 | 18,025.00 |
| 7/31/36 | 26,241.66 |
| 7/31/37 | $52,083.34 |
| 7/31/38 | 52,000.00 |
| 7/31/39 | 52,166.67 |
Petitioner used an accrual method of accounting, and when a subscription was received or an advertisement was printed the amount due was accrued on the books as income earned. On July 31, 1936, the petitioner's surplus account amounted to $109,850.47, but $68,173.72 of this was represented by uncollected accounts receivable. Experience had proved that only about 10 to*890 15 percent of the accounts receivable at any one time was uncollectible.
The net profit and annual surplus account of the petitioner reads as follows:
| Year ended | Net profit | Surplus |
| 7/31/31 | (loss) - $19,473.15 | (deficit) - $19,473.15 |
| 7/31/32 | 13,030.22 | (deficit) - 6,442.93 |
| 7/31/33 | 33,742.32 | 27,299.39 |
| 7/31/34 | 1,197.72 | 28,497.11 |
| 7/31/35 | 22,911.25 | 51,408.36 |
| 7/31/36 | $58,442.11 | $109,850.47 |
| 7/31/37 | 19,924.60 | 109,775.07 |
| 7/31/38 | 19,291.45 | 99,066.52 |
| 7/31/39 | 371.78 | 99,438.30 |
During the entire period beginning with the fiscal year ended July 31, 1931, up to and including the fiscal year ended July 31, 1936, the petitioner did not declare or pay any dividends.
During the period commencing with the date of organization and extending through the year ended July 31, 1939, the petitioner was either indebted to Wilkerson or Wilkerson to the petitioner in the following amounts:
| Year ended | Amount | |
| 7/31/31 | Petitioner owed Wilkerson | $2,153.14 |
| 7/31/32 | do | 5,993.59 |
| 7/31/33 | Wilkerson owed petitioner | 3,613.91 |
| 7/31/34 | do | 5,711.77 |
| 7/31/35 | do | 23,903.89 |
| 7/31/36 | do | 69,929.54 |
| 7/31/37 | do | 32,198.51 |
| 7/31/38 | Petitioner owed Wilkerson | 1,388.75 |
| 7/31/39 | Wilkerson owed Petitioner | 4,295.58 |
*891 *1272 As previously stated, however, by March 1938 Wilkerson had paid back all amounts and once more had a credit on the accounts of the corporation. To a large extent these repayments were effected by crediting his increased salary which he, as controller of petitioner's board, had voted to himself. In other words, when a salary became payable after July 1936 Wilkerson would often accept only a portion thereof, leaving the rest as a set-off against his account. The funds advanced by the petitioner to Wilkerson were used by him for three principal purposes - to enable Wilkerson to purchase the private residence mentioned above; to enable him to purchase for himself the stock of the petitioner from Sonn; and to pay various and sundry current personal bills.
The petitioner was availed of in the taxable year 1936 for the purpose of preventing the imposition of surtax on its shareholders through the medium of permitting gains and profits to accumulate instead of being distributed.
OPINION.
KERN: Petitioner here attacks respondent's determination of a surtax upon the taxpayer based upon section 102(a) of the Revenue Act of 1934 1 (48 Stat. 680, ch. 277). Respondent*892 does not claim that the taxpayer was formed for the purpose of preventing the imposition of a surtax on its shareholders, but merely that in the taxable fiscal year of 1936 it was availed of for that purpose.
In the instant proceeding respondent relies upon subsection (b) of section 102, supra, which provides:
(b) PRIMA FACIE EVIDENCE. - The fact that any corporation is a mere*893 holding or investment company, or that the gains or profits are permitted to accumulate beyond the reasonable needs of the business, shall be prima facie evidence of a purpose to avoid surtax.
It is an admitted fact in this proceeding that gains were permitted to accumulate during the taxable year; but that they were beyond the reasonable needs of the business is contested by the taxpayer. In support of his contention on this point respondent has cited several cases, among them . In *1273 that case, in finding against the taxpayer, the Court said: "That there was no need of accumulating any part of the year's earnings for the purpose of financing the business was shown by the balance sheet."
In the instant case a balance sheet would provide no basis for adjudging the necessity of a surplus. But the Court, in the National Grocery case, went on to say that no conceivable expansion could have utilized so large a surplus. It is possible, however, in the instant case, that the establishment of a New York daily and an annual could have completely exhausted the surplus, but these ideas were never carried*894 into effect and were, apparently, abandoned.
In , cited by the respondent, the court declared that "It is the accumulation of surplus plus its interdicted purpose that brings the statute into operation, and its size in relation to business needs is but a circumstance out of which a presumption of improper purpose arises, though such purpose may be shown by pertinent evidence with or without the presumption as an aid." This view has been accepted as correct by the Board and its application to the instant facts tests the validity of the respondent's contentions. The petitioner corporation certainly can not be judged by the same business standards as could a grocery store chain. What would clearly be an unreasonable surplus in the former case might be far from unreasonable in the latter. In , the Board, when confronted with this question, said: "The word 'reasonable' is a relative term. What would be reasonable in one situation or for one business might be clearly unreasonable in another."
Viewing the reasonableness of petitioner's surplus*895 in this light, and accepting as true the contention of Wilkerson, the sole witness introduced at the hearing, that petitioner's business was at best a gamble and one in which any year might bring unforeseen lack of patronage, we would then have to arrive at the conclusion that the surplus set up by the petitioner during the taxable year was not necessarily unreasonable. The purpose of accumulating the surplus was set forth by Wilkerson at the hearing and respondent introduced no witnesses to testify to the contrary.
Wilkerson testified that it was in order to avoid the effect of lockouts and to establish independent good will that he purchased the Bel Air property, where he might conduct business at the dinner table. His entry into the restaurant business, he testified, was also to enable petitioner to do business on a social basis. But, interestingly enough, the profits from the restaurants did not go to the petitioner, but to Wilkerson. It was his venture, not the petitioner's. Wilkerson testified also that he thought it would lend necessary prestige if petitioner *1274 could purchase an office building of its own, which would require a large amount of capital. And, *896 in addition to this, Wilkerson said that petitioner was also trying to garner a sufficient surplus to enable it to operate for a whole year without income in the event of disastrous boycotts. This, it was estimated, would require a reserve of at least $200,000. Further, Wilkerson said petitioner contemplated the organization of a New York corporation as a wholly owned subsidiary to publish a separate daily journal, and in 1935 passed resolutions authorizing the organization thereof. This was estimated to require an additional forty to sixty thousand dollars; and the further cost of the projected annual motion picture publication would be in the neighborhood of $60,000 per issue, according to Wilkerson.
Whether it be thought a prudent business venture to contemplate expansion or the doing of business on a large scale "front" is not for the Board to determine. It must be assumed that a business shall have the right to grow, ; and such growth is at the discretion of the corporation. However, in our instant case there appears no rational answer to the sudden abandonment of all the allegedly contemplated expansions. *897 Only one, the failure to build an office building, is satisfactorily explained. If petitioner actually intended the expansions set forth by Wilkerson, it is peculiar that it allowed its surplus on hand to be so diverted to the use of its sole stockholder that it could not make those expansions. Nor has it carried any of them into effect to date, except for the change in office address.
Respondent insists that further facts exist which controvert Wilkerson's statements as to the corporation's purposes and intentions. He points to the extensive borrowing of Wilkerson in the taxable year from the funds of the taxpayer. In the National Grocery Co. case, supra, the Court affirmed a principle laid down in ; affd., , to the effect that certain loans were incompatible with a purpose to strengthen the financial position of the petitioner and were entirely in accord with a desire to get the equivalent of the dividends under another guise. In the United Business Corporation case, supra, money was loaned to an individual who held all the capital stock except for three qualifying*898 shares. The Board there found as a matter of fact that the borrower was worth approximately three-quarters of a million dollars in addition to his interest in the corporation in the taxable year, and had the financial ability to meet his obligations to the corporation. He had the use of the corporation's funds in an amount greatly in excess of its surplus and made only *1275 a very small payment on account of interest. In the instant case, while the facts are not identical, they are, to say the least, related. The bulk of the loans to Wilkerson went for three main purposes - buying in the stock held by Sonn, financing the purchase of a private home, and paying current personal bills. Any benefit which accrued to the taxpayer from Wilkerson's uses of these funds seems in the main to be incidental. Certainly nothing was gained by the corporation by loaning money to Wilkerson to pay his personal debts. This was entirely beneficial to Wilkerson himself. Nor does the situation seem materially different in the case of the purchase of Sonn's stock. The acquisition of the stock gave an absolutely controlling hand to Wilkerson and at the same time quieted the voice of a man*899 who was hypercritical of Wilkerson's management and financial manipulations. Sonn was never a serious threat from the standpoint of disrupting the management of the corporation. He owned too small a block of stock. The minutes of the petitioner which have been put in evidence clearly indicate that Sonn's voice was most ineffectual. Consequently, it is difficult to see how the petitioner rather than Wilkerson himself received the benefit from the purchase of Sonn's stock. As for the third item - the funds used for the purchase of the residence - undoubtedly, as Wilkerson testified, it thereby became possible to establish valuable "over the table" contacts, which may ultimately have proved beneficial to the petitioner. But it seems a strain on a practical imagination to abide by Wilkerson's statement that the only reason for the purchase of the home was as a place for business contacts. The approximate cost of the residence was $160,000, which figure seems greatly out of proportion to the expected return on such an investment, if it can be thought to have been purchased solely as a business investment, inasmuch as the continued maintenance would run to an extremely high figure. *900 Also, there seem to have been other places in which to talk business "over the table." Wilkerson owned the Vendome and the Trocadero restaurants, which were admittedly patronized almost exclusively by the very people with whom petitioner sought to do business. The inescapable conclusion, in the eyes of the Board, is that the purchase of the residence was for the primary benefit of Wilkerson himself.
The amounts of the loans to Wilkerson are interestingly in proportion to his interest in the accumulated surplus in the years 1935 and 1936. In these years he had title to 80 percent of the outstanding stock (including the 15 shares held by the bank), and consequently, an interest in that proportion in any surplus which might be distributed in the form of dividends. The following shows the *1276 amount of loan, the surplus accumulated, and Wilkerson's contingent 80 percent interest in that surplus for the years 1935 and 1936:
| Year ended | Loan | Accumulation | 80% interest |
| 7/31/35 | $18,192.12 | $22,911.25 | $18,329.00 |
| 7/31/36 | 46,025.65 | 58,442.11 | 46,953.69 |
The close similarity between what Wilkerson borrowed and what he would have received as his share*901 of the dividends (subject, of course, to his wife's claim under their settlement agreement), while not determinative of the fact that it was Wilkerson's desire to get the equivalent of his dividends under another guise, certainly casts affirmative weight in that direction.
As respondent points out, Wilkerson actually held no bankable assets sufficient to entice a prudent disinterested corporation to make such large personal loans. If the petitioner was storing up a nest egg for future use in case of emergency, it stands to reason that it would require some form of security which could be readily liquidated. So far as the record indicates, the only security Wilkerson could offer was his interest in the two restaurants and in the private dwelling for the purchase of which he was borrowing. Wilkerson himself pointed out that the restaurants were indirectly beneficial to the business, and, consequently, it stands to reason that the corporation would be loath to see them sold. It is of no consequence that Wilkerson was willing to pay a higher rate of interest than the banks or other interested parties. In the United Business Corporation case, supra, the borrower guaranteed*902 to pay interest. As a matter of fact, he did not currently meet those interest payments. In the instant case the most convenient method of meeting interest payments on the loan would have been for Wilkerson to award himself a greater salary in the years subsequent to 1935. And this he did; whether for this purpose or because he calculated that he actually merited such increase. The evidence shows that by March 1938 Wilkerson had fully repaid the petitioner. The evidence, moreover, clearly shows that petitioner had declared dividends between July 31, 1936, and March 1938, sufficient to aid Wilkerson materially in offsetting the amounts he still owed on those dates. Added to this factor are the salary increases Wilkerson awarded himself, by means of which he paid off the balance. The entire picture, viwed in this light, indicates that the petitioner, at Wilkerson's direction, must have forthwith abandoned any alleged beneficial purpose for the accumulation of surplus. To conclude otherwise would necessitate overlooking a material inconsistency in petitioner's management.
Following the principle announced in United Business Corporation, National Grocery Co., and *903 , we find *1277 that the petitioner's loans to Wikerson did not constitute real investments by the former, and that the circumstances negative any real business purpose for the accumulation by petitioner of a surplus in the amount shown. After a careful consideration of the evidence adduced herein, we have concluded that respondent did not err in his determination that petitioner was subject to surtax under section 102 of the Revenue Act of 1934, set out above.
Reviewed by the Board.
Decision will be entered under Rule 50.
ARUNDELL, MURDOCK, BLACK, and LEECH dissent.
Footnotes
1. SEC. 102. SURTAX ON CORPORATIONS IMPROPERLY ACCUMULATING SURPLUS.
(a) IMPOSITION OF TAX. - There shall be levied, collected, and paid for each taxable year upon the adjusted net income of every corporation (other than a personal holding company as defined in section 351) if such corporation, however created or organized, is formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders or the shareholders of any other corporation, through the medium of permitting gains and profits to accumulate instead of being divided or distributed, a surtax equal to the sum of the following:
(1) 25 per centum of the amount of the adjusted net income not in excess of $100,000, plus
(2) 35 per centum of the amount of the adjusted net income in excess of $100,000. ↩