*252 Decisions will be entered under Rule 50.
Held, the transfer of certain rental property to Spencer Land Company by petitioner was a bona fide transaction consummated for business purposes and respondent erred in including income thereafter derived from such property within the community income of petitioner and his wife. Held, further, the sales of royalty interests in oil and gas wells located on petitioner's property to Spencer Land Company and Neches Contracting Company were bona fide transactions which were consummated to and did in fact furnish the corporations with needed operating capital, and respondent erred in including such royalty income within the separate income of petitioner.
*727 The Commissioner determined deficiencies in the income tax of petitioners in the following years and amounts:
| 1946 | 1947 | |
| John Junker Spencer | $ 22,411.76 | $ 25,000.26 |
| Nita Murry Spencer | 574.46 | 2,838.53 |
The petitioners in both dockets assign as error the respondent's inclusion of certain rental and interest income received and reported by the Spencer Land Company within their taxable community income. John Junker Spencer, the petitioner in docket No. 32267, also assigns as error the inclusion of certain oil and gas royalties received and reported by the Neches Contracting Company and the Spencer Land Company into his separate taxable income. Additional adjustments made by respondent in determining the respective deficiencies in both dockets, Nos. 32267 and 32268, are not herein contested.
FINDINGS OF FACT.
The petitioners, John Junker Spencer and Nita Murry Spencer, are individuals who, during 1946 and 1947, the years*254 here involved, were husband and wife residing in Beaumont, Texas. Each filed separate income tax returns on a community property basis for the taxable years with the collector of internal revenue for the first district of Texas at Austin. For convenience John Junker Spencer is hereinafter referred to as petitioner.
*728 Prior to 1942, petitioner was engaged in the management of properties which he had inherited from relatives. Such properties consisted of rental property in Beaumont, Texas, and extensive farm lands. In 1942, petitioner enlisted in the United States Coast Guard. He was separated therefrom in October 1945. During his absence while in the service, petitioner's properties were managed by his wife.
Upon his return from the Armed Forces, petitioner resumed his former activities. He also became more active in business, engaging at first in a grading business and construction work in connection with the remodeling and repairing of certain of his inherited properties. Petitioner desired to engage further in construction and other contracting business. He also wanted to continue the business of owning and managing realty, in addition to partaking of other real*255 estate activities. In both fields of endeavor, petitioner wished to be in a position possibly to give or sell an interest to his or other managerial personnel in order to stimulate their interest therein. He did not find a sole proprietorship or a partnership attractive as a means of doing business inasmuch as he felt that the corporate form would make for more efficient operations. He had also recently known of a substantial tort liability incurred with respect to the operation of the construction business. For this reason, among others, petitioner desired to cast his own construction and property management operations in such forms as would avoid and protect his investments from the personal liabilities that might otherwise be incurred by reason thereof.
On March 18, 1946, petitioner organized the Neches Contracting Company (hereinafter called Neches) under the laws of the State of Texas. The corporate purposes thereof are set forth in its charter, as follows:
The purpose for which it is formed is to contract for the erection, construction, or repair of any building, structure or improvement, public or private, and erect, construct or repair same or any part thereof, and to*256 acquire, own, prepare for use any materials for said purposes, as authorized by Subdivision 46 of Article 1302 of the Texas Revised Civil Statutes of 1925.
On the same date, March 18, 1946, petitioner also organized the Spencer Land Company (hereinafter called Land), the corporate purposes of which are set forth in the charter thereof, as follows:
The purpose for which it is formed is to erect or repair any building or improvement, and to accumulate and lend money for said purposes, and to purchase, sell and subdivide real property in towns, cities and villages and their suburbs not extending more than two miles beyond their limits and to accumulate and lend money for that purpose, as authorized by subdivision 47 of Article 1302 of the Texas Revised Civil Statutes of 1925.
*729 Petitioner beneficially owned all of the stock of both corporations which were each capitalized at $ 1,000. He was also president of both. Both corporations set up and maintained separate books of account, which were audited annually by an independent certified public accountant. Both had a minute book, a corporate seal, and a stock certificate book. Each corporation had its separate office, its own*257 telephone, and its own stationery. During 1946, Neches had an average of 12 employees and during 1947 had an average of 35 employees. It had a general manager who did buying and selling, hiring and discharging of employees, and who drew checks on its bank account. Neches also employed a construction superintendent who purchased materials, hired and discharged employees, and who was also authorized to draw checks on its bank account. Land had one salaried employee.
Each corporation has borrowed substantial amounts from various banks and has repaid such borrowings. Neither has ever made any loans to petitioner nor paid any of his personal expenses.
Neches has engaged in the usual business activities of corporations in the contracting business, such as the preparation of estimates and bids on construction jobs, the preparation of construction contracts, plans and specifications, advertising, and receiving and paying invoices. It also had a franchise for and sold the "Cox" fence during the taxable years.
Neches began construction of two homes in 1946 and 12 homes in 1947. One house was completed in 1946 and 10 were completed in 1947. Seven construction contracts were completed*258 in 1946 and 1947. Neches had substantial advertising expense in connection with selling houses, soliciting fence and grading business and general advertising. It also has furnished its general manager with a country club membership in order that he might make contacts that would prove beneficial to its business.
Upon the organization of Neches, petitioner transferred to it on April 24, 1946, ownership of certain construction equipment theretofore owned by him. The 1946 tax returns of petitioner and his wife each reflected the transaction, as follows:
| Description of property | Date acquired | Date sold | Sales price |
| 1/2 interest in tractor, | |||
| jeep, etc | Jan. 1, 1946 | Apr. 24, 1946 | $ 1,655.03 |
| Depreciation | Short term | ||
| Description of property | Unadjusted | sustained | gain realized |
| basis | |||
| 1/2 interest in tractor, | |||
| jeep, etc | $ 1,655.03 | $ 114.91 | $ 114.91 |
The insurance company carrying the insurance on the equipment thus sold was notified at the time of the sale as to the change in ownership, *730 and the insurance policy was changed accordingly. Although petitioner received a note from the corporation in payment for the construction equipment, no *259 payments of principal or interest were made thereon during the years 1946 and 1947. From time to time during the years here in question, Neches purchased equipment for its corporate purposes, such as tractors, trucks, shop equipment, saws, planers and similar items. It has also purchased real estate for construction activities from persons other than petitioner.
Shortly following the organization of Neches, petitioner also transferred to it royalty interests in certain oil and gas wells at the value placed thereon by a geologist. Later, royalty interests in other wells brought in on petitioner's lands were so transferred to Neches as production was reached thereon. Royalty interests thus sold by petitioner to Neches in 1946 and 1947 were as follows:
| Date | Date | Selling | |
| Well | completed | sold | price |
| 3-A | 1945 | Apr. 24, 1946 | |
| 5-A | 1945 | Apr. 24, 1946 | |
| $ 92,062.31 | |||
| 6-A | 1945 | Apr. 24, 1946 | |
| 7-A | 1945 | Apr. 24, 1946 | |
| 10-A | Apr. 24, 1946 | May 10, 1946 | 23,787.00 |
| 11-A | May 20, 1946 | May 28, 1946 | 9,727.00 |
| 14-A | Apr. 22, 1947 | May 6, 1947 | 24,098.80 |
Petitioner's bases in the above properties were zero. In each instance there was a deed in regular form, a note for the balance *260 of the purchase price due, and a deed of trust upon the property sold to give the seller security. Although the notes provided for the payment of 3 per cent interest, no interest was paid or accrued by Neches during 1946 and 1947.
The financial statement of Neches for 1946 shows the following:
| Income: | |
| Grading | $ 4,733.79 |
| Fence erection | 2,741.99 |
| Construction | 2,370.40 |
| Oil royalty | 44,654.95 |
| Total income | $ 54,501.13 |
| Net departmental profits or losses: | |
| Grading and fence departments | ($ 1,991.48) |
| Construction department | (1,329.26) |
| Oil and gas royalty | 3,546.13 |
| Total | $ 225.39 |
| General and administrative expense: | |
| Total | 1,402.27 |
| Net loss | ($ 1,176.88) |
*731 The 1947 financial statement of Neches shows the following:
| Income: | |
| Grading | $ 5,669.43 |
| Fence erection | 53,691.03 |
| Construction | 8,655.66 |
| Oil and gas royalty | 36,885.08 |
| Total income | $ 104,901.20 |
| Net departmental profits or losses: | |
| Grading and fence departments | $ 7,094.00 |
| Construction department | (986.59) |
| Oil and gas royalty | 9,540.20 |
| Total | $ 15,647.61 |
| General and administrative expenses: | |
| Total | 2,903.00 |
| Net profit | $ 12,744.61 |
*261 Neches paid a franchise tax to the State of Texas in 1946 and 1947. It paid the ad valorem tax to the appropriate authorities on all properties in its name. It also filed the usual reports to the various Federal authorities, such as Federal old age benefit contributions, withholding tax, income tax, etc. Neches filed its income tax returns for the taxable years in controversy with the collector of internal revenue for the first district of Texas.
Upon the organization of Land, petitioner transferred thereto the ownership of certain rental property. The realty in Beaumont, Texas, thus sold to Land on April 24, 1946, and the consideration involved were as follows:
| Land and brick building at 556 Pearl Street | $ 35,717.01 |
| Land and brick building at 447 Main and 395 Trevis, 260 and 288 | |
| Pine Street (All one building) | 31,389.26 |
| Land and brick building at 33 Trevis Street | 7,957.45 |
| Land and two houses 1188 Orleans Street and 458 Franklin Street | 25,135.91 |
| One-half interest in 270 acres in Charles Williams League -- | |
| purchase price | 21,328.00 |
| Total consideration | $ 121,527.63 |
The foregoing consideration was the book value of the properties, i. e., the fair market value*262 thereof in 1934 and 1935, less depreciation to the time of sale. For such sale there was a deed, a note in payment of the consideration, and a deed of trust as security for the note. Although the deed recited payment of $ 10 of the consideration involved and the note so given called for payment of 3 per cent interest, no payment of principal or interest was made thereon by Land during 1946 and 1947. At the time of the transfer of title to Land the tenants and the insuring agents were notified of the change by letters from Land.
*732 Aside from the property acquired from petitioner, Land purchased four lots on Gulf Street, two lots on Briarcliff, two building sites in Averill Addition, one in Englewood Addition, and several others, all of which were in Beaumont, Texas. It also sold the house located at 3385 McFaddin Street.
Land entered into various rental or lease agreements for its real estate during the taxable years. These leases were with several lessors and for varying sums of money. All leases and contracts made by Land were in the name of that corporation. During the two years in question, Land spent approximately $ 3,500 in improving, repairing and maintaining *263 its property. The contracts therefor were made with various contracting agencies in Beaumont. It invested $ 5,000 in the stock of a real estate company, the purpose of which was to purchase a tract of land within the city of Beaumont, have utilities installed, and then sell off as residential sites. This purpose was accomplished and a profit realized by Land.
As he did in the case of Neches, petitioner, shortly following the organization of Land, transferred to it the royalty interests in certain oil and gas wells at the value placed thereon by a geologist. Additional interests were later also transferred to Land as other wells were brought in and production reached on petitioner's lands. In 1946 and 1947 royalty interests in oil and gas wells were thus sold by petitioner to Land, as follows:
| Date | Date | Selling | |
| Well | completed | sold | price |
| 1-A | 1945 | Apr. 24, 1946 | |
| 8-A | 1945 | Apr. 24, 1946 | $ 64,044 |
| 9-A | Mar. 26, 1945 | Apr. 24, 1946 | |
| 12-A | Sept. 3, 1946 | Oct. 31, 1946 | 27,901 |
| 13-A | Jan. 6, 1947 | Feb. 5, 1947 | 3,154 |
In each instance there was a formal deed, a note for the balance of the purchase price due, and a deed of trust upon the property sold to secure such*264 payment. Although the notes called for payment of 3 per cent interest, no interest thereon was, in fact, paid by Land during 1946 and 1947.
Land's financial statement for the year 1946 shows, inter alia, the following:
| Income: | |
| Rent income | $ 12,468.06 |
| Oil and gas royalty | 11,787.51 |
| Gain on sale of theatre seats | 319.15 |
| Interest income | 1.02 |
| Total income | 24,575.74 |
| Expense: | |
| Rent property expenses | $ 8,379.21 |
| Oil and gas royalty expenses | 10,057.31 |
| Other expenses | 325.28 |
| Total expenses | 18,761.80 |
| Net profit | 5,813.94 |
*733 For 1947, Land's financial statement shows, inter alia, the following:
| Income: | |
| Rent income | $ 21,920.17 |
| Oil and gas royalties | 20,989.68 |
| Gain on sale of real estate | 361.56 |
| Interest income | 3.29 |
| Total | 43,274.70 |
| Expense: | |
| Rent property expenses | 10,395.76 |
| Oil and gas royalty expenses | 14,583.55 |
| Other expenses | 1,845.17 |
| Total | 26,824.48 |
| Net profit | 16,450.22 |
Land filed the required withholding and social security reports with the Federal Government, and unemployment compensation reports with the State of Texas. Its income tax returns for the*265 years 1946 and 1947 were filed with the collector of internal revenue for the first district of Texas.
Both Neches and Land were in existence at the time of the hearing and still owned all of the property above described as having been sold to each. Each is still actively engaged in business. At the time the aforementioned sales to each were effected, petitioner sought tax advice and was advised as to both the advantages and disadvantages inherent therein. The sales in 1946 of royalty interests to Neches and Land were reported in petitioner's 1946 tax returns, as follows:
| Payments | Long term | |||
| received | capital | |||
| Date of sales | Sales price | Cost | on sales | gain |
| in 1946 | realized | |||
| Apr. 24, 1946 | $ 156,106.13 | None | $ 3,000 | $ 3,000 |
| May 10, 1946 | 23,787.00 | None | 1,500 | 1,500 |
| May 28, 1946 | 9,727.00 | None | 1,500 | 1,500 |
| Sept. 25, 1946 | 27,901.40 | None | 1,500 | 1,500 |
| Total | 247,521.13 | $ 7,500 | $ 7,500 |
*734 Petitioner's 1947 return reflected the sales of royalty interests, as follows:
| Profits realized | |||
| Date of sales | Sales price | Cost | in prior |
| years | |||
| Apr. 24, 1946 | $ 156,106.13 | None | $ 3,000 |
| May 10, 1946 | 23,787.00 | None | 1,500 |
| May 28, 1946 | 9,727.00 | None | 1,500 |
| Sept. 25, 1946 | 27,901.00 | None | 1,500 |
| Feb. 5, 1947 | 3,154.80 | None | 1,500 |
| May 6, 1947 | 24,098.00 | None | 1,500 |
| Total |
| Payments | Long term | |
| Date of sales | received on | capital gain |
| sales in 1947 | realized | |
| Apr. 24, 1946 | $ 6,250 | $ 6,250 |
| May 10, 1946 | 1,250 | 1,250 |
| May 28, 1946 | 1,250 | 1,250 |
| Sept. 25, 1946 | 4,500 | 4,500 |
| Feb. 5, 1947 | 1,000 | 1,000 |
| May 6, 1947 | 1,750 | 1,750 |
| Total | $ 16,000 |
Each corporation received and reported on its income tax returns all of the income from the property purchased by each.
Sales by petitioner to the two corporations were valid, bona fide sales, motivated by adequate business purposes and in all respects legal and regular.
The sales of royalty interests in the oil and gas wells were primarily motivated by the desire to furnish both corporations with necessary operating capital.
OPINION.
The sole issue in these proceedings is whether the transfers of income-producing properties to Neches and Land are to be disregarded as being shams and the earnings thereof included within the separate and community incomes of petitioner and his wife, as determined by respondent.
The question thus presented is essentially one of fact and leaves little scope for legal interpretation. Petitioner organized two corporations in 1946 for the purpose of carrying on two*267 distinct businesses in which he was at that time engaging. Land was formed to take over and operate certain rental properties which had been inherited by petitioner and otherwise to engage in real estate activities generally. Neches was organized to carry on the contracting and construction business which shortly before had been started by petitioner. Upon Land's incorporation, petitioner transferred certain pieces of the inherited properties at the fair market value thereof determined in 1934 and 1935, less depreciation to the time of sale. Land made no payment of the principal or interest thereon during the taxable years. Shortly following the organization of both corporations, petitioner transferred to each the royalty interests in certain oil and gas wells. Thereafter as production was reached in other wells brought in on petitioner's property, the royalty interests therein were transferred to one or the other of the corporations.
*735 Respondent does not question the validity of either organization as being a separate taxable entity nor does he seek to base his actions upon the authority granted in section 45 of the Code. Rather, respondent maintains that the transfers*268 of income-producing properties to the corporations were not arm's length, bona fide transactions, i. e., were mere shams; that petitioner in substance remained in possession and control of the properties and the income therefrom; that there was no purpose in the transfers other than the tax savings that would result; and that, therefore, such transfers are to be disregarded for tax purposes and the income from the properties involved included within the incomes of petitioner and his wife as respectively determined under the provisions of section 22 (a), Internal Revenue Code. 1
*269 On the other hand, it is the position of petitioner and his wife that the controverted transfers were bona fide sales and that the method used in reporting their income was correct.
There is a well established principle in tax law that a taxpayer may legally and honorably take any steps approved by the law to arrange his affairs so as to minimize his tax liability. United States v. Isham, 17 Wall. 496">17 Wall. 496; Gregory v. Helvering, 293 U.S. 465">293 U.S. 465. The motive of tax avoidance for entering into a particular transaction has never been held a basis for liability unless the transaction itself first establishes such liability without it. Chisholm v. Commissioner, 79 F. 2d 14. That is to say, the transaction must actually accomplish in substance that which it purports to do in form. "It is axiomatic that the reach of the income tax law is not to be circumscribed by refinements of title. * * *" See Paul G. Greene, 7 T. C. 142. Mere passage of title to income-producing property unattended by a complementary shift of entire economic benefits of ownership, both direct*270 and indirect, will not suffice to relieve the transferor of liability for tax on the future income therefrom. Helvering v. Clifford, Jr., 309 U.S. 331">309 U.S. 331. The question ultimately to be answered in determining the reality of a transaction for tax purposes was succinctly stated by the Court of Appeals in the Chisholm case as:
* * * whether the transaction under scrutiny is in fact what it appears to be in form; a marriage may be a joke; a contract may be intended only to deceive others; an agreement may have a collateral defeasance. In such cases *736 the transaction as a whole is different from its appearance. True, it is always the intent that controls; and we need not for this occasion press the difference between intent and purpose. We may assume that purpose may be the touchstone, but the purpose which counts is one which defeats or contradicts the apparent transaction, not the purpose to escape taxation which the apparent, but not the whole, transaction would realize. * * *
When a taxpayer seeks to achieve a desired business or tax result, he has freedom of choice as to the form in which he will channel his business. Higgins v. Smith, 308 U.S. 473">308 U.S. 473.*271 If the taxpayer actually carries on business in the form so chosen, the Government may not deprive him of the benefits which flow therefrom unless such form be found to be but a fiction or a sham. Higgins v. Smith, supra;Rhode Island Hospital Trust Co., 7 T.C. 211">7 T. C. 211. Thus, when a corporate form for carrying on business is adopted and there follows an exercise of corporate powers and the doing of some business in the ordinary sense, regardless of quantum, the corporate identity constitutes a separate taxable entity and may not be disregarded. Moline Properties, Inc. v. Commissioner, 319 U.S. 436">319 U.S. 436. And the same is true whether there be one stockholder or many. For, as the Supreme Court said in National Carbide Corporation v. Commissioner, 336 U.S. 422">336 U.S. 422, 429:
Complete ownership of the corporation, and the control primarily dependent upon such ownership * * * are no longer of significance in determining taxability. * * *
Transactions between a corporation and its sole or majority stockholder are to be carefully scrutinized, Higgins v. Smith, supra;*272 Ingle Coal Corporation v. Commissioner, 174 F. 2d 569, lest what may appear in form have no reality in substance.
There can be no doubt that Land was conceived and organized for legitimate business reasons and that the transfer to it of the rental property in question was but a step in fulfilling the purpose for which it was primarily organized. After the acquisition of the property, Land became actively engaged in the exercise of its corporate powers in carrying on the business of managing and administering such property. The profits and losses derived from its operations were, in a very real sense, the profits and losses not of petitioner but of Land. We conclude from the evidence that such transfer was a bona fide transaction entered into for business purposes. Respondent does not contend otherwise. Indeed, any argument regarding the bona fides of the transaction under discussion is conspicuously absent from respondent's brief. Respondent erred in including such income within the community income of petitioner and his wife, and we so hold.
The sales of royalty interests in the oil and gas wells to Neches and Land present a somewhat different*273 picture. Neither corporation was authorized by its charter to own and operate oil properties and *737 in an appropriate action such transactions might have been tested as to whether they were ultra vires. Such, however, is not within our province here. The evidence shows that the sales were primarily motivated by the desire to furnish both corporations with necessary operating capital. This evidence stands uncontradicted and shows the presence of a legitimate business purpose. Moreover, the record indicates that the transactions were real, not shams, in that the income from the royalty interests so transferred appears to have been received by the corporations and utilized by them in furtherance of their corporate purposes. In fact, such income seems actually to have played an important role in maintaining the solvency and continued existence of Neches.
After careful consideration of all the evidence in the light of the principles above set out, we have concluded that such evidence fully supports petitioner's position that the sales of the royalty interests to Neches and Land were in fact realities and that the income therefrom was not the income of petitioner but of*274 the corporations receiving and using same. Respondent erred in determining otherwise, and we so hold.
Decisions will be entered under Rule 50.
Footnotes
1. SEC. 22. GROSS INCOME.
(a) General Definition. -- "Gross income" includes gains, profits, and income derived from salaries, wages, or compensation for personal service (including personal service as an officer or employee of a State, or any political subdivision thereof, or any agency or instrumentality of any one or more of the foregoing), of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. * * *↩