*755 1. Petitioner is a corporation which was engaged in the business of selling resort real estate. It owned certain recreational property, consisting, among other things, of a country club, a beach, a golf course, and a golf lodge. It transferred this property to a country club corporation in return for all of its corporate stock. In order to promote the sale of the residential property remaining in its hands, petitioner undertook to sell associate memberships in the country club at its own expense. Held, such expenses are deductible by petitioner as ordinary and necessary business expenses.
2. Petitioner was organized for the purpose of carrying on indirectly activities theretofore carried on directly by two individuals who were its only stockholders, each holding 50 percent of its stock, and who advanced certain sums to petitioner. During the taxable year petitioner purported to sell certain real estate to the individuals at a price fixed without regard to market value and paid for by a credit on the account of petitioner running to its two stockholders. The purpose of the sale was to establish a loss for tax purposes. Held, the purported sale was not in reality*756 such a transfer of ownership as to justify a loss deduction under the revenue act. Higgins v. Smith,308 U.S. 473">308 U.S. 473.
*1232 This proceeding involves deficiencies ditermined in petitioner's income and excess profits taxes for the fiscal years ended April 30, 1936 and 1937, in the following amounts:
| Year ended | Income tax | Excess profits tax |
| 4/30/36 | $1,971.60 | $710.70 |
| 4/30/37 | 23,749.29 | 378.73 |
The issue for the fiscal year ended April 30, 1936 (hereinafter referred to as the fiscal year 1936) is whether respondent erred in disallowing a deduction taken by petitioner in the amount of $16,721.10 representing commissions paid for the sale of associate memberships in the Rio Del Mar Country Club.
As to the fiscal year 1937, the issues are whether respondent erred in disallowing deductions claimed for losses sustained on the sale of land and an administrative building in the respective amounts of $70,897.62 and $18,192.17.
FINDINGS OF FACT.
Petitioner is a corporation organized*757 under the laws of the State of California. Petitioner keeps its books of account and files its *1233 income tax returns on a fiscal year basis, employing the accrual method of accounting. For the fiscal years ended April 30, 1936, and 1937, petitioner filed its income tax returns with the collector of internal revenue at San Francisco, California.
Shortly after its incorporation in 1935 and on or about May 2, 1935, the petitioner issued all its capital stock, consisting of 500 shares of common stock, to the Peninsula Properties Co., Ltd. (hereinafter referred to as Penproco), in exchange for certain realty in what is known as the Rio Del Mar development. This realty consisted of the recreational facilities of the development and contained, inter alia, a main clubhouse, a golf course, a golf lodge, and a private beach.
Sometime in May 1935 Penproco transferred all the stock of petitioner corporation equally to two individuals, L. G. Monroe and L. J. Miller, the consideration for the transfer being the offset of a credit to the individuals on Penproco's books in the amount of $182,188.06. It was pursuant to the plans of Miller and Monroe, hereinafter described, that*758 petitioner was organized and its stock transferred to them.
At the time of this transfer Monroe and Miller each owned one-third of all the outstanding stock of another California corporation known as Monroe & Miller, Ltd., the remaining third of whose stock was held by a bond house which had acquired it from Lyon, an individual formerly associated with the latter corporation until 1930 or 1931, when he disposed of his holdings. Until this latter date the corporation of Monroe & Miller, Ltd., had been known as "Monroe, Lyon and Miller, Inc."
Prior to May 1935 Penproco had issued all its capital stock to Monroe & Miller, Ltd., Belmont Country Club Properties, Inc., Los Altos Country Club, Inc., and about twelve individuals. The consideration for the issuance by Penproco of its stock to the three corporations was a transfer in each case of realty, the transfer from Monroe & Miller, Ltd., consisting of all the properties at Rio Del Mar. The consideration for the issuance of stock to the twelve individuals is not set forth in the record. Since Monroe & Miller, Ltd., owned all the stock of both the Belmont Country Club Properties, Inc., and Los Altos Country Club, Inc., the issue*759 of Penproco stock left that corporation under the control of Monroe & Miller, Ltd., inasmuch as the holding of the twelve indiduals was a small minority holding, and Monroe & Miller, Ltd., was, in turn, under the control of Miller and Monroe.
It was the intention of the parties that Penproco would subdivide and sell the greater part of the properties at Rio Del Mar with the exception of the properties constituting the recreational facilities of the development.
*1234 Prior to May 1935 the main clubhouse at Rio Del Mar, referred to above, had been operated as a hotel. It was built and operated by the Peninsula Properties Improvement Co. (hereinafter referred to as Impco), a corporation organized by Penproco, which latter corporation held all its capital stock and received the clubhouse upon a complete liquidation of Impco on May 1, 1935.
The recreational facilities acquired by petitioner from Penproco were transferred, in turn, by petitioner to the Rio Del Mar Country Club, Inc. (hereinafter referred to as Country Club, Inc.), a California corporation, in exchange for its capital stock. After this transfer and during the remainder of 1935 and during 1936, Country Club, *760 Inc., owned the main clubhouse, the beach, the golf lodge and course, and other recreational facilities. Country Club, Inc., was organized prior to this transfer and not solely for the purpose thereof. Its existence was part of a general corporate plan for the sale of subdivided lots to the public by first getting them to become members of the country club and thus acquainting them with the land for sale, which was adjacent to the recreational facilities.
Penproco was the selling corporation until the early part of 1935, when in May or June it entered into an agreement to dispose of most of its property to petitioner. Thereafter Penproco made no individual sale to the public. There existed an agreement between Penproco and petitioner that the cost to petitioner of the realty transferred from Penproco should be the basis in the hands of the transferor without regard to fair market value. The transactions were then recorded on the books of both corporations on this basis. Petitioner became the selling corporation and the one directly interested in the continued and successful existence of Country Club, Inc., as a means of introducing to prospective customers the properties held*761 for sale and as an inducement to them to locate at Rio Del Mar.
Country Club, Inc., had two types of membership - associate and founder. The associate membership, costing $9.90, entitled the associate member to no proprietary interest in the club. By virtue of such membership, the associate member was allowed to enter the club grounds and use any of the facilities upon the payment of stipulated fees, e.g., green fees were a prerequisite to use of the golf course, etc. The founder membership, costing $150, entitled the purchaser to one share of stock in Country Club, Inc., and to the use of the facilities without further payment except, of course, for food, beverages, and the like. By agreement between petitioner and Country Club, Inc., the founder memberships were to be sold by petitioner and, in addition, petitioner assumed the sale of the associate memberships, the petitioner bearing all sales expenses, commissions, and the like. Country *1235 Club, Inc., received from petitioner $9.90 for each associate membership sold and $30 for every founder membership sold, petitioner retaining the balance. It is not evident from the record whether any founder memberships had*762 been sold prior to the transfer of the property by petitioner to Country Club, Inc., in exchange for the latter's stock.
During the fiscal year ended April 30, 1936, petitioner employed a broker named Roth to sell associate memberships. Roth, in turn, employed salesmen for this purpose. Since petitioner considered membership in the club its best sales approach, it voluntarily paid out the commissions and expenses on all sales of associate memberships. The procedure in connection with sales of those memberships was as follows:
The salesman employed by Roth received the $9.90 from the purchaser, although the application blank called for payment to Country Club, Inc. The salesman then brought the money to the office of petitioner. Petitioner then paid Roth on the scale of remuneration currently existing between them and Roth paid his salesmen whatever amount had been agreed upon between them. The scale of remuneration between Roth and petitioner is not a matter of record, but the average payment to Roth for the sale of an associate membership was $9.90. And then, as per agreement, petitioner credited $9.90 to Country Club, Inc. Consequently, petitioner listed as obligations*763 $19.80 each time it took in $9.90 on the sale of an associate membership. The total amount of associate membership fees received by petitioner in the fiscal year 1936 was $16,721.10, which amount was credited to Country Club, Inc., on petitioner's books prior to the close of the fiscal year.
Petitioner endeavored through Roth to sell founder memberships to persons who had purchased associate memberships. One of the policies of petitioner in encouraging the sale of associate memberships was to provide a market for the sale of founder memberships as a step toward the eventual sale of subdivided lots.
During the fiscal year 1936 Country Club, Inc., added numerous facilities such as a clubhouse for the beach, its furnishings, tennis courts, and an additional large dining room and kitchens. The funds needed for payment for these improvements came out of the $30 received by Country Club, Inc., from petitioner on the sale of each founder membership under its agreement with petitioner. In addition funds were advanced by petitioner and the $16,721.10 mentioned above was credited against the advances. The credit was made by corresponding entries on the petitioner's books and those*764 of Country Club, Inc.; one on March 1, 1936, in the amount of $8,385.30 and one on April 30, 1936, in the amount of $8,335.80, both designated "Associate Memberships, Initiation fees."
*1236 Country Club, Inc., reported as income on its income tax return for the fiscal year 1936 the $16,721.10 credited to it by petitioner as initiation fees received.
Petitioner listed on its 1936 tax return as a deduction the same amount as commissions paid. By virtue of this deduction, petitioner's return disclosed a net loss of $2,382.17. Respondent has disallowed this deduction in its entirety.
In or about 1927 Penproco had issued bonds in the approximate face amount of one and one-half million dollars, the issue being secured by a trust indenture covering all its properties. As a result of the bad financial conditions resulting from the market crash of 1929 it became impossible for Penproco to realize sufficient income from the sale of its lands to make current payments on its outstanding bond issue. Due to this state of affairs a bondholder's committee was formed and a reformation of the trust indenture was effected. By virtue of the reformation any bondholer could trade in*765 his bonds and receive in return real estate. A schedule known as the Underhill appraisal was adopted and determined the value of the individual properties for purposes of the exchanges. The trustee under the trust indenture was by the reformation authorized to release from the lien of the trust indenture parcels of land corresponding in value according to this appraisal to the face value of the bonds surrendered for cancellation.
Pursuant to this arrangement and for the purpose of exchanging the bonds for property, Monroe and Miller, as individuals, purchased the majority of Penproco's outstanding bonds on the open market at an average cost of 11 cents on the collar. On March 6, 1936, they owned Penproco bonds in a total face amount of $494,500 out of a total outstanding of $632,000.
Petitioner's organization and the transfer of all of its stock to Miller and Monroe were parts of a plan conceived and executed by those two individuals.
Petitioner was caused to be organized for the purpose of obtaining property from Penproco on behalf of Miller and Monroe by the use of Penproco's bonds. They, as individuals, had been depositing with Penproco bonds of that company which they*766 had purchased at a heavy discount and receiving in return salable real estate. This practice had been objected to by the minority stockholders of Monroe & Miller, Ltd., and therefore petitioner was organized for the purpose of carrying on in a corporate form and for the benefit of Miller and Monroe, its only stockholders, the activities formerly carried on by them individually.
All the subdivided lands held for sale by Penproco were placed in escrow with the Santa Cruz Land Title Co. as security for the payment *1237 of assessments incurred by certain improvements to the realty which were made by the county and financed by a county issue of improvement bonds. On June 15, 1935, Penproco notified the Land Title Co. that all the Santa Cruz property (in Assessment District No. 1) which it held in escrow had been transferred to petitioner, subject to the escrow agreement. There was no cash payment by petitioner for this property, but only a running account on the books of both corporations. When during the fiscal year 1936 petitioner wanted to sell any of this land, it became necessary to have some of Penproco's bonds surrendered in order to clear title to the particular property*767 involved in the sale. For this purpose, Monroe and Miller, as individuals, turned over the necessary amount of bonds to petitioner, receiving a credit therefor of 70 cents on the dollar. Petitioner then turned the bonds in immediately to Penproco and received a credit on the running account in the amount of the full par value of the bonds plus accumulated interest. Penproco then canceled the bonds which petitioner had just turned in and thereby released from the trust lien the specific lands of which petitioner was making sale.
Monroe and Miller, as individuals, each reported on their individual income tax returns the difference between the cost to them of the bonds and the profit received by them from the transfer to petitioner
In the fiscal year 1937 Penproco transferred to petitioner a block of land containing 978.332 acres and also its administration building and the land upon which the building stood. The date of transfer of the 978.332 acres to petitioner was December 20, 1936; the date of transfer of the administration building was May 15, 1936.
At the time the 978.332 acres were transferred to petitioner no payment therefor was made nor were any bonds turned over*768 to Penproco at that time. A price of $92,902.40 was agreed upon between the two corporations and that amount was credited to Penproco on the intercorporate accounts. This amount did not purport to represent the fair market value of the land involved, such value not even having been considered, but was the cost price to Penproco as set up on the books of the latter corporation at the time of the transfer. The land was not subdivided; was in a single block located away from the subdivided land and the ocean; was unimproved and densely wooded; was not suited in its then condition for use in the manner of the other Rio Del Mar properties; and, in general, was in the same state as when purchased in 1925 by Penproco. No part of the land in this block had ever been sold by Penproco to the public. It had never been advertised for sale; but Penproco never had advertised any of its property for sale in the papers or through other popular mediums.
During the fiscal year 1937 petitioner was indebted on its books to Miller and Monroe for advances, and on March 1, 1937, the petitioner *1238 transferred the 978.332 acres to the two individuals at a price of $25 an acre. The debt from*769 petitioner to Miller and Monroe, as individuals, was decreased on the books by the amount of $24,458.30, in full consideration for the transfer.
This sale price of $25 per acre was the minimum sale price required by Penproco's escrow agreement with Santa Cruz County. The motivating purpose of this "sale" was to show a loss for the tax benefit of petitioner. There was no real business purpose for the transaction.
A loss of $70,897.62 (sic ) was claimed on its income tax return for the fiscal year by petitioner in respect to the sale of the 978.332 acres. Respondent has disallowed this deduction in full. By virtue of this loss and the loss claimed on the disposition of the administration building, petitioner's tax return for the fiscal year 1937 disclosed a net loss of $899.20 for the year.
The administration building is located on land approximately one hundred feet in width. It is a one-story building containing one large general office and three smaller ones. Prior to its acquisition by the petitioner, the building had been used by Penproco for book-keeping and as an information center. Interviews were held here with prospective purchasers of the subdivided lots. *770 After its acquisition by petitioner the same use was made of the building. Petitioner transferred this property to Miller and Monroe as individuals on April 2, 1937. After the transfer to the two individuals, the same use was made of the building and the petitioner credited its two stock-holders with a certain amount for rental. At the time petitioner acquired the building there was a mortgage outstanding secured by the property in the amount of approximately $4,853, and it does not appear that the mortgage indebtedness was lessened while the building remained in petitioner's hands. The sale price agreed upon was $6,000, which included the amount due on the mortgage. The $6,000 figure was recorded on the books of petitioner.
The difference of $18,192.17 between the cost of the building to petitioner ($24,192.17) and the sale price to the two individuals ($6,000) was deducted in full by petitioner in its income tax return for the fiscal year 1937 as a loss. The respondent has disallowed this deduction in full.
The motivating purpose of this "sale" was to show a loss for the tax benefit of petitioner. There was no real business purpose for the transaction.
The transactions*771 involving all the properties transferred by petitioner to Miller and Monroe, its sole stockholders, as individuals, were carried out by the two individuals without any third parties *1239 being included in the dealings or negotiations except the bookkeeper who recorded the transactions and althered the accounts in conformance therewith.
OPINION.
KERN: The first issue for our determination is whether respondent erred in disallowing a deduction taken by petitioner on its income tax return for the fiscal year 1936 in the amount of $16,721.10 as commissions paid for the sale of associate memberships in the Rio Del Mar Country Club, Inc. Respondent argues that this was not an ordinary and necessary business expense of petitioner and that the sales commissions, if deductible by anyone, were deductible only by the Country Club. As the facts disclose, the petitioner received $9.90 on each sale, credited the country club with $9.90 on a running account between the two corporations, and also paid $9.90 to Roth, the broker, as commission for the sale. The Country Club reported as income on its return the $9.90 placed to its credit on the books. It appears that the Country Club*772 did not also include in its income under any theory the $9.90 which petitioner paid to Roth on its behalf. Assuming that the Country Club had considered this latter $9.90 as having been income constructively received, then there is no doubt that the Country Club would have been entitled to claim a like amount as a deduction, for the net result of the sale of each associate membership was to make the Country Club $9.90 richer, to make Roth $9.90 richer, to make petitioner $9.90 poorer, and to leave the new member $9.90 poorer. But the equitable theory of constructive receipt is one to be sparingly applied and there does not appear to be sufficient ground for saying that the transaction should have been treated by the Country Club in any method other than was done, especially when the result for purposes of taxation would remain the same. Thus, we are not prepared to say that the deduction was available to the Country Club only, as respondent asserts.
Petitioner did not advertise its subdivided properties for sale, although these properties were apparently "out of the way." It depended for its sales upon prospective purchasers becoming interested in the location mainly because*773 of the existence of a going country club in the vicinity. But, since the properties were out of the way, this necessitated getting prospects to become interested in the club. Many realty concerns sell their lands in this manner, centering their sales talks around clubs maintained by them. It appears from the record that the reason petitioner was willing to pay the expenses of selling associate memberships in the club was to be sure of getting prospects to the location so that they might see the lots for sale and petitioner's *1240 sales force could then start their attempt to make sales. It is reasonable to anticipate that anyone who has paid $9.90 just for the privilege of entering upon the ground of a club will take advantage of that privilege at least once. That was all that petitioner anticipated; and that was why petitioner undertook to sell the memberships and pay the sales commissions.
Balancing the outlay against the benefits to be reasonably expected, the business interests of the petitioner were probably advanced. At least, it can not be said that it would be unreasonable or extraordinary to expect them to be advanced. Each sale to an associate member proved*774 the worth of this substitute for ordinary advertising.
Each case involving ordinary and necessary business expenses must be decided upon its own peculiar facts. Upon an analysis of the instant facts, we sustain petitioner's contention on this issue.
The remaining issue in this proceeding is whether respondent correctly disallowed in full certain losses claimed by the petitioner in the fiscal year 1937 as deductions on its income tax return. These losses arose from two transactions involving the sale of land and a building by the petitioner to Miller and Monroe, the only two stockholders of petitioner, jointly.
Respondent contends that his disallowance of these losses shouldbe sustained under the doctrine of . In that case the transaction was the reverse of the transaction in the instant case. There, the stockholder, who owned all of the corporation's stock, transferred properties to the corporation in order to avail himself individually of a deductible loss. The transaction took place prior to the enactment of section 24(a)(6), but, nevertheless, the Supreme Court held that the taxpayer's retention of control of the properties*775 transferred prevented his sustaining a true loss.
The Court held in that case that "dominion and control is so obvious in a wholly owned corporation as to require a peremptory instruction that no loss in the statutory sense could occur upon a sale by a taxpayer to such an entity"; that, although title passed to the corporation, control over the property was retained by the sole stockholder and thus there was "not enough of substance in such a sale finally to determine a loss."
If the Supreme Court had limited its opinion to a holding that a transfer by an individual stockholder to a wholly owned corporation was not a sale giving rise to a loss within the meaning of the revenue act because of the resulting retention of control over the property by the transferor, we might be able to distinguish that case, both as to holding and rationale from the instant proceeding, since in this case the transfer was from the corporation to its two stockholders and, *1241 obviously, there could be no retention of control by the transferor corporation. However, the Court went ahead to discuss *776 , in which a gain was held to have been realized by a corporation upon the sale of property to its sole stockholder. In reconciling its holding in that case with the holding in the Smith case, the Court made use of the following language:
* * * In the Commonwealth Improvement Company case, the taxpayer, for reasons satisfactory to itself voluntarily had chosen to employ the corporation in its operations. A taxpayer is free to adopt such organization for his affairs as he may choose and, having elected to do some business as a corporation, he must accept the tax disadvantages.
On the other hand, the Government may not be required to acquiesce in the taxpayer's election of that form for doing business which is most advantageous to him. The Government may look at actualities and upon determination that the form employed for doing business or carrying out the challenged tax event is unreal or a sham may sustain or disregard the effect of the fiction as best serves the purposes of the tax statute. To hold otherwise would permit the schemes of taxpayers to supersede legislation in the determination*777 of the time and manner of taxation. It is command of income and its benefits which marks the real owner of property.
The implication of this dictum seems unmistakably to the effect that when a corporation, formed for the purpose of carrying on a transaction or holding property as the corporate alter ego of its sole stockholder, makes a purported "sale" of property to such stockholder for the purpose of establishing a tax loss, the respondent can disregard the transaction as unreal, because, in reality, there has been no cange in the ownership of the property, the transferee having had command over the property prior to the transfer by virtue of being the sole stockholder of the transferor corporation.
This being our judgment as to the implications of the opinion of the Supreme Court in , we are constrained to uphold the determination of respondent on this issue.
The fact that petitioner had two stockholders instead of one we consider to be immaterial. It is apparent from an examination of the record in this case and the two related cases, that Miller and Monroe acted together in all respects and for all practical purposes had*778 a community of interests and a uniformity of action.
The reasons given by the petitioner for having transferred the properties to Miller and Monroe are too shallow to be accepted by us as reasonable explanations for its actions. Miller testified that the petitioner thought the Federal Government was going to buy the 978.332 acres for about $25 an acre and, because petitioner owed an account to its two stockholders, it was decided that they (the stockholders) should make the sale in order to realize some cash on their account. *1242 If petitioner believed, as testified by Miller, that the Government was going to offer approximately $25,000 for the large tract, there would be nothing gained by having previously transferred the property at the same price to Miller and Monroe. Had petitioner retained the property, sold to the Government at the allegedly anticipated figure, and turned over the proceeds to Miller and Monroe and debited their accounts in such amount, the same result would have been arrived at without the necessity for this book transfer of the property. The explanation for the transfer of the administration building, i.e., to shift the mortgage burden, also*779 appears to hold no weight. Miller testified that the reason petitioner acquired this latter property in the first place was because Penproco was in danger of losing it through foreclosure proceedings. He also testified that Miller and Monroe acquired it to save petitioner from the same fate. We conclude, however, that the real reason for both these transfers was the establishment of losses in the fiscal year 1937 for purposes of tax avoidance.
Having held on this question in favor of respondent, and to the effect the under the Smith case there was for tax purposes in reality no sale, it is unnecessary to consider the question of whether the transaction is subject to the provisions of section 24(a)(6) of the Revenue Act of 1934, set out in the margin. 1 Petitioner has advanced the rather technical argument that the use of the terms "individual" and "more than 50 per centum in value of the outstanding stock" precludes the application of that section to the instant facts. It is now unnecessary to determine whether we agree with the strict construction which petitioner urges should be given to the statute.
*780 Neither is it necessary to consider the question of whether the property, the legal title to which was transferred by petitioner, constituted capital assets or property held for sale to customers in the ordinary course of petitioner's business.
Decision will be entered under Rule 50.
Footnotes
1. SEC. 24. ITEMS NOT DEDUCTIBLE.
(a) GENERAL RULE. - In computing net income no deductions shall in any case be allowed in respect of -
* * *
(6) Loss from sales or exchanges of property, directly or indirectly, (A) between members of a family, or (B) except in the case of distributions in liquidation, between an individual and a corporation in which such individual owns, directly or indirectly, more than 50 per centum in value of the outstanding stock. For the purpose of this paragraph - (C) an individual shall be considered as owning the stock owned, directly, by his family; and (D) the family of an individual shall include only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants. ↩