*31 Decisions will be entered under Rule 50.
Each of two brothers who were equal partners subscribed and paid $ 1,000 in cash for all the stock of a new corporation. The two brothers then transferred a portion of the partnership assets valued at $ 1,026,951.32 to the corporation which assumed partnership liabilities of $ 53,862.52 and agreed to pay the partners $ 973,088.80 in four installments, with interest on the last three installments at 3 per cent. At the same time, the partners also transferred to the corporation without consideration assets other than those mentioned above having a substantial value to the corporation of several hundred thousand dollars. On the basis of the evidence, it is held:
1. The corporation was adequately capitalized.
2. The transfer for consideration was a bona fide sale.
3. The payments by the corporation on the purchase price of the assets transferred represented payments of proceeds of a sale rather than dividends.
4. Amounts accrued as interest on the deferred installments of the purchase price were deductible by the corporation.
5. The basis of the depreciable assets transferred was the price fixed in the purchase agreement.
*439 Respondent determined deficiencies in income taxes of petitioners and 5 per cent additions for negligence under section 293 (a) of the Internal Revenue Code of 1939 as follows:
| Additions | ||||
| Petitioners | Doc. | Year | Deficiency | under |
| No. | sec. 293 (a) | |||
| Ainslie Perrault and | ||||
| Mae Frances Perrault | 40668 | Dec. 31, 1948 | $ 97,102.15 | $ 4,855.11 |
| Lewis Perrault and | ||||
| Eda Belle Perrault | 40669 | Dec. 31, 1948 | 77,908.68 | 3,895.43 |
| Perrault Brothers, Inc | 40670 | Dec. 31, 1948 | 27,052.78 |
*440 Only a portion of the deficiencies is in controversy.
In Docket No. 40668, the only contested adjustments to net income in*33 the deficiency notice were "that in 1948 you received taxable dividends of $ 29,302.54 from the Allied Paint Manufacturing Co. and $ 125,000.00 from the Perrault Brothers, Inc. which you erroneously treated as part of the proceeds from two sales in your income tax return." The parties agree that our decision relating to the above item of $ 29,302.54 rests on an adjustment made in the related cases of Ainslie Perrault, Docket No. 40666, and Mae Frances Perrault, Docket No. 40667, and that the final decision in the said related cases shall be binding in Docket No. 40668.
In Docket No. 40669, the only contested adjustment to net income in the deficiency notice was "that in 1948 you received taxable dividends of $ 125,000.00 from Perrault Bros., Inc. which you erroneously treated as part of the proceeds from a sale in your income tax return."
In Docket No. 40670, the only contested adjustments to net income were the disallowances of deductions for depreciation of $ 102,243.19 and interest accrued of $ 21,394.34. 2
*34 Effect will be given to the uncontested adjustments and additions under Rule 50.
FINDINGS OF FACT.
The stipulation of facts in these consolidated proceedings is incorporated herein by this reference.
Petitioner Perrault Brothers, Inc., hereinafter sometimes referred to as the Corporation, was organized on January 29, 1947, under the laws of Delaware. The principal offices of the Corporation are in Tulsa, Oklahoma. It filed its income tax return for the calendar year 1948 with the collector of internal revenue for the district of Oklahoma. It keeps its books and files its returns on an accrual basis of accounting.
Petitioners Lewis Perrault and Eda Belle Perrault are husband and wife, and petitioners Ainslie Perrault and Mae Frances Perrault are husband and wife. Each couple filed a joint income tax return for the calendar year 1948 with the collector of internal revenue for the district of Oklahoma. Lewis and Ainslie are sometimes hereinafter referred to as the petitioners.
Lewis and Ainslie are brothers. From 1929 to 1939 Lewis was employed as a salesman by Hill-Hubbell Company. During that period he sold mill coated and wrapped pipe, that is, pipe which was coated and wrapped*35 in the mill before shipment to the pipeline companies. In March 1939, Lewis, Ainslie, and J. L. Gordon formed a partnership under the name of Petroleum Coating Company. This *441 partnership engaged in the business of manufacturing line-traveling coating machines. Its total initial capital was $ 11,338.64, and each partner had a one-third interest. A short time later Gordon sold equal shares of his interest to the petitioners. Between March 7, 1940, and May 15, 1942, the business was conducted as a corporation, first under the name of Petroleum Coating Company and then under the name of Petroleum Coating Machine Company. The petitioners each owned 50 per cent of the stock.
Before pipe is laid, it must be coated and wrapped. The coating protects the pipe from corrosion, and the wrapping, in turn, keeps the coating in place. The most desirable means of coating and wrapping pipe is a machine which simultaneously performs both of these functions over the ditch as the pipe is laid. This machine is called a line-traveling coating and wrapping machine. Because of patent restrictions the petitioners were unable to manufacture a machine which wrapped, as well as coated, the *36 pipe at the ditch. Through various licensing agreements Johns-Manville Corporation had assembled a pool of patents for the construction of a line-traveling coating and wrapping machine. Johns-Manville had then given Crutcher-Rolfs-Cummings Company a sublicense to manufacture the machine. The petitioners could not obtain a similar sublicense from Johns-Manville.
In 1939 only two companies made a suitable pipeline wrapper, known as asbestos line felt. The two companies were Johns-Manville and the Philip Carey Manufacturing Company, hereinafter referred to as Carey. In effect, Johns-Manville had a monopoly over sales of asbestos line felt because it controlled the patents for the machines which coated and wrapped the pipe. Carey had a patent for a wrapping head, but lacked the necessary patents or licenses to build a coating machine. In 1939 it offered petitioners a license to combine the wrapping head with their coating machine. Petitioners accepted the offer and, after some difficulties, perfected a machine which both coated and wrapped. However, they were immediately sued for infringement and practically put out of business. The business struggled along until the patent dispute*37 was finally settled in October 1941. Carey then acquired licenses from the patent holders similar to those obtained by Johns-Manville, and granted a sublicense to Petroleum Coating Machine Company on the same terms as the sublicense given by Johns-Manville to Crutcher-Rolfs-Cummings. No one else was given a license to manufacture machines covered by the patents.
Between May 15, 1942, and January 5, 1948, petitioners operated as a partnership under the name of Perrault Brothers, hereinafter *442 referred to as the Partnership. The Partnership resulted from a tax-free liquidation of Petroleum Coating Machine Company. Each petitioner had a 50 per cent interest in the Partnership. Throughout that period the business of the Partnership consisted of building, leasing, and selling line-traveling coating and wrapping machines, and of manufacturing and dealing in other pipeline equipment and supplies. The Partnership built the line-traveling coating and wrapping machines under licensing agreements with Carey. Until about the middle of 1947 the Partnership was the sole manufacturer of these machines except for Crutcher-Rolfs-Cummings Company. Thereafter one more competitor entered*38 the field.
In 1947 the Partnership operated under a licensing agreement with Carey dated December 17, 1946. The initial term of the agreement was 6 years. It was to be renewed for another 6 years if the Partnership was "in good standing" under the agreement. Carey reserved the right to cancel the license for any violation. The agreement stated that the machines were "to be leased or rented, but not to be sold," by the Partnership, and that they were "for use on work to be done within the confines of continental United States." If the Partnership desired "to conduct any business or rent any machines" elsewhere, it was required to obtain the written consent of Carey. The agreement further declared that "part of the consideration" for the license was the petitioners' "active interest and ownership" in the Partnership. Carey retained the right to end the agreement if the petitioners would "terminate their active interest" or "sell any or all of their present holdings" in the Partnership; if "the control" of the Partnership "passes to any person or persons, firm or corporation other than" the petitioners; if the Partnership "increases the number of co-partners or permits any other*39 person, firm or corporation other than" the petitioners "to acquire an interest" in the Partnership; or if "any competitor" of Carey "in the manufacture or sale of felts and other materials or equipment for coating or wrapping pipe acquires directly or indirectly any interest" in the Partnership. The principal patent covered by the agreement was the Fuller patent No. 2,034,755, which was to expire in March 1953.
The agreement with Carey provided that in the event of suits for patent infringement based upon the Carey wrapping head, all of the expenses of defending the suit should be borne by Carey. In the event of suits for patent infringement based upon a combination coating and wrapping machine, two-thirds of the expenses of defending the suit should be borne by Carey.
The Partnership's rentals from the line-traveling coating and wrapping machines were based on the size and footage of the pipe to be *443 coated and wrapped. Under the usual arrangement the contractor, after using the machine in a particular month, was supposed to report the completed footage to the Partnership on the tenth of the next month. The Partnership would then send an invoice to the contractor, and*40 payment would be due on the tenth of the following month. On many occasions the lag in payment was still greater because the contractors failed to report the footage on time. There were a number of jobs where the machine was rented on an indefinite basis rather than for a specified footage. In these cases the contractor would not report the footage until the work was done, and the Partnership would wait 7 or 8 months for payment. The Partnership did not accrue a rental until it received a report of the completed footage from the contractor. It accrued its sales of machines when they were shipped and invoiced.
In early 1947 Lewis consulted an attorney in Oklahoma City with regard to several business problems. At that time, Ainslie's health was very poor. The petitioners were particularly concerned about a provision in their Partnership agreement which gave the survivor an option to buy the interest of the other at book value, though the business was worth considerably more. The petitioners were also considering the advisability of selling the business. They felt that they were getting too old to devote as much personal effort and attention as the business required. The situation*41 was aggravated by Ainslie's continuing illness and curtailed activity. The petitioners were further disturbed by their tax situation. They thought that it was no longer feasible, from a tax standpoint, to conduct their business as a partnership, and that a corporation would be more advantageous as long as they stayed in the business. The attorney finally recommended, as the best single solution for all these problems, a sale of the Partnership assets to a newly organized corporation at a price equal to the current value of the assets. In this way, he advised the petitioners, the assets could be set up on the corporation's books at their current value and the option price payable by the survivor could be fixed in terms of that value. The attorney explained that his recommendation would require the petitioners to pay a capital gains tax. But he pointed out that this burden might well be offset by the benefit of increased depreciation based on the price paid by the corporation for the assets.
In accordance with the attorney's advice, the petitioners made the proposed sale of assets. On January 5, 1948, the Partnership assigned to each petitioner an undivided one-half interest *42 in the following properties listed at the following values: *444
| Office furniture and equipment | $ 8,591.83 |
| Tools and shop equipment | 33,314.67 |
| Two airplanes | 12,681.10 |
| Two trucks | 1,855.05 |
| 56 line-traveling coating and wrapping machines | 473,506.00 |
| Four stationary machines | 11,600.00 |
| Land | 17,500.00 |
| Buildings and improvements | 89,000.00 |
| Inventories | 378,902.67 |
| Totals | $ 1,026,951.32 |
Under the terms of the assignment, the petitioners jointly and severally assumed liabilities totaling $ 53,862.52.
On January 5, 1948, the petitioners, as vendors, entered into a purchase agreement with the Corporation, as vendee. In this agreement they sold the same properties to the Corporation for an aggregate price of $ 1,026,951.32, subject to the same liabilities of $ 53,862.52, or a net of $ 973,088.80 payable to them in equal shares. The price of each asset was the same as the value fixed for the asset in the Partnership's assignment to the petitioners. The Corporation agreed to pay the $ 973,088.80 in 4 installments over somewhat less than 3 years. The first installment of $ 250,000 was due within 120 days from the date of the transfer; the second of $ 300,000 was due*43 on or before January 2, 1949; the third of $ 300,000 was due on or before January 2, 1950; and the fourth of $ 123,088.80 was due on or before January 2, 1951. The Corporation also agreed to pay interest at 3 per cent on the last 3 installments and interest at the same rate on the first installment for the period that it remained unpaid after its due date.
The respondent made several adjustments in the depreciated cost of these assets to the Partnership. The following table indicates the depreciated cost on the Partnership's books as of January 5, 1948, the depreciated cost as adjusted by the respondent, and the values fixed in the purchase agreement:
| Depreciated | Depreciated | Value in | |
| Asset | cost on | cost as | purchase |
| books | adjusted | agreement | |
| Office furniture and equipment | $ 8,591.83 | $ 10,328.00 | $ 8,591.83 |
| Tools and shop equipment | 33,314.67 | 38,304.52 | 33,314.67 |
| Two airplanes | 12,681.10 | 13,567.75 | 12,681.10 |
| Two trucks | 1,855.05 | 1,855.05 | 1,855.05 |
| 56 line-traveling and wrapping | |||
| machines | 42,188.78 | 44,308.70 | 473,506.00 |
| Four stationary machines | 3,274.25 | 3,470.50 | 11,600.00 |
| Land | 5,000.00 | 5,000.00 | 17,500.00 |
| Buildings and improvements | 19,037.51 | 22,458.74 | 89,000.00 |
| Inventories | 378,902.67 | 378,902.67 | 378,902.67 |
| Totals | $ 504,845.86 | $ 518,195.93 | $ 1,026,951.32 |
*44 The sales price of each of these properties, as specified in the purchase agreement, did not exceed its fair market value as of January 5, 1948.
*445 The Partnership had manufactured the 56 line-traveling coating and wrapping machines between January 1, 1946, and September 30, 1947, at a total outlay of $ 59,879.92. The cost of the machines had ranged between $ 953.68 and $ 1,235.46. The sales price of such machines for use abroad varied between $ 9,240 and $ 15,840, depending on the size of the pipe to be coated and wrapped. The price charged for a particular machine was an amount equal to the rental charged for coating and wrapping 100 miles of pipe with the machine. In 1946 the Partnership sold 12 machines and in 1947 it sold 4 machines at a price determined on this basis. The total amount received for the latter machines was $ 44,362, f. o. b. Tulsa. The Partnership's competitors sold similar machines at a price fixed on the same basis. These machines sold for considerably more than their cost because of the practical monopoly created by the patent agreements and the complete absence of competition from abroad. Due to its monopoly, the Partnership realized much larger*45 profits from leases than from sales. The rentals earned by a machine in this country were usually two or three times as large as its sales price abroad, and sometimes four or five times as large. The Partnership was obliged to service the machines which were leased. The cost of servicing was small in some cases and a considerable amount in other cases.
The value placed on each of the 56 machines under the purchase agreement was the sales price for use abroad of a similar new machine, less a deduction for constructive depreciation of the particular machine. In these proceedings, the parties agree that machines of this type are depreciable for income tax purposes over a period of 5 years. The deduction for constructive depreciation on each of the 56 machines was computed on the basis of its sales price for use abroad and a 5-year life, and covered the period between the date of its acquisition and January 5, 1948. For example, the first of the 56 machines was acquired by the Partnership on January 1, 1946, and its sales price for use abroad was the rental charged for coating and wrapping 100 miles of pipe at 1.75 cents per foot, or $ 9,240 ($ .0175 X 5,280 X 100). The machine*46 was valued at $ 5,544 by deducting from $ 9,240 the amount of $ 3,696, representing 2 years of depreciation on the basis of the sales price from January 1, 1946, to January 5, 1948.
The Partnership had held all 56 machines for the production of rental income. In its return for the fiscal year ending April 30, 1948, the Partnership reported rentals of $ 150,195.06 from its line-traveling machines for the period between May 1, 1947, and January 5, 1948. On January 5, 1948, at least 45 of the machines were out under rental arrangements. After January 5, 1948, the Corporation similarly held the 56 machines for rental in the United States. The Corporation did not sell any of the 56 machines abroad. For 1948 it reported *446 rentals of $ 355,982.28 from these machines. In the same year, the Corporation sold 10 other line-traveling coating and wrapping machines which it manufactured. As in the case of sales made by the Partnership, the price of each of these 10 machines was the amount charged for coating and wrapping 100 miles of pipe. The total price received for the 10 machines was $ 142,560, f. o. b. Tulsa. On January 5, 1948, the fair market value of the 56 machines transferred*47 to the Corporation was the amount stated in the purchase agreement of $ 473,506.
Apart from the physical assets mentioned in the purchase agreement, the petitioners transferred to the Corporation their interests in the licensing agreement with Carey and their interests in various contracts which were outstanding on January 5, 1948. In an instrument dated March 23, 1948, Carey declared that it "consents to and approves of the transfer by Perrault Brothers, a copartnership to Perrault Brothers, Inc. of the interest of Perrault Brothers, a copartnership in the aforesaid agreement of December 17, 1946, for that portion of the period of time covered by said agreement in which the business of Perrault Brothers, Inc. is owned and carried on exclusively by Lewis Perrault and Ainslie Perrault." Carey reserved the right to cancel the agreement of December 17, 1946, if the petitioners "terminate their active interest" in the Corporation, "or sell or dispose of, or release control of, any or all of their interest" in the Corporation; if "control" of the Corporation "passes by law or otherwise to any person or corporation" other than the petitioners; or if "any person, firm or corporation acquires*48 directly or indirectly any interest" in the Corporation. The agreement of March 23, 1948, was executed in order to formalize the relationship between Carey and the Corporation.
The other contracts transferred to the Corporation included 34 firm rental agreements for coating and wrapping a specified footage; 4 rental agreements on a year-to-year basis without a specified footage; 2 firm orders from the Trans-Arabian Pipe Line Company for pre-moulded felt padding and glass pipeline wrap; a firm order from Williams Brothers Overseas Company for coating and wrapping machines, cleaning and priming machines, and tar kettles; and contracts for supplies and other inventory which the Partnership had shipped but not billed before January 5, 1948. These assets had a value to the Corporation of several hundred thousand dollars.
The authorized capital of the Corporation was originally $ 100,000, consisting of 5,000 shares of common stock with a par value of $ 20 per share. The petitioners each paid in $ 1,000 for 50 shares of stock. When the Corporation was organized, each partner intended to subscribe *447 for $ 50,000 of stock. Later they concluded that the Corporation did not require*49 any authorized capital beyond $ 2,000 because it was receiving assets, other than those mentioned in the purchase agreement having a substantial value to the Corporation of several hundred thousand dollars.
The minutes of a stockholders' meeting on April 5, 1948, state that the Corporation "had begun business on a considerable scale," and that "at this time, as far as could be determined, its operations appeared profitable and satisfactory in all respects." On April 6, 1948, the directors of the Corporation voted to reduce its authorized capital to $ 2,000, consisting of 100 shares having a par value of $ 20 per share. The minutes of the directors' meeting record that the "advisability" of reducing the number of shares of authorized capital stock "was discussed in detail by the directors." On May 3, 1948, the stockholders ratified the directors' action. According to the books and records of the Corporation, including its balance sheets, its total authorized and outstanding stock is 100 shares of $ 20 par value.
The opening entries of the Corporation recorded the purchase of the physical assets "from Ainslie Perrault and Lewis Perrault" for $ 973,088.80, and reflect a liability for*50 "Contract installments" in that amount. Each of the assets is listed with a debit entry equal to the value fixed for the asset in the purchase agreement. The debit entries total $ 1,026,951.32, and are offset, in part, by credit entries of $ 53,862.52, reflecting the liabilities assumed by the Corporation in the purchase agreement. The Corporation paid the petitioners $ 250,000 on April 3, 1948, $ 300,000 on January 6, 1949, $ 300,000 on January 9, 1950, and $ 123,088.80 on December 29, 1950. It paid each petitioner $ 10,695.68 on January 8, 1949, and $ 6,346.33 on March 15, 1950, as interest due under the purchase agreement.
On January 5, 1948, the Partnership had on its books liabilities of $ 467,821.31, of which the Corporation assumed only $ 53,862.52. The Partnership retained assets totaling $ 94,064.74, consisting almost entirely of cash and receivables. Before April 3, 1948, the Corporation loaned $ 249,177.08 to the Partnership to help it satisfy its net liabilities of $ 319,894.05. On April 13, 1948, the partners repaid the loan to the Corporation out of the $ 250,000 which they received on April 3, 1948, as the first installment under the purchase agreement.
From *51 January 5, 1948, until October 31, 1952, the Corporation operated the business previously conducted by the Partnership. During that time, Lewis and Ainslie owned all its outstanding stock in equal shares. Between January 5, 1948, and December 31, 1952, the Corporation earned the following net profits before and after Federal income taxes (prior to the adjustments due to changes made by the *448 respondent which have not been placed in controversy by the Corporation):
| Net operating | Net operating | |
| Year | profits | profits after taxes |
| 1948 | $ 508,135.98 | $ 295,975.89 |
| 1949 | 209,876.00 | 123,449.69 |
| 1950 | 287,849.72 | 185,012.12 |
| 1951 | 193,644.27 | 121,753.15 |
| 1952 | 20,495.43 | 17,006.98 |
From time to time the Partnership had regularly obtained bank loans in order to finance its operations. On January 5, 1948, its outstanding bank loans were $ 235,000. The Corporation similarly made temporary bank loans without any difficulty. On January 12, 1948, it borrowed $ 50,000, which it repaid on January 20, 1948. On February 18, 1948, it borrowed $ 45,000, which it repaid in the next 2 days. In June 1949, the Corporation borrowed $ 100,000, which it repaid 2 months later. In September*52 1949, it borrowed $ 30,000 which it repaid the next month.
In their returns for 1948 each petitioner treated the $ 125,000 received that year from the Corporation as an installment payment of the net sales price of $ 973,088.80. Each reported a long-term capital gain of $ 57,302.76 and a short-term capital gain of $ 14,554.67 on the installment basis. The respondent determined that the payments constituted "taxable dividends" rather than proceeds of a sale.
In its return for 1948, the Corporation deducted $ 21,394.34 as interest accrued that year on its installment obligation to the petitioners. The respondent disallowed the deduction as representing "interest on capital stock." The Corporation claimed a depreciation deduction, with respect to the depreciable assets transferred in the purchase agreement, based on the values assigned to those assets in the agreement. The respondent determined that the proper basis for depreciation was the basis of the assets to the Partnership. He further determined that the depreciation allowed by him was "reasonable regardless of the manner of acquisition of the depreciable assets." There is no dispute over the rates of depreciation used by *53 the Partnership or the Corporation. It is agreed that the line-traveling coating and wrapping machines were depreciable over a period of 5 years. Insofar as depreciation is concerned, the only issue is the Corporation's basis for the depreciable assets which it acquired under the purchase agreement.
No formal dividends as such were paid in 1948 by the Corporation to its stockholders.
The capital structure of the Corporation was adequate for the requirements of its business operations.
The installment obligation paid by the Corporation to the petitioners constituted a genuine and unequivocal indebtedness in the amount *449 of $ 973,088.80. The interest accrued on that indebtedness in 1948 was $ 21,391.35 and is deductible by the Corporation.
Payments on the principal amount of the purchase agreement entered into by the Corporation and its two controlling stockholders constituted the payments of proceeds of a sale rather than dividends.
The basis of the depreciable assets transferred was the price fixed in the purchase agreement.
OPINION.
The principal issue is whether the newly organized Corporation's promise made in the purchase agreement of January 5, 1948, to pay the two *54 Perrault brothers the amount of $ 973,088.80 in 4 installments on or before January 2, 1951, constituted a bona fide indebtedness of the Corporation as petitioners all contend, or whether the transfer of assets under the agreement of January 5, 1948, together with the almost simultaneous subscriptions by the brothers for all of the capital stock of the Corporation in the amount of $ 2,000, should in substance be regarded as a transfer of property within section 112 (b) (5) 3*56 of the 1939 Code, or whether in any event the selling price of the 56 machines was in excess of their fair value and thus not a bona fide indebtedness to the extent of the excess. Dependent upon how the principal issue is decided are three subsidiary issues: (1) Whether the payments made to the Perrault brothers by the Corporation under the January 5, 1948, agreement are payments of proceeds of an installment sale taxable to the extent of gain at capital gains rates as contended for by the recipients, or whether the payments are in substance dividends under section 115 (a) 4 of the 1939 Code as contended for by respondent; (2) whether the amounts accrued as interest by the Corporation on its promises under the*55 January 5, 1948, agreement are deductible as interest under section *450 23 (b) 5 of the 1939 Code; and (3) whether the basis 6 of the depreciable assets transferred by the two brothers to the Corporation under sections 114 (a), 113 (b), and 113 (a) of the 1939 Code was the price fixed in the purchase agreement as contended for by the Corporation, or is the same as in the hands of the transferor-stockholders under sections 114 (a), 113 (b), and 113 (a) (8) (A) of the 1939 Code, as contended for by respondent.
*57 The facts and circumstances emphasized by the respondent as requiring an adjustment of the tax consequences flowing from the so-called purchase agreement are mainly that the ratio of indebtedness to capital was so great as to make the capitalization of the Corporation entirely inadequate unless the assets which in form were sold to the Corporation be considered in substance as an exchange of property for stock; and that the price at which the 56 line-traveling coating and wrapping machines were allegedly sold was excessive. The respondent reasons that if the purchase agreement be taken at its face value then the ratio of indebtedness to capital would be $ 1,026,951.32 to $ 2,000, or a ratio of 1026 to 2, which he, in effect, says is so "terrific" as to demonstrate that what in form is indebtedness should in substance be considered capital. In support of this contention, the respondent cites such cases as Swoby Corporation, 9 T. C. 887; Sam Schnitzer, 13 T. C. 43; Isidor Dobkin, 15 T. C. 31; and R. E. Nelson, 19 T.C. 575">19 T. C. 575. See also Houck v. Hinds, 215 F. 2d 673.*58
But we think the respondent has overlooked the fact that in addition to the assets which the Corporation purchased for a total consideration of $ 1,026,951.32 it also acquired from the partnership for no consideration orders or unbilled items and goodwill having a substantial *451 value to the Corporation of, to wit, several hundred thousand dollars. The petitioners point to the fact that the Corporation realized from the rental contracts which were transferred to it on organization a total of $ 928,248.73. They also argue that goodwill of over $ 600,000 passed from the Partnership to the Corporation. We have not thought it necessary to determine the value of each separate asset that passed to the Corporation, but we have no hesitation in determining that they were of large value amounting to several hundred thousand dollars and constituted such an ample investment in the Corporation as to preclude any justification for holding under the thin capitalization doctrine that the transferred assets under the purchase agreement of January 5, 1948, should in substance be considered capital rather than a bona fide sale by the stockholders to the Corporation. John Kelley Co. v. Commissioner, 326 U.S. 521">326 U.S. 521;*59 Rowan v. United States, 219 F. 2d 51; Sun Properties, Inc. v. United States, 220 F. 2d 171; Sheldon Tauber, 24 T. C. 179. We hold, therefore, that the transfer of assets under the agreement of January 5, 1948, does not come within the provisions of section 112 (b) (5), supra. So long as the Corporation was provided with adequate capital, as we have held it was, we know of no reason why the organizers of the Corporation could not sell other assets to the Corporation providing the selling price was not out of line with realities. Bullen v. State of Wisconsin, 240 U.S. 625">240 U.S. 625; John Kelley Co. v. Commissioner, supra.
This leads us to a consideration of respondent's contention that the selling price of the 56 machines was in excess of their fair value. He makes the point that the machines had little actual cost to build and that the real item of value which was transferred to the Corporation was the licensing agreement and not the machines. The method used by petitioners in valuing the machines is fully set forth*60 in our findings. The evidence shows that although the machines could not be sold in the United States without Carey's consent they could be sold abroad at the prices mentioned in the purchase agreement; that competitors of petitioners sold similar machines on the same basis; that the rentals earned by a machine in this country were usually two to five times as large as its sales price abroad; and that in 1948 alone the Corporation reported rentals of $ 355,982.28 from these machines for which it agreed to pay $ 473,506. It may be admitted that without the licensing agreement the machines would not have had the value stated in the purchase agreement. But the fact that a portion of the value of the machines arises because there is present a patent monopoly is no reason to reduce the value of the machines as such and attribute the reduction to the patent. The Supreme Court, in Susquehanna Co.v. Tax Comm. (No. 1), 283 U.S. 291">283 U.S. 291, has made it clear that where the value of physical property has been enhanced by reason of the presence of an intangible *452 legal interest, nevertheless the enhanced value still adheres to the property. It is *61 our opinion that the value of the 56 machines in the purchase agreement of January 1948 was not in excess of the fair market value of such machines. It follows that the price the Corporation agreed to pay constitutes a bona fide indebtedness of the Corporation.
On the basis of our holding under the principal issue, we think it follows without any further discussion that the three subsidiary issues must be decided in favor of petitioners and we so hold.
Decisions will be entered under Rule 50.
Footnotes
1. Proceedings of the following petitioners are consolidated herewith: Lewis Perrault and Eda Belle Perrault, Docket No. 40669, and Perrault Brothers, Inc., Docket No. 40670.↩
2. The balance sheet of the corporation as of December 31, 1948, shows only $ 21,391.35 was accrued as interest.↩
3. SEC. 112. RECOGNITION OF GAIN OR LOSS.
(b) Exchanges Solely in Kind.
* * * *
(5) Transfer to corporation controlled by transferor. -- No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.↩
4. SEC. 115. DISTRIBUTION BY CORPORATIONS.
(a) Definition of Dividend. -- The term "dividend" when used in this chapter * * * means any distribution made by a corporation to its shareholders, whether in money or in other property, (1) out of its earnings or profits accumulated after February 28, 1913, or (2) out of the earnings or profits of the taxable year (computed as of the close of the taxable year without diminution by reason of any distributions made during the taxable year), without regard to the amount of the earnings and profits at the time the distribution was made.↩
5. SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
* * * *
(b) Interest. -- All interest paid or accrued within the taxable year on indebtedness * * *↩
6. SEC. 114. BASIS FOR DEPRECIATION AND DEPLETION.
(a) Basis for Depreciation. -- The basis upon which exhaustion, wear and tear, and obsolescence are to be allowed in respect of any property shall be the adjusted basis provided in section 113 (b) for the purpose of determining the gain upon the sale or other disposition of such property.
SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS.
(a) Basis (Unadjusted) of Property. -- The basis of property shall be the cost of such property; except that --
* * * *
(8) Property acquired by issuance of stock or as paid-in surplus. -- If the property was acquired after December 31, 1920, by a corporation --
(A) by the issuance of its stock or securities in connection with a transaction described in section 112 (b) (5) * * *, or
(B) as paid-in surplus or as a contribution to capital,
then the basis shall be the same as it would be in the hands of the transferor * * *
* * * *
(b) Adjusted Basis. -- The adjusted basis for determining the gain or loss from the sale or other disposition of property, whenever acquired, shall be the basis determined under subsection (a), adjusted as hereinafter provided.↩