*293 Decision will be entered under Rule 50.
1. The majority stockholders of the petitioner, which was engaged in the business of furnishing supplies, materials and a training base for the Civil Air Patrol, organized a partnership which took over the petitioner's operating activities. Held, the respondent erred in refusing to recognize the partnership for tax purposes, and in holding the petitioner taxable on the net income of the partnership either under section 22 (a) or section 45, Internal Revenue Code.
2. Held, further, there being no excess profits tax due for 1943, the petitioner is not subject to the 25 per cent delinquency penalty prescribed by section 291, Internal Revenue Code, for failure to file an excess profits tax return for that year.
3. Held, further, rental payments to the petitioner used to finance the construction of an airplane hangar on an airport leased to the petitioner by the County of Palm Beach, Florida, was taxable income to the petitioner.
*1170 The respondent has determined the following deficiencies in petitioner's income and excess profits tax:
| Declared value | Excess profits | |||
| Year | Income tax | excess-profits | tax | 25% penalty |
| tax | ||||
| 1942 | $ 4,583.27 | |||
| 1943 | $ 1,790.11 | $ 1,807.59 | 8,421.42 | $ 2,105.35 |
| 1944 | 1,542.98 | 76.68 | ||
| 1945 | 681.91 | |||
| 1946 | 21,777.90 |
Petitioner contests those deficiencies which result from the respondent's determination that (1) the income reported*295 by a partnership known as Lantana Aero Company for the years 1942 through 1946 is taxable to the petitioner; (2) the sum of $ 50,000 paid to the petitioner in the taxable years 1946 to 1948 was taxable income in 1946; (3) the petitioner is liable for the 25 per cent delinquency penalty prescribed by section 291 of the Internal Revenue Code for failure to file an excess profits tax return for the taxable year 1943. Other issues raised by the pleadings either have been settled by the parties or are dependent upon the resolution of the first issue mentioned above and by agreement of the parties will be settled under Rule 50.
FINDINGS OF FACT.
The petitioner is a Florida corporation organized in 1937 and has its principal place of business at West Palm Beach, Florida. Its income tax returns for the taxable years 1942 through 1946 were filed with the collector of internal revenue for the district of Florida. Its income was computed and reported on a calendar year and on an accrual basis.
From the time of its organization until December 1, 1941, the petitioner was engaged in the business of conducting a fixed-base operation for the servicing and maintenance of private aircraft and for*296 the sale of airplane parts, gasoline and oil. It conducted its operations at Morrison Field in West Palm Beach, Florida.
Shortly after the formation of the Civil Air Patrol, hereinafter referred to as the C. A. P., on December 1, 1941, the petitioner furnished *1171 supplies and materials and a training base for the C. A. P. program. All of petitioner's stockholders became active in that program since they operated private aircraft and were qualified in aviation. By the beginning of 1942, the petitioner's entire activity was centered on the operation of the C. A. P. program. In the early part of that year, C. A. P. and the petitioner were moved from Morrison Field to Lantana, Florida. The petitioner thereupon conducted its operations from Lantana Airport which it had leased from Palm Beach County on March 23, 1942.
Wiley Reynolds, Jr., and H. H. Basset, the two minority stockholders, each of whom owned five shares in the petitioner corporation, were opposed to the petitioner engaging in this wartime activity. In addition, Wright Vermilya, Jr., hereinafter referred to as Vermilya, the president of the corporation and the commanding officer of the C. A. P. unit, thought it*297 would be in the best interests of the corporation and the war effort to remove these operations from the corporation. He was of the view that if these operations were conducted by a partnership, there would be greater freedom of action in making and carrying out decisions and also it would be easier to comply with the secrecy restrictions necessitated by the war. For these reasons and not for the purpose of avoiding taxes, Vermilya requested and the majority stockholders agreed to the formation of a partnership which would conduct the operating activities theretofore conducted by the petitioner corporation.
On November 15, 1942, a partnership known as Lantana Aero Company, hereinafter referred to as the partnership, was formed for the purpose of managing an airport; providing airplane service, storage and repairs; selling gasoline, oil, airplanes and parts; providing flying instructions; and for other related activities. The partnership engaged in these activities until dissolved in 1946.
The partnership was composed of the majority stockholders of the petitioner corporation. Their proportionate interests in the partnership and in the 100 shares of outstanding capital stock of*298 the petitioner corporation were as follows:
| Interest in petitioner | |||
| Interest in | corporation | ||
| Member | partnership | ||
| (per cent) | |||
| Per cent | Shares | ||
| Wright Vermilya, Jr | 20 | 18 | |
| Theodore Hardeen, Jr | 20 | 18 | |
| Mary B. Donnelley | 20 | 18 | |
| Thorne Donnelley | 40 | 36 |
Wiley Reynolds, Jr., and H. H. Basset, the minority shareholders who held the remaining 10 shares did not become members of the partnership *1172 because of the objection of Wiley Reynolds, Sr., who was president of a bank in which these minority shareholders were officers and directors. On February 15, 1943, Wiley Reynolds, Jr., sold his five shares in the petitioner corporation to James P. Donahue.
The partnership on the date of its formation purchased on credit the petitioner's inventory of gasoline, oil, parts, and supplies for a total sum of $ 6,890.84, which represented the cost of these assets to the petitioner. The liability was recorded in the partnership books as an accounts payable and was discharged in later years. No capital was contributed to the partnership by any of its members.
On November 15, 1942, the partnership subleased from the petitioner Lantana Airport, together with all improvements*299 thereon, for a term of 1 year, renewable at the option of the lessee for a like period at the end of every term. The partnership was to pay to the petitioner as rental an amount equal to 10 per cent of its net profits and, in addition, was to pay the $ 500 annual rent due from petitioner to Palm Beach County, the original lessor. During the years in question, the partnership paid the rent based on the percentage of profit but did not pay the rent due to Palm Beach County.
The partnership maintained separate books of account and a separate bank account and was registered under the Florida Fictitious Name statute. It had printed and used bills, invoices and letterheads with the name "Lantana Aero Company" and conducted its operations under that name.
The partnership was under the full time management of Vermilya. When it was first formed, Mary B. Donnelley, wife of Thorne Donnelley, performed such services as assembling emergency equipment, first aid kits, and supplies used in airplanes. Thorne Donnelley, who was on active duty in the Navy at a nearby station, was present at the place of business on several occasions to provide advice and financial support. In addition, he was*300 able to procure equipment for the partnership. Theodore Hardeen, Jr., who was stationed nearby at Morrison Field, was also present at the place of business on several occasions for consultation with Vermilya.
After the formation of the partnership, petitioner's activities were confined to the collection of rent from the partnership and from the United States Air Force, to which Morrison Field had been subleased. payment of rent to Palm Beach County, and collections on franchises for the exclusive sale and distribution of petroleum products which had been sold to Gulf Oil Corporation. Vermilya continued to serve as petitioner's president. The partnership employed as bookkeeper and stock records clerk the individual who had been employed by the petitioner in that capacity. The mechanics and maintenance personnel were employees of the C. A. P.
*1173 In 1946 the partnership was liquidated because of the cessation of C. A. P. activities. Its assets were sold to the petitioner on May 23, 1946, and the partnership was liquidated and dissolved as of June 30, 1946.
The assets sold to the petitioner and the liabilities of the partnership assumed by the petitioner were as follows: *301
| Assets | |
| Cash | $ 3,122.58 |
| Accounts receivable | 9,544.96 |
| Inventory -- gas and oil | 1,180.18 |
| Inventory -- parts and supplies | 12,837.29 |
| Prepaid insurance | 96.19 |
| Total | $ 26,781.20 |
| Liabilities | |
| Accounts payable | $ 6,693.61 |
| Reserve for taxes | 476.56 |
| Total | $ 7,170.17 |
For the $ 19,611.03 excess of assets received over liabilities assumed the petitioner issued notes payable in the following amounts:
| Payee | Amount |
| Wright Vermilya, Jr | $ 3,922.21 |
| Theodore Hardeen, Jr | 3,922.21 |
| Mary B. Donnelley | 3,922.20 |
| Thorne Donnelley | 7,844.41 |
| Total | $ 19,611.03 |
The notes were dated September 17, 1946, and were payable September 17, 1951, with interest at the rate of 3 per cent.
For the taxable period beginning November 15, 1942, and ending October 31, 1943, the fiscal years ended October 31, 1944, and October 31, 1945, and the taxable period beginning November 1, 1945, and ending June 30, 1946, the partnership's net profit as reported in its partnership information returns was $ 23,917.24, $ 4,210.18, $ 5,107.74, and $ 2,150.61, respectively.
The partners' distributable shares as reported by the partnership in its partnership information returns were:
| Nov. 15, 1942 to | Fiscal year | |
| Member | Oct. 31, 1943 | Oct. 31, 1944 |
| Thorne Donnelley | $ 9,566.89 | $ 1,582.82 |
| Mary B. Donnelley | 4,783.45 | 791.41 |
| Theodore Hardeen, Jr | 4,783.45 | 791.40 |
| Whight Vermilya, Jr | 4,783.45 | 1,044.55 |
| Total | $ 23,917.24 | $ 4,210.18 |
| Fiscal year | Nov. 1, 1945 to | |
| Member | Oct. 31, 1945 | Mar. 30, 1946 |
| Thorne Donnelley | $ 1,941.84 | $ 755.68 |
| Mary B. Donnelley | 970.92 | 377.84 |
| Theodore Hardeen, Jr | 970.91 | 377.83 |
| Whight Vermilya, Jr | 1,224.07 | 639.26 |
| Total | $ 5,107.74 | $ 2,150.61 |
*1174 During the calendar years 1943 through 1945, the partnership made the following cash distributions to its members:
| Member | 1943 | 1944 | 1945 |
| Wright Vermilya, Jr | $ 1,620 | $ 810 | $ 540 |
| Theodore Hardeen, Jr | 1,620 | 810 | 540 |
| Mary B. Donnelley | 1,620 | 810 | 540 |
| Thorne Donnelley | 3,240 | 1,620 | 1,080 |
H. H. Basset and James P. Donahue rendered services to the partnership and each received from the partnership as compensation the sums of $ 450, $ 225, and $ 150 during the respective years 1943, 1944, and 1945.
In a notice of deficiency dated May 26, 1949, the respondent determined that the income from the Lantana Aero Company was taxable to the petitioner in its entirety and explained as follows:
It has been determined that the income from the business conducted under the trade name of Lantana Aero Company is taxable to you in its entirety. Your contention that the income from the foregoing source represents partnership*303 income taxable to the members of an alleged partnership is denied.
The plan whereby the partnership undertook the operating activities and the petitioner retained its leasehold interests provided a logical, natural division of the petitioner's business into separable, independent and noncompeting units.
Throughout its existence the partnership was actively engaged in the development of a real, going business and actually earned the income it reported in its income tax returns. The partnership was bona fide and was so intended to be by its members who were acting with a business purpose when they executed the partnership agreement, on November 15, 1942.
The lease agreement pursuant to which the petitioner leased Lantana Airport from Palm Beach County on March 23, 1942, provided that in addition to the payment of $ 500 annually, the petitioner was obliged to construct at the airport an airplane hangar to cost not less than $ 20,000. The petitioner began the construction of the hangar in 1942 before the formation of the partnership and completed it in 1942, shortly after the partnership was formed. The lease agreement provided that title to the hangar was to vest in the county*304 of Palm Beach upon termination of the lease.
The lease gave the petitioner "the exclusive right and privilege to select, designate and use, both for wholesale and retail sale and distribution, the aviation petroleum products of any manufacturer or refiner of aviation petroleum products, and the aviation petroleum products of the manufacturer or refiner so selected by the corporation shall be the only such products that shall be used on Lantana Airport *1175 by any of the tenants of the County who shall hereafter erect hangars or shops on said field, except, however, that this provision shall not include the United States Army, Navy, Marine Corps, or Coast Guard, or the Eastern Airlines or any other governmental licensed commercial air line." The right to designate the wholesale distributor of petroleum products was reserved by the petitioner in its sublease of the airport to the partnership.
On May 22, 1946, the petitioner gave the Gulf Oil Corporation (hereinafter referred to as Gulf) the exclusive right for 16 years to store, sell and distribute petroleum products at Lantana Airport. As consideration, Gulf agreed to pay the petitioner a total rental of $ 50,000. Gulf further*305 agreed to assist in financing the cost of a second hangar which the petitioner was permitted to construct by the terms of its lease agreement with the county of Palm Beach. Gulf agreed to make partial advances of the total rental upon receipt of invoices from the contractors and suppliers of materials or progress reports which were approved by the petitioner and the county engineer on behalf of the City of Palm Beach.
After the execution of this agreement with Gulf, the petitioner commenced the construction of the second hangar at the Lantana Airport, and Gulf made the payments agreed to by honoring drafts drawn on it by the petitioner through a bank in Atlanta. Invoices approved in the manner agreed to were attached to the drafts. Gulf made no attempt to supervise the construction, but did require that the invoices be approved in the manner agreed to before honoring the drafts.
Pursuant to its agreement with Gulf, the petitioner received the following sums during the years 1946 through 1948:
| Year | Amount |
| 1946 | $ 39,287.07 |
| 1947 | 9,610.21 |
| 1948 | 1,102.72 |
| Total | $ 50,000.00 |
The petitioner did not report any of these sums as income in its 1946 income tax return. The *306 petitioner did not file an excess profits tax return, Treasury Department Form 1121, for the taxable years 1943 through 1945.
The sum of $ 39,287.07 received by the petitioner from the Gulf Oil Corporation in 1946 constituted taxable income in that year.
OPINION.
We find no merit in the respondent's contention that the partnership formed by petitioner's majority stockholders was a sham and that its income should be attributed to the petitioner for tax purposes. There is sufficient evidence to establish that the partnership *1176 was a bona fide business organization, in substance as well as form, which should not be ignored for tax purposes. Respondent recognizes the well-established principle that a taxpayer may adopt any form of doing business that he chooses and is not required to conduct his business affairs in the form most advantageous to the revenue. Higgins v. Smith, 308 U.S. 473">308 U.S. 473; Seminole Flavor Co., 4 T.C. 1215">4 T. C. 1215.
The partnership was formed for a legitimate business purpose. Cf. Buffalo Meter Co., 10 T. C. 83. Vermilya, a majority stockholder and president of the petitioner*307 corporation entrusted with the management of its operating activities, desired greater freedom of action, especially since it became increasingly apparent that two of the remaining majority stockholders would be called into military service and would, therefore, be unable to devote much time to the petitioner's affairs. Also, he thought the secrecy restrictions surrounding petitioner's activities could best be complied with under a partnership form of business. In addition, the two minority stockholders disapproved of the corporation engaging in military operations relating to the C. A. P. program.
The majority stockholders agreed to form a partnership, embodied that agreement in written articles of partnership, transferred the operating activities of the petitioner to the partnership, left the leasehold interests in the two airports with the petitioner, and conducted the partnership as a going concern. Cf. Twin Oaks Co. v. Commissioner, 183 F.2d 385">183 F. 2d 385. The transfer of the operating activities and the retention of the leaseholds was a natural division of the petitioner's interdependent activities. Cf. Buffalo Meter Co., supra.*308
The partnership functioned as an entire separate economic entity and operated independently of the petitioner. There was a complete shift of economic interests in the operating assets, the petitioner's inventories were sold to the partnership, and Lantana Airport was subleased to it, all for a fair consideration which reflected arm's length dealing. Cf. Buffalo Meter Co., supra.The partnership assumed a trade name different from that of the petitioner; was registered under the fictitious name statute of Florida; used invoices, bills and letterheads bearing the partnership name, and openly dealt as a partnership; maintained separate books of account and separate bank accounts which reflected the business transactions by the partnership and the income it earned. Cf. Denning & Co. v. Commissioner, 180 F.2d 288">180 F. 2d 288. The partners rendered services to the partnership and as members subjected themselves to unlimited personal liability. Cf. Twin Oaks Co. v. Commissioner, supra.
In view of these facts and other evidence submitted by the petitioner, it is our considered view that the partnership*309 was a bona fide business organization established for legitimate business purposes *1177 and operated independently of the petitioner. It, therefore, should be recognized for tax purposes. Section 22 (a), Internal Revenue Code. Twin Oaks Co. v. Commissioner, supra;Buffalo Meter Co., supra;Seminole Flavor Co., supra;Denning & Co. v. Commissioner, supra.
On brief, the respondent argued alternatively that "the partnership income was properly allocated to petitioner under section 45, Internal Revenue Code." The notice of deficiency does not state or indicate that the respondent made his determination under section 45 of the Code, 1 and the pleadings were not amended to invoke the application of that section. Cf. Gould-Mersereau Co., 21 B. T. A. 1316. Moreover, section 45 authorizes the Commissioner only to "distribute, apportion, or allocate gross income or deductions." The Commissioner has not done this. Instead, he has combined the net income of the partnership with the net income reported by the petitioner and has determined*310 a deficiency on the basis of the income that resulted. We have held that such a combining or consolidating of net income by the Commissioner is not authorized by section 45. Chelsea Products, Inc., 16 T. C. 840 (on appeal, C. A. 3). For these reasons, the respondent's determination cannot be sustained.
*311 The respondent asserted the 25 per cent delinquency penalty prescribed by section 291 of the Code against the petitioner for failure to file an excess profits tax return, Treasury Department Form 1121, for the taxable year 1943. However, the respondent on brief agrees that the petitioner is not liable for excess profits tax in 1943, if, as we have held, the partnership income is not attributed to the petitioner. Therefore, there being no tax due, there is no penalty for failure to file the return. F. Hunt Lowry, 11 B. T. A. 409.
The respondent in his pleadings alleged that the entire advance rental in the amount of $ 50,000 received by the petitioner from Gulf Oil Corporation during the years 1946 to 1948 was taxable income in 1946, but on brief concedes that only $ 39,287.07, the sum received in 1946, constitutes taxable income in that year. The petitioner does not deny the well established rule that prepaid rent which, as here, is received under a present claim of full ownership and subject to the *1178 lessor's unfettered control, is taxable income upon receipt. Gilken Corp., 10 T. C. 445, affd. 176 F. 2d 141;*312 Hirsch Improvement Co. v. Commissioner, 143 F. 2d 912, certiorari denied 323 U.S. 750">323 U.S. 750; Astor Holding Co. v. Commissioner, 135 F. 2d 47; Renwick v. United States, 87 F.2d 123">87 F. 2d 123; Commissioner v. Lyon, 97 F.2d 70">97 F. 2d 70, but nevertheless argues the payments are not taxable income because they were applied to the cost of constructing a hangar to which it never at any time had title. Hence, argues the petitioner, it received no benefit from the payments.
We find no merit in the petitioner's argument. The sums paid by the Gulf Oil Corporation to the petitioner were paid as rental pursuant to the agreement entered into with the petitioner. The fact that the petitioner saw fit to use the sums to finance the construction of a hangar cannot change the fact that they constituted rental income when received. We, therefore, hold that the sum of $ 39,287.07 received from the Gulf Oil Corporation in 1946 was taxable income to the petitioner in that year. Gilken Corp., supra;Hirsch Improvement Co. v. Commissioner, supra;*313 Astor Holding Co. v. Commissioner, supra;Renwick v. United States, supra;Commissioner v. Lyon, supra.
Decision will be entered under Rule 50.
Footnotes
1. SEC. 45. ALLOCATION OF INCOME AND DEDUCTIONS.
In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Commissioner is authorized to distribute, apportion, or allocate gross income or deductions between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses.
Section 128 (b) of the Revenue Act of 1943 amended section 45↩ of the Code by striking out the words "gross income or deductions" and inserting in lieu thereof "gross income, deductions, credits or allowances." This amendment was effective with respect to taxable years beginning after December 31, 1943. Section 128 (c), Revenue Act of 1943.