*787 SECTION 104, REVENUE ACT OF 1932. - On the facts, held that petitioner corporation, which was actively engaged in the business of managing and operating a group of banks in Pennsylvania, was not formed, nor during the taxable year 1932 availed of, for the Purpose, of preventing the imposition of the surtax upon its shareholders through the medium of accumulating its gains and profits.
*1108 This proceeding is for the redetermination of the deficiency in income tax for the year 1932 in the amount of $49,222.16. The sole issue for decision is whether or not petitioner is subject to tax for the year 1932 under the provisions of section 104 of the Revenue Act of 1932.
This case was submitted on a stipulation of facts signed by the parties and filed at the hearing, in addition to which there was adduced the oral testimony of one witness. The stipulation is here adopted in full as part of our findings of fact, but only so much will be set*788 forth herein, together with other facts established by the oral testimony, as we deem essential to a discussion of the issue presented.
FINDINGS OF FACT.
Petitioner is a Pennsylvania corporation, with its principal office at Pittsburgh. It was organized under the following circumstances: For some years prior to 1929 R. B. Mellon was principally engaged *1109 in the banking business. He was an officer and director of the Mellon National Bank of Pittsburgh, and a director in other banks and trust companies. He was also a director of many other corporations engaged in different lines of business. In the course of his business activities he accumulated stocks in numerous banks located generally within a radius of 50 miles of Pittsburgh. The customers of those banks depended upon the Mellon name for safety and for ability to withdraw their deposits when wanted. Because of his numerous activities R. B. Mellon was unable to supervise personally the management and control of the banks in which he was interested. On October 1, 1929, he engaged one F. R. Denton to formulate plans for an organization to supervise and coordinate the activities of those banks and to arrange*789 for the acquisition of stock in other banks within the same area. Mellon wished to have available a group of banks in western Pennsylvania in the event branch banking should be legalized. Denton was a man of many years banking experience and had been a national bank examiner for approximately seven years. In 1929, at the time of his employment by Mellon, he was employed in the office of the Comptroller of the Currency as Assistant Chief National Bank Examiner. Denton proceeded immediately to make an investigation of the various banks in which R. B. Mellon owned stock. It became apparent from this examination that some form of organization was necessary to supervise the Mellon banks, since it was impractical for Mellon in his individual capacity to do so. The formation of corporations to manage banks was a common practice at that time. Accordingly, Denton recommended to Mellon that such a corporation be formed to handle the reports, examinations, and other activities connected with the supervision and management of the banks in which Mellon owned, or contemplated purchasing, stock. Pursuant to such recommendation, the Mellbank Corporation was formed on December 12, 1929, with*790 an authorized capital stock of 1,000 shares, without par value but a stated capital of $100,000.
Shortly after engaging Denton, Mellon purchased 1,631 shares of stock of the Latrobe Trust Co. at a cost of $642,614. On or about December 20, 1929, Mellon paid $10,000 in cash and transferred the 1,631 shares of stock of the Latrobe Trust Co. to petitioner corporation in exchange for its entire capital stock. This transaction was entered on the books of petitioner as follows:
| 12/20/29 - Capital stock subscriptions | $10,000.00 | |
| Investments | 642,614.00 | |
| To Capital Stock | $100,000.00 | |
| Surplus paid-in | 552,614.00 | |
| Issue of 1,000 shares to R. B. Mellon for 1,631 shares of LatrobeTrust Company. |
*1110 The total investment of petitioner in the stock of Latrobe Trust Co. was reduced to $618,674 in 1930 by reason of a refund of $20,000 on the purchase price of the stock and a sale of 10 shares for $3,940.
R. B. Mellon continued as the sole stockholder of petitioner corporation until May 10, 1932, on which date he sold 50 percent of his stock to the Smithfield Securities Co. and transferred the remaining 50 percent, together with other securities, to the Aloxite*791 Corporation in exchange for the stock of the transferee. From that date until December 22, 1933, these two corporations were the sole stockholders of the petitioner.
During the calendar year 1930 Mellon contributed to the paid-in surplus of petitioner stocks of banks located at Braddock, Wilmerding, Pittsburgh, Ligonier, New Kensington and Ellwood City, Pennsylvania, which stocks were entered on the books of petitioner as a credit to paid-in surplus in the aggregate amount of $447,350.
During the calendar year 1930 R. B. Mellon contributed $3,890,639.17 in cash to the paid-in surplus of petitioner, including two contributions under date of December 31, 1930, in the respective amounts of $515,000 and $25,084.17. The contribution of $515,000 was originally in the form of a loan made to petitioner in September 1930 from the joint account of R. B. Mellon and A. W. Mellon, which was assumed by R. B. Mellon and canceled on December 31, 1930. The contribution of $25,084.17 resulted from the assumption or payment of expenses of the corporation by R. B. Mellon.
Substantially all of the above contributions were made for the purpose of enabling petitioner to purchase stocks of banks*792 located in the vicinity of Pittsburgh, Pennsylvania. Petitioner also borrowed $500,000 from the McClintic-Marshall Corporation on July 9, 1930, in order to purchase bank stocks.
During the calendar year 1930 petitioner purchased stocks of other banks, all located in Pennsylvania, at an aggregate cost of $4,558,675.
The total income of petitioner for the calendar year 1930 was $183,306.15, consisting of interest received in the amount of $3,773.65 and dividends on bank stocks of $179,532.50. The latter amount included $7,678.15 attributable to surplus accumulated prior to March 1, 1913. The total expenses of the corporation for 1930 amounted to $32,663.30. The excess of income over expenses was $150,642.85, from which was deducted organization expense of $1,301.30, leaving an earned surplus of $149,341.55. The net income of the corporation for the calendar year 1930 was $142,964.70.
At December 31, 1930, the assets of the petitioner corporation consisted of cash $15,245.72, and investments in bank stocks in the aggregate amount of $5,624,699. Its liabilities consisted of capital stock *1111 $100,000, paid-in surplus $4,890,603.17, earned surplus $149,341.55, and*793 notes payable $500,000.
The bank depression of 1931 and 1932 was very serious in the Pittsburgh territory. In the last half of 1931 banking troubles in the United States increased substantially. The foremost national bank of Chicago became involved in difficulties so that the other banks of Chicago absorbed its deposits and assets, following which a wave of fear of banks spread throughout the United States. Pittsburgh, as an industrial community, was particularly affected. In the fall of 1931 the failure of the Bank of Pittsburgh, which up to that time was the largest national bank in the United States to fail, resulted in the failure of some 10 to 15 other banks in Pittsburgh during the months immediately following. The average bank was hard pressed. This condition continued throughout 1931 and became worse in 1932, culminating in the National Bank Holiday in March 1933. Petitioner did not acquire any additional stock in banks during 1931 and 1932, other than those reorganized banks in which it already had an interest.
During the calendar year 1931 R. B. Mellon contributed $2,036,395.15 in cash to the paid-in surplus of petitioner. Approximately one-half of this contribution*794 was used by petitioner to purchase stocks of banks which had been organized to assume the liability of existing banks which were in failing circumstances. During the same year petitioner deposited an aggregate of $350,000 with affiliated banks, which amount remained outstanding at the close of 1931. These deposits were necessitated by the financial condition of the respective banks and were made to enable those banks to meet the demands for withdrawals of their deposits.
During the calendar year 1931 petitioner received total income of $179,529.69, consisting of interest in the amount of $571.69 and dividends in the amount of $178,958. It total expenses amounted to $60,962.83, leaving an excess of income over expenses in the amount of $118,566.86.
At December 31, 1931, the assets of petitioner consisted of cash $17,687.23, investments in bank stocks of $7,163,599, deposits with affiliated banks $350,000, notes receivable $1,000, and accounts receivable $3,870.50. Its liabilities consisted of balance due on subscription to stock of the National Bank of Charleroi & Trust Co. $241,250, capital stock $100,000, paid-in surplus $6,926,998.32, and earned surplus $267,908.41.
*795 On January 7, 1932, R. B. Mellon contributed $200,000 in cash to the paid-in surplus of petitioner corporation, which was used, together with funds on hand, to pay the balance of $241,250 due on the subscription to 1,930 shares of stock of the National Bank of Charleroi & Trust Co.
*1112 The aggregate deposits of $350,000 which petitioner had with affiliated banks were technically available for withdrawal, but were practically unavailable for that purpose, due to the fact that if they had been withdrawn the banks would have closed up. In 1931 there was a run on the Citizens National Bank of Washington, Pennsylvania, a member of the Mellbank group, and R. B. Mellon personally deposited in the bank over a million dollars in cash in order to meet the run on its deposits. A run was averted on another member bank only by placing a sign in the lobby that it was controlled by the Mellons.
During the calendar year 1932 banking conditions steadily declined. Numerous bank stocks were offered gratuitously to petitioner by stockholders who wished to be relieved of liability. Lack of funds prevented petitioner from undertaking to reorganize those banks, but R. B. Mellon gave instructions*796 that all deposits and other liabilities of the member banks were to be protected, irrespective of cost.
During the calendar year 1932 R. B. Mellon contributed to the paid-in surplus of petitioner bank stocks which were entered on petitioner's books at an aggregate of $1,187,043.73.
During the calendar year 1932 petitioner corporation derived total income of $136,918.48, consisting of interest received in the amount of $22,465.21, other income $270.77, and dividends received in the amount of $114,182.50. Its total expenses for that year amounted to $40,153.16; including Christmas gifts to employees in the amount of $1,679. The excess of income over expenses (per 90-day letter) was $98,444.32.
At December 31, 1932, petitioner had total assets of $9,132,255.61, consisting of cash $86,495.79, investments in bank stocks of $8,640,-142.93, deposits with affiliated banks $398,539.63, notes receivable $3,100, supplies $589.17, and accounts receivable in the amount of $3,388.09. Its liabilities consisted of loans payable $530,000, capital stock $100,000, paid-in surplus $8,187,581.68, and earned surplus $364,673.73.
During the calendar year 1932 petitioner deposited an aggregate*797 of $270,000 with affiliated banks. These deposits were necessitated by the financial condition of the respective banks, and, with the exception of the Forbes National Bank, were made to enable those banks to meet the demands for withdrawal of their funds. Of the total deposits of $270,000, the sum of $200,000 was deposited with Forbes National Bank in 1932. During the same year $176,460.37 of that sum was contributed by petitioner to the capital of the Forbes Bank in exchange for worthless assets of the latter, which were charged off as worthless in 1932, and the paid-in surplus of petitioner was correspondingly reduced.
*1113 The outstanding loans payable of petitioner corporation, aggregating $530,000 at the close of the calendar year 1932, were increased to $674,200 prior to May 31, 1933. On the latter date the Aloxite Corporation and Coalesced Co. each loaned to petitioner the sum of $1,250,000. The Aloxite Corporation and Smithfield Securities Co. were at that time the sole stockholders of petitioner, and the Coalesced Co. owned all the stock of the Smithfield Securities Co. The loans of May 31, 1933, were used in part to liquidate all loans payable to others than*798 the Aloxite Corporation and Coalesced Co., so that as of June 30, 1933, petitioner had outstanding loans payable aggregating $2,519,200, one-half of which was owing to the Aloxite Corporation and one-half to the Coalesced Co.
On June 30, 1933, petitioner corporation debited its paid-in surplus in the amount of $3,722,426.51 on account of depreciation in value of stocks of affiliated banks, and on October 10, 1933, for the same reason debited paid-in surplus in the amount of $500,000. On December 31, 1933, petitioner corporation debited its paid-in surplus in the amount of $76,196.84, representing an amount contributed to the Forbes National Bank on February 16, 1933, in exchange for worthless assets.
On June 30, 1933, petitioner transferred certain securities to the Aloxite Corporation and Smithfield Securities Co., in equal shares, for a total consideration of $1,045,450. That amount was applied to reduce the indebtedness of petitioner to the Aloxite Corporation and Coalesced Co. The balance of $1,473.750 owing to the Aloxite Corporation and Coalesced Co. was liquidated on June 30, 1933, by a capital contribution in that amount to petitioner by the Aloxite Corpration and*799 Smithfield Securities Co., in equal amounts. Additional capital contributions during the calendar year 1933 aggregated $700,000, making total capital contributions in that year of $2,173,750.
During the calendar year 1933 petitioner deposited an aggregate of $1,185,068.43 with affiliated banks. The total deposits outstanding at the close of the year aggregated $100,000. These deposits were necessitated by the financial condition of the respective banks, and, with the exception of the Forbes National Bank and the Logan National Bank & Trust Co., were made to enable the banks to meet demends for the withdrawal of funds. On August 29, 1933, a deposit of $175,000 which petitioner had in the People's National Bank (Ellwood City) was applied to a subscription to 250 shares of that bank's stock at a price far in excess of its value, in order to restore the capital of the bank.
During the calendar year 1933 petitioner contributed an aggregate of $1,439,281.76 to the capital of affiliated banks. These contributions were necessitated by the financial conditions of the respective banks and were made to restore the capital of those banks. In 1933 *1114 petitioner acquired stocks*800 of other banks at an aggregate cost of $1,498,381.
Petitioner received total income for the calendar year 1933 in the amount of $61,360.43, consisting of interest in the amount of $18,964.96, other income $2,377.55, and dividends on bank stocks in the amount of $40,017.92. Its total expenses amounted to $76,904.61. The excess of expenses over income was $15,544.18.
At December 31, 1933, petitioner had total assets of $6,461,838.66, consisting of cash $99,456.63, investments in bank stocks $6,233,653.71, deposits with affiliated banks $100,000, notes receivable $250, accounts receivable $21,692.33, supplies $1,859.34, furniture and fixtures $3,433.22, and office machines $1,493.43. Its liabilities consisted of group insurance 78 cents, capital stock $100,000, paid-in surplus $6,012,708.33, and earned surplus $349,129.55.
During the years 1930, 1931, and 1932 petitioner received total dividends on all stocks in the amounts of $179,532.50, $178,958, and $114,182.50, respectively. During the same years the dividends received on the stocks contributed by R. B. Mellon accounted to $36,631.50, $35,428, and $16,005.50, respectively.
Petitioner did not declare or pay any dividends*801 during the calendar years 1930, 1931, or 1932. In his Federal income tax return for the year 1930, R. B. Mellon, then the sole stockholder of petitioner, included $37,705.09 of the undistributed earnings of the corporation. In his income tax return for 1931, Mellon included $118,566.86 representing the amount of the entire undistributed earnings of petitioner corporation for that year.
In his individual income tax returns for 1930 and 1931 R. B. Mellon reported dividends on stocks of domestic corporations (exclusive of the undistributed earnings of petitioner) in the amounts of $5,637,554.60 and $4,852,809.16, respectively. For the years 1930 and 1931 R. B. Mellon paid Federal income taxes in the amounts of $684,118.32 and $835,269.45, respectively.
Petitioner is not a mere holding or investment company.
The gains and profits of petitioner had not been permitted to accumulate beyond the reasonable needs of its business in 1932.
Petitioner was not formed, or availed of during the year 1932, for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed.
*802 OPINION.
HILL: The sole issue for decision in this case is whether or not petitioner is subject to tax under section 104 of the Revenue Act of 1932. Respondent has determined that it is so taxable. Petitioner had no net income for 1932 ordinarily taxable to a corporation, but *1115 sustained a net loss in the amount of $15,738.18, as adjusted by respondent under section 21 of the applicable statute. In determining the deficiency respondent included in petitioner's income the amount of $114,182.50 representing dividends received in the taxable year, and thus computed net income of $98,444.32 under section 104(c). If petitioner is not within the purview of that section, there is no tax due.
Section 104(a) subjects any corporation to a tax equal to 50 per centum of its net income, in addition to the tax imposed by section 13, if it was formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of beiong divided or distributed. And subdivision (b) provides that the fact that any corporation is a mere holding or investment company, or that the gains*803 or profits are permitted to accumulate beyond the reasonable needs of the business, shall be prima facie evidence of a purpose to escape the surtax.
In the deficiency letter respondent held only that petitioner was "subject to taxation under the provisions of section 104 of the Revenue Act of 1932." It was not indicated whether such holding was based upon the premise that petitioner corporation was "formed" for the prohibited purpose, or that it was "availed of" in the taxable year for such purpose, or both; nor did the deficiency letter hold that petitioner was a "mere holding or investment company" or that its gains and profits had been permitted to accumulate beyond the reasonable needs of the business. On brief respondent urges all of these grounds in support of his determination. We shall, therefore, consider seriatim the various factors stated.
The first, and of primary importance, is whether or not petitioner was formed for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed. This question, we think, must be answered in the negative.
*804 At the time of the formation of petitioner on December 12, 1929, and until May 10, 1932, R. B. Mellon was its sole shareholder. For some years prior to 1929, Mellon had been engaged in the banking business, and had acquired stocks in numerous banks in the general vicinity of Pittsburgh, Pennsylvania. Because of his other activities Mellon was unable to supervise personally the management and control of the banks in which he was interested, and he also wished to have available a group of banks in western Pennsylvania in the event branch banking should be legalized. Accordingly, on October 1, 1929, Mellon engaged F. R. Denton to formulate plans for an organization to supervise and coordinate the activities of the banks in which he was already interested and to arrange for the acquisition of stock in *1116 other banks in the same area. Denton had had considerable banking experience, and had been a national bank examiner for about seven years. He was then Assistant Chief National Bank Examiner in the office of the Comptroller of the Currency. After making an investigation Denton recommended to Mellon the formation of a corporation to manage the banks in which Mellon owned, *805 or contemplated purchasing, stock. This was a common practice at that time. Pursuant to that recommendation, the Mellbank Corporation, petitioner herein, was organized.
Of course, the fact that petitioner was organized primarily for the purpose of managing a group of banks is not conclusive evidence that there was not also another purpose of its formation, namely, to enable Mellon to escape surtax, and petitioner has the burden of proving that there was no purpose to prevent the imposition of such tax. . However, Denton testified at considerable length and in detail concerning the situation which lead to the formation of the petitioner corporation. The actuating motives were ample to justify the organization of such a corporation, any they were business reasons, wholly unrelated to any purpose to prevent the imposition of the surtax upon Mellon, the corporation's sole stockholder. The matter of taxation was never mentioned. We find nothing in the record to justify our disbelieving Denton's testimony on this point, even if it can be said that he was an interested witness. *806 His testimony is not inconsistent with but is corroborated by other evidence. We have no hesitation in concluding that petitioner was not formed for the prohibited purpose. Cf. .
Was petitioner, during the taxable year, a mere holding or investment company, or were its gains and profits permitted to accumulate beyond the reasonable needs of its business? If so, such facts, or either of them, would constitute prima facie evidence of a purpose to escape the surtax. Obviously, petitioner was not a mere holding or investment company. It had no investments in, and was not holding any corporate stocks, other than stocks of its member banks, which was necessary to enable it to carry on its business of managing, supervising, and operating those banks. This appears, notwithstanding that Mellon owned large amounts of stocks in other corporations, as evidenced by the fact that in his individual returns for 1930 and 1931 he reported dividends in excess of $5,600,000 and $4,800,000, respectively.
Nor did petitioner accumulate its gains and profits beyond the reasonable needs of its business. On the contrary, it appears*807 from the facts found that such accumulation was greatly inadequate to meet such needs. Petitioner's purpose in carrying on such business was not to save its shareholders from surtax, as in , *1117 but to safeguard its investments in the stock of member banks with a view to increasing its gains and profits, some of which would be taxable to it upon receipt and all of which would be taxable upon distribution to its shareholders. We are clearly of the opinion that the evidence in this case does not raise any prima facie presumption of a purpose to escape surtax.
Was petitioner in fact availed of during the taxable year for the purpose of preventing the imposition of the surtax upon the shareholders through accumulation of its gains and profits? Its net accumulation of gains and profits for the taxable year was $98,444.32. Its failure to distribute thisd amount is the basis of respondent's determination of the deficiency. At the end of the taxable year petitioner's total earned surplus or total accumulation of gains and profits amounted to $364,673.73.
*808 The fact that Mellon transferred certain bank stocks to petitioner corporation had the actual effect of relieving him of the surtax which would have been attributable to the accumulated dividends if they had been distributed. "The statute, however, does not operate merely because of such actual effect; it operates if such effect was the purpose." ;; affd., ; And while it is reasonable to infer that the effect of a voluntary act is among the purposes of the actor, such presumption can not be indulged when the facts indicate otherwise.
What then are the facts in this case with respect to whether or not the gains and profits accumulated by petitioner in 1932 were beyond its reasonable business needs? At the close of the taxable year the bank depressuion was rapoidly approaching a crisis. It resulted in the National Bank Holiday in the early part of March 1933. Numerous banks failed in the Pittsburgh area. In the preceding year, 1931, there had been a run on the Citizens National Bank of Washington, *809 Pennsylvania, a member of the Mellbank group, and it was necessary for R. B. Mellon personally to deposit a million dollars in cash in that bank in order to meet the run on its deposit and prevent the closing of the bank. At the beginning of 1931 petitioner had only $17,687.23 in cash and little if any additional liquid assets. It was therefore unable to go to the aid of the Citizens National Bank. Again, on January 7, 1932, Mellon was required to contribute $200,000 in cash to the paid-in surplus of petitioner in order to enable petitioner to pay the balance due on its subscription to stock of one of its member banks being reorganized to prevent failure. During 1932 petitioner deposited $270,000 in the affiliated banks to enable them to meet demands for withdrawal of funds. In 1933 petitioner deposited in excess of $1,185.000 with affiliated banks to meet withdrawal of funds *1118 and thus prevent closing; and petitioner contributed more than $1,439,000 to the capital of affiliated banks necessitated by their financial condition. These funds were borrowed from petitioner's stockholders and increased its loans payable in 1933 to $3,174,200. In the same year petitioner's*810 paid-in surplus was reduced more than $4,000,000 on account of depreciation in value of the stocks it owned in member banks. During 1933 petitioner received total dividends of only $40,017.92 on investments in excess of $6,000,000 in bank stocks, and its operating expenses exceeded its total gross income by the amount of $15,544.18.
The history of petitioner's operations to the close of the taxable year 1932, its financial status at that time, together with the conditions in the banking business which might reasonably be anticipated for 1933, certainly rendered inadvisable the distribution of any portion of petitioner's current earnings. The amount accumulated was wholly inadequate to meet its reasonable and legitimate business needs. If there had been any distribution, it would have immediately become necessary for petitioner to borrow a corresponding amount, or for its stockholders to contribute such amont to paid-in surplus, in order to protect its business and prevent large losses of both capital and income. We hold, therefore, that petitioner was not availed of in the taxable year for the purpose of preventing the imposition of the surtax upon its shareholders through*811 the medium of permitting its gains and profits to accumulate instead of being divided or distributed.
Reviewed by the Board.
Judgment will be entered for the petitioner.