*143 Decision will be entered for the respondent.
On the record, held:
(1) The contested payments were distributions of profits to shareholders and therefore were not deductible as royalties or otherwise under section 23 (a) (1) (A) of the Internal Revenue Code.
(2) Petitioner is not entitled to add the amount of $ 12,500 to its equity invested capital under section 718 (a) (6) of the Internal Revenue Code.
*1199 Respondent has determined deficiencies for the taxable year*144 July 1 to December 31, 1942, and for the calendar year 1943 in the respective amounts of $ 67,469.33 and $ 85,416.42. Two issues are presented: (a) Whether claimed deductions of $ 19,185.25 and $ 37,584.60 for alleged royalties paid to petitioner's stockholders in the taxable years 1942 and 1943, respectively, were in fact royalties deductible under the provisions of section 23 (a) of the Internal Revenue Code, and (b) whether petitioner is entitled to add the amount of $ 12,500 to its equity invested capital under section 718 (a) (6) of the Internal Revenue Code.
FINDINGS OF FACT.
Ingle Coal Corporation, petitioner herein, is a corporation duly organized under the laws of the State of Indiana on June 30, 1942, for the purpose of mining coal. Its principal office is located at Elberfeld, Indiana. Its authorized capital stock consisted of 3,000 shares of common, with a par value of $ 100. Its returns for the years here involved were filed with the collector of internal revenue for the district of Indiana.
Ingle Coal Co., petitioner's predecessor, was incorporated under the laws of Indiana in September 1928. Its capital stock consisted of 2,000 shares, which, on June 30, 1942, *145 were owned as follows:
| Stockholder | Shares |
| owned | |
| Frances I. Bebb | 500 |
| Katherine I. Mitchell | 500 |
| David Ingle | 300 |
| David Ingle, Jr | 100 |
| Thomas H. Ingle | 100 |
| William D. Ingle | 250 |
| William D. Ingle, Jr | 50 |
| Kenneth R. Ingle | 50 |
| Jane Ingle Fleig | 50 |
| Bradford B. Ingle | 50 |
| Donald B. Ingle | 50 |
| Total | 2,000 |
*1200 Frances I. Bebb, Katherine I. Mitchell, David Ingle, and William D. Ingle are brothers and sisters. David Ingle, Jr., and Thomas H. Ingle are the children of David Ingle. William D. Ingle, Jr., Kenneth R. Ingle, Jane Ingle Fleig, Bradford B. Ingle, and Donald B. Ingle are the children of William D. Ingle.
Ingle Coal Co. was engaged in the business of mining coal on lands held under lease. The lands originally held were worked out by 1940. On June 11, 1940, a lease on certain coal lands located near Elberfeld, Indiana, was executed by one Wasson and his wife, as lessors, and the Ingle Coal Co., as lessee. Under this instrument the Wassons leased to the Ingle Coal Co. all of the mineable coal known as vein or seam No. 6, in and under certain real estate consisting of 1,839.50 acres in Warrick County, Indiana, for a term of 20 years, "and until the unmined and*146 mineable coal in said demised premises shall be exhausted." The lessee agreed to pay to the lessors a royalty of 5 cents per ton for each ton of merchantable coal mined pursuant to the terms of the contract.
A supplement to the aforementioned lease of June 11, 1940, was executed by the petitioner and the Wassons, extending the lease to 230 additional acres of adjacent land which had been acquired by the Wassons.
During the year 1940 the Ingle Coal Co. opened up what was known as the Ditney Hill Mine on the Wasson lands and installed modern mechanized equipment. The coal was of good quality and the seam was of substantial thickness and located at a depth below the surface permitting it to be mined by a drift opening and the coal to be removed by cars drawn up this incline, thus avoiding a large part of the expense entailed in the hoisting of coal in a shaft mine.
During the year 1940 and thereafter coal was produced from the Ditney Hill Mine as follows:
| By Ingle Coal Co.: | Tons | |
| 1940 | 31,028 | |
| 1941 | 419,824 | |
| 1942 (first 6 months) | 322,421 | |
| By Ingle Coal Corporation: | ||
| 1942 (last 6 months) | 383,705 | |
| 1943 | 751,692 | |
| 1944 | 933,719 | |
| 1945 | 818,531 | |
| 1946 | 711,091 |
The gross sales*147 of Ingle Coal Co. in 1940, 1941, and the six months ended June 30, 1942, were $ 77,795.17, $ 588,011.56, and $ 474,145.22, respectively. Said company paid royalties during these years under the lease executed June 11, 1940, in the amounts of $ 1,551.40, $ 20,991.22, and $ 16,121.05, respectively.
*1201 In the spring of 1942, the Binkley Coal Co. of Chicago, Illinois, made an offer of $ 1,000,000 for the assets of Ingle Coal Co. This offer was rejected, one of the reasons being the substantial amount of Federal income taxes which would result with respect to both the company and the stockholders individually if the properties were sold.
David Ingle, the president of the Ingle Coal Co., was at all times the controlling and dominant personality in its affairs and those of petitioner and was aware that if additional royalty deductions claimed in the return were allowed, the corporate tax would be reduced. Prior to June 30, 1942, the question of a possible additional royalty deduction under the Wasson lease was discussed by David Ingle with others.
Coal was in great demand in 1942, to and through 1945, and there was a steady increase in the price of coal through the war years, *148 beginning in 1940.
On June 25, 1942, the directors of the Ingle Coal Co. held a meeting the minutes of which evidence the fact that it was planned that the company would discontinue business in the near future and distribute its assets to its stockholders and a new corporation would be formed by them to be named the Ingle Coal Corporation. The president and secretary of the company were authorized by the directors to consent that the persons desiring to form a new corporation, known as the Ingle Coal Corporation, be allowed to do so by the Secretary of State of Indiana.
On June 30, 1942, the stockholders of the Ingle Coal Co. held a meeting, all stockholders being present in person or by proxy. Thirty minutes later the identical persons holding the stockholders' meeting of the Ingle Coal Co. held a directors' meeting of the Ingle Coal Corporation, petitioner herein. At the stockholders' meeting of the Ingle Coal Co. it was resolved that that company should discontinue business and all of its property and assets of every sort and description should be distributed to its stockholders or to their nominee or nominees in proportion to their respective stockholdings. The president and*149 the secretary of the Ingle Coal Co. were authorized and directed to make all necessary transfers, conveyances, and assignments. All of the stockholders of the Ingle Coal Co. agreed to accept the proposed distribution and individually authorized and directed that the property of the corporation be transferred and conveyed to the petitioner.
The aforementioned first meeting of the board of directors of the petitioner, held 30 minutes later, after going through the formal actions necessary in its organization and the election of its officers, received from the stockholders of the Ingle Coal Co. a formal proposition for the conveyance of all assets of the Ingle Coal Co. to petitioner in consideration of its issuance to the stockholders of the Ingle Coal Co. of 2,000 shares of the authorized capital stock of the new corporation *1202 in the exact proportion of the stock holdings of each in the Ingle Coal Co., the assumption by the new company of all the debts and liabilities of the old, and an agreement by the new company to pay to the stockholders of the Ingle Coal Co. an additional royalty of 5 cents per ton upon all coal produced, this royalty to be paid to each stockholder in*150 the proportion of his stockholdings in the Ingle Coal Co. The proposal further provided for the purchase by Frances I. Bebb, Katherine I. Mitchell, David Ingle, and William Ingle of 500 additional shares of petitioner, to be issued 125 shares to each individual, for the sum of $ 12,500 paid by each, such payment to be made by crediting on the principal of certain notes payable to each of these four individuals representing indebtedness to them by the Ingle Coal Co., which indebtedness was to be assumed by the petitioner.
The above proposal for the acquisition by the petitioner of the assets of the former business was immediately accepted by petitioner through its officers and directors and a resolution was adopted authorizing the issuance of the stock as proposed, together with the acceptance of the properties and the assumption of liabilities as agreed upon, and thereupon the petitioner, by its president and secretary, executed and delivered to each one of the stockholders of the Ingle Coal Co. a separate agreement reciting its obligation to make payment to each of the individual stockholders of the former Ingle Coal Co. of an additional royalty of 5 cents per ton on all coal mined, *151 such payments to be in proportion to their stockholdings in the former company.
Deeds and conveyances of all the properties of the Ingle Coal Co. had been prepared and executed by its officers and were thereupon delivered by them, as officers of the Ingle Coal Co., to themselves, as officers of the petitioner, and the president and secretary were directed to issue shares of stock of the new corporation as agreed upon. Thereupon the shares of stock were so issued, including 125 additional shares to each of the stockholders named above, and $ 12,500 was credited upon the note due each by the Ingle Coal Co.
It was never intended to discontinue mining the coal under the lease in question and it was intended that not the stockholders, but petitioner corporation, should continue to mine that coal. The series of transactions were not at arm's length and were integrated steps in a single plan.
No dividends were declared or paid pursuant to resolution by Ingle Coal Co. in the calendar years 1939, 1940, and 1941 and the first six months of 1942. No dividends were declared or paid pursuant to resolution by petitioner in the last six months of 1942 and the calendar year 1943. Petitioner had*152 accumulated earnings and profits per its books of $ 56,884.82 on December 31, 1942, and $ 209,797.78 on December 31, 1943.
*1203 On its Federal tax returns for the taxable years 1942 and 1943 the petitioner claimed deductions in the respective amounts of $ 38,370.50 and $ 75,169.20, under the designation "Royalties." Included in those amounts were the amounts of $ 19,185.25 and $ 37,584.60, respectively, paid or accrued to James R. and Charlotte E. Wasson, lessors, representing monthly payments at the rate of 5 cents per ton for each ton of coal mined. Also included in said amounts were the amounts of $ 19,185.25 and $ 37,584.60, respectively, representing payments made by petitioner by monthly checks drawn on the City National Bank, Evansville, Indiana, and payable to the order of "David or Kenneth R. Ingle, Agents." These checks were endorsed either by David Ingle or by Kenneth R. Ingle and deposited in the account "David or Kenneth R. Ingle, Agents" in the Old National Bank, Evansville, Indiana. Said amounts were subsequently paid out of said account to Frances I. Bebb, Katherine I. Mitchell, David Ingle, David Ingle, Jr., Thomas H. Ingle, William D. Ingle, William D. Ingle, *153 Jr., Kenneth R. Ingle, Jane I. Fleig, Bradford B. Ingle, and Donald B. Ingle, who were the sole stockholders of Ingle Coal Co. and also the sole stockholders of petitioner on June 30, 1942.
The same basis was used in the computation of the depreciation deduction by petitioner for the taxable years 1942 and 1943 in respect of the property acquired on June 30, 1942, as was used by the old company for this purpose. The Commissioner made no adjustment with respect to the use of the same basis by petitioner for depreciation purposes.
On June 30, 1942, the books of account of the old company listed as a liability an amount of $ 272,460.79 representing notes due to each of its four stockholders in the sum of $ 68,115.20 to each. It showed equity invested capital of $ 199,767.48. It was agreed as part of petitioner's incorporation that petitioner would issue to each of such stockholders stock of the par value of $ 12,500, or a total of $ 50,000, and in consideration therefor each of the stockholders would reduce his claim by an equivalent sum. Equity invested capital was thereby increased to $ 250,000 and borrowed capital was reduced to $ 222,460.79. The balance of the equity invested*154 capital of $ 1,143.72 for 1942 is not material.
In determining petitioner's excess profits credit based on invested capital under section 714 of the Internal Revenue Code, the respondent has allowed borrowed capital in the amount of $ 222,460.79 and equity invested capital in the amount of $ 251,143.72 for the taxable year 1942 and has allowed borrowed capital in the amount of $ 195,173.12 and equity invested capital in the amount of $ 285,597.85 for the taxable year 1943.
Respondent, in determining the deficiencies, disallowed as deductions the amounts of $ 19,185.25 and $ 37,584.60 paid by the petitioner *1204 to its stockholders for the taxable period July 1 to December 31, 1942, and the calendar year 1943, respectively.
Petitioner, in filing its tax returns, included in invested capital for 1942 and 1943, $ 50,000 representing the par value of stock issued to its four stockholders, as hereinabove detailed, and, in determining the deficiencies, respondent made no adjustment with respect to this inclusion. Petitioner did not include any additional amount in invested capital with respect to the aforesaid $ 50,000 within the purview of section 718 (a) (6) of the Internal Revenue*155 Code, and respondent, in determining the deficiencies, did not add to petitioner's invested capital any sum on account of the provisions of the cited section.
OPINION.
The petitioner deducted 5 cents a ton as royalties paid to its stockholders in the taxable year. The respondent disallowed the deduction. The petitioner now contends the payments are deductible either as royalties, or as ordinary and necessary expenses under section 23 (a) (1) (A) of the Internal Revenue Code.
No authority is needed for the statement that the mere designation of the payments as royalties does not legally characterize them as such. Nor does the fact that the written obligation of the petitioner might, at least under some circumstances, have compelled their payment by the petitioner. Interstate Transit Lines, 44 B. T. A. 957; affd., 130 Fed. (2d) 136; affd., 319 U.S. 590">319 U.S. 590. The question is whether, in fact, the payment was a deductible expense, as a royalty or otherwise, under the controlling statute. The answer to this question is, of course, purely factual.
In our opinion, the contested payments were neither royalties*156 nor ordinary and necessary expenses, and therefore, they are not deductible.
The series of transactions between the two corporations and the stockholders of the first appearing in the findings of fact were obviously not at arm's length. The predecessor corporation, Ingle Coal Co., under its lease with the owners of the coal, had the right for 20 years to mine the coal under that lease at a royalty of 5 cents per ton. It was never intended to discontinue mining the coal from the lease in question. And it was intended that not the stockholders, but the petitioner corporation, should mine it. The distribution of that lease to the stockholders of the predecessor corporation and the assumption of the liabilities under that lease, plus a contract to pay an additional 5-cent overriding "royalty" to the stockholders, were wholly unnecessary to continue the right to mine coal under the lease. Although an effort was made to establish, as consideration for this action, the desire of several of the stockholders to receive some interest in lieu of their stock holdings which would more certainly secure their *1205 income, we are not impressed either as to its factual accuracy or as*157 to the legal conclusion therefrom, since, assuming that was consideration, it did not pass to the corporation. The expected benefit to the corporation in a reduction of its taxes resulting from the deduction of the overriding "royalty," although a reason for the agreement, is not, in the present picture, consideration therefor. In effect, petitioner received from the old corporation, not its shareholders, just what the old corporation had, namely, the right to continue mining coal under the lease. This is so regardless of the possibly enforceable obligation of the petitioner corporation, as between it and the shareholders, to pay the overriding "royalty." Interstate Transit Lines, supra.In short, under no aspect of the evidence, have we found or can we find that the petitioner corporation intended to or did receive any actual consideration for agreeing to pay this additional five-cent "royalty." The series of transactions constituted integrated steps in a single plan and must be so considered for tax purposes, which resulted in an unnecessary "obligation" upon the part of petitioner to pay the so-called overriding "royalty." Commissioner v. Ashland Oil & Refining Co., 99 Fed. (2d) 588;*158 certiorari denied, 306 U.S. 661">306 U.S. 661; Diescher v. Commissioner, 110 Fed. (2d) 90; certiorari denied, 310 U.S. 650">310 U.S. 650; Helvering v. Alabama Asphaltic Limestone Co., 315 U.S. 179">315 U.S. 179; Heller v. Commissioner, 147 Fed. (2d) 376; certiorari denied, 325 U.S. 868">325 U.S. 868; Koppers Coal Co., 6 T. C. 1209. We think, under the circumstances, the payment of this additional 5 cents per ton as an overriding "royalty" was a distribution of corporate profits to the stockholders receiving the same and therefore was not a deductible expense, either as a "royalty" or otherwise. See also Atlantic Monthly Co., 5 T.C. 1025">5 T. C. 1025.
The second issue, also factual, is whether petitioner is entitled to add the sum of $ 12,500 to its equity invested capital pursuant to section 718 (a) (6) of the Internal Revenue Code. That section, in substance, allows an amount equal to 25 per centum of "new capital" for such day. "New capital" is defined as so much of the money or property paid in for*159 stock, or as paid in for surplus or as a contribution to capital, as was previously paid in during a taxable year beginning after December 31, 1940. There are certain limitations prescribed. The facts basing this issue show that the predecessor corporation, as of June 30, 1942, had an equity invested capital of $ 199,767.48 and an average borrowed capital of $ 272,460.79, representing notes held by four of its stockholders in the amount of $ 68,115.20 each. Petitioner, on acquiring the assets of the old corporation, assumed the liability of $ 272,460.79. As a part of petitioner's incorporation, the four stockholders agreed that petitioner should issue to each of them capital stock of the par value of $ 12,500 and, in consideration therefor, each of the four stockholders would reduce *1206 his claim of $ 68,115.20 by the amount of $ 12,500, thus reducing the indebtedness assumed by petitioner to $ 222,460.79 and increasing equity invested capital to $ 250,000. By amended petition, it is now contended by petitioner that the $ 50,000 additional capital issue to such stockholders, as aforesaid, constitutes "new capital" entitling it to an additional 25 per cent in its equity*160 invested capital under section 718 (a) (6) of the code. The respondent argues that, under the facts presented, the limitation prescribed in subparagraph (A) of that section becomes applicable and requires a denial of the 25 per cent addition to invested capital. Subparagraph (A) contains, inter alia, the following limitations:
(A) There shall not be included money or property paid in by a corporation in an exchange to which section 112 (b) (3), (4), (5) or (10), or so much of section 112 (c), (d), or (e) as refers to section 112 (b) (3), (4), (5), or (10) is applicable * * *.
At the culmination of the several integrated transactions detailed in the findings of fact, petitioner had acquired all the assets and had assumed all the liabilities of the predecessor company. In effect for present purposes, the old corporation dealt directly with the new corporation, petitioner. (See discussion on first point.) That petitioner may have picked up an additional liability in the process in the form of the overriding "royalty" does not change that conclusion. Except for the assumed liabilities, the consideration for this acquisition by petitioner was solely voting stock of petitioner. *161 After the acquisition, the shareholders of the predecessor, transferor, were in control of petitioner. As was always planned and intended, petitioner continued to operate the business of the predecessor company. Obviously therefore, we think, there was a statutory reorganization under section 112 (g) (1) (C) and (D) of the Internal Revenue Code at least. Helvering v. Alabama Asphaltic Limestone Co., supra;Survaunt v. Commissioner, 162 Fed. (2d) 753; Estate of John B. Lewis, 10 T. C. 1080. The old corporation, a party to the reorganization, exchanged property in pursuance of a plan of reorganization solely for stock or securities in petitioner, a party to the reorganization, and the transaction is within the purview of section 112 (b) (4), which is one of the sections specifically mentioned in subparagraph (A), limiting the application of the 25 per cent addition to invested capital allowed by section 718 (a) (6). The effect of these several transactions was that whatever money or property petitioner acquired under the reorganization was "paid in" by the old corporation. The $ 50,000*162 additional stock issued resulted from a mere adjustment of the borrowed capital, and it is not "new capital" within the purview of section 718 (a) (6). 1*1207 We conclude that petitioner's contention that it is entitled to add $ 12,500 to its invested capital under section 718 (a) (6) of the code is without merit.
Decision will be entered for the respondent.
Footnotes
1. "The Report of the Senate Finance Committee, when section 718 (a) was amended by the Revenue Act of 1941, incorporating the provision relative to "new capital" states in part:
"* * * These limitations are intended, in general, to prevent a taxpayer from treating as new capital amounts resulting from mere adjustments in the existing capital, including borrowed capital, of the taxpayer, or of a controlled group of corporations." [S. R. 673, part I, 77th Cong., 1st sess., p. 38.]↩