*213 Decision will be entered under Rule 50.
1. The petitioners owned one-third of the capital stock of Empire. Late in 1947 personal differences as to the manner of obtaining loans for Empire developed between petitioner Howard A. Jackson and Julius H. Cohn, another stockholder of Empire, who had voting control of one-half of its stock. Thereafter and until April 1949 Jackson's and Cohn's relationship became increasingly strained. About the middle of April 1949 Cohn indicated his possible approval, subject to the working out of details, of a plan to reorganize the affairs of Empire whereby approximately one-third of its assets, including such as Jackson might desire, would be taken out of Empire. This was the first time Cohn had indicated his willingness to accept a solution of the differences between him and Jackson. Thereafter, on April 20, Delaware was organized to acquire for its capital stock a portion of the assets of Empire, and to be managed solely by Jackson. On April 27 Empire, in exchange for all of the capital stock of Delaware, transferred one-third of its net assets to Delaware, which thereafter carried on business. In the meantime, Jackson conferred with his *214 then attorney, whom he had consulted at intervals since 1947 respecting his liability as sole personal guarantor on certain indebtedness of Empire. Pursuant to the attorney's advice, petitioners on April 21 organized Dumelle and on April 22 transferred their one-third of Empire's stock to Dumelle for all of its capital stock. On April 25 Dumelle accepted the offer of Belgrade, a corporation whose entire stock was owned by Mrs. Jackson and whose assets were less than $ 1,000, to purchase the one-third of Empire's stock for $ 470,000, payable $ 1,000 cash and $ 469,000 in installments over a long period of years. Pursuant to the settlement of the remaining matters of friction between Jackson and Cohn the one-third of Empire's stock was surrendered to Empire on April 29, 1949, in exchange for all of the stock of Delaware. Neither Dumelle nor Belgrade has ever carried on any business at any time. Held, that the corporate identities of Dumelle and Belgrade and the transactions by them involving Empire stock are to be disregarded. Held, further, that the corporate identity of Delaware is to be recognized and that petitioners realized long-term capital gain on the surrender *215 to Empire of one-third of its capital stock in exchange for all the capital stock of Delaware.
2. Held, that petitioner Howard A. Jackson did not receive any income in 1949 with respect to notes issued to him by Empire and the payment of which was assumed by Delaware.
*2 The respondent determined a deficiency of $ 153,121.86 in the income tax of the petitioners for 1949. The issues are the correctness of the respondent's action in determining that during 1949 a certain corporation distributed one-third of its net assets to petitioners in exchange for their one-third stock in it and that as the result of the distribution the petitioners during 1949 (1) *216 realized capital gain of $ 469,333.34 on stock of the corporation, (2) realized capital gain of $ 69,580 on certain corporate stock sold to the distributing corporation in 1946, and (3) realized capital gain of $ 74,118.13 on other corporate stock sold to the distributing corporation in 1947.
FINDINGS OF FACT.
Some of the facts have been stipulated and are found accordingly.
The petitioners are husband and wife and reside in St. Thomas, Virgin Islands. They filed with the collector of internal revenue for the second district of New York a joint income tax return for 1949 showing thereon net income of $ 28,882.35 and a tax liability of $ 5,906.90.
At the beginning of 1949 and for several years prior thereto, Howard A. Jackson was a partner with Julius H. Cohn, Sidney E. Harris, and three other unrelated individuals in the accounting firm of J. H. Cohn & Co., which had offices in Newark, New Jersey, and New York, New York. Jackson's duties with the partnership were primarily those of business counsel to the firm's clients, advising them on financing, corporate reorganizations, and similar matters.
For some time prior to 1949 Jackson, Cohn, and Harris had also engaged in various business*217 ventures together. These ventures were mainly centered in Empire Industries, Inc., sometimes hereinafter referred to as Empire, a Delaware corporation organized in 1946.
Initially, Empire's total authorized capital stock of 50,000 shares was held as follows:
| Number of shares | |
| Howard A. Jackson | 12,500 |
| Elizabeth D. Jackson | 4,166 2/3 |
| Sidney E. Harris | 12,500 |
| Mrs. Harris (wife of Sidney E. Harris) | 4,166 2/3 |
| Julius H. Cohn and family | 16,666 2/3 |
| Total | 50,000 |
*3 In the early part of 1947 Empire was recapitalized and its capital stock increased to 200,000 shares. The increase in stock was distributed to its stockholders pro rata so that the proportionate interests of the Jackson, Harris, and Cohn families remained the same. After the recapitalization of Empire its capital stock was held as follows:
| Number of shares | |
| Howard A. Jackson | 50,000 |
| Elizabeth D. Jackson | 16,666 2/3 |
| Sidney E. Harris | 50,000 |
| Mrs. Harris (wife of Sidney E. Harris | 16,666 2/3 |
| Julius H. Cohn and family | 66,666 2/3 |
The shares of Empire stock owned by Mrs. Jackson, Mrs. Harris, Mrs. Cohn, and the Cohn children, both before and after the recapitalization, were represented*218 by voting trust certificates, issued under a voting trust agreement, dated June 16, 1947, pursuant to which Julius H. Cohn was named sole voting trustee. The voting trust agreement was in effect through April 1949. By reason of the shares he owned personally in Empire and the voting rights he had under the voting trust agreement, Julius H. Cohn controlled the voting rights of one-half of the stock in Empire.
At the time it was organized in 1946 Empire acquired a steel fabricating plant in Decatur, Alabama, and the stock of a subsidiary company with operations in Helena, Arkansas, and the stock of another subsidiary company with operations in Memphis, Tennessee. These subsidiary companies and another subsidiary company, which operated in New York, New York, and whose stock, thereafter and prior to 1949, was acquired by Empire, engaged in the distribution of industrial mill supplies. Other assets acquired by Empire prior to 1949 were a plant in which narrow gauge railroad cars were made for the lumbering and mining industries and a pump manufacturing plant in Shippensburg, Pennsylvania.
In addition to the foregoing, Empire, in 1946, purchased all the capital stock of Charles J. *219 Tagliabu Manufacturing Company from Jackson, Cohn, and Harris. Jackson had purchased 1,125 shares of the stock of that company on January 15, 1945, for $ 3,422.73 and sold them to Empire in 1946 at a total selling price of $ 82,788.07, payable as follows: $ 12,788.07 in cash and promissory notes, totaling $ 70,000, payable over the period ending June 1, 1948. In 1947, because certain liabilities of Tagliabu were assumed by Empire, the selling price of $ 82,788.07 was reduced to $ 72,788.07. The reduction was effected by Jackson surrendering to Empire, for cancellation, notes in the amount of $ 10,000. Jackson reported the gain from the sale of the Tagliabu stock on the installment basis in his income tax return for 1946.
*4 During 1947 Empire purchased all the capital stock of Flextite, Inc. One-sixth of that stock was purchased from Jackson on June 23, 1947, for $ 83,333.33, of which $ 6,266.66 was paid in cash and the balance of $ 77,066.67 was represented by promissory notes maturing over a period of 5 years. Jackson had acquired his one-sixth of the stock on November 22, 1946, at a cost of $ 166.66. In his 1947 income tax return he reported on the installment basis the*220 gain from the sale.
From the time of its organization in 1946 until April 29, 1949, Jackson was president of Empire, Harris was vice president, and Cohn was chairman of the board of directors. However, Jackson was the only one who actively participated in the management and direction of the affairs of Empire and its subsidiaries and during the 2 years prior to 1949 devoted about 80 per cent or more of his time to such activities.
Every undertaking entered into by Jackson, Cohn, and Harris, whether for the account of the partnership, or for Empire, or for themselves individually, was financed primarily with borrowed money. In the case of each loan, Jackson had been the sole, personal guarantor of the repayment of the borrowed funds. As a result, by the end of 1947 he was personal guarantor on indebtedness approximating 3 to 4 million dollars. However, Jackson's remuneration for his services and guarantees in connection with his association with Cohn and Harris in the various enterprises consisted solely of his distributive share of the profits earned by the accounting partnership.
Throughout the period 1946 through April 29, 1949, Harris remained on friendly terms with Jackson *221 and with Cohn. However, by the end of 1947 Jackson's relationship with Cohn had become strained. The difficulties Jackson experienced with Cohn arose principally from the personal guarantees given by Jackson.
In November 1947 Jackson had nearly completed negotiations for the acquisition of the stock of Connor Steel Company, which owned a steel-producing plant located in Birmingham, Alabama. This company was considered by Jackson as representing a very vital link in the activities conducted by Empire since Empire's other corporations were either distributors or consumers of steel. Jackson thereupon came to New York to make arrangements for a loan of $ 150,000 from the Bank of Manhattan Company in order to finance the acquisition of the stock of Connor Steel Company. The bank agreed to advance the money to Empire upon Jackson's personal guarantee. However, Jackson was unwilling to further increase his personal guarantees for the benefit of Cohn and Harris. Jackson then had a meeting with Cohn at which he explained the present status of the negotiations and stated that he would give his several guarantee for one-third of the proposed loan if Cohn and Harris would do likewise. *222 *5 Cohn refused to become a direct obligor on the loan. Thereupon, the meeting became extremely bitter and Jackson informed Cohn that he no longer proposed to take all of the risks and only a part of the profits and stated that he would acquire the Connor Steel Company on his own account. Cohn replied that he would do everything to prevent such action on the part of Jackson and reminded Jackson of the partnership agreement which precluded such independent action. At this juncture the meeting ended.
Jackson had given two personal guarantees to the Continental Bank and Trust Company in November 1946 with respect to a loan of $ 2,200,000 made to Flextite, Inc. Both Cohn and Harris had agreed to indemnify Jackson to the extent of one-third of any loss sustained by Jackson as a result of said guarantees. However, Jackson had become concerned about the two guarantees and consulted with his own counsel, Cornell Dikeman, midway of 1947 in an effort to explore the possibility of minimizing his liability on them. On December 10, 1947, Jackson wrote a letter to Lauson Stone, counsel for Empire, asking him to effectuate a reduction on these two guarantees. In addition, Jackson again*223 consulted Dikeman to see if it were possible to so arrange his affairs that his then assets would remain subject to the claims of his creditors but that any future increase in his net worth would inure to his wife and children. Jackson felt that if he should die at that time, the guarantees which he had given in connection with the various enterprises of Empire would act to tie up his estate leaving his family without any income. However, Dikeman did not make any recommendations to Jackson at this conference.
During 1948 and the early part of 1949, Jackson's relationship with Cohn became increasingly strained as a result of which Cohn and Harris began to take an active role in the affairs of Empire. Also, during this same period, Harris and Jackson conferred at various times in an effort to formulate a plan which would amicably resolve the differences between Cohn and Jackson.
During the weekend preceding Monday, April 11, 1949, Cohn, Mrs. Cohn, and at least one of their children had extended meetings with Harris respecting a settlement of the differences existing between Cohn and Jackson. During the morning of April 11, Harris, from his office in Newark, called Jackson at his*224 office, which was also the office of Empire, and made an appointment for a conference between them at Jackson's office later that morning. Harris' purpose in having the conference, which followed, was to consider the possibility of effecting a reorganization of the affairs of Empire by which Jackson could sever his interest in Empire since "patching up the quarrel" between Cohn and Jackson was no longer possible. During the ensuing conference Harris and Jackson made an appraisal of the *6 various assets of Empire, had a discussion as to what assets, comprising approximately one-third of the total book value of the assets or value as appraised by them, Jackson would desire in event of a split-up of Empire, and agreed to a division of Empire's assets in the manner they had discussed, provided Cohn was agreeable. Following a telephone call to him by Harris, Cohn joined the conference. After it had been explained to him how the proposed settlement had been arrived at, Cohn indicated his possible approval provided the various details involved could be worked out. This was the first time Cohn had given any indication to Jackson of his willingness to accept a solution of their *225 personal differences.
The next day, April 12, Jackson consulted with Dikeman and informed him of what had happened and the possibility of reaching a final agreement with Cohn. They again discussed Jackson's liabilities as guarantor and his personal estate problem with respect to his family. However, no definite plans were suggested or considered since Jackson had to leave for Memphis.
After his return and about April 18, Jackson again consulted Dikeman. At that time Dikeman recommended the following: (1) That petitioners organize a new corporation and transfer all of their Empire stock to it, and (2) that the new corporation then sell the stock in Empire to Belgrade Properties, Inc., sometimes hereinafter called Belgrade, and hereinafter referred to more fully. Dikeman advised Jackson that the proposed series of transactions would assure sufficient assets in Jackson to cover his personal guarantees and accomplish his objective of enhancing his wife's net worth.
Prior to April 20, 1949, Jackson and Harris discussed the question of the formation of a corporation, to which Empire would transfer a portion of its assets in effecting a reorganization of its affairs, the stock of which*226 would be owned by Empire, but the sole management of which corporation would be in the hands of Jackson without any participation by Cohn or Harris. Pursuant to such discussion, Lewis of Delaware, Inc., sometimes hereinafter referred to as Delaware, was organized on April 20, 1949. The office of Delaware was at the same place as Jackson's office, which also was the place of Empire's office.
Thereafter and on April 21, 1949, the petitioners organized the Dumelle Corporation, sometimes hereinafter called Dumelle, under the laws of Delaware, and Jackson became its president and treasurer. The following day, April 22, 1949, the petitioners transferred to Dumelle all of their shares of stock in Empire, i. e., 66,666 2/3 shares, for all of the stock of Dumelle. This exchange was in proportionate interest, and thereafter Jackson owned three-fourths of the stock of Dumelle and Mrs. Jackson owned one-fourth of its stock. The basis *7 of the 66,666 2/3 shares of the stock of Empire in the hands of Dumelle was $ 666.66, the same basis as in the hands of the petitioners.
Belgrade had been incorporated on July 29, 1947, under the laws of Delaware. All of the capital stock of Belgrade*227 was, and is, owned by Mrs. Jackson. She is the president of Belgrade and Jackson is vice president.
The balance sheet of Belgrade as of October 31, 1948, disclosed the following:
| Assets | Liabilities and capital | ||
| Receivables | $ 844.08 | Common stock | $ 1,020 |
| Organization expense | 143.92 | Surplus (deficit) | (32) |
| $ 988.00 | $ 988 |
There was no material change in the financial condition of Belgrade between October 31, 1948, and April 25, 1949.
On April 25, 1949, Belgrade offered to purchase from Dumelle for $ 470,000 the above-mentioned 66,666 2/3 shares of stock in Empire. The terms of payment as set out in the offer were as follows:
$ 1,000 in cash upon the transfer of said shares to us.
The balance of $ 469,000. to be payable in instalments, and the obligation to be represented by a serial instalment note, or, at your option, notes, providing for the payment of $ 22,500. on or before December 31, 1949, and the sum of $ 23,500. on or before the 31st day of December of each succeeding year until the said sum of $ 469,000.00 is paid in full. Interest shall be payable on the unpaid balances of such note or notes at the time of each principal payment, the rate of interest*228 to be 1-1/2% on all payments made on or before December 31, 1954; 2-3/4% on all payments made thereafter and on or before December 31, 1959; 4% on all payments made thereafter and on or before December 31, 1964 and 6% on all payments thereafter made.
On April 25, 1949, the board of directors of Dumelle met, Jackson being present, to consider the offer made by Belgrade for the purchase of the Empire stock. The minutes of the meeting recite the adoption of the following resolutions:
Resolved that the offer of BELGRADE PROPERTIES, INC. dated April 25, 1949 to purchase all of the right, title and interest of this Corporation in and to 66,666-2/3 shares of the capital stock of EMPIRE INDUSTRIES, INC. be and the same hereby is accepted;
Further Resolved that the officers of this Corporation be and they hereby are authorized to execute such instrument of transfer as may be necessary to assign and set over unto BELGRADE PROPERTIES, INC. all of the right, title and interest of this Corporation in and to said stock upon receiving the consideration therefor in the manner and upon the terms set forth in said offer;
Further Resolved that the expenses incident to this transfer be paid and, to *229 the extent required, charged to and paid by this Corporation;
Further Resolved that the said offer be affixed to these Minutes.
Under date of April 25, 1949, Dumelle executed an instrument reading as follows:
*8 Know All Men by These Presents that the undersigned, DUMELLE CORP., a Delaware Corporation, for valuable consideration to it in hand paid, has transferred, assigned and set over and does hereby transfer, assign and set over unto BELGRADE PROPERTIES, INC., a Delaware Corporation, all of the right, title and interest of this corporation in and to 66,666-2/3 shares of EMPIRE INDUSTRIES, INC., it being expressly understood that 16,666-2/3 of said shares are subject to the terms and provisions of a Voting Trust Agreement between certain of the stockholders of EMPIRE INDUSTRIES, INC. and JULIUS H. COHN, as Voting Trustee, a copy of which Voting Trust Agreement is on file at the Offices of EMPIRE INDUSTRIES, INC. * * *
In an income tax return filed for the fiscal year ended March 31, 1950, which was prepared on the basis of cash receipts and disbursements, Dumelle reported that in April 1949 it sold the 66,666 2/3 shares of stock in Empire to Belgrade for $ 1,000 in cash and *230 $ 469,000 in interest-bearing installment notes (neither the rate, or rates, of interest nor the maturity dates of the notes being shown), and that it thereby realized a gain of $ 469,333.34 which it was electing to report on the installment basis. A gain of $ 998.59 for 1949 was reported on the sale and an income tax of $ 167.71 was shown on the return. On its personal holding company return for the same year, a tax of $ 81.94 was shown.
On April 27, 1949, Jackson became president of Delaware, which had been organized a week earlier. Harris became vice president. Cohn became chairman of the board of directors. These were the same offices held by Jackson, Harris, and Cohn in Empire.
By an agreement dated April 27, 1949, Empire transferred to Delaware, in exchange for all of the latter's stock, net assets as follows:
| Assets transferred -- at cost to Empire: | ||
| Capital stock, Lewis Supply Co., Inc | $ 387,860.00 | |
| Capital stock, Lewis Supply Co., of Arkansas, Inc | 1,000.00 | |
| Net assets of Domestic Engine & Pump Division | 106,217.22 | |
| Prepaid interest -- Bank of Manhattan loan | 1,437.14 | |
| Prepaid interest -- H. A. Jackson | 2,396.00 | |
| Cash value of life insurance on H. A. Jackson | 897.00 | |
| Cadillac auto (net) | 1,380.07 | |
| Total assets transferred | $ 501,187.43 | |
| Liabilities assumed by Delaware: | ||
| Notes payable -- Bank of Manhattan Co | $ 185,000.00 | |
| Notes payable -- Howard A. Jackson | 144,266.66 | |
| Loan payable -- Lewis Supply Co., Inc | 6,500.00 | |
| Loan payable -- Lewis Supply Co. of Arkansas, Inc | 15,000.00 | |
| Account payable -- Howard A. Jackson | 4,848.62 | |
| Total liabilities assumed | $ 355,615.28 | |
| Net assets acquired by Delaware | $ 145,572.15 |
*231 *9 The foregoing assets were part of the assets which had been appraised by Jackson and Harris on April 11, 1949. They were selected for transfer to Delaware because the values at which they were transferred, less the amounts of the above-mentioned liabilities, approximately coincided with the Jackson family's one-third interest in the stock of Empire.
While the total cost to Empire of the above-mentioned assets transferred to Delaware exceeded by $ 145,572.15 the total liabilities of Empire assumed by Delaware, the total fair market value of such assets exceeded by $ 470,000 the total liabilities assumed.
Empire's notes to Jackson in the amount of $ 144,266.66, the payment of which Delaware assumed in the transfer, represented notes payable to Jackson as follows: $ 60,000 balance owing by Empire on its purchase of Tagliabu stock from Jackson, $ 77,066.66 balance owing by Empire on its purchase of Flextite stock from Jackson, and $ 7,200 owing on account of advances made by Jackson on behalf of Empire. Jackson had Delaware assume payment of these obligations because he "wasn't going to rely on Mr. Cohn to pay them off in view of the warfare that had gone on" between him and*232 Cohn. The notes in the amount of $ 185,000 owing by Empire to Bank of Manhattan Co., the payment of which Delaware assumed, had been guaranteed personally by Jackson. The reason Jackson had Delaware assume payment of the notes was to have them within his control so that he could see that they were paid in due course.
After the above-mentioned transfer of assets by Empire to Delaware there remained unsettled certain matters of friction between Cohn and Jackson. Negotiations for the settlement of these matters resulted in a settlement agreement between Cohn and Jackson on April 29, 1949, whereby on the same day the 66,666 2/3 shares of stock in Empire initially issued to petitioners were surrendered allegedly by Belgrade to Empire in exchange for all the capital of Delaware. The fair market value of the Delaware stock on April 29, 1949, was $ 470,000.
However, neither Harris nor Cohn knew of the existence of Dumelle or of Belgrade, and throughout the entire period of negotiations heretofore set forth, they dealt exclusively with the petitioners as the owners of the Empire stock which was exchanged for the stock in Delaware.
Since its organization Delaware has operated an engine *233 and pump plant in Shippensburg, Pennsylvania, and has received "management fees" from Lewis Supply Co., Inc., and Lewis Supply Co., of Arkansas, Inc., the capital stock of which was transferred to it by Empire. It also has engaged in some other transactions of an undisclosed *10 character. It has had an average net income of about $ 30,000 a year, but has never paid any dividends.
With respect to the notes of $ 185,000 owing by Empire to Bank of Manhattan Co. and the payment of which was assumed by Delaware, there was an understanding with the bank that so long as any portion of them remained unpaid Delaware would not declare any dividends. In addition, Jackson agreed with the bank to subordinate to the payment of the notes, owing to the bank, his claim to payment of $ 144,266.66 on notes owing to him by Empire and the payment of which was assumed by Delaware. In April 1953 Delaware completed payment of the notes owing to the bank and in June or July 1953 paid Jackson $ 24,266.66 on the notes owing to him.
From April 29, 1949, until the time of the hearing herein, Belgrade had not made any payments, either as interest or as principal, on the notes, totaling $ 469,000, which*234 it issued to Dumelle as partial payment for the 66,666 2/3 shares of stock in Empire initially issued to petitioners. However, Belgrade accrued and deducted in its income tax returns the interest accruing on the notes from the time of their issuance until the time of the hearing. The amended income tax return for Belgrade for the fiscal year ended October 31, 1949, and its income tax return for the fiscal year ended October 31, 1950, were filed on the accrual basis. Neither of them disclosed any income but each showed a substantial amount as a loss. These returns disclosed the following respecting the assets and liabilities of Belgrade at the end of the respective taxable years:
| Assets | ||
| Oct. 31, 1949 | Oct. 31, 1950 | |
| Cash | $ 214.08 | $ 184.08 |
| Investment in stock | 470,000.00 | 470,000.00 |
| Organization expense | 143.92 | 143.92 |
| $ 470,358.00 | $ 470,328.00 | |
| Liabilities and Capital | ||
| Accounts payable | $ 500.00 | $ 500.00 |
| Notes payable | 469,000.00 | 469,000.00 |
| Accrued interest | 3,565.21 | 10,600.21 |
| Capital stock | 1,020.00 | 1,020.00 |
| Earned surplus | (3,727.21) | (10,792.21) |
| $ 470,358.00 | $ 470,328.00 |
Neither Dumelle nor Belgrade was organized for a business*235 purpose nor has either of them at any time carried on any business.
In their income tax return for 1949 the petitioners reported no income or gain as arising from Jackson's sale to Empire of the *11 Tagliabu stock in 1946 and the Flextite stock in 1947 or from any dealings of petitioners with Dumelle, Belgrade, or Delaware or from the transaction in which the 66,666 2/3 shares of stock in Empire were surrendered to Empire in exchange for all the capital stock of Delaware. In determining the deficiency in question, the respondent determined that during 1949 the petitioners realized unreported capital gain of $ 613,031.47 of which $ 306,515.73 was taxable. The determination was explained in the notice of deficiency as follows:
(a) It has been determined that you realized a capital gain of $ 613,031.47 by virtue of the distribution of assets by Empire Industries, Inc. The computation follows:
| Market value of assets of Empire Industries, Inc | $ 470,000.00 |
| Base [sic] | 666.66 |
| Gain realized | $ 469,333.34 |
| Plus: | |
| Payment of installment note issued as payment for stock of | |
| Charles J. Tagliabu Manufacturing Co. $ 70,000.00 X 99.4 | |
| percent (percentage of gain) | 69,580.00 |
| Payment of installment note issued as payment for stock of | |
| Flextite, Inc. $ 74,266.66 X 99.8 per cent (percentage of profit) | 74,118.13 |
| Total gain | $ 613,031.47 |
| Gain included -- sec. 117 (b), I. R. C. 50 per cent | $ 306,515.73 |
*236 OPINION.
The petitioners take the position that they did not realize any gain in 1949 by reason of any of the transactions occurring between April 10 and April 30 of that year and culminating with the surrender to Empire on April 29 of the 66,666 2/3 shares of stock in Empire, initially issued to them, in exchange for all the capital stock of Delaware. In support of their position they contend (1) that the transfer to Dumelle, on April 22, of their stock in Empire in exchange for the capital stock of Dumelle was in good faith for a proper purpose and that no gain or loss was recognizable on the exchange, (2) that the sale on April 25 of the Empire stock by Dumelle to Belgrade was made in good faith for a full and adequate consideration and was properly reported by Dumelle as an installment sale, and (3) that on April 29 Belgrade, not the petitioners, exchanged the Empire stock for the stock of Delaware and that Belgrade properly reported the transaction in its income tax return for 1949. The respondent contends that on the factual situation presented the corporate entities of Dumelle, Belgrade, and Delaware should be disregarded and that the several steps or transactions involved*237 herein should be considered *12 as a single transaction for tax purposes, namely, as an exchange between petitioners and Empire by which Empire purchased one-third of its capital stock from petitioners in consideration of one-third of its net assets. In the alternative, he contends that if it be found that the corporate entities of Dumelle and Belgrade are to be disregarded but the corporate entity of Delaware is to be recognized, then the petitioners realized a long-term capital gain of $ 469,333.34 upon the exchange of their one-third of the capital stock of Empire for all the capital stock of Delaware. We will consider first the question of the recognition to be accorded Dumelle, Belgrade, and Delaware.
With respect to the recognition or nonrecognition of corporate entities, the Supreme Court in , said:
The doctrine of corporate entity fills a useful purpose in business life. Whether the purpose be to gain an advantage under the law of the state of incorporation or to avoid or to comply with the demands of creditors or to serve the creator's personal or *238 undisclosed convenience, so long as that purpose is the equivalent of business activity or is followed by the carrying on of business by the corporation, the corporation remains a separate taxable entity. ; . * * *
To this rule there are recognized exceptions. ; , and , have been recognized as such exceptions but held to lay down no rule for tax purposes. New Colonial Co. v. Helvering, supra, 292 U.S. 442, 54 S. Ct. 791, 78 L. Ed. 1348, note 5; Burnet v. Commonwealth Imp. Co., supra, 287 U.S. 419, 420, 53 S. Ct. 199, 77 L. Ed 399.*239 * * * In general, in matters relating to the revenue, the corporate form may be disregarded where it is a sham or unreal. In such situations the form is a bald and mischievous fiction. ; .
In considering the decision of the Supreme Court in the Moline Properties case, the Court of Appeals for the Second Circuit in , said:
In that case the question was whether the corporation might insist upon the Treasury's including capital gains within the gross income of its sole shareholder, and the court decided that it might not. That was the same situation as existed in Burnet v. Commonwealth Improvement Co., supra, 287 U.S. 415, 53 S. Ct. 198, 77 L. Ed. 399. The gloss then put upon ,*240 was deliberate and is authoritative: it was that, whatever the purpose of organizing the corporation, "so long as that purpose is the equivalent of business activity or is followed by the carrying on of business by the corporation, the corporation remains a separate taxable entity." . That, as we understand it, is the same interpretation which was placed upon corporate reorganizations in , and which has sometimes *13 been understood to contradict the doctrine that the motive to avoid taxation is never, as such, relevant. In fact it does not trench upon that doctrine; it merely declares that to be a separate jural person for purposes of taxation, a corporation must engage in some industrial, commercial, or other activity besides avoiding taxation: in other words, that the term "corporation" will be interpreted to mean a corporation which does some "business" in the ordinary meaning; and that escaping taxation is not "business" *241 in the ordinary meaning.
In view of what was said in the Moline Properties case and the National Investors case, it is clear that escaping taxation is not "business" in the ordinary meaning, and that for a corporation to be recognized as a separate entity for purposes of taxation it must be organized to, or must, engage in some industrial, commercial, or other activity besides avoiding taxation. Considering the facts here in the light of the foregoing, we find that neither Dumelle nor Belgrade has ever carried on any business at any time. The record discloses no transactions of significance since organization except those involved herein by which the stock of petitioners in Empire was routed back to Empire. While certain of Jackson's testimony is to the effect that since April 1949 he has been negotiating for the acquisition by Belgrade of a company in Arkansas, other of his testimony is that he has been desirous for many years of getting it for Mrs. Jackson or for Belgrade. At any rate, up to the time of the hearing the company had not been acquired by him, or by Mrs. Jackson, or by Belgrade.
Following the advice of Dikeman, Jackson's attorney, petitioners organized Dumelle, *242 transferred their Empire stock to it, and then had Dumelle transfer the stock to Belgrade by way of an ostensible sale. With Belgrade not shown to have had assets of as much as $ 1,000 and the terms of the sale being $ 470,000, payable $ 1,000 cash and $ 469,000 in a series of installment notes, we think it is clear that petitioners would never have authorized such a sale in an arm's-length transaction to a purchaser similarly situated. In , it was said:
The test to determine whether a transaction is a bona fide transaction is described by the term "arm's length," or, in other words, was the transaction carried out in the way that the ordinary parties to a business transaction would deal with each other?
Applying the "arm's length" test here, we think the arrangement employed by petitioners to get the Empire stock from themselves to Belgrade was lacking in bona fides.
Furthermore, petitioners, for reasons best known to themselves but not disclosed here, refrained from disclosing the existence of Dumelle or Belgrade to Harris and Cohn, who in a settlement of existing differences dealt exclusively with petitioners*243 as owners of the Empire stock which was exchanged for the stock in Delaware.
*14 In view of what has been said above, we think the corporate identities of Dumelle and Belgrade and the transactions by them involving Empire stock are to be disregarded here.
The situation with respect to Delaware is different. The evidence relative to it shows that it was formed pursuant to discussions by Harris and Jackson respecting the formation of a corporation to acquire, for its stock, a portion of the assets of Empire and which corporation was to be managed solely by Jackson without participation therein by Harris and Cohn. The evidence also shows that Delaware acquired certain properties of Empire including an engine and pump business which it has continued to operate. The evidence further shows that after the organization of Delaware and its acquisition of the above-mentioned assets certain matters of friction between Jackson and Cohn remained unsettled and that it was after the settlement of those matters and by reason of that settlement that there was a surrender by petitioners of their Empire stock to Empire in exchange for the stock of Delaware. Under the circumstances, the corporate*244 entity of Delaware must be recognized.
The record contains no evidence directed to the fair market value of the Delaware stock at the time it was exchanged by Empire for its own stock. However, the record shows that the fair market value of the net assets of Delaware was $ 470,000 and that its average net income since organization has been about $ 30,000 a year. In this situation, and in the absence of evidence indicating otherwise, we have found as a fact that the fair market value of the Delaware stock on the date of the exchange was $ 470,000. Since the basis to the petitioners of the Empire stock exchanged for the Delaware stock was $ 666.66, the difference between that amount and the fair market value of the Delaware stock, $ 470,000, or $ 469,333.34, constituted long-term capital gain to the petitioners.
The remaining issues involve the question of whether Jackson was in receipt of taxable income in 1949 with respect to the installment notes issued to him by Empire in connection with its purchase from him of Tagliabu stock in 1946 and Flextite stock in 1947. The respondent's determination that Jackson received payment of the notes in 1949 and was in receipt of income as *245 a result thereof was based on the conclusion that the corporate entity of Delaware was to be disregarded and that Jackson received assets from Empire of a fair market value equal to the amount of the notes. The evidence shows that Delaware assumed liability for the payment of the notes in connection with the exchange of its capital stock for certain assets of Empire and that nothing was paid by Delaware on the notes until 1953. In this situation, and since the corporate entity of Delaware is to be recognized and since the exchange between petitioners and Empire in 1949 was the exchange of Empire stock for Delaware stock, *15 it is apparent that Jackson received no payment on the notes in 1949. Consequently, he was not in receipt of income arising from payment of the notes as determined by respondent. Respondent's action with respect to these issues is not sustained.
Decision will be entered under Rule 50.