*789 PERSONAL HOLDING COMPANY - GROSS INCOME. - The petitioner entered into contracts with its two wholly owned subsidiaries whereby it undertook to provide the subsidiaries with the use of part of its plant and facilities, and to render certain services, and the subsidiaries agreed to pay, as consideration therefor, an amount measured by and equal to their respective shares of the petitioner's total annual overhead expenses, including such items as depreciation on buildings and equipment, property taxes, plant maintenance and repairs, light, heat, and power, officers' salaries, and office wages. Held, the share of the petitioner's expenses for the taxable year allocated and charged to the two subsidiaries constitutes part of the petitioner's gross income for that year within the meaning of section 22 of the Revenue Act of 1934 and the petitioner's total gross income for the taxable year is sufficiently in excess of its so-called personal holding company income to relieve it from tax under section 351 of the Revenue Act of 1934.
*869 The Commissioner determined the following deficiencies and penalty for the year 1935: Income tax, $792.13; personal holding company tax, $352,545.34; penalty for failure to file a personal holding company return, $88,136.34.
The petitioner concedes the correctness of the income tax deficiency, but contends that it is not liable for tax or penalty as a personal holding company. The only question presented for decision is whether or not the gross income of the petitioner includes $242,741.86 which the petitioner charged to John H. Woodbury, Inc., and the Jergens-Woodbury Sales Corporation for the use of space and equipment, and for services rendered those two corporations by the officers and employees of the petitioner.
FINDINGS OF FACT.
The petitioner was incorporated under the laws of Ohio in 1913. Its principal place of business is at Cincinnati, Ohio. It filed an original and an amended income tax return for the year 1935 with the collector of internal revenue for the first district of Ohio. It keeps its books and reports its income upon an accrual method of accounting.
The petitioner is and has been engaged in the business*791 of manufacturing toilet articles and preparations, including soaps, powders, creams, and perfumes, known as the "Jergens" line. This same business had been carried on for many years before the petitioner was formed.
John H. Woodbury Laboratories, Inc., had been engaged in the business of manufacturing similar products known as the "Woodbury" line. The petitioner in 1929 acquired all of the good will, trademarks, trade names, and rights pertaining to the products and business of John H. Woodbury Laboratories, Inc., and thereafter manufactured and sold the "Woodbury" line until September 1, 1930. It organized a new corporation in August 1930 known as John H. Woodbury, Inc., hereinafter called Woodbury. It organized this corportation upon the advice of counsel and transferred to it all of the rights and business pertaining to the Woodbury products for the purpose of protecting the Woodbury trademark rights by having them vested in a company under the Woodbury name. The transfer was made on September 1, 1930. The petitioner organized at the same time another corporation known as Jergens-Woodbury Sales Corporation, hereinafter called Sales, to take over the sales office of the*792 petitioner in Brooklyn, New York, and to market and distribute the Jergens and Woodbury products. The principal purpose for the formation of Sales was to discourage lawsuits in the courts of New York involving the Jergens and Woodbury trademarks and trade names. The petitioner had been advised by counsel that thereafter such suits could be instituted only in the courts of Ohio. The petitioner *870 has owned all of the stock of Woodbury and Sales at all times material hereto.
The petitioner and Woodbury entered into a contract on September 2, 1930, whereby the petitioner granted to Woodbury, "for the consideration hereinafter set forth, the right to use the manufacturing plant machinery and other manufacturing facilities" of the petitioner for the purpose of permitting Woodbury to manufacture the Woodbury line. It further agreed that Woodbury would furnish and pay for the materials used, and would pay to the petitioner the cost of the labor used in manufacturing the Woodbury products and a proportionate share of the overhead expenses of operating the factory of the petitioner, and a proportionate share of all other manufacturing expenses. The petitioner and Woodbury at*793 the same time entered into a contract with Sales whereby they agreed to sell their products to Sales on a cost-plus basis, and Sales agreed to distribute the products to the trade and to bear some of the selling costs. The contract was superseded by a new one on October 1, 1933, which was similar to the original contract except that Sales undertook to assume a greater proportion of the selling expenses. Sales had no other business. Prices of the products to the trade were to be fixed by the three companies. Sales was to pay or account for amounts due the petitioner and Woodbury upon their request.
The contracts above described were carried out in accordance with their terms throughout the taxable year. The Woodbury products were manufactured in the plant of the petitioner at Cincinnati after September 1, 1930, and throughout 1935, much the same as they had been manufactured prior to September 1, 1930. Sales occupied a part of the plant at Cincinnati. The petitioner was the sole owner at all times material hereto of the buildings, machinery, equipment, and other property used in the manufacture of the Jergens andWoodbury products. It supplied all of the light, heat, and power*794 for the operation of the factory. Woodbury had no bank account and no cash receipts or disbursements from the date of its incorporation up through 1935. The petitioner paid for all materials and labor used in the manufacture of the Woodbury products and paid all other expenses incident to the business of Woodbury. The petitioner and Woodbury had the same officers and directors. They received their entire compensation from the petitioner. The petitioner supplied and paid for all other administrative services incident to the manufacture of the Woodbury products.
All transactions pertaining to Woodbury were entered on the petitioner's books. The expenses connected with the manufacture of the Jergens and Woodbury products were debited to the various expense accounts of the petitioner. These included such items as depreciation on plant and equipment, taxes on real and personal property, *871 plant maintenance and repairs, light, heat, power, officers' salaries, and office wages. A portion of these expenses was then allocated to the manufacture of the Woodbury products and at the end of each year these amounts were transferred to skeleton books which the petitioner maintained*795 for Woodbury. The petitioner reflected these transfers on its books by debiting its accounts receivable from Woodbury with the amounts transferred to the Woodbury books and by crediting its various expense accounts with equivalent amounts. The result of this practice was to reduce the debit balance in the expense accounts of the petitioner by the amount of the expenses allocated to Woodbury. The share of the expenses allocated to Woodbury was not credited to rental or to any other income account of the petitioner and was not reflected in the gross income of the petitioner as shown by its books.
Transactions pertaining to Sales were handled by the petitioner in the same manner as it handled transactions pertaining to Woodbury until October 1, 1933, at which time Sales for the first time opened a bank account of its own in which it deposited its receipts and from which it paid its advertising and other selling expenses. The petitioner, however, continued to render service to Sales and to permit Sales to use a portion of its property, for which it allocated to Sales a portion of its salaries, maintenance, depreciation, taxes, and other items. The petitioner continued to pay these*796 items and to account for them on its books in the same manner as it accounted for similar items allocated to Woodbury. The portions of the overhead expenses of the petitioner for 1935 thus allocated to Woodbury and Sales under the contracts were as follows:
| Expenses | Woodbury | Sales |
| Depreciation on buildings and equipment | $55,066.25 | $2,370.21 |
| Taxes on realty and personalty | 18,357.11 | 1,228.19 |
| Maintenance and repairs - labor | 22,997.90 | 912.87 |
| Maintenance and repairs - materials | 18,313.19 | 566.80 |
| Light, heat, and power | 35,904.83 | |
| Officers salaries | 9,916.25 | 17,300.00 |
| Office wages | 22,509.23 | |
| Miscellaneous factory expense | 10,516.70 | |
| Other expenses | 25,735.78 | 1,046.55 |
| Total | 219,317.24 | 23,424.62 |
The deductions for depreciation and other expenses claimed by the petitioner on its original return represented the net balance of its expense accounts after those accounts had been reduced by the amounts allocated to Woodbury and Sales. Gross income of $1,752,042.36 was reported on that return.
$1,504,281.73 of the gross income of the petitioner for 1935 was derived from royalties, dividends, interest, annuities, and gains from the sale of stock or securities. *797 This amount included dividends of $679,060.89 from Woodbury and $727,321.74 from Sales. Sales paid *872 its dividends in cash. The dividends declared by Woodbury were transferred to the petitioner by means of book entries. The funds which Sales owed Woodbury on account of the sale of the Woodbury products were paid by Sales to the petitioner from time to time and were received by the petitioner in discharge of some or all of the debts due it by Woodbury. The record does not disclose to what extent the accounts and dividends due to the petitioner from Woodbury were discharged in this way during 1935.
The petitioner in July 1937 learned for the first time that the Commissioner was contending it was a personal holding company. Its accountants and attorneys then advised it that the various amounts allocated to Sales and Woodbury were in fact income and should be so reflected upon its books. The petitioner then made entries on its books for 1935 restoring to its various expense accounts at the end of the year the amounts theretofore eliminated from those accounts as allocable to Woodbury and Sales, and including in its rental and other income accounts the amounts eliminated*798 from expense. The result was to increase the gross income of the petitioner for 1935 by $242,741.86, the total amount of its overhead expenses allocated to Woodbury and Sales. These adjustments, whereby expenses were increased by the same amount that gross income was increased, effected no change in profit and loss for the year. The petitioner thereafter followed this method of recording its transactions with Woodbury and Sales for later years.
The petitioner, after it had made the changes on its books for 1935, filed an amended return on December 31, 1937, in which it reported the increased amount of gross income and the increased amount of deductions. It also reported on that return $502.50 as rent received for a separate piece of property which it had used to reduce a loss on its original return. The net income reported on the amended return was exactly the same as the net income reported on the original return.
The petitioner has never filed a personal holding company return for the year 1935.
More than 50 percent in value of the outstanding stock of the petitioner was owned, directly or indirectly, by or for not more than five individuals during the last half of*799 the taxable year.
The Commissioner in his notice of deficiency held that the petitioner is taxable as a personal holding company under the provisions of section 351 of the Revenue Act of 1934. He explained that the reimbursements for expenses incurred for Woodbury did not constitute gross income and, further, that the contract providing for such expenses and reimbursements was not entered into for gain or profit and no actual gain was realized or could result from such reimbursements.
*873 The amounts of $242,741.86, which the petitioner allocated and charged to Woodbury and Sales for services rendered and for the use of its facilities, and $502.50, rent received from another source, were a part of the gross income of the petitioner, and less than 80 percent of the gross income of the petitioner for 1935 was derived from royalties, dividends, interest, annuities, and gains from the sale of stock or securities.
All stipulated facts are incorporated in these findings by this reference.
OPINION.
MURDOCK: The parties have stipulated that more than 50 percent in value of the petitioner's outstanding stock was owned, directly or indirectly, by or for not more than*800 five individuals during the taxable year. The respondent concedes that the gross income of the petioner was $1,789,954.15, an amount somewhat larger than that reported on the original return. The stipulated amount of income derived from royalties, dividends, interest, annuities, and gains from the sale of stock and securities was about 84 percent of the gross income conceded by the respondent. The respondent contends, upon these facts, that the petitioner was liable for tax as a personal holding company under section 351. The first contention made by the petitioner is that its correct gross income for 1935 was $2,033,198.51, or $243,244.36 greater than the amount conceded by the respondent, and since its personal holding company income was less than 74 percent of that amount, it was not subject to tax under section 351. If the amount of $243,244.36 was properly a part of the gross income of the petitioner, then the other contentions of the petitioner to the effect that section 351 was never intended to apply to an operating company like the petitioner, and, if applied, would be unconstitutional, need not be considered.
The petitioner, at the end of each year, computed the portions*801 of its overhead and general expenses which were applicable to the conduct of the business of Woodbury and Sales. It then allocated those portions of its expenses to Woodbury and Sales and charged them to those two corporations on its books in accounts receivable. The respondent does not attack the method of allocation and he does not contend that an incorrect amount has been allocated to either Woodbury or Sales. He first suggests that the record is not clear that the two subsidiaries actually paid to the petitioner the amounts charged to them. However, since the petitioner was using an accrual method of accounting, actual payment was not necessary and there is no reason to believe that the accounts receivable were not genuine and adequate. He also suggests that the contracts were not entered into for profit. It is clear, however, that the contracts were entered into *874 for business purposes and for profit in a broad sense, even though the petitioner may have expected no direct profit from the contracts themselves. But in any event, this suggestion seems to lead nowhere. He next suggests that the amounts in controversy were advances, citing *802 , the petitioner and its subsidiaries were engaged in a joint venture, and the items in controversy were a mere adjustment of expenses. The real question is whether the items in controversy were properly a part of the gross income of the petitioner or whether they merely served to reduce the expenses of the petitioner without becoming a part of its gross income.
It is immaterial for the purpose of computing the income tax due under section 13 whether the petitioner reported the amounts charged to Woodbury and Sales as income and deducted the full amount of its expenses, or whether it applied the amounts charged to Woodbury and Sales directly to reduce the amount of its deductible expenses. it might be liable for a tax under section 351. It then attempted to it might be liable for a tax under section 351. It then attemptedto change retroactively its accounting method for 1935. The original method of accounting for these items may have some evidentiary value, but it is not determinative of the case. If the items in controversy were a part of the gross income of the petitioner, as that term is defined in section 22 of*803 the Revenue Act of 1934, then section 351 does not apply.
Gross income is defined in section 22 of the Revenue Act of 1934 as including gains, profits, and income derived from businesses, commerce, or dealings in property growing out of the ownership or use of or interest in such property, from rent or the transaction of any business carried on for gain or profit, and gains, profits, and income derived from any source whatever. The petitioner under its contract with Woodbury agreed to use its property and supply its services in manufacturing the Woodbury products. It was to receive compensation from Woodbury for those things. The compensation which it was to receive was measured by and was to be equal to that portion of its total overhead expenses allocable to Woodbury. The amount of the compensation was computed and was actually charged to Woodbury as an account receivable. The petitioner used an accrual method of accounting, and the amount charged to Woodbury was income to the petitioner under the broad definition of section 22. The same is true of similar items charged to Sales. The petitioner, as owner of the property, was entitled to deduct the full amount of the taxes*804 which it actually paid on its property, and the full amount of depreciation which it sustained on that property, as well as the full amount expended for labor and materials in repairing its property. The respondent does not contend to the contrary. Neither does he suggest any reason why the petitioner was not entitled to deduct on its returns *875 the full amount which it paid for light, heat, power, and the full amount of its other expenses incurred in the operation of its properties during 1935. Woodbury and Sales did not pay any taxes, suffer any depreciation, or expend any amounts for repairs. They were not owners of the property. The amounts charged to them by the petitioner were deductible by them on some other basis. Those amounts represented expenses of their business. They were either wholly, or partly, rent, and if not entirely rent, they were expenses paid out as compensation for services rendered by the petitioner. Similar expenditures were held to be deductible as rent in the case of . See also *805 , where somewhat similar items were held to be rent even though the contract stated that they were not rent. The petitioner in the latter case leased a part of a building for a long period as a residence, and agreed to pay his proportionate part of the operating expenses of the building, including annual interest charges and taxes. The Board held that all of the payments constituted rent, a nondeductible item in the case of a residence, and that no part of them were deductible as interest and taxes. See also . Thus, whether the expenditures are viewed from the standpoint of the petitioner or from the standpoint of Woodbury and Sales, they represent income of the petitioner. Cf. ; ; ; . See also articles 22(a)-20 and 23(a)-10 of Regulations 86. Whether the amounts charged to Woodbury and Sales*806 are designated as rents or as some other kind of income is not now important. The petitioner could not clearly reflect its correct gross income unless it reported the full amount which it charged to Woodbury and Sales to compensate it for the use of its property and the services which it rendered to those two companies.
It might be pointed out in conclusion that if the petitioner and its subsidiaries were engaged in a joint venture, or if the case of , applied, the petitioner would not be liable for tax under section 351. The Southern Pacific case is cited for the proposition that the mere receipt of money or other property does not necessarily imply the receipt of gross income. The proposition is, of course, sound. For example, the cost of goods sold is never regarded as a proper part of gross income and has been eliminated in the present case. But the Supreme Court in the Southern Pacific case completely disregarded the corporate entity of a subsidiary and held that dividends paid by the subsidiary were not income to the parent under the "very peculiar facts." Woodbury had no bank account, no manufacturing*807 plant or equipment, and no employees *876 of its own. All of its business and affairs were conducted for it by the petitioner. If the separate entity of Woodbury were to be disregarded, then all of the earnings of the group would be the earnings of the petitioner and there would be no dividends from Woodbury to the petitioner. Likewise, if the transaction were regarded as a joint venture, then the entire amount which the petitioner took out of the venture would be regarded as its share. In neither case would the personal holding company income of the petitioner amount to 80 percent of its gross income. The penalty falls with the tax.
Decision will be entered under Rule 50.