*207 Decision will be entered under Rule 50.
1. Business Deduction. -- Rotary Club dues of petitioner's president and majority stockholder held not deductible.
2. Salaries of Employees Disallowed in Part. -- Payment of salaries and bonuses paid to stockholder sons of administrative head of petitioner during period of employees' absence in military service, no replacements being required in the business, held properly disallowed in part by respondent.
3. Partnership. -- Respondent determined a deficiency against petitioner on the theory that partnership made up of a portion of petitioner's stockholders was a sham. Petitioner seeks redetermination on the theory that the partnership was entered into in good faith for a business purpose and that business was actually carried on and income here involved earned by partnership. Stated business purpose was primarily to afford opportunity for development of ideas and capabilities of sons of majority stockholder, and to avoid disruption in corporate affairs arising through conflict of ideas and business practices between sons and other majority stockholder. Secondary business purpose to obtain tax benefits. Alleged partnership*208 purchased several retail stores belonging to petitioner for that purpose. Sons in the armed services at all times during life of partnership except for latter portion thereof. Alleged partnership business carried on in same manner and under same management as before creation thereof. Held, partnership was not entered into in good faith for a business purpose and was a sham created to siphon off profits of petitioner for sole purpose of avoiding income tax. Respondent's determination of deficiency upheld.
*1197 This proceeding involves the following deficiencies:
| Declared value | Excess | |
| Year | excess-profits tax | profits tax |
| 1942 | $ 2,126.13 | $ 9,414.68 |
| 1943 | 4,038.36 | 46,401.01 |
| 1944 | 11,996.86 | 101,016.74 |
| 1945 | 20,663.37 | 128,020.99 |
The issues are whether the respondent erred in disallowing as deductions (1) the amount of $ 278 in the year 1943 as an expense for Rotary Club dues and (2) $ 825, $ 1,000, $ 1,480, and $ 1,932.50 in the years 1942, 1943, 1944, and 1945, respectively, of the total compensation paid to Irwin Friedlander and Max Friedlander, and (3) whether petitioner's income for the years 1943, 1944, and 1945 should include the income of Louis Friedlander & Sons, an alleged partnership or, *1198 in the alternative, whether certain deductions claimed by the petitioner for the years 1943, 1944, and 1945 are allocable to the alleged partnership. Other issues raised by the petition were conceded by the petitioner at the hearing.
FINDINGS OF FACT.
The facts set forth in a stipulation are*210 found as agreed to therein.
The petitioner, a Georgia corporation organized on August 19, 1929, has its principal place of business at Moultrie, Georgia. Its income and excess profits tax returns for the taxable years 1942 to 1945, inclusive, were filed with the collector for the district of Georgia.
Louis Friedlander, hereinafter for convenience sometimes referred to as "Louis," president of petitioner at all times since its organization, was the sole proprietor of a dry goods store at the place of business of petitioner in Moultrie, Georgia, from about 1909 to 1911, when he and his brother Nathan formed a partnership to conduct the business. In 1926 the business was incorporated and upon the organization of petitioner in 1929 assets received by Louis as a stockholder in dissolution proceedings of the corporation were acquired by petitioner.
In 1935 Louis transferred to each of six sons, Irwin, Malvin, Max, Richard, Herman, and Jack, without consideration, 125 shares of common stock of petitioner. A stock dividend paid December 1941 increased the holdings of each of the transferees to 175 shares.
Between June 30, 1943, and March 31, 1946, the petitioner's outstanding capital stock*211 consisted of 1,743 1/5 shares of common stock which was held as follows:
| Name and title | June 30, | July 1, | Dec. 31, | March 31, |
| 1943 | 1943 | 1944 | 1946 | |
| Louis Friedlander, Pres | 420 | 420 | 420 | 420 |
| I. B. Perlman, Vice Pres | 245 | 245 | 350 | 350 |
| B. M. Cohen | 2 4/5 | 2 4/5 | 2 4/5 | 2 4/5 |
| A. I. Halpert | 7 | 7 | 7 | 7 |
| R. L. Powell, Sec. & Treas | 1 2/5 | 1 2/5 | 1 2/5 | 1 2/5 |
| Irwin Friedlander | 175 | |||
| Malvin Friedlander | 175 | |||
| Max Friedlander | 175 | |||
| Richard F. Friedlander | 175 | 175 | 175 | 175 |
| Herman Friedlander | 175 | 175 | 175 | 175 |
| Jack Ira Friedlander | 175 | 175 | 175 | 175 |
| United Investment Co | 437 | 437 | ||
| Treasury Stock | 17 | 1 542 | ||
| Total Stock | 1,743 1/5 | 1,743 1/5 | 1,743 1/5 | 1,743 1/5 |
Louis and Esther Friedlander are husband and wife. I. B. Perlman is a brother of Esther and the husband of Fannye Perlman. R. L. Powell has been employed for many years by the petitioner as secretary and treasurer and has been in active charge of keeping its books of account*212 and other records. B. M. Cohen is a brother-in-law of I. B. Perlman and Esther. A. I. Halpert was not related to Louis or I. B. Perlman.
*1199 From June 30, 1943, to March 31, 1946, the stock of the United Investment Co. was owned as follows:
| Stockholder | Shares |
| Esther Friedlander | 28 |
| Irwin Friedlander | 18 |
| Malvin Friedlander | 15 |
| Max Friedlander | 14 |
| Louis Friedlander | 1 |
| Louis Friedlander, trustee for | |
| Herman | 12 |
| Louis Friedlander, trustee for | |
| Richard | 11 |
| Waldo DeLoache | 1 |
The United Investment Co. is mainly in the real estate business although it does some financing and lending of money on a small scale. It owns considerable real estate, most of which is in Moultrie, including the main store building of petitioner and The Fair Store building. Louis is secretary and treasurer of the company.
For a number of years prior to June 30, 1943, the petitioner operated a general merchandise business in a number of towns located in the southern part of Georgia and Alabama. The stores which the petitioner operated on June 30, 1943, were named and located as follows:
| Friedlander Corporation | Moultrie, Ga. |
| The Fair Store | Moultrie, Ga. |
| Nettler's Hardware | Moultrie, Ga. |
| Smart Shop | Moultrie, Ga. |
| Friedlander's | Fitzgerald, Ga. |
| Perlman's | Dothan, Ala. |
| Farmers Hardware | Tifton, Ga. |
| Famous | Andalusia, Ala.1 |
| Fashion Shoppe | Douglas, Ga. |
| Fashion Shoppe | Thomasville, Ga. |
The Friedlander Corporation store included a wholesale department, a retail department, and an appliance department. Nettler's Hardware, a contiguous unit, was also operated as a department of the store. The stores in Douglas and Thomasville and the Smart Shop in Moultrie were ladies' ready-to-wear shops. The stores in Fitzgerald and Dothan stocked wearing apparel, piece goods, household furnishings, luggage, and other merchandise that could be sold promptly at medium prices. The Fair Store was an outlet store and sold only seconds and close-outs, mostly work clothes and shoes. It catered to the farm trade. Farmers Hardware in Tifton handled only hardware and houseware. Petitioner leased the buildings in which the out of town stores were operated. All units, except the Friedlander Corporation, were exclusively retail operations.
Upon entering the regular employment of petitioner in 1940, Irwin and Max endeavored to put into practice ideas for the conduct of the business, including the sale of some of the stores and opening some small ready-to-wear shops, which conflicted with those of Perlman, *214 and as a result the sons and Perlman had quarrels, at times violent, about the matter, even though they recognized that Perlman got results. *1200 The sons and Perlman informed Louis of the prevailing condition, and he sought to correct it by a more definite assignment of duties for each so that there would be less personal contact. At one time a decision was reached to sell some of the stores and probably open one or two other stores to experiment with the ideas of Max and Irwin. By the time the sons entered the Navy, Perlman was practically in charge of the stores located outside of Moultrie and the sons were kept busy in the Moultrie stores. Perlman considered that his financial interest in petitioner was more important than his personal differences with them as to how the business of petitioner should be conducted. The differences between them were settled by Louis in a manner very satisfactory to Perlman before the sons entered the military service.
Separate books of account were kept for each department of the petitioner's stores in Moultrie, Georgia, and for each of its stores located in other towns. The net profit from each operation was computed separately prior*215 to July 1, 1943, and then consolidated for tax purposes.
Irwin, Max, and Malvin served in the armed forces as follows:
| Irwin | January 1943 to January 1946 |
| Max | September 1942 to November 1945 |
| Malvin | February 1943 to March 1946 |
Irwin and Max returned from the service in November 1945 on terminal leave.
On July 16, 1942, Irwin, Max, and Malvin executed an instrument the terms of which gave their father general powers of attorney. The instrument was recorded on December 11, 1943. In 1944 the sons executed supplemental powers which contained a general ratification of acts of their father under the July 16, 1942, powers of attorney.
On about three occasions prior to July 1, 1943, commencing about September 1942, Louis discussed with petitioner's outside accountant and tax consultant the question of forming another organization to acquire some of petitioner's stores. Louis preferred to organize a corporation but being interested in reducing tax liability on any profits inquired, about June 1, 1943, whether there would be less tax liability if the stores were owned by a partnership. The accountant informed him that there would be and Louis then instructed the accountant to form*216 a partnership as soon as possible. The accountant promptly prepared a rough draft of articles of copartnership and delivered it to petitioner's attorneys for completion. Louis informed him of the interest to assign to each of the contemplated partners. The accountant did not discuss the formation of a partnership or terms of a partnership agreement with any person other than Louis and petitioner's attorneys. Louis was never present when the subject was discussed *1201 by the accountant with petitioner's attorneys. Petitioner's income tax return for 1942 was filed on April 15, 1943, and was signed by Louis as president.
On or about July 1, 1943, Louis and Perlman and their wives and Irwin, Max, and Malvin executed an instrument, the terms of which recite, among other things, that they agreed to form a partnership to conduct a general retail merchandise business under the name of Louis Friedlander & Sons, hereinafter for convenience only to be referred to as the partnership; the interest of Louis and Perlman and their wives in the assets and profits and liability for losses to be 10 per cent each and 20 per cent for each of the other individuals. The instrument provided that*217 "From time to time the partners shall have such drawing accounts and such disbursements shall be made of the assets of the partnership, either division of profits or capital assets, as may be mutually agreed upon by the partners" and that in the management of the business Louis "shall be the Business Manager and Treasurer for the partnership with full authority to make purchases, incur obligations, make loans, secured or unsecured according to his judgment, and do any and all other acts incident, convenient and necessary to the conduct of the business." The agreement was to be effective for 5 years unless the partnership was dissolved as provided for in the instrument or by operation of law. Provisions in the instrument gave heirs or personal representatives of a deceased partner an election to continue as a partner and terms for the purchase of the interest of a deceased or retiring partner by the other partners. The instrument could not be amended without agreement of all of the designated partners.
All parties signed the agreement except Malvin, who was then in New Caledonia, and Louis acted for him under the power of attorney he held. Malvin did not personally participate in*218 the discussions leading up to the formation of the partnership and Max had no part in the decision to form a partnership. Irwin did not discuss any division of petitioner's business with his father until after he entered the Navy.
The primary motive for forming the partnership was to reduce tax liability.
On July 1, 1943, Max was in Norfolk, Virginia, Malvin was in New Caledonia, and Irwin was in Boston. On or about July 1, 1943, Louis, acting under the general powers of attorney, sold to petitioner at its par value of $ 17,500 the 175 shares of stock Max, Malvin, and Irwin each held in petitioner. Irwin did not make an investigation to determine the value of the stock or take part in the transaction. The stock had a value in excess of its par value. Petitioner's checks payable to the order of each seller bore the date of July 1, 1943. In July 1943 the checks were endorsed by Louis, acting under the powers of *1202 attorney he held, and delivered to the partnership as loans from his sons. As evidence of the loans the partnership issued its notes dated July 1, 1943, and maturing in 6 months with interest at the rate of 6 per cent. Irwin did not know that a note was issued*219 to him. The checks were deposited by the partnership and paid by the bank on July 31, 1943. The sales of stock and loans were a part of the plan to organize the partnership. The original deposit pass books of the partnership disclosed the following other deposits in its bank account during the month of July 1943:
| July 7, 1943 | $ 250 |
| July 13, 1943 | 1,500 |
| July 26, 1943 | 4,000 |
The partnership purchased as of July 1, 1943, for $ 111,718.90 the assets and assumed the liabilities of the stores belonging to the petitioner, except the Friedlander Corporation, Nettler's Hardware and Famous stores, in payment of which it gave its check for $ 52,500 and a note, dated July 1, 1943, in the amount of $ 59,218.90 for the balance. Nettler's Hardware was retained by petitioner because of the location and close connection with the main store.
The note for $ 59,218.90 was paid by November 24, 1943, and the amount borrowed from Max, Malvin, and Irwin was paid with interest on August 14, 1945. The amount of $ 17,500 received by each of the sons was immediately loaned to the United Investment Co. All of these transactions were handled by Louis acting through powers of attorney. The indebtedness*220 of the United Investment Co. to the sons is renewed each year and a new note is issued for the interest and principal.
Physical inventories were taken of each store on or as of July 1, 1943, and the merchandise therein was transferred to the partnership at the invoice cost price of $ 91,273.81. At that time the stores had an ample stock of scarce goods, no more than a normal amount of which was obsolete and unsalable. Merchandise then available in the open market was mostly of inferior quality. Accounts receivable were transferred for three-fourths of face amount, or $ 8,682.03, which was a very high price. Less than 50 per cent of the amount of the receivables was collected by the partnership. The fixed equipment sold to the partnership was transferred at book value, except equipment at The Fair Store and Fitzgerald store which was fully depreciated and was transferred for $ 500 each. The partnership agreement was recorded in all of the counties in which the stores were located. The recordation respecting three of the stores was made on July 2, 1943.
When merchandise was placed in the stores of petitioner for sale, the invoice cost price was increased 20 per cent because of*221 sales to *1203 clerks in the stores. Petitioner determined that the mark-up on sales to clerks was necessary to enable it to recover its entire cost of the goods.
There were no corporate minutes of the petitioner with reference to any matter during the period 1942 to 1946, inclusive, other than one entry pertaining to Office of Price Administration certificates.
Subsequent to June 30, 1943, and until March 31, 1946, the operations of the stores acquired by the partnership were recorded on the books of account of, and disclosed on information returns filed by, the partnership.
During the period beginning June 30, 1943, and ending March 31, 1946, separate books of account were maintained by the petitioner and the partnership. The petitioner's books were kept and its tax returns were filed on the accrual and a calendar year basis. The books of account and tax returns of the partnership were kept and filed on the accrual basis and a fiscal year ending June 30.
On July 1, 1943, the approximate net worth of Esther, Louis, Max, Malvin, and Irwin Friedlander, and I. B. Perlman was as follows:
| Esther Friedlander | $ 250,000 |
| Louis Friedlander | 200,000 |
| Max Friedlander | 100,000 |
| Malvin Friedlander | 100,000 |
| Irwin Friedlander | 100,000 |
| I. B. Perlman | 100,000 |
| Total | $ 850,000 |
*222 The partnership made purchases from the petitioner during the fiscal years ended June 30, 1944, and June 30, 1945, and the taxable period ended March 31, 1946, in amounts as follows:
| Taxable year ended | Amount |
| June 30, 1944 | 1 $ 77,493.32 |
| June 30, 1945 | 84,215.58 |
| March 31, 1946 | 83,413.70 |
| Total | $ 245,122.60 |
The sales were made at 5 per cent over invoice cost to petitioner, without adjustment for discount taken by petitioner in connection with the purchase of the goods, which averaged about 2.68 per cent. Sales of similar merchandise were generally made by petitioner to other purchasers at prices computed by the same method.
The total wholesale sales of the petitioner for the years in question were as follows:
| 1943 | $ 424,657.71 |
| 1944 | 123,012.08 |
| 1945 | 95,372.25 |
*1204 The store managers have always been responsible to both Perlman and Louis Friedlander, but Perlman was in actual contact with the units more than was Louis Friedlander.
Most of the merchandise in the stores was purchased by the store managers under the supervision of Perlman. The hardware stores buy almost all of their merchandise direct from the*223 trade. Of the total sales volume of wearing apparel, 65 per cent was of women's apparel. There is considerably more work involved in women's ready-to-wear due to the change in fashions.
The partnership maintained its principal bank account at Moultrie National Bank, Moultrie, Georgia, until March 31, 1946. There was no signature card in the bank files for the account. All of the checks drawn on the account were signed either by Louis Friedlander, R. L. Powell, or I. B. Perlman.
Louis Friedlander exercised control over the affairs of the petitioner and the partnership. Prior to July 1, 1943, most of the duties consisted of handling financial matters. Only a small part of his time was devoted to merchandising. Other services were performed in supervising some of the departments of petitioner, principally the hardware department.
In 1940, when Max and Irwin entered the regular employment of petitioner, the business of petitioner was divided. Louis took charge of and did the buying for the men's department and was assisted by Max. Perlman took over and did the buying for the women's department, assisted by Irwin. Subsequent to July 1, 1943, Louis' duties were substantially the*224 same.
Perlman has been associated with the business continuously since about 1918 and has been a particularly useful employee and officer. Prior to July 1, 1943, he was practically in charge of the ladies' departments and stores outside of Moultrie and devoted a considerable part of his time to the work. He also was the "merchandise man," i. e., he bought ladies' apparel, did supervisory work, planned sales and performed other allied work and at all times important did most of the merchandising work for petitioner and the partnership. His duties were substantially the same after July 1, 1943, except that he spent more time in Moultrie on account of the absence of Max and Irwin in the service. Perlman normally went to the markets in New York, Baltimore, Philadelphia, and Atlanta a total of four to seven times a year. He did not have a regular, monthly travel expense allowance as did Louis, but was reimbursed for actual expenditures by the petitioner. He traveled to and from the partnership stores in his personal car and sometimes in the petitioner's car, gasoline rationing being a factor in the use of his personal car during the war.
Max was born in 1920. He worked in the business*225 during spare time from the time he was a young boy. By 1940 he had considerable *1205 knowledge of the business. Max was graduated from Duke University in June 1940 and thereafter returned to Moultrie and went to work in the men's department of the store on a full time basis and had some charge of the department. He enlisted in the Navy in August 1942 and after about 4 months of duty in the United States was assigned to convoy duty for 6 months, during the course of which he reached a port in this country about every 5 weeks. Thereafter he was stationed at Norfolk. After Max returned from the service about the middle of November 1945 he took over the buying and merchandising of the men's department in the partnership stores. He was also placed in charge of a men's ready-to-wear store in Thomasville, which included the negotiation of a lease for the building and purchase of merchandise. The manager of the store was placed under his supervision.
Irwin was born in 1916 and is the oldest son of Louis. He has performed services of some kind for the Friedlander enterprises since he was about 8 years of age. The nature of the work assigned to him depended upon his age and ability. *226 By the summer of about 1935 when he was in his junior year at Duke University he was engaged in sales work. He opened the store at Dotham, Alabama, the next summer and operated it until September of that year. Upon graduation from Duke University in 1937 he went to work with L. Bamberger Co. of Newark, New Jersey, a branch of R. H. Macy & Co., for the purpose of obtaining experience in modern merchandising. After working 2 years with that company as salesman and assistant buyer, he returned home for a couple of months but returned to New York City after persuading his father to change the petitioner's account to the buying firm in New York City which was then employing him.
Irwin worked regularly for the petitioner from about March 1, 1940, until December 27, 1942. His ambition was eventually to be placed in charge of the entire business. During the first year he was an assistant to Perlman in the ladies' department. Thereafter he was supposed to take over the duties of Perlman in petitioner's store and Perlman was to take charge of the stores in the field. Instead he had complete charge of the toy department, worked with Max in advertising and Perlman in the ladies' departments, *227 did some buying and exercised some supervision over the personnel of the women's departments. Upon entering the Navy in January 1943 he was first assigned to duty in Charleston, South Carolina, for 13 weeks, and then to Harvard University for about 4 months. He returned home twice while at Charleston but at no time thereafter until he returned from the service about the middle of November 1945. He has been associated with the business at all times since then. When Irwin reentered active employment after his discharge from the Navy, he *1206 resumed his former duties. At that time his father was in charge of all the men's departments and Perlman was in charge of all the women's departments.
Malvin, during all of the taxable years, was a musician and did not render any services or devote any time to the business of petitioner or the partnership.
On one or more occasions after July 1, 1943, petitioner depleted its stock of letterhead stationery. On February 7, 1948, R. L. Powell wrote a letter as a representative of petitioner on letterhead stationery of petitioner containing the following:
The Friedlander Corporation
Jobbers, Commission Merchants
Chain Store Operators
*228 A comparative balance sheet of the partnership for the periods under review is as follows:| Items | July 1, 1943 | June 30, 1944 |
| Assets: | ||
| Cash on hand | $ 370.00 | $ 755.00 |
| Cash on deposit | 1,000.00 | 52,703.63 |
| U. S. Treasury bonds | 26,000.00 | |
| Accounts receivable | 8,682.03 | 14,388.83 |
| Merchandise inventory | 91,273.81 | 103,333.40 |
| Meter deposits | 120.00 | 120.00 |
| Prepaid taxes, licenses, etc | 37.50 | 182.63 |
| Leasehold improvements | 309.47 | 257.47 |
| Furniture and fixtures | 9,926.09 | 10,729.05 |
| Notes receivable | ||
| Total | $ 111,718.90 | $ 208,470.01 |
| Liabilities and net worth: | ||
| Owing employees | $ 31.25 | |
| Trade payables | 50,562.98 | |
| Notes payable | $ 111,718.90 | 52,500.00 |
| Accrued expenses | 11,735.34 | |
| Reserve for bad debts | 2,067.72 | |
| Reserve for depreciation | 1,038.21 | |
| Reserve for amortization | 171.64 | |
| Capital accounts | 90,362.87 | |
| Total | $ 111,718.90 | $ 208,470.01 |
| Items | June 30, 1945 | Mar. 31, 1946 |
| Assets: | ||
| Cash on hand | $ 755.00 | $ 955.00 |
| Cash on deposit | 100,255.42 | 16,212.03 |
| U. S. Treasury bonds | 78,000.00 | 127,000.00 |
| Accounts receivable | 11,959.02 | 77,199.75 |
| Merchandise inventory | 95,343.72 | 158,376.60 |
| Meter deposits | 120.00 | 120.00 |
| Prepaid taxes, licenses, etc | 247.75 | 412.93 |
| Leasehold improvements | ||
| Furniture and fixtures | 12,543.05 | 13,925.08 |
| Notes receivable | 35,000.00 | |
| Total | $ 334,223.96 | $ 394,201.39 |
| Liabilities and net worth: | ||
| Owing employees | $ 41.25 | |
| Trade payables | 40,273.21 | $ 52,260.94 |
| Notes payable | 52,500.00 | |
| Accrued expenses | 16,858.85 | 9,572.94 |
| Reserve for bad debts | 1,779.26 | 1,779.26 |
| Reserve for depreciation | 2,254.48 | 3,224.54 |
| Reserve for amortization | ||
| Capital accounts | 220,516.91 | 327,363.71 |
| Total | $ 334,223.96 | $ 394,201.39 |
*229 The net earnings of the petitioner and the partnership for the periods indicated were as follows:
| Name | Year ended | Net income |
| The Friedlander Corporation | Dec. 31, 1937 | $ 5,822.87 |
| Dec. 31, 1938 | 6,229.26 | |
| Dec. 31, 1939 | 8,870.30 | |
| Dec. 31, 1940 | (595.25) | |
| Dec. 31, 1941 | 26,744.74 | |
| Dec. 31, 1942 | 106,584.32 | |
| Dec. 31, 1943 | 83,717.64 | |
| Dec. 31, 1944 | 63,531.82 | |
| Dec. 31, 1945 | 82,243.36 | |
| Louis Friedlander & Sons | June 30, 1944 | 90,362.87 |
| June 30, 1945 | 171,110.40 | |
| Mar. 31, 1946 | ||
| (9 mos.) | 133,681.65 |
*1207 The main office of petitioner and the partnership were at the same location in Moultrie and the books and records for both were maintained in that office by the same personnel. Petitioner paid the rent for the entire building and the salaries of the employees. The salaries paid the office personnel were $ 7,140.52 in 1943, $ 8,692.63 in 1944, and $ 7,594.09 in 1945 and were paid by the petitioner without reimbursement by the partnership for its pro rata share of the expenses.
The petitioner did not charge the partnership with any amount for joint use of utilities or furniture and fixtures. Exclusive of the salaries of Louis and Perlman, the petitioner *230 paid all of the general administrative expenses of the main office in Moultrie. Except for small amounts, all of the legal, accounting and professional expenses of petitioner and the partnership during the taxable years were paid by petitioner and deducted in its returns. The amount of such expenses paid by the petitioner during the calendar years 1943, 1944, and 1945 were $ 3,927.31, $ 2,152.10, and $ 2,948.11, respectively. The books of the partnership disclose legal and accounting expenses of $ 9, $ 111, and $ 200 for the fiscal periods ended June 30 in 1944, 1945, and March 31, 1946, respectively.
Louis and Perlman made frequent trips to and from the stores of the partnership. A passenger car of petitioner was used at times to make the trips but the partnership was not charged any amount for operating expenses of the automobile. Louis had a monthly allowance of $ 100 for traveling expenses and received reimbursement for expenses on trips to markets. Perlman was reimbursed for traveling expenses.
During the taxable years petitioner and the partnership used the services of resident buyers to purchase merchandise. One of the agents rendered services for each but the partnership*231 was not charged for any of the expense. Louis and Perlman made trips each year to markets to purchase merchandise for petitioner and the partnership. Managers of the stores of the partnership generally accompanied Perlman on the trips to select merchandise for their stores. The books of the partnership contain only three charges for traveling expenses of Louis and Perlman, all of which, totaling $ 410, were made during the last taxable year of the partnership. The books of the partnership contain no charges for traveling expenses of store managers other than the following:
| Fiscal years | |||
| Store | |||
| 1944 | 1945 | 1946 | |
| Dothan | $ 245.13 | ||
| Fitzgerald | 139.91 | ||
| Smart Shop | 20.00 | ||
| Tifton | $ 27.25 | $ 29.00 | 17.00 |
| Thomasville | 215.00 | 32.00 | |
| Fair Store | 185.60 |
*1208 Louis and Perlman made long distance calls from the Moultrie stores in connection with the purchase of merchandise for stores of the partnership, the charges for which calls were paid by petitioner without reimbursement by the partnership.
The merchandise of petitioner and the partnership was covered by one policy of insurance. The partnership was charged for its pro rata share of the premiums.
*232 During the taxable years 1942 to 1945, inclusive, the petitioner paid salaries as follows:
| Name | 1942 | 1943 | 1944 | 1945 |
| Louis Friedlander | $ 14,000.00 | $ 15,400.00 | $ 15,200.00 | $ 15,200.00 |
| I. B. Perlman | 8,600.00 | 10,561.10 | 9,463.00 | 9,464.75 |
| Irwin Friedlander | 4,900.00 | 5,000.00 | 5,300.00 | 5,410.00 |
| Max Friedlander | 3,725.00 | 3,800.00 | 3,980.00 | 4,322.50 |
| Esther Friedlander | 172.00 | 168.00 | 202.03 | 28.05 |
| Fannye Perlman | 124.50 | 104.00 | 78.55 | 8.25 |
The regular salary of Max in 1941 was between $ 150 and $ 200 per month. Irwin was paid approximately $ 250 per month during the latter part of 1941. Louis was absent from the business during the last months of 1941 due to an injury. Max and Irwin assumed added responsibilities during the period of his absence and each received a bonus of $ 2,000 for 1941. Louis returned to work during the early part of 1942. During the period 1942 to 1946, inclusive, Louis' health was not good, but he was active in the financial management of the business. He spent about 3 weeks in a hospital in Rochester, Minnesota, in January of 1943. The medical treatment he received improved his health but he was advised to take it easy. Even when*233 sick he never relinquished the financial control of the business.
In each of the taxable years all of the employees of petitioner were paid a bonus. The bonuses paid to Max and Irwin were based upon the same percentage that was used in computing the bonuses paid to other employees.
Louis and Perlman received salaries from the partnership as follows:
| Louis | I. B. | |
| Fiscal year ending | Friedlander | Perlman |
| June 30, 1944 | $ 7,000 | $ 3,000 |
| June 30, 1945 | $ 7,000 | $ 3,000 |
| Mar. 31, 1946 | $ 5,250 | $ 2,250 |
In his determination of the deficiencies, respondent allowed each year as reasonable compensation for Irwin the amount of $ 4,300 and $ 3,500 for Max and disallowed the remaining amounts claimed as deductions for salary paid to them.
*1209 The credits to the capital accounts of the partners, withdrawals therefrom and balance on March 31, 1946, were as follows:
| Credits | ||||
| Name | Withdrawals | Balance | ||
| Salary | Profits | |||
| Fannye Perlman | $ 36,765.49 | $ 36,765.49 | ||
| Esther Friedlander | 36,765.49 | 1 $ 437.88 | 36,327.61 | |
| I. B. Perlman | $ 8,250 | 36,765.50 | 18,960.32 | 26,055.18 |
| Louis Friedlander | 19,250 | 36,765.50 | 30,931.55 | 25,083.95 |
| Max Friedlander | 73,530.98 | 3 16,461.46 | 57,069.52 | |
| Malvin Friedlander | 73,530.98 | 2 500.00 | 73,030.98 | |
| Irwin Friedlander | 73,530.98 | 2 500.00 | 73,030.98 |
At some undisclosed time the tax consultant who advised Louis on the creation of the partnership was consulted on whether the partnership form was the most advantageous at that time for tax purposes and his advice was that there was no tax advantage at that time. Thereafter Louis Friedlander & Sons, Inc., was organized as a corporation under the laws of the State of Georgia on April 1, 1946, to take over the assets and liabilities of the partnership at book value. Its capital stock, consisting of 1,250 shares, par value $ 100 each, was issued to the members of the partnership in proportion to their partnership interests.
The stockholders were charged par value for stock of the new corporation and the balance in their capital accounts in the partnership after the charges were entered in the books of the new corporation as an account payable. The amounts so entered and the credit balance in the accounts on April 27, 1951, were as follows:
| Credit | Balance | |
| Name | Apr. 1, 1946 | Apr. 27, 1951 |
| Fannye Perlman | $ 24,265.49 | $ 24,265.49 |
| Esther Friedlander | 23,827.61 | 18,827.61 |
| I. B. Perlman | 13,555.18 | 1 6,651.19 |
| Louis Friedlander | 12,583.95 | 83.95 |
| Max Friedlander | 32,069.52 | 2 5,946.87 |
| Malvin Friedlander | 48,030.98 | 13,638.40 |
| Irwin Friedlander | 48,030.98 | 3 5,078.67 |
At the time of the hearing herein Fannye Perlman was constructing a more pretentious home in Moultrie. Prior thereto she informed Louis of her intention to demand payment of the amount due her from the new corporation.
The officers of the new corporation are Louis Friedlander, president; I. B. Perlman, vice president; Irwin Friedlander, vice president; *1210 Max Friedlander, secretary-treasurer. Louis exercises control over the activities of the new corporation. For the fiscal year April 1, 1946, to December 31, 1946, the following salaries were paid by the new corporation:
| Louis Friedlander | $ 5,050.00 |
| I. B. Perlman | 2,137.50 |
| Irwin Friedlander | 660.00 |
| Max Friedlander | 660.00 |
Perlman and Irwin devote about 75 and 5 per cent, respectively, of their time to the affairs of the new corporation.
In his determination of the deficiencies respondent held that the income reported by the partnership constituted income taxable to*236 petitioner under the provisions of section 22 (a) of the Code and after recomputing it on a calendar year basis included the amount thereof in gross income of petitioner, $ 45,428.33 in 1943, $ 131,192.93 in 1944, and $ 174,623.62 in 1945.
The parties to the agreement of July 1, 1943, did not in good faith, and acting with a business purpose, intend to join together as partners in the present conduct of an enterprise.
Louis has been a charter member of the Rotary Club of Moultrie, Georgia, since 1922. Some of the leading business and professional men of Moultrie were members of the club. Louis was a regular attendant at meetings of the club when in Moultrie. He did not associate his membership in the club with petitioner's business. Petitioner did not claim as a deduction prior to 1943 any amount for Rotary Club dues. In its return for 1943 it claimed the amount of $ 278 as a deduction for Rotary Club dues. The amount was an accumulation of Rotary Club dues for prior years which had been billed to and paid by Louis. In his determination of the deficiency for 1943 respondent disallowed the deduction on the ground that the dues did not constitute an ordinary and necessary business*237 expense.
OPINION.
Petitioner contends that the membership in the Rotary Club afforded an opportunity for Louis, its president, to contact leading business and professional citizens of the community and create good will for the business. Substantial evidence is required to establish a right to deduct club dues as a business expense. . Cf. .
The fact that Louis paid the sum out of his personal funds during the course of his membership in the club for 21 years prior to the taxable year without any contention or proof that he sought reimbursement from petitioner or its predecessors, infers that he did not *1211 regard the cost as an ordinary and necessary business expense of his employer. He was prompted, according to his testimony, to seek reimbursement from petitioner in 1943 by advice from an unknown source, that petitioner should and could under the provisions of the Internal Revenue Code pay the expense. The effect of other testimony of Louis is that he regarded his membership in the club as having no connection with the business of petitioner.
*238 The evidence here does not justify a reversal of the respondent's action in denying the deduction. Accordingly, we sustain his determination that the amount is not an ordinary and necessary business expense of petitioner.
Of the salaries of $ 4,900, $ 5,000, $ 5,300, and $ 5,410 paid to Irwin during the respective taxable years, respondent allowed $ 4,300 each year and of the amounts of $ 3,725, $ 3,800, $ 3,980, and $ 4,322.50 paid to Max, he allowed $ 3,500 each year. The salaries paid included bonuses at the rate paid other employees, but the amount has not been shown.
Irwin and Max were employees of petitioner in 1941 but the amount paid to each was not shown by evidence in this proceeding. Petitioner asserts in its proposed findings that during the taxable years they were paid at the same rate as in 1941, plus an additional amount under a bonus system applied to all employees and refers to the approval of the 1941 compensation by this Court in a memorandum opinion entered in Docket No. 2053.
That proceeding involved the disallowance by the Commissioner of a special bonus of $ 2,000 paid to each, out of a total salary of $ 4,402.53 paid to Irwin and $ 3,501.26 paid to Max. *239 We found that the regular salary of Irwin was $ 2,150 and of Max $ 1,375 and that the remainder paid to each consisted of a bonus paid to all other employees. Louis testified here that he testified in that proceeding that the special bonus was paid because, among other things, of additional responsibilities assumed by Irwin and Max during his absence from the business on account of sickness. That fact was considered by us in reversing the respondent's action and allowing the entire amount as a deduction. No contention is made that they had additional responsibilities in 1942.
Irwin was absent in military service from January 1943 until November 1945 and Max from September 1942 until the same time and consequently performed no service for petitioner during such times.
Salaries paid to employees during absence in the military service are allowable as deductions upon the ground that they are "justified by past services and an employer's advantage in retaining the services of experienced personnel when released from service." .
*1212 The effect of the respondent's determination of $ 4,300 as reasonable compensation for*240 Irwin and $ 3,500 for Max was to allow the special bonus again in 1942, when Max was absent in military service for about 4 months, and in subsequent taxable years when both of them were on duty with the Navy until November 1945. Here, where the employees were stockholders and sons of the administrative head of the business, the motive for the payments is important. . It does not appear from the evidence that replacements were required during the absence of the employees or that salary payments were required to insure their return to the business after their discharge from the Navy.
Under the facts of record we are not warranted in disturbing the salary allowances made by the respondent. Accordingly, we hold for the respondent on this issue.
The third and primary issue is whether, as determined by respondent, the petitioner is taxable on the income of the partnership. The petitioner contends that the partnership was not a sham, and, therefore, should be recognized for tax purposes as a separate and distinct enterprise. The broad contention of respondent is that the various steps taken were paper transactions, without a sound*241 business purpose, to siphon off income of petitioner for the temporary benefit of its two controlling stockholders.
An established rule is that a taxpayer may select any form of organization through which to conduct business and is under no compulsion to adopt a type that will yield the greatest amount of tax revenue. , and cases collected therein on the point. In that case we said:
However, if the form of a business enterprise which a taxpayer adopts is a sham and a device to evade the burden of taxation, the law allows looking through the form to reality and disregarding the selected form of the business. ; .
See also , in which the Court said that "Escaping taxation is not a 'business' activity."
The device employed here was a dual family partnership to own and operate six of the nine stores being conducted by petitioner. Family partnership not created in good faith*242 for a business purpose may be disregarded and the profits from operations "taxed to him who earns it," .
Petitioner asserts that after prolonged discussion between and among Louis, Perlman, and the three Friedlander boys a determination was made in the fall of 1942 to set up for the boys a business which they could manage and control upon their return from military service and that 3 or 4 months later Louis requested petitioner's accountant *1213 to draft, with assistance of counsel, articles of copartnership containing provisions for the acquisition and operation of stores outside of Moultrie and the Smart Shop in that city. The alleged purpose is contrary to the facts of record.
No proof was made of the alleged determination by all of the interested parties at any time prior to the execution of the partnership agreement. Malvin, who did not enter military service until February 1943, did not participate in the discussions, and Max took no part in the final discussion to form a partnership. Irwin did not discuss a division of the business until after he entered the service of the Navy in January 1943, *243 and Perlman could recall no discussion on the subject until the early part of 1943. No contention is made that the wives ever participated in consideration of the plan, or that they "rendered any services to the partnership which would have the effect of validating it." It was not until about June 1, 1943, which was after petitioner's income tax return for 1942 was filed, that Louis requested the accountant "to get busy" and create a partnership as soon as possible. None of the alleged partners other than Louis conferred with the accountant on the subject and it does not appear from the evidence that they were aware of any of the terms of the agreement until it was presented to them for signature. The inference from the facts is that Louis dictated the plan and that the other partners accepted, without protest, whatever he chose to do. The point has particular significance because six of petitioner's stockholders, who held about 30 per cent of its stock, were not assigned partnership interests and the wives were not stockholders. The result was a division of corporate assets disproportionate to stockholdings. There is no indication in the evidence that nonparticipating stockholders*244 of petitioner were consulted. Any bona fide division of corporate activities for business purposes would have recognized the interests of the minority.
Petitioner's position with respect to the business purpose which necessitated creation of the partnership may be broadly stated as follows: that it was, prior to the formation of the partnership, a closely held dual family corporation with the exception of some very minor stockholders; that disputes arising between Louis' sons and Perlman because of their greatly divergent views on the subject of merchandising were a disrupting unhealthy factor in the conduct of corporate business affairs; that the partnership provided a means whereby a complete separation of fields of authority would be obtained and also provided a business separate from the corporation in which the sons' ideas and business capabilities could be put to use and developed.
That the purpose above stated was not in the minds of the parties to the partnership agreement becomes fairly obvious in the light of circumstances existing at the time the partnership was created and in *1214 the light of events subsequent thereto. On July 1, 1943, the date of execution of*245 the partnership agreement, all three of Louis' sons were in the armed services. Their availability to participate in partnership affairs could not then be anticipated. Their discharge from the armed services would occur at some unascertainable future time. Certainly they were not in a position to be a disruptive influence in corporate affairs while so engaged, and they were certainly not then in a position to manage partnership affairs. It is also worthy of note that the term of the partnership agreement was only 5 years. So short a term is more consistent with an intent to adopt the partnership form for tax reasons only, than with an intent to provide a real and permanent business organization for the development of the business ideas and capabilities of very young men. That such was not the real purpose behind the creation of the partnership is apparent when it is considered that Perlman, the arch rival of the sons in merchandising matters, was the person who, during the sons' absence and thereafter, managed the stores held by the partnership with the same authority and in the same manner as when said stores were owned by the petitioner. In fact, we are unable to discover*246 any real difference in the fields of authority and methods of conducting business on the part of Louis and Perlman after creation of the partnership. In view of the foregoing we are forced to the conclusion that the creation of the partnership was for the sole purpose of siphoning off the profits of petitioner with resulting tax benefits being the ultimate goal.
The transfer of assets did not flow from an arm's length transaction. The merchandise, scarce at that time, was transferred at mere invoice cost price, and, therefore, excluded amounts for transportation, handling and other charges that enter into the total cost of goods. It discloses a purpose of petitioner to place others in a position to make profits at its expense; a release of earnings without consideration. . Aside from the transfer of merchandise at less than actual cost to petitioner, no consideration was paid for the value of the stores as going concerns. The large amount of good will value of the stores is demonstrated by the earnings of $ 395,000 of the partnership during its existence of 33 months without a cent of capital contributions, an amount*247 of earnings $ 166,000 in excess of the net income of petitioner for the calendar years 1943, 1944, and 1945.
The fact that some consideration was given as early as September 1942 to a plan for dividing the business of petitioner is not decisive. The evidence here does not disclose any of the details of the scheme considered at that time, and, therefore, we are not in a position to say to what extent they were put into effect. Our answer must be found in what was actually done.
*1215 In , there was a severance of nondependent divisions of the enterprise in an arm's length transaction. In , affd. , the corporations organized to sell the corporate taxpayer's products had essentially the same stockholders and were held to have been organized for business purposes. Legitimate business reasons were the basis for the division in .
Here there was no substantial change in the operation of the stores after they were transfererd to the partnership. *248 Petitioner's officers continued to operate the stores without any material change of procedure and petitioner paid, without apportionment, numerous classes of expenses that would be chargeable to an independent entity. The outward appearances of separateness are frequently found in division of a business amounting to no more in the final analysis than paper transactions.
Louis, the architect of the plan, testified, in effect, that taxation was the predominant motive for the creation of the partnership. Such a purpose, if the plan for its accomplishment is not unreal or a sham, is of course not fatal, but the separation here was only nominal and availed of for the obvious intent of temporarily reallocating, without consideration or business reasons, petitioner's income among family groups of petitioner's selection. Only by its action could a scheme of the kind involved here have been put into effect. Such anticipatory arrangements are ignored for tax purposes. ; .
Decision will be entered under Rule 50.
Kern, J., dissenting: Two things*249 should be stressed in a consideration of this case: (1) it does not present the usual "family partnership" question, and (2) it does not involve the application of section 45 of the Internal Revenue Code, under which the Commissioner might allocate income or deductions between the corporation and the partnership in order to clearly reflect the income of both, but involves the application of section 22 (a). In order to reach the result reached by the majority herein it is necessary to conclude that there was, in reality, no partnership in existence during the taxable years, regardless of who the partners were. For example, it would not be enough to conclude that the Friedlander sons were not bona fide partners; it would be necessary to conclude that there were not any bona fide partners, and that even a partnership composed of Louis Friedlander and Perlman was a sham and without reality.
*1216 My interpretation of the facts is that a partnership was formed by some of the petitioner's stockholders, that petitioner transferred certain of its assets to the partnership, that the partnership paid petitioner for these assets, that the partnership used these assets in the conduct*250 of the business for which it was formed, that the partnership actively carried on a business during the taxable years, that the income from this business was distributed to the partners, that petitioner corporation did not earn or receive this income, and that the assets of the partnership eventually went into the hands of another corporation, none of the stock of which was owned by petitioner. This being my interpretation of what I consider to be the pertinent facts, I am unable to agree with the conclusion of the majority that the partnership was a sham.
The reality of a business organization is not to be tested by the motive leading to its formation, but by the purpose which it accomplishes and performs. See , affd. . In the instant case, where the partnership took over a business and operated it for several years, it would appear to me to have been formed for a business purpose even though the motive of the individuals leading to its formation was to minimize taxes.
The fact that the partnership acquired its assets from petitioner at a more reasonable price than*251 it could have acquired similar assets from another source and the fact that the partnership was not composed of all of petitioner's stockholders seem to me to be immaterial. Even though it be granted arguendo that the partnership was conceived in iniquity, nevertheless, it was conceived and came into being, and, in my opinion, it can not be disregarded as never having been in existence.
The case of , affd. , and the Buffalo Meter Co. case, the Chelsea Products, Inc., case and the Palm Beach Aero Corporation case, cited in the majority opinion, appear to me to be in basic conflict with the result reached by the majority herein. I therefore respectfully note my dissent.
Footnotes
1. Sold Dec. 31, 1944, at par, 105 shares to I. B. Perlman, and 437 shares to the United Investment Co.↩
1. The stipulation includes this unit but it is not referred to in other evidence.↩
1. Does not include opening inventory.↩
1. To pay gift tax.↩
3. To pay Federal and state income taxes↩
2. To pay estimated income taxes for 1944.↩
1. Debit balance.↩
2. Includes adjustment for additional credits totaling $ 2,110.30.↩
3. Includes adjustment for additional credits totaling $ 3,545.54. Except for about $ 500 each year, all of the amounts withdrawn were used to pay taxes.↩