*312 Decisions will be entered under Rule 50.
King Grocery Company for many years operated five wholesale grocery houses in five different towns in Mississippi. On January 3, 1944, it reorganized and the five houses became the five petitioner corporations. Petitioners claim separate excess profits tax exemptions under section 710 (b) (1), Internal Revenue Code, of $ 10,000 apiece, or a total of $ 50,000, in lieu of the single exemption of $ 10,000 to which King Grocery Company would have been entitled, in each of the years 1944 and 1945.
On the facts, held, the principal purpose of the reorganization was a business purpose and was not, within the meaning of section 129 of the Code, the evasion or avoidance of Federal income or excess profits tax, and petitioners are entitled in 1944 and 1945 to the separate excess profits tax exemptions claimed by them.
*75 Respondent determined deficiencies as follows:
| Declared value | Excess | |||
| Docket | Petitioner | Year | excess-profits | profits |
| No. | tax | tax | ||
| 21118 | Alcorn Wholesale Co | 1944 | $ 5,706.99 | |
| 26420 | 1945 | 6,290.12 | ||
| 21170 | Lee Wholesale Co | 1944 | $ 127.16 | 8,101.71 |
| 26421 | 1945 | 2.40 | 6,937.11 | |
| 21171 | Pontotoc Wholesale Co | 1944 | 3,241.89 | |
| 26422 | 1945 | 6.60 | 4,391.47 | |
| 21172 | Union Wholesale Co | 1944 | 7,112.67 | |
| 26423 | 1945 | 4,361.07 | ||
| 21187 | Tippah Wholesale Co | 1944 | 4,067.99 | |
| 26424 | 1945 | 9.90 | 6,247.89 |
The proceedings were consolidated for hearing.
The question presented is whether the five petitioners herein are entitled in 1944 and in 1945 to a specific exemption from excess profits *76 net income of $ 10,000 each under section 710 (b) (1), Internal Revenue Code, or only to a total exemption of $ 10,000 in each of those years, under section 129 of the Code, as determined by respondent. Other adjustments made by respondent are uncontested.
FINDINGS OF FACT.
Petitioners*314 are corporations organized and existing under the laws of the State of Mississippi. Their returns for the years here involved were filed with the collector of internal revenue for the district of Mississippi, at Jackson, Mississippi.
Reeves Grocery Company was incorporated under the laws of the State of Mississippi on December 23, 1905. The authorized capital stock was $ 50,000, consisting of 500 shares of $ 100 par value each. By various amendments to the charter, the capital stock was increased from time to time. As of January 1, 1924, the capital stock was $ 160,000. The company was engaged in the business of a jobber or wholesale seller and distributor of groceries and notions. Merchandise was sold through the medium of traveling salesmen.
A business depression occurred in this country following World War I from 1920 to 1924. Reeves Grocery Company suffered financial losses during the years 1920, 1921, and 1923. It made a very small profit during 1922. As a result of depressed business conditions following World War I, the company's capital decreased from $ 160,000 to approximately $ 22,000.
The principal business of the area served by Reeves Grocery Company and its successor*315 is farming. Cotton is the principal crop of the area. The depression of 1920-1924 caused a sharp decline in the price of farm products. The decline in the price of cotton adversely affected business conditions in the area.
Because of the financial difficulties Reeves Grocery Company encountered during the depression that followed World War I between 1920 and 1924, the company sought the services of J. M. Whiteside as general manager. Whiteside would not agree to accept employment with the company until an audit of the business was made and he could investigate its financial condition. Oliver P. Cobb and Company of Memphis, Tennessee, made an audit covering the years 1921, 1922, and 1923 and the month of January 1924. After the audit Whiteside agreed to become general manager and secretary-treasurer of the business. He insisted that additional new capital be invested in the business. Bankruptcy would have resulted unless new capital was invested. New capital was invested, increasing the actual capital from $ 22,000 to $ 50,000. In addition, the name of the business was changed from Reeves Grocery Company to King Grocery Company.
*77 Until 1925 the only place of business*316 of the King Grocery Company was located in Tupelo, Mississippi. Branch houses were opened by King Grocery Company in Mississippi -- in 1925 at Pontotoc, in 1926 at New Albany, in 1927 at Ripley, and in 1934 at Corinth. All the branches used the name of King Grocery Company.
By 1943, in general, the territory served by King Grocery Company, (hereinafter referred to as King), was north Mississippi, south Tennessee and northwestern Alabama. King's store in Tupelo, which became the business of petitioner Lee Wholesale Company, served the Mississippi counties of Lee, Itawamba, Monroe, Clay, Oktibbeha, Chickasaw, Calhoun, and Lafayette and the Alabama counties of Marion, Lamar, and Lafayette. King's store in Corinth, which became the business of petitioner Alcorn Wholesale Company, served the Mississippi counties of Alcorn, Prentiss, and Tishomingo and the Tennessee counties of McNairy, Chester, Hardin, and Wayne and the Alabama counties of Lauderdale, Colbert, and Franklin. King's store in Ripley, which became the business of petitioner Tippah Wholesale Company, served the Mississippi counties of Tippah and Benton and the Tennessee county of Hardeman. King's store at New Albany, *317 which became the business of petitioner Union Wholesale Company, served the Mississippi counties of Union and Marshall. King's store at Pontotoc, which became the business of petitioner Pontotoc Wholesale Company, served the Mississippi county of Pontotoc.
The principal office of King was located at Tupelo in Lee County. New Albany is located 25 miles west of Tupelo in Union County; Ripley is located 48 miles northwest of Tupelo in Tippah County; Corinth is located 50 miles north of Tupelo in Alcorn County, and Pontotoc is located 18 miles southwest of Tupelo in Pontotoc County.
King was engaged in the business of a jobber or wholesale seller and distributor of groceries and notions but also sold building supplies, staple hardware, steel products, automobile tires, ammunition, and drugs. The merchandise was sold to independent retail merchants through the medium of traveling salesmen. The goods were delivered by truck or by freight.
In 1943 and prior thereto, the officers of King subscribed to several business services which issued weekly letters advising the general trend of commodity prices, labor conditions, finances and other subjects of usual interest to businessmen. These*318 services were predicting an early conclusion of the war and counseling businessmen to get their house in order, reduce inventories, and keep their business on a healthy financial basis. The weekly letters were predicting a decline in commodity prices and a business depression similar to that which followed World War I. The officers of King relied on these predictions.
*78 There was intense competition in the wholesale grocery business in the area served by King. In 1943 there were a number of competing wholesale grocery firms in the cities where King operated. In Tupelo, Mississippi, a town with a population of about 10,000 people, there were four wholesale grocery companies other than King. In Corinth, Mississippi, a town of 9,000 or 10,000 population in 1943, there were three major wholesale grocery companies other than King. In addition, there were smaller competitors who peddled merchandise direct from cars. In New Albany, Mississippi, a town with a population of 3,500 in 1943, there were two competitors of King. In addition to the wholesale grocery companies that were located in the towns served by King, there were other firms selling wholesale groceries in King's*319 trade area from adjacent areas.
In 1942 and 1943 it appeared to the officers and stockholders of King that business conditions generally were developing along lines similar to those that existed during World War I, prior to the previous unfortunate experience of the business that followed World War I. The officers realized that the disastrous results to the business during the years 1920 to 1924 were brought about by the depressed business, economic and financial conditions following shortly after the conclusion of World War I. The officers anticipated a similar depression would occur after the conclusion of War War II.
On February 13, 1943, the board of directors of King held a special meeting, the minutes of which are as follows:
KING GROCERY COMPANY
MINUTES OF A SPECIAL MEETING OF THE BOARD OF DIRECTORS
A special meeting of the Board of Directors of the King Grocery Company, a Mississippi corporation, was held at the office of the said corporation in the city of Tupelo, Mississippi, on February 13, 1943, at 2:00 P. M., pursuant to waiver of notice signed by all of the directors of the corporation.
The following directors were present:
J. Albert King
Robert King
J. M. Whiteside
*320 S. E. Long
O. D. Conner
being all of the Directors of the corporation, and constituting a quorum.Mr. J. Albert King, Chairman of the Board of the corporation, acted as Chairman of the meeting and Mr. O. D. Conner, Secretary-Treasurer of the corporation, acted as Secretary of the meeting.
The Chairman stated the purpose for which the meeting had been called was to consider a "Suggested Plan of Reorganization" of the company, with a view of increasing the good will of the company in the various communities in which it operates and, thus, increase sales and profits, increasing the safety of the investment of the stockholders in the company and minimizing tax burdens.
In a full discussion of the problems of the company brought about by the War, the following points were brought out:
*79 (1) The Company now operates stores in five different cities in Mississippi under the name of King Grocery Company and in competition with several wholesale grocery concerns. There is a strong feeling of local pride and resentment toward "outside chain" stores in Mississippi. Consequently, business has suffered in many instances by reason of competitors saying that the King Grocery Company is*321 an "outside chain" which is not wholly owned nor operated by the citizens of the city, or locality, in which each store is located and that the store in each particular city is a "branch house". It is believed that business would be increased and such competitive arguments overcome if each of the stores bore the name of the city or locality in which it is located. This idea could be best carried out by having a separate corporation organized for each store, with each separate corporation bearing the name of the city, or locality, in which it is located, and having its "principal" office in such city or locality.
(2) The war emergency has brought a large number of persons into the area served by the company's stores. A sudden termination of the war may mean that the said persons will leave the area, with a resulting decline in business. Such a situation might be more severe in the area, or areas, served by one or more of the company's stores, as compared with other stores. The effect of such a situation upon the volume of business, ability to collect accounts receivable, and other factors applicable to one store should not be borne by the other stores owned by the company, and*322 not so affected.
(3) The company's stores are located in agricultural communities and are prosperous in direct ratio to the agricultural prosperity of their areas. The war has resulted in many young men being called from the farms to the colors. A large proportion of these men may never return to their former homes. This causes a large element of uncertainty as to the post war agricultural prosperity of the areas served by the stores. Conditions in the area served by one store may differ greatly from conditions in areas served by other stores.
(4) In the past the agricultural prosperity of the areas served by the company's stores has been, in certain years, adversely affected by blights, such as, the boll weevil, and weather disturbances in the nature of unusually heavy, or unusually light rainfall, and the like. Such conditions may exist during any one year in the area served by one or more of the company's stores and not exist in areas served by other stores.
(5) The Federal income and excess profits laws give a decided tax advantage to corporations with a small, or low volume of earnings.
In view of the foregoing circumstances, the Chairman stated it appeared advisable to *323 consider dividing the business of the company into five separate corporations, with each of the said five corporations owning and operating one of the company's present stores. By following this procedure, the investment of the stockholders would not be jeopardized by having the entire business in one corporation subject to various hazards in five separated communities.
Discussion was then had as to the effect, from a Federal tax viewpoint, of carrying out such a plan. Consequently, upon motion made, seconded and unanimously carried, the following resolutions were adopted:
RESOLVED, that the President and Secretary-Treasurer be and they are hereby authorized and directed to take all necessary steps, execute all necessary documents, and employ necessary legal and accounting assistance, to secure from the Bureau of Internal Revenue a written ruling advising the tax consequences in the event the said suggested plan of reorganization is carried out; and
RESOLVED FURTHER, that the President and Secretary-Treasurer be and they are hereby authorized and directed to submit the following Suggested *80 Plan of Reorganization to the Bureau of Internal Revenue for the purpose of securing*324 such a ruling:
SUGGESTED PLAN FOR THE REORGANIZATION OF KING GROCERY COMPANY
A. Purposes and objects of the plan:
1. To eliminate the "anti-chain store" feeling that exists in the area served by the company.
2. To minimize the risks and hazards of the capital invested in the business.
3. To minimize taxes.
B. Steps to be taken and procedure to be followed for accomplishing the purposes and objects of the plan:
1. Segregation of the functions and assets of this corporation into five separate new corporations to be organized under the laws of the State of Mississippi, one for each of the stores now operated by this company. The said five corporations will have a total of 3,000 shares of no par value common stock, with each new corporation to have the number of shares of its capital stock determined by the approximate net value of the assets and business of the store of this corporation which it will succeed.
The said approximate value of the various stores, and the number of shares of stock in each of the new corporations is as follows:
| Approximate | Number of | |
| value | Shares | |
| Tupelo | $ 90,000.00 | 900 |
| Corinth | 90,000.00 | 900 |
| Ripley | 45,000.00 | 450 |
| New Albany | 45,000.00 | 450 |
| Pontotoc | 30,000.00 | 300 |
*325 2. Transfer of all of the business and assets of this corporation to the new corporations and the assumption and payment of its corporate debts, and the discharge of its corporate liabilities by the new corporations, all to be done in exchange for a total of 3,000 shares of common stock of no par value in the new corporations, as outlined in the preceding paragraph.
The assets transferred to and the liabilities assumed by each of the five new corporations are to be on the basis of, and in accordance with, the assets and liabilities applicable to each of the five stores of this corporation, as shown by the balance sheet of this corporation on the date of the reorganization, and which are approximately as set out above.
3. Dissolution of this corporation.
4. Distribution of certificates representing shares of the common stock of each of the five new corporations to the holders of the common stock of the present corporation upon surrender of their certificates representing their common stock on the basis of, and in the same ratio, as stock is held in the present corporation. Expressed another way, such an exchange will be on the basis of the holder of each ten shares of stock in the*326 present corporation receiving stock in the five new corporations in the following amounts:
| Tupelo | 6 shares |
| Corinth | 6 shares |
| Ripley | 3 shares |
| New Albany | 3 shares |
| Pontotoc | 2 shares |
*81 C. Mechanics:
1. Adoption of appropriate preambles and resolutions by the directors of this corporation, and of the new corporations, to effectuate the "plan", all to be subsequently ratified and approved by stockholders of this corporation.
2. The use of contracts to simplify the transfer of assets of this corporation to the new corporation except in the case of real estate.
RESOLVED FURTHER, that if the Bureau of Internal Revenue rules that the proposed plan may be carried out without tax liability being imposed upon any of the corporations which are parties to the reorganization, or their stockholders, the officers of this corporation are directed to take such steps as may be necessary to effectuate the suggested plan not later than ninety days from the date of securing the said ruling from the Bureau of Internal Revenue.
There being no further business, upon motion made, seconded and unanimously carried, the meeting was adjourned.
[Signed] O. D. Conner,
Secretary.
[Signed] *327 J. Albert King,
Chairman.
On December 15, 1943, the board of directors resolved to reorganize the King Grocery Company into five separate corporations. The plan of reorganization is set forth in a resolution of the stockholders at a meeting held on December 31, 1943, as follows:
RESOLUTION OF THE STOCKHOLDERS OF KING GROCERY COMPANY, INCORPORATED, ADOPTING AND APPROVING THE PLAN OUTLINED BY THE BOARD OF DIRECTORS OF SAID CORPORATION FOR A REORGANIZATION THEREOF.
WHEREAS, it appears to the stockholders of King Grocery Company, Incorporated, that the Board of Directors of said company, at a meeting duly held on the 15th day of December, 1943, determined that the best interests of said company would be conserved by a reorganization thereof, and at said meeting set forth in its minutes certain points outlining the benefits to be derived from the reorganization which were respectively numbered "(1)" to "(7)" inclusive, which points were followed by a resolution adopted by said Board of Directors setting forth the purposes and objects of the plan, the steps and procedure to be taken, and the mechanics thereof, which points set forth in the minutes of said directors meeting, and which*328 resolutions are in the following form, to-wit:
"(1) Frequently in the past the company has been required to borrow money to properly operate its business. At the present time all inventories are depleted. In addition, because of the inability to purchase new automotive equipment, such automotive equipment is likewise depleted and getting in a bad state of repair. Therefore, it is apparent that when markets are again opened, large sums of money will be required to bring the stock of merchandise up to normal and to replace automotive equipment. To replace such inventories and automotive equipment, it is contemplated that large sums of money will have to be borrowed. The company has never established foreign lines of credit, and depends upon local banks, in the towns or area where its stores are located, to take care of its required borrowing. Under the statute of the State of Mississippi, no bank can lend more than fifteen per cent of its capital and surplus to any one borrower, greatly limiting the line of credit to the one company. *82 Under the reorganization plan, with five separate corporations, the local banks could stay within the law and lend the reorganized company, *329 if necessary, five times as much money as under the present law.
"(2) The war emergency has brought an increased number of persons into the area served by the company's stores, and a change in business and economic conditions. The termination of the war may mean that said persons will leave the area, and that the earnings of those remaining may be reduced, and that business conditions will undergo a further change, with a resulting decline in business. Such a situation might be more severe in one area, or areas, served by one or more of the company's stores as compared with other stores. The effect of such a situation might weaken the entire financial structure of the present operating setup, while under the proposed reorganization plan only those stores in the affected area, or areas, would be endangered thereby. Under the new setup, therefore, the credit of only the stores in the affected areas would be weakened, where otherwise the entire structure would be weakened.
"(3) The company's stores are located in agricultural communities and are, in normal times, to a certain extent, prosperous in direct ratio to the agricultural prosperity of their areas. The war has resulted in*330 many young men being called from the farms to the colors. A large proportion of these men may never return to their former homes. This causes an element of uncertainty as to the postwar agricultural prosperity of the areas served by the stores. Conditions in the area served by one store may differ from conditions in areas served by other stores, bringing about the same situation mentioned in paragraph '(2)' above.
"(4) In the past the agricultural prosperity of the areas served by the company's stores has been, in certain years, adversely affected by blights, such as, the boll weevil, army worms, and weather disturbances in the nature of hail or unusually heavy, or unusually light rainfall, and the like. Such conditions may exist during any one year in the area served by one or more of the company's stores and not exist in areas served by other stores, and the reorganization would prevent a resulting disaster in the area of one store from endangering the solvency of the remaining stores.
"(5) There is always danger of tort actions, based on alleged negligence, either brought by an employee, or by someone injured by a truck or on the premises of the company. In such event a large*331 judgment against the present organization might be disastrous, while under the reorganization plan only one of the new companies could be affected.
"(6) There are many mercantile fields in which there are competing lines, the handling of two or more of which might sometimes be advantageous to the company, but a company handling one of these competing lines would not be allowed to handle the line of its competitor. Under the present setup, the organization is limited, in many instances, to only one line in that particular field. Under the reorganization plan, one company could handle one line, another of the corporations could handle a competing line and they could work the same territory to the advantage of the organization.
"(7) The company now operates stores in five different cities in Mississippi under the name of King Grocery Company, and in competition with several wholesale concerns. There is a feeling of pride in local ownership, and resentment toward 'absentee ownership'. Consequently, business has suffered in some instances by reason of competitors saying that the King Grocery Company is not a home-owned organization, owned nor operated by the citizens of the city, or*332 locality, in which each store is located. It is believed that business would be increased and such competitive arguments overcome if each of the stores bore the name of the city or locality in which it is located. * * * *83 This idea could be best carried out by having a separate corporation organized for each store, with each separate corporation bearing the name of the city, or locality, in which it is located, and having its 'principal' office in such city or locality.
"In view of the foregoing circumstances, it appeared advisable to consider dividing the business of the company into five separate corporations, with each of the said five corporations owning and operating one of the company's present stores. By following this procedure, the investment of the stockholders would not be jeopardized by having the entire business in one corporation subject to various hazards in five separated communities. In addition, increased borrowing capacity, ability to handle competing lines of merchandise and other obvious advantages would result to the business as a whole.
"Discussion was then had as to the effect, from a Federal tax viewpoint, of carrying out such a plan and it is apparent*333 that adoption of the plan will not increase the Federal tax liability of the business. Consequently, upon motion made, seconded and unanimously carried, the following resolutions were adopted:
RESOLVED, that the President and Secretary-Treasurer be and they are hereby authorized and directed to take all necessary steps, execute all necessary documents, and employ necessary legal and accounting assistance, to carry out the said suggested plan of reorganization which is:
A. Purposes and objects of the plan:
1. To increase the borrowing capacity of the business as a whole so that when conditions permit the purchase of merchandise to replace depleted inventories and automotive equipment, it will be possible to borrow sufficient money to meet the needs of the business.
2. To minimize the risks and hazards of the capital invested in the business.
3. To permit the handling of competitive lines of merchandise.
4. To eliminate the prejudice against absentee ownership and to appeal to local pride.
B. Steps to be taken and procedure to be followed for accomplishment of the purposes and objects of the plan:
1. Segregation of the functions and assets of this corporation into five separate*334 new corporations to be organized under the laws of the State of Mississippi, one for each of the stores now operated by this company. The said five corporations will have a total of 3,000 shares of no par value common stock, with each new corporation to have the number of shares of its capital stock determined by the approximate net value of the assets and business of the store of this corporation which it will succeed.
The said approximate value of the various stores, and the number of shares of stock in each of the new corporations is as follows:
| Approximate | Number of | |
| Value | Shares | |
| Tupelo | $ 90,000.00 | 900 |
| Corinth | 90,000.00 | 900 |
| Ripley | 45,000.00 | 450 |
| New Albany | 45,000.00 | 450 |
| Pontotoc | 30,000.00 | 300 |
2. Transfer of all the business and assets of this corporation to the new corporations and the assumption and payment of its corporate debts and the discharge of its corporate liabilities by the new corporation, all to be done in exchange for a total of 3,000 shares of common stock of no par value to the new corporations, as outlined in the preceding paragraph.
*84 The assets transferred to and the liabilities assumed by each of the five new corporations*335 are to be on the basis of, and in accordance with, the assets and liabilities applicable to each of the five stores of this corporation, as shown by the balance sheet of this corporation on the date of the reorganization, and which are approximately as set out above.
3. Dissolution of this corporation.
4. Distribution of certificates representing shares of the common stock of each of the five new corporations to the holders of the common stock of the present corporation upon surrender of their certificates representing their common stock on the basis of, and in the same ratio, as stock is held in the present corporation. Expressed another way, such an exchange will be on the basis of the holder of each ten shares of stock in the present corporation receiving stock in the five new corporations in the following amounts:
| Shares | |
| Tupelo | 6 |
| Corinth | 6 |
| Ripley | 3 |
| New Albany | 3 |
| Pontotoc | 2 |
C. Mechanics:
1. Adoption of appropriate preambles and resolutions by the directors of this corporation, and of the new corporations, to effectuate the 'plan', all to be subsequently ratified and approved by stockholders of this corporation.
2. The use of contracts to simplify the transfer*336 of assets of this corporation to the new corporation, except in the case of real estate.
RESOLVED FURTHER, the officers of this corporation are directed to take such steps as may be necessary to effectuate the suggested plan as promptly as possible."
AND WHEREAS it appears, after mature consideration, that said reorganization, as proposed and outlined by the Board of Directors, would be beneficial and should be authorized and approved.
THEREFORE BE IT RESOLVED by the stockholders of King Grocery Company, that we hereby adopt, confirm and approve the proposed reorganization of the company, and the plan for such reorganization, as outlined in the minutes and resolution of said Board of Directors hereinbefore set forth in full in this resolution, and we hereby authorize and empower the Board of Directors to take such steps as it deems necessary and proper to effectuate, complete and consummate said plan of reorganization as promptly as possible.
The foregoing resolution after being duly read and considered was unanimously adopted by all of the stockholders and stock of said corporation voting therefor.
Under the banking laws of Mississippi a bank will only loan a person or corporation*337 money not exceeding 15 per cent of the aggregate paid-in capital and surplus of the bank. In 1943 the average capital and surplus of the banks with which King did business was $ 50,000. King borrowed from six banks. The most that was ever borrowed at one time was $ 40,000. In 1943 the management of King estimated that it would need to borrow considerable sums to replenish its depleted inventories and replace worn out equipment. However, the *85 petitioners were not required to borrow immediately, since merchandise was not available but was sold by manufacturers and producers on an allotment basis. Therefore none of the petitioners borrowed from banks in 1944 and 1945. However, since the end of the war the petitioner companies have built up their inventories. It has been necessary for them to borrow over $ 100,000. The business could not have borrowed the amount of money the various petitioners did borrow from the banks if it had been operating as a single corporation. For example, the People's Bank at Ripley, Mississippi, loaned money in 1947 to Lee Wholesale Company, Alcorn Wholesale Company, Union Wholesale Company and Tippah Wholesale Company, amounting to over $ *338 50,000. The maximum amount that the People's Bank could loan a single borrower, under the laws of Mississippi, based on its capital, was about $ 13,500.
The principal source of income of the people who live in the trade territory served by the petitioners is farming and the major crop is cotton. However, the various areas within that territory differ as to both agricultural and industrial economies. The income of the stores in the various trade areas depends upon the prosperity of the area each serves and in some years some stores have prospered while others have not.
Prior to 1943 King had been sued for tort actions many times. In 1943 the company operated 20 to 25 trucks and between 12 and 15 automobiles in its business. It had previously been sued for $ 50,000 on one occasion when it had insurance coverage of only $ 5,000 to $ 10,000. The case was settled. However, the insurance company cancelled its insurance and withdrew from the State of Mississippi. It was difficult to obtain liability insurance in Mississippi. If each of the stores was operated as a separate corporation, a judgment against one of the corporations would not endanger the financial position of the entire*339 business. The other corporations would not be affected at all.
King had experienced difficulty in obtaining more than one competing line of merchandise. Manufacturers or producers grant exclusive franchises for the sale of their products in different localities. Because a competitor of King had a franchise in Tupelo for the distribution of Omega flour, it could not be procured by any of King's stores. After the reorganization the Omega flour franchise was procured at Corinth by the Alcorn Wholesale Company. Similarly, products of Keasbey & Mattison, producers of asbestos roofing and siding, and products of the Flintkote Company and Dole Pineapple were procured after the reorganization by the various petitioners, although King was unable to obtain them, because exclusive franchises had been granted to some competitor of King in one of the trade areas. It was planned that the petitioner companies would take on competing *86 lines of merchandise and work one another's trade territory. This would increase the volume of sales of the businesses.
In Mississippi there was local resentment against businesses with absentee ownership, i. e., owner not living in the town or community*340 in which the store is located. King was known as a Tupelo concern, though each of its branches was operated by local people. In Corinth competitors would use this fact against King in dealing with the local merchants.
After the reorganization, by naming the stores after the counties in which they were located, it was implied that they were locally owned.
On December 31, 1943, the stockholders of King approved the action of the board of directors and the plan of reorganization was carried out. Five new Mississippi corporations were organized in accordance with the plan of reorganization and began business on January 3, 1944. The new corporations are the petitioners in the present proceedings. On January 3, 1944, the assets of King were transferred to and the liabilities assumed by the petitioner corporations on the basis of the assets and liabilities applicable to each of the five stores. Stock in the petitioner corporations was issued to the stockholders of King in the proportion that the stockholders owned stock in King. On July 14, 1944, the King Grocery Company was dissolved.
On January 1, 1944, King mailed to its suppliers a circular letter reading as follows:
KING GROCERY*341 CO. Incorporated
Wholesale Exclusively
TUPELO, MISS.
Branches
Pontotoc, Miss.
New Albany, Miss.
Ripley, Miss.
Corinth, Miss.
Home Office
Tupelo, Miss.
January 1st, 1944.
Over a period of years we have operated Branch Stores at Pontotoc, New Albany, Ripley and Corinth, Mississippi. This operation has been under one charter -- King Grocery Company, Tupelo, Mississippi. Due to prevailing conditions we consider it advisable to incorporate each store under separate charter.
The assets of King Grocery Company will be taken over by the five new companies. The stockholders of King Grocery Company will accept stock in the new companies in exchange for the assets of King Grocery Company. There is no change in the ownership or management.
The capital and name of each store is [sic] follows:
| Capital | Formerly | |
| A corn Wholesale Co., | ||
| Corinth, Miss | $ 90,000.00 | King Grocery Company, Corinth, Miss. |
| Lee Wholesale Co., | ||
| Tupelo, Miss | 90,000.00 | King Grocery Company, Tupelo, Miss. |
| Tippah Wholesale Co., | ||
| Ripley, Miss | 45,000.00 | King Grocery Company, Ripley, Miss. |
| Union Wholesale Co., | ||
| New Albany, Miss | 45,000.00 | King Grocery Company, New Albany, Miss |
| Pontotoc Wholesale Co., | ||
| Pontotoc, Miss | 30,000.00 | King Grocery Company, Pontotoc, Miss. |
*342 *87 The accounting for all five companies will be done by Lee Wholesale Co., Tupelo, Mississippi. Render all invoices in duplicate and mail to the company receiving shipment. The original of said invoice will be approved by the company receiving shipment and forwarded to Lee Wholesale Co., Tupelo, Mississippi, for payment.
Purchasing for the five companies will be operated as heretofore. All orders will be placed or approved by the Ripley or Tupelo, Mississippi offices.
Financial statement will be available as soon as Auditors complete audit and transfer.
If additional information is needed, address communications to Lee Wholesale Company, Tupelo, Mississippi.
Yours truly,
JMW: MA
KING GROCERY COMPANY
The managers of the five petitioners were the same as the managers of King.
The stockholders of the five petitioners immediately after the split-up and for some time thereafter were the same people as the stockholders of King. The Pontotoc Wholesale Company was liquidated in 1948.
After the reorganization each individual corporation kept separate books of account recording transactions with suppliers and with customers. Each corporation made up a daily report from its books*343 showing accounts receivable and so forth, and mailed it to the Lee Wholesale Company at Tupelo. Bills from suppliers of the five petitioner corporations were paid at the Lee Wholesale Company with checks drawn on the corporation owing the bill. A master record was kept there of each corporation's transactions with suppliers.
The net income of King and the petitioners for the fiscal years ended June 30, 1938, to and including the taxable year ended December 31, 1945, was as follows:
| Taxable net | ||
| Name | Year | income |
| King Grocery Co. | June 30, 1938 | $ 5,248.60 |
| Do | June 30, 1939 | 16,643.60 |
| Do | June 30, 1940 | 20,579.05 |
| Do | June 30, 1941 | 34,395.40 |
| Do | June 30, 1942 | 38,326.88 |
| Do | June 30, 1943 | 32,969.85 |
| Do | 6 mos. ended December 31, 1943 | 42,581.93 |
| Taxable net income | Taxable net income | |
| as of December | as of December | |
| 31, 1944 | 31, 1945 | |
| Alcorn Wholesale Co. | $ 19,250.13 | $ 18,595.68 |
| Lee Wholesale Co. | 22,708.30 | 25,653.12 |
| Pontotoc Wholesale Co. | 7,701.12 | 8,974.38 |
| Union Wholesale Co. | 15,066.77 | 10,707.90 |
| Tippah Wholesale Co. | 12,468.70 | 13,308.44 |
| Total | $ 77,195.02 | $ 77,239.52 |
*88 The King Grocery Company was reorganized into the five*344 petitioner corporations on January 3, 1944, principally for business reasons and not principally to evade or avoid tax.
The petitioners are each entitled to a specific excess profits tax exemption of $ 10,000 during 1944 and 1945 as prescribed by section 710 (b) (1) of the Internal Revenue Code.
OPINION.
King Grocery Company for many years operated five wholesale grocery houses in five different towns in Mississippi. On January 3, 1944, it reorganized and the five houses became five separate corporations, the present petitioners. Respondent contends that the principal purpose motivating the reorganization was "the avoidance of a fair share of excess profits tax through the medium of obtaining, if possible, a total exemption of $ 50,000 under section 710 (b) (1) 1 of the Internal Revenue Code in lieu of a single exemption of $ 10,000". He maintains that, therefore, under section 1292 of the Code the petitioner corporations are only entitled to a total exemption of $ 10,000 in each of the years 1944 and 1945.
*346 Petitioners contend that section 129 is inapplicable because (1) that section was not intended to apply to "split-up" reorganizations such as that here, and (2) the principal purpose of the reorganization was not to evade or avoid tax. We find it unnecessary to consider petitioners' first contention. For we have found as a fact that the *89 reorganization here in question was effected principally for business reasons and not principally to evade or avoid tax. Accordingly, section 129 of the Code is not applicable, respondent erred, and petitioners are each entitled to a specific excess profits tax exemption of $ 10,000 during 1944 and 1945 under section 710 (b) (1) of the Code. We have made a finding that they are so entitled.
Our findings therefore dispose of the only issue in these proceedings. The issue being chiefly one of fact, little further discussion is necessary. Suffice it to say that, in our opinion, the reorganization was not an arbitrary and artificial arrangement but a natural division for business reasons of the King Grocery Company, with its five wholesale houses, into five corporations. We have set forth at some length these business reasons. Briefly, *347 they were: (1) To increase the combined borrowing capacity. Under Mississippi law, a bank can only loan one person or corporation 15 per cent of that bank's aggregate paid-in capital and surplus. (2) To limit the liability so that a financial disaster to one petitioner arising from a tort judgment or other event would not affect the other petitioners. (3) To permit the handling of competitive lines of merchandise. Where an exclusive franchise had been granted for the sale of a product to some competitor of King Grocery Company in one of the trade areas, King Grocery Company was unable to obtain a franchise for the sale of that product in another of the trade areas. After the reorganization, the petitioner corporations could separately obtain franchises for the sale of competing products. (4) To eliminate the prejudice against absentee ownership. King Grocery Company was known as a Tupelo, Mississippi, concern and so was considered an absentee owner in other trade areas. After the reorganization, the naming of the stores after the counties in which they were located implied to the public that they were locally owned.
Petitioners do not deny that their officers were aware of*348 the Federal tax consequences at the time of the reorganization. "The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted." Gregory v. Helvering, 293 U.S. 465">293 U.S. 465. It may not be amiss to point out, of course, that the reorganization was not an unmixed blessing taxwise. For instance, profits of one store could no longer be offset by losses of another store. But even assuming that tax avoidance was one of the purposes of the reorganization, our only inquiry under section 129, Internal Revenue Code, is whether tax evasion or avoidance was the "principal purpose" of the reorganization. See Commodores Point Terminal Corporation, 11 T. C. 411. We have found that such was not the case. Accordingly, petitioners must prevail.
Decisions will be entered under Rule 50.
Footnotes
1. SEC. 710. IMPOSITION OF TAX.
* * * *
(b) Definition of Adjusted Excess Profits Net Income. -- As used in this section, the term "adjusted excess profits net income" in the case of any taxable year means the excess profits net income (as defined in section 711) minus the sum of:
(1) Specific exemption. -- A specific exemption of $ 10,000, * * *.↩
2. SEC. 129. ACQUISITIONS MADE TO EVADE OR AVOID INCOME OR EXCESS PROFITS TAX.
(a) Disallowance of Deduction, Credit, or Allowance. -- If (1) any person or persons acquire, on or after October 8, 1940, directly or indirectly, control of a corporation, or (2) * * * and the principal purpose for which such acquisition was made is evasion or avoidance of Federal income or excess profits tax by securing the benefit of a deduction, credit, or other allowance which such person or corporation would not otherwise enjoy, then such deduction, credit, or other allowance shall not be allowed. For the purposes of clauses (1) and (2), control means the ownership of stock possessing at least 50 per centum of the total combined voting power of all classes of stock entitled to vote or at least 50 per centum of the total value of shares of all classes of stock of the corporation.
(b) Power of Commissioner to Allow Deductions, Etc., in Part. -- In any case to which subsection (a) is applicable the Commissioner is authorized --
(1) to allow as a deduction, credit, or allowance any part of any amount disallowed by such subsection, if he determines that such allowance will not result in the evasion or avoidance of Federal income and excess profits tax for which the acquisition was made; or
(2) to distribute, apportion, or allocate gross income, and distribute, apportion, or allocate the deductions, credits, or allowances the benefit of which was sought to be secured, between or among the corporations, or properties, or parts thereof, involved, and to allow such deductions, credits, or allowances so distributed, apportioned, or allocated, but to give effect to such allowance only to such extent as he determines will not result in the evasion or avoidance of Federal income and excess profits tax for which the acquisition was made; or
(3) to exercise his powers in part under paragraph (1) and in part under paragraph (2).↩