*142 Decisions will be entered under Rule 50.
Griswold and Fielden, individuals, purchased the entire outstanding stock of a corporation engaged in the retail cigarette vending machine business. The corporation had a zero basis in the locations at which its machines were placed. Some months later the corporation was liquidated and its assets were transferred to a new corporation formed by Griswold and Fielden for that purpose. Held:
1. The purchase of stock and the liquidation in the circumstances of this case were not parts of one transaction and did not amount to a purchase of the assets of the corporation by Griswold and Fielden. Accordingly, it was not proper to allocate a portion of the purchase price of the stock to the locations, to be carried over into the hands of the new corporation for purposes of amortization.
2. Notes issued by the new corporation to its sole shareholders herein did not represent true indebtedness. Amounts paid by the corporation to the shareholders or for their benefit must be treated as dividend distributions to them to the extent of available earnings and profits, and no part of such distributions may be deducted by the corporation as "interest" *143 paid.
*463 The Commissioner determined the following deficiencies against petitioners:
| Addition | |||
| Name | Taxable year ended -- | Deficiency | sec. 6653(a) |
| E. T. Griswold | Dec. 31, 1961 | $ 3,199.87 | |
| J. F. and Marjorie Fielden | Dec. 31, 1961 | 3,918.69 | |
| Independent Cigarette | June 30, 1961 | 6,542.65 | $ 327.13 |
| Service of Dade, Inc. | June 30, 1962 | 8,200.14 |
Two principal issues remain for decision, first, whether the corporate taxpayer may amortize the "value" of 500 cigarette vending machine "locations" in the circumstances of this case, and second, whether payments made by the corporate petitioner on behalf of the individual petitioners are to be treated by the latter as dividends or payments in respect of alleged notes payable from the corporation to them. A related question is whether the corporation may deduct a portion of these payments as interest.
FINDINGS OF FACT
Two stipulations of fact filed by the parties, together with exhibits attached thereto, are incorporated by this reference.
*464 E. T. Griswold is an individual, residing in Dade County, *144 Fla. For the calendar year 1961, E. T. Griswold and his wife, Tommie Griswold, filed their joint Federal income tax return 2 with the district director of internal revenue, Jacksonville, Fla. J. F. and Marjorie Fielden, husband and wife, reside in Dade County, Fla. For the calendar year 1961, J. F. and Marjorie Fielden filed their joint Federal income tax return with the district director of internal revenue, Jacksonville, Fla.
Independent Cigarette Service of Dade, Inc. (more fully hereinafter described and referred to herein as Independent No. 3), is a corporation organized under the laws of the State of Florida, with its address at 3939 NW. Seventh Street, Miami, Fla. For its fiscal years ended June 30, 1961, and June 30, 1962, it filed its Federal income tax returns with the district director of internal revenue, Jacksonville, Fla.
About 1939, the male petitioners, *145 Griswold and Fielden became engaged in the wholesale cigarette sales business as equal partners. In 1948, they expanded their activities by entering into the operation of retail cigarette vending machines. In 1958, several corporations were formed with Griswold and Fielden as major but not sole shareholders, to conduct the wholesale cigarette and retail cigarette vending machine business previously carried on by Griswold and Fielden as partners. One such corporation, which carried on a portion of the vending machine business, is the Miami Cigarette Machine Co. of Dade, a Florida corporation, with its address at 3939 NW. Seventh Street, Miami, Fla. The remainder of the vending machine business was conducted by another corporation, Miami Cigarette Machine Co. of Broward.
When Griswold and Fielden entered into the cigarette vending machine business in 1948, they had only one such machine. In 1960, Miami Cigarette Machine Co. of Dade had machines at approximately 800 locations and Miami Cigarette Machine Co. of Broward had machines at 170 locations. Some of these locations were solicited and some were purchased from other companies. None of the companies from which machines and*146 locations were purchased were corporations.
In the operation of a vending machine business, the most important factor is the placement of machines in good locations. In the Miami area, for the privilege of putting one of its cigarette vending machines on someone else's property, e.g., restaurants, drugstores, grocery stores, gas stations, etc., an operator is required to pay to the occupant of such property a commission on each pack of cigarettes sold from the machine, ranging from one-half cent to 2 cents per pack.
*465 In some cases the agreement is reduced to writing while in others it remains merely an oral understanding. When reduced to writing, the agreement usually provides a definite period of time, 1 to 3 years, during which the machine is to remain at the location. In most cases the owner of the location would be paid a bonus of up to $ 500 at the outset of the agreement. Additional bonuses would have to be paid upon each renegotiation of the agreement. In situations where the agreement is not reduced to writing, there is no bonus paid, and only commissions are paid based on the number of packs of cigarettes sold.
On April 4, 1960, Griswold and Fielden purchased*147 all of the outstanding capital stock of Independent Cigarette Service, Inc. (hereinafter referred to as Independent No. 1), a Florida corporation whose principal assets were 500 cigarette machines at various locations and cigarette inventory. The purchase agreement provided in part as follows:
This Agreement made and executed this 4th day of April, 1960, between LEWIS SPRATLAN, RAY HELFRICH, JACK MESE, PAUL C. TAYLOR and ROBERT S. MILLER, parties of the first part, hereinafter called Sellers, and J. F. FIELDEN and E. T. GRISWOLD, parties of the second part, hereinafter called Purchasers, Witnesseth:
The Purchasers have this day purchased of and from the Sellers all of the issued and outstanding shares of capital stock of INDEPENDENT CIGARETTE SERVICE, INC., a Florida corporation, for the total purchase price of $ 234,500.00, which purchase has been made partly in cash and partly on terms, as follows:
| Purchased for Cash | |||
| Number | Cash | ||
| Purchased by | Purchase from | of shares | consideration |
| J. F. Fielden | Lewis Spratlan | 3 | $ 9,000 |
| J. F. Fielden | Ray Helfrich | 5 | 15,000 |
| E. T. Griswold | Jack Mese | 5 | 15,000 |
| E. T. Griswold | Paul C. Taylor | 5 | 15,000 |
| Purchased on Terms | ||||
| Number | Paid on | Unpaid | ||
| Purchased by | Purchased from | of shares | account | balance |
| J. F. Fielden | Lewis Spratlan | 12 | $ 1,000 | $ 40,250 |
| J. F. Fielden | Ray Helfrich | 10 | 5,000 | 30,250 |
| J. F. Fielden | Robert S. Miller | 5 | 16,750 | |
| E. T. Griswold | Jack Mese | 10 | 5,000 | 30,250 |
| E. T. Griswold | Paul C. Taylor | 10 | 5,000 | 30,250 |
| E. T. Griswold | Robert S. Miller | 5 | 16,750 |
*148 The unpaid purchase price to each of the Sellers is evidenced by promissory notes in collateral form, copies of which are hereto attached and made a part hereof, and each of said notes is and shall continue to be secured by the pledge of the number of shares of capital stock purchased by each respective Purchaser from each respective Seller.
* * * *
The Sellers have cause to be delivered to the Purchasers all of the books and records of the corporation, including, but without limitation, the Stock Certificate *466 Book, Minute Book, Books of Account, a duly certified copy of the Certificate of Incorporation, copies of all Federal State and local tax returns, financial statements, whether audited or not audited, and all supporting data, and all other documents and records of the corporation.
Sellers, each for himself and not for the other, covenant and agree to and with the Purchasers, to refrain from carrying on or engaging in any business similar to that of the Company and from soliciting customers of the Company at any time within five (5) years within Dade County and Broward County, so long as the Purchasers or the Company continues to carry on the business now conducted by*149 the Company.
The Purchasers have covenanted and agreed to and with the Sellers, and each of them, as follows:
1. That although the Purchasers have executed their separate notes for the stock which they severally purchased from the Sellers, each of the Purchasers is jointly and severally liable to each of the Sellers for the full amount of the indebtedness owed to such Sellers for such purchase of stock, each of the Purchasers having endorsed the notes of the other.
2. That the corporate existence of the Company will be maintained at all times in good standing and that no change will be made in the authorized capital stock of the Company except that the Purchasers may change the authorized capital from 100 shares of no par value to 5000 shares of the par value of $ 1.00 each, provided that upon the re-issue of such stock pursuant to an amendment to the Certificate of Incorporation, the re-issue stock shall be exchanged with the respective Sellers in the place of stock held as collateral for the payment of the promissory notes held by the Sellers, and provided further, that the Sellers shall always hold as collateral in their respective proportions all of the issued and outstanding *150 capital stock of the company. The name of the corporation may also be changed.
3. Until all of said notes have been paid in full the Company shall at all times maintain and keep in good working condition and on location not less than 500 cigarette vending machines and a proper officer of the company shall furnish a certificate at the end of each 90-day period after the date hereof showing the number of machines in operation and the location thereof. In the event the company shall at any time have less than 500 cigarette vending machines in operation such default shall be cured within 30 days.
4. So long as any of the notes of the Purchasers remain unpaid the Purchasers will not permit the Company, without the written consent of a majority of the Sellers, to pay any dividends in cash. Dividends payable on the common stock of the company may be declared and paid to the stockholders, but all such dividend stock shall be pledged to and held by the respective Sellers in proportionate amounts to secure the unpaid purchase price evidenced by the notes of the Purchasers.
Pursuant to the above agreement Griswold and Fielden paid $ 70,000 in cash and issued to the sellers six promissory notes*151 in the aggregate amount of $ 164,500 in exchange for the stock of Independent No. 1. The notes were placed for collection with the Little River Bank & Trust Co., Miami, Fla., and the stock of Independent No. 1 was put up with that bank as collateral for the notes. Two of the notes were payable in 5 years; the other four were payable in specified monthly installments, the final payment being due in about 6 years. All six notes bore interest at the rate of 6 percent per annum on the unpaid *467 balance. The selling price of $ 234,500 was arrived at after negotiations between the parties. It was based on the ultimate determination of the sellers that the corporation was selling about 90 cases of cigarettes per week, and that the number of cases sold should be multiplied by $ 2,600 per case to arrive at an estimate of the value of the business. This was acceptable to Griswold and Fielden who estimated that the 500 machines were worth $ 150 each and reached a final estimate that the 500 locations were worth an average of $ 368 each for a total value of $ 259,000.
For any of the assets of Independent No. 1 which were to remain with the company other than the located machines *152 and cigarette inventory not in excess of the liabilities of the company, an addition was to be made to the price of the stock. This was arranged by a supplemental agreement also executed on April 4, 1960.
The business of Independent No. 1 continued in essentially the same manner as previously carried on after the acquisition of its stock by Griswold and Fielden, except that its offices and warehousing activities were moved immediately to facilities used by other corporations operated by Griswold and Fielden. Three of the seven employees of Independent No. 1, two routemen and one mechanic, were kept on after the stock purchase. Griswold and Fielden each owned 35 of the 70 outstanding shares of stock of the corporation and served as officers and directors thereof. Also, serving as an officer and director of the corporation was T. G. Rice, a long-time employee of Griswold and Fielden.
In the early part of 1960, prior to the April 4, 1960, purchase of the stock of Independent No. 1 by Griswold and Fielden, Fielden had discussed with Charles Lindfors, a certified public accountant, the possibility of acquiring the business of that corporation. Lindfors had been doing accounting work*153 for Griswold and Fielden and the cigarette enterprises in which they had a majority interest. Lindfors advised Fielden that if it was not possible to purchase the assets of that corporation, then Griswold and Fielden should buy the entire capital stock of the corporation and liquidate it immediately thereafter. Notwithstanding this advice, Griswold and Fielden entered into the foregoing agreement of April 4, 1960, in which they covenanted with the sellers (par. 2) that the corporate existence of Independent No. 1 would be maintained at all times in good standing, except that the authorized capital stock might be increased in accordance with specified conditions.
Within the framework of these conditions, the charter of Independent No. 1 was in fact amended on or about April 26, 1960, to increase its 70 shares of capital stock to 3,500 shares, which shares were distributed equally to Griswold and Fielden. These 3,500 shares were *468 substituted as collateral for the notes given under the purchase agreement. On April 30, 1960, the name of the corporation was changed from Independent Cigarette Service, Inc., to Independent Cigarette Service of Dade County, Inc. (referred to *154 herein as Independent No. 2). No action was taken at that time with respect to Lindfors' recommendation that the corporation be liquidated.
About September 30, 1960, while auditing the books of the enterprise, Lindfors discovered that his suggestion to liquidate the purchased corporation had not been carried out, but that it had only been recapitalized and had its name changed.
The minutes of a special joint meeting of the shareholders and directors of Independent No. 2 (Fielden, Griswold, and Rice), dated as of December 12, 1960, but notarized as of December 27, 1960, disclose that a plan of liquidation was adopted in spite of the specific provisions of the purchase agreement, but without objection by the sellers, to take effect as of the close of business December 31, 1960. Under the terms of the plan of liquidation all of the assets of Independent No. 2 were to be transferred to Griswold and Fielden in return for their stock, and the corporation dissolved.
The record does not disclose that the assets of Independent No. 2 were in fact transferred to Griswold and Fielden prior to January 23, 1961, when Independent Cigarette Sales Service of Dade, Inc. (referred to herein as Independent*155 No. 3), the corporate petitioner herein, was formed under Florida law. Those assets were then transferred to Independent No. 3, which had an authorized capital stock of 5,000 shares of common of $ 1 par value each, of which 3,500 shares were issued as follows:
| Number | ||
| Subscriber | of shares | Position with corporation |
| Fielden | 1,750 | President and director. |
| Griswold | 1,749 | Vice president and director. |
| Rice | 1 1 | Secretary-treasurer and director. |
At the same time the corporation also issued unsecured 6-percent demand notes in the amounts of $ 85,000 to Griswold and Fielden (or a total of $ 170,000), which, together with the newly issued stock, were substituted for the stock of Independent No. 2 as collateral with the Little River Bank & Trust Co. in respect of the obligations of Griswold and Fielden incurred in connection with their acquisition of the stock of Independent No. 1. In addition, $ 4,580.94 was credited to the loan accounts of Griswold and Fielden -- $ 2,290.47 each.
The *156 following are the closing balance sheet of Independent No. 2 on December 31, 1960, and the opening balance sheet of Independent No. 3 of January 1961, as shown in joint exhibits of the parties: *469
| Comparative Balance Sheet Independent No. 2 and Independent No. 3 | |||
| December 31, 1960, and January 1961 | |||
| Assets | Dec. 31, 1960 | Jan. 1961 | |
| Cash in bank | $ 603.07 | $ 603.07 | |
| Cigarette inventory | 31,027.50 | 31,027.50 | |
| Loans | 5,244.58 | 5,244.58 | |
| Loan receivable -- Dugger | (5.00) | (5.00) | |
| Loan receivable -- Fuller | 10.00 | 10.00 | |
| Loan receivable -- Fuller | 357.73 | 357.73 | |
| Loan receivable -- Hope | 147.43 | 147.43 | |
| Loan receivable -- Hewitt | 36.00 | 36.00 | |
| Loan receivable -- Hewitt | 255.07 | 255.07 | |
| Loan receivable -- Mills | 61.40 | 61.40 | |
| Loan receivable -- Macahill | 276.86 | 276.86 | |
| Loan receivable -- J. Fielden | 2,163.20 | 127.27 | |
| Loan receivable -- E. Griswold | 2,192.40 | 98.07 | |
| Cigarette machines | $ 100,745.22 | ||
| Less reserve depreciation | 59,172.20 | ||
| 41,573.02 | 74,801.00 | ||
| Auto equipment and mchy | 5,821.07 | ||
| Less reserve depreciation | 2,716.71 | ||
| 3,104.36 | 4,765.00 | ||
| Office furniture and fixtures | 2,216.65 | ||
| Less reserve depreciation | 761.81 | ||
| 1,454.84 | 1,750.00 | ||
| Utility deposits | 90.00 | 90.00 | |
| Miami Cigarette Machine of Dade | 6,433.73 | 6,433.73 | |
| Prepaid location costs | Not listed | 148,406.10 | |
| Total assets | 95,026.19 | 274,485.81 | |
| Liabilities | |||
| Loans payable -- Helfrich | $ 1,583.57 | $ 1,583.57 | |
| Loans payable -- R. G. Mills | 802.30 | 802.30 | |
| Loans payable -- J. Mese | 300.00 | 300.00 | |
| Contracts payable -- Central Bank & Trust Co | 337.53 | 337.53 | |
| Contracts payable -- Continental Vending Mach | 1,657.14 | 1,657.14 | |
| Contracts payable -- operations service | 6,930.17 | 6,930.17 | |
| Contracts payable -- First Natl. Bank of Boston | 1,237.46 | 1,237.46 | |
| Contracts payable -- Thomas J. Cole | 9,505.62 | 9,505.62 | |
| Contracts payable -- Spratlan, Helfrich, Miller | 906.00 | 906.00 | |
| Note payable -- Ray Harrison | 10,000.04 | 10,000.04 | |
| Note payable -- Little River Bank & Trust Co | 1,200.00 | 1,200.00 | |
| Note payable -- Ray Helfrich | 2,500.00 | 2,500.00 | |
| Escrow a/c Spratlan, Helfrich, Miller, Mese, Taylor | 1,310.25 | 1,310.25 | |
| Federal income tax payable | 315.05 | 315.05 | |
| Notes payable -- Griswold at 6% | Not listed | 85,000.00 | |
| Notes payable -- Fielden at 6% | Not listed | 85,000.00 | |
| Total liabilities | 38,585.13 | 208,583.13 | |
| Net worth | |||
| Capital stock | $ 3,500.00 | $ 3,500.00 | |
| Paid in surplus | 31,500.00 | 61,950.00 | |
| Earned surplus | 21,441.06 | ||
| Liabilities and net worth | 95,026.19 | 274,035.13 |
*157 *470 As of April 12, 1965, Independent No. 3 had approximately 343 locations of which only 164 remained from the 500 held by Independent No. 1 on April 4, 1960.
On its returns for its fiscal years ending June 30, 1961 (covering a period of 6 months ending on that date), and June 30, 1962, Independent No. 3 claimed deductions in respect of "Location Costs" in the amounts of $ 19,390.07 and $ 33,057.16, respectively. Independent No. 3 had undertaken to amortize over a 5-year period the "Prepaid Location Costs" which it attributed to the locations owned by Independent No. 1 when the stock of the latter was purchased by Griswold and Fielden and which were included in the opening balance sheets of Independent No. 3 in January 1961. The foregoing deductions included such amortization as well as other undisclosed components. The Commissioner disallowed these deductions for "Location Costs" for the 2 fiscal years to the extent of $ 14,472.02 and $ 28,944.05.
Between January 31, 1961, and January 31, 1963, Independent No. 3 made the following payments to the Little River Bank & Trust Co. to be applied against the notes of Griswold and Fielden held by the bank:
| Date | Fielden | Griswold | |
| 1961: | |||
| Jan. 31 | $ 910.00 | $ 910.00 | |
| Feb. 28 | 910.00 | 910.00 | |
| Mar. 31 | 910.00 | 910.00 | |
| Apr. 30 | 910.00 | 910.00 | |
| Apr. 30 | 910.00 | 910.00 | |
| June 30 | 910.00 | 910.00 | |
| July 31 | 910.00 | 910.00 | |
| Aug. 31 | 910.00 | 910.00 | |
| Sept. 30 | 910.00 | 910.00 | |
| Oct. 31 | 910.00 | 910.00 | |
| Nov. 30 | 910.00 | 910.00 | |
| Dec. 31 | 910.00 | 910.00 | |
| 1962: | |||
| Jan. 31 | 910.00 | 910.00 | |
| Feb. 28 | 910.00 | 910.00 | |
| Mar. 31 | 910.00 | 910.00 | |
| Apr. 30 | 2,076.60 | 179.46 | |
| May 31 | 1,768.30 | 1,334.14 | |
| June 30 | 1,666.09 | 1,328.95 | |
| May 31 | 1,659.46 | 1,323.76 | |
| Aug. 31 | 1,652.82 | 1,318.58 | |
| Sept. 30 | 3,285.75 | 2,621.58 | |
| Nov. 30 | 1,632.93 | 1,303.01 | |
| Dec. 31 | 1,626.29 | 1,297.01 | |
| 1963: | |||
| Jan. 31 | 1,619.65 | 1,292.62 |
*158 *471 The amounts of principal required to be paid on the notes owed by Griswold and Fielden during 1961 and 1962 were in the aggregate of $ 1,820 per month -- $ 840 on the notes signed by Griswold and $ 980 on the notes signed by Fielden. However, in accord with the purchase agreement Griswold and Fielden were both jointly and severally liable for the full amount of the indebtedness to the sellers. Entries were made on the books of Independent No. 3, with respect to such payments in 1961, debiting notes payable, Griswold and Fielden, each in the aggregate amount of $ 10,920 and crediting cash $ 21,840.
Also during these years, interest on the obligations owed by Griswold and Fielden, was paid directly to the Little River Bank & Trust Co. by Independent No. 3, which made entries on its book debiting interest payable, Griswold and Fielden, and crediting cash. In respect of these payments Independent No. 3 claimed interest deductions on its income tax returns in the amounts of $ 4,803.96 and $ 8,287.65 for its fiscal years ended June 30, 1961, and June 30, 1962, respectively, which the Commissioner disallowed.
In determining the deficiencies against the individual petitioners*159 for the calendar year 1961, the Commissioner treated the foregoing payments made in their behalf in 1961 (payments of both principal and interest on their notes to the sellers of the stock of Independent No. 1) as distributions of taxable dividends to Griswold and Fielden by Independent No. 3 to the extent of available earnings and profits of Independent No. 3. The Commissioner thus increased Griswold's 1961 taxable dividends to the extent of $ 9,019.81 and Fielden's 1961 taxable dividends to the extent of $ 9,623.28 in respect of these distributions. His computation was as follows:
| Griswold | Fielden | |
| Payments on principal obligation | $ 10,920.00 | $ 10,920.00 |
| Payments of interest | 4,168.15 | 4,542.00 |
| Total | 15,088.15 | 15,462.00 |
| As limited by available earnings and profits | 9,019.81 | 9,623.28 |
OPINION
1. Amortization of Location Costs. -- When all the assets of Independent No. 2 were taken over in January 1961 by the corporate petitioner herein, Independent No. 3, an item designated "Prepaid Location Costs" in the amount of $ 148,406.10 appeared as an asset on the opening balance sheet of the new corporation. No such asset was reflected in the closing balance*160 sheet of its predecessor. It is the contention of Independent No. 3 that it is entitled to amortize that item over a 5-year period. We hold that these locations, which *472 were not shown to have any basis other than zero in the hands of the old corporation, must be treated on this record as having a zero basis, with the consequence that no deduction for amortization is allowable in respect thereof. 3
*161 The taxpayer's position rests upon the so-called Kimbell-Diamond rule which grew out of the decision in , affirmed (C.A. 5), certiorari denied , and which has been applied in a variety of situations. Cf., e.g., (C.A. 5); (C.A. 5); , affirmed (C.A. 5); ; ; ; . In substance, the Kimbell-Diamond doctrine is to the effect that where the stock of a corporation is purchased for the purpose of liquidating it and obtaining its assets, the transaction will be regarded merely as a purchase of those assets. *162 Thus, it is the essence of petitioner's position that Griswold and Fielden were not interested in acquiring the stock of Independent No. 1; that they were interested only in the assets of that corporation; that they paid for the stock solely in order to liquidate the corporation and obtain those assets; that the most important asset owned by the corporation was reflected in the locations; that a substantial portion of the purchase price was accordingly paid for those locations; and that when Griswold and Fielden liquidated Independent No. 2 (which was merely the recapitalized Independent No. 1) and contributed the locations to Independent No. 3, the locations retained the same basis in the hands of the latter that they would have had in the hands of Griswold and Fielden, namely, that portion of the purchase price of the stock of Independent No. 1 that was allocable to the locations.
The difficulty with the foregoing position is that, granted that Griswold and Fielden were highly interested in the assets owned by Independent No. 1, we cannot find on this record that they purchased the stock of that corporation with the intention of liquidating it. To be sure, there is evidence that*163 prior to the stock purchase the accountant, Lindfors, advised Fielden to liquidate the corporation. But the fact is that notwithstanding such advice, Griswold and Fielden entered *473 into a contract for the purchase of the stock in which they covenanted explicitly:
That the corporate existence of the Company will be maintained at all times in good standing and that no change will be made in the authorized capital stock of the Company except that the Purchasers may change the authorized capital from 100 shares of no par value to 5000 shares of the par value of $ 1.00 each, provided that upon the reissue of such stock pursuant to an amendment to the Certificate of Incorporation, the re-issue stock shall be exchanged with the respective Sellers in the place of stock held as collateral for the payment of the promissory notes held by the Sellers, and provided further, that the Sellers shall always hold as collateral in their respective proportions all of the issued and outstanding capital stock of the company. The name of the corporation may also be changed.
Here then was a clear expression of a purpose not to liquidate the corporation. And in accordance with these provisions*164 Independent No. 1 was thereafter recapitalized with a modification in its name which we have referred to herein as Independent No. 2.
We give but very little weight to the contention that the lawyer, since deceased, who represented Griswold and Fielden, failed to follow their instructions to liquidate Independent No. 1 and merely recapitalized it. We doubt on this record that any such instructions were ever given to the lawyer. Rather, the evidence more compellingly indicates that the lawyer was acting within the framework of the purchase contract which permitted a recapitalization but forbade a liquidation, and we do not find credible the suggestion that Griswold and Fielden, who signed the contract, had given their lawyer instructions which in effect required him to violate its terms. Nor do we find credible the suggestion that they were ignorant of the provisions of the contract. These provisions were clearly understandable by any businessman, and we do not believe that Griswold and Fielden were unaware of them when they signed the contract. Petitioner's entire position on this point rests upon evidence that does not carry conviction with us. Its burden of proof has not been*165 met as to this issue.
In the circumstances, we cannot find that Griswold and Fielden purchased assets rather than stock, and accordingly we cannot find that the locations in question had a basis in their hands which they contributed to Independent No. 3. As a result, these locations which indisputably had a basis of zero in the hands of Independent Nos. 1 and 2 cannot acquire a stepped-up basis in the hands of Independent No. 3. The transaction whereby all the assets of the predecessor corporation were transferred to Independent No. 3, with the same stockholders owning their stock in the same proportions, was plainly a nontaxable reorganization and the zero basis for the locations was carried over in the hands of the new corporation. We do not understand *474 petitioner to contend otherwise, once it is decided that the Kimbell-Diamond rule is inapplicable.
To be sure, the entire matter might have been handled differently by the parties so as to enable them to provide a stepped-up basis for these locations. But tempting as it may be to try to relieve them of the consequences of their mistakes, we cannot do so on this record. The belated liquidation which occurred herein*166 does not convince us that Griswold and Fielden intended to liquidate the corporation when they purchased the stock.
In view of our conclusion as to the zero basis for the locations we do not reach the Government's alternative contention in respect of this issue that the locations in question were a "mass asset" not subject in any event to amortization, having an indeterminate useful life. Cf. ; but cf. , affirmed (C.A. 1).
2. Payments on Notes. -- During the years 1961 and 1962, Independent No. 3 made payments to the Little River Bank & Trust Co. to be applied against the obligations of Griswold and Fielden on their purchase-money notes which were held by the bank for collection. As the payments were thus made the amounts of principal and interest allegedly owed by the corporation to Griswold and Fielden on the $ 85,000 "notes" which it had issued to each of them were reduced accordingly. We find that these $ 85,000 notes did not in fact represent a bona fide indebtedness of the corporation, with the result*167 that the payments made thereon by Independent No. 3 were simply corporate distributions in behalf of its stockholders; such distributions were taxable to the stockholders as dividends to the extent of available earnings and profits, and no part thereof was properly deductible by the corporation as "interest."
Independent No. 3 came into existence as a result of the reorganization of Independent Nos. 1 and 2, as previously set forth. Prior to the reorganization, Griswold and Fielden each owned 50 percent of the outstanding stock of Independent No. 1, the total combined cost of which was $ 234,500. This stock was purchased in an arm's-length transaction. After the reorganization Griswold and Fielden each owned 50 percent of the stock in Independent No. 3. In addition to the stock, Independent No. 3 issued unsecured demand notes of $ 85,000 to each of them, for which they contributed no new property.
The record clearly establishes that these notes did not represent bona fide debts of the corporation. Rather, the evidence shows that they were issued merely to set the stage to enable Griswold and Fielden to withdraw corporate funds, tax-free to the extent of $ 85,000 each, to pay *168 off the notes which they in turn had given on their purchase of the stock of Independent No. 1. The purpose of issuing these notes was *475 plainly revealed in the testimony of Lindfors, upon whose advice the notes were issued. He testified as follows:
Q. I call your attention to January of 1961 at the time that Independent No. 3 was incorporated and the opening entries were made upon the books and records.
I hand you a copy of Exhibit 21-U and ask you to again tell the Court who made those opening entries?
A. My office did.Q. Upon whose advice was that?A. Upon my advice.Q. Why did you advise that transaction to be handled in that fashion?
A. In order that Mr. Fielden and Mr. Griswold could withdraw sufficient funds from this organization to pay off their personal obligations that they had signed in purchasing the stock of the old corporation. I set it as $ 170,000 owing to them, $ 85,000 each. [Emphasis supplied.]
I had told them, in the first place, this was the only way they can operate this corporation.
We do not find it necessary to review the various cases in which corporate obligations have been held to be true debts in some instances or merely evidences of capital*169 in other instances. Suffice it to say that on this record we have found that the $ 85,000 notes did not in fact represent true debts. Not only is this conclusion supported by Lindfors' testimony, but it is buttressed by all the surrounding facts including the fact that these notes were put up with the bank along with the stock in Independent No. 3 as collateral for the purchase-money notes of Griswold and Fielden under a contract calling for collateral of the "stock" or re-issued "stock." Surely, these notes were regarded as "capital" by Griswold and Fielden as well as by the holders of their purchase-money notes, who acquiesced in the transfer of the business to Independent No. 3 upon receiving all the stock and the $ 85,000 "notes" as collateral.
The fact that payments were made directly to the collecting bank for their benefit rather than to Griswold and Fielden personally is of no consequence. (C.A. 4).
Decisions will be entered under Rule 50.
Footnotes
1. Proceedings of the following petitioners have been consolidated herewith: J. F. Fielden and Marjorie Fielden, docket No. 5253-63; and Independent Cigarette Service of Dade, Inc., docket No. 5254-63.↩
2. Although the applicable deficiency notice was addressed to both spouses, only E. T. Griswold is the petitioner herein in respect of that notice.↩
1. The share held by Rice was a qualifying share actually owned by Griswold. About Sept. 25, 1961, 160 shares were issued to Rice in exchange for funds contributed to the corporation.↩
3. The deductions for "Location Costs" claimed on the taxpayer's returns for its fiscal years ending June 30, 1961, and 1962 were in the respective amounts of $ 19,390.07 and $ 33,057.16. (The return for the fiscal year ending June 30, 1961, represented operations covering only a 6-month period.) The Commissioner disallowed these deductions to the extent of $ 14,472.02 and $ 28,944.05, respectively, which have been assumed to relate to amortization of the location costs appearing on the taxpayer's opening balance sheet. The nature of the remaining portions of the claimed deductions in respect of location costs which were not disallowed is undisclosed on this record.↩