*1446 1. Assessment and collection from petitioners, as transferees of corporate assets, of liabilities representing unpaid taxes of such corporation for the calendar year 1920, held, not barred by the statute of limitations.
2. Petitioners are held to have received, as stockholders of the taxpayer corporation, liquidating distributions representing all of its assets and, in consequence, to be each liable for unpaid taxes of such corporation to the extent of the value of the corporate assets received by each in such distribution.
3. Substantial minority interests in the stock of the Renim Specialty Company and the Mica Condenser Company are shown by the record to have been held during the year 1920 by individuals owning no stock in the taxpayer corporation, and the control by stockholders of the taxpayer corporation of the voting rights of such minority interests not having been shown, such corporation is held not to have been affiliated with the two mentioned corporations for that year under section 240(b)(2) of the Revenue Act of 1918.
4. The action of respondent in disallowing a deduction by the taxpayer corporation of $120,000 of a total of $180,000 paid by*1447 it as representing executive salaries for the taxable year is sustained, it being held that petitioners have failed to show that the payments made represented reasonable and necessary salaries.
5. The valuation of cost, less 25 per cent, placed upon the mica inventory of the taxpayer corporation as of December 31, 1920, by its officers, as representing market value on that date, held to be correct.
*971 These proceedings, consolidated for hearing, are appeals from liabilities determined by respondent under section 280 of the Revenue Act of 1926, against petitioners as transferees of assets of Watson Brothers, Inc., as follows:
| Petitioner | Docket No. |
| Frederick L. Watson | 28475 |
| Elbridge Watson | 28476 |
| Arthur Watson | 28477 |
For unpaid income and profits tax assessed against Watson Brothers, Inc., in the amount of $95,131.11 for the calendar year 1920.
*972 Petitioners contend (a) that the assessment against or collection of any liabilities from them as transferees is barred by the statute of limitations, (b) that*1448 they are not liable as transferees of the taxpayer corporation, and (c) that there is no liability on the part of the corporation for unpaid taxes for the calendar year 1920, respondent having erred in determining a deficiency in respect of that corporation in that he (1) failed to allow the corporate claim of affiliation for that year with two other corporations; (2) disallowed a deduction of $52,843.96 by the corporation in its return as representing a bad debt; (3) disallowed as a deduction certain salary payments made in that year to officers of the corporation.
FINDINGS OF FACT.
Petitioners are residents of Boston, Massachusetts, and for many years have been engaged in the business of buying mica in bulk, fabricating it into the sizes required by industry and selling it in various lines of manufacture. For many years prior to this time petitioners' father had carried on this business and had trained them as mica experts. The business is a highly specialized one, requiring expert knowledge gained only through long experience. The buying of the mica is in bulk, either at the mines in India, Africa and Brazil, or upon the auction floors in London, and to buy advantageously*1449 requires a technical knowledge of grades and ability to determine from inspection of the bulk mica the grades and sizes of sheets into which it may be separated.
Prior to 1916 petitioners carried on business as a partnership, under the firm name of Watson Brothers. In that year petitioner Frederick L. Watson had become involved in certain personal litigation, as the result of which the partnership business was being harassed by attachments filed against its property, and to meet this situation petitioners, by advice of counsel, formed a corporation, under the name of Watson Brothers, Inc., to which the petitioners conveyed all of the partnership assets, each receiving in return one-third of the issued corporate stock. Following this, the business was operated as a corporation until the close of the calendar year 1920. Late in that year, the personal litigation of Frederick L. Watson having been settled, it was decided to liquidate the corporation and carry on the business, as in the past, through a partnership. The reason for this was that the operation of the business required the absence of one or more of petitioners for long periods of time in foreign countries, necessitating*1450 the giving of powers of attorney by them to the remaining petitioner to act for them, and making it difficult for them to participate in corporate action requiring from time to time their actual presence in Boston.
*973 Accordingly, on December 15, 1920, formal notice was given of a special meeting of the stockholders to be held on December 31, 1920, for the purpose of dissolving the corporation. The minutes of such meeting read as follows:
The clerk submitted an offer from Frederick L. Watson, Arthur Watson and Elbridge Watson under date of December 27, 1920, a copy whereof is as follows:
BOSTON, MASS., Dec. 27, 1920.
WATSON BROTHERS, INC.
We hereby offer to purchase all the assets of every name and nature of Watson Bros. Inc., including its merchandise in stock and in process of manufacture, tools, machinery, accounts and bills receivable, cash, securities, contracts, trade marks, patent rights and good will, and to pay for the same the sum of $60,000, and as part of the consideration and purchase price, assume all outstanding debts and obligations and liabilities of the Corporation as they shall appear upon the books of the Corporation as of December 31, 1920. *1451 The said sum of $60,000 to be paid by three negotiable promissory notes of $20,000 each, signed by us, dated December 31, 1920, and payable six months after date with interest at the rate of 6% per annum.
FREDERICK L. WATSON.
ARTHUR WATSON.
ELBRIDGE WATSON.
On motion duly made and seconded it was unanimously voted, all the Capital Stock of the Company outstanding voting in favor, that this Company accept the offer of Frederick L. Watson, Arthur Watson and Elbridge Watson addressed to it under date of December 27, 1920, and that a bill of sale in conformity with the terms of said offer be made, executed and delivered in the name and behalf of the Company by the Treasurer, and that this Company receive in full payment therefor said promissory notes.
On motion duly made and seconded it was unanimously voted that the promissory notes received from Frederick L. Watson, Arthur Watson and Elbridge Watson in payment of the purchase price of the assets of this Corporation, be distributed pro rata among the stock holders in proportion to their holdings of Capital Stock, and that this Company cease to do or transact business as of December 31, 1920.
On December 31, 1920, each*1452 petitioner was solvent and possessed a personal estate of approximately $200,000 and the notes had a fair market value equal to their face value.
On December 31, 1920, the books of the corporation showed assets and liabilities as follows:
| Liabilities | |
| Cash | $12,332.43 |
| Renim Specialty Co | 4,659.52 |
| Accounts receivable | 6,769.32 |
| Inventory - mica | 106,765.24 |
| Mica advances | 7,634.32 |
| Machinery | 971.19 |
| Furniture and fixtures | 500.00 |
| Good will | 150,000.00 |
| A. Watson | 19,976.26 |
| Total | 309,608.28 |
| Accounts payable | $486.00 |
| Federal tax, 1918 additional | 22,523.51 |
| Lease | 80.00 |
| J. B. Moors & Co | 2,000.00 |
| Discount reserve | 67.69 |
| E. L. Watson | 22,695.51 |
| E. Watson | 10,660.72 |
| C. E. Watson | 14,027.25 |
| Capital stock | 60,000.00 |
| Surplus | 177,067.60 |
| Total | 309,608.28 |
*974 The item of "good will" in the amount of $150,000 appearing in the above statement had been carried forward each year from 1917, it having been set up on the books in that amount at that time by the examining accountant. No item of good will appeared among the assets taken over by the corporation and when set up in 1917 it was merely by a credit to surplus without debit to any account*1453 of expenditure. The item of mica inventory in the sum of $106,765.24 appearing in this statement represented cost of this material less 25 per cent, deducted in adjustment of such cost to market. This valuation represents actual market value of the inventory on that date.
Beginning January 1, 1921, the business was carried on as a partnership, under the firm name of Watson Brothers. The petitioners, with partnership funds, satisfied all of the corporate liabilities appearing on the books of the corporation at December 31, 1920, and in addition paid Federal and State taxes and $15,826.85 interest later assessed against the corporation.
The corporation was regularly dissolved under chapter 180 of the Acts of Massachusetts, effective March 31, 1922. No receiver was appointed for the corporation at any time. The three notes for $20,000 each mentioned above were held in the treasury of the corporation. No collection of principal or interest was made and in 1923 these notes were returned to the three petitioners and destroyed.
For the year 1917 salaries of $30,000 each were regularly authorized to be paid petitioners by corporate resolution of January 5 of that year. For*1454 the year 1918 salaries of $45,000 each to petitioners were authorized and these amounts were duly paid to Arthur and Elbridge Watson, payment being made to Frederick L. Watson for 10 months of service at this rate. For the year 1919 salaries of $45,000 per year were authorized and paid to petitioners Arthur and Elbridge Watson, and for 1920 salaries in this same amount were authorized and paid all three of the petitioners and also to C. E. Watson, a brother, who owned no stock in the corporation, but had for many years been associated with petitioners in the business as its technical expert on the working of mica in bulk, being in charge of the plant. This individual had had many years of experience in this work and had devised methods for splitting and working mica and had obtained certain patents on his inventions.
The net sales of the corporation and salaries paid by it were as follows:
| Year | Net sales | Salaries |
| 1917 | $430,788.26 | $90,000 |
| 1918 | 802,778.04 | 127,500 |
| 1919 | 425,336.23 | 90,000 |
| 1920 | 898,255.71 | 180,000 |
*975 Shortly prior to 1920 petitioners organized two corporations, the Renim Specialty Company and the Mica Condenser Company. The*1455 first was organized to market a device, the patent upon which had been acquired by Watson Brothers. The second was to manufacture condensers, the main component of which was mica. These corporations had each 500 shares of issued stock. During the calendar year 1920 the stockholdings in these companies and Watson Brothers, Inc., were as follows:
| Watson Bros., Inc. | ||||
| Stockholder | Beginning of year | End of year | ||
| Shares | Per cent | Shares | Per cent | |
| Arthur Watson | 200 | 33 1/3 | 200 | 33 1/3 |
| Elbridge Watson | 200 | 33 1/3 | 200 | 33 1/3 |
| F. L. Watson | 200 | 33 1/3 | ||
| Subtotal | 400 | 66 2/3 | 600 | 100 |
| Treasury | 200 | 33 1/3 | ||
| C. E. Watson | ||||
| F. G. Crowley | ||||
| W. J. Barkeley | ||||
| A. R. Goodwin | ||||
| Total | 600 | 100 | 600 | 100 |
| Renim Specialty Co. | ||||
| Stockholder | Beginning of year | End of year | ||
| Shares | Per cent | Shares | Per cent | |
| Arthur Watson | 200 | 40 | 200 | 40 |
| Elbridge Watson | 200 | 40 | 200 | 40 |
| F. L. Watson | ||||
| Subtotal | 400 | 80 | 400 | 80 |
| Treasury | ||||
| C. E. Watson | ||||
| F. G. Crowley | 50 | 10 | 50 | 10 |
| W. J. Barkeley | 50 | 10 | 50 | 10 |
| A. R. Goodwin | ||||
| Total | 500 | 100 | 500 | 100 |
| Mica Condenser Co. | ||||
| Stockholder | Beginning of year | End of year | ||
| Shares | Per cent | Shares | Per cent | |
| Arthur Watson | 188 | 37.6 | 110 | 22 |
| Elbridge Watson | 187 | 37.4 | 170 | 34 |
| F. L. Watson | 110 | 22 | ||
| Subtotal | 375 | 75 | 390 | 78 |
| Treasury | ||||
| C. E. Watson | 65 | 13 | 110 | 22 |
| F. G. Crowley | ||||
| W. J. Barkeley | 30 | 6 | ||
| A. R. Goodwin | 30 | 6 | ||
| Total | 500 | 100 | 500 | 100 |
*1456 Watson Brothers, Inc., advanced money to the Mica Condenser Company. That company was also largely indebted to it for mica furnished for its work. This company proved to be a complete failure before the close of the calendar year 1920, and on December 31 of that year a balance due from it to Watson Brothers, Inc., representing unpaid advances of cash and material in the sum of $52,843.96, was charged off by the latter company to profit and loss. The account was worthless and known to be worthless in 1920.
Watson Brothers, Inc., filed on March 15, 1921, a Form 1120 for the calendar year 1920, on the basis of affiliation with the Renim Specialty Company and the Mica Condenser Company. This form was neither signed nor sworn to. On December 31, 1924, respondent assessed against Watson Brothers, Inc., additional taxes for the calendar year 1920 in the sum of $95,161.11. In determining this deficiency respondent disallowed a bad debt deduction of $52,843.96 taken by the corporation, as representing the Mica Condenser Company account charged off; allowed $60,000 in place of $180,000 deducted as executive salaries; disallowed the claim of affiliation, and computed income of the*1457 corporation upon a separate basis.
OPINION.
SMITH: Petitioners' contention, that the statute of limitations bars assessment of this deficiency against them as transferees, requires little discussion. The corporate return for 1920, filed March *976 15, 1921, was neither signed nor sworn to and was accordingly insufficient to start the running of the statute. . It is indicated that an amended consolidated return was filed on April 21, 1924, and, assuming that such return was properly executed, the five-year period for assessment and collection from the taxpayer would not expire until April 21, 1929, or subsequent to the enactment of the Revenue Act of 1926. The applicable provision of that act is accordingly section 280(b)(1), and the period of limitation in respect to assessment and collection against a transferee would not expire until long after the determination of the liabilities here in question and the appeals therefrom.
Respondent contends that petitioners are liable as transferees of assets of Watson Brothers, Inc. It is his contention that the acquisition of the assets by petitioners, its stockholders, *1458 on December 31, 1920, was for an inadequate consideration, leaving the corporation with insufficient assets to pay its debts, and that the transfer of these assets to petitioners was accordingly, to the extent of such excess value, a distribution of corporate property to them, as stockholders, in fraud of creditors. In the alternative, he charges that, if it be found that the acquisition of these assets was for a sufficient consideration, these petitioners are liable as transferees, by reason of the distribution to them, as stockholders, in 1923, of all of the assets of the corporation upon its liquidation, these assets consisting of three notes for $20,000 each.
Section 280 of the Revenue Act of 1926 provides, so far as material, as follows:
(a) The amounts of the following liabilities shall, except as hereinafter in this section provided, be assessed, collected, and paid in the same manner and subject to the same provisions and limitations as in the case of a deficiency in a tax imposed by this title * * *:
(1) The liability, at law or in equity, of a transferee of property of a taxpayer, in respect of the tax (including interest, additional amounts, and additions to the*1459 tax provided by law) imposed upon the taxpayer by this title or by any prior income, excess-profits, or war-profits tax Act.
The facts of record show that it was the intention of the stockholders on December 31, 1920, to dissolve the corporation, to take over its assets, and, from January 1, 1921, to carry on the business as partners. The petitioners offered to buy the assets of the corporation "and to pay for the same the sum of $60,000, and as part of the consideration and purchase price, assume all outstanding debts and obligations and liabilities of the corporation as they shall appear upon the books of the corporation as at December 31, 1920." The sum of $60,000 was to be paid by three negotiable promissory notes of $20,000 each, dated December 31, 1920, and payable six months after date, with interest at the rate of 6 per cent per annum. *977 The resolution of acceptance of the offer provided that the notes should be distributed pro rata among the stockholders in proportion to their holdings of capital stock. It thus appears that each petitioner had a right, from the date of the acceptance of the offer to purchase, to demand from the corporation the return of his*1460 note. In this situation it must be held that the giving of the notes was an act devoid of substance. The fact is that all the assets of the corporation were turned over to the petitioners as of December 31, 1920, and the petitioners paid not only the liabilities of the corporation, as shown by its books of account, but other liabilities as well. The petitioners must be held to be transferees of the assets of the corporation and, as such, liable for its debts to the extent of the value of the assets received, plus interest on the value of such assets at 6 per cent per annum, the legal rate in Massachusetts, from December 31, 1920, the date of distribution.
The next question is the value of the assets distributed to each of the petitioners. The balance sheet of the corporation at December 31, 1920, shows assets in excess of liabilities, other than capital liabilities, of $237,067.60. The petitioners contend, however, that the inventory of mica on hand of $106,165.24 was in excess of the fair market value of the inventory at that date and that the actual market value of the mica was much below that figure. This issue is disposed of by the finding that the valuation used represents*1461 actual market value on that date. The figure represents the opinion of the petitioners as at the close of the calendar year 1920, which was cost less 25 per cent. Petitioners' opinion, formed more than 10 years after that date, that the market value was at that time 50 per cent below cost, and the present opinion to the same effect of a witness introduced by them, can not be given the weight of their opinion in the determination of value made at the close of 1920 with knowledge of existing facts. This is especially true when it is taken into consideration that petitioners were mica experts, with exceptional knowledge and judgment as to market conditions.
The petitioners further contend that the good will of the corporation was without value. It is shown in the balance sheet as having a value of $150,000. It was arbitrarily set up on the books of the corporation in 1917. From a consideration of the entire record we are of the opinion that the good will of the corporation had no cash value and we agree with counsel for the petitioners that it should be eliminated for the purpose of determining the net value of the assets over the liabilities. Eliminating the book value of the*1462 good will from the assets, it is found that the assets had a value in excess of liabilities of $87,067.60.
Subsequent to January 1, 1921, the petitioners liquidated certain liabilities of the corporation which were not shown upon its books of *978 account at December 31, 1920. Taxes had accrued against the corporation in the amount of $15,826.85, which the petitioners paid. The deduction of this amount from the $87,067.60, above referred to, leaves the net value of the assets received by the petitioners as $71,240.75.
The petitioners claim that following the acquisition of the assets they paid additional debts, totaling approximately $15,000, which represented liabilities of the corporation. But we are unable under the proof to verify such liabilities. It is true that the petitioners paid amounts for auditing the books of account either of the corporation or of the partnership, but we can not determine that these constituted any liabilities of the corporation on December 31, 1920. Upon the record it must be held that the petitioners received net assets of the corporation of $71,240.75 and that these assets belonged to the petitioners in equal shares. We are therefore*1463 of the opinion that each petitioner is liable as a transferee of the assets of the corporation to the amount of $23,746.92, plus interest at 6 per cent per annum, the legal rate in Massachusetts, from December 31, 1920, the date of distribution.
In respect to respondent's denial of the corporation's claim of affiliation, petitioners contend that substantially all of the stock of the Renim Specialty Company and the Mica Condenser Company was owned or controlled by the same interests during the taxable year. We have set out in the findings of fact the ownership of this stock during that period as shown by petitioners' proof. From this it will be seen that all of the stock of Watson Brothers, Inc., was owned equally by the three petitioners, that 80 per cent of the stock of the Renim Specialty Company was owned by two of the petitioners, the remaining 20 per cent standing in the names of F. G. Crowley and W. J. Barkeley, and 78 per cent of the stock of the Mica Condenser Company was owned by petitioners, the remaining 22 per cent standing in the names of C. E. Watson, F. G. Crowley, W. J. Barkeley and A. R. Goodwin, none of whom owned stock in Watson Brothers, Inc. No facts are*1464 proven showing control of the voting rights of the minority stock by petitioners. Proof that these minority stockholders were employees of Watson Brothers, Inc., does not establish such fact. The petition alleges that the stock issued these employees was bought and paid for by petitioners and issued to them merely as a method of guaranteeing a percentage of the profits, but with the understanding that the actual ownership and voting rights of the stock were to remain in petitioners, but this allegation was denied by the answer and the record contains no proof of such facts. The facts proven fail to show affiliation under section 240(b) of the Revenue Act of 1918 of the taxpayer corporation with *979 the Renim Specialty Company and the Mica Condenser Company. ; ; ; ; .
In determining the deficiency for the year 1920 against the corporation, respondent disallowed a deduction*1465 of $52,843.96 taken by it as a debt ascertained to be worthless and charged off in that taxable year.
We have found that this amount was owing to the taxpayer from the Mica Condenser Company, that the debtor corporation was a total failure in that year, and that this indebtedness was charged off by the taxpayer at the close of the year to profit and loss. The taxpayer's claim to affiliation has been denied, and no question can be raised as to this indebtedness being one arising from an intercompany transaction. We accordingly hold that respondent was in error in his disallowance of this item.
The remaining issue is upon respondent's action in disallowing $120,000 of a total deduction taken by Watson Brothers, Inc., in the sum of $180,000 as representing salaries of $45,000 each, paid to petitioners and a brother employed by the taxpayer. Respondent has allowed a salary of $15,000 to each of these individuals as representing reasonable compensation for services rendered. The burden is accordingly upon petitioners to show that the amount disallowed in fact represented reasonable compensation to be paid for the services performed. Upon this question petitioners have introduced*1466 no proof of what would be a reasonable salary for such services. It is merely shown that these sums were voted by the corporation as salaries in January, 1920, and represented approximately 19 per cent of the net sales of the corporation for that year, and that payments in past years of executive salaries had averaged approximately this percentage. We do not think that this proof establishes the fact that the salaries paid were wholly for the services performed or represented only reasonable compensation for such services. The fact that petitioners were owners of all the stock of the corporation and the close relationship to them of C. E. Watson calls for a closer scrutiny of these payments than of salaries voted by corporate directors having no interest other than that of the corporation itself. In , we said:
* * * For the purpose of determining taxable net income, the deduction [for salaries] is limited to amounts which are reasonably commensurate with the personal services actually rendered and thus are no more than ordinary and necessary expenses of carrying on the business. Hence the directors' duty to the corporation is no*1467 criterion of the Commissioner's duty to limit the *980 tax deduction within the statutory bounds, and the two are not in conflict. When the Commissioner has made a determination, the taxpayer who attacks it must prove by evidence of the services rendered and their value that a correct determination would exceed that of the Commissioner. Where the payments are to kinsfolk or to shareholders, the proof must also show that they were not influenced by family considerations and were not disguised distributions of profits. See ; ; ; ; ; ; ; .
The evidence in the proceedings at bar is in our opinion insufficient to establish the fact that the payments to the four Watson brothers in the amount of $180,000 represented expenses*1468 reasonable and necessary in the carrying on of the business and the allowance of $15,000 in the case of each petitioner and of a like amount to the fourth brother, as made by the respondent, is approved.
The deficiency as determined against Watson Brothers, Inc., by respondent should be redetermined in accordance with this opinion.
Reviewed by the Board.
Judgment will be entered under Rule 50.
MATTHEWS concurs in the result.
GOODRICH dissents.
MURDOCK, dissenting: In my opinion, these petitioners are liable for the full amount of any deficiency which may be due in this case.