*742 1. LOSS ON STOCK. - The distribution of stock of other corporations as a dividend does not give rise to deductible loss where the dividend resolution provides for payment in the stock, following General Utilities & Operating Co. v. Helvering,296 U.S. 200">296 U.S. 200.
2. ACCRUED INTEREST AND CHARGES. - The evidence does not sustain respondent's affirmative allegation that he erred in allowing in 1929 part of a deduction for accrued interest and charges on amounts received by the petitioner under contracts with its shareholder where the contracts themselves and the consistent interpretation of them by the contracting parties indicate the amount of accrued interest and charges allowed by the respondent has been correctly computed.
3. SECTION 104 OF THE REVENUE ACT OF 1928. - The petitioner was not formed or availed of in 1929 for the purpose of preventing the imposition of the surtax upon its shareholder through the medium of permitting its gains and profits to accumulate instead of being divided or distributed within the meaning of section 104 of the Revenue Act of 1928.
4. Id. - Amounts received by a corporation which are offset by larger amounts accruable*743 as liabilities payable to its shareholder, under valid contracts, are not available for distribution as dividends and the accumulation of such amounts or receipts does not constitute an accumulation of "gains and profits" within the meaning of section 104.
5. Id. - Congress intended section 104 to apply to a corporation "availed of" within the taxable year through the medium of permitting its gains and profits of that year to accumulate, but did not intend to tax a corporation under section 104 merely because it had been availed of in other years or because it did not distribute in the taxable year a surplus accumulated in prior years.
6. Id. - Where, for the purpose of preventing the application of section 104, the sole shareholder of a corporation, who is also the person primarily responsible for its formation and operation, determines to have the corporation distribute all of its gains and profits for the taxable year, and honestly believes that the distribution determined upon and made constitutes a distribution of all the gains and profits, such a purpose is inconsistent with a purpose to avail of the corporation to avoid surtax upon him through the medium*744 of permitting gains and profits to accumulate even though later developments may disclose and actual accumulation of gains and profits.
7. Id. - Loans made by a corporation to its sole shareholder are not disguised dividends of its earnings and do not show a purpose to avoid surtax where principal and interest are paid in full and the shareholder at all times intended to pay them.
*1157 The Commissioner determined a deficiency of $335,908.89 in the income tax of the petitioner for 1929, solely upon the ground that the petitioner is subject to tax under section 104 of the Revenue Act of 1928. The respondent, in his answer, has raised the following issues by affirmative allegations and has made claim for the increased deficiency which would result if he should win:
(1) Did he err in allowing deductions of $37,662.50 and $25,740.00 for losses upon the distribution as dividends of 2,300 shares of Loew's Inc. 6 1/2 percent preferred*745 stock and 1,000 shares of Chase National Bank common stock on December 26, 1929? and
(2) Did he err in allowing a deduction of $31,096.19 as accrued interest and fees payable under contracts of September 13, 1922, and March 5, 1923?
FINDINGS OF FACT.
Charles A. Munroe was admitted to the bar in 1897, but ceased to practice law several years thereafter. He has been actively associated for many years with a number of corporations as president, vice president, or director. Most of the corporations are public utilities.
One of the corporations, the Federal Electric Co., sold various electric applicances upon the installment plan and received promissory notes for the deferred purchase price. It sold large quantities of the notes to acceptance corporations which made about 18 percent upon their investments in the notes. Munroe decided in 1922 that he would like to purchase some of the notes and was encouraged to do so by the president of the company. Munroe owned stocks and bonds worth approximately $2,000,000 at that time, but he did not have sufficient funds to make the purchases which he desired. He could not make satisfactory credit arrangements with his bankers without*746 personally guaranteeing the payment of the notes. He did not desire to personally guarantee the notes and decided to organize the petitioner and have it purchase the notes.
The petitioner was incorporated on August 16, 1922, under the laws of Illinois, to carry out Munroe's plan. He transferred 120 shares of stock of the Public Service Trust to the petitioner on August 16, 1922, in exchange for all of the authorized capital stock of the petitioner, consisting of 600 common shares of no par value. The shares were issued to three nominees of Munroe on September 13, 1922, and were immediately endorsed in blank and delivered to Munroe. He has since been the owner of all of the shares and has exercised complete control over the petitioner.
*1158 The purpose and powers of the petitioner as stated in its articles of incorporation are as follows: to purchase or otherwise acquire and to sell or otherwise dispose of, and genally to deal in capital stock of corporations and bonds, debentures, notes, open accounts and other evidences of indebtedness of corporations, partnerships, trusts, associations and individuals; to buy, sell and deal in bills of lading, warehouse receipts, *747 instalment contracts and all kinds of personal property; and to act as agent for corporations, partnerships and individuals; provided that the foregoing objects shall not include any business prohibited by the statutes of Illinois.
The assets worth $6,000 acquired by the petitioner in exchange for its stock were insufficient for the purpose of carrying on the business of purchasing the installment notes. Munroe had decided to furnish the petitioner with a basis for credit by means of a plan which had been used by an acquaintance of his. He accordingly entered into a contract with the petitioner dated September 13, 1922, and transferred to the petitioner under that contract securities belonging to him of the value of $1,575,695. The material parts of the agreement were as follows:
WHEREAS, the party of the first part [the petitioner] is about to engage in the business of purchasing deferred payment contracts for merchandise, said contracts to be signed by the original purchaser and to be endorsed and guaranteed by the respective vendor corporations;
WHEREAS, in the conduct of said business, the party of the first part requires a large amount of capital; and
WHEREAS, *748 the said party of the second part [Munroe] has agreed and is willing to supply the credit basis for securing such capital on the terms and conditions hereinafter set forth.
WHEREFORE, IT IS AGREED BY AND BETWEEN the parties hereto, as follows, to-wit:
The said party of the second part does hereby give, grant, assign, sell, transfer and set over, unto the said party of the first part, to be the absolute property of the said party of the first part, with the right to sell, transfer, pledge and dispose of all or any of the following described property, to-wit:
[Here follows a detailed description of the property transferred.]
That in consideration of said transfer of said property to said party of the first part, the party of the first agrees for itself, its successors or assigns, as follows:
Ten years from the date hereof, any of the above securities transferred and delivered to said party of the first part which have not been sold or disposed of shall be delivered to the party of the second part, his heirs, executors, administrators, or assigns, at the time above stated, and in addition to said securities, there will be paid in cash the proceeds, if any, derived, as interests*749 or dividends from said securities, plus one-fifth (1/5) of such amount each year, and said aggregate sum will bear interest at the rate of six (6) per cent per annum from the time the money is received until it is paid, but not compounded.
It is the purpose of this contract that in consideration of the furnishing of the capital to the said party of the first part, that the said party of the first part will pay as a fee for said capital, not only the amount that said company *1159 receives as interest or dividends from said capital but an additional sum equivalent to one-fifth (1/5) of such receipts.
In case all or some part of the securities this day delivered have been sold, that then ten years from the date hereof there will be paid to the said party of the second part, his administrators, executors or assigns, in cash, the proceeds of the sale of said securities, plus seven (7) per cent interest per annum on the proceeds of such sale, to be computed from the time the money is received until it is paid, but said interest shall not be compounded.
IT IS UNDERSTOOD AND AGREED THAT all interest or dividends received shall be used by said party of the first part as additional*750 capital.
Said party of the first part agrees that it will exact deferred payment contracts with unpaid balances equal to 110% of any loan, and that it will not extend credit in excess of One Hundred Fifty Thousand Dollars ($150,000) to any one corporation or individual.
The period of 10 years was fixed by Munroe as a reasonable one in which the petitioner could either acquire sufficient working capital from earnings or demonstrate that it would be a failure. One purpose of the contract was to supply the petitioner immediately with a means of acquiring credit with which to purchase installment notes. The petitioner used some of the securities transferred to it as collateral for bank loans and used the proceeds of the loans to purchase installment notes. The first purchase of the latter was made on September 21, 1922. The following table shows the cost of installment notes purchased by the petitioner:
| Year | Vendor | Cost to petitioner |
| 1922 | Federal Electric Co | $26,590.83 |
| Pascoe Oil Burner Co | 6,599.14 | |
| 1923 | Federal Electric Co | 281,738.34 |
| 1924 | Federal Electric Co | 39,003.06 |
| 1925 | Laclede Gas Light Co | 108,868.48 |
| 1926 | Laclede Gas Light Co | 119,640.71 |
| 1927 | None | |
| 1928 | None | |
| 1929 | New York Oil Co | 8,432.33 |
*751 The notes were for periods ranging from 6 to 24 months.
The petitioner required additional working capital early in 1923 and Munroe entered into a second contract, practically identical with that of September 13, 1922, whereby he transferred additional securities to the petitioner. They were worth $175,100. The second contract was dated March 5, 1923.
The securities transferred under the two contracts between Munroe and the petitioner had been acquired by Munroe after February 28, 1913, at a total cost of $944,650. They were entered upon the books of the petitioner at their cost to Munroe. They represented all of Munroe's assets, except some preferred stock worth about $300,000.
The petitioner in March or April 1923 began negotiations which *1160 resulted in the sale of two securities received under the contract of September 13, 1922. Their total value was $1,205,000 and they were sold for that amount in May 1923. The purchase price was paid by 5 percent notes of the purchaser due May 1, 1924. Some of the notes were discounted at par by the petitioner. All were paid in full at maturity.
The petitioner kept its books and made its income tax returns upon*752 an accrual method of accounting. Munroe used the cash method. The petitioner, during the years 1922 to 1929, inclusive, accrued on its books as liabilities owed to Munroe under the agreements of September 13, 1922, and March 5, 1923, items in the following total amounts:
| (1) Proceeds from sales of securities | $1,959,068.33 |
| (2) Income from securities | 168,248.85 |
| (3) Interest and fees | 213,070.96 |
| (4) Interest on proceeds from sales | 673,126.70 |
The proceeds from sales exceeded the cost to Munroe of the securities sold by $1,256,638.33. Neither the latter amount nor item (2) above was reported as income by Munroe or the petitioner and, although the Commissioner has been fully aware of the facts, he has never included those amounts in the income of Munroe or the petitioner. The petitioner has claimed and has been allowed deductions during the period for items (3) and (4) above. Munroe has not reported and has not been required by the Commissioner to report those items in his income.
The petitioner from time to time has loaned money to Munroe and has borrowed money from Munroe. All loans have been evidenced by interest-bearing notes of the borrower. The following*753 table shows for each year the loans to Munroe and the payments made thereon:
| Year | Total loans made | Payments on principal | Interest payments | Loans out-standing at end of year |
| 1922 | $65,744.04 | None | None | $65,744.04 |
| 1923 | 119,097.42 | None | $8,256.55 | 184,841.46 |
| 1924 | 80,950.00 | None | 14,057.62 | 265,791.46 |
| 1925 | 110,870.70 | None | 23,117.47 | 376,662.16 |
| 1926 | 184,588.20 | None | 36,553.64 | 561,250.36 |
| 1927 | 1,253,000.00 | $757,250.36 | 40,446.36 | 1,055,000.00 |
| 1928 | 1,140,000.00 | 2,195,000.00 | n1 6,115.31 | None |
| 1929 | 2,441,000.00 | 1,272,320.00 | (1) | 1,168,680.00 |
| 1930 | 6,000.00 | 651,445.01 | (1) | n2 523,234.99 |
All outstanding loans to Munroe were paid in full on November 30, 1927, on five occasions in 1928, and on three occasions in 1929. The petitioner borrowed $91,378.31 from Munroe during 1929. The petitioner loaned over $200,000 to a third party during 1928 and 1929, *1161 for which it received interest and a fee of six or seven thousand dollars.
The petitioner entered into a contract with Ohio Gas & Electric*754 Co. on September 30, 1922, whereby, in consideration of a cash payment of $30,000, it agreed to "undertake for a period of five (5) years from the date hereof, to sell and dispose of such preferred stock" of the Ohio Gas & Electric Co. as the latter "may from time to time, during said period, wish to dispose of, at a price to be mutually agreed upon between the two parties." The petitioner also agreed in the same contract to sell, within 30 days from the date thereof, 1,000 shares of Ohio Gas & Electric preferred stock at a net price to Ohio Gas & Electric of $95 per share. The contract was performed.
The petitioner, on February 2, 1924, had an opportunity to buy 53,600 shares of the common stock of the Laclede Gas Light Co. (hereinafter called Laclede Gas), the controlling interest in that company, for $5,650,000, but did not have sufficient funds at that time to purchase that stock. The petitioner assisted in the formation of a new corporation, the Laclede Gas & Electric Co. (hereinafter called Laclede Electric), in order to effect the purchase of the Laclede Gas stock. Laclede Electric was organized under the laws of the State of Delaware. Its capital stock consisted of 200,000*755 shares of common stock, $20,000,000 par value of preferred stock, and $20,000,000 par value of prior lien preferred stock. It was authorized to issue 15-year 7 percent debentures in the face amount of $15,000,000. Laclede Electric, with the assistance of Munroe and the petitioner, sold $4,700,000 face amount of its debentures to a syndicate for $4,465,000. The petitioner purchased 12,600 shares of Laclede Electric's preferred stock for $1,200,000 and acquired at the same time 120,000 shares of Laclede Electric's common stock without cost. The petitioner made this purchase with the proceeds from the stocks which it had sold in May 1923. Laclede Electric then purchased the 53,600 shares of Laclede Gas common stock on or about May 17, 1924, with the funds realized from the foregoing sales of its debentures and preferred stock. Laclede Electric, sometime thereafter, sold about $1,250,000 par value of its prior lien preferred stock and with the proceeds of that sale constructed a pipe line, which it used to transport refining gas from Wood River, Illinois, to St. Louis, Missouri. The refinery gas so transported was used to enrich the carbureted water gas manufactured by Laclede Gas. *756 This operation effected a saving to Laclede Gas of about 5 cents per thousand cubic feet in the manufacture of its gas, with the result that the earnings of both Laclede Gas and Laclede Electric were materially increased.
*1162 The Utilities Power & Light Co. entered into negotiations with the petitioner and Munroe sometime in April or early May 1927 for the purchase of the major portion of the Laclede Electric stock owned by the petitioner. The price at which the stock was to be sold represented a substantial profit to the petitioner. A plan was thereupon devised whereby the petitioner expected to spread its profit for tax purposes over a ten-year period. The petitioner, according to the plan, was to sell the Laclede Electric stock to Munroe for his personal interest-bearing notes, payable one-tenth annually during the period 1928 to 1937, inclusive, and then Munroe was to immediately sell the stock to the Utilities Power & Light Co. for cash in an amount equal to the face value of his notes to the petitioner. This plan was carried out. The petitioner sold to Munroe on May 6, 1927, 120,000 shares of the common stock of Laclede Electric and 10,100 of its 12,600 shares*757 of preferred stock of the same company, at prices of $70 per share for the common and $100 per share for the preferred. The petitioner received as consideration for the sale Munroe's unsecured notes - 10 notes of $101,000, each bearing interest semiannually at 7 percent, representing payment for the preferred stock and 10 notes of $840,000, each bearing interest semiannually at 6 percent, representing payment for the common stock. One 7 percent note and one 6 percent note became due and payable on May 6 of each year thereafter for a period of 10 years. Munroe, on May 8, 1927, gave the Utilities Power & Light Co. a 60-day option to purchase the Electric stock acquired from the petitioner at the same price he paid for the stock. Utilities Power & Light exercised the option within the 60-day period. It paid Munroe $8,400,000 for the common stock and $1,010,000 for the preferred stock, or a total of $9,410,000 in cash. Munroe received most of the cash payment at the time the option was exercised. The remainder, representing part of the consideration for the preferred stock, was paid within the following year.
The petitioner purchased other corporate securities from time to time, *758 some from Munroe, some from others. It also received some securities from Munroe in payment of interest. Munroe sustained losses on the disposition of some of the securities referred to in this paragraph as transferred to the petitioner and was allowed deductions therefor. The petitioner sold 100 shares of stock in 1928 and made numerous sales in 1929 for a total consideration of $1,905,843.01. It claimed a deduction of $224,262.53 on its return for 1929 on account of losses from the disposition of securities owned, including loss on the two securities distributed to Munroe as a dividend. The Commissioner, at some time in 1932, reduced the loss to $162,011.01 *1163 and the petitioner paid the resulting tax. The principal adjustment made was to allocate a part of the cost of some stock to additional stock acquired under stock-purchasing rights and, thus, to increase the profit upon the shares sold by $55,261.76.
The sale of the 120,000 shares of common and 10,100 shares of preferred stock of Laclede Electric to Munroe in 1927 resulted in a profit to the petitioner of $8,448,096.20. It recorded and reported that transaction as an installment sale. This method was questioned*759 by the Government on November 15, 1928, and thereafter the Government and the petitioner discussed the question of whether the gain could be reported upon the installment method or whether it should all be reported as income of 1927. Munroe and the petitioner during these discussions first became aware of section 104 and the possible application of that section and its antecedents to the petitioner. The petitioner in November 1929 agreed to pay the tax for 1927 on the entire profit from the Laclede Electric sale provided that its tax liabilities and those of Munroe up to 1929 be finally closed by agreements under section 606 of the Revenue Act of 1928. The Government representative then expressed his approval of such a plan. The proposal was immediately submitted by the petitioner in writing as follows:
As suggested at our informal conference of November 19, 1929, and in accordance with Mr. Shaw's conference with you on November 22, 1929:
I am herewith submitting to you, in writing, the tentative proposal I made at that time.
The proposal is that closing agreements, as authorized by Section 606 of the Revenue Act of 1928, be entered into with the Corporate Investment Company*760 and also D. A. Munroe, for the taxable years (calendar) 1926, 1927 and 1928.
The 1926 colsing agreements will show no deficiency or refund for either Mr. Munroe or the Corporate Investment Company.
The 1927 closing agreement for the Corporate Investment Company will include the deficiency now in controversy for that year, namely, $1,140,411.99. The 1927 closing agreement for C. A. Munroe will show no deficiency or refund.
The 1928 closing agreement of Corporate Investment Company will show a refund of the taxes paid by the Corporate Investment Company on the proportion of profit from the sale of the preferred and common stock of the Laclede Gas and Light Company, which was allocated by the Corporate Investment Company on the installment plan basis in the year 1928, which tax amounted to $101,377.14. The closing agreement for 1928 of C. A. Munroe will show no deficiency or refund.
As I told you at the conference this proposal is made for the purpose of settling all matters for the years in question and is not to be construed as an admission on the part of our clients:
That the 1927 transaction in controversy was not just what we have contended it to be, namely, a casual*761 sale of personal property for a price exceeding $1,000.00, where the initial payment was less than $25%, and therefore, taxable at the election of the taxpayer on the installment plan basis.
*1164 You stated at the conference that before such closing agreements could be made there would have to be an examination of the books of C. A. Munroe and Corporate Investment Company for the years that have not alredy been examined. I have been advised that the books of C. A. Munroe and the Corporate Investment Company have been examined for the years 1926 and 1927. There will remain, therefore, only the necessity of an examination of the books for the year 1928. If this proposal is accepted, an examination may be made at once in New York where the books of Mr. Munroe and the Corporate Investment Company are at present located.
While I appreciate that matters of settlement take time and can not be unduly pushed, it seems only fair that the Corporate Investment Company should know the position of the Government as early as possible, in order that it may know how to treat the third installment of the contract in controversy in its 1929 return.
The Commissioner examined the books*762 in 1930 and executed closing agreements in April 1930 as to Munroe and on July 23, 1930, as to the petitioner. The petitioner, however, had paid the tax in full on July 10, 1930. The amount paid, $1,183,502.94, included the tax and interest for 1927 less an overpayment of $101,522.65 for 1928.
The petitioner and Munroe gave consideration in 1929 to the question of the possible application of section 104 to the year 1929. They decided to avoid any possibility of the application of the section by distributing all of the gains and profits for the year as dividends. They had a survey of the books made at some time prior to December 26, 1929, for the purpose of estimating the maximum amount available for distribution. All profit from the Laclede sale was excluded from 1929 income because the Commissioner had determined to tax it as income for 1927. Five hundred sixty thousand dollars was estimated to be the approximate amount of gains and profits for 1929. The following charges against those earnings were anticipated although not entered on the books:
| (1) Depreciation in securities | $89,935.89 |
| (2) Interest on the proposed 1927 deficiency | 120,000.00 |
| (3) Federal income taxes for 1929 | 61,000.00 |
| (4) Lawyers' fees | 16,666.00 |
| 287,601.89 |
*763 Consideration was also given to the possibility of an early demand by the Commissioner for the tax proposed for 1927 to exceed $1,000,000. The petitioner decided to distribute $350,000, believing that its gains and profits for 1929 would not exceed that amount. It also decided to make an additional distribution early in 1930 if the annual audit showed a larger amount of gains and profits available.
The petitioner did not have sufficient funds on hand to make a distribution entirely in cash and decided to distribute the $350,000 partly in cash and the remainder in stocks of other corporations. The board *1165 of directors of the petitioner held a special meeting on December 26, 1929, at which the following minutes were recorded and the following resolution upon motion duly made and seconded, was adopted:
The Vice President stated that the Company's indicated earnings for the year 1929 would be $560,000, over and above $844,809.50 being 10% of the profit on the sale of Laclede Gas & Electric Company preferred and common stocks which the Government is now contending accrued in 1927 and not in 1929; that the Company holds at the present time securities, (exclusive of securities*764 under agreement) of a cost value of $2,781,952.14; that these securities as of the 26th of December, 1929, showed a market value of $89,935.89 less than the purchase price of the same; that after setting up a reserve adequate to take care of this depreciation in securities the Company could safely pay out the sum of $350,000 and suggested the Company pay this dividend as follows: 2,300 shares of Loews, Inc., 6 1/2% Preferred Stock taken at today's price, i.e., $85 per share, and 1,000 shares of Chase National Bank stock taken at today's price $151 a share, and the balance of the $350,000 to be paid in cash.
THEREUPON, on motion of Mr. Blind, and seconded by Mr. McIntire, the following resolution was adopted by vote of all the directors present:
RESOLVED, that a dividend of $350,000 be paid on the 600 shares of outstanding capital stock, as of close of business December 26th, 1929, payable that date; said dividend to be paid as follows: 2,300 shares of Loews, Inc., 6 1/2% Preferred Stock at $85 per share, and 1,000 shares of Chase National Bank stock at $151 a share, and the balance of the $350,000 to be paid in cash.
The dividend declared in the foregoing resolution was paid*765 to Munroe on December 26, 1929. Munroe reported the $350,000 dividend as income in his return for 1929. Three thousand five hundred dollars of the dividend was paid in cash. The fair market value of the 2,300 shares of Loew's Inc. stock was $195,500 and that of the 1,000 shares of Chase National Bank stock was $151,000 on December 26, 1929. The cost of the stock exceeded the fair market value at the time of the distribution by $37,662.50 in the case of Loew's Inc. stock and by $25,750 in the case of the Chase National Bank stock. The petitioner claimed the two latter amounts as deductions for losses in its income tax return for 1929. The deductions claimed were allowed by the respondent.
The annual audit of the books in 1930 disclosed no additional gains and profits, after allowing for the nonbook items and the Laclede profit already mentioned, and no additional distribution was made of 1929 gains and profits.
The securities owned by the petitioner at the close of 1929 had a basis for gain or loss of $3,370,919.30, but were then worth only $3,256,121.50. They were carried on the books at that time at $3,308,779.58.
*1166 The opening and closing balance sheets*766 of the petitioner for 1929 as shown by its books are as follows:
| Dec. 31, 1928 | Dec. 31, 1929 | |
| ASSETS | ||
| Cash in banks | $258,878.61 | $24,486.87 |
| Bankers acceptances | 2,208,870.86 | |
| Accrued interest receivable: | ||
| C. A. Munroe notes | 111,898.25 | 117,513.69 |
| G. H. Ennis notes | 3,675.00 | 6,825.00 |
| Other interest | 320.35 | |
| Accrued bond interest receivable | 12,051.25 | 4,741.00 |
| Notes receivable: | ||
| C. A. Munroe | 8,599,000.00 | 8,931,668.42 |
| G. H. Ennis | 210,000.00 | 210,000.00 |
| New York Oil Co | 909.15 | |
| Securities owned: | ||
| Stocks | 982,140.30 | 2,721,666.18 |
| Bonds | 241,339.50 | 632,361.00 |
| Less: Reserve for loss | 89,935.89 | |
| Securities held under agreement: | ||
| Stocks | 267,570.00 | 115,220.00 |
| Bonds | 127,000.00 | 127,000.00 |
| Furniture and fixtures | 2,145.84 | 1,907.41 |
| Securities held in trust | 40,000.00 | 122,306.30 |
| Total | 12,864,889.96 | 12,962,669.13 |
| LIABILITIES | ||
| Note payable, C. A. Munroe | $416,500.00 | $20,000.00 |
| Subscriptions payable | 2,397.50 | |
| Liability under agreement: | ||
| Securities held | 394,570.00 | 242,220.00 |
| Less: Capital stock subscribed | -6,000.00 | -6,000.00 |
| Proceeds from sale of securities | 1,682,259.30 | 1,959,068.33 |
| Income from securities under agreement | 157,663.83 | 168,248.85 |
| Interest accrued on income from securities under agreement | 167,963.98 | 213,070.96 |
| Interest on proceeds from sales of securities under agreement | 548,735.14 | 673,126.70 |
| Deferred profit - Laclede Gas & Electric stock | 7,603,286.50 | 6,758,477.00 |
| Deferred income | 109.05 | |
| Securities held in trust | 40,000.00 | 122,306.30 |
| Capital stock | 6,000.00 | 6,000.00 |
| Surplus | 1,851,513.71 | 2,770,041.94 |
| Total | 12,864.889.96 | 12,962,669.13 |
*767 The distribution of December 26, 1929, was the first ever made by the petitioner. Its surplus shown upon its books was as follows:
| Year | Surplus at end of year |
| 1922 | 1 -$502.16 |
| 1923 | 10,869.54 |
| 1924 | 1 -53,590.09 |
| 1925 | 18,175.30 |
| 1926 | $116,118.86 |
| 1927 | 482,154.03 |
| 1928 | 1,851,513.71 |
| 1929 | 2,770,041.94 |
*1167 The petitioner received dividends and interest from the securities held under the agreements of September 13, 1922, and March 5, 1923, and dividends from other securities, as follows:
| Securities under agreements | |||
| Year | Dividends | Interest | Dividends from other securities |
| 1922 | $8,459.00 | $20,083.33 | None |
| 1923 | 24,436.09 | 20,089.29 | $6,106.75 |
| 1924 | 28,814.89 | 1,583.84 | 59,151.00 |
| 1925 | 17,945.41 | 600.00 | 92,727.73 |
| 1926 | 12,068.00 | 600.00 | 169,911.92 |
| 1927 | 12,155.50 | 600.00 | 207,140.34 |
| 1928 | 16,628.48 | 600.00 | 30,632.31 |
| 1929 | 9,985.02 | 600.00 | 71,013.73 |
| 1930 | 2,197.72 | 761.67 | 69,128.15 |
The petitioner accrued on its books and claimed and was allowed a deduction of $45,106.98 for 1929 representing interest and fees due Munroe under the contracts of September 13, 1922, and March 5, 1923.
*768 The total income tax of the petitioner as finally determined for all years other than 1927 and 1929 was about $62,000, for the period up to 1930. The total income tax paid by Munroe for the period 1922 to 1928, inclusive, was about $30,000. Munroe owned securities at the end of 1929 which had cost at least $1,000,000 more than their then market value. He claimed and was allowed for 1929 losses of $237,556.07 on securities, most of which he had transferred to the petitioner in payment of loans or interest. He reported on his 1929 return an excess of deductions over income in the amount of $53,730.91. Included among the deductions claimed was an item of $234,988.42 representing a note give to the petitioner in payment of interest. The Commissioner, several years later, disallowed that item, as not a proper deduction for one on a cash basis, and determined a deficiency of $61,789.62.
The petitioner filed its income tax return for 1929 with the collector of internal revenue for the first district of Illinois. In reported net income of $538,872 and income tax liability of $59,276.01. The Commissioner in 1932 made the adjustments already described, increasing net income to $600,804.05, *769 and assessed additional tax of $6,812.44, which was paid. The net income for the purpose of section 104 as determined in the notice of deficiency is the same amount of net income plus dividends of $71,013.73. The only explanation given in the notice as to the applicability of section 104 is that "the Bureau holds that your corporation is subject to taxation under the provisions of section 104 of the Revenue Act of 1928."
The petitioner ceased activities after October 7, 1930, when the transactions occurred whereby it transferred all of its assets and *1168 liabilities in a reorganization, as more fully described in the report of C. A. Munroe,39 B.T.A. 685">39 B.T.A. 685.
One of the purposes of the foregoing reorganization of the petitioner was to avoid certain Illinois tax risks by having the petitioner, an Illinois corporation, transfer its assets to a Delaware corporation. Another purpose was to postpone taxation on the amount payable to Munroe under the provisions of the agreements of September 13, 1922, and March 5, 1923. The reorganization of the petitioner was first considered sometime in 1929, although the final plan of reorganization was not worked out until*770 the fall of 1930. The cancellation of the agreements of September 13, 1922, and March 5, 1923, as part of the plan of reorganization was not considered until 1930.
The petitioner was not formed or availed of in 1929 for the purpose of preventing the imposition of the surtax upon its shareholder through the medium of permitting its gains and profits to accumulate instead of being divided or distributed.
The Commissioner erred in allowing as a deduction from the petitioner's income for 1929 losses of $37,662.50 and $25,740 claimed on the distribution of 2,300 shares of Loew's Inc. 6 1/2 percent preferred stock and 1,000 shares of Chase National Bank common stock.
The Commissioner did not err in allowing the deduction of $45,106.98 claimed by the petitioner as accrued interest and fees payable to Munroe on the income from the securities transferred under the agreements of September 13, 1922, and March 5, 1923.
OPINION.
MURDOCK: The two issues raised by the respondent will be discussed first, since they may have some bearing upon the main issue. The case of *771 General Utilities & Operating Co. v. Helvering,296 U.S. 200">296 U.S. 200, is controlling on the question of whether the distribution of the Loew and Chase stocks resulted in deductible losses. The dividend resolution in that case provided for a dividend of a certain amount payable in a named stock at a declared valuation. The Court held that no sale of the stock resulted and the stock was not used to discharge an indebtedness. Here the dividend resolution was strikingly similar and no deductible losses resulted. The Commissioner erred in allowing the deductions claimed on the return for losses on the two stocks distributed. Cf. First Savings Bank of Ogden v. Burnet, 53 Fed.(2d) 919; Commissioner v. Columbia Pacific Shipping Co., 77 Fed.(2d) 759.
The respondent has failed to show error in his allowance of the deduction of $45,106.98 claimed by the petitioner as accrued interest and a charge of one-fifth on income due to Munroe under the contracts of September 13, 1922, and March 5, 1923. The respondent *1169 concedes that an accrual and a charge in accordance with the terms of the agreements are proper deductions for 1929, *772 but argues that the correct figure is $14,010.79, not $45,106.98. The amount accrued and deducted for 1929 was computed in the same way that similar amounts were computed for all prior years. The evidence fails to show that the computation of the accrual for 1929 was not made in accordance with the intent of the contracting parties as expressed in their contracts. The contention of the respondent seems to be that no interest and no charge of one-fifth is properly accruable on income of prior years. The contract itself and the consistent interpretation of it by the parties are to the contrary. The deduction was properly allowed.
The most important issue for decision is whether the petitioner is subject to tax under section 104 as a corporation "formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed." The decision of that issue must depend, in the final analysis, upon the facts in this particular case. It is, therefore, not surprising that the cases cited by the parties are only of general interest and require no detailed*773 discussion. Both parties seem satisfied that all relevant facts are contained in the rather lengthy record. We have carefully considered all of that record, although not all of it has been set forth in detail in the findings of fact.
The test of "purpose" necessarily depends upon the state of mind of the person or persons responsible for the formation and operation of the corporation. United Business Corporation of America,19 B.T.A. 809">19 B.T.A. 809; affd., 62 Fed.(2d) 754; certiorari denied, 290 U.S. 635">290 U.S. 635. Even though the effect of the formation and operation of a corporation may have been to avoid surtax upon the stockholders, still section 104 does not apply unless the parties in control had the intent and purpose described in that section. Cecil B. deMille Productions, Inc.,31 B.T.A. 1161">31 B.T.A. 1161; affd., 90 Fed.(2d) 12; certiorari denied, 302 U.S. 713">302 U.S. 713; C. H. Spitzner & Son, Inc.,37 B.T.A. 511">37 B.T.A. 511; R. L. Blaffer & Co.,37 B.T.A. 851">37 B.T.A. 851; affd., *774 103 Fed.(2d) 487; Mellbank Corporation,38 B.T.A. 1108">38 B.T.A. 1108. Here Munroe created the corporation and completely dominated its operation, so that the real question is, What was his purpose in the formation and operation of the petitioner? He has testified that he did not have the purpose described in section 104, either in the formation or the operation of the petitioner. However, he is an interested witness and we have considered, not only his categorical denial of the existence of the proscribed purpose, but also all other evidence which might show that his purpose was, in truth, different from what he says it was.
*1170 There is a clear preponderance of evidence to show that the petitioner was not "formed" to avoid surtaxes upon Munroe through the means described in section 104. His primary purpose in forming the petitioner was to profit from the purchase of installment paper. Although he might have had additional purposes, and although some surtaxes may have been avoided eventually, nevertheless, this record indicates no purpose in the formation of the corporation which would bring it within section 104.
The only argument made by the respondent*775 upon this point is that Munroe, a very astute and active man in avoiding taxes, obviously intended from the very beginning to utilize the two contracts, dated September 13, 1922, and March 5, 1923, to avoid tax not only upon himself (since he was on the cash basis and was to receive nothing for ten years, he reported no income) but also upon the corporation, which was using an accrual method whereby it could currently accrue and deduct items eventually payable to Munroe. He does not contend that the agreements were invalid, that Munroe was required by statute to report any items due him under the contracts, 1 or that the petitioner was not entitled under the statutes to accrue and deduct amounts in accordance with the agreements. Yet he attempts to find, in the fact that the contracts were so effective in saving and delaying tax, a purpose to avoid surtax upon Munroe through the medium of having the corporation accumulate its gains and profits instead of distributing them.
*776 On sufficient answer to his argument it at once apparent. The moment the petitioner received anything under the contracts, it became indebted in a like amount to Munroe. It also had to accrue fees and charges on the receipts as amounts due Munroe. The Commissioner recognizes the propriety of these accounts. Thus the amounts due Munroe always were increasing more rapidly than the receipts under the contracts were being accumulated, and those receipts were not increasing the accumulated "gains and profits" of the petitioner or any fund from which dividends of the petitioner could come. The petitioner was permitted to use funds accumulated under the contracts to transact other business from which it might derive gains and profits of its own. But if it had had no business *1171 transactions, aside from receipts under the contracts, it would have had no accumulation of gains and profits to distribute as dividends and no surtaxes upon its shareholder could have been avoided. The large surplus which it accumulated was not the result of receipts under the contracts, but came from wholly different transactions. Although the contracts may have avoided or delayed tax on Munroe, *777 they do not bring section 104 into play, since their use did not serve to avoid surtax on Munroe through the medium of permitting the gains and profits of this petitioner to accumulate instead of being distributed as taxable dividends to Munroe. Munroe may have been tax conscious and his contracts may have been cleverly drawn to save him from tax, but still this petitioner is not subject to tax under section 104 unless the facts are within the provisions of that section, which Congress has made so definite and specific.
Although the foregoing discussion disposes of the only argument presented by the respondent on the purpose of formation, nevertheless we have considered the evidence from other angles. The history of the corporation during a reasonable period immediately following its incorporation shows that it was using large amounts in the purchase of installment paper but was not successful in accumulating sufficient working capital of its own. It had a paid-in capital of only $6,000 and, at the beginning of 1926, it had accumulated a surplus of only $18,175.30. It began to have greater financial success in 1926, about the time that it ceased purchasing installment notes. *778 But Munroe did not foresee that situation when he formed the petitioner. The evidence does not supply any sound basis for a finding that the purpose in forming this petitioner was such as to bring it within section 104.
The respondent next argues that the petitioner was "availed of" during the period 1922 to 1928, inclusive, for the purpose described in section 104 and the section applies, since Munroe did not include in his gross income for 1929 all of the net income of the corporation. He does not argue that the failure of the petitioner to distribute in 1929 the surplus accumulated in prior years is important. The words of the statute, the legislative history of section 104 and its antecedents, and the general scheme of the revenue acts taxing income upon an annual basis show that Congress intended to apply section 104 in case a corporation was "availed of" within the taxable year through the medium of permitting its gains and profits of that year to accumulate, but did not intend to tax a corporation under section 104 merely because it had been availed of in other years or because it did not distribute a surplus accumulated in prior years. the income tax acts have*779 always taxed income upon an annual basis and many terms which could refer to a different period *1172 are generally understood to refer to an annual period without any express statement to that effect appearing in the acts. Income, gross income, net income, and dividends are examples. Although some terms, particularly those relating to deductions, are expressly qualified so that they can refer only to the taxable year, nevertheless, where a term is used and is not expressly defined as relating to the taxable year, it is generally so understood. Thus the natural meaning to ascribe to the words "gains and profits" in section 104 is the gains and profits of the taxable year.
Furthermore, the use of the words "to accumulate" instead of some such phrase as "to remain accumulated" 2 is significant. Earnings of prior years may remain accumulated during the year but are not permitted "to accumulate" during that year. If Congress had intended to penalize the corporation for accumulating a surplus in prior years or for failing to distribute such a surplus in the taxable year, it would hardly have measured the penalty by the earnings of the current year or relieved the corporation*780 from the penalty upon condition that the earnings of the current year were distributed to or reported by the stockholders. See subsection (d), which permits the corporation to escape the tax if the stockholders report the net income of the corporation for the particular year as a part of their gross income. The thought back of this "escape clause" was that the penalty should not be imposed upon the corporation if the stockholders, like partners, reported the earnings of that particular year. See Committee Reports on section 220, of the Revenue Act of 1921. The Senate Finance Committee said, when it approved of the counterpart of (d) as section 220(e) of the Revenue Act of 1926, that there could be no avoidance of surtax on earnings if the stockholders reported their shares of the net income "and the reason for the imposition of the 50 per cent tax on the corporation no longer exists." S. Rept. 52, p. 22, 69th Cong., 1st sess. Thus it appears that Congress was thinking in terms of current income and current gains and profits when it enacted the provisions of section 104. The Bureau has always interpreted similar provisions as referring to "gains and profits" of and "availed of" *781 in the current taxable year. O.D. 188, 1 C.B. 182; I.T. 1572, C.B.II - 1, 139. The decisions of the Board are to the same effect. United Business Corporation of America,33 B.T.A. 83">33 B.T.A. 83; remanded, C.C.A., 2d Cir., Aug. 31, 1936; Almours Securities, Inc.,35 B.T.A. 61">35 B.T.A. 61; affd., 91 Fed.(2d) 427 (C.C.A., 5th Cir.); certiorari denied, 302 U.S. 765">302 U.S. 765; Dill Manufacturing Co.,39 B.T.A. 1023">39 B.T.A. 1023. Consequently, a detailed discussion of events of prior years is not necessary here, even though those *1173 events might show that the corporation was or was not availed of prior to 1928 for the proscribed purpose. They are important only in so far as they may tend to show a purpose, or lack of purpose, in 1929.
The argument of the respondent on the question of whether the petitioner was "availed of" in 1929 is relatively short. He attempts to show that the "gains and profits" for the purpose of section 104 were $977,909.35; the distributions*782 were limited to $350,000 so that Munroe would escape tax; no liability for the 1927 tax or interest thereon was accrued or accruable in 1929; and the contracts of 1922 and 1923 with Munroe, the losses realized by him upon stock transfers to the petitioner in 1929, and the loans to Munroe, show a purpose to avoid tax, as does the "repeat" attempt to avoid tax through the reorganization of 1930 contemplated in 1929.
The claim of the Commissioner, made in his brief, that the correct amount of "gains and profits" for 1929 was $977,909.35 is not supported by the pleadings or the proof but, on the contrary, is shown by the proof to be erroneous. He includes in that total the amount received during the year under the contracts of 1922 and 1923, contrary to his action in determining the deficiency, and he disregards the increase in the amounts due Munroe which he has heretofore allowed to offset those receipts in computing the deficiency. The words "gains and profits" are not defined in the statute. However, it is obvious that in this case they are not greater than the net income as defined in section 104(c). The later amount, as determined by the Commissioner in the notice of deficiency, *783 was $671,817.78. The pleadings and proof show that the only proper increase in that figure is $63,402.50, the amount disallowed as loss on the Loew and Chase stocks. Thus the correct amount of net income as defined in section 104(c) is $735,220.28. The petitioner contends that this figure must be reduced by several items in order to arrive at "gains and profits" within the meaning of those words as used in section 104. The first item is the income taxes for the year 1929 under section 13 as finally determined, and the Commissioner agrees that those taxes are a proper adjustment in arriving at "gains and profits." The correct amount of those taxes under this opinion will be about $73,700.
The petitioner also contends that the shrinkage in value of its securities should be deducted from "net income." The Board, however, has held to the contrary. Rands, Inc.,34 B.T.A. 1094">34 B.T.A. 1094. The other two items which the petitioner would use to reduce "net income" in arriving at "gains and profits" are interest of about $120,000 and lawyers' fees in the amount of $16,666.66. The interest is the amount which accrued during 1929 on the large deficiency for 1927. *784 The lawyers' fees were incurred in 1929 in connection with the 1927 tax *1174 controversy. Both of those items, although not entered on the books as expenses of 1929, were actually incurred as expenses in that year and were later paid. Perhaps they should have been accrued on the books as expenses of 1929. Lucas v. American Code Co.,280 U.S. 445">280 U.S. 445. The petitioner contends only that they are items which must be considered in determining how much of the earnings of 1929 were permitted to accumulate instead of being distributed. It may be argued that there is as much justification for reducing "net income" by those two items in order to arrive at "gains and profits" as there is for reducing "net income" by the income taxes for 1929. The taxes for 1929 under section 13 have a direct relation to the year 1929 and will have to be paid. The Commissioner apparently recognizes that earnings, to the extent of the taxes, will not be permitted to accumulate, but will be used to pay the taxes, even though they may serve to swell the book surplus at the end of the year. The situation is exactly the same in relation to the interest on the deficiency for 1927 and*785 the attorneys' fees. All three of the items were incurred during 1929 but not accrued on the books. The interest and attorneys' fees were actually paid in 1930, whereas the taxes have not been fully paid at this time. The amounts necessary to pay those items were accumulated only temporarily. It is difficult to see any distinction unfavorable to this petitioner between the taxes for 1929 and the interest for 1929 on the unpaid deficiency for 1927. The "gains and profits" for 1929 were either $524,853.62, or $661,520.28, depending upon whether or not the interest and attorneys' fees are proper adjustments to "net income" in order to arrive at "gains and profits."
It may be pertinent to determine the amount of the "gains and profits" actually permitted "to accumulate" during 1929. The distribution of the dividend eliminated $413,402.50 from surplus and that amount of the "gains and profits" for the year was not permitted "to accumulate." The basis and book value of the Loew and Chase stocks was $409,902.50, and the distribution of those stocks eliminated that amount from the assets of the petitioner, despite the fact that the distribution was described as a dividend of $350,000, *786 and the petitioner is not entitled to deduct any loss under section 23. But not all of the "gains and profits" for the year were distributed. The amount permitted to accumulate was either $111,451.12, or $248,117.78, depending upon the treatment to be accorded the interest and attorneys' fees above described. The fact that these "gains and profits" were permitted to accumulate raises the issue but is not determinative of that issue. The important question is, Was there any intention on the part of the corporation and its controlling stockholder, Munroe, to avail of the corporation in 1929 for the purpose of preventing the imposition of the surtax upon Munroe through the *1175 medium of permitting those "gains and profits" of the corporation to accumulate instead of being divided or distributed? It is appropriate, in order to answer that question, to consider the amount of "gains and profits" which Munroe thought the petitioner had towards the close of 1929 and what he proposed to do with theses "gains and the close of 1929 and what he proposed to do with these "gains and
Munroe had an estimate made at that time to determine what amount would be available for distribution*787 and would not be needed to pay expenses incurred during the year. The estimate was honestly made and convinced Munroe that about $350,000 would be accumulated unless it was distributed. This figure was arrived at by eliminating one-tenth of the gain from the Laclede sale, which the Commissioner had insisted was income of 1927 rather than income of 1929 as shown on the books. That left earnings of about $560,000. It was known that the petitioner had agreed to pay the large deficiency for 1927, interest would have to be paid on that deficiency, and the interest accruing during 1929 would amount to about $120,000. It was also known that lawyers' fees in the amount of $16,666.66 had been incurred in 1929 in connection with the tax controversy and would have to be paid. The taxes for 1929 were estimated at about $61,000. Munroe believed that all of those obligations were proper charges against 1929 earnings in determining the amount of those earnings available for distribution. It was estimated that the securities of the petitioner had depreciated in value to the extent of about $90,000. Munroe thought that allowance would have to be made for that shrinkage in determining the amount*788 of 1929 earnings available for distribution as a dividend. He concluded that a distribution of $350,000 would be proper, would represent a complete distribution of the "gains and profits" for the year, would permit none of those "gains and profits" to accumulate, and, therefore, would relieve the corporation from all possibility of tax liability under section 104. It now appears, as shown in the preceding paragraph, that the correct amount of "gains and profits" was somewhat in excess of his estimate. The fact that his estimate later turned out to be erroneous is not so important as the fact that it was honestly made in an effort to distribute the earnings of the petitioner as Munroe saw them. The errors which were made were not inexcusable ones. The evidence as a whole indicates that Munroe did not want to take any chances on the application of section 104, but intended to distribute all of the available "gains and profits" of the petitioner for 1929 and to permit none of those "gains and profits" to accumulate. Such an intent is inconsistent with a purpose to avail of the petitioner to avoid surtax upon Munroe through the medium of permitting its "gains and profits" to accumulate.
*789 *1176 Munroe filed a return for himself showing a loss and if he had had the matter in mind, he would have thought that his return could absorb tax-free even larger distributions from the petitioner. But apparently he was not thinking so much of the tax significance of the distribution to himself as he was of its importance to the corporation. The record does not support the respondent's claim that the amount of the dividend was fixed so that Munroe would not have any tax to pay. The figures used in the estimate, as well as other evidence in the record, corroborate Munroe's testimony that he had no purpose to avail of the petitioner in 1929 to avoid surtaxes upon himself through the medium of permitting its gains and profits to accumulate instead of being distributed. Furthermore, a "large portion of its earnings for the year in question" were distributed, a fact which also negatives intent to avoid surtaxes and brings the petitioner within Article 542 of Regulations 74, to the effect that the presumption of section 104(c) is thus overcome.
The importance of the 1922 and 1923 contracts has been discussed already and merits no further mention. *790 The fact that Munroe in 1929 discharged indebtedness to the petitioner by transfer of securities and thereby sustained deductible losses seems to have little or no significance for present purposes. The reorganization, which occurred in 1930, does not have any bearing whatsoever upon the present question, even though the Board has held that it was a nontaxable reorganization. C. A. Munroe, supra.The loans to Munroe in 1929 and those made in prior years do not show a purpose within section 104. They did not weaken the financial position of the petitioner and they were not disguised dividends of the earnings of the corporation. Cf. Helvering v. National Grocery Co.,304 U.S. 282">304 U.S. 282; United Business Corporation, supra; William C. deMille Productions, Inc.,30 B.T.A. 826">30 B.T.A. 826; A. D. Saenger, Inc.,33 B.T.A. 135">33 B.T.A. 135; affd., 84 Fed.(2d) 23; certiorari denied, 299 U.S. 577">299 U.S. 577. Munroe gave his notes for the amount of the loans, paid the interest in full, and paid the principal. There is every indication that he at all times intended to pay them. Cf. *791 Charleston Lumber Co. v. United States,20 Fed.Supp. 83; United States v. Tway Coal Sales Co., 75 Fed.(2d) 336. The petitioner had substantial income from the loans to Munroe, particularly in the year 1929. Furthermore, Munroe made loans to the petitioner and the latter was indebted to him for a large amount under the contracts. We can not find in the loan situation any purpose to avoid surtax upon Munroe by permitting the gains and profits of 1929 to accumulate.
The petitioner made its greatest profit from the sale of the Laclede stock in 1927. It attempted to spread the tax from that transaction over a period of ten years by taking Munroe's notes for the purchase price. It was not, however, a scheme to avoid taxes. Neither does *1177 it demonstrate any purpose within section 104 applicable to the year 1929. The Commissioner has refused to consider any of that gain as gain for 1929.
Both parties gave considerable time and thought to the trial and briefing of this case. All of the evidence and all arguments presented have been carefully considered in an effort to determine correctly whether section 104 applies. This opinion*792 would be entirely too long were it to contain a detailed discussion of all of the many points argued. We have concluded upon the entire record that section 104 does not apply.
Reviewed by the Board.
Decision will be entered under Rule 50.
OPPER, dissenting: While the section which is being resisted is penal in its nature, 1 the evil Congress intended to restrict by its enactment is clearly recognizable, 2 and one may assume that the application of the statute was intended so that it would be effective for the purposes for which it was designed. See Foster v. United States,303 U.S. 118">303 U.S. 118. What was within the manifest intention of the legislative body should be considered as much a part of legislation as what is included in its express terms. Helvering v. New York Trust Co.,292 U.S. 455">292 U.S. 455. And this rule does not yield to any effort to make the statute bear less heavily upon those subject to its operation. Helvering v. Stockholms Enskilda Bank,293 U.S. 84">293 U.S. 84.
*793 This is not to say that a technical construction of the section will fail to sustain respondent's position in this case, but merely that overlooking the main purpose of the provision so that we permit ourselves to be lost in a maze of detail will more easily result in an erroneous conclusion. The purpose of section 104 clearly was to penalize the intentional avoidance of surtaxes upon individuals by the intervention of corporations. Congressional Record, vol. 50, part VI, p. 5319. That precise result has been accomplished by the use of this petitioner. Since the conclusion that the section does not reach this case is at war with its evident purpose, only an unmistakable prohibition in the language of the act itself should preclude its application.
Petitioner's sole stockholder succeeded from 1922 to 1929 in escaping all individual income tax on the earnings of the securities he transferred to petitioner.3 This was the direct result of the plan disclosed by the present facts. It is not unreasonable to assume that *1178 a result so clear and inevitable was also a purpose, at least in the absence of countervailing proof. *794 R. L. Blaffer & Co.,37 B.T.A. 851">37 B.T.A. 851; affd., 103 Fed.(2d) 487 (C.C.A., 5th Cir.); certiorari denied, 308 U.S. 576">308 U.S. 576. He was enabled to accomplish this purpose by three elements in the plan: First, the creation of petitioner; second, the terms of the security transfers; and third, the failure to mesh the corporation's accrual method with the individual's cash basis. Because all three part of the plan were necessary to enable the shareholder to escape surtax, it does not follow that the corporation was not formed for that inhibited purpose. Itf formation was as much an integral and essential part of the scheme as either of the other elements. And because that was not its only purpose it does not follow that the impact of the section is averted. R. L. Blaffer & Co., supra.
*795 Petitioner must, therefore, it seems to me, be regarded as having been formed for the purpose of avoiding the imposition of surtax upon its shareholder, a result which so far brings the situation meticulously within the most technical reading of the first portion of the section. The majority opinion does not take a contrary view, but rejects the conclusion that this was to be done by permitting the gains and profits of petitioner to accumulate instead of being divided or distributed. That depends upon how we define the words "gains and profits" as used in section 104. There is no express limitation to "net" gains and profits. 4 Whether the provision must be restricted to such net gains in the ordinary and natural application *1179 of the section need not be considered. Clearly petitioner here had gains and profits before it set off against them the corresponding accrued liabilities to its shareholder. It seems obvious that Congress could not have intended the term "gains and profits", whether net or gross, to mean those resulting from an artificial calculation pursuant to a clever device for frustrating the fundamental purpose of the very provision in which the term*796 appears. Cf. Gregory v. Helvering,293 U.S. 465">293 U.S. 465. It requires no more penetration than it did in that case to conclude that the organization of petitioner and its accrual of these "expenses" was a mere "disguise for concealing its real character and the sole object and accomplishment of which was the consummation of a preconceived plan * * *. To hold otherwise would be to exalt artifice above reality and to deprive the statutory provision in question of all serious purpose." (Pp. 469, 470.)
But for the ingenious terms of the contracts there would have been no such accrued "expenses." Without the accruals there would clearly have been gains and profits in the strictest sense. The contracts pursuant to which petitioner made book entries purporting to offset these gains and profits with "debts" to the shareholder were an integral part of the very scheme by which the shareholder was to avoid surtax. *797 Moreover, these gains and profits were permitted - in fact, under the plan of petitioner's organization, were required - to be accumulated instead of being divided or distributed. That the ultimate division or distribution - the payment for contributed capital - would be in the bookkeeping form of compensation rather than dividends can not change the actuality of the gains and profits, or the fact of their accumulation. See Foster v. United States, supra.Viewed from the standpoint of reality, this corporation was formed, whether or not it was also availed of, 5 for the very purpose which the intent and a fair construction of the language of section 104 will easily cover. We should not permit a long and roundabout path to lead to a different place from the one to which the straight path would take us. Minnesota Tea Co. v. Helvering,302 U.S. 609">302 U.S. 609.
I am of the opinion that respondent properly sought to apply section 104 to this petitioner.
SMITH, STERNHAGEN, TURNER, ARNOLD, and HARRON agree with this dissent.
Footnotes
1. Deficit. ↩
1. He apparently has thought, in determining the tax liability of Munroe, that the case of Fremont C. Peck et al., Executors,31 B.T.A. 87">31 B.T.A. 87; affd., 77 Fed.(2d) 857; certiorari denied, 296 U.S. 625">296 U.S. 625↩, was not in point. There, some securities were loaned to a corporation under a contract somewhat like the one involved in the present case. The corporation had power to sell the securities, but was required to pay to the lender at the end of the period the amount of the dividends which it received on the stock. Although the lender was on the cash basis and did not receive the dividends, nevertheless, she was required to include them in her income for the years in which they were received by the borrower.
1. See Helvering v. Mitchell,303 U.S. 391">303 U.S. 391, 405↩.
2. Mead Corporation,38 B.T.A. 687">38 B.T.A. 687, 700↩.
3. Petitioner is obviously giving expression to a misconception when it says in its brief: "But there is no proof in this case of minimizing taxes. The record shows that with the exception of a small profit in 1923 ($5,264.95) the company had net losses for the first five years of its existence (Exhibit 38). During that same period Munroe's net income was less than the losses sustained by the corporation (Exhibit 39). It follows, therefore, that if he had made the transactions which were made by the corporation and sustained the same losses, all his income for those years would have been wiped out, and he would have had large net losses to carry forward."
The "net losses" to which petitioner refers were those taken for income tax purposes. They were evidently arrived at by deducting from gross income the accrued "liabilities" consisting not only of all of the income received on the securities contributed by Munroe, but of 20 per cent thereof in addition, or of 7 per cent interest on the proceeds of sales. Naturally these accruals could not have been deducted by Monroe if he had been receiving the income and reporting it for tax purposes. And of course the larger the income from these securities and the smaller the petitioner's income from other sources, the greater would be its net loss, since the receipt of income from that source required it to accrue as a "liability" a greater amount than the income received.
For example, petitioner's tax return for the calendar year 1925 shows a gross income of $179,442.17. Of this $114,346.30 is income from interest and dividends and only $14,554.84 is gross profit from its operations. The balance represents capital gains. Against this, in addition to the offsetting deduction for dividends from domestic corporations, it deducted $141,892.99 as "interest." It was thus enabled to show a "net loss", but its dividend and interest income was eight times as great as its operating income. If the bulk of this came from the securities contributed by Munroe or their proceeds, which seems certain, it is manifest that Munroe's net income for 1925 of $23,024.06 would have been augmented three or four times over for surtax purposes if he had retained the securities instead of transferring them to petitioner. ↩
4. See Revenue Act, 1928, section 22(a), where "gains" and "profits" are used in the definition of gross income. Cf. G.B.R. Oil Co.,40 B.T.A. 738">40 B.T.A. 738↩ dealing with the term "earnings and profits."
5. See Reynard Corporation,37 B.T.A. 552">37 B.T.A. 552, 562↩.