*198 Decision will be entered for the respondent.
1. Petitioner, successor corporation to a sole proprietorship, paid one-half of its profits as rent to Realty Company, its lessor, under an agreement wherein Realty Company had promised to finance the operations of the proprietorship, including the construction of a building, and was to receive therefor one-half of the profits. Also, in accordance with such agreement, Realty Company, in turn, paid as interest to petitioner's sole stockholder and former owner of the proprietorship, such stockholder being the party with whom the original agreement was first entered into, amounts equal to 6 per cent of the amount of his stockholdings because such stock investment in petitioner, in effect, reduced, pro tanto, the necessity for the lessor, Realty Company, to furnish any of the promised financing. Held, such amounts as were paid to petitioner's sole stockholder by Realty Company from its share of the profits of petitioner (received as rent) are not deductible by petitioner under section 23 (a) (1) (A), I. R. C. 1939, in accordance with respondent's determination.
2. Held, that petitioner has failed to meet the burden of proving*199 that additional amounts (claimed as deductions for rent but not accrued on its books in the years in question) were not in dispute in such years.
*237 The respondent determined deficiencies in income taxes of the petitioner as follows:
| Years ended | |
| September 30 | Deficiencies |
| 1948 | $ 2,891.81 |
| 1949 | 4,166.91 |
| 1950 | 6,951.17 |
| 1951 | 6,211.51 |
| 1952 | 2,250.00 |
The issues presented are: (1) Whether the respondent correctly disallowed the deduction of part of rental payments based on one-half of the profits of petitioner (lessee corporation) and lessor, where a portion of such payments were in turn paid over to petitioner's sole stockholder on the basis of his stockholdings, all in accordance with an agreement between such stockholder and the lessor providing that the lessor finance the business operations of the lessee, including the construction of a building, and also that the lessor pay to the petitioner's stockholder as interest the sum here in issue, for, in effect, reducing pro tanto the necessity for the lessor*200 to finance the lessee *238 by such stockholder's investing in the lessee; and (2) whether petitioner has met the burden of proving that additional amounts (claimed in its petitions as deductions for rent, which amounts had not been accrued on its books in the years in question) were not in dispute in such years.
FINDINGS OF FACT.
Part of the facts are stipulated, and, to the extent so stipulated, are incorporated herein by this reference.
Wade Motor Company, the petitioner, is a Tennessee corporation with its office and principal place of business located in Gallatin, Tennessee. It engages in the operation of an automobile dealership in Gallatin and keeps its records and files its income tax returns on the accrual basis of accounting. It filed its United States corporation income tax returns for the taxable years ended September 30, 1948, to September 30, 1952, inclusive, with the collector of internal revenue for the district of Tennessee.
Saundersville Realty Company or Saundersville Realty Corporation, sometimes hereinafter called the Realty Company, was incorporated in October 1941. Its office is located at 224 Second Avenue, North, Nashville, Tennessee. Other related*201 corporations also maintain their offices at this location. Since its incorporation, and during all of the years here involved, G. L. Comer has been the sole stockholder of the Realty Company. Shortly after its formation, W. P. Wade became its president and one of its directors.
In 1944, Wade resigned as president of the Realty Company to acquire an automobile dealership in Gallatin, Tennessee. Comer was then elected president of the Realty Company. Wade discussed the financing of the automobile dealership with Comer, and it was agreed that the Realty Company would finance the venture. Comer then referred Wade to Hatcher, a vice president of the Realty Company. Hatcher discussed the venture with Comer, was advised of the substance of the negotiations between Comer and Wade and drafted a contract between Wade and the Realty Company, which was entered into on December 12, 1944, and reads as follows:
This contract and agreement entered into this 12th day of December 1944, by and between W. P. Wade, an individual of Sumner County, Tennessee, known hereinafter as the party of the first part and the Saundersville Realty Company, Saundersville, Tennessee, a corporation existing under*202 the laws of Tennessee, known hereinafter as the party of the second part.
Witnesseth
Whereas: W. P. Wade has secured from the Ford Motor Company of Detroit, Michigan, the agency as Ford Dealer in Gallatin, Sumner County, Tennessee, and
*239 Whereas: the said W. P. Wade is not able to adequately finance the operations of said agency -- now therefore in consideration of $ 1.00 cash and other valuable consideration hereinafter mentioned the party of the first part agrees to devote his full time to the operation of said agency, to be known as the Wade Motor Company, and as consideration therefor shall receive one-half of the profits of said agency, or subagencies that may be acquired.
The Party of the second part agrees to furnish the necessary monies to finance operations of the agency including the construction of a building to be occupied by the Wade Motor Company, and shall receive as rental therefor one-half of the profit of the agency including subagencies that may be acquired.
The Party of the second part agrees that the party of the first part shall receive interest at the rate of 6% per annum on any money loaned to the Wade Motor Company, said interest to be paid by the *203 Saundersville Realty Company out of its one-half share of the profit.
The Party of the first part agrees to keep adequate books and records which may be open for inspection and verification by the party of the second part at any time.
It is mutually agreed between the parties that the party of the first part shall have a monthly drawing account not to exceed $ 250.00 per month, said drawing account to be deducted from the first party's one-half share of the profits at the end of each year.
It is further agreed that this contract is for a period of ten years from the date hereof and may be changed only by mutual consent of both parties.
This contract extends to the party of the first part, his heirs, legatees, legal representatives and assigns and to the party of the second part, its successor or successors, legal representatives and assigns.
In witness Whereof the parties hereto have hereinto affixed their signatures this 12th day of December 1944.
W. P. WadeSaundersville Realty Co.
G. L. Comer, President.
Wade then operated the automobile dealership as a sole proprietorship until September 3, 1946, when it was incorporated. Immediately after Wade obtained the automobile dealership*204 from the Ford Motor Company, the business occupied a small store on West Main Street in Gallatin, Tennessee. The business did not pay anything to the Realty Company in 1944 or 1945. In 1946, prior to the incorporation of petitioner, the business earned approximately $ 20,000, and $ 10,724.75 was paid to the Realty Company.
During 1946, Wade borrowed $ 50,000, personally furnished an additional amount, and built a building for the business to use. The building was completed in June 1946. It is a one-story brick building, 145 feet long and 85 feet wide, located on the main thoroughfare and just off the square in Gallatin. Later in 1946, after the building had been used for some time by Wade, the Realty Company purchased it for $ 76,000. Subsequently, the Realty Company made improvements totaling $ 7,500 or $ 8,000 to the building.
Petitioner was formed on September 13, 1946, to take over the automobile dealership previously operated by Wade. Prior to petitioner's *240 incorporation, Wade advised the Realty Company of his intention to incorporate the business, and it interposed no objection. Upon incorporation of petitioner, $ 30,000 of capital stock was issued to Wade. *205 Since that time Wade has acquired additional capital stock in petitioner on the dates, in amounts, and in the following manner:
| January 11, 1947 | $ 20,000 Stock for cash |
| October 31, 1947 | 20,000 Stock dividend |
| October 1, 1948 | 20,000 Stock dividend |
| October 1, 1949 | 10,000 Stock dividend |
During the years here involved petitioner paid to the Realty Company the following amounts:
| Year ended | |
| September 30 | Amount |
| 1948 | $ 32,818.15 |
| 1949 | 36,807.80 |
| 1950 | 44,174.59 |
| 1951 | 39,342.88 |
| 1952 | 22,292.56 |
The above amounts were computed as follows:
| September 30 | |||
| 1948 | 1949 | 1950 | |
| Net income per books (before deduction | |||
| of rent paid to Saundersville Realty) | $ 61,154.64 | $ 73,632.90 | $ 74,249.18 |
| Add: Salary W. P. Wade | 12,000.00 | 11,600.00 | 14,100.00 |
| Total | $ 73,154.64 | $ 85,232.90 | $ 88,349.18 |
| Deduct: Federal income tax for the | |||
| year | 7,518.34 | 12,017.30 | |
| Total | $ 65,636.30 | $ 73,215.60 | $ 88,349.18 |
| One-half of above | $ 32,818.15 | $ 36,607.80 | $ 44,174.59 |
| Error | 200.00 | ||
| Rent paid to Saundersville | $ 32,818.15 | $ 36,807.80 | $ 44,174.59 |
| Net income before rent | $ 61,154.64 | $ 73,632.90 | $ 74,249.18 |
| Less: Saundersville rent | 32,818.15 | 36,807.80 | 44,174.59 |
| Net income per books | $ 28,336.49 | $ 36,825.10 | $ 30,074.59 |
| Add -- Contributions: | |||
| Excess of 5 per cent | 332.97 | ||
| Erroneously accrued | |||
| Deduct: Contributions accrued | (900.00) | ||
| Rent -- Evans Building | |||
| Net income per return | $ 28,336.49 | $ 36,825.10 | $ 29,507.56 |
| September 30 | ||
| 1951 | 1952 | |
| Net income per books (before deduction | ||
| of rent paid to Saundersville Realty) | $ 63,685.76 | $ 30,835.12 |
| Add: Salary W. P. Wade | 15,000.00 | 15,000.00 |
| Total | $ 78,685.76 | $ 45,835.12 |
| Deduct: Federal income tax for the | ||
| year | ||
| Total | $ 78,685.76 | $ 45,835.12 |
| One-half of above | $ 39,342.88 | $ 22,917.56 |
| Error | ||
| Rent paid to Saundersville | $ 39,342.88 | $ 22,292.56 |
| Net income before rent | $ 63,685.76 | $ 30,835.12 |
| Less: Saundersville rent | 39,342.88 | 22,292.56 |
| Net income per books | $ 24,342.88 | $ 8,542.56 |
| Add -- Contributions: | ||
| Excess of 5 per cent | ||
| Erroneously accrued | 550.00 | |
| Deduct: Contributions accrued | ||
| Rent -- Evans Building | (1,800.00) | |
| Net income per return | $ 24,342.88 | $ 7,292.56 |
The Realty Company, in turn, from the amounts transferred to it by petitioner, paid sums, representing 6 per cent of the petitioner's outstanding capital stock, to Wade as follows:
| For year ended | |
| September 30 | Amount |
| 1948 | $ 4,200 (6 per cent of $ 70,000) |
| 1949 | 5,400 (6 per cent of $ 90,000) |
| 1950 | 6,000 (6 per cent of $ 100,000) |
| 1951 | 6,000 (6 per cent of $ 100,000) |
| 1952 | 6,000 (6 per cent of $ 100,000) |
*241 The*207 amounts paid to Wade by the Realty Company were computed at the rate of 6 per cent on the capital stock held by Wade in petitioner. During the years here involved Wade was petitioner's sole stockholder. The Realty Company has never loaned any money to the petitioner. The Realty Company never loaned any money to the business prior to petitioner's incorporation. There was no formal assignment or sublease to petitioner of the agreement between Wade and the Realty Company dated December 12, 1944, but upon the formation of petitioner as a corporation the parties continued to act under the agreement and the rental payments were made by petitioner pursuant to the terms thereof to the same extent and in the same manner as Wade had done during the period when he operated his agency as a sole proprietorship. Neither petitioner nor Wade entered into any other formal contracts with the Realty Company, but petitioner and the Realty Company did, by mutual consent, change the method of computing rents to be paid. In addition, although the agreement of December 12, 1944, provided for the payment of interest to Wade at the rate of 6 per cent per annum on any money loaned by him to Wade Motor*208 Company, the interested parties, by their conduct during all of the years here in issue, construed and implemented the agreement to the effect that the annual so-called interest payment was to be calculated on the basis of 6 per cent of the outstanding capital stock issued to Wade.
The building used by petitioner is the largest asset of the Realty Company. In 1949, Wade again became president of the Realty Company. On October 1, 1953, the Realty Company acquired all of petitioner's capital stock from Wade. He is still petitioner's president and supervises its operation.
Petitioner received income in the amounts of $ 1,256.24, $ 2,462.09, $ 5,084.64, and $ 4,470.72 for the taxable years ended September 30, 1948, 1949, 1950, and 1951, respectively, from finance reserves accrued by various finance companies during said taxable years. These items were not accrued as income on petitioner's books. Petitioner likewise did not accrue on its books for any of the years in question any amount as additional rent due Realty Company to the extent of one-half of said finance reserves.
Petitioner did not accrue on its books as additional rent due Realty Company for either of the taxable years*209 ending September 30, 1951, and 1952 one-half of salary payments disallowed by respondent for each of said years.
OPINION.
During the taxable years here in question (fiscal years from September 30, 1948, to September 30, 1952, inclusive), petitioner *242 was a corporation (hereinafter sometimes referred to as the Corporation) organized originally on September 13, 1946. Its outstanding stock was wholly owned by W. P. Wade. Petitioner's predecessor was a sole proprietorship owned by Wade and conducted as such until incorporation in 1946. During the periods of both sole proprietorship and corporate operation, the business conducted was that of a Ford agency in Gallatin, Tennessee.
The Corporation, without formal assignment, succeeded to, and carried out the provisions of a contract between Wade (then sole proprietor of the Ford agency) and the Realty Company dated December 12, 1944. Under the terms of the agreement, the Realty Company agreed to furnish the necessary funds to finance the operations of the agency, including the construction of a building to be operated by the latter, and the Realty Company was to receive as rental therefor one-half of the profits of the agency. *210 The contract further provided, however, that Wade was to receive from the Realty Company out of its one-half share of the profits interest at the rate of 6 per cent per annum on any money loaned by Wade to the Ford agency.
For all practical purposes, the arrangement with the Realty Company operated in such a way that the Realty Company furnished only such financing as was not furnished by Wade himself. Wade invested substantial amounts in the Corporation, and actually financed the construction of the building in which the agency was operated. The building was constructed in 1946 during the period of the sole proprietorship, but was bought later in 1946 from Wade by the Realty Company for $ 76,000. Subsequently, the Realty Company made improvements at a cost of $ 7,500 or $ 8,000.
During each of the taxable years in question, the Corporation paid one-half of its profits to the Realty Company, the payments being designated as rent, but the Realty Company, in turn, paid to Wade individually an annual amount based upon 6 per cent of his stockholdings in the Corporation.
Respondent determined that, to the extent of the amounts so paid to Wade, the payments to the Realty Company were*211 not rent, but amounted to a distribution to Wade of profits of the Corporation, and that such amounts were not deductible by the Corporation as rent. Petitioner asserts that the full amount paid to the Realty Company was rent, and that the amounts paid by Realty Company to Wade were interest paid by it, with which petitioner was in no way concerned.
We think it obvious that the payments to Wade were not interest. Wade loaned nothing to the Realty Company. What he actually did was invest money in the Corporation wholly owned by him. While his investment in the Corporation relieved the Realty Company, pro *243 tanto, from its obligation to furnish the finances, it did not constitute a loan either to the Realty Company or to the Corporation.
We also think it clear that the rent paid to the Realty Company, to the extent of the 6 per cent per annum payments from the Realty Company to Wade (subject to the adjustment hereinafter set forth), did not constitute "rentals or other payments required to be made as a condition to the continued use or possession, for purposes of trade or business, of property * * *" within the meaning of section 23 (a) (1) (A) of the Internal Revenue*212 Code of 1939. Under the terms of the original agreement of December 12, 1944, between Wade and the Realty Company (adopted by the Corporation when it took over Wade's business), the Realty Company was entitled to a full one-half of the profits as rent only if it furnished the necessary money to finance the agency (later the Corporation). This it did not do, and it is clear that the parties contemplated the likelihood that it would not do so, because the same contract provided that Wade himself would receive from the Realty Company 6 per cent per annum for any money loaned to the agency. The interested parties, including, later, the Corporation, made it clear by their conduct that the words "money loaned" were construed by them to mean or include any investment in or financing of the agency, and later the Corporation, by Wade. All that the agreement did, for practical purposes, was to measure the extent to which the Realty Company's right to receive one-half of the profits of the Corporation as rent would be reduced as a result of Wade's personal investment or financing. Whether the full one-half of the profits was first paid to the Realty Company under the guise of rent followed*213 by repayment of so-called interest by the Realty Company to Wade, or whether the rent to the Realty Company had been determined on a net figure based on the same calculations is immaterial. In either event, the actual rent to the Realty Company was one-half of the profits of the agency (and later of the Corporation) less the amount payable to Wade. Under the method actually used, the Realty Company was a mere conduit insofar as the payments to Wade were concerned.
It is clear that during the period of the existence of the Corporation (and the years before us are all during that period) the payments to Wade were keyed to his stockholdings, and not to any loan. He merely received, through the medium of the Realty Company, that part of the rent to which the Realty Company was not entitled under the agreement of the interested parties as extended and adopted by them upon the advent of the Corporation. To the extent of such repayments to him, the payments to the Realty Company were not rentals or other payments required to be made as a condition to the *244 continued use or possession of property. When received by Wade through the medium of the Realty Company, the payments were*214 clearly indirect distributions to him by the Corporation. We think the record clearly supports this view, and negatives any conclusion to the contrary. Certainly petitioner, which has the burden of proof, has failed to show error in respondent's determination to that effect.
Petitioner argues, however, that if we conclude (as we have done) that the payments to Wade were distributions to him by the Corporation and, as such, not deductible, the result is that the net income of the Corporation was thereby increased in the same amount; that one-half of such amount is payable to the Realty Company as rent; and that a deduction to the extent of such one-half of said paid payments must in turn be allowed.
We have carefully considered all of the circumstances in the setting of the close practical relationships of the parties in interest as detailed in our Findings of Fact, and have concluded that, irrespective of any contractual obligation to the Realty Company, petitioner (which has the burden of proof) has failed to establish that any derivative increase in income from a tax standpoint arising out of the disallowance of the deduction in question is a basis for holding that a resulting*215 obligation to pay one-half thereof to the Realty Company justifies a determination that such payment was required for the use or occupancy of property within the meaning of section 23 (a) (1) (A).
Although arising under factual circumstances differing from those presented in the instant case, our opinions in Roland P. Place, 199">17 T. C. 199 (1951), affirmed per curiam (C. A. 6, 1952) 199 F. 2d 373; Jos. N. Neel Co., 22 T. C. 1083 (1954); and Herbert Davis, 26 T. C. 49 (1956) reflect our approach to the construction of the relevant provisions of section 23 (a) (1) (A), supra, in a background where the close relationship of the parties and the nature of the transaction invite careful scrutiny.
Respondent has allowed the full rental claimed on petitioner's returns, less the amounts paid to Wade by the Realty Company discussed above. In the light of our discussion, supra, we sustain respondent in disallowing deductions for rent to the extent of such payments to Wade.
In his statutory notices of deficiencies herein, the respondent increased petitioner's income in*216 the amounts of $ 1,256.24, $ 2,462.09, $ 5,084.64, and $ 4,470.72 for the taxable years ended September 30, 1948, 1949, 1950, and 1951, respectively, for finance reserves accrued by various finance companies during these years. The respondent further disallowed a salary deduction in each of the taxable years *245 ended September 30, 1951, and September 30, 1952. The petitioner now concedes that these adjustments made by the respondent were correct but asserts that since these amounts increased the income of petitioner, it is obligated to pay one-half of such amounts to the Realty Company as rental. Based on this premise, petitioner then contends that it is entitled to a deduction for the amounts it is obligated to pay the Realty Company.
The petitioner maintains its books on the accrual basis of accounting. Petitioner concedes that it has neither accrued the additional income on its books nor accrued the additional expense of one-half thereof which it now claims is payable to the Realty Company as rent. The record does not indicate when the petitioner ceased to contest the respondent's adjustments or first admitted or recognized an additional obligation to the Realty Company. *217 It does indicate however, that it was some time subsequent to the taxable years here involved. Petitioner makes the following statement on brief in this connection: "Half of the finance reserves and excessive salary were not accrued as deductions because at first such items were not considered income."
We find the state of the record to be not only that petitioner did not accrue on its books as rent in or for any of the years in issue the portion of the items in question which it now claims to be due to the Realty Company as rent, but also has failed to offer any evidence that in any of such years it recognized that such amounts were due the Realty Company, or that claim therefor was asserted by the Realty Company in any of such years. The earliest indication in the record that the issue relating to finance reserves was not in dispute and that a corresponding obligation of one-half thereof to the Realty Company was recognized is to be found in the petition in Docket No. 48195, which was not filed until May 4, 1953. Likewise, the earliest similar indication with respect to the items of salary disallowance and related obligation to the Realty Corporation is to be found in the petition*218 in Docket No. 55687, which was filed on December 23, 1954. Under the circumstances, it is clear that petitioner has failed to meet the burden of proving that any of the items in question are to be accrued in any of the years before us. See Lucas v. American Code Co., 280 U.S. 445 (1930); Dixie Pine Products Co. v. Commissioner, 320 U.S. 516">320 U.S. 516 (1944); Great Island Holding Corporation, 5 T. C. 150 (1945); Arabol Manufacturing Co., 26 B. T. A. 1068 (1932).
We, therefore, approve respondent's disallowance for the years in question of accrual of rental deductions attributed by petitioner to one-half of the finance reserves and one-half of disallowance of salary.
Decision will be entered for the respondent.