*1092 The gratuitous forgiveness by a parent corporation of the indebtedness of a subsidiary to it, for the sole purpose of assisting the subsidiary "in its operations and in its business generally, and to improve [its] financial position," does not give rise to taxable income to the subsidiary benefited thereby. The transaction amounts to a contribution by the parent to the capital of its subsidiary.
*621 The respondent determined deficiencies in income taxes for 1927 and 1928, in the amounts of $297,395.18 and $4,114.15, respectively. The petitioner assails the determination in respect of 1927, alleging that respondent erred in adding $2,170,478.98 to the net income reported in the return for that year, said amount representing an indebtedness of the AutoStrop Safety Razor Co., petitioner's predecessor in business, to the Autan Transfer Corporation, which was canceled by the latter within the year in question. One other assignment of error made in the petition, relating to respondent's disallowance or failure to allow*1093 deductions for exhaustion of patents, was waived by the petitioner at the hearing.
FINDINGS OF FACT.
Petitioner, a New York corporation with its principal office at 656 First Avenue, New York City, was organized in June 1927.
In 1926 the AutoStrop Safety Razor Co. was indebted to the AutoStrop Co., for royalties, loans and interest, in the sum of $2,170,478.98. In that year the last mentioned company was dissolved and its assets, other than patents, including the said indebtedness of AutoStrop Safety Razor Co., were distributed in liquidation to the Autan Transfer Corporation, its sole stockholder.
On January 19, 1927, the Autan Transfer Corporation owned all of the outstanding capital stock of the AutoStrop Safety Razor Co. and on that day it executed an instrument which, so far as material here, reads as follows:
WHEREAS in and by a written agreement dated the 2nd day of April, 1909, AutoStrop Company, a New York Corporation, granted to the party of the *622 second part [AutoStrop Safety Razor Company] a license to manufacture safety razors under the patent or patents owned by said AutoStrop Company; and
WHEREAS in and by said agreement the party of the*1094 second part obligated itself to pay to the said AutoStrop Company certain royalties or commissions; and
WHEREAS royalties or commissions amounting to a considerable sum became payable from the party of the second part to the said AutoStrop Company, and the party of the second part became indebted to said AutoStrop Company on account of such royalties and commissions and for moneys loaned and advanced to it by said AutoStrop Company in a considerable amount; and
WHEREAS the said AutoStrop Company has been duly and legally dissolved and liquidated; and
WHEREAS at the time of the dissolution of the said AutoStrop Company the party of the first part [Autan Transfer Corporation] was the owner and holder of the entire outstanding capital stock of said AutoStrop Company; and
WHEREAS upon dissolution and liquidation of said AutoStrop Company the party of the first part became and is now vested with and the owner of all claims and demands of said AutoStrop Company against the party of the second part for royalties or commissions or for moneys loaned and advanced or otherwise; and
WHEREAS the payment by the party of the second part of such royalties and commissions and the repayment*1095 of the moneys heretofore loaned and advanced to the party of the second part by the said AutoStrop Company might result in hindering the operations of the party of the second part in marketing its products; and
WHEREAS the party of the first part is also the owner and holder of the entire outstanding capital stock of the party of the second part and is interested in the financial success of the party of the second part and in having the party of the second part sell as large a quantity of its product as possible.
Now, THEREFORE, in consideration of the premises and in order to assist the party of the second part in its operations and in its business generally, and to improve the financial position of the party of the second part, the party of the first part hereby releases the party of the second part from the payment of any and all indebtedness or obligations due or payable by the party of the second part to the party of the first part on account of royalties or commissions or on account of moneys loaned and advanced or otherwise.
The foregoing instrument was not signed, but was accepted, by the AutoStrop Safety Razor Co., and, upon the execution thereof by the Autan Transfer*1096 Corporation, the amount in question was transferred on the books of the AutoStrop Safety Razor Co. to surplus account.
The petitioner, though not organized until June of 1927, filed an income tax return for the full calendar year of 1927, in which it included the income and deductions of the AutoStrop Safety Razor Co.; but the cancellation by the Autan Transfer Corporation of the indebtedness of the AutoStrop Safety Razor Co. was not reflected in any way in the net income reported in that return. The respondent added the amount of canceled indebtedness, $2,170,478.98, to the reported net income.
*623 OPINION.
ARUNDELL: In the deficiency notice the amount involved was added to income by respondent, with the simple explanation "Returned royalties." The petitioner contends that the transaction amounted to a contribution of capital, or a gift, to a corporation by its sole stockholder, and the amount involved, therefore, is not taxable income.
The transaction in question was one between the Autan Transfer Corporation and the AutoStrop Safety Razor Co., this petitioner's predecessor, and it took place about six months prior to the organization of this petitioner. We*1097 are unable to determine from the evidence whether the petitioner and its predecessor are one or different taxable entities. The respondent treated them as one, and, though statements were made at the hearing by counsel for petitioner indicating the possibility that they hold a different view, no evidence was presented on the matter and the point is entirely forsaken in petitioner's brief. The point is not important, however, for we are of the opinion that no taxable income was involved in the transaction.
The Autan Transfer Corporation was the sole owner of all of the outstanding capital stock of the AutoStrop Safety Razor Co., and the purpose of the former's cancellation of the latter's indebtedness is clearly stated in the instrument by which the cancellation was effected to be to assist the latter in its operation and in its business generally, and to improve its financial condition. The transaction, it seems to us, falls squarely within the provisions of article 49 of Regulations 69, which was first adopted in substantially the same form under the Revenue Act of 1918 and has been adopted under all subsequent revenue acts, and which reads as follows:
ART. 49. Forgiveness*1098 of indebtedness. - The cancellation and forgiveness of indebtedness may amount to a payment of income, to a gift, or to a capital transaction, dependent upon the circumstances. If, for example, an individual performs services for a creditor, who in consideration thereof cancels the debt, income to that amount is realized by the debtor as compensation for his services. If, however, a creditor merely desires to benefit a debtor and without any consideration therefor cancels the debt, the amount of the debt is a gift from the creditor to the debtor and need not be included in the latter's gross income. If a shareholder in a corporation which is indebted to him gratuitously forgives the debt, the transaction amounts to a contribution to the capital of the corporation.
That the action of the Autan Transfer Corporation was entirely gratuitous on its part is evident from the absence, in the agreement, of any consideration moving to it from the benefited corporation. It sought by canceling the indebtedness to remove any hindrance to *624 operations and marketing of products by the debtor corporation. The accomplishment of that purpose would naturally redound to the Autan Transfer*1099 Corporation's benefit, since it was the sole owner of the debtor corporation; and the benefit so to be derived was evidently consideration enough for its action. No compensation for services, nor income from a transaction entered into for profit, nor gain derived from capital, or from labor, or from both, was involved in the transaction, and, therefore, the amount involved is not within the definition of income as defined in . The transaction constituted a contribution by the Autan Transfer Corporation to the capital of the AutoStrop Safety Razor Co. Cf. ; ; and . The respondent erred in adding the amount of the canceled indebtedness to income.
Decision will be entered under Rule 50.