*134 Decisions will be entered under Rule 50.
Held, that the operations of a long-established and successful downtown store and those of a separately and newly incorporated suburban store were all part of a single integrated business enterprise under common ownership and control; and that the Commissioner did not err in determining that, under section 482 of the 1954 Code, all taxable income of the suburban store for each of the taxable years involved is includable in the income of the downtown store.
*822 The respondent determined deficiencies in the income taxes *136 of the petitioners for their taxable fiscal years ended January 31, 1956 through 1958, as follows:
| Deficiencies | ||
| Fiscal year ended Jan. 31 -- | The Isaac | Hamburgers |
| Hamburger & Sons | York Road, Inc., | |
| Co., docket No. | docket No. 92387 | |
| 92388 | ||
| 1956 | $ 61,196.20 | $ 5,180.72 |
| 1957 | 67,563.00 | 5,820.00 |
| 1958 | 61,074.00 | 15,900.00 |
The cases were consolidated for trial.
Alternative issues are presented for decision:
(1) Was the respondent correct, either under the authority of section 61(a) or under the authority of section 482 of the 1954 Code, in taxing to petitioner the Isaac Hamburger & Sons Co., the entire taxable (net) income of petitioner Hamburgers York Road, Inc., for each of the years involved?
(2) If the first issue is decided adversely to the respondent, then whether the respondent was correct in disallowing to petitioner Hamburgers York Road, Inc., the exemption from surtax accorded by section 11(c) of the 1954 Code -- under the authority either of section 269(a) or of section 1551 of said Code.
Respondent conceded in his opening statement at the trial that if he is sustained on the first issue (i.e., that the taxable income of the York Road petitioner is *137 chargeable to the other petitioner), then there will be no deficiency due from the York Road petitioner for any of the taxable years.
Other issues raised in the petitions, relating to the amount of deductible compensation to the officers of each of the petitioners, have been settled in the stipulation entered into by the parties.
FINDINGS OF FACT
The petitioner in docket No. 92388 is the Isaac Hamburger & Sons Co. (hereinafter called Hamburger & Sons), a Maryland corporation, organized in July 1922, and having its principal place of business at Baltimore and Hanover Streets in the downtown section of the city of Baltimore. It kept its books of account and filed its Federal income *823 tax returns in accordance with an accrual method of accounting and for fiscal years ended January 31.
The petitioner in docket No. 92387 is Hamburgers York Road, Inc. (hereinafter called York Road), a Maryland corporation, organized in January 1955, and having its principal place of business at York Road and Walker Street in the suburbs of the city of Baltimore. It likewise kept its books of account and filed its Federal income tax returns in accordance with an accrual method of accounting and *138 for fiscal years ended January 31.
Both of said petitioners filed their Federal income tax returns for all taxable years involved with the district director of internal revenue at Baltimore.
Hamburger & Sons conducts the oldest and largest retail men's wear business in Baltimore. Its business was founded in 1850; and its present corporate form dates from 1922. On or about January 31, 1955, and continuing throughout all the taxable years involved, its common capital stock (the only class of stock which it had outstanding) was held as follows:
| Name of stockholder | Number of | Percentage of |
| shares owned | shares | |
| Sidney Berney | 1,000 | 33.8 |
| Robert Berney | 250 | 8.5 |
| Isaac Hamburger | 750 | 25.3 |
| Betty Hamburger | 10 | .3 |
| Henry Berney | 430 | 14.5 |
| Albert Berney | 280 | 9.5 |
| Richard Berney | 240 | 8.1 |
| Total | 2,960 | 100.0 |
On or about January 31, 1955, and continuing throughout the taxable years, the officers of Hamburger & Sons were: Isaac Hamburger, president; Betty Hamburger and Henry Berney, vice presidents; Albert Berney, treasurer; and Robert Berney, secretary. Each of the stockholders above listed, with the exception of Richard Berney, was also a director of said corporation. *139 Isaac Hamburger died in 1960, and he was succeeded as president by Albert Berney.
The above seven stockholders were members of three family groups. Sidney Berney and Robert Berney were father and son, respectively; Isaac Hamburger and Betty Hamburger were husband and wife, and Isaac was Sidney Berney's first cousin; Albert, Henry, and Richard Berney were brothers, nephews of Sidney Berney, and first cousins of Robert Berney. Sidney Berney had retired from active participation in the business operations of the Hamburger & Sons store some time prior to January 31, 1955; and Richard Berney at no time took any part in the business operations of said store.
*824 For several years prior to 1955, the stockholders of Hamburger & Sons had been considering opening a store in the Baltimore suburbs. A merchandising trend had set in following World War II for an ever-increasing amount of goods and services to be purchased in the suburban sections, due to the movement of population to suburbs. As a result of this trend, the sales of Hamburger & Sons had been steadily decreasing before 1955. Other business concerns in Baltimore (and throughout the country generally) had opened suburban *140 stores in order to maintain their sales position in the face of the population shift and the concomitant merchandising trend. By the fall of 1954, a decision had been reached by the Hamburger & Sons stockholders to open a suburban store.
Consideration was given by the Hamburger & Sons stockholders to the question of whether said store should be operated as a division of Hamburger & Sons, or as a corporate subsidiary, or as a separate sister corporation. The principal advocates of opening the new store and the persons most interested in getting it underway were the above-mentioned Berney brothers, Albert and Henry; and it was their desire that they be permitted to have a larger proportionate interest in the suburban store than they had in the downtown store. The other Hamburger & Sons stockholders were amenable to the Berney brothers' wishes. Each of the stockholders of Hamburger & Sons had received his stock by gift, purchase, or inheritance from relatives who were previously active in the business; and it had been largely the practice to let the ownership of the business follow the persons who were active in its operation. It was finally decided that, of the three alternatives*141 above mentioned, the separate sister corporation approach would be utilized. The Hamburger & Sons stockholders were advised by their accountants and attorneys that one of the benefits that would flow from this approach would be that the new corporation would get an additional surtax exemption, and thus enjoy a lower rate of tax on the first $ 25,000 of the taxable income of the enterprise.
Accordingly, in January 1955, petitioner York Road was organized as a Maryland corporation, with 2,000 shares of common capital stock outstanding, which was held as follows:
| Name of stockholder | Number of | Percentage of |
| shares owned | shares | |
| Sidney Berney | 300 | 15 |
| Robert Berney | 300 | 15 |
| Isaac Hamburger | 300 | 15 |
| Betty Hamburger | 300 | 15 |
| Henry Berney | 300 | 15 |
| Albert Berney | 300 | 15 |
| Richard Berney | 200 | 10 |
| Total | 2,000 | 100 |
*825 The following table shows a comparison of the percentage of ownership in each of the petitioner corporations, which was held by each of the above-mentioned family groups:
| Percentage of ownership | ||
| Family group | Hamburger & | York Road |
| Sons | ||
| Sidney and Robert Berney | 42.3 | 30 |
| Isaac and Betty Hamburger | 25.6 | 30 |
| Albert, Henry, and Richard Berney | 32.1 | 40 |
| Total | 100.0 | 100 |
*142 The officers of York Road were the same as those of Hamburger & Sons; and the directors of the former were the same as those of the latter, except that Sidney Berney (who, as above found as a fact, had retired from active participation in business operations) did not serve as a director of York Road.
The York Road stockholders acquired their stock for $ 10 per share, or an aggregate of $ 20,000. York Road also obtained additional working capital in the beginning, by means of two loans: One for $ 40,000 from a Baltimore bank (which was guaranteed by the York Road directors in their individual capacities); and the other for $ 25,000 from Sidney Berney and his wife, which was evidenced by York Road's unsecured promissory note. Hamburger & Sons did not, at or immediately following the organization of York Road, make any formal transfer of assets, tangible or intangible, to the latter corporation. Hamburger & Sons did permit York Road to employ the name "Hamburgers" for its own use, without any charge therefor.
York Road opened the doors of its store for business on February 8, 1955. The store occupied space in the newly completed Stewart-York Road shopping center on the road from *143 Baltimore to York, Pa., just at the line separating Baltimore City from Baltimore County.
A lease agreement was entered into by York Road and the owner of the new store premises. Among the provisions of this lease was a covenant by York Road that it would conduct on the leased premises a general men's clothing store, and would offer for sale therein "any and all merchandise and services that are being offered from time to time by The Isaac Hamburger & Sons Company at its downtown store in Baltimore City." By a separate agreement, Hamburger & Sons guaranteed performance of the lease by York Road.
In connection with the opening of the new store, Betty Hamburger (who served as advertising manager and had charge of public relations for Hamburger & Sons) was interviewed by reporters for the Baltimore newspapers. Based on said interviews, the Baltimore *826 News printed a story in its edition of February 8, 1955, which contained the following:
Branch stores of two well-known Baltimore retail outlets, Stewart & Co. and Hamburgers, opened their doors for business today * * *.
* * * *
The opening of Hamburgers' men and boys specialty store marks the first time since 1876 that Hamburgers*144 has done business off Baltimore Street.
In the edition of the Baltimore Evening Sun of February 7, 1955, the following appeared, based on a reporter's interview with Betty Hamburger:
Baltimore will have a new suburban shopping center opening tomorrow, * * * the main units of which will be branches of Stewart & Co.'s department store and of Isaac Hamburger & Sons, men's and boys' outfitters.
Both stores are the first suburban outlets of the two firms which long have had their headquarters in the downtown shopping district.
Betty Hamburger also caused advertising brochures to be prepared announcing that the same specified brands of quality merchandise sold at Hamburger & Sons, and the famous Hamburger label backed by 105 years of experience, would be found at the new store; and that "your Hamburger charge account is good at both stores." Advertisements to the same effect were placed in the newspapers, one of which stated that "Hamburgers-York Road is a new addition of Hamburgers main store." The advertisements also emphasized that customers would receive the same painstaking, courteous service at "our" new store that has built "our" reputation for 105 years.
The store operated by Hamburger*145 & Sons (hereinafter called for convenience, the downtown store) and the York Road store both had shield-shaped emblems on their front doors, on which appeared the legend "Since 1850." The trade name "Hamburgers" was displayed on the front of the York Road store in a sign of similar design to that displayed on the downtown store. Both stores had the same telephone number; and telephone service to both stores was handled through a PBX switchboard located in the downtown store.
As hereinabove found as a fact, the officers of the corporations operating the two stores were the same individuals. These officers made their headquarters at the downtown store, and spent most of their working time at that location. Isaac Hamburger, the president of both corporations during the taxable years involved, was the overall general manager of both stores, and devoted the bulk of his time to supervising the store buyers (or department managers) in merchandising activities. Betty Hamburger, one of the vice presidents for both corporations, had charge of advertising and public relations for both stores. Henry Berney, the other vice president, was the buyer for the men's clothing department in the *146 downtown store. *827 Albert Berney, the treasurer during the taxable years, served as comptroller for both petitioners (concerned with financial and budgeting matters) and assistant merchandising manager to Isaac Hamburger. Robert Berney, the secretary, served as personnel manager for both stores; and he was also store manager of the downtown store. The York Road store had its own store manager, who was not an officer, stockholder, or director of either of the Hamburger corporations.
Each of the stores had its own staff of sales clerks; but the store buyers, who had supervision over the sales personnel and the purchase and display of the merchandise, were the same individuals for both stores, with the exception of the men's clothing departments, which had a separate buyer for each store. These buyers were compensated on the basis of a percentage commission of the sales in their departments; and in computing the commissions payable to a particular buyer (except in the men's clothing departments), the sales of his department in each store were added together, and the appropriate percentage figure was applied to the sum total.
The pension trust established by Hamburger & Sons*147 was also used for the employees who worked at the York Road store.
The store buyers would, on their trips to the clothing manufacturing markets, make purchases of merchandise for both the downtown store and the York Road store; but the firms from which the merchandise was purchased were instructed to ship and invoice each store's purchases of merchandise separately. Credit rating was required in order to buy merchandise; but financial data were not submitted to suppliers with respect to York Road. Both stores handled the same lines of merchandise, a large portion of which contained special labels reading "Manufactured by the * * * [X] Company, especially for Hamburgers of Baltimore."
Sales in the two stores were of three types: (1) Straight cash sales; (2) regular 30-day charge accounts; and (3) so-called revolving credit sales, whereunder the customer agreed to pay a certain amount each month, depending upon the balance in his account at the end of a particular month. As far as the cash sales at the York Road store were concerned, that store had its own separate bank account for only the first 9 months of its existence (i.e., until November 1955), and for that period its cash *148 receipts were deposited in its own account. Said account was closed in November 1955, and thereafter and throughout the taxable years involved, there was only one bank account that served both stores; and said account was in the name of Hamburger & Sons. Following the closing of York Road's bank account, its cash receipts were deposited in the Hamburger & Sons account, with an accounting entry on York Road's *828 books debiting an intercompany account with Hamburger & Sons (instead of a "cash in bank" account) and crediting a sales income account. Concurrently an entry was made on Hamburger & Sons books of account crediting a complementary intercompany account with York Road.
With regard to the York Road store's credit sales (both the regular charge sales and the revolving credit sales), these were credited to the above-mentioned sales income account; but York Road did not carry its own customer accounts receivable. Instead they were "sold" daily at full face value to Hamburger & Sons, so that the related debit entry to the sales income credit entry was to the above-mentioned intercompany account with Hamburger & Sons; and the latter company would take the accounts of the *149 York Road's customers into its own accounts receivable and credit the intercompany account with the amounts thereof.
Thereafter, Hamburger & Sons handled the billing and collection of the customer accounts receivable which had originated in both stores. At the end of each month it would make a charge to the York Road store of approximately 1 1/2 percent of the accounts taken over from York Road during the month to defray the estimated costs of billing and collecting the accounts receivable which had originated in the York Road store, and also to defray any losses on said York Road receivables. Accountingwise, this monthly charge would be handled through the intercompany accounts. The normal cost in the Baltimore area for the commercial factoring of accounts receivable during the taxable years was approximately 9 percent of the face amount of any receivables sold to a factor.
Advertising played a substantial part in promoting sales at the stores. Advertising for both stores was handled, as above stated, by one and the same individual, Betty Hamburger. Following the opening of the York Road store, the format of the advertising copy remained practically identical to that which had*150 been used prior thereto. The only differences were: That whereas prior to the opening of the new store, the specially designed script legend for the word "Hamburgers" was supplemented only by the address of the downtown store; following the opening of the York Road store, said script legend was supplemented by the addresses for both the downtown and the suburban stores. Also following the opening of the new store, the information in the advertising regarding shopping hours was expanded to include the York Road store's hours of operation. The trade name "Hamburgers" was regarded as an important contributing factor in the production of sales.
A single customer list was used by both stores for advertising and charge accounts. The application form used at both stores to open a *829 charge account bore only the trade name "Hamburgers" to indicate the name of the business. When a customer opened a charge account, there was no distinction between the York Road store and the downtown store. Billings to the customers were made by Hamburger & Sons in its trade name; and all purchases made at both stores by a customer were included on one invoice.
The York Road store had only limited*151 space for storing offseason merchandise; and therefore it used the larger storage area available at the downtown store. At the end of a particular season, the unsold seasonal merchandise at the York Road store was transferred to said storage area in the downtown store; and to avoid a commingling of inventories which could lead to difficulties when the physical inventory counts were taken, said merchandise was removed from York Road's book inventory and charged to the book inventory of the downtown store. Subsequently when such seasonal merchandise again became salable, it was taken back to the York Road store, removed from the downtown store's book inventory, and charged once again to the York Road store's inventory.
Most of the alterations required on clothing sold at the York Road store were performed at the downtown store by the latter store's employees. The downtown store charged the York Road store for such services with a proportionate part of the alterations department costs and expenses; and in doing this it again utilized the intercompany account procedure outlined above.
A separate set of books of account were set up and maintained for the York Road store. Said books*152 were under the care and supervision of the same individual who kept the books for Hamburger & Sons; and he kept both sets of books in the office of the downtown store. As hereinabove found as a fact, during all except the first 9 months of the 3-year taxable period here involved, only one bank account was maintained -- that in the name of Hamburger & Sons. Therefore, for those direct costs and expenses of operation that were incurred in and pertained solely to the operation of the York Road store (i.e., such items as the wages of the York Road store's manager and sales clerks, and the purchases of merchandise inventory), these were paid by checks drawn on York Road's own account only during the first 9 months of its operations; and during all the remainder of the 3 years here involved, these costs and expenses were paid by checks drawn on the Hamburger & Sons account, and charged to the York Road store through the above-mentioned intercompany accounts.
As regards the various and sundry overhead expenses which applied to both stores (such as advertising, expenses of the store buyers' trips, telephone service, bookkeeping services, and supplies), there was no accurate system for the*153 division of these expenses between the two *830 stores. They were actually prorated between the stores in two different ways during the taxable years involved. During the first 2 years (i.e., fiscal 1956 and 1957) a tentative arrangement was adopted, under which the downtown store (which initially would pay such expenses in their entirety) charged York Road for its estimated share thereof through the intercompany accounts; and the share so charged was an amount equal to 3 percent of York Road's sales plus 3 percent of its profits. In the third taxable year here involved, the directors of the two corporations determined that under the foregoing method, York Road was not being charged a sufficient amount; and they agreed to a modification under which advertising expense was purportedly to be prorated between the two stores on the basis of their volumes of sales, while York Road's share of the other joint overhead expenses continued to be handled under the 3 percent of sales plus 3 percent of profits method above described. For fiscal 1958, the advertising expenses deducted by Hamburger & Sons and by York Road were $ 90,544 and $ 16,419, respectively. The expenses so deducted*154 by York Road were 15.3 percent of the total advertising expenses. The sales made at the York Road store were 25.4 percent of the aggregate sales at both stores.
The sales income of each corporation was reflected on its books of account in the conventional manner.
In addition to maintaining separate books of account, each corporation maintained separate minute books for the meetings of its stockholders and directors.
The net sales reported on the tax returns of the petitioners for the taxable years involved were as follows:
| Year ended Jan. 31 -- | Hamburger & | York Road | Total |
| Sons | |||
| 1956 | $ 2,444,920 | $ 636,529 | $ 3,081,449 |
| 1957 | 2,591,413 | 818,948 | 3,410,361 |
| 1958 | 2,463,916 | 849,010 | 3,312,926 |
The taxable income reported on said income tax returns was as follows:
| Year ended Jan. 31 -- | Hamburger & | York Road | Total |
| Sons | |||
| 1956 | $ 74,520 | $ 61,385 | $ 135,905 |
| 1957 | 13,233 | 76,097 | 89,330 |
| 1958 | 16,595 | 57,096 | 73,691 |
Beginning in fiscal 1957, Hamburger & Sons adopted the practice of reporting its own revolving credit sales on the installment method for Federal income tax purposes. Under such method, said corporation *831 had, in addition to the taxable *155 income which it reported on its returns, deferred gross profit on its revolving credit sales for fiscal 1957 and 1958 of $ 58,246 and $ 25,909, respectively. If its taxable income had continued to be reported on the same straight accrual method as had been employed in fiscal 1956, the taxable income of Hamburger & Sons would have been $ 71,479 for fiscal 1957 and $ 42,504 in fiscal 1958.
The reported taxable income of each petitioner (including therein for purposes of comparison, the deferred gross profit from installment sales of Hamburger & Sons for fiscal 1957 and 1958) bore the following percentage relationship to its sales for the taxable years involved:
| Percent of taxable income to | ||
| sales | ||
| Year ended Jan. 31 -- | ||
| Hamburger | York Road | |
| & Sons | ||
| 1956 | 3.047 | 9.643 |
| 1957 | 2.758 | 9.292 |
| 1958 | 1.725 | 6.725 |
Hamburger & Sons, in the return which it filed for each of the taxable years, did not include therein any of the income or expenses which had been reflected in the returns of York Road.
York Road, in computing its income tax liability on the return which it filed for each of the taxable years involved, availed itself of the surtax exemption provided for in section*156 11(c) of the 1954 Code; i.e., it did not show any liability for surtax (at the rate of 22 percent) on the first $ 25,000 of its taxable income.
The respondent, in his statutory notice of deficiency issued to Hamburger & Sons, included in the income of said corporation for each of the fiscal years involved, all of the taxable income which York Road had reported in its return for each such fiscal year. His explanation for fiscal 1956, which is similar to his explanations for fiscal 1957 and 1958, was as follows:
(a) Taxable income
It is held that gross income and deductions in a net amount of $ 60,771.00, which was reported by Hamburgers York Road, Inc. for the taxable year ended January 31, 1956 constituted income to you under the provisions of sections 61(a) and 482 of the Internal Revenue Code of 1954. The amount is computed as follows:
| Taxable income reported by Hamburgers York Road, Inc | $ 61,385.00 |
| Less: Deduction for pension plan contribution | 614.00 |
| Increase in income [of Hamburger & Sons] | 60,771.00 |
*832 The respondent, in his statutory notice of deficiency issued to York Road, determined, so far as is here pertinent, that said corporation was not *157 entitled to have the exemption from surtax which it had claimed; and he explained his action as follows:
It is held, under the provisions of sections 269 and 1551 of the Internal Revenue Code of 1954, that you are not entitled to the $ 25,000.00 surtax exemption provided in section 11(c) of the Internal Revenue Code of 1954, in the computation of your tax liability for the taxable years ended January 31, 1956, January 31, 1957 and January 31, 1958.
ULTIMATE FINDINGS OF FACT
The operations of Hamburger & Sons in its downtown store and those of York Road in its suburban store were all part of a single integrated business enterprise; and the suburban store was operated substantially as a branch of the downtown store. There would not have been any substantial difference in Hamburger & Sons operations, and no substantially different records would have been required by it if it had operated York Road store as a division without York Road having been incorporated.
The taxable income of said single integrated business enterprise, which was reported partly by Hamburger & Sons and partly by York Road on their separate income tax returns for each of the taxable years here involved, was produced*158 by and due to the long-established business reputation and goodwill of Hamburger & Sons, its business organization and procedures, the brands of merchandise which it handled, and its advertising program.
There was no substantial business purpose for the separate incorporation of York Road, which in its operation served merely as a division of Hamburger & Sons.
The principal purpose for the incorporation of York Road was to avoid Federal income taxes by securing the benefit of an additional surtax exemption.
The business transactions between Hamburger & Sons and York Road were not those of an uncontrolled taxpayer dealing at arm's length with another uncontrolled taxpayer.
The Commissioner, in attributing to Hamburger & Sons all of the taxable income of the single integrated business enterprise, did not act arbitrarily, capriciously, or unreasonably.
The action of the Commissioner, in allocating to Hamburger & Sons all of the taxable income of said single integrated business enterprise, was necessary in order to prevent evasion of taxes and clearly to reflect the taxable income (if any) of each corporation here involved, within the meaning of section 482 of the 1954 Code.
*833 *159 OPINION
Issue 1In considering the first issue in the instant case, we find that the respondent has determined that the taxable income of York Road should be included in the taxable income of its sister corporation, Hamburger & Sons, for each of the 3 taxable years here involved. As statutory warrant for his action, respondent relies upon section 61(a) and section 482 of the 1954 Code. We must decide whether on the basis of the facts and circumstances of this particular case, his determination is correct.
We first consider the case in the light of the impact of section 482, the regulations thereunder, and the judicial authorities construing said section and the cognate provisions of the prior revenue acts (principally section 45 of the 1939 Code). Section 4821 provides, insofar as is here pertinent, that in the case of two or more organizations or businesses owned or controlled directly or indirectly by the same interests, the Secretary or his delegate may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among them, if he determines that such actions are necessary in order clearly to reflect the income of any of such organizations*160 or businesses, or to prevent an evasion of taxes.
Decided cases make it clear that the Commissioner has broad discretion in applying section 482; and that the determinations which he makes pursuant thereto will be sustained unless the taxpayer establishes that the Commissioner has abused his discretion. A court's review of such determinations*161 is not de novo; and the determinations will be overturned only where the taxpayer proves that they are arbitrary, capricious, or unreasonable. See Grenada Industries, Inc., 17 T.C. 231">17 T.C. 231, 255 (and the cases cited therein), affd. 202 F. 2d 873 (C.A. 5).
The purpose of said statute is to prevent the evasion of taxes by the shifting of profits, the making of fictitious sales, and other methods customarily used to "milk" a taxable entity. H. Rept. No. 2, 70th Cong., 1st Sess., pp. 16-17, reprinted in 1939-1 C.B. (Part 2) 395; S. Rept. No. 960, 70th Cong., 1st Sess., p. 24, reprinted in 1939-1 C.B. (Part 2) 426. Ballentine Motor Co., 39 T.C. 348">39 T.C. 348, 357, affd. 321 F. 2d 796 (C.A. 4).
*834 The regulations under section 482( Income Tax Regs., sec. 1.482-1(c)) provide in here pertinent part:
(c) Application. Transactions between one controlled taxpayer and another will be subjected to special scrutiny to ascertain whether the common control is being used to reduce, avoid, or escape taxes. In determining*162 the true taxable income of a controlled taxpayer, the district director is not restricted to the case of improper accounting, to the case of a fraudulent, colorable, or sham transaction, or to the case of a device designed to reduce or avoid tax by shifting or distorting income, deductions, credits, or allowances. The authority to determine true taxable income extends to any case in which either by inadvertence or design the taxable income, in whole or in part, of a controlled taxpayer, is other than it would have been had the taxpayer in the conduct of his affairs been an uncontrolled taxpayer dealing at arm's length with another uncontrolled taxpayer. [Emphasis supplied.]
The regulations also define the term "true taxable income," appearing in the foregoing, as follows:
(a) Definitions. When used in this section --
* * * *
(6) The term "true taxable income" means, in the case of a controlled taxpayer, the taxable income (or, as the case may be, any item or element affecting taxable income) which would have resulted to the controlled taxpayer, had it in the conduct of its affairs (or, as the case may be, in the particular contract, transaction, arrangement, or other act) *163 dealt with the other member or members of the group at arm's length. It does not mean the income, the deductions, the credits, the allowances, or the item or element of income, deductions, credits, or allowances, resulting to the controlled taxpayer by reason of the particular contract, transaction, or arrangement, the controlled taxpayer, or the interests controlling it, chose to make (even though such contract, transaction, or arrangement be legally binding upon the parties thereto). [Income Tax Regs., sec. 1.482-1(a)(6).]
It will be observed that section 482 speaks of distributing, apportioning, or allocating "gross income, deductions, credits, or allowances" between or among controlled taxpayers. In some of the earlier cases, this Court and others held that the foregoing statutory language conferred no power on the Commissioner to distribute, allocate, or apportion net income. See Chelsea Products, Inc., 16 T.C. 840">16 T.C. 840, affd. 197 F. 2d 620 (C.A. 3); T.V.D. Co., 27 T.C. 879">27 T.C. 879. However, in the more recent case of Ballentine Motor Co., supra, which was affirmed*164 by the Court of Appeals for the Fourth Circuit, we took a contrary position, and there stated in part:
We believe that net income may in certain instances be properly allocated under section 45 and currently section 482. If net profits are shifted (one device at which the statute was specifically directed), it would be a logical short cut to allocate them instead of allocating "gross income, deductions, credits, [etc.]." The other devices of income shifting mentioned by the committee reports similarly suggest allocation of such income. The statute allows allocation of gross income and deductions, and to the extent this is permitted we believe it may be done as "net income."
*835 Bearing the foregoing criteria in mind, we turn to the facts of the instant case. It is at once apparent that there is here present the requisite common ownership and control over the two corporate business organizations involved. The same individuals served in the same officer capacities in both corporations. The directors were the same persons in both corporations, with the exception of Sidney Berney who was a director of Hamburger & Sons but not of York Road. And both corporations had the same*165 stockholders.
Common control, however, is not the end of the matter; for, as we stated in Ballentine Motor Co., supra, "taxpayers owned or controlled by the same interests may enter into transactions inter se and if fair, or resulting from arm's length bargaining, such transactions will be undisturbed." 39 T.C. at 357. Accordingly, if the respondent is to prevail on this issue in the instant case, it must still be found that Hamburger & Sons in the conduct of its affairs vis-a-vis York Road and in the transactions which it had with the latter corporation, did not deal with York Road at arm's length, as one uncontrolled corporation would have dealt with another uncontrolled corporation. In the light of the respondent's determination that all taxable income (actually, the equivalent of net profit) of York Road is to be included in the income of Hamburger & Sons, our more specific question becomes this: Have the petitioners established that the respondent was arbitrary, capricious, or unreasonable in his determination that if Hamburger & Sons and York Road had been dealing at arm's length as uncontrolled organizations, Hamburger*166 & Sons would have required that all profits of York Road be turned over to it?
The evidence establishes that the operation of the two stores here involved was substantially the function of Hamburger & Sons. Betty Hamburger, who had many years' experience as public relations director and advertising manager for the downtown store, placed all advertisements for both stores, and continued to employ the same tried and tested format that Hamburger & Sons had used prior to the organization of York Road. The selection of merchandise for both stores, the supervision over the display thereof at both stores, and also the supervision over the sales forces of both stores, were all handled by the department manager located at the downtown store, except in the case of one department at the suburban store which had its own manager. And even as to this exception, we believe it reasonable to infer that the overall merchandising supervision given by Isaac Hamburger and Albert Berney to all departments at both stores assured that Hamburger & Sons' long-established experience would be applied also to that one exceptional department.
In addition, the compensation paid to the department managers of *167 both stores was computed on a sliding scale, based on the combined sales of both stores. Employees of Hamburger & Sons made the alterations *836 on clothing sold at York Road. The downtown store furnished the telephone switchboard service for both stores. Moreover, Hamburger & Sons acted as the paymaster and disbursing agent for both stores; its employees kept the books for both stores; and all daily cash receipts of York Road were turned over to Hamburger & Sons for deposit in the latter's bank account for all 3 years here involved, except the first 9 months of the new store's operation. Hamburger & Sons also took over all the customers' accounts receivable which arose at the York Road store; and it billed and collected the same along with its own accounts receivable. Thus, the conclusion is a compelling one, that the two stores (which in form were operated by two separate corporations) were in substance and in fact, actually parts of a single, integrated retail men's clothing business -- with the downtown store of Hamburger & Sons serving as the headquarters, and with the suburban York Road store serving merely as a branch or division.
Our inquiry will now focus on what*168 Hamburger & Sons contributed to this integrated business enterprise, and what (if anything) York Road contributed. For more than 100 years, the founders of Hamburger & Sons, and their successors, had, through their labors, established one of the most outstanding men's wear businesses in the Baltimore area. The success of the business which they thus developed was due principally, not merely to the racks and display cases filled with merchandise, but rather to the reputation established for dependable and courteous service to the public and to the skills employed by its organization in selecting merchandise with an eye to high quality, right quantity, and salable style. And all these could only be assured through use of a knowledgeable purchasing and merchandising organization and through application of long years of experience. The name "Hamburgers" had, over the many years prior to 1955, become a hallmark for business integrity, and it was the focal point for a goodwill of great value which was primarily responsible for producing both sales volume and business success. Likewise, the customer lists and the sales organization of Hamburger & Sons were additional assets and attributes*169 of very substantial value in the retail clothing business.
All of the foregoing assets and attributes were contributed to the integrated and unitary enterprise which was operated after the establishment of the new suburban store in 1955; and the record herein clearly establishes that the York Road segment of the enterprise made full use of the same. The two stores were at all times represented to the public as "Hamburgers." The promotional advertising for both stores was continuously presented in one format, using the "Hamburgers" name; and after the York Road store was opened, the trade name "Hamburgers" was displayed on the front in a sign of similar design to that displayed on the downtown store, and a shield-shaped *837 emblem was placed on the front door on which appeared the legend "Since 1850." Also, existing customers of the downtown store were informed that their charge accounts at the downtown store could thereafter be used for purchases made either at the downtown store or at the York Road suburban store.
Notwithstanding the foregoing facts and circumstances, petitioners here contend that the net profits of York Road should be fixed by charging against the sales of*170 that store only the net current operating cost of such store, without any consideration being given to the above-mentioned factors of goodwill, trade name, experienced buying and selling organizations, customer lists, and advertising format which Hamburger & Sons furnished for the use of York Road. We are confident that Hamburger & Sons would not have permitted such an arrangement, if it had dealt with York Road at arm's length. For such use of its business organization and assets, Hamburger & Sons would, we believe, have claimed for itself the profits in their entirety of the York Road segment of the integrated business.
To be sure, York Road contributed to the integrated enterprise an attractive business location, and a modest amount of capital. But, when we examine these more closely, in their context in this case, their power to command any portion of the profits of the York Road segment of the integrated enterprise is quickly perceived to be more apparent than real. As regards the location, the findings of fact establish that the lease on the premises was acquirable by York Road only on the strength of its affiliation with Hamburger & Sons and on the strength of that corporation's*171 guaranteeing York Road's performance of its lease obligations. In short, Hamburger & Sons could have acquired the lease itself, and we believe that, in arm's-length dealing with a stranger (rather than with its sister corporation), it would have refused to yield any profits of the York Road segment as a consequence of York Road having the lease on the attractive business location.
As regards the capital of the York Road corporation, we find that it totaled only $ 85,000, consisting of $ 20,000 paid in for stock and $ 65,000 borrowed from two sources: (1) $ 25,000 from Sidney Berney and his wife on York Road's unsecured promissory note and (2) $ 40,000 from a bank on York Road's note which was guaranteed by its directors. Here again, we are led to conclude that Hamburger & Sons could have used its own capital funds to open the new suburban store; it was not compelled to seek outside financing for that purpose. In fact $ 45,000 came from Hamburger & Sons stockholders; and they would surely just as readily put such funds (assuming the need for the same) directly into Hamburger & Sons, rather than into a separate corporation. No doubt the bank's loan of $ 40,000 to York Road took *172 into consideration that Hamburger & Sons' business organization, assets, and attributes were being made available to the new store. Hence the loans *838 (that of the bank and that of the Berneys), realistically considered, were worth only the interest charges required to obtain them; and York Road's deductions for such interest have not been disturbed by the respondent. Those loans, and the paid-in capital, would not in our judgment have merited a share of the profits of the York Road segment of the integrated enterprise.
It must also be observed that there was no pressing business need requiring a separate corporation to operate the York Road suburban store. We have hereinabove found as an ultimate fact, after considering and weighing all the relevant evidence, that there would not have been any substantial difference in Hamburger & Sons operations, and no substantially different records would have been required, if it had operated the suburban store as a division of the Hamburger & Sons corporation. Thus, we are convinced, and we have likewise found as an ultimate fact, that the principal purpose for the separate corporation was to avoid Federal income tax by securing the*173 benefit of an additional surtax exemption -- which would be applied against that portion of the profits of the integrated, unitary enterprise that would be shifted over to York Road. True enough, under York Road's lease, the rental payable was in part pegged to the gross sales at the York Road store; and York Road was required to maintain such accounting records as would enable the lessor to verify the sales at that store. But separate incorporation was not required in order to permit compliance with these lease terms. Ascertainment of the sales of a divisional branch (or even a branch's net operating profit) is a familiar technique of conventional accounting for such branches. See Finney & Miller, Principles of Accounting -- Advanced, ch. 16 (5th ed. 1960).
Petitioner has argued in defense of the separate incorporation of York Road, that this was necessary in order to accommodate the desire of Albert and Henry Berney for a larger interest in the York Road store than they had in the downtown store. But this argument is not realistic. The evidence establishes, in the light of the close family relationship prevailing in the ownership and operation of Hamburger & Sons, the retired*174 status of Sidney Berney, and the historical pattern of keeping the ownership in the family and permitting such ownership to follow those who were actively participating in the Hamburger & Sons enterprise, that the Berney brothers' desire could have been met by appropriate adjustments in Sidney's stockholdings in Hamburger & Sons, without having to form a new corporation.
The petitioners have argued also that what was done here by the respondent amounted to effecting a consolidated return for Hamburger & Sons and York Road, in alleged contravention of the respondent's *839 regulations, section 1.482-1(b)(3), which read in part as follows:
Sec. 1.482-1 Determination of the taxable income of a controlled taxpayer. * * *
* * * *
(3) Section 482 grants no right to a controlled taxpayer to apply its provisions at will, nor does it grant any right to compel the district director to apply such provisions. It is not intended (except in the case of the computation of consolidated taxable income under a consolidated return) to effect in any case such a distribution, apportionment, or allocation of gross income, deductions, credits, or allowances, or any item of gross income, deductions, *175 credits, or allowances, as would produce a result equivalent to a computation of consolidated taxable income under subchapter A, chapter 6 of the Code.
But the same contention was adequately answered in Advance Machinery Exchange v. Commissioner196 F. 2d 1006, (C.A. 2), affirming a Memorandum Opinion of this Court, certiorari denied 344 U.S. 835">344 U.S. 835. There, the Commissioner had (as he has done here) allocated all of the net income of two other corporations and a proprietorship to the corporate taxpayer. The Second Circuit rejected the taxpayer's consolidated return argument, as follows:
At first blush, this regulation would seem to support the petitioner's position but analysis shows the contrary. The effect of such an interpretation would be to exclude from the applicability of § 45 fact situations like the present one if the separate entities involved were all corporations and the Commissioner had sought to allocate all of the income from each to one of them, since this "would produce a result equivalent to a computation of consolidated net income under § 141." * * * Whatever valid interpretation may be given this regulation, *176 the unsoundness of that of the petitioner is illustrated by the fact that it would exclude from the "policing" provisions of § 45 the most flagrant evasion by arbitrary shifting of income. It would let the Commissioner reallocate the income of these separate entities, to reflect the income of each correctly, if the amount involved, however great, did not equal their total combined income but he could not apply § 45 at all if the taxpayers succeeded in constructing a situation where, in order to prevent tax evasion or properly to reflect income, it were necessary to attribute all of the income of the separate entities to one of them, as was done here. Thus tax evasion could be so complete as to make itself invulnerable, a proposition whose statement discloses its fallacy.
Also, it must be observed that in the present case, a consolidated return could not have been filed for the two petitioners lacked a common corporate parent and were merely owned and controlled by the same individuals. See sec. 1504(a), 1954 Code.
In the light of all the foregoing, we are impelled to conclude that petitioners have not established that the respondent acted arbitrarily, capriciously, or unreasonably*177 in his determination under section 482 that York Road's taxable income was includable in the taxable income of Hamburger & Sons. Indeed, the evidence in this case affirmatively establishes the reasonableness of the respondent's action; and we have made an ultimate finding of fact that he did not act arbitrarily, capriciously, *840 or unreasonably. We accordingly approve the determination made under the authority of section 482.
Having thus sustained the Commissioner's determination under section 482, it is not necessary for us to consider or determine whether section 61(a) furnishes additional warrant for such determination.
Issue 2As regards the second issue, we have pointed out in our preliminary statement hereinabove, that the respondent conceded there would be no deficiency due from the York Road petitioner if the Court were to determine (as it now has) that York Road's taxable income is chargeable to Hamburger & Sons. Wherefore, it is not necessary for us to decide the second issue of whether York Road should be denied the exemption from surtax provided by section 11(c), under the authority either of section 269(a) or of section 1551.
To permit recomputations reflecting*178 the stipulations of the parties,
Decisions will be entered under Rule 50.
Footnotes
1. SEC. 482. ALLOCATION OF INCOME AND DEDUCTIONS AMONG TAXPAYERS.
In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Secretary or his delegate may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses.↩