*4051 1. Where a partnership agreement provides for the crediting of interest on the capital contributed by the partners, the so-called interest credited is not a business expense to be deducted from gross income in arriving at net income, but, under the facts in this case, is a part of the distributive share of the partners in the net income of the partnership.
2. A partner does not relieve himself of tax liability by agreeing that this "interest" on his capital contribution shall be credited to the account of someone else.
3. Funds in certain loan accounts carried on the books of the partnership determined to have been the property of persons not partners.
4. Interest credited by the partnership to these loan accounts for the use by the partnership of the funds in these accounts was interest on borrowed money, an expense of the business, and not taxable to the partners.
*698 The taxes in controversy in the case of Ella Daly King, as executrix under the last will and testament of Robert C. King, are individual *699 income taxes of Robert*4052 C. King for the calendar year 1920, and for the period January 1, to March 29, 1921, and income taxes on his estate for the fiscal year March 30, 1921, to March 29, 1922, in the respective amounts of $13,470.17, $1,402.58, and $764.50. The error alleged is in effect that the Commissioner has erroneously transferred as of each period certain amounts from the personal income of Ella Daly King to the income of Robert C. King.
The taxes in controversy in the case of William Ravner are income taxes for the calendar years 1920, 1921, 1922, and 1923, in the respective amounts of $931.12, $961.45, $1,515.83, and $1,500.51. The error alleged is in effect that the Commissioner has erroneously transferred as of each year to the income of William Ravner which the latter had reported as the income of his two children.
These cases were consolidated.
FINDINGS OF FACT.
Ella Daly King, who resides in Morristown, N.J., is the sole executrix under the last will and testament of Robert C. King, who died on March 29, 1921.
William Ravner is an individual residing in Scarsdale, N.Y.
For some time prior to the taxable years in question Robert C. King and William Ravner had been partners*4053 carrying on a general dry goods commission business in New York City. On December 31, 1918, they entered into a new partnership agreement which, by various endorsements, was to continue in force until December 31, 1921. Under this agreement King was to have a two-thirds interest in the partnership and was to receive $16,000 a year for his services, and Ravner was to have a one-third interest in the partnership and was to receive $10,000 a year for his services. Each was to contribute certain capital to the partnership. In addition the partnership agreement provided in part as follows:
SEVENTH: At the end of each six months interest at the rate of six per cent per annum on the capital contributed by Robert C. King and on any other sums of money standing to his credit upon the books of the firm shall be credited to an account to be kept in said books and to be known as the Ella Daly King Loan account. And at the same time interest at the rate of six per cent per annum on the capital contributed by William Ravner and on any other sums of money standing to his credit on the said books shall be credited to his personal account therein, and he shall have the option to have said interest*4054 paid to him. Any interest credited or paid under this division of this agreement is to be charged to the expense of the business.
FIFTEENTH: Should either of the parties hereto die during the continuance of the partnership hereby formed, its business shall, for the joint benefit of the survivor and of the legal representatives of the deceased partner, be continued until the end of the term of the partnership by the survivor * * *.
The *700 partnership received a certain commission, usually 6 per cent, from the manufacturers on all goods sold by it. It never owned any goods. After an order was received the manufacturer delivered the goods either to the warehouse of the partnership or to the purchaser and usually received all or a portion of the purchase price immediately from the partnership. For these advancements the partnership charged the manufacturer an amount which approximated interest at 6 per cent per annum from the time the advancement was made until the purchaser paid for the goods. Any surplus funds which the partnership had, in excess of the amounts used as above described, it invested or deposited so that some return was secured from the money.
Robert*4055 C. King at some time before he died wrote a letter as follows:
I hereby transfer and give to Ella Daly King all interest due or hereafter accruing on my capital invested in the firm of Robert C. King and Company.
(Signed) ROBERT C. KING.
After the death of Robert C. King this letter was found in the possession of his wife, Ella Daly King, enclosed in an envelope bearing the date January 1, 1917, in her handwriting.
For some time prior to January 1, 1917, an account entitled "Ella D. King Loan Account" had been carried on the books of Robert C. King & Co. During the taxable years the bookkeeper of Robert C. King & Co. credited to this account certain amounts due Robert C. King in accordance with article seventh of the partnership agreement. He made these credits pursuant to the provisions of the partnership agreement which he had seen and pursuant to the abovementioned letter of Robert C. King, which he had seen prior to 1917, and also pursuant to the verbal instructions of Robert C. King.
From time to time Ella Daly King deposited in this account money which had come from sources outside the partnership, such as dividends and interest on stocks and mortgages, respectively, *4056 purchased for herself from money which she had withdrawn from the account. She withdrew money from this account as she saw fit. She had no duties in connection with the partnership.
At the beginning of the year 1920, the books of Robert C. King & Co. showed that Robert C. King had invested in the company $445,085.59. Three per cent of this amount is $13,352.57. On June 30, 1920, there was credited to the "Ella D. King Loan Account," $13,332.68, which represented the aforementioned interest of $13,352.57, less $19.89, being the excess of interest on the average overdrafts over the interest on the average credit balances in the account for the preceding period of six months.
On June 30, 1920, the books of Robert C. King & Co. showed that Robert C. King had invested in the company $481,945.36. Three per *701 cent of this amount is $14,458.36. On December 31, 1920, there was credited to the "Ella D. King Loan Account," $14,587.67, which represented the aforementioned interest of $14,458.36, plus $129.31, being the excess of interest on the average credit balances over the interest on the average overdrafts in the account for the preceding period of six months.
At*4057 the beginning of the year 1921, the books of Robert C. King & Co. showed that Robert C. King had invested in the company $448,904.24. One and one-half per cent of this amount being interest at 6 per cent for three months is $6,733.57. On March 29, 1921, there was credited to the "Ella D. King Loan Account," $6,814.25, which represented the aforementioned interest of $6,733.57, plus $80.68, being the excess of interest on the average overdrafts over the interest on the average credit balances in the account for the preceding period of three months.
The Commissioner included in the income of Robert C. King for the calendar year 1920, the sum of $27,939.36, which had been reported by Ella Daly King, wife of Robert C. King, and for the period January 1, to March 29, 1921, the sum of $6,513.42, which had been reported by Ella Daly King. He also included in the income of the estate of Robert C. King for the fiscal year beginning March 30, 1921, the sum of $20,502.48, which had been reported by Ella Daly King.
Near the close of the year 1919 William Ravner, desiring to provide for his two small motherless children, after a conference with Robert C. King and the accountant for the*4058 partnership, delivered the following letter properly addressed to the partnership on January 1, 1920:
GENTLEMEN:
I beg to advise you that I have transferred to my two children, Janeth and Lucille, the amount $2364.12 standing to my credit on Loan Account on your books.
I desire to continue this account as Trustee for my children, Janeth and Lucille, the amount stated as well as all subsequent deposits made to this account, to be participated in equally by them, or in the event of the death of either, the entire amount for the use and benefit of the survivor.
(Signed) WILLIAM RAVNER
Theretofore the interest on his capital contribution to the partnership had been credited to this "Loan Account," and on or about January 1, 1920, he instructed the accountant for the partnership that thereafter all interest on capital contributed by him to the partnership should be credited to this account, which was thereafter designated "William Ravner Trustee Loan Account" or "William Ravner Trustee." From time to time William Ravner deposited in this account money which had come from sources outside of the partnership, such as dividends on stock purchased for the children from *702 *4059 money withdrawn from the account. He used the money withdrawn from this account entirely for the benefit of these two children and reported as income of these children the interest which was credited to this account on account of the capital which he had contributed to the partnership. After King's death on March 29, 1921, William Ravner carried on the business in accordance with the provisions of the partnership until the end of the year 1921, at which time a new partnership was formed, consisting of William Ravner and Charles Daly King, as general partners, and Ella Daly King, as a special partner, and the "William Ravner Trustee Account" was continued as formerly during all of this time, as was the practice of crediting to this account the 6 per cent on the capital contributed by William Ravner.
The partnership books showed William Ravner's capital account as having the following credit balances:
| January 1, 1920 | $44,358.34 |
| July 1, 1920 | 72,788.23 |
| January 1, 1921 | 67,502.14 |
| July 1, 1921 | 76,874.48 |
| January 1, 1922 | 100,000.00 |
| July 1, 1922 | 100,000.00 |
| January 1, 1923 | 104,311.24 |
| July 1, 1923 | 138,558.38 |
on which credit balances interest was credited to*4060 the "William Ravner Trustee Account" as follows:
| 1920 | $3,514.40 |
| 1921 | 4,331.31 |
| 1922 | 6,000.00 |
| 1923 | 7,227.09 |
Every six months as this interest was credited there was added an amount representing interest at the rate of 6 per cent per annum on the average credit balances in the "William Ravner Trustee Loan Account" for the period, and the two amounts were included in one total which formed the actual credit entry in the account, so that there was actually credited to this account from these two sources -
$3,607.47 for the year 1920,
4,438.36 for the year 1921,
6,016.48 for the year 1922, and
7,247.10 for the year 1923.
The above amounts were reported as the income of these two minor children.
The Commissioner added to William Ravner's reported income $3,607.47 for the year 1920, $4,438.36 for the year 1921, $6,016.48 for the year 1922, and $7,247.10 for the year 1923.
*703 OPINION.
MURDOCK: The petitioners contend that inasmuch as the partnership was paying 6 per centum on all monies contributed or intrusted to it and at the same time was charging interest at the same rate when it advanced the monies to others, the transactions had nothing*4061 whatever to do with profits, and the interest it paid on the capital accounts of the partners was an expense of the business and was not a part of the net income of the partnership and not a distribution of profits.
We assume, since the point has not been raised, that there was partnership income for each of the years or periods in excess of the amounts of so-called interest here in controversy. But in any event, we can not agree that "interest" credited on the capital advanced by the partners was a proper deduction from partnership income. It therefore follows in this case, that it was a part of the statutory taxable net income of the partnership and of a distributive share of the profits of the partnership. See .
We have heretofore held that one's tax liability can not be lessened by a transfer of income already earned, or expected to be earned. The very act of transfer is an exercise of enjoyment of the fruits of ownership of property and measures the transferor's ability to contributed to the cost of government. *4062 , in effect affirmed in ; ; ; ; .
Therefore, in the present case the various amounts credited to either the "Ella D. King Loan Account" or to the "William Ravner Trustee Account" or to the "William Ravner Trustee Loan Account" as "interest" on the capital contributed by the partners was not a proper deduction from income but represented taxable income of the partners. . In the case of King, these amounts were for 1920, $27,810.93 and for the period January 1, to March 29, 1921, $6,733.57. In the case of Ravner, these amounts were for 1920, $3,514.40; for 1921, $4,331.31; for 1922, $6,000; and for 1923, $7,227.09.
We come now to consider a small amount of interest of an entirely different character, being interest not on the capital contributed by the partners to the partnership, *4063 but interest credited by the partnership for its use of average credit balances in the two loan accounts above mentioned. If the funds once actually credited in *704 these accounts belonged not to the partners but to outsiders, then the interest credited to these accounts for use of the funds by the partnership would be a real expense of the business, being interest paid on borrowed money. In the case of King, all amounts credited to this account represented gifts to his wife and if she allowed a balance to remain undrawn which the partnership used and for which use it paid or credited interest to the account, clearly the interest was not income to King, but was in reality an expense of the partnership business.
The additions to King's income made by the Commissioner are not reconcilable with any amounts disclosed by the partnership books, despite the industry and frankness of the petitioner in endeavoring to account for the Commissioner's action. We therefore hold that in adding any amount in excess of $27,810.93 to King's income for 1920, the Commissioner was in error and that for the period January 1, to March 29, 1921, since only $6,513.42 was added to King's income*4064 by the Commissioner, the difference between that amount and $6,733.57 must be disregarded in the computation of the deficiency for the period.
The petition included an allegation that the Commissioner had erroneously transferred $20,502.48 "from the personal taxable income of Ella Daly King to the personal taxable income of Robert C. King" for the fiscal year beginning March 30, 1921. No proof was offered in regard to this allegation and therefore the deficiency for this fiscal year as determined by the Commissioner must be approved.
In the case of William Ravner, although the facts are somewhat different, we think the result must be the same, namely, that the earnings of this trustee account or loan account credited thereto for the use by the partnership of credit balances in the account were not income to Ravner, but were an expense of the partnership. Ravenr's letter stated that he transferred a definite amount standing to his credit, together with all future additions thereto, to his two children. He stated that he desired to continue the account as trustee. At all times thereafter he treated the amounts in this account as if they belonged to his children. He reported*4065 additions to the amount as income of the children. He used the money solely for their benefit and never has given any indication of a change of attitude in regard to this fund. It is not necessary to decide whether his acts constituted a gift or created a trust, since we are satisfied that one or the other result must follow and in either event the earnings of the fund were not his income, but were an expense of the partnership.
Of the amount which the Commissioner added to Ravner's income, we have held that a part was properly added, being a distributive share of partnership net income, and that the remainder *705 was improperly added, since it was, in fact, the interest credited to an outsider's account by the partnership for its use of the average balance in that account.
Judgment will be entered in accordance with the foregoing opinion on notice of 20 days, under Rule 50.