*252 Decision will be entered under Rule 50.
In 1940, Atlas Corporation owned all the stock of petitioner, which was then operating as an investment company. On December 28, 1940, Atlas caused petitioner to distribute to it certain securities which it wished to retain, leaving petitioner with assets consisting almost entirely of cash and marketable securities in three widely owned companies. Thereafter, on the same day, Atlas sold all of petitioner's stock to Floyd B. Odlum, Atlas' president, after securing the permission of the Securities and Exchange Commission, for a price equal to the liquidating value of petitioner's stock plus $ 1,000. Odlum, on December 30, 1940, donated to petitioner all his stock in Virginia Rubatex Corporation, a corporation which he wholly owned and which was engaged in the manufacture and sale of certain rubber products. On December 31, 1940, petitioner liquidated Virginia Rubatex Corporation into it, taking that corporation's assets, assuming its liabilities, and thereafter carrying on its business. Held, on the facts, the aforementioned transactions were not undertaken for the sole or principal purpose of avoiding excess profits taxes by making*253 available to Virginia Rubatex Corporation petitioner's high historic equity invested capital. Accordingly, in computing its excess profits tax for 1941, petitioner is both entitled and required to determine its equity invested capital under section 718 of the 1939 Code.
*1161 The Commissioner determined a deficiency of $ 94,650.31 in petitioner's excess profits tax for the calendar year 1941, and, as a result thereof, an overassessment of $ 24,269.23 in petitioner's income*254 tax for that year. The only adjustment contested by petitioner is explained in the statement accompanying the deficiency notice, as follows:
It has been determined that your [excess profits tax] invested capital for the taxable year 1941 was $ 378,448.54 in lieu of the amount of $ 40,880,521.46 claimed by you.
Petitioner assigns error to the Commissioner's foregoing determination, as follows:
(a) The Commissioner erred in determining that petitioner's invested capital for said taxable year ended December 31, 1941, was $ 378,448.54, and
(b) The Commissioner erred in failing to determine petitioner's invested capital for said taxable year ended December 31, 1941, to be $ 83,572,418.75, in lieu of the amount of $ 40,880,521.46 as claimed by petitioner in its returns for said taxable year 1941.
FINDINGS OF FACT.
Some of the facts were stipulated, are so found, and the stipulation thereof is incorporated herein by reference.
Since its incorporation in the State of Delaware in 1928, petitioner's name has been changed several times. From 1938 to 1942 its name was Salta Corporation and, on November 12, 1942, it adopted the name it now bears. Petitioner filed its income and excess profits*255 tax returns for 1941 with the collector of internal revenue for the fifth district of New Jersey.
From its inception petitioner was operated as an investment company until it ceased operations as an investment company after December 31, 1940. In 1936, after various intercorporate financial transactions, petitioner became the wholly owned subsidiary of the Atlas Corporation. The Atlas Corporation is one of the nation's largest investment companies. It was founded and is guided by Floyd B. Odlum, its president and one of its five directors. Odlum is one of Atlas's largest stockholders, though never owning more than about 7 per cent of its stock.
Between 1930 and 1935, Atlas was acquiring interests in investment companies which were in difficult straits and whose shares, consequently, were often available for much less than the value of their portfolios. As a result of acquiring controlling interests in a number of those companies which, in turn, controlled other investment and operating companies, Atlas' corporate structure was becoming exceedingly complex and the administrative mechanics of operating its system were burdensome and expensive. Atlas thereafter became engaged in*256 a process of simplifying its structure by sale, merger, consolidation, or liquidation of its subsidiaries.
*1162 After it became a subsidiary of Atlas, petitioner continued to operate as an investment company until the end of 1940. As was the case with Atlas' other investment company affiliates, petitioner's principal office was in Atlas' office, its only employees were its officers and directors, Atlas' personnel performed necessary services for it without charge, but it did pay its own direct expenses (e. g., directors' fees, auditing and legal expense, insurance, etc.).
During the period 1936-1940 the book cost of petitioner's portfolio of securities exceeded 5 million dollars -- over 4 million of which represented shares of stock in American Company, a corporation controlled by Atlas. It engaged in very little buying and selling of securities (in fact, no such purchases or sales were made by it in 1939) and its income was derived from receipt of dividends and interest on the securities it held.
The following table summarizes information reported on petitioner's returns:
| Year | Dividends | Interest | Capital gain | Net income |
| (or loss) | (or loss) | |||
| 1936 | $ 114,110.62 | $ 45,317.92 | 1 ($ 1,813,234.49) | ($ 982,902.54) |
| 1937 | 166,818.60 | 49,079.10 | (456.63) | (1,874.71) |
| 1938 | 13,003.75 | 44,066.59 | (4,865.63) | 45,016.71 |
| 1939 | 15,080.00 | 6,047.26 | ||
| 1940 | 2 77,562.51 | 85,518.16 | (465,091.59) | (402,478.14) |
Petitioner's statement of financial condition (based on market valuations) on September 30, 1940, i. e., just prior to the commencement of the transactions relevant to the instant case, was as follows:
| ASSETS | |||
| Cash | $ 12,131.21 | ||
| Accounts receivable | 1,760.00 | ||
| Sesurities owned, valued at September 30, 1940, market prices: | |||
| Common stocks (pledged as collateral for notes payable to | |||
| American Company, infra) | 247,850.00 | ||
| Investment at liquidating value in the capital stock of: | |||
| American Company, 118,288 shares at a value of $ 43.93 per | |||
| share (115,527 shares of above together with 412,827 shares | |||
| borrowed from Atlas Corporation are pledged as collateral | |||
| for notes payable to American Company, infra) | 5,196,841.84 | ||
| Investment in capital stock of Standard Equities Corporation | |||
| (pledged as collateral for notes payable to American Company, | |||
| infra) | 402,156.38 | ||
| Deferred charges | 1,282.46 | ||
| Total assets | $ 5,862,021.89 | ||
| LIABILITIES | |||
| Notes payable -- American Company | $ 7,665,000.00 | ||
| Accounts payable and accrued expenses | 534.73 | ||
| Accounts and notes payable -- Atlas Corporation | 832,619.82 | ||
| Liability for taxes | 606.10 | ||
| Provision for contingencies | 32,800.00 | ||
| $ 8,531,560.65 | |||
| CAPITAL | |||
| Common stock, no par value, 10,000 shares | $ 10,000.00 | ||
| Deficit | $ 3,474,378.28 | ||
| Less, unrealized appreciation | 794,839.52 | 2,679,538.76 | $ 2,669,538.76 |
| Total liabilities and capital | $ 5,862,021.89 |
*258 *1163 In 1940, the structure of Atlas and its investment company subsidiaries, including petitioner, was still somewhat complicated as a result of the existence of intercorporate debts and stockholdings which crisscrossed between and among Atlas and those companies. The pendency of the Investment Company Act of 1940 (which became effective November 1, 1940) was an added spur to simplification of the Atlas system because Atlas' officers were aware that that Act would require Securities and Exchange Commission approval of various transactions between affiliated investment companies and, therefore, that any simplification or rearrangement of its complex corporate structure subsequent to the effective date of that Act would be beset by administrative complications and difficulties not theretofore existing. At least as early as June 12, 1940, Atlas' executives were concerning themselves with plans to rehabilitate petitioner (i. e., rearrange and simplify its financial structure) as a preliminary step either to liquidating petitioner or selling its stock in petitioner.
In October 1940, certain intercompany transactions were undertaken between and among Atlas and its affiliated investment*259 companies which culminated in the liquidation of one of those affiliates and rehabilitation of the remaining affiliates. The major effects of those transactions, as regards petitioner, were elmination of its indebtedness to American Company and Atlas, elimination of its investment in Standard Equities Corporation, and acquisition of certain stocks, including a large stock investment in Ogden Corporation (cf. petitioner's statement of financial condition as of September 30, 1940, supra). The following is a statement of petitioner's financial condition, based on market values at December 14, 1940, which reflects the changes resulting from the aforementioned transactions: *1164
| ASSETS | |||
| Cash | $ 76,561.28 | ||
| Accounts receivable | 1,000.00 | ||
| Securities owned, valued at December 14, 1940, market prices | 247,675.00 | ||
| Investment in capital stock of Ogden Corporation | 975,000.00 | ||
| Investment at liquidating value in the capital stock of: | |||
| American Company, 118,288 shares at a value of $ 32.35 per | |||
| share | 3,826,791.15 | ||
| Other investments | 5,913.50 | ||
| Deferred charges | 1,151.19 | ||
| Total assets | $ 5,134,092.12 | ||
| LIABILITIES | |||
| Accounts payable and accrued expenses | $ 534.73 | ||
| Liability for taxes | 606.10 | ||
| $ 1,140.83 | |||
| CAPITAL | |||
| Common stock, no par value, 10,000 shares | $ 10,000.00 | ||
| Surplus | $ 3,885,591.64 | ||
| Add, unrealized appreciation | 1,237,359.65 | 5,122,951.29 | $ 5,132,951.29 |
| Total liabilities and capital | $ 5,134,092.12 |
*260 Atlas, as a matter of corporate policy, endeavored to offset all its gains for a year by at least an equal amount of losses (realized by sales of securities on which it had a tax basis higher than the sales price) so that it would not be liable for any income taxes and so that the distributions made to its shareholders would not be taxable to them as ordinary dividend income. Atlas had been highly successful at this and its shareholders had almost never been subject to ordinary income tax on the distributions they received. The shareholders had come to expect this tax result and Atlas' stock was traded with that in mind.
Early in 1940 (probably in April) Atlas realized a capital gain of $ 10,353,186.78 ($ 9,619,542.76 long-term and $ 733,644.02 short-term) in a certain financial transaction. To offset this gain it sold on the open market, in June and July, common stock of the Central States Electric Corporation, having a basis in its hands of over $ 43 per share, for a price of 10 cents per share -- thereby receiving for that stock $ 9,897,745.89 less than its basis therefor.
Late in 1940, Charles Reuter, head of Atlas' tax department, feared that the Bureau of Internal Revenue*261 might disallow Atlas' capital loss on the sale of its common stock in Central States Electric Corporation (hereinafter referred to as Central States) on the ground that such stock had become worthless in a prior year. Since at least 1937, the market value of Central States' assets had been over $ 30,000,000 less *1165 than necessary to meet the claims of its debentures and preferred stock, thus leaving nothing for the common stock and, although Central States' stock continued to be traded on the market, its prices had been negligible for years and it was considered highly speculative. Were the aforementioned loss disallowed, Atlas would have had taxable net income of about $ 10,300,000 for 1940, and the distributions of $ 2,729,623 which it made to its stockholders that year would be regarded as dividends taxable to them as ordinary income. Because of these possible consequences Reuter felt he could not rely on an oral, unbinding statement from an employee of the Bureau of Internal Revenue (obtained in April 1940, by the accounting firm retained by Atlas) to the effect that the Bureau's "attitude" was that Central States' common stock was not yet worthless since the corporation*262 was still in existence and no bankruptcy or receivership proceedings had been instituted.
In December, Reuter suggested to Odlum that Atlas sell its stock in petitioner so as to register an additional loss in 1940, and thereby cover itself should the loss on the Central States' stock be disallowed. Odlum was interested in disposing of petitioner anyway in order to further simplify Atlas' structure. Accordingly, Odlum made several attempts to sell petitioner's stock to outsiders but met with no success. Since the end of the year was close at hand Reuter suggested that Odlum (who he knew had sufficient personal resources) himself buy petitioner's stock and Odlum agreed.
The plan for the sale was that petitioner would first distribute to Atlas six groups of stock (including its stock in American Company) which Atlas wished to retain, leaving petitioner with marketable securities in three companies, i. e., Chrysler Corporation, International Harvester Company, and United Fruit Company. Odlum would then purchase petitioner's stock at its liquidating value, based on current market prices, plus $ 1,000. At a meeting of Atlas' board of directors, on December 16, 1940, such sale was authorized*263 to be made (Odlum not voting) on or before December 31, 1940. The minutes of that meeting state that the sale was recommended by Atlas' "Executive Vice-President * * * in order to simplify the corporate structure [of Atlas] and to reduce the number of controlled companies registered under the Investment Company Act."
On December 19, 1940, Atlas filed an application with the Securities and Exchange Commission, under section 17 (b) of the Investment Company Act of 1940, for exemption from the provisions of section 17 (a) (2), the terms of which made it unlawful for a registered investment company's officer, such as Odlum, to knowingly purchase securities from his company. The application first detailed the transaction and then stated that:
[it] will result in further simplification of the applicant's corporate structure by the elimination of Salta Corporation as a subsidiary with consequent savings *1166 in operating expenses and administrative costs. Furthermore, the sale of the stock in question should result in a substantial tax loss to Atlas Corporation which it is desirous of realizing prior to the end of the calendar year 1940.
A public hearing on the application of*264 the Atlas Corporation was held before the S. E. C. at Washington, D. C., on December 26, 1940. The S. E. C. promulgated its Findings and Order on the aforesaid application of the Atlas Corporation on December 28, 1940. Pertinent portions of said Findings and Order read as follows:
The Commission having examined the record in this matter finds:
1. Atlas Corporation and Salta Corporation are closed-end investment companies registered under the Investment Company Act of 1940; Floyd B. Odlum is the President and a Director of Atlas Corporation.
2. Salta Corporation is a wholly-owned subsidiary of Atlas Corporation, having outstanding 10,000 shares of capital stock, all of which are owned by Atlas Corporation.
3. It is proposed that Salta Corporation distribute as a liquidating dividend to Atlas Corporation a part of its assets and that thereafter Atlas Corporation enter into an agreement with Floyd B. Odlum providing for the purchase by the latter of the 10,000 outstanding shares of stock of Salta Corporation in cash at a price equal to the liquidating value of such shares at the time of such sales, plus $ 1,000. In computing the liquidating value of such shares, the remaining securities*265 in the portfolio of Salta Corporation are to be valued at their respective market prices on the New York Stock Exchange at the close of business on the day prior to the sale.
4. On December 27, 1940, the applicant filed a copy of its agreement with Floyd B. Odlum, executed December 26, 1940. The terms of said agreement as executed conform to the summary of the proposed agreement as set forth in the application and in paragraph 3 of these findings.
5. The terms of the proposed transaction, including the consideration to be paid and received, are reasonable and fair and do not involve overreaching on the part of any person concerned.
6. The proposed transaction will tend to simplify the capital structure of Atlas Corporation and its subsidiaries, and is consistent with the policy of Atlas Corporation and Salta Corporation and with the general purposes of the Investment Company Act of 1940.
Wherefore, It Is Ordered that the sale by Atlas Corporation of the shares of stock of Salta Corporation to Floyd B. Odlum in the manner above recited be and the same hereby is exempted from the provisions of Section 17 (a) (2) of the Investment Company Act of 1940.
On December 28, 1940, petitioner*266 first distributed the designated six groups of stock to Atlas and, immediately thereafter, Atlas transferred all of petitioner's 10,000 shares of outstanding stock to Odlum for $ 235,075.02 in cash, which sum represented the liquidating value of petitioner's assets plus $ 1,000. Petitioner then had only one minor outstanding liability and its net worth of $ 234,075.02 was composed almost completely of cash ($ 73,708.62) and marketable securities ($ 159,012.50) in the aforementioned three companies. (In January 1941, petitioner sold those securities for $ 153,636.69, or a loss of $ 5,375.81.)
*1167 After December 31, 1940, Salta ceased operation as an investment company and became an operating company as will hereinafter be shown. In 1941, as will more fully appear hereafter, Salta's sole operation was that of a manufacturer of rubber products. On November 12, 1942, Salta changed its name to Great American Industries, Inc., by which it is presently known.
Atlas, on its 1940 income and excess profits tax returns, claimed and was allowed a long-term capital loss of $ 33,429,916.64 and a short-term capital loss of $ 7,459,124.65 on the sale of petitioner's stock to Odlum. After*267 taking into account all its gains and losses, including the $ 9,897,745.89 capital loss on the sale of its Central States' stock (which was in fact allowed), its returns for that year showed a net loss of $ 33,720,156.54. It paid no income or excess profits taxes for 1940 and the distributions made to its stockholders were not taxable to them as ordinary income from dividends. Even though its loss on the Central States' stock was allowed, Atlas, had it not sold petitioner's stock, would still have had normal tax net income of $ 44,412.21 and the distributions to its stockholders would, at least in small part, have been taxable to them as ordinary income from dividends.
The World War II excess profits tax law was enacted October 8, 1940, and made effective as of January 1, 1940. Atlas and the petitioner, as investment companies, were not particularly concerned with that law in 1940 because virtually all of their income was from dividends of domestic corporations and long-term capital gains, both of which were exempt from the tax. Odlum had a general idea, in 1940, of how the law operated and was aware that one of the credits allowed in determining the tax was based on invested *268 capital. However, Odlum made no investigation of the amount of petitioner's invested capital prior to his purchase of petitioner's stock from Atlas.
Petitioner's invested capital credit was not the consideration in Odlum's decision to buy petitioner's stock. Odlum's principal purpose in buying the stock was to enable Atlas to both simplify its corporate complex and realize a loss in 1940, which could be used in reducing its tax liability.
Prior to 1940, Odlum in his individual capacity had never engaged in any business transactions with Atlas. Moreover, because he devoted all his time to Atlas' affairs and always turned over to Atlas any promising opportunities for the acquisition of businesses, he had not personally acquired any interests in businesses except for primarily personal, as distinguished from profit, motives. Before 1936, the only such investments Odlum made were in (a) a mining company with some friends and relatives, (b) a cattle-breeding ranch in England, with his brother, and (c) the cosmetics business of his wife, a noted aviatrix. The first two mentioned were not profitable ventures and his interests in them terminated before 1936.
*1168 On September 24, *269 1936, Odlum organized, and became sole stockholder of, Virginia Rubatex Corporation (hereinafter sometimes referred to as V. R. C.). A friend of Odlum's had obtained the American rights to a process for production of a type of cellular rubber called Rubatex which he had unsuccessfully attempted to exploit through a corporation of his own. Odlum formed V. R. C. in order to undertake the successful commercial development of Rubatex and V. R. C. obtained, from his friend's corporation, a license to manufacture Rubatex, bought that corporation's equipment and took over its factory. One of the principal reasons Odlum engaged in this venture was to provide Wesley L. Smith (a friend of his and his wife's flying instructor) with an opportunity for employment and to give his then 20-year old son, Stanley, a chance to get experience in the business world which Stanley had just recently entered. Smith and Stanley were made V. R. C.'s executive officers and Smith, for the most part, ran the corporation's affairs. Odlum had almost nothing to do with V. R. C. and, in all its years of operation, only visited its plant for a few hours on one day.
The following table represents various aspects*270 of V. R. C.'s operations from its formation through the end of 1940:
| Research and | Net income | ||
| Year | Gross sales | development | (or loss) |
| expense | |||
| 1936 | $ 5,387.59 | $ 6,328.09 | ($ 5,819.41) |
| 1937 | 74,085.33 | 64,042.74 | (47,660.29) |
| 1938 | 78,417.32 | 38,162.11 | (33,806.32) |
| 1939 | 153,458.85 | 9,846.25 | 1,444.07 |
| 1940 | 679,181.26 | 6,847.60 | 147,585.91 |
As a result of initial difficulties in production techniques, necessary research and development activity, and the problem of finding markets for its relatively new product, V. R. C. did not reach a profitable level until 1939. The profits realized in 1939 and 1940 resulted primarily from production for military uses not only of Rubatex but of ordinary solid rubber. Sales were made to the Armed Forces during those years of solid rubber gas mask parts and of Rubatex for self-sealing gas tanks, airplane wing fillers, and pontoon bridges.
In the fall of 1940, Odlum was not overly optimistic about V. R. C.'s prospects because peacetime markets for Rubatex were largely undeveloped, World War II had resulted in some shortages in rubber supply, and V. R. C.'s position was uncertain in the event of American participation in the*271 war. No backlog of advance military orders existed and continuation of V. R. C.'s military production could not be counted on because the armed services were improving their equipment, thus continually changing the specifications therefor, and because the larger rubber companies would, in the event of America's *1169 entry in the war, be more intensely in competition with V. R. C. both for military orders and the available rubber supply. (In fact, military orders for gas mask parts ceased by the end of 1941 and, by 1942, the armed services stopped using Rubatex in self-sealing gas tanks.) V. R. C. showed no liability for excess profits tax in its return filed for 1940.
V. R. C.'s worth on December 30, 1940, was as follows:| ASSETS | |
| Cash | $ 22,696.57 |
| Accounts receivable | 79,654.81 |
| Inventories | 60,157.47 |
| Land and depreciable assets (less allowance for depreciation) | 1 222,523.01*272 |
| Patents | 13,603.43 |
| Prepaid expenses, etc | 4,061.37 |
| Total | $ 402,696.66 |
| LIABILITIES | |
| Notes and accounts payable | $ 231,552.29 |
| Accrued expenses | 18,940.76 |
| Reserve for contingencies | 77,900.00 |
| Reserve for bad debts | 1,600.00 |
| Total | $ 329,993.05 |
| Net worth | 2 $ 72,703.61 |
From time to time since V. R. C.'s formation Odlum had found it necessary to lend V. R. C. money. At the end of 1940, V. R. C. was indebted to Odlum on account of those loans in the amount of $ 126,709.39. V. R. C. also owed Odlum's brother and sister a total of $ 39,000 on account of loans by them in 1940. (These debts are reflected in the above net worth statement.)
At the time Odlum agreed to purchase petitioner's stock from Atlas, in December 1940, V. R. C. was in need of additional financing to stockpile crude rubber (in anticipation of future rubber shortages), purchase machinery and equipment, be in a position to discount its bills thus getting the maximum benefit out of operation, etc. Odlum, therefore, decided to employ petitioner's liquid assets to place V. R. C. in a more stable cash position thereby obviating the necessity of further periodic loans to V. R. C. Odlum was aware that excess profits tax benefits would flow from liquidating V. R. C. into petitioner.
*1170 *273 On December 30, 1940 (following his purchase of petitioner's stock from Atlas), Odlum made a capital contribution of his V. R. C. stock to petitioner, petitioner's directors voted to liquidate V. R. C., and petitioner's officers and directors were replaced by Smith, Stanley Odlum, and Odlum's secretary. V. R. C. was liquidated and dissolved on December 31, 1940, petitioner receiving its assets and assuming its liabilities.
Petitioner continued to operate the business heretofore carried on by V. R. C. with the same personnel and facilities. The manufacture and sale of Rubatex and other rubber products was petitioner's only business during 1941 and until November 1942. Its normal tax net income (computed without deduction of excess profits tax) and excess profits net income for 1941, after adjustments by respondent which petitioner does not contest, were $ 188,805.19 and $ 241,576.50, respectively. For the first 11 months of 1942 its net income, before taxes, was $ 44,227.78. Petitioner acquired other interests in November and December 1942, and thereafter conducted its rubber products business as its Virginia Rubatex Division. The net income, before taxes, of that Division was*274 $ 180,222.12 in 1943, $ 37,321.25 in 1944, and $ 89,530.61 in 1945.
Petitioner, which had assumed V. R. C.'s liabilities, paid Odlum $ 127,154.03 in February and March 1941, on account of his loans (plus interest) to V. R. C. On March 12, 1941, Odlum's brother lent petitioner $ 6,750 and, on July 1, 1941, petitioner issued 6 per cent preferred stock to Odlum's brother and sister in satisfaction of all the loans (plus interest) made by them to V. R. C. and petitioner. Petitioner paid Odlum a dividend of $ 82,500 on March 14, 1941, and a dividend of $ 39,750 later in the year. It paid the two preferred stockholders a dividend totaling $ 1,500 in that year. Petitioner made additions of $ 111,781.72 to its fixed assets during 1941. Petitioner's December 31, 1941, balance sheet showed $ 63,396.12 in notes and accounts payable and $ 26,030.72 in earned surplus.
In arriving at its excess profits tax for 1941, petitioner computed its excess profits credit on the basis of invested capital. It determined, under section 718 of the 1939 Code, that its equity invested capital as of January 1, 1941, was $ 41,601,851.78 and reported no excess profits tax for the year. Petitioner reported *275 normal tax net income for the year of $ 172,442.69, on which total income tax was due of $ 53,207.24. The parties have stipulated that, if it is determined that petitioner is entitled to compute its equity invested capital under section 718, petitioner is entitled to an equity invested capital of at least $ 25,521,939.63. The parties have also stipulated that during 1941 petitioner's daily average net equity invested capital additions were $ 25,068.49, its daily average borrowed invested capital was $ 28,389.96, and its ratio of inadmissible assets to total assets was 1.624 per cent.
*1171 Since 1945, Odlum, his son Stanley, and Smith have had no interest in petitioner, either as stockholders or employees. By the close of that year Odlum and Stanley (to whom Odlum had given some of his stock in petitioner) had sold the last of their stock in petitioner at a substantial profit.
The evasion or avoidance of excess profits taxes was neither Odlum's sole nor principal purpose in purchasing petitioner's stock from Atlas and liquidating V. R. C. into petitioner.
OPINION.
The controversy in this case is whether petitioner, in computing its invested capital credit for purposes of arriving*276 at its 1941 excess profits tax liability, may determine its equity invested capital under section 718 of the 1939 Code. Petitioner maintains that it is entitled and required to use section 718, thus determining its equity invested capital on a historical basis commencing with its incorporation in 1928. The provisions of section 718 which are applicable hereto are printed in the margin. 1 The parties have stipulated that, if section 718 is applicable, petitioner's equity invested capital computed thereunder as of January 1, 1941, is at least $ 25,521,939.63, which the parties agree is more than sufficient to eliminate petitioner's excess profits tax liability for 1941.
*277 Respondent contends, relying on Gregory v. Helvering, 293 U.S. 465, and Higgins v. Smith, 308 U.S. 473, that the series of transactions culminating in Odlum's purchase of petitioner's stock from Atlas and his liquidation of V. R. C. into petitioner, was a scheme with no business purpose other than the evasion or avoidance of excess profits taxes by giving V. R. C. the benefit of petitioner's high equity invested capital. He, therefore, argues that petitioner's equity invested capital must be *1172 computed pursuant to the method prescribed in section 723 of the 1939 Code. 2 Such computation, if the Commissioner is entitled to make it under the method prescribed in section 723, would give petitioner an equity invested capital of $ 378,448.54 as of the beginning of 1941, and would result in its being liable for excess profits taxes for that year, as respondent has determined in his deficiency notice.
*278 Respondent, in support of his aforementioned position, also argues that following petitioner's December 28, 1940, distribution of certain securities to Atlas (leaving it with cash plus marketable securities in the Chrysler, International Harvester, and United Fruit companies) petitioner was "essentially an empty corporate shell" and that under Ward M. Canaday, Inc., 29 B. T. A. 355, affd. (C. A. 3) 76 F. 2d 278, certiorari denied 296 U.S. 612, and Kent Oil Co., 38 B. T. A. 528, "an empty corporate shell later revived by new stockholders and a new kind of business cannot be used as a shield against tax liabilities otherwise due." 3 The short answer to this latter argument is that it must fail because the major premise upon which it rests, viz, that petitioner became an empty corporate shell, is not true. True it is that, as a result of the December 28 distribution to Atlas, petitioner's net assets were reduced from over $ 5,000,000 to $ 234,075.02, but we do not think it is unrealistic to conclude that those remaining assets were still substantial. Petitioner was not*279 left a mere shell. It still had assets of approximately $ 235,000, with substantially no liabilities. The major portion of those assets ($ 159,012.50) consisted of securities in three companies, namely, Chrysler Corporation, International Harvester Company, and United Fruit Company. These securities were readily marketable and did not represent deadwood assets. We conclude that there are important factual differences between the instant case and the Canaday and Kent Oil cases, both supra, and that, consequently, respondent cannot be sustained in his attempt to here apply those decisions.
We next consider whether respondent is correct in his contention that the "business purpose" doctrine*280 of Gregory v. Helvering and *1173 Higgins v. Smith, both supra, requires that petitioner's equity invested capital be computed pursuant to the method prescribed in section 723, rather than that in section 718 of the 1939 Code. Although respondent's argument is phrased somewhat differently from that made by him in Alprosa Watch Corporation, 11 T. C. 240, it is in essence the same and, just as in that case, the record here compels us to decide against respondent. In the Alprosa Watch Corporation case, respondent argued "that the whole transaction was unrealistic, served no business purpose, and should be rejected on the authority of Gregory v. Helvering, * * * and Higgins v. Smith, * * *." We rejected respondent's argument and held that the transactions in that case were not mere form but had substance and that Gregory v. Helvering and Higgins v. Smith did not apply.
The question here is largely one of fact and we have found, after a careful consideration of the entire record, that the avoidance or evasion of excess profits taxes (through use of petitioner's historic equity invested capital) *281 was not Odlum's sole or principal purpose in acquiring petitioner and liquidating V. R. C. into it. Each step in the transaction before us, and the transaction as a whole, had substance as well as form and we cannot say that the hallmark of sham is here present.
We have made detailed findings of fact in this case which support our conclusion. It is unnecessary to restate them here except to note the following salient points:
At least as early as June 1940, well before the passage of the excess profits tax law in October, Atlas officials were considering the rehabilitation, and either sale or liquidation, of petitioner as a step in the simplification of Atlas' corporate structure. The pendency of the Investment Company Act of 1940 (which became effective November 1, 1940) acted as a spur to the simplification program since, after its passage, that Act would require S. E. C. approval of transactions between investment companies and their affiliates, thus increasing Atlas' administrative burdens. Following the passage of the Investment Company Act of 1940, petitioner was rehabilitated and made ready for sale.
Late in 1940, Atlas' tax man, Charles Reuter, felt that a certain tax loss*282 which Atlas intended to claim on its 1940 return might be disallowed and, therefore, that Atlas needed to realize an additional tax loss were it to be assured that it would have no taxable income for 1940 and that the distributions made to its stockholders would not be taxable to them as ordinary dividend income. It was decided to realize the additional tax loss by selling petitioner's stock (on which Atlas had a high basis) at its book value plus $ 1,000, after first having petitioner distribute to Atlas those securities in petitioner's portfolio which, for one reason or another, Atlas decided to retain. Ridding *1174 itself of petitioner's stock would also help to accomplish Atlas' objective of simplification of its corporate structure. These, then, were the motives behind Atlas' sale of petitioner's stock and we think it clear that the sale of stock was bona fide. Atlas no longer owned the stock and Odlum unquestionably became its owner. Sun Properties, Inc. v. United States, (C. A. 5) 220 F. 2d 171.
Odlum agreed to purchase petitioner's stock from Atlas only because no other purchaser could be found and there was little time remaining*283 in 1940 within which to make the sale. We are convinced that Odlum's principal purpose in making that purchase was to aid Atlas in its dual objectives of realizing an additional tax loss in 1940 and simplifying its corporate structure. Odlum is closely identified with Atlas and the testimony shows that he is regarded as its guiding force.
Soon after acquisition of petitioner's stock from Atlas, Odlum contributed his stock in V. R. C. to petitioner and caused V. R. C. to be liquidated into petitioner with a view of changing petitioner into an operating company instead of an investment company. A major reason for this action was to give V. R. C. the benefit of petitioner's cash and liquid assets. Odlum had been advancing money to V. R. C. over a period of years and, at the end of 1940, V. R. C. was indebted to him in the total amount of $ 126,709.39. V. R. C. wished to stockpile rubber in anticipation of supply shortages occasioned by World War II and to expand its facilities (which facilities were, in fact, expanded in 1941). Additional cash was deemed necessary for these purposes. Odlum felt that liquidation of V. R. C. into petitioner was the best way to provide for that cash*284 need and would obviate his having to make a series of further personal advances to V. R. C.
Odlum was also aware of the excess profits tax advantages that would result from his liquidation of V. R. C. into petitioner, but the law is clear that a taxpayer may arrange his affairs so as to minimize or altogether avoid taxes so long as the transactions he utilizes toward that end have substance and reality and are not a mere sham. Chisholm v. Commissioner, (C. A. 2) 79 F. 2d 14, certiorari denied 296 U.S. 641; Chamberlin v. Commissioner, (C. A. 6) 207 F. 2d 462, certiorari denied 347 U.S. 918. That legal principle, incidentally, effectively answers the many suggestions in respondent's brief of other methods, more expensive taxwise, which Odlum might have utilized to handle the entire matter.
After the completion of the above-described transactions petitioner began and continued to engage in the manufacture and sale of Rubatex. It has also engaged in other lines of business. Chisholm v. Commissioner, supra.The change in petitioner's*285 character, from an investment company to an operating company, does not prejudice its case. Alprosa Watch Corporation, supra;WAGE, Inc., 19 T. C. 249.
*1175 In light of what we have above said, it is our holding that the transactions here involved may not be denied recognition under the doctrine of Gregory v. Helvering and Higgins v. Smith, both supra, and that petitioner is entitled and required to compute its equity invested capital for 1941 under section 718 of the 1939 Code. It certainly cannot be said that it is impossible to compute petitioner's equity invested capital under the provisions of section 718 because the parties have stipulated that:
Assuming that the Tax Court determines that the petitioner is entitled to compute its equity invested capital under the provisions of section 718 of the Internal Revenue Code rather than under the provisions of section 723 of the Code as determined by the respondent in the notice of deficiency * * * then and in that case the parties are agreed that the petitioner is entitled to a minimum equity invested capital at the beginning of such taxable year *286 under the provisions of section 718 of the Code of $ 25,521,939.63 * * *
The Commissioner is only authorized to compute a taxpayer corporation's equity invested capital in special cases under section 723 and those special cases are described as follows in section 723:
Where the Commissioner determines that the equity invested capital as of the beginning of the taxpayer's first taxable year under this subchapter cannot be determined in accordance with section 718, the equity invested capital as of the beginning of such year shall be an amount equal to the sum of * * * [Emphasis supplied.]
Now it is true that the Commissioner in his deficiency notice determined petitioner's equity invested capital under the method prescribed by section 723, but if he did so under the theory that petitioner's equity invested capital cannot be computed under section 718 of the Code he clearly erred. And it must be kept in mind, as we have already endeavored to emphasize, that the Commissioner is only authorized to use the method prescribed in section 723 in those special cases where the corporation's equity invested capital cannot be determined under section 718. That situation does not exist*287 here. On this issue we hold for petitioner.
Decision will be entered under Rule 50.
Footnotes
1. Resulting primarily from the disposition of an investment held for several years in an operating company.↩
2. This includes $ 62,342.51, or 3.904 per cent, of a $ 1,596,888 dividend received from American Company on October 30, 1940. The balance of that dividend was, according to petitioner's return, "tentatively ruled to be non-taxable."↩
1. Included herein (and reflected in the net worth) is a $ 30,000 valuation (less depreciation allowances of $ 5,400) ascribed by VRC's directors to a contract relating to the acquisition of fixed assets and other rights.↩
2. As of December 31, 1940, VRC had capital stock of $ 50,000 stated value, capital surplus of $ 50,000 and a $ 27,296.39 deficit in earned surplus. The sum of these figures is $ 72,703.61.↩
1. SEC. 718. EQUITY INVESTED CAPITAL.
(a) Definition. -- The equity invested capital for any day of any taxable year shall be determined as of the beginning of such day and shall be the sum of the following amounts, reduced as provided in subsection (b) --
(1) Money paid in. -- Money previously paid in for stock, or as paid-in surplus, or as a contribution to capital;
(2) Property paid in. -- Property (other than money) previously paid in (regardless of the time paid in) for stock, or as paid-in surplus, or as a contribution to capital. Such property shall be included in an amount equal to its basis (unadjusted) for determining loss upon sale or exchange. If the property was disposed of before such taxable year, such basis shall be determined in the same manner as if the property were still held at the beginning of such taxable year. If such unadjusted basis is a substituted basis it shall be adjusted, with respect to the period before the property was paid in, in the manner provided in section 113 (b) (2);
(3) Distributions in stock. -- Distributions in stock --
(A) Made prior to such taxable year to the extent to which they are considered distributions of earnings and profits; and
(B) Previously made during such taxable year to the extent to which they are considered distributions of earnings and profits other than earnings and profits of such taxable year;
(4) Earnings and profits at beginning of year. -- The accumulated earnings and profits as of the beginning of such taxable year;↩
2. SEC. 723. EQUITY INVESTED CAPITAL IN SPECIAL CASES.
Where the Commissioner determines that the equity invested capital as of the beginning of the taxpaper's first taxable year under this subchapter cannot be determined in accordance with section 718↩, the equity invested capital as of the beginning of such year shall be an amount equal to the sum of (a) the money plus (b) the aggregate of the adjusted basis of the assets of the taxpayer held by the taxpayer at such time, such sum being reduced by the indebtedness outstanding at such time. The amount of the money, assets, and indebtedness at such time shall be determined in accordance with rules and regulations prescribed by the Commissioner with the approval of the Secretary. In such case, the equity invested capital for each day after the beginning of the taxpayer's first taxable year under this subchapter shall be determined, in accordance with rules and regulations prescribed by the Commissioner with the approval of the Secretary, using as the basic figure the equity invested capital as so determined.
3. Respondent correctly recognizes that section 129 of the 1939 Code "has no application to the instant case because it was made to apply to taxable years beginning after December 31, 1943" and because it "also otherwise appears to be inapplicable." See Alprosa Watch Corporation, 11 T. C. 240↩.