*284 Decision will be entered under Rule 50.
Held:
1. The respondent's action in including in petitioner's gross income in the taxable year involved the amount of $ 5,865.50, allegedly representing 4 per cent interest on sums borrowed by its parent corporation on non-interest-bearing demand notes, was an improper exercise of the authority conferred by section 45 of the Internal Revenue Code.
2. The amount of $ 3,000, paid by petitioner to its parent corporation for management services and advice actually rendered to petitioner in the taxable year involved, constituted an ordinary and necessary business expense deductible under section 23 (a) (1) (A) of the Internal Revenue Code.
3. Under the facts shown, petitioner is entitled to deduct the respective amounts of $ 900 and $ 100, paid to the Chamber of Commerce of Flint, Michigan, and the Chamber of Commerce of the United States in the taxable year involved, as ordinary and necessary business expenses.
*287 This proceeding involves deficiencies in income and excess profits taxes for the taxable year ended January 31, 1944, in the respective amounts of $ 33.12 and $ 18,185.
The issues are:
1. Whether the respondent erred in adding the amount of $ 5,865.50 to the taxable income of petitioner, as allegedly constituting interest which respondent asserts should have been charged by petitioner on non-interest-bearing loans to its parent corporation, pursuant to the provisions of section 45 of the Internal Revenue Code.
2. Whether petitioner is entitled to a deduction of the sum of $ 3,000, paid in the taxable year to its parent corporation for management services actually rendered to petitioner in such year, as ordinary and necessary expenses of its business.
3. Whether the respondent erred in disallowing to petitioner a deduction of the amount of $ 900 paid to the Chamber of Commerce *288 of Flint, *286 Michigan, and the amount of $ 100 paid to the Chamber of Commerce of the United States in the taxable year, as ordinary and necessary expenses of its business.
Certain facts were stipulated and are so found.
FINDINGS OF FACT.
Petitioner was incorporated on January 12, 1907, under the laws of the State of Michigan. Its principal office and place of business are at Flint, Michigan, where it has been continuously engaged in the operation of a retail department store.
Petitioner's tax returns for the period involved were filed with the collector of internal revenue for the district of Michigan.
On January 15, 1929, Continental Department Stores, Inc. (hereinafter referred to as Continental), a Delaware corporation, acquired ownership of all the capital stock of petitioner and was the owner of all such stock during the taxable year ended January 31, 1944.
During the taxable year ended January 31, 1944, and at all other relevant times, the books of account of both petitioner and Continental were kept on the accrual method of accounting and the tax returns of both corporations were filed on that basis.
On November 5, 1942, Continental had outstanding debentures having a par value of $ 238,100*287 which were redeemable at 102 per cent of par value plus accrued interest at the rate of 5 per cent to the date of redemption.
On November 5, 1942, Continental's board of directors adopted the following resolution:
| Resolved: | 1. That on December 31, 1942, this corporation redeem $ 100,000 |
| of its outstanding debentures at the redemption price of 102% | |
| of the par value of said debentures, plus accrued interest to | |
| date of redemption. | |
| 2. That this corporation borrow the funds necessary to effect | |
| said redemption from Smith-Bridgman & Company. |
Pursuant to such resolution Continental borrowed $ 104,500 from petitioner. On November 10, 1942, Continental delivered to petitioner a non-interest-bearing demand note for $ 104,500. On December 31, 1942, Continental retired $ 100,000 of its outstanding debentures at 102 per cent of par value plus interest. On November 19, 1943, Continental's board of directors adopted the following resolution:
| Resolved: | 1. That on January 1, 1944, this corporation redeem all of its |
| outstanding debentures at the redemption price of 102% of the | |
| par value of such debentures plus accrued interest to date of | |
| redemption. | |
| 2. That this corporation borrow the funds necessary to effect | |
| said redemption from Smith-Bridgman & Company. |
*288 *289 Pursuant to such resolution Continental borrowed from petitioner on November 24, 1943, the sum of $ 143,274.50, delivering to petitioner its non-interest-bearing demand note in such amount. On January 1, 1944, Continental retired the remainder of the outstanding debentures of the par value of $ 138,000 at the redemption price of 102 per cent plus accrued interest. Included in the debentures redeemed were debentures in the par amount of $ 22,500 owned by petitioner, which were redeemed at their cost to petitioner in the amount of $ 21,910.
Petitioner did not receive from Continental or accrue on its books of account or report as income on its tax returns for the taxable years ended January 31, 1943 or 1944, any amount as interest on account of the non-interest-bearing demand loans made by it to Continental.
Continental did not pay to petitioner or accrue on its books of account or claim as a deduction on its tax returns for the years ended January 31, 1943 and 1944, any interest expense on account of the non-interest-bearing demand notes representing money borrowed by it from petitioner. The respondent made no adjustment of the items shown on the tax returns of Continental.
*289 J. W. Knapp Co. is a Michigan corporation and operates a retail department store in Lansing, Michigan. All of its issued and outstanding capital stock during the taxable period involved was owned by Continental. During the taxable year ended January 31, 1944, J. W. Knapp Co. was indebted to Continental in the amount of $ 120,754.10, represented by six promissory notes bearing interest at the rate of 4 per cent per annum. During the taxable year ended January 31, 1944, Continental received from J. W. Knapp Co. the sum of $ 4,830.16 as interest on the aforementioned loan, which amount Continental reported in its gross income on its income and excess profits tax returns for the taxable year ended January 31, 1944.
Continental's tax returns for the year ended January 31, 1944, disclose a net loss of $ 2,302.42 after carrying over and using as a deduction a prior net operating loss in the amount of $ 1,780.07. On its tax returns for the taxable year ended January 31, 1945, Continental reported a net income of $ 733.78 and an income tax liability of $ 183.45, after carrying over a net operating loss deduction in the amount of $ 522.35 from its taxable year ended January 31, 1944. Continental*290 filed its tax returns for the year ended January 31, 1944, on April 15, 1945. The deficiency notice involved in the instant proceeding was mailed to petitioner on October 5, 1948.
In his deficiency notice to petitioner the respondent added to petitioner's net income the amount of $ 5,865.50, identified and explained as follows:
(a) Interest income $ 5,865.50
* * * *
*290 The net income reported by you has been increased in the amount of $ 5,865.50 which represents interest income to you as explained in the forepart of this statement.
The explanation referred to is as follows:
Interest income, in the amount of $ 5,865.50 for your taxable year ended January 31, 1944, has been allocated to you from your parent company, Continental Department Stores, Incorporated, under the provisions of Section 45 of the Internal Revenue Code.
A more complete explanation of the nature of the adjustment and the manner in which the amount is computed is contained in the Revenue Agent's report covering his examination of the returns for petitioner's taxable year ended January 31, 1944, which reads in part as follows:
The adjustment proposed is to accrue interest on loans (non-interest bearing notes) *291 made to the parent company (Continental Department Stores, Incorporated) by this subsidiary. See Section 45 of the Internal Revenue Code and the decision of the Board of Tax Appeals (now Tax Court of the United States) in 40 B. T. A. 97.
The entire stock of this taxpaper is held by Continental Department Stores, Incorporated, whose offices are with those of this taxpayer.
It is significant that the parent company's loans of $ 120,754.10 to J. W. Knapp at 4% yielded $ 4,834.16 interest during fiscal year ending January 31, 1944.
As of January 31, 1943 the parent company owed taxpayer $ 126,410.00 on demand non-interest bearing notes. On November 30, 1943 an additional $ 121,364.50 was loaned the parent company. The loans were made to retire some of the interest-bearing obligations of the parent company. Interest has been accrued at a rate commensurate with what taxpayer is receiving on loans from affiliate companies.
| 4% of $ 126,410.00 for twelve months | $ 5,056.40 |
| 4% of $ 121,364.50 for twelve * months | 809.10 |
| Total | $ 5,865.50 |
*292 During the taxable year ended January 31, 1944, Continental furnished to petitioner valuable management services and advice in connection with the operation of petitioner's business. Continental also furnished similar services to J. W. Knapp Co., its other subsidiary, during the same taxable period. In the course of furnishing such service, Continental incurred expenses as follows:
| Executives's salary | $ 5,500.00 |
| Other salaries | 645.85 |
| Traveling | 832.27 |
| Telephone and telegraph | 43.10 |
| Postage | 33.18 |
| Stationery and supplies | 95.29 |
| Total | $ 7,149.69 |
Continental determined that approximately 65 per cent of the salary expenses, substantially all the traveling expenses, and the *291 material part of the other expenses above enumerated were incurred in furnishing the management services and advice rendered to its two subsidiaries. It charged a total of $ 5,000.04 to its two subsidiaries. Continental estimated three-fifths of the cost was for services and advice rendered to petitioner, and accordingly charged petitioner $ 3,000, which petitioner paid, and claimed such amount as a deduction on its tax return for the taxable year ended January 31, 1944, as an ordinary*293 and necessary business expense. The respondent, in determining the contested deficiency, disallowed the claimed deduction in full for lack of substantiation.
The amount of $ 3,000 was paid by petitioner to Continental for management services and advice rendered by Continental to petitioner during the taxable year ended January 31, 1944, and constitutes an ordinary and necessary business expense of petitioner.
During the taxable year ended January 31, 1944, petitioner paid $ 900 to the Chamber of Commerce of Flint, Michigan, and $ 100 to the Chamber of Commerce of the United States, and claimed a deduction of $ 1,000 on its tax return for that year.
The amount paid to the Flint Chamber of Commerce was for the following purposes and activities:
| (1) Current annual membership dues paid for the account of 16 named | |
| employees of petitioner at $ 25 per member, for which petitioner | |
| was not reimbursed by said employees | $ 400 |
| (2) Four current annual membership dues, no individual names | |
| designated | 100 |
| (3) Retail Promotion Fund | 400 |
The Retail Promotion Fund was maintained by the Flint Chamber of Commerce during the taxable year ended January 31, 1944, and expenditures were made*294 therefrom for Christmas street decorations, conventions, retail sales promotions, advertising the operating hours of retail store members, war bond promotions, and the operation of classes in retail distribution and sales training clinics. All of such activities were designed to promote the business interests of the member retail stores in the City of Flint, Michigan.
The Flint Chamber of Commerce is an association of business and professional men and women, corporations and business and civic associations of Flint, Michigan, organized, among others, for the following objectives:
By proper co-operative measures --
1. To advance, develop and foster the commercial, financial, industrial and civic interests of Flint and the surrounding area;
2. To extend the trade of its business enterprises, increase business, and preserve and strengthen business institutions throughout the community;
3. To encourage the development of its natural resources, means of transportation and communication;
*292 4. To support all appropriate steps looking to a sound growth of the city and the proper utilization of its resources.
During the period involved herein the Flint Chamber of Commerce carried*295 on an active program in furtherance of the above aims and objectives. Among its activities during the taxable year was the conduct of an "aggressive wholesale and retail trade expansion program" and the seeking of new and wider outlets for the goods and services of Flint business enterprises.
The Chamber of Commerce of the United States is an organization whose members consist of local chambers of commerce, business organizations and individuals. During the years 1943 and 1944 it carried on activities designed to improve business, commerce and industry. It undertook to bring about cooperation between domestic business organizations and Governmental agencies in the effective prosecution of the war. It maintained a war service division to assist members in communicating with appropriate Governmental agencies with respect to war time business regulations. It published fortnightly a "War Service Bulletin" summarizing all important Government war-related orders and rulings affecting business, particularly those relating to production and price control. It rendered other assistance and services of similar nature.
In determining the contested deficiency, the respondent disallowed $ *296 875 of the payment to the Flint Chamber of Commerce and $ 75 of the payment to the United States Chamber of Commerce, on the ground that "it has not been established that such expenditures were ordinary and necessary business expenses incurred in the operation of your business for that taxable year."
The payments made in the taxable year to the respective chambers of commerce were reasonably motivated by and with reasonable expectations that the business of petitioner would be advanced and constitute ordinary and necessary expenses of its business.
OPINION.
The first issue involves the propriety of respondent's action in adding to the income of petitioner in the taxable year the amount of $ 5,865.50, as interest income.
It is the respondent's position that in order to reflect clearly the income of petitioner pursuant to section 45 of the Internal Revenue Code1 he has allocated to petitioner the amount of $ 5,865.50 of *293 the income of Continental Department Stores, Inc., the parent corporation.
*297 It is the contention of petitioner that the respondent has merely created fictitious interest income where none in fact existed, that section 45 confers no such authority, and the action of the respondent is arbitrary and capricious.
Petitioner is the wholly owned subsidiary of Continental, which had outstanding debenture bonds in the face amount of $ 238,000. In 1942 Continental borrowed from petitioner the sum of $ 104,500, for which amount it delivered to petitioner its non-interest-bearing demand note. Continental thereupon redeemed $ 100,000 face value of its debentures. Similarly, in the taxable year ended January 31, 1944, here involved, Continental borrowed from petitioner the further sum of $ 143,274.50, for which amount Continental delivered to petitioner its non-interest-bearing demand note. Continental thereupon retired the remaining outstanding debenture bonds in the face amount of $ 138,000. The debenture bonds were all redeemable at 102 per cent of par value plus interest accrued to date of redemption.
Purporting to act under the authority of section 45 of the Internal Revenue Code, the respondent, in the taxable year involved, has added the sum of $ 5,865.50 to*298 petitioner's income, repesenting a 4 per cent charge against Continental on the aforementioned non-interest-bearing demand loans.
In support of his action the respondent argues that Continental, in securing these non-interest-bearing loans from petitioner, was enabled to relieve itself from paying interest on its outstanding debentures; and, furthermore, he argues, petitioner could have loaned the funds which Continental borrowed without interest to third parties at 4 per cent interest. Therefore, in order to prevent evasion of taxes and to clearly reflect the income of such related businesses, he has "allocated" to petitioner part of the income of its parent, in the exercise of the discretion conferred by section 45 of the code. The decisions involving section 45 make it clear that its principal purpose is to prevent the manipulation of or improper shifting of gross income and deductions between two or more organizations, trades, or businesses. Its application is predicated on the existence of income. The courts have consistently refused to interpret section 45 as authorizing the creation of income out of a transaction where no income was realized by any of the commonly controlled*299 businesses. Tennessee- Arkansas Gravel Co. v. Commissioner, 112 Fed. (2d) 508; E. C. Laster, 43 B. T. A. 159, modified on other issues, 128 Fed. (2d) 4; Epsen-Lithographers, Inc. v. O'Malley, 67 Fed. Supp. 181; cf. Hugh Smith, Inc., 8 T. C. 660, affd., 173 Fed. (2d) 224, certiorari denied, 337 U.S. 918">337 U.S. 918.
We regard these authorities apposite and controlling here. We think this record clearly establishes that the respondent has not distributed, *294 apportioned, or allocated gross income, but has created or attributed income where none in fact existed.
That the respondent did not "allocate" gross income of Continental to petitioner is apparent, since the record shows that he made no adjustment to the income or deductions of Continental. He argues that no such adjustment was required, since Continental in its taxable year ended January 31, 1944, had no net income. Such argument overlooks the established fact that Continental in the taxable year 1945 did have net income*300 against which it could have applied the additional net operating loss carry-over. While we do not have the tax liability of Continental before us, we think the above facts support the petitioner's contention that the respondent has created rather than allocated gross income.
The respondent contends that his action finds support in such authorities as Asiatic Petroleum Co., Ltd., 13 B. T. A. 1152, affd., 79 Fed. (2d) 234, certiorari denied, 296 U.S. 645">296 U.S. 645; G. U. R. Co. v. Commissioner, 117 Fed. (2d) 187, affirming 41 B. T. A. 223; National Securities Corp., 137 Fed. (2d) 600, affirming 46 B. T. A. 562; Welworth Realty Co., 40 B. T. A. 97. An examination of these cases discloses that each involved either the distribution, apportionment, or allocation of income or actual deductions of related businesses, thus distinguishing them from the instant case.
We, therefore, hold that the respondent's action in adding the sum of $ 5,865.50 to the income of petitioner*301 in the taxable year involved, not being authorized by section 45 of the code, is arbitrary and unwarranted.
The second issue involves the question whether petitioner is entitled to a deduction of the sum of $ 3,000 paid in the taxable year to Continental for management services actually rendered to petitioner in such year.
The respondent disallowed the claimed deduction on the ground that it had not been established that the amount was a proper expense of operation for such taxable year.
The record shows that petitioner sought and secured almost daily advice on various management and policy matters affecting the operations of its business from certain executive officers of Continental. Similar services were rendered to Continental's other subsidiary, J. W. Knapp Co. The evidence shows that Continental incurred expenses in connection with the furnishing of such services and advice in an amount in excess of $ 7,000. Continental charged its two subsidiaries a total of $ 5,000 of such expenses, allocating $ 2,000 to J. W. Knapp Co. and the sum of $ 3,000 to petitioner. This latter amount was paid by petitioner in the taxable year, which amount it claimed as a deduction as an ordinary*302 and necessary business expense. The record satisfies us that petitioner availed itself of such services and that they were directly *295 related to the operation of its business. The respondent makes no argument that the method of allocating the expenses incurred by Continental or that the amount charged petitioner by Continental was unreasonable. His position is that since Mr. Krave, whose duties for Continental included the management services to petitioner, received $ 1,100 directly from petitioner and $ 900 from the J. W. Knapp Co. for services as vice-president and director of those respective companies, no part of the $ 5,500 paid him by Continental should be charged against the subsidiaries. We think the small amount paid directly to Krave by petitioner was not paid for the services rendered petitioner by Krave as an officer of Continental, but rather for his services as vice-president and director of petitioner. Therefore we conclude that the sum of $ 3,000 paid to Continental by petitioner in the taxable year involved for management services and advice constituted an ordinary and necessary expense of petitioner's business and is an allowable deduction under section*303 23 (a) (1) (A) of the Internal Revenue Code.
The final issue involves the propriety of respondent's action in disallowing as deductions in the taxable year involved a part of the payments made by petitioner to the Chamber of Commerce of Flint, Michigan, and the United States Chamber of Commerce, as ordinary and necessary expenses.
In our findings of fact we have set forth in some detail the purposes and aims of these respective organizations receiving the payments. We have found that the payments were motivated by and with reasonable expectations that the business of petitioner would be advanced. Hence they constitute ordinary and necessary expenses of its business. Hirsch-Weis Mfg. Co., 14 B. T. A. 796; Emery, Bird, Thayer Dry Goods Co., 20 B. T. A. 796; A. L. Killian Co., 44 B. T. A. 169, affd., 128 Fed. (2d) 433, on other issues. The respondent relies wholly on I. T. 2375, which we think is clearly inapplicable.
Other adjustments made by respondent are not contested; therefore
Decision will be entered under Rule 50.
Footnotes
*. A longhand notation indicates that this should be 2 months.↩
1. SEC. 45. ALLOCATION OF INCOME AND DEDUCTIONS.
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 Commissioner is authorized to distribute, apportion, or allocate gross income or deductions 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 such organizations, trades, or businesses.↩