11 T.C. 164">*164 Respondent determined a deficiency of $ 30,305.24 in petitioner's income tax for the calendar year 1943.

In the original petition herein certain assignments of error and issues were presented respecting the year 1942, involved herein, because of the Current Tax Payment Act of 1943. By amended petition all assignments of error and issues respecting 1942 were eliminated. The questions presented under the amended petition are:

(1) Whether petitioner's wife, daughter, 1948 U.S. Tax Ct. LEXIS 108">*109 and son were bona fide partners during the year 1943 and, if so, whether they were partners effective January 1, 1943, or effective November 1, 1943.

(2) Whether petitioner is entitled to a deduction in the year 1943 of $ 8,640 as interest paid in that year to his wife.

The tax returns were filed with the collector of internal revenue for the twenty-third district of Pennsylvania at Pittsburgh.

11 T.C. 164">*165 FINDINGS OF FACT.

Partnership issue. -- The partnership here involved was first organized in 1926, for the purpose of designing and manufacturing hearing aid devices sold under the trade-mark "Radioear." It then, as now, operated under the name of E. A. Myers & Sons, with headquarters in Pittsburgh, Pennsylvania. At the time of its organization the partners were petitioner and his two sons, Edwin J. Myers and Leslie M. Myers. Approximately one year after the formation of the partnership Leslie resigned for the purpose of engaging in another activity.

The partnership continued in business thereafter with the two remaining partners until December 28, 1935, when two additional partners, Samuel F. Lybarger, petitioner's son-in-law, and Alfred E. Pelz became partners.

The partnership1948 U.S. Tax Ct. LEXIS 108">*110 operated in the form as above indicated until January 2, 1942, when Alfred E. Pelz withdrew. There were no further changes until November 1, 1943, when the articles of copartnership were amended to recite that Leslie, Sara, petitioner's wife, and Alberta M. Lybarger, his daughter, were partners.

The amendments to the articles of copartnership executed on that date read, in part, as follows:

Whereas, the party Sara M. Myers of the Township of Mount Lebanon, County of Allegheny, State of Pennsylvania, is desirous of becoming a full partner in the said partnership in consideration of a payment made to the partnership in the amount of Sixteen Thousand Dollars ($ 16,000.00), receipt of which is hereby acknowledged; and

Whereas, the party Alberta M. Lybarger of the Township of Peters, County of Washington, State of Pennsylvania, is desirous of becoming a full partner in the said partnership in consideration of a payment made to the partnership in the amount of Ten Thousand Six Hundred Ninety-six and 96/100 Dollars ($ 10,696.96), receipt of which is hereby acknowledged; and

Whereas, the party L. M. Myers of the Township of Mount Lebanon, County of Allegheny, State of Pennsylvania, is desirous1948 U.S. Tax Ct. LEXIS 108">*111 of becoming a full partner in the said partnership, in consideration of a payment made to the partnership in the amount of Four Thousand Eighty-Two and 67/100 Dollars ($ 4,082.67), receipt of which is hereby acknowledged;

It Is Hereby Agreed

1. That the parties Sara M. Myers, Alberta M. Lybarger and L. M. Myers shall, in consideration of their investments tendered and accepted as of this date, be accepted into full partnership in the firm of E. A. Myers & Sons, with the understanding that the above-mentioned new partners shall have the right to full and complete participation in the profits for 1943, the same as if this Amendment had been executed as of January 1, 1943.

* * * *

3. From and after the date hereof, said partnership agreement of December 28, 1935 shall continue in force and shall govern the relations of the partners 11 T.C. 164">*166 among themselves; it being understood that this Amendment is not intended to supersede nor in any way affect said partnership as concerns the rights or obligations of individual partners.

Paragraphs 3 to 8, inclusive, of the partnership agreement of December 28, 1935, incorporated in the amendatory agreement of November 1, 1943, by paragraph 3 thereof1948 U.S. Tax Ct. LEXIS 108">*112 as above set forth, provide as follows:

3. Each partner shall be entitled to share in the profits of the business for the year One Thousand Nine Hundred and Thirty-six (1936) and for succeeding years, in direct proportion to the ratio which exists, at the end of each year, and as provided herein, between the amount of his investment account and the total amount of the investment account. As partners' investment accounts may not be constant throughout the entire year, as a result of withdrawals (as provided herein), for the purpose of arriving at the amount of a partner's investment account for ony one year, the amount of the investment account, as it stands on the books at the end of each month shall be added and divided by Twelve (12) and this average sum shall be construed to be the amount of each partner's investment, for the purpose of distribution of profits at the end of the year.

4. At the end of each year, it shall be decided by the parties representing the majority of the investment account, what disposition is to be made of the accrued book-profits for that year; that is, whether all or any part shall be paid in cash to each of the individual partners as their interest 1948 U.S. Tax Ct. LEXIS 108">*113 may appear, or whether it shall be allowed to remain in the business as working capital and as such, be credited in the proper proportion to each partner's investment account.

5. Should the parties representing the majority of the investment account decide to increase the capital investment, each partner shall be privileged to make a further investment, which shall bear the same ratio to the total increase contemplated as his individual investment bears to the total investment account before this increase is effected. In case any one or more of the partners should not desire to take his or their proportion of this increase, his or their portion of this increase may be taken by the remaining partners under the same plan of distribution.

6. Withdrawals of any amount of capital from the investment account, at any time, shall be made only upon the agreement of the parties representing the majority of the investment in the business.

7. In every instance, where perfect agreement between the partners does not exist with reference to the policies to be followed by the partnership, the partners representing the majority of the investment shall have the right to decide what policy or policies1948 U.S. Tax Ct. LEXIS 108">*114 shall be followed and the other partner or partners shall consider this decision as final.

8. If the parties representing the majority of the investment account should decide that it was for the best interests of the business, for any reason whatsoever, to have any one or more of the partners discontinue his connection with the business, such remaining partners shall have the option of purchasing his or their holdings at their then book value plus Twenty (20) per cent of said book value; provided further, that if the discontinuance of such withdrawing partner is caused by any illegal or dishonest act against the best interests of the business, said Twenty (20) per cent bonus shall not be paid. The judgment of the partners representing the majority of the investment in the business shall be accepted as final with respect to whether or not the circumstances surrounding a partner's forced withdrawal, shall or shall not warrant the payment of the Twenty (20) per cent bonus mentioned herein.

11 T.C. 164">*167 In the articles of copartnership (above set forth in part) executed on December 28, 1935, the control and management of the partnership was vested in the partner representing the majority1948 U.S. Tax Ct. LEXIS 108">*115 of the investment account. Such partner was petitioner, who held the majority of interest in the partnership from 1936 through 1942. He determined, by virtue of his majority interest, what disposition was to be made of accrued book profits; decided whether the capital investment of each partnership should be increased; approved all withdrawals of money; determined what policy or policies should be followed by the partnership in case of disagreement with respect thereto among the other members of the partnership; and decided whether, if it was believed to be in the best interest of the firm, any one or more of the partners should discontinue their association with the firm. Those articles of copartnership governed the activities of the partnership from December 28, 1935, and through the taxable year here in question.

Sara, who according to the amendment to the articles contributed $ 16,000 to the partnership, married petitioner in 1896. At the time of their marriage Sara received a gift of $ 135 from her father. She was admitted to practice law in the State of Indiana just prior to her marriage, but she did not practice either before or after that time.

Soon after the marriage1948 U.S. Tax Ct. LEXIS 108">*116 (the exact date is not shown) Sara invested the $ 135 wedding gift in a company known as the Garrett Engine Boiler & Machine Works. That company was reorganized and its name changed to Model Gas Engine Co. in 1904. It continued in business until about 1915, when a dispute arose between petitioner and certain other members of the board of directors. This led to petitioner's severing his connection with it in 1915. His rights in the company were purchased for $ 92,000. Of this amount petitioner gave Sara $ 5,000. In 1918 she received $ 1,000 from the estate of an aunt and in 1922 she received an additional $ 1,000 from the estate of her mother. She loaned all of the above mentioned sums to petitioner.

In 1930 Sara and petitioner built a new home in Mount Lebanon, Pennsylvania, at a cost of $ 18,000. She agreed to share equally with petitioner in the expense of purchasing that home and the money used for her share was considered to be repayment for the sums she had previously loaned to petitioner. Title to the property was conveyed to Sara and petitioner by a joint deed. Sara did not loan any money to petitioner subsequent to that time.

On November 1, 1943, petitioner gave 1948 U.S. Tax Ct. LEXIS 108">*117 Sara a check for $ 17,000. Sara deposited this amount in the Farmers Deposit National Bank of Pittsburgh. On November 8, 1943, she drew from this account a check for $ 16,000 payable to the partnership for an interest therein. Sara did not serve the partnership in any capacity during 1943, either in the way of contributing services or of sharing in the management. Her only record of any services to the firm was prior to 1928 when 11 T.C. 164">*168 she performed clerical duties, and during the years 1928 and 1929, when she helped petitioner demonstrate his hearing aid devices in various places throughout the country.

Alberta Lybarger, who according to the amended articles contributed $ 10,696.96 to the partnership, is Samuel F. Lybarger's wife. He was during the year in question, as heretofore mentioned, a partner, and, in addition, was the firm's chief engineer.

On December 23, 1937, petitioner wrote Alberta that he had given her on that day the sum of $ 5,000 which was to be invested in the partnership. This letter reads in part as follows:

The sum of five thousand dollars ($ 5,000.00) I have given you this day is to be invested in the Radioear Hearing Aid business of E. A. Myers & 1948 U.S. Tax Ct. LEXIS 108">*118 Sons, in a way that it will share in the earnings of the business in equal proportion to investments made by the partners.

At the end of the year 1938 and each year thereafter, the earnings from this five thousand dollars (exclusive of any part of such earnings which may have been or are to be paid in cash, in accordance with the plan of distribution of the profits of E. A. Myers & Sons' partnership) are to be invested in like manner.

The purpose of this gift is to enable one of the partners to make and keep this investment for you, and this investment, when properly made by one of the partners, shall be, in every respect, subject to the articles of the Partnership Agreement.

In accordance with the above instructions Alberta's husband wrote the partnership the following letter under date of December 30, 1937:

Gentlemen:

I am enclosing my check for five thousand dollars ($ 5,000.00) to be credited to my invested capital account.

Inasmuch as this is money received from Alberta E. Myers Lybarger, my wife, which I have agreed to invest for her, this part of my investment is being made by me in her behalf and for her benefit, and all profits derived therefrom will be payable by me to 1948 U.S. Tax Ct. LEXIS 108">*119 Alberta E. Myers Lybarger, my wife.

You are hereby authorized to set up a special investment account in my name in this amount and to treat this special account in the same way as my regular investment account with the Company.

On December 3, 1941, petitioner gave Alberta an additional $ 4,000, which was part of a donation of $ 12,000 he made to all three of his children. Concerning this transaction, petitioner stated as follows in a letter dated December 3, 1941:

I have this day made a gift of twelve thousand dollars ($ 12,000.00) to my three children, to be distributed equally, four thousand dollars ($ 4,000.00) to Alberta E. Myers Lybarger, L. M. Myers and E. J. Myers. Four thousand dollars ($ 4,000.00) is to be transferred from my investment account to the investment account of E. J. Myers.

Four Thousand Dollars ($ 4,000.00) is to be transferred from my investment account to the special investment account of S. F. Lybarger as provided for such special investment in S. F. Lybarger's letter of authorization of December 30, 11 T.C. 164">*169 1937, [set forth in part above] covering a similar investment made by him for the benefit of his wife, Alberta E. Myers Lybarger.

In a letter written1948 U.S. Tax Ct. LEXIS 108">*120 by E. J. Myers to petitioner dated December 28, 1942, the following is stated concerning Alberta's proposed investment in the partnership.

As far as Alberta is concerned, all of the earnings of her special investment will be paid to Sam and Sam in turn will pay that amount to Alberta and thus his income will be split up to enable separate tax returns to be filed.

The "special investment" mentioned in the above quoted paragraph was $ 9,000 given to Alberta by petitioner for the purpose of putting it in the partnership. In accordance with the above instructions, the earnings from the above mentioned sums were either left to accumulate in the capital account of the partnership or were distributed to Samuel, her husband, who deposited such moneys in their joint checking account. On August 27, 1943, Samuel wrote the officials of the Treasury Department located in Pittsburgh, Pennsylvania, in part as follows:

My wife, Alberta M. Lybarger, is not, and never has been a partner in E. A. Myers and Sons. * * *

The actual situation is that I have invested money belonging to my wife in the partnership. This money is invested in my name, and as far as the partnership is concerned, is handled1948 U.S. Tax Ct. LEXIS 108">*121 in the same way as the rest of my investment, except that I have had the bookkeeper carry the amounts separately so that I know how much is due my wife from me.

In increasing my investment with money belonging to Mrs. Lybarger, I agreed that any earnings on this money would be paid to her by me. The first increase in my investment account with money I received from Mrs. Lybarger was made on December 20, 1937. A second increase was made on December 3, 1941.

Alberta did not contribute services or share in the control and management of the firm during 1943.

Leslie M. Myers, according to the amended articles, contributed $ 4,082.67 to the capital of the partnership. Leslie received a gift of $ 2,500 from petitioner in 1937. This was not invested in the partnership. On December 3, 1941, petitioner gave him $ 4,000, which was donated for the specific purpose of investment in the partnership. In a letter written under date of December 3, 1941, petitioner gave the following instructions with respect to this money.

Four thousand dollars ($ 4,000.00) is to be transferred from my investment account to a special investment account in my name. This special investment account will then represent1948 U.S. Tax Ct. LEXIS 108">*122 the four thousand dollars ($ 4,000.00) gift to L. M. Myers thus invested by me on behalf and for the benefit of L. M. Myers, and all profits derived therefrom shall be payable by me to L. M. Myers, except that in view of L. M. Myers' previous indebtedness to me, all of the first four thousand dollars ($ 4,000.00) earned by this special investment account shall be payable to me to apply on the said indebtedness. Earnings in excess of this four thousand dollars ($ 4,000.00) exclusive of any part of such earnings which may be paid 11 T.C. 164">*170 in cash, in accordance with the plan of distribution of the profits of E. A. Myers & Sons' partnership, are to be credited to this special investment account in my name and are to be paid by me to L. M. Myers.

During the taxable year in question Leslie established a program for rationing hearing aid batteries. This work included determining the number of batteries which should be allocated to the partnership's various distributors. In addition to that, he purchased supplies needed for the manufacture of the products of the partnership, which required that he do considerable traveling for the purpose of seeing Government officials with respect to1948 U.S. Tax Ct. LEXIS 108">*123 obtaining priorities and contacting suppliers relative to obtaining required materials. Moreover, he tested hearing aid devices, for which, by virtue of his deafness, he was peculiarly adapted, and he was in charge of the program for establishing additional distributors for the partnership's products.

The net distributable profits of the partnership for the taxable year 1943 amounted to $ 82,353.14.

From 1936 through 1947, the various percentages of interest for the different partners were as follows:

In his notice of deficiency, under "Explanation of Adjustments," the respondent stated as follows:

(a) It is determined that Alberta Lybarger, Canonsburg, Pennsylvania, L. M. 1948 U.S. Tax Ct. LEXIS 108">*124 Myers, Pittsburgh, Pennsylvania, and Sara M. Myers, Pittsburgh, Pennsylvania, were not members of the partnership firm of E. A. Myers and Sons during the year 1943 for income and victory tax purposes, and it is further determined that your distributable share of the corrected income of that partnership for the year 1943 amounted $ 65,943.37 rather than $ 38,283.02 as reported in your return; accordingly, your income from that source has been increased to the extent of $ 27,660.35.

Interest issue. -- In his 1943 individual income and victory tax return petitioner deducted the amount of $ 8,640 as interest paid during the taxable year.

In an explanation of adjustment with respect to the reported interest payment attached to the notice of deficiency, respondent stated as follows:

(b) It is determined that the amount of $ 8,640.00 claimed in your return as 11 T.C. 164">*171 alleged interest paid to Sara M. Myers is not an allowable deduction in the computation of your income tax net income and victory tax net income.

From and after 1930 petitioner owed no debt to Sara and there was no accrual of interest due from petitioner to Sara in 1943.

OPINION.

The respondent contends petitioner's wife, 1948 U.S. Tax Ct. LEXIS 108">*125 Sara, his daughter, Alberta, and his son, Leslie, were not, for Federal tax purposes, partners of E. A. Myers & Sons during 1943, and that the distributable share of the partnership income attributed to them is taxable to petitioner. The Tower and Lusthaus cases ¹ determined that a member of a family may become a partner for tax and other purposes if he either invests capital originating with him, or substantially contributes to the control and management of the business, or otherwise performs vital additional services.

So far as Alberta and Sara are concerned, it is admitted by petitioner that during the taxable year in question they neither performed services nor shared in the control and management of the business. It is urged, however, that they both invested capital originating with themselves. We do not agree with this contention.

The facts disclose that1948 U.S. Tax Ct. LEXIS 108">*126 prior to 1930 Sara loaned petitioner certain sums she had previously received from him, from her father as a wedding gift, and from the estates of her mother and an aunt, and that he repaid his debt to her in full when they shared the expense of purchasing their home in 1930. There is not in this record convincing evidence of any additional loans Sara made to petitioner.

It is claimed by petitioner, however, that he owed Sara $ 17,000 in 1943. He made out a check to her for this amount drawn on partnership funds on November 1, 1943, and she in turn, gave $ 16,000 of this amount to the partnership on November 8, 1943.

Sara could not explain the origin of this alleged debt. Upon cross-examination she was asked:

Q. Can you tell us, Mrs. Myers, the principal amount -- can you state precisely just how your husband owed you this $ 17,000 you claim he owed you?