16 T.C. 1566">*1567 Respondent determined a deficiency in petitioner's excess profits tax for the calendar year 1943 of $ 8,153.39.

The only issue presented for decision is whether respondent properly determined that the amount of $ 90,000 covering notes paid in for stock did not constitute invested capital under section 718 of the Internal Revenue Code or a capital addition under section 713 in computing petitioner's excess profits credit.

At the hearing respondent conceded that petitioner was entitled to deduct the entire amount of $ 1,800 paid its president for services rendered in 1943. Other adjustments made by respondent are not disputed.

1951 U.S. Tax Ct. LEXIS 150">*151 Petitioner filed its return with the collector of internal revenue for the district of Mississippi.

The record consists of testimony and various exhibits.

FINDINGS OF FACT.

Petitioner is a Mississippi corporation organized in 1938 under the name of Copiah County Building and Development Company (hereinafter called Copiah) with an authorized capital stock of $ 10,000 consisting of 100 shares of common stock. The original incorporators were H. J. Wilson, D. A. Graves, and H. H. Parker. Petitioner received its present name in 1943. Its principal place of business is in Hazlehurst, Mississippi.

Copiah was engaged principally in operating a commissary for the Graves Lumber Company, although it also engaged in construction work and dealt in real estate.

The principal individuals involved and their family relationships are as follows: H. J. Wilson and Mamie F. Wilson are the parents of Alex (also known as Alec) Wilson and Margaret W. Graves. Margaret W. Graves was the wife of D. A. Graves, Copiah's manager, who died in 1941. Hardy Wilson Graves is their minor son. His mother is his legal guardian. Viola Graves is the mother of D. A. Graves.

Early in 1943 it was decided to change Copiah's1951 U.S. Tax Ct. LEXIS 150">*152 name and to have it take over some of the business activities engaged in by the Wilson and Graves families through other corporations. It was thought that additional capital might be needed.

The stockholders met on March 23, 1943, and changed Copiah's name to Graves, Inc., also providing that the authorized stock be increased to $ 100,000 (1,000 shares). The stockholders at the time, with their holdings, were as follows: 16 T.C. 1566">*1568

On April 6, 1943, at a meeting of petitioner's board of directors, Viola Graves was elected president; W. M. Ford, vice president; and Margaret W. Graves, secretary and treasurer. It was unanimously agreed that the president and secretary of Graves, Inc., purchase the entire stock of building materials owned by the Graves Lumber Company. It was also agreed that the president of Graves, Inc., be authorized to contract with the Southern Package Corporation in regard to furnishing materials and facilities for staining ammunition boxes being manufactured by that corporation for the War Department and to save that corporation harmless1951 U.S. Tax Ct. LEXIS 150">*153 from any and all damage that might result from fire occasioned by explosion or ignition of the dye solution used in dyeing or staining the boxes and material covered by the contract.

In addition, a motion was unanimously adopted ordering that the remaining capital stock be sold to Viola Graves and Margaret W. Graves in such proportion as they may decide between themselves, provided that the stock was sold for cash and not below its par value.

On April 8, 1943, petitioner issued certificates of stock representing $ 90,000 par value, Viola Graves receiving 400 shares (two certificates for 200 shares), and Margaret W. Graves, 500 shares (two certificates for 250 shares). The stockholders' holdings were then as follows:

Payment for the stock was made in the following manner. The two Mrs. Graves each executed and delivered two promissory notes to the Sopaco Finance Company (hereinafter called Sopaco). The two notes of Viola Graves were each in the amount of $ 20,000, and those of Margaret W. Graves were in the amount of $ 25,000. All four notes were due 1951 U.S. Tax Ct. LEXIS 150">*154 and payable January 1, 1944, and carried interest at 6 per cent per annum. The stock issued by petitioner was pledged as security.

Sopaco, in turn, executed and delivered to petitioner three promissory notes, payable on demand, each in the amount of $ 30,000, and bearing interest at 2 per cent.

16 T.C. 1566">*1569 Sopaco was a partnership organized under Mississippi law on November 23, 1942, with its principal office in Hazlehurst. The partners were H. J. Wilson, Alex Wilson, and Mamie F. Wilson.

On or about May 25, 1943, the Wilson Investment Company was incorporated, and it took over the assets and liabilities of Sopaco. The incorporators were the three Sopaco partners. In a short time the authorized capital stock of $ 500,000 (5,000 shares) was issued to and paid for by the three incorporators and Margaret W. Graves.

Sopaco and its successor, the Wilson Investment Company, had sufficient cash and liquid assets to pay the three $ 30,000 demand notes at any time that petitioner may have requested.

In April 1943, petitioner acquired the Graves Lumber Company assets -- accounts receivable, building materials inventory, and paints -- for a total consideration of $ 30,419.19, which was paid1951 U.S. Tax Ct. LEXIS 150">*155 in full, in cash and materials, before the year expired. The paint acquired (valued on the books at $ 5,754.80) was owned actually by the Southern Package Corporation, although it was carried on the books of the Graves Lumber Company. The Graves Lumber Company continued in the business of manufacturing lumber.

Mr. H. H. Parker, who had managed the retail lumber and building materials department of the Graves Lumber Company, became manager of petitioner's retail building materials department which sold lumber and building material for repair work and miscellaneous purposes. He also undertook building and construction work. The plan was to build about 40 houses in 1943, but permits were required for construction, and only five or ten houses were built.

The subcontracts for staining or camouflaging ammunition boxes for the War Department were carried out in a successful manner. The Government paid petitioner every ten days for its work.

Petitioner received its contracts to stain and camouflage ammunition boxes from the Southern Package Corporation and the Port Gibson Veneer & Box Company only after the authorized and issued capital stock had been increased. However, the increase1951 U.S. Tax Ct. LEXIS 150">*156 was not made at the suggestion of or as a requirement of any of the parties with whom petitioner contracted.

Petitioner reported on its corporation income and declared value excess-profits tax return for 1942 a net income of $ 596.29. Its 1943 return showed a net income of $ 56,909.42. ¹

In January of the years 1944-46, inclusive, petitioner declared, and subsequently paid, dividends to each of its stockholders as follows: 16 T.C. 1566">*1570

Each year the Wilson Investment Company paid petitioner the interest due on the three demand notes.

At a stockholders' meeting held on March 13, 1946, a reduction of $ 70,000 in petitioner's outstanding stock was authorized. The two Mrs. Graves surrendered for cancellation the stock certificates issued to them on April 8, 1943, and each1951 U.S. Tax Ct. LEXIS 150">*157 received a new certificate for 100 shares. As a result, Margaret W. Graves' stockholdings were reduced to 112 shares and Viola Graves' to 110 shares.

On March 20, 1946, petitioner returned to the Wilson Investment Company the three $ 30,000 demand notes. No part of the principal amount of these notes had been paid. Thereupon, the Wilson Investment Company returned to the two Mrs. Graves the promissory notes they had executed and delivered to Sopaco. Although these four notes were due and payable on January 1, 1944, no portion of the principal amount had been paid. It was not intended that payments be made on any of these notes unless and until financial conditions of Graves, Inc., required such payment.

The business associations of the principal individuals involved are as follows:

H. J. Wilson -- an incorporator of Copiah; partner in Sopaco; incorporator and shareholder in the Wilson Investment Company; president and general manager of the Southern Package Corporation; before his death financial adviser to the two Mrs. Graves.

Mamie F. Wilson -- partner in Sopaco; incorporator and shareholder in the Wilson Investment Company.

Alex Wilson -- partner in Sopaco; incorporator 1951 U.S. Tax Ct. LEXIS 150">*158 and shareholder in the Wilson Investment Company; assistant general manager and treasurer of the Southern Package Corporation; president and general manager of the Port Gibson Veneer & Box Company.

Margaret W. Graves -- officer and shareholder in petitioner; guardian of Hardy Wilson Graves; a shareholder in petitioner; shareholder in the Wilson Investment Company.

Viola Graves -- officer and shareholder in petitioner.

This group also operated the Graves Lumber Company.

Respondent in his review of petitioner's return held that the amount of $ 90,000 covering notes paid in for stock did not constitute a proper inclusion in invested capital in computing petitioner's excess profits credit under the invested capital method and that the amount was not a capital addition for purposes of computation under the income method.

16 T.C. 1566">*1571 The amount of $ 90,000 covered by demand notes was not invested in petitioner's business.

OPINION.

The only issue for decision is whether respondent properly determined that the amount of $ 90,000 covering notes paid in for stock did not constitute invested capital under section 718, or a capital addition under section 713 in computing petitioner's excess profits1951 U.S. Tax Ct. LEXIS 150">*159 credit. The applicable sections of the Code are set out in the margin. ²

1951 U.S. Tax Ct. LEXIS 150">*160 Petitioner computed its excess profits credit by using the invested capital method and reported its credit to be $ 7,408.51. Respondent determined that the amount of $ 90,000 covering notes paid in for stock issued did not constitute invested capital and recomputed petitioner's credit to be $ 616.59. ³ Section 712 (a) provides that the excess profits credit shall be computed under the income method or the invested capital method, whichever results in the lesser tax. Therefore, respondent then computed petitioner's excess profits credit under the income method and found it to be $ 1,047.74. In this computation respondent refused to include the $ 90,000 in notes as a capital addition. 3 Petitioner alleges that the $ 90,000 in notes constituted an investment under sections 718 and 713 and that the respondent erred in excluding that amount from invested capital. Respondent denies petitioner's allegation.

We hold that the respondent properly excluded the $ 90,000 in notes from1951 U.S. Tax Ct. LEXIS 150">*161 invested capital under section 718 and from capital additions under section 713 in computing petitioner's excess profits credit.

16 T.C. 1566">*1572 We are dealing with the excess profits tax. In computing the adjusted excess profits net income, the law permits a credit, section 710 (b) (2), to be deducted from the excess profits net income. This credit can be computed on an invested capital basis, section 714, ⁴ or on an income basis, section 713. ⁵ The purpose of this credit is "to establish a measure by which the amount of profits which were 'excess' could be judged." West Construction Co., 7 T.C. 974, 978 (1946). In fulfilling this purpose, before capital can be considered in computing the excess profits credit, it is required that the capital actually be invested as part of the working capital; that the capital be utilized for the earning of profits; and that the capital be subject to the risk of the business. Hart-Bartlett-Sturtevant Grain Co. v. Commissioner (C. A. 8, 1950), 182 F.2d 153, affirming 12 T.C. 760 (1949). In short, the capital must actually be "invested" in the business. 1951 U.S. Tax Ct. LEXIS 150">*162

The evidence shows that the notes were given to petitioner for contingent use and that they were canceled when it was seen that they would not be needed, which was after the excess profits tax legislation had been repealed. Mr. Alex Wilson, one of the chief1951 U.S. Tax Ct. LEXIS 150">*163 stockholders in the Wilson Investment Company, testified as follows:

Graves, Incorporated, had Wilson Investment Company demand notes for certain dollars and the Wilson Finance Company paid them two per cent for not cashing those notes and taking the cash at that time, unless it was necessary in the business.

In addition, not even partial payments were made on the notes of the two Mrs. Graves, although they were due and payable January 1, 1944. Yet, at this time, Margaret W. Graves was liquidating assets in order to purchase Wilson Investment Company stock for cash.

Petitioner has failed to show that any of the companies with which it contracted required petitioner to increase its capital in order to secure business, or that by obtaining the notes it bettered its credit position. In fact, petitioner has made no showing that the $ 90,000 in notes was of the slightest aid in earning the increased profits for 1943. The notes merely represented a promise to increase petitioner's 16 T.C. 1566">*1573 working capital if needed while apparently the funds of the Wilson and Graves family groups were used elsewhere.

We conclude that the notes were never invested in petitioner's business and were1951 U.S. Tax Ct. LEXIS 150">*164 not utilized in the earning of its increased profits. Therefore, the amount of $ 90,000 cannot be considered in determining petitioner's "excess" profit. West Construction Co., supra.⁶

Respondent's determination is sustained.

Decision will be entered under Rule 50.