21 T.C. 1020">*1021 Respondent determined the following deficiencies in income tax:

The primary issue presented is whether a partnership existed between petitioner, his wife, and two trusts which were organized for the benefit of their two children. A secondary issue is whether the petitioner is taxable, under , for the gain paid or accrued to the trusts.

FINDINGS OF FACT.

Some of the facts are stipulated and are so found.

Fred M. Harvey was a resident of Nashville, Tennessee. He filed his individual income tax returns for the years before us with the collector of1954 U.S. Tax Ct. LEXIS 258">*259 internal revenue for the district of Tennessee.

Petitioner has been in the department store business practically all of his life. Starting with the year 1928 he managed Lane Brothers in Detroit, Michigan, for 4 years. Subsequently he worked in Stern Bros., in New York City; Mabley & Carew in Cincinnati, Ohio; Crowley-Milner Company in Detroit; and from 1938 to February 1942 he was a merchandise manager for Marshall Field & Company in Chicago, Illinois.

His wife, Dorothea S. Harvey, had similar experience in the merchandising field. She worked in Filenes in Boston, Massachusetts, and was a buyer for R. H. Macy & Company in New York City. After she married petitioner she worked with him in Lane Brothers in Detroit.

For some time prior to 1942 petitioner and his wife had planned to own and operate their own business. In furtherance of this plan, in January 1942, petitioner purchased for approximately $ 133,000, part as a down payment and the balance with a promissory note, all of the capital stock of Denton & Company. Denton & Company, a corporation organized under the laws of the State of Tennessee, operated a department store in Nashville. For this purchase petitioner used his1954 U.S. Tax Ct. LEXIS 258">*260 and his wife's money; in addition he borrowed $ 30,800 from various individuals and $ 20,000 on his life insurance. From time to time between 1940 and 1944 petitioner's wife contributed money to the family unit; this was money which she received from her father's estate. Between 21 T.C. 1020">*1022 1940 and 1944 her aggregate contributions amounted to more than $ 5,000. Dorothea S. Harvey was a corporate director from January 1942 to April 1943.

The department store was operated as Denton & Company from January 1942 until April 23, 1942, when the corporate name was changed to Harvey's, Inc. Harvey's, Inc., continued in business until it was liquidated April 30, 1943. At that time a liquidating trustee was appointed to take over the assets of the corporation. The liquidating trustee transferred the assets and the leases of the corporation to petitioner as sole stockholder.

The business in 1942 and the early months of 1943 was heavily indebted. It was expanding rapidly and never had sufficient capital. Department stores require heavy investments in inventories and capital is vitally necessary for the successful operation of this type of business. By April 1943 the corporation had reached1954 U.S. Tax Ct. LEXIS 258">*261 the limit of its capacity to borrow and petitioner sought some way to better the credit rating of the business and increase its borrowing capacity. The accountant for the corporation advised petitioner early in 1943 that a change from a corporation to a partnership would improve the credit rating of the business.

On May 1, 1943, petitioner and his wife executed an agreement whereby they agreed to become partners in a business known as The Harvey Co. The partnership was to own, operate, and conduct a department store or stores. The term of the partnership was 25 years from May 1, 1943. Petitioner was to contribute all of the assets of Harvey's, Inc., to the partnership. Paragraph (7) of the agreement is as follows:

(7) Fred Harvey has given, transferred and assigned to his wife, Dorothea S. Harvey, a one-tenth undivided interest in said business, and will give to each of his two children, Frederic Morton Harvey and Judith Harvey, a one-tenth undivided interest in said business by establishing for them a trust with James M. Todd, as Trustee. It is a condition of this gift that said interests of the children shall be subject to the claims of all creditors of the business. ¹

1954 U.S. Tax Ct. LEXIS 258">*262 In addition the agreement provided that petitioner would receive a salary of $ 20,000 per year and the remaining profit or loss would be divided so that the petitioner would receive seven-tenths, Dorothea S. Harvey one-tenth, and the trustee two-tenths. Petitioner was to have general direction over managerial details of the business, including such functions as signing checks, borrowing money, and entering into leases. If Dorothea S. Harvey desired to sell her interest in the business petitioner was to have first choice in purchasing it.

21 T.C. 1020">*1023 On May 2, 1943, petitioner as grantor entered into two trust agreements with James M. Todd as trustee. Under the terms of these agreements petitioner transferred and conveyed a one-tenth undivided interest in the business to the trustee in trust for Frederic Morton Harvey, petitioner's son, and a like one-tenth interest for Judith Harvey, his daughter. The stated purpose for creating these trusts was not to provide income for maintenance and support of the children but to create an estate which would increase with each year. To accomplish this end net income after taxes and expenses was to be left in the business.

The beneficiaries1954 U.S. Tax Ct. LEXIS 258">*263 could not anticipate, mortgage, or sell either the corpus or the trust income, but the children's interests were subject to the claims of all business creditors. Petitioner reserved the right to pledge the entire assets of the business in borrowing money for business transactions. The trusts were to terminate when petitioner's son and daughter were 30 years old; however, petitioner reserved the power to extend the life of the trusts for an additional period, not exceeding 10 years. The trustee had no authority to sell or encumber the interests of the beneficiaries unless he received written authorization from the petitioner. Moreover, petitioner reserved the right to direct the investment of funds resulting from such a sale. Petitioner also retained power to remove any trustee and to appoint a successor.

The principal creditor of Harvey's, Inc., the Commerce Union Bank of Nashville, was notified in advance of the proposed changes in the business form and the bank approved the change. Dun & Bradstreet and other credit reporting agencies were also notified of the liquidation of Harvey's, Inc., and the formation of the new business.

A gift tax return was filed by petitioner for1954 U.S. Tax Ct. LEXIS 258">*264 1943. This return reported the gifts of the business interests to his wife and the trusts. On this return each 10 per cent interest was valued at $ 15,653.99. On February 1, 1944, and on February 1, 1945, petitioner transferred an additional 5 per cent interest in The Harvey Co. to James M. Todd, trustee for Frederic Morton Harvey. ² These conveyances with the original gift gave the trust for Frederic Morton Harvey a 20 per cent interest in the business. Amendments were made to the partnership agreement of May 1, 1943, for these additions to the trust.

On February 1, 1944, petitioner sold a 5 per cent interest in the business to Edward J. Miller, an employee of The Harvey Co., for $ 33,500. The partnership agreement was amended on February 1, 1944, to reflect the following ratio of1954 U.S. Tax Ct. LEXIS 258">*265 profit distribution after allowing a salary of $ 20,000 per year to petitioner: 21 T.C. 1020">*1024

On February 1, 1945, another amendment to the May 1, 1943, agreement provided that James M. Todd, trustee for Frederic Morton Harvey, would be entitled to 20 per cent and Fred Harvey 55 per cent. The other interests were unchanged.

The capital accounts as shown on the books at May 1, 1943, and on January 31, 1946, for The Harvey Co. were as follows:

For each of the years before us a long-form audit was made of the business books. The auditor's reports treated the business as if it were a partnership composed of petitioner, his wife, the two trusts, and Miller, in the proper1954 U.S. Tax Ct. LEXIS 258">*266 years.

Throughout the period from May 1, 1943, to February 1, 1946, Dorothea S. Harvey devoted most of her time to household duties and to the care of her children. However, she also worked in the business and aided in the determination of store policy. She had excellent business judgment and was partly responsible for the success of the business.

During these years the business was primarily devoted to ladies' ready-to-wear. Dorothea S. Harvey worked with the buyers, helped in the advertising, and assisted in merchandise display. She followed fashion trends, made buying trips, and gave valuable advice as to the style of merchandise offered for sale. She initiated and in part directed national advertising for the business. She devised and put into operation the plan of "bus stop" benches. Under this plan the business furnished benches for bus passengers to use while they waited for their bus.

Withdrawals for Dorothea S. Harvey from the business earnings were used primarily to pay her income taxes and to pay the decorating costs of the Harveys' home.

James M. Todd, trustee for the children's trusts, had been employed by Denton & Company prior to petitioner's purchase of its 1954 U.S. Tax Ct. LEXIS 258">*267 capital stock. Todd continued in the employment of Denton & Company 21 T.C. 1020">*1025 after it was acquired by petitioner. He became secretary and a director of Harvey's, Inc., and at one time was vice president of that corporation. He also acted as liquidating trustee for Harvey's, Inc. During the time from May 1, 1943, to February 1, 1946, he remained in the business as comptroller and later as general superintendent in charge of the business properties. He worked under the supervision of petitioner. He did not own an interest in the business, nor did he receive any fees or remuneration as trustee.

Petitioner's son, Frederic Morton Harvey, was 10 years old on August 20, 1942. Even though he regularly attended school, he actually grew up in the business. He worked in the store on evenings, Saturdays, and on vacations. When we look to the years subsequent to the ones before us, we find that petitioner's son majored in business administration in college. He also attended nationally known managerial clinics in New York City, and, further, he has continued to work in the business.

Judith Harvey, petitioner's daughter, was 13 years old in 1942. She has not developed into any important1954 U.S. Tax Ct. LEXIS 258">*268 position in the business.

Edward J. Miller was a merchandise manager for The Harvey Co. and later became a partner in the business.

The Harvey Co. was terminated as of February 1, 1946. All of the assets of the business were conveyed to a newly formed corporation, The Harvey Co. The new corporation assumed all debts and obligations of the former business. The stock on February 1, 1946, of the new corporation, was issued as follows:

Part of the statement attached to the deficiency notice was as follows:

It is held that your wife, Mrs. Dorothea S. Harvey, was not a partner in the1954 U.S. Tax Ct. LEXIS 258">*269 business operated under the name of The Harvey Company within the meaning of the Internal Revenue Code and that you remained the true owner of the interests in such business which were allegedly conveyed to the trusts for your son, Frederic M. Harvey, and your daughter, Judith Harvey, within the meaning of and .

Petitioner and Dorothea S. Harvey, acting in good faith and with a business purpose, intended to join together as partners in the conduct of the business, known as The Harvey Co., from May 1, 1943, to February 1, 1946.

21 T.C. 1020">*1026 OPINION.

The first issue we shall consider is whether there was a partnership, which can be recognized for Federal income tax purposes, between petitioner, his wife, and the two trusts. It is petitioner's contention that such a partnership did exist. On the other hand, respondent has determined that neither petitioner's wife nor the two trusts were partners. The parties agreed that Edward J. Miller was a partner from February 1, 1944, to February 1, 1946.

One of the questions which always arises where there is a business reorganization of the kind before us is whether there was a 1954 U.S. Tax Ct. LEXIS 258">*270 business purpose in the change. There is undisputed evidence that there was a business purpose in the change. The corporation, Denton & Company, and its successor in name, Harvey's, Inc., needed to improve its credit rating. When petitioner discussed this matter with his accountant it was decided that the credit rating could be improved if a partnership were formed. With the approval of the business creditors, the partnership agreement of May 1, 1943, was executed by petitioner and his wife. By this agreement petitioner and his wife agreed to be partners in the business known as The Harvey Co. In the same instrument it was stated that he "has given, transferred and assigned to his wife" a one-tenth interest and "will give to each of his two children" a one-tenth interest in the business by establishing trusts for them. Petitioner and his wife also agreed that the profits and losses of the business would be shared in the ratio of their interests, that is, seven-tenths for petitioner, one-tenth for his wife, and one-tenth for each of the trusts.

In addition to this written agreement there is other evidence which supports petitioner's contention that his wife was a partner. The1954 U.S. Tax Ct. LEXIS 258">*271 evidence indicates that Dorothea S. Harvey was experienced in department store work. She contributed services to the business from the time it was first operated as a corporation and continued to render services to the business during the time before us. While she could not be classified as a regular employee or executive, her work in advertising and management adequately supports a finding that she contributed services to the business in the years before us. We also believe that petitioner has shown that his wife received money from independent sources and that some of this money helped petitioner in purchasing the corporate stock and in financing the business during the first years of its operation.

The business books were kept on a partnership basis and Dorothea S. Harvey's capital account was credited with her share of the net profits of the business. She paid income tax on this gain. The validity of her interest in the business as a partner was also evidenced by the fact that she received in exchange for her interest in the partnership 10 per cent of the capital stock in the corporation which was 21 T.C. 1020">*1027 formed on February 1, 1946, to take over the partnership. Even 1954 U.S. Tax Ct. LEXIS 258">*272 though her interest was originally a gift, the capital represented by this gift was used in the business. And since capital was an important element in the business, her capital and her services contributed to the success of the business. Again, the fact that she was known to be a partner by credit organizations, such as Dun & Bradstreet, indicates that her interest in the business was a matter of public knowledge.

From the record we find and hold that petitioner and Dorothea S. Harvey, acting in good faith and with a business purpose, intended to join together as partners in the conduct of the business from May 1, 1943, to February 1, 1946.

Up to this point we have only considered petitioner's wife. However, petitioner also contends that the trusts for his son and daughter were also partners in the business. It is respondent's position that the children's interests should not be recognized as partners. It has been held in prior cases that trusts can be valid partners for Federal income tax purposes. .

On May 2, 1943, by a written agreement petitioner assigned a one-tenth interest in the business to James M. Todd1954 U.S. Tax Ct. LEXIS 258">*273 in trust for his son and another like interest for his daughter. By subsequent amendments to the trust agreement petitioner increased the interest of his son's trust to 20 per cent. Gift tax returns were filed and gift taxes were paid for these gifts. The partnership agreement of May 1, 1943, executed by petitioner and his wife, was amended effective for February 1, 1944, and February 1, 1945, to account for the changes in the business interests. The amendments to the partnership agreement were executed by petitioner, his wife, and James M. Todd, as trustee, and Edward J. Miller. It should be pointed out that the trustee did not execute the May 1, 1943, partnership agreement which was executed by petitioner and his wife.

The partnership agreement of May 1, 1943, did not specifically call the trusts, the trustee, or the children, partners. It did provide, however, that the interests of the children would be subject to all claims of business creditors and further provided that James M. Todd, trustee for the children, would participate in two-tenths of the business profits or losses.

In determining whether the trusts were partners in the business for tax purposes we must look to1954 U.S. Tax Ct. LEXIS 258">*274 the activities of the trustee and the extent of the grantor's control over the trusts.

James M. Todd, the trustee, was an employee of the corporation, Denton & Company, and Harvey's, Inc. The Harvey Co., the partnership, continued him in its employment. While there is evidence that he held a responsible position in the partnership, the evidence only supports a finding that he acted as an employee. There is no showing 21 T.C. 1020">*1028 that Todd, the trustee, participated in the business as a representative of a partnership interest. In this respect the present case differs from such cases as ; , affd. (C. A. 9, 1954) ; , affd. (C. A. 9, 1954) ; and , where there were independent trustees well aware of their independence and responsibilities as fiduciaries. In the present case Todd as trustee could not even execute trust papers unless petitioner had given his written1954 U.S. Tax Ct. LEXIS 258">*275 approval.

When we consider the control petitioner as grantor exercised over the trusts, it is apparent that he retained control over the business as if the trusts were nonexistent. First, petitioner reserved the full power to remove any trustee and to appoint his successor; there is no restriction to the appointment of the petitioner himself as a trustee. The beneficiaries were not entitled to any current income; it was to be left in the business "to create for * * * [the beneficiaries] an estate which will increase with each year." In fact the beneficiaries were specifically prohibited from the use of the corpus or income for any purpose; however, the trust interests were subject to the claims of all business creditors, and the petitioner could pledge the trust interests for any business purpose. The petitioner could also authorize and direct the sale of the trust interests and the disposition of the funds received from such a sale. While the trusts were to terminate when the children were 30 years old, or within 10 years thereafter, there is no provision for the disposition of the trust interests at the termination of the trusts. The trusts were not irrevocable. All of these1954 U.S. Tax Ct. LEXIS 258">*276 facts show petitioner's real control over the trusts.

The inactivity of the trustee in the business as a partner, together with petitioner's retention of the incidents of ownership, forces us to conclude that the trusts were not partners in the business for Federal tax purposes. , affd. (C. A. 8, 1954) ; .

It might be argued that the trusts contributed capital to a business where capital was essential for the production of income; however, it should be remembered that the trusts did not contribute any original capital. The same argument was raised by the taxpayer in , affirming . There, on page 91, the court considered the agreement and concluded "that the trust's ownership of gift capital is not a contribution sufficient to offset the inferences to be drawn from the failure to contribute original capital or vital managerial services." The same conclusion is proper here. The respondent is sustained in his determination1954 U.S. Tax Ct. LEXIS 258">*277 that the trusts were not partners.

Since we have determined that the trusts were not partners, it is not necessary to discuss the applicability of , 21 T.C. 1020">*1029 to the present facts. Nor do we know of any reason which would require us to discuss the matter of estoppel as raised by petitioner, for in this case the validity of the gifts to the trusts did not control the determination that the trusts were not partners for Federal tax purposes.

Decision will be entered under Rule 50.