17 T.C. 1399">*1399 Respondent determined deficiencies in income tax for 1946 against petitioners as follows:

Petitioners assign as error respondent's1952 U.S. Tax Ct. LEXIS 267">*268 determination that proceeds they received upon transfers in May and October 1946 of preferred stock to their wholly owned corporation constituted a dividend under section 115 of the Internal Revenue Code.

FINDINGS OF FACT.

Petitioners G. E. Nicholson and J. B. McGay, the husbands, and the other petitioners, their respective wives, were residents of Tulsa, Oklahoma, during 1946 and all filed separate individual income tax returns for that year with the collector for the district of Oklahoma.

17 T.C. 1399">*1400 In January 1932 petitioners G. E. Nicholson and J. B. McGay formed a corporation to manufacture contract items, including wash boilers, hair curlers, and oil field control instruments. Parking meters were added in 1934 to the items manufactured.

In December 1940 the form of operation was changed to that of a partnership known as the Macnick Company, hereinafter sometimes referred to as the company. In January 1941 each made a gift to his wife of a one-fourth interest in the company.

Because of wartime limitations the company discontinued production of parking meters in June 1942. During the war years it manufactured fuses for the United States Army and aircraft parts for the United1952 U.S. Tax Ct. LEXIS 267">*269 States Navy.

About the time of the termination of its war contracts the company began designing for resumption of parking meter production. In August 1945 a sales corporation known as the Magee-Hale Park-O-Meter Company, hereinafter sometimes referred to as sales company, was organized to sell and service the meter. One-half of the stock was owned by Magee and Hale and the other half owned disproportionately by petitioners.

Sales of meters were to municipalities generally pursuant to a plan providing that payment be made from 50 per cent of meter collections. Business was competitive and sales were procured by submission of bids. To insure performance of the sale contract the sales company was often required to submit a "bid bond" and evidence of financial responsibility; the latter being satisfied generally by a balance sheet indicative of stability. In the early post war period because of the poor financial condition evidenced by the sales company's balance sheet a combined Macnick Company and sales company balance sheet was submitted.

On November 30, 1945, the Macnick Company's balance sheet listed current assets of $ 75,942.30 as compared to current liabilities of $ 86,097.781952 U.S. Tax Ct. LEXIS 267">*270 which latter figure included a notes payable item of $ 80,000. By about the last week in December 1945 additional borrowings increased this notes payable indebtedness to $ 110,000.

Partly because of the risk involved in the business of manufacturing the parking meters for sale and their individual liability as partners, petitioners decided to change the company's mode of operation from the partnership to the corporate form.

To improve the company's unfavorable balance sheet petitioners, in preparation for incorporation of the company, decided to borrow money to pay off part or all its notes payable. They consulted their banker, informing him that it was their desire that the money they proposed to borrow and then advance to the company to retire the outstanding notes payable be treated as a loan to the company and 17 T.C. 1399">*1401 they as its creditors. The banker agreed to loan money for that purpose on assurances that the proposed loans by petitioners to the company would not take precedence over the bank's loans thereafter to the company. Because of this condition and their desire to reduce the current liabilities of the proposed, corporation petitioners decided that their transfer1952 U.S. Tax Ct. LEXIS 267">*271 of money to the company be considered as in exchange for preferred stock to be issued by the proposed corporation. Pursuant to this plan each petitioner borrowed $ 25,000 from the bank on December 28, 1945, secured by pledges of their respective personal assets and evidenced by their individual promissory notes, and with the proceeds paid off the company's notes payable account within the year.

On January 2, 1946, all assets of Macnick Company, the partnership, with the exception of the plant building and an apartment house, were transferred to the Macnick Company (hereinafter referred to as Macnick), a corporation organized under the laws of the State of Oklahoma on December 7, 1945. The partnership was dissolved. In exchange for the transfer of its assets petitioners as equal partners each received 250 shares of preferred stock with a par value of $ 100 and 350 shares of common stock with a par value of $ 10. The rights of petitioners as preferred stockholders as recorded on the stock certificates, included the following:

The owners of Preferred Stock of this corporation are entitled to receive out of the net earnings thereof a fixed non-cumulative dividend at the rate of interest1952 U.S. Tax Ct. LEXIS 267">*272 not exceeding six per centum per annum, payable semiannually, before any dividend whatever can be paid upon the Common Stock, and in case of liquidation or dissolution of the Corporation, the owners of the Preferred Stock shall be paid in full both the par value of their shares and any current dividend thereon, before any amounts shall be distributed to the owners of the Common Stock.

This Preferred Stock Certificate shall be subject to redemption at the option of the Corporation at any time upon sixty days written notice by the Corporation, at the price of $ 102.00 per share, plus current dividends thereon.

In March 1946 in settlement of an account owing to it by the sales company, Macnick acquired $ 24,000 of that company's Class B preferred stock. Petitioners obtained a short term bank loan of $ 24,000 in May 1945, and purchased the sales company stock. Within two or three days Macnick, using this $ 24,000, redeemed 60 shares each of petitioners' Macnick preferred stock at $ 102 a share.

Minutes of the special meeting which record the resolution authorizing the purchase read, in part, as follows:

The Chairman called attention to the current cash position of the company and reviewed1952 U.S. Tax Ct. LEXIS 267">*273 in detail the current statement of assets and liabilities pointing out that the company was in a favorable position to purchase two hundred and forty (240) shares of the outstanding preferred stock. * * *

17 T.C. 1399">*1402 On October 23, 1946, an additional 400 shares of Macnick preferred stock were redeemed, 100 shares of each petitioner, at $ 102 per share. Petitioners' proportionate ownership of preferred stock remained identical after both the May and October redemptions.

In December 1946 petitioners sold part of their remaining preferred stock to certain employees of Macnick. G. E. Nicholson and Bonnie McGay sold 60 shares each; Oma M. Nicholson and J. B. McGay sold 40 shares each. In each instance the consideration received was $ 100 a share.

Petitioners' total proprietary interest at the organization of Macnick amounted to $ 114,056.36, classified as follows: $ 100,000 represented by preferred stock, $ 14,000 by common stock, and $ 56.36 in surplus.

In 1946 Macnick paid no dividends on common stock, but paid $ 2,280 in dividends on preferred stock. Its income and declared value excess-profits tax return filed for the fiscal period January 1 to and including September 30, 1946, 1952 U.S. Tax Ct. LEXIS 267">*274 listed net income of $ 103,376.50. Its income tax return filed for the fiscal period October 1, 1946, to and including May 14, 1947, listed net income of $ 240,643.35.

In their respective individual income tax returns filed for 1946, petitioners G. E. and Oma Nicholson each reported gain of $ 120 on the redemption in May of 60 shares of the Macnick corporation preferred stock and a gain of $ 200 on the October redemption of 100 shares of preferred stock, 50 per cent of which latter figure was included in taxable income. Petitioners J. B. and Bonnie McGay reported a combined total of $ 640 gain received on both stock redemptions before a division as community property, of which $ 320 each was reported in their respective individual income tax returns.

Respondent determined petitioners' individual tax liabilities, eliminated the reported capital gain from their respective net incomes, and added as a taxable dividend the total proceeds of $ 16,320 each received on the May and October transfers to Macnick.

OPINION.

The purpose of section 115 (g), ¹ Internal Revenue Code, has been elaborated elsewhere, see Pearl B. Brown, Executrix, 17 T.C. 1399">*1403 26 B. T. A. 901, 906,1952 U.S. Tax Ct. LEXIS 267">*275 affd. (C. A. 7), 69 F.2d 602, certiorari denied 293 U.S. 570">293 U.S. 570; Elwood W. McGuire, 32 B. T. A. 1075, affd. (C. A. 7), 84 F.2d 431, certiorari denied 299 U.S. 591">299 U.S. 591, and cases cited; and need not here be restated. Nor will it aid this inquiry to trace the plethora of cases cited by the parties in the search for a definite and useful yardstick determinative of its application. ²

It is abundantly clear from the facts that petitioners by retiring the notes payable indebtedness of Macnick, the partnership, preparatory to formation of Macnick, the corporation, intended to substitute themselves instead of the bank as creditors of the partnership and of the corporation. Contrary to the usual case involving section 115(g) in which the initial capitalization effected a conversion of earned surplus or undivided profits into capital stock, cf., e. g., Flanagan v. Helvering (C. A. D. C.), 116 F.2d 937, the securities in this case were issued to evidence the transfer to Macnick -- via the partnership and by the retirement of the latter's notes payable indebtedness -- of $ 100,000 by these petitioners. "* * * If the fund for distribution was a part of the capital contributed by the shareholders1952 U.S. Tax Ct. LEXIS 267">*277 to be used in the actual business of the corporation, its distribution in whole or in part would of course be liquidation * * *." Hyman v. Helvering (C. A. D. C.), 71 F.2d 342, certiorari denied 293 U.S. 570">293 U.S. 570. Here was no preconceived plan to drain off fat profits accumulated over a period of years in the form of capital gain; but, to the contrary, applying any of the recognized tests, see James F. Boyle, 14 T.C. 1382, affd. (C. A. 3) 187 F.2d 557, certiorari denied 342 U.S. 817">342 U.S. 817, the present transaction was most analogous to the partial recovery by petitioner shareholders of capital loans which were found to be unnecessary although founded in sound business caution. "As the taxpayer may not, in view of the statute, avoid the tax by an artificial device of empty forms * * * so the Government may not * * * impose a tax merely because there has been a stock redemption, where the circumstances are free from artifice and beyond the terms and fair intendment of the provision." Pearl B. Brown, Executrix, supra, 907.1952 U.S. Tax Ct. LEXIS 267">*278

Because petitioners are willing to concede ³ ordinary income treatment as essentially tantamount to interest of the so-called premium of $ 2 received on retirement of each security, respondent's determination to that extent is sustained without the necessity of extended discussion of that aspect of the controversy.

Decision will be entered under Rule 50