19 T.C. 1197">*1197 This proceeding involves the following deficiencies:

The issues are whether the respondent erred in disallowing as deductions (1) the amount of $ 278 in the year 1943 as an expense for Rotary Club dues and (2) $ 825, $ 1,000, $ 1,480, and $ 1,932.50 in the years 1942, 1943, 1944, and 1945, respectively, of the total compensation paid to Irwin Friedlander and Max Friedlander, and (3) whether petitioner's income for the years 1943, 1944, and 1945 should include the income of Louis Friedlander & Sons, an alleged partnership or, 19 T.C. 1197">*1198 in the alternative, whether certain deductions claimed by the petitioner for the years 1943, 1944, and 1945 are allocable to the alleged partnership. Other issues raised by the petition were conceded by the petitioner at the hearing.

FINDINGS OF FACT.

The facts set forth in a stipulation are1953 U.S. Tax Ct. LEXIS 207">*210 found as agreed to therein.

The petitioner, a Georgia corporation organized on August 19, 1929, has its principal place of business at Moultrie, Georgia. Its income and excess profits tax returns for the taxable years 1942 to 1945, inclusive, were filed with the collector for the district of Georgia.

Louis Friedlander, hereinafter for convenience sometimes referred to as "Louis," president of petitioner at all times since its organization, was the sole proprietor of a dry goods store at the place of business of petitioner in Moultrie, Georgia, from about 1909 to 1911, when he and his brother Nathan formed a partnership to conduct the business. In 1926 the business was incorporated and upon the organization of petitioner in 1929 assets received by Louis as a stockholder in dissolution proceedings of the corporation were acquired by petitioner.

In 1935 Louis transferred to each of six sons, Irwin, Malvin, Max, Richard, Herman, and Jack, without consideration, 125 shares of common stock of petitioner. A stock dividend paid December 1941 increased the holdings of each of the transferees to 175 shares.

Between June 30, 1943, and March 31, 1946, the petitioner's outstanding capital stock1953 U.S. Tax Ct. LEXIS 207">*211 consisted of 1,743 1/5 shares of common stock which was held as follows:

Louis and Esther Friedlander are husband and wife. I. B. Perlman is a brother of Esther and the husband of Fannye Perlman. R. L. Powell has been employed for many years by the petitioner as secretary and treasurer and has been in active charge of keeping its books of account1953 U.S. Tax Ct. LEXIS 207">*212 and other records. B. M. Cohen is a brother-in-law of I. B. Perlman and Esther. A. I. Halpert was not related to Louis or I. B. Perlman.

19 T.C. 1197">*1199 From June 30, 1943, to March 31, 1946, the stock of the United Investment Co. was owned as follows:

The United Investment Co. is mainly in the real estate business although it does some financing and lending of money on a small scale. It owns considerable real estate, most of which is in Moultrie, including the main store building of petitioner and The Fair Store building. Louis is secretary and treasurer of the company.

For a number of years prior to June 30, 1943, the petitioner operated a general merchandise business in a number of towns located in the southern part of Georgia and Alabama. The stores which the petitioner operated on June 30, 1943, were named and located as follows:

The Friedlander Corporation store included a wholesale department, a retail department, and an appliance department. Nettler's Hardware, a contiguous unit, was also operated as a department of the store. The stores in Douglas and Thomasville and the Smart Shop in Moultrie were ladies' ready-to-wear shops. The stores in Fitzgerald and Dothan stocked wearing apparel, piece goods, household furnishings, luggage, and other merchandise that could be sold promptly at medium prices. The Fair Store was an outlet store and sold only seconds and close-outs, mostly work clothes and shoes. It catered to the farm trade. Farmers Hardware in Tifton handled only hardware and houseware. Petitioner leased the buildings in which the out of town stores were operated. All units, except the Friedlander Corporation, were exclusively retail operations.

Upon entering the regular employment of petitioner in 1940, Irwin and Max endeavored to put into practice ideas for the conduct of the business, including the sale of some of the stores and opening some small ready-to-wear shops, which conflicted with those of Perlman, 1953 U.S. Tax Ct. LEXIS 207">*214 and as a result the sons and Perlman had quarrels, at times violent, about the matter, even though they recognized that Perlman got results. 19 T.C. 1197">*1200 The sons and Perlman informed Louis of the prevailing condition, and he sought to correct it by a more definite assignment of duties for each so that there would be less personal contact. At one time a decision was reached to sell some of the stores and probably open one or two other stores to experiment with the ideas of Max and Irwin. By the time the sons entered the Navy, Perlman was practically in charge of the stores located outside of Moultrie and the sons were kept busy in the Moultrie stores. Perlman considered that his financial interest in petitioner was more important than his personal differences with them as to how the business of petitioner should be conducted. The differences between them were settled by Louis in a manner very satisfactory to Perlman before the sons entered the military service.

Separate books of account were kept for each department of the petitioner's stores in Moultrie, Georgia, and for each of its stores located in other towns. The net profit from each operation was computed separately prior1953 U.S. Tax Ct. LEXIS 207">*215 to July 1, 1943, and then consolidated for tax purposes.

Irwin, Max, and Malvin served in the armed forces as follows:

Irwin and Max returned from the service in November 1945 on terminal leave.

On July 16, 1942, Irwin, Max, and Malvin executed an instrument the terms of which gave their father general powers of attorney. The instrument was recorded on December 11, 1943. In 1944 the sons executed supplemental powers which contained a general ratification of acts of their father under the July 16, 1942, powers of attorney.

On about three occasions prior to July 1, 1943, commencing about September 1942, Louis discussed with petitioner's outside accountant and tax consultant the question of forming another organization to acquire some of petitioner's stores. Louis preferred to organize a corporation but being interested in reducing tax liability on any profits inquired, about June 1, 1943, whether there would be less tax liability if the stores were owned by a partnership. The accountant informed him that there would be and Louis then instructed the accountant to form1953 U.S. Tax Ct. LEXIS 207">*216 a partnership as soon as possible. The accountant promptly prepared a rough draft of articles of copartnership and delivered it to petitioner's attorneys for completion. Louis informed him of the interest to assign to each of the contemplated partners. The accountant did not discuss the formation of a partnership or terms of a partnership agreement with any person other than Louis and petitioner's attorneys. Louis was never present when the subject was discussed 19 T.C. 1197">*1201 by the accountant with petitioner's attorneys. Petitioner's income tax return for 1942 was filed on April 15, 1943, and was signed by Louis as president.

On or about July 1, 1943, Louis and Perlman and their wives and Irwin, Max, and Malvin executed an instrument, the terms of which recite, among other things, that they agreed to form a partnership to conduct a general retail merchandise business under the name of Louis Friedlander & Sons, hereinafter for convenience only to be referred to as the partnership; the interest of Louis and Perlman and their wives in the assets and profits and liability for losses to be 10 per cent each and 20 per cent for each of the other individuals. The instrument provided that1953 U.S. Tax Ct. LEXIS 207">*217 "From time to time the partners shall have such drawing accounts and such disbursements shall be made of the assets of the partnership, either division of profits or capital assets, as may be mutually agreed upon by the partners" and that in the management of the business Louis "shall be the Business Manager and Treasurer for the partnership with full authority to make purchases, incur obligations, make loans, secured or unsecured according to his judgment, and do any and all other acts incident, convenient and necessary to the conduct of the business." The agreement was to be effective for 5 years unless the partnership was dissolved as provided for in the instrument or by operation of law. Provisions in the instrument gave heirs or personal representatives of a deceased partner an election to continue as a partner and terms for the purchase of the interest of a deceased or retiring partner by the other partners. The instrument could not be amended without agreement of all of the designated partners.

All parties signed the agreement except Malvin, who was then in New Caledonia, and Louis acted for him under the power of attorney he held. Malvin did not personally participate in1953 U.S. Tax Ct. LEXIS 207">*218 the discussions leading up to the formation of the partnership and Max had no part in the decision to form a partnership. Irwin did not discuss any division of petitioner's business with his father until after he entered the Navy.

The primary motive for forming the partnership was to reduce tax liability.

On July 1, 1943, Max was in Norfolk, Virginia, Malvin was in New Caledonia, and Irwin was in Boston. On or about July 1, 1943, Louis, acting under the general powers of attorney, sold to petitioner at its par value of $ 17,500 the 175 shares of stock Max, Malvin, and Irwin each held in petitioner. Irwin did not make an investigation to determine the value of the stock or take part in the transaction. The stock had a value in excess of its par value. Petitioner's checks payable to the order of each seller bore the date of July 1, 1943. In July 1943 the checks were endorsed by Louis, acting under the powers of 19 T.C. 1197">*1202 attorney he held, and delivered to the partnership as loans from his sons. As evidence of the loans the partnership issued its notes dated July 1, 1943, and maturing in 6 months with interest at the rate of 6 per cent. Irwin did not know that a note was issued1953 U.S. Tax Ct. LEXIS 207">*219 to him. The checks were deposited by the partnership and paid by the bank on July 31, 1943. The sales of stock and loans were a part of the plan to organize the partnership. The original deposit pass books of the partnership disclosed the following other deposits in its bank account during the month of July 1943:

The partnership purchased as of July 1, 1943, for $ 111,718.90 the assets and assumed the liabilities of the stores belonging to the petitioner, except the Friedlander Corporation, Nettler's Hardware and Famous stores, in payment of which it gave its check for $ 52,500 and a note, dated July 1, 1943, in the amount of $ 59,218.90 for the balance. Nettler's Hardware was retained by petitioner because of the location and close connection with the main store.

The note for $ 59,218.90 was paid by November 24, 1943, and the amount borrowed from Max, Malvin, and Irwin was paid with interest on August 14, 1945. The amount of $ 17,500 received by each of the sons was immediately loaned to the United Investment Co. All of these transactions were handled by Louis acting through powers of attorney. The indebtedness1953 U.S. Tax Ct. LEXIS 207">*220 of the United Investment Co. to the sons is renewed each year and a new note is issued for the interest and principal.

Physical inventories were taken of each store on or as of July 1, 1943, and the merchandise therein was transferred to the partnership at the invoice cost price of $ 91,273.81. At that time the stores had an ample stock of scarce goods, no more than a normal amount of which was obsolete and unsalable. Merchandise then available in the open market was mostly of inferior quality. Accounts receivable were transferred for three-fourths of face amount, or $ 8,682.03, which was a very high price. Less than 50 per cent of the amount of the receivables was collected by the partnership. The fixed equipment sold to the partnership was transferred at book value, except equipment at The Fair Store and Fitzgerald store which was fully depreciated and was transferred for $ 500 each. The partnership agreement was recorded in all of the counties in which the stores were located. The recordation respecting three of the stores was made on July 2, 1943.

When merchandise was placed in the stores of petitioner for sale, the invoice cost price was increased 20 per cent because of1953 U.S. Tax Ct. LEXIS 207">*221 sales to 19 T.C. 1197">*1203 clerks in the stores. Petitioner determined that the mark-up on sales to clerks was necessary to enable it to recover its entire cost of the goods.

There were no corporate minutes of the petitioner with reference to any matter during the period 1942 to 1946, inclusive, other than one entry pertaining to Office of Price Administration certificates.

Subsequent to June 30, 1943, and until March 31, 1946, the operations of the stores acquired by the partnership were recorded on the books of account of, and disclosed on information returns filed by, the partnership.

During the period beginning June 30, 1943, and ending March 31, 1946, separate books of account were maintained by the petitioner and the partnership. The petitioner's books were kept and its tax returns were filed on the accrual and a calendar year basis. The books of account and tax returns of the partnership were kept and filed on the accrual basis and a fiscal year ending June 30.

On July 1, 1943, the approximate net worth of Esther, Louis, Max, Malvin, and Irwin Friedlander, and I. B. Perlman was as follows:

1953 U.S. Tax Ct. LEXIS 207">*222 The partnership made purchases from the petitioner during the fiscal years ended June 30, 1944, and June 30, 1945, and the taxable period ended March 31, 1946, in amounts as follows:

The sales were made at 5 per cent over invoice cost to petitioner, without adjustment for discount taken by petitioner in connection with the purchase of the goods, which averaged about 2.68 per cent. Sales of similar merchandise were generally made by petitioner to other purchasers at prices computed by the same method.

The total wholesale sales of the petitioner for the years in question were as follows:

19 T.C. 1197">*1204 The store managers have always been responsible to both Perlman and Louis Friedlander, but Perlman was in actual contact with the units more than was Louis Friedlander.

Most of the merchandise in the stores was purchased by the store managers under the supervision of Perlman. The hardware stores buy almost all of their merchandise direct from the1953 U.S. Tax Ct. LEXIS 207">*223 trade. Of the total sales volume of wearing apparel, 65 per cent was of women's apparel. There is considerably more work involved in women's ready-to-wear due to the change in fashions.

The partnership maintained its principal bank account at Moultrie National Bank, Moultrie, Georgia, until March 31, 1946. There was no signature card in the bank files for the account. All of the checks drawn on the account were signed either by Louis Friedlander, R. L. Powell, or I. B. Perlman.

Louis Friedlander exercised control over the affairs of the petitioner and the partnership. Prior to July 1, 1943, most of the duties consisted of handling financial matters. Only a small part of his time was devoted to merchandising. Other services were performed in supervising some of the departments of petitioner, principally the hardware department.

In 1940, when Max and Irwin entered the regular employment of petitioner, the business of petitioner was divided. Louis took charge of and did the buying for the men's department and was assisted by Max. Perlman took over and did the buying for the women's department, assisted by Irwin. Subsequent to July 1, 1943, Louis' duties were substantially the1953 U.S. Tax Ct. LEXIS 207">*224 same.

Perlman has been associated with the business continuously since about 1918 and has been a particularly useful employee and officer. Prior to July 1, 1943, he was practically in charge of the ladies' departments and stores outside of Moultrie and devoted a considerable part of his time to the work. He also was the "merchandise man," i. e., he bought ladies' apparel, did supervisory work, planned sales and performed other allied work and at all times important did most of the merchandising work for petitioner and the partnership. His duties were substantially the same after July 1, 1943, except that he spent more time in Moultrie on account of the absence of Max and Irwin in the service. Perlman normally went to the markets in New York, Baltimore, Philadelphia, and Atlanta a total of four to seven times a year. He did not have a regular, monthly travel expense allowance as did Louis, but was reimbursed for actual expenditures by the petitioner. He traveled to and from the partnership stores in his personal car and sometimes in the petitioner's car, gasoline rationing being a factor in the use of his personal car during the war.

Max was born in 1920. He worked in the business1953 U.S. Tax Ct. LEXIS 207">*225 during spare time from the time he was a young boy. By 1940 he had considerable 19 T.C. 1197">*1205 knowledge of the business. Max was graduated from Duke University in June 1940 and thereafter returned to Moultrie and went to work in the men's department of the store on a full time basis and had some charge of the department. He enlisted in the Navy in August 1942 and after about 4 months of duty in the United States was assigned to convoy duty for 6 months, during the course of which he reached a port in this country about every 5 weeks. Thereafter he was stationed at Norfolk. After Max returned from the service about the middle of November 1945 he took over the buying and merchandising of the men's department in the partnership stores. He was also placed in charge of a men's ready-to-wear store in Thomasville, which included the negotiation of a lease for the building and purchase of merchandise. The manager of the store was placed under his supervision.

Irwin was born in 1916 and is the oldest son of Louis. He has performed services of some kind for the Friedlander enterprises since he was about 8 years of age. The nature of the work assigned to him depended upon his age and ability. 1953 U.S. Tax Ct. LEXIS 207">*226 By the summer of about 1935 when he was in his junior year at Duke University he was engaged in sales work. He opened the store at Dotham, Alabama, the next summer and operated it until September of that year. Upon graduation from Duke University in 1937 he went to work with L. Bamberger Co. of Newark, New Jersey, a branch of R. H. Macy & Co., for the purpose of obtaining experience in modern merchandising. After working 2 years with that company as salesman and assistant buyer, he returned home for a couple of months but returned to New York City after persuading his father to change the petitioner's account to the buying firm in New York City which was then employing him.

Irwin worked regularly for the petitioner from about March 1, 1940, until December 27, 1942. His ambition was eventually to be placed in charge of the entire business. During the first year he was an assistant to Perlman in the ladies' department. Thereafter he was supposed to take over the duties of Perlman in petitioner's store and Perlman was to take charge of the stores in the field. Instead he had complete charge of the toy department, worked with Max in advertising and Perlman in the ladies' departments, 1953 U.S. Tax Ct. LEXIS 207">*227 did some buying and exercised some supervision over the personnel of the women's departments. Upon entering the Navy in January 1943 he was first assigned to duty in Charleston, South Carolina, for 13 weeks, and then to Harvard University for about 4 months. He returned home twice while at Charleston but at no time thereafter until he returned from the service about the middle of November 1945. He has been associated with the business at all times since then. When Irwin reentered active employment after his discharge from the Navy, he 19 T.C. 1197">*1206 resumed his former duties. At that time his father was in charge of all the men's departments and Perlman was in charge of all the women's departments.

Malvin, during all of the taxable years, was a musician and did not render any services or devote any time to the business of petitioner or the partnership.

On one or more occasions after July 1, 1943, petitioner depleted its stock of letterhead stationery. On February 7, 1948, R. L. Powell wrote a letter as a representative of petitioner on letterhead stationery of petitioner containing the following:

The Friedlander Corporation

Jobbers, Commission Merchants

Chain Store Operators

Kern, J., dissenting: Two things1953 U.S. Tax Ct. LEXIS 207">*249 should be stressed in a consideration of this case: (1) it does not present the usual "family partnership" question, and (2) it does not involve the application of section 45 of the Internal Revenue Code, under which the Commissioner might allocate income or deductions between the corporation and the partnership in order to clearly reflect the income of both, but involves the application of section 22 (a). In order to reach the result reached by the majority herein it is necessary to conclude that there was, in reality, no partnership in existence during the taxable years, regardless of who the partners were. For example, it would not be enough to conclude that the Friedlander sons were not bona fide partners; it would be necessary to conclude that there were not any bona fide partners, and that even a partnership composed of Louis Friedlander and Perlman was a sham and without reality.

19 T.C. 1197">*1216 My interpretation of the facts is that a partnership was formed by some of the petitioner's stockholders, that petitioner transferred certain of its assets to the partnership, that the partnership paid petitioner for these assets, that the partnership used these assets in the conduct1953 U.S. Tax Ct. LEXIS 207">*250 of the business for which it was formed, that the partnership actively carried on a business during the taxable years, that the income from this business was distributed to the partners, that petitioner corporation did not earn or receive this income, and that the assets of the partnership eventually went into the hands of another corporation, none of the stock of which was owned by petitioner. This being my interpretation of what I consider to be the pertinent facts, I am unable to agree with the conclusion of the majority that the partnership was a sham.

The reality of a business organization is not to be tested by the motive leading to its formation, but by the purpose which it accomplishes and performs. See , affd. . In the instant case, where the partnership took over a business and operated it for several years, it would appear to me to have been formed for a business purpose even though the motive of the individuals leading to its formation was to minimize taxes.

The fact that the partnership acquired its assets from petitioner at a more reasonable price than1953 U.S. Tax Ct. LEXIS 207">*251 it could have acquired similar assets from another source and the fact that the partnership was not composed of all of petitioner's stockholders seem to me to be immaterial. Even though it be granted arguendo that the partnership was conceived in iniquity, nevertheless, it was conceived and came into being, and, in my opinion, it can not be disregarded as never having been in existence.

The case of , affd. , and the Buffalo Meter Co. case, the Chelsea Products, Inc., case and the Palm Beach Aero Corporation case, cited in the majority opinion, appear to me to be in basic conflict with the result reached by the majority herein. I therefore respectfully note my dissent.