24 T.C. 179">*180 The Commissioner determined deficiencies as follows:

1955 U.S. Tax Ct. LEXIS 191">*193 The issues for decision are (1) whether payments on notes of a new corporation, issued for property transferred to it, were dividends, as determined by the Commissioner, or (2) whether the Commissioner has properly pleaded and proven as an alternative issue the contention that the petitioners realized gain in 1946 as a result of transferring partnership assets to a corporation in exchange for stock and other property (notes) in a transaction coming under section 112 (c) (1) of the Internal Revenue Code.

FINDINGS OF FACT.

The petitioners filed returns during the taxable year with the collector of internal revenue for the first district of New York.

Celia Tauber is the wife of Rudolf and Sheldon is their son. Myrtle is Sheldon's wife, and Rose is a sister of Rudolf.

Rudolf founded the business involved herein in 1909 and 1910 and has been engaged therein ever since. The business consists of doing finishing for the printing and lithographing trade. The work comes to this business in the form of printed or lithographed sheets of paper which must be cut, folded, bound, etc., into various forms such as books, pamphlets, pop-up books, cut-outs, etc. The business was conducted under corporate1955 U.S. Tax Ct. LEXIS 191">*194 form from about 1926 to 1943. A limited partnership was organized on October 21, 1943, in which Rudolf and Sheldon were general partners and Celia and Rose limited, or special, partners. That agreement is not in evidence. The business was continued 24 T.C. 179">*181 as a partnership under the agreement as amended until April 1, 1946, at which time a corporation known as Tauber's Bookbindery, Inc. (hereinafter called the corporation), was formed.

The minutes of the corporation state that the partners, on or about March 30, 1946, made an offer to sell the assets and business of the partnership to the corporation at a price equivalent to their net worth as of March 31, 1946; the purchase price was to be paid to the partners in proportion to their respective interests in the partnership assets; the obligation to pay the purchase price was to be evidenced by promissory notes of the corporation made to each partner in the amount due him; the corporation was to pay $ 8,000 per month on the notes until April 1, 1947, when the entire balance was to become payable; and the deferred payments were to bear interest at 4 per cent. The corporation accepted the offer and issued its notes dated April 1955 U.S. Tax Ct. LEXIS 191">*195 1, 1946, as follows, for the purchase price:

The partnership, on its closing balance sheet for March 1946, showed assets in the total amount of $ 485,399.57, liabilities of $ 77,153.49, and net worth of $ 408,246.08. The assets included loans receivable due from individual partners in the amount of $ 187,361.79 which were not transferred to the corporation but were charged against the capital accounts of the partners. All of the other assets subject to the liabilities, as shown on the balance sheet, were transferred to the corporation. Subtracting the loans due from individual partners from the assets and making other stipulated adjustments leaves a net worth of $ 209,464.10, but due to a mathematical error the parties used $ 209,453.38 in computing the amount of the notes. The assets transferred to the corporation included accounts receivable of $ 31,763.69, cash of $ 31,520.96, and government bonds in the amount of $ 105,187.50. The balance sheet did not reflect any "assets called good will (including in that term for present purposes excess of1955 U.S. Tax Ct. LEXIS 191">*196 actual value over book value, value as a going business, backlog of orders, backgrounds and experience, and other factors not reflected in book value of tangible assets) etc."

The corporation issued to each of the four Taubers "25 shares of its capital stock for $ 1.00 per share."

Existing business conditions and prospects for future business conditions for the partnership were excellent at the time of the transfer. The partnership at that time had orders for over $ 500,000 worth of business. The fair market value of the assets and business transferred to the corporation at the time of the transfer was at least $ 150,000 in 24 T.C. 179">*182 excess of the total asset values then shown on the books of the partnership and of the corporation.

The operations of the corporation were profitable from the beginning.

The four individuals agreed on April 1, 1947, to extend the due date of the notes and, at some time not shown by the record, waived the payment of interest thereon. The corporation carried the notes on its books as liabilities and paid thereon $ 116,520.92 prior to April 1, 1947, $ 49,238.79 prior to April 1, 1948, and $ 43,743.67 during the next 6 months.

Celia and Rose, as limited1955 U.S. Tax Ct. LEXIS 191">*197 partners, contributed to the partnership in 1943 the interest which they as stockholders had received from the former corporation by virtue of their stock ownership therein and their interests as limited partners were of the agreed value of $ 15,154.96 and $ 5,051.93. Their basis for those contributions is not shown by the record. The interests of the four partners were in no sense equal in the beginning. The partners entered into an agreement dated May 1, 1945, which amended a paragraph of the October 21, 1943, agreement relating to the sharing of profits by providing that after May 1, 1945, the paragraph would --

provide that after paying all expenses of the partnership, including the drawings of RUDOLF and SHELDON, and the payment to CELIA and ROSE of 6% of their capital contribution, and the division of the first $ 15,000.00 of profits between CELIA and ROSE, all remaining profits shall be divided equally among all of the partners instead of as provided in said agreement, so that each of the parties hereto shall receive 25% of said remaining profits.

and losses would be shared equally.

The following is also from paragraph 4 of the agreement:

the value of the partnership1955 U.S. Tax Ct. LEXIS 191">*198 interests hereinabove allocated shall be computed upon the following formula or basis: the net worth of the partnership as of the end of said fiscal year [March 31, 1945] plus 25% of the net profit (as hereinafter defined) realized by the partnership during said fiscal year shall be deemed and defined as the total present value of the partnership interests. "Net profit" shall be defined as the balance of the profits of the partnership business for the fiscal year ending March 31, 1945 after deducting all expenses of the partnership including the $ 10,000. drawings of SHELDON and RUDOLF, and the 6% paid or payable to CELIA and ROSE on their capital contribution. The item of the first $ 15,000. of the profits divided between CELIA and ROSE shall not be deducted in computing the net profits above defined but shall be included therein.

The agreement provided in paragraphs 5, 6, and 7 that Rudolf agreed to sell Rose 19 per cent, Celia 5 per cent, and Sheldon 5 per cent, of his interest in the partnership, to increase the interest of each of the three to 25 per cent. Each was to pay to Rudolf a price equal to the value of the percentage purchased as above computed, except that up to 1955 U.S. Tax Ct. LEXIS 191">*199 $ 30,000 the transfer to Sheldon was to be a gift. The record 24 T.C. 179">*183 does not show whether or not the parties carried out the purchase provisions of that agreement or what amounts, if any, were paid to Rudolf in that connection.

A balance sheet for March 31, 1945, is in evidence but it does not show the information necessary for the computation of prices required by paragraph 4 of the agreement.

The record does not show the amount or the bases of the contributions of the general partners to the partnership under the agreement of October 21, 1943, or the basis to any one of the partners of his or her interest in the partnership as of the end of March 1946.

The stipulation of facts is incorporated herein by this reference.

OPINION.

The principal argument made by the Commissioner in this case is in support of his determination that the notes were actually evidence of capital contributions and the payments thereon were taxable dividends. He contends that the transfer of the assets and the receipt of the notes was not a sale, as the petitioners contend, but was a contribution of capital since otherwise there would have been capital of only $ 100 in relation to indebtedness of $ 209,453.38, 1955 U.S. Tax Ct. LEXIS 191">*200 in other words "thin" capital inadequate for the purposes of the business. It will be demonstrated that there was here no "thin" capitalization, although the importance of "thin" capitalization in this case is not readily apparent.

The four partners decided to incorporate their business in 1946 and adopted a plan for that purpose. They knew that the assets of their business were worth substantially more at that time than the value of assets shown on their books. They fully intended to transfer that excess value to the corporation as a part of the whole transaction. The partnership carried on its books at March 30, 1946, loans to the partners in the total amount of $ 187,361.79 which, if offset against the capital accounts of each partner carried on the books of the partnership, would reduce the latter to a total of $ 209,464.10, made up of unequal net amounts to which the four partners would have been entitled.

They decided to equalize this situation in connection with the creation of the corporation, and for that purpose subtracted the loans from the capital accounts and had the corporation issue its notes equal to the balance then remaining in the capital account of each partner. 1955 U.S. Tax Ct. LEXIS 191">*201 The transfer of all of the other assets after elimination of the loans to partners, to the corporation, as an integral part of the plan, had the intended effect of contributing to the actual capital of the corporation the excess of the actual value of the transferred assets over $ 209,464.10. The evidence shows that that excess was a substantial amount, probably 24 T.C. 179">*184 in excess of $ 150,000. Thus, the initial capital of the corporation was not merely the $ 100 of cash paid in by the four individuals and shown as capital on the books of the corporation, but was a much larger amount not shown on its books which was nevertheless available as working capital. The total capital of the new corporation could not fairly be called "thin."

The intention was to have the corporation pay the equalizing notes within a relatively short time and it actually paid them, $ 116,520.92 within 1 year, $ 49,238.79 within 2 years, and the balance within 2 1/2 years of the transfer of the business from the partnership to the corporation. Those payments made up for the fact that some partners had withdrawn or borrowed more from the partnership than others. The Commissioner does not suggest that the1955 U.S. Tax Ct. LEXIS 191">*202 satisfaction of the debts or the earlier withdrawals were taxable transactions or that equalizing withdrawals would have been taxable transactions, and his argument that the equalizing payments were taxable as dividends, thus taxing the four partners in inverse proportion to their debt satisfactions and withdrawals, is not persuasive. The notes evidenced amounts owed and cannot be regarded as evidence of capital of the corporation. The facts in this case amply distinguish it from those cited by the Commissioner in which evidences of indebtedness issued by a corporation were held to be the equivalent of stock because of thin capitalization, that is, unreasonable disproportion between the amount of stock and the amount of other securities issued by a corporation for property.

The Commissioner is thus left with nothing to support the deficiencies which he determined. He argues, in that event, that there was an exchange which would have been within section 112 (b) (5)¹ except that property other than stock (notes) was received by the transferors and the resulting gain to the transferors is recognized for tax purposes under section 112 (c) (1)² to the extent of the value of the 1955 U.S. Tax Ct. LEXIS 191">*203 other property, the notes. He does not contend that the amounts are taxable on any other theory and the Court will consider no other. Counsel for the petitioners, by amendments at the hearing, substituted a new paragraph, 5 (r) of the petitions, claiming that assets of a value in excess of book value had been transferred to the corporation 24 T.C. 179">*185 to give it capital in excess of the $ 100 paid in cash for shares, and counsel for the Commissioner stated that he had no objection to the amendments, would file denials, and would file amended answers to raise an alternative issue. The nature of his amendment was not clear, but the trial proceeded without objection. The actual amended answers were filed several days after the hearing and contained the following upon which the Commissioner relies to raise an alternative issue:

If it should be judicially determined that in 1946 the partnership assets were transferred to the corporation in exchange for the alleged "notes" plus stock and that the payments on the alleged "notes" did not constitute a distribution of income, contrary to respondent's determination, then a taxable exchange occurred in 1946 and any gain to petitioner from the1955 U.S. Tax Ct. LEXIS 191">*204 transaction should be recognized in accordance with section 112 (c) of the Internal Revenue Code.

The Commissioner also moved, in those amended answers, for any increased deficiencies which might result under the alternative contention.

1955 U.S. Tax Ct. LEXIS 191">*205 The Commissioner must properly plead and prove any such alternative issue as the one he has in mind, which is upon a new theory different from and inconsistent with his determination of the deficiencies. Hull v. Commissioner, 87 F.2d 260; Estate of William Beale Hibbs, 16 T.C. 535 (1951); John O. Fowler, 40 B. T. A. 1293, reversed on another point (C. A. 6, June 25, 1941); Constance McCormick, Executrix, 38 B. T. A. 308 (1938); Security First Nat. Bank of Los Angeles, Executor, 36 B. T. A. 633 (1937), appeal to C. A. 9 dismissed 99 F.2d 1000; Rule 32 of the Rules of Practice of the Tax Court of the United States. Both the pleadings and the brief of the Commissioner on this alternative point are superficial and inadequate. They do not state the facts necessary to make a case and, furthermore, the record does not disclose the required facts to justify the determination of any deficiencies on this new theory. For example, the Commissioner has failed to plead or prove that the stock issued to each1955 U.S. Tax Ct. LEXIS 191">*206 partner was "substantially in proportion to his interest in the property prior to the exchange," the basis of each partner for gain in the transaction, and the amount of "any gain" realized.

The notes received by the petitioners were not "securities in such corporation" within the meaning of section 112 (b) (5), but could be "other property" within the meaning of section 112 (c) (1). The petitioners contend that section 112 (c) (1) does not apply because it was stipulated that the stock was issued for cash and the evidence shows that the assets were sold to the corporation in a separate transaction for no gain. The Commissioner, however, may properly regard the issuance of the stock and the transfer of the assets as integral parts of a single plan for income tax purposes, but nevertheless, he has failed 24 T.C. 179">*186 to sustain his burden of proof on this issue. Not only has he failed to show that the four individuals were entitled to share equally in the profits and assets of the partnership immediately prior to the transfer, but the evidence shows affirmatively that they neither shared equally in the profits nor had equal interests in the assets. The profits in which they were to1955 U.S. Tax Ct. LEXIS 191">*207 share equally were after drawings of Rudolf and Sheldon in undisclosed amounts, the payment to Celia and Rose of 6 per cent of their original capital contribution, and the division of the first $ 15,000 of profits between Celia and Rose. The evidence proves that, aside from the unequal sharing of profits, the partners also had unequal interests in the transferred property "prior to the exchange." There is no evidence to show what the agreement of the partners was in regard to a division of the assets upon termination of the partnership, but the amending agreement of May 1, 1945, suggests that Celia and Rose were probably to have their original contributions returned to them before the remaining assets would be divided equally. Clearly the capital accounts of the four partners which equalled the book net worth as transferred were unequal "prior to the exchange" and the unequal notes were issued by the corporation for the express purpose of offsetting those unequal interests in the transferred assets. Thus the Commissioner has failed to show that the interests of the partners in the property prior to the exchange were substantially equal as required by section 112 (b) (5), ³ and1955 U.S. Tax Ct. LEXIS 191">*208 the evidence of profit sharing and of interests in the property prior to the exchange indicate that they were unequal.

The Commissioner states that "Petitioners' basis * * * is the approximate figure of $ 209,000 (which represents the book value of the assets transferred)," and he concludes that the excess of the fair market value of the transferred asset over the value of the transferred assets shown on the books of the partnership was a gain. He does not go into detail to explain how that gain is to be allocated to each of the four individuals, but under his theory the basis of each 1955 U.S. Tax Ct. LEXIS 191">*209 partner for computing his gain on the transaction would be the $ 25 which he paid in to the corporation plus his adjusted basis for his interest in the portion of the partnership assets and business which was transferred to the corporation. The petitioners, in connection with their theory that they received the notes as purchase price for the sale of the assets, admit that their basis for computing gain in that sale exactly equalled the amount of the notes received by each, explaining that their capital accounts were created by leaving the distributable portions of the earnings 24 T.C. 179">*187 of the partnership in the business. However, the Commissioner's theory is that they transferred their entire interests in the partnership, except for the loan accounts, in exchange for stock and notes. The record does not justify a finding, despite the noted admission, that the adjusted basis of each partner in the portion of his interest transferred was merely the net balance in his capital account on the books of the partnership. The evidence shows that those bases included additional amounts not reflected in the capital accounts. The original contributions of Celia and Rose were recognized 1955 U.S. Tax Ct. LEXIS 191">*210 as having values of $ 15,154.96 and $ 5,051.93 and must have had some basis. Value and basis are not synonymous. Celia, Rose, and Sheldon all agreed to purchase a part of Rudolf's original interest, but the record does not show the effect in dollars of those agreements upon the bases of the interest of each. It does not show what the original contributions of Rudolf and Sheldon were to the partnership or the cost or basis of any original contribution. Clearly the Commissioner has failed to show what the basis for any one of the partners was in computing any gain under section 111, if section 112 (c) (1) applies.

Decisions will be entered under Rule 50