41 T.C. 205">*205 The respondent determined deficiencies in petitioner's income tax and additions to tax as follows: 41 T.C. 205">*206

The issue is whether petitioner's claim for deductions under section 172 for net operating losses carried forward from prior years must fail because of the special limitations on net operating loss carryovers in section 382 or because of the provisions of section 269.

1963 U.S. Tax Ct. LEXIS 20">*23 FINDINGS OF FACT

Some of the facts were stipulated and they are so found.

Fawn Fashions, Inc., sometimes hereinafter called the petitioner, was incorporated under the laws of the State of Georgia on June 2, 1954, under the name of Fashions by Fawn, Inc. Petitioner filed its Federal income tax returns on an accrual basis using a fiscal year ending January 31. Petitioner's returns for the fiscal years ended January 31, 1955 through 1961, were filed with the district director of internal revenue, Atlanta, Ga.

Petitioner was formed primarily as a sales corporation and has been engaged in the sale of infants' clothing as a wholesaler. Petitioner's original stockholders were Gwinn Stickney, 200 shares; H. H. Wulf, 100 shares; Henry E. Patat, 5 shares; and E. Neal Nottingham, 5 shares. Stickney was petitioner's president. Stickney and Wulf are manufacturer's representatives and have always accounted for a considerable part of the petitioner's sales. A manufacturer's representative works strictly on a commission basis.

Dunton Whitehead, who was also a moving force in the petitioner's incorporation, organized a corporation, Fawn Manufacturing Co., on September 7, 1954, under the laws1963 U.S. Tax Ct. LEXIS 20">*24 of the State of Georgia. Fawn Manufacturing Co. changed its name to Dunton, Inc., on December 12, 1955. Dunton, Inc., was a clothing manufacturer which acted as a contractor in the manufacture of infants' clothing for the petitioner.

Dunton Whitehead had been active in the infants' wear industry for some years. He had started the plastic diaper cover industry in the middle or late 1940's and he had been successful in that venture.

On March 16, 1956, a creditor of petitioner filed suit on an account due, in the Superior Court of Fulton County, Ga., and petitioned for the appointment of a receiver. On the same date the court appointed a receiver for the petitioner. On March 20 and 28, 1956, the petitioner's 41 T.C. 205">*207 receiver petitioned for the sale of all of the petitioner's inventory and equipment. On April 13, 1956, the sale of such assets was confirmed. These assets were sold to two buyers for a total consideration of $ 5,380.

L & B Enterprises, Inc., hereinafter called L & B, was incorporated under the laws of the State of Georgia on August 12, 1955. L & B was originally formed by Leonard Bock to operate an advertising venture which was never fully developed. On August1963 U.S. Tax Ct. LEXIS 20">*25 15, 1955, Bock purchased at par value 500 shares of L & B common stock with a $ 1 par value. On April 2, 1956, L & B issued the following additional shares of common stock: Bock, 17,000 shares; Leonard T. Michalove, 17,500 shares; and Edward Jacobson, 10,000 shares. On September 26, 1956, Bock and Michalove purchased Jacobson's stock, and thereafter each held 22,500 shares of L & B stock.

Prior to April 1956 Bock was engaged in the retail business of ladies' wear in Atlanta and also worked with his father in wholesaling ladies' ready-to-wear in that city. Bock and Michalove, who operated two retail children's wear stores in Atlanta, became interested in organizing a children's wear manufacturing company and early in 1956 they worked with a designer and a sample maker on this project.

Bock and Michalove learned that the machinery and equipment of Dunton, Inc., were for sale, and together with Edward Jacobson, who had some experience in sewing-room operations, they entered negotiations with Dunton, Inc. On April 2, 1956, L & B purchased certain machinery and equipment, including patterns, from Dunton, Inc., and began the manufacture and sale of infants' clothing under the brand 1963 U.S. Tax Ct. LEXIS 20">*26 name of Fawn Fashions. L & B retained the manufacturing personnel and the key stylist of Dunton, Inc., as well as its rented premises. L & B registered the name Fawn Fashions in Fulton County, Ga.

When L & B began its manufacturing operations in April 1956 it sold the Fawn Fashions products through about six manufacturer's representatives, including Stickney and Wulf, all of whom had previously sold petitioner's products. Some of these representatives had obtained orders for petitioner's products in November and December 1955 and in the early part of 1956, which orders had not been filled by April 1956. L & B undertook to fill these orders for children's wear. In its manufacturing operations L & B continued styles and sizes of children's wear which had previously been sold by petitioner.

L & B's operations in its first fiscal period ended August 31, 1956 (including about 5 months of operations), showed a loss of between $ 1,000 and $ 2,000. About September 1956 Jacobson's employment 41 T.C. 205">*208 with L & B was terminated and his stock in L & B was purchased by Bock and Michalove.

In the fall of 1956 L & B developed a cost-saving method of manufacturing one of its basic products 1963 U.S. Tax Ct. LEXIS 20">*27 which would permit a significant cut in retail price. A separate corporation, called the Dry Pants Corp., was formed in January 1957 to sell the cheaper product to chain stores and supermarkets. A primary purpose for forming the new corporation was to disassociate the cheaper product from L & B's regular line of children's wear.

As of March 1957, 36 creditors, the receiver, and other persons had filed claims in the petitioner's receivership proceedings totaling $ 110,000. These claims, in accordance with the applicable preference were subsequently satisfied to the extent of $ 12,710.32, which represented the total amount collected in the receivership through March 1957.

Under sections 22-1401 through 22-1403 of the Georgia Code, Annotated, it is provided that the franchise of a private corporation which becomes insolvent may be sold as an asset by the receiver under order of the proper State court. It is further provided (in section 22-1403) that "Such purchasers, their associates and assigns may organize anew in the manner prescribed by law."

At a meeting of the board of directors of L & B on April 20, 1957, it was resolved that L & B would "offer to purchase for $ 500.00 from1963 U.S. Tax Ct. LEXIS 20">*28 Claude Hambrick, Receiver of Fashions by Fawn, Inc., the franchises, corporate name and all the rights, privileges and immunities granted under the charter of Fashions by Fawn, Inc., exclusive of all liabilities of said corporation and upon condition that all right, title and interest in said corporation of the present stockholders of Fashions by Fawn, Inc. be terminated upon the purchase of this corporation."

On April 22, 1957, L & B made an offer to the receiver to purchase for $ 500 the "franchises, corporate name and all of the rights, privileges, immunities and advantages contained in the Charter of Incorporation of Fashions by Fawn, Inc., a Georgia corporation." By an order dated May 28, 1957, the judge of the Superior Court of Fulton County, Ga., approved the receiver's application to make the sale, and the sale to L & B was consummated shortly thereafter.

On June 2, 1957, L & B petitioned to Superior Court to organize petitioner anew, and on July 8, 1957, the Superior Court ordered that the petition be granted.

On July 15, 1957, the receiver made his final report to the Superior Court and on July 20, 1957, he was discharged as receiver.

In June or July 1957 the L & B Manufacturing1963 U.S. Tax Ct. LEXIS 20">*29 Co. was formed by L & B to carry on the manufacturing operations.

On July 31, 1957, L & B purchased one share of stock in petitioner, and the petitioner canceled the remaining outstanding shares of stock. 41 T.C. 205">*209 Upon application of the petitioner, its charter was amended by the Superior Court of Fulton County in August 1957 changing its name to K & S Corp. On October 8, 1957, petitioner filed a petition in voluntary bankruptcy in the United States District Court for the Northern District of Georgia, which was granted on October 17, 1957. A list of claims, prepared by L & B's representatives sometime in July 1957, showed unsecured creditors' claims against petitioner of about $ 135,000 and minimal assets. By an order dated December 31, 1957, the petitioner was discharged in bankruptcy.

At a meeting of the L & B board of directors held on December 31, 1957, it was decided to transfer the sales activities of L & B to the petitioner, which was then briefly known as the K & S Corp. A resolution was adopted at the meeting to sell to K & S Corp. all of L & B's finished goods and shipping supplies, less any liabilities due thereon.

On December 31, 1957, L & B subscribed to and purchased1963 U.S. Tax Ct. LEXIS 20">*30 200 shares of petitioner's stock for $ 20,000. Upon application by the petitioner its charter was amended by order of the Superior Court of Fulton County on January 10, 1958, changing petitioner's name to Fawn Fashions, Inc.

Since before petitioner's receivership proceedings a fawn has been used to identify its products, together with the name Fashions by Fawn, or Fawn Fashions, or Fawn Togs. Neither petitioner nor L & B has ever made application to the U.S. Patent Office to register as a trademark the Fawn name and emblem.

Howard Aronin, who was the accountant for L & B and for petitioner (since its acquisition by L & B), received copies of petitioner's tax return for the fiscal year 1955 late in the year 1958.

Petitioner's income tax returns for the fiscal year ended January 31, 1958, was due on April 15, 1958, but was not filed until March 16, 1959.

Petitioner incurred and reported on its Federal income tax returns the following net operating losses and net profits before special deductions:

1963 U.S. Tax Ct. LEXIS 20">*31 At the time of the trial L & B was a management and holding company and did not engage in the manufacture or sale of clothing.

Petitioner, on its returns, showed net income before deduction of net operating loss carryovers as follows: 41 T.C. 205">*210

Petitioner claimed a net operating loss deduction carried forward from prior years on its return for the fiscal year ending January 31, 1958, in the amount of $ 193,535.11 and carried forward the unused balance to each of the succeeding fiscal years through January 31, 1961, in which year petitioner claimed a net operating loss deduction of $ 81,411. Respondent disallowed the net operating loss deductions claimed for each of the fiscal years involved. Respondent explained that these amounts were "not available to you as a deduction," citing sections 172 and 382. Respondent also invoked section 269 to support his disallowance of these deductions.

OPINION

Section 269 provides that if "any person or persons acquire, or acquired on or after October 8, 1940, directly or indirectly, control of a corporation * * * and1963 U.S. Tax Ct. LEXIS 20">*32 the principal purpose for which such acquisition was made is evasion or avoidance of Federal income tax by securing the benefit of a deduction, credit, or other allowance which such person or corporation would not otherwise enjoy, then such deduction, credit, or other allowance shall not be allowed." Section 269(c)² provides that where the corporation described in section 269(a) is acquired for a purchase price which is "substantially disproportionate" to the total of the adjusted basis of the property of the corporation and the tax benefits acquired, then such fact "shall be prima facie evidence of the principal purpose of evasion or avoidance of Federal income tax."

L & B paid $ 500 for petitioner about June 1957 and acquired net operating loss carryovers in the total amount of $ 193,535.11. Petitioner's assets at the time of acquisition were minimal. It is obvious that the consideration paid was "substantially disproportionate" 1963 U.S. Tax Ct. LEXIS 20">*33 to the tax benefits acquired and to petitioner's property, and petitioner acknowledges this on brief.

To meet its burden of showing that the acquisition did not have the avoidance of tax as its principal purpose, petitioner contends that L & B was concerned about the Fawn name which L & B was using on its products (children's wear) and that its dominant purpose in acquiring petitioner was to protect the use of that name.

It seems strange that L & B manufactured and sold its products under the Fawn name for about a year before it felt enough concern 41 T.C. 205">*211 for the name to do something about it. Petitioner, a sales corporation, had managed to accumulate net operating losses of about $ 188,000 in the first year and a half of its existence (June 1954 through the fiscal year ending January 31, 1956) and by the end of 1955 the corporation practically ceased operations. The value of the Fawn name under these circumstances is, at best, conjectural.

As for the purported reasons that prompted L & B to protect the Fawn name by acquiring petitioner in the middle of 1957, there are some broad, and wholly uncorroborated, generalities as to the possible machinations of a certain Dunton Whitehead, 1963 U.S. Tax Ct. LEXIS 20">*34 who had been a moving force in petitioner's incorporation in June 1954. Much of the testimony regarding this man is extremely vague. Briefly stated, the testimony is to the effect that Whitehead (for some unexplained reason) was unhappy about the sale of the machinery and equipment of Dunton, Inc. (the contract manufacturer of the children's wear sold by the petitioner corporation in 1954 and 1955), to L & B in April 1956, and L & B feared that Whitehead, who was a "rather unpredictable" individual, "could very well step in at a later date and manufacture an identical product, and possibly put us out of business." If L & B was so concerned, it would have been a logical and prudent move to acquire the Fawn name from petitioner in April 1956, ³ when L & B began its manufacturing and selling operations. But L & B's attorney who was involved both in the purchase of the machinery from Dunton, Inc., in 1956 and the acquisition of petitioner by L & B in 1957, made no move to acquire the Fawn name at that time and, in fact, he testified that "There was no discussion about acquiring the name Fawn." We find the evidence on this whole matter of Dunton Whitehead singularly unpersuasive.

1963 U.S. Tax Ct. LEXIS 20">*35 It also appears that neither petitioner, up to the time it went into receivership in 1956, nor L & B all during the period it manufactured and sold the Fawn products in 1956-57 ever made an application to register the Fawn name and emblem as a trademark in the U.S. Patent Office. L & B's attorney testified that he learned from trademark counsel in Washington that "there were several different types of concerns that had registered the name Fawn, and that there was one that had registered the name Fawn with a mark which was similar to the deer." So, continued the attorney, "we have never pressed it because we felt if we filed an application for a trademark, then the other people would become aware of it; and this might stir up something that we don't really want now." But the significant fact in all this is that the inquiries were made, according to the attorney, after L & B had acquired the petitioner. We find it highly 41 T.C. 205">*212 implausible that such pertinent inquiries as to the validity and worth of the Fawn name as a trademark would be made after the acquisition of petitioner, rather than before, if the dominant purpose for the acquisition of petitioner was, in fact, 1963 U.S. Tax Ct. LEXIS 20">*36 to obtain the name.

No convincing reason appears in the record as to why L & B did not simply buy the name Fawn from the receiver instead of going through the tortuous procedure of buying the franchise of the product corporation under a unique provision of Georgia law (which both parties indicate has not been interpreted by the State courts), then change the name of the shell corporation to K & S Corp., then put K & S Corp. through bankruptcy proceedings in the Federal District Court, then obtain the discharge in bankruptcy some 7 months after L & B acquired the corporation, then transfer L & B's sales activities to the corporation, and then change the name of the corporation from K & S Corp. back to Fawn Fashions, Inc. The attorney for L & B admitted at the trial that the name Fawn "probably could have" been purchased from the receiver, and he further admitted he made no attempt to purchase the name.

It is contended that when L & B acquired petitioner in the middle of 1957 no one knew the exact nature of the losses incurred during the year and a half of petitioner's operations as a sales corporation, and that no one on L & B's behalf had ever seen petitioner's books or tax returns1963 U.S. Tax Ct. LEXIS 20">*37 prior to the acquisition. From this premise, it is argued that no one knew of the tax benefits to be derived and that, consequently, the proscribed purpose for the acquisition did not exist. We are satisfied, however, that all of the interested parties knew, prior to the acquisition, that petitioner was in financial distress and had incurred sufficient losses to place it in receivership. Michalove (L & B stockholder) testified that he was aware of substantial claims in the receivership proceedings. He also testified that he thought petitioner had some losses but he "had no way to judge the extent of their losses." Bock (L & B stockholder) testified that he "naturally" knew of petitioner's troubles. When L & B commenced operations in April 1956 it took over the premises formerly used by Dunton, Inc., and petitioner, which were in the same building. L & B even filled orders which had been obtained by petitioner's representatives in the field. We cannot believe that Bock and Michalove were ignorant of petitioner's financial plight before the acquisition. L & B's attorney, who was directly involved in the acquisition of petitioner, was aware of the large number of creditors' claims1963 U.S. Tax Ct. LEXIS 20">*38 in the receivership and he "just assumed that there was a loss."

It is immaterial for purposes of section 269 that the parties were unaware of the precise amount of the losses. In Zanesville Investment Co., 38 T.C. 406">38 T.C. 406, on appeal (C.A. 6), this Court said: "We do 41 T.C. 205">*213 not believe that the statute requires at the time of acquisition a precise awareness of every deduction, credit, or other allowance that such acquisition will bring to the taxpayer. It is enough if at the time of acquisition the principal purpose was to obtain a tax benefit." See also R. P. Collins & Co. v. United States, 303 F.2d 142. It is enough, we think, that the parties involved here had knowledge of significant losses which could be turned to their tax benefit by acquiring petitioner. Petitioner's attorney was certainly not unacquainted with tax matters. ⁴

1963 U.S. Tax Ct. LEXIS 20">*39 In Army Times Sales Co., 35 T.C. 688">35 T.C. 688, this Court said: "The judicial ascertainment of someone's subjective interest or purpose motivating actions on his part is frequently difficult. One method by which such ascertainment may be made is to consider what the immediate, proximate, and reasonably to be anticipated consequences of such actions are and to reason that the person who takes such actions intends to accomplish their consequences." Here, L & B's operations were beginning to prove profitable, after an initial year of slight losses. L & B transferred its sales operations to petitioner on December 31, 1957, the same day petitioner was discharged in bankruptcy. Petitioner showed net profits (before deduction of net operating loss carryovers) in the fiscal years ending January 31, 1959, 1960, and 1961, of $ 68,215.98, $ 40,013.51, and $ 128,637.98. As a result of the acquisition, petitioner was able to utilize net operating losses in excess of $ 190,000.

We find, and so hold, on the basis of the considerations discussed above and on the entire record, that the petitioner has not established that the principal purpose for its acquisition was other1963 U.S. Tax Ct. LEXIS 20">*40 than to obtain the benefit of its net operating losses.

Respondent presents a second argument, which we consider sound, in support of his determination. Section 382 disqualifies a net operating loss where three conditions are met: (1) An increase of at least 50-percentage points in the stock ownership of a corporation by a prescribed number of persons within a taxable year beginning after June 22, 1954; (2) the increase in ownership is attributable to purchases of the stock; and (3) the corporation has not continued to carry on a trade or business substantially the same as that conducted before any change in the percentage ownership of the stock. It is agreed that the first two conditions are met here. Respondent, relying on his regulations under section 382, contends that the third condition is also met. Section 1.382(a)-1(h)(6), Income Tax Regs., provides that a "corporation has not continued to carry on a trade or business substantially the same as that conducted before any increase in the ownership 41 T.C. 205">*214 of its stock if the corporation is not carrying on an active trade or business at the time of such increase in ownership." Petitioner argues that the regulation is arbitrary1963 U.S. Tax Ct. LEXIS 20">*41 and inconsistent with the intent of the statute and therefore invalid.

Respondent's regulation clearly covers the situation here. Petitioner's sales activities ceased about the end of 1955 and the corporation remained inactive for about 2 years, until L & B revived it early in 1958. It was a shell corporation when L & B acquired it in the middle of 1957, about a year and a half after it ceased operations. Legislative history supports the correctness of respondent's regulation. S. Rept. No. 1622, 83d Cong., 2d Sess., p. 285.

Respondent also determined that petitioner is liable for addition to tax under section 6651(a) for the taxable year ended January 31, 1958, for failure to file a timely return. It is stipulated that the return was due April 15, 1958, but was not filed until March 16, 1959. Petitioner makes no argument on brief to show that such failure was due to reasonable cause. We sustain respondent on this issue.

Decision will be entered for the respondent.