54 T.C. 705">*705 Respondent determined deficiencies in petitioners' income taxes for the taxable year 1964 as follows: 54 T.C. 705">*706

After various concessions, the following issues remain for our decision:

Whether the petitioners or any of them were incorporated for the principal purpose of evasion or avoidance of Federal income tax, within the purview of section 269, ² by securing the benefit of the surtax exemption.

FINDINGS OF FACT

Some of the facts and exhibits have been stipulated and are incorporated herein by this reference.

Dredge Clinton, Inc., and Dredge Cherokee, Inc., are South Carolina corporations. Southern Dredging Corp. is a North Carolina1970 U.S. Tax Ct. LEXIS 173">*175 corporation. All three corporations had their principal office in Charleston, S. C., at the times of filing the petitions herein. They filed their corporate income tax returns for the taxable year 1964 with the district director of internal revenue, Columbia, S. C.

In approximately 1934, the Merritt Dredging Co. began doing business as a partnership consisting of two brothers, Lucien and Harry Merritt. Richard and Duane Merritt, the sons, respectively, of Lucien and Harry, later joined the partnership. At one point of time, the interests in the partnership were held equally by the four partners. After Lucien's death, there was a realignment so that each of the remaining partners had a one-third interest.

At or about its inception in 1934, the partnership acquired the dredge Cherokee at a cost of approximately $ 25,000. The Cherokee, a relatively small-sized and lightweight (800 tons) dredge, was only utilized in performing light dredging work in protected, safe waters such as the Intracoastal Waterway. The dredging work in the protected waterways, commonly referred to in the trade as "millpond" work, did not expose the Cherokee to any great risks or hazards.

The1970 U.S. Tax Ct. LEXIS 173">*176 dredge Clinton was acquired by the partnership in 1958 or 1959 at an approximate cost of $ 86,000. Weighing approximately 1,000 tons, the Clinton was utilized in more hazardous open waters, such as Charleston Harbor, where strong tides and currents, together with heavy commercial and naval traffic, prevail. Attendant to the assumption of dredging work in open waters was a much greater exposure, in contrast to millpond work, to potential accidents and resulting liability and losses therefrom. The Clinton would at times 54 T.C. 705">*707 be working in the area of a channel being traveled by hundred-million dollar submarines.

Because of the increased exposure to accident and resulting liability in open-water dredging, the matter of limiting such potential liabilities became a topic of discussion among the partners. Considering the idea of incorporation, the partners concluded that the only satisfactory way to protect one dredge against the liabilities incurred by the other dredge was to set up separate corporations.

In addition to the dredges Cherokee and Clinton, the partnership owned various barges, dredge tenders, and other equipment necessary to operate a dredging1970 U.S. Tax Ct. LEXIS 173">*177 business. Just prior to its termination, as of December 31, 1959, the partnership owned the two dredges, two derrick barges, two fuel barges, two dunnage barges, several other barges not specifically identified, and five dredge-tender boats. As of that time, the dredge-tender boats ranged in value from $ 15,000 to $ 30,000.

The partnership had repair facilities and employed personnel for the purpose of making repairs to and maintaining its equipment. Such facilities were constantly employed by the partnership in the regular and systematic repair and maintenance of the equipment used in its dredging operations. On some occasions, substantial repairs were made on the dredging equipment. At the time of its termination, the repair and maintenance facilities accumulated by the partnership had an approximate value ranging between $ 30,000 and $ 40,000.

The partnership carried marine insurance on some of its vessels to provide protection against sinking, or other similar losses, such insurance being in amounts considered necessary to salvage the particular vessel and restore it to service. The partnership also carried liability insurance.

In the last 20 years of its existence, the 1970 U.S. Tax Ct. LEXIS 173">*178 partnership sustained only one loss to another party for which it did not have sufficient liability insurance; it was consequently required to pay a part of this claim. During these years the partnership had numerous small claims against it which ranged from a few hundred to several thousand dollars, none of which exceeded $ 25,000. None of the vessels owned by the partnership was ever adjudged unseaworthy by any court. The partnership also never permanently lost a major piece of equipment, such as a dredge, through accident or negligence.

During the last 10 years of its existence the partnership did not sustain any operating losses.

Up to the time of Lucien Merritt's death, both he and his brother Harry made the major policy decisions for the partnership. Upon Lucien's death, Harry assumed the sole position of making these 54 T.C. 705">*708 decisions. While Harry did seek the advice of his son and nephew, the two younger partners, he alone came to the final decision on any important matter. Having a great deal more experience in the dredging business than Richard or Duane, Harry felt that they were too immature, in terms of business judgment, to be in the position of making final decisions1970 U.S. Tax Ct. LEXIS 173">*179 on important matters.

Harry was in his late seventies, sometimes forgetful, and also hard of hearing during the latter 1950's; and it became difficult to communicate with him in the conduct of the dredging business. Having reinvested his share of the profits in the partnership and having no other source of income, Harry was completely dependent on the dredging business for his support and security.

On one occasion, Harry approached some unrelated third parties with a proposition regarding the purchase of his interest in the partnership. Richard did not find this prospect very palatable and would not have agreed to a new and unrelated partner coming into the business.

In December of 1959, Harry mentioned to Richard and Duane the possibility of the sale of his partnership interest to them. During the following several weeks, Harry, Richard, and Duane conducted negotiations with respect to the price and other terms of the purchase by them of Harry's partnership interest. As had been their experience in the past, Richard and Duane found Harry obstinate in his demands during the negotiations. Harry was asking a price which Richard and Duane found exorbitant. Notwithstanding Harry's1970 U.S. Tax Ct. LEXIS 173">*180 monetary demands, Richard and Duane were quite anxious to buy him out of the partnership and, consequently, they acceded to them.

During these negotiations, the idea of incorporation was revitalized. All the parties agreed that three corporations would be the most satisfactory solution to the limitation of liability problem and, moreover, Harry was insistent on this solution in order to protect his position as a future creditor of the corporations. Harry Merritt stipulated during the negotiations that three corporations be set up. Two of the corporations would each own one of the dredges, and they, in turn, would lease the dredges to the third corporation, which would actually carry out the dredging operations. The idea of having only two corporations, with both dredges being owned by the non-operating corporation, was rejected by the partners because of the lack of protection that each dredge would have from potential liabilities of the other.

On December 17, 1959, Harry, Duane, and Richard met with an attorney to arrange the purchase and sale of Harry's interest. Harry told the lawyer of his decision to sell his interest as of December 31, 1959. The parties' decision to set1970 U.S. Tax Ct. LEXIS 173">*181 up the three corporations was also 54 T.C. 705">*709 related to the lawyer at this meeting. With Harry, Duane, and Richard in his presence an agreement was dictated by the lawyer providing that Harry agreed to sell his one-third interest in the partnership to Richard and Duane for a purchase price of $ 300,000. The agreement, which was duly executed on that same day by the parties, had a final provision stating, inter alia, that the delivery of the partnership interest was to be made on December 31, 1959. The parties were advised that the agreement of December 17, 1959, would suffice for the time being, but that further work would be necessary as to the details and paper work involving the corporations.

By an instrument dated December 31, 1959, Harry bargained, sold, and delivered his one-third interest in the Merritt partnership to Richard and Duane as equal partners in a new Merritt Dredging Co. partnership, in exchange for their promissory note for $ 300,000 payable $ 30,000 on December 31, 1960, and $ 30,000 annually thereafter until December 31, 1969, with interest payable quarterly from December 31, 1959, at the annual rate of 5 percent on the unpaid balances.

Harry did not request1970 U.S. Tax Ct. LEXIS 173">*182 or obtain a chattel mortgage as security for repayment of the $ 300,000 debt. In his discussions with Richard and Duane, Harry expressed the thought that a mortgage would be ineffective protection in the event of an accident caused by one of the dredges because the damaged party would have the right to seize the dredge. Harry also indicated that he thought a mortgage would weaken Merritt Dredging Co.'s position with its bonding company and bank.

On January 6, 1960, Merritt Dredging Co., Dredge Clinton, Inc., and Dredge Cherokee, Inc., were incorporated under the laws of South Carolina. The lawyer who handled the initial agreement also attended to the legal matters pertaining to the three incorporations.

At or about the time of the incorporations, an attorney specializing in taxation, was contacted by the lawyer for the Merrits with regard to some phase of the transactions involving the Merritts and their dredging business. During this same period of time, after January 1, 1960, but possibly before January 6, 1960, Richard and Duane had a meeting with the tax lawyer for the purpose of having him double check the tax consequences of their already formulated plan regarding the new1970 U.S. Tax Ct. LEXIS 173">*183 corporations and transfer of partnership assets to them. In his testimony at trial this tax lawyer could not recall the details or the specific matter about which his advice was sought.

The barges, tender boats, and other facilities and all the other assets, except the two dredges, were transferred to the newly incorporated Merritt Dredging Co. The dredges Clinton and Cherokee were transferred, respectively, to Dredge Clinton, Inc., and Dredge 54 T.C. 705">*710 Cherokee, Inc. Both dredges were seaworthy at the time of these transfers.

Upon incorporation, Merritt Dredging Co. issued certain notes to Richard and Duane. The corporation subsequently made full payment of these notes.

On January 11, 1960, Merritt Dredging Co., Dredge Clinton, Inc., and Dredge Cherokee, Inc., each issued half of its shares of capital stock to Richard and the other half to Duane. Up to the date of trial, no other shares of stock had been issued by any of the three corporations.

On January 11, 1960, the directors of Merritt Dredging Co. held a meeting at which it was resolved, inter alia, that the corporation issue to Harry Merritt 60 notes for $ 3,000 each, bearing interest at 5 percent per annum1970 U.S. Tax Ct. LEXIS 173">*184 on the unpaid balances, payable 6 notes on December 31, 1960, and 6 notes annually thereafter. It was also resolved that Merritt Dredging Co. enter into bare-boat charters with Dredge Cherokee, Inc., and Dredge Clinton, Inc.

On that same date, a meeting was held by the directors of Dredge Clinton, Inc., at which it was resolved, inter alia, that the corporation issue to Harry Merritt 20 notes for $ 3,000 each, bearing interest at 5 percent per annum on the unpaid balances, payable 2 notes on December 31, 1960, and 2 notes annually thereafter. It was also resolved that Dredge Clinton, Inc., enter into a bare-boat charter with Merritt Dredging Co.

On that same date, a meeting was held by the directors of Dredge Cherokee, Inc., at which resolutions identical to those described above of Dredge Clinton, Inc., were passed.

Similarly on that date, Harry executed an instrument whereby he agreed to accept notes of the corporation to replace the $ 300,000 note he had originally received from Richard and Duane.

In the separate bare-boat charter instruments, as executed on January 11, 1960, the "owners," Dredge Clinton, Inc., and Dredge Cherokee, Inc., leased their dredges to the "charterer," 1970 U.S. Tax Ct. LEXIS 173">*185 Merritt Dredging Co. at rates of $ 4,000 per month (for the dredge Clinton) and $ 3,300 per month (for the dredge Cherokee). The term of the bare-boat charter in both cases was 1 year, which would be extended from year to year unless either of the contracting parties should give written notice of cancellation not less than 30 days before the expiration of any lease period. In addition to the terms described above, the bare-boat charter instruments provided as follows:

In addition to the cash rate of hire the Charterer agrees that it will provide all maintenance and upkeep of the Dredge and all insurance necessary to fully protect the Owner against loss and from claims which may be made by members of the crew or other persons or corporations. The Charterer will furnish all 54 T.C. 705">*711 personnel to operate and/or care for the Dredge during the period of this Charter and return the Dredge in the same condition as when received, normal wear and tear excepted.

It is agreed that the Owner will from time to time make improvements on the Dredge to increase the efficiency of the Dredge when the Charterer agrees to an adequate adjustment in the monthly cash hire to justify improvements.

1970 U.S. Tax Ct. LEXIS 173">*186 At the inception of 1960, Merritt Dredging Co., Dredge Clinton, Inc., and Dredge Cherokee, Inc., were insured against property damages liability in the amounts of $ 10,000 per accident and $ 40,000 for the aggregate of accidents. The premium payable for this insurance policy was $ 1,100. On January 22, 1960, the insurance policy limits were increased to $ 100,000 per accident and $ 400,000 for the aggregate of accidents. The premium payable for the new policy was in the approximate range of $ 10,000 to $ 12,000. Additional insurance coverage was available if desired. A policy with an upper limit of $ 1 million would have cost approximately $ 27,000. Realizing that $ 400,000 coverage was still not adequate liability protection, Richard and Duane nevertheless decided that they could not afford the premium which would be due on a policy providing such increased coverage of $ 1 million. This decision was made in light of the fact that the three corporations would be making combined annual payments of $ 30,000 to Harry for the next 10 years.

At some time subsequent to the execution of the charter agreements, extensive improvements were made to the dredge Cherokee, rendering 1970 U.S. Tax Ct. LEXIS 173">*187 it capable for the first time of performing open-water dredging. These improvements were paid for by Dredge Cherokee, Inc., with funds ($ 100,000) borrowed from Merritt Dredging Co.; in return for this loan, Dredge Cherokee, Inc., issued its note for $ 100,000 to Merritt Dredging Co.

On November 13, 1963, Southern Dredging Corp. was incorporated under the laws of North Carolina. On November 21, 1963, Southern Dredging Corp., in exchange for $ 50,000 issued 250 shares of its common capital stock to Merritt Dredging Co. and 250 shares to Richard and Duane (125 shares each). Of the total $ 50,000 received in exchange for the capital stock, $ 25,000 was paid by Merritt Dredging Co. and $ 25,000 was paid by Richard and Duane ($ 12,500 each). Up to the date of trial, no other shares of stock had been issued by Southern Dredging Corp.

The formation of Southern Dredging Corp. was part of an effort by Richard and Duane to diversify their dredging business. Owning a portable dredge vessel, the "Dredge Junaluska," which, in contrast to the dredges Clinton and Cherokee, was capable of being employed in inland waterways beyond the coast, Southern Dredging Corp. was conceived by1970 U.S. Tax Ct. LEXIS 173">*188 Richard and Duane as a self-contained company, 54 T.C. 705">*712 bidding and performing such inland jobs, particularly for hydroelectric companies, in the western North Carolina and South Carolina areas.

As was the case in prior years, Richard and Duane were quite concerned with protecting the new dredge against the liabilities incurred by the other dredges, and vice versa. Richard and Duane were also concerned with any potential harm that might result to the established reputation of Merritt Dredging Co. by virtue of a costly accident involving the portable dredge, the operation of which was a new and unfamiliar venture. These concerns led to the ultimate conclusion that the portable dredge should be separately incorporated. Incorporating Southern Dredging Corp. in North Carolina was part of their strategy to put the corporation in a more favorable position to obtain contracts in that State.

As things worked out, however, Southern Dredging Corp. never did operate as a self-contained company, bidding and performing its own jobs. During the embryonic planning stages for a separately incorporated portable dredging business, Richard and Duane decided that they would not purchase the new 1970 U.S. Tax Ct. LEXIS 173">*189 dredge, nor form another corporation, until they had successfully negotiated a contract for the employment of the portable dredge. Consequently, the first contract was negotiated by Merritt Dredging Co. Subsequent to the successful negotiation of the first contract by Merritt Dredging Co., Richard and Duane tried to persuade the other party to the contract to allow Southern Dredging Corp. to be substituted in the contract in the place of Merritt Dredging Co. The other party, relying on Merritt Dredging Co.'s reputation and experience, and not being familiar with the newly formed Southern Dredging Corp., refused to have Southern Dredging Corp. substituted in Merritt Dredging Co.'s place. The contract, consequently, was carried out by Merritt Dredging Co., using the dredge Junaluska, which, pursuant to a charter agreement, was leased from Southern Dredging Corp. This mode of operation was continued, whereby Merritt Dredging Co. negotiated and carried out the contracts calling for a portable dredge. Southern Dredging Corp. did not make any further attempts to procure any contracts in its own name.

The aforementioned charter agreement between Southern Dredging Corp. and Merritt1970 U.S. Tax Ct. LEXIS 173">*190 Dredging Co. was executed on January 1, 1964, and provided, in pertinent part, as follows:

1. (a) SOUTHERN agrees to Charter to MERRITT the dredge vessel JUNALUSKA and its appurtenances for the term of one year, on the basis of rental payments of Nine Thousand and no/100 ($ 9,000.00) Dollars per calendar quarter, payable on the last day of each such quarter. The said term to begin on the first day of January and to terminate on the 31st day of December, as hereinafter provided. * * *

54 T.C. 705">*713 (b) * * * It is agreed and understood that, upon request of MERRITT, at any time or from time to time, SOUTHERN will assist MERRITT in a consulting and advisory capacity. Such assistance shall be limited to the following items and be rendered only when the said dredge vessel is not in operation:

(1) Advice relating to proper maintenance of the dredge vessel.

(2) Inspection reports as to the state of repair and general condition of the dredge vessel.

(3) Advice as to the general and necessary job qualifications of personnel employed.

(4) Advice in general and incidental reports concerning the suitability or seaworthiness of the dredge vessel for any contemplated job.

(5) Advice on any other1970 U.S. Tax Ct. LEXIS 173">*191 problems or matters not relating to the operation of the dredge.

(c) As stipulated compensation for the above (subparagraph (b)), it is further agreed and understood that, in addition to the said rental payments recited hereinbefore, MERRITT shall pay "Advisory Payments" in the sum of Ten Thousand and no/100 ($ 10,000.00) Dollars per calendar year. All Advisory Payments" will be due and payable by MERRITT under this agreement at the time and in the manner herein set forth.

* * * *

2. (a) * * * MERRITT further agrees that, in addition to making the Rental Payment and the Advisory Payment required hereunder, it will provide all maintenance and upkeep of the dredge and all insurance necessary to fully protect the owner against loss and from claims which may be made by members of the crew and any other persons or corporations.

(b) MERRITT agrees to employ and furnish all personnel required to operate and/or care for the dredge vessel, and to provide all incidental services including, but not limited to, oil, gasoline, lubricants, electric power, and other necessary or customary services required.

(c) It is agreed that SOUTHERN will, from time to time and when the said dredge vessel is1970 U.S. Tax Ct. LEXIS 173">*192 not in operation, make improvements on the dredge vessel to increase its efficiency, provided MERRITT agrees to an adequate compensation adjustment sufficient to justify such improvements. It is further agreed that, as to such agreed improvements, SOUTHERN shall supervise their design and installation; provided, however, that no direct charge shall be made by SOUTHERN for such supervision and installation and that the aforesaid "Advisory Payment" shall be considered as providing full compensation for the aforesaid supervision, design and installation.

3. It is further agreed that this contract arrangement will be extended from year to year unless either party shall give notice in writing of its cancellation not less than thirty (30) days before the expiration of any contract period.

4. In the event any amount or sum payable by MERRITT under the Charter of Dredge Agreement and the Advisory Agreement, at the time and in the manner herein provided, is not recognized as a proper deduction for income tax purposes, and is disallowed, SOUTHERN shall be entitled to receive, and MERRITT shall promptly pay to SOUTHERN a refund of the amount of such disallowance.

The Junaluska was purchased1970 U.S. Tax Ct. LEXIS 173">*193 secondhand by Southern Dredging Corp. for a total purchase price of $ 160,000. Funds were borrowed on the credit of Merritt Dredging Co. in order to make up the difference between the purchase price of the Junaluska and the capital available to Southern Dredging Corp.

54 T.C. 705">*714 Weighing approximately 80 tons, the portable dredge Junaluska can be dissassembled and shipped on freight cars or trucks to points inland where it can be reassembled and launched on a lake or other site. On two occasions the Junaluska was shipped inland for use in freshwater lakes. It has otherwise been employed in saltwater dredging operations.

Approximately 15 people, taking between 1 to 3 weeks, are required in the assembling of the Junaluska. It is difficult when working inland, in contrast to the coastal area, to find many people experienced in dredging operations.

The transportation of the Junaluska usually involves the use of low grade, lightly traveled roads and bridges. The low quality of these roads and bridges does give rise to some concern as to the possibility of damage to them under the great weight of the dredge. Some of the asphalt roads so utilized have in fact been1970 U.S. Tax Ct. LEXIS 173">*194 damaged, subjecting Merritt Dredging Co. to liability for repairing them.

In harbor dredging, silt is normally disposed of in a dike-protected part of an undeveloped or unpopulated area. When working inland, however, it is sometimes difficult to find such an area for this purpose, and, consequently, the silt must be disposed of in a dike-protected part of a developed or populated area. In the event that a dike in such an area were to break open, flooding may result, thereby rendering substantial damage to the property surrounding the dike.

When dredging work is performed inland, the bonding companies' rate is double that for coastal dredging work.

Pursuant to its obligations under the aforementioned charter agreements, Merritt Dredging Co. provided all the insurance for the protection of Dredge Clinton, Inc., Dredge Cherokee, Inc., and Southern Dredging Corp. against losses and from claims which may be made by members of the crew or other third parties. By 1964, the four corporations were insured against property damages liability in the amounts of $ 400,000 per accident and $ 400,000 for the aggregate of accidents.

On its Federal income tax return for 1960, Merritt Dredging Co. 1970 U.S. Tax Ct. LEXIS 173">*195 reported taxable income in the amount of $ 211,606.35. It reported taxable income of $ 453,395.33 for the taxable year 1964.

Southern Dredging Corp.'s sole source of income, during the taxable year 1964, was derived from the rental and consulting fees (in the amount of $ 46,000) paid to it by Merritt Dredging Co.

Dredge Clinton, Inc., and Dredge Cherokee, Inc., both derived the major part of their income for the taxable year 1964, from the rental fees (in respective amounts of $ 90,409.05 and $ 48,000) paid to them by Merritt Dredging Co. They both reported relatively 54 T.C. 705">*715 minor amounts of income from interest and State capital-stock tax refunds.

The rental fees which Merritt Dredging Co. paid pursuant to the charter agreements were based on amounts that Richard and Duane felt would be fair and reasonable to both the leasing and operating corporations. In arriving at these amounts, Richard and Duane took into account how much Merritt Dredging Co. could afford to pay and what minimum amount the leasing company could afford to charge. Since its original entrance into charter agreements with Dredge Clinton, Inc., and Dredge Cherokee, Inc., Merritt Dredging Co. has paid increased1970 U.S. Tax Ct. LEXIS 173">*196 amounts of rental fees to these corporations.

With one minor exception, Merritt Dredging Co. has never resorted to chartering a dredge from any parties other than the petitioners. The possibility of Merritt Dredging Co. chartering a dredge from an outside party at a reasonable cost is very limited.

All three dredges are employed by Merritt Dredging Co. intermittently. They are in active use approximately 50 percent of the available working time. The selection of a dredge for any specific job is made in accordance with the particular needs of such job.

It is necessary to have trained personnel to operate the dredges, barges, dredge tenders, and harbor facilities used in the dredging business. Some of the employees were experienced upon their hiring and others were trained on the job. There are living quarters on the dredges, which are used by the employees while on a job. The employees are usually divided into three crews, one sleeping, one working, and the other off duty.

The dredges are employed primarily in ship channels which have been shoaled up with silt. The function of the dredges is to remove the silt deposits, thus allowing the ship channels to remain open for traffic.

1970 U.S. Tax Ct. LEXIS 173">*197 A dredge is a relatively stationary vessel, the only movement of which on the job is very slow and gradual. When operated, the dredge is anchored from one end and swings in an arc about the spot where is it picking up silt and other materials from the floor of the ship channel.

Dredge tenders are used to tow the dredges about on a job and sometimes from one job to another. On other occasions the dredge operators hired others to tow the dredges to other jobs. While the speed at which a dredge and other attendant vessels tied behind it are towed is relatively slow, the towing of such vessels is nevertheless an unwieldly task, where an emergency stop can only be made several hundred yards after the necessity for such stop arises.

Dredges must have their supplies of diesel fuel replenished while they are on the job. Barges, towed by dredge tenders, are employed 54 T.C. 705">*716 to convey the supplies to and from the dredges while they are in operation.

In comparison to ships, dredges are small, light, and unstable in rough weather, thus being subject to the primary dangers, from a loss standpoint, of capsizing and sinking. Should a dredge sink in shallow water, it can be raised and salvaged1970 U.S. Tax Ct. LEXIS 173">*198 unless, upon sinking, it turned over on its side, in which case it is extremely expensive to salvage.

The most hazardous condition under which a dredge must operate is that of foggy weather. Open harbors and inland waterways are both subject to foggy atmospheric conditions. With ships using the ship channel night and day, regardless of any fog, Merritt Dredging Co. has many times had the experience of having a ship rush dangerously close by one of the dredges, barely avoiding a catastrophic accident. Each vessel is equipped with signal lights and whistles.

There are limitations on the speed that vessels may travel in harbors. These speed limitations, however, are not always strictly observed.

Merritt Dredging Co. has its own internal policies and procedures whereby the vessels it owns and charters are periodically inspected and maintained. Merritt Dredging Co. still uses the repair and maintenance facilities and equipment which were built up over the years of operation as a partnership.

Merritt Dredging Co. has procedures whereby defects in vessels owned or chartered by the corporation are brought to the attention of the management. The superintendent of Merritt Dredging is 1970 U.S. Tax Ct. LEXIS 173">*199 charged with the duty of either reporting any defects in the vessels or assuming the responsibility of seeing to the repair of such defects himself.

Before the insurance company with which Merritt Dredging Co. deals will issue a liability insurance policy, it sends out a safety engineer to make a physical inspection of the vessels involved in order to determine their seaworthiness. Merritt Dredging Co. has effected changes in the manner of operation and condition of its equipment pursuant to the requests of its insurance company.

The petitioners and Merritt Dredging Co. all have the same address, 500 Albemarle Road, Charleston, S. C. They also share the same office space, telephone number, and post office box. The officers for all these corporations are Richard Merritt (president), Duane Merritt (vice president), and H. George Dent, Jr. (secretary). Each of the officers is paid $ 600 per year as compensation by each of the petitioners. Excluding the officers of petitioners, none of the petitioners has ever had any employees on its payroll.

All the bookkeeping for the petitioners since their incorporation has been performed by employees of Merritt Dredging Co.

54 T.C. 705">*717 In response1970 U.S. Tax Ct. LEXIS 173">*200 to a question contained in each of their 1964 Federal corporate income tax returns as to whether any corporation, individual, partnership, trust, or association at any time during the taxable year owned directly or indirectly 50 percent or more of the corporation's voting stock, the petitioners provided an affirmative answer. Petitioners did not attach a separate schedule, as directed on the corporate returns, showing the name, address, employer identification number, and percentage of voting stock owned by the 50-percent or more stockholders.

On these same returns, Dredge Clinton, Inc., and Dredge Cherokee, Inc., each computed their tax payable on the basis of the first $ 12,500 of their taxable income being subject to the surtax exemption. Southern Dredging Corp., for that same year, computed its tax payable, taking into account a $ 25,000 surtax exemption.

In his notices of deficiency, respondent, inter alia, disallowed the use of any surtax exemptions, determining that petitioners were not entitled to them.

ULTIMATE FINDINGS OF FACT

Dredge Clinton, Inc., Dredge Cherokee, Inc., and Southern Dredging Corp. were formed for the principal purpose of insulating each of the dredges1970 U.S. Tax Ct. LEXIS 173">*201 against the potential liabilities incurred by each of the other dredges. Neither of these corporations were formed for the principal purpose of evasion or avoidance of Federal income tax by securing the benefit of the surtax exemption.

OPINION

The issues presented for our decision are whether all or any of the petitioners were incorporated for the principal purpose of evasion or avoidance of Federal income tax, within the purview of section 269, by securing the benefit of the surtax exemption.

Section 11(d) provides an exemption of $ 25,000 in imposing the surtax on the taxable income of a corporation. The right to this exemption is sometimes qualified in the application of section 269(a), which provides, in pertinent part, as follows:

SEC. 269. ACQUISITIONS MADE TO EVADE OR AVOID INCOME TAX.

(a) In General. -- If --

(1) any person or persons acquire, or acquired on or after October 8, 1940, directly or indirectly, control of a corporation, * * *

* * * *