Court Opinion

ID: 4591794
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:06:34.912772+00
Date Added: 2024-06-11T07:59:18.279487
License: Public Domain

Gooding Amusement Company, Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent.  F. E. Gooding, Petitioner, v. Commissioner of Internal Revenue, Respondent.  Elizabeth Gooding (Also Known as Anna Elizabeth Gooding), Petitioner, v. Commissioner of Internal Revenue, Respondent.  F. E. Gooding and Elizabeth Gooding (Also Known as Anna Elizabeth Gooding), Petitioners, v. Commissioner of Internal Revenue, RespondentGooding Amusement Co. v. CommissionerDocket Nos. 40039, 40040, 40041, 40042United States Tax Court23 T.C. 408; 1954 U.S. Tax Ct. LEXIS 32; November 30, 1954, Filed 1954 U.S. Tax Ct. LEXIS 32">*32 Decisions will be entered under Rule 50.  1. Accruals and payments on short-term notes issued by corporation to its three controlling stockholders, consisting of husband, wife, and infant daughter, held, not interest on indebtedness under section 23 (b), Internal Revenue Code, and, hence not deductible from the corporation's gross income.2. Payments on the principal of the above mentioned notes, held, to constitute the distribution of taxable dividends under section 115 (a), Internal Revenue Code.3. Property obtained by petitioner corporation in exchange for its stock and the aforementioned notes, held, to have been acquired in transaction described in section 112 (b) (5) wherein no gain or loss is recognized under the law applicable to the year in which the transfer was made.  Held, further, the basis of such property is the same as it was in the hands of the transferors and may not be increased by the amount of gain which was in fact recognized through error and on which petitioners and their daughter paid capital gains tax.  Roger K. Powell, Esq., for the petitioners.Robert E. Johnson, Esq., for the respondent.  Van Fossan, Judge.  Withey, J., concurs in the result.  VAN FOSSAN 1954 U.S. Tax Ct. LEXIS 32">*33 23 T.C. 408">*409   Respondent determined income tax deficiencies against the below named petitioners in the amounts and for the years as follows:PetitionerYearDeficiencyGooding Amusement Company, Incorporated1947$ 9,337.59Gooding Amusement Company, Incorporated19486,800.58Gooding Amusement Company, Incorporated194911,785.94F. E. Gooding194719,307.82Elizabeth Gooding19472,449.02F. E. Gooding and Elizabeth Gooding194815,983.02The issues in these proceedings are (1) whether certain amounts accrued by the1954 U.S. Tax Ct. LEXIS 32">*34  petitioner Gooding Amusement Company, Incorporated, during the years 1947, 1948, and 1949 represented interest on indebtedness within the meaning of section 23 (b), Internal Revenue Code; (2) whether the payments on the principal amount of the notes issued to petitioners constituted a taxable dividend under section 115 (a) or a redemption of stock essentially equivalent to a distribution of a taxable dividend under section 115 (g); and (3) whether, for the purposes of determining depreciation expense and capital gains and losses, the basis of the assets acquired in 1946 by the petitioner corporation should be increased in the amount of gain recognized by the transferors, petitioners F. E. Gooding and Elizabeth Gooding and their 5-year-old daughter, upon the transfer.Petitioner corporation contests only those of respondent's adjustments to depreciation and capital gains and losses which are attributable to his denial of an increase in the basis of the depreciable assets acquired by the corporation in 1946.FINDINGS OF FACT.Many of the facts were stipulated and are incorporated herein by reference.23 T.C. 408">*410  Petitioner Gooding Amusement Company, Incorporated, hereinafter referred 1954 U.S. Tax Ct. LEXIS 32">*35  to as the corporation, is an Ohio corporation which filed income tax returns for the calendar years 1947, 1948, and 1949 with the collector of internal revenue for the eleventh district of Ohio.  The corporation was organized August 24, 1946, and filed an income tax return for the latter part of the year 1946.F. E. Gooding and Elizabeth Gooding, hereinafter sometimes referred to as petitioners, are husband and wife.  During the years in question they were stockholders and officers in the corporation.  They filed separate individual income tax returns for the year 1947 and a joint income tax return for the year 1948.In about 1913, F. E. Gooding, hereinafter referred to as petitioner, went to work for his uncle, J. E. Gooding, who owned and operated an outdoor amusement business.  The function of the business was to supply and operate portable equipment, such as merry-go-rounds and Ferris wheels, and other entertainment designed for use at fairs, parks, celebrations, church bazaars, and the like.  J. E. Gooding had been engaged in the business for about 20 years and was operating under his own name when petitioner entered his employ.  Several years later petitioner became an independent1954 U.S. Tax Ct. LEXIS 32">*36  operator in the amusement business and continued as such until the year 1932, except for 2 years when he was in a partnership with his two brothers.On December 29, 1932, petitioner organized F. E. Gooding Amusement Company, a corporation, with the stated purpose "to buy, sell and operate amusement devices and places of amusement; to lease and sublet amusement devices; to contract for sites and places of amusement, and to sublet the same." This corporation was the operator-lessee of the portable rides, i. e., merry-go-rounds, Ferris wheels, etc., which were owned by petitioner individually.On April 17, 1934, a second corporation, Gooding Greater Shows, Inc., was organized with the following stated purpose:To own, operate, buy, sell, lease and sublet amusement devices, riding devices, shows and other entertainment; to contract for sites and places of amusement and to sublet same; to acquire, lease own and maintain any and all real and personal property as may be necessary and proper for the objects and purposes aforesaid; to sublet, lease or rent the same; and to do all things necessary and incident thereto.Gooding Greater Shows, Inc., was not, in fact, an operating company. 1954 U.S. Tax Ct. LEXIS 32">*37  It was dissolved on June 22, 1939.  F. E. Gooding Amusement Company, the operating company, was dissolved on December 31, 1942.In 1942 petitioner hired as a tax consultant a certified public accountant.  The latter has been associated with petitioner's business ever since.On January 1, 1943, F. E. Gooding Amusement Company (hereinafter referred to as the partnership), a partnership, was formed with 23 T.C. 408">*411  F. E. Gooding, Elizabeth Gooding, and Joyce Ann Gooding, their 1-year-old daughter, having, respectively, four-sevenths, two-sevenths, and one-seventh interests therein.  The Bureau of Internal Revenue determined that Joyce Ann Gooding was not a bona fide partner for income tax purposes, which determination was accepted by petitioners, and her one-seventh interest in the partnership was taxed to her father for the years 1943 to 1946, inclusive.  Petitioner sold the amusement devices and portable rides to the partnership, which operated them without having to pay rent therefor.The partnership obtained public liability insurance in the principal amount of approximately $ 50,000, which, in the opinion of petitioner, went a long way toward covering any liability that might arise1954 U.S. Tax Ct. LEXIS 32">*38  from accidents involving the partnership's property.  The largest accident claim ever paid on behalf of the amusement enterprises controlled by petitioner was in the amount of $ 18,000.The net taxable income of the partnership was as follows for the years 1943, 1944, 1945, and 1946:1943$ 158,254.491944151,007.581945257,437.331946 1153,661.58From 1932 to the years here involved the corporations and partnership in some cases executed "privilege" contracts between 2 and 12 months in advance, which entitled them to the use of certain locations on which the amusement devices could be placed and operated.On August 24, 1946, petitioner corporation was organized with F. E. Gooding, Elizabeth Gooding, and Kathleen Holleran, as its president and treasurer, vice president, and secretary, respectively.At the close of business August 24, 1946, the partnership distributed to its three partners, assets consisting of advances to employees, accounts and notes receivable, land, buildings, cables, electrical equipment, office equipment, electrical towers, trucking equipment, canvas, mechanical rides, unexpired insurance, and advance payments on1954 U.S. Tax Ct. LEXIS 32">*39  equipment.  This distribution was made to the partners as tenants in common, with the result that F. E. Gooding, Elizabeth Gooding, and Joyce Ann Gooding owned, respectively, an undivided four-sevenths, two-sevenths, and one-seventh interest in all the assets distributed. The book value of the assets so distributed was $ 177,037.29, and the book value of the undistributed cash, investments, land, and accrued interest was $ 285,745.84.  In connection with this distribution each partner assumed a joint and several obligation to pay certain notes payable of the partnership in the total amount of $ 13,969.25, such payment to be made in accordance with his respective undivided interest in the distributed assets.  The capital account of each partner 23 T.C. 408">*412  on the books of the partnership was proportionately reduced, so that the net total reduction in the capital account due to the distributions was $ 163,068.04, which was equivalent to the book value of the assets distributed, less notes payable assumed.  The partnership continued in existence throughout the period here involved.Included in the assets distributed to the partners were depreciable assets having a net book value on the1954 U.S. Tax Ct. LEXIS 32">*40  books of the partnership of $ 152,764.55, of which $ 129,899.13 represented trucking equipment and mechanical rides. The privilege contracts referred to above were not carried at any value on the books of the partnership as of August 24, 1946.On August 24, 1946, concurrently with the distribution of the partnership assets having a book value of $ 177,037.29, the partners made an offer to the newly formed corporation to exchange the aforesaid distributed assets at a value of $ 294,970.39.  The difference between the depreciated book value of the distributed assets in the amount of $ 177,037.29 and the amount offered of $ 294,970.39, or $ 117,933.10, was the difference between the $ 129,899.13 book value of trucking equipment and mechanical rides on the books of the partnership, and the fair market value of these assets as appraised by petitioner with the help of Kathleen Holleran, the secretary of the corporation.  In the process of making the new valuations, petitioner surveyed the equipment and rides in use on the various locations, checked the inventory records, and consulted his foremen from time to time with regard to the mechanical condition of the equipment and rides. The1954 U.S. Tax Ct. LEXIS 32">*41  following table shows a comparison between the partnership book value of the trucking equipment and mechanical rides and the new values assigned to these assets by petitioner:Book value perNew value inAssetpartnershipNew valueexcess of partnershipbooksbook valueTrucking equipment$ 29,244.06$ 65,933.50$ 36,689.44Mechanical rides100,655.07181,898.7381,243.66$ 129,899.13$ 247,832.23$ 117,933.10Pursuant to the above mentioned offer, the corporation accepted the following assets at the indicated valuations:Accounts receivable$ 2,097.49Notes receivable3,643.91Advances to employees1,010.35Depreciable assets (net)270,697.65Land4,500.00Unexpired insurance10,020.99Advance payments on equipment3,000.00Total$ 294,970.3923 T.C. 408">*413  The corporation also assumed the notes payable in the amount of $ 13,969.25 which had been assumed by the partners upon the distribution of partnership assets.  In return for these assets in the net amount of $ 281,001.14, the partners received in proportion to their respective partnership interests the following:PartnerReceivedAmountF. E. Gooding140 shares of no-par common stock havingstated value of$ 28,000.005 notes due in 5 succeeding years beginningin 1947 at $ 26,514.42 (or $ 26,514.41) each132,572.08Elizabeth Gooding70 shares of no-par common stock having statedvalue of14,000.005 notes due in 5 succeeding years beginningin 1947 at $ 13,257.20 (or $ 13,257.21) each66,286.04Joyce Ann Gooding35 shares of no-par common stock having statedvalue of7,000.005 notes 1 due in 5 succeeding years beginningin 1947 at $ 6,628.60 (or $ 6,628.61) each33,143.02Total$ 281,001.141954 U.S. Tax Ct. LEXIS 32">*42 There was no identification of the portion of the assets contributed for the shares and the portion contributed for the notes.  The corporate notes were ordinary negotiable judgment notes, each containing an unconditional promise to pay on a fixed date the principal thereof, together with interest at 5 per cent per annum.The opening entries on the corporation's books dated August 25, 1946, were as follows:Dr.Cr.Advances to employees$ 1,010.35A/c receivable2,096.49Notes receivable3,643.91Unexpired insurance10,020.99Advance payments on equipment3,000.00Land -- 1300 Norton Ave., Columbus, Ohio4,500.00Building -- 1300 Norton Ave., Columbus, Ohio15,823.17Cables1,805.34Electrical equipment2,527.02Office equipment1,203.81Electrical towers316.15Trucking equipment1 65,933.50Canvas647.52Mechanical rides1 181,898.73Maintenance equipment542.41Notes payable -- various$ 13,969.25Notes payable -- F. E. Gooding132,572.08Notes payable -- Mrs. F. E. Gooding66,286.04Notes payable -- Joyce Ann Gooding33,143.02Capital stock49,000.00$ 294,970.39$ 294,970.391954 U.S. Tax Ct. LEXIS 32">*43 The privilege contracts of the partnership were not carried at any value on the books of the corporation as of August 25, 1946.  The 23 T.C. 408">*414  corporation performed the services required of the partnership under the contracts and in 1946 received income as a result thereof.  The "Gooding" name was well established in the outdoor amusement business and was of substantial value in the securing of such contracts.  No value was ascribed to goodwill on the books of either the partnership or the corporation.Of the nonoperating assets in the amount of $ 285,745.84 left in the partnership, the sum of $ 184,444.23 was cash.  The corporation received no cash from the partnership and made no borrowings in 1946.For the taxable year 1946, each partner reported as a long-term capital gain his proportionate share of the difference 1 between the depreciated cost of the transferred assets and the amount at which such assets were offered to and accepted by the corporation.  On these gains the individual petitioners paid a total tax of $ 28,683.27.  By a report dated March 29, 1948, respondent accepted1954 U.S. Tax Ct. LEXIS 32">*44  petitioners' 1946 returns without eliminating therefrom the aforesaid capital gains.In reporting in its income tax returns for the period August 24, 1946, to December 31, 1946, and the taxable years here involved depreciation expense and capital gains and losses attributable to the trucking equipment and mechanical rides acquired August 24, 1946, the corporation used as the unadjusted basis of such assets the increased valuation assigned to them by petitioner.Between August 24, 1946, and December 31, 1952, the corporation sold 14.96 per cent of the trucking equipment and 56.85 per cent of the mechanical rides acquired on the former date.  The following table indicates with respect to the above mentioned assets, the relationship of sale prices to appraised values:Cost perYearappraisedDepreciationsoldvalue, Aug.to date ofSale price 1Gain (loss)24, 1946saleTrucking equipment (in units):31947$ 3,050.00$ 211.78$ 1,000.00($ 1,838.22)119481,094.00119.16450.00(524.84)2 219491,421.62376.721,000.00(44.90)319503,422.001,261.211,525.00(635.79)21952875.00528.55400.0053.55 Totals$ 9,862.62$ 2,497.42$ 4,375.00($ 2,990.20)Mechanical rides (in units):61946$ 15,803.82$ 378.97$ 18,592.10$ 3,167.25 119473,375.00194.167,500.004,319.16 119483,375.00977.575,500.003,102.57 6 3194921,379.935,455.9522,000.006,076.02 8195044,354.7817,310.6636,400.009,355.88 5195110,612.445,217.8111,700.006,305.37 119524,500.002,525.406,000.004,025.40 Totals$ 103,400.97$ 32,060.52$ 107,692.10$ 36,351.65 1954 U.S. Tax Ct. LEXIS 32">*45 23 T.C. 408">*415  By an agreement dated December 20, 1946, certain of the corporation's key employees, in consideration for shares of the corporation's stock theretofore or thereafter issued to them, gave the corporation an option to repurchase any of such issued shares at any time at progressively increasing prices, beginning with $ 220 per share in 1947 and ending with $ 400 per share in 1956.  It was further agreed that the option should expire at the close of 1956 unless extended for a further period by mutual agreement.By the end of 1947 employees of the corporation had acquired 24.39 per cent of its outstanding stock. Additional shares were issued to employees in 1948 although the percentage of the employees' holdings dropped to 22.3 per cent, where it remained throughout 1949.In 1947 the corporation acquired new equipment and rides at a total cost of $ 306,894.27.In connection with its operations, including the acquisition of additional equipment in 1947 and later years, the corporation obtained funds and credits, which were evidenced by notes, from1954 U.S. Tax Ct. LEXIS 32">*46  banks, merchants, petitioner, Joyce Ann Gooding, and the partnership. These notes were recorded in the corporation's Miscellaneous Notes Payable account and totaled $ 138,572.08 in 1947, $ 186,018.92 in 1948, and $ 246,149.40 in 1949.  Included in these notes were those issued to petitioner, his daughter, and the partnership, as follows:Date ofnoteDue dateAmountDate paid1947F. E. Gooding AmusementCo. (Part.)4/4/47Demand$ 12,0001948F. E. Gooding4/3/4810/3/487,0009/30/48F. E. Gooding4/14/4810/14/4810,0009/30/48F. E. Gooding Amusement Co.(Part.)4/14/489/14/482,5009/14/49F. E. Gooding Amusement Co.(Part.)4/16/489/16/485,0009/14/491949F. E. Gooding Amusement Co.(Part.)2/14/492/14/501,500F. E. Gooding4/6/4910/6/4910,00010/4/49F. E. Gooding3/30/499/30/498,4306/15/49and9/28/49Joyce Ann Gooding1/29/497/29/495,0007/29/49Joyce Ann Gooding3/24/499/24/492,0009/23/49Joyce Ann Gooding7/29/491/29/505,000F. E. Gooding12/31/49Demand20,475$ 88,905UnpaidUnpaidUnpaidat 12/31/47at 12/31/48at 12/31/491947F. E. Gooding AmusementCo. (Part.)$ 12,000$ 12,000$ 12,0001948F. E. GoodingF. E. GoodingF. E. Gooding Amusement Co.(Part.)2,500F. E. Gooding Amusement Co.(Part.)5,0001949F. E. Gooding Amusement Co.(Part.)1,500F. E. GoodingF. E. GoodingJoyce Ann GoodingJoyce Ann GoodingJoyce Ann Gooding5,000F. E. Gooding20,475$ 12,000$ 19,500$ 38,9751954 U.S. Tax Ct. LEXIS 32">*47  During 1947 the partnership and Joyce Ann Gooding advanced to the corporation an additional sum of $ 23,000, of which $ 17,000 was outstanding at the close of both 1947 and 1948 and $ 14,000 was outstanding at the close of 1949.23 T.C. 408">*416  The following schedule shows the extent to which the corporation made payments in respect of the corporate notes issued August 24, 1946, to petitioners and their daughter:Unpaid asPayeeAmountDue dateDate paidof 12/9/53E. Gooding$ 26,514.428/24/478/24/4726,514.428/24/48194826,514.428/24/49195026,514.418/24/50$ 26,514.4126,514.418/24/5126,514.41Mrs. F. E. Gooding13,257.218/24/471 8/24/478,257.2113,257.218/24/4813,257.2113,257.218/24/4913,257.2213,257.218/24/5013,257.2013,257.208/24/5113,257.61F. E. Gooding as natural6,628.618/24/476,628.61guardian of Joyce Ann6,628.618/24/486,628.60Gooding6,628.608/24/496,628.606,628.608/24/506,628.606,628.608/24/516,628.88Total$ 232,001.14$ 147,457.11The principal of the1954 U.S. Tax Ct. LEXIS 32">*48  notes issued to petitioner was paid back as set forth above for the reason that he, unlike his wife and daughter, needed the money for investment in some apartment houses.  The principal amount of the other notes issued August 24, 1946, was not paid because the corporation was heavily indebted to outsiders and at no time during the period involved had a sufficient cash balance.  Petitioner, who as president and majority stockholder 2 controlled the corporation, subordinated the claims of himself and his family to those of banks and other third parties.  Petitioner felt that such subordination was necessary in order to maintain the corporation's credit standing.  Petitioner and his family at no time had any intention of enforcing their matured claims against the corporation.After 1947 when it paid about one-fourth of the interest owing petitioner and made no interest payment to petitioner's wife and daughter, 1954 U.S. Tax Ct. LEXIS 32">*49  the corporation paid interest on the notes here involved as it fell due.  3In its 1947, 1948, and 1949 income tax returns the corporation claimed as interest expense the amounts of $ 12,988.01, $ 13,879.25, and $ 13,345.15, respectively.  Of these amounts, $ 10,277.34 in 1947, $ 9,568.99 in 1948, and $ 8,698.61 in 1949 represented claimed interest on the notes issued August 24, 1946.  In the tax returns of petitioners and their daughter the above amounts were reported as interest income received from the corporation.The income tax returns and books of the corporation indicated that as of the close of the years 1946 through 1949, inclusive, the stated 23 T.C. 408">*417  value of the corporation's common stock, the number of such shares outstanding, the dividends paid thereon, and earned surplus after payment of dividends and taxes were, respectively, as follows:1946194719481949Stated value of common stock$ 64,800$ 76,000$ 76,000$ 76,600Number of shares outstanding324380380383Dividends paid$ 648$ 7,600$ 7,600$ 3,830Earned surplus$ 67,580.79$ 139,667.51$ 203,997.39$ 236,254.111954 U.S. Tax Ct. LEXIS 32">*50  As a consequence of the issuance of the notes of August 24, 1946, there was not established between the corporation and the individual members of the Gooding family the relationship of debtor-creditor.The payments made by the corporation to petitioners in 1947 and 1948 on the principal of their notes were in their entirety essentially equivalent to taxable dividends.OPINION.The first question is whether on or about August 24, 1946, there was created between petitioner corporation, on the one hand, and petitioners and their infant daughter on the other, a debtor-creditor relationship.  If so, the judgment notes issued that day by the corporation were genuine evidences of indebtedness and the amounts accrued thereon by the corporation as interest expense and subsequently paid out in cash to the holders of the notes constituted interest on indebtedness under section 23 (b), Internal Revenue Code of 1939, 4 and, hence, proper deductions from gross income. If not, the amounts so accrued and paid were not interest and the respondent's disallowance of these amounts as deductions from the corporation's gross income should be sustained.1954 U.S. Tax Ct. LEXIS 32">*51 This is another in a long series of cases wherein the stockholders of a closely held corporation have attempted to establish between themselves and the corporation the relationship of creditor-debtor.  Cf.  John Kelley Co. v. Commissioner and Talbot Mills v. Commissioner, 326 U.S. 521">326 U.S. 521; Kraft Foods Co., 21 T.C. 513; Tribune Publishing Co., 17 T.C. 1228; Toledo Blade Co., 11 T.C. 1079; Mullin Building Corporation, 9 T.C. 350; Clyde Bacon, Inc., 4 T.C. 1107, to cite only a few of the cases involving this problem.  Oftentimes 23 T.C. 408">*418  the desire to obtain for the corporation a tax advantage is a principal motive, the tax advantage being in the fact that amounts paid out as interest on indebtedness are deductible from the corporation's gross income, whereas the same is not true of dividends paid out on stockholdings.There is nothing reprehensible in casting one's transactions in such a fashion as to produce the least tax.  The courts have often reaffirmed this view.  Bullen v. Wisconsin, 240 U.S. 625">240 U.S. 625;1954 U.S. Tax Ct. LEXIS 32">*52 United States v. Isham, 84 U.S. 496">84 U.S. 496. On the other hand, tax avoidance will not be permitted if the transaction or relationship on which such avoidance depends is a "sham" or lacks genuineness.  The concept that substance shall prevail over form has likewise been enunciated in numerous cases.  Cf.  Higgins v. Smith, 308 U.S. 473">308 U.S. 473; Gregory v. Helvering, 293 U.S. 465">293 U.S. 465; 1432 Broadway Corporation, 4 T.C. 1158.In the light of the above considerations, the courts have undertaken to deal with the kind of question presently before us.  In deciding each of these cases on the basis of its own peculiar facts, the courts have been careful not to lay down any all-embracing rule of general application.  Instead they have invoked and relied upon certain criteria, none of which is, by itself, determinative of the ultimate fact question.  Cf.  Bowersock Mills & Power Co. v. Commissioner, 172 F.2d 904; Ruspyn Corporation, 18 T.C. 769; New England Lime Co., 13 T.C. 799.1954 U.S. Tax Ct. LEXIS 32">*53 In the instant case, in the matter of form, the notes in question present no problem of interpretation.  The formal criteria of indebtedness are unquestionably satisfied.  The notes on their face are unconditional promises to pay at a fixed maturity date a sum certain and the payment of interest thereon is not left to anyone's discretion.  The instruments in form are pure evidences of indebtedness.But we are not limited in our inquiry to the instruments themselves.  We may look at all the surrounding circumstances to determine whether the real intention of the parties is consistent with the purport of the instruments.  Proctor Shop, Inc., 30 B. T. A. 721, affd.  82 F.2d 792.The most significant aspect of the instant case, in our view, is the complete identity of interest between and among the three noteholders, coupled with their control of the corporation.  The noteholders were husband, wife, and infant daughter, respectively.  The husband held the majority stock in the corporation.  It is, in our opinion, unreasonable to ascribe to the husband petitioner, F. E. Gooding, an intention at the time of the issuance of the notes1954 U.S. Tax Ct. LEXIS 32">*54  ever to enforce payment of his notes, especially if to do so would either impair the credit rating of 23 T.C. 408">*419  the corporation, 5 cause it to borrow from other sources the funds necessary to meet the payments, or bring about its dissolution.  Compare, on this aspect of the case, the reasoning in Mullin Building Corporation, supra, at pp. 355, 356. In addition, a realistic appraisal of the family situation can lead, in our view, only to the conclusion that with regard to the disposition or enforcement of their notes petitioner's wife and daughter never contemplated acting either independently of or contrary to the wishes of the petitioner.  The fact that the majority of the notes here involved, all of which have long since matured, have not been paid lends corroboration to our finding that at no time material to our consideration did the noteholders intend to enforce payment of their notes or assert the rights of bona fide creditors.  If the state of mind of the noteholders was as above indicated, it is apparent that their position with respect to the amount represented by the principal of the notes was akin to that of the ordinary shareholder, who 1954 U.S. Tax Ct. LEXIS 32">*55  understands that his investment is subject to the risks of the venture and the prior claims of creditors.  The incidence here of the subordination of the Goodings' notes to the claims of others is too marked to permit us to find that a bona fide debtor-creditor relationship was established between the corporation and its controlling stockholders.1954 U.S. Tax Ct. LEXIS 32">*56  In support of its position, petitioner corporation points to an initial financial structure that reveals no excessive ratio of debt to stock. In fact, if a reasonable value is attributed to goodwill, the portion of the assets subject to the prior claim of the alleged debt was no greater than that remaining for the stock. But the "thin capitalization" factor is only one of the indicia from which the presence or absence of a debtor-creditor relationship may be determined.  We do not consider it decisive of the present issue.It is further urged on behalf of the petitioner corporation that there were excellent business purposes behind the issuance of the notes 23 T.C. 408">*420  in such large amounts as compared to the capital stock. Petitioner contends that since the amusement device business is constantly subject to the imposition of crippling liability as a result of accidents he desired that he and his family become substantial creditors, on a par with other unsecured general creditors, as well as shareholders of the corporation.  Thus, it is argued, in the event of a disastrous accident and the ensuing heavy liability, petitioner and his family, by virtue of their status as creditors, 1954 U.S. Tax Ct. LEXIS 32">*57  would be able to salvage some portion of the corporate assets -- a result that would be highly improbable if they were stockholders only.  While the above consideration may have entered into petitioner's calculations, the record indicates that its status as a motive for the issuance of notes instead of stock was minor.  It will be noted that at the close of 1942, when presumably the risk of massive liability due to accident was no less than it was in 1946, the petitioner changed from the corporate form of doing business to a partnership. If petitioner was so little concerned about the possibility of financial ruin in 1942 and 1943 that he risked doing business as a partnership, we doubt that he was much, if any, more anxious about such an eventuality in 1946, notwithstanding the disastrous Hartford circus holocaust which petitioner tells us made such an impression on him.  Furthermore, the record indicates that the liability insurance carried by the corporation was more than adequate to cover any claim that might reasonably have been expected to arise against the corporation as a result of an accident.  61954 U.S. Tax Ct. LEXIS 32">*58  Petitioner also urges that his desire and intention to allow key employees to have stock in the corporation constituted another cogent business purpose.  Such an attitude has great merit and is to be encouraged, but we are unable to agree to the conclusion implicit in the argument that a comparatively small capitalization is required to achieve this objective.  Moreover, we cannot avoid the thought that an equally cogent reason for permitting employees to subscribe to approximately 24 per cent of the stock following the exchange of August 24, 1946, was to avoid, if possible, the impact of the "control" provision of section 112 (b) (5) of the Code.Thus, we find no substantial merit in the arguments advanced by petitioner in support of his contention that nontax considerations were the significant factors in the decision to take short-term judgment notes, in addition to stock, in the newly formed petitioner corporation.  What remains, therefore, is the stark fact that the only substantial purpose motivating the transaction was one of tax avoidance.  23 T.C. 408">*421  When this fact is considered, together with the extent to which the notes were subordinated to the claims of creditors, the 1954 U.S. Tax Ct. LEXIS 32">*59  reality of the amenability of petitioner's wife and infant daughter to his desires in respect of the notes, and the absence from the transaction of any true borrowing element or new contribution to the enterprise, we must conclude that no indebtedness within the meaning of section 23 (b) arose between the Goodings and the corporation.  Since there was no indebtedness, the accruals in question could not represent interest.  We, therefore, sustain respondent on the first issue.The second issue is closely related to the first and involves the question whether the payments in 1947 and 1948 by the corporation on the principal amount of the notes issued to petitioners in 1946 constituted a taxable dividend under section 115 (a) or a cancellation or redemption of stock essentially equivalent to the distribution of a taxable dividend under section 115 (g) of the Code.  71954 U.S. Tax Ct. LEXIS 32">*60 The usual presumption of correctness inhering in respondent's determination also applies in the present instance.  George Hyman, 28 B. T. A. 1231, affd.  71 F.2d 342, certiorari denied 293 U.S. 570">293 U.S. 570. The burden, therefore, is on the petitioner to establish by a preponderance of the evidence that the payments in question were not essentially equivalent to dividends.The petitioners have rested almost their entire case on the proposition that the notes here involved were genuine evidences of indebtedness. We have found to the contrary and held accordingly on the first issue.  The same evidence that failed to carry the day on the first issue is equally deficient with respect to the instant issue.  Since the notes did not, in reality, represent creditor interests, the payments made to the stockholders who held such notes must be considered not as payments of a bona fide indebtedness of the corporation, but as distributions of corporate profits to the stockholders as stockholders and not as creditors.  Therefore, we conclude that they constituted dividends under the broad language of section 115 (a).  1954 U.S. Tax Ct. LEXIS 32">*61  Cf.  Emil Stein, 46 B. T. A. 135; Houck v. Hinds, 215 F.2d 673. The corporation had accumulated earnings both before and after the payments.  The proportional ownership of the stockholders was unchanged after the payments.  The fact that the corporation, or rather the petitioner, may have had no intention of distributing earnings 23 T.C. 408">*422  under the guise of discharging debts is immaterial.  As the court in McGuire v. Commissioner, 84 F.2d 431, said:Neither artifice, subterfuge, or bad faith need be present to bring a transaction within the meaning of the statute here involved, for as we read the law a taxpayer may well act with the utmost good purpose and without evil intent and yet his transactions may in effect be the equivalent of the distribution of a taxable dividend.Nor does the fact that the payments here involved were not made pro rata among all the shareholders alter the net effect of what was done.  As we said in James F. Boyle, 14 T.C. 1382, 1389:Much is made of the suggested inequality of the distribution as among the stockholders. 1954 U.S. Tax Ct. LEXIS 32">*62  The contention is not impressive on either the law or the facts.  Legally it is not alone distributions which are true dividends to which the section applies.  "* * * this theory assumes that the distribution must in fact meet the legal test of a dividend to fall within section 201 (g) [the predecessor of 115 (g)].  If this were sound, that provision of the statute would be surplusage, as such a dividend would be taxable under other provisions.  Cf.  United States v. Katz, 271 U.S. 354">271 U.S. 354. The purpose of this section is to tax distributions which effect a cash distribution of surplus otherwise than in the form of a legal dividend * * *." Shelby H. Curlee, Trustee, 28 B. T. A. 773, 782, affirmed (C. C. A., 8th Cir.), 76 Fed. (2d) 472, certiorari denied, 296 U.S. 599">296 U.S. 599.Accord, J. Natwick, 36 B. T. A. 866.For the reasons above stated, we hold for the respondent on the second issue.  See Houck v. Hinds, supra. It is unnecessary to decide whether or not section 115 (g) is applicable in the situation herein1954 U.S. Tax Ct. LEXIS 32">*63  presented.The last issue requires a determination as to the proper basis for the depreciable assets acquired by the corporation in pursuance of the exchange of August 24, 1946.  Respondent contends that the 1946 exchange was nontaxable under section 112 (b) (5) of the Code, 8 that gain should not have been recognized as a result, and that, therefore, the assets acquired by the transferee corporation should retain the adjusted bases they had in the hands of the Goodings, the transferors. Thus, urges respondent, it was improper to use the fair market value of such assets at the time of the exchange in 1946 23 T.C. 408">*423  as the unadjusted bases for the calculation of depreciation expense and gains and losses from capital sales for the taxable year here involved.1954 U.S. Tax Ct. LEXIS 32">*64  It is the contention of the petitioner corporation that the exchange involved did not come within section 112 (b) (5), but, to the contrary, was a transaction taxable in part under section 112 (c) (1) of the Code of 1939, 91954 U.S. Tax Ct. LEXIS 32">*65  and that, therefore, the bases of the assets so transferred to the corporation include, pursuant to section 113 (a) (8), Internal Revenue Code of 1939, 10 the amount of gain thus recognized.  Such conclusion is a non sequitur, with which we disagree.As a condition precedent to the application of section 113 (a) (8), supra, it is first necessary that compliance be had with the section 112 (b) (5) requirement.  That1954 U.S. Tax Ct. LEXIS 32">*66  is to say, the property involved must have been acquired by the corporation by issuance of stock "in connection with a transaction described in section 112 (b) (5)." Since we have found hereinabove that the notes which were received by petitioners and which by them are claimed to represent "other property" under section 112 (c) (1), were in fact representative of risk capital invested in the nature of stock, the "solely in exchange for stocks or securities" requirement of section 112 (b) (5) was, in our considered judgment, satisfied.  Furthermore, immediately after the exchange the transferors were in control of the transferee corporation, and the stock which they received was in proportion to their interests in the property prior to the exchange.  Thus, in our opinion, the exchange involved was a so-called section 112 (b) (5) transaction, as a result of which no gain or loss should have been recognized.  The fact that gain was erroneously recognized to the extent that the 23 T.C. 408">*424  fair market value 11 of the assets exceeded their depreciated cost and a capital gains tax paid thereon by petitioners and their daughter, and the consideration of petitioners' redress in the premises1954 U.S. Tax Ct. LEXIS 32">*67  are matters beyond the scope of this opinion.The corporation having received the property in question in a transaction described in section 112 (b) (5) wherein no gain or loss is recognized "under the law applicable to the year [1946] in which the transfer was made," see section 113 (a) (8), we have no alternative to denying petitioner corporation the stepped-up bases which it seeks.  Consequently, respondent is sustained as to this issue.Decisions will be entered under Rule 50.  Footnotes1. January 1 to August 24.↩1. The payee of these notes was "F. E. Gooding as natural guardian of Joyce Ann Gooding."↩1. These figures reflect the increased values determined by the petitioner prior to the exchange.↩1. As finally adjusted by the revenue agent, the total capital gain recognized was $ 114,733.10.↩1. Trade-in values received are included.↩2. Includes one unit written off.↩3. Includes miscellaneous items written off.↩1. Only $ 5,000 was paid on the maturity date of this note.↩2. At all times during the taxable years, petitioner owned 50 per cent or more of the corporation's capital stock.↩3. The record is not clear as to whether interest was paid on notes after their maturity.↩4. SEC. 23.  DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:* * * *(b) Interest.  -- All interest paid or accrued within the taxable year on indebtedness, except on indebtedness incurred or continued to purchase or carry obligations (other than obligations of the United States issued after September 24, 1917, and originally subscribed for by the taxpayer) the interest upon which is wholly exempt from the taxes imposed by this chapter.↩5. At the hearing, petitioner testified as follows:Q. So that in order to continue operating, you needed those funds and the other notes that were left in the corporation during '46 to '48?A. Well, it was more necessary that we pay other obligations than it was those.  Those were our family obligations and could be put off whereas the banks that we borrowed money from or other indebtedness that we may have had, we tried to keep those bills paid up to date and not to have a lot outstanding in order to have a good credit rating.* * * *Q. It didn't matter to the family whether the bills were paid or not?A. What bills are you referring to?Q. You said -- say notes?A. It didn't matter to the family.* * * *Q. So that in substance it wouldn't have mattered to your family whether the notes were paid now or maybe five years from now or whether they were paid?A. At that particular time, no.* * * *↩6. The face amount of the corporation's liability insurance in 1948 and 1949 was $ 50,000/$ 200,000, a figure considerably in excess of the partnership insurance policy, which petitioner testified would "go a long way" toward covering any potential liability.  Note also that the largest claim ever paid on behalf of petitioner's amusement enterprises was $ 18,000.↩7. SEC. 115. DISTRIBUTIONS BY CORPORATIONS.(g) Redemption of Stock. -- If a corporation cancels or redeems its stock (whether or not such stock was issued as a stock dividend) at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend.↩8. SEC. 112.  RECOGNITION OF GAIN OR LOSS.(b) Exchanges Solely in Kind.  -- * * * *(5) Transfer to corporation controlled by transferor. -- No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.  Where the transferee assumes a liability of a transferor, or where the property of a transferor is transferred subject to a liability, then for the purpose only of determining whether the amount of stock or securities received by each of the transferors is in the proportion required by this paragraph, the amount of such liability (if under subsection (k) it is not to be considered as "other property or money") shall be considered as stock or securities received by such transferor.↩9. SEC. 112. RECOGNITION OF GAIN OR LOSS.(c) Gain from Exchanges Not Solely in Kind.  -- (1) If an exchange would be within the provisions of subsection (b) (1), (2), (3), or (5), or within the provisions of subsection (1), of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph or by subsection (1) to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.↩10. SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS.(a) Basis (Unadjusted) of Property.  -- The basis of property shall be the cost of such property; except that -- * * * *(8) Property acquired by issuance of stock or as paid-in surplus.  -- If the property was acquired after December 31, 1920, by a corporation -- (A) by the issuance of its stock or securities in connection with a transaction described in section 112 (b) (5) (including, also, cases where part of the consideration for the transfer of such property to the corporation was property or money, in addition to such stock or securities), or(B) as paid-in surplus or as a contribution to capital, then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made.↩11. We think petitioner's valuation of the depreciable assets involved was substantially correct.  Any overvalution of the trucking equipment was more than offset by what appears to have been an undervaluation of the mechanical rides.↩