Train, Judge:
Respondent determined deficiencies in the taxes of Weiser Company, transferor, as follows:
Year Taa> Amount
1953 Income and excess profits_$89,152. 26
1954 Income_ 131,698.45
Respondent further determined that petitioner was liable, as transferee, for Weiser Company’s deficiencies for those years to the extent of $1,727.12.
The only issues presented relate to the deficiencies determined against the transferor:1
(1) Whether the amounts it paid in the form of rent to University Hill Foundation are deductible as rental expense; and
(2) Whether certain expenditures totaling $26,504.71 are deductible as expenses or otherwise for 1954.
FINDINGS OP PACT
Some of the facts are stipulated and are hereby found as stipulated. Our use of “sale,” “lease,” and corresponding terms is merely for ease of expression. As our opinion indicates, we are not persuaded that the transactions so denominated in this case should be given the Federal income tax consequences normally resulting from leases and sales.
Petitioner, Warren Brekke, resides in Salt Lake City, Utah. He is one of 54 transferees of a dissolved corporation, Weiser Company, hereinafter sometimes referred to as Weiser #2. Weiser #2 filed its accrual basis Federal income tax returns for the calendar years 1958 and 1954 with the district director of internal revenue at Los Angeles, Calif.
On or about November 23, 1945, Weiser Company (hereinafter sometimes referred to as Weiser #1) was incorporated in California. On December 1, 1945, Weiser #1 entered into the business of manufacturing and selling hardware, particularly locks for residential uses. It was a continuation of a partnership which had previously conducted this business.
Weiser #l’s original stockholders were David Weisz, Edward Melt-zer, Julius Fligelman, and Philip Meltzer. Although he was president and general manager of Weiser #1, Fred J. Russell (hereinafter sometimes referred to as Russell) was not, at first, a stockholder. About a year after Weiser #l’s incorporation, Russell purchased one-third of its common stock.
On June 30, 1950, Weiser #l’s stock was owned as follows:
BtochhoXder Common Preferred shares shares
Edward Meltzer-1,088% 62y2
Frieda Meltzer_ 416% 12%
Philip H. Meltzer_ 1,000 _
Fred J. Bussell_ 1,666%
Julius Fligelman-416% 12%
Molly S. Fligelman_ 416% 12%
Total_ 5,000 100
In June of 1950, Russell was contacted by Malone, representative of University Hill Foundation (formerly Loyola University Foundation and hereinafter sometimes referred to as Foundation), a California corporation, with respect to a sale of all the stock of Weiser #1 to Foundation. Prior to this time Russell had never known or heard of Foundation, nor had he known Malone, and none of the selling stockholders had any interest in Foundation.
One of the Weiser #1 stockholders suggested a total sales price of $990,000, the first amount offered in the negotiations, and that figure was accepted.
On June 30, 1950, an agreement was executed providing for the sale of all the oustanding shares of Weiser #1 for $990,000. The first $10,000 paid was to be allocated to the preferred stock and the remaining $980,000 to the common. Five thousand dollars was to be transferred concurrently to the sellers. The remaining $985,000 was to be paid as follows: For 5% years (until January 1,1956), 90 percent of the cash Foundation received either as net profits from operation of the Weiser #1 business assets or as rent from lease of those assets; for 4% years thereafter (until July 1,1960) 60 percent of such profits or rents; hut during each period at least $4,000 per month; all until the full purchase price was paid. “Net profits” was defined as net profits before income and similar taxes and before depreciation or amortization of any asset owned by Weiser #1 on June 30, 1950. The entire purchase price was in any event due on July 1, 1960. As security, Foundation was to pledge with the sellers all of the Weiser #1 stock. In the event of default, the sellers could enforce payment only out of their collateral.
Attached to the purchase agreement was a balance sheet of Weiser #1 as of July 1,1950, as follows:
Assets
current
Cash on hand and in bank_ $6, 918. 75
Accounts receivable, trade_ $127, 207. 49
Less provision for bad debts_ 6, 359. 94
120, 847. 55
Advances and loans receivable — employees and others_ 16,199. 19
California franchise tax refund receivable_ 1, 256. 34
Inventory_ 126, 557. 49
Unexpired insurance and prepaid postage_ 3, 902. 85
Total current assets. 275, 682. 17
FIXED Cost Provision for depreciation Cost less depreciation
Land_ $8, 757. 35 $8, 757. 35
Buildings_ 75, 032. 67 $8,150. 58 66, 882. 09
Machinery and equipment. 147, 907, 59 36, 751. 35 111, 156. 24
Furniture and fixtures_ 7, 284. 49 3, 689. 25 3, 595. 24
Tools_ 16, 530. 50 12, 670. 36 3, 860. 14
Dies and molds_ 27, 876. 45 24, 654. 98 3, 221. 47
Patents_ 3, 475. 02 492. 64 2, 982. 38
Truck_ 1, 348. 89 1, 348. 89
288, 212. 96 87, 758. 05 200, 454. 91
Total fixed 200, 454. 91
OTHER
Deposits_ 425. 00
Total assets. 476, 562. 08
Liabilities
current
Accounts payable_ $15, 971. 45
Accrued profit sharing_ 15, 187. 35
Accrued wages, commissions, and interest_ 11, 413. 07
Notes and loans payable (due within 1 year):
Union Bank & Trust Co. — unsecured_ $85, 000. 00
Officer — unsecured.'_ 15, 000. 00
Union Bank & Trust Co. — secured by first trust deed on real property_ 6, 348. 00
Officer and other — secured by second trust deed on real property_ 9, 589. 52 115, 937. 52
Taxes payable:
Payroll, including employees’ withholding_ $10,188. 58
California sales_ 9. 77
Real and personal property_ 6, 437. 00
Federal income_ 36, 761. 21
California franchise_ 1,884.50 $55,281.06
Total current liabilities_ 213, 790. 45
LONG TERM
Notes and loans payable (less amounts included in current liabilities):
Union Bank & Trust Co. — secured by first
trust deed on real property- 13, 665. 80
Officer and others — secured by second trust deed on real property_ 9, 537. 45
Total long-term liabilities_ 23, 203. 25
Total liabilities_ 236, 993. 70
Capital
CAPITAL STOCK
Preferred stock; 6% cumulative; $100.00 par value; 100 shares
issued and outstanding_ $10, 000. 00
Common stock; $1.00 par value; 5,000 shares issued and outstanding — stated value_ 2 100, 000. 00
Total capital stock_ 110, 000. 00
EARNED SURPLUS
Balance, November 1, 1949_ 2 101, 254. 22
Net income for period November 1, 1949 to July 1, 1950_ 28, 914. 16
2 130, 168. 38
Less dividends paid on preferred stock_ 600. 00
Earned surplus, July 1, 1950_ 2 129, 568. 38
Total capital_ 239, 568. 38
Total liabilities and capital_ 476, 562. 08
Weiser #l’s books and income tax returns showed the following:
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Weiser #1 paid no dividends on its common stock. It paid dividends on preferred stock totaling $2,200 as follows:
Xear ended Oct. 31: Amount
1947_$483.34
1948 _ 516.66
1949 _ 600.00
June 30, 1950_ 600.00
It was understood by the parties to this agreement that Foundation would liquidate Weiser #1, would transfer the current assets to a new company formed to operate the business (that new company, Weiser #2, would assume in return, the current and fixed liabilities and would give Foundation a note for the difference), and would lease the remaining assets to that new company. It was understood that Bussell would be the general manager of that new company. Essentially all the management of Weiser #1 was retained to manage Weiser #2.
Following the purchase of the Weiser #1 stock, Foundation caused Weiser #1 to be dissolved and received the assets on dissolution.
As security for the unpaid balance of the purchase price the Weiser #1 sellers received from Foundation: An assignment of Weiser #l’s lease to Weiser #2; an assignment of Weiser #2’s note; a chattel mortgage on the personal property received by Foundation on the sale; a deed of trust on the real property received by Foundation on the sale; and a security assignment of Weiser’s #l’s patents. The patents were reassigned to Foundation on April 13,1953.
On or about June 21, 1950, Weiser #2 was incorporated in California under the name of Bewise Company. It subsequently changed its name to Weiser Company. Russell became president and general manager of Weiser #2 at approximately the same salary per year as he had received in the positions he held in Weiser #1.
The initial capital of Weiser #2 consisted of 100 shares of $1 par value stock for which there was paid into the company $1,000 in cash. No Weiser #2 stock was ever issued to any of the former stockholders of Weiser #1. Russell’s father and brother purchased varying amounts of stock. They never held more than a total of 15 shares. Russell set up the basic criteria as to how many shares of stock could be purchased by employees according to their respective positions in the company. All but 3 of the 70 persons who ever were Weiser #2 stockholders were employees of Weiser #2. The last stock certificate outstanding to a nonemployee was canceled on January 4,1952. All stockholders paid cash for the stock received.
Stockholders terminating their employment with Weiser #2 for any reason transferred their shares back to the company at book value as of the preceding December 31. Subsequent acquisitions of Weiser #2 shares were made from the company at book value on the preceding December 31. Amounts in excess of par value received by Weiser #2 for shares were credited on its books to paid-in surplus.
Stockholders who acquired shares in 1950 paid $10 per share; in 1951, $187.58 per share; in 1952, $598.55 per share; and in 1953, $1,148.15 per share. On June 12,1952, Weiser #2’s board of directors granted Russell and his brother, Frank W. Russell, options to purchase 35 and 5 shares, respectively, of Weiser #2. Russell never exercised his option and, at his request, it was canceled early in 1953. However, on December 28, 1953, his brother purchased 5 shares at $598.55 per share.
On or about July 1, 1950, Weiser # 2 entered into a 5-year lease with Foundation covering the assets received by Foundation on the liquidation of Weiser # 1, except for current assets consisting of cash, receivables, inventory, and prepaid items. Those items ($275,-682.17) were transferred to Weiser # 2 in exchange for the assumption of current and long-term liabilities ($236,993.70) and a 5-year non-interest-bearing promissory note for $38,688.47. The note contained no provision for interest in the event it was not paid in full at maturity.
The lease provided that until Weiser # 2 paid a total rental of $1,100,000, the rent would be 80 percent of net profits but not less than $4,500 per month. Thereafter the rent would be 60 percent of net profits. Weiser # 2 was obliged to maintain the premises in a good state of repair. It could make capital improvements with the cost to be credited upon rental to a maximum of $10,000 in any year, unless Foundation consented in writing to a greater amount. Weiser # 2 was to pay all property taxes and to fully insure the property. In the event of damage, the proceeds of insurance policies were to be used to restore the premises. Weiser #2 could not assign the lease or sublet the property without Foundation’s written consent. At all times during the continuance of the lease a majority of Weiser # 2’s outstanding stock must be held only by such persons as Foundation approved.
By amendment approved November 21,1952, and effective January 1, 1953, the amount of capital expenditures that could be credited against rent without Foundation’s consent was raised to $50,000 per year. By amendment dated May 7, 1953, the minimum rent for 1953 was reduced to $9,300, payable by October 10, 1953. The minimum rent for 1954 was reduced to $9,300 payable by April 10, 1954, and $7,000 payable by October 10,1954.
Early in 1953, Foundation borrowed $400,000 from the Bank of America and used the proceeds to pay the balance of the purchase price owing to Frieda Meltzer, Philip Meltzer, Julius Fligelman, and Molly S. Fligelman. The balance owing to Edward Meltzer was paid with $96,650.10 cash and a 60-day promissory note for $49,347.41 bearing interest at 4% percent. Bussell, the last of the sellers to get paid, was fully paid on December 4, 1953. In consideration of this prepayment of the purchase price, Bussell and the other sellers agreed to reduce the purchase price of the common stock by $50,000.
By amendment dated April 1, 1954, Weiser #2 agreed to prepay rental if necessary in order to provide funds sufficient for Foundation to pay the principal and interest installments on its note to the Bank of America.
The balance due the Bank of America was paid on December 20, 1954. On December 15, 1954, Weiser #2 and Foundation agreed to cancel the lease as of December 31,1954. Foundation concurrently returned Weiser #2’s note for the current assets less liabilities, on which note no payments had been made. Weiser #2 paid Foundation $100,000 in settlement of all rental obligations to Foundation.
During 1953 and 1954, the sellers of Weiser #1 made substantial loans to Weiser #2. Unsecured notes payable (outstanding balances) on the indicated dates were:
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The total rent due Foundation under the lease was as follows:
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The following amounts were spent for the acquisition of new assets subject to the lease and were credited against rents in each of the indicated years:
Credited Tear Spent against rent
1950 (6 mos.)_$15, 899.27 $15, 899.27
1951_ 56,663.46 149,999.76
1952 _ 177, 315. 38 130,000. 00
1953 _ 271, 337.20 168,338.42
1954 __ 44,591.29 101,569.15
565, 806. 60 565, 806. 60
The cash flow to Foundation and then to the sellers was as follows:
Cash received by Foundation:
From Weiser #2, 7-1-50 through 12-31-54_$795,472. 05
From El Toro Management Co., 12-2-54_ 200, 000. 00
Total _ 995,472.05
Cash paid out by Foundation:
To sellers ($990,000 less $50,000 discount)_ 940, 000. 00
Interest on note to Bank of America_ 9,287.50
Interest on note to Edward Meltzer_ 277.50
949, 565. 00
Cash retained by Foundation_ 3 45, 907. 05
Total_ 995,472.05
During the 6 months ended June 30, 1954, Weiser #2 expended certain amounts which it considered represented credits against percentage rental under its lease with Foundation. By letter dated July 28, 1954, a list of such expenditures, totaling $71,096, was transmitted to Foundation and a claim for credit against rent was made.
Foundation replied by letter dated July 30, 1954, objecting that the list contained a substantial number of what appeared to be expenses rather than capital items.
After further correspondence on the subject and in connection with the lease cancellation and settlement of accounts between Weiser #2 and Foundation, the parties agreed that expenditures totaling $44,591.29 should be credited against rent. The $26,504.71 difference between the amount claimed as credit against 1954 rent and the agreed amount was, by journal entry dated October 31, 1954, charged to expense accounts of Weiser #2 other than rent. All of the items represented by this entry, to the extent they had not been used up during the year, were left to Foundation on the cancellation of the lease.
In computing Weiser #2’s taxable income for 1954, respondent determined that the expenditure of $26,504.71 resulted in the acquisition of capital assets subject to depreciation. Accordingly, respondent disallowed deductions in the amount of $26,504.71 and allowed in lieu thereof a depreciation deduction in the amount of $2,650.47, for a net disallowance of $23,854.24.
In computing Weiser #2’s taxable income for 1953 and 1954, respondent disallowed as rental deductions $177,638.42 and $279,412.03, respectively, but allowed a deduction of $50,000 in each year “for the use of the property which amount has been determined to be a reasonable allowance.” On brief, respondent explains that “This sum was approximately the same as the amount of allowable depreciation and is not to be construed as an amount of rent which is reasonable.”
On December 31, 1954, Weiser #2 sold all of its assets (current assets and various listed capital assets) to El Toro Management Co. (hereinafter sometimes referred to as El Toro) for $200,000, represented by a 7-percent demand note, plus the assumption of all liabilities except Federal and State income taxes. Included in the assets sold were machinery and factory equipment with an adjusted basis of $102,892.89 and furniture and office equipment with an adjusted basis of $1,961.12. Thereafter Weiser #2 had no assets except the demand note.
On December 20,1954, Foundation leased to El Toro for a 30-year term the same property and equipment that had been under lease to Weiser #2. The rent was $200,000 for the first 18 months and $100,000 annually thereafter. The initial $200,000 was paid at the time the lease was entered into.
Russell was president of El Toro, which was wholly owned by Southland Water Co., which in turn was wholly owned by Russell. There was no change in management when Weiser #2 canceled its lease with Foundation and El Toro took over the operation of the business.
After December 31, 1954, Weiser #2 collected on the El Toro demand note interest and sufficient principal to satisfy the Federal and State income tax obligations shown on its returns. On April 1, 1955, there remained a balance due of $181,347.85 available on the books for distribution to Weiser #2’s stockholders.
On April 1, 1955, that demand note was exchanged for a series of 7-percent demand notes aggregating $181,347.85, one note for each of the 54 stockholders, in amounts representing those stockholders’ respective shares of that aggregate amount. Thereupon those notes were distributed in complete liquidation and Weiser #2 was wound up and dissolved in accordance with. California law.
On or about December 28,1955, much of the property which Foundation had been leasing to El Toro was sold by Foundation for $400,000 to L. G. Development Co. Russell also owned the latter company. Two hundred and forty thousand dollars of the price was allocated to the real property. Of this amount, $25,000 was allocated to the land and $215,000 to the buildings. The remaining $160,000 of the price was allocated to the equipment.
The lease between El Toro and Foundation was amended on December 28, 1955, to reduce the rent from $200,000 for the first 18 months and $100,000 a year thereafter, to $50,000 a year, and to permit the lessee to arbitrarily cancel the lease upon giving the required notice. The property that remained subject to the lease as amended included the name and goodwill of “Weiser Company” and the patents originally subject to the lease.
El Toro subsequently found that, because of modifications in lock design, it was making very limited use of the leased patents. El Toro’s determination to cancel the lease led to negotiations culminating in El Toro’s purchase from Foundation of the property hitherto leased by it from Foundation.
The fair market value of Weiser #1 at the time of its transfer to Foundation was not more than $500,000.
The amounts paid by Weiser #2 to Foundation as rent pursuant to the terms of the July 1,1950, lease were not in excess of a fair rental as determined on a percentage basis for a 5-year term commencing on the effective date of the lease.
OPINION
Respondent maintains that the payments made by Weiser #2 under its lease from Foundation “were in substance the distribution of business earnings and profits before these earnings and profits were properly taxed.” Petitioner maintains that the amounts paid under the lease were a reasonable rental,4 that the assets were used in Weiser #2’s business, that Weiser #2 had no equity in the assets, and that the payments were no more than what was required to be paid by the lease. Petitioner also maintains that the bona fides of the 1950 transfer are irrelevant to the issues before us.
We agree with respondent’s conclusion.
This Court has had before it a number of cases involving quite similar fact patterns. In Emanuel N. (Manny) Kolkey, 27 T.C. 37 (1956), affd. 254 F. 2d 51 (C.A. 7, 1958), and Clay B. Brown, 37 T.C. 461 (1961), on appeal (C.A. 9, June 25, 1962), we were faced with the issue of tax treatment of the amounts received by the sellers. In Kolkey, we held there was no real sale. In Brown, Anderson Dairy, Inc., 39 T.C. 1027 (1963), and Royal Farms Dairy Co., 40 T.C. 173 (1963), we agreed that the sales were bona fide, giving rise to capital gains for the sellers. In Anderson and Royal Farms we were faced also with the treatment of lessee corporation’s rental payments. Having found the original transfer bona fide in both cases, we allowed deduction of the entire payments in Anderson and a reasonable rental in Boyal Farms. Unlike the four cases above-mentioned, the sellers in this set of transactions are not before us. We are concerned here with the taxes of the lessee corporation.
The picture presented by the evidence is sufficiently involved to warrant a brief summary.
In mid-1950, Weiser #1 was transferred to Foundation for $990,000, later reduced to $940,000, almost double its fair market value at the time.5 Foundation immediately liquidated Weiser #1 and sold or leased its assets to Weiser #2. The rent called for in the lease was a reasonable rent for the property subject to the lease. Four and one-half years later, Weiser #2’s 5-year lease was canceled by mutual consent. Weiser #2 sold the assets it had accumulated to El Toro for $200,000. Foundation leased its assets to El Toro. A year later, Foundation sold its assets, other than patents and the name “Weiser Company,” to L.G. Development Co. for $400,000. The patents and the name continued under lease to El Toro until, at some later date, El Toro purchased those items from Foundation for an amount not disclosed by the record.6 Eussell owned approximately one-third of Weiser #l’s stock and none of Weiser #2’s stock, but was president and general manager of both corporations. Eussell owned, directly or indirectly, all of the stock of El Toro and of L.G. Development Co. During the years which gave rise to the deficiencies here at issue, Russell, his wholly owned corporations, and the other sellers made substantial loans to Weiser #2 and unsecured notes payable to them constituted approximately 80 percent of the outstanding unsecured notes payable at the end of each of Weiser #2’s last 3 calendar years.
At best, the evidence in this case is inconclusive on the question we think to be determinative — whether Weiser #2 had any equity in the property subject to the lease. Putting it another way, the question is whether Weiser #2’s right to use the property in its business derived from the lease or from Weiser #l’s ownership of the property.
The high ratio of sales price to fair market value of the business and Foundation’s action to transfer substantially all of the business assets to Russell’s corporation 5% years after their purchase (note the absence of the compelling business circumstances present in Brown. and Royal Farms) combine to give a vastly different color to a set of facts otherwise largely similar to Brown, Anderson, and Royal Farms. The circumstances of Russell’s prearranged employment by and control over Weiser #2 (despite his not being a stockholder), substantial debts owed by Weiser #2 to Russell, his wholly owned corporations, and the other stockholders,7 the relationship between the rental rates and the amounts Foundation was required to pay the sellers, the substantial earned surplus in Weiser #1, the remarkable tax consequences should the hoped-for tax treatment become actuality, and the absence of evidence regarding negotiations between Foundation and the Weiser #1 sellers, all suggest that a facade was here created. Too, if Weiser #2 capital expenditures were to be credited against rent, we find it difficult to understand how Weiser #2 accumulated machinery and furniture for which it had a basis of over $100,000. These items were transferred to El Toro on December 31, 1954.
We recognize that this record is far less favorable to respondent than that we met in Kolhey. Nevertheless, we conclude that petitioner has failed to sustain his burden of proving that the transactions entered into had the real effect of separating equity in the business assets from use of the business assets. Accordingly, we cannot say that Weiser #2 was required to pay these amounts or any amounts for the use of property in which it has no equity. See Catherine G. Armston, 12 T.C. 539 (1949), affd. 188 F. 2d 531 (C.A. 5, 1951); R.E.L. Finley, 27 T.C. 413 (1956), affd. 255 F. 2d 128 (C.A. 10, 1958).
In light of this determination, petitioner’s persuasive evidence as to a reasonable rental value becomes irrelevant. Catherine G. Armston, supra.
On this issue we hold for respondent.
Weiser #2 is not a petitioner in this proceeding — its deficiency has been drawn in question by a transferee, who is liable as such only up to the value of the assets transferred to him. The transfers determined by respondent to be the bases for transferee liability on account of Weiser #2’s taxes are the 1955 transfers of El Toro’s notes aggregating $181,347.85. If we were to decide in favor of the petitioner the second issue here presented, Weiser #2’s total deficiency would nevertheless exceed the total transferee liability. Consequently, our views on that issue cannot affect the decision to be entered in this case. Under such circumstances, and especially since the parties have not discussed the significance for this issue of the findings requested by respondent on the first issue, we will not essay the task of applying the law to a set of formal events whose reality has not been demonstrated.
Decision will be entered wnder Rule 50.